By John W. Schoen
msnbc.com
updated 10/25/2004 3:09:59 PM ET 2004-10-25T19:09:59

With the U.S. presidential election approaching, Sara in New York wants to know: just how does the federal budget deficit affect

? Jim in Las Vegas, meanwhile, is wondering if one of Wall Street's favorite formulas is upside down.

         

You have every reason to be confused. There’s been an awful lot of hand wringing and doomsday predictions about the swelling federal budget deficit — despite very little agreement among economists about whether there’s really any reason to worry. Even those who are worried are a little fuzzy on just why.

The conventional argument against federal budget deficits is that they raise interest rates and “crowd out” other borrowing, which, in turn, makes it more difficult for the U.S. economy to grow. Here’s (in theory, anyway) how:

Say you decide to start a business when you graduate from school, and you need to borrow money to get it started. If your friends and family have put their savings in all those Treasury bills sold by the government to pay for the deficit, there’s less money lying around to invest, so you’ll have to pay someone a higher rate to get them to lend you money. That higher interest rate cuts into your profits, making it harder for your new business to survive and grow. (Even if you don’t plan to start a business, the job you’ll be looking for when you graduate could depend on some other business borrowing money to expand, create a new job and hire you.)

But it turns out the real U.S. economy hasn’t studied economics. Since 2000, the budget surplus has flipped over to huge deficits (no one’s really even sure just how big they are) mostly due to big tax cuts and increased spending on the Iraq war. Meanwhile, interest rates have actually fallen during that period. (The reasons for that are even more confusing, but if you want to dive into that question, check out this excellent paper by Sylvain Leduc at the Philadelphia Fed. He concludes that rates only rise if people are worried about future deficits)

So if the current budget deficit hasn’t raised interest rates and it doesn’t seem to be hurting the economy, why are some people — including Fed Chairman Greenspan, who knows a thing or two about economics  — warning that deficits are so bad? The answer is that deficits may rise and fall, but they can’t keep rising forever. So, as Greenspan warned this summer, things may be OK for now, but he’s worried about looming Social Security and Medicare costs from the “inevitable retirement of baby boomers starting in 2008 and beginning to accelerate in 2011 and 2012.” In other words, you may be able to carry your credit card balance OK today, but if you think you’re going to need to buy a new car tomorrow, you’ve got a problem.

It’s also important to look at where the money is coming from to pay for the federal budget deficit. If Uncle Sam borrows from you and me, and we buy Treasury bills with savings from our paychecks, that’s not such a bad thing. The interest we earn on those T-bills goes back into the economy and keeps it growing. And eventually we can cash in our T-bills and buy more stuff.

But what’s happening now is that more and more of those T-bills are being bought by people outside the U.S. — who are making more and more of the stuff we buy. That means 1.) Americans aren’t saving as much as they used to and 2.) we’re basically financing our appetite for imports with debt held by foreigners. In other words, the American economy is running up its credit card with money borrowed from the rest of the world.

That’s OK for now: much of the money foreigners lend to us goes right back to their economies when we buy stuff made somewhere else. So they like to keep lending, and we like to keep borrowing. But the trend is not sustainable. It could take decades, but sooner or later Americans will have to 1.) pay cash for what we buy from abroad and 2.) pay back all those foreigners who lent us money.

Major Market Indices

If that happens gradually, there’s no reason to think it will hurt the U.S. economy. But if the process happens too quickly — if for example, the dollar plunges and foreigners decide they’re not that interested in buying T-bills any more — that wouldn’t be good. A rapidly falling dollar could spark inflation (because you have to use more dollars to buy the same German car or Asian-made cell phone.) And the solution to inflation is higher interest rates. Which, once again, makes it harder for you to open up that new business or find one that’s hiring.

Upside down P/E?
The P/E earnings (ratio) has always confused me. Isn't the number an inverted fraction? If XYZ company's stocks sell for $1 and it earned $0.05 ,the price to earnings is 20 (1.00/.05) -- instead of a more friendly representation like 5 percent (.05/1.00 * 100). I would think it would be easier to understand if XYZ told its investors their stock value earned 5 percent. Please correct me if I'm wrong.
          Jim C. -- Las Vegas, Nev.

