Last Sunday, in Long
Beach, California, the impossible happened…it rained for the second consecutive
weekend. Just ask anyone who lives here. That never happens.
We’re not complaining.
Without the wet weather we would have never discovered the hole in the bottom
of our shoe. Nevertheless, we bring this up to make the point that the
seemingly impossible happens all the time.
Last August, for
instance, something absolutely ridiculous occurred…during the summer twilight
the world was preparing for mass inflation and mass deflation in tandem.
This manifested for everyone to see when, in broad daylight, $1,820 per ounce
gold and 1.98 percent 10 Year Treasury yields came into existence
simultaneously. If we hadn’t witnessed this extreme and illogical price
disparity with our own two eyes we’d say it was impossible. Yet it
happened all the same.
By all accounts, what the
world learned last summer was what happens when the Fed borrows vast quantities
of money into existence and uses it to buy government debt. For a time,
gold prices go up and bond yields go down. But what happens after such
devious money games are played is what has yet to be discovered.
Perhaps, we will soon
find out.
So far this year stocks
have been going up nearly as fast as gas prices. Year to date the S&P
500’s up over 12 percent. Gold, on the other hand, has sagged to the mid
$1,600s.
More ominously, on March
19th, yields on 10 Year Treasuries jumped above 2.37 percent. Could this
be a signal the great government debt bubble, which has been continuously
puffing up over the last 30-years, is coming to an end?
INSIGHTFUL
INSTRUCTION FROM JAPAN
Obviously, the Fed is
determined to prevent this from happening. They’ve promised to keep the
federal funds rate near zero until late 2014. Still, despite their ardent
resolve, they may not be successful…particularly if the economy improves.
After years of heavy
handed market intervention by the Fed, a perverse paradox has taken
place.
The Fed wants low
interest rates to boost the economy. Yet an improving economy entices
money to exit treasuries and chase higher returns in higher risk assets like
stocks. If money flows out of government debt too rapidly, treasury investors
may panic and dump their holdings causing yields to spike upward while
depressing the economy.
In this respect, the
sweet spot for the economy is growth ranging from 1-to-2 percent and a flat
stock market. Anything less and the Fed will have to print money to keep
debt deflation from taking over. Anything more and treasury markets could
destabilize.
But before things really
get out of hand in the United States we suspect there will be some insightful instruction
offered up by Japan.
If you didn’t know it,
Japan’s public debt is 200 percent of GDP. By comparison, that’s double
that of the United States. Different than the United States, however,
Japan has financed its debt domestically.
The way Japan has been
able to get by without borrowing from foreigners is through its positive trade
balance. By exporting more than they import Japan’s population could use
their proceeds to support their government’s budget gaps. But those days
may have come to an end.
JAPAN
WILL TAKE THE WORLD’S BREATH AWAY
Years ago, when New Deal
policies rocketed U.S. government debt into the stratosphere, the FDR brain
trust came together to dismiss the concern. At the center of the brain
trust was John Maynard Keynes, the grandfather of public spending.
Together they came up with a new theory of public debt so indifferent, and
cavalier, it excused the politicians in power and dumbfounded the opposition.
In a 1958 speech, the
late William F. Buckley Jr. recounts the saga:
“Depicting the intoxicating political consequences of Lord Keynes’s discovery, the wry cartoonist of the Washington Times Herald drew a memorable picture. In the center, sitting on a throne in front of a maypole, was a jubilant FDR, cigarette tilted up almost vertically, a grin on his face that stretched from ear to ear. Dancing about him in a circle, hands clasped together, their faces glowing with ecstasy, the braintrusters, vested in academic robes, sang the magical incantation, the great discovery of Lord Keynes: ‘WE OWE IT TO OURSELVES.’
“With five talismanic words, the planners had disposed of the problem of deficit spending. Anyone thenceforward who worried about an increase in the national debt was just plain ignorant of the central insight of modern economics: What do we care how much we ~ the government ~ owe so long as we owe it to ourselves? On with the spending.”
Here at the Economic
Prism, like Buckley, we take issue with Keynes’ insight. But, at the
moment, that’s beside the point. For the point is, unlike the United
States, Japan has owed their massive debt to themselves.
But, alas, that may now
be changing…
In 2011, Japan ran a
trade deficit for the first time since 1980. What’s more, in January,
Japan ran a trade deficit of $5.4 billion, its largest monthly trade deficit
ever. If this keeps up Japan will have to turn to foreign investors to
finance their government debt. That means Japan will no longer owe it to
themselves.
Moreover, at a debt to
GDP level of 200 percent, who in their right mind will buy Japan’s government
debt…especially when their 10 year bond’s yielding just 1 percent?
