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California’s Crash Omen of Nation’s Future

May 22, 2009 by 2 Comments

Borrow and Spend = Crash and Burnbig bag of indeterminate money

California has always been the trend setter for the nation but never more so than today as it totters on the edge of insolvency.  The theory that States or Nations cannot go bankrupt due to their unlimited taxing powers has reached its limits as California voters have resoundingly rejected further tax increases.  Without a Federal bailout, the State of California will be forced to make massive budget cuts.  The illusion of a free lunch, paid for with borrowed money is now replaced by the harsh reality of a mortgaged future.

California may be in the spotlight today as the first major state to collapse financially, but most of the Nation’s other 49 states are not far behind.  Tax revenues have declined in 45 other states by almost 13% in the first quarter and are likely to continue declining as both corporate and personal incomes decline.  For the first time ever, the biggest source of revenue for the States is from the Federal Government.  Almost all 50 States are at the precipice.

Given the absolute financial disaster occurring in almost every State, how long can it be before the ability of the US Government to pay its debts is called into question?  The United States is not an abstract construction with a separate economic destiny,  immune to events in the rest of the nation.  The United States are 50 States joined as one.  If nearly every one of the 50 states is an economic train wreck, the conclusion for Uncle Sam  is obvious.  Can the whole be greater than the sum of its parts?

Numerous doubts are being aired daily about the credit rating of the United States.  Consider some comments from today:

Britain’s Debt Omen

For a warning about America’s fiscal future, consider yesterday’s news from Britain. United Kingdom stocks, bond futures and sterling all fell after Standard & Poor’s lowered the country’s credit outlook.

But in both the U.K. and U.S. today, the politicians in power equate government spending with growth. So on present course, Britain’s credit future could well be America’s in the coming years as U.S. spending soars.

Dollar Is Dirt, Treasuries Are Toast, AAA Is Gone

Several policy missteps suggest that investors should stop trusting — and lending to — the U.S. government.

“All currencies are being debased dramatically by their central banks at extraordinary speeds and so in relative terms it appears there is no currency problem,”  In reality, however, paper money is highly vulnerable to a public catalyst that serves to acknowledge it is all merely vapor money.”

For the fiscal year ending Sept. 30, the Congressional Budget Office forecasts a record deficit of $1.75 trillion, almost four times the previous year’s $454.8 billion shortfall and about 13 percent of gross domestic product. Bear in mind that the target demanded of European nations wanting to join the euro was a deficit no greater than 3 percent of GDP.

David Walker, a former U.S. comptroller general, wrote in the Financial Times on May 12 that the U.S.’s top credit rating looks incompatible with “an accumulated negative net worth” of more than $11 trillion and “additional off-balance-sheet obligations” of $45 trillion. “One could even argue that our government does not deserve a triple A credit rating based on our current financial condition, structural fiscal imbalances and political stalemate,” he wrote.

Flip-Flops and Governance

Mr. Obama campaigned on “responsible fiscal policies,” arguing in a speech on the Senate floor in 2006 that the “rising debt is a hidden domestic enemy.”

However, Mr. Obama’s fiscally conservative words are betrayed by his liberal actions. He offers an orgy of spending and a bacchanal of debt. His budget plans a 25% increase in the federal government’s share of the GDP, a doubling of the national debt in five years, and a near tripling of it in 10 years.

US Officials Vow Fiscal Vigilance

Treasury Secretary Geithner and President Obama both acknowledge that out of control spending could eventually lead to default, credit market rejection and a lower standard of living as the cost of debt servicing destroys our standard of living.

Geithner Pledges To Cut Deficit

May 21 (Bloomberg) — Treasury Secretary Timothy Geithner said the Obama administration is committed to reducing the federal budget deficit after concerns rose that the U.S. debt rating may eventually be threatened with a downgrade.  He added that the target is reducing the gap to 3 percent of gross domestic product or smaller, from a projected 12.9 percent this year.

– the co-chief investment officer of Pacific Investment Management Co., said the U.S. “eventually” will lose its AAA grade.

