Archive for the ‘Enough!’ Category

“We owe it to ourselves” is not a solution to the debt crisis

Saturday, October 12th, 2013

One problem with the argument that “we owe the skyrocketing debt to ourselves, so we can limit the impact”: each of those debts represents a promise to pay someone. If we can’t pay as agreed, the impact is severe. For example, if we don’t pay Grandma the $20K/year in Social Security because we can’t, and instead we only pay her $10K, that creates a problem. Alternatively, if we pay her $20K but we’ve driven monetary inflation (and skimped on the COLAs) so that it only buys $10K worth of goods, that still creates a problem. Piling on more promises now won’t change what Grandma’s going to get in real long-term value. The only thing that’s going to save Grandma is if someone else doesn’t get what they were promised… Now we have to repeat the same argument for everyone who was promised something — bottom line, we face a political vicious cycle for years to come.

Adding more to the debt without generating real GDP improvements will only aggravate the vicious cycle. And the data shows that the debt piled on since 2000 or so has done precious little to boost GDP, but represents an enormous number of promises relative to that GDP.

It is true that there are ways to break promises gently, rather than defaulting brutally, but the root problem is that our governments (at all levels) have, in aggregate, made far more promises than can realistically be kept. Politically it makes a big difference how you do it, but in practical terms the outcome is bad no matter what. There will be massive financial haircuts and broken expectations.

Furthermore, a political process, rather than a rational process, is going to decide who gets the worst cuts. This is not a recipe for peace and prosperity in a vicious-cycle political climate.

Even worse, the exaggerated promises are now so blatant that the government is losing credibility. As the promises lose credibility that creates all kinds of political and economic issues, because people here, and worldwide, will modify their behavior if they don’t think we can deliver.

Putting it all together, the problem is here and now, and aside from the immediate crises the risk of something catastrophically bad happening is rising exponentially. Papering the problem over with politically palatable platitudes isn’t a panacea.

There needs to be structural economic reform. The government needs to prioritize wants vs. needs, and we as a nation need to find better ways to direct labor to where it can generate genuine improvements in well-being.

Why we cannot “borrow our way to prosperity”

Friday, December 2nd, 2011

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Only in the past few decades have we brainwashed ourselves into thinking that debt levels of 40-80% of GDP were normal, or that there could be such a thing as a “sustainable deficit”.  Our forebears were demonstrably wiser than most Boomers today, and I believe we’re about to relearn some very painful historical lessons.

Historically the US, like other nations, has sought very hard to stay out of debt, not to add to it with allegedly “sustainable” deficits.  This is illustrated very dramatically with the historical debt charts.  The ones on Wikipedia are particularly accessible:

US Federal Public Debt, 1800-1999

U.S. pubic debt was only 20% of GDP in the early 1800s, and the debt was all but extinguished from 1830-1860.  The Civil War led to a debt burden of 30-40%, which was again extinguished by 1910.  World War I led to another 30% burden, which had been cut to 20% when the Great Depression hit.  Even in the GD, the debt only went up to 40%.  It was only World War 2 which pushed the debt to 110% of GDP, and once again as soon as the war ended we sensibly reduced the debt burden, reaching about 25% of GDP in 1970-1980.

Throughout all of these periods, rising national prosperity has led to a reduction in debt relative to GDP.  We have never been able to “borrow our way to prosperity”!

As the more recent data below shows, since 1980 we have gone on a debt binge.  We are not alone. The European PIIGS “canaries” are screaming that we now live in an unsafe “coal mine”, a debt trap!

US Debt to GDP, 1940-2010

If we don’t get our debts back into balance, we face horrific declines in our national standard of living, because if we don’t pay the debt off, the alternatives are either default or inflation.  And when debt exceeds 100% of GDP, it’s very hard to pay the debt off.

It is time to bring the Debt-to-GDP ratio back down.  Any incremental debt must therefore have a strong impact on GDP growth.  The current Administration and Congress are unable to deliver.  We need to change, if we are to have hope!

However, I do not currently see, nor do I expect to see, public attitudes shifting quickly enough.  Too many think that we can live with “sustainable deficits”, despite the fact that unexpected events happen every year which force debtors into defaults.  Those who try to “sustain” their deficits find, almost inevitably, that sooner or later they are “unexpectedly” bankrupt.

