Tuesday, February 16, 2010

The risk trade comes back


This is a Bloomberg index of real-time commodity prices. Commodities have bounced nicely in the past 10 days. The dollar is no longer rising and may be turning down. Gold prices are up. Oil is up. Equities are up. The "risk trade" is back, mainly—I think—because the signs of improving economic activity continue to trump the market's fears. A recovery like we have underway is not something that is easily derailed. Yes, policies remain awful, but that's been the case for the past year. On the margin the outlook for policy has improved, and that is what's important.

I note today the news that a Rhode Island town decided to fire all of its unionized teachers after they refused to work 25 minutes more. This probably marks the tipping point for public sector workers' compensation packages all over the country. The fact that public sector workers have great job security and make a lot more than their private sector counterparts just doesn't make sense. I won't be surprised to see many more towns and states imposing pay cuts and layoffs on their public sector workforce. This is a good thing for the economy (though of course painful for those affected). It better happen here in California.

12 comments:

Sean said...

Scott,
What Bloomberg tool do you use to create these charts? Is it available to anyone?

randy said...

The most obvious and direct way to improve federal and state finances is to extend retirement age, and make public sector retirement packages more like private sector. One day it will be inevitable.

It's not hard to appreciate the Germans reluctance to bail out Greece. From the National Review:

http://corner.nationalreview.com/post/?q=OTNkMTM5NzlmNzllOGYxNDgxZjI5YTViN2MwNWFiYTQ=

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~


The U.S.A.'s Very Own Greece Problem

In her first term, Angela Merkel raised Germany's retirement age to 67 from 65 in an effort to rein in the deficit to meet EU goals. I don't imagine too many people have trouble understanding why German workers, who can't draw their state pension till 67, are reluctant to bail out Greece so that Greek workers can go on retiring at 63.

The U.S.A.'s public sector — federal, state, and local — is to the private sector as Greece is to Germany. And then some: the gap that has opened up between the pay and (especially) the benefits for our public sector, as compared with those in the private sector, is far greater than a mere 67-63 difference in retirement ages. You want to talk retirement ages?

In California . . . a bipartisan bill that passed virtually without debate unleashed the odious "3 percent at 50" retirement plan in 1999. Under this plan, at age 50 many categories of public employees are eligible for 3 percent of their final year’s pay multiplied by the number of years they’ve worked. So if a police officer starts working at age 20, he can retire at 50 with 90 percent of his final salary until he dies, and then his spouse receives that money for the rest of her life. Even during the economic crisis, "3 percent at 50" and the forces behind it have only become more entrenched.

Scott Grannis said...

Sean: the charts are just part of the Bloomberg service package. It's available to anyone, but for a pretty steep price (~$1800/mo)

Scott Grannis said...

randy: I think it is also inevitable that state, local, and federal governments everywhere are going to be put under the screws. Spending must at least be frozen for a period of years. And of course pensions must be cut back. Government will almost always spin out of control if not constantly checked. "The price of liberty is eternal vigilance."

j said...

I saw a program on C-Span a couple of weeks ago on Calif public sector compensation gone wild. He gave the example of Newport Beach lifeguards being reclassified as 'public safety' employees, the same classification as fire and police officers. The top lifeguard is paid $180,000 per annum and can retire with 80% of pay indexed to inflation. I think this problem is a nationwide pandemic.

Family Man said...

Could you comment this please, what is the risk that US goes for deflating its debt by ca 4% a year, and what impact on asset prices do you reckon?
http://alturl.com/7atf

Edward said...

Good post, however attacking current "policies" is somewhat disingenuous. Every state, including many republican states, are benefiting from stimulus money which is going to public works projects and so forth, and that in turn is pushing up the recovery data we get every week. It was the prior administration policies, the 700 billion unconditional bailout to banks and of course the lack of a single spending veto for 8 years that started the mess. Please don't mix your great market insights with political cliches, which in fact are historically inaccurate. Our tax rate is less than under Regan, he also increased our debt three fold and had over 10% unemployment in his second year. Objectivity, please.

W.E. Heasley said...

