"Downtown construction, Washington, D.C."
Ilargi: News has come in of the death of Matt Simmons late Sunday night. Matt will be sorely missed. Our thoughts are with his family.
Ilargi: I know I've suggested before that John Williams of the highly regarded Shadowstats.com site might be better at collecting data than interpreting them (something to do with that silly hyperinflation idea) , but I figured if I asked Stoneleigh to weigh in on a recent interview with him, she might just hammer that point home better than I could at the moment.
There are quite a few voices out there who -sort of- see what's going on, but who most of them go completely astray when it comes to the interpretation of the data; to what will come after. Stoneleigh and I have never had any doubts, other then in timing, i.e. another taxpayer trillion dollars straightening the ship for another month. John Williams sees a lot of it, which makes him an interesting guy to listen to. But on the flipside, he misses out on some of the perhaps most crucial parts of the entire story. Which is a shame.
Stoneleigh: There's an interesting interview at The Energy Report with John Williams of Shadow Stats ( John Williams: Times That Try Our Souls ), which I wanted to discuss because, while there are many aspects are we would agree with, there are other glaring differences with how The Automatic Earth sees the future unfold. It is worth looking at the article in some depth in order to find the source of the disparities.
Mr Williams' prediction is hyperinflation, although, like us, he is predicting a great depression. One major distinction between TAE's view and that of many inflationists is the definition of inflation. It is clear from the interview that Mr. Williams' definition is increasing prices. Readers of TAE will know that our definition is a monetary one - an increase in the supply of money, credit and velocity thereof relative to available goods and services. We have consistently pointed out that using a price definition of inflation removes all the explanatory and predictive value from the concept. Prices changes are lagging indicators of changes in the money supply, complicated by other factors, both globally and locally. For instance, global wage arbitrage has been a major factor driving prices down in recent years, despite a tremendous credit expansion.
Prices do not tell a story by themselves. It is necessary to assess price drivers in order to understand what is unfolding. It is then necessary to adjust prices for changes in the money supply in order to see what is happening to prices in real terms, as opposed to merely nominal terms. Prices in real terms show what is happening to affordability, as it is not price by itself that matters, but price relative to how much money one has in one's pocket.
Despite his call for an inflationary future, Mr Williams lays out the case for deflation, as defined in monetary terms:
JW: "If you strangle liquidity you always contract an economy and deliberately or not, liquidity is being strangled, resulting in sharp declines in consumer credit, commercial and industrial loans..... "
".....We're still seeing contractions in liquidity, and that's adjusted for inflation. In real terms, M3 money supply is down almost 8% year-over-year."
Williams also points out that the actions of the FED so far are not having an inflationary effect:
"The banks are not lending. The money the Fed put into the system in terms of buying mortgage-backed securities from the banks and trying to help bank liquidity ended up back with the Fed as excess reserves. We have well over $1 trillion there; had the banks loaned that money in the normal stream of commerce, it would have added more than $10 trillion to the broad money supply, which otherwise is up around $14 trillion. That certainly would have had some inflationary impact if not in terms of actual business activity. You can't always get the economy to grow by pushing money into it. Sometimes it's like pushing on a string.
It is indeed pushing on a string. Trying to stuff more credit into a system that is already choking on it will do nothing to increase the money supply in circulation. It cannot -even possibly- be inflationary. We are already in monetary contraction, as Williams has noted, and the contraction of credit makes the situation considerably worse than it appears from traditional money supply measures. Contraction is being aggravated by a fall in the velocity of money, as people, companies and banks hang on to what cash they have.
In a deflation, real interest rates are always higher than nominal rates. The real rate is the nominal rate minus inflation, and when inflation is negative, the numbers are added rather than subtracted. Even zero in nominal terms is not low enough to make the real rate sufficiently low to reignite borrowing and lending.
This is the liquidity trap, and governments are thoroughly caught in it already.
There is no chance that the money injected by the Fed will find its way into the real economy, and no chance that it will ignite a wage/price spiral in an era of credit contraction and rising unemployment. Employees will have no pricing power at all under such circumstances, which means that wages will fall rather than rise. Prices will also fall, as the withdrawal of credit will remove price support across the board. However, even as prices fall, affordability will be getting worse, because purchasing power will be falling faster than price.
People typically understand that inflation can make things less affordable over time, but deflation can do so much more quickly and much more comprehensively. The scenario that Williams describes is one of the effects of deflation, with real prices shooting up and everything becoming dramatically less affordable in a very short space of time.
We agree with Williams as to the prospects for the real economy in the near term:
"I expect an accelerating pace of downturn in the next couple of months. The numbers will turn sharply worse....
....By then we'll find the consensus pretty much in the camp that we're in a double-dip recession. The popular press will describe it as a double dip, but we never had a recovery. Actually, this is just a very protracted, very deep downturn that has had a pattern of falling off a cliff, bottoming out, having a little bit of bump due to stimulus and then turning down again. Sort of shaped like the path of a novice skier going down a jump for the first time. Speeding sharply down the hill, he goes up in the air and starts spinning wildly as he tries to figure out which end is up with his skis. Then he takes a pretty bad tumble. We're beginning to spin in the air."
We also agree with Williams as to the nature of the problem - credit expansion - and his observation that credit availability is decreasing:
"Most of the growth we'd seen in the last decade prior to this downturn was due to debt expansion. The debt structures have pretty much been put through the wringer and consumers are not expanding credit, generally because it's not available to them. Absent debt expansion and/or significant growth in income, no way can the consumer expand personal consumption."
Without the ability to expand consumption, there is no price support even at current levels, let alone a chance for prices to rise. Credit expansions are based on Ponzi dynamics - the creation of multiple and mutually exclusive claims to the same pieces of underlying real wealth pie, as opposed to cutting the pie into a larger number of smaller pieces as currency inflation would do. The Ponzi nature of credit expansion is the determining factor in the ultimate fate of all bubbles.
Like many inflationists, Williams describes a deflationary scenario, but then says that governments will simply print currency:
"But in this crazy, almost perverse circumstance, the renewed weakness to a large extent will help push us into higher inflation....The only option left going forward is for the government eventually to print the money for the obligations it cannot otherwise cover, which sets up a hyperinflation."
This projection does not recognize the power of the bond market, which is much greater than that of governments. Any government attempting to print actual currency is going to find that the bond market sends its interest rates through the roof in very short order.
Governments do not set interest rates.
They merely choose a rate to defend. If that rate is radically different from what the bond market thinks appropriate, then the government will bankrupt itself very quickly.
If the bond markets raise interest rates even marginally, while so many governments are very vulnerable to any increase at all, the result will be a tsunami of debt default, which is deflation by definition.
Again, as with most inflationists, Williams supposes that governments have the power to prevent extremely negative outcomes:
"Irrespective of the politics of big government spending, quantitative easing, renewed bailing out of banks, whatever is involved, I'd argue that the government still will do whatever it takes to prevent a systemic collapse....
....The federal government isn't going to let California or New York or Illinois collapse. Those are threats to the systemic survival. They're also going to spend a lot more to support people on unemployment."
Governments do not have the power that people imagine them to have. They cannot overcome the power of the collective, when that power is focused like a laser beam in one direction. Governments are going to find that the number of claims on their resources skyrockets, even as their tax receipts fall dramatically and their ability to borrow is curtailed by rising interest rates as a reflection of rising sovereign debt risk. Debt-junkie governments will be caught in a liquidity trap until the power of the international debt financing model is finally broken, as it will eventually be.
However, this does not happen overnight. Until it does, the power of governments to print will be sharply limited. We would expect this to remain the case through the era of deleveraging, which should last for several years. While inflation may be a long term threat once the power of the bond market is broken, that threat lies much further down the line. It is deflation that is today's threat, and deflation that people must prepare for right now.
We agree with Williams' diagnosis that a depression is imminent, but not his hyperinflationary rationale for it:
"I've been talking about an economic recession, but we are headed for something far worse. I define a depression as a 10% peak-to-trough contraction in the economy. In terms of the broad economy, we're not down 10% in GDP yet. So while we're not formally in depression, we're certainly seeing it in a number of indicators and I think we'll be in a depression, with GDP down 10%, in the near future.
A contraction greater than 25% peak-to-trough puts you in a great depression. That is what I envision, but we'll be taken there by hyperinflation and a resultant cessation of normal commerce."
Wiliams has a very different view than The Automatic Earth has of the relatively near-term prospects for the US dollar:
"We're getting extraordinary protestations from other central banks about the U.S. finances, its solvency, risk of the dollar. Before the current crisis you never would have heard any central banker making such comments. As this breaks, it's going to be obvious that the U.S. is moving to debase its dollar.
It'll have no option to do otherwise. I would fully expect some foreign holders looking to dump the Treasuries. With the dollar plunging, the Treasury won't be able to get the funding that it needs from a practical standpoint in the open markets.
The Fed will come in to salvage that situation, becoming the lender of last resort to the Treasury—literally monetizing the Treasury debt. The Fed might have a couple different ways to address the dollar situation, from raising interest rates to direct intervention, slapping on currency controls. I can't tell you exactly how it's going to go. But you'll have an environment that's effectively creating a perfect storm for the U.S. dollar."
The Automatic Earth says that the value of the dollar will increase sharply in the short term - over the next year or two - on a combination of a knee-jerk flight to safety into the global reserve currency and the deflation of dollar denominated debt. Both of these factors will create a demand for dollars, which should act to increase their value relative to other currencies for a period of time. We are not arguing that the dollar is a long term bet - far from it in fact. All fiat currencies eventually die, but now is not that time.
We have argued that people need to hold liquidity during the period of deleveraging, as the risks to cash will be lower than most other wealth preservation strategies. At the point when they can afford to do so without debt, which will depend on how much money they have to begin with, they need to move into hard goods. In doing so, they will prepare for an eventual bottom, at which point inflation should be a genuine threat. People need to be fully liquid at tops and fully invested (in hard goods in this case) at bottoms. In doing so they will be doing the exact opposite of the larger human herd, which is always the best prescription for success.
Williams holds a commonly-held view of the direction of oil prices, and their 'inflationary' impact (in price terms):
"Heavy dollar selling will be exceptionally inflationary. Oil prices will spike in response to the weakness in the dollar. Oil is a primary commodity that drives consumer inflation; that's how you can have inflation in a recession. The traditional wisdom is that strong demand against limited supply causes inflation, but you can also have inflation due to commodity price distortions, which is what we had back in '73 and what we've seen over the last year or so."
This is at odds with The Automatic Earth's view of where oil prices are heading in the short term. Our prediction is that falling demand (where demand is not what one wants, but what one can pay for) will lead to falling prices, but that more rapidly falling purchasing power (due to the collapse of the credit that represents over 95% of the money supply) will ensure that lower future prices will be less affordable than higher current ones.
We are predicting lower prices for oil initially, but are expecting demand collapse to set up a supply collapse down the road due to lack of investment in exploration, development and maintenance of existing infrastructure.
The financial crisis thus takes the pressure off in energy terms initially, at the cost of aggravating energy crises significantly in the longer term. Supply collapse will lead to skyrocketing prices in an era of tight money, when most people have very little purchasing power. It will also greatly increase the odds of a resource grab by governments seeking the ultimate source of liquid hegemonic power. Oil can be expected to lose fungibility, and ordinary people may be priced out of the market for fossil fuels entirely.
Williams offers a prescription for preparation that we would take issue with in a number of important respects:
"Hold some gold, silver, precious metals. I'm talking physical possession. Preferably coins because coins, sovereign coins, are recognized as such. They don't have liquidity issues. Having some assets outside the U.S., and certainly some assets outside the U.S. dollar, is a good thing. I like the Australian dollar, the Canadian dollar, the Swiss franc in particular. They won't suffer the same hyperinflation in Australia, Canada and Switzerland as we do in the U.S., so those currencies will tend to act as ways of preserving wealth. Over time real estate is a traditional store of wealth, but it's not portable and sometimes it's not liquid."
While (physical) precious metals have been money for thousands of years, and can be expected to hold their value over the long term, they are not ideal for those who are not exceptionally wealthy, i.e. those who can sit on them for perhaps 20 years without having to rely on the value they represent.
Those who would be forced to sell - into the ultimate buyers market of the coming years of deleveraging - would have been better off holding the cash that most will be seeking in the not too distant future.
Governments are very likely to seek to control assets as valuable as precious metals, as they did during the depression. Ownership could be banned and precious metals could be confiscated. It can be as challenging being too close to a source of great value as it is being too close to the centre of power in difficult times. It can mean constantly having to watch your back and never being able to trust anyone. Our view at TAE is that there are many things you could own which will serve you much better than precious metals.
We would agree with Williams' suggestion as to what kind of supplies to hold in order to have some control over the essentials of your own existence:
Most importantly, build up a store of supplies, more than you would normally consume over a couple of months, particularly food and water, canned goods. Having those goods can save your life in a number of ways. You'd have food to eat, and if you have extra you can use it to barter.
I met a guy who'd been through hyperinflation and found for purposes of the barter system those airline-size bottles of high-quality scotch proved quite valuable. Buy things that you would otherwise consume and rotate your inventory. Don't go out buying all sorts of things you'll never use. Keep what makes sense to you and your circumstances. Make sure you have things that are stable. Not too perishable.
While he suggests this as a hedge against inflation, we suggest it as a hedge against general economic disruption. Deflation is very likely to lead to a collapse of global trade, as letters of credit dry up and protectionism leads to retaliation-inspiring and -inspired import tariffs and trade wars. As we have a trade system built on long and vulnerable just-in-time supply lines, supply disruption under such circumstances is very likely. Holding one's own supplies of certain goods, along with liquidity, is therefore a good idea.
We have a great deal of respect for John Williams and what he has achieved with Shadow Stats, but it is always important to assess the foundation of people's predictions. Williams does not appear to accord sufficient significance to the role of credit and the effect of its evaporation during a Ponzi implosion. He also, in our view, chronically over-estimates the power of governments to control the way that events unfold. Outcomes are possible, indeed probable, that no one would choose. We simply do not have that choice to make. We will be at the mercy of the underlying logic of the system we have built during the expansion years, and that logic leads directly to a deflationary depression.
John Williams: Times That Try Our Souls
by Karen Roche - Energy Report
When Fed Chairman Ben Bernanke admits to seeing an "unusually uncertain" economy ahead, it's pretty terrifying to imagine what he's really thinking. What John Williams envisions—and he's by no means looking to the far horizon—is a systemic collapse, a hyperinflationary great depression and the cessation of normal commerce. Despite that bleak outlook, however, when the economist and editor of ShadowStats.com sat down for this exclusive Energy Report interview, he also had some good news.
The Energy Report: A few months back, John, you said, "if you strangle liquidity you always contract an economy and deliberately or not, liquidity is being strangled, resulting in sharp declines in consumer credit, commercial and industrial loans." Does this mean it would spur more economic growth if banks actually started lending?
John Williams: It sure wouldn't hurt. We're still seeing contractions in liquidity, and that's adjusted for inflation. In real terms, M3 money supply is down almost 8% year-over-year. It's the sharpest fall in the post -World War II era. It's not so much the depth of the decline in the liquidity or the duration, but the fact that the liquidity turns negative year-over-year that signals the economy turning down.
We had the signal in December of 2009 indicating intensification of the downturn, in this case, within six to nine months. We're in that timeframe now and see softening numbers. People are talking about a weaker economy. Even Mr. Bernanke has described the economy as "unusually uncertain" in terms of its outlook. Wording like that from the Fed is a pretty good indication that something's afoot.
TER: Why is M3 still contracting?
JW: Just as you noted, the banks are not lending. The money the Fed put into the system in terms of buying mortgage-backed securities from the banks and trying to help bank liquidity ended up back with the Fed as excess reserves. We have well over $1 trillion there; had the banks loaned that money in the normal stream of commerce, it would have added more than $10 trillion to the broad money supply, which otherwise is up around $14 trillion. That certainly would have had some inflationary impact if not in terms of actual business activity. You can't always get the economy to grow by pushing money into it. Sometimes it's like pushing on a string.
TER: And you say that a contracting money supply is a sure sign of trouble?
JW: When it contracts year-over-year adjusted for inflation, that's a signal for a downturn or an intensified downturn. It happens every time. Squeeze liquidity and business activity contracts.
