A very brief look at how the economy works
By Melvin J. Howard
The financial instruments through which speculators invest in are getting more and more complex, and layer upon layer of instrument is forming. This surreal speculator world requires a whole new vocabulary - things like options, swaps, naked calls, floors, caps and collars. Then they seem to mate and have offspring like - swaptions, captions, knock-out options and roller coaster swaps. Not even the players themselves really know whats going on. We all are just there for a quick profit, and have hired the best mathematical minds money can buy to help us do this. Lets not go into the details of how these multiplying and magical instruments work. Rather we note that their growing use makes economies more wobbly everyday, and that these financial markets are becoming too complex to regulate. On top of this, for every regulation curtailing speculator activity a new instrument materializes to circumvent it. In this way speculator instruments multiply like new strains of bacteria, gaining resistance to the old treatments. We well be taking a look at some of the ways banks are likely to further increase the riskiness of their activities and be able to transfer the costs of those risks to those who can least afford it. In this context it will be appropriate to look at the supervision of banks and well ask the question "Who is supervising the banks anyway.
Finally well take a look at some arrangements being made under the new Basel Capital Accord, an effort sponsored by the Bank for International Settlements in Switzerland, to address the issue of bank and speculator risk. The Bank for International Settlements (BIS) might be considered the third arm of the major global financial institutions, the other two being the World Bank and the International Monetary Fund, which have achieved widespread fame in recent years. In comparison the BIS seems to be quite shy and gets very little public attention, which might make one suspicious that it is up to no good. The BIS is owned by the central banks of the richer countries. Central banks in other countries are like the Federal Reserve here. That is, they are responsible for monetary policy or, creating base money. The real activities of the BIS are extremely well shrouded in secrecy, as is the fine tradition of the banking sector. I do not know anyone who knows what they really do. But one thing we do know is that they host the discussions and rule-making about how countries should supervise their banks to make sure they are not getting into too much mischief, which might in turn upset the global financial system. While they host the international bank supervision meetings (closed to the public) the BIS says they are not responsible for the Basel Accords, which set international bank supervision standards. This is most probably because supervision is much despised in banking circles, and the banks would rather get rid of it so they could just supervise themselves.
"The Imperial March"
There appear to be at least as many permutations and combinations available for presenting US Federal Budget and Government Spending data as there are years that it would take you to count to $2 Trillion dollars, which is about 60,000! (Note that [in the US] the number One Trillion is One Million times by One Million, or 10 to the power of 12).[By the way, for the mathematically inclined, the correct mathematical definition of One Trillion is One Million to the power of 3, and the correct mathematical definition of One Billion is One Million to the power of 2. BUT in America numbers work differently, and so it came to be that One Billion got redefined as One Million to the power of 1.5, and One Trillion is redefined as One Million to the power of 2. The effect of being the Imperial Power is that everybody else in the world has now had to adopt this number convention]. How you would like to present the Federal Budget depends entirely on the bias you start with and the point you are trying to make. Therefore it was decided in my episode to admit the bias up-front and then you can better decide what to do with the data. My bias in looking at US federal spending was the thought that maybe we might just be the Roman Empire woken up from a 1,500-year nap after thoroughly exhausting ourselves last time. To be sure, the Roman Empire had many similarities with the modern US Empire - both being Empires built on a combination of clever legal systems, hard-work, confidence, much brutality in military conquest and extensive use of slave labor, coupled with a system of desirable, tempting, and free entertainment to warm the masses to the Empire, as well as erratic spouts of helpful assistance to the poor. Certainly also, a widespread Roman currency and trade system, and an extensive taxation and government spending program were just as critical to the success of the Roman Empire, as they are to today's American Empire.
The comparison of Imperial Budgets started with finding a Roman budget at a time around when their leaders stopped being elected and instead were "appointed" and when ancestral lines of Emperors became very popular. So I started with the early Empire days of the 1st - 2nd Centuries AD. A rather technical history book called "Money and Government in the Roman Empire" by Richard Duncan-Jones, published by Cambridge University Press in 1994 explains an approach, based on historical data from those days, to calculating the Roman budget in this period. The total Roman budget was about $1 billion sesterces, a common Roman currency that started in the BC years as about 1/4 of the Moneta denarius that I spoke about earlier. I was able to get estimates for the Roman budget in 150 AD broken down into the following expenditure categories:
Roman Empire Budget Distribution Source of Roman Data Expense Item Percent Outgo
Military 70%
Civil Service - Judiciary, Police, Government Departments 10%
Social Spending 5%
Economic Infrastructure 5%
Other - Mostly Foreign Affairs 10%
I then compared this to US Actual Government Spending in the year 2001 (Total $1.9 Trillion) by first subtracting both Social Security and Medicare (Total $0.6 Trillion) which have been more than fully self-funded by separate taxes (the FICA taxes) since the early 1980s and that we will devote the last section of this episode to. Then I also subtracted interest on public debt ($0.2 Trillion) for comparison purposes since the Roman Empire did not have a consistent, well-developed system of Sovereign debt issuance like the modern Empire does. Some other adjustments I made to US Imperial Spending were to include Veterans Benefits, Military Retiree benefits and Military Assistance to the Provinces (Countries) of Judaea and Egypt (Israel and Egypt) with Military Spending. The inclusion of benefits to ex-military employees is consistent with the way the Roman data was derived, and the inclusion of military aid to Israel and Egypt was done because these were the two most expensive outer-Provinces to maintain under both Empires.
