December 27, 2013
Part II: The Long-Term Outlook – Even a Strong Economy Doesn’t Change the Ultimate Outcome
Posted in business, debt, Economic Growth, Economy, Europe, Finance, Foreign, Inflation, investment advisor, investment banking, investments, Markets, National Deblt, Robert Barone at 4:46 PM by Robert Barone
If you’ve read Part I of this year end outlook, you know that it is our view that the underlying private sector is healthy and, except for the fact that the real rate of inflation is much faster than the ‘official’ rate, we could well have a short period of prosperity.
Unfortunately, our long-term outlook is not as sanguine as our short-term view. The eventual recognition of the inflation issue, the dollar’s role as the world’s reserve currency, the bloated Fed balance sheet and the resulting excess bank reserves, and the freight train of unfunded liabilities and its impact on the debt and deficit are issues that have large negative long-term consequences. Remember, the long-term unfolds slowly, and we don’t expect that we will wake up one day to find that all has changed. Still, the changes discussed below could very well take place over the next decade, and investors need to be prepared.
The Dollar as the Reserve Currency
The dollar is currently the world’s reserve currency. Most world trade takes place in dollars, even if no American entity is involved. Because world trade has rapidly expanded over the past 20 years, more dollars have been needed than those required for the U.S. economy alone. As a result, the U.S. has been able to run large deficits without any apparent significant impact on the dollar’s value relative to other major currencies. Any other country that runs a large deficit relative to their GDP suffers significant currency devaluation. Current policy in Japan is a prime example. A weakening dollar has implications for the prices of hard assets.
In addition, the Fed’s policy of Quantitative Easing (essentially money printing) has disrupted emerging market economies. Zero rates and money creation caused hedge fund managers to leverage at low rates and move large volumes of money offshore to emerging nations where interest rates were higher. The initial fear of “taper” in May and June caused huge and sudden capital outflows from those countries resulting in massive economic dislocation in those markets. In India, for example, the Rupee was pummeled as the hedge fund investors, fearing that interest rates were about to suddenly rise, all tried to unwind their Rupee investments at the same time. And now that ‘taper’ has officially started and longer-term rates are expected to rise, these issues will continue. Those countries have all taken defensive measures. India, for example, imposed taxes on gold imports, which has impacted the gold markets but has reduced India’s balance of payments deficit.
As a result of such tone deafness on the part of the Fed, and because there now appears to be enough dollars in the world for the current level of trade, the international appetite for U.S. dollars is clearly on the wane. Japan and China, the two largest holders of Treasury debt, have recently reduced purchases. Most emerging market nations and large players like Russia and China have vocally called for an alternative to the dollar as the world’s reserve currency. This movement is alive and well.
The Fed’s Balance Sheet
As the economy expands, the size of the Fed’s balance sheet and the level of excess bank reserves will become a problem. There are $2.3 trillion of bank reserves in excess of what are ‘required’ under the law and regulations. (Required reserves for the U.S. banking system are $.067 trillion; so, the system has 34x more reserves than it needs.) Under ‘normal’ conditions, and the way the system was designed to work, if the economy got too hot, the Fed could sell a small amount of securities out of its portfolio which would reduce bank reserves to the point where banks would have to ‘borrow’ from the Fed. Because bankers are hesitant to do that, and because the Fed could raise the ‘discount’ rate, the rate charged for the borrowings, the Fed could control new lending and thus the economic expansion. This isn’t possible today as the Fed would have to sell $2.2 trillion to cause banks to have to borrow. Such a volume of sales would likely cause a crisis in the financial system, or even collapse. Today, the only way the Fed has to stop the banks from lending is to pay them not to lend – this is exactly the opposite of the intent of the original legislation and the opposite of how the Fed has worked for most of its 100 year history.
Furthermore, given the growing lack of confidence in the dollar as the world’s reserve currency, if fiscal budget deficits grow in the future, the Fed may end up as the major lender (i.e., lender of last resort) for the U.S. Treasury. That simply means more money creation.
