Author: Bonddad

There is a group of people who are very important to the national economy that speak often but never receive adequate press coverage.  There people are the various heads of regional Federal Reserve Banks.  Over that last month, their message has been consistent: they are concerned about inflationary pressures in the economy.
Atlanta Federal Reserve  President Jack Guynn on October 3:

“I consider inflation risks to be elevated at the moment, he said. “I think one has to give considerable weight to the fact that not only in some of the headline measures, but in some of these core measures, we may see the pass-through of at least some of the energy cost increases.”

Federal Reserve Bank of Kansas City President Thomas Hoenig on September 26:

Hoenig noted that the consumer price index has already pushed up significantly from a year ago, thanks to high energy prices, while unit labor costs were rising and economic capacity was being absorbed by the strong U.S. economy.

“When you see all three coming together you must be alert,” he said. “The mission of the Fed is to be sensitive to these pressures.

San Francisco Federal Reserve President Janet Yellen on September 27:

She said higher energy prices “put U.S. monetary policy on the horns of a dilemma” as policymakers balance possible passthrough of prices to core inflation against potential long-lasting cuts in consumer spending if high prices persist.

“Estimates of the extent of spending are escalating, and the recovery and bounce-back, fueled by massive fiscal stimulus, could propel the U.S. economy on an unsustainable upward trajectory,”

Chicago Feder Reserve President Michael Moskow on September 26:

Michael Moskow said there may still be excess capacity in the nation’s economy but that inflation is running at the upper end of the Fed’s comfort zone – a position he’s offered in other recent speeches.

First, let me offer some explanations.  The Fed’s policy is accommodative when they was the economy to expand.  This means lowering interest rates to a low-enough point to stimulate borrowing.  The Fed’s policy is neutral when they feel rate levels are low enough to stimulate economic growth through borrowing and high enough to prevent inflation from increasing.  The Fed’s policy is restrictive when rates are high enough to prevent economic growth and inflation.  There is no empirical formula to derive these levels.  It is largely based on the personal perception of various members of the Federal Reserve.

So, what are they worried about?  First there is the increased cost of energy. That is concern enough.  However, there are indications at other levels of the economy that inflationary pressures are increasing.  Each month, various Federal Reserve regions issue a regional manufacturing report that is broken down into various sub-categories.  The price categories of these reports have all shown a recent sharp increase in prices.  The Empire State Index’s recent prices component increased by 20 points.  The most recent Richmond Federal Reserve Survey showed an increase in the projected prices paid for future manufacturing inputs.  The most recent Philadelphia Manufacturing Survey also showed a sharp increase in prices paid by manufacturers.

Several non-Federal Reserve Manufacturing reports have also showed a similar increase in prices.  The recent National Association of Purchasing Managers Index showed a 14 point increase in its most recent survey.  The latest ISM Manufacturing survey showed a sharp uptick in prices as well.

All of the above indicators occur in the economic chain before the consumer price index; they occur in the production of goods the consumer buys.  As a result, these price increases may not have passed onto the consumer yet.  However, it is only a matter of time.  As a result, expect more Fed rate hikes.  

Larry Kudlow is the most dangerous conservative economic pundit. He is one of he prime architects of the “phrase tax cuts pay for themselves.”  Obviously, he has never bothered to examine these tables from the Congressional Budget Office – especially table 3 which clearly prove tax cuts decrease revenue.   Never let the facts get in the way of a fiscal agenda that has racked up nearly 5 trillion in debt in 17 of the last 25 years.  (By the way Larry – it took 200 years to get to the first trillion.  Way to over-achieve).  Now he is arguing that the increased debt load from hurricane Katrina relief is “no big deal”.  
First, here is a link to Larry’s editorial.

In this new spending environment, total U.S. debt held in public hands will rise a little more quickly to the $4 trillion mark. But that’s a small fraction of our nation’s wealth. The Federal Reserve recently indicated that total family net wealth — which includes the value of our nation’s businesses, bonds, stocks, and real estate — just hit an all-time high of $50 trillion. This illustrates the firepower of the free nation and economy that the radical Islamic fundamentalists desire to overthrow.

Here Larry makes a classic Republican argument that is wrong.  He only uses the debt held by the public to calculate the national debt.  Here’s the problem with using only that figure: there is a second category of debt called intra-governmental debt.  According to the General Accounting Office:

Intragovernmental Debt Holdings represent federal debt issued by Treasury and held by certain federal government accounts, such as the Social Security and Medicare trust funds.

