Deficit Spending

Amidst all the "fiscal cliff" talk of raising tax rates, few dare to ask: have tax revenues topped out? How could tax revenues decline as rates go up? Easy: people modify their behavior in response to whatever incentives and disincentives are present. Make mortgage interest deductible and people will rack up huge mortgages. Reduce the yield on savings to near-zero (thank you, Federal Reserve) and people will save less. Raise tax rates and people will lower their income or move to low-tax locales. As the saying has it, "Money goes where it is treated well." Supporters of higher rates tout studies that find upper-income taxpayers shrug off higher rates, staying put in high-tax states: Do High Taxes Chase Out The Rich? and Superrich stay put in high-tax states like California. On the other side of the ledger is this study from Britain: Two-thirds of millionaires left Britain to avoid 50% tax rate. Which view is correct? Both, as a result of different dynamics. There are at least four separate dynamics in play.

The Great Depression brought about the Keynesian Revolution, complete with new analytical tools and economic programs that have been relied upon for decades. In dampening each successive downturn, authorities accumulated increasingly larger deficits and brought about a debt supercycle that lasted in excess of half a century. The efficacy of these tools and programs has slowly been eroded over the years as the accumulation of policy actions has reduced the flexibility to deal with crises as we reach budget constraints and stretch the Fed’s balance sheet beyond anything previously imagined. Some have referred to this as reaching the Keynesian endpoint. Keynes would barely recognize where we now find ourselves. In this ultra loose policy environment we are limited by our Keynesian toolkit. Without a new economic paradigm, the deleterious consequences of the current misguided policies are a foregone conclusion.

Salma Hayek is beautiful, rich and famous. Friedrich Hayek is a deceased Austrian economist. He wasn’t very good looking, certainly not wealthy but he did become famous – but only 20 years after his death and then only within the make believe world of nerdy economists. Fortunately for the World today, if we are lucky, Friedrich Hayek may become the most famous Hayek of them all. Until then, the World remains firmly trapped in an economic hell created by Friedrich’s (and therefore Salma’s) arch enemy – John Maynard Keynes. IceCap's Keith Dicker points out that, as most politicians and central bankers view the World in very short time frames, to truly understand the devastation wreaked by Keynesian economics, one has to take a step back and see how the financial destruction accumulated over time. It is true that these policies initially provided sugar highs for the economy – but the 3 step cycle of cutting interest rates, cutting taxes and borrowing money to create growth has finally reached its end point. If Mr. Keynes was alive today, we are confident he would be embarrassed that his lifelong work had been so severely distorted.

In a recent article at the NYT entitled 'Incredible Credibility', Paul Krugman once again takes aim at those who believe it may not be a good idea to let the government's debt rise without limit. In order to understand the backdrop to this, Krugman is a Keynesian who thinks that recessions should be fought by increasing the government deficit spending and printing gobs of money. Moreover, he is a past master at presenting whatever evidence appears to support his case, while ignoring or disparaging evidence that seems to contradict his beliefs. Krugman compounds his error by asserting that there is an 'absence of default risk' in the rest of the developed world (on the basis of low interest rates and completely missing point of a 'default' by devaluation). We are generally of the opinion that it is in any case impossible to decide or prove points of economic theory with the help of economic history – the method Krugman seems to regularly employ, but then again it is a well-known flaw of Keynesian thinking in general that it tends to put the cart before the horse (e.g. the idea that one can consume oneself to economic wealth).

Have you ever wondered what the typical Chinese gold investor thinks about our Western ideas of gold? We read month after month about demand hitting record after record in their country – how do they view our buying habits? Since 2007, China's demand for gold has risen 27% per year. Its share of global demand doubled in the same time frame, from 10% to 21%. And this occurred while prices were rising. Americans are buying precious metals, no doubt. But let's put the differences into perspective.

There are many questions on the minds of weary precious metals investors after enduring the volatile yet range-bound price action of gold and silver over the past year:

• Have the fundamentals for owning gold & silver changed over the past year? No
• What are they? currency devaluation/crisis, supply-chain risk, ore grade depletion
• How should retail investors own gold? Mostly physical metal, some quality mining majors (avoid the indices), and ETFs only for trading
• Is gold in a bubble? No
• Could gold get re-monetized? Quite possibly
• Where is gold flowing? From the West to the East. At some point, capital controls will be put in place

Jeff Clark and Chris Martenson believe everyone should have exposure to gold and silver as a defense for preserving the purchasing power of their weath. The key question is: how much exposure?

As if we needed more proof that the course implemented by the eurocracy becomes increasingly untenable politically, millions decided to strike in several European countries this week. The demonstrations have, as they are wont to do these days, turned violent in a number places. The protests were most intense in Spain, where unemployment is at over 25% and desperation over the collapse of the bubble economy is growing by the day. This is what happens when after decades of socialism, the money to pay for the freebies finally runs out. What the protesters don't seem to get: the status quo ante cannot be recreated by decree. There is no magic wand for anyone to wave. The protesters have every right to be enraged, but they are raging against something that cannot be changed at the flick of a switch – the wealth is gone.

