Flotte’s Outlines

United States Economics

General Economics

International Economics

Medical Economics

2008 Financial Crisis

1. US Gross Domestic Product
2. Productivity and Technology
3. Consumer Spending and Debt
4. Employment and Wages
5. National Debt and Federal Budget
6. Medicare, Social Security, and Healthcare Spending
7. Inflation
8. Interest Rates
9. Trade Deficit
10. Value of the Dollar
11. US Corporations
12. Stock Market

Real Estate

US Economic History

Pre-Civil War

· The South was primarily an exporter of raw materials and importer of manufactured goods, whereas the opposite was true in the North. This led the North to favor tariffs and the South to oppose them, which further divided the two regions.

· The North becomes an industrial power, while in the South cotton-growing is king.

· Banks at the time require charters from state legislatures, encouraging corruption in many cases

· Banks, municipalities, trade associations, and other entities all print paper money, called “scrip”, although banknotes from the Bank of the United States (when in existence) are the most common form of currency)

· 1790 The first American cotton mill (spinning mill) is built in Providence, R.I. by Samuel Slater, an emigrant from England, and the American Industrial Revolution begins. Until then textile production was dominated by Britain, which guarded its machines and technical experts carefully, forbidding their export or emigration. Cotton mills spread around New England, which becomes the second largest textile producer (behind England). Mills and factories gradually replace New England farms. In 1814 the first factory is built in Massachusetts to turn cotton bales into finished cloth.

· 1793 Eli Whitney invents the cotton gin, spurring the growth of the cotton industry and helping to institutionalize slavery in the U.S. South. It separated the cotton lint from the seeds by having tines pull it through a grill (the seeds were left behind). A single laborer could now due the work of 25 laborers working by hand. American cotton production goes from 5 million pounds in 1793 to 2 billion pounds in 1860, and from 1% to 70% of the world’s cotton supply in the same period. It is grown best in Alabama’s black belt and the Mississippi Delta. In the 1810s South Carolina was the leading producer, in the 1820s it was Georgia, and in the 1830s Mississippi and Alabama, followed by Louisiana. American raw cotton was shipped to Britain where cloth was produced.

· 1807 Embargo Act bans all trade with foreign countries and forbids American ships to set sail for foreign ports. It is proposed by President Jefferson as a response to the forced impressments of American ships and sailors by Britain and France. This act has a lasting negative effect on New England seaports. Exports drop from $48 million to $9 million. New England governors refuse to supply militia to enforce the Embargo Acts. It is repealed in 1814.

· 1807 Robert Fulton builds the first steamboat, the Clermont, to run from New York up the Hudson. Robert Livingston, minister to France, had employed him and they both win a monopoly on steamboat travel on the Hudson fron the New York legislature.u7

· 1813 During the War of 1812, with the bank of the United States’ charter expired in 1811, America goes in to extreme financial difficulty. The war effort is saved by a $16 million bond issue subscribed to by the likes of John Jacob Astor and Stephen Girard.

· 1816 The Second Bank of the United States is founded. The South favored its recharter because of a chronic lack of specie, which ended up in Northern banks due to a trade surplus. It over-lent and then called in its money, sparking financial panic. President Andrew Jackson ended its special status in 1836. Five years later, as an ordinary commercial bank, it went bust.

· 1816 Congress passes the first protective tariff for the New England textile industry, which is heavily opposed by the South.

· 1817 The New York Stock and Exchange Board is founded. At the time Philadelphia has the nation’s largest stock exchange (founded in 1792), and Boston also had a large exchange. It becomes the New York Stock Exchange in 1863.

· 1825 The Erie Canal is completed. The produce of the Midwest is shipped via the Great Lakes to the Hudson River and New York. New York becomes the commercial hub of the nation and its largest city. John Jacob Astor, owner of Manhattan real estate, becomes the nation’s richest man. The first load of Midwestern grain is shipped in 1836

· 1826 First American railroad completed in Quincy, Massachusetts

· 1828 The federal “Tariff of Abominations” which benefited Northern industrialists at the expense of Southern planters leads to the South Carolina nullification crisis.

· 1832 Henry Clay pushes through a bill to recharter the Bank of the United States. The Bank’s president, Nicholas Biddle, conspires with Clay. Jackson personally opposes Biddle and vetoes the bill. 1833 Under Jackson’s instruction, the government shifts its deposits from the Bank of the United States to state banks, a move that weakens the Bank. The act is of dubious legality, and Jackson fires two Treasury Secretaries until the third complies with the order. The Senate censures Jackson over the issue, until 1834 when the Democrats win the Senate and expunge the censure. By 1836 the Bank is defunct.

· 1835 The national debt is paid off for the first and only time under Andrew Jackson’s direction. To increase the amount of available money needed for a growing economy, the state banks begin to issue bank notes not backed by gold and silver. Inflation results.

· 1836 The problems arising from growing inflation, land speculation, and worthless currency lead President Jackson to issue the Specie Circular, which requires that public lands be paid for in gold or silver instead of paper money, which had been issued in an uncontrolled fashion by banks.

· 1837 Following several months of increasing inflation and shrinking credit as Western banks fail due to the Specie Circular, the Panic of 1837 begins, causing widespread bank failures and unemployment. 90% of the nation’s factories close, cotton prices fall by 50%. Philadelphia’s days as a rival to Wall Street end. The recession bottoms in 1843.

· 1858 Financial Panic of 1858

· 1862 U.S. notes, (called “greenbacks”) the first national currency, began circulating during the civil war; they were authorized by the Legal Tender Act of 1862. The Department of the Treasury issued these notes directly. Congress limited the amount of U.S. notes in circulation $300 million. (The Treasury Department stopped issuing U.S. notes in favor of Federal Reserve Notes, and none have been placed into circulation since 1971. Those that remain in circulation are obligations of the U.S. government.)

Post-Civil War

· Foreign investment and massive flows of immigration fuel infrastructure and industrial growth

· The “golden age” of railroads begins. The rail network grows from 35,000 in 1865 to a peak of 254,000 miles in 1916.

· 1869 Jay Gould and Jay Fisk attempt to drive up the price of gold and corner the market. On 9/24, "Black Friday," President Grant releases $4 million and drives the price down, an action that causes a stock-market panic.

· 1873 Financial Panic of 1873 begins with the failure of Jay Cooke and Company after years of inflation, speculation, and the overproduction of paper currency. The Stock Exchange closes for 10 days.

1880-1890s Emergence of trusts & monopolies, the “Robber Barons”

· 1870 John D. Rockefeller founds the Standard Oil Company. 1882 Rockefeller organizes the Standard Oil Trust.

· The Dupont company had been formed in 1802 by Irinee Dupont, who had studied under Lavoisier, to sell gunpowder. Pierre S. Dupont made a fortune in World War I selling munitions, then bought a controlling interest in General Motors. The company diversified into chemicals (nylon and synthetic fibers, lacquers, etc) to avoid antitrust laws.

· 1887 Interstate Commerce Act passed

· 1890 Sherman Anti-Trust Law

· 1893 Panic of 1893

· 1897 Backing away from earlier pro-business decisions, the Supreme Court votes 5-4 that railroads are subject to the Sherman Anti-Trust Act, led by Supreme Court Justice Louis Brandeis (who wrote Other People’s Money and How the Bankers Use It.)

· 1900 Spindletop claim in Beaumont, Texas brings in oil, the first in that region. Starts the Texas Oil Boom.

· 1907 Panic of 1907. Financier J. P. Morgan manages the crisis, importing $100 million in gold to bolster U. S. currency.

· 1911 Supreme Court orders the breakup of Standard Oil and American Tobacco Company

· 1913 The Federal Reserve System is formed after the Panic of 1907.

· 1914 Federal Trade Commission formed. Clayton Anti-Trust Act.

· 1914-1920 WWI brings temporary but substantial government intervention in the free-market economy, including regimentation and takeover of key industries such as railroads

· 1920s Stock market boom, return to unfettered capitalism

• An era of "laissez-faire" capitalism under conservative presidents concerned with fiscal rigor sees boom times in the urban economy and the emergence and rise of large modern corporations. Protectionism in trade mirrors isolationism in foreign affairs, but U.S. investment spreads around the world. Farmers do not share in the good times, as agrarian recession turns to deep depression.
• Stock market investing is fueled by the invention of ticker tape

· 1929-1939 The Great Depression

• 1929 On "Black Thursday" 24 October, 13 million shares are sold on the New York Stock Exchange; despite efforts to shore up prices by J. P. Morgan and John D. Rockefeller, prices fall again on 29 October, "Black Tuesday," as 16 million shares are sold. By 13 November, $30 billion has been lost in devalued stocks. Although all of the effects are not felt immediately, the stock market crash marks the beginning of the Great Depression

· Samuel Insull: head of Chicago Edison, held 65 chairmanships, 85 directorships, 11 presidencies thru holding companies, is bankrupted. Becomes a symbol for capitalist excesses

· 1932-1939 Roosevelt’s New Deal

· 1932 Congress sets up Reconstruction Finance Corporation to stimulate economy.

