Saturday, February 26, 2011

4th Quarter GDP Revised Downward; Headwinds Persist In 2011

The federal government and state governments are already beginning to see the bitter side of budget cuts; reduced economic output.

The Commerce Department has revised fourth quarter GDP downward to 2.8 percent from the earlier estimate of 3.2 percent. The original consensus estimate was 3.6 percent growth, so the new number is considerably lower than initially anticipated.

That presents an ominous sign of what's ahead as the federal government tries to reign in its serial deficits that are now exceeding $1 trillion annually.

Faced with continuously steep budget shortfalls, state governments cut spending by 2.4 percent in the fourth quarter, which greatly exceeded the 0.9 percent first estimated.

As previously noted, I was quite dubious about initial consumer spending estimates that came in at 4.4 percent. The revised number was lowered to 4.1 percent. Yet, due to rising gas prices, more and more disposable income will be directed toward fueling up cars, leaving less money for other purchases.

If consumers can't maintain their fourth-quarter spending pace — which was still the highest since 2006 — the effects of federal and state cutbacks will be all the more severe.

Higher gas prices will affect every facet of the economy, from production, to agriculture, to shipping, to transportation, to hiring, and on and on.

The economy grew 2.8 percent in 2010, the highest in five years. Yet, that was a relatively weak pace. From 1965 to 2008, US economic growth averaged 3.2 percent.

The other side of the coin is that 2010 was a marked improvement from 2009, the year the US experienced its worst economic output since the Great Depression.

Consumer spending accounts for 70 percent of all US economic activity. However, if the unemployment problem doesn’t turn around — and there are no indications that it will — consumers will be unable to spend the country out of its doldrums.

Even if unemployment were virtually cut in half for all of 2011 — coming down to 5 percent — it would only lower the jobless rate by one percentage point.

The economy needs to add about 150,000 jobs a month just to absorb the annual population increase and the entrance of new people into the workforce, such as college grads.

That gives you some perspective on the kind of problem we're up against.

Moreover, newly created jobs tend to be lower-paying than those they've replaced.

Paul Ashworth, chief U.S. economist at Capital Economics in Toronto, says that many of the jobs being created don't match the pay, the hours, or the benefits of the 8.75 million positions that vanished in the recession.

These lower wages and salaries will limit consumer spending and economic growth.

That's why it's hard to imagine consumer spending being hearty enough to reignite the economy, or that economic growth will maintain a healthy pace.

Friday, February 25, 2011

Congress Robbed Social Security And Doesn't Want To Pay It Back

Last year, for the first time since its creation in 1935, Social Security received less money through payroll taxes than it paid out in benefits.

And this year, the Congressional Budget Office (CBO) projects that Social Security will collect $45 billion less in payroll taxes than it pays out in retirement, disability and survivor benefits.

Most disturbingly, the CBO says that Social Security is now officially cash negative.

However, during the intervening 75 years, Social Security collected about $2.5 trillion more than it paid out. Those surplus funds were used to buy special bonds from the U.S. Treasury, creating the so-called Social Security Trust Fund.

That surplus amounted to a loan from the people to the government.

But the government spent all that money on various other budget items — every penny of it. And now that the Baby Boomers (a quarter of the population) have begun retiring, that debt will have to be paid back by the federal government from its general expenditures — the annual budget.

While the idea of slashing Social Security is now being discussed in Washington, the politicians should remember that American workers have already paid an excess of $2.5 trillion into that system. To meet the anticipated higher retirement costs of the baby boom, workers and their employers contributed more than was needed over the past few decades to meet current costs.

That money is now owed to them. They expect to be paid back. The problem is that the money is gone. It's all been spent.

All that's left is the "full faith and credit of the United States," whatever that's worth at this point. Nothing remains but a giant pile of IOUs.

The reality is that, to this point, Social Security has not contributed one penny to the debt. Instead, Social Security ran up a $2.5 trillion surplus, which the government looted and spent.

The problems in the system are only poised to worsen. The payroll tax — a 6.2 percent tax paid by both workers and employers that funds Social Security — was cut by Congress and the president late last year, even as Social Security revenues had already been reduced by chronically high unemployment.

The lost revenue is supposed to be repaid to Social Security from general revenue funds, meaning it will add to the growing national debt. Such behavior just continued our government's decades-long trend of making promises that it cannot keep.

There are fewer workers paying into the system today, and millions more who have taken pay cuts or who can only find part-time jobs, which is also trimming revenues.

According to the CBO, Social Security will post nearly $600 billion in deficits over the next decade as the economy struggles to recover and millions of Baby Boomers enter retirement.

