Friday, February 26, 2010

The Day After

The US national debt is currently about $12.4 trillion. Interest on the debt is about $.2 trillion annually. Actual federal tax revenue is about $2.1 trillion, while the budget is over $3.5 trillion. To bring the budget in balance immediately would require an across the board cut of at least 33% in federal spending.

Federal spending has increased on average about 8% over the past decade, while average annual GDP growth is closer to 3%. National debt is now almost 87% of GDP and rising. No one is proposing any real reduction in federal spending. In fact, many are pushing for more. A lot more.

It was once conceivable that we could grow our way out of this situation. But the growth rate required to keep up with government spending trends would spur skyrocketing interest rates, which would cause the deficit to spiral out of control at an even faster clip.

At this point, you have to believe one of two things. The government will muster the political courage to make massive cuts in spending or the failure of this government is imminent. It might be next week. It might be in 20 years, but without a sea change in policy, behavior and the philosophy of the government’s role in society, it’s not a question of if it will collapse, just when.

Right now, politicians are playing fiscal hot potato. The hope is that they can continue as is until they are out of office and safely retired. The next crew will figure something out. But the next crew will be the same personalities in different suits.

All I can recommend is that you ground yourself in your principals. There will be a day after. There may be no avoiding the train wreck, but you control how you’ll respond to it. Make it something future generations can be proud of.

Friday, February 12, 2010

Ramsay's Record

On Ramsay's Kitchen Nightmares, Chef Gordon Ramsay comes into a troubled restaurant and tries to get it turned around. No matter how dreadful the situation, he always seems to end his week long project with a successful relaunch and a staff committed to doing things right from now on. But what happens after he leaves?

I got curious when I watched the J. Willy's episode and later the Fiesta Sunrise episode and thought "There's no way this place is still open." I was right. As it turns out, roughly two thirds of the restaurants featured on Kitchen Nightmares, in 5 seasons in the UK and now in its 3d season in the U.S., have either closed or changed ownership. Some have pointed to these stats as evidence of failure on Ramsay's part. I beg to differ.

First of all, the vast majority of the restaurants featured on the show have one foot in the grave when he walks in the door. The fact that 1/3 of them have survived is really quite impressive. The thing that gave me the willies about J. Willy's, was that it appeared to me that the owner was simply banking on the publicity from the show to make him rich. Of course everyone smiled for the cameras, put on a good show and pledged to take Ramsay's advice to heart. Publicity wont make your food taste good. It wont make people okay with waiting too long for sub-par food at inflated prices. You have to continue to execute and provide value. Incredibly, although J. Willy's closed down, there's still a website that encourages people to "invest" in the brand name sauce that Ramsay developed for the restaurant to try to save their sorry behinds.

In the case of Fiesta Sunrise, Vick was clueless when Ramsay got there and just as clueless when he left. Yes, they had a good night, new furniture, flashy new signage and cleaned the place up. But then, they handed the reins back to Vick. But at that point I don't think Warren Buffet could have made it work. The place had 120 seats, a 90k a month break even point and was 850k in debt. Do the math. They would have had to fill the place, twice over, every day, 7 days a week, 365 days a year for about 10 years to pay off that debt.

Ramsay doesn't provide salvation. He provides a fighting chance. He goes into places that are on death's door and gives them the insight and opportunity to work their way back. But, the same people who drove it into the ground are responsible for turning it around after their one-week crash course in restaurant and business management. It's a long shot to say the least. I'd wager that his 30+% success rate is about 29% better than the results would have been without him.

Monday, February 8, 2010

Creating work vs. creating wealth

I saw a report some years back that studied the correlation between average global temperatures, as determined by ice core samples, and global economic activity (sorry I couldn't find it online). The conclusion was that there is a direct connection. Lower temperatures directly correspond to less trade. Higher temperatures directly correspond to increased trade.

Part of that may be psychological. People may be more sluggish and less productive when they're colder, but a big part of it is how resources are expended. One might think that snowstorms and cold weather are job creators and thus, good for the economy. But while colder temps may require more work, that work does not result in more wealth.

