Tuesday, August 25, 2009

Rude Awakening - See Uncle Sam Borrow

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Rude Awakening

The Rude Awakening

Laguna Beach, California

Tuesday, August 26, 2009


* Treasury auctions hit a ludicrous rate of $5 trillion per year,

* The third and fatal stage of a great country's life-cycle,

* See Uncle Sam spend and borrow like there's no tomorrow and more...


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Eric Fry, scratching his head in Laguna Beach, California…

See Uncle Sam borrow. Borrow, Uncle Sam, borrow! Borrow. Borrow. Borrow. Uncle Sam likes to borrow. Borrowing is fun.

See Uncle Sam spend. Spend, Uncle Sam, spend! Spend. Spend. Spend. Uncle Sam likes to spend. Spending is fun. It is fun to borrow and spend…

Sustainable or Unsustainable?

Let the reader decide…And while trying to decide, let the reader also guess whether America's skyrocketing debt load will ever cause a rain cloud to pass over Wall Street.

Based on recent trends, for example, the more money the government borrows, the higher the stock market flies. The eager buyers of common stocks don't seem to care about the uncommonly large debts the government has been piling up lately. Nor do the eager buyers of common stocks seem to care about the sluggish economy, the rising unemployment rate, the slumping dollar or any other seemingly sub- optimal data point.

The federal debt has clearly snapped loose from its moorings to fiscal probity. But since so many investors have snapped loose from their mooring to caution, the stock market continues to soar. Rising prices are fun. They cause investors to imagine wonderful things about the economy…and to assume that share prices will continue rising for a long time.

Meanwhile, over in the bond market, investors continue to show up to buy Treasury bills, notes and bonds…no matter how large the quantities of debt that Uncle Sam is peddling.

Last week's auction schedule was truly amazing, in and of itself:

* $31 billion in three-month bills

* $30 billion in six-month bills

* $27 billion in 52-week bills

* $42 billion in two-year notes

* $39 billion in five-year notes

* $28 billion in seven-year notes

"This is the price of supporting the graft and fraud in our banking system," gripes market commentator, Karl Denninger. "I count $207 billion, coming two weeks after a $250 billion dollar week. Let's annualize - that would be about $5 trillion a year in annualized issuance. My-oh-my how long can this continue?

"Who knows?" Denninger says in response to his own question. "What I do know is that this is absolutely unsustainable, it is approaching 40% of GDP annually, and yet this is what is required to keep all the balls and plates in the air…The world's tolerance for this will eventually end."

Maybe yes. Maybe no. The world's investors seem to tolerate dubious investment propositions for a very long time. At present, for example, they are tolerating a 30-year Treasury bond yielding only 4.24%. In fact, they aren't merely tolerating it; they're diving in and buying the stuff hand over fist.

Seems like a funny response to America's soaring indebtedness. It would be like refusing to lend your unemployed brother-in-law ten bucks…until he had already borrowed $10,000 from someone else.

If we were inclined to worry, we might worry that investors are confusing government debt with private capital. Money is money, of course, but the source of the money might matter a little bit.

Usually, economies flourish when the private sector amasses capital and re-invests that capital in productive endeavors of various sorts. UN-usually – as in, never – economies flourish when governments borrow outrageous sums of money and disperse the proceeds across the economy like confetti over a ticker-tape parade.

The confetti contributes to a temporary feel-good atmosphere, no doubt. But after the parade ends, the confetti is just a messy pile of worthless paper. Hmmm…

For more on this baffling topic, read on…

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See Uncle Sam Borrow
By Bill Bonner

The United States is in the third and fatal stage of a great country's life-cycle – the political stage. In this stage, money and power migrate from the financial community to the political community. The politicians get away with taking trillions out of the productive economy and spending them on their pet projects and private corruptions.

"Politics is about what works," someone once said. Someone said it…someone who is an imbecile. Politics is not about what works, it's about what you can get away with. And what you can get away with is often exactly what doesn't work at all.

What the United States is getting away with, from a financial point of view, in addition to counterfeiting, is grand larceny on a Super- Madoff scale. It is borrowing trillions of dollars even though it has no way to honestly pay back the money.

Still, so eager are the lenders to part with their money that the 10-year T-note yields a miserly 3.46%. The more the feds borrow, apparently, the more lenders are willing to lend. But this is a story that will end badly.

Warren Buffett described the America of the bubble years as "Squanderville." Private citizens were living beyond their means, he pointed out. But he hadn't seen nothin'. Now, government does the squandering. The politicians are spending trillions they don't have on projects nobody was willing to pay for even when they had some money in their pockets.

What the government can get away with now – under cover of a financial crisis – is a big grab for money and power. It 'works' in the sense the feds are able to get away with it. But it will prove fatal to the dollar…and to the US economy.

The Fed is intervening in markets as no Fed ever has. Its balance sheet – a measure of how much intervention it has done – has shot up in a way that is not only unprecedented, but also almost unbelievable. In an effort to provide liquidity, the Fed has bought up the contents of every neglected refrigerator on Wall Street. This smelly, furry stuff enters the Fed's books as an asset, along with various not-so-pungent assets like US Treasury bonds. Altogether, the Fed's balance sheet shows more than $2.7 trillion worth of this unappetizing hodgepodge.

"It's not sound economics – nor is it ethical – to trash the US dollar and bail out incompetent investors who poured billions into CMBS at the peak of the bubble," says Strategic Short Report's Dan Amoss. "There is no longer a 'systemic risk' argument for The Fed to be propping up the price of such securities.