Obama Says US Long-Term Debt Load “Unsustainable”

May 14 (Bloomberg) — President Barack Obama, calling current deficit spending “unsustainable,” warned of skyrocketing interest rates for consumers if the U.S. continues to finance government by borrowing from other countries.

“We can’t keep on just borrowing from China,” Obama said at a town-hall meeting in Rio Rancho, New Mexico, outside Albuquerque. “We have to pay interest on that debt, and that means we are mortgaging our children’s future with more and more debt.”

The Future Reality

The President and Treasury Secretary say what they have to say.  The reality is that the present course of unlimited credit expansion, quantitative easing, bailouts  and massive deficit spending will continue in an attempt to re-inflate asset values and stimulate spending.   The Government will not accept  alternatives that they view as being worse – deflation and a collapsing economy with civil unrest.  California will be bailed out like everyone else.

The course of action for long term wealth accumulation under the present circumstances seems obvious.   Avoid  an over concentration in paper assets (debt) that can be produced by governments in infinite quantity at zero cost.   Diversify into assets backed by 1) real services or goods that there will always be a demand for and 2) natural resources such as commodities, oil and gold.

Filed Under: Confidence, Economy, Government spending, printing money, Sovereign Default Tagged With: ,

America’s Triple A Credit Rating – At The Precipice?

May 13, 2009 by Leave a Comment

Black Swan Events Becoming Routine

Our Nation has avoided the decline into the abyss that many have been predicting during the economic crisis.  At the cost of approximately $13 trillion in government bailouts and guarantees the system has been held together but at a very high cost that future generations will bear through higher taxes or a much lower standard of living.

Our “prosperity through debt financed spending” philosophy has deeply indebted every sector of the economy.   Our leaders implore us to borrow and spend.  The US budget deficit is projected to hit $2 trillion dollar this year and continue indefinitely.

What we cannot borrow, we can simply print in unlimited amounts, imperiously oblivious to the serious risks and consequences of such financial folly.  Logical minds reject these unsound theories and realize that every nation has financial limitations,  whether we like it or not.  The risk of default by the United States, once considered unthinkable, is now a topic of debate by serious minds.  Consider the following from The Financial Times.

America’s Triple A Rating Is At Risk

Long before the current financial crisis, nearly two years ago, a little-noticed cloud darkened the horizon for the US government. It was ignored. But now that shadow, in the form of a warning from a top credit rating agency that the nation risked losing its triple A rating if it did not start putting its finances in order, is coming back to haunt us.

That warning from Moody’s focused on the exploding healthcare and Social Security costs that threaten to engulf the federal government in debt over coming decades. The facts show we’re in even worse shape now, and there are signs that confidence in America’s ability to control its finances is eroding.

Prices have risen on credit default insurance on US government bonds, meaning it costs investors more to protect their investment in Treasury bonds against default than before the crisis hit. It even, briefly, cost more to buy protection on US government debt than on debt issued by McDonald’s. Another warning sign has come from across the Pacific, where the Chinese premier and the head of the Peoples Bank of China have expressed concern about America’s longer-term credit worthiness and the value of the dollar.

The US government has had a triple A credit rating since 1917, but it is unclear how long this will continue to be the case.

For too long, the US has delayed making the tough but necessary choices needed to reverse its deteriorating financial condition. One could even argue that our government does not deserve a triple A credit rating based on our current financial condition, structural fiscal imbalances and political stalemate. The credit rating agencies have been wildly wrong before, not least with mortgage-backed securities.

One way out of these problems is for the president and Congress to create a “fiscal future commission” where everything is on the table, including budget controls, entitlement programme reforms and tax increases.

Recent research conducted for the Peterson Foundation shows that 90 per cent of Americans want the federal government to put its own financial house in order. It also shows that the public supports the creation of a fiscal commission by a two-to-one margin. Yet Washington still sleeps, and it is clear that we cannot count on politicians to make tough transformational changes on multiple fronts using the regular legislative process. We have to act before we face a much larger economic crisis. Let’s not wait until a credit rating downgrade. The time for Washington to wake up is now.

