Monday, June 28, 2010

Getting Our Financial House in Order

Countries, like individuals, need to work hard on getting and keeping their finances in order. Otherwise it can have a negative impact on their population as well as the country itself. As most of us know, one of the reasons for our recent national financial crisis, from which we're still recovering, including the high unemployment rate, and the huge number of unfortunate home foreclosures we're currently experiencing in many parts of the country, is that a large number of Americans were living well beyond their means.

They were purchasing more expensive homes than they could afford, they were borrowing too much on their home equity, and they were using credit cards excessively, not paying enough attention to the very high interest rates they were paying on their card balances. Of course, it's correct that banks and other financial institutions were improperly facilitating this imprudent and dangerous behavior, and our regulatory agencies were not monitoring all this activity the way they should have.

Right now, as widely reported in the media, a number of countries have gotten themselves into serious financial conditions as a result of both the worldwide economic crisis and risky and careless financial policies over the past many years. They include many European countries, including, among others, Greece, Ireland, Iceland, Italy and Spain, but also the U. S. and Japan. Other countries faring poorly, and even possible bankruptcy, include such as Pakistan, Ukraine, Kazakhstan, and Argentina. Some countries are still doing remarkably well for varying reasons. Most prominent of these is China, and others include certainly Brazil, as well as smaller countries like Romania, Norway and Denmark.

Why is it highly important for a country to be in good financial shape and what are possible consequences of being in poor shape? It's important because, among other reasons, it can have a substantial affect on the country's ability to provide needed services to its people, on their ability to provide jobs for people in the public sector, and for the country's ability to play a constructive role in the world, working together with other nations. Possible consequences are that the country may have to go into bankruptcy, may not be able to get needed financial help from financial institutions such as banks, the International Monetary Fund (IMF) and the World Bank. Furthermore, a country's poor financial shape can lead to lower standards of living for their people, especially harming those who are already poor themselves, and this in turn can lead to significant social unrest and widespread protest movements. We don't want to risk going there!

There are many reasons why some countries do poorly and others remarkably well in terms of their financial well-being, and it can be rather complicated to explain. One reason is that countries who do relatively well tend to have very diversified economies with large businesses which are generally well managed. Another reason is that these more successful countries tend also to have very experienced and effective national policy-makers and managers, including those who manage banking systems, the money supply, budgets, and economic advice to the political leaders. An effective, observant private sector media can also be an important factor. However, these factors don't always guarantee good performance, as in the case of the U. S.

How is the financial well-being of a country typically measured? Here is where it can get somewhat complicated. There are many different measurements used. The most common ones include: the level of national economic growth as usually measured by the change in Gross Domestic Product (GDP) after inflation, sometimes viewed on a per capita basis; the level and change over time of the federal Budget Surplus or Deficit; the level of Trade Deficit or Surplus, which is basically the level of net exports compared to net imports; and the level of National Debt (also known as Public Debt) compared to GDP, and the change in this percentage over time.

The U. S.' deteriorating financial position is fairly evident from looking at the above criteria and it looks more worrisome when one looks at economic projections for the next several years. While GDP in China and Brazil, for example, grew significantly in 2009, the U. S.' declined by 2.4%. While our GDP grew in the first quarter of 2010 at a fairly good annual rate of 2.7%, this was due largely to non-recurring factors which will not be in place for the rest of the year. Growth is expected to be very low for the next few years. The U. S. had a huge $1.4 trillion (not billion) federal Budget Deficit last year (fiscal year-end 9/30/09) and it's expected to increase to $1.6 trillion this year (FYE 9/30/10).

We've had a Trade Deficit every year since 1976 and it's getting worse. While it averaged about 3% of GDP since 1980, it has averaged roughly 4-5% of GDP over the last 10-12 years. Our level of Public Debt to GDP has been mostly on a sharply upward and negative trend for many years. While it was a very satisfactory 26% in 1980, it grew to 42% in 1990, and is now at only a marginally satisfactory 61%. Very worrisome, it's going to get much worse. According to the Congressional Budget Office, our Debt to GDP ratio is projected to reach a scary 100% in 2012!! These percentages don't even take into account the huge government debt obligations of the Social Security Trust Fund!

