Sunday, February 12, 2012

The U.S. Unemployment Rate: "Lies, Damned Lies, and Statistics"

The quote from Mark Twain, "Lies, damned lies, and statistics," sums the theme of this blog. Politicians are haunted by one fundamental law of economics; a downturn in an economy leads to an ouster of its political leaders. Hence, our governmental leaders will do anything that is immoral, illegal, or unethical to garner votes for another term in office. Furthermore, the politicians may encourage government agencies to skew, distort, or exaggerate its statistics to appease, mollify, or mislead its citizens, especially the ones who vote. Consequently, this blog examines the U.S. unemployment rate in order to gain insight about the true impact of the 2007 Great Recession.

The first observation of U.S. government statistics is the sheer volume of information, data, and reports a bureaucracy can offer. Each department of the U.S. federal government has a branch that collects, analyzes, and publishes statistics. Then this branch literally publishes hundreds of different statistics with thousands of technical reports. Most people who visit these websites are easily overwhelmed by the information. The Bureau of Labor Statistics is the branch that collects and publishes statistics for the U.S. Department of Labor.

The second observation is the definition of unemployment. The U.S. government defines unemployment (called U3) as a person who is currently not working and actively seeking employment. If a person works one hour per week, he/she is not technically unemployed, although an hour a week cannot support a level of living. If a person wants to work, but the job market is extremely bad, he/she gives up, then that discouraged worker is no longer considered out of work. Consequently, the unemployment rate can decrease if a large number of jobless give up the pursuit for a job. The Bureau of Labor Statistics publishes the labor underutilization statistic (called U6) that includes discouraged workers and part-timers who want to work full time. The (seasonally adjusted) U6 was 15.1% for January 2012.

The third observation is a bureaucracy continuously revises its statistics. Hence the reported numbers are always in flux. For example, the Bureau of Labor Statistics uses telephone surveys to gather unemployment data and examines reports from the states' unemployment offices. Then the statisticians compute the statistic for that month, quarter, or year. Here is the kicker. After a statistic is released to the public, a bureaucracy may boost or reduce this number a few times over the next several months. Why are the numbers constantly revised? Did the statisticians not count all the surveys? Were the states late in reporting their statistics? Hence, government statistics have a degree of arbitrariness as the numbers are continuously revised.

The fourth observation is the statisticians seasonally adjust the numbers for monthly and quarterly data. For instance, the Bureau of Labor Statistics reported the U.S. unemployment rate fell to 8.3% in January 2012. The news reporters blindly reported this number to the masses without any serious analysis or verification. U.S. reporters have regressed into parrots who caw in unison for the government's slogans, sound bites, and propaganda. What does 8.3% really mean? First, this statistic was seasonally adjusted. Statisticians smooth monthly and quarterly statistics; high numbers are reduced while low numbers are increased. The reason is the economic activity is different for every month. January cannot be compared to December because December has more economic activity than January. Once the statistics are seasonally adjusted, then different months or quarters can be compared. The unemployment rate that is not seasonally adjusted was 8.8% for January 2012. Although this number cannot be compared to December, it can be compared to January 2011, which was 9.8%. Similarly, the not seasonally adjusted U6 was 16.2% for January 2012, falling from 17.3% for January 2011.

The fifth observation is the slight upward trend of the unemployment rate. In Figure 1, the annual unemployment rate is plotted between 1947 and 2011. The blue line indicates the jagged oscillations of the unemployment rate. Economists define a recession when the real growth rate of the Gross Domestic Product (GDP) is negative for two consecutive quarters. All recessions since 1947 were drawn with pink boxes on the graph. When examining Figure 1, the Great Recession of 2007 and the recessions of the early 1980s were particularly severe when compared to previous recessions because the unemployment rate soared to 10%. The early 1980s had a quick succession of three recessions. Using statistics to fit the best line through the data yields the red line. Moreover, the examination of Figure 1 shows the impact of the housing bubble during the 2000s. The housing bubble temporarily lowered the unemployment rate below the trend, as the bubble created millions of jobs. Unfortunately, the red line angles upward with a slight slope, indicating over time, the unemployment rate is creeping upward. Thus, the U.S. economy went through structural changes that were not conducive to low unemployment rates. The structural changes were de-industrialization, outsourcing, rise of the service economy, rise of the IT industry, aging population, and growth in government. Consequently, all structural changes impose benefits and costs on society, and they would require a separate blog.

