Troubles Ahead For Our Economy?

by

Phil Meinhardt

What happens to our economy this year and the following years may be in areas beyond our control. Recessions in the European Union may severely affect our economy. In addition, turmoil in the Middle East and the Iranian threat may affect oil supplies/prices.

Universities teach that there are basically two ways for a government to fight recessions and stimulate economic activity. These are increased government spending, particularly investments, and lowering interest rates. President Herbert Hoover, during the Great Depression did just the opposite. He decreased government spending and raised interest rates. (Note: It is somewhat difficult to understand but expendables like bombs and ammunition do not count as investments.) Unfortunately, at the same time as the Federal government was stimulating the economy after 2008, the state and local governments were contracting their spending because of deficits primarily in the pension and medical care areas. So the overall effect on the economy was muted.

What the universities have not taught is what to do when a government cannot borrow any more money and the interest rates automatically go up with the poor credit. That is currently the state of the European Union and they are reacting by doing the same thing as Hoover--cutting spending and indirectly, at least, raising interest rates. It is not working!

Struggling euro-zone economies like Greece, Portugal, Spain, Malta, Cyprus, Ireland and Italy cannot cut their spending as a way back to growth--they are currently in recession. Demanding rigid austerity from them as the price of European support has lengthened and deepened their recessions. It has made their debts harder, not easier, to pay off.

The London Times's Landon Thomas Jr. reported this week that Portugal has met every demand from the European Union (EU) and the International Monetary Fund (IMF). It has cut wages and pensions, slashed public spending and raised taxes. Those steps have deepened its recession, making it even less able to repay its debts. When it received a bailout last May, Portugal's ratio of debt to gross domestic product was 107 percent. By next year, it is expected to rise to 118 percent. That ratio will continue to rise so long as the economy shrinks. Portugal projects a 2% shrinkage in its economy in 2012. Unemployment is 12.4%.

Similar procedures in Ireland, Spain, Greece, and Italy have so far been disastrous. England is also having tough going. Spain has an unemployment rate of 22.9%, Greece is 19.2, Ireland is 14.5% and England is 9.2%. All rates are growing monthly. Italy has just gotten started with its austerity measures and France is next.

There are 17 countries who use the Euro (Eurozone) while there are 27 countries in the European Union. Eurostat, Europe's statistics agency, reported that the European Union shrank by a quarterly rate of 0.2 percent in the second quarter of 2012. In the first quarter, output for both the Eurozone and European Union was flat. A recession is officially defined as two straight quarters of falling output. The Eurozone has an overall unemployment rate of 11.2%. Germany and France did best. Germany had a quarterly growth of 0.3%, whereas France had no change from the first quarter.

Why do we care? Because the EU is a big trading partner with China and the U.S. Their economic troubles will drag the whole world downward. European Union accounts for 25% of U.S. exports. 40% of McDonald's earnings come from Europe and General Motors sold 1.7 million cars in Europe last year. The Great Depression affected both the U.S. and Europe; unemployment rates were on the order of 25% in the U.S. and 20% in Europe.

It is a tough situation, but here is what I think should be the approach. Forgive the current debt in exchange for fundamental reform that says all future benefits must be tied to employee contributions. Employees would pay a selected amount from their wages, depending on what benefits they want, and the employer, whether private or government, would pay a matching amount. Benefits over time would be more privatized to discourage waste and fraud. Chile did just that when socialism became unsustainable during the Allende/Pinochet period and now is doing quite well economically by comparison. Chile was guided by Milton Friedman and the University of Chicago Business School. In my opinion, they went a little too far. Social Security was abolished and replaced with a 401K type system. Now, 45% of Chileans have no Social Security/pension system. The United States had a well structured Social Security Program where everyone paid into the program and the money was invested. Unfortunately, President Johnson embezzled the funds to pay for the Vietnam War. Social Security Benefits keep people from sleeping on the streets.

I must admit that I don't know all the ramifications of forgiving debt in countries like Greece, Portugal, Spain and Ireland. In its ultimate form it would be bankruptcy and restructuring. Part of the debt in Greece was forgiven in exchange for austerity measures. In any event, the current European government benefits from womb to tomb have peaked and are unsustainable, just as they were unsustainable in the old Soviet Union. To be sure, Europeans are heavily taxed in a variety of ways; that system should be reformed also. Unfortunately, it is not likely to happen. The Germans are the only ones with money and the German Finance Minister is running the show. It appears that the EU and IMF will pour good money after bad and the economic situation will only get worse. Political turmoil will likely follow.

