Unimaginable Math Problems

In 1980, the US government owed, in one fashion or another, $909 Billion, which was about 35% of GDP. Federal spending that year was $591 Billion. If you adjust these numbers for inflation, the 1980 spending was $1,700 Billion and the debt was $2,615 Billion. Today the government spends over $3,000 Billion and the national debt is $19,000 Billion. The current estimates say the debt-to-GDP ratio will be close to 90% this year and will break 100% sometime in the next administration.

I use 1980 as a benchmark because Reagan ran on the debt issue, making it a popular topic in politics ever since. In that time, Republicans have controlled the White House for 20 of those 36 years. They have controlled the House for 18 of those years. The point here is both parties have had chances to arrest the growth of spending and debt accumulation, but neither team has bothered. As long as the Fed can monetize the debt, the politicians keep spending.

Another reason to think back to 1980 is that no one thought the current debt levels were possible. The NYTimes first used the word “trillion” in the 1970’s. The rationale behind Reagan’s tax plan was that making high taxes politically impossible meant spending would have to decline. After all, who in their right mind would keep buying bonds, even at the elevated rate of 10% for the 10-Year Treasury?

The future turned out to be a very different place than the planners of the 1980’s imagined. That’s important to keep in mind when you see stories like this regarding the nation’s public pension systems.

The US public pension system has developed a $3.4tn funding hole that will pile pressure on cities and states to cut spending or raise taxes to avoid Detroit-style bankruptcies.

According to academic research shared exclusively with FTfm, the collective funding shortfall of US public pension funds is three times larger than official figures showed, and is getting bigger.

Devin Nunes, a US Republican congressman, said: “It has been clear for years that many cities and states are critically underfunding their pension programmes and hiding the fiscal holes with accounting tricks.”

Mr Nunes, who put forward a bill to the House of Representatives last month to overhaul how public pension plans report their figures, added: “When these pension funds go insolvent, they will create problems so disastrous that the fund officials assume the federal government will have to bail them out.”

Large pension shortfalls have already played a role in driving several US cities, including Detroit in Michigan and San Bernardino in California, to file for bankruptcy. The fear is other cities will soon become insolvent due to the size of their pension deficits.

Joshua Rauh, a senior fellow at the Hoover Institution, a think-tank, and professor of finance at the Stanford Graduate School of Business, who carried out the study, said: “The pension problems are threatening to consume state and local budgets in the absence of some major changes.

“It is quite likely that over a five to 10-year horizon we are going to see more bankruptcies of cities where the unfunded pension liabilities will play a large role.”

The Stanford study found that the states of Illinois, Arizona, Ohio and Nevada, and the cities of Chicago, Dallas, Houston and El Paso have the largest pension holes compared with their own revenues.

In order to deal with the large funding shortfall, many cities and states will have to increase their contributions to their pension funds, either by raising taxes or cutting spending on vital services.

That’s one possible future. The important thing to remember is the US government has no money of its own. It either taxes, borrows from foreign sources or creates credit money through the machinations of the Federal Reserve. Given the state of the federal budget and projected debt, it’s unlikely the Feds could bailout the state pension systems completely. The CBO says the total debt could hit $30,000 Billion in ten years.

The other possible future is the pensioners don’t get paid. When a company goes bankrupt, the creditors don’t get paid. At least they don’t get paid in full. When cities and towns can no longer make their pension payments, they will stop making those payments. The old retired employees will sue and petition their legislatures, but you can’t get blood from a stone. The best case is the pensioners take a hefty cut in benefits.

The thing no one discusses is why these funds are in trouble. The reason for the trouble is the artificially low bond rates we have seen for two decades. In order to finance Federal spending, borrowing rates have been driven down to near zero. The biggest buyers of treasuries used to be pension funds. They could expect a return exceeding their target of 7.5% and not carry much in the way of risk. Being a pension fund manager used to be the easiest job in finance.

