Posts Tagged ‘Federal Spending’

The Achilles Heel of the US Economy (Koesterich)

Tuesday, May 22nd, 2012

 

The Achilles Heel of the US economy may just be that entitlement programs haven’t kept pace with US demographics, a fact that has long-term implications for investors.

According to a recent annual government report on entitlement programs, the Social Security trust fund is likely to run out of money in 2033, three years earlier than previously projected. Meanwhile, both Social Security and Medicare aren’t sustainable in the long term without structural changes.

As I point out in my recent Market Perspectives piece, one reason that these entitlement programs, which rely on current workers to fund current retirees, are facing such problematic outlooks is that they were designed decades ago for a population that looked very different demographically from today’s aging US population.

Social Security, for instance, was formed in the 1930s when there were approximately 40 working age Americans per retiree. Medicare was introduced in 1965 when there were approximately 25 workers per retiree. Today there are roughly 3.3 workers per retiree and at some point before 2050, the ratio is likely to drop to approximately 2 workers per retiree. Due to demographic shifts in the US population, today there are more and more retirees, and fewer and fewer workers.

At the same time, Americans are living much longer and (paradoxically) retiring earlier than previous generations. Back in the 1950s, the average age of retirement was about 67. Today, it’s 62. Longer lives coupled with earlier retirements mean longer retirements that have to be funded by these programs.

Without significant reform, US entitlement programs are likely to pose a growing economic strain on the economy. For example, without a change to current laws, federal spending on Medicare and Medicaid combined will grow to almost 10% of gross domestic product by 2035, up from roughly 5% today. If left unchecked, Social Security and Medicare will eventually help crowd out all other government spending.

And if the United States continues to fail to tackle unfunded liabilities, the economic strain from entitlement spending is likely to be greater in the United States than in other developed countries.

For investors, especially those who don’t believe the strain is going to be alleviated anytime soon, here are three long-term implications:

1.) Consider raising allocations to equities in emerging markets with younger populations such as Brazil, Mexico, India, Indonesia and the Philippines. Developed world countries with aging populations are likely to grow slower, and trade at lower valuations, than younger, faster growing economies (potential iShares solution: the iShares MSCI Brazil Index Fund (NYSEARCA: EWZ)).

2.) Remain underweight Treasuries. The massive spending pressure on the federal government from unreformed entitlement programs will likely mean a larger supply of Treasuries. In the absence of the Federal Reserve or other public institutions buying the larger supply, yields should rise, a negative for Treasury bonds.

3.) Opt for certain sectors. If rates rise thanks to a larger supply of Treasuries, certain segments of the equity market are likely to get hurt more, while others should prove more resilient. Typically sectors such as healthcare, energy, and technology hold up the best when rates rise. Meanwhile, sectors such as consumer discretionary, financials and utilities suffer the most (potential iShares solution: the iShares S&P Global Energy Sector Index Fund (NYSEARCA: IXC)).

To be sure, there’s always the chance that Congress will figure out a way to fix the programs. One potential solution, probably the easiest and most obvious, is to gradually raise the retirement age one must reach to take part in the entitlement programs. Raising the retirement age could shorten the retirement period that has to be funded, which would shorten the funding burden on the programs and on the government.

What do you think of this potential solution? What do you think should be done to extend the longevity of US entitlement programs and why?

Sources: Bloomberg, Congressional Budget Office

Russ Koesterich is the iShares Chief Investment Strategist and a regular contributor to the iShares Blog. You can find more of his posts here.



The author is long EWZ and IXC

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country and narrowly focused investments may be subject to higher volatility.

Tags: , , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off

Paul Kasriel: We’re All Keynesians Now – Except Me

Thursday, November 24th, 2011

This post is a guest contribution by Paul Kasriel, chief economist of The Northern Trust  Company.

If you want federal debt reduction, you are going to get it Super-Committee “failure” or not. The recent debt-ceiling legislation calls for $1.0 trillion less-than-otherwise federal spending over the next 10 years. The “trigger” calls for $1.2 trillion less-than-otherwise federal spending over the next 10 years. And, with the return to the Clinton-era personal tax rates for all household income groups on January 1, 2013, revenues will increase by $3.5 trillion more-than-otherwise over the next 10 years. So, that is $5.7 trillion of less federal debt issuance than otherwise over the next 10 years. Now, that’s what I would call a grand bargain. And don’t forget, unless Congress acts before yearend 2011, an extra $168 billion of federal debt that otherwise would have been issued won’t be because of an expiring FICA tax “holiday” (just in time for the holidays?) and the expiration of extended unemployment insurance benefits. The U.S. as the next Greece? I beg your pardon. Try Canada, eh?

But most economists are not celebrating this significant prospective slower growth in federal debt. Rather, this dismal lot is busy marking down their real GDP forecasts. Why? Because they are partial-equilibrium Keynesians. Allow me to explain why I think they are too quick to reduce their forecasts of economic activity.