Our Nation’s future is being risked by a ruling class that continues to refuse to tell us what we need to be told – I thought we were promised that it was time for a change?

More on this topic

Alarm Sounded on Social Security – The financial health of the Social Security system has eroded more sharply in the past year than at any time since the mid-1990s, according to a government forecast that ratchets up pressure on the Obama administration and Congress to stabilize the retirement system that keeps many older Americans out of poverty.

Filed Under: Congress, Government spending, printing money, Sovereign Default Tagged With:

Inflation, Deflation or World Depression?

March 31, 2009 by Leave a Comment

calculatorShould We Discount The Consensus?

The debate on the outcome of bailouts and money printing continues.  A review of some of the current thoughts on Fed and Governmental action predict different possible outcomes – none of them particularly desirable.   When the consensus seems unanimous, maybe it’s time to discount the consensus?

The Marc Faber Interview by Peter Schiff

Marc Faber explains why bailouts and fiscal stimulus don’t work and are counterproductive to economic recovery.  Inflating our way out of the financial crisis is seen as the only option by the government.  Higher inflation  will be negative for both bonds and equities.

The Marginal Productivity of Debt

New money creation will only cause a further drop in price levels and cause a further contraction in the economy since the marginal productivity of debt has turned negative.  Bernanke’s flood of new money may cause something far worse than a depression.

Bailout Economics

Are we destroying capitalism by trying to save it?  The diversion of capital to failed enterprises is a recipe for disaster as money moves to the weaker hands.  What types of reform would foster an economic recovery?

Barack Obama as Herbert Hoover

How one small unanticipated event can trigger another depression.

Obama’s Auto Plan Gets Mixed Reviews

The administration’s first effort at ending the endless bailout cycle gets mixed reviews.  Sometimes you just can’t win.

US Mint Suspends Production of More Gold Coins

For those seeking the safety of gold coins, more bad news as the US Mint further restricts the production of gold coins.  Is the US Treasury seeking to limit the exchange of paper money into  hard assets?

Money Creation and The Fed

Does the explosive growth in the monetary base imply future uncontrollable inflation?

Filed Under: Bailout, Economy, Government spending, printing money, Roundup, US Mint Tagged With: , ,

Markets Plunging On Geithner’s Remarks

March 30, 2009 by 2 Comments

bearGeithner Does It Again

The Treasury Secretary said Sunday that some banks will need large amounts of financial aid.  Geithner’s comments seemed to imply that his recently announced rescue plan for the banking industry is only a first step and that additional government funds will be needed.  Markets responded with a massive selloff in Asia and the Dow futures are down heading into Monday morning.

Bloomberg: “Some banks are going to need some large amounts of assistance,” Geithner said yesterday on the ABC News program “This Week.” The terms of a $500 billion public-private program to aid banks “cannot change” for investors or they’ll lose confidence in the plan, he said on NBC’s “Meet the Press.”

The Obama administration is pursuing the most costly rescue of the U.S. financial system in history while facing taxpayer concerns the aid is bailing out Wall Street firms that took excessive risks. After allocating about 80 percent of $700 billion in aid approved by Congress, administration officials want to keep open the option of seeking more.

Geithner said the Treasury has about $135 billion left in a financial-stability fund while declining to say whether he will request additional money.

“If we get to that point, we’ll go to the Congress and make the strongest case possible and help them understand why this will be cheaper over the long run to move aggressively,” he told ABC News.

Most members of Congress probably wouldn’t support a request for new bailout funds because they aren’t clear about how the government used the $700 billion authorized in the first legislation, McCain said.

“We still don’t have the transparency and oversight,” McCain said on “Meet the Press.” He said his biggest concern is that the cost of stemming the financial crisis will worsen annual deficits projected to exceed $1 trillion for many years.

“What I am most worried about is laying the debt on future generations of Americans,” he said.

