Government as Usual, Making a Bad Financial Situation Worse

Posted by PITHOCRATES - June 8th, 2011

The Federal Debt is Bad; what we’re Adding is Worse than can be Imagined

If you thought the debt was bad, you ain’t seen nothing yet (see U.S. funding for future promises lags by trillions by Dennis Cauchon posted 6/7/2011 on USA Today).

The government added $5.3 trillion in new financial obligations in 2010, largely for retirement programs such as Medicare and Social Security. That brings to a record $61.6 trillion the total of financial promises not paid for.

This gap between spending commitments and revenue last year equals more than one-third of the nation’s gross domestic product.

The current outstanding U.S. debt is $14 trillion and change.  So, in addition to that debt, the U.S. has to borrow an additional $61.6 trillion sometime in the future.  Meanwhile they debate deficit reduction in Washington.  And the Obama administration is desperately trying to get the Republican-controlled House to raise the legal debt ceiling.  By a whopping $2.4 trillion.  You don’t have to be a whiz kid to see that something bad financially is coming this way.

Medicare alone took on $1.8 trillion in new liabilities, more than the record deficit prompting heated debate between Congress and the White House over lifting the debt ceiling.

Social Security added $1.4 trillion in obligations, partly reflecting longer life expectancies. Federal and military retirement programs added more to the financial hole, too.

It’s those social democracy things.  The same things that are bankrupting countries in the European Union.  Free health care.  And free pensions (with everyone living longer people are collecting far, far more than they ever paid into these programs).  Which just goes to show that free things are very expensive.

The $61.6 trillion in unfunded obligations amounts to $527,000 per household. That’s more than five times what Americans have borrowed for everything else — mortgages, car loans and other debt. It reflects the challenge as the number of retirees soars over the next 20 years and seniors try to collect on those spending promises.

Imagine yourself living as you are.  Working hard to pay your bills (mortgages, car loans and other debt).  And then adding another mortgage to the mix for a magnificent half-million dollar home.  Only without the home.  Just the mortgage payments.  If you’re not good at imagining that’s okay.  Because you’ll be living it within 20 years.  Can it get worse?

The government has promised pension and health benefits worth more than $700,000 per retired civil servant. The pension fund’s key asset: federal IOUs.

Why, yes.  It can.  While you struggle to pay these enormous bills you can think about this.  Your civil servants.  The people that work for you.  They will be making about $173,000 more in retirement than you.  Their boss.  That ought to put a smile on your face.  And a skip in your step.

Here Comes National Health Care

And it’s going to get worse.  Because national health care is coming (see Study Sees Cuts to Health Plans by Janet Adamy posted 6/8/2011 on The Wall Street Journal).

A report by McKinsey & Co. has found that 30% of employers are likely to stop offering workers health insurance after the bulk of the Obama administration’s health overhaul takes effect in 2014.

The findings come as a growing number of employers are seeking waivers from an early provision in the overhaul that requires them to enrich their benefits this year. At the end of April, the administration had granted 1,372 employers, unions and insurance companies one-year exemptions from the law’s requirement that they not cap annual benefit payouts below $750,000 per person a year.

But the law doesn’t allow for such waivers starting in 2014, leaving all those entities—and other employers whose plans don’t meet a slate of new requirements—to change their offerings or drop coverage.

Bill Clinton lost the 1994 midterm election because he campaigned as a moderate and governed as a liberal.  With Hillarycare being the poster child of his liberal agenda.  Barack Obama lost the 2010 midterm election because he campaigned as a moderate and governed as a liberal.  With Obamacare being the poster child of his liberal agenda.  The people spoke.  Then.  And now.  They don’t want national health care.  That’s why Hillarycare failed.  And why they watered Obamacare down to be something short of national health care.  But Obamacare will serve its purpose.  It will kill the private health insurance market.  Setting the stage once and for all for national health care in the United States.

In surveying 1,300 employers earlier this year, McKinsey found that 30% said they would “definitely or probably” stop offering employer coverage in the years after 2014. That figure increased to more than 50% among employers with a high awareness of the overhaul law.