If the government borrows less than otherwise, then, all else the same, the demand for credit, at the margin, will have fallen. Entities that had intended to restrain their current spending in order to transfer that spending power to the government now find themselves with more spendable funds than planned. They may be able to entice someone else to borrow and spend if the interest rate at which they are willing to lend is lowered marginally. And/or, at a lower interest rate level, these lenders may decide to become spenders themselves. So, with the government demanding less credit over the next 10 years, private borrowers will step up to absorb the “excess” offered credit and/or lenders will become spenders themselves. So, why mark down your GDP forecast?

It could be a bit more complicated if we take into consideration Fed policy and banking system credit creation. And, this is where some markdown in the GDP forecast could be appropriate. Suppose the Fed is targeting the level of the federal funds rate when the government’s demand for credit is increasing more slowly. As I indicated, this weaker demand for credit would result in a decline in the interest-rate structure, all else the same. But all else is not the same if the Fed is targeting the level of the federal funds rate. If the Fed maintains the same target level of the federal funds rate in the face of weaker overall credit demand, then the interest-rate structure will not be permitted to fall fully to its new lower equilibrium level.

How does the Fed maintain the same level of the federal funds rate in the face of weaker overall credit demand? By draining cash reserves from the banking system. What happens to bank credit growth under these circumstances? It slows. Why? With the interest rate structure not being allowed to decline to its new lower equilibrium level, the quantity demanded of nongovernment credit (a movement along the credit demand curve) will not increase enough to offset the decline in the demand for government credit (shift back in the credit demand curve). Some of the credit demand that banks were providing is now being accommodated by the entities who were formerly lending to the government. Hence, with overall credit demand growing more slowly, bank credit growth slows. Why don’t banks lower their loan rates more to restore their loan growth? Because banks’ marginal cost of funds, the federal funds rate, has not declined even as their loan rates have. In effect, banks’ marginal return on capital has declined.

 

In this case, the slower growth in the demand for government credit will lead to a decline in the growth of bank credit. Remember, banking system credit, along with Fed credit, is credit created “out of thin air.” An increase in the growth of “thin air” credit results in a net increase in the growth in spending in the economy. Conversely, a decrease in the growth of “thin air” credit results in a net decrease in the growth in spending in the economy. Thus, to the extent that weaker growth in government credit demand results in weaker growth in bank credit, then the GDP forecast should be marked down. But because the decline in the dollar change in bank credit is likely to be of a smaller magnitude than the decline in the dollar change in government credit demand, the markdown in GDP growth would be much smaller than the Keynesian forecasters are contemplating.

If the Federal Reserve were targeting a rate of growth in bank credit (or even more radical, targeting a rate of growth in the sum of bank and Fed credit), then, in the face of weaker growth in government credit, the Fed would operate so as to maintain the growth rate in bank credit rather than passively allowing it to slow. In this case, weaker growth in government credit demand would not result in weaker bank credit growth. Thus, there is no reason to markdown one’s GDP forecast.

So, in my non-Keynesian (lonely) world, whether slower growth in government credit demand leads to slower growth in overall economic activity depends critically on the behavior of bank credit growth. If the Fed is targeting the federal funds rate, which it normally does, and does not lower its target rate so as to maintain the growth in bank credit, then the pace of future economic activity likely will be slower, but not nearly as slow as the Keynesians argue.

Note: The comments above are dedicated to the memory of Robert (Bob) Laurent, Milton Friedman’s most brilliant student (in my opinion) and my most brilliant “teacher.” If only Bob were here, someone would understand these comments. I miss you, man.

Are We about to Find Out that the Fed “Has no Clothes?”

From the minutes of the November 1-2 FOMC meeting, we learn that the Committee had an in depth discussion about policy communication. (I wonder if they brought in consultants and engaged in role playing.) As usual, no decisions on changing the FOMC’s communications policy were made. Below is a passage that caught my attention:

“More broadly, a majority of participants agreed that it could be beneficial to formulate and publish a statement that would elucidate the Committee’s policy approach, and participants generally expressed interest in providing additional information to the public about the likely future path of the target federal funds rate. The Chairman asked the subcommittee on communications to give consideration to a possible statement of the Committee’s longer-run goals and policy strategy, and he also encouraged the subcommittee to explore potential approaches for incorporating information about participants’ assessments of appropriate monetary policy into the Summary of Economic Projections.”

The first rule of economic forecasting is never give a date along with a numerical forecast for GDP/inflation/unemployment. The second rule of forecasting is that if you violate the first rule, never give a fed funds rate forecast with your GDP/inflation/unemployment forecast. This is sure to embarrass you if anyone keeps a record. Now, just after I read this passage from the FOMC minutes, I happened to catch this Reuters News headline:

“[Minneapolis Fed President] Kocherlakota [says] FOMC Forecasts Do Not Reveal ‘Special Information’ About Economy.”

