Having a nice day? Me too. Think everything is looking peachy? Yep. Just leave aside a looming financial disaster, Peak Oil, and a rising ratio of parasites to the productive. No reason to let these things get you down. Things look great. But the old Chinese curse (or so I've been told) of "may you live in interesting times" seems appropo. Mario Draghi, the top guy in Europe's Central Bank, thinks the current course of the euro zone can't be sustained.
FRANKFURT, Germany—The head of the European Central Bank warned Thursday that the euro currency union is "unsustainable" without stronger political and financial ties, and called for a new course to save it from a crippling debt crisis.
What I can't figure out: Is the Euro elite just stumbling along driven more by the internal politics of each state? Or are they intentionally letting this crisis build up to such a scary looming financial disaster that they can push thru an effective United States of Europe? Stumbling to disaster? Or Machiavellian scheming toward closer union?
Mario Draghi said the central bank could not "fill the vacuum" left by member states' lack of action as it was claimed the zone is on the point of "disintegration".
Italian Prime Minister Mario Monti says Europ needs to try harder to limit the contagion. That means closer fiscal integration with the various member states getting veto power over each other's fiscal policies.
"I think Europe should accelerate its efforts in order to limit the contagion, not simply because a huge financial contagion and crisis would be a frightful event, but even more because this would dismantle support for sustainable fiscal discipline," he said.
How is this going to resolve? Are a bunch of schemers thinking "We've got this in the bag. The crisis is big enough to let us gut the remaining sovereignty in the Euro states"? Or are they stockpiling food and moving money to safer havens?
Lots of state and local governments use very unrealistic assumptions about rates of return on public pension fund investments and are headed for a fall. The City of New York assumes an absurdly high long term rate of return for their pension funds.
In New York, the city’s chief actuary, Robert North, has proposed lowering the assumed rate of return for the city’s five pension funds to 7 percent from 8 percent, which would be one of the sharpest reductions by a public pension fund in the United States. But that change would mean finding an additional $1.9 billion for the pension system every year, a huge amount for a city already depositing more than a tenth of its budget — $7.3 billion a year — into the funds.
Billionaire Mayor Michael Bloomberg quite correctly points out that even 7% is indefensible.
“The actuary is supposedly going to lower the assumed reinvestment rate from an absolutely hysterical, laughable 8 percent to a totally indefensible 7 or 7.5 percent,” Mr. Bloomberg said during a trip to Albany in late February.
Absolutely hysterical. Laughable. He knows. Listen to him. NYC and many other government units are headed for financial disaster. Huge cuts in services. Huge cuts in pension pay-outs. Big tax increases. We are living beyond our means.
Expect many city bankruptcies due to pension fund liabilities they have no chance of paying in full. Back in November 2011 Michael Lewis wrote a great piece in Vanity Fair about how California cities are headed for bankruptcy due to unpayable public employee pension fund liabilities. San Jose's going down baby.
I expect the problem to be far worse than currently projected even by the pessimists because I expect much lower economic growth (or even an extended period of contraction) due to Peak Oil and deteriorating demographics. Oil extraction costs have gotten too high.
Global inflation might have already pushed the costs of exploring and producing oil from new most expensive projects - known in the industry jargon as the marginal cost of production - above $100 per barrel, according to JBC energy consultancy.
Rising oil extraction costs have already helped cause the Social Security actuaries to pull in by 3 years the date of total drainage of that fund. The real financial disaster comes sooner. Get ready for hard times.
The debate is raging about whether Greece will leave the euro currency zone. Hard to see how it can manage to stay. But now the debate is starting to shift toward the question of the euro's survival. The Europeans are blowing it on a monumental scale. A grandiose epic mistake.
AS problems mount in the euro zone, it’s increasingly evident that we’ve been witnessing an institutional failure of monumental proportions.
Read the full essay. His conclusion is horrible but likely true: The Euro zone is a failed idea. Given the speculation (see below) about what Greece's exit from the euro zone will do to Greece imaging a larger scale failure of the euro. Many more countries would get thrown into depression.
Financial contagion baby!
What is to be done about Greece? Simply keeping it in the euro zone won’t help much, even if it’s possible. The continuing crisis has sapped confidence in banks not only in Greece, but also in Spain, Italy, Portugal and Ireland, though to varying degrees. Unless there are explicit guarantees to these banks soon, the market will likely take a further turn for the worse.
Aside from shipbuilding, most of Greece’s industrial base has eroded in the 30 years since the government nationalized large areas of industry. Wealth-generating businesses diminished, and tens of thousands of laid-off workers were absorbed by the state to reduce unemployment.
The whole world economy will go into deep recession if the Euro zone falls apart.
There’s no question that quitting the euro would be an easy way for Greece to shrink its unsupportable debt. Yet if Greece does leave or is kicked out of the single currency, it will most probably suffer inflation, layoffs, capital flight, shortages of essential commodities, and civil unrest, judging from what happened in Argentina when that country quit its dollar peg a decade ago.
But Greece will go through this chaos after a few years of economic contraction and therefore already high unemployment and lowered living standards. How bad can things get? The economy of poor pathetic Greece shrank 6.9% in 2011 and will shrink 5% in 2012. The Greek economy also shrank 2% in 2009 and went down 4.5% in 2010.An exit from the Euro will lop off another 10% from the Greek economy. The total contraction might exceed a quarter of its 2008 economy once it bottoms out after a return to the drachma.
The International Monetary Fund estimates that a Greek exit from the euro would lop more than 10 percent from Greece’s gross domestic product for at least the first year after a return to the drachma.
That's just one small European country. If many countries exit the euro zone then the disruptions would feed on each other and the downturns would be much worse for each country. So if Tyler's right about the euro as a failed idea Europe is headed for an economic depression and a the rest of the world is headed for a deep recession.
By many indicators, Greece is devolving into something unprecedented in modern Western experience. A quarter of all Greek companies have gone out of business since 2009, and half of all small businesses in the country say they are unable to meet payroll. The suicide rate increased by 40 percent in the first half of 2011. A barter economy has sprung up, as people try to work around a broken financial system.
Greece is going to become less regulated and less socialist just due to lack of money. Foreign investors will swoop in to pick off pieces that become available as the Greek government sells assets. Greece will become a cheap holiday resort destination. Chinese and German companies will compete for pieces of the carcass.
Even with a bail-out and a more than halving of government debt Greece may end up once again unable to service its debt.
The Germans are getting ready for the Greeks to bail from the Euro currency zone. Read that article. The severity of the problem has sunk for the Germans.
Plans for Greece to default, potentially leaving the euro, have been drafted in Germany as the European Union begins to face up to the fact that Greek debt is spiralling out of control - with or without a second bailout.
If the oil price spike causes another world recession (and I rate that likely by 2013 or 2014) then I'm counting Italy and possibly Spain or Portugal or Ireland as candidates to leave the euro zone. The world economy is bumping up against resource limits.
While some argue that European economic troubles will dampen Europe's oil demand enough to keep prices down I think they miss the big picture. The developing nations of south and east Asia will grow their own demand enough to eat up that oil. The US and Europe are going to have to keep cutting back their own demand to make up for rising demand in Asia. that means our economies will perform poorly and our living standards will at best stagnate and due to declining labor force quality more likely living standards will decline.
My standard advice: Try harder to learn more skills and pursue a more rewarding career. You need to compensate in your own life for what's going wrong at the macro scale.
Update: One of Greece's problem is that government employees are corrupt and expect bribes. That's a reflection on the population that they come from. The Greeks should behave with more virtue and force their government to do the same.
Something is fundamentally wrong with a currency zone where Germany has the lowest unemployment rate in over 20 years while southern Europe has depression-level unemployment.
There are some bright spots as Europe enters 2012. The recent drop of the euro currency against foreign rivals like the yen and the dollar makes European exports more competitive — a critical advantage for Germany, Europe’s largest exporter and its largest economy. German unemployment now stands at 5.5 percent, the lowest since German reunification.
Not blaming the Germans. Just saying the euro is obviously not a one-size-fits-all currency zone.
Pat Buchanan makes an argument about Angela Merkel's attempt to commit all European countries to a treaty that prevents them from profligacy: Nationalism in Europe is on the rise and the Mediterraneans won't want to live poorly for a decade to pay off accumulated debts.
Nationalism is on the boil across Europe, and it is impossible to believe the leaders of those 26 EU countries, by cutting some deal with Angela Merkel and Nicolas Sarkozy, can bind their countrymen forever to cede veto power over their future budgets to Brussels.
Will Greeks and Italians really accept a decade of austerity to pay off debts larger than the national economy, to banks and bondholders, for hundreds of billion of euros already spent?
Pat sounds right to me. The southern Europeans aren't going to accept austerity based on some economic theory about how it will be better for them in the long run. It is rather inconsiderate of Europe's elites to keep countries in the euro zone that, for very fundamental reasons, don't belong there. Those reasons have caused southern European labor to become too high priced for southern European exports to compete. This is one of a few reasons the southern Euros can't grow their way out of debt.
Increases in employment costs of all euro nations outpaced Germany’s in the decade through 2010. German hourly labor costs rose an average 1.7 percent per year, while they jumped 2.9 percent in Portugal, 3.2 percent in Italy, 3.4 percent in Greece and 4.1 percent in Spain, the labor union-affiliated IMK institute said Dec. 12.
The causes of those high rates of hourly cost rises aren't easy to fix (see my "fundamental reasons" link above). This was true a when the euro zone was created (making the inclusion of southern Euros in the euro zone an act of lunacy). It was true a few years ago when the financial crises almost turned into a world Great Depression. It is still true today. It will be true next year.
As Tim Duy at Fed Watch points out all of the options for Europe are pretty bad. Some of the theoretical options aren't anywhere near the realm of political plausibility. The resentments between European nations are getting more intense and ruling out more options.
The already low odds of continued full service of all that sovereign debt will go even lower when world oil production goes into permanent decline at some point in this decade. Near flat oil production is already restraining economic recovery. Gail Tverberg gets it right when she argues we can't decouple GDP growth from energy growth (more details here). Since oil as a transportation fuel is hard to replace with other energy sources (at least for the next 10-15 years) I expect declining oil production to pull down the world economy with it. Then heavily indebted European governments will get hit by rising costs and dropping tax revenues.
You hear a lot about renewable energy sources. But as International Energy Agency chief economist Fatih Birol points out, the world's dependence on coal has actually grown over the last 10 years.
"We rarely talk about coal," says Birol. "But over the last 10 years, 50% of the growth in global energy consumption has come from coal."
That 50% of growth from coal is rather like a canary in the coal mine. That the world needs to boost coal consumption in order to boost energy consumption is telling in a "Limits To Growth" sort of way. Other energy sources cost more. Oil has about quadrupled in price. Solar and wind still cost too much. While natural gas prices have come down in the US at a global scale dirty coal is still the go to energy source.
Another reason for the heavy weighting toward coal: China consumes most of its energy as electricity and most of its electricity is generated using coal. Plus, China uses a lot of coal for steel making. But as China's demand for cars goes continues to grow China's oil demand will drive up oil prices and squeeze Western economies even harder. Competition for oil and other natural resources is going to become an even greater impediment to economic growth (and therefore tax revenue growth) in the West. So Europe's economies can not return to Business As Usual. Therefore economic growth can not provide Europe with the cash flow needed to pay off its debts. The politicians who are trying to avoid sovereign defaults are making the defaults bigger when they come.
Too many discussions about economics and financial crises ignore the physical world. We face stronger head winds against economic growth in the Western countries and limits in natural resources.
Entering the euro zone hasn't worked out well for Greece. With an unemployment rate already at 18.4% the outflow of deposits from Greek banks puts their banking system at risk of collapse. This is a silent bank run. How do the Greek banks avoid collapse even before the Greek government defaults on the government bonds held by the Greek banks?
At the start of 2010, savings and time deposits held by private households in Greece totalled €237.7 billion -- by the end of 2011, they had fallen by €49 billion. Since then, the decline has been gaining momentum. Savings fell by a further €5.4 billion in September and by an estimated €8.5 billion in October -- the biggest monthly outflow of funds since the start of the debt crisis in late 2009.
The Greek central bank estimates that around a fifth of the deposits withdrawn have been moved out of the country.
Imagine you lived in a country where the government was at risk of defaulting and causing massive bank failures and unemployment was at depression levels and the economy was still going to contract for another year. Surely a nightmare for the Greeks.
Greece still has a lot of down side risk. The next global oil price spike could prevent a projected drop in the Greek sovereign debt level.
The United States also faces a worrisome debt-to-GDP ratio. Imagine a huge oil spike lays the economy low in, say, 2013. The debt-to-GDP ratio would get scary.
If the current 335% ratio of household, business and government debt-to-GDP sounds bad now, just imagine if GDP were to contract. A 3% drop in nominal GDP from current levels would push that ratio up by more than seven percentage points to 342%. This is the trouble with austerity measures, and is why Greece's debt-to-GDP has soared, not
Many cans have been kicked down the road. The cans have grown larger and more numerous and the road is looking pretty blocked. Investors are beginning to panic. Ambrose Evans-Pritchard of The Daily Telegraph reports on Asian bond holders who are bailing out of European holdings.
Asian investors and central banks have begun to sell German bonds and pull out of the eurozone altogether for the first time since the debt crisis began, deeming EU leaders incapable of agreeing on any coherent policy.
This could turn into a stampede. How do you view your job security? Take a cold hard look at it. The financial markets are headed for rough waters.
Andrew Roberts, rates chief at Royal Bank of Scotland, said Asia's exodus marks a dangerous inflexion point in the unfolding drama. "Japanese and Asian investors are for the first time looking at the euro project and saying `I don't like what I see at all' and fleeing the whole region.
Felix Salmon says European banks are in a liquidity crisis. Unlike with US banks in 2008 and 2009 the European Central Bank is not tasked with assuring bank liquidity. The Germans look unlikely to support a massive expansion of the ECB's remit. Given that even German interest rates are rising as investors flee Europe it is not surprising that Germany and France have held talks about fracturing the Euro zone. It seems unlikely a single currency zone can survive.
The New York Times is reporting the same flight from European bonds. A serious liquidity crisis is brewing. If countries default on their sovereign bonds then a solvency crisis will follow as bank losses on sovereign bonds put them underwater.
Financial institutions are dumping their vast holdings of European government debt and spurning new bond issues by countries like Spain and Italy. And many have decided not to renew short-term loans to European banks, which are needed to finance day-to-day operations.
Tough talk from Euro elites on Greece have scared investors about Italy, Spain, and other at-risk countries. Can the mainstream consensus admit the Euro was a bad political idea??
In fact, aggressive remedies for Greece may have worsened Italy’s situation this week. The never-before-voiced suggestion that countries weren’t forever bound to the euro may have scared Greek leaders into submission, but it also scared bond markets into raising the price that Italy pays to borrow money to levels that forced Greece, Ireland and Portugal to take bailouts.
That’s precisely what European leaders didn’t want. Problems in the peripheral countries were always manageable — in the worse case, France and Germany’s hulking economies could swallow the cost of paying off the tiny ones. Italy, however, owes creditors $2.6 trillion — far too large an amount for France and Germany to backstop.
Instead of "too big to fail" we have "too big to save". America will get there eventually.
This debt crisis isn't of a short term nature. Slowing economic growth makes it much harder to service debt. The Western countries can't grow out of their debts because the Western countries (including the United States) are in decline. The American middle class has been getting poorer for decades. Putting both members of couples to work delayed the living standard decline for a while - at least for the married. But that way of compensating for decline has run out of steam.
The great hope is economic growth. American and European politicians still keep hoping for it. But Europe is heading back into recession and rising oil prices threaten to do the same for the United States.
Europe may be slipping into a “deep and prolonged recession” as high levels of government debt, financial market turmoil and political paralysis stoke a dangerous downward cycle, the European Commission said Thursday.
The Euro currency zone needs to drop about a half dozen members. Maybe the southern Europeans could shift to a Mediterranean currency called the Med.
Let me repeat some advice: Try harder to learn more valuable skills. Try harder in your career. Live a more frugal life. The economies of the Western democracies are in serious troubles that will take many years to work out.
Greece is relying on Iran for most of its oil as traders pull the plug on supplies and banks refuse to provide financing for fear that Athens will default on its debt.
Think about that. Greece is in such dire straits it is now reliant on Iran to keep the oil flowing. If I was a Greek I'd transfer all my money out of the country into a mix of German and American banks. I'd also be stocking up or looking for a job abroad. A foreign job would be best since the drachma will be a pretty weak currency and foreign-earned money will enable some Greeks to pick up cheap housing and cheap failed businesses back in Greece.
Mish has more. Mish thinks since the exit of some Euro currency zone members is inevitable we should move on to discussing how best to do that and which members should leave. He suggests Germany. Very contrary thinking.
German Chancellor Angela Merkel’s Christian Democratic Union party voted to allow euro states to quit the currency area, endorsing the prospect of a move not permitted under euro rules.
Greece's choices at this point are default within the Euro or default outside of the Euro. The problem is that default causes Greek banks to collapse as they are major holders of Greek government debt. The Greek government will have to try to save depositors even as it stiffs lenders. The Greek economy will contract much more once the government defaults and the Greek economy is already contracting this year.
The German government has been simulating a range of scenarios to prepare for a possible exit of Greece from the euro zone. Under a worst-worst-case scenario, the country could descend into a vicious circle of misery that could last decades.
Why are the Germans considering cutting Greece loose? One possibility: To save their powder for trying to save Italy and Spain. Italy is already paying an interest rate on new bond issues that it can't sustain. Anything above 6% is basically unsustainable danger zone. As old bonds get redeemed the higher interest rates on new bonds become too high a cost for a country with debt equal to around 100% of GDP.
Even with the change of government in Italy, a Monday auction of five-year bonds saw the government pay rates of nearly 6.3 percent — the highest since the country adopted the euro and more evidence that the ECB was not moving aggressively to hold down the country’s borrowing costs.
Meanwhile, rising interest rates on French debt threaten to undermine France's ability to participate in bail-outs for the southern European nations.
On Monday, the yield on France’s 10-year bond — the usual yardstick for a country’s borrowing costs — rose 0.05 percentage points to 3.42 percent. That’s nearly twice Germany’s and significantly more than the roughly 2 percent paid on 10-year U.S. Treasury notes.
European governments are trying to prevent widespread bank failures due to bank losses on the Greek sovereign debt they hold.
European Union governments will spend the next six weeks building a financial firewall to protect their fragile banking systems against what is now seen as an inevitable Greek default.
G20 sources said that up to 50% was likely to be wiped from the face value of Greece's €350bn debt – but not until Europe had put into place a war chest to prevent the contagion spreading.
If the contagion spreads then you might want to read up on how to sell apples at street corners or perhaps effective techniques for begging. Plus, get to know where the food banks are located.
France rejected speculation that it was preparing to put up to €15bn (£13bn) into its banking sector despite fears about the impact of losses from Greek debt might have on some of the country's banks – and others across the eurozone.
Maybe the French think the European Central Bank can bail out French banks.
In the absence of other structures, a consensus is emerging that the European Central Bank will have to monetise debt by buying large quantities of Greek bonds to keep banks, especially in France, afloat.
