FedUpUSA

Archive for July 7th, 2011

In the past, there certainly have been governments that have gotten into trouble with debt, but what we are experiencing now is the first truly global sovereign debt crisis.  There has never been a time in recorded history when virtually all of the governments of the world were drowning in debt all at the same time.  This sovereign debt crisis is never going to end until there is a major global financial collapse.  There simply is no way to unwind the colossal web of debt that we have constructed in an orderly fashion.  Right now the EU and the IMF have been making “emergency loans” to nations such as Greece, Ireland and Portugal, but that is only going to buy those countries a few additional months.  Giving more loans to nations that are already drowning in red ink may “kick the can down the road” for a little while but it isn’t going to solve anything.  Meanwhile, dozens more nations all over the globe are rapidly approaching a day of reckoning.

All of the bailouts that you are hearing about right now are simply delaying the pain.  The reality is that when the “emergency loans” for Greece stop, Greece is going to default.  Greece is toast.  The game is over for them.  You can stick a fork in Greece because it is done.

One of the big problems for Greece is that since it is part of the euro it can’t independently print more money.  If Greece cannot raise enough euros internally Greece must turn to outside assistance.

Unfortunately, at this point Greece has accumulated such a mammoth debt that it cannot possibly sustain it.  By the end of the year, it is projected that the national debt of Greece will soar to approximately 166% of GDP.

The financial collapse of Greece is inevitable.  If they keep using the euro they will collapse.  If they quit using the euro they will collapse.  When the rest of Europe decides that it is tired of propping Greece up the game will be over.

At this point very few people are interested in lending Greece more money.

As I wrote about yesterday, many of the nations around the world are only able to keep going because they are able to borrow huge amounts of money at low interest rates.

Well, nobody wants to lend money to Greece at a low rate of interest anymore.

Today, the yield on 2 year Greek bonds is back over 28 percent.

Fortunately for the rest of the world, Greece is just a very, very small part of the global economy, but when interest rates start spiking like that on U.S. debt or Japanese debt the entire world financial system will be thrown into chaos.

So why is there so much of a focus on Greece right now?

Well, there is a real danger that the panic will start to spread.

The other day, Moody’s Investors Service slashed the credit rating on Portuguese government debt by four notches.

Portuguese debt is now considered to be “junk”.

But even more alarming is that Moody’s stated that what is going on in Greece played a role in reducing the credit rating of Portugal.

The following is a portion of what Moody’s had to say when they cut the credit rating of Portugal by four notches….

Although Portugal’s Ba2 rating indicates a much lower risk of
restructuring than Greece’s Caa1 rating, the EU’s evolving approach to providing official support is an important factor for Portugal because it implies a rising risk that private sector participation could become a precondition for additional rounds of official lending to Portugal in the future as well. This development is significant not only because it increases the economic risks facing current investors, but also because it may discourage new private sector lending going forward and reduce the likelihood that Portugal will soon be able to regain market access on sustainable terms.

Do you understand what is being said there?

Basically, Moody’s is saying that the terms of the Greek bailout make Portuguese debt less attractive because Portugal will likely be forced into a similar bailout at some point.

If the EU is not going to fully guarantee the debt of the member nations, then that debt becomes less attractive to investors.

The downgrade of Portugal is having all kinds of consequences.  The cost of insuring Portuguese government debt set a new record high on Wednesday, and yields on Portuguese bonds have gone haywire.

If you want to get an idea of just how badly Portuguese bonds have been crashing, just check out this chart.

But it is not just Portugal that is having problems.

Just recently, Moody’s warned that it may downgrade Italy’s Aa2 debt rating at some point within the next few months.

Spain is also on the verge of major problems and Ireland may need another bailout soon.

Things don’t look good.

Unfortunately, if the dominoes start to fall the entire EU is going to go down.

Big banks all over Europe are highly exposed to sovereign debt and they are leveraged to the hilt.

