The Daily Reckoning December 20th

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The Entitlement Cliff

The Welfare States of the Developed World are “long growth.” Without it, their finances are doomed.

First, a little background…

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Generally, investors will pay more for a dollar’s worth of earnings from a stock than from a bond. Stocks are riskier than bonds, in the sense that share prices tend to go up and down more, depending on company results. But investors believe this ‘risk premium’ is worth it, because there is more ‘upside’ in stocks; they will grow with the economy. Over the long run, therefore, the rate of return on stock market investing should more or less reflect the stream of dividends received, plus the rate of growth in the economy. If the economy doesn’t grow, however, the risk premium becomes a costly artifact of an earlier age.

Pension and insurance funds, too, count on growth. They collect money. They invest it and make projections based on what they consider a likely rate of return. The difference between what they collect in premiums…and what they need to invest to cover their costs and payouts…is profit. As of 2012, the typical pension fund — such as those operated by state and local governments — was banking on a rate of investment return as much as four times higher than the GDP growth rate. If growth does not pick up, these funds will go broke.

Private households, pension and insurance funds all are on one side of the trade, betting that growth rates will recover to those of the ’80s or ’90s. If so, disaster might be averted. Higher growth rates will permit governments to keep the rate of debt growth in line with revenue increases. But if growth doesn’t recover, public finances all over the planet are doomed.

Over the last 4 years the number of people on disability has risen more than 7 times faster than the number of people with jobs. The number of people on food stamps has increased by 17 million during Obama’s term in office. From the beginning of Obama’s first term to the end of it, approximately 4.6 million jobs disappeared. But the number of additions to food-stamp and disability roles jumped 21.2 million.

Why were so many more people suddenly disabled? Was there a plague that struck the nation? Were millions crippled in a nationwide auto pile-up? Of course not. Instead, in a low-growth economy, $1,000-a-month without working had begun to look pretty good.

“You get what you pay for,” said Milton Friedman. You pay people to be disabled. You get plenty of them.

Everybody’s worried about the fiscal cliff. But there’s a much bigger cliff coming up, and it’s the “Entitlement Cliff.” In the four years since Obama took office, entitlement participants have grown exponentially.

Driving through East Baltimore recently, I saw slews of billboards with ads by shyster lawyers encouraging poor people to get in on disability payments or to sue their employers or their landlords. Here’s one of the billboard ads:

DENIED DISABILITY? Call THE FIRM. The Cochran Firm.

Johnnie Cochran was the lawyer who successfully defended O.J. Simpson. Now his firm has 30 offices around the country helping people get on disability. Apparently, he’s been pretty successful at this too.

Change in Social Security Disabilty vs. Change in Employment

More and more people are finding ways to get paid without contributing to useful output. This is just another part of the reason that growth slows: much of the society’s energy is diverted to unproductive uses.

I had not gone to East Baltimore for pleasure. I was going there to waste energy. Specifically, the state of Maryland required me to have my auto emissions checked. Practically everyone with an automobile is now required to drive where he doesn’t really want to go…wait in a line he doesn’t really want to be in…and pay $14 to have his auto emissions checked.

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As Bastiat reminds us, there are always unseen consequences as well as those that are obvious. For every ‘bad’ auto the test uncovers — whose emissions are unnecessarily noxious — many more good autos are forced to drive miles and miles they didn’t otherwise have to drive, just to take the test. At the test station I used there were six lines of traffic…about six cars in each line…and each idling its motor while waiting to move forward.

“It’s worse than that,” my secretary volunteered.

“The test doesn’t work on newer cars, or at least some models of them. So, you get there…they take your $14 and they just waive you through.”

But emissions testing is now a part of the complex economy. Entire industries are devoted to it. Employees are trained to do it. And lobbyists work hard to keep the whole thing going, whether it really makes any sense or not. Once again, it was Milton Friedman who pointed that “there is nothing as permanent as a temporary government program.”

