Deflation: Making Sure "It" Doesn't Happen Here

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The trend is abundantly clear; the U.S. economy has been slowing for more than six months and is perilously close to contraction.

After growing at a robust 4.1% clip in the last three months of 2011, gross domestic product fell to 2% growth rate in the first quarter, before falling again to 1.5% in the second quarter.

Using monetary policy, the Federal Reserve has made repeated attempts to stimulate the economy and raise it from its listless state. The Fed has held short term rates at a remarkably low level of between 0% and 0.25% since December 2008. It has also purchased nearly $3 trillion worth of Treasuries and housing-related assets to lower long-term interest rates and try to spur the economy.

If these efforts have worked at all, they have so far averted a double-dip recession. Yet, these extraordinary measures have not resulted in an economic recovery. To the contrary, things are getting worse.

Clearly, the economy is contracting, or deflating. Recessions are technically defined by two consecutive quarters of contracting GDP. Though we aren't there yet, the current trend is worrisome. Recessions are, by definition, deflationary. Above all else, the Fed fears deflation; it is harder to control than inflation and once it takes hold, deflation can be crippling.

The U.S. economy is built on a perpetual growth model. Deflation aside, even stagnation is debilitating. Growth is imperative.

The Fed likes inflation because it makes debts easier to repay. But inflation also devalues the money in everyone's pockets and bank accounts.

At a rate of three percent annual inflation, your money loses 30 percent of its buying power over the course of a decade. For example, inflation was 27% from 2000 to 2010. That's a hidden tax on all Americans, young and old, rich and poor. So, inflation is also a pernicious thing.

With that in mind, what follows are highlights from a speech given by Ben Bernanke on Nov. 21, 2002. This is the infamous speech that earned Bernanke the moniker "Helicopter Ben."

As you read the speech, bear in mind that it was given a full six years before the financial collapse, which led to the federal funds rate being reduced to its present level of 0% to 0.25%. It was also four years prior to Bernanke being nominated as chairman of the Federal Reserve.

As you'll see, Bernanke had a plan, a vision and a philosophy — all of which explains what is going on today, monetarily. You can see Bernanke's utter fear of deflation. Concerns about inflation? They hardly exist. In fact, Bernanke makes clear that central banks seek an inflation rate between 1 and 3 percent per year.

Bernanke also outlines the "special problems" that central banks face when the federal funds rate reaches zero due to deflation. This should cause the reader to wonder how bad the problem could become, considering that the rate is already effectively zero. As Bernanke notes, a zero interest rate places a "limitation on conventional monetary policy."

However, in Bernanke's view, even when the interest rate has been forced down to zero, the Fed "has most definitely not run out of ammunition."

There is a singular strategy always at the Fed's disposal, according to Bernanke, providing it "considerable power to expand aggregate demand and economic activity" and allowing it "to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero."

What is that strategy, you are surely asking?

Printing money.

The problem is that printing large sums of money, without any relation to a corresponding increase in the amount of goods and services in the economy, devalues all of the money in circulation.

"By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so," said Bernanke, "the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."


Note: The bolded areas are my emphasis. The italicized areas are Bernanke's.

Deflation: Making Sure "It" Doesn't Happen Here

The Congress has given the Fed the responsibility of preserving price stability (among other objectives), which most definitely implies avoiding deflation as well as inflation. I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief.

Before going further I should say that my comments today reflect my own views only and are not necessarily those of my colleagues on the Board of Governors or the Federal Open Market Committee.

The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand — a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending — namely, recession, rising unemployment, and financial stress.

However, a deflationary recession may differ in one respect from "normal" recessions in which the inflation rate is at least modestly positive: Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero. Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash. At this point, the nominal interest rate is said to have hit the "zero bound."

Deflation great enough to bring the nominal interest rate close to zero poses special problems for the economy and for policy. First, when the nominal interest rate has been reduced to zero, the real interest rate paid by borrowers equals the expected rate of deflation, however large that may be. To take what might seem like an extreme example (though in fact it occurred in the United States in the early 1930s), suppose that deflation is proceeding at a clip of 10 percent per year. Then someone who borrows for a year at a nominal interest rate of zero actually faces a 10 percent real cost of funds, as the loan must be repaid in dollars whose purchasing power is 10 percent greater than that of the dollars borrowed originally. In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. Capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn.

Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value.

Beyond its adverse effects in financial markets and on borrowers, the zero bound on the nominal interest rate raises another concern — the limitation that it places on conventional monetary policy. Under normal conditions, the Fed and most other central banks implement policy by setting a target for a short-term interest rate — the overnight federal funds rate in the United States — and enforcing that target by buying and selling securities in open capital markets. When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target.