Intragovernmental debt holdings represent balances of Treasury securities held by federal government accounts, primarily federal trust funds, that typically have an obligation to invest their excess annual receipts over disbursements in federal securities. Most federal trust funds invest in special U.S. Treasury securities that are guaranteed for principal and interest by the full faith and credit of the U.S. government. These securities are nonmarketable; however, they represent a priority call on future budgetary resources.

…debt held by the public and intragovernmental debt holdings are very different. Debt held by the public approximates the federal government’s competition with other sectors in the credit markets. Federal borrowing absorbs resources available for private investment and may put upward pressure on interest rates. In addition, interest on debt held by the public is paid in cash and represents a burden on current taxpayers. It reflects the amount the government pays to its outside creditors.

In contrast, intragovernmental debt holdings perform an accounting function but typically do not require cash payments from the current budget or represent a burden on the current economy. In addition, from the perspective of the budget as a whole, interest payments to federal government accounts by the Treasury are entirely offset by the income received by such accounts-in effect, one part of the government pays the interest and another part receives it. This intragovernmental debt and the interest on it represents a claim on future resources and hence a burden on future taxpayers and the future economy. However, these intragovernmental debt holdings do not fully reflect the government’s total future commitment to trust fund financed programs. They primarily represent the cumulative cash surpluses of those trust funds and also reflect future priority claims on the U.S. Treasury. They do not have the current economic effects of borrowing from the public and do not currently compete with the private sector for available funds in the credit markets. However, when trust funds redeem Treasury securities to obtain cash to fund expenditures, and Treasury borrows from the public to finance these redemptions, there is competition with the private sector and thus an effect on the economy.

Notice some key words from the GAO.  Intra-governmental holdings are represented by special issue government securities.  These are guaranteed by the “full faith and credit of the US government.”  They are non-marketable (they can’t be sold) – but they have a priority claim.  This simply means they jump to the front of the line when new revenues come into the federal treasury to get paid-off.

Here’s the somewhat over-simplified translation.  Intra-governmental debt is essentially an IOU.  Suppose the VA is running short of funds and Social Security has a surplus.  SS sells its surplus to the Treasury for a special issue IOU.  The cash from the transaction goes to the VA.  The IOU has a priority claim on future government revenues.  In other words, it is still a debt that must be paid.  Because these holdings are debt instruments, they are entirely relevant to a discussion of national debt.

Now, according to the Bureau of Public Debt total public and intra-governmental debt holdings are 7.9 trillion.  Notice how this figure is nearly twice the 4 trillion Larry quoted in the article?  Isn’t that amazingly convenient he finds a lower figure to quote to make his master look good.

Larry continues:

In this new spending environment, total U.S. debt held in public hands will rise a little more quickly to the $4 trillion mark. But that’s a small fraction of our nation’s wealth. The Federal Reserve recently indicated that total family net wealth — which includes the value of our nation’s businesses, bonds, stocks, and real estate — just hit an all-time high of $50 trillion. This illustrates the firepower of the free nation and economy that the radical Islamic fundamentalists desire to overthrow.

Bankers often talk about debt-to-equity ratios when it comes to financing corporate deals. Well, our federal-debt-to-national-wealth ratio is a paltry 8 percent — a metric that would make any M&A specialist gleeful. Of all the commentary I’ve seen about the so-called fiscal crisis of hurricane-recovery spending, only Nick Danger of the RedState blog has had the sense to argue the issue like a banker. Global financing markets will underwrite new U.S. spending without a drop of perspiration.

Isn’t this wonderful?  The national debt/equity ratio is a paltry 8%?  Hell, let’s keep that wonderful federal credit card going!  Borrow and squander our future!!!!!!

Here, once again, Larry is involved in the big smoke screen.  The standard metric used to determine the size of the national debt is debt/GDP ratio, not the national debt/equity ratio.  According to the CIA factbook, the US’ 2004 estimated GDP was 11.75 trillion.  That makes the 8 trillion total debt (pre-Katrina spending) 68% of the total US GDP.  This is the measurement every other economist uses.  However, Larry decides to drive off the range and make the rules up as he goes along.

I just watch Sin City again and was again totally amazed by the movie.  There is a scene in the movie when the politician is talking to Bruce Willis while Willis is in the hospital.  The politician says something to this effect: “I deal in lies.  And when you get people to believe the lie, you have them by the balls.”  This is the central problem with right-wing talking head economic pundits.  They make up all sorts of ways to justify their party’s policies.

