 | | The Daily Reckoning | Tuesday, August 2, 2011 | - Debt ceiling to be raised by $2.1 trillion...we're saved!
- Or not...what taking on more debt means for you, individually,
- Plus, Bill Bonner with more on the eventual, ultimate and unavoidable collapse of empires...
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|  | | | | Debt Ceiling Madness | | Why kicking the can down the road solves absolutely nothing. | | |  | | Bill Bonner | Bill Bonner, reckoning today from Paris, France...
First, we turn to the news. And what do we find? Netscape's Money & Business has this report:
The House on Monday evening passed a bill that would raise the U.S. debt limit by at least $2.1 trillion and cut spending by a similar amount over the next decade. The agreement was reached Sunday night by congressional leaders and President Barack Obama. The Senate is expected to approve it on Tuesday, and it will go to Obama, who has indicated he will sign it. If you read that fast enough, and drink enough whiskey, you might even think the feds have the situation in hand. Cut spending by an amount equal to the debt ceiling hike...hmmm....sounds almost like you come out even.
But wait, these are two very different things. If you would come out even, there would be no need to increase the debt ceiling. Instead, the deal allows both spending and the debt to go up. It will go up $2.1 trillion...and then, they'll raise the debt ceiling again.
And yes, they will 'cut' spending too. From about $45 trillion over the next 10 years...down to $42.9 trillion (we're just estimating...we haven't seen the feds' numbers in any detail). A $2.1 trillion cut.
Analysts for the feds say they need about $4 trillion in cuts in order to keep the situation under control. That would allow the debts and deficits to increase...but at a pace equal to the growth in the economy.
Alas, the poor schmucks have no idea what they are doing. They base their assumptions on growth rates registered BEFORE the Great Correction began. They assume a full recovery, in other words.
It ain't gonna happen...for all the reasons Dear Readers know so well.
...an economy burdened by debt does not grow very fast
...an economy that is in the middle of a debt contraction barely grows at all
...forget adding more cash and credit 'stimulus' -- it doesn't work when an economy is already drenched in debt
...the US economy is also burdened by the cost of maintaining a military empire -- costs that aren't going away
While revenues will not meet expectations, spending will exceed them. Why? Because the softness in the economy will leave more and more people on government support. Already, 59% of the public gets money from the feds. And because spending ALWAYS exceeds expectations...
Even $4 trillion worth of budget cuts would probably not be enough...not by a long shot.
As we told the investment conference in Vancouver, there is something bigger, more important going on. A Great Correction is underway. We wait to find out what it will correct.
...a real estate bubble?
...a bull market in stocks?
...a credit expansion?
...a great empire?
...the rise of the European powers after the invention of the steam engine?
...the outsized gains brought by using cheap oil? We don't know its final destination. All we know is that a Great Correction is underway.
| | | | | | | | | | | | The Daily Reckoning Presents | What Investors Need to Know
About America's Debt Crisis
(Hint: The Ceiling Doesn't Matter!) | | |  | | Chris Mayer | Forget the government nonsense about the U.S. debt ceiling "deal." All the posturing, scolding and cajoling ignored an important point.
The fact is, even with the President's and Congress' agreement to increase the government's borrowing limit, America is still in deep financial trouble. And this reality will affect investors much more than they expect.
Before I explain why, let's get beyond the rhetoric and see what's really going on.
First of all, raising the debt ceiling is not a magic cure-all for America's debt problems. Raising the ceiling just gives the U.S. Treasury permission to borrow more money. It does that by issuing Treasury bonds and notes -- in effect, they take out loans, promising to repay the bondholder the principle plus interest.
Here's the thing, though -- right now, the only way the government can repay its existing debt obligations is to take on more debt!
According to the Bipartisan Policy Center, almost $500 billion in U.S. Treasuries will mature in August 2011. Mature, as in, the government will need to make good on the loans. If it's short by a single dollar, the United States is in default.
Keep in mind, that's $500 billion on top of August's projected $159 billion budget deficit. So the government will need to raise $659 billion, just to keep the lights on during the month of August alone!
To put that in perspective, that's more debt than the entire QE2 debt-buying campaign... in one month... without the Feds as the backdrop to buy the debt.
So if the debt ceiling is raised, one of the top priorities will be to "roll over" its existing debt -- that is, create new debt to pay off old debt. It's sort of like using credit cards to pay your mortgage.
And that's still not the end of it. According to the U.S. Government Accountability Office, just over $3 trillion of debt matures during the next four years. Yet the debt ceiling plan coming out of Washington aims to trim the budget by just two trillion dollars over the next 10 years.
