 | | The Daily Reckoning | Monday, May 16, 2011 |
- Debt ceiling breeched: The US passes $14.29 trillion mark...TODAY!
- Why living standards must fall...are you properly prepared?
- Plus, Bill Bonner with tales from Shanghai, the city of the future...
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|  | | | Borrowing More Money | | A Short-Term Solution to a Very Long-Term Problem | |  | | Eric Fry |
Reporting from Laguna Beach, California...
As we begin a new week, the morning papers are full of headlines about an alleged rape committed by a high-profile politician. There are also a few stories about IMF Chief, Dominique Strauss-Kahn, assaulting a hotel maid. According to reports, Strauss-Khan dragged her kicking and screaming into his hotel bedroom.
But let's return to that rape story...
It seems that at least one very prominent politician wishes to continue violating the US taxpayer by raising the nation's debt ceiling, without also proposing a viable means ofreducing the nation's debt. (At least those are the shocking allegations by his accusers). It is not our place to name names. We are neither judge nor jury, just bystanders with a keyboard and a website. So we will allow the accused and the accusers to speak for themselves.
Over the weekend, US Treasury Secretary, Tim Geithner, warned, "A default [by the US government] would inflict catastrophic, far-reaching damage on our nation's economy, significantly reducing growth and increasing unemployment."
Geithner's solution: Borrow more money.
President Obama engaged in similar fear-mongering on CBS's Face the Nation. Said the President: "[If investors] around the world thought the full faith and credit of the US was not being backed up, if they thought we might renege on our IOUs, it could unravel the entire financial system. We could have a worse recession than we've already had."
Obama's solution: Borrow more money.
Both Geithner and Obama are urging Congress to raise the nation's $14.29 trillion debt ceiling. Neither Geithner nor Obama is addressing the dubious logic of borrowing money to bolster credit-worthiness.
The US will reach its debt limit sometime today. But Geithner says he can juggle some things around at the Treasury to keep the cash flowing until early August. The government can continue borrowing until mid- summer, Bloomberg News explains, "by taking steps that include declaring a 'debt-issuance suspension period' under the statute governing the Civil Service Retirement and Disability Fund."
To be sure, desperate times call for desperate measures. But we are not certain that desperate insolvency calls for desperate borrowing...and half-hearted attempts at fiscal restraint.
Geithner and Obama may have their macroeconomic snow globes turned upside down. Christmas trees don't hang from the sky, scattering snowflakes across the clouds below. And neither do trillion-dollar deficits buttress the "full faith and credit of the United States."
"Even a short-term default could cause irrevocable damage to the American economy," Geithner warns. Maybe so, but long-term fiscal recklessness is the blight that is already causing irrevocable damage to the US economy...and the US dollar. Default is merely an effect, not a cause.
"To raise the debt ceiling without dealing with the underlying problem is totally irresponsible," scoffs House Speaker, John Boehner.
Senate Minority Leader, Mitch McConnell, concurs: "We need to do something significant. We need to impress the markets, impress foreign countries that we're going to get our act together, and astonish the American people that the adults are in charge in Washington and are actually going to deal with this issue."
Your editors here at The Daily Reckoning have no particular grudge against Obama and Geithner, nor any particular affinity for Boehner and McConnell. (Neither the Democrats nor the Republicans hold a monopoly on bad ideas).
But we do have a certain contempt for idiotic notions that purport to work, simply because they have not yet failed. And we also have a certain fondness for discarding idiotic notions before they cause irrevocable harm.
One of the foremost idiotic notions of the moment is called quantitative easing (QE). That's the process by which the Federal Reserve prints dollars to buy bonds from the federal government. Ben Bernanke, the architect and leading advocate of QE, says printing dollars will stimulate economic growth. A companion idiotic notion is that the government can stimulate economic growth by spending money it does not have.
Operating in concert, these idiotic notions simultaneously debase the dollar and increase national indebtedness. Which brings us to the leading idiotic misconception of the moment - that "spending cuts" are synonymous with "debt reduction."
President Obama says he wants to "trim" $4 trillion from the federal budget over the next 12 years. To most Americans, that sounds like debt reduction. But it's not. It is only a cut in planned spending, the effect of which would make the planned budget deficits slightly less obscene.
In other words, Obama's "money-saving" budget proposals would cost America trillions of dollars - trillions that the government does not possess, that taxation alone could not raise and that foreign creditors would be increasingly unlikely to provide.
According to analysis by the Congressional Budget Office (CBO), the president's budget would produce average annual deficits of nearly $1 trillion over the next 10 years. Total indebtedness would soar by a massive $10 trillion over that timeframe, as total annual spending would surge 57 percent - from $3.7 trillion this year to $5.8 trillion in 2021. In reality, these deficit numbers would probably be much higher still.
