Friday, August 27, 2010

Interest Rates Suck Big Time

The going joke is “If you ask 3 economists their opinion on the economy, you get 5 different answers.” The question arises today, if economists have inside knowledge to the economy, why didn’t they spot this mess coming years ago?

And then we have the question will it be inflation or deflation. Out come the experts with all sorts of graphs and charts pointing to deflation. Meanwhile I went over to Wendy’s for my 99¢ bacon cheeseburger today and the price is now $1.29. That’s a 30 percent increase. And if that wasn't bad enough, my Gin went up a dollar to $14 for 1.75 liters (I'm not sure that at that price it is considered Gin, rocket fuel might be a better description).

The real question is this, the government borrowed 10 trillion dollars from all of us and we feel comfortable loaning it to the government for only TWO PERCENT INTEREST. I’ve heard of The Dumb Friends League, but investors aren’t dumber than pets, are they? What gives?

Borrowed money is one thing, printed money is another. When Ben buys one of Geithner’s T-bills, that is printing money (the Treasury sells Bernake a T-bill and the Treasury gets a bank entry for cash in the government account). No real dollars are printed; from there, the government just prints a Social Security check or an unemployment check. Of course, the government can tax and the Treasury can redeem Tim's markers at any time. The real question comes up, how much in markers does the Federal Reserve hold? I’m guessing, anywhere from 2 trillion to 10 trillion dollars. Just the management of Freddie and Fannie implies about 3 trillion right there. What they bought from the banks could be a rather absurd amount, possibly mind boggling. No saver has lost a bank dollar, but our government had to pony up printed dollars for the losses on all the failed banks' ledger sheets.

Look at it a different way, say you have one million dollars in the bank. Gee, that means you get 20k a year in interest. Let’s not all queue up at once to take advantage of this wonderful offer. It sucks so bad, why even put your dollars in the bank? Why not just spend it?

The government has printed money, borrowed money and spent every bit of it. The only reason there is no apparent inflation with interest rates is because the government has taken risk out of the market, all bank loans are insured against loss. Without risk, there is no need for higher interest rates. Of course one issue pops up. Gold had one hang up, it paid no interest. Today looking at long term, GOLD is better than holding government paper.

Ask yourself one question, where will the money come from to pay for all of the health care and Social Security benefits in the future? The money isn’t there; it will have to be printed. We couldn’t pay for it as individuals. What makes it more affordable as a government plan? Do we charge everyone a fair share for all of these new benefits? That doesn’t seem very likely. The absurdity of zero percent interest rates and a national debt towering over 13 trillion dollars should set off an alarm bell somewhere. Credit cards are charging 14 percent. No discount for taxpayers???--kind of figures doesn't it.

The thing we need to interpret from this mess, is that the information we are getting from our government is incomplete. The pieces of this puzzle are all there and they do not fit together as expected. Zero interest rates are similar to a hooker offering free sex. How you ended up in a closet nude, with your hands tied behind your back, is another story.

Copyright 2010 All rights reserved

Tuesday, August 17, 2010

The Impending California “Bankruptcy”

The State of California taxes its residents and provides services. The legislature which has a Democratic majority can’t quite come up with a two thirds vote needed to raise taxes (two Republicans need to vote with them). And of course since the Governor is a Republican, it’s all his fault. The State is running out of funds; expenses are greater than the incoming taxes.

One thing little noticed, in the last 20 years, because it has been so gradual, is the absurd rise in pay and retirement benefits for public employees. It used to be that you got your experience in the public sector and then moved into the private sector for a pay raise—government jobs used to be a joke.

Presently, we have a State that can’t produce a balanced budget without "creative accounting." The thing to remember is that California is supposed to pay education and bond interest first out of the tax revenues. Then there is this State retirement plan called CALPERS.

CALPERS assets dropped from 260 billion to 180 Billion in a span of one year. At the time, 260 billion was sufficient; dropping to 180 billion ought to set off an alarm somewhere. The implication here is that the State guarantees your retirement even if the investors at CALPERS screw up. These money managers bought boat loads California Nevada and Arizona real estate paper. All we need now is a stock market crash and CALPERS will be sucked down a drain. It is assumed the taxpayers of California will be responsible to make up the shortfall of the CALPERS fund. Profits belong to the retirees, losses belong to the taxpayers. That’s not quite right.

Two questions arise. CALPERS took some horrific losses; are these losses automatically insured by the California taxpayer? If the cities/counties declare bankruptcy, is the State liable for their incurred losses? The answer is no in both cases.

Here is where things could get quite peculiar. Bankruptcy laws don’t cover States. California as a State can’t file for bankruptcy (it doesn’t have to), but every city and county in the State can. Bankruptcy is a tool used by many to avoid paying their debts. Stating matter of factually that the State cannot file for bankruptcy kind of implies that the State is on the hook no matter what, and that is a very wrong assumption.

States can repudiate their debts, it happened in the 1840’s. The real issue is state sovereignty. The concept of bankruptcy revolves around the settlement of debts through the courts. The courts can’t force the State to do anything. The 11th amendment prohibits citizens from suing the State.

