Quantum Pranx


Here’s the Problem…

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by David Galland
Managing Director, Casey Research

Posted originally November 03, 2010

The problem is multifaceted, but with the same outcome.
I’ll get to that outcome momentarily, but first the facts of the problem…

The U.S. and most of the world’s major economies are flat broke. Bankrupt, actually. Forget the whole debt vs. GDP metric… focus instead on debt + obligations vs. GDP, as that’s where the scale of the problem – and the scope of the coming pain – is most apparent. We are literally tens of trillions of dollars underwater. To return to fiscal solvency is now impossible without overt default, or the covert default of a serious inflation.

• It’s too late.
The debt problems are now so extreme that the Republicans, tea partiers, and desperate Democrats now rediscovering good old fiscal sanity have no feasible way of making a dent. Even the stingiest Republicans are only talking about freezing spending at 2008 levels. For the record, that still means an annual federal budget deficit of just shy of half a trillion dollars.

Add to that approximately $150 billion in annual state budget shortfalls. And that’s before the economy is knocked sideways by the onrushing tidal wave of retiring baby boomers… or body slammed by the inevitable increase in U.S. interest rate expenses, as rates move up sharply from today’s unsustainable historic lows.

The point is that, even to get back to 2008’s budget deficits, will require cutting almost a trillion dollars in federal spending. And that’s just for starters. Talk about a pain party.

• In a democracy, there’s always another election.
Today, the “morning after”, the Republicans are feeling pretty happy, as I am sure, are the Tea Partiers. Pats on the rumps and knucks at the water cooler and all that. But in no time at all – a few weeks at most – legions of political operatives will begin focusing on winning the next election… the big one in 2012. With that in mind, let me ask you a question or two…On surveying the political landscape, do you think that Republicans, Democrats or even Tea Partiers will raise their hand in favor of slashing social security to the extent necessary to advert the coming currency crisis? How about Medicare? The military?

Sure, they might fiddle around with the category labeled as “Other Spending” in the graphic above… but imbedded within even that category are touchy areas such as education, school nutrition, aging infrastructure, etc. While the public might cheer on the canceling of high-speed trains, are they ready to accept large potholes and collapsing bridges as the new normal?

What I’m trying to say here is that we have reached the point where nearly everything is politically off limits… and the deep, deep cuts required to put government back in the box it needs to be for a healthy economy to re-emerge just aren’t going to happen given the coming election cycle. And in America, there’s always a new election cycle.

• Watch what you wish for.
Listen, I’m personally okay with gridlock and the consequences. But I doubt most people have really thought this thing through to its logical conclusion. With the core issues bedeviling the economy still unaddressed – structural issues such as historic levels of debt; the long-lasting damage that follows a busted housing bubble; persistent unemployment; and trillions of dollars worth of toxic paper still on the books of the banks and Fed, to name just a handful – the consequence of a government freeze-up will be dire.

Not “may be dire”, but “will be dire”.

Postpone the expiration of the Bush tax cuts, yes! Stop feeding money to the flailing states, right on! Cancel spending on infrastructure, go for it! Stop artificially suppressing short-term interest rates and let Fannie and Freddie fail, count me in! And I’m actually for all of that, and much more.

But how, I ask, will the public – already deeply concerned about the economy – react when foreclosures soar, as they must if we’re ever to see the other side of the housing bubble? What about when unemployment, instead of easing, starts to ratchet up over 10% and shows every sign of heading higher still?

And the deficits everyone’s worried about? What if instead of falling, they go up even further as faltering tax revenues from a collapsing economy coupled with no new taxes makes things even worse?

Simply, given the decades of capital misallocation, waste, and debt creation we’ve just come through, a serious crash is not only coming, but is necessary to unclog the economy. And not just in the U.S., but globally.

But to expect the politicians – of any stripe – to embrace that view and by so doing assure that they’ll soon be back on the street looking for a job seems almost laughable.

