Point of no Return

This week's edition of the The Economist featured an article on Japan and its demographic (ageing) crisis.

Voodoo Economics

Not surprisingly, the article missed out on by far the most important point regarding Japan and a key point that is instructive for all nations currently running deficits.  The point is that once a country starts running structural deficits to fund operating expenditures, it soon becomes mathematically and politically impossible to ever pay off the debt.  Economists like to point to the ability of countries to "out grow" their debt and deficits via Supply Side Economics.  A third grader is smart enough not to believe such a load of rubbish, but not so today's average economist/politician/bankster.

One can easily construct a financial model to indicate the impact to the Japanese economy were it to even attempt to start paying down its debt.

Assumptions:

 - Current Federal debt at 200% of GDP (which it is)

 - Average Duration of debt: 30 years (this is a VERY generous assumption)

 - Average interest rate on debt: 1% (The rate on JGBs fluctuates, but is currently very low)

Now we see why it was so easy to ignore this problem in Japan for so long.  With interest rates at 1%, the conventional wisdom is that "Debt Service Costs" are extremely low, so there is no harm in taking on more debt.  Unfortunately for the purveyors of this "load", there is more to debt service than simply the current interest i.e. principal.

Plug the above figures into Excel and now assume that all of this debt needs to be paid off in 30 years time.  In this model, we are solving for the Payment (a blend of principle + interest) i.e. the true debt service cost and the one that would have saved "The Economist" from devoting a lengthly article to evading the simple truth.

Over 30 years, as a percent of GDP, the payment is: 8%  !!!

Wait, it gets worse.  Obviously in order to pay down debt, a country needs to first stop accruing new debt i.e. first eliminate the annual recurring deficit.  Japan's fiscal deficit for 2010?  10%

The Bottom Line for Japan:

In order for Japan to START paying down its current level of debt over a 30 year period it would have to incur a 16% hit to GDP immediately and that figure will only grow into the future.  (NOTE: 2% of GDP is interest and already included in the deficit).

U.S. Example:

Variables for the U.S.:

 - Current Federal debt at 100% of GDP 

 - Average Duration of debt: 20 years (average duration is currently 5 years, so this is very generous)

 - Average interest rate on debt: 3% 

 - Current annualized deficit for 2010: 10%

Level of GDP that would be removed by paying off debt over 20 years:

[Ongoing debt service cost, amortized over 20 years: 6.7% of GDP] 

Including 10% Deficit: ~14% (after taking out the 3% interest due to double-counting) 

Keep in mind, both countries are applying unprecedented fiscal and monetary stimulus at this juncture and yet there is minimal growth in either country i.e. no sign whatsoever that either country could possibly remove the bulk of stimulus while at same time maintaining a positive economic growth rate MUCH LESS pay down a $1 of debt.

Definition of Recession is Totally Bogus
Officially, according to NBER, the U.S. is out of recession, and has been since June 2009.  Of course, that is totally bogus because the "official" definition of recession does not take into account fiscal deficits, so it is meaningless.  Whether, the deficit was at 0% or 10% of GDP (as it is now), the U.S. would still be deemed to be out of recession.  Currently, as I write, GDP growth is running at ~2% year over year, so in reality, the true economy is running at a negative 8%.  When a country can borrow 10% of its GDP and then declare that the economy is "growing" at 2%, that's the trifecta - bad math, denialism and stupidity all rolled into one.

Legacy of the Baby Boomers
That 14% represents the hole in the economy left behind by the most greed-addled, self-indulgent generation in world history.  Not only are the Boomers spending the wealth inherited from their parents, they've underfunded and raided their own 401k retirement funds, bankrupted Medicare and Social Security, and on top of all that left A GAPING 14% SMOKING CRATER where the economy used to be, for their children and grandchildren to inherit.

As I have said before, GAME OVER, MAN.  We just need Wall Street and the morons with the fancy degrees to wake up and smell the fucking napalm.

