Tuesday, June 24, 2014

The Federal Debt is Hiding in the Corner

The big exam is coming up. You have plenty of time to study and get ready for it. But stuff keeps happening. Your neighbor asks you to mow her yard. Your best friend turns 21 and you have to celebrate with him. It is a beautiful night and life is too short to not appreciate it. The test day arrives and you never got around to studying. Ugh.

It is easy to get diverted from disagreeable tasks. Today it is especially easy for our government to forget about some basic issues. The list of diversions right now is very long. No one can argue that each and every one of these issues is important in its own right – Fed monetary policy, Iraq, Russia, Iran, Libya, IRS, North Korea, Bergdahl, Minimum Wage, and so on.

But when is the last time you heard anyone talk about the national debt? I guess we must have solved that problem. Or maybe it wasn’t a problem at all? Maybe the debt should be collecting dust in the back of a closet somewhere?

I don’t think so. Current data and projections show we have made zero progress with the US national debt and it remains a ticking time bomb. And the worst thing about the debt is that it is self- exploding. It is like potato chips. You have one and then you have to have another. And before you know it you look like a before photo of Jared.

·        When the national debt gets bigger – that means the country pays more interest to bondholders.
·        Interest expense is part of government spending, so that means government expenditures rise and create a bigger deficit.
·        The bigger deficit means the government sells more bonds and increases its debt...

That sounds pretty dire but it just gets worse. The explosion gets bigger whenever interest rates rise. The Fed is projecting higher rates next year and beyond. By all accounts these projections underestimate what will happen. Ask anyone who defaulted on their home recently – debt is no laughing matter.

But isn’t the economy improving? Won’t these improvements bring in more tax revenues and reduce spending on social programs. Didn’t Congress make some compromises lately? Won’t all that help? Yes, all that is true. All those things will help to improve future government deficits and debt. But unfortunately other things are happening that continue to make matters worse. This is all laid out by the Congressional Budget Office in a coloring book. Well not exactly.

There is something on the CBO web page called “April 2014 Baseline from Update Budget Projections: 2014 to 2024”  http://www.cbo.gov/publication/45069  Click that link and you get a lovely XLS spreadsheet. The CBO puts a bunch of government projections of budgeting data together in 5 tables. We are currently in the government’s 2014 fiscal year – they project through 2024. These projections rely on the most current federal laws that guide future government spending and revenues – and use economic projections about GDP, prices, interest rates, and so on.

Below are some of the key projections…

·        After being $680 billion in 2014, the government deficit will improve for two years (2015, 2016) and then get increasingly larger in every year thereafter reaching $1 trillion by 2023.
·        Despite the 2015 and 2016 small improvements, all years from 2014 to 2024 will have government budget deficits and they will generally increase over time.
·        After many years of making a positive contribution to the budget, the so-called off-budget part (mostly from the Social Security Programs) will go negative in 2018. That means all those Boomers will be taking out more than the kiddies are putting in.
·        But it would be wrong to conclude that Social Security is the main issue behind larger deficits. Between 2015 and 2024 the off-budget deficit will increase by a total of $650 billion. The rest of the budget will worsen by approximately $7 trillion. The Social Security deficits are, therefore, less than one-tenth of the problem.
·        Since all the future annual deficits will be negative and growing, this means the national debt will grow each year – and will grow faster than GDP. Really!
·        The government debt held by the public in 2007 was $5 trillion or 35% of GDP. In 2014 it will be $12.7 trillion. It will rise in every year and reach nearly $21 trillion in 2024. It will have risen from 35% of GDP in 2007 to 78.1% in 2024. 

Clearly the debt took a huge jump during the financial crisis and we apparently have no plan to remediate that jump. I guess all is fine. There is no urgency perhaps not even a recognition that a more-than doubling of the nation’s debt burden is a problem or even a serious risk factor.

It isn’t like we are having major tax cuts that have reduced future government revenues. Total government revenues in 2013 were about $2.8 trillion. They will rise by $1 trillion in the next five years – that’s an increase of about 36% by 2018. Between 2018 and 2013 they are expected to rise by another $1.1 trillion. Tax revenues will be just a little under $5 trillion in 2024. So the explosion in deficits and debt has not come because we have restricted the government’s income. Hey mom – will you increase my allowance by 36%?

