THE U.S. NATIONAL DEBT: HOW BAD IS THE PROBLEM?

BACKGROUND and FRAMING OF THE ISSUES

One of the most widely discussed and often misunderstood areas of the U.S. economy is the current amount of the United States’ national debt, which currently totals $18.8T. Yes, currently the U.S. Government owes a collective $18.8T to both American households and institutions ($12.6T or 67%) and to foregin households and institutions ($6.2T or 33%). This borrowing occurred because the U.S. government has spent in excess of its tax revenue over the years, which, in economic speak, is called “deficit spending”. In short, the U.S. government must borrow when its spending exceeds its tax revenue. Over the past 15 years especially, government spending has well exceeded tax revenue almost tripling the national debt during that period. A combination of two wars, two recessions, and two political parties that have not yet made deficit fighting an urgent priority accounts for this surge in debt over the past 1 5years.

The shear magnitude of the U.S. national debt ($18.8T), coupled with alarmist comments by the U.S. Congress and the American press lead most Americans to conclude that our country is perhaps on the verge of bankruptcy due to debt levels that will be impossible to pay back. Moreover, many Americans are aware that future Federal payouts for Social Security and Medicare alone will rise at a much faster rate than the current tax revenues for those same social programs further increasing the national debt.

THE IMPORTANCE OF DEBT TO A COUNTRY

Contrary to what many Americans believe to be conventional wisdom, debt can actually be a very beneficial and recommended pursuit, if used correctly, since it enables a nation or an individual to equalize income and expenditures over time, and improve standards of living earlier than what would otherwise be attainable without borrowing. It is easier to accept this premise on the personal or household front as millions of Americans have been able to improve their standard of living currently by pulling their future incomes forward via borrowing to purchase homes, cars, and education. Of course, we all know that debt, like a car, can cause damage if it is not used and managed wisely, and that is where many alarmists focus and even some go so far as saying that all debt is bad and should be avoided. Many nations, with Russia being a prime example, have been criticized by economists for not borrowing more (ie, increasing national debt) to improve their national infrastructure, education, and employment with the end goal of increasing their citizens' standards of living. Thus, hopefully, with a conclusion that debt can actually be a "good thing", if used for productive purposes and managed wisely, one can then proceed to the next section as to exactly what are acceptable levels of national debt for a country.

$18.8T: AN AFFORDABLE LEVEL OF NATIONAL DEBT?

The United States' current level of national debt, has grown, according to most economists, too rapidly over the last decade and has developed into what many economists believe to be a major fiscal problem in the United States. The problem is that with the continued rate of growth in the debt, especially as has occurred over the last 15 years, a "debt crisis' could develop meaning that lenders to the U.S. Government could become leery of lending additional money because of the fear of not getting their loan paid back. In addition, a greater loss of confidence by the public in the U.S.'s ability to pay back their loans will cause the Government to have to raise interest rates on any new debt to entice new lenders to take a chance and lend their money to the Government. This raising of interest rates by the Government to obtain new lending will permeate through the economy as private businesses will also need to raise their interest rates to compete with the government in order to obtain loanable funds for their own businesses. These higher interest rates will "crowd out" private business investment (Ig) and reduce economic growth.

Whether it is an individual or a country, the level of debt that one can afford is best measured against one's income. For example, perhaps your parents can afford a debt level of $500K on their homes and cars whereas Donald Trump can afford a debt level in the hundreds of millions! . A country is no different from a household in that debt levels must be benchmarked against income and a country's "income" is called GDP (Gross Domestic Product). Currently, US GDP is $18.4T annually and represents all of the gross income (wages, profits, rents, interests) earned by households and institutions within the United States. In short, GDP or gross income is the tax base or earnings that Congress has the authority to tax against to raise revenue to run the country and pay off current maturities of the national debt. Thus, the key point is that debt must be benchmarked to income, whether a household or government to determine whether that debt is affordable.

The United States debt-to-GDP ratio is currently at 102% ($18.8T in debt / $18.4T in GDP). When comparing the U.S. to other nation's, economists have concluded that the U.S.'s 102% national debt/GDP percentage is, in fact, well above average compared with most modern economies, but it is certainly not the highest as economies like Japan, Italy, and Greece currently have debt/GDP levels at 230%, 132%, and 177%, respectively. Moreover, the level of U.S. national debt today at a percentage of GDP of 102% is still below where it was back in 1945, where it reached 121% after having financed World War II.