Unfunded Liabilities-
The U.S. Treasury officially recognizes $85 trillion as the amount of unfunded liabilities of the Federal Government. Other professionals set this number near $120 trillion. For comparison, the annual U.S. GDP is about $16 trillion. The budget deficit reported in the media is a cash flow deficit (tax collections minus expenditures). The budget deficit doesn’t include promises made for future payments (Medicare, Medicaid, Social Security, government pensions) which have been running between $4 and $5 trillion annually for the past few years. These amounts simply get added to the ‘unfunded’ liability number.
As the population ages, these payments will have to be made, and the budget may become overwhelmed. (You see the relevance of the remark made above about the Fed being the lender of last resort for the Treasury.) This is the heart of the debate about ‘entitlements’ that has been front and center for the past decade.
Solutions (none of which you will like)
Philipp Bagus is a fellow at the Ludwig von Mises Institute in Europe. He is well known in Europe for his work on financial issues there. In a recent paper, Bagus says that there are several possible ways out of the current money printing predicament. Any one or a combination is possible. We have put them in an order of most likely to least likely to be used:
- Inflation – this is the natural outcome of printing money;
- Financial Repression – this is current Fed policy; savers and retirees bear a disproportionately large burden as inflation eats at their principle but there is no safe way to earn a positive real rate of return;
- Pay Off Debt – this means much higher levels of taxation, and is definitely a real possibility. In Europe, the International Monetary Fund (IMF) has proposed a one-time 10% wealth tax. As the unfunded liabilities push up the federal deficit, expect such proposals in the U.S.;
- Bail-In – In ’08-’09 we saw ‘bail-outs’ where the government saved GM, Chrysler, AIG and the Too Big to Fail banks by buying stock or otherwise recapitalizing them. A ‘bail-in’ refers to the financial system. Banks and other depositories have liabilities called deposits. The depositors do not consider themselves ‘lenders.’ But, in a ‘bail-in,’ it is the depositors who lose. Their deposits are ‘converted’ to equity in the bank. When they try to sell their bank shares, they find that it will fetch only a fraction of the value of their deposits. A variant of this is what happened in Cyprus in the spring of 2013. Because of the distaste the public now has for ‘bail-outs,’ if there is another financial crisis, this is likely to be the method used;
- Default on Entitlements – when we talk about ‘entitlement reform’ in the U.S., we really mean at least a partial default. It is likely that some people simply won’t get what they were promised. We put this low on the list because we have witnessed a political process that won’t deal with the issue;
- Repudiate Debt – Because the government can simply print money to pay it debts, this is the least likely of all of the possibilities in the U.S.
The long-term issues are serious. And not addressing them simply means a higher level of pain when addressing them is required. Remember, these are long-term issues. They are all not likely to occur at the same time, nor will they simply appear overnight. The first signs of trouble will occur when markets begin to recognize that the ‘official’ inflation rate significantly understates reality, or that the inflation data become so overwhelming that they can no longer be masked. Even then, markets may come to tolerate higher inflation, as after 100 years of fighting inflation, the Fed and the world’s major central banks have embraced it as a good thing.
Meanwhile, as set forth in Part I of this paper, the immediate outlook for the economy is upbeat. Enjoy it while it lasts.
December 20, 2013
Robert Barone, Ph.D.
Joshua Barone
Andrea Knapp Nolan
Dustin Goldade
October 23, 2012
Borrow money? ‘No thanks,’ say consumers
Posted in debt, Economy, recession, Uncategorized tagged census bureau, consumer spending, mortgage rates, QE3, Robert Barone at 9:43 PM by Robert Barone
Borrow money? ‘No thanks,’ say consumers
- Three-quarters of Americans are not inclined to take on debt right now.
- The Federal Reserve announcement to keep rates low to 2015 may have dampened borrowing.
- Uncertainty is affecting consumer confidence, which impacts borrowing.
What affects consumer borrowing
No shortage of debt
So what do low interest rates do?
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521.
Ph: (775) 284-7778.
August 2, 2012
Equities: Is a bear market inevitable in this economy?
Posted in debt, Economic Growth, Economy, Europe, Finance, government, investment banking, investments, payroll tax reductions, recession, Stocks, Uncategorized, Unemployment tagged advisor, ancora west advisors, Banking, Bob Barone, confidence, consumer confidence, consumer debt, economic policy, Federal Reserve, Finance, financial adviser, fiscal cliff, nevada, Recession, reno, Robert Barone, taxpayer, unemployment at 7:40 PM by Robert Barone
All of the data and the trends in the data indicate that it is possible that a recession might already have begun.
