Category Archives: The Economy

Nothing Unusual Here

Zero hedge of course. Just for the record.

Universal Basic Income

The left continues to be fascinated with the idea of re-distribution. It believes that the whole notion of some people being paid more than others is fundamentally unfair, that they must have had some advantage – skin color, parents, brains, whatever – which was just a matter of luck. “You didn’t build that,” as Obama famously said.

So the latest brainchild of this idea is the notion of a monthly check from the government that is sufficient to provide a comfortable lifestyle regardless of whether or not the recipient chooses to work.

A single program that replaced the myriad of transfer payment programs, from welfare through Social Security, would save an enormous amount of administration costs at all levels of government and help to pay for the program. The “poverty trap” would be eliminated as the payment could be “universal” that is, not means tested. Minimum wage laws would need to be abolished, of course, since the “living wage” would be redundant. Might not work, but there seems to be some potential anyway.

But that is not what is proposed. In general, it seems that this would be yet another program which would be funded by even more government borrowing. This, it is claimed, would “grow the economy by $2 trillion.” Please.

There are only two ways to grow the economy. One of these is to increase labor utilization, the number of hours worked in a given period. The other is to increase the productivity of that labor, that is the amount of output produced for each hour of labor. That’s it.

Existing programs already provide a major disincentive for work – the “poverty trap.” This would add another. Productivity is improved by investment – in technology, skills, infrastructure, etc. More spending on consumption would not help this, but would certainly provide more inflation, which would act to deter investment. If you want to see the outcome of this kinf of program, just check the news from Venezuela.

 

 

That Which Is Not Seen

Alhambra Partners

After tax, corporate profits are still slightly less in Q2 2017 than in Q4 2014, and barely more (+3.4%) than in Q1 2012 five years ago.

SocGen’s Albert Edwards:

Our Ice Age thesis has always called for US and European 10 year bond yields to converge with Japan. We still expect that to happen, with the downward crash in US yields likely to be particularly shocking. There is mounting evidence that underlying US CPI inflation has already slid into outright deflation in exactly the same way that Japan did seven years after its credit bubble burst. Hence we repeat our call for US 10y bond yields to ultimately converge with Japan and Germany at around minus 1%.

In short, stocks are grossly overvalued and Treasury bonds are similarly undervalued. Not news, of course, just some confirmation bias.

Government Shutdown?

Many voices are being raised to warn of the danger of a government “shutdown” should Congress fail to raise the debt limit.

Why, one might ask, is this so dangerous? It is simply the fact that U.S. Federal deficit is still running about 3% of GDP. Cut Federal spending back to match its income and recession will certainly ensue.

Of course, the steady accumulation of debt is even more dangerous, but less immediate. So the voices hope.

A “shutdown” would not need to be anything more than a modest 15% reduction in run rate. Inconceivable.

The Economy In One Chart

Source: WSJ

Illinois And The Tsunami

Apparently the standoff between Governor Rauner and Speaker Madigan continues. As it should. Madigan’s willingness to dispense unfunded largesse to his supporters is largely responsible for the state’s financial woes. Today also the state was ordered by a Federal court to pay its backlog of Medicaid bills, which will be interesting as the state is already cash flow negative.

However the biggest issue is the unfunded state employee pension obligations. This article from Bloomberg contains a nice graphic ostensibly showing the funding levels of most states (no data for California? Really? just check this blog)

These reported funding levels are a cruel joke. These funds continue to assume 7-8% returns, despite the fact that they have not achieved them for years. Just look at the column showing the decline in funding ratio from 2014 to 2015. Not only are the assumptions high, but they are for long-term averages, so that they adjust future return estimates higher to compensate for below-average realized returns. John Hussman’s work shows more or less zero returns for the next 12 years, with the high likelihood that there will be a major drawdown in that period. Drawdowns are lethal to pension funds because the payment of benefits continues, sapping the capital base and making recovery to previous levels nearly impossible.

Pension funds used to invest in bonds. The trustees would meet once a quarter, review the actuarial forecast of liabilities and approve adjustment of the laddered bond portfolio’s maturities to exactly meet the liability schedule. Then there would be lunch and golf. The future returns would be locked in and the contributions needed to fund the bond portfolio would be obtained from the sponsor. Everyone got to sleep at night.

Then Wall Street decided that pension funds had a lot of money, and not enough was being siphoned off into Wall Street pockets. So the sales force went out, armed with charts showing that stocks had historically offered higher returns than bonds. Higher returns mean that less contributions would be needed, so fund sponsors bought the pitch. Yes, stocks have offered higher returns but for a reason – much higher risk. Well, we’ll just assume a long-term average return and surely it will average out. GLWT.

Unexpected Outcome

People seem to be surprised that the Fed’s rate hikes have resulted in rates declining. Really? It seems pretty clear that the Fed’s outlook is at odds with reality, and that rates are responding to the real outlook, which is that Fed rate hikes are a negative for an economy that is already tanking.

The Future Is Now

Debt pulls demand forward in time. Borrowers use debt to pay for consumption today and commit future income to service the debt.

The amount available for consumption today represents the present value of that committed income, discounted by the prevailing interest rates.

The further that borrowers reach into the future, the more that discount lessens the amount available today. The Fed wants consumption today, so it attempts to induce inflation in order that borrowers are more confident of their future nominal incomes, while holding interest rates low so that the discounting of that income is minimized.

This strategy has sustained consumption in the short term, at the expense of reducing future income available for consumption.

The problem is that the future is now.

As consumption slows, so does production and inflationary pressure. Defaults rise – just look at the subprime auto loans. Yes, defaults eliminate debt – but only at the expense of the creditor who takes an immediate hit to income, charged against net worth or equity capital. Lenders are forced to reduce their assets.  Borrowers find that debt service takes more of their income than they had expected. Purchasing power erodes and deflation sets in. Spending capacity falls even more rapidly and the economy slides into recession and depression.

The larger the accumulation of debt, the longer it takes to purge the financial system and restore it to stability. Debt – credit – is a necessary and healthy part of the economic system. But the economy cannot depend on consumption funded by the continuous growth of debt. Debt must revolve, expanding and contracting within limits proportional to the size of the economy.

A Bit Of Math

Simon Mikhailovich of Tocqueville Bullion Reserve reminds us of the deadly numbers with a sobering tweet:

A bit of math. With the global debt / GDP ratio at 320% and the cost of average debt service at 2%, it takes 6.4% growth per annum just to service the debt. Not happening.

No Joy In Mudville

Well the employment report this morning was a big miss to expectations on all fronts. The household report showed a net loss of jobs, and overall the quality of jobs declined as part-time, minimum wage jobs replaced full-time. However, the VIX sellers strode in to pump up stocks, leaving Treasuries as the main beneficiary of the report, with the 30-year yielding 2.86% as I write. TRIN at 2.03 shows that while the VIX sellers hold up the mega-caps, there’s a lot of distribution going on.

Oil is trading weak, in the low 47s. Wages disappointed as the employment mix changed unfavorably, even though shortages of skilled workers are widespread.