The government would have to double income tax rates and not see any tax avoidance or evasion to close the deficit.

Did you know? The government would have to double income tax rates and not see any tax avoidance or evasion to close the deficit.

• 2011 Deficit: $1,299 billion
• 2011 Income tax revenue: $1,273 billion

Repeating history: The future of Greece, Europe, and the United States.

I’m rereading The Path to Tyranny to prepare it for a second printing and came across this section about Germany in the late 1920s and early 1930s (before the Nazis took over) very relevant for today:

The country’s economic problems worsened and the government approached bankruptcy. To reduce the budget deficit, the government raised unemployment insurance premiums, increased duties on wheat and barley, reduced pension and unemployment benefits, and cut the salaries of civil servants. The Social Democratic Party’s popularity declined even more when these measures pushed up unemployment even further and weakened the already fragile banking system. The government was trapped in a no-win situation. It cut back on spending to avoid bankruptcy, but this increased hardship on the people and reduced the government’s popularity. On the other hand, the government could have continued providing welfare to the people, but this would likely have forced Germany to default on its debt, which would have resulted in massive inflation and a flight of capital out of the country. The German government’s large deficits, which were the result of the economic depression combined with Germany’s already semi-socialist economy, forced Germany to decide between two equally bad choices. The resulting economic and political crisis was inevitable, regardless of what the government chose to do.

Are we in the same no-win situation today? If governments cut back on spending, this reverse-stimulus will hurt the economy and the removal of economic support will certainly increase the pain for many poor people. However, if the government continues with its deficit spending, bankruptcy will eventually occur, first in Greece which already has debt to GDP of 173%, but eventually in most if not all Western countries.

Related post: The Founding Fathers Solve Our Debt Crisis

Obama’s State of the Union: $400 billion of what?

In the State of the Union, President Obama pledged to cut the “deficit by more than $400 billion.” Well, just how much money is that?

First of all, that’s a $400 billion cut over the next decade. In other words, he wants to cut $40 billion per year.

Let’s put that in perspective:

• $40 billion is about 3% of the current deficit.
• $40 billion is about 1% of current federal government spending.
• $40 billion is about 0.3% of our GDP.

Basically, $40 billion is a rounding error. Obviously, I’m very skeptical by calls for small spending cuts when, at the same time, the President also said he plans to increase spending… I mean investments… in other areas.

Dear comrade to propose even more deficit spending (via Da Mook)

The President will propose more spending, or “targeted investments” as he calls it, in his State of the Union.

This is President Obama’s idea of being a moderate? Oy!

Imagine this scenario: You get a brilliant idea that you can beat the odds in Las Vegas. You mortgage your home to the hilt, empty your savings accounts and your kid’s piggybank and drop it all on a single roll of the roulette wheel. Naturally, you lose everything. So, what now? Well, being broke you don’t have a lot of options. But if you’re a bureaucrat and you’re playing with someone else’s money, the answer is simple – double down. That’s ess … Read More

via Da Mook

Irish Credit Rating Crashes

Just yesterday, somebody told me the Irish credit problem has been solved. With the market indexes trading at or near two-year highs, that would seem to be the case.

But then we get news that Moody’s cuts Irish credit rating by five notches:

Moody’s Investors Service said Friday it has cut its rating on Irish government bonds by five notches to Baa1 from Aa2. The credit rating agency said the outlook for the rating is negative. The downgrade comes after the agency said in November that the most likely outcome for Ireland’s credit rating was a multi-notch downgrade that would leave it within the investment-grade category. “Ireland’s sovereign creditworthiness has suffered from the repeated crystallization of bank related contingent liabilities on the government’s balance sheet,” said Dietmar Hornung, lead analyst for Ireland. As well as the cost of supporting the banking sector, Moody’s said the increased uncertainty over the country’s economic outlook and the decline in the Irish government’s financial strength contributed to the downgrade.

OUCH! Ireland’s credit rating drops 5 notches and the outlook is still negative, which means Moody’s could downgrade it even further.

The sovereign debt crisis is far from over.

Government says it’s OK to break social security agreement, but not pension agreements.

Barack Obama’s debt commission proposed several changes to Social Security to help reduce the deficit. The New York Times reports:

The plan would reduce cost-of-living increases for all federal programs, including Social Security. It would reduce projected Social Security benefits to most retirees in later decades, though low-income people would get higher benefits. The retirement age for full benefits would be slowly raised to 69 from 67 by 2075, with a “hardship exemption” for people who physically cannot work past 62. And higher levels of income would be subject to payroll taxes.

I have no idea how much these measures will contribute to reducing the deficit or paying off the debt. My complaint is more ideological.