Talk about an understatement! If the FOMC begins to lay out a federal funds rate forecast that it thinks is consistent with its economic forecast, the public is going to find out, indeed, that the FOMC has no “special information.” At a time when the American people are losing confidence in so many of our institutions, is wise for the Fed to expose itself to such public scrutiny?

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

Source: Paul Kasriel, Northern Trust – Daily Economic Commentary, November 22, 2011.

Tags: , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off

“Got Jobs?!” (Saut)

Tuesday, October 25th, 2011

“Got Jobs?!”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

October 24, 2011

“President Barack Obama has a jobs plan, in case anyone has been off the planet for the past month. House Republicans now have a jobs plan. Each of the presidential candidates has some kind of employment blueprint. Members of Congress have a bipartisan jobs plan: to keep their seats. Even Washington lobbyists have one, which is to ensure that the grotesque 72,536-page tax code doesn’t sacrifice a single line of print. After all, without it they might have to return to the dreary practice of law. Everyone, it seems, has a jobs plan so why not your humble correspondent? I’ve had plenty to say about Obama’s plan, so it’s only appropriate to offer some concrete ideas of my own. By calling it a jobs plan, the president and Congress re-enforce the notion that they hold the closely guarded secret of job creation. Most reasonable people understand that the president doesn’t create jobs, unless he’s in the market for a White House chef, a dog walker for Bo or a horticulturalist for the Rose Garden. And yet, the name implies just that. Employment is the outcome of economic growth. Focus on creating an environment for the economy to flourish, and the jobs will come.”

… Caroline Baum (Bloomberg)

I love Bloomberg’s Caroline Baum and have read her insightful prose for years. In this particular article she is talking about an economic plan that fosters growth. To be sure, economic growth is the only out of the situation we have painted ourselves into. To that point there was an article in the WSJ on 8/10/11 titled, “A New Strategy for Economic Growth.” In said article quips like these appeared:

“Policy makers should cease the barrage of ad hoc, short-term policy initiatives. Is increased federal spending across government agencies a grand strategy? . . . The debt-limit debate caused policy makers to recognize what citizens already knew: We must put our fiscal house in order. Cutting spending is essential. But we will never cut our way to prosperity. So, what should be the economic grand strategy? In a word: growth. . . . Absent strong growth, any projected improvements in the country’s fiscal position won’t materialize.”

Speaking to growth, while the economic reports over the past few weeks are not particularly strong, they have been better than expected. Earnings too are coming in better than estimated, for as of last Thursday the 93 S&P 500 (SPX/1238.25) companies that had reported showed earnings that were up by 23.4% with revenues better by 9.2%. We think that “beat” trend will continue, making it increasingly uncomfortable for the underinvested crowd. Indeed, professional money is profoundly underinvested. For example, a few months ago I made my annual sojourn to Europe to speak with institutional accounts. In seeing more than 100 portfolio managers (PMs) I could not find one that had more than a 15% weighting in U.S. equities despite the fact those PMs’ performance benchmark, the MSCI World Index, has a ~43% weighting in U.S. stocks. Yet, it is not just the Europeans that are light U.S. stocks. Here in our country endowment funds are under 10% weighted in U.S. equities. Ladies and gentlemen, there is no way an endowment fund can achieve its annual mandated return of between 6% – 9% with ~2.2%-yielding 10-year Treasury Notes! Accordingly, even a marginal shift in asset allocations to out of bonds and into stocks could cause stocks to trade higher than most expect. Verily, with an improving U.S. economy, Asian monetary conditions gradually easing, and an evolving solution for Europe, the chances of a Santa Claus rally have risen.

Nowhere was that more evident than last week with the SPX not only confirming the renewed uptrend we spoke of when the SPX closed above our pivot point of 1217, but it also traveled above the August intraday reaction highs clustered around 1230. To the underinvested types, last week’s action was a nightmare. The trick for this week will be for the SPX to remain above the 1217 level and attempt to distance itself further from that pivot point. While there is always the risk of an upside breakout failure, if prices can hold above last week’s breakout levels, the credibility of said breakout should gain more traction. Interestingly, on a weekly basis, the equity markets have a full load of internal energy to extend the now 13-session rally, which has lifted the SPX some 15% from our October 4th “buy ‘em” call, as the October 1978 and October 1979 analogues continue to play. Manifestly, the recent rally can now be termed a “Buying Stampede,” suggesting it could run for the full 17 – 25 sessions. Recall, Buying Stampedes typically run 17 – 25 sessions, with only one- to three-session pauses, or pullbacks, before they exhaust themselves. While it is true some have lasted for 25 – 30 sessions, it is pretty rare for one to extend more than 30 sessions. In fact, the longest stampede previously chronicled in my notes of more than 40 years lasted for 43 days, that is up until the September 2010 to June 2011 upside skein following the announcement of quantitative easing 2.

