Thirty years after the Berlin Wall fell

Germans still don’t agree on what reunification meant

Discontent may even be growing

ON NOVEMBER 9TH 1989, as the Berlin Wall tumbled, Hans-Joachim Binder was on night shift at the potash mine in Bischofferode, a village in the communist-ruled German Democratic Republic. Mr Binder, a maintenance worker who had toiled in the mine for 17 years, had no idea of the momentous events unfolding 240km (150 miles) to the east. The first sign something was up was when most of his colleagues disappeared to investigate what was happening at the border with West Germany, just ten minutes’ drive away. Only three returned to complete their shift.

Less than a year later Germany was reunited, capping one of the most extraordinary stories in modern history. Not only had a communist dictatorship collapsed, releasing 16m people from the fear of the Stasi (secret police) and the stultification of censorship. Unlike any other country ever freed from tyranny, the entire population of East Germany was given citizenship of a big, rich democracy. As a grand, if ill-fated, gesture of welcome the West German chancellor, Helmut Kohl, converted some of their worthless savings into hard currency at the preposterously generous exchange rate of one Deutschmark to one Ostmark.

More than 1m Ossies took advantage of their new freedom by moving to the West, where most thrived. Official statistics no longer counted this group—who were disproportionally young, clever, female and ambitious—as East Germans. For those who stayed behind, however, the 30 years since the fall of the Wall have been a mix of impressive progress, often taken for granted, and sour disappointment.

A price to pay

The harm wrought by four decades of oppression and indoctrination could not be undone overnight. But a people brought up in a society where initiative was ruthlessly crushed had to adapt suddenly to the rigours of capitalism. Unsurprisingly, many could not. Mr Binder was laid off. So were hundreds of thousands of others who previously toiled in safe, dreary and unproductive state-backed jobs.

Despite attempts to save it, including large protests and a hunger strike, the potash mine was shut down—one of 8,500 companies in the east privatised or liquidated by the Treuhand, a new government agency. Mr Binder bounced around in odd jobs for a while, eventually winding up on Hartz IV, the stingiest of Germany’s unemployment benefits, where he languishes today. Like many East German women, his wife retrained and left for a job in the west. Asked how he feels about the reunification of his country, he shrugs. “My safe job was gone. For me, the GDR could have carried on.”

There was no manual to guide the absorption of east into west. The policies that failed people like Mr Binder were always going to be subject to fierce dispute. The surprise, as Germany approaches the 30th anniversary of the fall of the Wall, is the speed with which these debates have roared back into the public sphere. Newspapers and magazines are full of reassessments of the Wiedervereinigung (reunification); westerners are lapping up memoirs and polemics by eastern authors. Never before has Germany debated its reunification with such vigour. Why?

Many observers say the debate grew louder three or four years ago. The most obvious explanation is therefore the migrant crisis of 2015-16. Petra Köpping, the integration minister in Saxony, one of the five eastern states established at reunification, says that when she tried to explain to her constituents why the state was helping refugees, some replied: “Integrate us first!” Many easterners resented the resources being devoted to help newcomers when they felt left behind. They also disliked the labelling of their complaints as racist.

But the refugee crisis merely triggered a deeper shift, says Christian Hirte, the government’s special commissioner for east Germany. One idea, floated by Angela Merkel, who as chancellor is east Germany’s best-known export, is that the east is undergoing something comparable to the experience of West Germany in 1968, when children forced their parents to account for their activities in the Nazi period. Now, the argument runs, young east Germans seek explanations for what happened to their parents in the early years of reunification. “The long-term wounds were concealed because people were absorbed finding a place in the new society,” says Steffen Mau of Humboldt University in Berlin. “Perhaps you need 25 years to realise this.”

This summer Marie-Sophie Schiller, a young Leipziger who hosts a podcast called “East—A Guide”, had an “emotional” talk with her parents about their experiences after 1990. She was astonished to learn about their daily hardships and humiliations. Stefan Meyer, an activist who grew up in East Berlin, remembers watching his parents’ confidence ebb as they struggled to find their feet in the new country.

After 1990 “the whole software of life changed” for east Germans, says Markus Kerber, a bigwig at the interior ministry. Short-term pain was inevitable. Average labour productivity in the east was 30% of that in the west. Kohl’s decision to exchange Ostmarks at a 1:1 rate for Deutschmarks made swathes of firms uncompetitive overnight. Those that survived struggled with the western rules they had to import wholesale. By one estimate, 80% of east Germans at some point found themselves out of work.

Perhaps the Treuhand could have proceeded more gently, some argue today. Maybe the unified country should have developed a new constitution rather than simply extending the western one eastwards. The west might have learned from the more enlightened aspects of life in the GDR, such as free child care and encouraging women to work outside the home. Radical parties on left and right take such arguments to a ludicrous extreme, arguing that reunification was the “colonisation” of a bewildered people by an exploitative west.

Understanding required

Such views tap into a feeling among many easterners that they have struggled to take back control of their own destiny. Ms Köpping says east Germans hold barely 4% of elite jobs in the east. Many rent flats from westerners, who own much of the eastern housing stock. “Sometimes east Germans feel that they’re ruled by others, not themselves,” says Klara Geywitz, a Brandenburger running to lead Germany’s Social Democrats. Nor have east Germans stormed the national citadels of power.

Almost 14 years after she took office Mrs Merkel—and Joachim Gauck, president from 2012-17—remain exceptions rather than a vanguard. Rarely one to dwell on her origins, Mrs Merkel has lately begun to reflect publicly on the mixed legacy of reunification. “We must all…learn to understand why for many people in east German states, German unity is not solely a positive experience,” she said on October 3rd.

One obstacle to such understanding is that Germans view reunification differently. Half of west Germans consider the east a success. Two-thirds of east Germans disagree. Many westerners were oblivious to the upheaval their new compatriots endured. “On October 4th 1990 [the day after reunification], after a night of partying I carried on my life as normal,” says Mr Kerber. “Not a single east German had the same experience.”

In places western stereotypes of easterners have persisted, the Jammerossi (“complaining easterner”), ungrateful for the largesse showered on the east after unification, or Dunkeldeutschland (“dark Germany”), a cold-war term implying backwardness. More recent is the notion of the east as a cradle of neo-Nazism, bolstered by the strength there of the far-right Alternative for Germany (AfD). Portrayals of the east in Germany’s national (for which read western) media have often read like dispatches from an exotic, troubled land, where the far right are always marching in the streets or thumping immigrants.

Such accounts risk ignoring the huge strides made by east Germany since reunification.

Citizens were liberated from the humiliations of life in a surveillance state. They were allowed to choose their leaders, express their opinions and travel, to west Germany and beyond.

Economically, despite the hardships of the early years, the east soon began to converge with the west, and life improved drastically across a range of measures. Today some east German regions have lower unemployment rates than western post-industrial regions like the Saarland or the Ruhr valley.