Because central banks conventionally conduct monetary policy by manipulating the short-term nominal interest rate, some observers have concluded that when that key rate stands at or near zero, the central bank has "run out of ammunition"— that is, it no longer has the power to expand aggregate demand and hence economic activity. It is true that once the policy rate has been driven down to zero, a central bank can no longer use its traditional means of stimulating aggregate demand and thus will be operating in less familiar territory. The central bank's inability to use its traditional methods may complicate the policymaking process and introduce uncertainty in the size and timing of the economy's response to policy actions. Hence I agree that the situation is one to be avoided if possible.

However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero.

There are several measures that the Fed (or any central bank) can take to reduce the risk of falling into deflation. First, the Fed should try to preserve a buffer zone for the inflation rate. That is, during normal times it should not try to push inflation down all the way to zero. Central banks with explicit inflation targets almost invariably set their target for inflation above zero, generally between 1 and 3 percent per year.

Under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning.

U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

In the United States, the Department of the Treasury, not the Federal Reserve, is the lead agency for making international economic policy, including policy toward the dollar; and the Secretary of the Treasury has expressed the view that the determination of the value of the U.S. dollar should be left to free market forces. Moreover, since the United States is a large, relatively closed economy, manipulating the exchange value of the dollar would not be a particularly desirable way to fight domestic deflation, particularly given the range of other options available. Thus, I want to be absolutely clear that I am today neither forecasting nor recommending any attempt by U.S. policymakers to target the international value of the dollar.

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.

Each of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.

Don't Expect Justice in a Corporatocracy

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For any society to survive, much less thrive, it must be rooted in trust. The citizenry must trust the government and, most importantly, the justice system. It also helps if the people trust the banks that hold their money and finance their nation's economy.

However, that sort of trust is now virtually non-existent in our society.

According to a Gallup poll, only 18% of Americans — an all-time low — have confidence in banks. And a Pew Research survey found that Americans' trust in government is only marginally higher, at 22%.

Perhaps Americans have come to the conclusion that their government is colluding with the banks against their best interests. The examples are far and wide. In fact, they are so numerous that listing them all would be tedious, and reading them all would be cumbersome.

But, just to make the point, here are a few less than shining examples:

The SEC charged Wells Fargo with selling products tied to risky mortgage securities, causing municipalities and non-profits to suffer substantial losses as a result.

In response, Wells Fargo, the nation’s biggest consumer bank, recently agreed to pay a $6.5 million fine for these offenses without admitting or denying the charges.

Wells Fargo reported second-quarter pre-tax profits of $8.9 billion. This means that Wells Fargo will cough up a $6.5 million penalty from the nine-thousand-million dollar profit it made in just the second quarter of this year alone. That's about 0.07 percent of a single-quarter's profit.

Does this sound like justice to you? Will such a fine cause Wells Fargo to change its behaviors and practices? That's a rhetorical question.

A Senate report issued in July found that a "pervasively polluted" culture at HSBC allowed the bank to act as financier to clients moving shadowy funds from the world's most dangerous and secretive corners, including Mexico, Iran, Saudi Arabia and Syria.

The report said large amounts of Mexican drug money was likely to have passed through the bank. HSBC's U.S. division provided money and banking services to some banks in Saudi Arabia and Bangladesh that are believed to have helped fund al-Qaida and other terrorist groups.

The U.S. unit of the London- based HSBC, Europe’s biggest bank, “offers a gateway for terrorists to gain access to U.S. dollars and the U.S. financial system,” according to the report.

Laundering money for criminal enterprises, including drug cartels, is nothing new for the Big Banks.

In 2010, Wachovia Bank (now owned by Wells Fargo) paid $160 million to resolve a criminal probe that Mexican cartels were using currency-exchange firms to launder cash through the bank.

British bank Standard Chartered recently agreed to a settlement of $340 million with New York’s top banking regulator, Benjamin Lawsky, over claims that it laundered hundreds of billions of dollars in tainted money for Iran and lied to regulators in the process.

The New York Department of Financial Services charged that the bank schemed with Iran for nearly a decade to hide from regulators 60,000 transactions worth $250 billion.

Lawsky’s office threatened to revoke the bank’s state license at a hearing scheduled this week, prompting Standard Chartered to settle. Such a move would have been a death knell for the bank.

For a bank that announced record profits of $6.78 billion in 2011, a $340 million fine is nothing more than a slap on the wrist. In fact, it amounts to just 5 percent of last year's profits. That sort of expense is simply calculated into the cost of doing business.

According to the New York Times, a trove of e-mails and memos detail an elaborate strategy devised by the bank’s executives to mask the identities of its Iranian clients and to thwart American efforts to detect money laundering.

In light of all this, it's tough for anyone to reasonably claim that justice was served because Standard Chartered paid a $340 million fine. Sadly, that sort of outcome is the rule, rather than the exception.

