The Democratic Party War

While attention focuses on the battle in Wisconsin between a Republican Governor and public employee unions who overwhelmingly support Democrats, it is in California where the future role of public sector unions in politics is being most severely tested. Because in California, Democrats exercise nearly absolute control over the state’s political agenda, and as a result, Democrats are forced to confront the unsustainable and counterproductive public sector union agenda all by themselves.

An interesting article in the March 2011 issue of Reason Magazine by Tim Cavanaugh, entitled “Farewell, My Lovely – How public pensions killed progressive California,” opens with a statement that clearly expresses the political reality in California today, “In November, bucking the national trend, Democrats in California won not just the governorship but 51 Assembly seats to Republicans’ 29, 24 state Senate seats to Republicans’ 14, and every statewide office. With the passage of a referendum lowering the number of legislative votes required to approve a state budget (from a two-thirds majority to a simple majority), California is that rarest of land masses for the 2011 Democratic Party: conquered territory.”

Cavanaugh goes on to describe the slow realization by California’s Democratic lawmakers that their visions for California’s future “are being derailed by a labor movement nobody can harness.” Referring to California’s unsustainable pension benefits package granted unionized state and local government employees, Cavanaugh observes “…the most aggressive lobbying for pension reform is coming not from fiscal conservatives but from progressives, who see the logarithmic cascade of pension liability as a threat to public parks, environmental programs, and rail transit.”

The looming schism between progressive Democrats and union Democrats in California affects all government programs, but the insolvency of public employee pension benefits and the failing system of public education are two of the most visible. In San Francisco, Supervisor Jeff Adachi, a Democrat, sponsored a pension reform bill in November 2010 that would have imposed very modest increases to pension contributions by city workers. He was bitterly opposed by public employee unions, and the measure was defeated. Quoting from Cavanaugh’s article, here are some of the people who backed Adachi on the bill:

“Adachi’s allies on Prop. B included Willie Brown, a Democrat who was mayor of San Francisco from 1996 to 2004 and speaker of the California State Assembly from 1981 to 1995, and the Green Party’s Matt Gonzalez, former president of the San Francisco Board of Supervisors and Ralph Nader’s 2008 vice presidential candidate.”

As noted in SF Weekly on Feb. 16th, “Jeff Adachi Already Crafting ‘New Prop. B’,” Adachi is going to try again. And this time the spotlight will shine even brighter on a phenomenon that has started in California and will sweep across the blue states of America – Democrats vs. Democrats fighting for the agenda of their party.

Turning to California’s troubled system of public education, a Sacramento Bee story published today entitled “Democratic schism opens on fixing schools,” by Laurel Rosenhall offers an impressive list of Democrats who have decided a primary obstacle to improving public education is the teacher’s union. Here are excerpts from Rosenhall’s report:

“Gloria Romero, the former [Democratic] state senator from Los Angeles who lost her bid this year to become the state superintendent of schools, is heading the new California chapter of Democrats for Education Reform, a PAC that operates in 10 states… ‘It’s a donkey in the room,’ Romero said. ‘It’s Democrats who have been tightly aligned with education’s special interests year after year, decade after decade, and we haven’t progressed. So we have to examine our conscience, our party, and really forge a new path forward.’ ”

“In a speech earlier this month, Los Angeles Mayor Antonio Villaraigosa, a Democrat who got his start as a union organizer, blasted the L.A. teachers union for blocking changes in the schools.”

“Michelle Rhee, the former Washington, D.C., [Democratic] schools chancellor who fought the teachers union there over tenure and merit pay, is launching a national advocacy group to back politicians who can’t get union support because of their views on education.”

” ‘It’s a people’s movement, in a way, from groups like NAACP saying ‘enough is enough,’ ‘ said Alice Huffman, president of the California NAACP, which supported Romero’s bills. Taking a position against the unions was a switch for Huffman, a Democratic Party activist who worked for the CTA for 12 years and describes herself as a strong believer in labor rights. ‘I’m not trying to destroy the union,’ Huffman said. ‘But sometimes you have to make a choice in life and right now, the education of our young people is more important than protecting the union.’ ”

There are two types of Democrats – union democrats, who want to retain over-market pay and inefficient practices for their powerful union constituencies, and government services Democrats, who want infrastructure projects and social programs. In California, where these Democrats wield monopoly control over the political process, the hard reality is that they will have to choose between the union agenda vs. the government services agenda. This hard reality will expose the agenda of the unions more explicitly than events in Wisconsin ever will, because in California there is no Republican opposition to scapegoat in order to hide the true issues of solvency and sustainability.

In California, Democrats of conscience, loyal to their ideal of government as an investor in infrastructure and provider of services, are rejecting major elements of the union agenda, and as a party, they will have to weather the ensuing turmoil and impoverishment. This will force realistic assessments of what is politically and financially feasible by Democrats, transforming their party. This process has already begun in the Golden State.