No doubt, when push comes
to shove, we fully expect the Bank of Japan will monetize the debt.
What come after will take
the world’s breath away.
JAPAN WILL TAKE THE WORLD’S BREATH AWAY
PART 2
The National Bureau of
Economic Research marks June 2009 as the end of the Great Recession.
That means the United
States economy has been in recovery for nearly three years.
Semantically this is
accurate…all the stimulus and monetary easing has successfully pushed GDP into
positive over this time. But just what type of recovery is this?
According to the
latest CNBC All-American Survey, 36
percent of the American public believes the economy will improve over the next
year. Apparently, this is a 9 percent increase over the survey results
from November 2011.
Yet, despite the marked
improvement, what this means is, 64 percent of Americans still believe the
economy will not improve over the next year.
Clearly, the populace has
become aware that something has gone seriously wrong with the economy.
Across the republic,
people are coming to grips with the fact that it’s not possible for an economy
to borrow and spend its way to prosperity indefinitely. Eventually the
debts must be reckoned ~ either by default or inflation.
Earlier this week
we scribbled some thoughts on
the current pickle Japan finds itself in; namely, a debt to GDP level of 200
percent, its first annual trade deficit in over 30-years, and the likely
propensity to cover the budget gap through debt monetization.
Several reader comments
requested a part 2, specifically detailing what they should do to prepare for
the looming crisis. While we don’t have the answers, we do have some
anecdotes and we are glad to offer them.
To begin, the approaching
Japanese debt crackup will be a warm up for the subsequent U.S. debt
crackup. In fact, for a time, as Japan blows up, the U.S. may appear to
be in good shape.
When investors exit
Japanese government debt it’s likely that some will enter U.S. government
debt. This will push treasury yields down…giving the U.S. government a
little more rope to hang itself with.
Nonetheless, the U.S.
will eventually have its turn in the barrel. At some point, foreign
creditors will exit their treasury holdings and the Federal Reserve will be
forced to print money to paper over the government’s budget shortfall.
This will be the ultimate conclusion to the dollar standard era.
During periods of rapid
currency debasement, tangible assets, like gold, silver, oil, and farmland, are
proven vehicles for wealth preservation. No doubt, those with the means
to do so should consider diversifying some of their savings into established
inflation hedges.
But for the rest of us
working stiffs struggling to make ends meet ~ aside from purchasing food
storage, stocking up on gravity flow water filtration systems, and planting a
vegetable garden ~ the best thing to do is to try to stay out of the way.
In a moment, we’ll provide
some practical ideas, including a 12-point plan that anyone can follow to do
so. But first some thoughts on what to expect, garnered from experiences visiting
in-laws in Mexico City:
HOW
GOVERNMENTS IMPOVERISH THEIR CITIZENRY
Mexico City, if you’ve never
been, is quite a sight. It’s more than double the population of Los
Angeles. What’s more, the pace of activity makes Los Angeles feel sleepy
and southern California’s Highway system seem, calm, organized, and sound.
The juxtaposition of
pre-colonial ruins, Medieval Spanish architecture, and modern skyscrapers is
extraordinarily fascinating. But for us, with each visit, what we find
fascinating is the ever present instruction of what happens when overzealous governments
overspend then inflate their currency to pay their debts.
So, too, we find ominous
warnings of what may come for the United States because of the government’s
financial imprudence.
Like the United States,
Mexico’s economy experienced robust growth during the mid-part of the 20th
century. The period from 1930 to 1970 was later called the “Mexican
Miracle” by economic historians for this reason.
Mexico’s GDP increased
4.2 percent between 1929 and 1945 and then it accelerated to 6.5 percent
between 1945 and 1972. Even during the inflationary 1970s, Mexico’s
abundance of oil and other resources helped sustain a 5.5 percent GDP between
1972 and 1981.
But the high water mark
for Mexico, culminating with the 1968 Olympics in Mexico City, had already
surged, and the flow of wealth had begun to recede, so that by the late 1970s
living conditions were second rate for the broad population.
What went wrong?
During the 1970s, the
successive administrations of Luis Echeverría Álvarez and José López Portillo,
dramatically expanded the Country’s social development policies. In other
words, they increased public spending and financed the spending with debt.
During this period,
Mexico’s external debt soared over 300 percent from $6 billion in 1970 to $20
billion in 1976.
The effect was many
violent devaluations of the peso, from 12.50 pesos per dollar in 1954 to 20
pesos per dollar in late 1976, which devastated the middle class. In
1981-1982 oil prices crashed on the international market just as interest rates
spiked. After that, the government really made a mess of things.
