Bonds Don’t Lie; Thoughts on Sovereign Debt Investments; And Who’s To Blame for the Financial Crisis

June 10, 2011 · Posted in General Economics · Comment

A refreshingly interesting and open conversation on CNBC.

I happen to agree that bond markets are the best predictor of where markets in general are headed. As I noted before, treasuries have been rallying pretty much since February of this year, portending a slowdown that may be the second leg down for the double dip recession that is to come. It’s likely that gold, the Dollar, and Treasurys will to continue to do well …

Tags: bond market, debt, public debt, slowdown, sovereign debt, treasury rally

More Debt = Lower Unemployment?

December 27, 2010 · Posted in General Economics · 2 Comments

This is the video in question:

These are the numbers I am looking at:

History of the US Public Debt

History of US Unemployment

Tags: debt, deficit, unemployment

Congress Increases Debt “Limit” to $12.4 Trillion

December 27, 2009 · Posted in Government · Comment

In yet another predictable move, Congress has increased the debt limit by another $290 billion:

Congress’s move to lift the federal government’s borrowing limit by $290 billion — enough to last about two months — sets the stage for a contentious debate early next year on government spending.

The Senate on Thursday approved the increase in a 60-39 vote that was largely along party lines. The House passed the measure last week.

The additional $290 billion in borrowing ability lifts the total public debt the federal government can hold to about $12.4 trillion and will allow the government to keep borrowing through February.

Treasury officials had warned that the current limit of $12.1 trillion was close to being breached. Congressional leaders scrambled to raise the ceiling before they began the holiday recess.

An increase in the debt ceiling is largely symbolic as it represents money already spent by the U.S. government. In the unlikely scenario where it was ever breached, however, there would be significant consequences for the financial markets. The federal government would be forced to default on its obligations, and could lose its top credit rating, having to pay much higher interest rates as a result.

Just two weeks ago, several senior Democratic lawmakers had said they were close to reaching an agreement on an increase in the debt limit of $1.8 trillion to $1.9 trillion, enough to support the federal government’s borrowing needs through 2010. That would have avoided the need to take up the issue again next year, when many Democratic lawmakers are expected to face tough re-election battles.

But when it became apparent there wouldn’t be sufficient support in the Senate for that, Democrats scaled back their ambitions and moved forward with the more modest increase.

That leaves Congress facing another debate on the issue before the end of February. Senate Majority Leader Harry Reid (D., Nev.) said this week that would be the first order of business the Senate deals with when lawmakers return Jan. 19.

Republicans are hoping to tap into the public’s anxiety about the federal government’s finances to make gains in the polls next November.

When the Senate takes up the debt issue in January, Republicans plan to hold votes on a number of measures that would seek to restrain the federal government’s ability to spend. These include discretionary spending caps, a move to strip out already-committed funding from the fiscal 2010 budget and the creation of a commission to investigate longer-term solutions to the debt issue.

I love the part about “creating a commission to investigate longer-term solutions to the debt issue”. This is precisely what we can expect from Congress. More commissions, debates, talk, surprises about this or that shortfall, and so on and so forth.

Every month someone from some party says we have to deal with the debt issue, reign in spending, cut expenses and return to fiscal discipline. Yet, when it comes to actually voting on the single measure that matters in this regard, they are rather quick to approve more of the same.

Note that the official debt numbers are a sham anyway. Total US debt is not at $12 trillion. The Treasury itself estimates that total government obligations for Social Security and Medicare are at $43 trillion, as I noted before:

The SOSI provides additional perspective on the Government’s long term estimated exposures and costs. However, it should be noted that the Government’s financial statements do not reflect future costs implied by any current policy, such as national defense, the global war on terrorism, and disaster relief and recovery. Table 3 shows the Government’s estimated present value of future social insurance expenditures, net of dedicated future revenues for the programs reported in the Statement of Social Insurance (SOSI), projected to be $43 trillion as of January 1, 2008 for the ‘Open Group’6. While these expenditures are currently not considered Government liabilities, they do have the potential to become liabilities in the future, based on the continuation of the social insurance programs’ provisions contained in current law.

