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Economic and Market Commentary

The Gang Who Couldn’t Talk Straight

"Let's shoot straight, folks, without the requisite hyperbole that seems to define America's modern age and current politics."

A copy of the annual Economic Report of the President arrived at my desk the other day, replete with a giant bald eagle on the cover and formatted, incredibly enough in OVERSIZED print – fit for an aging boomer population. My compliments to the chef, at least for the exterior garnishments. The verbiage however, was another story. It’s not so much that the report was a compilation of untruths or even half-truths. It’s just that it failed to tell the truth, the whole truth, and most definitely nothing but the truth. Although submitted by ex-CEA Chairman and newly christened Fed Chairman Ben Bernanke, it was as if it had been written by Dick Cheney, a man who not only cannot shoot straight but seems to have difficulty talking straight as well. If there were WMD in our economic future, you’d be hard pressed to find them here. Mild innuendos about global and demographic challenges yes, but nothing that couldn’t or wouldn’t be overcome with good old American ingenuity, hard work, and a fawning foreign investment public nearly trampling each other to get their hands on attractive U.S. "investments." Nowhere to be found was the catchy phrase à la Tennessee Williams referring to the "kindness of strangers" or a suggestion of "living on borrowed time." Our 700 billion dollar current account deficit, in fact, could and might continue "indefinitely" as long as we use the capital inflows in ways that promote future growth, the report intoned. Ah, but that, it seems to me, was the critical rub. Have we, can we, will we use capital to foster future growth or must we earmark it for future liabilities that have been under-reserved? Have we borrowed from the future to pay for today’s party and will our future creditors allow us to pay it back on our own terms with low yields and a strong dollar? While the gang that couldn’t shoot (or talk) straight expressed few doubts, I as you can probably tell, have mine. Let me summarize a few of the pertinent chapters of this year’s report to help you make up your own mind.

As we shall see in future paragraphs, the U.S. is beset with the necessity to provide services and funding for an aging boomer population. Chapter 2 of the Council’s report speaks to skills for the U.S. workforce and suggests the obvious – that education will be a key contributor to the economic growth which will provide these future services, and that the "U.S. can create a workforce that will thrive in the fast-changing world economy." A few pages in, however, the report offers a Cheneyesque comment that the "U.S. still has great potential for increases in the schooling levels of its residents." Turns out that "great potential" was a misplaced euphemism for "failing grade." The Council’s own math and science rankings on international tests are shown in Chart 1 and they don’t even include those of Japanese and Asian competitor nations. If grades were awarded on a curve, a D+ for our graduating seniors would be the honest result. "Potential" indeed – as in nowhere to go but up! If these students are whom we boomers are relying upon to take care of us during our old age, then we’d better petition Congress to release Dr. Kevorkian from prison instead.

Figure 1 is a table showing the rank of the United States relative to other countries in math and science for ages 9, 13, 15 and the last year of secondary school. The USA’s best rankings are the highest for 9-year-olds, at fourth for math and third for science. They fall at later ages, to fifth in math and fourth in science at age 13, and 11th in math and 10th in science by age 15. For the last year of secondary school, kids in the US rank 10th in math and ninth in science. Exact rankings for each subject are detailed within.

Social Security and Private Pensions
The Council’s report seems confused as to whether Americans are adequately prepared for the inevitable aging of the boomer generation. "What does ‘Retirement Preparedness’ mean?" they query at one point. They later suggest that it means the accumulation of wealth necessary to maintain a desired standard of living, but then wonder whether either our future wealth will be enough or our "desire" for benefits too much to guarantee preparedness. What shouldn’t be confusing for our "straight talk" challenged gang is their own opening quote that "recent newspaper headlines suggest that Americans have stopped saving and are at risk of sharp reductions in both private and public benefits." Thank God for a free press I suppose because the gang only suggests that these concerns have "some basis" in fact. 75 pages later, in a chart buried in a lengthy denial of the current account deficit, comes the evidence displayed in Chart 2. The headlines it seems, are right. Americans (consumers, businesses and government) have indeed stopped saving and now rank at the bottom of the international totem pole just like they do with education. If "savings" are the prerequisite for future private and public pension solvency as the Council suggests, then dial 911 and get the emergency room set up, you straight-talkers you. Paddles!

Figure 2 is a line graph showing the savings rate of the United States compared with those of Japan, Italy, Canada, Germany and Great Britain. The time period shown is 1995 to 2004. The rate for the United States is the lowest of all countries from 2002 to 2004, ending at around 12%, down from its highest point of around 17% in the late 1990s and early 2000s. The 12% number for the United States compares with the rate of 28% in 2004 for Japan, 23% for Canada, 21% for Germany, 19% for Italy, and 14% for Great Britain.

