A picture is worth a thousand words. The Dallas Fed provides this chart depicting, better than words can articulate, the Failed Policies of Barack Obama:
Rosenberg argues the nominal yield curve would be inverted right now if it were not for the fact that short term rates are essentially at zero. The Treasury shows the Friday July, 9 nominal yield curve as:
| Date | 1 mo | 3 mo | 6 mo | 1 yr | 2 yr | 3 yr | 5 yr | 7 yr | 10 yr | 20 yr | 30 yr |
|---|
| 07/09/10 | 0.16 | 0.16 | 0.20 | 0.30 | 0.63 | 1.03 | 1.85 | 2.52 | 3.07 | 3.85 | 4.04 |
If we assume that expected inflation for the short term is (say) -3, that is, that deflation is expected over the short term, but that inflation is expected to rear its ugly head over the long term (say) + 3, then we can use Fisher’s relation that nominal rates less expected inflation equals real rates, to see that the REAL yield curve could be inverted right now:
2 year Short term nominal (.63) – expected deflation (-3.00) = 3.63 real
30 year Long term nominal (4.04) – inflation (+3.00) = 1.04 real
If the real yield curve is inverted, it’s an ominous sign…
Market Ticker often posts this graph of total debt (public and private) in the US:
We can see from that graph that the trend is now changed to “down” after 50 years of “up”. The Federal government has been unsuccessfully attempting to offset the decline in private debt with increases in public debt. With the trend to more austere budgets, the growth rate in Federal debt will also begin to decline, accelerating the decline in total debt. What does this mean for interest rates? A shrinking supply of total debt means there is a shrinking supply of debt securities in which investors can invest. All other things held constant, this implies that debt prices will be bid up and interest rates down. In the case of US Treasury debt, we can expect a significant fraction of it to be monetized – bought by the Federal Reserve and paid for with Dollars that don’t cost the Treasury any interest. This monetization process will not increase the total amount of dollars available, but it will further reduce the supply of interest bearing debt instruments available for investors to buy – resulting in still more upward pressure on Treasury prices and downward pressure on rates. There appears substantial probability that long term Treasury Bond rates could be cut in half (from 4 to 2%) within 18 months. Only when the private economy begins to recover with real, non-government financed growth will we have significant risk of a rise in interest rates.
Look at the photo of a dollar below:
See where it says “Federal Reserve Note” and where it says “This note is legal tender…”? Dollars are notes or debts, that is, obligations of the Federal Reserve. When the Federal Reserve buys US Treasury Bonds from the open market and pays for them with dollars (a process some refer to as “monetization” or “printing money”), it and the marketplace has simply exchanged one form of debt for another. The supply in the hands of the market of one kind of debt (dollars) increased while another (Treasury Bonds) decreased. Long before the Federal Reserve got involved to exchange dollars for Treasury Bonds – when the Treasury bonds were first created and sold to the public – that’s when the notional value (that is, the proceeds) of those Treasury Bonds was attached to goods and services. Increases in government debt, as well as increases in private debt (net), are inflationary. But not the monetization of the debt by the Federal Reserve.
At present, we have a situation where private debt is being reduced faster than government debt is being increased so that, in aggregate, total debts are declining – this is deflationary.
Technically, the total supply of debt can increase in an amount equal to the amount which society saves each year without inflation. Conversely, total debt (including new equity shares) must increase by the amount of savings each year, or… we will have deflation.
You don’t have to be a bank to inflate or deflate.
Jimmy Songwriter sitting at the bar has a flash of inspiration and quickly writes down a new song. His somewhat inebriated friend, Joey Songsinger hears the song once and enthusiastically offers to buy it for a price equal to “whatever it takes – even if it’s the whole income of the United States”. Jimmy Songwriter, as a joke and to teach his friend a lesson, tells Joey he will sell the song for $13 Trillion and that he would finance it and Joey signs a note to Jimmy for $13 Trillion. This single transaction goes on record as the highest price ever paid for a song… drives up the average price of all songs by a factor of thousands…and doubles nominal GDP and the average price of all goods and services in the United States. The next year at Christmas, when the note comes due, Jimmy sends his friend Joey an email offering to “settle” the note for $500. Joey gladly agrees. After all they both knew that’s what the song was truly worth …and what Joey could pay. That year, nominal GDP falls from the previously inflated level by roughly 50% with a 50% deflation in the price level as there are no more songs sold (and financed) for such exorbitant prices.
Notice:
1. We didn’t need banks or the Federal Reserve to create the price inflation or the price deflation which followed. All we needed was debt creation and then the subsequent de-leveraging and return to “normalcy”.
2. Neither Jimmy nor Joey had the legal power to “print” or coin “money” and they did not need it to affect the price level.
3. Most importantly, what Jimmy and Joey do can offset and overwhelm whatever the Federal Reserve and the banks do.
Dave Rosenberg in his “Breakfast with Dave” for Thursday, May 20th points to the Shiller PE ratio:
In the past 130 years, whenever the Graham/Dodd/Shiller normalized P/E ratio goes above 20.6x (it is 21x today), the market experiences a significant correction – a correction of 31% on average over the next 16 months. It never fails.