West-east transfers of close to €2trn ($2.2trn) have reduced the infrastructure gap. (Today they run at around €30bn a year, mainly in the form of social-security payments.) Wages in the east now stand at around 85% of the level in the west, and the cost of living is lower. The life-expectancy gap has closed, the air is cleaner, the buildings smarter.

According to Allensbach, a pollster, 53% of east Germans are content with their personal economic situation, the same figure as in the west. “It all worked surprisingly well, but this story doesn’t fly in the east,” says Werner Jann of the University of Potsdam.

One of the best

Last year Andrea Boltho, Wendy Carlin and Pasquale Scaramozzino, three economists, contrasted east Germany’s post-reunification performance favourably with the Mezzogiorno in Italy, where GDP per person remains little over half that of the north. Perhaps the most apt comparison is with other parts of Europe that shook off communism.

East Germany’s per capita growth has outstripped most other eastern European countries (see chart), despite starting from a higher base. As Richard Schröder, a former East German dissident, notes, the application of western laws and practices saw off the threat of oligarchic corruption that has plagued many of Germany’s eastern neighbours.

Yet if east Germans do not always appreciate their good fortune, it is because their reference points have been Hamburg and Munich, not Bratislava or Budapest. Implicit in the promise of reunification was a pledge that east Germans could finally enjoy what they had so long envied in the west. For years they were forced to witness a lifestyle that remained out of reach, in the packets of coffee and sweets sent by relatives in the west, the western goods on display in Intershop outlets accessible only to those with hard currency, or the commercials on western television beamed across the border.

In 1990 Chancellor Kohl promised east Germans “blooming landscapes”. Instead they got deindustrialisation and mass unemployment. “In 1990 300,000 people came to shout ‘Helmut!’ on Augustusplatz [in Leipzig],” recalls Kurt-Ulrich Mayer, who helped establish Kohl’s Christian Democratic Union (CDU) in Saxony. “Four years later he came back, and we needed umbrellas to protect him from all the eggs and tomatoes.” Unlike Poles or Hungarians, east Germans had someone else to blame when things went wrong.

The convergence between west and east eventually ground to a halt. Today just 7% of Germany’s most-valued 500 companies (and none listed in the DAX30 index) are headquartered in the east. This starves municipalities of tax revenue and contributes to the east-west productivity gap, which has stood at around 20% for 20 years. Most assets liquidated by the Treuhand fell into western or foreign hands, hindering the development of an eastern capitalist class.

For many, the best way to get western lifestyles was to move west. Over one-quarter of east Germans aged 18-30 did so, two-thirds of them women. Rural parts of the east were especially affected. As towns and villages emptied and tax revenues slumped, schools were closed, shops shuttered and housing blocks demolished. The mass emigration of youngsters led to a plummeting number of births. Since 2017 net east-west migration has been roughly zero, but there has been no growth in the number of people moving east; the westward exodus has simply fallen to match it.

The east is also much older than the west. Since 1990 the number of over-60s there has increased by 1.3m even as the overall population has fallen by 2.2m. IWH, a research outfit in Halle, thinks the working-age population in the east will fall by more than a third by 2060. By 2035, 23 of Germany’s 401 Kreise (administrative districts) will have shrunk by at least a fifth, says Susanne Dähner at the Berlin Institute for Population and Development; all of them are in the east. In some districts, there will be four funerals for every birth. Instead of losing people to the west, eastern Germany will lose them to the grave.

The constitutional pledge of “equivalent living conditions” across Germany thus looks unattainable. The government tries to help so-called “structurally weak” regions, in the east as well as the west. But although investment in infrastructure or technical universities may help some towns, it cannot stop the demographic decline in many east German regions.

Coming to terms

The picture is much brighter in some eastern cities. Potsdam, Jena and Dresden have clusters of industry and tourism as well as cheap housing; some, like Leipzig (“Hypezig”, to irritated locals), have been booming for years. The “bacon belt” around Berlin benefits from the success of the capital, especially as older workers move out to the suburbs. Yet even as overall emigration to the west dries up, eastern cities are sucking educated people away from already struggling small towns and villages. That trend may continue, as only half of east German workers work in cities, compared with three-quarters in the west.


The changes in the east have social, cultural and political consequences which are now coming to the fore. Last February thousands of Dynamo Dresden supporters at an away game in Hamburg began an unfamiliar chant: “Ost [east], Ost, Ostdeutschland!” A video of the episode went viral, sparking a lively debate: were the fans expressing a dubious “eastern” variant of militant German nationalism? Or was this a cheerful reappropriation of an identity that for so long was taken to connote stupidity and closed-mindedness?

“Identity is key to understanding east Germany,” says Franziska Schubert, a thoughtful Green who represents Görlitz in Saxony’s state parliament. Fully 47% of east Germans say they identify as easterners before Germans, a far higher proportion than at the euphoric moment of reunification. (The equivalent is true for 22% of westerners.) Regional identity is hardly abnormal in Germany—ask the Bavarians—but in the east it can seem grounded in politics as much as culture or tradition.

When Jana Hensel, a writer, recently gave a talk to a school in her home town of Leipzig, she was astonished to find herself spending half an hour fielding questions from teenagers about an Ossiquote (a proposal to give east Germans preference in public jobs). “More than 25 years after the end of the GDR, students have become east German again,” she says. “If we’re not careful, we’ll lose another generation.”

The AfD has exploited the power of eastern particularism. Under slogans like “The east rises up!” the party has scored 20%-plus in eastern state elections, most recently in Thuringia on October 27th. There, and in recent elections in Brandenburg and Saxony, it was only voters over 60 whose support for the established parties ensured that the AfD did not come first.

In Saxony and Thuringia the AfD was the most popular party among under-30s. This is worrying in a part of the country where extremism has found fertile ground. More than half of Germany’s hate crimes take place in the east, though it has just 20% of the population and few immigrants.

But eastern identity is not the exclusive preserve of extremes. Many young easterners simply developed an “Ossi” identity after encountering ignorance or scorn in the west. Nor need it be only negative. Matthias Platzeck, a former Brandenburg premier now in charge of a commission for the 30th anniversary of reunification, says that the recent election in his state was the worst-tempered ever.

Nonetheless, he hopes for the emergence in the east of healthy self-confidence, built on the back of success stories—and a new focus on the many problems that span east and west. His commission’s informal motto, he says, is “as little state celebration as necessary, as much discussion as possible.” And since the Berlin Wall has gone, no amount of debate will land anyone in jail.

The politics of fiscal stimulus are problematic  

Central banks do not have the tools to tackle the supply side shocks facing the global economy

Megan Greene

30 October 2019, Berlin: German Chancellor Angela Merkel (R) and Minister of Finance Olaf Scholz arrive to attend the weekly cabinet meeting at the Federal Chancellery. Photo: Michael Kappeler/dpa
German finance minister Olaf Scholz and Chancellor Angela Merkel are in no rush to inject a fiscal stimulus into the German economy © Michael Kappeler/dpa

We have heard repeatedly this year that co-ordinated monetary easing is not going to be enough when the next recession comes. Fiscal stimulus will be necessary to maintain global growth. Unfortunately, this pronouncement reminds me of my childhood Christmas wishlist. For several years running, I put a baby brother at the top. But doggedly wishing for something is not enough to make it happen.

