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.

Video: Richard Duncan on The New Depression

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.

Video: Michael Burry 2012 UCLA Commencement Address

How Some U.S. States Subsidize Other States

With the political battle over government spending raging across the globe the story of how some U.S. states are subsidizing others is getting more attention.

Here is a good post on this topic from the NY Times Economix blog with several useful links, as well as the below chart showing how much extra federal spending each state receives beyond each federal tax dollar paid into the federal government by that same state's taxpayers.

(click to enlarge)

And here is a map plotting the above data.

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From the chart and map you can see that in 2005 the state of New Mexico received back over twice the amount of money it paid into the federal government. 

In contrast, the state of New Jersey received $0.61 back on every dollar it paid into the federal government. 

In short, the New Jerseyans are subsidizing the New Mexicans via tax transfers conducted at the federal level.

Another observation is that just 17 states received back less than what they paid in while 32 received more back (Rhode Island received back exactly what it paid in). In other words, a minority of states are subsidizing the majority.

More from the NY Times:

Readers contemplating the table will discover in it a certain paradox — that those residents who most often denounce big government and call for sharp cuts in government spending often benefit themselves from such spending or live in regions that receive significant government support. This was also noted by the Tax Foundation. In presenting the data in the form of a geographic map, the foundation wryly observes: 

As you can see from the map, states that get the “worst deal” — that is, have the lowest ratio of federal spending to taxes paid — are generally high-income states either on the coasts or with robust urban areas (such as Illinois and Minnesota). Perhaps not coincidentally, these “donor” states also tend to vote for Democrat candidates in national elections. Similarly, many states that get the “best deal” are lower-income states in the Midwest and South with expansive rural areas that tend to vote Republican.

In other words, there is correlation between the above map and the below map which shows general U.S. Presidential voting patterns for Republicans (dark red solidly Republican, light red leans Republican) and Democrats (dark blue solidly Democrat, light blue leans Democrat), and white states a toss up.

Bottom line: the subject of some states, which primarily vote Democrat in the Presidential election, subsidizing Republican voting states is a topic that could generate significant political friction in the years ahead.

Will the Next Decade Be Dominated by America?

'Tis the season for predictions and STRATFOR's George Friedman has come up with a whopper.

The first chapter of his new book has been posted here. The main provocative claims is that the American 'Empire' will continue to be dominant over the next decade.

Will it? Here are a couple comments on Friedman's chapter:

First, I would take some issue with simplifying the Great Depression down to having originated in Germany. The role of Germany in the Great Depression does actually deserve more popular credit than it receives, but the scholarly consensus would not agree with Friedman's assertion that its "roots" reside in Germany.

Second, on his main argument, the IMF is projecting that China's economy will surpass the U.S.'s (on a purchasing power parity basis) in just five years in 2016. The EU economy is already larger than the U.S.'s. and has blocked U.S. mergers (e.g., GE's attempted acquisition of Honeywell).

Yes Europe has problems, and yes China may be experiencing the Mother of All Bubbles. But for Friedman to argue that the U.S.'s relative power in the next decade will be anything like it has been over the past 20 years seems incredibly optimistic and naive. The U.S. would appear to be at a significant cyber-warfare disadvantage compared to China at present (Update: within a few hours of this post STRATFOR's website was hacked and private client data posted on the internet). The U.S. has also failed to demonstrate that it can keep the nuclear weapons genie in the bottle in potentially hostile parts of the world. China is developing its first world class navy in 600 years. In short, examples abound of the U.S.'s relative power weakening.

Friedman writes about the U.S.'s need for a regional strategy. One interesting and rarely discussed possible outcome of the fiscal crunch facing America is the potential for unprecedented regional infighting inside the United States. For example, how difficult is it to imagine Texans questioning whether their tax dollars should continue subsidizing Maine, Oregon and Vermont? Or Californians funding Sarah Palin's Alaska?

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This is the exact argument which is taking place in Europe right now between Germany and Greece. Yes, there are large differences between American and European social cohesion. But I would not be surprised to see growing regionalization within the U.S. as a key emergent theme in the years to come. In the absence of existential external threats the justification for an extremely powerful and centralized U.S. federal state is more open to question.

Overall, Friedman's chapter is written from the perspective of an all-powerful emperor and not from one bearing witness to the paralysis which has gripped Congress in recent years. I'm also not sure he has a firm grasp on some of the social-demographic shifts which are emerging nor the current economic/financial situation.

In short, this chapter seems more a treatise on how Friedman would prefer to see the world than how it actually is.

Video: Jeffrey Sachs Full LSE Talk on The Price of Civilization

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.

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: Carmen Reinhart on a Decade of Debt

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

Video: Robert Shiller on Why Housing Has Not Bottomed

Book Review: 'Sustainable Wealth' By Axel Merk

Axel Merk’s Sustainable Wealth is very readable personal finance guide to today’s increasingly complex investment world. The book contains a wealth of practical information, and it can be particularly useful for novice investors who are interested in learning more about the role of macro forces and currencies, and how they influence markets.

About the Author

Axel was born in Munich, Germany and grew up in a family of investors. It was during college that he first began investing on behalf of clients. His academic training is in finance and computer science, and he has lived in many parts of Europe before relocating to the U.S. He is the founder and CIO of Merk Investments, a Palo Alto, California based mutual fund focused on currencies. In his personal life he is a distance runner and pilot, and he is married with children. Axel Merk also gives regular media interviews and periodically writes for SeekingAlpha.

