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Public Debt is Like a Giant Ponzi Scheme

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Bob Chapman
International Forecaster
Feb 24, 2011

Public debt has become a problem worldwide. What is becoming more and more evident is that it is unsustainable and simply unpayable. It could be compared to a giant Ponzi scheme. We see no meaningful debt reductions thus, government will have to raise taxes, which will further suppress the economy, or people and companies will be forced to buy such bonds, or perhaps pension and retirement funds will be seized to continue the game for a while longer.

The whole concept of government debt in the US, whether it’s federal, state, municipal, corporate or personal stands on very shaky ground. Debt is serviced with revenues and income and when both are falling it is difficult to service. We have begun to enter a period of slowly rising interest rates. In the US the Fed has managed interest rates to be as low as possible to both aid in a recovery and to keep the financial edifice from collapsing. Over the past six months the bench mark 10-year Treasury note yield has risen from a yield of 2.20% to 2.74% and presently stands at about 3.60%. That 1.4% rise in rates has been offset by GDP growth of 3%. The problem is that such GDP growth has been maintained by growth in debt. The two sources of debt are the Fed and government. The Fed has been buying the government debt by creating money out of thin air. That is called monetization and it causes inflation. The government demand comes from revenues that have fallen and continue to fall, and as a result government issues more debt. The lenders, the bond buyers, sell dilution in the value of debt and in the dollar and as a result demand a higher yield. At this stage you can see how important QE1 and 2 and fiscal stimulus have been over the past 2-1/2 years. Had they not been implemented the economic and financial system would have collapsed. The next question to be asked is will we have to have quantitative easing and stimulus indefinitely? The answer is yes, but unfortunately if that path is followed lenders will demand ever-higher interest rates and the dollar will continue to fall in value versus gold and silver and other currencies. We estimate GDP growth to be 2% to 2-1/4% in 2010, down from 3%, all of which were aided by quantitative easing, the creation of money and credit and fiscal stimulus the result of debt. Without these props there would have been little or no growth, and fairly quickly the economy would have faltered. That would have brought about a classical purge accompanied by a deflationary depression. There will soon come a time the creation of money and credit and fiscal stimulus will no longer work and the system will finally fail. That is inevitable. That will begin to happen when interest rates are rising faster than growth rates. Once that condition exists there is no further hope of servicing debt or creating more debt, because there will be no natural buyers and inflation will be raging if not hyperinflation. The US is not the only country staring into this abyss; most countries around the world have the same problem.

As you probably have already figured out such fiscal and monetary policies of many countries cannot continue. The issuance of new debt has to be curtailed, as well as the growth of future liabilities. On its present course the US is headed toward a deficit in excess of 100% of GDP in just 1-1/2 years.

These countries have experienced and most still do, profligate government spending, little fiscal restraint and outright criminal behavior. Such action in time cause markets to put pressure on governments to mend their ways. That is where the higher yields come into play and as we pointed out we are already witnessing that. In 1 to 1-1/2 years the cost of carrying debt will begin to reduce GDP, because government debt demands will crowd out private investment. Except for AAA corporations we have already seen that over the past two years, as lenders retain cash and generally refuse to lend to medium and small companies and individuals as well.

A product of these conditions is a perpetuation of unemployment, which we believe is 22.6% presently, for years into the future. In addition, we have had 20 years of free trade, globalization, offshoring and outsourcing that has lost America 8.5 million good paying jobs and the loss of 42,400 businesses. We have extended unemployment, but every month millions fall off leaving them on their own and food stamps. These transfer payments make up 20% of household income, which is also unsustainable. Our guess is that the current extended benefits will be extended further in spite of a projected $1.6 trillion deficit. Political types prefer an extension to revolution, but the cost is more debt, a falling dollar and rising gold and silver prices. In addition, an end to extended benefits will sap consumption that must be maintained at 70% of GDP in order to keep the economy from failure. Do not forget the US is not the only country with debt problems. In the same league are Greece, Ireland, Portugal, Belgium, Spain, Italy, England and above all Japan, which is more than 200% and growing exponentially. None of these countries are capable of growing out of their debt problems and thus, eventually we see a multilateral default of debt, which will probably entail a 2/3’s write off of debt. A jubilee of sorts.

