Tuesday, June 29, 2010

G-20 Pledge To Cut Deficits/Debt Will Have Multiple Consequences

Investors fear that the Group of 20's pledge to cut deficits could hurt global growth.

The stock market is tumbling.

Investors are concerned that a pledge by G-20 nations to halve their deficits by 2013 and stabilize their debt by 2016 sends the message that the days of endless stimulus are over.

G-20 countries set "goals" to cut their deficits in half by 2013 and to "stabilize or reduce" debt-to-GDP ratios by 2016. Given the state of the global economy, that seems unlikely. But should they follow through on this pledge, it will undoubtedly slow the global economy.

That's what you call a catch-22, or being caught between a rock and a hard place.

Governments are faced with a couple of ugly choices, Absent government stimulus and deficit spending, they face stagnating economies due to lowered demand, which will lead to layoffs and slower job creation.

To avoid that, they can continue to spend heavily, running up greater deficits and debts. However, that will hurt their fiscal position and likely lead to demands of higher interest rates on the bond markets.

To complicate things even further, a nation cannot pay off its massive debts without achieving strong economic growth.

Greece is the perfect model of what can happen when government spending, deficits and debt get out of control. Who wants to buy the bonds of a nation that may not be able to pay you back?

The Obama administration said Sunday that it will work to reduce the U.S. fiscal deficit to 3% of GDP by 2015.

The problem is that the private sector isn't nearly robust enough to sustain the economy on its own. In fact, multiple indicators show that the economy is faltering. Without growth, there are no jobs. And without jobs, there can be no meaningful, sustainable, recovery.

American consumers see the signs and they are rightfully worried.

The consumer confidence index plummeted to 52.9 in June - the lowest level since March -- from a downwardly revised 62.7 in May. That's a huge drop. A reading above 90 indicates the economy is on solid footing; above 100 signals strong growth. By this measure, we are a long way from recovery.

There appear to be limits to how much the federal government can help. The stimulus money from last year is drying up and first quarter GDP came in at a disappointing 2.7%. Early indicators show that the second quarter could be even worse.

We're in a vicious cycle; no growth, no jobs, no recovery.

Growth would need to equal 5% for all of 2010 just to lower the average jobless rate for the year by 1 percentage point. Clearly, that is not going to happen.

How will Americans respond when the government eventually begins cutting the budget and eliminating spending for popular programs?

Europeans are letting their opinions be heard loud and clear; Greece and Spain have been beset with protests and labor strikes.

Major cuts have already begun in states across the US.

Last week, the Senate shot down a bill that would have extended unemployment benefits yet again. Congress had previously extended benefits four times since 2008.

Aside from affecting nearly a million unemployed Americans, the decision will also deny states billions of dollars in financial assistance, leading to even more draconian budget cuts.

That will in turn create even more pressure on GDP, undoubtedly shrinking it. The economy will contract if consumers and governments aren't active. Someone has to spend.

The denial of unemployment benefits will also create a drag on economic growth. Millions of Americans will no longer be pumping that money back into the economy.

As I've said repeatedly, there are no good answers; only very difficult choices. We have entered a debt trap that presents an enormous conundrum; do we continue to mortgage our nation's future by becoming even more grossly indebted? Or, do we show fiscal restraint and suffer the consequences of another possible depression?

These are the hard and nasty choices we face as a nation.

Saturday, June 26, 2010

First Quarter GDP Revised Down Again; Q2 Not Looking Good Either

Most economists expected first quarter GDP to come in at 3.5%. However, when the preliminary results were released in April, the number was just 3.2%. That number was then revised downward to 3% in May. And just today, that number has been revised down yet again, to 2.7%.

This is a serious blow. Our government embarked on an absolutely massive $787 billion stimulus plan last year that was designed to step in for the struggling private sector. Consumers simply weren't consuming, or spending.

It's worth noting that $300 billion of that stimulus came in the form of tax cuts for 95% of Americans, but apparently they didn't put that money back into the economy. Instead, they used it to pay down debt.

No matter, the government took extraordinary steps to end the recession and renew economic growth.

Yet, despite the magnitude of this federal stimulus program, and $2.3 trillion in spending by the Federal Reserve, we still ended up with a measly 2.7% first quarter GDP.

