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A Piece of the Pie (Wednesday, May 19, 2010)

Interest rates on short-term Treasury bills and money market alternatives remain around zero from an earlier post. Instead of weeks it is now in terms of years. Therefore, there are virtually no incentives for savings particularly for regular folks and ordinary consumers which are the basic components for many financial institutions.

Today’s new buzz word is “sustainability” since various entities are trying to sustain expenditures despite contracting revenues. Unfortunately, the sustainability term does not reflect mathematical and economic reality.

This is the plight of various governments and organizations. Visualize 3 pizza pies sliced into 8 equal pieces. The first pie is small, the second is large and the third is medium. Each slice represents 12.5 percent of each pie; however, the slices vary in size from pie to pie.

In case #1, one slice represents taxes and fees, in case #2, three slices represent taxes and fees due in part to progressive taxing structures, and case #3 represents a 2-slice revenue stream. The transition from the small to large pie was accompanied by institutionalized spending. Thus, when the process moved to the third pie the organization was still spending at a rate of 3 large slices despite the reduction to 2 medium slices. The consumption/expenditure rate dominates the production/revenue rate and hence it is unsustainable. Depending on the relative sizes of the pies, there are outcomes where borrowing other slices may not be sufficient. In fact, the increases in borrowing/debt eventually consume the entire pie.

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