Tuesday, May 4, 2010

Real Math For Real Problems In The Entitlement Sector

The Welfare State Meets Mathematics

The simple matter is that many nations have been living beyond their means and investors are beginning to doubt governments are good credit risks. That’s saying something, when governments can simply confiscate from the public the money needed to pay bond holders. But debt-to-GDP levels are now so high across the Western world that bond investors (and ratings agencies) are having serious doubts.The credits ratings analysts at Standard and Poor’s have been busy. A day after downgrading Greek and Portuguese debt, the analysts downgraded Spanish debt too. And now words like “viral” and “contagion” are…uh…spreading like…a disease.

The contagion from a Greek default could also spread to much larger economies where the public finances are also fragile, including the U.K. and, perhaps the biggest risk of all, Japan,”said Julian Jessop, chief international economist at Capital Economics. Jessop somehow left out the U.S, which is astonishing given that the U.S. Treasury Department will auction US$129 billion in new debt this week. Yields on 2-year, 10-year and 30-year U.S. debt all rose (and prices fell).But now the metaphors get complicated. You’re going to start hearing a lot of commentators say that this is a crisis of confidence. But when is the last time you stopped a cold with a strong sense of self belief?To say the sovereign debt crisis is just a crisis of confidence is to ignore Europe’s (and Japan’s, and the U.K.’s, and America’s) failing fiscal welfare state model. This model is not surviving its first contact with the inevitable math of demography, where you have more pensioners and rising health care costs and fewer tax receipts.That’s why it’s not a question of confidence. It’s a question of debt default. Who’s going to go first?The alternative being contemplated is a kind of firebreak engineered by the IMF and the European Central Bank. These organisations would draw “a line in the sand” and provide a large line of credit or loan guarantees to all the troubled nations of Europe. And how much would THAT cost?According to the good people at Goldman Sachs and JP Morgan, about €600 billion. That seems like a lot of money. And that seems like a big gamble. You try and restore confidence by putting a trillion dollars on the table and saying, “Look at THAT!”But that looks more like bravado than real self-confidence. So it looks like we’ll see how durable the common currency project is. And in the meantime, that ought to mean more U.S. dollar and gold strength. In fact, with so many governments in so many places printing so much money, it shouldn’t surprise you to see a whole basket of commodities benefit...for now.However this just pushes out into time and amplifies in size the next phase of the crisis. It’s all, at heart, a debt crisis. And before it’s over we reckon there will be both collapsing asset values AND hyperinflation.

And here’s a bonus thought for the day: what if the inevitable collapse of the social welfare state funding model leads people to change their primary loyalty from the State to something more local? For starters, it would mean, we reckon, that the centralising principle of the last 200 years of Western history (in commerce, politics, and living arrangements) may have reached its natural limits.The centralising principle would reach those limits for various reasons. One is the inherent fragility of complex systems and their increasing vulnerability to systemic collapse. Globalisation and the division of labour on a global level creates tremendous complexity AND vulnerability.Politically, the centralising principle, as emotionally successful as it has been in winning market share/votes (let us live at one another’s expense) is being exposed as economically fraudulent (as well as morally wrong to coerce other people to your way of thinking through taxation). It’s a nice idea, but it may be unaffordable without literally mortgaging the future or destroying our standard of living in the pursuit of a social welfare utopia.Robb defines a primary loyalty as “a connection to a non-state group that is greater than loyalty to a state. These loyalties include those to clan, religion, tribe, neighbourhood gang, etc. These loyalties are reciprocated through the delivery of political goods (by the group that the state cannot or will not deliver).”In a prosperous liberal democratic state where people see justice as fair and view the burden of civilisation (taxes) as equitably shared, where corruption is not rife and opportunities exist for social and economic mobility, having your primary loyalty to an abstraction (the rule of law or the State) is no problem. It is the norm.But when the State expands the promises it makes and then fails to deliver on more basic ones, people begin to question their primary loyalty. This doesn’t mean they revolt. No one really wants to do that. You only do that when you have no recourse economically and no better prospects.We reckon a retreat to a more local way of life is in the works. The rising cost of energy and capital will be one factor. And frankly, to use a Marxist term, people might feel less alienated from their labour and life if they felt more connected to their neighbours and their work. And that’s more possible in a small, more sustainable resilient community than it is in an artificial mega-city of millions. But now we’re just prattling on!


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