I came up with the following distribution of expenses on a comparable basis derived from Table 26.2 of the full current Budget of the US Government, available in Spreadsheet Form by going to the Office of Management and Budget Website at www.whitehouse.gov/omb, click on Budget link and go to Spreadsheets, then click on Detailed Functional Tables (Chapter 26). If you want to see how I categorized the data, that will be posted on the Howard Capital web site you will have to ask for a special password to access to it. OR you can go Directly to US 2001 Spending Breakdown OR Go to Directly to OMB Detail Data American Empire Budget Distribution Expense Item Percent Outgo
Military 40%
Civil Service - Admin, Justice, Treasury, Fed Civil Retirees 10%
Social Spending - Medicaid, Food, TANF, Umempl, Housing, SI 30%
Physical and Economic Infrastructure 10%
Other - Education/Training, Research, Foreign Affairs 10%
Clearly the data indicates that social spending in the Roman Empire was generally at a very low level. However social spending tended to happen erratically in much larger amounts, depending on the Emperor of the day, and the need to win over public opinion. What is clear from looking at the two budgets is that the current US budget has more regular proportions of social spending, especially in comparison to military spending. However it should be noted that the US budget looked much more Romanesque in earlier decades of last century, notably during the 40s for WW2 and during the 50s in gearing up for the Cold War, where military expenditures were close to, and sometimes even exceeded, the Roman proportion.
The move from a Romanesque budget of the 1950s to the current US spending distribution has a lot to do with increased healthcare expenditures such as Medicaid, and the introduction of things like the Earned Income Tax Credit, and changes to Unemployment, Housing and Food Assistance Programs. Note that most of these social spending items included in the 30% fall under the grouping of "Means Tested Entitlements" which means that they make up the social safety net for people whose income and assets fall below a certain threshold. The other primary social spending benefits or social safety net items are Social Security and Medicare, which apply to Retired and Disabled Persons and are not means tested. As noted earlier these benefits have been self-funded through separate employer and employee contributions (known as the "FICA taxes") for the past two decades. Because of the unique circumstances and confused public debate surrounding Social Security and Medicare, I will devote a entry on the Centurion Health site entirely to both of them in the future.
In general, rising medical costs affect both Medicare and the means tested healthcare entitlements such as Medicaid. In fact, one of the Historical Data Tables in the Budget (Table 16.1) shows total government spending on all health programs to have increased from about 2% of the Imperial Budget in 1962 to just over 10% by 1980, to almost 25% or one quarter of the Imperial Budget by the year 2001! As anyone with a health insurance policy will also know, health care costs continue to rise. Overall, an increasing amount of America's total Gross Domestic Product (GDP - a measure of the total economy) is spent on health care. To keep score of the size of an economy and the size of national income people often talk about GDP or Gross Domestic Product. This measure of national income is also equivalent to Annual Consumption Expenditure plus Government Spending plus Investment - which are the only three places your money can go. That is, any income you get either goes to taxes, you spend it or you invest it. US GDP is about $10 Trillion US dollars. Consumption Expenditure makes up about 65% of GDP in total. Government spending makes up about 20% of GDP or $2 Trillion dollars a year.
Today healthcare expenditure makes up about 14% of US GDP. About 30% of this is picked up in Government Spending, the rest is in private spending on this issue it must be more. By the end of this decade healthcare spending will be inching close to almost a fifth of the total Imperial GDP! America spends more on healthcare as a percent of GDP than any other developed nation, but has less public coverage for this cost and a large uninsured population. So the high spending on healthcare in the US must be explained by something other than a general concern that everyone have adequate care.