So, if Japan's debt is relatively higher than the U.S. at 230% versus 102%, does that mean that the U.S. can afford to borrow a lot more, even twice as much since Japan already has? Not necessarily. A nation can only borrow if the public has enough confidence in the government to pay the loan back. Lenders to Greece panicked once the Greece debt/GDP ratio passed 100%. Spain, currently at a 98% debt to GDP ratio is having a public loss of confidence right now forcing the Spanish government to significantly increase the interest rates that they pay on new debt to entice Spanish lenders to take a chance on loaning the money. The point is that a debt panic can happen at any time and no one can predict when. When it takes hold, the public is no longer willing to loan money causing Governments not to be able to fund their initiatives. Thus, the U.S. needs to be careful! Several years ago, independent debt raters (S&P) downgraded the U.S. government's debt paying ability saying that lenders should start to be careful in loaning to the U.S. government as the debt to GDP ratio was rising too fast and Congress didn't seem to be able to agree on how to stop the unfavorable debt growth. However, recently the U.S. debt rating was upgraded to the highest quality rating once again as US deficits and debt growth have flattened out in the last 18 months meaning the debt/GDP ratio has remained the same. 

 

WHO IS THE NATIONAL DEBT OWED TO?

Much has also been made of the fact that $6.2T of the U.S. national debt, or 33%, is owed to foreigners. The fact that a good chunk of the debt is owed to foreigners is not nearly as much of a concern as the growth of the national debt in general. Foreign debt is nothing more than foreigners temporarily saving/loaning their U.S. dollars, the same dollars sent to them for their products imported into our country. Some foreigners elect to temporarily save these dollars and earn interest by lending the U.S. dollars back to the U.S. Government by purchasing bonds. Most economists don’t consider the fact that debt is “foreign owned” to be a significant problem, as these dollars will eventually be paid back to the foreigners with interest by the U.S. Government and these same dollars will, in turn, be spent back into our U.S. economy. Debt held by foreigners is “dollar savings” by the foreign public just like debt held by American citizens is “dollar savings”, so, in other words, it is really not that important whether the debt is held by foreigners or US citizens since eventually those dollars will be spent back into the U.S. economy since they can’t be spent in another economy! Most Americans incorrectly believe, due to the American press and our politicians running for office, that most of the debt is owed to China. This is not true as China holds only 6% of the total debt ($1.2T) and China's share has been constant of late. We actually owe the same amount of debt to Japan, also at $1.2T.

The National Debt Never Has To Be Paid Back!
The national debt collective level never has to be reduced! Many non-economists believe that the national debt total must be paid back by the current or next generation through higher taxes. It does not! The U.S. Government is in a unique situation in that it can simply refinance the debt (issue new debt to pay for maturing debt) into perpetuity. The key point is that the debt must be kept at an acceptable level of GDP (100% of GDP would be a good target, in my opinion) and then the national debt must be maintained at that 100% of GDP or less out into perpetuity. This means that the national debt can grow higher nominally each year as long as it does not grow at a percentage rate faster than the rate of growth of our economy (GDP) and tax revenues, which have been historically around a 3% growth rate per year. Just like families growing in household income continue to increase their nominal amount of debt held, Governments can do the same without any risk to their credit rating! Tell this to your parents at the dinner table: "Latter said that the national debt will never be paid back and does not have to be paid back and that it is misinformation that future generations have to pay it back". Yes, when you are my age, the national debt will most likely be greater than $50T and it may be less of a problem/issue than it is today!

WHAT ABOUT THE FUTURE?

Many have argued that the U.S. aging population (the "baby boomers") moving into their retirement years will cause social security and Medicare alone to "shoot through the roof" and cause the U.S. national debt to reach disastrous levels, potentially even bankrupting the U.S. Government. Many use extrapolations of future social security and Medicare payments out into varying distant futures based on the number of retiring baby boomers and increasing life spans concluding that there are trillions of unfunded (promised) government obligations (over $50T is one recent estimate) which are insurmountable. The problem with most all of these analyses is that they fail to address how simple and relatively small adjustments to the current law make these problems disappear. For example, on social security, an increase in the social security tax rate from its current rate of 12.4% (6.2% for employees matched by employer) to 15.9% is deemed by one source to fully fund social security at today's benefit structure out into perpetuity (i.e., forever). Similar analyses are out there for other actions such as updating social security retirement ages to be more consistent with longer life spans. What will likely happen, once Congress actually addresses the fiscal imbalance, will be a combination of different types of changes including reduced benefits, higher taxes, later retirement ages, and perhaps re-allocations of the overall federal budget. 

What is perhaps our nation's top concern regarding the growing national debt is that our Government officials have shown little political will to monitor the growth in the national debt relative to GDP. Most economists would say that the nominal rise in the national debt should be no more than $0.5T ($500B), or 3% of GDP, since it is actually safe for the debt to rise at no greater a rate than the growth in annual GDP. Currently, as of this writing, our annual deficits are growing at exactly 3% of nominal GDP, which is good, and this means that our 102% debt/GDP ratio would stay the same if we keep this relationship, although the debt will still grow nominally at the $0.5T per year. We will see if our President and Congress can make the tough fiscal changes needed to maintain our deficits/debt  percentage at around 100%, so we will not end up like Greece!

