Posts Tagged The Economy
U.S. Economic Outlook
Posted by Harley in Financial Education, The Economy on July 30, 2009
By Steve Christ
Thursday, July 30th, 2009
Before the bulls break out the champagne here, I would warn them not to get too far ahead of themselves.
After all, euphoria is a dangerous emotion that can lead to big losses — in this market, or in any other, for that matter.
And as for Dennis Kneale’s breathless prediction that the “recession is now over,” the picture on that score is about as clear as mud. . . the U.S. Economic Outlook is murky, to say the least.
What is crystal clear, however, is that our problems are actually getting worse, not better. Fundamentally, is as bad as it has ever been — even though the bulls have broken out the party hats, insisting that somehow the markets really can grow to the sky.
Of course, we know otherwise. If only it were so. . .
Instead, I’m firmly in the camp that believes a “new normal” has begun, and it’s based more upon frugality more than frivolity.
That’s because as unemployment surges, home prices continue to drop, and more wealth evaporates, consumers are more likely to try a least to live within their means. . . no matter how hard that may be.
As a result, without an uptick in jobs and a boost in income, a repeat of the debt-financed binge we just lived through simply isn’t going to happen.
It can’t be recreated either — even though the Fed is trying its best to do just that.
So, what we’re essentially left with is a classic case of a reluctance to borrow or consume: a big problem, since that is what the lion share of the U.S. Economy has been based on since 1982.
As a result, we have too many cars, we have too many houses, and we have too many debt holders teetering on the brink.
What we don’t have — or what we have a lot less of — are people with the cash flow to support it all. Sure, money still exists and there is lots of it, but it has very little velocity when a nation of “Good Time Charlies” suddenly turns frugal.
That being said, I thought we would play a game of connect the dots today as we view the current rally not only with awe, but also a deep-seeded suspicion.
Here are nine reasons why the champagne will have to stay on ice for the time being. . .
9 Hurdles to the U.S Economic Outlook
1. The Wealth Effect in Reverse
During the heydays, rising asset prices were all it took to get consumers to spend themselves into deeper into debt. However, these days the reverse is actually true.
Because according to the Federal Reserve, U.S. household net worth fell by $1.3 trillion in the first quarter, proving that green shoots are something of a fairy tale — at least for the American consumer.
In fact, since its peak in the third quarter of 2007, household wealth has decreased by 21.6%, or more than a fifth. That is the most dramatic fall in the series since reporting began more than 50 years ago.
Yet somehow, the bulls keep pounding the table, saying there is light at the end of the tunnel, even though consumer spending is over 70% of the U.S. GDP. The truth is when taking huge losses, belts usually get tightened, not loosened.
2. The Heavy Chains of Debt
Meanwhile, consumer debt is still off the charts. In fact, household debt as a proportion of disposable income hit 133% as the recession began. Since then it has eased a bit to 128%, but its still way too high — not to mention unsustainable. At minimum, consumer debt should be 100%, and even that is a slippery slope.
By comparison, the consumer debt level coming off of the tech bubble in 2003 was around 85%, which tells you where all that “growth” came from: Households levered up. This time that’s impossible — for a whole host of reasons. So the while the FED has cut this rate to zero, it hasn’t done much to get people to the mall this go-round. . .
So just looking at it from a balance sheet perspective, either wages have rise quite a bit or debts have to be reduced dramatically. Otherwise the numbers for the average consumer just won’t add up.
3. Rising Unemployment
On a day when the stock market shot up by more than 250 points two weeks ago, the Fed minutes from June were quite a bit more sobering. Unemployment, according to the Fed, will top 10% this year. . . while most Fed policy makers said it could take “five or six years” for the economy and the labor market to get back on a path of full health in the long term.
So it looks like 2015 will be the year to look forward to. At best, the recovery will be jobless — which makes you wonder how it could be called a recovery at all.
Here’s betting unemployment tops 11%.
Meanwhile, 7.2 million people have lost their jobs since December 2008, making this the only recession since the Great Depression to wipe out all of the job growth from prior periods of expansion:
By the way, the real unemployment rate, or U-6, is 16.5% It accounts for those poor folks who are unemployed but are so discouraged that they have stopped looking.
