The Second Great Depression… But Not Really

By John Mauldin

 
"It's a recession when your neighbor loses his job;
it's a depression when you lose yours."

—Harry S. Truman, 33rd US President

 
In recent weeks, numerous commentators started to suggest the US and the world are entering a depression.

For some areas of the economy, that is clearly true. But not every area.

Today we will explore what some smart minds are saying about the current economic environment. I'll also aim to help you navigate through its complexity.

Here's one thing I think we can all agree on…

This recession/depression is unlike anything we have experienced in the history of the US.

I am at a loss to find anything like it in world history. That is because we have never experienced an economic disaster—and that’s the correct phrase—like we are witnessing today.

Furthermore, the recovery—when it happens, and it will come—is going to be very uneven.

  • Part of the economy will be in what can only be described as a depression for quite some time.

  • Another part will recover, albeit a little slowly, but faster than the Great Recession.

  • Other parts of the economy are going to take off like a rocket ship.

The media and politicians tend to talk about “the economy” as a general term. But I think that will be a misnomer. How fast you will see recovery, or how long you will see depression, depends a great deal on where you are and what part of the economy you are in.

My friend George Friedman of Geopolitical Futures suggests that our search for answers starts with September (emphasis mine):

"I have argued that unless a solution is found by September, the probability that the recession could turn into a depression would mount. A recession is a normal part of the economy, a primarily financial event that imposes disciplines on an overheated economy. A depression, from a geopolitical standpoint, involves the physical destruction of the economy, something that lays waste to businesses, dislocates labor and vaporizes capital. A recession is the economy cycling. A depression is an economy breaking.

"I chose September because two quarters of intense economic contraction is instructive. Economists’ definition of a recession is two successive quarters of negative growth (also known in English as decline). This is generally enough time to understand how resilient an economy is. Uncoincidentally, it is also the point at which economies begin to recover in normal cycles. Under normal circumstances, basic economic structures remain intact during recessions so financial stimulus measures can restart the system. "


Just for the record, there have been five depressions in the history of the US: 1807–1814; 1837–1844; 1873–1879; 1893–1898; 1929–1941. I believe all of them were associated with banking crises and financial panics.

A little history is in order to understand why the current situation is different from anything we have seen…

The first four “depressions” were indeed banking panics. But they were also associated with the agricultural cycle.

Farmers would borrow money in the spring and pay it back after the fall harvest. Money would move from money-center banks in the big cities, especially New York, to smaller banks out in the country. And then back.

(Think about the old piece of market wisdom here: "Sell in May and go away." The money-center banks would have less money to lend for speculation during the summer.)

If you're as fascinated by this topic as I am, Art Cashin turned me on to a book by Walter Lord called "The Good Years." Truly the best 99 cents you can spend. Click on the chapter heading "1907" and read how J.P. Morgan essentially forced bankers and financiers to save the country.

It was actually quite the harrowing tale. And it was what led governments and banks to create the Federal Reserve in 1913, to have a lender of last resort.

Things indeed changed. Not long afterward, the US became less dominated by the agricultural cycle and more dominated by the manufacturing cycle.

As my friend Dr. Woody Brock says, when Henry Ford would lay off 10,000 workers, that also meant steelworkers, tire manufacturers in Akron, and so on were also laid off.

That percolated throughout the economy. And we got what we called the Great Depression. (I know this is a huge oversimplification: Herbert Hoover allowed Smoot-Hawley in 1930. He also raised taxes in the teeth of a depression/recession. Monetary policy was not helpful.)

After World War II, “recessions” became more frequent. (Sidebar: You won’t find the term “recession” in the historical literature prior to World War II.)

Up until 2000, recessions were associated with the manufacturing cycle. But those became milder over time. That is because manufacturing had less of an impact on the economy.

Going into 2020, 85% of the US economy was in the service economy. The Great Recession was caused by financial excess, but we worked through it.

And then we get to the current crisis. And something happened that never happened before…

We literally shut down 30% to 40% of the service economy. Wiped it out. Restaurants, hotels, gyms, airlines, tourism, all manner of personal services. The list can go on forever.

The Independent Restaurant Coalition conducted a poll by Compass Lexecon, a Chicago-based consulting firm. The report predicts a grim future for roughly 500,000 (of 660,000) Main Street restaurants unless a more robust financial assistance program is established.

