Category: debt

The Weathervane of Growth

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April 10, 2016

CWPI (Constant Weighted Purchasing Index)

March’s survey of Purchasing Managers showed a big upsurge in new orders for the manufacturing (MFR) sector. Export orders were up 5.5% in both the manufacturing and services (SVC) sectors and overall output increased 2% or more.  After contracting for several months, MFR employment may have found a bottom.  The total of new orders and employment is still growing but below five year averages.

The broader CWPI is still expanding but at a slightly slower pace for the past seven months.  The cyclic pattern of declining growth followed by a renewal of activity has changed. While there is no cause to make any strategic changes to allocation, it does bear watching in the months ahead.

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IRA Standard of Care

Financial agents – investment advisors, stock brokers and insurance agents – have had different standards of care when they deal with their clients.  The first and highest standard is fiduciary: the agent should operate with the best interests of the client in mind.  Registered Investment Advisors (RIA) are registered with the SEC and follow this strict standard. The second and more lax standard is suitability: the agent should not sell the client anything that is not suitable for the client based on what the client has told them about their circumstances.  Here’s a short paper on the difference between the two standards.

This week the Obama administration issued new guidelines for agents servicing IRA account holders, requiring agents to maintain the higher fiduciary standard starting in 2017.  This requirement was left out of the Dodd-Frank finance reform bill because many in the investment industry lobbied against it.  Here is the first rule proposal in February.

Opponents will criticize the Obama administration for this “new” set of regulations but this policy has been recommended by some in the industry, on both sides of the political aisle, for at least 25 years.  During the 1980s Congress made several changes that made IRA accounts available to a wide swath of savers, most of whom were unfamiliar with the marketplace of financial products now available to them.

Some in the insurance and investment industries fought against the imposition of a stricter fudiciary standard because it would require more training and would likely reduce the sales commissions of agents.  The growing volume of tax deferred employee retirement plans has generated a steady stream of fees for those in the financial industry.

Keep in mind that the new policy only applies to retirement accounts.

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Debt

Banks are in the business of loaning money, meaning that they must loan money to stay in business.  Most of the time some part of the economy wants to borrow money.  Borrowers come in three types:  Household, Corporate and Government.  If households cut back on their borrowing, corporations may increase theirs.

A historical look at total debt as a percent of GDP shows several trends.  Keep in mind the leveling of debt since the financial crisis.  We’ll come back to that later.

In the thirty years following World War 2, debt levels remained fairly consistent with the pace of economic activity.  The three types of borrowers offset each other.  Households and corporations increased their borrowing while government, particularly the Federal government, paid down the high debt incurred to fight WW2.

In 1980 the Reagan administration and a Democratic House began running big deficits, contributing to a spike in the the total level of debt.  By 1993, when President Clinton took office, Federal and State Debt as a percent of GDP was about the same as it was at the end of WW2.

A combination of higher tax rates and cost cutting by a Republican House elected in 1994 led to a reduction in government spending as household and corporations increased their spending.  Total debt levels flattened during the late 1990s.

Following the 9/11 tragedy and a recession, government debt levels increased but now there was no offset in household borrowing as mortgage debt climbed.  Helping to curb the pronounced rise in total debt levels, a Democratic House at odds with a Republican president dampened the growth of government borrowing in the two years before the financial crisis.

Arguably the most severe crisis in eighty years, the financial crisis caused both households and corporations to cut back on their borrowing.  Offsetting this negative borrowing, the Federal government assumed an often overlooked role – the Borrower of Last Resort.  We are accustomed to the role of the Federal Reserve Bank as the Lender of Last Resort, but we might not be aware that some part of the economy has to be the Borrower.  That role can only be filled by the Federal government because the states and local governments are prohibited from running budget deficits.

Look again at the second chart showing the huge spike in government borrowing following the financial crisis.  Now remember the leveling off of total debt shown in the first graph.  The Federal government has increased its debt level by more than $10 trillion.  Almost $4 trillion of that has come from the lender of last resort, the Fed, but the rest of that borrowing has offset a significant deleveraging by corporations and households.  Had the Federal government not borrowed as much as it did, many banks would have experienced significant declines in profits to the point of going out of business.

There is a potential bombshell waiting in the $2 trillion in corporate profits that businesses have parked overseas to delay taxes on the income.  If Congress and the President were to lower tax rates so that corporations could “repratriate” these dollars, two things would happen: 1) corporations could lower their debt levels, using the cash to pay back the rolling short term loans they use to fund daily operations; and 2) the Federal government would lower its debt levels as the corporations paid taxes on those repatriated profits.