Figure 1:  The U.S. Unemployment Rate between 1947 and 2011

The sixth observation is the structural change in employment. All the statistics were converted to a percentage of the U.S. population to remove the impact of a growing population. In July 1, 1947, the United States had a population of approximately 144 million, which increased to 312 million by July 1, 2011. In Figure 2, the first trend is the shift to more part-time labor. Part-time labor comprised 5.3% of the population in 1968 and gradually rose to 8.8% in 2011. The second trend is the impact of a recession on full-time employment. Every U.S. recession since 1947 was drawn manually onto Figure 2 in pink boxes. A recession always caused the destruction of full-time jobs. The 2007 Great Recession was particular nasty as the percent of full-time workers decreased from a peak of 40.4% in 1999 to 36.1%. This indicates a loss of approximately 13.5 million full-time jobs in 2011. The third trend is the rise of the number of people who dropped out of the labor force. Again, the 2007 Great Recession had a severe impact on the economy. The percent of people not in the labor force was 27.6% in 2011, increasing from a trough of 24.8% in 2000. Approximately, 8.7 million people left the labor force. Many reasons account for the exit from the labor market, and they are discussed in the next paragraph.

Figure 2:  Full time, Part time, and Unemployed

The seventh observation is a little discussed statistic buried within the Bureau of Labor Statistics' website. The statistic is the labor participation rate as a percentage of the population (age 16 and older). This statistic by nature will never equal 100% because several groups of people are not in the labor force. The groups are teenagers (16 to 18 years old), discouraged workers, retired workers, prisoners, committed patients, students who do not work, and soldiers. Illegal immigrants who work may not be reflected in the participation rate because the Census Bureau counted them in the population, but the Bureau of Labor Statistics did not count them in the labor force. In Figure 3, the labor participation rate is graphed between 1947 and 2011. The U.S. recessions were drawn manually onto Figure 3 as pink boxes, and a recession always lowered the labor participation rate. The 2007 Great Recession was particularly gruesome. The labor participation rate fell to 58.4% in 2011 from a peak of 64.4% in 2000. (The Year 2000 was an exceptional year). Roughly, 14.2 million people left the labor force. (The last paragraph indicated 8.7 million workers dropped out of the labor force; government statistics when viewed from different angles usually yields different results!) The real question is where did these people go? Are they discourage workers who gave up the pursuit of a job? Did more people retire? Did more people enter college without working, or the states incarcerate more prisoners?

Figure 3:  Labor Participation Rate between 1947 and 2011

One important assumption was made in this blog; the assumption is the Bureau of Labor Statistics is not manipulating the numbers. Although U.S. bureaucracies are not political in nature, the top leaders of the bureaucracies are chosen by the President with confirmation of the Senate. Moreover, a bureaucracy's funding depends on the President and Congress. The President and Congressmen want to be re-elected, and they may put pressure on the bureaucracies to release positive statistics. Consequently, bureaucrats have an incentive to skew the statistics, making it appear the economy is improving especially before an election. The 2012 presidential election is around the corner, and the news is reporting optimistic unemployment statistics, indicating a possible economic recovery. However, if one reads the comments at the end of those rosy unemployment stories, the readers' opinions express disbelief in those numbers. Unfortunately, this blog cannot uncover fraudulent government statistics. Nevertheless, the U.S. government's statistics do indicate the following:

  • The 2007 Great Recession was one of the worse recessions to hit the U.S. economy since the Great Depression. 
  • Employers are using more part-time labor and fewer full-time labor.  The 2007 Great Recession was particularly harsh on workers with full-time jobs.
  • A large number of workers left the labor force.  The million-dollar question is why did these workers go?  Did millions of workers become discourage and give up their search for a job?  Are more workers retiring?  If more Americans are retiring, why are the younger workers not filling these vacancies?

Monday, February 6, 2012

Hyperinflation: Effects, Cause, and Survival

Many Americans have never experienced hyperinflation, and they do not know how to protect themselves from it. We had an excellent political and economic system that sheltered us from hyperinflation for two centuries. Hyperinflation is the rapid, excessive growth of prices, when a country's inflation rate exceeds 130% per month. What does this mean in real terms? If the United States has 100% inflation rate per year, then every year on average, prices would more than double. If your favorite bubbly soda cost $1 at the beginning of the year, subsequently, its price would rise to $2.00 by the end of the year. If your house were appraised at $150,000, then its price would climb to $300,000 by the end of the year. Thus, hyperinflation increases the prices of all products and services in our economy.

Hyperinflation, unfortunately, disrupts an economy. Hyperinflation rapidly decreases consumers' purchasing power because prices in an economy rise faster than workers' wages. Employers and workers who once enjoyed the comforts of middle class can be shoved into poverty overnight. For example, if our economy experiences an inflation rate of 100% and workers' wages rise by 50%, then these workers suffer a decline in their purchasing power. For instance, you earn $30,000 per year at the beginning of the year, and your favorite soda costs $1. Thus, your income allows you to buy 30,000 sodas. However, if the inflation rate is 100% while your salary rises by 50%, then you can only buy 22,500 sodas at the end of the year. The price for soda rises to $2 each while your salary climbs to $45,000, causing a 25% decline in purchasing power.

