How Is GDP Financed?

It may seem strange to ask how GDP is financed.  GDP simply measures the total market value of final goods and services that an economy produces.  It is a way to measure national income, not a measure of assets on a national balance sheet. 

But the way GDP is paid for does matter.  If large quantities of borrowed money finance GDP, then GDP in future years may be less sustainable than GDP produced by organic growth (i.e., GDP derived from people and companies spending their earnings, rather than borrowings).  The pauper nations of the EU, mostly located on the southern rim, are good examples.  They borrowed heavily (or their banks borrowed heavily) to finance consumption.  For a while, their GDPs grew.  But debt, unfortunately, has to be repaid.  A nation's whose GDP is heavily dependent on borrowed money will eventually have to pay the piper.  If those payments are burdensome enough, the nation's GDP bubble will burst, and recession will follow.  That isn't hypothetical; look at Greece, Ireland, Cyprus and Spain.  Indeed, look at the EU as a whole, which is sinking into recession even as we blog.

In America, the picture ain't pretty.  Even though GDP is nominally growing, in the first quarter of this year at an annual rate of 2.5%, the question of sustainability looms.  The federal government is constraining its borrowing (partly because of sequestration and partly because of Social Security and income tax increases).  Thus, the federal budget wouldn't be a source of GDP growth. 

But the Federal Reserve's quantitative easing program is.  The Fed is pumping $85 billion a month into the economy through purchases of financial assets.  Over a full year, the QE program would pump $1 trillion into the economy.  That's equivalent to about 6% of America's $16 trillion GDP.  It wouldn't be accurate to say that $1 trillion spent on QE results in $1 trillion of GDP.  Much of the money printed by the Fed for QE is recycled back to the Federal Reserve System in the form of member bank deposits at Federal Reserve banks.  This process is a near wash (except that it gives the depositor-banks riskless profits).  But QE is boosting the economy.  Our stock market--bizarrely exuberant in the face of a tepid economy--needs its regular fix of QE to maintain and increase its high.  The real estate markets seem to be getting a boost from the Fed's purchases of mortgage-backed securities.  Increases in asset values such as these appear to be creating a wealth effect that boosts spending (mostly by the top 10%).  That is probably a primary source of GDP growth today. 

But QE is similar to borrowed money.  At some point, the Fed will start selling down its more than $3 trillion balance sheet.  This akin to debt repayment.  It will remove money from the economy.  When there is less money to spend, there may well be less economic growth.  The Fed is hoping that the economy will be organically growing briskly by the time it goes into QT (i.e., quantitative tightening).  But there's no way to know for sure that will be the case.  The Fed may have to shift to QT because of a rise in inflation, whether or not growth has revived.  Whatever the reason for QT, it will constrain growth.  In some circumstances, it could produce a recession. 

Like toothpaste and genies, QE on the loose isn't easily put back into the place where it came from.  There's no riskless way to execute QT.  It's possible that continuation of the Fed's QE program could stimulate the economy to resume vigorous growth.  But that's far from certain.  And every additional month of QE heightens the risks that our economy is becoming overleveraged.

Will the Affordable Care Act Lower Health Insurance Costs?

In 2014, two of the most important provisions  of the Affordable Care Act take effect.  These require health insurers to accept all applicants without regard to prior medical conditions, and to provide unlimited coverage.  Although some recent news stories indicate that health insurers are raising premiums in 2014 to compensate for these provisions, it's possible to foresee a time when these same provisions will constrain the growth of health insurance costs. 

These requirements--no exclusion for prior medical conditions and unlimited coverage--provide powerful incentives for insurers to manage health care rationally.  Currently, many health insurers endeavor to limit their exposure to the costliest patients (i.e., those with existing medical conditions and those needing very expensive care).  In other words, insurers attempt to avoid covering those most in need of coverage.  It's no surprise that the most common reason for individuals to file bankruptcy is unmanageable medical bills.  It is perhaps surprising that most of these individuals have some health insurance coverage--but not enough. 

By forbidding insurers to squeeze out those in the greatest need of coverage, the Affordable Care Act now steers insurers' attention toward managing care rationally and providing the best quality, most effective care.  Preventive care, such as regular physicals, screenings, immunizations, wellness programs, and so on will take priority. People will hopefully fall ill and injure themselves less often and perhaps less severely.  In the long run, this fundamental change in approach may lower the growth of premiums, as improvements in health from better preventive care hopefully reduce the need for medical treatment.  Premiums will rise next year for many--but only because they're getting better coverage.  And that improved coverage may pay off in the long run.

