Saturday, August 22, 2009

Government Debt --- Double the Trouble?

The older members of the baby boom generation are 62.  Over the next 10 years, in the absence of  major tax law or benefit reductions, Medicare will go bankrupt.  Obama has finally admitted that his plan adds up to 9 Trillion Dollars of new spending!  The current debt of 7.4 Trillion, accumulated over decades, could more than double, in only 10 years, if Obama's programs are passed.  .

In the short run, excessive government spending is being offset by excessive consumer savings.  In the long run, excessive government spending will significantly reduce funding for some really neat private enterprises--the kind that make your life better.

The recession is over because GDP, which is an average of all economic sectors, is growing perhaps at 3.5% or better; weak sectors are recovering and strong sectors are booming.  Capital is rapidly moving from "old business sectors" to "new business sectors".  Instead of building thousands of 5,000 square feet million dollar mansions, America is building multi-billion dollar communications networks, nano-technology factories, and health care research facilities.  The computer network components include millions of hand held computer-phones, billions of down-loaded software programs and all the supporting equipment and facilities.  The production of nano products and genetically based health care products is growing extremely fast from a small base.  All three sectors will ultimately change the way you live.  Indeed, the health care advances will change how long you live.  

To produce these benefits, the market place needs very large amounts of capital.  If the demand for trillions of of dollars of business capital has a head-on collision with Obama's demand for 9 trillion dollars of new government spending, we will likely suffer from a bad case of crowding out.  The failure of the congress to pass very expensive cap and trade legislation and very expensive health care legislation gives me hope.

Rose Friedman died last week.  She and her deceased husband Milton were champions of freedom.  They understood that the political allocation of resources starts with good intentions, but ends in massive waste.   Power corrupts so there will always be the occasional extra purchase of a few 220 billion dollar fighter jets or a few of the $900 toilet seats.  Voters must eliminate as much wasteful pork spending as possible.  

One modern myth is that America is no longer producing goods.  The reality is that we are producing more goods than ever before but doing it ever more efficiently.  The number of American's who work in manufacturing is below 9% for the first time in a 100 years or more.

TV talking heads and stock market gurus beat the drum of economic boom and bust as the consequence of boom and bust in consumer spending.  They tend to make far too much of the fact that 70% of government reported spending is done by consumers.  They don't know, have forgotten or they ignore fundamental laws of economics.  Long ago, economist understood that investment cycles are capital spending cycles.  In regard to consumption, they discount the fact that production creates its own demand!  Say's law, "A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value." (Wikipedia), tells us that the many people who are making money writing software applications for dozens of new products, will spend those dollars on other goods and services.  

A few years ago, the truth of Say's law was admiringly called supply-side economics, mostly by republicans in office, and it was denigrated as trickle-down economics, mostly by democrats seeking office.  Obama's policies are geared to create production by stimulating demand.  The problem is that such tactics are nothing more than a game of robbing Peter to pay Paul.  While I can't blame consumers for accepting some portion of the $4,500 clunker gift from taxpayers, the result in the short run is the purchase of too many cars at the expense of other items.  The most successful software engineers are doing quite well because software is leaping off the shelf with very little money being spent on distribution, but they could be selling more.    

Most people have the view of "what's the harm in subsidizing cars, instead of other products, such as software"?  Rose and Milton Friedman understood the ramifications.  In this instance, Obama's policy makes it less expensive to drive and thus causes more miles to be driven, more gasoline and oil to be consumed and more carbon dioxide to be produced.  Indeed, some of the money that has been spent on new cars would have been spent on new Internet connected phone plans with programs designed to reduce the number of miles driven.  

I am in full agreement with Rose and Milton Friedman in regard to the "government deficit trouble".  I am not greatly concerned about the size of the deficit except for the mis-allocation of resources.  As far as the fear of hyper-inflation, I don't think it matters if our government is responsible for 3 trillion of 16 trillion in spending or if it is responsible for 4 trillion of 16.  As Rose and Milton taught us, inflation is actually a monetary phenomenon, not a fiscal problem.  

The Lord certainly knows that, during the early days of economic crisis, our government "back doored" our banks by severely limiting the liquidity available at banks.  Our government imposed the same draconian "vacuum cleaner" accounting rules that killed scores of banks during the great depression.  After the crisis was in full steam ahead mode, our central bankers then brought in truck loads of "new money" through the banks front doors of selected banks.  The friends of high level officials were saved while the enemies were sent to the slaughter house.  

Because the Fed borrowed money from the treasury to lend to the banks, it's balance sheet shot through the roof;  many pundits saw the rise and were convinced that a great hyper inflation is coming.  (We recently saw one of the greatest inflation rate declines in history.)  If you take a look at total bank loans and leases, you will see that the "normal" pattern is playing out.  Total lending growth is nil because the average investor has been misled into believing that now is the time to pay-down debt.  The reality is that there has never been a much better opportunity to pick up leveraged assets such as real estate.  

I admit that I missed the timing of the recession.  I knew something big was cooking but I expected the big cards to be played after the election.  There is no point to crying over spilled milk, however, understanding where we are in the business cycle grants us great opportunity.  Since the stock market has run-up 55% from the March bottom, it makes sense to be a little cautious but for the aggressive investor, I'm talking about 95% exposure to stocks with 5% in cash.  Margin investors should have cash to add on dips.  

So, government spending need not be more wasteful than individual spending or corporate spending but the bigger the entity the bigger the mistakes.  Under these circumstances, we would do well to severely limit the size of government.  But!  The odds of massive takeover has fallen and each time the odds fall the higher the market goes.  An extraordinary business investment cycle is already underway!  Huge and unknown profits and benefits are going to be realized from investments made.