CONCLUSION

Today's $18.8T U.S. national debt has risen at too fast a rate. In just 15 years, the U.S. debt level has gone from 58% of GDP in 2000 to 102% today. We can afford to carry a debt load of 102%, and perhaps much higher, but no one really knows when the debt level could cause a panic (like Spain or Greece) throwing our economy into turmoil.

The U.S. economy has some sizable challenges ahead in terms of keeping our increasing national debt in line with increases in our economic growth (GDP). Most notably, our demographic trends of fewer births and increased retirees with longer life spans will put additional strains on our country's debt/income relationship as Medicare and Social Security will continue to skyrocket unless changes are made. Medicare and Social Security alone are over 40% of all Government spending so those are the budget areas we need to target. We also will likely need to increase taxes somewhat to help cure the high deficits.

Should we be optimistic?  Our Government has shown before that we can pare our debt down. Our nation restored fiscal soundness after World War II when national debt reached an all time high of 121% of GDP and again in the 1990’s as our Government made significant changes in government spending and taxation policies to curb our debt from 67% of GDP to 58% of GDP.

On the other hand, the last several years has been a miserable display of Congressional teamwork and effectiveness, in my opinion, as Democrats and Republicans decided not to work together to revamp our social security and Medicare programs, which are the largest portions of the fiscal budget. I hope it does not take a debt panic crisis to significantly slow down the rate of our national debt growth. The good news, though, is that in the last year our deficits/debt has grown in line with nominal GDP which is the ultimate goal. 

The next 5 years will be very important years in our country to establish the fiscal discipline to ensure that our debt to GDP levels remain at current levels. If not…well….move over Greece, here we come!

Questions:

1. How would an economist determine whether the nominal size of the national debt is too high?

2. What are your reactions to Japan's and Italy's debt being higher than the United States' debt. Does this give you some hope that our country still has several more years to fix our deficit/debt problem?

3. $1.2T of our $18.8T in national debt is owed to China. What would happen if China decided not to lend to the US anymore?

4. Explain why the United States never needs to nor will pay the national debt back and why their really isn't a $18.8T burden to be paid back by either my generation, yours, or your children's? Does this fact make you feel at least a little less concerned about the high level of the debt?

5. Do either of your parents understand that the national debt levels never need to be reduced (paid back) and that all we have to do is control the rate of the national debt growth to equal to or less than the rate of growth in GDP?

6. If you were President, what areas of government spending cuts and/or tax increases would you propose?

Unemployment & How To Avoid It!

I was thinking about the talented students that I teach and wondering what they should be doing TODAY to increase their odds of NOT being one of the future unemployed in our country’s unemployment statistics. But before I give that advice, let’s first look at the composition of the unemployed using the official unemployment statistics as reported by the Government's Bureau of Labor Statistics (BLS) for the most recent October 2015 monthly unemployment report:

The current 5.0% official unemployment rate average, down from a 5.8% unemployment rate one year ago, consists of the following subcategories based on educational attainment:

2.5% unemployment for those with a college degree or advanced degree
4.4% unemployment for those with some college or an associate's degree

5.2% unemployment for those with a high school degree (no college)
7.4% unemployment for those with less than a high school degree

It is easy to see from the above trend that one should pursue as much education as possible! The jobs in today’s advanced economies are clearly geared towards those with advanced skills, and education is the clearest path to get those 21st century skills!

Besides teaching Economics, I also teach Personal Finance. When learning about careers in Personal Finance, I suggest to my students that they should be concerned more majoring in “LIFE”, as an equally important second major to majors such as Marketing, History, Education, Economics, or Political Science. Moreover, they should be just as focused on majoring in LIFE as they are in trying to get accepted to Virginia Tech, James Madison University, the University of North Carolina, or Georgetown. By majoring in LIFE they are more apt to have the best college experience and career possible, and increase their likelihood of never being unemployed.

So, you might be asking, what exactly is this LIFE major?

I’m glad you asked!

LIFE is an acronym for what I, and many others, consider the 4 key skill sets to thrive in 21^st Century future careers, which will include a rate of technological, social, and global change never seen before. Those four employment key skill sets for the future are:

Leadership

Interpersonal skills

Flexibility

Emerging technology mastery

Leadership

Are you thinking about how you will learn to become more optimistic and a confident initiative taker and leader? Having been a member of management for many years, prior to becoming a teacher, I learned that companies were always quicker to lay off those that lacked initiative (“it’s not my job!”). Very often, we would somehow find a new job for the employee whose job was going away if they were strong in leadership and initiative. Often, “initiative” hurts, as it causes one to work harder with more stress, which is why so many workers do not exhibit it.

Interpersonal Skills

Tomorrow’s career “winners” will need to take their leadership skills and team with others more so than ever before. The rate of specialization is increasing in our global economy, which necessitates collaborating more effectively than ever to get any job done. Consider reading Thomas Friedman’s The World Is Flat to learn about how specialization and collaboration will continue to increase in any future 21st Century career. Continue to work on your initiative (leadership) and your ability to team successfully with others in all that you do. Don’t be the person who has 5 reasons on why it won’t work, but rather, be the person that can explain to the team the 5 reasons on how it can work!

