Back to AIG: As I said before, AIG is an insurance company that is worldwide in scope, operating in 130 countries. You have certainly heard that it is “too big to fail.” It may well be. According to Time Magazine, AIG insures 180,000 entities, which together employ 106 MILLION people worldwide. Those entities include banks, farms, hospitals, and nonprofits among other things. AIG is the country’s largest life and health insurer. If AIG goes down, the companies they insure could also fail, resulting in more unemployment and a stock market crash. Some believe our recession would become a depression.
A few critics are saying that if AIG had gone into bankruptcy, the economy could have withstood the repercussions. It’s just that no one has been willing to put it to the test. After all, would you want to make the decision that could potentially bankrupt the world? And that is a distinct possibility, should the company fail. Geithner may be wrong or right in what he is doing, but he must certainly have the most stressful job in America, and I wouldn’t have it for anything. Besides, he definitely knows far more about what is going on than any of us do!
The point is, we may be “mad as hell” about the bonuses paid to fat-cat executives, but we better be very careful that, in punishing AIG, we don’t bring the whole economy down around our ears! Right now, my major concern is that Congress may do just that. They know very little about high finance, but they do know what will cost them reelection, so they are probably more likely to listen to the ignorant masses than people who know something. (At least we hope they know something; at this point, I’m not sure anyone really knows what to do.)
It’s not just that AIG is a big company; it’s that they are so systemic. They are intertwined in financial institutions all over the world. Their failure could create a domino effect. No one knows where it would end, and no one particularly wants to find out!
AIG got in this situation for the same reason our whole economy got into such a mess. It all goes back to the housing market. Somehow, the idea that everyone deserves a home of their own whether they could afford it or not caught on among politicians in Washington. This really got pushed during the Clinton administration. The requirements for getting a home loan became less stringent, often requiring no down payment at all, and interest rates were kept low by the Federal Reserve. It finally got to the point that people did not even have to provide proof that they had a job! Not only that, but mortgage companies were pushing adjustable rate mortgages that started off at a low interest rate that could increase later on. People who didn’t know any better were sometimes misled into buying more home than they could afford, and other people who did know better figured they could always sell the house at a profit before their payments went up. They gambled – and lost.
You may wonder why mortgage companies would make such risky loans. Don’t they want to get paid back? The problem is, they did not keep the loans and so had nothing to lose. They made their money up front with fees charged to the buyer and then turned around and sold the loan on the secondary mortgage market. About 60% of that market is controlled by Fannie Mae and Freddie Mac.
Fanny Mae and Freddie Mac are government sponsored businesses. They are owned by stockholders like any other corporation. However, they get special protection and financial backing from the government. Fannie Mae was started by FDR during the Depression to increase home ownership. The company buys mortgages from lenders and then turns them into securities that can be bought and sold on Wall Street. Anyone can buy these. If you have a 401K or mutual fund, it’s possible that you own some and don’t even know it! If you own these securities, you will make money on them as long as people continue to pay for the houses they bought. If, however, people cannot afford to make their payments and their houses go into foreclosure, your bonds rapidly decline in value, and may even be worthless.
The party lasted for years. People were flipping houses and making a small fortune. With so many people buying houses, demand pushed the prices of homes much higher than they were actually worth. This is what is called a “bubble.” And like any bubble, it was bound to burst sooner or later. Eventually, interest rates rose on those adjustable rate mortgages, and many people could not afford the higher payments. When they tried to sell their homes, they found that many other people were also trying to sell. Builders had overbuilt as well, creating a housing glut. With too many homes for sale and not enough buyers, the only way to sell a house was to lower the price significantly. We personally experienced this, as we decided to move right before the bubble burst. Some people were really in trouble, however, because they owed more on their house than they could get for it! Many of these people just walked away and let the house go into foreclosure. This brought the prices of houses even lower. Loans were defaulting all over the place, and those mortgage-backed securities were rapidly losing value. Many banks owned these, and suddenly found themselves with huge deficits on their books. They couldn’t loan money. When they stopped loaning money, few people could get a loan to buy a house or car, and the housing and automobile industries suffered even more. As these industries and others suffered from an inability to get credit, they were forced to lay off workers. Unemployed workers have no money to buy goods and so retail stores were hit as well. It has just kept spiraling downward.
As for AIG, they had insured many of those mortgage-backed securities and were now having to pay out. They were bleeding billions. That’s when the government stepped in to the tune of 182 billion dollars, in an attempt to stop the bleeding. In helping AIG, they were also helping all the banks they had insured.
Somehow, someone has to figure out a way to get the banks in better financial shape so they can start lending money again. That is Geithner’s terrible job. Like I said, I don’t envy the guy.
Friday, March 27, 2009
Sunday, March 22, 2009
So what is AIG, and why is everyone so mad at it?
If you’ve heard any news at all in the past week, you know that lots of people are steamed about bonuses paid to executives at AIG. But what exactly is AIG, and how did this happen? Since you and I own controlling interest in the company, we really ought to know that.
What, you didn’t know you owned it? Well, you do. When the company was on the verge of collapse and came crawling to the government for help, they got it – big time. So far, AIG has received over $182.5 BILLION in bailouts from the federal government. We, the taxpayers will foot the bill for this. In exchange for our generous donations, AIG had to hand over about 80% of the stock in their company to the government – that’s us, remember. We now have controlling interest in AIG. We, therefore, feel we should have some say in how it is run. So does Obama. In effect, the company was nationalized, though no one calls it that.