You could calculate it that way, but looking at the price paid for every penny of earnings is more like putting a “price tag” on each stock. To the extent that stocks trade on earnings, keeping the price in the numerator more accurately reflects prices paid. So the higher the P/E, the more you’re paying for the stock. (Inverting it would reverse this comparison.)

The percentage measure is usually reserved for ratios like Return on Equity or Return on Investment. That’s given as a percentage because it more like the return you get on a fixed income security or the dividend return on a stock.

About the only place you typically see a percentage given as a price is when you’re talking about bonds. When Treasury bonds are first issued, investors bid on them by naming the minimum interest rate they’ll accept before they’ll part with their money, lending it to the government. As those bonds are traded in the secondary market, the yield moves up and down depending on how much payback new investors want for their money.

Sept. 17, 2004

Last week's column on the Bush administration's tax cuts prompted a number of readers, including Gary in Pennsylvania, to ask: who, exactly, should get the blame for the lousy economy during much of Bush's term in office? Meanwhile, Curt in Minnesota is trying to figure out how to avoid picking up the tab for back taxes apparently owed by his wife's former spouse.

The 'Bush' recession?
Would you please explain why the Republicans keep saying they inherited a recession?  How accurate is that statement?
         
Gary G. -- Sinking Spring, Penn.

Like much of what you hear during this political season, there's a bit of truth on both sides. Let's look at the numbers:

Employment levels peaked in March of 2001 with 132.5 million American on non-farm payrolls – two months after Bush took office. So, if you go by the jobs data, the recession began on Bush’s watch.

That's one of the key statistics cited by the National Bureau of Economic Research, the private group that tracks business cycles. It’s widely regarded by economists as the arbiter of just when recessions begin and end. According to the NBER, the recession began in March, 2001.

But economic expansion doesn’t come screeching to a halt just because a new president takes office. The seeds of the slowdown were clearly in place. After nearly a decade of uninterrupted quarterly gains, the Gross Domestic Product shrank by 0.5 percent in the third quarter of 2000. (A slight drop in GDP doesn’t by itself, indicate a recession is near. But in this case, it seems to have foreshadowed the slowdown.) More important, perhaps, was the bursting of the stock market bubble. Measured by the S&P 500 index, the stock market peaked on Sept. 1, 2000 at 1520.77.  Again, a stock market pullback -– by itself -– doesn’t indicate the start of a recession. But it’s often a pretty good predictor of an impending slowdown.

The real question is whether the Bush administration did everything it could to reverse the decline and get the economy back on track. For example, Bush has very appropriately blamed the terror attacks of 9/11 for sending the U.S. economy further into recession. But were those attacks preventable? If so, should the Bush administration bear some of the responsibility for not heading them off? (We'll let you decide the answer to that one.)

As with much of the debate in the current presidential campaign, these numbers probably won’t change too many minds. The record clearly shows that the recession began on Bush’s watch, even though there were signs it was coming during the last months of the Clinton administration. Whether the outcome would have been different with a Democrat in the White House is really unknowable.

Paying your ex's taxes
My wife and I were married in April this year and I was planning to file our 2004 federal taxes married-jointly come next April.  However my wife had her last (albeit small) refund zeroed out by the IRS when she filed married-separately in year 2000 (while married but separated from her former spouse).  Instead of the expected refund she got a form letter from the IRS saying that the $64 refund was being applied "to other federal taxes owed on a secondary social security number."  The letter listed the social security number of her ex-husband (now deceased) and said the refund was being applied to 1996 tax owed.  Her ex-husband had her sign their married-jointly tax returns up through 1999 and she was unaware that any shenanigans were taking place.  We don't know the extent of how much money was or is still owed.  They separated in 2000 and he passed away in March 2004.  The little estate he had left was handled by his friend/executor.

