 Paying off the Piper
John Myers
May 24, 2004
The Daily
Reckoning PRESENTS: Given the size of the U.S. debt bubble and
the fact that the Federal Reserve has the means to print as much
money as it likes, why would the U.S. even consider repaying
its loans with today's expensive dollars when it can simply inflate
and repay with tomorrow's cheap ones?
"I
place economy among the first and most important of republican
virtues, and public debt as the greatest of dangers to be feared."
-Thomas Jefferson
The majority
of stock and bond investors are facing a dire future. The only
thing higher than tensions in the Middle East is the price of
crude oil. Meanwhile, the popular press openly questions whether
the president has the leadership skills to warrant re-election.
I am referring to 1979, but the parallels to 2004 are undeniable.
President George
W. Bush is certainly cut from a different cloth than President
Jimmy Carter, yet the problems America faced in the late 1970s
- rising debt, slow growth and an explosive Middle East - have
returned in droves.
Those of us
with a few gray hairs remember the '70s, not just for the outlandish
clothes and mindless music, but also for the long lines of cars
snaking from gas stations during the Arab oil embargo. And who
could forget the decade-long bear market in stocks and bonds?
In the 1970s, the concept of perpetual government debt was still
a relatively new idea in the United States. In fact, at the dawn
of that decade, the United States was the world's largest creditor.
Since then, however, successive presidents and Congresses have
refused to let a large deflationary period occur on their watch.
Big companies like Chrysler near bankruptcy? No problem - taxpayer
money will bail them out. The same solution was used for reviving
both the banking and thrift industries during the S&L crisis
of the 1980s.
It seems as
if there is no problem that Washington cannot wash away with
taxpayer money. But just as there are limits to how much oil
we can draw from the Earth, there are limits to how much money
Uncle Sam can borrow without triggering an economic crisis. After
all, our government does not earn money. It can only fill its
coffers in two ways: taxation and borrowing. But borrowing has
become an albatross around the government's neck.
Currently, the federal government is spending half a trillion
dollars more than it collects. Even in the face of this troubling
fact, the president and Congress continue to contract new obligations.
There is the $100 billion - and growing - tab for our involvement
in Iraq and the $14 billion conscripted for the war on terrorism.
That is even before we spend a nickel on traditional social and
defense spending. In the midst of this, our president is determined
to cut taxes to revive a mature economy. And then there are the
interest costs on all this debt.
The financial
obligation is so big that it is hard to fathom. One way to look
at it is to consider the fact that America's annual deficit almost
matches the total value of goods and services that Canada produces
in a single year.
U.S. federal debt was relatively flat until the mid-'70s. But
from then on, it has been on an almost uninterrupted upward trajectory.
We have reached a point where federal debt stands at a level
so that each American owes roughly $25,000. A bit of arithmetic
shows that a family of four is on the hook for $100,000 in federal
IOUs.
Most shocking is that half of this debt - some $3.5 trillion
- has been borrowed since 1990! That is amazing when you consider
that since the creation of our nation until the mid-1970s - a
span of 200 years that included two world wars - our federal
government had accumulated a debt of less than $1 trillion.
Now fast forward to 2004. Washington's guns-and-butter course
of action will result in a debt of $1 trillion a year by the
end of this decade.
Not that long
ago economists argued that federal debt was of little consequence,
since it was money we owed to ourselves. That is no longer the
case today. Of the $3 trillion in Treasury debt outstanding,
foreigners hold more than half of it.
In other words,
the rest of the world - much of it envious of the American way
of life - is financing America's social spending, the government's
interest payments and even our defense spending.
Today the United
States no longer faces the threat of Soviet aggression, but the
country now faces a much more subtle threat - mass selling of
Treasury bonds by foreigners. The results of any rush for the
exits by our foreign creditors would make the stock market crash
of October 1929 look like an inconvenience. The fact is that
the greenback is vulnerable to a sudden and devastating vote
of no-confidence.
The divestment
of Treasury debt by foreigners would send the dollar reeling
and wreck havoc in the bond markets. America has made itself
so dependent on the lending of foreign interests - most notably
foreign central banks - that it wouldn't know how to survive
without.
In military
terms, the United States' power is unparalleled; but it is nevertheless
vulnerable to the economic whims of foreigners, who own $8 trillion
of U.S. financial assets, including 13% of all stocks and 24%
of corporate bonds. And foreigners have the ability to slowly
but surely divest themselves out of dollars. In fact, I believe
this is exactly what has been happening over the past year.
But keeping
foreign nations committed to U.S. dollars and Treasurys is becoming
tougher by the day as the value of the dollar slides and America
keeps spending money it doesn't have. The United States must
try to manage a delicate balancing act between borrowing heavily
from foreigners and keeping rates low for the folks at home.
To keep the
economy out of the ditch, the Fed must not only keep rates low
to make government borrowing affordable, but also they must create
an atmosphere where the vast majority of Americans can afford
to spend now and pay later. Just how long this loop can continue
remains to be seen, but if the government has its way, the payments
promised in the future will exact a lot less pain than most anticipate.
One thing seems
certain - with a total debt load now measuring four times America's
GDP, the nation's ability to pay back what it borrowed is next
to impossible. It is probably safe to say that no empire has
faced such a startling predicament since Rome.
America's debt
bubble has grown so big that there is only one way out - inflate
the dollar and reducing the real cost of its payments. In order
to do this the Fed will not be able to raise interest rates.
It wouldn't
take much in the way of interest rate hikes to collapse this
debt-laden economy. The last time the Fed raised rates (1999
to 2000), it brought about a collapse in the stock market and
a subsequent recession. Today the economy is far more dependent
on asset inflation in real estate, stocks, bonds and mortgages.
Therefore, a sharp rise in rates would bring about severe asset
deflation in paper assets.
The long and
short of it is that credit will continue to be expanded in this
country until no more borrowers can be found. Then, when borrowing
dries up, the government will become the borrower-of-last-resort,
the Fed monetizing all the government's excess borrowing or budget
deficits. This monetary inflation virtually guarantees a bull
market in gold, silver and commodities.
Keep printing,
Dr. Greenspan, keep printing...
Regards
John Myers
for the Daily
Reckoning
Editor's note:
John Myers - son of the great goldbug C.V. Myers - has
been helping readers earn suprisingly lucrative returns in stocks
largely unknown to Wall Street's wunderkinder since his
early 20s. Our man on the scene in Calgary, John has his fingers
on the pulse of natural resource profits - including oil, gas,
energy and gold.
___________
321gold Inc
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