Approaching the three-day week?

It begins; dig out the loon pants and beads. "If you're going to San Franciscooooo..."

Mr Schwarzenegger also issued an executive order mandating that many state offices close the first, second and third Friday of each month until June 2010 in an attempt to save money.

The dolorous stroke

Another letter to The Spectator

Sir:

Irwin Stelzer (“No more consensus: this time there is a choice”) holds up Ronald Reagan as a model of a Conservative working for the ordinary voter. He could hardly have chosen a worse exemplar.

From 1947 to 1981 (the year in which Jimmy Carter left, and the Great Communicator took office), US public debt outstanding had fluctuated between $2 – 2.5 trillion (inflation-adjusted to 2009 dollars). Carter ended his Presidency with the debt no worse than it had been when he began. Under Reagan, the debt doubled in real terms (average 9.7% p.a. increase). Bush senior continued this trend (7.3% p.a.); the next two terms under Clinton showed a significant slowing (1.8% p.a.); but Bush junior picked up the pace again (6.3% p.a.) America now has $11.4 trillion public debt around its neck, approximately 5 times the equivalent in 1980, when Reagan asked voters, “Are you better off than you were four years ago?”

Well, how much better-off is Joe Average now? In the latest issue of Harvard Business Review, Gary Pisano and Willy Shih conclude that “average real weekly wages have essentially remained flat since 1980.” Instead, the “trickle-down effect” has turned out to be a torrent for the upper stratum only: in a 2006 speech reviewing hourly wage rate increases from 1973 – 2005, the economist Janet Yellen, of the Federal Reserve Bank of San Francisco, said “... the growth was heavily concentrated at the very tip of the top, that is, the top 1 percent”. The rest played catch-up by taking on extra personal debt: an investment analyst quoted in The Economist (22 January 2009) says “... the share of household and consumer debt alone went up from 100% of GDP in 1980 to 173% today, equivalent to around $6 trillion of extra borrowing.” Naturally, this process was much to the advantage of bankers, brokers and others in the top 1%.

In short, America has been pretty nearly busted by and for its elite. So much for the party of smaller government; so much for supporting the core Conservative, hard-working average wage-earner; not so much clear blue water, as a tide of red ink. One can only hope that the next British Conservative government, if there is one, will seek not to emulate Reagan and the Bushes.

Yours,

Down

Read Brad Setser on the USA's deterioration in the net international investment position.
The left-hand scale is in $billions.

To quote Status Quo, "down down, deeper and down".

US public debt since 1945 - inflation-adjusted

Sources: Treasury Direct, Robert Sahr. Click to enlarge.



Presiding over indebtedness... or as helpless as King Canute?

US Public debt vs. gold

Still trying to see the debt mountain in context... So let's see how hard it would be to pay off in gold, assuming that in 1791 a single "bag" of gold would have cleared the account.

For the first 70 years, the gold-priced public debt was always less than twice its 1791 level, and often below the starting point.

Now to see the progress of the public debt since 1860:

... and second, since 1945:

These pictures seem to indicate the influence of:

(a) two world wars

(b) the closure of the "gold window" in 1971

(c) monetary expansion since the 1980s

(d) the Grand Bust of 2000, NOT 2007, and the consequent flight to commodities

- and on this way of measuring the catastrophe, we're 50% worse off than at the end of WWII - plus we're not rebuilding the economy, we're doing the reverse.

Glory days

How did they do it? How can we do it again?

Perhaps staying out of wars, and quickly jailing greedy bankers, would be a start.

US Public Debt - annual rate of change

And the rate of change in the past has been frightening at times.

Here's the overall view from 1791 onwards:

Next, from 1945 to now:

Before that, The Roaring Twenties up to the end of World War II:

1900 - 1920:

1835 - 1900:

And from 1791 to 1835:

US Public Debt - the long view

The figures in the following graphs are from Treasury Direct. They are not adjusted for inflation, population size or GDP - all three of which would make interesting bases for comparison. But perhaps these pictures will show that the USA has come through equally bad, or worse, times before now.