That's potentially 85% of independent food establishments, gone forever.

I am told by a member of the National Restaurant Association that, as things stand, some 30% to 40% of restaurants will likely close by year-end without further aid.

Yelp is a surprisingly good source for information on business closings. Some 55% of businesses that are listed as closed on Yelp have been closed for good.


Image credit: MarketWatch


It's not just restaurants…

Half of hotel rooms in the US are empty as of six days ago. They need at least 80% occupancy to break even. Some 70% of hotels in India are expected to close.

Hotels that depend on tourism? Toast. Airlines? The list goes on and on.

And it's not just the US…

Other countries around the world are having their own problems. Liz Ann Sonders gives us this graph:


Be sure to follow me on Twitter (@johnfmauldin) so that you can see my research, analysis, and retweets of important charts like these in real time.

Emerging markets and frontier markets are having their own even worse crises brought on by COVID-19.

The Eight-Body Problem

If you have three large objects that have gravitational impact on each other, you can determine where they have been in the past. However, you cannot predict where they will be in the future. At least, not without great difficulty.

In physics, this is called the three-body problem.

In economics, we are well beyond the three-body problem. I think it is more like an eight-body problem. See if you agree:

Body No. 1: The service economy has imploded. We don’t know when it is coming back. I am not going to argue the correctness of whether we should lock down or open up. I am simply talking about what is. And it appears that much of the economy is going to be locked down for some time. There is simply no telling when that part of the economy will normalize.

Body No. 2: We have seen the largest central bank intervention, not just in the US but in many parts of the world, ever in history. Clearly that is keeping markets up. Furthermore, governments are providing fiscal stimulus in an unprecedented manner. In essence, the government borrowed money to give people the money that they would’ve earned in their jobs. Interestingly, not all of it was spent. We have seen a record amount of disposable income being added to savings.

The US government is in a food fight over the next round of stimulus. Not that the purpose of this letter is to argue what is correct. Some amount will likely be determined. Your guess is as good as mine. But can we keep that up in 2021? How long? That is a major economic gravitational body, and we have no idea what it will look like this year, let alone next year and 2022.

Body No. 3: Federal Reserve policy and, to some extent, government policy has short-circuited both Schumpeter’s creative destruction cycle and moral hazard. We literally have no idea how that’s going to impact the future, but those are big deals. Companies with the lowest-rated junk bonds are refinancing their debt at lower rates. We are keeping zombie companies afloat. Is every company that accesses the market a zombie company? No, of course not. But many are.

Body No. 4: Global trade is beginning to implode. Like it or not, we truly live in a global economy. This is a global depression and it affects everyone. I was writing 20 years ago that the biggest threat to prosperity in the future would be protectionism and tariffs. I have made it clear that China is not a good actor, and we need to review our policies and our reliance upon them. But tariffs are just a bad idea, whether it’s China or Europe or whatever country. Can we say Smoot-Hawley?

Body No. 5: On average, six companies with assets larger than $50 million have filed for bankruptcy every week since April. This is going to increase and become a tsunami. Small local companies don’t even bother filing because it’s too expensive. Every one of them represents jobs.

This is the hard one…

Body No. 6: The working class will be last to see the recovery. Most of the jobs that are being lost are by the least-well-off in our society. They can’t work from home. Those with children have to figure out how to take care of them in case schools don’t open… or if they don't want to send them back. Unemployment insurance won’t cover the bills when the federal money runs out.

This represents tens of millions of workers. Unemployment is not going to bounce back miraculously in the first quarter of next year. It is going to be a long, slow climb.

Now for some good news…

Body No. 7: Entrepreneurs will re-emerge, and new ones will seize this moment to shine. All those businesses going bankrupt or out of business? They are run by entrepreneurs who have the entrepreneurial bug. It is part of their DNA.

I was talking to a Dallas restauranteur who is “down” to three restaurants. He is stretching his cash and hoping for another round of PPP. He will breathe easier when he can get his normally booming restaurants up to 50% occupancy.

Depressed? Not at all. He believes this will all eventually normalize, and he will have the greatest opportunity he has ever had. He can see 10 restaurants in his future. This is the kind of vision that accelerates recoveries.

He and hundreds of thousands of other entrepreneurs throughout the country and the world look for opportunity. It’s just what they do They can’t help themselves.

