The Interest Rate Curve

August 4, 2019

by Steve Stofka

I was doing some work on various 1930s Depression era programs and ran across this precursor to Social Security call the Townsend Old-Age Revolving Pension. You can read more about it at the Social Security website in the notes below (Note #1).

The idea was to give people 60 years and older $200 a month. Pretty cool, I thought. Then I checked the BLS inflation calculator and found out that $200 at that time was equivalent to $3900 a month! That’s almost 2-1/2 times the average $1,461 a month that current Social Security recipients receive. The program was to be funded by a 2% national sales tax somewhat like the VAT tax in Europe. Seniors loved the program. They would be receiving twice what an average working person received each month.

A bill was introduced in Congress to adopt this plan; when the proponents of the program appeared at a Congressional hearing, it became apparent that they had not done any research on the amount of taxes needed to fund the program – more than half of the entire federal budget. The idea was shelved but inspired the creation of the Social Security program a few years later.

A unique feature of the plan was that recipients had to spend the money every month or lose whatever they did not spend. As the economy slowed down in early 2008, the Bush Administration sent out tax rebates to everyone in the hopes that the increased spending would stimulate the economy. A 2008 consumer confidence survey indicated that only a third of people spent the rebate (Note #2), but a 2009 Congressional Budget Office analysis indicated a higher percentage (Note #3).

In Obama’s first months in office after the 2008 Financial Crisis, the issue was a hot topic among policymakers and economists. The government could send out another round of rebate checks to people, but it couldn’t make them spend it to stimulate the economy. The Fed had cut interest rates to near 0%. What else could it do?

In an April 2009 NY Times op-ed, the prominent economist Greg Mankiw discussed a proposal that one of his students offered (Note #4). Essentially, the scheme was to announce a lottery that would invalidate 10% of all money. The nominal cost of holding money would go from 0% to -10%. By nominal, I mean excluding inflation which was zero or negative in early 2009. In advance of the lottery, people would want to hold as little money as possible. Would they spend it, or deposit it in the bank?  In today’s digital economy, most of us do not hold as much money as we did several decades ago. Would such a scheme encourage people to spend more?

I remember reading a suggestion at the time that the government should send credit cards to taxpayers instead of checks. The thinking was that people would have to spend the rebate instead of being saved or paying off debt. However, money is fungible, or interchangeable. After receiving my credit card loaded with $600, for example, I could pay my utilities or rent with that and put $600 in my savings account. I have spent nothing extra, which is what the government wants me to do.

If government can’t force people to spend money, then the government must spend the money directly to stimulate the economy during a downturn. But that leaves it to Congress to decide what to spend the money on and that is a long and difficult process of debate and competition for political and economic power.

It has been more than ten years since the financial crisis. That’s ten years of some very smart and experienced people trying to think of solutions to the next crisis, whenever it comes. No one has been able to come up with a workable solution. I think that’s why the Fed announced a small decrease in the prevailing interest rate this week. In the face of some weaker manufacturing data in this country and around the world, they are trying to steer the economy away from any rocky shore. 

Have policymakers unwittingly crafted a financial world that can no longer cope with the normal downs in a business cycle? There are imbalances that build up during an expansion. A downturn is a correcting mechanism. After ten years, the Fed hasn’t been able to raise rates to a normal 3-4%. Because developed countries around the world have large debts that they must service, central banks are pressured to keep interest rates low.  The low rates entice companies to borrow money to buy back their own stock to make their future earnings more attractive to equity buyers. The low rates fuel robust credit growth among consumers who feel more confident in the future as stock prices continue to rise. The money spent spurs more growth. Eventually, the growth rate of employment and house prices and credit slows to zero. Then comes the downhill part. I think the Fed knows that the brakes on this economy are not working very well and are taking us down a road where the downhill might be more gradual. I hope.

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Notes:

  1. The Townsend Old-Age Pension program
  2. A preliminary analysis 2008 tax rebate
  3. A CBO analysis of the 2008 tax rebate
  4. Greg Mankiw’s NY Times op-ed “It May Be Time for the Fed to Go Negative.”

Marching Forward

April 28, 2019

by Steve Stofka

When former President Obama took the oath of office, the economy was in the worst shape since the Great Depression 75 years earlier. Tax receipts plunged and benefit claims soared. Millions of homes and thousands of businesses fell into the black hole created by the Financial Crisis. In sixteen years of the Bush and Obama presidencies, the country added $16 trillion to the public federal debt, more than tripling the sum at the time Clinton left office in early 2001.

Although growth has remained slow since the financial crisis (see my blog last week), the economy has not gone into recession. Despite the fears of some, a recession in the next year does not look likely. The chart below charts the annual percent change in real GDP (green) against a ratio called the M1 money multiplier, the red line (Note #1). Notice that when the change in GDP dips below the money multiplier for two quarters we have been in recession.

The money multiplier seems to act like a growth boundary. While some economy watchers have warned of an impending recession, GDP growth has been above 2.5% for more than a year and is rising. In 2018, real disposable personal income grew nearly 3%. This is not the weak economic growth of 2011 or the winter of 2015/16 when concerns of recession were well founded.

The number of people voluntarily quitting their job is near the 1999 and 2006 highs. Employees are either transferring to other jobs or they feel confident that they can quickly get another job. An even more important sign is that this metric has shown no decline since the low point in August 2009.

