Thursday, June 30, 2011

Which Way Will Be The American Way of the Future?

"We the People" are faced with a momentous decision and thus have a compelling reason to become both deeply aware and knowledgeable. It's very much about choosing the right path forward for our American future.
Robert Frost's 1920 poem "The Road Not Taken" must have been written with just this type of decision in mind. His poem is definitely worth reading again, so you may wish to take a few minutes to bing it or google it at your leisure.
While all the daily headlines currently review every piece of theatrics from the Washington based politicians and their positions about how to resolve the issue du jour ..... the debt ceiling resolution ....... that's not the fundamental issue facing us. Here's the real question for us to decide.
Will we embrace freedom, personal responsibility and what we've always believed to be the big idea about what it is to be an American, or will we choose to become even more like the Europeans?
While this America or Europe choice may sound like "Greek" to some, the choice is certainly not Greece for me. Similarly, the way forward is not Italy, Portugal, Spain, Britain, France or Germany either.
Please take the time to read A Debt-Limit Election.
Thanks. Bob.

Wednesday, June 29, 2011

Public Employee Pension Benefits Need to be Addressed Now

Almost 40% of public employees belong to unions. For comparative purposes, only 7% of the employees working in the private sector are union members.

Public employee unions are too strong and represent a huge fiscal problem for the well-being of many large and small cities nationwide.

By looking at just the retirement portion of the compensation program for public employees, we can shed some light on what is rapidly becoming perhaps the single most important issue facing American cities today. It's important to all of us as American citizens, because whether we belong to a union or not, and whether we work in the public or private sector, we're all in this together.

Unlike governments, private sector businesses have been adopting defined contribution plans in increasing numbers. Governments continue to offer pension plans while struggling with a multitude of other financing issues. This single issue goes way beyond defined benefit vs. defined contribution choices concerning employee retirement benefits. It strikes at the very core of the public versus private sector "system" of economics.

Public employee unions today are much stronger than unions representing the employees of private businesses. That's changed over the years as worldwide competition has heavily impacted private companies while, of course, that's not been the case with our cities. As a result, pension plans for the private sector have been disappearing even while they remain omnipresent in the public sector.

The pension benefits promised today by taxpayer representatives won't come due until well in the future. As such, their true cost to future generations of taxpayers won't be known for many years. On the other hand, a particular private business may not exist several decades from now. But if it does, it will be because it has done what is necessary to remain competitive.

It's reasonable to ask why the taxpayer of today makes promises regarding the highly uncertain cost of tomorrow's benefits. Those future promised benefits for today's workforce, since in most instances they aren't being adequately prefunded, will of necessity be funded by the taxpayers of the distant future.

Here's my simple question: If we want to provide the benefits for tomorrow, why can't we fund them today? And here's my simple answer: Because that would raise taxes today, so let's stick the taxpayer of the future with the bill.

Doesn't seem fair. Not at all.

So let's briefly summarize what makes businesses and governments act so differently when it comes to pensions and 401k/IRAs.

(1) Businesses and governments have totally different purposes. Peter Drucker, management guru, stated that the purpose of business is simply to create and keep a customer.

In stating the purpose of government, John Locke (whose views served as the foundation for our Declaration of Independence) believed that it is simply to protect its citizens from each other and provide for the common defense.

(2) Businesses and governments are financed quite differently. Businesses are financed by "at risk" investors, both owners and lenders. Governments are financed by taxpayers (and all too often by lenders as well).

(3) Businesses have to compete successfully with other businesses to stay in existence whereas governments are basically monopolistic creatures and have no existential issues.

Summary of the Differences

The customers sought by businesses have freedom of choice concerning whether to buy from a particular business, another and different business or to elect not to buy at all. Investors put their money at risk with the hope of receiving a satisfactory return, or profit, on their investment. By selling their stake, investors can withdraw their money from a particular business investment. Earning a satisfactory profit for investors is therefore the cost of staying in business, and this staying power is only achieved by satisfying customers and investors alike.

Governments ----- Governmental entities fund their operations through taxes, fees and sometimes borrowings. When they occasionally do "compete" with the private sector, they do so as a favored and protected monopoly, and thereby are in an advantaged position relative to their private "competitors".

Recipients of government services, unlike customers of private businesses, are generally not free to choose when "purchasing" from a monopolistic government agency. The bureaucrat knows this and so does the citizen taxpayer. We're not treated like customers who have choices, because we don't have choices.

Compensation Differences

Compensation, including benefits, is another area of difference between businesses and governments. If businesses commit to future employee benefits which they cannot fulfill, they either have to convince employees to accept less or else go bankrupt, in which case all employees will lose their jobs. The firms will then cease to exist, and the investors will lose their investment.

When a government entity makes promises concerning benefits for the future which it can't fulfill, however, it won't go broke. And it won't cease to exist. The government's power to tax its future citizens puts the public employee union representatives in an apparent "no lose" situation while simultaneously putting the future taxpayer in a "no win" position.

That's the fundamental reason why the responsibilities of public employee union officials are different in kind from private sector union officials. The public sector representatives have lots of advantages with respect to negotiating power. In the private sector, however, the company can either lose its customers, investors or both if its labor or other costs get out of hand. Thus, the unions, while not powerless, have considerably less power with private companies than unions have in the public sector.

To reiterate, staying power is not a problem in the public sector. Whereas the private company may enter bankruptcy and go and out of business, that's not going to happen to a city. Due to its taxing power, the government won't cease to exist. The taxpayer makes all the difference. And that taxpayer pays.

It's as simple as that. Unions, employees and investors all know the different games being played. It's time the taxpayers wise up, too.

Hopefully, this brief public to private sector comparison will help clarify things. Regrettably, far too many American cities are facing huge financial issues today, in large part because of the pension benefits they've granted to public employees over the years. For a sobering analysis of the issue as it pertains to cities such as Providence, New Haven, Madison, Chicago, Detroit, New York and others, please read The Local Government Pension Squeeze. And lest we forget, the identical problem exists in England and elsewhere, too (Britain's Classroom Arithmetic).

In sum, businesses must control costs, get and keep customers, and earn a satisfactory profit for their "at risk" investors or they will go out of business. But governments are a totally different story. Unfortunately.

Thanks. Bob.

Tuesday, June 28, 2011

four good reasons to get involved

(1) Our "leaders" in Washington are engaged in political theater these days about raising the national debt ceiling, spending cuts, revenue increases and the like. Undoubtedly and unfortunately, they'll declare victory sometime during the next several weeks without having seriously addressed the real and enormous issues of entitlements like social security and medicare, or their erroneous assumptions about future interest charges on the national debt, or even their use of overly optimistic assumptions about economic growth in the next several years (The Deficit Is Worse Than We Think).

(2) Politicians have long gotten away with this all too typical gamesmanship, because we the people haven't taken the time to become informed with respect to what's really going on in government or the long term economic impact thereof. Thus, we are all too often fed half truths and even untruths.

Only when we the people make the required effort to know how these things really work will the politicians begin to act like responsible adults in servant leadership roles. At such time, as a society we'll then be able to discuss and make realistic choices about what to do and when to do it (In economics, you can't have it both ways).

(3) Greece is rioting today. I guess it beats working, even if it solves absolutely nothing. They also are planning a national "yard sale" to raise money (Ailing Greece Tries National Tag Sale). Sadly, they've already achieved financial ruin as a nation. We can only wonder how many others will follow.

(4) Let's be optimistic about our American future, but let's have legitimate reasons for that optimism. Let's all get involved, because the more we know, the more others, including our politicians, will come to know as well.

Thanks. Bob.

Monday, June 27, 2011

Social Security and Our Investment Choice of Stocks vs. Bonds .... an Overview


There's a real and somewhat silly ongoing debate about whether as individuals we can be trusted to save for our own retirement security or whether we can instead look to future generations to pay our way. How much future social security should pay retirees, in other words, and who should pay for it.

Some suggest that since we don't save enough as individuals to take care of ourselves in retirement, we should simply raise the Social Security entitlement payments and send the bill to the grandkids. Another argument suggests that we should finally acknowledge that social security insurance really isn't insurance at all, despite what it's been officially called since its enactment in 1935. We could then call it what it really is ...... another entitlement and income redistribution program. Then we could make the highly paid workers "contribute" (the honest word is tax) even more into the "fund" (there is no fund) and pay for the social security insurance (again, there is no insurance) that way.


But this isn't about the fiction we call social security. It's about our future personal financial security, no matter wherefrom. Due to the fact that somebody needs to save and invest or there won't be sufficient funds in the future, it's really up to each and all of us, one way or another. The free lunch underfunded entitlement approach has been tried and found lacking time and again. And if tried yet again, it will inevitably come up short ..... again. In the end, somebody has to pay. And that somebody is "We the People".

So let's discuss the pros and cons of investing our individual savings in stocks or bonds, recognizing that first there have to be savings in order to have funds to invest.