California created a retirement fund that guarantees benefits according to the wage earners salary and not on what the fund has available to pay out. These two facts point to the obvious, you can’t have it both ways. That and the 40 billion dollars that the State needs to keep going next year means that California is at the end of its rope. California will run out of money soon.

If the State is short of funds there is no bankruptcy dodge, it can decide who gets paid and when. California doesn’t even have to repudiate the debts; it just doesn’t pay them all. Investors will find out what the implications are, when loaning to a sovereign State. You can’t sue them. Plus if you’re a city in trouble, file BK and give your debts to the State, chuckle, chuckle.

With CALPERS, California will contribute its designated percentage for this year’s wages to the fund. But from there, CALPERS is toast. The State is not obligated to bail them out. So a lot of these 100k retirement plans now have some issues. The item that amuses me, does CALPERS have sovereign immunity just like the State?

Things are getting a little dicey; reality and retirement are on a collision course. It reminds me of the airline pilot who use to email me, he had a future 80K pension and bought a 300K house just before retiring. When his airlines came out of bankruptcy he had a 40K pension and lost the house.

The Great Depression of 2006—seems like a start, and it is 2010 and the show has hardly begun—everyone is dragging their feet, and I don’t blame them. I hate to contemplate what's next.

Karl Denninger has also written some material on this. Here is a link to it.

Sunday, August 08, 2010

Inflation the Path to Future Deflation

There are two ways a government can tax. The obvious way is with taxes, and the other way is by printing money. We hear all of this hoopla of “Tax the rich.” I can’t quite figure that one out. First of all if you’re rich, you don’t need to work and there isn’t much the government can tax except for your toys, like mansions, fast cars and yachts. Now if you’re earning quite a bit of money, then the government could get a good share of it. Of course that’s assuming that you’re dumber than a sack of rocks.

Here is a quote from the WSJ by Arthur Laffer
Just look at Sen. John Kerry’s recent yacht brouhaha. He bought and housed his $7 million yacht in Rhode Island instead of Massachusetts, where he is the senior senator and champion of higher taxes on the rich, avoiding some $437,500 in state sales tax and an annual excise tax of about $70,000.
(WSJ Aug2, 2010 page A13)

The government can try to levy a high income tax on the rich, but it will fail miserably. A tax accountant knows all the loop holes that the rich can use to their advantage to avoid taxes.

Inflation is one invisible tax that gets into everyone’s wallet. The eerie thing, is the poor (those living from paycheck to paycheck) never really experience the full blast of inflation. Those saving for retirement get hit the hardest 20 years down the road.

Figure an average taxpayer paying 20% in income taxes. His savings is being taxed by inflation rate of about 6%. Neat! huh? And the ├╝ber rich, with bundles of dollars in the bank, are being taxed while they sleep. In 12 years they will have lost half their purchasing power from inflation alone. Of course if you’re unemployed and broke, you’re not very concerned about taxes or inflation.

In a depression unexpected things happen. Increasing tax rates brings in less revenue. Plus unemployed people generate less tax revenue. At this point, the government has to print more dollars to cover the short fall. It is the same with private business, the fixed costs are still there, the profit isn’t. This is where the herd gets thinned out, only the strong survive. Private enterprise can’t print their way out of this mess like our government can.

The quasi appearance of deflation will show up in items that we can do without; fast food, cable TV, Internet, sports tickets, advertising. The reduction in price of a taco at Del Taco from 59 cents to 39 cents is the final step before bankruptcy---sell them a taco and hope to make a buck on the soft drink. What we are looking at are institutions, that relied on a wild spending economy, to survive. Business models are collapsing. Can a basketball team afford to pay a superstar 16 million if the fans and advertising drop 50 percent? Do we need a Starbucks coffee shop spaced every half mile?

And with public services, we found out here in San Marcos what happens when everyone got together and cut down on water use during the drought, we got charged more for consuming less!

The real thing that bothers me is that the country as a whole is oblivious to the fact that the national debt is drastically out of whack. It’s the concept; “We did it yesterday and it worked, let’s do it again today.” Collectively we have 17 trillion in savings, and the government has borrowed and spent 13 Trillion of it. This is one of those plans that work until it doesn’t.

The deflation that we seem to be experiencing is coming from over capacity. Too many homes, too many restaurants, etc; lack of consumption is about to fix that. The inflation out there is real. My paycheck is buying less and less every day. The neat thing about inflation, the government doesn’t have to collect it as they do with taxes. Inflation generates more taxable income. The government finds it easier to pay off hard earned borrowed dollars with inflated ones in the future.

Real deflation (massive debt destruction) is still possible with this out of control unfunded government deficit spending. All it would take, is for interest rates to hit 8% and Uncle Sam would be insolvent; the national debt bubble would pop. Vaporizing 13 trillion in debt would be equivalent to what happened during the Great Depression. So its full speed ahead, the national debt be damned. We’re not sure where we are going, but we’re making excellent time.