• Job creation has been dismal in the second quarter, with little hope for improvement soon; jobless claims are, once again, on the rise.
• Retail sales have fallen three months in a row; this has never occurred without an ensuing recession. What is of greater concern is that this has occurred while gasoline prices have been falling.
• While market pundits have cheered small gains in housing data, it is clear that housing is still bottom bouncing. Changes in foreclosure laws have caused supply constraints that have made it appear that home prices are rising again.
• Industrial production, the one bright spot in the economy, showed a decline in May before recovering somewhat in June.
• The drought has caused raw food and commodity prices to spike. These will soon translate into higher food and raw input costs. (Is anyone now questioning the wisdom of the congressional mandate to produce increasing quantities of ethanol from corn instead of sugar?)
• Consumer confidence continues at levels below those seen in past recessions . Much of this is due to uncertainty surrounding fiscal policy and taxes.
• In the June Philadelphia Fed Survey, manufacturers were asked to list reasons for slowing production; 52 percent cited uncertain tax policy and government regulations.
• Real incomes are falling. The downward bias in the inflation numbers produced by the government inflates the reported GDP numbers. It has been my view that, as a result of the biased reporting, the recession never really ended, and real GDP is much lower than reported.
Equity market up for year
Nevertheless, despite all of the poor data, the equity markets have held up. At 1,338 (the closing level on July 25), the S&P 500 is still 6.4 percent higher than it was at the beginning of the year. This is strange, given that every other major market in the world is down 20 percent and in bear market territory. Here are a couple of possible explanations:
• The equity markets used to be a leading indicator of the economy. Severe market corrections (20 percent or more) usually meant recession was either imminent or already here. But, with the advent of computerized trading, the market now appears to be more of a coincident indicator. In late 2007, when the last recession began, the market was only off 5 percent from its October peak.
• Europe: There is such financial chaos in Europe that a flight to the dollar is continuing. Because higher quality bond yields are so low, some of the funds have found their way into the U.S. equity markets, thus keeping them buoyed.
Neither of these two reasons should give investors any confidence that U.S. markets can hold up. Besides the poor internal economic data within the U.S., worldwide data have been weak. In addition to the obvious problems in Europe, China is in a much slower growth mode, as is Japan, the rest of Asia, and even the commodity producers like Australia and Canada.
orderly plan for countries to exit the monetary union than to deny that the union isn’t in any danger of falling apart.
Solvable “fiscal cliff”
Finally, the approaching “fiscal cliff” in the U.S. is another wild card that could have a significant impact on capital markets. The good thing about the “fiscal cliff” is that it isn’t an outside force being imposed. The cliff is avoidable and completely under the control of Congress and the president.
With all of this going on, is a bear market inevitable? While I think that the confluence of events (worldwide economic slowdown, slowdown in the U.S., European financial chaos, “fiscal cliff”) make it likely, as I indicated in my last column, the application of “business friendly” policies could prevent it.
Until visibility into policy becomes clearer, investors should continue to be extremely cautious. They should remain liquid.
Finally, the U.S. economy is so fragile that any external shock, like a financial implosion in Europe, is certain to have negative impacts on U.S. markets. Policy responses to economic slowdown or financial chaos (e.g., printing of money by the European Central Bank or QE3 by the Fed) are likely to have a positive impact on the value of precious metals and commodities. And the ongoing drought will definitely move food and commodity prices upward.
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.
July 23, 2012
Time for us to make enlightened policies
Posted in Armageddon, Bankruptcy, debt, Economic Growth, Economy, Europe, Finance, Foreign, recession, Spain, Uncategorized, Unemployment tagged adviser, advisor, ancora west, ancora west advisors, bank balance sheet, Bob Barone, consumer debt, economics, Finance, financial adviser, Inflation/Deflation, nevada, reno, Robert Barone, unemployment at 8:10 PM by Robert Barone
• Taxes: Uncertainty surrounding tax policy causes the private sector to take less risk, which lowers investment and job creation. For the last several years, Congress has signaled that significant tax increases are just ahead (currently referred to as the “fiscal cliff” due to occur on Jan. 1, 2013), only to push them back at the last minute for another short period. Nevertheless, the uncertainty persists, and economic hesitancy pervades.