It's very clear we need to get our financial house in order and the Obama Administration and the Congress need to make this a higher priority. Some recognition of the need for meaningful global corrective action came up at the just concluded G-20 talks in Canada. But the agreed actions seem to me to be inadequate, constrained by political differences of opinions on the need for more spending to continue economic recovery versus cutting public debt. The public and the media need to get better informed and concerned about this critical issue. Right now we have a very sensitive specific national vulnerability, as a consequence of our poor financial house. China is a major creditor of the U. S. in that they own 17% of outstanding U. S. Treasury securities, i. e. our Public Debt. If they were to decide that owning these is too risky, although that's not likely, it could pose a big problem for us. Other thoughts, some of which I've discussed in previous posts:

1. We need to move toward a firm balanced federal budget within the next several years and manage our affairs so that is maintained in subsequent years.
2. This will definitely involve more serious prioritization of national needs and making tough political decisions on budget cuts, spending versus debt reduction, infrastructure investments, and a number of tax issues to potentially increase federal revenues. While this will be politically difficult and contentious, it's necessary for the country's well-being.
3. A significant factor on budget cuts will involve military and related expenditures abroad, including those on the costly wars in Iraq and Afghanistan and on maintaining our military bases at over a hundred different properties abroad, especially, aside from those in the Middle East and Central Asia, those in in Korea, Japan, and Germany. Keep in mind that our military spending budget for FYE 2010 is as much as $664 billion! That's larger than the entire GDP of most countries!
4. With respect to taxes we must overhaul and simplify our unnecessarily complex and archaic tax system. This includes the IRS doing a better job in collecting taxes owed by both businesses and individuals, and lowering corporate tax rates, now among the highest in the world, to make us more competitive with foreign firms and induce companies to hire more employees, enabling us to reduce our high unemployment rate and grow GDP of which consumer spending is such a major part.


wondarwie said...

The U.S. is a financial mess and we need to take quick action to prevent a major meltdown.

To begin with, just the annual interest on our national debt is $164 billion. Our mandatory spending in 2010 is $2.18 trillion. Discretionary spending is up to $1.37 trillion. Since we only expect to rake in $2.38 trillion, we have a problem. A BIG, BIG problem.

Just at a glance, it is clear we have to eliminate most discretionary spending to even hope to break even. We can start with the $664 billion we are spending through the Department of Defense. Do we still need all those military bases around the world? Or how about the $72 billion we are spending through the Department of Transportation? Aside from the Federal Aviation Administration, why can't the rest of these DOT agencies be served by state agencies? Or how about the $47 billion being spent on the Department of Housing and Urban Development? How did the federal government get in the housing business?

Somehow this whole thing has gotten out of hand. We need to back off on spending in every single agency that absorbs discretionary spending. Obama needs to just tell these federal agencies that they are all taking a 25 percent hit this year and they will have to figure out which of their programs is going to have to be shelved. Then he needs to create some kind of think tank to deal with our fondness for spending our descendent's money.

We cannot just keep on spending money we don't have. It will eventually catch up with us and when it does, our finanical system is fried.

Viking Views said...

I'm in general agreement with Wondarwie about the nature and scope of our big financial problem and what needs to be done, but have some very important points to add.

My research indicates that, rather than $164 billion, interest expense on our national debt was $189 billion (FYE 2009), but this excludes non-cash intra-government interest expense of $192 billion to our Social Security Trust Fund. So total interest expense actually totaled $381 billion! This was based on a very low average interest rate of just 0.3% p. a. resulting from our financial crisis. When rates begin increasing to more normal interest rates for Treasury securities, our interest expense on the debt will rise very substantially! For example, if the average rate had been just 2.0% p. a. the interest expense would have totaled about
$2.54 trillion, or more than the federal government's total revenues!! And with continuing annual budget deficits our national debt will increase significantly, adding much more to our debt's interest expense! This is very serious, folks!

While shocking, it's not difficult to figure out that we need major cuts to all discretionary spending categories, increases in tax revenues, achieve balanced budgets ASAP, hope that interest rates on our debt stay low for quite some time, and also hope that our international creditors, especially China, continue to be willing to hold our Treasury securities. In terms of taxes, we should probably establish a federal sales tax similar to those most European nations have and significantly increase the tax on gasoline to provide government revenue, discourage some driving and also to reduce our dependence on imported oil.