At present, more than 54 million people receive retirement, disability or survivor benefits from Social Security. Monthly payments average $1,076. But the number of retirees will swell over the next two decades due to the demographic bubble known as the Baby Boomers.

What many Republicans, and perhaps even some Democrats, are now proposing is that the government shouldn't have to pay back all of the $2.5 trillion in surplus Social Security funds that it essentially stole from the American people.

With that $2.5 trillion surplus, Social Security would remain fully solvent until 2037. Thereafter, it would still be able to pay out 78% of benefits owed.

Due to government recklessness, some combination of tax hikes, benefit cuts, or an increased retirement age is coming. The present retirement age is 66, and it is already slated to move to 67 for those born after 1960.

But such measures wouldn't have to be enacted any time soon if not for the absolutely epic case of grand larceny committed against the American people by their own government, which has robbed them blind.

And to now hear politicians complaining that the American people actually expect to be repaid is beyond the pale. It is simply outrageous.

Yet, it's reasonable to ask where a government so deeply in debt — to the tune of more than $14 trillion, and counting — will ever find that money.

The federal budget deficit will surge to a record $1.5 trillion this year. Unemployment remains high, as do associated benefit costs. A record number of Americans — 1 in 7 — are on food stamps. And the Bush-era tax cuts were extended, even as government revenues were already in decline.

The nation is also still fighting two wars, which President Obama — unlike his predecessor — actually lists in his budget. Those war costs will be with us for decades to come, long after the wars have finally ended.

As it stands, the government is already borrowing 40 cents of every dollar it spends. The bipartisan legislation passed in December that extended Bush-era tax cuts, provided unemployment benefits for the long-term jobless, and a 2 percent payroll tax cut this year, will add almost $400 billion to this year's deficit, according to the CBO.

The government will soon face a funding crisis. Major budget cuts need to be soon initiated.

But before politicians even think about touching Social Security they need to significantly cut the single largest budget item or expenditure — defense and Homeland Security. Taken together, the two added up to $706.4 billion in the fiscal 2010 budget.

Yet, money for the Energy Department to work on the nation’s nuclear arsenal, the Selective Service, healthcare for war veterans, and other defense-related spending pushes the total far higher.

In fact, about 58 percent of all discretionary funding is defense related, according to Donald M. Snow, Professor Emeritus at the University of Alabama.

The defense and security budget needs to be cut in half. We would still spend more than any other nation, and still maintain the world's most powerful military. But we need to recall most of the 500,000 military personnel, stationed on over 700 military bases, in more than 150 nations around the world.

Our military footprint is far too big. We're bleeding ourselves to death.

Additionally, research shows that military spending is robbing jobs from the private sector. Years of persistently bloated defense spending is draining resources from the productive economy.

In real dollars defense spending today is 13 percent higher than during the Korean War, 33 percent higher than during the Vietnam War, and 23 percent higher than under President Reagan.

There is indeed fat to be cut from the federal budget, but it isn't found in Social Security. The program should have the benefit of a $2.5 trillion surplus that the politicians looted from the system. Asking the American people to now accept cuts to that program — to accept this blatant theft — is unacceptable and should not be tolerated.

As Americans for Tax Reform noted, "Department of Defense spending, in particular, has been provided protected status that has isolated it from serious scrutiny."

While defense spending has long been viewed as sacrosanct, that is no longer so. There is now a large chorus of deficit fighters, antiwar activists, Tea Partiers, and libertarians who all want to shrink the Pentagon budget.

Try finding large groups of Americans similarly in favor of cutting Social Security, arguably the most popular government program in American history.

Saturday, February 19, 2011

Higher Fuel Prices Driving Demand For Small Cars

Every driver has surely noticed the continual rise of gas prices over the last few months. And due to rising global oil demand, that trend is expected to continue.

The inability to match supply and demand is pushing up both oil and gas prices.

The International Energy Agency says that global oil and liquid fuels consumption grew by an estimated 2.8 million barrels per day in 2010, to 87.8 million barrels per day, the second largest annual increase in at least 30 years. And it foresees consumption rising to 89.3 million barrels per day this year.

Though global oil consumption had slowed during the recession, it is now higher than before the economic downturn.

The US Energy Information Administration (EIA) expects that world oil markets will continue tightening over the next two years.

That's because the EIA projects that world oil consumption will grow by an annual average of 1.5 million barrels per day through 2012.

At the same time, the EIA expects the growth in supply from non-OPEC countries to average about 0.3 million barrels per day this year, and to remain flat in 2012.

