Leeds on Finance

You’ve probably read that China is no longer the “cheapest manufacturer in town”.  While I heard this many times, I didn’t know much about it.  So, this past week, I read a really interesting paper about the subject, “The End of Cheap Chinese Labor”, by Hongbin Li, Lei Li, Binzhen Wu and Yanyan Xiong.  The paper was published in the Journal of Economic Perspectives in late 2012.

 

This paper is interesting because it explains how wages are increasing in China.  But, I think that there’s something even more interesting to think about…as the Chinese work force becomes more educated, will they start to compete with some of the more sophisticated manufacturing that we have in the U.S.?

 

Here’s a summary of the paper:

 

Background Numbers – Rising Wages

 

1. Cheap labor has played a pivotal role in the Chinese model (which has been to grow through exports).

 

2. In 1978, the average Chinese urban worker was making $1,004 (in 2010 dollars). Now, that same worker is making $5,487.

 

3. From 1978 through 1997, the average salary of the urban worker only increased .1% per year (from $1,004 to $1,026). This was much slower than real GDP growth.  (NOTE: the growth rates in this paper are low because they are measuring wages in “real U.S. dollars”.  The Chinese currency was actually overvalued in the late 1970s – so as it lost value, the result is that wages were not rising at a high rate in “real U.S. dollars”.)

 

4. From 1982 through 1997, labor productivity grew almost 3 times faster than real wage growth. This means that Chinese labor was becoming cheaper.

 

5.  From 1998 through 2010, the average annual growth rate of real wages was 13.8%.

 

6. Since 1997, China’s wages have increased at a much faster rate than productivity. This means unit labor costs were increasing.

 

7. Wages are increasing for all levels of workers. The fact that low skill workers are also seeing this increase suggests an overall rise in wages.

 

8. Wages are rising in both the more developed coastal regions and the less-developed inland regions. They are rising for both exporting and non–exporting firms.

 

9. Major exporters are labor-intensive. As a result, their costs are increasing.

 

 

Three Reasons Why Urban Wages Have Grown So Fast (in China) Since 1997

 

1. Compensation has become tied to productivity. This resulted from the privatization of state-owned enterprises in the mid-1990s. Workers were no longer allocated by central planners. Firms gained the right to pay higher wages to more productive employees. Private sector employment went from nearly zero in the 1980s to approximately 80%.

 

2. There was a growing shortage of labor. China had a baby boom from 1950 through 1978, with women averaging 5.2 births. In 1979, China started the “one child policy”. For many years, China has benefited from the “demographic dividend” – where a large percentage of the population was working and there were relatively few dependent children or elderly people. China’s population is expected to begin declining by 2015 and of the labor force may have already peaked.

 

3. There was slowing migration of rural workers. Prior to 1997, the growth rate of migrant workers was 10.8% per year. Since then the growth rate has been 4.6%. Those who are most willing to migrate already have done so (the low hanging fruit has been picked). The Chinese registration system means that rural citizens cannot enjoy public services in the cities (such as education, medical insurance, housing or pensions). Many migrants want to stay closer to home now. At the same time, it is difficult for firms to move inland.

 

 

 

The Cycle is Ending

 

1. In the 1980s and 1990s, Chinese workers had low unit labor costs.

 

2. Foreign firms earned profits by outsourcing to China.

 

3. This triggered fast employment growth and rural-to-urban migration.

 

4. There is no longer a huge amount of slack in the labor supply and the “underpricing” of Chinese labor is coming to an end.

 

5. Wages are rising faster than productivity, particularly in labor-intensive exporting industries.

 

6. If wage growth continues at this pace, the average real wage in urban China would reach $20,000 by 2020.

 

 

China Will Move Up the Technological Ladder

 

1. Labor productivity has been increasing at 11.3% per year for over a decade.

 

2. Manufacturing firms have made heavy investments in research and development (R&D per worker has increased 16.9% per year in the past 20 years).

 

3. Capital is deepening (total assets per worker increased to $94,000 in 2010).

 

4. Human capital has risen dramatically. College entry class enrollment increased from 1.1 million in 1998 to 6.6 million in 2011.

 

5. By 2050, 40% of China’s labor force can be expected to hold a college degree.

 

 

So Where is China Headed?

