Really Bad Ideas (Part 2: Giving Up Without Admitting It)

Doing the right thing is hard for both individuals and their governments. Name the goal – maintaining a healthy weight, paying off high-interest credit cards, keeping debt-to-GDP at reasonable levels, whatever – and with each missed deadline or broken promise success recedes further into the distance. And the temptation grows to just give up and pretend that the goal never really mattered.

This is happening everywhere. In the US, state and local pension plans are underfunded to the point of becoming a political (not just a long-term financial) issue. And governments, confronted with the resulting set of unpalatable options, are surrendering without admitting it. In California, for instance, the governor is proposing to fund part of its several hundred billion dollar pension liability by, believe it or not, borrowing more money:

California Proposes $6 Billion Boost to CalPERS

(Chief Investment Officer) – California Gov. Jerry Brown’s revised state budget proposes a $6 billion supplemental payment to The California Public Employees’ Retirement System (CalPERS), which he says will save the state $11 billion over the next two decades.

The supplemental payment effectively doubles the state’s annual payment. It is intended to ease the effect of increasing pension contributions due to the state’s unfunded liabilities and the CalPERS Board’s recent decision to lower its assumed investment rate of return to 7% from 7.5%.

California currently has $282 billion in long‑term costs, debts, and liabilities; $279 billion are related to retirement costs of state and University of California employees, according to the revised budget.

“These retirement liabilities have grown by $51 billion in the last year alone due to poor investment returns, and the adoption of more realistic assumptions about future earnings,” said Brown in his budget.

The funding for the supplemental payment will be paid through a loan from the Surplus Money Investment Fund.

Borrowing to make a pension payment is known as a “pension bond,” and is analogous to funding your kid’s private school tuition with credit cards. It gets you through the year but at the cost of potentially-big trouble down the road. In California’s case, the assumption that the pension fund will generate a higher return on its investments than the state has to pay to borrow requires a continued bull market in stocks and bonds to work out. In a bear market – which based on history is seriously overdue, pension assets will depreciate, while the state’s debt will not. Result: An even bigger mess, very possibly resulting in some form of bankruptcy on the part of the pension funds or even the state. For a glimpse of where the pension bond mindset can lead, see Fear of junk bond ratings hangs over Illinois budget crisis.

Japan, meanwhile, is like one big, grossly-underfunded pension plan. Its government debt is the world’s highest relative to GDP and it has been trying, without success, to get its fiscal house in order for decades. Recently it came up with an excuse to stop trying:

Free education gives Abe cover for delaying debt reduction

(Nikkei Asia) – Japanese leader may be wavering on achieving a primary surplus by fiscal 2020

Japanese Prime Minister Shinzo Abe is mulling a constitutional change to guarantee free education.

TOKYO — As Japan debates its core economic policy for this year, Prime Minister Shinzo Abe is seizing on a proposal for free college education as a way to stimulate spending and possibly push back the debt reduction deadline.

“Higher education must be truly available to all citizens,” Abe said in a policy speech on Jan. 20, signaling his support for amending the constitution to eliminate tuition for kindergartens through colleges. But he did not once mention achieving a primary balance — matching government spending excluding debt-servicing costs with revenues — even though it was frequently brought up in previous statements.

Abe seems to be responding to a proposal by opposition party Nippon Ishin no Kai, which wants to revise the constitution to guarantee free education. In a meeting with party chief Ichiro Matsui and legal adviser Toru Hashimoto on Dec. 24, the prime minister stressed that he needed the party’s cooperation and political expertise in achieving the agenda.

Nippon Ishin no Kai’s plan will cost Japan an estimated 5 trillion yen ($44 billion) a year. While it is almost impossible to secure such a large sum through the regular budgetary process, the government may legally be required to do so if the constitution explicitly guarantees free education.

Free tuition would be a boon to Abe’s own agenda as well. If it frees up the 5 trillion yen Japanese households spend yearly to send their children to school, they can use the cash elsewhere to help Japan overcome deflation. The government will be able to address deflation and change the constitution at the same time, while also coming up with an excuse for postponing its goal to achieve a primary surplus.

Abe found further support at an economic policy meeting on March 14. His guest, Nobel Prize-winning American economist Joseph Stiglitz, stressed the importance of investing in education while asserting that the Japanese debt load is not as grave as people thought. The Columbia University professor argued that the Bank of Japan should work with the government to cancel debt.

“Professor Stiglitz articulated what I have always wanted to say,” Abe said, welcoming the statement. He also echoed Stiglitz’s assessment that Japan’s fiscal situation did not call for much concern.

There it is: The goal was never that important, and now we have a new goal – free education – that takes precedence. So put a pin in the fiscal responsibility thing and we’ll revisit it later.

This is pure — and depressingly familiar — rationalization. Behaving with discipline turned out to be hard, so never mind. The consequences of which are the same as for a grossly overweight person who gives up trying to get in shape: a stroke, heart attack or some other catastrophe somewhere down the road. In financial terms this translates into massive cuts in public services, higher taxes, declining standards of living and eventually a financial crisis that starts in the mis-managed periphery and spreads to the core of the system.

Courtesy of Dollar Collapse