It will take time, and they have to figure out where the capital will come from. But I am convinced that entrepreneurs will be the ones to dig us out from this, not governments.

Body No. 8: We are in the midst of The Greatest Transformation in history. Elon Musk just launched and landed a massive rocket as a test. That is just a very visible example of tens of thousands of new technological revolutions happening all around us.

These disruptive technologies will truly change the world. I can’t even begin to describe what is happening in the biotechnology and aging space. Artificial intelligence, robotics, self-driving cars, incredible advances in agriculture, shipping, quantum computers… you name it The list is just too long. And it's growing.

We are about to witness history-making advancements… potentially in record-breaking time.

What the Recovery Looks Like

I frankly think it is misleading to draw a graph and say this is what the economic recovery will look like.

Talk about a V- or U-shaped recovery is simply silly. Every one of the “bodies” I mentioned above will have a significant recovery impact. We don’t know how they will interact.

My guess is that we are going to see several different economies. Heather Long (a fellow Camp Kotok regular) illustrates this for The Washington Post.

This dichotomy is evident in many facets of the economy, especially in employment. Jobs are fully back for the highest wage earners, but fewer than half the jobs lost this spring have returned for those making less than $20 an hour, according to a new labor data analysis by John Friedman, an economics professor at Brown University and co-director of Opportunity Insights.


If we have to choose a letter for the economic recovery, maybe it should be a “K.” Some go up and others go down.

I have two more charts for you today. The first is what I call Economy Part 1. This graph goes back to 2000, and the red lines roughly show the trajectory of the recovery. The St. Louis Federal Reserve database has not updated the second quarter, but I tried to represent it.

For a large part of the economy—maybe the largest part—recovery is going to be slower than that of The Great Recession. And it is going to be lumpy. Notice that I have a recovery with a lower slope.

That is in part because of the research by Dr. Lacy Hunt and others demonstrating that growth is slower in high-debt economies. Just a fact

Note that we do recover; it just takes longer for this portion of the economy.



Then we come to Economy Part 2. Faster recovery and the slope of the recovery is higher. More like what I call the Stumble-Through Economy.

It still doesn’t look like the recoveries of the past, but perfectly acceptable given the problems.



On this second chart, I want you to look at the yellow line I call the Disruptors. These are the companies that are truly changing the world and their growth is, well, through the roof.

I think by now most investors are well aware of the FAANG or FAAMG stocks, or whatever acronym we use. I am not including them in my thought experiment version of Disruptors. I mean, they are, but they have been around for a while.

Rather, I’m talking about the new companies that will not replace them, but will join them in the pantheon. (Though some of them may get replaced. Don’t ask me which ones.)

Some of the Consequences of a Three-

Part Economy

Whether it's K-shaped or some other to-be-determined letter, there are three economic takeaways:

1. This is going to change the way we live. We have already seen savings increase, not unlike our parents and grandparents during the Great Depression. It is going to change spending and saving habits. It is going to force businesses and entrepreneurs to adjust in ways that they never dreamed they would need to.

I think it is fair to say that many of us have looked at our lives and decided we don’t need quite as much “stuff” as we did before. We are not going to hunker down in caves, but we may pack them with less paraphernalia.

Each one of those choices represents a buying decision that impacts some entrepreneur who provided that product.

This crisis is simply the greatest demand destruction of our lifetimes. It will come back, but it is not going to come back to what it looked like in 2019.
 
Our future economic buying decisions are going to be different.

Everything, I mean everything, is going to be repriced and thought through. You can’t take anything for granted. Inflation numbers and measures are going to be warped for at least a few years. We are using old tools to measure a new economy. We are going to have to develop new models to appropriately analyze the world we now live in.

How do we value the price of a home or apartment? I don’t think it is unreasonable to expect 10% unemployment, or something close to it, in the middle of 2021. That is going to affect prices up and down the housing value chain.

How do you value retail and office space? If your tenants are gone, do you pay the mortgage? Hotels will come back, eventually, but who is going to own them? The old private-equity owners or the new ones? At what price? We already knew we had too many retail stores. What is the correct number in the future? How will malls and commercial space be repurposed?

Hundreds, if not thousands of planes are sitting on the tarmac. Who is going to own them?

There are thousands of scenarios playing out in thousands of industries all over the world. What they have in common is that…

Everything is going to be repriced.

That makes me very uncomfortable.