Whether this stampede turns out to be that strong will likely depend on the economy, our changing political environment, and Europe. On those fronts, however, I remain cautiously optimistic, believing there is a change afoot inside the D.C. Beltway whereby business people are being elected, fostering the hope of simple, market-based solutions to our Nation’s ills. And, over the last three weeks the stock market appears to be sensing this as well with winning sectors continuing to be Energy, Financials, Consumer Discretionary, and Materials. Such sector rotation suggests the stock market believes things are getting better as well.

Meanwhile, over the past two weeks the SPX has rallied more than 10%, yet investors have “pulled” some $11 billion from equity mutual funds. That’s the highest two-week total since early August when the stock market was in a free-fall. Such mutual fund redemptions are symptomatic of past stock market bottoms, which reinforces our belief that the October 4th intraday low of 1074.77 should mark the low for the year. Regrettably, we also think the May 2nd intraday high of 1370.58 will stand as the high for the year since there has been so much technical damage. Given those parameters how should investors, and traders, position themselves into year-end? Well, traders should have raised stop-loss points on their remaining “long” trading positions because of the short-term overbought condition. That said, overbought markets can stay overbought for longer than most expect. Investors, on the other hand, should continue to accumulate favorable stocks during periods of weakness. One screen investors should consider are companies that have recently beaten earnings estimates, beaten revenue estimates, and have raised forward earnings guidance. Our friends at the invaluable Bespoke Investment Group have published such a list and noted, “Typically less than 5% of stocks during any given earnings season will report triple plays, which makes them extremely rare.” Names in that group that have reported such metrics and are followed by Raymond James’ fundamental analysts include: Abbott Labs (ABT/$53.86/Outperform); Chubb Corporation (CB/$68.71/Outperform); Intel (INTC/$24.03/Outperform); Select Comfort (SCSS/$21.57/Strong Buy); and Tractor Supply (TSCO/$73.46/Strong Buy).

The call for this week: Chinese numerology, and Feng Shui, for 2011 suggests this year we are going to experience four unusual dates: 1/1/11, 1/11/11, 11/1/11, 11/11/11 and that’s not all. Take the last two digits of the year you were born, and the age you will be this year, and the result will add up to 111 for everyone! This is the year of MONEY. Also, in this year, October will have 5 Sundays, 5 Mondays, and 5 Saturdays. This happens only once every 823 years. These particular years are known as Moneybag Years. The proverb goes that if you send this quip to eight good friends, money will appear in the next four days. Those who don’t continue the chain won’t receive any money. It’s a mystery, but it’s worth a try. We certainly hope the balance of the year will be fruitful for investors; and we continue to invest and trade accordingly.

P.S. – I am traveling the rest of the week so there will probably be no verbal strategy comments until next Monday.

 

Copyright © Raymond James

Tags: , , , , , , , , , , , , , , , , , , , ,
Posted in Bonds, Brazil, Markets | Comments Off

Boehner Humiliated, Cancels Vote, Stock Futures Tank; Stocks and Treasuries Unusually Correlated

Friday, July 29th, 2011

by Michael ‘Mish’ Shedlock, Global Economic Trends Analysis

Thursday morning Bloomberg reported House Majority Leader Cantor Predicts House Republicans Will Pass Debt Plan Today

House Majority Leader Eric Cantor predicted Republicans would pass a debt-limit increase plan today as some freshman lawmakers pledged support for the measure in the face of unified Democratic opposition in the Senate.

Vote Cancelled

Kiss that prediction of Cantor goodbye. Thursday evening Republicans put off vote on debt limit because Boehner clearly lacks the votes.

An intensive endgame at hand, Republican leaders abruptly postponed a vote Thursday night on legislation to avert a threatened government default and slice federal spending by nearly $1 trillion.

“The votes obviously were not there,” conceded Rep. David Dreier, R-Calif., after Speaker John Boehner and the leadership had spent hours trying to corral the support of rebellious conservatives.

The decision created fresh turmoil as divided government struggled to head off an unprecedented default that would leave the Treasury without the funds needed to pay all its bills. Administration officials say Tuesday is the deadline for Congress to act.

Senate Democrats stood by to scuttle the bill — if it ever got them — as a way of forcing Republicans to accept changes sought by Obama.

Based on public statements by lawmakers themselves, it appeared that five of some two dozen holdouts were from South Carolina. The state is also represented by Sen. Jim DeMint, who has solid ties to tea party groups and is a strong critic of compromising on the debt issue.

Others said conservatives wanted additional steps taken to try to ensure that a constitutional balanced-budget amendment would be sent to the states for ratification. As drafted, the legislation merely requires both houses of Congress to vote on the issue.

