Agora Financial’s Rude Awakening

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Laguna Beach, California

• How 180 million miles of deficit dollars really stacks up,
• Will the fed’s monetary “Hail Mary” pay off?
• A tale of fiscal irresponsibility, from Bush to Obama, and much more…

Eric Fry, reporting from Laguna Beach, California…

Nearly three years ago, the man who signs your California’s editor’s paychecks, scribbled some words of nearly equal importance. In the August 15, 2006 edition of the Daily Reckoning, Bill Bonner wrote:

“Every public spectacle is amusing in its own way. But all have the same basic theatrical elements – each begins with legerdemain or an outright lie; it progresses into a farce and ends in disaster. The founding lies of the Fed are – that a bank can create money out of thin air, that experts who can’t tell you whether oil is going up or down tomorrow can nevertheless manage an entire economy and that a committee of bureaucrats can cobble together a short-term lending rate better than the market itself.

“This same Fed has now turned the world economy into a financial circus; accountants juggle the books, deficits soar through the air like trapeze artists, the animals in the trading pits roar, the magicians try to convince the rubes that they can’t believe the evidence of their own eyes, and the clowns at the Fed pretend that they know what they are doing.

“The dollar is now so elastic, people think that the budget can be stretched like lycra tights on a fat woman and yet somehow it will snap right back into place. They believe they can spend, spend, spend and daddy will never take the T-bird away.

“In the last 9 years, $40 trillion worth of new financial commitments has been added to Social Security and Medicare alone, USA Today tells us.

“Who is supposed to make them good?

“It is as if a man were to go into a restaurant, order a bottle of champagne, enjoy a nice meal…and when the bill comes around, say: ‘My wife had a son last week, save this for him. Just let the interest build up until he’s ready to begin paying it off.’”

In 2006, Bonner’s remarks would have elicited as many chuckles as “Amens!”; Today, these identical remarks elicit sorrow and anger and citizenship applications for Turks and Caicos.

The runaway budget deficits of 2006 have broken into a full gallop in 2009. And as these deficits gallop into the tens of trillions, most of us Americans are just trying to avoid getting trampled. What happens next, we wonder? How do we protect our financial well being?

In keeping with tradition here at the Rude Awakening, we will refrain from answering the questions we pose. Frankly, we have no idea what happens next, nor exactly how to protect our financial well being. But we do have a couple of guesses that might help. Our first guess is that the credit crisis is far from over…very, very far from over. (We’ll examine this topic up close next week). Our second guess is that private capital is neither able nor willing to provide the funding necessary to finance government deficits AND to counteract the global forces of de-leveraging. Which means that our third guess is that governments will try to accomplish what private capital fails to do. Governments will try to provide the dollars and/or loans necessary to repel the onset of recession/depression. How will governments accomplish this task? The way they always have: by reaching up into the air and pulling down dollar bills.

In other words, governments of the world, beginning with our government right here at home, will try to “inflate their way” out of crisis. This monetary “Hail Mary” might work. Averting a deep recession is certainly possible. But here’s the rub: Monetary “Hail Marys” don’t revive economic activity nearly as well as they revive inflation.

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The $1.8 Trillion Question
By Eric J. Fry

What comes after a trillion? Inflation…and lots of it.

Just about one year ago, in the May 8, 2008 edition of the Rude Awakening, your editors asked, “What comes after a trillion?” Today we know the answer: two trillion…and then three…and then four. But in May of 2008, the answer was not as obvious as it is today. And so we wondered aloud, “How much is one trillion anyway?”

We answered the question from a variety of perspectives. For example: “One trillion seconds equals 31,546 years. One trillion dollar bills placed end to end would reach 96.9 million miles, far enough to reach the Sun. The average new car costs $28,400. $1 trillion would buy more than 35 million cars.”

Why did we bother trying to quantify the sum, one trillion? Because just a few weeks earlier, the International Monetary Fund had estimated that the global banking crisis would produce about $1 trillion of losses. Shortly thereafter, then-President George Bush delivered America’s first $3 trillion budget. Suddenly, the kind of arithmetic that required twelve zeros had become an exercise of national importance.

One year later, this exercise has become vastly more important. The IMF has doubled its estimate of banking sector losses to $2 trillion (while many private economists put the number between $3 and $4 trillion). Furthermore, the U.S. government of 2009 does not merely count its budget in the trillions of dollars, it counts its budget DEFICITS in the trillions of dollars. According to the latest estimates, President Obama’s very first budget will produce a deficit of $1.8 trillion in 2010. And that’s the OPTIMISTIC guess.

So where’s the shock over this shocking development? Where’s the awe? Where’s the national outrage over the mind-numbing cost of bailing out Wall Street’s self-serving speculators?

There isn’t any. No shock. No awe. No outrage…and the reason is very simple: almost no one gets it…literally. The numbers are simply too large.

