DJ30 – 11,191   up 147
US Treasury 10 Year Bond – 2.02%    up 0.11%
USDEUR  -  1.3601
Gold – $1655  up $52
Oil – $83.53    up  $3.29

Positive day in stocks with big jumps of up to 6% in Europe.  Interest rates are rising, and have been up 1/4% in 3 days.  Gold turned around has gained today.

How to Multiply Money…….

Here is a great example on how to “print money” the easy way.  This is being planned right now in Europe and is a perfect example of how inflation really works.

The Europeans a little while ago in May, 2011 created the EFSF or European Financial Security Facility to provide 440B Euros, or about $600B, for use to lend out to EU/Euro members in financial trouble – think Greece, etc.  The EFSF is a credit facility which has a AAA rating – and this is an important point.  It is provided by all the EU nations and therefore by European taxpayers.  Consider this facility a very special bank with a singular purpose – because that is what the EU leaders are thinking right now.

Well, here is the scheme being devised right now.  The idea is to “lever up” the fund 8 fold.  How you say?  Well, this is just like any bank in the world that uses its deposits to lend out much more than it takes in.  This is called the fractional banking system.  The proportion classically used for levering up is 10 to 1.  So, 8 to 1 is a little more conservative?

So, levering up at 8 to 1, the $600B fund can lend out 8 x $600 = $4.8 TRILLION.  Now we are starting to talk about some real money here.

What are they going to do with that money?  They will purchase those bum bonds from Italy, Spain, maybe other nations like Greece.  Then the EFSF will hold those lousy bonds which in the case of Greece are worth about 50% (or less?) than their face value.  The lending nations (Greece, etc) are off the hook until it is time to pay interest on those bonds, or to pay back the principle.

The EFSF using those bonds are collateral will then issue new bonds for sale under its own banner of EFSF bonds – and these new bonds will be AAA bonds.  So, the EFSF will be paying the lowest interest rate while holding bonds from nations who have much less than AAA rating, and using those bonds as collateral.

Do you think this is a trick?  Well, it is, and if the population of Europe falls for it, they will be paying the price tag sometime in the future.  Or, following the US example, maybe their kids and grandkids will be paying the price tag.

Will this actually happen?  It all depends on the German Parliament.  They will be voting on this proposal tomorrow.

Where does this EFSF action go……..

It is pretty obvious that this money printing exercise will create inflation in Europe.  You can personally gain on this by “shorting” the Euro.  But, a warning, I don’t recommend doing this unless you are an expert in the futures market.  The Euro, technically speaking, will be going down to 1.29, and then on to 1.16 Euros/Dollar.

Then, a little further into the future, European inflation will pick up as goods from outside of Europe have higher Euro prices – like things from China or the USA.

A higher inflation rate in Europe will lead to a further slowdown in the European economy – and could lead from a recession into a depression.

There aren’t many actions being proposed or taken by governments today that don’t feed further into a very negative economy.  Our government and the world’s governments are all in collaboration in this – as the only way out of the debt situation they created in the first place.  From an economics point of view, any solutions must go to recession as the problem is excess debt, and the solution is always getting rid of the debt – either by default or by inflation.  Naturally, we are not used to this as a population because we personally ALWAYS pay off our debt by using earned or saved money.  The governments are much more devious, and are working against your best interest – so sorry to report this.  Remember to vote the pin-heads out of office – - – vote soon and vote often.

DJ30 – 12,572   down 15
US Treasury 10 Year Bond – 2.93%    up 0.04%
USDEUR  -  1.4228
Gold – $1599     up $10
Oil – $98.09    up $0.69

Oil continues its rise, and the Dollar is definitely falling right now – kind of crazy.  The Yen is hitting new recent highs.  Gold rebounded from yesterday’s fall as the “Gang of Six” debt talks started to get some objections.

Debts and Deficits…….

Where do debts and deficits lead when they get out of control?  Today, I want to drive home the point on why I am so concerned about the US economy (and other countries too) and why I keep hammering home the possibility of inflation in the future.

