US deficit and debt ceiling

An interesting chart showing payments to be made by the US Government after Tuesday 2 August deadline when the debt ceiling will be reached and the US no longer able to borrow: on July 28^th the US debt stood at USD 14,293.275 billion extremely close to the statutory limit of USD 14,294 billion.

The Bipartisan Policy Center calculated that August 10 is the date when the US will run out of cash and not August 2. Anyway the day of reckoning is getting really close…

It is worth noting that the debt ceiling has been increased 78 times since 1960, or 47 times the USD 300 billion record reached during WWII.

If a bipartisan deal is reached by then, expect the USD to rally and precious metals to fall.

Source:

Bipartisan Policy Center: Debt Limit Analysis

http://www.bipartisanpolicy.org/sites/default/files/Debt%20Ceiling%20Analysis%20FINAL%20%28updated%29.pdf

The New York Times: Charting the American Debt Crisis

http://www.nytimes.com/interactive/2011/07/28/us/charting-the-american-debt-crisis.html?ref=politics

How much money did the US Government commit during the financial crisis to date?

Here is a diagram that summarizes the current state of the US commitment to avail the current financial crisis: $7.8 trillion and counting...



Source:

The Washington Post
http://www.washingtonpost.com/wp-dyn/content/graphic/2009/02/11/GR2009021101150.html

Governement debt: a huge Ponzi scheme?

Since Central Banks wide-open an endless flow of money, I have warned about the next bubble to implode, “The Mother of all Bubbles”: Government debt.

Eric Sprott & David Franklin, of Sprott Asset Management from Canada, recently wrote a paper on where the huge amount of new debt issued by the US Treasury went: “Is it all just a Ponzi scheme?”

I found their findings particularly interesting (emphasis mine):

In the latest Treasury Bulletin published in December 2009, ownership data reveals that the United States increased the public debt by $1.885 trillion dollars in fiscal 2009. So who bought all the new Treasury securities to finance the massive increase in expenditures?

So to summarize, the majority buyers of Treasury securities in 2009 were:

1. Foreign and International buyers who purchased $697.5 billion. (+23% from FY 2008)
2. The Federal Reserve who bought $286 billion. (+60% from FY 2008)
3. The Household Sector who bought $528 billion to Q3 – which puts them on track to
purchase $704 billion for fiscal 2009.- (+35x (!!) from FY 2008)

In fact the third group is labeled as “others”, but, after careful analysis, Sprott discovered that most of this group represented the “Household Sector” (and this is outside of Money Market Funds, Mutual Funds, ETF’s, Life Insurance Companies, Pension and Retirement funds and Closed-End Funds, which are all separate reporting categories).

Who could believe that Households could have increased their 35 times in a year after the crisis we went through? So, our Sprott friends went a bit further and their discovery is somewhat scary:

So to answer the question - who is the Household Sector? They are a PHANTOM. They don’t exist. They merely serve to balance the ledger in the Federal Reserve’s Flow of Funds Report.

Already PIMCO’s co-chief investment - Bill Gross, the world most powerful bond investor – is advising to front run Government debt and and boosted cash to the highest level since 2008.

Zhu Min, deputy governor of the People’s Bank of China, alongside other foreign holders, also expressed concern over new Treasury purchases. He went on to say, “The United States cannot force foreign governments to increase their holdings of Treasuries… Double the holdings? It is definitely impossible.”

If the foreign support wanes in 2010, the US will require significant domestic support to fund future debt issuance, which is far from assured if we refer to Mr. Gross’s recent comment.

Sprott concludes:

The fact that the Federal Reserve and US Treasury cannot identify the second largest buyer of treasury securities this year proves that the traditional buyers are not keeping pace with the US government’s deficit spending. It makes us wonder if it’s all just a Ponzi scheme.

Me too... Don't be long Government debt.

Source:

Sprott Asset Manangement: "Is is all just a Ponzi Scheme?"-Markets at a glance December 2009
http://www.sprott.com/Default.aspx?uType=can

Business Week: Pimco's Gross Boosts Cash to Most Since Lehman Failed
http://www.businessweek.com/investor/content/dec2009/pi20091217_105749.htm

Shanghai Daily: Harder to buy US Treasuries
http://www.shanghaidaily.com/sp/article/2009/200912/20091218/article_423054.htm

Federal Reserve: Flow of Funds Accounts of the United States - Q3 2009
http://www.federalreserve.gov/releases/z1/Current/z1.pdf

A new challenge to US domination?

The financial crisis has heralded the start of US decline as WWI did for Europe. The shift of power is becoming more vocal and organised: over the pas few months China and Russia voiced their concern about US budget deficit and mounting debt; they now are joined by Brazil and India, BRIC countries demanding more clout, commensurate with their 15 percent share of the world economy and 42 percent of global currency reserves.

Brazil and Russia joined China this week in saying they would shift some $70 billion of reserves into multicurrency bonds issued by the IMF: this is a clear signal to the US to get their house in order.

