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...

Roadmap for the near future (DOW circa 1929)

This chart (click to enlarge) shows the first leg down on the Dow in 1929. From peak to trough the first leg down was about a 50% drop (380 to 235). That long rise into the spring of 1930 was widely heralded as a "New bull market". However, the Dow subsequently declined to 40 by mid 1932. Basically a 90% fall in 2.5 years.

I predict a similar path will be followed this time. This initial decline will have many believing that it's "1987 all over again". Unfortunately, it's not 1987...

VIX UPTREND

Q: If the Volatility Index (VIX) above was a stock, would you buy it?

A: I Would

However, it's not a stock, it's an index that measures investors' anxiety levels as imputed from option prices. Therefore, a rising VIX indicates rising anxiety levels.

If we have a breakout above that triple top, Wall Street will shit a brick.

NEXT UP: LIQUIDITY TRAP

It's February 8th, 2008 and the Fed has now cut interest rates at the most aggressive pace in decades. In January alone, the Fed cut 1.25% from the Fed Funds Rate. As the FFR now stands at 3%, the Federal Reserve is running out of bullets. To wit, the stock market (S&P 500) is lower than it was when the Fed first started lowering rates, and spreads between Treasury ("risk free") bonds and junk bonds are at their widest point in years, reflecting growing risk premiums.

This suggests the inevitability of a "Liquidity Trap". A liquidity trap is a situation where interest rates are lowered to such a point (i.e. 0-1%) that the Fed's standard tools for stimulating the economy no longer work. At very low interest rates, lenders are unwilling to lend, because it's not worth taking risk to receive such low returns. Would you put your money in a bank a) if you only received .5% interest and b) you were worried that you might never see your money again? Neither would I. So, those lucky few who actually have money, end up stashing it under their mattress or caching it in the backyard.

That's when the Government turns to "printing money", as in handing out "Stimulus checks", which is what Congress voted to do this week.

As this decline unfolds, I predict many more rounds of stimulus checks, however, each round will be less and less "stimulating". As I've indicated in my earlier post, the forces of deflation will exert a far greater contractionary force than can be offset by a few rounds of charity checks, especially when foreigners catch on and start pulling their money out of the U.S.

The fact that there are so few economists (any?) who see a liquidity trap on the horizon, is one of the most troubling aspects of this whole debacle.

ECONOMIC FIASCO BLAME LOG

What fiasco would be complete without a listing of the key stooges responsible for this monumental debacle?

In order of responsibility:

1) The Fortune 100 Multinationals
- For engaging in industrial arbitrage (moving jobs and entire INDUSTRIES from the U.S. to overseas)
- For playing one country off against another and making damn sure there will never be a global labour or environmental standard

2) United States Congress
- For sitting on their hands for 30 years and looking the other way
- For selling out their country while pretending to be patriots
- For having the attention span of a coked up flea

3) Special Interest Groups
- For owning BOTH political parties and making a joke of democracy

4) Wall Street
- For carving up and selling off the United States of America

5) Alan Greenspan
- For presiding over the biggest credit bubble in human history
- For falsely believing in the all-mighty power of monetary policy

6) American electorate
- For electing Ronald Reagan and George Bush (Jr.), two unqualified morons. No country can survive that magnitude of incompetence over such a short span of time

7) The Baby Boomer Generation
- For being the largest group of assembled hedonists since ancient Rome
- For mixing, pouring and handing out the "Kool Aid" that made this fiasco possible

8) The Economics "Profession"
- For looking the other way as every basic rule of Economics is being broken
- For ignoring history and believing that "It's different this time"
- For having the credentials, but lacking the insight or comprehension to go with them

9) The Japanese and Chinese
- For pursuing an aggressive mercantilist trade policy against the United States

10) The Media and the CNBC financial cheerleaders
- To the Cramer's and Kudlow's for cynically pretending to care about your country, yet not giving a damn for 95% of Americans
- For spinning every story into a bullish tale for ease of public consumption


KEY NOTES:

1) I did not directly blame Bush or Reagan, as I don't believe either of those simpletons is/was capable of understanding the impact of their policies. They were just figure heads for the Special Interest groups who elected them

2) I did not directly blame Ben Bernanke, as he inherited this unholy mess; however, to the extent that he belongs to the broader community of economists, he shares blame for "not getting it"

MASS INCOMPETENCE

Today the U.S. Federal Government unveiled its "Economic Stimulus Plan", designed to stave off the pending recession. The plan is a fiscal stimulus program designed to inject up to $150 billion dollars into the U.S. economy. Bernanke gave testimony in front of Congress today to discuss the plan and to discuss the state of the U.S. economy. When asked what he thought of the plan, Bernanke thought it was a good idea and should be implemented sooner rather than later...

