13/6/17: Four Months of the Invisible Fiscal Discipline

U.S Treasury latest figures (through May 2017) for Federal Government’s fiscal (I’m)balance are an interesting read this year for a number of reasons. One of these is the promise of fiscal responsibility and cutting of public spending and deficits made by President Trump and the Republicans during last year’s campaigns. The promise that remains, unfortunately, unfulfilled.

In May 2017, cumulative fiscal year-to-date Federal Government receipts amounted to $2.169 trillion, which is $30 billion higher than over the same period of 2016. However, Federal Government’s gross outlays in the first 8 months of this fiscal year stood at $2.602 trillion, of $57.345 billion above the same period of last year.As a result, Federal deficit in the first 8 months of FY 2017 rose to $432.853 billion, up 6.77% y/y or $27.44 billion.

Given that 4 out of the 8 months of FY 2017 were under the Obama Presidency tenure, the above comparatives are incomplete. So consider the four months starting February and ending May. Over that period of 2017, Federal deficit stood at $274.274 billion, up 11.17% or $27.569 billion on February-May for FY 2016. In this period, in 2017, Trump Administration managed to spend $51.9 billion more than his predecessor’s presidency.

You can see more detailed breakdown of expenditures and receipts here: https://www.fiscal.treasury.gov/fsreports/rpt/mthTreasStmt/mts0517.pdf but the bottom line is simple: so far, four months into his presidency, Mr. Trump is yet to start showing any signs of fiscal discipline. Which raises the question about his cheerleaders in Congress: having spent Obama White House years banging on about the need for responsible financial management in Washington, the Republicans are hardly in a rush to start balancing the books now that their party is in control of both legislative and, with some hefty caveats, the executive branches.

6/1/2013: Houston, we've got a (US) problem?..

2013 biggest Grey Swan might be not China's slowdown or Euro area's continued debt crisis (although both are pretty much still on the books, although the former is less likely than the latter). It might not even be the Japanese economic implosion (albeit Japan is sick beyond any repair)... oh, no... the real Grey Swan of 2013 might be the markets starting to take a closer look at the US.

This might sound bizarre during the weekend following Friday, when the VIX index collapsed 39.1% - more than in any other trading day in its history, and when the US markets have ended the first week of the year with total gains almost equivalent to what some are projecting for the entire 2013... and yet... as some would say: "Houston, we've got a problem!"

The problem is best illustrated in the following three sets of chart, all comparing US fiscal performance to the peers.

Structural Deficits:

As two charts above highlight, the US Government structural deficits are massive. Since 2011, these are shallower than those of Japan (and Japan's figures in charts above are likely to become even worse following the latest Government appointment and their commitment to debase/in-debt the Japanese economy out of existence) but they are the worse in the entire G7 group save for Japan. More ominously:

• The IMF is predicting the structural deficit to worsen once again starting in 2015
• The above projections by the IMF do not reflect the disastrous consequences of the 'Fiscal Cliff' deal struck on December 31, 2012 (see here).
• In 2013, US structural deficit is projected to be around 5.49% of GDP against the G7 average of 3.04%
• In 2010-2017, according to the IMF projections, the US cumulated structural deficits will add up to 44.84% of GDP - against Japan's 58.53% and the G7 average of 24.97%. For 2013-2017, the same figures are: US 21.43%, Japan 33.31% and G7 average 10.48%. In other words, things are going to get worse in the US compared to G7 average in 2013-2017 than they were in 2010-2012. They will be worse still in Japan, but everyone expects Japan to remain the sickest member of G7, so there is little surprise or repricing that can be expected before the US risks are repriced.

Primary Deficits:

Ugly picture for the US vis G7 counterparts continues with primary deficits as well. Per above:

• The US is the second weakest link in G7 in terms of primary deficits
• In 2010-2017 period, the US is expected to generate cumulated primary deficits amounting to 37.65% of GDP and this is against Japan's 52.42%, but G7 average of 15.99%. In the period from 2013 though 2017, the US cumulated primary deficits are expected to come in at 14.21% of GDP against the G7 average of 3.54% of GDP and Japan's 25.73% of GDP. Once again, relative to G7 average, the US performance is expected to worsen in 2013-2017 compared to 2010-2012.

