Tuesday, March 27, 2012

Will The Standard of Living of Our Children Decline Due To Profligate Spending and Depletion of Resources?

I got into a debate the other day about whether our children will experience a declining standard of living. My opinion is that the standard of living in the U.S. for our descendants is going to be significantly below current levels due to: 1) massive government debt; 2) underfunded pension and medical obligations, 3) an ageing population; 4) resource depletion; 5) extreme weather.

Regardless of whether my bleak view of the future is accurate, I find the complacency regarding the risks of the economy heading off a cliff to be inexplicable. The U.S. economy may muddle through for the next few years, but the fact that our profligate behavior is creating so much risk for our children is concerning. If the World War II generation was the “greatest generation”, will we be considered the “worst generation”.  I do not think it to be much of an exaggeration to consider our generation to be financial sociopaths. We continue to pile up government debt to support our lifestyles, while leaving the burden for future generations to pay off.

It seems highly likely that the U.S. will elect politicians in November that will continue to pile up trillion dollar annual deficits. At some point, the massive government deficit and debt will become unsustainable. Further, U.S. voters do not have the political will to address the coming Medicare crisis. The depth of the Medicare crisis is outlined in Mish’s post on the 2013 Budget Showdown.

The current frustration over the current high cost of gasoline may grow in intensity as the supply of cheap oil is depleted. While enough new sources of oil has and will be discovered such that we will not run out oil during this century, supply is tight and may get tighter. As the expensive of pumping and refining new sources of oil continues to go up, so will the price of gasoline.  Further, investment in clean energy simply produces electricity, it does not replace oil. I challenge anyone to remain complacent about the impact the cost of oil may have on the U.S economy after reading Global Oil Risks in the Early 21st Century.  Oil is not the only resource that is being depleted. Aquifers are being depleted. The oceans are being over fished and becoming more acidic.

The more time that passes before U.S. voters address the fact that we are on a path toward an economic calamity, the harder it will be to avert the crisis. Given the current failure and total lack of political will to address hard economic choices, I fear the standard of living of our children will be substantially lower than what we have experienced. 

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Tuesday, March 13, 2012

Insane Interest Rates - Countries With 10 Year Bond Yields Lower Than Their Rate of Inflation

The Fed warned today that "inflation could rise temporarily because of the recent increase in oil and gasoline  prices." Given the likelihood of inflation increasing, it seems insane that the interest rate premium for 10 year U.S Treasuries is below the level of inflation. It is straight out of economics 101 that bond pricing includes
An inflation premium added to compensate for the expected loss of purchasing power;
thus, it is obvious that the U.S. bond market is being artificially manipulated to keep interest rates low. While the interest on the 10 Year Treasury did rise a bit today to 2.077% , the rate is still well below the 2.9% rate of inflation in the U.S.

However, as shown in the chart below, the U.S is just one of a number of countries with interest rates on sovereign debt that is below the rate of inflation, basically featuring negative real rates of return. The market with the most negative real rate of return is Hong Kong at -4.8%. The negative real rate of return in the U.S. is also surpassed by Singapore, the UK, Finland, and Denmark. (For reference, today's rise in the U.S. rate on the 10 year note is not reflected in the chart below)

Given that interest rates on sovereign debt is likely to revert back to levels above the rate of inflation at some point, and the world could be in for a nasty bout of inflation due to higher oil prices and money printing by central banks, it seem unlikely that the 10 year notes of the countries listed above will turn out to be good long term investments.

Thursday, March 8, 2012

Proposing A $1 A Gallon Gas Tax Would Be Political Suicide, But Would It Be Good Policy?

Most car and truck drivers probably have a viscerally negative reaction to the idea of higher gas taxes. However, given the tightness of oil supplies and the massive budget deficit, this might be a tax that is appropriate. Reducing demand for oil would extend and conserve this resource for future use. As has been shown with tobacco taxes, behavior and consumption is influenced by price. Reduced demand for oil in the U.S. would make us less dependent on hostile foreign sources and reduce the number of dollars flowing out of this country. Further, increased oil drilling (drill baby drill) and reduced consumption are not incompatible. Both are required to eliminate the 9 million barrels of oil the U.S imports daily.

New technologies and newly discovered oil finds seem to have pushed back peak oil by a decade or so, but the world is running out of easy to find, easy to pump oil.  The cost of oil seems likely to be on a slow upward spiral as demand  from Asia increases and oil becomes increasingly expensive to find and pump. More leaks and spills seem likely as drilling takes place in hostile and fragile environments. 

