I recently sent an email to an associate. We had been having a conversation about the budget deficit, the leadership deficit at Washington, Federal taxes and entitlements. Here is part of that email:
"Here’s the current numbers, as a percent of spending of the federal budget. This illuminates some of my recent statements:
Social Security 20%
Miscellaneous Security (Food Stamps, Unemployment Comp) 16%
Social Security 20%
Miscellaneous Security (Food Stamps, Unemployment Comp) 16%
Medicare 13%
Medicaid 10%
All of the above = 59%
Highlights of a few others:
Highlights of a few others:
Defense, including two ongoing wars 20%
All Science, Space and Technology 1%
Servicing the debt 5%
Education 3%
The above is why a credit downgrade of the US is a probable reality. The “social programs” are growing as a percentage of the budget and there is no reduction in sight. As I recall, in 1960 the US spent 20% on social programs and about 50% on defense."
Well, here we are and S&P did, in fact downgrade the US. Moody's has stated the US outlook is "negative." So What's Next????
The fact is, it’s going to take some political will to solve this. That requires tax increases and entitlement spending freezes or cuts. The sooner the better.
The S&P downgrade was fueled by the realization that this will not happen in the near future. According to S&P, even France has a better outlook than the U.S. at this point. Moody’s has said the outlook is “negative” for the U.S. The ratings agencies do not price U.S. debt; the markets do this. So in some respects I think this is a “non-event.” It is also a moment when U.S. debt was changed from “risk free” to “having some risk.” That is a big deal. Stepping outside the box, I think it’s useful to remember that S&P once downgraded BRK. However, what is significant is the way the politicians handled this, the continuing lack of leadership from the White House, and the post downgrade rhetoric coming out of Washington.
Hmmm, I do have to wonder if President Obama will take to the airwaves and tell us about how this is another "Sputnik Moment" in American history?
What no one in government wants to talk about is the consequence of a protracted 10% unemployment. That has created an incredible government revenue decrease and contributed to the budget shortfall. It’s the #1 reason for the rapidly rising debt. The projections usually include a reduction in unemployment and unemployment benefits payments coupled to rising government revenue. That has not happened, and won’t unless there is a tax increase. Things were bad because of the out of control entitlement spending. Now, with income shortfalls, the financial health of the U.S. is much worse. When politicians pretend the current deficit issue can be dealt with by increasing taxes, they are showing their lack of financial acumen. How do you deal with an economy in which the entitlements are 59% percent and increasing at an alarming rate? Raise total revenue from 25% to 40%? So to be realistic Washington must make significant cuts to entitlements. Certainly more substantial than the amount to be gained by raising taxes.
As is true of other bubbles created by the politicians, the "entitlement bubble" will not go away and can't be taxed away. Not when an increasing percentage of those living in America are moved from the rolls of wage earners to entitlement earners each and every year.
The politicians always pretend the latest stimulus program or whatever will solve the problem, and that “everything will be back to normal” by next year. That of course, allows them to maintain the status quo, and their voter base. They tell us what we want to hear. Now it is to be expected that Democrats will argue that political sabotage by Republicans forced the S&P downgrade, and Republicans will argue that it is because of irresponsible government spending by the Democrats. Individual Americans will pick the argument that best supports their personal financial position, supports their personal lifestyle, and inflicts the pain on others.
Obviously, as far as I am concerned this is all about money, and greed. This pretending also allows Americans to continue on their profligate ways with the assumption that “someone else” (our descendants) can pay the piper.
Politicians made note of what recently happened in
"Jubilant supporters chanted, "Medicare! Medicare!" after Democrat Kathy Hochul shocked the political world with her upset win in a special election in New York's conservative 26th Congressional District, for a seat held by Republicans for all but 16 of the past 154 years."
According to AARP last May, “Democrats see Medicare as winning issue for 2012 election.”
So should I be surprised by the recent shenanigans in Washington? The Democrats telegraphed their position in May. It’s all about votes. As for the AARP statements about SS, I suppose their position that “Social Security doesn't contribute to the deficit, and shouldn't be cut to fix it.” is literally true, but those special federal IOUs aren’t backed by anything but the government’s ability to print money (debase the currency or raise taxes). Recently, the income collected for SS benefits did not match payouts. I suppose these are inconvenient details.
Of course, when revenue falls, spending is supposed to also fall. But not here in the U.S. Not for many families and certainly not for government. Up until recently, home equity and credit cards were personal money printing presses for many people. Unlike the U.S. government, we can’t default on our personal debts unless we find some way to declare bankruptcy. Many have. More will as this economic malaise continues.
