Tag Archives: Social Security

Debt too high saps economic growth.

Debt. You don’t like it. I don’t like it. No one likes it.

And yet, without it, much of the prosperity and technological progress we rely upon would not be possible. Finance and the power of compound interest has thrust our economy forward faster than any in history. Yet, compound interest is not a tool you want to be used against you. As New York Times columnist Carl Richards notes, “It’s always been one of the most powerful forces in the financial universe.”

Don’t think it matters? Just consider the result of the downgrade of American credit:

Think about that for a minute. If those worst-case-scenario interest rates came to pass and persisted, we’d be approaching a trillion dollars in interest payments per year. That’s what compound interest looks like when it’s working against you.

If that trillion dollar number doesn’t do it for you (that’s 1,000,000,000,000), consider it on a more personal scale.

On a personal scale, you get a taste of it every month if you get careless with credit cards. Take a look at a bill. For every month you carry a balance, there’s a minimum payment required.

Use carefully, it’s a great tool for growth.

Without financing, countries–and businesses and families–are poor and stay poor. Whether it’s a student loan to get through college and get a job that pays better, a business loan to cover the cash flow gap between invoice and payment, or money to build infrastructure and fund the armed forces, finance is a necessary part of growth and getting out of poverty.

Yes, taking on debt creates vulnerabilities for any of these parties; however,  debt managed and controlled brings prosperity.

On the other hand, debt out of control creates financial crises. It stops = growth and harms economies.

When the ratio of debt to income rises to a certain level, a new study shows, financial crises–be it household debt, corporate debt, or a national government’s debt–“become both more likely and more severe.” In other words, too much debt is not a good thing.

Well, duh.

The study, entitled blandly but descriptively “The real effects of debt,” was reported by Stephen G. Cecchetti, M.S. Mohanty, and Fabrizio Zampolli, economists at the Bank for International Settlements, at the “Achieving Maximum Long-Run Growth” Symposium in Jackson Hole last week.

I can only imagine that the report’s findings threw a lot of cold water on the “more stimulus/raise the debt ceiling” crowd (aka “New Keynesian orthodoxy” believers, according to the economists), including Fed Chairman Ben Bernanke, fresh back from scolding Republicans for their reticence to raise the debt ceiling.

Why? Because, at least in part, the finding vindicates Republican fears about the malignant effect debt can have, and is having, on the national economy.

From the Introduction:

Our result for public debt has the immediate implication that highly indebted governments should aim not only at stabilising their debt but also at reducing it to sufficiently low levels that do not retard growth. Prudence dictates that governments should also aim to keep their debt well below the estimated thresholds so that even extraordinary events are unlikely to push their debt to levels that become damaging to growth.

Emphasis my own.

Which leads to the question: at what levels does begin to hurt and retard growth? The empirical results of the study, based on review of debt levels in 18 OECD countries from 1980 to 2010, show that:

  • Households can handle a threshold of about 85% of debt to income.
  • For corporations (non-financial), the number is about 90%.
  • Governments can borrow between 80 and 100% of GDP.

But that’s just in the short-term. Looking at advanced economies–in other words, Western Europe and the United States, Japan, and Australia– the problem is

compounded by unfavorable demographics. The ageing of populations and the rise in dependency ratios have also the potential to slow growth, making it more difficult to escape the negative debt dynamics that are now looming.

In other words, in our economy more of our population is getting old and few children are being born, which means that Social Security, Medicare, and Medicaid all have fewer  people paying for them and more and more people drawing on them.

If I’ve learned nothing from leaving the bachelor world for the role of a family man, buying too many Happy Meals for the kids may make me feel good, but it’s more expensive than a BBQ at home, and its less healthy, too. And when costs are going up faster than my income, that’s not the time to go out and get more debt.

What is our current federal debt ratio to GDP, then? Check out the chart below, and how it compares over our history. Note that, prior to recent history, the level of debt is only comparable to times when we have been at war.

World wide war.

In the meantime, we’ve become addicted to the Happy Meals as a national economy. While Social Security, Medicaid, and Medicare were all begun with the laudable, and often successful, goal of caring for the poor, sick, and elderly, they have expanded to bloat our national budget to a place where our ability to help those needy groups will someday become questionable.

And I do emphasis will. It is inevitable that if we continue on our current track we will be unable to aid those in need. The time for reform was last year, and the longer we delay, the more difficult it will be. We’re not getting any younger as a nation, and we’re not getting any richer either.

The debt is just too damn high.

[via CNBC, New York Times, and BIS]

Enhanced by Zemanta

Entitlement Reform: Start with Social Security

INFOGRAPHIC - Why Social Security Needs To Be ...

Image by Third Way via Flickr

It is almost cliché for my generation to joke that  Social Security will be gone before we retire.  It may be a stretch, but it really is no joking matter. Social Security is in a bad way, and it is getting worse.

The number of Social Security recipients is  growing faster than the number of people paying into it. It is a likely scenario that the Social Security trust fund (which doesn’t really exist, anyway) will be gone by the time I stop paying in and start asking for it back.