Hyperinflation causes interest rates to soar. The increase in interest rates is similar to a decline in purchasing power. If the inflation rate equals zero, and a bank charged a 5% interest rate on a loan, subsequently, economists call this interest rate real because the borrower repays his loan with 5% more money. If the inflation rate climbs to 10% and the bank still charged 5% interest, at the end of one year, the average prices in our society increased by 10%, but the bank only collects 5% more money. Consequently, the purchasing power for the banks falls by 5%. Thus, hyperinflation can disrupt a country's financial sector. Banks and financial institutions can collapse overnight as the value of their loans shrivels to nothing.

Hyperinflation harms the savers. If a person saves money by hiding it in their mattress or deposits it in a bank account, his or her savings lose value. For example, Brazil saw a hyperinflation rate of 10,000% per year during the 1980s. At the beginning of the year, a city bus ride cost one peso that soared to 10,000 pesos by the end of the year. Hyperinflation wipes out savings as consumer prices rise to astronomical levels. If a saver deposits their savings at a bank and the bank pays a low interest rate, then hyperinflation reduces the savings’ purchasing power. (Of course, we assume the bank can remain in business). Thus, savers must convert their savings into a stable currency or into physical assets to protect their purchasing power.

Hyperinflation is cruel to people on fixed incomes. Hyperinflation quickly erodes a person’s income from Social Security, an annuity, fixed investment income, or government aid. The U.S. government does index Social Security for inflation. Hence, government payments automatically rise with inflation, or at least in theory. However, hyperinflation causes prices to soar quickly, and the government might not boost Social Security in step with inflation. Consequently, people on fixed incomes will become the most vulnerable in society and will succumb to hyperinflation.

Hyperinflation could benefit the debtors, depending on the loan type. For example, if a debtor owes $100,000 mortgage on his house with a fixed interest rate, a debtor can repay this debt with devalued money. The hyperinflation boosts the value of the house and the debtor's wages, but the monthly loan payments remain fixed while people repay them. If the loans have an adjustable interest rate, the debtor's monthly payment rises as both the interest rate and hyperinflation rise. Then the debtor could default as his monthly payments spiral to high, new levels, far beyond his income. Consequently, debtors with fixed interest rate loans will benefit, while those with adjustable interest rates will most likely default.

A country in the throes of hyperinflation will suffer from a severe recession or depression. As the currency’s value rapidly deteriorates, hyperinflation shoves the savers and people on fixed incomes into poverty. Consequently, Hyperinflation quickly erodes the value of their savings and fixed income. The loss of purchasing power will reduce imports, improving a trade deficit. (Hyperinflation could boost exports if the exporting industries can survive the hyperinflation). Moreover, foreign countries will also stop accepting that country's currency for payment. Then hyperinflation causes interest rates to rise to insane levels, shutting down the financial system. Banks, finance companies, and pension fund companies will close their doors. Finally, hyperinflation destroys the tax base, causing government tax revenues to fall. People may evade their taxes if they know their tax office is devastated. (A tax authority cannot audit a person if tax officials do not report to work.)

Hyperinflation has only one source if it exceeds 10% per year. That country's central bank creates inflation by expanding the money supply. For instance, the central bank can help a government finance its budget deficit and debt. Consequently, government in countries with towering deficits and debt tend to experience high inflation rates. Many believe the United States will experience hyperinflation as the Federal Reserve finances the U.S. government's deficit and debt. The U.S. government debt has grown to a catastrophic $1.5 trillion deficit and a soaring $16 trillion debt. The U.S. government does not index most of its debt for inflation. Thus, hyperinflation can wipe this debt clean. Unfortunately, the United States would enter a severe recession that we would export to the world. Finally, the U.S. dollar as the world's reserve currency ends.

The expansion of the money supply is more complicated than printing money. For example, the Federal Reserve granted anywhere from $2 trillion to $8 trillion in emergency loans to banks during the 2008 Financial Crisis. (Nobody really knows the exact amount except the Board of Governors of the Federal Reserve). The Federal Reserve changed numbers in their computer system for the loan amount that the banks held at the Federal Reserve. Nevertheless, the banks chose to save this money. If banks loaned this money to borrowers, then the banks convert their reserves into loans that people eventually deposit in checking and savings accounts, boosting the money supply. Then inflation tails the growth in the money supply.

People will have a warning sign before the hyperinflation strikes the U.S. economy. Observe the international investors. Investors and governments in China, Kazakhstan, South Korea, Russia, etc. believe the U.S. growing debt is unsustainable. Consequently, investors would reduce their holdings of both U.S. dollars and U.S. government securities. Subsequently, the U.S. debt will reach a point when investors stop buying U.S. government securities. Then the U.S. government would be short of cash in the trillion-dollar range. If the U.S. government does not have the cash, then it cannot pay its workers, bureaucrats, soldiers, or citizens receiving entitlement benefits. Thus, the Federal Reserve could buy this debt, and the inflation begins to soar as the government spends the reserves, injecting the reserves into the economy.