4. Tax Revenues are Plummeting
Calfornia’s fiscal woes are only the tip of the iceberg. Falling tax revenues in 45 of the 50 states have left all of them facing fresh budget shortfalls.
In fact, according to a recent report from the Rockefeller Institute of Government, tax collections dropped by 11.7 % the first quarter — the largest fall on record. Meanwhile, early figures for April and May show an overall decline of nearly 20 per cent for total taxes. That will undoubtedly reduce demand and slow down the recovery, since government spending acccounts for 18% of U.S. GDP:
As for the Federal government, there has been a 22% drop in individual tax receipts so far this year, along with a 57% drop in corporate taxes.
In short, while the government is always out of money, it has never been close to this bad. Without the printing presses, we would already be bankrupt.
5. Rising Prime Mortgage Defaults
Remember when subprime mortgages began to blow up? Of course you do. . . that’s old hat at this point. Today, those defaults have moved right on up the value chain.
Delinquency rates on the least risky mortgages more than doubled in the first quarter from a year earlier, as prime mortgages 60 days or more past due climbed to 2.9 percent through March. Serious delinquencies on prime loans, which account for two-thirds of all U.S. mortgages, rose to 661,914 in the first quarter from 250,986 a year earlier. Meanwhile, mortgages 60 days or more past due rose 88 percent from last year.
The good news is this is the last of the mortgage dominos. After prime mortages, there’s nothing left to fail. Unfortunately, this is the biggest domino of them all.
6. Oh, but Wait. . . I Forgot about Option ARMs
As my pal Ian Copper has been writing for some time now, Option ARM resets will be tougher for the economy to handle than subprime and we will see greater numbers of bank failures, foreclosures, delinquencies, and economic hardships because of it.
What should concern you is that about $750 billion worth of option ARMs were issued between 2004 and 2007 and will begin resetting shortly. Worse, as of December 2008, about 28% of option ARMs were either delinquent or in foreclosure, according to reports.
But here’s the kicker: nearly 61% of option ARMs originated in 2007 will eventually default, according to a Goldman Sachs report. And due to the way these mortgage nightmares are structured, the rest of them won’t fare much better.
61%??? That’s enough to make a banker take a leap.
7. Next Up: The Credit Card Debacle
According to reports earlier this month, credit card losses are continuing to accelerate with Capital One reporting that write-offs have reached 9.4%. . . with no end in sight. Meanwhile, American Express Co., the largest U.S. credit card company by purchases, wrote off 10 percent of its own loans.
Simultaneously, revolving credit totaled $939.6 billion in March and the Federal Reserve reported that 6.5 percent of it was at least 30 days past due. That is the highest percentage since the Fed began tracking this number back in 1991.
What has evolved is an environment where banks are much less eager to hand out the plastic, since the business isn’t exactly what it used to be. And as a result, banks sent out only about 500 million credit card solicitations in the first quarter. That is fewer than in any year since 2000, as overall available credit shrinks.
And when the credit card swamp finally gets drained, a “new normal” will be here to stay.
8. The Commercial Real Estate Crash
At this point in the cycle, most people recognize that commercial real estate is following the same exact path as the housing bubble — the exact same path!
And we all know how that one turned out.
In fact, losses on commercial loans could reach as high as $30 billion by the end of the year as property values plummet, rents decline, and defaults reach record levels. All of this is a recipe for disaster. . . and industry leaders have estimated that 200,000 businesses and 10 percent of the nation’s shopping malls will shut their doors over the next year.
That means that we’re maybe only in the second inning here as this crisis unfolds.
So, with roughly $530 billion in commercial mortgages coming due for refinancing in 2009-2011, and some estimates showing that as many as 68% of loans maturing during that time will FAIL TO QUALIFY for refinancing, you have to wonder how it will all get done.
The short answer is. . . it won’t.
In fact, as Federal Reserve Bank of Atlanta President Dennis Lockhart said earlier this year, the mortgage bonds due this year and next “are coming up against capital markets not active enough to deal with those maturities.”
When that happens. . . big companies go under.