When investing, asset allocation is critical. Asset allocation simply means what portion of our investment goes into each of the available investment instruments. We'll restrict our choices herein to stocks and bonds. And we won't concern ourselves with diversifying among the two asset classes. In fact, my view is that for the long term investor, today's historically low interest rate environment argues for an all stock portfolio with no bonds, but we'll defer that "no diversification" discussion for now.

Let's compare the two choices and why stocks are clearly preferable to bonds for many years to come. We will not adopt a trading approach to investing but rather will choose the "old fashioned" buy-and-hold system. Both history and logic dictate that buy-and-hold is the optimum approach for those who are focused on the long haul, which we are. A long term buy-and-hold investment strategy is not exciting, but it is the best way to a secure financial future.

We'll also look only at tax free investing currently (401k/IRA). Also, transaction costs (brokerage, bank or money manager related) or other often "hidden" costs aren't part of the comparison either. We'll deal with all these issues at a future time but for now, it's the KISS method all the way. Besides, when we do at a later time consider taxes, transaction costs, money management fees and the like, the case for the recommended buy-and-hold stocks methodology will be even stronger.

The straightforward bond vs. stock comparison can be illustrated as follows: we have $100 to invest for 30 years; and we're deciding whether to place our money in either (1) U.S. government bonds or (2) a wide variety of blue chip stocks through a Standard and Poor's 500 index fund.

If we select bonds, we'll choose government bonds, since they are the safest of all fixed income instruments.

If we choose a basket of stocks, we'll choose the "blue chip" Standard & Poor's 500 Index (S&P 500). The index is made up of 500 stocks and represents "the market". Firms like Exxon, McDonald's, Wal-Mart, GE, Pfizer, Merck, Microsoft, Intel, Apple, Whirlpool, Pepsi, Home Depot, JP Morgan, Wells Fargo, Caterpillar and Deere are a few of the prominent names on the list.

Back to the comparison.

Thirty year government bonds currently yield ~4%. The current dividend yield on the S&P 500 index is ~2%. Since four beats two, we'd pick bonds, all other things being equal, but, of course, they never are. So let's look closer. Much closer.

If we purchase government bonds with the $100, we'll receive $4 each year for the next thirty years in the form of interest income. At the end of those 30 years, we will have received a total of $120 in interest and will have our initial investment of $100 returned as well. So we'll have gone from $100 to a total of $220. The $220 will probably be worth much less in thirty years than the $100 is worth today. That's due to inflation.

If we choose stocks, despite the daily, monthly and annual ups and downs of the market, over the thirty years we'll likely enjoy a total average annual return of ~9%. 7% will come from stock appreciation and another 2% will represent the current yield on the portfolio's value over time. Thus, we should expect to receive total dividends of ~$82 (the initial $2 compounded at 7% annual growth over 30 years). The stock price should increase from $100 to ~$800, using the same 7% annual appreciation assumption. Therefore, the total dollars in the case of a stock purchase, including dividends received, should be worth ~$882 in 30 years. And $882 in purchasing power then should be worth much more than $100 is worth today. We'll beat inflation by a bunch, in other words.

$882 compares nicely to $220, so we'll choose stocks over bonds.

But that's not all. If our total stock value of $800 is invested in a government bond yielding 4% thirty years from now, when we may need the income, we'll receive $32 annually in interest each year thereafter. On the other hand, if we take the $100 principal from bonds at the end of the 30 years and reinvest it at 4%, we'd only receive $4.

$32 beats $4. Thus, let's invest in stocks for the next thirty years and then consider switching to bonds, in whole or in part, thereafter.

But even that's not all. If our total stock investment return of 9% annually consisted of 7% in annual price appreciation and 2% in dividends, then the $2 in annual dividends will have grown to ~$16 by year thirty.

Thus, in year 31, the stock price would be $800 and the annual dividend would be $16, still representing a 2% current yield. When looked at from a return on the initial cost of $100, however, that's a 16% yield on cost. And it will likely continue to grow from that point forward as well.

In the bond case, in year 31 we would collect $4 in interest on our $100 principal, or 4%.
In the stock case, in year 31 we would collect $16 in dividends on our $800 stock value, or 2%.

That's the magic of compounding accompanied by the magic of ownership. And although in the example it's just math, the math correlates nicely with historical performance. For an additional argument in favor of stocks today, the starting point reflects the current level of historically low interest rates.

All in all, it's a no brainer.

Thanks. Bob.

Sunday, June 26, 2011

the case for graduation from college just got stronger

Making the case for getting a college degree is invariably an easy one. Well, it just got easier. Since encouraging our young people to go to college and graduate makes sense, helping them to enter college well prepared makes even more sense.
There are lots of alarm bells going off today regarding the pervasive lack of adequate preparation for newly arriving college students. One disturbing study concludes that 75% of new students arrive unprepared.
Ever the optimist, however, to me that simply means that the 25% who arrive well prepared will have every opportunity to excel, both absolutely and in relation to their classmates.
In any event, no matter what we choose to do after getting the sheepskin, the effort will have been worth making. In this regard, please see "Even for Cashiers, College Pays Off". Of course, the high achievers and the well prepared can expect to do much better than that.
As the Boy Scouts say, "Be Prepared".
Thanks. Bob.

Saturday, June 25, 2011

cornflakes, gasoline prices and deficits

The price of corn, by far our nation's biggest crop, has doubled in the past year. As a result, corn related government ethanol subsidies now account for a significant portion of both high food and gas prices.
In fact, 40% of all corn production now goes into ethanol, up from 10% just a few years ago. And to make a bad situation even worse, due to government subsidies, farmers are now exporting "low cost" ethanol while the general public is importing "high cost" oil. Of course, these subsidies add meaningfully to the growing fiscal deficits and resultant debt levels.
So why does our government incentivize ethanol when its impact is harmful to so many consumers and many other aspects of our economy as well? It's an example of public choice theory, pure and simple. As we all know, high food and energy costs negatively impact consumers. Yet the ethanol and other corn subsidies remain. But serving the general public is not what matters in Washington, or at least not until now.
What does matter to the politicians? To borrow from the first Clinton Presidential campaign slogan about the weak economy, "It's the agricultural lobby, Stupid!". Iowa is both the biggest corn grower and the first of the Presidential election primary States. Iowa and the rest of the farmers, along with the ethanol industry, enjoy their clout. The rest of us pay.
"The Great Corn Con" editorial is an excellent read.
Thanks. Bob.

Friday, June 24, 2011

public choice and debt/deficits vs. servant leadership and inverted pyramids

Public choice theory says that politicians act out of self-interest. That's fine as long as we can get their self-interest to match the general welfare of the broad public. So let's review what needs to happen to go from our current three sided losing game of public choice/special interests/unknowing citizens to the public servant model of leadership where we all play to win for America.

Organizations of all kinds either operate in top down fashion or through a servant leadership approach. Here's the model for winning. Think of an inverted pyramid where the people being served are at the top and their servant leaders are at the bottom. It's as simple as that. Organizations exist solely to serve people. Accordingly, people properly serving organizations dedicate their efforts to serving other people. In business, it's often the shareholder being served, but in government, it's the general public. Not some people but all the people.

My view is that this is all coming to a head in our country. And it's way overdue. Since water runs downhill, the real action will occur at the State and local levels. In warfare, cutting off the supply lines of the enemy is often critical to success. If the supplies and reinforcements keep coming, however, it's very hard to stop the enemy's advance and ultimate victory.

In our current debt and deficit ridden society, the supply of funds is at risk of being curtailed if not cut off. And that's not a bad thing as we strive to get our "house" in order.

In particular, the States have come to rely upon the federal government for 30% of State budgets each year. In turn, local governments rely upon the State for the major part of their spending on education, their biggest expenditure.

Now that our federal politicians are belatedly but of necessity addressing the national spending, deficit and debt issues, the "supplies" to State and local governments will be curtailed meaningfully. That means States and municipalities will have to make choices with respect to spending limited funds. That's not been happening to any measurable degree. Just look around at all the nice new buildings and such that we the taxpayers have been building for our "public servants", educators and other interested parties with "public choice decision driven" funding. And while you're at it, take time to look at the promised retirement benefits for these public employees which are either at best underfunded.

The bills for all this are coming due shortly. What choices will we make? More taxes, fewer public employees, including reduced pay and benefits, higher property and other local taxes, or all of the above? We'll have to get involved and knowledgeable to make informed decisions. Unless, of course, we want to trust those same "public servants" to continue to do as they've done until now. It's our choice. Oversight, anyone?

Now don't misunderstand what I'm saying. If the good citizens of Laguna Beach, Calififornia want to pay retired lifeguards annual pensions of $113,000 (see below), that's fine with me. And if the citizens of any community want to pay public employees more than their private sector counterparts, that's ok with me, too. And what's wrong with a Taj Mahal or two, assuming we will pay for it? It's our money, so it's our choice.