Even before the House voted, Reid served notice he would stage a vote to kill the legislation almost instantly.

“No Democrat will vote for a short-term Band-Aid that would put our economy at risk and put the nation back in this untenable situation a few short months from now,” he said.

Boehner Humiliated

Boehner was humiliated and justifiably so. He had nothing to gain and everything to lose by attempting to ram-rod a gaseous bill through the House that was guaranteed dead-on-arrival in the Senate.

Majority leader Cantor made matters worse by predicting passage.

Stock Futures Tank in Unusual Correlation with Treasuries

Please consider U.S. S&P 500 Futures Retreat as McCarthy Says No Vote on Debt Plan Tonight

Futures on the Standard & Poor’s 500 Index fell after the U.S. House of Representatives postponed a vote to increase the nation’s debt limit, boosting concern that the lawmakers are far from an agreement to avoid default.

S&P 500 futures expiring in September lost 0.8 percent to 1,286.9 at 12:28 p.m. in Tokyo. The decline suggests the U.S. equity benchmark may extend its 3.3 percent slump from the past four days when markets open in New York.

Stocks and Treasuries are moving in tandem twice as often as they normally do, a sign investors are growing convinced the U.S. will lose its AAA credit rating and that an impasse among lawmakers may spur losses in both markets. The S&P 500 has risen or fallen together with 10-year Treasury notes 80 percent of the time in the last 10 days, compared with the average since 2000 of 41 percent, according to data compiled by Bloomberg.

Not Raising the Debt Ceiling Would be Blessing

I am sticking to what I said in Not Raising the Debt Ceiling Would be Blessing; Debt Limit Analysis; Interactive Map, You Decide What Not To Pay

All things considered, especially since Boehner’s credibility is gone in his latest gaseous proposal, the best thing for Congress to do would be to NOT hike the debt ceiling and work out a credible plan over the next month.

Is Mish a “closet Liberal-humanist?”

In response to that post I received a humorous email from “BC” who wrote…

Mish, your choices reveal your empathy! Are you a closet Liberal-humanist?!

Your choices favor the elder working class, the working-class and poor ill, unemployed, poor and “food challenged”, and imperial legionaries and auxiliaries against the corporate-statists!!!

Are you one of those maladjusted working-class types who just doesn’t “get it”?!

Wink , wink ;-) ;-).

To see my choices as to what I would cut and to make your own choices about what to do if the debt ceiling is not raised, click on the above link for an interactive map.

Mike “Mish” Shedlock

http://globaleconomicanalysis.blogspot.com

Copyright © Michael ‘Mish’ Shedlock, Global Economic Trends Analysis

Tags: , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off

Bill Gross: Investment Outlook (April 2011)

Wednesday, March 30th, 2011

Investment Outlook

by William H. Gross, April 2011

Skunked

  • Medicare, Medicaid and Social Security now account for 44% of total federal spending and are steadily rising.
  • Previous Congresses (and Administrations) have relied on the assumption that we can grow our way out of this onerous debt burden.
  • Unless entitlements are substantially reformed, the U.S. will likely default on its debt; not in conventional ways, but via inflation, currency devaluation and low to negative real interest rates.

That adorable skunk, Pepé Le Pew, is one of my wife Sue’s favorite cartoon characters. There’s something affable, even romantic about him as he seeks to woo his female companions with a French accent and promises of a skunk bungalow and bedrooms full of little Pepés in future years. It’s easy to love a skunk – but only on the silver screen, and if in real life – at a considerable distance. I think of Congress that way. Every two or six years, they dress up in full makeup, pretending to be the change, vowing to correct what hasn’t been corrected, promising discipline as opposed to profligate overspending and undertaxation, and striving to balance the budget when all others have failed. Oooh Pepé – Mon Chéri! But don’t believe them – hold your nose instead! Oh, I kid the Congress. Perhaps they don’t have black and white stripes with bushy tails. Perhaps there’s just a stink bomb that the Congressional sergeant-at-arms sets off every time they convene and the gavel falls to signify the beginning of the “people’s business.” Perhaps. But, in all cases, citizens of America – hold your noses. You ain’t smelled nothin’ yet.

I speak, of course, to the budget deficit and Washington’s inability to recognize the intractable: 75% of the budget is non-discretionary and entitlement based. Without attacking entitlements – Medicare, Medicaid and Social Security – we are smelling $1 trillion deficits as far as the nose can sniff. Once dominated by defense spending, these three categories now account for 44% of total Federal spending and are steadily rising. As Chart 1 points out, after defense and interest payments on the national debt are excluded, remaining discretionary expenses for education, infrastructure, agriculture and housing constitute at most 25% of the 2011 fiscal year federal spending budget of $4 trillion. You could eliminate it all and still wind up with a deficit of nearly $700 billion! So come on you stinkers; enough of the Pepé Le Pew romance and promises. Entitlement spending is where the money is and you need to reform it.