 

1. The end of cheap labor does not mean the end of economic growth.

 

2. Rising productivity and education mean that China’s comparative advantages are shifting.

 

3. If China can improve the quality of education and foster innovation and entrepreneurship, they can become a force in the high value added manufacturing sector.

 

 

Have a great week.

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Below, find some of the most interesting things I read in the last week.

 

Lower Q1 earnings.  Sixty-three S&P companies have lowered their forecasts for Q1 earnings, while 17 have raised them.  This is the largest disparity since the firm began tracking the data in 2006.

 

When will QE end?  St. Louis Fed President Bullard suggested that the Fed could reduce their monthly $85 billion of bond purchases by $15 billion for each .1% that our unemployment rate drops.  (The unemployment rate was 7.9% in January.)  Cleveland Fed President Pianalto also suggested that the benefit / risk tradeoff of quantitative easing leads her to conclude that we may need to slow the purchases (although she didn’t offer a specific plan like President Bullard).

 

The bullish argument for gold.  Central banks bought 535 tons of gold in 2012.  This is the most since 1964.  Net purchases by central banks accounted for 12% of overall demand in 2012.   ETFs purchased 279 tons.  The bar and coin market was 1,259 tons.  Until four years ago, central banks as a whole had been net sellers for 15 years.  They had been selling 400 – 500 tons.  Now, they’re buying 500 tons.  This is a large swing in a 4,400 ton market.

 

The bearish argument against gold.  George Soros cut his investment in the SPDR Gold Trust by 55%.  Billionaire investor Louis Moore Bacon sold all of his investment in the same ETF.

 

Huge news if this trend continues.  From 2009 to 2011, total health spending grew at the lowest annual pace since they started keeping these records (52 years ago).  In fiscal year 2012, Medicare spending per beneficiary grew just .4%.  Overall Medicare spending grew 3% (because there are more beneficiaries).  The CBO projects spending on Medicare and Medicaid in 2020 will be $200 billion – a 15% drop from the CBO’s projections three years ago.

 

Compare the slowdown to historical growth.  For the past 43 years, Medicare spending per beneficiary grew 2.7% faster than the overall economy.  Medicare spending grew from $7.7 billion in 1970 (.7% of GDP) to $551 billion in 2012 (almost 4% of GDP).  But, for the last three years, Medicare costs per person have grown 1.3% slower than GDP.

 

What explains this drop?  Analysts think that the weak economy is only part of the reason for reduced growth in health spending.  We’ve also been starting to see changes in the way insurance is compensating doctors.  The slowdown in spending started even before the recession (so it’s not purely a recessionary issue).  On the downside: (1) this doesn’t solve our problems; (2) we’ve had temporary slowdowns in spending before; and (3) this may reduce pressure on Congress to address our long-term problems.

 

The future isn’t pretty.  Unfortunately, the number of Medicare beneficiaries is projected to grow 3% each year as the boomers retire.  This is why Medicare spending is expected to be more than 4% of GDP in 2023 and 6.7% in 2037.

 

Income inequality is returning post-recession.  According to Berkeley economist Emmanuel Saez, incomes rose 1.7% during the economic recovery.  When you break that down, income rose 11% for the top 1% of earners while the other 99% saw a .4% decline.  This is largely the result of increasing stock prices (helping shareholders) and high rates of unemployment (holding down the income of wage earners).  The income gap had shrunk during the recession (which is what normally happens).

 

Top 10% are doing relatively well.  Excluding earnings from investment gains, the top 10% of earners received 46.5% of all income in 2011.  This is the highest proportion since 1917.

 

The median household isn’t doing great.  Median household income was $50,054 in 2011 – 9% lower than it was in 1999, after accounting for inflation.  Other studies show that middle-class incomes have grown at a higher rate if you include transfer programs and benefits.

 

So we’re done fixing the budget?  A week ago, President Obama said, “Over the last few years, Democrats and Republicans have come together and cut our deficit [over the next decade] by more than $2.5 trillion through a balanced mix of spending cuts and higher tax rates for the wealthiest Americans.  That’s more than halfway towards the $4 trillion in deficit reductions that economists and elected officials from both parties say we need to stabilize our debt.”  The upcoming sequester could get us even closer to the $4 trillion goal.  (This ignores the fact that we’re stabilizing the debt at a higher level and when the baby boomers are fully retired, our debt-to-GDP ratio will be destabilized.)

