7/6/17: Equity Markets Continue to Mis-price Policy Risks

There has been some moderation in the overall levels of Economic Policy Uncertainty, globally, over the course of May. The decline was primarily driven by European Uncertainty index falling toward longer-term average (see later post) and brings overall Global EPU Index in line with longer term trend (upward sloping):

This meant that short-term correlation between VIX and Global EPUI remained in positive territory for the second month in a row, breaking negative correlations trend established from October 2015 on.

The trends in underlying volatility of both VIS and Global EPUI remained largely the same:

The key to the above data is that equity markets risk perceptions remain divorced from political risks and uncertainties reflected in the Global EPUI. This is even more apparent when we consider actual equity indices as done below:

Both, on longer-run trend comparative and on shorter term level analysis bases, both S&P 500 and NASDAQ Composite react in the exactly opposite direction to Global Economic Policy Uncertainty measure: rising uncertainty in the longer run is correlated with rising equities valuations.

7/6/17: Markets, Investors Exuberance and Fundamentals

Latest data from FactSet on S&P500 core metrics is an interesting read. Here are a couple of charts that caught my attention:

Look first at the last 6 months worth of EPS data through estimated 2Q 2017 (based on 99% of companies reporting). The trend continues: EPS is declining, while prices are rising. On a longer time scale, EPS have been virtually flat in 2014-2016, but are forecast to rise nicely in 2017 and 2018. Whatever the forecast might be for 2018, 2017 increase would do little to generate a meaningful reversion in EPS to price trend

However, the good news is, expectations on rising EPS are driven by rising sales for 2017, and to a lesser extent in 2018. This would be (if materialised) an improvement on the 2014-2016 core drivers, including shares repurchases (chart below).

Next, consider P/E ratios:

As the chart above indicates, P/E ratios are expected to continue rising in the next 12 months. In other words, the markets are going to get more expensive, relative to underlying earnings. Worse, on a 5-year average basis, all sectors, excluding Financials, are at above x14. Hardly a comfort zone for 'go long' investors. The overvalued nature of the market is clearly confirmed by both forward and trailing P/E ratios over the last 10 years:

Forward expectations are now literally a run-away train, relative to the past 10 years record (chart above), while trailing (lagged) P/Es are dangerously close to crisis-triggering levels of exuberance (chart below).

In summary, thus, latest data (through end-of-May) shows continued buildup of risks in the equity markets. At what point the dam will crack is not something I can attempt to answer, but the lake of investors' expectations is now breaching the top, and the spillways aren't doing the trick on abating them.

6/6/17: Trump, Paris, Climate: The Problem is Bigger than COP21

U.S. withdrawal from Paris Climate Accord has been described by various policymakers, analysts and journalists around the world as a travesty, betrayal of the environment, and the surrender of the U.S. leadership (from undefinable 'global leadership' to historically incorrect 'environmental leadership'). In reality, it is none of the above, despite the fact that it does not bode well for the future of environmental policies worldwide and for the environment in general.

Paris Agreement: Taking an Unnecessary 'Exit' Route

The reasons for why the U.S. 'exit' from Paris deal is more rhetorical than tangible are numerous, but here are some major ones.

1) Paris COP21 Agreement was never ratified by the U.S. so, technically-speaking, the Trump Administration has managed to 'exit' what the U.S. has not 'entered' into in the first place. Let me explain, briefly: the Paris climate agreement (the Paris COP21 Agreement) was "adopted" via a Presidential executive order on September 2016. This raised a range of questions - at the time barely-covered by the media - as to the validity of such an order. Unlike normal executive orders, the Treaty adoption was committing the U.S. to an agreement with a four-year breaking clause period, thus de facto binding the one-over Presidential Administration to Obama Administration order. In contrast to the U.S., all other signatories to the agreement required ratification by their legislatures or via other constitutionally-stipulated procedures. The U.S. was unique, to-date, in not seeking domestic ratification. 

A constitutional position - that the Paris treaty should not be treated as an ordinary 'executive order' agreement was expressed by some legal scholars who view the Paris agreement as more than a simple executive agreement. Bodansky (2016) points to the fact that COP21 adoption via an executive order belongs to a category of commitments that "have a long, heretofore undiscovered [constitutional] pedigree." In other words, the actual act of 'adoption' of the Paris agreement by the U.S. can be legally shaky and it is shaky especially given that there is clearly not a chance that the COP21 can be ratified by the current Congress. 