· 1933 National Recovery Administration: cooperation of labor, business, & government to reduce output, set prices, increase incomes. Thrown out by 1935.

· Security & Exchange Commission is formed to limit insider trading, reporting requirements, independent audit, etc. after it was discovered that New York Stock Exchange president Richard Whitney had embezzled $30million. Led by Joseph P. Kennedy & James Landis

· 1935 Public Utility Holding Company Act dismantled holding companies

· Regulatory commissions established during this period: Federal Power Commission, Federal Communications Commission, Civil Aeronautics Board, National Labor Relations Board

· Tennessee Valley Authority developed as an experiment in state-ownership

· Dollar is put on the gold-standard ($35/oz)

· Recession in late 1930s is allegedly caused by a “capital strike” as business withheld capital to protest regulation & undermine the New Deal

· 1938-1940 began to be influenced by Keynes – deficit spending

· 1941-45 WWII The Office of Price Administration & War Production Board manages the economy

Post-WWII

The US and USSR become the principal economic forces after World War II, while Europe loses its dominance.

1946-1965: Steady growth occurs in the post-war economy, as the US becomes a dominant economic power. Keynesian economics and socialism dominate the US.

· 1946 Employment Act. Truman embraces Keynesian policies to expand the economy through full employment. Wartime controls are gradually released as the economy stabilizes. The OPA & WPB led bad taste in public’s mouth for government control as being overly intrusive and lead to a decline of regulation under Truman & Eisenhower. Truman's social liberalism comes up against dissent in his own party, and a growing anticommunist, security-focused sentiment stoked by the Korean War and the onset of the Cold War

· When Truman ordered the Commerce Department to take over 87 steel plants crippled by striking workers during the Korean War, the high court ruled that he had pushed executive prerogative beyond acceptable bounds

· 1947 The Marshall Plan is initiated to rebuild Europe while preventing the spread of communism

· 1950s Defense spending due to the cold war is the primary engine of growth

· 1952 A complaint is filed against IBM, alleging monopolistic practices in its computer business, in violation of the Sherman Act. It will last until dismissed in 1982.

1965-1982: The economy stagnates as inflation rises and oil crises hurt the economy

· 1970s The rise in oil prices sends the US into recession with rising unemployment and inflation (stagflation). Nixon attempts to impose wage and price controls but they fail to control inflation or improve unemployment. This leads to downfall of Keynesianism and the end of fixed-exchange rates and controls of capital.

· 1971 Inflation rises from 1.5% to 5%, unemployment 3.5% to 5%. Nixon declares “I am a Keynesian”. Budget includes deficit spending for full employment. Arthur Burns, Fed chairman, believed that competition between unions and business was pushing prices and wages up. Aug.: New Economic Policy: developed at Camp David conference. A 90 day wage and price freeze is instituted. Takes the dollar off the gold standard, ends fixed exchange rates. The US balance of payments deficit was high due to foreign governments accumulating dollars. In August Britain had requested $3billion to be converted to gold.

· 1970–1975 Burdened by regulation and subsidized competition, nine railroads file for bankruptcy. The Rail Passenger Service Act creates Amtrak to take over intercity passenger service. Consolidated Rail Corp. (Conrail) is created from six bankrupt Northeast railroads.

· 1973 The OPEC oil embargo delivers a shock to the economy. Inflation begins to rise again due to the international economic boom, crop failures in the USSR, and oil prices. Nixon imposes a second round of price controls, which are abolished in 1974 (except for oil & gas)

· 1974 Inflation rate is highest since the 1920s, unemployment is at 9%. Nixon creates several regulatory agencies: Environmental Protection Agency (EPA), Occupation Safety and Health Agency (OSHA), Equal Employment Opportunity Commission (EEOC)

· 1974 Deregulation of the US airline industry begins. There had been no new airline companies in 40 years – as the regulation protected the companies from competition. This is led to closure of the Civil Aeronautics Board. As a result prices fall and airline travel increases.

· 1976-1980 Inflation and unemployment remain major problem during the Carter administration despite his Keynesian methods to fight them

· 1979 Inflation hits 13%. Paul Volcker takes over as Federal Reserve Chairman; his tight-money policy and raising of interest rates triggers a recession but controls inflation

· 1980 The Staggers Rail Act reduces the Interstate Commerce Commission's regulatory jurisdiction over railroads and sparks competition that stimulates advances in technology and a restructuring of the industry.

1982-2001: A steady period of growth occurs during the 1980s that continues into the 1990s

· 1980 Ronald Reagan institutes “Reganomics” - a “supply-side” free-market economics in which incentives are given to business to stimulate growth, instead of governing spending being used to increase demand. It has 4 key elements: low government spending, deregulation, low tax rates, and sound money. Keynesianism is seen as being inherently inflationary.

• Ronald Reagan's economic advisor Arthur Laffer theorized that by cutting tax rates, the US would enjoy so much extra growth that tax revenues would actually rise. Critics state that Reagan's tax cuts did not lead to higher tax revenues but instead resulted in massive deficits
• 1980 The Staggers Rail Act reduces the Interstate Commerce Commission's regulatory jurisdiction over railroads.
• 1981 Reagan fires striking air traffic controllers permanently altering balance between management and labor
• 1987 Conrail is privatized in what was the largest share offering in U.S. history
• Reagan’s tax cuts lead to a growing economy but large deficits

· 1984 AT&T and the Bell System are broken up

· 1985 Saving & Loans crisis. The Savings and Loan crisis was a wave of savings and loan failures caused by mismanagement, rising interest rates, failed speculation, fluctuation in real estate values, and, in some cases, fraud.

· In 1982 S&Ls were deregulated so they could pay higher market rates for deposits, borrow money from the Federal Reserve, make commercial loans, and issue credit cards like commercial banks. Deregulation at the federal level caused a race to the bottom at the state level (especially in California) because state regulators were paid by the thrifts they regulated, and they didn't want to lose that money.

· In an effort to take advantage of the real estate boom and high interest rates of the early 1980s, many S&Ls lent far more money than was prudent, and in risky types of ventures in which many S&Ls were not competent. Whereas insolvent banks in the United States were typically detected and shut down quickly by bank regulators, the S&L regulators were apparently surprised by deregulation, and not sufficiently competent or staffed to perform the due diligence needed to regulate effectively. Many banks, but particularly savings and loan institutions, were experiencing an outflow of low rate deposits, as depositors moved their money to the new high interest money market funds. At the same time, the institutions had much of their money tied up in long term mortgages which, with interest rates rising, were worth far less than face value.

· The ultimate cost of the crisis is estimated to have totaled around $150 billion, about $125 billion of which was directly borne by the U.S. government, which contributed to the soaring deficits of the early 1990's. The concomitant slowdown in the finance industry and the real estate market may have been a contributing cause of the 1990-1991 economic recession.

· 1985 The Gramm-Rudman-Hollings Act called for automatic cuts in discretionary spending when certain deficit-reduction targets were not met. When it began to affect popular programs, and was partially overturned in the courts, it was first amended to postpone the strength of its effects until later years, and then repealed in its entirety.

· 1987 Alan Greenspan becomes chairman of the Federal Reserve Board, replacing Paul Volcker.

· 1980s Junk-bonds are popularized by Michael Milken at Drexel after he showed that below investment grades companies paid 3-10% higher interest but went bankrupt only slightly more often.

· 1980s Corporate takeovers streamlined American economy for globalization

· 1987 On “Black Monday” October 19 the stock market drops 508 points (23%), representing $1 trillion.

· The crash was exacerbated by a complex, volatile trading strategy called "index arbitrage" -- which had come to account for 10% of shares traded on the NYSE.

