What is it like to be German today?

First it was Greece and now Ireland. Who’s next? On Sunday the European Union (EU) agreed to give $89.4 billion in bailout loans to Ireland to help it weather the storm created by its massive banking crisis. Two of the 16 euro-zone nations have now sought financial support from the EU and the International Monetary Fund (IMF). Portugal and Spain are rumored to be next on the list of countries needing financial assistance. Germany has reluctantly supported the bailouts so far. The question is: Will they continue to offer their support if Portugal and Spain need a bailout too?


Germany is in a decent fiscal position today compared to the rest of the euro-zone with a Debt to GDP ratio of about 63%. Reference www.visualeconomics.com/gdp-vs-national-debt-by-country/ Germany has been proactive with their fiscal responsibility. They have a very hardworking culture and several years ago increased their “normal” retirement age from 65 to 67 to compensate for a rapidly ageing population that is living longer. However, in neighboring France a recent plan to raise the official retirement age from 60 to 62 provoked massive protests and outcry. Could the European Union shrink from 16 nations to something smaller so that Germany doesn’t have to continue supporting the bailouts of weaker countries like Greece and Ireland? At what point does the market start to demand higher interest rates on Germany’s debt because of the sins of their neighbors?

Certainly additional fiscal tightening is needed across the region. Tax increases are also likely to occur. Fiscal austerity is a must but does it threaten the structure of the EU or push the euro-zone back into Recession? Expect the financial problems of Europe to play out over a number of years and keep an eye on Germany as the key opinion in terms of both future bailouts and any eventual changes in the makeup of the European Union.

Public-Employee Union is Biggest U.S. Election Outside Spender

One can't help but notice that on the heels of the U.K. announcing significant public-sector job cuts in an effort to balance their budget, in the U.S. the biggest outside spender for the 2010 elections is the American Federation of State, County and Municipal Employees (AFSCME).  Given an early 2010 Supreme Court decision that permits corporations and unions to use their own funds to pay for political ads, AFSCME is directing $87.5 million to help elect Democrats and presumably protect public sector jobs.

AFSCME's membership has grown 25% in the last decade, the Wall Street Journal reports http://tinyurl.com/284zude.  As government spending at all levels comes into the cross-hairs of those determined to reduce deficits, it is astounding to see the open effort by AFSCME to elect those who they will then turn to and ask for job protection.  Here's hoping the election winners are the candidates who will most honestly approach our budget deficit issues at the local, state and national levels!

U.K. Government Planning Significant Cuts

The U.S. should sit up and take notice at the significant cuts planned by the U.K. government http://tinyurl.com/26lpupc.  As many as 500,000 public sector jobs will be cut, although it is worth noting the U.K. presently has 6 million government jobs in a country with 62 million population, while the U.S. has about 2 million government jobs and 300 million population.

Still, the U.K. is taking the route of trusting that significantly shrinking the public sector will permit the private sector to flourish.  Maybe after the November elections some in political leadership will have the courage to follow a similar theme in the U.S. while we still have time to do more measured cuts and before we are backed into the same drastic cuts corner where the U.K. now finds themselves!

Austerity

Two small articles in today's Wall Street Journal addressing deficit reducing steps by countries outside the U.S. are eye-catching. 

French workers are trying to organize open-ended strikes to protest President Nicholas Sarkozy's plans for raising the retirement age from 60 to 62.  The strike may not be taking hold as the state-run railway SNCF said Tuesday saw 40% of workers on strike and then Wednesday this number was down to about 25%.

In the U.K. plans were announced to cut 192 government agencies (out of 901 agencies reviewed), while another 118 agencies will be consolidated down to 57.  The U.K. government goal is $815 million of annual savings from such cuts.  Interestingly, comments from the U.K.'s largest union, Unite, protested the cuts.

It would seem that the global winners will be those countries, states, and municipalities (and for that matter, corporations) that can most quickly and effectively identify and implement appropriate austerity moves.

Los Angeles area city is example of outrageous public spending

On Thursday July 23, the city of Bell, California (population 37,000) accepted the resignations of three top officials due to public outcry over their high salaries.  The city manager salary was the highest at  $787,000 annually, the police chief at $457,000 per year and the assistant city manager at $376,000 per year (see article at http://tinyurl.com/27deo2k).

The debate at all levels of government over how to control spending is beginning to pick up as taxpayers are struggling with their personal finances.  There is also much discussion over what to do with income taxes and other taxes on the revenue side of the equation.  One wonders how many situations of excessive government spending exist across our country like in Bell, California.  Taking steps to control spending first would certainly make any revenue increases easier to accept for those who work hard, earn good incomes and create investment and wealth.