Mr. Grannis:

Agree that states need to immediately reduce size and scope of government. Further, states need to address pensions that currently give retired workers a major claim against the stream of future state tax revenue.

For many states cutbacks will need to be deeper then merely reaching current operational budget equilibrium. Given the amazing amount of additional debt load taken on during the past 10 years, the debt acquired requires budget austerity for years to come in order to service and retire the debt load.

Finally, many states have raised taxes in 2009 yet revenue continues to decline (Laffer Curve). However, they have balanced their budgets with federal stimulus money. Stimulus money to the tune of a billion (or more) in many cases. When the stimulus money dries up, which will be very soon, in conjunction with declining tax revenue, not only will size and scope of government be cut back, pensions reduced, debt drag causing a depletion of tax revenue….the “e” word will surface. They will have to cut entitlements.

Scott Grannis said...

Family Man: Morgan Stanley appears to have its facts right, but its conclusions don't necessarily follow. A high debt/GDP ratio can be dealt with through nominal GDP growth, but it doesn't have to be. Japan is the classic example, since it has supported a 100+% debt/GDP ratio for many years with virtually no inflation.

The error in the MS analysis is that inflation is not caused by the amount or level of government debt. Inflation is caused by monetary policy: the central bank. The Fed may choose to inflate away our federal debt burden, but that is far from being a foregone conclusion. I worry a lot that we will have higher inflation than the market expects, but we haven't seen it yet and the Fed is under no obligation to deliver high inflation.

If we do have inflation of 4 or 5% per year going forward, you can expect to see a number of developments: Treasury note and bond yields will soar (and their prices will fall); corporate bond yields will tend to rise, but spreads to Treasuries will fall (i.e., corporate bonds will strongly outperform Treasuries); commodity prices will rise significantly; stocks may tend to underperform for awhile, but in the long run equity prices should at least keep pace with inflation; cash yields will soar; gold prices may rise further, but they have largely priced in such an inflation scenario, so i doubt they would keep pace with inflation.

Scott Grannis said...

Family Man: Morgan Stanley appears to have its facts right, but its conclusions don't necessarily follow. A high debt/GDP ratio can be dealt with through nominal GDP growth, but it doesn't have to be. Japan is the classic example, since it has supported a 100+% debt/GDP ratio for many years with virtually no inflation.

The error in the MS analysis is that inflation is not caused by the amount or level of government debt. Inflation is caused by monetary policy: the central bank. The Fed may choose to inflate away our federal debt burden, but that is far from being a foregone conclusion. I worry a lot that we will have higher inflation than the market expects, but we haven't seen it yet and the Fed is under no obligation to deliver high inflation.

If we do have inflation of 4 or 5% per year going forward, you can expect to see a number of developments: Treasury note and bond yields will soar (and their prices will fall); corporate bond yields will tend to rise, but spreads to Treasuries will fall (i.e., corporate bonds will strongly outperform Treasuries); commodity prices will rise significantly; stocks may tend to underperform for awhile, but in the long run equity prices should at least keep pace with inflation; cash yields will soar; gold prices may rise further, but they have largely priced in such an inflation scenario, so i doubt they would keep pace with inflation.

Scott Grannis said...

Edward: I am an equal opportunity basher of bad public policies, whether they come from a Republican (as many have) or a Democrat. Obama and the current Congress are a breed apart, however, having broken all records for fiscal profligacy. Bush was bad enough, but Obama takes the cake.

As for Reagan: he lowered the top tax rate from 70% to 28% (lower than today's top rate), yet federal revenues as a % of GDP hardly budged. The main sources of the Reagan deficit were a) higher defense spending, which helped produce the collapse of the USSR, and b) rampant fiscal spending mandated by a Democrat-controlled Congress.

Regardless, the Reagan deficits were almost insignificant compared to today's.

If you catch me praising a Republican who spends too much and fails to appreciate the power of lower tax rates and limited government, then you can justifiably call me a horse's a**. About the only good thing that Bush II did was to cut tax rates in 2003. Most of the rest of his legacy was dreadful.

Scott Grannis said...

WEH: You are exactly right. Budget constraints coupled with righteous indignation on the part of the electorate will eventually get our fiscal house in order.