Unions and America’s Ills

On February 9th, 2011, the Detroit News, as part of its “Labor Voices” series, published a guest editorial by the President of the International Brotherhood of Teamsters, James Hoffa, entitled “American ills not caused by unions.” In this editorial Hoffa made many statements that require a rebuttal, starting with this: “Across the country, new governors and new legislatures are demanding cuts to jobs, pensions and concessions from public employee unions. Their demands are nothing more than payback for the billions of dollars that the ultra-rich have poured into political campaigns.”

What Hoffa ignores is the political fundraising reality in America, which is that corporations are split relatively evenly between those who will back union reformers – usually Republicans, and union protectors – usually Democrats. Corporations hedge their bets. Very few large corporations openly challenge the union agenda, or even have reason to, since unionization drives off emerging competitors.

Similarly, wealthy individuals are split relatively evenly in their political affiliations in America. For every billionaire who backs Republicans, there is a billionaire who backs Democrats – for every Koch, there is a Soros.

At the grassroots, however, something very different occurs. Because labor unions, which still command over 16 million members in the United States (ref. U.S. Census, Bureau of Labor Statistics), nearly always give money to union-friendly Democratic candidates and issues. If you estimate the average annual dues of a union member at $500 per year, this means unions in America have over $8.0 billion per year that they can spend any way they please. There is simply no source of grassroots political fundraising that comes anywhere close to the financial power of unions, and unlike every other grassroots political fundraising entity in America, unions compel their members to pay union fees, which in effect means they compel their members to support their political activity. In the analysis, Public Sector Unions and Political Spending, it is estimated that public sector unions in California spend over $250 million per year on political activity. The idea that any competing interest comes even close to that is absurd.

Hoffa goes on to suggest that “government employees did not blow a hole in any state budget…” He points out as an example that “the typical public employee’s pension is only $19,000 per year.” This is all simply inaccurate. Using California as an example, here is the true figure for pensions as reported by Daniel Borenstein in his February 5th column in the Contra Costa Times entitled “Public employee pensions much higher than advertised:”

“In fact, CalPERS data shows the average career public employee, who put in at least 30 years of service and retired in the 2008-09 fiscal year, collected a starting pension of $67,000 a year, or 2.5 times the advertised figure. The higher number is buried deep in the retirement system’s financial statement and never makes it to the promotional material CalPERS hands out.”

As for compensation, as estimated in the post “How Much of California’s Budget is Personnel Costs?” the average total compensation for a worker employed by the state of California is $106,000 per year, before increasing their pension contribution to reflect the higher contributions necessary to keep those funds solvent under the current benefit formulas. At least two-thirds of California’s state budget is to cover personnel costs.

In his editorial, Hoffa apparently believes the real culprit in America’s current ills is Wall Street. Well there certainly is blame to go around, and Wall Street shouldn’t be spared. As Hoffa puts it:

“Public employees didn’t create a huge housing bubble. Wall Street did that. And public employees didn’t cause the Great Recession through reckless speculation. Wall Street did that, too. State governments didn’t get $3 trillion dollars in loans from the Federal Reserve and profit from those loans by relending them. Again, that was Wall Street.”

Taking Hoffa’s three points about Wall Street one at a time: (1) Failure to regulate mortgage lending was indeed the primary reason for the housing bubble – but public agencies, thirsting for the income tax and property tax revenue, had no incentive to pull the plug, and they didn’t. They did, however, use the unsustainable increase in tax revenues as their pretext for unprecedented, ridiculous increases in their public employee compensation packages. (2) As for “reckless speculation,” who does Mr. Hoffa think provides the backbone of funding to Wall Street for their gambling escapades? There is no source of new money pouring into Wall Street that begins to match the monies coming from public employee pension funds. These funds, which in aggregate manage trillions in assets, are under severe and unrelenting pressure to deliver higher returns than are possible over the long-term. “Reckless speculation” is largely driven by Wall Street’s incestuous, unhealthy partnership with public sector unions. (3) And as for those “trillions in loans from the federal reserve,” most of that borrowed money went to preserve public sector jobs at their inflated rates of compensation.

Here’s what’s really happening, Mr. Hoffa:  For over 20 years, with increasing influence and with worsening effect, public employee unions have used taxpayer’s money, confiscated from public worker paychecks, to buy our politicians and control our elections. They have used this power to “negotiate” grossly over-market rates of compensation and benefits to unionized government workers, especially at the entry and mid-level jobs, and because employee compensation is by far the largest category of government expenditures, it is breaking budgets, leading to tax increases and service cuts. Meanwhile, public employee unions, in their insatiable demand both for more revenues to pay their over-paid members, as well as to expand their memberships, are prevailing upon politicians to expand government and expand regulations – increasing the cost of living for everyone. This translates into cost-of-living increases for the unionized government workers, and a lower standard of living for the rest of us whose taxes support the entire corrupt mess. At the same time, Mr. Hoffa, your public sector union pension funds are the collection agent for the overbuilt Wall Street machine you claim to abhor.

