Archive for the ‘Debt & Deficit’ Category

“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

With those words, John Maynard Keynes–the inventor of the “prime the pump,” economic stimulus theory employed by both FDR and Obama–tells you everything you need to know about current U.S. monetary and fiscal policy.  And while he said this as an attack on inflation, it is ironic that his policies have–in some people’s minds–led to high levels of inflation right here in the United States.

American Endgame has already touched upon inflation in fleeting terms.  We have discussed the idea that inflation is the rate at which a particular currency loses its value.  For example, a 2% rate of inflation will leave a dollar with 25% of its buying power after about 75 years.  A 6% rate of inflation will accomplish the same in just over 20.  But one thing we have not discussed is how inflation may be purposely being employed by the U.S. Government–and governments around the world–to both buy this economy more time and to establish a solution to America’s “there’s no way we can pay off our debt” problem.

The mechanics of inflation are fairly straightforward.  Assuming a fixed supply of currency, businesses will accept the fact that there is a finite amount of money to be “earned,” and prices will stabilize around a strategy to maximize a business’ ability to get the largest chunk of that pot as possible.  By way of example, if there were $1,000,000 in the U.S. economy, an intelligent businessman would recognize that there are $1,000,000 in circulation and “up for grabs” among the workers.  Some of these dollars would be given to the workers through paychecks, while others would be made available through bank loans, credit card borrowing, etc.  This intelligent businessman would also recognize that, on average, each American has access to $1,000,000/x, with x being the number of workers in the country (this is dramatically simplified, but bear with me).  After factoring how much of that money must go to basics needed to survive, a businessman makes a calculation of how much they will charge for their good or service to entice workers to spend a portion of their $1,000,000/x dollars on their product to maximize their profit.  Conversely, as a worker with only $1,000,000/x dollars available to spend, one must carefully determine how much they must spend to survive, buying food and clothing, paying rent and utilities, before going out to buy other goods.  Every purchase results from a calculation that goes approximately like this: “I have $1,000,000/x, so I can still afford to buy…”

Now, what would happen if the U.S. Government made arrangements to introduce an extra $1,000,000 into the economy?  This could be done through various methods, including physically creating more currency or by lowering the amount of money banks must hold in reserve, thus allowing them to fractionally lend greater amounts of their deposits.  Either way, let us say that now the U.S. economy consists of $2,000,000, and the amount of money available to workers is $2,000,000/x, on average.  Of course, this increase will come almost entirely from bank lending and credit card borrowing, since no one is going to advocate doubling a worker’s pay in America–not even in our hypothetical scenarios is that anywhere near realistic.  So, now the intelligent businessman recognizes that there are two times as many dollars out there to get his hands on.  In this way, prices would rise in all sectors because people are now “twice as able” to buy the products they’ve been buying all along.  And while the original intent of the government introducing more currency would have been to get people to buy “extra” stuff with their “extra” money, the effect is almost always different: people will end up buying the same stuff at an “extra” cost.  The effect is highly detrimental, and not stimulative at all.

