FEDERAL INCOME, SPENDING, AND DEFICITS

There is a very interesting article on Federal spending and deficits at: http://blogs.wsj.com/economics/2015/01/26/you-ask-we-answer-why-is-the-debt-rising-faster-than-the-deficit/?mod=djemRTE_h  I suggest reading the whole article, but here are a few parts of it:

Click on picture to enlarge.


They also explain some apparent discrepancies:

After accounting for cash, the discrepancy in December was small, and is explained by little changes across Treasury’s several dozen other financial accounts, which include obscure assets like securities in the National Railroad Retirement Investment Fund, accounts at the International Monetary Fund, Special Drawing Rights, etc.

What about the change over all of calendar year 2014? The Treasury reported deficits of $488 billion but borrowed $668 billion. What happened with the other $180 billion? Again, cash explains part of it. Cash rose from $162 billion to $223 billion. That’s $61 billion accounted for and $119 billion unexplained.

What else does the government do in addition to spending and accumulating cash? It issues loans. The government’s loan financing climbed by $118 billion over the course of 2014. With lending programs, the government borrows from the public and turns around and lends out that money. (Most direct lending from the government is for student loans, but the departments of transportation, agriculture and energy, the Small Business Administration and the Export-Import bank all have significant lending programs too.)

Lending is not spending. If the government spends $1 million the money is gone. If the government makes $1 million in loans to lots of different borrowers, the odds are that most of the loans will be paid back. To be sure, these programs carry credit risk and can cost the taxpayer money when loans aren’t repaid. The solar-energy company Solyndra famously defaulted on a $535 million loan from the Energy Department, for example. But even Solyndra was part of a much bigger energy lending program that has an overall loss ratio of about 2%.

http://blogs.wsj.com/economics/2015/01/26/you-ask-we-answer-why-is-the-debt-rising-faster-than-the-deficit/?mod=djemRTE_h

OUR LIQUIDITY TRAP

"A liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels. http://en.wikipedia.org/wiki/Liquidity_trap

How did we get here? Excessive leveraging by the commercial and private sectors. Because of large Federal budget deficits, I had expected runaway inflation since 2001. Even now with Federal deficits shockingly high, I have read that the total debt (government plus companies plus private) in the country is decreasing because of rapid company and private debt deleveraging. I didn't recognize this and didn't understand why runaway inflation was not coming. Eventually I came to recognize that Federal deficits will have little effect on inflation because we are in a liquidity trap. In fact most of the developed world seems to be in a liquidity trap. Before that I invested in bonds and CDs nervously expecting their value to be consumed by inflation. I had avoided commercial bonds and preferred stocks my whole investing career of more than 50 years because of inflation fears. Once I became convinced that Federal pumping of money into the economy would have little effect, my fears were overcome and I entered all three investments with some gusto. At first I bought commercial bonds and preferred stocks timidly in the last decade, but as time went on I have become more bold. So far, so good. In fact our preferred stocks are often all above par,and some have gotten so far above par that I have sold a few for capital gains. (For preferred stock investing see: http://stopcontinentaldrift.blogspot.com/2011/11/preferred-stock-investing.html)

A problem with liquidity traps is that no one seems to know how to get out of them. Of course, I believe that at some time, some year, we will get out of it and have real, maybe even runaway, inflation, but I have no idea when that will be. I certainly don't have the feeling that we are close to it. In fact, the more austere we become in trying to lower our rapidly growing national debt, the more the liquidity trap probably will be prolonged. There are some encouraging signs, however, that our economy is slowly recovering, but I think that serious and runaway inflation is still some years off. When the company and private deleveraging is complete, then the situation may reverse?

IS IT REALLY STARTING?

I have long wondered why the American electorate has been so docile under the present economic climate. Where are the demonstrations? In past downturns more mild than the present, there have been marches on Washington, D.C., particularly by farmers driving tractors into the Reflecting Pond and the like.

