Of deficits and capital flight

The global economic meltdown continues to gather speed.  USA Today had a scary report this morning about how the 'Real federal deficit dwarfs official tally'.

The big difference between the official deficit and standard accounting: Congress exempts itself from including the cost of promised retirement benefits. Yet companies, states and local governments must include retirement commitments in financial statements, as required by federal law and private boards that set accounting rules.

The deficit was $5 trillion last year under those rules. The official number was $1.3 trillion. Liabilities for Social Security, Medicare and other retirement programs rose by $3.7 trillion in 2011, according to government actuaries, but the amount was not registered on the government's books.

Deficits are a major issue in this year's presidential campaign, but USA TODAY has calculated federal finances under accounting rules since 2004 and found no correlation between fluctuations in the deficit and which party ran Congress or the White House.

Key findings:

• Social Security had the biggest financial slide. The government would need $22.2 trillion today, set aside and earning interest, to cover benefits promised to current workers and retirees beyond what taxes will cover. That's $9.5 trillion more than was needed in 2004.
• Deficits from 2004 to 2011 would be six times the official total of $5.6 trillion reported.
• Federal debt and retiree commitments equal $561,254 per household. By contrast, an average household owes a combined $116,057 for mortgages, car loans and other debts.

"By law, the federal government can't tell the truth," says accountant Sheila Weinberg of the Chicago-based Institute for Truth in Accounting.

There's more at the link.  Unfortunately, it's nothing new.  We've known about this for years.  The fact that USA Today made it into a scary headline is just journalism at work, I'm afraid.  I guess someone was trying to make a splash on a slow news day.

The same institutionalized lying about the economy and national debt is, of course, evident almost everywhere.  This week alone, Spain has been forced to admit that the public debt of its regions isn't a 'mere' 8 billion Euros, as previously announced, but in reality more like 36 billion!  Still, what's a few hundred per cent increase in debt between friends?  China's economic data are also highly suspect, according to Bloomberg (and as we mentioned a few days ago).

Numbers don’t mean much. Most [Chinese] companies have three books: a real one for internal use, one for the tax bureau and one for the CEO’s wife (and, in some cases, a fourth for his mistress).

More than a decade later the practice hasn’t changed much, as has been highlighted by the recent allegations of fraudulent accounting associated with a slew of China-based U.S.-listed companies. China as a whole is a giant black box -- no one really knows what is in it. Chinese bureaucrats don’t have any interest in reporting anything that doesn’t paint a good picture, and, even if they did, the statistics bureau remains woefully inadequate.

At the same time, gross domestic product forecasts issued by major investment banks are equally unreliable. Just as with equity research analysts and stockbrokers who package IPOs and sell them to investors, major banks’ economists try to curry favor with Chinese bureaucrats. As such their forecasts are essentially a point-for-point rehash of what fiscal and monetary policies the bureaucrats say are coming down the pipe. The information is repackaged and sold as euphoria to support banks’ profit-generating activities, such as IPOs and securities trading.

. . .

There is a Chinese saying usually applied to the legal system: While the top has its policies, the bottom has its counterpolicies. In economics, if the bottom can’t meet the mandate, they cook the books and send the data back up the ranks. Everyone’s happy -- for a while.

It’s as if Mao’s proposed farming methods could actually produce the amount of crops that were being reported -- if the powers that be must be pleased, so be it. As long as the upper levels of governance maintain their authority and lower levels of governance don’t take any heat for a missed target, then everyone can be happy.

Many unbiased economists would argue that it is statistically improbable for any economy to have produced a real GDP data stream as smooth as China’s since 1980.

. . .

GDP-ism has become the Chinese government’s strongest ideology, and as such might not be an accurate indicator of reality.

Again, more at the link.  Taking China's data problems with the 'official lies' from Spain and the USA, and you see why many investors and analysts now discount almost completely the economic statistics provided by governments.  They prefer to confirm them from independent sources.  That, too, is why optimistic forecasts from governments and central banks that the current economic crisis is being resolved should be taken with not so much a pinch as a couple of tons of salt!

Capital is also taking flight from riskier countries, seeking safety.  We saw yesterday how Germany is regarded as so safe a haven that it can issue zero interest bonds - and have them over-subscribed!  Money is also flooding out of China, Russia and Italy, although its ultimate destination is unclear at this time.  There's even a suggestion that capital flight from Europe as a whole has become a serious economic factor, although this too is not yet fully clear.  The Financial Times reports that large European investment funds are dumping Euro-denominated assets.

CNBC wonders whether investors are 'running out' of safe havens for their money.

Much has been made recently of how gold no longer offers its traditional buffer against financial turmoil, with the yellow metal in a sharp pullback since early March.

But some strategists are beginning to worry that other places where investors are stowing their money — high-grade bonds, Treasurys and defensive stocks in particular — also could be losing their protective shields.

"The problem is we're seeing safe-haven flows with shrinking instruments into which you can run," says Kim Rupert, managing director of global fixed income analysis at Action Economics in San Francisco. "Once the run for the exits gets started it's going to be an absolute stampede."

. . .

Rupert worries that once the Fed is force to raise rates — either because of inflation or economic recovery — those holding Treasurys could get hammered with principal losses. Compound that with the European debt crisis [cnbc explains] and the burgeoning debt and deficit problem in the U.S., and it makes for a troubling future for government debt.

She thinks "a couple of failed auctions" would trigger that stampede in which investors, "no matter what the price aren't willing to take down one more bit of paper."

"It could just be no sovereign debt instrument is safe and people move cash under the mattress or into cans of tuna fish and ammo," she says. "It sounds very apocalyptic, but this is probably as nervous as I've ever been about conditions."

There's more at the link.

The problem is, when capital flight becomes established in so many countries - Greece, Spain, Italy, Russia, China, and doubtless others too - it gains a momentum that's almost unstoppable.  Furthermore, it's infectious.  Investors in other countries can see it happening, they become scared in their turn, and they too start to look for safe(r) havens for their money.  This may actually benefit the USA in the short term, as in (for example) wealthy Chinese emigrants seeking to 'buy' their way into this country;  but in the long term we'll get hammered too.  It's inevitable.

There's not much you or I can do about the approaching economic train-wreck except sit back and enjoy the show.  What we're seeing now are the warm-up acts.  The main event will be here shortly . . . and I doubt whether we'll have time for an intermission beforehand.

Peter