Borrow or Balance: The Feds’ Only Two Choices

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The feds got over the first hurdle. They cut a deal to keep the government in business a while longer.

But that’s not the end of the story. It’s just the beginning.

The New York Times has the story:

Congressional Republicans are vowing that before they will agree to raise the current $14.25 trillion federal debt ceiling – a step that will become necessary in as little as five weeks – President Obama and Senate Democrats will have to agree to far deeper spending cuts for next year and beyond than those contained in the six-month budget deal agreed to late Friday night that cut $38 billion and averted a government shutdown.

Republicans have also signaled that they will again demand fundamental changes in policy on health care, the environment, abortion rights and more, as the price of their support for raising the debt ceiling.

In a letter last week, Treasury Secretary Timothy F. Geithner told Congressional leaders the government would hit the limit no later than May 16. He outlined “extraordinary measures” – essentially moving money among federal accounts – that could buy time until July 8.

Once the limit is reached, the Treasury Department would not be able to borrow as it does routinely to finance federal operations and roll over existing debt; ultimately it would be unable to pay off maturing debt, putting the United States government – the global standard-setter for creditworthiness – into default.

The repercussions in that event would be as much economic as political, rippling from the bond market into the lives of ordinary citizens through higher interest rates and financial uncertainty of the sort that the economy is only now overcoming, more than three years after the onset of the last recession.

Here’s the story. The feds spend more than they “earn” in taxes – almost 100% more. That gives them only two choices…balance the federal budget, by raising taxes and/or making spending cuts…

Or…borrowing money.

Borrowing is a lot easier than taxing or cutting. So, that’s what they’ll do. Forget the grandstanding…forget the agit-prop theatre…

..they either borrow…or they balance the budget.

And they’re not going to balance the budget. Because too many voters expect to get more from government than they have paid for. That was the unstated promise of modern, social welfare governments:

Let us control your lives. We will give you more in benefits than you pay for.

How can you give people more than they pay for? Only by taking the money from someone else. But governments have learned that taxing the rich heavily actually reduces the GDP and the amount of money that can be given to voters. So, they turned to taxing the next generation.

After all, they don’t vote.

And more thoughts…

Buenos Aires is beautiful. We have been blessed with good weather.

The city is booming, too. Strong agricultural prices have done what they always do in Argentina – they’ve set off a boom.

“Property prices are up about 30% over the last 3 years,” says our BA- based colleague, Rob Marstrand. “But this is such a funny place. I love living here, because you see everything. If not in the present, certainly in the past…or the future. Booms, busts, corruption, inflation – everything.

“Only about 6% of properties are sold with mortgages. So this is a real boom – where people are paying cash. But, where does this cash come from? Much of it comes from the bull market in farm products. Argentina is one of the world’s top producers of cereals, for example. But there is probably a lot of money coming from the government too. The inflation rate is about 25%.

“Now, you’d think that a country with a 25% inflation rate would have a currency that is falling through the floorboards. But no. The authorities have been supporting the peso; it actually went up 4% against the dollar. Put the dollar’s drop and Argentine inflation together, and you get a loss of dollar purchasing power of 30%.

“People want to protect themselves. And here, they do it by buying real estate.

“Americans might want to think about it too.”

Prices are down 30% nationwide in the US. In Florida, Nevada, and most of California, they’re half off. Even if they might go down a bit more, there are some very good deals available now. A friend of ours is able to buy apartment buildings for little more than 5 times rent income. If upkeep and taxes take half of that, that still gives him a 10% return. But it could be much better. Suppose he takes out a 30-year, fixed rate mortgage. Now, suppose inflation goes up. Every percentage point that consumer prices rise is another percentage point of yield for a fully- mortgaged investor.

Rob also is in charge of our Family Office investments.

“I don’t see any way that they can unwind all this debt and spending without causing even more problems,” he says. Investors might get some protection from real estate or stocks. But the best protection is gold.

“But we’re still in a correction,” Rob continued. “It wouldn’t be surprising to see gold fall when this round of QE ends. Take away the money-printing and gold could sell off along with everything else. But people are now catching on. When the economy worsens, they expect the feds to add more stimulus…or lower rates…or more QE. So, they know that over the long run, the effect will probably be to undermine the dollar. I wouldn’t be at all surprised to see gold down 15% in the next sell-off.