The CBO's terrifying projections include an array of hopeful assumptions, the most significant of which are that interest rates remain near generational lows and that tax revenues climb at a robust pace. The president is counting on tax revenues to double over the next ten years.
Your editors are not engaging in this "fun with math" exercise simply to tweak President Obama's nose, we are doing so to highlight the extreme danger that now faces the US bond market and, by extension, the US dollar.
Bond yields won't soar into double-digits immediately, nor will the dollar slide to zero overnight. Even decay takes its sweet time. In fact, we predicted a dollar rally in the April 28, 2011 edition of The Daily Reckoning.
"At some point, perhaps very soon," we remarked, "the 'overbought' gold and silver markets will conspire with the 'oversold' Dollar Index to embark on ferocious counter-trend moves. We should be prepared for such an eventuality, but not perplexed by it... If/as/when the dollar rallies, don't forget to hit the bid. The greenback remains a sick puppy...and inflation is its life threatening disease."
A few days later, in the May 2, 2011 edition of The Daily Reckoning, we offered a companion prediction that the silver market would crack.
"Over the next few weeks," we wrote, "the precious metals are likely to become a bit less precious for a while... A major correction in the silver market is very likely, very soon."
Both predictions/guesses have come to pass. The Dollar Index is up more than 3% since the end of April, while the silver price has plummeted more than $10 an ounce. These counter-trend moves mean only that the dollar is a better sell and silver is a better buy.
As reported in our May 2 column, "Your editor does not raise this caution to suggest that silver be sold. Rather, he raises it to suggest that silver be bought...at lower prices... The silver rally still 'has legs,' even if those legs might wobble occasionally."
For as long as the leaders of this nation portray "money they don't borrow" as "money saved," the dollar will remain a long-term "sell," while gold and silver will remain long-term "buys."
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| | The Daily Reckoning Presents | | In an Undercollateralized World | |  | | Frederick J. Sheehan |
The world is undercollateralized. This is the single most important feature of the 2011 economy. Sixty years ago, if assets were worth less than loans, it was possible to work our way into the black. In 1950, 59% of US corporate profits were from manufacturing; 9% were from finance. The roles of manufacturing and finance have reversed. Thus, we witness the desperate attempts to forestall what cannot be prevented. Yet, the world must deleverage. Banks must write off loans. Loans to bankrupt developers and companies must be called. Living standards must fall.
The authorities are doing all they can to prevent the necessary deleveraging. That is the context in which Michael A.J. Farrell, CEO of Annaly Capital Management (NYSE:NLY), spoke to investors during his company's first quarter 2011 conference call:
"[T]he change that is happening in the financial markets is a chaotic mess. I believe the simultaneous execution of radical monetary policy, fiscal policy, and financial regulatory reform is introducing rather than reducing systemic risk in the global financial system by ignoring the simplest lesson of the scientific method. Rather than change one variable in a complex system and test the outcome, regulators and policymakers are changing virtually all of them at the same time: QRM [quantitative risk management], risk retention, the Volcker Rule, Basel III capital rules, derivatives clearing and related margin requirements. GSE reform. FAS 166 and 167. Zero-bound fed funds policy and QE2. Deficit financing, structural budgetary imbalances, and debt limit debate."
Where will this end? Michael Lewitt, proprietor of Harch Capital Management in Boca Raton, Florida, discussed the consequences of our leaders' catastrophic policies in the May issue of his monthly letter, The Credit Strategist:
"Rather than confronting sources of volatility, policymakers have sought to smooth out volatility at all costs. Unfortunately, these costs are proving to be very high and will ultimately prove prohibitive. Pressures build inside complex systems until they can no longer be suppressed. When these pressures can no longer be contained, they tend to erupt with far greater violence than had they been allowed to adjust earlier.
Lewitt continued. Federal Reserve Chairman Greenspan and Bernanke "convinced investors the Fed would bail them out if the economy or markets got into serious trouble. As a result, investors engaged in increasingly reckless behavior..." The result: "Rather than saving the markets, Mr. Greenspan's philosophy and approach guaranteed their failure." One of the consequences is "the build-up of unsustainable debt levels."
We are overleveraged, undercollateralized, and accentuating these unsustainable imbalances. Lewitt notes, "the Federal Reserve has accounted for 101 percent of the net Treasury bond issuance during the first four months of 2011." He goes on: "The US government has been the largest purchaser of Treasuries, promulgating a Ponzi scheme of unprecedented scale."
The US Treasury issues debt and QE2 buys it. Lewitt notes that 10-year Treasury yields have fallen from 3.59% on April, 11 2011, to 3.15% on May 6, 2011.
Since the Fed is the sole net buyer, the 10-year-yield is not a real interest rate. This is also true of the zero-percent short-term yield, one of the trial balloons listed by Michael Farrell. Interest rates are integral to the pricing of assets. A country without an interest rate has a stock market with a price, but not a value.