In any case, someone has to properly align the choices of the constituents with their elected representatives. Alas, it doesn't appear that the interests of the governed and those doing the governing are currently well aligned. As we get involved, we'll have plenty of interesting choices to make in light of the limited supplies/resources available (due to the debt and deficits).

So far the State and local news is developing favorably. The inverted pyramid servant leadership model may be starting to take the place of the public choice model. At least there's the beginning of a healthy debate starting to take place. And when the debate is over, we'll have decided how to apply our scarce resources to the unlimited choices available. Or we'll have decided to pay much higher taxes and keep doing what we're doing, thereby accepting the consequences of lower economic growth and high unemployment for the indefinite future.

As for me, I'm confident that we'll make the right choices about our future. As Winston Churchill once said, "Americans can always be counted on to do the right thing...after they have exhausted all other possibilities." That time to "do the right thing" has arrived.

Finally, let's look at some examples of relevant current State and local activity throughout our great country.

In a sign of bipartisan leadership, New Jersey politicians of both parties just yesterday made a momentous choice to practice servant leadership despite the passionate opposition of public employee unions and some affiliated Democratic party allies (N.J.Slashes Public-Worker Benefits). While one swallow does not a summer make, it's a good start and a strong step in the right direction. Chris Christie is making a difference.

An even better start comes from the city of Atlanta. The Atlanta mayor is proposing to lead his city (and the country as well) to transition from a pension benefit plan to a 401k defined contribution plan for public employees (New Front in Benefits Fight, Atlanta May Drop Pensions) due to a shortfall ($1.5 billion) in funding levels.

As an aside, the overall retirement funding shortfall nationally for States, excluding cities, is approximately $1 trillion. Thus, there will continue to be lots of activity in this defined contribution (401k/IRA) versus defined benefit (pension) discussion in the months and years ahead. As the Atlanta mayor puts it, "The steps we are taking are going to have to be done across the country." He's right about that.

For a different and somewhat less enlightened perspective, consider Calfifornia and the aforementioned Laguna Beach lifeguard who retired at age 57 with a $113,000-a-year pension (Public Unions Take On Boss to Win Big Pensions). The biggest reason to read this lengthy article is to learn about the effects of the less-than-arms-length-negotiating process that has occurred routinely between union represented public employees and their government employers. Public choice theory in action, in other words.

And finally, there is the article comparing the situation that exists between Indiana and its neighboring States of Illinois and Ohio (The Indiana Exception? Yes, but...).

To summarize, the battleground action will now take place more and more at the State and local levels. Perhaps the national politics will get most of the headlines, but that's not what matters most to our future American way of life.

I'm betting on servant leadership and inverted pyramids.

Thanks. Bob.

Thursday, June 23, 2011

basic economics, public choice theory and us

Basic economics in part joins the concepts of scarcity and choice. Because no society has the resources necessary to produce all the goods and services necessary to satisfy all human wants, scarcity always exists. Because of this always present scarcity, we are required to make choices.

Public choice theory studies the behavior of politicians and bureaucrats at all levels as mostly self-interested individuals (motivations include such things as power, money, influence, fame, electability and, occasionally, public service). Instead of acting solely in what they consider to be the long term best interests of the general public, these players behave in a self-interested manner.

Time inconsistent behavior means that we too often favor short term outcomes even though these choices will have negative long term consequences.

We'll try to answer herein the three following questions with the aforesaid principles in mind; (1) Why is it seemingly so hard to live within our means, (2) Who's to blame, and (3) What does the future look like?

Before trying to answer, let's review what "public choice theory" has to teach us. To repeat, public choice theory regards politicians and government officials as mostly self-interested agents who are active players "in the system" instead of impartial referees or public servants acting objectively and outside of or "on the system". Politicians in effect represent just another self-interested competitor among the various other competitors, in other words.

It also helps if we understand that even while getting into the economic mess we're in today, most participants in the process have acted "rationally", at least in the short term.

My optimistic conclusion, nevertheless, is that better times lie ahead. Our enormous debt levels, when combined with high unemployment and weak economic conditions, will mandate that we stop kicking the can down the road (along with the rest of the world, too) and face directly our all too real longer term issues. As we do, our politicians and bureaucrats at all levels of government will jump in front of the parade and begin to act in the best interests of the general public.

What will precipitate this much needed change in alignment? Our debts and deficits. An old and somewhat trite aphorism says that if something can't go on forever, it won't. Our current private and public debt levels aren't sustainable and can't go on, so our future "rational" choices must of necessity deal with this enormous debt issue in a serious and effective way.

Public choice theory explains that while the political decision making process is often rational in the short term, it is also in direct conflict with the long term general welfare and overall desires of the general public". As an example, although "bridges to nowhere" and other wasteful pork barrel projects are not desired by the general public, it is often rational for politicians to vote them into existence anyway.

In this "game" of public choice, the private (specific industries) or public sector (unionized public employees such as teachers) special interests and related lobbying groups are focused intensely on getting the favorable treatment sought from the politician. By spending time and money to gain the politician's favor and the grant of taxpayer money (whose own money the politician isn't spending), the lobbying party prevails. In the short run, for the favor seeker as well as the favor granter, it's been time and money well spent. And finally, let's not forget the taxpayers at large. We the disinterested and uninformed taxpayers have acted rationally as well, since it would have cost us a whole lot of precious time, energy and money to defeat the individual proposal. The benefit of defeating that single project or favor would have been very small to the unfocused and unconcerned general public. At least in the short term.

Hence, in the three party (favor seeking special interest, favor granting politician and disinterested general public) game that's been played for far too many decades now, everybody acted rationally in the short term, even though the long term best interests or even wishes of the general public were not served.

Because of the current debt levels, however, the long term future is here. As George Allen, former head coach of the NFL Washington Redskins once said, "The future is now."

Debt has accumulated to unsustainable levels as government spending consistently has grown at an unprecedented rate while we've all been playing the short term rationally irrational game described so well by public choice theory.

Special interest industry lobbyists (companies, unions, localities, elderly, public employees and so forth) and the rational ignorance of a very broad cross section of passive consumers/citizens/owners/taxpayers have combined to cause or enable the politician to spend taxpayer money improperly but at no cost to his political future. In fact, it helped his future as a politician.

That game is now over. Debt levels are going to force us into playing a long term rational game now. That time consistent approach will help create a brighter future for one and all.

Back to the questions of (1) why is it so hard to live within our means, (2) who's to blame and (3) what's the outlook?

In my view, the answers are as follows: (1) It won't be that hard to live within our means, because it will be necessary, (2) we are all to blame and (3) the outlook, once we get past the short term, is looking better as we begin to act as responsible American adults.

Let's recap what happened in the past. The smaller (relative to the whole society), the better organized and the more focused the group, the more likely it was able to get what it wanted from the political class. And this was true whether the politician "listeners" resided in Washington, the state capitol, city hall or wherever else the piles of "free taxpayer money" could be found. As a result of this three party short term oriented "spend the taxpayer money" game, we've all suffered greatly, and we'll still be suffering for years to come.

The Chamber of Commerce has its headquarters in our nation's capitol for a compelling reason. As does the American Association for Retired Persons (AARP). As does the largest union of public employees, the Service Employees International Union (SEIU). As do countless other special interests. Why Washington? As world famous bank robber Willie Sutton replied when asked why he robbed banks, "That's where the money is."

The solution is straightforward. For those who insist on acting solely in their self-interests, let's hunt them all down and run them out of town, at least figuratively. {As for us, we've been too ready to applaud when our local congressman brought home the "local goodies". So have the constituents of the other 534 national congressmen. In so doing, we've all ignored the much bigger and wasteful game that was being played. Let's stop applauding.}

The money the government "gives" comes from its citizens. That's us. If we take out more than we pay in, a fellow citizen foots the bill. The same lack of conscious thinking applies to government borrowing and debt. Borrowings are nothing more than deferred taxes to be paid at a later point in time. Who will pay these deferred taxes?. Maybe we will or maybe our children will or maybe our grandchildren will. But in the end, somehow they will be paid by someone. We all know that. And China sure won't pay our way, nor will Japan.

So why the optimism? Ironically, in large part it comes from the debt we've accumulated. We simply have to get serious about stopping its growth and start doing what is necessary to resume strong economic growth. And to begin again to live within our means. So we will.

The short term time inconsistent political game is going the way of the dodo bird. Independents are becoming, if they aren't already, the "biggest political party", and a backlash against wasteful and unaffordable government spending is growing each day.

My bet is that the political class will give us the government we want. And that government will be a fiscally responsible government at all levels. The game of "get what you can from your fellow citizens through the politicians" is over. We're heading back to the future and in the direction of smaller government and greater individual self reliance. Finally.

Thanks. Bob.

Wednesday, June 22, 2011

addressing our lack of global competitiveness ..... a sober analysis

Bill Gross is a prominent California based money manager who oversees the management of $1 trillion in investment securities. He has just published a timely commentary on what ails America and how we are failing to address the serious competitive issues facing us globally.

