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Sunday, November 7, 2010

What’s in Your Wallet

Giving money and power to government is like giving whiskey and car keys to teenage boys.” — P. J. O'Rourke

Federal Reserve Chairman Ben Bernanke defended the Fed's new $600 billion program to aid the economy on Saturday, rejecting concerns that it will spur runaway inflation. Critics, including some Fed officials, fear that all the money being injected into the economy could ignite inflation or speculative bubbles in the prices of bonds or commodities.

Speaking to a conference on the Georgia coast, Bernanke said the new program, announced Wednesday, won't push inflation to "super ordinary" levels. The Fed will buy $600 billion worth of government bonds in a bid to make loans cheaper and get Americans to spend more. Doing so would help the economy and prompt companies to boost hiring.

Bernanke said; “The economy hasn't been growing fast enough to reduce unemployment, which has been stuck at a high of 9.6 percent for three straight months. The Fed worries that high unemployment, lackluster wage gains and still-weak home values will weigh on consumer spending, a major drive of overall economic activity. Because companies are loath to raise retail prices in this climate, inflation has been running at very low levels. That gives the Fed leeway to launch the new aid program.”

Earlier in the week, Bernanke expressed confidence that once the economy is on firm footing, the Fed will be able to smoothly soak up all that money without harming the economy and unleashing inflation.

In a speech given at the Annual Meeting of the Rhode Island Public Expenditure Council, Providence, Rhode Island on October 4, 2010 Bernanke had this to say:

“Our fiscal challenges are especially daunting because they are mostly the product of powerful underlying trends, not short-term or temporary factors. Two of the most important driving forces are the aging of the U.S. population, the pace of which will intensify over the next couple of decades as the baby-boom generation retires, and rapidly rising health-care costs. As the health-care needs of the aging population increase, federal health-care programs are on track to be by far the biggest single source of fiscal imbalances over the longer term. Indeed, the Congressional Budget Office (CBO) projects that the ratio of federal spending for health-care programs (principally Medicare and Medicaid) to national income will double over the next 25 years, and continue to rise significantly further after that.3 The ability to control health-care costs as our population gets older, while still providing high-quality care to those who need it, will be critical not only for budgetary reasons but for maintaining the dynamism of the broader economy as well.”

“The aging of the U.S. population will also strain Social Security, as the number of workers paying taxes into the system rises more slowly than the number of people receiving benefits. This year, there are about five individuals between the ages of 20 and 64 for each person aged 65 and older. By 2030, when most of the baby boomers will have retired, this ratio is projected to decline to around 3, and it may subsequently fall yet further as life expectancies continue to increase. Overall, the projected fiscal pressures associated with Social Security are considerably smaller than the pressures associated with federal health programs, but they still present a significant challenge to policymakers.”

“The same underlying trends affecting federal finances will also put substantial pressures on state and local budgets, as organizations like yours have helped to highlight. In Rhode Island, as in other states, the retirement of state employees, together with continuing increases in health-care costs, will cause public pension and retiree health-care obligations to become increasingly difficult to meet. Estimates of unfunded pension liabilities for the states as whole span a wide range, but some researchers put the figure as high as $2 trillion at the end of 2009. Estimates of states' liabilities for retiree health benefits are even more uncertain because of the difficulty of projecting medical costs decades into the future. However, one recent estimate suggests that state governments have a collective liability of almost $600 billion for retiree health benefits.6 These health benefits have usually been handled on a pay-as-you-go basis and therefore could impose a substantial fiscal burden in coming years as large numbers of state workers retire.”

In an interview with Terence P. Jeffrey of John Allison, who for two decades served as chairman and CEO of BB&T, the nation's 10th largest bank, told it is a “mathematical certainty” that the United States government will go bankrupt unless it dramatically changes its fiscal direction.

Allison said; “It is a “mathematical certainty” that the United States government will go bankrupt unless it dramatically changes its fiscal direction.” Allison likened what he sees as the predictable future bankruptcy of the United States to the problems at Fannie Mae and Freddie Mac, whose insolvency he also said was foreseeable to those who studied their business practices and financial situation.

