What Does Cyprus Mean for Us?

The recent events in Cyprus have many in our country debating whether Cyprus and the larger financial problems mean anything for the U.S.  There are two questions that people ask most: 

1.  Will the events in Cyprus affect us?

2.  Can we become like Cyprus if our debt becomes too large?

First, it is important to quickly cover some background on Cyprus and the larger problems in several European countries like Portugal, Italy, Ireland, Greece and Spain (PIIGS).  The bottom line is that all of these countries face growing turmoil due to large debt compared to their GDP.  Their ability to pay back their debt is in serious doubt so other countries are unwilling to loan them more money unless they take steps to curtail their deficits through a combination of spending cuts and tax increases, typically referred to as austerity measures.  For more background on austerity, I refer back to an older post on the topic:  The Myths of Austerity.  The biggest difference between a country like Cyprus and the U.S., and this is important, is that Cyprus does not have a sovereign currency.  They belong to the Eurozone and use the Euro as their currency.  That means they cannot simply print more money to pay off their debt.  Cyprus made headlines recently because of the seizure of portions of private bank accounts to help pay off their debt.

So to answer the first question, can Cyprus affect the U.S, the answer is no in the short term but possibly in the long term.  Cyprus is a tiny country so their economic problems should not directly affect the U.S.  However, the problems in Cyprus and the reaction to the problem of seizing people’s private funds could cause more widespread concern in the PIIGS countries.  If people in those countries believe that their bank accounts could be targeted as well, they could cause a run on the banks and create greater economic problems throughout Europe.  The other short term problem that could happen is if countries throughout Europe decide that the Euro is no longer a viable currency and a nation like Germany, tired of being forced to bail out their Mediterranean neighbors, decides to dissolve the Euro experiment.  Although some feel this is a better option in the long term, the short term chaos would cause problems here in the U.S. since Europe is our largest trading partner.

Now for the second question, can something like Cyprus happen here, the short answer is no but the larger answer is a little less definite.  Remember when I said that we have a sovereign currency.  So technically we can always pay off debt by printing more money.  The problem becomes when we accumulate too much debt and print too much money.  Experts disagree on when that point occurs, but if more currency is put into circulation, eventually the value of all of the currency decreases.  That is inflation.  Now creditors will want more return for their investment because each dollar they receive back is worth less, so the price of borrowing goes up.  Now some argue that despite all the money that the Fed has printed over the last few years that inflation is still low.  They miss the point in two areas.  One, the official inflation rate or Consumer Price Index (CPI) is low because it includes housing rental prices, which have been low due to the crash of the housing market.  With a lot of empty houses due to foreclosure and people underwater and unable to sell their homes, rental prices dropped.  But, think about the things you buy every day like gas and food and you get a sense of real inflation.  Also, higher unemployment rates have kept inflation low because fewer people have money to spend.  However, no one can argue that an almost limitless printing of money will eventually cause inflation.  Without a gold standard to back up our money, the currency gets its value from the full faith and credit of the government.  In other words, creditors have to believe the money has value.  If there is so much of it in circulation, the dollar will lose value, making everything we buy more expensive.

So Cyprus and the events in other European countries are important to watch for a couple of reasons.  One, a larger economic catastrophe in Europe will affect our economy.  Two, the problems countries like Cyprus and Greece have with their debt is actually a better comparison to the issues our states and cities will face due to debt or bankruptcy.  The national debt of Cyprus is about $19 billion.  The debt of California is about 20 times that and like Cyprus, California does not have a sovereign currency.

Pork For Our Time

 In 1938, British Prime Minister  Neville Chamberlain met personally with Adolf Hitler to work out a deal to prevent conflict in Europe.  He basically agreed to let Germany take part of Czechoslovakia without repercussions.  When Chamberlain returned from Germany after making a deal with the devil, he told the British people that they would see “Peace for our time”.    Chamberlain’s name has become synonymous with the term appeasement and people have used his actions to show that you cannot negotiate with a madman.  If you examine his words in more detail though, it is even more disturbing.  When Chamberlain said “for our time” he had to know that Adolf Hitler did not have peaceful intentions and eventually there would be war.  He just didn’t want to deal with it, despite the fact that Germany was only growing more dangerous every day.  In other words, as long as we have peace now, who cares what happens later.

