Month: September 2020

The debt bomb

Posted on by j.giglio

This year, the federal debt is on track to exceed the size of the entire U.S. economy.

The United States’ debt-to-GDP ratio rose sharply during the Great Recession of 2008-2009 and has continued to rise, reaching 106 percent in 2019. Last year, the GDP was $21.4 trillion, but it is expected to shrink this year. U.S. debt is projected to exceed about $20 trillion and is growing like kudzu.

While the subject of debt and deficits may be dishwater dull to the average American living unemployment check to unemployment check, consider that the Congressional Budget Office (CBO) has warned that the Social Security Trust Fund will run out of money by 2031. Closely related, Medicare’s hospital insurance trust fund is now on track to run out of money in 2024.

The debt-to-GDP ratio compares a country’s public debt to its gross domestic product. By comparing what a country owes with what it produces, the ratio indicates that country’s ability to pay back its debts.

Debt is eating away at the American economy like a swarm of termites invisibly consuming a house. The fiscal follies continue, with the only certainty being that the accumulated debt will be passed on to future generations and jeopardize their chance to live a prosperous life.

It may be time for Washington to consider a new financing instrument to address America’s debt bomb so future generations have a chance to enjoy greater prosperity once the pandemic is behind us. The issuance of 100-year Treasury bonds to fund ballooning deficits, with the interest income indexed to the CPI as a hedge against inflation, may be an idea whose time has come. It would give the next generation, which has to pay down the debt, a break by locking in rock-bottom interest rates. These bonds may appeal to long-term investors, such as pension funds and insurers and be used to fund infrastructure projects.

Long-term bonds are not unusual. Disney issued 100-year bonds in 1993; Norfolk Southern did so in 2010; and Coca-Cola, IBM, Ford and other companies have done the same. Oxford University, Ohio State, Yale and other universities have done the same. Fourteen Organization for Economic Co-Operation and Development countries have issued debt with maturities ranging from 40 to 100 years. Austria, Belgium, and Ireland have all issued century bonds within the last two years.

With COVID-19 and the economic contraction, the CBO has estimated that the deficit for fiscal year 2020 which ends this month will exceed $3 trillion. According to the Committee for a Responsible Budget, this amounts to around 18 percent of GDP for the year. As things stand, the federal debt is expected to reach 108 percent of GDP by next year.

To put these figures into perspective, the U.S.’s highest debt-to-GDP ratio was 112 percent at the end of World War II. The war was financed with a combination of roughly 40 percent taxes and 60 percent debt.

If the great and the good in Washington don’t address how to reduce the deficit-to-GDP ratio and find a fiscally sustainable path after COVID-19, large debt burdens can slow economic growth, raise interest rates, and lead interest on the debt to consume an ever-large proportion of the federal budget, crowding out spending on other priorities. But there is a trust deficit when it comes to the faith sentient Americans have in Washington’s ability to deal with the issue intelligently.

The only approach politicians can agree on to manage the debt and deficits is to steal from future generations by passing on to them the accumulated debt burden. So much for intergenerational fairness. As Admiral Mike Mullen, the former Chairman of the Joint Chiefs of Staff said: “Our national debt is our biggest national security threat.”

Extraordinary situations call for extraordinary measures and the issuance of 100-year bonds might be one way to deal with intergenerational equity.

Financialization of the economy

Posted on by j.giglio

Financialization refers to the increase in size and importance of the financial sector relative to the overall U.S. economy. Simply put, it is the wonky term used to describe the growing scale, profitability, and influence of the financial sector over the rest of the economy. Combine it with deregulation, less antitrust enforcement, and easy monetary policy from the 1980s onward and you get financial institutions that were too big and too speculative in the years leading up to the financial crisis in 2008.

Today, Wall Street buccaneers don’t just exert great influence over the economy; they are also a major influence in politics and government policy. The financial industry spends millions annually in Washington promoting the Panglossian view that the financial markets promote economic growth and contribute to economic well-being. It would be more accurate to say they contribute to economic inequality and the decline of U.S. manufacturing.

According to data from the Center for Responsive Politics, seven banks spent over $13 million on campaign contributions in the 2018 election cycle and over $38 million on lobbying during the 2017-2018 Congress. Not surprisingly, the top five campaign donors were Bank of America, Goldman Sachs, Morgan Stanley, JPMorgan Chase, and Citigroup.

Any wonder why the Washington crowd favors Wall Street over Main Street? Only the health care industry spends more.

For many Americans, the stock market acts as a barometer for the economy. U.S. financial markets are the largest and most liquid in the world. In 2018, the finance and insurance industries (excluding real estate) represented 7.4 percent or $1.5 trillion of the U.S. gross domestic product. In 1970 the finance and insurance industries accounted for 4.2 percent of GDP, up from 2.8 percent of GDP in 1950. In contrast, manufacturing fell from 30 percent of GDP in 1950 to 11 percent in 2019.

Prior to COVID-19, finance and insurance industry profits were equal to a quarter of the profits of all other sectors combined, even though it accounted for just 4 percent of jobs. These data are evidence of the industry’s growing weight within the American economy.

The figures do not reflect the extent to which non-financial firms derive revenues from financial activities, as opposed to productive investments in real assets. For instance, prior to the 2008 market crash and meltdown, GE Capital generated about half of General Electric’s total earnings. GE became an example of the financialization of American business. In the years leading up to the financial crisis, It became one of the world’s largest non-bank financial services companies, meaning it avoided the level of regulatory scrutiny official players like Wall Street banks face. After it crashed and burned in 2008, GE Capital got a whopping $139 billion taxpayer bailout.

Another example of corporate America moving to the rhythm of Wall Street is the case of Boeing’s 787 Dreamliner aircraft, which famously encountered delays and massive cost overruns due to its incredibly complex supply chain, which involved outsourcing 70 percent of the airplane’s component parts to multiple tiers of suppliers scattered around the world. The Dreamline supply chain reflects the pressure to maximize return on net assets. and was consistent with Wall Street’s approach.

Return on net assets is a key measure financial analysts use to evaluate how effectively management is deploying assets. The goal is to make the most money with the fewest possible assets. In the end, the Dreamliner became an embarrassing failure that cost billions more than it should have. In such instances, financialization reduces the dependence of corporate America on domestic workforces, which leads to offshoring manufacturing jobs.

The financial sector has amassed great power since the 1980s and contributed to the decline of U.S. manufacturing as well as income and wealth inequality. As Supreme Court Justice Brandeis allegedly said in 1941 with great foresight: “We can have democracy in this country, or we can have great wealth concentrated in the hands of a few, but we can’t have both.”