If we use history as our guide, and look at other countries that have gone through big (or hyper) inflation, then you come to the conclusion that their cause without exception was national debt and deficits.  (As an aside, I can name 22 countries that have had hyperinflation since 1900, and, of those, 14 that have had hyperinflation since 1990 – that should scare you right away.)  Okay, I hear you say, but “money printing” is the root cause of inflation.  Yes, that’s right.  But, let’s look a little deeper, and ask why countries did all that money printing.  You will see that it was debt and deficit.  Governmental annual deficits add up to total debt, and debt needs to be repaid by interest payments on that debt.  The higher the debt; the larger the interest payment.  Also, as Greece/Italy/Spain/Ireland are finding out today, the worse your debt position as perceived by bond investors, the higher the interest rate they demand to buy your debt.

So, we see that there are two major pressures on a nation’s annual payments

1. the total debt size
2. the average interest rate on that debt (and the average interest rate is determined by the credit rating of that nation’s debt).
   

The first times the second equals the amount of interest paid for that year.  And, that money is paid first from the national coffers because default (non payment of the interest) is so painful to the nation that it is never considered an option.

So, back to the question “Why do countries do all that money printing?”  At some point as interest increases each year, the total amount of interest becomes onerous.  At that point, the country in question starts looking around for money to pay for all those other things that nations spend their money on.  They look for higher taxes (sound familiar?)  They rarely look at reducing spending, but they even do that under extreme conditions (like the  dictator needs a new airplane, so the soup lines are shortened.)  Eventually, someone smart comes around and tells the leadership that all that debt, or at least the interest on the debt can just be printed by the national printing press, and only the ink has to be paid for – so why not do it???  This is the easy way out, and leads to the slippery slope of no inflation – to mild inflation – to real inflation – to high inflation – to hyperinflation.

I hope that simple explanation is clear – as it applies today in the US and Europe and even China (in my opinion.)  The US is approaching the point where the interest is becoming onerous.  Europe is a little beyond that point, and is bailing out nations (rather than allowing default) – and is wrestling with the thought of buying the “bad” debt into the ECB – thereby inflating the Euro.  China is growing so fast that inflation is growing too fast, and China is battling the good battle by increasing interest rates (the classic method to fight inflation).

One big difference between the historic examples of hyperinflation and the US today is that historically, the printing press is controlled by the government directly. Thus it becomes easy to approve the printing of money.   In the US, the printing press is controlled by the Federal Reserve, and (theoretically) the FED is independent from the government.  The reason the FED is independent has many reasons, but one of them is to break the link (and temptation) between the government and the printing press.

Europe also has a somewhat “independent” central bank, the European Central Bank (ECB), as each nation uses the Euro, but only the ECB can print money.  Right now the ECB is run by an inflation hawk, Jean-Claude Trichet, who remembers the bad days less than 100 years ago when Germany succumbed to hyperinflation.  As a reminder of those days, take a look at this money……

China is a more classic example as the printing press is controlled by the Chinese Government directly – as are interest rates, etc.

The science of hyperinflation has been studied to death, but the measures of an economy that leads to hyperinflation is not scientifically known – but there are some good guesses out there.   Here are the measures:

1. Debt to GDP ratio exceeding 250%
2. Interest payments to tax revenue ratio greater than 30%
3. Budget deficit size
4. Familiarity with inflation
   

Let’s look at the US today using these measures:

