Indian Summer

I read an interesting interview with Former Treasury Secretary O'Neill. I think it was on PBS, and I will post the link later when I find it at the office.

http://www.pbs.org/wgbh/pages/frontline/tentrillion/interviews/oneill.html

“Here’s the fundamental problem: How much money can a society borrow before it begins to have negative effects on our ability to borrow any more? … When you get to the point that people won’t loan you any more money as a government, you’ve got a horrendous problem. And it’s happened to governments - - in Argentina, most famously, in recent times. Mexico was kind of in that situation until we gave them a very big loan.

… Now, what happens before that, is governments raise the interest rates so that people will loan them money. … Unfortunately, when interest rates get that high, economic activity slows down and eventually it will stop. We’re not at that level yet with our $11 trillion worth of acknowledged debt, but there’s a bigger problem out there, which is $53 trillion worth of unfunded liabilities that we, the American people, have signed up for. Most of the American people don’t know that we have these so-called unfunded liabilities. An important part of that is Social Security and Medicare…

… This fundamental crisis in retrospect will look like a child’s game compared to what we’re heading into when we have to begin raising enormous amounts of money through floating debt, or reneging on the obligations we made to people that they thought were good and clear from Social Security and Medicare benefits…”

What in the world is “acknowledged debt”? Paulson is admitting that the US Government has it’s own off-balance-sheet-accounting (ala Enron), via agencies like Freddie, Fannie, Sallie and the TVA. I think those amount to another $7 trillion. You can add AIG and AIG as well, for another $3.5 trillion. I’m sure there is more, but you get the idea.

The issue we are running into is that there are no buyers for US Government Debt at these interest rates, so the Government has to buy its own debt (ie, print money).

More O'Neill –
Interviewer –“I've got a credit limit - - there’s a certain point where nobody is going to give me any credit - - and you, too … Does the United States government?

O'Neill – “we do. We have a point where we won’t be able to get other governments, or the American people for that matter, to lend money, because they’ll be afraid we won’t honor our obligations.”

“Since 1935 we’ve talked that talk, like we were saving money. We’ve been spending money all along. It’s a GIANT FRAUD; IT’S A GIANT PONZI SCHEME (caps added by me). Every year we took the money and we spent it on other things.

There’s a so-called famous lockbox in West Virginia I went to look at when I was Secretary of The Treasury. You know what’ in the lockbox? Actually it’s a filing cabinet, and there are some pieces of paper that say, “We owe you.” There’s no money there; there are no investments there. There’s nothing there but a piece of paper. IT’S A FRAUD.”

People think, “Hey, I out money all my life in Social Security and Medicare.” You didn’t really. The government just took it and spent it on something else. There’s no money there”

The US is drowning in debt. Private debt is 300% of GDP ($14 trillion). This is twice as much as at any other point in history. Total Federal debt and entitlements is now over $80 trillion. State and Municipal debt is another several trillion. That is what, $130 trillion or so? World GDP was $64 trillion last year and will fall in 2009…

Indian Summer
The only solution is to try and reinflate speculation, via cheap money, subsidies and overt asset price manipulation. Once asset prices are artificially propped up, then the game will be to inflate away the real value of all the debt outstanding. 3 years of 20% inflation cuts the real value of the debt to 58 cents on the original dollar.

I’ve been wanting to post on entitlements for some time. My belief is that the Medical Insurance entitlement is as impossible to pay for as all the others and is just being offered to gain votes for a few years, until the true cost becomes apparent and somebody else will need to deal with it then.

Boomers Prepare
I want to quote a little from a book written in 1997, “The Fourth Turning” (William Strauss and Neil Howe) -

“Sooner or later, the truth will dawn on old Boomers that the money simply won’t be there to support their accustomed consumption habits in old age. Neither they nor their nation will have saved enough.

From this sudden realization could issue the end game of Boomer lifecycle consumption and saving habits: the Great Devaluation. At long last, aging Boomers will focus on the hard fact that a newly endangered America truly cannot (and younger generations will not) make their old-age subsidies a top public priority. This realization will render Boomers jittery about preserving their remaining assets. Some unforeseeable happenstance could spark a precipitous market selloff, as old investors will want to liquidate their equities to a shrinking universe of buyers. The main domestic buyers would be (Generation X), who will have lower incomes and far fewer assets than Boomers and who will be of no mind to take risks with wobbling markets. Foreigners will be hesitant to acquire more U.S. assets in a time of pending fiscal crisis, especially since so many of their societies will be facing similar demographic problems. A brief but precipitous panic could ensue. Years of savings could vanish in a matter of days – or hours.

The Great Devaluation is likely to hit Boomers just as their first cohorts are reaching the official ages of retirement, long before Social Security is now projected to go into official bankruptcy. Indeed, the panic could be triggered in part by the crystallizing financial anxieties of leading-edge Boomers. The flash point may well occur when the new elder mindset (of the 1943 “victory baby” cohort) combines with the new demographic realities (of the large 1946 “baby boom” cohort) to reach a critical mass. This could occur a few years before or after 2005 – perhaps between 2002 (when the 1943 cohort reaches the IRA distribution age of 59 ½) and 2008 (when the 1946 cohort reaches the initial Social Security eligibility age of 62, the age at which two-thirds of American now start receiving benefits).” (page 283)

“…The typical Boomer will live on bits and pieces of SEP-IRAs, Keoghs, 401ks, federal benefits, and assorted corporate pension scraps that will vary enormously from person to person. For many, this will add up to a lot; for many others, nearly nothing.
When the market hits bottom, millions of Boomers will find themselves at the brink of old age with far smaller nest eggs than they ever expected. They will immediately have to make do with steeply diminished material consumption.” (page 284)

We all understand the consequences of a rapid collapse in “confidence” in Social Security (per Paulson, the US Government version of the Madoff Ponzi Scheme). This is the reality that the government is trying to avoid.

The Obama Administration will now lever up the US Government, via the TARP, TALF and PPIP, to reinflate asset prices. Make no mistake about it - this rally in prices will be in nominal terms (inflation assisted) and will be met with massive liquidations from Pensions, both Public and Private.

I would expect the rally to carry into the 2012 Presidential Election and maybe into the first few years of Obama’s potential 2nd Term (no hate mail please – this sounds more realistic than Sarah Palin’s 1st term). But make no mistake about it - this will be like a late-October heat wave, into which you should be harvesting the last of your crops and not planting new ones.