Quote of the Day: This Time is Different: Sovereign Debt Crisis will Wipe Out Pensions

Why is this Sovereign Debt Crisis collapse different from 1931? When the governments of the world defaulted on their debts in 1931, there were no pension funds. Government has exempted itself from all prudent reason for you take the state operated pension funds, like Social Security in the USA, where 100% of the money is in government bonds. They may have no intention of defaulting, but very few government have ever paid off their debts in the end. 

Then there are states who regulate pension funds requiring more than 80% to be in government bonds. A Sovereign Debt Default this time around will wipe out socialism, yet the bulk of the people are clueless not merely about the risk, but the ramifications. Younger generations do not save to support their parents for that was government’s job post-Great Depression. Socialism has altered thousands of years of family structure following the ranting of Karl Marx. This has been one giant lab experiment that ended badly in China and Russia and is coming to a local government near you. 

So this time it is SUBSTANTIALLY DIFFERENT. Government is now on the hook, which is part of the reason why they are moving to eliminate cash to prevent bank runs and to force society to comply with their demands. This is why we have people like Gordon Brown, who sold Britain’s gold reserves in 1999 making the low, claiming now that eliminating cash will eliminate the boom and bust of the business cycle. Let’s face it, Gordon Brown has NEVER been right when it comes to politics, not even once, and he has been the worst manager of finance that Britain has ever known. He sold the low in gold and now he presumes he can fulfill Marxism by eliminating cash. He postulates ideas that are theory without any support whatsoever. We cannot afford more arrogant people like this in politics who believe they have a right to experiment with society. 

This time it is very different. They have wiped out society placing the entire scheme of socialism as a terrible nightmare that will end badly, and they have ruined the social family structure disarming people that for thousands of years was our very means of self-sufficient survival. These clown have set the tone for wiping out the dreams they sold the elderly, all while hunting taxes and causing job creation to implode as the youth has been converted into the lost generation. All this with pretend good intentions. Can you imagine the damage to society if they had actually intended this mess? They have lied to themselves and to the people. We have to crash and burn – that part is inevitable. Only when the economy turns down will we then argue over solutions.

(italics mine)

This is from economist Martin Armstrong from his website.

Related to  this, for all the economic 'boom' projected by record stocks, the Bloomberg recently reported that 32 out of 50 or 64% of US states have been faced with budget gaps and thus have been making cuts, tapping reserves or face higher budget shortfalls. And the same report says that state governments have only about half of reserves compared to the pre recession era.

And due to pension concerns Moody's recently downgraded Chicago. 

Puerto Rico which is categorized as Unincorporated territory of the US has  currently been enduring a debt crisis, that has put to risk social services provided by socialism.

Data on US State fiscal and debt conditions can be found here.

Additionally the pension warning doesn't just apply to the US but to many other developed economies as well (OECD data as % of GDP  here).

Japan's Nikkei Flies 3.98% Yesterday as PM Abe’s Two Ministers Resigns

As expected, Friday’s US-Europe pump apparently did spill over to Asia. But the gains have been much unimpressive for the region except for Japan’s Nikkei. Japan's key equity bellwether recovered four fifth of last week’s losses in just one day!

From collapse to melt up. Yet despite yesterday’s fabulous 3.98% surge, the Nikkei remains down by 7% from the recent highs.

The Japanese government made sure that the US-Europe pump had a domestic component.

Remember Japan’s government hasn’t been coy in lending support to her stock markets. Stock markets, as I have been saying here, have become propaganda tools for governments—where higher stock market are portrayed as G-R-O-W-T-H so as to gain popular (approval rating) support.

As for stock market support, Japanese traders have noted of the “1% rule” where the Bank of Japan (BOJ) intervenes each time the Nikkei falls 1% and below by buying the ETFs of the index and or individual stocks. 

The BOJ’s serial interventions has led to a record accumulation of 7 trillion yen in stocks and ETFs last August. Nonetheless record intervention appears to falter as the Nikkei has been on a decline with the exception of yesterday

And now for yesterday’s domestic icing on the cake pump; from Bloomberg:

Japanese shares surged, with the Topix (TPX) index climbing the most in more than a year, after a rebound in global equities and a report the nation’s pension fund will boost domestic stock holdings…

Japan’s $1.2 trillion Government Pension Investment Fund will increase its allocation target for local shares to about 25 percent from 12 percent, the Nikkei newspaper reported without attribution. GPIF will also boost its holdings of foreign bonds and stocks to about a combined 30 percent from 23 percent, while reducing domestic debt to the 40 percent level from 60 percent, the Nikkei said Oct. 18.