Unfortunately, the whole problem with this "fiscal stimulus plan" is that we already had a massive fiscal stimulus plan five years ago, known as the Bush tax cut. That tax cut substantially increased the U.S. deficit and has kept the country in deficit throughout the past five years of expansion. So here we are again five years later, facing yet another recession, but we still haven't dug ourselves out of the hole we dug from the last recession! Economics 101 prescribes that a country should run deficits in recession and SURPLUSES in expansion, to pay down the debt incurred during the prior recession. Now we just run deficits all the time, meaning we take new loans to pay off the old loans (i.e. Ponzi Borrowing). This "plan" is analogous to me losing my job and then going to the bank to cash out my home equity, so I can continue spending at my accustomed level. Likewise, this "stimulus" (as in short-term stimulus, long-term pain) package is a loan from both foreigners and our children, so that we as a nation can continue spending at the same profligate level.

By all accounts the vast majority of politicians and economists think this new plan is a good idea, which leads me to conclude that MASS INCOMPETENCE has pervaded all elements of the economic policy-making establishment.

Deflation vs. Inflation vs. Both

Much has been written (here and elsewhere) regarding the rampant stupidity that caused us to reach this financially lethal point in history, but there remains one key unsettled question.

Among the few bloggers and individuals who understand the gravity of the current economic situation, there appears to be a growing debate as to whether or not to prepare for inflation or deflation. Most bearish observers seem to be leaning to the inflation/hyper-inflation scenario as the most likely outcome. Belief in the hyper-inflation scenario is abetted by the government's persistent under-reporting of inflation, the high price of gold (~$900) and the weak dollar - i.e. recent conditions.

I, and a few others, (EWI for example) believe strongly that the next episode will be a severe round of deflation leading ultimately to hyper-inflation. So, true, hyper-inflation will be the end result, but the circuitous route of getting there (via deflation) could see many bears wiped out, especially the current cohort of gold fanatics.

The reason to expect deflation has to do with the money multiplier and the expansion/contraction of credit. For the past 30 years credit has expanded to an unparalleled extent. Based on a fractional reserves system, banks take in deposits and then write loans against the deposits, holding only a fraction of the deposit in reserve. Once the loan is deposited at the next bank, then that bank makes additional loans against the same original deposit, holding again only a fraction in reserve. So forth and so on, until for each $1 in original deposit, there are now many dollars worth of loans outstanding. Therefore, the "money supply" consists of physical money (dollar bills, coins etc.) and derived money (electronic deposits). In precise terms, physical money is M0 and derived money is M2. M2 happens to be many times larger than M0, due to the money multiplier. The key issue is that once economic collapse goes into full motion (it's only in slow motion now), then the money-multiplier will actually go into reverse and not expand, but collapse. Here are the key reasons to expect a collapse in M2:

1) Bad Loans/Defaults, will cause banks to raise reserves and forestall making new loans to preserve needed reserve capital

2) Lack of new deposits: Due to general lack of confidence and highly public bank runs (think Northern Rock, recently), eventually people will pull their money out of the banks and stash it, which will cause a reduction in the reserves base

3) Repricing of exotic investments: As we are already seeing, there are many illiquid "assets" in the system that are "marked to model", not "marked to market". As each of these come to light, banks and other financial institutions will realize they are under-capitalized

4) Most importantly, a collapse in collateral values which we are already seeing in the housing market. This collapse will spread to all markets (commercial real estate, private equity etc.) and cause many borrowers to be upside down in their loans (owe more than the asset is worth), causing a downward spiral in asset values.

5) Borrowers won't be willing to borrow and lenders won't be willing to lend. Classic deflationary behaviour.

Bernanke and Co. will eventually realize that the situation they are facing is highly deflationary, but they will be slow to act, meanwhile the Ponzi deleveraging of M2 will be lightning fast. Ultimately Uncle Ben will throw cash from helicopters like he promised, but he will need a million helicopters to keep up with relentless unwinding of the massively leveraged M2 money supply.

The corollary: The money supply is massively leveraged, resembling an inverse pyramid with a very small deposit base and a very large derivative credit supply. Since it takes only $1 in deposits to support several dollars of loans, then each dollar removed from the deposit base will have a corresponding leveraged contractionary effect on the supply of outstanding credit ("money").