 

How’s this for an instruction manual?  A Wall Street Journal piece said that the federal government issued 70,000 pages of guidance last year to help explain The Affordable Care Act.

 

Another example of the cost of education.  A New York Times article said that a bachelor’s degree from Appalachian State can easily cost $80K for a state resident (including tuition, room, board and other expenses).  Approximately 40 years ago, the cost was $550 / year.  With inflation, that would equate to $4,000 / year today.

 

A large percentage of undergrads spend significant hours working jobs.  As of 2010, 17% of full-time undergraduates (traditional age) worked 20 – 34 hours per week.  Approximately 6% worked 35+ hours per week.

 

I knew I should have been part of Baywatch.  A recent Wall Street Journal op-ed piece said that 30,000 retired California government employees receive pensions higher than $100,000.  There are ten that will combine to receive $50 million.  One retired San Diego librarian receives $234K.  Orange County beach lifeguards are retiring at age 51 with $108,000 annual pension plus health-care benefits.

 

State and local employees need to prepare.  The Florida Supreme Court ruled that public employees’ pension contracts can be adjusted.  A 2011 state law requires state employees to contribute 3% of their salaries to the pension fund.  It is expected that this case will ultimately be decided by the U.S. Supreme Court.

 

Take some time off!  The NY Times published a piece about the fact that we would be more productive if we relaxed more.  More than 1/3 of employees eat lunch at their desks.  More than 50% of workers assume that they’ll work during their vacations.  Sleep deprivation (defined as less than six hours of sleep per night) costs American companies $63.2 billion / year in lost productivity.  Sleep deprivation is one of the best predictors of on-the-job burn out.  (So, I guess this means that having children ultimately leads to job burn out?)  Americans left an average of 9.2 vacation days unused in 2012.

 

Evidence that the world is crazy.  Wrestling will be removed from the Olympics in 2020.  So, let me get this right…wrestling is no longer an international sport, but rhythmic gymnastics, where girls (or worse, women) prance around with a ribbon is a sport.  Maybe wrestling took three minutes away from the television coverage of beach volleyball (a well known sport from the original Olympics) and that’s why it needed to be canceled?

 

Political sausage-making is hard to watch.  Here’s a link to a really interesting PBS Frontline documentary about our financial crisis.  It’s called “Cliffhanger”.  It aired on February 12^th and is approximately 55 minutes long.  You’ll have to watch for yourself, but my view was that it was not favorable to either President Obama or Representative Cantor.  I thought it was somewhat favorable to Speaker Boehner.  He seemed to be the most willing to compromise and find a middle ground (knowing that no one would be happy).

 

Have a great week.

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I don’t typically discuss specific companies, but sometimes corporate events allow me to think about bigger issues.  Today, I want to talk about Dell – because it allows me to discuss something that I’ve always been opposed to – management buyouts (MBOs).  I don’t think it’s a coincidence that MBO is just a letter switch away from MOB – because in an MBO, management tries to “make you an offer you can’t refuse.”  We prosecute mobsters, yet somehow management is allowed to do worse.

 

Imagine that I am the founder and CEO of a company.  You invest in my company.  You risk your capital.  You trust me to run the company for your benefit.  I am your agent.  Then, I come to you and I tell you, “I’ve got great news.  We’ve received an offer from some people who want to buy the company.”  As a shareholder, you respond, “that’s great…who is interested?”  I respond, “me and my friends.”

 

How do you feel at that point?  Didn’t you hire me to maximize the value of this company for you?  Why is the company worth more to me?  How will the company be worth more if I squeeze you out and own the company with my friends?

 

Ultimately, this is what Dell is doing.  I’ve always thought MBOs were outrageous and this deal is no different.  Fortunately, there are some large, sophisticated investors and they appear ready to fight back.  I hope they’re successful.

 

I’ve read through Dell’s 8-K about this deal.  I want to share a few of my favorites from it:

 

1. Dell says, “The price represents a premium of 25 percent over Dell’s closing share price of $10.88 on January 11, 2013, the last trading day before rumors of a possible going-private transaction were first published.”

Of course, what Dell didn’t say is that “the $13.65 price is 24% less than the $18 price that the stock sold for less than one year ago.”

 

2. Dell says, “The independent directors of the board have concluded that the proposed all-cash transaction offers an attractive and immediate premium for stockholders.”

