The sailor got his pass to go ashore. He made a bee-line straight for the red-light district in the port city. He rapped on the door in the code he knew well. The door opened and the Madam stood in the gap.
"No! You come here every night and never pay. Your tab is to big." says the Madam.
The sailor walks away. He tries a few more houses of ill-repute but the same thing happens at them all. Indeed, the sailor owed the bordellos more than he made in a year at sea.
The US Central Government got the same welcome by it's creditors Friday evening. The S&P told our government that we owe too much, spend too much and it doesn't make enough to cover the bills. In other words we are overdrawn.
It does not come to any real surprise to more than a few of us in the USA. As people feel the heat of the hellish economy they try to get loans to cover the costs of life till things pick back up, only to be rebuked by the bank manager who tells them that their income does not cover the debt they already have and the loan cannot be approved.
The difference between Americans and their government is that Americans cut back on their spending, reduce their bills as much as possible and sacrifice all they can to make ends meet; the government thinks that in hard times it can spend ramp up the spending. Does not sound smart, and indeed I agree.
If you were wondering why some politicians think they can spend themselves into a hole to create wealth I will explain the theory as it was explained to me in my macro-economics course.
A nation's productivity is measured as the value of all the final goods and services Consumed within it's borders, all the capital Investment, what the Government spends, and the value of the Net Exports (what is exported MINUS what is imported) in a given year. This is the GDP. It is expressed in the equation Y=C+I+G+Nx. Notice the G for government spending increases the GDP for the year. So far their theory looks good, but wait! In order for the government to get money to spend it must do one of two things: 1- Tax something; or 2- Borrow the funds. (Y is the variable used for GDP and for expendable personal income)
If the government imposes a tax to raise the funds then it takes away the available funds from Consumers that they use to buy stuff. If the government raises income taxes it directly decreases the income of the Consumer. If government raises taxes on the goods or services, it decreases the purchasing power of the Consumer (the increase in prices reduces the amount you can buy if your paycheck remains the same). This is expressed in the macro-economic equation of Y(income) = I+T-G. This means that your total income is the money your gross earnings (paycheck or income from investments) PLUS whatever the government gives to you in transfer payments (earned income credits, welfare checks, food stamps etc..) MINUS what the government takes from you. 55% of wage earners paid taxes last year, a vast majority of them in the middle and upper income levels. As their wages are relatively high they do not qualify for government assistance payments so taxes hit them the hardest (T is less than G). The other 45% of wage earners are low wage earners who do not meet the minimum income level to pay taxes. They qualify for most assistance programs so taxes barely touch them and they benefit the most from transfer payments (T is greater than G). Then there are those who do not earn a wage yet still receive transfer payments.
In micro-economics, a decline in income has a few negative effects. The first effect is on demand. Demand is the relationship between the price of something and the amount you are willing to pay for that price. Expressed in a graph, this is a downward sloping line from left to right. When income decreases, both the price your are willing to pay and the amount you are willing to buy go down. This is a shift in that graph line tot he left, and is called a decrease in demand. Another negative effect in lower incomes is the switch from normal goods to inferior goods. In other words, when your income is normal you would grab the name brand gourmet spaghetti noodles, but when your income is decreased you search out the Ramon Noodles.
If the tax is collected during production of the goods or service (or at the point of purchase) the cost of production to suppliers increases. That means prices increase. If prices increase, the amount of goods or services the same amount of money in your paycheck will not buy as much. An expected increase in prices causes the Demand for goods to increase BEFORE the increase occurs, then a decrease in demand for those same goods and services AFTER the price increase. If the price of your favorite coffee is going to increase tomorrow you will buy more than usual today (stock up) then search for a cheaper option (either another brand or a smaller amount) once the prices rise. Then the same switch from normal to inferior goods occur.
Both methods of taxation have the same effect on firms. Firms see the shift in Demand downward and cut production to meet the lower Quantity Demanded. Firms do not like to produce a surplus of goods that wont sell. It wastes money to produce them and the surplus inventory lowers prices. A cut in production usually means a cut in the number of employees. Firms also do not like to retain more labor than is necessary to efficiently produce the market demand. This causes a cycle of demand and supply shifting until a new equilibrium is found.
Therefore, in a bad economy when the government decides to spend it's out of the hole by digging it deeper it does not like to tax for the extra income. They prefer the second option of borrowing the funds. The problem with borrowing the money is that it only postpones the above negative effects till it is time to pay the money back.
