The Tipping Point

Since 2011, a steady reorganization of Michigan’s fiscal policies has buoyed business spending and growth, but political indecision in Washington threatens to bring the entire global economy to a screeching halt.

The beauty of nearly all three-year economic recoveries is that they have historically provided “wiggle room” — time for political debates and compromises on matters of policy realignment. That is to say, by the third year of an economic uplift, most people customarily are feeling more confident about the direction of their careers, finances, and mobility.

Unfortunately, this “normal” expansion psychology has not prevailed in 2012. Instead, the expansion has been snail-paced rather than robust, and many people are asking, “What if, as a result of inattention and carelessness with our financial health, we are out of wiggle room, leaving us with few and politically polarizing options?” Ironically, our nation’s out-of-control debt crisis is precisely what our Founding Fathers warned us about 236 years ago.

Economic turbulence following World War II was buttressed by decades of robust GDP growth, savings, wealth, optimism, entrepreneurship, and job-creating momentum. These growth factors are what endowed policymakers with wiggle room, or flexibility. Voters and their elected officials had an array of policy choices regarding government spending, taxation, regulation, and monetary stimulation. Consequently, our rising standards of living built a safety net of financial reserves to cushion recessions, unexpected calamities, and personal or business errors, along with Washington’s policy blunders.

Our rapidly advancing economy set in motion higher earnings from greater employment, and generated larger consumption expectations among households at every income level. Today, this element of positive expectation has lapsed into profound apprehension, thereby removing many policy choices and considerably diminishing our level of flexibility for quickly enhancing prosperity.

Consider, for example, the lackluster results from Washington’s so-called “stimulus” and “bailout” programs, which have left unemployment rates at remarkably high levels. Campaign rhetoric featuring virulent class warfare and promises to enact mountains of new legislation to rectify the failed policies of the past have saddled American industry with unaffordable and often unintelligible regulations. From health care and banking to the coal industry and gas/oil pipelines, the traditional U.S. job-creation engine — including any plans for hiring, training, and upward mobility — has been compromised.

An exponential rise in fear for one’s economic survival has replaced America’s optimism and private sector risk-taking investment philosophy. Such a seismic change in outlook is accompanied by the growing dependence on government programs. Illustrating this highly atypical development are three facts:

— By mid-2011, 107 million Americans (out of 310 million total) received government welfare, excluding Medicare or Social Security, according to a U.S. Senate Budget Committee.

— From May through July 2012, more Americans applied for Social Security disability payments than for private sector jobs.

— Some 70 percent of federal budget spending is now redistributed as subsidies to individuals for housing, food, income, and student loan assistance.

An even darker side to this growing dependency mentality is reflected in the hundreds of billions of taxpayer dollars that are annually supporting a ballooning corporate welfare sector, comprised of industries from agriculture to so-called green and alternative energy firms.

Consequently, any wiggle room in policy formulation that once helped the nation reach bipartisan consensus on course corrections has given way to highly entrenched political warfare between an immense population that believes it requires and is entitled to benefits — paid for by those perceived as better off — and the rest of the population, which is becoming more desperate to maintain their living standards and defend their own children’s futures. Politicians at every level of government simply mirror this economic and social strife.

Economic Outlook: 2013 and Beyond

Crucial to the nation’s long-term prospects is the constituency’s ability to thoroughly understand that budget flexibility has virtually vanished. It is no longer a question of spending more or less. Rather, Uncle Sam must rationalize and reverse its spending. Washington is borrowing 42 cents of each dollar, and it cannot repay the full value of its bonds, balance budgets, or pay down the debt without further impairing the economy if policies resort to higher taxes and debilitating inflation.

Michigan’s economy is especially sensitive to such threats because robust auto sales depend on a minimum of 3 percent yearly growth in consumer discretionary income (i.e., after discounting inflation and taxes) and affordable auto loan rates, which cannot coexist with rising inflation as it relates to fuel costs, insurance, and vehicle maintenance. The starting point for 2013’s economic forecast is an updated determination of our real GDP growth potential. It is important to recognize that real, long-term growth of any economy equals the sum of two growth rates: workforce expansion, and the productivity gains of that workforce. By and large, the component of growth related to worker productivity depends on the nation’s long-term rate of savings.