Essentially, no matter what the House, the Senate and the President agreed on, the United States will need to continue borrowing money to pay for the money they've already borrowed.
To roll over so much debt, the United States will need a lot of investors willing to step in and buy that debt. But as more investors worry about America's financial health, they will need more incentive to buy its notes and bonds. Convincing them to take on the risk will require a higher interest rate.
You can see that happening in Europe right now. Despite all the problems in the eurozone, the German economy remains fairly strong. Since it's in such a low-risk position, the yield on a short-term German bond is less than 2%. But in Greece, where a government default seems inevitable, bonds are yielding over 14%. And Greece's 2-year bonds yield more than 30%!
That's one of the reasons there's so much worry about the United States' credit rating. A lower rating means the United States would have to pay higher rates to borrow. As long as the government can keep rolling over debt, the United States will certainly keep its AAA rating. Raising the debt ceiling eliminates the risk of an immediate downgrade... but it won't eliminate the risk of a downgrade in the future.
The Bipartisan Policy Center spells it out: "Treasury will have to pay higher interest rates to attract new buyers... [or] it is possible, if unlikely, that not enough bidders would appear."
As you no doubt noticed, the Bipartisan Policy Center thinks a failed Treasury auction is unlikely. It has a good reason to believe that, too. So far, people have had no trouble buying U.S. debt.
You've no doubt heard the stories -- the Treasury Department reports that China holds $1.2 trillion in notes and bonds. Japan is sitting on $912 billion. Conspiracy theories aside, there's only one reason these countries are holding U.S. debt -- because they think it will pay off. But the debt-ceiling debate is probably creating some anxiety among the biggest traditional buyers of Treasury debt.
As Howard Marks of Oaktree Capital warns, "The world has awakened to the undesirability of ever-growing government debt."
OK, so far this discussion has been fairly abstract. The amounts of money involved just boggle the mind, and the politicians have spent more time talking about "our children's future" or "not mailing Social Security checks" than the day-to-day consequences for you.
Unfortunately, that's exactly why so many investors are going to get blind-sided.
Higher Treasury rates will create a ripple effect, forcing other interest rates up, too. Suddenly, the cost of borrowing money goes higher for everyone, which will encourage more saving than spending.
Say goodbye to the recovery!
Then there's the U.S. dollar to consider. A massive bond sell-off will put it in the tank. As Marks puts it in this situation, "I strongly doubt the dollar can remain the world's reserve currency."
Gold, oil and anything else denominated in U.S. dollars will soar.
Pretty scary stuff. And remember, this can all happen even with an agreement on the debt ceiling. Things are out of the government's hands. We are completely at the mercy of the people holding America's debts. If they stop borrowing, we're sunk.
To be clear, this isn't the fault of any political party -- for decades we've rung up more and more debt regardless of who was in power. And this isn't some crackpot scheme by other countries to bring America down -- a U.S. default or ratings downgrade would be just as disastrous to them as it would be for us. In fact, we'll need their support to keep us afloat!
Understanding what's happening is the first step to protecting yourself. Stay away from the U.S. dollar as much as you can. Consider ways to invest in gold and oil, whether physically or in the form of exchange-traded funds.
Regards,
Chris Mayer,
for The Daily Reckoning
Joel's Note: The debt ceiling debate is but one of the many important nexus points between economics and politics that threatens to drag the US Empire into its final stages of demise. Sound dramatic? Check out the latest report from Addison Wiggin's Apogee Advisory, a research service dedicated to helping you navigate the choppy waters ahead, whether they flow from Washington or Wall Street. Don't be left in the dark. Check out Addison's presentation here.
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| | | | | | And now back to Bill, with more from his Vancouver speech (updated): | | The Great Correction...5 years On, Part III | | More from Bill's Presentation in Vancouver. |  | | Bill Bonner | It is true; Washington is paralyzed, but not in the way the commentators think. They'll get a budget/debt deal done. The trouble is, it will be a joke...just like the deal made in Europe.
The Greek debt deal was essentially another bank bailout. The US deal is another can kicked down the road...to be stumbled over after the next election.
In the end, goes the theory, Americans will come together to get the job done. The US is a winner. "Nobody ever got rich betting against America," chimes Warren Buffett.
But gold is fundamentally a bet against America. It's a bet that, over the long run, America's experiment with a pure paper money system will not work...and that no matter how smart or innovative its central bankers and authorities are...they will not be able to hold the system together any better than any other geniuses throughout history.
