A different take on the economy (???)

An acquaintance of mine, Doug Tengdin, a CFA (Chartered Financial Analyst), writes an engaging five-days-per-week financial commentary on his employer's website.

His perspective about the state of America's finances has seemed so far out-of-step with what I've been thinking that last week I "couldn't take it anymore." So I wrote him:

Doug:

Your Global Market Update for last Friday (i.e., 2/12) suggested Greece’s economic difficulties should be “a cautionary tale for all countries with budget problems.”

I'm curious, then, why you seem rather sanguine about the United States’ situation. . . . I can't put my finger on specific posts, but that has been my general feeling.

I “just” wish I could get a stronger sense of WHY I should look with favor on the U.S.’ position . . . or acquire some kind of confirmation that I'm not quite crazy to be writing posts like these on my blog:

• The long-term demise of the U.S. dollar
   
• The financial future of the United States
   
• Need a Churchill for our age?

Yesterday morning’s post:

• The Greenspan-Guidotti Rule (or Guidotti-Greenspan)

. . . I'm hoping perhaps some of this might inspire a post or two. . . .

Thanks!

He wrote back pretty much what he posted on Tuesday in Why Not Here? Major reason people in the U.S. ought not to worry: "The US isn’t Greece."

• "We don’t have a culture of permanent employment and tax evasion as a national sport."
   
• "We have a culture that includes a modest safety net along with entrepreneurial innovation."
   
• "We have an incrementalist political culture that is . . . hostile to revolutionary change. . . . That’s a good thing for investment and wealth accumulation."
   
• "The US debt level isn’t as high as many people fear. Much of our 'debt' is held internally by Social Security."
   
• "For the past 30 years, real economic growth has averaged 3%. Deficits have averaged 2.5%. So the debt, as a percentage of the economy, has been getting smaller."
   
• "Greece [ran 10% deficits] for years. And played with the accounting rules to mask this. We didn’t do that." (On the other hand, "if we run 10% deficits in the long run, that’s another story.")
   
• "[T]he government is a much smaller part of the economy here than most people realize. Government spending makes up about 28% of GDP. By contrast, the Greek public sector is 40% of their economy. So it’s harder to cut spending there without pushing Greece into another recession."

There was one last comment he made in his personal response that particularly struck my eye.

It appears he read my Banking, lending . . . and government bond auctions post in which I reference Bob Prechter of Elliott Wave fame.

Doug wrote:

I’m skeptical of the Elliot Wave. . . . History is not destiny—it’s a guide as to human character and behavior. Prechter misses the fundamentals for the charts.

Here’s a fundamentalist I respect:

http://www.ft.com/cms/s/0/7467f85e-1b30-11df-953f-00144feab49a.html


In this post Martin Wolf quotes Brad DeLong. I’m not so keen on DeLong, but he makes a good point: short-term deficits are a bet that borrowing is worth it in the long run. If the present value of the future cash streams of the borrowing are less than the present value of the income stream that you create by avoiding the wealth destruction of a financial panic (or revolution or war), then the borrowing was an economic plus.

Many of the gloom-crew ignore Stein’s Law: If something cannot continue it will stop. And Coolidge’s dictum: if ten problems are coming toward you down the road, chances are that nine of them will go off into the ditch before they reach you.

There's a lot in these three paragraphs. But even more in the referenced article. And at far too many points, in what Doug wrote and in what I read in the referenced article, I found (and find) myself highly skeptical or critical of what the authors are saying.

Let me begin with Doug's comments:

• "We don’t have a culture of permanent employment and tax evasion as a national sport." --Okay. That's good. I'll buy that. For now. (Though it appears our country is heading downhill on this score.)
   
• "We have a culture that includes a modest safety net along with entrepreneurial innovation." --Again a good point. Indeed, a very good point. May it continue!
   
• "We have an incrementalist political culture that is . . . hostile to revolutionary change. . . . That’s a good thing for investment and wealth accumulation." --Amen.

But now I begin balking:

• "The US debt level isn’t as high as many people fear. Much of our 'debt' is held internally by Social Security." --???? I'm afraid our debt is far higher than our government acknowledges. What about all the unfunded future obligations? And what about the debt Doug tries to minimize by means of the quotation marks? He says it is "held internally by Social Security." --And we are supposed to take comfort in that? The fact that the government uses debt to pay debt? That it has already spent all the funds Americans have "invested" in their Social Security accounts? The fact that all of the federal government's future obligations for Social Security and Medicaid and Medicare are going to have to be funded through future taxes . . . because it has saved absolutely no money in any of the "fund" accounts that have supposedly been "set aside" for those purposes?
   
• "For the past 30 years, real economic growth has averaged 3%. Deficits have averaged 2.5%. So the debt, as a percentage of the economy, has been getting smaller." --There is some truth and, I'm afraid, quite a bit of falsehood in that statement. Yes, the debt as a percentage of the economy declined quite steadily from 1948 till 1974; but then it began increasing--in fact, it more than doubled--from 1974 through the early 1990s. At that point, it officially began to hold steady and even decline till about 2001. But then it has taken off again.
  
  Part of the problem, however: We are talking about acknowledged public debt. We are not talking about the government's massive unacknowledged "off-book" and unfunded obligations. As Michael Hodges explains in answer to the question, "Since debt increased each year, how could [federal government] officials claim they had a budget surplus in the late 1990s and 2000?"
  