US Public Debt since 1997

Data source: Treasury Direct

The new debt in perspective

Figures are inflation-adjusted. Source: Barry Ritholtz. Htp: Bearish News. Click to enlarge.

Giant US slush fund?

Karl Denninger continues to reflect on a story that hasn't had much coverage - two Japanese have been caught in Italy, attempting to smuggle $134 BILLION in bearer bonds. KD thinks it's part of secret additional financing for the US.

This is not quite as ludicrously James Bond-ish as it seems. Bear in mind that some time ago, Brad Setser studied Treasury bond purchases by China and the UK and concluded that the latter country was acting as an additional conduit for the former's loans.

Good news for the Italians - their law says they'll take 40% of the contraband.

Scene of the crime: US debt acceleration

(Data source)

Where is all the money going?

I read recently that both in the US and the UK, a significant part of the "quantitative easing" is repurchasing sovereign debt from foreign holders. In other words, money is being created to buy back government bonds from overseas investors.

This says two things to me: (a) the new money thus created is not going to help kick-start our economies, and (b) foreigners are losing confidence in us and want out, before inflation and defaults shrivel the value of their investment in us. As to the latter point, I said last August that I thought the Chinese wouldn't let themselves be swindled.

So I suspect we are still headed for slump, currency devaluation and, eventually, high interest rates.

Maybe a new currency, to whitewash the mess and make further progress towards some New World Order political grouping - Oceania, Eurasia etc. Any news on the Amero?

Good and bad borrowing

Karl Denninger covers a lot of ground - perhaps too much in one posting - in his attempt to clarify fractional reserve banking and its consequences.

What seems to me a major point in his conspectus, is the difference between borrowing for production, and borrowing for consumption. If you borrow at 5% to get a machine that makes you 10% profit, that's fine; but borrowing for a private house to live in, a car for personal use, music and TV, alcohol and weekly groceries - madness.

How long will the bear market last?

Jesse quotes this comparison of the current bear market with three previous ones, mixing stats for the Dow and the S&P 500:

But taking similar periods for the Dow only, adjusting for CPI inflation, and adding the long period from 1966 to 1982, we get this:

I'd suggest we should look at when the recent bubble really burst - end 1999, then desperately disguised by monetary inflation from 2002/03 onwards; if that's right, we have maybe another 6 years to go through.

The shapes of these two lines do sort of rhyme, don't they? And if so, looking at where the end of the red line is, maybe a bear market rally is now due, like the c. '75 - '76 mini-recovery.

End point in real terms this time, my guess, is the equivalent of 4,000 points today. However, there are features unique to the present situation, especially the size of debts, the loss of much of the West's manufacturing base, and the interconnectedness of modern world markets and economies.

Deflation, inflation, distress

The Contrarian Investor gives a lucid explanation of the potential consequences of deflation.

In Australia (as in the UK, as I think I showed here), the nation owes more money than it has in savings, so it depends on foreign investment.

If interest rates fall, foreign capital will go away to where it can earn more. This reduces the demand for our currency and makes it cheaper. So goods we sell to foreigners get cheaper, and things they sell us get more expensive. They buy more from us, we buy less from them (or they have to cut their prices so we can afford their stuff). More money comes into our economy; all well again.

Except...

• What if , thanks to decades of spending lots without earning much (and borrowing the difference), we no longer make things foreigners want?

Then we become "distressed gentlemen". As the money runs low, we run up accounts at the tailor and the wine merchant, and write IOUs which we hope will not be presented to us soon. Maybe we begin to cut a few luxuries, but old habits die hard, not to mention ingrained addictions.

• What if they sell us things we can't do without, and won't cut their prices?

The money runs out. Unless we are Royalty, and too dangerous to dun, eventually the bailiffs must arrive. In the modern world, the sovereign wealth funds, perhaps.