Larry has of course conveniently overlooked the standard economic measure of national debt because it doesn’t look good for Bush’s policies.  Larry has conveniently overlooked warnings from current Fed chief Greenspan, ex-fed chief Volcker and the International Monetary Fund about the US’ reckless spending habits, fiscal and international trade balance situation.  Instead, Larry has decided it is better to go along with Bush instead of standing up and saying this is a situation that cannot continue without some serious economic pain.  I would say I feel sorry for him.  But I don’t.  He is in a position to tell the truth – however damn ugly it really is – to help the country fix the problem instead of denying it exists.  Funny how many religious people overlook the lying commandment.

There are all sorts of great issues on the political scene now.  There is the “Culture of Corruption” thanks to Delay, Frist and a whole host of other Republicans.  The Iraq War also comes to mind.  Both of these issues are strong issues for the Democrats.  However, there are other issues that are just as important that lack the visceral nature of corruption and war.  These issues center around economic issues, or as I like to think of them “kitchen table issues.”  If a family can’t afford health insurance or tuition, if they aren’t making more money than they were 4 years ago, then the other issues don’t matter.  People have to survive before they can think about grander themes.  Right now, Bush’s policies have hurt the middle class in numerous ways that II will document below.  These have to be part of our themes in the 2006 election.
Below, I will use statistics from January 2001 when Bush was sworn in as president.  Some Republicans use 9/11 and the recession as mitigating factors to explain Bush’s poor performance.  These are mitigating factors.  However, Bush got the job.  He gets credit for the whole enchilada – not just the part that looks good.

Wages

According to the Bureau of Labor Services, the average hourly earnings of production workers was $14.27 in January 2001 and was $16.16 in August 2005 for an increase of 13.24%.  Over the same period of time, the overall inflation index for all items increased from 175.1 to 196.4 for an increase of 12.16%.  That means after inflation, the average production wage increased 1.08% in 4 and a half years.  This is why the average American feels so much richer under Republican economic leadership.

Jobs

According to the Bureau of Labor Services, total nonfarm employment was 132,454,000 in January 2001 and 133,999,000 in August 2005 for a net 4.5 year gain of 1,545,000.  This breaks down to approximately 28,600 jobs/month over the period.  This is important because the economy must create 150,000 jobs/month to deal with natural attrition, people looking for new jobs, people entering the workforce etc….  In other words, Bush’s economy has not created enough jobs to deal with the natural expansion of the population or generally economic conditions.  The next question to answer is “why is the unemployment rate so low?”  The unemployment numbers do not count people who have not looked for work in the last 4 weeks.  This is better documented by the labor participation rate which was dropped from 67.2% in January 2001 to 66.2% in August 2005.

In addition, the Bush economy is heavily skewed towards housing.  Over the same time, the net gain in construction employment was 418,000, or 27% of total employment growth.  In addition, financial services jobs increased by 487,000 over the same period.  All of the financial jobs are not related to real estate.  I have not seen any statistics that break this number down into a real estate and non-real estate portion. So let’s make a simple conservative assumption and say that 20% of the financial services jobs are related to real estate activities.  That would mean 6.2% of the jobs created in the financial services area are related to real estate, bringing the total number of housing related jobs to 33.2% of total ob creation during the recovery.  Finally, business and professional services increased employment by a little over 100,000.  Assuming 10% of these are real estate related, an additional .5% of job growth is real estate related, bringing the grand total of housing based employment to 33.7% of all jobs created in the last 5 years.  So, when housing slows so will the job market.  

Of particularly scary significance is the loss in high paying technology and goods producing jobs.  January 2001, the US economy has lost 2.8 million manufacturing jobs and 560,000 information jobs.   These numbers alone should concern anybody who is concerned with the US’ mammoth international trade deficit.

Health Care

Actually, it would be better to title any description of Bush’s efforts on heath care as lack of health care.  Kaiser Health recently issued its annual survey of health care.  Here are some of the high points:

Premiums increased an average of 9.2% in 2005, down from the 11.2% average found in 2004. The 2005 increase ended four consecutive years of double-digit increases, but the rate of growth is still more than three times the growth in workers’ earnings (2.7%) and two-and-a-half times the rate of inflation (3.5%). Since 2000, premiums have gone up 73%.

