So the debt ceiling was finally passed by Congress with all the passion of a divorcing couple sizing each other up as their mortal enemy. Each party boldly declared victory while blasting the other party as the major impediment to what could have been an earlier solution. Yet, for all of their grandstanding, what did it really get us?
Well, for one it raised the ceiling by a total of $2.4 trillion, $400 billion of it effective immediately. An additional $500 million can be requested by President Obama as soon as the next few months, but can be rejected by a two-thirds override by Congress, which would be veto-proof. Finally, the balance of $1.2-1.5 trillion could be doled out at a later date if a special 12 panel committee (six nominated by Republicans, six by Democrats) deems it necessary AFTER they find a matching amount of spending cuts. Hmmm…I’ll bet there will be at least 12 districts that won’t feel much pain from THOSE cuts. However (at least there’s a “however”), if the Fab 12 simply cannot agree on which cuts to make (or if they’re rejected by Congress), then automatic $1.2 trillion of “across the board” spending cuts will take place.
And as usual, there is a big Washington caveat to all of this; the special commitee will not be meeting until later and they must have a final vote on the cuts by December 23rd. In the meantime, apparently vacations and palm pressing (while filling up the 2012 re-election coffers) are in order, more so than getting our fiscal house straightened out. Talk about kicking the problem down the road. Again.
And the payoff for all this intense Congressional wrangling? A whopping $900 billion of savings over the next ten years. Sarcasm aside, when you’re running a deficit of $14 trillion (more on that later), $900 billion over a ten year period is not going to get the job done. Unless the CBO (Congressional Budget Office) is looking at an economy expanding at a rate of 4-5% annually (so tax receipts come in as a perpetual tidal wave), Uncle Sam is still going to be in direct competition with you and me for those dollars. One guess who usually wins that tug of war. So while I’m pleased that the ceiling WAS raised (as distasteful as it was) to avoid our creditors’ crisis of confidence, I’m none too thrilled that the hard decisions of what exactly gets cut are yet again deferred, as well as left lacking in real substantive reductions.
Anyhow, with the debt ceiling being “settled”, a poem from my childhood came to mind immediately; one that’s been ringing in my ears ever since. It’s entitled “Mighty Casey At Bat” by Ernest Lawrence Thayer and it’s one which I’ve recalled on more than one occasion when I’ve come across overconfidence (of course, never relating to your author, ahem…). The taste of humility is never sweet at the time, but like any hard lesson, it’s one that bears fruit over time. You can click the link here to read the poem. Note the date it was published. Some things really are timeless. http://ops.tamu.edu/x075bb/poems/casey.html
The Irony of Austerity
Wikepedia gives the definition of austerity as “sternness or severity of manner or attitude”. In economic terms, “the policy of deficit cutting, lower spending and the reduction in the amount of benefits and public services provided”. These definitions point clearly to Greece and what will amount to its near and long term future. Plainly speaking, it’s my opinion that Greece is headed toward an all-out depression, regardless of what the media says or what Greece itself wants to believe. Years upon years of living beyond its means, giving out generous social benefits which generations came to believe was their birthright, all the while failing miserably at collecting taxes on their citizenry have led to massive deficits and continued refinancing of their debt. And when it came time to join the EU (European Union) and adopt the euro as their currency, Greece was more than happy to tie their debts to a currency that was stronger than their drachma (their native currency). After all, the euro is primarily tied to the two largest economies in Europe: Germany and France. It didn’t take long for the Greeks to realize that if they weren’t able to solve their problems on their own, they would now have deeper pockets upon which to rely to solve them. Greece’s problems would become Germany and France’s problems. Greece saw an economic savior of sorts, while Germany and France would basically inherit the equivalent of a dysfunctional family who lacked the discipline to make the hard choices at the time when they mattered.
Why is it Germany and France’s problem? While the Greek economy is tiny compared to other European economies, their debt was bought by those other economies (across Europe, not just Germany and France) and became a virus of sorts in European banks and other investments. When that debt started to lose significant value due to the inability of Greece to make good on its debt payments, those institutions were facing sizable losses. All of which meant that the free flow of credit in Europe could freeze if enough losses and fear were realized (as in, runs on banks). Since Germany and France are the two largest economies in Europe, as losses mount and economies unravel, they would inevitably begin to feel their economies slow down; slow at first, then all at once. It’s in their interest to string along Greece until a true solution is found that doesn’t have as much of a potential impact on them as an all-out default. What that is, if it even exists, remains to be seen.