As the result, Trump Administration did not claw back on U.S. international commitment, but it did renege on President Obama's international commitment. The U.S. is not equivalent to President Obama, unless we get comfortable with an idea of Presidents residing above the Constitution. Which, given the current White House resident, might be the case of 'watch what you wish for'.

2) President Trump has committed to withdrawing from the agreement some time in late 2020, and potentially, given the questionable constitutionality of the agreement validity in the first place, some time after that or never. The Paris Agreement allows withdrawal only following a four year delay period, after the agreement coming into power. If the U.S. adoption of the agreement requires approval by the Congress, the actual date of the treaty coming into power can be set as the date of such an approval. And the four year delay period will have to start from that date. I am not a legal scholar, so I am speculating on this, but it might just be the case that the U.S. might technically remain within Paris agreement past 2020 election and into the next Administration. 

3) Now, consider the gargantuan misrepresentation of the nature of the Paris agreement by the Trump Administration. The President made repeated statements that Paris agreement imposes severe burdens on the U.S. economy, with potential for costing some 2.7 million American jobs. In reality, the agreement is a non-binding and non-enforceable commitment. If the U.S. faced with severe damages to its economy from Paris commitments, instead of withdrawing from the accord, the Washington could simply reduce promised deliverables and let its emissions reduction targets lapse. There would have been no repercussions for the U.S., beyond bad PR (the same bad PR that is already forthcoming). In fact, one of the reasons that Nicaragua (one of only two non-signatories, alongside Syria) refused to join the agreement was that the SOP21 lacked meaningful enforcement and had no commitment obligations with respect to targets. 

In other words, Trump Administration 'exited' an accord that had, materially, no legally binding power to change anything. Which also flies in the face of the President claiming he can re-negotiate U.S. position in the Paris agreement. Why would you need to renegotiate that which can be changed unilaterally at will?

As the Paris Agreement is a non-binding and non-enforceable, calling the U.S. participation in it an example of U.S. 'leadership' is nonsense. Calling the U.S. withdrawal from it a 'tragedy' is a case of hysterical overreaction. And, equally, calling it 'draconian' in terms of its potential impact on the U.S. is pure demagoguery. 

Policies, not Non-binding Treaties, Matter

What really is of concern here is not the U.S. participation or non-participation in the Paris COP21 Agreement, but the Administration's policies on the environment, including matters relating to President Trump's desire to 'resurrect' the U.S. coal industry, and his push for more oil and gas production, as well as his attitudes to the EPA, the plans to open up commercial and mining / extraction development on protected Federal lands, etc, etc, etc. 

These policies are worth criticising and fretting about. COP21 is only tangentially material to them. 

In fact, President Trump's obsession with making 'coal great again' is worrying not only from environmental perspective, but also from economic development perspective, and it exemplifies the Administration's bizarre view of the U.S. economy. For a number of reasons, which I don't have room to discuss here at length, but are worth mentioning in passing. 

Much of the decline in coal's fortunes from 2012 on is accounted for by non-environmental policy factors. As the report shows, growth in energy supply from natural gas accounted for 49 percent of the total market share loss accruing to coal. Further 26 percent of coal's decline was down to a drop in overall demand, and 18 percent was accounted for by renewables. Only 3-5 percent of coal's market share decline was down to Obama Administration's environmental regulations.

Someone has told President Trump a porky: clawing back on Obama's environmental regulations would have saved, at most, only 2,900 coal miners jobs out of 58,000 lost during the 2012-2016 period. Though even that figure is highly questionable, as research linked above suggests that the true number of jobs saved would be closer to 1,700. 

Here's a chart from the above-linked study estimating jobs impact of the President Trump's policies favouring coal:

The U.S. leadership on the environment comes through with all its shoddy 'glory' in coal's fortunes history. High coal prices in the first decade of the century were driven by the demand for energy from China and, arguably, by sky high global price of oil. As Chinese demand fell, starting, in 2011, the U.S. environmental leadership turned out to have little to do with globally collapsing demand for coal and coal prices or with an ongoing substitution away from more CO2-intensive fossil fuels in the global energy production mix. Active Chinese shift away from coal to other sources of energy plus decline in the rate of growth on Chinese energy demand drove down global prices, accounting for almost half of the entire decline in the U.S. (and global) coal's fortunes.

