Thursday, December 1, 2016

"Granola Shotgun" and the Eventual U.S. Sovereign Debt Crisis

Some highlights from "Granola Shotgun", I think the entire blog is worth reading.

  • As I went through life I watched as another boom and bust cycle played out with the crash of October 1997 and then again in the crash of September 2008. The interesting thing to me is the way different generations interpreted these events. The older folks never adjusted their penny pinching when times were good. They reflexively saved against lean times regardless of the current abundance. Boomers never learned to restrain their enthusiasm no matter how often they screwed up. They held firm to their buy-now-pay-later ethos decade after decade. A dog doesn’t change its spots. -"The Lost World of the Solvent American"
  • The solution is always the same – work harder, earn more money, wait longer, take on more debt, buy something that someone else built, and feed the existing system regardless of how inefficient or pointless it might all be. - "Building Codes and the Self Built Mortgage Free Home"
He has a number of examples of how crushing regulatory burdens - at the county level - make it very difficult to build small, efficient commercial or residential properties. [See: 1, 2, 3, 4, 5 for examples.]

I've been looking quite a bit at the projected budget deficits over the coming two decades that will be caused by Social Security, Medicare, Medicaid and state pension obligations. State pensions are massively underfunded - to the tune of several trillions of dollars. Social security and Medicare represent liabilities of tens of trillions.

The federal budget deficit is now over a trillion dollars per year. Using accounting tricks, the government claims it's less than that, but look at the amount that the public debt grows every year. The increase in debt = expenses less revenue = true deficit. Simple check: the federal debt grew by $10 trillion in Obama's eight years. I think we can count on $1 trillion as the baseline going forward.

Using the government's own projections, Medicare will cause the deficit to increase by another $500 billion annually by 2026, Social Security will have the deficit increasing by a bit less but still several hundred billion, and Medicaid an extra couple hundred billion. (This assumes, of course, other federal expenditures and revenues held constant.) The total increase is a trillion dollars per year, which means eventually $2 trillion annual deficits for the federal government.

The current plan is just to borrow this. But these are enormous amounts of money. To put it in an individual perspective, there are fewer than 100 million federal income tax payers in the U.S. The current public debt of $19 trillion is $190,000 per taxpayer. Outspending revenue by $2 trillion annually is $20,000 per taxpayer.

If this sounds crazy, it is because you're looking at the endgame of a Ponzi scheme that ended when it caused the total fertility rate, and thus - eventually - the worker retiree ratio, to drop too much.

To put in a different perspective, the total equity value of the S&P 500 companies is less than $20 trillion. Imagine the federal government exhausting that much capital in ten years. I don't know when it will happen, but I think the bond market will choke. Occasional spikes in bond yields will be the signal that no more can be borrowed. (Ask James Carville.)

The alternative to borrowing is to get expenses back below revenues. There seem to be hard limits to the percentage of GDP that a government can collect (Laffer curve), although I'm sure it could collect more than it does now. If so, corporate taxes will be higher, not lower, and corporate profits will decline. Disposable income will fall significantly when income taxes rise. (Think: luxury cars, Starbucks, Amazon, Apple, cable TV bills, restaurants and breweries.)

In terms of cutting expenses, the federal government's largest expenses are these retirement Ponzi schemes. (And why would any baby boomer continue to support the federal government if these promises are not paid?) The only other expense that comes close is the military.

Interestingly, only a third of the military budget is for personnel. You could save maybe $200 billion a year if you stopped all materiel purchases and brought them back to bases in the U.S. to do pushups all day. If you want to get really clever, retrain them to do infrastructure repair of roads, bridges, water, sewer - another multi-trillion dollar can that has been kicked down the road and I am not even going to talk about in this post.

These cuts and tax increases are going to be very painful. I would imagine they will be the only political topic under discussion. No more neocon wars, no more gay marriage disputes. I would not bet on selling a new jet fighter or a 1,000 ship Navy. The Ponzi scheme disputes will have a racial identity politics dynamic because the older Ponzi participants are much whiter than the working age population.

Thus, my overall impression is that the U.S. is less rich than people currently believe or people's behavior currently implies. Stocks aren't worth their current multiple of earnings at peak profit margins; bonds shouldn't be yielding so little given that there is a recipe for a sovereign debt crisis. People's thinking right now is clearly delusional: Uber apparently subsidizes rides to the tune of 60% of the fare, so logically it is not worth the ~$100 billion that people think.

And in a period of rising property taxes, income taxes, and interest rates, people are going to find out that residential housing is not an investment. Depending on state law, it may be possible for retired municipal employees to expropriate significant amounts of home equity to maintain their pensions.

What do people say to this? I find that the rebuttal is that the Fed will print money and buy the government bonds to fund the deficit. That is what is going to look really delusional in the history books!

I realize that people have been talking about this for decades. I guess the mistake then was thinking that this would matter as long as interest rates were still falling. But I think it will be a mistake to assume it will never matter.