According to Goldman Sachs, the BRICs may overtake the combined $30.2 trillion gross domestic product of the Group of Seven nations by 2027, 10 years earlier than previously forecasted.

It will be interesting to see what comes out of their meeting in Russia on 16th June; one sure thing: a multipolar world is being fostered.

Emerging markets is one of my other favorite investment themes.

Source:

El-Erian Says Summit Shows `Rebalancing' as BRICS Buy IMF Bonds
Bloomberg, June 12 2009
http://www.bloomberg.com/apps/news?pid=20601087&sid=atucH58_sh8s

US budget deficit and debt: unthinkable solutions?

VAT to plug the deficit?

Facing unprecedented budget deficits and mountains of debt plus a health care reform, the US administration has already tested the water about introducing a VAT (Value Added Tax) that is common in most countries across the world.

Discussions are ranging from a 10% to a 25% rate depending of the scope, the latter permitting a balanced budget, financing of Medicare and Medicaid, exempting most of the population from income tax and slashing the top rate down to 25%. Paul Volker seems to have endorsed Yale law professor Michael J. Graetz of a VAT of 10% to 14% to finance the health reform and exempt 90% of the population from income tax.

The Obama administration is also testing the water to tax greenhouse-gas emissions could raise trillions of dollars. Alternatives are discussing new taxes on sugary soda, alcohol and employer-provided health insurance. The last proposal could raise a lot of money - nearly $1 trillion over the next five years, according to White House budget documents.

Since Detroit and the American way of life have been dented with the fall of the US auto industry and green discussions about carbon emissions are becoming more entrenched, let's have a look at an increase of taxation on gasoline which today is way below European levels: at the actual $2.6 per gallon, the price of gasoline in the US is +/- 50% the level of Europe and the American motorists consume 142.4 billion gallons a year… if the US administration takes an additional 25 c / gallon (i.e. a 10% increase on current prices), it would raise $35.6 billion a year, and be still way below European prices.

I am sure of only one thing: taxation will increase in the US (as well as in Europe) to pay the bill and arrears.

I despite government intervention as much as over-taxation (i.e. in my opinion paying to the State more than 20-25% of what you earn, including health care), but some situations require war style answers. And this is less bad than over-inflation (even if any new tax will increase prices when introduced). Let’s clean the house and start on new foundations, leaving entrepreneurship strive and keeping governments and large corporations (that often act inefficiently like administrations when not managed by entrepreneurs – it is time to study again the agency theory…) out of the way: only the former is really creating wealth (intellectually, financially and socially) and makes humanity move on..

Doom, gloom or boom? (Part 2)

2. Is the US moribund?

Despite the long term demise of the US (in relative terms – not to talk about Europe that is in a worse situation), the leash effect of the country on the word economy and markets is still present.

We are told by Nouriel Roubini , the IMF (note: with its 2,500+ economists it went from “it will be ok” in 2007 to “oh! My God!” 2 months ago – a useless organization that found a new “raison d’être” after the G20 summit in London) and some other that, depending on sources, the finance industry has USD1.3 – 2.5 trillion of forthcoming losses to absorb in addition to the $1 trillion that already hit their balance sheets, due to a near zero GDP growth, a continuing deteriorating real estate market (residential and commercial, the latter having more bad surprises to come with many shopping mall in bad shape for example and too many office space available – have a look at Manhattan -, as well as an increased delinquency for credit cards). That may be true or probable (making the banking sector insolvent at least in the US), I do not know; what I know is that helicopter Bernanke and pilot Tim will throw whatever money is necessary to avoid a collapse, even at the price of high inflation in the years to come, despite all the rhetoric of denial. Next year you get Senate and US House of Representatives elections, so do not expect any tightening (beyond a token one) for a good 12 months.

Debt and deficits are however a real problem. I posted a must see video on the sheer size of the problem the US is facing. Obama, Geithner, Bernanke and the lot are well aware of this and talk about it, but no real measures are taken to tackle it. The Chinese are becoming impatient but have no real alternative (but buying real assets, like natural resources; the West will, with reason, resist it however – see Rio Tinto as the most recent example – beyond Africa, the Chinese eye Australian and Canadian resources); it will be interesting to follow the results of Obama's forthcoming trip to China.

The latest revised deficit projection (May) brings the expected US budget deficit to $1.84 trillion (4 times the previous year), from a February projection of $1.75 trillion. For the 2010 fiscal year, the new estimate is $1.26 trillion, up from $1.17 trillion. Since optimism usually reigns in the blind kingdom of politics, just round the numbers to $2 trillion and $1.5 to get closer to the truth. On the official numbers, this represents a shortfall of 12.9% of GDP for 2009 and 8.5% for 2010.

We are back to the end of World War II! In February, in his 10-year budget outline, Obama projected the US would fall back just below the 3% level in the last months of his term, in the 2013 fiscal year: by “chance”? Who can believe a politician making such an assumption at time of his re-election time?

