When Manmohan Singh speaks he puts us to sleep.
When Barack Obama speaks the world listens. In his speech to accept the nomination to run for his second term as President, Obama touched all the right chords. The speech had the right amount of nostalgia, advise, self marketing and hope built into it.
His vision of future, as is the case with anyone asking for votes in a democracy, was optimistic, without getting into the specifics. The American dream is still on, despite the difficulties the country has faced over the last five years due to the financial crisis. That was the takeaway, one got from Obama’s speech.
“But as I stand here tonight, I have never been more hopeful about America. Not because I think I have all the answers. Not because I’m naïve about the magnitude of our challenges. I’m hopeful because of you,” said Obama
While hope is a good thing to have but then at times to hope we need to ignore the mess that we are in, in order to have some hope. And that precisely is my problem with Obama’s speech. There was a lot that he should have said, but did not.
The biggest problem in America today is not unemployment or slow economic growth but the unfunded liabilities like pensions, social security and medical care benefits that the government has promised to the citizens. .
As economist Laurence Kotlikoff wrote in a recent column “The 78 million-strong baby boom generation is starting to retire in droves. On average, each retiring boomer can expect to receive roughly $35,000, adjusted for inflation, in Social Security, Medicare, and Medicaid benefits. Multiply $35,000 by 78 million pairs of outstretched hands and you get close to $3 trillion per year in costs. This is not a partisan issue. The dirty little secret that neither President Obama nor Mitt Romney is telling you is that our kids, who are being stuck with the bill, can’t afford it.”
The three trillion dollars that Kotlikoff is talking about is a lot of money. The current American yearly GDP is $15trillion. Hence, the costs Kotlikoff is talking about amount to nearly 20% of the annual American GDP. And it is unfunded.
Before we go further let’s try and understand what unfunded liabilities are. Let us say I plan to retire 10 years from now. I feel that Rs 16 lakh per year should be enough for me to sail through the year. But to earn that Rs16 lakh I would need to build a corpus of Rs 2 crore in 10 years time, and assuming that I am able to earn an interest of 8% on this corpus, 10 years from now (8% of Rs 2crore works out to Rs 16 akh).
In order to build a corpus of Rs 2 crore in 10 years time I will have to start saving and investing money regularly from now. If I don’t I will be in trouble ten years from now. Either I won’t be able to retire or if I retire I will have to borrow to meet my expenses.
The same logic at a very basic level works for governments as well. The government gives a pension to people when they retire. If a certain number of people are expected to retire ten years from now, then they would have to be paid a certain amount of pension. While estimating the exact amount is difficult, estimates can be made. But what we know for sure is that money is to be saved now so that citizens can be paid pensions later.
If governments don’t invest the right amount from now on, which a lot of them don’t including the US government, they will have to pay these citizens by borrowing money later. And if pensions and other commitments made to the citizens cannot be funded through the investments already made, they are said to be ‘unfunded’.
Mitch Feierstein in his book Ponzi Power – How Politicians and Bankers Stole Your Future writes “Using proper accounting methods…the true value of the state and municipal pension liability is at $5.2trilion. When you deduct the $1.94trillion of pension assets that have already been set aside, you get a net liability of $3.26trillion.”
Other than this the US government already has an existing debt of around $15trillion. Feierstein also points out that the social security programme of the US government is underfunded to the extent of $18.8trillion. The underfunding in Medicare, the health insurance programme, amounts to around $38.5trillion. So if you add all of this up the number comes to greater than $75 trillion and that is what Feierstein feels the US government owes to other governments and its own citizens.
And that’s just one estimate and a very conservative one. Kotlikoff’s estimate is scarier. As he wrote in a recent column “I recently calculated the fiscal gap…The fiscal gap measures the present value difference between all projected future federal expenditures (including servicing official debt) and all projected future taxes. The fiscal gap is thus the true measure of our government’s total indebtedness and the true measure of fiscal sustainability. How big is the fiscal gap? Brace yourself. It’s $222 trillion large!… In short, our government is totally broke. And it’s not broke in 30 years or in 20 years or in 10 years. It’s broke today.”
So how large is $222trillion? The annual GDP of the whole world is around $60trillion. The GDP of the United States of America is around $15trillion.
So what is the way out of this? “Here’s one way to wrap your head around our $222 trillion fiscal hole: closing it via tax hikes would require an immediate and permanent 64 percent increase in all federal taxes. Alternatively, the government could cut all transfer payments, e.g., Social Security benefits, and discretionary federal expenditures, e.g., defense expenditures, by 40 percent. Waiting to raise taxes or cut spending makes these figures worse,” writes Kotlikoff.
Another way out for the American government is to print money to meet its expenses (something which is it is already doing). As Kotlikoff puts it another column “The first possibility is massive benefit cuts visited on the baby boomers in retirement. The second is astronomical tax increases that leave the young with little incentive to work and save. And the third is the government simply printing vast quantities of money to cover its bills. Most likely we will see combination of all three responses with dramatic increases in poverty, tax, interest rates and consumer prices. This is an awful, downhill road to follow, but it’s the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.”
If America has to get out of this hole, the American way of life has to change. And that as Obama’s speech clearly points out is unlikely to happen.