Consequently, the decisions of US car-buyers are being driven by rising gas prices. According to the latest sales figures, many buyers are trending toward smaller, more fuel-efficient cars and hybrids.

For example, Toyota sold almost 11,000 Prius hybrids in the U.S. in January, an increase of more than 25% from a year earlier; Nissan sold 47% more Versas in January from a year earlier; BMW's Mini Cooper sales were up more than 22%; and sales of the Ford Focus jumped 41%.

With gas prices expected to range from $3.50 to $4.00 throughout the nation this year, the demand for small cars should remain strong. In response, automakers are launching an assortment of smaller, more fuel-efficient models.

A survey by Kelley Blue Book found that 61% of the respondents say that they have changed their driving habits as a result of rising gas prices, and many indicate they are considering making trade-offs on their next vehicle choice to save money on fuel.

According to the survey, 48% said they would consider a smaller engine size in their next vehicle to deal with rising gas prices; 36% said they would pick a smaller vehicle, such as moving from a mid-size car to a compact car; and 31% said they would move to a more fuel-efficient auto category.

Kelley Blue Book said consumers start to think about changing auto buying habits once gasoline prices cross about $3 a gallon. When it hits $4, about 80% of consumers say gas prices will alter their purchase decisions. And by $5 a gallon, the sentiment is almost universal.

So, based on current trends, from now on the vast majority of car buyers will be factoring gas prices into their purchase decisions.

Thursday, February 17, 2011

Hirsch Report Reveals US Totally Unprepared for Peak Oil Era

"When oil production goes into decline, it’s going to be a defining issue for humanity." — Robert Hirsch

Robert L. Hirsch is the lead author of a stunning report — Peaking of World Oil Production: Impacts, Mitigation & Risk Management — written for the US Dept. of Energy’s National Energy Technology Laboratory (DOE, NETL).

The report, published in February 2005, is more commonly known as the "Hirsch Report." This extraordinary document examines the time frame and implications of Peak Oil, and looks at what preparations need to be undertaken at a national level to mitigate its impacts.

Written by Hirsch and two colleagues, the report's introduction reads as follows:

The peaking of world oil production presents the U.S. and the world with an unprecedented risk management problem. As peaking is approached, liquid fuel prices and price volatility will increase dramatically, and, without timely mitigation, the economic, social, and political costs will be unprecedented. Viable mitigation options exist on both the supply and demand sides, but to have substantial impact, they must be initiated more than a decade in advance of peaking.

And from there the report goes on to outline the numerous, and rather grave, troubles that lie ahead as a result of peaking oil production. It's the kind of stuff that can keep you awake at night, questioning the future. What's most troubling is that virtually nothing has been done since the report's release to prepare for this looming watershed.

It's been six years since the Hirsch Report warned of a global problem of "unprecedented" proportions with economic, social, and political impacts that are likely to be extremely severe. The authors forecast "protracted economic hardship" for the United States and the rest of the world. They warned that Peak Oil is a problem that deserves "immediate, serious attention."

Yet, the media haven't given this topic the coverage it clearly warrants. As a result, the public is largely unaware of this pending crisis. Apparently, fear of initiating a panic takes precedence over careful planning and public policy.

The subject of Peak Oil is a tough one, because its implications are so dire. But it is by no means a cryptic or fringe concept. If you've seen the documentary "A Crude Awakening," you know that this topic is a widely accepted reality in oil industries and government ministries across the globe. The film is chock full of interviews with petroleum geologists, former OPEC officials, energy analysts, politicians, and political analysts — all of whom recognize the gravity of the situation.

Last year, the Dept. of Energy publicly stated that Peak Oil is all but upon us. And a report from the U.S. military paints an alarming picture of future oil supplies; it predicts that global production will peak within two years, and there could be shortages by 2015.

The sad truth is that new oil-field discoveries peaked in the late 1960s, and that's why petroleum companies are going to such extremes as to drill in 2-3 miles of ocean water to retrieve oil. The more difficult it becomes to access oil, the more expensive it becomes.

Everything in our modern society is oil-dependent — from food production and distribution, to textiles and manufacturing, to the transportation of all goods and people.

The Hirsch Report notes that over the past century the US economy has been shaped by the availability of low-cost oil and that Peak Oil will present the US with economic losses that will be measured in the trillions of dollars.

According to the report, peaking oil production will be abrupt, providing little time to evolve. Consequently, the repercussions will be revolutionary. And without massive mitigation, the report warns, the problem will be pervasive and long-term.