In 2013, the Social Security disability fund was in crisis and predicted to run out of money within a decade. As the economy has improved, disability claims have plunged to all-time lows and the Social Security administration recently extended the life of the fund until 2052 (Note #2).

Approximately 1 in 6 (62 million) Americans receive Social Security benefits and that number is expected to grow to 78 million in a decade. However, the ratio of workers to the entire population is near all time highs. The number of Millennials (1982-1996) has surpassed the number of Boomers. This year the population of iGen, those born after 1996, will surpass the Millennial generation (Note #3). Just as a lot of seniors are leaving the work force, a lot of younger workers are entering. The ratio of worker to non-worker may reach 1 to 1. 45 years ago, one worker supported two non-workers.

As the presidential cycle gets into gear, we will hear claims that there are not enough workers to pay promised benefits. Those claims are based on the Civilian Employment Participation Rate, which is the ratio of workers to adults. While the number of seniors is growing, the number of children has been declining. To grasp the total public burden on each worker, we want to look at the ratio of workers to the total population. As I noted before, that is at an all time high and that is a positive.

Raising a child is expensive. The average cost of public education per child is almost $12K (Note #4).  Public costs for housing, food and medical care can push average per child public cost to over $20K annually.

Let’s compare to public costs for seniors. The average person on Social Security receives $15,600 in benefits (Note #5). In 2018, the Medicare program cost an average of $10,000 per retiree (Note #6). The public cost for seniors is not a great deal more than those for children.

As a society, we can do this.

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Notes:

  1. The M1 money multiplier is the ratio of cash and checking accounts to the amount of reserves held at the Federal Reserve.
  2. SSDI solvency now extended to 2052. Here’s a highlight presentation of the trustee’s report.
  3. Generation Z will surpass the numbers of Millennials in 2019. Report
  4. Public education costs per pupil
  5. Social Security costs
  6. Medicare program cost $583 billion. There are approximately 60 million on the program. CMS

Trends

April 14, 2019

by Steve Stofka

In the current housing market, there are .4 new homes started for every 100 people, near century long lows. The Millennials (1981-1996) are now the largest generation in history but home builders are not responding to the population boom (Note #1). In the 1970s, home builders started triple that number of homes in response to the swelling number of Boomers coming of age.

Have you heard that there won’t be enough workers to support Social Security and Medicare payments for the retiring Boomer generation? Here’s the ratio of seniors to the core work force aged 25-54. Yes, it has gone up since the Financial Crisis.

Here’s the ratio of seniors to all workers. Each worker’s social security taxes are “funding” benefits for three seniors. The Social Security fund was never a separate fund, only an accounting gimmick that politicians enacted eighty years ago. As former Fed chairman Alan Greenspan explained, the federal government can continue to make payments to seniors (Note #2).

Have you heard that the interest on the debt is going to grow so large that it will crowd out all other spending? As a percentage of total expenses, it is at a low level.  Each year the federal government runs a deficit of about 2.4% (Note #3). Can it continue to do that indefinitely? Yes.

Each day we hear a lot of half-truths and outright lies. As the 2020 Presidential election gets nearer, half-baked versions of reality will grow like mold on bread. The Constitution was structured to encourage debate as an alternative to war among ourselves. The 1st Amendment guarantees everyone a right to spout half-truths and lies. Two dominant political parties compete for our belief in their version of the truth. This is the land of argument.

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Notes:

  1. Pew Research has redefined the Millennial generation as those born 1981-1996.
  2. YouTube video of Alan Greenspan explaining to Representative Paul Ryan that the Federal Gov’s checks are good
  3. The 80-year average of deficits is 2.4%. Not including debt for wars, it is 2.2%, per Steve Keen, author of Debunking Economics.

Green Debt

March 17, 2019

by Steve Stofka

Imagine a world where, each year, the U.S. government (USG) gave $1000 to each of it’s approximately 300 million citizens (Note #1). The annual cost of the program would be $300 billion, about $120 billion more than the 2017 tax cuts (Note #2). As it does every year, the USG would borrow the money and issue Treasury bills, which are traded around the world. Although there is more than $23 trillion of Treasury debt – a plentiful supply – there is not enough to meet world demand.

Let’s say that the American people spent 80% of that $300 billion each year and saved the rest (Note #3). Let’s also calculate a multiplier of 1.5 so that the extra $240 billion of spending generates $360 billion of GDP (Note #4), about 1.7% of last year’s GDP. The increase in GDP would return about $60 billion to the USG in tax revenues (Note #5). The net cost to the USG is $300 billion less $60 billion in additional tax revenue = $240 billion.

Will the slight increase in GDP each year generate higher inflation? Inflation occurs when too much money chases too few goods and resources. Efficiencies in world production of goods and services has caused a continuing deflation in developed economies. Against those headwinds, inflationary pressures will be modest.

At the end of ten years, this program would create an additional $3.5 trillion in U.S. debt, the same amount of debt that the Federal Reserve accumulated in 2008 to protect the jobs and bonuses of Wall St. bankers. The Fed still owns most of that debt (Note #6). Which is fairer? A program to distribute money equally to everyone or a program to distribute the same amount to a select few?