· 1990s The economy enjoys steady growth as the Internet and Information Revolutions lead to increases in productivity

• Budget deficits fall as the economy grows and spending is cut
• 1991 A brief recession occurs related to the Persian Gulf War

· 2001-2002 The stock market falls and economy slows

· Dot.com bubble: Stocks, particularly technology stocks, had become overvalued

· Corporate Accounting Scandals

· September 11, 2001 terrorist attacks

· The 2001 downturn was primarily accounted for by the sharp cutback in business spending, while US households continued to expand their spending

· Other factors: balance-sheet stress in the corporate sector, low profitability, and an investment overhang, particularly in Information Technology (IT) and communications, all of which weighed on the ability of US businesses to invest.

· The Federal Reserve lowers its Federal Funds Target Rate from 6.25% in 2001 to 1% in 2003-2004.

· 2003-2007 The U.S. economy has now been expanding for more than five years — 63 months

· Since World War II, the average time between recessions has been just 57 months. On the other hand, the last period of sustained economic growth lasted 10 years, from 1991 to 2001. And the one before that lasted 92 months, from 1982 to 1990.

· The Federal Funds Rate remains as low as 1%, until well into 2004, when it is gradually raised to 5.25% in 2006.

· In 2003 Congress passes an Economic Stimulus Package.

· 2001-2007 The US budget deficit and trade deficit continue to grow

· Developing countries will not be prepared to go on financing America’s massive current-account deficit for much longer. At some point, therefore, America’s cost of capital could rise sharply. There is a risk that the American economy will face a sharp financial shock and a recession, or an extended period of sluggish growth. Falling house prices would add to Americans’ existing concerns about stagnant real wages, creating more support for protectionism.

· In a speech in 2004, then Federal Reserve Chairman Alan Greenspan said: "It is difficult to imagine that we can continue indefinitely to borrow savings from abroad at a rate equivalent to 5% of U.S. gross domestic product."

· By the third quarter of 2006, the U.S. was dependent on foreign lending of more than $860 billion, or about 6.5% of gdp.

· U.S. household debt as a percentage of income rose to 130% during 2007, versus 100% earlier in the decade.

· 2001-2005 US Housing/Real Estate Boom

· The real estate boom is encouraged by low interest rates, and declines as interest rates rise in 2004-2006

· The Fed's easy monetary policy helped raise house prices over several years. In turn, a large number of first-time buyers took advantage of low mortgage rates, especially on adjustable-rate loans, to stretch their buying power in the hopes of leveraging their way up the home-buying ladder. But in late 2005, and the buying dried up.

· The Fed's concern over housing's potential effect on the broader economy led it to lower interest rates, despite signs that inflation risks remain.

· The U.S. home ownership rate increased from 64 percent in 1994 (about where it was since 1980) to a peak in 2004 with an all time high of 69.2 percent

· Between 1997 and 2006, American home prices increased by 124%.

· Homeowners used the increased property value to refinance their homes with lower interest rates and take out second mortgages or Home Equity Lines of Credits (HELOC) to fund for consumer spending.

· 2006- Real Estate Depression

· 2007 Subprime Crisis and Credit Crunch

Federal Reserve System

Creation

· In the early 1900s, the nation was suffering from periodic liquidity crises. These crises or "panics" occurred because the banking system was fettered with a rigid amount of currency that could not meet unusual demands, and a system of reserves that pyramided up to New York. During these panics businessmen and farmers were unable to obtain credit to finance inventories and the production and transportation of crops. The crises spread across the country and converged upon Wall Street, resulting in plunges in the stock market, a large number of bank and business failures, and a further shortage of currency.

· Unlike other industrial nations, the United States had no central bank to ease the effect of economic shocks or to prevent them, by creating or depleting bank reserves. European banking experts had long been appalled by its irrationality and lack of central control. For several years, leading bankers such as Jacob Schiff had predicted disaster and some had proposed reforms, such as assigning central banking functions to the Treasury or creating an asset-based currency, but neither Congress nor President Theodore Roosevelt had taken action.

The Panic of 1907

· Between 1903 and 1906, with their vaults full of gold, banks had extended credit freely; business growth had surged, and visions of boundless prosperity had beckoned. Finally, production had caught up with demand, inventories began to accumulate and business slowed down. The Bank of England and the Reichsbank raised their discount rates late in 1906, and at first the gold flow to the United States was reduced, and then reversed.

· In 1906, with some financial constriction already under way, a committee of the New York Chamber of Commerce recommended creating a central bank patterned after the Reichsbank.

· As money tightened, the stock market declined, with a sharp break in March 1907. In October, nervous depositors began a run on New York banks, which dried up call money and caused a further decline in the stock market. An uneasiness spread over the country, banks withdrew reserves from reserve city banks, which in turn called back reserves from New York and the other central reserve cities. The public was suspicious of banks and withdrew its deposits to hoard cash, and banks were suspicious of each other and hoarded their reserves, all with a paralyzing effect on the economy. Eventually banks throughout the country suspended payments, refusing to pay out cash on demand. This was hard on depositors and business, but it saved all but the weakest banks

· In 1895, J.P. Morgan had acted as a lender of last resort, and the banks looked to him for help in 1907. Either he could not stop the panic or he chose not to. After sitting on the sidelines until mid-October, he stepped in with some allies to aid some banks, after he had refused to help the Knickerbocker Trust, which closed its doors. Morgan did not like trust companies, which he believed were promoters of speculation, and he may have believed Knickerbocker deserved to fail. He did rescue New York City by purchasing an emergency $30 million bond issue, and he persuaded other strong banks to resume lending to brokers to prevent the stock exchange from closing.

· The Treasury was more active than Morgan, though partly at his instigation. For several years, it had placed some of its funds in national banks instead of the sub-treasuries, and in the spring of 1907 it increased deposits and reduced withdrawals. In early September, Secretary George Cortelyou began depositing $5 million a week in banks, and with two more giant trusts about to go under, he loaned $25 million interest-free and without restriction to New York banks on October 23. He poured in another $10 million in the next eight days, but the banks restricted payments to depositors anyway and turned to another time-tested expedient to reduce suspensions.

· In 1873 and again in 1893, clearing-house associations in New York, St. Louis, Philadelphia and other major cities had issued clearing-house loan certificates when money dried up. Banks who were members could pledge illiquid securities in return for certificates that could be used to settle imbalances with other banks. Weak banks with a lot of bad paper could not qualify, but sound banks top-heavy with long-term loans were saved from short-term starvation. In 1907, the New York Clearing House issued $101 million in certificates and $256 million was the national total. Nationally, bank failures barely exceeded the figures for "normal" years and did not outnumber new banks created.

· After the breathing spell afforded by payment restrictions, banks furnished cash on demand to depositors in January 1908, and within a few weeks, depositors regained confidence and began to return currency to the banks. Contemporaries viewed the events of 1907 as a relatively mild contraction that became severe because of the bankers' panic and the restriction of payments. Some favored creating a central currency reserve to meet emergencies, which would not be touched in ordinary times. During the panic, Cortelyou had used Treasury funds in this way, but he had too little cash available to stave off the restriction of payments.

· Another proposal would have empowered national banks to supplement their government bond-backed notes with notes backed by cash in vault and deposits in reserve (or central reserve) city banks. This requirement, using the same assets employed to back deposits, would have solved the inelasticity problem. There was also support among bankers for a banker-controlled central bank such as that advocated by Frank A. Vanderlip of the National City Bank of New York. Vanderlip had gathered support from several leading New York businessmen for his plan, but few congressmen liked it. Agrarians and most Midwestern bankers saw too much Wall Street in the scheme.

· William Jennings Bryan, waging his third presidential campaign in 1908, made an issue of federally guaranteed bank deposits. This idea, which he had first advocated in 1894, was popular not only with farmers but with country bankers in the Midwest. Country bankers thought a federal guarantee would free them from the dictation of the East and New York in currency matters. Larger bankers, in the East especially, hated the idea because it would involve the government in banking, a dangerous precedent which carried the potential of taxing all banks to finance the guarantees.

· 1908 The Aldrich-Vreeland Act provided for the issuance of emergency currency and created a bipartisan National Monentary Commission to study central banking.

