×

Farrell: It's Like a New Year's Resolution

Greece's austerity plan is like a New Year's resolution says Harvard economist, Ken Rogoff, who also served as the International Monetary Fund's chief economist at one point, easy to make but very hard to keep. The Greek plan calls for job cuts and tax increases to push the overall budget deficit toward a smaller percent of GDP. Job cuts, if enacted, tend to be very real reductions. But tax increases never take into effect that behavior changes with higher taxes. Budgets always assume static revenues. But the new Greek budget raises the Value Added Tax (VAT) to 21% from 19%, increases the tax on petrol and diesel, cigarettes and alcohol, adds a new excise tax on electricity, and increases the excise tax on luxury goods. All of this will raise some money but not what is hoped for and the problem is a long way from being solved.

The original Euro pact required member states to limit budget deficits to 3% of GDP and total government debt was never to exceed 60% of Gross Domestic Product. The truth is Greece has never been within 30% of that last target. They have never met the 3% budget deficit but once in 2006. This year's budget deficit was first estimated to be 3.7% of GDP but when they refigured it, it rose to almost 13% of GDP. In short, you can't rely on any number coming out of Greece.

But other member states have their own issues. France and Germany are the ones everyone is relying on to backstop any solution, but France's budget deficit this year will be 7.5% of GDP. Germany, the strongest of all Euro countries, will run a deficit of 6.3% of GDP. Spain is facing a continued recession, 19% unemployment and a budget deficit of 10% of GDP. Italy may have $2 trillion in total government debt but, oddly, its budget deficit is 5.4% of GDP since the economy is figured by most to grow about 1% this year. All of Europe as a whole is running about 6% plus deficits to GDP. The UK is a whole other case though.

The UK has a budget deficit similar to Greece's at 12.5%. As mentioned in a note last week, British household debt is 170% of overall annual income and variable rate mortgages are common and represent a ticking time bomb. The one advantage the UK has is an average debt maturity of 14 years. In most European countries the average lies between five and nine years. In Greece is almost eight years. Germany is six years. Having such a long average maturity is one benefit to the UK. Meanwhile, back in the USA, the average is less than five years, leaving Washington, as the Financial Times said last Friday, "staring at one of the biggest rollover challenges in the world."

This week the government will continue to address the rollover challenge with the sale of $40 billion of three-year notes on Tuesday, $21 billion of ten-year notes Wednesday, and $13 billion thirty-year bonds on Thursday. With interest rates so low it would make sense for the Treasury to sell longer maturities and lessen the risk rising interest rates hold. I think they should sell as much in the way of thirty-year bonds or even longer. Our budget deficit as a percent of GDP is horrifically high and rivals both Greece and the UK. The nonpartisan Congressional Budget Office issued a report the other day that said "based on the...administration's budget proposal, deficits would be $1.2 trillion higher than the White House estimated." The CBO estimates deficits from 2011-2020 would be more than $9.7 trillion compared with $8.5 trillion projected by the administration. Great! While there seems to be little inflation risk now with stagnant wages and low capacity utilization, it would take some number of years to lengthen the average maturity of our debt.

The best part of the jobs number last week was the continued growth of temporary jobs. In a recovery, productivity comes first (productivity rose at an annual rate of 6.9% in the fourth quarter), then temporary jobs (48,000 new ones this past month), followed by full time jobs, followed by better wages. The household survey, which is used to figure the rate of unemployment, rose sharply by 308,000. Average weekly hours declined slightly to 33.8 but that was the effect of the snowstorms. Consumer credit expanded $5 billion which is good and bad, but since it's the first increase in 12 months, let's call it more good than not. Pending home sales dropped -7.6% in January and that was measured before the bad weather. With the $8,000 tax credit still in effect and mortgage rates so low, this number is troublesome. The non-manufacturing ISM did uptick to 53 and the employment sub-index contained within the overall index did expand to 48. While that is still below the 50 level that signals expansion, it is up smartly from prior months. It is not going too far out on a limb to guess that next month's job report will show nice growth in full time jobs.

_______________________________________