In simple terms, coal hardly makes any sense as a target for either investment, or jobs creation, or economic value added creation. Not because the U.S. is leading the world on the environmental policies, but because China is shifting its energy mix toward cleaner alternatives. Worse, improving coal demand outlook makes even less sense for an Administration that actively promotes more gas production and exports. President Trump is missing the main point of changing global economy: no one wants coal anymore. Nor do many want more supplies of oil and gas, as clearly evidenced by collapse in worldwide prices of these sources of energy. 

Another point shows that the alleged U.S. leadership on environmental policies has been bogus at best, even during the 'environmentally conscious' Obama era. The very reason why the COP21 Agreement was left without an enforceable commitment mechanism and with a unilaterally adjustable targets is... the U.S. push for these features of the agreement. During the treaty negotiations, it was the U.S. that insisted on undermining the treaty strengths in order to increase the number of signatories. And although the U.S. was one of the countries that insisted on public monitoring of the Paris Agreement progress, such insistence was little more than rhetorical, given the fact that global research into CO2 emissions would have provided de facto public disclosure of countries' progress.

COP21: A Problem Was Always Bigger than the Solution

Confused, yet? You shouldn't be. The problem with the Paris agreement is the same as the problem with the U.S. 'leadership' on the environment and is identical to the broader problem of so-called global 'leadership' on the environment: there is no material will on behalf of core countries (including the U.S., but excluding Europe) to do anything serious about setting, achieving and enforcing robust and meaningful environmental targets. 

Paris agreement in and by itself is a fig leaf of decorum. Being a part of it or being outside of it are rhetorical positions, more designed to shore up symbolism of 'something being done', than actually doing what would be needed to address a wide-ranging case of environmental degradation and depletion of the natural capital. Note: environmental problems vastly exceed carbon emissions, alone, despite the fact that media and politicians are hell-bent on talking primarily about carbon.

Which brings us to another mystery, worth mentioning in passim, again due to space constraints. What constituency does President Trump serve in withdrawing from the agreement? Not getting drawn into speculating about the right- v left- wing opportunism, here are the simple facts: the Paris Agreement is more popular than the President himself. November 2016 survey by the Yale University showed broad-based support for the treaty and the U.S. participation in it. Some snapshots from the survey:

• 69% of registered voters said "the U.S. should participate in the international agreement to limit climate change (the Paris COP21 agreement), compared with only 13% who say the U.S. should not";

• 66% of registered voters "say the U.S. should reduce its greenhouse gas emissions, regardless of what other countries do", aka independent of the COP21; 

• "A majority of registered voters want President-elect Trump (62%) and Congress (63%) to do more to address global warming";

• "A majority of registered voters say corporations and industry should do more to address global warming (72% of all registered voters; 87% of Democrats, 66% of Independents, and 53% of Republicans)". Which means that, based on party affiliation, in each party, including the Republican party, majority of voters support greater action on global warming;

• When it comes to 'making coal great again', 70% of U.S. registered voters "support setting strict carbon dioxide emission limits on existing coal-fired power plants to reduce global warming and improve public health, even if the cost of electricity to consumers and companies would likely increase – a core component of the EPA’s Clean Power Plan. Democrats (85%), Independents (62%) and Republicans (52%) all support setting strict limits on these emissions". Again, we have majority support even amongst the Republicans;

• "A large majority of registered voters say the Federal government should prepare for the impacts of global warming, prioritizing impacts on public water supplies (76%), agriculture (75%), people’s health (74%), and the electricity system (71%)".

1. Carbon intensity of the global economy will continue to fall, irrespective of whether the U.S. presidential administration likes it or not. The reasons for this go beyond simple carbon accounting, and deeper into the issues of public health, quality of life and changing energy intensities of production. The transfer is happening not from the U.S. to foreign destinations, but from the U.S. carbon-intensive economy to the U.S. carbon-reducing economy. The same transfer is happening in other economies. Here's an OECD report on the trend and potential for such transfers. More partisan on the issue NDRC had this report on jobs generation in the alternative energy sector.

