Monthly Archives: May 2012

Like Europe We Have Our Own Problems

Lately, the media has been extensively covering the bad financial news coming out of Europe. Meanwhile, the financial problems here in the U.S. have persisted. This is not intended to downplay the importance of Europe to our economy and the global financial system. On the other hand, we have our own critical economic headwinds to be concerned with.

For starters, we have many states and localities that are nearly bankrupt. This is somewhat comparable to the members of the European Union. States, like European Union countries, cannot control their own money supply. Therefore, they have to raise taxes and cut benefits. One key difference, however, is that states don’t have the option to leave the union unlike the members of the EU.

The federal deficit is one of the biggest problems we currently face. The aging demographics only compounds the problem. Medicare especially will add strain to our government’s financial problems. The mushrooming costs of Medicare are simply not sustainable. In the future, our health care system will have to adapt and become more cost efficient. Health care costs have been rising much faster than incomes and inflation.

Our national debt has reached a level in which it will be a drag on the economy. According to Carmen Reinhart and Kenneth Rogoff’s This Time is Different, large federal deficits are a drag on economic growth. In this type of situation, government spending crowds out private investment. In addition, government spending has a slightly negative multiplier on the economy. This is the opposite of private investment.

The odds of government debt default are very high once a nation’s debt to GDP (Gross Domestic Product) ratio gets to be over 90%. That said, the term ‘default’ is much broader than simply failing to make the payments. The most common form of default is through inflation. In this situation, the decrease in value of a country’s currency reduces its debt burden. This is a form of cheating creditors because they are being repaid with money that’s less valuable compared to the principal that was originally lent.

In the end, large and growing federal deficits lead to subpar economic growth. Recovery from large deficits can be long and painful. At best, we will go through a muddle through period. This is a period similar to the environment we are currently in. Yes, GDP is growing. On the other hand, the growth rate is slow with unemployment persistently high. To many, this feels as if the last recession never ended. This has all happened despite the fact that the government has been on a spending binge.

The largest spending binges occur after financial crises according to the research done by Reinhart and Rogoff. The financial crisis of 2008 was no exception. In the long run, however, the extra spending will only add to the problem.

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Three Headwinds that Today’s College Students Face

You should always treat your education like it’s an investment. That said, when the cost of any investment rises beyond that point at which a reasonable return can be made, it’s time to look at different options. This may include not making a decision at all. It is also important to note that by doing nothing, you are still taking a position. In fact, we see this in investing all the time. For instance, by deciding not to be in the stock market, you are taking a position in either cash or an alternative investment.

In recent years, tuition prices have risen to unbelievable levels. Despite this, young students are advised they should go to college regardless of the cost. This can be bad advice. There are three major problems that students are dealing with today. Obviously, the high tuition fees result in high student loan balances. The average borrower in his or her 30’s today has a student loan debt balance of $28,500.

The second major headwind is the fact that the job market has been weak since the 2008-09 recession. This economic recovery has been unusually weak. Indeed, the unemployment rate for those who have degrees is generally lower. However, companies are reluctant to hire inexperienced workers and invest a large amount of capital to train them. This only makes the debt woes worse. Coupled with a high balance, new graduates are unable to make their loan payments. If they get behind on these payments, penalties and interest raise the loan balance. Student loan debt is also difficult to get rid of through bankruptcy. This is because most debt is issued or guaranteed by the federal government. Similar to that of income taxes, it’s much more difficult to default on government debt than private debt.

The third headwind college students face today is globalization and technology. Many mid-level professional jobs have been eliminated through automation and outsourcing. Being able to obtain a steady career with long-term employment is becoming rare. Since the economic recovery, retail and food service have been the fastest growing job sectors. This shows that there is a mismatch between what the market demands and what colleges are preparing students for.

The media, especially the financial news, likes to talk about the value of human capital. With the price of robotics falling and the productivity improvements of software, companies can get more done with less people. Where the jobs will come from in the future is unclear. This does not ensure that the future will be grim. Productivity gains lead to lower prices which is a great benefit for consumers. Lower prices can, in the end, lead to new industries and new innovation. If consumers can get more for less, history shows they willingly spend more. 

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