Continue reading

Cutting Non-Defense Discretionary Spending Just Isn’t Enough

Cutting discretionary spending alone is not going to solve our fiscal woes. Entitlement reform must happen if we’re to maintain our economic strength.

That, or raise taxes. A lot.

Adding up the Federal Balance Sheet

Click to see larger image.

Do you know your net worth? If you add up all your assets (cash, property, etc) and subtract all your liabilities (debts), do you know what you are worth?

As a person, your net worth on paper doesn’t really account for your intangibles, like personality, education, or dashing good looks. Just your value if you sold everything you own.

Now how about the United States?  What is the net worth of our “of the people, by the people, for the people” government? If we were to add up all the assets and liabilities, what would our country be worth (or owe, as the case may be)?

The question matters. Though we hear a lot of talk about deficits, earmarks, and budget cutting, there is a world of difference between what politicians usually deal with–discretionary spending–and what is the biggest debts on the US balance sheet–the entitlements.

Let’s look at the stuff we hear a lot about: cutting  the discretionary spending in the federal budget. In reality, this is one of the smaller items on the federal balance sheet, but it’s the one that gets the most play in the news.  For example, look at this visualization by William Gross:

Look at “Non-Defense Discretionary” on line three of this (extremely) simplified  federal budget. In 2011, non-Defense Discretionary items will make up just a quarter of the budget. Over the last 40 years, it makes up on average only 23%. I doesn’t change that much. In other words, when we hear about politicians cutting discretionary items, they’re just chopping at the leaves, but leaving the trunk relatively unscathed.

That trunk is the other 75% of the budget. It’s stuff that Congress doesn’t mess with, can’t mess with, or, and here’s the kicker, is afraid to mess with. We’re talking entitlements, defense, and interest payments on the debt the United States owes to creditors. This means Medicaid, Medicare, Social Security, the Departments of Defense and Homeland Security, and, of course, interest payments on debt to, increasingly, people who live overseas and have loaned the US government money.

Of those, the scariest, the piece of the budget that is the largest, and that is going to grow the fastest in the coming decades, too, is the entitlement part. It’s Medicaid, Medicare, and Social Security. And it’s not even funded. The Congress has promised these benefits to people without coming up with a way to pay for them.

Remember, were talking liabilities, here, and unlike Defense spending, which has been fairly constant over the last forty years, entitlements will grow at a rate faster than tax revenues.  Because they are unfunded, and because they will grow rapidly over the coming decades, the government will need to borrow to pay for them. As  a result, as they grow, they’ll be paid for with more debt, which will increase the size of the interest payments.

Check it as Gross explains the danger:

The above four multi-trillion-dollar liability balls are staggering in their implications. Remember first of all that the nearly $65 trillion of entitlement liabilities shown above are not some estimate of future spending. They are the discounted net present value of current spending should it continue at the projected demographic rate (importantly ­– it is much higher than the annual CPI + 1% used as a discounter because demand for healthcare rises much faster than inflation.) And while some Honorable Congressional Le Pews would counter that Medicaid is appropriated annually and therefore requires no discounted reserve, those words would surely count as “sweet nothings,” believable only to those whom they romance every several years at the polls. The incredible reality is that the $9.1 trillion federal debt that constitutes the next-to-tiniest ball in our chart is nothing compared to unfunded Medicaid and Medicare. It is like comparing Pluto to Saturn and Jupiter. The former (the $9.1 trillion current Treasury debt) does not even merit planetary status in our solar system of discounted future liabilities. It’s really just a large asteroid.

Look at it another way and our dire situation becomes equally revealing. Suppose that the $65 trillion of entitlement liabilities were fully funded in a “lockbox,” much like Social Security is falsely imagined to be. Just suppose. And say the cost of that funding (Treasury debt) was the same CPI + 1% that was used to produce the above discounted present value in the first place. Actually, that’s not a bad guesstimate for the average yield of all Treasury debt. If so, then the interest expense on the $75 trillion total debt would equal $2.6 trillion, quite close to the current level of entitlement spending for Social Security, Medicare and Medicaid. What do we pay now in interest? About $250 billion. Our annual “lockbox” tab would rise by $2.35 trillion and our deficit would be close to 15% of GDP! The simple conclusion would be this: Unless you want to drastically reduce entitlement spending or heaven forbid raise taxes, then Pepé, you’ve got a stinker of a problem.

What would happen if we threw in agency debt and student debt, too, liabilities that the federal government insures?  Add another $65 Trillion to the debt side of the balance sheet.

Oh, and what about the assets side? Well, if our GDP is $14.9 Trillion and our tax revenues are estimated at about 35% of GDP, then do the math: we’re on track to never pay down our debt.

Indeed, because entitlement costs are going to continue to grow, and faster than inflation, sometime in 2040, mandatory budget items will exceed government revenues (or taxes collected).

Ouch. As Gross says, were out Greeking the Greeks with our debt, here.

In the real world, when things get this bad for a company, or for a person, they become insolvent. Since were talking about a country here, and not just any, but one of the most successful countries, bankruptcy is not exactly an option. It would destroy the world economy.