Such mitigation efforts will require abundant preparation and substantial time, the report warns. Waiting until production peaks would leave the world with a liquid fuel deficit for 20 years. Initiating a crash program 10 years before peaking leaves a liquid fuels shortfall of a decade. However, initiating a crash program 20 years before peaking could avoid a world liquid fuels shortfall.

Aggressive fuel efficiency and substitute fuel production are the recommended means to provide substantial mitigation.

Yet, even though this essential document was issued six years ago, little to nothing in regard to mitigation has been done on a governmental or national level.

Mr. Hirsch outlined the challenges ahead in a 2009 interview with the Association for the Study of Peak Oil (ASPO).

"We found that because the decline rate in world oil production was going to be in multiple percents per year, it was going to take a very long time for mitigation to catch up to the decline in world oil production. Basically, the best we found was that starting a worldwide crash program 20 years before the problem hits avoid serious problems. If you started 10 years before-hand, you are in a lot of trouble; and if you wait to the last minute until the problem is obvious, then you’re in deep trouble for much longer than a decade. As it turns out, we no longer have the 10 or 20 years that were two of our scenarios."

An expanding global population, coupled with increasing living standards and energy consumption in the developing world (particularly China and India) are all elevating the demand for oil.

Yet, as a finite resource, the supply of oil is fixed and will not be able to keep up with rising demand.

This is a point the Hirsch Report makes clear:

World oil demand is expected to grow 50 percent by 2025. To meet that demand, ever-larger volumes of oil will have to be produced. Since oil production from individual reservoirs grows to a peak and then declines, new reservoirs must be continually discovered and brought into production to compensate for the depletion of older reservoirs. If large quantities of new oil are not discovered and brought into production somewhere in the world, then world oil production will no longer satisfy demand. That point is called the peaking of world conventional oil production....

Some economists expect higher oil prices and improved technologies to continue to provide ever-increasing oil production for the foreseeable future. Most geologists disagree because they do not believe that there are many huge new oil reservoirs left to be found. Accordingly, geologists and other observers believe that supply will eventually fall short of growing world demand — and result in the peaking of world conventional oil production.

Though we may never fully run out of oil, we will eventually run out of cheap oil. That's when life as we've known it changes immutably.

Mr. Hirsch's expertise and advanced pedigree accord him unimpeachable authority, and that's exactly what compelled the government to commission his Peak Oil report. The fact that the Hirsch report was produced at the request of the US Department of Energy lends it all due credibility.

Hirsch started his career in the field of nuclear energy, did fusion research and ultimately managed the government's fusion program. Over the years, he also worked on renewable energy sources and managed the federal renewables program. He then went on to work in the oil industry, where he managed research on long range refining and synthetic fuels, and later managed upstream research and development—the exploration and production of oil and gas.

However, despite being commissioned by the DOE, the Hirsch Report was buried by the department because it believed the American public could not deal with the idea that its way of life might be threatened. The DOE simply determined that the public couldn't handle the report because it was just too painful.

"When they saw the final report, it shocked them, even though they could see what was coming," said Hirsch in a 2009 interview with ASPO. "When the report was done, management at NETL really didn’t know what to do with it because it was so shocking and the implications were so significant. Finally, the director decided that she would sign off on it because she was retiring and couldn’t be hurt, or so I was told. The report didn’t get widely publicized. It somehow was picked up by a high school someplace in California; eventually NETL put it on their website."

The media didn't help. Instead of running excerpts and summaries of the Hirsch Report, US newspapers and newsmagazines have generally ignored it.

In late May 2005, Hirsch presented the substance of the report at the annual ASPO Workshop in Lisbon, Portugal to an audience of about 300. The event received virtually no press coverage in the US.

However, in the six years since the report was formally unveiled, the Internet chatter has never waned. Thank goodness for the blogosphere and alternative media.

When the report was issued, Hirsch didn't take a position on when Peak Oil would occur. Hirsch says that when he got into the subject he "knew enough about the uncertainties and unknowns to feel... that I could not make a reasoned judgment early on."

Over time, as his research developed and evolved, that changed.

"I spent a number of years listening to what other people had to say, studying their analyses, and looking at what was happening in the real world before I came to a conclusion for myself... I wasn’t about to take a position on timing without having a lot of evidence that would support my position. And so it wasn’t until about [late 2007, early 2008] that I began to home in on the likely timing of the decline of world oil production being sometime within the next five years."

We've been in a race against time for years, and yet our government has showed no sense of urgency. That lack of preparation will haunt us, says Hirsch.

