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.