1. Reductions in carbon intensity of production are not a zero sum game, but rather create opportunities for innovation, increasing value added, deepening the customer base and improving efficiencies in production and investment. Environmental market worldwide is estimated at USD 1.4 trillion in just 'advanced energy' segment, of which the U.S. domestic market accounts for just 1/7th. Cleantech market size is USD 6.4 trillion, and so on. An example of the opportunity space open for business investment and development in the environmental services, energy and manufacturing sectors is so significant that days after President Trump's decision to exit COP21, the State of California signed a long-term agreement with China to engage in joint development of "climate-positive" technologies and emissions trading. Ironically, few years back, Chinese carbon permits system drove the global carbon markets off the cliff. Today, Beijing is trying to position itself as a positive player in rebooting these markets.

1. Environmental protection (and policies aimed at alleviating the adverse impact of global warming) is more than a market for new goods and services. From both economic and (more importantly) social perspectives, it is also about improving quality of air, quality of water (e.g. here and here), public health (for example, here) and food security (e.g. here and here). In the end, treating environment as part of our productive, long-term investable, tangible capital, is more about preventing future social suffering and unrest than about earning profits. But, even for those politicians solely concerned with jobs and financial or economic bottomline, the case for environmental protection-led economic development is very strong.

x

So the really puzzling matter for the Trump Administration and the U.S. political elites (namely the Republicans' dominated Congress) is: what on Earth are they doing in dismantling the environmental policies in a wholesale fashion? 

President Trump, and a range of his advisers, appear to believe that environmental policies are zero-sum game, transferring income, wealth and jobs from 'traditional' (carbon-intensive) sectors of the U.S. economy to foreign competitors. Which is simply false. For a number of reasons, again worth touching here:

Incidentally, China's commitments (or pledges) prior to the COP21 clearly show that its leadership sees all three of the above points as salient for the country future. Back in 2014, the Chinese government has promised to peak its emission by or before 2030, first time ever setting a deadline for peak emissions. It also promised to increase the renewables share in its energy mix to 20% by the same date. Doing this will require China to instal some 800-1000 gigawatts of carbon-free energy generation capacity, or more than its current coal capacity and close to the total current market size for electricity generation in the U.S. The Obama Administration claimed credit for 'bringing China' to agree on these environmental targets, but reality is quite different: Beijing is desperate to clean up its urban environment, claw back on severe pollution of its water sources and secure some sort of sustainable agriculture and food production. Of course, not is well on the Chinese front either. As a side note, those who are worried about China taking the leadership jersey from the U.S. on environment, should read this report: like the U.S., China is producing more rhetoric than action.

In short, the problem of addressing huge gaps between political rhetoric and the reality of our deteriorating global environment remains insurmountable to our political leaders. President Trump's extreme position on COP21 is just an outlier to the cluster of politicians worldwide who are strong on promises and media soundbites, yet unable and unwilling to develop a global policy framework that can deliver measurable, enforceable and transparent commitments on the environment. The problem of finding a solution to continued depletion of our natural capital around the world remains larger than COP21. With the U.S. 'leadership' in it, or without.

26/5/17: Defense Stocks Valuations: U.S. Budgets and Military Conflicts Engagements

Our new paper on U.S. Defense Budgets, military conflicts engagements and their impact on defense industry equity valuations is now available on SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2975368.

23/5/17: U.S. Mint Gold Coins Sales 1Q 2017

Updating, with a lag, my data for U.S. Mint sales of gold coins, here is 1Q 2017 in its full glory.

Total sales of U.S. Mint gold coins stood at 221,500 oz in 1Q 2017, down from 363,000 oz in 4Q 2016 and down on 305,500 oz in 1Q 2016. However, 1Q 2017 sales were better than 1Q sales in both 2014 and 2015.

Total number of coins sold by the U.S. Mint stood at 438,000 in 1Q 2017, down on 647,500 in 1Q 2016. In terms of number of coins sold, 1Q 2017 was the slowest of all 1Q periods since 1Q 2012.

Average weight per coin sold was 0.5057 oz/coin, stronger than in 1Q 2016 (0.4718 oz/coin) and stronger than 1Q average coin weight for 2014 and 2015.

Monthly data, plotted alongside historical and period averages shows that more recent months (especially April) posted weak sales performance.