One doesn’t have to be a prize-winning economist to see that this set of circumstances is not only happening today, but very dangerous indeed.  After all, if I make a fixed amount of money, and prices continually rise because more money is available to use, this is highly problematic.  My purchasing power drops continually as my slice of the overall pie continues to dwindle as I sit helpless.  If, in order to keep up, I do what so many Americans do and borrow money from banks or use credit cards to fill the gap, I am doubly in trouble.  How will I ever pay it back on a fixed, finite amount of pay? (I say “fixed” and “finite,” and I use those terms in a relative sense.  A 3% payraise–unimaginable for most of us–is not “fixed,” but might as well be for the purposes of taking on inflation, since the numbers we see suggest inflation is somewhere near 9 or 10%.)  So why does the U.S. Congress and the Federal Reserve continue to make more money available?  Consider the alternative.  Should the Federal Reserve end its policy of introducing more currency into the system on a fairly constant basis–this introduction is easy because U.S. Dollars, as we’ve learned, are fiat and have no real value–people will be forced, finally for the first time in probably 30 years, to live within their means.  “Living within their means” scares the Hell out of Congress.  Without more money always being introduced into the system, the United States would experience a highly deflationary event.  Americans would quickly begin to conserve and spend far more preciously the currency they possess in order to survive.  Without additional availability of credit, we would see money spent on food, utilities, gasoline to get to and from work, clothing, and other basics.  Goodbye, Channels 2-300…  Goodbye, trips to the movies for a family of four…  Goodbye new cars that can’t be paid for from savings…  You get the picture.  While the uber-rich would probably be fine, the 99% would vastly reduce their spending, and this would cause a massive collapse of the United States’ economy for want of customers.  Layoffs would ensue, and a deflationary spiral–where prices would fall to keep up with spending habits, which would lead to layoffs, which would lead to businesses shuttering, which would lead to catastrophe–would be almost certain.

There are some who dare suggest that this type of event is inevitable and necessary to fix the problem we’ve created by allowing too much debt to accumulate in the system.  After all, $55 trillion is a lot of debt, and like any massive debt, it will save a lot of money in the long-term were it paid down or paid off.  The devil is in the interim.  The contraction of such an overinflated economy would most likely feel like something between the Great Depression and the Dark Ages.  And as we’ve seen this year in Greece, when the government reduces its spending–ending favored social programs, reducing benefits, lowering minimum wages, and potentially increasing taxes–ain’t nobody gonna be happy.  The problem then becomes not only an economic problem, but a major social problem and a political problem.  And Congress and the White House don’t have the stomach for an American Spring, which is what they would be looking at if they make the necessary changes.

I am of the mind that we are definitely going to experience this “something between the Great Depression and the Dark Ages” event–you could probably tell by the title of this blog.  The question is not whether a major credit crisis will occur.  The questions are “when will it occur,” “how do we mitigate the impact on our society,” and “what do we owe to our progeny?”  If our generation could shoot for the Great Depression–an event which we survived–and take that on, it would be a great contribution to our nation’s future.  This would be far better than the Dark Ages scenario.  However, we grew up in a society so focused on material gain, selfish behavior, and instant gratification, that we may not have the mental fortitude to take this on.  The alternatives are dire.

One way or another, this event is unavoidable unless we make changes to our spending now.  The selfish path leads to our annihilation.  The selfless path–where Medicare, Social Security, low taxes, and military omnipresence are sacrificed–may get us out of this mess in the next 50 or 60 years.  I am simply not yet convinced we as a people have the foresight and strength to recognize the need for these changes and make them.  Even if our Congress sees the need and tries to save us from ourselves, we will probably “unelect” them or riot in the streets.  Either way, the outcomes will most likely be the same and we’ll have an interesting lifetime to look forward to.

~ DS

Today is a busy day at the Smith homestead, so this might be a brief piece, but will cover an important topic we will definitely be hearing more about in the weeks and months ahead.  We can’t go too far down this rabbit hole without touching on precious metals, primarily gold and silver.  Some of you probably know a ton about this–even more than me.  Others may have no idea about the wealth-preserving nature of these metals.  It is this second group that I’m hoping to reach with this post.  Enjoy…

One of the things we learned in a previous post discussing the nature of money creation (please see “How The Federal Reserve Creates $$ Out of Thin Air”), and one thing we know from Chris Martenson and his Crash Course video series, is that the process by which any government or central bank can create money is relatively simple.  In fact, it doesn’t even take an act of Congress any more…  Through a process the Federal Reserve likes to call “Quantitative Easing,” or QE, the Fed essentially creates more Dollars electronically (they don’t physically print more money these days–that’s so Weimar Republic!) by buying financial assets from banks on paper and paying the banks in Dollars as part of this quid pro quo.  Usually, the swap involves the Fed buying long-term maturity paper of some kind in exchange for cash.  This only makes sense when the Fed’s interest rate (the price it charges for banks to borrow money) is near zero, which it is right now.  In any event, the Federal Reserve has already employed this technique multiple times, and with predictable outcomes.  For a time the economy is stimulated, but eventually prices rise and inflation ensues.  The Fed knows this happens, and understands that really all they’re doing is making things worse in the long run, but they almost certainly see themselves as having no choice.  Its a choice, using a poor medical analogy, between taking years off the end of the patient’s life or having them die right there on the operating table at that moment.  Hence, Quantitative Easing.