For the past two months, Eurocrats have been talking increasingly confidently about an 'orderly' default within the euro. While the markets might refuse to lend to welshers, the EU could supply the shortfall. In the mean time, Brussels would bail out the banks which had foolishly bought Greek bonds.
Watch interest rates on Italian, Spanish, Portuguese, and Irish bonds if you want to find out whether the markets believe the firewall will work. If interest rates on Italian or Spanish debt go over 6% and stay there then much bigger dominoes are going to fall.
A poll in Greece shows two-thirds want to remain in the Euro zone rather than revert to using the drachma. Will they get their wish?
For the first time ever, a clear majority (60%) of Germans no longer sees any benefits to being part of the Eurozone, given all the risks, according to a poll published September 16 (FAZ, article in German). In the age group 45 to 54, it jumps to 67%. And 66% reject aiding Greece and other heavily indebted countries. Ominously for Chancellor Angela Merkel, 82% believe that her government's crisis management is bad, and 83% complain that they're kept in the dark about the politics of the euro crisis.
The odds of a bailout of the southern European countries seem to be getting worse. At the same time, I expect their financial conditions to worsen as economic growth fails to resume. So the need for a bailout seems likely to grow. Does this mean the end of the Eurozone? Or just a splitting off of some members? Or perhaps the creation of a couple of smaller Euro currencies? Will the Germans bring back the Deutsche Mark while some neighboring countries (e.g. the Netherlands) decide to use it?
Denkverbot: a cool word. You can classify people by whether they support or oppose denkverbot. The denkverbot supporters on a particular subject may cloak their opposition to thinking thru evidence and debating a subject. But their intentions are usually clear enough.
"There cannot be any prohibition to think" just so that the euro can be stabilized, wrote Philipp Rösler, Minister of Economics and Technology, in a commentary published on September 9 (Welt, article in German). "And the orderly default of Greece is part of that," he added. Instantly, all hell broke loose, and Denkverbot (prohibition to think) became a rallying cry against the onslaught of criticism that his remarks engendered.
Once the taboo breaks against seriously considering alternatives to the current Euro zone the debate might spark a large flight of deposits out of banks in heavily indebted countries. Those banks hold lots of sovereign debt. If the southern European governments don't get bailed out then the banks will fail. You can expect to see Greek, Italian, Spanish, and Portuguese banks totter. If they aren't propped up then watch the dominoes fall. The 1931 Credit Anstalt collapse in Austria is the historical precedent most feared by policy makers.
You might think bailout is the right response to a financial crisis that has the potential to cause a big economic downturn. The problem that the Germans correctly sense is that Greece is unlikely to reform if the past pattern up the the present is any indication. Prudent people not under the sway of denkverbot would admit this.
Greece is a chronic defaulter. Since winning independence from the Ottoman Empire in 1832, the nation has spent half its time in various stages of default or restructuring.
Yet various writers keep proclaiming that surely now the Greeks have learned the folly of excess deficit spending. To which I reply: The Americans haven't even learned that lesson.
The idea, which has floated around for months without getting much uptake from European decision-makers, is to scarf up Greece's unaffordable debt on the open market and exchange it for new, more affordable long-term bonds issued by a (presumably) reformed Greek government.
The Euro zone is the creation of idealistic fools. Milton Friedman opposed the Euro founding in 1999 and commented in 2004 that its collapse was "a strong possibility". Given that the Germans have taken positions that make a Greek hard default and even a Portuguese hard default very likely if the Germans intend to eject a few Euro members they had better shift into high gear with preparations to redraw the boundaries of the Euro. The faster done the better. Read that last link. Ambrose Evans-Pritchard of The Daily Telegraph takes a look at the European debt and currency crisis from lots of angles.
The key people behind these moves also agreed that one topic was off the agenda: the possibility of a break-up of the euro and, more immediately, the ejection of Greece, was not to be spoken of in public. Chancellor Merkel warned wayward German MPs to “weigh their words very carefully”. Geithner urged EU policy-makers to avoid “loose talk”. Luxembourg prime minister Jean-Claude Juncker, presiding over the Eurogroup, called for “verbal discipline”, lest saying the wrong thing should trigger “irrational” market responses.
Right now the market is pricing in a big default in Greek debt. Is that what the German leaders have decided on? Sovereign default, prop up some banks, and then keep Greece in the Euro? If that's not their conscious choice then are they stalemated?
The European financial crisis continues to build. A shockingly high number. I can understand a high yield given that the Greeks are going to default. But will principal loss be so high as to justify 88.48% yield? That's a huge number. If I was in Greece I'd get some of my money transferred into northern European banks and perhaps some in a Canadian or Australian bank. Get your money into resource-rich industrialized countries.
Mish also points to Silvio Berlusconi's attempt to cut spending and raise taxes to try to get Italian government interest rates below 6%. Once a country with high debt gets interest rates up in the 5-6% range it is hard to prevent default. The cost of servicing debt becomes too large a fraction of total GDP.
The Germans appear to have decided to let Greece default. Will Greece stay in the Euro zone once that happens? Can the Germans prevent Italy and Spain from defaulting? What's the end game? Sovereign debt default means bank failures. Why we should care: the domino effect. Can a firewall prevent dominoes from falling into northern Europe and then into the United States?
Economic growth is not going to save the southern European countries from default. High oil prices preclude that possibility. Can Italy and Spain cut spending severely enough to avoid default? Taxing their way back to solvency seems hard to do as higher taxes will cut growth even further.
I find the scale of the European debt crisis an amazing thing to behold given the depth of the underlying problems and the potential for spread into other financial markets. In this crisis I look for clues on whether stagnant and eventually declining world oil production will cause slow economic contraction or episodes that parallel the great contraction of 1929-1933. Is slow decline possible? Or will financial market panics cause sharp contractions? The level of debt globally makes the slow decline scenario less likely. Cascading defaults and sudden sharp cutbacks seem more likely.
When "helicopter Ben" Bernanke was trying to prevent another Great Depression back during the global financial crisis in 2008 and 2009 the US Federal Reserve Bank lent large to the biggest banks in America and abroad. Bloomberg News won a court case to find out how ginormous the lending was. The cost of preventing (delaying?) Great Depression II:
The largest borrower, Morgan Stanley (MS), got as much as $107.3 billion, while Citigroup took $99.5 billion and Bank of America $91.4 billion, according to a Bloomberg News compilation of data obtained through Freedom of Information Act requests, months of litigation and an act of Congress.
What I'd like to know: Why the big lending to German, British, and other foreign banks? Couldn't their own central banks bail them out? Or are too many of their loans in dollars?
Even banks that survived the crisis without government capital injections tapped the Fed through programs that promised confidentiality. London-based Barclays Plc (BARC) borrowed $64.9 billion and Frankfurt-based Deutsche Bank AG (DBK) got $66 billion.
$84.5 billion for the Royal Bank of Scotland too.
There's another aspect of this that's interesting: The timeline of the big borrowing. Most people think that the big borrowing started after Lehman collapsed in September 2008. But there's this:
U.S. Federal Reserve borrowings by Societe Generale SA, France's second-biggest bank, peaked at $17.4 billion in May 2008,
Societe Generale was in trouble at the time due to their trader Jerome Kerviel losing $7.2 billion. But why didn't the French government or the European Central Bank lend to Societe Generale? Why did this burden fall on the Fed?
Also, Citibank's TAF (Federal Reserve's Term Auction Facility) borrowing started in December 2007 on the day TAF opened. So the financial crisis really was already playing out in late 2007.
All the above is worth thinking about because we might be heading into another financial crisis. A debate is currently raging about the financial soundness of Bank of America with Henry Blodget (see link) taking a skeptical view of BofA's soundness. Since BofA hides too much about its financial position we can't be sure.
With much greater certainty it is possible to see a big sovereign debt and banking crisis brewing in Europe. a silent bank run in Greece and signs that other southern European banks are getting frozen out of credit markets suggests that at very least the countries of southern Europe, Ireland, and possibly Belgium are at risk of sovereign default, major bank failures that their own governments can not afford to handle, and even exit from the Euro zone. Hard to see how all that can go wrong without at least another recession.
Robert Samuelson says "Why are we in this debt fix? It’s the elderly, stupid." Yet as he points out, cuts for the elderly remain taboo. How much longer will that taboo last?
By now, it’s obvious that we need to rewrite the social contract that, over the past half-century, has transformed the federal government’s main task into transferring income from workers to retirees. In 1960, national defense was the government’s main job; it constituted 52 percent of federal outlays. In 2011 — even with two wars — it is 20 percent and falling. Meanwhile, Social Security, Medicare, Medicaid and other retiree programs constitute roughly half of non-interest federal spending.
The approach of this crisis was easily seen in advance. But due to high commodity costs and the housing bubble the timing was sooner than mainstream debt worriers (e.g. the Concord Coalition) probably expected. The aging population problem is being exacerbated by other things going wrong in the US and other Western economies (e.g. physical limits to growth, too low a rate of innovation, and unfavorable demographic changes) and also by the rise of China and India.
Those entitlements programs mentioned by Samuelson take up over half of US federal spending before the coming doubling of the number of people over age 65. Those spending levels are before medical spending rises a projected 58% more by 2020. With massive deficit and debt already before those things happen it only makes sense that S&P downgraded US sovereign debt from AAA to AA++. (anyone want to predict when it'll hit single A?)
All that debt and unfunded entitlements would become a smaller and more manageable problem if the US economy could grow rapidly. But as Steven Pearlstein points out, since we can't get the economy growing and we've shot our wad already we now face the need to do painful restructurings, just like the PIIGS of Europe.
Unfortunately, we never reached that escape velocity and have now pretty much exhausted our policy ammunition. As a result, we are now going to have to make the rest of those painful structural adjustments — eliminating jobs, closing companies, lowering incomes, reducing government services — in the context of a stagnant economy. And its not just the United States. Similar adjustments will be required in Europe, Japan, China and much of the rest of the world as well.
Since I believe long term growth will stay below post-WWII trend for many years to come I tend to agree with those like Peter Schiff who think federal debt will spiral out of control as tax revenue growth fails to materialize. So the deficit will grow. The debt will grow even faster if the economy goes into a double dip recession.
One of the very big problems we face in this crisis is that our elites do not yet grasp the absolute size and length of it. Signs of economic faltering bring a chorus of calls for QE3 (another round of central bank quantitative easing) as if we just need to prime the pump once again. In the political realm in the fight over the federal budget each side is still trying to close the deficit on their terms without giving up much. Yet both sides of the partisan divide need to give up more than even their opponents demand. Ross Douthat says the liberals have boxed themselves into a place where they find themselves defending middle class entitlements over programs for the poor.
Here American liberalism risks becoming a victim of its own longstanding strategy’s success. Because yesterday’s liberals insisted on making universal programs the costly core of the modern welfare state, on the famous theory that “programs for the poor become poor programs,” today’s liberals find themselves defending those universal (and therefore universally-popular) programs at the expense of every other kind of government spending — including, yes, programs for the poor. It’s a classic example of putting liberal political interests ahead of liberal policy priorities.
Showing a liberal awareness of this conflict Ezra Klein comes out against cuts in discretionary non-security spending. But by citing cuts in highway maintenance as an example of false economy (small potholes are cheaper to fix than big potholes) he tries to imply the obvious falsity that most of the non-security discretionary spending has the same characteristic. He wants that spending for redistribution, not economic efficacy. He ought to say so. Many forms of discretionary spending, for example housing subsidies aren't achieving real savings or wealth generation for the taxpayer. Such subsidies are just transfer payments to the poor which subsidize dysfunction.
Both resource limitations and demographic changes are becoming big weights on economic growth. Even if we inflate away some of our debt (as Ken Rogoff, Scott Sumner and Tyler Cowen all advocate) other fundamental drags on the economy will remain. Growth is not going to save us. Even Rogoff thinks debt deleveraging after a big debt bubble takes 7 years.
If I'm right about the other weights on the economy 7 years until the resumption of normal growth is optimistic. Therefore some of the promises made to all the old folks and other feeders at the public trough can't be honored. Raising the eligibility age for Medicare and Social Security seems inevitable. Also on the list of the inevitable: big cuts in the welfare state for the poor, big cuts in defense spending, and higher taxes.
Since we can't afford our lifestyles and our current size of government we need to find ways to do more with less. I'd love to see more liberals and conservatives think harder about how to do more with less (e.g. automate education and cut the administrative fat which has built up in higher education) and also to think about what's really necessary to do in the first place (e.g. militarily babysit the Middle East?). We live in an age of sharpening limits. We need to start accepting these limits and working more smartly within them.
Investors drove borrowing costs for Italy and Spain to 14-year highs, fueling sharp stock market drops in London, Frankfurt, Paris, Milan and Madrid. Though Italian and Spanish bonds later rebounded, borrowing rates for both nations remained dangerously high, at more than 6 percent — and closing in on the 7 percent threshold that eventually triggered bailout talks with Greece, Ireland and Portugal.
The weak economic recovery this year has made the markets doubt tax revenues will grow fast enough to pay the interest on the large debts of the southern European countries. The amount of debt outstanding today was issued based on rosier expectations for economic growth. Take away economic growth for an extended period of time and the result will be massive defaults.
Since the PIIGS (Portugal, Italy, Ireland, Greece, Spain) owe European banks and even some American banks big bucks sovereign defaults run the risk of triggering bank failures and a freeze-up in the willingness of banks to lend to each other. We could go thru a re-run of the late 2008 financial crisis.
Before we reach an acute crisis stage the European Central Bank might step in and buy up large amounts of Italian and Spanish debt at lower interest rates. But that's just kicking the can down the road if robust economic growth does not come back. Since I expect Peak Oil to weigh down Western economies I do not expect we will see a return to fast economic growth. Rather I expect the choice faced by central banks is between high inflation or many more sovereign defaults, bank failures, and future financial panics.
What is still not clear: do our financial problems indicate that we are nearing the end of empire?
For some types of debt the problem with having lots of it is that interest on the debt can go up. Currently the US government can manage to service its enormous and growing debts because interest rates are so low. But what if interest rates turn back up? Lawrence B. Lindsey, a former US Federal Reserve governor, says, if interest rates go back up to levels seen on average over the last couple of decades then the US federal deficit will swell by hundreds of billions per year.
First, a normalization of interest rates would upend any budgetary deal if and when one should occur. At present, the average cost of Treasury borrowing is 2.5%. The average over the last two decades was 5.7%. Should we ramp up to the higher number, annual interest expenses would be roughly $420 billion higher in 2014 and $700 billion higher in 2020.
By running up large deficits even before the bulk of the baby boomers retire Congress and Presidents Bush and Obama have put the US government in a tenuous financial condition. Interest payments are already set to soar. A spike in interest rates could cause a sovereign debt crisis.
Against a background of growing debt, large deficits as far as the eye can see, and a very weak economic recovery we are beginning to see serious proposals to cut entitlements programs. After decades of their unchallenged growth finally we are nearing limits. Representative Paul Ryan wants to turn Medicare into an insurance voucher program. As an alternative Senators Joseph Lieberman and Tom Coburn want to raise Medicare eligibility age to 67 years old. Jennifer Rubin argues only the left wing of the Democratic Party denies current entitlements are unsustainable.
Congress might still duck responsibility for years. But the interest rate risk described by Lindsey could materialize if we continue to see weak economic growth. Deficits will widen and the market will grow nervous about US government debt. I see continued weak economic growth due to peak oil, limited other natural resources, and demographic changes.
The problem is even bigger than the mainstream discussion recognizes because a return to business as usual economic growth rates is still assumed in mainstream models of future program costs and tax revenues. Therefore for your own personal life planning expect to need to work years longer than current retirees did. Raising retirement ages, means-based eligibility testing, cuts in benefits, and higher taxes will all be used as policies to fund entitlements. So even once you retire at a later date you'll be faced with higher out-of-pocket costs.
Given the US government's $61.6 trillion in unfunded liabilities one naturally wonders how the US government will deal with mounting debts and rising demands on its tax revenues. Higher taxes? Huge cuts in benefits? Or high inflation? Given the popular opposition to both higher taxes and less benefits hyperinflation begins to look plausible. The willingness of Ben Bernanke and the US Federal Reserve to resort to "quantitative easing" (create cash out of thin air and use it to buy hundreds of billions of debt) seems to show some willingness to opt for inflation as a policy tool. Some commentators call for inflation to allow escape from debt. So is hyperinflation in the cards?
Please note that banks do not want hyperinflation or even massive inflation. The reason is simple: Banks will not want to be paid back with cheaper dollars, especially worthless dollars, and Congress is beholden to itself and the banks.
Hyperinflation could theoretically come from massive sustained political will to bail out the little guy at the expense of the banks, the wealthy, and the political class. However, unlike Mugabe and Zimbabwe, neither the banks nor the Fed nor the political class wants to bail out the poor at the expense of the wealthy.
Indeed, Bernanke's, Paulson's, and Geithner's actions to date have done the exact opposite!
We have bailed out the banks at the expense of the ordinary taxpayer (keeping the little guy in debt).
This is what it comes down to: In theory, Congress can easily cause hyperinflation. In practice, they won't, and neither will the Fed. As Yogi Berra once quipped "In theory there is no difference between theory and practice. In practice, there is."
So does big money oppose hyperinflation? I am uncertain and welcome any insights into how the balance of interests will develop with regard to inflation. I see the US government's financial situation as more dire than mainstream projections would lead one to expect. Peak Oil is near and will prevent the economic growth needed to pay off debts and entitlements promises. So the pressure to escape financial obligations will grow much larger. How will that pressure be relieved?
In some nations (e.g. Argentina) the financial balance of power within government is still too weak against inflation. In Argentina the government flagrantly lies about the inflation rate.
The government’s official 10.9 percent inflation rate is less than half the estimate of private economists and firms like Ecolatina, which put inflation at 26.6 percent in a report last month. The official 12 percent number for poverty is also well below independent estimates of about 30 percent.
All nine Argentine economy watchers dinged with hefty fines of about $120,000 (U.S.) apiece said inflation is well above official estimates.
John Williams of ShadowStats on his web site publishes results from older methods the US government used to use to measure of inflation and he argues the US government is under-reporting inflation. Williams is predicting hyperinflationary depression. Is he right? Or will we have a deflationary depression as Nicole Foss (Stoneleigh) predicts?
Update: Ron Paul expects default by loss of value in the currency. i.e. inflation.
Al Hunt: Your speaker John Boehner says he will absolutely insist on a dollar of spending reduction for every dollar the debt ceiling goes up. Do you take that seriously?
Ron Paul: I don't take that seriously. President Reagan wanted 2 dollars of cuts. The deficit exploded. Do you think the American people will believe that we are going to cut in the future? The only budget that counts is this year. 10-year programs are pie-in-the-sky talking. This year our obligations are 5 trillion dollars.
Al Hunt: The idea of a spending cap that takes place in 10 years does not appeal to you?
Ron Paul: A 10-year spending cap is too little, too late. No one is going to believe it. All governments when they get this far into debt, default. They don't default by not paying the bills. We will always pay the bills. The default comes from the devaluation of the currency.
If you do not think inflation will become a major tool for the US government to escape from debt then how else do you think the US government will deal with the problem? High taxes? Huge slashes thru spending programs? The size of the needed adjustment is unavoidably very large. But what form will it take? This question going to be one of the biggest political battles of the next 20 years.