Annual deficits would never dip below $500 billion and would total $7.1 trillion over 2010-2019. And those dismal figures rely on economic projections that are significantly more optimistic (1.2% decline in GDP in 2009 and a 3.2% growth rate for 2010) than those forecast by private sector economists and the Congressional Budget Office.
And do not forget the +/- 41 trillions more in Social Security, Medicare and Medicaid obligations as baby boomers retire (If significant reforms are not undertaken, benefits under entitlement programs will exceed government income by over $40 trillion over the next 75 years according to the Governement Accountability Office).This would cause debt ratios relative to GDP to double by 2040 and double again by 2060, reaching 600 percent by 2080). Some argue that the total US Government current and future liabilities amount today to an astonishing $65.5 trillion and counting. Whatever the number, it is huge, enormous, unthinkable.

This leads to a ballooning debt standing at $11.4 trillion early June due to increase to $20 trillion in 2015.

Consequences are threefold:

• Issuance of Government debt will be huge during 2008-2009 fiscal year [link to part 1]

• The yield curve is steepening very quickly over the past few weeks (the difference between 2 and 10 year Treasury notes has reached 2.75% surpassing the previous record of 2.74 % set on Aug. 13, 2003).

• Either(1) markets anticipate a recovery, or (2) anticipate a quick deterioration of the US fiscal outlook or (3) Chinese are refocusing their portfolio on short dated maturities or (4) investors anticipate the huge increase in supply. It is probably a combination of the four factors, but I would put a 90% probability on the latest three that are linked anyway. The consequence would be for the FED to buy more US Treasuries to keep long rate down in order to limit/stop any hike in mortgage rates.
  

• Increase taxes, increase inflation or a combination of the two, leading to lower standard of living of American citizens and a continued debasing of the USD.
  

Whether the US will be moribund and in a secular decline will depend on policies adopted to fix the debt/deficit problem. On sure thing, the American people will have to pay for having lived on steroid for too long; using the $ dollar devaluation tool to have other countries paying for the US financial and economic sins will not longer work with foreign savings needed more than ever to pay for the US historical deficits and debt burden.

The leash effect of the US economy will diminish over time. During the current crisis, it is the Chinese market that led the rally: for investments, look at East and South not West.

For the US, gloom, not yet doom.

In part 3 , I will review one of my favorite investment theme: commodities.

Doom, gloom or boom? (Part 1)

1. Where are we?

GM is dead after several years of agony and Chrysler is Italian. Ford is the only surviving automaker (pending what the new GM will become).

Citicorp and GM are no longer constituents of the Dow Jones.

This must look like a revolution for our American friends.

Since its low on March 9, equity markets have sharply rallied, with the financial sector leading the charge. The MSCI world index is up 47% and emerging markets display an even better performance: +64% for the MSCI emerging markets index (interestingly, the low was posted in October and in March the low was a couple of days earlier than in developed countries)

In the meantime, the USD index has rapidly fallen at -14%. The safe haven status of the USD (which I have difficulties to see) has disappeared as fast as the perceived meltdown has receded.

The commodity and energy complex has also bottomed out, posting steep increases:



Interest rates are on the increase and artificially low yielding government debt is the last bubble (the mother of all bubbles?) to explode.



10 yr US Treasuries yield increased over 80% (or 101 basis points) from 2.05% at the end of 2008 to 3.06% on June 2. And this move applies to all government debt around the world, to a lesser magnitude however (30%-35% in the UK, Japan, Canada and somewhat less in the eurozone – from 7% for Italy to 28% for Germany).

This sharp increase is due to (1) to the receding market fear that benefited the US Treasuries and (2) investors demanding more remuneration to compensate for their perceived risk of holding US Treasuries.

At the end of April 2009 the total marketable US Treasuries was $5.8 trillion (ex TIPS). In 2008, the flight to safety helped US debt to rally 14%. We are now at juncture where the US:

• is perceived to have its economy bottoming out
• has huge fiscal deficits to finance ($1.85 trillion in 2009 and $1.38 in 2010 projected according to the Congressional Budget Office)
• needs to raise $3.25 trillion in 2009 (less than $1 trillion in 2008) according to Goldman Sachs
• faces the largest foreign buyer, China ($ 768 billion invested), getting nervous about its ability to control the situation and reign in fiscal deficits
• sow the seeds of inflation with its 12. 8 trillions of government and Fed spending and commitment to unfreeze the credit market
  

This year, the Treasuries have lost 5.1% in value i.e. $295 billion and we are jut at the beginning of a long, very long downward trail; the bull market for treasuries lasted 28 years (thank you Mr. Volker). The bear market is just starting. Assuming a loss equivalent to 18 % 2008 gains spread over 2 years (quite a conservative assumption) losses will reach more than $1 trillion; bond investors have a good reason to be nervous...

Still gloom.

The next article will review whether the US is moribund.

US debt & budget deficit: I.O.U.S.A.

Very interesting and well documented documentary on the sheer size of the US debt and budget deficit, with an historical perspective and the astonishing magnitude of the problem lying ahead. And this is before the sub-prime crisis... Do you really want to hold USD?

A must to watch!

Cartoon of the day

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