Credit Trumps Equities

from Macrostory blog:
Credit markets are truly forward looking. Equity not so much. History clearly shows credit should never be ignored. There have been three large divergences between equity and credit since the late 90′s and each time credit forced the hand of equity.
Here we are once again on the eve of a possible breakout in the entire treasury curve to new all time highs (low yields). History does have a way of repeating when it comes to the capital markets.
Below is a 15 year comparison of the 10 year yield and the SPX. Also note the orange circles outlining that huge head and shoulder’s pattern on the SPX that has taken a decade to form. In the words of the Dos Equis man “stay thirsty my friends.”

Central Banking and the Destruction of Free Markets

Submitted by Jeffrey Snider of Atlantic Capital Management
Volatility Is The Price Of Real Progress
As we all ponder what may come at us in 2012, the ongoing volatility in almost every corner of every marketplace is certainly concerning, as it should be.  This record volatility has enormous implications for any investor, but especially those in leveraged ETF’s.  Volatility is the anathema to these vehicles, as has been well discussed, but that does not diminish their targeted usefulness.
As a portfolio manager I use leveraged inverse ETF’s as hedges against the dramatic downside.  They have a very narrow window and only perform when the market more or less moves in a straight-line down – just as it did in early October 2008, May 2010 or July/August 2011.  Other than those sustained sell-offs, they are a drag on portfolio performance, a cost of doing business in this risk-on, risk-off “marketplace”. 
I willingly pay that cost because I have no concrete idea when another fit of sustained selling will actually take place, but I have more than an inkling that it will.  Instead, this massive and growing volatility, even though it is costing me some short-term performance, is a good sign that there is actually progress being made.  What we are witnessing is a titanic battle between the world as it really is and the one central banks need you to believe it might be (if only you would set aside your own perceptions and self-interest).  The fact that volatility has risen is a clear indication that the central bank-inspired anesthesia is no longer as effective as it was in 2009, or even in the QE 2.0 inspired insanity of 2010.  Reality, and the free market, is being imposed – and that means there is a place for even narrowly-useful hedging vehicles.
The current market battle is nothing more than the extreme measures of the rational expectations theory and a form of the fallacy of composition, combined with the political aspirations of a century-old theoretical notion of how the economic system should be ordered.  Mainstream economic “science” has developed in a relatively straight line since the Great Depression, starting with the idea that the economy must be governed in emergencies.  Executive Order 6102 and the subsequent devaluation of the dollar solidified the place for the entire field of economic management, marking perhaps the last time it would be challenged by mainstream thought.
Without the guiding hand of the educated economist, capitalist, free market economies are believed to be wrought with the danger of total collapse, unable to escape from their own emotional whimsies.  At the most primal level of modern economics is a deathly fear of deflation, a fear that is best summed up by Fisher’s paradox.
In 1933, Irving Fisher published a paper in the Federal Reserve’s Econometrica circular that amounted to a point-by-point logical deduction of the string of events that led to the unusual collapse of the economic and banking systems.  The scale and pace of the disaster confounded “experts” of the era (it seems experts have trouble with inflections in every era), so his deduction offered a highly plausible, well-reasoned and “logical” explanation. 
For Fisher, the combination of over-indebtedness and deflation was the toxic mix from which the calamity grew.  But within that mix lay a paradox that formed a trap by which no self-made recovery was possible:

“…if the over-indebtedness with which we started was great enough, the liquidations of debts cannot keep up with the fall of prices which it causes.  In that case, the liquidation defeats itself.  While it diminishes the number of dollars owed, it may not do so as fast as it increases the value of each dollar owed.  Then, the very effort of individuals to less their burden increases it, because the mass effect of the stampede to liquidate in swelling each dollar owed.  Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions:  the more the debtors pay, the more they owe.  The more the economic boat tips, the more it tends to tip.  It is not tending to right itself, but is capsizing.”