"[This] is going to be very difficult because people don’t like to hear bad news, and this is terrible news. And as it sinks in, markets will drop and there will be an immediate recessionary reaction because people will realize that this is such a horrendous problem that having a positive outlook on employment and the economy is just simply unrealistic."

Large scale events have a way of speeding up, especially when leaders are not paying attention. Complex systems can break down and unsustainable systems always breakdown. The implications of Peal Oil will likely be sudden and abrupt.

The Hirsch report projects that if Middle East reserves are much less than stated, life in a post peak oil world will be even worse than projected. Such a worst-case scenario may have been realized just last week.

According to leaked confidential cables from the US embassy in Riyadh, the US fears that Saudi Arabia, the world's largest exporter of crude oil, may not have enough reserves to prevent oil prices from escalating.

A senior Saudi government oil executive warns that the kingdom's crude oil reserves may have been overstated by as much as 300 billion barrels — or nearly 40% — and that this was done to spur foreign investment.

At this point, waiting for the federal government to act is futile. It's now time for local communities and even individuals to act and come up with their own plans.

The situation will not suddenly improve. It is only poised to worsen.

Wednesday, February 09, 2011

US Manufacturing: The Backbone Of Our Economy Has Been Broken

For many decades, manufacturing was the backbone of the US economy. Manufacturing allowed people with only high school degrees to become part of the middle class, to buy a home, to buy a new car every five to 10 years, and to even put their children through college.

But over the past three decades, US manufacturing jobs have been steadily outsourced to workers overseas. Millions of good, blue-collar jobs — the kind that grew the middle class in America — have vanished, taking a serious toll on our economy.

In fact, largely due to outsourcing, the number of workers in manufacturing dropped by one-third over the past decade.

The absence of a solid manufacturing base doesn't just mean fewer good jobs for Americans; it also means we have to import more goods and have fewer of them to export. That combination results in billions of dollars leaving the US each and every month.

Manufacturing has declined from 14.2% of GDP in 2000 to just 11% of total output today. According to the Bureau of Economic Analysis, in 2009 US GDP was $14.2 trillion. Manufacturing contributed just $1.5 trillion to the total.

As a result of our shrunken manufacturing base, it's no surprise that the US has led the world in imports for decades or that exports now represent just 12% of our economy. It's a bad combination. The US now has a massive trade deficit and is the world's biggest debtor nation.

A wider trade deficit creates a drag on economic growth because more of the nation's consumption is coming from overseas rather than from domestic production.

So, why have US corporations slashed so many American jobs, only to hire workers in foreign nations instead? It's simple; money.

The average wage in developed economies is about 10 times the average level in emerging economies. That's the inherent flaw in "free trade". Simply put, due to higher wages, it costs a lot more to produce goods in the US than it does in developing countries.

Due to the impact this is having on their economies, last August, the National Conference of State Legislatures called for major reform of US trade pact model. It's now clear that free trade isn't all it was touted to be.

Here's a rather simple formula: No jobs = no spending = no growth = lower tax revenue = higher deficits = higher debt = higher tax rates & interest rates = no growth.

But it's not just manufacturing jobs that have been lost. Millions of workers — like file clerks, ticket agents and autoworkers — have been displaced by technological advances and international trade. Millions of other jobs, such as clerical and administrative positions, printing machine operators and travel agents have all been eliminated.

Most of these occupations will never come back, regardless of what happens to the US economy. The skills of these workers are now largely irrelevant. Even if the recession hadn't occurred, employers still would have eliminated many of these jobs through attrition or buyouts. The recession only accelerated the process.

Though the federal Trade Act allows workers who've lost jobs to get retraining for higher-skilled jobs, a 2006 federal study found that most workers who do take retraining benefits get lower pay in their new jobs.

That's a truly sad state of affairs. Such a trend will only hasten the shrinking of what remains of the American middle class.

In a 2007 paper, Princeton economist Alan Blinder estimated that 22% to 29% of US jobs are vulnerable to being "off-shored" in the next 10 to 20 years. What may come as a surprise is that many jobs requiring a college education are the most vulnerable.

As the old saying goes, constant change is here to stay. From now on, workers will have to be nimble, adaptable and quick to adjust to employment trends.

The days of going straight from high school to a lifetime job at the factory, followed by a decent pension upon retirement, are long gone. Most workers will have numerous jobs, and perhaps even multiple careers.

The oft-repeated claim that the average American worker will have seven different careers in his or her lifetime is unfounded. The U.S. Bureau of Labor Statistics, the Labor Department's data arm, doesn't track lifetime careers. In fact, the BLS website notes that "no consensus has emerged on what constitutes a career change."

