Suburbistan: Here Comes the Fiscal Firestorm

Suburbistan: Here Comes the Fiscal Firestorm
by Dan Denning
The Daily Reckoning
Wednesday, March 22, 2006

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Bogus Fed numbers…Bernanke triggers a rise for the dollar…
Dollars, dollars everywhere, but not a drop of real liquidity…Buffett's bet against the dollar…
History, that coy tease, continues her grind…two out of three Americans now think the war against Iraq was a mistake…and more!

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The U.S. economy is not growing, it is shrinking, says Walter J. Williams. We are already in recession. Forget stagflation, he adds. What we need to prepare for is "hyperinflationary depression."

We are still quaking from yesterday's revelations, reported at the bottom of our very own Daily Reckoning. We knew the Feds' numbers were bogus. Now, along comes an honest economist, the aforementioned Mr. Williams, with a serious reckoning of how bogus they really are:

Unemployment is not 5% or 6%. Computed the way it used to be, it is twice as high. And the U.S. deficit? If the Feds didn't use Enronesque accounting techniques, it would be around $11 trillion. As for the national debt, Williams says, "The fiscal 2005 statement shows that total federal obligations at the end September were $51 trillion; over four times the level of GDP."

There will be hell to pay for all these statistical prevarications, Mr. Williams believes. And the first payment is likely to be in the imperial currency itself - the dollar.

But yesterday, Ben Bernanke spoke and the dollar rose.

"Market participants do not harbor significant reservations about the economic outlook,'' said the nation's top banker, adding that corporate risk spreads "would seem to be consistent with continuing solid economic growth.''

There is the problem, dear reader. Despite the repeated alarum sounded in these pages, more "market participants do not harbor significant reservations about the economic outlook." What are these market participants thinking? Significant reservations are exactly what they most desperately need and most recklessly lack. You can buy a junk bond and get only 3% more yield than you would get from a U.S. Treasury. Surely, the treasuries are time bombs, but what are the bonds of Iraq or a dreamy dot.com? They don't even have timers; they could blow up at any moment.

But who knows? And who cares?

Both junk and non-junk are calibrated in dollars. The dollar itself is the currency about which one should harbor the most significant reservations.

Here, we turn the microphone over to an old man - Warren Buffett. The Sage of Omaha is 75. As far as we can tell, he still has his wits about him. But, there are some markets to which youth is better suited than age, recklessness is better rewarded than prudence, and ignorance pays off better than wisdom. This Fin de Bubble period is one of those times. You'd have to be a fool to buy many of today's popular investments, but being a fool is the only way to make money. Fortunately for the bubble people, there are a lot of fools, and a lot of investors whose ignorance is not merely spotty, but encyclopedic.

Poor Buffett is neither ignorant, nor reckless, nor young. He doesn't seem to fit in. Earlier this week, a popular financial columnist declared him "out of touch" with modern market forces. Why? Well, it's because he, almost alone, harbors significant reservations - notably about the dollar. Yesterday brought news that Buffett is still out of touch.

Bloomberg reports: "'I think over time the dollar will weaken,' Buffett told reporters, after ringing the opening bell at the New York Stock Exchange on Monday. 'I have no idea if it'll be this year or five years from now.'

"Buffett, chairman of the [Berkshire Hathaway] insurance and investment firm, has been betting the U.S. trade deficit would weaken the nation's currency since 2002. Between 2002 and 2004, Berkshire made $2.96 billion on Buffett's bet against the dollar. Last year the company had $955 million in losses as the U.S. Dollar Index advanced 13 percent.

"'It's the consumer action in the end. We have no governmental policies to counteract that we are sending a couple billion dollars a day abroad,' Buffett said. 'We are buying goods and selling capital.'

"To compensate for the current-account deficit and maintain the value of the dollar, the U.S. needs to attract about $2.5 billion a day from overseas, or about $75 billion a month."

We checked; in terms of euros, the dollar has barely moved for a long time. But, in terms of gold, it is worth only half what it was in 2000. This is where history will be made, we think. But what history?

Against gold, the dollar is collapsing and people scarcely notice, except the English, who have finally realized what bunglers their central bankers are.

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The London Times: "Merrill Lynch predicted that gold would hit $600 an ounce in the long term after its recent rise above $500. Last month the precious metal hit a 25-year high of $579.50 an ounce amid concern among investors that America's huge trade gap would force a weakening of the dollar. The Chancellor sold 395 tonnes of Britain's gold reserves between 1999 and 2002, generating $3.5 billion. At yesterday's London closing price of $554.10 he would have generated more than $7 billion (£4 billion)."

