April 24, 2018
Crisis of States
If you live in Florida, you can see the mass exodus of people moving from high tax states such as Connecticut, New Jersey, New York, Illinois and other states whose tax rates have created a burden on the pocket books of those residents. Those state leaders should expect to see a dramatic loss of their taxpayer bases, due to their profligate spending, and dreadful mismanagement of their state finances. New federal tax changes to the deductibility of state income and property taxes will only increase the flight from these states. Approximately 7 ½ years ago, Meredith Whitney in her 600-page report “Tragedy of the Commons”, described murky patterns of spending, revenues and benefits programs, and likened states poor disclosure and accounting rules to those used by the banks before the 2008 – 2009 financial crisis. She was taken to the woodshed, and hasn’t been heard of much since. Many of the problems she described, such as states leverage to the housing market, growing pension liabilities and other postemployment benefits, as well as increasing long term liabilities, have not gone away, but rather have only increased in scale. A fair amount of complacency in the muni market, combined with financial stress and/or default by states as we have seen recently with Puerto Rico, could very well add fuel to the next economic crisis. The following tables from the Mercatus Center at George Mason University published in 2017, illustrate just how profound many states debt and finances have become. At the end of this report is a summary of their findings, as well as a link to their website for further in-depth analysis.
Respectfully yours,
Emerson Letter Editor
November 13, 2015
The Return of Cash Flow & Value Investing:
Recent comments from a very bright colleague in the financial markets, have inspired me to write this latest Emerson Letter. He most insightfully stated that cheaper and cheaper corporate debt prices will diminish the appeal of equities. This will prove to be a time of opportunity for credit investors. Financial markets will also increasingly mirror markets of the late 1970s and early 1980s, where Graham and Dodd value and cash flow driven investing proved to be profitable. Those investors who know how to invest in negative trending markets will thrive.
Central Bank QE, ZIRP and NIRP have created massive multi-asset bubbles. These debt-financed bubbles across many industries, most specifically the energy industry, are and will continue to pop, and the subsequent re-pricing of these credit markets will be very bullish for credit opportunity funds. Old fashioned credit work, combined with a shrewd understanding of potential outcomes, will reward those patient investors with new cash to invest. Due to cheaper and cheaper credit markets, equity markets will simply become an unattractive and an unpredictable place to invest.
As my astute colleague commented, the page is turning and the only way out is through the “flaming door” of rising interest rates. The Fed and other Central Banks led the world into this easy money environment, they will have to try and gently lead the world away from low interest rate policy. Jim Read from Deutsche Bank has described their unconventional actions in the past 9 years as “Plate Spinning.” Each year, as these unconventional policies prove more and more fruitless, the Central Planners have simply added more “Spinning Plates” from their newfound policy toolboxes. Will they be able to slow down the spinning of the plates before they all coming crashing down, or are current dislocations and re-pricing in various credit markets including energy and materials a forewarning of a deeper credit adjustment to come?
Respectfully yours,
Editor@EmersonLetter.com
October 22, 2014
Everyone Wants a Free Pony
One true measure of a sovereign’s ability to service its debt is Total Debt to Total Revenues. In the last dozen years, Total US Public Outstanding Debt to Total US Treasury Revenues has doubled from 3.25X to 6.50X. Even after 4 years of ZIRP and a Nationalized Yield Curve, US Treasury Debt to Revenues remains at historically high levels. And these debt figures don’t even include Fannie and Freddie debt which together would add another $5 trillion to the tab. The administrators of this country simply spend too much. This addiction to spending started a long time ago, and has continued unabated for decades.
We continue to hear arguments that rising debt inhibits economic growth, retards inflation, and thus pushes down interest rates. Although rising debt levels inhibit growth and retards inflation, at a certain point rising debt levels will no longer result in lower interest rates. It is illogical and unsustainable to assume that debt levels can continue to climb without an eventual exhaustion of a sovereign nation’s balance sheet. At a certain level, new debt created to service old debt and “create growth”, is simply ineffective. Furthermore, it is also unreasonable to assume that the cost to service this debt will remain low forever, due to current artificially low interest rates.