Meanwhile, a look at quarterly aggregates indicates that while 1Q was weaker than 4Q 2016, it is still in line with the generally upward trend that has been present (with some serious volatility) since the end of 2013.

Both, the monthly series and the quarterly aggregates indicate relatively stable and strong negative correlations between the price of gold and the demand for U.S. Mint coinage over the last 6 months within the range of -0.62 and -0.84.

23/5/17: Eurocoin: Growth Momentum Slips Marginally in April

A quick update to the old-running series: Eurocoin, the leading economic growth indicator for the euro area, published by CEPR and Banca d'Italia posted another (second in a row) moderation, falling from 0.7 in March 2017 to 0.67 in April. The indicator remains at the upper range of growth for the current upside cycle, and within lower range of growth compared to previous upside cycle:

On the drivers side, stock markets valuations helped to push growth forecast higher, while a slowdown in industrial activity pushed growth expectations lower. In other words, absent the financial assets impact, growth indicator would be much lower.

While euro area overall HICP was at 1.9% in April (bang at the upper range of ECB's target), 12mo trailing average inflation rose to 0.8% from 0.7% in March. Which means the ECB has moved out of the 'policy corner' and is now positioned to start unwinding assets purchasing programs. It will proceed gradually and at a later date, due to political, not monetary reasons.

Meanwhile, although Eurocoin averaged 0.72 in 1Q 2017, actual growth came in at (first estimate) 0.5%. This marks the largest gap between Eurocoin and actual growth since 2Q 2014. This is hardly surprising. In general, the gap between leading indicator-implied growth forecast and actual growth outrun is usually wider during periods of elevated uncertainty about the economy, and especially when financial economy takes over as a major contributor to overall economic growth outlook.

22/5/17: Eurogroup and Greece: Wrestling Defeat from the Claws of Victory

Today's Eurogroup meeting on Greece ended in no agreement and extends the current tranche negotiations into June 15, the date of the next Eurogroup meeting.

For the background:

• Greece is an economy brought to its knees by the Eurogroup and the ESM, as detailed in a range of facts well-summed up here: http://blogs.lse.ac.uk/eurocrisispress/2017/05/01/greece-any-better-times-or-more-pitfalls-ahead/; and
• Greece is now back in a recession, with dire consequences for both, the economy and the Greek society, and for fiscal targets and programs previously agreed by the Eurogroup: http://trueeconomics.blogspot.com/2017/05/18717-greece-in-recession-again.html.

The key sticking point so far is the scheduling of future primary surpluses (budgetary surplus before the debt servicing costs are factored in). The Eurogroup insists on these surpluses running at 3.5% of Greek GDP for the first 5 years following 2018, declining to 2% or 2.2% (depending on the version of the draft agreement) for 2023-2060. 

In very simple terms, such commitments are absolutely bogus (and dangerous). They are bogus because there is absolutely no way anyone can project growth rates out to 2060 from today that can be in any way reasonably accurate to predict primary surpluses. They are dangerous, because they will shackle Greek governments to running buffer funds to compensate for possible recessionary and non-cyclical shocks to the primary surpluses. These buffers will imply underinvestment within the Greek economy (public investment) over the long term. Which, of course, will damage the Greek economy and increase the risk of non-compliance with the deficit rules.

Here is how unrealistic the current proposed targets are. Consider, first, IMF projections (April 2017 data) for primary surpluses over the next 5 years (2018-2022). Remember, Greek target (grey line) is 3.5% for that period:

With exception of Italy, no other advanced euro area economy comes even close to the proposed target. And no one is making a case that Italy running these surpluses is somehow consistent with structurally strong growth expectations over the period.

Now, consider past and present performance, based on 10 years windows. For 10 years window, Greek target surplus is 2.85% per annum:

The view is a bit brighter. 

In the 1990s, two countries managed to run surpluses at or above the target set for Greece forward: Belgium and Ireland. Both countries were recovering from substantial fiscal crises of the late 1980s-early 1990s.  But, unlike Greece today, both countries benefited from exogenous shocks that boosted significantly their surpluses and growth: Belgium gained substantial income transfers from growth of the EU institutions, and Ireland gained from a large scale FDI boom. Neither country needed to run large scale public investment programmes financed from own (internally-generated) funds. 