The future-focused investor should estimate the value of stocks, commodities, and bonds as if interest rates were 5% higher. That day will come to pass: when assets seek the price of their true collateral. This is not widely appreciated. For instance, the recent dive in silver prices has been acclaimed as a bubble that popped. That might be true, if paper contracts were worth the value they purport to represent. There is not enough silver in the world to meet derivative claims - of ETFs, forward contracts, and so on. When this misrepresentation is widely recognized, physical silver will attract panic buying.
Silver is a fairly small market, so this may go unnoticed. That will be a shame for the majority since everyone holds a paper claim that is not worth the money it is written on. Dollar bills, still flowing forth from the Federal Reserve (more exactly: from the US Treasury's Bureau of Printing and Engraving), are losing value every minute. Treasury securities are undercollateralized: the Treasury spends $3 for every $2 it receives in tax payments.
What to do? One idea comes by way of footnote #8 in this month's The Credit Strategist: "Readers interested in owning the Chinese currency can walk into the Bank of China in New York or Los Angeles and open a remnimbi-denominated account. While these accounts originally had limits on size, The Credit Strategist understands that these limits have now been lifted and meaningful amounts of money can be invested. These accounts are insured up to $250,000 by the FDIC (there must be some irony in that.)"
Regards,
Frederick J. Sheehan,
for The Daily Reckoning
Joel's Note: Mr. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and The Coming Collapse of the Municipal Bond Market (Aucontrarian.com, 2009)
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| | | | Bill Bonner | | The Land of Rising Prices and Stagnant Incomes | |  | | Bill Bonner |
Reckoning from Shanghai, China...
...Cathedral's going by to the right, so that means they are, what? two blocks away from the Bund. A Yangtze River Patrol gunboat is tied up there, waiting for the stuff they've got in the back of this truck. The only real problem is that those particular two blocks are inhabited by about five million Chinese people.
Here you've got the Hong Kong and Shanghai Bank of course, City Bank, Chase Manhattan, the Bank of America, and BBME and the Agricultural Bank of China and any number of crappy little provincial banks, and several of those banks have contracts with what's left of the Chinese Government to print currency. It must be a cutthroat business because they slash costs by printing it on old newspapers, and if you k now how to read Chinese, you can see last year's news stories and polo scores peeking through the colored numbers and pictures that transform these pieces of paper into legal tender.
As every chicken-peddler and rickshaw operator in Shanghai knows, the money-printing contracts stipulate that all of the bills these banks print have to be backed by such-and-such an amount of silver; i.e., anyone should be able to walk into one of those banks at the end of Kiukiang Road and slap down a pile of bills and (provided that those bills were printed by that same bank) receive actual metallic silver in exchange.
Now if China weren't right in the middle of getting systematically drawn and quartered by the Empire of Nippon, it would probably send official bean counters around to keep tabs on how much silver was actually present in these banks' vaults, and it would all be quiet and orderly. But as it stands, the only thing keeping these banks honest is the other banks.
Here's how they do it: during the normal course of business, lots of paper money will pass over the counters of (say) Chase Manhattan Bank. They'll take it into a back room and sort it, throwing into money boxes (a couple of feet square and a yard deep, with ropes on the four corners) all of the bills that were printed by (say) Bank of America in one, all of the City Bank bills into another. Then, on Friday afternoon they will bring in coolies. Each coolie, or pair of coolies, will of course have his great big long bamboo pole with him--a coolie without his pole is like a China Marine without his nickel-plated bayonet--and will poke their pole through the ropes on the corners of the box. Then one coolie will get underneath each end of the pole, hoisting the box into the air. They have to move in unison or else the box begins flailing around and everything gets out of whack. So as they head towards their destination--whatever bank whose name is printed on the bills in their box--they sing to each other, and plant their feet on the pavement in time to the music. The pole's pretty long, so they are that far apart, and they have to sing loud to hear each other, and of course each pair of coolies in the street is singing their own particular song, trying to drown out all of the others so that they don't get out of step.
So ten minutes before closing time on Friday afternoon, the doors of many banks burst open and numerous pairs of coolies march in singing, like the curtain-raiser on a f*&@ing Broadway musical, slam their huge boxes of tattered currency down, and demand silver in exchange. All of the banks do this to each other. Sometimes, they'll all do it on the same Friday, particularly at times like 28 November 1941, when even a grunt like Bobby Shaftoe can understand that it's better to be holding silver than piles of old cut-up newspaper. And that is why, once the normal pedestrians and food-cart operators and furious Sikh cops have scurried out of the way, and plastered themselves up against the clubs and shops and bordellos on Kiukiang Road, Bobby Shaftoe and the other Marines on the truck still cannot even see the gunboat that is their destination, because of this horizontal forest of mighty bamboo poles. They cannot even hear the honking of their own truck horn because of the wild throbbing pentatonic cacophony of coolies singing. This ain't just your regular Friday P.M. Shanghai bank-district money-rush. This is an ultimate settling of accounts before the whole Eastern Hemisphere catches fire. The millions of promises printed on those slips of bumwad will all be kept or broken in the next ten minutes; actual pieces of silver and gold will move, or they won't. It is some kind of fiduciary Judgment Day.
