Stansberry’s Investment Advisory — The Wages of Obama’s Sins

Clark Gable

This was written in my recent issue of the Investment Advisory and because it explains many of the problems being caused by our inept president I decided to re-blog it for my readers. I believe that we will pay for Blah Blah Oblahma’s Sins.

We begin 2013 in awe of what’s happened to our country…

Since 2008, when President Obama was elected, the official, net public debt of the U.S. federal government has increased by $5.5 trillion.

That’s more than double the size of the total net public debt of the U.S. in 2007, the year beforeObama was elected ($5.03 trillion). These additional new debts have swollen the total net debt of the federal government to more than $11 trillion, or roughly 80% of GDP.

These overwhelming public financial obligations are completely unprecedented in the history of our country, outside of the two major global wars we fought in the 20th century.

But even these incredible figures don’t tell the real story. Or even half of it.

You see, these are merely the debts that we, federal taxpayers, are actively paying interest on right now. These don’t include any of the additional $4.8 trillion in debts held by various government agencies (but which still cost us interest every year). Nor do they include any of Fannie Mae‘s or Freddie Mac‘s obligations, two private companies that were taken over by the federal government during 2008 and whose total obligations stand at a little more than $5 trillion.

We’ve paid nearly $200 billion in interest for these obligations, though they remain completely off the federal balance sheet. Nor do these numbers include any of thetrillions of dollars in additional Federal Reserve assets that have been created out of thin air to manipulate the market rate of interest lower during this period of rapidly growing demand for federal debt.

When you add these other, genuine, federal obligations that exist right now, today, you come up with a total debt figure that’s much more than $20 trillion. Far more than half of these debts were assumed under President Obama.

We don’t know what the full burden of these new and existing debts will be in total, over time. That’s because the Fed’s power to manipulate interest rates is unlimited. We don’t know how much of Fannie’s and Freddie’s bad debts will eventually be covered by the U.S. Treasury. (We do know they have an unlimited line of credit… so it’s a safe bet that we haven’t seen the last of these charges.) Finally, we have no idea what the eventual costs of the Federal Reserve’s ongoing expansion of the monetary base will be over the long term.

There is one thing that’s certain, however: these debts will not be free. They will carry a burden.

I (Porter) call that burden the wages of sin because the effort to cover our country’s current expenses with debts that will be borne by generations of Americans is simply evil. There’s no other word for the people who have done this to our country. By refusing to take responsibility for their own policies and by refusing to make their constituents responsible for their own poor choices, they’ve doomed our country to a future that will certainly include a government that’s far larger and more expensive.

That means a lower standard of living for all of us.

To give you some idea of the real, underlying costs we face, we can simply apply a real-world interest rate to the total debts we enumerated above. Let’s pretend there’s a lender large enough to finance our federal burden, someone who is able and willing to extend us credit larger than our entire economy. And let’s pretend he’s willing to do so for 30 years to make the payments affordable to us.

You can imagine this as a huge mortgage our leaders have put on top of our economy. How much would we have to eventually spend in interest to cover these debts in a legitimate way? When you buy a home, you’re given the same information from your lender. It’s part of the housing law that governs the mortgage industry – the Fair Lending Act. So using exactly the same guidelines, how much should we expect to spend on interest and principal, for these debts?

If the average real interest rate ends up being 4% annually, we’ll spend $34.3 trillion to simply repay what we owe right now. If the rate ends up being 5%, we’ll spend $38.6 trillion. If the rate ends up being 6%, we’ll spend $43.1 trillion.

Now, of course, our politicians believe that through policy and currency manipulation, they can simply avoid paying any of these costs. They can order the Federal Reserve to prevent interest rates from ever rising to a level that would cost the American people anything. They believe they can manage the economy, so the debts of Fannie and Freddie won’t go bad. They believe (without any proof whatsoever) that they can stimulate the economy by even more deficit spending, so that it grows faster, allowing tax revenues to produce a surplus. Repaying these debts, they say, will be easy and painless.

