DJ30 – 12,267   up 65
US Treasury 10 Year Bond – 3.37%    no change
USDEUR  -  1.4331
Gold – $1497     up $4
Oil – $108.15    up $1.33

Gold topped $1500 during the mid day trading today.  Psychologically important.  Now we are ready to go higher.

The Debt Ceiling……

Let’s talk about the debt ceiling since we are going to hear a lot of “hot air” on this subject over the next few weeks (and possibly months.)

I would like to start by quashing a statement that is repeated on the news, and by people who know better.  That statement is that if the debt ceiling is not raised, the US will default on its debt.  What rubbish.

Let’s start with a definition.  Defaulting on the debt by the US means that the US Treasury will not be able to pay the US Treasury bond holders off when those bonds become due and will not be paying any interest on the bonds outstanding.  Let’s examine what happens if the Debt Ceiling is not raised.

First of all, legally it means that the US Government must stop its deficit spending at the point where the Debt Ceiling is reached ($14.3TRILLION).  That’s all it means.   Period, over and out.  Now, while this would be extremely painful, and would force the US economy into a recession or depression, it would NOT cause the US to default on its debt.

The US Treasury is receiving about $2TRILLION in tax income this year, and could use that money to pay any debt that is owed (about $341B in interest this year.)

When a US Treasury bond ends its life, the US Treasury must pay the holder of that bond, the face value of the bond – typically $1000 per bond.  However, let’s look at this a little closer.  When that bond is redeemed, the US owes that much LESS, and the DEBT decreases by the same amount.  The US Treasury can issue another bond for the same face value, and the net effect on DEBT is ZERO.  In other words, bonds coming due is not a cause of concern.

So, I hope I have put the argument that the US will default on its debt to bed – once and for all.  Please just laugh the next time you hear that statement.  Especially if it is “tax cheat” Tim Geithner, Secretary of the Treasury, stating it.

The 2011 Fiscal Budget……

The US Congress (all those people who we voted in) and the Senate (more of them) and the President (voted in too) all agreed to cut this year’s budget by $34B (but it reality is less than $400M and was a trick) – but the main point is that EVERYONE (that counts) has agreed that Obama can spend like a drunken sailor until October 1, 2011.

But, the Debt Ceiling will be breached in April or May of this year.  This is a big embarrassment for all those folks who voted and agreed on this year’s Fiscal Budget.  In effect, didn’t they all agree to raise the Debt Ceiling at the same time they voted for that budget?  After all, everyone knew the budget would be busted when they voted for it.  I think there was a tacit agreement – one that the public wasn’t made aware of.

There is going to be a lot of ranting and whaling over the issue of raising the Debt Ceiling, and the Democrats are going to have to concede something – and what they concede will be interesting to see.

In the end, the Debt Ceiling will be raised.  Hope this helps you understand this murky issue.

Sometime in April the US Government will have spend so much money that it’s debt will be hitting up against the “debt ceiling” created by Congress.  Congress created it to have a mechanism for reining in governmental spending.  Today’s debt ceiling is  $14 TRILLION plus change.

Every time we have hit up against that debt ceiling in the past, the Congress has blustered, and then raised that ceiling.  Every time, someone has stated that if we hit the debt ceiling the US would default on its debt – an unthinkable thought.   After all, the US Dollar is the Reserve Currency of the “world.”  So, in the past, the debt ceiling has been considered a speed bump in the way of increased spending – nothing very serious.

But, today there are a bunch of new Congressmen and women who have been elected to rein in spending.  And, their mantra and the strength of their election has scared the “professional” politicians into being cowed into supporting that position too – at least if they are Republican and Independent thinkers.  Some Democrats are also cowed (especially in the Senate), but their Progressive ideals keep them in the camp of spend, spend, spend (until the country fails.)  (My comment in parenthesis).

What is the point of each side?????

Keynesian economics dictates that the government can “fix” a slowing economy by spending more.  This is the position of President Obama, the Democrat Party and the Federal Reserve.