The report issued by the Financial Crisis Inquiry Commission nearly two years ago found that, by 2006, Goldman Sachs traders knew that they were selling dangerous investments packed with subprime home mortgages. Goldman was making big profits on these toxic investments, which they privately characterized as "junk," "dogs," "big old lemons" and "monstrosities."

These mortgage investment products eventually collapsed in value, bringing down the housing market and very nearly the American economy along with it.

Despite misleading investors about the risks of a mortgage-backed investment product known as Abacus (which Goldman was in fact betting against), Goldman Sachs was allowed to settle with the Securities and Exchange Commission for just $550 million.

Goldman had revenue of $28.8 billion and net income of $4.44 billion in 2011. Once again, the fine was merely a slap on the wrist that will not dissuade or prevent the Wall St. bank from similar behavior in the future. Such a penalty is merely calculated into its cost of doing business.

The SEC has also dropped its investigation into Goldman Sachs over a $1.3 billion mortgage bond known as Fremont Home Loan Trust 2006-E, even though it indicated earlier this year that charges were likely. Moreover, the Federal Housing Finance Agency had filed a lawsuit against Goldman alleging that it knew that Fremont, a subprime lender, was selling it mortgages certain to fail.

The Department of Justice also announced that it is ending its own Goldman investigation, launched after a congressional investigation chaired by senators Carl Levin (D-Mich.) and Tom Coburn (R-Okla.) issued a report that found Goldman Sachs sold investments "in ways that created conflicts of interest with the firm’s clients and at times led to the bank's profiting from the same products that caused substantial losses for its clients.”

In May, the SEC dropped its probe of Lehman Brothers, even though an independent examiner appointed by the bankruptcy court of the defunct bank concluded that there were "actionable claims" against senior Lehman officers for using an accounting tool known as Repo 105 to book billions of dollars in phony sales to disguise the true extent of the bank's financial woes.

These are just the latest indications that the federal government has been neutered by Wall St. The revolving door between Washington and Wall St. has created a good old boys network, a corporate/political alliance that now controls our government. Our alleged leadership has been bought and paid for.

Regulation is dead. The industry's complaints about the burden of regulatory rules are absurd and fantastical.

Accountability and an adherence to the law are no longer expected from the Banksters. They do whatever they wish, gutting laws, ripping off their clients and paying meager fines to continue their perverted business as usual. Justice is only for regular people.

Ethics, scruples and moral decency are wholly absent. The government refuses to enforce its own laws and it allows bank lobbyists to water down others until they are meaningless.

More than 2,500 banking lobbyists are swarming the halls of Congress each week, fighting reform, meaning that the Big Banks now have five lobbyists for every member of Congress.

The Justice Department refused to pursue cases against Angelo Mozilo, the former head of the defunct mortgage giant Countrywide and Joseph Cassano, who ran the financial products division at AIG. These two men were central figures in the financial collapse, which led to the crisis that continues to destabilize our economy. And yet they remain free men.

I could go on and on with examples of paltry fines, dropped charges and cases that were never even opened. It's all so disgusting and disheartening. How can this nation claim to observe the rule of law when it refuses to uphold and enforce its laws?

How did the mega banks and corporations become exempt?

This nation's Supreme Court has upheld the absurd notion that corporations are people, due all the same rights under the law. While such a suggestion is absurd on its face, the deeper problem is that corporations — such as banks — are afforded an entirely separate set of rights and privileges that are not afforded to real, living, breathing, human citizens.

This nation's judicial, executive and legislative branches of government are all corrupt. How can anyone reasonably expect Wall St. or big business in general (Big Media, Big Energy, Big Agriculture, Big Pharma, Big Insurance, etc. ) to be otherwise? They are all part of the corruption.

The heart of the problem is that corporate financing of political campaigns has led to corporate control of our country. Corporations have bought our government and they now own it. They control the country and the government.

This nation is now a corporatocracy. We are officially the United States of Corporate America.

Despite Headlines, Jobs Problem Continues to Confound U.S.

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The government reported that 146,000 nonfarm payroll jobs were created in November. Though the creation of jobs is always welcome news, it must be viewed in the proper perspective.

Over the past year, employment has risen by an average of 157,000 per month in a country with 134 million jobs. That’s an increase of about 0.1% a month.

While the unemployment rate also fell sharply to 7.7%, it was due to a decline in the labor force, not to any improvement in the labor market.

The labor force fell by 350,000 in November and the labor force participation rate (the percentage of people employed and those who are unemployed but seeking a job) fell to 63.6% from 63.8% in October.

For perspective, the labor force participation rate was 67.3 in January 2000. Yet, when the recession began in December of 2007, the participation rate had fallen to 66 percent.

This means that in less than 13 years, the percentage of Americans participating in the labor force has dropped from 67.3% to 63.6%, a rather striking decline.

Clearly the long term trends are not good. The unfortunate reality is that discouraged people continue giving up their search for work.