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If stabilization and growth have to be based on continued creation of money and credit and monetization then the system has to eventually collapse. It is no more a solution than extended unemployment benefits, federal government spending and hiring and food stamps. It throws the problems into the future at a terrible cost. In spite of this largess unemployment won’t improve and the monetary and fiscal effect on the economy will lesson. We call it the law of diminishing returns. Last year we saw 3% growth, or so we are officially told, and this year we believe it will be about 1% less at 2% to 2-1/4%. The effectiveness of the policy is losing momentum and strength. The next question is will a $1.7 trillion QE3 with $850 billion in additional fiscal spending be able to maintain 1% growth. Our answer is we do not think so. This fading monetary and fiscal policy will be accompanied by ever falling government revenues, unless ever more debt is created. Are you getting the feeling that governments are running around in circles with no solution in sight? If you are you are correct. The only answer is to purge the system and the sooner the better. The longer the problems are extended and individuals will be faced with unemployment and under employment and that means borrowing and the use of credit cannot be extended and that means the economy cannot grow. Even if spending cuts and higher taxes were implemented the economic and financial affects would not be felt for 6 months to a year. Government has waited too long.

Projections for the future are very difficult if for no other reason than we do not know where interest rates will be. We assume they will be higher, but how much higher? We just do not know. We can tell you that in 1980 official inflation was 14-3/8% and the long bond yield was over 20%. Will that be repeated, we do not know, but we can say we could see something close to that. If we have hyperinflation we could see 30% inflation. Who knows – we won’t know until we approach getting there. Are we going to look like the German Weimar Republic of the early 1920s or today’s Zimbabwe? We don’t know but it is certainly possible and near the edge of probability.

What really gets our attention is that elitists that control all this really believe they can retain control. If they cannot they figure they will just have another major war, like they always have had. They know what we now. They know deficits are going to further rise precipitously, unless there are major policy changes, spending cuts and higher taxes. Even if the proper steps were taken we are probably looking at 30 or more years of depression. Debt cannot be kept within bounds, just look at what is going on today. The elitists have no intention of radically changing their ways. There will be more of the same until the system ceases to function.

We have written about rising interest rates in the whole spectrum of government and corporate bonds. The average has been 100% to 150%. Official rates have been raised in Brazil, India and China. In the US, bond buyers have already been pricing in yield increases, which they feel are necessary to offset inflation losses. Unfortunately for buyers they have not gotten nearly enough yield to compensate and are losing money on return and currency depreciation versus other currencies, but particularly versus gold and silver. In order to offset real losses, real yields will have to rise and they will. The first stop for the US 10-year note should be a move upward from 3.60% to 4% to 4.25%. That should happen this year. The next move in 2012 should be to 5% to 5.60% and the second move from 5.60% to about 7%. Mind you these are very conservative estimates. Any recovery in housing will be impossible with prices falling another 15% to 20%. Anyone with an ARM will be a dead duck. That means about a 60% plus failure rate. Bumping along the bottom could take 8 to 30 years and as we mentioned before government could end up with most of the housing eventually causing a process of nationalization.

These higher rates, which are inevitable, will raise havoc on the Federal budget and its debt service. Average maturities are 4.5 years – a very foolish move that began some 15 years ago. This means even if taxes are raised and the budget deficit cut, they will only serve as a damper on costs, which would lead to dollar depreciation and default. Worse yet, who will want to buy bonds and in particular US dollar denominated bonds as gold and silver are soaring and profits are falling along with the stock market? The Fed is buying and monetizing at least 80% of treasuries now. That means they will have to buy them all, including some from nations such as China, Japan and Middle Eastern owners. Long-term bond holders will be looking at 30% losses and the stock market 50% plus losses. The monetization process at this point will produce inflation from 14% to 40%, which could well be accompanied by hyperinflation. That hyperinflation could come quickly once inflation passes 14-3/8%, which it officially hit in 1980. At that time 30-year T-bond rates were more than 20%. We do not know exactly what the numbers will be, but we do know they will be terrible. Some time along the way the US will be forced to default and then China will own a goodly part of the US. We also believe that a major world war will be in progress. Again as a diversion from the massive economic and financial problems plus revolutions worldwide, which could short circuit having another world war. We do not know how these events will roll out, but we do know they are probable.