Olivia Mitchell, a professor at the Wharton School at the University of Pennsylvania, told FTfm last month that US public pension plans face “grave difficulties”.

“I do believe that US cities and towns will continue to suffer, and there will be additional bankruptcies following the examples of Detroit,” she said.

Currently, states and local governments contribute 7.3 per cent of revenues to public pension plans, but this would need to increase to an average of 17.5 per cent of revenues to stop any further rises in the funding gap, the research said.

Several cities and states, including California, Illinois, New Jersey, Chicago and Austin, would need to put at least 20 per cent of their revenues into their pension plans to prevent a rise in their deficits, while Nevada would have to contribute almost 40 per cent.

Mr Rauh’s study claims the “true extent” of funding problems in US public pension system has been obscured because plans calculate both their costs and liabilities on the assumption they will achieve returns of between 7 and 8 per cent a year. The academic believes this rate is “wildly optimistic and unlikely to be achieved”.

Mr Rauh said a more realistic return rate, based on US Treasury bond yields, was around 2-3 per cent a year.

Ultra-low bond rates have forced pension funds into higher risk investments as they try to hit their target of 7% per year. This is fine when the market is performing at or near its historic averages and the fund managers are smart enough to bet the broader market. It also assumes that cities and states pay their pension obligations, without actually borrowing from those same pension funds. Now we know why the pension system is in trouble.

This is just one small aspect of the daunting math facing the United States over the next decade. Again, no one imagined the current math was even possible 35 years ago. If you told 1980 people that the Federal debt would be $19 Trillion, they would have laughed in your face. Maybe ten years from now $50 Trillion is no big thing. The math is unimaginable, but today’s math was once unimaginable. Alternatively, perhaps what’s coming is unimaginably awful. I don’t know, but the math problem facing America beggars the imagination.

34 thoughts on “Unimaginable Math Problems

  1. Pingback: Thursday morning links - Maggie's Farm

  2. “The CBO says the total debt could hit $30,000 billion in ten years”

    Well, setting aside the fact that the CBO’s forecasts have been consistently way off the mark for decades, that would be a remarkable achievement, considering that the federal debt has been doubling roughly every seven years since 1980. Assuming we continue at that rate–which frankly seems like a very good assumption as nothing in Washington DC ever seems to change–we should be right around $50,000 billion by 2026.

  3. The pension system is in trouble because JFK permitted their establishment by introducing public-sector unions — thereby creating an intractable moral hazard: the higher the union demand for over-generous pensions, the greater the political remedy to tax the general public to pay for them, and the more entrenched the corruption between unions and politicians — with Joe citizen not only picking up the tab but losing his representation in the process.
    So, why isn’t anyone writing about attacking the cause of the problem and not merely addressing the symptoms and fallout?

    • I agree, public employees have no constitutional right to unionize. The legislation that authorizes it can be repealed. Why doesn’t anybody talk about it? Probably because lots of union money is going into lots of pockets.

    • Federal Employees can’t negotiate wages or benefits. It is the states, not the feds, which permit state and local government unions to negotiate wages and benefits. Public employee unions were around long before JFK. The Boston Police Strike of 1919 was an attempt to force the State of Massachusetts to recognize the AFL-backed police union. I think Wisconsin and New York State were the first states to permit public employee unions with the power to negotiate wages and benefits. The individual states can eliminate public employee unions at any time.

      The Feds adopted the Federal Labor-Management Relations Act during Carter’s administration, as I recall. The State Department has its own employee union act.

      Public employee unions really took off at about the same time that private employee unions started to fade.

  4. “Today the government spends over $3,000 Billion and the national debt is $19,000 Billion”.
    Probably better not to use the term Trillion, most folks can’t “experiential”, or even” “conceptualize” the magnitude of million.
    Using exponents, outside of real science, make the numbers of “1s”, or “100s” even MORE unfathomable.

    • Some old fashioned sorts think “million” is the top. They eschew billion and trillion. A trillion rice grains laid end to end is roughly 2 million miles long. That’s how unfathomable these numbers are for humans.