Strategy: In the short-term, it's time to own cash or short-term Treasuries (gold made a recent new high, but the dollar did not make a new low - very bullish for the dollar). The time to own precious metals for the long-term is down the road a bit: Once the current horde of short-term gold speculators has long vanished, and the deflation thesis becomes widespread, and the Fed has lowered Fed Funds several more times (and realizes they are pounding sand)... THEN THAT WILL BE THE TIME TO OWN PRECIOUS METALS

Voodoo Economics

Under the continuing theme of "How did this happen?", we can all thank the policy of "Supply Side Economics" for being the specious excuse by which massive debt accumulation was not only tolerated, but condoned. You see, in order to convince average citizens to do something that we have been taught from our birth is very bad (increase debt), it takes a Ph.D (in this case Arthur Laffer), some good old fashioned fantasy story-telling, and of course a receptive audience.

The basic theory behind SSE is that if you cut tax rates, you will reduce the size of government, free up capital for investment and hence increase economic growth rates. But wait! It gets even better! This new high level of growth will provide an increased tax base and therefore have an overall offsetting effect against the rate cut by actually INCREASING Government revenues! But wait! It gets even better! Act now and we will throw in 6 free Ginsu knives at absolutely no cost to you!!!

Now, in all fairness, it's mathematically possible, that at extremely high tax rates of say 80%, that an ensuing growth burst would be large enough to offset the direct reduction in tax revenues; however, at moderate tax rates (30-40%), it becomes essentially mathematically impossible for the tax cut growth to offset the lost revenues.

I will leave to the academics to debate the mimimum tax rate at which the Laffer curve becomes feasible, HOWEVER, as usual, in all of this specious reasoning, the real point got missed:

In order to free up the economy for long-term and sustainable increased growth, government spending must ALSO be controlled, or else, the plan isn't based on sustainable growth, it instead becomes a cleverly disguised deficit-driven Ponzi Scheme. And of course, the politicians (starting with Reagan), did the first part of cutting taxes, but conveniently skipped the part about cutting spending, and instead proceeded to massively INCREASE spending, hence kicking off the massive debt ponzi that we live under today.

Of the Imminent Vertical Collapse and the Path Least Travelled

The stage was set several decades ago. The secular (recurring) trade deficit first occurred vis-a-vis Japan in the 1970s. Astute policy-makers should have woken up to the obvious and crucial fact that the United States was no longer competitive. A choice was to be made: consumption vs. savings and investment. However, the United States does not have an industrial policy, nor a long-term economic strategy, so the easiest path was taken. Thanks to the Nixon Administration's rejection of the Gold Standard, the Japanese took their profits in dollars and used that money to start buying chunks of the United States - primarily real estate. Therefore the U.S. started selling off pieces of itself to fund consumption. Yet, not withstanding this new ominous trend, by the close of the 1970s the United States was still the world's largest creditor...

Fast forward a few decades and the Japanese have been replaced by the Chinese, as the vendor of choice. Throughout the intervening period U.S. policymakers have failed to address the competitiveness issue, and the combined National debt now stands at 4xGDP ($48 trillion)!!! i.e. the U.S. is now the world's largest DEBTOR nation. But the Ponzi has gone into overdrive in the past decade. U.S. Corporations have found a unique one-time way of massively increasing their profit margins. It's a widely used trick that has leveraged the world's economy to an unprecedented degree of risk, yet has deceptively lulled everyone into believing that it's actually a good idea. The concept: Lay off workers in the U.S. and outsource to China. Cut labor costs by 90%. Every major Corporation has done this in the past 10 years and realized phenomenal profit margins. This is Industrial arbitrage: buy low in China and sell the same goods in the U.S. at high prices, for enormous profits. Unfortunately it's a short-term strategy, as those workers (aka. customers) laid off in the U.S. have been forced into lower and lower paying jobs. The majority of American workers now have no protection, because the minimum wage is at a decades' low, unionization membership is at a decades' low and the trade policy is wide open - come in and take what you want. But don't despair, because the Chinese, like the Japanese before them, have been propping up their largest customer by recycling their profits back into the U.S. economy, funding mortgages, home equity lines of credit - all manner of debt instruments. The American consumer has been given all of the money he needs to leverage up to the maximum extent possible, regardless of (in)ability to repay.