However, BLS economist Chuck Pierret has been conducting a study to better assess U.S. workers' job stability over time, interviewing 10,000 individuals, first surveyed in 1979, when group members were between 14 and 22 years old. So far, members of the group have held 10.8 jobs, on average, between ages 18 and 42, using the latest data available.

According to the U.S. Census Bureau's Current Population Survey, the typical American worker's tenure with his or her current employer was 3.8 years from 1996 to 2008, the latest available data. Given that a person may work for 45 years, or so, it's easy to assume that he or she may have 10 or more jobs in their lifetime.

It's one thing if this is the result of personal choices. However, in many cases it isn't. Regardless, is not the hallmark of worker stability.

Free trade has been a double-edged sword for the US. Though it has brought American consumers lower prices, it has also cost many of them their jobs. Being an import-driven, consumption-based economy is not working. It has led to a massive trade deficit, massive debt, and millions upon millions of outsourced American jobs.

If Americans are willing to pay more for American-made goods, US manufacturing could begin again in earnest. We could consume what we produce and recirculate our money back into our own economy, instead of sending it overseas. Such a transition would shrink the trade deficit, though much of it is driven by oil imports.

Clearly, the status quo isn't working. At present, we are on the road to nowhere, or perhaps even worse.

If this situation doesn't change soon, the US will be facing multiple and uncorrectable crises of rampant and unyielding unemployment, greater poverty and income disparity (already the highest in the developed world), plus the eventual and inevitable bankruptcy of our nation.

After all, given its relatively low export base, where will the US continue getting all that money for all those imports?

As Stein's Law famously concludes, "If something cannot go on forever, it will stop."

Monday, February 07, 2011

The Reagan Myth

Ronald Reagan is famously remembered for cutting taxes in 1981, his first year in the Oval Office.

However, Republicans, who worship Reagan in hero-like fashion, often forget (or neglect to mention) that Reagan was a consummate political pragmatist who subsequently raised taxes numerous times during the remainder of his tenure in the White House.

Former Republican Senator Alan Simpson, a friend and colleague of Reagan's, notes that the president raised taxes a total of 11 times and calls Reagan "a total realist as to politics."

Due to the same political roadblocks that still exist today, Reagan was unable to come up with the spending cuts necessary to pay for his historic 1981 tax cut program. Consequently, those cuts blew a massive hole in the federal budget.

Though Reagan oversaw a modest reduction in domestic spending, it was dwarfed by a large buildup in the Pentagon budget.

Subsequently, the pragmatic president wisely — though regretfully — raised taxes multiple times. Ultimately, the repeated hikes unwound about half the savings of the '81 cut.

Former Reagan Budget Director David Stockman says it was a tough decision for Reagan.

"He wasn't very happy about it. He did it reluctantly. But at the end of the day, the math was overwhelming," says Stockman.

Reagan was stymied by the popularity of entitlements and the lack of political will to significantly cut those programs in order to pay for all his tax cuts.

"The White House and President Reagan himself retreated within three days when it became clear the enormous political resistance that would occur if you were going to cut entitlements," Stockman remembers.

The president also recognized that he couldn't significantly increase defense spending while simultaneously reducing government revenues.

What's often lost in all of the conservative idolatry of Reagan is that he was a realist, not an ideologue.

"Ronald Reagan was never afraid to raise taxes," says historian Douglas Brinkley, editor of Reagan's diaries. "And so there's a false mythology out there about Reagan as this conservative president who came in and just cut taxes and trimmed federal spending in a dramatic way. It didn't happen that way. It's false."

Faced with either raising taxes or an even bigger federal debt, Reagan chose to raise taxes. That's an important lesson at a time when the nation is facing a much larger debt — not just in terms of total dollars, but also in debt-to-GDP ratio.

With a stalled economy, a shrunken tax base and two ongoing wars, government revenues and expenditures are moving in opposite directions.

The bipartisan Deficit Reduction Commission recently warned that the deficit problem cannot be solved without a combination of spending cuts and revenue increases.

The latter may be in the form of tax hikes, or a restructuring of the tax code that streamlines and simplifies the system, while eliminating all deductions, credits and write offs. Such an overhaul could simultaneously lower rates, raise more revenue and level the playing field for everyone.

But to do that, the Republicans need to overcome their knee-jerk opposition to raising revenues, even if it means raising taxes, at least until the deficit is wiped out.

Upholding the Reagan myth gets in the way, says Stockman.

"I wouldn't call it merely airbrushing. I would call it outright revisionism, if not fabrication of history."