When employees contribute to social security, they are doing so with the understanding that they will receive certain benefits starting at a certain date. Currently, an American expects to pay a certain amount each year into the system, retire at age 67. and receive cost of living adjustments (COLA) each year. The proposals by the debt commission would violate this agreement, forcing people to pay more each year if they earn over a certain amount, retire at a later date than originally agreed to, and receive less in benefits than promised as the COLA is reduced. In effect, the government is unilaterally canceling its contract with each American and replacing it with a less attractive one.

In reality, I am not opposed to these changes, especially the retirement age which will not fully take effect for 65 years, thus having little effect on anybody working today. The reduction in COLA would have a much greater effect on everybody starting in the near future while the removal of the cap on social security taxes would have an even larger effect, but only the wealthy. But while these are necessary changes, contrast this with the government’s stance on pension funds.

In a Q&A titled The pension time bomb, The Week asks:

Can benefits be scaled back?

Only for future employees. New Jersey Gov. Chris Christie recently signed legislation reducing pension benefits for new state employees. In California this month, voters in nine municipalities approved ballot measures to limit benefits for future public employees. And governments are starting to take a harder line in collective bargaining with public unions. “I’ve seen a sea change in the local collective bargaining process,” said Dwight Stenbakken, deputy executive director of the League of California Cities. Some analysts recommend following the lead of Georgia, which requires that prior to being enacted, any changes to retiree benefits be studied for long-term impacts. According to the Pew Center on the States, the policy has helped Georgia avoid “costly and irreversible” mistakes.

These pension liabilities have already been promised to employees and retirees. The government has a contractual obligation to pay the pensions as promised.

So why are the pension obligations sacrosanct while money can be taken from Social Security beneficiaries? Social security is just as much a contractual obligation as public union pensions. If social security benefits are to be reduced for those who have already paid in, public union pension benefits should be as well.

* Though I have not yet read this (too busy writing my next book), Robert Graham discusses this topic in much more detail in his Job Killers: The American Dream in Reverse. How Labor Unions are Destroying American Jobs and the Economy. If you’ve read it, leave a comment here or send me an email, tweet, or facebook message letting me know what you think of it.

Am I really that smart? Or is the EU-IMF that stupid?

The EU and IMF had hoped that bailing out Ireland would end the sovereign debt crisis or at least forestall it for the time being. As I explained previously:

I don’t see how this changes anything. It may stave off immediate default, but Ireland is simply borrowing more money, exactly what got it into this mess in the first place. This simply buys them time to get their house in order, but will they?

I then compare the bailout to Dr. Evil:

These bailouts, loans, and austerity measures in Greece, Spain, Portugal, and Ireland are “an easily escapable situation involving an overly elaborate and exotic death.” Instead of eliminating the deficit immediately, they have convoluted plans to reduce it over a five-year period. Will these plans work? Nobody knows. But that’s okay because “we’ll just assume it all went to plan.”

It only took a few days to prove that I am correct. Marketwatch reports:

European government bond markets were in turmoil Tuesday, as Portuguese and Spanish yields followed Irish yields sharply higher on growing doubts about the ability of politicians to contain the euro zone’s sovereign-debt crisis.

Rising bond yields underline fears that the debt crisis, which has already forced Greece and Ireland to seek bailouts, will spread to other high-deficit countries, potentially shutting them out of credit markets.

The yield premium demanded by investors to hold Portuguese 10-year bonds versus German bunds widened to 4.34 percentage points from around 4.08 percentage points Monday.

The spread between Spanish and German yields widened to 2.32 percentage points, exceeding the spread of 2.27 percentage points seen earlier this month.

How could the EU and IMF really be so stupid to believe their bailout would work. They thought their bailout of Greece and 750 billion Euro backstop would end the crisis once and for all. That failed, but they didn’t let that stop them from making the same mistake again.

It is often said that insanity is “doing the same thing over and over again and expecting different results.” Supposedly, Einstein said as much.

This leaves us with three options:

1. The EU and IMF are stupid.
2. The EU and IMF are insane.
3. The EU and IMF have some ulterior motive.

Which do you think it is?

Ireland gets its bailout. You ain’t seen nothing yet!

So Ireland finally got its bailout. I discuss the true cost of the bailout here and how this is only a temporary solution here.

Focus has now shifted to Portugal and Spain. Ireland is a country with just 4.5 million people, whereas Portugal has 11.3 million and Spain has 46.0 million. People are now guessing at how big their bailout will be if they are needed.

According to The Telegraph:

Analysts estimate that a Portuguese bail-out might require less than euro 50 billion, less than the sum lent to Greece or Ireland. But rescuing Spain from crisis would require a much bigger sum.