Seemingly a revolution of sorts was started by the so-called Tea Party group. I have found that group rather surprising in that many of the early members were unemployed; yet, their cry against the government was that it was too large and running up too great Federal deficits. They have had a lot of success in electing like-minded people to congress. Certainly the size of the Federal deficits is scary, but I have to wonder if they misread the electorate? It seems to me that a lot of the new people elected to congress were actually elected with expectations that they would do something about the job situation* rather than to try to cut down the size of government. Not much has been done so far, and I wouldn't be surprised if many of the Tea Party congressmen are returned to their private lives in the 2012 election. I'm also surprised by Tea Partiers willingness to eliminate such programs as Social Security and Medicare as many of the members are middle aged and not wealthy.

The Tea Party has been followed by the Occupy Wall Street (OWS) movement that is mainly objecting to economic inequality of incomes, high unemployment, the huge wages of those on Wall Street and the lack of any prosecutions of those responsible for the economic fiasco we have been undergoing since late in 2007, and the influence of corporations on the government.** One other message stood out to me in that many seemed to want their student loans to be forgiven. This has not been done although President Obama has lowered the percentage of income to 10% of discretionary income that must be devoted to paying off the student loans and reduced the number of years to 20 from 25 until the residual of the loan is forgiven (http://www.washingtonpost.com/blogs/44/post/obama-administration-announces-plan-to-ease-student-loan-burdens/2011/10/25/gIQAGbKrGM_blog.html). By an large, however, it appears to me that the OWS is still in a disorganized state although it has expanded across the country and even abroad. So the movement has struck a cord that seems to have considerable staying power. So far as I know, OWS is not yet backing certain candidates for election to congress with the possible exception of Elizabeth Warren. Whether this movement can get organized to have any real affect, remains to be seen.

* Also see: http://stopcontinentaldrift.blogspot.com/2011/01/whatever-happened-to-jobs-jobs-jobs.html

** http://en.wikipedia.org/wiki/Occupy_Wall_Street. Perhaps the most significant influence came with the Supreme Court ruling that companies are people. The Chairman of the Board therefore can give not only his own donations, but also donations from the company no matter what the employees or the stockholders might think.

WHAT ARE THE CONSEQUENCES OF FEDERAL BUDGET DECREASES

A key metric in how well our (U.S.) economy is doing is GDP (Gross Domestic Product). The formula for GDP is:

GDP = C + I + G + Net Exports , where C is consumption, I is investment, G is government spending, and Net Exports is total exports - total imports.

To get a positive GDP, Net Exports has always been negative since 1977 because of our insistence on importing so much oil so C+I+G must increase to make up for the Net Exports. The sum of these three almost always will more than make up for the negative Net Exports although the trade deficit can be significant ($695.9 billion in 2007*). Now there is a move to try to eliminate or at least reduce Government deficits or reduce G (i.e. government spending in the formula). Therefore, C+I must increase more than the reduction in G plus a negative Net Exports in order to achieve a positive GDP. The bigger the reduction in G, the more difficult it will be for C+I to turn GDP positive.

Recently congress passed and the president signed a bill to cut the 2011 Federal budget by $38.5 billion in the last five months of the fiscal year.** If all these budget cuts were to occur this fiscal year as many wanted, to have a positive GDP over this period means that C and I must increase by more than $38.5 billion during these five months. I confess I have no idea how easy it would be for C+I to do this; however, consumption under the present depressed economic environment, where median household income is declining, is unlikely to increase much. So it falls mainly on investment to increase by most of the $38.5 billion.

It turns out, however, that only about $385 million of the $38.5 billion will occur in Fiscal Year 2011, and I would expect the economy to easily handle that. But the rest of the cuts are real though they will occur in future years and spreading them out like that should make them easier to handle especially if the economy continues to recover from the Great Recession.

There will be attempts to make even larger cuts in the Federal budget in future years so the impacts on GDP will be larger if they are instituted. Actually, the best time to cut the Federal budget significantly is during a rapidly rising economy when both C and I are rapidly increasing and not, as now, during a slow recovery from a Great Recession. Yes, declining G will lower the GDP by some amount during a rapidly expanding economy depending on the size of the Federal budget reduction and on how fast C+I are increasing.

