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Saturday, September 10, 2011

Oh no...Not again!

As the financial calamity is unfolding in Europe, I see remarkable parallels similarities between every budget crisis which has unfolded in the past 20 years. The present crisis involving Greece and the EU, has been punctuated by specific episodes where Greece faces a liquidity crisis prompting it to make an urgent request to the EU (primarily Germany) to provide access to emergency loans. The loans are made technically made contingent upon financial reform in Greece. However, once the loans are made, the leverage to hold the Greeks to their promises evaporates. With each additional cycle, those loaning the money become more and more vested in avoiding a Greek default, thus perpetuating the cycle of profligate spending, emergency bailout, followed by additional spending which outstrips economic productivity. 
The problem is the asymmetry of power based on the chronology of required action. Those providing the funds for bailout are required to take action up front while those who as ostensibly bound to to respond afterwards with financial reform and spending cuts are able to renege on whatever agreement that was hammered out initially. The may be because the agreement was made in bad faith but even more likely because whomever made the agreement in the first place is no longer in power when austerity actions are required to be put in place.

The same dynamic is operational in budget negotiations  in the US. Almost invariably, tax hikes are implemented immediately, sometimes retroactively. Business planning for 2011 is based upon a tax environment which may be in place as much as 12-24 months prior to 2011. However, tax rates for 2011 can be hiked basically anytime prior to when 2011 taxes are due. This can be as late as April 2012. On the other hand, spending cuts tend to be most heavily focused on out years, particularly years well after upcoming elections, after which elected officials may have little or no incentive to be held to promises which they did not make.

 This dynamic is acutely relevant to our present state in the finance of health care. I found a very interesting in Greg Mankiw's blog where he calls attention to a 1967 quote from Paul Samuelson from Newsweek magazine.

The beauty of social insurance is that it is actuarially unsound. Everyone who reaches retirement age is given benefit privileges that far exceed anything he has paid in -- exceed his payments by more than ten times (or five times counting employer payments)!
How is it possible? It stems from the fact that the national product is growing at a compound interest rate and can be expected to do so for as far ahead as the eye cannot see. Always there are more youths than old folks in a growing population.
More important, with real income going up at 3% per year, the taxable base on which benefits rest is always much greater than the taxes paid historically by the generation now retired.
Social Security is squarely based on what has been called the eighth wonder of the world -- compound interest. A growing nation is the greatest Ponzi game ever contrived.
While we were at the helm of a growing wealth generating engine which used to the the US economy, making such promises as Social Security, Medicare, and Medicaid could be done without fear that the chickens would come home to roost in any near term time frame. The asymmetry of time frame allowed for implementation (the glory) without immediate impact the wealth engine making things possible (the pain). Those Jeremiahs who could see the crisis coming and made attempts to inject fiscal discipline may have temporarily appeared to be successful. Agreements generally involved immediate revenue enhancements coupled with spending cuts in the longer term, agreements which fail to materialize well after tax increases were set in stone. They have been much like Charlie Brown, forever the optimist, committing to kick that ball,  firmly believing that Lucy will not snatch the football away.  

It is unfortunate but it appears that the process continues until one or more of the parties is incapable of continuing because they broke and flat out of money.  Ponzi schemes always end and generally not well. In the case of the US economy, when the growth rates drop and the demographics of the US population turn less than favorable, the game is over unless we learn from the events unfolding in Europe.

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