1. Debt to GDP ratio is either 100% or 400% depending on what you include. As you know the Debt CAP is $14.3T, but we’ve already exceeded that and it is now at $14.5T (as Geithner is borrowing money from Federal Employee retirement funds – looting the pensions as I would say), and GDP is $15.0T – so that gets us to 100% or will get us there later this year.  However, the US “owes” Social Security and Medicare to its citizens, and the money collected from paychecks has already been spent, and replaced with IOUs, so the government owes all this money too.  If you do a “present value” calculation on this money and use the age and life expectancy of Americans, the total Debt soars, and the ratio becomes 400%.
2. Interest payments on the debt to tax revenues ratio will exceed 30% in October this year.
3. Budget deficit size is $1.5T – and this is a record breaking number.  More importantly, the current plan is to have deficits of this size out for the next 10 years – imagine that!!!!!!
4. Familiarity with inflation.  The FED was created in 1913, and a “nickel” in 1913 would require $1 to buy the same thing today.  In other words, the Dollar has lost 95% of its purchasing power over the lifetime of the FED.  I think we are very familiar with inflation as it is part of our life as Americans – I am sorry to say.
   

So, the purpose of that is to say that we are approaching the starting point of inflation in the USA.

But, I hear you say, “Why hasn’t inflation been much worse than the 4% it is today?”  “Hasn’t the FED printed a bundle of money since the 2008 meltdown?”  Well, my first answer is “It is worse.”  The government changes the definition of CPI from time to time, and always to lower the calculated inflation number – so it isn’t 4% today.  Also, it is very easy to come to the conclusion that the CPI calculation just doesn’t apply to you and me – it applies to the “average” American – and we both know we are not average.

However, there is a more complex answer to this question.  Our current dilemma is one of “deflation”.  By deflation, I mean that the value of things (houses, some stocks) are going down.  When housing values went down – and they are still going down – the total value of homes in the USA declined, and declined by TRILLIONS of Dollars.  This money went to “money heaven” – which is the opposite of printing money, or inflation.  In order for inflation to really kick in, the  “deflation” holes must be filled with inflationary new money.  It is no coincidence that the FED has printed about $3T worth of new money since 2008.

Now, you know why I get so excited about QE3 – as any Quantitative Easing is inflationary.  At some point, and I believe we are very close to that point, the deflationary holes will be filled, and the added new money will go straight into inflation – inflation that you can touch and feel every day.

But, now back to the point of this article.  Our economy is either worse or very close to that of Greece.   And, you can see what’s going on in Greece and did you know that the number of people in poverty is soaring as are the soup lines? .  We owe too much money, and that debt is causing interest payments to blossom into something big.  Our government lives on inflation already, so it isn’t any big leap to encourage the FED to keep on printing.  Our deficit problem is big, and probably (we’ll see after August 2 when the Debt Cap talks are supposed to conclude) will continue to be big for at least on more year – or maybe 5 more years – it all depends on the 2012 election.

DJ30 – 12,004   up 43
US Treasury 10 Year Bond – 2.94%    up 0.04%
USDEUR  -  1.4307
Gold – $1540     up $11
Oil – $92.91    down $2.04

Stocks continue to move sideways in the trading gap defined by the S&P 500 between 1250 and 1350 – currently at 1272.  Stocks have had a great run up and are deciding whether or not a 10% correction is enough from their highs.  I think there is something more fundamental going on – specifically whether or not the QE2 money running out in a little over a week will stop supporting stocks, and cause a further downward movement.  We’ll see.

Oil is trading down nicely, and gasoline is going down too as you can see each day at the pumps.  Now that oil has got down to $92, the next test lower is $85 technically speaking.

World events – like the Greek tragedy – are weighing heavily on financial markets as risks and worries.  Gold is buoyed by these fears.

Inflation – Is there a set-up???????

I listen to the news outlets regularly watching for trends and messages that could be coming out for general public consumption.  I just might have seen one that confirms one of my worst fears.  Both the Wall St Journal and CNN have had articles/defined opinions that favor having inflation solve our economic problems in the US.  These happened this past week.  The Wall St. Journal stated that a CPI of 5% is what’s needed to get us out of our economic mess.  (CPI is the measure of inflation – so don’t be lulled into complacency by the term CPI).

Both of these news outlets provide government PR spaces for future possible governmental actions.  So, my fear is that these news articles are a precursor of future government actions.