On occasion, we've had recessions without a preceding downturn in the money supply. And sometimes, the money supply has turned positive but the economy has not followed—again, pushing on the string. Expanding money supply has led to upturns as well, so the Feds had to give it a try to stimulate the economy. But the one sure signal is the downturn. You don't get it often but it's very powerful when you do.
We're beginning to see the data break. Some unusual factors have been at work. I expect an accelerating pace of downturn in the next couple of months. The numbers will turn sharply worse. Consensus estimates are already moving in that direction and most everything will follow. Industrial production is still up but retail sales have been falling. Payroll numbers have been flat when you take out the effects of the census hiring. Those employment numbers will turn down in the next month or two, providing an important indicator of renewed economic contraction.
So we'll see how it develops, but we're at that turning point. It is happening as we speak. At the end of July, we got an estimate of the second quarter GDP, where the pace of annualized growth slowed to 2.4%. The early GDP estimates are very heavily guessed at, so most of the time you don't know if you're getting a positive or a negative number. You get a margin of error of plus or minus 3% around the early reporting. That happens also to be about average growth.
Nevertheless, on a quarter-to quarter-basis, I think we'll see GDP down again in the third quarter. With the bulk of the reported GDP in the first half due to inventory building, the stage for renewed contraction has been set. By then we'll find the consensus pretty much in the camp that we're in a double-dip recession. The popular press will describe it as a double dip, but we never had a recovery. Actually, this is just a very protracted, very deep downturn that has had a pattern of falling off a cliff, bottoming out, having a little bit of bump due to stimulus and then turning down again. Sort of shaped like the path of a novice skier going down a jump for the first time. Speeding sharply down the hill, he goes up in the air and starts spinning wildly as he tries to figure out which end is up with his skis. Then he takes a pretty bad tumble. We're beginning to spin in the air.
TER: But we've been in recession for three years now?
JW: The second leg that I'm talking about is the one now underway as we get to the middle of 2010. December 2007 is when this recession officially started, although I contend that it started earlier in 2007. At any rate, the economy plunged through 2008 and well into 2009. The numbers were pretty much bottom-bouncing during the second half of 2009. The auto deals and the homebuyer deals added a little spike to the growth pattern, but that growth was stolen from the future. It didn't create new demand.
Let me just clarify a bit. Recession, at least traditionally, was defined as two consecutive quarters of contracting real GDP growth adjusted for inflation. The National Bureau of Economic Research, the defining authority as to whether we're in a recession, will deny it, but at one time they used that general guideline as well. They've always used other numbers, too, such as employment and industrial production, trying to time the beginning or the end of a recession to a particular month. Significantly they did not call an end to this recession. They said it was too early to call, but I think they had a pretty good sense of what was going to happen. So what we're seeing now just looks like an ongoing deep recession. The next down leg is going to be particularly painful and I'm afraid particularly protracted.
TER: Can the governments pull any more stimulus levers yet this year?
JW: Oh, I think they'll try, but nothing much they can do will have anything other than short-term impact. If they write everyone a check, people go out and buy things. That would give the economy a quick boost but do nothing to change the underlying fundamentals or to correct the structural problems in this recession. Those are tied to the lack of robust growth in consumer income.
TER: So consumer income is a key factor.
JW: Absolutely. If you put in housing that's related to the consumer, that's three-quarters of the GDP. The average household is not staying ahead of inflation, and unless income grows faster than inflation, the economy won't grow faster than inflation—and that means that GDP is not growing. Income sustains consumption. When income grows, consumption grows. The only way to have sustainable long-term economic growth is to have healthy growth in income. You can buy some short-term economic growth, though, without growth in income, through debt expansion, which is what Greenspan tried.
Most of the growth we'd seen in the last decade prior to this downturn was due to debt expansion. The debt structures have pretty much been put through the wringer and consumers are not expanding credit, generally because it's not available to them. Absent debt expansion and/or significant growth in income, no way can the consumer expand personal consumption. You have to address employment, quality of jobs.
TER: You're suggesting that problems with the quality of jobs, if not the quantity, goes back to Greenspan—before the recession kicked in.
JW: Yes. A lot of high-paying jobs have been lost to offshore competition, to U.S. companies moving facilities offshore and to outsourcing offshore. That's been the primary driver of declining household income.
TER: We no longer really have the option of expanding the debt and it's doubtful that even short-term stimulus will have much impact. Looking at this next leg down against that backdrop, what projections would you make about unemployment, housing prices, GDP as we look through the end of 2010 and into '11?
JW: Unemployment will be a lot worse than most people expect. Housing will continue to suffer in terms of weak demand. But in this crazy, almost perverse circumstance, the renewed weakness to a large extent will help push us into higher inflation. Real estate tends to do better with higher inflation, but it's not going to be a happy circumstance for anyone.
The government is effectively bankrupt. Using GAAP accounting principles, the annual deficit is running in the range of $4 trillion to $5 trillion. That's beyond containment. The government can't cover it with taxes. They'd still be in deficit if they took 100% of personal income and corporate profits. They'd also still be in deficit if they cut every penny of government spending except for Social Security and Medicare. Washington lacks the will to slash its social programs severely, to change its approach to ever bigger government. The only option left going forward is for the government eventually to print the money for the obligations it cannot otherwise cover, which sets up a hyperinflation.
All of what I just described was already in place when the systemic solvency crisis broke. Before this crisis the government was effectively bankrupt. In response to the crisis, the government may have gone beyond what it had to do, but you err on the side of conservatism when you're trying to prevent a systemic collapse. That was a real risk. It still is. Irrespective of the politics of big government spending, quantitative easing, renewed bailing out of banks, whatever is involved, I'd argue that the government still will do whatever it takes to prevent a systemic collapse. That last series of actions had the effect of rapidly exploding the deficit. In just a year, we went from something under $500 billion in official reporting, on a cash basis as opposed to GAAP basis, to something close to $1.5 trillion.
TER: How big will that deficit grow in this second painful and protracted period?
JW: I can't give you a hard number, but I can tell you this. The markets came into this year on consensus projections that we'd have positive economic growth. Forecasts for the federal deficit, treasury funding, banking system solvency, etc. all were based on assumptions of recovery, of positive growth. Those assumptions presumably still underlie what I consider to be an irrational stock market.
But those projections and assumptions were wrong. We're going to have negative growth. The downturn will intensify. We're not in recovery. We have states on the brink of bankruptcy. The federal government isn't going to let California or New York or Illinois collapse. Those are threats to the systemic survival. They're also going to spend a lot more to support people on unemployment. Again, putting aside election year politics and such, the banking industry will need further bailout as solvency issues come to a head again. The federal deficit is going to balloon. It's going to blow up much worse than any formulas would give you, and Treasury funding needs will explode.
TER: Clearly you see us spiraling out of control.
JW: We've been talking about an economic recession, but we are headed for something far worse. I define a depression as a 10% peak-to-trough contraction in the economy. In terms of the broad economy, we're not down 10% in GDP yet. So while we're not formally in depression, we're certainly seeing it in a number of indicators and I think we'll be in a depression, with GDP down 10%, in the near future.
A contraction greater than 25% peak-to-trough puts you in a great depression. That is what I envision, but we'll be taken there by hyperinflation and a resultant cessation of normal commerce.
TER: Hyperinflation means different things to different people. How do you define it?
JW: My definition has been and will remain very simple. When the largest-denomination note in circulation—the $100 bill in the case of the U.S. dollar—has the same value as toilet paper, you have a hyperinflation. You saw that in the Weimar Republic. People papered their walls with money.
TER: I think you've said that the only reason that Zimbabwe's economy survived is because they started using dollars as black market currency.
JW: But you don't have anything like that in the United States as a backup. We're going to have a much rougher time in the U.S., of all places, than they had in Zimbabwe. Zimbabwe was able to function because people could exchange the local currency into dollars, and then buy things with the dollars, so the economy continued to function. Without some kind of a backup system, as the currency becomes worthless you'll see disruptions to key supply chains. When people don't have food, you end up in very dangerous circumstances.
TER: Do you see any real potential for precious metals or another currency as a backup?
JW: Well, yes. I think they will become a backup fairly quickly, but we don't have any widely developed black market for another currency at this point because the dollar remains the world's reserve currency. All sorts of things may develop that we don't anticipate. What will be used to cover for the dollar? Gold and silver? The precious metals are limited in supply and not widely held by the population in general. Hard currency from Canada or Australia? That wouldn't be in wide circulation, at least not early on. I think a barter system is where it will go until the currency system is stabilized, but the currency system can't stabilize until the government's fiscal house is in order.
There's no sense in setting up a currency on a gold standard if you can't live within your means, because you'd just end up going through successive devaluations against gold. So whatever's done to set up a new currency system will have to be in general conjunction with the overhaul of the government's fiscal condition. But in the interim, something of a barter system would evolve. Even that, though, is something that may take six months to get stabilized.
TER: It's hard to imagine.
JW: In the Weimar Republic, you could go into a fine restaurant one evening and enjoy its most expensive bottle of wine with a nice dinner. You'd probably negotiate the price before you sat down, because the price would be higher by the time you finished dinner. By the next morning the empty wine bottle would be worth more as scrap glass than it had been worth as an expensive bottle of wine the night before. That's how rapidly things change in a hyperinflation.
But we have a circumstance that did not exist in the Weimar Republic. Our society is heavily dependent on electronic cash. Say you have a credit card with a $10,000 limit. In hyperinflation, that $10,000 might be enough to buy you a loaf of bread.
TER: There's not even enough physical cash running around anywhere in the United States that actually represents what goes back and forth electronically. If you can't use your debit card, how do you pay for your coffee at Starbucks? And how will companies and banks adjust?
JW: You're not going to have electronic payments that are in-barter equivalent that I can foresee. That would be a fairly sophisticated system and the needs are going to be immediate. When hyperinflation starts to break, it can unfold in a matter of weeks, months. You'll need to be able to handle things rapidly. Frankly I think the system will tend to break down. It's not a happy circumstance. How will a small company get its goods to people? There might be blackouts. Who's going to get the fuel to the power plants?
TER: And to the gas stations for the cars for people who still have jobs?
JW: Yup. It will get very difficult. Society won't run as we're used to it. People will find a way, but it's going to take a little while for that to stabilize.
In an electronic society it's going to take some creative thinking by businesses. I'm sure some people will figure out some ways to accommodate these changes, but it's going to be a painful, costly process that won't be conducive to normal revenue flows—at least not as measured in inflation-adjusted dollars.
TER: I'm almost afraid to ask, but how will the stock markets fare when the system breaks down?
JW: Stocks generally tend to reflect inflation, since revenues and profits are in inflated dollars. If you look at stock prices adjusted for inflation, you can have a bear market as well as a bull market. But these are not going to be good economic times. So I think we're going to have a real bad stock market adjusted for inflation. I'd stay out of stocks in the U.S. With the U.S. markets in serious trouble, the rest of the world probably will see lower stock prices as well, but they're not going to have the hyperinflation.
TER: What will plunge us into this abyss? And when?
JW: I think the odds are extremely high that we'll see it break within the next year. I would put it six months to a year, outside. We're getting extraordinary protestations from other central banks about the U.S. finances, its solvency, risk of the dollar. Before the current crisis you never would have heard any central banker making such comments. As this breaks, it's going to be obvious that the U.S. is moving to debase its dollar. It'll have no option to do otherwise. I would fully expect some foreign holders looking to dump the Treasuries. With the dollar plunging, the Treasury won't be able to get the funding that it needs from a practical standpoint in the open markets.
The Fed will come in to salvage that situation, becoming the lender of last resort to the Treasury—literally monetizing the Treasury debt. The Fed might have a couple different ways to address the dollar situation, from raising interest rates to direct intervention, slapping on currency controls. I can't tell you exactly how it's going to go. But you'll have an environment that's effectively creating a perfect storm for the U.S. dollar. I hate to use the term but it's a good one.
Heavy dollar selling will be exceptionally inflationary. Oil prices will spike in response to the weakness in the dollar. Oil is a primary commodity that drives consumer inflation; that's how you can have inflation in a recession. The traditional wisdom is that strong demand against limited supply causes inflation, but you can also have inflation due to commodity price distortions, which is what we had back in '73 and what we've seen over the last year or so.
Most of the recent volatility in the CPI has been due to swings in oil prices, which have been directly tied to swings in the value of the U.S. dollar. About $7 trillion in liquid dollar assets that overhang the market outside the U.S. could be dumped overnight. We're going to be seeing a lot of pressure to accept that back in our system, and it will be very inflationary. The Fed's options will be limited, but again I'd expect them to try and maintain systemic solvency.
So what we end up with is a circumstance where the dollar is under heavy selling pressure. People will feel the squeeze on their inflation-adjusted income with much higher prices for gasoline and fuel oil. The route to the monetary inflation will take hold from the Fed's direct monetization of Treasury debt. As we discussed earlier, the mortgage-backed securities taken off the bank balance sheets have generally gone to excess reserves and are sitting with the Fed. That hasn't been inflationary so far because it hasn't gone into the money supply.
TER: How do we get through this, John?
JW: If there's no solution for the system—and I don't see one; I think it just has to run its course—there still is good news. We as individuals have ways of protecting ourselves, our families, our friends, our businesses—whatever is important to us. To do that we have to preserve the value of our wealth and assets in order to ride out the storm. As terrible as it will be, it will end. A time will come when things become self-righting and the people who have been able to survive will be able to do some extraordinary things.
TER: And what do you advocate in terms of individuals preserving wealth and assets?
JW: Hold some gold, silver, precious metals. I'm talking physical possession. Preferably coins because coins, sovereign coins, are recognized as such. They don't have liquidity issues. Having some assets outside the U.S., and certainly some assets outside the U.S. dollar, is a good thing. I like the Australian dollar, the Canadian dollar, the Swiss franc in particular. They won't suffer the same hyperinflation in Australia, Canada and Switzerland as we do in the U.S., so those currencies will tend to act as ways of preserving wealth. Over time real estate is a traditional store of wealth, but it's not portable and sometimes it's not liquid.
If I'm right about what's going to unfold, a significant shift in government is possible; suppose the government moved so far to the left where maybe private ownership of property was not allowed. Having a lot of assets in real estate under those circumstances might not be so good. I think generally real estate is a good bet but you also have to consider the risks. Use common sense. Think through different things that could happen.
Most importantly, build up a store of supplies, more than you would normally consume over a couple of months, particularly food and water, canned goods. Having those goods can save your life in a number of ways. You'd have food to eat, and if you have extra you can use it to barter. I met a guy who'd been through hyperinflation and found for purposes of the barter system those airline-size bottles of high-quality scotch proved quite valuable. Buy things that you would otherwise consume and rotate your inventory. Don't go out buying all sorts of things you'll never use. Keep what makes sense to you and your circumstances. Make sure you have things that are stable. Not too perishable.
I had a professor at Dartmouth who'd lived for a while in a hyperinflationary environment that devolved into a barter system. He told a story about how his father had traded his shirt for a can of sardines. He decided to eat the sardines, which was a mistake because they had gone bad. But nonetheless that can of sardines had taken on monetary value. So when you look to trade things you want to be careful what you're doing.
TER: How long does a hyperinflation environment typically last?
JW: I guess it depends on how comfortable people can be in the environment. It went on for a couple of years in Zimbabwe, but they were able to function. Here, in a system that can't function well with it, it's not going to last too long. You won't have a usable currency. It's likely a barter system would evolve, and if it became stable and functioned well, it could last for a while. People don't want to starve. If that's a real risk, they will take action to protect themselves. We may have rioting in the streets. The government might declare martial law. If people can live comfortably with hyperinflation it would tend to linger. The more difficult things are, the faster people will move to remedy it.
TER: Well on that note is there anything that we can do as voting citizens to turn this around? Or minimize the impact?
JW: If things break slowly enough that people can see what's coming and respond, tremendous change may result from what comes out of elections. Incumbents are going to have a rough time. The circumstance is open for the development of a major third party that could knock out either the Republicans or the Democrats as a second party. Over time, pocketbook issues tend to dominate elections. If things are going well, if people are prosperous, they ignore the corruption in political circles as being just part of the system. But when they're hurting, they turn out the bastards and look to put in some change. We sure need change. I can tell you that. It's not just one party. Both major parties have an equal share of guilt in what's unfolding. Whichever one is in power keeps making it worse.
