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Today’s Daily Reckoning had a good piece (as usual) from Bill Bonner.  He had an imaginary conversation with Tim Geithner about how to handle the debt bubble.  I wish I would have thought of that, but I’m not known for being original.    Here’s part of the conversation where Tim calls up Bill and asks for Bill’s advice:

“We need to recognize, first, that this is not just a regular recession. So you can forget the usual recession remedies – a few points off the Fed funds rate…a little counter-cyclical fiscal spending. This is much more serious.

“What we have here is a depression. It’s a depression because it requires a fundamental restructuring of the international financial model. You know how it worked during the Bubble Epoch; Asians made things…Americans bought them. Asians made money; Americans spent it. Asians saved; Americans borrowed. And now the Asians have money; and Americans have debts. Not really very complicated, is it?

“Well, these programs of trying to bailout businesses…and the banks…and the economy…you can see how they are all a waste of money. All of these efforts are trying to revive the old model. They’re trying to free up credit so that Americans can buy more! Now, we don’t really have to explain why that won’t work, do we? More debt won’t do Americans any good; more IOUs from Americans won’t do China any good.

“Instead, the model has to be taken apart and reconstructed. China needs to sell more to people with money – its own people, mainly. Americans need to pay down their debts before they can take up serious consumption again.”

“But wait, Bill,” Mr. Geithner interrupted. “Won’t that cause serious disruptions? When Americans save, in order to reduce their debts, they take away the single primary source of demand for the world economy. If they don’t begin buying soon, businesses all over the world will go broke. That’s why I’ve spent so much money trying to bail out the banks. Americans have no money. So the only way they can spend is if the banks provide credit. So, we have to save the banks first…then they’ll begin lending…and then the economy can begin growing again.”

“Uh…no. That’s not how it works. Even if you make all the banks solvent, whom are they going to lend to? Who’s going to borrow? Americans have too much debt already. Right now, if they get any money, they’re holding onto it…and using it to pay down their debts. They’re not going to start spending just because a bank offers them a loan.

Good stuff!  One thing that Bill left out is the power of savings.  Americans don’t have any savings to speak of, that’s why our government needs to borrow from China and Japan.  When the government ran up huge debts during the Depression and WWII, American citizens were the people who provided that money.  They provided it from savings, and we don’t have the money to do that today.

So when we purchase something made in China (or Germany) we have to effectively borrow that money in order to buy it.  That’s what a trade deficit does over time.  Wealth is extracted from the country with the deficit, and it flows into the country with the surplus.  It’s not rocket science.

Note – I am NOT suggesting that we pass protectionist measures to combat the trade deficit.  The fix to that is to simply live within our means and only purchase what we can afford.  That means paying as you go.  No new debt.  Pay down the old debt and save actual money.  When the debt is gone, people can once again buy more things – as long as they pay for it.

Robert Heinlein wasn’t the first to say it, but he said TANSTAAFL in a way that I remember it.  “There Ain’t No Such Thing As A Free Lunch”.  He’s right, and we’re finding that out in the US now.

I’m currently re-reading volume one of The Story of Civilization. “Our Oriental Heritage” and it’s amazing how many times throughout history that government (and people) think they can rewrite the laws of nature.  Supply and demand is one of those laws, and no amount of wishful thinking and no amount of new regulations is going to change it.  The countries that have tried it in the past are gone.

I fear we’re following rapidly down that well trodden path.  I wish that weren’t the case, but idiots keep voting for bread and circuses.  Unless that changes, we’re going downhill.

gk

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Make note of this date – March 18th, 2009.   100 years from now, historians will point to it as the day the United States of America sealed its’ fate.

Today the United States shifted from a long slow decline into high gear – and nailed the accelerator pedal to the floor.  There are several other dates which may be picked as well, such as the AIG bailout on September 16th, 2008, or even the Bear Stearns bailout on March 14th, 2008, but today is the one that should be remembered.

It should be remembered as the beginning of the end, because today, for the first time, the Federal Reserve announced that it is going to directly purchase US Treasuries.  $300 billion worth – and that’s in addition to $1 trillion in mortgages.  The full text of the Fed announcement is here.