9. The Ghost in the Machine
Here’s a chart that speaks for itself. It is a measure of U.S. Industrial capacity that shows almost one third of US industry is now sitting idle:
Enough said.
Now if there is a pony somewhere in all of that mess, I just can’t find it. And I haven’t even brought up the prospect of higher taxes through cap and trade, or what a massive health care package will do to small businesses.
Meanwhile, I think we are going to find out this fall that the government doesn’t have any of the answers after all.
Besides, violent bear market rallies are entirely commonplace. In fact, some of strongest occured after Black Monday in 1929.
Take a look:
So while the bulls have had their way here lately, the bigger picture lurks in the background.But to see it, you have to have the courage to connect the dots.
That means that now, more than ever, it’s a stock picker’s market — especially if you have a taste for champange.
Your bargain-hunting analyst,
Steve Christ, Investment Director
P.S. According to Moody’s, commercial real estate values around the country have dropped 35 percent from their peak in October 2007. But that’s just the beginning. . . the decline appears to be accelerating. In fact, values have dropped by more than 15 percent over April and May. To learn more about how to win big as commercial real estate crumbles, click here.
What Cycle is America in Today?
Posted by Harley in The Economy on July 20, 2009
The average age of the world’s great civilizations has been 200 years. These nations have progressed through the following sequence:
From bondage to spiritual faith,
From spiritual faith to courage,
From courage to liberty,
From liberty to abundance,
From abundance to selfishness,
From selfishness to complacency,
From complacency to apathy,
From apathy to dependency,
From dependency back to bondage.
Hitmen Contracts to Bust Comex
Posted by Harley in Financial Education on June 3, 2009
[Sorry for the length but important for your reading, Harley Hunter]
by Jim Willie, CB. Editor, Hat Trick Letter | May 28, 2009
Major dislocations are coming. Tremendous disruptions are coming. Price discontinuities are coming. Price chart patterns might be rendered useless soon. Last week, the case for a grand Paradigm Shift was made, covering many elements in order to paint a mosaic. Taken in isolation, any one point is important in its own right, but not enough to convince of a structural change. Taken in entirety, the many points create a full picture that is more easily recognized. The ruinous events of the Wall Street banks last September and October surely served as an extreme event loaded with profound disruption. The Chinese have proceeded with a transition to yuan-based domestic banking, with an installation of yuan swap facilities around the world, with an ASEAN regional fund again supplied by yuan for flexible purposes, with permission granted to two Hong Kong banks to sell yuan-based bonds, with an admitted rise in significant gold bullion reserves, and with continued verbal battles over legitimacy of the US Dollar as the global reserve currency. These Chinese initiatives in recent weeks, occurring rapidly, are serving as a collective extreme event with the potential for profound disruption. A gold-backed yuan currency would surely cause massive disruption in a climax merger of events. The barter system set up between Russia and Europe will bypass the US$-based settlement system, as will the barter system set up between Russia and China. The avoidance of contract settlement in USDollars would result in extreme disruption to the global banking system. The creditor nations are plotting to organize and launch alternative currencies, maybe to fortify existing currencies (like the euro or yuan or ruble) with a gold component, maybe also with a crude oil component. A challenge to the USDollar by asset-backed currencies would result in extreme disruption to the global banking system. The hidden nitroglycerine to the disruptions is the Russian military, and any pledges of support for nations attempted to force systemic changes. These are just some important examples of change agents.
All Paradigm Shifts result in extreme disruption. That is the essence of Paradigm Shifts. The entire table changes, like its shape, its seats, its location, even who sits at the table, and in particular who sits at the head of the table. Big disruptions are to come from the COMEX pit of corruption, the central nexus for controlling illicitly the price structure for gold, the USDollar, and the USTreasury Bonds. The COMEX in all likelihood is the weakest link in the US-UK chain of corrupted financial markets. For many months my view has been that gold fights the political battles, while silver gathers more than its share of rewards and spoils. Gold has a long history of experience fighting grand battles. It can be placed in dungeons, but not for more than a couple decades. The rot in financial systems without golden foundations forces gold to the surface!
