Dangerous Debt

According to the Schwab Investing Insights, June 2009, the $10 trillion the government owes has an average maturity of 4.7 years. That means, on average, that the government must refinance $2.12 trillion in debt every year -- in addition to borrowing $1 trillion or more in new debt ($1.8 trillion this year!). This means that the US federal government must borrow, on average, over $3 trillion per year.

This is a recipie for disaster.

Why I Like Lower Home Prices

In recent months, American home prices have dropped dramatically, wiping out hundreds of billions of dollars of equity and significantly reducing my personal net worth, so why am I happy to see home prices drop? Regardless of the current pain, high home prices mean high living costs for everybody, forever.

Home prices can do three, and only three things:

1. Go up


2. Go down


3. Stay the same
4. 
   

Let's consider each:

Home prices go up

This benefits people who have many houses a great deal, they gain wealth. Those with only one home gain wealth too, but they can't use it. You have to live somewhere, and if you sell your only home you have to pay rent or buy another. You can borrow against the new value of your home, and the money can be useful, but the home doesn't help you pay the loan back; and as many have found, refinancing to gain spending money can lead to bankruptcy and losing your home entirely if things go wrong. Sooner or later, things always go wrong. The kicker is that when housing prices go up and stay up almost everyone pays more for housing -- forever. The houses deliver exactly the same value -- living in them is the same regardless of price -- but they consume more of our income and savings. Maybe it's me, but this doesn't seem like a good thing.

Home prices go down

Those with many houses lose big, their usable wealth decreases. Those with one home feel bad because the number attached to their net worth is lower, but they are living in the same houses and paying the same amount for them. However, if prices go down and stay down then almost everyone pays less for housing forever. The value of the housing is the same, it just costs less money. Again, maybe it's just me, but seems to be a good thing.

Home prices stay the same

Nobody wins, nobody loses.

Thus, although there is a lot of pain as housing prices drop, if the prices stay down nearly everyone forever gets the same housing at a lower price. This is a good thing, and has implications for government policy.

Ignoring bubbles, house prices are more-or-less determined by supply and demand. To make housing more affordable, the government pumps money into the housing market. This can result in increased construction, but mostly it adds money to the housing market and thus increases prices, which makes it hard for people to buy homes, particularly the first one.

The government subsidizes low income people, of course, but this is a relatively small subsidy. The big subsidies are the tax deduction for mortgage interest and the creation of special lending institutions for mortgages -- which recently needed massive government bailouts to survive. The net result of these subsidies is higher home prices. Thus, all of these subsidies should be eliminated; particularly the mortgage interest tax deduction.

This was, apparently, done in England some time ago. According to some reports, home ownership actually increased.

The End of the Space Age?

The recent collision between an Iridium satellite and a dead Russian satellite created at least a thousand pieces of space debris. On that day, there were 151 more probable in orbit collisions. There is a real possibility of a slow motion chain reaction, where each collision begets several addition collisions until LEO (Low Earth Orbit) is unusable. LEO operations are already more expensive because of space debris. There is a real possibility that, if left unchecked, space debris could put an end to commercial exploitation of, at least, LEO.

If you thought that environmental concerns could be left on Earth, you were wrong.

Data: http://uk.reuters.com/article/UKNews1/idUKTRE51C73720090213

Where We Are

The Democrats control both Congress and the White House for the first time since 1994. This follows Republican rule of the White House since 2001 and Republican control of Congress for most of that period. I believe that the Republican defeats in the last two elections are, at their core, due to poor governance. Today, America is economically, financially and militarily weaker than we were eight years ago and our standing in the world is substantially reduced. Not only is America weaker, but our enemies are stronger, in part due to oil revenues and nuclear weapon development.

The Democrats now have a chance to govern. In two years we will have a chance to judge Congress, and in four, Obama. When that time comes, I intend to look at this post to see how they've done. To first order, I believe that good governance should result in definite signs that things are turning around in two years, and some real gains in four. To make that judgement, here's my assessment of where we are right now. If you see anything wrong or missing, please let me know and, if I agree, I'll make changes.

Economy

The federal government is $10 trillion in debt.

The projected deficit for fiscal 2008 is $1.2 trillion (not counting the stimulus package).

The economy is losing half a million jobs a month, a total of three million in the last year.

Total debt, government, commercial, and personal, is about $53 trillion.

The Dow Jones is around 8,000, down from around 14,000 a year earlier.

The S&P 500 is around 800, down from around 1,400 a year earlier.

The top 5% of tax returns contained over 36% of the nation's income (2006 data).

The bottom 50% of tax returns showed a per-return, inflation adjusted increase of less than 1% between 2000 and 2006.