Here’s an important part:  To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. [Emphasis mine]

The term “increase the size of the Federal Reserve’s balance sheet” is a euphemism for “create money of out thin air” – or as it’s more commonly known – printing money.

It’s time for a refresher in basic economics – although this isn’t in Econ 101 – but it should be.  In the past, the Federal Reserve served simply as a clearing house for banks.  They would lend money to banks, but they effectively “held the mortgage” on whatever collateral the banks put up.  The collateral was commonly US Treasuries, although it could be almost any asset.  So the Federal Reserve might do something like take $100 million in US Treasuries from Bank of America and in return the Federal Reserve would give the Bank of America $100 million in US dollars. (Hypothetical situation)

They printed up $100 million to loan out, but they received $100 million in assets, so the net effect on the balance sheet of the Federal Reserve was zero.  This is important – please re-read that if you don’t understand the process.  No money was created that didn’t already exist.  In the hypothetical example above, the Bank of America gave the Federal Reserve $100 million in the form of US Treasury bills, and the Federal Reserve gave them $100 million in cash in return.  The Bank of America can now loan out that $100 million to others – something they couldn’t do with a Treasury note.

But the net effect on the balance sheet is zero.  No new money was created.  It all existed in some form before the transaction, so the net effect is zero.  You can’t give the local grocer a US Treasury bill for a loaf of bread – you can give him dollars.  That’s what the Federal Reserve effectively did – they provided a liquid form of money (dollars) in exchange for illiquid money in the form of Treasury notes.

Got it?  Ok, read on….

Another part of the announcement says Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

You really need to understand that the Federal Reserve doesn’t actually have any money, so when they “purchase” something – as opposed to normal lending – with what do they  purchase it?  The answer is really simple – they make up money.  They create it out of thin air.  Unlike the example above, this money isn’t backed by anything.  Nodda.  Zilch. Zip.

They simply make a few keystrokes and “create” more US dollars.  This is the electronic way to debase the currency.  The Romans did this by alloying other metals such as lead into their gold coins.  The end result is the same.  Inflation.

When you make each coin (or dollar) worth less, you are expanding the supply of money.  The amount of goods in the economy hasn’t changed at all.  If you read through an earlier post of mine, you’ll see that money is simply a way to facilitate transactions – but all money needs to represent actual goods produced that have not yet been consumed.

When the Federal Reserve buys US Treasuries, they are doing the same thing that the Romans did – causing inflation by debasing the currency.  It’s the law of supply and demand.  The Federal Reserve announcement today directly expanded the money supply by $300 billion.  That’s why gold soared today at the exact time of the announcement.

US Treasuries also soared on the news, but that will prove to be short lived.  It will be short lived because traders will realize Treasuries soared because the Chinese have dramatically slowed down their purchases of US debt – and their initial joy that someone is going to purchase the treasuries will fade when they realize that the purchases are being made with funny money.  The Chinese have made it clear that they won’t sit by idly and watch the value of their investments be debased by US policy.

Here’s a link to a NY Times article with a few different takes on the news.  It’s good, read it.  A few choice quotes are copied here:

• Although the notion of quantitative easing has been much discussed in the past few months, the policy clearly took effect today. Many thought it would never come to pass. In many ways this is a tragedy that could have been avoided. (Joseph Brusuelas, Moody’s Economy.com)
• Today’s announcement that the Fed is committed to purchase more than $1 trillion in Treasury and agency debt is great news for current holders of those instruments looking to bail out, but horrific news for just about everyone else, particularly long-term holders of U.S. dollars-based assets. (Peter Schiff, Euro Pacific Capital)
• But by being the buyer, not just the lender, of last resort, the Fed has laid in a course that can only lead to ruin for the U.S. dollar. (Peter Schiff, Euro Pacific Capital)
• Adding up these programs puts the Fed’s balance sheet somewhere around $4½ trillion before the end of this year… We think the Treasury rally will be short lived and see these purchases as negative for the dollar against foreign currencies and gold. (John Ryding and Conrad DeQuadros, RDQ Economics)

If you’ve read this far I congratulate you.  If you read through this looking for advice on what to do with your money, or what the stock market will do, here’s my take.  This advice is free and worth every newly debased penny.  Go long on anything that’s sold in dollars, because as each dollar becomes worth less and less, the value of those items is more and more when measured in dollars.