Medicare will exhaust its trust fund 5 years sooner than projected last year. My advice: save money for your retirement medical costs.
Today, the Medicare trustees issued their annual assessment of the government insurance program’s fiscal health. The prognosis: the trust fund (covering hospital stays) will be exhausted in 2024, as the WSJ reports. That’s five years earlier than they predicted last year; the sluggish economy has led to lower payroll taxes, but health costs keep going up.
Think about that. Over the course of a single year the Medicare trustees pulled in the bankruptcy date for Medicare by 5 years. Imagine (as seems likely) economic growth does not return with vigor over the next 10 years. The system assumes and depends upon vigorous growth. The argument for running up huge deficits for Keynesian fiscal stimulus during the current downturn is that the spending would bring back growth and thereby pay for itself in the long run. But if that return to Business As Usual (BAU) fails to materialize then the debts taken on in recent years will crush our standards of living and sorely tempt the US government to inflate away federal debts.
Last year the Medicare trustees changed their projected bankruptcy date for Medicare by pushing it out 12 years into the future. They did this on the theory that the Obama medical insurance legislation would greatly slow the growth in Medicare spending. Well, that was never realistic. So now the are readjusting back toward reality Not a full adjustment so far. But in future years Medicare will come up with more revisions on who gets what and when.
Harvard economist Kenneth Rogoff says high levels of debt slow economic growth. That puts us in even worse shape.
Q: What's the risk in the U.S. having so much debt? Other countries, like Japan, have larger debt burdens.
A: It doesn't automatically cause a crisis, but it certainly weighs on the recovery. Very roughly speaking, when a country has public debt over 90 percent of income, growth is about 1 percent lower for a very long time.
Slower growth means less taxes collected and an even earlier bankruptcy of Medicare.
Crisis with approaching problems is the new normal. You can not expect efficacy from the US federal government as the crisis intensifies. Save more for your own retirement and expect higher taxes.
Reading a Wall Street Journal article about why Portugal isn't going to be able to grow its way out of being deeply in debt and the incredibly low rate of high school graduations leaps out.
Just 28% of the Portuguese population between 25 and 64 has completed high school. The figure is 85% in Germany, 91% in the Czech Republic and 89% in the U.S.
Anyone understand Portugal much? National IQ does not appear to be low enough to explain it.
The article puts the current drop-out rate as only at 37%. That's a lower drop-out rate than Hispanics in America. So the US is on course to have a higher overall drop-out rate than Portugal as whites fade as a percentage of the US population.
LONDON — As Europe struggles to come to grips with its debt crisis, which has deepened with the collapse of Portugal’s government after it pushed for yet another round of budget cuts, three numbers stand out: 12.4, 9.8 and 7.8.
Those are the interest rates currently paid on 10-year government bonds for Greece, Ireland and Portugal.
While Germany pays just 3.24% on 10 year bonds Greece pays 4% on money lent by the EU and that is still too high given the state of the Greek economy.
Greece, for its part, has already secured more favorable terms for its EU loans. The country is now paying 4 percent interest on the billions in aid it has received. Nevertheless, tax revenues are shrinking -- by close to 10 percent in January and February -- and it will be extremely difficult for the government to continue to operate without even further austerity measures. Many expect that Greece will ultimately have to restructure its debts.
Since I expect another oil price spike to push the world economy back into recession in a year or two the idea that economic growth can solve these sovereign debt problems does not seem credible. Restructuring with haircuts for bond holders seems inevitable.
But a new report from the Little Hoover Commission in Sacramento makes a more troubling point: Many state and local government employees have been promised pensions that the public couldn't have afforded even had there been no crash.
The public employee unions managed to bribe politicians to get these pensions. The mistake is up there with the Iraq war in terms of great US national policy mistakes. Still not in the same league as the massive mistakes made in the last 45 years of immigration policy. But state and local governments are increasingly going to serve their retirees more than their citizens.
The Democratic Party basically made a pact with the devil: In exchange for getting mandatory union member membership fees funneled into Demo campaign funds the Demo politicians voted to put the interests of state employees far ahead of the interests of the larger public.
But the report argues that political factors have been at least as important in driving up costs, starting with the Legislature's move in 1999 to reduce the retirement age for public workers, base pensions on a higher percentage of a worker's salary and increase benefits retroactively. The increases authorized by Sacramento soon spread across the 85 public pension plans in California.
Compounding the problem, the state has increased its workforce almost 40% since the pension formula was changed and boosted the average state worker's wages by 50%. Local governments, meanwhile, raised their average salaries by 60%. Much of the growth came in the ranks of police and firefighters, who increased significantly in number and in pay.
Fat city. But now we are well into the phase of costly consequences. Government debts have gotten too big to keep kicking the ball down the road.
The daunting tower of national, state and local debt in the United States will reach a level this year unmatched just after World War II and already exceeds the size of the entire economy, according to government estimates.
The Tea Party-led rebellion against government employee unions is an absolutely necessary (but insufficient) corrective. Wisconsin Governor Scott Walker has to massively cut down the power of the unions as a defensive measure for the public.
Nationally, Walker's efforts to break the power of public service unions - being replicated to some degree in several other Republican-led states - have thrown public employee unions into an existential crisis.
Crashing some of the public employee unions is a deserved outcome for the damage they've caused. Gutting their power to bribe the Democrats would result in much more fiscally responsible and frugal government. We'd get higher quality services at lower cost and bloat would be easier to cut.
This is "an assault on unions," said President Barack Obama of Gov. Walker's plan.
That's true. But Franklin Delano Roosevelt, the president most favorable to industrial trade unions, would have stood with Mr. Walker.
"Meticulous attention should be paid to the special relations and obligations of public servants to the public itself," FDR said in 1937. "The process of collective bargaining, as usually understood, cannot be transplanted into the public service."
When you hear official estimates of underfunded pension funds keep in mind their books are somewhat cooked. So their real problems are much bigger than they officially claim. The states use unrealistic future stock market returns to avoid admitting the size of their unfunded liabilities.
The Pew Center on the States finds that the US states have $1 trillion in unfunded pension and health care liabilities. The states are in worse shape than they officially state because they assume ludicrous rates of return on their investments. The lowest assumed annual return rate is 7.25% for North Carolina and South Carolina. The highest at 8.5% is used by 5 states (CO, CT, IL, MN, NH). This is delusional. Click thru on that link to figure out whether you need to plan to move to another state.
The interview with Chanos is worth reading for his comments about proper uses of credit default swaps.
2/16/2011 - Associate Professor Joshua Rauh testified before members of the U.S. House Judiciary Committee Feb. 14 on the role of public employee pensions and the risk of state bankruptcy from these underfunded liabilities.
Based on his research, Rauh predicts that without basic reform to the current pension system, many large state pension funds will run dry, even if they achieve predicted 8 percent annual returns. Rauh estimates taxpayers will bear a large share of the financial burden of the $3 trillion in unfunded legacy liabilities associated with state pension plans.
Even a very successful gutting of union power by Republican governors and legislatures would still leave at least $1 trillion in unfunded liabilities. Throw in Peak Oil and I expect the problem to be much worse. We face something worse than a zero sum struggle for money over the next 10-15 years. Economic growth has in the past allowed politicians to pay back bribes and votes from assorted groups. But we are now in an era where elected officials will have to cut cut cut. The cutting we are witnessing at the state and local level will eventually happen at the federal level too. Though the US federal government and other governments with their own central banks will probably opt for some inflation to cut down at least a portion of their liabilities.
Our problem is that collective expectations and promises far exceed future wealth. Expect lots of wails and conflicts as expectations and reality continue to collide.
Interest payments on the national debt will quadruple in the next decade and every man, woman and child in the United States will be paying more than $2,500 a year to cover for the nation's past profligacy, according to figures in President Obama's new budget plan.
If you are among the ranks of net taxpayers (paying the government more than you get back) then your cost for servicing the debt will be much higher than $2500 per year. Higher earners will have to pay for most of the debt interest. Expect higher taxes.
That $2,500 of interest per resident (not just citizens) is most likely on the low side. Mainstream economic models of future US economic growth are still too optimistic. There's still the assumption of a return of "normal" growth rates. It will take some more years of economic growth that is below the growth rate of the last hundred years before economists fully accept that fundamentals have changed in ways that lower potential growth rates. So disastrous projections of future government deficits and interest payments still are unrealistically optimistic.
Ken Rogoff gets that we are not growing fast enough. Without high economic growth governments can not pay what they've promised their growing elderly populations.
"We're running a gigantic deficit, and we're not growing very fast," said Kenneth Rogoff, an economics professor at Harvard University and former chief economist at the International Monetary Fund. "We're on a dramatically unsustainable path."
That we are in an extended period of slow growth is beginning to sink in with some economists. I encourage you to read Tyler Cowen's new Kindle book (a mere $4) The Great Stagnation: How America Ate All The Low-Hanging Fruit of Modern History,Got Sick, and Will (Eventually) Feel Better. Tyler says the rate of innovation is too slow to enable fast economic growth. The fundamental innovations (e.g. the discovery of the transistor) are not happening often enough. So too much of our innovations come from refining technologies. There are diminishing rates of return from refinement. Economic growth suffers.
I think our prospects for economic growth are even worse than Tyler foresees. Our demographics are deteriorating. On top of that, I expect Peak Oil will cause an extended period of outright economic contraction. Replace economic growth with contraction and government deficits balloon out of sight and interest payments soar. That's the prospect we face.
Much like Ireland, Greece, and other basket case European countries the US faces a considerable risk of hitting a breaking point where the accumulated debt causes investors to dump sovereign debt as too risky. Then a vicious cycle will set in where interest rates soar, making debt service cost more than government services. The US government will be tempted to use hyperinflation to inflate away the debt mountain.
Update: How can we reach the disaster point? What would do it: Another recession while the US deficit is already huge going in. That's not as far off as it might seem. A big oil price spike will push the US economy back into recession. We are closer to recession-causing high oil prices than it seems when watching US financial news reports on oil prices. The widely quoted West Texas Intermediate crude oil price in Cushing Oklahoma is much lower than the average global price of oil.
The spread between West Texas Intermediate crude oil for delivery at Cushing, Oklahoma and comparable oil for delivery almost anywhere else in the world has surged to record levels. The discount of WTI to Brent hit a previously unfathomable $18.50 a barrel as Brent crude traded at $103.93 per barrel, up $2.29, while NYMEX WTI traded at $85.43, up only $1.11 a barrel. (WTI has historically sold at a dollar or two premium to Brent, which is a slightly heavier and more sour blend.) Clearly there is a supply/demand imbalance at Cushing, Oklahoma not replicated elsewhere in the world, and specifically not replicated anywhere you can just put oil in a tanker and send it to China.
Increased flows from Canadian tar sands and the Bakken shale fields in the northern Great Plains have sent oil flooding into Cushing, Okla., where the WTI crude contract is priced. But because pipelines are set to run into Cushing, not out, much of that oil is going into storage rather than into refineries. Oil stockpiles in Cushing hit their highest level in seven years last month.
The glut has disconnected the widely quoted WTI market from a sobering energy market reality. "Cushing isn't worth looking at," says Steve Kopits of energy forecaster Douglas Westwood in New York.
The US government (and other Western and East Asian governments) will not be able to afford fiscal stimulus in the next recession. We will go into the next recession with much higher deficits, much higher debt, and much higher unemployment rates. In the next recession governments will cut spending, not increase it.
Even so, Medicare’s spending on physician services per beneficiary rose 61 percent, an average annual compound rate of 5.4 percent a year.
The difference between the tiny increases in physician fees and the large increase in spending on physician services reflected, of course, a sizable increase in the volume of physician services per Medicare beneficiary. It grew by 46 percent over the period, at an average annual compound rate of 4.3 percent a year.
Take that government-funded Medicare spending per person going up faster than inflation and add in a rapidly aging population. We can not afford this.
About 13 percent of the population today is 65 or older; by 2030, when the last of the baby boomers are 65, that rate will have grown to 18 percent. In addition to testing the sustainability of entitlement programs like Social Security, this wholesale redefinition of old age may also include a pervading sense that life has been what might technically be called a “bummer.”
The US government deficit is already beyond the Bernholz warning limit on fraction of spending funded by debt. Historically, countries that breach this limit suffer from hyperinflation.
In his famous book, Monetary Regimes and Inflation: History, Economic and Political Relationships, Bernholz demonstrated that hyperinflations resulted whenever 40 per cent or more of government expenditures were financed by money creation (resort to the printing press). In 2009, approximately 42 per cent of US government expenditures were financed by some form of credit. So the prospect of hyperinflation, however remote that may appear to be at the present time, cannot be ignored.
We aren't going to soon do a combination of large tax increases and large spending cuts to bring sanity to the US government's books. The best bet is on continued massive fiscal irresponsibility. We are not even lucky enough for this to be the only thing going wrong on an epic scale in America.
Imagine you were on the bridge of the Titanic and an iceberg was spotted with enough time to avoid it. But the captain, crew, and passengers said "It will cause us too many inconveniences to change course and our ship can plow right thru that iceberg and keep going". That's America.
In order for the European Union's common currency area to survive it must become even to a greater extent a Euro Transfer Union (ETU) that takes from the rich countries and gives to the poor countries. But there is a limit to how far the wealthier countries will go. So will the ETU break down?
In the long run, taxpayers in the wealthier countries may balk, said Jörg Krämer, the chief economist at Commerzbank in Frankfurt.
“In the beginning people may say that a transfer union is a price you have to pay so that the euro survives,” Mr. Krämer said. “Fine. But the perceived costs of a transfer union may go up over time. There may be a time when the voters say, ‘We don’t want this.’ ”
I expect Peak Oil to put too large a strain on the ETU and force at least a partial break-up. Check out PIIGS bond spreads over Germany. The market it starting to build up for the next phase of the crisis.
Looking at the future of the Euro Simon Johnson basically says more ETU is the next step.
Step 1: Agree on greater fiscal integration for a core set of countries. This will not be full fiscal union but some greater sharing of responsibilities for each other’s debts. There is much room for ambiguity in government accounting and great guile at the top of the European political elite, so do not expect something completely clear to emerge.
But Germany will end up underwriting more liabilities for the European core; its opposition Social Democratic Party and the Greens are pushing Chancellor Angela Merkel in this direction, calling her “un-European.”
But Johnson's third step has Greece falling out of the Euro zone, possibly along with Portugal or Ireland. He can't rule out Spain or Italy either. I repeat: Peak Oil will amp up the size of the bad debts and cut the revenue flows to fund them. So some countries will get ejected from or run away from the Euro.
Johnson then says something scary but it sounds right to me: Then comes the American government, burdened by massive debts, under attack by the financial markets.
And when the financial markets are done with Europe, they will come to test the fiscal resolve of the United States. All the indications so far are that our politicians will struggle to get ahead of financial market pressure.
We will not get the fiscal sobriety needed to save us. The 2010s are going to be a long running series of financial crises.
Megan McArdle suspects both political parties will not face up to the need to balance the budget until the system reaches a crisis. (my bold emphasis added)
I assume that at some level, Republicans understand that cutting taxes will make it that much more wrenching when we finally have to cut the deficit. I assume that at some level, Democrats knew that passing the health care bill would make it harder to balance the budget, because we used up the easiest, most obvious tax increases and spending cuts on expanding health care coverage, instead of using them to bring revenues and spending into roughly the same ballpark. But I think they view this as a way to improve their initial position in the final showdown, meaning that overall, we'll end up with [lower taxes/higher spending] than we would if they just left well enough alone.Despite Ross Douthat's optimism, I am very much afraid that this we are headed for a terrible crash. Game theorists tell us that the way to win a game of chicken is to make a highly credible committment: rip off the steering wheel, and throw it out the window. They do not tell us what to do once you have thrown it--only to realize, in horror, that the guy in the other car has just done the same thing.
I hold this view as well. Watching state-level fiscal crises get far worse than I originally expected (not just California - but also Illinois, New Jersey, and others) I no longer think the center is big enough or either party dominant enough to force thru a compromise. At the federal level we will have to reach a point where the markets begin to price US debt as highly risky before both big spending cuts and big tax increases become feasible. Absent need to stop a panic I do not expect anything resembling fiscal sobriety. An irrational faith in American exceptionalism has combined with political divisions to make it impossible to admit to our limits.
This paper examines the growth of government during this century as a result of giving women the right to vote. Using cross-sectional time-series data for 1870–1940, we examine state government expenditures and revenue as well as voting by U.S. House and Senate state delegations and the passage of a wide range of different state laws. Suffrage coincided with immediate increases in state government expenditures and revenue and more liberal voting patterns for federal representatives, and these effects continued growing over time as more women took advantage of the franchise. Contrary to many recent suggestions, the gender gap is not something that has arisen since the 1970s, and it helps explain why American government started growing when it did.
The welfare state that women vote for feeds the rise in divorces. Women initiate most (somewhere between two thirds and three quarters) of all divorces. They'd be far less likely to file for divorce if the state did not help them out with social programs. So more social programs lead to more divorce which translates into more support for social programs. Meanwhile, the married people and the singles without children pay more taxes to support those with unstable relationships. Part of the stand-off between tax increasers and spending cutters is a fight over marriage and social obligations. I am on the side of spending cutters because I do not want to pay to raise the children of others.2010 December 26 SundayNY Times On Deeply Indebted States
The editors of the Gray Lady take note of the perilous condition of Illinois state finances and the big debts of some other states.
For most of this year, the state of Illinois has lacked the money to pay its bills. Some of its employees have been evicted from their offices for nonpayment of rent, social service groups have laid off hundreds of workers while waiting for checks, pharmacies have closed for lack of Medicaid payments. Faced with $4.5 billion in overdue payments, Illinois has proposed a precarious plan to sell its delinquent bills to Wall Street investors in exchange for cash, calculating that the interest it must pay the investors will be less than the late fees it owes.
Attempts to push the reckoning off have not succeeded. The future is here.
But that future is not so distant, and the crushing debt has made recovery far more difficult to achieve. As The Times reported, Illinois, California and several other states are at increasing risk of being the first states to default since the 1930s. The city of Prichard, Ala., has stopped sending out its pension checks, breaking state law and shocking its employees.
The Times editors predictably argue for higher state taxes and more federal aid to the states. But the states need to learn to get by on much less. High oil prices are on course to go higher still until they trigger the next recession. The states need to adjust now to a poorer future. Business As Usual is not in the cards.
You might wonder how could not just California, but Illinois and New Jersey get into far more dire straits than they acknowledge (the numbers at that link are incredible btw). To understand these failures of governance what's needed is an unromanticized view of democracy such as is found in Bryan Caplan's The Myth of the Rational Voter: Why Democracies Choose Bad Policies. I say blame the ignorant, uninterested, not sufficiently intelligent voters. Okay, now what?
We need bigger cuts in spending. But cuts and even tax increases probably won't be enough when Peak Oil causes the next recession. Debt holders and especially government retirees are going to have to take haircuts. I am firmly with those who argue that Euro states and American states need legal structures for bankruptcy so that they can go bankrupt with a minimum of resulting chaos.
Update: Here's a list of US cities running big budget deficits. Stay away from them. Some are cutting police staffing in a big way.
