April 28, 2011

War, Debt, Health Care how are they related?

And a lesson on America’s AAA Bond rating

By Melvin J. Howard

Remember that old song War What Is Good For? Absolutely nothing well that’s not so true at least not when it came to financing it. You have probably heard about Bond no not James Bond.

I am talking about the financial kind. So just what are Bonds a Bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest. There are many kinds of bonds but for this entry we will be focusing on Government Bonds. One of the first persons to master the Bond market was Nathan Rothschild. Master of universe at that time, he boasted that he was the arbiter of peace and war, and that the credit of nations depends upon his nod.

Nathan Mayer Rothschild, founder of the London branch of what was, for most of the nineteenth century, the biggest bank in the world. But it was the bond market that made the Rothschild family rich real rich. Lord Rothschild, Nathan's great-great-great-grandson. Said of Nathan he was 'short, fat, obsessive, extremely clever, wholly focused I can't imagine he would have been a very pleasant person to have dealings with. The Battle of Waterloo was the culmination of more than two decades of intermittent conflict between Britain and France. But it was more than a battle between two armies. It was also a contest between rival financial systems: one, the French, which under Napoleon had come to be based on plunder (the taxation of the conquered); the other, the British, based on debt. Between 1793 and 1815 the British national debt increased by a factor of three to more than double the annual output of the UK economy. This increase in the supply of bonds had weighed heavily on the London market.

Now let’s jump to the other side of the Atlantic to another war the Civil war in America and how the North really won. The South's ability to manipulate the bond market depended on one overriding condition that investors should be able to take physical possession of the cotton, which underpinned the confederate bonds if the South failed to make its interest payments. Collateral is; after all, only good if a creditor can get his hands on it. And that is why the fall of New Orleans was the real turning point in the American Civil War. With the South's main port in Union hands, any investor who wanted to get hold of Southern cotton had to run the Union's naval blockade not once but twice, in and out. Given the North's growing naval power in and around the Mississippi, that was non-starter. If the South had managed to keep New Orleans until the cotton harvest had been offloaded to Europe, they might have been able to sell more cotton bonds in London. The Confederacy had miscalculated. They had turned off the cotton tap, but then wasn’t able to turn it back on. By 1863 the mills of Lancashire England had found new sources of cotton in China, Egypt and India. And now investors were rapidly losing faith in the South's cotton-backed bonds. The consequences for the Confederate economy were disastrous. With its domestic bond market exhausted and only two paltry foreign loans, the Confederate government was forced to print unbacked paper dollars to pay for the war and it’s other expenses, 1.7 billion dollars' worth in all. Both sides in the Civil War had to print money. But by the end of the war the Union's 'greenback' dollars were still worth about 50 cents in gold, whereas the Confederacy's 'greybacks' were worth just one cent. The situation got worst by the ability of Southern states and municipalities to print paper money of their own.

With ever more paper money chasing ever fewer goods, inflation exploded. Prices in the South rose by around 4,000 per cent during the Civil War. By contrast, prices in the North rose by just 60 per cent. Even before the surrender of the principal Confederate armies in April 1865, the economy of the South was collapsing, with hyperinflation remember this word I will come back to it later. Was the partner of the North in the defeat of the South. Those who had invested in Confederate bonds ended up losing their shirts. The North pledged not to honor the debts of the South. In the end, there had been no option but to finance the Southern war effort by printing money. It would not be the last time in history that an attempt to buck the bond market would end in ruinous inflation and military humiliation. The fate of those who lost their shirts on Confederate bonds was not especially unusual in the nineteenth century.

The Confederacy was far from the only state in the Americas to end up disappointing its bondholders; it was merely the northernmost delinquent. South of the Rio Grande, debt defaults and currency depreciations verged on the commonplace. Latin America in the nineteenth century in many ways foreshadowed problems that would become almost universal in the middle of the twentieth century. Partly it was because Latin American republics were among the first to discover that it was relatively painless to default when a substantial proportion of bondholders were foreign. It was no mere accident that the first great Latin American debt crisis happened as early as 1816, when Peru, Colombia, Chile, Mexico, Guatemala and Argentina all defaulted on loans issued in London just a few years before.