You can make a lot of money by watching bankers, we long ago concluded. You see where they are lending money - and you sell the borrowers short. Or, you look at what they are selling - and you buy it. In the late '90s, so many banks wanted to sell gold that they had to collude to avoid glutting the market. Each central bank was only allowed to sell a certain amount each year. Britain led the way with its massive sale of nearly 400 tons, driving the price of gold down to a 20-year low. Debts and deficits were running wild. Wall Street was giddy over the biggest bubble in history. All over the world, central banks were goosing up their printing presses trying to keep up with the stacks of dollars arriving in their vaults. Was there ever a worse time to sell gold? We can't think of one.

But, bankers - especially central bankers - like politicians, can generally be counted on to do the wrong thing. At the end of the millennium, they did not let us down.

If Buffett, Williams, and The Daily Reckoning are right, this history has only begun. The dollar will lead the economy into a "hyperinflationary depression." If we are right, there will be dollars, dollars everywhere, but not a drop of real liquidity.

Eventually, the Bank of Ben Bernanke will do just what it has promised: increasing the money supply as fast as it can, but people will still not be able to pay their bills. Prices for oil, gold, copper, and dinner may soar…while mortgages will go unpaid, houses will be foreclosed, and real incomes will fall. Gasoline prices rose 14 cents in a single week, says the Atlanta paper, but producer prices registered their biggest drop in almost three years, says Bloomberg.

Inflation and deflation side by side. The dollar will plummet on world markets, and yet, in the hands of American lumpenconsumers, it will be more precious than ever. How is it possible? What does it mean?

Ah, dear reader, that history…that coy tease…she will reveal all, but only when she wants, and only at great expense.

Over to Aussie Joel and The Rude Awakening for more news…

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Justice Litle reporting from the pristine shores of Lake Tahoe:

"As super-major oil companies like Exxon struggle to replace their oil reserves at a reasonable cost, the demand for alternative energy and clean technology will only grow stronger."

For the rest of this story, and for more market insights, see today's issue of The Rude Awakening:

"Green is Green"

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Bill Bonner, back in London with more views…

*** We went over to the Savoy for breakfast with a friend this morning. If you have never been to the Savoy, it is worth a visit. The place is elegantly furnished - almost opulent in an English kind of way. High tea at the Savoy is a treat. (We used to prefer high tea at Browns, but they've recently redecorated Browns so that it is more stylish and less attractive.) The last time we were there, we were entertained by a string quartet, while eating more delicate sandwiches and pastries than we could comfortably stomach. Breakfast, on the other hand, was very simple - just tea and croissants.

A French woman accompanied us; we were not in the mood for a full English breakfast.

"We were sorry to leave London," she told us. "Compared to Paris, London is really much more lively. Paris seems dreary after you've lived in London. I know it has become very expensive to live in London, but sometimes I think it is worth it.

"There are so many restaurants - so much to do. And it's so good for the children…especially our children. They are among a different crowd of people - much more diverse, and of course, English-speaking, too. So, they get the best of both cultures. We spoke French at home, and they spoke English and French at school. They had friends from many different backgrounds. Yes, we were sorry to go back to Paris…it was a very difficult adjustment for the children."

For a while, the sun came out. It looked as though spring might really be coming. But by the time we had finished our tea, the sky had clouded over again; an icy wind blew.

*** History continues grinding away at George W. Bush's administration. There seems no end in sight to the bad news coming out of the Middle East.

The London papers say two out of three Americans now think the war against Iraq was a mistake. The other one is an idiot, they imply.

The British prime minister, meanwhile, is an "honorary neoconservative," says Francis Fukayama, who has deluded himself into thinking that democracy can be imposed at the speed of one's choosing - and at the point of a gun.

"Something similar happened to Bush," Fukayama continues. "When he stood for president, he talked about having a 'humble' foreign policy and attached nation building, and since then he has talked himself into believing in it.

"That's why this whole thing has been such a terrible disappointment. It has turned out exactly the opposite."
Wars of choice are almost always disappointing, we notice. Whether you call them "preemptive" wars, or merely opportunistic wars - they all seem to end up in misery and regret. As Bismarck put it, "it is like committing suicide for fear of death."

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The Daily Reckoning PRESENTS: This year could be the year where we see a silent tipping point in American politics. It will be a point of no return, where interest rates rise as America's borrowing costs no longer seem so easily manageable. Follow along as Dan Denning explores what might happen when a generation of young taxpayers is pitted against a generation of retiring pensioners…

SUBURBISTAN: HERE COMES THE FISCAL FIRESTORM
By Dan Denning

"With the median home price rising by 26% in the past five years - while young adults' income has gone up less than 10% - people in their twenties are playing an endless game of catch-up. Buying a home isn't even in the cards since prices in many urban areas where young people go to start their careers have more than doubled."

