In The Long Run We Are All Dead

It has been pointed out that the example of Japan tells us that everything is hunky-dory. This is Krugman's opinion. As I pointed out two weeks ago, this is not entirely wrong. 

However, it is clear that because of the power of compound interest, our current path is not sustainable. We may have a few years to make the needed changes, but what we are doing now cannot continue. It will take us ten years or so to reach the point Japan is at now. 

How is Japan doing? Uniquely, Prime Minister Yoshihiko Noda is being honest with his people:

Prime Minister Yoshihiko Noda said containing Japan’s public debt load, the world’s largest, is critical after Standard & Poor’s downgraded credit ratings on France, Austria and seven other European nations.

Europe’s fiscal situation “isn’t a house burning on the other side of the river,” Noda said on TV Tokyo Holdings Corp.’s program on Jan. 14. “We must have a great sense of crisis.” 

It is as difficult to cut spending in Japan as it is in America, so Noda is proposing to double the national sales tax to ten percent. 

Noda reshuffled his cabinet last week, aiming to win support for doubling Japan’s 5 percent national sales tax by 2015 to trim the soaring debt. S&P said in November Noda’s administration hadn’t made progress in tackling the public debt burden, an indication the credit-rating company may be preparing to lower the nation’s sovereign grade.

Why is Noda concerned? It is the exact same reason I am. If interest rates increase, a very bad deficit becomes a catastrophe. 

Japan’s government, which has enjoyed borrowing costs that are around 1 percent, wouldn’t be able to manage its finances if bond yields surged to 3 percent, Noda said last week. The country risks seeing a spike in government bond yields unless it controls a debt load set to approach 230 percent of gross domestic product in 2013, the Organization for Economic Cooperation and Development said on Nov. 28.

Even with this massive tax increase, things could get very bad in Japan. 

“The proposed increase in the consumption tax to 10% would not be enough to put the public finances on a sustainable track,” David Rea, a Japan economist at Capital Economics Ltd. In London, wrote in a report last week. “A larger increase is needed, and soon, but is highly unlikely without a specific mandate from the electorate as support from the opposition and even some elements of the ruling party is non-existent.”

This is the problem everywhere. There are a certain number of politicians who refuse to see reality. In America they are called Republicans and Democrats. I suppose Republicans could take comfort in that the fact that the Republican car is racing toward the cliff at 40 mph while the Democratic car is racing at 60 mph, but I am not comforted. Yes, as Lord Keynes said, in the long run we are all dead. This is not an encouraging fact as we live in Keynes' long run.

Why Aren't They In Jail?

This is a question that goes back to the Bush Administration. Obama has continued the Bush policies in most things, the lack of prosecution for bankster criminals is one of them.

It Depends What The Meaning of "Is" Is: Chevy Volt "Call Back"

As long as the government mandates environmental rules with no regard for the market, we will have bizarre incidents like the three I will talk about today. 

The first is the Chevy Volt "recall." For some reason they have decided not to call it a recall, but a “call back.”

The fixes are similar to a recall and involve about 8,000 Volts sold in the U.S. in the past two years. GM is making the repairs after three Volt batteries caught fire following crash tests done by federal safety regulators. The fires occurred seven days to three weeks after tests and have been blamed on a coolant leak that caused an electrical short.

The reason it is not a recall has nothing to do with the fact the Volt is a politically correct car—of course not! 

The German government is in the forefront of alternative energy. You would think the renowned German efficiency would allow them to remember that if you generate electricity from offshore wind farms that you need a way to get the electricity to the mainland. Or maybe not: 

The generation of electricity from wind is usually a completely odorless affair. After all, the avoidance of emissions is one of the unique charms of this particular energy source.

But when work is completed on the Nordsee Ost wind farm, some 30 kilometers (19 miles) north of the island of Helgoland in the North Sea, the sea air will be filled with a strong smell of fumes: diesel fumes.

The reason is as simple as it is surprising. The wind farm operator, German utility RWE, has to keep the sensitive equipment -- the drives, hubs and rotor blades -- in constant motion, and for now that requires diesel-powered generators. Because although the wind farm will soon be ready to generate electricity, it won't be able to start doing so because of a lack of infrastructure to transport the electricity to the mainland and feed it into the grid. The necessary connections and cabling won't be ready on time and the delay could last up to a year.

In other words, before Germany can launch itself into the renewable energy era Environment Minister Norbert Röttgen so frequently hails, the country must first burn massive amounts of fossil fuels out in the middle of the North Sea -- a paradox as the country embarks on its energy revolution. 

Do we laugh or cry? Government-regulated monopolies somehow forgot that electricity needs to flow. 