Although a bad idea, at least in my opinion, Gross wants greater government involvement for the next few years to address our competitiveness issues. While I disagree with his prescription for bigger government, even temporarily, his argument about the lack of American competitiveness is on the mark and must be addressed.

(My view is straightforward about the role of government in economic matters. I agree with what President Reagan said that government isn't the solution to our problem; it's our problem.)

Nevertheless, Gross makes a strong case that we have a long term structural as opposed to a temporary cyclical unemployment problem. Unfortunately, it's due in large part to our relatively high paid and low skilled American manufacturing work force. In simple terms, we largely lack the required technical skills required to compete in today's global environment.

Accordingly, our competitiveness issues are long term in nature and will take years to solve, even if we do all the right things to solve them. And eliminating deficits and balancing the budget, while quite necessary, won't bring sorely needed American manufacturing jobs back. The commentary is titled "School Daze, School Daze Good Old Golden Rule Days".

In arguing that our work force is too expensive and poorly educated for today's global marketplace competition, Gross says that "we are left untrained, underinvested and overindebted relative to our global competitors." Accompanying that debilitated condition is that a college degree today is in not a ticket to success, since many of our graduates lack the necessary educational and technical skills to compete in the world market. As a result, manufacturing companies will continue to invest "over there" where it's less expensive than "over here".

Finally, U.S. employment based on real estate and related asset appreciation/finance isn't anytime soon, if ever, going to be the job producer it was until the real estate related bubble burst in 2008.

As a result, we need a manufacturing renaissance to restore American competitiveness and create the necessary employment for Americans. And that will be both a serious and difficult problem to solve. In sum, Gross presents a sobering point of view that can no longer be ignored.

It's time we as a society look closely at the future and how we restore American leadership in education, technical skills and our "lost" manufacturing jobs.

Thanks. Bob.

Tuesday, June 21, 2011

investing our savings .... the case for stocks over bonds and cash

A new study (Come On Gen X, Take Some Chances) reveals that younger people between the ages of 18-34 (mean age of 31) are now more conservative when making investment choices than the oldsters (65+). Preserving principal and generating income are more important to them than growing assets or increasing their portfolio value as much as possible.

While perhaps understandable in the present anxious if not fearful state of today, the survey results were somewhat surprising to me and continuing to follow along this path will definitely not be in the long term best interests of the young.

Let's summarize how this investing stuff really works.
(1) Cash and cash equivalents (money market funds, CDs, etc.) won't maintain purchasing power and will result in decreased purchasing power over time.
(2) Because of the stream of interest payments during the life of the bond, fixed income instruments may retain purchasing power and even perhaps result in modest "real" income, although the principal amount returned at the time of maturity will have declined in purchasing power due to inflation.
( 3) Common stocks or equities will return income in the form of increasing cash dividends, and the price of these holdings will likely also appreciate in real value over time. Thus, stocks represent the highest return and least risky investment, albeit the most volatile, of the three under consideration. Stocks both preserve and enhance purchasing power.

If we assume a 3% annual rate of inflation and another 6% real return from stocks due to the risk reward factor, that results in the historical average nominal annual return of ~9% for stocks. Thus, stocks over time earn more than 6% in real terms, and represent the only legitimate choice to beat inflation and enhance purchasing power. Bonds may result in real income gains, especially during the early years, but the purchasing power of the principal will decline due to inflation over the life of the bond. In last place is cash which will be lucky to keep pace with inflation and is most likely to diminish in real value.

Over long periods of time, stocks (we're considering only common stocks herein) will realize a real rate of return approximately double that of bonds. (We will not address commodities or currencies, since these are not viewed as appropriate long term investments. Neither will we consider real estate as an appropriate investment vehicle. Homes should be lived in and not considered as investments.)

The long term case for stocks is uniquely compelling due to several factors, not the least of which is their long term historical performance. That long term performance is largely due to a very simple fact which is often neglected when people decide how to invest their savings ...... the relationship of risk and reward in our market based capitalist system of ownership.

Stocks involve ownership and ownership involves risk. While risk is admittedly a scary word for some, it's really just another word. That's because decisions to invest or not to invest involve risk. All non-decisions likewise involve risk. Risk is everywhere and all the time, whether we acknowledge its presence or not. Risk is.

Accordingly, in our capitalist system stocks not only will, but in fact must, earn a premium to bonds and cash over time. That's the only way our free market ownership system and American way of life will survive. Investors will both demand and receive a higher return from equities than from bonds, simply because stocks involve greater risks than bonds.

Bonds represent legally enforceable contracts whereas stocks promise nothing other than a piece of the rock .... ownership. Hence, unless investors have faith in the future, they won't invest in stocks. Therefore, stocks must generate higher returns in order to compensate for the higher risks assumed by the stock investor. For those of us who believe in the American way of life, in the long run there is no better place for our savings than stocks.

The historical record is that inflation of 2.5% plus a plus a historical risk premium for stocks of more than 6.5% equals an average annual nominal return of greater than 9%. Comparatively, bonds generally yield between 4% and 5%, or ~2% greater than inflation. Cash earns at roughly the rate of inflation.

In future postings we'll go into greater detail but for now suffice it to say that a basket of diversified but strong stocks should be the overwhelming investment of choice for the long term investor. We need to get comfortable with that thought and capable of ignoring the short term volatile twists and turns of equity prices.

American capitalism is not going away, at least not anytime soon. Accordingly, it's a most appropriate time to invest in our great American free market system by owning a piece of the future earnings of our strongest American companies.

Thanks. Bob.

Monday, June 20, 2011

is this guy serious?

Two editorials from today's WSJ and NYT by the same Chicago based union lawyer should give thoughtful people everywhere the urge to speak up. This guy's reasoning is so bad that I won't comment further. At least not yet. Maybe later.

You must read it to believe it. The rest of us need to take this stuff seriously and speak up as well.

See Boeing's Threat to American Enterprise and Get Radical: Raise Social Security. In the meantime, I'll simply state that you can't make this stuff up.

Now I know what it means to be a representative or mouthpiece for special interests (unions and the elderly, as examples).

Thanks. Bob.

Friday, June 17, 2011

first, we avoid debt and develop the habit of saving

Defined benefit (pension) plans are being replaced with defined contribution (401k and IRA) plans throughout America as we transition from a guaranteed monthly benefit upon retirement to a self managed account with no guaranteed benefit. To repeat, the pension benefit is fixed whereas in a self managed account the benefit received depends upon how well our personal investment account performs over the years.

Although in the future we'll discuss in greater detail the implications of this transition from a sum certain pension benefit to an "uncertain" benefit amount, suffice it to say for now that knowledge about these matters will be important.

In a defined contribution plan, how early in our work career we begin saving, how much we save and how often we add to those savings, along with the investment results achieved thereon over time, when combined with any matching contributions from an employer, are all factors that will determine our final benefit. In this largely new world of saving and investing, it's now largely up to us, in other words.

For too long we've tended to ignore this area of personal responsibility, perhaps thinking that social security and our private employer will take care of the details for us. That's no longer the case, if it ever was. Accordingly, it is now essential that we "educate" ourselves as to how this really works. We'll then be better able to fulfill our responsibilities with respect to the future financial security and well-being of ourselves and our families.

In order to be in a position to save and invest, we must first avoid or at least minimize taking on debt. That's because if we accumulate substantial debt early in our adulthood, the resultant interest and principal payment requirements will delay our ability to save. To state the obvious, unless we first generate savings (income less spending = savings), we will have nothing to invest. So it makes little sense to enter into a discussion of investing until we have addressed, at least in general, the perils and pitfalls of taking on debt early in our adult lives.

The three biggest individual debt obligations are related to (1) credit cards, (2) student loans and (3) home mortgages.

Debt is a huge problem. To seriously address this issue, especially in our younger years, we must be ready to think for ourselves and be prepared to go against the "conventional wisdom" of the crowd.


The worst of the three biggest personal debt issues concerns credit cards. Bank issued credit cards are easy to get and are frequently used by the holder for major discretionary purchases with annual interest rates of ~15% being common. In comparison, banks currently pay us virtually nothing on savings deposits. As a result, the bank borrows our money (deposits) from us at a cost of less than 1% and then loans us back our same money at an annual cost of 15%.

Obviously, that's a great deal for the credit card issuing bank, but it's a really terrible deal for the credit card holder. Accordingly, we must make every effort to establish the habit of avoiding interest charges by paying in full any card balances at the end of each month. In fact, we should carefully consider avoiding the use of credit cards at all.


{NOTE: Human capital is our most valuable asset. We need to develop it each day and at every opportunity. I sincerely recommend that everyone work hard and continuously to develop the habit of acquiring knowledge. I also encourage people to get as much education as possible and attempt to graduate from college and graduate school as well, if that's the chosen route. That said, let's be careful about how much, if any, debt we accumulate along the way. My view is that it's best to avoid borrowing, but in the end that's your decision, of course. Let's just try to make it, along with all other decisions, an informed one.}

Now on to student loans .......

