Euro Crisis

The European sovereign debt issues have become a contagion. Foreign politicians will have to make difficult decisions when it comes to saving sovereign bond markets as well as large private European banks. 

This past weekend, the Eurozone had an economic summit to discuss how to handle the sovereign debt issues with the PIIGS Nations [PIIGS = Portugal, Ireland, Italy, Greece, and Spain].  These countries have been net importers since the euro was created in 2000.  As members of the European Union (EU) they inherited credit ratings that should have been exclusive to Germany, France, and the Netherlands.  The PIIGS nations were able to exploit the EU with unchecked borrowing and spending.  All of these countries were able to live high off the hog while Germany, Netherlands, and France continued to produce and save. 

The PIIGS nations can be viewed as the misfit children in the European system.  Their mother and father, France and Germany, have been forced to continually bail them out in recent months.  However, after throwing more cash in the trash, the parents are starting to realize that they need to cut their children off from the unlimited credit. 

Portugal, Ireland, and Greece are the worst of the PIIGS nations.  All three countries have received IMF bailouts and remain on life-support.  Their debt to GDP ratio is through the roof because they have large burdensome governments.  Since these countries aren’t big exporters, their expenditures vastly exceed their revenue. There is no question that these three countries would have defaulted by now if it wasn’t for Germany and France providing a cheap credit line to them in exchange for austerity measures.  Austerity generally means getting back to the basics and stripping a lot of the government fat.  Unfortunately, this means government workers losing their jobs and benefits—hence the Molotov cocktail parties.   The good news is that this deleveraging** is needed to get their fiscal house in order. These economies are in trouble because they have become reliant on cheap credit, low-interest rates, and enormous government spending (cough USA cough).  However there is a catch!

France and Germany cannot afford to allow any of these PIIGS nations to default. This is where it gets trickier than my previous analogy suggests.  The hidden problem is that French and German banks have huge exposure to the PIIGS bond markets.   Not only are they heavily invested in the bond market but also bond derivative markets.  Many of these banks have leveraged insurance on the PIIGS nations’ bonds.  To keep the analogy going: the parents have already started to pay for college ahead of time even though it appears none of the kids will be able to graduate high school. 

There are several goals behind this weekend’s Euro-summit:

1-Find ways to restructure Greece’s debt

2-Recapitalizing private banks

3-Create a EU rescue fund to keep the Greece, Ireland, and Portugal problems from spreading to Italy and Spain (Europe’s third and fourth largest economies).

First, with respect to Greece, experts agreed that bond holders of Greek’s debt would need to take a 50-60 percent haircut (devaluation)  in order to make Greece’s debt sustainable.  Secondly, the leaders have already agreed that 100 billion euros would be needed to keep the French and Germany banks solvent in the face of PIIGS defaults.  Lastly, the rescue fund has become the most controversial topic. German leaders are facing resistance from the general public on the issue of using Germany’s funds to save the Eurozone.  For the rescue fund to work, many European economists are recommending between 1 trillion and 2 trillion euros.  Germany only seems comfortable contributing around 400 billion euros.  This would leave the fund inadequate and would involve kicking the can a few more months. It appears the solution that is gaining the greatest traction involves leveraging the 400 billion euros. If this doesn’t make sense then you are a logical person. Again we have the problems of financial innovation to solve an already over-leveraged system. The take-away message is that the system will live to see another day, either by increasing financial innovation or money printing.  With these leverage-increasing measures, we are only increasing the likelihood of a larger calamity. 

National Bank Transfer Day

One promising thing that has come out of Occupy Wall Street has been the formation of National Bank Transfer Day.  On November 5th thousands of Americans will close their accounts in Too-Big-To-Fail (TBTF) banks and open accounts in credit unions or community banks.  