The lessons of this paradox are interwoven into the fabric of modern/conventional economics, that whenever deflation might be present a recovery has to be forced since it cannot start on its own.  But it is extremely curious that only one half of the equation was chosen as an outcast:  deflation.  Over-indebtedness has, obviously, been warmly embraced in the decades since Fisher’s proposition.  The development of the mainstream of economics has led to the belief that intentional inflation can always defeat deflation, and therefore debt can assume a role, even a primary role, within the schematic of economic stewardship.
Fisher’s paradox survives in many forms, but among the most important was a logical derivation, namely the idea that economic participants can do what they believe is best for themselves, but in doing so harm themselves through systemic processes.  This is known as a fallacy of composition; that what is good for individuals is not necessarily best for the whole.  It overturned the traditional economic notion of an economy at its most basic level, from the time of Adam Smith describing individual self-fulfillment.  Sure, this idea had been around for awhile before Fisher’s paper, but the Great Depression “proved” that the fallacy was real and potentially cataclysmic.  Originally it was confined to the narrow interpretation of depression economics, and so the evolution of unquestioned economic management started from there.
The economics profession truly believes that there exists economic states where individual self-maximization no longer benefits the larger societal association of economic actions, so it “logically” follows that some process (or entity) has to step in and enforce conditions contrary to individual notions of self-maximization.  In other words, there are times when people must be forced to do what they perceive is against their own best interest.
In the context of depression avoidance this seems to be rather innocuous, but in the displacement of political thinking since the 1930’s, it was a slippery slope.  What Fisher’s paradox essentially required was a benevolent authority to administer and visit a kind of beneficial tyranny upon the economic population.  In the constant forward roll of history, though, the slippery slope of needed benevolence has been applied to a larger and larger cohort of economic circumstances – emergencies breed human desire for such authoritarianism.
It is important to remember that the Federal Reserve was a secondary institution for much of the post-Depression period.  After the monetary debacles of the Great Depression, especially the unnecessary reserve requirement hike in 1936 that initiated the depression-within-a-depression in 1937, the Fed was relegated to being simply a monetary check-writer.  The Treasury Dept. was the economic powerhouse, especially during a time in which the dollar was the primary tool of economic management.  The Fed was consigned to managing the money supply around treasury debt auctions to ensure the federal government’s uninterrupted ability to borrow (in some ways things never change).  When that borrowing exploded in 1965, the money supply went with it and the seeds of the Great Inflation were embedded.
Paul Volcker changed this with his “heroism” in defense of the dollar, a dramatic departure from the previous era of Treasury Dept. domination.  Conventional wisdom posits that it was Volcker’s Fed that vanquished the inflation dragon, in doing so he “created” another pillar of the fallacy of composition (high interest rates were not good for individuals, but seemed to be good for the larger system).  The chastened Fed of 1965 that allowed inflation to begin building was dropped for the activist Fed of 1980 that could apparently do no wrong (the monetary history of the 1970’s was completely and conveniently ignored).  The Fed’s reputation soared with the perceived economic success of the 1980’s, handing Alan Greenspan an amount of power unparalleled in human history. 
But how much economic success in the 1980’s was earned?  Again, conventional wisdom sees the Great Inflation ending in 1982, giving way to the Golden Age of Economic kingship – the Great Moderation.  What I see is simply a transformation of inflation from consumer prices to asset prices.  Instead of overwrought money creation circulating within the real economy in the form of wages and higher consumer prices, new credit production capabilities allowed a secondary circulation of credit money into assets, indirectly feeding into the real economy – first as interest income, second as debt – as the notorious “wealth effect”.  The economy in this age would transform from one based on earned income to one based on paper movements of created money, with the irony of the “wealth effect” being its tendency to incrementally create economic activity without actually creating productive wealth.  The global economy was increasingly reliant solely on money creation, a transformation that cannot be understated and a prime cause for re-evaluating the whole of the Great Moderation.