The only problem with QE is that it leads to your Dollars being worth less.  The simplest way to explain this is to say that if there were twice as many Dollars in the world, each Dollar would be half as scarce, or half as precious.  People, therefore, have to work half as hard to get ahold of one Dollar, making every Dollar half as valuable.  This is a major oversimplification, but it will do for now.  In any event, therein lies the major issue with fiat currency, as we discussed in previous posts: when your money has no actual intrinsic value–when your money is linen and fiber–its value is subject to an increase in the supply, which, as we stated above, is very simple to achieve.  That is precisely why the Federal Reserve and the U.S. Government use such currency as their tender.  It is easily manipulated.

Where do the precious metals come in?  Gold and silver are the two main precious metals that people deal in, although platinum is also somewhat common.  These metals are also a form of currency.  They, in fact, better meet the traditional definition of a currency than the USD: a true currency must have intrinsic value, must be scarce enough to maintain its value, and must be easily transferable as part of a currency transaction.  So, depending on what form you hold your precious metals in, the “easily transferable” part might be difficult.  I’d personally feel awkward trying to buy a mansion with a 100 kilo brick of gold bullion.  Of course, these metals come in all sizes and denominations.  In any event, the first two criteria are met by PMs head on.  There is almost always more demand for gold and silver than there is production, and this kind of production can’t happen at a printing press or a bank of computers.  The intrinsic value of gold or silver is really a discussion for a philosophy class, but silver itself has significant industrial uses and is, I would argue, intrinsically valuable for its uses as a part of manufacturing.

These metals are Kryptonite to the Fed’s QE plans.  Think about it this way:  If you buy an ounce of gold today for $1700, and tomorrow the Federal Reserve created–out of thin air–another $1 trillion in currency, and massive inflation ensued as it usually does, and the price of gold rose as a result of this inflation to $2000 an ounce, you just made money.  Of course, you must be careful (DON’T MAKE ANY PURCHASES OF ANY PRECIOUS METALS ON MY ADVICE–I AM FAR FROM AN EXPERT ON PRECIOUS METALS–I SPEAK FROM MY HEART AND SPEAK THE TRUTH AS BEST AS I CAN, BUT I AM NOT A FINANCIAL ADVISOR) because today there are paper precious metal exchange mechanisms called ETFs, which trade the “paper” value of gold or silver like stocks or mutual funds, and the price is subject to wild fluctuations in the short term.  To be clear, the wealth-preserving properties I am discussing relative to precious metals only apply to actual physical gold and silver, not gold or silver funds that you buy on E-Trade.  So, your $1700 today might become $1400 tomorrow.  But, over time, as more Dollars are printed, the physical asset you bought in the past is worth more and more Dollars, in theory. Its something that most people use, not as a way to get rich–although some people who figured this out 30 years ago are swimming in it now–but as a way to preserve your wealth in an era when savings accounts yield something like 0.25% and stocks against inflation often lose money.  Hell, governments are now charging investors to loan them money in some countries.  With PMs, you have a means of protecting and preserving your assets if and when (hyper)inflation ramps up.

That’s enough for today.  We’ll get WAY more into this topic in future posts, but for now, knock yourselves out doing research on this stuff.  There are dozens and dozens of websites out there that talk PMs, but I would start at TF Metals Report or Silver Doctors.  In the meantime, enjoy your Monday.  Silver and gold are already doing battle this morning, and if this is the first week you ever get into following this stuff, you picked a wild one–should be fun.