Hedging Chaos with Gold
by Darryl Robert Schoon
…what if history is not cyclical and slow-moving but arhythmic, at times almost stationary, but also capable of accelerating suddenly, like a sports car? What if collapse does not arrive over a number of centuries but comes suddenly, like a thief in the night… dramas lie ahead as the nasty fiscal arithmetic of imperial decline drives yet another great power over the edge of chaos.- Niall Ferguson, July 28, 2010
The nasty fiscal arithmetic of imperial decline that Harvard professor Niall Ferguson refers to is America’s unsustainable debt. Growing levels of debt according to Ferguson are now about to drive the US, like other great powers before it, over the edge of chaos; an event Ferguson believes will come sooner rather than later.
…most imperial falls are associated with fiscal crises…empires behave like all complex adaptive systems. They function in apparent equilibrium for some unknowable period. And then, quite abruptly, they collapse.
In 2010 the U.S. government is expected to issue almost as much new debt as all other governments, around the world, combined.
The resemblance between the above chart and the following is obvious - except, of course, to those in denial. [see them side by side here]
The US borrows 45 % of all moneys borrowed by all governments and spends virtually that same percentage of global military spending. Beginning in 1980, President Reagan started the US on the road to financial collapse, borrowing heavily in order to fund the US military buildup, an act of fiscal irresponsibility that would later prove fatal. In his two terms, Reagan increased the US national debt by 258 %, the cost of which would be the loss of America’s economic power-base.
After WWII, both the USSR and the US spent vast amounts of their respective GDPs on military expenditures. Bankrupted, the USSR collapsed in 1992. Three decades later, the US now faces the same fate.
America’s pending bankruptcy reflects America’s shift from the world’s creditor to its largest debtor. Prior to Reagan’s military buildup, the US did not need to borrow to support the global deployment of its military; instead, in order to do so the US spent its entire hoard of gold - 21,775 tons.
The only gold the US now possesses is there because in 1971 the US refused to convert its remaining gold for dollars as required under Bretton-Woods; and by the time Reagan was elected, the US could pay for its global military force only by indebting itself to others
When Reagan took office, total US debt was $980 billion. Today, the budget deficit for this fiscal year alone is projected to be $1.4 trillion. After the Reagan presidency, the US accelerated its spending until sovereign default or currency debasement are its only options.
Sovereign Debt Sovereign Default Sovereign Denial
The Emperor has no clothes, i.e. the empire has no money
The publication of Rogoff and Reinhart’s seminal work on sovereign debt in 2008 predated the sovereign debt crisis by two years; and if Rogoff and Reinhart were not surprised, they would be surprised that it would be industrialized nations that would find themselves under the scrutiny of global debt collectors.
In 2010, sovereign default concerns unexpectedly shifted from developing nations, i.e. Rogoff and Reinhart’s sovereign rite of passage, to industrialized nations - Greece, Spain, Italy, the UK, the US, and Japan etc.
The shift in sovereign debt concerns was accompanied by another extraordinary shift. Between 2000 and 2010, China became America’s creditor as well as its sweatshop; and China knows that the US owes so much money that only by borrowing more can it pay what it owes, a condition economist Hyman Minsky called ponzi-financing, the last stage prior to debtor default.
In truth, the US is not the default virgin described in Rogoff and Reinhart’s study. The US default on its gold obligations was perhaps the most important monetary default in history, plunging the entire world into a regimen of fiat money against its will
Sovereign default, however, is not the only strategy available to the US regarding its unpayable debt. The US could alternatively pay down its massive obligations by debasing its currency, a strategy wherein the US would pay its creditors with increasingly worthless US dollars - to the US, a far more convenient solution.
This is why China is worried - and the rest of the world (including Americans) should be worried too.
Borrow Borrow Borrow Spend Spend Spend
No one will be surprised when the US again tries to borrow its way back to economic growth. This has been the default strategy of the US ever since Ronald Reagan’s Treasury Secretary, Donald Regan said, “Deficits don’t matter”, a financial heresy that would eventually undermine the American economy.
Capitalism is an uneasy balance between credit and debt. However, in the 1980s, far more credit was created and far more debt resulted. Combined with the removal of gold as a constraint on monetary growth, it would be only a matter of time until capitalism’s accrued debt would overwhelm the capacity of credit to contain and service it. That time has now arrived.
Bankers have unleashed a beast they cannot contain. The beast is of their own making although they are careful to deny their patrimony. The bankers’ deflationary black hole of defaulting debt is now destroying capital faster than bankers can create it.
This is why Fed Chairman Ben Bernanke is contemplating flooding the US economy with even more printed dollars, the so-called helicopter drop of money (Milton Friedman’s term), the proscribed solution of Milton Friedman to the Great Depression.
Because Friedman observed that the money supply had contracted during the Great Depression, Friedman erroneously believed sufficient monetary expansion would prevent another depression in the future. This is why Bernanke flooded the US with money and credit in 2009 hoping Friedman was right.
But Friedman was wrong. Bernanke’s palliative was temporary, producing only a short boost instead of a sustained recovery. Despite trillions of dollars spent and interest rates lowered to zero, the US money supply is still contracting - and the US economy is again slowing.
Chart courtesy of www.sirchartsalot.com
Despite Friedman’s failed theory, Bernanke still believes more injections of credit and debt can do what previous injections didn’t. This is akin to an alcoholic believing more alcohol will dispel the hangover that previous drinks did not. Friedman and Bernanke’s helicopters are coming. Get ready.
Can you hear the helicopters coming
Sounds of choppers fill the sky
Whirling birds of destruction
This is how currencies die
Printing money is easy
The problem is the debt
Money’s source is credit
You ain’t seen nuthin’ yet
Bernanke’s dream is our nightmare
His solution is our demise
Helicopters filled with money
Dropping from the skies
The Golden Hedge Against Chaos
In The Critical Path (St Martin’s Press 1981) Buckminster Fuller predicted the world’s power structures would fall, plunging the world into an unprecedented crisis. Communism collapsed in 1992. Now, capitalism is about to do the same. Bucky’s predicted crisis comes next.
In The Great Wave (Oxford University Press 1996), Professor David Hackett Fisher observed we are at the end of a great wave - a phenomena that separates historical epochs, a phenomena which always end in the complete economic collapse of the existing order. Great Waves last 80 to 120 years. The current wave is 114 years old.
At the 2010 Aspen Ideas Festival last month, Harvard Professor Niall Ferguson warned the collapse of the American empire could be imminent.I think this is a problem that is going to go live really soon,” Ferguson said. “In that sense, I mean within the next two years. Because the whole thing, fiscally and other ways, is very near the edge of chaos..
When America’s empire does collapse and, like all empires, it will, chaos will reign. Today, the US is the world’s super power, its dollar is the world’s reserve currency. The collapse of the US will change all this and more.
This is why the price of gold has quintupled in only ten years. America’s failing grasp on power has been mirrored by gold’s rise during that same time. In 2000, America’s credit-driven prosperity began to falter with the collapse of the dot.com bubble. Ten years later, America has still not recovered. Indeed, as Niall Ferguson predicts, its demise is imminent.
Since the 1980s, the US has conspired with others to suppress the price of gold as it is an indicator of the failings of the fiat financial system upon which its power is based. This is akin to doctors icing the thermometer to convince others that the patient is not in danger; and while they have been successful in so doing, the patient is now about to expire.
When the US empire implodes, the global geopolitical matrix will collapse as will much of the world’s financial underpinnings. It will be a time of chaos; and gold - history’s hedge against chaos - will again perform its time-honored role.
Responsibility And Renewal
In an extraordinary mea culpa published July 31st in the New York Times, President Reagan's Director of the Office of Management and Budget, David Stockman, a Republican, blamed his own party for four critical errors that contributed to America's decline:
The errors are as follows:The first of these started when the Nixon administration defaulted on American obligations under the 1944 Bretton Woods agreement to balance our accounts with the world. It is.. an outcome that Milton Friedman said could never happen when, in 1971, he persuaded President Nixon to unleash on the world paper dollars no longer redeemable in gold or other fixed monetary reserves. Just let the free market set currency exchange rates, he said, and trade deficits will self-correct.[But] relieved of the discipline of defending a fixed value for their currencies, politicians the world over were free to cheapen their money and disregard their neighbors…
The second unhappy change in the American economy has been the extraordinary growth of our public debt…This debt explosion has resulted not from big spending by the Democrats, but instead the Republican Party’s embrace, about three decades ago, of the insidious doctrine that deficits don’t matter if they result from tax cuts…
The third ominous change in the American economy has been the vast, unproductive expansion of our financial sector…the trillion-dollar conglomerates that inhabit this new financial world are not free enterprises. They are rather wards of the state, extracting billions from the economy with a lot of pointless speculation in stocks, bonds, commodities and derivatives. They could never have survived, much less thrived, if their deposits had not been government-guaranteed and if they hadn’t been able to obtain virtually free money from the Fed’s discount window to cover their bad bets.
The fourth destructive change has been the hollowing out of the larger American economy…It is not surprising, then, that during the last bubble (from 2002 to 2006) the top 1 percent of Americans - paid mainly from the Wall Street casino - received two-thirds of the gain in national income, while the bottom 90 percent - mainly dependent on Main Street’s shrinking economy - got only 12 percent. This growing wealth gap is not the market’s fault. It’s the decaying fruit of bad economic policy. Read here.
Stockman’s mea culpa is an unexpected admission of political responsibility especially at a time when Americans are searching for someone to blame. But there’s no one to blame except America itself. The Russians aren’t responsible, the Muslims aren’t responsible and guess what, illegal immigrants aren’t responsible either - America, and America alone, is responsible for its own demise.
America was born out of the desire for freedom and a better life for all (apologies, however, are due to the Native Americans and the African slaves who suffered in the process). But, along the way, America chose to instead pursue power, not freedom; and, today, the considerable bill for America’s fatal choice is coming due - and more paper money won’t pay it.
God save America from itself.
Buy gold, buy silver, have faith.
Social Security to pay out more than it takes in for first time ever
by Kenneth R. Bazinet - NY Daily News
The recession and droves of retiring baby boomers will force Social Security to pay out more than it takes in for this year for the first time ever. The tipping point has come six years sooner than was projected in 2009, Treasury Secretary Tim Geithner said Thursday, as he released annual trustees' reports on the fiscal health of Social Security and Medicare. Geithner said Medicare's financal outlook has dramatically improved since the passage of health care reform earlier this year.
Medicare will remain in the black until 2029 under its current structure, mainly because of cost cutting-measures included in the health care legislation, the trustees reported. The program serves 46 million retirees and people with disabilities. Social Security is projected to pay out more than the $41 billion it is expected to take in this year in payroll taxes, the trustees disclosed. Some 53 million Americans collect Social Security, which is projected to run out of money by 2037 unless Congress makes benefit cuts or raises revenue sources to put it back in fiscal balance. Some Republicans questioned the administration's accounting practices and its claim that health care reform will save Medicare money and extend its solvency.
The Coming Class War Over Public Pensions
by Ron Lieber - New York Times
There’s a class war coming to the world of government pensions.
The haves are retirees who were once state or municipal workers. Their seemingly guaranteed and ever-escalating monthly pension benefits are breaking budgets nationwide. The have-nots are taxpayers who don’t have generous pensions. Their 401(k)s or individual retirement accounts have taken a real beating in recent years and are not guaranteed. And soon, many of those people will be paying higher taxes or getting fewer state services as their states put more money aside to cover those pension checks. At stake is at least $1 trillion. That’s trillion, with a "t," as in titanic and terrifying.
The figure comes from a study by the Pew Center on the States that came out in February. Pew estimated a $1 trillion gap as of fiscal 2008 between what states had promised workers in the way of retiree pension, health care and other benefits and the money they currently had to pay for it all. And some economists say that Pew is too conservative and the problem is two or three times as large. So a question of extraordinary financial, political, legal and moral complexity emerges, something that every one of us will be taking into town meetings and voting booths for years to come: Given how wrong past pension projections were, who should pay to fill the 13-figure financing gap?
Consider what’s going on in Colorado — and what is likely to unfold in other states and municipalities around the country. Earlier this year, in an act of rare political courage, a bipartisan coalition of state legislators passed a pension overhaul bill. Among other things, the bill reduced the raise that people who are already retired get in their pension checks each year. This sort of thing just isn’t done. States have asked current workers to contribute more, tweaked the formula for future hires or banned them from the pension plan altogether. But this was apparently the first time that state legislators had forced current retirees to share the pain.
Sharing the burden seems to be the obvious solution so we don’t continue to kick the problem into the future. "We have to take this on, if there is any way of bringing fiscal sanity to our children," said former Gov. Richard Lamm of Colorado, a Democrat. "The New Deal is demographically obsolete. You can’t fund the dream of the 1960s on the economy of 2010." But in Colorado, some retirees and those eligible to retire still want to live that dream. So they sued the state to keep all of the annual cost-of-living increases they thought they would be getting in perpetuity.
The state’s case turns, in part, on whether it is an "actuarial necessity" for the Legislature to make a change. To Meredith Williams, executive director of the Public Employees’ Retirement Association, the state’s pension fund, the answer is pretty simple. "If something didn’t change, we would have run out of money in the foreseeable future," he said. "So no one would have been paid anything." Meanwhile, Gary R. Justus, a former teacher who is one of the lead plaintiffs in the case against the state, asks taxpayers in Colorado and elsewhere to consider an ethical question: Why is the state so quick to break its promises?
After all, he and others like him served their neighbors dutifully for decades. And along the way, state employees made big decisions (and built lifelong financial plans) based on retiring with a full pension that was promised to them in a contract that they say has the force of the state and federal constitutions standing behind it. To them it is deferred compensation, and taking it away is akin to not paying a contractor for paving state highways. And actuarial necessity or not, Mr. Justus said he didn’t believe he should be responsible for past pension underfunding and the foolish risks that pension managers made with his money long after he retired in 2003.
The changes the Legislature made don’t seem like much: there’s currently a 2 percent cap in retirees’ cost-of-living adjustment for their pension checks instead of the 3.5 percent raise that many of them received before. But Stephen Pincus, a lawyer for the retirees who have filed suit, estimates that the change will cost pensioners with 30 years of service an average of $165,000 each over the next 20 years. Mr. Justus, 62, who taught math for 29 years in the Denver public schools, says he thinks it could cost him half a million dollars if he lives another 30 years. He also notes that just about all state workers in Colorado do not (and cannot) pay into Social Security, so the pension is all retirees have to live on unless they have other savings.
No one disputes these figures. Instead, they apologize. "All I can say is that I am sorry," said Brandon Shaffer, a Democrat, the president of the Colorado State Senate, who helped lead the bipartisan coalition that pushed through the changes. (He also had to break the news to his mom, a retired teacher.) "I am tremendously sympathetic. But as a steward of the public trust, this is what we had to do to preserve the retirement fund."
Taxpayers, whose payments are also helping to restock Colorado’s pension fund, may not be as sympathetic, though. The average retiree in the fund stopped working at the sprightly age of 58 and deposits a check for $2,883 each month. Many of them also got a 3.5 percent annual raise, no matter what inflation was, until the rules changed this year. Private sector retirees who want their own monthly $2,883 check for life, complete with inflation adjustments, would need an immediate fixed annuity if they don’t have a pension. A 58-year-old male shopping for one from an A-rated insurance company would have to hand over a minimum of $860,000, according to Craig Hemke of Buyapension.com. A woman would need at least $928,000, because of her longer life expectancy.
Who among aspiring retirees has a nest egg that size, let alone people with the same moderate earning history as many state employees? And who wants to pay to top off someone else’s pile of money via increased income taxes or a radical decline in state services? If you find the argument of Colorado’s retirees wanting, let your local legislator know that you don’t want to be responsible for every last dollar necessary to cover pension guarantees gone horribly awry. After all, many government employee unions will be taking contrary positions and doing so rather loudly.
If you work for a state or local government, start saving money outside of the pension plan if you haven’t already, because that plan may not last for as long as you need it. And if you’re a government retiree or getting close to the end of your career? Consider what it means to be a citizen in a community. And what it means to be civil instead of litigious, coming to the table and making a compromise before politicians shove it down your throat and you feel compelled to challenge them to a courthouse brawl. "We have to do what unions call givebacks," said Mr. Lamm, the former Colorado governor. "That’s the only way to sanity. Any other alternative, therein lies dragons."
