Dear Reader, Queensland…beautiful one day, further in debt the next. The Queensland State Government is a shocker. Our Treasurer, Comrade Jackie Trad, is hopeless when it comes to managing the state’s finances. As reported in the AFR December 2019 (emphasis added): ‘Queensland's total debt — which was already the worst in the nation — was due to top $90 billion by 2022-23.’ The solution to our state’s parlous debt situation? Public sector job cuts? Privatisation? No. According to the AFR, our Treasurer Trad has something far more ‘creative’ in mind (emphasis added): ‘…a move by Treasurer Jackie Trad to raid the defined benefits superannuation scheme for public servants to create a new Queensland Future Fund to tackle debt…” How much will this ‘smash and grab’ operation net? ‘…the decision to take $5bn from the surplus of the public servants’ defined benefit superannuation fund for a new debt offset account…’ The Australian 14 February 2020 The State’s newly formed debt offset account — sorry, Queensland Future Fund — is expected to offset how much debt? According to the AFR: ‘Queensland Investment Corporation [QIC] would be asked to invest the [raided] money which is expected to deliver returns of about $400 million a year which would be used to pay down debt and interest payments.’ QIC expects the $5 billion to generate about $400 million, an 8% return. Of course, no one knows what the actual outcome will be…that’s in the lap of the markets. Comrade Trad’s desperate actions to ‘paper over’ her appalling lack of budget discipline has far reaching consequences. Defined benefit plans are ticking time bombs...all over the developed world. Employees — in both the private and public sectors — have been promised guaranteed indexed pensions in retirement. The pension payment is determined by an individual’s years of service and final average salary. These plans were commissioned into existence in an era when life expectancies were much lower than today AND risk-free interest rates (government bonds) were much higher. Honouring promises was a whole lot easier. Not today. Actuarial calculations — educated guesses on the life expectancy of members; estimated rates of return; future contribution levels — provide a guide as to whether the plan has sufficient funding to meet its obligations. In Queensland, the number crunchers reckon there’s more than enough in the pot to meet present and future promises…that’s assuming their assumptions are correct. But, what if members — on average — live much longer? Or, what if estimated future returns are much lower? Should either or both these variables spring a nasty surprise, then ripping $5 billion out could render the fund incapable of meeting — in full — its promises. Surely, even our hapless treasurer is aware of the trouble brewing in defined benefit funds in the US? United in varying states of distress Some of the more troubled US private and public sector funds have suspended annual indexation and/or reduced payments or in more dire cases, temporarily ceased payments. The breaking of pension promises has so far been largely contained to smaller municipal funds and company schemes. In the pension ocean, these plans are the plankton, but what about the whales? And in terms of states, they don’t come any bigger than California. ‘If California were its own nation, it would be the fifth largest economy in the world. With a GDP of $US2.9 trillion, California would slot between Germany and the United Kingdom in the world’s top economies.’ Business Insider CalPERS (California Public Employees’ Retirement System) is the fund that manages the pension and health benefits for California’s public sector employees. The following graphic is from ‘CalPERS — Comprehensive Annual Financial Report Fiscal Year Ended June 30, 2019’: A few things to note here… The figure of…70.2%...funded. Or to put it another way, CalPERS is 30% UNDERfunded. CalPERS lacks sufficient capital to meet its obligations. How do the administrators plan to fix this rather serious problem? With a two-pronged approach… Assume the fund will deliver a 7% rate of return each year. The fund’s performance of 6.7% was just shy of the forecast return…so all good…except, these are the very best of times for markets. What awaits when the cycle turns and markets head south? And, the second prong? Tap the taxpayers. According to The Sacramento Bee, CalPERS… ‘…is in a decades-long process of increasing funding to get to 100 percent. State and local governments and school districts have to pay extra until the fund reaches 100 percent.’ These are lessons Queenslanders should take heed of. QIC is unlikely to deliver the expected 8% per annum. And, when returns DO turn negative and the defined benefit fund is declared UNDERfunded, taxpayers WILL feel the government’s fingers reaching deeper into their pockets. There are 712,000 retirees and beneficiaries relying on CalPERS being able to honour its retirement funding obligations. And as CalPERS stated in its Annual Report (emphasis added): ‘Retirement benefits play a vital role in the state’s economy. The most recent Economic Impacts of CalPERS Pensions in California report shows that the $18.9 billion paid in retirement benefits during Fiscal Year 2017-18 to California retirees and beneficiaries generated $23.5 billion in economic activity that supported jobs and increased business and tax revenue. The economic impacts are significant throughout the state, and especially in smaller communities.’ The honouring of those pension promises has far reaching economic consequences. Any disruption — suspension of indexation and/or reduction in payments — would have deflationary ramifications…less money going around in the system. Think about this highly probable scenario. Markets turn from up to down and the fund falls well short of its expected 7% per annum return. And, the market downturn triggers a recession that leaves taxpayers unable to provide the additional coffers needed to keep the fund solvent. What if the unfunded status drops closer to 50 or 60%? And, what about employees in the private sector? The February 2020 Milliman report on the health of America’s largest corporate plans, was titled ‘Milliman 100 PFI [Pension Funding Index] funded ratio plummets to 85.7%’. Here’s an extract (emphasis added)… ‘As we enter the 20th year of reporting the Milliman 100 Pension Funding Index (PFI), the funded status of the 100 largest corporate defined benefit pension plans fell by $73 billion during January. The funded status deficit swelled to $273 billion due to a decrease in the benchmark corporate bond interest rates used to value pension liabilities.’ Based on expected lower interest rate returns, the number crunchers have estimated the funds are UNDERfunded by close to US$300 billion…that’s hardly a rounding error. The following chart provides some valuable insight into what the future may hold for these funds. In previous good times (pre-tech bubble bursting and pre-GFC) strong returns put the funds into surplus. But something interesting has happened since 2009. The long and strong market has NOT delivered the returns needed to put the funds back into surplus. That tells you something about the sheer volume of liabilities — pension promises — that are building within these funds. Again, what happens when the cycle turns and funds start racking up negative returns? Will the corporate sponsors be able to make good the shortfall? Maybe. Maybe not. If there’s a severe recession, then bottom lines are going to be adversely affected. If the corporates are forced to tip the defined pension fund tin, then earnings shrink even further. Falling earnings multiplied by a lower PE multiple, takes share prices down...further compounding the problem. Could those companies then be forced to stop paying dividends to meet pension fund obligations? That’s a very real possibility…especially when you consider what future returns for these funds might be. The following chart based on estimated (blue line) and actual (red line)12-year returns from a ‘balanced’ portfolio — 60% shares/30% bonds/10% cash — should send shivers down the spine of defined benefit fund administrators. The forecasting model dating back to 1928 has a 93% accuracy. The current forecast is for the traditional balanced fund to earn ZERO per cent per annum for the next 12 years. That’s a long way short of the 7% per annum needed by CalPERS and other funds to just tread water in their currently UNDER-funded status. The Pension Benefit Guaranty Corporation — the US Government agency established in 1974 to guarantee the pensions of failed corporate plans — made this sobering admission in its latest annual report… ‘The Corporation is in a difficult financial position today. The Single-Employer Program continues to see improvement; however, it still faces considerable risk. The Multiemployer Program faces a crisis that threatens the retirement security of millions of American workers, retirees, and their families. Without reforms, our Multiemployer Insurance Program — the backstop that is the last resort for retirees when a plan fails — is very likely to become insolvent in 2025, leaving participants and beneficiaries with significantly less than the level of benefits guaranteed by the PBGC. The alarm bells are ringing, and legislative changes are necessary.’ Difficult financial position. Insolvent in 2025. How many current (not, future) participants are we talking about? ‘…the Corporation provides retirement security for about 1.5 million participants and beneficiaries in more than 4,900 plans that have failed since PBGC was established.’ That’s a lot of households. Please remember all these funds are struggling AFTER benefiting from the longest bull market in history. When bull turns to bear, these funds are going to be faced with a serious reality. What’s happening in Queensland is part of a global story…one where hope is triumphing over reality. Hopes for an 8% return, in an environment where government bonds are paying less than 2%, will be dashed. Hopes for pension promises to be fully honoured, will prove to be misplaced. The deflationary impact of shrinking retirement incomes — lower pension payments and lower dividend payments — will mean hopes for tax revenues do not eventuate. The reality is this cycle (like all previous cycles) will rotate from up to down. When it does, the chronic underfunding in defined benefit plans will create doubt over the payment of these promises. And if people are a little suss about receiving their promised pensions…they’ll rein in their spending. Defined Benefits Plans will become mockingly referred to as ‘Deflation Breeding Plans’. Regards | Vern Gowdie, Editor, The Rum Rebellion |
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Sun, Sand, Relaxed Beachfront Charm By Bill Bonner We’ve come up to Cancún to take a look at the future. Our first visit to the area around Mérida and Tulum was about 40 years ago. At the time, Cancún barely existed. And the beaches — except for a few naked hippies — were largely deserted. We guessed then that the place wouldn’t remain undiscovered for long. It didn’t. Now, Cancún gets millions of visitors per year. The bay around Akumal is now dotted with houses, restaurants, and bars. And last night, they were full, with mostly older people from north of the Rio Grande. ‘What brings you here?’ we asked one of them. ‘It’s safer, cheaper, and no snow…just nicer than back home,’ came the answer. Some 11,000 Americans retire every week. Three out of 10 of them have no savings. What are they going to do? Where are they going to go? Developers down here