And the problem has been worsening in the second quarter. The Commerce Department reported that consumer spending didn't grow at all in April. And then it reported that retail sales fell 1.2 percent in May, the first time they've fallen since Thanksgiving.

That makes you wonder where we go from here. The government is relying on foreigners (largely foreign governments) to loan us the money to continue our deficit spending. And the Fed is simply printing money out of thin air, which it then uses to buy Treasuries. This is akin to the left hand borrowing money from the right hand. It is an absolutely insane policy.

Our government hopes to cure its deep debt by growing its way out of the problem. But advanced economies are mature, and harder to grow.

The stunning reality is that growth has been rather slow for a number of years, as is often the case with mature economies. Since the second quarter of 2006, there has only been one quarter in which GDP was at least 4%. And the 5.6% growth in the fourth quarter of 2009 was largely the result of government stimulus spending.

According to Gallup, the under-employment rate is 20%. This includes not only the unemployed, but also those who can only find part-time jobs, yet want full-time work. Economist John Williams puts the real unemployment number at 22%.

Quarterly GDP would need to grow at 5-6% just to bring the national unemployment rate down a single percentage point. At that pace, a 4-5% unemployment rate) could be achieved by 2015.

One-quarter of all US mortgages are under water, which means nothing unless the owners suddenly need to sell. But the reality simply makes people feel poorer. It's a psychological effect, albeit a powerful one.

Even worse is this: roughly one-in-seven of the 52 million households with mortgages are in delinquency or foreclosure.

With numbers like these in mind, it's no wonder that consumers are retrenching. Clearly, these people aren't shopping or taking on further debt.

Instead of borrowing, Americans are paying down debt and saving at a 3.4% rate. That does not bode well for an economy 70% reliant on consumer spending.

But what about this alleged recovery the mainstream media has tried to continually sell us? What about the "greenshoots" we've heard so much about? It was all nonsense based solely on optimism. But that doesn't by groceries.

With the stock market up 80% in almost 14 months at its April peak, people "felt" like they had more money. Call it the "wealth effect." Let's hope that some of them took their profits while they could. The stock market is nothing more than a fantasy rooted in delusion and entirely lacking in fundamentals.

It's not just consumers who are retrenching either. In the first quarter, spending by state and local governments declined by the largest amount since 1981. Tax revenues have plummeted and they are all going broke (see the cover of this week's TIME).

Many states will soon need — and ask for — their own bailout from the Federal government. But where will the money come from?

The US, the largest debtor in the world, is simultaneously fighting two separate wars that are adding more than $12 billion to that debt each month. Meanwhile, the national debt has now exceeded $13 trillion.

There are — and will continue to be — calls for additional stimulus spending to keep the economy from going backwards. And there are already calls to extend the first-time home-buyer's credit. The program, which helped more than 2.5 million people buy homes, has already distributed $18 billion in tax credits.

And this week, the Senate shot down a bill that would have further extend unemployment benefits. The decision will affect nearly a million Americans and deny states billions of dollars in financial assistance. That will lead to even more draconian budget cuts. Congress had previously extended benefits four times since 2008.

Bu things will soon get even worse for the unemployed.

Department of Labor estimates show two million workers, or 20 percent of all recipients of jobless aid, will fall out of the Emergency Unemployment Compensation program by the second week of July.

While the denial of benefits certainly won't add to the deficit this year, it will create a drag on economic growth. Millions of Americans will be pumping less money back into the economy.

This, in conjunction with the exhaustion of stimulus funds, will cause GDP to falter in coming quarters. It's going to get ugly, folks.

Wall Street got a bailout. Detroit got a bailout. Now state, cities, and everyday Americans want a bailout too. To be truthful they all need it. But our government has been in debt for decades, and it's only getting worse.

The reality is that public sector needs a bailout, yet there is no private sector entity large enough to bailout the public sector.

So what now?

That's the million-dollar question. More stimulus means more debt. But without further stimulus and more aid to states and millions of individuals, the economy will limp along desperately.

There are no good choices, just harsh realities.

Thursday, June 24, 2010

Trade Deficit Still Growing; Get Set For Higher Prices

The Commerce Department says the trade deficit widened in the first quarter to $109 billion, or 3% of US GDP. It was the third consecutive quarterly increase.

