Britannia Radio

The Daily Reckoning U.S. Edition

Home . Archives . Unsubscribe

The Daily Reckoning | Wednesday, September 29, 2010 There she goes again: Gold touches another record high, Your thoughts on Social Security and a closer look at what's inside, Plus, Bill Bonner on the luck of the Irish, the plight of the dollar and plenty more... The Folly of the Fed A History of Inflation, Deflation and Monetary Meddling Joel Bowman From the "Paris of the South," Argentina... "Forget football," a friend told us when we arrived in Buenos Aires a few weeks back. "Avoiding taxes is the national sport down here." There are few things in life a freedom-loving wanderer appreciates more than a healthy distrust of the state. More on that later in the week. But first, the noise... Stocks inched higher again yesterday, up almost half a percent by the close. Gold was up too. The anti-dollar investment had retreated a few dollars off another record high, last we checked. An ounce, as of this writing, will cost you (or bring you, depending on whether you are buying or selling) around $1,309. Not bad for a metal that, just one short decade ago, was shunned from polite conversation. So we get gold's mood. At least, we think we understand why the metal is moving higher. Put simply, there are trillions of reasons for it to, most courtesy of the Federal Reserve. Even the mainstream media is beginning to notice. Writing in the UK's Telegraph, Ambrose Evans-Pritchard explains...in an admirably penitent kind of way: "I apologise to readers around the world for having defended the emergency stimulus policies of the US Federal Reserve, and for arguing like an imbecile naif that the Fed would not succumb to drug addiction, political abuse, and mad intoxicated debauchery, once it began taking its first shots of quantitative easing." Kudos to Mr. Evans-Pritchard. Anyone can make a mistake. It takes a steely resolve to admit it...and to a mass audience, no less. Like many before him, the Telegraph'sInternational Business Editor believed that the Fed was capable of the one thing it most sorely lacks: restraint. "My pathetic assumption was that Ben Bernanke would deploy further QE only to stave off DEFLATION, not to create INFLATION," he wrote. "If the Federal Open Market Committee cannot see the difference, God help America." And therein lies the problem. Unlike Mr. Evans-Pritchard, who can cop to folly with few repercussions for the greater public, Mr. Bernanke enjoys no such leeway. The Fed Head must - and will - follow his convictions through to their inevitable end. One turn of the lever begets another. A tinker here, an adjustment there, each movement grounded on the fallacious assumption that one man, one panel of experts, can truly know and set the price of money itself...and before you know it you've got the credibility of an entire currency weighing on your back...and debtors from around the world knocking on your door. Like a spineless man in a bad marriage, Mr. Bernanke will follow his promises to the grave, from health to sickness, from better to worse, forever and ever. Amen. Since 1913, when the Federal Reserve first assumed its role as money- printing monopolist, the value of the dollar has fallen some 97%. And with each freshly inked bill that hits the streets, the value of every one that preceded it erodes a commensurate amount. Pretty soon, the price of the "stuff" those dollars are chasing begins to go up. Inflation begins at the bank. Or, as Milton Friedman better phrased it, "Inflation is always and everywhere a monetary phenomenon." In this instance, not only is gold "stuff"...it is also the right stuff. Not only is it a commodity in and of itself, in other words, it is also the one true money, the sound alternative to a fiat anchored, papier-mâché economy built in the path of a rising tide. This is what happens when planners get to planning. Whether it is your education, healthcare or the price of money itself, meddlers always find a way of making a reasonable situation worse. Take, for example, Social Security. As of tomorrow, September 30, 2010, your retirement "fund" officially begins shelling out more money than it is taking in. Over the past couple of weeks, our special reports correspondent, Ian Mathias, has provided a few essays on that so-called retirement "lock box" and the millions of Americans who are counting on it to supplement their golden years [see Part I and Part II here]. Here's what a few readers had to say: Thank you for your article on Social Security. Let me offer you another slant on that awful program. One argument that I have used in the past against SS is a rather religious one, mainly the 4th commandment: Honor thy father and mother. When I was growing up, of course that always meant I was suppose to obey my parents...well, at least try. But as I got older, that also meant to take care of my parents when they became elderly. What I have argued is that SS short-circuits that process. Why bother with taking care of them monetarily? After all, they have Social Security, and that frees me from that responsibility. In addition, it seems to me, that it diminishes the connection between generations. Obviously, there's going to be more interaction between you and your parents if you're helping to support them. And then there is the resentment that drives a wedge between generations. Why should I pay more and more into a program that isn't going to be worth a damn once I retire? They're going to get theirs, but I'm not going get anything. I will be eligible for SS in 5 years. Believe me, I'm not counting on it. God help the people who are because they're going to be in for one hell of a jolt. And