Additionally, the average duration of unemployment was at 40 weeks in November, near historic highs.

The official unemployment figure doesn't include those who have lost their unemployment benefits. Nor does it count those who only have part-time jobs but want full-time work.

None of that is encouraging.

It takes about 125,000 new jobs per month just to keep up with population growth. Though the economy is currently achieving that, we need 250,000 new jobs per month for a year to truly drop the unemployment rate by a little more than 1%. Yet, in order for that to happen, the economy needs to grow north of 3% per year.

However, U.S. gross domestic product increased at an annual rate of 1.3% in the second quarter and by 2.0% in the first quarter. That does not bode well for job creation.

Unfortunately, at this rate, it will take years to create jobs for everyone who wants one.

At the pace of job creation over the past two years, the U.S. would not return to pre-Great Recession employment levels until after 2025, according to the “jobs gap” calculator from The Hamilton Project.

The Great Recession—which officially lasted from December 2007 to June 2009—resulted in massive job losses that the economy is still trying to recover. In 2008 and 2009, the U.S. labor market lost 8.4 million jobs, or 6.1% of all payroll employment. This was the most dramatic employment contraction (by far) of any recession since the Great Depression. By comparison, in the deep recession that began in 1981, job loss was 3.1%, or only about half as severe.

The economy has since recovered four million of those lost jobs, meaning we are only half way to recovery. Yet, that doesn't even begin to address the monthly increase of new entrants into the labor market, which creates a continual need for even more jobs.

Despite the slow but steady state of job creation, here’s the underlying problem: the recovered jobs on average pay a lot less than did the jobs that were lost. Low-wage jobs like retail and food service workers have made up 58 percent of the subsequent job growth. With less income, Americans have less to spend and spending is what expands economies.

Wages in the retail industry remain low compared to other sectors, with the average full-time sales worker making just $21,000 per year, according to the Bureau of Labor Statistics.

Peter Edelman, a law professor at Georgetown University, says the proliferation of low-wage jobs is the single biggest cause of persistent poverty.

"The first thing needed if we're to get people out of poverty is more jobs that pay decent wages," he argued in a July New York Times op-ed. "We've been drowning in a flood of low-wage jobs for the last 40 years… Half the jobs in the nation pay less than $34,000 a year, according to the Economic Policy Institute. A quarter pay below the poverty line for a family of four, less than $23,000 annually."

And wages in the bottom half "have been stuck since 1973, increasing just 7 percent," Edelman noted.

Jeff Faux, a progressive economist who founded the Economic Policy Institute in 1986, argues that by the mid-2020s, even with the most optimistic assumptions about economic growth, current trends indicate that the average American's wages will drop about 20 percent. One big factor is that more and more good jobs will go overseas, leaving even America's best and brightest no alternative but to enter the service industry.

America's dual problems of high unemployment and low-wage jobs will continue to have negative consequences for our consumption-based economy, which is 70% reliant on consumer spending.

Obviously, there is less consumption when fewer people are working and when so many of those with jobs are earning so comparatively little. Ultimately, there is less disposable income being directed back into the economy. It also results in lower tax receipts at both the state and federal levels.

If unemployment remains stubbornly high, wages will also remain stagnant. That will create a negative feedback loop of both lower consumer spending and lower economic output.

As of now, we're still a long way from recovery, and a full recovery is anything but assured.

Japan's bubble economy burst in the late 1980s and, nearly a quarter-century later, it has yet to recover.

That's a horrible precedent for the U.S.

Congressional Intransigence Jeopardizes U.S.

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Only in Washington could an agreement designed to avert a fiscal crisis actually add to, rather than decrease, the government's annual budget deficits and, ultimately, the national debt. But that's exactly what the deal Congress agreed to on New Year's day has done.

What a gift the American people.

The fiscal cliff agreement added $4 trillion to budget deficits over the next decade, according to the Congressional Budget Office (CBO). As always, Congress put off many tough decisions and even punted on some rather easy ones.

For example, as part of the fiscal cliff agreement, lawmakers extended dozens of business and industry tax breaks to the tune of at least $67.9 billion this year, according to Congress' Joint Committee on Taxation.

The breaks for these special interests are exactly the kinds of things that Congress should have been targeting, not extending. For example, Congress extended tax breaks for the moguls who own car racing tracks, saving them about $70 million over the next two years.

This should have been the easy stuff. What happens when Congress actually has to make the really tough choices, the ones it has been putting off for many years? That moment will soon be at hand.

A great way for Congress to begin addressing its deficits and debt would be to end all corporate welfare to Big Agriculture, Big Pharma, Big Oil and Big Insurance — to name but a few privileged, and very profitable, industries that continue to feed off the American tax-payer.

But those are the wealthy, powerful special interests that pay for political campaigns, and ours is clearly a pay-to-play system. It's quid pro quo, not money for nothin'.