When you create something that is worth more than the sum of its parts, you have created wealth. Tie a rock to a stick and you have a hammer or an axe, worth more than a rock plus a stick plus some binding. When you provide a service that makes someone else more productive, you create wealth. If you deliver something for me, allowing me to continue to work on something more valuable than what I'm paying you, you have added value.

When I have to spend twice as much on snow removal this year as I did last year, that's not a creation of wealth, it's a transfer, and there is a net loss in the process. You get my money, but you have expenses, and in the end, the result is at best, a return to pre-storm status quo. No value has been added in comparison to last year.

This is a dynamic that the current crop of economic eggheads in Washington D.C. completely misses. They believe that any transfer of money is good for the economy. They don't recognize any difference between paying people to dig holes, then fill them back in and paying someone for something that's worth more to the recipient than it is to the provider. The latter is how free markets work. Both parties voluntarily enter into a transaction that leaves each with more value than they started with. The former is central control. It serves to keep people busy and has the added benefit of generating tax revenue, since whenever money changes hands in this country, it's usually subject to some sort of tax. It does not create wealth, it consumes it.

The challenge for the government now is not to "put people to work", but to enable wealth creation by allowing individuals to reap the rewards of their good ideas and hard work. To do that, they must enable individuals to choose what to spend their money on and when. They must also allow producers to offer their goods and services at market determined prices, with minimal government interference.

This is in direct contradiction to the nature of most politicians. They generally seek more control, not less. As long as this is the case, the global economic cooling trend will continue.

Thursday, February 4, 2010

What will the U.S. debt lead to?

The problem people are having in getting their heads around what a $13 trillion dollar debt means, with deficits running 30 - 40% of the total federal budget, is that we're in uncharted waters. This is a level of fiscally throwing caution to the wind that the world has never seen before. It's hard to say what might result from this because there's no example to look back on.

There may not be a historically significant example, but I do have a personal annectdote that may apply. Back in my younger days, I liked to play poker with the guys at work. Sometimes we'd get a bit carried away and the pots would get pretty big. We began to exchange "markers" or I.O.U.'s, which we agreed would only be collected upon at the poker table. We didn't want to take anyone's grocery money after all. However, if you had outstanding "markers" you didn't get to leave the table with any cash. You had to pay down what you could before calling it a night.

This went on for a while, and worked out pretty well, until one evening when the pots got really out of hand. I was having a winning night, and many of my colleagues were trying to make all their losses up in one hand. Long story short, I wound up with something like $13 million in "markers". Everyone was having a good laugh and decided that of course, we should just throw these markers out. I said I had no problem with that provided that the $600 or so of markers I had outstanding before that night's game were also thrown out. This caused a big uproar of protest. So I said I'd honor my $600 in markers if those who owed me the $13 million honored theirs. The markers were all thrown out. We dispensed with the marker system and started playing cash only.

The level of U.S. debt is beginning to approach the level of ridiculousness of my $13 million in markers. Other countries are in a similar pickle. In the end we may have to employ a solution similar to the one my poker buddies and I came up with. Clear the books, call it even and start over with a new system. This would cause the most heart ache at the millionaire and billionaire level, so it will be avoided as long as possible. But, it seems we're all playing with funny money already. It's just a matter of time before the major players have to acknowledge it.

Tuesday, February 2, 2010

How more money in campaigns could make for smarter voters

So Bill O'Rielly and John Stassel are arguing the merits of the Supreme Court's decision to strike down a key element of Campaign Finance law. That is, the Supreme Court has determined that Congress cannot limit the amount of money that corporations, unions or organizations spend to get out a political message.

Stassel stood up for free speech, but missed the main point. O'Rielly expressed concern that a foreign government could funnel big dollars into the U.S. for political purposes. That's true. But to assume that the American voter (it's still one man, one vote) is going to go for whatever idea has the most money behind it, is insulting. Suppose a law were proposed that each Thursday, every man, woman and child in America smash their own thumb with a hammer. Now suppose the Chinese government spends $100 billion promoting it. Would you vote for it? What if the ads were really funny?