Home foreclosure filings in January 2009 totaled 274,399 [Reuters].

Major financial institutions have failed completely, others avoided failure only with massive government subsidies, and many more are on the brink of collapse.

Two of the three major American car manufacturers require massive government subsidies to avoid bankruptcy.

The official unemployment rate is 7.6%.

U.S. GDP has been down every quarter for about a year. It was down 6.8% in the last quarter of 2008.

Foreign Affairs

Iraq is, relatively, peaceful and arguably democratic.

The ruling parties in Iraq have very close ties with Iran. Iran also has very close ties with rulers in the Kurdish areas.

America has approximately 150,000 uniformed forces and 190,000 'contractors' (aka mercenaries) in Iraq.

The Taliban have the initiative in Afghanistan and are making major gains.

The Taliban have repeatedly cut NATO supply routes through Pakistan; in one case destroying hundreds of trucks filled with supplies. In another, destroying a hundred foot long bridge. NATO is being forced to develop alternative supply routes.

Major news stories say Kyrgyzstan will close the Manas air base used to support and supply NATO forces in Afghanistan.

The Taliban control substantial and growing swaths of territory in Afghanistan and Pakistan.

The Taliban leadership lives more-or-less openly in Quetta.

The Taliban just cut a deal with local government leaders to impose Sharia on the Swat in exchange for a cease fire.

The Taliban just launched a successful attack in Kabul, the capital of Afghanistan.

Basically, the Taliban are kicking our butts. These are the guys that harbored al Qaeda at the time of the 9/11 attack. They are still close allies.

The Isrealis and Hamas just ended three weeks of major fighting.

Particularly prior to Obama's election, much of the world viewed America as a country that tortures people, invades others, and pursues a largely go-it-alone, my-way-or-the-highway foreign policy. Many perceive America as a bully.

America has suffered major Islamic extremist terrorist attacks in the first few months of the last two presidential administrations. That would make us due for one now.

North Korea tested their first nuclear weapon in 2006.

North Korea conducted a number of long range missile tests, including multiple simultaneous launches (important for defeating missile defense).

Iran has made major strides in developing the technology and infrastructure to support development of nuclear tipped missiles.

Governing Operations

The Republican and Democratic parties are bitterly divided and partisan; so much so that two Republican senators refused an invitation to watch the Super Bowl at the White House and an economic stimulus package passed with only three Republican votes in Congress. Nearly all economists, left, right and center, agree a large stimulus is needed to avert economic catastrophe.

Government is generally viewed as grossly incompetent.

U.S. intelligence services regularly spy on American citizens, in America, communicating with others in America, without a warrant.

The U.S. government operates a network of out-of-country prisons specifically intended to evade the rule of law. Guantanamo being the crown jewel of the network.

Medical

In 2008 there were almost 46 million Americans without health insurance. RWJF. America is the only industrialized country without nearly universal health care insurance.

The World Health Organization (WHO), in 2000, ranked the U.S. health care system as the highest in cost, first in responsiveness, 37th in overall performance, and 72nd by overall level of health (among 191 member nations included in the study).

The Stimulus Package and the Crash

Stimulus

Almost all economists will tell you we need some sort of stimulus to have a chance of getting out of the amazing economic mess we find ourselves in. The biggest controversy on the stimulus is the Republican plan to use tax cuts, and only tax cuts, as opposed to the combination of spending and tax cuts that Obama proposes. Our economy was greatly shaped by the two big tax cuts of the early 2000s and there was a $160 billion tax cut last year to stimulate the economy. We are in this mess anyway. This suggests that pure tax cuts will not be effective. It seems time to change direction.

Crash

In a previous post (It's the Debt, Stupid) I identified excessive debt as a root cause of our economic problems, and briefly noted that excessive compensation to people not doing a particularly good job may also be at fault. There is some support for this view in "The Great Crash 1929" by John Kenneth Galbraith. On page 177 he identifies excessive concentration of wealth, 1/3 of all income going to the top 5%, as a primary cause of the Great Depression. He notes that people living paycheck-to-paycheck will reliably spend all their money, whereas wealthier individuals can stop buying luxuries and investing whenever they choose; thereby creating a big drop in demand. This is, among other things, exactly what happened in the Great Depression; in part because this group lost a great deal of money in the crash. Here's the scary part, take a look at the income data at Summary of Federal Individual Income Tax Data 1980-2006. In particular, examine Table 5, Adjusted Gross Income Shares, 1980-2006. There you will see that in 1980 the top 5% of earners took in 8.46% of all personal income. By 2006 this had risen to 36.66% -- well over 1/3, the level partly responsible for the Great Depression.

