Tuesday, August 9, 2011

Living Within Our Means As Americans

Living within our means as a country, and for many individuals as well, has now become a necessity. Our financial situation has become untenable. We can't continue to spend money we don't have if for no other reason than our lenders will soon run out of patience with us.

Soon we will have to begin the transition to living within our means, and given the political will to do so, we can begin whenever we make that choice or series of choices. Accordingly, the choice before us now is how and not whether we shall choose to live within our means.

How did we allow the debt and deficits problem to get so far out of hand that our choices are so limited now? And when did all this happen?

As to when, it took decades. My own view is based on the Cold War as well as several additional contributing factors such as the opening of China in 1978 and the fall of the Berlin Wall in 1989.

When the Cold War began as World War ll ended in 1945, the world's economies were pretty much divided between consumer driven market based economies and top down driven command and control economies. Other than the financially debilitated UK, the U.S. essentially entered the post World War ll period as the only large free market based economy. Japan and Germany were non-factors economically for many years after the war, and Russia and China were both communist command and control economies. After fighting two world wars, the UK that emerged therefrom was broke. After World War ll, they also began a decades long period of socialistic programs as well as austerity, at least until the Thatcher government came along in 1979.

The U.S. pretty much had the fruits of worldwide capitalism and market based competition to ourselves. As a result, we dominated the world economy and grew ever more prosperous each year. Until things changed, of course, but that story can wait for now.

During our initial dominance of the post WW ll period, we created many entitlement programs for our citizens but didn't set aside the money to pay for them over the long haul. Because we didn't pay for the programs by funding them properly, the post war baby boom generation demographics have made our nation's long term financial picture especially bleak now. As a result, down the road we will be unable to pay social security, medicare and medicaid benefits without big changes to catching up with respect to funding or reducing those promised benefits, or a combination of both.

That's due to having fewer and fewer workers per retiree from the post war period until now and in future years, too. We've gone from ~10 workers for each retiree to only 3 for each beneficiary. And soon it will be 2 for 1. On top of that, many female workers have joined the the work force since the end of WW ll, so there will be no further influx of that segment of the population to offset our growing list of retirees. All in all, this demographic debacle in the making was for a long time predictable and foreseeable. And its financial ramifications were ignored.

In addition to not funding our future related entitlement promises properly, we borrowed to purchase things in the here and now, and especially real estate related assets. Of course, we indirectly borrowed much of this real estate related money from other countries such as China.

Accordingly, both our unfunded entitlement promises and our funded debt picture changed enormously over the ensuing years. And this was true for households, municipalities, states and the national government, too. Free lunches for one and all. Except our future generations, that is.

As if that weren't bad enough, worldwide competition heated up right before our very eyes. But our "dominant" eyes were pretty much closed to the effects of this new and increasing competitive reality. So when the Chinese began their version of market based competition in 1978 and the Berlin Wall fell in 1989, we didn't heed the ominous signs about future global competition for goods and services. Why?

Perhaps because we're so very human. By that I mean that we tend to see the future as an extrapolation of today. In other words, we individuals have a tendency to believe that whatever is happening now is what's most likely to happen in the future. Of course, that's not true, but that is pretty much how we tend to see things. In other words, trendlines continue until they don't. Then entirely new trends emerge, even though we don't foresee the very much foreseeable when it is right before our eyes.

When we exited the 1980s and entered the 1990s, worldwide competition had already intensified. In fact, new competitors worked for less and worked hard at the same time. Nevertheless, we kept on creating new and largely unfunded programs for ourselves despite the developing demographics within our society and despite the new global competition. In addition to China, Eastern Europe and Russia, by then the Japanese and Germans also had totally recovered from their WW ll setbacks and were in the global competitive game, too.

So today we have much of the debt that we've incurred for economically non-productive and non-competitive assets that we've acquired, especially real estate related. And we have made promises to ourselves for future entitlement promises which we won't be able to keep without a strongly growing economy, which only comes from being competitive with all comers in the world, bar none. We've made promises we won't be able to keep, in other words.

The foregoing is intended to be only a brief, simple and straightforward explanation of where we are and how we got here. What we the people choose to do about it is what's important now. Our choices will become clear in the months and years ahead. And that will tell us about the future of America and Americans.

Even if we choose to continue down the present path leading to more entitlements and more socialism, we'll still have to find a way to live within our means. One way we can do that is by taxing ourselves more and more for the things we vote to give ourselves.

As we do that, our economy will grow very slowly, if at all, and we'll begin to look more and more like a modern day European welfare state. In that regard, entitlement spending in the U.S. already has grown as a percentage of federal spending from ~28% in 1965 to ~66% today (America Gets Downgraded). Of course, LBJ's Great Society entitlement programs of medicare and medicaid, along with greatly expanded social security benefits and other government goodies, began in the mid to late 1960s.

My point is simply that choosing the route of funding through higher tax rates will beget lower economic growth over time. And more spending by the government, for whatever reason, will also require more revenue in the form of higher tax rates. And lower future economic growth than what we've experienced historically will deliver a different America in terms of what we leave behind for future generations of Americans.

If we choose the path to higher growth, fewer entitlements and smaller government, however, in time we'll end up with higher tax revenues through lower rates of taxation. But that requires we choose a smaller government, which in turn will result in fewer and less expensive entitlement programs and promises.

That's what's great about America. We're free to choose.

Thanks. Bob.

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