| Case for Gold vs. the Case for Treasuries; Is Bill Gross Talking His Book or Talking Reality? Posted: 02 Oct 2013 10:15 PM PDT On October 1, Bill Gross stated U.S. Will Avoid 'Catastrophic' Default on Debt, stating the odds of a default are "a million-to-one". Is that reality, or is Bill Gross talking his book? The answer is yes, to both. The odds of default are probably far greater than a million-to-one. "The Treasury is not going to default on their debt simply because the debt ceiling isn't going to be raised. There will be other repercussions like slower economic growth. But the Treasury is not going to default." said Gross. I strongly agree. I suggest the debt ceiling will be raised by October 17, and probably a lot sooner. Moderate Republicans will cave in soon. But even if they don't, there will not be a treasury default. Where are Treasury Yields Headed? With default silliness, out of the way, let's turn our focus on a far more serious question: Where are Treasury Yields Headed? Reuters reports Pimco's Gross: Low interest rates may persist for decades Bill Gross, manager of The Pimco Total Return Fund, said on Wednesday that the global economy may be facing low policy rates for decades.
Gross wrote in his October investment outlook that investors should "bet against" expectations that the federal funds rate - the U.S. Federal Reserve's benchmark short-term borrowing rate - will rise by one percentage point by late 2015.
"The U.S. (and global economy) may have to get used to financially repressive - and therefore low policy rates - for decades to come," wrote Gross, a co-founder and co-chief investment officer at Pimco, whose flagship Pimco Total Return Fund has roughly $250 billion in assets.
"Right now the market (and the Fed forecasts) expects fed funds to be 1 percent higher by late 2015 and 1 percent higher still by December 2016. Bet against that," he wrote in the letter entitled "Survival of the Fittest?"
Gross's outlook on the level of rates is important because Pimco manages roughly $1.97 trillion and is one of the world's largest bond managers. Gross and co-Chief Investment Officer and Chief Executive Mohamed El-Erian's views on Fed actions and global credit also influence other investors because of the firm's size in the marketplace. Two Points of Interest - Gross's fund had outflows of $5.4 billion in September, marking the fifth straight month of outflows from the fund, Morningstar data showed on Wednesday. While the withdrawals were sizeable, they were the lowest since May.
- Pimco had outflows of $6.5 billion across its U.S. open-end mutual funds last month, marking the fourth straight month of outflows from the funds, according to Morningstar. The outflows marked an improvement from withdrawals of $11 billion in August.
Book-Talking Synopsis It would be easy to dismiss Gross' opinion as talking his book. Yet, I believe he is quite accurate. That does not mean I see value in treasuries (I don't). I see little value anywhere except gold, cash, and Yen-hedged equities. Of course, one can accuse me of talking my book. But who doesn't talk their book (except day traders who don't have a book)? I would rather be long mid-term treasuries than long equities-in-general or long corporate bonds. I believe both equities and corporate bonds are well into bubble territory. The pertinent question on equities and corporate bonds is "when does the bubble break?" The pertinent question for treasury investors is the same one as gold investors "what if I am wrong?" Those in long-term treasuries will get clobbered if rate raise. Those in gold face the risk the bull market is over. The Case for Gold I have mentioned the case for gold numerous times: Briefly, sentiment is extremely negative, the Fed is unlikely to hike rates, central banks globally are likely to step on the liquidity spigot at the first sign of trouble, and markets in general do not top until nearly everyone is a believer (housing is a perfect example). The Case for Treasuries Amusingly, the case for treasuries is similar. The Fed is highly unlikely to hike and probably will be far slower at tapering than most think. Hyperinflationists are in la-la land with no understanding of debt deflation, demographics, or any other pertinent facts. Gold vs. Treasuries Bill Gross stated himself Bull Market in Bonds Is Over. Yet, the primary upside for treasuries will occur if Bill Gross is wrong (and once again, I do not think he is). On the other hand, gold and miners can do very well on a substantial rally, even if the top is in (and for reasons stated, I highly doubt that it is). Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Social Security "Lock Box" Revisited (and Its Relation to the Government Shutdown) Posted: 02 Oct 2013 04:00 PM PDT Reader Doug is concerned about Social Security. We all should be. Doug emailed " Most Americans assume that Social Security has money in the bank, so to speak." He wants to understand the mechanics by which Congress can take Social Security receipts and use them for other purposes. Specifically, he asked if I would elaborate on something I said in More Government Shutdown Hype. The section Doug asked about is in reference to a hyped-up report How budget showdowns could squeeze the US economy by the Associated Press. Here is the section that triggered the email: Q. What about the federal borrowing cap? First of all, what is it?