There is widespread agreement that central banks do not have the tools needed to address the kind of supply-side shocks the global economy is facing. The world is caught in a liquidity trap, with persistently low interest rates and a glut of savings. Fiscal stimulus would be one way to escape it.

But while the economics are sound, the politics are problematic. In the US, the 2020 election means bipartisan consensus on any major new initiatives is all but impossible. Fiscal stimulus in an election year is not unprecedented — a Democrat-led Congress and Republican president passed a programme in February 2008 amid signs of a sharp slowdown. But US growth in the third quarter this year was 1.9 per cent, slow but not alarming.

Prospects for fiscal stimulus may be limited even after 2020. Democrats and Republicans say infrastructure spending is needed, but for years have been unable to agree on how to pay for it. The recent Congressional Budget Office forecast that US deficits will top $1tn next year makes an agreement even harder.

The chances for significant fiscal stimulus in the eurozone are equally grim. Many look hopefully to Germany, which has a large current account surplus, reflecting an excess of national savings over investment. But Chancellor Angela Merkel’s centre-right Christian Democratic Union views the balanced budget as one of its crowning achievements. In August, finance minister Olaf Scholz suggested Germany could muster a €50bn fiscal expansion, but made it clear he is in no rush to do so.

This is partly because some risks to the German economic outlook — trade and Brexit uncertainty — could abate without public spending. It is also because, as a number of CDU members of parliament explained to me, German politicians are more worried about unemployment than growth. A mild recession would not be enough to trigger a fiscal response.

That would require a spike in unemployment, and so far the labour market remains robust.

Germany’s room for manoeuvre is also limited by its constitution, which prevents the federal government from running structural deficits of more than 0.35 per cent of gross domestic product outside times of crisis. This debt brake would cap stimulus at an estimated €5bn next year and €10bn in subsequent years — hardly a game changer.

France and Italy are still on the long, hard road back to fiscal credibility and have little room to spend. If things got really bad — we are nowhere near that — eurozone fiscal expansion could come in the guise of climate change initiatives.

Germany recently launched a €54bn programme to counter climate change. Eurozone governments and companies could ramp up the issuance of green bonds to finance environmental projects, which the European Central Bank is already buying.

When Chinese growth slowed in 2008 and 2015-16, authorities provided overwhelming stimulus that reflated the economy and buoyed global demand. This time, Beijing’s stimulus has been more targeted and domestically focused, diminishing spillover benefits.

I wouldn’t hold my breath for significant fiscal stimulus from the world’s largest economies.

The real question we should be asking is, what happens when it fails to materialise. There’s an old saying: hope is not a strategy. I wanted a baby brother. I have three sisters.

The writer is a senior fellow at Harvard Kennedy School

The end of Evo Morales

Was there a coup in Bolivia?

The armed forces spoke up for democracy and the constitution against an attempt at dictatorship

There are few more emotive words in Latin America than “coup”, and for good reason. From 1930 to the 1970s, the region suffered the frequent overthrow of civilian governments in often bloody military putsches. The victims were usually of the left.

In 1954 a moderate reforming government in Guatemala was ousted in the name of anti-communism by the cia. Other coups followed, including that of General Augusto Pinochet against Salvador Allende, a radical socialist, in Chile in 1973.

Since the democratisation of the region in the 1980s, coups have been rare. But the very idea has become a potent propaganda tool, especially for leftists. Scarcely a week goes by without Nicolás Maduro, Venezuela’s fraudulently elected dictator, claiming that he is threatened by one. Daniel Ortega in Nicaragua says the same. Dilma Rousseff, a leftist president in Brazil who spent her way to a second term in violation of the country’s fiscal responsibility law, also claims that her impeachment in 2016 was “a coup” even though it followed strict constitutional procedures.

The latest claim involves the fall of Evo Morales, Bolivia’s leftist president since 2006. He resigned on November 10th, fleeing into exile in Mexico. This prompted a chorus of denunciations of a coup from the Latin American left and even some European social democrats. This time, at least, the critics are wrong.

True, Mr Morales’s term was not due to end until January. His fall followed violent protests and a mutiny by the police, who failed to suppress them. The final straw came when the head of the armed forces “suggested” that he quit. But that is to tell only a fraction of the story.

Mr Morales, who is of Aymara indigenous descent, long enjoyed broad popular support. He imposed a new constitution, which limited presidents to two terms. Thanks to the commodity boom and his pragmatic economic policy, poverty fell sharply. He created a more inclusive society.

But he also commandeered the courts and the electoral authority and was often ruthless with opponents. In his determination to remain in power he made the classic strongman’s mistake of losing touch with the street. In 2016 he narrowly lost a referendum to abolish presidential term limits. He got the constitutional court to say he could run for a third term anyway. He then claimed victory in a dubious election last month. That triggered the uprising.

An outside audit upheld the opposition’s claims of widespread irregularities. His offer to re-run the election came too late.

Mr Morales was thus the casualty of a counter-revolution aimed at defending democracy and the constitution against electoral fraud and his own illegal candidacy. The army withdrew its support because it was not prepared to fire on people in order to sustain him in power. How these events will come to be viewed depends in part on what happens now.

An opposition leader has taken over as interim president and called for a fresh election to be held in a matter of weeks. There are two big risks in this. One is that ultras in the opposition try to erase the good things Mr Morales stood for as well as the bad. The other is that his supporters seek to destabilise the interim government and boycott the election. It may take outside help to ensure a fair contest.

That the army had to play a role is indeed troubling. But the issue at stake in Bolivia was what should happen, in extremis, when an elected president deploys the power of the state against the constitution. In Mr Morales’s resignation and the army’s forcing of it, Bolivia has set an example for Venezuela and Nicaragua, though it is one that is unlikely to be heeded.

In the past it was right-wing strongmen who refused to leave power when legally obliged to do so. Now it is often those on the left. Their constant invocation of coups tends to be a smokescreen for their own flouting of the rules. It should be examined with care.

Tariffs Aren’t the Only Driver of Auto Stocks

Hopes that the trade war is easing have buoyed the European auto sector in recent weeks, but another profit warning from Daimler is a reality check

By Stephen Wilmot

Trade-deal hopes have given investors a useful opportunity to bail out of European auto stocks. Daimler’s latest profit warning shows why they should seize it.

Europe’s auto sector has had a strong few weeks on the stock market as fears about a global trade war have eased.

Not only have the U.S. and China edged toward a deal, but the White House has also quietly backed away from its threat to slap a 25% tariff on imported cars, which would have been devastating for German brands popular among American consumers.

The Euro Stoxx Autos & Parts index is up almost 11% so far this quarter.