Unfortunately, we see this same sentiment today when it comes to dealing with our nation’s debt.  Experts argue about when the debt will become a crisis, but few will dispute that excessive debt hurts our country.  We also know that, if nothing changes, the debt will only get worse.  And nothing is really being done about it.  Despite the fact that Rep. Ryan’s budget is already under attack by some, it only begins to address the debt ten years from now.  The budget submitted by Sen. Murray never balances the budget so will never address debt.  

So where does the problem lie?  The majority of Americans feel that the government should live within its means.  However, mention reduced spending on any program, and some group will protest.  To make things worse, few politicians have the courage to propose reduced spending to any specific program because of the repercussions.  In some ways, that makes our behavior even more cowardly than Neville Chamberlain’s.  At least his decision to sacrifice part of Czechoslovakia was based on life and death decisions, war and peace.  The decisions our elected leaders take now to guarantee ‘Pork for Our Time’ and push this problem off to future generations is strictly based on political gain.  And the American people are not facing the threat of another World War like the British were in 1938.  Will we be willing to sacrifice anything to avoid passing the burden of debt to future generations or will we only be concerned with ‘our time’?

Why Worry About the Debt?

Austerity the Boogeyman

Anyone who is using the term ‘austerity’ to describe the proposed budgets in Congress is irresponsible and dangerous, and here is why.  A debt that is already large and continuing to get larger is not good for this country.  I’ve already written about how non-discretionary spending will become an increasingly larger portion of our spending in Budget, how the debt hurts our foreign policy in It’s the Debt Stupid, how solving the debt problem will become more and more difficult over time in The Biggest Loser, and how nothing in the Ryan or Murray budgets comes close to being described as ‘austerity’ in Myths of Austerity so I don’t want to revisit those ideas in this post.  

So why is using the word austerity irresponsible and dangerous?  First, it is simply not accurate.  Neither budget cuts spending.  They reduce the rate of growth of spending.  If an alcoholic drinks 8 beers every night, plans on drinking 10 tomorrow but only drinks 9 when tomorrow comes, did he cut down on drinking?

But more importantly, the word austerity scares people and makes them think that we are about to take draconian measures.  People equate austerity with chaos and rioting in the street so using the word makes it less likely that people will be willing to consider any deficit reduction measures.  

Here’s the problem.  Imagine the debt is a cavity on your tooth.  In Ryan’s plan the cavity keeps getting worse for 10 years and then stabilizes.  In Murray’s plan the cavity will keep getting worse forever.  Either way, the cavity is continuing to decay for a while.  Now imagine your friend or a loved one tries to scare you about seeing a dentist to get a filling.  Being scared, you do nothing until eventually the tooth gets so bad you need a root canal or get the tooth pulled completely.  By scaring you about handling the problem at an earlier stage, the problem got worse and required more drastic measures.  The same analogy from the Biggest Loser post could be used here as well.  Imagine that you have an overweight friend.  Their excess weight is causing health problems but they just continue to put on more weight.  Would you scare them by talking about how horrible exercise is or how brutal eating right is going to be, or would you explain to them the health risks of obesity and look for sensible ways to address the problem?  If you scare them now into doing nothing, it will only get worse.

Scaring people with the word ‘austerity’ will have the same effect on doing something about the deficit and debt.  Make people aware of the facts and let them make a decision on deficit reduction, but don’t use the boogeyman of austerity to scare people away from the facts.  When you see the word ‘austerity’ trying to describe any attempt to reduce the deficit, call the writer out as irresponsible and false.  I think the American people know that we can not continue to add to our debt year after year with no plan in sight to reverse that trend.