Here's an idea for real campaign finance reform. What if individuals actually paid attention to what they were voting on? What if they educated themselves with regard to the underlying principals of the issue? What if they actually evaluated a candidate's competence for the job they're seeking?

We have a choice here. Dispense with freedom of speech, because we fear some may speak too much, or make more thoughtful decisions on an individual basis. The latter could actually make us all wiser and wouldn't cost us a dime.

The Global Casino

In thinking about the direction that global markets are heading, it occurred to me that they are increasingly operating in an environment very similar to what you see in a casino.

Government needs producers, entrepreneurs, people willing to take risks. These are the people that fund everything else. They are the players. The government is the house. The house always gets a cut. In fact in government, the cut is much bigger than in the casino. Whether you win, lose or draw, you'll pay through license fees, taxes on employees, unemployment insurance, workers compensation, use taxes and other fees. If you win, you pay even more, through income and capital gains taxes.

In a casino, you have the dealer watching the players, someone else watches the dealer. Someone else watches the watcher, and so on. Government is very much the same. There are a myriad of departments, agencies and employees who's ultimate purpose is to monitor the free market players.

Whether it's government or the casino, the system is designed so that the house always wins over time. At least in the casino, you only pay when you lose (and if you play long enough, you always lose). In the market place, you pay to play all the time.

The difference is that in the casino model, players go outside the casino and earn more money, so they can come and play another day. There is no system outside the reach of government where players can accumulate wealth to spend in the marketplace.

We are now in a situation where 50% of the country pays no income tax and the top 1% pays more than the bottom 95%. The number of watchers continues to increase as the pool of players gets smaller. Obviously this is not sustainable. As government seeks to limit risk, it also limits reward. The game becomes less rewarding and less fun. Fewer individuals are interested in playing. At the same time, more and more people are dependent on the house's take. The house keeps promising more while taking in less.

How long can this model continue? Well, I don't see any indications out of Washington or on the world stage that we're going to change direction, so I suppose we're about to find out.

Monday, February 1, 2010

All tax cuts are not created equal

The theme for the week in Washington D.C. is jobs, jobs, jobs. That's a good thing right? Well, the solutions may just be worse than the problem. A variety of tax cuts and new spending programs are being discussed and proposed. Most of them are of the targeted variety. There is nothing more un-American than a targeted tax cut.

Under some of the ideas being kicked around, if you hire new workers, you get a tax break. If you just keep the ones you have, you don't. If you're a company that wants to make monorails, you'll get government money. If you make something else, you don't. If you buy a new house, you get a tax cut. If you're just trying to keep the one you have, you don't. You get the idea.

The President just submitted a $3.8 trillion budget. That means our federal government's expenditures are now approaching 30% of the total goods and services produced in this country. What they don't own, they want to control. One way to exercise control over things you don't own is through the tax code. You take from those who aren't behaving according to the master plan, and give to those who are.

According to the Heritage Foundation and Wall Street Journal's Index of Economic Freedom, the United States has fallen to 8th place in the world, behind Hong Kong and even Canada. We now rank as "mostly free".

Perhaps it's the sheer size of government that leads inevitably to more and more government control. Money is power and nobody has more of it to throw around than the U.S. government. The progressive movement has a vision, whereby we all happily work at our appointed duties and contribute to the greater good of society as determined by those smarter and wiser than a mere citizen. The ultimate goal is similar to the society depicted in Star Trek and other sci-fi favorites, where the ugliness of capitalism, free markets and even currency have been dispensed with in favor of dedication to duty. The only difference between a hard core communist and a progressive is how we get from point a to point b. Communists prefer armed conflict followed by a 'transition period', where progressives believe legislation, policy and executive order will gradually move society where they want it to be.

Maybe we'll embrace individual freedom before it all comes to a head, maybe we wont. Whether we move toward a more collectivist society via warfare or policy initiatives, the movement will not end well. It never does.