Your Social Security Benefits: Countering the Chained CPI

The President has proposed using the Chained CPI as the measure for cost-of-living increases in Social Security benefits, and other federal and military retirement benefits.  The impact on benefits would be to reduce the annual increase by about 0.3%.  While this amount seems small, it accumulates over time.  After ten years, your benefits would be reduced by 3-4% per year.  After twenty years, the reduction would be around 6-7% per year.  If you receive Social Security for thirty years, the reduction would be around 9% or more per year.  For those relying heavily on Social Security, which could be up to half of all recipients, that can hurt, especially considering the unstoppable, uber-inflationary costs of medical care for the elderly.  The Chained CPI proposal is criticized for hitting the most elderly and vulnerable the hardest.  Women take a bigger hit than men because they live longer and depend more heavily on Social Security.

The Chained CPI would also increase taxes.  Tax brackets and certain other features of the tax system are adjusted for inflation.  If the adjustment is smaller, as it would be with the Chained CPI, the effect would be to raise taxes.  As with Social Security benefits, the tax increases would fall most heavily on those at the lowest income levels (who otherwise are taxed lightly).

If you're wondering if implementation of the Chained CPI would affect you, the answer is yes.  It affects everyone, although the well-off would suffer the least in relative terms.  The likelihood of the adoption of the Chained CPI is difficult to predict.  Conservatives and many moderates generally like the idea, although the white Boomers at the heart of the Republican Party will sooner or later figure out that they would take a bullet for their party's ideology from the Chained CPI.  When they do, we'll find out if there's a cure for stupid.

Anyway, how could you counter the impact of the Chained CPI, if it's adopted?  Save more.  Start saving more now, and save more every month.  It's hard to estimate how much more, because the answer would depend heavily on the specifics of your financial situation.  But a rough guesstimate might be 1% of your income or a bit more if you're in your 20s or 30s, 2% for those in their 40s, and 3-4% if you've reached the Big 5-0.  This may not sound like much, but try doing it (remember, this amount would be in addition to other saving you should be doing for retirement).  A lot of Americans can't.  Those who fail should acquire a taste for dog food, because it looms in their futures.

President Obama may think that proposing the Chained CPI keeps federal spending at a relatively stimulative level in the near term future, to help pull the economy out of the Great Recession, while reducing long term spending to help control the deficit.  But if rational Americans begin saving more to compensate for the lower benefits and higher taxes promised for their retirements, the near term impact of the Chained CPI would be to reduce consumption and retard recovery.  And continuation of the Great Recession would prolong the large deficits we now have.

The President seems obsessed with attaining a Grand Compromise.  He seems to think doing so will burnish his legacy.  That's weird.  Consider the Presidents who attained greatness through compromise.  There's . . . uh . . . well . . . I mean . . . you know . . .  Okay, look at the flip side of the question.  Consider the great Presidents.  George Washington, who lost 7 of the 9 major battles he fought in the American Revolution, didn't compromise with the British.  Abraham Lincoln, who dallied initially with compromise until the Confederates digitally and martially expressed their views, became the great non-Compromisor who rid America of the curse of slavery.  Franklin Delano Roosevelt, greatest President of the 20th Century, allowed Republican leaders as much input into the New Deal as Mozart had into Jailhouse Rock.  Let us recall the great proponents of compromise in America's history:  Henry Clay, Daniel Webster, and John C. Calhoun.  Their accomplishments as progenitors of accommodation are known to as many as 26% of all high school students for a period of time not exceeding 36 hours before and 2.14 minutes after exam time.  This is a desirable legacy?  Well, maybe in the eyes of some, but, please, not at the expense of those least able to bear that expense.

The Beginning of the End For Facebook

Today (April 2, 2013), the SEC announced that public corporations can use social media such as Facebook and Twitter to announce information to investors.  (See http://www.sec.gov/news/press/2013/2013-51.htm.)  Now that Facebook has been given official recognition, it becomes irredeemably uncool.  Who wants to spend time on a website where trends in product sales and revenue growth are disclosed?  Or the latest in earnings per share?  Yuck.  Where's the fun in that?  After all, social media sites are, above all, supposed to be fun.  Now that Facebook is becoming a place where serious stuff is discussed, the fickle herd of young and highly mobile people crucial to the success of any social media website will get bored and look around for something that's more entertaining.  Bye, bye, Facebook.