Of course, not all investors have risked their capital with the hope of a “quick pop”.  Many were buying this company as a long-term investment because they believed that it was undervalued.

 

3. Here’s my question for Dell.  If another buyer had approached Dell and had offered them $15 per share, but Michael Dell would have had to sell all of his shares (so that the buyer could be the 100% owner), would he have presented this as a good deal for shareholders?

Why is $13.65 a good deal for all shareholders other than Michael Dell?

 

4. Dell says, “We fully believe that we can and will achieve our transformation into a leading global, end-to-end solutions provider, but we are best served pursuing this route as a private company.”

I’m trying to understand why this is.  What about your shareholder base has stopped you from this transformation?

Here’s what really gets me.  I’m going to look into my magic ball and try to see the future.  After this “transformation” is complete, what are the chances that Dell is going to come back and tell me that they will operate best as a public company?  Mr. Magic Ball tells me that the chances are pretty darn high…bordering on 100%.

 

5. Dell says that they will have “a so-called ‘go-shop’ period, during which the Special Committee – with the assistance of Evercore Partners – will actively solicit, receive, evaluate and potentially enter into negotiations with parties that offer alternative proposals.”

This is being discussed as if it ensures that this is a fair deal – one that is maximizing the value.  From what I’ve read, this is being done to shift the burden of proof in a lawsuit (a lawsuit that I hope and expect will occur).  If Dell did not set up this Committee, Dell would have the burden of proving that this was a fair deal (if they were sued by shareholders).  Since they have established this committee, the plaintiff shareholders will have the burden of proving that the deal is unfair.

 

So, here’s how I see it.  Michael Dell believes that the company is undervalued.  Shareholders believe that it’s Mr. Dell’s job to maximize the value of the company.  Michael Dell believes that he can maximize the value for himself and Silver Lake Partners.  Apparently, being a public company was holding Dell back.  That makes me feel a lot better.

 

I have no idea whether Dell should be an $8 stock or a $24 stock (like some of Dell’s institutional investors believe).  (For a very compelling argument that Dell is worth $24, see Southeastern Asset Management’s letter to the Dell board of directors.)  Most importantly, I have not heard any explanation as to why Dell will be more successful as a private company.  This appears to be Michael Dell trying to capitalize on a depressed stock price in order to enrich himself.  Dell has squeezed vendors for years…now they’re squeezing shareholders.  In my opinion, this is the type of behavior that is bad for investors and ultimately bad for capital markets.

 

Have a great week.

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My blog topics tend to replicate my parenting skills, where I like to praise once for every 48 times I punish / criticize.  So, having just finished my 48^th critical article, I thought that I would share some ideas from a more optimistic article that I read recently.

 

Roger Altman (President Clinton’s Deputy Treasury Secretary and currently the Chairman of Evercore Partners) wrote “The Fall and Rise of the West” that was published in the current issue of Foreign Affairs.  He identified five reasons to be optimistic about the United States:

 

1. The Housing Market – whenever this market has been pushed down far enough for a long enough period of time, it eventually rebounds.  New home construction and sales of those homes fell by two-thirds after the bubble.  In addition, banks have improved their mortgage underwriting standards.  Securitization markets and household attitudes toward mortgages and home-equity financing have become healthier.  Mortgage credit is more available.  Finally, population growth will couple with a recovery in household formation to drive high demand.

 

2. New Technologies in Oil and Gas – we now have access to energy deposits that were previously unknown or inaccessible.  Natural gas output is 25% higher than five years ago.  The output of oil and other hydrocarbons rose by 7% in 2012 (the largest single year increase since 1951).  The International Energy Agency projects that the U.S. will surpass Saudi Arabia as the world’s largest oil producer by 2017.  This will create jobs and reduce oil imports.

 

3. The U.S. Banking System Has Been Recapitalized and Restructured – they have shed the bad assets and improved their capital and liquidity ratios.  While outstanding loans are still below 2008, consumer credit started hitting new highs again in 2011.

 

4. The Great Recession has Spurred Greater Efficiencies in the U.S. Manufacturing Sector – unit production costs are 11% lower in the U.S. than ten years ago.  Foreign competition is seeing their costs rise.  Resurgence in housing is helpful because it drives demand for manufacturing.  The decrease in energy prices will result in lower manufacturing costs (and greater competitiveness).

