The Cofall Curve: Why Government Spending & Jobs Are Burden

Smaller is better…really…

If there was ever a time to make a more compelling case for smaller government, this is it.

We are in the midst of a slow motion, economic dream sequence wherein a rapidly aging work force yields declining personal consumption. There is a virtual absence of any wage pricing power, predominantly due to the effects of globalization on a maturing economy and an education system that now ranks 14th in the world and getting worse. Short-term deflationary pressures will tip the hand of the Fed and debt monetization will become the norm. Property values continue to decline and taxes at all levels of government continue to decline.

Deficits are unsustainable and will soon become unserviceable if we have any hope of retaining any semblance of dollar purchasing power.
Our options are quickly diminishing but every scenario requires, at its very core, smaller government at every level.

Yet this is much more about the financial viability of the Republic as opposed to a political position. In 1980, our national deficit was about $1T. Today, it is in excess of $14T. This is a GDP to national debt ratio of 1:1. This is third world territory, at least according to the International Monetary Fund (not one of my favorite sources, however). Both parties are responsible for this debacle.

As our economy continues to contract, only the most “experimental” economists (“Keynesian” if you prefer) believe that increasing taxes will right the ship and increase wages and employment. This leaves us with only Hobson’s Choices (a choice with equally negative alternatives) and each and every scenario includes shrinking government.



It is imperative that a simple and irrefutable case be made directly to the American public.

Simply, there are certain essential costs a society must bear – these costs are represented on the X-axis and are percentages of our GDP. Currently, our total federal government spending is approximately 30% of our GDP. This number approaches 50% when you consider state, regional and local government spending.

Certain benefits to our society are derived from these expenditures and these are represented on the Y-axis. Essential services yield significant social benefits. Yet, at some point, government spending becomes discretionary and detrimental. Beyond this point, each dollar of government spending has a greater than one dollar of negative effect on society. The negative effects include inefficient allocation of capital to the essentially administrative public sector and the equally inefficient and insufficient capital allocation to the productive private sector.

For example, private sector jobs and public sector jobs are not the same. There are essential government jobs that, without which, our economy and our quality of life suffer. Soldiers, food inspectors, intelligence gatherers, law enforcement, fire and rescue, some legislators and other value added public sector employees.
However, past a certain point, the benefit of these employees is overshadowed by the cost to and burden on a society. Bureaucrats, paper pushers, administrators, regulators, layers of middle management, employees doing the jobs that the private sector can do more efficiently, some legislators…these are all examples of costs and not benefits to society.

Take for a moment the very simple fact that it takes the taxes paid by 5 to 10 private sector jobs to pay the cost of just 1 public sector employee. Recent data suggests that total compensation to each public sector employee is approximately $120,000 -double that of the $60,000 compensation for each private sector employee. Let’s say the average private sector employee cost is $60,000, including taxes and benefits. That employee pays about $9,000 in federal income tax. The average public sector employee costs $120,000, including benefits. This means that it takes 13 private sector jobs to pay for the cost of just 1 government employee. For the moment, we will ignore excess state and local taxation and employment, though this curve works at all levels.

The benefit to our society of essential public sector employees vastly out weighs the costs…what price can you put on our military, our intelligence community or food inspectors, just to name a few? Remember, first responders and teachers are the fiscal responsibility of local, regional and state governments. Yet, once we begin to hire federal governmental employees merely to create jobs, we burden the private sector with unnecessary taxes, more national debt and a devalued currency based upon merely printing money…monetizing the debt. We must levy ever more taxes just to service the debt created by excess public sector employment.

At the apogee of this curve, the benefits to our society out weigh the costs. Beyond this point, each marginal government employee becomes a huge burden. Every public sector job added beyond this point burdens society with excess costs as well as the almost incalculable additional fiscal burden upon the private sector created by these massive bureaucracies and the resulting red tape and excessive and conflicting regulations.