Meanwhile, in May, China's exports rose 49% from the year-earlier month. China's trade surplus widened to $19.53 billion in May, from $1.68 billion in April.

For the trade deficit to become more balanced, Americans will have to save more and spend less; while the Chinese will have to do exactly the opposite.

Yet, that alone won't remedy of the problem for the US. As long America continues to import two-thirds of the oil it uses, that trade imbalance will not shrink.

This dependence fully explains why oil companies have set up oil rigs in mile-deep water in the Gulf of Mexico, only to then drill three miles into the sea bed. But I digress.

Additionally, the Chinese currency, the yuan, has been artificially suppressed by the Chinese government, keeping it from rising to a higher value.

However, ahead of this week's G-20 meeting, Beijing bowed to pressure and agreed to ease the yuan's tie to dollar, gradually strengthening its currency. Right on cue, the yuan advanced to its highest level since 1993 in afternoon trading today in Asia,

The 0.4% rise was the biggest single-day advance in the two years since the People's Bank of China re-linked the yuan to the U.S. dollar.

That will make dollar-based goods more competitive and provide a more level playing field forthe US andother exporting nations. In essence, the dollar has dropped in relation to the yuan, and other currencies as well.

The downside of a Chinese currency revaluation — in conjunction with ongoing wage increases for Chinese workers — is that it will raise the cost of Chinese goods sold by U.S. retailers to U.S. consumers.

Get ready for higher prices, Wal-Mart shoppers.

Wednesday, June 23, 2010

Housing Market Cannot Sustain Without Government Support

Weak Housing Numbers Undermine Hopes of Recovery

The National Association of Home Builders' monthly index of builder confidence is down to levels not seen since February. That's why Harry Reid and other Senate Democrats are pushing for an extension on the $8,000 tax break being offered to first-time homebuyers.

Under the original deal, buyers who were in contract by the end of April would have until the end of June to close. If that deadline is extended, they'd have until the end of September.

The National Association of Realtors (NAR) estimates that almost one in six home buyers this year will take advantage of the tax credit.

The home buyer's tax credit was expensive, costing taxpayers over $12 billion. At that cost, the government can't prop up home sales indefinitely. And considering our government's balance sheet, it shouldn't be undergirding it at all.

What's equally troubling is that current homeowners are among those subsidizing the purchases of new owners. After all, these tax credits are funded by all taxpayers.

The government is intervening in the housing market in a desperate attempt to maintain consumer demand, and thereby GDP.

The US government, by way of Fannie Mae, Freddie Mac and the FHA, underpins about 95% of the mortgage market. The market is purely on government-provided life support.

But, right now, the patient doesn't look good.

The NAR said sales of previously owned homes slipped 2.2% in May. Sales had increased for two consecutive months due to the now-expired tax credit.

The economic data clearly reveals that consumers are still struggling. For most Americans, this recession isn't nearly over.

Meanwhile, as the government futilely attempts to prop up demand, the deficit and debt continue to swell. The 20% of Americans who are either unemployed or under-employed are paying little, if any, taxes, causing government revenues to plummet.

That only raises the deficit, the debt, and their ratio to our GDP. And without continued government support (aka, deficit-spending), our nation's GDP will be challenged to grow, and may even stagnate.

That's not how a debt-based, growth-driven economy is supposed to work. The reality is that system is irrevocably broken.

Tuesday, June 22, 2010

The Debt Trap; No Way Out

Deficit-Spending and Currency Printing are the Roads to Nowhere

On June 5th, G20 finance ministers made a rather remarkable (and perhaps under-reported) decision to drop their support for fiscal stimulus. Concerns over sovereign debts have raised an urgent need for deficit reduction and trump desires to spur false, government-created economic growth.

The G20 (with the notable exception of the US, UK and Japan) no longer believes that deficit spending is sustainable or effective in fostering an economic recovery. The confidence of a dubious bond market will instead take precedence.

This puts the majority of the G20 at odds with the US, UK and Japan, who are going full steam ahead with their efforts to stoke consumer demand.

