Is the U.S. Bankrupt?

Laurence Kotlikoff, Economics Professor at Boston University, believes we are worse off than Greece and effectively bankrupt. I totally agree. He penned an Op-Ed piece this morning in which he wrote:

But delve deeper, and you will find that the IMF has effectively pronounced the U.S. bankrupt. Section 6 of the July 2010 Selected Issues Paper says: “The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates.” It adds that “closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP.”

To put 14 percent of gross domestic product in perspective, current federal revenue totals 14.9 percent of GDP. So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.

It appears the math just doesn't work out. The present value of our debt will rise at unsustainable compounding rates if we don't get our house in order immediately. Sure the U.S. can borrow at record low rates, but this gross mispricing by investors is creating a dangerous false sense of security. 

Current bond yields are not pricing in a potential default. This implies the market believes we will see fiscal austerity, which implies a sharp reduction in revenue. But a sharp decline in revenue is inconsistent with a reduction in our national debt unless we see a truly drastic drop in expenditures. Why is this a problem?  

We must remember that Keynesian economic policy has become the baseline scenario, and that this has created a truly bloated public sector. Fiscal austerity, or a reduction in government expenditures, will destroy the public sector and send unemployment through the roof. This isn't really politically viable.

In truth, we will probably see both a devaluation of the dollar and a gradual contraction of the public sector. Rising bond rates will force the government to choose between fiscal austerity and inflation. All signs indicate they will choose inflation. This will lead to many, many years of economic/political instability.

Read more...

Do You Hear the Helicopters?

After touting an economic recovery non-stop for the first half of the year, the Fed has suddenly turned sour on the economy. The Fed took its first steps towards QE2 with its announcement today that it would use its MBS portfolio to buy longer term U.S. Treasurys. This all stems from healthy fears of a slowing economy and deflation.

There was never any doubt in my mind that helicopter drops were coming again from the Fed. During the duration of this false recovery, I said that eventually people would come face to face with reality. Well reality is here. The Fed characterizes growth in the economy as "modest", but if growth in the economy were really modest, the Fed would not be taking these steps to stimulate the economy.

Like it or not public confidence in our leaders is collapsing. Were we not supposed to be humming along in an organic economic recovery by now? Where are the jobs? Where's the housing recovery? Why are most economic indicators rolling over?

Gold is going to explode as the Fed stimulates us to oblivion. This is just the beginning. It always takes time for perception to catch up with reality.

Read more...

Gold: The Next 6 Months

We are on the brink of a major parabolic move in gold that will coincide with peak bond bullishness and deflation fear mongering. This stems from the very basic misunderstanding of what "quality" is in a debt crisis.

History is a great thing. It allows you to confirm that yes, people were just as irrational and foolish back then. I have recently been perusing first-hand accounts of the Great Depression, and let me tell you, people never change. The majority of people are clueless.

A debt crisis implies there is a major shift in public confidence. So someone please explain to me how capital will continue to concentrate in U.S. government bonds while confidence is collapsing. What people must understand is that there are cascading levels of quality. Retail investors are currently flooding into bond funds thinking that this represents the highest level of quality. These are what we call sheep right before the slaughter. They fail to realize that the ultimate form of quality is gold.

During the Great Depression, massive capital flows into bonds preceded a major concentration of capital in gold. A global debt crisis forced FDR to devalue the dollar even though he maintained that he would not devalue. The dumb money believed FDR; the smart money anticipated the inevitable devaluation and accumulated gold.

You hear the same standard government lies today about the dedication to a strong dollar and how U.S. bonds, a mere derivative of the dollar, is top-quality. To the clear-headed, this is an obscene whopper of a joke that proves people will believe anything. I don't have the patience for ridiculous notions. I am 100% sure that the only way out of this crisis is through a devaluation, with gold playing a role as an anchor to the global currency system. I really don't care what other people say in defiance to the facts- they are living in a dream world.

Gold: What's Next?

The truly mind-boggling moves in gold are ahead. What you have seen up to this point is just the warm-up.

If you were smart, you were buying into weakness and are now positioned to ride this next leg up intelligently without chasing. If you catch about 60% of any swing move, you are doing pretty well. To do this, you must be able to buy weakness and sell strength.

A correction will arrive once the supply and demand dynamic gets stretched to its limit. This usually occurs when gold is trading 20-30% above its 200-day moving average.  Gold is in the early stages of this intermediate term rally, and is trading only 4% above its 200-day moving average. The next leg up in gold can easily bring us between $1500 and $1600 dollars.

When we get to $1500, we can reevaluate. If gold bubble experts are still clamoring about the imminent decline in gold (after losing another 20% of their money on the short side), then you know we probably have more room to run. Remember, people who have been perpetually bearish and wrong on gold are psychologically inclined to maintain their position. It is the rare investor who can tame their human pride and admit they were wrong. So when everyone calls gold a bubble, relax. It is their emotions speaking, not their logic.

Read more...