Ah once again pension fund to be used in support of stocks. Yet if the "pump" morphs into a "dump" then the "greater fool" would be the significant population of Japan’s elderly (centenarians at record highs) who will agonize from either pension shortfall or a collapse in purchasing power (as BoJ monetizes welfare deficits). 

Sad to see governments manipulate stocks which will only suffer the population (here welfare recipients) through boom bust cycles.

Oh, by the way, the don’t worry be happy pump comes as Abe’s two cabinet members resigned yesterday.

From the Washington Post: (bold mine)

Two female Japanese cabinet ministers, appointed last month as part of Prime Minister Shinzo Abe’s plan to let women “shine,” resigned their posts Monday amid allegations of financial impropriety.

Their departures undermine Abe’s efforts to lead by example when it comes to promoting working women, and they cast a dark cloud over his administration at a difficult time. The prime minister’s “Abenomics” plan to revive the economy looks to be fizzling out, and he must decide in the next few months whether to press ahead with a hugely unpopular rise in the consumption tax.

“I apologize to all citizens for what happened,” Abe told reporters outside his office Monday afternoon as Trade and Industry Minister Yuko Obuchi and Justice Minister Midori Matsushima resigned within hours of each other.

See “Difficult time” and the “economy looks to be fizzling out” are really good signs for a pump, right? Well no problem, regardless of "fundamentals", stocks are bound to rise forever.

And to see what has caused the resignation of the two ministers, again from the Wapo

The first minister to fall on Monday was Obuchi, a 40-year-old mother of two young children and daughter of a former prime minister, who was widely touted as potentially “Japan’s first female prime minister.” Abe last month promoted her to lead the powerful Ministry of Economy, Trade and Industry (METI), making her one of five women in the newly reshuffled cabinet…

Only six weeks after she was promoted to the cabinet, reports surfaced that her political funds report for 2012, the year of the last general election, did not include revenue and spending on theater tickets for her backers, organized by her support group. There was a gap of about $424,000 in her accounts.

Another support group bought $35,000 worth of goods from businesses run by Obuchi’s sister and brother-in-law, the public broadcaster NHK reported, in violation of political funding laws…

Only a few hours later, Matsushima also submitted her resignation. Shehad been accused of breaking political campaign laws for distributing paper fans during summer festivals.

Hmmm using public office for personal gains...sounds very much like the public choice theory to me.

Meredith Whitney: Detroit as precedent to the staggering aftershocks of the largest municipal bankruptcy in US history

Bank analyst Meredith Whitney who correctly called on the Citibank fiasco during the 2007-2008 crisis warns in the Financial Times that  the Detroit episode serves as precedent to a coming wave of municipal bankruptcies. (bold mine)

As jarring as the reality may be to accept, Detroit’s decision last week to declare bankruptcy should not be regarded as a one-off in the US municipal market – which is what the bond-peddlers are now telling their clients. The aftershocks of the largest municipal bankruptcy in US history will be staggering, and Detroit will set important precedents.

Municipal bankruptcies have historically been rare for a number of reasons – including the states’ determination to preserve their credit ratings, their access to cheap funding and the stigma of bankruptcy. But, these days, things are very different in the world of municipal finance.

At the root of the problem is the incentive system that elected officials used to face. For decades, across the US, local leaders ran up tabs for future taxpayers; they promised pensions and other benefits for public employees that have strong legal protection. That has been a great source of patronage for elected officials: they can promise all sorts of future perks to loyal supporters (state and local workers) with very little accountability on the delivery of those promises.

Today, we are left with the legacies of this waste. The bill for promises past is now so large for some cities and towns that it is crowding out money for the most basic of services – in the case of Detroit, it could not even afford to run its traffic lights. Across many American cities, cuts to basic social services have already been so deep that they have made the communities unpleasant places.

Read the rest here.

Ms. Whitney has had strident critics for predicting defaults by 50 to 100 cities to the tune of of “$100s of billion dollars” in 2010 such as David Kotok of the Cumberland Advisors.

Nonetheless currently the unfunded state and local pension liabilities has been estimated at a huge $3.8-4 trillion. This should gobble up a huge share of state budgets in the backdrop of a highly fragile steroids dependent economy. Also, pension shortfalls increases state or muni credit risks, if expected or targeted returns are unmet.

Yet if bond vigilantes continue to unsettle the interest rate markets, and or, if the FED does “taper”, where Dr. Bernanke said last week, “If we were to tighten policy, the economy would tank”, then it wouldn’t be far fetched for Ms. Whitney’s predictions to come to fruition.

Spanish Government’s Ponzi Financing Scheme

More signs why the European debt crisis is far from being over.