THE HITMEN COMETH
It has come to my attention that several private parties have accepted contract assignments to neuter the COMEX and London Metals Exchange, to render ruin to its gold market. That bears repeating from the rooftops. MUTLIPLE HIRED HITMEN HAVE ASSIGNMENTS TO KILL THE COMEX GOLD MARKET. That is the lynchpin to control the US Dollar, the US Treasurys, and the corrupt mechanisms used by the New York and London syndicates. Their clear criminal behavior is beyond the reach of law enforcement, but they are not beyond the reach of hitmen. The US Dollar has been in violation of the US Constitution since 1971, perpetuated by a renegade series of administrations. The global creditors for the USTreasury Bonds are so angry at the past suffered losses, the prospect of deep future losses, and the corruption laced throughout the US financial system, that they have hired third parties to kill off the US$-gold platforms, to destroy the burdensome banking ballast dominated by protected entrenched fraud experts, to lay waste to the vehicles used by the US-UK bond trafficking syndicate totally saturated with corruption, dishonesty, and collusion, replete with greed, totally absent conscience. They have systemically been dismantling the COMEX pillars and levers over the last several months, quietly and without fanfare, surely without publicity. If gold investors knew of their actions, they would become much bolder. Some want the bankers in their gunsights not to be warned. They await their fate with the Financial Grim Reaper. Their executions will be as swift as brutal.
The HITMEN have been hired, with highly lucrative contracts and wide berth in methods to be put to use. Their assigned task is to castrate the levered family jewels from some of the major players who illegally keep the gold price and silver price artificially low. The targeted victims know their awaited fate, and are presently defecating in their skivvies. A short list of banks facing the firing squad is already known, details for Hat Trick Letter members. Some detailed speculation will be devoted to the June HTL reports, since too controversial. This will be an evolving story, with new chapters soon written. The executions will be sudden. The missing US-UK levers will be immediate. Since last autumn, the global powers have aligned against Wall Street, even if the central bankers have supported it. If one wants to destroy a building, then weaken its pillars, cut a few support beams, then rush in a crowd of people, and wait for a turbulent storm. In the case of the COMEX, the wicked players will crowd the corrupted building. They will sink into ruin and then oblivion. They might become objects of mockery when they make noises from prison. If lucky, they will join Ken Lay from Enron fame in a remote Caribbean island where other favored operators live a secluded life, but a life nonetheless, complete with plenty of sunshine, fresh air, beaches, bikinis, and sailboats, but no intrusive cameras. Please, do not disturb the quasi-dead!
The financial cartel dominated by the United States and United Kingdom is soon to suffer some serious blows. The list of their financial crimes is as magnificent as it is long. Its list of victims is as prominent as it is long. The harbored resentment is great by many global players. They waited patiently for the Obama Admin to install a new group, but the old group remains due to a revolving door from the same smoky club, dominated by Goldman Sachs once more. Their influence, if not bribery, of the US Congress is in continuation, sufficient for unwanted obsequious approval. The regulatory agencies are from the same encrusted chambers replete with stench. The Coup d’Etat of the US Govt financial offices has not changed with Obama, who sounds like a refreshing leader but who is actually a marionette under control by those who selected him, favored him with publicity, then enabled his election. Nothing has changed except the rhetoric of change and the pace on the path to bankruptcy for a few icon firms like General Motors and Chrysler, if not the desperate cries from the 50 states suffering from insolvency. More prominent failures will follow, since nothing has been remedied. The channeled funds directed to Wall Street firms continue unabated. The bread crumbs to Main Street and the people continue unabated. Even the war continues unabated. Forget not that Marie Antoinette once said “Let them eat cake” before the French Revolution and the Storming of the Bastille. Today, the Bastille is the entire US Economy where insolvent Americans are stuck.