  5. I can suggest one possible solution. It’s awful, but honestly — how many people here in this, the Current Year, could explain why? Strip out the country-specific references, and you could win most Republican primaries, and all Democrat ones, on that platform right now. Even the hint of a crunch is going to make it look more attractive. Yep, we’re screwed.

  6. This phenomena is part of an overall systemic collapse, across the developed world. Much like when an individual is dying from multiple organ failure. At every level of society, incompetent people are present, which is equivalent to individual cells in an organ malfunctioning. Just as individuals become obese (and come down with metabolic illnesses) the government has become obese and is starting to “die”. It’s a beautiful symmetry.

  7. Witness the problems of governments living beyond their means for decades. Things start to come apart at the seams. Most people chose not to notice the leaks and the pressure building. They ignore evidence right in front of their faces or get distracted by nonsense such as – who gets to pee in which bathroom.

  8. Seems like Bernake et als have been trying to gin up inflation for awhile, without much success. What happens when country after country, state after state, city after city, default on their debt? Who is left holding the bag? Soros? If a world wide debt jubilee is called, would the system just reset and then keep running as usual?

    • I’m doing a lot of spitballing this morning (laying out the corner cases), but you’re right. Deflationary pressures are counteracting all the attempts at currency inflation so far.

      I saw the jubilee concept raised in a serious publication about a month ago for the first time ever. I think that if you do that, investors will demand very high rates of return on bonds afterwards and will be adverse to buying long-term bonds. Assuming that pension obligations remain intact, then you probably trigger the worst case scenario that Zman described in his comment above: even though you have universal debt forgiveness, you haven’t changed government cost structure, so you just plunge back into insolvency straight away.

      • I think people miss what’s happening. Central banks are not printing cash money to goose prices and spending. Wholesale inflation has been fairly flat. What they have been doing is asset inflation. Home prices, equities, various synthetic instruments based on asset-based lending and, to some degree, commodities. Clothing is cheaper, but your house has appreciated by 10% a year for two decades. Your investments have grown at five times inflation, while the interest on saving has gone negative. Debt has become an asset, which is a new thing. There are no good historical analogies.

        • I agree, Z. The world ain’t seen nothing like this.

          I heard a Japanese economist say in spring 2009 that it was over. That in six months the Japanese could not afford the buy anymore US debt. That shortly afterwards, the Yen would appreciate rapidly against the dollar and that the Japanese economy would then collapse. Yet here we are seven years later and the status quo is persisting.

          Except that maybe it won’t: http://www.telegraph.co.uk/business/2016/04/11/olivier-blanchard-eyes-ugly-end-game-for-japan-on-debt-spiral/

          The bet of the cloud people is pretty straightforward. 2.5B First World petite burgeousie filled with unbounded amour propre will accept any amount of financial shenanigans over a decade or more of general immiseration.

          Their bet is simple but their methods are convoluted and opaque. Eventually someone breaks right who should have broken left, and the whole Rube Goldberg apparatus falls to bits.

          • I was just reading that Telegraph piece. It’s a good example of how QE eventually ends up as money printing. It has too. The old gag about socialism was that you eventually run out of other people’s money to spend. With monetarism, you eventually run out of other people’s money to borrow.

      • “I think that if you do that, investors will demand very high rates of return on bonds afterwards and will be adverse to buying long-term bonds.”
        In other words, exactly what investors should be demanding in a rational economy.

      • It won’t be just investors that will demand very high rates of return if debt forgiveness were to occur, it will be the lenders who end up eating the losses from “forgiven” debts. Someone will be taking the loss. There’s no such thing as a free lunch. Would a lending institution be willing to lend in the future if there’s a chance the debt is to be forgiven? Maybe at extraordinarily high rates. Yes, any lender takes the chance that debts won’t be repaid, but the non-payment of debt has very real and long-lasting consequences, none of them good, and people (and countries) end up a great deal poorer.