Great.  Lower debt is good, right?  Unless households were to step up their borrowing, total debt could fall significantly, causing another banking crisis.  Although politicians on both sides like to talk about bringing profits home, such a move will have to be done slowly so that the economy and the banking system can adjust in slow increments.

Partisans cheer when candidates express strong sentiments in rousing words, but cold caution must quench hot spirits. We can only trust that candidates for public office will temper their campaign rhetoric with prudence if entrusted with the office.

Rebound

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October 25, 2015

Last week we looked at two components of GDP as simple money flows.  In an attempt to understand the severe economic under-performance during the 1930s Depression, John Maynard Keynes proposed a General Theory that studied the influences of monetary policy on the business cycle (History of macoeconomics).  In his study of money flows, Keynes had a fundamental but counterintuitive insight into an aspect of savings that is still debated by economists and policymakers.

Families curtail their spending, or current consumption, for a variety of reasons.  One group of reasons is planned future spending; today’s consumption is shifted into the future.  Saving for college, a new home, a new car, are just some examples of this kind of delayed spending.  The marketplace can not read minds.  All it knows is that a family has cut back their spending.  In “normal” times the number of families delaying spending balances out with those who have delayed spending in the past but are now spending their savings.  However, sometimes people spend far more than they save or save far more than they spend, producing an imbalance in the economy.

When too many people are saving, sales decline and inventories build till sellers and producers notice the lack of demand. To make up for the lack of sales income, businesses go to their bank and withdraw the extra money that families deposited in their savings accounts.  Note that there is no net savings under these circumstances.  Businesses withdraw their savings while families deposit their savings.  After a period of reduced sales, businesses begin laying off employees and ordering fewer goods to balance their inventories to the now reduced sales.  Now those laid off employees withdraw their savings to make up for the lost income and businesses replace their savings by selling inventory without ordering replacement goods.  As resources begin strained, families increasingly tap the several social insurance programs of state and federal governments which act as a communal savings bank,   Having reduced their employees, businesses contribute less to government coffers for social insurance programs.  Governments run deficits.  To fund its growing debt, the Federal government sells its very low risk debt to banks who can buy this AAA debt with few cash reserves, according to the rules set up by the Federal Reserve.  Money is being pumped into the economy.

As the economy continues to weaken, loans and bonds come under pressure.  The value of less credit worthy debt instruments weakens.  On the other side of the ledger are those assets which are claims to future profits – primarily stocks.  Anticipating lower profit growth, the prices of stocks fall.  Liquidity and concern for asset preservation rise as these other assets fall.  Gold and fiat currencies may rise or fall in value depending on the perception of their liquidity.

Until Keynes first proposed the idea of persistent imbalances in an economy, it was thought that imbalances were temporary.  Government intervention was not needed.  A capitalist economy would naturally generate counterbalancing motivations that would auto-correct the economic disparities and eventually reach an equilibrium.  Economists now debate how much government intervention. Few argue anymore for no intervention.  What we take for granted now was at one time a radical idea.

While some economists and policymakers continue to focus on the sovereign debt amount of the U.S. and other developed economies, the money flow from the store of debt, and investor confidence in that flow, is probably more important than the debt itself.  As long as investors trust a country’s ability to service its debt, they will continue to loan the country money at a reasonable interest rate.  While the idea of money flow was not new in the 1930s, Keynes was the first to propose that the aggregate of these flows could have an effect on real economic activity.

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Stock market

A very good week for the market, up 2% for the week and over 8% for October.  A surprising earnings report from Microsoft lifted the stock -finally – above its year 2000 price.  China announced a lower interest rate to spur economic activity.  ECB chair Mario Draghi announced more QE to fight deflation in the Eurozone. Moderating home prices and low mortgage rate have boosted existing home sales.

The large cap market, the SP500, is in a re-evaluation phase.  The 10 month average, about 220 days of trading activity, peaked in July at 2067 and if it can hold onto this month’s gains, that average may climb above 2050 at month’s end.

The 10 month relative strength of the SP500 has declined to near zero.  Long term bonds (VBLTX) are slightly below zero, meaning that investors are not committing money to either asset class.  The last time there was a similar situation was in October 2000, as the market faltered after the dot-com run-up.  In the months following, investors swung toward bonds, sending stocks down a third over the next two years.  This time is different, of course, but we will be watching to see if investors indicate a commitment to one asset class or the other in the coming months.

The Future is Past

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June 21, 2015

Returning to our Heaven On Earth scenario: why can’t the government just print up a bunch of money and give it to people?  Centuries of historical data shows that inflation inevitably results when governments do this.  However, the Federal Reserve has pumped in almost $4 trillion dollars in the past seven years and no inflation has resulted.  We saw that the Federal Reserve has been offsetting the lack of private spending, particularly the lack of savings that is devoted to investment.