The Truth About the Sequester

The purpose of this post is not to blame the right or the left for sequestration.  There is enough blame to go around on both sides.  For a reminder of how we got to sequester, go back and read an earlier post on the topic:  How the Sequester Got Started.  The real purpose of this post is to cut through the various and sometimes conflicting views on whether or not the cuts are minor or serious.

Imagine you run a family budget and you have to cut about 2% per year from spending.  Now a little over half of the budget is tied up in house, car and insurance payments that you are not willing or able to cut.  So that 2% cut has to come from the other half of your budget, which makes it a 4% cut from that half.  Let’s say that 25% of the budget is for entertainment and recreation and the other 25% is for living expenses like food, gas and day to day items.  Keep in mind that these don’t represent an actual family budget, they are just to show a point.

Let’s say you decide to spread that 4% cut evenly over the entertainment and living expenses portions of your budget instead of cutting one part 8% and the other 0%.  Now if we just focus on the 4% cut to living expenses, imagine that you can’t cut your gas costs or your food costs for whatever reason.  So your day to day items budget has to absorb all of that 4% cut to the living expenses portion, which could amount to closer to a 12% cut in that area.  Keep in mind that you are already halfway through the year so a 12% cut is really like a 25% cut of the budget you have remaining for the year.

Take the numbers above and substitute non-discretionary spending on Social Security, Medicare, and Medicaid for your untouchable house, car and insurance payments.  Substitute Defense and non-Defense discretionary spending for you living expenses and entertainment budget (the terms don’t mean anything so don’t read into whether Defense is entertainment or living expenses).   Now you can see why it is possible to say simultaneously that these cuts only represent 1-2% of spending and cannot possibly be devastating and that they represent up to 35% of some programs and will be painful.  Statistics and numbers can be manipulated to say what you want them to say.  Although the cuts are only 1-2% of the overall budget, they were targeted at smaller portions of the budget and do not allow for flexibility in how they are implemented.  In the family scenario above, you might get by with a 25% cut in your day to day items budget.  Could you do the same with your food or gas budget?

So what does this all mean?  One, it means that both sides are partially right and partially wrong when describing the effects of the cuts.  Take Defense cuts once again.  They represent half of the sequester cuts, despite the fact that they are less than 20% of spending.  When you take into account that they cannot cut uniformed personnel pay or costs for ongoing operations you see that the DoD has to make the cuts in limited areas like training and new equipment.  Not exactly good news if something unexpected happens, like say Syria or North Korea.

This also means that if the American people are not willing to seriously look at non-discretionary entitlement spending that any future cuts will come from an increasingly smaller piece of the pie.  Entitlement spending is already over half of the US budget and along with interest on the debt, will only increase in proportion every year if no changes are made.  I have already written on entitlement programs and compared the life expectancy when the programs were created to the life expectancy now at the link here Budget.  It doesn’t take a mathematician to realize that the longer people live and the more medical care costs, the more that these programs will cost the nation.  Are we willing to say that maybe 60, 62, 65 or 67 are not the same as those age milestones were in the 1930s or 1960s?  Are we willing to make any spending cuts at all that are not tied to a game of chicken called the sequester?  If so, are we only going to make those cuts from less then one half of the budget and shrinking?

What the Biggest Loser can Teach us About the Debt!

If you have seen an episode or even heard of the Biggest Loser TV show, you know what the show is about.  If not, the basic premise is that people who are extremely overweight go on a reality show where they live away from their families and compete to lose weight under the demanding routines of their physical trainers.  Their entire lives become focused around proper nutrition and punishing workouts in a last-ditch attempt to reverse their unhealthy lifestyles.  So what can this show teach us about the nation’s current debt situation?

The contestants on the show are clearly obese and at risk for a host of health problems.  If you think about the path that got people to that point, you have to wonder at what point did they realize they had a problem?  At what point did their weight and health become a crisis?  When they were 30, 50, 100, or even 200 pounds overweight and increasing every year, where were the alarm bells?  How did they get to 300, 400 or even 500 pounds without themselves, a loved one, or a friend doing something about it?