Peace out girl scout.

~ DS

“A man in debt is so far a slave.” ~ Ralph Waldo Emerson

And with these blunt words, we launch into today’s AE missive on U.S. Debt.  After all, people who live in glass houses should not cast stones, and before we stare at Greece like the guy who just got mauled by the lion at the zoo, or gleefully root for a default like bombs over Baghdad, we might want to recognize that Greece and other nations (Italy, Portugal, Japan, etc.) are the canaries in the coal mine.  Until we have our own financial house in order, no one should find the current financial collapse in other nations around the world fascinating, exciting, or informative.  We should find it scary as Hell!

So, let’s take a snapshot in time right now, courtesy of the wonderful website usdebtclock.org:

This website contains fascinating information, and should be viewed regularly if and when you feel the need to vomit in your mouth. We immediately see several things.  Primarily you will tend to view the amount in red under “US NATIONAL DEBT.”  It currently stands at $15.4 trillion and change (I’m rounding today FYI).  This number, for the record, is climbing.  We are spending $3.6 trillion a year and only taking in $2.3 trillion.  As usual, Americans want to have their cake and eat it too.  Typical.  Obviously, as we posted earlier in our discussion on the Federal Reserve and money creation, Congress is more than happy to oblige because its the only way they stay in power.  More on the political implications of our debt later.  For now, let’s stick to the numbers.

So our public debt stands above $15 trillion, but our “US TOTAL DEBT” clears $56 trillion!  This is insane.  It represents all the debt in the whole country: Federal, state, and local government outstanding debt, as well as personal debt (home loans, auto loans, credit cards, etc.).  I will be honest when I’m unsure of something, and I will be honest here: at publication time, our crack research team has not been able to establish whether or not the $56 trillion includes unfunded liabilities such as Social Security, Medicare, Medicaid, our public and private pensions, etc.  In my opinion, the number is too small to include all of that.  So potentially double the actual TOTAL DEBT number to include those other items.

Now I want to address the hardest part for people to get their brains around, because I can hear a lot of you know: “we owe all this money, so what?”  After all, its not like we have to pay it all back right now, right?  This is obviously a debt that gets paid back over time (we discussed earlier in the week how the Treasury takes on debt 30 years at a time–a treasury bond sold this year doesn’t come due until 2042).  This is true.  Just like we don’t pay off a 30-year mortgage in one year, this debt will be serviced over time.  The problem is that we owe so much, we will never pay it off without cutting services or raising taxes, and this is where things will get dicey.

Buried in those numbers above is our GROSS DEBT TO GDP RATIO, which stands at 102%.  This means that we owe more public debt than the value of goods and service our nation produces in a year.  This is equivalent in personal terms to owing more than you make in a year of work.  If you calculate our this ratio using total debt instead of public debt, the number is more like 367%.  This is not good.  Even though we don’t need to service all this debt in one year, the price we pay to borrow money changes with our credit risk.  For some reason, individuals, banks, corporations or countries who would lend the United States money have a hard time mentally lending money to a nation that owes more than it makes?  Would a bank lend you money if you already owned more than you earned?  Well, it might if you were as important to the global economy as the United States is, but this doesn’t make the lending warranted.  Eventually, the price to service our debt will far outreach our own domestic spending priorities, and the amount we’ll need to borrow to stay afloat will outstrip the resources of the nations and entities that lend to us.  And then we’ll get cut off.  And then we’ll be Greece: a nation that has to double or triple its taxes, hack its social safety net in half, lower the minimum wage back to $5.50, and potentially dismantle our army.  Can you imagine what our nation will look like when this happens?

But, please, don’t worry about any of this.  Go back to believing the mainstream media, who tells us every day that Whitney Houston is more important than 30-year bond yields or the destruction of the cradle of Western Civilization.  After all, we’ll all be gone in 50 years, and our kids can fend for themselves.

~ DS