We see this quite clearly in the consumerism of the period.  In 1975, household spending was still largely a function of wage income.  If we adjust Disposable Personal Income by subtracting asset income (interest and dividends), we see a modest deficit in spending sources of about 3.5%.  Households spent more than they brought in from wages, benefits, government transfers (net of taxes) and rental income. Consumer/household spending needed asset income to make up that small funding shortfall (and to go beyond to generate a positive savings rate).  By the midpoint of the Great “Moderation” in 1990, the spending deficit was a chasm, 19.3%.  Without the $898 billion (nominal dollars) in asset income there was no way that consumer spending would have grown so far so fast.
That interest/asset income was a leftover effect of the Great Inflation when monetary creation found its way into growing stockpiles of “safe” financial assets for the household sector.  By 1990, US households had accumulated $5.1 trillion in deposits and credit market assets (largely US treasury bonds) against only $3.6 trillion in debt (including mortgages).  But that was a huge “problem” for the growing acumen of an activist Federal Reserve.  As the 1980’s progressed, interest rates were declining with consumer inflation (and providing a helping hand to asset prices running wild with credit now focused in that direction).  The mainstream of economics took this as a sign of success, but it was really just a marked decrease in monetary efficiency since new money was now circulating heavily in asset prices (the junk bond bubble and the new, great bull market in equities).
Concurrently, economic management had evolved in the 1980’s with the innovation of the “rational expectations” theory.  It was hailed as a huge advancement in monetary thinking coming out of the Great Inflation.  In many ways it was an adjunct to the fallacy of composition.  The rational expectations theory holds that the economic children of modern society can be fooled into undertaking activity that might be against their own best interest if some benevolent authority simply makes it look like everything will be better in the not-too-distant future.  If the Fed screws with the price and cost of money (for debt accumulation), manipulates the price of gold (for inflation expectations), or “nudges” stock or real estate prices in the “right” direction (the notorious wealth effect), the population will act today on those conjured expectations of good times tomorrow.
By the end of the 1980’s, the S&L crisis (a stark warning that economic management might not have been all that it was advertised to be, a warning that has largely been ignored) threatened to plunge the world back into depression.  The Fed and Alan Greenspan feared the consequences of a banking crisis and any attendant deflation.  The Fed funds rate was pushed from around 8.25% in April 1990 to a ridiculous 3.25% by July 1992 – staying at that low level well into 1994.  Alan Greenspan was trying to save the entire banking system from the S&L crisis by reducing the cost of funds so dramatically (hoping to see an increase in bank profits, leading to higher retained earnings and therefore equity capital upon which to pyramid more debt).  The pressure on household spending because of the collapse in interest rates necessitated a marginal change in spending, but not back toward earned income.  Instead we got the wealth effect and the myth of Greenspan’s genius.
Despite a persistently weak recovery (just ask George HW Bush) from a relatively mild recession, the Fed’s management of the economy into a “soft landing” was hailed as a new form of a New World Order.  The business cycle could be smoothed (or even eliminated) by the marginal attraction to debt and the wealth effect.  If expectations were properly managed, the public would suppress their base emotional instincts and dance to the tune set by the monetary kingship. 
It was hubris of the highest order, of course.  By the time the tech bubble finally burst (another warning of the dangers of an artificial economy) the Fed doubled down to save itself and its primacy.  The results have been disastrous as the marginal economy progressed further and further away from the fundamental foundation of wages and earned income.  The savings rate fell to zero by 2005.  Worse than that, US households added $10 TRILLION (+269%) in debt between 1990 and 2007, with $7 TRILLION coming after 2002 alone.  The household funding deficit reached a high of 24%!  Even worse than that, households had shifted preferences out of “safe” credit market assets or bank deposits and into much riskier price assets simply because the systemic cost of risk was intentionally held artificially low.
The economic foundation of the Great Moderation was an illusion, nothing more than asset prices and debt; wealth effect and rational expectations.  None of this describes a free market, capitalist economy.
