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Eye on the Market | April 9, 2012
J.P.Morgan

Q&A on the USA, with a watchful eye on the risk of giant man-eating plants; Spain

What is The Day of the Triffids?
It’s a 1951 science fiction novel. There’s a meteor shower, and most people go outside to look at it. The next morning, everyone who looked at the meteor shower ends up blind, and Earth is taken over by giant man-eating venomous plants. The point: some amazing events which look benign have unforeseen consequences. Will a pact of going for growth pay the freight of higher Federal debt in the long run? Hard to say; there are not a lot of examples to draw from. Economic theories and their associated debt bubbles don’t always work out as planned¹. After WWII, the US also faced a debt ratio of 80% of GDP. Austerity was not the answer back then; government receipts and outlays as a % of GDP did not change much during the 1950’s, and net debt was flat. So how did US debt/GDP fall from 80% to 46% in just ten years? Robust annualized real growth of more than 4.0%, and 2.0% inflation. However, unique economic conditions and productivity gains of the 1950’s (e.g., interstate highway, rebuilding of Europe and Japan) may not be repeated, and the country was not headed into an entitlement time bomb. If the US does not experience a growth/productivity boom, the burden of higher debt could last for a generation or more. A pro-growth Administration would probably help, but the difficulty lay in defining exactly what that means.

Isn’t it amazing?
[Image of starry sky/meteor shower]

1950’s debt reduction was based on growth, not austerity
[Table Headers]: Net debt (% of GDP) | Net debt (bn) | Nominal GDP (bn) | Real GDP (bn 1950 USD) | Outlays (% of GDP) | Receipts (% of GDP)
1950 | 80% | $219 | $273 | $273 | 16% | 14%
1951 | 67% | $214 | $320 | $302 | 14% | 16%
1952 | 62% | $215 | $349 | $322 | 19% | 19%
1953 | 59% | $218 | $373 | $341 | 21% | 19%
1954 | 60% | $224 | $377 | $343 | 19% | 19%
1955 | 57% | $227 | $396 | $354 | 17% | 17%
1956 | 52% | $222 | $427 | $368 | 17% | 18%
1957 | 49% | $219 | $451 | $377 | 17% | 18%
1958 | 49% | $226 | $460 | $377 | 18% | 17%
1959 | 48% | $235 | $490 | $398 | 19% | 16%
1960 | 46% | $237 | $519 | $415 | 18% | 18%
Comp. ann'l gr: | 0.8% | 6.6% | 4.3%
Source: OMB, BEA.

Are there debt vs austerity parallels at the state and local level?
Yes and no. At the state and local level, over last decade, more than 1 trillion in unfunded pension and healthcare (OPEB) related liabilities were recognized (they were accrued over a longer period). Even these “as-reported” estimates, which come from the states, may be underestimated. A 2011 analysis by the Joint Economic Committee shows that lower portfolio return assumptions on pension assets sharply increase the magnitude of underfunded pensions (see chart, right)².

[Chart 1 Title]: As reported unfunded state pension and OPEB liabilities
Billions, USD
[Graph showing rise from 0 to 1,400 billion between 2001 and 2009, divided into Pension and OPEB]
Source: State Comprehensive Annual Financial Reports.

[Chart 2 Title]: State and local unfunded pension liabilities under different portfolio return assumptions, Trillions, USD
[Bar chart showing liabilities increasing as return assumptions decrease: 8% Return (~0.7T), 6% Return (~1.6T), 5% Return (~2.2T), 4% Return (~2.9T)]
Source: CBO, Center for Retirement Research.

¹ Example: here’s a link to a 2007 article by Austan Goolsbee, former Chairman of the Council of Economic advisors and a member of the Obama Cabinet. Goolsbee praises the benefits of subprime lending and related affordable housing policies, mocks Congress for holding hearings on the subject and cites Federal Reserve papers in saying that the “mortgage market has become more perfect, not more irresponsible”. Some things are only clear in hindsight. http://www.nytimes.com/2007/03/29/business/29scene.html?_r=2
² This is why under-risked pensions may create huge problems for themselves and their associated state/local governments.

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