 2. Inequality is not going to get better. Thought experiment: It is more than probable we will see some form of universal basic income in the future. It will not solve the inequalities of either income or wealth, but it will still be tried.

Those individuals who were part of the devastated service economy will still struggle for jobs, and they are in the lower income group already. The second part of the economy will be growing and pulling away from that first part.

And that doesn’t even begin to describe what happens to the disruptors.

Just for the record, in this letter and on op-ed pages in various publications, I outlined a methodology for increasing taxes while actually improving the ability to create new businesses and to help those in the lower echelons of income.

I am not a priori against higher total revenue for the government. It’s all about how we collect it. Social justice as our driving mechanism for tax policy is not going to improve the comity in our country. 
3. We have two major cycles coming into play at the same time in this decade. One I have written about on numerous occasions: The End of the Fourth Turning. It is always a time of great social unrest, and we are just at the beginning of the end. I expect the period between the middle of this decade and the end to be far more disruptive than where we are today.


In it, he discusses two separate cycles in American history, an 80-year cycle and a 50-year cycle. Both are disruptive. For the first time, they coincide in the latter part of this decade.

He predicts that the 2020s will bring dramatic upheaval and reshaping of government, foreign policy, economics, and culture.

A two-part/three-part economy, where the outcomes for significant portions of the population are dramatically different, is a recipe for the types of crises both of their books outline.

And just so I can pile on, just as we are in the middle of their crises, we get to experience The Great Reset. It is a toss-up whether we will have a $30 trillion national debt by New Year’s Day. We will be at $40 trillion by 2025. Plus massive corporate debt, multiple pension crises that will boggle the mind.

All of the debt MUST be "rationalized." We have absolutely no idea how, because we don’t know who will be in charge or what the crisis will look like.

All while disruptive technologies are changing the very foundations of our society and job.

Various people will read this letter and have different reactions.

I hope most of you come away with the idea that you want to find out who the disruptors will be and how you can participate, rather than hunkering down.

I am a believer in the entrepreneurial free market society, and I believe that is what will ultimately bring us into that period that George Friedman calls "The Calm" after the upheaval of the '20s.

I am excited about the future. I truly think we are on the cusp of actually reversing aging in our lifetimes, if not this decade. And that's just one of many other wonderful things.

As my dad would say, don’t let the bastards—the crisis around you—get you down.

Look for the opportunity. There’s a pony in there somewhere.

On the Road Again: Montana

This Monday, I will wake up at 4:45 am (ugh) and get on my first plane for five months, eventually landing in Missoula, Montana, where I will meet Shane coming from California. We will stay at my friend Darrell Cain’s home on Flathead Lake for four days.

I have no other flights planned for this year. It was only three years ago that I traveled 250,000 miles in one year. I regularly notched 200,000-mile years. American says I have 8 million miles.

I don’t miss airports, but I do miss travel. I miss going to New York and putting together dinners with brilliant people. Actually, I miss going anywhere and doing that. And my family. I find I spend more time on the phone and I’m starting to Zoom because I just miss my friends. And my gym.

This letter could have easily been 10,000 words. Maybe even a book. My partners tell me to keep it at 3,000 words. But I tried to hit the highlights of how I think.

New technologies allow us to amalgamate a wide variety of offerings into one framework. It is really rather cool to see it come together.

And with that, I will hit the send button. Have a great week and join me in calling more friends!

Your looking for opportunities in the midst of change analyst,



John Mauldin
Co-Founder, Mauldin Economics

Tourism’s collapse could trigger next stage of the crisis

The economic impact will stretch well beyond the travel industry

Rana Foroohar


© Matt Kenyon


Last summer around this time, I did an interview with Ulf Lindahl, the chief executive of currency manager AG Bisset. At the time there was growing concern that the unwinding of the unprecedented corporate debt bubble created over the past decade could cause a sharp economic downturn.

He put forth a novel idea — that global tourism might be at the centre of the storm when it struck. “Everyone goes on vacation”, he said, “but it’s also the thing that you can cut back on quickly — unlike your car or your phone.”

If people did stop travelling because of some unforeseen economic shock, he posited, the effects would ricochet through nearly every industry and business, from manufacturing to real estate, restaurants, luxury goods, financial services — you name it. All this would risk setting off a raft of corporate insolvencies, high unemployment and a sharp downturn.