The Problem with Pensions
by John Mauldin - Frontlinethoughts
A report just out from the Center for Policy Analysis, by Courtney Collins and Andrew J. Rettenmaier (solid academic types from Mercer University and Texas A&M respectively), that indicates that state and local pension funds are drastically underfunded.
I first wrote about public pension problems in 2003, suggesting that pensions would soon be underfunded by $2 trillion, as a long-term secular bear market would dampen returns. Turns out that I am once again proven to be a wild-eyed optimist. Quoting from the executive summary:
"Many state and local government pension plans' liabilities are calculated using discount rates that are not commensurate with the risk they may pose to taxpayers. Accounting standards allow pension funds to calculate their liabilities using a discount rate comparable to the expected rate of return on the funds' assets. This typically high discount rate tends to reduce the size of a pension plan's accrued liabilities. However, pensioners have a durable legal claim to receive their benefits and consequently, it is more appropriate to use a lower discount rate in calculating the plans' accrued liabilities.
"Due to the use of high discount rates, the liabilities of state and local government pension plans are underestimated. For example, recent reports by the Pew Center on the States and others indicate that assets will cover about 85 percent of the pension benefits owed to participants. But other studies that adopted lower discount rates have found liabilities may actually be 75 percent to 86 percent higher than reported. As a result, taxpayers' role as insurer may be much greater than anticipated."
You can read the whole report and see how your state is doing here.
Turns out that, by the authors' calculations, state and local pensions are underfunded by $3 trillion (with a T). Of course, some states are much worse off than others. The report has numerous graphs but the following one tells us a lot. It is the unfunded liabilities as a percentage of state GDP.
In the paper (less than 20 pages) they cite the work of Novy-Marx and Rauh and another paper by Biggs. They all use very different methodologies but come up with roughly the same $3 trillion underfunding.
First, understand that in most states the law will not allow for adjustment of pensions. Taxpayers are completely on the hook. That money WILL be found at the expense of either higher taxes or reduced services (such as health care, roads, or police).
Second, the hole is getting deeper each year. Most pensions assume they are going to get an 8% return on their investments. This in a time of a slow economy for years ahead (as I have shown elsewhere), very low bond yields, and a stock market that I think is still in a long-term secular bear market for another 6-7 years, which suggests a continuation of the current sideways, volatile market.
What if instead of getting an 8% return, total returns were 5%? That would mean the hole would be getting deeper by about $75 billion a year. And what if people lived longer, as is clearly the trend, as the actuaries keep changing the longevity tables every few years for the better? (Which for this 60-year old is a very good thing!)
Why use an 8% assumption? Because if you used more conservative numbers, as the academic studies suggest, you would have to make larger current contributions to the pensions, when state and local governments and schools are already in fiscal trouble. So what do the pension plans do? They hire "consultants" who tell them they can expect 8%, as shown by all the nice models and papers that back up their "advice." Note that if you were a consultant who said you should use a 5% discount rate, you would not be hired. Hmmm, where have we seen that phenomenon before?
My friend Paul McCulley (of PIMCO) quipped that the ratings agencies were supplying fake IDs at a teenage drinking party, when it came to the subprime mortgage ratings. The pension consultants are providing a similar service to their clients, who are told what they want to hear, pay large fees for the privilige, and thereby increase the risk to taxpayers and reduce the current pain for politicians.
This is going to end in tears for many states and municipalities. I mean real tears. Pension funding in some states will be required by law to consume 25-30% or more of tax revenues. That is going to mean much higher taxes or reduced services. I would seriously consider checking how your state and locality are funded. You might not want to retire to a place that is on a collision course with serious pain. Just a thought.
Workers in big Canadian pension plan could soon face cuts in benefits
by Tony Van Alphen - Toronto Star
Reductions could reach 50 per cent because of plan shortfall depending on negotiations
Canada’s biggest multi-employer pension plan says thousands of members could soon face future benefit cuts of 15 to 50 per cent depending on negotiations with companies. The Canadian Commercial Workers Industry Pension Plan, with 130,000 active members, said in a recent letter to members that companies in Ontario will need to increase their contributions by up to 40 cents an hour per worker by Sept.1 just to maintain current levels for future benefits.
Wayne Hanley, a senior trustee of the plan and president of the United Food and Commercial Workers, also said Thursday that if some employers don’t agree to negotiate adequate contributions in new contracts or in special bargaining, the amount of future benefits could quickly plunge by 50 per cent. "If there is no additional negotiated contributions as of Sept.1, then members of the plan with that employer will go on to a benefit scale that is up to 50 per cent of what they are accruing on a future basis," Hanley said in an interview. He added the situation of continuing funding shortfalls in the plan could lead to labour unrest. "There may be a few strikes over this," Hanley said. "This is an important issue to the members ."
The letter from trustees also disclosed that inactive members who have left a contributing employer but are still eligible for a pension will take a 40-per-cent hit on future benefits next month. However, those inactive members over 50 years of age who would be eligible to draw a pension now won’t be affected by the reductions. The plan, which has assets of more than $1.58 billion, provides benefits to about 20,000 retired union members and their spouses. It also has 130,000 active members working at more than 300 employers and another 150,000 deferred or inactive members. The squeeze on the plan’s finances has not affected the pensions of retirees or accrued benefits of active members.
In the letter, the trustees said a significant recovery in 2009 hasn’t made up for the steep decline in financial markets in the second half of 2008. "Assets have shrunk while liabilities have increased, leaving large unfunded liabilities," the trustees’ letter added. "The CCWIPP, like all others, did not escape the financial crisis which has affected the funding status of the plan considerably." The trustees warned members of a "benefit restructuring" a year ago but would not comment on the possibility of any significant benefit cuts at that time. The plan had already cut future benefits for members by 20 per cent in 2005, In 2008, the plan posted a negative 19.6 per cent return on investment but it turned into a 17.1-per-cent gain last year, which outpaced many other major plans.
The plan has not released an actuarial valuation for 2009. But at the end of 2008, actuarial liabilities topped assets by $759.3 million on a "going concern" basis, which underscored the plan’s difficulties. Trustees representing the union have pushed employers to jack up their contributions to bolster the plan for more than a year. Hanley said some companies such as the Metro Inc. grocery store chain have "stepped up" in bargaining to make the adequate hourly contributions to maintain future benefit levels. But he said it is a major issue in current bargaining for a new contract covering thousands of workers at Loblaw Cos.
Greg Hurst, a prominent Vancouver-based pension consultant, said active plan members not close to retirement should be "very concerned" if their company closes and they become a deferred or inactive member and a potential victim of a 40-per- cent cut. "The impact of a decision or circumstance (which may not be in the individual’s control) that results in termination from the plan prior to retirement is draconian and extraordinary," Hurst said. "If I were a member, I would make my concerns known to the Financial Services Commission of Ontario and my local MPP."
A court fined nine trustees of the plan including Hanley and founder Cliff Evans a total of $202,500 earlier this year for spending too much of the fund’s money on questionable investments in Caribbean hotels and resorts.
139,000 full-time Canadian jobs disappear
by Jeremy Torobin - CTV
The labour market’s stunning rebound of recent months ground to a halt in July, as the economy lost a net 9,300 jobs and the unemployment rate edged back up to 8 per cent, according to data released from Statistics Canada on Friday.The unexpected drop marks the first decline in employment this year and comes after a near-record increase of more than 93,000 jobs in the previous month. The jobless rate rose unexpectedly from 7.9 per cent in June, when it had fallen below 8 per cent for the first time since early 2009.
In July, employers slashed 139,000 full-time positions while adding almost 130,000 part-time jobs. The full-time losses included drops of more than 65,000 jobs in education services as many teachers, administrators and custodial staff shifted to part-time status at the end of the school year, and about 30,000 in finance, insurance, real estate and leasing, in part because the housing market is cooling across the country. Since July of 2009 though, Canada’s recovery from the recession has included the creation of 393,700 positions, Statscan said Friday, meaning that even with the drop last month the economy has still recouped most of the jobs lost during the slump. Indeed, manufacturing, one of the hardest-hit industries when exports to the U.S. plunged in late 2008, saw a monthly gain of about 29,000 jobs - the biggest increase in two years.
The surprise dip in employment pushed the Canadian dollar down for the first time in three days because it boosts the likelihood that the Bank of Canada will pause its tightening cycle after one or two more interest-rate hikes. Equally important to the trajectory of the economy and the central bank’s rate path, the U.S. Labour Department reported Friday that American private employers added 71,000 jobs in July, fewer than expected and not enough to cut into the 9.5-per-cent unemployment rate as the U.S. Census Bureau laid off tens of thousands of temporary workers.
Economists took the tepid Canadian reading in stride, saying it was in the works after June’s gain and an unprecedented increase of about 109,000 two months earlier, and dismissing the notion that the drop may be the start of a new trend. "The first drop in employment since December does not signal a fundamental shift in the economy,’’ said Doug Porter, deputy chief economist at BMO Nesbitt Burns in Toronto. "The main driver of the weakness was the heavy-duty decline in education jobs, which looks highly suspect - look for a recovery on this front in the months ahead. Overall, this report appears to be a very mild payback for previously amazing strength, and the bigger picture is that almost all of the recession’s job losses have been reversed in the very short space of a year.’’
That’s in stark contrast to the U.S. labour market, which will be very slow to recover the 8.4 million jobs lost during that country’s worst downturn since the Depression as companies remain skittish about hiring. Still, economic growth from April to June slowed to almost half the pace of the previous quarter, the Bank of Canada said in a quarterly forecast last month, kicking off four consecutive quarters in which austerity measures in Europe and a fragile U.S. rebound will contribute to a slower domestic recovery than the central bank had expected. Governor Mark Carney and his deputies say Canada’s growth at an annual rate slowed to 3 per cent in the second quarter, after a 6.1-per-cent pace in the first three months of the year, and that growth will come in at a 2.8-per-cent pace in the current quarter and 3.2 per cent between October and December.
Canada’s bounce-back from the global downturn has been the envy of the Group of Seven club of advanced economies, and Mr. Carney has already raised interest rates twice starting in early June. His next decision is scheduled for Sept. 8. Even as the U.S. economy seems at risk of a dreaded "double-dip’’ back into recession, which could be disastrous for Canadian exporters, the July report from StatsCan indicated that some inflationary pressures could be building on this side of the border. Average hourly wages rose 2.2 per cent in July from the same month a year earlier, compared with a 1.7-per-cent pace in June.
Mass strikes loom in a 'winter of discontent' for UK Government
by Louisa Peacock - Telegraph
The Government must win the "hearts and minds" of public sector staff to gain their trust ahead of swingeing cuts or face mass strike action in a winter of discontent, an employers' group has warned. Whitehall has been urged to bolster employee consultation and communication during the toughest cutbacks in decades, or risk staff siding with trade unions to cause mass disruption to services, according to the Chartered Institute of Personnel and Development. The CIPD's employee engagement survey published last month found just 16pc of public sector staff trust their senior leaders. Job satisfaction has also plummeted to a record low.
Mike Emmott, employee relations adviser, said the Government had to bolster managers' leadership skills, provide meaningful consultation opportunities for staff and more effective communication to help employees understand the changes. He said: "Trade unions have the power to disrupt only if employees trust them more than they trust management. The fundamental need is not to 'manage the trade unions', it is to manage the employment relationship and communicate the case for change."
However, in a new paper published today, the CIPD said it was "incumbent" for the Government to consider its options for reducing the risk of disruptive and damaging industrial action by public sector staff, such as banning strike action of those involved in the delivery of essential services. More than 40pc of employees are in favour of such a ban, according to the CIPD survey. But Mr Emmott warned: "If the Government was forced to go down this route it would be a sign of its failure to make the case for change to public sector employees." He urged the Government to try to steer consensus among employees rather than just assume they would strike. "Unions, government, front line workers and the public alike have far more to gain from a strategy focused on building trust and avoiding conflict," he said.
Earlier this week it emerged Leeds City Council had written to staff asking them to find different ways to cut £19m, in an attempt to minimise job losses. Bosses have already received hundreds of responses suggesting ideas – including putting an end to shelling out £50 every time a light bulb needed changing. A Leeds spokesman said the move was designed to foster open and honest communication for staff and to involve them in difficult decisions. "We're one of the first councils to have done this," he said. In contrast, neighbouring council Kirklees said it would cut 1,500 jobs by March next year in response to budget cuts, which has already seen workers threaten industrial action.
Derivatives Made Up 25% to 35% of Goldman's 2009 Revenue
by Liz Rappaport - Wall Street Journal
Goldman Sachs Group Inc. told the Financial Crisis Inquiry Commission that 25% to 35% of its revenue comes from derivatives-based businesses, according to a person familiar with the situation. The figures are part of Goldman's response to a request by the panel to disclose information about its derivatives holdings and operations. Derivatives have been blamed for exacerbating the credit crisis, and Goldman has faced scrutiny from the FCIC for its derivative contracts with American International Group Inc., the insurer bailed out by the U.S. government.
A memo sent to the panel Thursday night by the New York company included an analysis of derivatives-based revenue at Goldman from 2006 through 2009, said the person familiar with the matter. Based on the percentages provided by Goldman, such businesses generated $11.3 billion to $15.9 billion of the company's $45.17 billion in net revenue for 2009.
An FCIC spokesman wouldn't immediately confirm that the panel has received the information from Goldman or any other firm. "We've asked for the same information from several banks," the spokesman said. "They have all indicated they are working hard to provide that information to us. If we need additional information, we will ask for it." The 10-person commission is required by Dec. 15 to issue a report on the causes of the financial crisis.
Goldman's analysis reflects all derivatives products, ranging from credit to equity to interest rates, traded on and off exchanges, said the person familiar with the situation. Goldman said it doesn't conduct its businesses in a way that delineates revenue from derivatives transactions or other types of trading, this person said. For example, Goldman cited credit-trading desks that are separated by industry group, adding that traders are indifferent to whether they are selling clients a bond or a credit derivative. As a result, separating the revenue among the two product lines is useless, Goldman told the FCIC. The firm also said its technology systems firm-wide don't single out derivatives transactions.
The analysis was based on a "best guess" of the main type of trading on each Goldman trading desk at the firm, said the person familiar with the matter. The numbers vary widely, with the company's fixed-income unit getting much more of its revenue from derivatives than investment banking, where no revenue is tied to derivatives.
Is the Stock Market or Bond Market Right?
by Tim Iacono
Another item from Dow Jones, this one offering a few thoughts by Allen Mattich on the subject of whether the stock market or the bond market is correctly forecasting the future.
One thing is certain, they both can’t be right and, at some point in the not-too-distant future, stocks and bonds will stop rising together. What would really stump market analysts is if they both started falling together… Oh Dear… Maybe I shouldn’t have brought that up…
Agflation fears as Russia halts all grain exports
by Ambrose Evans-Pritchard - Telegraph
Russian premier Vladimir Putin has ordered a halt to all exports of wheat and other grains from August 15, raising the stakes dramatically in the crisis over wheat supplies. "This is very serious," said Abdolreza Abbassanian, chief grain economist at the UN Food and Agriculture Organization. "It's a desperate situation because it has caught everybody off guard. We're not facing the situation of two years ago but there is a risk of destabilising panic."
The shortage may trigger a bout of "agflation", posing a quandary for central banks. Professor Charles Goodhart from the London School of Economics fears that rising food prices will add 0.5pc to Britain's sticky inflation, already testing market tolerance. Wheat prices surged by their maximum daily limit of 60 cents to $7.86 a bushel on Chicago's exchange, with knock-on effects across the nexus of tradable grains. Mr Putin said it was a temporary ban on wheat, corn, barley, rye, and grain products until the end of the year due to "abnormally high temperatures", adding that Russia needs to cap domestic food prices and build its own reserves.
Wheat has surged 69pc since June, but is still far below it $13 peak in 2008. The spike guarantees a sharp rise in bread prices this Autumn. Premier Foods said a loaf of bread may go up to 10p. Mr Putin pressured Kazhakstan and Belarus to impose similar curbs as the worst drought in a century threatens to drag into late August. "It is unprecedented to ask neighbouring countries to do the same," said Mr Abbassanian. Ukraine insists that exports are safe, but analysts fear it may follow suit. The Black Sea belt and Eurasia's Steppes produce a quarter of global wheat exports. The saving grace is that stocks are 187m tonnes, against 124m in 2008.