Flexibility

Those that are not “lifetime learners” or those that do not embrace constant learning may soon be unemployed as the rate of constant change in our globalized world will leave them behind. Strengthen your tolerance to setbacks, or stated more positively, develop into the employee that actually embraces change, even that employee that can envision and lead organizations towards more productive and value-added solutions. If you get “bent out of shape” too easily when your plans go awry, or when you are faced with unforeseen obstacles, it is time to start now, while in high school to change your levels of patience, perseverance, and commitment to success. Flexibility and patience can be learned, it is not genetic.

Emerging Technology Mastery

Embrace and continuously pursue and integrate the latest in technology into your daily life and education. Tomorrow’s employment and career winners will have “in their blood” the ability to be a technology step ahead from the average worker. Start immediately as it is delusional to avoid being an early adopter today and think that somehow you will become an early adopter in the future. Stephen Covey, the famous author on human effectiveness, believes that effective people simply have developed successful habits. Strongly consider taking a computer science course in your freshman year of college or in your senior year of high school if you are a current junior (AP Computer Science, Honors Java, etc.) and consistently use your laptop in planning, organizing, and performing course work. Can you aim to be the resource that other students or workers go to for application and technology help?

Let me end this blog by letting you in on a “dirty little secret” known by managers and industry leaders across the globe: when it is time for a promotion or when it is time to reduce the work force ( a layoff) due to a slowing business, managers get very creative and are biased towards promoting, or not laying off, those that have majored in LIFE…whether you went to Virginia Tech, Duke, William & Mary, or Georgetown makes little difference in career success in the long run, although. granted, it certainly opens more doors in the short run. So absolutely, do aim for that best college and bachelor's degree or higher that you are passionate about, but please don't forget to "double major in LIFE"!

Discussion Questions:

1. Does the above breakdown of unemployment by educational category surprise you? What message, if any, do you take away from these statistics?

2. Is the LIFE acronym pursuit valid, in your opinion, as an early focus to help avoid unemployment in your future? Do you think the LIFE major is a necessary, intentional focus/practice along with your college major or do you think the development of these LIFE skills will simply progress naturally?

3. Which area of the LIFE acronym are you strongest at? Weakest?

4. Do you think becoming unemployed (laid off) is more "bad luck" or more deteriorating business conditions? Do you believe you can help ensure your own employment destiny through mastery in the LIFE major? 

5. What was my “dirty little secret”, referenced above, and does it make common sense to you?

GDP Made Simple

Two weeks ago, the U.S. Government’s Commerce Department reported that the country’s 2nd quarter (April-June 2015) Gross Domestic Product or GDP grew at a 3.9% annualized rate over the first quarter (January-March 2015). This was great news as the U.S. historical rate of annualized GDP growth is 3.2%.

GDP reports are of special interest to countries since they provide an important macroeconomic measurement of how much an economy's goods and services supply has grown, or recessed, compared to the prior three calendar months. GDP is considered the most important macroeconomic measurement to most economists as it measures the goods & services produced for its citizens.

Let me try to make the measurement of GDP easy to understand and learn why it is considered the most important macroeconomic measurement of any nation.

GDP is simply a calculation that measures the market value (final price) of all the final goods and services produced within the borders of our country, whether or not those goods and services were produced by an American or a foreign company. Thus, U.S. GDP includes Toyotas produced in Alabama. but the calculation excludes Cadillac’s made in Canada. GDP includes all U.S. exports (goods sold to other nations) since they were produced in the U.S. but the GDP calculation excludes all U.S. imports since imports, by definition, are produced in another country.

If you think about it, ultimately our country's economic satisfaction is best measured by the goods and services that are produced and that we, as citizens, have access to, which is why GDP is the measurement that is synonymous with “economic growth” or growth in goods and services for its citizens. In addition, rising GDP (more goods and services) is the ultimate economic goal of any economy, which can best be accomplished through the means of two other key macroeconomic measurements of employment and productivity, which are not the subject of this particular blog.

Let’s describe how the GDP calculation is made. Each quarter, the Government (Commerce Department) compares the final value of the domestic goods produced and services rendered in the current quarter to the final value of the goods produced and services rendered in the previous quarter. The calculation then takes the quarter-over-quarter percentage gain and annualizes the percentage by essentially multiplying by 4. The percentage growth comparison is always restated for inflation so that the production figures are comparable from one period to the next and are not impacted by changing price levels. For economic purists, we call this “real GDP” which is the only GDP reported by the media, even though the word “real” is almost always dropped to avoid confusion with the average citizen. For example, the second quarter 2015 U.S. GDP report included a 3.9% estimated GDP annualized growth rate. This means that the second quarter final value of goods and services produced was approximately .9% higher than the first quarter value. If we annualize the quarter over quarter growth that would mean we are growing at a 3.9% annual growth. 