This concentration of wealth confirms a prediction I heard way back in 1979. That year I read a book called "Global Reach" about the rise of transnational corporations driven solely by profit. Although it was meticulously researched, I didn't buy most of their argument. However, I remember their prediction: that America would begin to resemble a banana republic: heavily in debt, militaristic, questionable elections, and, most important for our purposes, characterized by a few very wealthy people surrounded by a sea of poor folks. A very real trend in this direction is clear from the tax data.

No one really knows what will or won't get us out of this fix short term, but long term I think we need to substantially reduce debt and flatten incomes. During one of the primary debates, Ron Paul tried to made the case that our accounting system is out of whack, excessively rewarding a small fraction of the population at the expense of everyone else; based not on productivity, but rather who controlled the accounting system. There's very little that Ron Paul and I agree on, but this is one of them.

Israel and Gaza

Israel and Hamas are fighting in Gaza, again. Countless articles, editorials, and blog posts are discussing this fight, most focused on the tactical picture: what is happening today, who's to blame, who should be condemned, etc. I'd like to step back and look at the strategic picture.

In 1948, Jews and Arabs started shooting and bombing each other in Palestine/Israel. The UN, motivated by the nearly successful German attempt to kill all the Jews in Europe, had granted the Jews small bits of territory in British-administered Palestine and called the new country Israel. Although the British had controlled Palestine since 1919 and the Turks controlled it for a few centuries before that, the mostly Muslim Arabs that lived there quite reasonably considered it their land. They saw no reason that the sins of the mostly Christian Germans should be paid for with their land. The Jews, having lived for thousands of years in territory controlled by others, being severely repressed and eventually nearly wiped out, were determined to control their own country. The differences were irreconcilable so there was nothing to do but fight it out.

At the time there were about 50 million Arabs and only 100,000 Jews in Palestine, the Arabs had professional armies, the Jews had a few thousand veterans of World War II. Everyone thought the Arabs would finish the job the Nazi's started, but they were wrong. With help from Czech weapons, the Jews won the 1948 war and even captured significantly more territory than the UN granted them. Since then fighting between Israel and the Arab world has erupted periodically, with big wars in 1956, 1967, and 1973 and countless smaller conflicts.

The basic Arab strategy is to keep the conflict going (1). Israel is 300 miles long and 70 miles wide with a population of a few million. Arabs control all of North Africa and the vast majority of the Middle East with a population measured in hundreds of millions. Arab armies only have to win once and Israel will be destroyed, Israel has won again and again but cannot possibly develop the strength to occupy and control the vast Arab lands. Thus, even though Israel would be very difficult to conquer today, if the Arabs just keep the conflict going, eventually the military balance will change and Arabs will again control Palestine from the river to the sea.

Israel's strategy has been to build a crackerjack military to avoid a defeat leading to extermination and using this army to take territory they don't really need then trade it for peace. They traded the Sinai for peace with Egypt, and there's been no significant fighting for 40 years. They traded parts of the West Bank and Gaza for peace with Jordan and the PLO (2). There has been no fighting with Jordan, but peace with the PLO has not been complete. Israel even tried withdrawing from Lebanon and Gaza without a peace deal, but there is still fighting on both fronts. Nonetheless, the basic strategy is working fairly well. Although the vast majority of the Arab world, plus Iran, is still officially committed to the destruction of Israel and reclaiming the land they feel is rightfully theirs, the only immediate neighbors in that group are Lebanon (including Hezbollah), Syria, and Hamas-controlled Gaza. These have very short, easily defended borders with Israel. Furthermore, many Arab states have indicated they might agree to recognize Israel under various conditions.

There are only two ways for the Arab-Israeli conflict to end: the destruction of Israel, probably including killing or driving most of the Jews out of Palestine, or the Arab world accepting the loss of much of Palestine to Jewish control. Some advocate a democratic secular Palestine neither Jewish nor Muslim, where the rights of all citizens would be respected. One might remember, however, the Weimar Republic in Germany after World War I was a democratic country where the rights of all, including Jews, were respected and Germany had a long history of policy friendly to Jews. Nonetheless, within a couple of decades, the Jews of Europe were nearly wiped out by these same Germans. Jews would be fools indeed to willingly put their survival in the hands of others. If the Arabs want all of Palestine, they will have to fight for it.