Buy gold.  Buy silver.  Buy oil. Buy the Euro, the Brazilian Real, the Chinese Yuan – and short the dollar.  The dollar is officially toast.

I’ll end with a note that I REALLY hope I’m wrong.  I hope that the US isn’t headed down the path to inflationary ruin.  But that’s just hope.  My head says that this is the beginning of the end of this brief experiment, and that the United States as we know it will cease to exist at some point in the next 10 to 20 years.  Damn I hope I’m wrong….

gk

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At the current rate, at some point withing the next 24 to 48 hours, the US Government debt is going to hit $11 trillion.  According to the US Treasury website “Debt to the Penny” as of right now (8:45pm EDT) we owe $10,951,578,308,859.02. Look at the Debt Clock at the top of this page for the current number.

That’s the US government debt only – there aren’t any firm numbers on the total state and local debt, but historically it’s about the same as the national debt.

That’s $22 trillion you and I owe to others.  And that doesn’t include any credit cards, car loans, mortgages, consumer debt, etc that you may personally owe.

There are about 306 million Americans according to the US Census Bureau, so that comes out to $35,947.71 for every man, woman, and child in the US.  That’s your share of the public debt.

That debt will never be paid.  The US has 2 choices:

1. Inflate the dollar so the massive debt can be paid back with cheaper dollars in the future.
2. Default on debt payments.

Since the US government alone has the ability to print dollars, a true default will not happen.  They’ll just crank up the printing press in order to create money (out of thin air) to pay the bills.  And when you print money, it’s worth exactly what it’s printed on.

Supply and demand doesn’t disappear because of a government rule or law.  When you print more dollars out of thin air, each dollar is worth less.  Eventually, each dollar is worthless.

You don’t need to look very hard to find out what happens next.  Look at Rome, Germany in the 1920’s, Argentina in the 1980’s, or Zimbabwe now.   Dictatorship ALWAYS follows the anarchy which is brought about by hyper inflation.

No, I’m not optimistic that we’ll be the first country ever to break that cycle.  I don’t know the time frame (1, 2, 10, 20, or 50 years) but it will happen here if we don’t stop printing and spending.  Now.  It’s not even tax and spend anymore, the US government has gone straight to print and spend.

Pretty gloomy huh?

gk

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Excellent post on Save Capitalism today about what we should have learned – but obviously didn’t – from the Lehman Brothers debacle.  Here’s a snip:

The saviour from the disaster of global economic collapse is government debt. It has served as a temporary cushion for the system to fall back on. The danger is that people think it can lie there infinitely, which it can’t. The risk of bankrupcy has simply been moved from private banks to governments. Ireland and Spain is predicted to possibly default on their debt. What is ignored is that by any logic, both the UK and the US is guaranteed to default on their debt, unless they inflate away their currencies. Something they are currently considering by letting central bank institutes buy government debt.

The Save Capitalism blog is written in Sweden, but he has a clearer picture of what’s happening in the US than most of our politicians.  Check it out.

gk

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I mentioned this just yesterday, and it looks like it’s quickly becoming a major issue.  According to a story from Reuters today, Chinese Premier Wen Jiabao said “Whether we will buy more U.S. Treasury bonds, and if so by how much — we should take that decision in accordance with China’s own need and also our aim to keep the security of our foreign reserves and the value of them.”

In other words, China is concerned that their holdings of dollars isn’t going to be worth much, and they (understandably) will be cautious in loaning us money- buying US bonds.

The Reuters story also says Concerns that China may lose its appetite for buying Treasuries have helped depress U.S. government debt prices, along with worries about the slew of bonds that will be needed to finance the next U.S. economic stimulus package.

