Federal Deficit

Readers may recall that Ron Paul once surprised everyone with a seemingly very elegant proposal to bring the debt ceiling wrangle to a close. If you're all so worried about the federal deficit and the debt ceiling, so Paul asked, then why doesn't the treasury simply cancel the treasury bonds held by the Fed? After all, the Fed is a government organization as well, so it could well be argued that the government literally owes the money to itself. He even introduced a bill which if adopted, would have led to the cancellation of $1.6 trillion in federal debt held by the Fed. Of course the proposal was not really meant to be taken serious: rather, it was meant to highlight the absurdities of the modern-day monetary system. In a way, we would actually not necessarily be entirely inimical to the idea, for similar reasons Ron Paul had in mind:  it would no doubt speed up the inevitable demise of the fiat money system. Control can be lost, and it usually happens only after a considerable period of time during which their interventions appear to have no ill effects if looked at only superficially: “Thus we learn….to be ignorant of political economy is to allow ourselves to be dazzled by the immediate effect of a phenomenon."

If there is one dominant consensus in the financial sphere, it is that the Federal Reserve's $85 billion/month bond-and-mortgage-buying "quantitative easing" will inevitably send stocks higher. The general idea is that the Fed buys the mortgage-backed securities (MBS) and Treasury bonds from the banks, which turn around and dump the cash into "risk on" assets like equities (stocks). This consensus can be summarized in the time-worn phrase, "Don't fight the Fed." This near-universal confidence in a QE-goosed stock market is reflected in the low level of volatility (the VIX) and other signs of complacency such as relatively few buyers of put options, which are viewed as "insurance" against a decline in stocks. The usual sentiment readings are bullish as well.

But what if QE fails to send stocks higher? Is such a thing even possible? Yes, it does seem "impossible" in a market as rigged and centrally managed as this one, but there are a handful of reasons why QE might not unleash a flood of cash into "risk on" assets every month from now until Doomsday

Well, my fellow Slope-a Dopes, your favorite intrepid seafaring Frenchman got blown out of the water by Benjamin Moby-Dick Bernanke once again.  I have to hand it to captain grey beard, for a guy with a curiously quivering lower lip, who seems so utterly unsure of himself every time he opens his moronic mouth, he sure does have some pair of ballistic brass balls.  Not only did he delivered on his QE3 promise, but he actually turbo charged it into a terrifying trifecta!  Boatswain BDI was left for dead, desperately drowning in a sea of red DOOMs (Deep Options Out of the Money).  So now that Moby Dick has breached and surged the equity waves to new highs, where do we sail from here?  

Miracles of cosmetic surgery.

How does the current 'recovery', which according to the NBER officially began in June 2009, compare to those of the past? The Council on Foreign Relations updates its recovery chartbook and succinctly notes that "the current recovery remains an outlier among post-war recoveries along several dimensions." Consumers remain reluctant to take on new debt and the stock of debt is lower than it was when the recovery officially began. The global economic slowdown is beginning to manifest itself in world trade. After staging the strongest recovery of the post–World War II era (thanks to the depth of the plunge), growth in world trade has begun to decelerate.

Reuters summarizes the key facts about the 42-year old House Budget Chair and potential future American vice president. Enclosed also select reactions from various individuals across the political spectrum to his nomination as well as a summary of his lifetime donors as well as those of Joe Biden.

Critical of the market's reaction to the 'no new QE' news, Biderman and Bianco wholeheartedly believe yesterday's plunge was entirely due to the fact that the 'Bernanke Put' - that we have become so conditioned to expect - did not appear at the levels many expected. Despite a federal deficit of $100 billion per month, it seems the Fed is now in agreement with Biancerman that US growth is limping along at best but notably Jim Bianco believes the fiscal cliff will end up more of a bump in the road as he sees politicians being forced to agree to extend or roll-back (maybe at the very last minute) offsetting the abyss. However, with the debt ceiling looking like it will be hit before the election, it will be interesting to see what political parlance is used if-and-or-when Geithner borrows from the trust funds to keep the government going this time (or not). Positive on Gold longer-term, Bianco sees it like other markets: "Gold is a junky that has not got its money fix" and the only reason to believe Gold is a sell is if you think CBs are done - they are not! Finally the two discuss the fact that 'nobody wants to be bearish anymore' when looking at sentiment surveys - setting up a 'trap-door' for the market.

With all the buzz about the 'Fiscal Cliff' – that toxic combination of tax increases and spending cuts due to take hold in a few months – the subject of ongoing Federal budget deficits has fallen by the wayside.  ConvergEx's Nic Colas believes that’s a temporary phenomenon, for Congress will have to hammer out agreements to raise the debt ceiling right alongside its negotiations over the 'Cliff' items.  His back-of-the-envelope attempt to quantify how much a multi-year debt limit increase would run to take this burdensome legislative issue off the Congressional docket for 5, 10 or even 20 years is worrisome at best with a $3.4 trillion for the 5-year runway, but this assumes a high level of incremental taxation. The number could be as high as $4.5 trillion.  As for the longer time horizon debt runways, think in terms of an incremental $6.5 -9.5 billion for a 10 and 20 year horizon. And without significant changes to taxes and/or spending, more.  Much more. We cannot help but think about Paul Krugman as we ponder these numbers.  His recent book, End this Depression Now, proposes that “A quick, strong recovery is just one step away, if our leaders can find the intellectual clarity and political will to end this depression now.”  This “One step” is deficit spending that is orders of magnitude greater than anything spent already.  We have no idea if he really believes any of this, since it is politically impossible, but he does have a Nobel (though so did the guys at LTCM).