• Corporate tax rate: Having one of the highest corporate tax rates in the world discourages investment at home and makes investment elsewhere more fruitful. Corporate taxes are paid by consumers via higher prices.
• Energy policy: Cheap energy is the No. 1 requirement for robust economic growth. Current policies appear to be designed to raise energy prices to spur the development of government selected industries. The result is great waste (e.g. Solyndra) and significantly reduced economic growth.
• Taxmageddon: The U.S. has a joke for a tax code. Talk about a Rube Goldberg! High, and threatened increased taxes on capital and investment just discourage economic growth. The tax code needs to be thrown out in favor of a broad-based, simple, and fair system.
• The financial system: Scandal after scandal show how pervasive lawlessness is among the world’s “too big to fail” institutions. So far, no U.S. banker has gone to jail, nor trial, nor has anyone been indicted. Regulatory policy encourages moral hazard (excessive risk taking backed by implicit taxpayer bailouts) and discourages lending to the private sector. All of this reduces economic growth.
Investing in a deleveraging world
2) Policymakers must identify those businesses that would benefit from such a philosophy. There might be several categories that would so benefit, but one immediately comes to mind (maybe because I have worked in it all my life) — financial and intangible asset firms. This category includes managers of investments, hedge funds, trusts, patents and trademarks, insurance companies and services, banking and subsidiary finance companies. While these firms are usually small, their salary levels generally are high. A University of Nevada, Reno study indicates that salaries in these firms average $88,000, twice the state’s average.
Jon Ralston, a political columnist and host of a daily political commentary show seen locally, recently criticized the Apple move, saying that they will grow “astronomical profits” but that the state won’t benefit much because the number of jobs is small. But its move, along with those of Microsoft (which now employs several hundred), Intuit (also a large employer), Oracle and others, appears to recognize that Nevada, indeed, has something to offer now. If the state attracts enough of these companies, there will be plenty of tax revenue generated. The state should play to its current strengths and make sure its policies protect and nurture those strengths.
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.
July 9, 2012
Economic issues, good and bad
Posted in Banking, Big Banks, debt, Economic Growth, Economy, Europe, Federal Reserve, Finance, government, greece, Housing Market, International Swaps and Derivatives, investment advisor, investment banking, investments, Italy, recession, sovereign debt, Spain, taxes, Unemployment tagged advisor, ancora west, ancora west advisors, Banking, Ben Bernanke, Bob Barone, consumer debt, consumption, Debt, devaluing US dollar, economic policy, economics, fair value, Federal Reserve, Finance, financial adviser, Inflation/Deflation, nevada, Obama, Recession, Robert Barone, small business, taxpayer, too big to fail, U.S. Treasury, unemployment at 3:17 PM by Robert Barone
Positives
• Corporate health (economics): Large corporations are extremely healthy with large cash hoards and many have low cost and low levels of debt.
• Politics (policy): Americans are tired of special interests’ ability to pay for political favors.
• European Monetary Union (policy): A Greek exit from the euro is still probable after recent election and is likely to spread contagion to Portugal, Spain and even Italy. There is also danger here to America’s financial system.
• Brazil, Russia, India, China or the BRIC, Growth Rate (economics): China appears to be in danger of a hard landing, as is Brazil. India is already there. This has serious implications for commodity producers like Canada and Australia.
• Fiscal cliff and policy uncertainties (policy): A significant shock will occur to the U.S. economy if tax policy (Bush tax cut expiration and reinstatement of the 2 percent payroll tax) isn’t changed by Jan. 1, 2013.
• Housing (economic & policy): In the U.S., housing appears to have found a bottom, but because of falling prices and underwater homeowners, a significant recovery is still years away. Housing is a huge issue in Europe, especially Spain, and it will emerge as an issue in Australia and Canada if China has a hard landing.
• Energy costs (economics & policy): The current high cost of energy is killing worldwide growth (see “Positives” above).
• U.S. taxmageddon (policy): The U.S. tax system discourages savings and investment (needed for growth), encourages debt and favors specific groups.
• Too Big To Fail (TBTF) (policy): The U.S. financial system is dominated by TBTF institutions that use implicit government backing to take unwarranted risk; TBTF has now been institutionalized by the Dodd-Frank legislation; small institutions that lend to small businesses are overregulated and are disappearing.