Now let me get to my favorite point on GDP, which most citizens do not understand. GDP growth in goods and services value is precisely the same as income growth! For example, in the second quarter of 2015 we can also say that incomes for Americans grew by 3.9% on an annualized basis, restated for inflation. Said another way, our country’s purchasing power grew by 3.9%, which represents the income growth to purchase the increasing 3.9% increase in goods and services. You probably never thought about it this way but every time you purchase something, every dollar you spend is going to someone as income, whether it is to the workers as wages, the landlords as rent, a bank that has made a loan as interest income, or to the owners of the business as profits. In short, Real GDP = Real Income and the only question is how that real income is dispersed among owners (profits), workers (employee wages), lenders (interest), and lessors (rent). Many citizens are unaware that the Government calculates GDP both in terms of the final market value of the goods and services PRODUCED under the “expenditure method”, which is the version that the media uses which focuses on what goods and services are produced and purchased, as well as a GDP calculation version called the “income method”, which focuses on the REAL INCOME (gains in purchasing power) earned from that same production.

I find the preceding paragraph, GDP = Income, to be a breakthrough moment for a citizen, or a first time economic student, in truly understanding the value of the GDP measurement. It is easier for most to think in terms of percentage growth in income in lieu of a fuzzier wording like GDP percentage growth. 

The final point of caution is that the real GDP or income growth rate is a collective U.S. average, thus the growth in GDP or incomes does not indicate how those real income gains are accruing to the various socioeconomic classes or professions. Over the past 15 years, most of the gains in GDP or real income is accruing to the educated resulting in higher income inequality. Said another way, and using the 3.9% real GDP report, most of the 3.9% increase in incomes is going to the educated and skilled workers and to the owners (entrepreneurs)! As discussed in my last blog posting, over the last 15 years the real income gains of the middle class have stalled and have even slightly declined as global labor competition and technology have combined to "put a lid" on their real income growth.

Discussion Questions:

1. What is real GDP?

2. Why does Real GDP = Real Income? 

3. Which four groups earn the income generated by the production of goods and services?

4. Many analyses show that our nation's middle class have made virtually no real income gains over the last 15 years. How could this be so if GDP = Income and our real GDP has been growing over the last 15 years?

5. What are the most important determinants of real GDP growth? Hint: we learned this when we studied the Productions Possibilities Curve.

6. Describe three things you would try to do as President to increase Real GDP (economic growth).

What? Product Prices Are Cheaper Than Ever Before?

I wonder how many people in countries like the United States, Switzerland, South Korea, Brazil, Canada, Russia, and China would be surprised to learn that prices of products and services in their countries have become much less expensive over the years.

Say what? You must be crazy! Prices are not falling, you are thinking! They are rising way too fast is probably what you believe!

Yes, most citizens see their purchases as becoming more expensive when, in actuality, most goods and services are becoming relatively less expensive. Of course, the paradox is that although nominal prices (the actual price tags) are, in fact, increasing, nominal income (the average, actual wage or salary) has been growing even faster over the decades. This is a topic that in economics is called “real income” or a macroeconomic measurement that compares a nation’s nominal income growth relative to the nominal growth in prices that the same income buys. In the United States, and virtually every country around the world, nominal income has grown at a faster percentage than nominal prices causing real income to increase, meaning that most Americans enjoys greater access to more and better goods and services than ever before.

Let’s take some specific facts:

In the United States real median household income grew from $42,934 to $53,657 from 1967 through 2014 for a total percentage gain of 25% (source: U.S. Census Bureau). Both of the aforementioned median household incomes are stated in current dollars, which makes the comparison valid meaning that inflation is stripped out of the comparison. Median household real income is an attempt to quantify the progress that the “middle American” family or typical family has made over time. So, in summary, the median household in America can buy 25% more with their income today than they could in 1967. In other words, relative prices are lower than they have ever been before. Due to productivity (think PPC curve shifts right due to technology, education, and trade) we are producing more products and services than ever before and anytime there is more of something the price will fall relative to income.

If we look at the same United States income data over the same period for real average household income, there is real income growth of nearly 60%. The higher growth rate (60%) in real incomes for the average household versus the median (middle) growth rate (25%) is explained by the fact that much of the growth in United States’ real incomes has accrued disproportionately to the college educated and highly skilled driving up real income average growth rates much faster than the median or middle household. (Hint: continue your education!)

