3 Dirty Little Secrets Of The U.S. Economy

By Leon Wilfan, Chief Investment Strategist, Cashflow For Retirement The gap in funding for U.S. state and local pensions is greater than the German economy. That is to say: If you're counting on a state pension for your retirement, I suggest you start looking at alternatives, because there's a chance the money won't be there when you need it. Leon Wilfan Most state retirement systems are currently unsustainable. They can't meet their investment targets and didn't set aside enough funds to support pension promises made to employees. Further, unfunded state and local pension liabilities have increased drastically since the last financial crisis and now exceed $4 trillion. Again, that's more than the entire GDP of Germany and nearly as large as the GDP of Japan. Looking more specifically, in 2017, Illinois' unfunded pension liabilities stood at 601% of state revenue. Next most dramatic gap as of 2017 was in Connecticut, where unfunded pension liabilities were 360% of state revenue. In Kentucky the gap was 332% of state revenue; in New Jersey 290%; and in Maryland 263%. Last year, U.S. public pension funds tried to calm the situation by projecting that 2018 stock performance would surely be so strong that it would narrow the gap substantially. We all know how that turned out. 2018 was the worst year for stock markets in a decade, closing in the red for the first time since 2008. I hate to be the bearer of bad news, but this means the unfunded liabilities gaps will widen even further. The problem is that most public pension funds continue to expect a 7% average annualized return for their portfolios. This is unrealistic in the current environment. Stocks have little room to grow at this point, and bonds are offering dismal yields. That's dirty little secret #1 of the U.S. economy right now. Student Loan Debt Bomb Will Put The Brakes On U.S. Economic Expansion In the last 10 years, higher education costs in the United States have increased by 5% per year, far outpacing inflation. This has led to the expansion of the government's student loan asset balance from $130 billion to $1.23 trillion, a near tenfold increase in one decade. This acceleration of debt puts the younger generation in uncharted territory. At $1.3 trillion, student loans are now the second-highest consumer debt category, behind mortgages, exceeding both auto loans and credit card debt. Moreover, unlike other types of debt, you can't discharge it in bankruptcy, unless you go to court and pass the Brunner test. One in seven Americans today holds student debt. The number is even greater when you consider that parents often co-sign loans for their kids. Equally alarming are the latest figures showing that 43% of those who hold student loans are behind in payments or have deferred them because of financial distress. The student loan debt bomb could significantly hinder U.S. economic performance for years. First, it will anchor consumer spending for decades in a way no previous generation has had to deal with. Second, if the interest rates on student loans continue to rise faster than inflation, eventually people won't be able to pay them back, leading to a decrease in federal revenue and an increase in federal deficit. That's dirty little secret #2. So What If U.S. Debt Increases Forever? Dirty little secret #3 isn't a secret. Federal debt is the highest it's been in 60 years and growing. In theory, the United States could increase its debt forever without going bankrupt—as long, that is, as the economy keeps growing. The key is to keep debt as a percentage of GDP at a stable level. Debt crises happen when that level gets out of control. Bond buyers get nervous, which increases interest rates and the cost of servicing the debt. This puts the country at risk of default, further fueling skepticism, interest rates, and debt-to-GDP levels. U.S. debt is now growing faster than GDP and tax revenues, resulting in a rapid increase of the debt-to-GDP ratio, which is now the second highest in the country's history, surpassed only by World War II levels. The most significant jump happened during the last financial crisis, when large deficits increased the debt-to-GDP level by more than 60% in just a few years. In 2018, the government cut taxes but didn't cut spending. This will translate into a few hundred billion additional dollars of budget deficit every year. Unless tax revenues increase or federal spending decreases, debt as a percentage of GDP will just keep on rising. You Can Profit From The Coming Storm If You Act Fast Each of these three bubbles, when it bursts, will have a dramatic effect on the U.S. economy. The federal government may have to step in and bail out public pension funds. This would result in a large fiscal deficit that would have a limiting effect on government spending for decades to come. Meantime, future generations of middle-class consumers won't be spending either, because they'll be paying off their student loans. Less spending means less GDP growth and a stagnating economy. Finally, if government debt-to-GDP levels keep on increasing, U.S. credit ratings will downgrade. This will increase the cost of debt and could even result in a full-on debt crisis. None of these three bubbles show signs of slowing down. It's imperative you have an effective risk-management strategy in place. If you don't already, you need to start working on one ASAP. Stay vigilant, Leon Wilfan