Friday, September 18, 2009

Its all about Oil and Debt

So, where to from here?

The housing/mortgage/financial system train wreck that came about over the past 3 years or so was an easy one to see - that is unless you were a classically trained economist with a 7 figure Wall Street pay package or a government Central Bank economist.  Then you were deaf, dumb, and blind... but at least your establishment credentials SAID you were intelligent...

That was then, and this is now.  

Where are the Western financial markets going?  What about the US$? Oil?  Ranting about the end of the world is not going to make one a living.  Losing one's life savings is not that appealing either...

The U.S. and OECD governments have won the deflationary battle much earlier than I would have thought.  Read my posts over the past 60 days or so... time and time again I mention that the US$ MUST begin to recover RIGHT NOW - or else.  It appears that we should get ready for the "or else" series of outcomes, because in succeeding to reinflate the U.S. Treasury and Federal Reserve Bank have ensured the demise of the U.S. currency.  Actually, that's not fair.  The Treasury and the Fed were merely hand maidens for the elected nit wits leading our country for the past 50 years.  It was NEVER possible to actually pay for all of the liabilities of Medicare and Social Security (among other silly things dreamed up by what should have been our best and brightest).  

The US$ is going to experience a very tough slog over the next 10 years (and that might be the understatement of a lifetime).  There appears no other way.What is the point of working hard, saving and investing wisely, only to have all of your work blown away?

I had this to say in my November 15, 2006 Post:

The only way to pay the debt back is to increase net nominal (not real) tax revenues, actually or de facto. This can be done in a number of ways:

• The U.S. can raise tax rates.
• The U.S. can cut services, entitlements, and spending for defense
• The U.S. can grow the size of its economy, thereby collecting more taxes without necessarily raising tax rates. For this to work, the U.S. must still get a hold of its spending.
• The U.S. can debase (lower the value of) its currency (or its trading partners can do it for the U.S.).

It is extremely doubtful that the U.S. could raise its tax rates enough to make much of a dent in its budget deficit and entitlement liabilities – to do so, the U.S. would have to tax its citizens into penury. How likely is it that the U.S. Congress would cut services and entitlements in the absence of crisis? Pigs have a better shot at flying. Can we grow our way out of this mess? Sure, if we had an unlimited supply of domestic Oil and Natural Gas (“NG”) and if we were also able to control our spending. In order to grow the economy we must increase our consumption of energy. And “therein lies the rub”: The only energy source we can increase consumption of is Coal, and Coal will not run the U.S. transportation system. Coal will not heat the homes of the approximately 60% of Americans that use NG for home heat. Not to mention the external environmental costs concomitant with the use of Coal.

So we are left with the currency. You see, to pay its IOU’s, a government is very much able to print more money and use it to pay its debts. The problem with that is the contra party, the guys that hold those IOU’s, don’t like that very much. They won’t extend any more credit on such terms. They will want MORE of that less valuable money in the form of interest in the future and for the exchange of goods and services that they sell us. That means higher interest rates and higher inflation. Much higher, and we all know what that means
Then a couple of days ago the Mad Scientist sent me this from a Research Report from Sprot Asset  Management: (here is a link to the entire report)

So how will this US debt crisis ultimately resolve itself?  Let’s consider the options. It would appear from our analysis that the spending ‘promises’ are the crux of the problem now facing the US Government. If there isn’t enough new capital in the current environment to fund new Treasury bill issues (as we argued in “The Solution... is the Problem”), then there certainly isn’t enough capital to pay for the US’s unfunded future obligations. The choices, therefore, are bleak:

1. Default on Medicare promises. (Unlikely given the current debate in Washington to  

expand medical coverage.)  

2. Default on Social Security promises. (Unlikely given the increasing average age of the  

voting public.) 

3. Put forward a credible plan to balance the budget. (Unlikely given the most recent budget 


4. Default on outstanding debt. (Unthinkable) 

None of these options are feasible for the US Government. So they realistically only have one option left – to print their way out of their debt crisis. 

We keep coming back to the numbers for the US debt, and they don’t add up. Even Alan Greenspan, former Chairman of the Federal Reserve, believes that the rising budget deficits in the United States are “unsustainable”.  Because the US Government is printing dollars to fund their liabilities, it is highly unlikely that we will ever see a failed bond auction similar to that of Poland. The far more likely outcome, therefore, will be a US dollar crisis. It is for this reason that we have positioned our hedge funds and mutual funds so heavily in precious metals. At the end of the day, when the world finally realizes what the US has done to the world reserve currency, international investors will shift into an asset that no government can print. In our opinion the US dollar’s status as a ‘port’ in the financial storm has officially come to an end.