The Republicans think that there is a limit to spending, and the new Republicans are ashamed of their party’s past excessive spending.  They believe in the Austrian school of economics which says that the government gets in the way of economic growth, and private free enterprise creates jobs and the wealth in any nation.

Is there a limit????

I strongly believe that there is a limit to excessive spending.  Keynesian spending worked in the past when the US had “mild” recessions, and a very low debt.  Modern Keynesian economics ignores the debt of the nation in its assumptions.  Past Keynesian spending has lead the US to the position it finds itself today – so it can be argued that Keynesian economics has “failed” in that it hadn’t considered the long term consequences of its actions.

So, let’s use our common sense for a moment, and ignore all the rhetoric.

What happens when the debt of the US gets too big?  Let’s ignore “how big is too big” for this argument.  In reality, no one can define when “how big is too big.”

As the US Fiscal Debt grows, the amount of interest the US must pay grows accordingly.  The annual interest is the product of the average weighted interest rate and the total debt.  In other words, the greater the interest rate, the greater the interest that must be paid.  And, the greater the total debt, the greater the interest that must be paid.  Both the interest rate and the total debt are directly proportional to the amount of interest paid.  That means the interest rate and the total debt are both VERY IMPORTANT drivers in the amount of interest paid each year.  ( I have purposely stated these things many times to drive home the point.)

So, the next logical question is “How much annual interest is too much?”  This is a hard question to answer, but the best minds of America think that excessive interest payments slow the annual GDP growth.  From a common sense point of view, the amount of interest paid REDUCES the amount of money the government can spend on other things.  And for those of you who believe in “stimulus spending”, that means there is less money to stimulate the economy.  No matter how you look at it, large annual interest payments are bad for the US.

At some point, and let’s take it to an extreme, the amount of interest that must be paid is equal to the total “income” – and that means taxes – of the US Government.  I would content that that is a “limit.”

But, there are many more practical limits to the amount of interest that kills the US economy.  There are three main economic statistics pointed to by economists as being indicative of “too much interest payments” or just too much debt.

1. the ratio of total debt to GDP
2. the ratio of total annual debt payment to the total Fiscal Budget.
3. the ratio of the annual deficit to the total Fiscal Budget
   

Without going into any detail, let me just say that all of these measure are flashing “red” for the United States.  One proof is the threat of the rating agencies to reduce the AAA bond rating for US Government debt.

So, what is unthinkable?????

Today’s debate within Congress is whether or not to increase the debt ceiling.  The Congressional majority’s feeling is that they will only increase the debt ceiling if the Administration agrees to large budget cuts.  The President has not agreed to large budget cuts, but said he is freezing his already excessive spending, and will reduce spending by an average of $40B per year – an insult to any thinking deficit reducer.

So, there is a game of chicken going on.

What happens if the debt ceiling is not raised?  It means that the US Treasury cannot issue more debt (US Treasury bonds) to pay for the government’s spending.  What happens next?

First of all, the Treasury can do some financial maneuvering with its money, and avoid crossing the debt ceiling by several months.  That would buy time if it is needed.

Secondly, at some point, the government must pay its bills.  Those bills are:

1. interest on the debt
2. governmental payroll
3. entitlement paychecks
4. project spending
   

The government would have to make a decision on what bills to pay, and what bills not to pay.  Naturally, that decision is politically unacceptable.  But, the easiest one not to pay is the “project spending.”  The interest on the debt must be paid, or the US government would be in default, and the interest on our debt would soar, and the spiral downward would begin again.  I put the four categories of governmental bills in the priority order that I believe the government would pay its bills (as a morally sound decision.)

My point is that you should listen to the arguments going on in the press, and by the politicians, with an educated “ear.”