Higher interest rates will cause major problems for banks, private equity funds and hedge funds. The cost of borrowing and using leverage will be prohibitive. Many banks and funds will go under. Defaults will abound and cash flow to bond holders will diminish making outflows greater than inflows. This process of losses will in part mirror what we saw in the early 1930s, not only in reduced value but also in the doubling of gold prices and the increase in gold and silver shares of more than 500%. This also will be accompanied by a complete collapse in living standards.

At this stage we depart from the crowd of economists. We think these conditions will persist for some time. Wall Street and banking will still exist but in an abbreviated form. The stars of Wall Street will be gold and silver shares free to trade freely without government manipulation. Tariffs on goods and services will be erected and money will start to flow to redevelop industry. Savings rates will rise and capital formation will take place. The illegal aliens will be forced to return to their homes and people will start to get on with their lives. The world will go on having been taught a good lesson.

Sources at the United States Embassy in Beijing China have just CONFIRMED to me that the United States of America has tendered to China a written agreement which grants to the People’s Republic of China, an option to exercise Eminent Domain within the USA, as collateral for China’s continued purchase of US Treasury Notes and existing US Currency reserves!

The written agreement was brought to Beijing by Secretary of State Hillary Clinton and was formalized and agreed-to during her recent trip to China.

This means that in the event the US Government defaults on its financial obligations to China, the Communist Government of China would be permitted to physically take inside the USA land, buildings, factories, perhaps even entire cities to satisfy the financial obligations of the US government.

Put simply, the feds have now actually mortgaged the physical land and property of all citizens and businesses in the United States. They have given to a foreign power, their Constitutional power to “take” all of our property, as actual collateral for continued Chinese funding of US deficit spending and the continued carrying of US national debt.

This is an unimaginable betrayal of every man, woman and child in the USA. An outrage worthy of violent overthrow.

I am endeavoring to obtain images or copies of the actual document but in the interim, several different sources both in the US and in China have CONFIRMED this to me.

U.S. livestock prices may reach records in the next two quarters as farmers reduce herds while China imports the most pork since at least 1992 and the largest amount of beef in three years, according to Societe Generale. Lean-hog futures will climb to a record $1.10 a pound in the second quarter and live cattle prices will be at an all-time high of $1.30 a pound by the third quarter, Societe Generale SA said in a report. The bank correctly forecast higher grain prices in May. Chinese imports of pork will gain 5.7 percent in 2011 and beef purchases will advance 43 percent, U.S. Department of Agriculture estimates show.

World food prices rose 28 percent in the past year, reaching a record in January, according to the United Nations. Riots partly linked to food inflation ended Zine el Abidine Ben Ali’s 23-year rule in Tunisia and Hosni Mubarak’s three-decade- long rule in Egypt. Finance ministers from the Group of 20 nations last week signaled concern that surging commodity costs are driving inflationary pressures around the world.

“Meat will start to have an impact on the price index and start to put a pinch on the consumer’s pocketbook,” Jason Britt, president of Central States Commodities Inc., a brokerage in Kansas City, Missouri, said by phone on Feb. 17. Britt correctly forecast a rally in hog prices in 2008.

The unrest in Wisconsin this week over Governor Scott Walker’s plan to cut the bargaining rights and benefits of public workers is spreading to other states.

Already, protests erupted in Ohio this week, where another newly elected Republican governor, John Kasich, has been trying to take away collective bargaining rights from unions. In Tennessee, a law that would abolish collective bargaining rights for teachers passed a state Senate committee this week despite teachers’ loud objections. Indiana is weighing several proposals to weaken unions. Public workers in Pennsylvania, who are not facing an attack on their bargaining rights, said yesterday that they nonetheless planned to wear red next week to show solidarity with the workers in Wisconsin.

In many states, Republicans who came to power in the November elections, often by defeating union-backed Democrats, are taking aim not only at union wages, but at union powers as they face continuing budget gaps in the years ahead.

The images from Wisconsin with its volatile protests, the shutdown of some public services, and an exile by Democratic lawmakers, who fled the state to block a vote evoked the Middle East more than the Midwest.

The parallels raise the question: Is Wisconsin the Tunisia of collective bargaining rights?