AIG originally stood for American International Group, but these days people believe it stands for Arrogant, Incompetent, and Greedy. In my opinion, that pretty well sums it up. This humongous corporation is actually an insurance company with fingers in lots of other enterprises as well, such as financial services. It’s the financial services division that screwed up the entire company. Some of the executives in that division received part of the $218 million in bonuses the company paid out recently. These are the same people that were stupid and greedy enough to cause the company to nearly collapse. Now, in the world where most of us live, bonuses are paid to people as a reward for good work. Apparently, that is not how Wall Street operates. On Wall Street, salaries are kept relatively low with the expectation that bonuses will be paid each year. A typical executive might have a set salary between 200 and 300 thousand a year, but receive an end-of-the-year bonus of 2 to 10 million. The amount is based on the volume of business they brought into the firm over the year. (One of the problems has been that they have been rewarded for the quantity of their investments, not the quality.) These executives see themselves as entitled to this money, as though it was really part of their regular salary. It is even written into their contracts. So part of the outrage is caused by the fact that we define a bonus one way, and Wall Street execs define it another.
It seems to me that these rich financial guys live on another planet and really don’t have a clue how the ordinary American taxpayer sees this situation. In 2007, the median household income in the Unites States was $50,233. That means half the households in American somehow manage to get by on around $50,000 while Wall Street executives make six figure salaries and expect additional bonuses in the millions. Of course the average American is going to be outraged! Especially when these fat cats have nearly devastated our economy and expect us to bail them out. Not only that, but they retire with their “golden parachutes” while the rest of us are the ones who suffer from their mismanagement. These people have lived in a bubble for so long they don’t even know how an ordinary person lives anymore.
So we are mad, and for good reason. But Obama said one thing I actually agree with. He said that we shouldn’t govern out of anger. I’m sure most of us have said or done really stupid things when we were angry, so that makes sense to me. Right now, Congress is trying to do just that. The House has already passed a bill that would tax those Wall Street bonuses at a rate of 90%! That is the only way they can figure out to get the money back that they carelessly let get gone in the first place. After all, they passed the original TARP legislation and the stimulus bill. Now we learn that language in the bill allowed these bonuses to be paid. What a surprise! Congress passed a bill without knowing what was in it! Now they have the nerve to act all hot and bothered about it. If they are allowed to pass a punitive, compensatory, retroactive tax aimed at a specific group of people, (which is probably unconstitutional), it sets a dangerous precedent for the rest of us. Sure, we hate what AIG has done. But anytime government acts, we must beware of the Law of Unintended Consequences.
I agree with Mike Huckabee, who says that if Congress wants to punish AIG by taxing them at 90%, they should tax their own salaries at 90%, since they also had a lot to do with getting us in this mess.
I personally believe the President could use his influence to get the executives to voluntarily return most of the money. Instead of cracking jokes on Leno, he needs to be leading right now. He needs to personally call these executive to account and appeal to their sense of patriotism and love of country, if they have any, to do the right thing.
What, you didn’t know you owned it? Well, you do. When the company was on the verge of collapse and came crawling to the government for help, they got it – big time. So far, AIG has received over $182.5 BILLION in bailouts from the federal government. We, the taxpayers will foot the bill for this. In exchange for our generous donations, AIG had to hand over about 80% of the stock in their company to the government – that’s us, remember. We now have controlling interest in AIG. We, therefore, feel we should have some say in how it is run. So does Obama. In effect, the company was nationalized, though no one calls it that.
AIG originally stood for American International Group, but these days people believe it stands for Arrogant, Incompetent, and Greedy. In my opinion, that pretty well sums it up. This humongous corporation is actually an insurance company with fingers in lots of other enterprises as well, such as financial services. It’s the financial services division that screwed up the entire company. Some of the executives in that division received part of the $218 million in bonuses the company paid out recently. These are the same people that were stupid and greedy enough to cause the company to nearly collapse. Now, in the world where most of us live, bonuses are paid to people as a reward for good work. Apparently, that is not how Wall Street operates. On Wall Street, salaries are kept relatively low with the expectation that bonuses will be paid each year. A typical executive might have a set salary between 200 and 300 thousand a year, but receive an end-of-the-year bonus of 2 to 10 million. The amount is based on the volume of business they brought into the firm over the year. (One of the problems has been that they have been rewarded for the quantity of their investments, not the quality.) These executives see themselves as entitled to this money, as though it was really part of their regular salary. It is even written into their contracts. So part of the outrage is caused by the fact that we define a bonus one way, and Wall Street execs define it another.
It seems to me that these rich financial guys live on another planet and really don’t have a clue how the ordinary American taxpayer sees this situation. In 2007, the median household income in the Unites States was $50,233. That means half the households in American somehow manage to get by on around $50,000 while Wall Street executives make six figure salaries and expect additional bonuses in the millions. Of course the average American is going to be outraged! Especially when these fat cats have nearly devastated our economy and expect us to bail them out. Not only that, but they retire with their “golden parachutes” while the rest of us are the ones who suffer from their mismanagement. These people have lived in a bubble for so long they don’t even know how an ordinary person lives anymore.