Update: Mish Shedlock is doing a great job blogging on the government debt disaster. For example, see his post Pensions Eat 70% of Decatur, Illinois' Budget; New York City's $76 Billion Shortfall; Houston Mayor Wants Pension Benefit Cuts. The Decatur, Illinois budget shows where other cities and states are headed.2010 December 24 FridayElena Carletti: Fast Euro Default Mechanism Needed
Elena Carletti, a professor of economics at the European University Institute in Florence, Italy, says sovereign defaults need to be set up so they can occur very quickly.
A sovereign default would need to be done very quickly, otherwise it would trigger enormous capital flows in the euro area from countries perceived to be weak to those seen as strong, such as Germany.
Of course, the biggest problem with this quite reasonable suggestion is that the Euro mandarins do not want to admit the high probability of eventual sovereign default. So they won't act fast enough now, before the acute severe crisis is upon us, to set up all the mechanisms needed for a lightning fast default.
The same holds with a country exiting from the Euro currency union. It has to be done fast. But that means governments, banks, and businesses need to be set up to handle the transition.
There is an alternative to sovereign default in the euro area: A country could simply leave the currency union, possibly temporarily. This would also need to be done quickly to avoid massive capital outflows.
Think of all the back office accounting systems that would need to know about a new currency distinct from the Euro. Think of all the businesses that do Euro transactions in from their home bases in Greece or Ireland or Italy both in their home country (where the currency would change) and abroad (where the currency would remain the Euro. They'd suddenly need to start doing their local payroll and utilities and local services in a new currency while doing some of their business transactions in Euros. The accounting costs and frictions would be high. An article in The Economist also argues for the need for a rapid transition when reinstating an old currency.
I do not expect the Euro zone countries to be saved from default by economic growth. If the price of oil continues its ascent then we'll head back into recession long before indebtedness begins to shrink and government deficits will hit levels that will guarantee default.
The United States faces a similar need for a default mechanism (without the need for a way to exit the US dollar) due to the financial troubles of states like Illinois and California. Massive unfunded government employee retirement liabilities and other costs make the eventual need for bankruptcy a real possibility. Reihan Salam points to a a recent piece by David Skeel on the need for a national law on state-level bankruptcy. Given the precedent of long established law for municipal bankruptcy it should not be hard to come up with an equivalent for states.
One can imagine something like a liquidation sale for cities and even states. Indeed, in the early 1990s, professors Michael McConnell and Randal Picker proposed that Congress amend the existing municipal bankruptcy chapter to allow just that. They argued that many of a city’s commercial, nongovernmental properties could be sold in a municipal bankruptcy, and the proceeds simply distributed to creditors. (They also suggested that municipal boundaries could be dissolved, with a bankrupt city being absorbed by the surrounding county.) Although California has taken small steps in this direction on its own—it recently contracted to sell the San Francisco Civic Center and other public buildings to a Texas investment company for $2.33 billion—it seems unlikely that Congress would give bankruptcy judges the power to compel sales in bankruptcy. Nor could it do so with respect to any property that serves a public purpose. Liquidation simply isn’t a realistic option for a city or state. (The same limitation applies to nation-states like Ireland and Greece, whose financial travails have reinvigorated debate about whether there should be a bankruptcy-like international framework for countries.)
Again, it is better to create a legal framework before a crisis reaches an acute stage. Skeel and Reihan think it cruciall to get this reform enacted before the US government decides to start bailing out states. But after Skeel points out the need for bankruptcies to enable rewriting of union contracts Reihan points out why passing this law will be so difficult:
Simply put, this is the reason why bankruptcy for states is so vitally important, and why it will prove an extremely tough political fight. State governments need to be given the option of preserving core public services even if it means forcing creditors to take a haircut and forcing public sector employees to accept the kind of retiree health benefits and pensions offered to comparable workers in the private sector.
Even with the Republicans in control of the House I give such a reform poor odds of passing. But I'm a little more optimistic that the US government won't bail out states. First off, California is so not a Republican state any more that Republicans in Congress will oppose a bail-out. Also, when the big federal fiscal crunch reaches a crisis stage in a few years (helped along by rising oil prices which will bring on another recession) the federal government will not have the money to bail out states. It'll be every government for itself. Then the states will do battle with their public employee unions.
Update Mish Shedlock says the state pension funds of New Jersey, California, and other states are in far worse shape than reported. He's right. These pension funds assume unrealistically high rates of return for their investments. They need high rates of economic growth that probably aren't in store. The fiscal crack-ups that are coming are epic in scope.2010 November 24 WednesdayBut Who Caused Irish Financial Crisis?
Punish the Irish for their profligate ways? Stick them with IMF supervision and harsh austerity measures? That appears to be the way things are heading. But how about a reality check? Ireland's banks are going to get bailed out by Irish taxpayers for years to come (and many Euro country banks will benefit).
Ireland is still negotiating the terms of the bailout with European Central Bank and IMF experts. It hopes the tough budgetary medicine will permit its 2014 deficit to fall to 3 percent of gross domestic product, the limit for the 16 nations that use the euro currency.
While most eurozone members are violating that rule, Ireland's deficit this year is forecast to reach 32 percent, a modern European record, fueled by exceptional costs from Ireland's unfathomable bank-bailout effort.
Here's what I want to know: Why didn't the Irish government let its banks fail and for the non-depositor creditors of those banks (mostly other European banks) take a bath on their credits? Ireland's property bubble was fueled by loans flowing into it from reckless banks of other countries. Why weren't these banks made to pay for their foolishness?
The view that Ireland was a spendthrift country just like Greece knocks up against the fact that in Greece it was the government borrowing and spending like mad. Whereas in Ireland it was the banks which lent like mad. So posturing by, say, Germany demanding greater fiscal responsibility from Ireland really misleads on the causes of the crisis. Why wasn't the German government (and other Euro governments) preventing their banks from lending so recklessly to Irish banks? Lenders should be responsible for their recklessness. Making the Irish people pay the vast bulk of the bill for mistakes of both Irish and non-Irish banks seems morally wrong. Lending is a risk. That's why the interest rate on commercial loans is higher than the cost of money for very low risk borrowers such as the German government.
There has been a quiet exodus of billions from Ireland in recent weeks. Most international investors were no longer willing to lend Irish banks as much as a cent. The Irish banks repaid €55 billion ($75 billion) to their international creditors, mainly German, French and British banks, because the corresponding bonds had matured. But those creditors took the money and fled from the country. Only government-owned banks were still willing to lend money.
Estimates of lending from non-Irish banks to Irish banks cover a wide range. Here's an estimate of $170 billion. But keep in mind that some non-Irish banks have already managed to get paid back with the debts shifting onto the ECB and Irish taxpayers. Is that fair? No.
Even without the CDS loss multiplier, the impact of debt haircuts would be painful for British and international banks. According to the Bank for International Settlements, total lending of non-Irish banks to Irish banks is around $170bn, of which British banks provided $42bn, German banks provided $46bn, US banks $25bn and French banks $21bn.
French banks had lent $493 billion to Spain, Greece, Portugal and Ireland by the end of 2009 while German banks had lent $465 billion, according to the report by the Bank for International Settlements, an institution based in Basel, Switzerland, that acts as a clearing house for the world’s central bank.
All told, Spain, Ireland, Portugal and Greece owe nearly $1.6 trillion to banks in the 16-country euro zone, either in the form of government debt or credit to companies and individuals in the four countries, the report said. Credit from French and German banks accounted for 61 percent of that total.
The German banks put themselves at considerable risk by lending so much to the Irish. The German banks were enablers of the Irish property bubble.
SPIEGEL ONLINE: According to Germany's central bank, the Bundesbank, German banks are Ireland's biggest creditors, to the tune of €166 billion ($226 billion), and that includes hundreds of short-term loans to Irish banks. How dangerous is the Irish crisis for Germany?
Bofinger: The situation is very dangerous. The German government has a vital interest in ensuring the solvency of the Irish state and its banks.
Update: Simon Johnson says Ireland's debt is even bigger than it looks.
To be clear, Ireland owes a huge amount of money to the outside world. In the best scenario, Ireland’s government debt is likely to stabilize at more than 100 percent of gross national product, or G.N.P.; in the worst scenario, with greater real estate losses and a deeper recession, this level could reach 150 percent.
That’s a higher number than you see in many news reports, in part because officials are still focused on gross domestic product, a misleading statistic in the Irish case, as Peter Boone and I have been arguing in this space for some time.
Come Peak Oil several Euro states will default on their debt and the Euro zone will break up. Will a smaller Euro zone survive?2010 November 20 SaturdayEconomic Growth Essential For Balanced Budgets
Since the rate of economic growth has a huge impact in the sizes of government deficits I am expecting big deficits until either sovereign default or stealth default by inflation.
If the economy grew one half of a percentage point faster than forecast each year over the next two decades — no easy feat, to be fair — the country would have to do roughly 40 to 50 percent less deficit-cutting than it now appears, based on my reading of budget data from the economists Alan Auerbach and William Gale.
To get a concrete sense for what this would mean, you can play around with the The Times’s online deficit puzzle. It asks you to find almost $1.4 trillion in annual spending cuts and tax increases by the year 2030. If growth were a half point faster than expected, the needed savings would instead drop to less than $700 billion. That would mean many fewer painful choices, be they tax increases or Medicare cuts.
These results illustrate the US government's desperate need for economic growth. The economists assume economic growth and within that Business As Usual framework they examine the effects of different rates of economic growth. But what happens if the expected growth does not happen?
Suppose growth is 0.5% less than mainstream economists expect. Likely the deficit would grow about $700 billion bigger by 2030. That's just from lower growth. Imagine instead what sustained economic stagnation - same total GDP from one year to the next - would do to US government finances (to say nothing of states and localities). The rising costs of a larger retired population combined with a rising segment of poor people would necessitate severe cuts in retirement benefits, raised retirement ages, cuts in defense, cuts in spending on poor people, education, road maintenance, and in many other government programs.
But I expect something far worse. Starting some time in the next 5 years imagine that that the US economy (along with most of the rest of the world) starts shrinking every year for at least 10 years. Tax revenues would decline even more rapidly than the economy (especially since revenues from taxing profits would plummet is profits evaporated and many corporations filed for bankruptcy). At the same time, the number of poor people asking for government help would soar, large numbers of banks would fail with huge deposit insurance costs on national governments, and returns on government and private pension plans would go negative, forcing benefits cuts. Either the US government and other Western governments would default or they would jack up inflation to do a stealth default via inflation.
So why will the US economy shrink? Primarily the peak in world oil production. See The Impending World Energy Mess by Robert L. Hirsch, Roger H. Bezdek, and Robert M. Wendling and Hubbert's Peak: The Impending World Oil Shortage by Kenneth Deffeyes. Even before the peak production is growing so slowly that oil prices are staying high even during a recession with about 10% unemployment. World oil production is about where it was in 2005 or 2006 but with more demand from India and China displacing oil consumption by Americans and other Western developed populations.
My expectation is that once governments give up hope in the resumption of normal economic growth the threat of inflation will become very real. It is not QE 2 (the recent Quantitative Easing round 2 by the Federal Reserve) that will cause inflation. It will be the money supply expansion that the Fed will be pressured into doing once a sovereign debt crisis grips the US (and the UK and assorted Euro countries) with no relief in sight. Central banks could buy sovereign debt once the markets become unwilling to do so and deficits soar even higher than they are today. Since the highest levels of US national security circles show every indication of being Peak Oil aware my guess is they've already thought about inflation as a tool for dealing with it. I'd really like to know what they have concluded.
John Dickerson points out that the US population is very uneager to cut the size of government. They want lower taxes but higher spending. This is a recipe for continued profligacy. The American people are not responsible citizens as a group.
People aren't desperate to go on a diet, so they're not willing to embrace any plans to shrink the buffet. According to a recent NBC poll, 70 percent of Americans say they would rather not cut programs like Medicare, Social Security, and defense. Fifty-seven percent said they were uncomfortable with increasing the Social Security retirement age to 69 over the next 60 years. A recent CNN poll showed that people are extremely reluctant to cut any big areas of the federal budget. Faced with the choice of cutting a program to reduce the deficit or protecting the program from cuts, 79 percent opposed cuts to Medicare, and 69 percent wanted to protect Medicaid. On Social Security, the equivalent figure was 78 percent. Sixty percent or more favored protecting aid to farmers, college loans, and unemployment assistance. The country is split evenly on cutting defense spending. What do people want to cut? Government salaries, "welfare," and the arts, which, depending on how you figure it, represent around 10 percent of the budget.
A site called defeatthedebt.com has a page with visitor votes on how to cut the US federal debt. What's most notable about it: people are overwhelmingly opposed to higher taxes or higher age for Medicare eligibility. Any policy that would substantially cut spending or increase taxes has weak support or strong opposition. So it is unrealistic to expect the 2 major US political parties to tackle this problem until the US national debt has gotten so large that it precipitates an international financial crisis.
On a related note, Ferdinand Bardamu argues that the Tea Party is all about reserving spending for old people. There is some truth in that argument. I expect to see sharpening inter-generational and also inter-racial disagreements about taxes and government spending. It will no longer be possible for the government to buy off all major interest groups. Will divisions between generations, occupations, income levels, races, cultural groups, and religions become deeper and more bitter and angry as a result?2010 October 22 FridayYet Another Report On California Financial Disaster
Mish Shedlock takes a look at a new Milken Institute report about California's massive unfunded pension liabilities. The disaster is epic in scope. What is most important about this problem: Governments are losing the ability to pay off all their major interest groups. Governments are going to be forced to deliver less year after year.
- By around 2012 or 2013, the three major state pensions’ obligations will be more than five times as large as total state tax revenue.
- Not only will California’s growing senior population depend on Medi-Cal and other state services, but public school enrollment is likely to rise in the coming years. The state can ill afford to fund pensions by cutting back on these services.
- In 2009, the pension liability came out to $3,000 per working-age adult in the state. By 2014, it will triple to over $10,000 per working-age Californian.
- Raising employee contributions alone will be less effective over time as the ratio of actively contributing members to benefit recipients continues to decrease.
- Currently, the average state employee contributes to the system for 25 years, but will receive benefits for 26 years — and the number of benefit-receiving years is increasing as longevity improves.
Obviously retirement ages must be raised. People can't work for fewer years than they collect benefits. That's ridiculous and should be stopped pronto. You might think that the state pension funds deny the size of the problem and that maybe the outsiders complaining are just anti-government rabble-rousers. But no. The chief actuary of CalPERS (one of the 2 big Cal state pension plans) says the system is not sustainable. He's the chief actuary saying this. The unfunded liabilities hole can't be filled just with taxes.
The problem is not limited to just one state government. A former mayor of LA says the bankruptcy of Los Angeles is inevitable. Many state and local governments underfunded their public employee pension programs. Since state pension funds use unrealistic assumptions of 7.5% to 8.5% yearly average returns on their investments their underfunding is worse than their official claims. Imagine we go thru a 10 year period with near 0 returns on stock market. The unfunded liabilities of the states would balloon so large that bankrupcty would be hard to avoid. I expect The Impending World Energy Mess to slash state and local government tax revenues while also turning stock market returns negative.
So which interest groups will take the biggest hits? The hits might not be proportional to how much each group is getting now. Current government employees, retired government employees, poor folks, children, car drivers, firemen, school administrators, school teachers, bureaucracies that build low income housing, and assorted other groups will all lose something. How will the hits fall? Which groups have less defensible positions? Which groups are least sympathetic?
Government outlays could rise even as their perceived levels of delivered benefits decline. How? Partly because of interest payments. When interest payments rise faster than tax revenues then outlays for services today go down.
Also, retirement benefits deliver large numbers of tax dollars to a small fraction of the population (e.g. Cal state government retirees). So the surge in outlays for retirees means that a far larger number of direct and indirect recipients of smaller amounts of government outlays will feel the pinch. Everyone will experience worse roads for example. Parents will watch their local schools get their budgets cut for expenditures on current teachers, administrators, supplies, and buildings. Fewer police will mean more crime.
The fiscal disaster of US states such as California and Illinois has a lot of parallels with that of Greece and other PIIGS. What we see in California and Greece presages a much larger government funding crisis that is building up. This crisis is obviously important because of its impact on taxes and government services. But it is even more important because it effectively is a wall that the growth of the welfare state is running into.
Hitting the wall of government growth means resentment of elites will grow. It also means the elite factions and other factions will come into more direct conflict and settled issues will become unsettled again. Fixed entitlements will become unfixed. Decades long promises will be broken. As governments approach bankruptcy old settlements of political battles will be repudiated out of necessity.
Firemen have always been popular with citizens. But government employees are coming to be seen as having it much better than the masses. Conor Friedersdorf points to a great xtranormal video on extremely well-paid fire fighters in California.
Resentment of fire, police, housing agencies, and assorted pieces government will grow as people feel more economic pain. Lots more mocking and angry videos to come. On the bright side, we should get to watch some really good biting satire.2010 June 22 TuesdayState Pension Cuts Too Far In Future
A New York Times article by Mary Williams Walsh outlines many ways that state governments are cutting pension benefits that they can not afford. But there's one big twist: the states are not cutting benefits for existing workers. So the states are still going to run out of money in their pension funds decades before the cuts will start to cut outlays.
But there is a catch: Nearly all of the cuts so far apply only to workers not yet hired. Though heralded as breakthrough reforms by state officials, the cuts phase in so slowly they are unlikely to save the weakest funds and keep them from running out of money. Some new rules may even hasten the demise of the funds they were meant to protect.
Lawmakers wanted to avoid legal battles or fights with unions, whose members can be influential voters. So they are allowing most public workers across the country to keep building up their pensions at the same rate as ever. The tens of thousands of workers now on Illinois’s payrolls, for instance, will still get to retire at 60 — and some will as young as 55.
I can understand not taking back benefits already earned. But why should it be illegal to tell existing employees they will no longer earn additional benefits at such a fast rate?
The article reports Colorado as an exception because the state is cutting benefits for existing employees. Some other states are on course to run out of money in their pension funds in less than 10 years.
Joshua D. Rauh, an associate professor of finance at Northwestern University who studies public pension funds, predicts that at the current rate, Illinois’s pension system could run out of money by 2018. He believes the funds of other troubled states — including New Jersey, Indiana and Connecticut — are also on track to run out of money in less than a decade, unless they make meaningful changes.
Illinois would need to spend half of all tax revenues on pensions after 2018 if it does not cut benefits. It is no wonder that insurance for Illinois state debt prices in a high risk of default higher than California's.
Many US states are headed for a fiscal disaster. My advice: Do not move to a state whose state government is fiscally unsound. Avoid the cuts in service, the increases in taxes, and damaged economy as industries flee. The fiscal disaster will be even worse than forecast by economists because another approaching financial disaster is going to choke economic growth and cut into expected tax revenues.2010 June 20 SundayIllinois Passes California In Debt Default Risk
The CMA Sovereign Risk Monitor calculates probability of default within 5 years by sovereign credit issuers in the US and other nations using market prices for credit default swaps (CDSs). They now have Illinois at greater risk of default in 5 years with Cumulative Probability of Default (CPD) of 23.26% versus California at only 22.73%. Both states beat Latvia at a mean 21.71% but lag behind Iraq at 23.79%.