These TBTF banks have not learned their lesson since 2008’s near systemic collapse.  They may have become flush with cash from central banks, but they still have not deleveraged** their balance sheets.  To the contrary, they have continued to invest trillions of dollars in risky derivatives and stinky packaged debt obligations—this time with exposure to sovereign debt.  Bank of America and JPMorgan recently moved 74 trillion and 79 trillion dollars in off-sheet derivatives to their banks, respectively.  These clandestine moves provide collateral for the derivatives, in the form of depositor bank accounts.  Shockingly, if these banks fail then the derivative holders will have their losses settled first.  That leaves the FDIC holding the bag for over a trillion in depositor bank accounts.  The FDIC only holds a small percentage of what it insures, so it too would face insolvency.  FDIC has been publicly outspoken on this issue, but to no avail.  The Fed has approved and encouraged these moves, putting them at odds with the FDIC.  My guess is the Fed realizes that it would have to backstop the FDIC and reimburse the depositors before there is a system-wide bank run.  They better start their printing press!

If you have an account at a Bank of America, JPMorgan, Wells Fargo, and an other TBTF bank then you may want to consider moving it  to a credit union or community bank.  The 2008 crisis came without much warning, but this time you can protect yourself.  It’s up to you to make the prudent choice. 

Understanding the Occupation

It has been two years since the formation of the Tea Party, a radical right group.  Finally, the left have responded with their own radical group; Occupy Wall Street (OWS).   Thus far, OWS has been an unorganized assembly of students, unemployed workers, and unions.   The topics of attention have ranged from beheading corporate leaders to legalizing drugs.  However, one underlying theme has been the onslaught of the rich.  Some of ‘The 99%’ have clearly placed their cross-hairs on ’The 1%’. 

However, I would argue that class warfare is not the answer.  I have heard far too many politicians crying that the rich need to contribute “their fair share.”  How much is their fair share?   Somebody making 10 million dollars pays 35% income tax which enables the government to collect $3.5 million in revenue.  Another person may make $100,000, which puts them in the 20% tax bracket.  Their tax responsibility is $20,000 a year.  So the millionaire contributed $3.5 million and the $100,000 worker contributed $20,000.   Is the wealthier individual getting more benefits from the government?  No way Jose.  However, someone making 10 million is probably a business owner.  Not only is he contributing more in taxes but he is also supplying people with jobs!  People don’t get rich at the expensive of other people.  They get rich because they provide goods or services that people want or need.

Let’s take a look at some of these one-percenters; Steve Jobs, Bill Gates, Sam Walton.   Steve Jobs was the fifth wealthiest individual in the United States when he passed away last month.   He has been an idol to American businessmen and a charitable individual.  As CEO of Apple he received $1 a year as his salary.  Jobs achieved his high net-worth via Apple’s stock, which is arguably the best stock in the last ten years.   His stock-option salary is only vulnerable to the capital gains tax of 15%.  According to Warren Buffett and Barack Obama he would not be contributing his “fair share.”    Should we demonize Steve Jobs?  Hell no, we all know that Apple has employed millions of Americans and provided many of us with high-tech gadgets ahead of their time.  Same respect and thankfulness should apply to Bill Gates, Microsoft, and the Gates Foundation.  And what about Sam Walton and Wal-Mart?  Americans would riot if they couldn’t get their cheap Wal-Mart goodies.  

So we need to redefine who we are angry at.  We can’t get angry at entrepreneurs and producers who are already hurting from the recession.  We need to focus our disproval on the companies that engage in ‘crony capitalism’ with the government (see figure above).   I’m personally peeved at the TBTF (too-big-to-fail) banks, the Federal Reserve, and the US Government for all their hand holding.  What do they really contribute to society besides phony derivatives and triple packaged “shit” (as some Goldman Sacs employees called their Credit Default Swaps)? The banks and hedge funds are the only ‘corporations’ that engage in predatory trading, where deception is a tactical skill.  These organizations also have the nerve to give their management bonuses with tax-payer money that was used to save them from failure.  Wall Street lobbyists have infiltrated and corrupted our government.  Our economic system can no longer be called Capitalism.  Capitalism has not failed us.  Crony-Capitalism is what we have and it is still failing us.   These financial organizations remain overleveraged and on the brink of failure because they continue to engage in risky trading.  These TBTF financial companies know their losses are backstopped by the government that turns to the tax-payer.   The Federal Reserve has encouraged this whole racket by keeping interest rates low—encouraging people not to save, but to invest in the stock market or buy a house/car.  Nothing will change and our economy will not recover until we cut the giant debt caboose loose.  How do we do this?  END THE BANKING CARTEL.  