 

5. Increased Chances That Washington Will Fix the National Debt Problem – President Obama has cited deficit reduction as his top priority and the Republicans are finding that their anti-tax stance is not politically popular with the masses (according to Altman, who is a Democrat).

 

Never able to give unadulterated praise, I’ll rain a bit on this parade.  I’m (by far) most excited about #2 (energy changes).  I think #1 (housing recovery) and #4 (manufacturing recovery) are significant, keeping in perspective that both are still coming off deep drops.  I’ll side with Dallas Fed President Fisher on issue #3 – we still need to end “too big to fail”, not just for the risk it creates but also for the unfair competitive edge that it gives to the largest banks.  Finally, I disagree with #5 – I don’t see the political will to solve the debt issue.  The hard decisions will involve how much we’re going to cut spending and / or increase everyone’s taxes (not just the taxes of the top income earners).  I don’t see the political will to take on any of these issues or to reach any compromise.

 

I hope this can count as a positive blog.  I feel somewhat dirty for having written it.

 

And speaking of dirty, I’m writing this blog in anticipation of the Super Bowl.  I love the Super Bowl and I’m anxiously awaiting this game.  I will give loads of credit to Jim Harbaugh for what he’s accomplished – although I’m just not a Jim Harbaugh fan.  I really don’t have a reason – I just don’t care for him.  (It’s probably similar to the way that many non-Alabama fans don’t care for Nick Saban.)  That makes it a little difficult to root for SF.  With that said, I could never cheer for Ray Lewis.  I’m all for forgiveness.  I guess, it’s just that I’m for forgiveness after some significant time in the penitentiary.  He’s pled guilty to obstruction of justice in a (double) murder case.  The idea that ESPN has hired him and that I’m going to have to listen to this criminal makes me sick.  I’m going to be watching the Super Bowl with the remote in my hand so that I can mute the sound when the announcers start to praise this guy.  Ugh.

 

As always, it’s tough being me.

 

By time this blog gets sent out, I hope that you’ve enjoyed the Super Bowl and you’re having a great week.

 

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I want to give you two quick things to think about:

 

1.  When will we ever fix our problems?

Here are two common arguments I hear:

Argument A: If we raise taxes now or if we cut government spending, it could lead to another recession.  So, we can’t act now.  We need to get the economy on firm ground before we make those changes.

Argument B: We have to give people time to adjust before we cut Social Security (or Medicare) or any other benefit that they receive.

 

So, my question is…when do you think that we’ll feel that the economy is so strong that our politicians will say, “now is a great time to balance our budget”?  When will we address our long-term structural problems?  Shouldn’t we be deciding on these changes right now and locking them in – so that we can start to adjust our behavior for the future?

 

2.  Could we afford for interest rates to return to their prior levels?  The math does not work out for interest rates to ever increase.  Let me take you through some numbers (realize that we standardize all numbers by comparing them to GDP):

Our total debt (including what we owe to the Social Security “trust fund”) = $16 trillion.

Our GDP is also approximately = $16 trillion.

So, we say our debt = GDP  (or we say debt = 100% of GDP)

Tax revenue for the past 50 years has been = 18% of GDP  (on an annual basis)

From 1988 – 2007, five-year U.S. Treasuries had an average interest rate = 5.72%

If interest rates returned to this level, interest expense would = 5.72% of GDP.

Spending 5.72% of GDP on interest expense, when we take in tax revenue that is = to 18% of GDP doesn’t work.  That’s almost 1/3 of our tax revenue just being used to pay interest.

Do you think that the Fed thinks this is sustainable?  Absolutely not.

I’ll write more about this problem in the near future…

 

Have a great week.

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Dallas Fed President Richard Fisher gave a great speech last week about ending “too big to fail” (TBTF) – the situation where a handful of banks are so large and important to the economic system that it is implicitly understood that the government would bail them out, rather than let them fail.  Here are a few highlights (most of this is lifted straight from the speech or is slightly paraphrased):

 

1. TBTF defined.  President Fisher defined TBTF as firms whose owners, managers and customers believe themselves to be exempt from the processes of bankruptcy and creative destruction.

 

2. Moral hazard.  These firms are effectively subsidized (compared to their non-TBTF competitors) and the result is that they are likely to take greater risk in search of profits.

 

3. Hurting the recovery.  These banks are limiting the effectiveness of monetary policy because sick banks don’t lend.

 

4. Ineffective regulatory solutions.  Now, Dodd-Frank has 16 titles and runs 848 pages.  More than 8,800 pages of regulations have been proposed (and we’re not done).

 

5. Dallas Fed’s solution to TBTF.  The Dallas Fed believes that only commercial banking operations (not shadow banking facilities or the parent company) should benefit from the safety net of federal deposit insurance and access to the Fed’s discount window.

 

6. There are a few HUGE players.  Approximately 98.6% (5,500 out of 5,600) of U.S. banking organizations are community banks with assets less than $10 billion.  They only account for 12% of total industry assets.    There are 70 banks with assets between $10 billion and $250 billion.  They account for 1.2% of banks and 19% of assets.  Finally, there are 12 institutions with assets between $250 billion and $2.3 trillion.  These are .2% of all banks, but they hold 69% of industry assets.  See chart below.

 

7. Little outside control over the TBTF banks.  In comparing the different-size banks, President Fisher doesn’t believe that there’s much regulatory authority or investor control over the large banks.  Because management does not believe that they would be allowed to fail, regulators have little control over the largest banks.  Unsecured depositors and creditors offer their funds at a lower cost to TBTF banks than to mid-sized and regional banks that face the risk of failure.  See chart below.

 

8. Huge financial subsidy. The TBTF global subsidy has been estimated as being worth $300 billion (annually) for the largest 29 banks.  To put this in perspective, all the US bank holding companies summed together reported earnings of $108 billion in 2011.

 

9. Tremendously complex.  See chart below to understand just how complex the five largest U.S. banks are.

 

10. More of the solution.  We must reshape TBTF banking institutions into smaller, less-complex institutions that are economically valuable; profitable; competitively able to attract financial capital and talent; and of a size, complexity and scope that allows both regulatory and market discipline to restrain excessive risk taking.

 

11. Lets not penalize the majority of banks.  At present, 99.8 percent of the banking organizations in the U.S. are subject to sufficient regulatory or shareholder/market discipline to contain the risk of misbehavior that could threaten the stability of the financial system.  Zero-point-tow percent are not.  Furthermore, to contain that risk, regulators and many small banks are tied up in regulatory and legal knots at an enormous direct cost to them and a large indirect cost to the economy.

 

12. We need an alternative solution.  There should be more than the present two solutions: bailout or the end-of-the-economic-world-as-we-have-known-it.  Both choices are unacceptable.

 

I love the fact that President Fisher is keeping the pressure up on this issue.  Remember that President Fisher was the member of the FOMC who was saying that there were significant problems that were going to play out with our banks as the crisis started — see story here.  While I tend to favor the required use of contingent convertible debt by banks (see my earlier blog post here), I’m just happy that we’re still talking about it.

 

Have a great week.

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IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

 

 

 

First, thanks for all of your emails.  I received a ton of emails about the video in last week’s blog.  I read all of the emails.  I don’t have the chance to respond to most (unfortunately).

 

Today, I want to show you three more interesting charts from the “Citizen’s Guide to the 2012 Financial Report of the United States Government”.

 

1. The Ugly Demographics

This chart shows the retirement of the baby boomers.  Social Security is really set up as a “pay-as-you-go” system.  Current workers pay for current retirees.  This works well when a lot of people are working and not many people are retired.  When the situation is reversed (not many people working and a lot of people retired), it doesn’t work out as well.

 

In this chart, you see the increase in the number of Social Security beneficiaries per 100 workers (who will be working and contributing to pay for those retirees).  Before you send me your ugly emails, remember…you really haven’t been paying for “your” Social Security.  We’ve been paying for the Social Security of people who are already retired.  Our kids will (hopefully?) be paying for “our” Social Security.  See chart below.

 

 

2. Our Tax Revenue

This is just a reminder that the vast majority of our tax revenue comes from income taxes plus payroll taxes.  We spend so much time arguing about (and avoiding) corporate taxation.  Yet, as a source of revenue, it’s relatively small.  See chart below.

 

 

3.  Is Corporate Taxation Progressive?

I thought that this was a really interesting chart.  The largest companies (ranked by assets) pay less in taxes as a percentage of their income (when compared to smaller companies).  See chart below.

