As is my usual practice it's that time of year when I score my "best guesses" from the previous year, and look forward with my next set. If you're not inclined to bother with long-winded explanations the title is probably sufficient. But for everyone else, let's look at the 2011 list and see how I did.
Well that "more or less" worked out. I don't have the final numbers yet and won't for a bit as I'm writing this before the end of the year, but we most-certainly did not run a $2 trillion deficit. As of 12/21 it's right near $1.1 trillion gross ($1.3ish involving cash adjustments.) This is a bad number though as the most-recent data isn't in and neither are the cash adjustments that Treasury usually makes. Nonetheless there's no way we're going to see another trillion "magically appear", so that's a point.
Nothing but net on this one.
Nothing but net again.
How's that gold trade working out for 'yall? Topped nicely and sliding now. Point.
Miss, but I think only on time. The lawsuits are coming -- California and Nevada are leading this charge but I said 2011 and it didn't happen. No score when the timing is wrong.
Score. Shanghai market is down about 25% on the year. They're not done either.
Half-point; we got a massive restatement on sales but the 1x decline in prices didn't happen. No bottom though -- that's agreed by pretty-much everyone.
Score. No defaults en-masse but the games and the problem were spot-on.
Nope. Early -- this one gets repeated for 2012 though.
Eh, no point. But the earnings flow-through on the PPI is here but I can't take the point yet. This one gets repeated for this coming year and I might have only been off by three months. Nonetheless, early is wrong.
It got talked about but didn't hit earnings until the start of 4Q. Miss on time, will repeat this one too.
Ditto. No point.
I'll take that point. NO QE3, despite everyone who called for it.
We got a lot of it but not enough. Half credit - big sell-offs but the ending point is definitely wrong.
Uh, yeah. Point.
Miss. "Occupy" doesn't count and while there has been some over in Europe in particular what we've seen is not what I had in mind. No point.
Looks like 10 out of 21. Remember that to be right you have to hit both the event and the time, so I consider this a pretty good score. You can judge it however you want.
Now let's look at how things are today.
As this goes to press The ECB has tried to "put out" the Euro debt zone fire for about the 10th time this year. None of the others have worked and this one won't either. There's simply no "there" there. The EU banks are ridiculously over-levered, there is no real attempt to force them to cut that crap out and in fact at this point they probably can't since they've geared up on sovereign debt -- if they sell it down rates will spike to the moon and the entire EU comes apart. If they don't and something goes wrong (anything!) then they blow up, rates spike to the moon and the EU comes apart.
If you're wondering why there's been no solution that's the reason -- there isn't one that doesn't involve taking these wealth-destroying institutions out back, shooting them, paying off depositors as best you can and then either charging their executives under the law or simply turning them over to the now-very-pissed-off citizens who just saw their pensions and social benefits go "poof" (never mind that it's really the politicians fault that it all happened in the first place!)
Speaking of that I want to go into a bit of detail, because it seems that people just don't "get it" in this regard. It's convenient to blame the big banksters, and they're certainly a big part of it. But the primary blame has to rest with the political class for two reasons: They make the laws under which the banks operate and they love making political promises to spend money they both don't have and are unwilling to tax someone to acquire.
What Congress spends but doesn't have Treasury must borrow. When Treasury borrows it creates the capability for banks (including The Fed) to create monetary inflation and bubbles.
There are three sorts of "money" -- actual surplus capital from past economic activity, self-liquidating credit and non-liquidating credit. All three spend exactly the same but they are not the same.
The first is earned by someone's efforts and it is what's left after you pay your costs (including taxes, if any.) That's actual wealth -- and is the only sort of "money" that one can call "real." At least in theory it is supposed to be durable and able to be saved, invested, or spent as you choose.
The second is credit money that is created to liquify an asset. An example of this is a letter of credit guaranteeing payment for a shipment from Japan to the United States. It's hard to sue someone in the US from Japan, so this is very useful to commerce. But this credit money goes away when the bill is either paid or defaulted. The same model exists with a credit card that you pay off every month. This has no inflationary impact because it disappears when the transaction is closed.
The third is credit money that is created based on nothing other than a promise to produce something tomorrow. In the case of government that "something" is of only one form -- taxes. In the case of an unsecured private loan it could be anything from a revolving credit card to an OTC derivative trade. The problem with such a loan is that it does not self-liquidate as it's never closed -- instead, it's rolled over again and again. Since this sort of loan permanently expands the number of monetary units in circulation it is a pure act of monetary inflation. It is important to note that all government deficit spending has been of this form in the modern era -- we have never actually run a budget surplus save one year -- a tiny one in calendar 2000 (but not fiscal 2000.)