While many might have agreed with his thesis, nobody could have predicted the Covid-19 pandemic. Now the coronavirus-related collapse in world tourism, which represents more than 10 per cent of global economic output, according to the World Travel and Tourism Council, may well trigger the next stage of this crisis, in which we move from a public health emergency and mass unemployment to widespread insolvencies in myriad industries.

Countries such as Italy, Mexico and Spain, which have some of the highest levels of tourism as a proportion of gross domestic product, will be hardest hit by the fact that few people are travelling across borders this summer. However, the US, which has just posted the sharpest postwar contraction in second quarter, will probably be at the centre of the broader economic storm.

Congress cannot agree on the next stimulus package, and viral cases are surging. Nearly 17m American jobs are at risk as a result of the tourism downturn alone. Countless companies may be threatened, too. Even with billions of dollars in government aid programmes, US commercial bankruptcies were up 43 per cent in June compared with the same month of 2019. It is hard to imagine what will happen when the bailouts stop coming.

At the top of this hierarchy of pain are companies such as Boeing and Airbus. With global airline traffic forecast to fall 60 per cent this year, the two major aircraft manufacturers are facing a flood of order cancellations just as trade tensions between Europe and the US are flaring up. This, of course, adds fuel to wider US-EU trade disputes in areas from aircraft subsidies to digital taxation. It also puts pressure on manufacturing supply chains around the world.

The fact that people are not travelling — not even as far as the office — affects real estate, too.

The value of global real estate is greater than that of stocks and bonds combined. According to Green Street Advisors, the unleveraged value of commercial real estate in the US is down by 11 per cent since the outbreak of the pandemic.

Transaction volumes in the second quarter of the year dropped by 68 per cent, the lowest level since the post-2008 financial crisis. There was distress across every property type, in every part of the country. Given that most Americans hold the majority of their wealth in real estate, that will hurt consumption.

It will also hit public sector spending. Real estate is the largest portion of the tax base in New York and other cities. Neighbourhoods where expensive office towers sit empty have a spooky, deserted atmosphere. Big tech firms such as Google, among the top real estate spenders in many big US cities, are not sending workers back until next summer.

Some surveys estimate that 40 per cent of US tenants are at risk of eviction if stimulus cheques stop. The collapse in the housing market will affect city budgets and services, quite possibly creating a 1970s-style snowball effect where wealth moves out, further degrading the tax base.

The travel crisis is also affecting the sharing economy. Brian Chesky, Airbnb’s chief executive, who laid off 25 per cent of his workforce in May, says mass cross-border travel may never return to its pre-pandemic levels. This means fewer purchases of luxury goods and expensive overseas educations.

It will provide a further blow to restaurants that are already struggling to stay open at the half-capacity required for social distancing. In the US, the decline in manufacturing jobs over the past two decades was matched by a rise in food service employment, but that increase has now gone into sharp reverse.

As AG Bisset put it in a June research note, the collapse in mass tourism and the potential reverberations from it recall the 1928 collapse in grain prices that ultimately helped to trigger the 1929 market crash and the Depression. Back then, a bubble in wheat subsidised by easy credit led to overproduction and sharply falling prices, which ricocheted throughout the rest of the economy and eventually triggered an equity sell-off as investors saw the dominoes falling.

Many people are still finding a way to take a summer holiday, usually within driving distance. But globe-trotting as we once knew it is unlikely to restart any time soon. What we are seeing is the demise of an industry that has supported many other sectors.

I suspect that once vacation season has come and gone, particularly if the US fails to provide more stimulus money, we will see ramifications that stretch far beyond the travel and tourism business itself.

The absent student

Covid-19 will be painful for universities, but also bring change

They need to rethink how and what they teach



In the normal run of things, late summer sees airports in the emerging world fill with nervous 18-year-olds, jetting off to begin a new life in the rich world’s universities. The annual trek of more than 5m students is a triumph of globalisation.

Students see the world; universities get a fresh batch of high-paying customers. Yet with flights grounded and borders closed, this migration is about to become the pandemic’s latest victim.

For students, covid-19 is making life difficult. Many must choose between inconveniently timed seminars streamed into their parents’ living rooms and inconveniently deferring their studies until life is more normal. For universities, it is disastrous. They will not only lose huge chunks of revenue from foreign students but, because campus life spreads infection, they will have to transform the way they operate (see Briefing).