Implementation of such a program is unlikely but illustrates the lack of a moral rudder in our Congress. Self-branded fiscal conservatives in both parties promote the fiction that the Social Security and Medicare funds will “run out of money” at a certain date in the future. These funds are part of the Federal government and are nothing more than bookkeeping entries on the Federal government’s books. The Social Security Administration explains this: “[the funds] provide 1) an accounting mechanism for tracking all income to and disbursements from the trust funds, and (2) they hold the accumulated assets. These accumulated assets provide automatic spending authority to pay benefits” [my emphasis] (Note #7). The accumulated assets are paper IOUs from the government to itself so that Social Security benefits are beyond the reach of Congressional infighting and debate each year. When it was created, President Roosevelt called Social Security an insurance program because it was insured against Congressional tampering.

Republicans propose to privatize Social Security while Democrats propose additional taxes to “fully fund” Social Security. These schemes are built on accounting fictions and sold to the general public as prudent solutions. Will the trust funds run out of money? Congress can change this with a stroke of a pen. Just as they “borrowed” from the funds, they can “loan” to the funds (Note #8). Both parties are trying to convince voters that big changes must be made because Congress is too incompetent to make a small legislative change. Will voters buy this nonsense and let them keep their jobs?

Around the world, the value of US Treasury debt is more trusted than gold. It is more than a bond because it trades among commercial banks like currency. The U.S. enjoys a unique position. Its debt is a trusted part of the world’s savings. This country has worked hard and prudently to make the U.S. dollar the world’s money. Over the past century, the U.S. has managed its economy and debt better than other large developed countries. Let us take advantage of that position. Let’s stop the political ploys around Social Security and other federal entitlement programs. Let’s have a serious discussion about investing in building new schools and transportation solutions, as well as needed infrastructure repairs. Let’s stop posturing like buffoons and start behaving like the leader we are.

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Notes:

1. Census Quick Facts
2. Annual loss of tax revenue about $180 billion times 10 years = $1.8 trillion per CBO estimate 
3. Americans usually save about 5% of income.
4. More on fiscal multipliers. 1.5 is an average of various multipliers.
5. USG revenues average 17% of GDP.
6. Fed’s balance sheet over time. The Fed buys Treasury debt in the secondary market from large banks that buy the debt at Treasury auctions. The Fed continues to hold $1.6 trillion of mortgage-backed securities, the same kind of debt that led to the Financial Crisis. Current balance sheet.
7. Social Security Administration FAQ #1 on the nature of the funds . Also, see their page debunking SS myths promoted on the Internet
8. The Federal government pays below market interest rates for the money that it “borrowed” from the SSA funds. Decades ago, the interest rate was set at approx. the five-year average for funds “borrowed” for several decades. If 20 or 30 year rates had been used, the SS funds would be much larger. There would be no “crisis” to argue about.

Deepening Debt

December 2, 2018

by Steve Stofka

Each time the Federal Reserve raises interest rates, the President tweets out his disapproval. This week Fed Chair Jerome Powell indicated that interest rates increases might be slowing and the Dow Jones average jumped up more than 2% in a few hours (Note #1). Presidents don’t like rising interest rates because they contribute to a slump in housing and car sales, two relatively small pieces of the economy that create ripples throughout a community’s economy. Trump’s strategy relies on strong growth.

The passage of the tax law last December reduced Federal tax revenues, which contributed to a rising deficit. The gamble was that the repatriation of corporate profits plus a reduced corporate tax rate would spur higher GDP growth which would offset the falling revenues. It hasn’t so far.

Let’s get away from dollars and use percentages. Economists track the annual budget deficit as a percent of GDP. I’ll call it DGDP. Let’s say a family made $50,000 last year and had to borrow $1000 because they spent more than they made, their DGDP would be $-1,000/$50,000 or -2%. In a growing economy, the DGDP rises, or gets less negative. It falls, or gets more negative, as the economy nears a recession.

DeficitPctGDP

A DGDP below the 60-year average of -2.5% indicates an unhealthy economy and, by this measure, the economy has not been healthy since 2007. The DGDP was the same in the last year of Bush’s presidency as it was in the last year of the Obama presidency. By 2014, it had risen above -3% and rose slightly again in 2015 but fell again the following year.

In 2016, the last year of the Obama presidency, the DGDP was -3.13%. In the first year of the Trump presidency it fell slightly to -3.4%. As I said earlier, the administration and Congressional Republicans hoped the tax law passed at the end of 2017 would spur enough GDP growth to offset declining corporate revenues. So far, that has not happened. The 2018 budget year just ended in September. Preliminary figures indicate that the deficit will be 3.9% of GDP this year (Note #2). Some economists project a DGDP near -5% in 2019.

Japan’s economy for the past two decades strongly suggests that an aging population weakens GDP growth. The U.S. economy must flourish against that demographic headwind. By December this year, Social Security (SS) benefits will surpass the $1 trillion mark, equal to or surpassing SS taxes collected (Note #3). For years, the excess in SS tax collections has lessened the amount that the Federal government had to borrow from the public. Each year, the government has left an I.O.U. in the SS trust fund. The total of those IOUs is almost $3 trillion.

Now the Federal government faces two challenges: interest on the ever-growing Federal debt and the government’s need to borrow more from the public to “pay back” those IOUs. The interest on the debt will soon overtake defense spending. Politicians could reduce cost of living increases in SS benefits by indexing benefits to the chained price index, a flexible measure of inflation that assumes that human beings alter their consumption in response to changing prices. Benefits are currently indexed to the Consumer Price Index (CPI) whose fixed basket of goods never changes. The CPI overstates inflation, but seniors are sure to lobby against any changes that would reduce cost of living increases. Politicians are reluctant to face angry seniors who might boot some of them out of office at the next election.