American ills today may not be entirely attributable to unions, but to suggest that the drive to reform unions, public sector unions in particular, is nothing but “payback” to special interests who oppose unions is to ignore where the money is spent in politics, where the money is spent in the public sector, and how union control of public policy is distorting our financial markets and bankrupting our government.

California’s State AND Local Government Personnel Costs

Last week CIV FI posted an analysis, “How Much of California’s Budget is Personnel Costs?” that estimated about two-thirds of California’s state budget covers state employee compensation expenses. This was in response to a widely quoted estimate that the number was only about 12%. Due to the huge disparity in these claims, and the implications having the correct number may have on the debate over public employee compensation, I decided to dig a little deeper.

For expert information, I talked with two individuals at the California Office of Legislative Analyst, Jason Sisney, the Director of State Finance, and Nick Schroeder, Public Employment and Fiscal Oversight. Both of them confirmed that state government employees compensation consumes about 12% of the state general fund budget. But the devil is in the details.

Probably the best source for information on state expenditures in California is available at “California Budget Information,” produced by the state Dept. of Finance. Using this data, and corroborating this data with other sources, this post will produce another, more in-depth estimate of what percentage of the state budget is consumed by personnel expense, as well as what percentage of state and local budgets combined are consumed by personnel expenses. Both Sisney and Schroeder, who ought to know, stated that arriving at a meaningful figure is “nearly impossible,” but they agreed with the rough percentages that will be arrived at in this analysis.

Beginning with how much state employees make in average salary; sources of information include the following:

State Finance Department: Personnel Years and Salary Cost Estimates, 2009-2010, which shows 345,777 full-time state employees in that year, collectively paid $23,104,763,000 in that year, which averages $66,820 each. This does not include benefits.

U.S. Census Bureau: California State Government Employment Data, March 2008, which shows 338,725 full-time employees who were collectively paid in that month $2,002,723,495, which averages $70,950 per year each, not including benefits. This page includes important additional information, the “full-time equivalent” number of part-time employees, 48,212, collectively making an additional $2,798,685,61, which averages $58,050 each. Using this data, the composite average of full-time plus full-time equivalent employees working directly for the state of California is $68,102 per year for 393,989 employees, which costs $26.8 billion per year. What about benefits?

To reprise the data presented in our last post, the overhead rate we used came from a 2010 study entitled “The Truth about Public Employees in California: They are Neither Overpaid nor Overcompensated,” from the Institute for Research on Labor and Employment at the University of California, Berkeley. In this study, the authors found “Public employers underwrite 35.7% of employee compensation in benefits.” If 35.7% of compensation is in the form of benefits, this means 64.3% of compensation is in the form of wages. To develop an overhead rate, you would determine what percentage 35.7 is of 64.3, i.e., the value of state employee benefits is equal to 55.5% of their compensation. This means total state worker compensation is $26.8 billion plus 55.5% of that number ($14.9 billion), which equals $41.7 billion.

What percentage of the total state budget does this represent? Here the numbers become even more subjective, because the state budget includes vast categories of “pass throughs” which are monies not used by the state, but passed on to local governments and agencies. A breakdown of the major categories of state revenues can be found at the Dept. of Finance’s “Chart B, Historical Data, Budget Expenditures,” where for the 2009-2010 year they report total revenue of $206.1 billion, breaking down into $87.2 billion into the General Fund, $23.5 billion into “Special Funds,” $6.3 in Bond Funds, and 89.1 of Federal Funds.

When speaking with Jason Sisney at the California Dept. of Finance, he claimed that virtually 100% of the Bond Funds and Federal Funds were pass-throughs to local governments and agencies, and that about 70% of the General Fund are passed through to local governments and agencies. This leaves between 30% of the General Fund and 100% of the Special Funds to pay for state employees, i.e., $49.7 billion. Using these numbers, state employee compensation consumes 84% of the state revenues that are retained by the state and not passed through to local governments.

To remain fair, the amount that employee overhead truly costs the state is debatable. One may argue it is overstated here, since it is applied to full-time equivalent figures for part-time employees. But typically part-time state employees accrue benefits at the rate they work; if they work 50% of the time, for example, their pension benefits accrue at half the rate they might accrue if they were working full time. One may also argue the Berkeley study was estimating an overhead rate of 37.5%, not that benefits consume 37.5% of compensation – which is what they said. But even if that is the case, realistic reductions to the estimated long-term returns on pension funds will pump that overhead rate right back up from 37.5% to 55.5%. More detailed analysis of overhead rates for California’s state and local employees can be found in the post “Calculating Public Employee Benefit Overhead.”

