Education and Student Debt

Republicans and Democrats attempt to differentiate themselves via their views of the government’s role in the economy.  With close examination, it is hard to find real differences between them.

Those on the Right promote the benefits of “true” capitalism that allows markets to set prices via supply and demand.  Those on the Left share the view that capitalism is too harsh and that the government needs to step in and smooth out inequities created by markets.  At the extreme Left, socialism is promoted, irrespective of its history of failure.

At the macro-economic level there is little difference between Republicans and Democrats.  Crony capitalism is rampant within both parties.  Republicans typically support large industries and those in the military industrial complex.  Democrats promote social programs that benefit industries including education, social services, medical services, and trial lawyers.  The result of crony capitalism has been a significant increase in governmental spending and a surging United States’ debt over the past 50 years.  This debt is in part responsible for the economic malaise that has been inflicted on the country over the past decade.

An example of crony capitalism and the damage it has done is the educational industry.  Through the US Department of Education, as well as at the state and municipal levels, the funds spent on primary education have been skyrocketing as indicated by the charts below.

Total Educational Spending

However, the increased spending has not resulted in improved education.  The chart below shows how poorly our students are doing in basic reading comprehension.

The problem is more significant at the college level.  The educational industry, with support of the US government and its loan programs, has created the false narrative that all Americans require and deserve a college education, irrespective of whether or not it improves their economic well-being.  As a result, the amount of student debt now exceeds $1 trillion and a significant portion of college graduates cannot make an income level that would allow them to pay off the debt in a reasonable period of time.  Many have been forced to move back into their parents’ houses.Student Debt

While a market-based economy can be a cruel arbitrator of scarce resources, crony capitalism has proven to be catastrophic to those who have been cajoled into inappropriate economic decisions based on government programs.  It is a major cause of the growing wealth disparity between the ultra-rich and average Americans.

Yes, both Hillary Clinton and Donald Trump have prospered under crony capitalism.  The same cannot be said for most Americans.

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Brexit Consequences to Come

The political elites and many in the economic community warned of dire consequences should Britain vote to leave the European Union.  Immediately following the announcement of the vote equity markets worldwide drop significantly.  However, one week later they have rebounded and are about back to where they started.

The action of the equities markets suggest either the predicted dire consequences were severely exaggerated, or as an alternative, equity markets with the assistance of continuous central banker interventions no longer believe that stock valuations can go down.  Neither is very comforting.

How the UK’s exit from the EU will affect the world economy remains to be seen.  The Daily Reckoning suggests that political elite Progressives will take a play out of Obama associate Rahm Emanuel strategy book, who infamously said: “You never want a serious crisis to go to waste.”  Using this strategy, they will use the Brexit vote as an excuse for more central bank spending and interventions into the economy.  Why not, that strategy has failed for the last eight years so let’s double up on it.

The Daily Reckoning reports that since 2009 central banks have printed over $12 trillion.  In addition, they have made 654 interest cuts worldwide.  This has succeeded in creating equity bottles that have made the wealthy wealthier.

The Daily Reckoning expects more Quantitative Easing, QE 4, and an even more radical policy called “helicopter money” where the Fed basically froze money to the masses.  These radical steps are not taken out of stupidity.  Instead, they are an acknowledgment by central banks that we are reaching the end game.  Without continuous and more aggressive interventions, the rebalancing of the economy will begin and it will be painful.  Irrespective of the central banks’ actions, that rebalancing will occur.  It is only a matter of time.

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Western Capitalism Morphs into Socialism

There is an unholy and symbiotic relationship between government and those who benefit from its largess. Those receiving entitlements believe the benefits are holy and guaranteed forever. Those employed by the government become beholden to it. In addition, through crony capitalism corporations become dependent on government for sales and earnings.

The relationship between government and those dependent on it creates a “positive” feedback loop that has the most negative consequences. Those dependent on government continue to vote into power politicians that will increase their benefits, whether entitlements, salary, or government contracts. This then creates still larger government and payouts. It then becomes nearly impossible to stop the cycle until an economy reaches the tipping point where the expenses become too great for income or borrowing to continue the payouts.