There is a story that gets to the core of the Palestine/Israel situation. I don't know if it's true, but it's a good story nonetheless. One night shortly after the 1948 war a pregnant Jew in a kibbutz near the Egyptian border was killed. The tracks of the killers lead directly to an Arab village on the Egyptian side. A young Israeli officer was told to take his men to the village and a lot of Arabs were killed. A few days later there were outraged articles in newspapers around the world condemning Israeli atrocities in the village. The officer, distraught, went to David Ben-Gurion, the first Israeli prime minister. To the officer's surprise, Ben-Gurion was happy with the newspaper coverage. The officer asked why. Ben-Gurion said that for thousands of years killing Jews had been easy, safe, and painless; and the primary purpose of Israel was to make Jew-killing difficult, dangerous, and painful. The newspapers were helping spread the word.

That's what's going on in Gaza today. Hamas considers itself a religious organization (3) with a duty to destroy Israel, which they are too weak to do at present. To keep the fight going, Hamas launches rockets into Israel, occasionally killing a Jew or two. Israel is making that activity difficult, dangerous, and painful in hopes that, like Egypt, Jordan, and the PLO before it, Hamas and the rest of the Arab world will eventually give up trying to destroy Israel. That will end the Arab-Israeli conflict.

NOTES

(1) This is why the 750,000 Palestinian refugees created in the 1948 war were never resettled anywhere in the vast Arab lands and millions of their descendants now live in crowded refugee camps. A few years earlier, in 1945 at the end of World War II, there were millions of refugees in Europe, all of whom have long since been resettled. Indeed, about 600,000 Jews were expelled from Arab lands in 1948 and fled to Israel, all of which have also long since been resettled even in tiny Israel. By refusing to resettle the Palestinian refugees, the Arab elite have cultivated a large population who, quite understandably, hate Israel. This helps immensely to keep the fight going.

(2) It should be said that all of these governments, Egypt, Jordan, and the Palestinian Authority, are fragile. They are all dictatorial, corrupt, or both and could be replaced by governments actively hostile to Israel. For example, Hamas won the last Palestinian Authority legislative election.

(3) This is important to understanding Hamas. For example, the ideal Muslim is the prophet Muhammad, and good Muslims often emulate his life. Muhammad was, among other things, a very successful warrior. At one point Muhammad made a ten year truce with his enemies. The people asked him why. He said that at the moment the enemy was too strong to defeat, but he could use the truce to build up his strength and defeat them, which is exactly what happened a few years later. This is why Israel is reluctant to negotiate a truce with Hamas.

It's the Debt, Stupid

I'm beginning to believe that America, the whole country, has hit her debt limit. Consider:

The federal government owes $10.6 trillion. By contrast, the Russian government's debt is zero. That's right, zero.

The increase in federal debt over the last year was about $1.4 trillion.

Total mortgage debt is about $12 trillion.

Total credit card debt is around $1 trillion.

110 million Americans have bad credit -- that's almost half of the roughly 240 million adults in America.

Total American debt (household, business, financial and government) is $53 trillion.

All this on a $14 trillion yearly GDP.

One consequence, the American government must come up with over a trillion dollars a year to service the debt. Assuming an average 10 year term, $1 trillion is needed to pay off bonds coming due every year. Assuming 3% interest, we need $300 billion/year to pay interest. That's $1.3 trillion per year in taxes or borrowing to get -- nothing. The money has already been spent. Unless we pay down the debt, this will continue forever.

America has been living high on the hog by borrowing, and someday that borrowing will have to stop. That day appears to have come. We must live on what we earn, minus very large debt payments. That means we have to buy less. That's ok, our garages are already stuffed with expensive stuff we don't use.

There's a chart of different parts of the debt from 1957 to now at http://mwhodges.home.att.net/nat-debt/debt-nat-a.htm. The two parts that have really taken off are financial sector debt and household debt. Financial sector debt appears to have been created by clever people lacking regulation so they could get rich on commissions. The household debt has been financed by rising home values. This allows people to borrow against their home.

Unfortunately, while rising home prices allow home owners to borrow, it doesn't help them pay off the loan. High housing prices are bad because everybody, forever, must devote a great deal of their income to keeping a roof over their head. Fortunately, prices are coming down. Before the bubble median house prices were about three times median income. Median income is about $50K, so median house prices will probably fall until they reach about $150K. They're about $200K now.

If this line of reasoning is correct, financial rescue attempts based on getting people to borrow money will fail, although perhaps not right away. The good news is that buying more stuff wasn't going to make our lives much better anyway. The bad news is that adjusting to living within our means and paying down our debt will be very painful. The millions losing their homes, jobs or both have already noticed that.

There is some reason to hope for better times. Specifically, the price of oil is almost back down to what it was before the big rise, and that will make everything cheaper. Second, the economy is strongly influenced by the President and the incoming guy is extremely intelligent.