Keywords

Sequester; public health care; currency wars; rising health care costs; unwarranted health care endowments; health care bankrupts America; Sweden’s example of coming up from under; currency devaluations; currency wars

10.1 Sequester

“The president got his tax hikes on 1st January. The issue here is spending. Spending is out of control,” said John Boehner, Speaker of the US House of Representatives.¹ By end of February 2013 everybody in Washington was aware of the fact there was no resolution at hand to stop the $85 billion in automatic spending cuts. These were mandated by the sequester² which targeted a total of $1.2 trillion of reductions on federal budget expenditures over 9 years.

“I don’t think anyone quite understands how it gets resolved,” Boehner told NBC’s Meet the Press on March 3, 2013, repeatedly rejecting the White House’s call for new tax increases to end the impasse, and questioning some of Barack Obama’s most dire warnings about the impact of sequestration. To Boehner’s opinion, such claims were exaggerated.

Budgetary deficits are nothing really unusual. What attracts attention is their huge size and tendency to grow by leaps and bounds every year (see also Chapter 11). When the pace of growth is overwhelming and the reasons for it have to be brought to public attention with a clear statement by the White House on whether the US debt can be repaid or has to be written off. (The same is true of Britain, France, Italy, Spain, and Greece.)

Like most of the western European countries, America urgently needs a way to deal with its long-term spending problems as well as its self-delusion to say that the search for a solution can be limited to tax reform. No nation can cut its way to prosperity by being a big spender. To be effective any solution has to lead to real economic growth and this is not done just by

The irony is that sequestration will practically touch only lightly the heavy chapters of expenditures, because in their origin is a swarm of public health care sacred cows. Curiously, without anybody really paying attention to it, the United States joined France and Italy in the art of surviving its big budgetary deficits through a cocktail of inflation and devaluation—but in the case of the United States neither of them has worked (see Section 10.6).

Devaluation of the dollar and “controllable” inflation have been Ben Bernanke’s not-so-secret goals with QE 1, 2, 3, and 3.5 (Chapter 12). But after years of trying he failed in reaching his goals. While other “strong” currencies devalued against the international monetary system, such as the British pound and the Japanese yen, the United States cannot do so because the dollar is the international monetary system. (More on this in Section 10.6.)

So it is if you like it and so it is if you don’t. The Fed engaged in plenty of extra curricula activities to help White House and Congress with their huge budget deficits, but at the end of the day these extra curricula did not deliver. The sequester became unavoidable, given the extremely large buildup of debt, which is undoing the American economy single-handed. Nobody should expect that sequestration will produce miracles. Official statistics suggest that

Even the 2 percent reduction of Medicare funds is theory rather than fact. Some analysts suggest that Medicare cuts with the sequester will not be higher than 0.25 percent of allocated funds and the Obama Administration can always count on the support of labor unions to go on strike against a deficit reduction plan by Congress.

It happened in the Netherlands the first days of March 2013 when a euro 4 billion ($5.2 billion) package of additional austerity measures aimed at enabling the country to hit EU deficit targets in 2014, led to a bitter clash with trade unions. The assault against the plan started with Holland’s largest labor federation attacking the cuts as stupid and ill-advised.

Superficially, people look at austerity plans and sequesters as totally different things, but down to basics the notions propelling them tend to converge. The idea is to blow open policies and practices underpinning inaction on debt issues and stop further financial bleeding by

All this has to be studied under real life conditions which involve plenty of headwinds: payroll tax increases, delayed tax refunds, higher gasoline costs, you name it. These have had a discernible impact on the citizen’s spending practices and on taxable income, translating into declining ability to repay the debt.

The worst enemy is inaction. With no alternative solution in sight, on March 1, 2013 president Obama had no alternative to ordering the start of $85 billion in government spending cuts, beginning a potentially decade-long wave of belt-tightening. The Office of Management and Budget sent Congress a detailed list of program cuts and government agencies notified their employees and informed affected government contractors.

Everyone will feel the pain of these cuts which have been “a solution by default,” rather than one properly planned. They were intended to be so onerous that Congress and the president would not let them occur, by coming up with a debt control plan ahead of the March 2013 deadline. Moreover, everybody knew that the sequester is an inefficient way of cutting government spending. It was not designed to address the soaring cost of health care entitlements, even if the share of US GDP consumed by Medicare alone is projected to rise:

Another weakness of the sequester is that it provides no prioritization, as guide to budgetary reductions. The FBI, Center for Disease Control, Food and Drugs Administration, and Federal Aviation Authority would temporarily lay off 10 percent of their workforce, causing chaos throughout the country. By contrast, health care and pensions will steam through unscathed. It would have been more rational if the sequester was not looking only after the symptoms of the disease:

but also what created the illness:

Like in France, Italy, Spain, and plenty of other western bankrupt countries, the underlying problems are home grown. Hence the urgent need for thorough reexamination of all public expenditures, with no sacred cows escaping the slaughter; making a 10-year projection of government revenues on the base of different scenarios of tax income; and comparing receipts against expenditures, looking at primary and full budget surpluses and coming to a conclusion on which expenditures have to be cut with a sharp knife.

The sequester is not doing this. It just orders the aforementioned $1.2 trillion savings over 9 years. That’s not enough. To increase transparency, the analytical steps I am suggesting should be extended to the level of the single individual benefiting from Medicaid, Medicare, and Obamacare—with emphasis on his or her use or overuse of common funds.