Yet the disaster may have an upside. For many years government subsidies and booming demand have allowed universities to resist changes that could benefit both students and society.

They may not be able to do so for much longer.

Higher education has been thriving. Since 1995, as the notion spread from the rich world to the emerging one that a degree from a good institution was essential, the number of young people enrolling in higher education rose from 16% of the relevant age group to 38%. The results have been visible on swanky campuses throughout the Anglosphere, whose better universities have been the principal beneficiaries of the emerging world’s aspirations.

Yet troubles are piling up. China has been a source of high-paying foreign students for Western universities, but relations between the West and China are souring. Students with ties to the army are to be banned from America.

Governments have been turning against universities, too. In an age when politics divides along educational lines, universities struggle to persuade some politicians of their merit. President Donald Trump attacks them for “Radical Left Indoctrination, not Education”. Some 59% of Republican voters have a negative view of colleges; just 18% of Democrats do.

In Britain universities’ noisy opposition to Brexit has not helped. Given that the state pays for between a quarter and a half of tertiary education in America, Australia and Britain, through student loans and grants, the government’s enthusiasm matters.

Scepticism among politicians is not born only of spite. Governments invest in higher education to boost productivity by increasing human capital. But even as universities have boomed, productivity growth in the rich-country economies has fallen. Many politicians suspect that universities are not teaching the right subjects, and are producing more graduates than labour markets need. Small wonder that the state is beginning to pull back.

In America government spending on universities has been flat in recent years; in Australia, even as the price of humanities degrees doubles, so it will fall for subjects the government deems good for growth.

There are questions about the benefits to students, too. The graduate premium is healthy enough, on average, for a degree to be financially worthwhile, but not for everybody. In Britain the Institute for Fiscal Studies (IFS) has calculated that a fifth of graduates would be better off if they had never gone to university. In America four in ten students still do not graduate six years after starting their degree—and, for those who do, the wage premium is shrinking.

Across the world as a whole, student enrolment continues to grow, but in America it declined by 8% in 2010-18.

Then came covid-19. Although recessions tend to boost demand for higher education, as poor job prospects spur people to seek qualifications, revenues may nevertheless fall. Government rules will combine with student nerves to keep numbers down. Last month the Trump administration said new foreign students would not be allowed to enter the country if their classes had moved online.

Sydney, Melbourne, unsw and Monash, four of Australia’s leading universities, rely on foreign students for a third of their income. The ifs expects losses at English universities to amount to over a quarter of one year’s revenues.

The damage from covid-19 means that, in the short term at least, universities will be more dependent on governments than ever. The ifs reckons that 13 universities in Britain risk going bust. Governments ought to help colleges, but should favour institutions that provide good teaching and research or benefit their community. Those that satisfy none of those criteria should be allowed to go to the wall.

Those that survive must learn from the pandemic. Until now most of them, especially the ones at the top of the market, have resisted putting undergraduate courses online. That is not because remote teaching is necessarily bad—a third of graduate students were studying fully online last year—but because a three- or four-year degree on campus was universities’ and students’ idea of what an undergraduate education should look like. Demand for the services of universities was so intense that they had no need to change.

Now change is being forced upon them. The College Crisis Initiative at Davidson College says that less than a quarter of American universities are likely to teach mostly or wholly in person next term. If that persists, it will reduce the demand.

Many students buy the university experience not just to boost their earning capacity, but also to get away from their parents, make friends and find partners. But it should also cut costs, by giving students the option of living at home while studying.

Back to the mortarboard

Covid-19 is catalysing innovation, too. The Big Ten Academic Alliance, a group of midwestern universities, is offering many of its 600,000 students the opportunity to take online courses at other universities in the group.

There is huge scope for using digital technology to improve education. Poor in-person lectures could be replaced by online ones from the best in the world, freeing up time for the small-group teaching which students value most.

Universities are rightly proud of their centuries-old traditions, but their ancient pedigrees have too often been used as an excuse for resisting change. If covid-19 shakes them out of their complacency, some good may yet come from this disaster.

Fed policy could leave retirees broke after crisis

A 5% yield on a $1m nest egg delivers $50,000 a year but the egg must be five times bigger to produce that at 1%

John Dizard


President Trump’s proposal for a payroll tax cut and the Fed’s path in the fixed income market are defunding Americans’ retirement income © Andrew Hamik/AP


During the shambolic negotiations between Congress and the White House, one of US president Donald Trump’s proposals was to suspend the payroll tax funding social security for several months, ie long enough to buy some popularity before the elections. That was rejected by the Democrats for not covering the unemployed and for reducing the dedicated funding for the national pension system.

