Too Big to Fail

By Scott Silva

Editor,  The Gold Speculator

7-12-11

The United States is too big to fail. The largest economy in the world is too strong and too influential to fail. The United States economy leads all other economies as it has for the last 100 years; it has extensive ties to the global economic community. What’s good for the US is good for the world. And what’s good for the US government is good for its citizens.

These are the arguments we hear as the US debt issue approaches a full-blown debt crisis, similar to the near bankruptcy in Greece that continues to plague the EMU.  Today Italy and Spain appear to have caught the Greece contagion.

Could the US actually default on its obligations?  Would default be catastrophic? Is the United States, in fact, too big to fail?

There is no doubt that the United States is coming very close to actual default, just as Greece did earlier this month. The US Treasury must pay interest on outstanding national debt by August 2, 2011. It pays interest from monthly federal income (taxes, fees and interest earned) and from borrowing. The Federal government borrows 40 cents of every dollar it spends. And there’s the rub. Federal borrowing is limited by law, and Congress has already spent up to (and a bit beyond) the legal debt limit of $14.3 Trillion. So if Congress does not raise the debt limit by $2.5 Trillion by August 2^nd, the Treasury will be forced to pay debt interest and not pay out some domestic obligations. If it defaults on its debt payments, the credit rating of its sovereign debt will be downgraded, and the Dollar will decline. Secretary Geithner called the potential result “catastrophic.”

Unlike Greece, the US has no higher collective available with bail-out funds at the ready. Neither the ECB nor the IMF can help the US. Not even the Bank of China could rescue the US today. It already owns over a $1Trillion is US Treasurys.

The current Keynesian solution is to raise taxes by $1Trillion or more over the next ten years, and maintain the current growth rate for federal spending.  Maintaining the growth rate of federal spending implies cuts in federal programs because national demographics portend rapid cost growth in entitlement programs such as Medicare and Social Security. The tax hikes, now called “revenue increases” would come in the form of “closing tax loopholes” on corporations and setting higher tax rates for “millionaires and billionaires.” Taxing the rich, it is thought, will help close future budget deficits and therefore reduce the federal debt. Budget cuts would maintain the current spending growth rate (rather than reverse the slope of the spending curve), and be limited to discretionary programs, including defense, but would not include Medicare and Social Security.

Those opposed to raising taxes cite the nation’s anemic GDP growth rate, which has slowed to just 1.8%, and persistent high unemployment, which ticked up to 9.2% in June. Raising taxes, the opponents claim, might push the economy into a double-dip recession, or worse.

The president agrees that raising taxes in a recession is a bad idea. That’s why he said in his press conference on Sunday that no new taxes will take effect until 2013. The president has stated this position before. In August 2009, on a visit to Elkhart, Indiana to tout his stimulus plan, Obama sat down for an interview with NBC’s Chuck Todd, who passed on a question from Elkhart resident Scott Ferguson: “Explain how raising taxes on anyone during a deep recession is going to help with the economy.” The president responded, “First of all, he’s right. Normally, you don’t raise taxes in a recession, which is why we haven’t and why we’ve instead cut taxes. So I guess what I’d say to Scott is – his economics are right. You don’t raise taxes in a recession. We haven’t raised taxes in a recession.”

But delaying tax hikes to 2013 will not change the need to pay debt obligations on August 2, 2011. And not fixing Medicare and Social Security is no solution to the controlling the largest consumers of the federal budget.

Opponents say it is time to re-prioritize the federal budget, and slash programs that are not essential to operating the federal government, while lowering taxes across the board.  In Greece, the parliament agreed to deep cuts and a wide-ranging austerity program, required by its bail-out creditors.

The bail-out creditors in our case are the US citizens and businesses that pay federal taxes, purchase goods and services with US Dollars. Without substantial budget cuts and entitlement reform, taxpayers will pay more for spiraling federal costs directly by taxes, or indirectly through the inflation that follows the creation of money (and US Treasurys) out of thin air.

So it is the US taxpayer that will bear the brunt of a decision that does not cut federal spending by 3 times or more than the debt ceiling credit raise.

The US debt negotiations are being held in secret, away from the well of the Congress, away from debate, and away from the American people. The people are left with one-way press conference quips and few facts on which to judge, much less to act. And the story keeps changing.  It’s a wonder that the rating agencies have not come down with a verdict already. But the day ain’t over yet.

The markets are reacting. Monday, the Dow dropped 150 points. The NASDAQ shed 2%. The sell-off may have come in part from new fears of debt crisis contagion in Italy and Spain. But there is no good news coming out of the secret US debt crisis negotiations. To the contrary, the US Treasury Secretary took to the Sunday talk shows with a message of impending doom.

Gold is reacting also. Gold continues to move up in price as investors seek the safe-haven trade.

Gold open interest has swelled by 12,000 overnight contracts. Large Speculators have increased their long positions substantially, according to the CFTC.

What is more significant is the fact that since the negotiations began, Gold and the Dollar are moving in positive rather than traditional negative correlation.