Analysts fear the escalating currency row, if it results in China buying fewer Treasuries, will make it more expensive for the United States to service its long term debt.

If China stops loaning us money, who will?  This irresponsible government spending will eventually stop – either voluntarily or it’ll be forced on us.  I say we should voluntarily stop it now to avoid the crisis that will ensue when we’re forced to stop.  This may be our last chance to head off hyper-inflation.

gk

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Just read an interesting post on the Yahoo Tech Ticker site titled “Sum of All Fears: Stocks Slump But Bond Woes Are the Real Concern” and it mentions something that I haven’t talked about in quite awhile.  Bond prices.

You see, when we (the US Government) borrow billions and trillions to bail out bad companies, that money has to come from somewhere.  Since the government is broke and already owes over $10 trillion, who do they borrow it from?

In the 30’s and 40’s, we borrowed it from ourselves.  FDR’s massive spending on the New Deal and World War II was almost 100% financed by people in the US buying bonds.  Savings bonds and  war bonds were bought by millions of average American families – because they believed in the government – and because (this is key!) they had savings to invest.

As a country, we no longer have savings to invest.  The collective savings rate over the past few decades has been steadily declining.  You can see some decent stats on it here.

So where does the Fed get the trillions of dollars they are spending?  Mainly from foreign countries.  And China is by far the largest loan shark we deal with.  The Chinese currently own over 22% of our public debt, followed by Japan with about 19%.   The Chinese and Japanese have savings.

To put it another way, we owe those two countries about $1.2 trillion as of November 2008.  I can’t find more recent numbers anywhere right now, but since our national debt has exploded since November – thanks to the B.O. (Bush and Obama) bailouts – I can only assume  that that number has expanded by quite a bit.

But that’s not why I wanted to write this….

I wanted to write this to highlight something that many people are utterly ignorant of – what happens when (not if) the Chinese, Japanese, and other foreign investors come to realize that we’ll never pay them back?  That we don’t have enough money to even pay the interest we owe them?

At some point, foreign investors will realize that they’re lending us money to make interest only payments on the money they loaned us 10 years ago.  If they have any common sense – and I believe the Chinese and Japanese are not short of that commodity – they’ll force us to pay much higher interest rates if we want to borrow their money.  As a nation, we’ve become sub-prime borrowers.

The Yahoo article I mentioned in the first line of this post has this paragraph: Prices of Treasuries with maturities of two-years and longer fell sharply in reaction to the lackluster demand for the 5-year auction, which “may signal investors will have trouble absorbing the as-much-as $2.5 trillion in debt the U.S. is likely to issue this year to pay for a $1 trillion budget deficit and programs to spur the economy,” Bloomberg says.

The last paragraph is particularly ominous and talks about what I’ve been saying:  Then there’s the scenario where the U.S. government is forced to pay extremely high interest rates – or is simply unable to sell Treasuries – because foreign buyers go on strike. We’re a long way from that “sum of all fears” outcome, but comments from Chinese Premier Wen Jiabao at Davos critical of U.S. economic policy suggest it’s getting closer – especially in the wake of Tim Geithner’s “manipulation” comment.

The article says “We’re a long way from that “sum of all fears” outcome” but I don’t think the timing of that outcome really matters.   It will happen, and the faster we borrow as a nation, the faster that day will come.

Guess what happens on the day that foreigners no longer want to buy our debt?  We’re technically bankrupt now – when that day comes, it’ll be official.  The headlines will read “USA, RIP”.

(Added a few minutes later) I forgot to mention an alternative to this scenario.  Instead of borrowing money from foreigners, we could simply print more money.  Which causes hyper-inflation.  I suspect we’ll combine these two methods of bankruptcy, so we’ll borrow money as long as we can, then we’ll print it.

The details don’t really matter, as the end result is always the same.  Read some history.  Here’s what happens over and over.  A total collapse of the economy, followed by anarchy, followed by a dictatorship.  I hope I’m wrong.  I fear I’m right.

gk

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