The annual premiums for family coverage reached $10,880 in 2005, eclipsing the gross earnings for a full-time minimum-wage worker ($10,712). The average worker paid $2,713 toward premiums for family coverage in 2005 or 26% of the total health premium. While workers’ share of their premium has been relatively stable over the past few years, they are now paying on average $1,094 more in premiums for family coverage than they did in 2000.

For those who want the hard numbers, annual premium increases for 2001-2004 were 10.9%, 12.9%, 13.9%, and 11.2%.  Read the rest of the report to get an idea for how poorly Bush’s ideas have not solved the problem.  This is a crisis that has only grown in size and magnitude since Bush came into office.  He has done nothing to address the problem.

College Tuition

I have an idea: let’s educate people so they can get better jobs.  Call me a revolutionary.  Or a fool.  The last 4 years have seen large increases in public college education costs.  Annual increases in the cost of public education from 2001-2005 were 7.1%, 9.1%, 13.9% and 10.6% respectively.  The average cost of 452 state school tuition costs was $5153 in 2005, with the average for room and board expense coming in at $6058.  This brings the 4-year total to $40,764 for an education and room and board.

 Tuition and fees have increased 51% since the 1994-1995 school year.  In addition, tuition has increased faster than inflation since the early 1980s.

But wait!  A student can get a grant!  This situation isn’t so bad!  Well, the problem is the state and local grants aren’t keeping pace with the tuition increases.  Therefore, the grants are now paying for less of the education than before.  The bottom line is college is slowly becoming more and more a luxury people are having a more difficult time affording.  

One of these days, I will figure out a way to make these issues really exciting and visceral so people actually start talking about them.  Until that happens, these issues will probably continue to fall through the cracks of US political dialog — along with the middle class.

These evacuations are equivalent to 72.40% of 819 manned platforms and 47.76% of 134 rigs currently operating in the Gulf of Mexico (GOM).

Today’s shut-in oil production is 1,511,715 BOPD. This shut-in oil production is equivalent to 100% of the daily oil production in the GOM, which is currently approximately 1.5 million BOPD.

Today’s shut-in gas production is 8.027 BCFPD. This shut-in gas production is equivalent to 80.27% of the daily gas production in the GOM, which is currently approximately 10 BCFPD.

The cumulative shut-in oil production for the period 8/26/05-9/28/05 is 37,881,777 bbls, which is equivalent to 6.919 % of the yearly production of oil in the GOM (approximately 547.5 million barrels).

The cumulative shut-in gas production 8/26/05-9/28/05 is 180.560 BCF, which is equivalent to 4.947% of the yearly production of gas in the GOM (approximately 3.65 TCF).

From the Minerals Management Service

The last sentence from the Minerals Management Service should send shivers up anyone’s spine.  The total shut-in oil production is almost 7% of yearly totals.

For the last 6 months or so, the oil market has rallied whenever there was news of a refinery problem.  US refineries are operating near 100% capacity, and have been for about the last 6 months.  As a result, the oil refiners cannot simply shift production to a plant that has extra producing capacity because that plant does not exist.

And the problem won’t go away soon, as Reuter’s reports:

Oil prices jumped more than $1 on Wednesday after the U.S. government said up to 15 percent of the nation’s storm-battered refining capacity could stay shut for weeks, rekindling fears of fuel shortages.

Strikes in France, a leading U.S. gasoline supplier, could worsen the problem by hurting Europe’s ability to send shipments across the Atlantic, with the biggest French refinery already shut down by a work stoppage.

“The longer these refineries remain shut down, the more serious the situation becomes, particularly with the heart of the winter season just a few months away,” the U.S. Energy Information Administration said in a report about the storm-struck U.S. petroleum infrastructure.

As a result of lost production, a winter heating spike is now in the cards.  The only question is if the projections of a 30-70% increase were too low.

 

Housing is the current engine of the US economy.  It is responsible for over 40% of recent job creation.  Equity extraction is one of the primary ways for consumers to maintain their level of consumption.  Therefore, a fall in housing could have a serious detrimental national effect.  There is a great deal of speculation about when the housing bubble will end and whether it will end with a slowdown in price escalation or a crash.  Regardless of the form, it appears more and more factors are lining up, signaling the beginning of a slowdown.
First, the good news for housing: last month sales of existing homes increased 2%.  However, this number is very volatile.  It dropped 2.7% the preceding month, and has exhibited a fairly high volatility over the past 12 months.  This makes it a fairly poor gage of the overall housing picture.