- Vanessa Robertson, MSNBC

"While there are exceptions in industries less subject to intense competition, G.M. is like many other once impregnable American corporate titans in arguing that reducing the burden of caring for retirees has become essential to compete against foreign companies with lower benefit costs and domestic rivals with younger work forces and less generous benefit packages. With retirees living longer and accounting rules forcing companies to more honestly reflect their full costs on their books, the corporate-sponsored social contract is no longer sustainable."

- Eduardo Porter and Mary Williams Walsh, The New York Times.

Over five years ago, Addison Wiggin and I sat at our desks in Baltimore and had a right good laugh over the term Suburbistan. We knew the boomers would begin retiring soon. We knew the government wouldn't have the money to pay for it. We knew that when you pit a generation of young taxpayers against a generation of retiring pensioners, you'd get some conflict.

But Suburbistan?

Is it really possible that when cities, states, and the federal government can no longer pay their bills or keep their promises, you'll see more strident political fights between the generations? More conflict?

If you leave it up to politicians, you can almost guarantee it! Just ask Hillary Clinton. She spent a few days shilling for votes at the United Auto Workers Convention, where delegates sought a Marshall Plan for the U.S. Auto Industry.

Don't get me wrong. I think America has made a serious strategic error selling off its industrial assets, or allowing them to rust away, to say nothing at the loss of real manufacturing skill that's accompanied the loss of three million jobs to China and India. Part of this is the auto industry's inability to adapt to a world where labor is cheap and oil is expensive. The UAW is complicit in its own demise.

But what does this all mean?

Do you remember what it was that caused oil to bounce off $25 in 2003? Following the commencement of hostilities in Iraq, the oil price fell. But then it started climbing. And it kept climbing. And it's still climbing.

What happened?

Somewhere along the way, markets realized that something important had changed in the world. It wasn't just speculative traders and geopolitical traders. It wasn't just the loss of Iraqi production and the growth of Chinese demand. It was, for lack of a better word, a silent tipping point.

Since then, we've begun to discuss and absorb the realities of the global energy market, namely the likelihood that global oil production has peaked, and that from here on out oil is going to be harder to find and costlier to get out of the ground.

This year could be the year where we see a silent tipping point in American politics. It will be a point of no return, where interest rates rise as America's borrowing costs no longer seem so easily manageable. Political rhetoric will be more strident, as it was at Corretta Scott-King's funeral. After all, it's an election year.

But more than that, people will begin to feel in their guts that not everyone is going to get through this equally. Do the maths, as the British say. They don't add up. America can't pay for all its guns and all its butter.

To meet its borrowing needs, the American government has re-introduced the 30-year bond. There's a market for the longer-term bonds. And they help the government finance its projects. But the gap between what the American government spends and what it receives in revenue keeps growing.

According to a recent Reuters articles by Pedro Nicolaci da Costa (great name), "If the budget gap continues to grow as a percentage of the total economy, some worry the long-term attractiveness of the United States as an investment destination could be tainted as investors fret over the country's ability to manage its debts.

"Ballooning deficits could also create trouble for consumers down the line if foreign investors lose their affinity for U.S. assets, forcing a spike in interest rates."

You've heard this before, so it's not news. But this year is different. And yes, this time is different. The U.S. Treasury market is the most liquid on the face of the planet. It's the natural destination for the world's surplus savings and capital.

But that is exactly what seems to be changing before our eyes. Foreign creditors are realizing that while the return on U.S. bonds is getting better all the time with rising rates, it might not be as safe as it looks. And with major global energy projects to invest in (see below), investing in hard assets and energy might be a much better destination for global savings.

If and when that happens, it will set off a domino effect in American political and economic life. It will unleash Suburbistan, as American government - at all levels - is unable to borrow in order to pay for the promises it's made to a population that now demands government "help."

What will happen? Will payroll taxes be increased? Will GM and Ford get bail-out packages from the next president?

Those are all stories we'll be following in the next two years. But I'm pleased to report that there is an investment solution to this problem. One thing we can be certain of is that as political strife in America increases, so will volatility on the stock markets.

Dan Denning
The Daily Reckoning

Editor's Note: Dan Denning is the editor of Strategic Investment, one of the most respected "big-picture" investment newsletters on the market. A former specialist in small-cap stocks, Dan has been at the helm of Strategic Investment since 1999 - where, drawing from his network of global contacts, he has designed an investment strategy that takes into account global political and economic trends.

To learn more about Dan's highly regarded investment newsletter, see here:

Strategic Investment

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