Sustainable Wealth

With his book, written following the financial crisis in 2008, Merk aimed to reach an audience that is intelligent and interested but not necessarily educated in economics or currencies. While Merk runs a currency mutual fund, the book is not aimed at currency traders. Rather the book primarily targets the man in the street who is concerned with the actions of today’s policymakers. In the book Merk describes the pressures between where the market would like to go and the interference run by policymakers. Understanding this pull-push dynamic is at the heart of Sustainable Wealth.

One of the key themes of the book is the idea that “there is no such thing as a safe asset” and that investors may want to take a diversified approach to something as “mundane as cash”. The book contains a number of helpful, easy to understand explanations about the fundamental nature of the world’s current debt problem, and ways to address it on a personal level.

During an interview, Merk emphasized his independent opinion. That certainly can bee seen with his often seemingly minority view on the euro versus the U.S. dollar over the past 12+ months. Other than the temporary slide in the euro last summer to $1.18, Merk’s view on the euro has more or less proven correct. However, it is worth keeping in mind that Merk runs a currency mutual fund inside the United States, and that one of the ways in which more American investors would take an interest in his fund is if they are concerned about the fate of the U.S. dollar.

Continue reading the full review at SeekingAlpha here.

Video: Raise the Debt Ceiling Rap

A little late to spot this one, but it's well done and will be relevant again in a few months time when the debt ceiling vote comes up again.

The Root of All Sovereign-Debt Crises (and How to Prevent Them)

A good read and interesting suggestion from Professor Amar Bhidé and Nobel Prize Winner Edmund S. Phelps on how to put a permanent end to sovereign debt crises.

Chart of the Day: U.S. Debt Ceiling Over Last 30 Years

Why Bankrupt America Needs a Third Political Party

From Boston University Professor Laurence Kotlikoff:

The Republicans and Democrats have done a terrible job of managing our country and economy, transforming the American dream into a nightmare. They’ve squandered our youth and wealth in endless wars we couldn’t win, and spent six decades running an intergenerational Ponzi scheme, racking up huge official and unofficial debts for our children to pay. 

By some measures, the U.S. is now in worse fiscal shape than Greece. True, our official debt is a much smaller percentage of economic output. But our unofficial debt is much larger. The unofficial debt includes primarily the obligation to pay 78 million baby boomers roughly $40,000 a head each year of their very long retirements in Social Security, Medicare and Medicaid benefits. To get our overall fiscal gap under control, the U.S. must cut spending or raise tax revenue by $20 trillion over the next decade, far more than either the president wants or the House Republicans seek.

Full must read op-ed at Bloomberg.

Reinhart and Rogoff on Why Heavily Indebted Economies Can't Grow

Coinciding with Moody's placing the U.S. debt rating on negative review, Carmen Reinhart and Ken Rogofff remind us that country's will high debt levels often struggle to grow (attention Paul Krugman, they're talking to you!):

Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP. Nevertheless, many prominent public intellectuals continue to argue that debt phobia is wildly overblown. Countries such as the U.S., Japan and the U.K. aren’t like Greece, nor does the market treat them as such. 

Indeed, there is a growing perception that today’s low interest rates for the debt of advanced economies offer a compelling reason to begin another round of massive fiscal stimulus. If Asian nations are spinning off huge excess savings partly as a byproduct of measures that effectively force low- income savers to put their money in bank accounts with low government-imposed interest-rate ceilings -- why not take advantage of the cheap money? 

Although we agree that governments must exercise caution in gradually reducing crisis-response spending, we think it would be folly to take comfort in today’s low borrowing costs, much less to interpret them as an “all clear” signal for a further explosion of debt. 

Several studies of financial crises show that interest rates seldom indicate problems long in advance. In fact, we should probably be particularly concerned today because a growing share of advanced country debt is held by official creditors whose current willingness to forego short-term returns doesn’t guarantee there will be a captive audience for debt in perpetuity. 

Those who would point to low servicing costs should remember that market interest rates can change like the weather. Debt levels, by contrast, can’t be brought down quickly. Even though politicians everywhere like to argue that their country will expand its way out of debt, our historical research suggests that growth alone is rarely enough to achieve that with the debt levels we are experiencing today. 

The full Reinhart and Rogoff article can be found here.

Roubini on the Eurozone: 'Messy marriages lead to messy divorces'

Nouriel Roubini

Some of the other choice quotes:

• 'when Greece folds like a wet gyro, and it will...'
• 'the politicians at these meetings will not be the same ones at a similar meeting in two years'
• 'but if the marriage doesn’t work, even the threat of a messy divorce cannot keep couples together that are not a long-term match'
• 'Let me suggest to my fellow US citizens that you really pay attention to this. If you think that we can somehow avoid making difficult choices by kicking the can down the road, watch the European theater. And coming to a theater near you in a few years will be a real Japanese monster movie. Godzilla on steroids.'

Roubini's full analysis on why Greece and other PIIGS will ultimately be left with no choice but to exit the euro and return to their respective currencies (e.g., the Greek drachma) here.

Video: Niall Ferguson on Why Larry Summers is Wrong, the Germany-ECB Spat, and Fixing the U.S.

Video here.