Unfortunately,  our government (and many others) has accumulated a debt burden which is only sustainable if the bond market chooses to sustain it. The bond market has voted otherwise in Europe, and could easily do so here. These governments, rather than being led by their people’s votes, are now at the mercy of their financiers.

The pattern of accumulating more debt than you can pay off (without rolling or refinancing) needs to be tamed. Because if a nation can pay off its debt without depending on bankers, it has far more freedom. As it is, we have fallen into debt serfdom.  I don’t think the American people will want to stay in that position, so I think we are in for a painful awakening, and a return to more historical attitudes towards debt.

Towards an Activist Federal Reserve

Tuesday, February 15th, 2011

I’m still thinking about the Macroblog post last week on Inflation Confusion, which said in part:

“When food prices rise or oil prices rise, people are right to feel in some sense worse off, because they are. And if you are tempted to call that “inflation,” I understand.  But for policy purposes, the distinction between cost of living increases and inflation as a deterioration in the generalized purchasing power of money is critical.”

If that distinction is really so critical, shouldn’t policymakers utilize inflation metrics which explicitly focus on prices other than consumer prices?  If in fact monetary policy wants to focus on something other than ensuring a stable cost of living for the median consumer, why is the public emphasis of policymakers always on the CPI?  Furthermore, why did these policymakers explicitly ignore huge warning flags such as house prices grossly above historical norms (2005-2007), stock market valuations grossly above historical norms (1998-2001), and rapid expansion in money and credit at rates vastly greater than underlying GDP (1982-2008)?  Policymakers who actually cared about monetary inflation should’ve taken away the punch bowl a lot sooner in each instance.  The fact that they did not gives the impression that policymakers were in fact focusing only on the cost of living, ignoring the distinction claimed above. (The other commenters at that post also critiqued this distinction.)

Now, the current inflation angst may also be partly about displaced budget frustrations.  For many groups of people — the unemployed, the underemployed, those re-employed at lower wages, workers facing state and federal wage freezes and endless, inevitable budget cuts, and retirees whose savings/CD income has been crushed by low interest rates while Social Security hasn’t budged, to name a few — there are plenty of reasons to be worried that a deflating income won’t stretch to meet inflating goods prices… especially when debts have to be repaid as well.  So even if the goods prices aren’t inflating much, the income deflation and debt burdens are bad enough.

At the end of the day, however, the real problem in restoring prosperity isn’t about inflation, it’s that we need to restructure both the economy and the government.  We need to get more people producing genuine goods and services, things that really make the nation a better place to live in.  We need to shift workers away from wasteful and even counterproductive activities.  And we need to face the reality that for decades to come, there are going to be more retirees and probably fewer workers to provide for them all.  We need political leaders willing to roll up their sleeves and do some serious work, not simply grandstand for narrow constituencies while exempting themselves from the laws they write for the rest of us.

But, going back to the Inflation Confusion post, we see no evidence of an Activist approach to running the Federal Reserve.  Instead, we see this quote from Atlanta Fed president Dennis Lockhart:

Monetary policy is a blunt instrument without the capacity to systematically influence prices in targeted markets.

The good leader appears to forget that the Federal Reserve, and the government more generally, have all manner of policy tools at their disposal, and some of these are quite sharp.  For example, the Federal Reserve has a tremendous amount of regulatory discretion. Used judiciously, this tool could not only clean up terrible financial institutions, it could “systematically influence prices in targeted markets”. As just one example:  had the Federal Reserve bothered to enforce reasonable lending standards in 2004-2007, they certainly could have “systematically influenced prices in targeted markets”, namely the price of housing in the bubble states, where the most egregiously bad lending took place.  That would have been painful at the time, since no one wants to take away the punch bowl and be blamed for starting a recession.  But such a policy would have prevented the far greater economic pain we have suffered since 2007, including most recently the current inflation problem.

Is there a similar policy tool, which might inflict some economic pain now, but which will prevent far greater pain down the road?  I think there is!  Here are a few policies we could pursue that might hurt now, but would clearly fix things that are out of balance, and should help us later:

First, we should persuade all trading partners to float their exchange rates over the next 2 years. Keeping the dollar misaligned relative to our partners subsidizes their economic development at our expense.  But we cannot afford to subsidize the economic development of the rest of the world for much longer.  Another problem with misaligned exchange rates is that capital flows out of the U.S., while debt remains.  This is not stable and the imbalance needs to be unwound. The current monetary inflation is a step in the right direction, but more needs to be done to increase savings rates and reduce debt-to-money-supply ratios within the U.S.

