Reality Check on the State of World Economics and Geo-Politics

Part 1: Europe

The world markets are volatile, the United States Congress broken, and Europe on the edge of a proverbial financial knife blade. The media loves those soundbites. The current market crisis does not have any new elements just new perceptions facilitated by the media and politicians. The world economy is not at a precipice and improvements have been ignored by investors' panic.

Current market turmoil is certainly blown out of proportion but however illogical the turmoil is it will have an effect on the economic and political structures of nations. The significance of market turmoil is subject to existing and established structural weakness in various world economies. This article will focus on how volatility will interact with the European zone of economic collaboration. The debt crisis in Europe has been evolving since the fall of Lehman Brothers and the focus of the new market upheaval has been directed towards the contagion of debt problems in countries such as Italy and Spain. Although Italy and Spain's debt problems should not be taken lightly there have been several developments towards a solution. In addition the specter of a new mortgage crisis in Central Europe has been entirely ignored by most market participants.

When market participants are infected with fear they will traditionally dump the riskier assets and flock to “safe” assets such as government paper or bank certificates of deposit. However, fixed income products are yielding almost nothing. Investors searching for safety have been storing their wealth by direct purchases of currency or indirectly through Electronically Traded Funds (ETF's). In Europe investors have flocked to the Swiss Franc and subsequently driven the currency much higher than the European Euro.

The Swiss banking system has long been held in high regards and Central European nations, namely Poland and Hungary, have taken home mortgages denominated by the Swiss-Franc. These mortgages have much lower rates and were very attractive to borrowers in the old Soviet-Bloc. Currently, 53 percent of mortgages in Poland and 60 percent of those in Hungary are denominated in Swiss-Francs. If the Franc continues to rise in value compared to the neighboring Euro the effect is essentially the same as a sharp interest increase of debts in Poland and Hungary. Because Poland and Hungary are part of the Euro-Zone they are at the mercy of how markets will value the Euro in relation to the Franc.

The Swiss Banking system has been buying Euro debt in an effort to stop the sharp increase in the value of its currency but it has had little effect on stopping the upward trend. On August 11th, the Swiss national bank made an announcement that they were considering a directive to peg the the Franc to the Euro. Shortly after the announcement the Franc fell 600 blips compared to the Euro but quickly regained most of that loss by the end of Friday. The Swiss find themselves in a difficult spot, if the Euro-zone continues to struggle with the debt crisis than Switzerland can not afford to attach its independent currency to a sinking ship. On the other hand, if it does not find a way to decrease its currency than its banks will surely suffer large losses due to waves of mortgage defaults in Central Europe.

The underlying issue is that the Euro-zone is at a debt crossroads but a solution has been signed that has escaped the markets. On July 24th the German Government agreed to sign as the underwriter for the newly reformed European Financial Security Facility (EFSF). The purpose of the EFSF was to provide loans to the indebted Mediterranean nations as a form of refinance. The issue the EFTF immediately faced was that the organization relied on funds from the northern and wealthier members of the Euro-zone to donate funds. Germany has the assets but giving money directly to the EFSF is politically unpalatable to German politicians who do not want to be viewed as bailing out member nations. Instead, the Germans have signed in a fashion that allows the organization to raise funds through the sale of bonds on Germany's credit rating.

This has accomplished two objectives. First, the EFSF can raise unlimited amounts of money to lend to the peripheral Euro-Zone nations at a rate far lower and on longer terms than could be issued otherwise. Second, The German population has not seen this move as a direct bailout, although that could change in the future. The catch to this whole EFSF deal is that Germany and Germany alone has the right to decide who can tap the EFSF for money. The EFSF has in effect created a central financial monetary leader and the leader of the Euro is the German State. Member nations do no have to gain permission from the European Central Bank to tap into the capital of the EFSF but member nations will have to understand that the Germans now hold the purse strings.

In all reality Germany is the only nation with the resources to save the Euro-Zone and Germany owes its economic success to the creation of the Euro-Zone. Germany decided to take responsibility and become the economic leader of Europe. The question becomes, is Europe ready to rally around Germany as it's leader?