• Senator Nelson Aldrich, the chairman, was a former banker allied with the House of Morgan; he had written the Gold Standard Act of 1900, and he was the Senate's leading protectionist.
• Aldrich went to Europe for almost two years to study that continent's banking systems and identified what he saw as the "evils" of the system in the United States — the "decentralization of reserves and the immobilization of [commercial] paper." To remedy this, he (and Paul Warburg) advocated the development of an American discount market and a European-style commercial paper.
• Aldrich and the other commissioners returned convinced that the United States should have a central bank controlled by bankers and issuing notes based on commercial paper. This was a surprising reversal for Aldrich, who previously had opposed any significant changes in the existing system, believing that only bond-related notes should be issued. The commission made no immediate proposal for legislation, knowing that an extensive campaign would be required to educate bankers and the public, especially after the Democrats gained control of the House of Representatives in 1910
• This system was based partly on a concept known as the "real bills" doctrine, which maintained that the money supply should vary with the short-term "legitimate" needs of business and commerce. By allowing banks to borrow only against short-term loans, the real bills doctrine, in theory, provided liquidity through the discounting (or selling) of loans and at the same time restricted the ability of a central bank to expand the supply of money.
• They also proposed the creation of a "central reserve" or central bank that would hold the reserve funds of member banks so that collective funds could be made available to a bank in need of liquidity. Both the discounting and reserve concept would help make money and credit more elastic and keep interest rates stable.
• In 1909, a poll conducted by Paul M. Warburg revealing that nearly 60 percent of the banker respondents favored a central bank--as long as it was not dominated by Wall Street. Warburg, a member of a powerful Hamburg banking family, had come to New York in 1902 to work for Kuhn, Loeb and Company, which was headed by his father-in-law, Jacob Schiff. Shortly after he joined the firm, he wrote a critique of the American banking system for his senior partners, giving them the benefit of his expert knowledge of international banking and the Reichsbank. Schiff advised him not to circulate his memorandum further; warning that advocacy of central banking would damage his standing among bankers. Warburg complied, but after the Panic of 1907 had shattered the complacency of his fellows, he emerged as a major spokesman for reform
• Warburg met Nelson Aldrich in 1907 and was not impressed by the senator's knowledge of banking, but they became a team after Warburg proposed his "United Reserve System" at a meeting of the Academy of Political Science in 1910. With Aldrich in the audience, he outlined this plan for a central bank with a regional flavor. Twenty well-distributed banking associations, controlled by a central bank in Washington with a capital stock of $100 million, would stabilize the American economy. The central board would be elected by the associations, its bank and public stockholders, and the government. It would set discount rates for the associations and issue notes against commercial paper purchased from them. Only paper representing actual transactions (real bills) would qualify for rediscount.
• The real bills doctrine, long dominant in Europe, was popular with many Midwestern bankers. Currency based on real bills was supposed to be elastic and self-regulating, expanding and contracting as business activity rose and fell. Warburg favored it, but he knew it was not self-regulating. There was no guarantee against over-expansion of credit, and at the other end of the scale, there was always a chance that demand for commercial paper would dry up, making a central reservoir with the means and power to intervene essential.

· 1910 A secret meeting occurs on Jekyll Island, Georgia (then a resort hotel) to discuss the creation of the Federal Reserve.

· It was led by Senator Aldrich, and included representatives of the Treasury Department, Rothschild's Kuhn, Loeb & Co., the National City Bank of New York, J. P. Morgan Company, the Morgan-dominated First National Bank of New York, and Benjamin Strong representing J. P. Morgan himself, in total representing about one-sixth of the world's wealth.

· Aldrich was so impressed with Warburg's formulation that he invited him; along with Frank A. Vanderlip of the National City Bank, Morgan partner Henry Davison, and A. Piatt Andrew of Harvard University to join him for a secret conference on Jekyll Island, Georgia, an exclusive resort owned by John D. Rockefeller and J. P. Morgan. Since the Monetary Commission had not yet produced a recommendation, the three Wall Street bankers, the academic economist, and Aldrich were ready to rectify the omission. To guard against revelations of their identity and their purpose, they took elaborate precautions, traveling separately to Hoboken, where they boarded a private railroad car for Savannah, using only their first names in front of the train crew

· Warburg's United Reserve System was the point of departure for the week-long session, and the document that emerged did not stray far from his ideas. Senator Aldrich brought the proposal to the National Monetary Commission as his own. The commission published it January 1911. The Aldrich plan set up a "National Reserve Association," which, according to the Monetary Commission, would provide an elastic currency without drawing down reserves, and extend credit based on cotton, grain and other commodities "without expensive shipments of cash." In panics, it would provide loans to banks under pressure, "more important than currency circulation:" The commission stressed the point that the NRA would decentralize credit, freeing banks from reliance on New York banks.

· During the congressional investigation of the "Money Trust," the House Banking Committee held public hearings in 1912 and 1913 that revealed a level of concentration in the financial world that startled nearly everyone and stirred public resentment. After interviewing J. R. Morgan, George F. Baker, Jacob Schiff and other Wall Street figures, the committee concluded that a "few leaders of finance" controlled railroads, industrial corporations and public utilities and held the control of the nation's money and credit in their hands. Morgan and the banks allied with him held 341 directorships in 112 of the country's largest corporations. Morgan testified that he had no power in these firms and that he had taken away the Equitable Life Assurance Society from Thomas Fortune Ryan simply because it would be "a good thing to have."

· 1913 The Federal Reserve Act, a revised version of the Aldrich plan constructed by President Woodrow Wilson and his advisors, is passed. It differed in its government control of the central board and 12 (instead of five) regional banks.

Federal Reserve Structure

· It now consists of the 12 regional Federal Reserve Banks, and the seven-person Board of Governors in Washington, D.C., headed by the Federal Reserve Chairman.

· The Board of Governors sets the discount interest rate (the rate the fed charges banks for overnight loans). They serve 14-year terms, except the Chairman and Vice-Chairman who serve 4-year terms. The members are nominated by the President and confirmed by the Senate. By law, the appointments must yield a "fair representation of the financial, agricultural, industrial, and commercial interests and geographical divisions of the country."

· The Federal Open Market Committee (FOMC) is made up of the Board of Governors, the president of the Federal Reserve Bank of New York, and presidents of four other Federal Reserve Banks, who serve on a rotating basis. The FOMC oversees open market operations, which is the main tool used by the Federal Reserve to influence money market conditions and the growth of money and credit.

· The Federal Reserve's responsibilities duties fall into four general areas:

• conducting the nation's monetary policy by influencing money and credit conditions in pursuit of full employment and stable prices
• supervising and regulating banking institutions
• maintaining the stability of the financial system
• providing certain financial services to the U.S. government, to the public, to financial institutions, and to foreign official institutions, including playing a major role in operating the nation's payments systems
• Banks get cash from Federal Reserve Banks. Most medium- and large-sized banks maintain reserve accounts at one of the 12 regional Federal Reserve Banks, and they pay for the cash they get from the Fed by having those accounts debited. Some smaller banks maintain their required reserves at and get cash through larger, "correspondent," banks, which charge a fee for the service. The larger banks get currency from the Fed and pass it on to the smaller banks.

· It is an independent entity within the government, having both public purposes and private aspects. As the nation's central bank, the Federal Reserve derives its authority from the U.S. Congress. It is considered an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive or legislative branch of government, it does not receive funding appropriated by Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms. Employees of the Federal Reserve Banks are not government employees. They are paid as part of the expenses of their employing Reserve Bank. However, the Federal Reserve is subject to oversight by Congress, which periodically reviews its activities.

· The twelve regional Federal Reserve Banks, which were established by Congress as the operating arms of the nation's central banking system, are organized much like private corporations--possibly leading to some confusion about "ownership." For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. Holding stock in a regional Reserve Bank does not carry with it the kind of control and financial interest that holding publicly traded stock affords. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6% per year and stockholders elect six of the nine members of the Reserve Bank's board of directors.

· The Federal Reserve's income is derived primarily from the interest on U.S. government securities that it has acquired through open market operations. Other sources of income are the interest on foreign currency investments held by the System; fees received for services provided to depository institutions, such as check clearing, funds transfers, and automated clearinghouse operations; and interest on loans to depository institutions (the rate on which is the so-called discount rate). After paying its expenses, the Federal Reserve turns the rest of its earnings over to the U.S. Treasury.

· The Federal Reserve issues Federal Reserve notes and places them in circulation.

• The Federal Reserve Act of 1913 authorized the production and circulation of Federal Reserve notes. Although printed by the Bureau of Engraving and Printing (BEP), these notes move into circulation through the Federal Reserve System. The Bureau of Engraving and Printing (BEP) produces currency and stamps, and the U.S. Mint produces our nation's coins. They are obligations of both the Federal Reserve System and the U.S. government. Both U.S. notes and Federal Reserve notes are part of our national currency and are legal tender. They circulate as money in the same way.
• National bank notes still in circulation are legal tender at face value as a matter of law. National bank notes were issued from 1863 to 1935. They are probably worth more than face value to currency collectors, however, because they are very rare.
• The largest note ever printed was the $100,000 gold certificate, 1934, featuring Woodrow Wilson. It was issued only to Federal Reserve Banks against an equal amount of gold bullion held by the Department of the Treasury for certain credits established between the Treasurer of the United States and the Federal Reserve Banks.