More importantly is the increase in inventories from the same report.  In March, total national inventory was 2,297,000. This number was 2,856,000 last month – a 24% increase in 6 months.  It has incrementally increased each month as well, making it appear as though an increasing number of people are looking to sell their houses.  The month’s supply of houses has also incrementally increased over the same time from a 4 month’s supply in March to a 4.7 month’s supply last month.  The inventory situation does not bode well for the continued price appreciation consumers have come to expect from homes.

More importantly are two factors outside the housing sector.  The first was the recent large drop in consumer confidence:

U.S. consumer confidence fell to the lowest since 1992 after Hurricane Katrina devastated the Gulf Coast and pushed gasoline prices to a record high.

The University of Michigan’s preliminary index of consumer sentiment fell to 76.9 from 89.1 in August. The reading compares with the median forecast of 85 in a Bloomberg News survey of 53 economists.

The current conditions index, which reflects Americans’ perception of their financial situation and whether it’s a good time to buy big-ticket items, fell to 97.7 from 108.2 in August. The expectations index, based on optimism about the next one to five years, fell to 63.6 from 76.9 last month.

This drop could be a simple one-month drop related to Katrina.  However, the size of the drop is very disconcerting.  Consumers would have to have a sharp rebound confidence to return to previous levels.  This type of sharp turnaround is unlikely.  More importantly is the drop in the expectations index, as this has a direct effect on housing.  A house is usually the largest purchase consumers make; they are not going to purchase a house if they think the future is bleak.  The drop in the future expectations index indicates a larger percentage of people will most likely put-off buying a house for the next month.

This leads to the second external factor that will negatively impact the housing market: energy prices.  Katrina seriously crimped US refining capacity.  As a result, the price of fuel derivatives is increasing.  Heating oil is 35% higher this October than last October.  Natural gas is 44% higher.  Unleaded fuel is 50% more expensive.  Newspapers across the entire northern US from California to Massachusetts have warned about sharp price increases in heating expenses over the winter.  Derivatives prices are likely to remain high over the winter as repairs from Katrina related damage to refineries could take through the end of the year.

High energy prices will harm the economy in two inter-connected ways.  First, higher prices will lower consumer confidence or keep it at its current depressed level as consumers feel more and more burdened by this necessary expense.  In correlation, the longer energy prices remain high, the more consumers will trim their other expenses and investments – namely housing.  

In summation, more people are looking to sell their homes.  This will slow price appreciation, probably driving more people to sell their homes, creating an escalating spiral of dumping while prices are still high.  Katrina sharply knocked consumer confidence, lowering the possibility that people will be willing to make their largest lifetime purchase.  And finally, energy price increases will further crimp already constrained consumer budgets, further lowering housing demand.  In short, various elements are lining up to slow the housing market.  The main question that only time will answer is the degree of the slowdown.  

There are a lot of Republicans like my Dad who vote Republican largely based on the perception Republicans are the party of fiscal responsibility.  This perception comes from the 1950s when Republicans were actually fiscally responsible.  However, starting in 1980 and the “Reagan Revolution”, that changed.  The Republicans became the party of “borrow and squander”.  Regrettably, they have left the US with a legacy of debt that will burden our children, grandchildren and probably our great grandchildren.  Moreover, as the US population ages and the baby-boomers retire, it could crush the US’ national budget.
Below I will run through a history of US budget deficits and total debt.  There is some debate among various economic factions about what debt to use when discussing the US’ public debt which is divided into publicly held debt and intra-governmental debt.  Publicly held debt is debt held by the public.  Intra-governmental debt is held by various government agencies when they borrow from one another.  I will use the total amount of debt which totals the combined public and intra-governmental debt.  The reason is simple: regardless of who holds the debt. it is still a debt obligation of the US government and much be paid off on maturity.

All of the information here is derived from the Congressional Budget Office and the Bureau of the Public Debt.