Gold Permabears Never Learn, Nearing Extinction

It appears the gold rocket launch is underway, which of course means that gold permabears will soon go into hiding. Was it really only 10 days ago that weak hands were panicking; Dennis Gartman was saying he was no longer a gold bull; and deflationists took center stage?

Intermediate term bottoms in gold always "feel" the same. Not only do you need a sleep-inducing period of consolidation followed by a steep sell-off, but you need sentiment to turn decidedly sour. You can always spot bearish sentiment through certain key words. These key words are: gold bubble; Robert Prechter; CNBC; gold bubble; deflation; gold bubble; shorting gold; gold bubble; "stupid" gold bugs; and of course, gold bubble. Come across these words enough times and you know a bottom is at hand. Get ready to back up the truck like I did when I said to embrace the sell-off in gold. At the time I said:

To me, the current sell-off in gold is reminiscent of the sell-off in stocks 3 weeks ago. While bears were blindly and recklessly going short, the smart money was sitting patiently with their fingers hovering over the "buy" button.


Based on the aforementioned, is it time to buy?



Shorting a bull market is the stupidest thing you can do as an investor. You are swimming against the tide and making investing a lot harder than it needs to be. The second stupidest thing you can do is lose your long positions in a bull market because you panicked.

At the end of the day there are really only two kinds of investors: the smart money and the dumb money. The dumb money always hands over ownership of shares to the smart money at major bottoms. The dumb money is scared of adding in a correction. The dumb money always chases tops.

The smart money understands the relationship between price and value. The smart money is patient. The smart money understands that the biggest profits in bull markets go to those who wait.

This bull market has years to run. Skeptics will be shorting this market and losing money for the next 5 years just as they have the past 10 years. Don't complain, just thank them for giving you the opportunity to accumulate. These same investors will be buying from you at much higher levels. Eventually I will join the bears and short the gold market with conviction, but it is not time yet.

Read more...

Unemployment Rate Steady at 9.5%, Payrolls Fall 131,000

From the BLS:

Total nonfarm payroll employment declined by 131,000 in July, and the unemployment rate was unchanged at 9.5 percent, the U.S. Bureau of Labor Statistics reported today. Federal government employment fell, as 143,000 temporary workers hired for the decennial census completed their work. Private-sector payroll employment edged up by 71,000.

While the unemployment rate was unchanged, total nonfarm payrolls declined by 131,000, reflecting a loss of 143,000 Census jobs. Payrolls for June were revised down sharply to a loss of 221,000 from the initially reported loss of 125,000.

Labor Participation Rate

The civilian labor force participation rate (64.6 percent) and the employment population ratio (58.4 percent) were essentially unchanged in July; however, these measures have declined by 0.6 percentage point and 0.4 point, respectively, since April.

The civilian participation rate is at the lowest level of the entire recession. The only thing keeping the unemployment rate down is a contraction in the labor force.

Marginally Attached Workers

About 2.6 million persons were marginally attached to the labor force in July, an increase of 340,000 from a year earlier. (The data are not seasonally adjusted.) These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.

The number of marginally attached workers is also at the highest level of the entire recession. People obviously aren't flooding back into the job market yet.

Labor conditions are clearly deteriorating at this point. It's been over a year since the "green shoots" economic recovery propaganda campaign began. The euphoria surrounding the imaginary recovery has dampened considerably in the past couple of months, and with good reason. There are no jobs, housing is stalling, and consumer confidence is falling. Expect further deterioration in the 2nd half of 2010.

Read more...

State Handouts Accelerating, New York Fiscal Black Hole Showing

The unstoppable fiscal train wreck of states is coming to a head.  Without the wherewithal to turn their budgets around, states are turning to the bankrupt federal government for assistance. Rest assured, this is only the beginning. From the WSJ, State Set for Boon in Aid:

New York finally got some good news from Congress on Wednesday when the Senate pushed forward $2.6 billion in aid for the state, after two months of lost votes on the issue threatened to blow big holes in local and state budgets.

Just a day earlier, Albany lawmakers had approved a contingency plan to impose spending cuts if the federal money didn't arrive. Both Mayor Michael Bloomberg and Gov. David Paterson had warned that without the funds, layoffs would be likely.

The measure would provide about $2 billion in health-care payments to the state, roughly $530 million of which would go to New York City. It also provides about $600 million in statewide education funding, which supporters say will save an estimated 7,100 teacher jobs.

If you follow the budget crisis in New York and negotiations with unions, you know that it's one big farce. Teachers in New York City who have come to expect annual 4% pay raises are apparently making huge "sacrifices" by accepting only 3.3% salary increases based on seniority. Is it just me or is there a huge disconnect between the public and private sector? Nonetheless, there will eventually be an implosion in states' budgets followed by drastic public sector cuts when the federal bond bubble pops.

Whenever you artificially create a bubble, the inevitable contraction leaves behind a swath of destruction. The real estate bubble created job growth that was concentrated in the housing sector. When the bubble popped, most housing sector jobs disappeared. We currently have a historic bubble in the public sector that will eventually pop. This will have deep ramifications in the years ahead.

