America Runs on Debt
We have in America, a Debt Based Money System where all money is debt. We don't print money, we borrow it. It is created in a ledger at banks on their books with a keystroke.
Because all money is debt and debt has interest attached to it, the debt will continue to grow and grow until we stop this insane game of borrowing into perpetuity.
There are 2 major scenarios we are contending with how this will all end:
1. A "You can lead a horse to water but you can't make him drink" scenario
2. The only commercial activity left becomes "speculation" scenario.
In scenario 1.: You can make interest rates ZERO, but you can't make them borrow. Borrowing slows and as a whole, the nation begins to pay down or default on its debt. Most of the debts that get paid down will be paid down via default. But the overall debt goes down. This would give us a deflationary depression, like what happened in the US in the 1930's. Money would be scarce as dollars would be in great demand to be had to help pay debts.
In essence, in this scenario, the dollar becomes strong, but stocks fall, unemployment soars and bankruptcies soar. Likely, commodities, like gold, silver and oil, would fall in price too during the time of the deflationary depression. It would probably last a few years depending on how extreme the fall..the greater the fall, the shorter it would last. But it would at least bottom and we could rebuild from there.
* Also if banks did not have credit available, then few new loans would be made as well leading to this scenario.
There are many who have been suggesting this scenario is right around the corner for some time now and I have been watchful for this to ultimately play out. But as of yet, this has not been the case.
In scenario 2. The borrowing continues and the debt keeps growing. Interest rates are low and credit is made easily available. This makes it tempting to borrow money to speculates say on Gold, Real Estate or even Stocks.
Inflation is higher than the rates of return being provided at savings accounts. Dollars are plentiful and credit is easily had. There is little hope in saving dollars to preserve wealth and thus, everyone has to become a speculator to try to salvage what's left of their savings. In the end, this would lead to a hyperinflation as the monetary instruments soar while the physical economy continues breaking down. Debt soars, but physical output in goods and services falls resulting ultimately in a hyperinflation where as nobody wants to hold dollars and at some point, no one wants to accept dollars for payment. That's when its game over for the dollar, a paper currency backed by faith.
It all comes down to policy. Policy of Banks and policy of Government.
What is being tried
What is being tried is to find the perfect balance between growing the debt just enough to avoid an avalanche of defaults. (no different than Bernie Madoff trying to find just enough new investors to continue to pay off the old investors) At the same time, to keep inflation from running out of control.
This is obviously risky and makes our economy very fragile still yet.
I have developed a Three Prong Approach to dealing with the risks we face to both our standards of living and our financial well being.
Let's first talk about the Debt as this is what is crucial in at least better "guessing" at what the likely outcome is to be with respect to a Scenario 1 or a Scenario 2.
The total amount of money owed as of March 31st, 2011 is $52.603 Trillion. This debt base includes everything from household debt like mortgages, credit cards, car loans and student loans to business debt, to state and federal debt to financial instutitions debt. Add it all up and it's $52.603 Trillion.
If this "overall debt" were to begin to contract, like it did in 2009, we would be in a situation where we would get what would be called a "deflationary depression."
In a deflationary depression, dollars would be in great demand and assets would fall in price as households, businesses and financial institutions begin to sell off assets to attempt to pay down debt and deleverage their balance sheets. The overall economy would slow too resulting in more job losses.
Sounds bad, but it's like a forest burning down. It's healthy part of the normal cycles of the universe.
In the worst case scenario, the entire financial system would freeze up and might even collapse. If it were to happen like that, it would be nothing abnormal but rather just part of the cycle of money and civilization. Just like the cycle of forests that burn and come back to become vibrant again.
Rather than allow "nature" to run its course and for all the debt to be ridden with in 2010 and 2011, the Federal Gov't and the Fedeal Reserve stepped up efforts to lend and spend.
Why did the Federal Gov't borrow so much money?
It did so, I believe, to make up for the lack of borrowing from the Household and Business sectors.
Remember, when the borrowing stops to slows, we'll get a deflationary depression.