Whatever we don’t consume is called savings.  Savings can be put to two different uses:

1) Invest in Yesterday’s spending, or debt.  This can be either our own debt or the debt of others.  We might pay down a credit card balance we owe or a mortgage.  We might buy a corporate or government bond.  Savings, checking and money market accounts are an investment in debt.

Household and business non-financial credit market debt is more than $21 trillion.  Included in that amount is $9.3 trillion in home mortgages.  Most of us who buy a home don’t think of it as “yesterday” spending.  To us it is an investment in our future.  However, the purchase of a home consists of two components:
1) the transfer of the replacement cost of the dwelling – yesterday’s spending adjusted for the change in price of the labor and material to build the home.
2) Someone else’s profit, and this is the key component of these two types of spending, yesterday and tomorrow.  Whether buying a new home or existing home, we are buying the costs and profit of the builder or previous owner.

Below is a chart of household and business non-financial credit market debt as a percentage of GDP.  From 1980 through the end of 1994, the SP500 index quadrupled from 110 to 470, an annual gain of a bit over 9.5% per year.   In the mid-1990s, household and business debt started a steep climb to 140% of GDP by 2007 and this probably pulled in more savings to service that debt. In the next 15 years, the SP500 grew by only 233%.

But wait!  That’s not all! – as the late night commercials remind us.  Governments at all levels borrow savings from private households and businesses.  The current total is about $16 trillion.

Adding the $16 trillion government debt to the non-fianncial debt of the private sector totals $37 trillion of yesterday’s spending that needs to be fed with today’s savings..

2) The other option for savings is to invest in equities – Tomorrow spending – and the profits generated from that spending.  We might buy stocks, real estate or some other physical asset which will generate some production, a profit, or a capital gain from an appreciation in the value of that asset.  The World Bank estimated the total market capitalization in the U.S. in 2012 at $18.7 trillion.  Add on 33% or so since then to get an updated total of about $25 trillion.  We could debate the valuation but it is clear that debt – investment in yesterday’s spending – is clearly winning the race against investment in the profits of tomorrow’s spending.

If future growth looks modest it is because we are still in a defensive posture – weight on our back foot, so to speak. Low interest rates encourage investment in Tomorrow spending and the Federal Reserve has kept rates low to encourage us to lean in, to shift the weight, the energy of our investment from the past to the future.

Transfer Payments

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February 16th, 2014

In this election year, as in 2012, the subject of transfer payments will rear its ugly head with greater frequency.  In the mouths and minds of some politicians, “transfer payments” is synonymous with “welfare.”  Don’t be confused – it is not.  As this aspect of the economy grows, politicians in Washington and the states get an increasing say in who wins and who loses.  Below is a graph of transfer payments as a percent of the economy.  I have excluded Social Security and Unemployment because both of those programs have specific taxes that are supposed to fund the programs.

Transfer payments, as treated in the National Income and Product Accounts (see here for a succinct 2 page overview), are an accounting device that the Bureau of Economic Analysis (BEA) uses to separate transfers of money this year for which no goods or services were purchased this year.  The BEA does this because they want to aggregate the income and production of the current year. Because that category includes unemployment compensation, housing and food subsidies, some people mistakenly believe that the category includes only welfare programs.   Here’s a list of payments that the BEA includes:

Current transfer receipts from government, which are called government social benefits in the NIPAs, primarily consist of payments that are received by households from social insurance funds and government programs. These funds and programs include social security, hospital insurance, unemployment insurance, railroad retirement, work­ers’ compensation, food stamps, medical care, family assistance, and education assistance. Current transfer receipts from business consist of liability payments for personal injury that are received by households, net in­surance settlements that are received by households, and charitable contributions that are received by NPISHs.

That settlement you received from your neighbor’s insurance company when his tree fell on your house is a transfer payment.  Didn’t know you were on welfare, did you?  Some politicians then cite data produced by the BEA to make an argument the government needs to curtail welfare programs.  Receiving a Social Security check after paying Social Security taxes for forty plus years?  You’re on welfare.  A payment to a farmer to not grow a bushel of wheat – an agricultural subsidy – is not a transfer payment.  A payment to a worker to not produce an hour of labor – unemployment insurance – is a transfer payment.  Got that?  While there are valid accounting reasons to treat a farmer’s subsidy check and a worker’s unemployment check differently, some politicians prey on the ignorance of that accounting difference to push an ideological agenda.