Quote of the Month: Steve Jobs

“Being the richest man in the cemetery doesn't matter to me. Going to bed at night saying we've done something wonderful... that's what matters to me.” -Steve Jobs

Steve Jobs has been a captain of innovation his whole life.  Curiosity and perseverance enabled him to become a successful pioneer in the computing industry.  As his quote suggests, he was not driven by riches.  That’s not to say that he cursed the profits that followed his success.  My argument is that the most successful entrepreneurs make it because they want to make a difference in people’s lives.  Arguably, there is a lot of luck involved too as Malcolm Gladwell repetitively points out in Outliers.   With that said, people make it big when they want to change the world and the world is ready for the change.

Too many of us are chasing the job that pays the best salary.  In the process we have put family and happiness on the back burner. I believe we need more people who want to make a difference in a community.  When you look back on your life– do you want to be proud of what you accomplished or be proud of how much money you made?  Or even better, how many lives did you affect?

There are two ways to excel in life.  You can work hard, follow the rules, and do as your told.  The other option is to veer from the beaten path and think for yourself.  The best sign that I have seen from the Occupy Wall Street protest was one which said “Think for yourself or be thought for.” 

My generation knows something about everything but not everything about something. We have been falling deeper into a hedonistic, sound-bite society.  Facebook status updates have supplanted conversations while reality television has replaced true relationships.  I hope the meaning of life is a little more than being entertained and having a job.  We should question everything around us and ask why that is the way it is.  This world still needs a lot of work.  Where are our Ghandis, Mother Teresas, Bob Marleys, or Thomas Jeffersons?   It’s time to leave your mark. 

Investing in Precious Metals

Click to Enlarge!

Click to Enlarge!

The Great Gold Bubble

Almost every day that I tune into CNBC I have to listen to someone warn Americans about the potential bubble in the Gold Market.  They have been calling it a bubble since gold was $850 an ounce.  With gold now closing in on $2,000 dollars an ounce, it is making headlines daily.   So what do you think?  Is gold in a secular bull market or is it in a bubble? 

I would like you to try to name five people who invest in physical gold or silver.   Notice I said physical and NOT precious metals stocks or exchange traded funds (ETFs).    A majority of stocks and ETFs mirror the metals’ spot prices but do not keep any physical metal in inventory.   I bet you were unable to think of three or more people investing in precious metals.   That is because almost nobody is buying physical precious metals.  I have noticed dozens of gold shops spawning up all around me but this does not suggest that gold is in a bubble.  This verifies my position, that the masses are still net sellers of gold and silver because they would rather have quick cash. You may be asking then who is buying precious metals that are causing the sky rocketing prices in the precious metals markets?  Answer:  Central Banks.  China, Russia, India, Mexico, and most recently South Korea have been buying tons (or tonnes) of gold at a staggering rate. 

Why do central banks hold gold?  Ben Bernanke said “because of tradition”, but I would say because gold and silver have been money since 7^th century B.C. when Greek city states first started bartering in coins.   Throughout history, gold and silver have remained valuable – serving as both jewelry and money.  Paper currency was first issued as way to exchange precious metals without having to carry the metals around.   Eventually, people became accustomed to exchanging the gold notes instead of physical gold and silver.   The price of gold provided an exchange rate between international currencies prior to 1945.  In 1945, the Bretton Woods System was set up and 29 nations agreed to accept the US dollar as the currency by which international business was to be conducted.  For example, if Britain was to purchase goods from Norway, they would settle in Federal Reserve Notes instead of Pounds.  At the time, the US dollar was a stable currency because it was still on a gold standard.  Thirty-five dollars equaled one ounce of gold.   However, in the early 1970’s the US economy was suffering from stagflation as we found ourselves in a never-ending conflict with Vietnam.  Low interest rates, rising military costs, and increased domestic spending (sound familiar?) paved the way for inflation and a loss in US Dollar confidence.  In early 1971 countries started to cash in some of their paper money for physical gold.  Switzerland traded in $50 million in paper for physical gold and France followed suit by redeeming $191 million for gold.    On August 15^th, 1971 President Nixon took the most drastic response and closed the gold window to prevent foreign countries from emptying Fort Knox.  Since that day, which became known as Nixon Shock, gold has been sky rocketing and the dollar has been weakening as a result of our growing trade deficit and the FED’s inflationary monetary policy.   So gold may be in a bubble, but we are only in the beginning stages!