• Debt overhang (economics): The federal government, some states and localities and many consumers have too much debt; the de-leveraging that must occur stunts economic growth.
• Inflation (economics & policy): Real inflation is much higher than officially reported. If a true inflation index were used, it is likely that the data would show that the recession still hasn’t ended.
It is clear from the points above and from the latest data reports that worldwide, most major economies are slowing. It is unusual to have them all slowing at the same time and thus, the odds of a worldwide recession are quite high.
In the context of such an event or events, the U.S. will likely fare better than most. But that doesn’t mean good times, just better than its peers. There is also greater potential of destabilizing events (oil and Iran, contagion from Europe, Middle East unrest), which may have negative economic impacts worldwide. Thus, in the short-term it appears that the U.S. economy will continue its lackluster performance with a significant probability of an official recession and vulnerable to shock type events. (Both the fixed income and the equity markets seem to be signaling this.)
Looking back at my blogs over the years, I have always been early in identifying trends. The positive trends are compelling despite the fact that the country must deal with huge short-term issues that will, no doubt, cause economic dislocation.
The only question is when the positives will become dominant economic forces, and that is clearly dependent on when enabling policies are adopted. 1) In the political arena, there is a growing restlessness by America’s taxpayers over Too Big To Fail and political practices where money and lobbyists influence policy and law (e.g., the Taxmageddon code). 2) The large cap corporate sector is healthier now than at any time in modern history. Resources for economic growth and expansion are readily available. Only a catalyst is needed. 3) America is on the “comeback” trail in manufacturing. Over the last decade, Asia’s wages have caught up.
Cultural differences and expensive shipping costs are making it more profitable and more manageable to manufacture at home. 4) Finally, and most important of all, unlike the last 40 years, because of new technology, the U.S. has now identified an abundance of cheaply retrievable energy resources within its own borders. As a result, just a few policy changes could unleash a new era of robust economic growth in the U.S. Let’s hope those changes occur sooner rather than later!
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.
The New Bank Paradigm: Squeezing Out the Private Sector
Posted in Banking, Big Banks, debt, Economic Growth, Economy, Europe, greece, Italy, Spain, Uncategorized tagged adviser, advisor, ancora, ancora west, ancora west advisors, bank balance sheet, Banking, Bob Barone, consumer debt, consumption, economic policy, Federal Reserve, Finance, financial adviser, MF Global, Obama, Robert Barone, U.S. Treasury at 3:08 PM by Robert Barone
One of the reasons for all of the stress in Europe is the fact that their banking system holds huge amounts of periphery country debt (Greece, Spain, Portugal, Italy) with no capital backing. On a mark to market basis, most, if not all, of the capital of the periphery banks disappears. In fact, the European Central bank (ECB) itself is still carrying the Greek debt it holds on its books at par, as if there is no chance that they won’t be repaid in full.
Since the financial crisis of ’08-’09, Western banking systems have come to rely on government, at first as the capital provider of last resort, but now, at least in Greece and Spain, as the capital provider of first resort (most likely because there is no other). In a symbiotic relationship, those same governments have come to rely on the banks to purchase their excessive supply of debt. The capital rules favor this unhealthy relationship. In effect, we now have a banking DNA bias against private sector lending.
We have heard the politicians in Washington rail against the banks for not making loans to the private sector. Yet, all of the rules, regulations, and enforcement processes make it difficult, if not impossible, to do just that. The overbearing regulatory process strangles private sector lending at small community banks. And, as indicated above, the capital regime itself, which impacts all banks, discourages private sector loans. For example, a $1 million loan to the private sector requires $200,000 in capital backing plus an additional $20,000 to $30,000 in loss reserve contribution from the capital base. That same $1 million loan to the US Treasury, via purchases of Treasury securities, requires no capital or reserve contribution. The ultimate result is that, since the financial crisis when western governments found out that it was politically okay to “save” (i.e. recapitalize) large banks with public monies, they also found out that the capital and regulatory regime now made those same banks major buyers of excessive government debt.