The U.S. government could increase taxes or reduce government spending to reduce the deficit and slow the debt’s growth. However, we will reach a point of no return. Congress and the President remain at an impasse, and they have no intentions to boost taxes or reduce government spending or eliminate the trillion-dollar deficit. In 2012, the average U.S. debt per every American man, woman, and child was approximately $50,000, far exceeding most people's income level. Unfortunately, Americans have entered a dangerous time, when deficit spending sparks a severe financial crisis while the United States enters the Second Great Depression.

How do you protect yourself from hyperinflation?

1) Hyperinflation will lead to a breakdown in society. Store shelves will become empty and bare as food prices exponentially rise. You need to stock up on the following items:

  • If you require medications, then you need to stock a year supply or more. Furthermore, you must stock a first-aid kit that includes antibiotics and painkillers.

  • Stock up on nonperishable food because they can be stored safely for years. Many dried fruits, dried milk, dried vegetables, dried soups, dried beans, and dried lentils could be stored for years and safely eaten. Canned products could spoil within a year or two. Some recommend you scatter your food over several secret storage sites. As millions go hungry, they will resort to violence, theft, or home invasions, searching for food and supplies.

  • Accumulate weapons, such as guns, bullets, and knives to protect yourself and your family. If riots break out in the cities and hyperinflation whittles police paychecks to nothing, then the police may not show during outbursts of violence. In some U.S. cities in 2011, police do not show for minor offenses.

  • Become self-sufficient. Learn to grow a garden, raise chickens, fish, or hunt. You would also need to stockpile equipment that supports these activities. Even if you do not smoke tobacco, you should grow tobacco. You can use tobacco to barter with friends and neighbors for things you need.

  • You need access to safe drinking water. You may need to boil water to kill any microorganisms.

  • Accumulate useful items such as an emergency radio, flashlight, small propane stove, tools, etc. Some good items include a hand crank radio, or a solar cell panel that charges batteries.

2) Money becomes useless during hyperinflation as money quickly loses its value. People who depend on the government for income such as Social Security, Medicaid, Medicare, food stamps, etc. will see their benefits erode. A government will raise the benefits slower than the inflation rate. Unfortunately, our most vulnerable citizens might perish during a bout of hyperinflation.

3) If you are still earning wages, then once your employer pays you, you convert your wages into assets. Many analysts recommend people to invest in gold, silver, and other precious metals. With the downturn in the world economy in 2012, these metals could rapidly soar in price. However, they may or may not be good investments. First, government can pass laws to confiscate gold and precious metals to protect its national security. Usually government officials worry about their safety and security before their citizens. Second, people cannot appraise the value of a gold coin. The person must know the purity of the gold because coins can be gold plated with a zinc core. However, any assets other than precious metals will retain their value. Once money becomes useless, people will barter for goods, they need. Medications, seeds, guns, bullets, gasoline, cigarettes, liquor, and nonperishable food become the new currency.

4) If you want to transfer money outside of the country, transfer it now. During a financial crisis, a country can impose capital controls. Often capital controls limit the outflow of currency or precious metals. If you are planning to flee the country searching for greener pastures, then you must do this before hyperinflation strikes. Other countries will erect barriers to isolate themselves from the crisis and prevent an influx of refugees. Fleeing to another country does entail risk. If a worldwide depression ensues after the U.S. hyperinflation, a country may expel all the foreigners. For example, Britain plans to close its borders, expel foreigners, and impose capital controls after the euro collapses and the European Union begins disintegrating.

5) Many Americans live from paycheck to paycheck and do not have financial resources to weather and survive a hyperinflation. Riots and civil unrest will erupt in the cities as people search for food to feed their friends and family. The Occupy Wall Street protestors were tame and would pale in comparison to civil unrest from a starving population. Unfortunately, government officials will do anything to retain their power and control. If hyperinflation severely limits and reduces a government's resources, it will use soldiers to fire real ammunition on its citizens, retaining control over society. Rural towns become the best places to live, far away from large cities. Then you become friends with your neighbors, and watch each other's backs, forming a true community.

6) Do not count on the media to warn their viewers of imminent hyperinflation. Unfortunately, reporters rely on the government for information, and they never ask our political leaders the difficult questions or rarely checks facts. Most government officials will not inform the public after hyperinflation strikes the economy. However, the news will bombard the viewers with the hyperinflation diet, how to look fabulous on a hyperinflation income, or dating secrets for singles who have hyperinflation troubles. Unfortunately, hyperinflation comes swiftly and unannounced like a torrential storm system pummeling a small town. The only signal is investors stop buying U.S. government debt. Afterwards, prices for food and consumer goods begin rising gradually at first, and then the prices accelerate to insane high levels.

