Tuesday, 06 April 2010 19:08

A Summary and Related Thoughts on the IMF's "Strategies for Fiscal Consolidation in the Post-Crisis

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The IMF has recently released a white paper labeled "Strategies for Fiscal Consolidation in the Post-Crisis World". Here's a synopsis:

Introduction:

The fiscal state of the developed world is facing the question of solvency for the first time since WWII, and this time demographic trends are incredibly unfavorable. See Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! for explicit evidence.
Current fiscal models for the developed world see fiscal tightening starting in 2011 [in 8 months governments are going to start tightening liabilities? Possible, but I wouldn't hold my breath for this one]
The only G-7 economy with debt projected at <85% of GDP is Canada [True, but is that because it is temporally behind the curve? See Easter Weekend News Update:
- Canadian Dollar Too Strong? Bloomberg.com:
- Minority opposition in Canadian Parliament is growing over strengthening Loonie
- Leaders fear fallout in exports from CAD nearly at parity with USD
- CAD strength is directly tied to Chinese commodity demand (is the CAD bubblicious, too?)
  - Relevant BoomBustBlog content (we gave you an explicit warning of this in early January): China's Most Expensive Export: Price Inflation
  - Canada is undergoing the beginnings of a housing bubble as I type this!]

Debts in emerging markets are beginning to look safer as they pare down stimulus packages plus old debt.

Potential Exit Strategies:

Inflating (debasing) one's own currency to pay off debt is too dangerous on a social level to be seriously considered, especially for emerging markets
Over the past three decades, the most successful method of managing debt and securing social safety has been to expand the primary balance surplus

Reference What Country is Next in the Coming Pan-European Sovereign Debt Crisis? - illustrates the potential for the domino effect

Click to enlarge...

Currently, the biggest step toward renewing primary surpluses in the developed world would be to phase out entitlement/pension funding or drastically modify payout schemes

[But who really knows where all of the bodies are buried? Reference Smoking Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer Beware!

The French

In 1997, the French government received an upfront payment of £4.7 billion ($7.1 billion) for assuming the pension liabilities for France Telecom workers in return. This quick cash injection helped bring down France's deficit, helping the country to meet the pre-condition to join the Euro zone. You may reference the pdf Laurent_Paul_and Christophe_Schalck_study for a background on the deal. I don't necessarily concur with their conclusions, but it does provide some info

For the record and according to the doc referenced above, according to the State balance sheet for 2006, total pension liabilities of civil servants have been estimated at 941 billion €, i.e. 53% of annual GDP in France. An attempt to reform all special schemes in 1995 collapsed because of severe strikes on the railways. Sounds awfully Hellenic in nature, doesn't it??? I, for one, believe that Greece is getting a bad rap, and not becaue it is being falsely accused but because it is just a lot sloppier at covering up its shenanigans than its European neighbors.

Now, back to France. A transaction similar to the France Telecomm deal took place in 2006 with La Poste which still employs 200,000 civil servants, but is now facing the same evolution as France Telecom in 1997. But an important difference with France Telecom is the obvious insufficiency of the lump sum paid by the postal company (2 billion €) compared to the amount of pension liabilities transferred (70 billion € at the end of 2006).

Almost 1/5 of public spending stabilization could come without affecting public investment, and simply cutting wage and transfer payments
The IMF recommends setting up government institutions to enforce budget restrictions (the ridiculousness of one government entity stopping a handful of spendthrift entities is mind boggling)

Global Adjustments:

Emerging markets that have opted to inflate away debt have seen interest rates skyrocket for years, while other who opted to adjust the primary balance deficit have seen interest rates fall
The average G-20 nation will need to adjust its balance sheet 8.8% by the end of the decade to reach public debt targets [RIIIGHT!!!! Like the Maastricht Treaty which, after 18 years has been respected by exactly 0.000000% of its members, all of whom are well below the 3% debt to GDP threshold by about an average of negative 300%!!!!]
Over the past 30 years, Greece has made a "large fiscal adjustment" once (1995), where they had more success generating new revenue, andbarely managed to cut expenditures. Greece's inability to make any sort of cuts to preserve fiscal responsibility is going to embarrass the cheerleaders looking to save Europe without lifting a finger. Spanish and Italian efforts have yielded similar results

Long Term Growth:

Over the previous 15 years, a clear inverse relationship has developed between debt ratios and real GDP growth
Evidence on whether adjustments should be upfront (shock therapy 1990's) or gradual is inconclusive according to IMF staff
One of the easier methods of reducing public expenditures is to tighten and reform pension policy (the days of mandatory retirements, backloaded payouts based on final five years average salary, etc, are numbered)
Countries with higher domestic debt ownership are more likely to honor debt and have higher debt tolerances among citizenry (i.e. Japanese JGB hoarding vs. USA tea parties)

Conclusion:

The IMF has an incredible data set to work with yet somehow continues to see a picture far rosier than what meets the eye. The impacts of measures to manage sovereign debt loads seemed to be futile in the medium-long term. The situation we currently see is similar to the 1950's in data only. The demographic makeup of the world today (particularly in Europe) is one that is aging, dependent on entitlement programs, and underfunded pensions that are seeing falling/no incoming revenue. This is a clear contradiction to the call for managing or reducing entitlement and wage expenditures at the government level (globally), and is a sign that fears over a global sovereign default among advanced economies is a legitimate threat over the next decade.