this: The system may "go into the red"...but the federal government owes the trust 2.7 trillion dollars and the program is solvent for many years to come...unless the government defaults on its commitment to the trust... And, finally: As I fast approach the age of 70, I think back to the time when I first got a SS card. I was 11 years old, living in New York. I had a chance to get a paper corner on the crossroads of two busy streets, 5th Avenue & 5th Street in the Bronx. I had to get an SS card to get the corner. I was excited and when I got my first payment for the job I was doing, I questioned the card that came with the cash about the deductions that were withheld. SS was explained to me and I have been paying into this fund for almost 60 years. During those years I seem to remember the government borrowing from the fund for some crisis or something a couple of times. My grandfather made the comment to me before his passing that SS should always be there unless the government does not pay back what they borrow. Is this in fact what happened, and if so, did they ever pay back what they borrowed? Thank you to all our Fellow Reckoners who wrote in with thoughts and concerns regarding this very important topic. In today's guest column, Ian Mathias takes a look at these issues and more. Please enjoy... The Daily Reckoning Presents What's Really in the Social Security Trust Fund? Ian Mathias "You're kidding, right?" a Daily Reckoning reader wrote after our briefing from last week: "The End of Social Security As We Know It." "Are you the only ones who believe in the accounting farces that are the Social Security and Medicare 'Trust Funds'? Every dollar in both of those funds has been spent by the US Treasury..." We weren't kidding, dear reader... There's only so much reckonin' we can do in one day. Last week we chronicled a turning point for retirement in America: On September 30, the Social Security Trust Fund will officially begin paying out more than it's taking in. Now, you - and many others who wrote in - provide an inadvertent introduction to our final question in this Social Security Series: What, exactly, is in that fund? The quick answer is this, as we noted Saturday. "With $2.6 trillion left in the Social Security war chest, there is no immediate threat to the status quo." The Social Security Trust Fund is, in fact, worth roughly $2.6 trillion. The status quo is safe at the moment. But as you hinted, there isn't a single US dollar in that fund...and anyone who thinks the money they've been sending the government to pay for retirement is neatly stacked in a giant vault - some super-sized swimming pool of money - has the wrong idea. Indeed, your government-sponsored retirement fund has all been spent already. Didn't you get your receipt? The World's Biggest Bond Investor - You You, loyal taxpayer - not the Chinese - are the biggest US Treasury Bond investor in the world. The entire balance of the Social Security Fund, all $2.6 trillion of it, has been borrowed by the US government. Upon receipt of your payroll taxes (those are the ones that fund Social Security) the Treasury instantly converts them to special issue Treasury bonds. In simpler terms, money is taken out of the Social Security "vault" and replaced with an IOU. That's not necessarily bad. Many sovereign states purchase debt from other nations, government owned companies or private institutions, and for good reason. If that money is not needed right away, the interest on the bond will help guard the fund against inflation. Those bonds might even make some extra money. But such an investment doesn't work when a debt-burdened government borrows money from itself. While the American Social Security scheme is not quite as simple as taking money out of one pocket and putting it in another, it's darn close. "Since 1983, the money from all payroll taxpayers has been building up the Social Security surplus, swelling the trust fund," the LA Times' Michael Hiltzik neatly explained in August. "What's happened to the money? It's been borrowed by the federal government and spent on federal programs - housing, stimulus, war and a big income tax cut for the richest Americans, enacted under President George W. Bush in 2001." The government is not using your payroll taxes to build retirement nest eggs or to insure the elderly and disabled. Rather, the SSTF is used to sustain government itself. Not a dollar is set aside for you...just debt. Given the current state of US affairs - $13 trillion in public debt, weak economic growth and a $1.3 trillion budget deficit for 2010 - this is not the kind of sovereign debt most investors want to own. We should note, this is no conspiracy theory. On the SSTF website, the Trustees offer to-the-month spreadsheets of fund holdings, each and every one revealing nothing inside but US Treasury bonds. President Bush himself laid it out quite simply back in 2005: Some in our country think that Social Security is a trust fund - in other words, there's a pile of money being accumulated. That's just simply not true. The money - payroll taxes going into the Social Security are spent. They're spent on benefits and they're spent on government programs. There is no trust. There is No Trust... So Why Trust Social Security? This bookkeeping scheme known as the Social Security Trust Fund is not the biggest issue in America for one reason: US Treasuries are currently as good as cash. In fact, since they pay a paltry yield and are accepted everywhere, they might even be better than dollars. But in a real, utilitarian sense, T-Bonds in the SSTF are way, way worse than cash. They are a liability, not an asset. The SSTF can exchange them for