Once we begin to equate a public sector job to a private sector job, we loose sight of how many private sector jobs are lost paying for just that one public sector employee. At this point, conventional wisdom becomes counter-intuitive. Past the peak of the cost-benefit curve, the greatest benefit to society becomes reducing government employees and not creating “make-work” jobs. This means fewer burdens on tax revenues, more capital available for private investment and more private sector job growth.

Due to the leverage of the number of private sector jobs necessary to support a public sector job, our economy is dramatically and negatively affected by surplus governmental employment.

The debate about how large our federal government should be is as old as our country. This argument becomes more essential as federal spending dramatically escalates at the same time as federally mandated state spending is bankrupting virtually every state. And states can go bankrupt. Remember, states do not have printing presses. But these excess public sector employees will find abundant jobs in the private sector as tax payers, who no longer bear the financial burden of make-work government employees nor the excessive regulatory and bureaucratic pressure, will create new businesses and consume more due to having more disposable income.

The essential problem is that we have relied upon the fallacy of Keynesian economic policies for so long, it seems so logical that if we have high unemployment we should put these unemployed to work for the government. An essential element in this debate is that public sector employees generally administer society while private sector employees generally produce things and services of transactional value. Don’t believe this? May I ask the last time you asked the government to invent anything, to sell you a gallon of gas, to brew a cup of morning coffee for you or build a house for you? When is the last time you asked a machinist to renew your driver’s license, asked a dentist to put out a fire or asked a bartender to record a deed? And, yes, this example does not take into account the amazing accomplishments of our military and intelligence communities and DARPA that have created everything from the Internet to space travel. Remember, we said that there are such things as essential government employees.

We need to resist the “benevolence” of excess government spending and the unneeded public sector employment at exactly the wrong time. We cannot fall for the trap of substituting the immediacy of “feel-good” public sector employment producing virtually no long term benefits for the more difficult to create yet more sustainable and valuable private sector job growth. This will be one of the most difficult decisions a politician or central banker will every make – bring on the “Big Reset” now, face the financial pain now and shorten the recovery time OR make the easy choices, kick the can and grow government. This should separate the statesmen from the politicians.

Bank of England Takes First Step to Nationalizing Consumer Credit

Credit in the UK is so broken that the idea of banks being able to submit almost all forms of consumer credit as collateral for liquidity loans actually seems like a good idea to the BOE…read the full article at Minyanville

Feeling Rich vs. Being Rich

Nationalizing the consumer credit industry is one way to simulate a healthy economy. Future administrations can deal with the mess it leaves behind...check out my article at Minyanville:
http://www.minyanville.com/businessmarkets/articles/cofall-bush-tax-cuts-capitalism-government/7/13/2010/id/29129?camp=featuredslide&medium=home&from=minyanville

Making Tough Decisions to Repair Our Fiscal Future

How we handle our money, government spending, Social Security, and many other factors must be re-evaluated. It will hurt today, but tomorrow will be better...read the full article at Minyanville: http://www.minyanville.com/businessmarkets/articles/dan-cofall-keynes-spending-politicians-america/6/29/2010/id/28962?page=2

Hyper-stagflation© - Where we are today, what we must go through and where we will be

Hyper-stagflation© - This newly minted term is fixed wages due to lack of pricing power resulting from globalization combined with the devaluation of the dollar combined with rising consumption costs and higher borrowing costs. This is the economic version of the bogie-man in the basement that your parents always warned you about.

The missing link between where we are today, what we must go through and where we will be is the delta between 2010 and 2011 US Budget actual and estimates.

Estimates are for a deficit of $1.3T in 2010 rest entirely upon 2010 being a recovery year and an improvement in GDP. If this does not happen, and it does not look as if it will, budget gaps will widen, the dollar will be pressured and borrowing will become more costly. As borrowing costs increase, so will the budget gap widen further.

The Federal Reserve will become the lender of last resort.