A. It's a legal limit on how much debt the government can pile up. The government accumulates debt two ways: It borrows money from investors by issuing Treasurys. And it borrows from itself, mostly from Social Security revenue.
Mish: It's important to note there is no social security fund whatsoever. Every penny and then some has been borrowed and spent. Here comes the hype. ..... [click on the top link for my point by point analysis of the hype] emphasis in red added No Lock Box I am not sure what most believe, but anyone who thinks there is a trust fund, a lock box, or money in the bank is way off base. I have commented on this numerous times actually. Social Security Recap - April 03, 2009: Social Security: There Is No Trust; There Is No Fund
- January 11, 2013: Social Security Payouts Per Worker; Accrued Interest on Accrued Promises; Imagination
- January 11, 2013: Making Social Security Actuarially Sound in a Business-Friendly Manner
- January 17, 2013: Social Security Cliff in Sight; Retirees Will Outlive Trust Fund; Ramifications of Nonmarketable IOUs and Privatization
For a nice recap of the problem, please see links 2 and 4. For my proposed solution, please see link 3. Here are some charts from Reader Tim Wallace from link 2 The charts are from year-end 2012. Social Security Burden on Non-Farm Workers
The line in red shows the expected trend if payouts had increased at the rate of inflation. Instead, escalating costs and the shrinking number of workers per beneficiary, has placed tremendous stress on workers ability to support beneficiaries.
Average Monthly Social Security Benefit
Social Security Beneficiaries vs. Total Non-Farm Employment
Ratio of Workers to Social Security Beneficiaries
Social Security Benefits Analysis
- The ratio of workers to beneficiaries peaked in 1999 at 2.927 to 1.
- The ratio of workers to beneficiaries was 2.361 to 1 at the end of 2012.
- The ratio of workers to beneficiaries is falling fast and will continue to fall fast for a decade as the baby boomer population ages.
- The average payout and the number of payouts are both rising fast
- Total Social Security payouts (a multiplication of two rising numbers) are on an unsustainable exponential growth path.
Social Security Deficit?
In my first post I cited a CNS News article that made this claim Social Security Ran $47.8B Deficit in FY 2012.
Reader David White objected, noting an increase in assets. Here is the chart from the Social Security Administration.
White protests "The "$47.8 billion deficit" mentioned in the post does not include interest income. This omission blatantly misrepresents the Social Security Trust Fund data."
Blatant Misrepresentation
If anything, the above chart highlights the sheer absurdity of the alleged "Trust Fund".
The blatant misrepresentation is the notion there is a trust "fund" at all.
In reality there is no fund, and if there is any trust in the system, there shouldn't be.
Accrued Interest on Accrued Promises
The assets are nothing but IOUs, and interest income is actually interest on money long since spent.
The entire "Trust Fund" is nothing but a promise to pay. There are no real assets (other than the ability to raise taxes to meet current expenses). Everything else is just a promise, and even more absurdly, accrued interest on accrued promises.
The chart provided by Wallace should give everyone second thoughts about the ability to raise taxes to meet expenses. The Cliff Link 3 above, discussed "the cliff", including a response from Jed Graham at Investor's Business Daily. Here is a snip ... Cliff Now in Sight
Nonmarketable IOUs
Jed and I are 100% in agreement that the alleged "trust fund" is nothing more than "nonmarketable Treasuries — really IOUs from one branch of government to another" that have no real value.
As Jed states, those IOUs provide the Social Security administration the "legal authority to run cash deficits until they're spent."
The key points are as follows: There is no lock box, there is no fund, there is a deficit, and IOUs in a pretend piggy bank are not the same as marketable bonds.
Amusingly, I got into an exchange with a reader just a few days ago over the IOU concept. Reader Elliot wrote "You don't seem to understand bonds. They're just an IOU. The Chinese give us $$, we give them an IOU, and then we spend the dollars."
Clearly, one major difference is the trust fund has nonmarketable IOUs, not marketable bonds.
I responded to Elliot that "You cannot owe yourself money and it's even more ridiculous to put an IOU in a piggy bank and pretend to collect interest on it."
Elliott was not convinced. The discussion with Elliott proves that some people will continue to believe whatever nonsense they want, no matter how carefully facts are presented otherwise.
One thing I did not realize before exchanging emails with Jed Graham was that the payroll tax cut did not actually contribute to the current Social Security deficit (SS was not charged for the reductions in payroll taxes). Rather, the cuts simply added to the general deficit, funded as temporary stimulus.
Thus, the current deficit is real, not imagined, no matter how one looks at it. The payroll tax cut did not temporarily overstate the problem.