But you know better, my friend. You must know better. The wages of sin must be paid. And they will be paid. Just consider the plans of those who argue otherwise…

Paul Krugman, the publicity-hungry M.I.T. economist, pens a column for the New York Times that’s ironically titled The Conscience of a Liberal. He recently suggested a simple and completely pain-free way around the debt ceiling, that flimsy piece of legislation that was supposed to slow the growth of the federal debt.

The problem of our debt is easy to solve, according to Krugman: Just mint a $1 trillion coin (or coins) and deposit it with the Treasury:

There’s a legal loophole allowing the Treasury to mint platinum coins in any denomination the secretary chooses. Yes, it was intended to allow commemorative collector’s items – but that’s not what the letter of the law says. And by minting a $1 trillion coin, then depositing it at the Fed, the Treasury could acquire enough cash to sidestep the debt ceiling – while doing no economic harm at all.

Very few people, even our most influential economists, seem to remember that the utility of money and credit are based upon their soundness.

Money allows people to exchange goods and services widely, greatly increasing the specialization of labor and facilitating the economic magic of competitive advantage. Money also plays the critical function of facilitating communications between and among many disparate actors. Price changes guide producers and consumers.

But… when the money can’t be trusted… this entire system breaks down. The price signals can’t be relied upon. And it becomes harder and harder for people to exchange labor and capital.

Likewise, credit enables an economy to grow by facilitating the growth of savings and capital investment through real interest rates. But very few people are willing to delay consumption and trust their savings in an economy that refuses to pay savers anyreturn above inflation for their savings.

Actions that undermine the legitimacy of our currency or that threaten the stability of our credit will cause enormous problems – real costs – to our economy. Pretending otherwise won’t change these facts in the slightest. Minting coins with a real intrinsic value of maybe $3,000 and claiming they’re worth $1 trillion is Mugabe finance. Just reading about the possibility of this plan in the pages of the New York Times will damage the stability of our money and credit.

But regardless if our creditors read the New York Times, they will soon realize there’s no way we can finance, in real dollars, our existing federal debt of $20 trillion. Assuming the real rate of inflation (today) is 4%, we should expect to pay at least 6% annually to finance these debts. That would mean interest payments of more than $500 billion annually.

This is impossible. Ignoring payroll taxes (which finance Social Security and Medicare… at a loss), the federal government takes in roughly $2.4 billion in income and corporate taxes. Social Security, Medicare, and federal pension spending currently total more than $1.8 billion, leaving roughly $600 billion for all other forms of government spending (including the military). Even all of the remainder isn’t likely to cover the real costs of our debt for long, given the inevitable (and huge) increases to Medicare and Social Security spending.

And so that leaves us, at the start of 2013, wondering how we will pay for the wages of Obama’s sins… and the inevitable consequences of refusing to acknowledge these debts or the politics that led to them.

We have some ideas…

The First Places You’ll See Our Government 
Reach the Tipping Point

First and foremost, policies that undermine the stability of our currency (such as runaway fiscal deficits, the Fed’s quantitative easing, and the absurd $1 trillion coin) will lead more and more of our creditors to hedge against a collapse in the dollar. China and Russia will buy more gold. Likewise, the world’s creditor nations will do whatever they can to develop a more reliable international currency. That’s absolutely not priced into the value of the dollar today.

Second, other democracies that have faced similar financial problems have all gone down the same path of denying the extent of their financial obligations and turning to “alternative” methods of financing their debts. This has always led to inflation, economic instability, and, eventually, political instability. I believe the same thing will happen here, especially because all the actions our politicians are taking follow the “script” so closely.

Our leaders continue to finance their deficit spending with economically disastrous policies, while narrowing the tax base to build an unbeatable coalition of voters who believe they will never have to pay for the benefits they’re receiving. This will make it more and more impossible to beat the Democratic Party at the pollswhile deeply dividing the country between the few who must pay for government and the many who are completely dependent on it.

