To me, the most lethal by-product of the permanent bailout regime we’ve experienced in Western financial markets since the 1980s (too big to fail, the Greenspan put, Rubin’s personal Mexico rescue, LTCM, post-2000 rate cuts, TAF, Maiden Lane, Fannie and Freddie, AIG, TARP, TSLF and, of course, QE) is not the legacy of increasing taxes, permanently inflated equity and property prices and extravagantly overcompensated bankers, hard though all that is for most people to accept.
(I’m sure I’ve missed a few bailouts: here’s a more complete list of the scattergun 2008-09 programmes in the US).
Instead, the worst result of all this meddling in the free market has been a narrowing of policymakers’ options to the extent that there is no real exit from the current predicament.
I refer specifically to what might be called the tyranny of growth assumptions.
For example, only in the weird and wonderful world of national accounting and budget planning can a so-called cut in public spending by 2014-2015 actually equate to a £92 billion increase in cash outlays by that date. Those figures, in fact, are from the UK, where the Chancellor of the Exchequer is right now preparing to announce “the biggest programme of cuts in decades” – even though in cash terms public spending is due to rise from £600 billion last year to £692.5 billion in 2014-15. The reason that “cash” spending increases and “real” decreases can be presented as the same thing is of course the result of the highly optimistic assumptions about growth and inflation that are built into the government’s budget.
Take another example, US public sector pension funds. Only an assumption of 8% per annum portfolio growth allows them to appear even vaguely solvent, and even on that measure most are underfunded, according to an excellent piece in last week’s Economist.
Source: The Economist
As Bill Gross of PIMCO recently pointed out, with current bond yields of 2% and a typical portfolio weighting of 60% in equities and 40% in bonds, a long-term total return of 8% for a pension fund requires a return of 12% on equities. With the S&P 500 index yielding just 2%, dividends would have to grow by 9-10% a year to hit that target – or we have to move back to bubble-type valuations, from a starting point where the equity market’s yield is already towards the bottom of its historical range. And the further the government succeeds in pushing down bond yields, the more and more unrealistic the return assumptions from equities have to become.
You can see why the King and Bean duo running the Bank of England and Bernanke’s Fed are so desperate to get some inflation back into the system. Their only objective is to get nominal GDP to pick up; otherwise the whole pyramid of unrealistic promises that’s built into the current political system will surely come crashing down.
Can they succeed? The gulf between public sector obligations (such as those on public spending and state pension provision, even after the “cuts”) and the ability of the private sector to generate the tax revenue needed to finance these obligations now seems close to unbridgeable.
The turmoil in France resulting from even the smallest proposed change to the retirement age is a sign of how difficult pushing through real public sector cuts will be, while in the background is the spectre of Ireland, a reminder that there’s no guarantee that you can get nominal GDP to increase at all (it fell by nearly 20% in 2008-09 and has been merely flatlining since then).
The assumption of growth has become a tyranny, and overcoming it will be the hardest challenge of all in the years ahead.