And so, a part of the nation’s energy — time, money, fuel, capital, engineering ability — is now taken up by emissions testing. Little of this shows up as government spending. It is the private sector that spends the money. You may think of the security checks in airports if you want to find a parallel. Millions of people spend millions of hours per year — an immense ‘investment’ of energy — merely keeping people who had no intention of blowing up airplanes from doing so. Or, think of filling out your tax forms. It is a cost imposed by government, but not included in the federal budget.

How much of the economy’s energy is sapped by these unproductive activities?

Nobody knows. But it must be a lot. Every business now has its own overseers and regulators. Every one spends time and money complying with complex regulations — many of which did not exist a few years ago.

According to the latest estimate, Americans spend 6.1 billion hours just complying with tax legislation. And think of the new paperwork blizzard Obamacare has imposed. Think of the law firms and accountants who work full time trying to figure out how to comply with Fatca, Dodd-Frank and other financial regulations.

Google Dodd-Frank and you get 5,460,000 hits. Each one is an attempt to understand, influence, implement or comment on this legislation. And most of this activity occurs in the private sector of the economy, where it is recorded as positive increments to the GDP! But it is a huge diversion of resources, taking them away from what might otherwise be useful and productive activity.

An article in Cato Institute’s “Regulation” magazine, Fall 2012, shows the cost of the 10 Top Regulations Affecting Small Businesses. These are: Energy Conservation Standards, Affordable Care Act Menu Labels, Transportation’s Hours of Service Rule, Affordable Care Act Vending Machine Labels, NLRB’s Union Notification Standards, Education’s Gainful Employment Rule, EPA’s Fracking Regulations, Dodd-Frank Regulation Z, Affordable Care Act Physician Fee Schedule, Dodd-Frank Regulation E. Together these cost small businesses $3.5 billion annually, according to the study. And they add 28.7 million hours of paperwork.

We don’t have to decide whether Dodd-Frank or emissions testing or airport screening is good or bad…necessary or unnecessary…we only have to recognize that much of our energy is now spent on things that reduce output. As another measure of how much time and energy is wasted, data from the Mercatus and Weidenbaum centers show that budgets for the main federal regulatory agencies multiplied 14 times between 1960 and 2007, in constant dollars. The payoff from all this extra investment is hard to measure; most likely it is starkly negative.

Nor do we have to single out the US as particularly wasteful. France is worse, with more than 50% of the nation’s GDP spent by the government. But all mature economies drift towards unproductive activity like old elephants heading for the burial ground. Either they don’t know what happens there. Or they feel compelled to go in that direction anyway.

Regards,

Bill Bonner
for The Daily Reckoning

The Entitlement Cliff appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

The Irreversible Plight of the Aging Welfare State

Eighteen years ago, Morgan Stanley’s Investment Strategist, Byron Wien, quipped, “Unless Europe engages in an extensive program of restructuring, in 20 years it will be a vast open-air museum.”

But Europe did not restructure herself. Instead, she clung tenaciously to her beloved Welfare State. As a result, the museum’s doors are now open…and what a delightful museum it is!

Every exhibit hall features fascinating artifacts of capitalism and/or real-time interactive displays of the “Welfare State in Motion” — i.e. in stasis. The “Paris Exhibition” gets our top vote: Plop yourself down at a café table, sip a $15 cappuccino and watch unionized employees pretend to work.

Be sure to put it on your bucket list.

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As museums go, this one may be the most dynamic and expansive one on the planet. If current trends continue, a brand new “American Wing” will be opening soon. In fact, to judge from the graphic below, this museum may soon have docents strolling the streets of almost every major economy in the Developed World.

The Shifting Composition of World GDP Over the Last Decade

During the last decade, the six largest economies of the Developed World lost “market share,” while six of the seven largest economies in the Developing World gained market share. America’s share of world GDP, for example, plummeted from roughly 32% to 22%. By contrast, China and Brazil both doubled their shares of world GDP, and most other Emerging Economies posted similar results.

These data points show the world as it is; not as we might like it to be…and certainly not as Americans believe it to be. Yesterday’s superstar economies are fast-becoming today’s has-beens, while many of yesterday’s basket-case economies are fast-becoming today’s dynamic upstarts.