An example is the data which hit the public eye in February 2013. In the average, over his lifetime of health care service each beneficiary of Medicaid contributes to the common purse of Medicaid $110,000 and uses the system’s common funds to the tune of $333,000. Has anyone searched to find how a system which rewards its “clients” to the rate of 300 percent the money they cash in, can survive?

That’s worse than a Ponzi game and economists have plenty of reasons to worry about what happens next. The challenge is not just inflation, which for the time being in the United States (but not in Britain) is subdued; though the inflation worry is not totally absent. With inflation already forecast to be above target for 2 years, a growing number of economists abandoned the camp wanting more QE and joined the opposite side.

In conclusion, the advent of flat sequestration is a low point for Washington, giving everyone the message that congressmen—both representatives and senators—have lost their ability to make up their mind. They take too lightly the risks which accompany rising public debt. But there is at least one thing the sequester did right. It hit the nation’s discretionary expenditures. Almost all forms of so-called discretionary spending that Congress gets each year will be cut equally and indiscriminately. Well done. Nothing hurts the politicians more than losing access to the pork barrel.

10.2 Don’t Let Grandparents Steel the Young Generation’s Money

Stan Druckenmiller has been one of the best-performing hedge fund managers during the last couple of decades. Based on his experience he has this warning for young Americans: don’t let your grandparents steel your money. In the background of his advice are the mushrooming costs of Social Security, Medicare, Medicaid and Obamacare—with unfunded liabilities of $211 trillion:

“While everybody is focusing on the here and now, there’s a much, much bigger storm that’s about to hit,” Druckenmiller said in an hour-long interview he gave to Bloomberg News, adding that: “I am not against seniors. What I am against is current seniors stealing from future seniors.” To his opinion, espoused by many other knowledgeable people, unaffordable and unsustainable spending will bring a crisis worse than the financial meltdown of 2008, when $29 trillion was erased from global equity markets.

People who care for their country’s and their currency’s survivability say that what’s particularly troubling is that skyrocketing government expenditures are more and more related to programs for the elderly. The US government budget went out of control, even before the first baby boomers (those born in 1946) started turning 65 adding themselves to the retired. In parallel to this imbalance which has created unfunded liabilities of $211 billion came up a plain un-American credo: “Spend Now, Earn Later.”

An example of “spending without limits,” associated to poorly planned and badly executed big government policies, is Obamacare (officially known as the Affordable³ Care Act (ACA)). By mid-2013, with a few months to go before the main feature of the 2010 US health care law takes effect, the White House was confronted by mounting bureaucratic challenges of a sweeping legislation. Critics argued that this is evidence of

The new rules are promoting “spending without limits” as the state exchanges will (for one year) be able, in cases where the information is not easily available electronically on a federal database, to waive the requirements that they verify the income of individuals seeking tax credits.⁴ Sampling procedures adopted by the Obama Administration’s do not solve the problem of dependability, unless accompanied by severe penalties for false declaration (which is not the case). Simply auditing a small sample of randomly selected files is a half-baked solution.

The end result is that, for reasons of its own doing, the Obama administration is now coping with an untenable situation and it is being blamed for incompetence. This incompetence also led to a breakdown in the normal legislative process, as on July 18, 2013 Congress stroke out two chapters from Obamacare’s 600-page regulation. By way of lousy management, in three quarters of a century we have gone a long way in terms of spoiling the nation’s financial resources.

Publicly supported pensions and health care were invented almost simultaneously, in 1936, by the Roosevelt Administration in Washington and the Leon Blum government in Paris. The idea was sound if, and only if, they were kept away from politics and their deliverables were always kept in a zone of expenditures which was affordable and, in the long term, it could be honored.

This has not been the case. “We must be conscientious that in France social policy and demagoging policy are always being confused,” said George Pompidou a former president of France.⁵ Back in 1964, Pompidou foresaw that the simple train of social measures being taken will outrun before too long the country’s financial possibilities. This proved to be the right estimate. The so-called French model failed when the entitlements it guaranteed could no more be financed by

In a letter George Pompidou wrote to Charles de Gaulle, then president of the French Republic, he clearly stated that reforms which go against economic realities always fail.⁶ This is precisely the condition western governments are confronting—America above all others because its economy is so large and so is the size of its problems.

This underlines the tensions between Republicans, who see the expansion of Medicaid ordered by the 2010 Affordable Care Act—the unaffordable big government initiative. Plenty of Americans, particularly the young, now appreciate the 2010 Act was not studied in terms of its affordability. As it stands, it would add a lot to the already sky-high budget deficit.

Politics, however, blur the people’s mind and Democrats who want “more Medicaid and Medicare” at any cost. Under the ACA, states are mandated to expand their unbalanced and uncovered Medicaid programs, which provide health services to the poor, children, and disabled—the criterion being incomes below 133 percent the poverty line. That meant that in one shot the federal government promised to pay all of the cost for 3 years⁷ for:

Companies, too, could pay a heavy price for the political wrangling, and the issue became so fraught that even the Chamber of Commerce has opted to stay out of the fight. Hospitals are among the most concerned. “One of the biggest things every hospital is going to pay attention to is the expansion of Medicaid,” said Steve Glass, finance chief of the Cleveland Clinic. “Medicaid is the worst payer because it pays below cost but it’s still better than someone who doesn’t have any insurance at all.”⁸

While the argument about “paying below cost” is open to debate, there is an even more important question which needs to be addressed. In simple terms: What’s the value of the health care the common citizen buys with the money of a highly indebted sovereign. Is he or she paying two cents for something worth one?