Corn futures rose 5.8pc, oats rose 4pc, and rice rose 2.8pc on the news. "Food markets are linked. This is going to put further strains on corn. Animal feed prices will go up, affecting meat," said Mr Abbassanian. Commodity spikes can be inflationary but also deflationary, depending on context. Central banks in Europe and the US misjudged events two years ago, mistaking oil and food rises for the start of a 1970s price spiral. In fact, it drained demand from economies already tipping into recession.
"This is more deflationary than it looks," said Albert Edwards from Societe Generale. "The risk is that central banks will hold off from further easing that I think is needed, increasing the risk of a hard-landing." Mr Putin acted after meteorological experts issued further drought warnings, raising fears that the ground would be too hard to seed the winter crop next month. The loss of both crops would force Russia to withdraw from export markets for two years. Rabobank expects Russia's wheat output this year to fall from 58m to 45m tonnes.
Kirill Podolsky, head of Russia's grain group Valars, told Bloomberg that the ban had created havoc. "We have ships lined up for grain and no idea what to do. This will be a catastrophe for farmers and exporters alike," he said. The move will be welcomed by grain firms that fixed supply contracts in advance, and are now caught short. Some may declare "force majeure", suspending contracts for reasons beyond their control. The FAO said low-income countries such as Egypt or Pakistan that depend on imports will be worst hit. The concern is that some countries will take emergency action to secure vital supplies.
Wheat Heads for Biggest Gain in Half a Century on Export Bans
by Luzi Ann Javier, Maria Kolesnikova and Jeff Wilson - Bloomberg
Wheat headed for the biggest weekly gain in half a century on concern other countries may follow an export ban by Russia, and may reach $10 a bushel, a price not seen since the global food crisis in 2008. Russian Prime Minister Vladimir Putin said Kazakhstan and Belarus should also suspend shipments as Russia announced a ban on grain exports from Aug. 15 to yearend. "It’s got $10 written all over it," said Peter McGuire, managing director at CWA Global Markets Pty, who on Aug. 3 correctly forecast the surge to $8.50. Wheat was last at $10 in March 2008, and a gain to that price would be up 23 percent from yesterday’s close.
Russia’s ban may benefit rival producers, including the U.S., the largest exporter, Australia and Argentina, according to Rabobank. Wheat prices have doubled in less than two months as drought slashed the harvest in Russia, the third-largest grower, and rains cut Canadian output. The surge may herald a new food crisis as corn and other staples jump, said a trade group from Indonesia, Asia’s top wheat buyer. "This situation is reminiscent of the irrational moves already seen in the past, for example at the start of 2008," Bourges, France-based farm adviser Offre et Demande Agricole said in a comment today. "It’s always very hard to say where prices can end up in such conditions."
Wheat for December delivery rose 1.2 percent to $8.25 a bushel on the Chicago Board of Trade at 2:14 p.m. Paris time, taking gains for that contract to 25 percent this week. That’s the most since at least 1959. Wheat is the best-performing commodity this year on the UBS Bloomberg CMCI Index, ahead of coffee and nickel. "We believe that the rally in wheat prices is overdone, but would not short wheat," Morgan Stanley analysts including Hussein Allidina said in a note to investors, referring to making bets that prices may drop. Other wheat-growing countries may opt to limit exports, potentially boosting prices, even though global wheat stockpiles are ample, they wrote.
Milling wheat for November delivery traded on NYSE Liffe in Paris rose 1 euro, or 0.5 percent, to 224.50 euros ($295.91) a metric ton. Investors bought and sold a record 74,729 contracts yesterday, the exchange said today. Wheat has rallied as a heat wave in Russia, dry weather in Kazakhstan, Ukraine and the European Union, and flooding in Canada hurt crops. Some Russian farmers are reluctant to sow winter grains after soil became too dry because of the drought, the government said today.
Wheat reached a record $13.495 in February 2008, part of a surge in prices that sparked food riots from Haiti to Egypt. Still, concern that lower-than-expected wheat output may contribute to a food crisis is "unwarranted at this stage," the UN’s Food and Agriculture Organization said on Aug. 4. There should be sufficient global supplies of wheat, "barring no more production setbacks," said Doug Whitehead, an analyst at Rabobank in London. "The market will pay very close attention to crop prospects in Australia and Argentina."
Halting Russia’s wheat shipments would be "appropriate" to contain domestic prices that jumped 19 percent last week, Putin said. The country exported 17.4 million tons of wheat in the year through June, the Federal Customs Service of Russia said today. The Russian ban will "rattle the markets for the next several months" and boost demand for stockpiles from the U.S., Bob Young, the chief economist at the American Farm Bureau Federation, said yesterday from Washington.
"When Putin speaks, the world listens," said McGuire at CWA, referring to the possibility other nations may curb shipments. U.S. farmers would benefit because they have the supply to meet demand in the global market, he said. "They’ll all be driving Lamborghinis." Kazakhstan, Russia’s partner in a customs union, exported 7.5 million tons in the year ended June 30, while Belarus, also a partner, shipped 400,000 tons, according to the U.S. Department of Agriculture. Ukraine accounted for 9.2 million tons in the same year, it said.
World wheat stockpiles may fall 2.5 percent to 192 million tons by June as the dry weather hurts the outlook for crops in Russia, Kazakhstan, Ukraine and the EU, the International Grains Council said on July 29, reversing a forecast for higher inventories. Corn for December delivery fell 0.7 percent in Chicago to $4.1525 a bushel while soybeans for delivery in November were unchanged at $10.29 a bushel.
Investors fear re-run of great grain robbery
by Isabel Gorst - Financial Times
"We have had almost no rain for three months," says Vladimir Kochetkov, a manager at one of the biggest state-owned farms in Nizhny Novgorod, in the heart of European Russia. "There has not been such a long drought here for more than one hundred years," he adds, with an air of resignation. The grain crop at the 8,000 hectares of farmland he manages has been halved by the lack of rain.
He is not alone in facing a ruined crop. In the area around Nizhny Novgorod, about 400km east of Moscow, officials fear the grain harvest will drop to 600,000 tonnes, less than half last year’s 1.4m. "It’s a disaster," says Alexander Efremtsev, at the Nizhny Novgorod Grain Union. Hot summers are not unusual in Russia’s grain belt, which stretches from the Black Sea to Siberia and enjoys some of the world’s most fertile soil. This year, a severe heat wave and drought have destroyed the country’s grain crop, pushing farmers to the brink of bankruptcy and exposing the fragility of world food supplies. Prices of everyday food staples including bread are likely to jump as a result.
Global wheat prices soared this week on news of the deteriorating Russian harvest. European milling wheat has surged 80 per cent in the last six weeks alone, stirring memories of the 2007-08 food crisis. The acute shortage of supplies and fears of even steeper rises in wheat and food prices spurred the Kremlin on Thursday to announce an export ban on grains until the end of the year. The ban, which surprised traders and food companies, set wheat markets on fire. In Chicago, US wheat hit an intraday high of $8.41 a bushel on Friday, up more than 25 per cent on the week and, excluding the 2007-08 food crisis, a record high.
The prices of other crops, from corn and soyabean to rapeseed and barley, used to make beer, have also jumped sharply. This wider rally reflects not just the direct impact of the drought on these commodities, but the risk that lower supplies of wheat, which is also used to feed livestock, will lead to higher demand for alternative animal feed such as corn. The panic buying comes as traders predict Russia’s exports will drop to just 3m tonnes – the total shipments that left the country before the export ban – far below the 18m tonnes it sold overseas last year, worth $2.7bn, after a bumper crop.
Luke Chandler, grains analysts at Rabobank in London, says the sudden shortfall in global supplies coincides with Russia’s rise to prominence as an important exporter, particularly for North Africa and Middle East countries, which, he says, are "becoming increasingly reliant on Russia". Importing countries and food companies will now have to rely on wheat from the European Union, the US, Australia and Argentina. Traders and analysts say there are enough stocks to bridge the gap left by Russia, but no safety cushion. In other words, the weather between now and the harvest in Australia in December needs to be perfect.
The long-term consequences of the drought and the export ban remain unclear. Analysts, though, point out that the Black Sea region is well known for its volatile grain production. It was a drought in the same area that triggered sweeping grain purchases by the Soviet Union in 1972, an episode that became known as the "Great Grain Robbery". Moscow corralled all exportable supplies for the US. This year’s crop failure marks a major setback for the Kremlin, which is carving a role for Russia as a global grain power. Dmitry Medvedev, Russian president, has set a goal to double its grain exports by 2020 and challenge US supremacy. The US exports half the world’s corn, a third of its soyabeans and a fifth of all wheat, making America the powerhouse of agricultural markets.
Agriculture is one of four industries being prioritised by the Kremlin as it tries to overturn the disastrous legacy of Stalin’s collectivisation. A decade ago Russia depended on US wheat imports to feed itself, but government reforms, including a law allowing foreigners to buy land, have boosted interest in farming. Grain harvests have risen steadily since 2000, driven by more generous state subsidies and growing Russian and foreign investment in farming and food processing. There is room for more – Russia is one of the only countries in the world with the potential to increase sharply grain production. According to the World Bank, the country could double its annual harvests if farming methods were modernised and idle land put to use.
Analysts and farming executives say the crisis is likely to accelerate the consolidation of Russian agriculture already under way, allowing big conglomerates to swoop on struggling small farmers. Black Earth Farming, an international company farming in Russia, says its winter harvest is down 44 per cent but that it will keep investing. "We are here for the long term. This is a tough year but it will not scare us off," says Gustav Wetterling, its head of investor relations.
Dmitry Rylko, the director of the Moscow-based Institute for Agricultural Market Studies, says the failed harvest, while creating "tremendous difficulties", is unlikely to lead to an exodus of investors. "Russia is extremely promising for agriculture," he says. "We have been lucky with the harvest for almost ten years. Crop failures happen everywhere from Argentina to Brazil and Ukraine."
Russia's wheat woes could hit U.S. grocery shelves
by P.J. Huffstutter and Sergei L. Loiko - Los Angeles Times
The price of America's daily bread and meat could soar this fall, as surging wheat prices in anticipation of a Russian ban on exports stoked fears about tight supplies. Grain shortages and food price hikes in 2007 and 2008 sparked riots worldwide, but agriculture analysts said the U.S. wheat crop has been strong, and that stockpiles of wheat and other grains worldwide are greater now than they were three years ago.
According to media reports, U.S. farmers have rushed to put out millions of bushels of wheat to bolster worldwide inventories. Wheat prices on Friday dropped by 60 cents on the Chicago Board of Trade, voiding Thursday's price run-up. Yet analysts warned that consumers might be hit with higher prices at the grocery store in the months ahead because of a convergence of factors. With the memory of the previous food crisis still fresh, some countries and consumers may resort to hoarding, which could push prices upward. Speculators and some food companies might seek to exploit public worries.
"The situation is still in flux," said Phil Flynn, a commodities analyst at PFG Best in Chicago. "It is far too soon to say that this is over." The price of wheat surged to a two-year high when Russian Prime Minister Vladimir Putin announced the ban Thursday. Wildfires and serious droughts have ravaged a large swath of central Russia this summer, destroying one-fifth of its crop. Russia is one of the world's largest wheat exporters. The Ukraine government, also a large global wheat supplier, reportedly canceled a number of its contracts because of similar dry-weather issues.
Russian officials quickly backpedaled from their earlier firm stance that the export ban would begin Aug. 15 and last through the end of the year. On Friday, Igor Shuvalov, Russia's first deputy prime minister, said the government would honor current contracts and might revisit the ban later this year. The country, according to media reports, is considering whether to delay the ban until Sept. 1, to let at least 700,000 tons of grain shipments already en route to leave the country.
Government officials acknowledged that it was still unclear whether the drought would stretch into the fall, when farmers would be gearing up to plant next year's crop. Shuvalov also said that the government didn't know how much grain it would ultimately be able to harvest in the fall.
Condos for less than the cost of a Corolla
by Les Christie - CNNMoney.com
The housing bust has made owning a home a lot more affordable -- but in some places, prices are extraordinary; you can buy a nice condo for less than the cost of a new family car. Some cities have dozens of attractive condominium listings selling for $50,000 or $25,000. There are some selling for less than a new Toyota Corolla. And these are not derelict hovels in crime-ridden communities: These homes are often in move-in condition and located in nice neighborhoods.
"Not to sound like a salesman, but there are some real bargains out there," said Kevin Berman, a broker with Bankers Realty Services in Fort Lauderdale, Fla. The housing bust has taken down the national median home price by about 23% since 2007, according to the National Association of Realtors (NAR). But condo have fallen even further, down about 25%. In Sacramento, Calif., condo prices have fallen 59% from what they averaged in 2007, according to NAR. Miami condo prices have plunged 65%, and in Las Vegas they are off 66%.
Prices of individual units are down even more. One condo in Deerfield Beach, Fla., that sold for $115,000 five years ago now lists for $25,000. That's a drop of nearly 80%. Much of these price drops can be attributed to over development during the boom. Much of that came in Sand State markets such as Las Vegas Miami and Phoenix, where prices for all properties are have fallen precipitously.
Berman has a one bedroom condo in one of these areas with a listing price of $15,000. He said it needs a little work, and it's in a community that doesn't allow you to rent out the property,, but still, $15,000? "It's great for a vacation property or a retirement home," he said. Another of his listings is in North Miami, about three miles from the beach. It's a 900-square foot, one-bedroom, one-and-a-half bath with a community swimming pool, central air and assigned parking that costs just $23,450. That's less than a fully loaded new Camry.
In Las Vegas, there are more than 200 condos listed for $30,000 or less. A two-bedroom, two-bath condo with a covered patio in North Las Vegas can be had for just $30,000. Of course, condo owners have other expenses, particularly maintaining the grounds and common areas, but these tend to be quite low. And the property taxes are also often modest. Plus, if these housing markets ever rebound, there's even likely to be some price appreciation for these homes. You can't say that about a new car.
US mortgage rates hit record lows
by Julie Haviv - Reuters
Mortgage rates fell in the past week to the latest in a series of record lows amid concerns about the state of the economy, according to a survey released on Thursday by Freddie Mac. Rock-bottom rates offer a glimmer of hope for a housing market struggling to gain traction since the recent expiration of popular home-buyer tax credits. Interest rates on 30-year fixed-rate mortgages, the most widely used loan, averaged 4.49 percent for the week to August 5, down from 4.54 percent a week earlier and 5.22 percent a year ago, according to the survey. Thirty-year rates have fallen to fresh lows in six out of the last seven weeks. Freddie Mac, the second-largest U.S. mortgage finance company, started the survey in April 1971.
Fifteen-year fixed-rate mortgages averaged 3.95 percent, down from 4.00 percent last week, the lowest since Freddie Mac began surveying this loan type in 1991. Fifteen-year rates have hit fresh lows in five of the last seven weeks. With rates near their lowest since Freddie Mac started the survey, demand for loans to refinance or purchase homes has picked up, boding well for the market and the economy. "Yet again, interest rates for fixed-rate mortgages and now the hybrid 5-year ARM (adjustable-rate mortgage) fell to ... record lows this week following the second-quarter GDP release," Frank Nothaft, Freddie Mac vice president and chief economist, said in a statement.
Annual revisions cut cumulative growth in U.S. gross domestic product over the past three years to 0.6 percent from 1.4 percent, reducing inflationary pressures and allowing longer-term rates room to ease, he said. Mortgage rates are linked to yields on both U.S. Treasuries and mortgage-backed securities. Home sales have fallen since the expiration of government tax credits. To take advantage of them, buyers had to sign purchase contracts by April 30. Contracts originally had to close by June 30 but that was extended by three months.
Cameron Findlay, chief economist at LendingTree.com in Charlotte, North Carolina, said the housing market is vulnerable, with a flood of foreclosures in the pipeline and high unemployment weighing heavily. "The world essentially collapsed after the tax credits expired," he said. "This baby cannot walk on its own without government intervention." Findlay said his biggest concern is that the economy is going to stall and believes there is a 30 percent chance of a double-dip recession. "Low mortgage rates are certainly a positive, but jobs growth is more important and without that, a housing rebound will not emerge," he said.
The U.S. Labor Department said on Thursday new claims for unemployment benefits rose last week to the highest since early April. On Friday it will release July U.S. payrolls data. The Mortgage Bankers Association said on Wednesday U.S. mortgage applications to purchase homes rose last week for a third straight week as rates tumbled. Freddie Mac said the rate on the 5/1 ARM, set at a fixed rate for five years and adjustable each following year, was 3.63 percent, down from 3.76 percent last week, its lowest level since Freddie Mac began tracking this loan type in 2005. One-year ARMs were 3.55 percent, down from 3.64 last week. A year ago, 15-year mortgages averaged 4.63 percent, the one-year ARM was 4.78 percent and the 5/1 ARM 4.73 percent.