“The scale of what President Barack Obama proposes to do to the American economy is so enormous, so far-reaching and so potentially disastrous that the [Republican] party is having a hard time describing it,” writes Byron York, chief political correspondent for the Washington Examiner.

“GOP message mavens are struggling with something that academics call ‘insensitivity to scope,’” York continues. “It affects us all; we can understand something on a small scale but have a difficult time comprehending the same thing on a massive scale. Insensitivity to scope is a major obstacle to understanding the Obama administration’s $3.6 trillion 2010 budget. People simply have trouble understanding a number so big. A recent poll asked Americans how many millions are in a trillion. Twenty-one percent of respondents got the answer right — it’s a million million. Most people thought it was a lot less.”

So that means that four out of five respondents got the answer wrong…and most of them guessed too LOW. No wonder a $2 trillion deficit doesn’t seem like a problem.

“[One GOP pollster] tries to explain it,” York goes on, “by asking people to think of a dollar as a second — one dollar, one brief tick of your watch. A million seconds, the pollster explained, equals eleven days. A billion seconds equals 31 years. And a trillion seconds equals 310 centuries…After a review of the Obama budget’s numbers before formal submission to Congress, Budget Director Peter Orszag said this year’s deficit will be $1.841 trillion — $89 billion more than previously estimated. If you’re listening to the ticks of your watch, that’s about 570 centuries.”

And let’s not forget that the Obama budget assumes the economy will be growing at a 3.5% annual rate by the end of this year. That’s a good number in GOOD times. In bad times, such as we are now enduring, a 3.5% growth rate is nothing short of delusional. So we’d guess that the actual budget deficit is likely to be much larger than the already-large numbers the Obama camp is tossing around.

What does all this mean for investors? Hard to say exactly…but not that hard to say inexactly. A $1.8 trillion funding shortfall is a great big hole to fill. Indeed, it is a hole so large that tax receipts could not possibly fill it. Foreign capital and/or domestic savings could theoretically fill it. But in the real world, that’s not likely – not at meager 3% and 4% rates of interest over ten to thirty years. So the most probable “solution” to the funding shortfall is also the most expedient one: the government will buy bonds from itself.

This ancient remedy to fiscal imprudence used to go by the name of currency debasement. But today this process comports itself with an air of sophistication by wearing the title, “quantitative easing.” Different name; same result: inflation.

The financial markets are picking up the scent already. Ever since March 18, when the Federal Reserve announced its intention to purchase $300 billion of Treasury debt, most financial markets began pricing in an inflationary threat. Gold, commodities and bond yields have been moving higher, while the dollar’s value has been moving lower.

“We are experiencing a deleveraging on a scale in the world that is absolutely breath-taking in its scope,” warns John Mauldin, editor of Outside the Box, “And to balance that, governments are going to have to issue massive amounts of sovereign debt to deal with their deficits. But who will buy it, and at what price? And in which currency? Even though we can see the challenge, it is not clear what the final outcome will be, other than stressful volatility as the market reacts.”

We’re guessing the volatility will be much less stressful for those folks who hold a significant amount of their assets in gold and commodities. And the stress might even morph into pleasure for gold-holders if, as we expect, the governments of the world enthusiastically pursue the stealth larceny of currency debasement. You can dress the debasement process in Harvard B-school jargon, surround it with Federal Reserve White Papers and re-christen it, “quantitative easing.” But after all that, you’ve still got the same old process of currency debasement, which produces the same old results: inflation and loss of purchasing power.

Joel’s Note: In times of such extreme, bipartisan fiscal irresponsibility, you really have to ask yourself just one question: Do I have gold? Well, do ya, punk? (Whether you do or not, here’s five ways to invest in our favorite metal that you might not yet have considered.

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[Rude Endnote: A little green to round out the week for Asian and European markets overnight.

Asia first where Japan’s Nikkei 225 bounced back almost 2% by the close of today’s trading session. Over in Hong Kong, the island’s Hang Seng index gained 1.5% while, Down Under, the Aussie All Ordinaries clawed back 1.3% after some dismal losses earlier in the week.

Over in Europe, most major indexes were headed higher last we checked. London’s FTSE was up about 0.3% while Germany’s DAX and France’s CAC 40 managed to inch higher by 0.2 and 0.5% respectively.

In the commodity pits, crude shifted slightly higher overnight, reclaiming the $58 mark, despite the IEA’s forecast for slower demand over the coming months. Guess traders are paying more attention to the supply side, where arctic credit markets have shelved important exploration and development projects. We’ll see…

Gold lost a couple of bucks overnight, but still holds pretty firm around $924 per ounce. At current levels, history’s most reliable store of wealth sits at less than half its inflation-adjusted high (around $2,300 per ounce, depending on your inflation figures). Makes sub-1k gold look pretty cheap, huh? If you’re so inclined, you can learn about five ways to get your hands on some here.

We’ll be back tomorrow with our usual weekend wrap-up.

Until then…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com