At the same time, there is a cross-party consensus that the Federal Reserve should not raise policy interest rates, and to continue open-ended funding of what will be an even larger federal deficit.

But Trump’s unloved (and cynical) proposal for a payroll tax cut, and the Fed’s path in the fixed income market are really the same thing: defunding Americans’ retirement income.

At the present trajectory of Fed policy, the 10-year bond will be close to yielding zero per cent by election day in November. The Fed will be trying to defend the “zero lower bound”, a set of points on a yield curve just above negative interest rates, for short-term funding. But by the time the 10-year rate gets within 10 or 20 basis points of the ZLB, the curve is telling you that there is no reward for saving money for the long term.

At that point, which by simple extrapolation comes in three months or so, fixed income investors will frantically chase yield from anywhere available. That is already happening.

Reported defaults and filings are far behind the reality

The Bank of America/ICE CCC index of yields on bonds one step away from default has rallied from 19.03 per cent on March 23 to 12.55 per cent on August 3. At the same time, actual defaults are rising fast. According to Fitch, 5.5 per cent of junk bonds defaulted in the year up to the end of July.

By the end of next year, the defaults will accumulate to higher than the yield on CCC junk. The courts are so backed up by covid-related closings and slowed procedures that reported defaults and filings are far behind the reality. So extreme yield chasing will end badly.

This is about desperation, not high spirits.

David Rosenberg of Rosenberg Research in Toronto says: “As the boomers head into retirement age, what do they need? Income. What has this Fed strategy done? It has stripped the markets of income and forced investors into growth stocks. Those are long duration stocks. Retirees don’t need duration. They need cash flow.”

For the moment, the capital gains in US pension and retirement accounts created by yield chasing have masked the shortage of cash flow signalled by the curve flattening. But the impoverishing of retirees will take on a new form as currency debasement whittles away the purchasing power of the tiny yields they have bought. Or so the gold price says.

Jim Grant, editor of Grant's Interest Rate Observer, gives some thought to the particular sort of inflation experienced by the near-retiree: “I wonder if our monetary masters realise that they have created a rip-roaring inflation in the cost of retirement. The lower the interest rate, the greater the principal required. At a 5 per cent yield, a $1m nest egg delivered $50,000 a year. You need a fivefold larger egg to produce that at 1 per cent.

The public pension fund beneficiary who may or may not be aware of how precarious his future has become, can look forward to higher taxes, as the actuaries and portfolio managers plead for new capital infusions from the rate payers. All in all, one must wonder just how stimulating is monetary stimulus.”

The Social Security System looks as though it has a sounder actuarial basis than private pensions and retirement savings. The (financially positive) effects of early deaths are, however, more than offset by declines in tax revenues from employed workers. Social security will need some combination of increased taxes and decreased benefits by 2034, about a year earlier than previous projections.

To my way of thinking, the worst news for all retirement prospects is the continuing decline in the US total fertility rate, ie the number of children an American woman is likely to have in her lifetime. That has continued to fall since 2008, and is now at an all-time low of 1.75. Anything lower than 2.1 means the population is not replacing itself.

Those are the workers who will not available to produce the tax revenues or corporate cash flow needed to pay for future retirees. So you have to keep working, if you can.

Recovering from the EU’s Recovery Fund

Amid the celebrations following European leaders' deal on a €750 billion recovery fund, many seem to have forgotten that both the European Union and the eurozone remain under constant threat of sovereign-debt crises. Until that fundamental weakness is addressed, the champagne corks should stay in their bottles.

Willem H. Buiter

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NEW YORK – After arduous negotiations between member states’ governments last month, European Union leaders are celebrating their agreement on a €750 billion ($886 billion) rescue package for EU countries hit hard by the COVID-19 crisis. But it is too soon to pop open the champagne. The plan for the “Next Generation EU” recovery fund has two major weaknesses that will make it not only ineffective but also a threat to the eurozone’s very existence.

From Latin America’s lost decade in the 1980s to the more recent Greek crisis, there are plenty of painful reminders of what happens when countries cannot service their debts. A global debt crisis today would likely push millions of people into unemployment and fuel instability and violence around the world.