It’s easy to forget how easy it is to organize and unite the coalition of people who depend on the federal government for their daily bread. Never before in American history have so many people been so dependent on the government. Around 70 million people in our country depend on the government for food stamps, retirement benefits, health care, job training, or a host of other benefits… costing $2.5 trillion a year, which is more than we collect in income taxes.

Meanwhile, less than 15% of Americans pass what I consider to be the bare minimum test of financial independence – a net worth of more than $10,000 and at least $10,000 in liquid savings. That means around 85% of the country will be in dire straits if the Fed’s money spigot is ever turned off. And that means it will never happen… not even when the threat of inflation has become clear to all.

The other significant structural political problem is that the benefits of our generous Uncle Sam are being provided by a tax base that grows smaller and smaller every year.

While almost half of Americans pay no federal income tax at all, 70% of the total revenues collected come from just 10% of the population. No, this isn’t caused mostly by growth in “income inequality.” It’s the result of an extremely progressive tax code. The top 5% of taxpayers collect about 20% of the income reported… they pay about 40% of all the taxes. In other words, they’re paying twice the average rate of tax on their incomes.

What’s scary is that Congress shows no hesitation to make the code even more progressive. That’s exactly what happened last month, when taxes on the rich were allowed to increase, while taxes for the vast majority of Americans again didn’t. These policies won’t do much to solve our fiscal problems. And over time, they will greatly exacerbate our fiscal and political problems as the State becomes seen not as a neutral arbitrator, but as a weapon of the poor.

Third… as the government poisons the economy by ruining our money and destroying our credit… it will become more and more difficult for politicians to deliver on any of their promises to the poor. We’re on the cusp of this tipping point. We believe it will become evident in two areas of the economy this year – health care and college education.

Both fields have become incredibly bloated by government-financed demand. But doctors and hospitals will prove to be unable to meet the demand at the price that’s set by the government, as happens in every state-led health care system in the world. And it will lead more and more doctors to quit… and more and more patients to die unnecessarily.

Likewise, the cost of a college education has become totally unaffordable, thanks to the enormous amount of credit (more than $1 trillion) that has been extended to students. None of this spending makes the education any better, by the way… it just makes it more expensive. It has financed a huge college building boom and led college salaries – especially of senior administrators and football coaches – to become absurdly, laughably rich. These things won’t last.

The question is… when our hospitals really fall apart… and when our colleges begin to default on their debts… what will happen? Will these failures be seen as evidence that our system of endless money printing and false economic promises isn’t working? Or will the feds respond by narrowing the tax base further, spending and printing even more, and trying to blame the private sector for the ills of their own policies?

If history is any guide, these first collapses will only be a start. And you can be sure what will happen next: the feds will demand still more power, curtail civil liberties even further, and begin to prosecute anyone who tries to stop them, even if only through civil means. That seems to have already started, too.

So sadly, we begin 2013 more fearful than any previous year in our lives. Meanwhile, the stock market is reaching new all-time highs in many indexes. And the Volatility Index (which measures fear in the markets) is hitting lows we haven’t seen since the height of the mortgage bubble in 2005. Our view that dark days remain ahead for our country seems totally out of sync with the markets.

How would we explain the dichotomy?

The beginning of every great inflation is painted over with cheap money, which creates optimism and economic growth. The economy, we admit, seems to be improving dramatically. That’s because it’s easy to grow when money is essentially free and no one has to pay the real costs.

We won’t be surprised to see the stock market have a great year – better than last year. We will be surprised to see the bull market in bonds continue. We think bonds will get killed this year. (Yes, we thought so last year, too.) And we expect investors will ignore the warning signs of the bond market for several more quarters.

Good times, it will seem, will be here to stay. But just remember… the wages of sin must be paid. And they will be here, too.

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About geneb527

Retired, but still spending an inordinant amount of time thinking about all things big and small. I am proud to be a strong constitutional conservative. I am also proud to have been married over 56 years to my wonderful wife, Louise. I continue to be amazed that she has put up with me for such a long time, but have been happy that she decided to do so. "The democracy will cease to exist when you take away from those who are willing to work and give to those who would not," warned Thomas Jefferson.
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