While this analysis attempts to estimate the percent of state spending consumed by employee compensation, the discussion would not be complete without at least considering what costs the state imposes on taxpayers by virtue of better-than-market benefits that are so-called soft costs. For example, if the state did away with the “9/80″ program, a benefit that is, after all, unheard of by the ordinary private sector worker, how many fewer bureaucrats (40% of the state workforce) could they hire? The 9/80 program essentially provides state bureaucrats with an extra 26 days off per year, which means if all of them got this benefit and it were eliminated, the state could eliminate 10% of their bureaucrats, or 4% of the entire state workforce. This is just one example of hidden costs of staggering magnitude.

Since such a high percentage of state revenues are passed directly through to the local governments and agencies in California, what percentage of their spending is to compensate local government employees? This is a very difficult question to answer, since there are over 400 incorporated cities, 58 counties, and countless administrative districts for, for example, K-12 schools and public utilities. But let’s try:

The average local government worker, using the Census Bureau as the source; Public Employment Data 2008, Local Governments, indicates 1,451,619 (full time equivalent) local government workers made on average $64,285 per year, which totals $93.3 billion. Add 55.5% benefits overhead to that amount and you have a total of $145.1 billion in local government employee compensation per year in California. How much did local governments spend?

For this data it is again necessary to rely on census data, referencing compilations put together by analyst Chris Cantrill on the website USGovernmentSpending.com. His chart (click the tab “Local”), Local Government Spending California, 2009 estimate, shows local government spending totaling $270 billion. This suggests that spending for employees in local governments in California, on average, consumes about 54% of the total local government budgets.

With respect to local government, however, a collective figure can be quite misleading. At the county level where social services agencies issue direct payments to needy citizens, or in the case of public utilities and construction projects where there is substantial allocations for capital investments, the percentage of funds allocated to employee compensation may be relatively minute. In smaller incorporated cities, on the other hand, the percentage of funds used for employee compensation may be 90% or more.

Readers are invited to review these calculations and the underlying assumptions. But given California’s state and local governments combined spend nearly $200 billion per year to compensate state and local workers, a discussion of whether or not their compensation might be reduced to market rates is not only relevant from the standpoint of fairness, but may also be a meaningful option towards reducing budget deficits.

How Much of California’s Budget is Personnel Costs?

An influential blogger in Orange County, California, made the following claim on January 25, 2011 in a post “Busting The Myths About Public Employee Pension Costs,” “For California’s budget, salaries represent 7.5 percent of the total state budget. The costs for healthcare and pension benefits are another 3.7 percent.” If only this were true.

Because this claim is being repeated as if it were fact, such as by guest columnist Nick Berardino in the Orange County Register, who on February 4th, 2011 in a “Reader Rebuttal” accused that newspaper of having “continued its misleading and irresponsible assault on public employees,” it is important to take a closer look. Using core data, as well as some studies funded by union-friendly think-tanks (hopefully to avoid accusations of bias), here are some numbers:

As a baseline, the California Governor’s Budget Summary for fiscal 2011 shows projected revenues and expenditures balanced at $89.6 billion. Using straightforward multiplication, if salaries and benefits only consume slightly more than 10% of California’s state budget, this means salaries, healthcare and pensions should cost (.075 + .037) x $89.6 = $10.4 billion. So how much does California’s state government actually spend on total employee compensation?

According to California’s own state government payroll records, in March of 2008 there were 393,989 full-time workers employed by the state of California, and their payroll for that month was $2,235,947,296 (ref. http://www2.census.gov/govs/apes/08stca.txt). This equates to an average of $5,675 per employee per month, or $68,102 per year. So by using data that is nearly three years old and assumes zero increases to compensation since then, in aggregate, just payment of salaries to workers employed directly by the state of California totals $26.8 billion per year.

In percentage terms, this figure would suggest that just wages for California’s state workers consume $26.8 / $89.6 = 30% per year. But there’s much more – benefits. If you read the definitions section of the U.S. Census Bureau Data, “gross payroll” is defined as “all salaries, wages, fees, commissions, and overtime paid to employees before withholding for taxes, insurance, etc. It also includes incentive payments that are paid at regular pay intervals. It excludes employer share of fringe benefits like retirement, Social Security, health and life insurance, lump sum payments, and so forth.” How much do benefits cost the state?

