Why Economists Are Confused

As you know, the crystal ball of all economists remains murky these days. This results in a wide range of opinions about the economy for the next year or two. The biggest issue is whether PCE will stay around 70.0 percent of GDP or decline as consumers return their debt-to-income ratios to the 90.0 percent or so that was ” normal” in the 1990s or if they’ll return to more recent spending patterns with debt ratios around 110.0 percent. If the former develops (Ian Shephardson is quite articulate in this camp), then consumers will save much more than in the last 3 decades and the US economy will be on a permanently lower growth path. Variations on this theme fuel the predictions of Nouriel Roubini, who is not in any forecasting panels, and Rajeev Dhawan, who is.

If consumers find a way to keep spending (drawing down assets or finding new ways to raise their incomes) then the recovery will be robust. No one knows how this will turn out, so the arguments are endless and occasionally, even interesting.

Perhaps more harrowing than the prospect of slow growth is the oncoming bankrupcty of the US. The Pete Peterson- and Rudy Penner- or Larry Kotlikoff-types keep talking about the $55-75 trillion net present value of the deficit. Click here to read the full post and comment (Insights subscribers) »

Be Afraid, Be Very Afraid

In a front page story in USA Today, on May 29, Dennis Cauchon laid out the stark picture of how deep a hole Congress has dug for all citizens of the US. The net present value (NPV) of all the commitments that Congress has made added up to $546,668 for every household in the country in 2008. That was an increase of $55,000 or 12.0 percent per household.

The total NPV was $63.8 trillion at the end of last year. That dwarfs our $14.3 trillion in GDP in 2008 and is 23.9 percent larger than the $51.5 trillion in net worth held by consumers on December 31, 2008.

By far the biggest problem is Medicare. It accounts for $284,288 or 52.0 percent of the obligation per household. Social Security is second at $160,126 or 29.3 percent. The two entitlement programs combined account for $444,414 or 81.3 percent of the total.

There are no simple and obvious solutions or Congress would have used them by now. One possibility is a flat tax on consumption with a cap on total spending for Medicare. Social Security can be solved by raising the retirement age in the future (ten years or so from the change) and indexing the annual increase in benefits to wages rather than prices.

The national debt accounts for only $54,537 per household. That part is manageable.

The debate on how to resolve this huge gap between commitments and reserves to pay for them will consume increasing amounts of time until the situation is resolved. That is unlikely to be soon. Sadly.