But surely solar power is our future! Even with massive subsidies the industry has a few problems:

Idaho Power plans to cut off electricity on Tuesday to plant in Pocatello, Idaho, that makes material for solar energy, because the factory owes $1.9 million in unpaid utility bills. The dispute is with Honolulu-based Hoku Scientific, Inc., which is backed by Chinese financing and enjoys federal and state incentives.

Oops. 

As long as the government mandates, instead of the market, we will have odd examples like this. Market solutions work. 

Our Energy Policy is a Giant Accident Just Waiting to Happen!For example, the huge anti-market subsidies that are given to autos are not well understood by the average person. If you included the defense expenditures that the US makes to keep the oil flowing in your auto's fuel bill, the price of gas would at least double. All such subsidies, whether it is for politically correct forms of energy, or for gasoline, morph the market into something quite different and artificial than what it would have been otherwise. 

Stop all subsidies and let the market decide. 

Debt Crisis Revisited

On Monday I wrote long and hot about our national debt problem. This video explains it in a few minutes-with humor. 

When Does The Fecal Matter Hit the Circular Air Circulation Device?

Is This Krugman? I must just be stupid. Paul Krugman has a Nobel Prize in Economics, surely he must know what he is talking about? In a recent column, "Nobody Understands Debt," : 

In 2011, as in 2010, America was in a technical recovery but continued to suffer from disastrously high unemployment. And through most of 2011, as in 2010, almost all the conversation in Washington was about something else: the allegedly urgent issue of reducing the budget deficit.

So the fact that for every dollar the government spends 42 cents is borrowed is not a cause for concern. The fact that the government debt to GDP ratio for the first time is over 100% is no cause for alarm. Really? Here is part of his argument:

And while they’ve been waiting, those rates have dropped to historical lows. You might think that this would make politicians question their choice of experts — that is, you might think that if you didn’t know anything about our postmodern, fact-free politics.

Yes in the short term Krugman does have a valid point. Even a radical cutter like me would go about the needed reforms gradually, over 5 years or so. 

Lord Keynes was famously asked about what the effect of his policies would be in the long term. He said "In the long run we are all dead." Of course Keynes is dead and we are living in his long term. We cannot continue to kick the can down the road forever. This is far better than allow a crisis to occur and be forced to either print money or drastically cut government spending all at once. 

Of course Krugman thinks we can. 

Deficit-worriers portray a future in which we’re impoverished by the need to pay back money we’ve been borrowing. They see America as being like a family that took out too large a mortgage, and will have a hard time making the monthly payments.

...

First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.

To a degree Krugman is right. However we are living in a time where the tax base is NOT growing as rapidly as the debt, nor is it likely to grow that fast anytime soon. The Japanese have been stuck in this scenario for 20 years and their debt to GDP ratio is over 200%. This cannot be sustained. The Japan example does tell us that the US has a few years before the proverbial "fecal matter hits the circular air circulation device." 

I have been saying that this is 4 to 8 years. It could be longer, or it might be shorter. The question is asked in environmental circles. If you have a pond and it takes 30 days for the lily plant to cover the pond, and the lily plant grows 50% every day, on what day is the pond 1/2 full? The answer is on day 29. The point they are making is that with exponential growth the problem is not recognized until it may be too late. 

We may not have much warning when the bond buyers quit buying. In fact if the US attacks Iran, I can see Russia and China quit buying bonds and selling the ones they have. The problem is inevitable, if things continue as they are, but the exact time of the crisis is not predictable. 

Even with the unrealistic growth predicted by the Congressional Budget Office, even with the Office predicting the Bush tax cuts expiring next year (a 4 trillion tax increase), the Office is still projection a 13 trillion dollar increase in the debt over ten years. (This is from July 2011)

This almost doubles the debt in ten years. 

Here is a debt chart from the interestingly-named site Babylontoday.com 

The chart is a little out of date, US Government debt debt is now 15 trillion.

Here is the projected government debt over the next few years. 

(If you notice this chart includes State and Local government debt, but does not include government guaranteed debt like Fanny Mae and Freddy Mac.) 

Let’s say the debt does double over the next ten years and interest rates also double. What will that do to the deficit? Let’s do the math. 

From a little google research it appears that the percentage of interest of government expenses is 6%. Since we borrow 42 cents for every dollar that is spent that means the percentage of the interest of total government revenue is 6/58 or roughly 10%. So if interest rates go from the historic low of 2% they are now to 4%, and the debt doubles, that means the ratio of the interest payments to government revenue will go up to 40%. Obviously this is a back-of-the-envelope kind of calculation that ignores economic growth. The point is that we have reached a point where the current deficit of the US Government is not sustainable. 

Krugman is right, "no one" understands debt. No one in government, and especially no one that writes for the New York Times understands debt.