Debt Crisis is upon us

I know some people are skeptical about huge spending cuts outside of Defense, but consider the following.... I have never really posted this before, so I figure it's time. The major problem I see with current budget proposals and projections of all kinds (left, right, middle, and official) is that it's a moving target and future projections don't take into account certain realities... I'm assuming mostly out of hopeful thinking and political positioning. However, in order to understand these realities, you have to have a decent understand certain macroeconomic principles... something I'm afraid most politicians do not have. 

First, and perhaps the most important - INTEREST RATES. The grand-daddy of all scary things, with as much debt as our government is paying interest on today, it's at least somewhat manageable today since we locked interest rates super-low for the past decade or so (one of the benefits of being the reserve world currency). However, there is a limit to how long we can do this before we lose control. Think about it in purely rational terms: Would you buy USA treasuries & bonds if you thought the principal upon expiration would be significantly lower than the original investment date? Essentially, you would be losing money, considering the low interest you are being paid to hold it! That's what the policies of the government are doing, we're depreciating the USD by printing money to pay our bills, but at the same time, we are scaring away foreign USD investors because of this increasing and consistent depreciation policy. It's a self-perpetuating problem, because the more we scare away countries from funding our debt, the more money we must print ourselves to cover our bills, which in turn scares away foreign investors even more, and the problem feeds onto itself!  This is why US national debt is going parabolic in recent years, it's practically a straight line up on a 50 year chart. So realistically, and rationally, how do you think this will end? (serious question)

I'll answer my own question, but I still invite you to think about it. 1 of 2 things MUST happen:

    1) We keep increasing the money printing rate to counteract the decreasing foreign buyers of our debt. This causes the dollar to depreciate even further at a parabolic rate, scaring away even more foreign investors, and eventually causing hyperinflation. Read about Germany circa 1920's or Zimbabwe to appreciate the repercussions of this. It's not good.... at all.

    2) We start easing on the money-printing to attract more foreign investors, but we have so much inflation/USD depreciation already that they will demand much, much higher interest rates. In the case of scenario #2, our interest payments on the national debt will skyrocket, and this is the whole issue. According to Wikipedia, our current spending on interest at super-low interest rates (significantly less than 1%, somewhere around 0.3%) is somewhere around 10%  of total government spending. So if interest rates spike to just 10% (a highly conservative estimate well below what they were in the 70's), this represents at a MINIMUM of 10X-20X more interest cost! IE our entire budget wouldn't even be able to pay just the INTEREST on the national debt anymore. If this doesn't scare the bajesus out of you, nothing will.

The fact is, that countries around the world have been pulling out of the dollar for years now because of our currency policies. It can't be done all at once though, because the sheer amount of money we are talking about is astronomical. It can only be done incrementally over time to avoid an entire world economic meltdown, due to the supply and demand curve. But there are active efforts by developed countries and China to replace the USD as the reserve currency though. This trend is real and accelerating every year. Just google reserve currency replacment to find some of the info.

Next: Baby Boomer retirements:

We are only at the beginning of the 1-2 decade long baby boomer retirement era. It has literally just been getting started in recent years, as baby boomers turn 65-ish. As our retired population grows, our overall government tax revenue declines Substantially. Not only this, but social security paid and medicare/medicaid benefits will continue to rise in coming years for the same reason (ok, this much is understood by most people). If we have a problem balancing the budget today (actually, we're not even remotely close to being able to), think about when the baby boomer retirements keep mounting. Keep in mind this is all happening at the same time we are Parabolically Increasing government expenditures!!! Our deficit is going to continue to get worse and worse at an alarming pace. Current budget proposals really use the most rosy of estimates, and really don't factor this new era into the mix).

BTW, the baby boomer retirement era is another reason why the stock market is going to be in the doldrums over the next decade or 2.  It is well understood that retirees spend a lot less money in retirement compared to when they are employed. This means that less consumption will occur, and corporations will earn less money.... causing a depression together with our debt issues.

There are many other reasons how are deficit will continue to go out of control, but these are probably the most important.

Most Americans I think suffer from the Normalcy Bias when it comes to the economy and the national debt. If you don't know what the normalcy bias is, I invite you to read about it here: http://en.wikipedia.org/wiki/Normalcy_bias -- Basically, we as Americans collectively think that bad things only occur in other countries. We couldn't have an economic collapse, because we're the USA. We're too good for that.  But then when it happens, everyone is blind-sided and most people are completely ill-prepared for it and suffer great losses as a result. 2008 Financial Crisis anyone?  The thing is, the next crisis I think will be much worse than 2008, based on the numbers and the numerous economic issues we have at hand (most of which I haven't even covered in this e-mail), caused by mounting leveraged debt across both public and private sectors.

