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

It’s the Debt, Stupid

With the sequester in the news right now, the discussion about the nation’s debt and deficits rages on.  There are some who say that the debt is not out of control and we should not worry about our increased debt.  Others feel that we must do something about our rising debt but disagree how to attack the problem.  The two political sides differ on whether increased taxes, decreased spending or some combination of the two are the correct approach.  

For those wondering whether excessive debt is a problem, the saying goes “Those Who Fail to Learn From History are Doomed to Repeat It”.  A look back at the Suez Canal crisis of 1956 is telling.

Without going into all of the details of the Suez Canal crisis, which can be explored in more detail here: http://www.economist.com/node/7218678, the event took place in 1956 at a time when global politics were changing.  Britain, France and the other countries of Western Europe were declining in influence as the U.S. and Soviet Union were emerging as the world’s only superpowers. 

When Egypt nationalized the Suez Canal, Britain risked losing vital maritime access to India.  At the risk of overly simplifying the situation, Britain, France and Israel put forces on the ground in Egypt.  The U.S. and Soviets opposed their actions but with Britain and France holding United Nations vetoes, there was not much the U.N. could do.  However, when President Eisenhower influenced the IMF to refuse loans to Britain, the British economy could not handle the economic pressure and they were forced to end their military actions.  

“America struck at Britain’s fragile economy. It refused to allow the IMF to give emergency loans to Britain unless it called off the invasion. Faced by imminent financial collapse, as the British Treasury saw it, on November 7th Eden surrendered to American demands and stopped the operation, with his troops stranded half way down the canal. The French were furious, but obliged to agree; their troops were under British command.”

Britain obviously had a substantial amount of debt from the aftermath of World War II (which they just paid off to the U.S. in 2007 , by the way).  Their reliance on other nations for loans made them vulnerable in foreign policy.  Not only did this vulnerability force them to withdraw from Egypt, it signaled the change in the balance of power from “Old Europe” to the United States that has stood to the present day.

What makes this story important now?  The U.S. now owes over $16 trillion.  Some of that debt is to countries that don’t necessarily share our interests in the world.  Imagine a potential conflict between China and Taiwan or China and Japan.  What if China tried to flex it’s muscle and claim additional territory in the Pacific or deny access to certain waterways?  What if we tried to intervene and China used our debt as leverage?  Could that mark our decline as a superpower because we could not manage our own financial situation?

Our world influence depends on our moral example, our military might, and our economic might.  Rising debt diminishes all three sources of power and risks making the U.S. less relevant on the world stage.   

 

Buffett and Sequester

Buffett and Sequester

Buffett not overly worried that sequester will drag the economy down – Economy Watch on NBCNews.com.

 

More important than the discussion on the sequester is the discussion on the possible impact of the eventual rise of the interest rates in this country?  Is that the next bubble?