miércoles, 25 de marzo de 2015

miércoles, marzo 25, 2015
'The U.S. Is Broke'

by: Shareholders Unite            
    

Summary
  • From time to time, we hear deeply serious economists expound that the US is broke.
  • Invariably, this involves discounting future entitlement obligations to present day dollars, which usually deliver intimidatingly large sums scaring the uninitiated.
  • The curious thing is, if the US is broke, somebody should tell US bond market investors, as rates should rise dramatically if the 'broke' analysis is right.
  • A less dramatic look at the issues shows that the markets have it right. The US is far from broke.
According to Laurence Kotlikoff, the US is broke. To be more precise, it's broke today! While stuff like this has moved down a little on the current wall of worries (it used to be much more popular) it still gets remarkable traction. Kotlikoff really should know better. Here he is:
"Our country is broke. It's not broke in 75 years or 50 years or 25 years or 10 years. It's broke today," he told the Senate Budget Committee. "Indeed, it may well be in worse fiscal shape than any developed country, including Greece."
Worse than any developed country? Worse than Greece? How's that? Well, here is his explanation of sorts:
"Instead, the federal debt and its annual change, the deficit, are purely linguistic constructs that reflect how members of Congress choose to label government receipts and payments." For example, that figure omits the almost $750 billion the government is collecting this year in Social Security payroll taxes from workers and the future Social Security transfer payments these FICA contributions secure, he explains. "Were we to go back in time and re-label all past Social Security taxes as borrowing, official federal debt held by the public would not be $13 trillion, but $38 trillion, which is 211 percent of U.S. GDP." In reality we're facing a fiscal gap of $210 trillion, Kotlikoff proclaimed. That's 16 times larger than official U.S. debt.
We'll get to the social security nonsense in a moment. First, a couple of other things one has to realize.
 
Markets
 
It seems that "broke" is also a linguistic construct, because Kotlikoff argues that the US is broke today. This is remarkable. Somebody tell the investors in US debt! They are still willing to lend the US at record low interest rates, so there really must be some mass psychosis going on in the bond US markets, which is one of the most liquid markets in the world.
 
It is even more remarkable because many of the people who argue this sort of stuff (the US is broke) also often have great faith in the wisdom of markets. The markets give this nonsense a thorough thumbs down, and rightly so.
 
Countries
 
Unlike Greece, the US can issue its own currency, so it can basically always pay for its obligations.
 
Yes, under some conditions, this could lead to inflation taking off, but to get there things have to get pretty dire.
 
Today we see Japan monetizing its debt in a pretty dramatic fashion in order to create at least a modicum of inflation, so far with fairly limited success, that should tell you how difficult this actually is. We're not in Venezuela or Argentina, let alone in Weimar or Zimbabwe.
 
Also, you have to remember that countries are not households. We are the owners of much of the outstanding US debt, foreigners hold roughly $5B of the $17B outstanding debt (but we also hold foreign assets...). So the future generations, which we're supposed to burden with all that debt also inherit most of the bonds issued in relation to it.
 
Social security
 
One of the 'owners' of US debt is actually the social security trust fund (or better, funds as there are two). These funds put the excess of payroll taxes it receives in the trust fund in order to meet future obligations. Until 2009, payroll tax receipts exceeded current social security payments, so the trust fund increased. This is no longer the case.
 
Under present projections the Old Age and Survivors Fund runs out in 2033 and the smaller Disability Insurance Trust Fund could run out much sooner, by next year. The latter should be manageable, as the figures involved are small:
In December 2014, nearly 11 million people received Disability Insurance from Social Security, with an average benefit of roughly $1,000 per month. While the Old-Age and Survivors Insurance Trust Fund, the portion of Social Security that most people think of as their retirement benefits, is not set to run out of money in the trust until 2033, the Disability Insurance Trust will run out in 2016 if nothing is changed. This shortfall would result in a nearly 20% cut to benefits, reducing those $1,000 checks down to $800 a month.
That's a shortfall of 20% of 12 times $11B or $26.4B a year, which is just 0.15% of GDP, no reason to worry. Given that we also know that the number of pensioners will increase we can safely conclude that the problems are with the pension trust fund, not the disability fund.
 
Remember, what is lacking is the difference between the trust fund and the payout. That is, present contributions from the payroll tax (plus interest income on the fund itself) are not enough to cover pensions, which is why the trust fund is slowly depleting, expected to run out of money.
 
The corollary of that is that payroll taxes are covering most of the pensions, but not all of them.
 
So when the trust fund runs out, they'll have to cover all of the pensions. Instead of discounting all future payments back from infinity into today's dollars (the preferred method for those that want to scare the living daylights out of you), let's simply look at what kind of percentages of GDP it takes:
 
 
There are several rather noteworthy (and dare we say, reassuring) conclusions to draw from this graph:
  • Note the rather unprecedented decline in discretionary public spending after 2009, the state has been shrinking, not expanding.
  • As far as the automatic programs are concerned, the medical programs are increasing more (which is not surprising, given increased life expectancy, introduction of new expensive medicines and treatments, and difficulty to increase productivity in the medical sector). And the good news here is that the cost curves have started to bend, at least partly because of Obamacare, despite all the histeria.
  • The biggest factor in the debt projections is actually the projected rise in interest rates on the debt. It's also the most uncertain factor.
  • Pensions are expected to reach roughly 6% of GDP by 2039, and you can see in the graph that there really isn't a steep increase, it's roughly 5% of GDP now.
Does this sound like a crisis (let alone a US bankruptcy) to you? Hardly. Since the payroll tax is covering almost, but not quite all of pensions today, and pensions are likely to increase by 1% of GDP over the next 25(!) years, payroll tax needs to find an additional 1-2% of GDP over the next 25 years.

This is certainly not negligible (1% of GDP is $170B), but the time frame is very large, so it can be done very gradually. In fact, lifting the payroll tax from 6.2% to 7.6% (a 1.4% increase, double that for self-employed as they also pay the employer part) would eliminate the deficit and maintain the trust fund.

It's hardly bankruptcy...

And there is quite a bit that can be done to make this more palatable, like lifting the payroll ceiling (that is, taxing higher incomes), increasing the retirement age and/or means-testing benefits, etc.

In a way, the outcome is totally unsurprising. The US is a country with a fairly low tax pressure and good demographics, the combination of which should make any pension problem rather manageable. The US isn't Japan, which has a more serious problem with its declining population and steeply increasing dependency rates.

And the funny thing is, what do the scaremongers usually want to do with respect to this non-existing social security problem? Cut pensions! So we have to cut pensions now in order to avoid having to cut pensions in a couple of decades (even if there are other options available, like increasing pension age, etc.)? It doesn't really make sense.

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