Video: Bill Emmott's 'Good Italy, Bad Italy - Girlfriend in a Coma' (Full Video)

Why Italy Isn't In Such Bad Shape, But the U.S. and UK Are

Bill Gross runs PIMCO's huge flagship bond fund which, having engaged in an untimely shorting of U.S. Treasuries, has hit a bit of a rough patch in recent times. Some have suggested that the 69-year old might be a few years past the recommended portfolio manager retirement age and that it's no longer as useful as it once was to read his monthly investment newsletters.

Think again.

While Gross's timing on shorting U.S. treasuries has been poor, and his revealing in this month's column of memory issues is a little unnerving, his analysis of the fundamentals and medium to long-term sovereign fiscal picture remains sound.

Take his updated 'Ring of Fire II' chart, the first version of which he first published a few years back. The chart (below) plots countries by both their annual public sector deficit (y-axis), which is the difference between government spending and taxes, and what is termed a 'fiscal gap' (x-axis). The fiscal gap takes into account future expenditures, which in the U.S.'s case include entitlements such as Social Security, Medicare, and Medicaid.

As you can see from the chart Italy appears to be in better fiscal shape than several 'Ring of Fire' members like the U.S., Japan and the UK.  How is this possible? Italy has been experiencing what economists refer to as a 'speculative attack' from the sovereign bond market, while the three Ring of Fire countries are currently enjoying record low yields on their government debt. 

Continue reading the full article here.

California's Debt 6-12X Higher Than Previously Estimated

California Governor Jerry Brown thought he only had a $28 billion 'wall of debt' to deal with, but it turns out it is much larger. From the NY Times:

Directors of the State Budget Crisis Task Force said their researchers had found a lot of other debts that did not turn up in California’s official tally. Much of it involved irrevocable promises to provide pensions to public workers, health care for retirees, the cost of delayed highway maintenance and an estimated $40 billion bill to bring drinking water up to federal standards. 

They also pointed out many of the same unpaid bills from previous years that the governor had brought to light, like $8 billion in delayed payments to schools and community colleges, and $250 million that was raided from a fund dedicated to transportation and treated as revenue. 

The task force estimated that the burden of debt totaled at least $167 billion and as much as $335 billion. Its members warned that the off-the-books debts tended to grow over time, so that even if Mr. Brown should succeed in pushing through his tax increase, gaining an additional $50 billion over the next seven years, the wall of debt would still be there, casting its shadow over the state.

First, $40 billion for drinking water? As a longtime Bay Area resident I've regularly sung the praises of San Francisco's water and had no idea the rest of the state's water was so far off the mark.

Second, it is important to keep figures like California's estimated $335 billion debt in perspective. According to Wikipedia, California has the world's ninth largest economy with a 2010 gross state product (GSP) of $1.9 trillion, or 13% of the United States gross domestic product. Assuming the top end $335 billion debt figure is accurate that works out to only a 17% debt to GDP ratio for the state. Compare that with Japan's and U.S. federal governments's approximately 225% and 100% debt to GDP ratio's, respectively.

Having said that, the significance of these new debt estimates should not be underestimated, particularly when you consider how politically difficult it has been for Brown and the California legislature to address a shortfall which was estimated as a small fraction of the true debt.

Other than the NY Times article, which was cross-published at CNBC, this news is getting zero attention. This is somewhat surprising given that the independent panel includes former Federal Reserve Chairman Paul Volcker. However, I couldn't find anything on either the LA Times or the San Francisco Chronicle's website on this topic.

"Those whom the gods would destroy, they first encourage to borrow cheaply"

Today's must read on the next financial panic.

Video: Simon Johnson's White House Burning

Video: Carmen Reinhart vs. Paul Krugman

This event occurred back in June but the video just surfaced.

Watch live streaming video from nytimesopinion at livestream.com

Steve Keen on How He Saw "It" Coming and Why We're in a Depression

A must watch interview with Economist Steven Keen, the first part of which is embedded below (remaining parts can be found here).