A former juvenile court judge was convicted yesterday of racketeering in a case that accused him of sending youth offenders to for-profit detention centers in exchange for millions of dollars in illicit payments from the builder and owner of the lockups. Mark Ciavarella, 61, former Luzerne County judge, left the bench in disgrace two years ago after prosecutors charged him with engineering one of the biggest courtroom frauds in US history by using juvenile delinquents as pawns in a plot to get rich. Federal prosecutors accused Ciavarella and a second judge, Michael Conahan, of taking more than $2 million in bribes from the builder of the PA Child Care and Western PA Child Care detention centers and extorting hundreds of thousands of dollars from the facilities’ co-owner. Ciavarella insisted that the payments were legal and denied that he incarcerated youths for money.

A federal jury in Scranton returned a mixed verdict, convicting Ciavarella of 12 counts, including racketeering and conspiracy, and acquitting him of 27 counts, including extortion.

The Republican-controlled U.S. House voted to cut at least $61 billion in federal spending this year, setting up a battle with Democrats over the budget that threatens a government shutdown.

After more than 90 hours of debate, the House decided 235-189 early today to send the measure to the Senate.

Members adopted a number of changes that will make it harder to reach agreement with the Senate, including a ban on funds for President Barack Obama’s health-care overhaul or for Planned Parenthood, which provides abortions. The measure would block regulations on greenhouse-gas emissions, for-profit colleges and the Federal Communications Commission’s “net neutrality” Internet rules.

Senate Democrats already said they won’t accept the steep cuts in the $1.2 trillion spending bill, and Obama’s budget office has threatened a veto. With Congress out of session next week lawmakers have little time to work out their differences. Current spending authority ends March 4, and without a new plan the government will shut down. House Speaker John Boehner, an Ohio Republican, said this week he won’t accept a short-term extension without some spending reductions. “Read my lips: We’re going to cut spending,” he told reporters.

Legislation being pushed by House Republicans could require many states to disclose larger shortfalls in their pension plans and force them to take more aggressive steps to get their finances in order.

The Public Employee Pension Transparency Act, introduced by Rep. Devin Nunes (R., Calif.) earlier this month, would compel states and municipalities to meet stringent standards for reporting on the finances of employee-pension funds, and would expressly ban any federal bailouts. Opponents view it as another congressional Republican swing at public-employee unions, which have come under fire as federal and state governments seek to tame budget deficits.

Citigroup Inc., the third-largest U.S. bank by assets, will split at least $11.9 million among four executives if the company meets profit thresholds set at less than half what the lender generated since 2009.

The executives, including Chief Operating Officer John Havens, 54, and Chief Financial Officer John Gerspach, 57, will get a percentage of cumulative pretax income at the New York- based bank’s Citicorp division if that figure exceeds $12 billion over the next two years, according to a filing. Citicorp reported $27.7 billion of cumulative pretax profit in 2009 and 2010, based on the definition in the new filing.

Based on one analyst forecast, the payday could be four times bigger. Oppenheimer & Co. analyst Chris Kotowski predicted in a Nov. 29 note that pretax income at Citicorp as defined by the bank will be around $49 billion in 2011 and 2012. At that level, the executives would share about $48 million, according to Bloomberg’s calculations.

“If this was set up where they only have to achieve half of what they achieved in the past two years, then that should be a lay-up,” said Gary Townsend, who manages about $2 million of Citigroup shares for Hill-Townsend Capital LLC in Chevy Chase, Maryland. “I expect that they will do much better in the coming two years than they have in the past two years.”

Citigroup is rebounding from a $45 billion government bailout in 2008, which came with government caps on pay. The funds have since been repaid. Citicorp contains the bank’s trading, investment banking and consumer banking units.

Bank of America Corp., the biggest U.S. lender by assets, almost doubled a goodwill impairment for its credit-card unit to $20.3 billion to reflect increased defaults and an almost 2-year-old change in rules.

The bank restated federal regulatory filings to record the writedown to its FIA Card Services unit in 2009’s first half, the firm said yesterday in a statement. The non-cash charge, which replaced a $10.4 billion impairment booked on the unit last year, doesn’t affect “the financial results, safety and soundness or the capital position” of the Charlotte, North Carolina-based parent company, said Robert Stickler, a spokesman.

The writedown shows the credit-card unit’s prospects may have deteriorated more than initially disclosed after the U.S. passed legislation, known as the Card Act, in May 2009 to curb fees and interest-rate increases. In November, the bank said some measures would cut annual revenue by $1 billion, undermining efforts by Chief Executive Officer Brian T. Moynihan, 51, to improve returns for investors. The firm yesterday said the act and “deteriorating credit quality” caused the revision.