USA's Boogeymen: The Battle Lines are Drawn

What do Osama bin Laden and Saddam Hussein have in common besides being boogeymen to Westerners?  They were both CIA assets at some point in their lives.

Saddam Hussein was a member of a small Arab nationalist party known as the Ba'ath Party.  In 1959, at the young age of 22, Saddam was part of a six person CIA operation to rout out the Iraqi leader General Abd al-Karim Kassim.  Kassim was an enemy of the US’s because in two short years he nationalized Iraq’s oil, threatened invasion of Kuwait, and shifted Iraq’s cold war position from US to Soviet.   Saddam was the gunman in the assassination attempt of Kassim, but he ended up botching it.  Kassim stayed in power for another three years while Saddam fled to Egypt for safety.  In 1963 Kassim was successfully assassinated and Saddam returned to Iraq.  He was immediately instated as the head the Al-Jihaz al-Khas, the clandestine Ba'athist Intelligence organization.  His cooperation and effectiveness in eliminating Communists allowed him to rise through the ranks until he became the leader of Iraq in 1979.  The USA and Britain allied themselves with Saddam’s Iraq during the 1980 Iraq-Iran war.  The western powers and Saddam Hussein were both fearful of the rise of Shi’a Muslims in the region, which may be why the US turned a blind eye to Saddam Hussein’s suppressive regime.  It wasn’t until Iraq’s invasion of Kuwait, a long time US alley, did Saddam step on the US’s toes.   Saddam’s betrayal was used to make an international example of what will happen to those who defy us.   We couldn’t get him the first time around (due to the elite Iraqi Republic Guard) and he wasn’t corruptible so it required a second attempt.  

Bin Laden grew up in an affluent Saudi family which made their money through oil and banking.  In 1979, he left his family to help fight against the Soviets in Afghanistan.  Osama bin Laden has always been an Arab nationalist, rejecting any sort of western guide to righteousness. Shortly after arriving in Afghanistan he became leader of an organization known as Maktab al-Khidamar (MAK), which was an Afghan mujahedeen [A group of guerilla Islamic fundamentalists].  Osama bin Laden’s money and connections to Saudi government and the Pakistani Inter-services Intelligence (ISI) allowed Arab countries to funnel money and arms to the rebels.  The CIA noticed the rise of these “Freedom Fighters” and helped train, fund, and arm the MAK and similar organizations in their fight against the Soviets.   Osama bin Laden did not shift his hatred to the western world until the first invasion of Iraq in the early 1990’s.  To throw salt in the wound, it was the royal Bin Laden family that permitted the United States to use Saudi Arabia as a launching pad for operations in Iraq. Feeling disowned by his own family, he shifted his anger and operations towards the new occupying power: The United States of America.

*Note: Shortly after news of Osama Bin Laden’s death.  China released a statement “Any attack on Pakistan would be construed as an attack on China.”

Mahmoud Ahmadinejad, may be the next boogeyman in line.   Will the US connect the dots between Afghanistan and Iraq?  Occupation of Iran would be a logistical boon to US military operations in the region.  Also, with access to the Caspian Sea and the Persian Gulf, there would be great possibilities for Government contractors to build the mother of all oil pipelines.  Motive for war is already being laid down; there are reports that Iran is developing excessive amounts of radioactive materials.  Iran claims that their nuclear program is strictly for bolstering electricity supply and to provide fuel for medical reactors.  The UN, Israel, and the USA are growing increasingly wary of the situation and may make a pre-emptive move.  There is only one little issue that stands in the way: Iran is China’s largest oil supplier.