Everyone who has borrowed money before knows that you have the choice of two payments to make every month: the minimum payment due or pay as much on the principle as possible. Smart people know you choose the latter over the former. When you pay down the principle of the loan (the core debt of the money owed plus accrued interest from previous cycles) it lowers the baseline from which interest is charged. For example: with an interest rate of 10% per month and a loan of $100, if you pay only the minimum payment (which is usually only the accumulated interest and very little principle up front) you pay only $10 that month but still have $100 in debt. The next month you owe the $100 plus another $10. If you keep making the minimum payments you will pay $10 per month for the rest of your life. Like I said before minimum payments have a little chunk of principle in it. In our example then the minimum payment would be $11 per month. This would take you about 18 months or so to pay back. $11 x 18 = $198 total payments. But if you make greater than minimum payments every month, you pay off the accumulates interest PLUS much more of the principle. Let's say you pay $20 per month. The first month you pay $10 to interest and another $10 on principle. The next month interest only collects on $90 (instead of $99 with the minimum payment) and you pay $9 in interest and $11 on principle leaving $79 left on the principle. The following months are ... $7.9 interest and $67 left, $6.7 interest and $54 left, $5.4 interest and $39.5 left, $3.9 interest and $23.5 left, $2.3 interest with $5.50 left and you pay it off the next payment with $6.05. You pay it off in 8 months spending only $146. You save $52 and ten months of payments.
All that to tell you that the US government is not that smart. For the last few years they only paid on the interest of the money they borrowed. On top of the that, they continue to add to the principle by borrowing more and more each year. During the last two and half years we added an average of $1.5 Trillion to the principle of the national debt per year. This is insane to any person.
To put the insanity into perspective, we owe 99% of national GDP right now. That means if government taxed everything at a rate of 100% the nation as a whole would have a whopping $150 Billion left over. That is $483.88 for everyone in the country (man woman and child), and I did not take anything out to cover any government expense. [the numbers I used were GDP=$15Trillion; Debt=$14.85Trillion (both not too far off the actual numbers) and the US Pop= 310Million people]
The insanity goes on till you puke. But to me the most sickening thing about this whole thing is that no politician knows what to do about it. In fact, they don't even know what the problem is that they need to fix. The politicians, mostly in the GOP, all say "we need to end spending, we need fiscal responsibility." WELL NO DUH SHERLOCK!!! So they proposed a Balanced Budget Amendment to the Constitution that will probably not pass the process, as well it shouldn't. It does not solve the problem. Some politician today said they need a law to cap the annual deficit each year.... WHAT??? Most politicians are clueless.
Let's say they pass that Constitutional Amendment and that Congressional law. Let's say they are both written in blood on solid gold tablets wrapped with a silver bow then hand delivered by God Himself to the President. Without any EXTERNAL checks to enforce it, it will be ignored. In fact, most of all the Constitution is ignored today and the law is violated on a regular basis for all to see. We have had a balanced budget law in effect since 1981 and yet no balanced budgets. We have laws that making it illegal to use governments buildings to make campaign ads, yet obama films himself in the White House map room delivering a campaign ad marketing a dinner with him and biden. So my pessimism has foundation.
An oath is only as good as the word of the person who makes it. The government says "trust us, we will enforce it on ourselves...pinkey promise we will." And this is what every politician is saying. We need a law to enforce the law that we passed to enforce this other law. Sorry GOP, I don't buy it. You are either ignorant, stupid or involved in the conspiracy. You want us to think that wiping the nose will cure the cold. NOPE! I am not stupid.
The problem is not your spending, and the problem is not the borrowing. If these were problems then the Founders would forbid you to spend anything. But the Founders did prevent you from consolidating power into your hands. They put many layers of checks to prevent you from gathering power, they used layers of balances to moderate the powers you do have. Each check and balance was EXTERNAL to the national government. And even with all these external enforcers they still put in internal checks and balances on the national government. The Founders did not want you to have POWER.
The solution then is not laws that will be ignored the day they are written, but to restore the EXTERNAL checks and balances that demand you follow the law and has the power to force you to do it. Repeal the 16th, 17th and 24th Amendments to restore the states as the power check of the purse and co-equal authority. Restore the power of the vote by re-instituting voter standards so that all voters contribute to society to earn the vote and as invested voters make responsible decisions.
Just like the horny sailor in town eventually has to report to his captain on ship and account for his actions, these solutions will return accountability to government just as the captain will return discipline to his underling.
Thanks for reading this and GOD bless.
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