To short-circuit a war of battling studies, let’s use a supposedly authoritative study recently produced by the U.C. Berkeley Center on Wage and Employment Dynamics, Institute for Research on Labor and Employment, entitled “The Truth about Public Employees in California: They are Neither Overpaid nor Overcompensated” where they calculate an average overhead cost for California’s state and local workers at 36% of total compensation. That is, they claim 36% of total compensation is benefits overhead, and 64% is actual pay. 36% of total compensation equates to a 56% overhead rate, i.e., [ 1 / (1 – .36) ] = .56. The Berkeley researchers, who did a very comprehensive study, had no motivation to overstate the benefits overhead paid to public employees. It is likely the actual overhead is probably much higher than 56%, because it is unlikely the Berkeley researchers included an amount any higher than the current official rates for the necessary pension fund contribution, because the conventional wisdom still adheres to higher rates of investment fund returns than are probably out there over the next 20-30 years. But when you apply a 56% overhead rate – which is probably on the low side – to an average base salary of $68,102, you arrive at a total compensation estimate for the average state government worker in California of $106,239 per year.

What this means is the total direct employee costs for California’s state government is not $26.8 billion per year, based on salary alone, but 393,989 x $106,239 = $41.9 billion per year, which is 47% of the total state budget. And yes, there’s more:

If you take a look at the data from the U.S. Census bureau, referenced earlier, you can see the many job descriptions where salary expenditures are tabulated do not include K-12 education employees. This is because the state doesn’t pay these employees directly, but helps fund them through transfer payments to the local school districts. Returning to the California Governor’s Budget Summary for fiscal 2011, page 11, $36.2 billion is proposed for K-12 education expenditures. The skeptical reader is invited to study the details of this line item, but barring such analysis, it is a reasonable assumption that half of that money is going to be spent on compensation for K-12 education employees – another $18.1 billion.

When you add this all up, personnel costs for California’s state government are not somewhere barely above 10% of their total expenditures, as Prevatt asserts, but, doing the math, $41.9 (direct employees) + $18.1 (K-12 employees) = $59.96 / $89.6 = 67%. That is, using data taken directly from the state’s payroll records, combined with overhead calculations courtesy of an exhaustive study commissioned by an (arguably) sympathetic academic institute, along with very reasonable assumptions regarding transfer payments – not even considering transfer payments to localities for line items other than K-12 education – taxpayers are seeing at least 2/3rds of California’s state budget used to pay employee compensation.

Aside from overheated rhetoric and cherry-picked statistics, have those who still claim that public sector compensation isn’t a legitimate issue for civil discourse actually tried to run the numbers themselves? A final thought: When public entities are required to contribute into funds for retirement pensions and retirement health care at more realistic, lower rates of investment returns, the percentage of public sector budgets that are consumed by employee compensation will go up by 10-20% overnight. However comforting it may be for critics of these numbers to assert otherwise, it is hard reality, not wishful thinking, nor anti-public employee sentiment, that informs whatever bias may seep through this analysis.

Can Developing Nations Avoid Catastrophe?

Advocates for free markets and free enterprise will assert that if political preconditions can be established to nurture these freedoms, prosperity and liberty will increase, and population growth rates will voluntarily decrease in favor of education and career aspirations. The so-called developed nations nearly all have embraced the fundamental principals of free markets and free enterprise and now confront new challenges – how to provide for aging populations, what environmental goals to prioritize, what investments to make in emerging technologies, and how to manage their floating currencies, freewheeling commodities markets, and burgeoning debt. It is important for members of the developed world to understand what a luxury it is to have such challenges.

Using Egypt as an example, this post will present data on their population trends and agricultural production, comparing that to how much of their household income is spent on food, global food prices, and their balance of trade. These hard numbers will underscore how daunting the task may be for many developing nations to emerge economically.

While everywhere in the world the rate of population increase is slowing, in nations like Egypt the projected slowdown in population growth lags well behind the rest of the world. Projections that place the global population maximum occurring sometime between 2030 and 2050, at a total of somewhere between 8.0 and 10.0 billion people, generally view large developing nations such as Egypt, Pakistan, India, Indonesia and Nigeria as the wild cards. How quickly they develop economically is considered the key to how soon their populations level off. Here is the current projections for Egypt from the U.S. Census Bureau International Data Base:

As the above chart indicates, Egypt’s population is projected to double between 1995 and 2025, a period of only 30 years. Currently there are 82 million people living in Egypt, and according to the best data we’ve got, their population increases at a rate of 2.0 million people per year. So how much food does Egypt produce and consume? According to IndexMundi, whose mission is “to turn raw data from all over the world into useful information for a global audience,” using data provided by the U.S. Dept. of Agriculture, in 2005 Egypt produced 5,860,000 metric tons of corn and consumed 10,300,000 metric tons of corn. Similarly, in 2005 Egypt produced 4,130,000 MT of rice and consumed 3,300,000 MT of rice, and they produced 8,184,000 MT of wheat and consumed 14,800,000 MT of wheat. (ref. IndexMundi/Egypt/Agriculture).

If you review the complete list of major agricultural commodities the Egyptians rely on for nourishment, you will see that corn, rice and wheat are by far the most significant. In 2005 Egypt imported 10,226,000 metric tons of critical grains, and in 2011 there are an additional 10 million more people living in Egypt. Have they expanded their agricultural production? How? Where? Egypt in 2005 was only producing 64% of its critical grains domestically, and it is unlikely that percentage has improved. So how does Egypt pay for this food?