Some might wonder what was the turning point that resulted in hired hitmen to be under contract against certain US financial markets. Some might say the failures of Lehman Brothers, American Intl Group, and Fannie Mae. Not so! In my opinion, it was the invasion in the South Osettia region of Georgia in August 2008. The events around Georgia, with the United States Military deeply involved, along with a certain tiny mischievous ally nation, lit a fuse that set off a chain of events. In time, events led to orders given by high level powers, for the US fraud kings on Wall Street to swallow the medicine no later than first thing Monday morning on September 15th. When the Jackass inquired as to the nature of the urgency leading into that understood stated deadline date, no answer was given. The guess of the Bank For Intl Settlements was submitted by me, and it was confirmed. Other sources, the US Treasury Bond creditors, also applied the pressure, it was told. Rumor was thick that death threats had been delivered to certain Wall Street executives, such as Paulson. Thus the pressure passed on to the USCongress for passage of T.A.R.P. funds. The disbursement of those funds have not been made public partly because Wall Street (read Goldman Sachs) does not want the US people to be aware of payoffs for bond fraud under death threats. Also, the Congressional Inspector has cited a few dozen recommendations for criminal fraud investigations of the same T.A.R.P. funds. The US financial sector has become a den of vipers, no longer the bastion of gentlemen, but rather of syndicate bosses.
COMEX STRESS NEAR A BREAKING POINT
Sources from GATA (the Gold Anti-Trust Action committee) report growing distress for participants in the COMEX gold contracts, where a commercial party is very short and in deep trouble. They have sold more gold bullion than they can deliver. They are likely one of the big banks who violate the law with impunity, with US Govt sanctioned protection. By that is meant they routinely do not post 90% of the metal as collateral that they illegally sell. This is naked shorting by any other name. There are reports of grave concern over the upcoming June gold option expiration. If too many deliveries are ordered, then the commercial shorts would be under stress for exposure for naked shorting. They will eventually be caught in a bind and default on contracts. The important loaded monthly contracts are March, June, September, and December. The COMEX has tried to limit the ability of buyers to take delivery, running them around in circles, and entangling them in red tape, all clearly restraint of trade endorsed by the USGovt. Such rules are not in effect for cotton or soybeans or crude oil or pork bellies. After all, a financial crime syndicate has taken control of the USGovt, ever since Robert Rubin took charge at the USDept Treasury in 1992. His major project was to gut the nation of its gold, for the private profit of his friends. Recall Rubin came from Goldman Sachs. Rubin was the author of the Strong Dollar Policy which brought ruin to the nation. Hey, just my opinion!
Background inventory strain has come from unexpected sources. The Germans have demanded that gold bullion held in US custodial accounts be returned to their owners, with physical gold shipped back to Germany. The Dubai bankers have demanded that gold bullion held in London custodial accounts be returned to their owners, with physical gold shipped back to the United Arab Emirates. They are following the hired German counsel. In all likelihood, neither US nor London sources are in possession of all the gold held in those custodial accounts, since at least some of it probably was improperly leased. By that is meant without owner permission or knowledge. So an uproar could come soon with charges of gold bullion theft, or at least failure of fiduciary responsibility. Theft is a simpler description.
China is the biggest gold producer in the world now, but none of its output is directed to the open market. Russia is a significant gold producer also, but none of its output is directed to the open market either. A near default occurred in early April from a close call to Deutsche Bank on 850 thousand ounces of gold. The tarnished bankers at D-Bank dug up over a million ounces on the quick from the ready Euro Central Bank mine shifts in the nick of time. Never ignore the basic fact that COMEX lies through its teeth about the gold bullion in its vaults, since audits do not occur, some is leased (replaced by paper certificates), and some is committed in some fashion to very wealthy parties (unavailable). Far less gold bullion rests in COMEX vaults than is advertised. All signals point to serious strain in COMEX gold supply.
FEEDERS FOR GOLD FULLY LOADED
Two important feeder systems continue to be US Dollar weakness and US Treasury Bond weakness. More important than these is the systematic ruin of the major global currencies generally, but a convenient chart is not offered to track it. Just note the near 0% official rates dictated by the failed franchised Politburos known as central banks in most countries, or the movement toward 0%. The US Dollar has broken below important support at 81. Expect it to fall further after more dithering. The long-term US Treasury Note has suffered a fast rising surge in its bond yield. Its target from different perspectives is 4.1%, and right quick. These two highly favorable charts will power the gold price to new highs very soon. Nobody knows how soon, but soon. Rarely does one see both the US Dollar and US Treasurys fall in value simultaneously. They are now, and will provide a jet assist to gold, which is held back only by COMEX corruption. Their illicit maneuvers are more obvious and desperate with each passing week. Someday their actions might even be on the news. The imminent Standard & Poors debt downgrade of the UKGilt (bonds from British Govt) hit the credit market last week like a bolt of lightning. My belief is that it might have short-circuited the US-UK financial foundation, and burned out some major circuit boards. The US and UK share Third World finance characteristics. If a Fourth World existed, the US would merit it.