That agenda is based on a valid question: should a government be in the business of providing selective welfare; that is, to only a small subset of the population?  Some say yes, some say no.  If the answer is no, does that include relief for the victims of Hurricane Katrina, for example?  Even those who do say no would agree that emergencies of that nature warrant an exception to a policy of no directed subsidies or welfare payments.  It was in the middle of a national emergency, the Great Depression, that Social Security and unemployment compensation were enacted.  Government subsidies for banks began at this time as well.  Agricultural subsidies began in response to an earlier emergency – a sharp depression a few years after the end of World War 1.  Health care subsidies were enacted during the emergency of World War 2.  The pattern repeats; a subsidy starts as a response to an immediate and ongoing emergency but soon becomes a permanent fixture of government policy.

Tea Party purists think that the Constitutional role of the federal government is to tax and distribute taxes equally among the citizens.  Before the 16th Amendment was passed a hundred years ago, the taxing authority of the Federal Government was narrowly restricted.  However, the Federal Government has always been selective in distributing  the resources at its disposal.  Land, forests, mining and water rights were either given or sold for pennies on the dollar to a select few businesses or individuals. (American Canopy is an entertaining and informative read of the distribution and use of resources in the U.S.) By 1913, the Federal Government had dispensed with so much land, trees and water that it had little to parlay with – except money, which it didn’t have enough of.  Solution: the income tax.

In principle, I agree with the Tea Party, that the government at the Federal and state level should not play God.  How likely is it that the voters of this country will overturn two centuries of precedent and end transfers?  When I was in eighth grade, I imagined that adults would have more rational and informed discussions.  Sadly, our political conversation is stuck at an eighth grade level on too many issues.

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While most of us pay attention to the unemployment rate, there is another statistic – the separation rate – that measures how many people are unemployed at any one time.  The unemployment can be voluntary or involuntary, and last for a week, a month or a year.  Not surprisingly, younger workers change jobs more frequently and thus have a higher separation rate than older workers.  In the past decade, almost 4% of younger male workers 16 – 24 become unemployed in any one month.  Put another way, in a two year period, all workers in this age group will change jobs.  For prime age workers 25 – 54, the percentage was 1.5%.  In a 2012 publication, Shigeru Fujita, Senior Economist at the Philadelphia Federal Reserve Bank, examined historical demographic trends in the separation rate.

On page five of this paper, Mr. Fujita presents what is called a “labor-matching” model that attempts to explain changes in unemployment and wages, primarily from the employer’s point of view. Central elements of this model, familiar to many business owners, include uncertainty of future demand and the costs of finding and training a new worker.  Mr. Fujita examines an aspect that is not included in this model – the degree of uncertainty that the worker, not the employer, faces.  In the JOLTS report, the BLS attempts to measure the number of employees who voluntarily leave their jobs.  These Quits indicate the confidence among workers in finding another job.  The JOLTS report released this week shows an increasing level of confidence but one which has only recently surpassed the lows of the recession in the early 2000s.

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Labor Participation
In a more recent paper, Mr. Fujita examines the causes of the decline in the labor participation rate, or the number of people working or looking for work as a percentage of the people who are old enough to work.  As people get older, fewer of them work; the aging of the labor force has long been thought to be the main cause of the decline.  That’s the easy part.  The question is how much does demographics contribute to the decline? What Mr. Fujita has done is the hard work – mining the micro data in the Census Bureau’s Current Population Survey.  He found that 65% of the decline of the past twelve years was due to retirement and disability.  More importantly, he discovered that in the past two years, all of the decline is due to retirement.  The first members of the Boomer generation turned 65 in 2011 so this might come as no surprise.  The surprise is the degree of the effect;  this largest  generational segment of the population dominates the labor force characteristics. During the past two years, discouraged workers and disability claims contributed little or nothing to the decline in the participation rate.  Another significant finding is that relatively few people who retire return to the work force.

In this election year, we will be bombarded with political BS: Obamacare or Obama’s policies are to blame for the weak labor market; the anti-worker attitude of Republicans in Congress are responsible.  Politicians play a shell game with facts, using the same techniques that cons employ to pluck a few dollars from the pockets of tourists in New York City’s Times Square.  Few politicians will state the facts because there is no credit to be taken, no opposing party to blame.  Workers are simply getting older.

In 2011, MIT economist David Autor published a study on the growth of disabiliity claims during the past two decades and the accelerating growth of these claims during this Great Recession.  Mr. Fujita’s analysis reveals an ironic twist – at the same time that Mr. Autor published this study, the growth in disability claims flattened.  The ghost of Rod Serling, the creator and host of the Twilight Zone TV series, may be ready to come on camera and deliver his ironic prologue.

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Lower automobile sales accounted for January’s .4% decline in retail sales. Given the continuing severity of the weather in the eastern half of the U.S., it is remarkable that retail sales excluding autos did not decline.  In the fifth report to come in below even the lowest of estimates, industrial production posted negative growth in January.  By the time the Federal Reserve meets in mid-March, the clarity of the economy’s strength will be less obscured by the severe winter weather.