Why is this understanding so important, you might ask? That's simple -- it is the explicit and intentional acts of the government in their overspending that lends cover to virtually all of the other ills with capital misallocation, trade imbalance and other games.
Let's take a simple example: Nation "A" and "B" both have floating fiat currencies. Nation "A" runs a trade deficit with Nation "B". What happens? Capital drains from Nation "A" to "B" since the funds to buy the goods move and never come home. This makes Nation "B" more wealthy and "A" poorer; that in turn makes the goods "B" is exporting more expensive in "A"s terms and almost-immediately cuts off the imbalance.
So how do you prevent that? Oh that's easy -- get the government to run a $600 billion budget deficit! Now you can "replace" $600 billion of capital with $600 billion of non-liquidating (that is, permanent) credit money. Heh maw, look -- my trade deficit didn't self-extinguish!
But notice what's going on under the surface: Capital and credit aren't the same thing. One is wealth, the other is a promise to labor tomorrow. In other words one is the product of free men and women, the other is a demand that others submit to slavery -- a promise that others will pay taxes in the future!
If you're wondering where our jobs went, that's how it happened. The actual capital flowed out of the country and was replaced by credit which spends the same but isn't the same at all. What disappeared was wealth and freedom, and what replaced it was bondage, unemployment and McJobs. If you're wondering why despite Congress saying they don't want to see all of our jobs go to China and Mexico it keeps happening, it is happening precisely because Congress will not stop spending more than they tax!
In other words it is Congress that has drained the capital of our nation through their policies. They have serially lied to us for thirty years in this regard with those lies really picking up steam in the last decade. The so-called "Tea Party" along with the Democrats and "mainstream" Republicans are all liars in this regard -- every one of them is complicit, as any of these groups could have shut this down at any time.
Had the Congress refused to raise the debt ceiling in August it would have immediately forced a balanced budget -- without the need for a Constitutional Amendment.
Remember too that the House and Senate both have permitted "Continuing Resolutions" to run the government now for two years. This was agreed to by both Houses, ergo, it's both of their fault and those claiming otherwise are liars.
This same dynamic has played out over in Europe. Greece, Spain, Portugal, Italy and others have all made promises they can't keep with their current tax revenues. The same dynamic has led to the same outcome -- they're just a bit ahead of us on the road to perdition.
Of course the political impetus to spend money you don't have is strong. It's easy to buy votes for a while by promising people things you know you can't afford, and it is wildly unpopular for a politician to say "No." Even the vaunted Ron Paul who claims to be "Dr. No" in his voting record in fact does not honor that when it comes to earmarks -- he lambastes them on the floor but when it comes to vote he pushes for, votes for and accepts them for his own district!
The reason of course is simple -- he wants to keep his seat.
But overspending is a corrosive act no matter who is doing it. It eventually bankrupts any entity that engages in this practice, but when governments get involved the results are particularly nasty, as it is the entirety of the nation that suffers. The more attempts are made to cover up the effects of the stupidity, such as by financial repression of interest rates, the worse the harm and the more-widely that harm is spread across the population.
There's been no honest attempt to deal with any of these issues, including most-particularly in the United States. You cannot solve a debt problem with more borrowing any more than you can drink yourself sober. We continue to believe we can run trillion-dollar+ deficits without consequence and the 10 year Treasury yield seems to agree. What must be kept in mind is that this is the same dynamic that played out in Europe -- including in both Greece and Italy -- right up until it didn't, and when the bond market came apart there it did so with extreme violence. The same thing can and will happen here.
This, of course, leads to the obvious next question: when? It is here that math provides a useful degree of guidance.
In 2007 we had to shrink our Federal Government by about 20-25% in order to restore balance to the economy. Those who have followed The Ticker for what is now approaching five years and 5,000 articles know that I've been calling for this realignment incessantly since that time. Instead we grossly expanded the size of our vote-buying programs with more and more deficit spending. This led us to today where the required shrinkage is now approaching 50% in size -- four years later.
This is an important fact, because that is a geometric progression. Now let's go back and see what we have four years previous and see if the progression holds up -- to 2003.
In 2003 we ran about a $600 billion deficit against a GDP of $11.5 trillion, which was about 6%. That is, we tracked under the geometric expectations on a backtest (which were about 10-11%.)
Can we survive a 50% reduction in the size of the Federal Government, a doubling in actual taxes received by the government, or some combination of the two? I don't know, but it doesn't matter whether we can -- one of the two or some combination adding to that point is going to happen whether we survive it or not!