However, until this happens, the economy will feel “normally sluggish” for a few months. Markets will be choppy. Some days it will feel like a recovery and others not so much. New and unexpectedly high unemployment will persist and the costs of increasing employment artificially with government jobs will further balloon the deficit. New stimulus plans will add additional burden. January 1, 2011, taxes will revert to pre-Bush cuts and the economy will now face a dramatic drop in disposable income that will accelerate this cycle.

The result will be less private sector jobs, health care costs pushed onto government, state and local governments relying upon federal bailouts and we will have passed our “Peak Lifestyle©” with declining disposable incomes, fewer private sector jobs, dramatically increasing debt at all levels of government and fewer tools for the FED and the Treasury to use. Any future social benefits from the government will be in dollars will declining purchasing power.

We have already reached unsustainable debt levels at all levels of government and these debts will increase at an increasing rate. After all, we don’t want rioting in the streets do we?

The governments must now figure out what benefits to cut and to whom to cause the least likelihood of rioting in the streets. Any guess as to whether benefits for older or younger Americans will be cut? And guess as to whether healthy or not so healthy American’s benefits will be cut? It is all about who will react most violently and who are the most productive. Just as Zeke Emmanuel (more on him later but look him up now…no, really, right now…and look at his “life cycle curve”). Let’s hope that you are not very young, very old, unproductive or sick.

The key is to look to assets not directly linked to the dollar…the Australian, Canadian and Swiss currencies, gold, silver, etc. Be cautious of the Australian Dollar as they are directly linked to the prosperity of China and China is just now facing their own massive banking crisis with vast amounts of bad real estate loans yet unreserved for. Canada is linked to the US and may face their own problems. The Swiss economy is fragile. There are not many sure bets out there over the long term except for gold but there will be great values if you have quick reactions and don’t listen to the drumbeat of the perma-bulls on TV and radio and from our own government and the entirely independent Federal Reserve. Remember, they are selling PMA – Positive Mental Attitude – not reality.

Of great importance is that you must focus upon purchasing power and wealth preservation. If everything goes down but you go down less, you win. Paper is still paper and US paper is still the most at risk. Going to cash (including non-TIP treasuries) is your first instinct for safety (as you have always been taught). But this will be a trap mid-term. Going to non-US related cash and cash equivalents (including the ultimate currency, gold) will be essential.

One thing you cannot do is to pull out of all investments and stay in US cash. Cash will decrease in purchasing power and we want to preserve purchasing power. That requires that you stay invested but you must improve your investment strategy and the speed with which you adopt and proactively act. Speed is critical in this worldwide game of investment musical chairs. To win, you must be right and fast and you must look further into the future and ignore the noise around you. You must act on conviction and not on whim.

The wild card is world conflict. If it is regional, the US dollar and treasuries will see an improvement but will ultimately succumb. The likely area of conflict is the Middle East. The Korean Peninsula is a second possibility but the key is whether or not it is a nuclear exchange. A nuclear exchange and all bets are off. Non-nuclear and it is manageable.

Assuming conflict will not escalate, the tealeaves are cast for the US on its current path and with the current administration. State, regional and local governments are bankrupt, tax burdens will increase and jobs and investment will suffer. Unions will be rescued and national healthcare for all is just about here but no one has thought through to the end game. That endgame will be here sooner than you might think.

It now seems apparent that stimulus spending will not end any time soon. Given this inevitability, we have our own proposals to IMMEDIATELY help middle America and small businesses and all taxpayers simultaneously. And it will cost less than the government intends to spend. We will cover these ideas daily on our show and I will update these postings as we cover them.

Just for reference, the President today began the process of floating a new stimulus plan. This without a care for any semblance of fiscal responsibility. But that is fine as it seems that the EU's charade of refocusing on Austrian economics and acknowledging the abuses of Keynesian economics is becoming more apparent. One might say that monetizing is preferred to rioting.