Crony capitalism and government dependence growth has been accelerating for decades. Those that believe it will result in bad consequences are now outliers. Still, the results are clear. The United States debt is now approaching $20 trillion, with much greater debt kept off books.

Americans and many Westerners have become immune to one side of capitalism; its inherent ability to ultimately balance supply and demand, as well as assets and liabilities. A recent article by investor Vitaliy Katsenelson explains the efficiency of capitalist markets and specifically its “invisible hand”, as republished below. The markets will have their day!

Whatever Happened to the Invisible Hand of Capitalism? By Vitaliy Katsenelson

When I was growing up in the Soviet Union, our local grocery store had two types of sugar: the cheap one was priced at 96 kopecks (Russian cents) a kilo and the expensive one at 104 kopecks. I vividly remember these prices because they didn’t change for a decade. The prices were not set by sugar supply and demand but were determined by a well-meaning bureaucrat (who may even have been an economist) a thousand miles away. If all Russian housewives (and househusbands) had decided to go on an apple pie diet and started baking pies for breakfast, lunch and dinner, sugar demand would have increased but the prices still would have been 96 and 104 kopecks. As a result, we would have had a shortage of sugar — a very common occurrence in the Soviet era. Continue reading

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Greek Banks Close for a Week as Crisis Grows

The Wall Street Journal reported that Greece has ordered that its banks remain closed for the next week to the stem panicked cash withdrawals by depositors.  This drastic move indicates that the five year long Greek debt crisis is coming to an end game.

After the financial meltdown occurred in 2008, the economic folly of Europe’s single currency, the Euro, became apparent.  The European Union was created in an effort by Europeans to create a political climate that would lessen the likelihood of future wars on their continent.  This desire was a reaction to the carnage that inflicted on Europe during two world wars in the 20th century.  While the political idea was noble, little thought was given to the economic consequences that a central currency would lead to.  Those consequences are now playing out.

The Euro was destined to create an economic calamity because the political union was not accompanied by a truly economic union.  European countries maintain their own banking systems and Euro central bank was weak.

catharsisAfter the European Union and the Euro were created, the more efficient and stronger economies of North Europe, specifically Germany, obtained the lion share of benefit created by the Union. With nearly all European countries having a single currency, less efficient countries had their cost of labor increased in relation to more efficient ones.  As a result, the poorer countries had a artificially strong currency that enabled them to consume increased amounts of the more efficient countries’, i.e. Germany.  Through the Euro, Greece had to access to relatively cheap borrowing via an overall European credit rating that did not reflect the realities of individual countries.  As a result, Greece and other Southern European countries borrowed more funds than they could afford to pay back and use these funds to purchase imports from Germany and other exporting countries.

When the recession hit, Greece and other countries were unable to make payment on their debt.  This led to a battle between the creditor countries such as Germany and debtors like Greece.

For five years the Greece debt crisis has been a can kicked down the road.  Creditors including, Germany, have been unwilling to forgive Greece’s debt, even though Greece is not a position to repay it.  Had Greece continued to have its own currency, it would have devalued versus the German currency making its exports cheaper and more likely that it would have been able pay back its debt obligations.  The single currency has curtailed this natural rebalancing mechanism of sovereign debt. Continue reading

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Chicago’s Credit Downgraded to Junk Category

Given the recent Amtrak crash and lengthy problems in Baltimore, there has been little news bandwidth remaining for financial issues. This dearth does not indicate a lack of serious issues.

During the past couple weeks the bond markets have been in turmoil. With rapid and nearly daily increases in interest rates, values’ have dropped by about 9% wiping out hundreds of billions of dollars of wealth. Should this continue it places substantial risk for financial institutions, money market funds, pension funds and other investors who stand to incur losses.