Although not as bad as credit cards, student loans are something to avoid. So work hard to get the degree(s), but don't borrow a bunch of money to get it/them. But we need to go to a good school, you say. You will. There are lots of very good colleges that aren't all that expensive to attend. Besides, it's the work of the student that truly makes the difference and not the name or location of the school. In other words, you'll do well wherever you go, and lifetime earnings, and happiness, won't be adversely affected at all, if you wisely choose a good but inexpensive college to attend. So try hard to stay away from the debt accumulation game. OK?

Here are a few additional facts to consider. The average student loan balance upon attaining an undergraduate degree exceeds $24,000. Thereafter, of course, the principal amount of the debt, together with interest charges thereon, must be repaid. Considering the cumulative interest charges and the debt principal as a single whole, a reasonable assumption would be that total payments of ~$32,000 would be required to retire the loan in full.

Now let's look at what could we do with that amount of money if we saved it as opposed to borrowing and repaying it. A whole lot, as a matter of fact. Here it really gets interesting.

The effect of compounding relates to (1) the length of time money is invested (time) and (2) the rate of return (rate) earned on that money. Money invested at an early age is often worth multiples of that same amount of money if not invested until a later point in time.

Here's the appropriate comparison. The earlier mentioned ~$32,000 invested at age 25 would reasonably be expected to grow to more than $1 million by age 65 (compounded annually for forty years at an assumed average rate of return of 9%). On the other hand, if our young graduate instead opts for the "Debt Assumption Plan" while in college and has to wait until age 33 to begin investing (the same ~$32,000 dollars at the same 9% average annual yield), he will accumulate a total amount of $500, 000, or about 50% less than what he would have acquired had he begun investing eight years earlier at age 25.

The point is simply this; the effect of compounding is real, whether it's working for us as an investor or against us as a debtor. So it pays to start saving and investing as early as possible.

(The "rule of 72" as applied to the example herein holds that for each eight year period, at an average annual rate of return of 9%, the result will be a doubling of the initial amount invested (8x9=72). Hence, our bright young graduate's decision to avoid debt and start the investment process at age 25, or eight years earlier than age 33, is a smart one indeed. To illustrate the rule of 72 with a few more examples, if the assumed rate of return is 10%, the money would double in about seven years, at 12% in six years, at 6% in twelve years and so on.)

Accordingly, starting early in life with no debt and some savings gets us to a completely different end result than borrowing to go to college, incurring debt and then taking several years to pay off that debt. Of course, actual results in each case would be different than the above assumed results, but the compounding rules always apply.


This is perhaps the most difficult of the three debt problems facing millions of Americans today. My view is that we must persuade young people not to rush into debt. Although home ownership is a big part of selling the much publicized "American Dream", my view is that taking on too much debt, too soon, is a bad thing.

We should avoid home related debt (when looked at as an investment, a home represents a highly leveraged, undiversified and illiquid investment) at least until we've saved some money for a reasonable period of time and are well on our way to stability and success in our chosen career. Until then, flexibility and mobility are essential. In these younger years, we can rent an equivalent place (rent almost always is cheaper on a monthly basis, contrary to popular belief) and avoid the heavy long term oriented financial burden of a a mortgage loan.

To make the point even more strongly, if we've bought a home and then need or want to sell, we must not only find a willing buyer, but we'll also have to pay a ~7% real estate commission, among the other costs of moving. Thus, if we don't sell for significantly more than 107% of what we paid, we'll lose money. In the early years especially, that's money we can't afford to lose.

Houses are usually hard to sell at an appreciated price in a short period of time (maybe even a long period if there's a "soft" market like we've experienced these past few years) unless we're what the realtors label a "motivated seller", which simply means that we'd be willing and able to accept substantially less than what we paid initially. Again, we'd lose.

Warren Buffett advises us to aspire not to buy the house of our dreams but to aspire to buy a house that we can afford. So let's not hurry into buying, since if for no other reason, the longer we wait to buy, the better the home we'll be able to afford. And with peace of mind, too.

That's my view of credit cards, student loans and early adulthood home mortgages. Avoid them if you can. But if you decide to go ahead anyway, do so with your eyes wide open.

Thanks. Bob.

Thursday, June 16, 2011

"We the People" are Waking Up

Two very good but different articles are worth a look today. A sense of optimism surrounds each about our American condition and future as well.

In "Rick Perry: Ready for Prime Time?", the recent Texas record reveals super strong job growth accompanied by things like no state income taxes, a disdain for overleveraged home mortgage obligations and a healthy respect for the tenth amendment (keeping the "well intentioned" national politicians from controlling everything), and all of these things contribute to making a Rick Perry presidential candidacy in 2012 a compelling alternative to the current administration.

Simply stated, the question to be put before the voters would be whether the road to recovery requires less or more national government intervention.

I'd bet on the inherent wisdom of our fellow citizens in making the right choice.

In "States Want More in Pension Contributions", there's a good discussion about how almost all of our 50 states are addressing in an aggressive manner the underfunded (to say the least) public employee pension financing issue by requiring either more contributions or reduced benefits, or both, with respect to public employees. These changes would in turn bring public employee retirement benefits closer to, but not at parity with, those received by private sector employees.

Looking back at history, Presidents Franklin Delano Roosevelt, Jimmy Carter and Barack Obama all came to office after the economy was in a severely weakened condition, and the American people were concerned and perhaps even scared about our economic future. Government solutions through intervention and active programs were offered by all three Presidents, and "We the People" bought the story each time. When we discovered each time that government intervention wasn't, because it couldn't, going to provide any real solution to our problems, we chose the free market entrepreneurial approach to economic growth. Such an individual driven free to choose based private sector system, although imperfect for sure, best describes our American "memes".

In the end, "We the People" believe that a government based on individual rights and responsibilities provides the best opportunity for prosperous economic growth. The individual's right to be left alone is a strong one indeed

To summarize, my strong view is that our economic history teaches that we Americans are a freedom oriented resilient people who genuinely prefer limited government, but that sometimes we look for what appears to be the easy answer during economically stressful times. Soon thereafter we invariably regain our collective and peculiarly American "can do" spirit of rugged individualism.

Because I expect that to repeat itself this time, I'm very optimistic about our American future. First, however, we'll have to wake each other up and smell the coffee.

The two referenced articles today indicate, at least to me, that we're very much in the process of that awakening, even if we're not yet completely alert. Stay tuned.

Thanks. Bob.

Wednesday, June 15, 2011

Military Spending and Our NATO "Partners"

We and our NATO "partners" have some serious strategic choices that must be made and soon (Can We Afford the Military Budget?).

As usual, we do and pay for far more than our fair share. More than twice as much, in fact.

It's time for our "partners" to make all of this much more equitable in every way, lest we are forced to separate ourselves from the group.

Times are changing. Bob.

Don't Know Much About History .... Hope for Economics

National test results indicate that History is the worst subject for 12th graders while their best performance is in Economics.

This is hard to believe as an understanding of history is a solid foundation, if not a prerequisite, for our ability to understand economics.

Oh well, we have to get to work hard on this so our young people will know where the words "We the People" originated.

Tuesday, June 14, 2011

Savings, 401k plans and such .... The Road to Knowledge

The referenced article (Retirement Plans Make Comeback, With Limits) deals with the current state of private sector 401k defined contribution retirement plans and the reinstatement of company matching contributions.

Along these lines, my own view is that each of us must make a serious effort to gain more knowledge about saving and investing as it clearly represents one of the keys to our future well being as members of a free and self reliant society. The financial security for future generations will only come as a result of our individual and combined efforts to make it happen. First, we must come to know that which in the past we perhaps didn't need to know.

Accordingly, we and our fellow citizens need to take the time to acquire the necessary knowledge to make good financial related decisions both for ourselves and our families.

This entire and very important subject of defined contribution versus defined benefit plans, social security versus our individual saving and investment responsibilities, private versus public sector benefits and plans, and our competitiveness as a nation, when coupled with the history of all of the above, will require lots of analysis and discussion.

We'll begin this investigation soon, and I hope you'll participate, as I intend to, in the learning process ahead.

Thanks. Bob.

Monday, June 13, 2011

the local school funding silliness maze .... time to become knowledgeable

Households owe an all time high of more than $13 trillion. That's the bad news. The good news is that they are gradually reducing their debt load (Number of the Week: Average Household Still Needs to Trim $26,172 in Debt

Overall the national debt is $14 trillion, continues to climb daily, and even optimists expect daily increases in the debt for years to come. No good news there.

The household debt will definitely come down over time as people necessarily "deleverage" during the next several years, a process, albeit painful, which already is well underway. However, that deleveraging process will have a restraining effect on economic growth rates for many more years and thereby limit employment gains.