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A reader sent me a link to short article on the national debt.  For those of you who need a refresher, the author includes a number of links to common topics and maintains a fairly neutral stance.  I still hear Congresspeople misusing the words “debt,” the accumulation of the deficits of past years, and “deficit,” the current year’s shortfall or the difference between revenues collected and money spent.  Could we have a competency test for all people who wish to serve in Congress?

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The House and Senate both passed legislation to raise the debt ceiling this week.  The stock market continued to climb from the valley it fell into two weeks ago and has regained all of the ground it lost since the third week of January.

Tax Cuts and Us

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Until the end of the year, we will hear and read a lot about the expiration of the Bush tax cuts.  For those who want to extend all the Bush tax cuts, you will hear stuff like this: “The non-partisan Congressional Budget Office (CBO) has predicted a recession in 2013 if the Bush tax cuts are allowed to expire.”  As with most political claims, this is slightly true.  Remember that politicians are little more than magicians practicing a logical sleight of hand in order to convince you of some claim.  What the CBO actually said in a May 2012 report was “if the fiscal policies currently in place are continued in coming years, the revenues collected by the federal government will fall far short of federal spending, putting the budget on an unsustainable path.” (Source)  In the next sentence, the CBO cautions “On the other hand, immediate spending cuts or tax increases would represent an added drag on the weak economic expansion.”  Is there room for compromise in this dysfunctional Congress?

While many politicians are aware of the difficult trade-offs, they dare not mention that to voters, who, they presume, are stupid.  On Fox News, MSNBC and other media, we will continue to hear simplified versions of a complex debate because – well, we’re just too dumb to pay attention to complex arguments that involve math.  If you are like most voters, many politicians reason, you have already stopped reading this because it has too many adjectives, verbs and commas.

The CBO does its best to estimate the long term impact on the federal budget and economic activity as a result of a paticular policy. To illustrate just how difficult this task is, let’s look at a July 2007 letter from the CBO to the Congressional Budget Committee projecting “For 2008 through 2011, CBO’s baseline budget projections show deficits of $113 billion, $134 billion, $157 billion, and $35 billion, respectively.”  Deficits were actually $458 billion, $1,413 billion, $1,293 billion and $1,300 billion.  Actual deficits were almost ten times what the CBO projected!  Knowing that ten year projections are almost pure fantasy, Congress continues this practice.  Each party uses the CBO estimates to support or attack a particular policy. 

The CBO projects a recession in 2013 if ALL tax policies were allowed to expire, including the Bush tax cuts.  “These include the Bush tax cuts, the alternative minimum tax (AMT) patch, the temporary payroll tax cut, and other temporary expiring provisions, many of which are commonly referred to as “tax extenders.” (Source)   The Congressional Joint Committee On Taxation (JCT) has a complete seven page (!!!) list of “temporary” tax cuts that are due to expire at the end of this year. 

What is the bottom line for the individual taxpayer if ALL the fiscal policies, including the Bush tax cuts, were allowed to expire?  In a 2012 report by the Congressional Research Service, they cite estimates by the Tax Policy Center that, in 2010, “the Bush tax cuts resulted in the lowest 20% of taxpayers seeing their income rise by 0.5%, while the top 20% saw their after-tax incomes rise by 4.9% and the top 1% saw their income rise by 6.6%”. (Source).  What will be the impact on most taxpayers if the Bush tax cuts expire?  Some but certainly not as dire as some politicans predict.  But that is not how politicians get votes.  To get us to the polls, politicians and their pundit lackeys who appear on TV and radio talk shows try to breed fear in voters.  The media is happy to oblige; fear makes for better ratings.

Based on estimates from the Tax Policy Center and the IRS, below is a comparison of what 2012 tax rates would be with and without the effect of what are commonly called the Bush tax cuts. (Source) This is just a “what if” scenario since the Bush tax cuts are still in effect for the 2012 tax year, but it does give us a good guesstimate of the effect of letting the tax cuts expire.

Using that data, I have projected what the effective tax rate on adjusted gross income would be for 2013 if the tax cuts are allowed to lapse.  It includes the tax brackets that includes the majority of tax payers.

The couple making $40K in adjusted gross income would pay $645 more in Federal income taxes.  The couple making $80K would pay $2225 more; the couple making $120K would pay $6669 more.  Those in the top 20% would see tax increases of $16K and more.  It is understandable that taxpayers with income in the millions would want to keep their gravy train going.  They need government mostly to protect their property rights; everything else, all the regulations and social support programs, is just wasted tax money.  Most of the rest of us don’t like paying taxes either.  We could step up to the plate and pay down some of the debt that we have run up; or maybe we should just let our kids figure it out.