Unfortunately, while governments like this and will continue to promote it because it keeps the cost of borrowing low and provides them with a ready market for deficit spending, government is not the economic engine. That is what the private sector is. Simply put, the banking model in the west now promotes moral hazard (banks making bets that are implicitly backed by taxpayers) and Too Big To Fail (TBTF) policies while it stifles private sector lending. The Dodd-Frank legislation has institutionalized this model with government intervention now seen as the first response to a banking issue. If it hasn’t, then why did President Obama say on The View the business day after JPMorgan Chase (JPM) announced its trading loss that it was a good thing that JPMorgan had a lot of capital else the government would have had to “step in.” Or why has Jamie Dimon, JPMorgan’s CEO, been required to testify before both House and Senate Committees about a loss of less than 3% of the bank’s $190 billion capital base? As further proof of government control of the banking system, the FDIC recently announced that, under its Dodd-Frank mandate, it is ready to take over any TBTF institution, “when the next crisis occurs.” Isn’t it clear that the relationship between the US federal government and the banking system is unhealthy, perhaps even incestuous, to the detriment of the private sector? That very same banking model is emerging in Europe with the emergency funding by the European Financial Stability Fund (EFSF) to recapitalize the Spanish banks and talk of a pan-European regulatory authority and deposit insurance.
The emerging banking model is one in which central governments and the money center banks co-exist in a mutual admiration society where government capitalizes the banks and the banks are the primary buyers of excessive government debt. Because government doesn’t create any real economic value (it regulates it and transfers it from one group to another), the domination of government assets on bank balance sheets in place of private sector assets spells real trouble for the future economic growth in the Western economies.
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.
April 9, 2012
Financial armageddon: Should you worry?
Posted in Armageddon, Banking, crises, debt, Economic Growth, Economy, Finance, government, Housing Market, investment advisor, investment banking, investments, IRS, medicare/medicaid, Nevada, payroll tax reductions, recession, social security, taxes tagged advisor, ancora west, ancora west advisors, armageddon, Bob Barone, bush tax cut, consumer debt, devaluing US dollar, economics, Federal Reserve, Finance, financial adviser, fiscal cliff, payroll tax deductions, Recession, Robert Barone, taxpayer, usdebtclock.org at 8:37 PM by Robert Barone
Some analysts fret about the “fiscal cliff” on Jan. 1, 2013 when the Bush tax cuts are scheduled to expire along with the 2 percent payroll tax reduction for individual social security contributions.
Those analysts put the impact of these at a 3 to 4 percent GDP reduction. When the Bush tax cuts expire, the Federal government theoretically could collect about $300 billion more in taxes if economic activity were otherwise unchanged (a heroic assumption). In addition, the reinstatement of the 2 percent social security tax on individuals will add about $160 billion to tax revenues (again, assuming no decline). The breakout with this story is an estimate of what the deficit would be and its relationship to 2016 GDP. It assumes the Bush tax cuts have been eliminated, the payroll taxes are reinstated, and economic activity is not negatively impacted, so it is likely to understate the deficit. The tax revenue growth rates (left hand column) begin in 2013, after the “fiscal cliff.”
As you can see from the table, reinstatement of the Bush tax cuts and the payroll tax reductions alone do little to solve the issue, as the deficit remains at $1.54 trillion if no further tax increases occur.
OUR ‘FISCAL CLIFF’
If Tax CAGR is: | Deficit/GDP will be: | Deficit will be ($trills): |
0% | 9.1% | $1.54 |
5% | 6.6% | $1.12 |
7% | 5.5% | $0.93 |
8% | 4.9% | $0.83 |
10% | 3.7% | $0.63 |
16% | 0.0% | $0.00 |
Robert Barone and Joshua Barone are Principals and Investment Advisor Representatives of Universal Value Advisors, LLC, Reno, NV, an SEC Registered Investment Advisor. Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. Universal Value Advisors, LLC is a registered investment adviser with the Securities and Exchange Commission of the United States. A more detailed description of the company, its management and practices are contained in its “Firm Brochure”, (Form ADV, Part 2A). A copy of this Brochure may be received by contacting the company at: 9222 Prototype Drive, Reno, NV 89521, Phone (775) 284-7778. Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, an SEC Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778. |
March 26, 2012
Robert Barone: Is U.S. housing healing?