 

 

 

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Late Thursday, the “Citizen’s Guide to the 2012 Financial Report of the United States Government” was released.  As you can imagine, this is always an exciting time for me.

 

Actually, I think that a lot of the ideas and charts contained in this report are crucial.  Today, I want to share five slides with you.  Later this week, I will share four more that I found interesting.  Hopefully, it will give you a little something to think about.

 

Five Slides

1. We have huge unfunded liabilities.  Depending on how you measure it (closed group or open group), Social Security and Medicare are going to cost $38 trillion – $50 trillion more in the next 75 years than we’re going to take in from dedicated taxes.  (If you don’t know the difference in the closed group and open group, here’s a link where I discussed this in the past.) The underfunding ($38 trillion – $50 trillion) is measured in today’s dollars (i.e., that’s the present value). 

To give you context, we have $16 trillion of debt outstanding, only $12 trillion which is held by the public.  (The rest is held by “trust funds” such as the Social Security trust fund.) Think of it this way: if we had the proper amount of money today in order to satisfy the promises that we’ve made, we’d have another $38 trillion – $50 trillion of debt! In actuality, this is somewhat of an exaggeration because some of these programs were intended to be partially funded by general revenue (such as Medicare Parts B and D). But, it’s certainly fair to say that we’re $20 trillion underfunded (and that would more than double our debt level). See chart below.

 

 

2. If you don’t limit yourself to the next 75 years, but measure this unfunded liability for the infinite horizon, we’re $66 trillion underfunded.  See chart below.

 

 

 

3. One underfunded liability that you rarely hear discussed is the liability for pensions to government employees (retirees) and veterans.  This is approximately $6 trillion.  See chart below.

 

 

4. Our future deficits will grow over time.  Deficits will result in higher debt and that will lead to large interest payments.   Look at this chart and realize that most of what we spend is Social Security, Medicare, Medicaid and defense spending.  I constantly hear people say that we just have to cut “waste”, but alas, it’s not that easy.  See chart below.

 

 

5. Finally, look at how our debt is expected to explode.  Show this picture to your grandkids and tell them “sorry from Uncle Sandy.”

 

 

My sports comment for the day… I’ve heard a lot of people defend Lance Armstrong by citing Livestrong.  Well, Livestrong may be a great organization, but don’t forget that Lance attacked many innocent people and ruined many of them.  Here’s a great interview of Greg LeMond’s wife.  As a reminder, Greg LeMond is the only American to ever have won the Tour de France.

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A few things that I found interesting in my reading…

 

Interesting Bloomberg article about concern over Fed policy. 

1. K.C. Fed President Esther George recently said, “Prices of assets such as bonds, agricultural land, and high yield and leveraged loans are at historically high levels.  We must not ignore the possibility that the low interest rate policy may be creating incentives that lead to future financial imbalances.”

2. Credit Suisse’s index of 1,500 junk bonds hit a record low 5.9% last week.  It was at 8% a year ago.

3. Junk bond yields are 8 basis points lower than what is paid on leveraged loans.  As recently as June, junk bonds yielded 114 basis points more than more senior leveraged loans.

4. Bonds are expensive compared to stocks.  The price that investors are paying for  income from bonds is more than 50X (in other words, paying $1000 for 1.82% yield on 10-year UST) while they’re paying just 14.8 times earnings for stocks.  This disparity is close to the highest level since 1920.  (Of course, this is a somewhat misleading comparison; earnings are not dividends and involve greater risk.)

5. Non-irrigated cropland prices were up 25% from a year earlier and irrigated land values advanced more than 20 percent.

 

Some Other Stats and Ideas

Downgrade potential.  Fitch warned that failure to raise the debt ceiling would very likely result in a downgrade of our credit rating.  Of course, S&P downgraded the U.S. back in August 2011.

 

Unfunded liabilities.  Cities employing nearly half of U.S. municipal workers saw their pension and retiree health-care funding levels fall from 79% in FY 2007 to 74% in FY 2009.

 

More slow growth.  The World Bank said it expects the global economy to expand just 2.4% this year.  They predicted that the U.S. would grow 1.9%.  (This could be lower if “political paralysis” sets in.)  Developing economies are expected to grow 5.5% this year, higher than last year’s 5.1%, but much slower than the past decade.