Our nation’s debt is following the same pattern as we speak.  Experts and politicians argue whether we are in a debt ‘crisis’ or not and struggle to even define what constitutes a debt crisis.  Here is what we do know.  We are almost $17 trillion in debt and increasing that every year.  Even the Ryan budget, which is regarded as extreme by those on the left, only gets us to a balanced budget in 10 years.  In other words, in 10 years we only get to the point where we stop putting on weight but we have not lost a pound in that 10 years and have continued to pack on the weight, only more slowly.  Maybe we are not at a debt crisis now, but what does it take for the country to recognize that the trend is not good and that if nothing is done, we will just keep adding to the problem?

Because the contestants on the show have become extremely obese, their problems are compounded.  First, they require major lifestyle changes to improve their health.  They try to change their eating habits drastically and endure tough workouts.  These workouts are made more difficult by the extra weight that affects their joints and  hearts, and by the fact that their bodies are typically not ready for physical activity due to years of sedentary lifestyles.

Likewise, the worse the debt becomes, the harder it will be to reverse the problem.  The interest alone on the debt will be like that extra weight threatening the body’s health.  The shear amount of debt to pay off will force future generations to take more drastic measures.  Compare that to the minor and gradual lifestyle changes that can be taken when a person is only 15 or 20 pounds overweight and can simply cut out that extra dessert, reduce portions slightly and get out for a daily walk.  A crushing level of debt will require a radical change in diet and punishing physical activity to get it under control.

A couple of decades ago we were probably at our ‘ideal weight’ when it comes to the debt.  Four or five years ago we were showing telltale signs of being overweight.  In the last four to five years we have been packing on the pounds at a very rapid pace.  If we are not in a crisis yet, why wait until we get there?  Why wait until we are so heavy that it is tough to move and we have so much weight to lose.  Why not push away from the table now, start exercising and reducing the waste in our diet so that we can make some positive changes before we need Jillian and Bob yelling in our faces.  Now some will argue that the debt is different than weight because we can simply print more money.  That is true, but that is like converting your weight from pounds to kilograms because it sounds better, or going on a quick fad diet to drop a few pounds.  You haven’t changed the fundamental problem.  Printing money eventually just lowers the value of all the money in circulation so while we address the immediate debt, we cause inflation.  And while we may have dropped a few pounds or paid off some debt temporarily, if we don’t change our lifestyle we will just keep adding it back on.

Before every contestant on the show reached the point of being morbidly obese, there had to be a point where all the bad signs were there and they chose to ignore them.  Do we need to do the same as a nation?  Let’s put down that piece of cake and go for a walk while we still can.

The Myths of Austerity

If you spend some time on blogs and message boards you see a lot of different reactions to the current discussion in Washington about our debt and deficits.  Inevitably, someone talks about the debt crisis in Europe and the PIIGS countries in particular.  In these discussions, I have seen a few alarming flaws in logic regarding the word austerity that is typical of the reason why we have a difficult time discussing this topic in our country.

Pundits, politicians, experts and everyday people argue whether or not we have a debt problem in this country, and if we do, what is the best way to address it.  Is it increased taxes, decreased spending, or a combination of the two?  This article is not to address those issues.  But what it is important to address are fundamental logic flaws about the concept of austerity in Europe that many people in this country have.  To do so, I will focus on Greece in particular as an example of the worst of the problem.

Greece is in an economic crisis because their debt to GDP ratio became so high that their ability to ever pay back their debt was put in question.  As a result, their bond rates increased making it more difficult for Greece to pay back debt.  In addition, the global market crash in the late 2000s affected Greece’s GDP, making it even more difficult to get their debt under control.  Because the country is part of the EU they do not have the same flexibility with their money that the U.S. does.  But, the fundamental problem for Greece was that their debt to GDP ratio simply became too high.