If voters were rational they would examine every government-sponsored action should be examined under this criterion of cost/effectiveness, because in the last analysis they will foot the bill through higher taxation. Here is an interesting example on what can happen. In 2012, the US government spent $116 million minting pennies which since 2006 has cost more than a cent to produce (mainly due to the price of zinc, the coin’s primary ingredient).

Because for small coinage costs exceed value, in Canada the government recently ditched its steel-based penny. Relegated to jars and lost behind cushions, the penny has failed to perform its primary function: facilitate commerce. Vending machines and parking meters don’t accept it. Penny critics note that fiddling with them adds some two seconds to each transaction, costing the economy many millions of dollars on an annual basis.

The more the cost of the penny increases, the more zinc industry lobbyists pressure the government. The coin’s demise, they say, would cost consumers, as merchants would round prices up to the nearest nickel. “Economists disagree,” says an article in the Economist which suggests that “shop keepers might in fact round down in order to avoid moving from a price of, say, $9.99–$10.”⁹

Similar spoilage but at grand scale is happening with health care costs. The numbers are astronomical. There are simply good reasons why the United States spends way above publicly supported health care expenses in Britain, Germany, France, Italy, and Spain—or for that matter a high multiple of what is spend in neighboring Cuba more or less equal longevity (Section 10.3). This is a go-for-broke policy, which

So far American politicians have not been brave enough to say, in no uncertain terms, what Stan Druckenmiller stated about grandfathers and grandmothers stealing the money from their grandsons and granddaughters via unfunded liabilities (the $211 trillion stuff). Using their very powerful lobby the seniors keep on getting more and more transfer payments from the younger generations to their own. That’s no more the pay-as-you-go system Social Security and public health care used to be in the United States or anywhere else.

In 1990, Social Security, Medicaid, and Medicare accounted for 34 percent of the government’s expenditures. This hit 44 percent in 2011, a mere 21 years down the line, according to statistics compiled by the government’s Bureau of Economic Analysis. In 2011, the cost to the federal government has reached a cool $3.7 trillion, and it keeps on growing almost without bounds.

In 2010 in the United States, there were 40 million people 65 years old or over, according to the US Census. According to the Department of Health and Human Services, by 2020 that number is expected to hit 55 million—a significant increase which will reflect itself into the ongoing government deficits making it all but impossible to balance the budget.

To the opinion of Lawrence Kotlikoff and Scott Burns, authors of “The Coming Generational Storm,” by 2030 there will be about two workers per retiree, down from 3.4 workers in 2000. Similar statistics (indeed, even worse) prevail in western Europe. In future seniors are taxed at the same rate as today’s working population, they will get (at best) less than half of the benefits that our present day seniors are getting. This has been Druckenmiller’s message.

As for the unfunded liabilities the way to bet is that they will be reaching for the stars, hitting $1 quadrillion. Eventually the market will wake to the fact that behind commitments made by the central governments of western democracies is only hot air.

When this sips down the market’s mind, its response will not be mild.

If the reader does not believe that, left unattended, the present unfunded liabilities of the United States can grow to $1 quadrillion, then he or she should use Italy as proxy of the rise of US public debt. In both countries, the political and economic situation has shown similar (as well as disturbing) long-term implications, with common ground the tendency of modern democracies to pile up debt by making unaffordable spending promises—essentially, by lying to the voters.

Mario Monti, Italy’s former prime minister, said that much without ifs…and buts. The fact that he spoke his mind was not appreciated by the voters. Monti ended a poor fourth in the February 2013 elections. For a little more than a year (late 2011 to late 2012) his government and its reforms won the approval of the markets—but not of the voters, with the result that Monti trailed to an undistinguished position.

Like Italian politicians of the Berlusconi class (Monti’s nemesis), American politicians responded to the economic crisis by lifting the debt ceiling, ignoring the debt ceiling, making permanent tax cuts, and introducing new taxes with any coherent plan. The keyword is spending. To put the size of the current QE3.5 program of the Fed into context, when the US stock exchanges closed for a week in response to the 11 September 2001 terrorist attacks, the Federal Reserve injected $34 billion into markets. That’s less than 2 weeks expenditures of the current QE3.5 permanent program.

This ratio helps to dramatize the level of the current public debt crisis in the United States. Section 10.3 will bring to the reader’s attention statistics of runaway health care costs around the globe and also demonstrate that there exist no miracle solutions. Miracles are the things we don’t understand, said Isidor Isaac Rabi, the physicist of the Manhattan Project.

10.3 Case Study on Health Care Expenditures and Their Incoherence

The danger of a default gets a boost when unsustainable debt levels become chronic and nothing is done to turn around the situation (other than words and very light commitments). For any economy a default would be a social, logistical, economic, and political challenge of the first order. The government would in effect have to engage in a massive effort not only trying to find the money to pay for the essentials but also deciding which payments

In early- to mid-2011 Tim Geithner, Treasury secretary, has been warning Congress about the dangers of failing to raise America’s borrowing limit. Barack Obama himself stepped in to spell out the implications of a default. On August 3, 2011, the day after the final deadline, the US government was due to send out some 70 million checks. This is not just a matter of Social Security checks, Obama commented. These are veterans’ checks, these are folks on disability. But with the arguments about raising the US debt limit still ongoing, he said he could not guarantee that the checks would be posted.