When looked at in relation to the national debt, there is no realistic hope that the ongoing individual debt reduction effort will offset the annually expanding national debt levels.

Making a bad situation worse, our government continues to "incentivize" people to borrow. The tax laws encourage our fellow citizens to take on heavy levels of debt, specifically with respect to home purchases and student loans. As a result, they're the two biggest individual debt items while credit cards are a close third.

To cite just a couple of these government "incentives" to induce citizens to become indebted, let's mention just a few of the home related goodies. These include tax deductible mortgage interest, property tax deductibility and government guarantees of thirty year fixed interest rate loans, thus spurring buying by granting much more favorable credit terms and interest rates than a private lender could grant. And taxpayer subsidized student loans for college and trade schools are now available to just about anybody who can sign the papers.

Now let's get local. We'll use the county school district where I live as an example. The annual operating budget is ~$200,000 million, excluding the capital spending for land and school construction, transportation, maintenance and the like. Of the operating budget only 40%, or $80 million, is funded by local property taxes. The remaining 60%, or $120 million, is funded by the state ($100 million) and the federal government ($20 million). The capital budget is to be funded by a local sales tax in the county.

Our approach to funding the K-12 county schools is convoluted, to say the least, and needs a complete revision. If we choose to keep following the same funding and financing formula with respect to operating our county public schools and their construction and financing, we would need to triple the level of property taxes to pay for the schools ourselves and not borrow from the Chinese, which we in effect do now, albeit in a most indirect way.

We build some really expensive schools. For instance, the land and construction costs for one recently built county new high school amounted to $40 million. Another school's land and construction recently cost $20 million. And another cost $15 million. And so on.

The "logic" seems to be that if we build it, they will come. And when they come, they will buy homes and buy lots of things at our retailers as well, thus increasing such things as property valuations, property taxes and sales taxes, too. The freshly found money would then be used to pay off the loans and, for many of the participants, to turn a nice profit as well.

All in all, adopting a speculative at best real estate centered approach to sustained county economic growth seems more than a little risky to me and probably to others as well (The Sickness Beneath the Slump). To repeat, the apparent local government "business model" has the school district borrow the money to buy the land and build the new schools. In turn the real estate industry builds the shopping centers, golf courses, recreational facilities, residential areas and supporting infrastructure to accommodate all the people who we hope will move into the school district and attend the new schools.

Unfortunately, the build it and they will come real estate related prosperity model seems to have broken down in our area, as it has elsewhere. Yet our "local" appetite seems endless for this type of endeavor. So if that's "our plan", then let's agree to pay our way as we go and see what happens.

Accordingly, here's a silly proposed "attention getting" solution.

We simply add to the individual taxpayer's annual property tax burden directly in a pay as we go fashion instead of our traditional kick the can down the road way.

One way to do this would be by tripling our local property tax bills. Or doubling the sales taxes, or some such combination thereof. Or if we locals don't want to do that, we could decide instead to immediately curtail our local government's unnecessary spending in a big way. I'd vote for that.

Maybe this sort of drastic "tax it now if we're going to spend it" suggestion would get our fellow citizens directly involved. And in turn, it would then get the involvement of our elected public servants at the local, state and federal levels, too. At least we can try.

Let's sum it up now. In round numbers, total local K-12 education funding in the county (for operations only) is supported by ~40% with our c/o/t local property taxes. Another 48% comes from the state and the other 12% from the national government. Like most other states, we also have substantial unfunded pension and health obligations for retiring school employees, too. Of course, since 30% of the state budget is financed by the federal government and since 12% of our local school funding comes directly from the federal government as well, and since the federal government doesn't have any money of its own to grant our states and local school districts, we in essence have been building schools and operating them with loans from the Chinese. I say we stop it.

In the end, it's simple. It's our c/o/t money, so we need to take charge. And why not start now? As President Reagan said, "If not us, who? If not now, when?"

You probably won't like my tripling of the property taxes or doubling of the sales taxes proposal. Neither do I. But it's past time for us to get "in the arena" and take meaningful action. So let's agree to do something, if only at first to take the time to become knowledgeable about what's going on in our own back yard. Wherever we live.

Thanks. Bob.

Friday, June 10, 2011

How to Create Jobs

Today's highlighted articles deal with economic growth and job creation. They each and all relate to the prior posting about our citizens' upcoming free choices about taxes, hard work and the dole.

(1) "The Lone Star Jobs Surge" describes how Texas, happily for Texans, is a genuine outlier among the states when it comes to creating jobs during the past several years. In fact, Texas alone has been responsible for 37% of job growth throughout America since the summer of 2009. Its free market and business friendly approach has been effective, unlike the national direction taken in Washington and in most other states as well.Link
(2) "A Gulf Oil Drilling Revival" concerns the ability of the private sector to invest in a productive manner that will support economic growth and, in this instance, a much needed domestic energy production boost, too. When government chooses, America loses. When the market is allowed to work, America wins. Scarce capital is best allocated by the private sector MOM methodology by engaging the animal spirits of companies and their shareholders who choose to invest their own, and not the taxpayers', money and thereby accept the risks and potential rewards associated therewith.

(3) "Three Jobs Scenarios: Which is Most Likely?" and "Will Stronger Exports Lead to Significant Job Growth?" are concerned with jobs, manufacturing and exports. The central thesis is that the manufacturing sector must again become a sufficient employment grower between now and 2020 to get us back to the 2007 pre-recession unemployment rate of ~5%. It's not likely to happen, however, and the articles explain why that's the case.

To grow the economy and regain the jobs we've lost, we need strong manufacturing growth. To achieve that, we need to be world class competitive in both skills and productivity, and our labor costs on an all-in basis must be competitive to enable us to gain market share.

Regaining our winning ways economically to achieve the desired employment growth anytime soon currently looks like a long shot at best, but it's sure not a job that government can address successfully. The private sector is our only way to victory in this world wide competitive economic struggle, whether we like it or not. And I like it.

Thanks. Bob.

Thursday, June 9, 2011

Two Questions; More taxes needed? Do we choose work or the dole?

A friend recently asked my opinion on two questions; (1) whether we should raise taxes and if so, on whom, and (2) given a clear choice, how many of us would choose to be on the dole as opposed to working for our income.

First, let's tackle the tax question. As a general guideline, I'd propose what can be referred to as the 90/10 rule. If we always followed its guidance, we would have, if not an entirely appropriate tax policy, at least a sensible one.

In essence the rule can be stated as follows; if the majority of the people vote to have 90% of the population pay more taxes in a compassionate effort to assist the assumed 10% of the people who really need help, then let's do it. On the other hand, even if 90% of the people would be willing to vote to raise taxes on the remaining 10% of the people in order to spread entitlement benefits throughout the society, then let's not do it.

In other words, "We the People" should have the government that we are willing to pay for with our own money.
Now for the second question; Would most of us choose the dole or work, given a well and clearly explained choice? Choosing the dole or work approach is a false choice in the end. That's because nobody would agree to work and provide the free lunches for those who chose the free lunch route. In other words, we can't all be on the dole and prosper.
When comparing socialism and capitalism, Churchill described the situation thusly, "The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries."

Accordingly, my bet is that pursuant to the be careful what you wish for school of thought, a realistically communicated choice between work and dole would result in the vast majority of our fellow citizens opting for the work route.

But even if I'm wrong and the voters would opt for the dole instead of work, we self chosen workers would simply withdraw from such a socialistic society in which "we" wouldn't fit and clearly wouldn't belong. In sum, if nobody works hard, then nobody lives on easy street with free lunches being served. It's as simple as that.

Currently we rightfully don't trust our elected officials to act routinely in the best interests of our larger society. And that's a genuine problem which needs to be faced directly and continuously until it's solved by "We the People" taking the reins.

In fact, there are far too many factions or special interests which seek and secure particular governmental favors, even though these interests are often contrary to society's interests as a whole, and don't "promote the general Welfare", to cite the Constitution.

For a relevant and still pertinent discussion of the role of special interests or factions and their long term historical influence on government, please refer to James Madison's Federalist paper #10 from 1787 which reads in part as follows, "But the most common and durable source of factions has been the various and unequal distribution of property. Those who hold and those who are without property have ever formed distinct interests in society. . . . The regulation of these varying and interfering interests forms the principal task of modern legislation, and involves the spirit of party and faction in the necessary and ordinary operations of the government."

And when you finish that one, please go to Madison's Federalist paper #51 which points out that men aren't angels, whether the men involved be those men then being governed or those then doing the governing. In sum, government needs to be restricted to having very few powers over the people.

Finally, here's a quote worth remembering from the French anti-socialist Frederic Bastiat. Circa 1850 Bastiat said this of how government functions "The state is that great fiction by which everybody tries to live at the expense of everyone else."

That's the French way. But it never has been and never shall it be the American way. At least that's way I see things.

Thanks. Bob.