In 1982, President López
Portillo, just before ending his administration, suspended payments of foreign
debt, devalued the peso and nationalized the banking system, along with many
other industries that were severely affected by the crisis. Any hope for
a quick return to economic progress vanished.
But ten years later it
looked like Mexico had finally turned a corner. After 12-years of
economic malaise, it appeared Mexico was primed for an economic boom.
NAFTA had been approved
and everyone just knew that Mexico was going to be the next big thing.
The world took note and foreign investment flooded into the country inflating
the value of the peso.
The administration of
then President Carlos Salinas de Goratri couldn’t believe their good
fortune. Like any good government…they spent their bonanza ~ and then
they spent some more. By the end of 1994 Mexico was running a deficit
that was 7 percent of GDP and foreign investors had seen enough.
They dumped their
holdings and the peso crashed in spectacular fashion. In the space of one
week the peso fell 44 percent against the dollar. Mexico’s economy
crashed too.
Currencies, both north
and south of the Rio Grande, ain’t what they use to be. Not long ago they
were as reliable as a rooster at dawn; now they’re as crooked as a politician’s
spine. We know this not by reading the history books, nor by hearsay, but
by the honest, verifiable, silver dollar and silver peso we’re holding in our
hands.
The Peace Dollar is a
United States dollar silver coin minted in the 1920s. At the time of its
mint, one coin equaled one dollar and each dollar contained 0.77344 troy ounces
of silver. The 1932 Un Peso is a Mexican silver peso. At the time
of its mint, one coin equaled one peso and each peso contained 0.3856 troy
ounces of silver.
The exchange rate was
really simple. Based on their silver content, two pesos equaled one
dollar. Nowadays, both pesos and dollars are merely paper promissory
notes from the government.
Their value is derived by
their government’s track record of stewardship and the international currency
market’s acceptance of the government’s ability to make payments on their debt.
Today it takes about 13
pesos to buy one dollar. As you can see, until recently, the Mexican
government has been less upright in managing its currency than the United
States has over the last 80 years. But when you use silver as the
measuring stick, the picture changes…
Where it took about $1.29
dollars to buy an ounce of silver in the 1920s, today it takes $31.98 dollars
to buy an ounce of silver. This means silver costs 2,479-percent more in
dollar terms.
In pesos, however, it’s a
downright disgrace. Where it took $2.58 pesos to buy an ounce of silver
in 1932, today it takes $407.75 pesos to buy an ounce of silver.
Astonishingly, silver now costs 15,804-percent more in peso terms.
Here’s the point:
It doesn’t take much time
touring around Mexico City to discover that behind the hustle and bustle, not
only has the government successfully vaporized their currency, they have
successfully vaporized their middle class.
You can actually see its
nonexistence everywhere you look and, if you squint your eyes just right, you
can see the ashes of its prior existence within the cracks of decay.
Mexico is a textbook
lesson on how governments impoverish their citizenry. One day, perhaps
soon, similar consequences of government money mischief will be splattered
across El Norte too.
What to do about it?
HOW
TO SURVIVE THE ECONOMIC CRISIS
Several years ago,
following many reader inquiries, we attempted to offer ~ from the heart ~
practical, discretionary advice on
what to do to survive the economic crisis. At the time, it served our
readers well. For your benefit today, and by reader request, we’ll
revisit it…with some minor updates…
1. Always take what’s yours…plus a little bit more. You’ll undoubtedly need it with Barack Obama in office for another term.2. Never shake hands with your right hand, without first crossing the fingers of your left hand securely behind your back.3. Always look out for No. 1, save stepping in No. 2.4. Never give a beggar your pocket change, except when to do so is to buy them a drink.5. Know the difference between honesty with yourself and honesty with others. The former must be rigorous; the later must be flexible…especially when applying for insurance.6. Never kick a man when he is down; so too, never hasten to help him up.7. Always stiff your waitress…barring the rare occasion they actually earn the tip.8. Never con widows and orphans; all others are fair game.9. Do not worry about money; what you don’t have should be of little concern.10. Never forget that there’s a fool on every corner and a sucker born every minute. Avoid being one of them when at all possible; for it is both demoralizing and expensive.11. Do not take it personal when you lose your job…this economy stinks; a lot of other good people will have lost theirs too.12. Remember always that this too shall pass; though never fast enough. So keep your head up. For even during a depression the birds still sing, the flowers still bloom, and those of sound mind and body get through it a little wiser…if not a lot slimmer.
Thanks for reading.
MN
Gordon (send him email)
is the editor of the Economic Prism. Visit Economic Prism. The Economic Prism is published by Direct Expressions
LLC. Subscribe Today to the Economic Prism E-Newsletter at http://www.economicprismletter.com
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