I've stated on multiple occasions in recent months that we will be FORCED to do drastic budget cuts across the board eventually, even in areas which no one would even *dream* of cutting today. I believe this will happen sometime this decade (but probably sooner rather than later). Now you can get a picture for why I say this. The financial balance sheet of this country is terrible today, but in a small handful of years, it is quite likely to be catastrophic for the reasons I mention above.  This is why I strongly believe that this is the absolute #1 issue in our country today by a wide margin and needs to be dealt with Now. I fear it is already too late, but if it goes unchecked, it will definitely end in a catastrophe (You can quote me on that).

Believe it or not, some people actually do get it.

I highly encourage you to listen to Peter Schiff's web blogs (at least certain ones). Many are more commentarial on market action, but I could point you to some of the best, most informative ones if you want. I think he is an absolutely brilliant economist (actually he is not technically an economist, he just plays one on TV), and *by far* the most knowledgeable about macroeconomics I have ever seen. I would describe him as a "100% non-religious" Tea Partier, even though I've never heard him actually label himself as one. I've seen him debate other economists and financial professionals on numerous occasions and he tears them apart pretty much every time. Sometimes the other person pretty much looks uninformed/foolish by the end of the debate (such as the recent debate with one of the editors of Politifact.com, Jacob Geiger, claiming that Jamie Radtke was "barely true" in that corn/wheat prices were rising because of Federal Reserve policies). http://www.youtube.com/watch?v=FyN9QVB-UhI&feature=channel_video_title 

Peter Schiff is one of the few people on Earth that not only correctly predicted the financial crisis/housing bubble years in advance, he did so with absolute precision that is frankly astounding (8 part 1 hour long series: 1st video is http://www.youtube.com/watch?v=6G3Qefbt0n4). He previously called the tech bubble, and many other events such as the current commodity bubble currently in-the-works. These events are all long-term predictable in the macro-picture as he explains, just using economic principles that most people don't account for (or understand, in the case of politicians). He also wrote a book that explains how an economy works in laymen terms that is really well written. http://www.amazon.com/How-Economy-Grows-Why-Crashes/dp/047052670X --- it basically (indirectly) shows why current fiscal policies of the USA are headed for a total disaster if we don't change it soon.

Prediction for 2011-2012

First off, obviously this market is in full blown rally mode, and my call for a impending market top in October was premature. I underestimated the power of the Federal Reserve in convincing people that everything is going to be all right. This continuous, unbroken 4 month long rally has made even some of the so-called 'perma-bears' start to get optimistic on the economy for 2011. However, as long as the fundamentals of the economy are as bad as they are;  High unemployment, falling home prices, higher costs of living through commodity inflation, overwhelming debt in both private/public sectors, local/state governments on the verge of a meltdown, long lists of foreclosures and shadow inventory in real estate..... then I really don't see much to like in this economy.  The Fed's QE2 is yet another bubble in the making, and I don't think it will take long for it to burst once the underlying economic reality slaps everyone in the face (again).

The result of QE2 and the 4 month long rally is that we are now seeing extreme optimism in the market like I have never seen before.  By most measures, it's even more extreme than it was in October 2007 when the market peaked just before the 2008 Financial crisis. But there's an old saying, originally quoted by John Maynard Keynes:   "The market can remain irrational longer than you can remain solvent".  Now I don't agree with much of Keynes' economic views (a subject for another day), but I give credit where credit is due, and this saying is very true.  We are in rally mode, and even though investor sentiment is sky high right now, it doesn't mean that it can't go higher. But this brings me to my prediction for the next couple of years.

The year 2011 will bring a major market top in the stock market that will form a high that will not be seen in the indices for many years to come.  Our economy is way off balance, and is just teetering on the edge of disaster.  The Fed's QE2 just prolonged the rally temporarily, but it does nothing to solve the underlying issues in the economy.  In fact, the Fed's ongoing intervention (in the form of money-printing) and government stimulus has been slowly making the economy sicker and sicker, while propping up the markets artificially in the short term. The relatively few economists who understand this not only predicted the financial crisis well in advance, but have been calling for the double dip ever since the middle of 2009.  In all likelihood, the market top will form sometime in the 1H of 2011, although 2H 2011 can't be completely ruled out just yet. After this, a new bear market will be born that will last at least 1-2 years and bring us to lows we haven't seen since the early 1990's. I believe there are 2 likely catalysts that will set the start of this new bear market:  1)  Housing prices continue to fall, as they have been starting to trend over the past couple of months. OR 2) State/local government debt crisis heats up to the point where we can't ignore it anymore.  It could be a combination of these 2 things, but's the writing is on the wall... the only question is a matter of when will the bomb drop?