Which brings us to the present. Greece has now received two “stays of execution” regarding its debt with the ECB (European Central Bank). Not only has the ECB given out additional loans to keep the Greek economy afloat, but it also “restructured” the duration of the original debt, which means that the major players (Germany and France) have had to agree to extend the duration of that debt to allow Greece time to get its economy in economic order. And just what is that “economic order”? This is where austerity comes in. Part of what Greece agreed to was the implementation of severe governmental spending cuts. Those cuts included much of the entitlements the Greek populace became dependent on, namely governmental pensions, early retirement income payments and other public services which were taken for granted. Remember, generations of Greeks viewed these benefits as their right and when they learned that they were being cut dramatically, rioting broke out in the streets.
So what is the economic irony in the austerity measures? Well, since the Greek government is such a big part of their economy (when they make pension payments to their citizens for example and that money is spent in their economy), a serious reduction in those payments means that the amount of cash spent in the economy will be severely cut as well. If there’s that much less money in circulation in the economy, it’s only a matter of time before businesses start failing, which leads to higher unemployment. Two things happen here: one, tax receipts will be lower initially, since there’s less money in circulation and two, as businesses start to fail an additional shortfall of tax revenue now exists. The end result is that for a government (which is depending on a consistent tax revenue amount to be generated) to make its agreed upon restructured debt payments as promised, its cutbacks in benefits have actually made it more difficult for it to do so. So the irony is that the very cuts the EU wants to see so that Greece does not overspend (they only spend approximately what they bring in) will inevitably lead to slower growth, further layoffs and finally, lower tax receipts to pay off its obligations. Greece finds itself in a very sticky situation; it must either cut its spending and thrust itself into a painful, very slow growth path or it can do what many believe is its eventual outcome: default and a return to its own currency. Doing so might give it the fresh start it needs, but the economic fallout in Europe (as well as the precedent it would be setting to other countries) would be nothing short of volatile.
Austerity American style, anyone?
First, the good news: we’re all Americans. Regardless of how we feel about our elected officials and the general state of the economy, I feel that there is truly no better place to build (or rebuild) a rewarding life, limited only by our imagination and perserverance. We’re free (in too many ways to mention here), with many brave men and women having given their lives so that we can have the opportunities available to fulfill our dreams now. Let’s never forget that. We owe them at least that much.
Now the not-so-good news: our government has a leadership void and the American people are beginning to realize it. This doesn’t manifest itself in an obvious manner, much like when there’s an argument and each side is loud and argumentative about their position. Rather, it’s more of a retrenchment, where consumers put their hand on their wallet (or purse) and decide it’s probably better to “wait and see” than buy now. As I said in ” The Road Narrows”, when there is no leadership, there’s very little confidence. If individuals, companies and municipalities don’t know what the economic landscape (jobs and taxes) is going to look like within the next few years, they have little incentive to put their hard earned cash in big dollar purchases (durable goods, capital spending).
This is beginning to show up in the numbers: revisions to our gross domestic product have gone all the way back to the fourth quarter of 2010 and not in the right direction. For the 4th quarter of 2010, the economy only grew 2.3% (initially, it was 3.1%); 1st Qtr 2011: 0.4% vs 1.9% initially; 2nd Qtr 2011 1.3% vs initial forecast of 1.8%. Wrong direction indeed. Further, consumer confidence is at its lowest level since 1980 and shows no sign of rebounding to the upside soon. What we’re beginning to see is that more Americans are once again implementing their own brand of self imposed austerity; spend less and save more (or pay down debt). And when consumers pull back, tax receipts inevitably contract. This is where a different kind of auterity settles in; one not mandated by creditors, but rather one that evolves due to lack of confidence and uncertainty. Since the government coffers shrink due to less spending, two things happen: first, federal spending declines, meaning entitlements and transfer payments (unemployment comp, food stamps, etc…) might be cut, along with payments to states. Secondly, state budgets must adjust to lower tax inflows, meaning all non essential items in the budget get cut (and perhaps some essentials, like lower education spending, which would have catastrophic long term competitive results). Either way, it has the same outcome in principle as what Greece is experiencing; whereas Greece’s economy was government fueled, the U.S. economy is 70% fueled by consumer spending. Reductions in the type of spending that an economy is used to will result in contraction and, if not remedied, recession or possibly depression.