The Obamacare legislation was something like a thousand pages long.  Guaranteed to confuse.  In fact, it was so confusing that Democrats voted for it without reading it.  Republicans read as much of it as they could.  And because they saw what was in it they voted against it.  Those who take the time to read it don’t like it.  Including the 50% of employers surveyed.

The nonpartisan Congressional Budget Office, in a March 2010 report, found that by 2019, about six million to seven million people who otherwise would have had access to coverage through their job won’t have it owing to the new law. That estimate represents about 4% of the roughly 160 million people projected to have employment-based coverage in 2019.

So let’s crunch some numbers.  Private insurers can’t cap benefits below $750,000 per person per year.  Some 6-7 million people will lose their insurance because of Obamacare.  So if the government has to pick up the costs for half of the lower amount (3 million) of these people consuming $750,000 each that comes to…$2.25 trillion.  That’s a lot.  Now let’s say the 160 million who have employment-based coverage lose it.  And that half of them need $750,000 in benefits.  That comes to…$60 trillion.  How about that?  That’s about the same as the amount of the government’s unfunded financial liabilities. 

So, in addition to the $14 trillion or so in debt, there may be another $120 trillion that we’ll have to borrow.  And that’s a little more than the $2.4 trillion the Obama administration is desperately trying to get the House to approve.  And warn about dire consequences if the Republicans refuse to do so.  This reminds me of that scene in Jaws where Chief Brody was throwing out that chum to attract the shark.  It worked.  The shark appeared.  Only it was a lot bigger than Brody thought it’d be.  He told Captain Quint, “You’re gonna need a bigger boat.”  Because fighting a $120 trillion debt with a $2.4 trillion dingy is going to lose the battle.  And by ‘lose the battle’ I mean the United States will end up like Greece.  Only without anyone big enough to bail her out.

OPEC not increasing Oil Production, no Help for Depressed Economies

That’s some pretty doleful news.  Maybe there’s a white knight rushing to the rescue.  Perhaps the economy will rebound and go gang busters.  Maybe the United States will grow itself out of this debt sinkhole (see OPEC Keeps Lid on Oil Production Targets by The Associated Press posted 6/8/2011 posted on The New York Times).

OPEC decided on Wednesday to maintain its crude oil output levels and meet again within three months to discuss a possible production increase.

The decision was unexpected and reflected unusual tensions in an organization that usually works by consensus.

Saudi Arabia and other influential oil-producing nations had pushed to increase production ceilings to calm markets and ease concerns that crude was overpriced for consumer nations struggling with their economies.

To quote a line from Planes, Trains and Automobiles, they have a better chance of playing pickup sticks with their butt cheeks.  The moratorium on oil drilling in the Gulf of Mexico put pressure on supply.  Then the unrest in the Middle East and North Africa added more.  The recession had kept oil down for the last year or so.  But with supply being squeezed that wasn’t going to last.  It’s back up.  With an assist from Ben Bernanke.  Whose quantitative easing devalued the dollar and sparked some inflation.  For we buy and sell the world’s oil in U.S. dollars.  So consumer prices are up.  While high unemployment and flat wages continue to make life hard for the American consumer.

Those opposed were led by Iran, the second-strongest producer within the Organization of the Petroleum Exporting Countries…

Iran and Venezuela came to the meeting opposing any move to increase output, which would have probably lowered prices for benchmark crude from the present levels of around $100 a barrel.

But OPEC powerhouse Saudi Arabia, which favors prices of around $80 a barrel, wanted higher production levels — and served notice that it was prepared to raise production unilaterally, to close to 10 million barrels a day from its present daily production of about 8.7 million barrels.

How about that?  Our enemies want to keep the price of oil up.  While our friends want to bring it back down to $80 per barrel.  Yet the Obama administration demanded that Mubarak step down from power in Egypt (a move the Saudis did not like as Egypt was anti-Iran and kept a lid on radical Islam like the Muslim Brotherhood) while doing nothing to help the democracy movement in Iran.  And Obama himself has a close and personal relationship with the Venezuelan dictator.  Hugo Chavez.