States Should be Taking Responsibility

November might be a long way off but the ominous political summer storm will soon engulf the entire nation. I can already hear the political radio adds blasting over the airwaves and see the polarized television commercials between innings of baseball games. Even in this remote area of Colorado the political bashing will reach uncomfortable levels and stress the community to the breaking point. In fact, political rage might be worse in smaller rural areas due to recent popularity of the Tea Party movement.

From my removed prospective, the fundamental issues for our national and local governments is lost in political polarity of both major parties. The issue is really a simple concept for most people on an individual level but due to political positioning the concept has been twisted and manipulated into large scale arguments and complicated solutions. So what is this simple issue that faces our nation?

It is paying for what we receive. All taxes have an associated expense in government, from the local level all the way to Washington. American society expresses what public goods that we want and governments respond by estimating the cost and collecting taxes for each public service. For example, Americans love roads because it allows the freedom to go where we want, when we want. Having well maintained roads is an American tradition that started at the foundation of this nation. In return, the roads provide more than personal freedom, it connects cities, towns and individual houses and allows commerce to flourish. These fee-free roads have helped America become an economic power house.

Paying for what we receive is not a complicated concept. However, both political parties use misleading statements to paint the idea that taxes are bad, instead of taxes being a basic price tag on a good or service. The Tea Party movement owes its popularity to the concept of evil taxes and the opinion taxes should be kept to an absolute minimum.. Far left Liberals on the other hand think of taxes as a corrective tool to punish large companies or wealthy individuals, taxes are ok as long as the rich pay. These two extreme understandings of taxes have diluted the middle of the political spectrum to a point that politicians can buy votes by promising but never paying.

This ongoing process has resulted in citizens who no longer remember why we pay taxes. Citizens want more services and no taxes. The concept of a negative change to the status quo of taxes is known as psychological price anchoring. Humans usually use a starting number to determine the value of a good or service. The starting number does not have to reflect the true cost or value of the good or service but it always effects what the individual thinks of the value.

For example, if I paid $50 in taxes a year (including sales taxes) due to a tax relief program, then I would use that $50 as my anchor in determining the value of public goods I received. The next year a new government was elected and repealed the tax break due to a rise in the state deficit. My taxes are now $1500 a year. Due to the anchoring effect my brain uses, my first reaction would be outrage due to the raise in my taxes. I received all the same services the year before for $50 and now I have to pay $1450 more this year. However, if I took an account of the services I received and then calculated the cost of my share of those services. I would discover that the $1500 was a really good deal. So instead of anger, I might feel good about the services I am receiving.

What am I getting at with this lengthy description of taxes? As a society we enjoy the benefits of public goods and services. So instead of trying to get more without paying we need to account how our tax dollars are used. Right now America can see how inefficient the national government has become and it is not because everyone in congress is corrupt. (although there are many examples of corruption) It is due to the fact one city cannot provide all public services for 300 plus billion people.

States and local governments can effectively handle how much to tax vs. how many services communities want and need. The benefits of having local economies handle their own taxes and finances are enormous. Taking a quick account of service provided to citizens and adding in future goals and projects, local government can then tax the population accordingly. If there is corruption or serious mismanagement of taxes the local population can take action quickly and not have to worry about lobby groups, corporations and other stalling tactics that are present in Washington. Taking responsibility for our taxes is the best way to improve this nation over a long time horizon.

The sad truth is the majority of local governments would rather receive “free” money from the federal government because it helps in elections. Why tax for something when you can get it for free? Well, rational people understand that nothing is free and by delaying payment for a service, we only hurt ourselves in the future. It is time for people to stop complaining about taxes and hold states and local governments accountable for the services we receive. Until then, politicians will promise more and pay for less. America will continue to add to the debt until we are forced to cut most services or raise taxes to unattainable level. Either way, citizens will pay for our lack of fiscal responsibility.

The Exploding Cost of College

I wince in mental anguish every time my grandparents recall how much they paid for college in the early 1950’s at Colorado State University. Their yearly tuition was less than $100 per year. Yes, the 1950’s was a long time ago but the cost of college has beat in inflation by astronomical levels. According to an article in 2008 by U.S News, the average cost of attending a four year public university was $17,000 a year. $100 in 1950 adjusted for inflation equals $900 presently, how did college cost get so out of control?

Many colleges argue they offer more services to their students now than they did 60 years ago such as internet, TV, parking, computers and so on. However, does that account for the fact college is seventeen times more expensive than in 1950?