In the 2000s, Belgium continued to run large surpluses and it was joined in this by Finland. Belgium surpluses drivers remained the same, while Finland carried out substantial fiscal consolidation in the wake of the early 1990s crisis timed perfectly to coincide with rapid economic growth in the economy. 

In simple terms, no advanced euro area economy has managed to run surpluses expected of Greece at the times of adverse economic growth conditions or immediately after a major recession.

As I noted in the earlier post on the Greek economy (see http://trueeconomics.blogspot.com/2017/05/18717-greece-in-recession-again.html), the state of Greek economy has been so highly uncertain over the last few years, that any projections 3-4 years out from today are simply an example of a delirious wish-for-thinking. In this environment, setting targets out to 2060 is absurd, and dangerous, for it commits Greece to targets that may or may not be to the benefit of the Greek economy and sets up the euro area fiscal policy architecture for a failure at the altar of extreme conviction in technocratic targeting. 

22/5/17: The Economist Calling a Bubble in Cryptos? Why not...

A very interesting chart from The Economist from last week providing evidence on rapid evolution of cryptocurrencies:

Source here

In basic terms, the value of cryptocurrencies market has risen to over USD60 billion, tripling within less than 6 months of 2017, while trading across cryptocurrencies markets has increased tenfold to ca USD 2 billion per day (average) and 38 initial coin offers have been launched in 2017 so far.

What is also notable is that Ripple is now on par with Ethereum and their combined valuation is now a challenger to Bitcoin.

Uncharacteristically for The Economist,  the publication that never sees a bubble until it pops is calling a bubble in the cryptos. Perhaps due to a freshly acquired consciousness of empiricism or due to the publication's innate distaste for anything not-state-centric. Still, given the exponential growth so far this year, cryptos are overdue a major correction. When and how will it be triggered is anyone's guess.

22/5/17: U.S. Autoloans Market: Careless Lending, Defaulting Buyers

Auto loans are now coming through as a growing concerns area in terms of U.S. household credit. Auto loans originations have risen, in total volume from $123.9 billion in 1Q 2016 to $132.4 billion in 1Q 2017, an all-time high for 1Q period on record. Total volume of auto loans debt outstanding is at $1,167 billion, up on $1,071 billion in 1Q 2016 and at an all-time record. Year on year growth in auto loans is at 9%.

However, origination has been more subdued in 1Q 2017 for subprime loans, with issuance for credit score below 620 falling to $25.9 billion in 1Q 2017 compared to $26.9 billion a year ago. Likewise, near-sub-prime originations (credit scores 620-659) also declined, from $16.1 billion in 1Q 2016 to $15.6 billion in 1Q 2017.

However, owing to rapid growth in recent years in sub-prime originations, auto loans currently exhibit third highest rate of delinquencies across all forms of household debt, with 3.82 percent of all auto loans currently 90+ days delinquent, the highest since 1Q 2013 and up on 1Q 2016 reading of 3.52 percent.

As noted in a recent Bloomberg article (see https://www.bloomberg.com/news/articles/2017-05-22/subprime-auto-giant-checked-income-on-just-8-of-loans-in-abs), much of the problem arises from sloppy, or outright careless, origination by some key lenders. 

22/5/17: U.S. Public Pensions System: Insolvent to the Core

A truly worrying view of the U.S. public sector pensions deficits has been revealed in a new study by Joshua D. Raugh for Hoover Institution. Titled “Hidden Debt, Hidden Deficits” (see http://www.hoover.org/sites/default/files/research/docs/rauh_debtdeficits_36pp_final_digital_v2revised4-11.pdf) the study opens up with a dire warning we all have been aware of for some years now (emphasis is mine):  “Most state and local governments in the United States offer retirement benefits to their employees in the form of guaranteed pensions. To fund these promises, the governments contribute taxpayer money to public systems. Even under states’ own disclosures and optimistic assumptions about future investment returns, assets in the pension systems will be insufficient to pay for the pensions of current public employees and retirees. Taxpayer resources will eventually have to make up the difference.”

Some details: “most public pension systems across the United States still calculate both their pension costs and liabilities under the assumption that their contributed assets will achieve returns of 7.5–8 percent per year. This practice obscures the true extent of public sector liabilities.” In other words, public pension funds produce outright lies when it comes to the investment returns they promise to generate. This, in turn, generates delayed liabilities that are carried into the future, when realised returns come in at some 3-4 percent per annum, instead of promised 7.5-8 percent.