Veteran check and health care deals come out of the same purse. For how long can the US government, or for that matter any government, guarantee that it can keep on paying the ever rising health care expenditures? Health care has been one of the entitlements whose infinite continuation is typically taken for granted. That’s wrong. There are reasons why economists and politicians have entered the debate regarding the

The big question is not one of just developing some more refined version of publicly supported health care. It’s one of continuing to pay ever increasing costs in a low growth economy. The whole system has to be reexamined bottom up, including its details, to restore its credibility and assure that what is retained is affordable.

This means major cuts in order to be able to promise that what remains in health welfare will not be subject to new and steady cuts. Given lower than hoped for federal revenues, how will the government confront the entitlements without the ax? Solely by imposing new taxes on the wealthy? Fiddling with the idea of a balanced budget is meaningless if economic growth weakens while health care and other entitlements costs are rising.

Obamacare, Medicare, Medicaid, and all other health care plans for an aging society are an excellent ground where to apply the principle of sustainability. This is not a subject born last night. The budgetary pressures arising from health care paid by the common purse have been a cause for concern for a long time. But reforms have always been half-baked while the need for timely and comprehensive real policy reform remains high. Until this takes place, risks to long-term fiscal sustainability will continue being elevated because

While particularly expensive is the long-term care brought to the foreground by an aging society, the overall concept of nanny state health care lacks a rational analysis in terms of costs and deliverables. A generally held notion is the higher are health care expenditures, the longer the life expectancy. Such a notion is utterly wrong.

An excellent study published by Crédit Suisse brings this issue in perspective. Its basic premise is that no country has yet figured out a sustainable solution to health care financing. All developed nations are coming under cost pressure, though some much more than others, but “good health care” is more than just a matter of money: above all, it requires out of the box ideas.¹¹

So far new ideas are in short supply. Statistics are however revealing particularly the lack of correlation between health care costs and longevity, suggesting that if it is to rein-in skyrocketing health care costs, then everything connected to health (not only to health care) should be on the table. Table 10.1 provides statistics on health care costs per capita and GDP per capita, in 9 countries.¹²

In the first decade of this century, among western countries the steepest increase in health care costs has been in Spain, Britain, the United States, and Switzerland (the latter particularly in hospital spending). The four are followed by Japan, Germany, France, and Italy (in this order). While in statistical terms the smaller increase in percentage points was in Italy, it has been an extravagant and unaffordable 147 percent in 10 years.

The usual excuse for spending and spending is that “health is precious.” Table 10.2 brings to the reader’s attention the fact that health care costs and life expectance don’t correlate. On equal life expectancy of 78 years, the United States spends 1377 percent more money than Cuba. Is it that the Cubans are world masters in health care? Or is health care money spoiled the big way in the United States? Short of unprecedented spoilage these figures simply don’t add up.

Spoilage is a many-headed curse. India’s 1.2 billion inhabitants use about $10 of packaging per person annually, compared with $40 a head in China, $100 in Brazil, and $400 in the United States.¹³ I lack statistics on the cost of packaging in Greece prior to WWII, but based on remembrance my guess is that it was not far from that of today’s India—while at the present time it is nearer to that of the United States, which means spoilage of resources.

Health care specialists who are not afraid to express their honest opinion suggest that what people eat has more to do with longevity than money spent on health care. The speed with which obesity has risen to global epidemic proportions is staggering, as are the consequences for patients and health care costs. The dramatic growth trend in obesity rates seen over the past decades is expected to continue as citizens in western nations go for fast food and emerging countries are increasingly opting for high-calorie unhealthy western diets.

Moreover, the trend in urbanization lessens the amount of physical activity. The switch from bicycling or walking to the automobile has been one of the factors contributing to obesity. The physical environment is another big factor while zoning laws and market conditions have created “food deserts”¹⁴ where whole neighborhoods have no access to fresh produce unless they drive to the supermarket.

Spoilage in personnel cost is another of the debt hydra’s heads. In late 2012, the US postal service pleaded with Congress to vote a law permitting to end Saturday deliveries and restructure its health care plan for retired employees. This asking for indulgence revealed that most of its recent $16 billion annual loss was due to health care benefits the postal service had provided.¹⁵

There is no evidence that US postmen live much longer than their colleagues in Cuba in spite of 2000 percent higher health care costs to the taxpayer. Something similar can be stated with the 80–82 years life expectancy. The big spender in this case is Switzerland. Though 36 percent lower than in the United States (Table 10.1), per capita health care costs in Switzerland are 68 percent higher than in Japan (an aged society) and 55 percent higher than in Britain. Yet, Britain’s National Health Service (NHS) is known for its inefficiency.

In the 65–68 bracket of life expectancy, Russia spends on a per capita basis 77 percent more than India on health care. Similarly, at the level of 50–52 years life expectancy, South Africa spends on health care 1044 percent more than Burkina Faso (inefficiency aside, another reason may be that in South Africa 17.8 percent of people are infected with HIV).

These statistics are suggesting that the more money the government taxes the more it spends on publicly supported health care without any change in life expectancy. Such statistics give plenty of food for thought. Something is basically wrong with the way the publicly supported health care system is set up and operates. Abuse is known to be rampant. In France, 50 million people have the right to a health care chip-in-card which pays their medical expenses and pharmaceuticals, but 60 million cards are in circulation.