Despite this palpable reality, most Americans continue to invest as if past performance does, indeed, guarantee future results. They prefer the “known quantity” to the “unproven prospect.” Problem is; the “known quantity” doesn’t really exist. The “known quantity” may be known, but its future performance is a complete unknown…as the history of sport frequently reminds us.

In 2007, the final year of Roger Clemens’ legendary, 24-year baseball career, he signed a $28 million contract to wear Yankee pinstripes. He would go on to win six games (and also to lose 6 games) that season with an ERA of 4.18. That’s almost $5 million per win, or $5 million per loss, depending on your perspective.

That same year, the L.A. Galaxy soccer team paid $250 million to import soccer legend, David Beckham, for a five-year contract. During those five years, Beckham spent lots of time nursing injuries and very little time leading his team to victories. Sure, he delivered a few memorable moments on the pitch, but not $250 million worth.

Known quantities may be familiar, but that doesn’t qualify them as intelligent investments. Out in the global economy, for example, many of the preeminent known quantities are losing their edge to relatively unknown up-and-comers.

Half of global GDP is now produced by what we call the Emerging Markets. Looking farther out, the IMF expects the Emerging Markets to produce more than 60% of the world’s GDP growth over the next four years — or about five times the growth the G-7 countries will contribute.

The IMF has been known to make a mistake from time to time. But its forecast is probably close to the target in this case. So perhaps the time has come to cast aside our fears and to embrace the world as it actually is, not as we might like it to be.

Aging superstar athletes cannot rejuvenate themselves…and neither can aging Welfare States.

Eric Fry
for The Daily Reckoning

The Irreversible Plight of the Aging Welfare State appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Down and Out In California

Gas in Vegas is a dollar cheaper a gallon than in the Golden State, or so a friend and recent LA transplant tells me. He went on to say the top tax rate in California is over 13%, while, of course, Nevada has no state income tax.

Over dinner at Del Frisco’s, he explained how industries are being ruined by runaway government in his old home state. Nevada would surely benefit from businesses making their escape. Plenty of people are leaving California — nearly 700,000, I read somewhere — however, my friend says these 700,000 have been replaced by an equal amount of uncounted “illegals,” as he put it.

The California legislature has democratic supermajorities in both chambers, and of course, California voters have determined that what ails their great state can be fixed with the return of Jerry Brown to the governor’s mansion.
But what really ails California, like many other states, is mathematics. The state’s inflow doesn’t cover its outflow. Like Greece, California can’t print its own currency (although it does resort to IOUs occasionally). Gov. Brown was stunned to find a $28 billion “wall of debt” when he took office.

How’s this happen in a state with so much going for it?

California is one of many despotic states that are losing residents in favor of those that are less despotic.
People are leaving the red for the green, and none is redder than the one-time golden state. Here is a picture of what freedom does (it attracts people) and what tyranny does (it drives people away). Fear not: pick up and move! It’s more effective than political action.

In general, state governments don’t seem to be the best negotiators when putting together pay and retirement packages. There’s something about spending someone else’s money that makes one less careful than if spending his own.

“It starts with the governor and the legislature and wanders down the line. These people are playing with the taxpayers’ money,” said Steven Frates, research director of Pepperdine University’s Davenport Institute.

States paid out more than $711 million to 111,000 people who left jobs as employees of the 12 most populous U.S. states last year for unused vacation and other paid time off, according to payroll data on 1.4 million public workers compiled by Bloomberg.

Employees from California accounted for 39% of that total. Since 2005 the Golden State has shelled out $1.4 billion for unused vacation and other paid time off. That kind of money would put a lot of cops on the beat and teachers in classrooms. Instead, this taxpayer dough is ensuring cushy retirements for government workers who are no longer on the job.