Hugo Chavez, the current leader of Venezuela, has been drawing more attention recently.  Just last month, Chavez nationalized gold producers in Venezuela.   That same day he announced that he was withdrawing all of Venezuela’s wealth (cash & gold bullion) from western banks to keep Venezuela’s worth in “countries that have more solid economies.”  This move will transfer $12 Billion in gold and $6.5 Billion in cash from HSBC, JP Morgan, Barclays, and Bank of England to Chinese and Russian banks.   In my opinion this move makes perfect sense because Venezuela is China’s second largest oil supplier after Iran and before Sudan.    With growing tensions between China and the United States, other countries may follow Venezuela’s move and start securing their wealth through their allies. 

Kim Jong-Il, North Korean dictator and longtime ally of the Chinese government.  All I have to say is: Bat Shit Crazy. 

Warren Buffett: Quote of the Month

The Oracle of Omaha has become the Nutcase from Nebraska.  Warren Buffett, currently the third wealthiest person in the world, was once a voice of reason in the world of investing.  In January of 2004, he had an article published in Fortune Magazine titled “Squanderville Versus Thriftville.”  The article was widely acclaimed and is a must read for anybody trying to understand the economic relationship between China and the United States.  Simple and brilliant, the article displays that Warren Buffett had a sound understanding of macroeconomics to accompany his investing talent.  However, Warren Buffett now dances to a different tune.  He no longer warns Americans of inflation or a declining dollar.  He has become a confidence cheerleader. 

Following the S&P downgrade Warren Buffett came out and announced, “In Omaha, the U.S. is still triple A. In fact, if there were a quadruple-A rating, I'd give the U.S. that.”  This statement is a direct contradiction to his “Squanderville Versus Thriftville” essay.  Since his 2004 essay, the National Debt has ballooned from 7 trillion to 14.7 trillion, the dollar has continued to decline, domestic production is down, and consumption has risen.  So why would Warren Buffett do a complete 180 with his view on the trade deficit and how it affects our credit?   It doesn’t take a rocket scientist (or a Princeton Economist) to see that sovereign debt across the globe is suffocating what may be described as a comatose economy.   But this is AMERICA!  We are the most successful and powerful nation!  We will not admit to be being broke! We will continue to spend and ignore our debt until Daddy takes away our credit card!   Substitute China for Daddy and Printing Press for credit card.  

Maybe Buffett realizes the severity of the situation and is doing this to inject confidence in the domestic markets.  He has always kept his investments confined within the United States.  Soon he may be recommending specific American stocks such as GE, Goldman Sacs, and Bank of American.  All of which he is a large shareholder receiving  preferred stock at high 7-10% usury rates.

WELCOME

Friends and Family, it is my pleasure to reveal the first installment of my monthly newsletter.  For some of you this will come out of left field whereas others may have seen this coming a mile away.  Paramount Times will be my outlet for channeling my obsession with economics and world affairs.             


The purpose of my writing will be to cut through the fat preached by the talking heads.  These so-called pundits are consistently shouting their opinions and using slander to appeal emotionally.  They want you to think with your heart instead of your brain.  Just remember, the mainstream media sells entertainment not facts. I hope my writing will sift through the entertainment, the news, and highlight the most critical issues.  With that said, I will not regurgitate articles or ideas.  I want to motivate you to think and build your own boat in this ocean of opinions. If I succeed in this journey then you will question stories that you hear and if I fail then you will just have another news source for economics and world affairs.

Paul Krugman (left) and Ben Bernanke (right) have many things in common besides their wisdom whiskers.  They have both been chairmen of Princeton University’s Department of Economics.  Paul Krugman is the current chairman and often writes for the NY Times.  Ben Bernanke was appointed chairmen of the Federal Reserve under Bush and Obama has kept him.  Both men are proponents of easy credit and stimulus packages to pull the economy out of recession.  They have even suggested dropping money from helicopters.  No joke.

Inflation, Deflation, China-Nation

What is inflation?  It is often defined as a general rise in consumer prices.  This is the new definition of inflation that people gravitate towards.  However, if you look up the definition of Inflation in a Merriam-Webster dictionary published before 1980 it will say:  Undue expansion or increase, from overissue of currency.   Inflation should be viewed as the expansion of the money supply.  Deflation, on the contrary is a contraction or decrease in the money supply.  Rising or falling prices are symptoms of money creation or destruction.