Even then, the situation is almost beyond repair. Check out the Treasury’s and Health and Human Services’ own data for the net present value of entitlement liabilities shown in Chart 2.

Pages: 1 2

Tags: , , , , , , , , , , , , , , , , , , , , , ,
Posted in Infrastructure, Markets, Outlook, Silver | Comments Off

Runaway Government Spending? You Decide (Kasriel)

Thursday, August 12th, 2010

This post is a guest contribution by Paul Kasriel, Chief Economist of The Northern Trust  Company.

The U.S. Treasury released its budget status for July. As Chart 1 shows, the cumulative deficit in the 12 months ended July was $1.318 trillion – the lowest since June 2009’s $1.255 trillion. So far, the largest 12-month cumulative deficit reading has been $1.477 trillion in the 12 months ended February 2010.

The deficit is narrowing because total federal spending has begun to decline and because total federal receipts are declining at a slower pace. As shown in Chart 2, in the 12 months ended July 2010, total federal cumulative spending contracted by 1.94% vs. the cumulative spending in the 12 months ended July 2009. The fastest growth in 12-month cumulative federal spending was 19.17%, which occurred in July 2009. Also shown in Chart 2 is the slowing in the rate of decline of federal receipts. In the 12 months ended July 2010, cumulative federal receipts contracted by 2.42% vs. the 12 months ended 2009. This is the slowest rate of contraction in 12-month cumulative federal receipts since September 2008 at minus 1.71%. The most severe rate of contraction in 12-month cumulative receipts occurred in November 2009 at minus 17.59%.

On the receipts side of the Treasury’s ledger, two factors that are playing important roles in slowing down the rate of decline in federal receipts are corporate income taxes and Federal Reserve profits (see Chart 4). Now that corporations are once again earning profits after the largest contraction in corporate profits in the post-WWII era, corporate tax receipts have begun to grow again. And with the explosion of the Fed’s balance sheet from $877 billion at the end of 2007 to over $2 trillion today, the Fed is enjoying record profits, most of which it turns over to the Treasury. Hooray for seigniorage!

Source: Paul Kasriel, Northern Trust – Daily Global Commentary, August 11, 2010.

Tags: , , , , , , , , , , , , , , , , , ,
Posted in Markets, Outlook | Comments Off

Canada, Land of Smaller Government

Monday, August 9th, 2010

This note is a guest contribution by Paul Kedrosky, author of the Infectious Greed Blog.

From my friend Jason Clemens at the Pacific Research Institute, how Canada (sic.) is newly the land of smaller government. I don’t agree completely, as Canada has been the beneficiary of a massive, unpriced subsidy – proximity, physical and economic, to the U.S. and its debt-happy consumers – but makes some useful and intriguing points.

Canada, Land of Smaller Government

When Americans look to Canada, they generally think of an ally, though one dominated by socialist economic policies. But the Canada of the 1970s and early 1980s—the era of left-wing Prime Minister Pierre Trudeau—no longer exists. America’s northern neighbor has transformed itself economically over the last 20 years.The Canadian reforms began in 1988 with a U.S. free trade pact that would lead to the North American Free Trade Agreement. But change really began to take off in 1993. A socialist-leaning government in Saskatchewan started by reducing spending and moving towards a balanced budget. This was followed by historic reforms by the Conservatives in Alberta, who relied on spending reductions to balance their budget quickly.

In 1995, the federal government, led by the Liberal Party, passed the most important budget in three generations. Federal spending was reduced almost 10% over two years and federal employment was slashed 14%. By 1998, the federal government was in surplus and reducing the nearly $650 billion national debt. Provincial governments similarly focused on eliminating deficits by paring spending and reducing debt, and then they started to offer tax relief.

All government spending peaked at 53% of Canadian GDP in 1992 and fell steadily to just under 40% by 2008. (Government spending in the U.S. was 38.8% of GDP that year.) The recession has caused government spending to increase in both countries. But if present trends continue, within two or three years Canada will have a smaller government as a share of its economy than the U.S.

Canadian taxes have also come down at the federal and provincial level. They were reduced with the stated goal of improving incentives for work effort, savings, investment and entrepreneurship.

Jean Chrétien (a Liberal) won elections in 1993, 1997 and 2000 by promising to balance the books, to prioritize federal spending to ensure that government was doing what was needed, and also to deliver tax relief. Mr. Chrétien’s former finance minister, Paul Martin, became prime minister in 2003, but he lost power to the Conservative Party in 2006, in part because he moved away from some of the Chrétien principles.

