Economy

Unless you’ve just woken up from a week-long coma, you already know that Ben Bernanke, Chairman of the Federal Reserve, announced the Fed is going to maintain its Zero-Interest Rate Policy for the next 2-3 years. It is also going to buy $500 billion worth of mortgages every year until the economy improves.

One opponent of this measure was president and CEO of the Dallas Federal Reserve, Richard Fisher. Fisher maintains that buying bonds probably won’t help stimulate the economy. Instead, it will however increase inflation, and expectations of inflation.

As one of the richest members of the Fed, we should probably listen to him. Worth an estimated $21 million, Fisher has worked as a Banker and a Hedge Fund Manager. And he’s been voicing inflation concerns since 2005.

While opposing the Fed’s stance on bond purchases, his personal portfolio is well positioned to benefit from any inflation that might occur due to it.

Fisher owns about $1 million worth of gold in the form of the gold ETF (GLD), $250,000 in uranium, and over 7,000 acres of land in the Mid-West.

In a prior post, I mentioned that everyone’s portfolio deserves an allocation to gold. As a percentage of his portfolio, Fisher’s allocation to gold is sitting at about 5%. In addition to gold, real estate is also inflation hedges. (While I wouldn’t necessarily recommend uranium as an inflation hedge, it is a commodity and thus being somewhat uncorrelated to either stocks or bonds, would provide some value in a portfolio).

So he’s definitely set up his investments to benefit from inflation.

What else does he own? Several million in Texas Municipal Bonds – earning him tax-free interest on his money. And a lot of blue-chip stocks like Eli Lily and Du Pont along with MLPs like Magellan Midstream Partners. You can check out the entire list here.

Nothing like a well-balanced portfolio to live out your retirement years in case your cushy government pension runs out!

Gold broke another record today, closing just over $1,700/oz. The Dow Jones Industrial Average dropped 634 points (5.5%) and not surprisingly, US Treasuries jumped.

This was the expected response to S&P’s cut in US credit rating.

The irony is the jump in US Treasury prices caused a decline in the interest rates.This is because bond prices and interest rates are inversely correlated.

Usually, when your credit rating is cut, the interest rate at which you can borrow goes up.  But, in the case of the US government, it has gone down.

The current yield on a 10-year Treasury is 2.31%.  Last month it was 3.02%. Similarly, the yield on a 30-year Treasury bond is 3.65%, down from 4.28% last month.

Maybe S&P should take down the US’s credit rating another notch, and cause interest expenses to fall even further!

Okay, I’m being facetious.

But I don’t like the way it’s playing out. The current economic scenario reminds me of Japan over the past two decades.

Will the US economy continue to flounder for the next several years just as Japan did?

Will the government continue to prop up failing banks and poorly run business at the expense of the tax-payer?

Will interest rates continue their downward spiral?

Will real estate continue to slide for the rest of the decade?

Are we really turning Japanese?

I really think so!

Today the US debt broke the $13 trillion level. Considering that the US GDP or the US economy is $14.2 trillion (according to the World Bank), that makes our debt level just over 91% of the GDP. Greece’s debt-to-GDP ratio is currently at 115%  (or 133% depending on who you ask – I don’t think even the Greeks know for sure!) and look at the trouble it’s facing!

Professor Morici, of the University of Maryland, is critical of excessive government spending. He claims that whenever the debt-to-GDP ratio exceeds 150%, you run the risk of hyperinflation or “the Chinese buying up Wall Street”, a reference to China being the largest foreign lender to the US government. Either way, he claims that we will run the risk of losing our financial standing.

On a brighter note, the UK is trailing right behind us with a debt-to-GDP ratio of 78%.  But the real leader of pack is Japan, with a whopping 227%! Not to worry, we’re nowhere close to Japanese levels yet!

