Panic Signs

The Beginning of the Panic

In the next six weeks, our country will enter a period without precedence in our experience.

On June 30, the Federal Reserve has pledged to cease buying U.S. Treasury bonds. This is the second time since the financial crisis it has intervened in the Treasury market in a major way. The program of buying new Treasury issues has been dubbed "quantitative easing II" (QE2).

We'd wager not one in 1,000 Americans has any idea (or at least any real understanding) of what has been going on in the market for U.S. Treasury bonds since the financial crisis. For the last nine months, the Fed has been printing up new dollars and buying huge amounts of newly issued debt from the U.S. Treasury – $600 billion of bonds. And these purchases followed a $1.75 trillion program of quantitative easing that ran from March 2009 to March 2010.

It is no exaggeration to say that a printing press has kept our economy going for the last two years. But what will happen when the printing stops?

Answering that question is the focus of this month's issue. While we honestly don't know, we're going to speculate that, in the short term, the U.S. dollar will rally and commodities will suffer a serious correction. We will see a dramatic slowdown in the rate of monetary inflation. People will think prices will stop going up. Economic activity will begin to decline. Fear will lead a lot of investors to "go to cash." That means buying short-term U.S. Treasury bonds because they're the most liquid, most frequently traded form of cash.

As this process unfolds, we expect to see another global panic. Especially if Bernanke's decision to stop the presses coincides with a Republican political gambit – refusing to raise the debt ceiling, which could cause a default on U.S. Treasury bonds.

Whether the debt ceiling is raised or not, it's only a matter of time before the Fed will have to turn on the presses again for reasons we detail below. And when "QE3" begins, it will send our creditors an unmistakable message: You will never be repaid in anything other than massively devalued paper.

That will be a horrible day for the value of our currency. It may even mean the end of the U.S. dollar as the world's reserve currency.

We Can't Borrow Forever... and We Can't Stop

On May 11, the U.S. Treasury updated the public on our federal government's finances. So far this fiscal year (which began October 1, 2010), the feds have borrowed nearly $1 trillion. April marked the 31st consecutive month of deficit spending at the federal level. It did not matter that tax receipts have rebounded substantially – growth in spending on social programs has far outpaced the increase in revenues.

In total, President Obama's economic mandarins now forecast the fiscal year 2011 deficit will come in at $1.6 trillion.

To put this figure in perspective for you, when Ronald Reagan took office, the entire national debt totaled less than $1 trillion. Even as late as 2002, the national debt was only $6 trillion. Obama's administration will almost surely borrow more than $6 trillion in only his first term. In four years, Obama will double our entire national debt from its pre-financial crisis levels.

This has never happened in peacetime.

Keep in mind, this is the same president who, after taking office in 2009, held a widely publicized Fiscal Responsibility Summit and pledged to "halve the deficit we inherited" by 2013.

The budget deficit in Bush's last year in office (the 2008-09 calendar year) was $1.2 trillion – due largely to the Wall Street bailout and Iraq war.

Today, both of these major sources of spending have largely disappeared. The government is selling assets acquired during the financial crisis. That generates revenue. Yet rather than decreasing the deficit, Obama has allowed it to grow by 33% annually.

This same man, while a U.S. senator, called 2006 efforts to raise the debt ceiling "a sign of leadership failure." He voted against raising the debt ceiling to $9 trillion, proclaiming, "Americans deserve better." Obama noted, accurately in our view, these mounting federal debts were "shifting the burden of bad choices onto the backs of our children and grandchildren."

We hope history will hold Obama accountable for his actions. We're not holding our breath. Federal, state, and local government spending now makes up about 45% of the U.S. economy. Hardly any major business in America doesn't count on the government for a significant amount of its earnings. While we used to call this kind of system "socialism," today the popular term is "crony capitalism."

Whatever you call it, it leads to collapse.

Another worrisome sign? A record number of people (almost 70 million) now depends on the U.S. government for their daily housing, food, and – most of all – health care...

Today, 45% of American households receive some form of direct government payments. And 132.5 million people pay no federal taxes whatsoever – a record number of people who neither paid federal income taxes in 2010 nor were claimed as a dependent by another taxpayer.

Tallying up all these numbers, you discover something quite amazing. A tiny number of Americans pays for the well-being of nearly a majority. While half of the population may pay something in taxes, only the top 10% – people earning more than $113,000 – pay a substantive amount. These few citizens pay 70% of all the income taxes collected.

Benefits funded this way are unsustainable. According to a recent study published in the Wall Street Journal, the average couple that retires at age 66 on Social Security and Medicare will receive $1 million in benefits. On average, they and their employers paid $500,000 into the system.

The federal government is taking an excessive amount of money from its few high earners – a wealthy minority – and redistributing inefficiently to pay for services the country can't realistically afford...

Individuals, of course, are not the only beneficiaries. Entire industries gush cash thanks to the generosity of the federal treasury – mortgage REITs, defense companies, and most of the health care complex.

The system is so broken, not even the already lopsided system is enough. Not even close. Every week we hear more demands for the "rich" to pay their "fair share." The political reasons for spending are so powerful, until the government can take it from there, they will continue to borrow it from somewhere else.

We don't believe Americans are intrinsically superior to the Egyptians of the 1870s or the British of the 1910s. Surely, many people in those societies recognized the approaching financial disaster. Any American with the ability to balance a checkbook can discern the serious nature of this financial situation, and the politics that explain its origins. Yet the borrowing and spending continue to accelerate. In the battle between political expediency and financial probity, the lust for power will always win.

Thus have all of Suez's masters destroyed themselves. Thus shall we be destroyed.