Monday, January 30, 2012

The Problems of Higher Education and the College Bubble

The Occupy Wall Street protestors meander through the cold streets during the 2011 winter. Corporate greed, crony capitalism, income inequality, and corrupt politicians anger them. They have united their voices and screamed for change. They interrupted political speeches, boycotted the large banks, and in one cases, shut down the Oakland California seaport. Although participating in the protest movement, the college students remained silent about greed in higher education. When did colleges and universities become exempt from public criticism? Unfortunately, university leaders are just as greedy as the Wall Street bankers are. This blog outlines the greed in higher education and the financial storm that will unravel the college bubble.

One sign of greed is the rapid tuition rises for higher education. Tuition increases have greatly outpaced inflation. For example, I graduated with a bachelor's degree from a small liberal arts college, Northern Michigan University, in 1993. I paid roughly $2,000 tuition per year. In 2011, this university charged about $8,000 per year. If the university increased the tuition at the end of the school year, then the administrators increased tuition 7.5% per year. On the other hand, the average U.S. inflation rate ranges from 2 to 3% per year, far below the tuition increases. Unfortunately, my university is typical of higher education because most U.S. colleges and universities increased their tuition at similar rates.

The rapid rise of tuition does not tell the complete story. College administrators created a variety of fees to extract additional money from students. Most universities and colleges charge application fees for admissions, library fees, computer lab fees, building maintenance fees, etc., continuing ad nauseam. Unfortunately, administrators boost both fees and tuition. When a university or college experiences a little financial trouble, they create new fees to generate more revenue source. Unfortunately, some institutions charge fees that rival the tuition, and some college administrators are disingenuous. When a university or college reports a tuition increase to the public, they often are quiet about the rising fees.

Leadership in universities and colleges deliberately skew statistics. Looking at my alma mater, Northern Michigan University, the State of Michigan appropriated roughly $39 million for Fiscal Year 1992, which climbed to $45 million for Fiscal Year 2011. Although the State of Michigan is mired in a perpetual recession since 2001, the state government still increased my university’s appropriations. Thus, the university gained an extra $6 million in funding, amounting to a 0.75% annual increase. If the inflation rate is 3%, then the State of Michigan reduced its funding by 2.25% in real terms, or 0.75% subtracted from 3.0%). Similar to the U.S. federal government, a program's budget increase just became a decrease. Consequently, university leaders never report their state appropriations, nor show the state appropriations over time. They must show statistics where the state harms and underfunds higher education.

University officials often quote the startling statistic, the state funding percentage. For example, the State of Michigan provided 60% of funding to Michigan universities in 1987. By 2011, the state only provided 18% of a university's funding. Thus, the State of Michigan is cruel, heartless, shortsighted. Then a state winds up with an uneducated workforce, and it can never attract the high-tech industries, but we know the truth. The State of Michigan did increase its appropriations to its public universities and colleges during tough times. Two factors could worsen a state's funding percentage. First, a university increasing its tuition faster than state funding increase causes the state funding percentage to fall. Second, a university enrolling more students receives more tuition dollars. If the state funding remains constant, then the state funding percentage drops. Consequently, university and college leaders use misleading statistics to grab greater state funding, which suspiciously sounds like greed.

Greed rears its ugly head, when private businesses produce and sell goods and services on a university campus. The university and colleges lease retail space to fast-food restaurants, coffee shops, stores, and travel agents. In 2003, Oklahoma State University experienced a budget crisis, and the administrators boosted tuition by 24%. Furthermore, the administrators forced a coffee shop owner to leave the student union because a national chain offered to pay more for the lease then she did, and the chain did not want competition. Furthermore, universities and colleges have thousands of students (i.e. consumers). The administrators enter into contracts with particular suppliers such one beverage company. Then only that company’s sodas are available on campus, and in turn, the beverage company bestows gifts and endowments upon the university.

The higher education leaders often misrepresent tuition increases. For example, they claim they will boost financial aid if the university can raise its tuition. On the surface, this sounds reasonable, but it does not hold once you peer under the surface. For example, if a university increased tuition by $10 million and subsequently offered $10 million more in scholarships, the university does not collect more funding. A university would never do this. However, if the students would receive more scholarship money from outside the university or would apply for more student loans, then the university receives more money from the tuition increase (assuming the university does not lose students). Thus, financial aid coming from the university's pocket book would never keep abreast with the tuition increases.

Administrators increasing tuition force students to accumulate debt. Students, on average, have borrowed $25,000 in 2011, doubling from 1993. Unfortunately, some students do not realize federal student loans are not grants, and they must be repaid. We can estimate the monthly loan payment by the Rule of 100. If a student owes $50,000, then he or she pays roughly $500 per month (just divide loan balance by 100). Some professionals, such as PhDs, lawyers, medical doctors, and dentists accumulate student loans in excess of $100,000. Using the Rule of 100, their monthly payments would exceed $1,000 per month. Finally, the government claims it will forgive a student loan after twenty years of repayment. However, if a student defaults on the loan, the 20-year limit does not apply.

