Consequences of lack of Fiscal Policy at the top, Corporate mismangement in the middle tier and Social irresponsibility at the bottom tier.
Note: The audience of this document is common man(and woman) like you and me. The idea is to first understand our economical footprints before we analyze and implement the changes to our life style. This article does not suggest what life style changes everyone needs to make, that is beyond the scope. As it is happening in today’s world the onus is ‘still’ on the individual. That being the intention, I have tried to make this article as simple as possible. Some technical jargons had to be used and I have tried to quote as much reference as possible to make it easy to understand. I am neither an economist nor a mathematician to make calculations and pass judgments. This article is just an attempt to present facts in plain and simple terms so we do understand as what kind of mess we have created for ourselves. At the end of the day it is all about adjusting oneself to ‘Supply and Demand’, as simple as that.
Government’s primary job is to streamline its income and expenditure in such a way that it favors the economy and fuels healthy and sustainable living standards to its citizen. In mathematical terms, when the income exceeds the expenses it is surplus and when it is the other way it is deficit(debt). United States currently has a public debt of over 16 Trillion financed as bonds and treasuries. Yes, Trillion with a ‘T’. This debt has been accumulated over the years by adding deficit from each individual year ‘progressively’. For instance the year 2012 alone contributed over 1 Trillion of this deficit. US GDP(Gross Domestic Product – investopedia definition - ‘Is the monetary value of all finished goods and services produced within a country’s border in a specific period of time’) for 2012 is around 16 Trillion. Current US debt is around 100% of its GDP. To compare this historically, the previous highest deficit was during the post great depression in 1943(30% of GDP). To give an idea as what it takes to repay this debt, the whole of US needs to work real hard for one year and not consume anything that is produced in this period(including food, gas, homes, cars etc) and repay those proceeds towards the debt for that debt to become zero. Agreed this is not a viable solution, let us divide the debt equally among all of us. US population is about 315 Million, if we were to divide this debt equally to all citizens then each of us(including newborns) will get a ‘share’ of around USD 51,000. Both solutions are practically impossible to implement. Before we try to address a solution, let us examine and understand as how we created this mess (both from government and public perspective).
US government very clearly lacks a ‘Fiscal Policy’ - wiki definition – ‘Is the use of government revenue collection (taxation) and expenditure (spending) to influence the economy’.
In the recent past, US government has been spending ‘excessively’ than what it takes as revenue. In 1998, the federal budget reported its first surplus ($69 billion) since 1969. In 1999, the surplus nearly doubled to $125 billion, and then again in 2000 to $236 billion. It has gone down spirally since then. The four main contributors for this being a.) the ‘dot.com’ bubble, b.) 9/11 attacks(huge defense spending on Afghan and Iraq wars), c.) Tax cuts to the tune of 1.35 Trillion and d.) Recession initiated Economic Stimulus in the name of Quantitative Easing as a result of deregulation in the Financial Sector and Mortgage Backed Securities.
These four toxic events have severely contributed and still contributing to the mess we are in today. The mess is still piling up without any sight of it ending in the near term. Current policies and actions are geared up towards piling up more and more debt. Country’s financial credibility is surely being threatened. Imagine the possibility of defaulting on such a huge debt by a developed country that leads in many areas including space and military research. Thought alone is scary, let alone its worldwide consequences.
US has moved past the dot.com bubble and 9/11 emotionally, but the financial impact that these events have created has left a huge scar which still has not been repaired. The positive from this unwanted exercise is that it is not creating any major addition to the deficit any longer.
Tax cuts are still an issue, "U.S. Treasury Department", "Center on Budget and Policy Priorities" and the "Congressional Budget Office" have clearly been opponents of the Bush-era tax cuts stating that it has added about 1.35 Trillion to public debt so far. As designed if continued, it can potentially add another 3.3 Trillion to the deficit in the next decade.
The last and the most horrific event is the ‘effects’ of deregulation of financial sector that is in place for the last two decades. The mess that this has created is much bigger than all three above incidents put together. The US government is clear and adamant as not to have a Fiscal Policy. To a large extent (mis)handling in this area is currently done by the Central Bank(Fed). In the wake of lack of fiscal policy from the government, the loopholes in the derivatives markets and the mortgage backed securities have been thoroughly utilized by the corporate heads to inflate the profits of their respective companies. Which have resulted in huge pay hikes and bonuses for them. Since ‘ethics’ is no longer an accepted product in the corporate premises, the blame now squarely lies on Fed and govt for creating such a mess. One of the primary jobs of a democratically elected government has unofficially been delegated to Central bank(Fed).