Tellingly, the last three Canadian elections have all had key debates on tax relief—not whether there should be tax cuts but rather what type of tax cuts. Beginning in 2001 under a Liberal government, even the politically sensitive federal corporate income tax rate has been reduced. It is now 18%, down from 28%, and the plan is to reduce it to 15% in 2012. The U.S. federal rate is 35%.

Yet much of the tax relief since 2000 has been on personal income taxes. The bottom two personal income tax rates have been reduced, and the income thresholds for all four rates have been increased and indexed to inflation. Canada has also reduced capital gains taxes twice (the rate is now 14.5%), cut the national sales tax to 5% from 7%, increased contribution limits to the Canadian equivalent of 401(k)s, and created new accounts similar to Roth IRAs.

Government austerity has been accompanied by prosperity. According to the Organization for Economic Cooperation and Development (OECD), between 1997 and 2007 Canada’s economic performance outstripped the OECD average and led the G-7 countries. Growth in total employment in Canada averaged 2.1%, compared to an OECD average of 1.1%.

During the mid-1990s, Canada’s commitment to reform allowed it to tackle two formerly untouchable programs: welfare and the Canada Pension Plan (CPP), equivalent to Social Security in the U.S. Over three years, federal and provincial governments agreed to changes that included investing surplus contributions in market instruments such as stocks amd bonds, curtailing some benefits, and increasing the contribution rate. The CPP is financially solvent and will be able to weather the retiring baby boomers.

The one area Canada has been slow to reform is health care, which continues to be dominated by government. However, some provinces have allowed a series of small experiments: a completely private emergency hospital in Montreal and several private clinics in Vancouver. British Columbia and Alberta also are experimenting with market-based payments to hospitals. While these are incremental steps, the path in Canada is fairly clear: More markets and choice will exist in the future. The trend in the U.S. is the opposite.

Most strikingly, Canada is emerging more quickly from the recession than almost any industrialized country. It’s unemployment rate, which peaked at 9% in August 2009, has already fallen to 7.9%. Americans can learn much by looking north.

Mr. Clemens is the director of research at the Pacific Research Institute and a co-author of “The Canadian Century: Moving Out of America’s Shadow” (Key Porter Books, 2010).

Copyright (c) Paul Kedrosky, Infectious Greed

Tags: , , , , , , , , , , , , , , , , , , , ,
Posted in Bonds, Canadian Market, Markets | 2 Comments »

Paul Kasriel (Northern Trust): Airplane Musings, Part Deux

Tuesday, June 15th, 2010

This article is a guest contribution by Paul Kasriel, Chief Economist, Northern Trust.

These are some stream-of-consciousness thoughts that came to me at 35,000 feet.

The Federal Government Deficit – Congressman, Heal Thyself!

On one of this past Sunday’s morning political talk shows, I heard a congressman say that the runaway federal government spending had to stop. Congressman, sir, although the spending continues to increase, the rate of growth in that spending has slowed enormously. In the 12 months ended May 2010, the accumulated spending by the federal government totaled $3.437 trillion, enough to keep the late Senator Dirksen spinning in his grave for near eternity. Although an admittedly high level, this 12-month accumulated total federal spending was only 2.6% higher than the 12-month accumulated total federal spending for May 2009 (see Chart 1). This is quite a deceleration in growth from the 15.3% registered for the 12 months ended 2009 vs. 2008, near the trough of the last recession. Moreover, the 2.6% year-over-year growth in the 12-month accumulated total federal outlays in May 2010 is considerably lower than the 8.4% year-over-year growth in the 12-month accumulated total federal outlays in May 2006. Why do I mention May 2006? Because at that time, the congressman’s political party controlled Congress and the White House. Congressman, heal thyself!

Chart 1

At the same time that the growth in federal outlays has slowed dramatically, the rate of contraction in federal revenues also has slowed dramatically. The year-over-year percent change in the 12-month accumulated federal revenues in May 2010 was minus 6.6%, a slower rate of contraction than the 13.6% contraction for May 2009 (see Chart 2).

Chart 2

Why the slowdown in that rate of growth in federal spending and the rate of contraction in federal revenues? The economic recovery, for one thing. As the economy started to grow again in the second half of 2009, the rate of growth in government transfer payments to households, such as unemployment insurance benefits, has slowed sharply (see Chart 3). Also, as the economic recovery has set in, corporate profits and, thus, corporate tax receipts have picked up (see Chart 4). Again on the spending side, there has not been a repeat of the $500 billion+ in TARP expenditures in 2008.

Chart 3

Chart 4

Barring the economy slipping back into another recession, which I do not believe is likely, the worst of the cyclical deficit is behind us (see Chart 5). Now, if the aforementioned congressman will offer some constructive reforms to curb the projected increases in Medicare spending over the next 20 years, spending that he and his fellow baby boomers will be the beneficiaries of, then the structural deficit issue will have been solved. As an aside, it was when the congressman’s political party controlled Congress and the White House that legislation went into effect (January 1, 2006) increasing the “out-year” projections of Medicare spending, the unfunded entitlement program known as Medicare Part D. We are waiting for your constructive reform proposals on Medicare, Congressman.