As if on cue, Japan's central bank announced it will offer financial institutions up to $33 billion in new lending, while also leaving its key rate unchanged at 0.1%. However, Japan already has an abundance of available liquidity. Yet, it hasn't translated into strong credit growth primarily due to sluggish demand.

What this proves is that you can try to entice people to borrow, but you can't force them.

Japan has been faced with economic stagnation for 20 years and the IMF predicts it could grow by an anemic 2% this year and next. Deficit spending hasn't gotten Japan anywhere, except further into debt.

Japan's debt is nearly 230 percent of its GDP, the highest of any industrialized nation. Yet the Bank of Japan will continue its policy of saddling the nation with even more debt.

Faced with the same concerns about slow economic growth, the US government has been underpinning the economy for more than a year through government stimulus.

And the Federal Reserve will continue its program of expanding the money supply, or "quantitative easing" as it likes to call it.

However, despite an $787 billion federal stimulus program and $2.3 trillion in spending by the Fed, in the past year we've only seen an average of 2.38% growth.

But even the Fed can't force open the wallets of Americans, who are paying down debt and saving at a 3.4% rate. That does not bode well for an economy 70% reliant on consumer spending.

It seems that Japan, the US and the UK have not learned anything from the Greek debt crisis. Greece's debt isn't any bigger now than it was a year ago, it's just that everyone is suddenly paying attention. And Greece's prospects continue to go from bad to worse.

Last week, Moody's lowered Greece's bond ratings by four notches, taking it out of investment grade and into speculative 'junk' status.

The US, UK and Japan should take notice. Yet, these nations are being driven by politics, particularly a fear of how voters will react to economic pain. So the elected officials avoid it at all costs.

As a result, each nation continues to try to prime the economic pump through deficit spending and by printing money out of nothing. After all, under our economic system, if you're not growing you're dying. Stasis equals death. This is a dangerous strategy that will result in a debt trap from which there may be no escape, other than currency devaluation.

That will be very uncomfortable to the citizens of these nations. Their governments know this, and they also know the danger of simply printing money — inflation, or even hyperinflation.

But they seem to fear economic stagnation even more. Without government intervention, these economies certainly won't grow, which will increase their debt-to-GDP ratios. The US and UK, in particular (which have much larger external debts than Japan), need to finance their deficits or risk a dramatic rise in interest rates.

That would only make unemployment worse and risk social unrest.

The reality is that there are no easy options, no good choices. These governments are damned if they print money, damned if they continue deficit spending and — at least in the minds of the central bankers and the political leaders — damned if they don't.

They have entered the debt trap, and there is no way out.

At a minimum, there are only painful choices ahead.

Saturday, June 19, 2010

The Rising Debt, Shrinking GDP Conundrum

A country's Gross Domestic Product is comprised of personal and business consumption, government spending and exports.

The state of a nation's economy is dependent on whether the private sector and the government are borrowing money or paying down debt. In the case of the US government, it is always borrowing money to pay off old debts and to maintain its deficit spending.

The US economy is heavily reliant on consumer spending, which accounts for 70 percent of GDP. However, after a decade of unbridled spending, American consumers are tapped out and trying to reduce debt. Due to job losses, foreclosures, and the general fear generated by the recession, consumers have pulled back. That has created a drag on the US economy.

This restraint has gotten the attention of economists and bankers alike. No less than William C. Dudley, President and CEO of the Federal Reserve Bank of New York, recently noted, "Households are still in the process of de-leveraging."

No kidding.

Into the breach leapt the federal government, initiating a $487 billion spending bill last year. Though it was widely billed as a $787 billion spending package, $300 billion of it was dedicated to tax cuts for 95 percent of taxpayers.

However, all those billions are now drying up, which is creating a drag on the economy.

Further, exports account for just 12-13 percent of the US economy and cannot make up for shrinking consumer spending. As it stands, the US consistently runs a gaping trade deficit because we import more than we export.

The ability to increase exports won't just happen overnight. It would require a rapid expansion of our diminished manufacturing base. In addition, higher American wages, plus a rising dollar relative to other currencies, make US products less competitive than those from developing nations. That's a disadvantage that will be difficult to overcome.

For years, the US has been simultaneously running a trade deficit and rapidly growing its government debt. The government mantra has always been, "We can grow our way out of debt."