Video: Kyle Bass' Full BBC Hardtalk Interview

"Capitalism without bankruptcy is like Christianity without Hell" and other choice comments from the hedge fund manager profiled in Michael Lewis' most recent book, Boomerang.

h/t Zerohedge

Quote of the Day: On the Megabank-Government-Central Bank Axis

Portuguese President Anibal Cavaco Silva is calling for the ECB to go beyond just being a lender of last resort to banks and to become one for his and other European governments. Specifically, he's calling on the ECB to make "unlimited" purchases of EU sovereign debt. This may be the first time one of Europe's leaders has publicly asked the ECB to take this step.

Would such a move by the ECB be a sound one? From a recent editorial in the FT:

"If governments stand behind banks and banks stand behind governments and the central bank lends freely to both and also underwrites financial markets, then financial asset prices become completely detached from economic reality. In this “system”, the central bank implementing more quantitative easing is no different, in economic terms, from Bernie Madoff marking up his client accounts every month."

From 'Circular commitments lead to a Ponzi economy'.

More on the distinction between what is meant by being a lender of last resort to banks versus the governments here and why lender of last resort to sovereign countries is the proper role for the IMF.

What If We Paid Off The Debt? The Secret U.S. Government 'Life After Debt' Report

This secret report was obtained through a Freedom-of-Information request by NPR:

The copy of Life After Debt we obtained reads "PRELIMINARY AND CLOSE HOLD OFFICIAL USE ONLY." 

The report was intended to be included in the official "Economic Report of the President" — the final one of the Clinton administration. But in the end, people above Jason Seligman decided it was too speculative, too politically sensitive. So it was never published.

Here's more:

The report is called "Life After Debt". It was written in the year 2000, when the U.S. was running a budget surplus, taking in more than it was spending every year. Economists were projecting that the entire national debt could be paid off by 2012. 

This was seen in many ways as good thing. But it also posed risks. If the U.S. paid off its debt there would be no more U.S. Treasury bonds in the world. 

"It was a huge issue.. for not just the U.S. economy, but the global economy," says Diane Lim Rogers, an economist in the Clinton administration.

The U.S. borrows money by selling bonds. So the end of debt would mean the end of Treasury bonds. 

But the U.S. has been issuing bonds for so long, and the bonds are seen as so safe, that much of the world has come to depend on them. The U.S. Treasury bond is a pillar of the global economy.

Banks buy hundreds of billions of dollars' worth, because they're a safe place to park money. 

Mortgage rates are tied to the interest rate on U.S. treasury bonds. 

The Federal Reserve — our central bank — buys and sells Treasury bonds all the time, in an effort to keep the economy on track. 

If Treasury bonds disappeared, would the world unravel? Would it adjust somehow?
"I probably thought about this piece easily 16 hours a day, and it took me a long time to even start writing it," says Jason Seligman, the economist who wrote most of the report.
It was a strange, science-fictiony question. 

Full story and audio clip here.

h/t Barry.

Links to Chapters in Michael Lewis' New Book 'Boomerang'

Besides a new preface, which Zerohedge has done a nice job highlighting here, Michael Lewis' new book Boomerang is a collection of his previously written stories about the financial problems of various European countries and one U.S. state (California).

Below are links to each of those stories in the order of their publication. They're all worthwhile and still very relevant.

 1. Wall St. on the Tundra (Iceland)

2. Beware of Greeks Bearing Bonds (Greece)

3. When Irish Eyes Are Crying (Ireland)

4. It’s the Economy, Dummkopf! (Germany)

5. California and Bust (California)

Video: Kyle Bass on the Worldwide Problem of Too Much Debt

Link to Kyle's video presentation here.

Kyle, btw, is the protagonist in Michael Lewis' latest book, Boomerang. Zerohedge has posted some of the highlights about Kyle from the book here. 

Interactive Global Debt Clock

Courtesy of The Economist

The clock is ticking. Every second, it seems, someone in the world takes on more debt. The idea of a debt clock for an individual nation is familiar to anyone who has been to Times Square in New York, where the American public shortfall is revealed. Our clock shows the global figure for all (or almost all) government debts in dollar terms. 