  Answer: the general federal government did not have a surplus. In fact, they ran a huge deficit each and every year. . . . The Deficit-Trust Report shows the general government spent more than its general revenues, but they covered up the over-spending deficit by siphoning-off all surpluses from all trust funds, including spending every penny remaining in the social security trust fund on non-pension items - - while creating even more debt IOUs to 'paper-over' their actions. . . . See the 1999-2000 data report.

• "Greece [ran 10% deficits] for years. And played with the accounting rules to mask this. We didn’t do that." --Really? You wouldn't call the use of all the Social Security funds for current government expenses, and the massive increases in unfunded mandates and unfunded future obligations and massive "off-book" accounts (for example, the trillions of dollars of Fannie Mae and Freddie Mac obligations now being guaranteed by our government--off the books--a kind of "playing with the accounting rules"?
   
• "[T]he government is a much smaller part of the economy here than most people realize. Government spending makes up about 28% of GDP. By contrast, the Greek public sector is 40% of their economy. So it’s harder to cut spending there without pushing Greece into another recession." --How wonderful! But should we rejoice simply because they are worse off than we?

But where I really got bogged down was here, in the material Doug had me consider from the "fundamentalist" he said he respects:

First, Doug's comment about Brad DeLong's "good point" . . . that "short-term deficits are a bet that borrowing is worth it in the long run."

And I wonder: Are they really? Always? Or do some people--and some governments--borrow not with any real intention of paying the debt back, but with the (vain) hope that somehow, somewhere, someone will get it paid back . . . "just so long as it's not us (or me) right now." --The whole "Let's palm our problems off on someone else" methodology; the kind of behavior that Porter Stansberry noted that GM managers were engaging in for years before the company was finally forced to declare bankruptcy: "GM had no conceivable way to repay its debts. It was even borrowing money to pay for the interest expense on its existing debts." Moreover, "GM used byzantine accounting to hide the truth of its deteriorating fiscal condition." --And isn't that what the United States government is doing at this point?

"Many of the gloom-crew ignore Stein’s Law," Doug says: "If something cannot continue it will stop."

Oh, yes! That is correct. It will stop. The question is, will it stop of its own accord, with a positive outcome? Or will it stop in pain by the force of outside agencies?

"And [the gloom-crew ignore] Coolidge’s dictum: if ten problems are coming toward you down the road, chances are that nine of them will go off into the ditch before they reach you."

Very nice.

But/and/then, what are we to make of Martin Wolf's concluding remarks?

[A]s the BIS [Bank of International Settlements] paper . . . noted, long-run fiscal prospects, largely driven by ageing, are dire. Projecting forward from the dreadful starting points [i.e., where these nations' balance sheets are today], the BIS authors argue that ratios of public debt to GDP could reach 250 per cent of GDP in Italy by 2050, 300 per cent in Germany, 400 per cent in France, 450 per cent in the US, 500 per cent in the UK and 600 per cent in Japan. If the sovereign debts of high-income countries are not to be reduced to junk, these countries do indeed need credible plans for retrenchment. On this there is no disagreement.

????!!!!

Did you catch what Wolf is saying? That the United States, Great Britain and/or Japan might wind up with public debt equivalent to 4.5, 5, or even 6 times their Gross Domestic Products?

Can you imagine anyone being foolish enough to lend a government money so it can go that far into debt?

Suppose we take the "conservative" 450% of GDP number that the authors of this study--and the "conservative" fundamentalist Martin Wolf!--suggest for the United States.

At an interest rate of only 5%--which is extremely low, considering the risks involved!--the interest payments alone on such a debt would amount to 21.25% of Gross Domestic Product. That is interest only. No current expenses. No services. No employees.

I don't believe that day will ever get here. Impossible. Doug is correct: Stein’s Law will come into play long before that occurs: "If something cannot continue it will stop."

But what really gets me is how Wolf "argues" his "case."

Look at his conclusion:

The best approach [to the future crisis] would be sharp reductions in long-term growth of entitlement spending. Furthermore, as economies recover, short-term fiscal action will be needed. Actions will have to include spending cuts and increases in tax, to restore revenue lost forever in the crisis. . . .

So, yes, high-income countries face huge fiscal challenges. And yes, the crisis-hit countries start from grossly unsustainable fiscal positions. But the US is not Greece. Moreover, a massive fiscal tightening today would be a grave error. There is a huge risk – in my view, a certainty – that this would tip much of the world back into recession. The private sector must heal. That, not fiscal retrenchment, is the priority.

In other words: Yes, we're in trouble, and yes, we need to take care of the dire future we can see coming at us. And, yes, we need to sharply reduce our entitlement spending. But . . . not now. Not now. This is a bad time.

Put another way: "I don't really have any good solutions. But tightening our belts right now is a very bad idea."

And I reply: Based on the federal government's behavior throughout the last 40 years, when is a good time to tighten our belts?

My hypothesis?

Never. Never "now." Tightening our belts is always a good idea "sometime in the future."

From the politicians' perspective, it is never a good time to pay back debts we have accrued. It is always a fine time to borrow on the future.

. . . Which brings us back to the issues I've been raising in so many of my posts over the last few weeks: My friend Doug's attempts to dissuade me notwithstanding, I don't see a bright future for our country . . . primarily because there is no one who has the guts to address the fundamental fiscal problems that confront us.