If taxes are not the culprit, how about spending? Total Federal government outlays in 2013 were close to $3.5 trillion. If you believe what you hear about government austerity then you might expect slowly growing government spending. But spending rises to $4.4 trillion in 2018 and to $5.9 trillion by 2024. Between 2013 and 2024 government spending will increase by about 69%. That is probably at least twice the rate of inflation over than same time period. It would be hard to call that austerity.

The upshot is that despite fairy tales that say the opposite our Federal government is doing nothing to reverse our exploding national debt. Taxes are rising at a generous pace. Spending is growing more than revenues so deficits and debt are increasing absolutely and as a share of the size of the economy. As for the spending, below you see where the spending increases are coming from in the next five years. The largest contributors to the increase in dollar terms is the mandatory spending category Social Security. In terms of fastest growing are Health Subsidies under Obamacare and Medicaid. In case you are wondering, present plans call for defense spending to be $623 billion in 2018, about $3 billion less than the $626 billion of 2013.  Spending on various social programs (found in the discretionary spending part of the budget) like unemployment insurance and food stamps, will fall by $18 billion between 2013 and 2018.

This is not rocket science. Tax rates will have gone from 16.7% of GDP in 2013 to 18.3% in 2024. Spending will increase too from 20.8% to 22.1%. More typical would be revenues at about 17% and spending at 19% of GDP. Clearly our buddies in Washington are planning tax rates and spending rates that are in excess of what has been normal for this country. In case you hadn't noticed, 2024 is almost 15 years since the recession ended. The debt ballooned in the recession and will get even bigger in the next decade. Who is minding the store? 

         2013    2018  $CHG  %CHG
Total                    $3.455     4.391   .936   27%
Mandatory             2.032     2.692   .660   32%
Social Sec.              .808     1.048   .240   30%
Medicare                 .580      .706    .121   21%
Medicaid                 .265      .418    .153   58%
Health Subsidy        .001      .103    .102   Huge

Income Security      .340      .322   -.018  -5.3%

Tuesday, June 17, 2014

Value of Obama's Words 2008 to 2014: A Supply and Demand Analysis

Supply and demand analysis is the economist's tool for explaining changes in value over time. Below is a S&D chart helping us understand what happened to the value of the words uttered by President Obama. 

In 2008 the President's words had high value as shown at the intersection of the Supply of O-words in 2008 with the Demand for O-words in 2008. 

The chart shows that the demand for O-words remains unchanged in 2014 but the change on the diagram is the large increase in his spoken words in his many speeches -- as shown by a rightward shift in the O-Supply Curve in 2014.

The result is a glut of words and therefore a drop in the value of his words. If my quantitative estimates are correct, the O-Supply Curve shifted enough to drive down the value of his words into negative territory.

A negative word value means that the President would have to pay people to listen to him. This puts him in the same league with Mel Gibson and your mother-in-law. I think that people of both parties agree with this analysis.

Tuesday, June 10, 2014

The Big Deflation Monster

When I was a kid 200 years ago I sometimes had trouble sleeping because I was pretty sure there was a monster lurking around outside my bedroom window. If you knew the neighborhood where I grew up you’d know I wasn’t that wrong but I had real monsters in mind – monsters with horns who snorted fire and back in those days pajamas were not fire retardant.

Today kids don’t need to worry about such things because their parents are already very consumed by the deflation monster. If you read the newspapers you can see that deflation has all the central banks shaking in their boots. Most recently the European Central Bank confirmed this paranoia by setting a key interest rate below zero. That’s a pretty cold interest rate!

An article last Friday in the Wall Street Journal (page A7, Deflation More than Threat to Some) said, “Deflation posed a threat to the fragile recovery across the 18-national euro zone. But it has already taken hold in Portugal, Greece, Cyprus, and Slovakia.” The article writes about the many ways that deflation is a scary monster. The problem with this story is that it is only half complete and as such is at least half wrong in its policy prescriptions.

To tell this story properly we need a big glass of JD and for your neighbor to stop mowing the yard. First, what is deflation? One definition is that deflation tells you why your bicycle is harder to peddle. Another concerns a deflated ego and why you lack confidence at dance parties.  But a more relevant definition of deflation has to do with changes in the national price level. Let’s suppose Uncle Oscar gave you $100 last year which you tucked away in a safe hiding place under your Beautyrest Recharge Catskills Firm Pillowtop Queen Mattress. Over the year the price of a QFO Quad Fighter Mini-Quad RC Gaming Drone fell from $100 to $90. You would say that the price of this drone fell by 10%. You would be really happy that you waited because now that $100 bill will get you the drone and the optional but extra laser guided missile that goes with it. We would call that a price reduction. That is getting close to the idea of deflation, but no cigar.