Central banks and economists love to talk about economic potential, spending so much time trying to calculate it with their complex modeling capabilities and elegant mathematical equations.  But the hard truth of economic overlordship is rather simple.  The Federal Reserve, in cooperation with global central banks, Wall Street and the interbank wholesale money marketplace, simply substituted credit for earned income.  And the reason is also very simple, because debt accumulation is far more easily manipulated.  As long as households remained attached to earned income and “safe” savings assets, economic management was nearly impossible.  The rational expectations theory needs a system more attuned by asset prices and malleable debt levels.  And so marginal consumer spending shifted away from the solid foundation of jobs and wages right into the hands of the fallacy of composition and the rational expectations theory.
It is more than a little ironic that the Fed so willingly embraced indebtedness in light of their history with Fisher’s paradox.  But mathematical advances in modeling along with a growing commitment to steady inflation allowed the Fed to really believe it could stave off deflation.  So they made a deal with the debt devil to obtain the keys to the marginal economic castle and its grand artificial economy, and in the process dangerously surrendered to the over-indebted part of the Fisher’s paradox equation.  Thus the housing bubble to mediate the tech bubble since the tech bubble had some potentially deflationary consequences.  Even today, everything the Fed has done since 2007 can be seen in these terms:  the fallacy of composition, rational expectations and the preservation of the benevolent stewardship of the economic, academic masters. 
Somewhere in all this transition from Fisher’s paradox to Greenspan’s genius to debt-slavery, the system ceased to function as a free-market, capitalist system.  The free market values the bottom-up dispersal and divergence of billions and billions of free opinions, freely associating together as unfettered price discovery.  A central bank devoted to the fallacy of composition and rational expectations is a top-down system committed to manipulating price discovery to achieve ends that seem to be, and very often are, contrary to the perceptions of the vast majority of doltish economic participants.  The monetarist system is forced upon the population, no matter how much they resist. 
Indeed, the idea of an economic fallacy of composition is itself a logical fallacy.  I have no quarrel with the idea of a fallacy of composition or any logical fallacy for that matter, but logic holds no special place in social interactions.  There are no logical deductions from economics no matter how much math is applied.  It is, and will remain, a subjective interpretation of events.  Even the vaunted Fed and its accumulation of Ivy League PhD’s performs no leaps of logic.  Like anyone else with an opinion, whatever fallacy of composition it thinks it sees is still just subjective interpretation. 
And that is the real danger.  Cloaked in the apparent objectivity of math, the economic elite have gained unlimited economic power.  When you stop and think about it, you can create a fallacy of composition pretty much anywhere (and write and enforce rules based on it) – from the steep tax on savers with five-plus years of zero interest rates to mandating everyone has to purchase health insurance even if they don’t have the need for it.
The volatility of today is nothing more than a fight between the active perceptions of participants trying to maximize self-interest within the classical, traditional concept of a free economy, and the opposing forces of overlordship of the landed economic elite, trying to get the uninitiated to simply follow orders.  The elite really believes that if everyone would gladly pile on even more debt and spend with reckless abandon, the Great Moderation would once again be within reach.  Consumers should only stop thinking for and of themselves since common sense is dangerous to the controlled economic system.  To get more debt “flowing” requires active price manipulation to make the world seem like it will be better in the near future so that people will start acting like it.
Economic potential to the Fed is the level of economic activity of 2006.  To them, this is a cyclical recovery from a cyclical interruption in their normal smoothing of the business cycle.  Sure it veered way off into panic, but that was just more confirmation that human emotion needs to be managed.  But if we view the economy from the historical perspective, the lack of a cyclical recovery is not at all surprising.  The Fed spent decades building up so much monetary inefficiency, so many artificial monetary channels for indirectly “stimulating” economic activity, that it will simply take an enormous amount of new money to get it all moving in the “right” direction again (Ben Bernanke and Paul Krugman at least have that part right). 