Policies like these will do little to bring the price of oil down.  Or make the economy rebound and go gang busters.  So there’s little hope of the U.S. growing its way out of their unfunded financial obligations. 

Monetary Policy doing more Harm than Good

And it doesn’t help to have Big Government Keynesians trying to fix things (see Sizing up the Fed’s few options by Cyrus Sanati posted 6/8/2011 on CNNMoney).

At the time the Fed began its second round of quantitative easing, inflation was low, so Bernanke felt comfortable instituting a program that would see $600 billion injected into the economy. After all, how much inflation can $600 billion cause when the country has a national debt load of $14 trillion and a personal debt load of $30 trillion?

Inflation has jumped in the last three months at a much faster pace than historical averages. The consumer price index rose by 6.1% annually during the April quarter, and core CPI, which excludes food and energy, rose by 2%. Such an accelerated move in inflation would be explainable if there was strong economic growth, but that’s not the case.

Higher prices without economic growth.  We saw this in the Seventies.  Under Jimmy Carter.  His treasury secretary, Paul Volcker, raised rates to reduce inflation.  Interest rates soared.  But he tamed inflation.  And he didn’t do it with quantitative easing.  He did it by doing the exact opposite.  Bernanke could learn a lesson from Volcker.

“If you’re Bernanke and you are seeing this rapid acceleration in core inflation and a high unemployment rate, you got to be thinking to yourself, ‘Gee, my models aren’t working right,'” says Drew Matus, senior U.S. economist at UBS Investment Research. “This should cause more caution in the part of the Fed and it is this caution that will keep them from doing QE3.”

Yes.  The models don’t work.  They’ve never worked.  And never will.  Because monetary policy is not the be all and end all of economic activity.  Think of it this way.  Say there is a restaurant not doing well.  The Keynesian would help that restaurant with monetary policy.  It would lower prices on the menu.  To make the menu items cheaper (like making money cheaper to borrow from a bank).  The only problem is that this restaurant has problems.  People aren’t going there.  The food is bad, the service is poor and it’s dirty.  Lowering the menu prices isn’t going to fix those problems.  So lowering prices is not going to bring the people back.  Just as making money cheap to borrow won’t bring the consumers back to the market.

People need Disposable Income and Responsible Government

Unemployment is high.  A lot of people have no jobs.  Or disposable income.  Meanwhile, prices are going up.  Leaving even less disposable income.  Businesses aren’t going to borrow cheap money to hire people to expand production.  Because current production levels are already in excess of current demand.

People need disposable income.  Inflation is taking that money away from the people.  And two things are driving inflation.  High oil prices (demand greater than supply).  And bad monetary policy (a devalued dollar increases the price of oil and everything else).  We need to fix these things.  We need to drill.  We need to increase American production of oil.  And we need to stop printing money.  We need to do these two things ASAP.

Then we need to address the insanity of spending money we don’t have.  And stop it.  Sooner or later, we have to address entitlements.  Actually, later may no longer be an option.  With $60 trillion in unfunded liabilities in the pipeline.  And with Obamacare potentially adding another $60 trillion.  That’s just too much.  Trying to pay this will kill economic activity.  It will require more taxes, more borrowing and more printing.  Everyone of which will increase the cost of doing business or investing.  Which will ultimately kill jobs.  Giving people even less disposable income.

Benjamin Franklin warned, “When the people find that they can vote themselves money, that will herald the end of the republic.”  That’s why they designed the republic to have disinterested, responsible people between the treasury and the people.  But that was then.  When disinterested, responsible people were in government.  Perhaps not everyone, but enough to keep the republic solvent.  Today most serve themselves.  The treasury is just a tool to buy votes.  And to hell with the consequences because most of them will be dead by the time the republic ends.

So don’t expect them to do the right thing anytime soon.  Because doing the right thing will not make their lives better.  Only ours.

www.PITHOCRATES.com

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LESSONS LEARNED #20: “It is never a consumer that complains about ‘predatory’ pricing.” -Old Pithy

Posted by PITHOCRATES - July 1st, 2010

ECONOMIES OF SCALE and vertical integration can do two things very well.  Make industrialists rich.  And make the things they sell cheap. 