But by the later nineteenth century, countries that defaulted on their debts risked economic sanctions, the imposition of foreign control over their finances and even, in at least five cases, military intervention. Defeat itself had a high price. All sides had reassured taxpayers and bondholders that the enemy would pay for the war. Now the bills fell due take Berlin Germany for instance. One way to understand the post-war hyperinflation was a form of state bankruptcy. Those who had bought war bonds had invested in a promise of victory; defeat and revolution represented a national insolvency, the brunt of which necessarily had to be borne by the Germans creditors. At the conference at Versailles, which imposed an unspecified reparations liability on the fledgling Republic the total indemnity was finally fixed in 1921, the Germans found themselves saddled with a huge external debt with a nominal capital value of 132, billion 'gold marks' (pre-war marks), equivalent to more than three times national income. Although not all this new debt was immediately interest-bearing, the scheduled reparations payments accounted for more than a third of all hail Hitler’s expenditure in 1921 and 1922.

Hyperinflation seemed to be the word of the day after the First World War. Austria - as well as the newly independent Hungary and Poland - also suffered comparably bad currency collapses between 1917 and 1924. In the Russian case, hyperinflation came after the Bolsheviks had defaulted outright on the entire Tsarist debt. Bondholders would suffer similar fates in the aftermath of the Second World War, when Germany, Hungary and Greece all saw their currencies and bond markets collapse. It could be easy to associate hyperinflation with the costs of losing world wars; it would be relatively easy to understand. Yet there is a caveat in more recent times, a number of countries have been driven to default on their debts. Either directly by suspending interest payments, or indirectly by debasing the currency in which the debts are denominated.

There is a slight gamble involved when an investor buys a bond. Part of that gamble is that an upsurge in inflation will not consume the value of the bond's annual interest payments. If inflation goes up to ten per cent and the value of a fixed rate interest is only five, then that basically means that the bond holder is falling behind inflation by five per cent.' As we have seen, the danger that rising inflation poses is that it erodes the purchasing power of both the capital sum invested and the interest payments due. And that is why, at the first whiff of higher inflation, bond prices tend to fall. In 1975, as inflation soared around the world, the bond market made the casino’s look like a pretty safe place to invest your money. At that time when US inflation was surging into double digits, peaking at just fewer than 15 per cent in 1980. That was perhaps the worst bond bear market in history.' To be precise, real annual returns on U.S. government bonds in the 1975 were minus 3 percent, almost as bad as during the inflationary years of the world wars. Today, only a handful of countries have inflation rates above 10 per cent and only one, Zimbabwe, is afflicted with hyperinflation.'"" But back in 1979 at least seven countries had an annual inflation rate above 50 per cent and more than sixty countries, including Britain and the United States, had inflation in double digits. Among the countries worst affected, none suffered more severe long-term damage than Argentina.

Inflation has come down partly because many of the items we buy, from clothes to computers, have got cheaper as a result of technological innovation and the relocation of production to low-wage economies in Asia. It has also been reduced because of a worldwide transformation in monetary policy, which began with the monetarist-inspired increases in short-term rates implemented by the Bank of England and the Federal Reserve in late 1975 and early 1985. Also trade unions have become less powerful. Loss-making state industries have been privatized. But, perhaps most importantly of all, the social constituency with an interest in positive real returns on bonds has grown. A rising share of wealth is held in the form of private pension funds and other savings institutions that are required, or at least expected, to hold a high proportion of their assets in the form of government bonds and other fixed income securities. With every passing year, the proportion of the population living off the income from such funds goes up, as the share of retirees’ increases. In a graying society, there is a huge and growing need for fixed income securities, and for low inflation to ensure that the interest they pay retains its purchasing power. As more and more people leave the workforce, recurrent public sector deficits ensure that the bond market will never be short of new bonds to sell. People forget just months before President Bush's election, in September 2000, the National Debt Clock in New York's Times Square was shut down at $5,676,989,904,887 it ran out of room. Bush agreed with the principle of paying down the debt but did not have a committed specific date for eliminating it. That lack of commitment on President Bush’s part was a tale tale sign of things to come. When Bush entered the White House, his administration ran a budget deficit in seven out of eight years. The federal debt has increased from $5 trillion to more than $10 trillion when Bush left office the national debt stood at over 11 ½ trillion dollars. The National debt now stands at over 14 trillion dollars.