The US states have been very irresponsible in promising big pension benefits that they can not afford to pay. I am expecting lots of sovereign defaults. The dominoes will start falling fast when peak oil hits.2010 June 16 WednesdaySan Diego Grand Jury Recommends Govt Bankruptcy
June 16 (Bloomberg) -- The city of San Diego should consider Chapter 9 municipal bankruptcy to help it reduce fringe benefits, pension and health obligations.
That’s one of the suggestions made by the San Diego County Grand Jury, which does the normal duties of recommending indictments as well as reporting on local governments and special districts.
It would be fun to have a way to bet on whether Los Angeles or San Diego will file for bankruptcy first. Will Antioch California or Miami Florida beat them to the punch?
I see this as inevitable. The younger generations in California will have much lower earning power. High school drop-outs can't maintain a society as technologically advanced and productive as the society that made high wages for government employees possible. California is a shadow of its former self. Something has to give. With much fewer net taxpayers in future generations government's reach has got to pull back to more modest goals that fit with much more modest means. The last generation of white civil service workers will feel screwed up this process. But they did nothing to stop the processes that will seal their fate. The die is cast. Empires rise and fall and California is no exception. Neither is Texas. The nation as a whole is going to have to start thinking about the need to scale down the number of people in the military.
Demographics and huge pension burdens already spell financial armageddon. But wait. there's more. The 2010s are going to be an era of intense shocks. Better to mentally accept the changes now so that you do not feel psychologically shocked as you navigate thru what is in store. My advice: Adjust to what's coming before circumstances force change. If you change jobs, careers, move, lower your living standard or make other changes before forced to do so you can make these changes with less stress, less of a feeling of loss, and with much better outcomes from each change. Change from a position of strength rather than wait till you have to change from a position of weakness.2010 June 14 MondayMoody's Downgrades Greek Debt To Junk Status
ATHENS, Greece -- Moody's Investors Service slashed Greece's credit rating to junk status on Monday in a new blow to the debt-ridden country that is under intense international scrutiny after narrowly avoiding default last month.
Moody's must have discovered some previously secret facts about Greek debt in order for it to lower Greece's debt by 4 notches. Either that or they got around to reading the newspapers from January.
You got to admire how Moody's and the other ratings services are so on top of the Greek sovereign debt situation. With a downgrading like this you might begin to think that Greece will have a hard time raising money on the capital markets, what with the capital markets now apprised of Greece'e debt problem. Maybe European governments might try to get together to do a bail-out. Or maybe credit default swaps in Greek debt will soar in price. Oh wait. That already happened weeks and months ago.
Why do credit ratings agencies still exist? Anyone know? Do they have some carefully concealed purpose? Their predictive powers are a joke.
Greek credit swaps signal a 48.5 percent probability the nation will default within five years. The cost of insuring $10 million of Greece’s bonds for five years jumped $55,500 to $811,000 a year, making the nation’s debt the third most expensive to protect after Venezuela and Argentina, according to CMA DataVision.
I think Greece has a near 100% probability of default. So even the credit default swap prices seem to underestimate the odds of default.2010 May 31 MondayWPost Sees Problem With Public Employee Unions
MONTGOMERY COUNTY has just completed a nightmarish budget year. Stressed, squabbling and besieged elected officials savaged services and programs and jacked up taxes to eliminate an eye-popping deficit of almost $1 billion in a $4.3 billion spending plan. Meanwhile, across the Potomac River in Fairfax County, all was sweetness and light by comparison. With a budget roughly equal to Montgomery's, Fairfax officials erased a deficit a quarter as large with relative ease and far less drama.
Click thru and read the details. Montgomery County Maryland voters basically get less service for the money.
Why the difference? Unions. Maryland allows collective bargaining by government employee unions while Virginia does not allow government employees to organize. Keep that in mind when choosing where to live.
Virginia law denies public employees collective bargaining rights; that's helped Fairfax resist budget-busting wage and benefit demands. As revenue dipped two years ago, Fairfax officials froze all salaries for county government and school employees with little ado. By contrast, Montgomery leaders were badly equipped to cope with recession. County Executive Isiah Leggett took office proposing fat budgets and negotiating openhanded union deals after he succeeded Mr. Duncan. Then, as economic storm clouds gathered, he shifted gears and cut spending -- while still trying to appease the unions.
Notoriously, one such deal guaranteed almost $300 million in pension benefits over 40 years to thousands of employees based on salary increases they never received. The giveaway became known as "Phantom COLAs," for the cost-of-living raises that were never paid. And even when Montgomery's teachers agreed to give up cost-of-living raises last year, about two-thirds of them continued to receive step increases of up to 4 percent.
Public employee unions spend big on elections. Elected officials become tools of the unions. The voters mostly do not understand what's going on and naively think that endorsements by firemen, police, and teachers mean that a candidate is for keeping houses safe from fires, the streets safe from criminals, and good teachers in classrooms. But in reality what voters are voting for is more money for less work for employees of government agencies.
Since I'm expecting economic contraction due to a peak in world oil production the ability of governments to cut costs rapidly is going to become far more important than it already is. For jurisdictions where government workers can form unions what's needed are better laws for handling government bankruptcies. Governments are going to need ways to dump liabilities quickly and efficiently so that they can continue to deliver needed services.
Anyone know a good list of which states allow unions to do collective bargaining for government employees? I wonder how strong the correlation is between states with large unfunded pension liabilities and states that allow collective bargaining. Do any states allow collective bargaining but manage to avoid ruinous labor contracts due to very rightward-leaning electorates?2010 May 30 SundayMiami And Antioch Headed For Bankruptcy?
An NBC Miami news video reports that Marc Sarnoff, a commissioner in Miami's government, is pondering the possibility of bankruptcy for the city of Miami. He does not think elected officials can make the decisions needed (primarily take on the public employees unions) to get the city's finances back in balance. He says they either need to renegotiate union contracts or lay off 800 employees. He does not think the voters will accept tax increases.
Sarnoff sounds like he's lost his faith in democracy: "You no longer have 5 people making political solutions. You now have one person who is looking after the best interest of the taxpayer of the city of Miami, without any politics getting into his or her way." One of the results of so many local governments falling under the heavy influence of public employee unions is this loss of faith in democracy as a way to run governments. Our voters are, for the most part, too dumb to see that the election advertisements run by fire, police, and other public employee unions amount to (quite successful) attempts to trick the voters into lowering their own living standards in order to raise the living standards of government employees.
In Miama the average city employee makes $76k per year versus the average Miami resident making only $29k per year. The ruling class definitely knows how to feed itself. Pension costs have rising from $16 million in 2000 to $70 million in 2009. With a population of about 390k that works out to city government pension costs of about $180 per capita. Those costs will rise as more employees retire.
20% of city property taxes will go to retirees this year. The city is trying to modify its contract with the firefighters' union and they are fighting it in court. Click thru and read the details. These stories show you what you'll eventually see closer to home.
At the end of this budget year, Miami will have to shell out more than $100 million to make the city's pensions whole. That means 20 cents of every dollar Miami takes in from property taxes goes to the retirement of city workers.
Antioch California also joins the list of municipal bankruptcy candidates. Vallejo led the way. Antioch might follow.
Antioch's leaders earlier this month said bankruptcy could be an option for the cash-strapped city of roughly 100,000 on the eastern fringe of the San Francisco Bay area.
Some other local governments are at much higher risk of going bankrupt. Detroit is on that list. I am surprised it has avoided bankruptcy for this long. Harrisburg PA is probably going under due to some bad infrastructure investment decisions. Jefferson County Alabama is in similar straits. But these 3 aren't typical of the new breed of failing governments. The new breed is in trouble mainly due to fat union retirement benefits combined with the bursting of the real estate bubble.
This is just a trickle before the flood. At bad as city, county, and state finances are now (and they are pretty bad) once world oil production starts declining each year any government already remotely near bankruptcy will get shoved hard into insolvency.
At his office in Burbank, Calif., Richman navigates to his group's Web site, where he's posted a list of retired public employees in California who receive six-figure pensions. Number one is Bruce Malkenhorst, a retired city manager near Los Angeles who collects a half-million dollars a year. Next on the list is Joaquin Fuster, who gets $296,000. And James Stahl, who was with the Los Angeles County Sanitation District, receives $265,000.
There are more than 5,000 Californians on this list. These six-figure pensions make up only one percent of retired public workers, but many others still have a sweet deal. Take cops and firefighters, for example: If they retire, say, after 30 years of service, they make 90 percent of their top salary each year — guaranteed — until they die.
Update: The governor of New York doesn't appear to have what it takes to go up against the NY state government employee unions. This illustrates why states need Congress to pass laws regulating state-level bankruptcy. Elected officials are too weak and lame to responsibly handle state finances.
Its Apr. 1 budget deadline long past, New York's dysfunctional legislature remains divided over a $9.2 billion deficit. Democratic Governor David Paterson says he's "virulently opposed" to issuing new debt to close the gap, though he may cave in the face of resistance from public sector unions to education and health-care cuts.2010 May 23 SundayIreland Debt Seen Rising To Unsustainable Levels
Out of the PIIGS nations Ireland gets less attention since the crisis in Greece has focused attention on southern Europe. But econ prof Morgan Kelly takes a look at why Ireland is in trouble and finds the government take-over of failed Irish banks was done in a way that assures Ireland's sovereign debt burden will reach levels similar to Greece.
This debt would probably be manageable, had the Irish government not casually committed itself to absorb all the gambling losses of its banking system. If we assume – optimistically, I believe – that Irish banks eventually lose one third of what they lent to property developers, and one tenth of business loans and mortgages, the net cost to the Irish taxpayer will be nearly one third of GDP.
Adding these bank losses to its national debt will leave Ireland in 2012 with a debt-GDP ratio of 115%. But if we look at the ratio in terms of GNP, which gives a more realistic picture of the Ireland’s discretionary tax base, this is a debt-GNP ratio of 140% – above the ratio that is currently sinking Greece. Even if bank losses are only half as large as we expect, Ireland is still facing a debt-GNP ratio of 125%.
When the banks were taken over the Irish government did not just make whole depositors. The government also bailed out bond holders. That seems incredibly foolish. Why'd they do that?
If Kelly is correct then Ireland faces a future where at some point the market will demand far higher interest rates for Irish sovereign debt than the Irish government can afford to pay. At the same time, the bail-out for Greece just kicked the Greek problem into the future by 2 or 3 years.
I am wondering how the European sovereign debt crisis (and the coming US sovereign debt crisis) will resolve itself. Ross Douthat sees expanding state power in the US and Europe. IN Europe in particular the emotional bonds across nations seem much shallower than the emotional bonds across US states. So I see pretty severe limits in the willingness of the Dutch, Germans, and other more affluent and financially sound European states to bail out the other states.
At the same time, the European Central Bank seems unlikely to inflate away all the debt. Inflation has better prospects in America than in Europe. So default still seems like the most likely outcome in Europe. The question then arises: Default in the euro zone or default while exiting the euro zone? Will Greece, for example, default on its debt and yet still remain in the euro? Or will it default and bring back the drachma currency at the same time?
I also wonder in event of default whose decision will it be on whether Greece leaves the euro? Will the Greek government decide? Or will the Germans and some nations allied with them decide to eject a nation that dares to default? Will the Germans see a default as an opportunity to eject a nation which does not share its economic values with regard to currency soundness and public finance?
The avoidance of either default thru inflation or explicit default seems a very remote possibility. European welfare states already face aging populations and over-promises on entitlements.2010 May 15 SaturdayFelix Salmon: Great Euro Experiment Unwinding
Felix Salmon argues that the scale of a default by itself does not matter. Default matter far more when they are unexpected. The markets were (quite irrationally IMO) treating Greece and other southern European countries as low default risks. Institutions (e.g. banks) that normally only buy high quality credits bought large quantities of sovereign bonds that are now at high risk of default. Salmon sees serious risk to the European political union. I realize this will come across as a statement of the obvious to many well-informed readers. But sometimes the obvious needs stating.
All of which is to say that the great euro experiment seems to be unwinding, the Estonia news notwithstanding, and no one knows where it’s headed over the medium term. If economics and politics become fractious and nationalized across Europe, then within the region only Germany will any longer provide the kind of safety that investors are currently looking for; everybody else is going to start returning to their pre-convergence trade levels, which were a long way away from where we are now.
So anything which threatens the unity of the eurozone or the EU is surely going to have market consequences much worse than a single day drop of a few percentage points on European stock exchanges. And right now it’s far from clear that the political will to keep the union together is going to be sufficient.
Yves Smith makes the point that one big battle over Greece is whether the Greek populace or the lenders pay. You might think the borrowers ought to pay. But if the lenders do not get bailed out by governments (who just shift the costs to a larger set of taxpayers) then lending losses will discipline lenders to not lend money to a country up to the point of well past 100% of GDP. This financial disaster in the making would not have been possible without irresponsible lenders putting up the money in the first place.
I see many things going wrong in Western societies, economies, and politics that are going to cause large, and to the vast majority quite unexpected, discontinuities. While the threat to the euro's existence might seem sudden and unexpected Milton Friedman famously doubted its stability from its founding in 1999 and as recently as 2005 when he was 94 years old.
The euro is going to be a big source of problems, not a source of help. The euro has no precedent. To the best of my knowledge, there has never been a monetary union, putting out a fiat currency, composed of independent states. There have been unions based on gold or silver, but not on fiat money—money tempted to inflate—put out by politically independent entities.
Friedman's comments on a European common currency in 1992 bear reading today. He saw the problems with it and he would not be at all surprised by recent events.
A break-up of the euro in the next few years would probably throw us back into a recession again starting from already high unemployment rates. Could a mechanism for defaults within the euro save the currency? Or is union power and public worker power in southern European states too strong to make their membership in a sound currency workable? Just the labor mobility problem across states with so many different languages alone makes the idea of a common currency seem foolish.
In America the great dumbing down looks on course to go very far. This is totally off the radar screen of what passes for mainstream elite conventional wisdom. But it will depress the US economy in coming decades.
Another really biggie on my radar screen is Peak Oil. See the graph here of world oil discovery and production rates. Production first exceeded discovery around 1981 and the gap between them has grown much bigger. We are now burning thru oil about 3 times faster than new oil is discovered. It is going to get ugly.
Many political divisions that are papered over now with money will rise up into political conflicts. Much larger fraction of populations will be impacted and competition for shrinking pies will intensity. Acrimony over government spending, taxes, and racial preferences systems will become much more intense. I'm expecting street battles by opposing groups of marching protestors.2010 May 13 ThursdaySpain Labor Market Incompatible With Euro
One of my frustrations with the press comes from having to read a large number of news articles to find out the underlying causes of political and economic phenomena. Fundamentals are rarely addressed. Sometimes talented bloggers provide translations of articles that are written within politically correct mental strait jackets. But more often one has to just plow thru enormous numbers of articles to get to the core of a problem. Well, reading thru Op-Ed pieces in the New York Times I came across a short piece by U Maryland economist Gayle Allard who explains a core problem with Spain's economy as a member of the Euro: The country needs periodic bouts of inflation to undo the distortions caused by very powerful unions. This makes Spain's entry into the euro zone an act of enormous political folly for all involved.
While it was doing its fiscal homework, however, Spain overlooked a key requirement for the currency area: staying competitive without a national exchange rate. Spanish labor costs chronically rise much faster than productivity.
Read this and marvel at the absolute madness of adding the southern European countries to the euro zone. Yet a large number of politicians in Europe joined together to implement this madness.
In the past, the government periodically devalued the peseta to restore competitiveness. The euro took this escape valve away, but policymakers neglected the structural reforms that could help Spain compete without an exchange rate.
Spain’s key problem lies in its labor market. Collective bargaining is politicized and far from the realities of the firm. Unemployment benefits are high and easily collected, giving Spaniards incentives not to work and pushing market wages higher. High dismissal costs protect an “aristocracy” of workers from firing, making them immune to pressures to restrain their wages or boost their productivity.
Spain needs bouts of inflation as long as collective bargaining remains highly politicized. A country that needs periodic bouts of inflation should not share a currency with Germany. One doesn't need to be a rocket scientist running complex computer models to figure that out.
What is the most remarkable thing about the current European financial crisis? It was set in motion by the criteria used for choosing euro zone members. The steps that led into the crisis were obviously wrong to anyone who understood the distortions in the labor markets in southern Europe.
Think the Spanish government can fix Spain's economy? To do that involves taking on a huge system of job entitlements. Probably too many voters are in on the game for an elected government to undo it.
Overpaid American public sector workers are like most of Spain's economy. Imagine how much more messed up the United States would be if our problems with government worker unions extended into the entire economy. Overpaid public sector workers in the US are going to end up forcing some governments into bankruptcy.2010 May 12 WednesdaySpending Cuts And Tax Increases Coming To US
David Leonhardt of the New York Times lays out argument for how the US government budget deficit is so large that neither spending cuts or tax increases alone are likely to be able to balance the US federal budget.
As a rough estimate, the government will need to find spending cuts and tax increases equal to 7 to 10 percent of G.D.P. The longer we wait, the bigger the cuts will need to be (because of the accumulating interest costs).
Seven percent of G.D.P. is about $1 trillion today. In concrete terms, Medicare’s entire budget is about $450 billion. The combined budgets of the Education, Energy, Homeland Security, Justice, Labor, State, Transportation and Veterans Affairs Departments are less than $600 billion.
There's no way to close that gap without reducing consumption. That means lower living standards. The cost of closing that gap will wider with each year that the total government debt grows. Eventually the need to cut and tax will be forced by the market via a sovereign debt crisis where US and foreign investors become unwilling to buy US Treasury bonds. Greece and California both serve as models for what is coming for the United States: A several years long crisis period with increasingly severe cuts and troubles. Even basic services will get cut. Expect much less from your government in the future and you won't be disappointed.
The basic problem is that the American people do not want to admit they are living beyond their means. Even worse, I believe the gap between what we can afford and what we are getting is even bigger than the US federal budget deficit suggests. For example, State and local government pension plans and employee benefits are out of control. State and local governments are therefore accumulating obligations beyond their means to pay.
At 3.5 percent of GDP, the trade deficit subtracts more from the demand for U.S.-made goods and services than President Obama's stimulus package adds to demand. Moreover, Obama's stimulus is temporary, whereas the trade deficit is permanent and growing again.
When world oil production starts shrinking every year the ensuing financial crisis will be so severe that lots of currently sacrosanct spending programs will get cut. Do not rely on US government entitlements programs for old age. The US government will be forced to make cuts as severe as those made by Greece.Estonia To Replace Greece In Euro Zone?
As I see it, the Euro currency zone leaders are lining up replacements for those members that will drop out of the euro in order to escape excessive debt burdens. The Euro mandarins might see it differently. But given that continued PIIGS (Portugal, Ireland, Italy, Greece, Spain) membership in the euro is uncertain it makes sense to think of Estonia as a substitute for Greece.
The Baltic republic of Estonia, a country of 1.3 million people, is on course to adopt the euro in January 2011, the European Commission says.
The recommendation still requires the approval of all 27 EU member states, 16 of which are in the eurozone.
What if Greece votes the membership out of sour grapes as Greece leaves? Or maybe Portugal will threaten a veto in order to get bigger loans.