Recession Costs Small Businesses $2 Trillion
by Bradenton Herald
Small businesses report losing an estimated $2 trillion in lost profits and asset valuation since the recession started in December 2007, according to a new study released by Barlow Research. That works out to an average loss of $253,000 for each of the eight million U.S. businesses with sales between $100,000 and $10 million. Larger companies have been less affected and are recovering more quickly according to the survey, which was fielded in July 2010. After showing guarded optimism in the first half of the year, pessimism has returned for an increasing number of small business owners. Only 35% indicated their financial condition was improving, down from 46% in the second quarter.
When asked to estimate the chances that their company will survive the next year, 14% are less than 50% confident they will still be in business by August 2011. "One in seven small business owners are estimating their chance of survival by the flip of a coin," said Bernie Kuechler, the Barlow Research Analyst who authored the study. The study reveals that few small businesses believe the recession has ended. Fifty-six percent of small businesses expect the recession to last beyond 2011. Less than one in ten businesses believe the recession is over.
"We should not expect significant job creation in the near term from this segment," according to Kuechler. More small businesses are reporting intentions to decrease than those planning to increase full-time employees, with the most planning to stay the course. The study does forecast job creation from companies with sales greater than $10 million, where optimism and growth in sales is improving.
Trading volumes retreat with investor trust
by Gillian Tett - Financial Times
It is summer time, but the livin’ feels far from easy on Wall Street. In recent weeks, the main equity indices have been trending higher, helped by good US earnings and the European stress tests. But while the S&P 500, say, rose about 7 per cent last month, the mood is anything but euphoric. As my colleagues Francesco Guerrerra and Michael Mackenzie reported this week, one striking feature of this summer is that trading volumes in many asset classes have tumbled.
This is partly because many institutional investors have quietly gone on strike, choosing to sit on their cash rather than trade. But something curious is happening in the retail world too. In recent months, US retail investors have continued to put money into government and investment grade bond funds. More recently, there have also been some flows into junk bond funds. But in the equity world – which is perhaps the most visible cornerstone of American finance – retail investors are also on strike. Last week there were $1.5bn outflows from US equity mutual funds, after $3.2bn and $4.2bn of outflows in each of the previous two weeks. Indeed, in the past 12 weeks – or since May – there have been continuous outflows of more than $40bn.
So what on earth is going on? Optimists like to blame it on a summer lull, or temporary jitters about US unemployment or the eurozone. They may be right. But personally, I suspect that there is something more fundamental going on too. The most pernicious issue hanging over the system right now is a loss of confidence – not merely in the idea that the future will be a brighter place, but also, most crucially, about whether anybody is able to predict that future at all.
Think back, for a moment, to the halcyon years before the summer of 2007. Back then, it seemed to be such a cosy and stable economic era that economists dubbed it "the Great Moderation" and most investors and businesses had absolutely no qualms about making 10-year plans. Indeed, that was expected in a world, where long-term planning – armed with complex computer forecasts – appeared to be not just rational, but a hallmark of modern society, something that separated us from earlier ages.
However, the financial crisis has shattered that sense of complacency. And while the immediate panic that erupted in the autumn of 2008 has now ebbed away, in its wake it has left a loss of trust – and innocence. These days, investors and businesses know that the world can sometimes be a profoundly unpredictable and uncontrollable place. No longer does it seem wise for corporate boards (or investors) to make 10-year plans, instead, time horizons have shrunk and many businesses and financial players have developed a mentality more akin to third-world peasants, who create strategies – but do so with bated breath, constantly braced for fresh storms.
And in practical terms, there are a myriad of uncertainties – or potential storms – out there now. The political trajectory in the US, for example, seems pretty volatile, given the rise of populist rhetoric. The government is intervening in the economy in unpredictable ways and financial reform could potentially change capital flows significantly. New jitters are afoot about a double-dip recession and deflation too. And just to make matters worse, the memory of the May 6 "flash crash" haunts the markets. In the past three months, US regulators and bankers have scurried around trying to work out what caused equity prices to gyrate so wildly that day. But, thus far, they have not offered any convincing explanation.
That is shocking and profoundly debilitating. After all, it is bad for investors to feel confused about the outlook for government regulation or deflation; but it seems that nobody really understands how the basic mechanics of the equity market work any more, it is hard to trust that the stock markets are a good destination for your money. Little wonder, then, that those US equity mutual fund outflows have accelerated.
Of course, as I said above, all this may yet turn out to be just a temporary phenomenon. If, say, the outlook for financial regulation becomes clearer or the economy rebounds, animal spirits may yet return. But the history of Japan shows that this does not always occur – a full two decades after its bubble-and-bust, most retail investors (and even some institutional investors) remain terrified of putting their money into stocks, due to a corrosive loss of trust. The US is nowhere near that point yet. But policy makers and bankers alike had better keep watching those trading numbers. And cross their fingers that there will not be another "flash crash" any time soon.
US economy 'on the road to deflation', warns Pimco boss El-Erian
Mohamed El-Erian, the head the world's largest bond fund, has said the United States faces a one in four chance of suffering deflation and a double-dip recession. "I do not think the deflation and double-dip is the baseline scenario, but I think it’s the risk scenario," Mr El-Erian, chief executive officer at Pacific Investment Management Co. (Pimco), told reporters in Tokyo on Thursday. "If you wonder how meaningful 25pc is, ask yourself the following question: if I offered you that I would drive you back to work, but there's a one in four chance that I get into a big accident, would you come with me?"
Mr El-Erian, who helps manage more than $1 trillion in assets, warned that action needed be taken quickly to prevent a economic slowdown. Mr El-Erian said that downward pressure on prices – translating into a rise in real borrowing costs – was already encouraging companies to accumulate cash "in a way that was unthinkable just two years ago", while individuals were being driven to save. "On the road to deflation, which is what the United States is on today ... policy becomes less effective," he said. He also warned that US unemployment was likely to stay "unusually high".
US inflation is currently at it lowest rate in 44 years. Consumer prices dropped 0.1pc month-on-month in June, following a fall of 0.2pc in May. The core consumer price index, which excludes volatile energy and food prices, increased 0.2pc in June, but is well below the 2pc growth targeted by the Federal Reserve. Concerns over deflation has already led some major investment funds to hedge against stock falls while buying more interest-bearing assets.
The rush to safety saw two-year US Treasury yields fall to a record low of 0.51pc on Tuesday. The 10-year Treasury yield dropped to a 15-month low of 2.85pc in July. Bill Gross, manager of Pimco's record $239bn Total Return Fund, raised holdings of US government-related debt to the highest level in eight months in June, according to the company’s website.
Western shoppers stay on the shelf
by Amy Wilson - Telegraph
For people searching for signs of life in the stagnant economies of Europe and the US, results from the world's consumer goods giants Procter & Gamble and Unilever won't have made happy reading. Paul Polman, Unilever's chief executive, says anyone counting on consumers to spend those markets out of their torpor will have a long wait – it could be five years before any significant growth returns. Mr Polman does not regard himself as a pessimist, but a "realistic optimist". And with more than 50pc of the company's revenue in emerging markets, where sales volumes grew at 10pc and above in the first half of 2011, he has plenty of reasons to be cheerful. Unilever's emerging markets of Asia, Africa and Latin America have become "decoupled" from the developed economies, he said.
It's the same picture painted by Reckitt Benckiser, the maker of Dettol and Vanish, and Procter & Gamble (P&G) which is aggressively chasing growth in Asia as American shoppers turn to supermarket own-label products. For companies of their size, the fast-growing emerging economies offer a growth engine. But for politicians on both sides of the Atlantic struggling to withdraw fiscal stimulus and cut debt, without sending the economy into another downturn, the indicators from the consumer sector are that the situation at home remains very fragile.
Companies like Unilever, P&G and Reckitt pride themselves on knowing what you, the consumer, wants before you know yourself. But the most recent results show the siege mentality of the recession has not lifted – we want to pay as little as possible for exactly what we need. The era of continual consumption, which drove the US and UK economies in the last decade, will not be staging a comeback any time soon. "I cannot see that Europe and the US will show significant growth for five years at least," Mr Polman said after Unilever announced first-half results yesterday. "Our business is driven by employment levels and consumer confidence. In Europe it will be difficult to move unemployment from 10pc."
However, he did make clear the situation was "nothing to panic about" from the company's point of view, with Unilever focused on taking share from its rivals with innovative new shampoos, deodorants and washing powder, and improving profitability. Promotions and discounts have been the lifeblood of the branded food and household products makers for the past 18 months. Along with the retailers, they have offered two-for-ones and 20pc extra free to keep cash-strapped customers loyal. Premier Foods, the maker of Hovis and Branston pickle, said the same trend prevails in branded food.
"Six months ago we were seeing 4pc growth in our markets in Europe, now it is below 1pc... In Europe there is now virtually no market growth," said Bart Becht, chief executive of Reckitt, when the company reported second-quarter results last month. "We have not lost market share. The key driver of the fall was extra promotional spend to maintain market share, coupled with economic problems." Mr Polman said Unilever has also invested in promotions, and that is unlikely to change soon. "We have spent time in Europe making sure that our brands are cost-competitive," he said, but insisted it is not a straightforward case of belt-tightening in Europe. Sales of cheaper supermarket own-label goods have not increased in the sectors where Unilever competes.
In the US there has been more of a shift away from the big brands, but the own-label share was lower to start with. About 20pc of the markets Unilever trades in – personal care, laundry powder, home cleaning, ice cream, tea and savoury food such as stock cubes and sauces – are own-label in Europe, compared to 12pc in the US. P&G, Unilever's US-based rival whose biggest brands include Gillette razors and Pampers nappies, reported an 11pc fall in profits earlier this week, admitting shoppers in the US are turning to own-label to save money. "We see a mixed effect as consumers without jobs or in challenging positions trade down," said Bob McDonald, chief executive.
Desirable new products are still a vital part of sales growth in the developed markets, and the consumer-goods companies have spent more on advertising to lure shoppers. Innovation is "not a sticker saying '€5 off' " Mr Polman said. "We do this seriously," he said, citing Dove conditioner which repairs damaged hair and longer-lasting deodorant as recent product improvements. But like everything else consumer goods companies are doing, their new improved products are aimed at least as much at the emerging markets as the traditional ones. "People there have been exposed to all these products and they want choices, they want something better," Mr Polman said. "Anyone who thinks they don't needs to catch up."
Surprise fall in UK industrial production
by Katie Allen - Guardian
Industrial production suffered a surprise fall in June while factories continued to grapple with rising costs. The Office for National Statistics said today that industrial output fell back 0.5% on the month in June, reversing May's rise and undershooting economists' forecasts for a 0.2% pickup. The drop was mainly due to a fall in oil and gas extraction, the statisticians said, citing early maintenance work on oil fields. Yet the decline would not be enough to push down a first estimate of second-quarter GDP growth of 1.1% released last month.
Within the industrial sector, manufacturing posted a smaller rise in output than expected. Production went up 0.3%, matching June's increase but below the 0.4% forecast in a Reuters poll of economists. While factory output continued to rise, surveys suggest the pace of expansion is softening and experts warn there could be tougher months ahead for the sector with fragile demand in key export markets and a fiscal squeeze at home. "Manufacturing remains the star of the UK economic show, with further good news in today's ONS figures. However, many manufacturers we speak with are now reporting something of a summer slowdown, as growth in orders begins to level out after a period of rapid restocking and a burst of essential investment," said Graeme Allinson, head of manufacturing at Barclays Corporate.
Separate data from the ONS showed factories' input prices in July rose at a faster pace, up an annual 10.8% from 10.7% in June but slightly below forecasts for 11.4% inflation. There were signs though that companies were starting to pass some of those rises on to customers with inflation at the factory gate at 5%, little changed from 5.1% in June and above forecasts for 4.9%. The data echoed recent reports from food producers such as Flora margarine-maker Unilever and Hovis bread-maker Premier Foods that they were having to look at raising their prices. The ONS said food prices were by far the biggest factor in rising factory gate prices in July.
Jonathan Loynes, chief European economist at Capital Economics, said that overall though the thinktank expects producer prices (PPI) to ease over coming months as pressures from energy prices wear off and activity in the sector starts to slow. "One potential threat is the recent sharp rise in agricultural commodity prices. But provided they do not soar too much further, their impact on both PPI and consumer price inflation should not be too big. Overall, while the industrial sector is currently acting as a useful driver of overall economic growth, we don't see it is a source of strong inflationary pressure," he said.
Germany Posts Surprise Fall in Industrial Production
by Patrick McGroarty - Wall Street Journal
German industrial production fell 0.6% in June from the previous month on unexpected declines in the construction and manufacturing sectors, government data showed Friday. Economists surveyed by Dow Jones Newswires had expected a 0.7% increase from May. "One has to put things in perspective: this contraction came on the back of a whopping 2.9% month-on-month expansion in May," Peter Vanden Houte, an economist for ING Bank, said in a research note. "While today's figures came in weaker than expected, the German growth locomotive is definitely not slowing down."
Friday's data were in contrast to manufacturing orders figures released Thursday, which showed German orders increasing 3.2% in June from May. "In light of the drastically improved orders environment, industry will above all remain a central factor in Germany's continued economic recovery," the ministry said in a statement as it released the data. The ministry didn't give a clear reason for the unexpected decline in production in June.
On an annual basis, industrial production grew 10.9% in seasonally adjusted terms and 14.7% in unadjusted terms. May output figures were raised to show a monthly increase of 2.9%, from 2.6% previously. Production in both the construction and manufacturing sectors fell 0.9% from the previous month. Output of intermediate goods—part of the manufacturing process—declined 1.0% on the month in June after an increase of 3.1% in May. The production of capital goods showed the biggest swing, to a 1.1% decline in June from a 4.1% increase in May.
Production of consumer goods was up 0.2% in June after a 1.2% increase in May. Production in the energy sector climbed 3.6% on the month in June, matching growth in May. Despite the unexpected drop, production across the May-June period was up 3.3% compared with the March-April period, the data showed.
Bad Mortgage Debts Continue to Bleed Home Loan Banks
by Nick Timiraos - Wall Street Journal
Souring mortgage bonds that aren't backed by the government continued to cause heartburn for some of the Federal Home Loan Banks in the second quarter. Two banks reported second-quarter losses in part because of larger loss provisions for what are called private-label mortgage securities. In a sign of how losses have spread to the broader mortgage market from the subprime sector, the Indianapolis and Pittsburgh home-loan banks said they were expecting steeper losses on bonds backed by prime loans, or those to borrowers with good credit.
Overall, the Federal Home Loan Banks reported $326 million in combined second-quarter net income, down 71% from a year earlier, according to preliminary earnings reports compiled by the Office of Finance for the FHLB system. The $797 million fall in net income from a year earlier resulted from larger provisions for credit losses and net losses on derivatives and hedging activities.
Several home-loan banks have been weakened by bad bets on private-label securities they scooped up during the housing boom in a bid to boost profit. Now, those banks have had to take repeated write-downs on the value of those securities as foreclosures mount. That has forced some banks to reduce or eliminate the dividends paid to their members in a bid to shore up capital. The Indianapolis bank swung to a net loss of $12.9 million from the year-earlier net income of $53.3 million. It wrote down the value of its mortgage securities by $68 million.
The Pittsburgh home-loan bank swung to a net loss of $68.2 million from net income of $32.1 million. The loss was driven by write-downs of nearly $111 million on mortgage bonds. The Seattle bank, which has been among the hardest hit, reported net income of $8.2 million, compared with the year-earlier net loss of $34.3 million. The improvement resulted from gains on derivatives and smaller write-downs on its private-label securities.
Last month, Standard & Poor's Ratings Services lowered its ratings outlook on the Seattle bank to negative after its federal regulator reaffirmed its "undercapitalized" designation for the bank and asked for additional information as part of a capital restoration plan submitted last year. The Seattle, San Francisco and Pittsburgh banks each have filed lawsuits in a bid to force securities issuers to buy back busted mortgage securities. In separate lawsuits, they have argued that more than $23 billion in securities were sold with misleading information.