Abuse of public health care benefits is surely accompanied by mismanagement, and other more esoteric reasons which have not been as yet properly researched. Finding out “what” and “why” is most urgent because unless all background factors influencing health care costs are found and corrected nothing will stop them from rising at high pace.

As these statistics document, there is no time to lose in bringing health care costs under lock and key. The public budget does not only to address health expenditures, there are as well other entitlements requiring a great deal of funds—pensions and education being examples. It is simply impossible to give to anyone of them the lion’s share of the sovereign’s annual income.

What is true for government is also true for companies which have assumed health care expenditures for their employees. No surprise, therefore, that some of them are shifting health costs to their workers. Examples are: Sears, the retailer, and Darden Restaurants, which operate Olive Garden and Red Lobster restaurant chains.

This switch hit the public eye in September 2012 as the aforementioned companies unveiled a “defined contribution” health insurance plan which would give employees a lump sum of money and allow them to choose from a variety of choices in a menu of insurance options. This is an emulation of the change many companies made from traditional pension schemes to the 401(k) program (in the case of the United States) that give employees greater choice while assuming more risk.

Precisely because of this risk component to be assumed by employees and workers, the possibility of private exchanges becoming mainstream has raised concerns among consumer advocates. Their main objections are that low-wage workers will be at risk:

Some years ago similar objections were made as companies altered their pension plans to a defined contribution basis. To the opinion of those against the switch shifting responsibility on to workers as a way to cut costs, the defined contributions health care is unlikely to work because doctors and hospitals have incentives to make them spend more. To the contrary, the pros say that with a defined contributions plan employees and workers will benefit from greater choice and the option of purchasing a less expensive health insurance.

Curiously enough, absent from argument advanced by the critics is whether sovereigns and the companies can afford to pay wholesale the rising medical, hospital, and pharmaceutical costs of their citizen and of their employees. There is plenty of proof that the way the now classical system has worked is unsustainable. In a manner not dissimilar to that of pensions, the population health care dynamics have changed. Not only a great deal needs to be done to bend the curve of rising health care costs but also a new solution has to be found in cost sharing in order to avoid that the whole health care system goes bankrupt.

“People who have high cost sharing tend to use less services, don’t take medication or go to the doctor,” says Tim Jost, a professor at Washinggton and Lee University School of Law. “if there is anyone out there who thinks this care is going to be free, they’re probably in for a bit of a surprise.”¹⁶

10.4 A Bankrupt America Needs an Age of Austerity, Says Mort Zuckerman

Economic growth in the United States continues being slow despite all the money thrown at the problem by the Obama Administration as well as the Federal Reserve’s quantitative easing and its other unconventional policy tools. The bigger uncertainty is what the government will do with its own fiscal challenges. Back in January 2012, a poll by PWC found that 48 percent of American company CEOs thought that over the next couple of years the situation will get worse, not better. As far as the US economic outlook is concerned there has been concern about diminishing visibility which made the CEOs uneasy.

Nothing has changed during 2012 and 2013. What was true then, continues being the case today. Companies want clarity in economic outlook, not uncertainty. Lack of clarity leads to indecision, with the result that senior management holds back investments which damages the economic outlook. The longer the distrust continues, the deeper the economic impact. Distress is exported:

“… this is being called the most predictable crisis in US history. For who could dispute, when our government must borrow $4.5 billion a day just to keep going, that our debt is now an existential threat?” wrote Mort Zuckerman¹⁷ in a July 2012 article, “… knowledgeable people in finance are aware that the Fed has been buying 70 percent of all new Treasury paper, making the government by far the largest client of its own debt. This is possible only by increasing the money supply and the balance sheet of the Fed itself, a practice that sooner or later must blow up.”¹⁸

Zuckerman’s advice is that the US government adopts a long due policy of austerity. Being a pragmatist Zuckerman appreciates that since taxes cannot be raised enough to recover the ever increased expenses, the United States has no choice but to enter its own age of austerity by way of long-term spending reductions. And he is right when he says that the scale of deficits and debt, demands nothing less if the country is to save itself from default.

Compare this with the Fed chairman’s congressional testimony in early February 2012. After a vague reference to supposedly improved economic conditions, Ben Bernanke went on to stress that the sluggish expansion has left the economy vulnerable to shocks and economic developments must be monitored closely because the outlook for the United States remains uncertain. This is not too different from what Zuckerman wrote, but instead of following his own advice in September 2012 Bernanke engaged in QE3 and in December 2012 in QE 3.5.¹⁹

Reconciling the Zuckerman and Bernanke approaches presents a dilemma. We can claim that one is right and the other is wrong. Or we can consider the possibility that the Federal Reserve is motivated by more than the state of the US economy, and therefore saying one thing and doing another is not as contradictory as it might seem. But whatever else may be motivating it, is it enough to justify throwing more liquidity in an already overliquid market?

Somehow it seems to have escaped the Fed chairman’s attention that in the longer run “more of the same” is an unhealthy economic policy. As its debt mountain continues rising, the United States will eventually have to decide between another rating downgrade due to overspending or risking a recession due to an emergency in cutting the deficit.

This challenge is not as far away as the neo-Keynesian economists hope. On June 13, 2011, Bloomberg’s ticker carried a statement by Bill Gross, of PIMCO, that the United States is in worse shape than Greece. When Gross expressed this opinion, Greece was at the brink of bankruptcy.