May 12 (Bloomberg) -- New York University professor Nouriel Roubini said Greece and other “laggards” in the euro area may be forced to abandon the common currency in the next few years to spur their economies.
A “real depreciation” in the euro is needed to restore competitiveness in nations including Spain, Portugal and Italy, he said in an interview on Bloomberg Television today. The euro will remain the currency for a smaller number of countries that have “stronger fiscal and economic fundamentals,” Roubini said.
“I was stunned,” Rogers, chairman of Rogers Holdings, said in a Bloomberg Television interview in Singapore. “This means that they’ve given up on the euro, they don’t particularly care if they have a sound currency, you have all these countries spending money they don’t have and it’s now going to continue.
Rogers is raising his young daughters to speak Mandarin because he sees the 21st century as the Chinese century.2010 May 11 TuesdayFelix Salmon On Rising Resentment In Europe
The debtors and creditors will resent each other more in the future. This does not bode well for the euro.
So while the EU’s trillion dollars is surely sufficient to prevent any country from having to default in the next few years, I fear that its enormity will only exacerbate tensions between the euro zone countries over the long term. They’re not all partners together anymore: now they’re bifurcating into the rich lenders, on the one hand, and the formerly-profligate debtors, on the other. The mind-boggling sums involved are only going to increase resentments both of the south in the north and of the north in the south.
I expect the latest "shock and awe" bail-out of the PIIGS in Europe will just set up for bigger sovereign defaults further on down the road. This bail-out does not address root causes. It just stops a market stampede.
While Germany's exports rose an astonishing 65% from 2000 to 2008, its domestic demand flatlined near zero. Without strong export growth, Germany's economy would have been at a standstill. The Netherlands is also a big exporter (trade surplus of $33 billion) even though its population is relatively tiny, at only 16 million. The "consumer" countries, on the other hand, run large current-account (trade) deficits and large government deficits. Italy, for instance, has a $55 billion trade deficit and a budget deficit of about $110 billion. Total public debt is a whopping 115.2% of GDP.
Spain, with about half the population of Germany, has a $69 billion annual trade deficit and a staggering $151 billion budget deficit. Fully 23% of the government's budget is borrowed.
Although the euro was supposed to create efficiencies by removing the costs of multiple currencies, it has had a subtly pernicious disregard for the underlying efficiencies of each eurozone economy.
The next round of financial disasters will matter more than the most recent crisis of the last few years because the next round will come on top of existing economic weakness. Watch the price of oil. If it goes above $100 then expect another recession, sovereign defaults, and more bank failures.2010 May 05 WednesdayGermany Wants Bankruptcy Mechanism For EU States
The German government seems to be coming around to the position that bankruptcy with losses by lenders is preferable to bail-outs by wealthier EU states (e.g. Germany). ParaPundit agrees.
“We quite urgently need something for the members of European Monetary Union that we also didn’t have during the banking crisis two years ago,” German Finance Minister Wolfgang Schaeuble told reporters yesterday. “Namely the possibility of a restructuring procedure in the event of looming insolvency that helps prevent systemic contagion risks.”
Is Schaeuble saying that European governments should have established procedures for going bankrupt? Sounds to me like Angela Merkel prefers loan defaults and losses of principal by creditors.
Merkel, who faces elections in Germany’s most populous state on May 9, is seeking to shift focus from the Greek bailout to drawing lessons from the euro’s biggest crisis. An “orderly insolvency” process would ensure that creditors participate in any future rescue, she said on ARD television yesterday.
Merkel's government wants to find a way to keep states as members in the Euro zone without having to periodically bail them out with loans. I think this position makes sense. I doubt that the German voters are going to accept their role as funders of more spendthrift states.
The United States Congress needs to pass legislation that makes it easier for state governments to declare bankruptcy. Government bankruptcy might be the only practical way to close the widening gap between public sector and private sector pay. Parenthetically, that gap really started to widen in 2005 and 2005 just happens to be the year of peak world oil production which wasn't surpassed in the following 4 years.
With the debt loads of other European nations beginning to rattle the markets it is important to appreciate the level of German popular opposition for the Greek bailout which is a close call with the German electorate.
The urgency was evident in Mrs. Merkel’s television blitz on Monday, with a news conference in the afternoon and appearances on three stations in the evening.
“If she’s taking such drastic measures, it means that she fears that if she can’t anchor her version that it will cause real damage,” said Oskar Niedermayer, professor of political sociology at the Free University in Berlin. “It’s still unclear at the moment which view of the Greek crisis will win the upper hand in the minds of the public.”
The German electorate clearly opposes bailing out Greece. That makes bailing out Portugal and Spain even more problematic. The Germans will be even more resentful of bailing out still more countries. Hence the interest in organized ways for states to go bankrupt.
Opinion surveys in Germany have for months shown a sizable majority of the population here opposed to any bailout for Greece, with a constant drumbeat of news media coverage about Greek profligacy helping fuel the discontent.
Against this backdrop, the spread on Spanish credit default swaps rose 29% to 210 basis points from 163 basis points on Monday, according to Markit. That means it would cost $210,000 a year to insure $10 million of Spanish debt against default, compared to $163,000 on Monday.
The Portuguese CDS spread rose to 350 basis points from 284, while the Irish CDS spread rose 31 basis points to 220, and Italy's was up 18 basis points to 160.
Greece's CDS spreads fell 1 basis point to 725, but still remain at very high levels, according to data from Markit.
So if the Portuguese CDS spread doubles then crisis #2 will hit and then Spain will be teed up to become crisis #3. A sovereign debt ratings downgrade for Spain and Spain's lackadaisical approach to the approaching crisis makes a Spanish debt crisis all the more likely.
Will the Euro members all stay in the monetary union? Stay in and go bankrupt? Or bail from the Euro entirely? There's not a third choice given German voter aversion to subsidizing other Europeans states.
Update: We need fast clear mechanisms of bankruptcy for governments because the financial conditions of governments will deteriorate. Governments are going to be faced with a choice between credit defaults and currency inflation. I would prefer the bankruptcies and shedding of obligations. Inflation, by contrast, will distort markets and deliver much more unfairness.Public Pensions Bankrupting Los Angeles
Richard Riordan, former mayor of Los Angeles, and Alexander Rubalcava, president of an investment advisory firm write in a Wall Street Journal Op-Ed that the city of Los Angeles is headed for bankruptcy. Read the whole thing.
Los Angeles is facing a terminal fiscal crisis: Between now and 2014 the city will likely declare bankruptcy. Yet Mayor Antonio Villaraigosa and the City Council have been either unable or unwilling to face this fact.
According to the city's own forecasts, in the next four years annual pension and post-retirement health-care costs will increase by about $2.5 billion if no action is taken by the city government. Even if Mr. Villaraigosa were to enact drastic pension reform today—which he shows no signs of doing—the city would only save a few hundred million per year.
Los Angeles shows us America's future. The rest of the country will catch up eventually.
The city assumes a ridiculous 8% annual return from its pension funds. The current mayor and city council are tools of the public worker unions. The city is going to keep squandering the taxpayers' money on overpaying public workers. That is part of a much bigger pattern of more rapid compensation increases in the government sector than in the private economy. That pattern is headed for a collision with a solvency crisis for many cities and states.
See Inevitable Bankruptcy Seen For Los Angeles and US States In Deeper Financial Trouble. I expect the sovereign debt problem in the US to hit in full force during the next recession. I expect the next recession to be caused by dwindling reserves of oil. The Deepwater Horizon accident in the Gulf of Mexico is a symptom of how desperately we must now pursue oil under extreme conditions in order to keep our economy going.2010 May 02 SundayEU-IMF Greece Bail-Out Delays Reckoning
The 110 billion Euro IMF/EU bail-out for Greece will keep it from defaulting on its debt for 3 years. But The Economist sees the bail-out as an attempt by the EU to convince the market that there's no point in dumping the debt of Spain, Portugal and other financially shaky EU members.
The pattern of the past three months has been a series of gambles by EU leaders. Their bet, each time, has been that a fierce enough political declaration will intimidate markets into backing away from a weak member of the club. This latest announcement looks different but it is not: it is just the biggest and fiercest declaration yet that markets should leave the eurozone alone. The idea is to shock and awe markets with a big number, so that Greece and its toxic public finances are ringfenced behind a wall of European political will. But this, too is a gamble. If markets lose confidence in other members of the club, such as Portugal, the whole scramble for solidarity will begin again.
I do not think the market will be convinced by this move. Why should it? Spain and Portugal need to take more aggressive austerity steps before the market forces them to do it. If they wait too long then the market will insist on an EU bail-out.
Spain has a GDP 3 times the size of Greece and so a bail-out for Spain would cost much more. If the markets decide Spain is too risky then the EU would need to come up with 1 trillion or more Euros and the political will does not exist inside the Euro zone to come up with that amount of money.
Both Greece and Portugal are rather small, moreover. If the markets find good reasons to doubt the long-term sustainability of a much bigger economy, Spain, the cumulative bailout bill for other EU governments quickly reaches a very big number indeed (in Brussels, figures of a trillion euros or more are talked of in queasy tones). In the words of one Brussels official tonight: “the EU can’t afford Spain.”
Greece is a pretty corrupt place. That alone makes me doubt that it will put its financial house in order. When the EU and IMF loans run out in 3 years unless it is enormously improved the market might force it into bankruptcy then. The EU has basically kicked the ball down the court for 3 years - and only for Greece. The sovereign debt crisis will continue.
Since I expect declining oil production due to diminishing returns from drilling for oil which is a result of using up most of the extractable oil reserves (great interview with petroleum geologist Colin Campbell) economic growth will not allow Greece to cut its debt burden. Ditto Spain, Portugal, Ireland, and Iceland. So the Euro zone leaders are either going to have to allow sovereign defaults within the Euro zone or eject some current Euro zone members.
Parenthetically, the US Congress should pass legislation that creates a mechanism for state governments to default on debt.2010 April 25 SundayInevitable Bankruptcy Seen For Los Angeles
California politicians see the public pension system as unsustainable. A couple of generations of politicians were bought by the public sector unions and signed union contracts that are going to bankrupt some California governments.
"The single biggest threat to our fiscal health and California's future is our public pension system," Schwarzenegger said at a Capitol news conference, declaring the growing costs a "crisis."
"Here in Sacramento, pension reform must be our No. 1 priority," he said.
Earlier in the day, Villaraigosa declared in Los Angeles that the city's "pension system is no longer sustainable.''
Retirement benefit costs will consume 19% of the city's general fund budget in the coming fiscal year, he said.
Mayor Antonio Villaraigosa and the City Council have said repeatedly that, come what may, declaring Los Angeles bankrupt is not an option.
But with city leaders avoiding the tough decisions to mend L.A.'s financial health - opting instead for easy fixes that allow the city to limp along for another month or two - some are saying bankruptcy is just the ticket.
For one thing, it could lead to speedier reform of the pension system, which many economists and politicians say is necessary if the city is to prosper long term.
"I've suggested it since 2005," former Mayor Richard Riordan said. "The city, the way it is going, is unsustainable. If they don't do it this year, they are going to have to do it in the next four or five years."
That's Richard Riordan saying it. Wow.
Jerry Brown, former governor of California, former mayor of Oakland, current state Attorney General, and Democratic candidate to be the next governor says defined benefit pension plans should not be scaled back. He's beholden to the public employee unions.
Public pensions came up. The current system, reported by nearly all responsible officials and media, is either bankrupt or on the verge of bankruptcy because it promises specific amounts to retirees. That is a "defined benefit" plan. Brown stated that he “supports a defined benefit plan,” (which is the current system), but was quick to add that “pension spiking-we need to curb that.” "Pension spiking" is the practice of promoting a public employee at the end of his or her tenure or assigning more overtime in order to increase the amount of pension paid during that person's lifetime in retirement.
The problem goes much deeper than pension spiking.
Crane traces the political takeover by the unions to the Dill Act signed by Governor Jerry Brown in 1978 giving the public unions collective bargaining. As the unions power over the legislature has grown the concern is reform on the pension front will be more and more difficult to accomplish.
California used to be the dream state. Somewhere alone the way it became the nightmare state.
Writing for the City Journal Steve Malanga explains just how beholden California governments have become to the unions.
Consider the California Teachers Association. Much of the CTA’s clout derives from the fact that, like all government unions, it can help elect the very politicians who negotiate and approve its members’ salaries and benefits. Soon after Proposition 13 became law, the union launched a coordinated statewide effort to support friendly candidates in school-board races, in which turnout is frequently low and special interests can have a disproportionate influence. In often bitter campaigns, union-backed candidates began sweeping out independent board members. By 1987, even conservative-leaning Orange County saw 83 percent of board seats up for grabs going to union-backed candidates. The resulting change in school-board composition made the boards close allies of the CTA.
But with union dues somewhere north of $1,000 per member and 340,000 members, the CTA can afford to be a player not just in local elections but in Sacramento, too (and in Washington, for that matter, where it’s the National Education Association’s most powerful affiliate). The CTA entered the big time in 1988, when it almost single-handedly led a statewide push to pass Proposition 98, an initiative—opposed by taxpayer groups and Governor George Deukmejian—that required 40 percent of the state’s budget to fund local education. To drum up sympathy, the CTA ran controversial ads featuring students; in one, a first-grader stares somberly into the camera and says, “Pay attention—today’s lesson is about the school funding initiative.” Victory brought local schools some $450 million a year in new funding, much of it discretionary. Unsurprisingly, the union-backed school boards often used the extra cash to fatten teachers’ salaries—one reason that California’s teachers are the country’s highest-paid, even though the state’s total spending per student is only slightly higher than the national average. “The problem is that there is no organized constituency for parents and students in California,” says Lanny Ebenstein, a former member of the Santa Barbara Board of Education and an economics professor at the University of California at Santa Barbara. “No one says to a board of education, ‘We want more of that money to go for classrooms, for equipment.’ ”
Government bankruptcies. They'll start out local, move up to the state level, and eventually the US government will face a sovereign debt crisis. What I want to know: Will the feds use inflation to do a de facto default on US sovereign debt? How will the US government respond when world oil production goes into permanent decline and pulls economies down with it?
Update: See this Barrons chart of state credit ratings and pension funding. California has the lowest credit rating followed by Illinois. If you are thinking of moving consider states that have high credit ratings and no income taxes. Florida, Tennessee, South Dakota, and Washington state are all candidates. In the Barrons table the column for percent funded is misleading. The states all have unrealistically high assumptions for the rates of returns on their pension investments. Best to choose a state that provides low public employee retirement benefits. I'd like to know the details on that issue.2010 April 17 SaturdayJim Chanos: Greece Is Prelude For Other Governments
Hedge fund billionaire Jim Chanos says the financial crisis in Greece is a prelude to what's in store for other governments which have promised far more than they can deliver.
You know they came in and discovered the hole in the budget deficit and discovered a lot of the off balance sheet stuff that was not of their doing. And he's taking the politically unpopular step of extending the retirement age and cutting government wages not knowing if it's going to be enough and so far the market is pretty skeptical, but I think the Greek government is being more courageous than some of the other western-European governments who aren't addressing these issues and are going to be facing these same problems like Greece down the road. So Greece is a prelude to the problems that a lot of other countries will face that have made promises to their people without the ability to pay for them.
Not just other countries. The Pew Center on the States finds that the US states have $1 trillion in unfunded pension and health care liabilities. The states are in worse shape than they officially state because they assume ludicrous rates of return on their investments. The lowest assumed annual return rate is 7.25% for North Carolina and South Carolina. The highest at 8.5% is used by 5 states (CO, CT, IL, MN, NH). This is delusional. Click thru on that link to figure out whether you need to plan to move to another state.
The interview with Chanos is worth reading for his comments about proper uses of credit default swaps.
States do not want to get realistic on rates of return because they can't afford higher pension fund contributions that would come from more realistic assumptions. This article reports that states are increasing their risks in order to try to get higher rates of return. This will end in tears for the taxpayers.
A growing number of experts say that governments need to lower the assumptions they make about rates of return, to reflect today’s market conditions.
But plan officials say they cannot.
“Nobody wants to adjust the rate, because liabilities would explode,” said Trent May, chief investment officer of Wyoming’s state pension fund.
The $30 billion Colorado state pension fund is one of a tiny number of government plans to disclose how much difference even a slight change in its projected rate of return could make. Colorado has been assuming its investments will earn 8.5 percent annually, on average, and on that basis it reported a $17.9 billion shortfall in its most recent annual report.
But the state also disclosed what would happen if it lowered its investment assumption just half a percentage point, to 8 percent. Though it might be more likely to achieve that return, Colorado would earn less over time on its investments. So at 8 percent, the plan’s shortfall would actually jump to $21.4 billion. Contributions would need to increase to keep pace.
More realistic assumptions lead one finance prof to estimate the states are $3 trillion underfunded. The article includes an estimate that the Chicago area government pension funds are underfunded by over $5800 per resident. So the potential obligations you can get stuck with in a high tax area are huge.
But as NPR and others noted, that $1 trillion figure is unrealistically low. Experts like Joshua Rauh, an associate professor of finance at the Kellogg School of Management at Northwestern University, say pension funds are using exaggerated assumptions about investment returns. "Our calculation is that it's more like $3 trillion underfunded," Rauh told NPR.
The 2010s will feature a series of financial crises that will intensify until the crisis is large and continuous. Peak Oil is going to cause tax revenues to decline and investments to produce negative returns.
What I want to know: Can US states cut benefits for people already retired? US cities can go bankrupt and get out of pension obligations that way. States can default on debt. But can states get out of retiree pension and health care obligations? Will Congress eventually pass legislation that provides a mechanism for states to shed obligations?
Update: Newly elected governor Chris Christie of New Jersey wants to figure out ways to cut retirement benefits for existing state workers.
Facing unfunded liabilities of $90 billion in pension and medical plans, Mr. Christie worked with lawmakers to change retirement benefits for new workers and to require all new state employees to pay 1.5% of their medical insurance costs. Until now they were paying nothing.
He wants to go further. "We need to move forward to try to make some changes in the pension system for current employees," he says. "There's all kinds of problems in doing that, some legal. . . . You can't take away vested benefits, but the argument of whether increases going forward are actually vested or not is an interesting legal issue that we're going to attempt to challenge. . . ." He adds that the current retirement age for state employees, 62, "needs to be moved up further."
The State of New Jersey is one of the fiscal basket cases. California gets more attention. But if you look at the Pew Center on the States pension fund report you will see that California gets higher grades on pension soundness than New Jersey. Pension costs are a major portion of total state costs. So this measure is a good indication of the fiscal soundness of the states.2010 April 11 SundayUS States In Deeper Financial Trouble
California has 6 times more unfunded liabilities than debts just due to underfunded pension fund programs for state employees.
An independent analysis of California’s three big pension funds has found a hidden shortfall of more than half a trillion dollars, several times the amount reported by the funds and more than six times the value of the state’s outstanding bonds.
The Governator wants the California state legislature to face the problem. I'm pretty confident they won't. The crisis will get much larger.
The guy at Stanford who did the study says California can't hope to meet these obligations. So Cal state employees aren't going to get as rich of retirement benefits as they have been promised.
"What is so alarming is there is no way that the state will be able to meet these obligations," Nation tells HuffPost. "The odds are so heavily stacked against the state on this one. The question is how we dig out of this."