The more you make, the less each thing you make costs.  Businesses have fixed costs.  Big one time investments in plant and equipment.  Businesses have to recover these costs.  Each thing they sell has a portion of these fixed costs added to its price.  The more they sell, the less they need to add to each unit sold.  This is economies of scale.  Think of bulk goods.  Warehouse clubs.  Places where you can buy large quantities of things at lower unit prices.  You may buy an ‘economy pack’ of 3 bottles of shampoo shrink-wrapped together.  The purchase price of a 3-pack will be greater than the price of a single bottle of shampoo at your convenient corner drug store.  But the unit cost of each of the bottles in the 3-pack will be less.  You save more over time by buying 3 bottles at a time.  Spending more, then, means spending less.  In time.

Few of us buy raw materials.  Few have a need for crude oil.  Iron ore.  Coal.  Limestone.  Manganese.  But they make the stuff we buy.  A lot of things have to happen before those raw materials make it to us in those things we buy.  It has to be mined or drilled/pumped.  Transported.  Processed.  Stored.  Transported again.  Processed again.  Stored again.  Transported again.  There are many different stages between extracting raw materials from the earth and incorporating them into a final product we consumers buy.  At every stage there are costs.  And inefficiencies.  Which add to costs.  By reducing these costs along the way, the component materials used at the final manufacturing stage cost less.  This reduces the selling price of the final product.  This is what vertical integration does.  It puts everything from the extraction of raw materials to the incorporation of those processed materials into the final product for sale under control of the final user.  It brings in a high level of quality, cost containment and reduction of inefficiencies into the entire process resulting in a high quality, mass produced, inexpensive product.

Not everyone can do these things.  You have to live and breathe the industry you’re in.  You have to understand it intimately.  An industrialist at the top of his game can do this.  A politician can’t.  States trying to take control of their economy have failed.  Every time they’ve tried.  Why?  Politicians are ‘intellectuals’.  They’ve never run a business.  They only thought about it.  And, somehow, that gives them the moral authority to tamper in something they are simply unqualified to do.  And when they meddle, they destroy.  Purposely.  Or through unintended consequences.  In the process, though, they enrich themselves.  And their cronies.

ANDREW CARNEGIE WAS a brilliant entrepreneur.  After working for a railroad, he saw the future.  Railroads.  And he would build its rails.  And its bridges.  With his Keystone Bridge Company.  Which used steel and iron.  So he built his Union Mills.  Which needed pig iron.  So he built his Lucy blast furnace.  Which consumed raw material (iron, coke, limestone).  So he secured his own sources of raw materials. 

His Lucy blast furnace set world records, nearly doubling the weekly output of his steel competitors.  No one made more steel than Carnegie.  For less.  In about 20 years, he brought the price down for steel rails from $160/ton to $17/ton.  And got rich in the process.

Economies of scale.  Vertical integration.  And innovation.  Carnegie hired the best people he could find and used the latest technology.  Always improving.  Always cutting costs.  Always making steel more plentiful.  And cheaper.  His steel built a nation.  Dominated the industry.  And destroyed the competition.  Of course, that drew the attention of the government.  And they tried to break up the steel giant because it was unfair to the competition.  Who couldn’t sell steel as cheap as he could.

JOHN D. ROCKEFELLER was a brilliant entrepreneur.  After trying the oil drilling business, he saw the future.  The refining business.  For America lit the night with kerosene.  And he would provide that kerosene.  At prices that a poor man could afford.  And he did.  And he saved the whales in the process (his cheap kerosene put the whale oil business out of business).

Like Carnegie, cutting costs and production efficiencies consumed him.  He built his own kilns and used his own timber for fuel.  He made his own barrels from his own timber.  He used his own horse-drawn carts, boats, rail cars and pipelines.  He bought up competitors.  He grew to dominate the industry.  By far the biggest shipper, he got better shipping rates than his competitors.  And he constantly innovated.  When others were dumping the gasoline byproduct from refining kerosene into the river (no internal combustion engine yet), he was using it for fuel.  He hired the best talent available to find a use for every byproduct from the refining process, giving us everything from industrial lubricants to petroleum jelly (i.e., Vaseline).