dollars, but those dollars must come from the very government that's on the other side of the exchange. As President Clinton's Office of Management and Budget once explained: Balances are available to finance future benefit payments and other Trust Fund expenditures - but only in a bookkeeping sense.... They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. This is a similar situation to what China has called its "nuclear option." As the largest foreign holder of US Treasuries, China could cripple the US by cashing out its bond holdings. The Treasury would be forced to either redeem the bonds or default, both of which would send American interest rates through the roof...maybe even destroy our economy altogether. The SSTF isn't that different, except China holds "just" $846 billion in US bonds, about a third of what's owed to the Social Security Trust Fund. So add up the American fiscal condition as we know it, dear reader, and tell us what you get: 76 million Baby Boomers about to retire + Life expectancies increasing + A Social Security Administration that's now paying out more than it's taking in + The Social Security Trust Fund holding nothing but $2.6 trillion in US debt + A national debt over $13 trillion + The worst US economy since the Great Depression + Unemployment near generational highs + Stagnant wages for over a decade + Average personal savings rate of 6% of disposable income + Minimal interest rates on those savings + Home prices (most people's largest investment) down 20% from their peak + Stock indexes (and most private retirement funds) down 25% from their peak + Rising energy and healthcare costs The sum of these parts, among other things, equals a lousy retirement landscape in America. Like so many other economic matters these days, it's hard to picture a worse scenario for retirees since the Great Depression. It Could Be Worse One cliché has been working overtime lately: The night is always darkest before dawn. No one really knows how long this "night" will last in America. It's running about 20 years strong in Japan, an economy eerily similar to our own. But just the same, most people felt like nothing could possibly go wrong in early 1999... and by September 11, 2001, just about everything had. Maybe now, as most of us are choking in the dark smog of this economy, a breath of fresh air might blow our way. Who knows? But to bank on that is a bad move. If America doesn't return to booming prosperity, the Treasury and Social Security Trustees will have to do something to keep the program alive. In the past, that's meant raising payroll taxes and reducing benefits. Not only will the government have to accommodate Social Security operating at a deficit, but they'll have to deal with all these bonds... the trillions owed to the American public and trillions more to foreign investors. Either income or sales taxes will have to rise dramatically, or the Fed will have to print money. Both "solutions" would seriously impact American purchasing power, particularly retired Americans living on a fixed income. Even the rich ought to devise a retirement Plan B. The richest 1% of US population now accounts for 24% of the country's income, the highest ratio since just before the 1929 market crash. Most of the other 99% is understandably bitter about that, and especially given the tendencies of the current administration, we expect the rich to get soaked good and hard over the next few decades. As we've forecast before, expect a Social Security means test in the near future and a hike in the SS taxable wage base even sooner. Thus, all economic classes in America could feel the sting of imminent Social Security reform. Those that need it will likely receive fewer benefits, and those wealthy enough to retire on their own will likely be forced to pitch in for those that can't. Meanwhile, all government welfare programs will likely be reduced, as one day - who knows when - Uncle Sam will have to start paying back money borrowed from the Social Security Trust Fund. Your choice is to wait for that day and see what happens...or start preparing for it now. Good luck, Ian Mathias for The Daily Reckoning P.S. If you're looking to build your own retirement trust fund - or bolster the one you've already got - you should check out one of our newest presentations. There's boatloads of information in here on the plight of Social Security, plus details on a fund you can purchase that will help you secure your retirement...independent of US government shenanigans. Catch it here: Legally Collect Thousands of Dollars Each Year... from the Other Government-Backed Retirement Program Bill Bonner The Legacy of the Current Recession Bill Bonner Reckoning from Baltimore, Maryland... Epithet for a doomed economy... What will they say? How will they describe the '00s and '10s? Irish Prime Minister Brian Cowen was accused of being drunk when he gave a "croaky" radio interview two weeks ago. He denied it. But we'd be tempted to turn to the bottle too if we were in the fix Ireland is in. Ireland's banks got into trouble. So the government threw them a lifeline...forgetting that the line was tied to its own neck. It guaranteed bank liabilities equal to four times Irish GDP. But isn't that going to be the story of the whole period? Private sector banks and speculators got in trouble. Then, the public sector went down with them. Irish bond yields hit a new record high yesterday - over 6.7%. Investors are afraid Ireland will default. If it does, its bonds will fall even more. This is either a great opportunity or a trap. Investors could realize a huge windfall. If Ireland is bailed out...yields could fall in half. Then bond prices