Why I’m Not Worried About China

There are a lot of folks out there that seriously believe that China is not only a rising superpower, but that they will dethrone the U.S. as the global leader. While there are many home-grown reasons for why the U.S. may tumble from the throne, I’m pretty sure it won’t be because of China’s ascendance.

The chart below shows why–Demographic Winter. New population projections from the U.S. Census Bureau shows that China’s population will peak at 1,395,015,000 in 2026 and will go into a free-fall shortly thereafter.

By 2050, China’s population will have already fallen by 100 million people. More troubling, the annual population decline will be averaging 6 million people per year with the drop accelerating by 300,000 per year.

In contrast, the U.S. population is forecast to grow continuously reaching 422,554,000 by 2050. This also means the U.S. will have a more balanced age pyramid than China. Both are good for economic growth.

Of course, forecasts can be wrong. If China’s forcast is wrong, it’s most likely because the Census Bureau is understating the demographic cliff the country is facing. I recently came across a story in The Telegraph by Xue Xinran which stated:

Today, more than half the number of divorces are between people in their twenties and thirties, most of them from the first generation of the single-child policy. Many of this generation don’t even want children. Some don’t like the idea of being ousted from their position within the family; others say they simply don’t have the time to care for a child. At least they know their limitations. In the last five years, there have been numerous cases of two and three year-olds who have suffocated to death in family cars. Why? Because their distracted parents entrusted them to the care of drivers who left them locked in airless cars while running errands. It’s hard to take in, but it’s happening.

A one-child policy is bad enough, but a no-child policy is societal suicide. This is compounded by the skewed gender imbalance towards males which means, by definition, fewer women and babies. China will simply be crushed by a dramatically aging society before it ever reaches super-power status.

That’s not to say we should ignore China. They could still wreck havoc both economically and militarily before their demographic crisis hits. In short, I’m less concerned about China overtaking us as I am worried about China taking us down with them–say via WWIII.

Chart Showing China versus American Population Growth 2011 to 2050

New Estimate Shows Public Pension Shortfall Ballooning to $4.4 Trillion

Creative Commons License photo credit: emsphotonut41

Joshua Rauh just blogged on “Everything Finance” a new estimate of the current unfunded public pension liability for both state and local governments:

Using June 2009 data, Robert Novy-Marx and I measured a $3.1 trillion gap in state and local pension systems, arising from $2.3 trillion in assets and $5.4 trillion in liabilities.

Since then, the situation has evolved in several ways. First of all, the stock market continued to recover from the financial crisis . . .

More importantly, the true financial value of the liabilities that have been promised have grown substantially due to much lower bond yields . . .

the total unfunded liability is $4.4 trillion.

And folks are wondering why consumers aren’t spending?! Until policymakers come up with definitive solutions to these massive unfunded liabilities (that don’t involve raising taxes), then the uncertainty it creates will force consumers to pay down their own debt (or save) and restrain consumption.

These are structural issues that can not be fixed by monetary policy actions from the Federal Reserve. Ironically, as pointed out by Rauh, loose monetary policy is worsening the situation by keeping interest rates low and ballooning these unfunded liabilities. The Fed needs to stop babying politicians with cheap money and let them take their Castor Oil (via higher interest rates).

Capital Gains Roller-Coaster and the Size of Government

New 2009 data from the IRS shows how foolish it is for government to tax capital gains income.  As shown in the chart below, capital gains income for 2009 is now back to 2002 levels ($224 billion).  Of course, thanks to the housing bubble, this is after a massive run-up in capital gains income to $819 billion in 2007.  This led to a whopping 73 percent drop in capital gains income from 2007 to 2009!

The capital gains roller-coaster also has a disproportionate effect on government budgets, especially Uncle Sam’s.  The IRS data shows that, in 2009, 87 percent of all capital gains income was claimed by those folks with income (as measured by Adjusted Gross Income) over $200,000.  That means these folks are paying at the highest marginal tax rates which can lead to rapid increases/decreases in government revenue.

This revenue volatility should also concern good/small government folks.  According to Dr. W. Mark Crain in his book Volatile States: Institutions, Policy, and the Performance of American State Economies:

 . . . uncertainty is the enemy of efficiency in public as well as private enterprise.  Budget volatility precludes efficient planning and adds significantly to the cost of government-provided services.  Put differently, a reduction in spending volatility would be equivalent to a funding increase.  The empirical evidence indicates that a 10 percent reduction in budget volatitlity generates efficiency gains comparable to a 3.5 percent increase in the level of funding . . .

The analsysis suggests that the reliability of tax revenues influences the size of government.  Greater instability in tax revenues contributes to spending instability that impedes the efficiency of long-run state government operations.  With less efficient planning, the level of government spending increases, which of course requires additional revenues. [emphasis added]

So in the long run, the volatility in the capital gains tax is helping to increase the size of government at all levels . . . with the exception of those states without an income/capital gains tax.  Um, like New Hampshire 🙂

There is, however, a silver lining in the capital gains volatility.  With capital gains income at such a low level, now is the time to ax the capital gains tax at the federal and state levels.  Not only is the cost of doing so minimized to government coffers, but it would also boost the incentive to invest in new capital which is exactly what the economy needs in this so-called “recovery.”

Chart Showing Capital Gains Income from 1997 to 2009

The Real Federal Debt

Creative Commons License photo credit: TimothyJ

I’m so sick of this debt ceiling debate because it is all a ruse.  The federal debt, as defined by the debt sold by the U.S. Treasury, is only a small fraction of all the obligations that the federal government owes.  Thankfully, I just found this nifty debt clock (in the sidebar) from the good folks at the Institute for Truth in Accounting.  Here is how they derive their higher estimate:

The Institute’s Debt Clock is an estimate of the nation’s publicly-held federal debt, intergovernmental debt held by the various branches of the government, the unfunded obligations related to social insurance programs as well as the pensions and retirement benefits promised to military veterans and government workers.The debt represented by notes, bonds and bills are known to the penny and can be seen here.

Estimates of the unfunded portion of America’s obligations are not so precise.Unfunded obligations include Social Security, Medicare, pensions, etc, and the components of the estimate come from several agencies, the most important of which are from the Social Security Administration’s trustees.

Typically, the trustees make their actuarial estimate and release it on April 1st, each year.This figure represents the trustees’ best estimate of the demographic factors that will affect the receipts and payments that the system will pay for old age and medical benefits for the many Americans receiving benefits. This year, the trustees have deferred issuing their estimate because they want to have more time to calculate the effect of the new health care law.Their estimate must cover the next 75 years rather than the 10 years of taxes and the six years of benefits the Congress used to estimate reform’s costs.We expect that their estimate will be released  in June, at which time we will reset the Institute’s Debt Clock.

Click here for a more detailed explanation.

Watch it and weep . . .