A table to summarise the above two sets of charts on a longer time horizon scale:

Government Debt:

The US is positioned as the third weakest G7 economy in terms of levels of Government debt it carries - after Japan and Italy. However, this analysis neglects the fact that according to the IMF projections, the US debt situation is expected to continue worsening through 2016 (when US debt is expected to peak at 114.19% of GDP), while Italian situation is expected to improve from 2013 peak of 127.85% of GDP into 2017. Similarly, compared to G7 average, the US debt dynamics post-2013 are unpleasantly convergent to the higher G7 average (driven by Japan's debt levels).

Stripping out Japan from debt analysis:

• In 2001, US debt to GDP ratio stood at 11.83 ppt below G7 (ex-Japan) average. By 2012 this number has reversed into US debt overshoot of G7 average by 10.06 ppt. By 2017 the same overshoot is expected to rise to 19.57 ppt.

Table below summarises the long-range view of the charts above:

To summarise the above evidence, the US debt levels are not sustainable in the long run, even though current growth (above debt financing costs) and funding costs (exceptionally low yields on Government bonds and the printing press effect on these yields) are delivering short-term sustainability. However, as shown above, the US primary deficit ius huge and not abating fast enough. This implies debt to GDP ratio will be rising into 2016, if not after. Which, in turn, implies rising susceptibility of the US to risk-repricing in the markets.

It is worth contrasting the US case with that of Italy and Japan. In Italy's case, there is significant surplus on the primary balance and overall deficit due to high cost of funding even higher debt, compounded by economic growth well below the cost of funding the state debt pile. In Japan - there are severe problems across all parameters: high primary deficits, growth well below the cost of debt funding, and debt pile so large that structural deficits are alarming.

All of which means that all three economies can be severely tested by the markets. As long as global economic environment remains that of subdued economic activity, so that risk aversion remains high and monetary policies remain extremely accommodative, the US is out of the investors' crosshairs and Italy is in. Should these environments change, all bets are off for the US - at least in the medium- to longer-term.

2/1/2013: The Bitter ATRA Fudge

Some say never shall one let a good crisis go to waste... US Fiscal Cliff 'deal' of December 31st is an exact illustration. Here is the list of pork carriages attached to the Disney-styled 'train' of policies the US Congress enacted.

Have a laugh: http://www.nakedcapitalism.com/2013/01/eight-corporate-subsidies-in-the-fiscal-cliff-bill-from-goldman-sachs-to-disney-to-nascar.html

And to summarise the farcical output of the Congressional effort:

• The American Taxpayers Relief Act (ATRA) has raised taxes on pretty much everyone. Taxes up means growth down. Now, recall that the US economy is not exactly in a sporting form to start with (link here).
• The payroll taxes cuts are not extended into 2013 so every American is getting whacked with some 2% reduction in the disposable income, taking out $115 billion per annum (the largest revenue raising measure in the ATRA) out of households savings, investment and consumption, or under 1% of annual personal consumption.
• The super-rich (or just filthy-rich, take your pick, but defined as those on joint incomes at or above $450K pa) will see income tax rising to 39.6% and will have to pay an additional 0.9% in Medicare tax to cover that which they will not be buying - the Obamacare. They (alongside anyone earning above $250K pa) will also pay 3.8% additional tax on 'passive' income - income from capital gains and dividends for same Obamacare.
• Dividends and CGT are raised from 15% to 20% (again for joint earners above $450K pa).

Meanwhile, the US has already breached the debt ceiling and the ATRA has done virtually nothing to address the deficit overhang. So in a summary, the 'deal' is a flightless dodo flopping in the mud of politics. There are no real cuts on the expenditure side, there are loads of tax hikes that are likely to damage demand and investment and lift up the cost of capex funding for the real economy. And there is simply more - not less - uncertainty about the future direction of policy, as the White House and the Congress are going to be at loggerheads in months to come dealing with the following list of unaddressed topics:

1. Spending cuts
2. Budget deficit
3. Further tax hikes
4. Debt
5. Reforms of the entitlements system
6. Growth-retarding effects of ATRA and Obamacare.