(The article originally appeared on www.firstpost.com on September 8,2012. http://www.firstpost.com/world/the-truth-obama-didnt-tell-his-party-the-us-is-broke-448686.html)
(Vivek Kaul is a writer. He can be reached at [email protected])
“So things are getting worse in Europe,” she said.
“Let me tell you a small story I read on a blog recently,” I replied.
“Seth Godin, one of the world’s premier brand experts and famous blogger, wrote a blog on the rock band The Rolling Stones, a while back.”
“But why are we talking The Rolling Stones?” she asked. “I am talking economics, you’re talking rock.”
“Men are from Mars, Women are from Venus!”
“Never mind. So in this blog Godin writes “Keith Richards (guitarist and vocalist of The Rolling Stones) tells a great story about Charlie Watts, legendary drummer for the Stones. After a night of drinking, Mick (Jagger, the lead vocalist of The Rolling Stones) saw Charlie asleep and yelled, “Is that my drummer? Why don’t you get your arse down here?” Richards continues, “Charlie got dressed in a Savile Row suit, tie, shoes, shaved, came down, grabbed him and went boom! Don’t ever call me “your drummer” again. You’re my … singer. No drums, no Stones.”
“No drums, no Stones?” she asked. “What does that mean?”
“What I am trying to say is that at times there is a need to look at things differently.”
“Yes with all this brouhaha about Europe, people have forgotten the United States(US),” I explained.
“So you mean that there is no problem in Europe?”
“Of course not. But just because there are problems in Europe doesn’t mean things are fine in the US.”
“So what you mean is that with all the attention being paid on Europe, people are ignoring the issues in the US?”
“Right. In fact, the unfunded liabilities of the US government are huge.”
“Now what are unfunded liabilities?” she asked.
“Let us say you want to retire 10 years from now,” I started to explain.
“Ten years? Why should I retire so early?” she interrupted.
“It’s an example yaar.”
“So let us say you want to retire 10 years from now. You feel that an income of around Rs 8 lakh per year should be enough for you to sail through.”
“Bus.That’s too low an amount.”
“To earn an income of Rs 8 lakh per year you would need to build a corpus of Rs 1 crore, assuming that you manage to get an interest of 8% on the corpus you build. But this Rs 1 crore is not going to come out of thin air.”
“So you will have to save regularly to build that Rs 1 crore corpus,” I said.
“Yes. Paisa kamane ke liye bhi paisa chahiye,” she replied. “But what is all this got to do with the US government?”
“Well the logic is the same. What works for you also works for the government. The government gives a pension to people when they retire. If a certain number of people are expected to retire ten years from now, then they would have to be paid a certain amount of pension. While estimating the exact amount is difficult, estimates can be made. But what we know for sure is that money is to be saved now so that citizens can be paid pensions later.”
“Yup. So what was that part about the unfunded bit?” she asked.
“If governments don’t invest the right amount from now on, which a lot of them don’t including the US government, they will have to pay these citizens by borrowing money later. And if pensions cannot be funded through the investments already made, they are said to be ‘unfunded’.”
“I was reading this interesting book Ponzi Power by Mitch Feierstein. He writes “Using proper accounting methods…the true value of the state and municipal pension liability is at $5.2trilion. When you deduct the $1.94trillion of pension assets that have already been set aside, you get a net liability of $3.26trillion.””
“These are big numbers,” she said.
“Yes. Other than this the US government already has an existing debt of around $14.6trillion.”
“So that’s about it?”
“Feierstein also points out that the social security programme of the US government is also underfunded to the extent of $18.8trillion. The underfunding in Medicare, the health insurance programme amounts to around $38.5trillion. So if you add all of this up the number comes to a whopping $75.2trillion and that is what Feierstein feels the US government owes to others like governments and its own citizens. To give you a sense of proportion, the US yearly gross domestic product (GDP) is at $15trillion. The GDP of the entire world is around $60trillion. So these are big numbers we are talking about”
“But isn’t that an estimate?” she asked
“Yes it is. But it has been drawn partly from documents of the US government. The private estimates are worse. Economist Edward Chancellor writes in a report “One estimate of US healthcare and pension liabilities runs to 7 times the country’s GDP.” This estimate suggests that the US government owes more than $100trillion. There is no single precise measure of the indebtedness of the US government. But there are big numbers and there are bigger numbers.”
“Laurence Kotlikoff of Boston University has made a lifetime study of the present value of unfunded commitments using data from the US Congressional and Budget Office. He puts the true level of US indebtedness to around $202trillion.”
“Oh my god!”
“So what is the way out?”
“Well all these welfare schemes will have to be dramatically cut and that may not be a politically popular move. Otherwise the US debt is going to go up dramatically from its current levels.”
“But I am confused. If things are so bad, why does the US dollar continue to be seen as a safe haven?”
“Well, for the simple reason that dollar is the international reserve currency, and if things become too bad the US can always print it to repay. Hence every time there is a hint of a crisis anywhere in the world more money moves to the dollar.”
“But that’s stupid.”
“Yes it is. But remember as the economist Herbert Stein once wrote, “If something cannot go on forever, it will stop.””
“When will it stop?”
“Let me end with a line from John Maynard Keyens. As he famously said “markets can remain irrational longer than you can remain solvent!” And as the first rule of forecasting is that give them the forecast or the date, but never both!”
The article originally appeared on Rediff.com on June 28.2012
(Vivek Kaul is a writer and can be reached at [email protected])