To a very large extent the high level of American healthcare spending is a result of America becoming victim of its own technological success, its sedentary lifestyle and a culture obsessed with longevity, overcoming natural cycles and the desire to "stay young". The latter appears to be common to inhabitants of Great Empires of the past. This cultural obsession, fed by medical technologies far superior to those of any other country, may one day suck up so much of the US economy that it wont be able to sustain Empire status. Indeed it is perhaps the very fear of this that is really driving the attempt to redefine Social Security and Medicare that we shall talk about later. This drives home to my earlier comments that the Government and the Private sector must come together to find solutions. The Government cannot do it by themselves and the Private Sector will not do it by themselves.
Moving on to some of these other expense items, it should be noted that "Other Spending" includes Foreign Affairs expenditure other than the expenses of maintaining the outer provinces of Israel and Egypt, which are included in the Military item. Under both Empires so-called "foreign aid" is or was an important part of keeping peace with peripheral provinces or countries. Unlike Rome, the US Empire also successfully uses loans through various multi-lateral institutions such as the IMF, World Bank and Inter-American Development Bank to maintain optimal relations with peripheral sovereigns. This use of loans gets to one of the fundamental differences between Rome and America - the role and leverage of the Empire's financial system.
Recall that I discussed the role of leverage in our modern financial system 1, and its part in driving both the industrial and technological revolutions. The US Empire's success is largely due to the success, and complete faith in, its highly leveraged and purely fiat (meaning that money has no storage or intrinsic value) monetary system. In contrast, the Roman Empire's monetary system was almost entirely metal based and while there was easy access to credit for the ruling classes this was not true for other classes. There appears to be much debate among historians about what stopped the Roman Empire from having an industrial revolution. But whatever one's opinion, surely a pre-requisite is a highly leveraged, and maybe purely fiat, monetary system with sophisticated, widespread access to credit. But Rome never got to such sophistication with its financial system. This provides us with another reason why its success was always more driven by military conquest than anything else. In contrast, for the modern American Empire, financial influence is on a par with military power, and both feed off each other.
The financial success of the American Empire has also made its tax collection process far more efficient than any previous Empire, the biggest problem being with collecting from the rich. Since the financial system is a fiat system, financial transactions can be purely electronic and thus tax payment happens before many of us even get our monthly or fortnightly pay. Contrast this with the resource intensive system of the old Roman tax collectors having to go door to door to collect weighty coins and various goods such as wheat grains.
Treasury Management
The role of the Treasury Department or Treasurer of any body is to deal with financial issues - to collect income, to disperse expenditures, to maintain the books, see to the investment of surpluses and the borrowing necessary to cover shortfalls. So to with the US Department of Treasury that oversees the management of the biggest account in the world, that of the US Government. The US Treasury Department overseas the main governmental revenue collector, the IRS or Internal Revenue Service, the Bureau of Public Debt that manages government debt issuance, and the US Financial Management Service, who manages "The Books".
It is important to appreciate that the accounts of a government do not look at all like the accounts of any body in the private sector, be it a for-profit or a non-profit organization, or even an individual. Indeed if you viewed the US government balance sheet through a private sector lens you would immediately declare it bankrupt and wonder why US Government Bonds are considered the safest assets in the world!
However the reason a government's balance sheet doesn't tell you what you need to know about the safety of a government obligation is because it doesn't place a value on the right of a sovereign to tax its residents. This right of the sovereign, held only by the sovereign, generally makes obligations of the sovereign a safer investment than any private sector body licensed by, or domiciled in, that same sovereign nation. Then, the higher the national income (or the tax-base) in that country the higher the expected revenue to the sovereign body, and the more likely it will be able to meet its own obligations (provided its debt levels stays within certain bounds). Thus it comes as no surprise that the country with the largest economy and national income also issues the least risky type of debt security - and in today's world that is the US Government or Treasuries.
The resulting easy ability for the government to both tax and to borrow facilitates the type of military expenditure and infrastructure spending necessary for empire building and further economic growth. Economic growth spurs further access to capital for military and infrastructure expansion, and so the cycle continues. Any empire would then be very concerned about the following two primary threats to this pattern:
1. Growing expenditures that increasingly take money away from the primary empire building and maintenance expenditures (military and infrastructure investment).
2. Emerging empires with fast economic growth that could take your place.
And so it would be that some of the main concerns of Imperial Financial Management today are:
1. In the first category of competition for empire building funds are two main things: First is terrorist actions that make economic infrastructure more expensive to maintain. The other is the aging of the US population and increasing healthcare costs.
2. In the second category of emerging empires comes China holds the largest in US treasuries in comparison to other foreign countries.
There are many reasons empires come and go economies rise and fall. Wars are declared or not declared. When I was a kid I thought these things were left to chance but as I come to grasps the viability and probability of certain equations. My conclusion is it’s all in the numbers everything on this side of the big bang.