Before we delve into the actual fiscal record of the various administrations, I want to deal with the Laffer curve.  This economic theory states that tax cuts will eventually pay for themselves because lower tax rates will empower individual taxpayers to work harder because they are keeping more of their money.  This harder work in turn leads to increased tax revenue.  The Reagan administration used this theory to cut tax rates in 1981.  However, it is very important to note that before this theory came into prominence among conservative ideologues, tax revenue from individuals was already increasing, essentially doubling every ten years.  From 1962 – 1970 revenue from individual taxpayers increased from 45 to 90 billion dollars (non-inflation adjusted) and from 1970 revenues from individual taxpayers increased from 90 billion – 244 billion (non-inflation adjusted).  The point of these previous observations is many factors aside from marginal tax rates are responsible for increased revenue from individual taxpayers.

Reagan

The beginning of the 1980s marked the Republican’s return to power, as Regan took control of the presidency and the Republicans gained control of the Senate.

Reagan used the Laffer curve to justify cuts in marginal tax rates.  As a result, tax receipts barely increased from 1981-1984, when receipts from individual taxpayers were 285 billion, 297 billion, 288 billion and 298 billion respectively.  At the same time, outlays increased from 678 billion to 851 billion, respectively.  As a result of the difference between receipts and expenditures, the federal budget deficit increased from 73 to 188 billion from 1981-1984.  This pattern of events established in the early 1980s by the Republicans is clear: cut taxes on the wealthy, increase spending and hope the Laffer curve works.

Reagan raised taxes in 1983 as a result of his administrations concern over the growing federal debt load.  However, he did not curtail his spending

Ronald Reagan started his term with total debt outstanding of 930 million and increased total debt outstanding to 2.7 trillion.  This is a 13.71% compound annual increase.  He never balanced a budget.

Bush 41

The biggest point of Bush’s presidency was his breaking the “no new taxes” pledge.  However, it is important to note this was the fiscally responsible thing to do.  It is also important to note that the increased taxes did not help the budget situation in the slightest.  Receipts from individual taxpayers increased from 991 to 1091 billion.  At the same time, federal expenditures increased from 1.064 trillion to 1.381 trillion.

Bush I started his term with outstanding debt of 2.7 trillion and increased total debt to 4 trillion.  This is a 10.32% compounded annual increase.  He never balanced a budget.

Bush II

Bush essentially tried to do the same thing Reagan did – cut taxes and increase spending.  He cuts taxes for the wealthy which decreased tax revenue from individuals from 1.991 trillion to 1.880 trillion.  At the same time, he increased spending in turn increasing the deficit from 32 billion in 2001 to 567 billion in 2004.  

Bush II started with 5.6 total outstanding debt and increased total outstanding debt to 7.7 trillion.  This is a 6.5% annual increase.  He has never balanced a budget.  

Conclusion

Simply put, the Laffer curve is better named the Laugher curve; it is a joke.  Tax revenue increases are just as likely the result of GDP growth.

More importantly, Republican economic thinking has dominated national economic policy for 17 of the last 25 years.  It has accomplished nothing more than indebting this country for numerous future generations.  

U.S. Federal Reserve Chairman Alan Greenspan told France’s Finance Minister Thierry Breton the United States has “lost control” of its budget deficit, the French minister said on Saturday.

“‘We have lost control,’ that was his expression,” Breton told reporters after a bilateral meeting with Greenspan.

“The United States has lost control of their budget at a time when racking up deficits has been authorized without any control (from Congress),” Breton said.

I know the Greenspan is not the most popular Central Banker especially among Democrats.  I have to admit he has dropped a few notches on my ratings as well.  I would add, however, he remains a very bright economist who has had more than a few important insights about the US economy.

I was particularly surprised this story did not get more press in the US.  It is a very telling statement about the current state of the US Congress undere Republican leadership.

The Republicans have lost their claim to fiscal conservatism.  There is no way they can argue they are fiscally conservative after the last 5 years.  But, the Dems need to remind voters of the stark contrast between Bush’s and Clinton’s economic leadership.  Dems balanced budgets.  This is a huge issue for a lot of people out there.  I don’t care if they begrudingly pull the Dem lever, just so long as they pull it.

Link

Standard & Poor’s said it may downgrade the credit ratings of Germany and Italy, two of Europe’s largest economies, unless their governments rein in spending and cut debt.

Germany risks losing its triple-A credit rating in 18 months unless it curbs budget spending and reduces debt, said Konrad Reuss, managing director of sovereign ratings at Standard & Poor’s. Italy’s AA-minus rating is also at risk unless the government of Silvio Berlusconi goes ahead with plans to cut spending, Reuss said.