This is by no means an isolated way of looking at the coming peril. Interviewed on July 2, 2012 by Bloomberg News, David Cote, Honeywell’s chairman, had an advice for Washington. The monitor asked: “As a successful businessman, given Honeywell’s results, what would you have done to redress the American economy if you were running the government?” Without a glimpse of hesitation, Cote answered: “I would declare bankruptcy.”

What was meant, though not explicitly stated in this exchange, is that there is no question the status quo can continue with budget deficits a daily ritual and an ever increasing cost of endowments. While taxes may rise, as the last two decades of sovereign spending habits document public expenditures will rise faster. Alternatively, the quantity and quality of public services will shrink to make the ends meet. In the aftermath, the citizens

Critics may say that the opinions expressed by Gross and Cote are pessimistic views of the future of the American economy, but one should not forget that there were reasons for them. “Free university education for all” provides an example, albeit from the other shore of North Atlantic. In Europe, university studies are largely featherbedded by the sovereign (an exception is Britain where college fees were established in the Blair years). In the United States, the fact that universities spend beyond their means is reflected in student loans which hit $1 trillion and in ever increasing tuition fees. Between the mid-1970s and 2012:

This is quite a substantial increase in administrative costs in education, and it provides evidence that the business of homo bureaucraticus is kicking. The same is true of administrative costs in health care, with the result that taxpayers are charged for a booming bureaucracy, exactly the sort of thing an overindebted society does not need.

Administrative costs have to be cut with a sharp knife, even if this is sure to encounter political resistance, while all other costs have to be examined from the viewpoint of their deliverables based on firm evidence. The budget must be balanced and to do so no stone should be left unturned. If public debt continues its current course, then outright bankruptcy will be an option. The government could write off trillions of dollars at a stroke, but this will have a huge negative impact on the economy with end result a total loss of confidence.

Bankruptcy might also happen by default. Debt reduction via hyperinflation is another option, leading to forced downsizing of federal debt at the expense of common citizens²¹ and investors. This, too, will negatively affect the economy and have a global wide impact. Most significantly it would imply heavy taxation of the poor, as is always the case with inflation.

According to his critics, with QE1, QE2, QE3, and QE3.5 Bernanke allegedly tried to engineer the latter alternative. Drastically devaluing the dollar is still another option, which will most likely ignite a wave of competitive devaluations, like the one that preceded WWII. This solution is far from unthinkable, as there is precedence to it. In 1933, President Roosevelt fixed its value of the ounce of gold at $35.00 against the then prevailing rate of $20.67.

Financial history books write that prior to making up his mind on this de facto 43 percent devaluation of the US dollar against gold, which affected all outstanding debt, Roosevelt asked the respected Democratic Senator Gore of Tennessee for his opinion: It will be stealing Mr. President, would it not? Gore replied. Stealing or not, this halving of the dollars’ value did take place 80 years ago; hence, it is not unthinkable that it could happen again.

It is far from being clear which of the major alternatives will be adopted for pulling the American economy from the precipice. Much depends on political will. Factors which will probably impact on the final choice include:

Why not to consider another alternative: that of pulling the Swedish economy away from the cliff. It is interesting because of some striking similarities between the American economy in 2013 and the Swedish in 1993. In the post-WWII years, Sweden used to be famous for its generous welfare state and full employment. This was the envy of other countries. George Pompidou, the French president, once said that he wished France to be a kind of Sweden by the Mediterranean. The system worked, or at least gave the impression of doing so, by

In his predictions contributed to the Financial Times A-List on the big challenges of 2012 (written on January 3, 2012) Jeffrey Sachs, of Columbia University, has this to say about events down the line: Barack Obama will be reelected because of his consistent strategy to stay one step towards the center of the right-wing Republican party. But the presidential elections will do nothing to reinvigorate American society. Government will remain corrupt, incompetent, and shortsighted. Let’s see how the Swedes handled that problem.

10.5 Sweden’s Near Bankruptcy in 1993 Provides Food for Thought

The majority of people running western governments find it difficult to understand that if their electoral promises materialize then the result would be catastrophic for their country, even if it helps them individually to sustain the image of exceptional politicians who stick to their word. Yet, the economic realities are those they are. It is better to decelerate debt issuance and reverse gear than to press on the accelerator, because the latter leads straight against the wall. Sweden provides an excellent example on, and precedence to, the challenges today confronting the United States.

The Swedish government’s nightmare came in the 1993 fiscal year, when the budget deficit soared to about 14 percent of GDP. To make matters worse, Swedish banks lost at this time so much money, that only a deep-pocketed government could help keep them afloat. The prediction of a study group of economists, headed by professor Assar Linbeck, was that worse was yet to come. It proved true, and it was left to a right-wing government, a rare bird in Swedish politics, to save the day.

The Linbeck study blamed several decades of socialist government mistakes and reckless endowment policies for Sweden’s plight. Sounds familiar? It is precisely so. Today, each one of the mistakes identified by Linbeck and his associates finds its counterpart in the United States. As far as Sweden is concerned, the post-WWII period were the years when

All this led to a dismal economic record which in our days is by no means unheard of. Every one of the aforementioned problems now affects not only the American economy but also all other in the industrial countries—with Italy, Spain, and France in the frontline. Yet, most surprisingly, nobody really studies the pre-1993 Sweden as a model of what not to do.

What not to do is to try to appease the market by throwing money at the problem, and by keeping the cost of money near zero over the medium to longer term. That’s the Bernanke policy. By contrast, in 1993 the president of Riksbank (Swedish central bank) did quite the opposite, and who would argue with success?