In addition to being too small, Next Generation EU lacks essential conditionalities for fiscal sustainability, including an orderly sovereign-debt restructuring mechanism (SDRM). The recovery fund’s €390 billion grant component is a mere 2.8% of the EU27’s 2019 GDP. And even if one counts the €360 billion loan component and the €100 billion in lending through the Support to mitigate Unemployment Risks in an Emergency (SURE) program, the total still reaches a mere 6.1% of GDP.

Worse, even though fiscally challenged national governments need financial support immediately, the recovery fund will not make funds available to member states until 2021, at which point the €750 billion allotment will be expected to last for three years. (The relatively insignificant SURE program is already operational.) Nor can European governments expect much help from the 2021-2027 EU budget, which amounts to no more than 1.1% of annual EU GDP, and is not meant to provide additional funding for the COVID-19 crisis.

To be sure, Next Generation EU could be significant from a longer-run perspective if it were to establish a precedent for either regular intergovernmental fiscal redistribution programs or (preferably) a supranational fiscal facility within the EU. A new joint facility that could borrow, spend, and tax according to clear rules and with proper accountability to the European Council and the European Parliament would represent a significant step forward. But that outcome is extremely unlikely. After all, the EU has made loans to member states outside the eurozone since 2002 under the balance of payments assistance facility, and even that did not spur the development of the EU’s fiscal capacity.

When it comes to cross-border fiscal and financial assistance, there is significant distance between the positions held by the “frugal four” (Austria, Denmark, the Netherlands, and Sweden) and the governments of southern EU countries like Italy, Portugal, and Spain. As such, it is extremely unlikely that Next Generation EU will lead to a meaningful fiscal union. Moreover, the European Council has made clear that the fund is “an exceptional response” to “temporary but extreme circumstances,” and that the European Commission’s borrowing power remains “clearly limited in size, duration, and scope.”

The absence of a meaningful EU or even eurozone-wide fiscal facility will leave both groupings (especially the eurozone) at constant risk of national sovereign-debt defaults, owing to the lack of national monetary-policy instruments. In fact, in the eurozone’s case, the logic of Modern Monetary Theory applies.

When a country’s debt is denominated in its own currency, and when there is a national central bank that is ultimately subservient to the national fiscal authority, sovereign default is a choice, not a necessity. But eurozone member states cannot rely on a national central bank stepping in to monetize national public debts. Because their public debt is effectively denominated in a foreign currency, sovereign defaults can occur as a matter of necessity.

With the debt burdens of fiscally challenged member states rising steadily, this is not some distant or marginal concern. It is absolutely crucial that the grants and loans allocated by Next Generation EU be made conditional on fiscal sustainability; apparently, however, they won’t be.

On a more positive note, the fiscal rules of the Stability and Growth Pact (which did not offer any loans or grants) have been suspended. They should now be scrapped permanently, and replaced with fiscal sustainability conditions for any financing offered by a central EU fiscal authority.

But even the most ambitious European fiscal support mechanism that is politically feasible is unlikely to be sufficient to prevent further sovereign defaults, especially in the eurozone. To avoid another Greek-style debt crisis, the EU needs an orderly SDRM. The best way to achieve that is to turn the European Stability Mechanism into a European Monetary Fund (EMF), which should then be empowered to provide conditional financial support to distressed eurozone member states, consistent with a debt-sustainability analysis conducted by the EMF.

An EMF structured in this way should be able to manage any necessary sovereign-debt restructurings in an orderly manner. It could impose a standstill on debt service, and it could force minority creditors to accept a deal approved by a qualified majority. (Of course, collective-action clauses that cover only individual debt contracts would need to be transformed through comprehensive aggregation clauses.)

Any new debt issued by the EMF or EMF-sanctioned parties should be made senior to outstanding debt. To ensure that the EMF does not run out of liquid resources, it should have a credit line with the European Central Bank (guaranteed by eurozone member states). The size of the credit line could be decided by a qualified majority of eurozone governments, most likely through the Eurogroup of finance ministers.

With a much larger countercyclical recovery fund, proper conditionality to ensure fiscal sustainability, and an effective SDRM, there would be hope yet for the eurozone and the EU. Without these reforms, the threat of a breakup will always be present.


Willem H. Buiter, a former chief economist at Citigroup, is a visiting professor at Columbia University.