Trump has a better alternative than strategically lowering benefit increases for the swelling ranks of retiring Boomers – increase SS tax collections. The only way to do that is jobs, jobs, jobs. Jobs that are “on the books,” that take out SS taxes with each paycheck; not the jobs of the underground economy that flourish in immigrant communities. More jobs to draw in the half million discouraged workers who are sitting on the sidelines of the job market (Note #4).

Jobs, jobs and more jobs take care of a lot of budget problems. Campaign strategist James Carville stressed that point to Bill Clinton during the 1992 Presidential campaign. Higher interest rates hurt the construction, auto and retail industries, and blue collar small business service industries. All of these are more likely to reach out and hire marginal workers.

The headwinds are more than demographic. The economy has been stuck in low for a decade. In the eleven years since the 3rd quarter of 2007, just before the 2007-2009 recession, real GDP has averaged only 1.6% annual growth (Note #5). That is barely above population growth. Sectors that were strong, housing and auto sales, have slowed. Housing sales have declined for six months. Auto sales have declined for 18 months. Fed interest rate policy has been very supportive but that is slowly being withdrawn.

The DGDP is one more indicator that we should already be in a recession or approaching one. A recession will add to the demographic headwinds, increase the annual budget deficit and swell the accumulated federal debt. Job growth must counter job loss due to automation. Good policies are those likely to add jobs. Bad policies are those that thwart job growth. It doesn’t matter how well intentioned the policies are. Good or bad for job growth is all that matters in the next decade.

Here’s why. Another credit crisis is building. Low interest rates transferred billions of dollars in interest from the savings accounts of older people to businesses and government, who were able to go on a borrowing binge. Defaults and delinquency on business loans will probably be the source of our next crisis. After that is the coming pension crisis in several cities and states. Let’s hope those two don’t hit simultaneously.

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Notes:

  1. Within a day, interest rate futures that had priced in a 1/2% increase in the Fed Funds Rate during 2019 fell to just .3% for next year.
  2. Estimates of 2018 Fed deficit and GDP
  3. Social Security trustees’ summary report for fiscal year 2017.
  4. BLS series LNU05026645 discouraged workers. After ten long years, there are now as many discouraged workers as October 2008, just as the financial crisis sent the economy into shock. Within two years after the onset of the crisis, the number of discouraged workers had exploded 250%, reaching 1.25 million in October 2010.
  5. Real GDP: 3rd quarter 2007 – $15,667B. 3rd quarter 2018 – $18,672B. Constant 2012 dollars.

Grandma’s Kids

May 27, 2018

by Steve Stofka

The birth rate has touched a 30-year low, repeating a cycle of generational boom and bust since World War 2. The first boom was the Boomer generation born in the years 1946-1964 (approx). They were followed by the baby bust Generation X, born 1964-1982. The Millennials, sometimes called Generation Y and born 1982 – 2001, surpassed even the Boomers in numbers. Based on the latest census data, Generation Z, born 2002- 2020, will be another low birth rate cohort.

These numbers matter. They form the population tide that keeps the entitlement system afloat. Social Security and Medicare are “pay as you go” systems. Older generations who receive the benefits depend on taxes from younger generations for those benefits. As the population surge of Boomers draws benefits, the surge of Millennials is entering their peak earning years.

To maintain a steady population level, each woman needs to average 2.1 births. During the Great Recession, the birth rate for native-born Hispanic and Black women fell below that replacement level. White and Asian women fell below that level during the recession following the dot-com boom in the early 2000s. Foreign born Hispanic and Black women are averaging a bit more than 2-1/2 births. The average of foreign born White and Asian women is just about replacement rate.

Around the world, birth rates are falling. Social welfare programs depend on inter-generational transfers of income. When a smaller and younger generation must pay for a larger and older cohort, there is an inevitable stress.

I will distinguish between social welfare programs and socialist welfare programs with one rule: the former require that a person pay into the program before being entitled to the benefits from the program. In this regard, they are like insurance programs except that private insurance policies are funded by asset reserves held by an insurance company. Government “insurance” programs are “pay as you go” systems. Current taxes pay for current benefits. The Social Security “reserve” is an accounting fiction that the Federal government uses to track how much it has borrowed from itself.

Examples of social welfare programs that require the previous payment of dues are: Social Security, Medicare, Unemployment and Workmen’s Compensation Insurance. Although the latter two are paid directly by employers, they are effectively taken out of an employee’s pay by reducing the wage or salary that the employer pays the employee. Employers who fail to understand this go out of business early in the life of the business. I have known some.

Examples of socialist welfare programs that are based on income, or need: Medicaid, TANF (Welfare), WIC, Food Stamps, Housing and Education Subsidies. There is no requirement that a person pays “dues” into a specific program before receiving benefits.

Health care in America is primarily a social welfare program with socialist elements. The Federal government does subsidize all employer provided health insurance and most private insurance through the tax system or the Affordable Care Act. However, most beneficiaries must pay some kind of insurance to access benefits. Under the 1986 EMTALA act, emergency rooms are notable exceptions to this policy. They are required to treat, or medically stabilize, all patients insured or not.