The fact that resistance is growing, that investors are not drinking the economic Kool-Aid as much as 2009 or late 2010 is a sign of growing discord.  The efforts in the realm of rational expectations are simply not working.  That is the ultimate danger because the entire central bank gameplan is based on only that.  Without willing adherents (useful idiots?) to the central authority of economic management, everything falls back to the true potential – earned income and boring cash flow of un-manipulated dollars or euros.  With such a massive chasm between marginal economic activity and earned income sources of spending, it is not likely to be a shallow or short transition (this explains most of the inability of the economy to create jobs – so many jobs in the central planning era were based on money creation and financial “innovation”).
That is both the opportunity and danger of a system reaching its logical end.  Put another way, there is a growing realization that while free markets are messy and somewhat unstable, central planning is not really a cure for those symptoms.  In fact, it has created more harm ($13 trillion in debt is only US households) than good, more illusion than solid results.  Volatility means that the free market is at least attempting to impose itself at the expense of central planning’s soft financial repression and control.  By no means is such a beneficial outcome assured; rather the other half of all this volatility (the risk-on days) is the status quo desperately trying to hang on through any and all means (even those less than legal, like bailing out Europe through cheapened dollar swaps).
So the cost of using leveraged ETF’s as insurance against the failure of soft central planning necessarily rises, but that just may mean their ultimate usefulness is closer to being realized.  Unless you know exactly when this transition might reach its conclusion, it is, in my opinion, a cost worth bearing.

Why "Tax the Rich" Won't Work!

by Charles Hugh Smith at the Of Two Minds blog:


Will "Tax the Rich" Solve Our Deficit/Spending Crisis?   (December 28, 2011)
If we look at tax revenues and income in a practical way, we find "tax the rich" will not close the widening $1.5 trillion gap between Federal revenues and spending.
Clearly, $1.5 trillion annual Federal deficits to fund the Status Quo--fully 10% of the nation's GDP--is unsustainable. Eventually, the ad hoc "solutions" currently being pushed by the Federal Reserve--zero interest rates to keep borrowing costs artificially low and money-printing operations that buy Treasury debt--will encounter political and/or market pressures which will limit the marginal effectiveness of these interventions, and the real cost of these historically unprecedented deficits will trigger a host of unintended consequences--all negative.
Everyone knows there are only two ways to bring deficits back to sustainable levels: skim more tax revenues from the national income or cut spending on the massive Status Quo programs of Defense/National Security, Medicare/Medicaid and Social Security. The rest of the Federal programs so reviled by various constituencies are a relative drop in the bucket.
Everyone with a stake in the Status Quo Federal spending--and that is certainly in excess of 100 million residents of the U.S.--is vocally in favor of "taxing the rich" as the "obvious and just solution" to the widening gap between revenues and spending.
If there is one stance that can gather non-partisan support, it's "tax the rich." More knowledgeable observers refine this to "tax the super-rich," as the majority of the wealth and income of the top 1% is actually held by the top 1/10th of 1%.
We can break this idea down into two basic parts: the ethical case and the revenue case. Ethically, at least in a democracy, the idea that everyone with substantial wealth and income should pay at least as much (as a percentage of income) as wage-earning citizens is compelling.
Various studies have found that the extremely wealthy pay about 17% of their income in Federal taxes, which is less than half of what we self-employed people pay (15.6% self-employment + 25% Federal tax on all income above about $34,000 = 40.6%).
The merely well-off--typically professionals, managers and small business owners--pay the majority of Federal taxes, with the very wealthy paying a substantial share as well. Roughly half of all those filing tax returns pay no Federal tax other than the employees' 7.65% FICA (Social Security) tax.
In the larger scheme of things, the bottom 60% of the workforce pays relatively little of the total Federal tax revenues. (Check U.S. Census records or search my site for sources that break down the sources of Federal tax revenues.)
