Thursday, April 8, 2010

Why the West Has a Debt Problem

With a few exceptions (Denmark for one), every country in Europe as well as the United States has a debt implosion in progress. Why? Why now?

Part of the answer is that world savings have grown as the world has grown wealthier and the ability to finance a larger amount of debt has increased dramatically over the past four decades. Human nature tells us that when you can borrow more, you borrow more. Countries are even more susceptible to this disease than individuals.

But the real problem is not the availability of credit. That will eventually reach limits. What is unlimited shows up on the expenditure side.

As long as governments merely provide for court systems, police protection, national defense, most countries have no problems funding themselves. What takes things to a different level is the modern (European and American) concept that certain goods and services are "rights" that must be provided to everyone and that no one should be required to pay for them. Retirement and health care now fall into that category for most western nations. In Europe and America, retirement and health care are now "basic human rights." Using that phrase means, if you don't have the money to pay for these things, they will be paid for anyway by the government.

"Rights" become free goods. No one needs to save now in order to provide these goods for themselves. They will be provided free. By whom? The demand for a free good is essentially unlimited. That's why US health care costs have been rising dramatically since medicare was first enacted in 1964. These rising costs have only just begun. Having free retirement rights means no one has to save for their retirement. Why bother? Retirement is free.

As you expand the free services of government, someone has to pay for it. Who pays? First you go after rich people. Then the almost rich. Then you go to the international debt market (you have to go international, because free retirement and health care eliminates the need for saving by your own citizenry). Then you try a sleight of hand -- sales tax, value added tax, whatever. None of this will help. A free good is a free good. Nothing slows its price increase. More revenue simply sends the prices soaring even higher.

We've taxed the rich and the near rich. Further rate increases will yield less revenue, not more, as income is shifted or shielded away from the tax code. We are nearing the limits of our international debt capacity. Greece is simply the opening bell of an international debt conflagration. Now Volcker and Bernanke are calling for value added taxation. Value added taxation is mainly a tax on the middle class, in much the same manner as a sales tax. It won't matter. There is no revenue solution to the entitlement program.

There are no free goods. Either the entitlement program is dishonored and/or dismantled or the western nations and the US will go bankrupt. There are no other outcomes, given the arithmetic.