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Milton J. Madison - An American Refugee Now Living in China, Where Liberty is Ascending

Federalism, Free Markets and the Liberty To Let One's Mind Wander. I Am Very Worried About the Fate of Liberty in the USA, Where Government is Taking people's Lives ____________________________________________________________________________________________ "Extremism in defense of liberty is no vice. Tolerance in the face of tyranny is no virtue." -Barry Goldwater-

Thursday, February 25, 2010

Why the financial problems in Greece are so important to contemplate......

As the developed world layers on social safety nets designed to 'protect' middle class people from the normal responsibilities and challenges of everyday life, these nations are finding that the costs to these plans are not static but robust.

As early legislation intended, since the demographics were favorable, they have become popular entitlements to the people of a nation. The indulgence of adopting these plans was that it relied upon continued strong growth in population so that many working people support those that decide to not work anymore. However, as the demographics of Western nations have changed, the methods of paying for these plans have not. Most of these entitlement programs collect payments in the form of payroll taxes and redistribute them to others that are entitled to collect this entitlement.

But there are several problems with this;
1. Relies upon a robust and growing economy
2. Relies on growing or stable populations of workers relative to people that collect benefits
3. Discourages workers from savings since these entitlements are viewed as savings by people that are being done through the central government
4. Discourages workers from savings for potential health problems since others will take care of that
5. Government entitlement programs do not actually save money for these benefits but solely relying upon taxing power of current working people
So, we are seeing the early stages now of a collapse of the socialist systems that have infected Western Europe and the US over the past several decades. AS this writer thinks, this is just the beginning of a collapse of these Utopian income redistribution plans....
The meaning of Greece transcends high finance.

Every advanced society, including the United States, has a welfare state. Though details differ, their purposes are similar: to support the unemployed, poor, disabled and aged. All welfare states face similar problems: burgeoning costs as populations age; an over-reliance on debt financing; and pressures to reduce borrowing that create pressures to cut welfare spending. High debt and the welfare state are at odds. It's an open question whether the collision will cause social and economic turmoil.

Greece is the opening act in this drama; already, its budget problems have spawned street protests. By the numbers, Greece's plight is acute. In 2009, its government debt -- basically, the sum of past annual deficits -- was 113 percent of its economy (gross domestic product, or GDP). The budget deficit for 2009 was 12.7 percent of GDP. Two-thirds of the debt is owed to foreigners, reports the Institute of International Finance.
From here. Similar problems face the United States government as it runs deficits of over 10% of GDP and this will mean that the US will be heading into territory where other nations have had very difficult problems. If nominal GDP grows at 5% a year, and deficits are 3-5% of GDP, a nation can sustain a stable debt level. Yes, from a nominal basis, these numbers look bigger and bigger over the years as GDP grows, but it is most relevant to look at these as a percent of GDP.

As debt balloons in the nations and finances weaken, lenders become less-and-less inclined to offer new funds as governments become more risky as a credit. This will also affect the rest of the economy as this tightening of credit and the potential for higher taxes reduces the rewards to investors within that jurisdiction. Companies and investors become less certain, on the margin reduce investment and hiring and this weakening of the real economy will lead to a relative decline in economic activity and tax revenues leading further government funding problems.

It will all end badly. And what is so amazing about this, is the US is engaging on increasing these entitlements and government intervention under the disguise of social protection and providing healthcare for all. Its a Utopian dream. IT will never work and it will cost every American dearly going down this path.


At 7:51 PM, Anonymous Anonymous said...

I have to chuckle a bit here in that I have said for years that using an inflated view of the US GDP as a percentage of spending was ok to use as a comfort zone for the future.
It never took into account the realities of shifting wealth centers. It was/is a myopic view of wealth patterns.

At 9:06 AM, Blogger glenzo said...

A nation can sustain a deficit as long as it is less than the growth in nominal GDP. Imagine this, If GDP is $10 and the government accumulated deficit is $1, the debt to GDP percentage is 10%. If the GDP grows to $20, the nation can afford another $1 of accumulated deficit to maintain the 10% debt to GDP. The US has grown GDP but has grown government spending at much more rapid rate leading to higher debt as a % of GDP.

Even more troublesome, is that Social Security, Medicare and federal retirement benefits are entitlements that are earned but never accounted for as a liability on the balance sheet of the US government. Federal worker retirement benefits alone, at this point in time have accumulate almost a $1 trillion of intergovernmental debt.

Additionally, Social Security and Medicare have assets in the form of intergovernmental debt of somewhere around $3 trillion. These are FICA taxes over and above the actual spending on these program that have been borrowed by the US Treasury that was spent on other things. These surpluses and interest on the balances borrowed are now around $3 trillion.

However, the present value of the obligations for these programs are in the tens of trillions. This can only be met by future taxes and unless the GDP grows at an enormous annual rate, the nation will never be able to meet these obligations.


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