You may think only European countries have VAT (value-added taxes), but America has one, too--it's just hidden in the sprawling "healthcare" system, i.e. sickcare. A value-added tax (VAT) is a broad-based consumption tax designed to raise tax revenues from across the entire economy. Since it's in everything you buy, you can't escape paying it unless you go to another country without a VAT. While the U.S. doesn't have an official VAT, it has an unofficial one that we all end up paying for indirectly: the 8% difference between what we pay for our bloated, fraud-ridden healthcare system and what our global competitors pay for their universal-care healthcare systems.

The pathway of dissent is to resist financial feudalism and its enforcer, the expansive Central State. Here are twelve paths of resistance any adult can legally pursue in the course of their daily lives:

1. Support the decentralized, non-market economy
2. Stop participating in financialization
3. Redefine self-interest to exclude debt-servitude and dependence on consumerism and the Central State
4. Act on your awareness that the nature of prosperity and financial security is changing
5. Stop supporting distant concentrations of capital that subvert democracy by using their gargantuan profits to buy the machinery of State governance and regulation
6. Stop supporting the debt-and-leverage based financial aristocracy
7. Transfer your assets out of Wall Street and into local enterprises or assets that do not enrich and empower Wall Street.
8. Refuse to participate in consumerist status identifiers and the social defeat they create
9. Vote in every election with an eye on rewarding honesty and truth and punishing empty promises
10. Stop supporting inflationary policies such as “money creation” by the Federal Reserve and Federal deficit borrowing
11. Become healthy, active and fit
12. Embrace self-directed coherent plans and construct a resilient, diverse ecology of identity and meaning

The USDA’s Food and Nutrition Service released a new report on Supplemental Nutrition Assistance Program (SNAP, commonly known as Food Stamps) earlier this week with some fresh data on the program. Given our earlier note on Mr.EBT, we thought the following brief clip from Bloomberg TV on the $82bn-per-year program would provide some rather shockingly sad insights and then Nic Colas' recent focus on the SNAP report provides some much more in depth color.  First and foremost, there are 46.5 million Americans in the program as of the most recent information available (January 2012), comprising 22.2 million households.  That’s 15% of the entire population, and just over 20% of all households.  Moreover, despite the end of the official “Great Recession” in June 2009, over 10 million more Americans have been accepted into the program since that month, and the year-over-year growth rate for the program is still +5%.  The USDA’s report is, not surprisingly, very upbeat on the utility of the program.  Fair enough.  But what does it mean when 20% of all households cannot afford to buy the food they need for their families?  To our thinking, it highlights an underappreciated new facet of American economic life – one that will be felt everywhere from the ballot box to the upcoming Federal Deficit debates.

Last night, Goldman entered into unchartered territory with its first observations of the student loan bubble in a piece titled "Are Student Loans Driving Consumer Credit Growth?" Most of the observations are nothing new, although author Alec Phillips does bring up one amusing implication of what the soaring student debt may mean in macro terms. Specifically, to Goldman the rise in debt is merely "A more important source of countercyclical credit. Since federal student lending standards are looser than most other forms of credit, they now rely mainly on Treasury borrowing for financing, and demand for them appears stronger when the labor market weakens, it seems likely that education-related debt will grow fastest at times when the economy slows and other lenders are pulling back." In other words, the rate of change in student debt is inversely proportional to the improvement in the US economy, or directly proportional to its deterioration. So since the student debt chart is, for lack of a better word, parabolic, what does that mean for the broader economy?

A strong case can be made that the fundamental supports of the housing market-- demographics, employment, creditworthiness and income--will not recover for a generation. It can even be argued that housing has lost its status as the foundation of middle class wealth, not for a generation, but for the long term. Let's begin by noting that despite the many tax breaks lavished on housing--the mortgage interest deduction, etc.--there is nothing magical about housing as an asset. That is, its price responds in an open, transparent market to supply and demand and the cost of money and risk. There are a number of quantifiable inputs that feed into supply and demand--new housing starts, mortgage rates and income, to name three--but there are other less quantifiable inputs as well, notably the belief (or faith) that housing will return to being a "good investment," i.e. rising in price roughly 1% above the rate of inflation. If this faith erodes, then the other factors of demand face an insurmountable headwind, for the most fundamental support of housing is the belief that buying a house is the first step to securing middle class wealth.

Federal debt has expanded by $9.5 trillion - from $5.7 trillion in 2000 to $15.2 trillion at the end of last year and, as Neal Soss of Credit Suisse notes, is still growing over $1 trillion a year (or $5 billion per day). The state of fiscal sustainability, as explained in this compendium of slides, is perilous, but as Soss notes - interest expense did not go up because interest rates fell faster than debt went up. Looking ahead, he notes that political choice theory suggests that taxes can go up, but not a lot (even as the change-maker-in-chief presents his case) and at the same time an unprecedented aging (demographic) shock limits the ability to control expenditures. None of this is news to readers but the financial implication is critical: interest rates must be kept as low as possible to avoid explosive debt dynamics. As Soss concludes therefore, and something we have been clear about for a long time, the era of independent central banks is closing as those institutions revert to their foundational role as fiscal agents of the state.

A few weeks ago when discussing the imminent debt ceiling breach, and the progression of US debt/GDP into the 100%+ ballpark, we reminded readers that in February S&P said it could downgrade the US again in as soon as 6 months if there was no budget plan. Not only is there no budget plan, but the US is about to have its debt ceiling fiasco repeat all over as soon in as September. Which means another downgrade from S&P is imminent, and continuing the theme of deja vu 2011, the late summer is shaping up for a major market sell off. Minutes ago, Egan Jones just reminded us of all of this, after the only rating agency that matters, just downgraded the US from AA+ to AA, with a negative outlook.