I will be the first to admit that the deflation argument held sway with me for a short period of time - and it cost me in lost opportunity. When the data changes and you don't change fast enough with it... you won't be in my business for long.

More to come.



Anonymous said...

At first I bought into the deflation theory, but when Bernanke announced that he was throwing the dollar under the bus to prevent a depression, that was your cue to long commodity assets.

Since it appears the money printing has turned the tide of deflation, we are only seeing a glimpse of inflation. China is also encouraging it's people to buy gold and silver!!

bureaucrat said...

I must have started reading you in 2006 cause I remember that word "penury." :)

OK, lots of items, but I'll keep them short ...

1) Deflation is still in play. Even if you printed/created an ocean of dollars, you have a LONG way to counteract the $20 trillion in credit that has been destroyed in the past year. Demand for everything will also continue to drop due to generational factors (older baby boomers won't buy much now and their kids will stop spending too)

2) I got Cs in my college courses in economics (2 of them), taught by a guy at NU named Prof. Gordon. I thought he was a goof then and I've been vindicated.

3) The economic "hiccup" we're seeing now with the sucker's rally will go back to downward shortly

4) Forget about the health care debate for now. They won't be able to afford anything except single payer very shortly anyway.

5) If the U.S. economy is on a 30 year cycle (1980-2010 = great times, 1950-1980 = sucked eggs), the next 30 years means: higher interest rates, inflation, crappy stock market, debt defaults.) Now throw in energy depletion? Good night!

6) The world isn't going to come to an end, but a "changeover" to a new way of living is going to suck. Higher prices will too.

7) While coal and natural gas seem to have the wind at their backs, those green shoots may be misinterpreted.

8) If Venezuela can survive at 15-20% inflation (bigtime currency printing), we can do the same thing .. for awhile .. and after that, all possibilities stink.

9) Before we get into the wonders that are precious metals, everyone should be aware that the damn things are HEAVY. I have gold and 600 ounces of silver. You can't move this stuff around very easily.

10) I won't repeat how NEAR-IMPOSSIBLE it is to cut the Federal budget. 80% of the money goes to five WILDLY popular programs. We're gonna end up printing, unless American adults decide to sacrifice WAY more than the "Greatest Generation" ever did.

Greg H. said...

I was totally in the inflationary camp until everything crashed. Now I'm not so sure any more.

People are getting frugal which will drive down prices on non-essentials. However, the essentials in life will eventually become harder to get which will drive up prices on the must haves (food, energy, water, etc).

Of course frugal people will learn to get by using less and our economy is presently geared to provide way more than we really need.

So until production actually drops below what we "really" need I think we'll be in deflation. After that we'll have inflation on the essentials and deflation on the non-essentials. Such as "I'll give you 5 gallons of gas for that flat screen TV". Or "A bag of rice for your Beamer", (they make great chicken coops :)

As Mr Jeffers says, thing don't just zig. They zig and zag. At times we'll feel like we are heading towards inflation and at other times it will feel like deflation.

The markets are being gamed by propaganda and surgically directed cash flows. They need the sheeple to buy into the recovery. However, everything will return to equilibrium eventually.

bureaucrat said...

Jeffers had something to say on this topic this month (and last) ...

From "The Mess That Greenspan Made"/CNN/Money sites ...

"Where we used to live in Northern California, news came recently that a couple just put their retirement home up for sale (purchased in 2007, ouch!) after the recession had taken a toll on the business owner's income while the college tuition bills just kept coming.

As said business owner was of the view that the U.S. economic slowdown was nothing more than a "media-created" event as recently as a year ago, his plight will not elicit any sympathy from these quarters but, based on this story at CNN/Money, he is surely not alone.

As much as a college diploma may assist today’s youth with their future employment, paying for that education is giving their parents a severe headache. New surveys released by Fidelity Investments, the College Savings Foundation, and Sallie Mae have found that parents understand they’re not saving enough, are worried about it, and are even planning to delay their own retirement to pay their kids’ tuition..
Make no mistake, college is expensive. This year’s numbers aren’t out, but college costs have risen 23% since 2000, after inflation. It’s great that many parents are willing to delay retirement a few years. But if it comes down to a decision between retirement savings and college savings, don’t feel guilty for making your kid finance his education or work his way through school. If you’re able to save more down the road, you can always help him pay off his loans, but no bank is going to lend you money to supplement your retirement savings if you come up short.

The approach to saving for both retirement and college that seemed to work so well earlier in the decade (i.e., figuring that your rising home equity will not only fund your kids' education but your golden years as well) is, sadly for many people, not working so well anymore."