The gold price is on the verge of a breakout to new nominal highs. The chart demands it. It needs only a trigger, in a land where potential triggers dot the charred landscape. A gold event will be unavoidable. Its chronic strain has derived from the extreme disparities between the physical market mired in shortage, versus the paper market with unlimited supply. The tail is wagging the dog here, as it has been for years, soon to end. The silver price will easily recover to the 17 level in a flash. It has already surpassed the February high. It is loading up for the next little surge to resistance that awaits at the 17-19 range. The potential sling shot momentum boost for silver will be powerful, enough to send its price to 30 with ease. Think pendulum.
NOW FACTOR IN DISRUPTIVE EVENTS, THE PRICE DISLOCATIONS, AND THE OVER-ARCHING PARADIGM SHIFT IN PROGRESS. THE GOLD PRICE COULD REACH 1300 SUDDENLY. WITH EXTREME CONTROVERSY FROM COMEX, LIKE DELIVERY DEFAULTS, PUBLICIZED CORRUPTION, AND EVEN FRAUD INDICTMENTS, THE GOLD PRICE COULD OVER-RUN THE 1300 TARGET AND HEAD FOR 1500 AND BEYOND. SILVER COULD AS A RESULT FOLLOW ITS WARRIOR BROTHER, HEAD PAST 20 IN A FLASH, AND PURSUE 30 EASILY.
Little attention has been given lately to one of the most reliable time-tested forward indicators of the gold price. The ratio of the 10-year USTreasury Note yield to the 2-year USTreasury Bill yield has always been highly reliable in predicting a move in the gold price. The simple chart of bond yields versus maturity years is known better as the Treasury Yield Curve. The ratio is more amenable to chart analysis. A breakout in the Treasury Yield Ratio is in progress. All benefits from the mid-March monetization announcement have vanished. If the 2-year bond yield remains near 1%, where it appears stuck, then the breakout target would indicate that the 10-year bond yield is heading to 4.1% at least. Yet another method targets 4.1% in the long bond yield. The presented ratio contains information on the future prospect of price inflation, in a reliable contrast of time perspectives. Knuckleheads who insist on pounding the Deflation Tables might want to check this indicator, and look at the crude oil price. It is $63 per barrel, not the $20-25 predicted by these lost troopers. Yo Mish Bro, can you spare me a deflating dime? The strict definition of money is useless anymore. The Shadow Banking system is an actual part of the real world, which you do NOT count.
To the fools, dolts, and morons out there who cling to notions of recovery and Green Shoots, bless your heart. Hope has clouded your minds. Once more you believe the liars and purveyors of propaganda, after being nearly fatally burned. You must believe in the Easter Bunny, Santa Claus, and the Tooth Fairy. You should not be in charge of investment funds, but rather of crayon supply cabinets and Beanie Baby collector items. The Case Shiller housing price index this week reported a 19.1% annual decline in 1Q2009 from Q1 last year. Foreclosures in April were up 32% over last year, as the nightmare continues. That is 1 in 374 homes with mortgages in America in some process of foreclosure. A relentless decline in home prices erases household wealth, and the source of consumer spending. Consumer confidence is ephemeral and baseless. The mortgage rate has just gone above the pre-March levels, when the US Fed announced they would monetize $1050 billion in both US Treasury Bonds and US Agency Mortgage Bonds. The benefit has been erased. Today’s underwater mortgage is tomorrow’s foreclosure, made worse by job losses. The FDIC this week reported a 25% rise in non-current loans in 1Q2009 from Q4 of last year. Greater bank losses will come, much like floods follow hurricanes. And lastly, give credit to the US Govt stat rats in their busy laboratories. They decided to ramp up the Q2 Gross Domestic Product by including all US Govt rescue funds for the big banks, including the diverse funds from the many liquidity facilities. All those funds will go directly into the GDP for Q2 as a special line item. Expect a miraculous economic recovery in the second quarter, based in vapor. The stock rally since March was based in accounting fraud. These are true American innovations, but too bad they are not exportable! They are not, since they have no value.