Spain’s pension fund has been loaded with debt from the Spanish government

From Bloomberg: (bold mine)

Spain’s pension reserve-fund ramped up its holdings of domestic debt last year, profiting from a rally across southern Europe and making it easier for Prime Minister Mariano Rajoy to raid the fund to finance his budget.

The so-called Fondo de Reserva de la Seguridad Social in 2012 increased its domestic sovereign debt holdings to 97 percent of its assets from 90 percent at the end of 2011, according to its annual report due to be presented to lawmakers today at 12:30 p.m. in Madrid and obtained by Bloomberg News.

The fund purchased about 20 billion euros ($26 billion) of Spanish debt last year, while it sold 4.6 billion euros of French, Dutch and German bonds. More than 70 percent of the purchases took place in the second half of the year, after European Central Bank President Mario Draghi pledged to do “whatever it takes” to defend the euro, boosting Spanish bonds.

Two insights from the above.

One, pension funds are subject to government’s predation, thus can’t be relied on.

Two, if the Spanish government defaults on their debt, pension fund beneficiaries will get cleaned out.

Yet more signs of increasing vulnerability of Spain’s welfare state. More from the same article: (bold mine)

Spain’s state-run social security system, also in charge of unemployment benefits, stopped registering surpluses in 2011. Its deficit was 1 percent of GDP last year, contributing to the nation’s total budget gap of 10.2 percent of GDP.

A recession is crimping contributions paid by workers and their employers. At the same time spending has increased due to a record jobless rate of 26 percent and a pensions’ bill, which has risen to 9 billion euros a month from 8 billion euros in 2004.

While the fund stopped receiving government contributions in 2010, its managers changed rules on July 17 to profit from returns from Spanish securities, according to the document.

The maximum amount that can be invested in a given security was increased to 35 percent of the total portfolio from 16 percent. At the same time, the fund raised to 12 percent from 11 percent its maximum share in the Treasury’s total outstanding debt. The Treasury’s debt stock was 634 billion euros in February, according to data on its website.

See why governments have used central bank inflationism to boost asset prices? Gains from asset arbitrages have been used to cover funding shortfalls!

This reminds me of Hyman Minsky’s Ponzi finance from his Financial Instability Hypothesis

Mr. Minsky defines Ponzi finance as (bold mine)

cash flows from operations are not sufficient to fulfill either the repayment of principle or the interest due on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stock lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. A unit that Ponzi finances lowers the margin of safety that it offers the holders of its debts.

In short, Ponzi finance depends on asset values from which is used either as collateral for borrowing or for funding purposes through asset sales.

 

How Ponzi schemes implode, again from Mr Minsky

In particular, over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance.

Furthermore, if an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values.

The difference here is that Mr. Minsky refers to capitalist economies or private finance units as practitioners of Ponzi financing, whereas today it has been governments that rely on Ponzi finance via asset bubbles to sustain their welfare states.

And Spain’s Ponzi finance scheme shows why debt laden governments will unlikely resort to the “exorcise inflation by monetary constraint”, since this will “lead to a collapse of asset values”, thus extrapolates to the collapse of Spain's welfare state.

At the end of the day, what is unsustainable will simply not last, like all ponzi finance schemes, they will fail.

Is US Dollar’s Price Action Reflecting The State Of Deleveraging?

According to Sir Isaac Newton, ``To every action there is an equal and opposite reaction”.

In terms of the US dollar index, Newton’s Third Law of Motion seems at work.

The US dollar index remarkably spiked just as after the Lehman Bros declared bankruptcy last September 15. But has surrendered more than three-fifths of its most of recent gains, with the gist of these losses surfacing during the past two weeks.

Courtesy of Bespoke Investment

Bespoke Invest notes that ``The US Dollar index fell another 2.2% today for its biggest 6-day decline ever…the current 6-day decline of 8.07% tops the prior record decline of -7.48% set back in September of 1985. If it's not one asset falling these days, there's sure to be another.”

So the amazing rise has now been equally met by an astounding fall. The question is if the recent decline will wipe out the entire gains accrued during the September-October rump.

Yet, some suggest that the US dollar is either in a long term bull market or will remain cyclically strong because of the present environment deleveraging, recession, risk aversion, narrowing growth differentials and the US dollar as reserve status.

While these factors may have, to varying degrees contributed, to the US dollar’s recent strength, we have long argued (see Demystifying the US Dollar’s Vitality) that deleveraging and the unwinding carry trade seem to be the critical binding force in pushing up the US dollar especially against Asian and other currencies, aside from the collapsing global financial markets and commodities.

Courtesy of Casey Research Charts

The post Lehman bankruptcy sent foreign buyers, mostly central banks, scrambling into US treasuries (US $147 billion-Casey Research) which drove yields to historical record levels and even to “negative yields” (see Living In Interesting Times).