How big is the hole? “In aggregate, the 564 state and local systems in the United States covered in this study reported $1.191 trillion in unfunded pension liabilities (net pension liabilities) under GASB 67 in FY 2014. This reflects total pension liabilities of $4.798 trillion and total pension assets (or fiduciary net position) of $3.607 trillion.” This accounts for roughly 97% of all public pension funds in the U.S. Taking into the account the pension funds’ penchant for manipulating (in their favor) the discount rates, the unfunded public sector pensions liabilities rise to $4.738 trillion.

“What is in fact going on is that the governments are borrowing from workers and promising to repay that debt when they retire. The accounting standards allow the bulk of this debt to go unreported due to the assumption of high rates of return.”

Actually, what is really going on is that the governments create a binding contract with their employees to loot - at some point in the future - the general taxation funds to cover the shortfalls on these contracts. How much looting is on the pensions liabilities? Take the unfunded liability estimate of $4.738 trillion. And consider that in 2014, total revenues collected by state and local governments stood at $1.487 trillion. Pensions deficits alone amount to 3.2 times the underwriters’ income. In household comparative terms, this is like having a full 100% mortgage on a second home, while still running a full 100% mortgage on primary residence (day-to-day expenses).

Or, put more cogently, the entire system is insolvent. And is getting more insolvent, the longer the local and state governments refuse to use more honest accounting models.

Couple of charts to illustrate

CHART 2: State Contributions: Actual vs Required to Prevent Rise in Unfunded Liability

Now, observe in the above: the distance between the green triangle (required contributions) and the blue dot (actual contributions) is the gap in public pensions funding that has to be extracted to make the contracts whole. This will either have to come from tax hikes or from increased contributions from the public sector workers or from cut in future benefits to these workers. Or from all three.

In a range of the states, e.g. California, New Jersey, Illinois, etc we are already facing draconian levels of taxation, and falling real incomes of private sector workers. In a range of other states, municipal and local taxes are high, while the cost of living increases are swallowing income growth. In other words, there is not a snowball’s chance in hell these gaps can be funded from general taxation in the future.

When all ameliorating assumptions are made (to the upside for public pensions schemes), Raugh concludes that “despite markets that performed well during 2009–2014, state and local government pension systems are still underwater by $3.4 trillion. With relatively poor performance in fiscal years 2015 and the first part of 2016, this figure is likely to be even larger today. Finally, the report reveals the extent to which state and local governments are in fact not running balanced budgets. While they contribute 7.3 percent of their own-generated revenue to pensions, the true annual ex ante, accrual-basis cost of keeping pension liabilities from rising is 17.5 percent of state and local budgets. Even contributions of this magnitude would not begin to pay down the trillions of dollars of unfunded legacy liabilities.”

Yes, the entire system of public pensions is insolvent. No surprise there. And there is not enough fiscal space to recover from that insolvency without cutting benefits, raising taxes and hiking employee contributions. No surprise there either. Finally, although Raugh does not say so himself, it is pretty clear that there is zero will on either side of the Washington’s political divide to do anything tangible to address the problem.


Note: you can read a series of previous posts covering various sides of household debt in the following threads: Total Household Debt http://trueeconomics.blogspot.com/2017/05/19517-us-household-debt-things-are-much.html; U.S. Social Security Insolvency  http://trueeconomics.blogspot.com/2017/05/19517-reminder-social-security-is-only.html, and Student Loans Explosion http://trueeconomics.blogspot.com/2017/05/21517-student-loans-debt-bubble-is.html).

21/5/17: Student Loans Debt: The Bubble is Still Inflating

Having covered the latest news on the U.S. household debt continued explosion (see http://trueeconomics.blogspot.com/2017/05/19517-us-household-debt-things-are-much.html) and the ongoing deepening of the long term insolvency within the U.S. Social Security system (here: http://trueeconomics.blogspot.com/2017/05/19517-reminder-social-security-is-only.html), let’s take a look at the second largest source of household debt (after mortgages): Student Loans.