The CNN debate was very telling.  In it, a professor said that inflation is the ONLY solution available to the government to pay off the enormous debt that we have and are creating each year.  Otherwise, we will have to default on our debt – and we just won’t default – so inflation is the only way out of the mess.

Why is this my biggest fear?  Probably because I agree with the professor – inflating our way out this mess is our only course of action.  However, it will destroy many middle class and poor Americans.  All their life savings will be wiped out by this insidious increase in inflation.  I devoted a past economyguy to the motivations of government to lean toward inflating our way out this economic mess – and they are persuasive.

Remember that inflation is really a decrease in the buying power of YOUR Dollars.

Inflation is a tax – but one that no elected official ever voted on.  It is a tax on all Dollar holding people, but one that no voting American ever voted on.  Who creates inflation then?  The Federal Reserve creates inflation by increasing the money supply.  (If you disagree with this definition of inflation, you need to do a lot of research on what inflation really is.  And, you are dangerous to society as you probably would propagate a myth that inflation is something else.  The news outlets are currently propagating that myth right now.)

My fear is that the government is giving a “wink and a nod” to the Federal Reserve to fix all our problems by creating a bunch more money supply.

I am writing this economyguy as a warning to you to watch the news for yourselves – and decide if the seeds of inflation are being “sold” to Americans by our press.  And, then watch the measures of inflation – such as CPI and PPI for signs that inflation is actually happening.  And watch all the actions of the Federal Reserve for any actions that might increase the money supply.  Most importantly, protect yourselves and your families from the ravages of inflation.  Remember that during periods of inflation – it is better to own “things” than to keep your money in savings (money, bonds, money market, etc.)

What is inflation?

1. An increase in the money supply.
   

What does inflation cause?

1. Decreased purchasing power of the Dollar
2. Increased prices
3. Increased wages lagging the increased prices (hard to catch up)
4. Devastation of any savings held by individuals
5. Increase in the “value” of things – houses, antiques, cars, just about anything ultimately.
6. Destruction of the bond market – all bonds – Treasuries, Industrials, Municipals, bond funds, etc.
7. Chaos in the stock market – as analysts try to determine the effect of inflation in specific companies – but in the long run, higher stock prices.  (Better to be out of stocks, and only get back into stocks when the future is very clear.)
8. Increase in all commodities.
9. Chaos in exchange rates – as it isn’t only the Dollar that would inflate, but also the Euro, Yen, Yuan, etc.
10. Possible chaos in the streets – if people don’t have enough money to support their lives.  You are seeing this is Greece right now.
11. Gold and silver go up, up, up – as the alternative to money.

DJ30 – 12,691   up 95
US Treasury 10 Year Bond – 3.37%    up 0.05%
USDEUR  -  1.4788
Gold – $1530     up $22 – A NEW ALL TIME HIGH
Oil – $113.32    up $1.11

Bernanke Speaks…..

Today FED Chairman, Ben Bernanke, spoke in a Press Conference at the FED Building in DC.  This is historic, as FED Chairmen haven’t spoken about their FOMC meetings in public before.  The markets were anxiously awaiting his every word.

Here is a summary of what he said, and I am happy to say that I hit a homerun on predicting what he would/would not do.

1. The QE2 spending of $600B will end in June as initially planned.
2. There will not be an extension of bond buying using the same techniques (printing money).
3. The FED will continue to buy US Treasuries using the $17B/month of income coming from the (junk) Mortgage Securities purchased in 2008.
4. Interest rates will be kept low through this year, and will be raised at the end of the 2011 or in 2012.
5. In spite of the oil price rise, inflation is low and will come back down in the future.
   

My  previous predictions included that the stock market would react negatively to the ending of the $600B bond buying program (or money printing program – depending on your point of view).  We will have to wait to see if this plays out or not.  It’s just too early today.

The Dollar fell today and gold rose – so those markets have spoken fairly loudly regarding the announcement.