The letter gave no indication that the IRS is going to do anything aside from take her refunds.  In the 3 years since (2001-2003) she did not have a refund coming so the issue has not resurfaced but I would not be surprised if the IRS would continue to take any refunds. I have 2 questions:

1)  I am expecting a pretty good refund for 2004.  If my wife and I file married-jointly, can the IRS take that refund for her past "sins" given that I had nothing to do with it?  If that is possible then both of us will file married-separately.

2)  Could the IRS come after our joint assets (due to our marriage)?  She has no significant assets of her own.  If so, should we contact an attorney or what would you recommend?
          
Curt S. -- Lakeville, MN

For starters, you should definitely contact a good tax accountant if you don't already have one. You need to find out more about those "other federal taxes owed on a secondary social security number."  Specifically, how big is that number? If it's relatively small, it's probably better (and cheaper) to pay it and put the matter to rest.

If the IRS believes your wife still owes a substantial tax for the jointly filed returns of a previous marriage, it really doesn't matter how you file future returns or title your assets. For people like you and me who follow the rules, it's not easy to hide from the IRS when it comes to back taxes. For example, they could put a lien on (the legal term is "garnishee") your wife's wages.

If she has sizable "back taxes" (according to the IRS) you may also be able to challenge that position on the grounds that she had nothing to do with failing to pay those taxes. For that, unfortunately, you'd almost certainly need to hire a tax lawyer. The IRS takes the position that spouses signing tax returns are legally bound to vouch for the truth of everything in that return and bear the burden of seeing that those taxes are paid.

September 10, 2004

With the presidential campaign heating up, Answer Desk readers are getting into the swing of things. George in Arkansas wants to know just how much impact the Bush tax cuts have had on the economy. And Thomas in New York is wondering if the Chairman Greenspan and the rest of the Fed take politics into account when they set interest rates.

Tax cut math
I was wondering what exactly is the idea behind the benefits of Bush's tax cuts? I understand that there are two very opposing views on this, but maybe if someone could explain to me the alleged math behind it, I would find it a little easier to decide who to vote for. What is all this about trickle down economics and such that I'm missing?
           George G. --  Little Rock, AR.

In theory, tax cuts help stimulate the economy by putting more money in peoples’ pockets, which they then spend on goods and services. The increased demand for those goods and services creates new jobs, which puts more money in those new job holders’ pockets, and around and around it goes. That’s the “trickle down” part. Economists also call it the “multiplier effect” -– one dollar in tax cuts produces more than one dollar in new economic activity.

It’s generally agreed that the Bush tax cut did have the intended impact: The economy perked up and so did job growth. The question is whether the tax cut was the best way to accomplish that goal. For one thing, tax cuts work best if they’re targeted at people who will spend the money. It’s less clear that wealthy people change their spending habits much; many simply use the tax cut to acquire more wealth, which does little to help economic growth. (Democrats argue that too much of the tax cuts were aimed at the wealthy; Sen. Kerry has proposed reversing the cuts for the very wealthiest.)

It’s also not clear how much “staying power“ the latest round of tax cuts will have.  If you give everyone a few hundred dollars to spend, things will pick up as that “tax rebate” moves through the system. But once spent, will the economy keep growing or weaken until the next tax cut comes along? Critics of tax cuts argue the money would be better spent on things like job training to give people skills to get better jobs, which help make the economy stronger. But the success of past jobs training programs has been mixed.

The staying power of this economic recovery over the next two months will be critical to the outcome of the election. That’s why everyone is focused so closely on the monthly employment numbers; they’ve been showing OK — but not great — economic growth. Keep in mind there are other economic forces at work as well; by some estimates, the recent rise in the price of oil pretty much wiped out the economic benefits of the Bush tax cut.

What’s more troubling to “fiscal conservatives” of both parties is that the combination of massive tax cuts and major new spending for the war in Iraq has destroyed a decade’s worth of work (by both parties) on balancing the federal budget. For the first time in modern history, the U.S. government in the late 1990s behaved like most U.S. wage earners — it lived within its means. But deficits are once again piling up at the rate of hundreds of billions of dollars a year. So in that sense at least, the Bush tax cut simply doesn’t add up.