        • An awful lot of this “money” was created out of thin air by the government. Is there a “lender” other than the government involved? Imagine it from the little guy’s perspective; no more credit card debts, no mortgages, etc. And if Soros loses a B or two, who will shed a tear?

  9. A relative of mine thinks that every country, all around the world, should just print more money. Her answer to the problem is as the world is a self-contained entity, then everyone printing more money solves the problem typically created if only one or two countries were printing more banknotes.

    Her argument would be that some countries want to stay ahead in the currency game, but everyone setting the presses rolling at the same time would cancel all debts and everyone stays where they are, free of charge.

    I am sure economists have either debated this already or would find no problem in shooting it down. But… I wonder…

    • Instead of going through the charade of printing all that currency, why wouldn’t you just do a debt jubilee? Because that’s effectively what your friend is proposing. Some people think a jubilee is the only way out.

  10. It is amusing to hear it said that to pay off public pensioners (more money than their miserable work ethic deserves for jobs that never should have existed) that taxes must be raised, as if raising tax rates increases tax revenue. Then after experiencing exactly the opposite effect, they raise taxes again.

    The advantage of the world past of private capitalism was that failure was inevitable, and somewhat regular. When the foolproof never happen again government dam breaks it’s going to be special.

    • “…..more money than their miserable work ethic deserves for jobs that never should have existed…..”

      Someone needs to chisel that into granite.

  11. If Detroit is an example, the pensions will be paid off in full but the bond holders will get screwed.

    • The trick some states are doing is quietly transferring the pension plans to cities and counties. The state teacher pension is being pushed down to the county and city pension. The reason for this is bankruptcy. Rich counties will just jack up property taxes to cover their pension systems. That works for a number of reasons. Poor counties will simply go bust and and that works too.

      The monster in the room is the bond market. If borrowing rates rise to historic averages, every western government, including the US, faces default.

      • Plus state debt is sovereign and cannot be discharged through Chapter 9. The municipalities’ debt is not sovereign, so they can file for bankruptcy if need be.

        I’m sure there are already statists and centralizers trying to figure out how to take advantage of this and further undermine the Constitution and states rights: make a Mephistophelean deal with the states… give up your right to issue sovereign debt, we’ll let you declare chapter 9, we’ll partially underwrite your pension debt, but here is a list of pesky states rights that you will have to forego in exchange.

        BTW, the Japanese debt to GDP ratio was 2.279 last year. Out elites see that as a model, not a problem, at least to some articles I’ve been reading.

      • Watch Westchester County NY for the next couple of years. It’s rich. But tax carry is about 3% of market value in most municipalities. Cuomo allegedly “capped” taxes, but provided no legislative relief for mandates. Most have bumped along, but this year are getting hit with pension catch ups (NY at least doesn’t permit funding to get severely in arrears) due to lower than expected returns. Now the shit is hitting the fan as the draft municipal budgets are getting kicked 5-7% in a income flat environment. And as you used to see in the CT/NY border tax arbitrage, the rise in taxes directly impacts value of the dwelling. Not a lot of happy campers. The capacity of the “rich” is not infinite.

    • The easy way out for the politicians and bankers — but not the American people — would be to use some combination of fiscal and monetary policy to trigger hyperinflation, then do a currency swap — trade “new dollars” for old — say one new dollar for every 1,000 old dollars. Of course they would do it in such a way to force the bond holders and pensioners to take a haircut. Maybe their investment would be worth half of what it was before inflation. The swap would also present the bankers and politicians an opportunity to reach their goal of a cashless economy. We peons would be trading paper dollars for e-dollars.

      I hear that Christina Fernandez-Kitchner is looking for work. She could sign on as a consultant.

  12. the Reckoning will bring the most high to their knees, most of the rest of us will be prostrate, the lucky will be dead and gone………thankfully we are immortal, otherwise it ain’t going to be pretty by a long shot.

  13. Pingback: Unimaginable Math Problems | Western Rifle Shooters Association

Comments are closed.