GOLD IS MONEY PART 1

I wasn't intending to write this topic for several months, as I was planning to wait for my entry point for buying gold and silver, but events of the past several weeks have convinced me otherwise. With this entry I want to clarify my position on owning the precious metals and lay out my strategy for the long-term.

First off, let me start by saying that ALL predictions around the timing and price of commodities or any other asset class need to be taken with a big grain of salt. Regardless of the relentless descent of the economic fundamentals that we are now witnessing, financial markets will do what they do, which is to rise sharply, fall sharply, meander sideways and otherwise move in such a way as to confuse and torture as many investors as possible. The market is a casino, if you stay at the table long enough, eventually the house will get its money back.

That said, I believe, based on my deflation thesis, that there will be an entry point for gold and silver that is significantly lower than these current levels, and I am willing to play my hand that way. From the 2001 low of ~$250 to the recent high of $1000+ dollars, gold has risen 300% in what I believe is the "first wave" in a long-term secular move. Furthermore, based on the chart pattern and Elliot Wave analysis, I believe that we will see a deep pullback to roughly $500 per ounce (+- $50), which would be a 62% Fibonacci retracement.

I know, there are many who believe that gold is a "safe haven" and therefore will continue to rise, as the world stock markets fall. However, that common belief is also predicated on the view that the U.S. dollar will continue to sink inexorably into oblivion. In a deflationary environment, however, there will be a shortage of U.S. dollars and the dollar (beyond all expectations) will rally. Also, contrary to the "safe haven" theory, when global stock markets sold off hard into their January panic lows, gold fell in synch with the stock market. Therefore, one must surmise that this rally in gold is just another product of the credit bubble and the overall rise of all commodities. Once the commodity bubble bursts, gold will come down with everything else.

There is a somewhat risky assumption built into my prediction however, and that is in assuming foreign creditors will continue to sponsor the U.S. debt ponzi well into a deflationary downturn. If they don't, and there are reasons to believe they may not, then the U.S. dollar would collapse and gold would soar. Back in October, the Chinese raised the specter of using the "nuclear" option of selling off their U.S. dollar holdings. At the time, they were obviously just playing political games, but if they do eventually liquidate their U.S. holdings, then the only safe place in this country will be a bunker in Montana with 10 years worth of food and 100,000 rounds of ammunition.

Which gets us back to the title of my post, that in the long run gold is the only true money. They say money doesn't grow on trees, but in fact it does. Paper comes from trees and therefore there is literally an endless supply of "money". Paper currency has no intrinsic value; it has only notional value, based on the faith and trust people have in the Government issuing it. Once that faith and trust is lost, the value of paper currency will be lower than 4-ply toilet roll, and gold could easily be at $4000 an ounce (bread will likely be over $8 per loaf - maybe we should stockpile bread...).

How do I reconcile my short-term belief that gold is not currently a "safe haven" vs. my long-term belief that gold is the only money worth owning? Easy, based on the fact that most people still have faith in the U.S. dollar as their primary currency. Trying to determine when widespread recognition of the fallacy of this faith occurs, is obviously difficult to predict. For my part, as indicated above, I will trust the technical (chart-based) road map for determining my entry point for gold, unless I see something event-driven that changes my mind - which could occur at any time...

To be continued...

BANKRUPT

The United States Government is now officially bankrupt.

For 2008, the White House projects the fiscal deficit to be over $400 billion dollars (the entire Federal budget is a record $3.1 trillion dollars). Meanwhile, INTEREST on the national debt is expected to be also over $400 billion (The national debt itself is now over $9 trillion dollars and growing exponentially).

That means that the Government's entire new borrowings this year ($400B) will be allocated just to pay the INTEREST on past borrowings, without a dime left over for anything else. Putting this in perspective, if the Government was me or you or a Corporation, it would be legally bankrupt.

This by all definitions is the very meaning of PONZI borrowing. Investors purchasing bonds from the Federal Government will be paying themselves back, with yet still more bonds!

...And to think the economy is not even in recession...yet...