Economies in Crisis: Domestic and Global Economies Are All Affected
Rauf Naqishbendi
December 26, 2008
There seems to be nothing on the economic radar these days but bad news. Pessimistic doses of both domestic and international economic news are a daily event. How these economic predicaments affect both federal and state governments and their potential ramifications on the life of the nation is the subject of this essay.
The federal government through the Department of the Treasury and the Federal Reserve Bank has allocated trillions of dollars to bail out troubled financial institutions resulting in government borrowing at an unprecedented rate. The government must borrow responsibly, meaning that it should borrow only what it can reasonably repay without detrimental consequences to society. The United States government has been flooding the marketplace with its paper bonds to finance its deficits for decades. Given the current economic difficulties, that trend will be inflated. Healthy economic growth allows reasonable borrowing because the government borrows today what it will repay in the future. When the economy grows at a steady pace, it can afford to repay the loans. But borrowing during this time of economic stagnation with future growth uncertain, only adds to the size of the debt, and is a formula for hardship. The degree of hardship is dependent on the amount of the debt. In this case the amount of the debt is one of mammoth proportions.
The federal deficit, by the time President-Elect Barack Obama is sworn in, will exceed $12 trillion. Given what is in the pipeline to subsidize troubled institutions the deficit soon will exceed $20trillions. Conservatively estimating interest at 3.5%, and government´s revenue at $2.5 trillion, the interest alone will be $750 billion or about 30% of government´s total revenue. That figure will keep growing and a balanced budget isn´t anticipated for a long time to come.
The federal government´s primary source of revenue is capital gains from real estate, the stock market, and payroll taxes. The stock market is struggling in a bear market; the real estate market is in a slump; and the size of the national payroll is in decline. All of this adds up to a dismal prospect for government revenues. This is a worst-case scenario whereby government´s spending far outweighs its income due to a decline in revenue and a muted economic growth. At that point government´s borrowing will constitute a huge drain of liquidity from the marketplace resulting in less money to invest. This may perpetuate a bear stock market for years to come. The biggest risk to the global market will be when government´s debt grows to such a perilous level that the rating agencies downgrade government bonds.
The state governments are also in trouble. State revenues are generated mainly from property taxes, payroll taxes, real estate and stock market capital gains, and sales taxes. Property taxes in most states had to be reassessed at a lower rate thus significantly reducing revenues from that sector. The size of the states' payroll taxes, due to high unemployment, decreased as well. The amount of taxes collected from both real estate and stock market capital gain will probably be minuscule if anything as they are both in the doldrums. Consumer spending is drastically declining, and that will negatively impact sales tax. More people will be forced to enroll in welfare programs. As people lose their jobs, they lose their health insurance, and many will be qualified for Medical. Overall, the states will have less revenue and higher expenditures resulting in a pattern of deficits and borrowing.
While states can borrow money, it is not as easy for them as it is for the federal government. States' credit worthiness can easily be downgraded by rating agencies. If that happens it will result in higher borrowing costs and, in severe cases, if it cannot borrow, the state may be forced into bankruptcy. If states must continue borrowing to meet their obligations, at a certain point state bonds will be decreased to junk bond status.
The economic meltdown began with the residential real estate crisis. This predicament crossed all sectors of the economy. As one sector falls into disrepair it easily feeds into other sectors of the ailing economy, making it worse overall. For instance, the decline in consumer spending is causing many businesses to close down. With the increase in vacant commercial real estate properties, the lending institutions will once again find themselves in crisis, perhaps not in the same degree as was felt with residential real estate, but bad enough to reverberate across broad financial institutions. Again it's bad news for both the federal and state governments.
Government keeps on pouring money into bailing out financial institutions without any observable benefit to the average citizen. It is all targeted at a quick fix rather than a real fix. A good fix will be a long term sustainable solution which requires sacrifices and hardship. No one is willing to suffer now if they can postpone it. That is exactly what government is doing, and it will not work. Unfortunately the average citizen seems to be the only one unable to postpone sacrifice and hardship.