have found they can provide what mature Americans want — sun, sand, relaxed beachfront charm — for a fraction of the price in Florida or Arizona. ‘Yes, an American can live well down here on Social Security alone,’ says a developer friend. It appears to be true. Once in the development, a cup of coffee is $1. A massage is $5. Medicines, yoga, dance, language lessons — all are cheap. ‘They’re delivered at cost’, he explains. ‘We make our money by selling condos’, our friend explains, ‘not selling coffee. We want to make the whole experience pleasant and affordable’. Calm and prosperity This is the east coast of Mexico. Driving down the highway, you might think you are in Florida. Same cars. Same gas stations and strip malls. And the people speak the same language as they do in Florida — Spanish. It’s cheap because Mexican wages are low and the logistics are easy — with flat, wide open roads providing easy access. Already, more than a million Americans are retired in Mexico — including, notably, Linda Ronstadt. Our guess is that many more will join them. In the world of the future, more and more Americans may want to leave behind the chaos, crime, and inflation of a failing, degenerate empire. Who knows? Mightn’t they cross the Rio Grande and drive down to the relative calm and prosperity of the ‘Riviera Maya’? Peak glory We’ve been exploring the many disappointments of the 21st century. By our reckoning, the US empire hit the peak of its glory in 1969, and then a final peak in its power and prestige about 30 years later. That was when its fake money and bad policies caught up with it. Since then, the economy kept growing, but like the fingernails of a dead man. Technology did not save it. Wars made it worse. And MAGA isn’t going to happen. America is doomed by human nature and the life cycle of empires. People are always greedy…for power, money, and status. As an empire matures, the worst of them capture the government…and use it for their own ends. But we’ll see that more clearly tomorrow. Today, let’s stick with the money. Since 1999, in real terms, both capitalists and the proletariat have taken a hit. The rich saw their stocks fall in half, as measured by the old, reliable pre-1971 gold-linked dollar. It took over 40 ounces of gold to buy the Dow stocks in 1999. Now, it takes fewer than 20. The wage earners took an even bigger hit. According to a tweet from commodities expert Josh Crumb, the minimum wage before 1971 was 1.42 grams of gold per hour. Now it’s only 0.32 grams. People who sell time now get only a quarter as much real money for it. And by the way, real money and the fake stuff are moving farther and farther apart. This week, gold hit a new high over $1,600 per ounce. It’s signalling that, in real terms, almost everyone who counts his wealth in new dollars is getting poorer. Great economy But wait. What about that great economy we keep hearing about? If you listen to the mainstream media, you might think the economy is doing great. And you’ve certainly heard that Donald Trump is likely to be re-elected ‘on the strength of the economy.’ Which just goes to show how our expectations have fallen in line with the real decline of the US As they say on Wall Street, markets make opinions. After so many years of claptrap, if we were to get sensible policies and real growth it would seem unhealthy. The January new jobs numbers, for example, showed 225,000 new jobs were created. It was greeted as a ‘blockbuster’… as if the economy were ‘firing on all cylinders’. But, as Emil Kalinowski from Enterprising Investor points out: ‘If we define ‘blockbuster’ as results in the top 90th percentile, use the 1990s and 2000s as our control group, and adjust for today’s larger US labor force, then we would need between 317,000 and 433,000 jobs a month. And that’s if we’re being conservative. The 1960s, 1970s, and 1980s saw much bigger job gains as a proportion of the labor force.’ Silent depression The most important indicator in a modern economy is the rate of industrial production. It’s the backbone of the economy, where the goods come from. How’s that doing? Kalinowski again: ‘The index of industrial production was reported to be 109.7 [in December 2019]. That is only 4.1% higher than in December 2007. US industrial production has grown 4.1%. Not per year. But in 12 years. Total!’ Taking a slightly longer view, growth remained on an upward, steady trend until 1999. Then, it flattened out, with little gain since then. Since the crisis of ’08-’09, says Kalinowski, the US has been in a Silent Depression – the third longest, weakest growth period in its history. It began in the Obama years. And it continues today, with no material change in the trends. US manufacturing got famously ‘hollowed out’ because of low wages overseas and funny money at home. Foreigners exported products to the US America exported dollars to pay for them. And the trend is so far advanced that many ordinary items are no longer made in the US at all. Recently, financial author Matt Stoller reported: ‘The head of the American Bridal & Prom Industry Association said, ‘we can’t make wedding gowns and prom dresses in the United States.’ Stoller goes on to quote Stan Jantz, representing the Evangelical Christian Publishers Association: ‘Chinese printers have developed the technology and the artistry to produce the kinds of bibles people want which is why over 50 percent of the bibles published by ECPA members are printed in China. In fact, more bibles are printed in China than any other country on earth.’ The fake-money-for-real-stuff trade is alright as long as it lasts. Eventually, though, the foreigners will want real money. And then, even US retirees in Mexico will be in trouble. Regards, | Bill Bonner, For The Rum Rebellion |
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