Copyright © 2009 Jim
Willie, CB
Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a Ph.D. in Statistics. His career has stretched over 25 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials.
http://www.financialsense.com/fsu/editorials/willie/2009/0528.html
Exploding Debt Threatens America
Posted by Harley in Financial Education on June 3, 2009
by John Taylor
Published: May 26 2009 20:48 | Last updated: May 26 2009 20:48
Standard and Poor’s decision to downgrade its outlook for British sovereign debt from “stable” to “negative” should be a wake-up call for the US Congress and administration. Let us hope they wake up.
Under President Barack Obama’s budget plan, the federal debt is exploding. To be precise, it is rising – and will continue to rise – much faster than gross domestic product, a measure of America’s ability to service it. The federal debt was equivalent to 41 per cent of GDP at the end of 2008; the Congressional Budget Office projects it will increase to 82 per cent of GDP in 10 years. With no change in policy, it could hit 100 per cent of GDP in just another five years.
“A government debt burden of that [100 per cent] level, if sustained, would in Standard & Poor’s view be incompatible with a triple A rating,” as the risk rating agency stated last week.
I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis. To understand the size of the risk, take a look at the numbers that Standard and Poor’s considers. The deficit in 2019 is expected by the CBO to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?
Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth – probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.
The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised. That the Fed may have a difficult task reducing its own ballooning balance sheet to prevent inflation increases the risks considerably. And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar. Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change; rather it is an indication of how much systemic risk the government is now creating.
Why might Washington sleep through this wake-up call? You can already hear the excuses.
“We have an unprecedented financial crisis and we must run unprecedented deficits.” While there is debate about whether a large deficit today provides economic stimulus, there is no economic theory or evidence that shows that deficits in five or 10 years will help to get us out of this recession. Such thinking is irresponsible. If you believe deficits are good in bad times, then the responsible policy is to try to balance the budget in good times. The CBO projects that the economy will be back to delivering on its potential growth by 2014. A responsible budget would lay out proposals for balancing the budget by then rather than aim for trillion-dollar deficits.
“But we will cut the deficit in half.” CBO analysts project that the deficit will be the same in 2019 as the administration estimates for 2010, a zero per cent cut.
“We inherited this mess.” The debt was 41 per cent of GDP at the end of 1988, President Ronald Reagan’s last year in office, the same as at the end of 2008, President George W. Bush’s last year in office. If one thinks policies from Reagan to Bush were mistakes does it make any sense to double down on those mistakes, as with the 80 per cent debt-to-GDP level projected when Mr Obama leaves office?
The time for such excuses is over. They paint a picture of a government that is not working, one that creates risks rather than reduces them. Good government should be a nonpartisan issue. I have written that government actions and interventions in the past several years caused, prolonged and worsened the financial crisis. The problem is that policy is getting worse not better. Top government officials, including the heads of the US Treasury, the Fed, the Federal Deposit Insurance Corporation and the Securities and Exchange Commission are calling for the creation of a powerful systemic risk regulator to reign in systemic risk in the private sector. But their government is now the most serious source of systemic risk.
The good news is that it is not too late. There is time to wake up, to make a mid-course correction, to get back on track. Many blame the rating agencies for not telling us about systemic risks in the private sector that lead to this crisis. Let us not ignore them when they try to tell us about the risks in the government sector that will lead to the next one.
The writer, a professor of economics at Stanford and a senior fellow at the Hoover Institution, is the author of ‘Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis’
Copyright The Financial Times Limited 2009
US MARKET NEWS:- UPDATE - Tyco International profit beats forecasts (at Reuters)
- Wall St futures point to higher open as data eyed (Reuters)
- Stocks struggle to hold gains after Fed caution (at Financial Times)
- Stocks set for early gains as investors await more earnings (at CNNMoney.com)
- Wall St futures point to higher open; data eyed (at Reuters)