For instance, the state of California cut a $608,821 check to psychiatrist Gertrudis Agcaoili, who retired last year from a state mental hospital in Napa, Calif. Ms. Agcaoili kept her nose to the Freudian grindstone for 30 years, not taking vacation, and now she’s cashing in. She makes no apologies, telling Bloomberg, “It was my prerogative, I did not go on vacation.” End of interview.

But in the private sector, vacation is a use-it-or-lose-it proposition. Or maybe a few weeks can be banked, but not 72 weeks like Ms. Agcaoili had, who pulled down $2.4 million in pay from the state since 2005. And there should be no fear that Ms. Agcaoili will be dining on cat food in her retirement: The California Public Employees’ Retirement System (CalPERS) will be paying her $199,000 a year in pension payments.

Since the state is so short on money, employees have actually been encouraged not to take their vacations. In fact, the state is happy to accommodate them, because filling in for vacationers is costly.

“Requiring employees to take all of their leave would have increased overtime costs at state prisons and hospitals, lowered reimbursements in tax collection and other fee-generating programs, and reduced services in other settings,” state of California HR man David Gay told Bloomberg.

Prison guards in California can now accrue unlimited vacation time courtesy of Gov. Brown. According to California’s nonpartisan Legislative Analyst’s Office, the average prison guard has accumulated 19 weeks of unused vacation, a liability estimated at $600 million. These are the same prison guards that received a 34% raise in pay from Gov. Gray Davis when he was in office.

“Of the 100 biggest payments in 2011 in the dozen [most populous] states, all but 10 went to California state workers. The average payout for the top 100 was $178,267, in addition to regular wages,” says Bloomberg.

There’s a rule limiting the accrual of unused leave to 640 hours, but everyone ignores it. Well, evidently, as Bloomberg reports, unused leave grew from $1.4 billion in 2003 to $3.9 billion in 2011.

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Paying out for the accrual of unused leave would bankrupt a private company. While government workers are always believed to be underworked, many assumed they’re underpaid as well. Not hardly, as Michael B. Marois & Rodney Yap explain:

“The lump-sum retirement payments, seldom granted in private industry, mirror a broader trend in which California’s public employees receive far more than comparable workers elsewhere in almost all job and wage categories, from public safety to health care, base salary to overtime. California, the world’s ninth- biggest economy, has set a pattern for lax management, inefficient operations, and out-of-control costs, the Bloomberg data show.”

In addition to Ms. Agcaoili, other state employees are cashing in big. A highway patrol officer collected $484,000 in pay and pension benefits while 17 employees received checks of more than $200,000 for unused vacation and leave. According to Bloomberg’s data, the best-paid staff in other states earned far less for the same work.

But California is hardly alone with inflated government salaries. Firemen in Clark County, Nev. (Las Vegas), routinely make well into six-figure salaries and overtime pay. The first several pages of these salaries compiled in 2009 by Las Vegas Channel 8 are firefighters making well over $100,000.

Ms. Agcaoili is 79, but many cops and firefighters retire in their 50s, collect nearly 100% of their salary as a pension, and then start new careers.This leaves cities and states to pay for two or three cops to have only one on the beat.

The math just does not work. The clock is ticking on California. People are fleeing. Soon it will not be so golden.

Sincerely,
Douglas French

Original article posted on Laissez-Faire Today 

Down and Out In California appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

If The Market Plummets, Buy These Midstream Assets…

Investing in your favorite oil driller or gold miner is risky business.

Resource companies, like these, go to great lengths. Whether it be mining for gold hundreds (or thousands) of feet underground in South Africa or drilling for oil amidst the rolling sea-swells in the North Sea, it takes a certain ilk to profit in this business.

Investing in these plays harkens the same level of expertise.

Today I want to take a look at a few pitfalls in the resource sector. But, instead of lamenting about profits we could’ve made, I want to take those lessons learned and hand you one simple strategy to stay ahead of the S&P or any other market barometer in the year to come.

First though, let’s lament.

The resource sector is filled with pitfalls. Looking at your own portfolio I’m sure it’s easy to pick out the stocks you shouldn’t have bought. Same goes for my calls…

Back in 2009 I remember beating the drum for one specific oil company (BP), because of its superb ability to get oil to the surface efficiently and pay a nice divided.