· The Federal Open Market Committee (FOMC), composed of the 7 governors and 5 of 12 regional bank chairmen, sets the short-term federal funds rate (the overnight rate banks charge each other) and the every 6 weeks. The FOMC can buy or sell US Treasury bonds, pumping or withdrawing cash into/from the economy.

US Gross Domestic Product (GDP)

GDP by State

· In 2001, current-dollar GSP for the nation was $10.1 trillion. California accounted for the largest share (13%), its GSP has exceeded $1 trillion since 1997, followed by New York, Texas, Florida, and Illinois.

· See The 2007 State New Economy Index:

Productivity

· In the late 1990's, growth in labor productivity - the amount of output per hour per worker - increased.

o From 1996 through 1999, it grew at an annual rate of 2.5 percent, compared with 1.4 percent from 1972 to 1995.

o Economists generally believed that the higher rate was a byproduct highly productive businesses that made information technology products - companies like Dell, Intel and Microsoft - and by their customers, who spent heavily to deploy productivity-enhancing PC's and software.

· Productivity appears to be rising to a new level. It's moved up to a 2 1/2% to 3% annual rate as people learn how to apply information technology. Productivity growth has averaged 3.6% annually over the past five years, compared with 2.4% a year for the past 15.

Research & Development

· Estimated amount U.S. companies spend annually on R&D: $194 Billion. Estimated amount U.S. companies spend annually on tort litigation: $205 Billion

· Rank of American eighth graders in science proficiency among 45 countries: 9 Rank of American eighth graders in math proficiency among 45 countries: 15

· Percent of engineering Ph.D's awarded in the United States that go to foreign-born students: 56

· Number of the world's Top 25 information-technology companies based in the U.S.: 6 Number of the world's Top 25 information-technology companies based in Asia: 14

· U.S. trade balance in high-tech manufactured goods, 1990: $33 Billion U.S. trade balance in high-tech manufactured goods, 2004: -$24 Billion

· In 2003, the last year for which full international data are available, the US R&D investment from all sources was larger than the total R&D expenditures of Japan and larger than the entire European Union combined. The United States spent 38% of world R&D, a share that has declined only slightly over the last decade

o China, which doubled its spending on R&D between 1995 and 2002,7 calculated as a percentage of gross domestic product, has emerged as a major R&D investor this decade. China is now the third largest R&D performer in the world, behind only the United States and Japan

o As a percentage of GDP, federal investment in physical science research is half of what it was in 1970. By contrast, in China, R&D expenditures rose 350 percent between 1991 and 2001, and the number of science and engineering PhDs soared 535 percent

· In 2002, the number of US doctoral degrees granted in science and engineering was the lowest since 1993.

o China now graduates 4 times the number of first university engineering degrees than does the United States

o Immigration policies implemented in response to the events of the September 11 attacks are limiting the number of talented students coming to US campuses from abroad. Applications to US science and engineering programs have declined by more than 25% in the past 3 years. At the same time, conditions and opportunities for science and engineering specialists are improving in other countries.

· See Porter, JAMA 9/05.

Consumer Income, Spending, and Debt

· The U.S. has about $158 billion in personal savings and an average savings rate of only about 2% (China has about $1 trillion in personal savings and a savings rate of close to 50%).

· The debt explosion, driven by a doubling of home-mortgage debt to $8 trillion since 1998, poses substantial risks to individual borrowers and to those who lend them money.

o Low real interest rates have resulted in record leverage in the U.S. economy. Record household borrowing has led to escalating debt-service burdens despite low nominal interest rates.

o Consumers learned that the easy credit terms now available on mortgages enable them to borrow much larger amounts than they can with credit cards, and the debt does not have to be paid off for five to 40 years, if ever.  Another advantage is that, unlike credit-card debt, the interest on first and second mortgages usually can be deducted from taxes.  

o The discovery of easy mortgage financing led U.S. households to escalate borrowing to more than $1 trillion for the first time in history in 2004 and 2005. Before 2000, consumers had never borrowed more than $488 billion in one year.

o Withdrawals from home equity exploded to an estimated $800 billion last year from $66 billion in 2001. Homeowners used most of it on items from cars to college education, surveys show.

· Exotic Mortgages: What came into vogue were mortgages that start out with low monthly payments, such as "interest-only" loans that require payment of interest only in the first five years or so, and "option ARMs" that enable consumers to decide whether to make a minimum payment or add in principal each month.  

o These exotic mortgages reached nearly $600 billion.

o In California and other high-priced housing markets such as Washington, 55 percent to 80 percent of home buyers snap up the unconventional mortgages.  

o Low introductory rates of 1 percent to 2 percent were introduced, and they started routinely approving loans that require 50 percent to 60 percent of a borrower's gross income, before taxes, to pay each month. Loans financing 100 percent to 120 percent of a house's price already were routine.   Old borrowing rules such as the need for a good credit history or stable income were eliminated. Many lenders provide loans to borrowers who have no proof of income or who have just emerged from bankruptcy and have tax liens on their homes.

· The delinquency rate on sub-prime mortgages, now above 10%, is near record levels.

o Banks that bought up those loans for securitization are now demanding to be repaid, meaning that smaller institutions who thought they'd sold off their exposure are finding themselves on the hook, in some cases forcing them into bankruptcy.

Employment

· Rise of the Service Economy: Because of globalization, the US tends to lose manufacturing jobs to low-wage countries, while the service, health care, and education sectors increase.

Unions

· Union membership continued to decline during the 1990s

· Some contend this was exacerbated by competition with foreign workers via globalization and immigration, which hurt unions’ bargaining power

· Right-to-work states are Alabama, Arizona, Arkansas, Florida, Georgia, Idaho, Iowa, Kansas, Louisiana, Mississippi, Nebraska, Nevada, North Carolina, North Dakota, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia and Wyoming.

· 2000s Bankruptcies in the airline and automotive industries are felt by some to be due to generous union benefit contracts

Wages, Income Inequality, and Offshoring

· During the 1950s and 1960s, the halcyon days for America's middle class, productivity boomed and its benefits were broadly shared. The gap between the lowest and highest earners narrowed. After the 1973 oil shocks, productivity growth suddenly slowed. A few years later, at the start of the 1980s, the gap between rich and poor began to widen.

· Thanks to a jump in productivity growth after 1995, America's economy has outpaced other rich countries' for a decade. Its workers now produce over 30% more each hour they work than ten years ago. In the late 1990s everybody shared in this boom. Though incomes were rising fastest at the top, all workers' wages far outpaced inflation.

· But since 2000 the wages of the typical American worker rose less than 1% adjusted for inflation. In the previous five years, they rose over 6%. If you take into account the value of employee benefits, such as health care, the contrast is a little less stark. The fruits of productivity gains have been skewed towards the highest earners, and towards companies, whose profits have reached record levels as a share of GDP.

· Economists have long debated why America's income disparities suddenly widened after 1980. The consensus is that the main cause was technology, which increased the demand for skilled workers relative to their supply, with freer trade reinforcing the effect. Some evidence suggests that institutional changes, particularly the weakening of unions

· Despite a quarter century during which incomes have drifted ever farther apart, the distribution of wealth has remained remarkably stable. The richest Americans now earn as big a share of overall income as they did a century ago, but their share of overall wealth is much lower. Indeed, it has barely budged in the few past decades.

· The elites in the early years of the 20th century were living off the income generated by their accumulated fortunes. Today's rich, by and large, are earning their money. In 1916 the richest 1% got only a fifth of their income from paid work, whereas the figure in 2004 was over 60%.

· Several new studies show parental income to be a better predictor of whether someone will be rich or poor in America than in Canada or much of Europe. In America about half of the income disparities in one generation are reflected in the next. In Canada and the Nordic countries that proportion is about a fifth. Many studies suggest that mobility between generations has stayed roughly the same in recent decades, and some suggest it is decreasing.

· The proportion of Americans who think you can start poor and end up rich has risen 20 percentage points since 1980. That helps explain why voters failed to respond to class politics. John Edwards, the Democrats' vice-presidential candidate in 2004, made little headway with his tale of “Two Americas”, one for the rich and one for the rest. Over 70% of Americans support the abolition of the estate tax (inheritance tax), even though only one household in 100 pays it.