A federal student loan is worse than dealing with a loan shark. The U.S. government imposes drastic penalties that can haunt a student, who defaulted. First, the student cannot file for bankruptcy because a bankruptcy court cannot discharge federal student loans. Second, the loan holder, the U.S. Department of Treasury or SallieMae, often add fines and penalties, which could double the loan balance. The loan holder will capitalize the interest, which means, the lender adds the unpaid interest onto the loan balance, causing it to grow. (I strongly disagree with this practice because if a loan can never be forgiven, why can the government double the loan balance.) Third, the seven-year rule for bad debts does not apply to student loans. A student could be plagued with bad credit as long as he or she is in default. Fourth, the government excludes the students who defaulted from federal contracts and programs. If the student becomes a dentist, doctor, or professional, then a defaulter cannot see patients, clients, or federal employees who are insured by the U.S. government. Finally, the U.S. government may withhold tax refunds, garnish wages, or garnish Social Security Benefits. Thus, student loans can shackle a student for the rest of his/her life.

Greed shows up in school spirit. Freshmen are happy and proud to move away from their parents, and they begin their studies. They often buy their school's clothing and knickknacks. The universities and colleges own the trademarks for their logos and names, and they collect a percentage of sales from every t-shirt, clothing, or knickknack, blazoned with the university’s logo. If the college or university has a popular sports team, a university or college receives a 10% royalty for every trademark item sold, netting the institution with millions of dollars per year. Finally, every college and university have an Alumni Association, which encourages the college graduates to join and donate money to the university. Although I received a good education from Northern Michigan University, I will never donate money to this institution. I remember how those greedy bastards in the administration acted, when I owed the university a $100. An administrator threatened to withdraw me from the university halfway through the semester. (I experienced similar problems with my alma maters, Oklahoma State and Texas A&M; unfortunately, it’s all about the money.)

Administrators in higher education greedily collect their tuition dollars and squeeze anyone associated with the university or college for money. Greed is not necessarily bad, depending where they spend this money. Administrators often claim the university raises tuition to hire more professors and improve the quality of education. However, this is partially true. First, a growing trend is administrators hire more adjunct faculty (or part-time professors) or enroll more graduate students who teach the low-level courses. Adjunct faculty and graduate students earn low salaries, have few fringe benefits, and reduce a university's cost. Second, universities and colleges pay salaries unequally. At one college where I taught, the salaries ranged from $30K for an English professor to $100K for a finance professor. Finally, the golden rule for colleges and universities is the more distance between the employee and the classroom, the greater his or her salary. Consequently, the sport coaches, presidents, provosts, and deans earn the highest salaries on campus.

Administrators often proclaim the higher tuition and larger fees help support more research. Administrators transfer tuition and state funding to build new laboratories and research facilities because the research universities are the best U.S. universities. However, administrators do not reveal the full story. The administration encourages the scientists, researchers, and professors to find external funding to support their research. In some cases, a professor's longevity at his or her university depends on his or her ability to obtain research money. Professors must apply for grants from corporations and governments. Consequently, administrators force professors to finance their research with outside funding sources.

Higher education leaders use tuition and state funding to fund sports programs that can easily cost millions of dollars for a large university. In some cases, a coach of a popular sports team could earn a higher salary than the university president earns. What does sports have to do with educating students? Absolutely nothing! However, the university operates as a business. If the revenue from game tickets, merchandise, and advertisement exceed the sports program’s cost, then the university should keep the program. Unfortunately, many universities and colleges without a popular NCAA team subsidize their sports programs with tuition and state funding, diverting money away from education, and the classrooms.

The tuition and state funding, unfortunately, support the university leaders. Usually colleges and universities have layers upon layers of senior management. The upper management consists of the president, provosts, and deans. The university or college president earns a salary ranging from $200,000 to $500,000 per year with many perks. One perk is the president lives in the campus mansion for free. Other leadership positions include the provosts and deans whose salaries range from $100,000 to $200,000 per year. Although salaries in higher education are not on par with bankers' salaries on Wall Street, the salaries show the same trend. Universities and colleges cut costs by hiring more adjunct faculties or enrolling more graduate students. Moreover, administrators create new positions, such as a lecturer that pays a lower salary than a professor. Towards the top of the hierarchy, salaries for deans, provosts, and presidents are soaring.

Salaries for presidents, provosts, and deans will continue to rise because institutions stopped promoting faculty to leadership positions within the university. Thus, the United States has a shortage of leaders, causing many vacancies Then the administrators boost salaries to attract applicants from rival universities, instead of promoting within their ranks. Usually, a president, provost, or dean works at the college for several years until they transfer to a higher-paying position at another university. Before the 1990s, presidents, provosts, and deans would work for one university for their whole life. At one small university where I taught, the president's position was vacant for two years. If the university can survive without a president for two years, then the university has a great opportunity to eliminate a position, saving the state and students some money.