So we are mad, and for good reason. But Obama said one thing I actually agree with. He said that we shouldn’t govern out of anger. I’m sure most of us have said or done really stupid things when we were angry, so that makes sense to me. Right now, Congress is trying to do just that. The House has already passed a bill that would tax those Wall Street bonuses at a rate of 90%! That is the only way they can figure out to get the money back that they carelessly let get gone in the first place. After all, they passed the original TARP legislation and the stimulus bill. Now we learn that language in the bill allowed these bonuses to be paid. What a surprise! Congress passed a bill without knowing what was in it! Now they have the nerve to act all hot and bothered about it. If they are allowed to pass a punitive, compensatory, retroactive tax aimed at a specific group of people, (which is probably unconstitutional), it sets a dangerous precedent for the rest of us. Sure, we hate what AIG has done. But anytime government acts, we must beware of the Law of Unintended Consequences.
I agree with Mike Huckabee, who says that if Congress wants to punish AIG by taxing them at 90%, they should tax their own salaries at 90%, since they also had a lot to do with getting us in this mess.
I personally believe the President could use his influence to get the executives to voluntarily return most of the money. Instead of cracking jokes on Leno, he needs to be leading right now. He needs to personally call these executive to account and appeal to their sense of patriotism and love of country, if they have any, to do the right thing.
Friday, March 20, 2009
And it's worse than you think...
So, since I started writing this blog, the debt clock has passed the eleven trillion mark. But here is the real shocker – our true debt is at least 53 trillion and will likely surpass 56 trillion before the end of this year! How is that, you may ask.
Well, remember – the 11 trillion is a combination of public debt and intragovernmental debt. Just to recap, public debt is the money the government owes to people, states, institutions, and foreign investors who hold United States treasury bonds, bills, and notes. (From now on, I will use the word “securities” to denote all types of investments.) Intragovernmental debt is what the government owes itself as a result of raiding the Social Security trust fund. That part is not included when the government tells us the current year’s deficit. It’s a very convenient way for politicians to cover up the true scope of their borrowing and spending. The kicker is, it will eventually have to be paid back when more people start drawing Social Security.
But that’s just part of it. The government has many other future obligations to be paid as well. For example, pensions for retired federal workers and military personnel. (Doug and I are owed some of that!) Then there are all the future Medicare pay-outs. That one is the true budget buster. Then you have to figure the effect of compounding interest on the growing deficit and bail-outs. Add it all up, and you get that 53 trillion in debt and future obligations. It’s mind-blowing.
Some people don’t worry about it too much. They point out that we can and will fix Social Security when we have to, and they believe the health care system will be reformed as well. As for the debt, we just keep rolling it over, never really needing to “pay it off.” As long as our economy grows, we will take in enough taxes to pay the interest on the debt. Of course, that has been the big worry recently – the economy has been shrinking instead of growing. Hopefully, that will turn around soon.
However, some pretty knowledgeable people believe our current situation is unsustainable. I’m afraid I agree with the pessimists.
Well, remember – the 11 trillion is a combination of public debt and intragovernmental debt. Just to recap, public debt is the money the government owes to people, states, institutions, and foreign investors who hold United States treasury bonds, bills, and notes. (From now on, I will use the word “securities” to denote all types of investments.) Intragovernmental debt is what the government owes itself as a result of raiding the Social Security trust fund. That part is not included when the government tells us the current year’s deficit. It’s a very convenient way for politicians to cover up the true scope of their borrowing and spending. The kicker is, it will eventually have to be paid back when more people start drawing Social Security.
But that’s just part of it. The government has many other future obligations to be paid as well. For example, pensions for retired federal workers and military personnel. (Doug and I are owed some of that!) Then there are all the future Medicare pay-outs. That one is the true budget buster. Then you have to figure the effect of compounding interest on the growing deficit and bail-outs. Add it all up, and you get that 53 trillion in debt and future obligations. It’s mind-blowing.
Some people don’t worry about it too much. They point out that we can and will fix Social Security when we have to, and they believe the health care system will be reformed as well. As for the debt, we just keep rolling it over, never really needing to “pay it off.” As long as our economy grows, we will take in enough taxes to pay the interest on the debt. Of course, that has been the big worry recently – the economy has been shrinking instead of growing. Hopefully, that will turn around soon.
However, some pretty knowledgeable people believe our current situation is unsustainable. I’m afraid I agree with the pessimists.
Friday, March 13, 2009
"So just print more money!"
My students always had answers for our economic problems, which I would shoot down one after the other. When they realized that we owed real money to real people and we had to pay it back, their next question was usually, “Well, can’t we just print more money?” That’s when they got The Helicopter Story. It goes like this:
Suppose we are sitting here in class one day when we hear the roar of helicopters outside – lots of helicopters. Naturally, we all jump up and run over to look out the window. Staring up into the sky, we are amazed to see a dozen helicopters dumping baskets of hundred dollar bills onto the ground below. You know what happens next! There is a mass stampede as we rush outside to start scooping up all the bills we can stuff into our pockets, shoes, whatever. Suddenly, we are rich!
Overjoyed, we immediately start planning what to do with our newfound wealth. Let’s say you decide you are going to Best Buy to get that $2500 big-screen TV you’ve had your eye on for months. As soon as school gets out, you hop in the car and head on over. You are shocked when you find the parking lot full and people lined up outside the door, trying to get in. You are even more shocked when you finally get in and find the price of your TV has jumped to over $100,000! What happened?
Well, apparently, helicopters were dropping money everywhere, and now many, many people have lots and lots of money to spend. The store owners know this and reason that they can get a lot more money for their goods. After all, there are only so many TV’s, so you would be willing to pay more to be sure you get one of them. You have just experienced what we call inflation.