· The exact size of that gap depends on how you measure it. Look at wages, the main source of income for most people, and you understate the importance of health care and other benefits. Look at household income and you need to take into account that the typical household has fallen in size in recent decades, thanks to the growth in single-parent families. Look at statistics on spending and you find that the gaps between top and bottom have widened less than for income. But every measure shows that, over the past quarter century, those at the top have done better than those in the middle, who in turn have outpaced those at the bottom.

· The typical worker earns only 10% more in real terms than his counterpart 25 years ago, even though overall productivity has risen much faster.

· The gap between the bottom and the middle—whether in terms of skills, age, job experience or income—did widen sharply in the 1980s. High-school dropouts earned 12% less in an average week in 1990 than in 1980; those with only a high-school education earned 6% less. But during the 1990s, particularly towards the end of the decade, that gap stabilised and, by some measures, even narrowed. Real wages rose faster for the bottom quarter of workers than for those in the middle.

· After 2000 most people lost ground, but, by many measures, those in the middle of the skills and education ladder have been hit relatively harder than those at the bottom. People who had some college experience, but no degree, fared worse than high-school dropouts. Some statistics suggest that the annual income of Americans with a college degree has fallen relative to that of high-school graduates for the first time in decades. So, whereas the 1980s were hardest on the lowest skilled, the 1990s and this decade have squeezed people in the middle.

· Computers and the internet have reduced the demand for routine jobs that demand only moderate skills, such as the work of bank clerks, while increasing the productivity of the highest-skilled.

· For the most talented and skilled, technology has increased the potential market and thus their productivity. Top entertainers or sportsmen, for instance, now perform for a global audience. Some economists believe information technology has made top managers more mobile, since it no longer takes years to master the intricacies of any one industry. Global firms plainly do compete globally for talent: Alcoa's boss is a Brazilian, Sony's chief executive is American (and Welsh).

· But the scale of America's income concentration at the top, and the fact that no other country has seen such extreme shifts, has sent people searching for other causes. The typical American chief executive now earns 300 times the average wage, up tenfold from the 1970s. Continental Europe's bosses have seen nothing similar. This discrepancy has fostered the “fat cat” theory of inequality: greedy businessmen sanction huge salaries for each other at the expense of shareholders.

· The structural changes in America's job market that began in the 1990s are now being reinforced by big changes in the global economy. The integration of China's low-skilled millions and the increased offshoring of services to India and other countries has expanded the global supply of workers. This has reduced the relative price of labor and raised the returns to capital, reinforcing income concentration at the top

· The number of American service jobs that have shifted offshore is small, some 1m at the most. And most of those demand few skills, such as operating telephones. Only 15 radiologists in India are now reading American X-rays. But nine out of ten Americans worry about offshoring.

· America has had the estate tax since 1916. The estate tax affects less than 2% of Americans in recent decades. In the late 1990s it generated just over 1.5% of all tax revenue, or around 0.3% of GDP.

· During the five years from 2000 to 2005, the US economy grew in size from $9.8 trillion to $11.2 trillion, an increase in real terms of 14%. Productivity - the measure of the output of the economy per worker employed - grew even more strongly, by 16.6%. But over the same period, the median family's income slid by 2.9%, in contrast to the 11.3% gain registered in the second half of the 1990s. The share allotted to corporate profits increased sharply, from 17.7% in 2000 to 20.9% in 2005, while the share going to wages has reached a record low.

· Some argue that low minimum wages, weakened union power, and the loss of both blue and white-collar jobs to off shoring do much to explain the jobs picture. Also important is immigration, which may have a greater effect on the wages of low-skilled workers. Another is the "China effect”, the idea that low prices of imported manufactured goods are pushing US industry to cut its workforce in order to increase productivity.

· The incomes of the top 20% have grown much faster than earnings of those at the middle or bottom of the income distribution. The income of the top 1% and top 0.1% have grown particularly rapidly. From 1992 to 2005, the pay of chief executive officers of major companies rose by 186%. The equivalent figure for median hourly wages was 7.2%, leaving the ratio of CEOs' pay to that of the average worker at 262. In the 1960s, the comparable figure was 24.

· Currently, 47 percent of growth is flowing to corporate profits, by far the largest share than that in any of the other eight post-World War II recoveries. Fifteen percent goes to wages and salaries, the smallest share of economic growth in more than 50 years. To make matters worse, the share of compensation that is devoted to health and pension benefits is far larger during this recovery than in any other, representing a further squeeze on the wages and salaries of ordinary Americans. In 2004, take-home pay as a share of the economy dropped to its lowest level since 1929, when the government started keeping records.

· See The Economist 6/15/06

Outsourcing

· The outsourcing or offshoring of U.S. tech and service jobs has become a hot-button issue. American workers in Silicon Valley and elsewhere feel anger and uncertainty as white-collar tech jobs quickly move to lower-cost countries like India and China. Offshoring has sparked grass-roots protests from New York to California and spurred protectionist legislation in eight states. Business executives and economists argue that the offshoring of jobs is unstoppable and ultimately healthy for the United States, spurring this country to shed certain jobs and create more sophisticated ones in order to stay atop the ladder of innovation. Demand for technical talent in India is taking off -- to the point that companies are recruiting in Silicon Valley for positions in India. What's making the loss of jobs all the more scary for tech workers is the speed with which companies can now send jobs overseas because of today's sophisticated communications technology. Tech jobs seem to be moving to India faster than manufacturing jobs moved overseas in decades past. With union support, legislation has been proposed in eight states to limit offshoring. None of the bills has yet become law. It has always been the trend that as soon as technology products and services become commodities, then they face competition from overseas producers.

· Low-cost communications, the Internet and digitalization mean that many business services can be shifted abroad. Companies have moved call centers, accounting operations and software development to offshore locations, particularly in India. Wages in India are 20 % of U.S. levels, and even after other costs are included—communications, travel, intercultural problems—savings can amount to about 40 %. In 15 years, 3 million U.S. service jobs will shift abroad. On paper, the number of jobs is only 2 % of U.S. employment now (137 million) and an even smaller share of projected future employment. Moreover, jobs lost should—in theory—be offset by jobs gained. Until now, white-collar professionals—software engineers, accountants—haven’t felt exposed to foreign competition the way blue-collar factory workers have. Protectionist attitudes could move up the social spectrum.

· Of the 1.5 million jobs lost last year in "mass layoffs'' - that is, when 50 or more workers are let go at once - less than 1 percent were attributed to overseas relocation; that was a decline from the previous year. In 2002, only about 4 percent of the money directly invested by American companies overseas went to the developing countries that are most likely to account for outsourced jobs - and most of that money was concentrated in manufacturing. The data did show that from 1997 to 2002, annual imports of business, technical and professional services increased by $16.3 billion. However, during that same half-decade, exports of those services increased by $20.5 billion a year. In 2002 alone, the United States ran a $27 billion trade surplus in business services, the sector in which jobs are most likely to be outsourced.

National Debt and the Federal Budget

· The National Debt is the total amount of money owed by the government; the federal budget deficit is the yearly amount by which spending exceeds revenue.

· The estimated population of the United States is 294,980,891 so each citizen's share of this debt is $25,522.69 (Dec. 2004). The National Debt has continued to increase an average of $1.72 billion per day since September 30, 2003.

· Over 40% of the debt is owed to the Federal Reserve Bank and to other government accounts; that is owed by one part of the government to another. The remaining 60% of the Debt, roughly $3.3 trillion, is privately held.

· The O.E.C.D. estimated that the US current-account deficit would rise steadily over the next two years to 6.4% of GDP in 2006, from an already large 5.7% in 2004.

· 2000s The Bush administration converted a budget surplus of more than 2 % of GNP in 2000 to a budget deficit of 5 % of GNP. Critics charge this was due to irresponsible tax cuts, massive increases in military spending, and even spending on some domestic social programs. Some of this was the result of a slowing economy and the Iraq War.

· 2002 The Bush administration lets the Budget Enforcement Act of 1990 expire, which required any “pay-go” spending increases or tax cuts to be accompanied by a matching spending decrease or tax hike.

· Mandatory spending for entitlement programs with benefits set by law accounts for more than half the total budget or 10.8% of GDP. Medicare, Medicaid and Social Security cost more than $1 trillion; additional programs benefit farms, veterans, civil servants and others.