I believe the worst isn't over for New York, and one of the key reasons is real estate. In the chart below, you'll notice that California and New York, states with two of the bigger fiscal black holes, both experienced relatively muted housing declines. This has kept revenue via property tax collections relatively stable. Remember, everything hinges on real estate. Municipalities cannot support a further 10% decline in real estate, which is something I fully expect.

After two months of setbacks, Senate Democrats were able to persuade two Maine Republicans to support it, giving them the votes necessary to overcome a GOP filibuster. One of those senators, Olympia Snowe, warned that this would be the last batch of aid for states.

"The states are becoming completely dependent on us,'' said Senate Minority Leader Mitch McConnell, who opposed the bill. "When does it end?''

Mr. Bloomberg called the expected aid "a significant measure of relief,'' though the mayor warned that even with the funds, the city faces a projected $3.3 billion deficit next year

There is no way this is the end of bailouts for municipalities. This insidious form of quantitative easing will have consequences. There is no free lunch.

Read more...

Initial Claims Rise to 479,000

From the Department of Labor:

In the week ending July 31, the advance figure for seasonally adjusted initial claims was 479,000, an increase of 19,000 from the previous week's revised figure of 460,000. The 4-week moving average was 458,500, an increase of 5,250 from the previous week's revised average of 453,250.

Initial claims came in at 479,000, which was 24,000 higher than forecast. The 4-week moving average of claims rose to 458,500 from 453,250, last week. The labor market is still exhibiting a lot of weakness, with extended benefits up nearly 17% from last year. Put simply, there is absolutely no recovery in the labor market.

Read more...

The Deflation Bogeyman, Part 1

I initially planned to address the concerns about deflation in a brief post, but the subject is so complex that I'm afraid I will have to address it in 2 parts. Part 1 will lay out where we currently stand, while part 2 lays out my inflationary argument for the future.

First of all, what is deflation? Is it the contraction of money supply and credit, or is it the general decline of prices? (You know you are in the middle of a controversial debate when people can't even agree on basic definitions).  I think we can all agree that economics is useful only to the extent that it explains the real world. Is my standard of living going down? Is food becoming more expensive? Is the government robbing my future by debasing our currency? That being said, I think the best definition for the sake of argument is that deflation is the decline in general price levels.

There are a growing number of investors who are expecting a deflationary collapse in America. Put another way, that believe the dollar will rise in value. I will devote Part 2 of this series to why this is utterly insane. But basically I believe it is impossible to have a long term deflationary trend in a pure fiat system as long as the government is determined to prevent it. Absolutely, positively, 100% impossible.

Let me lay out an undeniable fact for both inflationists and deflationists: We are currently experiencing both inflation and deflation. Home prices and bond yields are falling, but inflation expectations remain elevated. Many other costs are rising as well, with the biggest increases coming in medicine and higher education.

Medical Costs

Medical costs are one of those things you can't avoid. Anyone who has had a serious illness understands how onerous medical costs can be.

The standard defense against rising medical costs is that medical care has improved. Strange, but you never hear these kind of arguments for computers, cell phones, or anything else that is in a steady trajectory of improvement. The fact remains that medical costs have risen in this so-called deflationary environment.

Tuition Costs

I believe higher education is the second biggest bubble I've seen in my life, trailing only U.S. government bonds. Tuition costs have risen to the point where the long-term value of a liberal arts education is very dubious. There is only so long this bubble can last. When people talk about deflation, they certainly aren't talking about tuition costs.  

Trusting the CPI?

Many deflationists have a healthy dose of skepticism towards the government. They know the Fed is a private corporation; they understand the statistical joke that is the unemployment rate; and they understand that Social Security is a giant Ponzi scheme. The truly ironic thing is that these same people then turn around and accept the government's CPI figures as gospel. They'll point to a 0.1% decline in the CPI (according to the government) and scream that a deflationary collapse is upon us. Am I the only one who sees the humor in this? Anyone with some knowledge about economic statistics knows that CPI is incredibly flawed.

Anyway, does this look like a deflationary collapse to anyone?

A lot is made of the deflationary tsunami and "lost decade" of Japan. But if you take the time to plot consumer prices during this presumed deflationary collapse, you'll find that consumer prices actually rose. Real estate and stocks, of course, are a different story.

So why all the hoopla about deflation? Well I'll tell you why Helicopter Ben is scared of deflation; it's because of real estate. Do you think Bernanke cares if gas prices go down? What about food prices? Consumer electronics? No, everything hinges on real estate.

I can virtually guarantee a 10% drop in real estate will result in a deep recession. With the ongoing contraction in bank loans, this appears to be a near certainty. For example, banks have only recently imposed standards by which future cash income from a property is not included in present income. This directly contracts the borrowing capabilities of consumers. There are so many factors that are weighing down on housing that explaining it all warrants a post in itself. Without going into specifics for now, let me just say that I am almost positive that home prices nationally will decline again.

The trends present today will determine the trends of the future. Deflation, however tame, leads to inflation.  

Read more...