Cash is King.

Market Topping - The Bull's Logic

Bullishness in the market has never been so high since late April of this year.  The Fed has repeatedly come out and assured people that they will intervene with QE2 if necessary and the investor public sees this as a good thing and bids stock prices up.  What's funny is investors are eyeing the weekly jobs report with the following rationale:

• If the jobs report is better than expected, then the economy is recovering and we can be optimistic and buy stocks.
• If the jobs report is worse than expected, then Bernanke will implement QE2 and this will be bullish for stocks and gold.

When the market gets to this level of optimism where nothing can go wrong and no matter what happens, we go higher, that usually is indicative of a top in the market. Also, bullish sentiment is near late April 2010 sentiment, volume continues to be weak, and we are at the top end of our trading channel, and quite near resistance.  All highly suggestive of a top in the market.

We are days if not hours away from a big (probably steep) correction in the market.  We might make one more stab upwards in anticipation of the jobs report, but any rally at this point is a fantastic opportunity to go short.

We are about to enter "minor wave 3" down, and that means the sell-off at the very least must breach the lows of the end of wave 1, approximately 1010 on the S&P 500. In all likelihood, we will at least sell off to 9400 DOW before the end of wave 3.  Of course, it won't be a straight line down, but that is the next big target before we have a significant rally.

Protect your Assets

The S&P 500 has rallied over the past couple of weeks by over 8%, as more and more bulls jump on the bandwagon. Bullish investor sentiment is now closing in on 90% which is quite high and indicative of a short term top. This is just another counter-trend rally in a larger Bear market.  At the beginning of a Bear market, there is typically a significant number of months of heavy resistance to the downside as hope and optimism keep the markets propped up while economic indicators slowly deteriorate. Some people refer to this period as the "Slope of Hope", but once it subsides, the sell-offs can be steep and nasty.

So I think now is an appropriate time to start discussing where one should put your money to keep it safe.  In a deflationary environment, there are not many stocks that will make you money.  But in severe deflation (which I believe we are headed towards), all stocks will be big losers, even some of the best quality dividend paying stocks that are regarded as "safe havens".  Just look at 2008-early 2009 as illustration of this.  There was almost no stock that didn't sell out well into double digit percentages before bottoming in March 9, 2009.  So, what good is a "safe" dividend stock paying 6-8% dividend if it loses 20-40% of its value???

You might be thinking "what about bonds?" at this point.  In a normal environment, bonds would be a logical alternative to stocks, but this is not a normal environment. Debt-ridden businesses and municipalities will make even bonds a risky investment in the coming years.  Municipalities and even entire states will be facing bankruptcy in the coming years as continued high unemployment and high debts wreaks continued havoc on balance sheets. Of course, there will be a very high pressure to bailout the biggest bankruptcies, but why take the risk?

Real Estate is even worse.  As I have posted before (twice), real estate is still over valued and is due for more corrections. Even precious metals like gold & silver sell off in a deflationary spiral.

One word: CASH.  This is the only asset class (other than shorting the stock market) that will survive unscathed in a deflationary spiral where panic sets in.   If you think you can stick it out through the next leg down and keep the "buy and hold" mentality alive, you are wrong. If you thought the March 9 low was ugly, you haven't seen anything yet.  The vast majority of individual investors who "hold" their assets through the sell-offs will eventually panic out near the low points in the market.  It happens in every recession, but this one especially as we will see extreme lows in the market that will shock almost everyone.  There are few people that will have the stomach to weather the storm all the way through, and large fortunes will be lost as a result. Don't be one of them, protect your assets NOW.

Crossroads: Inflation vs Deflation

As time goes by, I get more and more Bearish on the long-term economy.  First, let me tell you what I know for certain:  We are in a depression, and the worst is yet to come. There is really no doubt about this in anyone's mind who has a clue about economics and a record of predicting market trends correctly.  Years from now, when the history books are written, this decade will be referred to as the darkest, deepest depression our country has ever seen, and there is nothing we can do to stop it at this point. The question is really what type of depression we will face.

In one camp, we have the inflationists, with Peter Schiff being one of the most well known. They say (in a nutshell) that the dollar will continue to plummet to farther and farther lows due to money printing and as a result we will see commodities and precious metals soar in price, dramatically raising the cost of living for the United States as unemployment stays high, taxes are raised.  This could very well cause hyperinflation.  However, in this scenario, since our economy is so weak, stocks would underperform inflation as everyone flocks to commodities to keep their net worth from sinking in value.  Ultimately, the United States would be forced to raise interest rates to stave off inflation but this will slow down the economy even further relative to inflationary pressures.