The Romans tried central financial planning too. Under Diocletian they tried to control prices. It didn't work. Then Richard Nixon tried the same thing in the '70s. It didn't work either. But the US leadership still clings to the idea that it can control the economy...that by some magic as yet never fully described...it can do what the Romans couldn't do...that there is no destiny involved in a paper money system.
Of course, it should be obvious to everyone by now that the real problem in Europe as well as America is debt. In Europe, government debt is a problem. In America there is government debt plus household debt. Both are problems. America has about as much government debt as France -- about 5 times GDP when you include unfunded pensions and health care costs. But America also has huge household debts.
Generally, Europe can solve its debt problem by cutting government spending. America can't. One reason for this is that Europe only has to worry about social welfare spending, which can be cut fairly easily. A big item of the Italian budget, for example, is chauffeurs for government employees. This kind of silly spending can be cut without too much suffering. And the economy will be better off as a result.
Also, Europe is not facing the same sort of household de-leveraging as America...so there's no private sector slump, dragging the economy down just when government has to cut back too. Cut government spending in the US and the economic slump will worsen -- at least, in the short term.
But the main reason Europe can cut its spending is because it has little choice. The European central bank...and the European authorities...are not in a position to be able to permit runaway spending and debt in their member states. They have no way of forcing the Germans to pay for the Greek's bad debts. So, the Greeks eventually run out of money and have to cut back.
That's the big difference between Europe and the US. In America, the authorities have both the means and will to continue to run up huge debts and debase the currency. And since they can, they will. Or, to put it another way, when the authorities don't have to cut, they won't be able to do so. And the experts will find plenty of reasons why cutting spending (or raising taxes) is not only unnecessary, but undesirable. As the Great Correction intensifies, the demand for US social welfare spending, and counter-cyclical stimulus spending, will increase. Revenues will fall too, leading to bigger budget deficits and more debt. More debt, in turn, depresses growth...leading to a greater demand for bailouts and boondoggles...and so forth.
The other noteworthy difference between Europe and America is that Europe is free from the burden of empire. The US is the world's only empire, and has been ever since the Soviets closed up shop 22 years ago. The Soviets found that the combination of central economic planning and the expense of a military empire were just too much to bear. They gave up.
The US is now conducting war-like operations in at least six different countries. The problem, of course, is that it is ruinously expensive. In all of history no empire has been able to resist the urge to overdo it...to commit suicide -- either by military or financial "overstretch." In America's case, it does both.
The cost of maintaining the empire...fully loaded...is about $1.2 trillion a year. That's the Pentagon, the Department of Homeland Security, fortified embassies -- everything. Take it away, and the US budget is almost in balance.
But Washington won't seriously cut military spending. Why not? It's the way destiny works. First, she disarms you of your critical intelligence. And they she shoots you in the back of the head.
An empire continues until it drops. It does not back up. It does not reconsider its mission -- not until it is forced to. How is it forced to? In the usual way...it runs out of money. And as Doug Casey pointed out, its old, fat, expensive military machine -- zombified like other bureaucracies -- is defeated by newer, better, cheaper technology and a leaner, more efficient military rival. At some point in the future, for example, I wouldn't be at all surprised to see the US navy's billion dollar battleships sunk off the coast of Vietnam by cheap Chinese missiles.
But let's go back and look at the situation of the typical American household. This is a subject that hasn't gotten enough attention, in my view. The average middle and lower-middle class family is in a very bad situation. Almost an unbelievably bad situation. Hourly wages for a middle class worker topped out 40 years ago. This is important...so remember...real wages hit a high in the US in 1971. Since then, the average guy has had no wage increase. So, he put his wife to work. And when that source of revenue was squeezed out, he and his wife ran up debt...so they could increase their standards of living even though wages weren't increasing. This is the source of the big problem at the household level in the US today. From a low of 31% of GDP after WWII, private debt rose to about 300% at the top of the credit bubble. You know all about that, so I won't bore you with the details. But at the present rate -- about 5% per year -- it will take a nother 32 years of de-leveraging before debt is down to a more comfortable level.
Since 2000 do you realize how much the US private sector has grown? Hardly at all. Zero.
And how many new jobs have been created? I'll give you a hint. Think of a number with a hole in the middle of it.
And how many more automobiles do we sell in America? In fact, we sell nearly a third less than we did 10 years ago.
And how much more are our stocks worth? Adjusted for inflation...not a penny more.
How about houses? Again, adjust for inflation and the average house is worth less than it was in 2001.
What kind of decade was this? It was a lost decade. And it looks like another 3 decades will be lost -- unless something happens to speed up the process. How? When?
Stay tuned...
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