Germany and Italy, the first- and third-largest economies on the 12-nation euro region, are struggling to contain spending amid an economic slowdown. Inconclusive elections in Germany and the resignation of Italy’s finance minister this week left both countries in a state of political uncertainty, which may delay measures needed to spur economic growth.

There are three credit ratings agencies: S and P, Moody’s and Fitch.  These are each independent companies performing independent analysis on the financial conditions of companies that publicly issue debt.

 
It is important to note the reason S and P is threatening to downgrade both countries’ credit ratings because of deficit spending.  According to the CIA factbook, Germany’s debt as a percentage of GDP is roughly 65% and Italy’s is slightly over 100%.  What’s interesting is the US’ debt as a percentage of GDP is more than Germany’s.  According to the Bureau of Public Debt, the US as just under 8 trillion in debt and according to the Bureau of Labor Statistics us GDP is just over 11 trillion.  This makes the US debt/GDP ratio a little over 70%.

The only difference between the US and Europe is their respective economic rate of growth.  Europe is mired in a slow-growth problem while the US is growing at over 3%.  But that won’t last forever.  All economies eventually slow down.  So, what will happen when the US economy eventually goes into a recession?  Will the ratings agencies downgrade our debt?  

Link

Boy I wish I had come up with that title.  But I didn’t.  It comes from the Cato Institute’s report The Grand Old Spending Party.  This report is absolutely devastating to the current Republican leadership of this county because it demonstrates one fact very clearly.  The Republicans can no longer claim the mantel of fiscal conservatism; they spend in a manner far worse than those “tax and spend” Democrats.
Just to really illustrate the difference between these parties – and to really tick off Republicans – let’s compare Bush to Clinton.  

Budget as a Percentage of GDP

At the beginning of Clinton’s term, the Federal Budget was almost 22.5% of GDP.  By the time he left office, that percentage was a little under 18.5% — a net decrease of 4%.  

At the beginning of Bush’s first term, the Federal Budget was a little under 18.5% of GDP.  Currently, that percentage was a little under 20.3% — a net increase almost 2%.

Growth Rate of Government Outlays

Under Clinton, the real annual growth rate of total government outlays was 1.5%.

Under Bush, the rea
l annual growth rate of total government outlays is 5%.

Growth Rate of Non-Defense Spending

Under Clinton, the real annual growth rate of non-defense and non-homeland security spending was 2.1%.

Under Bush, the real annual growth rate of non-defense and non-homeland security spending was 4.8% — over twice Clinton’s increase.

The result of this Republican spending spree is a ballooning of the Federal Deficit.  When Bush was elected, the total federal deficit was 5.8 trillion.  Now it is nearly 8 trillion – an increase of 38%.

The Cato Institute is not the only Republican organization to begin chaffing at the bit over Republican spending.  From Fareed Zakaria’s Leaders Who Won’t Choose

Whatever his other accomplishments, Bush will go down in history as the most fiscally irresponsible chief executive in American history. Since 2001, government spending has gone up from $1.86 trillion to $2.48 trillion, a 33 percent rise in four years! Defense and Homeland Security are not the only culprits. Domestic spending is actually up 36 percent in the same period….”throughout the past 40 years, most presidents have cut or restrained lower-priority spending to make room for higher-priority spending. What is driving George W. Bush’s budget bloat is a reversal of that trend.” To govern is to choose. And Bush has decided not to choose. He wants guns and butter and tax cuts.

It also appears Republicans are starting to distance themselves from Bush’s spending recklessness (which they enabled and egged on):

Rep. Mike Pence, R-Ind., said there is a need for dramatic spending cuts in “big-ticket items.”

“We haven’t been disciplined enough over the last 10 years. We need to do that, and we needed to do that before Katrina. We still need to do that over the medium and long term,” Vitter said.

Sen. Lindsey Graham, R-S.C., said an across-the-board cut in spending, excluding defense spending, would be appropriate.

“We’re failing when it comes to controlling spending,” Graham told “Fox News Sunday.”

Republicans are now the party of fiscal irresponsibility.  How can they go to the voters and now claim they’ve seen the light?  Their previous actions – especially when compared to the fiscally responsible Clinton – speak louder than their words.  They spend recklessly, passing the bill to our children.