Then, as it were, if you followed the news in spring of 2010 then you know BP’s Macondo well blowout in the Gulf of Mexico was a tragedy of epic proportions. Something that even this big oil standout couldn’t stop.

The tumble in BP’s share price couldn’t be stopped either. Along with falling from over $60 to under $30, the company cut its longstanding dividend. If you were looking to weather the storm, this wasn’t your shelter.

Yep. To say investing is tough, in these proverbial waters, is quite an understatement.

Same goes for some of the gold mining woes we’ve seen this year.

Don’t get me wrong – I like, scratch that, I LOVE big oil and big gold companies – but even the big dogs in the gold sector appear to have their tail between their legs.

As we’ve covered extensively, this year (and last) has been a struggle for big gold. Miners can’t control costs and gold is getting harder to find (in large mineable amounts.) Add it up, and buying into these companies, much like the BP buy turned out to be a 24-month disaster.

Luckily there’s a strategy that could get us back on track.

An Investment Strategy For 2013…

Okay, enough of the bad news and horror stories in the resource sector. Like any savvy investor, we need to get up, dust ourselves off and keep an eye out for the best way to keep making money.

Today I see an opportunity right in our wheelhouse – that still has plenty of upside.

I’m talking about “midstream” players. These are the companies that transport and process oil and gas that flowing profusely from America’s shale patch. Earlier this year we covered a similar idea – something that is referred to as the “harvest” phase.

Today there’s mounting evidence that these players are going to continue to rake in money – by charging a fee for transport of oil and gas – and continue paying solid dividends.

The story is easy to follow, too. With each passing day the U.S. is producing more barrels per day. This simple up-tick in production is creating all sorts of opportunities around the country. All of a sudden there’s a glut of oil in Cushing, OK. Who profits from this glut? The guys that can move the oil.

Same goes for natural gas. With so much of the stuff flooding the pipelines there’s plenty of opportunity to process and move it. Propane, Butane, Ethane… any company, from Texas to Pennsylvania, that can process this gas stands to make a buck. And better yet, pass some of that buck a long to you!

Here’s a few of the best midstream players we’ve covered:

• Access Midstream Partners LP* (ACMP) – 5.4%
• DCP Midstream Partners LP (DPM) – 6.8%
• Plains All American Pipeline LP (PAA) – 4.7%
• Williams Partners LP (WPZ) – 6.6%

[*Note, this is the former Chesapeake Midstream…
a spin off from Chesapeake’s ailing energy company]

With more oil and gas flowing – through pipelines, trucks and railways – these logistic companies are in the right spot of this budding market (and the list above is by no means exhaustive, either!)

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Remember, production from many of the now-prolific shale plays in the U.S. is just ramping up. Take a look at the table I shared back in October:

More oil and gas, regardless of price, will mean big things for the U.S. midstream sector.

That’s great news for us. But it gets even better…

First, these midstream companies love to pay consistent dividends. At a time when the Federal Reserve is printing U.S. dollars like Chinese carry-out ads, these stable dividends couldn’t come at a better time.

Second, we’re still keeping an eye out for a pullback in market prices. That said, if any of these midstream assets fall in price – due to the fumbling U.S. Congress – there could be a short window of time to pick em up on the cheap. That means lower entry price and higher dividend payout.

Getting back to our discussion above, the U.S. midstream sector is one of the safest places to stock some investment cash. A lot of the variables that can plague other resource sectors – dry holes, bad core results, high costs, and overzealous management – don’t apply here. Simply put, these are some of the most straightforward resource bets you can make.

If you’re looking to stuff your portfolio with homegrown dividend plays, hopefully on the cheap, you’ll want to keep an eye on the midstream guys.

Keep your boots muddy,

Matt Insley

Original article posted on Daily Resource Hunter 

If The Market Plummets, Buy These Midstream Assets… appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

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avatarThe Daily Reckoning - The Daily Reckoning posted Thursday, December 20th, 2012.

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