The current government solution seems to be to allow inflation to occur and debase the dollar, thereby reducing the consequences of the U.S. debt for the government, and inflating our way out of this dilemma. In fact, at present, the U.S. is only paying interest on the debt equivelant to about 1.5% of GDP, the lowest since 1973. For nearly TWO decades it was above 2.0% and was generally above 3.0% from 1985 to 1997!
Here’s an excerpt of what S&P said in their downgrade. I’m sure you read this, but it’s worth repeating to every American and politician in Washington. S&P is emphasing spending discipline, as in “containment of entitlement spending.” I read their entire statement at the S&P website. Emphasis is mine:
"We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade……Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability…………The outlook on the long-term rating is negative.”
I am absolutely certain this will be resolved, one way or another. First, foreign governments will continue to press to have our debt downgraded. This is one way to increase the yield. So the tug of war is the U.S. debasing the dollar and foreigners including governments and banks, pressing for a change that increases their return. As I recall, 45% of all U.S. debt is held by foreigners.
Of course, the U.S. consumer and savers of U.S. dollars will all suffer.
There is no doubt that the free ride in entitlements will end. Benefit cuts and means testing are inevitable. What is uncertain is how long the politicians can hold out. Holding COLA and other benefit increases at 0% is the other preferred tactic. It has to be this way because of that incredible 59% of the budget for “entitlements” and related social programs. We can end the wars, but that will only buy the U.S at most 5 years, at the rate of medical and cost benefit increases. Ultimately the entire U.S. budget will be consumed. But nearly everyone is in denial about this, just as they were about the housing market, the debt bubble, etc.
Meanwhile, here is what the AARP says on their website about the current battle:
“AARP CEO A. Barry Rand offered the following statement after the House and Senate passed the Budget Control Act of 2011 to raise the debt ceiling. Throughout the past several months, AARP has been focused on preventing cuts to Social Security and Medicare benefits for the millions of beneficiaries who have paid into the systems over their working lives…..”
As I stated in my “Reality Check” article, the only option is for individuals to save more for their future. This is a very unpopular choice. In view of the current situation, I have to admit that saving in dollars doesn’t seem to make much sense.
Looking ahead, I can’t see the 20 and 30 year olds of this country paying increased amounts in taxes to fuel my retirement party or to pay for my protracted health care. That party is over. We may resist and the politicians will attempt to avoid but they cannot. The pool of payers is shrinking. We are beyond the tipping point.
The next tax revolt will be age based. So far the talk has been disguised as “rich” versus “poor” but I do think it will get ugly. So far (since about 2005), I’ve been pretty accurate in my assessment of the situation. I think this too will be accurate.
No one will like it. That’s what happens when a really deep financial hole is dug. There are no easy solutions. And no one, except the very rich or politicians can escape the pain. There will be higher taxes, there will be smaller COLA increases for retirees, there will be means testing, medical co-payments will increase, and the costs of everything for everyone will go up. As I said, no one will like this.
How ugly will it really get? I would prefer not to say; besides, I don't have a crystal ball. However, I can say I've been pretty accurate for the past decade. More accurate the the economists, the Fed, and the politicians in Washington. Or perhaps I've simply been more honest.
Of course, the real question is what to do to prepare for this politically inspired future. The truth is, there are no easy answers for individual families. 1) Save more and spend less. 2) Prepare for reduced entitlement payments. 3) Prepare for increased taxes. 4) Prepare for inflation. 5) Prepare for protracted high unemployment; I was expecting another 5-7 years. Now, I think the current situation could span another decade or more. Just as individual investors are leaving the U.S. markets to buy gold or whatever, companies (which are headed by human beings) will make their investments as in building factories, elsewhere. Our work force is no longer the most educated and motivated on the planet. For companies, this shift away from America took a turn when they quietly stored their $Billions in cash overseas (MSFT, AAPL, CSCO, etc. ). Now the move will accelerate.
Note: GE gets the bad press about "low taxes" because it's an old line industrial company. The tech darlings get away with their shenanigans by both politicians and the popular media. I suspect that for the media, it's because of personal bias; a lot of these "journalists" own stock in publicly traded companies. Who is going to be honest enough to hit the companies in which they own stock? Certainly not the popular press.
The wild card in all of this? Europe, which is actually in worse shape than the U.S., overall. That’s why people continue to buy dollars even with all of the shenanigans by the politicians in the U.S. However, should the EU get its act together, or should individuals decide that will happen, then the change for the U.S. will be swift and devastating. I think that's something for Americans to think about.