After WWII, our debt stood at 125% of our GDP and we were able to bring it under control. Let’s hope we can do the same thing once again. Meanwhile, we can all watch our share of the federal debt over on http://www.usdebtclock.org, and how the national debt seems to be growing $50,000 every second!

With the passing of the Health Care Bill, there is a slew of tax increases that will go towards paying for it. I don’t think any of them are going towards paying down our ballooning debt. Congress probably feels that inflating it away is the easiest solution! And it is, provided the inflation comes in an orderly fashion. But what if it doesn’t?

If you believe the government or the popular press, the economy is out of recession and everything is business as usual again. Last month there was an increase in jobs by 162,000, home sales jumped 8.2%, the Dow is now almost at 11,000 and interest rates are inching upwards  in recognition of the economic recovery. It’s all peaches and cream isn’t it!

Unfortunately, I don’t believe the government or the popular press. I like to look at the facts and draw my own conclusions. First of all, the 162,000 new jobs includes 48,000 temporary census jobs. What happens when these jobs go away? And compared to the millions of jobs lost, 162,000 jobs doesn’t feel like anything to celebrate in the first place.

According the Associated press, in February the pending home sales number jumped 8.2%. This is not year-over-year but rather from January to February. Don’t know if anyone remembers but it was awfully cold in January. Historically home sales slow down during winter, especially when you have pretty bad snowstorms. An 8% increase doesn’t sound like newsworthy at all.  Additionally, the government has been offering a ton of incentives to home buyers, which is probably just cannibalization of future home buying. From the California Association of Realtors:

Californians have a brief window of opportunity to receive up to $18,000 in combined federal and state home buyer tax credits.  To take advantage of both tax credits, a first-time home buyer must enter into a purchase contract for a principal residence before May 1, 2010, and close escrow between May 1, 2010 and June 30, 2010, inclusive.  Buyers who are not first-time home buyers may use the same time frames to receive up to $16,500 in combined tax credits if they are long-time residents of their existing homes as permitted under federal law, and they purchase properties that have never been previously occupied as provided under California law.

And why is the DOW on the verge of breaking 11,000? Is it the fact that the government spent around a trillion dollars propping up the economy or could it be that consumer spending is back? May be its consumer spending. After all, the malls seem full around here. But did you hear that 25% of homes in the US are underwater on the mortgage on 14% of all houses are in some state of default? Being in default means that the monthly mortgage payments are not being made. Doing some back of the envelope calculations, TraderMark was able to put a figure on these numbers. By not paying their mortgage, Americans have an extra $160 billion per year to spend on clothes, cars, vacations and other random stuff.  To see the numbers, check out this post on the hidden stimulus package. No wonder the retailers have been doing well!

And are the interest rates trending higher because the market expects a recovery? Or is it because it expects inflation? If you look at the number of people clamoring for TIPS (Treasury Inflation Protected Securities), the number is trending higher as well. Seems like people aren’t big believers of the US Government’s ability to curb long term inflation.

So what is it – peaches and cream or doom and gloom? The truth is somewhere in the middle. With the government willing to spend money (it doesn’t have) to keep stimulating the economy, it looks like the economy is recovering pretty well. But it cannot come without consequence. At some point someone will have to pay the price of all these bailouts and packages. It might be us, our children or foreign bond holders, but that day will come. Just make sure you invest accordingly.

A lot of people don’t even know that Greece’s debt is a problem that is threatening to bring down the European Union. And of those that have heard about, few realize its significance and potential impact on the US. John Mauldin has done a fine job explaining that in his most recent newsletter. It’s written as a letter to his kids explaining how the current economic situation affects them.

Why is Greece important? Because so much of their debt is on the books of European banks. Hundreds of billions of dollars worth. And just a few years ago this seemed like a good thing. The rating agencies made Greek debt AAA, and banks could use massive leverage (almost 40 times in some European banks) and buy these bonds and make good money in the process. (Don’t ask Dad why people still trust rating agencies. Some things just can’t be explained.)