A liability, or debt, is simply “the obligation of one person or group to provide future goods to another person or group.” Thus, for the discerning economist, it is rather irrelevant if the government “considers” or “officially calls” them liabilities. As far as their impact on human action is concerned, and thus all that economics cares about, they are debts.

This brings the total US government debt up to $55 trillion, an implicit mortgage burden of $491,000 per US household. Anyone in Congress wanna deal with THAT?

Of course not, they will continue to push the boundaries, and of course they will raise the limit once again, come February.

Remember:

From 1989 on, the Japanese government has launched one stimulus after another to no avail, leaving Japanese taxpayers with the largest public debt per capita of all industrialized nations.

A burden that the US government seems to be more than willing to have its taxpayers shoulder over the years to come unless someone picks up a history book and tries not to feverishly repeat mistakes others made in the past.

Thus the long term outlook for the US economy is the fate Japan took: A long lasting correction supercycle with one failing “stimulus” program after another, and with on and off periods where the economy slips out of and back into recessions from time to time.

The public should not be deluded into thinking that such thing as a “limit” exists in the minds of their representatives.

May I ask: If all Congress keeps doing is to raise the debt limit quarter by quarter, why not get rid of the damn thing altogether?

Tags: debt, public debt, public debt limit

Geithner Asks Congress to Raise Debt Limit

August 11, 2009 · Posted in Government · Comment

Today is August 11th. I just double checked. It is not April 1st. Nor does it seem like Geithner issued the statements below for The Onion. He appears to be serious … seriously, Geithner Asks Congress to Increase Federal Debt Limit:

U.S. Treasury Secretary Timothy Geithner asked Congress to increase the $12.1 trillion debt limit on Friday, saying it is “critically important” that they act in the next two months.

Mr. Geithner, in a letter to U.S. lawmakers, said that the Treasury projects that the current debt limit could be reached as early mid-October. Increasing the limit is important to instilling confidence in global investors, Mr. Geithner said.

The Treasury didn’t request a specific increase in the letter.

“It is critically important that Congress act before the limit is reached so that citizens and investors here and around the world can remain confident that the United States will always meet its obligations,” Mr. Geithner said in a letter to lawmakers.

Mr. Geithner said the that it is “clearly a moment in our history” that requires support from both Democrats and Republicans for the increase.

“Congress has never failed to raise the debt limit when necessary,” Mr. Geithner said.

The non-partisan Congressional Budget Office said Thursday the federal government’s budget deficit reached $1.3 trillion through the first ten months of fiscal 2009, on track to reach a record high of $1.8 trillion for the 12-month period.

A statement like this could be out of some of the more bizarre sections of Atlas Shrugged, at the point where nobody really cares about anything or anybody anymore.

Is this for real? When I ask banks to loan me more money, and that it is of critical importance that they do so, will this instill confidence in other investors of mine?

How is it more likely that I will meet my obligations if I take on more … obligations?

Hasn’t Congress’s biggest failure been its lack of fiscal discipline, its rampant and neverending spending, its inability to pay down some of its debt? How then can we even for one second consider calling it a failure to not add to this public debt?

How badly has brain damage progressed in Tim Geithner’s head? How gullible and stupid does he think the people are? This guy needs to step down and needs to do so quickly. Listening to his nonsense is painful and insulting.

Tags: congress, debt, public debt limit, tim geithner

Inflation & Deflation Revisited

June 5, 2009 · Posted in Global Economics, Monetary Economics · 15 Comments

I have in the past defined inflation as an increase in the true money supply. I defined deflation as a drop or only a very minor increase in the money supply. In those strict terms I have interpreted economic data correctly. I said we were in a major inflation through the 90s and from 2001 through 2006, then I switched to the deflationary camp and later, and toward the end of 2008 again supported the inflationary view. The chart below shows the money supply growth up until the end of 2008.

I include only actual money in cash or in checking accounts in my data. I still would not change a word of what I said regarding what is and what is not to be included in the true money supply, the supply of the medium of exchange inside a country.

But I admit that I used an insufficient definition for inflation and deflation. What I was really referring to was monetary inflation. We create definitions in order to understand and/or explain cause and effect of market events.