To understand our current financial crisis and potential solutions – one must understand monetary policy. 

Money can be created in numerous ways.  The fractional reserve banking system is the most traditional.  Whenever you deposit 100 dollars into a bank, only 10% must be held as reserves.  The other 90 dollars can be lent to somebody as a loan.   The person who receives that loan will likely deposit a large portion of that money into a bank as well.   Let’s say they deposit 2/3rds: 60 dollars is deposited into a bank.   Only 6 dollars needs to be held whereas the rest can be lent out.  As you can see: your 100 dollars has suddenly blossomed into 244 dollars (100+90+54). 

If you needed to withdraw your 100 dollars from the bank then the bank should have sufficient reserves to deliver.  However if 100,000 people wanted to withdraw a 100 dollars each then you may end up with a run on the bank.   The bank would become insolvent and default because it would not be able to honor all its customers.  This is exactly what happened during the Great Depression.  As thousands of banks went under, their assets and liabilities went with them.  The gigantic contraction of the money supply caused a deflationary spiral:

¨ People withdrawing their funds and/or stocks in fear of collapse

¨ Banks become insolvent and collapse

¨ Companies that lost capital from bank failures would go bankrupt

¨ Employees lost their job

¨ Less people could afford to buy goods or make deposits

¨ Repeat

Deflation-debt spirals are very troubling for all.  Backstops were put in place to prevent this from happening again – i.e. the FDIC.  Now a majority of banks are insured by the federal government.   However, insurance only works if subjects are independent of each other.   Unfortunately the US banking system is interconnected and too concentrated.   The four largest banks make up more than 80% of the banking sector (Bank of America, JPMorgan Chase, Citigroup, Wells-Fargo).   These entities have been deemed ‘Too Big to Fail’ which has given them a government safety net in the sake of protecting America’s prosperity. 

Since 2008’s meltdown, we have seen bank bailouts (TARP, 700B), Obama’s stimulus package (ARRA, 787B), Quantitative Easing 1 (QE1, 1.4T), Quantitative Easing 2 (QE2, 600B).   These four economic stimulus packages have totaled over $3.4 trillion and suggest that this time around they will err on the side of doing too much instead of too little. 

If the federal government and the Federal Reserve did nothing, we would certainly enter into a deflationary depression on par or worse than the Great Depression.  Both of these entities have done an adequate job of keeping us afloat but at the expense of the currency.  Since 2008, our money supply has more than doubled.   Interestingly we have not experienced much price increases domestically.  However, that is because most of the goods and resources that we buy come from abroad.  For example, when a Chinese product is sold in Walmart the revenue and profit dominated in US dollars is shipped back to China.  The Chinese banks then exchange the US dollars for Chinese currency (RMB or Yuan).   The Chinese banks can sit on the US dollars or they can exchange them for US treasuries in order to earn interest.  The Chinese have cash reserves and US treasuries totaling over $4 trillion.   For many years now, China has pegged their currency to the US dollar in order to keep exports strong.   In order to maintain the dollar-peg, the Chinese have had to print money in step with the US causing their inflation rate to rise to 10-12% (year over year).  The only way to combat this inflation problem will be to de-peg from the dollar and allow their currency to appreciate.  In doing so, the Chinese will shift from the world’s greatest exporter to the world’s greatest importer because their citizens will have a new found purchasing power.  Consequentially, the flood of US dollars into the markets will cause noticeable devaluation of the dollar.   This is known as the dollar trap because if they allow their currency to appreciate too quickly than they risk destroying the US dollar in which they are heavily invested.  At this point, our government and Federal Reserve System may have exhausted all options and appear to be at the mercy of our distant relatives: The Chinese.   

  

Debt Ceiling Debate: A Case of Irrelevant Theatrics

If one second is one dollar then a million dollars is 11.5 days and our national debt is 457,000 years.   So does it matter if we raise the debt ceiling?

We have already indirectly defaulted.   The question now is do we want a hard landing or a soft landing?

Back on May 16^th, 2011 we officially hit the debt ceiling limit of $14.294 Trillion.  Our treasury secretary, Timothy Geithner, bought us some time until August 2^nd by raiding retirement funds.  But don’t worry too much; he replaced the cash with IOUs or US treasury bonds.  Interestingly the news outlets and rating agencies have saved the fireworks for now. 