To answer that question let us look at the cost of college since 2000. Business Week released statistics on the cost of college; the average cost of college has gone up 92% since 2000. There are two main reasons for this explosion in college education.



The first reason is colleges are paying more for the retirement of their professors and faculty members coupled that with earlier retirement by most professors the costs to maintain pension plans is becoming increasingly expensive. The second main reason for college cost is the fact the federal government is giving more aid. When Washington gives out aid, colleges counter by increasing tuition and other costs and the result is a back and forth game of rising costs verses rising aid. The problem is much of the federal aid is in the form of student loans which have to be paid back and adds to the debt burden of college students.

There are several other reasons for the rise in the cost of college but it is clear these are the two main culprits. In a weakening economy many students are taking a huge gamble on going to college only to find they cannot find a job even at low paying jobs. The result is jobless grads with an enormous debt load that cannot be refinanced or defaulted on, when the students cannot pay; their credit rating suffers making the probability of getting out of debt even lower.

At some point college, even on a community college level, is going to become too expensive to justify for most middle class students. This will leave the majority of the work force without the education it needs to make the United States economy as powerful and flexible as it has been. At some point colleges need to understand they are crippling many students before they even graduate and the government needs to recognize they cannot handout aid to colleges that take advantage of government help.

I do not believe this country can take another 92% rise in the cost of education in the next decade without severe social and economic repercussions.

It is All Greek to Grecce

Every morning I log onto the Wall Street Journal.com to read the finical headlines and just about everyday there is an article dedicated to the massive debt Greece is finally having to come to terms with. When the world discovered Greece might default on the national debt a month ago the world had a panic attack. Investors across the globe worried Greece was the first in a long chain of nations to go belly up in financial Armageddon.

However, the dominions have not tipped quite yet and it seems Germany will come to the aid of Greece on several conditions. Germany is willing to help if Greece cuts back on spending and creates a long term plan for paying off the debt. Investors relaxed and went back to watching Olympic curing on CNBC with the comforting knowledge the world might not end before Ice Dancing is wrapped up. The problem with relying on Germany to save the world is many investors and political leaders are forgetting the social unrest that Greece and other socialized countries face when they try to cap their huge budget shortfalls.

The forgotten factor in all of the international wheeling and dealing is the citizens of the socialist countries. The people of Greece have been promised every type of social program imaginable in return for votes. However, taking the benefits without paying the taxes has created an enormous deficit which needs to be controlled if Greece has any hope of getting aid from the European Union or Germany. According to The Wall Street Journal, Greece has pledged to cut their deficit from 12.7% of GDP to 8.7% by the end of the year. These austerity cuts will come in the form of a freeze on public worker’s raises, cuts in public-sector entitlements by 10% and closing many tax loopholes on civil servants and the wealthy.

Greek’s responded with a massive nationwide strike yesterday that crippled the country. The international airport closed, the newspapers closed, many schools and universities closed, when all the public workers took to the streets with signs that said, “keep your hands off our benefits” and “people are more important than markets and banks.” The president of the civil servants labor union stated, “we can’t take any more austerity measures.”

The problem with not cutting back on spending is the government will default on its loans in March and send the country into a depression. There is no question about what will happen but the public sector unions do not seem to realize the situation and the part they play in the problem. Public sector employees are paid 14 months of wage every 12 months; this essentially is a mandatory bonus the government pays. In addition all government employees pay 10% less taxes then their private counterparts. One in three workers in Greece are civil servants and these workers can retire as early as 54 with 96% of their post-pension wages. These civil servants are earning full payment for being retired. The private sector workers can’t retire until 62.

The lesson the rest of the world should take away from Greece is balancing a budget is not a burden, it is a reality. It is fine to have a socialist system if that is what the citizens’ want but the country has to pay for the socialism, the money does not grow on olive trees. The civil servants of Greece have become spoiled on high government checks and avoiding most taxes yet they blame the rich and the European Union for causing the budget shortfalls. The question for America, can we keep holding out our hands for benefits without paying taxes? Eventually America will end up like Greece. It might be time to readjust our opinions of federal handouts.

Sources
Wall Street Journal.com 2/24/10 “Greek Strikes Cripple government”