On the debt: If you’ve been reading my articles, you already know that I am incredibly concerned about the debt level in America. While a certain deleveraging has occurred at the business level and the household level (two sectors I believe have responded smartly to an overleveraged debt bubble), debt levels are still not in line with income and have to be reduced further. This process will not conclude anytime soon. But at least it is underway, and only upon its conclusion may we once again enjoy a new virtuous economic cycle where growth spurs jobs which lifts income, thus increasing consumer spending (of the good kind), ultimately leading to more growth, perpetuating the cycle. Unfortunately, the government, shockingly late in understanding what exactly was breaking down, has taken the exact opposite approach. Justified as the “spender of last resort,” bureaucrats have stepped in for all groups deleveraging in the name of stabilizing growth. Priority Number 1 for this clan is clearly not putting the country, our country, our one and only, back on firmer footing for the future after a period of such drunken excess, mismanagement, and greed. No, it is to look good to the people (I can’t get that Youtube of Jon Edward’s 30 minute hairstyling session out of my mind http://www.youtube.com/watch?v=7kCAFkfFLQQ ) and, more importantly, maybe, to come out of the current recession as fast as possible. As a matter of fact, it certainly seems as if massive action has been taken to mask the problem until perhaps the 2010 mid-term elections, at the expense of sound balance sheets, balance sheets that may permit a tax code that is supportive of growth and not suppressive of it (though they may be dumb enough to think this response might actually work!) It’s these intentions that I cannot confirm, but my mind wanders. Other people tell me, “No, they know, but if there is a rug to sweep something under, they will sweep it every time.” Adjustments are coming, of course they are. So the question is, “Did they know and deceive us, or were they just dumb?” Of adjustments, I am hearing rumors flying of an August downgrade to the 2009, and potentially 2010, budget projections, during the mid-year budget assessment, due in July, but creatively postponed by Obama and friends. They will say that unemployment has exceeded their estimates, putting pressure on growth and income, while expenses are at the high or higher end of the range. This is only the beginning of such downgrades in this author’s opinion. I am quite sure this “disappointment” in our fiscal strength was a driving factor behind the Obama Administration’s hopeful insistence (not granted) on rolling out health care reform before the August recess. Passing health care, with all of its new calculations by the Congressional Budget Office, always the same, higher costs than envisioned, would be easier before the revisions to the overall national deficit projections, so that is the reason for the delays and now the rumors. It seems pretty clear that, in the end, a watered-down version of health care reform, if it can still be called health care reform, will be championed by the Democrats even though most onlookers will know quite well that they botched this one big-time, and should suffer consequences as a result.
But back to the debt. These revisions are going to be the trouble here. Revisions cause new math, and new math will show rising debt to GDP levels. It has been predicted by some that debt to GDP ratios for developed countries may rise to 120% by 2013. This would be a first, and the big question of course, is where all this money is going to come from? The second question is that, if the money does happen to be garnered from the global private sector, how much investment demand (non-governmental demand) is going to be crowded out? In laypersons terms, if a bunch of private money gets invested in the endless stream of bond auctions occurring around the globe to finance such “public spending,” what effect will that have on all the private money that is supposed to be invested in the real economy, on up-start business, and the like—traditional engines of real growth? So now you understand crowding out. Anyhow, large persistent deficits will make crowding out a big problem. If not financed through bonds sales, large deficits can be attacked by raising taxes which also serve to strip people of the money they would otherwise use to make investments. The final way to make the difficult numbers of a large deficit work is to print a portion of the revenue gap. Over time, this method will also backfire on itself as the increased money supply will ultimately work its way into the real economy, thereby reducing the value of the money itself which makes goods and services more expensive (requiring more of the weakened money to purchase them). We call this inflation. Unfortunately, this government will never be truthful about the real rate of inflation, it will always understate it, as entitlements of all kinds, Medicare and social security, are indexed to the Consumer Price Index. We already have no idea how we are going to pay what we have promised to an aging generation. Can you imagine what those numbers would look like if compounded by a 10% annual rate of inflation? Yikes! Like during 2005-2006, when homes, food, gas, health, and education costs were doubling in some cases with official CPI figures standing under 5%. You will be on your own to know, no, to feel, when this monetary devil has struck. Good news, you will not be alone, the bond market vigilantes will be right there with you. But this is still a ways off in an economy that continues to deleverage. The deflation story is hard to ignore, as credit, employment, income, consumption, and production continue to contract. Further, I do adhere to the narrowly understood view that inflation and deflation are somewhat psychological phenomena as they are driven by the perception of future pricing, or the future value of money. Currently, fundamental deflationary forces listed above could very well combine with changing consumer attitudes towards debt and “extravagance” and perpetuate a spiral if you will, one that is feared most by policy makers and bankers who understand that a system based on leveraging the value of assets, requires growth above all else to preserve itself. Danger awaits, sadly enough.