When lots of money chases after fewer goods and services, the prices of those goods and services go up. It is kind of like we are outbidding each other to get what we want. Who is willing to pay the most? The highest price that enough shoppers are willing to pay will become the market price of that item. In a free market economy like ours, that (price) is how we determine who gets what.
By now it should be obvious what would happen if the government just prints more money. Inflation would be the result. There would be more dollars, but they wouldn’t be worth as much. Remember, the more there is of something, the less it is worth – that old sand and diamonds analogy.
If your dollars aren’t worth as much as they were before, it will take more of them to buy that car you want. Maybe you won’t even be able to afford it. Maybe lots of people won’t be able to afford a car, and the demand for cars will decrease. Manufacturers will stop making more cars than they can sell and probably lay off workers. The economy will eventually slow down – again. So, printing more money definitely has its drawbacks!
Suppose we are sitting here in class one day when we hear the roar of helicopters outside – lots of helicopters. Naturally, we all jump up and run over to look out the window. Staring up into the sky, we are amazed to see a dozen helicopters dumping baskets of hundred dollar bills onto the ground below. You know what happens next! There is a mass stampede as we rush outside to start scooping up all the bills we can stuff into our pockets, shoes, whatever. Suddenly, we are rich!
Overjoyed, we immediately start planning what to do with our newfound wealth. Let’s say you decide you are going to Best Buy to get that $2500 big-screen TV you’ve had your eye on for months. As soon as school gets out, you hop in the car and head on over. You are shocked when you find the parking lot full and people lined up outside the door, trying to get in. You are even more shocked when you finally get in and find the price of your TV has jumped to over $100,000! What happened?
Well, apparently, helicopters were dropping money everywhere, and now many, many people have lots and lots of money to spend. The store owners know this and reason that they can get a lot more money for their goods. After all, there are only so many TV’s, so you would be willing to pay more to be sure you get one of them. You have just experienced what we call inflation.
When lots of money chases after fewer goods and services, the prices of those goods and services go up. It is kind of like we are outbidding each other to get what we want. Who is willing to pay the most? The highest price that enough shoppers are willing to pay will become the market price of that item. In a free market economy like ours, that (price) is how we determine who gets what.
By now it should be obvious what would happen if the government just prints more money. Inflation would be the result. There would be more dollars, but they wouldn’t be worth as much. Remember, the more there is of something, the less it is worth – that old sand and diamonds analogy.
If your dollars aren’t worth as much as they were before, it will take more of them to buy that car you want. Maybe you won’t even be able to afford it. Maybe lots of people won’t be able to afford a car, and the demand for cars will decrease. Manufacturers will stop making more cars than they can sell and probably lay off workers. The economy will eventually slow down – again. So, printing more money definitely has its drawbacks!
Thursday, March 12, 2009
Still MORE dangers of debt...
Proverbs 22:7 The rich ruleth over the poor, and the borrower [is] servant to the lender.
Our government cannot borrow enough money from American investors to cover its budget. Remember, there is a limited amount of money and credit available. One reason the government cannot get enough money from American institutions and investors is that Americans have, in recent decades, spent everything they earned instead of saving and investing it. In fact, until the recent financial crisis, Americans spent MORE than we earned. We had what is called a negative rate of savings. This is not good for individuals, and it is not good for the country.
Think about it this way. Banks can only loan out a certain amount of money based on their holdings. The more of people’s savings they have, the more they can loan out. Less savings means less money available for investing in economic growth. Of course, this is offset to some degree by the fact that our spending also leads to economic growth. The more we consume, the more factories will sell and the more they will produce. The point is, both saving and spending are important for our economic well-being, so we need a good balance of both.
As an interesting aside, for the first time in a long time, we are saving too much! Americans are worried about the future of our economy, and they are worried about their jobs. Logically, they are holding on to their money. This is the smart thing for individuals to do, but it is not helping end this recession. The government would like very much for us to go on a spending spree! (Don’t do it, though – you may be sacrificing your own well-being for the economy. Frankly, I don’t think ANYONE’S job is safe!)
OK, back to my original topic: the government needs more money than it can get from American investors. So what does it do? It turns to foreign investors. That is why China holds over 700 billion in U.S. securities, and Japan holds over 600 billion. Many other countries have invested in America as well. This has been a good thing so far. It has helped hold interest rates down and it has financed our ever-growing deficits. However, some economists and government officials worry that there is a danger involved, especially where China is concerned. Although we are heavily entwined with China from a trade and financial point of view, no one would say that our governments are the best of friends! In fact, China is a major competitor and one of the few remaining Communist countries. China is growing at a remarkable rate, and would no doubt like to dominate the world stage much as we have in modern history. You have to wonder, how much leverage do we want to give a nation like that?
How, you may ask, have we given them leverage? Well, as best as I can understand, the danger is that China could suddenly sell off a large amount of its U.S. holdings, in other words, dump them on the world market. With dollars flooding the market, their value would go down. (The more there is of something, the less it is worth. Grains of sand are plentiful and worth very little; diamonds are a whole different story!) If the value of the dollar depreciates (declines), we would have to pay more for all those goods we import from China and other nations. The clothes you buy at Kohl’s would cost more. So would a lot of other things, so we would probably experience inflation and, as a result, a lower standard of living – at least in the short run. In the long run, it might actually be good for American industries, as they would get more of our business. That could be good for our economy.