Tariffs aside, though, conditions are only getting tougher for Europe’s vehicle industry.

Daimler, which makes Mercedes-Benz DMLRY -0.89%▲ cars and Freightliner trucks, spelled out the problem in sobering investor days in London on Thursday and New York on Friday.

Investors had hoped that a brand new management team led by Chief Executive Ola Källenius,who took the top job from longtime boss Dieter Zetsche in May, would somehow reinvigorate the Daimler investment case after a string of profit warnings—possibly even by splitting the company up.

Instead, Mr. Källenius’s first big step has been to lay out the immense scale of the challenge.

Daimler stock fell 4.5% Thursday and was also down in early trading Friday.

This year has been “relatively difficult,” said Mr. Källenius, but next year will be even worse—and even after that the recovery appears highly risky.

The operating margin of the flagship Mercedes-Benz car division, which accounts for roughly half the company’s revenue, will fall to roughly 4% in 2020 from 5% this year.

Analysts had been expecting something close to 6%.

The company now says the margin only will recover to that level by 2022.

Even these downbeat forecasts seem dependent on punchy assumptions: No recession, sales growth approaching 3% and no tariffs.

If President Trump’s trade talks fall apart and China increases its tariffs on vehicle imports from the U.S. next month, as threatened, the Mercedes-Benz operating margin would barely exceed 3% next year.

Daimler exports sport-utility vehicles to China from its plant in Tuscaloosa, Ala.

There are two big reasons why margins are falling: the need to sell less profitable electric vehicles to meet new European emissions regulations that partially come into force next year and higher depreciation charges.

Daimler has been investing heavily in recent years, but the impact on its earnings has been masked because it has counted an increasing part of the bill as capital rather than current spending.

At some point it has to pay for that approach: Capital must be depreciated, while the proportion of capitalized costs can’t rise indefinitely.

Daimler needs to offset these pressures.

The main lever available is squeezing suppliers to cut material costs, but the company is also reducing staff numbers, particularly in the car division.

In total it said staff costs would be reduced by €1.4 billion ($1.54 billion), which will irk Germany’s powerful unions but equates to less than 1% of the company’s €167 billion in revenue last year.

Daimler is an extreme example, given its history of under-managing costs, but all car makers face the same formidable regulatory conditions in Europe and China.

For now, the U.S. is taking a longer road to electrification, easing the pressure on Detroit, but U.S. car makers are working toward the same ultimate destination.

Seeking refuge in scale, which gives car makers more leverage over suppliers, is one response—hence the merger plan under negotiation between Fiat Chryslerand Peugeot,and the platform-sharing deals between Volkswagenand Ford.

After the recent rush of trade optimism, the Euro Stoxx Autos & Parts index fetches roughly eight times expected earnings—close to an 18-month high. Now is a good time for investors to limit their exposure.

Whatever happens with Mr. Trump’s tariffs, next year’s emissions regulations will cause an almighty pileup.

If Firms Leave China, Will US Tariffs Follow?

By: Phillip Orchard

Stroll down the electronics aisles of any big box store in America, and you’re bound to see an array of products from companies that are moving manufacturing from China to Southeast Asia.

Much of the components in Apple’s AirPods, Google’s next Pixel phone, and Nintendo’s Switch, for example, are now made largely in Vietnam.

Sony has moved operations to Thailand, while Samsung is shifting notebook and smartphone production to Taiwan and Malaysia.

This is, to a large extent, the result of the U.S.-China trade war, which has sent firms scrambling to adjust their supply chains to minimize the effects of existing or scheduled U.S. tariffs.

But firms in China haven’t exactly been stampeding for the exits. Among other sources of hesitation is major uncertainty about where the White House’s trade war might expand to next.

After all, China has never been the sole focus of the United States; Washington kicked off the trade war in spring 2018 with metals tariffs applied almost globally, and it’s been gradually ramping up pressure on dozens of other countries.

Over the past few months, U.S. President Donald Trump has claimed that both the European Union and Vietnam are worse trade abusers than China.

On Oct. 25, the U.S. revoked special trade privileges affecting some $4 billion in exports from Thailand – a move similar to ones it also made this year against India and Turkey (and threatened against Indonesia and Kazakhstan).

Bottom line: Few low-cost manufacturing hubs are safe from U.S. pressure altogether. But trade pressure is hardly the same thing as a trade war, and Southeast Asia will largely be spared.

A Partial Exodus From China

Relatively few firms are abandoning China as a manufacturing base altogether.

Most companies that make things in China do so in part to ensure their ability to sell their products to Chinese consumers, who make up the world’s second-largest consumer market.

The fact that other major consumer markets – Japan, South Korea and Europe, in particular – have politely declined to follow the United States’ lead with tariffs on Chinese exports of their own further diminishes the need for firms to pull up stakes.

Moreover, though Chinese exports to the United States are finally starting to show sharp declines, U.S. consumers continue to eat a large portion of the costs of U.S. tariffs on China.

The reality is that moving operations is expensive, disruptive and time-consuming, so many firms are reluctant to do so – especially since at least some of the U.S. tariffs are likely to be lifted if and when Washington and Beijing eventually reach a trade deal.

Of course, the trade war has made abundantly clear the risks of being too reliant on any one place, along with the fact that many frictionless supply chain models have been optimized to the point of becoming excessively fragile and vulnerable to disruption.

And for firms in high-tech and advanced manufacturing sectors with national security implications, U.S. restrictions on China-made imports are quite likely to remain in place for the long haul.

As a result, we’re seeing an increasing trend of firms considering moving just enough operations out of China to be able to put the uncertainty of the trade war behind them and get on with business.

But even among those for whom relocating is worth the time and expense, there’s still the issue of finding a suitable alternative to China. There are two main problems with Southeast Asia and other low-cost hubs.

First, no single alternative hub boasts China’s combination of advantages.

Despite its rising labor costs and loss of some low-skill manufacturing to frontier markets, China remains uniquely attractive as a well-oiled export machine for goods further up the value chain.

Its infrastructure, near-bottomless pool of well-trained workers, and the abundance of financial incentives available from local governments keen to prevent large-scale job losses have helped offset the rising costs of production.

India, for example, has the bottomless low-cost labor pool, but not the infrastructure, streamlined regulatory schemes or tech sector experience needed to lure away firms en masse – and it’s too far from East Asia’s most important tech clusters to fit seamlessly into the industry’s tightly integrated supply chains, anyway.

Malaysia and, to a lesser extent, Thailand rate highly on infrastructure and tech sector expertise, but not on labor pool depth, and both are a bit too far from other regional hubs to be considered ideal.

Vietnam has the ideal location, the low labor costs and open access to consumers in its fellow Trans-Pacific Partnership members, but its weak infrastructure became quickly oversaturated after the trade war exodus began.

Infrastructure can of course be built, and regulatory and incentive schemes can be adjusted to meet exporters’ needs.

But these are long-term projects.