The biggest coming bull market will be in printing press manufactures and service companies. And pity the poor countries without their own central bank. Those are the countries that can go bankrupt. And they can drag others down with them.

However, my tea leaves still say it's pedal to the metal for the reflation trade. Print, monetize, demonize inflation while debasing every currency. As long as all currencies are essentially devalued simultaneously, maybe folks won't notice. Remember the old story about boiling a frog.

There is always a vaccine for deflation and our FED holds the patent. The only thing that kept the Federal Reserve from doing this in the 30's was gold. Today, that's no barrier.

Stimulus plans are here to stay. And, buried deep within each bill will be bailout monies for state and local governments.

Stayed tuned. We will show you, if you must stimulate, how to get the biggest bang for your buck...and exactly why our government has neither the will nor the intelligence to choose this option.

If you could lie to save the world, would you?

This may be the most profound question and thought process I have had about the financial problems of the world today. It was astonishing how clear things have just become knowing that this is how things work. It is rather peaceful knowing that we have absolutely no control over our financial world. The only question is whether to keep playing or dig in. Infinite number of metaphors that may be applied to this thought process. Even if you dig in, you must be exceptionally careful that you have REALLY dug in, not just engaged in “papering the downside”.

This might be a really good opening for your seminars. You said that fear sells and I agree but in this case, the truth would sell because it is terrifying. I’m curious what you think. Read below...



How far would you go to save the financial world if you were in charge?

Here is the solution to all of our worldwide financial problems...LIE.

Lie about your debt (Greece/Goldman).

Lie about how much money you print (England – they agreed to stop telling their citizens how much they are printing).

Lie about your bad loans (the whole damn banking crisis AND STILL lying – what do you think the off-balance sheet accounts and unconsolidated companies are for?

Lie about how much you REALLY owe (US - $100T worth of accrued but unexpensed liabilities Social Security, healthcare, etc).

Lie about who you lent it to (US – IMF – EU). The US has really lent to the EU through the IMF – almost the same as the payment through the European banks BACK to Goldman.

Lie about it being paid back (GM and CEO Whitacre and the $4.7B).


Who would know? Print too much, lend too much, write off trillions in bad loans...

If there is no proper accounting and no proper audit of central banks...who will know?

How will we know? What metric will tell us? We don’t report M3 anymore...too “expensive to do so”, according to the FED.

Governmental accounting has no balance sheet – it is essentially cash based.

What is really parked on the balance sheets of local, state and federal governments and financial institutions and companies and central banks?

Isn’t the capacity to borrow only constrained by the ability and desire to lie – especially if we do not have audits and safeguards in place?


Question:

If you were a central banker, how far would you go to “save your country or your Euro or the world?

The excuse that everyone who supported bailouts and stimulus is that we must do EVERYTHING we can to avert a collapse.

They did and it is getting worse with the $600B to $1T the EU is about to put up.

Does the end justify the means?

Does the world really want you to fix the problem or tell the truth?

Just where is the EU going to get $1T to “fix” the sovereign debt problem? IMF? It gets it primarily from the US and we are bankrupt!

We have praised Bernanke for the way he handled the crisis – we praised him for lying!

The ONLY reason for the gold standard was to PREVENT our leaders from lying!!!

We are taught not to lie but we seldom think why not lie. Usually, it is because of the consequences. What if there were no consequences because no one could prove you lied?

In our world, the best liar wins and we wonder why.


So how will you know when it is time to get out?

Bernard Beruke said “The secret to my wealth is always getting in too late and out too early.

Maybe smart money has already gotten out...

Maybe our financial and political leaders all lie...

But it’s for our own good...

Isn’t this really just like the fantasy of Merrill saying they knew the mortgage fiasco would end badly but that they would lay right up until the end and they couldn’t get out in time?

Is this your investment strategy – invest right up until the end and hope that you can get out in time?

My money says that this is exactly what virtually every investor thinks because you cannot ignore the fact that the world is bankrupt...and that our leaders lie.