Cornelia Meyer, CEO & Chairman, MRL Corporation, told CNBC Monday:

She predicted that a Spanish bailout would likely cost up to 500 billion euros; but there is no “real mechanism” to deal with it, Meyer added.

While a bailout of Portugal would likely be small, a bailout of Spain would be five times greater than that of Ireland.

One thing analysts are forgetting is that the PIIGS also includes Italy. If Italy, with it 60.4 million people, needs a bailout, it could eclipse Spain’s total. Nobody is talking about bailout for Italy, but nobody was talking about bailouts for Spain and Portugal just months ago. If Spain and Portugal take bailouts, focus will then shift to Italy.

If all five PIIGS need bailouts, we are talking about well over a trillion Euros. Good thing money grows on trees.

If this story sounds familiar, it should. It is eerily similar to the US banking crisis in 2008. First Bear Stearns went bankrupt. An isolated case. Then Lehman Brothers. OK, a second special situation. Next was AIG. Then Citigroup, Wells Fargo, Bank of America, and the rest suddenly needed help from the government. BofA, Wells Fargo, etc. may not have been in real trouble when the whole thing started. Instead, it was an old fashion bank run where depositors/investors get their money back because they don’t trust the banks and banking system. Now we are seeing the same thing in Europe. Ireland didn’t need a bailout… until last week when depositors withdrew billions of dollars from Irish banks. Today, Spain, Portugal, and Italy may not be in trouble, but if people start thinking they are “at risk,” they’ll withdraw their funds and it will become a self-fulfilling prophecy.

And all the bailouts in the world won’t end this madness until these countries get their fiscal and monetary houses in order. Until then, the sovereign debt crisis will spread from one country to another.

Ireland gets its bailout. Now who will bail out the rest of the world?

So Ireland got its bailout. Marketwatch reports:

After weeks of insisting that it didn’t need a bailout, the Irish government said late Sunday that it will start formal negotiations with the European Union and the International Monetary Fund over a financial rescue package.

The United Kingdom and Sweden have also indicated that they are ready to consider loans.

Earlier in the day, Irish Finance Minister Brian Lenihan had declined to specify a total figure for the bailout except to say that it would be less than 100 billion euros ($136.7 billion).

The Irish government will put forward a strategy to provide details of €6 billion of fiscal consolidation in 2011 in order to cut the country’s deficit to 3% of gross domestic product by 2014. An overall consolidation of €15 billion is expected to be achieved over the four years to 2014. Irish Prime Minister Brian Cowen detailed in a press conference that spending cuts of €10 billion and tax increases of €5 billion are expected to make up the total amount.

Additionally:

Ireland’s banks will be pruned down, merged or sold as part of a massive EU-IMF bailout taking shape, the government said Monday as a shellshocked nation came to grips with its failure to protect and revive its banks under its own powers.

But the story is far from over.

First:

A “multi-notch downgrade” of Ireland’s Aa2 rating is now the “most likely” outcome of a review of the nation’s sovereign-credit rating, Moody’s Investors Service said Monday in its weekly credit outlook. Such a downgrade would leave Ireland’s rating within the investment-grade category, the agency said. Ireland on Sunday applied for a European Union-International Monetary Fund aid package that is expected to be used to make direct capital injections into the nation’s banks. While the move is positive for the standalone credit quality of the banks, it will shift the burden of support to the Irish government, underline bank-contingent liabilities on the government balance sheet and increase the sovereign’s debt burden, the agency said, “a credit negative for Ireland and, consequently, the credit quality of bank deposits and debt that the sovereign explicitly and implicitly supports.”

And:

Ireland’s Green Party, the junior partner in the coalition government, on Monday said the nation needs to hold a general election in the second half of January, according to Irish state broadcaster RTE. Party Leader John Gormley said he had discussed the issue with Prime Minister Brian Cowen. Gormley said the government needs to produce a credible four-year plan, deliver a 2011 budget and secure funding support from the European Union and the International Monetary Fund. Gormley said people felt misled and betrayed and that the Irish people need political certainty to take them beyond the coming two months, RTE reported.

But Ireland is just the tip of the iceberg. Or maybe Greece was the tip and Ireland is the rest of the above-water portion of the iceberg. But remember, 90 precent of the iceberg lies underwater. Any way:

Any deal between the Irish government and the European Union and International Monetary Fund to resolve Ireland’s financial crisis is ultimately aimed at cutting short the turmoil in sovereign bond markets that policy makers fear could one day price Portugal or even Spain out of global credit markets.

Portugal, which like Ireland is a small economy with a relatively illiquid debt market, is seen as the next country likely to find itself in the sights of bond traders.