Private Investor Participation Is A Sham

It seems clear that there is dwindling public support for further massive bailouts of Wall Street and the banking industry.  Geithner’s plan of bailing out the banking industry with a “public/private” partnership is an attempt to deceive the public about the true extent of the cost of the bank bailout.

Taxpayer backed loans will be used to fund most of the asset purchases under the so called Public-Private Investment Program (PPIP).  Private investors can lose no more than their initial investment but can potentially earn huge returns if the assets purchased recover in value.  Geithner is offering these generous returns to lure in potential private investors who will be deceptively portrayed as the risk takers in the bank bailout, when in fact, the taxpayers are the ones at risk.

“We’re all mad here” – Lewis Carroll, Alice in Wonderland

Geithner’s solutions to solving the banking and financial crisis is increasing being viewed by many as something straight out of Alice In Wonderland.

Banks need to show more willingness to take risks and restore lending to businesses in order for the U.S. economy to recover from the recession, Geithner said.

“To get out of this we need banks to take a chance on businesses, to take risks again,” he said.

Banks did not become insolvent because they made too few loans or took too few risks.  The banking crisis was caused by too much lending to unqualified borrowers who are now defaulting.  Proposing to lend more to those already carrying an intolerable debt burden is sheer madness.   The President of the European Union, Czech prime minister Topolanek, called the bailouts and stimulus plans “a way to hell”.  The Emperor has no clothes and people are starting to notice.

The United States has been pushing other nations to imitate our borrowing and spending rampage with little success.  In fact, opposition to the American “solution” has become so vocal that this topic has been taken off the table by the Obama administration for the upcoming Group of 20 economic summit.

WASHINGTON — U.S. officials preparing for the Group of 20 economic summit on Thursday in London are playing down fiscal-stimulus targets and focusing on objectives such as new rules for tax havens and coordination of financial regulation.

European opposition to additional spending to stimulate economies has grown sharper over the past weeks. Obama administration officials have opted to back off the public spat.

Avoid All Pain At All Costs

A recession is the solution to curing economic excesses.  Recessions bring economic pain but lay the groundwork for a fundamental economic recovery by reallocating capital to healthy enterprises.  Attempting to paper over inevitable economic corrections with oceans of debt and spending only serves to further destabilize any recovery.   Economic policy makers did not see this financial disaster coming and their “solutions” have made the problem worse.

Rolfe Winkler, Option ARMageddon, makes a clear assessment of the current crisis.

The problem isn’t falling asset prices, it’s not rising foreclosures, it’s too much debt.

And yet American policy-makers appear convinced that more debt can rescue an economy already drowning in it. If we can just keep the leverage party going, all will be well. $787 billion to fund “stimulus,” another $9 trillion committed to guarantee bad debts, 0% interest rates and quantitative easing to drive more lending, new off balance sheet vehicles to hide from the public the toxic assets they’ve absorbed. All of it to be funded with debt, most of it the responsibility of taxpayers.

If I may offer just one reason this will all fail: rising interest rates. Interest rates need only revert to their historical median in order to hammer asset values, and balance sheets, into oblivion.

Picture it if you will: the economy stabilizes, money flows out of Treasurys, which drives interest rates back to normal. Asset values that had appeared to stabilize fall again. More writedowns ensue, more balance sheets turn up insolvent. The debt deflation conflagration ignites again, burning up what’s left of the economy.

If our experience to date has taught us anything it should be that kicking losses up to bigger balance sheets solves nothing. Losses have to be taken. The balance sheets on which they reside will end up insolvent. Why compound our problems by piling up more debt and concentrating all of it on the public’s balance sheet? Is American arrogance so great that we believe our Treasury and our currency will survive the trillions of $ worth of losses and stimulus we’ve already agreed to fund?

At the end of the day, flushing more debt through the system is the only lever policy-makers know how to pull. Lower interest rates, quantitative easing, deficit spending, it’s all the same. It’s all borrowing against future income. Each time we bump up against recession, we borrow a bit more to keep the economy going. With garden variety recessions, this can work. Everyone wants the good times to continue, so no one demands debts be paid back. Creditors accept more IOUs and economic “growth” continues apace. If it sounds like Bernie Madoff’s Ponzi scheme, that’s because it is.