Taxes – Not In My Backyard!

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There is a lot of discussion about the renewal of the Bush tax cuts enacted in 2003.  This past week the Senate passed a bill to renew the tax rates for all those with less than $250K taxable (not gross) income – $200K if filing single.  The measure is unlikely to pass the Republican dominated House which wants the cuts extended for all taxpayers, including the wealthiest.

For many of us, the tax rate cuts started in 1987, not 2003, after the Tax Reform Act of 1986.  Below is a 100 year chart of historical tax rates for a married couple with two children with a gross income of $66,000 in inflation adjusted dollars (thanks to the Tax Foundation)  After the standard deduction and exemption allowances, this is approximately $40,000 in taxable income.  This is middle class income, slightly below the median for married couples.

As you can see, we have enjoyed comparatively low income tax rates for the past twenty-five years.  For the past ten years, we have been conducting two wars without paying for them.  The rich are not paying.  The middle are not paying.  When our parents and grandparents ran up huge debts fighting WW2 and recovering from the 1930s Depression, they increased taxes on the middle class and the rich to pay down the debt.  This generation, the children and grandchildren of that WW2 generation, decided they had a better idea – charge it!  After all, we have expenses that previous generations didn’t have – like our cable TV bill and internet bill and cell phone bill.  The WW2 generation also had bills that previous generations didn’t have – car, electrical and phone bills for services and products that their parents and grandparents didn’t have.  Did they use that as an excuse to reduce their taxes?  No.

We continue to argue over how much government services and programs we want.  We argue over how much to spend on defense.  We argue whether we want somebody (but not us, God forbid) to pay more in taxes.  While we argue, the Federal debt continues to climb.

Federal Debt By President

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There are several “factoids” running around the internet that Obama has run up more debt than all past presidents combined.  According to the Treasury Dept that claim is not true but the run up in debt has been outstanding since Obama took office in January 2009.  When Bush left office, the total debt was 10 trillion.  It was 15.5 trillion at the end of February 2012.

As the graph below illustrates, we have been borrowing lots of money for the past thirty years.

Then I wondered:  after adjusting for inflation,what is the annual increase in federal debt for each President?  Adjusting for inflation allows us to compare apples to apples.  The Federal Reserve supplies us with both data on the debt and a deflator to adjust current dollars to real 2005 dollars.  Obama’s average is computed up to Dec 2011.

Remember, these are inflation adjusted dollars.  The big spending started with Reagan but both parties have become very practiced at developing good explanations for why we have to spend a lot of money. 

Like many, I have thought that the severe downturn has dramatically reduced federal receipts.  As a percentage of GDP, it has – receipts have been coming in at 15 – 16% of GDP, when the long term average is 18 – 19%.  But … bigger government spending has inflated GDP about 10%. What have receipts been over the past decade?  During the Bush years, the Federal government pulled in an average of 2.13 trillion dollars a year in 2005 real dollars.  During the Obama years, the average is 2.0 trillion.  The drop in receipts has been relatively slight.  80 – 85% of the responsibility for the big run up in the debt is spending.

Last week, Senator McCain acknowledged the true cost of defense spending at $1 trillion and it is defense spending that led the Bush administration to run up a $5 trillion dollar deficit in eight years despite four years of robust growth, fueled largely by a real estate bubble.  The bubble burst and the severe fallout from that debacle has prompted even more defense spending – social support programs to defend Americans against lost jobs, lost health insurance and lost home equity.

“Too much spending!” Republicans cry but do not want to cut back on defense spending or agricultural subsidies in rural areas where their support is strongest.  Income tax subsidies are another form of spending, one highlighted by the Simpson-Bowles commission.  In this broken, contentious political climate, neither side of the political aisle can agree on any meaningful reductions in tax subsidies because the voters who put them there can not agree. 

Since neither side can agree on spending cuts, there is only one other solution – higher revenues.  Yes, that’s the punch line.  Funny, isn’t it?  If neither side can agree on spending cuts, they surely can’t agree on where to get higher revenues.

Bleeding heart Democrats cry out for tax justice for the poor while Republicans stand strong for tax justice for the rich.  The Tax Policy Center can find no studies showing that taxes on the rich influence job creation, either positively or negatively.  To conservatives who believe that they do, facts are unimportant.  Conservatives are like football fans – all you gotta do is believe.

Democrats suffer from the same “fact blindness,” disregarding several studies showing that long term unemployment subsidies undercut the confidence and skills of the unemployed, making them less employable the longer they are out of work.  Car and home buying subsidies of the past few years have done little but push forward the buying of cars and homes.  When the subsidy programs expired, so too did the buying of cars and homes.  Despite the demonstrated ineffectiveness of these social subsidies, Democrats continue to propound that they are for the working person.  Another month and another proposal of yet another program for the “vulnerable.”