Obamanomics have delivered fudged recovery, fudged solutions to structural crises and real, tangible increases in taxation. The latter is the 'first' since 1993.

8/11/2012: A quick look at the 'fiscal cliff'

So with US elections over and status quo confirmed as the preferred option by the American voters, it's time to look at the 'fiscal cliff'. Not my favourite reading at night, but... here are some factoids and opinions:

Pictet's 'rough estimate':

And Barclays summary of alternative scenario forecasts:

Their analysis prior to the elections:
"The Congressional Budget Office has noted9 that if the fiscal cliff hits, ie, the stipulations under the current law are not changed or pushed forward (referred to as a “punt”), the fiscal tightening could lead to economic conditions in 2013 that would probably be considered a recession, with real GDP declining 0.5%, a 2.5-2.7% swing from 2012 GDP. This scenario is not our base case; we see 2012 and 2013 GDP at roughly 2.2% and 2%, respectively, as we expect new legislation to address broader fiscal concerns in the context of near-term stability. That being said, we believe the chances of going of the fiscal cliff temporarily are higher if President Obama is elected ...This supports the view that near-term risk-off (ie, breakeven steepener) sentiment is more likely in a Democratic win. In any case, the ultimate outcomes under both administrations are likely to be similar."

And: "The final question relates to the approach each administration would take to put the US on a sustainable medium term fiscal path. Here again, there are two very different plans. That passed by the Republican House focuses heavily on spending cuts ($6trn vs. the CBO alternative scenario), while the president’s plan relies more on revenue increases. The House plan pushes debt/GDP down to 62% by 2022 but implies heavier fiscal tightening than the president’s budget, which takes debt/GDP to 76%".

Note that the US is likely to face much steeper impact of the fiscal cliff than other countries:

Source: Goldman Sachs Research

JP Morgan: 

" Overall, we now see cliff-related fis- cal issues subtracting about 1%-pt from growth next year, up from our prior assessment of 0.5%-pt. The table ... summarizes our expectations regarding fiscal cliff outcomes. ...There are other important non-cliff fiscal issues, such as declining defense spending, which are not the topic of this note. (We estimate these non-cliff fiscal measures have subtracted about 1%-pt from growth relative to trend over the past year, and will sub- tract a similar amount in the coming year.)"

In contrast, here's the IMF view: "On the fiscal cliff in the United States, we believe that it must be avoided. It would entail a tightening of fiscal policy of roughly 4 percent of GDP and would plunge the American economy back into recession, with deleterious consequences for the rest of the world. You mentioned that fiscal adjustment has to happen in the U.S. to avoid a downgrade. Indeed, what we are advocating is a fiscal withdrawal, an adjustment of about 1 1/4 percent of GDP, which would entail that a number of the so-called Bush tax cuts could be prolonged, and that other measures that have helped support the economy can be prolonged too. But in the end, there would still be an adjustment, a reduction in cyclically adjusted terms of the fiscal deficit of 1 1/4 percent of GDP, and this puts the U.S. economy on track toward better public finances. What is much more important in all of this is that in the end there is a medium-term plan that is being developed that explains very clearly how the deficit is then brought down further over the next five years, and beyond, from the still high level that it would have next year."

Which is consistent with the IMF earlier Article IV assessment: "Ongoing political gridlock could block an agreement on near-term tax and spending policies. If all temporary tax provisions were to expire and the automatic spending cuts to take effect, the 2013 fiscal contraction would be very sizable
(over 4 percent of GDP). This “fiscal cliff” would reduce annual growth to around zero, and the economy would contract in early 2013. Even if the “fiscal cliff” were quickly unwound, the damage to the economy could be substantial, especially if consumers and businesses were faced with continued uncertainty about tax and spending policies. These strong negative growth effects would in part reflect the limited effectiveness of monetary policy at the zero interest rate bound. Some anticipatory effects from the cliff could be felt already in late 2012, with spending held back by policy uncertainty—subtracting perhaps ½ percent from (annualized) growth in the second half of 2012 according to the Congressional Budget Office (CBO)."