The 12 home-loan banks lend to more than 8,000 banks, thrifts and credit unions at below-market rates to finance mortgage holdings. The banks have about $850 billion in debt outstanding, making them collectively one of the world's biggest borrowers.
US national park faces sale
by Chris McGreal - Guardian
Some might call it blackmail. The governor of Wyoming calls it desperation. Governor Dave Freudenthal is threatening to sell off a chunk of one of America's most beautiful national parks unless the Obama administration comes up with more money to pay for education in the financially beleaguered state. He says he will auction land valued at $125m (£80m) in the Grand Teton national park, one of the country's most stunning wildernesses. Part of the park was donated by John Rockefeller Jr.
Other parts belong to the state government including two parcels of land of about 550 hectares (1,360 acres) designated as school trust lands to be "managed for maximum profit" to generate funds for education in Wyoming. At present Wyoming raises only about $3,000 a year from the land by leasing it to a cattle rancher. Officials have menacingly suggested that the property might make a nice site for a ski lodge.
Freudenthal recently wrote to the interior department asking the federal government to trade the park land for mineral royalties. "If the federal government won't dance with us, we will go look for another partner," said Freudenthal. "The purpose is to force the federal government to come to the table." Washington says it is negotiating, but Freudenthal says the issue has dragged on for a decade. "The way the federal government has treated us to date is that we are like the people who own the land, but they figure there isn't anything else they can do with it," he said.
Previous negotiations led Washington to offer 800,000 acres of federal land in a swap but state officials rejected it as "trash land" not worth nearly as much as their "prime, in-park real estate". "I admit we aren't as bright as those boys on the Potomac," said Freudenthal. "But this ain't our first county fair."
Tier 5: Sen. Stabenow Introduces Bill To Help The 99ers
by Arthur Delaney - Huffington Post
Sen. Debbie Stabenow (D-Mich.) introduced a bill Wednesday that would provide extra weeks of benefits to people who've reached the end of their unemployment insurance lifelines. The measure would provide 20 extra weeks of unemployment benefits and extend a tax credit for businesses that hire workers who've been unemployed for 60 days or longer. "Across our state, more than 35,000 people who have lost their jobs have also exhausted their unemployment insurance benefits," said Stabenow in a statement. "I know that these men and women want to work and have been trying their best to find jobs in this difficult economy."
Through June and much of July, the Senate was locked in an epic struggle just to reauthorize existing benefits for people who've been out of work for longer than six months. Many Republican senators suggested that the extended benefits, which in some states provided up to 99 weeks of help, discourage people from looking for work and make the recession worse. A study by the San Francisco Federal Reserve found that the extended benefits "have not been important factors in the increase in the duration of unemployment or in the elevated unemployment rate."
In a strong economy, state governments provide layoff victims 26 weeks of benefits. In normal recessions, states and the federal government partner to provide an additional 20 weeks. To fight the worst recession since the Great Depression, Congress in 2008 and 2009 passed several measures to provide up to 53 additional weeks of federally-funded benefits, broken into four "tiers." The Labor Department estimates that 1.4 million people have exhausted all available tiers.
The National Employment Law Project applauded Stabenow's bill. "NELP commends Senator Stabenow and her co-sponsors of the Americans Want to Work Act both for being champions of those hardest hit by the recession, but also for keeping the focus on the most important thing -- getting those who have exhausted their benefits back to work," said NELP's Judy Conti in a statement to HuffPost. "We need to support these workers and their families both in their efforts to stay afloat while unemployed through no fault of their own, but equally importantly, in their efforts to find work and rebuild their lives after the devastation of such prolonged unemployment."
The "99ers" have clamored for a Tier 5 via grassroots online organizing. Stabenow's bill would provide 20 weeks of additional benefits in states where the unemployment rate is above 7.5 percent. It's not clear whether the bill would impact the deficit or if it's "paid for," in budget parlance. The text of the bill is not yet available.
It's also not clear when or how the bill could pass the Senate, which adjourns for its August recess this week. Republicans have insisted that domestic spending bills be paid for, but this week they nevertheless attempted to filibuster a bill to provide aid to states that would have reduced the deficit by $1 billion. And a few Democrats have said they do not support giving the unemployed additional weeks of benefits.
But a refusal to help the unemployed contrasts sharply with willingness to help the rich. "We've got people on the [Senate] floor now saying they believe there's sufficient capability to eliminate the estate tax, to give billionaires very large tax cuts," Sen. Byron Dorgan (D-N.D.) told HuffPost. "A country that can do that coming through the deep recession that we've had ought to be able to help those who are chronically out of work, even beyond the 99 weeks." Stabenow's bill is cosponsored by Sens. Chuck Schumer (D-N.Y.), Harry Reid (D-Nev.), Dick Durbin (D-Ill.), Carl Levin (D-Mich.), Bob Casey (D-Pa.), Chris Dodd (D-Conn.), Sherrod Brown (D-Ohio), Jack Reed (D-R.I.), and Sheldon Whitehouse (D-R.I.).
Tier 5: How Far Can The Lobbying Power Of The Unemployed Go?
by Arthur Delaney - Huffington Post
The pleas of hundreds of thousands of the long-term jobless were answered this week when a dozen Senate Democrats cosponsored a bill to provide additional weeks of unemployment insurance.
But given the incredible difficulty that Democrats faced breaking a GOP filibuster just to reauthorize the existing extended benefits, how do Sen. Debbie Stabenow (Mich.) and her cosponsors expect the bill to pass?
"I think when it comes down to it, it's going to rely on people like myself contacting their local representatives," said Jeff Lawson of Fresno, Calif., who told HuffPost he lost his job as a business consultant in 2008 and has since exhausted 99 weeks of benefits. "It's going to require forcing some of the moderate Republicans taking a stand against their own unemployed constituents in their own states."
The extended unemployment benefits that Congress reauthorized in July provide the unemployed up to 99 weeks of benefits in some states. Congress always gives the unemployed extra weeks of benefits during recessions, but in the worst recession since the Great Depression, an unprecedented 99 weeks of help still isn't enough for some. It's been estimated that as many as 1.4 million people have exhausted all four "tiers" of federal benefits. There are nearly 15 million people clamoring for just three million available jobs.
Some of the "99ers," as they've become known, organized online and coordinated lobbying efforts, which have resulted in phone calls, faxes, and even a petition delivery to Capitol Hill. Lawson said he made several calls himself, and had been assured by staffers over the previous months that "they weren't going to forget the 99ers." They didn't. "Their lobbying efforts of member offices certainly making an emotional impact, particularly on the staffers working on those issues who talk to their bosses about them," said one Senate Democratic aide. "People power does still exist -- particularly when it's tireless and unrelenting."
But Stabenow's bill, which would provide tax credits another 20 weeks of benefits in states with unemployment above 7.5 percent, faces incredibly tough sledding in the Senate. Democrats there struggled for nearly two months to reauthorize benefits, with Republicans and Nebraska Democrat Ben Nelson insisting that the measure not add a dime to the deficit even as 2.5 million people missed checks. The soonest this bill could possibly come to the Senate floor, if it ever does, is September.
Democratic strategists outside Congress said it's a no-brainer to push the bill, even if it fails to get anywhere. "What's the alternative to trying to extend unemployment insurance? Give up and turn your back on the American people?" said Todd Webster, founding partner of the WebStrong Group and a former spokesman for Senate Majority Leader Tom Daschle, who noted that the bill gives small businesses incentive to hire layoff victims. "On the politics of it, the messaging of it, and the policy of it, it is sound legislation."
Dave "Mudcat" Saunders, a former adviser to Virginia Democrats Mark Warner and Jim Webb, agreed. "I think the politics of it is magnificent. All over the country, the working people have been screwed by our government, so the least they can do is put a few beans on the table," Saunders told HuffPost. "If you look throughout the south, the manufacturing south, we ain't making shit anymore. The proof is in the pudding: The damn Mexicans are swimming across the river. Pretty soon the hillbillies are gonna swim across the river to Mexico."
Paul Brogan, who told HuffPost he received his final unemployment check in April, said he appreciated the bill even though it's a long shot and it wouldn't help him -- he lives in Portsmouth, N.H., where the unemployment rate is far below 7.5 percent. "I don't think it will pass, because with the election coming up it's going to be painted as something else that's going to increase the deficit, and it will be presented in such a way by Republicans and even some Democrats as a horrible, awful thing because these people are so lazy if they can't get a job in nearly two years," said Brogan, 59, a laid-off grantwriter. "Even the fact that they're willing to try this will help some people psychologically feel they're not alone, that somebody actually gives a damn."
China widens stress tests to steel, cement industries
by Langi Chiang and Simon Rabinovitch - Reuters
Chinese regulators have called for stress tests on loans to a range of industries, including cement and steel, whose fortunes are closely tied to property markets on the brink of a correction, official media reported on Friday. The tests, part of a broader investigation into banks' ability to withstand falls in housing prices, point to the government's determination to hold tightening policies in place until the property sector cools off.
The tests will probe the impact of a 60 percent plunge in housing prices, but analysts warned against reading too much into the extreme scenario, saying the market was likely to weaken but not collapse in such a spectacular fashion. "The banking system has made quite a lot of loans to industries upstream and downstream from the real estate market and their risks are intimately connected to the real estate market," the Shanghai Securities News said. "Therefore, regulatory agencies have demanded that corresponding stress tests should also be conducted for industries such as steel, cement and building materials."
China stepped up a tightening campaign earlier this year to squeeze any bubbles out of its red-hot property market, but while transactions have fallen, prices have barely dipped. The China Banking Regulatory Commission (CBRC) declined to comment directly on reports of the ultra-stringent bank stress tests. But in a statement on its website late on Thursday, it said that stress tests differed from bank to bank and formed part of continual efforts at risk management. Hypothetical scenarios examined in stress tests did not reflect regulators' forecasts for the property sector and nor did they herald any change in policy, the CBRC added.
"The tests show the government is not happy with the current prices. Prices haven't been falling deeply enough," said Cao Xute, a property analyst with Sinolink Securities in Beijing. "If prices don't fall in the next couple of months, the government could tighten further, through monetary and tax measures," he said. Industry insiders said that would not be necessary. "Price growth in key cities has declined and property sales have plummeted," Zhu Zhongyi, vice-chairman of the China Real Estate Association, a top industry think tank, was quoted as saying in the China Daily. "So there is little possibility that the government will launch more tightening policies for the real estate sector before the end of the year," Zhu added.
Shares of developers listed on the Shanghai Stock Exchange fell about 3 percent over two sessions after the stress tests were reported, before paring some of those losses at the close of trading on Friday. Shares of cement producers and steel makers climbed in line with the broader market's 1.4 percent gain. The property sector is a pillar of China's economy, accounting for about a quarter of all capital spending, so a collapse in housing prices could reverberate widely.
Concerns about a housing bubble have centred on top-tier markets where price rises have been most extreme. Banks in seven cities, including Beijing, Shanghai and Shenzhen, have been asked to examine the impact of a fall in property values of up to 60 percent, the official China Securities Journal reported. Banks in the seven cities must submit the stress test results to their provincial regulator before August 13, it added. There would be no "one size fits all" method and banks would decide for themselves how to conduct the tests based on the conditions of their local real estate market, the Shanghai Securities News said.
The CBRC has also instructed banks to stop extending mortgages to people buying their third homes in at least four booming cities -- Beijing, Shanghai, Shenzhen and Hangzhou. The government launched a property tightening campaign in April, demanding higher down payments and curbing loans to buyers of multiple homes, because of concerns that prices were rising too fast and morphing into a dangerous asset bubble. Speculation had been mounting that Beijing might relax the controls as the economy slows in the second half, but many analysts now believe that it will hold them in place until there is a clear correction in prices.
"In top-tier cities, prices will probably fall by 20-30 percent, returning to the levels where they started the year at the end of 2010," said Wang Xia, a property analyst with CCB International in Beijing. Earlier stress tests showed that Chinese banks could sustain a drop in housing prices of up to 30 percent without a sharp rise in bad debt ratios. Those tests, conducted in May, also looked at the risks posed by loans to sectors tied to the property sector, such as cement and steel.
China Visit: Economic Report
by Simon Hunt
In all likelihood, China has entered the most critical and taxing period since the country was reopened to the outside world in the 1970s. Domestically, there are a slew of issues, any one of which could create instability. These issues include:
- Home affordability
- Leadership instability
- A potential if not actual housing bubble
- The rising income and wealth differential between those who have made it and those who have not
- The country's continued dependence on exports as its principal driver of growth
- Cheap credit, which punishes savings and encourages investment/speculation
- The misallocation of capital that springs from the previous factor
- Local/provincial government indebtedness
- A new assertiveness and arrogance at all levels
- Policy making that focuses on short-termism without addressing structural and longer-term issues, etc.
- Impact of rising wages
- Energy intensity
- Role of foreign companies
- Resource dependability - water, raw materials, etc.
The list could go on, but these issues are evolving at a time when the global environment is fraught with difficulties and uncertainty, making policy making within China that much more complex. The infighting within the leadership, which goes beyond the normal tensions that often occur during the period leading up to a change in leadership (due in 2012), is making policy management more difficult and has led to conflicting views being expressed by various factions, in the media.
Few can know the full story of what goes on within the State Council, but there appears to be a battle royal being fought over the real estate sector. There are those within the leadership who are concerned that average home prices have gotten too high for most first-time buyers (see our previous visit report). They want to see average prices fall by 10-20% across the country. Against this group are not just real estate developers but local governments and many others within Beijing. This group, of course, depends for much of their revenue, or in the case of developers, their profits, on rising land and building values. In fact, local governments depend on land sales for one-third of their revenues. In 2009, land sales brought in RMB 1.6 trillion, compared with a total budget income of RMB 3.3 trillion. Moreover, land is the most-used collateral for bank loans; its value is thus crucial to the credit edifice.
Many local governments have not adhered fully to the new restrictions imposed by the central government on the real estate sector. This has infuriated those in Beijing who are determined to encourage a fall in home prices. In effect, what is being seen is a battle between central and local governments. In our view, this is a fight that central government cannot afford to lose.
The scale of speculation in real estate is enormous. There ia a total of 64.5 million apartments and houses lying purchased but vacant in urban China, about five times the surplus in the USA, according to an economist from the Chinese Academy of Social Sciences.
A report written by the National Bureau of Economic Research in July this year provides interesting data on China's housing market. Real housing prices have risen by 140% since the first quarter of 2007. In the first quarter of this year, house prices rose by a record 41%, since when it appears that prices have stabilised but not fallen. Price increases have not been driven by any shortage in housing. In five of the eight markets that the authors of the report studied, the net new number of housing units provided since 1999 was at least as large as the net increase in the number of households. In the three others, the relatively modest gap does not explain the huge rise in home prices.
In Beijing, there has been an almost eight-fold increase in land values since 2003, but since the end of 2007 land prices have nearly tripled. The impact of rising land prices on home and apartment prices has been equally great. From 2003 to 2007, the ratio of land-to-house values hovered between 30% and 40%, but since then it has doubled to just over 60%. The report also found that when a central government state-owned enterprise (SOE) was a winning bidder for land, prices rose by about 27% more than if they had not been involved, thus showing the influence that SOEs bring to bear on land values, an influence that grew in 2009 when they became more active. A separate report shows that so far this year 82% of Beijing's land auctions have been won by SOEs.
Price-to-rent values in Beijing and seven other large markets across the country have increased from 30% to 70% since the start of 2007, and current price-to-rent ratios imply very low user costs of no more than 2-3% of house value. Very high expected capital gains appear necessary to justify such low user costs of owning. The report continues with calculations suggesting that even modest declines in expected appreciation would lead to large price declines of over 40% in markets such as Beijing.
In summary, against a background of cheap money and plenty of credit, house prices across the country have become unaffordable to most first-time buyers. In Beijing, for instance, average house prices have been between 14 and 15 times incomes for the past three years, but rose to 18.5 times in the first quarter of this year. If average home prices do not fall significantly across the country, the risk is that Beijing will be forced to tighten policy another notch. A softening in monetary policy is likely only if average home prices fall within the 10-20% range.
This is what the policy fight is all about, because if these price developments continued unchecked the leadership would risk encountering social instability. Workers everywhere are demanding higher wages. The demands are not just amongst the SMEs and foreign companies, but within the SOEs. We understand that a significant number of SOEs have seen de facto strikes, just not in name. The workers clock in, go to their stations, put down their tools, and clock out without doing any work.