As Grandma begins to draw benefits from Social Security and Medicare, she relies on the earnings of her kids who form the core work force aged 25 – 54. Grandma has paid a lifetime of dues into the social welfare programs and wants her benefits. Grandma votes.

Her grandkids want government subsidies for educational needs and job training. They depend on socialist welfare programs with no dues. The grandkids don’t vote.

The kids are caught in a generational squeeze.  Their taxes are paying for both their parent’s benefits and their kid’s benefits.

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Housing Trends

In the spring of 2008, there was an eleven month supply of existing homes on the market.
2010 – 8-1/2 months
2012 – 6-1/2 months
2014 – 5-1/2 months
2016 – 4-1/2 months
2018 – 4 months

In some cities, a median priced home stays on the market less than 24 hours.

Here is another generational shift.  Grandma and Grandpa now own 40% percent of home equity, up from 24% in 2006. Their kids, the age cohort 45 – 60, own 45%. Those under 45 have only 14% of home equity, down from 24% in 2006.

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Brave New World

E-Commerce is now 9.5% of all retail sales, almost triple the percentage ten years ago. (Fed Reserve series ECOMPCTSA). In 2000, the percentage was less than 1%.

A Graduated System of Benefits

October 29, 2017

My kids will learn that they are the sons and daughters of charity parents.

Two weeks ago, I wrote about the measurement of the poverty rate in America. Why is our standard different than the one adopted by all other developed countries? What efforts have we made to alleviate poverty, and have those programs helped or hurt the poor?

Qualifications for benefits under various programs rely primarily on paid income. As a person exceeds certain thresholds of income, benefits are reduced or stopped entirely. Regardless of how we define a reduction in benefits, it feels like a tax to the recipients. Under these programs, the poor pay the highest tax – 100%. $1 earned above a certain threshold results in a $1 reduction in benefits. There is a very real incentive to hide reported income.

As I showed earlier, the poverty standard adopted by the U.S. undercounts the number of poor. On the other hand, income earned in the underground economy is not counted and results in an overcount of the poor.

We may associate “underground” with “illegal” but it includes both legal and illegal activities. A better synonym would be “unreported.” Workers in the unreported economy may include the kid down the block who mows our lawn, the guy who repaired our fence, the woman who walks our dog when we work late.

Almost all of us are part of the unreported economy whether we realize it or not. Recent estimates of the size of this shadow economy in the U.S. are from 7% to 11%. In dollar amounts, that’s $1.4 trillion to over $2 trillion. In less developed economies, it can be as much as 25%.

The tragedy of current programs is that they often discourage recipients from getting more work, or better paid work. The loss of Medicaid benefits dissuades a single mom with children from taking on employment unless she can find an employer who provides health insurance for her and her children. Many don’t.

Income above a certain threshold may disqualify someone from housing benefits. Under a Section 8 housing program, a low-income person pays 30% of their monthly income for housing (Section 8 FAQs). HUD, a Federal agency, and state agencies pay the rest of the rent. Section 8 housing is in short supply. The amount of paperwork and inspections required by HUD dissuades many real estate owners from enrolling their properties in the program.

These programs would improve by paying benefits on a graduated scale rather than using a qualifying threshold. Under the current system, a person making less than half the area’s median income, let’s say $24,000, gets housing assistance and other benefits. If they make above that, they may receive nothing under some Federal and state programs. That is the equivalent of a 100% – or higher – tax.

This graduated scale should apply to everyone. That includes the richest people on the planet like Bill Gates and Warren Buffett, who would also be eligible for housing vouchers, food stamps, for supplemental income and Medical benefits. As income increased, benefits would be gradually decreased. Bill Gates would be eligible for housing assistance, but his monthly benefit would be $0. For many of us, there would be no incentive to apply.

A graduated scale would help eliminate the quiet shame that some people experience when they receive public assistance. Like it or not, there is a stigma attached to being poor and receiving benefits.

A person with a disability can receive Social Security and Medicare. They can be quick to point out the fact. They are not on SSI, a program for low-income people. They are on Social Security. They paid into the insurance system. They got hurt. They are collecting on the insurance payments they made during a lifetime of work. Because they are disabled, they are on Medicare, not Medicaid. Medicaid is for poor people. If they are poor, it is only because they became disabled.

If I am a worker with a family to support and I make $11 per hour, or about $450 a week, my family is qualified to receive housing, food, medical and other assistance programs. I may be experienced in a few construction trades, but my tools were stolen last year. Perhaps I don’t have reliable transportation. I could make more money if I could get some tools or a more reliable car, but I can barely take care of my family. How can I get ahead?

A concrete contractor offers me a job paying $20 an hour for a project that will last the summer months for sure. However, the winter months may be a bit lean. The additional income will put me over the income threshold and my family will lose most of the benefits.

If I calculate the benefit my family currently receives in addition to my current $11 per hour wage as a janitor, I am receiving the equivalent of about $20 an hour. Even though I prefer to take the new job, I should continue to work at my current job for the sake of my family. Perhaps I can find a few jobs on the side, or “under the table,” but these are sporadic.

If I continue to stay out of the construction trades, my skills will atrophy. My self-confidence will erode. My kids will learn that they are the sons and daughters of charity parents.

The example above is all too common. If we had a gradual system of benefit awards, such a worker would be more inclined to take that better paying job. With a higher income, they might be able to get a loan for more reliable transportation. Their family might be able to afford more housing choices.