The economy started expanding in the first quarter of 2003.   Where is the money to pay for this expansion coming from?  According to statistics from the Bureau of Labor Services, non-supervisory wages are near stagnant since 2000.  US savings is at 0%, and have been decreasing since the early 1980s.  So consumers’ increased spending isn’t from an increase in wages or money they put aside for a rainy day.  That leaves one source: debt.  Steve Church has done a great analysis from the Federal Reserve’s Statement of Financial Flows, which clearly demonstrates debt is the US consumer’s main source of new money for expenditures.
The analysis uses a corporate cash flow model.  For those of you who are unfamiliar with this accounting format, it essentially states where money for a specific period comes from and goes to.  Every year, money comes in from a variety of sources and is paid to a variety of activities.  The cash flow statement shows where money comes from and where it goes.

For those of you who have detailed knowledge of a cash flow statement, you will notice that I am simplifying certain definitions for the lay-person.  This is not supposed to be a presentation to a group of MBA’s, but a presentation to a group of non-MBA’s so more people can understand what is going on beneath the surface of the US economy.

I have summarized the cash flow statements for ease of reading purposes.  If you want to see the spreadsheet, go here.

The figures below from the Federal Reserve’s Statement of Flows:

2003

Savings: Households net operating assets in 2003 were 357 billion dollars.  This is the total of savings and depreciation additions.  

This is where a cash flow statement starts.  It presumes people will spend first from what they already have.

Investment: Households net financing activities in 2003 were 1.142 trillion dollars. This is the total of mortgage, savings and other investment activity.

This tells us what consumers spent their savings on.  This is money the consumer spends during the year.

Financing: Households net debt acquisition in 2003 was 866.9 billion.  This is the total new debt minus repaid debt.

Outside of savings, this tells us where consumers got the rest of the money they used during the year.

2004

Savings: Households net operating assets in 2004 were 365 billion dollars.  This is the total of savings and depreciation additions.

Investing: Households net financing activities in 2004 were 1.341 trillion dollars.  This is the total of mortgage, savings and other investment activity.

Financing: Households net debt acquisition in 2004 was 1.044 trillion.  This is the total new debt minus repaid debt.

Let’s look at these numbers in a bit more depth.

First, before we get to the top line of the cash flow statement, we’re going to add another figure: wages.   If wages increased significantly, than it is possible the wage increases were used to finance the national economic expansion.  According to the Bureau of Labor Services, wages for non-supervisory employees have grown 4.35% from January 2003 to December 2004.  Over the same time, inflation increased 4.67%%, making inflation adjusted wage growth a -.32% from January 2003 to December 2004.  Because consumers aren’t making any more money, increases in wages are not responsible for consumer purchases during the period on the cash flow statement (2003-2004).

The top line of the statement is for savings.  “In the strictest definition, savings are that part of your production that is in excess of your consumption.”  In other words, savings is what is left over after you pay your bills and other expenses.  Depreciation is added to operating expenses because depreciation is essentially an accounting method of allocating the cost for a capital over that good’s expected useful life.  This allows a purchaser to allocate the cost of a capital good more effectively.  While a depreciation deduction technically lowers your operating income for tax purposes, you don’t really pay the money allocated to depreciation.  Therefore, from a cash flow perspective, depreciation is added back to monthly operating income to determine monthly operating income.  

You’ll notice that cash flow from operating activities is positive.  This means what you would think it means: that after savings and depreciation, consumers added money to their personal stash of money from savings and depreciation.

The next big area of the cash flow statement is from investing activities.  Loosely defined and investing activity is one that will hopefully increase cash flow in the future.  It shows there was a net cash outflow to investing activities greater than the cash inflow from operating activities. This means that after money from operating activities, (savings + depreciation) and money spent on investing activities, household’s cash balance is negative.  

So, how do households make up this difference between investment activities and operating activities?  They borrow heavily.

The third section of this annual household cash flow statement reveals a very important reality of the current expansion.  After deducting annual totals for repayment of debt, households are borrowing between 2.5 (2003) and 2.85 (2004) greater than their income savings.  

However, that is not the scariest conclusion the paper draws.

This paper analyzes the sources and uses of household cash flow.  We use the basic corporate cash flow statement format to identify operating, investing, and financing cash flow.  In order to meet current financing and investment requirements, we discover that households need to generate new cash equal to at least 13% of GDP every year.

Prior to 1993, the sources of household cash flow were split about 55% from income and 45% from new debt.  Beginning in 1993, new debt increasingly became the source of cash flow.  In 2005, new debt of about 12% of GDP should provide nearly 86% of household cash flow.

We are simply borrowing to create wealth.