Chart 5


U.S. Economy Still Starved for Credit Creation

Last week, the Fed finally got around to releasing its flow-of-funds data for the first quarter of 2010. Based on the Fed’s first guesstimates (regrettably, the Fed will keep revising these data over the coming years), the U.S. economy remained starved for credit emanating from the financial sector during the first quarter. Chart 6 shows that the most important of the financial intermediaries – commercial banks, money market mutual funds, ABS issuers and funding corporations (funding subsidiaries, nonbank financial holding companies, and custodial accounts for reinvested collateral of securities lending operations) – continued to contract their net lending in the first quarter to the tune of about $1.6 trillion at an annual rate. Although that is an improvement over last year’s fourth-quarter annualized contraction of $1.7 trillion, it still marks the fifth consecutive quarter of net credit contraction by this important group of intermediaries. Even when the entire financial sector is taken into consideration, including the Federal Reserve, net lending continued to contract through the first quarter of this years, albeit at a much reduced annualized rate of only $334.3 billion. But as Chart 7 shows, from 1952 through 2008, net lending by the entire financial system had never contracted. I consider this financial sector net credit contraction the major headwind for the economy, preventing a more normal robust cyclical recovery.

Chart 6

Chart 7

Money – Supply vs. Demand

Chart 8 shows the year-over-year percent change in currency, deposits and money market mutual funds held by U.S. households. It also shows this concept of money as a percent of total U.S. household financial assets. The year-over-year change represents the growth, or lack thereof, in the supply of money, which, by the way, is related to the amount lending banks are engaged in. Money held as a percent of total financial assets is related to the demand (to hold) for money. When households are more confident about expected returns on riskier financial assets, they reduce their demand for money and vice versa.

Chart 8

Notice that there was a steady downward trend in the ratio of money-to-total financial assets from the late 1980s through 1999, when the NASDAQ was topping out. Since then, there has been an uneven rise in this ratio, perhaps as investors have become more risk averse after the NASDAQ implosion and the recent bear market in equities. Now, let’s look at what has happened to the supply of money. In the first half of the 1990s, this concept of money was contracting. Similarly, this concept of money is contracting once again starting in the third quarter of 2009. In the early 1990s, when the supply of money was contracting, the demand for money (the ratio of money-to total financial assets) also was falling. Thus, the restrictive effect of a contracting household money supply was partially offset by a declining household demand for money. Today, the supply of money is contracting and, in recent quarters, the demand for money has declined. But the decline in the demand for money does not appear to be of the same trend nature as what occurred in the early 1990s. Moreover, with the recent correction in the global equities markets, U.S. households could become more risk averse, thus increasing their demand for money. If the supply of money does not start increasing soon and/or the demand for money does not continue declining, U.S. economic activity could slow significantly.

Now Is the Time to Buy a House, Not 2005-2006

By comparing the imputed rent on owner-occupied housing with the market value of that housing, a “yield” on owner-occupied housing can be calculated. That yield on owner-occupied housing is shown in Chart 9 along with the contract mortgage interest rate charged on loans for the purchase of existing homes. As shown in Chart 9, the norm is for the mortgage interest rate to be above the yield on owner-occupied housing. In the third quarter of 2008, however, the yield on housing rose above the mortgage rate and has remained so through the first quarter of 2010. Although the purchase of an owner-occupied house may be an even better investment in the coming quarters, that purchase was a much better-than-normal buy in the first quarter of 2010 – and a considerably better buy than it was in 2005 or 2006.

Chart 9


Deleveraging? Not Nonfinancial Corporations

We hear a lot of talk these days about private-sector deleveraging. Although household leverage ratios are falling – probably not voluntarily but because no one will lend to households – the ratio of debt to assets for nonfinancial corporations has climbed to a post-war record high (see Chart 10). Chart 11 illustrates what nonfinancial corporations were up to in the first quarter. They issued a net $289 billion of debt at an annualized rate and “retired” a net $208 billion of equity at an annualized rate. The solid line in Chart 10 represents corporate debt issuance as a percent of capital outlays. When the percentage is positive and rising, it indicates that corporations are issuing debt for reasons other than buying capital equipment. It is clear that in the first quarter, nonfinancial corporations were issuing debt to retire equity. This bit of financial engineering increases their earnings per share and rewards stockholders at the expense of bond holders.

Chart 10

Chart 11

Paul Kasriel is the recipient of the 2006 Lawrence R. Klein Award for Blue Chip Forecasting Accuracy

(c) Northern Trust

www.ntrs.com

Tags: , , , , , , , , , , , , , , , , , , ,
Posted in Bonds, Markets, US Stocks | Comments Off