Financial News 12/06/2011: Why Keynesian Economics is Getting Bashed

A key premise of Keynesian economics is that government spending spurs growth per the Cato Institute. Many argue this is little different than throwing good money after bad. Pointing to the Japanese economy as an example, the Wall Street Journal highlights how a decade of government stimulus did not amount to a whole lot of GNP growth.

Perhaps what anti-Keynesian economics is overlooking is what will happen if stimulus spending does not occur. Government spending may not grow an economy by much, but it has prevented it from getting worse. However, as Chris Edwards of the Cato Institute suggests, long-run fiscal reforms are a suitable context with which to provide extended payroll tax cuts, a form of economic stimulus. 

The reasoning behind calls for fiscal responsibility and anti-Keynesian sentiment is the undeniable growing national debt; a debt that the 'Congressional Super-Committee' failed to come to terms with per USA Today. That's just the fiscal side of things; the Federal Reserve Bank has also been spending to buy with massive balance sheet expanding bond purchases, loan loss backstops, commercial paper funding, 'QE1 and QE2' etc. The CNN Money 'Bailout Tracker' illustrates just how massive the spending has been.

The U.S. no longer controls more than 25 percent of global manufacturing, as evident in U.S. manufacturing employment data in a Reason Foundation report by Anthony Randazzo. Additionally, U.S. GDP as a percent of Global GDP translates to increased competition for global market share from Asia according to data from the International Monetary Fund.  In other words, U.S. national wealth is not growing like it used to, but spending like it still is continues.

• Reuters: S&P ratings agency puts Eurozone on credit watch
• ISM: November non-manufacturing index slowed by .9%
• Zero Hedge: Euro zone banks borrowed €252 billion to lose .35%
• Asia Development Bank: East Asia growth rates to moderate
• The Economist: Britain entering recession despite fiscal policy
• Reuters India: Chinese service sector index declined 1.6% in November

National Deficit vs National Debt: Both a Fiscal Issue

The national debt includes all the annual deficits that have not been paid back to the public. The deficit is the amount owed after federal receipts are subtracted expenditures. The 2011 deficit is a projected $1.645 trillion in 2011 or 10.9 percent of 2011's Gross Domestic Product per the U.S. Office of Management and Budget. The national debt is closer to 100 percent of GDP, an amount that has not been approached since World War II and the Great Depression.

Complete article link: http://www.helium.com/items/2149764-what-is-the-national-debt-and-deficit

Impact of Government AIG Bailout on Investors

The impact of the AIG financial bailout on investors varies depending on which investors one is referring to. U.S. banks and investors in American International Group (AIG) actually benefited from the bailout because AIG skirted bankruptcy and more severe repercussions from the impact of no bailout on the market as a whole. However, the affects of AIG's bailout on investors is not quite so simple as it involves a number of different investors from Wall Street to Main Street and around the World. Moreover, the reasons for the bailout are two sided, with both short-term and long-term repercussions for private and public investors alike.

Investors were impacted by AIGs bailout

Of the investors who did not benefit from the financial bailout of AIG are short sellers who are investors that believe the stock price of a company will decline. Short sellers did not benefit from AIG's bailout because the bailout propped up the price of AIG's stock. There are however, many levels to the impact of the AIG bailout meaning different investors were affected in different ways, some of who are listed below:

• U.S. Banks and the Federal Reserve
• AIG investors; stockholders, bondholders etc.
• Mutual funds, ETF's, Market makers
• Competing company/industry investors
• International investors

The impact of the AIG bailout on investors in general was that the bailout contributed to the restoration of the U.S. economy which in turn affected the securities markets from losing more confidence that it did. AIG equity valuations themselves experienced a propping up due to the financial bailout. This however, is debated because the main beneficiaries of the bailout is the company and the investment community rather than the average U.S. person, also referred to as 'main street' and the U.S. taxpayer.

Short term vs long term AIG bailout impact

The rules by which investors make their decisions were somewhat trumped by the Federal Reserve's decision to provide billions of dollars in financial assistance to AIG. The reasoning for the bailout was to prevent a decay of the U.S. standard of living via increased costs and lower household net worth as per the following linked to September 16, 2008 Fox news report. However, what this implies is that the banks that were insured by AIG later bailed themselves out by buying the insurer that would have otherwise went bankrupt i.e. the insured bought their own debt thereby gaining the capacity to write the debt off their own debt off via the Federal Reserve.

i) Reasons for AIG's bailout:

• Banks could save themselves
• Helped to restore economic stability
• Prevented the meltdown of large institutional investors
• Supported the financial community

The short-term benefits of the AIG bailout included 1) the prevention of multiple bankruptcies of major financial institutions across the United States, and 2) a short-term cubing of decline in investor equity valuations. The benefits outweighed the costs for banks, investors and the American economy at the expense of trust in the American financial system, it's administration and the public's wealth. Thus, the bailout only reduced the public's wealth rather than immobilizing it. After all, the wealth managers in America can't get rich if they completely bankrupt the source of their income i.e. the American people.

ii) Intangible affects of the bailout:

• Perception of financial administration
• Economic affect(s)
• Government credibility
• Decreases public wealth

In the long-run the affects of the bailout are better than worse for the U.S. economy. It waters down the solvency of the American government a little but does protect against the economy's complete failure. As a whole many investors lost net worth by the failure of the financial system courtesy of AIG, and national banks. If those investors were banking on the real estate market, their long-term prospects are financially hampered at the very least. However, those investors who were invested in long positions within the insurance industry were somewhat saved by the bailout's affect on equity valuations.

iii) Investment benefits of the AIG bailout:

• Greater control of financial markets
• Larger stake in the insurance industry
• Improved financial solvency
• Higher probability of long-run fiscal recovery

Summary

The Federal Reserve's multi-billion dollar bailout of American International Group (AIG) is essentially market manipulation by the banking community primarily for its own financial objectives, and secondarily, for the guise of protecting the U.S. economy from the very financial institutions that put the U.S. economy in danger in the first place. Since many banks heavily invested in mortgage derivatives were insured by AIG's credit default swaps, AIG's failure could have meant a collapse of America's financial institutions.