I suspect that most people who want large budget cuts NOW (including nearly all "tea partiers" it would seem), do not understand the equation for GDP. There are those, however, that do (e.g. John Mauldin). With them, they feel that cutting the Federal budget will give a morale boost and help the economy. More specifically the expectation is that Federal borrowing drives out private sector borrowing because there is only so much money. This claim is faulty, however, in that no one forces industry to buy Treasury bonds, notes or bills. If they are doing it, it is because the don't know of anything better to do with the money and want to park it somewhere safe. In addition, the wealthy do not invest much of their money on productive things in America but put a lot of it voluntarily into government bonds (not all American Treasuries) and "... goes to things that may benefit the global economy but have no or little benefit to the U.S. - such as purchasing chalets in Switzerland, Canadian bombardier personal jets, islands in the Bahamas, and the like.*** As the amount of Treasuries are reduced, the wealthy will probably still buy them in their usual amounts because they want to put most of their money into safe securities rather than taking on more risk, though this may drive up the price of the bonds.

The point is that if reductions in the Federal budget are instituted too rapidly, investment and consumption may not be able to keep up and therefore plunge our GDP into negative numbers, thus creating a recession or worse. Our best hope is that the current economic recovery continues and even accelerates which would even make the size of the Federal budget reductions more manageable. After all, Federal revenues are the lowest they have been in 60 years.

* http://en.wikipedia.org/wiki/Economy_of_the_United_States

** http://stopcontinentaldrift.blogspot.com/2011/04/385-billion-is-lot-of-money.html

*** http://stopcontinentaldrift.blogspot.com/2010/05/effectiveness-of-taxes.html

OBAMACARE & A FEW OTHER THINGS

I'm really, really surprised that Obmacare passed. I guess you have to chalk another one up to the comeback kid. The funny thing is that it is largely a Republican bill. Most things that are in it have been proposed in the past by some Republican. This was underlined in an article by the Secretary of Health and Human Services and someone else who told of a number of issues which Republican had proposed what item. I have trouble figuring out why Republicans are so enraged about it.

And why are Right To Lifers so enraged by the bill, especially when the President has issued an edict that no Federal money will be used for abortions (I guess they think an executive order is not binding.). It all seems irrational to me. Beside outlawing Federal money for abortions only applies to the poor and probably the lower middle class, The more wealthy can pay for their daughters abortions or even send them to some country where abortion is legal if abortion of any kind was outlawed in this country. Bring back the coat-hanger abortions? But ruling that no Federal money can go to abortion is made several different ways: now by the executive order and also the Hyde amendment. I would feel better about it if so many right to lifers weren't also for the death penalty. If life is sacred, how can you justify the death penalty. Apparently right to life only applies to the unborn.

The bill is 2,404 pages, I believe, including 900 pages of amendments of which 170 of the amendments are by Republicans. Of course it is hard to believe that anyone can keep in their mind all the things in such a bill. I guess we will just have to let things develop and see. But the big thing as I see it is the inclusion of the 32 million new uninsured. If we can't do this, maybe we don't deserve to be a country? Well, I have heard the problem is that people with health insurance say, "What's in it for me?" There are 14 items that will begin this year: http://majorityleader.gov/docUploads/Top14FINAL.pdf

Adding 32 million people to health care presumably will put a strain on our stock of primary care physicians. We are told that the poor now are covered by going to emergency rooms. So the thought occurs to me that if this is true, there will be less need for physicians in emergency rooms so they can have private practices to see new patients at less than one-third the cost of an emergency room visit. Hm, maybe not that many of the poor go to emergency rooms for their primary care. I took my wife once, and her visit lasted seven hours (this in northern Virginia). A lady we know went to an emergency room here in North Carolina because of a bad fall, and it took her six hours. After you do this once, you maybe try to avoid emergency rooms? So maybe there will be a shortage of primary care physicians. One of the things that will begin soon with the passage of Obamacare is support for the training of more primary care physicians. I know not how many.

Well, I think there is some legitimate concern that the budget balancing in the health plan bill will actually be sustained by future congresses. As to financial reform, it is certainly necessary. We cannot allow so many "too big to fail" organizations affect out country. The first big thing was repeal of the glass Steagal Act which Clinton signed; I believe it was his biggest mistake. It may be that the SEC has been lax in its enforcement, but we have had 20 years of deregulation of the financial industry in this country, and there is no regulation of hedge funds. And Bush idid things that have ruined the economy for the rest of my life (unfunded wars accompaying tax cuts, an unfunded prescription drug paln, among others.). Even closing down Lehman Brothers has almost done in the country. I suggest you read a book called The Big Short which has come out recently. I have not read the book, but I've heard the author on many occasions on radio and TV.