Instead of addressing corporate welfare, Congress did, however, raise the tax rate of the wealthiest Americans. Yet, that alone won't be nearly enough to address our deep fiscal imbalances.

As of January 1, the top income tax rate increased from 35 percent to 39.6 percent for individuals with at least $400,000 of taxable income, or couples with at least $450,000.

The problem for the federal government is that raising taxes on such a limited number of people won't rectify the revenue shortfall.

The original proposal would have raised income taxes on those with household income above $250,000, and individuals earning more than $200,000. But raising the tax threshold to $400,000 shrank the number of Americans affected, thereby sacrificing lots of additional revenue.

While nearly 2 percent of filers have adjusted gross incomes over $250,000, only 0.6 percent have incomes above $500,000, according to the Tax Policy Center. So a very small number of taxpayers have been affected, and the revenue raised will be insufficient to truly address the government's revenue shortfalls.

Moreover, what's the point of this new marginal tax rate if the effective tax rate is something lower?

Wealthy Americans can afford top-notch tax lawyers and crafty accountants who use an array of loopholes, deductions and exemptions to avoid paying the top marginal rate. Additionally, the wealthiest Americans also utilize offshore tax shelters to avoid taxes.

Sen. Bernie Sanders addressed the problem this way:

"We have got to eliminate loopholes in the tax code that allow large corporations and the wealthy to avoid more than $100 billion in taxes every year by setting up offshore tax shelters in places like the Cayman Islands, Bermuda and the Bahamas. This situation has become so absurd that one five-story office building in the Cayman Islands is now the "home" to more than 18,000 corporations."

The obvious solution is to lower marginal rates while closing all loopholes, write-offs and deductions, which would make tax preparation simple and straight forward. It would also make the tax code fairer and more effective. For example, perhaps the top rate could drop to something more like 33 percent.

Sooner than later, the government must get serious about fiscal policy, both on the revenue side of the equation and on the spending side. One or the other won't do.

As I've said repeatedly on this page, the government has a major spending problem. In the last fiscal year, the government spent 22.4 percent of gross domestic product (GDP). Though the government certainly has a role to play, right now it is just too big.

A 1998 Congressional Joint Economic Committee study concluded that the optimal size of government to maximize economic growth is about 18 percent of GDP.

However, the government also has a revenue problem. Federal revenue is now at 15.8 percent of GDP, lower than it was 60 years ago. Tax revenues have a historical average of 18 percent of GDP.

So, If spending were reduced to the recommended 18 percent level and revenues increased to their historical average, it would obviously result in balanced budgets.

However, that still wouldn't begin to address the $16.4 trillion debt; only continued surpluses would do that. But the best way to get out of a hole is to first stop digging.

The three biggest drivers of the debt have been:

1. More than $3 trillion in tax cuts that were not paid for with spending reductions.

2. Two wars that were not paid for.

3. An economic crash that led to the lowest revenues and the highest expenditures — as a percentage of GDP — in 60 years.

The U.S. narrowly averted a depression and, as a result, its debt exploded.

If that wasn't tough enough, now comes the really hard part: budget cutting.

In poll after poll, the most popular budget item for cutting is foreign aid. But that is a very small portion of the overall budget. In fiscal 2010, the United States spent $52.7 billion on foreign aid out of a federal budget of $3.55 trillion. In other words, foreign aid amounted to just 1.5 percent of the budget.

To really address the problem, Congress can't just tinker at the margins with small budget items, such as foreign aid.

However, the concern of almost every economist is the effect that budget cuts will have on the economy, which has grown so reliant on government input.

With government spending now fueling more than 22% of the U.S. economy, deep budget cuts could quickly derail the limited growth coming from the private sector (households and businesses). The Conference Board estimates that the U.S. economy grew just 2.1 percent in 2012, and that was before any of the pending cuts.

Fortunately, federal deficits are on the decline, though most Americans are probably unaware of this. Federal deficits have been steadily dropping as a percent of the total economy, or GDP, for four consecutive years.

For the fiscal year ending in September 2009, the deficit was 10.1 percent of GDP. In 2010, it was 9 percent. In 2011, 8.7 percent. In the 2012 fiscal year, it was down to 7 percent.

Yet, here's the rub: economists agree that a nation's deficit should not exceed 3 percent of GDP in any given year. The U.S. deficit is still more than twice that level.

Low interest rates are the only thing saving the U.S. from outright crisis as present. In fiscal 2012, the federal government spent $359.8 billion in interest payments on the national debt — and that was the lowest in four years.

The federal government collected $2.469 trillion in revenue in fiscal 2012. So the $359.8 billion spent on interest payments accounted for 15 percent of total revenues. That's money not spent on infrastructure, or healthcare or R&D.