The colossal government fund to bail out mismanaged corporations was implemented to avoid an economic catastrophe rather than enhancing the standard of living of average Americans. Ironically these self-avowed capitalists are proud of capitalizing their profit yet they are not ashamed of socializing their losses.
The federal government through the Department of the Treasury and the Federal Reserve Bank has allocated trillions of dollars to bail out troubled financial institutions resulting in government borrowing at an unprecedented rate. The government must borrow responsibly, meaning that it should borrow only what it can reasonably repay without detrimental consequences to society. The United States government has been flooding the marketplace with its paper bonds to finance its deficits for decades. Given the current economic difficulties, that trend will be inflated. Healthy economic growth allows reasonable borrowing because the government borrows today what it will repay in the future. When the economy grows at a steady pace, it can afford to repay the loans. But borrowing during this time of economic stagnation with future growth uncertain, only adds to the size of the debt, and is a formula for hardship. The degree of hardship is dependent on the amount of the debt. In this case the amount of the debt is one of mammoth proportions.
The federal deficit, by the time President-Elect Barack Obama is sworn in, will exceed $12 trillion. Given what is in the pipeline to subsidize troubled institutions the deficit soon will exceed $20trillions. Conservatively estimating interest at 3.5%, and government´s revenue at $2.5 trillion, the interest alone will be $750 billion or about 30% of government´s total revenue. That figure will keep growing and a balanced budget isn´t anticipated for a long time to come.
The federal government´s primary source of revenue is capital gains from real estate, the stock market, and payroll taxes. The stock market is struggling in a bear market; the real estate market is in a slump; and the size of the national payroll is in decline. All of this adds up to a dismal prospect for government revenues. This is a worst-case scenario whereby government´s spending far outweighs its income due to a decline in revenue and a muted economic growth. At that point government´s borrowing will constitute a huge drain of liquidity from the marketplace resulting in less money to invest. This may perpetuate a bear stock market for years to come. The biggest risk to the global market will be when government´s debt grows to such a perilous level that the rating agencies downgrade government bonds.
The state governments are also in trouble. State revenues are generated mainly from property taxes, payroll taxes, real estate and stock market capital gains, and sales taxes. Property taxes in most states had to be reassessed at a lower rate thus significantly reducing revenues from that sector. The size of the states' payroll taxes, due to high unemployment, decreased as well. The amount of taxes collected from both real estate and stock market capital gain will probably be minuscule if anything as they are both in the doldrums. Consumer spending is drastically declining, and that will negatively impact sales tax. More people will be forced to enroll in welfare programs. As people lose their jobs, they lose their health insurance, and many will be qualified for Medical. Overall, the states will have less revenue and higher expenditures resulting in a pattern of deficits and borrowing.
While states can borrow money, it is not as easy for them as it is for the federal government. States' credit worthiness can easily be downgraded by rating agencies. If that happens it will result in higher borrowing costs and, in severe cases, if it cannot borrow, the state may be forced into bankruptcy. If states must continue borrowing to meet their obligations, at a certain point state bonds will be decreased to junk bond status.
The economic meltdown began with the residential real estate crisis. This predicament crossed all sectors of the economy. As one sector falls into disrepair it easily feeds into other sectors of the ailing economy, making it worse overall. For instance, the decline in consumer spending is causing many businesses to close down. With the increase in vacant commercial real estate properties, the lending institutions will once again find themselves in crisis, perhaps not in the same degree as was felt with residential real estate, but bad enough to reverberate across broad financial institutions. Again it's bad news for both the federal and state governments.
Government keeps on pouring money into bailing out financial institutions without any observable benefit to the average citizen. It is all targeted at a quick fix rather than a real fix. A good fix will be a long term sustainable solution which requires sacrifices and hardship. No one is willing to suffer now if they can postpone it. That is exactly what government is doing, and it will not work. Unfortunately the average citizen seems to be the only one unable to postpone sacrifice and hardship.
The colossal government fund to bail out mismanaged corporations was implemented to avoid an economic catastrophe rather than enhancing the standard of living of average Americans. Ironically these self-avowed capitalists are proud of capitalizing their profit yet they are not ashamed of socializing their losses.