Another important financial “happening” occurred Tuesday when Reuters reported that Moody’s Investor Services downgraded Chicago’s bond rating to Ba1, “junk” status. In making the downgrade Moody’s announced that America’s third-largest city has an unfunded pension liability of $20 billion. Illinois has mandated that Chicago must pay in $550 million additional during 2016 to the fund. Chicago’s plan to meet their obligation; borrow it. However, that plan is now in jeopardy due to their credit rating downgrade.

Rahm EmanualChicago has the dubious distinction of having the second worst credit rating of any American city, only bested by Detroit who recently emerged from bankruptcy. Instead of addressing the problem of Chicago’s financial and political incompetence, its Mayor Rahm Emanuel attacked the messenger stating: “This action by Moody’s is not only premature, but it is irresponsible to play politics with Chicago’s financial future.”

If Emanuel had his way he would have Moody’s misrepresent Chicago’s actual financial condition so that unsuspecting investors will get burnt when the City is forced to ultimately declare bankruptcy. How about forcing that Emanuel, Pelosi, Reid, Obama and the rest of the Progressives who created Chicago’s problem to purchase the bonds at better than junk status; i.e. lower interest rates? Continue reading

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Australian Central Bank Cuts Interest Rates to Record Low

The Wall Street Journal reported on Australia’s central bank cutting its benchmark interest rate from 2.25% to a record low of 2.0%. The bank justified the cut due to a weakened Australian economy, the result of decreasing demand and prices for its commodities, such as iron-ore.

The Australian central bank has announced that it hopes the lower interest rates will increase economic activity in other Australian industries, such as construction. However, it is likely that Australia is also seeking to decrease the value of its currency to make its products more competitive in the world market. This might be a viable strategy except that other countries are also debasing their currencies through low interest rate policies.

It has been about eight years since the 2008 financial crisis that led to the worldwide economic recession that is ongoing. Since then governments and central banks have used record deficit spending and low interest rate policies in an attempt to invigorate economic growth. History has shown such policies to be a failure. Not only has economic growth been anemic, but the gap between rich and poor has increased with economic policies that mainly benefit the wealthy who own equities whose values have been inflated.

The Australian rate cut will likely not be its last. It will also be joined by rate cuts in other countries, as each tries to gain advantage in the ongoing currency war. This story has played out throughout history and it is outcome has not been positive.

Continue reading

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Japan’s Credit Rating Downgraded

The Wall Street Journal reported on Monday that bond rating service, Fitch Ratings, downgraded Japan’s credit rating by a notch from A-plus to A. According to Fitch, the downgrade was made due Japan’s deteriorating financial condition. This is highlighted by the fact that Japan’s debt to GDP ratio is now over 200% and projected to grow next year to over 240%. This would be the highest debt to GDP ratio for any foreign bonds rated by Fitch.

Japan’s sovereign finances are an example of the race to the bottom. Countries throughout the world have used public spending and low interest rate policies in an effort to stimulate growth. However, Japan has been in a 30 year period of stagnation, the poster child for the failure of these governmental interventions. It is likely that these interventions they inhibited real economic growth and recovery, leading not only to long-term problems in Japan, but also in other economies worldwide.

Under normal times Japan’s economic situation would cause substantial turmoil in financial markets. But these are not normal times. While Japan’s economic policies have failed and resulted in its significant sovereign debt, other countries are also running up debt to unprecedented levels. As a result the bond markets have not decided who to punish for imprudent economic policies. This equivocation has given countries like Japan some breathing space. However, economic markets always revert to the mean. Ultimately countries with bad finances will be punished by the markets. When this occurs it will likely come quickly and with little warning causing significant economic turmoil worldwide, a repeat of the economic turmoil that occurred in 2008.

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Stock Markets Slump Worldwide

Stock Markets Slump Worldwide

The Wall Street Journal reported Friday on the worldwide slumping stock indices. In the United States the Dow Jones Industrial Average fell nearly 280 points or 1.5%. In Germany the DAX fell over 2.6% with France’s CAC dropping 1.6%. The decreases were not confined to the West with Japan’s Nikkei losing 1.2% and the Chinese stock market down over 5%. This worldwide slump indicates investors are running scared.