It never fails… hmmm, 31% down on the S&P from here would put the S&P down to about 770.
TPC quotes Annaly Capital Management, who uses the following chart:
This chart makes the point that:
The primary function of government now seems to be transferring wealth from one group to another through programs like Social Security, Medicaid, Medicare, unemployment benefits, the new health care system, etc. It’s hard to consider this kind of spending stimulative…
As the federal government’s main reason for existence has evolved from protecting its citizens to that of a Robin Hood, the Top 10% of all earners, from whom all this wealth is “transferred”, are forced to pay an ever rising burden of the cost of “government”, including the ruling elite’s “commission”. IRS data on the share of taxes these earners pay allowed us to prepare the following chart. As the chart indicates, the top 10% earners will soon be tapped out. Once the pot-of-wealth from which our government transfers runs dry the primary function of this government ceases to exist.
Bill Frezza’s complete column is reproduced here – but, please visit his site.
How can the American people be so stupid….indeed.
The Dawn of a New Age In the United States
By Bill Frezza
Snatching victory from the jaws of defeat, after a tumultuous year of political theater, the Age of Obama has dawned.
With legislative success however tarnished by rancor and dissent, the hopes and dreams of generations of Progressives have been fulfilled. The trifecta of Social Security, Medicare, and the first installment of Universal Healthcare are now the law of the land.
Based on a common set of financial principals and an unshakable faith in the wisdom of government the productive power of the young, the healthy, the successful, and generations yet unborn are now fully lashed to the yoke of redistribution. The poor, the old, the infirm, the government employee, the union worker, the dropout, and the slothful have cause to rejoice as their party has delivered the goods.
Or so they think. Let’s take a quick look at the numbers.
According to the most recent Social Security and Medicare trustees report, the unfunded liabilities of these New Deal and Great Society programs exceed $100 trillion dollars. Add the unfunded Medicaid mandates imposed on the states along with the pension liabilities of millions of federal, state, and local government employees and the total becomes almost impossible to comprehend.
Try this on for size. If you confiscated the entire Gross Domestic Product of the US for ten years you couldn’t cover all these liabilities.
Confiscate the GDP? That’s Communism! OK, how about confiscating half the GDP? Too late, that money is already spoken for.
Combined Federal, State, and Local government spending is now at 37.5% of GDP and heading north. The European Union, our Progressive model, has already passed the 50% mark.
Note that these confiscatory levels of taxation can’t even cover this year’s spending. None of the money already being diverted from the economy is being used to shore up the aforementioned liabilities. These not only remain but are swelled by annual deficits.
Get the picture? Obama just handed the American people an empty gift box. Good luck collecting.
FDR promised that Social Security would never lead to runaway spending. LBJ promised the same for Medicare and Medicaid. President Obama is promising that his Universal Healthcare program will not only pay for itself but will generate savings that can be used to reduce the deficit.
The American people cannot possibly be so stupid as to take these political promises at face value. Somehow supporters must imagine that all these bills can be paid for by “the rich” while 95% of Americans enjoy tax cuts and subsidies. As citizens are invited to stick their hands ever deeper into their neighbors’ pockets, a majority of voters must believe they are going to get more than they have to give.
And why shouldn’t they? It’s worked so far hasn’t it? Our progressive income tax system has reached the point where half the population pays no income tax at all. What do they care if tax rates have to go up? And today’s retirees, like Bernie Madoff’s early clients, have already collected many times more than they paid in to Social Security and Medicare. Their thanks? A parting gift of consuming 30% of the nation’s healthcare budget in their final year of life.
FDR and LBJ died before anyone had to deliver on the promises they made. The problem for Obama is that his predecessor’s bills are coming due just as he is piling on more.
Social security recently passed its high water mark. The program now and forevermore will be paying out more than it takes in. In order to write these checks, the Social Security Administration has to redeem the vast mountain of IOUs it received when former Congressmen plundered every last penny of the so called “trust fund.” There is only one place today’s Congress can go to redeem these IOUs, and that is to the general taxpayer.
Kill the rich and eat them, there are too few to cover all these bills. The Age of Obama will certainly bring us equality. We will all be equally broke.
Meanwhile one form of inequality continues to grow unchecked, unnoticed as the media devotes all its energy to chasing banker bonuses. Studies show that government workers now get $1.45 in pay and benefits for every $1 received by comparable workers in the private sector. This should come as no surprise. While private sector unions have largely bankrupted their employers, save those like General Motors that have been nationalized, public sector unions have no such limitations. Representing a solidly Progressive voting bloc, the swelling ranks of public employees can be counted on to pass their bills along to the rest of us as they demand ever larger chunks of a shrinking pie.
This tragedy of abject profligacy can end only one way. Watch the drama unfolding in the land where democracy was born. German charity might allow the Greeks to enjoy their Progressive lifestyles a bit longer but eventually the disease of runaway social democracy will bankrupt the rest of Europe too.
Who wants to bet whether the Chinese will continue financing us long enough to be drawn down this rate hole of self-inflicted fiscal immolation?