The moderates of either party have either been voted out of office or left in frustration.  Olympia Snowe, a Republican Senator from Maine, is the latest to quit the carnival show of Congress.  She wrote, “I do find it frustrating, however, that an atmosphere of polarization and ‘my way or the highway’ ideologies has become pervasive in campaigns and in our governing institutions.”

We can not agree on spending cuts and we have two large spending items looming in the near future which will only exacerbate the debate.  The Boomers are just beginning to collect on their deferred annuity program – we know it as Social Security.  They are one kind of bondholder expecting the government to make good on the promises it has made.  The really big bond leviathan is that world wide group of holders of U.S. debt – over $10 trillion in treasury bonds and notes.   We have benefited from the “flight to safety” over the past few years as investors around the globe have bought U.S. debt at ridiculously low rates.  Investors will want a more normal return for their money eventually and when that happens, the annual interest expense on our debt will rise.  These two groups of bondholders with demands and expectations will light the fuse.

If you think the past decade has been contentious, you ain’t seen nothin’ yet.

Debt Comparison

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As this past quarter began in July, Greece’s debt was a concern but the countries of the EU were in negotiations to work it out.  QE2, the Federal Reserve’s program of bond buying, had just ended, prompting some to worry about a negative effect on the economy as that stimulus.   Early second quarter earnings reports in mid July were strong and the balance sheets of major companies showed that they had accumulated ample reserves of cash to weather any small downturns. Manufacturing was slumping a bit but that was attributed to supply chain disruptions from the March Japanese tsunami and was expected to grow again in the third quarter.  The moribund housing sector and stubbornly high unemployment remained a concern but the stock market is a pricing of future company earnings.  The companies in the S&P500 which have any foreign earnings receive the majority of their earnings from countries other than the U.S.  This global sales and revenue base makes these large U.S. companies less vulnerable to economic weakness in any one country.

Japan’s recovery in GDP in the second quarter surprised many, testifying to the resilience and industry of the Japanese people and Japanese industry.  China, Indonesia, India and Brazil were showing strong growth, perhaps a bit too much growth, as inflation in those countries and regions was prompting central banks to take steps to cool that growth.  Growth in the EU countries was a concern but German manufacturing was holding steady.

Toward the end of July, the EU reached an agreement to provide financing to Greece and, in the U.S., President Obama and House Speaker Boehner supposedly reached an agreement – dubbed the “grand bargain – for debt reduction.  On July 22nd, the S&P500 closed near 1350.  At the end of September, the S&P500 stood at 1130, a drop of 17%.  What happened?

The weekend after the “grand bargain” came news that there was no bargain.  During August, the American people stared in befuddlement at a dark comedy in which lawmakers and the President brought the country to the brink of default, prompting one rating agency to downgrade U.S. government debt. 

Computing the Gross Domestic Product (GDP) of an entire nation is a complex affair, one that requires an early estimate and two revisions. In the late days of July, the Bureau of Economic Analysis (BEA) revised the GDP growth for the 1st quarter of 2011 (ending in March) from a weak 1.9%  to an almost recessionary .4%.  This was a large revision and shook the markets, swiftly dropping the S&P500 index to about 1100. 

Germany reported strong manufacturing data for July but China showed a stalled growth in their manufacturing, adding to worries about a global slowdown.  Since early August, the market has behaved like a small boat in the Mid Atlantic, rising and falling dramatically with both news and worries about Greece’s debt as well as the debt of Italy, Spain, Ireland and Portugal.  Investors have fled from the stocks of banks holding the debt of those countries as well as larger banks which might have indirect exposure to that debt.  An index of large banks has fallen 28% since April of this year.  Many developed countries are wallowing in debt.  A slowdown in growth leads to less tax revenue to pay down that debt.  Worries of a global recession or a severe slowing of growth provoke fear of bank defaults, government defaults, and growing pressure on small and medium sized businesses, who are least able to withstand downturns in an economy.

Fractious meetings among EU member countries, among the various branches of the U.S. government leads many to regard politicians on both sides of Atlantic as dysfunctional, unable to resolve their ideological differences to make any functional policy decisions.  Investors worry about the viability and future of the euro currency, fleeing the Euro and parking their money in U.S. Treasuries, causing the price of Treasuries to rise and the yield (interest) on those bonds to fall to historically low levels.

In September, an HSBC index of small and medium Chinese manufacturers reported a slight contraction.  German manufacturing declined from strong numbers in July to a neutral stall speed in September, confirming fears of a global slowdown. 