“But when the feds step in with more spending, gold will be the clear winner. We already own a lot of gold. I feel like I want to buy more of it…”

Regards,

Bill Bonner
for The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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Comments

  1. @ Bill, or one of the DRA people,

    What is your strategy to protect your holdings of physical gold if the US Government determines that private citizens can no longer hold physical supplies of gold and also mandate that it needs to be sold to the Government at a price determined by them that may not reflect current pricing?

    Is the downside risk of a desperate Government intervention worth holding physical supplies of gold, silver and other hard assets?

    Reply
  2. “People want to protect themselves. And here, they do it by buying real estate.”

    It’s pretty difficult to fault that strategy, provided that it’s not a debt trap, the real estate is in a good location (eg: peaceful part of the world, adequate sunlight and rainfall, permission to grow your own stuff etc). Get some of that and you’re set.

    As for gold, I’d have thought that one of the most important things is not to let on you have any. Especially while fiat money is still king.

    Reply
  3. No mention here of the current Argentinian chronic power supply problems and the deterioration of public infrastructure that was once the equal or better to that in Australia in the early 20th century. No mention either that after the Argy’s reneged on the US private bondholders that a US military freighter was detained and that the cargo of arms and out of date drugs was seized.

    Reply
  4. Ross, what do you reckon, with the US going into a decline – is South America due for a bit of a boost in trade, productivity and living standards?

    Reply
  5. @Dan, those that were on the right path are getting smashed by capital inflows and rising exchange rates screwing their exports and sucking in Chinese USD priced imports.

    The Argy’s suffer culturally from the legacy of empowered bigotted buffoon ranchers and the rest of their elite cleptocrat class. The stupid bondholders who don’t want to be held accountable for their dumb lending decisions on Argy got debt defaulted and the Argy’s told the IMF to go to hell, it happened years ago but they still want to use the CIA bring the Argy’s down and reinstitute the dud paper in a settlement. The US also wants to take down an ever growing list of left leaning and rising indigenous populations in Bolivia, Peru, Venezuala (Paraguay to follow when they deal with the public service) plus the old Cuban stalking horse with the sugar plantations that will power Obama’s ethanol solution to the energy crisis his CFR built by shooting up too much of the middle east and north african production.

    Just like the Brits and the Dutch want to bring the Icelanders down when they failed to regulate private deposit taking institutional activity on their own soil and expect another sovereign and their taxpayers to pay for it.

    Socialist Dilma is sovereign risk personnified in Brazil because she is a little stronger than Lula. Lula was a bit of a joke who ran the place ok because everybody laughed off many of his socialist scripts. In a clear majority mandated socialist political economy Brazilians are also found to be the highest per capita supporters of capitalism on the planet so they have some hope (Australia sits about in the middle of that league table the US is only half way toward Brasil).

    So the short answer for mine is a sustained level of political risk despite the promise they have shown holding out political independence this long and an aversion to carry trade styled asset investments that were last decades trade and not this years because they will correct severely in tandem with the local currencies if QE is pulled and that will be a double whammy. I have invested in Canadian grain myself (Viterra). If the US starts making whoopy in Cuba I would be an early investor in there too on the back of Brazilian sugar ethanol technology and ride along with the rest of the herd for a short while (til local cultural economic sloth and fierce resentment catches up with the gringos again).

    Reply
  6. “Cuban stalking horse with the sugar plantations that will power Obama’s ethanol solution to the energy crisis”

    If all of Cuba’s agricultural land was planted with sugar cane (3.6 million hectares – assuming the same yields as they get in Brazil of 7500 litres/hectare) that will produce 50 billion litres of ethanol. That sounds like heaps but at a fuel economy of 10 km/litre (being very generous there) that will give you 500 billion kms. With the average light vehicle doing 20,000 kms/year – that in theory will supply 25 million cars or about 20% of the total passenger cars in the US.

    Not a bad start but hardly a solution and assuming that all of the land in Cuba is suitable for cane is a rather big one. Also telling the local population that food growing is out – sugar is in could cause problems. As far as expansion is concerned, approximately 60% of Cuba is already agricultural land so not much upside there. I would think – at best 5-10% of passenger vehicles – a big maybe there as well.

    Reply

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