It is almost as if we are looking at a replay of 2008 in many ways.

When Lehman Brothers finally collapsed, it was leveraged 31 to 1.

Today, major German banks are leveraged 32 to 1, and major German banks are currently holding a tremendous amount of Greek debt.

Anyone with half a brain can see that this is going to end badly.

So how is the European Central Bank responding to this crisis?

They are raising interest rates once again.

That certainly is not going to help the PIIGS much.

But Europe is not the only one facing a horrific debt crunch.

In Japan, the national debt is now up to about 226 percent of GDP.  So far the Japanese government has been able to handle a debt load this massive because the citizens of Japan have been willing to lend the government gigantic mountains of money at interest rates so low that they are hard to believe.

When that paradigm changes, and it will, Japan is going to be in a massive amount of trouble.  In fact, an article in Forbes has warned that even a very modest increase in interest rates would cause interest payments on Japanese government debt to exceed total government revenue by the year 2019.

Of course the biggest pile of debt sitting out there is the national debt of the United States.  The U.S. is so enslaved to debt that there is literally no way out under the current system.  To say that America is in big trouble would be a massive understatement.

In fact, the whole world is headed for trouble.

Right now government debt around the globe continues to soar at an exponential pace.  At some point a wall is going to be hit.

The Wall Street Journal recently quoted Professor Carmen Reinhart as saying the following about what we are facing….

“These processes are not linear,” warns Prof. Reinhart. “You can increase debt for a while and nothing happens. Then you hit the wall, and—bang!—what seem to be minor shocks that the markets would shrug off in other circumstances suddenly become big.”

That is the nature of debt bubbles – they keep expanding and expanding until the day that they inevitably burst.

Governments around the world will issue somewhere in the neighborhood of 5 trillion dollars more debt this year alone.  Debt to GDP ratios all over the globe continue to rise at a frightening pace.

Because the world is so interconnected today, the collapse of even one nation will devastate banks all over the planet.  If even one domino is toppled there is no telling where things may end.

The combination of huge amounts of debt and huge amounts of leverage is incredibly toxic, and that is what we have all over the globe today.  Almost every major nation is drowning in a sea of red ink and almost all of our major financial institutions are leveraged to the hilt.

There is only one way that the sovereign debt crisis can end.

Very, very badly.

I hope you are ready for what is coming.

The Economic Collapse

Right now, interest rates are near historic lows.  The U.S. government is able to borrow gigantic mountains of money for next to nothing.  U.S. consumers are still able to get home loans, car loans and student loans at ridiculously low interest rates.  When this low interest rate environment changes (and it will), it is going to absolutely devastate the U.S. economy.  Without low interest rates, the U.S. financial system dies.  When it comes to borrowing money, it is the rate of interest that causes the pain.  If you could borrow as much money as you wanted at a zero rate of interest for the rest of your life you would never, ever have a debt problem.  But when there is a cost to borrowing money that changes things.  The higher the rate of interest goes, the more painful debt becomes.

The only reason that U.S. government finances have not fallen apart completely already is because the federal government is still able to borrow huge amounts of money very cheaply.  If interest rates on U.S. government debt even return just to “average” levels, it is going to be absolutely catastrophic.

So what happens if rates go above “average”?

The reality is that if there is a major crisis that causes interest rates on U.S. Treasuries to go well beyond “normal” levels it is going to cause a complete and total collapse.

In 2010, the U.S. government paid out just $413 billion in interest even though the national debt soared to 14 trillion dollars by the end of the year.

That means that the U.S. government paid somewhere in the neighborhood of 3 percent interest for the year.

Considering how rapidly the U.S. dollar has been declining and how much money printing the Federal Reserve has been doing, a rate of interest that low is absolutely ridiculous.

The shorter the term, the more ridiculous the rates of interest on U.S. Treasuries are.

For example, the rate of interest on 3 month U.S. Treasuries right now is just barely above zero.