Now this is where austerity comes in.  Austerity was essentially forced on Greece as a condition to secure loans.  In other words, other countries said we do not want to give you more money until you demonstrate that you are going to take measures to get your debt under control.  So austerity was a result of out of control debt, not the cause of it.  I can’t count how many times recently I have heard people try to state that austerity was the cause of Greece’s problems.  Now, the other problem I see in this country is that many people are trying to equate Congressman Ryan’s recent budget proposal with austerity.  There are several logic flaws with this also.  First, if you try to look at what any U.S. budget proposal is, it is not really spending cuts, it is mainly slowing the rate of spending increases.  In other words, if I gain 3 pounds a year and one year I only gain 2 pounds, I didn’t cut any weight.  I just got heavier a little more slowly that year.  Second, the austerity measures in Greece are a combination of spending cuts, tax increases and other measures such as the privatization of some industries.  So to only equate austerity with spending cuts is not logically valid. In fact, austerity in Europe more closely resembles a balanced approach to deficit reduction, just on steroids.  There is a good link below that covers the austerity measures in more detail.

So what does all this mean?  When discussing our options for the deficit and debt, it is important to not only look to what other countries are doing but to fully understand what they are doing in context.  Austerity did not cause Greece’s debt crisis, over-spending on social programs, and a decrease in revenue due to a lowered GDP and problems with their tax code caused their debt crisis.  Their ability to handle debt differs from the U.S. because they are a member of the Eurozone and not in control of their own currency.  However, what made their debt a crisis was that they let it reach a level that made creditors doubt the country’s ability to pay it back.  Austerity was an attempt to fix the debt crisis and was required as a condition to get access to more money.  Finally, austerity for Greece involves large cuts in spending and large increases in taxes, large compared to what the U.S. is discussing.

 

http://www.bbc.co.uk/news/business-13940431

A View on how the Largest Economy in Europe views Debt

Germany agrees to ‘historic’ balanced budget – The Local.

Filibuster the Debt!

“The most significant threat to our national security is our debt.” — Admiral Mullen, Chairman, Joint Chiefs of Staff on August 27, 2010

 

“[O]ur rising debt levels…poses a national security threat…. And it also sends a message of weakness internationally.” — Secretary of State Clinton on September 8, 2010

 

“Our nation is on an unsustainable fiscal path. Spending is rising and revenues are falling short, requiring the government to borrow huge sums each year to make up the difference.”  – National Commission on Fiscal Responsibility and Reform, The White House December 1, 2010

 

If the most pressing issue for our country is the rising and unsustainable level of national debt, what are we doing about it?  First, there was a bipartisan commission led by Simpson and Bowles. Their recommendations were largely ignored.  Then there was the super-committee that failed to develop any meaningful plan to fix the debt crisis.  This debt, which is increasingly driven by mandatory spending on social security and medical programs, threatens to cripple our country’s future and force future generations to suffer.  This crisis requires a call to action.

Watching Senator Paul conduct a filibuster today to get information on drone strikes, one has to wonder why nothing like this is being done on the Senate floor to call attention to the larger problem of the debt.  While everyone acknowledges the problem and no solutions are forthcoming, will one Senator take a stand and go down in history as the one person in this country who started to turn the tide of rising national indebtedness? The upcoming votes on a Continuing Resolution and the debt ceiling will provide two opportunities to take a stand on this all-important crisis.  All we need is one Senator willing to bring attention to this problem until meaningful and comprehensive measures are implemented to address mandatory spending.

If you think that the debt is a problem for this country, and you think that something needs to be done about it, pass this message on.  Also, write to your Senator to encourage action on the most critical issue of our day.  

http://www.senate.gov/reference/common/faq/How_to_contact_senators.htm

Doing nothing is no longer an option if we do not want to crush future generations in debt because of our inability to make hard choices.

 

Credit Ratings and Debt to GDP Ratio

Credit ratings: The numbers behind the ratings | The Economist.

With all the attention that the PIGS countries (Portugal, Italy, Greece and Spain) in Europe receive for their debt problems and supposed austerity measures, it is interesting to see how the U.S. compares to their debt to GDP ratio.  Only Greece has a considerably higher ratio than the U.S.