But at a certain point, Ponzis get too big. There simply aren’t enough new investors to pay off older ones. In the aggregate, the same is true for Western economies. Their debt loads are now so huge, they are simply unpayable.

Economic Summit

The Group of 20 economic summit will accomplish nothing.  They have decided in advance to eliminate debate on the major issue – whether more debt will solve our debt problems.   The Czech prime minister should be the main speaker at this summit and our Treasury Secretary should be put in the front row.  It is a time for fiscal austerity – not more reckless borrowing.

Filed Under: Bailout, Banking Industry, Geithner, PPIP, printing money Tagged With: , , ,

Bank Of England’s Desperate Last Tactic Forestalls British Sovereign Default

March 16, 2009 by Leave a Comment

Printing Money – Final Desperate Tactic

The Bank of England is engaging in a massive repurchase of British debt in an attempt to pump cash into a crashing British economy.  The Bank of England’s money printing is necessary since Britain has run out of all other options – the vaults are empty and creditors will not buy her debt.

Never in history has a country printed money only for a short period of time; invariably it continues until the country’s currency is worthless and the economy in a state of total ruin.  Should the world economy improve and England maintains a functioning economy, her future would still be bleak.  The very fact that a nation needs to resort to printing money to stay afloat implies a crushing debt burden that is simply to large to ever pay back.  Printing money was the last resort option to sovereign default.  The larger question is what happens next, not only in Britain but throughout Europe.

In The Eurozone It’s A Total Catastrophe

Yes, it is dangerous for the Bank of England to buy up a third of all long-dated gilts. But it would be even more dangerous to allow deflation to run its course in an economy where debt levels have reached such extremes. Debt and deflation are a deadly mix.

We are now faced with the post-debt wreckage. The task at hand is to hold our societies together as best we can.

As it is we have seen industrial production collapse in every region. The drops in January were: Japan (-31pc), Korea (-26pc), Russia (-16pc), Brazil (-15pc), Italy (-14pc), Germany (-12pc). Falls that took two years from late 1929 have been compressed into five months.

Those who say this is nothing like the Great Depression are complacent. Household debt is higher today, and UK banks are in worse shape. (No bank of size failed in the British Empire during the slump). Britain’s economy contracted by 5.6pc from peak to trough in the early 1930s (Eichengreen). Some put the figure at nearer 8pc. We may surpass that this time.

America suffered worse. Real GDP fell 28pc. But the worst occurred in the second leg, after the heinous policy blunders of late 1931. Reading contemporary accounts, it is clear that hardly anybody – not even Keynes or Fisher – realised that the world was slipping into a depression during the first 18 months.

Nobel laureate Paul Krugman says the Fed has been as far behind the curve today as it was then, given the faster pace of collapse. It is bizarre that Ben Bernanke has not started to buy US Treasuries a full three months after he floated the idea, despite a yield rise of 80 basis points.

Given that Germany’s economy is imploding (Deutsche Bank sees 5pc contraction this year) one wonders if the Bundesbank would be less hawkish if the D-mark still existed. Even their hard-money brothers at Switzerland’s SNB are cash printers these days.

So has monetary policy in euroland been paralysed by squabbles at a calamitous moment, blighting every member state? Almost certainly.

Inflate or Default

The huge debt burdens of every sector of the economy and government are being compounded by the sharp reduction in world economic growth.  Debts that are too large to be repaid, will by definition, not be repaid.
The debt trap that the world finds itself in can be worked out by economic growth and the resulting increase in incomes to service the debt.  If economies continue to weaken, only two undesirable options remain – inflate the debt away (as Britain is attempting to do) or default.  Judging by the events in Europe, we are likely to discover just how undesirably these last two options can be.

Filed Under: Bank of England, Government spending, printing money Tagged With: , ,