Portugal debt downgrade-- more lessons for the U.S.

The ratings service Fitch downgraded the government debt of Portugal from AA to AA- given concern over the level of debt and a budget deficit that last year was 9.3% of GDP.  This left the 10-year bonds of Portugal trading at a yield of about 1.25% over the benchmark German bund.

In response today the Portugal parliament (led by the left-leaning Socialist party) passed a resolution of support for an austerity program that includes welfare benefit cuts, reduction in military spending and government employee pay freezes.  The goal of the austerity program is to reduce the deficit to under 3% of GDP.

These significant steps by Portugal are what must happen when the market loses confidence in your country's debt.  We should not overstate the magnitude of this issue, since Portugal has a GDP of about $230 billion making it about the same size economy as our own Indiana.  The lesson we hope Washington leaders would learn:  don't wait to behave in a fiscally responsible fashion until the market forces it upon you.

Record % of Americans pay Zero Taxes

The percentage of Americans that paid no income tax in 2008 rose to 34% according to a recent study by the conservative think-tank Heritage Foundation.  For comparison, in 1963 the percentage of Americans paying no tax was 16%.  The study is the annual update of the "Index of Dependence on Government" and can be found at http://tiny.cc/Lvavq. 

As the U.S. Congress come closer to passing dramatic new healthcare legislation that will further increase government benefits, we must ask ourselves;  How Much can the Productive Sector of Society Support?  We have record levels of future projected U.S. budget deficits and record levels of population percentage living off of the government.  It would seem that at some point we need entitlement cut, not expansion.  As the percentage of people who would get hurt by entitlement cut grows, the political math to actually have such cuts gets more challenging. 

p.s.  Some have asked who writes this Blog.  All entries on ths Blog are written by the professionals at Payne Wealth Partners and are part of our way to share our thinking with clients, prospective clients, and other interested parties.

Public sector spending- eventually this must come down

We can expect that the concern over public sector spending will continue to escalate, as more attention turns to budget concerns at federal, state and local levels.  A few facts help to put this spending in perspective:  (1) average wages in state and local governement at $26.24 per hour are well in excess of their private sector counterparts at $19.45 /hour (include benefits and this advantage becomes $39.60/hr versus $27.52);  (2) much of the public sector advantage comes from more generous health and retirement benefits, much of which is unfunded;  (3) many public sector employees (particularly those in public safety) can retire with full benefits after 20 or 25 years of service (it is said that 1/4 of New York City police retirees are under the age of 50).

The average citizen can expect that his own retirement benefits under Social Security will continue to be pushed out (already age 66 is full benefit age for average baby boomer), and his medicare benefits may be cut/taxed or otherwise reduced.  Expect the generous public sector benefit packages to generate more scrutiny as budget pressures rise.  Also, head counts in all levels of public sector employment will likely be under pressure as demands increase for less costly government.  The efficiencies and cost cutting that the private sector has been forced to incorporate must begin to find their way into the public sector in order to get budget deficits to come down.

Greece austerity package introduced- what can the U.S. learn?

Even though the U.S. controls its own currency (see post of February 24) there is still much we can learn from the Greece situation.  Note that Greece had a 2009 budget deficit equal to about 13% of its GDP while the U.S. had a fiscal 2009 budget deficit equal to about the same percentage of its GDP.  Of course the U.S. GDP is about $14 trillion (largest in the world) while Greece GDP is about $360 billion (smaller than 12 of our states and about equal to Massachusetts).

What Greece did was to sweep its budget deficit problems under the rug with creative accounting and political dealmaking (sound familiar to what we see today in the U.S?).  For years the Greece socialist government overspent on items such as their very generous public pension and high public sector (union) wages (again, sound familiar?).

So now Greece has to invoke a pretty severe austerity program to prove to Germany and others (who will bail them out) that they can get their deficits under control.  Today Greece announced cuts of about 12% in civil service entitlements and about a 2% increase in their value-added tax (from 19% to 21%).  Expect strikes and other protests from those affected, but Greece really has no choice.

The U.S. should learn that the longer a country waits to get its fiscal house in order, the more dramatic the eventual action will be.

Majority of labor union membership now works in public sector

According to a study released by the Heritage Foundation 52% of all labor union members worked for the government (http://tinyurl.com/ygunb4g).  To get an idea of how much this has changed over the past several decades, in 1973 only 17% of union membership was employed in the public sector (of course the other 83% were employed in the private sector).