And there’s little that can be done to offset these countries’ geographic or demographic disadvantages.

Trade Pressure on Southeast Asia, Not a Trade War

The second main problem is the concern that U.S. tariffs might just follow exporters from China to the next low-cost export hub.

The U.S. tariffs on China are indeed starting to hurt Chinese exports.

U.S. imports from China have fallen 12.5 percent so far this year, compared to 2018.

But this has done little to benefit employment in U.S. manufacturing outside of a small number of industries.

On the whole, U.S. exports of goods have declined around 3 percent year on year since the beginning of 2019, and U.S. manufacturing activity has contracted for two consecutive months, according to the Institute for Supply Management. (Some of this is due to the global slowdown more than the trade war.)

Other low-cost manufacturers, meanwhile, have generally benefited from the trade diversion.

Vietnam, for example, has been the clear winner at this point, with its exports to the U.S. surging some 40 percent year on year.

U.S. Import Growth by Country
(click to enlarge)

If the overriding goal of the Trump administration's tariffs is to revive the lost glory of labor-intensive U.S. manufacturing, then it stands to reason that eventually it would have to expand tariffs to other low-cost manufacturers running large trade surpluses with the United States as well. (The U.S. would probably also have to wage war on automation.)

To be sure, some in the Trump administration have certainly advocated for a much sharper turn toward autarky.

But that was always politically unrealistic. And if that were indeed the overriding goal, we probably wouldn’t be seeing the White House prepping the public for a deal with China that will almost certainly relax some tariffs.

And we wouldn’t have seen the Trump administration settle for largely cosmetic changes in its renegotiated trade deals with Mexico, South Korea and Japan.

(click to enlarge)

Rather, the two main goals of the tariffs are to pressure China into immense structural reforms and to contain China's accumulation of power more broadly.

We’re doubtful of the ability of tariffs to really do much toward either goal and think that the United States will eventually move away from tariffs as its favorite tool for resetting its trade relationships.

But the belief that China must be pressured to change one way or another and/or that China poses an intolerable threat to U.S. strategic interests is widespread on both sides of the aisle in Washington – far more so than the base of support for tariffs aimed at reshoring low-cost manufacturing jobs.

And expanding the trade war in full force to Southeast Asia and low-cost hubs elsewhere would conflict with both of these larger goals.

This doesn’t mean countries like Thailand, Vietnam and India are immune to U.S. pressure altogether.

The U.S. has long sought to nudge exporters everywhere to comply with global trade rules on issues like currencies and subsidies, whether with stick or carrot.

To maximize its campaign against China, the United States also has strong incentives to crack down on Chinese transshipments through regional hubs.

Perhaps the biggest risk for tech sector firms is that the U.S. expands measures aimed at mitigating supposed Chinese technological threats to U.S. national security to high-tech manufacturing operations elsewhere in the region – particularly Taiwan, countries vulnerable to Chinese intelligence, or countries with governments considered too cozy with Beijing.

Otherwise, U.S. trade measures targeting regional states will be relatively light, aimed at addressing narrow issues that are largely resolvable in negotiations. (The U.S. move against Thailand, for example, affects just 15 percent of Thai exports to the U.S. and was driven ostensibly, at least, by correctable human rights issues in the seafood industry.)

Most important, none of these countries has the capacity to fundamentally threaten the United States’ core interests economically or strategically.

Quite the contrary, in fact.

To establish long-term incentives to persuade China that it’s in its best interest to play by established rules and to undermine its coercive power regionally if it doesn’t, the United States will have greater reason to work with the region, not against it. 

Warren Buffett’s Berkshire Hathaway increases cash pile to $128bn

Sage of Omaha has struggled to find large acquisitions to boost returns

Richard Henderson and Jennifer Ablan

Warren Buffett, Chairman and CEO of Berkshire Hathaway, speaks to reporters during a tour of the CHI Health convention center where various Berkshire Hathaway companies display their products, before presiding over the annual shareholders meeting in Omaha, Neb., Saturday, May 4, 2019. An estimated 40,000 people are expected in town for the event, where Buffett and his Vice Chairman Charlie Munger will preside over the meeting and spend hours answering questions. (AP Photo/Nati Harnik)
Warren Buffett has gone nearly four years since completing a major acquisitio © AP

Berkshire Hathaway increased its cash pile to a record $128bn in the third quarter, as Warren Buffett struggled to find large acquisitions to boost Berkshire’s returns.

Mr Buffett has gone nearly four years since completing a major acquisition, forcing him and Charlie Munger, his longtime business partner and vice-chairman of Berkshire, to look elsewhere to invest their cash hoard.

Berkshire’s holding of cash or short-term Treasuries marks an increase from the $122bn it held in the prior quarter, the company said on Saturday as it reported third-quarter earnings.

Bill Smead, chief executive of Smead Capital Management, said Mr Buffett had not found an attractive M&A target and could be building the “monstrous cash hoard in the event Buffett or Charlie Munger — the masterminds of Berkshire — go into the hospital”.

Mr Buffett is 89 years old and Mr Munger is 95 years old.

Mr Smead said Mr Buffett could also be waiting to deploy Berkshire’s cash in the event the stock market faced a bear market akin to the 1987 crash.

As the cash pile grows, so too do profits from its vast business empire. The group posted a record $7.8bn in quarterly operating profit in the third quarter, a 14 per cent rise from the same period last year. These profits reflect earnings from Berkshire Hathaway’s businesses, but do not include paper gains from its investment holdings, which fluctuate with the stock market.

When these are included, the group’s overall profits were reported to have eased to $16.5bn in the quarter from $18.5bn for the same period in 2018.

“These are very strong results reflective of a strong domestic economy despite all of these challenges,” Jim Shanahan, an analyst with Edward Jones, said. The gains were driven by strong results from its railroad, utilities and insurance companies, he said.

Berkshire bought back about $700m of its own shares in the third quarter, bringing its total buybacks for the year to $2.8bn. The Omaha, Nebraska, conglomerate changed its buyback policy last year, and some shareholders are frustrated that the company hasn’t spent significantly more cash repurchasing its stock.

In addition to Berkshire’s portfolio of businesses, the group has expansive stock holdings dominated by shares in financial companies. American Express and Wells Fargo are among the group’s biggest holdings, while Apple stock, which Berkshire first bought in 2017, is now the largest.

The value of Berkshire’s shares in the iPhone maker grew $7bn to $57bn in the third quarter as Apple stock rose. Further gains by Apple in the fourth quarter so far have pushed that holding to $65bn, marking a $25bn paper gain for Berkshire this year alone.

In his annual letter to shareholders earlier this year, Mr Buffett said “sky-high” prices meant the likelihood of putting the excess money to work in a large deal was “not good.”

“That disappointing reality means that 2019 will likely see us again expanding our holdings of marketable equities,” he said. “We continue, nevertheless, to hope for an elephant-sized acquisition.”