However, the only way to grow an economy is to either increase your population or increase your productivity. But US debt is far outpacing both population and productivity growth.

The problem for the US is that its debt is growing faster than nominal GDP. And at some point, the market will begin to think the US won't be able to repay its debts. The reality is that no nation can continually grow its debt faster than its income because at some point it is no longer able to borrow money. Eventually, the interest expense consumes a crushing portion of that nation's budget.

For the US, and most of the other industrialized nations, reducing debt will require some combination of tax hikes and budget cuts. But both have consequences.

Tax hikes reduce discretionary income and therefore consumer spending. They can also lead to diminished job creation, and perhaps even layoffs.

And when the government eventually decides to cut spending (which it must do), it will inevitably shrink GDP. A record-low 41.9% of the nation's personal income came from private wages and salaries in the first quarter, down from 44.6% when the recession began in December 2007.

This means that 58% of personal income is coming from government-provided benefits — like Social Security, unemployment insurance, food stamps and other programs.

If the government decreases spending, either private business would have to increase their deficits, or the trade balance has to shift from negative to positive, or some combination. Yet, the fact that the US imports two-thirds of the oil it uses implies that the trade balance will not change any time soon.

In essence, reduced government spending will lead to slower growth – at least in the short run. The cruel reality is that even as a country acts to cut spending and debt, its debt-to-GDP ratio can actually worsen.

As noted, the typical hope of any country in deep debt is to grow its way out of the problem. But advanced economies are mature, and therefore harder to grow. Most of the potential growth is long since realized.

Under the current recession conditions, government revenues are dropping. Because the government is taking in less revenue, there is already downward pressure on GDP. This is happening at the federal, state and local levels.

In the first quarter, spending by state and local governments declined by the largest amount since 1981. That's because they are all going broke.

Last year, federal tax revenues suffered the biggest single-year decline since the Great Depression. And nothing has changed. In fact, indications are that it's now even worse. Through April 30, the federal government’s nonwithheld income taxes were down 17.6 percent from a year earlier.

With less income to tax there is less government revenue, which could necessitate even more cuts. It could beget a vicious cycle that would be very difficult to get out of.

First-quarter growth was revised down to 3.0% from 3.2%, due to smaller increases in consumer spending and purchases of business software. Economists expected first quarter GDP to be revised upward to 3.5%.

All of the happy mainstream media talk about economic recovery appears to be nothing more than false optimism. It's time for some realism. The process of de-leveraging and debt reduction by consumers and the government will be a long and painful one that will have unintended consequences, such as a shrinking GDP.

Our entire economic system needs to be rethought and shifted away from debt creation/expansion and perpetual growth. We need to learn to live with less and accept a new economic reality, or a new normal.

Wednesday, June 16, 2010

Despite Recession, Income & Wealth Inequality Growing

Prior to the 2008 financial crash and subsequent recession, income inequality in the US had reached highs not seen since the run-up to the Great Depression.

And yet, since the stock market has recovered much more quickly than the broader economy, the situation has actually gotten worse.

Even though the stock market slumped into early last year, the Dow Jones industrials gained 19% over the course of 2009. And because the rich own a significantly larger potion of all assets, they have enjoyed a nice wealth rebound the rest of the country hasn't.

As a result, the millionaire class now holds a larger percentage of the country's wealth than it did in 2007.

According to data just released by Boston Consulting Group, the number of US households with at least $1 million in "bankable" assets climbed 15% last year to 4.7 million, after tumbling 21% in 2008.

And the percentage of total wealth held by those households increased slightly from 2007 -2009, to 55%, according to the consulting firm.

The middle class relies on home values for a larger slice of family wealth, yet the Federal Reserve reported that the net value of real estate owned by US households fell again in the first three months of this year, after sinking a total of $7.7 trillion from 2007-09.

Despite the declines in home equity, the stock market rebound was so great that Americans' collective net worth still managed to grow 4.3% last year and 2% in the first quarter of 2010, the Fed reported.

The middle class clearly hasn't noticed.

Incredibly, instead of reducing income inequality, the Great Recession has actually worsened a problem that's been growing for more than 30 years.