Since 2008, the average interest payment has been more than $412 billion annually. But that could change in a hurry.

Historically, from 1971 until 2012, the United States interest rate averaged 6.2 percent. But the benchmark interest rate in the U.S. hasn't been above 0.25 percent since December 2008.

Most analysts expect short-term rates to begin rising soon. A mere 1 percent increase in interest rates could have a huge impact on government debt payments. Consider that 1 percent of the $16.4 trillion national debt is $164 billion. That's significant.

Under the CBO’s rosiest estimates, total Federal Debt is projected to rise to at least $21.7 trillion by 2022. However, the debt could also be as high as $29.2 trillion by that time.

If interest rates were to rise faster than inflation, it could pose a real threat to the U.S. economy.

With the economy growing so slowly, it is not possible to grow our way out of debt. The government's only hope is to inflate its way out of debt. That's because inflation reduces the value of the dollar. Since our debts are based on a specific dollar amount and not a specific value, the less our dollars are worth, the easier it will be for the government to pay off its debts.

Many of the nation's problems are so deeply entrenched that they will not be easily fixed — if they can be fixed at all. But inasmuch as some of our fiscal problems may have political solutions, our government is gripped by partisanship and intransigence.

The fiscal cliff agreement has delayed $110 billion in automatic spending cuts for two months, meaning those cuts will now occur simultaneously with the debt ceiling in late February. That will lead to the next major political melodrama and economic crisis in Washington.

As if that weren't enough reason for concern, the government has been operating since October 1st without a formal 2013 budget. In lieu of one, the president signed a stop-gap measure in the interim (called a "continuing resolution") which is currently funding the government. Aside from the fact that this is no way to run a government, the continuing resolution expires on March 27th. Yet, the fiscal year doesn't end until September 30th.

House Republicans have such deep ideological convictions that they say they are willing to let the nation default on its debt, which is unprecedented in U.S. history. At a minimum, they are inclined to shut down the government on March 27th in order to get the deep spending cuts they desire. Compromise doesn't appear to be on their agenda.

That will likely result in an epic political battle that will make the fiscal cliff fight look tame in comparison.

Perhaps all three of the above matters (the spending cuts, lifting the debt ceiling, and approval of the fiscal 2013 budget) will be negotiated all at once. Congress clearly has a lot to do and it must act quickly. But it would hardly surprise anyone if Congress is undone by its own obstinacy and fails to act.

Raising the debt ceiling is a matter paying bills the government has already incurred, not for funding additional spending going forward. If lawmakers are not wiling to pay for the budgets they approved (especially deficit spending), they shouldn't have voted for those budgets in the first place.

Fitch Ratings said the debt ceiling is an "ineffective and potentially dangerous mechanism" for enforcing fiscal discipline because it doesn't prevent the tax and spending decisions that will push the debt above the ceiling, while the penalty for not raising the limit is the risk of a sovereign default.

In August 2011, a delay in raising the debt ceiling caused one of the major ratings agencies (Standard & Poor's) to strip the U.S. of its vaunted triple-A status. It marked the first time that the U.S. had ever been below triple-A.

The three major bond rating agencies have warned that a failure to reach a credible deal to contain federal budgets deficits could bring yet another downgrade.

However, Congress can't even agree on relatively small budget cuts.

The reductions associated with the fiscal cliff (which had so many people in a panic) amount to about $1.2 trillion over 10 years, or just $110 billion a year.

Here's a little perspective:

The enacted budget for fiscal 2012, which ended on September 30th, had a deficit of $1.327 trillion.

In other words, these planned budget cuts — which will occur over the course of a decade — amount to less than one year's budget deficit.

That should give you a sense of the magnitude of this problem.

Infinite Growth in a World of Finite Resources?

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Perpetual Growth is the basic theory employed by all business economists in banks, corporations, academia and the Fed. But an infinite growth model cannot be supported by a world of finite resources.

Economic growth is often associated with the accumulation of human and physical capital, as well as the technological innovations that increase productivity. Yet, in the absence of natural resources, there can be no economic growth. Even a limit on resource availability will eventually limit economic growth.

Petroleum and fresh water are perhaps the two most critical resources, and the world is now grappling with the limited availability of both.

For example, in 1964, nearly 500 billion barrels of oil were discovered. By 2011, it had fallen to below 100 billion barrels.

In 1965, the world produced 32 million barrels of oil per day. By 1980, that number had almost doubled to 62 million barrels. However, since 2005, oil production has plateaued at roughly 75 million barrels per day. In that time, total supplies have bumped around within a narrow 5 percent band.

Early in the 20th century, much of the world's oil was untapped. At that time, prospectors merely had to drill a few yards into the ground and install inexpensive rigs to extract oil at rapid rates.

However, at the beginning of the 21st century, in order to achieve the same flowrates or less, oilfields must be drilled much deeper and managed with sophisticated techniques and equipment costing many hundreds of millions of dollars.