In addition, European bond markets are in turmoil. The yield on Greece’s 10 year bonds on Friday was 12.49%, while yields on its two-year bonds were over 26%. This perverse and inverse yield curve demonstrates substantial fear in the short-term relating to Greek finances.

According to the Journal, investor concerns center around three issues: 1) Greece’s financial situation, 2) China’s recent crackdown on stock market borrowing, and 3) weak in US corporate earnings.

As for the Greek financial crisis, this is an unresolvable problem without significant pain. Greece owes more debt than it can afford to pay back period. In addition, its economy has been rendered uncompetitive by the unnatural imposition of the euro on European economies. The European Union’s answer is to kick the can down the road by extending Greece’s loan repayment schedule. Each time and extension is given, equity markets sigh relief and bounce back only to be rattled when the extension runs out. Sooner or later the central bankers will have to admit the obvious, Greece’s debt will have to be written off with negative consequences to lenders worldwide.
The Chinese economic miracle has been built on the backs of cheap labor and significant debt used to inefficiently over build factories and cities. Chinese labor prices have been increasing. It is only a matter of time until a significant correction will be required to correct the imbalances created by imprudent use of debt.

Finally, the policies of the Federal Reserve and other central banks have resulted in an unnatural appreciation of the US dollar. While this has some positive implications, such as dropping oil prices, it also offers negative consequences. One such consequence is that US manufactured goods sold in dollars become uncompetitive in the world market. This leads to the third problem raised by the Journal, dropping US corporate earnings.

The problems that currently concern equity markets are the result of unnatural interventions by central banks and governments in their attempt to alleviate economic pain resulting from the 2008 meltdown. This meltdown was intern caused by the same central banks making credit available at artificially low rates and creating excess liquidity vis-à-vis poor lending practices. Had the central banks allowed the markets to take corrective action in 2008, while the initial recession/depression might have been deeper, the rebalancing of supply and demand would allowed for a stronger recovery. Instead, the economies worldwide jump from one problem to another and with investors then waiting for still further central bank corrective actions. Sooner or later this central bank alchemy will cease resolving problems even in the short run.

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China’s Growing Debt

This Blog has often referred to the real and potential problems associated with the growing debt in the United States and Western Europe.  However, the unsustainable growth of debt is a worldwide phenomenon that includes the fastest-growing major economy, China.

china debtThe Wall Street Journal reported on China’s growing debt.  According to the International Monetary Fund, China’s debt is growing quicker than that of Japan, who has a debt to GDP ratio of over 200%.  It is also growing faster than the debt of the United States and South Korea.

A significant portion of China’s debt is being created by local governments who borrow to finance projects in their areas.  The Journal reports that these local governments have accounted for 25% of China’s total debt since 2008 and in 2013 reached 36% of GDP, double the rate of five years earlier.  At this rate it is estimated that local borrowing will increase to 52% of GDP by 2019.

Incredibly, there are approximately 8,000 local quasi-government finance organizations throughout China.  This huge number and the large amount of debt lend themselves towards corruption and inefficient usage of the debt.  Also, since these finance organizations are related to the government, they are able to sell bonds with high risk at subsidize rates as lenders incorrectly believe that default is not possible.

This lose money policy in China lends itself to financing ventures that do not make economic sense, thereby increasing the likelihood of defaults.  This is eerily reminiscent of the lose money policies of the West and the United States in particular that led to the economic meltdown of 2008.  It is likely that China’s flawed financing practices will lead to similar results in that country.  Given the size of the Chinese economy, that will lead to contagion in economies worldwide.

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Corporate Bonds at Record Levels

The Wall Street Journal reported that corporations are issuing US bonds, i.e. taking on debt, at record levels.  This is the third consecutive year for a record.  So far for 2014 the issued bonds are just shy of $1 trillion.

When corporations sell bonds, typically this is done to raise funds to be used for future expansion.  Such expenditures are usually productive and can be beneficial to the economy as a whole.  However, these are not normal economic times. Continue reading

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