Instead, Gross anticipates four avenues the government can take to diminish it’s debt problems, none very attractive, and none very wise:

  1. Contractual abrogation. In other words, it will stop paying its debts and honoring its contracts. Extremely unlikely.
  2. Speeding up and increasing inflation. Dramatically. He thinks this is likely, but not sufficient.
  3. Push down the value of the dollar. Already happening.
  4. Decrease Treasury yields to historic lows, penalizing savers, and hope not one complains.

Or they could just reform entitlements. Entitlements are the heaviest weight on the federal balance sheet, and they are the part that will grow over the coming decades. Get entitlements under control, and suddenly the federal balance sheet is more manageable.

Who’s going to take it on? It’s political suicide for any serving politician to take on entitlements, and I doubt any of them currently serving has the courage, or the brains, to figure out how to do it.

Maybe it’s something that takes a whole generation. Maybe it’s time for the Baby Boomers to step forward. As Michael Kinsley recently wrote in The Atlantic Monthly, maybe it’s time for the descendants of the Greatest Generation to step forward and take one for their kids. Maybe it’s time to take one for the team:

So what do you give the country that has everything? You give it cash. The biggest peril Americans now face isn’t Islamo-fascism. It’s our own inability to live within our means. It would be nice to give our country the wisdom and self-discipline to stop running up the credit card. And we should try. But it’s unlikely that we can remake the national character (including our own) in 19 years. What we can do is offer a lecture and a fresh start. We should pass on to the next generation an America that’s free from debt. Instead of ignoring it, or arguing endlessly about whose fault it is and who should pay for it, Boomers as an age cohort should just grab the check and say, “This one’s on us.”

(h/t to PIMCO)

When is $100 billion not enough?

When it’s non-security discretionary spending cuts from the budget. That’s when.

Then it’s just not solving the problem. It’s pandering for the press and for constituents.

The problem, and all the talk Washington, is the deficit and getting it back to a manageable level.  Republicans in an effort to keep campaign promises and reduce the deficit, are working on cutting $100 billion out of the budget. The problem is, what they are cutting is just non-security discretionary spending. The real cause of deficit growth–and the looming monster on the horizon–is entitlement spending (Social Security, Medicaid, and Medicare) and interest payments on the federal debt. See, those two items will grow, under the Congressional Budget Office‘s projections, dramatically over the next decade. By 2024, tax revenues will not be enough to pay for the costs of entitlements and net interest payments.

Check it:

But isn’t $100 billion in cuts a good start? Yes…but no. It won’t affect the growth of entitlement spending a bit. Nor will it increase tax revenues (except perhaps to depress them) to pay for the growth in spending. Derek Thompson of The Atlantic likens it to a dentist telling you that you need to brush more or your teeth are going to fall out.

So you buy a toothbrush and you brush one tooth really really really hard for six months but leave the others untouched. By the time you return to the dentist, your teeth are all rotting except for one tooth that is so overbrushed, you’ve worn out the enamel.

Instead of helping your whole mouth, you end up hurting it, including the place you were focused so much. I don’t agree that discretionary spending cuts will hurt as much as that (such as, why does the federal government need to fund cowboy poetry?), but I do think they distract from the real problem that needs addressing–the cost our entitlements will levy on our country in the coming decade.

So why not work on entitlements instead of non-security discretionary spending? Why not stop chopping at the leaves and take the ax right to the trunk?

Because it’s hard and politically dangerous. The largest recipients of entitlement spending also tend to be regular and frequent voters. They are those who are in need. While polls tend to show that almost everyone agrees that cuts must be made, they also show that no one really wants to cut what they benefit from nor do they want the alternative of paying higher taxes.  And what rational congressman wants to go back to his district and tell them that he cut benefits to the poor, the elderly, or the sick?

Yeah. That’ll go over like a lead balloon.

Enter the dragon. Or rather, enter Rep. Paul Ryan, a Republican from

Paul Ryan (politician)

Image via Wikipedia

Wisconsin, and his planning to bring the budget back under control. He acknowledges that what he proposes–throttling back entitlement spending– may not necessarily help Republicans in the short-term.

“Is this a political weapon we are handing our adversaries? Of course it is,” Ryan said Thursday. “I think everybody knows that we are walking into I guess what you would call a political trap that arguably we are setting for ourselves … but we can’t wait. This needs leadership.

“If you just follow the polls, you are nothing but a follower,” Ryan said.

His budget is likely to shift the discussion from cutting discretionary spending to entitlement reform, something that President Obama notably left out of his budget when he proposed it to Congress.

While what exactly Ryan will propose is still unclear, and will be until April, it is speculated that the proposal will call for shifting Medicaid to block grants so as to limit how much growth can happen in a single year, as well as potentially a voucher system for Medicare recipients. Social security, the least problematic of the three, will probably remain untouched, for now (though, IMO, it’s still a payment I make every month that I’ll never see).

As long as voters vote for the short-term, we will all pay in the long-term.

Of course, as Keynes put it, rather without vision, “in the long run, we are all dead.”