According to Economy Watch’s “Egypt Trade, Exports and Imports” data compilation, “Egypt’s trade is characterized by huge trade deficits. The economy is highly dependent on oil exports. Since the 1990s, the government has pioneered several economic reforms through foreign donor aid. However, measurable benefits of these economic reforms are yet to be seen.” They go on to state that in 2009 Egypt’s exports were $29 billion and their imports were $56 billion, and that “Egypt has had a negative balance of trade since the 1980s.” Put another way, Egypt had a trade deficit in 2009 of $27 billion, which equates to $329 per capita. If that doesn’t sound like a lot, remember Egypt’s per capita income in 2009 was only about $5,700, and Egypt has been borrowing money every year for over 30 years. A rough calculation based on those variables would suggest that Egypt’s accumulated trade deficit over the past generation now totals more than twice the total annual income of the average Egyptian. Will investments make up the difference forever? And is foreign investment, hence foreign ownership, a desirable outcome for the Egyptian people?

What about food prices? Clearly if Egyptians import nearly 40% of their food, a change in global food prices is going to impact them severely, especially since they have low per capita incomes. The next chart, using data from the International Monetary Fund, shows what percentage of household income is spent on food in each nation in the world:

As the above chart indicates, in 2007, the average Egyptian was spending over 50% of their entire earnings just to buy food. This is unthinkable in nations like the United States, where only about 10% of the average income is used to pay for food. If the price of food doubles in the United States, the average household buys 10% less of something else. If the price of food doubles in Egypt, the average household spends 100% of their money on food. From the USDA, compiled by IndexMundi, here are price trends for corn, rice, and wheat for the last six months:

Summarizing these tables, in the last six months the global price for corn has increased from $166 to $253 per MT, rice has increased in price from $471 to $533 per MT, and wheat has increased in price from $197 to $308 per MT. Put another way, if all Egyptians ate were corn, rice and wheat, instead of spending 50% of the average household income on food, they would spend 100% of the average household income on food.

A deeper analysis of the Egyptian economy will undoubtedly uncover examples of resilience that ensure the apocalyptic scenarios that crude extrapolations may conjure are unlikely. Human adaptability even in repressive environments cannot be underestimated. But as more and more nations develop highly competitive advanced economies, nations left behind like Egypt risk ending up in a position where there is nothing they can export that other nations can’t also export at equal or more competitive prices. These nations risk being unable to secure additional investment because everything of value has already been collateralized or purchased outright. A nation like Egypt, who currently imports twice as much as it exports and has had massive trade deficits for 30+ years, and only grows 60% of the food it needs, is pretty close to that wall.

Once such a nation can no longer import more than it exports, it is forced to find the resources internally to support its population’s basic needs. At that point, one can imagine the horrors of Biafra, Cambodia, or Uganda, visiting these larger states. To avoid such catastrophe, is the only hope for these nations to become permanent wards of the world, failed welfare states that survive only on the perpetual brink of mass starvation? The most challenging question facing the developed world is how to humanely steer developing nations into self-sufficiency, when aid itself can defer or corrupt the process. To state the obvious, there are no simple answers.

When is Debt Unsustainable?

Two economists who are inspirations to me are Steve Keen, who publishes Debtwatch, and Mike Shedlock, who publishes Global Economic Analysis. I found them while trying to make sense of the credit bubble, and finding little or nothing forthcoming from the mainstream economic community. But Keen and Shedlock provided insights when most experts were silent, and they still do. I remember the summer of 2005, driving up Highway 99 in California’s Central Valley, and seeing a billboard advertising “ranchettes” that were “starting in the low $600,000’s” – in the middle of nowhere – in a state with a median household income of $60,000! People were buying homes that cost ten times their annual earnings.

A scathing recent post from Keen, “How I Learnt to Stop Worrying and Love the Bank,” and Shedlock’s “World Economic Forum Embraces Fraud,” followed by Keen’s response to Shedlock on the same topic, “Mish Mashes the WEF,” all reinforce this sad suspicion: Mainstream economists who think we can avoid deleveraging are still strangely clueless, or worse, they are in collusion and have a hidden agenda.

In Shedlock’s post, he calls attention to the report recently released by the WEF entitled “More Credit with Fewer Crises – Responsibly Meeting the Worlds Greater Demand for Credit.” Here is an excerpt from the press release for the WEF study, “Credit levels will need to double over the next 10 years, growing by US$ 103 trillion, to support consensus-projected economic growth. This doubling of credit could be achieved without increasing the risk of major crisis…” and here is Shedlock’s response, “The accompanying PDF [the WEF report] entitled “More Credit with Fewer Crises” is 84 pages of economic claptrap. The main mission of the World Economic Forum appears to cram more credit down the throats of a world so stuffed with credit it cannot possibly be paid back.”