His company, Standard Oil, was close to being a monopoly.  When they controlled 90% of the market kerosene was never cheaper.  He brought the price down from $0.26/gallon to $0.08/gallon.  And that was an outrage.  We can’t allow any one company to control 90% of the market.  Sure, consumers were doing well, but the higher-cost competitors could not stay in business selling at those low prices.  So the government broke up Standard Oil via antitrust legislation (the Sherman Act).  To protect the country from monopolistic practices.  And cheap kerosene, apparently.

BILL GATES WAS a brilliant entrepreneur in building Microsoft.  The personal computer (PC) was new.  You couldn’t do much with it in the early days unless you were pretty computer savvy.  But programs were available that made them great business tools (word processing and spreadsheet programs). 

IBM created the PC.  And they licensed it so others could make IBM-like machines.  IBM clones.  The PC industry chewed each other up.  But Gates did well.  Because all of these machines used his operating system (Microsoft’s Disk Operating System – DOS).  Apple developed the Macintosh (with a mouse and Graphical User Interface – GUI) but it was expensive.  Anyone who used one in college wanted to buy one.  Until they saw the price.  So they bought an IBM clone instead.  And when Gates came out with Windows, they were just as easy to use as the Macs.

Because of the higher volume of the IBM platform sold, Microsoft flourished.  Software was bundled.  New machines came preloaded with Windows.  And Internet Explorer.  And Windows Media Player.  You got a lot of bang for the buck going with a Windows-based PC.  And Windows dominated the market.  Consumers weren’t complaining.  Much.  Sure, there were things they did bitch about (glitches, drivers, viruses, etc.), but it sure wasn’t price.

Of course, Microsoft’s competitors were hurting.  They couldn’t sell their products if Microsoft was giving away a similar product free.  Because they were hurting their competitors, the government tried to break up the company with the Sherman Act. 

THE NORTHERN SECURITIES SUIT of 1902 found a holding company guilty of not yet committing a crime.  Teddy Roosevelt’s administration filed a Sherman antitrust suit against Northern Securities.  This was a holding company for Northern Pacific, Great Northern, and Chicago, Burlington, and Quincy Railroads.  What’s a holding company?  It replaced a trust.   Which large corporations created in response to government’s attacks on large corporations.

Small competitors feared large corporations.  They could not compete against their economies of scale and vertical integration.  The little guys couldn’t sell things as cheap as the big corporations could.  So the government intervened to protect the little guy.  So they could sell at higher prices.

But businesses grow.  All big corporations started out as little guys.  And the growing process doesn’t stop.  So the big corporations had to find other ways to grow.  They formed trusts.  Then the trust-busters busted up the trusts.  The next form was the holding company. 

The trust-busters said that the big corporations, trusts and holding companies were all trying to become monopolies.  And once they eliminated all competitors, they would raise their prices and gouge the consumers.  Northern Securities never did.  But they could.  So they were guilty.  Because they might commit a crime.  One day.

ALL BUSINESS OWNERS aren’t morally ethical and honest.  But the market is, albeit cruel.  Economies of scales will always put the little guy out of business.  Sad, yes, for the little guy.  But for every little guy put out of business, millions of consumers save money.  They can buy things for less.  Which means they have more money to buy more things.  New things.  Different things.  From new little guys who now have a chance with this new surplus of purchasing power.

But when politicians get involved, consumers lose.  When they help a competitor, they help them by keeping prices high.  To keep competition ‘fair’.  For the politically connected.

Consumers never complain about low prices.  Only competitors do.  Or their employees.  Those working on whaling ships didn’t like to see the low price of Rockefeller’s kerosene.  But the new refining industry (and its auxiliaries) created far more jobs than were lost on the whaling ships.  We call it progress.  And with it comes a better life for the many.  Even if it is at the expense of the few.

www.PITHOCRATES.com

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