The challenge of closing the budget deficit is illustrated by how little support a gas tax would engender. U.S. voters may approve of imposing increased taxes on the rich, but are unwilling to increase taxes that impact themselves. Cuts in entitlements are equally unpopular. Thus, the U.S. will continue to run up huge deficits for the foreseeable future. A gas tax would offer a long term benefit by preserving scarce oil resources, as well as reducing the budget deficit. However it has no chance of gaining support as long as U.S voters remain complacent about the deficit and the diminishing supply of cheap oil. Time will tell if our profligate behavior comes back to haunt us in the future.

Related Post
Will Oil And Gas Drilling Activity Determine Economic Growth Rates By State and Country?

Tuesday, March 6, 2012

Euro Zone Economy Declined Even With Mild December Weather, Cold Snap Impact to Show Up In Next Quarter Report

Headlines from Europe are causing losses in financial markets in the U.S. today. According to the European Union's statistics office, output in the 17 countries sharing the euro shrank 0.3 percent in October to December from the third quarter. While the uncertainty over a Greek debt deal may be an even bigger factor in the declines in the financial markets, concerns about the sinking European economy are contributing to the decline.

The monetary stimulus provided by the ECB has kept the European banking sector afloat and held down interest rates for sovereign debt, but has not provided a meaningful boost to economic activity. When reports on January through March economic activity are issued, it seems almost certain that further declines will be reported. The almost month long cold snap the began during the last week of January sapped economic activity in the eastern countries of the Euro zone. In particular, tourism and shipping declined due to the cold and snow. While the western countries of the Euro zone, including France and Germany, escaped the brunt of the cold and snow, they still felt the impact of higher energy costs due to high demand across Europe. The high heating bills during the cold snap were Euro zone wide and the reduced economic activity impacted a significant number of the member countries

The negative impact on economic activity from the cold snap, the higher cost of oil this quarter, and reduced government spending resulting from austerity budgets will combine to weaken first quarter economic activity in the Euro zone. The economic forecasts predicting a mild recession in Europe may be overly optimistic, at least in their predictions for the 1st quarter. Be very wary of the impact of the European recession on U.S. financial markets. So far, the weakness in the Euro zone has not spilled over into the U.S., but continued de-coupling is by no means assured.

Thursday, March 1, 2012

Would Greece Suffer From Food Shortages If They Left The Euro?

In previous posts, I have suggested that going back to the Drachma might be the only solution to the Greek debt problem. A devalued Drachma would make Greek exports more competitive and increase revenue from tourists taking advantage of low prices. Numerous other commentators have published posts along a similar vein.

However, there is a monster problem with Greece leaving the Euro, the country is not self sufficient in food production. The cost of imported food might double if the Drachma experienced a 50% devaluation. As reported by Megan Greene,
Greece has few export industries it could rely on to grow its way out of the crisis even if it devalued its currency. There is tourism, but any profits from shipping are kept out of the country and green energy is still but a mere pipe dream as an export industry for Greece. Given that Greece is not self-sustaining in agriculture,  a devaluation accompanied by hyperinflation would result in a starving population, and that the resulting civil unrest would destabilize the entire Balkan region
Thus, while a return to a devalued Drachma would be good for those whose make their livelihood from tourism and related services, the rest of the country would be plunged into even more dire straits. The high cost of imports, including food and energy, would push a significant portion of the population into poverty. 

The current efforts of the Troika are primarily based on avoiding short term damage to the European financial system from fallout that will occur when unsustainable Greek deficits and debt lead to a default on their sovereign debt. However, the austerity measures being forced upon the Greeks are destroying the economy. No real solutions that might potentially solve the problems caused by a government that spends more than it collects in revenue are even on table at this point. Given the downward spiral of the Greek economy, deficits will continue to mount. Eventually, the Greeks will either decide for themselves to leave the Euro zone or they will be forced out by the member countries that are already weary of funding Greek deficit spending. Regardless, of whether Greece voluntarily leaves the Euro zone or if they are forced out, the outcome will likely be years of grinding poverty for the Greek population.

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Voters in Euro Zone Will Elect New Leaders, U.S. Voters Likely to Extend Gridlock
Is The Greek Economy In A Death Spiral?