Fed politics
Who makes the interest decisions at the Federal Reserve? And are they politically motivated?  Is Greenspan a Republican? Recently, I noticed that interest rates are, of course, quite low, yet we have an expensive war going on that must be paid for.  Yet the "Fed" doesn't seem to take an expanding deficit into account when it makes its interest rate decisions. And don't very low interest rates destroy the "relative value" of our currency with respect to other currencies that can "pay" investors more?
          Thomas V. -- Elmsford, N.Y.  

The Federal Reserve's Open Market Committee meets about every six weeks to set interest rate policy. They do this by adjusting the fed funds rate and by adding or draining money from the banking system by buying or selling Treasury debt on the open market.

As for Greenspan's political leanings, he's worked under both Democratic and Republican administrations, and he's very careful in his statements on Capitol Hill to avoid partisan politics. But given the importance of the Fed's work and its impact on the election, it's almost impossible for the central bank to remain completely above politics. In the past, it has avoided major rate moves as elections approach. The Fed's main focus is to steer between fighting inflation (by raising rates) and keeping the economy moving along (by lowering them.) In its latest statement on the subject, the FOMC said it's currently not leaning one way or the other and will take a "measured" approach to rate moves. That sure sounds like they're trying to stay out of the political fray.

As for budget deficits, Chairman Greenspan has been clear that Congress needs to get the budget back into balance. As recently as this week, he repeated his warnings that the problem will only get worse as Baby Boomers begin retiring, placing even bigger strains on the budget.

Even it the Fed were to get political, it's grip on long-term interest rates is limited. Those are set by the bond market. Four times a year, the Treasury auctions off the new debt needed because Congress is spending more than it's collecting in taxes. Investors bid for that debt by naming the interest rate they'll accept; the government fills the lowest bids. Bonds then change hands in the secondary market (the bond market) and interest rates on that debt rise and fall based on market conditions. The size of the deficit only indirectly impacts interest rates; if investors think those deficits have weakened the U.S. economy, for example, they'll demand higher rates at the next auction or when they buy bonds in the open market. But as long as demand remain strong for Treasury debt, big deficits by themselves don't have much impact on rates.

All things being equal (which they never are) lower rates tend to lower the value of the dollar because Treasury debt is denominated in dollars. Higher rates boost the dollar in that they make those Treasuries more attractive to investors buying them with foreign currencies. But higher rates also tend to slow the U.S. economy, which can have the effect of weakening the dollar. (The Treasury officially supports a "strong dollar" but it has little practical control over its value.)

September 3, 2004

Today’s monthly employment report has prompted questions from several readers about just how reliable the numbers are. John in New Jersey is puzzled by conflicting claims by the presidential candidates about how many jobs have created or lost since President Bush took office. Elsewhere in New Jersey, Tom suspects the actual unemployment rate in his state is much higher than the “official” numbers suggest.

Numbers game
The Bush administration keeps quoting how they've created 1.2 million jobs (in the last 10 months, I believe). And, the media keeps reporting a net job loss of about the same amount.

However, from everything I've read, America has approximately between 130,000 to 150,000 people entering the work force each month. Bush has been in office from January 2001 till now. That's 42 months or 5.46 million. If Bush has created 1.2 million jobs, isn't the net loss the difference in those two numbers and should be 4.26 million?

Are my calculations sound or am I way off here?
          John -- Egg Harbor Township, NJ

The nice thing about statistics is that, by choosing the right numbers, you can make them say just about anything you want.

The Bush administration is correct in saying that it has created more than a million jobs (1.7 million, in fact) in the last 12 months. And Democrats are correct in saying that 1.1 million jobs have been lost since Bush took office. How can they both be right?