ON THE OTHER HAND – if foreign countries are no longer buying U.S. securities, how will we finance our government? In order for our govt. to entice new buyers, they will have to pay them higher interest rates. That means EVERYONE who borrows money will pay higher interest rates, including businesses that want to invest in new factories and growth, and you and me. So that could be bad for the economy! Pretty confusing, huh?
At any rate, the very possibility or threat that China could do this gives them leverage over us. They have threatened to dump securities if we come up with trade policies they don’t like. In a recent interview, officials from two Chinese government think tanks stated that China has the power make the U.S. dollar collapse. While it is doubtful they would actually do that, they don’t mind reminding us that they could. Does this have an effect? Yes. In a recent visit to China, Secretary of State Hillary Clinton did not make an issue of their human rights violations, in part because “How do you get tough on your banker?”
Most experts believe that China would not suddenly dump U.S. securities because our economies are so intertwined that we rise and fall together. Anything they do to hurt us would ultimately hurt them. That makes sense to me, so I am not terribly worried about our foreign debt from that standpoint. What does concern me is that this source of revenue might eventually dry up. Especially with our economy in trouble, other countries might lose confidence in us and the value of our assets. Then how we would finance our deficit? Furthermore, I don’t like being dependent on other countries!
There are other options for dealing with our deficits, but big problems exist with those options as well. I’ll look at those in my next post.
Our government cannot borrow enough money from American investors to cover its budget. Remember, there is a limited amount of money and credit available. One reason the government cannot get enough money from American institutions and investors is that Americans have, in recent decades, spent everything they earned instead of saving and investing it. In fact, until the recent financial crisis, Americans spent MORE than we earned. We had what is called a negative rate of savings. This is not good for individuals, and it is not good for the country.
Think about it this way. Banks can only loan out a certain amount of money based on their holdings. The more of people’s savings they have, the more they can loan out. Less savings means less money available for investing in economic growth. Of course, this is offset to some degree by the fact that our spending also leads to economic growth. The more we consume, the more factories will sell and the more they will produce. The point is, both saving and spending are important for our economic well-being, so we need a good balance of both.
As an interesting aside, for the first time in a long time, we are saving too much! Americans are worried about the future of our economy, and they are worried about their jobs. Logically, they are holding on to their money. This is the smart thing for individuals to do, but it is not helping end this recession. The government would like very much for us to go on a spending spree! (Don’t do it, though – you may be sacrificing your own well-being for the economy. Frankly, I don’t think ANYONE’S job is safe!)
OK, back to my original topic: the government needs more money than it can get from American investors. So what does it do? It turns to foreign investors. That is why China holds over 700 billion in U.S. securities, and Japan holds over 600 billion. Many other countries have invested in America as well. This has been a good thing so far. It has helped hold interest rates down and it has financed our ever-growing deficits. However, some economists and government officials worry that there is a danger involved, especially where China is concerned. Although we are heavily entwined with China from a trade and financial point of view, no one would say that our governments are the best of friends! In fact, China is a major competitor and one of the few remaining Communist countries. China is growing at a remarkable rate, and would no doubt like to dominate the world stage much as we have in modern history. You have to wonder, how much leverage do we want to give a nation like that?
How, you may ask, have we given them leverage? Well, as best as I can understand, the danger is that China could suddenly sell off a large amount of its U.S. holdings, in other words, dump them on the world market. With dollars flooding the market, their value would go down. (The more there is of something, the less it is worth. Grains of sand are plentiful and worth very little; diamonds are a whole different story!) If the value of the dollar depreciates (declines), we would have to pay more for all those goods we import from China and other nations. The clothes you buy at Kohl’s would cost more. So would a lot of other things, so we would probably experience inflation and, as a result, a lower standard of living – at least in the short run. In the long run, it might actually be good for American industries, as they would get more of our business. That could be good for our economy.
ON THE OTHER HAND – if foreign countries are no longer buying U.S. securities, how will we finance our government? In order for our govt. to entice new buyers, they will have to pay them higher interest rates. That means EVERYONE who borrows money will pay higher interest rates, including businesses that want to invest in new factories and growth, and you and me. So that could be bad for the economy! Pretty confusing, huh?
At any rate, the very possibility or threat that China could do this gives them leverage over us. They have threatened to dump securities if we come up with trade policies they don’t like. In a recent interview, officials from two Chinese government think tanks stated that China has the power make the U.S. dollar collapse. While it is doubtful they would actually do that, they don’t mind reminding us that they could. Does this have an effect? Yes. In a recent visit to China, Secretary of State Hillary Clinton did not make an issue of their human rights violations, in part because “How do you get tough on your banker?”
Most experts believe that China would not suddenly dump U.S. securities because our economies are so intertwined that we rise and fall together. Anything they do to hurt us would ultimately hurt them. That makes sense to me, so I am not terribly worried about our foreign debt from that standpoint. What does concern me is that this source of revenue might eventually dry up. Especially with our economy in trouble, other countries might lose confidence in us and the value of our assets. Then how we would finance our deficit? Furthermore, I don’t like being dependent on other countries!
There are other options for dealing with our deficits, but big problems exist with those options as well. I’ll look at those in my next post.