As a result the Fed had to come up with measures like ‘Quantitative Easing’ to help struggling corporates who are the bread givers of common man. A process in which Fed bought (rotten) Financial Assets (wiki definition – “Is an intangible asset that derives value because of a contractual claim. Examples include bank deposits, bonds, and stocks.”) from these corporates(commercial bank) by printing more money from ‘thin air’ and using ‘tax dollars’ in the intention to increase liquidity for these banks, so they can lend more to help the common man. That too at an interest rate close to zero(a great reward for corporate unethical practices). All this was done to help the common man, under the agreement that the corporates have to start lending again but with more rules and regulations in place. Now this brought two changes: One, the toxic assets were moved from the balance sheet of the corporates to the balance sheet of the Fed(replacing the printed dollars and our ‘tax dollars’) !!! Two, the corporates were able to a.) Hoard the money received from Fed to fulfill their reserve requirements imposed by Fed b.) Diversify the rest of the money received from the Fed into other profitable investments(like commodities, sending commodities like gold prices higher) and finally lend some money to the size of peanuts to the public. The corporates now can point to the stricter regulation for lending out such small money to the public. Clever, right ? The corporates are now back to business, they are again generating huge profits(from their investments) and are in a position to repay the ‘negotiated’(not the borrowed money) money back to Fed. The rest will be taken by tax payers, I guess. Just like what BOFA did today, which prompted me to write this article anyways.
The blame cannot squarely be put on Fed, Govt and Corporates alone. We as citizens have played our part too to contribute to the mess. We too to our capacity have used to loopholes in the system. We did the same what the corporate heads did, which is to buy homes beyond our reach just because easy loans were available under plans like ‘stated income’, ‘interest only’ and ‘balloon loans’. Just when we found that there were whole of people in the same boat which was about to sink, we jumped off it using the life vests(short sale and foreclosures) provided by Fed/Govt. A lot of us jumped out of the boat just because it was a bad investment decision we made and not because of a true situation where we could not repay. We are no saints either. We surely have contributed to this mess in the best possible way we can.
The blunt of all this is faced by all of us, including the tax payer who has not indulged in any of this activity(statistically majority of the people come under this category). Undoubtedly Fed and the Govt will reward such tax-payers, of course with a huge tax increase!!
So what is the path ahead ? Like I mentioned, I am no mathematician or economist, these are my common sense predictions, based on the events happened in the past under similar circumstances. Along with death, three things that are certain are very high Interest rates, high Tax rates and Dollar losing its status of reserve currency.
Current setup(low interest rates) seemed to have created equity for home owners without much progress in job front. The idea of Fed I believe(my speculation here based on fed reports, not fact) is that low interest rate will increase business output and in turn create construction and manufacturing job which will trigger the economy back to normalcy, slowly. If so, inflation will certainly go up, Interest rate is sure to raise just like Volker did(if not that bad). Bonds and Treasuries will crash and US stands to lose the status of reserve currency, not very far from now. That too considering that majority of US debt is financed by China and Japan.
Price of Gold has to go down when QE stops (these banks have to sell their investments to repay the cash). Technically gold has to go up when Inflation rises. The direction of gold price largely depends on how much of gold is sold by these commercial banks vs. Inflation rise. Trying to make an educated guess, Fed will start raising interest rates(in 2014-2015) to curb inflation and prior to that commercial banks will start selling their investments to repay their debt and both happening at the same time, commodities prices will fluctuate in the next few years. However when dollar loses its reserve currency status, the next viable alternative is gold. So it is hard to predict the direction of gold in the long run. In the near term gold has to go down to the levels of 1300-1500 and then climb back depending on the time(not a question of if but when) when dollar loses it reserve currency status.
Anyway the above is not the intention of this topic, getting back to the original thread, there is still no solution as how the public debt is going to be repaid. No measures have even been initiated in that regard. The cause for this situation needs to be equally shared by Govt for lack of Fiscal Policy, by Fed for handling the situation the way it has, corporate heads for manipulating the loopholes and the common man for going beyond his ways and means of life. The solution surely has to come from the government, deregulation of financial sector and lack of fiscal policy needs to be addressed first before anything else……….
“Earth has every resource for everyone’s need but not enough resource even for one person’s greed”, we have set up our self very well for this. The majority of the powerful people have been more than greedy along a small percentage of ordinary citizen. Let us see how it goes……..
God (alone) bless America.