“I think the first thing we have to realize is where we’re going and to face it objectively,” Allison told, when asked about the trillion-dollar-plus deficits the federal government has run for three straight years, the more than $13 trillion in federal debt, and the $61.9 trillion long-term shortfall the government faces (according to the analysis of the Peter G. Peterson Foundation) if the government is to pay all the benefits it has promised through entitlement programs.

“If you run the numbers, on all those numbers that you just talked about, which I think are accurate, very accurate, in 20 or 25 years, the United States goes bankrupt,” said Allison. “It’s a mathematical certainty.

“It reminds me very much of that story I told you about Freddie Mac and Fannie Mae,” said Allison. “We were running the numbers, and Freddie Mac and Fannie Mae went bankrupt, and we got there. In 20 or 25 years, the United States goes bankrupt.

Allison continued; “Now, countries don’t go bankrupt the way companies do. They don’t file bankruptcy. They usually hyper-inflate. They print a bunch of paper money, or they become Third World economies like Argentina--unless we change direction. So, we absolutely have to change direction.”

“And the irony of that is it requires an interesting combination. It requires both discipline, but it also requires a focus on growing our economy. And it means a fundamental philosophical change from where we are today, from the idea of redistributing wealth to the idea of creating wealth. The United States was founded on the concept of life, liberty and the pursuit of happiness—each individual’s moral right to what they create, what they produce, the best kind of incentive system you can possibly have. So we need to radically reduce the role of government, and in that process we will both incent growth and we can cut cost.”

“I’ll tell you one of the easiest ways to cut costs would be to cut the whole massive government bureaucracy and all the regulations that go with it. I know in my career, between 1971 and today, the amount of paper that it takes to make a loan has gone--you could make a loan with two sheets to whoever, two thousand sheets. I don’t know how many sheets of paper it takes to make a loan. And all that’s been added in the last 40 years. We could reduce bureaucratic overhead by hundreds of billions of dollars, maybe as much as a whole, if you look at the secondary effects, by a trillion dollars—and at the same time, the elimination of all that useless government red tape would spur economic growth and productivity.”

When asked about Medicare and Social Security’s $62 trillion dollars in unfunded liabilities Allison replied; “Well, it obviously helps, but, no, it doesn’t solve the problem. And here’s what we need to do in regards to entitlements. Social Security, interestingly enough, is mathematically fixable. It won’t be much fun, but it’s mathematically fixable by phasing in a higher retirement age and, unfortunately, maybe raising the taxes a little bit on higher-income people. But what we need to do is get rid of the long-term program. And the way to do that, even though it may create some short-term funding problems, would be to offer people privatized programs for retirement and effectively offer people under a certain age the option to get out of Social Security.

Allison continues; “And the reason that would be a double effect is you wouldn’t have these unfunded liabilities that you’re creating because you’re under-funding Social Security, but secondly, you would have a huge amount of capital created that could be used to make American workers more productive. If Social Security had actually been a private savings account and we had all that capital in the capital markets, we’d have much better equipment, we’d have much better technology, we’d have much better educational institutions, because there’s a double whammy with Social Security. There’s no real savings. We never saved the real money in Social Security, right. It’s a ponzi game that depends on the young people paying for the old people. And that means that there’s been no capital accumulation. So, you’re probably going to have to raise the age, raise the taxes, and offer young people an out so we start creating capital.”

Congressman Paul Ryan from Wisconsin, who is the ranking Republican on the Budget Committee, has offered legislation that would allow people to take a certain chunk of their payroll tax, which is for Social Security, and put it into mutual-fund-type investments over the course of their working lives. At the end of their working life, they’d be required to buy an annuity that would pay them the equivalent of a Social Security benefit and any surplus they had over and above that they could do whatever they wanted with. The actuary of Social Security has said that Ryan’s legislation would actually make the program solvent over the long run. When asked about Ryan’s proposal Allison responded;

“I would certainly like to see what Ryan is proposing. Personally, I would actually do more. I’d be even more dramatic because I don’t really think that it’s the role of government to force savings on people. I think that’s an individual choice, an individual responsibility, and they get individual consequences, right. They may have to work longer if they choose not to save. There’s certainly an interesting issue about the high savings rate forced on 18-year-olds when they go to get their first job, and 23-year-olds when they’re trying to raise their children. So, I’m not sure Social Security is economically efficient, but I don’t think we’ll get rid of it. So, I would certainly take Ryan’s proposal over anything else I’ve seen, practically speaking, offered in Congress.” You can read a transcript of Allison’s interview by clicking here.