The Federal Reserve has been playing all kinds of games in an attempt to keep interest rates on U.S. government debt low, and so far they have been pretty successful at it.

But they aren’t going to be able to do it forever.

Up until now, other nations and investors around the world have continued to participate in the system even though they know that the Federal Reserve is cheating.

However, there are signs that a lot of investors are finally getting fed up and are ready to walk away from U.S. government debt.

China has been dumping short-term U.S. government debt.  Russia has been dumping U.S. government debt. Pimco has been dumping U.S. government debt.

Others are taking things even farther.

In fact, there are some investors that plan on cashing in on the loss of confidence in U.S. Treasuries.  Renowned investor Jim Rogers says that he is now going to be shorting 30 year U.S. government bonds.

Just check out what Rogers recently told CNBC….

“I cannot imagine or conceive lending money to the United States government for 30-years at 3, 4, 5 or 6 percent —you pick a number — in U.S. dollars”

And he is right.  Who in the world would be stupid enough to loan the U.S. government money at a 4 or 5 percent rate of interest for the next 30 years?

Actually, most U.S. government debt is financed in the short-term these days.  In fact, the U.S. government issues a higher percentage of short-term debt than any other industrialized nation.

This trend really got started during the Clinton administration.  Back then they figured out that the U.S. could reduce its borrowing costs substantially by relying much more heavily on short-term debt.  The Bush and Obama administrations have continued this trend.

So these days the U.S. government constantly has huge amounts of debt that are maturing and that need to be rolled over.

This is great as long as interest rates stay very, very low.

But when interest rates rise the whole game will change.

In a recent article, Pat Buchanan explained that the Obama administration is being completely unrealistic when it assumes that interest rates on U.S. government debt will stay incredibly low over the next decade….

“The average rate of interest the Fed has had to pay to borrow for the last two decades has been 5.7 percent. However, President Obama is projecting the cost of money at only 2.5 percent.

A return to the normal Fed rate would, by 2020, add $4.9 trillion to the cumulative deficit”

Most Americans really cannot grasp how incredibly low interest rates are right now.

Sometimes a picture is worth a thousand words.

The following chart shows how interest rates on 10 year U.S. Treasury bonds have declined over the last several decades.

As confidence in the U.S. dollar and in U.S. government debt declines, interest rates will go up.

In fact, there are troubling signs that we are starting to see a move in that direction right now.  Last week, the yield on 5 year U.S. Treasuries experienced the biggest one week percentage jump ever recorded.

The big danger is that the political wrangling in Washington D.C. will start to cause a panic.  The managing director of Standard & Poor’s recently told Reuters that if the U.S. government starts defaulting on debt at the beginning of August, the credit rating on U.S. Treasury bonds that are supposed to mature on August 4th will go from AAA all the way down to D….

Chambers, who is also the chairman of S&P’s sovereign ratings committee, told Reuters on Tuesday that U.S. Treasury bills maturing on August 4 would be rated ‘D’ if the government fails to honor them. Unaffected Treasuries would be downgraded as well, but not as sharply, he said.

“If the U.S. government misses a payment, it goes to D,” Chambers said. “That would happen right after August 4, when the bills mature, because they don’t have a grace period.”

When a credit rating gets slashed, interest rates on that debt can go up dramatically.

Just ask the citizens of Greece.

Today, the interest rate on 2 year Greek bonds is over 26 percent.

You are delusional if you believe that something like that can never happen here.

Right now the U.S. national debt is completely and totally out of control.  If the U.S. government had to start paying interest rates of 10, 15 or 20 percent to borrow money it would be a total nightmare.

This year the U.S. government will have income of about 2.2 trillion dollars.

If in future years the U.S. government is spending a trillion or a trillion and a half dollars just on interest on the national debt, then how in the world is it going to be possible to even run the government, much less balance the budget?

But rising interest rates would not just devastate the federal government.

It would become much more expensive for state and local governments to borrow money.