It’s time to start thinking about real solutions to our spending problems. As usual, Europe is light years ahead of the United States. The EMU addressed the debt crisis in Greece by enforcing strict austerity by the Greek parliament. We should learn from this example before, by accident or by treachery, the US debt negotiation catapults into a full-fledged debt crisis.

Part of the solution should be a return to sound money-- Bretton Woods II, with some refinements based on experience. One cannot build a sound monetary system based on money backed by thin air. Gold-backed US currency would bring fiscal discipline to the government and help grow the economy.

With a gold standard, commerce would flourish and citizens would prosper.  The Federal government would be smaller and maybe more efficient. The United States economy would grow and become once again, a shining example for the world to see, a tower of financial and economic strength-- too strong to fail.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and growing inflation?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

GOLD AND SILVER ON THE RISE

By Scott Silva

Editor, The Gold Speculator

4-4-11

Even if stability were to return to the Middle East and North Africa, and Japan gets its damaged reactors under control, gold and silver will reach new highs over the next several months. There is no doubt that the popular uprisings in Egypt, Tunisia, Bahrain and now Yemen and Syria, and the shooting war in Libya have threatened stability in the region. Oil prices have spiked to over $100/bbl as Libyan refineries shut down, cutting off 1.6 million barrels a day to global supply. Libya is the world’s 12^th largest oil exporter. Iran, emboldened by the fall of the Mubarak, long time US ally and friend to Israel, for the first time in thirty years sent warships through the Suez, an act Israel’s prime minister described as “a provocative, unprecedented Iranian military presence” in the Mediterranean. More than two million barrels of oil transit Suez each day through the canal and its adjacent pipeline, accounting for at least two percent of global oil output. The political upheaval in Egypt was a surprise to many on watch. Events moved quickly in Egypt; the regime toppled in weeks. Traders (and defense analysts) worry popular unrest will spread to other countries in the region, including the world’s top oil producer, Saudi Arabia. Already, new clashes have erupted in Morocco, Jordon, Algeria, Yemen and Syria.

Gold prices have jumped since the first protesters took to the streets in Tunis and Cairo. Gold is a traditional safe haven for investors. Gold has gained 7 % since January 28, the day that the Egyptian government shut down internet service in an attempt to deny communication among protesters. Silver has gained 37% over the same period. Although the military has assumed control of the Egyptian government, it remains unclear what form the government will take after the scheduled September elections. And the outcome of the war in Libya is far from certain.

But there are other reasons gold prices will remain high. As you have read in these pages before, US government intervention in the financial markets is demolishing the US Dollar. The primary causes are unchecked deficit spending and the Fed’s easy money policies. The conviction to continue massive deficit spending is evident in the president’s $3.7 Trillion budget request for FY2012. Analysts project it will double the national debt to $23 Trillion by 2021. House Republicans are proposing a 2012 budget that targets $4 Trillion in cuts over the next ten years. Whatever budget level is negotiated, funding for much of the budget will come from continued government borrowing, that is, selling US Treasurys to the public and foreign investors. But borrowing at extreme levels (over 100% of GDP) may jeopardize the credit rating of US sovereign debt. Moody’ Investors Service has already indicated that it may be forced to downgrade its economic outlook for the US based on current projected debt levels. Investors seeking to preserve their wealth flocked to gold when the president’s budget was released.

Another factor driving the price of gold higher is new evidence on rising inflation. Commodity prices have been rising steadily since 2009. In fact, commodity prices as reflected in the CRB index have broken through the 2008 high, last week reaching a new high at 689. Higher commodity prices are now flowing into producer prices. The Producer Price Index (chart below), has increased over 23% in the last two months, recovering from the lows of the 2009 meltdown and well over its 2008 high.

Consumer prices are moving higher now as well, despite statements by Chairman Bernanke to the contrary, prices for almost every consumer item (except single family housing) are on the rise, some at double digit rates. For the past 3 months, the core inflation, as measured by the CPI, has moved up 3.9%. Food and energy prices have pushed up 3.1% and 28% over the same period. At the same time, the US Dollar has lost value against other currencies, reducing purchasing power. The US Dollar has lost 35% of its value in just the last ten years. Together, the combination of rising prices and a weaker dollar is a recipe for disaster.

Investing in the stock market is not the answer. Easy money has buoyed up stock prices in the last few weeks; the Dow closed over the 12,000 mark last month for the first time since 2008. But stocks prices are likely to slide steeply when the Fed is forced to tighten in a belated attempt to curb inflation. Continued government intervention may cause the economy to slip into stagflation, that eerie economic nether land of slow growth, declining wages, high unemployment and double digit inflation reminiscent of the Carter years.

Prudent investors can fight the ravages of inflation and debasement of the currency by investing in gold and silver. Gold has maintained its value during periods of high inflation. For example, gold tripled in price during the early 1970’s oil embargo, when oil prices suddenly spiked. In the late 1970’s gold prices climbed as much as 526% in Carter's first three years in office as the president struggled with stagflation. Today, as the Fed continues to print money to support more federal deficit spending, we are seeing once again, the onset of debilitating inflation at all levels.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the continued deficit spending and growing inflation? We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055