Most critically, Dr. Chris Martenson notes the following:

"In the past 22 years, half of all of the oil ever burned has been burned. Such is the nature of exponentially increasing demand. And the oil burned in the last 22 years was the easy and cheap stuff discovered 30 to 40 years ago."

The world's supply of clean, fresh water is also steadily decreasing. Ninety-seven percent of the water on the Earth is salt water; only three percent is fresh water. Moreover, slightly over two thirds of that is frozen in glaciers and the polar ice caps.

Water demand already exceeds supply in many parts of the world and as the world population continues to rise, so too does the demand for fresh water.

Water is obviously the key component for human life. It is also vital to energy, industry, agriculture and livestock. Decreasing water supplies will lead to higher food prices and perhaps even food shortages.

The world is also experiencing a peak in other key resources, such as rare-earth metals. The period of cheap and easy extraction is giving way to complex and expensive extraction.

Average ore grades are in decline for most minerals, even as production is increasing. Easily processed ores are becoming exhausted. Mines are becoming deeper, more remote and more inaccessible. This requires higher inputs of capital and energy for both extraction and processing. Lower quality resources are more expensive to extract and they eventually become uneconomic when the ore quality is too low.

For example, lithium, which powers the batteries in cell phones, laptops and electric cars, is difficult to find and excavate. The car manufacturer Mitsubishi has predicted a worldwide supply crisis by 2015 if new reserves are not discovered. A lithium shortage would affect the price of laptop computers, as well as cause a slowdown in the production of hybrid electric cars, increasing our dependence on oil.

As the world's population has steadily increased — now eclipsing 7 billion — so has demand for many of the essentials that make our world run so smoothly. The ability to exploit finite resources has provided much of the world with a better standard of living than at any other time in human history. But many of those essentials are finite and non-renewable.

There is a false perception among much of the public that technology can substitute for finite and non-renewable resources. However, while technology can lead to greater efficiencies, it requires energy — it does not create it.

The global population is on track to reach 9 - 10 billion people by 2050. The following should provide some perspective on what that means:

At present, the global population is increasing by 83 million people annually. In other words, each year the world is adding the equivalent of Egypt.

This rapidly growing population will require abundant energy and food. Can that be accommodated? Not likely. Across the board, the rate of resource depletion is accelerating.

According to the Global Footprint Network group of scientists and economists, the current population of seven billion is already consuming natural resources as if we have “1.5 Earths."

According to scientists, 43 percent of Earth's surface has already been cleared for urban development or agriculture. By 2025, the usage level is expected to exceed 50 percent, when the population reaches eight billion.

Our current levels of consumption will have devastating consequences to the forests that provide clean air and to the water resources that all life depends on.

In 1960 there were 1.1 acres of arable farmland per capita globally, according to data from the United Nations. By 2000 that had fallen to 0.6 acre. Yet, during that time, the global population doubled from 3 billion to more than 6 billion.

In other words, productive farm land and the human population are moving in the wrong directions.

Naturally, the developing nations — which hold 80 percent of the world's population — are demanding improved lifestyles.

However, if every person used as many resources as the average North American, more than four Earths would be required to sustain the total rate of consumption, depletion and waste assimilation, according to an environmental "accounting system" developed by researchers William Rees and Mathis Wackernagel.

A recent WorldWatch Institute report put it this way: “If everyone lived like the average American, the Earth could sustain only 1.7 billion people — a quarter of today’s population.”

WorldWatch anticipates “a future scenario not only incompatible with perpetual economic growth but likely to lead to economic and societal decline,” mass starvation, wars and pandemics.

The Pentagon agrees, predicting eventual mega-droughts, famine and widespread rioting erupting across the world.

As it stands, nearly half the world's population — more than 3 billion people — lives on roughly $2 per day. According to the World Food Programme, in some of the poorest countries households spend as much as 60-80 percent of their income on food.

Conversely, food spending in developed countries is quite low. People in most European countries spend over 10 percent of their incomes on food. Americans spend just 6 percent on food, less than people in any other country in the world.

An additional two billion humans competing for limited resources will trigger commodity shortages that will prove disastrous. The world will be confronting shortages of hydrocarbons, metals, water and fertilizer, which will dramatically affect global agriculture. The latter is critical.

Hidden in every calorie of food you eat are 10 calories of fossil fuels. Modern agriculture and food delivery is highly inefficient. In fact, this system is the first in history that consumes more energy than it delivers.

In the absence of abundant water resources, cheap hydrocarbons and the fertilizers derived from petroleum, that system will collapse.

If population growth rates remain as they were between 2005 and 2010, 27 billion people will inhabit the planet by the end of the century, says Anthony Barnosky from the University of California at Berkeley. That would lead to the disappearance of most large and small animals, and the collapse of food chains.