What can they take? In Australia, there are mineral deposits the Chinese will want, thinks the Contrarian Investor. Here in the UK, maybe some remaining profitable businesses and valuable technical expertise, maybe patents and secret technologies. And it's not only the Chinese that have been lending us their surpluses. We have other creditors.

Then, as the laden carts depart and the keys of the mansion are handed to the new owners, the decayed gentry become vagrants and vagabonds.

Unless we are too dangerous to dun. Perhaps America is; can we be so? And what if our creditors are not certain of our might? Uncertainty can trigger inappropriate actions. There is a Chinese saying, I believe: fear a weak enemy. Catastrophe can be avoided, but unless our leaders are tough with us now, we will learn a harder way later.

But if the master has become poor, what of his servants?

What if, like me, you're not one whose power and social status protects him from the worst effects? Do you believe that democratic societies can do the right thing? If not, this is a time for individuals to make their own quiet plans and preparations.

Learned fools

Forbes suggests that college education can be financially ruinous. The association of education with wealth only works when both are in limited supply, otherwise the Hedge Schools would have made Irish peasants rich. A silk hat does not make you a Bradford millionaire.

A doctor friend often used to quote some factoid that if the average doctor had left school at 16 and become employed in some capacity suited to his abilities, his hard-studying medical counterpart would never catch up in terms of total lifetime income earned.

I've heard it said that after the Revolution, the French trained thousands more lawyers, in order to devalue the profession.

Man to the plough;
Wife to the cow;
Girl to the yarn;
Boy to the barn;
And your rent will be netted.

Man tally-ho;
Miss piano;
Wife silk and satin;
Boy Greek and Latin;
And you'll all be Gazetted.

Number crunching - fractional reserve banking

Supposedly, banks lend 10 times (or more) what they have on deposit. Yet in June last year, it was estimated that total UK consumer borrowing (mortgages, loans and credit cards) stood at £1.444 trillion, and in October savings and deposits reportedly totalled £1.17 trillion - a ratio of c. 1.2 to 1.

By contrast, total U.S. household debt at the beginning of last year was estimated at $14.4 trillion, and in October the Mises Institute reckoned the True Money Supply to be $5.5 trillion, a ratio of around 2.6 to 1.

On the face of it, the American consumer is in twice as dire a state as his British counterpart.

I expect that's an oversimplification - but simplicity is in very short supply. I'd like to understand more, but I can't find reliable, user-friendly data on where all the money and debt is. There's far too much secrecy, complexity and obfuscation in this business.

Could US interest rates rise?

Brad Setser notes that far from declining in this recession, China's trade surplus is increasing, because although exporting less, it is also importing less. He estimates that China owns $900 billion of US Treasury bonds (and rising), some purchased indirectly via the UK.

However, enormous spending by the US means that it will have to issue a further $900 billion in bonds, and Setser opines, "China isn’t going to double its Treasury holdings in 2009."

If America needs to borrow more than China is willing to lend, the money must come from somewhere else, at a time when it's getting short generally. I have also recently read reports of concerns about the credit rating for US government bonds, which also supports the idea that rates will have to rise to pay for the increased risk of default.

How far will the dollar will be supported by this tendency? At least, in relation to sterling?

The UK is supposed to be an even worse basket case in terms of overall indebtedness, and that may make it politically very difficult to match rates with the US, because it could accelerate the rate of British house repossessions and business bankruptcies, even faster than in the US. So the pound could possibly fall even further against the dollar.

Perhaps Mr Cameron is right to warn that for the UK, the money may run out soon. Then we will have to pay high interest rates after all. And at last, we may be forced to borrow from the IMF and retrench savagely. Back to 1976. And will 1979 return? Cometh the hour, cometh the strong woman?

So, what's the implication of all this for the investor? Sell bonds and buy gold (despite its already high price) now, then reverse the process when high interest rates hit us?