Who benefits under the current system? Whenever a poorly performing system stays in place, there is usually a small group of people who benefit under that system. They don’t want it to change.

Am I being a bit too cynical? No. It is Realpolitik. The practical benefits for one group of people outweigh any moral considerations by that group. In a later blog, I’ll look at who benefits from the current system.

The Gravy Train

October 1, 2017

In the newly published “The High Cost of Good Intentions” author John Cogan relates a 230-year history of Federal entitlements, beginning with veterans’ pensions after the Revolutionary War. For 150 years the expansion of veterans’ benefits was prompted by budget surpluses brought on by high import tariffs. Each was targeted to a small number of soldiers who had died or become wounded during a war. Each program expanded into giant giveaways to any soldier or state militiaman and their wives.

Republicans expanded Civil War pensions to secure control of federal and state legislatures at the turn of the 20th century. Twenty years later, FDR and the Democratic Party used the same strategy of benefits to wrest control from Republicans.  First, the old system of service for benefits had to be curtailed. Like previous pension programs, benefits for WW1 veterans had been extended to those with non-service disabilities. Immediately after assuming office in 1933, FDR persuaded Congress to give him emergency authorization to alleviate the financial crisis. FDR eliminated almost a half-million veterans with non-service disabilities from the pension rolls and reduced pensions across the board. For the rest of the decade Congress tried to reinstate veteran’s benefits over the Presidential veto.

In 1934, the administration launched the New Deal, a series of programs to alleviate Depression-era hunger and unemployment. For 150 years, military service had been the prerequisite for federal benefits. Under FDR need, not service, became the primary requirement. An act of compassion quickly became a political tool that secured Democratic control at both the federal and state levels. Under the newly introduced Social Security program, a small amount of tax paid during the working years now entitled an older voter to federal pension benefits. No military service required.

For eighty years, benefit programs have become a political football. Two-thirds of the ten legislative increases to the Social Security program have occurred in election years. Today the total cost of entitlements is 60% of the $4.2 trillion in Federal spending.

If asked to list the federal entitlement programs, how many could we name? In addition to veteran’s benefits for service to the country, there are:
Income replacement programs like Social Security retirement and disability;
Income supplemental programs for poor families, such as the earned income tax credit (EITC), unemployment insurance, SSI and TANF;
Health insurance programs like Medicare and Medicaid, and the ACA’s health insurance subsidies;
Food assistance and price support programs like food stamps (SNAP) and child nutrition (WIC);
Business and individual loan guarantees and subsidized insurance programs including Sallie Mae education loans, FHA mortgage programs, and flood insurance subsidies.
This list does not include the many tax subsidies handed out by Congress.

I found that I could open this book at random and be both informed and entertained. Mr. Cogan combines an engaging narrative style and extensive research to construct an epic story of human need and greed, and the politics of pork.

I’ll turn to another book, “The Framer’s Coup” by Michael J. Klarman for some related backstory. At the Constitutional Convention in 1787, anti-Federalists objected to the “general welfare” clause of the proposed Constitution. What was to stop the Federal government from becoming a charity funded by taxes, they asked?

Nonsense, Constitutional delegates James Madison and Edmund Randolph countered, pointing to the enumerated powers in the Constitution as a restraint on the Federal government. Just as the anti-Federalists feared, the Court has long adopted a liberal interpretation of the Federal government’s enumerated powers. In the 1819 case of McCullough v. Maryland, Chief Justice Marshall set a precedent that the Congress could enact legislation that was “convenient or useful” to the exercise of its enumerated powers.  After that decision, then ex-President Madison admitted that if the Constitution had clearly stated the signers’ intention to firmly restrict the power of the Federal government, the Constitution would not have been ratified.

Turn the dial forward to the present. In the expansion of the welfare state during the 20th and 21st centuries, the Supreme Court has never found that the Federal government has exceeded its enumerated Constitutional powers. The most recent example was the Court’s finding that, under the enumerated power of taxation, the federal government could force people to buy health insurance under the ACA program.

The liberal interpretation of those two clauses – “convenient or useful” and “general welfare” – has unleashed the Federal government, whose agencies have become an omnipresent force in every American’s life. Each month, politicians in Washington take tax money from one set of voters and give benefits to another cohort of voters. Everyone  who receives benefits convinces themselves that they have paid into the system in some way. When it comes to tax money, it has always been better to receive than to give.

As the benefits to the receivers slowly exceed the taxes from the givers, there will be a crisis, and then some urgent half-baked legislative fix will be passed. I wish there was a better way.  Oh wait, I forgot.  There is a better way.  Paul Ryan, Speaker of the House, introduced the plan last year. Now that Republicans control the Presidency, Senate and House, they will fix the problem and avert a looming crisis of entitlements.  Silly me.  I can focus on the baseball finals now and stop worrying.

An Interest-ing Debt

February 12, 2017

Republicans used to talk about the country’s debt load but such talk is so inconvenient now that they control the House, Senate and Presidency. Perhaps it was never more than a political ploy, a rhetorical fencing. Now there is talk of tax cuts and more defense spending, and a $1 trillion dollar infrastructure spending bill. 48 states have submitted a list of over 900 “shovel-ready” projects.