Does it matter? After all, world governments owe the money to their own citizens, not to the Martians. But the rising total is important for two reasons. First, when debt rises faster than economic output (as it has been doing in recent years), higher government debt implies more state interference in the economy and higher taxes in the future. Second, debt must be rolled over at regular intervals. This creates a recurring popularity test for individual governments, rather as reality TV show contestants face a public phone vote every week. Fail that vote, as the Greek government did in early 2010, and the country can be plunged into imminent crisis. So the higher the global government debt total, the greater the risk of fiscal crisis, and the bigger the economic impact such crises will have.

h/t zerohedge

Video: Pimco's El-Erian Explains Financial Repression

Video: Michael Lewis on the New Third World

Michael Lewis on Bankrupt California

It's Michael Lewis week here at the PolyCapitalist.

His latest in a series of financial disaster pieces he's been penning for Vanity Fair is about his home state of California. The whole article is a must-read (here's a link to the full article) but below are a some of the highlights:

But when you look below the surface, he adds, the system is actually very good at giving Californians what they want. “What all the polls show,” says Paul, “is that people want services and not to pay for them. And that’s exactly what they have now got.” As much as they claimed to despise their government, the citizens of California shared its defining trait: a need for debt. The average Californian, in 2011, had debts of $78,000 against an income of $43,000. The behavior was unsustainable, but, in its way, for the people, it works brilliantly.

On the fiscal nightmare that is the City of San Jose...

The ex-Governator

The relationship between the people and their money in California is such that you can pluck almost any city at random and enter a crisis. San Jose has the highest per capita income of any city in the United States, after New York. It has the highest credit rating of any city in California with a population over 250,000. It is one of the few cities in America with a triple-A rating from Moody’s and Standard & Poor’s, but only because its bondholders have the power to compel the city to levy a tax on property owners to pay off the bonds. The city itself is not all that far from being bankrupt. 

By 2014, Reed had calculated, a city of a million people, the 10th-largest city in the United States, would be serviced by 1,600 public workers. “There is no way to run a city with that level of staffing,” he said. “You start to ask: What is a city? Why do we bother to live together? But that’s just the start.” The problem was going to grow worse until, as he put it, “you get to one.” A single employee to service the entire city, presumably with a focus on paying pensions. “I don’t know how far out you have to go until you get to one,” said Reed, “but it isn’t all that far.” At that point, if not before, the city would be nothing more than a vehicle to pay the retirement costs of its former workers. The only clear solution was if former city workers up and died, soon. But former city workers were, blessedly, living longer than ever. 

This wasn’t a hypothetical scary situation, said Reed. “It’s a mathematical inevitability.” In spirit it reminded me of Bernard Madoff’s investment business. Anyone who looked at Madoff’s returns and understood them could see he was running a Ponzi scheme; only one person who had understood them both­ered to blow the whistle, and no one listened to him. (See No One Would Listen: A True Financial Thriller, by Harry Markopolos.) 

“How on earth did this happen?” I ask him. 

“I think we’ve suffered from a series of mass delusions,” he says. 

I didn’t completely understand what he meant, and said so. 

“We’re all going to be rich,” he says. “We’re all going to live forever. All the forces in the state are lined up to preserve the status quo. To preserve the delusion. And here—this place—is where the reality hits.” 

...and the bankrupt hell that is the City of Vallejo:

On the way back to the elevators I chat with two of Mayor Reed’s aides. He’d mentioned to me that, as bad as they might think they have it in San Jose, a lot of other American cities have it worse. “I count my blessings when I talk to the mayors of other cities,” he’d said. 

“Which city do you pity most?” I ask just before the elevator doors close.

They laugh and in unison say, “Vallejo!” 