The credit bust resulted to a dysfunctional banking system in the US, which caused global banks and Emerging Market economies to jostle for US dollars for mostly purposes of payment/settlement and or for capital building.

Thus, the fear factor or risk aversion and magnified status of the US dollar as the world’s currency reserve have basically been an offshoot to the massive debt deflation process. Debt deflation accounted for as the cause, all the rest were attendant actions or the effects.

And as the deleveraging eases, the US dollar should likewise reflect on its intrinsic economic weakness (yes, the US is the epicenter of today’s woes and unlikely representative of “safehaven” status) and the expansive inflationary actions undertaken by its policy makers (Dr. Jekyll and Mr. Hyde- Bernanke doing a Dr. Gideon Gono-see Zimbabwe’s Gono Lauds US and UK For "Seeing the Light" and "Making Positive Difference").

We don’t share the view that the US will recover first simply because it is experiencing enormous structural internal changes coming from an imploding bubble, which will fundamentally alter the country’s political economic landscape, aside from the reverberating weaknesses from its external linkages (exports or capital flows).

Even, Gao Xiqing president of the China Investment Corporation, which manages “only” about $200billion of the country’s foreign assets, recently observed of such fundamental shifts. In an interview with James Fallows at the Atlantic Magazine, Mr. Gao said,

``The overall financial situation in the U.S. is changing, and that’s what we don’t know about. It’s going to be changed fundamentally in many ways.

``Think about the way we’ve been living the past 30 years. Thirty years ago, the leverage of the investment banks was like 4-to-1, 5-to-1. Today, it’s 30-to-1. This is not just a change of numbers. This is a change of fundamental thinking.” (bold highlight mine)

Also, we do not share the view that plain recession or risk aversion will lead to a support in the US dollar. For instance, Pension funds, which for some should serve as pillars for the vitality of the US dollar, seem to have been impacted by forces that should help not weaken the US dollar, such as

1) the economic weakness that poked big holes in corporate pension funding...

This from Businessweek,

``In pooling together assets from many different corporations, a multi-employer plan should minimize the risk of any one company's not paying its pension tab, since it can tap other companies in the plan to make up for the shortfall. But something unexpected is happening now: As the recession grinds on, companies in a broad swath of industries, from transportation and manufacturing to food services and lodging, are going out of business and have stopped making their pension payments. That has left the remaining companies—healthy or not—with the burden of making up for the massive shortfalls. "The multi-employer plan is a great model as long as all of the companies stay alive and grow," says William D. Zollars, CEO of trucking giant YRC Worldwide, which participates in such plans. "But the way the current plans are structured, you not only pay for your employees but all the orphans whose employers have gone out of business."

``To prop up multi-employer plans, companies will have to dip into profits, which could force them to tamp down salaries and bonuses, cut jobs, and slash capital spending. It's a vicious circle: The bigger the shortfalls in coming months, the more they will weigh on the already slumping U.S. economy—which will only make the pension situation worse.

courtesy of Businessweek

2) severe mark down of asset values in the portfolios of Pension funds...

Again from Businessweek ``At least some of the blame for the nation's pension woes lies with Washington, which has unwittingly tied the hands of companies with single- or multi-employer plans. Under the 2006 Pension Protection Act that's just now taking effect, employers must ensure their pension plans have enough money on hand to cover current and future benefits. If a plan is significantly underfunded—meaning its obligations exceed its assets—the company or companies must make up the difference within a certain number of years.

``Talk about bad timing. The legislation was meant to force corporations to shore up their plans so that the government wouldn't have to bail them out. But no one foresaw the great bear market of 2008. Now, just as the new pension rules are kicking in, investment portfolios are plunging. The nation's largest pension plans in late October had just 85 cents of assets for every $1 of current and future obligations, according to Standard & Poor's and that gap, a record $204 billion, has likely increased with November's stock market swoon. Goldman Sachs estimates that companies will be forced to boost their pension contributions to $40 billion in 2009, from about $18 billion this year….

``Taxpayers could find themselves picking up the tab, precisely the scenario lawmakers tried to avoid. The Pension Benefit Guaranty Corp., a federal government agency, was created in the 1970s to manage the pension assets of bankrupt companies. In recent years the PBGC assumed the benefits of steel giants like Bethlehem Steel and airlines such as United Airlines and Delta. But the PBGC is also hurting, with just $69 billion on hand and $80 billion worth of obligations. Should another big pension provider go under, the PBGC might need more public funding. "We are always trying to be prepared for the future," says Charles Millard, the PBGC's director. "We regularly update our contingency plans and review the funded status of plans and industries that concern us."

None of these looks US dollar bullish, especially if the deleveraging dynamics should ebb.