Yes, that’s correct. If households and businesses save an average of 3 percent of income each year, the national growth potential will also approximate 3 percent over the long haul. That’s because savings are invested in ever-improving technology that places more effective tools and capital equipment in the hands of labor. For example, in a market economy, if people fail to save a minimum of 3 percent per year, and companies fail to profit and reinvest their profits in like fashion, then the writing is on the wall: Real GDP growth potential decelerates. Worse, in a nation that is spending more than it saves, growth potential converges on zero percent. This is not an opinion; it is self-evident.

Where does the United States stand today? How does our growth potential stack up with what it once was? Compared to the postwar period (66 years), when long-term real GDP growth rates for the U.S. averaged 3.3 percent, the trend rate now stands at 2.5 percent — and it is falling. Similar deceleration in national GDP growth potential has overtaken practically every other developed economy on earth, with the exception of Sweden and a few other nations that are rapidly lowering their tax burdens and transitioning from socialism to competitive market systems.

The reduction in U.S. growth potential is neither surprising nor unique. Across the globe, identical economic decelerations correlate with burgeoning government spending. Mounting public debt, costly — and often counterproductive — regulations, and a proliferation of unaffordable public-union contracts now afflict the entire European Union and Japan.

Stagnant purchasing power, lower living standards, and rising levels of unemployment (counting labor-force dropouts) — along with increasingly stressed and bankrupt state and local governments, and flagging consumer confidence levels — are inevitable outcomes when competitive markets are overwhelmed by government-directed decision-making on the seminal economic questions of what, how, and for whom workers and investors produce and save.

What’s more, individual and corporate welfare programs have drained treasuries and favored special interests and powerful, well-heeled constituents who grease the political campaigns of incumbent officeholders with money and votes. It is rapidly becoming a game of “capture the flag.”

What Michigan Business Leaders Forsee // Click Here

Economic Implications

Our national predicament can no longer tolerate an extension of current trends. The threat America confronts today is financial annihilation. State economies, like that of Michigan, have nowhere to hide to avoid consequences in the event of a secondary nationwide downturn. In Michigan’s case, a loss of population, especially in the 25-to-34 age bracket, along with erosion in market share of auto sales for Detroit’s vehicle manufacturers, means that the state’s hope for economic salvation is totally reliant on a sustained U.S. real GDP resurgence over the balance of the decade. No other state could be as permanently damaged by a recurrence of virulent inflation or loss of global trust in the U.S. dollar as Michigan.

In short, as radical as it might sound, the stark reality boils down to this: Simply reducing the growth rate of our national debt, or simply slowing the pace of annual budget deficits, or even halting the spread of unaffordable public sector compensation packages, won’t cut it any longer. Such approaches to problem-solving today are far too timid to avert a disastrous tomorrow.

For instance, federal employee pay and fringe benefits now average 21 percent and 72 percent, respectively, above the private sector average. Such remarkable economic distortions recall Alexander Hamilton’s admonition from 230 years ago, “There is a tipping point” after which these trends must be reversed, and not simply slowed or stopped.

Here’s an up-to-date example of what Hamilton meant. Treasury debt already exceeds 100 percent of the size of the U.S. GDP. What if the level of interest rates surges from today’s artificially low levels? In fact, it is inevitable.

Interest rates will rise in order to reflect the true risk of holding government bonds, and to incorporate the actual and likely inflation rates that investors need to consider before they willingly invest in 10-year or 30-year Treasuries. If interest rates were to double or triple from today’s rates, our federal budget would need to allocate at least one-quarter of its entire annual revenue just to service interest payments on its debt — leaving nothing to repay debt principal or unfunded, or contingent, liabilities, such as the escalation of outstanding student debt.

As things stand, the U.S. Treasury services only the interest on outstanding debt at an annual cost of some $300 billion. The Federal Reserve has told the world it intends to maintain interest rates at current levels for another two years. But contrived interest rates, rather than market-determined rates, cannot last much longer.

When bondholders recognize that inflation will cause their investments to rapidly lose value in the future, the money charade becomes apparent and the game is over. If history were any guide, it would be normal to witness a sudden doubling or even tripling of interest rates from current levels by the beginning of 2015. Such an escalation could hike the Treasury’s debt-servicing costs to nearly $1 trillion annually, thus absorbing nearly one-third of the federal budget and rendering futile any exercise aimed at budget-balancing. At that point, fiscal prudence becomes “A Bridge Too Far.”