Except, now that Greek debt is risky. Today, it appears there will be some kind of bailout for Greece. But that is just a band-aid on a very serious wound. The crisis will not go away. It will come back, unless the Greeks willingly go into their own Great Depression by slashing their spending and raising taxes to a level that no one in the US could even contemplate. What is being demanded of them is really bad for them, but they did it to themselves.

But those European banks? When that debt goes bad, and it will, they will react to each other just like they did in 2008. Trust will evaporate. Will taxpayers shoulder the burden? Maybe, maybe not. It will be a huge crisis. There are other countries in Europe, like Spain and Portugal, that are almost as bad as Greece. Great Britain is not too far behind.

The European economy is as large as that of the US. We feel it when they go into recessions, for many of our largest companies make a lot of money in Europe. A crisis will also make the euro go down, which reduces corporate profits and makes it harder for us to sell our products into Europe, not to mention compete with European companies for global trade. And that means we all buy less from China, which means they will buy less of our bonds, and on and on go the connections. And it will all make it much harder to start new companies, which are the source of real growth in jobs.

And then in January of 2011 we are going to have the largest tax increase in US history. The research shows that tax increases have a negative 3-times effect on GDP, or the growth of the economy. As I will show in a letter in a few weeks, I think it is likely that the level of tax increases, when combined with the increase in state and local taxes (or the reductions in spending), will be enough to throw us back into recession, even without problems coming from Europe. (And no, Melissa, that is not some Republican research conspiracy. The research was done by Christina Romer, who is Obama’s chairperson of the Joint Council of Economic Advisors.)

And sadly, that means even higher unemployment. It means sales at the bar where you work, Melissa, will fall farther as more of your friends lose jobs. And commissions at the electronics store where you work, Chad, will be even lower than the miserable level they’re at now. And Henry, it means the hours you work at UPS will be even more difficult to come by. You are smart to be looking for more part-time work. Abbi and Amanda? People may eat out a little less, and your fellow workers will all want more hours. And Trey? Greece has little to do with the fact that you do not do your homework on time.

And this next time, we won’t be able to fight the recession with even greater debt and lower interest rates, as we did this last time. Rates are as low as they can go, and this week the bond market is showing that it does not like the massive borrowing the US is engaged in. It is worried about the possibility of “Greece R Us.”

Bond markets require confidence above all else. If Greece defaults, then how far away is Spain or Japan? What makes the US so different, if we do not control our debt? As Reinhart and Rogoff show, when confidence goes, the end is very near. And it always comes faster than anyone expects.

The good news? We will get through this. We pulled through some rough times as a nation in the ’70s. No one, in 2020, is going to want to go back to the good old days of 2010, as the amazing innovations in medicine and other technologies will have made life so much better. You guys are going to live a very long time (and I hope I get a few extra years to enjoy those grandkids as well!). In 1975 we did not know where the new jobs would come from. It was fairly bleak. But the jobs did come, as they will once again.

At least there is some good news in the end!

The underlying issue is the size of the country’s debt. At some point, either it becomes too big to service, or creditors get cold feet about the ability to service the debt and demand repayment – usually at the worst possible time. This is what happened to Iceland. They defaulted on $50 Billion euros of debt, not a large amount by US standards, but 488% of their GDP and a huge amount to their tiny population of less than 350,000. Greece, Portugual, Spain, Ireland and the UK are all in a similar situation.

Even the US isn’t too far behind. Currently our debt is nearly 400% of our GDP. At what point do our creditors stop lending us money?
USdebt-vs-gdp

The Wall Street Journal had an article advising homeowners who were upside down on their mortgage to just throw in the towel and walk away from their mortgage. Here’s the abridged version:

Millions of Americans are now deeply underwater on their mortgage. If you’re among them, you need to stop living in a dream world and give serious thought to walking away from the debt.

No, you shouldn’t feel bad about it, and you shouldn’t feel guilty. The lenders would do the same to you—in a heartbeat. You need to put yourself and your family’s finances first.