According to the data from the New York Federal Reserve, 1Q 2017 total volume of student loans outstanding in the U.S. was USD1.344 trillion, up on USD 1.310 trillion in 4Q 2016, marking the highest level of Student Loans debt in history. However, the Fed methodology does not include some of the more predatory types of loans extended to students.  This means that other sources report student debt at the end of 2016 to be between USD 1.44 trillion and USD 1.5 trillion (see for example https://studentloanhero.com/student-loan-debt-statistics/).

Setting aside the issues relating to data reporting, even by the official U.S. Fed standards, student loans debt is almost double the U.S. households’ credit cards debt, and is more than 10 percent higher than combined credit cards and HE revolving debt volumes.

Crucially, default rates on Student Loans are currently higher (at 11%) than for any other form of debt (credit cards defaults, second highest, are at around 7.45%).

With an average debt load of over USD36,000 per student, the expected Fed rates hikes through 2017 alone are likely to take some USD 270.00 per annum from household budgets already under severe strain from low income growth, and sky high and rising rents.

Meanwhile, the U.S. bankruptcy code now excludes Student Loans from protection, courtesy of 2005 Congressional decision, presided over by Joe Biden. Of course, Biden’s political machine was supported by one of largest student loans underwriter, the MBNA. President Obama promised to undo Biden’s changes to the bankruptcy code, but in the end did absolutely nothing to keep his promise and, in fact, made matters worse (https://www.bloomberg.com/news/articles/2015-10-14/obama-administration-hits-back-at-student-debtors-seeking-relief).  Subsequently, during his Presidential election campaign, Donald Trump said “That's probably one of the only things the government shouldn't make money off -- I think it's terrible that one of the only profit centers we have is student loans.”  Since election, however, the Trump Administration is yet to do anything on the issue.

In simple terms, American students have no friends in high places… but legislators like Joe Biden can roam free across campuses and events extolling own ethical virtues… for a fee... often paid for by students' tuitions.

19/5/17: A Reminder: Social Security is Only Getting More Insolvent...

On foot of my earlier post on U.S. household debt, it is worth mentioning another, much-overlooked in the media, fact concerning U.S. real economic debt crisis. This fact is a staggering one, even though it has been published a year ago, back in April 2016.

Based on the 2016 OASDI Trustees Report, officially called "The 2016 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds" (see link here: https://www.ssa.gov/oact/TR/2016/index.html).

• U.S. Social Security's total income will exceed total cost of Social Security payouts through 2019. However, beyond 2019, interest income and money taken out of reserves will have to cover the funds required to offset Social Security's annual deficits until 2034.
• Assuming the U.S. Presidential Administrations and the Congress continue business as usual approach to Social Security, the federal government payroll taxes will only be able to cover roughly 75% of scheduled retirement benefits until 2090
• As the result, the Social Security Administration now projects that unfunded obligations will reach USD 11.4 trillion by 2090 or some $700 billion higher than the USD 10.7 trillion shortfall projected a year ago
• Worse:  on an "infinite horizon" basis (netting Social Security expected future liabilities from forecast revenues) Social Security will face a USD 32.1 trillion in unfunded liabilities by 2090, or staggering USD 6.3 trillion more than 2015 projection

Chart below plots forecast Social Security unfunded liabilities corresponding to each forecast year:

The above clearly shows that the Social Security 'stabilisation' achieved in 2014-2015 is now not only erased, but is set back to what appears to be a rapid acceleration in liabilities back to 2008-2014 trend.

Yes, Social Security is a system in which people pay in taxes for an 'allegedly' ringfenced program that is supposed to supplement retirement. No, Social Security is not a program that is actually contractually ringfenced to provide anything whatsoever to those who pay into it. Which, really, means that the default on Social Security is looming large for the millennials and subsequent generations. And this raises the issue of what will happen to pensions provision across the entire U.S. Currently, even public sector pensions (across states and municipalities) are facing severe uncertainty and, in an increasing number of cases, actual cuts. Which raises public reliance on Social Security just at the time that the Social Security system is facing higher threats of insolvency. 

Meanwhile, household debt situation is getting from bad to awful (see this post: http://trueeconomics.blogspot.com/2017/05/19517-us-household-debt-things-are-much.html). 

The status quo is a prescription for a social, economic and political disaster. No medals for guessing what the Congress is doing about it all.