After yesterday Goldman mocked Trump' s budget (ironic as it was Trump' s ex-Goldman Chief Economic Advisor who conceived it) and said it had zero chance of being implemented, today it was JPM' s turn to share some purely philosophical thoughts on the shape of future US income and spending, which as we learned yesterday could balance only if the US grows for 10 years at a 3% growth rate, something it has never done, while slashing nearly $4 trillion in in spending, something else it has never done.

What caught our attention in the note by JPM' s Jesse Edgerton was his discussion on the thorniest issue surrounding the US: its unprecedented debt addition, what America' s debt/GDP will look like over the next 30 years, and whether there is any chance it could decline as conservatives in government hope will happen.

The answer to the final point according to JPMorgan, is a very resounding  no, or as the bank politely puts it, " Despite this week&rsquo s budget proposal, legislative changes that would reverse debt growth look unlikely to us." Translated:  US debt is never going down again.

Here' s why:

 

 

As the US population ages in the coming decades, federal government spending on Social Security and Medicare are set to grow as a fraction of US GDP. Meanwhile, our current tax system is expected to collect a roughly constant fraction of GDP in revenues. Thus, deficits and debt will likely grow over time.  The Congressional Budget Office (CBO) currently projects that the ratio of debt to GDP would reach an  unprecedented 150% within 30 years under current law  (Figure 1).

 

Figure 1 shows the CBO' s central projection for the ratio of federal debt held by the public to GDP under current law. (Debt &ldquo held by the public&rdquo excludes government trust fund holdings, includes foreign and Federal Reserve holdings, and is currently about $14.4 trillion.) The 2016 level of 77% is the highest in history outside of the World War II era. This debt ratio is projected to reach a new all-time high of 107% by 2035 and 150% by the end of the 30-year forecast horizon in 2047.

An interesting aside from Edgerton: is it worth even worrying about debt:

 

 

It is debatable how much these projections should cause immediate concern. Many (though not all) economists would agree that it can be appropriate for borrowing and debt to increase when the economy is weak to provide offsetting fiscal stimulus. Once the debt is on the books,  there may be no inherent reason it cannot be serviced in perpetuity and never paid back.  Even the extent to which we should be concerned about the debt placing a burden on future generations is unclear&mdash if the debt is largely internal to the US, servicing or repayment ultimately involves some future Americans writing checks to other future Americans.  And if future generations will be richer than we are due to economic growth, perhaps it makes sense to try to get them to pay for our retirement.

Once this rhetorical musing is past however, JPM shares is a rare admission for a bank that a record debt load may actually be a bad thing.

 

 

To be sure, it is debatable how large a problem this debt growth represents, and long-run debt projections are highly uncertain.  But, in our view, large deficits and debt likely place some burden on future generations, reduce capital formation, and create some small risk of financial crisis. Thus, there are solid arguments why we should aim to reduce debt ratios from current high levels when the economy is at full employment, as we believe it is now.

Such somber evaluation of the nation' s debt crisis: our compliments. Unfortunately, it is what JPM says next that is worse, because it too is spot on: the reason why debt will never again decline.

 

 

Although the administration&rsquo s budget proposal purports to reduce debt growth,  we currently see little appetite in Washington for the tax increases or spending cuts that could achieve this outcome. Our baseline forecast still includes a modest deficit-financed tax cut that would push in the opposite direction.

JPM' s dour conclusion:

 

 

With the unemployment rate now at 4.4%, solidly below our 5% estimate of its natural rate, we see no reason for fiscal policy to try to boost the economy right now&mdash in fact, it would make more sense to slow it down. And we do tend to think that high borrowing and debt levels have long run costs:  they likely reduce national saving, burdening future generations with external debt, and compete with the private sector for funds, reducing capital formation.  Plus,  an ever-growing debt ratio brings at least some small risk that investors would eventually grow concerned about the safety and soundness of US debt, feasibly triggering a rapid and destabilizing repricing.

We don' t know if JPM' s gloomy assessment is right, but one thing we are certain of: the last bolded sentence is one which nobody will think twice about, until it is far too late to do anything to prevent it from happening. Here' s why:

 

 

What could this look like in practice? Well, simple arithmetic shows that reducing deficits requires either higher revenues or lower spending. Higher revenues could come from either increasing tax rates or boosting incomes through channels like labor force participation, productivity growth, or immigration. (We note that we do not see any evidence that reducing tax rates would induce enough additional income growth to increase tax revenues.) And lower spending could similarly come from direct cuts or from other channels like reducing demand for safety net spending or slowing growth in medical costs. But as  discussed above,  the chance of changes like these being enacted in the coming years looks low to us.

 

Offshore Yuan tumbled as Moody' s cut China' s credit rating to A1 from Aa3, saying that the outlook for the country&rsquo s  financial strength will worsen, with debt rising and economic growth slowing. This leaves the world' s hoped-for reflation engine rated below Estonia, Qatar, and South Korea and  on par with Slovakia and Japan.

 

 

&ldquo While ongoing progress on reforms is likely to transform the economy and financial system over time, it is  not likely to prevent a further material rise in economy-wide debt, and the consequent increase in contingent liabilities for the government,&rdquo the ratings company said in a statement Wednesday.

And the most obvious reaction was Yuan selling.



 

Full Statement: Moody' s Investors Service has today downgraded China' s long-term local currency and foreign currency issuer ratings to A1 from Aa3 and changed the outlook to stable from negative.

The downgrade reflects Moody' s expectation that China' s financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows. While ongoing progress on reforms is likely to transform the economy and financial system over time, it is not likely to prevent a further material rise in economy-wide debt, and the consequent increase in contingent liabilities for the government.

The stable outlook reflects our assessment that, at the A1 rating level, risks are balanced. The erosion in China' s credit profile will be gradual and, we expect, eventually contained as reforms deepen. The strengths of its credit profile will allow the sovereign to remain resilient to negative shocks, with GDP growth likely to stay strong compared to other sovereigns, still considerable scope for policy to adapt to support the economy, and a largely closed capital account.

China' s local currency and foreign currency senior unsecured debt ratings are downgraded to A1 from Aa3. The senior unsecured foreign currency shelf rating is also downgraded to (P)A1 from (P)Aa3.

China' s local currency bond and deposit ceilings remain at Aa3. The foreign currency bond ceiling remains at Aa3. The foreign currency deposit ceiling is lowered to A1 from Aa3. China' s short-term foreign currency bond and bank deposit ceilings remain Prime-1 (P-1).

RATIONALE FOR THE RATING DOWNGRADE TO A1

Moody' s expects that economy-wide leverage will increase further over the coming years.  The planned reform program is likely to slow, but not prevent, the rise in leverage. The importance the authorities attach to maintaining robust growth will result in sustained policy stimulus, given the growing structural impediments to achieving current growth targets. Such stimulus will contribute to rising debt across the economy as a whole.

RISING DEBT WILL ERODE CHINA' S CREDIT METRICS, WITH ROBUST GROWTH INCREASINGLY RELIANT ON POLICY STIMULUS

While China' s GDP will remain very large, and growth will remain high compared to other sovereigns, potential growth is likely to fall in the coming years. The importance the Chinese authorities attach to growth suggests that the corresponding fall in official growth targets is likely to be more gradual, rendering the economy increasingly reliant on policy stimulus. At least over the near term, with monetary policy limited by the risk of fuelling renewed capital outflows, the burden of supporting growth will fall largely on fiscal policy, with spending by government and government-related entities -- including policy banks and state-owned enterprises (SOEs) -- rising.

GDP growth has decelerated in recent years from a peak of 10.6% in 2010 to 6.7% in 2016.  This slowdown largely reflects a structural adjustment that we expect to continue. Looking ahead, we expect China' s growth potential to decline to close to 5% over the next five years, for three reasons. First, capital stock formation will slow as investment accounts for a diminishing share of total expenditure. Second, the fall in the working age population that started in 2014 will accelerate. Third, we do not expect a reversal in the productivity slowdown that has taken place in the last few years, despite additional investment and higher skills.

Official GDP growth targets have also adjusted downwards gradually and the authorities' emphasis is progressively shifting towards the quality rather than the quantity of growth. However, the adjustment in official targets is unlikely to be as fast as the slowdown in potential growth as robust economic growth is essential to fulfilment of the current Five Year Plan and appears to be considered by the authorities as important for the maintenance of economic and social stability.

As a consequence, notwithstanding the moderate general government budget deficit in 2016 of around 3% of GDP, we expect the government' s direct debt burden to rise gradually towards 40% of GDP by 2018 and closer to 45% by the end of the decade, in line with the 2016 debt burden for the median of A-rated sovereigns (40.7%) and higher than the median of Aa-rated sovereigns (36.7%).

We also expect indirect and contingent liabilities to increase. We estimate that in 2016 the outstanding amount of policy bank loans and of bonds issued by Local Government Financing Vehicles (LGFVs) increased by a combined 6.2% of 2015 GDP, after 5.5% the previous year. In addition to investment by LGFVs, investment by other SOEs increased markedly. Similar increases in financing and spending by the broader public sector are likely to continue in the next few years in order to maintain GDP growth around the official targets.

More broadly, we forecast that economy-wide debt of the government, households and non-financial corporates will continue to rise, from 256% of GDP at the end of last year according to the Institute of International Finance. This is consistent with the gradual approach to deleveraging being taken by the Chinese authorities and will happen because economic activity is largely financed by debt in the absence of a sizeable equity market and sufficiently large surpluses in the corporate and government sectors. While such debt levels are not uncommon in highly-rated countries, they tend to be seen in countries which have much higher per capita incomes, deeper financial markets and stronger institutions than China' s, features which enhance debt-servicing capacity and reduce the risk of contagion in the event of a negative shock.

Taken together, we expect direct government, indirect and economy-wide debt to continue to rise, signalling an erosion of China' s credit profile which is best reflected now in an A1 rating.

REFORMS WILL NOT FULLY OFFSET THE RISE IN ECONOMIC AND FINANCIAL RISK

The authorities are part of the way through a reform program intended to sustain and enhance the quality of growth over the longer term, as well as to reduce the risks to the economy and the financial system posed by high corporate and, in particular, SOE debt. One related objective is to contain, and ultimately reduce, SOE leverage.

The authorities' commitment to reform is clear. It is quite likely that their efforts will, over time, improve the allocation of capital in the economy. Over the nearer term, the authorities have taken steps to contain the rise in SOE debt and to discourage some SOEs from further domestic and external investment, particularly in over capacity sectors.

However, we do not think that the reform effort will have sufficient impact, sufficiently quickly, to contain the erosion of credit strength associated with the combination of rising economy-wide leverage and slower growth.  In particular, in our view, the key measures introduced to date will have a limited impact on productivity and the efficiency with which capital is allocated over the foreseeable future.

For example, one key set of reforms is the program of debt-equity swaps which aims to lower leverage in parts of the SOE sector, transferring the associated risks to the banking sector. At present, we estimate that the value of swaps announced is a very small fraction -- around 1% -- of SOE liabilities. Moreover, there is very little transparency about the terms of these transactions or their likely impact on SOEs' and banks' creditworthiness.

Other measures intended to improve investment allocation include negative lists on investment in excess capacity sectors and the introduction of mixed ownership. The former will likely reduce the major losses on investments of the past. However, excess capacity sectors only account for a small proportion of total investment. Only limited improvement in the allocation of capital would result from such measures. Meanwhile, mixed ownership is at a very preliminary stage, having been introduced in only a few dozen SOEs, and on too small a scale for now to have any impact on productivity in the economy as a whole.

Looking beyond the corporate sector, the financial sector remains under-developed, notwithstanding reforms introduced to improve the provision of credit pricing of risk remains incomplete, with the cost of debt still partly determined by assumptions of government support to public sector or other entities perceived to be strategic.  And with increased scrutiny of capital outflows, the capital account remains largely closed. While that insulates the economy and financial system from global volatility, it also constrains the development of domestic capital markets by limiting the flow of inward and outbound capital.

Overall, we believe that the authorities' reform efforts are likely, over time, to achieve some measure of economic rebalancing and improvement in the allocation of capital.  But we think that progress will be too slow to arrest the rise in economy-wide leverage.

 

 

As time goes on, North Korea&rsquo s nuclear program is making war with the United States more and more likely.  As SHTFplan.com' s Daniel Lang details,  we&rsquo re on a terrible path that no one knows how to escape from.



On the one hand, North Korea is clearly led by an unhinged and tyrannical government that can&rsquo t be trusted with nuclear weapons. So you can understand why the US is so determined to stop their progress with these weapons. But at the same time, those nuclear weapons could one day guarantee that the leaders of North Korea will remain in power for a long time. Those weapons  would make any potential aggressor think twice  about trying to invade the bellicose nation, so there&rsquo s no way that North Korea is going to abandon its nuclear program.

Perhaps the only thing that&rsquo s preventing a war from breaking out right now, is the fact that North Korea doesn&rsquo t have an effective way to deliver a nuke, nor have they been making much progress in that arena. It seems like every time they test a long range missile, it fails spectacularly. So long as that state of affairs continues, war can be averted.

Unfortunately, North Korea&rsquo s missile program  has just made a huge leap.  On Sunday they tested a new missile that was arguably far more effective than anything they&rsquo ve ever launched before.

 

 

A Hwasong-12, a new medium long-range surface-to-surface missile, was launched from Kusong early Sunday morning. The missile flew roughly 430 miles, but the weapon was intentionally lofted. Analysts  suspect  the missile could potentially hit targets 2,800 miles away if fired along a standard trajectory.

In other words, the missile was launched with a steep arc, as a opposed to a relatively flat trajectory. This was done so that the missile could be tested without launching it over any neighboring countries. Most experts believe that if the missile had been given a flatter trajectory, it could have reached American military assets throughout much of the Pacific.

 

 

The North  &ldquo appears to have not only demonstrated an intermediate-range ballistic missile (IRBM) that might enable them to reliably strike the U.S. base at Guam, but more importantly, may represent a substantial advance to developing an intercontinental ballistic missile (ICBM),&rdquo John Schilling,  a respected aerospace engineer who specializes in rockets,  explained.

 

With the ability to strike Guam, the North may now have the means to strike most major U.S. strategic assets in East Asia and the western Pacific. While this would be an impressive achievement, North Korea is determined to master ICBM technology. The missile tested Sunday may be the predecessor to a future ICBM.

Is it any wonder why    North Korea is the perfect trigger for World War 3?  This unstable nation is rapidly increasing its nuclear capabilities, and it&rsquo s a nation that China and Russia have a vested interest in keeping alive. They want a buffer state between their borders and South Korea, which is allied with the United States. So any conflict with North Korea (a conflict that is looking more likely every day) could easily drag more nuclear armed nations into the fray.

Unless one side of this fight backs down, World War 3 is inevitable.  And so far it doesn&rsquo t look like either side is willing to compromise on North Korea&rsquo s missile program.

And here is how we got here,  courtesy of Goldman Sachs -  The Timeline of North Korea Developments



 

Finally, Goldman' s Jeff Currie and Mikhail Sprogis  discuss gold as a hedge against geopolitical events...

...we find that gold can effectively hedge against geopolitical risk if the geopolitical event is extreme enough that it leads to some sort of currency debasement, and especially if the gold price move is much sharper than the move in real rates or the dollar.  For these events, gold essentially serves as a call option and can therefore be thought of as a &ldquo geopolitical hedge of last resort.&rdquo

...This analysis, however, doesn&rsquo t take into consideration gold market liquidity itself, which can be crucial when deciding to hedge via physical gold in a vault versus COMEX gold futures.

Using a gold futures contract as the basis of the hedge makes the implicit assumption that market liquidity will not be a problem in the realization of a geopolitical event. The importance of liquidity was tested during the collapse of Lehman Brothers in September 2008. Gold prices declined sharply as both traded volumes and open interest on the exchange plummeted. After this liquidity event, investors became more conscious of the physical vs. futures market distinction and began to demand more physical gold or physically-backed ETFs as a hedge against black-swan events.



The lesson learned was that if gold liquidity dries up along with the broader market&rsquo s, so does your hedge -  unless it is physical gold in a vault, the true &ldquo hedge of last resort.&rdquo