That is why it is so imperative that health reform take root and not go back to the status-quo with out it we are on a collision course to debt hell. An estimated $2.26 trillion was spent on health care in the United States, or $7,439 per person. Health care costs are rising faster than wages or inflation, and the health share of GDP is expected to continue its upward trend, reaching 19.5 percent of GDP by 2017. As a proportion of GDP, government health care spending in the United States is larger than in most other large western countries. On top of that, there is substantial expenditure paid from private insurance. A recent study found that medical expenditure was the cause for 60% of all personal bankruptcy in the United States. According to Dr. David Himmelstein of Harvard University who helped author the study, "Unless you're Bill Gates or Warren Buffett, your family is just one serious illness away from bankruptcy for middle-class Americans, health insurance offers little protection.

The US spends more on health care per capita than any other UN member nation. It also spends a greater fraction of its national budget on health care than Canada, Germany, France, or Japan, In 2004 the US spent $6,102USD per person on health care, 92.7% more than any other G8 country, and 19.9% more than Luxembourg, which, after the US, had the highest spending in the Organisation for Economic Co-operation and Development (OECD). Hold tight here I am going to have to mention politics hear I know I know but there is no getting around it. Now I know most Republicans would rather not see our country crushed by hyperinflation, depression or default on America’s debt i.e. not lifting the debt ceiling just to prove an ideological point or to try to thwart President Obama’s domestic agenda. If that is the case it is distressing and malice for these issues are far too important to be playing politics with at this time. But history tells me that is exactly what is going on. Extreme conservatives that would be today’s Tea Party fought recovery in the last depression, and Roosevelt did not spend enough to get us out of it. It took World War II to provide the excuse for the enormous deficits that finally jolted the economy out of depression and into overdrive. You might ask yourself why borrow and spend i.e. Economic Stimulus? Let me give you an illustration why? Money flows in circles: you get paid; you spend it, and the store pays someone else, who spends at another store. But what if everyone only spent 10% and saved 90% in the bank? The circular flow of money would dwindle away to nothing, all the money would end up in the bank, the stores would shut down and we'd all be out of work and broke. You know like some of your friends and relatives are now!

April 11, 2011

Healthcare and the Impact on the Federal Budget

By Melvin J. Howard 

There appears to be at least as many permutations and combinations available for presenting the US Federal Budget and Government Spending data as there are years that it would take you to count to $2 Trillion dollars, which is about 60,000. Note that in the US the number One Trillion is One Million times by One Million, or 10 to the power of 12. For the mathematically inclined, the correct mathematical definition of One Trillion is One Million to the power of 3, and the correct mathematical definition of One Billion is One Million to the power of 2. But in America numbers work differently, so it came to be that One Billion got redefined as One Million to the power of 1.5, and One Trillion is redefined as One Million to the power of 2. The effect and advantage of being the Imperial Super Power is that everybody else in the world now had to adopt this number conversion.