Simply put, Social Security is already insolvent if one ignores imaginary interest deposited into an imaginary piggy bank. Only on a pretend basis, by counting interest owed to oneself in a piggy bank that does not even exist, is Social Security solvent.
Elliott's of the world aside, Jed points out the IOU pretense is universally understood by the CBO, by the administration, etc. Unfortunately, Congress ignores the problem for political reasons.
It's Magic Curiously, the government is running right now by borrowing against money budgeted for something else, then pretending to collect interest on the non-marketable securities owed to itself. If you think that makes sense, then put an IOU to yourself in your piggy bank, accrue imaginary interest on it, and then try to spend the IOU and the accrued imaginary interest. With Congress, the bigger the imaginary interest, the more it can spend. You cannot do that, but Congress does. Proposed Solutions For my proposed solutions, please see Making Social Security Actuarially Sound in a Business-Friendly Manner Unfortunately, making Social Security actuarially sound is insufficient because nothing stops Congress from using social security receipts for something else. In practice, we also need a balanced budget. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Pensions, Unemployment, Interest on Public Debt, Consume 54% of Spain's Budget; Debt Hits 100% of GDP; Expect Plan "B" or Plan "C" Posted: 02 Oct 2013 12:00 PM PDT On Monday, Spain reported that its debt-to-GDP ratio would hit 100% in 2014. Spain's public debt will soar to nearly 100 percent of output at the end of 2014, the government said Monday, despite massive spending cuts that have triggered angry street protests.
Spain's ratio of debt to gross domestic product (GDP) will hit 99.8 percent at the end of next year after rising to 94.2 percent at the end of 2013, higher than previously forecast, according to details of the government's 2014 budget presented in parliament.
The debt ratio has soared from 40.2 percent of GDP in 2008, when the end of a decade-long property boom triggered an economic slump that caused unemployment to jump and tax revenues to plunge.
Prime Minister Mariano Rajoy's conservative government had forecast in its 2013 budget that the debt-to-GDP ratio would stand at 90.5 percent at the end of this year.
Pensions will rise by just 0.25 percent in 2014, the minimum allowed under a pension reform approved by the cabinet on Friday that will stop indexing payouts to inflation. Where's the Money Going? Here's an interesting chart of Spain's budget allocation courtesy of La Vanguardia.  Via Mish-Modified Translation Pensions, unemployment and interest payments on the public debt eat more than half of budget expenditure planned for 2014, as stated in the draft State Budget (PGE ) for next year. Specifically, these three items totaling €193.801 billion, representing 54.6% of total expenditure in the budget provided, totaling €354.622 billion, 2.7% more than in 2013.
Spending on pensions, unemployment benefit and interest of the debt, the largest items along with transfers to general government, will increase next year by 3.5% compared to 2013. The biggest spending budget is pensions, which are carried €127.483 billion, representing growth of 4.9% over the previous year and 35.9% of total expenditure. The government plans to raise pensions by 0.25% in 2014.
Meanwhile, the unemployment starting with an allocation of €29.727 billion euros, up 10.1% and 8.4% of the total. As for public debt, interest will amount to €36.590 million euros, 10.3% of total expenditure, down 5.2% from 2013. Interest is equivalent to 3.5% of GDP.
Finance Minister Cristobal Montoro, says "next year we will not ask taxpayers to pay more taxes." Montoro stressed that budgets are based on the "reliability" of economic recovery, so that rules out a "plan B" that involves tax increases. Expect Plan "B" or Plan "C" Expect plan "B" or Plan "C" because there is no economic recovery. Eurointelligence has additional details ... - The budget does not contemplate raising tax rates, and includes tax incentives for entrepreneurs, to encourage self-employment;
- Public sector wages will be frozen, though the Summer and Christmas extraordinary payments won't be withheld;
- The number of pension recipients will grow by over 5%, and outlays on unemployment assistance are expected to grow by over 10%;
- Ministries will have their total budget reduced by nearly 5%, though Interior, Education, Employment, Industry, Agriculture and Economy will see budget increases;
- Government investment drops by over 7%, and in particular infrastructure investment will be reduced by over 9%;
- The net balance received by Spain from the European union will be a negligible €148m.