Conclusion:

1. The game of chicken being played in Washington can be very injurious to our health – our financial health.
2. The debt ceiling doesn’t “have” to be raised, as the Administration would be put in the position of deciding priorities on paying bills.
3. The game is a high risk game without a  known outcome.  Possible outcomes include:
   
   1. It could result in an agreement to cut the budget by a negotiated amount.  This is the probable outcome.  Any measure of success should be measured by
      
      1. Is the total debt being reduced?
      2. Is the fiscal deficit being reduced if the debt isn’t being reduced?
      3. Is there a plan to eventually reduce the total debt, the the total debt wasn’t reduced?
      4. How much was the spending reduced?
      5. If you don’t like the answers to these questions when we get them, then vote the bums out again next time – and with a louder message.
         
   2. It could result in a default on our debt.
   3. It could cause the US economy to tumble into another Depression.
   4. It could be the first step back to a healthy economy (but, I personally don’t think this is possible because of the Federal Reserve Quantitative Easing I and II actions – which are printing money and debasing our monetary base.)
   5. In any case, it will be the basis of the arguments to be used in the 2012 Presidential election.

Bonds hit another near term HIGH today as the US Treasury auction didn’t go that well.  Higher interest rates coming – see stories below.

Oil and gasoline also hit a near term HIGH today as oil is now over $71/barrel.

In the news today…..

Supreme Court doesn’t hear Chrysler bondholders claim – and they are allowing the sale to Fiat to advance.  So, why am I including this news story in the economic news???  Because it represents a legal precedent in my opinion that can be used in the future.  The government won this round, and did it by ignoring commercial law.  The legal system of the United States doesn’t appear to work well when it must move FAST.  We are in an emergency situation according to the government.  We can’t wait to think about the ramifications of decisions – we must act, and act the way the government says to act.

Here is the rub.  The government now has a precedent to ignore Commercial Law that can be used in future actions, and has the backing of a Supreme Court.

Mortgage Rates – are still rising.  The 30 Year fixed rate is now 5.57%, up from 5.25% last week. Interest rates are now a full percent higher than their low, and mortgage applications are falling accordingly.  This is the proof of the statement I made a few days ago that the FED program to save the mortgage market has failed.

Citibank – announced today that it will be converting $25B of the $45B of TARP money (YOUR money) from its current status as “preferred shares” into “common stock.”   Naturally, the Treasury made this decision “on your behalf.”  What’s the difference?  Well, preferred shares are paid a fixed dividend ahead of common share dividends – a dividend that you are NOT guaranteed by being a common share holder.  In fact, why would Citibank ever pay a dividend to common share holders when they need so much more capital injection???  With the conversion of $25B preferred shares into common shares, the government (that’s YOU) become the owner of 34% of Citibank.  

Congratulations.  Do you think the Treasury was doing this in YOUR best interest?  If so, what was that interest?  (My guess is that this conversion keeps the wolf away from the Citibank door for a little longer – and the Treasury believes this is in YOUR best interest.  The Treasury is betting the economy will turn around and these failing banks will find a way out of their quagmire someway.)  If not, what should the government have done?  (My answer is let Citibank fail and be broken up into smaller entities.  This course of action would cost the taxpayer less in the long run.)  You will now be earning LESS interest on your TARP investment in Citibank.  Why didn’t the government convert MORE of the $45B into common shares??  The reason – isn’t it obvious??? – is that the government would have owned a MAJORITY of Citibank in that case.  So, why didn’t the government go for the majority???  My guess is FEAR – the fear that Citibank might just go under, and if the government owned (controlled) the bank when it went under, it would be obvious that the government didn’t know how to run a bank.

10-Year Treasury Auction Fails – as the interest rate paid went as high as 4.01%.  While there were plenty of investors bidding for these new bonds, they got more interest than they anticipated.  This is a major increase in interest rates over the recently high interest rates; so, hold onto your socks folks – it’s going to get expensive.

FED Beige Book – says the “economy’s downward trend is moderating.”  The FED Beige Book is a look at the US economy through the eyes of the 12 FED Bank Regions.  Let me parse these words for you.  It means the economy is still GOING DOWN.  Just not as fast downward as it was going down before.  In fact, only 5 of the 12 regions said they saw “moderating” going on.  Is that good???  It’s in the eye of the beholder.  From my perspective, this is BAD news as the economy is WORSE today than it was a month ago; and until the economy starts getting BETTER, I will be looking at this glass as “half empty.”