The Road to Default

By John Mauldin


Nothing is forever, not even debt. Every borrower eventually either repays what they owe, or defaults. Lenders may or may not have remedies. But one way or another, the debt goes away.

One of Western civilization’s largest problems is we’ve convinced ourselves debt can be permanent. We don’t use that specific word, of course, but it’s what we do and is why government debt keeps rising. We borrow faster than we repay previous borrowing—and I mean governments everywhere, China as well as the US.

Our leaders have no real plan to reduce the debt, much less eliminate it. They just want to spend, spend, spend forevermore. And most citizens are okay with that. As I will note below, the Republican Party I grew up with, which back then seemed to constantly talk about deficits and debt, is now comfortable with 5% (and growing) of GDP deficits.

As a result, I think we will spend the latter part of the 2020s going through a kind of worldwide bankruptcy. We won’t call it that, and it will take a lot of argument because we won’t have a court to take charge. But we will collectively realize the situation can’t go on and find a way to end it. I’ve taken to calling this “the Great Reset.”

Once the Great Reset is over, we’ll find a much better world waiting for us. Getting there will be the hard part.
Debt Monster

In last week’s “Slowing but Not Stopping (Yet)” letter, we talked about the mounting signs of economic slowdown and possible recession. Falling freight volumes are particularly troubling.

My friend and economist Peter Boockvar wrote about the latest shipping data, which came out this week:

The October Cass Freight index fell 5.9% y/o/y which is the 11th straight month of y/o/y declines. Cass Freight repeated what they’ve said for the past 5 months that “the shipments index has gone from ‘warning of a potential slowdown’ to ‘signaling an economic contraction.’” Moreover, “Several key modes, and key segments of modes, are suffering material increases in the rates of decline, signaling the contraction is getting worse.” The underline is theirs, not mine. To continue, “The weakness in spot market pricing for many transportation services, especially trucking, along with recent airfreight and railroad volume trends, heightens our concerns about the economy.”

Here are the 3 main areas of concerns:

1) “We are concerned about the increasingly severe declines in international airfreight volumes (especially in Asia) and the ongoing swoon in railroad volumes, especially in auto and building materials;

2)We see the weakness in spot market pricing for transportation services, especially in trucking, as consistent with and a confirmation of the negative trend in the Cass Shipments Index;

3)As volumes of chemical shipments have lost momentum, our concerns of the global slowdown spreading to the US increase…The trade war looks as if it has reached a ‘point of no return’ from an economic perspective, as the rates of decline are accelerating.” Again, the underline is theirs.

But not all the news is bad, and we could muddle along in this slow-growth mode for a few more quarters or even years. The problem is that even this mild growth is happening only due to monster amounts of debt. A decade of bailouts, QE, ZIRP, and so on encouraged everyone to lever up, and they have. Ray Dalio described this in his latest LinkedIn post.

Because investors have so much money to invest and because of past success stories of stocks of revolutionary technology companies doing so well, more companies than at any time since the dot-com bubble don’t have to make profits or even have clear paths to making profits to sell their stock because they can instead sell their dreams to those investors who are flush with money and borrowing power.

There is now so much money wanting to buy these dreams that in some cases venture capital investors are pushing money onto startups that don’t want more money because they already have more than enough; but the investors are threatening to harm these companies by providing enormous support to their startup competitors if they don’t take the money.

This pushing of money onto investors is understandable because these investment managers, especially venture capital and private equity investment managers, now have large piles of committed and uninvested cash that they need to invest in order to meet their promises to their clients and collect their fees.

In other words, much of what we see right now isn’t real economic activity. It is artificial, incentivized by the monetary policies that ended the last crisis, but should have stopped much sooner.

Now people are beginning to see this emperor has no clothes. The first evidence is in the failure-to-launch of “unicorn” companies like WeWork, whose early investors assumed they could palm off their shares to unwitting IPO buyers. Nope, didn’t happen, not going to. But that’s minor compared to the other threat they face: rising interest rates.

In case you haven’t noticed, our negative-rate-loving overseas friends are having a change of heart. The Bank of Japan and European Central Bank are plainly looking for an exit from NIRP as their commercial banking sectors find it increasingly impossible to turn a profit. And whatever many on the progressive left think about banks, they are a critical part of the economy.

Over here, the Federal Reserve’s rate-cutting at the short end is raising rates at the long end and, not coincidentally, un-inverting the yield curve. (By the way, the yield curve almost always normalizes as recession begins. So that is not an “all clear” signal.)

This is happening, in part, because the Fed is having to “help” the Treasury sell enough T-bills to cover the government’s growing deficit. This is helping reduce interest costs a bit because shortening the average maturity lets the Treasury pay lower rates. But it also leaves less capital at the long end, pushing those rates higher. And loan demand isn’t shrinking because so many people figured they would keep refinancing forever.

This will change in due course. And as we see debt-laden businesses run into difficulty—often because they were bad ideas in the first place—bankers will tighten lending standards, and the dominoes will start to fall.
Recipe for Conflict

I realize some readers are of the progressive persuasion that debt doesn’t matter, we owe it to ourselves, etc. This is not correct. Debt does matter, and there are limits to how much an economy can bear. I’ll admit, the limit is proving higher than I thought, but there is one and every day brings us closer to it.

You really need to watch this video of a recent conversation between Ray Dalio and Paul Tudor Jones. Their part is about the first 40 minutes. Jones begins by positing that Donald Trump is the best salesman in American history because he (a) got the Republican Party to accept annual deficits at 5% of GDP and (b) convinced the Fed to cut interest rates even with unemployment at 50-year lows.

Of those two, the budget deficit is the least surprising. I (sadly) realized long ago that even Republicans are fiscal conservatives only rhetorically, and like all politicians will respond to constituent demands. Everybody wants lower taxes (for themselves) and higher spending (on their own priorities). That’s what our system delivers. Not good, but it’s reality. And so the debt grows ever larger.

No candidate can run on anything close to fiscal balance, because to do so would mean either advocating higher taxes or cutting entitlement programs. Both are guaranteed vote killers.

We learned this week that the federal deficit for the last 12 months rose above $1 trillion for the first time since 2013. The official on-budget debt is only part of it, too. Off budget will be at least another $200 billion.

With GDP weakening (today the New York and Atlanta Fed models both cut their fourth-quarter GDP growth projections to 0.4% or below) and without a significant trade deal (something more than just around the margins for optical reasons), we can expect lower government revenues and higher government spending to further increase the deficit.

Add in unfunded pension debt, both at the federal level and lower. Does anyone really think that in a serious crisis, Washington won’t bail out bankrupt state and local pension plans? And of course it will step in to save the laughably unfunded Pension Benefit Guaranty Corporation, which insures private defined benefit pensions. All these unaccounted-for liabilities will amplify future deficits at some point.

We are not going to get out of this debt trap by cutting benefits or raising taxes. I agree with Ray Dalio that we are almost certainly going to monetize it. I highly suggest that you read his latest piece titled “The World Has Gone Mad and the System Is Broken.” It is the shortest and best summary of his views that he has put out in a long time.