What the Public Thinks  Image from Yahoo! News (first link at the top). Recovery? What Recovery? Eurointelligence writes " What we are seeing in the eurozone cannot really be described as a recovery, but a return from negative growth rates to low positive ones – without any near-term prospect of a genuine recovery. The latter would require a significant drop in unemployment. Without a resumption in bank lending, given the continued constraints on fiscal policy and a stable but lacklustre global economy, it is hard to see where this growth is coming from." Bingo. There is no recovery and there will not be one. The structural problems are immense, and the euro itself is a huge part of the problem. In addition, tax hikes have been counterproductive. What's really needed is work rule and pension reform. Here is the pension and work rule reform progress to date: Italy has seen no reform, Spain very little, and France is heading in reverse. It's ridiculous to expect a recovery with those headwinds and zero net progress on badly needed structural reforms. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Vallejo, Mired in Pension Debt Again; Lesson for Stockton and Detroit - Shed Those Pension Obligations Now! Posted: 01 Oct 2013 11:48 PM PDT When Vallejo entered bankruptcy, it had a golden opportunity to shed pension obligations. When the city failed to do so, I made an easy prediction: Within years, Vallejo would be back in bankruptcy court. And here we go again: Two years after bankruptcy, California city again mired in pension debt. Less than two years after exiting bankruptcy, the city of Vallejo, California, is again facing a budget crisis as soaring pension costs, which were left untouched in the bankruptcy reorganization, eat up an ever-growing share of tax revenues.
Vallejo's plight, so soon after bankruptcy, is an object lesson for three U.S. cities going through that process today - Detroit, Stockton and San Bernardino, California - because it shows the importance of dealing with pension obligations as part of a financial restructuring, experts say.
The Vallejo experience may be particularly relevant to Stockton, which is further along in its bankruptcy case than Detroit and San Bernardino and has signaled its intention to leave pension payments intact.
"Any municipal bankruptcy that doesn't restructure pension obligations is going to be a failure because pension obligations are the largest debt a city has," said Karol Denniston, a municipal bankruptcy attorney in San Francisco.
"A city like Vallejo can be reasonably managed but it is still going to be flooded out because it cannot be expected to keep up with its pension obligations."
Vallejo, a port city of 115,000 near San Francisco that was staggered by the closure of a local naval base and the housing market meltdown, filed for Chapter 9 bankruptcy protection in 2008 with an $18 million deficit.
During its three-and-half year bankruptcy, the city slashed costs, including police and firefighter numbers, retiree health benefits, payments to bondholders and other city services.
The only major expense the city did not touch was its payments to the $260 billion California Public Employees Retirement System.
"We realized we did not have the time or the money to take on a giant behemoth like Calpers," said Stephanie Gomes, Vallejo's vice mayor.
When it exited bankruptcy at the beginning of 2011, the payments to Calpers were just over $11 million, or 14 percent of the fund. The latest budget pegs those payments at $15 million, or 18 percent of the general fund.
The increase comes largely from the recent decision by Calpers to lower its projected investment return rate, from 7.75 percent to 7.5 percent, and to change the way it calculates long-term pension maturity dates.
Those changes mean cities, state agencies and counties must pay rate increases of up to 50 percent over the next decade. Vallejo expects an increase in pension contribution rates of 33 to 42 percent over the next five years.
Marc Levinson, of the law firm Orrick, Herrington & Sutcliffe, was the lead attorney for Vallejo in its bankruptcy and has the same role for Stockton. He says his clients would welcome pension reform in California, and he is the first to say that contributions to Calpers are a big problem for cities.
But, Levinson said, dealing with the issue is no simple matter.
"How does a city start a new pension plan when it can't pay its bills?", Levinson said. "How can a city break away from Calpers and still retain employees when other jurisdictions have a pension plan?" Incompetence or Something else? Allegedly the city did not want to take on CalPERSs then. Instead, it is going to face another drawn out bankruptcy drama. Was there really much of anything to take on? I doubt it. The city had free rein in bankruptcy court to do what needed to be done: slash pensions. As for Levinson's ridiculous question " How does a city start a new pension plan when it can't pay its bills?" ... The city cannot pay its bills precisely because of preposterous pension payments! The simple solution would be to make sure the plan is fundable at a reasonable discount rate. The yield on 30-year US treasuries seems about right. Yes, that would be quite a haircut, but so be it. I also propose that the higher the current mandated pension payout, the bigger the cut. That way, some lowly clerk with a small pension would be more protected than city officials, police, and fire workers with high pensions. Retaining employees would be easy enough. I suggest the city seek a bankruptcy court agreement such that any city employees who quit now would forfeit their pensions (or whatever portion is necessary to make the system solvent). Ongoing, Vallejo should kill their defined benefit pension plan completely. With millions of people unemployed, I assure Vallejo would be loaded with qualified applications for whatever hires it needed to make (if indeed any). In retrospect, the vice mayor's statement " we did not have the time or the money to take on a giant behemoth like Calpers" sounds like a bald-faced lie. I suggest the real reason Vallejo did not go after pensions is the city bureaucrats would have cut their own pensions, and they did not want to! Regardless, Stockton and Detroit have a choice. They can cut pensions now, or cut them later in a second bankruptcy, just like Vallejo will. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
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