would double. On the other hand, the Emerald Isle could actually default. Bonds could take a big hit. Which will it be? We don't know. But we've been thinking a lot about the big picture. If you had been in the 1930s, the big picture would have been as difficult to see as ours is today. You would have had a lot of the same questions. Are stock prices rising or falling? Is the economy recovering or falling apart? Is it inflation we should worry about, or deflation? But now we have a narrative. We know how it turned out. There was a huge rally following the crash of '29. Stocks rose up more than 50% in the "suckers rally." There were several "recoveries" too. And there were 6 separate quarterly bounces between '29 and '33. They averaged 8% each. Investors were entitled to think that the economy "had turned a corner." Or, that the worst was behind them. Or, that they were "on the road to real recovery." But they would have missed the big picture. Looking back at it, the US economy was in a Great Depression. Investors would have been better off just staying away...from '29 to '49. Yes, dear reader, a 20-year period of abstinence would have made the heart grow fonder of equities - even though there were several good years as well as several bad years during that period. What about now? Are investors kidding themselves by trying to make money in this market? Would they be better off taking a leave of absence for the next two decades? We have to wonder about the big picture. What will people say about this period 30...50...years from now? How will they describe it? What will be the standard narrative? Will they say it was a recession followed by a recovery? Nope. That story has gone with the wind. What then? Maybe they will say it was a credit cycle correction...a balance-sheet recession...much like the '30s. "Investors should have taken a long sabbatical," they might say. "They should have sold in 2000...and come back in 2020..." Maybe... But this time there is more to the story than there was in 1930. Back in the '30s, the equity market turned sour...but the bond market was still safe and sound. The dollar was still as good as gold. Hundreds of local governments went broke, but there was never any question that the US government would default...or inflate...or ditch its own currency. Investors could take a break from stocks. All they had to do was to sell out...and hold onto their cash. They could buy the same stocks 20 years later for more or less the same prices. Why bother with risk? Why bother with the headaches? But don't try that this time, dear reader. We'll tell you why...below... And more thoughts... Why can't you just hunker down...hold cash...and wait until this Great Correction is over? Because this time money itself is up for correction. Yes, that's right. The dollar is no longer good as gold. Not even close. It was cut loose back in '71. Ever since it's been floating on a sea of debt, inflation, and hallucination. The feds imagine that they can create as many dollars as they want. They think inflation is good for the economy. The US money supply has increased 1,300% since 1970. And now that the economy is correcting, the feds think they can fix the problem with the same thing that caused much of the problem in the first place - more notional dollars. According to The Financial Times, Ben Bernanke is asking himself: should I, or shouldn't I. "Bernanke mulls launching QE2 to keep America afloat," says the headline. That's it! That's the solution! Flood the economy with dollars! So, that's what we're wondering. When they tell the story of the '00s and '10s, they'll probably omit the ups and downs...the "recovery" sightings...the inflation and deflation fears... The story will probably go something like this: "The private sector took on too much debt. It hit the wall. Then, the public sector took on too much debt. It hit the wall a few years later." Or, a slightly more detailed version: "The stock market peaked out in real terms in January 2000. The feds responded with huge inputs of fiscal and monetary stimulus, causing bubbles in housing, finance, oil and other sectors. But the credit expansion had reached its end by 2007. Then, the stock market, real estate market, and the economy all turned down. Despite several futile 'recoveries,' the correction continued for the next 10 years. Investors should have gotten out in 2000...and stayed out. "But not in dollars. Governments pumped trillions into the economy, beginning in 2008 - first borrowed money...and then printed 'quantitative easing' money. In the two years following the crisis, for example, only one out of every two dollars spent by the federal government came from tax receipts. The rest was borrowed. Or printed. For a few years, the gravity of private sector de-leveraging kept these additions to the money supply in check. But the feds just kept printing more and more money. And as they printed more paper money, the price of real money - gold - rose. "And then, all hell broke loose. All of sudden, people lost faith in the dollar. They fell over one another trying to get rid of it. They bought houses, cars, stocks, toilet paper - anything. Most of all, they bought gold. When they could get it. The price rose to $5,000 an ounce... "...and then it was over. The debt had been washed away. Savings, pensions, insurance plans... They announced a new currency, backed by gold, at $5,000 an ounce. It was over." *** A new movie, The Social Network, is getting a lot of attention. We haven't seen it yet. But we will. Daughter Maria has a small part in it. You gotta start somewhere... Look for her. She's the waitress. Regards, Bill Bonner, for The Daily Reckoning