What happens next?

We don't know. But it is far too early to expect the Fed to withdraw its easy-money policy. The Fed will have to stay on this road for much, much longer. Why? Because the "green shoots" are shriveling up. There is no real economic revival. And there can't be one until the underlying problems are corrected.

One of the big problems is too much capacity. During the Bubble Epoque the squanderers would buy anything. So, you could make an almost unlimited amount of money by providing them with things to buy. This meant building factories…buying trucks…and renting retail space. Now, however, the squanderers have come to their senses…or maybe they've just come to the limit of their credit lines. The squanderers now want to save their money. So, no need for so much retail space in the malls, so many trucks on the highways or so much retail space.

There are a number of sit-down restaurant chains that cater to the middle class – Applebee's…Chili's…Ruby Tuesday and a few others. They expanded greatly during the '90s and '00s in order to meet the desires of the big-spending masses. But now that the masses aren't so free and easy with their money, the New York Times reports that these chains are in desperate competition for remaining diners. This competition is manifesting itself as price deflation.

Applebee's offers dinner for two for only $20. Chili's advertises entrees for just $7. Ruby Tuesday's is going for a 2-for-1 deal. Buy one meal, get one free. All of them are making heavy use of discount coupons.

Oversupply is producing deflation. Prices are falling as suppliers fight for demand by offering more for less. And over at the Red Roof…the roof has already caved in, as the chain has defaulted on its mortgage debt.

This is what you'd expect at the end of a long period of credit expansion. EZ credit brought forth too much demand and too much supply. Now, the demand is disappearing…and the suppliers struggle to hold on.

Even now, we're facing an economy in which 70% of our economic output depends on consumer buying. And as we pointed out in the August 13, 2009 edition of the Rude Awakening (What is "Normal?"), consumers are in no condition to consume. Ergo, no buyers, no recovery.

Economic contraction is natural, normal and perhaps necessary to a market economy. And the current contraction will take years to sort out. Roofs have to fall in on thousands of enterprises, speculators and households. Then, the rebuilding can begin.

But the Bernanke Fed is not about to let nature take her course. Don't expect any tightening from the Fed anytime soon, dear reader…it is far too soon for that.

Governments are essentially parasites on productive activity. So the best governments are the smallest – meaning, the least parasitic. As has been said before, "That government is best which governs least."

But now we are in the third and fatal stage of a great country – the political stage. In this stage, the parasites take over. Government governs a lot. And governing a lot costs a lot of money. In England, the government budget is bumping up against half the total GDP of the nation. In America, health care is still largely a private matter, so the government spends a smaller percentage of GDP…but it is a percentage that is rising quickly.

Where will the money come from? Taxes? Gordon Brown has already put the income tax rate up to 50%. Michael Caine, an English actor who moved from the U.S. to England to escape the high taxes of the '70s, says he will tolerate 50%…but not a penny more.

"If it goes to 51% I will be back in America," he says.

Ahem…he might have to try somewhere else. Everybody's gunning for the rich – in America as well as in England. Obama has pledged to raise taxes on the rich. The states, notably California, are desperate for more revenue too. Add federal, state and local levies…and private health care costs…and you could easily be over the 50% bracket in America too.

The history of European monarchies is largely a history of debt. Kings and queens squeezed what they could out of the turnips. Then they turned to the moneylenders. These lenders had to be careful. They were happy to extend monarchs credit, because in this way they gained a measure of control over them. But there were many dangers. Kings lost their heads…or went broke. Or, often, the monarchs could turn the tables on the moneylenders…and have their heads cut off. Reading the history of the loans to the French crown is eye-opening. It is amazing anyone wanted to lend at all. The risks were great; the rewards were few. Rarely were the loans settled honorably.

Government raises money. Sometimes it repays the loan with revenues from other taxes. Sometimes, it is the lender who pays the tax himself – either because the government defaults…or because inflation reduces the value of his money. What you come to see is that lending to the government – which always has the power to betray the loan and behead the lender – is merely another form of taxation. But the lender can blame no one but himself for his losses. The wounds he suffers are self-inflicted.

This is a story that often ends badly, if not disastrously.

Joel's Note: Books forecasting the future only make it to a second edition if what they said in the first edition came to fruition. Fans of Bill Bonner and Addison Wiggin's bestselling books, Financial Reckoning Day and Empire of Debt, will therefore be pleased to see them updated for the second print.

Whether you are a long time "sufferer," or a first time fan, be sure to check out Bill and Addison's monumental works right here, complete with additional chapters and updated charts to reflect the predicted collapse and where to go from here. Financial Reckoning Day Fallout and The New Empire of Debt

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[Rude Endnote: Wall Street gave back all its early gains yesterday to end the day pretty much where they started it. Markets in Europe and Asia were a bit more decisive.

In Japan, the Nikkei 225 was up half a percent last we checked while Hong Kong's Hang Seng had run up around 1.11%. Down Under, the Aussie All Ordinaries had managed a gain of just over one third of a percent.

In Europe, morning trading seemed to be proceeding swimmingly. Indexes from the Thames to the Rhine were up about 1% when we had a look a couple of minutes ago.

Over in the commodity pits, crude slackened a tad after rallying over $74 per barrel. Gold too was unable to maintain its momentum above $950 and this morning sells for about $945 per ounce.

We'll be back with more Rude views when the sun comes up again tomorrow.

Until then...


Joel Bowman

The Rude Awakening

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