Along with cutting entitlements, raising taxes is one of the third rails of American politics. Just ask George H.W. Bush.

Reagan was the exception. Brinkley is amazed that Reagan somehow managed to raise taxes without paying a political price.

"He seemed to get away with both. He seemed to really be kind of a centrist, big government deficit spender, but also be seen as a budget cutter. And it's because his persona was so great."

After all, Reagan was known as the 'Great Communicator" and it served him well.

Friday, February 04, 2011

Fourth-Quarter GDP: Reality or Myth, Sustainable or Unsustainable?

In the midst of a near-constant stream of bad news about the US economy, there was some recent good news; gross domestic product grew at a 3.2% rate in the fourth quarter.

Though this was below the consensus estimate for 3.6% growth, it was an improvement from the 2.6% pace in the third quarter and 1.7% in the second quarter.

Much of the growth was attributed to consumer spending, which grew at a 4.4% rate. So, at first blush, it seems US consumers have returned from their hibernation.

But before you get too excited, let's explore a few important facts.

First, there are roughly 15 million unemployed Americans at present. And 17.3% of American workers were either unemployed or under-employed, meaning they can only find part-time work even though they are seeking full-time employment.

Second, due to the Christmas season, the fourth quarter is typically the most robust for retailers. According to the National Retail Federation, for some retailers, the holiday season can represent anywhere between 25-40% of annual sales.

Additionally, real income rose a paltry 1.7% in the third quarter. Which leads us to ask, where did consumers find all that extra spending money?

Well, savings dropped by a notable 0.5% in the quarter. And, according to Investment Company Institute, investors withdrew a whopping $33.12 billion from domestic stock market mutual funds in first seven months of 2010.

So, the draw down in savings accounts and mutual funds allowed for increased spending, even though wages and incomes were so tight.

Consumer activity comprises the bulk of the US economy — some $10 trillion of the roughly $14 trillion total. To put this into perspective, that $10 trillion is approximately half of the entire global consumer market. The combined BRIC nations — Brazil, Russia, India and China — account for less than one-third of that amount.

While consumer spending averaged 64% of GDP between 1950 and 1980, it has now reached 70% of GDP. Most of this was, and is, funded by debt.

Household debt in the US grew from 69% of our gross domestic product at the end of 1998 to 97% of GDP by the end of 2009.

We can see that the US embarked on a decade-long debt binge. And now the question is, how much longer can this last?

After the financial collapse in the fall of 2008, and the subsequent recession that lasted for six consecutive quarters, it seemed as if all that rampant consumer spending — and the debt that fueled it — had finally come to an end.

The Great Recession — which officially lasted 18 months, from December 2007 through June 2009 — was the longest since World War II. Its effects are still bitter and enduring for millions of Americans.

According to the American Bankruptcy Institute, 1.53 million US consumers filed for bankruptcy protection from creditors in 2010, up from 1.4 million in 2009. Consumer bankruptcies rose 9% in 2010, and the ABI expects that filings will keep climbing this year given high debts and weak incomes.

With all of this in mind, it's reasonable to ask if the initial fourth quarter GDP number was in fact accurate, or if it will later be revised downward, as so often happens.

And even if the 3.2% reading is ultimately found to be accurate, can it hold up in the first quarter of 2011? Now that the Christmas spending binge is over, can consumers continue to carry the US economy at that same pace?

My guess is no.

It's important to remember that the government is facing a massive and rapidly expanding debt exceeding $14 trillion. The last election was largely about the economy and the debt.

Consequently, the new Republican majority in Congress has pledged to slash government spending. Though long overdue, such spending cuts will create a major drag on the economy.

If consumers feel the hangover of all that Christmas spending — reflected in their recent credit card statements — and decide to tighten their purse strings as a result, the combination could be devastating.

When government and citizens attempt to pay down debt at the same time, the result is depression and deflation, which would make our debt problems even worse.

We'll know more in April, when the initial first-quarter GDP figure is announced. But it will hardly be surprising if the pace dips below the fourth quarter level, which was celebrated by many media pundits and talking heads.

At this point, everyone is desperate for good news. But we shouldn't fool ourselves. This kind of GDP growth will have to become a trend before I become a believer.

Wednesday, February 02, 2011

Japan Facing Terminal Debt Crisis

First it was Dubai. Then it was Greece. Then Ireland. Then Portugal. And there are also legitimate concerns about Belgium, Austria, Spain and Italy.

But those nation's debt problems are small potatoes compared to the burden that Japan is facing.