Now let’s get back to the main premise of the title of this blog and the opening assertion that prices are lower than ever. What we are really saying is that you have to benchmark actual product price increases to nominal income increases in order to really understand whether things are becoming relatively more expensive or inexpensive. The vast majority of products and services are relatively cheaper today in all nations than they have ever been before, which helps explain why more citizens than ever before can afford to own much larger homes, drive more and better cars, have cable and computers, and have access to better healthcare and prescription drugs. The reason we are led to believe differently (ie, prices are out of control!) is because we are victims of our own human nature, which tends to focus on the problem areas (higher actual or nominal prices) and not the true picture (lower relative prices when compared to income). Many citizens observe things adversely “at the margin” and quickly notice those products and service prices that are rising faster than average like gasoline prices, education, and healthcare! Hey, even gasoline prices are not at an all-time relative price high as incomes have increased faster over time.

Now, you may say to yourself that statistics can lie or mislead and you are sure in your gut that things are getting more expensive relatively. You can try to validate that incorrect “gut feeling” by examining whether a country’s middle class has access to more or less products and services. “Real income” really is just a measurement of the quantity of the products and services that the median family personally has, although it says nothing of the quality of those goods but quality has improved as well. The median and average American continually has more actual products and services in the aggregate as U.S. income gains have averaged 6.0% per year, over the last 40 years, outpacing higher price increases averaging 3.0% per year leading to a real, overall gain in products and services or income of 3.0% per year. True, there are many individual products and services that have risen in price faster than incomes (and big ones like education and health care!) but we must look at the whole picture of all prices to understand how our citizens, on average, are becoming economically better off.

Now let me introduce one word of caution; over the last 15 years in the United States, there has been an increase in real average incomes of 2.7% per year, but little of those real income gains have accrued to our nation's middle class, working class, or poor, but rather to the more highly educated and skilled. The purchasing power (real incomes) of the middle class has actually fallen from $56,080 in 1999 to $53,657 today, which is a 4% decline!. The primary reasons for this fall off in real incomes for the middle class family is attributed by most economists to increased global competition and increased technology integration into companies, which tends to keep wages down (more supply of global labor substitutes and technology keeping middle class workers keeping middle class wages in check). The educated and highly skilled, however, have seen their real incomes increase consistently over that same period. 

So fellow APers, my first new car, a 1979 Buick Regal that I bought out of college costing $6,700  with my $14,500 annual salary working for Price Waterhouse was a lot "more expensive" than the first new car of comparable status that you may buy immediately after college for $20,000! Get it?

Review Questions:

1. Before reading this blog, did you have an impression created by the media that the average American was somehow worse off economically than the previous generation?

2. Why are goods and services today relatively less expensive than they were for the previous generation? Provide an answer using the terms "nominal income", "inflation", and "real income". 

3. In Fairfax County, do you think nominal (actual) incomes have risen much faster than product prices when compared to the US overall average? Support your answer! Hint: you can get the correct answer if you trust your visual observation as you drive through the County! You don't need to do research via Google!

4. What has happened to the purchasing power or real income of the middle class in America since 1999? What is the cause? Do you have any recommendations or policy actions that you would take if you were President to increase middle class American's real income?

5. Explain the answer to my "car riddle" in the very last paragraph of the blog?

Socialism vs. Capitalism: A Classroom Experiment

This current week in my economics' classes we will be discussing different types of “economic systems” or the ways that economies tend to organize themselves. We describe the three types of economic systems in terms of a continuum with a purely free market economy (pure capitalism) at the one extreme and a command economy (communism) at the other extreme, with anything in between the two extremes being called a mixed system.

Often in the media, we use a word called “socialism”, which is economically close to “communism” in terms of households all earning closer to the same incomes even though workers provide varying skills and value to society. Usually, the word "socialism", when used in the United States regarding our current situation, is characterized by the wealthy paying increasingly higher taxes, relative to the poor, which are, in turn, spent by the government for common goods (national defense, health care, roads, airports, etc.) or directly transferred to the poor (more welfare, higher unemployment benefits, etc.)

Relatively more economists than non-economists would be in support of a more capitalistic system than a socialistic system as the study of economics (how do we satisfy our unlimited wants with scarce resources) is mostly about having the proper incentives.

Let’s consider a hypothetical experiment in socialism (communism) using an AP classroom full of high achieving economic students:

Effective immediately, all grades in AP Macro will be averaged together and everyone will receive the same grade. My guess is that after the first test the grades might average to a B. The students who studied hard would become upset and the students who studied little would be happy. But, as the second test rolls around, the students who studied little would probably study even less and the ones who studied hard would decide not to study as hard as they did on the first test. My guess is that the second test would average to a D or C-! After the second test, no one would be happy, especially with me, as they would see their college transcripts deteriorating rapidly. When the 3rd test rolled around the average would probably fall to an F. Attempts by certain classmates to rally the class to a higher average would probably not be effective, even though their grade or standard of living would be at risk. I would predict that the scores would never increase and bickering, blame, and name calling would result in hard feelings as no one would study any longer for the benefit of anyone else. All of you may end up failing, and I would quickly be fired and have my tires slashed!

Socialism is ultimately economically inferior to capitalism because under capitalism (free market economy) when the reward is great, the effort to succeed is great; but when the government levels the playing field and takes more of the reward system for the achiever away; few will try or want to succeed as much as before and things tend to worsen with less productivity.

