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December 22, 2010


We are on a crash course with destiny.  It is futile to think otherwise and I think most people secretly know it.  I think this holiday season has been a testament to people wanting to have a good time while they can.  Most people have no idea how to prepare for what is coming so there is no point in trying.  I think our national motto has become : Live now for tomorrow you die.  
The American election mandate in November was to get control over our national debt.  Instead we got a bi-polar tax bill that will add an additional trillion dollars to our national deficit.  The Fed is going to monetize everything the government can't sell elsewhere.  It has no choice, it has to.    

Here are the gruesome facts about our debt and deficit under the new bill:

1) Over the next two years we will take in 3 trillion in tax receipts and spend 5.  Politicians express the deficit as a percentage of GDP because they don't want to scare people by telling them they are planning to spend almost twice as much as they take in for at least the next two years.  Anyone who thinks this is sustainable is nuts.
2) In two years we will have a national debt of $18 trillion.  This is more than 120% of GDP and we have never surpassed this level in the history of our country.  No country has.  The net present value of our future entitlement commitment for social security and medicare exceeds the value of all the assets in America, which means we are technically bankrupt.  Anyone who thinks we can sustain a debt to GDP ratio in excess of 120% is nuts.
3) Japan and Europe are in even worse shape than we are.  As a group, we are issuing a tidal wave of sovereign debt.  In 2010 as a group we issued over $5 trillion of NEW sovereign debt.  Anyone who thinks this can go on for long is nuts.
4) The entire emerging world, including China, constitutes less than 20% of the world's total GDP.  In other words, investors who think the emerging world is going to be able to grow fast enough to rescue the mature world from its debt insanity are nuts.   
5) The Fed and the banks have been purchasing 90% of all new US Treasury bond issuance for the past two years.  There is no demand for new treasuries outside of the US banking system.  The reason the Fed is purchasing treasuries from the banks rather than directly from the treasury is because the Fed is limited by law to owning only 25% of any maturity.  So the Fed buys from the banks the maturities it still has room for so the banks can then buy what isn't selling in the open market.  As a result, the banks and the Fed combined own most of the long dated maturities while the central banks of other countries and the general public own short dated maturities.  Still, the average length of a treasury bond is only 4 years.  The good news is that we pay less in interest than we would on long dated bonds.  The bad news is that we have to not only place 2 trillion of new issuance annually, we have to also place 3.5 trillion of rolling issuance.  That means we have to sell 5.5 trillion of treasuries annually.  Anyone who thinks that isn't an insane and unsustainable amount of issuance is nuts.
6) Once bond vigilantes decide to go to work shorting a nation's debt and currency the interest rate on the ten year goes from a reasonable rate to an unreasonable rate very quickly.  Having to pay a higher rate of interest only compounds the problem.  For example, if the U S had to pay an additional 10% in interest (like Greece and Ireland), we would increase our deficit by 1.5 trillion annually.  It would take half our tax receipts just to pay the interest on our national debt.  All the austerity in the world can't make up for the higher interest payments, which is why it is only a matter of time before Greece and Ireland default.  Since mortgage rates are tied to the ten year treasury, a 6% ten year rate will also trigger another leg down in the housing market due to defaults on ARMs held by people who can barely afford to make their payments at 4%.  Anyone who thinks the Fed can prevent bond vigilantes from wreaking havoc on our interest rates without inducing hyperinflation is nuts.

We were at a crossroad with the November election.  The mandate was to rein in spending and fix the deficit.  We ignored the recommendation of the deficit commission and, instead, committed to increasing our deficit even more rapidly than before!  In a couple of months Congress is going to have to vote to increase our national debt ceiling.  They will posture and squawk to make it sound like they are concerned, but in the end they will put the increase through.
90% of our budget is defense, entitlements, and interest.  Republicans will refuse to cut defense, democrats will refuse to cut entitlements, and the result will be a gridlock failure to make any meaningful reduction in spending.  The world will continue on it's path of competitive devaluation as central banks in Europe, Japan, China, and the U S print money to spend on stimulus and strategic commodity stockpiling.  This can go on for a while, perhaps longer than anyone can possibly imagine, but then the whole thing will begin rapidly cratering.  In the meantime commodity prices will continue to go up, putting even greater pressure on the budget of the average American. 

Leading up to the Great Sovereign Bond Crisis you will see treasury rates creep upwards, despite purchases of treasuries by the banks and the Fed.  It will take higher and higher interest rates to attract non-Fed investors in a world where all the nations of the world are forced to sell billions in debt weekly and competing for scarcer and scarcer investor funds. 
Mortgage interest rates will go up.  Real estate tax rates will go up even as taxable values go down because state and local taxing authorities have to raise tax rates to make up for their budget shortfalls.  Higher mortgage interest rates and real estate taxes will trigger another leg down in the housing market.
The stock market will start to perform poorly as higher commodity input costs and interest expense cannot be passed on to strapped consumers, squeezing margins and profits.  People will spend what little money they do have on increasingly expensive food, shelter, gas and energy, hurting any company that provides optional goods and services.
In the short run the stock market may continue to rock as cheap money, a live now mentality, and handouts from the government mask the truth of how bad things are for average people in our country. 
But if you are smart you will watch for the cracks.  Notice the signs.  And get prepared.