The Riksbank brought the overnight interest rate sky-high and through this action it pruned the system, while remaining vigilant about the appearance of the next symptoms. It’s attention was not grounded in preserving and possibly amending a system which had failed, but in identified and closing the gap between measures taken and their practical results.

Contrary to what socialist-inclined economists had expected, the recovery of the Swedish economy proceeded speedily and was complete within a couple of years. The economic policy lesson from Sweden 1993 is that when the time comes for tough decisions the government should not flunk the test. The longer term should never be lost from sight. Even if the right decisions are unpopular in the short term, they have to be made. Seeing them through is more a matter of will than of ability.

“If you postulate a system that depends upon one country always following the right policies, you will find sooner or later that no such country exists,” says Paul Volcker. “The system eventually is going to break down … there is no easy way out of the burdens of leadership.”²² Integral part of that burden is steady watch and readiness for action, without cornering oneself to a road leading nowhere.

There exists in economics, particularly in econometrics, a mathematically unproven put powerful multiplication law. Its nature and impact is suggested through practical experience and anecdotal evidence. What it states is that, past a certain threshold, the mass effect tends to create an exponential curve:

The economic situation the United States confronts today is a year or two away from “Sweden 1993.” In the time preceding the Swedish debacle, proposed “solutions” were half-baked at best, lacking consistency and decisiveness. They were developed by politicians thinking of their careers and by bureaucrats dreaming of spending “more” of other people’s money.

This is one of the reasons why Stockholm 1993 and Washington 2013+ correlate. Another reason is the “unknown unknowns.” In the United States today three factors suggest that, percentage-wise, annual increases in the deficit in the near future may be way beyond those of Sweden in 1993:

Clear minds in America have seen well in advance the coming impasse. In a seminal book on his experience with US deficits, published in the 1980s, former White House Budget director David Stockmann demonstrated that unless the entitlement programs are radically cut the federal budget can never be balanced.²⁴ To Stockmann’s opinion runaway net expense categories include

More recently the current account, too, has been singled out as a source of anxiety. No country can run a trade deficit forever. It can borrow a lot before it goes broke, but at some point the world’s financial markets will clamp down on its finances just as they clamped down on Mexico. As Lester Thurow says: “The question is not whether an earthquake will occur. It will. The only question is when.”²⁵

The US current account deficit has been a long-standing drag on the dollar. In 2006, at the height of the credit boom, it reached $800 billion or 6 percent of GDP. Though the deficit has been reduced as the credit crunch which followed the 2007/2008 economic and financial crisis has lowered imports, it still stands at over 3 percent of GDP, largely because like Euroland, the United States remains a major energy importer.²⁶

In a way quite similar to “Sweden 1993,” the 2013+ US scenario will be dominated by the widening gap between booming sovereign expenses and fiscal contraction. Economists say that estimating the economic impact of fiscal contractions is made more difficult by the uncertainty surrounding the size of fiscal multipliers.

In addition, a big unknown is the speed with which households react to a potential increase in taxes, and on whether they will perceive the change in policies as transitory or permanent. There are as well adverse effects on confidence that may arise, if businesses and consumers start to perceive the risk of an abrupt fiscal change and restrain their spending plans.

Most Americans, even those benefiting from oversized entitlements, are afraid of an abrupt fiscal change because they can see that the US government’s deficit and debt are unsustainable. Not only policies to correct these imbalances are not advancing but they are not even on the table. Closely related to this is the fact that neither the White House nor Congress have defined what they want the United States to be in the twenty first century. Have the politicians who run the US fortunes decided where the nation is going? And, if yes, do they have a strategy to reach that goal?

Benjamin Franklin was the first member of the Constitutional Assembly to come in contact with citizens anxiously waiting outside the assembly hall to hear what kind of regime was decided by the Founding Fathers. They rushed to ask him and Franklin answered: “A democracy, if you can keep it.”

Benjamin Franklin’s “IF” is today’s Number 1 question for every American; evidently also for the president and for Congress. A democracy under an unsupportable weight of debt is not a democracy. If proof is needed, look at ancient Athens at the time of Pericles. He loaded the city-state under his watch with debt and exploited the Athenian empire to pay from it. The other member states of alliance revolted, and this led to the 30-year Peloponnesian War which brought to an end of ancient Greece.

10.6 Everybody Will Suffer from Currency Wars

Twenty years after “Sweden 1993” Bernanke’s Fed applied precisely the opposite policy of near zero interest rates over long stretches of time, and failed to move forward the American economy. Sweden was lucky to have at the helm of the central bank a person capable of deciding swiftly, taking risks and at the same time being in charge of assumed exposure through moves which were:

Sweden 1993 was a complex social, political, and economic crisis with more than one sector to be looked immediately after. Bernanke, too, confronted a double whammy. But the impact of his decisions, targetted the market, not the American Society at large. Therefore, the US economy did not see a rapid revival. Massive QE failed in its goals. Unemployment unwind only slowly and the prospects of economic activity remained subdued. That took care of Goal No. 1 in Bernanke’s policy. In addition, when one examines the decisions taken by a scholar of the First Great Depression, he cannot escape the thought that a competitive devaluation of the US dollar has been Goal No. 2 of the Bernanke’s Fed policy. This, too, has failed.