Traders and analysts had hoped that a bailout of Ireland would settle credit default fears, but it has done no such thing. Just look at the stock market today which is down about 100 points. Now that Ireland has been bailed out, instead of jumping for joy, traders are turning their attention to Portugal and Spain, wondering not if but how long until they too need bailing out.

And the sovereign debt crisis continues… Just as I predicted months ago.

Doctor Evil’s solution to the sovereign debt crisis

There are three stories out this morning regarding the sovereign debt crisis in Europe.

First off is Ireland:

Ireland is likely to end up tapping a loan worth “tens of billions” of euros as a result of talks between the government and officials from the European Commission, European Central Bank and the International Monetary Fund, the head of Ireland’s central bank said Thursday.

The talks aren’t about a bailout, but will lead to a loan to Ireland that the government would have to accept, Central Bank of Ireland Governor Patrick Honohan said in an interview, according to Irish state broadcaster RTE.

The yield on the 10-year Irish government bond fell to around 8% this morning from 8.3% Wednesday, strategists said. European equity markets rallied, with the Irish ISEQ stock index gaining 1.4%.

I don’t see how this changes anything. It may stave off immediate default, but Ireland is simply borrowing more money, exactly what got it into this mess in the first place. This simply buys them time to get their house in order, but will they?

Now, over to Spain:

Spain sold 3.654 billion euros ($4.943 billion) in 10- and 30-year bonds, but was forced to pay higher yields than two months ago as worries about fiscal problems on the periphery of the euro zone push up borrowing costs. The Spanish Treasury offered 3 billion to 4 billion euros of 10- and 30-year bonds. The government paid an average yield of 4.615% on the 10-year bond, up from 4.144% at a September auction, Dow Jones Newswires reported. The 30-year bond auction produced an average yield of 5.488% versus 5.077% in September. The 10-year auction produced a bid-to-cover ratio of 1.84, versus 2.32 in September, the report said.

The market is relieved that Spain was able to sell its bonds. Again, great news that Spain was not forced to default, but it doesn’t change Spain’s fiscal situation. In fact, one can argue that by lending to Spain is simply enabling one is enabling their addiction.

And over to Greece:

The Greek government on Thursday submitted to parliament a budget plan that it said would allow to stick to its target of reducing its deficit to 7.4% of gross domestic product in 2011 despite a sharp upward revision to its 2009 and 2010 deficit levels. The European Union statistics agency Eurostat earlier this week upwardly revised Greece’s 2009 deficit by nearly two full percentage points to 15.4% of GDP. The government raised its estimate of the 2010 deficit to 9.4% of GDP. The finance ministry said it would further cut spending and boost revenues to meet the 2011 deficit target, taking measures that include a rise in the lower value-added tax rate to 13% from 11%, a levy on highly-profitable firms, cuts in government operating expenditures and a nominal pension freeze.

Greece was forced to take more austerity measures because the economy did worse than expected. I am not surprised by this because the austerity itself hurts the economy, like a medicine that tastes bad but is required to kill an infection. I expect more such bad news over the following years. Government forecasts of narrowing deficits in Europe’s at-risk countries and here too in the United State rely on solid economic growth over the next three to four years. Yet, this optimistic economic outlook will only reduce their deficits, or so they hope, to about 3 percent of GDP. Why aren’t they trying to eliminate their deficits entirely? Why are they relying on optimistic economic growth rates? Has government never heard of “expect the worst, hope for the best?” Instead, they hope for the best and trap themselves in a corner if that does not occur.

All this reminds me of a scene from Austin Powers. Doctor Evil finally captures his nemesis Austin Powers:

Dr. Evil: Scott, I want you to meet daddy’s nemesis, Austin Powers.

Scott Evil: What? Are you feeding him? Why don’t you just kill him?

Dr. Evil: I have an even better idea. I’m going to place him in an easily escapable situation involving an overly elaborate and exotic death.

Later in the scene:

Dr. Evil: Come, let’s return to dinner. Close the tank.

Scott Evil: Aren’t you going to watch them? They’ll get away!

Dr.Evil: No, we’ll leave them alone and not actually witness them dying, and we’ll just assume it all went to plan.

Scott Evil: I have a gun in my room. Give me five seconds, I’ll come back and blow their brains out.

Dr.Evil: No Scott. You just don’t get it, do you?

These bailouts, loans, and austerity measures in Greece, Spain, Portugal, and Ireland are “an easily escapable situation involving an overly elaborate and exotic death.” Instead of eliminating the deficit immediately, they have convoluted plans to reduce it over a five-year period. Will these plans work? Nobody knows. But that’s okay because “we’ll just assume it all went to plan.”

Our governmental leaders may not be evil like Dr. Evil, but they certainly are as naive in assuming their plans will work. And they think we are too naive to notice their plans’ inadequacies.