According to Lawrence R. Mishel and David M. Frankel (The State of Working America), in 1973 the median male weekly wage was $486.10. Corrected for inflation, that is $2,361.45 in 2009 dollars, or $122,795.40 annually. In its report entitled "Usual Weekly Earnings of Wage and Salary Workers: Second Quarter 2009", the Bureau of Labor Statistics reported that the median male weekly wage is now $815, or $42,380 annually.

So, there's been a nearly two-thirds reduction in male wages. Inexpensive debt had previously concealed some of the ramifications of that collapse in real wages. That reality can no longer be hidden.

These findings are not unique.

According to the CIA World Factbook, since 1975, practically all the gains in US household income have gone to the top 20% of households.

In the fall of 2008, Time Magazine reported that the bottom 99% of American wage earners experienced a growth in real average income of just 8% since 1980, while that of the top 1% jumped 177%.

The surprising fact isn't that the rich are so rich; it's that a substantial portion of Americans are quite poor, while many others are part of the middle class only by a very slim margin.

According to an analysis of wage data by Pulitzer Prize Winner David Cay Johnston, 33% of US workers make less than $15,000 annually, and 76% make less than $50,000 annually. Johnston says that roughly half of American workers make less than $500 per week. This supports the contention that the middle class is vanishing.

This is not the sort of equality or equal opportunity generally associated with the US. Perhaps we imagine this inequality taking place in other nations, but not here.

The 30-nation Organization for Economic Cooperation and Development (OECD) released a report on income distribution and poverty in October 2008. The report highlighted global gaps between rich and poor. Guess what great industrialized nation had the fourth highest inequality in incomes, followed by Mexico, Turkey and Portugal? Disturbingly, it was the US.

The report stated, "Rich households in America have been leaving both middle and poorer income groups behind. This has happened in many countries, but nowhere has this trend been so stark as in the United States."

So the wealth has not been getting spread around, as some contend; it's been going in one direction — up.

The thing that masked this polarization was the massive expansion of consumer credit in the last decade.

In 2007, consumer debt came to equal gross domestic product, meaning that Americans owed as much as our entire economy was worth. And by 2008, household debt had reached $14.5 trillion, actually exceeding our $14.2 trillion GDP.

To make up for decades of stagnant wages, and to perpetuate our continual-growth economy, lending practices were loosened and credit was made cheap and easy. People were made to feel affluent with money they didn't really have, but would eventually need to pay back – with interest.

This is how the masses, the common folk, were allowed to participate in our consumption economy along with the truly affluent. It was simply an illusion of wealth for millions, an illusion rooted in debt.

Unfortunately, millions of Americans — ostensibly part of the middle class — are now paying the costs of their indebtedness through a decreased standard of living.

Wealth and income inequality are resulting in a very big difference in the way the Great Recession is being felt and experienced by the vast majority of Americans. For most, further indebtedness is either unwanted or unattainable, and the new reality is unaffordable.

Sunday, June 13, 2010

Economic Indicators Reveal Continuing Troubles

While the mainstream media continues to proclaim that a nascent economic recovery is underway (to the point of sounding like cheerleaders), the economic data reveal otherwise.

The Commerce Department reported that consumer spending didn't grow at all in April. And now it says retail sales fell 1.2 percent in May, the first time they've fallen since Thanksgiving.

Last month, sales of existing homes were down 3.6 percent from the same month last year, according to the National Association of Realtors. And mortgage applications for new purchases are now at a 13-year low. All of this occurred despite mortgage rates being below 5 percent, plus an $8,000 federal tax credit for first-time buyers. And the median U.S. home sales price for May was $173,000, down 16.8 percent from the previous May.

In other words, all the pieces were in place for much healthier and more vigorous home sales. Yet that didn't happen.

Though the summer months are traditionally the best for home-buying, it is expected that sales will show declines this month and next. That is attributable to the expiration of the new home-buyer tax credit, which required purchasers to sign a contract by the end of April.

People without jobs, and those worried about losing them, don't do a lot of shopping or home-buying.

Of the 431,000 new jobs added in May, only 41,000 came from the private-sector. Government hiring accounted for the rest. This means that less than 10 percent of job creation came from the private sector. The other 90+ percent was the result of the government's temporary hiring of census workers. Meanwhile, state, and local governments continue to cut payrolls as they face crisis-level deficits.