In the U.S. and Eurozone, governments at all levels have instituted austerity measures to cope with declining tax revenues.  Government employee layoffs increase the demand for social support programs, prompt civilians to curb their spending, resulting in less tax revenues for government, prompting more government cuts, ad nauseum.  Cautious companies hoard what cash they have, reduce their investments in anticipation of further slowdowns in consumer demand.

Weighing on the economies of the U.S, Japan and Europe are a decades long accumulation of debt.  Below is a chart of OECD data on the total debt of developed countries.  Debt in the U.S. doesn’t look bad compared to some of these other countries. (Click to enlarge in separate tab)

For the past thirty years, all of us in the U.S. have been running up debt.  People, companies and governments at the Federal, State and local levels have borrowed…and borrowed…and borrowed some more. 

The severely slumping U.S. housing market is a strong headwind to any GDP growth.  Lower valuations lead to less property taxes for local governments and schools, reduced government services, houses that are difficult for homeowners to sell without bringing cash to the sale. A recent report by the Commerce Dept. showed that housing has contributed an average of 4.7% to GDP for the past half century.  Last year, housing contributed only 2.2% to GDP.  If the health of the housing sector was just average, GDP growth in this country would be 2.5% higher.   Some in the industry anticipate that it will be another five years for housing to recover from the excesses of the past decade.

Debt Ceiling

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As Congress and the White House spend a summer weekend wrestling with negotiations over the debt limit, it helps to step back and look at the overall U.S. debt picture.

Since mid 2008, we have been on a dangerous trajectory, borrowing for TARP, stimulus plans of both spending and tax cuts, two wars, extended unemployment benefits, more tax cuts this past December and more and more defense spending.

Some argue that the only legitimate function of government is defense. Since we can never be safe enough, in principle there is no upper limit to how much we should spend on defense. Friday’s BEA report on GDP shows a 7.3% increase in defense spending.

“We can not abandon the most vulnerable members of our society” is a mantra repeated by some. As the population grows, so too will the vulnerable members of any society. As the population ages, that vulnerability will increase exponentially. In principle, there is no upper limit on our caring and generosity.

In reality, of course, there are limits. In our individual lives, in our communities and in the nation as a whole, we must struggle with the contradictions between our loftier principles and the harsher realities of living. For a while we can delay the reconciliation of principle and reality by putting off the inevitable compromises.

We have a natural knack for prognostication – one that we exhibit at an early age when we don’t clean up our room, do our homework or some other petty chore. Peoples of the future may label us “Homo Prognosticator”, not “Homo Sapiens.”

Debt is one indication of prognostication. We are getting really good at putting things off in the hopes that, one day, it will start getting better.

Below is a chart of federal debt since 2004, showing the increasing change in slope of the debt owed by all of us – our future selves, our kids and grandkids.

As I have noted in previous blogs, we have both a spending and revenue problem. To deny that we have both is more than prognostication – it’s delusion. Neither problem has broadly palatable solutions but the longer we delay implementing solutions, the worse it will get – exponentially worse. Anyone who has charged way too much on credit cards is well aware of that. The interest on the debt increasingly worsens any solution until bankruptcy is the only answer.

National bankruptcy is the sum of over 300 million personal bankruptcies.

Twin Horns of an Angry Bull

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On Fox News Sunday today, Eric Cantor, the current Republican whip and projected majority leader in the next Congress, stated that “we do not have a revenue problem. We have a spending problem.”

Below is a 10 year chart of Federal Revenues, excluding Social Security taxes (Source). Using CPI adjustment factors from the Bureau of Labor Statistics, I have shown revenues in constant 2000 dollars, or real dollars. Mr. Cantor does not think this is a “revenue problem.” I would not want Mr. Cantor as my accountant. (Click to enlarge in separate tab)

The real picture is that we have BOTH a revenue problem and a spending problem.

Below is a chart of defense spending in the past 10 years. In real dollars, it has almost doubled.

Next is a chart of human resource spending. I have excluded most of Social Security and Medicare. It has more than doubled in the past ten years.

Let’s imagine that you and your family were sitting at the kitchen table looking at similar charts of your finances. Your family income is about the same as it was 8 years ago yet your chief expenses have doubled. It’s obvious that your family will have to cut spending. It is also clear that you are going to have to find a way to bring in more money. Now imagine the budget fight when you suggest that you are going to cancel the data plan for your teenage daughter’s cell phone. How will you feel when your spouse suggests selling the newer model car you drive to work and buying an older compact car? What is your spouse’s reaction when you suggest that he or she deliver pizzas at night after work? These are tough discussions at the kitchen table or in the halls of Congress.