The U.S. Federal government has reformed retirement pensions to some extent when they converted from the Civil Service Retirement System (CSRS) to the Federal Employee Retirement System (FERS) in 1984. However, the military retirement system and the US Postal Service (USPS) still provide defined benefit plans. USPS is on the verge of default. The military system is also unfair in that you get nothing if you serve less than 20 years. Military pensions and Military retiree health care threaten to overwhelm the Defense Department Budget.

For the Federal Government, the other long pole in the tent is Medicare. I have seen an unverified projection that the Medicare Deficit will amount to 42.8 Trillion over the next 12 years. Medical expenditures must be controlled and fraud reduced. Fifty-two percent of medical expenditures in the U.S. occur in the last ten weeks of life. The doctors say that they will be sued if they don't provide the procedures to prolong life as long as possible and hospitals and doctors want the revenue. A new policy might be a 'look back' for medical services to people of advanced age. Payments to doctors and hospitals could be delayed until the recipient lived ten week beyond the medical procedures. Last week, my wife visited a 71 year-old woman who was in the hospital dying of massive cancer. She had a feeding tube. Why? This week, she died. Nowhere is the idea that people respond to incentives and/or disincentives more appropriate than in medical care.

As for American states, counties and cities, pension and healthcare costs for government employees is overwhelming most and is clearly unsustainable. Wisconsin had led the way with reform. The state went from a deficit to a surplus in one year. State and local governments must in the near future stop solely funding generous retirement programs. At the state, county, and city government levels, pension and supplemental medical benefits for retired employees must be reformed from 'defined benefits' to 'defined contributions'. All government employees must start contributing at least half of their retirement funds. With matching contributions from the employers, their individual retirement programs would then pay out what they have accumulated during their working careers including what has been earned from the invested funds. Any other way is unsustainable.

For example, California has the world's eighth largest economy and an official unemployment rate of 11.1%. A recent copy of our newspaper,has a cartoon of California as the skeleton of a cow picked clean to the bones and lying in the desert. From a higher education system that was the envy of the world in the 50's, 60's, and 70's, it has deteriorated to one that is hardly funded by the state and the students can't afford. The current projected deficit is 16 billion in a 90 billion budget. Governor Gerry Brown wants to raise taxes and rarely mentions retiree pension and medical care reform.

Another example, Riverside County taxpayers must pay off a $357 million pension obligation bond the county is using to offset some of their outstanding pension debt. This fiscal year, county taxpayers will pay $192.5 million to the county employee's pension system. They have a $1.144 billion pension gap and the yearly debt has grown by 80 percent in six years. Forty-four county employees made over $100,000 in retirement in 2006--now it is up to 233. Hundreds more are retired on full salary. By 2015, the retirement bill will more than double what it was in 2006. Even with modest, recent reforms, the system is unsustainable.

The following article was in the San Diego Union Tribune, August 1, 2012: San Diego Proposition B, a voter initiative, passed overwhelmingly in June 2012. It mandates replacing pension with 401 (K) style plans for most (police excepted) new city hires and a five year freeze on pensionable pay for current workers. The unions sued, claiming the initiative was orchestrated by the Mayor's office and City Councilman Kevin Faulconer. The Mayor is retiring. So far, the initiative has been upheld by the courts.

In May, the UCLA Forecast said the U.S. would grow at 2-3% annually for foreseeable future. In the April-June quarter, growth was at an annual rate of 1.5%, but expected to be revised upward to 2%. Predictions are 2.6 percent for July-September quarter and 3.0% for last quarter, by Joel Naroff, Chief Economist of Naroff Economic Advisors. UCLA predicted 150-200,000 jobs per month; May and June did not make it, but 163,000 were added in July.

Some economists, however, notably the ones who predicted the housing bubble and collapse of 2008, are predicting doom and gloom for the intermediate future in the U.S. They say inflation will rise by end-2013, followed by interest rate hikes. They see mid-term prospects for severe wealth loss, rising inflation, rising interest rates and rising taxes. Tax revenue and spending is such that four out of every ten dollars spent by the Federal government is borrowed. The current U.S. debt is 15.9 trillion and the deficit is 1.1 trillion.

This, according to the doomsayers and common sense, must change. Another example, the Associated Press, New York, this week said that 26 firms in the U.S. paid more to their CEOs last year than they did in U.S. taxes. The U.S. corporate tax rate is one of the highest in the world at 35% but the effective tax rate is about 5% because of loopholes.

The long-term prospects look much better with our bountiful supplies of Natural Gas and recently discovered, estimated, two trillion barrels of Oil Reserves. North Dakota has full employment, Montana is doing well, and Kansas farmers are getting rich from oil leases. Canada has lots of oil too--we need that pipeline. North America has oil reserves that can allow the U.S. to achieve energy independence in a couple of decades. What is needed is an 'adult conversation', devoid of emotional politics, to develop polices that will put America back in the safe zone.