In the opposite camp, we have the deflationists, with Robert Prechter and his Elliot Wave analysis at the forefront of predictions. This scenario, which I regard as significantly more likely, will be caused by the American people pulling back spending with increasingly pessimistic views of the state and future of our country and economy, sending earnings and the stock market in a downward spiral.  Deflation has already started happening in the past few months, but it is only in its beginning stages. Deflation theory at its core says that this must happen in order to de-lever the decades of debt our country and its people have been building up.

In my opinion, both camps are right and it is only a matter of timing.  I do believe that in the next few years, we will experience severe, unrelenting deflation only to eventually lead to high inflation afterwards.

But make no mistake..... no matter how the scenarios play out, it will be ugly. Really, Really, REALLY ugly.  I have been saying that I believe that less than 1% of the american people really have any idea of how severely bad our economy is going to get in the next 5 or so years.  Very few people in our time have experienced the Great Depression, but most of us have heard stories about it.  Banks failing left and right, people losing their entire net worth... unemployment at 25%.  So what can we expect in this decade??  I believe it will be even worse than the Great Depression for reasons which I will outline in future blogs coming soon. I will lay out survival strategies and what you need to do to protect yourself. For now, I will leave you with one thought until next post. Whatever you believe or don't believe about how bad our economy will get, do NOT, I repeat do NOT underestimate the severity of how bad it can get. It's human nature to do so, as we are all optimists by default but this is not a time to be complacent. Keep these thoughts in the back of your mind, and I'll post back soon with some specific predictions, thoughts, and strategies.

Chris

How to fix a debt crisis? Issue more debt of course!

This article comes a bit late, but I think this topic is important enough that it needs to be stated.  About a month ago, the European debt crisis which started in Greece started spreading to other countries in Europe, sparking a global sell-off in equities.  This is hardly surprising for anyone who understands economics, but what is unbelievable is what happened next.  A 1 Trillion dollar bailout package.  Wow.  Right when I thought government idiocy couldn't stoop any lower, they prove me wrong.  How do we solve the world's worst debt crisis in history?  Of course, issue more debt!  What's even more surprising is that many people are actually RELIEVED over this news, which shows absolutely NO understanding whatsoever about what caused this whole crisis in the first place.  "Kicking the can down the road" not only does not solve the problem, but it makes it worse. We have just entered the beginning stages of a worldwide sovereign debt crisis which will eventually spread to the United States, and it's going to get ugly. 


On Friday, we got a jobs report that was absolutely abysmal.  Although 430,000 jobs were created, almost all of those jobs were for the Census 2010 program!  In other words, the jobs are non-productive and they do not grow the economy like private sector jobs that produce goods and services that people actually want to consume.  This is just the latest indicator on how unhealthy this economy really is.  Many years of over-consumption for the US consumer is now going to be followed by another period of deflation, where consumers pull back and save money in the face of another down-turn in US housing prices which has just begun.


What all of this means for the stock market is a double-dip recession. The "recovery" that we experienced over the past year was not a real recovery, it was a result of stimulus programs, inflation, and relentless printing of money.  None of which actually improve the economy, but they do create the "appearance" of an improved economy.


The next 6-12 months will be ugly as the 2nd leg of the recession (depression) takes hold.  The fundamental problems that caused the recession in the first place (i.e. debt) have never been solved, and now it is time for it all to play out.  Cash is king, folks.  Prepare yourselves for some ugly times.

Double Dip is Imminent

I have been purposely reluctant to be calling for a double dip for the past few months because I was afraid that people would tend to just 'tune me out' and call me a crazy person in the face of a rallying stock market.  I have officially changed my stance as of today, the first day since July 2008 that the market has closed below the S&P 500's 200 day moving average.

The bulls' main argument against another deep correction is that earnings are very good.  This is of course a short-sited argument, but very typical nonetheless. Fundamentals always look good at the peak in a market. That's WHY it's the peak in the market.  With the entire global economy in debt-ridden turmoil, future U.S. company earnings are bound to be seriously impacted, and the stock market is now anticipating this.     But the United States debt is one of the worst in the world... do we really expect to come out of this unscathed?  Furthermore, the fear that this correction brings on will snowball to the downside.  As is typical in every market cycle, the markets will overcorrect and stocks will get extremely cheap.  A deflationary period is imminent which will cause a double dip recession. I expect 5000 on the DOW.

Prepare yourselves for a wild ride. It gets ugly from here on out.