Neither is the U.S. Treasury’s fiscal impasse helped by the Federal Reserve’s policies of monetary stimulation. The Central Bank continues to inject inflationary money reserves into the financial system in order to push interest rates lower — even below the current inflation rate (causing many retirees and other fixed-income bondholders to experience negative returns on their investments). By pumping excess liquidity into the financial arena, the Fed is only temporarily assuring the Treasury Department that U.S. borrowing costs are a bit more manageable.

The trade-off will prove painful, indeed. Monetary authorities, in less than three years, have already engaged in three rounds of massive “quantitative easing,” meaning a near tripling of U.S. monetary reserves. This degree of sustained liquidity stimulation carries ominous potential for doubling the U.S. price level in less than three years.

Moreover, the policy is highly suspect in economic terms, particularly because it has been timed — along with Fed Chairman Ben Bernanke’s unleashing of a third round of quantitative easing — right before a pivotal national election. To safeguard the integrity of the dollar and the domestic price level, monetary easing must be reversed at the first signs of a general economic upturn. That is, a symmetrical policy of “quantitative tightening” should be implemented if the economy accelerates in 2013 and beyond.

The Future is Still Salvageable

Fortunately, if responsible policies are enacted immediately over the next 24 months, the U.S. economy will respond with an exuberance rarely witnessed in our history. Recall that U.S. real GDP growth rates averaged 5 percent to 7 percent for many quarters following President Ronald Reagan’s four initiatives:  Reducing federal spending, lowering tax rates, removing counterproductive regulations, and reversing monetary stimulation.

Installing equivalent crisis management initiatives today would likely catapult noninflationary GDP growth even faster than in the Reagan years, due to pent-up demand and a pervasive restoration of confidence. Expansion rates of 7 percent to 8 percent would help refill badly depleted state, local, and federal coffers. National growth of that magnitude would enable states like Michigan to fund today’s unaffordable state and local pension obligations and health care costs.

Furthermore, Michigan, in the advent of U.S. economic acceleration, is positioned to reclaim its “Top 10” position in state rankings of business-friendly climates. For decades, Michigan’s status as a place to locate or expand a business has eroded. Yet in 2011, many indicators favorable to startups and expansion began to show signs of life for Michigan. Lawmakers in Lansing have been working to reduce licensing and regulatory burdens, and have removed a crushing business tax regimen installed by the previous governor.

How serious is this latest effort to effect durable growth? Lansing, working with Business Leaders for Michigan (BLM), a private, nonprofit roundtable of the state’s top corporate and university leaders, and data consultants from the global management consulting firm McKinsey & Co., has designed an economic development plan to thrust Michigan into the “Top 10” states for economic performance and business climate.

One gauge of the apolitical integrity of the initiative is its insistence on specifying benchmarks by which citizens can judge progress. Most importantly, BLM estimates what is required to reach “Top 10” status, in both Michigan’s per capita income between 2010 and 2020 (an increase of $15,275) and gains in private sector employment (213,735 more jobs). Three impressive things about the 2012 Michigan Turnaround Plan are the transparency, the use of per capita income (the most meaningful measure of material well-being of a population), and the use of “private sector” job growth as a measure for expanding the tax base and building fiscal capacity to transcend future turbulence.

This optimism is predicated on returning to a competitive market system with an emphasis on growing the private sector and shrinking the size of the public sector. Nonetheless, it would be foolhardy to ignore near-term institutional impediments to progress. After all, no serious reform policy agenda will be forthcoming nationally until February 2013. Why? History is unequivocal: The pre-November political gridlock and polarization that characterize presidential-year campaigns are invariably followed by lame duck sessions until after the inauguration in late January. Then, a newly constituted Senate and House will struggle to devise fresh strategies. As a result, valuable time is lost in confronting fiscal, monetary, and regulatory problems.

Reliable leading economic indicators are signaling the continuation of very subpar real growth (1.75 percent) in calendar year 2013, accompanied by 2 percent inflation and stable interest rates. Any tax increases, regardless of targeted group(s), will markedly slow the economy.

If tax rates rise in combination with further escalation of food and energy prices, then the U.S. economy and stock market will revisit the severe recession environment of 2007-2009. Simply stated, rampant loss of purchasing power would throttle both the sensitive auto and housing markets. Consumer and business confidence would be marginalized to the extent that neither fiscal nor monetary policy stimulation could stitch a recovery together before 2014. db

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