If you are reluctant to give up on “your” home, realize that it isn’t “yours.” If you are in negative equity, it’s the bank’s home. You’re just renting it. And right now you may be paying way above market rates. You need to be ruthless about your cash flow.

Still, when it comes to the idea of walking away from debts, many people are held back by a sense of morality. They feel it’s wrong to abandon their obligations. They don’t want to be a deadbeat.

Your instincts, while honorable, are leading you astray.

The economy is fundamentally amoral.

Whether we like it or not, walking away from debts is as American as apple pie. Companies file for bankruptcy all the time, and their lenders eat the losses. Executives and investors pocketed millions from the likes of Washington Mutual, Lehman Brothers and Bear Stearns when the going was good. They didn’t have to give back one cent of that money when the companies went into bankruptcy.

Wow, I’m speechless. It seems the greed of Wall Street has permeated down to the lower rungs of society and it’s perfectly okay to socialize your debts and losses. (By socializing, I mean the bank or taxpayer or a large group of people who are not affiliated to you end up paying for your debts/losses/mistakes/greed). Apparently its as American as apple pie. Is this the change I didn’t vote for? If everyone in all sections of society thinks its perfectly okay to default on your obligations, logically, the next question is

How much longer until the US Government starts defaulting on its debts?

Of course, the US Government cannot default, since it can keep printing US Dollars to pay for its debt. Which it is already doing. The only problem is that this increases the number of dollars in circulation and causes the currency to devalue. Sooner or later, we’re going to see a large of amount of inflation. No we may not see hyperinflation like Brazil or Zimbabwe, but we sure might see 10-12% inflation for a few years.

But 12% inflation for only 6 years would cause the price of everything to double. If you don’t think that’s possible, just look at a country which isn’t currently in deep recession, like India. Inflation in India is currently running at 9%. And over the past decade it has been running at a similar rate.

So what’s the effect on the average Indian? Highly skilled workers saw their salaries jump 10 times, while salaries for unskilled labor is up about 5 times. So everyone is better off, right? Not exactly, people living on fixed incomes basically got screwed as prices for everything else went up 5-10 times as well. It was great if you owned real assets like real estate, gold and to some extent stocks, but terrible if you owned bonds or cash. Just make sure your investments are tailored towards those investments that happen to do well during inflationary times.

Here’s an excellent video about an empty city in China that has been built using government funds. Ploughing billions of dollars in infrastructure and construction works theorectically improves the GDP but benefits no one (unless you count the companies that were awarded the contracts), and actually punishes tax-payers. But of course, the people reaping the rewards are not those being punished so there is no incentive to change the way things are.

The government bailout of poorly run companies (via direct investment and subsidizing of their products) also distorts the GDP. GDP numbers in the US without the Trillion dollar bailout would not look so rosy.

Despite all the talk of the economy being out of recession, 39 million people in are on food stamps. [source: USA Today] Thats 12.65% of the US population! And 6 million of that number have no other source of income. In what was once the world’s most prosperous nation, 2% of people would starve if the government didn’t send them food stamps.

Maybe they should start blogging to earn some online income. I see that LivingOffFoodStamps.com is still available!

Here’s a funny video explaining the true unemployment numbers that the BLS just released.

The Bureau of Labor Statistics (BLS) announced today that the unemployment rate for November fell to 10%. This figure represents 15.4 million officially unemployed people.

In reality there are over 26 million Americans who are either jobless or underemployed. The “real” jobless rate takes into account part-time workers seeking full-time work, discouraged job seekers and persons furloughed from full-time to part-time status. The real rate of unemployment is 17.2% and is a more accurate indicator of the labor market.

According to a quote in the Telegraph, HSBC has issued a new report stating that the Federal Reserve’s ultra-loose monetary policy is forcing China and other emerging countries to create a new global currency “order”. According to David Bloom, HSBC’s currency chief, the dollar looks like the sterling did after World War I.