“No, no… you’re wrong,” the Tea Partiers among you may now be muttering. “We’re going to be unremitting in pushing for change, even if it costs us our political jobs.” And, for the time being, I have no doubt that that’s true. It’s full speed ahead for hard choices on the road back to fiscal sanity.

It’s time to kick bad habits and jump on the straight and narrow.

To which I would respond by asking you to really think how even the most well-intentioned politician is going to hold up when John Q. Public, a fickle soul in the best of times, decides that what’s really important is jobs… but that all that stuff about deficits can wait for better times?

And, per above, are the politicians really going to stand up and pound the table for cutting Social Security, even if it’s political suicide? Are staunch conservatives really going to reverse course on waging endless war on the Islamic fanatics in Afghanistan and elsewhere, telling our troops to unceremoniously retreat once again?

I don’t think so.

The slide back to the spending compromises will start slowly, and begrudgingly, but as the grassroots pressure begins to rise in the face of the free-falling economy, compromises will be made. And in no time at all, the government will again find itself falling off the spending wagon and, figuratively speaking, standing naked in a restaurant bathroom with a porn star and a face covered with cocaine.

I could go on (as you know), but will try to arrive at a conclusion.

In our regular research meetings, I like to play the role of devil’s advocate. One of my favorite themes over the last couple of years can be summed up by my question to the team, “Does anyone think there is a political limit to the government’s deficit spending?”

Based on yesterday’s election results, one might be tempted to conclude that, yes, there is. But pushing back on my question, Terry Coxon – one of the soundest thinkers on such subjects I’ve ever met – always comes back with pretty much the same response, and it goes something like this.

“Why, yes, David – there is a political limit to deficit spending. Up until that point that the economic pain again becomes acute. At that point, the public again rises up to demand that the government ‘do something’ and the spending resumes.”

I can’t see a flaw in Terry’s logic. While the Republicans will have a brief honeymoon, and the fresh faces in Congress will thrill us all with their bold attempts to roll back the state, for the reasons mentioned above, this will be only a passing phase before the juggernaut again gains momentum in the wrong direction.

And so, with apologies for tossing cold water on the fresh blossoms of hope that many of you dear readers may be feeling today, I have to side with the view of my partner Doug Casey, a view he expressed in our call on Monday. And I paraphrase:

“I’m more convinced than ever that we’re about to go through a crash of epic proportions. It won’t just be bad, it’s going to be horrific, worse than even I can imagine.”

Now that might be tough to hear, and you may not like that I have cast a shadow over your sunny day, but I think it’s very important not to pull the blinders on, or get swept up in the moment as that could lead to making a personally devastating mistake… and likely missing a heck of a near-term opportunity.

Specifically, in the blush of optimism about the dawn of a new political era in Washington, the stock market and the dollar may rally, and gold may fall – but as they do, as an investor I would strongly caution you to keep things in perspective.

In the current context, when the public is faced with the suffering and misfortune that must worsen before things get better, we won’t take it stoically, but like the Mary Kay representative we will stomp our feet and raise our voices in unison as we demand the politicians return the prettily decorated box containing our lost lifestyle.

Sorry, but it’s long ago been tossed on the trash heap by the politicians. That’s not to say that we won’t build a new and better box down the road – we will – but it’s not going to happen until the nation, and much of the world, goes through a painful rebirth that leads us back to the path of self-reliance and fiscal propriety on a personal and institutional level.

Not wanting to exit these musings on such a somber note, I would like to close, for now, by pointing out something I think should be obvious – and that is that as bad as things may get here in the U.S. and other developed nations, the degree of suffering we’ll go through will never be as bad as it is on a daily basis in even the best of times for the unfortunates living in the truly dysfunctional countries of Africa, Central America, and elsewhere.

Do what you can to reduce the damage to you and your family – for instance, by buying silver and gold during the corrections – then go about enjoying your life… in my opinion, that’s the right perspective.


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