I agree with Mish in that:

I prefer a practical definition of deflation that matches and even predicts what the credit markets and stock markets are going to do, not some definition that is useless for anything but academic debate.

Inflation is broadly understood as an event where, due to monetary intervention, a large group of people consumes and/or produces differently from how they would have consumed or produced without the intervention. The dislocations of demand versus supply generally cause prices to rise differently from how they would have risen/fallen without the intervention. I explained these phenomena in the consumption business cycle and the production business cycle. Deflation is the reversal of this development back toward market equilibrium.

I said in The Dispute About the True Money Supply:

We are trying to ascertain the true money supply for a reason. We want to explain the current and the future development of asset and consumption prices in the country, measured in dollars. The more money is available for spending the higher will the prices be. But prices emerge in exchange transactions where money is surrendered in exchange for goods and services. They change over time as a result of continuous ongoing exchange transactions. As a tendency, they change with every additional exchange transaction. The medium used in these transactions and thus affecting prices, and nothing but it, is what we need to measure (…)

…maybe if we want to know how many media of exchange are available. But it won’t necessarily help us in explaining inflation and deflation. Why? It’s simple. Inflation is created based on how much money people think they have, not how much they actually have. People act based on perception. Their error will only become apparent at a later point in time. In addition to that, prices don’t necessarily have to emerge through exchange transactions only. When two investors agree on a certain price to trade claims to money from some business, then all other holders of the same may see that same price on their broker statement at the end of the day without having done anything.

Imagine a society with a relatively free market and a certain amount of fiat money in circulation. Now imagine the central bank or one of its fractional reserve banks offers to A a new credit of $100, pushing down interest rates and pushing up the prices for debt instruments. Now imagine the person A who receives the loaned money passes it on as a loan to someone else, B. If A is certain that he’ll be paid back with interest he will consider the claim to future money as good as money. B may do the same and so on and so forth.

All participants in this chain will think their claim to $100 is actually $100 of money owned. Each of them will, at worst, consider it a wash: I owe $100 and I am owed $100. In other cases they may value the asset owned higher than the money owed, especially when government intervention creates an ongoing demand for these claims by buying them up or by offering guarantees to banks who buy them up (see Fannie Mae and Freddie Mac) and push up their prices. Everyone will continue spending the rest of their other money as if their claim was as good as money. But what if the final debtor in the chain has squandered the money and defaults. Now others in the chain may default as well: The price of the claims drops to zero.

Suddenly reality kicks in and everybody realizes that they never owned as much money as they thought. “I have my money in mortgage backed securities.” or “I have my money in corporate bonds.” may be some of the things they used to say before their net worth evaporated. But they never had money in anything. They had given their money away in exchange for a future claim to it. There was never enough money in circulation to pay off every debt in the first place. This is when people begin appreciating true cash again, with no strings attached, earned money. Everybody will be scrambling for it on order to pay off their debts. Others see this happening before their eyes and will save more than they used to.

The US economy has been at the center of a worldwide network of such cascading credit relationships. Central banks loaned fiat money to fractional reserve banks, those would pass it on to financial institutions which would make it available as wholesale mortgages, individual mortgage banks would take those on and make loans to homebuyers. Insurance companies would insure one or the other loan in the chain and again consider the insurance policy as good as money, using it as collateral to obtain … more credit. On top of that, huge pension plans would invest money in such financial institutions and insurance companies. This is just one example of how the entire world economy has been permeated by credit that is now imploding.

Consumer behavior will obviously change drastically as a result of this. This is exactly what has been going on for the past 2 years. It is a credit deflation. The sum of money inflation/deflation and credit inflation/deflation can thus be defined as total inflation/deflation. The amount of debt at this point is so huge that the pure money inflation/deflation component almost doesn’t matter: The true money supply is currently at around $2.14 trillion. According to Michael Hodges, in January 2009 total Debt in the US excluding unfunded social security and medicare commitments is estimated at roughly $60 trillion, and at around $174 trillion when those are included.