Residential real-estate prices dropped in the 12 months to December by the most in a year, a sign the U.S. housing market is struggling even as the rest of the economy recovers.

The S&P/Case-Shiller index of home values in 20 cities fell 2.4 percent, the biggest year-over-year decrease since December 2009, the group said today in New York. The median forecast of economists surveyed by Bloomberg News projected a 2.3 percent decrease.

A predicted increase in foreclosures this year as banks resume seizures may depress home values further, prompting would-be buyers to hold off on purchases. Unemployment at 9 percent and declines in housing are among reasons the Federal Reserve has signaled it will proceed with its unconventional monetary stimulus.

“Home prices are still declining amid excess supply,” said Michelle Meyer, a senior economist at Bank of America Merrill Lynch Global Research in New York. “Although transactions have started to pickup, buyers are looking for very low prices. There is a backlog of distressed properties and it will flow into the market this year. We expect to see a gradual drop in prices.”

The housing crash may have been more severe than initial estimates have shown. The National Association of Realtors is examining the possibility that it over-counted U.S. home sales dating back as far as 2007.

The group reported that there were 4.9 million sales of previously owned homes in 2010, down 5.7% from 5.2 million in 2009. But CoreLogic, a real-estate analytics firm based in Santa Ana, Calif., counted just 3.3 million homes sales last year, a drop of 10.8% from 3.7 million in 2009. CoreLogic says NAR could have overstated home sales by as much as 20%.

While revisions wouldn’t affect reported home-price numbers, they could show that the housing market faces a bigger overhang in inventory, given the weaker demand…

NAR said the data, which are used by economists, investors and the real-estate industry to gauge the health of the housing market, could be revised downward this summer.

The Consumer Confidence Index rose in February to its highest point in three years as Americans are feeling more optimistic about their income prospects and the direction the economy is headed.

The Conference Board says its Consumer Confidence Index climbed to 70.4 this month, up from a revised 64.8 in January, hitting its highest level since February 2008. It was the index’s fifth consecutive monthly increase. The figure topped economists’ expectations of a reading of 65, according to FactSet.

While confidence is rising, it is still well below the 90-plus readings that signal a stable economy. Confidence fell off a cliff after the U.S. housing bubble burst and the financial crisis took hold in 2007.

It fell below 90 in January 2008 and hit an all-time low of 25.3 a year later. While confidence and spending have been inching back up as business conditions improve, Americans are still feeling cautious, especially when it comes to the job market.

Unemployment fell 0.4 percent in January after dropping the same amount in December, but the rate remains at 9 percent, a historically high level. That may be one reason consumers’ assessment of present-day business and employment conditions improved only moderately in February.

Those saying jobs are “plentiful” increased to 4.9 percent from 4.6 percent in January, while those stating that business conditions are “good” rose to 12.4 percent from 11.3 percent.

While this assessment of current business conditions “remains rather weak,” the index is at a three-year high “due to growing optimism about the short-term future,” says Lynn Franco, director of the Conference Board Consumer Research Center.

Consumers’ short-term outlook has improved since January. The share of respondents who expected business conditions to improve over the next six months increased to 24.4 percent from 24.0 percent, while the number that expected business conditions to worsen declined.

Federal, state and local debt hits post-WWII levels But any similarity between 1946 and now ends there. The U.S. debt levels tumbled in the years after World War II, but today they are still climbing and even deep cuts in spending won’t completely change that for several years.

The key factor in the rapid drop in government debt, said Harvard University economist Kenneth Rogoff, was fast economic growth. Spurred by a young labor force, world-leading manufacturers, high personal savings rates, a pent-up demand for consumer goods after years of war and the Depression, and a bout of inflation, the economy grew 57 percent in six years. Thanks to sharp postwar cuts in defense outlays, federal government spending also tumbled for a couple of years.

But today the U.S. economy is in a polar opposite condition. The labor force is aging, U.S. manufacturing often lags behind Asian and European rivals, households are in hock up to their eyeballs, and consumer appetite for goods is tepid. In addition, inflation is tame and government spending locked into entitlement programs and debt service that will be hard or impossible to alter.

This article was posted: Thursday, February 24, 2011 at 5:10 am





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