Since U.S. Banks are collectively the owners of the U.S. Federal Reserve, they also collectively decided to bail themselves out and take ownership of a greater stake in the future of America. Thus, in the short run, U.S. banks took a steep decline in equity valuations, however in the long run, the Federal Reserve and indirectly, U.S. banks have more control of the financial markets via ownership of the insurance company that insures them. In a sense, U.S. Banks are insuring themselves, henceforth, ensuring future profitability, leveraging and financial control. So, the biggest winners of the AIG bailout are the banks that own the Federal Reserve.

How the U.S. National Debt Affects Average Citizen's Personal Finances

How the U.S. National Debt affects average citizen's personal finances depends on the correlation of that debt with economic conditions and variables such as inflation, dollar valuation, cost of capital etc.

Since Government is the regulator of a country, a national marketing agent, and administrator of Federal services, a high debt can affect all these things and all those businesses, institutions, employees, and programs related to them.

The economy is affected by more than just national debt however; the affects of the debt on individuals may be subdued. Nevertheless, when high national debt is a significant problem it may lead to individual finance related concerns in the following ways:



• Income limitations, furlough, or reduction
• Higher cost of living
• Increased taxes
• Decreased spending power
• Lower performance on investments
• Decline in availability of capital

This article will discuss the above listed potential negative affects of high national debt in terms of 1) debt, currency valuation and capital, 2) money supply and 3) cost of living. Moreover, as alluded to in paragraph 1 of this article, exactly how much national debt is too high varies on a number of economic, administrative and political factors.

Even so, high debt means the same thing for Government as it does for a business, family or individual. Consequently, the U.S. National Debt may in some cases negatively affect the average citizen's opportunities, spending power, federal assistance, and costs. It does this through the economic, budgetary, and financial repercussions of the debt as illustrated henceforth.

National debt, the dollar and cost of capital

When the national debt is too high, it can undermine the credibility of a Government that in turn affects the public. This is why not having too much debt is critical for a national Government. When debt becomes too high, confidence, investment and liquidity in a country, its money, economy and people can wane thereby affecting the following factors that in turn affect the average citizen's personal finances.

i) Valuation of the dollar:

High debt can mean a low valued dollar due to lack of confidence in the economy as related to debt. When the value of the dollar declines, it takes more money to buy the same tings be they household products, business investments, imported goods etc.

ii) Lower foreign investment:

Foreign national investment may decline when other countries find reason to believe the high national debt may negatively affect the country's economic performance. In other words, it foreign investors feel their investment opportunities in a country are jeopardized, they may invest less.

iii) Higher cost of capital:

When debt rises, the cost of capital for consumers can rise thereafter due to either decreased value of currency and/or limited government funding through monetary policy. When monetary policy limits money supply the cost of capital rises for consumers through higher interest rates as is the case with lower currency values.

Less money for everyone

A higher national debt also means less money for government programs, industry, businesses and individuals. Moreover, when the Government has less money, it follows the same applies for the economy, the businesses and people within that economy. These decrease in the availability of money may be evident in the following ways:

i) Limitations on business subsidies:

Business subsidies come from earmarks and legislated government programs. When the government has less money, so to does the availability of money for such federal assistance. This in turn can impact business success which affects the wealth of business owners, and valuations thereby potentially lowering the value of retirement accounts, investment accounts, managed finances etc.

ii) Decline in Business investment:

If businesses notice the debt is impacting both subsidies and the ability of the economy to perform be it through higher taxes, lower liquidity or decreased consumer confidence, a decline in business investment may occur. This affects the average American by reducing the availability of goods and services through operational cutbacks within a cautious commercial enterprise. This can also negatively affect performance of public investment in both private and public firms.

iii) Reduced incomes and fewer jobs:

Government and business cut backs can also mean increased unemployment, income furloughs, reduced pay raises etc. When income and jobs decline, financial pressure becomes a problem for a larger amount of people.

Increased cost of living

Since economic conditions are at least partially linked and correlated to the national debt, a negative national debt can affect the consumer price index, taxes, and government services that are then privately attained by individuals.

In other words, the cost of goods and services can go up because of a potential decline in the value of the dollar and in order to pay for the debt, the government may increase various taxes such as sales tax, excise tax, sin taxes etc. and/or cut back in government programs that can lubricate the economy and cost individuals in compensation for such services.

i) Inflation:

Cost of goods and services may rise for a number of reasons related to debt. For example, the combined affects of lowered business, international and consumer confidence in the economy may lead to a decline in wealth overall. This can lead to inflation through an increase in costs passed onto the consumer.

ii) Higher tax-payer burden:

Excise, sales, business or income taxes may rise as a government measure to pay off the national debt. When taxes rise, less consumer income is retained making the same amount of income buy less in after tax dollars, thereby limiting the standard of living.

iii) Decreased services:

Lower services cost consumers time and money because they may require private alternatives to those services. For example, limitations in educational programs may spur the need for private education just as cut backs in government agencies such as tax services may necessitate an increased reliance on private tax services that cost consumers directly. When coupled with higher taxes, this can double the cost to the consumer.