Tuesday, March 10, 2009
More Trouble With Debt
Another problem many economists see with an ever-increasing national debt is that the federal government must compete with other privately issued securities. (Think company stocks and bonds.) Money that goes into U.S. treasury notes does NOT go into private companies that would hopefully invest in growth and job creation. Theoretically, this would slow the economy down. We would then see a drop in GDP (gross domestic product), the measure most commonly used to assess our nation’s economic well-being. GDP measures the value of all goods and services produced in a nation in one year. When GDP drops, that means factories and businesses are not producing as much and therefore need fewer workers, thus leading to higher unemployment. As we all know, this can lead to a vicious cycle, as unemployed workers have no income with which to buy goods and services, so even fewer goods and services will be produced, meaning even more workers are laid off, and on it goes. When GDP drops for two consecutive quarters, we are in a recession. That, of course, is where we are now. Some would even argue that we are in the beginning of a depression, but that is the subject of a future post.
Not only can federal borrowing slow economic growth, it can also raise interest rates, which eventually slows economic growth as well. If the government is borrowing lots of money, and so are businesses and individuals, there is a very high demand for credit. The Law of Demand kicks in. When the demand for something goes up, so does the price. The price for credit is interest. So, more demand for credit leads to higher interest rates. This definitely affects anyone who wishes to buy expensive goods, such as a house or a car. In fact, higher interest rates may just make that house unaffordable. If fewer houses are selling, there will be less need for carpenters, supplies, and all the people that provide supplies. Again, the result is lower GDP and higher unemployment.
Not all economists agree that the government competes with private industry, but it makes sense to me.
So, what happens if there is more demand for credit than there are people who are willing to provide it? Well, then the government must go outside the country to find people who will buy treasury bonds and notes. That is just what they have done, so that we now are in debt to China to the tune of over 700 billion dollars and Japan for over 600 billion. My next post looks at the possible dangers associated with this type of debt.
Not only can federal borrowing slow economic growth, it can also raise interest rates, which eventually slows economic growth as well. If the government is borrowing lots of money, and so are businesses and individuals, there is a very high demand for credit. The Law of Demand kicks in. When the demand for something goes up, so does the price. The price for credit is interest. So, more demand for credit leads to higher interest rates. This definitely affects anyone who wishes to buy expensive goods, such as a house or a car. In fact, higher interest rates may just make that house unaffordable. If fewer houses are selling, there will be less need for carpenters, supplies, and all the people that provide supplies. Again, the result is lower GDP and higher unemployment.
Not all economists agree that the government competes with private industry, but it makes sense to me.
So, what happens if there is more demand for credit than there are people who are willing to provide it? Well, then the government must go outside the country to find people who will buy treasury bonds and notes. That is just what they have done, so that we now are in debt to China to the tune of over 700 billion dollars and Japan for over 600 billion. My next post looks at the possible dangers associated with this type of debt.
Sunday, March 8, 2009
So What's So Bad About Debt?
“A trillion is not a ‘bleak’ number, per se. It's just a number. We might need two trillion,” said the University of Texas’s James Galbraith in an email. “Deficits have to grow. They will grow. Please get used to it.”
As the quote above indicates, not all economists are concerned about our rapidly growing deficits. Some believe that the only way to make our economy grow again is for the government to infuse huge amounts of money into it. In other words, we can spend our way out of this mess we are in.
You and I know, if we have one iota of common sense, that we can NOT spend our way out of debt. Nor can we go on borrowing forever – we will eventually run out of other people’s money!
In fact, such official sounding agencies as the OMB (Office of Management and Budget), the GAO (Government Accountability Office), and the CBO (Congressional Budget Office) have all issued statements to the effect that our current budgetary practices are unsustainable. Well, even a fifth grader should be able to figure that out!
So what is the problem with debt? One of our biggest problems is the fact that it keeps growing, and will continue to grow exponentially into the foreseeable future. Why? Because the government has certain debt obligations mandated by law that are certain to grow – namely Social Security, Medicare, and Medicaid, programs known as entitlements. (We Americans have been promised these payments and have paid into the system by having part of our income deducted from our pay checks. Therefore, we are “entitled” to them.) The reason entitlements will certainly grow is because of the existence of people like me – baby boomers. You remember that generation that came into being shortly following WWII; returning soldiers made babies, and lots of them! Now we, a very large generation of Americans, are beginning to retire and grow old. Soon, by 2017, there will be more of us drawing retirement checks than there will be young workers paying into the system. Then watch the debt really grow! Our health care needs will grow rapidly as well, requiring ever greater Medicare payments.
Other spending HAS to take place. Remember, the government is obligated to pay interest on our growing debt. Since our debt has exploded in the past few years, so has the amount of interest we are obligated to pay.
Entitlement spending and interest paid on the debt are known as mandatory spending, meaning we are required to spend this money. It’s kind of like when we sit down to do our personal budgets. Some things are just a given. We have to pay our mortgage if we want a roof over our heads, we have to buy food, we have to pay taxes or we’ll wind up in jail. And we have to pay our debts, you know, those credit card bills, or we will find ourselves in a world of trouble. We really don’t have much choice about those things. So what we do is set aside enough money to cover those mandatory things before we decide what we have left for things we would just like to have. Spending we don’t HAVE to do is called discretionary spending. Obviously, the more mandatory spending we must do, the less discretionary spending we can do. This is true for us individually, and it is true for our government as well.