Can the state legislature cut retirement benefits for those already retired? For those about to retire?
In New Jersey 2 successive governors have underfunded the retirement systems even as the retirement systems have lost money. The state is strapped for cash. The public doesn't want program cuts to pay for the state workers.
In New Jersey, Republican Gov. Chris Christie followed steps of his predecessor to address a budget gap for the coming fiscal year by proposing last month to skip a $3 billion payment to the retirement systems for teachers, state employees and other public employees, valued at $66 billion as of June 30.
New Jersey's prior governor, Democrat Jon Corzine, mostly missed a $2.5 billion payment to the pension system and allowed cities and other local governments to pay only 50% of their share of the pension contribution. The fund is one of the most underfunded in the country.
For many years public employee unions have funded and supported politicians who enact big benefits increases for state and local government employees. Basically the public got screwed for the benefit of well organized employees. As the US economy performs poorly in the 2010s the conflict between government employees and tax payers is going to get very intense. Will the governments need to declare bankruptcy in order to escape these costs? That's what Vallejo California did. Could be a model for other governments.
A think tank with ties to public employee pensions has released a study of state and local pension plans that may underestimate the unfunded liability by trillions of dollars.
The Funding of State and Local Pensions: 2009-2013 released Thursday by the Center for State and Local Government Excellence studied 109 state and 17 local government pension plans and came up with an unfunded liability of about $1.2 trillion by 2013. Overall, plans will be at funding ratios of 66 percent to 72 percent.
That figure does not include medical benefits for retirees. So the true total is much larger.
“If we ran into a situation where one state got into trouble, they’d be bailed out six ways from Tuesday,” said Kenneth S. Rogoff, an economics professor at Harvard and a former research director of the International Monetary Fund. “But if we have a situation where there’s slow growth, and a bunch of cities and states are on the edge, like in Europe, we will have trouble.”
Unfortunately, TFD today is merely the proverbial calm before the storm. In a world of endless red ink and the coming debt tsunami, spending rather than taxing is the true measure of government's burden.
Explains the Tax Foundation: "Since 2008, however, deficits have been massive by any measure, and as a result Tax Freedom Day may give the impression that the burden of government is smaller than it really is. If the federal government were planning to collect enough in taxes during 2010 to finance all of its spending, it would have to collect about $1.3 trillion more, and Tax Freedom Day would arrive on May 17 instead of April 9 – adding an additional 38 days of work to the nation's work for government."
The 1990s were party time in the stock market. Lots of boats were lifted by the financial tides. But in the 2000s slower economic growth and the bursting of two financial bubbles brought many government financing problems to the surface. Those problems are going to get far larger than the American people think possible.
The 2010s will continue the same pattern of slow growth and worsening government finances. Expect higher taxes, wide ranging cuts in services, and fights over who pays and who gets less. The financial and demographic deterioration of America is going to make the politics very bitter and angry.2010 April 03 SaturdayLithuanian Cut Government Spending 9%
Necessity is a mother. Lithuania, like Greece, presages America's future.
Faced with rising deficits that threatened to bankrupt the country, Lithuania cut public spending by 30 percent — including slashing public sector wages 20 to 30 percent and reducing pensions by as much as 11 percent. Even the prime minister, Andrius Kubilius, took a pay cut of 45 percent.
And the government didn’t stop there. It raised taxes on a wide variety of goods, like pharmaceutical products and alcohol. Corporate taxes rose to 20 percent, from 15 percent. The value-added tax rose to 21 percent, from 18 percent.
The net effect on this country’s finances was a savings equal to 9 percent of gross domestic product, the second-largest fiscal adjustment in a developed economy, after Latvia’s, since the credit crisis began.
We'll know when Congress is serious about cutting spending when wages and benefits for federal workers cease being untouchable. That'll happen when US Treasury bond yields shoot up high, causing a liquidity crisis that forces massive cuts in outlays.
When the US sovereign debt crisis hits with full force federal worker wages and benefits are going to get targeted for big cuts. As things now stand US federal workers make more than their private sector counterparts in most occupations.
Overall, federal workers earned an average salary of $67,691 in 2008 for occupations that exist both in government and the private sector, according to Bureau of Labor Statistics data. The average pay for the same mix of jobs in the private sector was $60,046 in 2008, the most recent data available.
The biggest difference comes from richer benefits for federal workers. Medical and retirement are much richer for the feds.
These salary figures do not include the value of health, pension and other benefits, which averaged $40,785 per federal employee in 2008 vs. $9,882 per private worker, according to the Bureau of Economic Analysis.
America's demographics trends (less skilled, older), unfunded entitlements liabilities, reckless government from both political parties, and Peak Oil all make a fiscal train wreck inevitable. We can study events in Lithuania, Greece, Argentina, and other countries that have gone thru sovereign debt crises to see what's in store. Plan accordingly.
One of the big political conflicts of the next 10 years is going to be over how much of the response to the coming sovereign debt crisis will be dealt with by savage spending cuts versus brutal tax rises. Either way, living standards will decline when we are forced to live within our means.
Update: The same pattern of more rapidly rising public sector pay holds for Britain too. Well, the British are headed for their own sovereign debt crisis. So the public sector's wages and benefits are headed for big cuts there too.
The earnings of people employed by the state grew by an average of 2.3% a year between 2001 and 2005, compared with growth of around 1.5% for those employed by private firms.
But workers in the public sector saw their pay increase at nearly twice the rate as their private sector counterparts once pension benefits were taken into account, according to the Institute for Fiscal Studies (IFS).Obama Sees Overtaxed Claim As Misinformation
Toward the end of a question-and-answer session with workers at an advanced battery technology manufacturer, a woman named Doris stood to ask the president whether it was a "wise decision to add more taxes to us with the health care" package.
"We are over-taxed as it is," Doris said bluntly.
Obama started out feisty. "Well, let's talk about that, because this is an area where there's been just a whole lot of misinformation, and I'm going to have to work hard over the next several months to clean up a lot of the misapprehensions that people have," the president said.
He then spent the next 17 minutes and 12 seconds lulling the crowd into a daze. His discursive answer - more than 2,500 words long -- wandered from topic to topic, including commentary on the deficit, pay-as-you-go rules passed by Congress, Congressional Budget Office reports on Medicare waste, COBRA coverage, the Recovery Act and Federal Medical Assistance Percentages (he referred to this last item by its inside-the-Beltway name, "F-Map"). He talked about the notion of eliminating foreign aid (not worth it, he said). He invoked Warren Buffett, earmarks and the payroll tax that funds Medicare (referring to it, in fluent Washington lingo, as "FICA").
If we aren't overtaxed now we are going to be. The US budget deficit is going be well over $1 trillion per year over the next 10 years and that is before Obama gets the government doing everything he wants the government to do. He's not done spending yet. He wants more spending programs.
The Democrats want to close the budget deficit with taxes. So it is not acceptable to Obama for someone to already feel overtaxed. He needs people to take on a 50% higher tax burden and still not feel overtaxed. So he feels a desperate need to convince people that they should not feel overtaxed. Yes, with taxes alone to close the deficit would require a 50% increase in federal taxes.
A solution that relied only on taxes would muzzle economic growth. To cover the costs of future spending — the retirement of the baby boomers and everything else — federal taxes would have to rise by almost 50 percent, immediately and permanently, according to a recent analysis by the economists Alan Auerbach and William Gale.
I do not think the vast majority of the public grasp the size of America's financial problems. After a slow growth last decade (about 2% GDP growth per year on average) we are now feeling the long lingering effects of a bank crisis. That's a really big deal. Bank crises have consequences that last far longer than recessions due to other causes. Plus, Peak Oil is approaching. The US economy is going to underperform the assumptions that go into current US government deficit projections. Far less tax revenue will flow in from an economy that will be smaller than business-as-usual economic modelers predict.
But business-as-usual modelers are already projecting deficits so large that we'll eventually hit a sovereign debt crisis. That next financial crisis will happen in part due to US Treasury bond interest rates too large for the US government to keep running deficits. The US is headed for a Greece-style crisis of confidence.
America's elites and populace act as if the United States is so rich and powerful that it is immune to a great reckoning. The current US fiscal course reflects their delusions. These delusions are headed for a collision with the limits of America's power. That collision is going to be ugly. Prepare yourself financially and emotionally.2010 March 13 SaturdayHeaded For Bigger Financial Crisis?
All crises end – this is actually Larry Summers’s famous line. We avoided a Great Depression primarily because, compared with 1929-31, we have a government sector that is large relative to the economy – and which does not collapse when credit goes into freefall. What exactly did the Obama administration do in ending the crisis that a Clinton or McCain administration – or even Bush – would not have done? The most plausible answer is: Nothing.
Geithner insists, according to John Cassidy, that the Obama administration has “proposed the biggest regulatory overhaul in seventy-five years.” This is the worst conceit. The sad and unfortunate truth is quite the opposite – because Mr. Geithner and his colleagues refused to seize the moment and didn’t break the economic and political power of anyone who mattered, they have doomed us to re-run the same horrible credit loop as before. Legislation may tweak the details, but the regulation and control of systemic risk remains just as weak as before.
Johnson believes that since the "too big to fail" banks are becoming even bigger we are setting up for a far larger crisis that might exceed the capacity of the US government to handle in a crisis.
If we continue to allow banks to grow, as they have over the last 30 years – and did again through the latest boom-bailout-rescue cycle – we head towards a day when Mr. Geithner or his successor will try to save the financial system and will fail.
You might think that is a good thing and for sure it will bring on a big change in creditor attitudes and presumably much stronger regulation. But, just as in the 1930s, first we will have to dig out from under a lot of economic rubble – and we’ll lose a lot more than 8 million jobs.
In a post entitled "Way Too Big To Save" Johnson argues that in the next financial crisis we might find ourselves faced with bailing out a future Citigroup that has assets equal to 100% of the US GDP.
Let’s take that leap of faith and say we use the favorite scheme of Gerald Corrigan from Goldman Sachs – he is widely promoting conservatorship as a transition to wind-down for large complex financial institutions – and let’s say that it “works”. Presumably this would mean something like the situation with AIG since September 2008, run somewhat more effectively –perhaps without the obnoxious bonuses. But would that really lower the fiscal costs of stabilizing the economy in the face of a major financial shock? And could we afford those fiscal costs?
Maybe. But the experience in Europe is definitely not encouraging. The Irish state is in serious trouble because major banks failed and were “saved”; let’s not even talk about Iceland (where banks assets peaked around 11-13 bigger than GDP, i.e., the size of the entire economy). And Switzerland faces serious risks – with banks that had peak assets over 8 times GDP – that the international community apparently just wants to ignore (perhaps because Switzerland is not in the G20 or the even the European Union).
In the UK, one bank (RBS) had assets that were more than GDP (1.25 times, by some estimates). Ask yourself this: if Citigroup, which was around $2.5 trillion before the crisis (including the off-balance sheet commitments, let’s call that just under 20 percent of GDP) had actually been $5 trillion, would our problems now be larger or smaller? What if Citigroup – or whoever becomes our biggest bank – reaches $10 trillion or $15 trillion in today’s dollars and then fails, how would you feel about that?
What would US government policy makers do? The Federal Reserve would be tempted to inflate away the debt. We could experience 20+% inflation for a few years. Debt holders would be forced to take a very big haircut as a way to avoid an explicit national bankruptcy.
When Peak Oil hits what I would like to know: Will the resulting downturn be inflationary or deflationary? With declining tax revenues and mounting sovereign debt I expect governments to heavily pressure their central banks to expand their money supplies so as to allow inflation to cut the cost of paying interest on existing debt. A government wanting could prepare for the Peak Oil financial crisis by issuing debt with longer maturity dates. That way when monetary policy becomes inflationary and the market demands higher interest rates a government can ride along paying low interest rates on debt issued before the crisis.Greece Still On Path Toward Debt Default
Peter Boone and Simon Johnson lay out arguments for why the Greek debt crisis is not in our rear view mirror.
By the end of 2011 Greece’s debt will around 150% of GDP (the numbers here are based on the 2009 IMF Article IV assessment; we make some adjustments for the worsening economy and the restating of numbers since that time – for example, the fiscal deficit in 2009 will likely turn out to be about 8 percent, which is double what the IMF expected until recently). About 80 percent of this debt is foreign owned, and a large part of this is thought held by residents of France and Germany. Every 1 percentage point rise in interest rates means Greece needs to send an additional 1.2 percent of GDP abroad to those bondholders.
What if Greek interest rates rise to, say, 10% – a modest premium for a country which has the highest external public debt/GDP ratio in the world, which continues (under the so-called “austerity” program) to refinance even the interest on that debt without actually paying a centime out of its own pocket, and which is struggling to establish any sustained backing from the rest of Europe? Greece would need to send at total of 12% of GDP abroad per year, once they rollover the existing stock of debt to these new rates (nearly half of Greek debt will roll over within 3 years).
This is simply impossible and unheard of for any long period of history. German reparation payments were 2.4 percent of GNP during 1925-32, and in the years immediately after 1982, the net transfer of resources from Latin America was 3.5 percent of GDP (a fifth of its export earnings). Neither of these were good experiences.
Boone and Johnson say the Greeks and other European countries have got to decide whether they are willing to pay the price to keep Greece in the Euro currency zone. Without guarantees by Germany, France, or the IMF on Greece's debt the debt interest costs will go too high and Greece will default.
But I'm less clear on how abandonment of the Euro helps. A withdrawal of Greece from the Euro zone could happen before or after a default. If Greece withdraws then its debt servicing problem remains. Greece would still have lots of outstanding debt denominated in Euros and the Greek drachma currency would drop against the Euro - making payment of existing Euro-denominated debt even harder.
What's interesting about their claims: They portray the European leaders as deceptive for pretending that the crisis is easing. They see the basic financial numbers as so bleak that the crisis looks set to escalate.
Tyler Cowen calls the article a a grim but realistic report. Paul Krugman argues that if the markets were willing to treat Greece as a very low default risk then Greece could easily afford to pay much lower interest costs on 150% GDP debt. So the question becomes: Can Greece convince the markets to treat it as a low default risk? If the markets decide Greece is a high default risk then Greece really is a high default risk.
I see another problem here: How can the Greek government maintain popular support for the austerity measures needed to prevent even higher debt accumulation if the markets decide to treat Greece as a low default risk? Absent a crisis various political factions in Greece will push for more spending for their benefit. Then the market will once again see Greece as high default risk. Interest rates demanded on new Greek debt issues will force Greece back down the path toward default.
Plans for a bailout for Greece totalling €20 to €25 billion will be put to a meeting of Eurozone finance ministers on Monday.
A system of co-ordinated bilateral moves has been agreed behind the scenes by major players among the 16 countries in the single currency, led by Germany. They will step in as a last resort if Greece requests help in meeting its huge sovereign debt repayments.
The package has been formulated to work around a "no bailout" clause in EU rules, and would amount to an agreement to facilitate loan guarantees if Athens finds the price of selling its debt pushed too high by speculators.
But this doesn't kick in immediately. The goal here appears to be to discourage the markets from driving up the interest rate of new Greek debt issues.
Wolfgang Schauble, German finance minister, has a surprisingly sensible op ed in today’s Financial Times. As we suggested yesterday, first the relevant Europeans should decide if they want to keep the euro - more precisely, who stays in and who leaves the currency union – then policy must be adjusted accordingly.
Mr Schauble is obviously correct that existing economic self-policing mechanisms are badly broken; the eurozone can only survive if there are effective monitors and appropriate penalties for fiscal and financial transgression. He is also right to fear that involving the IMF in Greece would necessarily give the Fund greater rights to kibbitz on European Central Bank monetary policy. Given the fear and loathing expressed for the IMF’s “4 percent inflation solution” (or is it 6 percent?) in eurozone policy circles, you can see why this gives the Greek prime minister some bargaining power – the Germans will do whatever it takes to keep him away from the IMF in the short-term.
If the Greeks do not get bailed out and the market senses they are going to default then the EU's rules allowing free movement of capital will allow a huge flight of capital out of Greece due to fear that Euros will get converted into Drachma. If I was a Greek right now I'd be opening a bank account outside of Greece and maybe even outside of the EU. Time to get money out of the reach of a desperate government.2010 February 28 SundayKenneth Rogoff On China And Greece
China, set to surpass Japan as the second-largest economy this year, has helped pull the world out of its deepest postwar slump. Record lending, soaring property values and accelerating economic growth prompted the government to begin retracting stimulus measures implemented during the global recession.
“Their response to the latest financial crisis clearly raised the risk that they have a debt-fueled bubble in the economy,” said Rogoff, who in 2008 predicted the failure of big American banks.
I happen to be reading and highly recommend This Time is Different: Eight Centuries of Financial Folly by Carmen Reinhart and Kenneth Rogoff. It is about the financial bubbles over centuries and the recurring pattern of claims that the bubbles weren't really bubbles because "this time is different". Nope, just another bubble.
For rapidly growing China the collapse of an asset bubble does not mean an economic contraction. Instead of growing at 9-10% per year growth will just slow down to 2-3% for about 18 months. China's long term prospects are very bright.
A collapse would depress output gains to 2 to 3 percent, a “very painful” period which would persist for about a year and a half, Rogoff said. The slowdown won’t lead to a Japan- like “lost decade,” he added. In a speech earlier yesterday, he said China will do “very well this century.”
Now that a big financial bubble has popped with widespread damage to financial institutions Rogoff sees worse troubles for other countries in the form of sovereign defaults.
Following banking crises, “we usually see a bunch of sovereign defaults, say in a few years,” Rogoff, a former chief economist at the International Monetary Fund, said at a forum in Tokyo yesterday. “I predict we will again.”
Europe is getting all the attention in terms of sovereign default risk with the PIIGS (Portugal, Iceland, Ireland, Greece, and Spain) getting the bulk of the attention. But other Eastern European countries as well as countries in Central and South America and Asia certainly must pose some risk. I'd like to know what the top sovereign default risks are globally.
GHARIB: What is the scary part?
ROGOFF: The scary part is we look at what's happening in Greece and we look at what's happening in the budget of our country. We wonder, you know, if within five years we might be having similar problems tightening our belts.
I expect America's coming sovereign debt crisis will follow California's pattern. Years of political gridlock over whether to cut spending or increase taxes will escalate for a few more years. Then a huge increase in sovereign debt costs will cause an acute crisis that forces huge cuts in the US federal budget across most categories of spending. Even entitlements will cease to be sacred. At the federal level tax increases will play a larger part of the solution. But the US government is clearly overextended and cutbacks will come in military spending, old age entitlements, medical spending for the poor, and assorted pork projects.
If the US sovereign debt crisis hits around the time world oil production starts declining then the spending cuts will have to be savage in scope as each year tax revenues plunge even if tax levels are increased.
Rogoff thinks it unlikely Greece will avoid a default in the long run.
GHARIB: What do you think is the timetable? I know it's hard to gauge. What is the timetable to resolve a crisis of this magnitude? Are we talking about months or years?
ROGOFF: Years. This is a drama in many acts. Probably they'll bring in the International Monetary Fund and then have to bring them in again. This tends to take a long time to play out. There will be ups and downs, but I think it's going to be very difficult for Greece to avoid a default in the long run.