FED lost $5.6B in 1Q 09 – on the assets they took over from Bear Stearns and AIG.  Those assets, including mortgage securities, fell in value by $5.6B.  Another way to look at this is that the FED is gambling with YOUR money.  Rather than sell these assets off, the FED chose to hold onto them, hoping they would increase in value – that’s my definition of gambling.  How much more will it lose???  Yes, the FED did earn some interest on its emergency loan programs – it earned $1.2B.  That’s just not enough to offset the losses.

Tonight’s Dinner Conversation….

Stagflation is here today.  What is stagflation?  “A condition of slow economic growth and relatively high unemployment – a time of stagnation – accompanied by a rise in prices, or inflation.”

Doesn’t the reality of the current US economy exactly fit the definition of stagflation?

Oil at over $70/barrel is the first price rise that will cause real pain to the US economy and the US people.  High oil prices will cause high gasoline prices (here today) and will be shortly followed by higher natural gas prices, higher electricity prices, higher home heating fuel prices, etc.  Higher energy prices will have kicked in by the end of the year.

And, what’s next?  The big threat is higher food prices in my opinion.  Commodities are controlled by world demand, and food is no exception.  This too will hit the American pocketbook, and will probably hit this year as a second major CPI measured inflationary force.

Here are the last numbers for today:
Dow Jones 30 Industrial – 8739 (down 24 points)
10 Year Treasury Bond – 3.94% (up 0.08%)
Euro – $1.3992
Gold – $955 (no change)
Oil – $71.33 (up $1.32) – another near term high
Gasoline $2.02 (up $0.05)

Bonds also moved sideways, as did the Dollar.

Oil and gasoline fell slightly.

Gold fell a lot, being down $25 today.  The new price has broken a trend line on the downside, and gold must test recent support levels at $850 to $860 before we know what the future might hold.  So my advice is to wait for the test of these levels, and see if it bounced upward or continues downward.  One of the two will happen.

In the news today……

Unemployment was reported at 8.5% last week.  However, one of the equally important statistics is Underemployment.  This represents people who are not looking for a new job any longer because they’ve given up and are doing something else (like going back to school) or have taken a part time job.  Underemployment is currently running at 15.6%.  Together this means that 24.1% of the people in the US are either unemployed or making a lot less at a part time job (or something else) than they want to make.  Another way to look at this is that the Unemployment statistic of BOGUS!!!!!!!

The FED set up currency swap agreements with Japan, the UK, the ECB and the Swiss today so they can acquire those four currencies at any time.  Why would the FED do this?  It could be very innocent – like they want to reciprocate with those countries as they have already provided Dollars in the other direction.  However, there is usually more than one explanation for a major FED action, and I just haven’t figured this one out yet.  Is the FED anticipating a downturn in the Dollar that they can counter with those currencies?  Are there “friends of the FED” who might need those currencies on a weekend?

The “Stress Test” being performed by the US Treasury is a SHAM.  The Treasury has already stated that the Big Banks are too big to fail, so they are basically excused from the stress test, or the stress test will be structured in such a way that they pass. The results of the “stress test” are anticipated to be announced at the end of this month.   All the Big Banks are “friends of Geithner”.  I fear for the mid-level sized banks who hold some toxic securities and are not “friends of Geithner” as the Secretary can shut them down at a whim.  

One small history lesson on “stress tests.”  Fannie and Freddie had legislated (required by law) stress tests in their charter, and long ago before the Freddie and Fannie scandals came out, Freddie and Fannie ALWAYS passed their stress test.  However, these industries turned out to be insolvent, and the taxpayer picked up the bill.  Herein ends the history lesson.

Here are the last numbers for today:
Dow Jones 30 Industrial – 7976 (down 42 points)
10 Year Treasury Bond – 2.94% (up 0.03%)
Euro – $1.3413
Gold – $873 (down $25)
Oil – $51.05 (down $1.46)
Gasoline – $1.48 (down $0.02)