Rome is Burning

The U.S. Federal Budget has been in the news a lot lately both Republicans and Democrats both showcasing their version of the numbers. How you present the Federal Budget depends entirely on the bias you start with and the point you are trying to make. Therefore I decided to admit the bias up-front and then you can better decide what to do with the data. My bias in looking at U.S. federal spending was the thought that maybe we might be on fire just like the Roman Empire was over 1,000 +-years ago. To be sure, the Roman Empire had many similarities with the modern U.S. Empire - both being Empires built on a combination of clever legal systems, hard-work, confidence, much brutality in military conquest and extensive use of slave labor, coupled with a system of desirable, tempting, and free entertainment to warm the masses to the Empire (think Roman Idol), as well as erratic spouts of helpful assistance to the poor. Certainly also, a widespread Roman currency and trade system, and an extensive taxation and government spending program were just as critical to the success of the Roman Empire, as they are now in today's American Society. 

The comparisons of Budgets started with finding a Roman budget at a time around when their leaders stopped being elected and instead were "appointed" and when ancestral lines of Emperors became very popular. So I started with the early Empire days of the 1st - 2nd Centuries AD. The approach I have taken is based on historical data from those days, to calculating the Roman budget in this period. The total Roman budget was about $1 billion sesterces, a common Roman currency that started in the BC years as about 1/4 of the Moneta denarius. These are estimates for the Roman budget in 150 AD broken down into the following expenditure categories. Roman Empire Budget Distribution Source of Roman Data Expense Item Percent Outgo:

  • Military 70%
  • Civil Service - Judiciary, Police, Government Departments 10%
  • Social Spending 5%
  • Economic Infrastructure 5%
  • Other - Mostly Foreign Affairs 10%

Now compared to U.S. Actual Government Spending in earlier years subtracting both Social Security and Medicare, which have been fully self-funded by separate taxes (the FICA taxes) since the early 1980s. Then you subtract interest on public debt for comparison purposes since the Roman Empire did not have a consistent, well-developed system of Sovereign debt issuance like America does today.

Some other adjustments to be made to U.S. Spending were to include Veterans Benefits, Military Retiree benefits and Military Assistance to the Provinces (Countries) of Judaea and Egypt (Israel and Egypt) with Military Spending. The inclusion of benefits to ex-military employees is consistent with the way the Roman data was derived, and the inclusion of military aid to Israel and Egypt was done because these were the two most expensive outer-Provinces to maintain under both Regimes. The following distribution of expenses on a comparable basis can be derived from the full current Budget of the U.S. Government. We are focusing on the demands on the Budget coming from the aging of the population and society's increasing medical expenses. America’s Budget Distribution Expense Item Percent Outgo breaks down to something like this:

  • Military 40%
  • Civil Service Admin, Justice, Treasury, Fed Civil Retirees 10%
  • Social Spending - Medicaid, Food, TANF, Unemployment, Housing, SI 30%
  • Physical and Economic Infrastructure 10%
  • Other - Education/Training, Research, Foreign Affairs 10%

Clearly the data indicates that social spending in the Roman Empire was generally at a very low level. However social spending tended to happen erratically in much larger amounts, depending on the Emperor of the day, and the need to win over public opinion. What is clear from looking at the two budgets is that the current U.S. budget has more regular proportions of social spending, especially in comparison to military spending. However, it should be noted that the U.S. budget looked much more Romanesque in earlier decades of the last century, notably during the 40s for WW2 and during the 50s in gearing up for the Cold War, where military expenditures were close to, and sometimes even exceeded, the Roman proportion.

The move from a Romanesque budget of the 1950s to current U.S. spending distribution has a lot to do with increased healthcare expenditures such as Medicaid, and the introduction of things like the Earned Income Tax Credit, and changes to Unemployment, Housing and Food Assistance Programs. Note that most of these social spending items included in the 30% fall under the grouping of "Means Tested Entitlements" which means that they make up the social safety net for people whose income and assets fall below a certain threshold.

The other primary social spending benefits or social safety net items are Social Security and Medicare, which apply to Retired and Disabled Persons and are not means tested. As noted earlier these benefits have been self-funded through separate employer and employee contributions (known as the "FICA taxes") for the past two decades and half. In general, rising medical costs affect both Medicare and the means tested healthcare entitlements such as Medicaid. In fact, one of the Historical Data Tables in the Budget shows total government spending on all health programs to have increased from about 2% of the Budget in 1962 to just over 10% by 1980, to almost 25% or one quarter of the Budget by the year 2001.