Back in 2010, led by Brazil, emerging economies accused America of instigating a currency war. The occasion was presented in 2010 when Bernanke’s Fed bought heaps of bonds with newly printed money. Investors rushed into emerging markets in search of better returns, and has been instrumental in lifting their exchange rates.

The issue of currency wars has been on and off for over 3 years. In February 2013, the Group of Seven issued a statement intended to calm spirits about “currency wars” but ended up causing more confusion than clarity. While the G-7 statement chided government intervention in currency markets, it also supported an effort by Japan to combat deflation. (Competitive devaluations in Britain and Japan were a key theme during that period of time.)

True enough, there is plenty of hypocrisy in the devaluation argument. Devaluing one’s currency against the global financial and payments system is the objective of every government overtaken by budgetary deficits, creeping uncompetitiveness, and a mountain of unfunded liabilities (Section 10.2). QE in Britain and QE in America had practically the same rationale:

In Britain this policy has succeeded, becoming the legacy Merwyn King left behind as he quit the governorship of the Bank of England. In a few days the pound fell by an appreciable 9 percent and it continued falling in the following weeks, albeit slowly.

It helped that under the Gordon Brown government the British banking sector was obliged to come clean on losses and be subject to needed recapitalization which made the sovereign majority owner of big British banks. Also, that under David Cameron every effort was made to accelerate needed structural reforms that might encourage higher investment by the private sector.

So, the British made it leaving Bernanke in the dust. Devaluation, of course, will not solve single-handed a sovereign’s problems, but it might succeed in boosting overseas demand for British products to bring about the rebalancing that the economy needs to have and improve Britain’s dismal current account.

One swallow, however, does not bring spring. Even after the 9.0 percent devaluation of the pound, data suggest that manufacturing remains uncompetitive relative to services, with the net rate of return on capital in manufacturing being a mere 4.7 percent—a small fraction of the rate of return in services.

This knocks down the argument that the real exchange rate of the pound was overvalued, a notion which has been debatable. What is true is that with demand abroad weak, manufacturers needed all the help they could get and a significant devaluation boosted their fortunes. In other terms while the fall in sterling could be economically helpful, the economy would as well require other measures all the way to

The lesson America can derive from the competitive devaluation of the pound is that it has been helpful to the economy, but far from providing “the solution.” It takes more than a devaluation to put the currency and the economy on track to competitiveness—and no doubt if Bernanke had succeeded with his $ devaluation he would have done nothing to kill the monster of $211 trillion in unfunded US liabilities.

A similar lesson can be derived from the other devaluation which took place more or less within the same time frame: That devaluation of the yen, from 77 to the dollar (September–October 2012) to 95 (March 2013). The yen has been another strong currency which capitalized on geopolitical changes to give the Japanese industry an edge in the global market. Investors and speculators who judged right the magnitude of the yen’s fall made a fortune. George Soros is said to have made $1 billion out of it.

Shinzo Abe, the new Japanese prime minister, promised bold stimulus to restart growth and vanquish deflation. He also called for a weaker yen to bolster exports. Since the end of September 2012, the Japanese currency has fallen 16 percent against the dollar and 19 percent against the euro. The steeper fall was in February 2013 when it became clear that Abe meant to exercise his power.

In currency exchange terms the Japanese and the British hit their goal, but the Americans did not profit. No matter what Bernanke does it is not possible that the dollar devalues against itself. The luminaries who invented the different devaluation theories as the neat way out did not understand that the dollar can only then devalue against the global financial system if it abandons its privileges.

From Bretton Woods times, all important global commodities are denominated in dollars. This gives the US currency a king-size advantage in the international market. Abandoning it by way of substituting the dollar by a basket of currencies is an option—one highly unwise from the American point of view. Here is then the top choice Bernanke and company have are confronting:

Trying to do both at the same time is a policy which has failed so far, and will continue failing. It’s like planning to kill two birds with one well-placed stone. Neither should it be forgotten that the dollar is refuge money. Every time something happens in the global political or financial landscape the dollar’s exchange rate goes up, no matter what Bernanke may be saying or doing. Uncertainty always favors the dollar.

Take the WSJ Dollar Index²⁷ as an example. In September 2012 it reached a low 69, then hovered around 70 till January 2012 when it took off. January to March 2013 the WSJ Dollar Index rose 5 percent, almost in straight line, helped by the chaotic result of Italian election and their impact on the euro—confirming one more time that, aside the other economic damages which it creates, Bernanke’s dream to talk down the dollar through massive QEs remains just that—a dream.

There are plenty of issues weighting against the dollar’s devaluation, Bernanke is desperately trying to achieve through quantitative easing. In addition, as we already discussed in connection to the British example, devaluing a currency does not necessarily lead a country to higher exports. Countries with traditionally strong currencies, such as Switzerland, Germany, and Japan, have a much more important industrial sector than countries with traditionally weaker ones, such as France, Britain, and the United States.

Neither is it true that exporting more assures that a country will grow faster. Exports are a complex issue where not only prices but as well the need for the product (for instance: oil), innovation, productivity, high quality, and cost control play important roles.

There exists as well the historical fact that if every industrial nation tries to devalue its currency in the end there are only losers. This “beggar-thy-neighbor” policy has led to the First Great Depression. Faced with recessions, many countries introduced protectionist measures in the form of tariffs²⁸ which ultimately backfired, and international trade crumbled, leading to recessions and depressions. The $211 trillion in uncovered liabilities is daunting, but it has to be solved within the US economy, not outside of it through QE.

End Notes