House Speaker Paul Ryan used to be concerned about the country’s debt. Perhaps he has been reading that deficits don’t matter in Paul Krugman’s N.Y. Times op-ed column. For those of us burdened with common sense, debts of all kinds – even those of a strong sovereign government like the U.S. – do matter. The publicly held debt of the U.S. is now more than the country’s GDP.

debt2016q3

In 2016, the Federal interest expense on the $20 trillion publicly held debt was $432 billion, an imputed interest rate of 2.1%. Central banks in the developed world have kept interest rates low, but even that artificially low amount represents 11% of total federal spending. (Treasury)  It represents almost all the money spent on Medicaid, and more than 6 times the cost of the food stamp program. (SNAP)

The latest projection from the CBO estimates that the interest expense will double in eight years, an annual increase of about 9%. The “cut spending” crowd in Washington will face off against the “raise taxes” faction at a time when a growing number of seniors are retiring and wanting the Social Security checks they have paid toward during their working years.

In the past twenty years the big shifts in federal spending as a percent of GDP are Social Security and the health care programs Medicare and Medicaid. These are not projections but historical data; a shift that the CBO anticipates will accelerate as the Boomer generation enters their senior years. Ten years ago, 6700 (see end of section)  people were reaching 65 each day. This year, over 9800 (originally 11,000, which is a projection for the year 2026) per day will cross that age threshold.

cbospendcomp1996-2016
CBO Source

A graph of annual deficits and federal revenue shows the parallel paths that each take. The trend of the past two years is down, promising to accelerate the accumulation of debt.

fedreceiptsdeficit1998-2016

More borrowing and higher interest expense each year will crowd out discretionary spending programs or force the scaling back of benefits under mandatory programs like Social Security, Medicare and Medicaid. President Trump can promise but it is up to Congress to do the hard shoveling.  They will have to bury the bodies of some special interests in order to get some reform done.

[And now for a bit of cheer.  Insert kitten video here.]

We already collect the 4th highest revenue in income taxes as a percent of GDP. Canada and Italy head the list at 14.5%.
South Africa 13.9%,
U.S. 12.0%,
Germany 11.3,
and France 10.9 all collect more than 10%. (WSJ) Those who already pay a high percentage in income taxes will lobby for a VAT tax to increase revenues. Income taxes are progressive and impact higher income households to a greater degree. Poorer households are more affected by a VAT tax.  Cue up more debate on what is a  “fair share.” Many European countries have a VAT tax and the list of exclusions to the tax are bitterly debated.

Adding even more social and financial pressure is the lower than projected returns earned by major pension funds like CALPERS. For decades, the funds assumed an 8% annual return to pay retirees benefits in the future. In the past ten years many have made 6% or less. Several years ago, CALPERS lowered the expected return to 7.5% and has recently announced that they will be gradually lowering that figure to 7%.

Each percentage point lower return equals more money that must be taken from state and local taxes and put into the pension fund to make up the difference. Afraid to call for higher taxes and lose their jobs, local politicians employ some creative accounting to avoid the expense of properly funding the pension obligations. In a 2010 report, Pew Charitable Trust analyzed the underfunding of many public pension funds like CALPERS and found a $1 trillion gap as of 2008. (Pew Report) The slow but steady recovery since then may have helped annual returns but the inevitable crisis is coming.

In December 2009, I first noted a Financial Times Future of Finance article which quoted Raymond Baer, chairman of Swiss private bank Julius Baer. He warned: “The world is creating the final big bubble. In five years’ time, we will pay the true price of this crisis.”
That warning is two years overdue. Sure hope he’s wrong but … here’s the global government debt clock. The total is approaching $70 trillion, $20 trillion of which belongs to the U.S.  We have less than 5% of the world’s population and almost 30% of the world’s government debt.  As Homer Simpson would exclaim, “Doh!”

Correction:  Posted figure for 10 years ago was originally 9000.  Current figure was originally posted at 11,000.  Projected for the year 2026 is 11,000.)

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Market Valuation

Comments by President Trump indicating a “sooner than later” schedule for tax cuts helped lift the stock market by 1% for the week. The Shiller CAPE ratio currently stands at 28.7, just shy of the 30 reading on Black Tuesday 1929. (Graph) Since the average of this ratio is about 16, earnings have some catching up to do. Today’s reading is still a bargain compared to the 44 ratio at the height of the dot com boom. Still, the current ratio is the third highest valuation in the past century.

The Shiller Cyclically Adjusted Price Earnings (CAPE) ratio
1) averages the past ten years of inflation adjusted earnings, then
2) divides that figure into the current price of the SP500 to
3) get a P/E ratio that is a broader time sample than the conventional P/E ratio based on the last 12 months of earnings.

The prices of long-dated Treasury bonds usually move opposite to the SP500.  In the month after the election, stocks rose and bond prices went lower.  Since mid-December an ETF composite of long-dated Treasury bonds (TLT) has risen slightly.  A number of investors are wary of the expectations that underlie current stock valuations.

The casual investor might be tempted to chase those expectations.  The more prudent course is to stick with an allocation of various investments that manages the risk appropriate for one’s circumstances and goals.

 

Inauguration 2017

January 22, 2017

Mr. Trump’s inauguration marks the first time in almost a hundred years that a business person assumes the highest political position in the country.  His cabinet choices share that same characteristic. There will be an inevitable clash of cultures.  Many civil servants are lifers, drawn to the generous benefits of government service, and the stability of employment.  Some may be drawn to the work because it gives them a sense of self-worth.