So what’s a government to do? It’s been debated by many that an all-out reduction in spending to only match that which is brought in (tax receipts) should be implemented so as not to add to the deficit. In this scenario, any additional spending would have to be met with cuts in current spending. The thought behind this logic is that it would deficit neutral, meaning that no additional debt would be taken on. This has merit, except that the initial shock of cuts to those receiving benefits currently would undoubtedly add to the unemployment rolls (it’s doubtful that eliminating all “pork” would balance income vs spending without affecting benefits payments). Doing so would decelerate spending intially, thereby actually adding to the deficit, by virtue of less tax receipts due to reduced spending. It may also add to the misery index of those who suddenly find themselves without income or a job.
Others (Keynesians) believe yet another round of stimulus (QE3) is the path that needs to be taken; this time squarely directed at infrastructure spending (roads, bridges, etc…), which may give a direct injection to the economy, as well as badly needed improvements. While I’m not advocating such a program, there is a significant difference between that type of stimulus and QE1 and QE2; QE1 was primarily directed at restoring liquidity to avoid credit freeze, with the unpleasant side effect of benefitting many who were responsible for the collapse in the first place; Qe2 was used to purchase treasuries and other debt to keep mid to long end interest rates down (to stimulate home sales, etc…). While it’s debatable if either was the success they were meant to be, (QE1 kept credit flowing, but actually increased risk by shrinking the number of major financial institutions; QE2 didn’t have the stimulative effect that was intended, ie: at least 3% GDP and also fueled the rise in equity and commodities prices; see “The Problem With Bubbles”), what isn’t debatable is that many now have no appetite for any additional government spending.
QE1 and QE2 also didn’t have a direct effect on the velocity of money (the frequency which money changes hands), only on the availability of credit and cost of borrowing, kept low to incentivize spending. In a capital improvements “stimulus”, states and municipalities could receive a certain amount dedicated for infrastructure. The state then can increase that amount by floating bonds if they desire, the interest of which can be paid by ”user fees” or increased tax receipts brought in by the increased spending. In a work for hire setting, when one is hired, he is paid fair market value for work performed. From his paycheck he purchases essentials (and perhaps non essentials as well). From that same paycheck he also pays taxes, which reimburses the government for part of the stimulus. Additionally, the merchants he buys from also pay taxes on the goods and services sold. Local and state taxes also increase, as the more money changes hands, the more tax is paid. The velocity has therefore increased not only from our employee, but also with regards to tax receipts and those he purchases from indirectly. One last additional “perk”; now that our individual is working, he’s undoubtedly feeling more confident about his own financial future and will probably work to rebuild his credit by paying off his debt (deleveraging). This “stimulus” is not without its own faults, but is better than handing a check to someone for doing nothing. Just saying…
Compare this scenario against what has taken place over the past few years, namely increased transfer payments (unemployment benefits, food stamps etc…). These payments, which primarily have fixed value, are given without any corresponding value in return. The velocity, therefore, is static at best and the payback to the government is limited (by the way, 40 million Americans are now on some form of “welfare”; this is way too sad and must be corrected!) Entrepreneurship and competition is non existent in this setting and the value of work (to both the individual and country) is devalued; in the former example, both are encouraged.
So what’s the answer to the current economic malaise we’re in? What’s NOT the answer is what Washington has been doing, namely attempting to paper over the problem without generating any real value. Somewhere in the answer lies a mix of spending cuts, redirected spending of existing resources to generate value and incentives for entrepreneurs to start businesses. And that requires leadership, which sadly, is AWOL at the moment. It won’t be easy, there will be pain, but it will be defined by the work ethic that made our country great in the first place. And we are great; it’s just occasionally a crisis needs to come along for us to rediscover what made us great in the first place. If we hold true to our work ethic, “American Austerity” will be one of manageable choice, not of mandate. God Bless.