· Discretionary spending for defense and domestic programs is what the president and Congress designate in yearly appropriations bills. It is less than a third of the entire budget, or 7.7% of GDP

· Defense and homeland-security funding since the Sept. 11, 2001, terrorist attacks has grown to 4.2% of GDP in 2006 -- or 4.6%, counting expected additional war funding -- from 3.4% in 2001.

· Interest on U.S. debt, after declining from 1998 through 2003, is now 8% of the budget, more than the entire budgets of the departments of Agriculture, Education, Energy, Homeland Security, Health and Human Services, Interior, Justice and Labor combined.

· There was a tenfold increase in Congress's appropriations "earmarks" for special projects -- numbering more than 14,000 last year -- since Republicans took over Congress in 1995, according to the conservative group, Citizens Against Government Waste. But relative to the total budget, such "pork" spending is the size of a rounding error. Nonsecurity domestic spending authority declined by 1% in 2005 and 4% in 2006, corrected for inflation

· Extending the Bush administration's basic tax cuts from 2001 and 2003, most of which expire around 2010, would cost about $178 billion over the next five years and $1.35 trillion over the next 10 years. Adding on all the other proposals in the budget, including renewing existing tax breaks and expanding tax breaks for programs like health savings accounts, the five-year tally of costs climbs to nearly $300 billion and the 10-year total passes $1.5 trillion. But the budget omits nearly a half-trillion dollars in costs that are likely to be incurred over the next five years. The omissions include any costs for the war in Iraq after 2007, any additional reconstruction costs for New Orleans after 2006 and any plan for preventing a huge expansion in the alternative minimum tax after the end of this year. The most obvious omission involves the costs of the war in Iraq, which have averaged nearly $100 billion a year since 2003. White House officials said Monday that they planned to ask Congress for an additional $70 billion this fiscal year, on top of the $50 billion it has already approved, and $50 billion for 2007, but the budget assumes that those costs will cease after 2007.

· Created in 1969 to stop the nation's richest citizens from taking too much advantage of tax breaks, the alternative minimum tax is set to engulf tens of millions of additional families over the next few years. Mr. Bush and Congressional leaders from both parties have promised to prevent that from happening, but Mr. Bush's budget still assumes that the government will reap hundreds of billions of extra dollars from the tax over the next five years. The new White House proposal includes about $34 billion to keep the tax from expanding, but that will cover only 2006. The budget commitment needed to keep the alternative minimum tax at current levels will keep rising and soon become as expensive as the war in Iraq. In 2009, the year in which Mr. Bush promises to reduce the deficit to $208 billion, the cost of preventing a de facto tax increase just for that year would push the deficit to nearly $300 billion.

· The White House budget outlines plans to shave about $65 billion from programs like Medicare, Medicaid, food stamps education and housing assistance for low-income families, the elderly and the disabled.

· Farm subsidies cost $15 billion a year

·

Unfunded Liabilities – Medicare and Social Security

· Official sources put the number of unfunded liabilities between $45 trillion and $74 trillion, depending on the timeframe. The Sarbanes-Oxley law that makes it a crime for corporate CEOs not to accurately report liabilities. ERISA laws require corporations to fund pensions on no more than 30 years. If the ERISA and Sarbanes-Oxley provisions were to apply to the government, it would only add over $1.5 trillion to the annual budget.

· The Congressional Budget Office has estimated that Medicare, Medicaid, Social Security and interest on the national debt could account for half of the U.S. gross domestic product by 2050.

· The current "fiscal imbalance" of the federal government is about $65 trillion. Medicare and Social Security taxes would have to double immediately to eliminate the deficit.

· Social Security unfunded obligations total $4 trillion (expressed in 2004 purchasing power).

• Cap on Social Security Payroll Tax was removed in 2006 (was $90K)
• Means Testing is another option

· Medicare has been growing twice as fast as Social Security.

· Public employees’ benefits amount to hundreds of billions of dollars over the next three decades, threatening some local governments with bankruptcy and all but guaranteeing cuts in services like education and public safety.

• New accounting rules issued by the Government Accounting Standards Board which become effective in 2008 require public agencies to disclose the future cost of health care and other benefits such as dental, vision and life insurance promised alongside traditional pensions.
• Public agencies have passed out generous retirement benefits during labor negotiations often in lieu of salary increases.
• JP Morgan projects the present value of unfunded health care and other non-pension benefits at between $600 billion and $1.3 trillion. By comparison, Standard and Poors estimates the country's total unfunded public pension debt at around $285 billion.
• The Government Accounting Standards Board is an independent nonprofit organization that establishes accounting standards for public agencies.
• Most governments now fund retiree health care on a pay-as-you-go basis, with annual appropriations from their general funds, focusing most of their attention on current expenses. Under the new accounting rules, the liability can be paid over 30 years, just like a home mortgage, but it forces public officials to recognize the debt and calculate an annual payment. If officials choose not to set aside additional money each year to cover the payment, it counts against net assets, potentially putting a city or agency deeper into the red. Because assets are a critical component in the credit ratings that allow governments to borrow money at lower interest rates, governments that don't handle their liability properly could end up insolvent.

Health Care Economics

Inflation

Interest Rates

Stock Market

· 1987 On October 29, “Black Monday”, the Dow fell by 22.6% in one day

· By 2003, index arbitrage was accounting for 33% of shares traded.

· 2007 Feb. 27 the Dow Jones industrial average fell 416 points (3.3%), its biggest one-day drop in three years. A 9% drop in Chinese stocks earlier in the day triggered the selling. This chain reaction plainly demonstrated the increasingly prominent place China now occupies in the minds of global investors.

Trade and Current Account Deficit

· In the third quarter of 2006, the U.S. current account deficit was $860 billion, or about 6.5% of gdp, and it will most likely hang above 6% through 2007.

o The big question: Can the U.S. continue to count on this massive amount of foreign capital to fund its overseas obligations and finance its economic growth

o In a speech in 2004, then Federal Reserve Chairman Alan Greenspan said: "It is difficult to imagine that we can continue indefinitely to borrow savings from abroad at a rate equivalent to 5% of U.S. gross domestic product."

o The previous record current account deficit was 3.7% of GDP in the 1980s. In 2004 the U.S. current-account deficit reached $668 billion (5.7% of GDP). 5 percent of the GDP current account deficit is typically a danger point. The U.S. now, directly or indirectly, absorbs two thirds of the total current account surplus run by every nation in the world.

o Net inflows of foreign capital into long-term U.S. securities fell to only $15.6 billion in December 2006. It was the skimpiest monthly total in almost five years. Consider that during all of 2006 the U.S. needed, on average, more than $70 billion a month in foreign funds to finance its current account deficit, made up mainly of the trade deficit, along with net investment income that the U.S. owes to foreigners and certain government transfers.

· In 2006 the trade deficit reached $764 billion. It was the fifth year in a row that the trade deficit broke through its previous record, which in 2005 stood at $717 billion. Gaps with China, the European Union, and Japan, respectively, made up 30%, 15%, and 11% of the total.

· While the dollar has been falling, making imports more expensive, imports have still risen faster than exports

· China is the country that has the most out-of-balance trade with the United States. For 2006, the trade gap with China was $232.5 billion on an unadjusted basis — another record.

· For only the second time in history, the US in 2002 imported more agricultural products than it exported. Farm exports had been the nation's bulwark against even larger overall trade deficits.

· America’s need for foreign capital lies in its lack of domestic savings. The retained earnings of U.S. businesses accounted for all of net US savings. The household and the government sectors were both net drains on U.S. savings. Households spent $111.7 billion more than they earned in the third quarter, and the personal savings rate for all of 2006 was negative for the second year in a row, something that hasn't happened since the Depression years of the 1930s. Plus, the federal government's outlays in the third quarter exceeded its receipts by $165.6 billion. U.S. savings financed only about one-quarter of last year's U.S. net investment, which excludes the outlays needed to replace depreciated equipment, buildings, and such. Foreigners supplied the remaining three-quarters.

The Dollar and US Currency

· As of July 2004, US currency in circulation totaled $730 billion.

· The amount of cash in circulation has risen rapidly in recent decades and much of the increase has been caused by demand from abroad.

· The Federal Reserve estimates that the majority of the cash in circulation today is outside the United States.

· In late 1996, the Treasury began issuing a series of Federal Reserve notes containing new features that make the notes harder to counterfeit. The most noticeable modification was a larger, slightly off-center portrait that incorporates more detail, thereby making the bill harder to counterfeit.