Deflation relates to more than the price a single good as when we talk about the CPI – the price of a basket of goods. No not the price of the basket. All the goods the typical consumer buys do not fit into a basket! Anyway, the CPI refers to what is happening to the prices of all those goods and services consumers buy. Usually the price of this basket of goods rises over time. I charted CPI data since 1950 and found that in the last 64 years, the CPI increased in 61 of those years. In only three years did the CPI fall – 1949, 1955, and 2009.

In the USA we can say that we experienced annual deflation three times since 1950.  But deflation quickly reversed itself each time. In 1951 the CPI rose by 8%.  In 1957 it was up to almost 4%. In 2011, consumer prices rose by more than 3%. In 1949 I was approximately three feet tall and was cute as the dickens.

Now we know what deflation is. It is pretty rare though as the WSJ said, some countries have caught the disease. I am looking at a set of CPI figures and forecasts done by the OECD  (http://www.oecd.org/eco/outlook/economicoutlookannextables.htm ) for 32 countries from 2000 to 2015.

·        Between 2000 and 2008, only one country had one year of deflation (Israel in 2004).
·        Six countries had deflation during one year in the financial crisis (2009).
·        Japan encountered deflation or near deflation from 2000 to 2013. Only in 2008 was the inflation as high as 1.4%.
·        With respect to OCED forecasts we find deflation or near deflation for all three years from 2013 to 2015 in four countries: Greece, Ireland, Portugal, and Switzerland

Deflation is a real thing – yes. But it clearly shows no generalized global or macroeconomic patterns. Except for Japan it seems to come and go. The largest financial economic collapse saw deflation in only 6 countries in 2009. By 2011 Japan was the only country continuing to experience deflation. By 2011, 22 of the 32 countries had inflation rates of at least 3%. If deflation is a monster it does not appear to be trying to permanently take over whole neighborhoods, except in Japan. Is Japan where we are all headed? Or is Japan a special case? Read on.

Deflation is when the price level of a country falls. I have shown that it seems to be in hiding most of the time and in nearly all places but has a way of coming and going here and there. So it is worth thinking about what causes it. And what is bad about it. And possibly what is good about it.

Since deflation relates to all the goods and services we buy as a nation, we think of it as we do other macroeconomic indicators – as being determined by aggregate demand and supply. When aggregate demand is very strong and rising, firms are expanding output and employment, and firms raise prices. But when aggregate demand for goods and services is weak or falling we imagine the opposite kind of macroeconomic situation where prices are rising more slowly (called disinflation) – or are falling (deflation). So you can see that aggregate demand can be very important.

But we shouldn’t forget that aggregate demand is not the only game in town. At times, aggregate supply is the driving force of the economy. When AS is rising rapidly relative to AD, this is usually a time when business productivity is rising faster than business costs. Firms can produce more and/or price more competitively. Thus a rising AS brings higher output with lower prices.  In contrast, in times when business costs are rising faster than business productivity, we find output slowing and prices rising more quickly.

Central banks that worry about weak economic growth and attribute this to weak aggregate demand, therefore, are prone to offsetting this with an aggressive expansionary monetary policy. But what if the weak growth is coming from the supply side? What if structural problems and regulatory haze makes firms reluctant to invest and expand and weakness is attributable to supply rather than demand factors? Treating a supply problem with a demand remedy would be a mistake. It might prevent deflation but it might aggravate the supply problems.

Beyond choosing the correct remedial policy another challenge of deflation is the basic premise that deflation is bad for a country and needs a remedy. The data suggests that except for Japan, recent history finds deflation to be here today and gone tomorrow. Treating deflation with a national policy is a little like putting a cast on a stubbed toe. By the time you get the doctor’s appointment that toe is already feeling better.

And what is so bad about bouts of deflation? The standard story goes something like this. Deflation makes it harder for government to pay off debts. Deflation may also make some people more willing to wait to buy goods – buying them in the future when prices are lower. As people wait to buy the economy gets weaker and people lose confidence. Dismal expectations make the economy that much weaker.