Inflation……

I get irate when I read that the FED thinks that inflation is under control, and will come back down in the future.  Here is why I am irate – and you should be too.  The words being used are misleading in the extreme, and paint a picture of the future that will not come to pass.

Let’s look at this numerically.  Let’s say that inflation is at an index value of 100.  Also, let’s say that a “small amount” of inflation comes around and takes this number up to 110 in a period of one year.  That means that inflation has risen 10% in that year.

Now let’s go forward and see what happens the second year.  Let’s say that there is no increase at the end of the second year, and the index remains at 110.  That means that inflation is now 0% – in other words, inflation is non existent.  BUT – the prices remain at the 110 level.

Let me relate this story to today.  Gasoline and food prices are rising, and will work their way into all prices over the next year.   Inflation will be rising in this scenario.  But let’s look another year ahead and speculate that prices don’t go up any further.   Then inflation would be 0% – and not rise one iota in that second year – BUT, you would be paying those higher gasoline and food prices in perpetuity.  Get it???  You’re screwed with those higher prices, but the FED and government politicians can say they have inflation under control.  This is what makes me irate.

In reality prices will just ratchet up to another higher level, and that new level will be a new baseline for inflation counting.

DJ30 – 12,320   down 31
US Treasury 10 Year Bond – 3.48%    up 0.04%
USDEUR  -  1.4181  - a weaker Dollar
Gold – $1438     up $14
Oil – $106.58    up $2.31 – a recent HIGH – very dangerous for our economy!!!!!!
Gasoline $3.11   up $0.05 – see you at the pump.

Today was a bad day for America in the markets.  Not only was the Dollar weaker, oil hit a near term high, and interest rates are creeping up after the very poor showing last week at the Treasury auctions.  Stocks even suffered a little, but this is a surprise given the money printing going on at the FED.

Morality……

Have you seen the news that shows that David Sokol has resigned from Berkshire Hathaway, and Warren Buffett accepted his resignation.  Sokol was one of the stars in Berkshire, and was rumored in line to replace Warren when he stops working.  This is a great lesson in morality, and the importance placed on good business practices by Warren Buffett.

Here is what happened.  David Sokol found a great company, Lubrizol, to invest in, and he bought a bunch of stock in that company at the beginning of 2011.  Then as he investigated the company further, he decided it would probably be a good company for Berkshire to buy outright.  Sokol was at the heart of these discussions, and made the contacts between that company and Warren Buffett – who is the only person in Berkshire who buys companies.

In the end, Berkshire purchased Lubrizol for $9B in March 2011.

No one in these transactions did anything illegal – and I think that is a very important point in this story.

When I heard just these facts, I felt funny about Sokol investing in a company he was recommending for Berkshire to purchase, as he would prosper from the acquisition.

It just so happens that two days ago, I read my copy of the Berkshire Hathaway Annual Report, as it is very illuminating to read what Warren Buffett says on any topic.  One of the inserts in that Annual Report was a letter that Warren sent to the Directors and Managers in Berkshire on 26 July 2010.

The key message of that was the Berkshire reputation was more important than anything else.  If a manager of Berkshire was making a decision, and it was close, but within, the law and standard practices, then that action should NOT be taken as there are many decisions that are well within good practices.  Warren asked that one test would be if the person making the decision would like to see that decision on the front page of their newspaper the next day.  Any bad news is just not worth the gain to be made by a business decision.

I believe that Warren Buffett sadly accepted Sokol’s resignation, but used the lesson stated in his memo as the reason.  Morality within Berkshire is more important than any person.

The lesson that I take from this story is that “morality” isn’t dead in America (as you might think it is if you only think about the big New York Merchant Banks), and that leading from a high moral position is always a winning position.

Inflation……

The CEO of Walmart says that he is expecting some “serious” inflation in the near future.  President Obama and Fed Chairman Bernanke say that inflation is under control, and there is not problem with inflation.

Now, I ask you.  Who are you going to believe?  The President and the FED Chairman, or the head of Walmart – where you buy a lots of your goods at the lowest possible prices?  Who is closer to the real market?  The answer if obvious, and it points out one of the major dangers facing America today.