With the second round of Quantitative Easing (QE2) the Federal Reserve will purchase $600 billion in U.S. Treasury bonds to drive down long-term interest rates and boost growth, despite strong reservations among financial experts and some Federal Reserve members. The expectations are that the Fed will purchase this Treasury debt with an eye toward lowering long-term rates and spurring more borrowing by consumers and businesses. The first round of QE brought down Treasury rates, which in turn cut other rates, enabling corporations to borrow cheaply and giving some support to housing demand as well as triggering mortgage refinancings that are putting more money into homeowners’ pockets.

The Fed believes that QE2, which would involve massive purchases of Treasuries, would push yields on Treasuries and bonds down and produce a surge in investment and consumption expenditures. Yet, this assumes that the economy’s recovery has been retarded by insufficient aggregate demand. In other words, the thinking goes, if the Fed could return the U.S. economy to the activity levels of the 1970s, even if that means 1970s-style inflation and consequent recession, that would be not as bad as  years of 1930s-style shortfalls in aggregate demand. And this is probably what the Fed is thinking as well.”

To me it’s like riding on a tire with a hole in it. You keep putting air into the tire but it keeps going flat. Until you patch the hole he tire will never inflate to its proper pressure. The tire will just require more and more air. This is called inflation.

Another good example of our monetary policy and inflation is the five-dollar gold piece. In 1900 you could buy a lot of stuff with a five-dollar gold piece. You could buy a new suit or a month’s worth of groceries. The gold piece was backed by the value of gold based on the weight of the coin. When we went off the gold standard in the 1933 and issued treasury notes backed by the “good faith and trust of the government” you had to turn in your five dollar gold piece for a piece of paper saying it was worth five dollars. You could still buy your new suit and a month’s worth of groceries.

As inflation, caused by wars and government spending, began to erode the purchasing power of the five dollar note wages needed to rise as prices went up and government spending increased. Today with your five dollar note you can buy a loaf of bread and a quart of milk, forget the suit. On the other hand if you has a few of those five dollar gold pieces stashed away you could convert the  gold to treasury notes —at $1,380 per once — and still buy a few suits and several month’s worth of groceries.

Inflation is a killer to American households. Everything goes up in price and those living on a fixed income suffer the most. Even those on some sort of government aid will suffer. Inflation is also a job killer. If things cost more and people buy less the companies that make and sell things hire less people. When these companies hire less people tax revenues decline and the government deficit climbs. Progressive will tell you that the government can hire these people for, but isn’t that one of the things that got us into this mess.

Right now our President is in India telling us how he is going to create 500,000 jobs through the Indian economy. Is this a joke? Are those 500,000 jobs going to be for the Indians?  Harley-Davidson, our last manufacturer of motorcycles has recently announced they will be moving some of their operations to India. This will mean jobs for India, not the United States. One of the world’s largest manufactures is the conglomerate TATA. The Tata group has vast holdings throughout the world and the make everything from home appliances to automobiles. Very soon they will begin exporting their version of the “Smart Car” to the United States. How many jobs will this create?

Government intervention gave us this recession and government policies have unnecessarily prolonged and intensified the pain. Now, Federal Reserve inflationary policies are apparently poised to sweep us up, up, and away until, that is, the balloon bursts once again.

After writing all of this monetary stuff I am so depressed and confused that I will now watch the Sunday football games and lose myself in the circuses provided by the emperor and his minions in the media. I don’t have enough money for the bread, so I will just settle for the circus.

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