Since there isn’t enough money to fund these pension and healthcare obligations, there will likely be an ugly battle to determine how much of the gap will be bridged by 1) cutting benefits, 2) raising taxes, and 3) printing money (which would have to be done at the federal level and pass to those at the state level who need it). This will exacerbate the wealth gap battle.

While none of these three paths are good, printing money is the easiest path because it is the most hidden way of creating a wealth transfer and it tends to make asset prices rise. After all, debt and other financial obligations that are denominated in the amount of money owed only require the debtors to deliver money; because there are no limitations made on the amounts of money that can be printed or the value of that money, it is the easiest path.

Note, Ray isn’t saying he prefers this path, or that it is a good choice. He thinks it is what we will do. I agree. This is what will happen, and it’s going to have consequences.

The big risk of this path is that it threatens the viability of the three major world reserve currencies as viable store holds of wealth. At the same time, if policy makers can’t monetize these obligations, then the rich/poor battle over how much expenses should be cut and how much taxes should be raised will be much worse. As a result, rich capitalists will increasingly move to places in which the wealth gaps and conflicts are less severe and government officials in those losing these big tax payers will increasingly try to find ways to trap them.

If that sounds like a recipe for conflict, you’re right. It will probably get ugly. We can’t yet say exactly how, because there are lots of ways this could unfold. The Fed has plenty of power already, and Congress can give it more. The only real limit is what the markets will bear in terms of currency depreciation.

One way or another, this will get to a Great Reset in which debt simply… disappears. That will inevitably create winners and losers. Some people who did everything right will get punished. Some irresponsible fools will get rewarded. Neither is good, but that’s not the point. We are talking about what will happen, not what we want.
Currency Wars?

In the video conversation mentioned above between Paul Tudor Jones and Ray Dalio, Ray again highlights some problematic similarities between our times and the 1930s. Both feature:

1.   a large wealth gap

2.   the absence of effective monetary policy

3.   a change in the world order, in this case the rise of China and the potential for trade wars/technology wars/capital wars.

He threw in a few quick comments as their time was running out, alluding to the potential for the end of the world reserve system and the collapse of fiat monetary regimes. Maybe it was in his rush to finish as their time is drawing to a close, but it certainly sounded a more challenging tone than I have seen in his writings.

It brought to mind an essay I read last week from my favorite central banker, former BIS Chief Economist William White. He was warning about potential currency wars, aiming particularly at the US Treasury’s seeming desire for a weaker dollar. Ditto for other governments around the world. He believes this a prescription for disaster.

One possibility is that it might lead to a disorderly end to the current dollar based regime, which is already under strain for a variety of both economic and geopolitical reasons. To destroy an old, admittedly suboptimal, regime without having prepared a replacement could prove very costly to trade and economic growth.

Perhaps even worse, conducting a currency war implies directing monetary policy to something other than domestic price stability. There ceases to be a domestic anchor to constrain the expansion of central bank balance sheets.

Should this lead to growing suspicion of all fiat currencies, especially those issued by governments with large sovereign debts, a sharp increase in inflationary expectations and interest rates might follow. How this might interact with the record high debt ratios, both public and private, that we see in the world today, is not hard to imagine.

I called Bill to ask if he thought this was going to happen. Basically, he said no, but it shouldn’t even be considered. It was his gentlemanly way of issuing a warning. Currency devaluations against gold were part of the root cause of the Great Depression. Coupled with protectionism and tariffs, they devastated global economic growth and trade.

Do I think it will happen in any significant way in the next few years? It is not my highest probability scenario. But imagine a recession that brings the US deficit to $2 trillion, possibly followed by a governmental change that raises taxes and spending. This could bring about a second “echo” recession with even higher deficits. This would force the Federal Reserve to monetize debt in order to keep interest rates from skyrocketing, thereby weakening the dollar.

Couple this with a concurrent crisis in Europe, potentially even a eurozone breakup, resulting in countries all over the world trying to weaken their currencies with the potential for higher inflation in many places.

In such a scenario, is it hard to imagine a desperate president and Congress, toward the latter part of the next decade, regardless of which party in control, instructing the US Treasury to use its tools to weaken the dollar? Can you say beggar thy neighbor? Can you see other countries following that path? All as debt is increasing with no realistic exit strategy except to monetize it?
Timing Is Everything

As Bill and I talked scenarios, he reminded me of Herbert Stein’s dictum: “If something can’t go on forever, it won’t.” But then he quoted another famous economist (whose name escapes me) who replied, “But it can go on a lot longer than you think.” Kind of like Keynes reminding us that the markets can remain irrational longer than you can remain solvent.

The world has grown accustomed to having the dollar as reserve currency. It is comfortable letting central banks monetize debt and governments run ever-larger deficits. Somehow, we’ve even become used to negative rates. Things can indeed go on longer than one might think.

I can seriously imagine the market rising significantly over the next few quarters as easily as I can imagine a bear market. But it will be a few years before the gut-wrenching Great Reset happens. We have time, if we properly use it, to position our lives and help those around us prepare for the coming storm.

We will have the chance to invest in new companies that will absolutely, astoundingly change the world for the better. They’re going to be extraordinarily valuable franchises. There will be fixed income opportunities even as interest rates drop.

I almost find it ironic that on the one hand I talk about the Great Reset while I am writing a book called the Age of Transformation, marveling at all of the wonderful new opportunities we will have.

Learn to deal with change and take advantage of it. Oh yeah, and consider slowly increasing your allocation to physical gold. I don’t think of gold as an investment. I think of it as central bank insurance. And after meditating on today’s letter, I think I may need a little more insurance. Just a thought…
Philadelphia and Dallas

I will be flying into Philadelphia for a “hit-and-run” set of meetings Thursday before flying back on Friday morning to Puerto Rico. Then the next week, Shane and I will be in Dallas for Thanksgiving with the family (I will have a big hand in the food preparation) and a wedding.

I have been trying to arrange a meeting with Ray Dalio, as I seriously want to talk with him about some of the scenarios he would pursue. Schedules are tricky things. I really appreciate his willingness to expose his ideas to the world, when at this stage of the game, he really doesn’t need to. But he clearly cares about the future of the Republic. And Leon Cooperman. If you haven’t read his latest letter to Elizabeth Warren, you should. I have always been a big fan of Paul Tudor Jones and after seeing him in that interview, it just reminded me how funny and thoughtful he is.

Thousands of others, less well-known but all up and down the income and political spectrum, are just as committed to the future of the country and humanity. Am I naïve to hope we can overcome the partisan divide? It wouldn’t be the first time that a divided country has come together to work for the common good. In fact (spoiler alert), that is precisely the scenario I see happening around the time of the Great Reset.

Do we have to get there? No, there are paths we can take to avoid all that. Just not one that I see as politically possible today. But by 2024, who knows? One can always hope.