Politicians and their appointees are NOT trusted.  Unfortunately, this is true not only at the Federal level, but also the state and local levels.  This is a very sad state of affairs.  It is going to take a big change of people to ever solve this problem – but it must be solved.  Otherwise, it leads to anarchy.

Ireland….

The Irish banking problem isn’t over yet.  Apparently, the big 4 Irish banks require another 25 billion euros (or $36B) to remain solvent as the stress of bad loans continue to mount in Ireland.

This is far worse than I first thought, and I was a pessimist about the losses of these banks in the first place.  The lesson to take away is that banks lie, and the lie a lot.  Don’t ever accept at face value anything that any bank tells you regarding its “soundness.”

The Dollar and gold moved sideways.

Oil and gasoline continue to slowly make new lows – great news for gasoline prices (they’re coming down folks).

In the news today…..

Budget Deficit – is now officially over $1 TRILLION.  This is a record, and it will be broken many times over as President Obama spends us into the poor house.  From a protection viewpoint, get ready for inflation in 2011 (best guess for a date out there) and benefit from this overspending.

Financial Sector – is gaining from the great earnings at Goldman Sachs (probably an exceptional company, compared to other junk banks).  That’s what caused stocks to jump today.

Here are the last numbers for yesterday:
Dow Jones 30 Industrial – 8332 (up 185 points)
10 Year Treasury Bond – 3.35% (up 0.05%)
Euro – $1.3998
Gold – $923 (up $10)
Oil – $59.69 (down $0.20)
Gasoline $1.64 (down $0.01)

Oil and gasoline gained on this latest news as speculators are gambling that this major Treasury step will lead to a recovery in the economy.

Gold held steady, only losing $4 on the news.  The steady gold price shows the battle between the “economic recovery proponents” which would bet on lower gold prices, and “inflation hawks” who would bet on higher gold prices.  I believe in the latter.
 
In the news today…..

Treasury Secretary Geithner today announced his not too hidden plans on solving the toxic mortgage securities problem that our big banks have.  Here it is in a nutshell:

1. He plans that $1TRILLION of this “toxic waste” will be purchased
2. It will be purchased by 3 groups
   1. 7% by Private individuals  
   2. 7% by the Government  
   3. The remainder (86%) by the government – probably the FDIC – as a “loan”.
3. The “toxic waste” will be valued by the private sector.
4. Not much detail in this plan, but a lot more than the “hope and a prayer” stated before.  The devil is in the detail!!!

Here is my observation and opinions on this plan:

1. Geithner thinks that the problem with the economy is that banks aren’t lending,
2. and they aren’t lending because they have these “toxic securities” on their books, and they are worried the future value of these securities will be going down making them insolvent.
3. So, let’s question this basic assumption.
4. Is that banks aren’t lending, or people aren’t borrowing?  I think it’s the latter, and my opinion is backed by the decreased public spending and increased public savings.  Remember that at least 2/3 of the economy is driven by the general public consumption.
5. Banks are lending because they don’t want to lend to deadbeats anymore. Remember that the government forced them to lend to people who couldn’t possibly pay back their mortgages.  They fully understand the ramifications of that line of action in spite of the fact that they make a ton of money doing it, and loved it.
6. Banks believe that house prices will continue to decline, and therefore, the value of their toxic securities will continue to decline.  A future decrease in their value if taken onto their balance sheet would force the FDIC to take them over – probably today.
7. The value of these assets are worth less than the banks state they are worth.
8. Geithner’s belief that our economic recovery will be lead by the banks if false.  It will be lead by consumers.
9. Geithner must believe there is no alternative.  Naturally, this is false.  The tried and true FDIC takeover of banks has a proven track record.
10. Only 7% of this “deal” will be offered to the private enterprises, like pensions and insurance companies and rich individuals??  WHY ONLY 7%?????  If this is such a great plan, don’t you think that private investment would want more than 7% of it?  Or, is this the maximum amount of money that the government thought they could get out of private investment?  Just the 7% figure raises a big RED FLAG for me.
11. If the value of this great investment actually goes down in the future, who bears the loss?  Do the 3 classes of investors share in the loss proportionately, or will one class (and I’m thinking the taxpayer) bear the entire loss?   Another way of addressing this question is “Are there any guarantees for the private investors?”  Details, details, details.