Of course we need to overhaul the income tax code, but everything that is in it is in it because some interest group wants it (We are a country of push and shove and anything goes.) so the reform is never done, and I doubt it ever will be, just made more and more complicated with time. I spend a large amount of time for about a month on our income tax.

In this blog, I have noted that you cannot balance the budget by eliminating the discretionary spending (which includes DoD,. by the way) of the Federal government. Total budget for discretionary spending is $1.4 trillion whereas the Federal deficit this fiscal year is currently estimated to be $1.55 trillion. So you could close down the entire Federal government as we think of it and not balance the budget. Actually the deficit would rise a lot because of the 2 million (about) Federal workers put out of work and discontinuation of all their contracts with industry.

So if we are to balance the budget, then we have to address entitlements (e.g. Social Security and Medicare) plus raise taxes. Any kind of even modest Federal budget decreases raises alarm. Obama proposed ending a program for manned missions to the Moon and a number of Republicans objected. Can you think of anything we need LESS than to send men to the Moon? It certainly is not essential. Yet, there are loud squeals.

The latest thing is about companies, that provided health care for prescription drugs, will have this benefit taxed. What is interesting about this is that the tax will be on a Federal SUBSIDY (!) given to such companies to continue drug coverage to their employees and retirees. In other words, it is a decrease in a Federal SUBSIDY. The Wall Street Journal loves to tell which company is taking what kind of hit. ATT, for example, is taking a billion dollar write down, and they have a hard time decreasing their prescription drug coverage because of all sorts of union agreements. Disclosure: We own some ATT stock. I still have trouble getting excited about this small decrease in a subsidy.

Personally, I feel companies shouldn't be providing heath care to employees anyway. It started as an accident in WW-II when salaries were frozen and Henry J. Kaiser decided to offer health care as an inducement to get more of the limited pool of workers. Among other things, it put a terrible onus on workers who will lose their health care if they quit, but companies are free to fire them any time they feel like it, costing them their health care. Labor is the main elastic component of business. I think that, at the very least, the health care insurance should be owned by the employee and a company could make donations towards it if they like. At least the employee can take the health care with them if they quit or are fired.

It would be even better to have a government operated health insurance system such a Medicare now (Ah, the Public Option which is not in the bill?). There is no restriction in Medicare as to which physician you go to. The doctor bills Medicare which pays some part of the bill (usually), and our backup plan pays the rest. If Medicare refuses payment, then our backup plan can too. Not every physician will accept Medicare, but there are a large pool that do. And Medicare doesn't pay everything. For example, they won't pay for anything they judge to be cosmetic surgery. And there are some tests they will only pay for once a year (I think some tests have even a longer time frame.). But overall, I think it works well for the patient.

THE BULL MARKET OF 2009

From about mid-March through the end of this year, the stock market indices have risen marketly. A common explantion of this increase in confidence in the investing community is that the week dollar is the cause. This may not be the case as the dollar was weaker in 2008 and the stock market indices declined.

From my post on Motley Fool - #313939 on the Investment Club Analysis/Macro Economic Trends and Risk.: About the stock rise being due to the falling dollar, from February 28th through August 5th in 2008, the dollar index spent only one day above 74.0 (June 13th at 74.06). All this period is lower than we have seen to date this year. I don't recall any boom in the stock market then. In fact the S&P500 fell from 1367 to 1285 during that period or 6%. Personally, I think the claim that our present stock market cyclical bull market is due to the weak dollar is pretty weak. I'm not sure what the bull market is due to, perhaps speculation that the stock market drop overshot in its decline? Optimism that the all the stimulation from super low interest rates and Federal stimulus is bullish long term?

Incidentally in an op-ed article on 3 December 2009, Robert Samuelson said, "Despite huge federal budget deficits, total borrowing in the economy dropped in the first half of the year; this hasn't happened in statistics dating to 1952." http://www.washingtonpost.com/wp-dyn/content/article/2009/12/02/AR2009120203400.html This is a measure of just how much borrowing has dropped in the non-govermental sector in 2009 to counteract Federal spending. In view of this, perhaps it is not surprising that inflation is tame.