None of this should have been unexpected. The economy is still anemic by almost any measure.

First-quarter growth was revised down to 3.0 percent from 3.2 percent, due to smaller increases in consumer spending and purchases of business software. Economists had anticipated the figure would be revised upward to 3.5 percent. That amounted to a significant decline from expectations.

And the projections show that things will get even worse.

The Consumer Metrics Institute expects the 3rd quarter GDP to be contracting at about a 2.0 percent rate.

Aside from being a warning to the US, the European debt crisis will have a more immediate economic impact here.

Though the US is not a significant exporter anymore (exports account for just 12-13 percent of GDP), the falling Euro only makes US goods more expensive, which will hurt our trade balance even further.

As the economy falters, the US government will be hard-pressed to intervene again — as it did last year — due to its heavy debt load.

The massive government stimulus applied to the economy in 2009, and the first half of this year, is now beginning to fade. What happens in the latter half of the year when the remaining funds are completely exhausted? All of those billions kept us out of a far more serious recession.

Government-provided benefits — from Social Security, unemployment insurance, food stamps and other programs — rose to a record high during the first three months of 2010, according to an analysis by USA Today. The analysis also found that paychecks from private business shrank to their smallest share of personal income in U.S. history.

A record-low 41.9 percent of the nation's personal income came from private wages and salaries in the first quarter, down from 44.6 percent when the recession began in December 2007.

This trend is simply unsustainable since the federal government depends on private wages to generate income taxes to pay for these programs.

Any economic improvements in the past year were attributable to the federal government's stimulus efforts. But, like it or not, all of that is coming to an end. The nation's economy will soon be required to stand on its own, but right now it is on wobbly legs.

Housing and jobs are years from real recovery. The nation will have to adjust to a new paradigm of lower and slower growth, and even the likelihood of economic stagnation. The mainstream media would do the nation a great service if it stopped peddling false hopes and instead focused on telling it like it is. We don't need phony optimism, we need realism.

"The recovery is not likely to be as robust as we would like... Households are still in the process of de-leveraging... The banking system is still under significant stress... Some of the sources that have supported the nascent recovery are temporary. The big swing from inventory liquidation to accumulation will soon end. And fiscal stimulus from the federal government is subsiding and will soon reverse." – William C. Dudley, President and CEO, Federal Reserve Bank of New York

Wednesday, June 09, 2010

The European Debt Crisis Should Be A Warning To The U.S.

However, two-thirds of federal budget is non-discretionary. That will impose some very difficult political and social choices.

The Greek debt crisis is emblematic of the larger debt problems spreading across the European continent. According to the World Bank, of the nations with the largest external debts (money owed to other nations), the top-10 are all European, and 17 of the top-20 are also European.

However, the US is #20, and has a deficit that is 10.6 percent of GDP for FY 2010, and will be 11 percent of GDP in FY 2011. As a consequence of years of continuous deficits, the national debt has now exploded to 89 percent of GDP.

Obviously, something's got to give. This sort of deficit spending simply cannot continue. It is likely that revenues (taxes) will have to increase and expenditures will have to decrease — substantially. The question is where those budget cuts will come from, and that will surely result in a major political battle.

The term “discretionary spending" refers to those parts of the federal budget over which Congress has the discretion to spend. These are the items that must be appropriated annually in order to receive government funding. In essence, the spending on these items is controllable.

However, most of the federal budget is non-discretionary spending, meaning it is mandatory. These expenditures — consisting of things like Social Security, Medicare and interest on the national debt — are automatic unless Congress acts to change them. The categories known as "entitlements" are often viewed as uncontrollable — politically at least — because Congress won't make the unpopular decisions to trim spending in these areas.

Due to the size of the Baby Boom generation (76 million strong), the number of people receiving entitlement benefits continues to grow. By 2030, 1 in 5 Americans will be 65 or over. This means that 20 percent of Americans will collecting Social Security and Medicare. We can expect the retirement age of 66 to be pushed back, and the enactment of higher payroll taxes (FICA).

Incredibly, agricultural subsidies also fall into the category of non-discretionary spending. That's right, Congress doesn’t have to budget that money each year either—it’s automatic. This is due to the enormous political power of the giant Agri-Business and it's ability to manipulate the $286 billion Farm Bill, which has resulted in an array of loans, price supports, subsidized insurance, disaster aid and money-for-nothing handouts.