Another interesting statistic is that the portion of American workforce belonging to unions has dropped from 23% in 1980 to 12.3% in 2009.  Looking into that statisic more deeply reveals that in 2009 the percentage of private sector employees in the union was at 7.2%, while the union percentage of government workers in 2009 was 37.4%.

As government at all levels is forced to cut spending to reduce budget deficits, look for plenty of conflict with the unions representing public sector employees.  The unions have already worked hard to oppose legislation for spending cuts in many states including California and Illinois (two states in real fiscal trouble).  Also, look for the unions to continue their heavy contributions to influence political decision making at every level.

U.S. Budget- Deficits as far as the eye can see

This week President Obama submitted to Congress his budget proposal for fiscal 2011 (ends September 30, 2011) through 2020.  Deficits for the 10 years average $853 billion (4.5% when expressed as a percentage of Gross Domestic Product- GDP).  U.S. national debt held by the public (meaning doesn't count debt held by other U.S. government agencies) as a percentage of GDP is projected to rise from 53% at the end of fiscal 2009  to 77% by 2020.  A web site has been established with all budget related information at http://www.gpoaccess.gov/usbudget/.

The ratio of debt to GDP is a big deal because those who buy our debt use this as a measure of risk in setting interest rates for such debt.  History is instructive here.  In 1960 debt was 46% of GDP, after declining from a high of 109% in 1946 from costs of financing WWII.  This decline continued to a low debt to GDP of 24% in 1974.  As recently as 2001 debt to GDP was 33%.  A rise to 77% in 2020 would make us a much bigger lending risk and would certainly drive interest rates higher.

The economic assumptions in the budget proposal reflect assumed 10-year Treasury interest rates (which are presently about 3.6%) averaging 4.5% in fiscal 2011 and then rising to a maximum of 5.3% over the balance of the time to 2020.  Actual interest rates could be much higher than these projections in a world where large budget deficits continue.  Higher interest rates would make reducing the budget deficit even more challenging.

No political leader of either party has put forth credible ideas of how to deal with this problem.  It takes political courage and the ability to voice why shared sacrifice now will protect future generations.  We can only hope some true leaders will step forward with some real solutions.  The longer we wait the harder the ultimate fix will be on everybody.

U.S. Budget Deficits affect everything (including war)

Tonight President Obama will present the latest planned changes in the Afghanistan war strategy in a speech to be given at the U.S. Military Academy at West Point.  There will likely be few surprises in the speech as the contents have been widely published already, including an increased 30,000 additional troops.  Today's Wall Street Journal contains an interesting article http://tiny.cc/vVaR1 on the economics of such troop additions.

A few numbers according to the article:

• $1,000,000-  annual cost per soldier in Afghan theater (White House estimate)
• $500,000-  annual cost per soldier in Afghan theater (Pentagon estimate)
• $400 per gallon-  cost of fuel when delivered to certain Afghanistan locations
• $1 per gallon-  cost of same fuel in the United States
• $30 billion-  annual cost of 30,000 additional soldiers (per White House)
• $3.6 billion-  present monthly cost of U.S. military deployment in Afghanistan
• $65 billion and $61 billion-  Afghanistan and Iraq, respectively, Pentagon budget requests for fiscal year ending September 2010 (prior to tonight's announced troop additions) 

Expect these costs and the affect they will have on the already outsized U.S. budget deficit to be front and center in the debate over the U.S. strategy in Afghanistan.

Former Treasury official's prescription for deficit reduction

Former deputy US Treasury secretary Roger Altman wrote an opinion article published in the Financial Times this weekend (http://tiny.cc/omEn6) in which he expressed significant concern over the level of budget deficits and their effect on interest rates and the US dollar.  Mr. Altman points out that the continued budget deficits over the next 10 years would result in the Treasury having to borrow $4 trillion annually and asks the question "does anyone think that once recovery takes hold and private demand for capital strengthens, the Treasury will raise $4 trillion per year at below 4 per cent, as it is doing today?"

Altman sees the potential for rising inflation, rising interest rates and significant decline in the value of the dollar unless something is done to get the US budget deficit under control.  His proposal-- legislation creating a bipartisan deficit reduction group of administration and congressional leaders who will study the possible solutions for cutting spending and raising revenues and make recommendations by December 31, 2010 that are then submitted to Congress for an up or down vote.

We can hope our leaders will do something like Mr. Altman has proposed and we can also hedge against the rising inflation, higher interest rates and weaker dollar in the event they don't.