Historically, economic growth was predicated on population growth, as well as cheap and plentiful energy supplies. But it is now clear that, going forward, population growth will be a limiting factor to economic growth. Additionally, cheap and plentiful energy supplies — once take for granted — are a thing of the past.

With all of this in mind, it's time to abandon the perpetual growth economic model and move instead to a model that stresses conservation, efficiency, recycling and renewability. Clearly, the world is on an unsustainable path and, by definition, anything that is unsustainable won't last.

Above all else, we must redefine quality of life as something other than just having "more." The goal should be to simply have enough. Our quality of life should not be measured by "stuff," but instead by the things that make life rich; our relationships, our hobbies, our work and our passions.

Bush's Legacy: Debt

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September 25th 2008

UNITED STATES - The Bush legacy is going to include a nasty four-letter word: debt.

On second thought, make that staggering, long-term debt, perhaps in excess of $11 trillion, that will tie the hands of the next president and Congress, to say nothing of imposing a crushing burden on taxpayers.

Just a few months ago, the Iraq war looked like the biggest thing in the eight-year era of the second President Bush, during which his party controlled Congress for six years.

Just a couple of Sunday mornings ago, Bob Woodward of the Washington Post said on national television that the war in Iraq “is probably the most important thing going on right now,” adding that in January the war in Iraq will be topic one in the next administration, and topic two will be the war in Afghanistan.

Now the country suddenly is facing a financial crisis fraught with the possibility of unprecedented economic disaster.

If that isn’t enough to make you reach for the antacid tablets, the president still has about three months left in office, plenty of time for yet another calamitous turn of events.

The national debt was about $5.7 trillion when Bush took office in January 2001. Today, after almost eight years and a couple of wars, the debt has risen to about $9.7 trillion.

And, by the way, that figure might rise another $1 trillion or so before Bush steps down on Jan. 20.

The national debt ceiling today is $10.6 trillion. Treasury Secretary Henry Paulson wants Congress to raise that to $11.3 trillion to clear the decks for massive borrowing to deal with the nation’s financial crisis.

A national debt of $11.3 trillion would come to more than $37,000 each for every man, woman and child in the United States.

And all this comes during an era of allegedly conservative, fiscally responsible Republican domination in Washington.

Obama's Achilles Heel: China

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UNITED STATES - The US National Debt continues to go up $3.87 billion USD per day and is currently hovering around $12.4 trillion.

The problem is its going to continue to skyrocket as long as the United States is fighting off a recession, two wars and high oil prices. US President Barack Obama thus has his work cut out for him, problems left behind by George W. Bush, and his problems are quantified by the statement that "Most Americans don't buy American, they buy Chinese."

"Most Americans don't buy American, they buy Chinese."

That is not completely true. What is true that on average the USA imports $2 trillion USD worth of products every year of which approx. $300 billion is from China (approx 15%).

That is peanuts when you realize the USA only exports an average of $65 billion to China annually. The end result is an annual trade deficit of $235 billion taken out of the American economy and bolstering China's economy.

China is not the only country that enjoys a trade deficit with the United States. Japan, South Korea and numerous other countries trade heavily with the USA, often in products that Americans "need" in terms of electronics, but also a lot of products that could be made in North America but has been outsourced instead.

What the USA needs is more factories inside America that is hiring people, making products Americans can use (preferably products and equipment that will make them more competitive internationally) and are priced fairly.

Otherwise what we're opening ourselves up to is to communism... Oh dear, I said it. The dreaded C-word.

If the USA cannot shake off the recession and high unemployment rate America's economy will continue to flounder and will eventually be forced to create a more socialist-based economy as capitalism falls apart. This means government "work-fare programs", huge cutbacks to arts & culture funding (including Hollywood), an increase in food stamp usage, and a skyrocketing crime rate as Americans become more desperate for survival.

The 1st thing the USA needs to do is put a halt on all free trade discussions with Asia. America isn't ready for such big trading partners. The economy is too fragile right now.

The 2nd thing the USA needs to do is find cheaper alternatives to expensive oil. Oil prices are simply too high and its hampering transportation costs of materials/products. Hydrogen power perhaps.

The 3rd thing the USA needs to do is cut taxes on the poor, increase taxes on the rich. The poor will spend every dollar they have anyway, whereas the rich have a tendency to stick their money in the bank and sit on it.

The 4th thing is create tax breaks for companies that operate solely in the USA. This will benefit small businesses and new startups.

The 5th thing the USA needs to do is enforce mandatory retirements. Old people who keep working when they should be retired are essentially stealing jobs from younger Americans. Exceptions can be made for industries that have a shortage (ie. doctors), but otherwise these people need to be put out to pasture.

The end goal is to get more Americans working and building things again, creating opportunities for a new generation of hard working Americans.