The USS Ark of Healthcare Reform

As anyone with a health insurance policy will tell you, healthcare costs under private sector coverage continues to rise. Overall, an increasing amount of America's total Gross Domestic Product (GDP - a measure of the total economy) is spent on healthcare. To keep score of the size of an economy and the size of national income people often talk about GDP . This measure of national income is also equivalent to Annual Consumption Expenditure plus Government Spending plus Investment - which are the only three places your money can go. That is, any income you get either goes to taxes, you spend it or you invest it. U.S. GDP is about $14.6 Trillion US dollars. Consumption Expenditure makes a Trillion dollars a year. Today healthcare expenditure makes up about 16.5% of U.S. GDP. About 30% of this is picked up in Government Spending; the rest is in private spending. At the current rate of growth, healthcare costs are predicted to nearly double to $4.5 trillion in the year 2019. At that point, those costs will account for 19.3 percent-almost a fifth-of our GDP. America spends more on healthcare as a percent of its GDP than any other developed nation, but has less public coverage for this cost and a large uninsured population. So, the high spending on healthcare in the U.S. must be explained by something other than a general concern that everyone has adequate care.

To a very large extent the high level of American healthcare spending is a result of America becoming victim of its own technological success, its sedentary lifestyle and a culture obsessed with longevity, overcoming natural cycles and the desire to "stay young". The latter appears to be common to inhabitants of Great Empires of the past. This cultural obsession, fed by medical technologies far superior to those of any other country, may suck up so much of the US economy that it won’t be able to sustain its global super power status. Indeed it is perhaps the very fear of this that is really driving the attempt to reform and redefine Healthcare, Social Security, Medicare and Medicaid.

Now moving on to some of these other expense items, it should be noted that "Other Spending" includes Foreign Affairs expenditure other than the expenses of maintaining the outer provinces of Israel and Egypt, which are included in the Military item. Under both Empires so-called "foreign aid" is or was an important part of keeping peace with peripheral provinces or countries. Unlike Rome, the U.S. also successfully uses loans through various multi-lateral institutions such as the IMF, World Bank and Inter-American Development Bank to maintain optimal relations with peripheral sovereigns.

This use of loans gets to one of the fundamental differences between Rome and America - the role and leverage of the financial system. The U.S. success is largely due to the success and complete faith in its monetary system. In contrast, the Roman Empire's monetary system was almost entirely metal based and while there was easy access to credit for the ruling classes this was not true for other classes. There appears to be much debate among historians about what stopped the Roman Empire from having an industrial revolution. But whatever one's opinion, surely a pre-requisite is a highly leveraged, monetary system with sophisticated, widespread access to credit. But Rome never got to such sophistication with its financial system.

This provides us with another reason why its success was always more driven by military conquest than anything else. In contrast, for the modern American super power, financial influence is on a par with military power, and both feed off each other. The financial success of the American Empire has also made its tax collection process far more efficient than any previous Empire before. In Roman time the tax collector had to go door to door to collect heavy coins, cattle, feed etc. But still just like then the biggest problem being with collecting from the rich. Remember the biblical character of Noah and the Ark warned of an impending storm like no other storm in history. Well our storm has arrived in the form of healthcare spending. And if we don’t take swift action the USS Ark of Healthcare Reform will close its doors and sail off leaving the bulk of its people medically stranded and unprotected. And just like Noah’s Ark the USS Ark of Healthcare Reform will not have any place to dock instead it will continually drift in a sea of red ink! This week one year ago, President Obama signed the historic Patient Protection and Affordable Care Act. Now maybe the USS Ark of Healthcare Reform can see port and start docking preparations.       
Original Article Published By Global Benefits Magazine April 5th 2011 http://www.globalbenefitsmagazine.com/