Many have little experience in private industry and distrust the motives of business owners.  Former President Obama was one of these.  An inspirational figure to some, his antipathy to business interests of all sizes antagonized political foes who challenged him for most of his two terms.

Mr. Trump has a similar weakness – his antipathy to and unfamiliarity with the insular culture of civil servants who work in a massive bureaucracy characterized by a thicket of rules and a lack of transparency.

Work in the private sector is characterized by competition, a striving for efficiency, the changing winds of people’s preferences, and the quality of the services and products we provide.  Employment in the public sector requires patience with burdensome procedure, a tolerance of a heirarchy of both the competent and the undeserving, and a willingness to work in a system that relies less on merit and more on seniority.

What will happen when these two diametrically opposed cultures mix?  Stay tuned.

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Obamacare Kaput?

Since FDR began the custom, Presidents have signed executive orders on their first day in office to signify that they are on the job for that portion of the American electorate that put them in office.  One of the highlights of Mr. Trump’s campaign was the repeal of Obamacare.  Shortly after his inauguration President Trump signed an order stating his intention to repeal the ACA.  The order freezes any further promulgation of rules and regulations pertaining to the act.   I thought it would be appropriate to republish a blog I wrote in April 2011, a year before the Supreme Court ruled that most of the ACA was constitutional.  Like Social Security, ACA premiums and penalties were a tax.

The problems of providing health care and the insuring of that care have not gone away: rising costs, more sophisticated and expensive therapies, more demand for care from an aging population.  The problem is a knotty one:  how to distribute health care costs.  We all benefit from the availability of medical resources, yet these resources are very expensive.  The 24 hour care and equipment that stays idle in an urban hospital must be paid for with funds from other parts of the health care system.

It might surprise readers that more than 50% of the $3.5 trillion in Federal outlays is for Social Security benefits ($930B), Medicare ($600B) and Medicaid and Community health programs ($500B).  Eighty years ago, FDR initiated a new role for the Federal Government: an economic support system. To do that, FDR had to threaten and cajole a Supreme Court reluctant to stretch the meanings of several clauses in the Constitution.

Even FDR would be appalled to learn that the Federal Government has become an insurance company whose chief function is the collection of insurance premiums through taxes in order to pay insurance claims in the form of Social Security, Medicare and Medicaid Benefits.

Readers who would like to read more on a pie chart breakdown of government spending can visit the Kaiser Family Foundation’s fact sheet. Dollar amounts are from the latest White House budget.

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MM Bash

I’m about to bash criticize some of the reporting in mainstream media (MM) publications, whose budgets rely on viewership.  When that audience was more predictable, flagship publications like the NY Times, Washington Post and Wall St. Journal could wait to verify facts before running a story.  In the current 24 hours news cycle and the rush to print, fact checking sometimes comes after the story is published online – if at all.

MM channels rested on their decades old reputations for thorough journalism and were willing to cut off at the knees any reporter compromising that reputation.  More than a decade ago, Dan Rather lost his anchor job with CBS for running with a story about George Bush that had not been properly vetted. News (fact-checked) and opinion (not checked) were clearly defined when they were in separate sections of the newspaper. In this new age when most information is delivered digitally, we are quoting blogs or other opinions that are not fact checked as reputable news sources without verifying the information.

A lie travels around the world by the time the truth gets its boots on. Something like  that.  In today’s lightning fast world of information flow, an apocalyptic news item that can move markets can be tweeted, webbed, facebooked, and retweeted.  “China fires on U.S. destroyer in South China sea!”  “N. Korean missle hits Alaska!” Sell, sell, sell, buy, buy, buy signals can flash instantly to world markets.

Later, it’s no, China didn’t fire on a U.S. destroyer.  China said it would fire if fired on by a U.S. vessel in the S. China Sea.  No, the North Koreans didn’t actually fire a missle.  Instead they said that they had a missle that could fire a nuclear payload on Alaska.  They’ve been saying that for several years.  Most defense analysts remain skeptical.  Oops, nevermind stock and bond markets.

We can not prevent this, nor can we hide our savings under a mattress.  We can prepare by making sure that we have some emergency funds in place.  Most financial advisors recommend six months replacement income.  Only after those funds are in place should we consider that boat we want on Craigslist or the down payment on that house we want to flip.  Don’t just plan to have a plan.  Have a plan.

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Household Net Worth Ratio

The zero interest rates for the past eight years are not natural and have created distortions in business and residential investment as well as stock market valuations. Let’s look at the residential side of the picture.  Below is a sixty year chart of the percentage of household net worth to disposable income.

The majority of the net worth of households is in their home.  The value of stocks and bonds comes second.  One or both of the two factors in that ratio is mispriced.  Perhaps disposable income has not grown to match the growth in asset valuations.  When reality doesn’t match predictions for a time, assets reprice.

What affects the pricing of these assets? The stock market rises on the prospect of sales and profit growth.   Salaries and wages rise as businesses compete for workers in a faster growing marketplace.  Disposable income rises.  Home prices rise on the prospect that more workers can afford to buy a home.

Now, what happens when disposable incomes, the divisor or bottom number in this ratio, don’t rise as much as predicted?  Yep, the ratio goes up, just as it did in 1999-2000 and 2006-2008, the peaks in the graph.