In Keen’s 2nd post on the WEF report, he highlights one of Shedlock’s many criticisms of the WEF’s assumptions, just one example of the astonishing vacuousness of this report. Here is an excerpt from the report where the WEF economists suggest that total debt can increase at a faster rate than GDP indefinitely:

“This means that the world’s stock of credit outpaced GDP growth by less than 2 percentage points a year – not a wide margin. In theory, there is nothing unsustainable about this picture: as long as credit grows broadly in line with economic growth, the credit is put to good use and borrowers can meet interest obligations and repay principal.”

And here is Keen’s response to this preposterous claim by the WEF:

“The American mathematician Andrew Bartlett claims that ‘The greatest shortcoming of the human race is our inability to understand the exponential function,’ to which I’d add that that shortcoming almost defines neoclassical economics. 2 percent per annum doesn’t sound like a lot, but over 36 years that means the ratio doubles, over 72 it quadruples, over 144 it becomes 8 times what it was, and so on. For the record, the actual rate of growth of the private US debt to GDP ratio was roughly 2.9% p.a. from 1945 till 2008. That means that the ratio doubled every 25 years, from 45% in 1945 to 90% in 1970, 180% in 1995, and if it had kept going, it would have been 360% in 2020.”

So when is debt unsustainable? In my recent post “National Debt and Rates of Return,” using crude estimates and assumptions, I attempted to calculate the total debt to asset ratio for the U.S. and other major nations. The total debt numbers for the U.S. are well documented; the other total debt numbers are informed guesses. Then, in an attempt to determine when debt becomes unsustainable, in column four I calculated “available credit” based on available credit being 50% of total assets, with (another crude assumption) total assets calculated as 10x GDP. Here is that chart again:

A reason to like this chart is because one may insert any set of assumptions they wish to estimate total assets as a multiple of GDP and total available credit as a percentage of total assets. Those numbers, while unknowable, are real. If debt expands faster than GDP for a prolonged period of time, even if the gap is only 2% per year, sooner or later collateral cannot support debt.

The next chart from that post also speaks to a concern I share with Keen and Shedlock, and perhaps even the WEF economists who dare not speak the word: Deflation. Because if total debt as a percentage of total assets grows because the rate of debt expansion continues to outstrip the rate of GDP growth, interest rates eventually have to rise to cover the increased risk. The less secure the collateral is, the higher the risk premium has to be.

This chart explains the paradox facing global bankers, and threatening the financial security of everyone in the global economy. If interest rates rise they will place an unbearable claim on global GDP, causing defaults. If interest rates stay low, debt/asset ratios will edge closer and closer to 1.0, worsening the eventual and inevitable process of deleveraging.

The question is does the ability of inflation to lower the real principal value of debt – which improves the debt/asset ratio – more than make up for the burden higher interest rates place on cash flows? The WEF is making this bet, perhaps because it is the only bet they have left.

Political Centrists & The Litmus Problem

A provocative column last week by Richard Cohen of the Washington Post, entitled “The GOP’s Litmus Problem,” makes the point that “GOP dogma” will “shrink the biggest of men.” As Cohen puts it, “they [successful Republicans] have to swear allegiance to a balanced budget, dangerously low taxes, cutting (trivial) waste, fraud and abuse from the budget, the sacredness of even microscopic life, the innocence of mankind in the cooking of the planet, the inviolability of the 18th century Constitution, meeting the challenges of globalism with even more localism, and a furious rejection of the lessons of Keynes – even when those lessons are successfully applied.”

Cohen goes on to say “it is simply impossible for a centrist to capture the Republican presidential nomination – maybe even to be a Republican. I challenge any of the above to wholeheartedly endorse evolution or global warming.” Cohen believes the Republican party “continues on a course that has already driven out the political moderates and pro-choicers that once comprised its intellectual and financial core…to call this a brain drain understates the calamity. It’s a political lobotomy.”

Notwithstanding some inconvenient facts; that John McCain was a centrist who captured the Republican Presidential nomination, or that Republicans, supposedly a dwindling party of ideological lemmings, recently took over the U.S. House of Representatives, captured 29 Governor’s mansions, and control both legislative houses in 26 states; how exactly does Cohen describe a centrist? Let’s examine Cohen’s “litmus test” for Democrats, based on the assumption they are the opposite of the “GOP dogma” that he claims bedevils the Republican party:

(1) Don’t worry about budget deficits or try to balance the budget:  Until when? Is Cohen suggesting we shouldn’t be alarmed at the fact that just our federal government budget deficit is over 10% of America’s GDP? Cohen may or may not believe America has a unique opportunity to simply print money, since America’s economy remains, by far, the largest and most diverse in the world (nearly 25% of global GDP), and America remains, by far, the world’s preeminent military power. But at what point do we squander that advantage? Would it not be centrist to simply want to revisit the path we’ve been on that has lead us to this point?

