Two Issues

"Penny-wise but pound foolish” I’m not sure where that saying came from, and I probably misquoted it, but it is an apt description of what is currently going on worldwide, but seemingly particularly so here in the U.S. I wanted to bring a couple of issues that you may not have heard about to light.

First is something the policy makers in Europe foolishly put into place under the idea that they were protecting their citizens from a potential future crash of the insurers. They decided that they wanted insurers to have more fixed income instruments and less equity in their accounts which cover their capital adequacy requirements. Basically they want to run a “stress” test that will see if the insurers will be able to withstand a couple of financial crises like the one we just went through while still holding enough capital to pay for all policies and then some. Sounds like a decent idea right? Make the insurers carry more “stable” investments in their coffers in case large problems occur and they need to pay out. In fact it sounded like such a great idea that the policy makers are not planning on stopping there, they now want pensions to do the same thing (since they function very much the same as insurers in Europe, in fact a lot are insurers); lower their equity exposure and add fixed income. Sounds great until you realize how bonds and other fixed income funds work.

Here’s a brief snippet from Niels Jensen of Absolute Return Partners that explains a little bit of the problem created from this.

“Going forward, the main issue facing the industry (and that is the same for insurers and pension funds) is the relentless drop in bond yields. As yields come down, so does the discount rate which is used to calculate future liabilities. A lower discount rate in turn leads to a falling solvency ratio. In the first half of this year alone, solvency fell by 13% on average as a result of falling bond yields. With Solvency II only two years away, a deeply worrisome situation is developing whereby low inflation forces bond yields down which again forces insurers and at least some pension funds to re-balance their portfolios in favor of more bonds and fewer equities, which will push bond yields even lower. This self-perpetuating mechanism amplifies an already unstable situation.

I am not sure if policy makers understand how potentially dangerous this situation is. We are on the road to insolvency. And, even if pension providers manage to stay solvent, future generations of retirees are likely to run into serious financial difficulties as their retirement savings earn next to nothing, because our political leaders forced new rules on the industry, the implications of which they did not grasp.”

The second item I wanted to bring to your attention is one you have likely heard a little about. A lot of the developed and developing nations are trying to devalue their currency in order to make their exports look more attractive than those of competing nations (Brazil just came out recently and openly talked about the currency war which has been going for a while now apparently). Let’s get into a little bit of the why this is happening and then the problems it is causing and will likely cause due to policy action.

As everyone knows GDP is the measure of a countries economy. The GDP is made up of four general measurements: Consumption (by far the largest portion in our GDP), Investment, Government, and Net Exports. If you add those up you get the GDP number. Our current government had the idea that they would get out of this mess in a two step method, they would take up the slack in consumer spending with massive government spending. Obviously that hasn’t worked as well as they would have liked because due to the government’s own regulations (at least for the most part) banks are not lending the massive amount of money that they have been basically given. Because this hasn’t been working as well they now are focused heavily on part two of their plan and that is to increase the exports significantly over imports. To do that we need to have better products, fair trade agreements with lots of other countries, and a currency that’s value is hopefully lower than our competitors and the receiving country. Rather than help with the first two they have decided to play the same political games they do here and they have blamed the trade “imbalance” on others. What you have likely seen is the increasingly heated arguments between the U.S. and China. The Obama administration is pushing so much on this issue that polls are showing greater numbers of people who believe we should put in trade policies to hurt China thereby saving jobs here(future post topic).

What most haven’t realized is that even if policies were put into place they would not likely change our export numbers significantly. They might change the import numbers a little and that is where it would probably hurt U.S. consumers who rely on cheap Chinese goods and probably don’t even know it. Many also don’t know or don’t want to look at the bigger picture.

China wants to change from being primarily an exporting economy. That is how they have grown to the size they are now, but they need more stable and home grown growth and so they have begun to focus on increasing consumption. That’s not a switch that can happen overnight and definitely not one which can be made during this economic slump. It will take time, but when the switch happens we had better be in a position to capitalize on these millions of new consumers.

In the mean time, why don’t we focus on the other parts of the GDP equation? The rule is, if you want to change GDP you have to change the population and/or production. Increasing the population is not going to be likely (I base this judgment on the looks my wife and I get in public when out with our four kids) and wouldn’t help us immediately anyway. So, why don’t we work on increasing production? To do that we need to get out of the way of entrepreneurs (i.e., taxes, over-regulation, etc.) and stop encouraging laziness (I read that unemployment is as long as 99 weeks in one state); it’s my opinion that the government should be stingy with handouts and the private sector should be freer with them. If we allowed good business to grow then we will get out of this. The problem with this in the politicians mind is that it will take a while and we will only experience slow growth until then and we have to stop spending money. Those three combined would mean re-election would be difficult at best.

Of course, we could do something about that attitude. We could stop “rewarding” politicians for their stupid, short-sighted ideas by voting for them again. We need to ignore what the politicians are saying and take a look at what they have done and are doing to fix problems for the long-term. That includes those running for office for the first time. What have they done? What are they doing now?

Here’s hoping for some real change.