Posted in Banking, Big Banks, debt, Economic Growth, Economy, Finance, Foreclosure, government, Housing Market, investment advisor, investment banking, investments, Nevada, recession, Uncategorized tagged adviser, advisor, ancora west, ancora west advisors, Banking, Ben Bernanke, Bob Barone, consumer debt, economics, Federal Reserve, Finance, financial adviser, home sales, housing, Inflation/Deflation, nevada, Recession, Robert Barone, stimulus, U.S. Treasury at 5:15 PM by Robert Barone
March 13, 2012
Greece Default Declaration Stabilizes CDS Markets
Posted in Banking, Bankruptcy, Big Banks, Bonds, credit default swap, debt, derivatives, Economy, Europe, Finance, Foreign, government, International Swaps and Derivatives, investment advisor, investment banking, investments, ISDA, Nevada, sovereign debt tagged adviser, advisor, AIG, American International Group, ancora west, ancora west advisors, Banking, Bob Barone, cd, collective action clause, consumer debt, credit default swap, Debt, devaluing US dollar, economic policy, europe, Finance, financial adviser, Greece, greek bonds, International Swaps and Derivatives, ISDA, Lehman, nevada, Recession, recovery, Robert Barone, Sovereign Debt, u.s. at 3:10 PM by Robert Barone
NEW YORK (TheStreet) — The determination by the International Swaps and Derivatives Association that Greece officially defaulted on its debt when it invoked its recent legislatively passed “Collective Action Clause” to force investors to take losses is actually good news for the other so-called troubled European sovereigns like Portugal, Spain, Italy and Ireland.
The ISDA determination assures private sector investors that if they buy the so-called troubled foreign sovereign bonds, hedge them with credit default swaps and a Greek style default occurs, they will be paid at or near par value.
If the CDS payout had not been triggered, the private sector investors would view the purchase of such sovereign debt as having significantly more risk, and that would result in a much higher interest cost of that sovereign debt to the issuing countries. In addition, it would throw the whole CDS concept into confusion, potentially impacting even the higher quality sovereigns like, Germany, the U.K., Canada, Australia, and even the U.S.
According to the ISDA, about $3.16 billion of Greek debt is covered by the CDS (4,323 swap contracts). On March 19, an auction will be held which will set the “recovery” value on the Greek bonds. The difference between that recovery value and par will be the payout of the CDS.
For example, if the auction results in a recovery value of 20%, then the CDS payment will be 80%, or about $2.5 billion. This is not a large amount in the context of world markets, and it would be a surprise if any viable CDS issuer will be greatly impacted, although it does appear that Austria’s KA Finanz, the “bad” bank that was created in 2008 when Kommunalkredit Austria AG was nationalized and given all of the “distressed” assets, will be stuck with CDS losses in excess of $550 billion which will require the Austrian government to step up with a significant capital injection.
The “non-eventness” of the CDS payouts is a result of the fact that there has been a long lead time for the issuers to adjust their risk portfolios to deal with the likelihood of a Greek default. Over the past year, the amount of Greek debt covered by the CDS has halved. Compare this to the Lehman default of $5.2 billion where there was almost no lead time between the emergence of the Lehman issue and its bankruptcy filing.
It was the lack of such a lead time that caught CDS issuers, like American International Group(AIG), with no time to adjust their risk portfolios, and required government intervention to prevent a domino default effect. With Greece, no such domino effect is expected although there is always the possibility (albeit low) of a surprise. We will know that soon after the March 19 auction when settlement must occur.
This is not to say that the world is now safe from financial contagion, as, in the context of world markets, Greece’s default is an expected and well prepared for event. The real worry should be if Spain, with a debt of about $1 trillion and/or Italy with a debt of about $2 trillion default.
In addition, the CDS market is not transparent, and no one knows where the CDS obligations lie. While a Portuguese and/or Irish default would have about the same individual impact as that of Greece (economies slightly smaller and not as indebted), we should worry that a rolling set of smaller defaults would eventually cause a major CDS insurer to fail due to the cumulative impact of the several defaults.
After all, it is likely that the CDS insurers who dabbled in Greek CDS, are also involved in CDS insurance of the other high debt European countries. And, if a significant CDS insurer defaults (e.g., an institution similar in size and stature to AIG in 2009), we could, indeed, have contagion.