The stage was set decades ago. The policymakers came to a fork in the road. One was a difficult little travelled path of long-term re-education and retrenchment to regain national competitiveness to the benefit of the majority of Americans. The other was the road of continued uninterrupted pleasure and consumption on an ever-more concentrated and grotesque scale, that would eventually benefit a small minority of Americans, and then none at all.

And of course, they took the path most easily travelled...AND IT WILL MAKE ALL THE DIFFERENCE...

Welcome to the DISINFORMATION Age

Years from now our children and grandchildren will look back and wonder how could so many people have abandoned all reason and engaged in such foolishness as is occurring now - just a massive herd of buffalo charging off of a cliff, without even a second thought. Yet, as we are now witnessing the peak in all markets (stocks, gold, oil, real estate), so too are we seeing the corresponding peak in mass foolishness and pervasive self delusion. With the economic "correction" to come, once again commonsense and basic reason will be in high demand.

There have been many factors contributing to this era of mass delusion, but one of the most important factors has been the rise of the DISINFORMATION AGE. Disinformation is the opposite of information, it does not inform and enlighten, it confuses and retards. Disinformation is based on false pretense and specious reasoning, as opposed to facts and critical thinking. It was the mass commercialization of the internet during the 90s that empowered the Disinformation age and allowed it to reach its full destructive potential. Ironically, instead of improving the dissemination of quality information, the internet has become a veritable sewer of junk information. For every legitimate .org and/or legitimate (non-biased) web site there are at least 100 .com/.net affiliated web sites with some underlying vested interest.

There are many other key factors feeding the relentless tide of disinformation and the corresponding culture of obfuscation and deception:

1) Denialism as an industry. There is now an entire movement underway to undermine legitimate public issues to ensure favorable commercial outcomes. The 'Denialism' tactics used by these commercial interests are both insidious and pervasive:

• Obfuscation/Indirection: No data needed, just confuse the issue, muddy the waters or change the subject


• Specious Reasoning: Simple minds want simple answers, so give the people what they want. Hitler above all proved that the masses prefer a straightforward construct that reinforces their preconceived biases and prejudices, over facts and reality.


• Ad hominem attacks: Again, no data needed. Simply impugn the integrity of the messenger. There can be no slimier example of this than the anti-John Kerry "Gun Boat Veterans Against John Kerry" campaign. I think this will stand the test of time as the sickest political slime campaign in U.S. history - at least we should hope so...

Denialism is a force to be reckoned with across myriad issues, including Climate Change, Peak Oil "Theory" (Reality), and my personal favorite Fiscal responsibility (lack thereof).

2) Marketing based economy. Over the past few decades the United States has transitioned from a manufacturing based economy to a marketing based economy. Essentially the country is a front sales office for goods made in China. With this transition has come the accompanying rise of marketing culture, language, and spin. In this new culture, straight talk is abhorred and highly "discouraged". In Corporate America today, nothing will derail your career faster than telling it like it is. The current lingua franca is strictly spin talk, sugar talk, indirect talk, pseudo talk, code language, bullshit whatever you want to call it, but regardless of what you call it, be sure to keep the facts, commonsense and reality to the minimum.

3) Spectacle vs. Reality: We are at that stage in the grand cycle of power when the people need something to take their minds off of the reality unfolding before their very eyes. Just as the Romans had the spectacle of the Coliseum, so too do Americans have Hollywood, ESPN, Disneyland and FOX News. And well beyond these well known purveyors of hollow content, basically every mainstream media source has turned full time to the "Infotainment" pseudo-informational format. PBS News may be one of the only reliable sources left, but only about .01% of Americans have even heard of Jim Lehrer.

4) Underneath it all, it boils down to human nature and the ebb and flow of the grand vices: greed, arrogance, laziness, instant gratification. As these vices are now at the high point of the pendulum, then so too do they contribute to the fevered manufacture of self-rationalizing disinformation. This is an age of moral relativity i.e. if everyone else is doing it, and I can get away with it, then it must be Ok. History has seen many such eras come and go, but the scale of this one is beyond anything ever seen before.

5) Poets, priests and politicians. Disinformation has found its way into every corner of our society. There are no more definitive sources for anything, as mass commercialization has ensured everyone now has a vested financial motivation. It's socially acceptable to be openly cynical about everything, and yet in being so, we tacitly accept the corruption and malfeasance occurring around us daily. No one blinks an eye that the U.S. is in Iraq to secure its massive reserves of oil. That fact is accepted and hence not even being debated! We have reached a full capitulation of morality.