What is wrong with this plan???

1. The debt remains. It isn’t going to be written off.  
2. The taxpayer is holding the bag, and the banks get off scot free – well, that hasn’t been truly determined yet because the banks should have to sell this junk at less than they think it’s worth.  We’ll have to wait and see.  I wonder how “transparent” the valuing process will be???   For sure, the banks won’t have to worry about their future as they do every minute of every day today.
3. A major portion of this toxic waste will never be paid back – and no one – neither the banks, nor the government – has addressed this issue head on.  You and I will be stuck with the loss.
4. Oh, by the way, when this additional cash comes home to roost, there will be more inflation created.

My conclusion:

This should help the big banks take a deep breath, and allow them to go back to business as usual.  I don’t like business as usual, as the banks were one of the major factors in getting us into this mess.  Where’s all the needed regulation by the government that was missing the last time around????

Without knowing the details, it is impossible to determine exactly how badly the taxpayers will get screwed, but you can count on it.

Without a complete destruction of this toxic waste, it will linger and be an albatross around the President’s neck.  The press will try to hide the truth of the demise of the money going down this rat hole.  

I think this is just another nail in the inflationary coffin that will hit the US in the future.  The only way this won’t be a major inflationary force is IF the housing prices of the US stabilize immediately and start back up.  I don’t see that happening soon.

 
Here are the last numbers for today:
Dow Jones 30 Industrial – 7775 (up 497 points)
10 Year Treasury Bond – 2.66% (up 0.04%)
Euro – $1.3655
Gold – $953 (down $4)
Oil – $53.80 (up $1.73)
Gasoline – $1.49 (up $0.03)  

Bonds, the Dollar and Gold went sideways.

Oil and gasoline fell slightly.

In the news today…..

The Unemployment Rate hit 7.6% in January from the December level of 7.2%.  There were 598,000 jobs loss last month.

Let’s look at this number and ask the question “How bad is this?”  We’re told by the government that we MUST stimulate the economy or we will have a catastrophe.  Well, the unemployment rate under Carter was greater than 10% – much worse.  We’re probably on our way to 10% ourselves this time.  

However, the economy is much worse today than then.  We have zero interest rates from the FED.  Carter had high inflation – well over 10%/year – and high interest rates – the 30 Year Treasury Bond was over 14%.  Carter had the tool that he could stop the inflation by allowing the markets to stop the inflation by just allowing a major recession to occur.  Kind of a “do nothing” tool.  What about us?  We’ve decided that we must interfere with the market economy by “printing money” aka a stimulus package.  (BTW – one of my favorite items in the package is buying “insurance” for some of the animal raising industries.  Buying insurance wouldn’t stimulate anything.)

Printing money has a very nasty by-product.  It’s called inflation.

Another difference between the Carter era and ours is that today the people of the US are significantly reducing their spending and increasing their savings (currently as good as 6 years ago.) This means that 2/3’s of our economy (of the GDP calculation) is slowing way down.  In Carter’s era, people just didn’t have jobs; but, when they got a job they spent just like they did before they lost their job – in other words, it was the good old paycheck to paycheck spending pattern.  Today, we not only have less working people, and Americans are spending less/saving more; we also have stopped the pattern of pulling money out of our homes (REFI’s) to pay for our excess spending patterns.  

Question for you today…..

“What would happen if we didn’t have any stimulus package spending by the government?”