However, the largest mandatory items are the entitlements and interest on the national debt. If you include payments to veterans, these items collectively account for about two-thirds of the federal budget.

That's worth repeating; two-thirds of the Federal Budget is comprised of mandatory spending.

Yet, these are the areas that need to be trimmed to truly have an impact. Eliminating things like the National Endowment for the Arts ($161.3 million), NASA ($18.4 billion), and even foreign aid ($36.7 billion — less than 1% of budget) is just tinkering at the margins and won't make any meaningful difference to our long term fiscal position.

The largest single portion of discretionary spending in the federal budget is in the defense budget. In fact, about 58 percent of all discretionary funding is defense related, according to Donald M. Snow, Professor Emeritus at the University of Alabama.

What this means is that non-defense discretionary spending is less than half of the discretionary category, which is itself only one-third of the total federal budget. In other words, non-defense discretionary funding makes up only 15 percent of this year’s federal budget.

It's clear that if discretionary spending is to be cut in any meaningful way, it will have to come from military spending.

Officially, spending on veteran’s medical care and pensions are classified as an entitlement expenditure, as opposed to part of the defense budget. As a result, that spending does not show up in defense outlays.

As a whole, the Veteran’s Health Administration delivers free and low-cost health care to more than 8 million veterans.

And the outlays will only grow; the Department of Veterans' Affairs reports a proposed, and unprecedented, 27 percent increase in benefits funding. It will be needed. The department broke the 1 million mark in benefits claims in 2009 and that is expected to increase by 13 percent this year and 11 percent in 2011.

For the next fiscal year, official estimates put defense spending at about $650 billion, plus an additional $200 billion or so for Iraq and Afghanistan. That's a total of $850 billion, yet not all defense spending is officially reported or budgeted.

Money for the Energy Department to work on the nation’s nuclear arsenal, the Selective Service, Homeland Security, and other defense-related spending pushes the number even higher.

According to an analysis of the 2011 Federal Budget by the War Resister's League (an annual project), when the cost of two concurrent wars, veterans benefits and the interest on the debt created by military spending are added to the current military budget, overall defense spending equals 48 percent of the total Federal Budget.

That's truly stunning.

Trimming the Federal Budget to get spending under control has to begin with the military. Consider this: more than 60 years after the end of WWII, the US still has more than 50,000 troops in Germany and 30,000 in Japan.

In fact, the US has over 1.4 million active duty military personnel — 500,000 of whom are deployed on over 700 bases in more than 150 countries and territories, including 37 European nations.

The stunning reality is that US military spending exceeds the combined total of every other country in the world. To put it another way, the spending amounts to $1.2 million per minute, or $1.7 billion per day.

Consider this; if the Pentagon were an independent country, it would be the 10th richest in the world.

Last week, the cost of the wars in Iraq and Afghanistan surpassed $1 Trillion. Yet, each and every month, the war in Iraq costs our nation an additional $5.5 billion, while Afghanistan drains $6.7 billion from US taxpayers. That amounts to more than $12 billion each and every month.

The nation simply does not have the resources to continue paying for these unyielding war costs, or the sheer weight of our bloated military budget.

Estimated federal revenues for fiscal year 2010 are $2.381 trillion, an estimated decrease of 11% from 2009. Meanwhile, the budget for 2010 totals $3.55 trillion, resulting in a deficit of $1.17 trillion. That's on top of the $1.42 trillion deficit for fiscal year 2009.

Last week, the national debt breached $13 trillion, and it is projected to reach $20 trillion by 2015. This path is simply unsustainable.

The US won't solve is severe debt problem unless is trims the two-thirds of the budget that it non-discretionary. Reducing deficits and debt will have to come through a number of means, from raising the retirement age to increasing payroll and income taxes (which will be painful and hurt GDP).

But, most especially, the outsized military budget — still geared toward fighting the Cold War — needs to be trimmed considerably.

All of these moves require great political courage, which is almost non-existent in Washington these days. That's why it is difficult to be optimistic about the process, not to mention our long term economic and fiscal prospects.