And that, economic students, is why virtually all economies tend to move in the direction of capitalism or free markets, as opposed to moving more towards communism or socialism.

Discussion Questions:

1. Is the classroom grading experiment discussed above a valid analogy, in your opinion, as to why most economists say that a capitalistic society will increase standards of living much faster than a more socialistic system (more leveling as the government transfers wealth from the rich to the poor)?

2. What positives can be achieved through a socialistic system, either economically or otherwise? Are their aspects of socialism in the US currently that you strongly support?

3. In the United States, many Republicans say that President Obama is intentionally leading the nation towards socialism. What do you think? Is this view simply an unsupported bias asserted by mostly Republicans since they currently don’t control the White House and want to gain reelection, or, is this view accurate and factual?

Economics: The 180 Degree Science!

Now is that time of year when thousands of high school and college students across the world, from Fairfax to Frankfurt, will be taking their very first economics course. Perhaps it will be a basic, high school introductory economics’ course, or perhaps an even more challenging AP or IB economics’ course. Or perhaps you are a freshman or sophomore in college taking an introductory macroeconomics or microeconomics course.

Whatever your situation, you will soon read that all introductory economic text book authors make the point, usually in their respective text’s first chapter, that a primary benefit of studying economics is that it aims to transform one into a more effective and influential citizen by enabling one to better understand and conclude on the economic positions and promises of those running for public office. The underlying logic is that a citizen or voter that is well-versed in basic economic principles will be a smarter citizen and more likely to vote for the political candidate or referendum that will deliver the greatest economic gain for the citizens of the locality, state, and/or nation. In fact, this “economics for citizenship” reason is why a growing number of states now require completion of a basic economics course as a requirement for high school graduation.

In my classroom, I informally call the study of economics “the 180-degree science” because as the student studies this social science for the very first time they often develop conclusions that are precisely the opposite (hence, the “180 degrees”) of what they had originally believed before taking their first economics course.

For example, here are two “180 degree moments”, which are applicable to the United States’ economy, that you may well learn in your first year economics’ course:

1. Pre-Econ Course or Misinformed View: “We don’t make anything anymore in America. America’s manufacturing prowess is in a state of constant decline. It seems like almost everything bought and used in the U.S. is made in China”

Post-Econ Course and 180 Degree View: The dollar value of manufactured goods in the United States, restated for price level changes so the comparison is accurate, is up over 50% for the last 15 years and has doubled since 1990! Yes, it is true that the U.S. has lost several million jobs in manufacturing over that same time period, but that is primarily due to rising manufacturing productivity (think machines and technology replacing humans), where the U.S. can now produce more higher value manufactured products than ever before freeing up those displaced manufacturing workers who now have found or must find employment in other growth industries such as technology or health care.

Moreover, believe it or not the US manufacturers more than both Japan and Germany combined, although China passed the US and moved into the number 1 spot in 2011 as it employs more than 5x that of the US in the manufacturing sector.  Although manufacturing output is at its highest level ever in the US and will continue to rise into the foreseeable future, it will also continue to decline as a percentage of overall economic activity as the United States is growing faster in services than in manufacturing.

2. Pre-Econ Course or Misinformed View: “It is patriotic for U.S. citizens to “buy American” so that we can help our own economy. When we buy foreign products (i.e., imports), in lieu of American products, we hurt our U.S. economy as we lose American jobs and incomes".

Post-Econ Course and 180 Degree View: The U.S. will benefit the most economically if Americans buy what they consider to be the very best product, in terms of price and quality, regardless of whether it is a foreign-produced product or an American-produced product. One of the greatest “ah-ha” moments in all of economics is when an economics’ student or citizen learns for the first time that every time a U.S. buyer purchases a foreign product (i.e., an “import”) that those same U.S. dollars spent on the foreign product circle back to a U.S.- based company, not a foreign company. Yes, I am telling you that when you (or Wal-Mart, for example) buy Chinese shirts, those same U.S. dollars spent on the Chinese shirts return into the bank accounts of, say, Apple, Microsoft, IBM, or Garmin as the Chinese must use those same U.S. dollars to buy U.S. products!

Let me try to explain this concept in more detail so that I may actually be able to convince you of this amazing “180 degree” revelation. I always say the more accurate slogan should be “Buying American is Un-American” if it is not the best product as it will create a weaker America and harm our economy!