Health Care Spending
Our gang really tries to con us when it gets to the topic of healthcare. Medical expenditures they suggest resemble a discretionary outlay – sort of like moving up from a Chevy ®  to a BMW ® or substituting a Heineken ® for a Budweiser ®. "As the United States grows richer and older," they write, "Americans are likely to continue to spend a rising share of their growing incomes on health." The "older" part is hard to dispute. That we would willingly allocate growing incomes on healthcare if given the chance and/or a more efficient system is debatable. Also under contention should be their follow-up statement that "our healthcare spending overall has returned good value with Americans living longer and healthier." Say what? Have they heard of the obesity/diabetes crisis? Have they checked into (and out of) a hospital lately to verify that "good value?" How about checking out their own chart and its projections for the next two decades (Chart 3). National healthcare will consume 23% of GDP in 20 years time vs. 6% in 1965 and 16% today. Who amongst you straight-talkers are going to suggest a way to pay for that?

Figure 3 is a line graph showing the national health expenditures as a percentage of gross domestic product for the United States, from 1965 to 2025. The chart shows a steady rise to about 22% by 2050, up from about 6% in 1965.

The Current Account Deficit
It’s in chapter 6 that the gang really becomes its most imaginative. Why admit to a chronic malady known as the current account deficit when tautologically you can discuss, and in fact label the entire chapter "The U.S. Capital Account Surplus!" A surplus sounds better than a deficit does it not? And if these surplus inflows reflect foreign investor preferences for "higher risk-adjusted U.S. returns," then all the better. You see folks, it’s not that we’re spending too much, it’s that foreigners are "pushing" (yes those are the authors’ words) in these funds because we’re so damned productive and we’ve got no recourse but to reap the rewards and shop ‘til we drop. Well, maybe as the gang suggests we should save a little of it to bring down this capital account surplus, but it’s really China, they claim and other Asian countries which need to promote higher domestic demand. Nowhere in the chapter is there a chart on the current account deficit. Instead we are treated to the rosier mirror image appearing in Chart 4 – "Net Capital Inflows." Additionally, we are told that these inflows (deficits) can continue indefinitely as long as we use these investments (spending) to promote economic growth.

Figure 4 is a line graph and bar chart showing net capital inflows to the United States from 1995 to 2004. Bars for each year show the dollar value of net capital inflows, scaled on the left-hand side. A solid line shows the net capital inflows as a percentage of U.S. gross domestic product, scaled on the right. Both metrics show a steady rise over the time period, and are at their highest levels in 2004, at about $650 billion worth of inflows, representing about almost 6% of GDP. That compares with about $100 billion, representing a little less than 2% in 1995.

Well, it’s at this point that any reasonable straight shooter would draw the following conclusion: If pensions, healthcare, (and defense), are going to drain such an increasingly significant share of GDP in future years, where does the money come from to promote economic growth of the sort that will pay for all of this? And how can we believe that America’s value added/productivity advantage in the one sector where we remain competitive – technology – will continue if our math and science report card keeps getting a D+? Let’s talk turkey; let’s shoot straight, folks, without the requisite hyperbole that seems to define America’s modern age and current politics. We can’t do it all – not just because our reach constantly exceeds our grasp but because this time we have exhausted our savings, lost our competitive edge and squandered our educational heritage. We have grown soft – THEY have grown stronger. We have lost a sense of why we have prospered – THEY have learned to replicate our work ethic of yesteryear. The solution as the Council rightly suggests, is to save more, get smarter, trade more freely and to maintain a competitive tax base. Well yes – thanks for the straight talk after all – but that is a plateful and it will require the long-term acquiescence of those strangers who will wish nothing more than to supplant us at the top of the economic/geopolitical totem poll. Instead, our solutions more likely will pursue an easier trail, characterized by currency devaluation, the inflating away of long-term pension liabilities, and the payment of rising healthcare expenses via higher personal and corporate taxes. Investment markets in the United States will not ultimately prosper under such an increasingly odorous environment. It is only sensible, therefore, to diversify globally. Sorry for the straight talk folks, but don’t you think it’s about time?

William H. Gross
Managing Director


Past performance is no guarantee of future results. This article contains the current opinions of the author but not necessarily those of Pacific Investment Management Company LLC. Such opinions are subject to change without notice. This article has been distributed for educational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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