Therein lies the trouble with debt. The more money we owe because of past spending, the less we have for current wants and needs. Our life style must be seriously downsized because of our past indiscretions. Eventually, our government will face the same problem. There will be less money for building roads and bridges, providing education, and keeping us safe. Programs will have to be cut; there will be great wailing and gnashing of teeth. People will not be happy with their government. (Yeah, I know, we’re not too thrilled with it now, but it can get a WHOLE LOT WORSE!)
There are other problems with debt as well, but I want to keep these posts short, so I will save them for another day.
As the quote above indicates, not all economists are concerned about our rapidly growing deficits. Some believe that the only way to make our economy grow again is for the government to infuse huge amounts of money into it. In other words, we can spend our way out of this mess we are in.
You and I know, if we have one iota of common sense, that we can NOT spend our way out of debt. Nor can we go on borrowing forever – we will eventually run out of other people’s money!
In fact, such official sounding agencies as the OMB (Office of Management and Budget), the GAO (Government Accountability Office), and the CBO (Congressional Budget Office) have all issued statements to the effect that our current budgetary practices are unsustainable. Well, even a fifth grader should be able to figure that out!
So what is the problem with debt? One of our biggest problems is the fact that it keeps growing, and will continue to grow exponentially into the foreseeable future. Why? Because the government has certain debt obligations mandated by law that are certain to grow – namely Social Security, Medicare, and Medicaid, programs known as entitlements. (We Americans have been promised these payments and have paid into the system by having part of our income deducted from our pay checks. Therefore, we are “entitled” to them.) The reason entitlements will certainly grow is because of the existence of people like me – baby boomers. You remember that generation that came into being shortly following WWII; returning soldiers made babies, and lots of them! Now we, a very large generation of Americans, are beginning to retire and grow old. Soon, by 2017, there will be more of us drawing retirement checks than there will be young workers paying into the system. Then watch the debt really grow! Our health care needs will grow rapidly as well, requiring ever greater Medicare payments.
Other spending HAS to take place. Remember, the government is obligated to pay interest on our growing debt. Since our debt has exploded in the past few years, so has the amount of interest we are obligated to pay.
Entitlement spending and interest paid on the debt are known as mandatory spending, meaning we are required to spend this money. It’s kind of like when we sit down to do our personal budgets. Some things are just a given. We have to pay our mortgage if we want a roof over our heads, we have to buy food, we have to pay taxes or we’ll wind up in jail. And we have to pay our debts, you know, those credit card bills, or we will find ourselves in a world of trouble. We really don’t have much choice about those things. So what we do is set aside enough money to cover those mandatory things before we decide what we have left for things we would just like to have. Spending we don’t HAVE to do is called discretionary spending. Obviously, the more mandatory spending we must do, the less discretionary spending we can do. This is true for us individually, and it is true for our government as well.
Therein lies the trouble with debt. The more money we owe because of past spending, the less we have for current wants and needs. Our life style must be seriously downsized because of our past indiscretions. Eventually, our government will face the same problem. There will be less money for building roads and bridges, providing education, and keeping us safe. Programs will have to be cut; there will be great wailing and gnashing of teeth. People will not be happy with their government. (Yeah, I know, we’re not too thrilled with it now, but it can get a WHOLE LOT WORSE!)
There are other problems with debt as well, but I want to keep these posts short, so I will save them for another day.
Wednesday, March 4, 2009
So who do we owe it to?
As I said in my previous post, our government owes real money to real people. Who are those people? Well, you might be one of them! Do you have a United States Savings Bond? If so, the government owes you the face value of that bond. That bond is simply an IOU from the federal government. Every time you buy a bond, you are loaning the government money that it can use for things like building bridges and paying someone’s welfare check. Of course, you do not loan the government money out of the kindness of your heart or because you are feeling especially patriotic. You expect to get your money back and then some. The extra money you get back is the interest the government pays on your bond.
Besides bonds, the government also sells securities known as treasury notes, bonds, or bills. You can go to the nearest Federal Reserve Bank and buy these. A short-term treasury bill will require a minimum investment of $1000, and will currently cost you around $99 per $100 face value. You don’t make much money on these, but it pays better than just letting it sit in your bank, and treasury bills are considered one of the safest investments you can make. After all, they are backed by the full faith and credit of the Unites States government. As long as our government is secure, your money should be also.
The government sells its securities to individuals, institutions, corporations, and even other countries. The Chinese currently hold around 700 billion in U.S. securities, and the Japanese hold another 600 billion. That eleven trillion dollar debt is really spread around!
When I explained to my students that the government owes money to real people and not to itself, someone would always ask, “Well, can’t the government just refuse to pay it back?” Theoretically, they could. But that would be a disastrous mistake! Our government would lose all credibility and makes lots and lots of people very, very mad. How happy do you think the Chinese would be if we reneged on that 700 billion? Think there might be some ramifications? Besides, canceling all the debt would make it extremely difficult for the government to continue future operations, because it would be so difficult to raise money. After all, if you lost $1000 on a U.S. treasury bill, would you buy another one?
So the debt continues to grow – and grow, and grow, and grow! What’s the harm in that? Some people, but not many, would argue that there really is no harm. We can just keep on going the way we have been for the past few decades. Most economists are not so optimistic. They see many problems with an ever-increasing debt. I will address those in my next post.
Besides bonds, the government also sells securities known as treasury notes, bonds, or bills. You can go to the nearest Federal Reserve Bank and buy these. A short-term treasury bill will require a minimum investment of $1000, and will currently cost you around $99 per $100 face value. You don’t make much money on these, but it pays better than just letting it sit in your bank, and treasury bills are considered one of the safest investments you can make. After all, they are backed by the full faith and credit of the Unites States government. As long as our government is secure, your money should be also.