Some may now ask “But what about the Fed with all its money pumping and printing?”. But the Fed is not just printing money and unloading it over our cities. The only way the Fed and other banks can currently add money to the economy is by offering credit. But when it offers credit then naturally someone on the other end must accept it. When the demand for credit dries up the game is over. Robert Prechter offers a great illustration with his Jaguar example:

Jaguar Inflation

I am tired of hearing people insist that the Fed can expand credit all it wants. Sometimes an analogy clarifies a subject so let’s try one.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing Jaguar automobiles and providing them to as many people as possible. To facilitate that goal, it begins operating Jaguar plants all over the country, subsidizing it with tax money. To everyone’s delight , it offers these luxury cars for sale at 50 percent off the old price. People flock to the showrooms and buy. Later, sales slow down, so the government cuts the price in half again. More people rush in and buy. Sales again slow, so it lowers the price to $900 each. People return to the stores and buy two or three, or half a dozen. Why not? Look how cheap they are! Buyers give Jaguars to their kids and park an extra one on the lawn. Finally, the country is awash in Jaguars. Alas, sales slow again, and the government panics. It must move more Jaguars, or, according to its theory – ironically now made fact – the economy will recede. People are working three days a week just to pay their taxes so the government can keep producing more Jaguars. If Jaguars stop moving the economy will stop. So the government begins giving Jaguars away. A few more cars move out of the showrooms, but then it ends. Nobody wants any more Jaguars. They don’t care if they’re free. They can’t find a use for them. Production of Jaguars ceases. It takes years to work through the overhanging supply of Jaguars. Tax collections collapse, the factories close, and unemployment soars. The economy is wrecked. People can’t afford to buy gasoline , so many of the Jaguars rust away to worthlessness. The number of Jaguars – at best – returns to the level it was before the program began.

The same thing can happen with credit.
It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing credit and providing it to as many people as possible. To facilitate that goal, it begins operating credit production plants all over the country, called Federal Reserve Banks. To everyone’s delight , the banks offer the credit for sale at below market rates. People flock to the banks and buy. Later, sales slow down, so the banks cut the price again. More people rush in and buy. Sales again slow, so it lowers the price to 1 percent. People return to the banks and buy even more credit. Why not? Look how cheap it is! Borrowers use credit to buy houses, boats and an extra Jaguar to park out on the lawn. Finally, the country is awash in credit. Alas, sales slow again, and the banks panic. They must move more credit, or, according to its theory – ironically now made fact – the economy will recede. People are working three days a week just to pay the interest on their debt so the banks can keep offering more credit. If credit stops moving the economy will stop. So they start giving credit away at zero percent interest. A few more loans move through the tellers’ windows, but then it ends. Nobody wants any more credit. They don’t care if they’re free. They can’t find a use for it. Production of credit ceases. It takes years to work through the overhanging supply of credit. Interest payments collapse, banks close, and unemployment soars. The economy is wrecked. People can’t afford to pay interest on their debts , so many bonds deteriorate away to worthlessness. The value of credit – at best – returns to the level it was before the program began.

I also explained this, albeit a bit less vividly, in Sick and Tired of Debt. I recommend reading Prechter’s excellent paper The Guide to Understanding Deflation in full. Nowhere else have I seen the concepts behind deflation explained so precisely and with so much foresight.

A lot of economists and investors, such as Peter Schiff and Marc Faber are ignoring the ideas that I outlined above. They are expecting a Weimar style hyperinflation. I used to think the same way. But I wasn’t looking at the details. Weimar Germany’s hyperinflation happened because the German government simply printed money, actual currency, in order to pay off debts owed to the victors from World War 1. Zimbabwe did the same thing to honor IMF loans. This is nothing near to what is going on in the US. Money is created by issuing new debt, not by paying it off. When people have had enough, it ends.

Hyperinflation is simply not going to happen under the current conditions. So long as credit remains the only means for the Federal Reserve Bank to “inject” money, deflation will continue to run its course.

What will happen after the debt is written off? Who knows. We may or may not see a hyperinflation at some point in the far distant future, depending on how monetary policy changes over time. But to put all your eggs in that basket, and to do so right now would be a mistake.

Tags: credit, debt, deflation, inflation