Second, we need to return to policies which encourage genuinely productive investment and reduce the national addiction to debt marketed as “credit”. At the moment we have a tremendous amount of malinvestment… we have a horrifically unproductive health care sector… we have a financial sector which appears to have been a net drag on the economy for a decade… and we have too much debt relative to tangible value. In fact, to rewrite the classic line by Churchill, it may be that we have reached a point where “never in human history have so many people owed too much, to too few“.Third, we need to bring the national and state government budgets back into balance at a level, relative to GDP, which is consistent with the middle of the historical range. As with any budget pruning exercise, a lot of worthwhile, very reasonable activities will have to be cut back or terminated in order to allow higher-priority, more worthwhile activities to continue.  No major budget category should be spared.

It’s ridiculous that we spend more on defense than the rest of the world combined. And we spend far too much relative to our GDP.  While our soldiers deserve our support when we send them into harm’s way, perhaps we are putting too many in harm’s way, for too little gain?  How ironic would it be if, in Egypt, the protesters achieve more in a month than the entire U.S. military (with trillions of dollars) achieved in a decade in Afghanistan?  But perhaps more importantly, it’s impossible to claim that the entire defense budget is “essential”, so let’s prune the nonessentials. And ridicule anyone who claims that the whole budget is essential to national survival. We will have to accept some consequences, but we have to live within limits again.

It’s even more ridiculous that we spend far more on health care (as a share of GDP) than any other major nation, and yet we get worse outcomes.  Social security needs to be updated for modern life expectancies, but it could include another lower-payout “early option” for those who are forced into medical retirement before the median age. And it could include a phaseout for those who have millions of dollars in assets, hundreds of thousands in income, and clearly don’t need welfare for the elderly.

And finally, a huge swathe of “discretionary” spending is in fact discretionary. Some of it is prudent investment, so it’s unfortunate that Congress is tackling this last part first, because I think it’s the hardest to fix.  There are too many details, and in proportion I think there’s less fat in this part of the budget, so I fear they’ll never get to the health care sector where the bulk of the budget problem lies.

Looking at these 3 policy approaches, what role could the Federal Reserve play?

First, the Fed could stop subsidizing congressional overspending.  As has been said, the national debt isn’t created by the Fed, it’s created by Congress. But Congress wouldn’t be “enabled” to borrow so much, if the Federal Reserve were to stop monetizing it — and especially not if the Fed began to raise interest rates to fight inflation, thus raising the cost to Congress of being in debt.  We should all be horribly ashamed that our great nation has gone from “tax and spend” (which I recall was a really bad thing in the 1980s!) to “borrow and spend”, and now we’ve reached “print and spend” within just 30 years. There’s a natural size for the government, above which bad things happen, and everyone should quit trying to make the government bigger than that size.  We should be debating what fits inside the government’s slice of the pie, and working to grow the pie for everyone — not borrowing to make the government’s slice bigger now at the expense of painful repayments later.

Second, the Federal Reserve could cease tacitly supporting financial fraud, clean up the banking sector, and bring to light as many cases as possible where bankers lent foolishly (or even criminally) and are now broke. Does the Federal Reserve represent the financial industry as a whole, or just a few of the most troubled banks?  If the former, then among the latter, those responsible for the destruction of national and shareholder wealth need to face punishment, not be silently rewarded.  We need to get to the same “never again” mindset that policymakers adopted in the late 1930s, and institutionalize that mindset so the reforms will stick for as long as possible.  The banks which get with the program and clean up their business could be rewarded… and if necessary, the others could be cleaned up through aggressive regulation, if the Fed learned how to lift its little finger.  It’s time to recognize that the system is more than a collection of parts, and indeed that those parts which are incorrigibly broken must be replaced.

Third, the Federal Reserve needs to start lobbying for, and implementing, systemic financial limits. To reduce debt levels relative to GDP, a good start would be to reduce financial leverage limits.  For every borrower there is a lender, and there are currently too many lenders willing to lend too much relative to GDP. At the moment the marginal utility of debt appears to be quite low, particularly in the housing sector, so a reduction in bank leverage might not have as much of an impact as it would if this policy were implemented in the depths of a recession or during a raging credit-starved economic boom.  This could be a golden opportunity, in fact.

