Prudent Bear Guest Commentary, by Richard Benson
Promises, Promises, Promises
March 4, 2003
>>Finally, if you hear from the government about a strong dollar, beware! You are getting a “Snow” job. Foreigners hold $3 Trillion of dollars in things like US stocks, bonds, Treasuries and Agencies. Currently, we ask foreigners to hold another $1.5 Billion a day to feed our trade deficit and consumption habit. Since Japan, China, and the rest of Asia, wants to sell us a lot of things, Asia’s Central Banks are willing to take on the dollars and bear the risk of having the dollar devalue (it’s good for business and helps move factories from the US and Mexico to their countries). However, when the US starts running big budget deficits as well, can we really expect the rest of the world to finance $1 Trillion a year in combined Trade and Federal Deficits? The dollar is still 30% over-valued and after falling 20% against the Euro, we are setting new record Trade Deficits. Since the US has virtually no savings, if foreigners don’t finance our deficits the Fed will have to “run the printing press”. The US has had the enviable position of having the world’s reserve currency. Today, the paper dollar is used to settle international accounts. Year’s ago, gold was real money. Over 70% of Foreign Central Bank Reserves are now in dollar assets. With US Trade and Federal Deficits, and the Fed running the printing press, “if it was your job to keep your country’s precious money reserves safe, how long would you stay in the dollar?” If the Fed can print unlimited amounts of dollars, how long can it stay real money? Is it rational to believe that a strong dollar is a promise that can be kept?
Indeed, if the Fed and US Treasury want to get inflation going, isn’t letting the dollar fall the easiest way to begin? There are a lot of things that one can invest in besides the dollar, such as gold, silver, commodities, real assets and all types of foreign paper currencies. Which of these look to you like “promises that can be kept”?<<
Richard Benson is president of Specialty Finance Group, LLC , offering diversified investment banking services.
In the late 1990’s Wall Street promised investors that stocks can only go up. They promised that if you bought stocks for the long term, you could only get rich. Indeed, investors would not need to save for their retirement because the stock market, and rising productivity insured by Greenspan’s Federal Reserve Printing Press, meant that we were getting so rich that there really was no need to postpone the immediate gratification of spending and actually put money away for a rainy day. In retrospect, instant and ever growing wealth from the stock market was a “promise that can not be kept”. In looking back, to believe these promises you would have had to be clearly blinded by greed. Many people were.
What drove the stock bubble was an unprecedented increase in the level of debt in the US economy. Corporations and the consumer have taken on enormous amounts of credit. Bankruptcies are at record levels. Much of the debt can not be repaid. These debts are “promises that can not be kept”. Corporations have pension funds that actually received a negative 10% return last year, but assume, for accounting, that they made 9%. Health care costs are rising. Airlines, steel, and other companies are filing BK because of their legacy costs (they have made “promises that can not be kept”). State and local governments are up to a $100 billion deficit for promises that can not be kept to tax payers for services. The US Treasury has promised a strong dollar while the country runs a 5% trade deficit and a federal deficit near 5%. Do you seriously believe that the promise of a strong dollar can be kept? Or, is the government using Wall Street style PR?
Total US Credit Market debt is over the $31 Trillion level as of the third quarter of 2002. Mortgage debt on single family housing is increasing at the rate of $600 billion a year, not only because of low interest rates but because of easy credit underwriting and rising housing prices. The Fed claims there isn’t a housing bubble - should you believe them or is this a “promise that can not be kept”?
The US government debt is hitting the debt ceiling of $6.4 Trillion. If George W. gets his war, the debt could hit $7 Trillion by year end. What does all this debt mean? Debt is a promise. We only have a $10 Trillion economy. The US government has made promises for Social Security, Medicaid, Drugs, IMF loans, War toys, and many other things that go beyond our ability to pay (just look at the deficit, which, like Enron, doesn’t even include trillions of off-balance-sheet financing and guarantees including Fannie Mae and Freddie Mac). Can all these promises be kept?
The surprising answer is yes, under the strict letter of the law. These promises account for a certain number of dollars; however, this has nothing to do with the worth of those dollars. The real question for our Federal Reserve and government is this: Should debts default and entities declare bankruptcy while preserving the value of the dollar? Or, should we devalue the dollar and inflate the currency so that we can “pretend” that promises have been kept? The Federal Reserve knows that there is a limit to the level of bankruptcies that our financial system can endure before risking a total collapse of the financial system. Indeed, we are not far away from that limit. The choice for inflation pushes the problem to the future, even though it may make the financing problem bigger.
