In spite of my retracting my prediction for a reversal, the market dropped last week. Not to worry, Bernanke and friends are now committed to buy $7 billion to $9 billion of bonds and other Important Stuff every business day for the rest of the year, indeed until April or so. The markets will recover soon and continue upwards for the rest of the year.
Bond interest rates in Ireland, Portugal, and Greece continue to raise until they hit the threshold of the European Central Bank. The ECB wants to keep alive the fantasy that these governments can continue to sell debt to investors, so when the rates get too high they step in and buy some bonds to lower interest rates for a time. This week they stepped in again, and rates stopped rising and actually dropped a small amount. We're pretty much guaranteed that next spring when the PIIGS need to sell more bonds to finance their governments for 2011, the ECB will be their only significant buyer. Europe is setting themselves up for a major currency crisis in 2012 or 2013.
Who else is in trouble? Japan is on the brink. For the last 20 years Japan has been running huge deficits, funded by their citizen's 15% savings rate. However, as the Japanese population ages, the savings rate has dropped, recently hitting 2%. In the near future Japan will be forced to fund their deficits by selling bonds on the world market. When this happens, their days of 1% interest are over. And of course the US is right behind Japan. We're already printing $600B to fund our 2011 deficit. Our status as the world's reserve currency and having an economy that accounts for roughly 50% of world personal consumption spending mean we will continue to get passing grades on this bad behavior for a while longer, but this will not continue indefinitely.
Where are we headed? In 1971, Nixon took us completely off the gold standard. Since then we have had what is known as a "fiat currency," meaning the value of the dollar is backed by the "full faith and credit of the United States." Unfortunately, we're starting to be able to see a time coming when the full faith and credit of the United States is worthless. We're living right now in a time when most of the world's major economies - the US, China, Japan, UK, much of Europe - are printing money like mad. This can continue for a time, as the alternative is a complete breakdown of world finances. However, if the world's top three economies - US, China, Japan - keep printing money like this, such a breakdown will come. It seems to me that history makes clear that absent the constraints of a gold standard, politicians will print money until stopped by catastrophe. I'm beginning to see a time, perhaps five to fifteen years in the future, when a world wide currency collapse brings us back to some kind of international gold standard.
Last week the government released employment figures that looked really quite good - so good that people looked around and asked, "Who has all these new jobs?" Turns out the government quietly changed their "seasonal adjustment" last month without telling anyone, so the number of new jobs is 100,000 higher than their data can support. This is why men don't ask for directions: we know that about a quarter of everyone works for the government, and the government lies.
California Governor Arnold Schwarzenegger said on Thursday he will call a special session of the state legislature on December 6 to tackle the budget deficit, newly estimated at more than $25 billion through the next fiscal year. Schwarzenegger said he would offer a plan including budget cuts, but Assembly Speaker John Perez rebuffed Republican Schwarzenegger and said he prefers to work on budget matters with incoming Governor Jerry "Moonbeam" Brown, a fellow Democrat who takes office in January.
Republicans will take over the house next January when the new members are sworn and seated. What will they do? Ron Paul, a famous libertarian, will most likely become chairman of the House Subcommittee for Domestic Monetary Policy. Up until now this subcommittee has mostly been concerned with commemorative coins and whether or not to eliminate the penny. Ron has been a proponent for years of requiring audits of the Fed, and eventually eliminating the Fed entirely. We may safely expect that the heat on Bernanke will increase dramatically, and audits may well be in his future. Imagine - the Federal Reserve Bank, an independent organization collectively owned by US banks which is running up several trillions of dollars in debts, may be required to stand to similar accounting transparency rules as every other company in the US. If the banks are required to reveal the details of what their little cartel is doing, this may be the end of Life As We Know It. Or not.
There is a lot of talk about republicans refusing to raise the debt ceiling, which would more or less throw the US into bankruptcy. I find this talk confusing - the playbook for this little game was established 15 years ago by Newt and Bill: the republicans refuse to raise the ceiling, Obama takes money from federal pension funds for a couple months to fund the government, then he has a press conference where he says "Well, the pension funds are out of money now. If the republicans don't raise the ceiling in the next 10 days, I will be forced to stop sending out Social Security checks." Then the republicans cave in. Republicans refusing to raise the debt ceiling is like your local high school football team calling out the Green Bay Packers: if they're lucky, they'll just be brushed off and embarrassed.
Some months ago Obama created a deficit reduction commission chaired by Clinton's Chief of Staff Erskine Bowles and retired Wyoming Senator Alan Simpson. They have released a preliminary report; the final report is due on December 1st. The report calls for a complete rebuild of our tax code, removing many deductions including the home mortgage deduction and lowering tax rates. It calls for severe cutbacks in military spending (the US currently spends nearly half of the world's total defense money, leading to an excellent question, "Are we preparing to fight the entire world?"), raising the retirement age to 69, reduce benefits for wealthier people, and expanding Obamacare's medicare cost reductions. Overall the plan cuts spending for $2 for each $1 of new tax revenue.
A quick glance at the Federal budget makes it clear that any deficit reduction program will have to include medicare, military, welfare and taxes; there's simply no other way. "Itís time to lay it out on the table and let the American people start to chew on it," said Simpson. Pelosi immediately called it "Simply unacceptable," so you know it has to be pretty good. Niall Ferguson, a Harvard economist who specializes in government economic collapse, says that historically entitlements are never cut - first comes capital controls, tax increases, bond value reductions, inflation, and even bond default. My take: it's a thoughtful and intelligent plan that has a pretty decent chance of working - but it's going to get voted on by Washington, so don't get your hopes up. The house isn't on fire yet, so there's certainly no reason to buy fire insurance or an extinguisher. And pay no attention to those guests smoking in bed.
Republicans are making a lot of noise about a balanced budget amendment. Of course this goes nowhere in the next two years. I see this as a marketing campaign, setting up the issue for 2012. Like many Americans, I would be strongly in favor of a balanced budget amendment. If one were to pass, here's what we would most likely see: 1) massive layoffs of federal employees; 2) massive cutbacks in defense spending, much like the Clinton era; 3) raising the contribution rates for Social Security and Medicare, and raising the retirement age further; 4) a strong push for a Value Added Tax, a national sales tax which would likely start at something benign like 5%, but which the history of Europe shows would quickly zoom to 20%. When Clinton was president, he balanced the budget mostly with cutbacks on the military. Since then interest on the National Debt has doubled, and so have social security and medicare pay outs. Military cutbacks will be a big part of this next time, but not nearly enough. Who's against a balanced budget amendment? Career politicians, government union employees, the Military-Industrial complex, Big Pharma, medical insurance companies. In short, all my least favorite people.