The answer is that the job market, while improving, still hasn’t made up for the jobs lost during the worst of the latest recession. Here are the numbers: when Bush took office in January 2001, total non-farm employment stood at 132.4 million. By August 2003, that number had shrunk to 129.8 million, a loss of about 2.6 million jobs. Since then, job growth picked up, raising the jobs number to 131.5, a gain of 1.7 million. (By contrast, during the eight years Clinton was in office, the economy produced something like 22.7 million jobs — or about 2.8 million jobs per year on average.)

Those numbers mask a huge churn of jobs moving from one part of the economy to another. Last year, some 30 million U.S. jobs were created — about 24 million from companies that expanded their payrolls and the rest from newly-created companies. But those gains were offset by the loss of 30.2 million jobs — from layoffs and companies going out of business.

Meanwhile, the labor force, as you point out, has been steadily growing — on average by about 90,000 workers every month since Bush took office. But there weren’t enough jobs to go around for all those new workers. That’s why the unemployment rate went up — from 4.2 percent when Bush took office to a peak of 6.3 percent last June. Since then, the unemployment rate has fallen to 5.4 percent, thanks to all those new jobs created in the past 10 months. So your math isn’t far off. But it’s not really accurate to say that those unemployed people represent jobs lost. Since they were new to the work force, they didn’t have a job to begin with.

Before you all take these statistics to the next political rally to support your favorite candidate, keep in mind that these are only estimates. And it’s worth noting that even though the folks at the Bureau of Labor Statistics take two separate monthly surveys, the numbers don’t add up. The data from the household survey — obtained by calling people up at home and asking them if they have a job — don’t match the payroll survey of employers. (Because the payroll survey covers more jobs, it’s generally considered more accurate of the two surveys, so those are the numbers we’ve used here.)

Crunching the numbers
There is a widespread belief in N.J. that our reported unemployment rate, recently said to be 4.9 percent in a mailout from our governor, is considerably below the true value.  One reason is said to be that when your unemployment benefits run out after 6 months, you are no longer considered unemployed.  This sounds ludicrous, but the story is repeated by word-of-mouth so frequently that I wanted to get to the bottom of it. I would also appreciate your comments regarding how this rate calculation is handled in other states. I am currently unemployed and this issue is near and dear to my heart.  I see far too many men driving around and jogging during the day in the neighborhood, and I think the true unemployment rate (when all the jobseekers are included) is much higher than what we are being told.
          
Tom S. -- Pennington, N.J.

The New Jersey governor’s mailing is correct — even if you add the upcoming loss of his job to the statistics. The state's employment picture roughly mirrors the rest of the nation: the unemployment rate has been falling over the last year from a high of 6.1 percent in July, 2003. Though the job drought is easing somewhat, the situation is nowhere near as rosy as it was during the boom of the late '90s — when the jobless rate in the state hit a low of 3.4 percent in February 2001.

As for how gets counted, the Bureau of Labor Statistics asks people in it household survey if they are employed, looking for work or not looking. If you’re looking for work and unemployed, you get counted as unemployed even if your benefits have run out.

Keep in mind these are statewide averages — the unemployment rate in your neighborhood will almost certainly be higher or lower. In New Jersey, for example, the numbers at the county level range from a low of 2.7 percent in Hunterdon County to a high of 7.0 percent in Cumberland County.

GOT A QUESTION?

Ever wonder what a P/E ratio is and why it's so important? Are you confused about the official definition of a recession? And just what the heck is a derivative? We're here to give you the answers. MSNBC.com's weekly feature "The Answer Desk" helps you make sense of business, the economy and investing. So send along your questions to answerdesk@msnbc.com and we'll try to get you the answer. (Please include your home town with your question; we'll only include your first name if we use your question.)

Any question is fair game, with one exception: no questions about specific investment recommendations, please -- we'll leave the stock picking to the "pros."

Each week, we'll take some of the most-frequently-asked questions and answer them here. We may not be able to answer every question, but over the weeks and months we will provide a comprehensive resource for you, explaining some more puzzling aspects of business and finance.

You can mail in questions at any time and then check this column every Friday for the answers.

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