The "outside window" on "when" is four years hence. Of course that's the "100% reduction" line at which point we simply collapse into civil war and anarchy forced by mathematics, and in truth we'll blow sky high long before we get there. You can reasonably expect that there will be attempts to push the line backward, but there is no actually stopping of the process until and unless we run a surplus in terms of economic growth -- that is, growth in the economy must exceed growth in government spending (this, incidentally, means that if economic growth is negative the government must shrink at least as much.)
The members of the Simpson-Bowles deficit commission had their own private estimates of "how soon." None believe we have more than two years left. I think that's about right, and we may not get that far. History says that these walls always are closer than they appear, just like the T-Rex was in the rear-view mirror in Jurassic Park. Revulsion tends to come from a "moment of recognition" that precedes the actual hitting of the wall, just as it did in Greece and the rest of the European continent. Thus it will be here if we fail to address the issues facing our nation and defer to political expedience and vote-buying.
Now let's look at the current macro picture. We have durables reports showing massive inventory levels -- in fact, the December report had inventory at all-time highs. This, standing alone, is bad -- it "pulls forward" GDP numbers but the sustainability of that is predicated on sell-through. If there is no sell-through you're in big trouble.
Add to that the earnings misses coming from various companies. We are now into the maw of the profit impact from the PPI ramps of a year to 18 months back, which I've been pounding the table on now since August of 2010. The PPI has slacked off on the rate of advance, but the damage is done. That's in the pipe and can't be avoided. In addition the organic profit cycle has almost-certainly peaked in terms of percentages of profit from gross sales. Those two factors plus the inventory situation are all the ingredients for a severe inventory (conventional) recession while The Fed has already backed itself into a corner with ZIRP and The Federal Government continued to overspend! In other words the policy tools to "help" are slim and none and Slim is in the bar getting drunk.
Politically we have a huge problem -- the premise is "tax cuts good, anything that raises taxes bad." At the same time "spend more" remains the mantra of both political parties. The "Pay For" on the recent FICA deal was spread over 10 years but the impact on the deficit -- some $200 billion -- is all right now. Of course in a year nobody will be willing to "raise taxes" either, so the $200 billion over 10 years will be $2 trillion. To those on the right who argue that "we can't give more to the government; they'll squander it" you're free to run that line when the budget is balanced -- until it is you're just arguing for jamming the accelerator as we approach the brick wall at 100mph, exactly as are those on the left. "Blow up in one year or blow up in two" still is "blow up." Both are stupid and indefensible and we should call them what they are -- calls for anarchy -- because that's exactly what we're going to get on this path.
Now let's look east -- specifically at Japan. The most-recent budget, accepted by their government, calls for an astounding near-50% deficit -- that is, they intend to borrow half of what they spend! The willingness of the bond market to swallow whatever the Japanese government emits has led them to believe they can continue that sort of game forever. They're wrong. And while I'm at it may I remind everyone that the Japanese stock market remains down more than 75% from its all-time highs -- 20 years ago? How's that "earnings growth" and "economic progress" thing working out over there?
Finally, China. The most-recent news is that of large minimum-wage hikes. Nice idea. Can they successfully navigate from a mercantile jackbooted exporter that steals anything that isn't nailed down (and some things that are) to a consumer-led, consumption-based economy that generates actual economic surplus? I'm not sold, especially when you add to that the need to stop treating the land, air and water like open sewers.
Returning back home we have one final area of contention to consider -- it's an election year. If you think either major political party is going to do anything that might be perceived as "helping the other guy", you're nuts. They most-certainly will not. This will lead to some very interesting times in the next few months, given that the second half of the debt increase is subject to vote and as of the 22nd of December we're a grand total of $113 billion from hitting the wall -- again. January is usually a month that Treasury runs a surplus due to tax payments, but you can still expect the clamoring -- and games -- to start up pretty much with the drop of the ball in Times Square.
Will the so-called "Tea Party" fold their claims of fiscal prudence once again? You bet. After all, they just did vote to blow a $200 billion hole in the deficit with the payroll tax cut extension -- a vote that was taken by "unanimous consent" because not one Representative out of 435 thought it was more important to stand on principle and demand a recorded vote than it was to drink eggnog with those providing their bribes -- er, "family and friends." You got that right folks -- not one man or woman stood on principle.
So we are consigned to the same sort of cock-n-bull game now that we were back in 2007, and 2008, and last year. But Mr. Market doesn't care. He's going to do what he's going to do, and he's issued his warnings -- which were ignored.
So with that, here's your 2012 Outrage List, and we'll see how many I get right.
Here 'ya are -- 15 for the New Year. As always I reserve the right to revise and extend until 12/31 at 11:59 PM.
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