(2) Go ahead and increase taxes because they are “dangerously low”:  It is difficult to talk about tax rates without talking about spending – and tax revenues have been increasing faster than the rate of inflation or real economic growth for a long time. Cohen would probably dismiss the Laffer curve, which documents the reality that higher tax rates stifle investment and innovation, ultimately leading to lower tax revenue. He probably would also dismiss the related, and well documented, fact that higher tax rates also cause slower economic growth. But he goes even further than this, apparently, if he thinks discussions of tax increases can take place apart from genuine rethinking as to what constitutes the optimal size of government. Wouldn’t a centrist want to at least consider cutting spending before raising taxes?

(3) Don’t worry about the sanctity of microscopic life:  Here we go again. Centrists get torn apart by both sides here – who does Cohen think he’s kidding? Open up the yellow pages and take a look at the full page ads that say “Abortion through 26 weeks.” What’s Cohen’s position on this? Is he revolted? Does he think those “dangerously low taxes” should be used to fund this butchery? Because that’s what it is. A centrist can argue about whether or not a frozen embryo should be preserved forever. But anyone ought to agree that taxpayer’s dollars shouldn’t pay for late term abortions.

(4) Blame mankind for the “cooking of the planet”:  Here Cohen really gets onto thin ice (oops, bad choice of metaphors), since his column reeks with disdain for “religious” people. Because anyone who has been objectively following the scientific debate regarding the extent, the trajectory, and the cause of global warming, certainly has observed the fanatical religiosity of global warming alarmists. And their logic and solutions are farcical. How exactly do we intend to replace fossil fuel within 20-30 years when 80% of our global energy comes from fossil fuel, it’s cheap and abundant, and global energy demand is going to more than double within that time? If we continue to develop inexpensive fossil fuel (burning it clean), we can accelerate prosperity, which slows population growth, causing our achievement of a sustainable civilization to occur sooner. But no – if you say “slow down, let’s think this through, let’s not be quite so intent on destroying our energy economy” – then according to Cohen, you are no longer a political moderate. Ouch. In the old days the crazies who walked around with signs saying the world’s coming to an end were the nut cases. Now those of us who think the world’s not coming to an end are the crazy ones, according to Cohen.

(5) The inviolability of the 18th century constitution:  Cohen probably has a point if he is suggesting we don’t all need to start wearing tricorns and ceremoniously reciting the constitution. But so what? Is Cohen saying we should rush to undermine or “change” this magnificent culmination of the western enlightenment, the foundation of the the most tolerant and benevolent great power in the history of the world? Once again, a centrist – a moderate – would think twice before tampering with the U.S. Constitution, or diminishing its significance.

(6) Don’t try to meet the challenges of globalism with more localism:  I’m not sure what Cohen is getting at here. Republicans certainly don’t want to abandon investment in our military, which is the backbone of globalism. Nor am I sure when Republicans suddenly started carrying the torch for protectionism, which is the bane of globalization. Is Cohen referring to the conservative push to rein in some of Washington’s bureaucracies? Why not? Tell the farmer who now has to fill out mountains of paperwork at the end of a hard day in the fields, the small businessman who has to issue 1099’s to every person who ever sold them more than $600 worth of goods, the doctor who has to turn away patients who pay cash, or the teacher who has to teach a one-size-fits-all lesson concocted by bureaucrats 3,000 miles away. In this context, the litmus test for a centrist is to find a moderate mean between federal regulations and local control.

(7) Finally, heed the lessons of Keynes, which “Republicans ignore even when it works”:  Oh please. Keynesian economics has nothing to do with spinning the printing presses to bail out poorly regulated banks who were permitted to sucker nearly the entire American population into borrowing more than they could afford, then gambled these credit receivables on derivatives. Restoring the solvency of America’s banking system through massive deficit spending is not the same as applying the lessons of Keynes to restore economic growth. And among Keynesians, the debate should be this: Do we engage in deficit spending to continue to pay over-market compensation to unionized government workers, or do we take that money and invest it in actual projects that will yield economic dividends – cheaper energy, water, and transportation (another area where the “greens” are standing in the way of recovery, ref. “Reviving California’s Economy” for ideas Keynes would have approved of). Cohen, should he actually understand Keynes, may wish to explore the true debate – how do we use deficit spending to build infrastructure that will make basic services cost less. A centrist might also explore this question.

What Cohen ignores perhaps most gratuitously is that the “litmus problem” applies to both parties. Democrats and Republicans both rely on shibboleths and sacred tropes, emanating from their fringes, alienating the center. But if these seven points that Cohen suggests are crippling handicaps afflicting the Republicans are the best he can come up with, it is small wonder the Republican party is on the rise again.