The goal must be to get to sustainable economic growth, not “growth at any cost”, and certainly not “the illusion of growth because we neglect to measure inflation adequately”…

Too Much Debt = Too Much Credit

Tuesday, May 25th, 2010

For every debtor, there is a creditor…

I have read a lot of concern about the debt burdens of various nations, including not just government debt but also corporate, private, etc.  Mortgages, car loans, credit cards…  But, for every debtor, there must be a creditor.  Who are all the creditors?  And, with so much unsustainable debt, why is there so much credit?  Why have so many lent so much?

Did we try to sell the “New American Dream” of retirement to too many people?  Is there too much “retirement savings” chasing too few potential borrowers?  Can the economy support so many millions of non-working retiree creditors, as we will soon have?

Or is the distribution of wealth too skewed, with too many owing too much to too few?  Is the debt burden just another tax on the young and productive, transferring wealth to the aged and/or unproductive?

As for the creditors:  Why are they still trying to lend?  What happens when they stop trying?  Which borrowers will be able to pay off their debts, and which will default?


Friday, April 30th, 2010

(1) Verb:  To review something and edit it so it “looks better”… but is no longer factual.

(2) Verb:  When a company’s auditor permits false and fraudulent accounting or reporting.

Labor Force Participation Rate Decline: Expected, and Bad News!

Saturday, January 9th, 2010

I’ve had this unscratchable itch after reading CR’s post about the labor force participation rate decline.  I wanted to know how labor force was defined (in the U.S., it’s everyone 16 and up minus students and a bunch of other exceptions), and whether the declining participation was related to the boomers hitting retirement age (or at least, early-retirement age), as opposed to their kids maybe not being so numerous to make up the difference.  At first glance, not so…  I went over to Wikipedia and found the population pyramid from the 2000 census data, which showed that the generational cohort currently entering the workforce is larger in number than the boomers.  Also, only the leading edge of the boomer population is in the 55-64 age group now, where early retirement might make sense for large numbers.

So I went looking for more information.  The BLS has a very nice economist named Mitra Toossi, who publishes reports every couple of years analyzing the labor force.

The most recent report (PDF alert) came out in November 2009.  Not too far back!  It says, on the first page, “the aging of the labor force will dramatically lower the overall labor force participation rate and the growth of the labor force”.  

I can see this.  The population aged 65+ is getting larger compared to the population aged 16+.  And those over 64 are less likely to be labor force participants.  Similarly, the population aged 55-64 is “booming” right now, and they are also less likely to be labor force participants (e.g. kids thru college and house paid off, so a lot of folks have more choices about whether or not to work…)

But then I ask myself, how much of this is “prediction” and how much is rear-view-mirror economythics?

So I open up the same report but from November 2007 (the previous version).  It says “BLS projects that the labor force participation rate will be 65.5% in 2016.”  That’s a no-growth prediction from the rate prevailing in 2007.  The all-time high was 67.1% in 1997 (or 67.3% in 1999-2000 if you look at their data (possibly revised since 2007)… The participation rate dropped to about 65.5% in 2004 after the dot-com recession.

More from the article:  “projected continuation of the decrease in the labor force participation rate of youths…”

“once the baby boomers exit the last years of the prime age group and enter the 55-and-over group, with participation rates roughly half that of the prime age group, the overall labor force participation rate will decline significantly…”

So it seems that some of this “labor force participation decline” was anticipated prior to the recession, and it’s just demographics.  If the marginal benefit from working is reduced (lower pay, less pleasant work environment), some folks who don’t HAVE to work right now, will wait for a better chance later.

