We all know that when we spend $1.20 for each dollar of income, we are headed for financial trouble. Some of us even believe that cash from a loan is income. So to make up the twenty cent shortage, we borrow or make purchases using a credit card. And with this abundance of ignorance, we are happy.
Let’s go over some basic rules that highly trained financial folks like me look at to determine whether a person can pay his bills. Sometimes, what is laid out in the first paragraph simply goes over people’s heads.
If the dollar collapses, at least it can be used for decorative purposes
One of the first things I look for is to see if a person (or a business) has a current ratio equal to 2 : 1. In other words, to be able to pay one’s bills, one must have $2 of current assets for each $1 of current liabilities.
Current assets are cash, assets convertible to cash in 30 days, receivables and inventory. Current liabilities are short-term liabilities that are payable within a short period of time, like credit cards and portions of long-term liabilities that are due and payable in 30 days.
The more critical ratio is the quick or acid test ratio, which is the relationship of current assets minus inventory as it relates to current liabilities. If this ratio is less than 1 : 1, then the person or business is considered to be insolvent and cannot pay his bills. If that person approaches you for a loan, you will be giving such a loan at your own great peril because I can assure you that he won’t be able to pay you back.
If we use this tool to determine financial stability, the Federal, State and County governments can be determined to be insolvent. If they were individuals, their credit rating would likely be below 400. The only thing they have going for them is their power to confiscate from the citizens using their taxing powers.
Standard and Poor did not downgrade the credit rating of the Federal Government because the politicians did not compromise, but did so because they did compromise.
Here’s what happened. It was already determined that the Federal government could not meet its obligations. Rather than get these ratios in line with responsible financial management, they raised the debt ceiling, meaning that they could borrow more, thereby increasing the current liabilities.
There was an agreement to cut future spending in exchange for the ability to borrow more and to spend more today. In other words, they opened up another credit card so that they can spend more today in exchange for the promise to cut future spending within the next ten years.
Not a responsible move. No Congress can dictate what future Congresses can or cannot spend. Each Congress has the Constitutional power to set its own budget.
Contrary to what politicians would like to have you believe, compromising was a bad thing.
Let us assume that one has a child who is 5 years old and that child is a borderline diabetic. It is one hour before dinner and there are five pieces of cake that the child wants to eat. The child whines and throws a tantrum.
In the interest of being deemed to be reasonable, the parent compromises and allows the child to have two pieces of the cake and the child happily stops whining. The child is overloaded with sugar and goes into shock. Not very responsible on the part of both the child and the parent.
This is what our politicians did. One side announced that they planned to spend more in order to get our economy going and the other side compromised and allowed for the debt ceiling to be raised in exchange for FUTURE spending cuts. S & P rightfully deemed this to weaken the government’s ability to pay and lowered the credit rating.
Politicians, do what they do best and immediately began trashing S & P for lowering the rating.
Our economy is based upon monetarist economics, or Keynesian economics. It measures growth or productivity using phony money. The government hires and pays a person $100 to dig a ditch. The next day, that person is paid another $100 to fill in the ditch he dug the day before. The government then announces that productivity was $200, but in reality, nothing of value was created.
Raising more revenue by increasing the tax rates for the rich is one solution that those who advocate more spending offered. They consider the individuals and corporations that make more than $250,000 a year are rich. If you are covered by a pension plan or have a 401 K plan, you are likely owners of these “rich” companies because you own these companies through your plan. A raise in tax rates would diminish your return on your investments.
You further end up paying more when you buy the products and services you consume because these businesses will have to raise their prices to pay the additional taxes. Companies that are profitable are left with fewer dollars and would be unable to expand or hire more employees. Unemployment will remain high or will go higher.
The dollar will erode further and those on fixed income like our Kupunas, will have to pay more for goods and services or do without. Those who feel entitled to government funds could riot. They’ll even trash those who drive luxury cars or live in expensive homes. What they’ve done in Europe is what could happen here.
Kupunas won’t be able to defend themselves and their property. Flash riots are hard to prepare for and to defend against.
Right now, there is no safe place to invest your money other than into hard assets. We need to wait and see what the markets are going to do when the investors come back into the market after Labor Day. More importantly, we need to see if we can get past September 11 safely and without a major terrorist attack. An attack will cause a market crash, putting further downward pressure on an already vulnerable dollar.