And with that, I will hit the send button. You have a great week.

Your already thinking about Thanksgiving dinner analyst, 


John Mauldin
Co-Founder, Mauldin Economics

State of denial

America’s public-sector pension schemes are trillions of dollars short

Police officers, teachers and other public workers face a brutal reckoning

Perhaps it takes teachers to give politicians a lesson. Any official who wants to understand the terrible state of American public-sector pensions should read the financial report of the Illinois Teachers Pension Fund.

Its funding ratio of 40.7% is one of the worst in America, according to the Centre for Retirement Research (crr) in Boston (see table).

Since it was established in 1939, Illinois officials have not once set aside enough money to fund the pension promises made.

As a result, three-quarters of the money the state (or rather the taxpayer) now pays in each year merely covers shortfalls from previous years.

The situation is getting worse.

In 2009 the schemes’ actuaries requested $2.1bn, but only $1.6bn was paid.

By 2018 the state paid in $4.2bn, still well short of the $7.1bn the actuaries asked for.

The trustees have warned that the plan would be “unable to absorb any financial shocks created by a sustained downturn in the markets”.

Other schemes have attracted similarly stark warnings.

Illinois is the class dunce, with six languishing schemes.

Chicago Municipal is just 25% funded and the actuaries warn that “the risk of insolvency for the fund has increased”.

The actuaries of the Chicago police scheme warn that “this is a severely underfunded plan” with a shortfall of $10bn; the funded ratio is not projected to reach 50% until 2043.

Offering workers a defined-benefit pension, where an income based on final salary is paid for the rest of their lives, is an expensive proposition, especially as life expectancies lengthen.

Pension shortfalls are common across America, with the average public scheme monitored by the crr just 72.4% funded.

That adds up to a collective shortfall of more than $1.6trn.

When a scheme is underfunded, one of three things can happen.

More contributions can be made, by employers or workers or both.

Benefits can be cut.

Or the scheme can earn a higher return on its investments to make up for the shortfall.

Cities and states are paying more, but still not enough.

In 2001 public-sector employers contributed a further 5.3% of their payroll to meet pension promises; now that figure is around 16.5% on average (see chart).

Even so, in no year since 2001 has the average employer contributed as much as demanded by actuaries.

Last year’s shortfall was just under 1% of payroll.

This reluctance is understandable.

Politicians dislike raising taxes—or cutting services to pay for higher contributions.

Workers do not want to see their current pay reduced by higher deductions, or their future benefits cut.

And in any case, in some states courts have ruled that pension benefits, once promised, cannot be taken away.

Arizona attempted a reform in 2012 that would have increased contributions for anyone with less than 20 years’ service.

Workers sued and the courts ruled in their favour in 2016, requiring the scheme to repay $220m.

Since the failed reform plan was instituted, employers’ contributions as a share of payroll have almost doubled.

So states and cities have crossed their fingers and hoped that their investments will bail them out. America’s buoyant stockmarket has done its best to help.

Returns on government bonds have also been good for much of the past three decades.

Even so, the average public-sector scheme is less well funded now than it was in 2001.

And the markets are unlikely to keep being so helpful.

In 1982 the government sold long-term Treasury bonds with a yield of 14.6%; now such bonds yield just 2.4%.

Equity valuations are high by historic standards.

That suggests future returns will be lower than normal.

Kentucky offers a sobering example of how states can spiral towards disaster.

In 2001 its retirement system was 120% funded and employers were putting in just 1.9% of payroll.

After the dotcom slump, the funding position deteriorated.

By 2005 the scheme was less than 75% funded and the required contribution had gone up to 5.3%.

But the state fell short of the target every year until 2015, by which point the contribution had leapt to nearly 33% of payroll.

In 2018 the actuaries asked for 41%.

Kentucky’s scheme covering “non-hazardous” workers (those who are not employed by the emergency services) is just 12.8% funded.

One of its beneficiaries is Larry Totten, who worked for Kentucky’s park service and retired in 2010 after a 36-year career.

When he found out about the scheme’s parlous state, he joined Kentucky Public Retirees, a group that lobbies for pensioners.

“There’s enough blame to go around,” he says.

Though it was state governors (of various parties) who failed to pay the required amounts into the scheme, it was the state legislature that let them get away with it.

Such severely underfunded schemes risk entering two vicious circles.

The first involves costs. Kentucky’s public pension scheme covers a wide range of state employers and some have to pay 85% of payroll to cover their pension obligations.

Employing someone on $50,000 a year requires an extra $42,500 of contributions.

They naturally seek to lay off workers to reduce this cost.

But that leaves fewer people paying in without changing the number currently receiving retirement benefits.

That increases the short-term squeeze.

The second concerns the accounting treatment of public-sector funds.

Many assume nominal returns on their portfolios of 7% or more after fees.

This optimism has a big impact.

Calculating the cost of a pension promise requires many assumptions—how long people will live, how much wages will rise and so on.

Future payouts must be discounted to calculate a cost in current terms, and thus contributions.

The higher the discount rate, the lower the current cost and the less employers have to pay in.

Public-sector schemes use the assumed rate of investment return as their discount rate—so a high rate lowers the apparent cost.

But if a scheme becomes severely underfunded, a plunge in the stockmarket could leave it unable to cover current payouts.

So it must invest in safer, lower-yielding securities, such as government bonds.

That reduces the discount rate and makes the pension hole even bigger.

Kentucky’s non-hazardous scheme uses an expected return of 5.25%, much lower than most public-sector schemes.

These calculations look surreal by comparison with private-sector pension funds.

Their accounting rules regard a pension promise as a debt like any other.

After all, courts insist pensions have to be paid, whatever the investment returns.

The discount rate must therefore be based on the cost of debt—for companies, the yield on aa-rated corporate bonds.

Since that yield, now around 3%, is far lower than the return assumed by public-sector funds, private-sector pension liabilities are very expensive.

Faced with a $22.4bn shortfall, General Electric recently froze pension benefits for 20,000 employees.

These different accounting approaches seem to imply that it is cheaper to fund a public-sector pension than a private-sector one. In reality, that cannot be the case.

The public-sector pension deficit is therefore much larger than the $1.6trn estimated by the crr.

It is hard to be precise about how much larger, but the accounts of troubled schemes give some indication.

The Chicago Teachers scheme has a shortfall of $13.4bn, and a funding ratio of 47.9% on the basis of an assumed return of 6.8%.

Its financial report reveals that a one-percentage-point fall in the discount rate would increase the deficit by $3bn.

The private-sector accounting approach would lower the discount rate by around four percentage points.

This is a crisis no one wants to solve, at least not quickly.

The Chicago Teachers scheme is aiming for 90% funding, but not until 2059—long after many retired members will have died.

New Jersey’s teachers’ scheme is not scheduled to be fully funded until 2048.

Such promises might as well be dated “the 12th of never”.

The bill for taxpayers seems certain to rise substantially.

For the states with the biggest pension holes, political conflict is in store.