For those a little dusty on their history, the British pound sterling (so called because it’s value was backed by sterling silver) was the world reserve currency until the 1930’s. After that, the sun set on the British Empire and the sterling was replaced by the US dollar. Now it seems the dollars time in the sun has come to end as well. The Telegraph article states:

Crucially, China and rising Asia have reached the point where they can no longer keep holding down their currencies to boost exports because this is causing mayhem to their own economies, stoking asset bubbles. Asia’s “mercantilist mindset” of recent decades is about to be broken by the spectre of an inflation spiral.

A monetary policy of near zero rates – further juiced by quantitative easing – is completely incompatible with circumstances in most of Asia, the Middle East, Latin America, and Africa. Divorce is inevitable. The US is expected to hold rates near zero through 2010 to tackle its own crisis.

Mr Bloom said regional currencies would emerge as the anchor for their smaller trading partners, with China, Brazil, or South Africa substituting the role of the US. Australia is already linking its fortunes to China through commodity ties.

This is nothing new, but it is the first time a major bank has openly stated this. But the important question hasn’t been answered.

What does it mean to the average American?

In order to obtain the necessary financing to fund the multi-trillion dollar stimulus/bailout package the government needs to sell bonds. Traditionally, the Chinese and other foreign governments have used their excess reserves of US dollars to purchase these bonds. If we switch to some other currency (or mixture of different currencies), the amount of US dollars held by foreign governments will decrease and the demand for US treasuries that yield next to nothing will decrease substantially. In order to entice the buying of these treasuries, the interest rates will have to jump substantially higher. And when this happens, the cost of the US government’s debt will start to rise. As will the cost of borrowing for US citizens and businesses. The government already pays nearly a billion dollars a day in interest payments (hat tip: Silver Bars Direct: Why $1,000 gold is now significant). If this cost were to double, and we add in the additional $9 trillion in debt the white house has admitted it is likely to borrow, we’re looking at over a trillion dollars a year in debt payments.

In order to repay this interest (and maybe the original principle too), do you think the government is likely to raise taxes or just print more money? If it prints more more, its just fueling the debt spiral which will lead to Zimbabwe-type hyper-inflation.

So what should you do?

Invest in hard assets that have been proven to keep their buying power during inflationary times.  Along with gold and silver bullion, buy some cheap land to either farm, hunt or bury your precious metals! And if you’re one of those people who think buying gold and silver is useless then hold on to your dollars and watch them become even more worthless. Since 1900, when the dollar coin actually contained silver, the dollar’s purchasing power has dropped to only4 cents. This trend is only like to get worse.

Purchasing-Power-of-the-US-Dollar-1900-2005

Disclosure: I own gold & silver bullion, numismatic coins and mining stocks.

Almost a year after the historic collapse of Lehman Brother, Fed Chairman Dr. Ben Bernanke announced that the worst recession since 1930 is finally over!

recession next exitHowever, this is only from a “technical perspective”, and unemployment for 15 million Americans (officially 9.7%) will continue, if not get worse. In fact, it may stay this way for nearly 4 more years according to other economists.

So what does this mean? The operation was a success but the patient still died!

Apparently pumping a trillion dollars in to the economy will create a technical expansion even if the net benefit to society is negative. What happens when the government pulls the plug on throwing money at the ecnomy? Won’t the GDP decline again, pushing us back in to a double dip recession?

And what happens if our lenders make this decision for us? Supposing China and Japan no longer want to buy our 30 years bonds at a measley 3 or 4%. What if the interest rates go up to 8%? Will we be able to afford $1 trillion dollars a year in interest payments? Will we start issuing notes for the interest payments? Nah, we’ll just devalue the currency and let inflation help us out of this mess. Either that or the government stimulus will continue indefinitely, aka monetary policy Zimbabwe-style! Oh wait, isn’t that the same thing?