That’s a pretty scary monster story and it seems to be relevant for Japan – and so we might take notice. But the data suggests that such deflations are few and far between. Are we really on the way to such a horrible set of outcomes? I doubt it and for reasons that are standard yet not often-enough discussed. Consider a few positive implications of deflation. As the price level in a country declines, its goods are cheaper. A standard demand curve suggests that lower prices stimulate spending. Lower inflation relative to competing nations indicates an international competitiveness that also should help improve the nation’s economy and trade balance. Lower inflation often brings lower interest rates and exchange rates which boost spending. Finally, if deflation is being caused by an expansion of aggregate supply then it is reflective of a stronger economy – not a weaker one.

There might be a monster outside our global window. That would be scary. But there might not be such a monster. Deflation is not always the sign of things going wrong. Deflation is often temporary. And deflation often has as many good as bad impacts on us. The ECB and the US Fed ought to be considering some of these things before they set their canons on a beast that doesn’t exist.

Tuesday, June 3, 2014

Hiccup or Real Concern -- April's Drop in Real Consumer Spending

The BEA (www.bea.gov ) published April’s Real Consumer Expenditure (RPCE) with a press release heading that read “Real Consumer Spending Falls in April.” Following this announcement I saw quite a few reactions. Most of them lamented the 0.3% April decrease and worried loudly that the general slowdown experienced in the first quarter might continue into 2014. The Wall Street Journal on May 31 wondered if economists’ projections might be too rosy for the coming year.

Note: This paragraph has changed thanks to an alert reader Danny finding an error in a calculation. See my comment below for more information. The newest data releases contain valuable information. They always do. They are news. But it is safe to say that one month’s spending data can also be highly misleading. For example, while April’s RPCE did fall by .3% it is also true that RPCE rose by .5% in February and .8% in March. If you average over these three months you get an average monthly gain of approximately 0.33%. Dig a little farther. These data are presented in real terms and are one-month growth rates. They have not been annualized. A 0.33% average annual compounded real spending gain amounts to almost 5% per year. If the three month Feb to April annual average gain were to keep up for the rest of the year – RPCE would increase by about 5% more than the inflation rate. That would be a pretty good year. I am not saying that growth rate will keep up. But if you get away from one month and take a longer look at what happened in the last three months – you get torrid growth in consumer spending.

While pessimists have focused on various disappointments in wages, this BEA report for April contained more hopeful information about personal income (PI) change. During the three months from Feb to April, PI rose an average of .4% per month. Removing consumer inflation and taxes you get real Disposable PI rising just shy of 0.3% per month. If you annualize that you get about 4% per year. While not spectacular, a 4% growth in real DPI means households were earning a lot more than inflation and taxes – with room left to spend and save to the tune of 4% more per year. I should also note that the personal saving rate averaged about 4% during those three months.

Monthly data is crazy. Suppose…

·        After a successful 10 month diet where you lost 40 pounds, you gained a pound yesterday.
·        After 22 miles into a marathon run, you averaged a slower pace over the last half mile.
·        After 45 years of marriage your faithful spouse was late for dinner last night
·        After winning 90 percent of their games your favorite sports team is behind its opponent at halftime.
·        After eating seven chili dogs your burp.

Okay, so I had a few JDs. But you get the point. The last observation is only the latest one. It might be a wonderful indicator of what is to come next. Maybe you will gain another 39 pounds. Maybe you will not go on to eat 12 chili dogs and not get your name on a plaque at the Corner Bar in Rockford Michigan. But then again, maybe the last observation is an aberration.

Monthly data bounces around. Stuff that usually happens in April this year might have been done late in May because of holidays, or weather, or because someone forgot! This is why we usually do not make too much out of last month and often either wait and see – or we combine last month with a longer stream of information to get a broader picture. When we do this with BEA’s spending, income, and saving data we get a pretty positive picture.

I am betting on momentum. Look at all the housing and stock market wealth that has been created in the last year. And while much of it went to high income people, a lot of it went to elderly and other people whose income depends on housing and stock prices. Employment gains have been slow but cumulative with a 2.3 million increase in workers on nonfarm payrolls in the past year. Note that while real GDP did contract in 2014 Q1, real consumer spending was up by 3.1% at an annual rate in that otherwise dubious quarter. The down quarter in real GDP came after four quarters with rates of 1.1%, 2.5%, 4.1% and 2.6%.

Betting on momentum and inertia does not translate into a record growth rate for 2014. But it does suggest a year in which overall real GDP and consumer spending will continue to gather steam and grow.  Analysts had fun getting all pessimistic about April’s consumer spending decline. But I doubt it is anything more than a little hiccup in an ongoing and fretful economic expansion.