Student loans would become much more expensive.

Car loans would become much more expensive.

Home loans would become out of reach for everyone except the very wealthy.

As we saw during the housing crash of a few years ago, rising interest rates can absolutely wipe homeowners out.

On a standard home loan, if you change the rate of interest from 5 percent to 10 percent you increase the mortgage payment by approximately 50 percent.

If you change the rate of interest from 5 percent to 15 percent, you roughly double the mortgage payment.

As the 30 year fixed rate mortgage chart below shows, interest rates are near historic lows right now….

Keep in mind that even with such ridiculously low interest rates the U.S. real estate market has been deader than a doornail.

So what would a significant spike in interest rates do to it?

When all of these low interest rates go away the entire financial system is going to change dramatically.

A significant spike in interest rates would wipe out U.S. government finances, it would push state and local governments all over the country to the brink of bankruptcy, it would bring economic activity to a standstill and it would destroy any hopes for a housing recovery.

This country, and in particular the federal government, is enslaved to debt but right now we are not feeling the full pain of that debt because interest rates are so low.

If you want to know when things are really going to start coming apart, just keep an eye on interest rates.  When they really start spiking you can start sounding the alarm.

The truth is that the state of the economy is going to continue to get worse.  Our debt is growing every single day and our country is getting poorer every single day.  When interest rates start surging it is going to start knocking over a lot of dominoes.

I hope you are getting prepared for when that happens.

The Economic Collapse

Can we cut with the tax cuts for private jets bullcrap?

We heard it again yesterday in Obama’s “twitterfest news event”, and it’s getting both old and is manifestly dishonest.

The same holds true for the so-called “racehorse exemption.”

Both claims come from the fact that business expenses are deductible.  So if you’re running a company and have a private jet, and the jet is used in some manner that furthers the business interest, you can deduct the cost of owning and operating it from gross revenues.  The same with the racehorse – if you raise horses to race with the intent of making money by doing so - that is, as a business – you can deduct the cost of raising the horses from your gross revenues (winnings.)

Are there reasonable debates to be had on where the line is between “business” and “pleasure”?  Sure.  The business jet issue is one that resonates well with middle-class America and its propensity for class warfare: “Those evil fat cats are flying around and not paying a damn dime in taxes on that ridiculously expensive jet!”

But if as an executive the jet costs $20,000 for the day’s operation, and as a consequence of flying in it I can do a business deal for $1 million that I would not otherwise complete since I would otherwise be spending my time being assaulted by the TSA and sitting in an airport lounge, then the argument is truly specious since the $1 million deal generates a taxable profit in the company and in turn the amount of tax revenue paid grossly exceeds that which would be collected were the $20 large to be taxed instead.

Of course the mantra from the other side is that “but we’ll get taxes from both the business deal and the plane if we cut out the loophole!“  My riposte to that is “Welcome to fantasy island“; this is the same claim that was run when the luxury tax on yachts was passed, and what actually happened was the destruction of the sport-fishing yacht industry in the United States putting hundreds of people out of work while almost zero tax was in fact collected.

At the root of these games and lies that are being run by both sides of the aisle is that the math is simple and quite-compelling: There is no way to get rid of the monstrous budget deficits without doing two things – (1) dealing with entitlements and (2) dealing with the fundamental problems with taxation, trade and demanded services.

#1 has been political suicide.  While everyone talks about Social Security the real nightmare is found in Medicare and Medicaid.  These two programs are mathematically impossible to fix without either massive tax increases in the hundreds of percent or fundamental reform of the medical system in this country.  Neither is being seriously discussed, yet the fact of the matter is that we spend twice what the rest of the developed world does on health care.  This is not fraud, waste and abuse, it is structural and intentional financial rape perpetrated on the people by the medical industry with the glad-handed and intentional assistance of Congress.