Finally, note the scary conclusion from the Granola Shotgun blog is that, at least at first, people are not going to be allowed (allow each other, really) to do a lot of the belt-tightening that will be needed to cope with the loss of illusory wealth. Can't build a little accessory dwelling in the backyard for your parents to live in.


CP said...

Again… there were willing buyers and sellers in the “free market” yet the banks and regulators rejected the sale. What gets built, bought, and inhabited has a lot to do with what larger institutions demand. The market is seriously stacked in one direction. Three bedroom ranch houses, strip malls, garden apartments, and suburban office parks are approved without hesitation all day long. Everything else is intentionally excluded.

CP said...

All the individual rules, procedures, costs, and restrictions that have built up over the years like an alluvial delta of red tape are perfectly reasonable when viewed in isolation. But collectively they make it impossible for ordinary people to meet their own basic needs, particularly at the bottom of the income pyramid. [...]

“Ohio is the solution to California’s affordable housing crisis.” Yeah, I know… it snows there. But with the $500,000 you save on a house you can buy a second home in the Caribbean. And the Ohio countryside is every bit as gorgeous as Sonoma.

CP said...

But it bothers me that each level of bureaucracy inevitably drags in other bureaucracies and institutions that all have their own demands and costs that raise the bar of entry without actually adding value to the finished building or business. In essence an entire class of unproductive middlemen have to be fed in order for neighbors to buy and sell onions and bread to one another.

I travel across the country often. I make comments about the financial insolvency that’s already baked in to the cake and local officials are incapable of using that information in any meaningful way. The suburbs have been built. They’re occupied by voters who expect certain things. This isn’t a conversation that anyone with a position in government can pursue and expect to stay employed for very long. The problem will fix itself as failure and abandonment set in.

CP said...

Honestly, every time I see someone drive out to the far edge and buy a big house off the side of the highway (Mason, Beavercreek, etc.) I think… well, if that’s what you really want fine by me. But I could never live in a place like that myself. And while such places are prosperous at the moment I don’t think they’ll hold up well over time. We’ll all see as events unfold in the future. Remember, the burned out ruins in Cincinnati used to be filled with the richest people in the region until the economic and social pendulum swung away. I’m taking a chance that things are swinging back again.

One of the ways newer suburbs have attempted to prevent this sort of thing from ever happening is to mandate minimum home and lot sizes. A 4,000 square foot house comes in at a certain price point that lower income people simply can’t afford. Problem solved, right? Well… I witnessed numerous subdivisions in Southern California collapse in value after the 2008 financial crisis. No buyers appeared and the foreclosed properties sat empty until they were bought by investors for pennies on the dollar. The absentee landlords then rented to whoever made the homes cash flow.[...]

The other thing to keep in mind is that production home builders and material suppliers have gotten very creative when it comes to supplying the demand for large homes by making them out of compressed dust and plastic film. Some of these places look like they were manufactured from cake frosting. They don’t hold up very well without continual care and feeding. [...]

There are larger economic forces at work here that can’t be addressed by local regulations. The American middle class has been shrinking for at least thirty years. Wealth and opportunity have been concentrating in fewer and fewer geographic locations. And across-the-board saturation debt levels are choking off more and more options for the larger population. Maintaining the suburbs in the ways they were designed to be maintained is extraordinarily expensive. And we’re broke. You can’t legislate prosperity.

CP said...

Unlike previous generations who placed themselves in great personal debt in order to acquire a large prestigious home to demonstrate wealth and status, Todd sees his home as a productive object to generate revenue. It’s precisely the opposite philosophy from the McMansion in a gated community. The value isn’t loaded on to the eventual speculative value of the home come sale time, but in the month-to-month productive capacity of the property. Status for him doesn’t come from a two story entry foyer or an extravagant master bedroom suite. Instead, he rejoices in the economic freedom of having a home that pays him each month rather than the other way around.

No one in 1940 could have imagined how far down the old Brooklyn neighborhood would sink by 1970. And no one in 1970 could have predicted the spectacular gentrification of 2015. For those people who purchased property in the area in 1940 it must have seemed like a smart move compared to buying a fallow potato field way out on Long Island or New Jersey. But it was all downhill for decades and they probably never lived to see Boerum Hill recover. For those who bought property in Boerum Hill in the early 1990’s it must have felt like a huge risk. But all those cheap run down old buildings proved to be a massive gravy train that just kept rolling in. That’s the cycle of history at work.

CP said...

This is just like the book Why Most Things Fail:

Back in the 1960’s and all through the 70’s and 80’s the old industrial cities emptied out. The Rust Belt was hit especially hard. Looking back, what could Buffalo, Cleveland, Youngstown, Altoona, or Rochester have done differently to save themselves from depopulation and insolvency?

Go back to an earlier era when small farm towns emptied out as all the young people poured in to big industrial cities grabbing at good paying factory jobs with both hands. What could any of those rural towns have done differently to prevent the exodus? A few lucky places had a university or a medical center or were especially beautiful and reinvented themselves as tourist or retirement destinations. Everyone else… toast.