GHARIB: So explain this to people who are listening in on this conversation. Is this really a Wall Street issue or is this a Main Street problem?
ROGOFF: Oh, this is a Main Street problem. I mean, we are in a very delicate global recovery. Unemployment is still very high. We don't want the economy to get shaken up. I mean, best guess is this is worse for Europe than the United States, but you don't want your biggest trading partner stumbling just as you're in a fragile recovery.
An excellent article in the New York Times about prospects for a Greece bail-out from Euro zone countries highlights some of the politics of whether Greece will get an EU bail-out or an IMF bail-out.
Germany is reluctant to sanction any bailout knowing that, as the euro zone’s biggest economy, it will bear the brunt of the cost. But France and Germany also believe that any recourse by Greece to the International Monetary Fund would damage the prestige of the euro, highlighting its inability to sort out internal problems.
Moreover, France’s president, Nicolas Sarkozy is said to be particularly reluctant to see a rescue orchestrated by the monetary fund, which is led by Dominique Strauss-Kahn, a Frenchman and a potential rival in the next presidential elections.
The political leaders in Germany need to show Germans that the Greeks are imposing a lot of suffering on themselves in order to justify to the German public a bail-out using German money. Will the Greeks raise their retirement age to German levels? Will they do more cuts in public sector wages and more tax increases? What's within the realm of the politically possible in Greece?2010 February 12 FridayEurope Might Bail Out Greece After All
German chancellor Angela Merkel really does not want to bail out the spendthrift Greeks. But fear of a larger debt crisis that would engulf the PIGS (Portugal, Italy, Greece, Spain) and possibly some eastern European countries like Estonia or Latvia have caused Germany to reconsider. Still at the moment all we've gotten is a big joint statement saying basically that Greece needs to be helped.
George Papandreou told Le Monde that it was important that the eurozone countries acted together to address the crisis. Papandreou said he expected fellow European leaders to support his efforts to cut Greece's debt, which is expected to hit 120% of GDP this year.
Britain, though, had already ruled out contributing to any rescue. The chancellor, Alistair Darling, said there was no plan to use UK taxpayers' money to support Greece. "The other members of the euro group want to monitor and manage the situation very carefully, they may have fresh proposals to make," Darling said.
"In a way, the Greek case signals that we are in a new phase of the global financial crisis where the forefront issue becomes fiscal sustain-ability rather than exiting the recession," Pier Carlos Padoan, chief economist at the OECD said in an interview with Reuters yesterday.
Based on projections from the International Monetary Fund, the average ratio of G20 government debt-to-GDP will reach 118% by 2014. The United States, the group's biggest member, will see its debt exceed 100% of GDP in two years' time. Its federal deficit already adds up to 10% of GDP.
Imagine what happens to US debt costs when 10 year Treasury bond interest rates go over 7%. The US government would need to pay the equivalent of over 7% of GDP just on interest costs. That'd run about $1 trillion per year. Welcome to the approaching era of high taxes and low levels of government services.
As the US sovereign debt grows the US government runs the risk of an acute crisis where suddenly the market dries up for new Treasury notes.
We are going to experience declining living standards due to accumulating government debt, the need to stop running trade deficits, a worsening demographic picture with an aging and dumbing down population, and Peak Oil.2010 February 06 SaturdayWill EU Stop Bankruptcy For Greece?
LONDON -- Governments in Athens, Madrid and Lisbon struggled on Friday to quell fears of a looming debt crisis in Europe that is pummeling the euro and rippling across global markets, as authorities vowed to impose fiscal austerity and plug their yawning budget deficits. The problem, however, is that investors don't appear to believe them.
On the one hand the French and German governments do not want a Greek loan default and probably will intervene to prevent it. On the other hand, they are reluctant to intervene and take pressure off the Greek government to cut spending and/or increase taxes. So we get to watch a game of chicken between Greece, France. Germany, and bond investors. Who will blink first?
What, me worry? Why are the markets getting worked up when Greece should be able to avoid bankruptcy for several months yet?
Senior officials at the major rating agencies on Friday played down the risk of an immediate debt crisis, saying even nations such as Greece have enough reserves to put off for months a day of financial reckoning.
With debt piling up to 113% of the economy, investors fear Greece won't pay its debts, in the form of government bonds — or will need a lifeline from other EU countries to meet its 54 billion euro ($74 billion) borrowing needs this year.
In spite of a long distinguished history of economic mismanagement continuing to this day Italy has failed to get the markets to take its rickety finances as seriously as those of Greece and Portugal. It seems unfair somehow. What do the Italians need to do to get attention?
Economy Minister Giulio Tremonti likes to remind Italy that it has "the third highest public debt in the world without having the world's third biggest economy".
Portugal, Italy, Greece, and Spain are now referred to in some financial circles as PIGS. The PIGS financial crisis. But not all analysts see their fates as so tightly bound together. What about contagion? Goldman Sachs says Greece stands above all others in financial recklessness. Ireland, Spain, Portugal, and Italy do not warrant the same degree of attention.
Ireland has made a “solid start” to consolidating its finances, Spain’s plans are “realistic and credible,” Portugal’s 2010 budget is “a beginning,” and Italy has “stronger balance sheets,” Nielsen said.
Spain has relatively low debt, but high unemployment and weak banks, and after the bursting of the housing bubble it can no longer rely on construction and inflated asset prices to propel growth.
These aspects, together with the larger size of the Spanish economy, had led Nouriel Roubini, a professor at New York University, to suggest this week that Spain is a bigger threat to the euro zone than Greece.
Writing in the New York Times Gretchen Morgenson assures us there's no way a financial contagion will spread off-planet. Your investments in asteroid mining operations and private sector Mars penal colonies are safe.
YOU know we’re in trouble when we’re told that the economic problems in Greece, Portugal and Spain, the most indebted countries in the euro zone, are likely to remain safely contained in those nations.
After all, we heard the same nonsense in 2007 from United States financial leaders talking about the subprime mortgage mess. Both Ben S. Bernanke, the chairman of the Federal Reserve Board, and Henry M. Paulson Jr., then the Treasury secretary, rolled out to reassure concerned investors that troubles in mortgage land wouldn’t permeate the rest of the economy.
As we all now know, mortgage woes were contained — to planet Earth. And so it may be with overleveraged nations in Europe.
Morgenson makes a number of good points about the failures of US policy makers in handling mortgages. I agree with her. The US government doesn't want to own up to the scale of the needed debt liquidation.2010 February 03 WednesdayMoody's Threatens US Government Bond Rating
Okay, I know the little boy cried wolf lots of times over the years and the wolf never came. But, hey, isn't there a later point in the story where the wolf finally shows up? The US government is yet another dubious borrower.
"Unless further measures are taken to reduce the budget deficit further or the economy rebounds more vigorously than expected, the federal financial picture as presented in [President Obama's Feb. 1 budget] will at some point put pressure on the AAA-government bond rating," Moody's said in a report Tuesday.
The debt trajectory isn't sustainable.
"The debt trajectory is clearly continuously upward if further measures are not implemented," Mr. Hess said.
I do not want to live thru hyperinflation or a depression. But we seem on course for some kind of economic disaster.
For the next 10 years the US Congressional Budget Office expects 2014 to be the best year with a $475 billion deficit. CBO expects the deficit to grow worse after 2020.
For the shorter-term, the CBO sees deficits of $980 billion in FY'11, $650 billion in FY'12, $539 billion in FY'13, and $475 billion in FY'14 and $480 billion in FY'15.
Looking further forward, the CBO sees deficits of $521 billion in FY'16, $525 billion in FY'17, $542 billion in FY'18, $649 billion in FY'19, and $687 billion in FY'20.
You might think that surely the US government won't let total government debt reach 100+% of the GDP. But I would have thought 10 years ago that the current debt and deficit levels would be politically impossible. Yet here we are with Obama and Congress trying to create massive new spending on health care on top of the Medicare drug benefit that George W. Bush and Congress put into place on an already financially rickety medical program.
If your retirement planning for the 2020s or 2030s includes government funding of a large part of your retirement and almost all your health care costs then think again. Expect higher taxes even in your retirement and means testing of more benefits. Also expect higher age requirements for retirement. You will work longer and pay more taxes.2010 January 31 SundayNew US Deficit Record In 2010?
A Congressional source told Reuters that the White House expects a new record one year deficit for 2010. $1.6 trillion in the red. Is that cool or what? I love it when humans strive to achieve what has never been done before.
Bill Gross of Pimco in his February 2010 column has a ring of fire around a group of industrialzed nations headed for sovereign debt crises. The United States is in that circle and will likely reach the important 90% of GDP sovereign debt threshold that is proposed by another book that I (and apparently Gross) am currently reading: This Time is Different: Eight Centuries of Financial Folly by Carmen Reinhart and Kenneth Rogoff. The book is a look at the history of sovereign financial crises. Reinhart and Rogoff built up a database of history of financial crises over many countries and 800 years. To my knowledge this is the first time a quantitative analysis on this scale has been done for sovereign debt and banking crises. The book is therefore able to offer unique insights into the frequency and triggers for financial crises.
Since the United States had such a financial crisis in 2008 and since its leadership shows no signs of developing an appreciation that we are skating on thin ice I expect we will experience a bigger financial crisis in the next 10 years or so. If the patterns Reinhart and Rogoff found are applicable to the US (and I see no reason to justify exceptionalism - look at 2008 for evidence of our fallibility) then our economic recovery will be slow for several years. Our big debt increase is no surprise to Reinhart and Rogoff:On average, government debt rises by 86 percent during the three years following a banking crisis. These indirect fiscal consequences are thus an order of magnitude larger than the usual costs of bank bailouts.
Anyone who says "this time is different" is deluded.Our immersion in the details of crises that have arisen over the past eight centuries and in the data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that "this time is different". That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy.
The book looks at inflation crises, currency crashes, currency debasement (when currencies used real metals and were debased with cheaper metals), the bursting of asset price bubbles, external debt crises, and domestic debt crises. The US has had the asset price bubble. Now it is moving on toward a debt crisis. At best US debt will weigh down the economy so that growth is slow. At worst, a bigger economic contraction could be heading our way.2010 January 03 SundayInterest Rate Rise To Trigger Euro Crisis?
Ireland and some southern European countries that are members of the Euro currency zone have run up too much public debt and some of them continue to run up sovereign debt at an alarming rate (just like the United States and Japan). A New York Times story suggests the moment of crisis could happen when economic recovery causes a sharp rise in interest rates. Suddenly sovereign governments that are already paying 1%-2.5% more than Germany on new debt will find their spread over German debt puts their cost of new bonds beyond their reach.
The true test for the world’s largest common currency zone, analysts say, will be whether it can withstand the economic, political and social strains once the European Central Bank begins to raise interest rates in response to economic improvements in Germany, France and other Northern European countries.
At that point, the laggards on the union’s fringe — Portugal, Ireland, Italy, Greece and Spain (the so-called Piigs) — will face even tougher choices to cope with what looks like several more years of stagnant economies, high unemployment and gaping budget deficits.
The higher their rates go the more the market will doubt their ability to pay and hence the market will demand even higher rates. Greece seems the likeliest candidate for such a crisis.
At that point a few choices become possible:
- Germany lends Greece a large sum of money. The Germans would find this a repugnant solution. It would enable the Greek government to keep running up more debt besides.
- Greece exits the Euro zone and borrows money from its own central bank in its reintroduced drachma currency. Then inflation makes the bonds worth less. Problem with this approach: Greece still needs to pay off large Euro bonds and an exit from the Euro would require it to use declining drachma to buy expensive Euros to pay interest and principal.
- The Greek government defaults.
- The Greek government increases VAT and other taxes to levels that drive out many of its most productive. Short term revenue boost but stagnation and crisis later.
- The Greek government must do massive lay-offs of government works and slashing of welfare state benefits.
Note that These options are not all mutually exclusive.
Whenever global oil exports start declining year after year sovereign defaults and/or high inflation will happen. If the Germans insist on a stable Euro then southern European countries will default on their debts. Outside of Europe some countries will pursue expansionary monetary policies in response to economic contraction caused by declining supplies of oil. Those countries will experience high inflation that will cut back on debt in inflation-adjusted terms.
What I would like to know: Which countries will experience inflation and which will experience deflation in response to declining world oil production?2009 August 09 SundayOdds Of Eventual US Sovereign Debt Default?
Jeffrey Rogers Hummel, an economist at San Jose State U in Silicon Valley, says eventual US federal default on sovereign debt seems likely.
What about increasing the proceeds from explicit taxes? Examine Graph 1, which depicts both federal outlays and receipts as a percent of GDP from 1940 to 2008. Two things stand out. First is the striking behavior of federal tax revenue since the Korean War. Displaying less volatility than expenditures, it has bumped up against 20 percent of GDP for well over half a century. That is quite an astonishing statistic when you think about all the changes in the tax code over the intervening years. Tax rates go up, tax rates go down, and the total bite out of the economy remains relatively constant. This suggests that 20 percent is some kind of structural-political limit for federal taxes in the United States. It also means that variations in the deficit resulted mainly from changes in spending rather than from changes in taxes. The second fact that stands out in the graph is that federal tax revenue at the height of World War II never quite reached 24 percent of GDP. That represents the all-time high in U.S. history, should even the 20-percent-of-GDP post-war barrier prove breachable.2
The point about historical tax revenue as a percentage of GDP seems persuasive. How many Americans are going to support cutting their own effective buying power by 20% to pay for US federal entitlements programs in the 2020s and 2030s? On the other hand, the people who want to get stuff from the government and the people who want them to get stuff from the government are substantial factions as well (with some considerable overlap with the people who do not want to be taxed).
Currently I see Obama doing something that is the mirror image of what Reagan tried to do. Reagan tried to cut taxes to starve government and cut its size. Obama is trying to so increase spending that taxes have to rise to support the spending programs. Once the spending programs get established they develop powerful constituencies to defend them. If Obama can enact more new spending programs he increases the odds of a call for a tax increase as the needed fiscal response.
But the problem is that government is already on an unsustainable course with growth in entitlements spending before considering new Obama entitlements such as medical insurance funded by government.
Compare these percentages with that of President Barack Obama's first budget, which is slated to come in at above 28 percent of GDP. Although this spending surge is supposed to be significantly reversed when the recession is over, the administration's own estimates have federal outlays never falling below 22 percent of GDP. And that is before the Social Security and Medicare increases really kick in. In its latest long-term budget scenarios, the Congressional Budget Office (CBO), not known for undue pessimism, projects that total federal spending will rise over the next 75 years to as much as 35 percent of GDP, not counting any interest on the accumulating debt, which critically varies with how fast tax revenues rise. However, the CBO's highest projection for tax revenue over the same span reaches a mere 26 percent of GDP. Notice how even that "optimistic" projection assumes that Americans will put up with, on a regular peacetime basis, a higher level of federal taxation than they briefly endured during the widely perceived national emergency of the Second World War. Moreover, once you add in the interest on the growing debt because of the persistent deficits, federal expenditures in 2083, according to the CBO, could range anywhere between 44 and 75 percent of GDP.3
I see about 4 possible resolutions of the coming financial crisis:
- US government default. This seems like the lowest probability outcome.
- Huge tax revenue increase. Only one way to do that: Stiff European-style Value Added Tax (VAT) that raises prices 10-20-30%. Goods and services become as expense as we see in Europe. We get a permanent large European-style welfare state but with a worse outcome. I see the people who support this as enemies.
- Inflation. This might happen thru the back door as a response to a financial crisis even bigger than what we saw last fall. The Federal Reserve's attempt to stop a panic will lead to an even bigger monetary injection than we've seen in the last year.
- Massive cuts in entitlements programs. California's fiscal crisis provides a demonstration.
If and when the US dollar ceases to be the world's reserve currency a sharp transition caused by large scale flight from the dollar could cause skyrocketing interest rates and a downturn that causes one or more of the above resolutions. We might get some combination of the latter 3 possibilities in a series of crises with different levels of contribution from each item.
The biggest mistake the Democrats are making is to assume economic growth will fund their dreams. I see demographic problems slowing economic growth as a lower skilled work force grows up to replace the smarter Baby Boomers. Also, Peak Oil is coming at most 11 years from now and possibly much sooner. Economist James Hamilton has explained in his paper Causes and Consequences of the Oil Shock of 2007-08 how oil price run-ups cause recessions. Well, our current recession is basically a rehearsal for worse recessions to come in the 2010s as a result of high oil prices. The money isn't going to be there to make the government spending scenarios above remotely possible.
As people get poorer due to Peak Oil and demographic problems they will become more opposed to taxes on what remains of their take-home income. So I'm expecting some really severe cuts in entitlements. Expect to work longer. Expect more entitlements for old folks to become needs tested. Save now because you are going to need the money in years to come.2008 November 02 SundayCurrent Financial Crisis Small Compared To What's Coming
David M. Walker, former Comptroller General of the U.S., argues that the current financial crisis is small potatoes compared to the coming unfunded entitlements US financial crisis.
At the dawn of the 21st century the U.S. had $5.7 trillion in total debt. As we approach the end of George W. Bush's presidency only eight years later, that sum has nearly doubled, thanks to war costs, tax cuts, spending increases, expanded entitlement programs, and now a welter of government bailouts and rescues.
This year was particularly bad. The federal budget deficit for fiscal 2008 hit $455 billion, up from $162 billion last year. That figure does not include the cost of the Emergency Economic Stabilization Act of 2008, which has an initial pricetag in the hundreds of billions of dollars. In fairness, some of that money presumably will come back to the Treasury, since the new rescue-related sums will be used to acquire preferred stock, mortgages, and other assets that someday could be sold at a profit.
Yet any such calculations are penny ante compared with the fiscal disaster that is bearing down on America.
The US old age entitlements are underfunded.
The U.S. Government Accountability Office (GAO), noting that the federal balance sheet does not reflect the government's huge unfunded promises in our nation's social-insurance programs, estimated last year that the unfunded obligations for Medicare and Social Security alone totaled almost $41 trillion. That sum, equivalent to $352,000 per U.S. household, is the present-value shortfall between the growing cost of entitlements and the dedicated revenues intended to pay for them over the next 75 years.
Do not plan on retiring at age 65. Here's why:
Today we are headed toward debt levels that far exceed the all-time record as a percentage of our economy. In fact, by 2040 we are projected to see debt as a percentage of our economy that is double the record set at the end of World War II. Based on GAO data, balancing the budget in 2040 could require us to cut federal spending by 60% or raise overall federal tax burdens to twice today's levels.
My guess is that the problem is much bigger than Walker expects. Calculations of the size of the unfunded liability are based on assumptions about future economic growth. These assumptions seem excessively optimistic for a couple of reasons. First off, Peak Oil is coming. That's going to cut into per capita GDP and cause the US economy to shrink for several years. Second, the aging of the US population is not the only large demographic crisis we face. Poorly performing Hispanic immigrants will cause declining per capita income in California The economy in Texas will become more like the Third World as well. The lagging groups will not get better with time. So declining per capita GDPs seem inevitable - at least until either artificial intelligence or genetic engineering overwhelm this trend. The libertarian view of immigration is deeply flawed. This means that the leftist welfare state and the libertarian dreams for a smaller government will both take big hits. So will your living standard. Plan and work accordingly.Site Traffic Info