The drama that you see unfolding between the blue and red teams may be irrelevant at this point.  The real meat of the matter can be found in the major players: the Federal Reserve and China.

The government is currently spending between 4 and 5 billion dollars a day and about 40-50 cents on every dollar is borrowed.  In the past decade, China and Japan have been our largest creditors.  However, since 2008 they have greatly reduced their purchases of long term treasuries.  Recently, the Federal Reserve has passed China as the largest holder of US treasuries.   This is no surprise with the Fed purchasing roughly 80% of the long term US treasuries every month since 2009.  The Fed’s purchasing plan has allowed China and Japan to reduce their holdings making the Federal Reserve the new, most powerful creditor on the block. 

A hard landing may occur if a debt limit deal is not reached by August 2^nd.  It would result in selling and panic in the markets and subsequently a deflationary scare like we saw in the latter part of 2008.  The good news is this will not happen.  As the largest US-debt holder and creditor of the US government, the Federal Reserve has the greatest incentives to keep the markets confident in US assets.  The key metric: bond yield, has been unfazed by the debt drama. 

At this point the most logical solution is the most unpopular one: Spending cuts accompanied with tax increases.  If we don’t generate some income to balance out our expenses then we will continue to add to the already blooming debt.  The deeper we climb into debt, the less likely there will be willing purchasers of our bonds.   As the demand for bonds fall, the federal funds rate (interest rate) will need to rise in order to attract new customers.   If interest rates climbed to 6%, interest payments on the debt would skyrocket– adding another 5 trillion dollars to our national debt.  

This time it may be different because we have the Fed willing to purchase as many treasuries as it needs to in order to keep a low-interest environment.  In exchange for US government treasuries the Fed gives the government freshly printed dollar bills to spend at its will.  With politicians accelerating spending to combat the recession and deliver on promises, it won’t be long before the markets are flooded with too many dollars.  A regimen of money printing and loose credit will delay the pain for the time being but eventually hyperinflation could set in. 

The truth of that matter is that we can keep getting drunk on the Government’s punch or we can sober up and face reality.   The hangover will come inevitably. 

Quote of the Month

"Treasury investors are going to get cooked like frogs in an increasingly hot pot of water.” –Bill Gross


If you throw frogs into a pot of boiling water—they will jump out.  However, if you place frogs in room temperature water and then bring it to boiling– the will get cooked.   You also may need to be cold-blooded to be investing in US treasuries.

For those who have never heard of Bill Gross, he is one of the few people that can move markets when he speaks.  Bill Gross is the founder and fund manager of the world’s largest bond company: PIMCO or Pacific Investment Management Company.   PIMCO has been the largest private holder of US treasuries until recently.  Bill Gross has been outspokenly critical of Ben Bernanke and the Federal Reserve’s Quantitative Easing programs.  With QE1, the Federal Reserve exchanged bad bank debt and toxic mortgage backed securities for $1.4 trillion in newly printed cash.  After QE1 ended the economy started to slump again.  The Federal Reserve intervened with QE2 which exchanged $600 billion in cash for long term US bonds. Since the introduction of QE2 the Federal Reserve has been purchasing around 80% of new long term treasuries (i.e. 10 yr and 30 yr treasuries).   Now that QE2 has expired, who should we expected to pick up that 80 percent? 

Our once great creditors: China. Japan, and Saudi Arabia have been greatly reducing their long-term US debt exposure.   Why would anyone want to own long term treasuries when the Fed is purposely employing inflationary tactics to stimulate the economy?  It makes little sense to hold a 10 year treasury that yields 3% when the country’s inflation rate is at 3.6% (The government’s own CPI number). Unless, you enjoy to losing money on purpose. 

Interest rates need to rise in order for more foreign and domestic investors to become attracted to US treasuries.  Unfortunately, we have an economy that has been addicted to 0% interest rates for 27 straight months so any rise could be catastrophic for the housing market and the ‘Too Big to Fail’ banks.

Welcome.

Soon to come.