Many of our suburban communities served their populations very well for fifty or sixty years. Now these places are aging poorly and the economy is leaving them behind. Some will be fortunate. Right place. Right time. Others? Not so much. So let the local authorities do whatever they can to hold things together. Some will be successful – more or less by accident. Other places will do exactly the same things and they’ll fail. That’s life.

ADL said...

Very interesting, very plausible (and the Granola seems like a great read so far). But...prognostication of any kind is perilous when it extrapolates from current trends and sees any kind of hard end. People get creative. Of course, the same can be said of those who extrapolate future comfort from current comfort. People can get too creative.

High Plateau Drifter said...

" What gets built, bought, and inhabited has a lot to do with what larger institutions demand. The market is seriously stacked in one direction. Three bedroom ranch houses, strip malls, garden apartments, and suburban office parks are approved without hesitation all day long. Everything else is intentionally excluded."

Of course, because replacing a rowhouse, brownstone with shared walls in urban environs requires a very expensive tear-down and removal. Once the neighborhood becomes dangerous and tear-down cheap, there is no viable market for rebuilds.

In contrast, open field suburban developments scale easily so there is enough "product" to front the costs of the permitting process (with vig for the local politicos) and to demonstrate that the upfront cost of roads, sewers and public utilities will be repaid out of the new tax base and utility fees.

Urban row house neighborhoods were inhabited with members of the local parish church or synagogue. It was a community of families who knew each other. When uprooted and looking for a new home they are not going to want to buy another row house and share a wall with total strangers. They are going to want some distance and privacy.

Clear field row house development won't sell so it doesn't get built.

The social engineers who long for the cohesive feel of the jewish sthetl and imagine that its cohesiveness can be recreated in clear field developments are kidding themselves. Crowding cheek to jowl with nosy neighbors is something that moderns wish for others but not for themselves.

bjdubbs said...

The story about buying the Cincinnati house for $15,000, wanting to invest lots of money, and then getting blocked, that was eye-opening. Why would Cincy not want more investment and better housing stock? That seems like such an obvious no-brainer. Not only should the city approve it, they should be giving tax breaks and begging people to do stuff like that. But no way, it didn't conform to a 100 year old code. Insanity. I guess it serves the interests of big developers, who don't have to compete with new supply? But they would benefit in long term. Hard to understand what is going on.

Ventriloquist said...

You don't get it.

But you are in very good company.

Kunstler doesn't get it.

Greer doesn't get it.

Dimitri doesn't get it.

NONE of you post-apocolyptics pseudo-journalists get it.

The fed can print zeros and ones on hard drives for relative infinity.

And print, and print, and print, and print.

And, there's nothing in the world that will stop this.

N O T H I N G.

Oh well, there is the . . . Bond Market ! ! !

Bullshit, the bond market means nothing.

Oh well, there is this massive deficit.

The ONLY thing that will be a TRUE game changer is when . . .

The US dollar is not accepted ANYWHERE by ANYONE.

Until then, they can print as much of this $hit as they want,
and the stupid masses WILL ACCEPT it for payment.

And until they don't, you are full of BULLSHIT.

Read it and weep.

Anonymous said...

Another important Granola Shotgun post:

So last week I was amazed as he described all the great things he was doing to his house with the borrowed money. I noticed he pulled up in a new truck that was even bigger and shinier than his old one. Times are flush again and he’s enjoying the buffet exactly like he did in the boom years that preceded the 2008 crash. I told him we’re in another bubble and this was not a good time to be taking on debt. Bubbles tend to pop. His house is already beautiful. There isn’t a damned thing wrong with his kitchen. And he could have gotten a few more years out of his old truck. He’s north of sixty. Does he really want to be paying off a second mortgage until he’s eighty?

Anonymous said...

Illinois real estate equity expropriation:

Illinois’ property taxes are higher than the property taxes in every state that has no income tax at all. Clearly, these states and many others are able to keep their property taxes low even without income tax revenues. Illinois property taxes are nearly triple those in neighboring Indiana, which also has a low, flat income tax rate.

Illinois Property Tax Increase Cap Introduced In State Senate

Illinois has been without a budget since summer 2015. A connected package of budget bills known as the “Grand Bargain,” which currently is being worked on in the Illinois Senate, proposes a 33 percent increase in income and corporate taxes, an expansion of the state sales tax to include a number of different services, and minor reforms to public pensions and workers’ compensation laws, among other things.

Anonymous said...

Forty percent of Quincy’s 330 full-time government employees cost taxpayers more than $100,000 a year in salary, health care and pension costs, according to the city’s total compensation report.

The city’s police and fire salaries have grown at twice the rate of household incomes over the past five years. Those salaries are now an astonishing 60 percent higher than the median household income in Quincy.

Anonymous said...

Social security:

Also important to read: