Avoid the "Ring-of-Fire" Countries

The following is a guest post from Marotta Wealth Management.

A few months ago Bill Gross, co-founder of PIMCO and the country's most prominent bond expert, wrote a provocative monthly newsletter. He evaluated countries based on their total public sector debt as a percentage of gross domestic product (GDP) as well as their annual deficit, which is making matters worse. Gross singled out those countries heaping significant deficits on their mountain of debt and called them "The Ring of Fire."

The eight countries he identified were Japan, Italy, Greece, France, the United States, the United Kingdom, Ireland and Spain. The International Monetary Fund (IMF) cautioned that rising government debt has replaced financial industry stress as the biggest threat to the global economy. Gross warned his readers to watch "the U.S. with its large deficits and exploding entitlements." We recommend that you reduce your investments in these countries.

Our own government spending spree was not necessary. A Heritage Foundation study concluded that the stimulus money spent by countries had a negative short-term correlation with that country's GDP. In other words, stimulus money may even have had a slight negative short-term effect as well as a stronger negative longer term effect.

The IMF study agreed, stating, "Longer-run solvency concerns could translate into short-term strains in funding markets as investors require higher yields to compensate for future risks." In other words, we've taken short-term financial illiquidity and turned it into a long-term government deficit, which in turn raises the cost of short-term liquidity.

If you've lost your job or are struggling to live within your budget, running up your credit card never helps. It may make you feel better momentarily, but it doesn't even really help your situation in the short term. Spending beyond your means only makes matters worse. And government spending is making everyone miserable.

A small amount of government spending is necessary for infrastructure, which appears to boost economic activity. Successfully funding the rule of law provides the economic freedom necessary for economic activity. The optimum amount of spending appears to be relatively small, perhaps about 18% of GDP.

In every economic analysis, greater government spending is associated with weaker economic growth. The Keynesian views of economic stimulus have been largely discredited, although its ideas continue to be misused politically to support massive government-spending programs.

Government intervention continues to do more harm than good. This past year it took a common recession and prolonged it into a more permanent malaise. GDP growth, which has historically averaged 6.5%, is liable to slow to a more European rate of 3 to 4%. Official unemployment numbers will lower but only as people drop out and are no longer counted. Real unemployment is likely to remain high for some time.

Lest you think these policies don't affect you, they do. Part of Greece's austerity measures include raising the retirement age 14 years. Lower U.S. stock returns could have the same impact on your ability to leave the workplace. For each 1% less in return over your working career, you will have to retire seven years later to achieve the same retirement lifestyle.

Countries obligated to impose austerity measures illustrate the natural consequences of spending money you don't have while taxing and regulating wealth creation. Politicians take the credit for enacting feel-good programs they can't pay for, and then they scapegoat private enterprise to cover their misguided thinking.

Reduce your investment in these countries. Put your money where the entrepreneurial spirit is rewarded and the welfare state is discouraged, not the other way around. We suggest lightening up on foreign investments that primarily just follow the MSCI EAFE index.

EAFE stands for Europe, Australasia and the Far East. It represents all the developed countries outside of the United States and Canada. This includes large investments in all seven of the non-U.S. ring-of-fire countries. The EAFE consists of 22% Japan, 21% United Kingdom, 10% France, 4% Spain, 3% Italy and 1% Ireland and Greece. In total, 61% of the EAFE index is invested in ring-of-fire countries.

But before you stop investing in foreign stocks altogether, remember that 100% of domestic stocks are invested in the eighth ring-of-fire country, the United States. And we need our own austerity measures. The total compensation package for federal workers in the United States is $108,476--a full 55% higher than workers in private industry whose total compensation amounts to only $69,928. Going forward may be one of the times when a strong tilt toward specific foreign countries may provide superior long-term returns.

Gross advises seeking return where "national debt levels are low, where reserves are high, and where trade surpluses promise to generate additional reserves for years to come." This suggests investing more in emerging markets such as Chile, China, India and Brazil.

It also includes emphasizing countries with economic freedom such as Hong Kong, Singapore, Australia, Switzerland and Canada. Or mostly free countries with lower debt such as Denmark, The Netherlands, Finland, Sweden, Austria, Germany or even Norway. These countries should outperform their debt-laden counterparts.

As Gross ended his newsletter, "Beware the ring of fire!"

Comments

[jim]

I'd love to hear the authors explanation of how he can spend most of the article railing over how high taxes & government spending as BAD and then end with the conclusion that we should instead invest in Sweden, Denmark, Norway, Canada which have higher taxes and higher government spending. I mean really. Socialism is bad so invest in Sweden? Thats the argument here?

[Eugene Krabs]

Another interesting and informative article.

Typically, when Bill Gross speaks, people listen, and this is no exception. Indeed, there are plenty of easier ways to gamble your money than buying toxic foreign debts, and most are far more entertaining.

I would, however, take a slight exception to domestic debts. For example, back in 2009, I bought and am still holding to what I feel are quality corporate bonds (Wal-mart in this case) that pays an impressive dividend to this date. But I'm OK with this if only because it was something that I could grasp and valuate as an individual investor, and it's one of the few exceptions in a vast sea of rules.

Otherwise, I do take Mr. Gross' advice here to heart. I think most traders do as well, as many are literally buying American only.

Finally, and certainly not least, there's always the controversial topic of the Stimulus package. However, I'm pooped out from this debate. All I am going to say about it is that there are very strong opinions out there about this, more than there appears to be usable facts regarding its true effectiveness, and only a portion of those facts are truly applicable to the average investor/trader.

[Tyler]

Like all financial professionals, Bill Gross talks his book. This doesnt mean he is wrong or one shouldnt listen to his insight, only that one should read his letters knowing he has a serious vested interest in future outcomes.

Niall Ferguson also agrees that when the debt/gdp ratio exceeds 90%, gdp will be diminished and a deflation spiral tends to result. (US expected to hit 112% by 2015) One must remember however this ratio has two inputs, Debt and GDP. Increase GDP while keeping dept constant and the ratio will fall.

[StLPastor]

just a couple of thoughts-
1) citation much? Neither Bill Gross nor the heritage foundation study are cited. I couldn't find the heritage study with a quick google search, but why is it surprising that growth is slower in countries forced to take extraordinary measures by economic recessions? I would expect countries that had passed a stimulus to be having more trouble, because they are the ones that were in deeper to begin with!
2) cutting government spending obviously has an effect on the economy-if we cut hundreds of thousand of teacher jobs because of State funding shortfalls, that is going to have reverberations through the economy. On a similar note-the government is only good for infrastructure spending? What about education spending, military spending, or a bare social safety net? These are all useless? An educated populace is one of the keys to national wealth, reducing education is a catastrophic idea.
3) I don't think its a coincidence that every single wealthy country in the world spends more like 40% of GDP on government spending than 18%. Government spending is useful, and does things we like. Here's a nice study, which suggests there is some positive correlation between government spending and GDP. http://anepigone.blogspot.com/2008/03/government-spending-as-percentage-of.html
4) If you're interested on a balanced discussion of the issues at hand in the stimulus, with actual citations of people from both sides of the question. I'd recommend this highly. http://www.economist.com/blogs/freeexchange/2010/06/recovery

[Bad_Brad]

jim - I think the argument is that investing in countries that have high levels of debt is bad. Some of the countries you mention do have high levels of government entitlements but they also have high taxes to pay for it. The countries that Bill Gross is talking about have wanted to have their cake and eat it too - high (or at least growing) levels of government entitlement without high enough taxes to fund all of it. That's a house of cards that's going to come crashing down on those countries at some point (including the USA).

[Tyler]

StlPastor-

Citations/reports/letters can be found on PIMCOs website and the Heritage Foundation website. The citations you want are not recent so go back 6 months or so.

Govt spending and govt debt are not the same. A govt doesnt need to go into debt to spend. 40% debt/gdp is very different than 90+%. 40% of gdp spending can occur without and debt financing.

What the govt spends money on is also very important- salaries where public sector makes more than private sector vs roads vs. health care to non productive age groups. Not saying any of these shouldnt be done, only that they are different and will likely yield different impacts on a nation/nation's gdp.

Teachers are mostly a local issue and nearly irrelevant to this national discussion. Including state debt paints an even more extreme picture.

[StLPastor]

Tyler,
If you found the citations from six months ago, why didn't you just link them?

I know spending and debt are different. Everyone agrees that the US needs to get the long term debt under control. I'd recommend doing this with a combination of raising taxes (hopefully a carbon tax!), cutting benefits for social security, reducing health care cost inflation, and quit getting in useless wars around the world. If you want to try it yourself, consider this calculator, its very cool: http://marketplace.publicradio.org/features/budget_hero/

I agree that what the government spends money on is important, and I'm glad that there are going to be new efficiencies in Medicare because of the Health Care bill, so that not all medical procedures to extend life for two weeks will be paid for by the government, and I think there are a lot of other things we could spend on (say, renewable energy infrastructure) that would be better than what we are doing now (agriculture subsidies).

However, my point was that if 18% is the proper amount of government spending to GDP (as Marotta claims) then every single wealthy nation in the world has a government sector that is two times too big, whereas the poorest nations are the most 'efficient'. Personally, I'll take the big government nations every time.

Also, I point out teachers because state cuts in spending have almost canceled out increases in federal government spending, meaning that total spending by the Government has stayed fairly constant during the crisis-with some hires being canceled out by other firing (see http://krugman.blogs.nytimes.com/2010/03/11/fifty-one-herbert-hoovers/)-the State data is very important in this national conversation, since half of US government spending is done by the states (see my previous citation on GDP/Spending ratios). Keeping spending the same at least means the government isn't contributing to the demand failure in the larger economy, but because of the states, the stimulus isn't as effective as it might be.

[Tyler]

I didn't find the reports today. I read them a while ago and I wasnt interested in spending a lot of time looking for them. This is old news.

I dont claim to know if 18% is desired, I do agree however that at 90% or above one should see a reciprocal drag on GDP.

I think if you include state debt and spending, the number jumps to over 300%. (This is just off the top of my head.)

Yes Krugman would argue a lot more spending is needed deficit be damned. It should be noted the Brazilian auction failed for the 3rd time today. Financing debt can only continue to a point. The US might be different, then again, it might not.

[JimL]

StLPastor,

The Medicare savings you hope for is a dream. First of all, the current medicare reimbursements do not fully cover doctors costs. Instead, they are being subsidized by private pay insurance patients. Secondly, much of the costs are managing people with diabetes and/or heart disease. Health habits by Americans are heading the wrong way. The only way to impact savings in that area will be a change in dietary and exercise habits. If the government follows through with the proposed medicare cuts, it will cause physicians to stop taking new patients or drop medicare all together.

As for the carbon tax, this is another potential disaster. All it will do is create another tax program that companies will pay and then pass on to consumers without making any real environmental changes. If the government really wants environmental changes, all they have to do is just pass the laws. There is no need to have a tax system built behind it. They already have the means of enforcement.

[StLPastor]

If medicare was being subsidized by private pay, no doctors would take medicare. Sure, the profit margins are smaller with Medicare, but they still exist. The whole reason for the 'Dr. fix' that congress passes every year is to make sure that reimbursement rates don't drop too far. The point of health care reform is not decreasing reimbursements, its making sure to only pay for things that are actually medically necessary, rather than giving 90 yr. olds hip replacements.

Also, there are plans for increased incentives for healthy living, particularly around diabetes and heart disease.

'Just pass the laws?' a carbon tax or cap and trade program are both much more elegant solutions to global warming. If you just pass laws against carbon emissions, then you have to decide how much each company gets to emit, which means massive intervention in all areas of the US economy. If you have a cap and trade program or a carbon tax, each company on its own gets to decide how much it wants to pay for the privilege to pollute, and while the worst polluters will pay the tax and then pass those costs on to the consumer, more efficient companies will avoid the tax/not have to buy permits on the exchange, they will offer cheaper prices, win market share, and drive those who refuse to adapt out of the market. I mean, this is basic capitalism-markets work better than regulation, markets require incentives, a cap and trade program creates an incentive for companies to emit less CO2. There are challenges in terms of enforcement, and how much economic disruption will be caused, but its a lot better plan than trying to regulate the problem out of existence.

[Tyler]

Sorry but this is faulty logic. "If medicare was being subsidized by private pay, no doctors would take medicare."

In addition to the logic being unsound, most doctors I talk to about the issue are reimbursed less than the cost for a number of things by medicare and then charge more when a privately insured person has the same thing done. (If I charge someone 50% of the cost and charge another 200% of the cost, I still make money.) Such a large percentage of people in need of medical attention are covered by medicare so a doctor/hospital needs to accept medicare for the revenue. Ask someone who runs a hospital their thoughts on medicare and you might be surprised what you learn.

[JimL]

stlpastor,

You are wrong. I have been working in the healthcare field for almost 25 years and understand the cost/compensation models. Notice how hospitals with a heavy medicare load need subsidies just to keep the doors open. Also, take a look at this link as to one example:

http://money.cnn.com/2010/02/24/news/economy/doctors_ditching_medicare_patients/

Further, you can also check with the AMA.

I can also give you a personal example. Two years ago, my father suffered a traumatic brain injury as a result of an accident. He had surgery to reduce bleeding to the brain, 2 weeks of Neuro ICU (24 hour nursing care), 2 weeks on the general neuro floor, surgery to repair his broken arm, reconstruction of nose and other facial issues and then 1 year of rehab (learning to walk, eat, etc). For all of this, the total medicare reimburesment was approximately $50,000.

In healthcare reform, the plan is to cut medicare payments, not reduce services. Remember the whole debate on "death panels"? When talk surfaced that decision would be made to reduce services, the political uproar stopped that idea. Instead, it went straight to payment cuts.

As to the carbon tax, I noticed you did not comment as to the impact on the consumer. It will obviously drive up prices. Can the average person in your congregation afford another 30% increase in overall costs? The company is not choosing to decide how much to pay. Instead, they will figure out how much they will pass on to consumer. Every time the government institutes a regulation that costs money, notice how those costs increases are passed on to consumers (evidence by continued profit rises in those industries).

[StLPastor]

Obviously a carbon tax/cap and trade program will increase prices to the consumer. I acknowledge it, and am sorry that it needs to happen-clearly we wouldn't institute a system like this if there wasn't a problem with carbon pollution and climate change that has to be stopped.

However the consequences to the consumer can be limited. For example, the current Cap and Trade program in the senate includes a system to offset the higher cost of home electricity using profits from the carbon exchange market (http://kerry.senate.gov/americanpoweract/pdf/consumer1page.pdf), meaning that while your costs for home heating and cooling will go up, you'll also get a check from the government to help cover it. This means, if you make your home more efficient, you (and efficient businesses) will make money on this program, at the expense of more destructive companies and people who refuse to change their patterns of behavior.

No one really thinks a carbon tax will increase prices 30%. Official estimates range from 3000$ a year (Republicans) to 800$ a year (Democrats) for the average family-see http://www.factcheck.org/2009/05/cap-and-trade-cost-inflation/

That is a lot of money, I agree, but we can't rely on foreign oil or deepwater drilling forever.

[Tyler]

From Senator Kerry's site and the link you posted...

"For those families that are disproportionately impacted, we include an additional refund. From the beginning of the program, fifteen percent of revenue raised will be used to help offset any increases in energy costs for low- and middle-income American families... Those with income below 150 percent of the poverty level – approximately $33,000 for a family of four"

So I may not receive what you claim I will receive. JimL has to make less than 33k per year to receive the benefit you claim exists. So in truth, someone is going to pay for the free lunch you claim exists. Please tax me more. Please increase my expenses so others can have a free lunch. Nothing is free. Someone pays.

[Stephan]

i think its important that everyone sees the problem we have and realizes that there is no one solution to it. for one, we have to raise taxes, there is no way around it, and we can get moving on reform and cutting expenses much sooner if the right recognizes that currently with out debt situation we have to raise taxes. however, i dont agree with the article and avoiding or pulling back investmenets in the countries listed. the best time to invest is at the bottom, and all these countries will react and change so they will stay relevant. none of them will accept being pushed back into the middle of the pack, so i expect all of them to imrpove greatly over the next decade in terms of economic performance.

Preferred Financial Services.

[JimL]

Also keep in mind that energy is tied to almost everything (manufacturing components, shipping ,etc.). Virtually everything you buy will be going up in cost, yet it is doubtful it will have much of any impact on carbon output.

Back on the medicare issue, notice that congress is once again trying to put off the planned medicare cuts to physician payments because of the known impact. As such, how will it work when trying to implement healthcare reform when it is a major cornerstone of paying for the increased costs?

[StLPastor]

Tyler-
I acknowledged that the current cap and trade system before congress would cost the average family between 800 and 3000 dollars a year. I think its safe to say that's no free lunch.

JimL-
the beauty of the Cap and Trade system is that it will definitely reduce carbon emissions, since the government will only sell enough permits for the amount of carbon emissions we want. I mean, really, either it increases costs, because emissions become a scarce resource that companies have to pay for, or it fails to decrease carbon emissions, because the cap is so big that emissions are really cheap and everyone just keeps poluting, but it can hardly do both.

One thing I'm hopeful about is that the Cap and Trade program for sulfur dioxide to deal with acid rain ended up both drastically reducing emissions and came in way under estimated expenses (see here: http://www.edf.org/page.cfm?tagID=1085) I have hopes of a similar result for carbon dioxide.

And I agree with PFS that we have to raise taxes, and if we tax carbon, at least we have a chance of helping the planet as well.

[JimL]

stlpastor,

Think again. If it raises revenue, do you really think the government has an incentive to limit permits? As said before, if they really want to control emissions, then they can pass laws. Or, why not just have a set number of permits, but not put a tax on them? It really is no different than putting taxes on soda, beer, groceries, etc. It is just another mechanism to raise revenue. In turn, it will just be added on to the consumer bill.

[StLPastor]

JimL
A cap and trade program has a set number of permits, which are sold at auction, not at a set price. If the government sells extra permits, then the price would go down. If the government reduces the number of permits, the price goes up. As the number of permits auctioned off goes down in the future (thus reducing the amount of carbon pollution) then there is greater incentive for all companies and individuals to find creative ways to get energy that does not require carbon pollution, and more creative ways to more efficiently use energy. Cap and Trade is a simple market mechanism to reduce pollution, rather than using heavy handed regulation.
If you 'pass laws' against pollution, companies would have to do exactly the same thing as with the Cap and Trade program: find other ways to create energy that doesn't involve carbon pollution. The cost to consumers would be either the same or greater than with the more economically efficient Cap and Trade program.
Plus, taxes on Soda, beer, and cigarettes have proven effective methods of reducing their consumption-if you want less of something tax it. We want less carbon in the atmosphere, the easiest way to do that is to make it more expensive.

[JimL]

You said "If you 'pass laws' against pollution, companies would have to do exactly the same thing as with the Cap and Trade program: find other ways to create energy that doesn't involve carbon pollution."

Further, the incentive to increase the number of permits is there. Take a look at everything being considered to increase tax revenue. Levels and things not even considered in the past are now on the table.

[Jeroen]

I quit reading after

"The Keynesian views of economic stimulus have been largely discredited, although its ideas continue to be misused politically to support massive government-spending programs"

which is both untrue and also using economics politically. Ask Krugman wether Keynnesianism is dead, frx.ex.

Earlier in the article it states that:

"And government spending is making everyone miserable. "

which, again, is just showing the author's politics instead of any kind of general truth. Are you telling me that governement spending on, say, digging ditches (for which they use private firms) is making people miserable? right...