The Two Parts to Debt ... One Easy, One Hard

Debt is easy to accumulate and hard to eliminate. It's as easy and as hard as that.
It's all part of the short versus long term equation or what economists label the time inconsistency problem. In the short run, going into debt by spending money that's not ours feels good. In the long run, come payback time, it's usually the kind of fun we wish we'd skipped.
Debt is a habit, and we should encourage our younger selves not to get into such a bad habit. It's easier to stay away from at the outset than to escape in the end. That's for certain.
The fact is that we have too much debt, both as individuals and as a nation, and we need to address the long term aspects of it now, so it won't get too far out of hand in the future. It's not irreparable just yet but a major effort is long past due.
First, let's generalize about how we get into debt so easily by using a straightforward explanation. Individuals as well as countries engage in financial activities which include generating income, incurring expenses, and then arriving at the resultant savings or borrowings therefrom. Savings can then be invested, while, on the other hand, borrowings represent debt along with the interest charges thereon until the debt has been repaid in full.
We create accounting reports in the form of income statements and balance sheets to tell us how we're doing financially. In brief and at the risk of oversimplification, the income statement reveals what happens to income in relation to expenses during a given period of time. If we bring in more money than we spend during that timeframe, we generate a surplus or savings. If we spend more than we bring in, however, we generate deficits and need to take on debt which is then owed to our creditors. Thus, over time, as a result of whether we spend more or less than we receive, we either accumulate savings or debts. Either is habit forming.
It really doesn't matter how much we earn or spend in absolute terms. It's the relationship of income to outgo that matters. We can always spend more than we make, regardless of our income, but we also generally can spend less than we make if we establish the habit early enough.
The balance sheet or statement of liabilities reveals the cumulative "over time" effect of savings or borrowings for each prior period unti today's date. That is, the balance sheet represents the current status of the our financial condition at a point in time which shows what's happened to the cumulative inflows and outflows over many years. An ongoing scorecard of where we stand at any point in time, if you will.
Income statements are often referred to as moving pictures and balance sheets or liability statements as photographs.
Debt is a balance sheet or liability item. It tells us what obligations we have undertaken and how much future income, over and above interest charges on the debt incurred, will need to be earned and then repaid to the creditors over time. Repayment is intended to be made possible by future earnings (income statement) and in large part from the returns on the investments made by the money spent as a result of the prior debt incurred and for which interest payments are being made.
Without going into unnecessary detail at this point, far too little attention is generally paid to the balance sheet or debt piece of the equation. Unfortunately we usually focus on the income statement piece instead. This is true whether we're looking at the behavior of individuals or for our country as a whole.
Debt represents neither more nor less than a claim on future earnings or surpluses. In addition, the interest on the debt is an ongoing "rental fee" charged for the use of the lender's money until repayment in full has occurred.
To repeat the obvious, the reason we incur debt is because we haven't saved enough or earned enough, as the case may be, to make the investment from our own funds. If in year one we earn 100 and spend 80, we save 20. But if we earn 100 and spend 120, we must borrow 20, and we incur debt. We experienced the exact same earnings in each instance, but due to different spending levels we ended up in a totally different situation with respect to the future opportunities or obligations for our family or country.

In order for us to be able to know how to manage all of these inflows and outflows properly, we must first obtain the requisite general KNOWLEDGE required to manage our financial affairs as responsible family members and informed citizens. In a free society, we simply must commit to take the time and make the effort to become knowledgeable citizens, the strongest piece of a free society. Accordingly, it's imperative that we become familiar with both the good and bad long term effects of cumulative savings and debt, as determined by annual surpluses and deficits.
As a country, we don't have so much of a short term problem as we do a long term and seemingly intractable situation. And too many people have the same problem as does our country as a whole. Knowledge is the only permanent answer. We need to know why we must take the near term, albeit perhaps somewhat painful, steps to get this debt situation under control and well on the way to a satisfactory long term resolution.

As individuals the temptation to take on debt begins early in life. We are encouraged by many to borrow for such things as student loans, credit card purchases, cars, houses and on and on. Borrowing isn't inherently bad, but if it precedes saving, it is bad, because it thereby precludes savings and investing.

In the end, it's all about habits. Both individually and as a nation. And as citizens of cities and states, too.
We'll spend some time on this "knowledge about debt" stuff in future posts. While it's obviously best to get this knowledge at a young age, it's never too late to decide to be a better informed citizen. Let's learn how to "keep it easy" together.
Thanks. Bob.

Tuesday, June 7, 2011

Finding Even More Debt Related Holes Dug by Pogo

Two articles today point out how deeply we've dug the debt hole as individuals.

They are "Second-Mortgage Misery" and "Zombie Consumers May Chomp Into Growth". While sobering, they both merit your attention.

A central and very critical real issue confronting our country today, both as individuals and as a freedom based society, revolves around the requirement for achieving basic financial knowledge.

It's essential that we as a free people learn from our mistakes of the past several decades and take the opportunity to become an even stronger nation as a result of this "new knowledge".

We'll be spending lots of time discussing how to assist in the financial literacy efforts ahead as well as its potential for helping Americans and America do even greater things in the years ahead.

Thanks. Bob.

Monday, June 6, 2011

Achieving Financial Literacy is Essential to all Americans

We are not yet a nation of financial literates as the article "Most Americans haven't Planned for
Retirement and Other Areas of Concern
" points out in some detail.

When we do become more financially literate as a society, we will insist that our elected representatives act in a time consistent and responsible manner as well. That would indeed be a wonderful development for all Americans.

In brief, the article points out that as the responsibility for making critical financial decisions has in recent years shifted to us as individuals, and in a difficult economy at that, not enough Americans have developed the capability to properly deal with these all important personal financial matters.

As an example, while the shift in retirement defined benefit pensions to defined contribution self directed plans such as the 401k and IRA has been occurring over several decades now, we have not yet become familiar enough to credibly manage these types of decisions ourselves in a responsible manner.

Regrettably, the same goes for far too many other financial choices as well.

Thanks. Bob.

Illinois Exemplifies State Issues of Timing Inconsistency

Illinois has gone from the Land of Lincoln to the Land of Delinquents.

It may make you ill, but I still recommend that you take the time to read a very recent example of political timing inconsistency at work (politicians choosing to focus only short term at the expense of the long term).

Unfortunately, this kind of political behavior is not especially unique to any particular state. But it is sad.

Thanks. Bob.

Sunday, June 5, 2011

debts and interest ..... a new way of looking at old things

There may be nothing new in the world except the history we have yet to learn, as President Truman said.
Still, I've been trying to look at our national debt and deficits in a new way, and it is this spirit that this "new" way of looking at this old problem is submitted for your thoughtful consideration.
Here's the sad but true situation. We're digging the tax burden hole deeper, because while we're not "officially" raising taxes, we are in effect increasing our national "tax" (state and local, too) burden each day as additional debt and the interest thereon accrues. And that's each day of every year.
Even worse, the added borrowings aren't going into investments that will improve the productive outputs of the economy. Accordingly, payrolls aren't being helped at all by these expenditures. Economic growth not only isn't being assisted; it's being restrained instead.
To repeat, the ever increasing debt and interest charges act as taxes. They are the result of unproductive spending as opposed to private sector investment.
In essence, and although well intentioned, we are borrowing this money and incurring these interest charges, at least indirectly, to provide benefits to the elderly through the medicare, medicaid (nursing home) and social security programs.
While we have always been, and will always be, a compassionate society, the type of compassion we Americans like to practice requires wealth to support it. Although we may well not be more compassionate than the citizens of many other countries, we are wealthier than most and therefore can afford to provide a degree of comfort to the elderly that many societies simply can't afford. That's being jeopardized by our actions.
In other words, we are in the midst of a goose and golden egg dilemma. That is, we have forgotten the main idea that a free and prosperous society is, is a foundation from which we can provide aid and an abundance of material comfort to the afflicted, the poor and the elderly.
An economically vibrant society is indeed the enabling the goose that lays the golden eggs. And without the eggs first being laid, borrowing to spend on compassionate and worthy matters will only exacerbate the ever growing problem of too much debt and too little economic growth. That means more unemployment and more pain for a long time to come.
Every economist, left or right, acknowledges that taxes impede growth. And that impeded growth results in fewer jobs. And fewer jobs means fewer government revenues in the form of income and payroll taxes.
Personal income and related payroll taxes amount to more than two thirds of federal taxes paid or inflows. On the other side of the ledger, more than one half of our federal spending goes for medicare, medicaid, social security and interest on the national debt. The inflows must necessarily precede the outflows. That means economic growth is essential or we're going off the national debt cliff down the line.
As we all know, the official national debt chart shows pretty much an upward sloping straight line since 1981. It has grown from ~$1 trillion to more than $14 trillion. Interest (tax) on that debt will be more than $400 billion in 2011.) Our national debt for years has been growing consistently at a compound annual rate of nearly 10%. Thus, it doubles every seven years. And now it's growing faster each year as the government programs and related interest charges pile up to "fix" or "stimulate" our way back to prosperity.
We are spending money as a federal government which we don't have. In fact, we now borrow 40 cents of each dollar we spend as a country.
But that's not even the half of it. We have created additional unfunded liabilities which are several times greater than the $14 trillion national debt. In fact, the unfunded medicare/medicaid and social security liabilities combined are substantially more than $50 trillion.
Then there are the unfunded state and local pension and medical benefits, debt on public and quasi public structures and I don't know what else.
When times are tough, Keynesian economics emphasizes demand and increasing the propensity to consume, which will in turn create additional supply. Keynesianism' opposing view, supply side economics, emphasizes supply and posits that increased supply will generate additional demand. Both theories are about creating economic growth, employment and a prosperous society. But they simply don't address our "new" problem.
To wit, economic growth won't be sufficient to put a dent in our "balance-sheet" and related issues unless and until we stop the deficits. The deficits can't stop until we stop creating funded or unfunded liabilities for the non investment, non wealth creating, non productive segments of our society. And, finally, we can't begin to repay debt until we stop the ongoing deficits.
No matter what it's called, the spending of today isn't investment in future growth. It's largely generational transfer payments.
Demographics also play a huge, if usually ignored or at least undiscussed, role as well. We are getting older. Also, we are retiring about five years earlier than we used to, and we are living about five years longer. That means ten more years of retirement pay, excluding medicare and medicaid (nursing home portion) payments, all of which contribute to the tax burden and transfer payment dilemma.
It's time that we emphasize debt and how our future is imperiled as a result of our actions over the past many decades. It's not a demand or supply side problem. It's a living within our means problem. And borrowing doesn't do anything except defer the day of reckoning.
Of our estimated 2011 federal budget deficit of ~$1.7 trillion, more than $400 billion is interest on the debt. It's not hard to envision that $400 billion becoming $1 trillion in less than a decade as deficits continue, the debt compounds and interest rates rise. And that doesn't include any amount .... not one cent .... for debt repayment either.
Spending $1 trillion on interest will further inhibit economic growth. Slower growth will reduce hiring and increase unemployment, which is turn will makes the problem even worse. This vicious spiral is in effect now and, absent effective remedial action, will accelerate over time.
Please consider a few more "offensive" facts to contemplate while pondering why we continue to elect not to tell ourselves the truth. Or more importantly, fail to do anything about it.