The government sells its securities to individuals, institutions, corporations, and even other countries. The Chinese currently hold around 700 billion in U.S. securities, and the Japanese hold another 600 billion. That eleven trillion dollar debt is really spread around!
When I explained to my students that the government owes money to real people and not to itself, someone would always ask, “Well, can’t the government just refuse to pay it back?” Theoretically, they could. But that would be a disastrous mistake! Our government would lose all credibility and makes lots and lots of people very, very mad. How happy do you think the Chinese would be if we reneged on that 700 billion? Think there might be some ramifications? Besides, canceling all the debt would make it extremely difficult for the government to continue future operations, because it would be so difficult to raise money. After all, if you lost $1000 on a U.S. treasury bill, would you buy another one?
So the debt continues to grow – and grow, and grow, and grow! What’s the harm in that? Some people, but not many, would argue that there really is no harm. We can just keep on going the way we have been for the past few decades. Most economists are not so optimistic. They see many problems with an ever-increasing debt. I will address those in my next post.
Monday, March 2, 2009
Debts and Deficits
Doug and I were watching the local news on FOX the other night, when the anchor woman gave a lead-in for a story that made me laugh – scornfully. She said that Obama has promised to get us out of debt in four years! Doug even backed up the DVR box to be sure that was what she had said. It was. Wow! That would be quite a feat, since our current national debt is nearing 11 trillion dollars! ($10,895,353,832,730.22 to be exact – that’s over $35,000 per U.S. citizen!) You can keep up with this growing monstrosity at http://www.brillig.com/debt_clock/, where you will find the National Debt Clock.
The anchor woman made a common mistake, though it shouldn’t be common for a journalist – she confused debt with deficit. What Obama actually promised was to cut the DEFICIT in half in four years. That promise is incredible enough in itself, given our current level of spending.
Each year the government takes in a huge amount of money (revenue) in the form of taxes, tariffs, and various fees. Unfortunately, most years the government spends an even larger amount of money (expenditures). When it does so, we have a deficit for that year. The amount of the deficit is equal to the difference between revenue and expenditures in one fiscal year. (The government’s fiscal, or financial, year begins on October 1st of one year and ends on September 30th of the following year.)
It is possible, of course, that the government could take in more revenue than it spends in a year’s time. When it does, the difference is called a surplus. You have probably heard that we had a surplus at the end of the Clinton administration. In one sense, this is true. Due to the dot.com bubble, we took in lots and lots of money in the form of income and social security taxes. The social security money was invested in government bonds, giving the government lots of money to spend on other projects, which it did. Unfortunately, that money will all have to be paid back to the Social Security fund, starting around 2017, when there will be more retirees drawing checks than there will be workers paying in. Basically, what the government did was “borrow” from the Social Security Trust fund and call it revenue, even though the money will eventually have to be paid back. That is how the government had a surplus.
In fact, the government has had a deficit budget every year since 1969. And all those deficits pile up. The accumulation of all the deficits over the years makes up our national debt – that eleven trillion monstrosity. That is an incomprehensible amount of money. (See my previous post, “So How Much Are We Spending?”) No one is going to pay that off anytime soon, if ever.
Whenever I told my students about the size of our national debt, someone would always ask, “But don’t we just owe it to ourselves?” I’m afraid many adults probably think the same way. In fact, we owe real money to real people, and it has to be paid back. I’ll address that in my next post.
The anchor woman made a common mistake, though it shouldn’t be common for a journalist – she confused debt with deficit. What Obama actually promised was to cut the DEFICIT in half in four years. That promise is incredible enough in itself, given our current level of spending.
Each year the government takes in a huge amount of money (revenue) in the form of taxes, tariffs, and various fees. Unfortunately, most years the government spends an even larger amount of money (expenditures). When it does so, we have a deficit for that year. The amount of the deficit is equal to the difference between revenue and expenditures in one fiscal year. (The government’s fiscal, or financial, year begins on October 1st of one year and ends on September 30th of the following year.)
It is possible, of course, that the government could take in more revenue than it spends in a year’s time. When it does, the difference is called a surplus. You have probably heard that we had a surplus at the end of the Clinton administration. In one sense, this is true. Due to the dot.com bubble, we took in lots and lots of money in the form of income and social security taxes. The social security money was invested in government bonds, giving the government lots of money to spend on other projects, which it did. Unfortunately, that money will all have to be paid back to the Social Security fund, starting around 2017, when there will be more retirees drawing checks than there will be workers paying in. Basically, what the government did was “borrow” from the Social Security Trust fund and call it revenue, even though the money will eventually have to be paid back. That is how the government had a surplus.
In fact, the government has had a deficit budget every year since 1969. And all those deficits pile up. The accumulation of all the deficits over the years makes up our national debt – that eleven trillion monstrosity. That is an incomprehensible amount of money. (See my previous post, “So How Much Are We Spending?”) No one is going to pay that off anytime soon, if ever.
Whenever I told my students about the size of our national debt, someone would always ask, “But don’t we just owe it to ourselves?” I’m afraid many adults probably think the same way. In fact, we owe real money to real people, and it has to be paid back. I’ll address that in my next post.
Subscribe to:
Posts (Atom)