Here is a chart of the Federal Reserves Balance Asset Base:
The Federal Reserve has been a huge buyer of US Treasuries over the last 2 years now. They had to be because there is not enough money out there to buy US Treasuries, especially when the interest rates on those treasuries are so low. The current yeild on a 10 year Treasury bond is 2.62%. For most of the things we want to save and invest for, like college or retirement expenses like food, energy and medical care, that is a negative real rate of return.
The Federal Reserve bank has no problem buying bonds that yield so low an interest rate, because the money they lend to the US doesn't cost them anything, so the interest is free money to them. That's at least how I see it.
Now lets look at a chart of Consumer Debt, which includes student loans, car loans and credit card loans:
Here is a chart of Mortage Debt:
Consumer debt was going down but is starting to rise again. But Mortgage debt continues to contract. The Gov't basically bribed Americans with an $8000 tax credit to buy their first home. Many did, but it still wasn't enough to get morgage debt growth, which is what banks want. (More Madoff investors to pay off the old investors.)
The job market, relating to the physical economy, remains under great stress. Less jobs = less tax reveune and it also = less money available to be spent. In also means less people being productive in the physical economy.
In order to keep consumers spending, again, all part of the ponzi that is our economy that runs under this debt based money system, the Gov't needed to get as many dollars in their pockets.
Here is a 10 year Chart of Total Wages from income earners in the US. You will notice incomes dipped as jobs dipped. This helped lead to a stock market crash and a major chance for a deflationary depression.
The Deflationary depression was held off by the Fed and their Quantitaive Easing or Money Printing as many refer to it as.
The Federal Gov't spent heavily. Much of the spending went toward what are called "Transfer Reciepts" which are social welfare benefits like social security, medicare, food stamps and emergency unemployement benefits.
Here is a Chart of Transfer Reciepts:
So while Income from working went down $400 billion from 2008-2009, Transfer payments went up $400 billion from 2008 - 2009. That helped keep the debt payments serviced too.
There are a lot of gimmicks that have been "tried" over these past 3 years now to keep our economy flowing while we have this monster debt over our shoulders.
- Historically low corporate tax revenues as a % of total corporate profits would be another example.
- Historically low interest rates to help keep debt service payments down
- Unpresedented actions from the Fedeal Reserve bank to stave off big bank collapses.
This has allowed for corporations to make record overall profits and has helped the stock markets in Europe and the US recover from 2009. It has also allowed for no more big bank failures to occur. For bonds to continue to be rolled over and for their interest rates to remain low.
I don't know if this gig is up with this recent Credit Downgrade or if it will continue on for a few more years even . But at some point, it's either we go the rout of Germany 1919-1923 or the United States 1930 - 1933.
Regardless, living standards fell and will likely fall again. Middle Classes were nearly wiped out and will likely see a major wipe out again.
There is no easy way to invest in this environment with so much Gov't intervention and more so, Central Bank intervention. This 3 prong approach however is what I believe to be our best hedges against the financial mismangement of our Government:
Prong 1: Become "Household Engineers." Learn to be more productive and efficient at running your life, your household and your business. This will help preseve and even grow your standard of living even while your purchasing power of your income goes down, or your income goes down due to loss of work. This includes investing in tools and technology to help you be more productive and efficient. I will expand on these ideas in a follow up.
Prong 2: We have got to be diversifed in assets in Asia. I believe the wealth of the world has been and continues to shift from the West to the East. The West, America and Europe, are basket cases in debt and the political will is proving again and again hopeless.
Prong 3: Gold and more so, Silver, should prove to be a better store of value than dollars in the long run and should be a part of your estate. Preferably in physical posession but can be had in your investment accounts through funds.
Disclosure: This newsletter is not a means to solicit any of the securities mentioned nor does it recommend it for any person before they speak with a licensed professional investment advisor for their own suitability. Investing in Equities bears risk of capital loss. This newsletter is strictly the opinion of Jason Tillberg, President and founder of Tillberg Capital Management, Inc. and shall not be held responsible for investment loss from this newsletter.
August 6, 2011
By Jason Tillberg