The following chart characterizes this addiction to debt, and the urgent need to address this issue before we fall into the footsteps of Greece and other sovereign nations who simply spent more than they earned.
Respectfully yours,
Editor@EmersonLetter.com
October 15, 2014
The End of Monetary Inflation & Kicking the Debt Addiction
SHOT ACROSS THE BOW
The recent financial crisis is a shot across the bow; a warning for us to get our personal, corporate and governmental financial houses in order.
QE1: NECESSARY, QE2: SUSPECT, QE INFINITY: BEYOND OVERKILL
Although QE1 was necessary in order for financial markets to avoid spiraling into an abyss, the excessive money creation that has followed (QE2 & QE Infinity), has only enriched the net worth of the wealthiest households. This money creation is not flowing into Main Street, but rather it has benefited primarily those who own financial assets. According to a recent Pew Research report, during the 2009-2011 period, the mean net worth of households in the upper 7% of the wealth distribution rose by approximately 28%, while the mean net worth of households in the lower 93% dropped by 4%. QE2 & QE Infinity is a rich man’s medicine.
During the past three decades, government solutions to each financial crisis have been to lower interest rates, increase the ease and availability of money, and increase debt levels. This is a form of can kicking the problem down the road. You can only paint over paint for so long, before all of the coats simply fall off. It is one thing to open the money spigot to stem a financial panic, but yet another to attempt to create prosperity through central banking models. Central bankers are addicted to debt creation, and are indeed no different from a drug addict who is unwilling to admit his addiction. Unfortunately, we have now arrived at a point where the creation of incremental debt is no longer producing the desired effect on our already heavily indebted nation. We need to address this “tsunami” of debt, or spiral into financial chaos.
Failed or non-existent budgets and policy are both being supported and subsidized by global central bank purchases of government debt and de facto nationalizations of yield curves. These actions are nothing more than a broad debasement of fiat currencies, a tax on savers, and a free pass to politicians who mask fiscal policy failures and continue to spend way beyond their countries’ means.
We have had six years of Zero Interest Rates, and Trillions of Dollars of Monetary Bribery. Due to these central bank policies and actions, bubbles have been created in real estate, bond & equity markets, and private equity markets. Debt supporting these policies has been piled onto global sovereign balance sheets. This debt must be repaid or extinguished at some point in time. Since almost no public authority has come to explain exactly how we will address this debt issue, as a nation the time has come for an honest conversation on the efficacy of these central banking policies, and their true costs-both long-term and short-term.
Below, you will find various charts showing the addition to debt by the US Government.
Respectfully yours,
Editor@EmersonLetter.com
September 15, 2011
Addicted to Debt
We are addicted to debt. We live in a make-believe world, pretending that there are no consequences to living beyond our means. We have become a nation of borrowers instead of savers; a nation of debtors instead of creditors. This addiction has resulted in the erosion of our cultural life. Just as with alcoholism, the addiction to debt has significantly undermined the stability of our families, our spirituality and peace of mind. Our government encourages this addiction by telling its citizens to spend, borrow, and buy lottery tickets. The recent financial crises demonstrate that this debt binge must end.
During the past three decades, our government’s solution to each financial crisis has been to create more debt by lowering interest rates, and to increase the ease and availability of money. Because previous interventions have generally stabilized financials markets, our political and financial leaders believe that this same prescription is the answer. Unfortunately, we have now arrived at a point where the creation of incremental debt is no longer producing the desired effect on our already heavily indebted nation. We need to address this “tsunami” of debt or spiral into financial chaos.
The current deleveraging process is painful, but this withdrawal is necessary in order to achieve true economic health. Our belief that debt is a cure-all elixir must end. We have deluded ourselves into believing that easy money is the solution to every hiccup in asset prices. Our national income simply cannot sustain current and future debt in the financial system (see attached charts). Unlike Alice in Wonderland, this is not just a bad dream from which we will one day wake-up without real life consequences.
Respectfully yours,
Editor@EmersonLetter.com