I notice on his shelf a copy of Fortune magazine, with Meredith Whitney on the cover. And as he talked about the bankrupting of Vallejo, I realized that I had heard this story before, or a private-sector version of it. The people who had power in the society, and were charged with saving it from itself, had instead bled the society to death. The problem with police officers and firefighters isn’t a public-sector problem; it isn’t a problem with government; it’s a problem with the entire society. It’s what happened on Wall Street in the run-up to the subprime crisis. It’s a problem of people taking what they can, just because they can, without regard to the larger social consequences. It’s not just a coincidence that the debts of cities and states spun out of control at the same time as the debts of individual Americans. Alone in a dark room with a pile of money, Americans knew exactly what they wanted to do, from the top of the society to the bottom. They’d been conditioned to grab as much as they could, without thinking about the long-term consequences. Afterward, the people on Wall Street would privately bemoan the low morals of the American people who walked away from their subprime loans, and the American people would express outrage at the Wall Street people who paid themselves a fortune to design the bad loans. 

The evolutionary explanation underpinning society's collective behavior:

The road out of Vallejo passes directly through the office of Dr. Peter Whybrow, a British neuroscientist at U.C.L.A. with a theory about American life. He thinks the dysfunction in America’s society is a by-product of America’s success. In academic papers and a popular book, American Mania, Whybrow argues, in effect, that human beings are neurologically ill-designed to be modern Americans. The human brain evolved over hundreds of thousands of years in an environment defined by scarcity. It was not designed, at least originally, for an environment of extreme abundance. “Human beings are wandering around with brains that are fabulously limited,” he says cheerfully. “We’ve got the core of the average lizard.” Wrapped around this reptilian core, he explains, is a mammalian layer (associated with maternal concern and social interaction), and around that is wrapped a third layer, which enables feats of memory and the capacity for abstract thought. “The only problem,” he says, “is our passions are still driven by the lizard core. We are set up to acquire as much as we can of things we perceive as scarce, particularly sex, safety, and food.” Even a person on a diet who sensibly avoids coming face-to-face with a piece of chocolate cake will find it hard to control himself if the chocolate cake somehow finds him. Every pastry chef in America understands this, and now neuroscience does, too. “When faced with abundance, the brain’s ancient reward pathways are difficult to suppress,” says Whybrow. “In that moment the value of eating the chocolate cake exceeds the value of the diet. We cannot think down the road when we are faced with the chocolate cake.”

Lewis concludes on an optimistic note:

When people pile up debts they will find difficult and perhaps even impossible to repay, they are saying several things at once. They are obviously saying that they want more than they can immediately afford. They are saying, less obviously, that their pres­ent wants are so important that, to satisfy them, it is worth some future difficulty. But in making that bargain they are implying that, when the future difficulty arrives, they’ll figure it out. They don’t always do that. But you can never rule out the possibility that they will. As idiotic as optimism can sometimes seem, it has a weird habit of paying off.

For more Michael Lewis, both past and present, simply click on the tag with his name at the bottom of this post.

Review Roundup for Michael Lewis' New Book - Boomerang: Travels in the New Third World

Below are a list of reviews published so far. And here are links to all the chapters in the book, which were previously published in Vanity Fair (except the book's preface on Kyle Bass).

NY Times

Telegraph

Forbes

Washington Post

Amazon customers

Video: Carmen Reinhart on a Decade of Debt

Here is a link to audio only versions of Carmen's presentation and the Q&A.

Graphic: Who Holds Sovereign Debt? 70% of U.S. Debt Held by Government Entities

Courtesy of Global Macro Monitor:

Here’s a great chart just released by the International Monetary Fund. Note that almost half — 47 percent – of the US$14.7 trillion U.S. federal government debt is held by the Federal Reserve and the government itself, such as the Social Security trust fund. Add to that the 22 percent foreign official holdings (mainly central banks) and almost 70 percent of the debt of the U.S. government is held by non-market/non-profit oriented public sector entities. Stunning! 

It’s also interesting to hear Europeans quote the $14.7 trillion (apx. 100% of GDP) figure while U.S. officials like to refer to marketable or debt held by the public, which totals US$10.1 trillion (apx. 75% of GDP).

(click to enlarge)

Barry Eichengreen on What Could Replace the U.S. Dollar

Professor Eichengreen explains the current state of the world's reserve currencies and makes the argument for GDP-indexed bonds here.