Today it is all about the elections. It is not about last night's relatively surprising RBA decision to not cut rates (on an attempt to create a reflexive feedback loop when it said that China has bottomed; it hasn't, and the RBA will be forced into another "surprising" rate cut as it did previously). It is also not about Europe missing its Service PMI estimate (just like the US), with the composite printing at 45.7 on expectations of a 45.8 print (with both core countries - Germany and France - missing badly, at 48.4 and 44.6 on expectations of 49.3 and 46.2, respectively).  It is not about reports that the EU believes Spain's GDP will again contract more than expected (it will, and certainly without any reports or beliefs). It is not about Greece selling €1.3 billion in 26-week bills even as, according to ANA, its striking power workers have taken 5 power plants online just as winter approaches. It is not about Jean-Claude Juncker telling the truth for once, and saying that Europe is still in crisis, and is facing the viability of the Euro (after saying weeks ago that the Euro is unshakable) and that some countries aren't facing up to their responsibilities. It most certainly isn't about German factory orders finally collapsing as the country is no longer able to delay its slide into full-blown recession, with a September decline of 3.3% on expectations of a modest drop of -0.5%, from the previous decline of 0.8% (the German ministry said that a weak Eurozone and lack of global growth are taking its toll; they will continue taking its toll for years and decades longer). No. It is all about the US elections, with the peak frenzy starting as soon as polls officially close at 8 pm. Everything else is noise.

It didn't take long for mainstream economists to provide us with some inane commentary regarding the latest natural catastrophe. Allegedly, the massive destruction of wealth hurricane 'Sandy' will leave behind has a 'silver lining'. We believe the main reason behind this stance is the unquestioned acceptance of one of Keynes' great fallacies: namely the idea that all economic activity – even unproductive activity – is somehow 'good'. Naturally, if it were really true that we could create economic progress by breaking windows or digging ditches (we will admit that pyramids at least render what one might term 'monument services', even if the expense seems hardly justified by this), then the government should pay half the population for digging ditches and hire the other half to wreak wanton destruction. The loss of wealth the hurricane has inflicted is very real; the wealth destroyed by it is most definitely gone.

What is really causing the economic malaise that the U.S. faces today?  Most economists believe that it is the lack of aggregate demand that is causing the problem which can be rectified by continued deficit spending.  The current Administration believes that it is simply the lack of the "rich"  not paying their "fair share" and that a redistribution of wealth will solve the issue.  Romney believes that his 5-point plan will create 12 million jobs in the near future.  All are wrong.  

The choice of the word “unadulterated” is not accidental.  There were many different kinds of gold standard, including what we now call the Classical Gold Standard, the Gold Bullion Standard, and the Gold Exchange Standard.  Each contained flaws; each was adulterated.

Even if we were able to squeeze some additional taxes out of the parasitic Elites, their income stream is dwarfed by the Federal spending that looms ahead. The top 1/10th of 1% cannot pay the rapidly expanding Federal benefits of the 99.9%, even if we confiscated every dollar of their incomes. How can tax revenues increase when household incomes are declining? Transfer more of the national income to taxes and that leaves less for savings, investment and consumption. The economy contracts, reducing the workforce and wages further. If that isn't a death spiral, it is a close approximation of one.

Debt.  There isn't a day that passes as of late that the issue of debt doesn't arise.  Federal debt and consumer debt (including mortgages) are of the most concern due to its impact on the domestic economy.   Debt is, by its very nature, a cancer on economic growth.  As debt levels rise it consumes more capital by diverting it from productive investments into debt service.  As debt levels spread through the system it consumes greater amounts of capital until it eventually kills the host. The problem is that during a “balance sheet” recession the consumer is forced to pay off debt which detracts from their ability to consume.   This is the one facet that Keynesian economics doesn’t factor in. It’s time for our leaders to wake up and smell the burning of the dollar – we are at war with ourselves and the games being played out by Washington to maintain the status quo is slowing creating the next crisis that won’t be fixed with monetary bailout.

Over the weekend there appears to have been more confusion about pretty much everything finance related by aspiring CTRL-V majors-cum-'market experts.' In this specific case, the correlation between the soaring US deficit is magically supposed to imply the causation of surging corporate profits. Standalone this would be wonderful, because in a socialist utopia thought experiment, where one could hit infinite deficits funded by some magic MMT money tree, corporation would make, well, an infinite amount of profits, and would be an incentive for the government to spend itself to oblivion. And everyone would be happy right: infinite corporate profits means at least some trickle down wealth, and infinity even minus a big number is still infinity, meaning full employment for everyone. Hence utopia. Idiocy of this conclusion aside, the bigger problem with making the biggest rookie mistake in finance (and statistics), namely confusing correlation with causation, is that it is, as usual, 100% wrong when presented with one counterfactual. And when it comes to counterfactuals of soaring deficits, one always goes to the place that has "been there and done all of that" before. Japan.

So far the Fed's 4 year old QEasing strategy has failed for the simple reason that the smart money instead of being "herded", has far more simply decided to just front-run the Fed thus generating risk-free returns, while the "dumb money", tired of the HFT and Fed-manipulated, and utterly broken casino market, has simply allocated residual capital either into deposits (M2 just hit a new all time record of $10.2 trillion) or into "return of capital" products such as taxable and non-taxable bonds. Alas none of the above means that the Fed will ever stop from the "strategy" it undertook nearly 4 years ago to the day with QE1. Instead, it will continue doing more of the same until the bitter end. But how much more is there? To answer this question, below we present the entire universe of marketable US debt, in one simple chart showing the average yield by product type on the Y-axis, and the total debt notional on the X.