 

A disconnect between markets and the economy.  World Bank Chief Economist Kaushik Basu sounded like Howard Marks (see Monday’s blog).  He said, “Financial markets are calmer, but there is no pickup in growth.  You can keep markets calm for one or two years, but if this is not backed up with real growth you could get another round of financial risks coming in.”

 

China is losing low cost manufacturing.  China is losing their competitive edge as a low-cost manufacturing base.  They want to shift to higher-value production and see incomes rise.  Total foreign direct investment flowing into China fell 3.7% in 2012.  (Direct investment in manufacturing contracted by 6.2%; investment in the service sector, excluding the property market, increased by 4.8%.)  By contrast, foreign direct investment into Thailand grew by 63% in 2012 and Indonesia investment up 27% in the first nine months of last year.

 

Comment on Notre Dame.  Here’s a line that I lifted from Notre Dame athletic director Jack Swarbrick’s press conference.   Mr. Swarbrick said:

“Was there somebody trying to create an NCAA violation at the core of this? Was there somebody trying to impact the outcome of football games by manipulating the emotions of a key player? Was there an extortion request coming?”

If this is what ND thought, it surprises me that they would not immediately contact law enforcement.  Law enforcement has much greater ability to investigate a case than a private investigator.  (For example, the government can get search warrants.)  In addition, if this was a sophisticated hoax (as they described), ND would need to think about other potential victims.  After the Penn State scandal, I’m surprised that the first call would not be to the FBI or local law enforcement.

 

Must watch video.  Here’s a great video about some brothers that you need to watch.  One of my former teachers (and a mentor of mine) sent it to me.

 

 

 

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A few interesting things I read on Tuesday…

 

Hate them all.  If you want to hate politicians, and I mean ALL politicians, click on this link.  It’s a Washington Post article that has a great speech made on the Senate floor in 2006.  It’s a passionate argument against raising the debt ceiling.  The problem is that it was made by (then) Senator Obama.  And, before all you Republicans rejoice, I encourage you to read the ENTIRE article.  The Democrats voted against raising the debt ceiling and the Republicans voted in favor of it.  They are all horrible…individually and collectively.

 

Get rid of the debt ceiling.  Chairman Bernanke weighed in on the debt ceiling, saying “it would be a good thing if we didn’t have it.”  Arguing that the increase in borrowing authority simply accommodates the spending that lawmakers have already approved, he said, “this is sort of like a family saying ‘well, we’re spending too much, lets stop paying our credit card bill.’”

 

It won’t end with the debt ceiling debate.  Former Vice-Chairman of the Fed, Alan Blinder wrote a great op-ed piece in The WSJ.  A few of his points about the debt ceiling:

1. Only in America is there another law that might, and sometimes does, contradict the budget law; a limit on how much the government may borrow.

2. The minority party always has a little political fun before letting the debt limit rise.  (See above)

3. Federal receipts currently cover less than 74% of federal outlays.  So, if we hit the debt ceiling, total outlays will have to be trimmed by 26% immediately.  That’s 6% of GDP.

4. After the debt ceiling, the next concern will be when the federal government’s current continuing resolution expires.  Because Congress has not passed a budget for several years, these resolutions keep the government operating.  They essentially maintain spending at current levels for a time.  The resolution now in force expires on March 27^th.  After that, we can have a government shutdown like 1995-96.

 

I’m not sure that this 401(k) thing is going to work out for us…Some fascinating numbers from a Washington Post article on 401(k) plans:

1. More than one in four American workers with a 401(k) uses the account to pay current expenses.  One in three people in their 40s does this.

2. In 1980, four out of five private-sector workers were covered by traditional pensions.  Now, just one in five workers has a pension.

3. In 2010, 28% of participants had an outstanding loan against their retirement account.  (While this money plus interest will hopefully be paid back to your account, it shows how stretched people are.)  This is a record.

4. Of workers changing jobs, 42% cashed out their plans rather than rolling them over.  That should work out pretty well…

5. A typical household approaching retirement age has $120K in retirement savings.  This is enough for a $7K annual annuity.

6. Approximately 30% of households earning less than $50K / year had cashed out a retirement plan for non-retirement purposes.  Only 12% of households earning between $100-$150K did this and 8% of those earning more than $150K did it.

 

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