The theory behind the stimulus package is that the government must pick up the spending that has been lost.  Americans aren’t spending at least $1Trillion/year that they were before this mess began.  So, the $830B (?) Stimulus Package is a more-or-less direct substitute for that loss.  (BTW – has anyone else ever talked about the Stimulus Package this way to you??  I’ve never seen this type of logic anywhere else.  Welcome to economyguy.)

If we didn’t have any stimulus package, we wouldn’t have that $830B go into the economy (over 4 or 5 years – not immediately as you are expected to believe), so the recession we are in would deepen.  More people would lose their job.  The housing market would plunge deeper in value.  More businesses would go bankrupt.  More banks would go bankrupt.  Prices would continue to decline – as would wages – which is normal in a recession (or depression if it gets much worse.)  

So, that’s about it.  How bad is that picture?  Pretty bad in my opinion.  

So, you’re thinking that the Stimulus Package is a good thing.  It could avoid some of that pain.  Is that right????

An Alternative Future…..

Maybe not so “alternative.”

Here is the other side of that story.  As in physics, every action has an equal and opposite reaction.  The stimulus package action would have a reaction.  What reaction you ask???

The stimulus package is paid by borrowing money (selling Treasury Bonds to people, organizations and nations.)  Treasury Bonds are backed by the full faith of the American Government, and the American Government’s ability to pay these bonds is backed by YOU – YOUR ability to pay taxes.

By printing money (and by that I mean the selling of Treasury Bonds), we are flooding the world with additional dollar denominated assets.  The natural market says that the increased supply of these assets will result in a decrease in their value.  The decrease in value of US Treasury Bonds means an increase in US Treasury Bond INTEREST RATES.  US Treasury interest rates are used as a baseline for all other US interest rates (and strongly influence world interest rates).  Mortgage rates would rise, corporate bond rates would rise, corporate earning would fall as higher debt payments would reduce earnings, etc.

Maybe we are seeing the beginning of this right now.  We’ve seen the 10 Year Treasury Bond go from 2% to 2.95% over the past 6 weeks.  This is a major move in interest rates.

Where does this thought pattern lead?  Very simple.  At some point, buyers of US Treasuries would question the ability of the US Government to pay back all that interest – in other words, they would start to believe the economic solvency of the USA.  When (and not if) that begins, the US Dollar will collapse.  People will stop buying US Treasuries and interest rates will soar to levels NEVER seen before in the US.  Inflation begins for real.  Not HIGH inflation, but HYPERinflation – as the US government has MORE stimulus packages and more FED/Treasury bailouts.  Remember reading about buying a loaf of bread with a wheel barrel of Deutschmarks during 1920’s?  Yes, it could get that bad.  

And here is the rub, “What happens to the average American during this meltdown?”

Do you remember the scenario I painted (above) about how bad the recession would be without a stimulus package??  Well, it would be WORSE under this scenario.  There would be higher unemployment.  Housing prices would go even lower.  MORE banks and companies would go bankrupt.  But, here is the really bad part – everyone’s Dollars would become worthless (or at least significantly devalued).  You would truly be lighting your cigars with $10 bills. (Or, if you don’t smoke, you would be using paper money for toilet paper.)  Yes, this would be MUCH WORSE for Americans.

Is this scaremongering?????

That’s up to you to decide.  I believe this is the road we are moving down right now.

I’m putting my money where my mouth is.  I believe that the best way to protect yourself in this terrible scenario is to buy gold, have foreign currencies, and own “things.”  Money will be come devalued (worthless?).  “Things” will become valuable.  This is the world of inflation.  I feel sorry for the younger generation who hasn’t lived through inflationary times (thank you President Carter.)

The one thing I can promise you is that I will be watching this possibility closely as the US economy evolves.
 

Here are the last numbers:
Dow Jones 30 Industrial – 8281 (up 218 points)
10 Year Treasury Bond – 2.98% (up 0.08%)
Euro – $1.2942
Gold – $914 (no change)
Oil – $40.17 (down $1.00)
Gasoline – $1.25 (down $0.02)