On the other hand, given that the decline in participation was forecast years in advance, shouldn’t policymakers have anticipated a deeper recession that normal just from the workforce demographics?  And perhaps more importantly going forward, since we know the boomers are going to be retiring en masse over the next few years (many with their belts fully tightened by the recession) doesn’t this imply a very weak recovery?  If workforce participation is going to be declining even in good times, the number of willing workers will be suppressed, and might even decline outright, even if total population remains stable to slightly increasing.  (It doesn’t help that the 2000s were a weak decade for population growth, with no sign of improvement, either.)  After all, it’s a mathematical identity that GDP is the product of the size of the workforce, the hours per worker, and the productivity per worker…  Size has some headroom due to layoffs, but not as much as it would if population were booming.  Hours are stagnant and honest-work productivity may be plateauing due to computer technology reaching the saturation point…  All of which points to weak growth in the U.S. for a while, which is not bullish for optimistic P/E multiples in the stock market.  Nor for bond default and/or rollover risks, with a lot of bond issuance predicated on perpetual-growth thinking…

Ruh-Roh!  The economy may have had “enough!”


About the Author and the Blog

Wednesday, December 30th, 2009

“Wisdom Speaker” is a working physical scientist living on the east side of the San Francisco Bay Area.  Wisdom Speaker is between 30 and 50 years old and has a top-tier Ph.D. in his field.  W.S. also has a spouse, 2 children in school, a house with a mortgage, and occasionally a sharp tongue. Like many his age, W.S. manages a portfolio that is “big enough to worry about, but too small to retire on”.

For years, W.S.’s spouse led the family to develop strong saving habits, and over the years they invested using conventional buy-and-hold, dollar-cost-averaging, asset-allocation methods. But in 2005 realized that conventional financial wisdom was no longer adequate to the times. Unfortunately this occurred after buying a new home near the peak of the 2000-2006 housing bubble. Although the home equity could not be saved (for some years, anyway), the housing experience “woke them up” to the speculative/Ponzi financial environment. Time was invested in a more detailed financial education. Abandoning “buy-and-hold” and taking detailed control of the household finances, W.S. went to cash and avoided the 2008 financial panic.

The family finances came out well ahead of their 75/25 allocation benchmark, but now the question arises as to how, exactly, one should invest for sustainable gains going forward.  The classic definition of an “investment operation” is one which, “upon thorough analysis, promises security of principal and a reasonable rate of return” (Benjamin Graham). In short, a sustainable gain!  Now, some of what is often considered speculation is in fact investment (e.g. trading with a high probability of success, but a short time horizon).  On the other hand, the lesson America failed to learn from Enron and the dot-coms is that too often, what is sold as “investment”, is actually speculation – or worse, fraud!  Clearly we cannot trust others to do our “thorough analysis”, guarantee “security of principal”, or deliver a “reasonable rate of return” for us.  How now to invest?  W.S. hopes to share what he has learned about investing for “Sustainable Gains”, and to learn from others with similar interests.

W.S. also believes that Graham missed a critical element of what constitutes an “investment”.  There is an ethical or moral dimension to investing:  one must put one’s time and treasure to good use, and be able to sleep well knowing what the “investees” are doing with one’s treasure.  An “Investment Operation” must be one which “upon thorough analysis, promises security of principal and a reasonable rate of return while putting capital to a use one can agree with.  Wave upon wave of financial scandal shows that this issue is far wider than “socially responsible” index fund sellers would have one believe.  Even the simple act of buying a CD, or a T-bill, has an ethical component. So “Ethical Investing” will be another theme covered here.

Another issue that comes up almost immediately is that the fiat money we use today isn’t wealth, or capital, or anything really.  It’s a bunch of carefully arranged electrons (or paper, or metal disks, but always of minimal intrinsic value) which record the exchange of debts.  But debt is not capital!  Capital is the surplus of production over consumption.  Debt is an agreement to deliver future production in exchange for current production.  True wealth might be better defined as accumulated resources to meet human needs.  W.S. has only dabbled in this area so far, but understanding the “Nature of Wealth” is vital to having “Sustainable Gains” in this area, and will be another theme here.

Finally, there is the eternal issue of time. One can often earn more money, or save it, but one’s time is far more strictly limited. Time spends itself whether one likes it or not, one never knows how much one has left, and it’s darned hard to get more!  But perhaps careful “Time Investing” (not just time management), particularly in conjunction with financial investing, can lead to sustainable gains (measured in terms of any personal goal) as well?  At any rate, between work, family, and personal needs, W.S. feels time-poor, and struggles to fit all the joys and sorrows of life into the 24-hour day, so “Time Investing” will be another theme here.

Hope you enjoy the site!  I look forward to seeing where this goes…