We say that our state's budgets are in balance as required by state law. Yet we are able to balance those budgets only because ~30% of state spending comes from the federal government, which doesn't have any money of it own.

And our average state spends close to 50% of its budget on medicaid and education. The medicaid expense is "shared" with the federal government, and education is "shared" with the local school districts.

Local school districts support less than 50% of what they spend with local property taxes. They get the rest of the money for schools from the states. In fact, on average they tend to look to the states for more than 75% of their school operating funds, including teacher salaries, pensions, health care benefits and such. The local districts don't have enough money, the states don't have enough money, and the feds don't have enough money. We pretend otherwise. So we borrow some more, build some more school buildings and the problem grows.

This local/state/federal spend money we don't have game reminds me of what happened in World War I when we loaned money to England to help them fight Germany. After the war ended England agreed to pay us back with payments/reparations from Germany, who had no money to pay England, so we loaned Germany money, so they could pay England, so they could pay us, and so forth. The same U.S. dollar passed around and around until the passing stopped when the Great Depression happened in the 1930s. The charade then ended.

That's how I see it, and I wanted to share what I'm seeing with you.
Thanks. Bob.

Saturday, June 4, 2011

citizens/owners/taxpayers and our short and long term actions

Citizens are owners, as are taxpayers. And citizens are taxpayers, too. Thus, we are all citizens, owners and taxpayers. We need to act accordingly.

Two recent articles make the point, at least for me. Student enrollment in public schools fell by 157,114 jobs in 2008-09, while teacher employment grew by 81,426 that same year. More teachers hired to teach fewer students in the midst of a recession. When combined with the new teachers hired, the total public education workforce grew by 137,000, or almost one new employee was added during the recession for each student who left the system (Notable and Quotable).

The second article (Doctors Inc.: As Physicians' Jobs Change, So Do Their Politics) revealed that many doctors in Maine are leaving private practice and taking salaried hospital jobs. As a result their priorities are changing. There is now a growing tendency to support the government's increasing role in medical care. These same practitioners, when they were owners of their practices, came down firmly and strongly on the side of individualism, entrepreneurship and ownership, arguing strongly for keeping government out of their business. This "old" view of the Maine doctors represents what we think of as the physicians' conventional view. So what changed?

In both cases, it seems like "We the People", or at least some of us, have misinterpreted the concept of citizen taxpayer ownership and instead adopted the all too prevalent short term oriented "it's not my money" stance as opposed to considering the long term responsibilities of citizenship. When the doctors owned their practices, they concerned themselves with both costs and patient care. Now they apparently don't concern themselves with the cost side of the equation. That's too bad. As for the school boards or administrations choosing to add staff in the midst of declining enrollment in a recession, that's not an act in the best interest of their fellow taxpayers and fellow citizens either.

Future generations depend upon current generations to act responsibly, with both a near and long term perspective (what behavioral economists refer to as "time consistency"). That means many things, not the least of which is to act like fiduciaries for the future citizen owners when performing our daily duties.
But too many of us have adopted the stance of John Maynard Keynes who said "The long run is a misleading guide to current affairs. In the long run we are all dead." I totally disagree with Keynes on this, as I do on many other things concerning Keynesian economics as well.
But back to the topic du jour. What does all this short term/long term/citizen/owner/taxpayer stuff have to do with doctors in Maine, public school administrations and concerned citizen taxpayer owners? And our staggering deficits and debt load?

Stated another way, why do otherwise good and responsible people act contrary to their and our long term best interests?
Behavioral economists refer to this as the "time inconsistency" problem. It involves taking actions today which are inconsistent with good policy in the future. This is turn often leads to very bad economic outcomes. A "time consistent" outcome, on the other hand, would dictate that we decide what to do in the here and now in a manner which is consistent with what we want to achieve in the longer term. So we tend to overemphasize the NOW, and that heavily influences, and often inappropriately, our current decision making. Simple examples of time inconsistent behavior would be postponing homework or, in my case, a much needed diet. For us as Americans, it's things like not addressing our deficit and debt problems but instead deferring them into the indefinite future.

Accordingly, my bet is that the aforementioned Maine doctors and public school administrators may well have acted differently if a long term view in the best interests of their "future citizen owner taxpayer selves" (looking at the situation 10 years hence, for instance) had received equal weighting in their respective judgments. But time inconsistency causes us all too often to ignore what's best in the long run and instead behave as if we agree with Keynes when he said, "The long run is a misleading guide to current affairs."

Keynes was wrong about that. My view is that we citizens of today have clear and unequivocal responsibilities to the citizens and adults of tomorrow. To put it directly, we adult citizens have "ownership/fiduciary" responsibilities to those who will follow. Of course, we also have every right to focus on the here and now as long as by doing so our actions don't harm future generations.

Someone needs to remind the Maine doctors of this simple truism. Those who run the public schools need to be told, too. The ability to walk and chew gum simultaneously is required of adult citizen/taxpayer/owners. Short and long term considerations both count equally. Time consistency needs to practiced by one and all. And the time inconsistency problem needs to be fought fiercely.

So why doesn't government cost containment work? It's a simple matter of human nature. In a government run or controlled enterprise, the taxpayer gets the bill. Thus, although government employees such as these Maine doctors and public school administrators obviously well understand that costs to taxpayers matter, they don't alwsys act that way. Nor do they act as if an ongoing cost/benefit analysis is as important in government run institutions as in any for profit business. "We the People" simply aren't as cost conscious when we're spending the taxpayers' money (OPM or other people's money) as we are when spending our own money. I call that the MOM (my own money) versus OPM conflict. MOM wins every time, or should.

So taxpayers generally aren't well represented by their fellow citizens when those citizens, whoever they may be (including well intentioned people like us) serve as government employees. It's not their/our money they're/we're spending, and their/our term of office is brief and may soon expire if they don't actively practice timing inconsistency behavior. The system isn't designed to work effectively, and it doesn't.

On the other hand, individuals, owners or entrepreneurs don't have the luxury of not concerning themselves with the long term and things like profit and cost containment. It's their money they're spending. And besides, they'll go out of business if they don't earn profits. Human nature works here, too.

Short term "time inconsistent" thinking and acting will us into the ground. Squandering societal resources will make us weak.

Free markets cause us to consider both costs and benefits with a long term, "timing consistent" perspective.
In free societies informed citizens will always act as if free lunches don't exist. Because they don't.

Citizen/taxpayer/owners focused on both the short and long term act to "promote the general Welfare", as stated in the Constitution.

Thanks. Bob.