[MONEY] The USA Debt Time-bomb

[Zenaan Harkness]

On Sun, Jul 31, 2016 at 12:31:34AM +1000, Zenaan Harkness wrote:
> F. William Engdahl
> The USA Debt Time-bomb Tocking, Ticking, Tock, Tick ...
> http://journal-neo.org/2016/07/28/the-usa-debt-time-bomb-tocking-ticking-tock-tick/
> 
> 
> 
> This one's gonna be big ..


>From the UK to Japan, North America to Australia, France, Italy, Greece,
Spain, Germany and the rest, all the big players are printing QE money
like there's no tomorrow and the small players are haemorrhaging
everywhere.

The news just keeps getting better (for negative interest rate values of
"better"):



By Vern Gowdie
http://click2.portphillippublishing.com.au/t/FA/FgE/Kgs/AAmANg/HKY/AAFmvw/Ag/kM72
in London

‘ Investors are buying bonds for capital appreciation and stocks for
income. The world has turned upside down… It is a poison brew that
central banks keep serving us. ’

— James Abate, Chief Investment Officer at Centre Asset Management LLC

‘Fears mount for pensions as gilt yields touch negative territory’

— Financial Times , 11 August 2016

‘Royal Mail set to close door on ‘gold-plated’ pension plan — Record-low
interest rates add to fears’

— Financial Times , 11 August 2016

In the blind pursuit of making debt cheaper to keep the debt-dependent
economic growth model in motion, central banks appear to have forgotten
Merton’s Law of unintended consequences.

Actions always have reactions.

With negative interest rates, governments, and some high quality
corporates, are now being paid to borrow money. This is plain dumb. But
that’s the upside-down world we currently inhabit.

I say ‘currently’, as it defies logic to think negative rates are a
lasting phenomenon.

Best guess is that it’s going to be one of those periods economic
historians will file away under ‘insanity’, ‘desperation’ or ‘what the
hell were they thinking back then?’

While some say economic pundits believe negative rates can become a
permanent fixture, the logic fails the ‘smell test’.

According to a September 2015 IMF paper titled ‘A Strategy for Resolving
Europe’s Problem Loans’:

‘ European banks face significant challenges from their high levels of
impaired assets. The global financial crisis and subsequent recession
have left many countries with elevated levels of nonperforming loans
(NPLs). NPLs in the European Union (EU) stood at about €1 trillion (or
over 9 percent of the region’s GDP) at end-2014, more than double the
level in 2009. ’

Given the plight of Italian banks, it’s not a stretch to think the
amount of non-performing loans in Europe could be even higher these
days.

This is the definition from Investopedia of a non-performing loan:

‘ A non-performing loan (NPL) is the sum of borrowed money upon which
the debtor has not made their scheduled payments for at least 90 days. A
non-performing loan is either in default or close to being in default. ’

In the old days, we called these ‘bad debts’.

But in this upside-down world, calling things as they are is a definite
no-no.

Why have non-performing loans doubled since 2009 (especially when
interest rates — the cost of money — have been falling)?

Deflation.

Sorry, I can’t call it as it is. The official spin goes something along
the lines of ‘sluggish growth’.

Semantics.

To put €1 trillion into perspective, it is roughly $1.5 trillion…which
is pretty much the size of the Australian economy.

How did all these loans become non-performing?

Underlying economic activity did not produce sufficient revenues to
fulfil loan obligations. You lose your job, or have your income reduced,
or your business turnover slumps (deflates)…then you go to your bank and
tell the [him/her/transgender/cross-dresser] bank manager ‘you’re up
s**t creek without a paddle.’

90 days later, you are a non-performing loan statistics. Welcome to the
club.

The bank is in a bind. Recovering its money is not that easy. The
security offered is worth far less than the loan. Not only that, but if
all banks started selling the assets behind the distressed loans, asset
prices would be driven even lower. So the non-performing loans sit on
the books…waiting.

Waiting for what? Economic growth. When the elusive growth does
eventually appear, it’ll pick up revenues — incomes rise, profits
increase, outstanding loan commitments can be repaid. The ‘non’ can be
dropped, and performing loans become the order of the day.

Call me silly, but for growth to make a sudden and lasting appearance on
the economic stage, I’d have thought providing people with an income to
spend would’ve been somewhat crucial to that outcome. As I said, ‘call
me silly’.

And that’s where the quotes and headlines at the start feed into this
perplexing story.

The traditional bastion of secure income used to be the fixed interest
bond…backed by ratings agency credit scores like AAA, AA+ and so on.

Pension funds — with obligations to pay employee pensions for decades to
come — have traditionally invested in high quality bonds to provide a
portion of the return required to meet those ‘written in stone’
obligations. Tens of millions of people are relying on their pension
fund to come good with the promised payment each and every month during
their retirement.

To meet these obligations, the pension funds have two options available
— firstly, to generate a rate of return on current assets and/or
secondly, where those returns fall short of the projected level, the
employer is required to make up the shortfall.

This sounds simple enough, but with millions of fund members having
varying life expectancies and differing pension entitlements, this
creates a mathematical nightmare…especially with medical science
increasing our life spans with every passing decade AND central banks
decreasing the rates of return on offer from the traditional safe haven
investment used by pension funds.

Which is why headlines like this…

‘US faces ‘disastrous’ US$3.4tn pension funding hole - Collective
deficit of retirement plans is three times larger than official figures’
— Financial Times , 10 April, 2016

…and commentary like this…

‘ Many well-known companies, including BT Group [British Telecom] , the
telecoms company, and energy businesses Royal Dutch Shell and BP, have
pension deficits that run into the billions, according to LCP, the
pensions consultancy.’ — Financial Times , 3 January, 2016

…are finding their way into mainstream reporting.

Pension funds (the primary source of retirement income for tens of
millions of baby boomers) are woefully underfunded. The prospect of
having the money available to meet these obligations grows dimmer each
year.

Depending upon which report you read, the average pension fund, to
fulfil its obligations, needs a return of between 5% and 8% PER ANNUM —
that’s each and every year.

Government bonds paying MINUS rates of return obviously make achieving
that projected return that much harder. Hence the headline — ‘Fears
mount for pensions as gilt [UK government bond] yields touch negative
territory’.

So where do pension funds go to achieve the desired rate of return?
Shares, hedge funds, junk bonds, and private equity funds.

Given that each of these investment categories has a history of
shredding investor capital, there’s the very real prospect that pension
funds could find themselves sliding further down the greasy ‘rate of
return’ pole…making their task of paying the promised pensions even
harder.

The central banks have indeed served up a poisoned brew .

With millions and millions of boomer retirees faced with the prospect of
lower retirement incomes, there’s no way the much sought-after economic
growth is ever going to be realised.

Non-performing loans are going to fester on the banks’ books until the
open sore can no longer be covered up with Band-Aid measures.

Failing banks will then need to be bailed out by shareholder capital,
bond holders and depositors…all this shreds more investor capital.

The negative loop means pension funds then lose even more money on their
bank shares, bond holdings and cash deposits. Pension payments are
cut...and we repeat the exercise.

This upside-down world has sent a lot of blood rushing to the head of
central bankers, denying them the ability to think and act with any
clarity.

Which is why I think, after the next credit crisis, we’ll see some sort
of permanent ‘helicopter money’ program introduced.

More unintended consequences are definitely in our future.

Regards,

Vern Gowdie,

For The Daily Reckoning