The second part of the issue is worse.  The government has basically doubled in size in the last decade.  This has outstripped the growth in the economy by essentially a double.  Government largesse and bloat is never willingly surrendered – these “jobs” are the worst sort of “McJob” in that they generate no real wealth improvement for the common man but are tremendously good for the government employee and they extend the tentacles of the government further into your life.

Witness, for example, the “War on Drugs.”  This has turned into a tens of billions of dollars industry in the United States employing literal tens of thousands of people, from DEA agents to local cops to prosecutors, attorneys and prison guards.  Yet these laws are, at their core, about punishing consensual adult behavior and as a consequence in order to do so it is necessary to intrude into people’s private homes and lives, effectively destroying the 4th Amendment. 

What “public good” and “benefit to GDP” has come from these policies?  None.  The person busted for doing drugs may well have an addiction, but giving them a permanent felony record isn’t good for GDP at all!  The temporary “lift” you get from employing the people to arrest, prosecute and jail him is offset with the permanent destruction in that individual’s earnings capacity within the marketplace which persists even if he quits using the drugs!

Or look at the TSA.  Beyond the civil liberties issue there’s the simple economic problem: The airlines have been relieved of financial responsibility for monitoring and protecting against terrorist acts.  The TSA is bloated, it has a documented history of employing people who commit crimes including both robbery and sexual assault and has become a self-justifying federal agency that has simply siphoned off tens of billions of dollars that would otherwise be spent in the private sector.  Never mind the daily commission of acts that, were you or I to perform a similar act, would land us on the wrong end of a (justified) felony indictment.  Are we safer?  I argue no: There are damn few people willing to die to commit an act of terrorism – those who argue otherwise need to explain away the fact that anyone with such murderous intent could get in a common Suburban and kill dozens by simply driving it down a busy sidewalk, or commit mass-murder with a common gasoline can intended for their lawnmower.  Where are all these murderous bastards? 

There’s also the other possibility, of course: The TSA has had nothing to do with air safety at all.  That is, the “use by” date of turning planes into flying bombs actually expired on 9/11 itself at 9:57 that morning when the passengers on Flight 93 revolted.  Since it is a fact that no “prohibited items” were ever brought on board airliners on 9/11, we are left with the uncomfortable conclusion that the TSA is nothing other than a liability shield for the airlines and a monstrous “make work” program sapping both the rights of Americans and our economic treasure.

Let’s face reality: By and large elementary logic makes clear that the alleged grand threat that the TSA uses to self-justify its existence, both as a matter of spending and intrusion into our lives, simply doesn’t exist.

The reality of our fiscal situation is found in these two charts:

and

That is, government deficits exist due to (1) overspending and (2) workforce deterioration.

#1 we’ve talked about.  But fixing #2 means making it unprofitable for corporations to offshore their labor.  When most of the “attraction” of offshoring production comes from the ability to pay and treat people like slaves (e.g. Foxconn) while at the same time exploiting the ability to dump environmental poisons into the air and water (which is not permissible in the United States) it is clear that absent constraints imposed by law a profit-seeking corporation will do exactly that.

Yet nobody – absolutely nobody – will talk about these fundamental realities.  Instead we hear about “free trade” while all that “free trade” has done is trash our trade balance, making clear that there’s nothing “free” about it.   This is not an accident – China routinely requires local sourcing, labor, and even transfer or joint ownership of intellectual property in exchange for access to their markets.  We, in turn, never require the same conditions on access to our markets.

The idiocy of the left and right in these “negotiations” is predictable and yet augers poorly for actual fixes.  We must address the structural factors – there’s no other way.  Producing products where the funds used in production do not circulate back into the national economy is suicidal; we’ve tried to bridge that gap with more and more debt and in fact have done so for 30 years but the end of that rope has been reached and we’re still 200′ above the floor of the cavern.

Our choices are simple: Climb back up, despite the required effort and short-term pain that must be accepted in order to do so, or rappel right off the end of the rope and die.

Choose wisely America.