Let’s say that the United States (we’ll say Wal-Mart) decides to buy some shirts costing $400 from a Chinese shirt manufacturer, in lieu of buying similar shirts from, say, a shirt manufacturer in Elon, North Carolina (USA). The first key point is that when Wal-Mart buys the shirts from China for $400, Wal-Mart can only pay China with US dollars. Why? Because Wal-Mart has only US dollars! Wal-Mart has no Chinese currency (Yuan). Wal-Mart literally drains its bank account of US dollars and pays them to the Chinese shirt vendor, who immediately exchanges the $400 with a Chinese foreign currency trader for the equivalent amount of Chinese Yuan! The Chinese foreign currency trader only purchased the $400 from the Chinese shirt vendor because he knows that he will immediately be able to sell the $400 to a different Chinese business or consumer who wants to buy the amazing products from the U.S. Said another way, the reason the $400 returns to the U.S. is that no one in China can spend any of the $400 in its own economy since only the Yuan is accepted as a medium of exchange in China! China is thus forced to either throw the U.S. currency away (not advised!), or spend the money back to the USA (advised!). Yes, the economic “punch line” is that all spending by the domestic nation on foreign products (imports), in turn, are spent immediately back to the domestic nation increasing or maintaining that domestic nation’s employment, income, and standard of living.

And, yes, let’s not forget about that Elon, North Carolina shirt maker that did not, in this example, get the original $400 from Wal-Mart. Any good economy promotes competition and, in this example, that North Carolina shirt manufacturer must “raise their game” by figuring out how to produce a better shirt in terms of either quality and/or price, and hopefully get the next shirt contract from Wal-Mart! If they are unable to compete, well, that North Carolina firm may just have to close down. But remember the key point is that the $400 spent for the Chinese shirts went to another more deserving U.S. company, in lieu of the North Carolina shirt manufacturer. If Wal-Mart would have “bought American” by buying from the Elon shirt manufacturer, even though the Chinese shirts were preferable, Wal-Mart would have prevented the more effective and deserving U.S. business from getting those same U.S. dollars by giving them to the less efficient North Carolina manufacturer. In short, Wal-Mart would have contributed to American inefficiency and mediocrity by subsidizing the less efficient and removing the incentive for them to perform better, thus hurting our country's ability to strive for producing the very best products! And that is un-American!

Now, you may be thinking the following if you have a little economics’ background: “But the US has a growing trade deficit with China, so the Chinese may not immediately buy those products from a U.S. economy immediately. And, you are correct, but that is also not a problem for either the United States or China. What China is really doing when they don't immediately buy U.S. products with the U.S. dollars paid to them for their products is to temporarily save or invest those same U.S. dollars in the U.S. Said another way, China is not currently buying as many US products as the US is buying Chinese products and, of course, we call that situation the US trade deficit which immediately seems to speak “problem”. But it is really not as big a problem as most people think! China is still spending their US dollars back into the US economy, but in different ways. China is saving and investing some of those US dollars directly into the United States economy by building plants in America, buying US stock to fund American companies’ expansions, and temporarily saving some of their dollars, for future US purchases, by buying US bonds to help the US government pay for other US government initiatives necessitating borrowing. Eventually, China will sell these US bonds for US dollars and be forced to use those same U.S. dollars to buy US products or build more plants in America, each of which will employ more Americans!

Yes, it is an economic principle that if U.S. citizens “buy American” driven solely by patriotism (and not because they think the product is superior) the American economy actually becomes weaker as the U.S. dollars spent out of patriotism on that American company are, therefore, unintentionally withheld from another more efficient and deserving American company.

In summary, when citizens of any country in the world buy the product that is best for them based on a combination of quality and price, they will be taking the most patriotic action possible to help their own country they love so much! If a domestic citizen sees the foreign product as a better alternative to the domestic product, buy it! Your money spent will immediately find its way back through the “trade loop” to another business within your country!
Of course, this is why all economists from around the world know that international trade, and not protectionism, helps a country’s standard of living and promotes efficiency and rising standard of livings!

Well enough for now. I could go on and on with more 180 degree moments relating to areas such as standard of living, unemployment, the minimum wage, gasoline taxes, and many others. But we’ll discuss some of those in class and I will cover others through this blog site. For now, I just really hope you look forward to and work hard in your economic course so that, you too, will become a more informed and influential citizen as you begin to see your nation’s economy, and our global economy, in a whole new light!

Discussion Questions:

1. What is the primary reason that employment in the U.S. manufacturing sector decreases over time, yet manufacturing output continues to rise? Why do most Americans believe that manufacturing is "in a state of decline" even though we are producing more than ever before?

2. Would you be surprised to know that manufacturing employment is also decreasing at the same rate in Germany and Japan as it is in the United States? Why do you think it is? Where do these displaced workers need to find jobs if it is not in manufacturing? 

3. What happens to the U.S. dollars that we send to Saudi Arabia to buy their oil? Can the Arabs use our U.S. dollars in their own economy? What are two logical choices that Saudi Arabia can do with the U.S. dollars that we send them for their oil?

4. When the U.S. buys a foreign product, how does an individual or business in that same foreign country get access to the U.S. dollars we just sent them?

5. Why do so many Americans think that "Buying American" is best for our country? What would happen to the U.S. standard of living if we could only buy American via a new law? Support your answer by describing how American firms might behave or progress because of this new law.