· The procedures for putting coins into circulation are similar to those for currency. The Treasury's Bureau of the Mint produces coins in Philadelphia, Denver, and San Francisco, and ships them to the Federal Reserve Banks and to authorized armored carriers, which supply banks that need coins to meet the public's demand.

· The distribution of coins differs from that of currency in some respects. First, when the Fed receives currency from the Treasury, it pays only for the cost of printing the notes. However, coins are a direct obligation of the Treasury, so the Reserve Banks pay the Treasury the face value of the coins. Second, large banks in some Federal Reserve Districts participate in a Direct Mint Shipment Program, and receive coins directly from the Mint. In the New York area, there also is an arrangement under which banks that need coins buy them from banks that have a surplus. To promote the arrangement, the New York Fed stands ready to match banks that have excess coins with those that need coins.

The Declining Dollar

· 2001-2004 The dollar is down 33% against the euro and 20% against the Japanese yen and has weakened against the pound and Canadian dollar. Japan spent record amounts on intervention, buying dollars for yen in an attempt to maintain its currency's competitiveness.

· The recent decline of the U.S. dollar has revealed that a weak currency need not always be a sign of a nation's weakness. The US seems equipped to minimize the negative consequences while taking advantage of the opportunities a weak dollar creates. The weak dollar is a big factor in the revived manufacturing sector. After some lean years, exports and factory profits are up.

· In the past, the strong dollar allowed the U.S. government to borrow cheaply and attract investment in the world’s safest currency. That helped finance the budget deficit, kept interest rates low and allowed Americans and the government to spend beyond their means. Foreigners are buyers of mortgage securities, which make purchasing real estate more affordable. They hold nearly $2 trillion of Treasury securities. But foreigners may be reaching their saturation point. The US has 80% of the world's available savings. If the dollar loses its cachet, foreigners will demand higher interest rates, which, if they rise fast or far enough, could topple the economy.

· If the dollar loses value slowly, giving businesses and investors time to adjust their spending and portfolios, the main effect may be to make the American economy more competitive. But if the dollar takes an abrupt dive, companies and consumers may find themselves stripped of purchasing power with high interest rates. A long-term decline in the dollar could hamper some economic trends, like the growing productivity of the American work force. If investors lost confidence in the business climate in the United States, or in the federal government's ability to pay its debts, the dollar could plunge sharply and interest rates could increase. If the flow of investment also slackened, the demand for dollars to buy American securities would dry up. That could be the start of a vicious cycle, forcing a further slide in the dollar and leading investors to demand an even higher return. A similar situation occurred two decades ago. The danger is if the decline in the dollar gets too severe, it could drive U.S. bond yields up like it did in the early 1980s with 15-20% mortgage rates. That could cause a recession despite the fact that the trade gap is closing. The best outcome would be a rise in U.S. saving coupled with a gradual decline in the dollar to a sustainable level

· Imports are becoming more expensive for Americans, and exports from the United States are becoming less expensive for foreigners.

· The dollar's depreciation has not narrowed the nation's trade gap. Exports have been increasing steadily, but imports have risen even faster. Both of these trends would be consistent with a gradual comeback in economic activity after prolonged weakness - and have perhaps little to do with the exchange rate. Will the sliding dollar ever eliminate the trade deficit? Not necessarily. Americans can keep buying more imports as long as foreigners are willing to accept dollars. The dollar's fall is a necessary but not sufficient condition for closing the trade gap. We also need an adjustment in the global saving and investment patterns. Saving by the private sector and by the government has to rise, or investment has to fall. No one wants to see investment fall in the United States, so we're looking at some sort of adjustment in saving. Shrinking the trade gap may require higher long-term interest rates, which could encourage Americans to save more and rely less on foreign financing. The potential for bigger budget deficits could help push to rates higher. Foreign lenders may start to demand higher interest rates from American borrowers, because payments in dollars are now worth less in the lenders' home currencies.

· The mystery to some economists is why long-term rates haven't risen already. A partial explanation is the demand of foreign central banks for American bonds. By keeping Treasury yields low, the foreign central banks are taking pressure off interest rates. But they have also prevented, or at least postponed, further decreases in the dollar's value. The banks were less interested in protecting the value of their dollar-denominated reserves than in protecting their countries' exporters, who have a harder time selling to the United States when the dollar weakens.

· U.S. labor is cheap relative to imported goods, leading to more employment and labor-intensive production. Though this may sound like good news, it stands in opposition to a long-running and in many ways beneficial economic trend. For decades, workers have had increasing amounts of capital like computers and machines -- making production more capital-intensive rather than more labor-intensive. When workers have more capital to use, they tend to be more productive - and to earn higher wages.

· The depreciation of the dollar may blunt the ability of foreign competition to transform industries in the United States. Firms that would have been put out of business by imports are going to stay in business.

· U.S. indebtedness is a key reason why the dollar has already declined 27% against a basket of major currencies since early 2002.

· The dollar will remain vulnerable, especially as the U.S. faces the enormous financing requirements created by the retirement and health-care needs of the baby boomers. In the near future, the U.S. will require either ever more foreign capital or an increased rate of domestic savings. The day of reckoning will be at the point when foreigners demand more for their money, either through a weaker dollar, higher interest rates, or both.

US Private Equity

· Venture capital investments, before World War II, were primarily the sphere of influence of wealthy individuals and families.

· One of the first steps toward a professionally-managed venture capital industry was the passage of the Small Business Investment Act of 1958. The 1958 Act officially allowed the U.S. Small Business Administration (SBA) to license private "Small Business Investment Companies" (SBICs) to help the financing and management of the small entrepreneurial businesses.

· General Georges Doriot is considered to be the father of the modern venture capital industry. In 1946, Doriot co-founded American Research and Development Corporation (AR&DC), the biggest success of which was Digital Equipment Corporation which provided AR&DC with 101% annualized Return on Investment. It is commonly accepted that the first venture-backed startup is Fairchild Semiconductor, funded in 1959 by Venrock Associates.

· Due to structural restrictions imposed on American banks in the 1930s there was no private merchant banking industry in the United States, a situation that was quite exceptional in developed nations.

· As late as the 1980s Lester Thurow, a noted economist, decried the inability of the USA's financial regulation framework to support any merchant bank other than one that is run by the United States Congress in the form of federally funded projects. These, he argued, were massive in scale, but also politically motivated, too focused on defense, housing and such specialized technologies as space exploration, agriculture, and aerospace.

· US investment banks were confined to handling large M&A transactions, the issue of equity and debt securities, and, often, the breakup of industrial concerns to access their pension fund surplus or sell off infrastructural capital for big gains.

· This industrial policy differed from that of other industrialized rivals—notably Germany and Japan—which at that time were gaining ground in automotive and consumer electronics markets globally. However, those nations were also becoming somewhat more dependent on central bank and elite academic judgment, rather than the more diffuse way that priorities were set by government and private investors in the United States.

· During the 1960s and 1970s, venture capital firms focused their investment activity primarily on starting and expanding companies. More often than not, these companies were exploiting breakthroughs in electronic, medical or data-processing technology. As a result, venture capital came to be almost synonymous with technology finance. Venture capital firms suffered a temporary downturn in 1974, when the stock market crashed and investors were naturally wary of this new kind of investment fund. 1978 was the first big year for venture capital. The industry raised approximately $750,000 in 1978.

· In 1978, the US Labor Department reinterpreted ERISA legislation and enabled pension funds invest in alternative assets classes such as venture capital firms. Venture capital financing took off.

· In 1983 there were over 100 initial public offerings for the first time in U.S. history. That year was also the year that many of today's largest and most prominent VC firms were founded. Due to the excess of IPOs and the inexperience of many venture capital fund managers, VC returns were very low through the 1980s.

· The late 1990s were a boom time for VC firms on Sand Hill Road in the San Francisco Bay Area. A number of large IPOs had taken place, and access to "friends and family" shares was becoming a major determiner of who would benefit from any such IPO; Common investors would have had no chance to invest at the strike price in this stage.

· The NASDAQ crash and technology slump that started in March 2000 shook some VC funds significantly due to losses from overvalued and non-performing startups. By 2003 many firms were forced to write off companies they had funded just a few years earlier, and many funds were found "under water" (the market value of their portfolio companies were less than the invested value). Venture capital investors sought to reduce the large commitments they had made to venture capital funds. By mid-2003, the venture capital industry would shrivel to about half its 2001 capacity.

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US Corporations

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Updated: 11/19/06