Colleges and universities find themselves in a difficult position in 2012. Although people flock to higher education to upgrade their skills during a recession, we are in the fifth year of the 2007 Great Recession, and no economic recovery is in sight. Higher education keeps raising the price of their service until the service becomes unaffordable. Any further tuition increases could cause students to flee. Many students do not want a college degree while they accumulate debt in the thousands and cannot find a job in a bad economy. The albatross of student loans may also haunt universities and colleges. If the 2012 college graduates cannot find jobs and start defaulting on student loans in large numbers, subsequently the U.S. government will restrict future loans. Then the U.S. government would end the era of easy loan money.

Universities and colleges cannot rely on foreign students to finance their budgets. Foreign students pay the full cost of their education, and college costs have become prohibited. Furthermore, the financial crisis is reducing the number of rich foreign students who can afford to pay high college tuition, and they have other options than to study in the United States. They can enroll in less-expensive universities in Europe or Asia, and these countries have easier visa requirements. Finally, a Chinese analyst stated in January 2012 - Although education in the United States and Europe are considered superior, and students will find better-paying jobs in their country with a U.S. or European degree, those students may not do better if they had stayed in their own country for an education. Once they include the education costs, the return to their education becomes negative. Many public universities and colleges charge foreign students between $30K and $50K per year for tuition.

The United States is caught in a college bubble. Universities and colleges have inflated their costs to unsustainable levels. Decreasing student enrollment will cause a financial tsunami that will devastate many colleges and universities. Unfortunately, universities and colleges evolved into bureaucratic institutions employing large armies of staff. Once funding starts decreasing, massive layoffs would follow. Some colleges and universities will not survive a contraction. One firm estimated 30% of U.S. universities and colleges will fail and disappear within five years. The Ivy League and well-funded public universities will survive the college bubble, but the expensive private universities, such as University of Phoenix, Kaplan University, and Devry will be the first casualties of the college bubble. University of Phoenix and Kaplan University already reported a 40% decline in enrollment for 2011. (These private for-profit universities took greed to a new level, and they deserve their own blog). Furthermore, several law schools reported 10% declines in enrollment for 2011. Some law school graduates are suing their alma maters because the law schools misrepresented the job placement statistics.

This blog's purpose is not to scare students away from higher education. This blog just illustrates that universities and colleges are greedy moneymaking ventures similar to their Wall Street counterparts. The only difference is higher education has fooled the public; they are profit institutions hiding behind their nonprofit status. The cost of higher education has exploded and has become unaffordable to students. Therefore, students must view higher education as a long-run investment, especially before they decide to accumulate thousands of dollars of debt.

Monday, January 23, 2012

The Fundamental Flaw of the Eurozone

Many people believe the Eurozone was untenable, impossible, and prone to failure, but this is not true. The Eurozone problem stems from members that cannot control their budget deficits. Most governments are also afflicted with this problem of deficit spending, when governments continually spend more than what they collect in taxes. Unfortunately, deficit spending during the Great Recession ruined the Eurozone and it will lead to its demise and break up.

The introduction of the Euro was efficient and beneficial to the Eurozone. When 17 countries use the same currency, money, resources, services, and goods can easily cross borders. (Britain still uses its Pounds and Hungary uses its Forints). In theory, regions in the Eurozone would specialize, causing production to expand and trade and commerce to flourish. With a unified currency, banks in one country could lend to citizens, businesses, and governments in other Eurozone countries. The exchange rate risk would be zero since everyone uses the same currency. Businesses could invest in other Eurozone countries with no worries of inflation or depreciating currency. Consequently, the Eurozone should unite Europe and help expand its economy.

Where is the origin of the European Debt Crisis? The problem lies with budget deficit spending, which the Maastricht Criteria explained explicitly. Before a country joined the Eurozone, a country's budget deficit could not exceed 3% of its Gross Domestic Product (GDP), and its government debt to GDP ratio could not exceed 60%. The 2011 statistics for some of the Eurozone countries are listed below in Table 1. Most Eurozone members have structural budget deficits and growing government debt far exceeding the membership criteria, specified in the Maastricht Criteria. Of course, the Maastricht Criteria impose many more conditions, but deficit and debt criteria will lead to the demise of the Eurozone and its break up.