Cryptonomicon by Neal Stephenson What happened on the 28th of November, 1941? Japanese troops entered Shanghai's international zone. Shanghai was occupied until the end of the war.
But you don't need an invasion to turn scraps of paper into bumwad. And when it happens, you'll want to have silver...or gold, rather than pulp products. Don't believe us? Stay tuned...
And more thoughts...
We're staying at the Peace Hotel in Shanghai. It's a beautiful art-deco building right on the Bund. We left the hotel last night and had dinner a few blocks north of here. When we saw Shanghai's skyline, across the river...it took our breath away.
"This must be a city of the future," said Jules. "You kind of expect a flying car to appear - like on The Jetsons."
Everything is lit up - including the boats going up and down the river.
In comparison, Paris is dull and predictable. New York is boring and worn-out. The view along the river reminded us most of London. It lights up its buildings. You get the same sort of view across the river. And London has some strikingly new and exciting buildings too.
But compared to Shanghai, London is small...and slow-moving. It is in the 'old world.' This seems like the new world.
Shanghai is not cheap. Dinner for a group of six, at a not-too-fancy joint on the Bund set us back $900. The hotel room is about $300 a night. And property? We've heard conflicting reports. It was recently the hottest city in the hottest economy in the world. The government has tried to calm the property market in China - with some success. Sales fell some 70% from the beginning of 2010 to the end of it. Prices dropped 30%.
And now?
"That's the thing about China," said a Dear Reader who joined us for a drink on Saturday night. "When you live in the US or in the UK you might think you know what is going on...but when you live here in China, you realize that you have no idea."
So, let's turn our attention back to the USA, where we have no idea either...but lots of opinions.
The Dow fell 100 points on Friday. Gold under $1,500. Oil under $100.
We've tried to get in the spirit of the 'recovery.' We just can't do it.
The recovery story was always phony. So then, what's the real story?
As near as we can tell, there are several stories running at once.
1) The Great Correction - in many of the advanced economies, but centered in America...
2) The continued rise of the developing economies...not just in Asia, but in Latin America and Africa, too.
3) The increasing scarcity of cheap energy, land, water and raw materials.
4) The decline (suicide might better describe it) of the American Empire.
5) The approaching end of the dollar-based world financial system. There are probably a few more we forgot to mention. Each one on its own might be fairly easy to decipher and predict. But they work together...and at cross-purposes. It's hard to figure out what is really going on...or what is causing it.
For example, the correction tends to depress prices. But the big expansion in the developing world tends to increase them.
And there's one more major pressure on prices - the feds. The US controls the world's reserve currency. And the US is working hard to inflate the world's supply of dollars. That too should increase prices, eventually.
The trouble with inflation today is that it is the worst kind of inflation. It makes prices go up...but not incomes, at least not in the US. Incomes are rising in Asia. So, people can buy more cars and more meat - and push up prices. Then, Americans pay higher prices...while their incomes don't rise.
Why don't their incomes rise too? Because the US is in a Great Correction. It spent too much and borrowed too much in the boom/bubble years. Now, it's paying the price. That's why so few houses are being built; we built today's houses yesterday. And it's why so little money is being borrowed and spent today; we already spent it.
The Fed seems to have no idea what is really going on - probably intentionally. So, it tries to combat the correction by issuing more credit and printing more dollars - as if we didn't have enough already. This extra money further pushes up prices, adding to Americans' misery.
*** No man ever added so much to the US defense industry's profits...or to the nation's losses. You'd think he'd get more respect. Maybe at least a memorial plaque at Blackwater's training ground in North Carolina. The company has made hundreds of millions on the War on Terror; you'd think they'd show some gratitude to the man who supposedly caused it.
But now, we discover that he not only helped bring down two empires - the Soviet Union and the US (a prediction, not a fact)...he liked to look at dirty pictures, too. The kill team found a stash of porn in Osama bin Laden's house. Hmmm.
And this just in...the head of the IMF has been arrested in New York on sex charges. Hmmm. Seems he violently attacked a hotel maid. Hmmm. He was considered a front-runner to oppose Sarkozy in the next election. Hmmm.
Hmmm...
For all we know, both stories are absolutely true.
Regards,
Bill Bonner
for The Daily Reckoning |
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