The list of grievances is long, with rising wages being one. How government deals with this situation remains to be seen. We were reminded that in 1989 it was only when the workers joined the students that an explosive situation developed. No one is expecting anything remotely similar, but these developments do illustrate the tensions lying beneath the surface which the leadership is having to grapple with.
Politics in China is all about maintaining social stability. The demographics of the country are forcing the leadership into a new economic model, which will be partially driven by the level of average wages over the coming five years being at least double that of the last five years.
Dr Clint Laurent of Global Demographics has consistently stated that China's statisticians have overstated the country's birth rates since 1990. This implied, as he said in a paper in 2005, that China's labour force would peak at 770 million in 2008, falling to 690 million by 2025. Another major consequence is that the important age group of 20-39 peaked in 2000 at 458 million and by this year will have fallen by 4%.
The consequences of these demographic changes are immense. First, wage inflation will be a given, not just in the private and foreign sectors but amongst the SOEs, as we mentioned earlier. Second, it means that manufacturers will introduce automated machinery to reduce the workforce (the new booming sector) and improve productivity. Third, rising wages lay the foundation for better consumer spending; though households, as in the past, will have to cover the losses racked up by local governments, according to Michael Pettis, a visiting professor in Beijing. Fourth, disposable income in the rural sector is improving. This development, combined with subsidies granted to rural households for buying a range of household appliances, has lifted the demand for these products in rural areas. Nonetheless, it is human nature that when a gift is offered there is a rush to buy, so how long the subsidies will affect sales of appliances is a moot point.
Finally, policy makers know that the time has come when the country's dependence on exports for growth must be replaced by domestically driven growth that focuses on consumer spending and not fixed-asset investment. Local coastal governments, however, will fight to see that exports from their regions continue to drive their own growth; but their success will depend on global trade.
Much of the surge in exports so far this year has been due to the replenishment of inventory within the distribution and sales channels and to the expected increase in export prices out of China. Inventory replenishment has now run its course in Europe and the USA. Given the expected slowing of consumer spending in the US in the second half of this year, some inventory liquidation might actually be seen. Even so, exports from China should weaken sharply by year-end.
The move to de-peg the RMB from the US$ gives Beijing the flexibility to either appreciate or depreciate the currency depending on global conditions. Any appreciation will be modest given the small margins that most exporters enjoy. If our profile of the world economy is even half correct, we should expect to see the RMB depreciate against the US$ and other currencies post-2012.
Wage inflation threatens to feed into general inflation. Food prices remain quite stable overall for now, but there is a risk that they will be rising by year-end. Vegetable prices are rising sharply, according to friends who shop every week. Meat prices are stable for the time being, but wheat prices had risen well above the government's sale price of RMB1800, to over RMB2350, when we last looked. Friends fear that food prices will be rising in the fourth quarter, with some economists predicting that CPI will be increasing at a 5% rate by then. We are told also that the cost of getting an electrician, plumber, etc. in to do odd jobs has doubled over the last year in Beijing and other major cities. Our general take is that China is on the threshold of seeing an overall increase in the cost of living. Whether it shows up in official numbers or not, households will feel it.
A long-term concern is whether China has key resources to maintain the growth profile that the country has experienced over the last 40-odd years. Water may well be a key constraint. China's water-resource capacity is only ¼ of that of the world average. In other words, the country has 20% of the world's population but only 7% of global water resources. The problem is compounded by the dispersion of those resources. The area around the Yangtze River accounts for 36.5% of the country's land mass, but holds 81% of its water. North of the Yangtze River lies 64% of the country's territory, but only 19% of its water resources.
A World Bank report shows that more than half of China's 660 cities suffer from water shortages; and 90% of cities' groundwater and 75% of their lakes and rivers are polluted. These are examples of the physical constraints on growth. China's rapid pace of industrialisation has left the country with severe burdens and a massive clean-up, not just in urban areas but throughout the countryside. Water is a global depreciating resource, as William Houston and Robin Griffiths showed in their book Water: The Final Resource. History also shows that wars are fought over access to water.
Local government indebtedness is being exposed as a potential time-bomb, as one friend remarked to the writer. Whatever the correct figure, it is large and is in the range of RMB6 trillion to RMB11.4 trillion, equivalent to 71% of the country's nominal GDP. Some reports suggest that banks will have difficulty recouping about 23% of what they have loaned out. The China Banking Regulatory Commission has told banks to write off nonperforming project loans by the end of this year.
No one should be surprised by these numbers. Back last October we were told - and we reported - that one-third of the fiscal stimulus and bank lending never went into the real economy. There are likely to be more hidden black holes. One consequence is that credit is tight, with receivables mounting across a wide swath of manufacturing.
Markets will sense some of these uncertainties. In line with falling global equity markets, which should start very soon, the Shanghai and other Chinese stock markets are likely to fall sharply by year-end. This will take the stuffing out of consumers' willingness to buy large-ticket items like cars and appliances. Already, so we hear, inventories of these items are growing within the distribution systems, with production levels likely to fall over coming months.
Many companies believe that the weakness now being seen is seasonal. But others, whose opinions we respect, believe that weakness will be seen at least until year-end. Prices of raw materials, semi-fabricated products, and finished goods are likely to start falling very soon. Instead of accumulating inventory, stocks within the entire manufacturing and distribution systems will be slashed, repeating to a lesser degree what occurred in the second half of 2008.
Construction activity will continue to slow, notwithstanding the continued high rate of completions, consumer spending will slow also, exports will be weak in the fourth quarter, and growth of fixed-asset investment will be lower. By year-end, the psychology of businessmen and consumers will have shifted from optimism towards pessimism in line with movements in the Shanghai stock market. Real business activity will be pretty flat in the fourth quarter. The latest PMIs from the Government's Logistical Office and from the HSBC both indicate a slowing economy. The former is geared more to the SOEs and the latter to the private sector. The HSBC sub-index of new orders fell from 49.7 in June to 47.9 in July.
In summary, we doubt there will be any easing of policy until average house prices fall into the 10-20% range. China is transiting into a very difficult period as focus shifts towards sustainable domestic growth and away from short-term measures to defend the 8% GDP mantra. This transition is occurring when the existing leadership is preparing to give way to the new set in 2012, when social stability could be threatened if there are policy mistakes, when the rest of the world is starting to stand up to China's increasing assertiveness, and when foreign companies are questioning their future in China. China will muddle through, but it won't be an easy ride.
Understanding the Social Security Trustees Report
by Keith Hennessey
Spendthrift teenager Billy Jones sits at the kitchen table, proudly examining a piece of paper.
"Why are you so happy, Billy?" asks his skeptical eight-year old sister, Suzy.
"Because today I am updating the balance on my Social Security Trust Fund and my Social Security credit card," replies Billy.
"Wait, I thought you had terrible credit," asks Suzy. "Is this a real credit card, like the one you use when your allowance runs out and you keep spending money?"
"Well, no. Technically this is more like an American Express card. It looks just like a credit card, but I have to pay the full balance immediately every time I use it. There’s no credit line attached to it, and it doesn’t let me borrow. But I like to pretend it’s a real credit card."
Suzy sighs. "You have this AmEx-like card, and you call it your Social Security Card, right?" asks Suzy.
"Right," says Billy. "And once a year I figure out how my Social Security financial picture looks, and I issue a report I call the Social Security Trustees Report. Today is that day."
Suzy shakes her head. "And you’re smiling. I was afraid of this. Let me review the situation to make sure I understand it."
"You typically get an allowance from Mom and Dad of about $18,000 per year. That’s money that the rest of us in the family don’t get to spend, it’s all for your purposes. You typically spend more than your allowance, about $20,000 per year, and you’ve been gradually accumulating credit card debt (on a real credit card that lets you borrow money from others). Lately you’ve been spending much more – like $25,000 this year and running up a huge amount of new credit card debt. Two days ago we looked at you lobbying Mom and Dad to allow your allowance to increase by about $500 per year on January 1st. I complained because that’s $500 less each year for the rest of the family."
"Right, but you’re an irresponsible little sister who won’t let me have a bigger allowance when I have this enormous credit card debt."
"Yes, but you have a bad habit of taking your allowance increases and spending them, as you did with that health care thing. But let’s not rehash Tuesday’s argument. As I understand it, you have two expensive spending habits, both centered on your iPhone: you spend a lot of money buying both music and movies. For some reason that I don’t understand, you call the music ‘Social Security,’ and the movies you call ‘Medicare.’"
"These two spending habits are growing rapidly. This year you’ll spend $4,800 on ‘Social Security’ music, and another $3,600 on ‘Medicare’ movies."
“So far, so good," says Billy.
"Right. And you always charge the music you buy to your ‘Social Security Card,’ and you charge the movies to your ‘Medicare Card.’ But these aren’t real credit cards that let you borrow. They work like American Express cards that require you to pay the full balance as soon as you incur the cost."
"Now of the $18,000 per year that you get in total allowance from Mom and Dad, some of that is for specific chores that you do. This year about $4,400 of that $18,000 total allowance is compensation for mowing the lawn, and you dedicate that portion of your allowance to your Social Security music spending. You call that your Social Security payroll tax allowance."
"And this year another $1,200 or so of that $18,000 annual allowance is compensation for shoveling the snow off the driveway. You dedicate that portion of your allowance to buying Medicare movies. You call that your Medicare payroll tax allowance."
"Doin’ great, sis."
"Thanks. Now today let’s focus just on Social Security. Since this card doesn’t actually let you borrow, you have to immediately find the cash you need when you buy Social Security music. This year you will spend $4,800 on Social Security music. You’ll take the $4,400 of dedicated Social Security payroll tax allowance you got because you mowed the lawn, and use that to pay for most of the music. That’s real cash you’re spending. But you need to find another $400 of cash to pay for the rest of the Social Security music costs incurred this year. That $400 comes from the rest of your allowance, from money not for any particular chore and not dedicated to any particular purpose. We can call that big stream of allowance money from which the additional $400 per year comes your general revenue allowance."
"You project your future music spending will grow faster than your lawn mowing dedicated revenues, so next year you’ll take more than $400 from your general revenue allowance to close the gap between your Social Security payroll tax allowance and your Social Security spending."
"Right, but it wasn’t always like this," says Billy. "I used to buy less music, so I was actually making more in dedicated Social Security payroll tax allowance from mowing lawns than I spent on Social Security music."
"And in past years what did you do with the extra money you made from lawn mowing that you didn’t spend on music? What did you do with that money that was supposed to be dedicated for Social Security spending?"
"Well, I carefully kept track of how much extra I made in Social Security payroll tax allowance that I didn’t spend on Social Security, and I wrote down those amounts on this piece of paper. I call this piece of paper my Social Security Trust Fund. Today I’m issuing my Social Security Trustees’ Report, which shows that I have a balance of $17,400 in my Social Security Trust Fund. I do the same thing for Medicare, sort of. That’s actually a bit more complicated."
Suzy looks quite puzzled. "This is messy enough, so today let’s stick to just Social Security. You kept track of past Social Security payroll tax allowance that you didn’t spend on Social Security music, and that has accumulated to $17,400."
Billy, "Well, actually, less than that, but I gave myself credit for interest."
Now Suzy looks worried. "You gave yourself credit for interest. But I’m confused. What did you do with the actual money in those past years?"
"What money?" Billy asks.
"The portion of your allowance that resulted from your lawn-mowing that in past years you didn’t spend on music. Your extra Social Security payroll tax allowance. Where did the cash go?" asks Suzy.
"Well … I … um …" Billy stutters. "I spent it on other stuff."
Suzy shakes her head. "Like what?"
"Oh you know, everything. I spent it on boxing lessons so I could defend myself, and I bought an awesome Trapper Keeper notebook with it. I bought a new bike for transportation, and I spent some of it going to museums and movies and parks. I even spent some on my online farm…"
"OK, stop, stop. You’re telling me you spent on other things the extra allowance that in the past you had dedicated to spend on Social Security music, but you also wrote down those amounts on this Trust Fund paper and said that it should go to future spending on Social Security music. This piece of paper you call a Social Security Trust Fund isn’t actually money. It’s just an accounting convention you created to keep track of how much of those past dedicated Social Security payroll allowance dollars you didn’t spend on Social Security, but you did spend on other things."
"Plus interest," adds Billy, nodding.
"Plus interest," sighs Suzy. "But this is interest you’re crediting on non-existent money. Now that your Social Security music spending has increased, each year you’re spending all your dedicated Social Security allowance on Social Security music, and you’re tapping into your general allowance to pay for the rest of your Social Security costs. You’re also subtracting this general allowance contribution from the ‘balance’ on your ‘Social Security Trust Fund’ piece of paper, even though there’s no real cash involved here. Subtracting from this so-called Trust Fund balance is pure optics, just like adding to that balance was in the past when you were spending the extra cash for other purposes."
"You’ve got it," says Billy proudly. "And I am announcing today in my annual report that my Social Security Trust Fund will be depleted in 2037."
"Riiiiiiight. Why does that matter?" asks Suzy. "That piece of paper that you call a Trust Fund has no actual resources behind it. There’s no money there."
"But it shows how much I should be able to draw from my future general allowance to spend on Social Security music, above and beyond my dedicated Social Security payroll tax allowance from mowing the lawn!"
"You can tell yourself that, but where does the money come from? You can make whatever promise you want about how much you will spend on music in the future, but the cash is going to have to come from somewhere. In fact, you’re taking $400 away from other needs just this year to pay for this year’s Social Security music spending."
"Let me ask you this," continues Suzy. "Suppose we doubled that number on your piece of paper. Suppose we just cross out the $17,400 balance on your so-called Social Security Trust Fund, and instead we write in $35,000. We’ll round up."
Billy says eagerly, "Suzy, that’s fantastic! Now I won’t run out of money for music spending any time soon! With $3,500 in my Social Security Trust Fund, it will take decades to draw down that balance."
"That’s exactly what worries me," replies Suzy. "We haven’t actually created any more money by doing this. We have just changed an accounting balance for an imaginary account. You can tell yourself that you have more money to spend on Social Security music, but you don’t actually have any more cash, now or in the future. It’s not like a bank account balance, or even like the real credit card debt you have been accumulating. I’m really worried that this Trust Fund balance and your Trust Fund reports are giving you a false sense of security, and they are preventing you from taking a hard look at how much you spend each year on Social Security music."
"You don’t have enough dedicated allowance this year to pay for your Social Security music spending this year. You have an immediate cash flow problem, in that you’re having to sacrifice $400 of other stuff just this year to make up the difference between what you collect in dedicated Social Security payroll tax allowance, and what you spend on Social Security. And that $400 gap will be bigger next year, and the year after that."
"Billy, this is a problem for you right now. You need to slow the growth of your Social Security music spending. When you combine that with your spending on movies that you call Medicare, over time it’s going to grow to consume most of your $18,000 annual allowance. It will squeeze out your ability to spend your general revenue allowance on those boxing lessons, those school supplies, those museums and movies and parks and even your online farm."
"You forget, sis," says Billy with a grin. "While this Social Security Card isn’t a real credit card, I do have a real credit card. I can just borrow the extra money I need and run a bigger deficit this year. I promised myself I’d spend this $17,400 on Social Security music over time, and I can’t break that promise. I’ll just keep increasing my borrowing on my real credit card to do so."
"And next year, and the year after that, …" cries Suzy.
"Yep. I plan to increase my spending each year on Social Security music. I’ll draw more from my general fund allowance to pay that which is not covered by my dedicated Social Security payroll tax allowance. If that threatens to constrain my other spending, I’ll just borrow and run up my credit card debt."
"And you’ll keep doing this until …"
"By my calculations, I’ll need to do something by 2037, when my Social Security Trust Fund runs dry."
"But there’s no money there. And if you keep telling yourself you’re OK for another 27 years, you’re not going to do anything about the real problem, which is that you can’t afford this growth rate of your Social Security spending. At some point this cash flow problem is going to cause your real credit card debt to get so high that you’ll bump against your credit limit. Then your only options will be to drastically cut back on your Social Security spending, or slash the amount your spend on other stuff, or …"
Suzy gasps. "Oh, no. Or you’ll wait until it’s too late, and then demand a bigger allowance, leaving even less money for the rest of the family."
Billy sits quietly, failing to suppress a smirk. "And we haven’t even discussed Medicare."