Over the two decades between 1989 and 2009, Japan's government debt exploded from 66% of gross domestic product to a whopping 226% — a staggering debt load that is by far the largest percentage of any industrialized nation.

Japan has been trapped in a deflationary spiral for the last two decades, and there are no signs of it ending any time soon. Despite massive government stimulus, the nation cannot seem to grow its economy, and therefore it's debt-to-GDP ratio just keeps expanding.

In 1968, Japan overtook Germany to become the world's second largest economy, behind the US. And it held onto that position for 42 years before finally being eclipsed by China last year. It was a historic sea change.

The combination of a shrinking economy and an ever-expanding debt were significant reasons that Standard & Poor's lowered Japan's credit rating last week, as it did in 2002. The downgrade pushed Japan's long-term rating from AA to AA-minus.

But the move was a long time coming. The writing was on the wall for many years.

Japan had been repeatedly warned to get its fiscal house in order. As it had previously, S&P noted that Japan has no "coherent strategy" to tackle problems that have been decades in the making.

"The downgrade reflects our appraisal that Japan's government debt ratios--already among the highest for rated sovereigns--will continue to rise further than we envisaged before the global economic recession hit the country and will peak only in the mid-2020s."

It seems that events have gotten away from the Japanese government and may have finally spiraled out of control.

Japan's public debt is racing toward 1 quadrillion yen, or $12 trillion. The good news is that the vast majority of that debt (95%) is owed domestically to banks, insurance companies and pension funds — not to foreigners. Japanese citizens hold an extraordinarily high household savings of $15 trillion, which has also allowed the government to borrow at home.

As Japan's economy stagnated in the late 1980s, the government stepped in and increased spending to offset private sector declines. But the economy continued to sputter even as government debt increased precipitously.

What once seemed impossible now seems inevitable; Japan appears headed for a full-fledged debt crisis and possibly a currency devaluation. When such a moment arrives, the impact will be felt globally and could push the world's economic system to the brink, triggering a global depression.

With one of the oldest populations in the world, Japan's problems are only mounting and remain poised to worsen.

Last year, Japan's population fell by a record number, as deaths exceeded births. The country's life expectancy is among the highest in the world, while its birth rate is among the lowest, a miserable combination.

People 65 and older make up about a quarter (23%) of Japan's population and the Baby Boomers are nearing retirement. By 2050, the government projects that fully 40% of the population will be over 65.

As it is, the percentage of retirees in Japan is three times that of the rest of the world, which is putting enormous stress on the retirement system. And it will only get worse.

Due to the combination of a low birth rate and long life expectancy, Japan's population has declined in each of the last four years. That will only exacerbate an already existing problem; there are too few workers to replace retirees and it is resulting in a shrinking tax base.

The poor economy and dour national mood have led to a very low birthrate; there were just over 1 million births last year in a population of just under 126 million.

In addition to shrinking the tax base, Japan's aging population is expected to shrink consumption annually from now on. At the same time, the majority of the national budget is already funded by deficit spending. What this means is that the already shrinking tax base and economy will get progressively smaller still.

As the tide of Japanese retirees continues to rise, more of them will be pulling money out of savings accounts and government pension funds. And as Japanese citizens start selling off government bonds to support their retirement, the government will be forced to rely on external, or foreign, lenders in the bond market.

However, with a debt load so perilously high, and structural problems so deep, the market will demand higher yields that could become crippling to the Japanese government.

Japan has never had to rely on the global bond markets. If it had to pay the same interest rates as the other G-7 nations, its interest costs would exceed revenues. Yet Japan's dire fiscal situation indicates that it should already be paying considerably higher rates than the other G-7 nations.

For example, Germany currently pays 2.25% for 3-year bonds, 2% for 5-year bonds and 2.5% for 10-year bonds. On the other hand, Japan is currently paying 1.4%, 0.5% and 1.2% for the same bonds.

At present, there is a total disconnect in the bond market that doesn't reflect Japan's dire fiscal and economic situations.

Japan's current debt payments are about $244 billion a year. Kyle Bass, who runs the Dallas-based hedge fund Hayman Advisors, has calculated that every percentage point in higher yields adds another $125 billion in annual interest expenses.

So if investors demand just an extra two percentage points above current yields — bringing Japan in line with Germany and the US — it would add $250 billion in annual interest payments to the country's debt figure. That would consume Japan's entire $489 billion in revenue.

Japan is the proverbial canary in the coal mine, and it serves as a warning to other industrialized nations also carrying unsustainable debts — including the US.

Once the bond market loses confidence in Japan, it's game over. The effects of that moment will be felt worldwide, and it will be seismic.