Table 1:  2010 Budget Deficit and Debt for Select EU Countries


Budget Deficit to GDP (%)

Government Debt to GDP (%)



















Source:  Eurostats,

Where did the crisis originate? Europe was doing well until the 2007 Great Recession. Recessions always reveal weaknesses in an economy. As bankruptcies rise, employers lay off workers, and income begins falling; governments might see their tax revenue start falling. Furthermore, more people use governments’ social programs and file for unemployment claims. This becomes the heart of a financial crisis. A recession compounds a government's budget deficit. For example, let us say before the recession, the Greek government had a budget deficit to GDP ratio of 3%. We use these imaginary numbers for illustration purposes only. Then the recession strikes. Consequently, tax revenues fall by 3%, and government spending rises by 3% as more people utilize government's social programs and file for unemployment. Now, the Greek government becomes plagued with a 9% budget deficit that Greek leaders cannot eradicate.

Governments, unfortunately, have trouble reducing budget deficits. For instance, if the Greek government increases taxes, the citizens become angry and protest. If the Greek government reduces government benefits, then its citizens again become angry and protest again. Reducing budget deficits have another side effect. When a government boosts taxes or decreases its spending, the economy slows down. Consequently, the Greek government has only one option – to sell bonds to investors to cover these large deficits.

A government selling bonds to cover budget shortfalls is a temporary solution. Investors will only invest in government bonds if they believe the government will repay the bonds at full value plus interest. Every year, many Eurozone countries keep issuing bonds to cover their deficits, and their debt continually climbs and accumulates. Once a country’s total debt reaches a limit, then investors will have stop buying bonds, sparking a financial crisis.

A growing debt forces the government to increase the interest rate to attract investors. Then the interest portion of the government's budget begins to grow, causing the deficit to widen even more. If a credit rating agency downgrades a country's credit rating, such as the Standard and Poor downgrade of nine Eurozone countries in January 2012, a downgrade informs investors that a government's bonds became riskier. Thus, a government must increase interest on the bonds to attract investors. Then Greece had raised the stakes by informing investors it would pay only 50 cents on every euro to its bondholders, imposing a massive negative return of 50%. This is a huge loss! Who will buy Greek bonds now, once the Greek government had screwed the investors? Unfortunately, Greece faces a bleak future, and it will leave the Eurozone and resurrect its currency, the Drachma, again.

Many countries with perpetual budget deficits have another financing option. They can print money to cover budget deficits. If the government cannot find investors to buy its bonds, then government forces its central bank to buy its bonds, injecting money into the economy. Unfortunately, injecting massive amounts of money into the economy always lead to inflation. If a country has an inflation rate greater than 10% per year, then this inflation originates from the money supply growth. Many people believe the U.S. government's massive debt will lead to a bout of high inflation. Once investors stop buying U.S. government securities, then the Federal Reserve will buy these securities, preventing the shutdown of the U.S. federal government. Government could shut down if government cannot pay its bureaucrats and agents. (I could be wrong on this. During the breakup of the Soviet Union, people still returned to work when employers have not paid workers in months.) Unfortunately, high inflation could have a disastrous impact on an economy such as the case with Zimbabwe. In Europe’s case, a member country has no control over the money supply because European Union assigned this responsibility to the European Central Bank (ECB). The ECB has only one task - maintain an inflation rate of 2% or less.

Now we arrive at the crux of the problem. Many Eurozone members have structural budget deficits, and the politicians cannot tackle them. If the politicians increase taxes or decrease government spending, then government hampers economic growth, deepening the recession and potentially sparking violent protests in their countries. Unfortunately, these countries continue issuing bonds and covering budget shortfalls until December 2011. Then investors shied away from the bonds, triggering a crisis.

The European Central Bank (ECB) kept the government bond market afloat in Europe in 2012. The ECB either guarantees or outright purchases government bonds. Once the ECB stops buying bonds, these countries have one last option, leave the Eurozone and reintroduce their own currency. Then the countries can print as much money as they need to cover their budget deficits. Unfortunately, printing money leads to inflation and a depreciating currency, but the only choice left when the politicians cannot resolve their budget problems.

The Eurozone is not flawed. It was the perpetual government budget deficits during the booms and recessions that will force countries to leave the Eurozone. If the politicians used Keynesian economics as intended, then the Eurozone could weather the recession and financial crisis. Pure Keynesian theory suggests the government should increase taxes or decrease government spending to slow down the economy during economic booms when income grows; unemployment remains low, and the economy experiences strong job growth. A government finances would improve, and it might experience falling debt. Then government would have resources for deficit financing during a recession, when government would decrease taxes and boost government spending to stimulate the economy. However, most governments used deficit spending during good times and bad until the politicians have broken the system. Now leaders have rendered Keynesian economics useless and ineffective.

The crisis scares investors away from the Eurozone. As the world moves away from the Euro, the Euro could depreciate against other strong currencies. If the Euro collapsed, the Eurozone would enter a deep recession that it would export to the rest of the world. During a severe financial crisis, a country can impose capital controls to prevent an outflow of money (i.e. capital). A large outflow of money causes a country's currency to depreciate, which deepens the recession. Great Britain has developed plans to close its borders to the European refugees and impose capital controls if the Eurozone sinks into a deep depression.