The Federal Government has been laying the ground work for significant inflation. The first step has been to change the CPI. The CPI has been modified to allow for all those wonderful “quality changes” in goods like computers. For example, a computer that is twice as fast is worth twice as much. In the past four years this effect in the GDP shows that the amount spent on technology equipment is up 60%, even though the actual number of dollars spent on technology is flat. Years ago my car had a real solid bumper that could mow down a telephone pole. Today when I buy a car, it has a plastic bumper that is designed to let the entire car disintegrate with a minor bump. Is today’s car worth so much more that it should pull down the CPI? The CPI is probably underestimated by at least 1%. I would encourage you to start looking at the cost of gas at the pump, insurance, public transit, cigarettes, college tuition, heating the house, property taxes, to name just a few. It can now cost a few hundred bucks to take the family to the ball game and dinner. Now look at the CPI. Notice anything? The government certainly hopes you don’t. Many monthly checks are tied to the CPI, such as social security, pensions, wages, etc. The best way for the government to keep “the promise that, of course, can not be kept”, is to have the CPI moving up, but trailing well behind reality.
The Federal Reserve has been laying the groundwork on inflation by trying to get us to “fear deflation”. The only deflation you will see is in assets whose prices were driven up by easy credit in the first place, and now are falling back because paying the debt backing the assets is a “promise that can not be kept”. As long as the public can be sold on “fearing deflation”, it postpones the inevitable day when they will need to notice inflation. When this occurs, you will be told that it is good for the economy because it encourages spending. That is like saying that watching your hard earned savings melt away before your eyes is good.
If you are interested in protecting your assets or profiting from events, knowing what “promises can not be kept” should lead you in the right direction.
Until inflation kicks in, investing in corporate credit will remain a “risky business”. While the mortgage and housing bubble go merrily along, selling a home at the top of the bubble may be a once-in-a-lifetime opportunity, while borrowing against a home will also be a once-in-a-lifetime opportunity to lock in government subsidized credit. However, buying the 5-Year Treasury note at 2.66%, or the 10-Year Treasury note at 3.69%, looks like the same long-term opportunity that buying stocks in 2000 offered. Buying treasury and other bonds now will be another once-in-a-lifetime opportunity to have your wealth confiscated as inflation rises while bond prices crash. Remember, under inflation you will owe real tax on income from bonds even though the income will not even keep up with the decline in purchasing power of the bond.
Finally, if you hear from the government about a strong dollar, beware! You are getting a “Snow” job. Foreigners hold $3 Trillion of dollars in things like US stocks, bonds, Treasuries and Agencies. Currently, we ask foreigners to hold another $1.5 Billion a day to feed our trade deficit and consumption habit. Since Japan, China, and the rest of Asia, wants to sell us a lot of things, Asia’s Central Banks are willing to take on the dollars and bear the risk of having the dollar devalue (it’s good for business and helps move factories from the US and Mexico to their countries). However, when the US starts running big budget deficits as well, can we really expect the rest of the world to finance $1 Trillion a year in combined Trade and Federal Deficits? The dollar is still 30% over-valued and after falling 20% against the Euro, we are setting new record Trade Deficits. Since the US has virtually no savings, if foreigners don’t finance our deficits the Fed will have to “run the printing press”. The US has had the enviable position of having the world’s reserve currency. Today, the paper dollar is used to settle international accounts. Year’s ago, gold was real money. Over 70% of Foreign Central Bank Reserves are now in dollar assets. With US Trade and Federal Deficits, and the Fed running the printing press, “if it was your job to keep your country’s precious money reserves safe, how long would you stay in the dollar?” If the Fed can print unlimited amounts of dollars, how long can it stay real money? Is it rational to believe that a strong dollar is a promise that can be kept?
Indeed, if the Fed and US Treasury want to get inflation going, isn’t letting the dollar fall the easiest way to begin? There are a lot of things that one can invest in besides the dollar, such as gold, silver, commodities, real assets and all types of foreign paper currencies. Which of these look to you like “promises that can be kept”?
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