In other words, the "rich"--or those who the average person considers "rich"--already pay most of the Federal taxes.
How much additional tax could be raised were the super-wealthy to pay the same 40% rate that we self-employed people pay? It is tempting to estimate that another $1 trillion or so could be raised from the super-wealthy, largely from non-wage (unearned) income.
I have addressed this yawning gap between spending and revenues in the past, for example:
The Promises That Cannot Be Kept (July 6, 2011)
As noted in the above entry (the TrimTabs chart), Americans' after-tax income is around $5.3 trillion and $900 billion in income from "other sources." Additional taxes would of course come from current after tax-income. It's difficult to sort out all the various measures of income; the BEA, for example, includes "government transfers" as personal income--though those transfers come from tax revenues.
Including government transfers and arcane categories such as "inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj)", the BEA counts $12 trillion in earned income. But if strip out transfers and inventory adjustments etc., that number drops to around $8.4 trillion. (Two Americas: The Gap Between the Top 5% and the Bottom 95% Widens August 18, 2010)
Total Federal tax revenues are about $630 billion from Social Security taxes and $1.5 trillion from Federal income taxes, or a total of $2.1 trillion. To Fix Social Security, First Ask Why It Is Deep in the Red (January 18, 2011).
There are local and state taxes, too, of course, which leaves the $6.2 trillion in after-tax income noted earlier. Since the top 10% collect roughly half the income, we can guesstimate that the top 10% receives about $3 trillion. To balance the current budget, they would need to pay 50% of their after-tax income ($1.5 trillion)--on top of the substantial taxes they already pay. (maybe the top 1/10th of 1% pay 17%, but the merely wealthy pay much higher rates on earned income.)
Add this up and you get tax rates of around 65% on the top 10% (25% total income rate plus 50% of the remaining income).
We then have to ask whether these rates would ever be collected.
There are a number of factors that affect actual tax collections from theoretical calculations. One is that Congress is a collection of wealthy people who are seeking to increase their power while minimizing their taxes and those paid by their cronies and contributors. As long as this is the case, then the tax code will continue to be thousands of pages long with exclusions, taxbreaks and exemptions for the politically connected wealthy.
Another is that studies have found Federal tax collections have historically topped out around 21% of total income. Above that level, people make choices that reduce their tax burdens.
Just as a thought experiment, put yourself in the shoes of someone with $20 million in assets and an income of $1 million. First off, you have a tax attorney who works the complex tax code to put as much of your income as possible in lower-rate income--for example, long-term capital gains.
Wealthy individuals shelter their income and assets with corporations, which have many more options in terms of shifting income.
Secondly, you have overseas accounts, assets and options. Let's say you are ethical, and pay your legal taxes without resorting to questionable tax havens. Let's stipulate that you are just like any other taxpayer--you feel no obligation to pay more than your legal share.
International agreements mean that income need only be declared and taxes paid on it in one jurisdiction. So income declared in Switzerland is exempt from taxes in the U.S., as taxes have already been paid in Switzerland.
Though I am not that knowledgeable about tax law, anecdotally it seems total tax rates in Switzerland are around 25%. If rates in the U.S. were jacked to 50% or higher, then very wealthy individuals will shift income to places like Switzerland and pay the lower tax rates there--perfectly legally. They would also liquidate assets in states which attempted to raise taxes on real property or enterprises, and shift those assets to lower-tax states or nations.
This would not be perceived as "tax avoidance," but as rational money management. In this sense, the super-wealthy are simply doing what every household does--attempt to lower taxes by whatever legal means are available. The means available to those with income and assets that can be shifted around are simply more capacious.
In practical terms, collecting another $1.5 trillion annually is problematic on multiple levels. Practically speaking, it might be wise to align total U.S. tax burdens with those of Switzerland and similar developed-world tax havens, for those essentially set the top rate that very wealthy individuals will pay.
Such a system would flatten taxation rates and very likely increase total tax collections. But it is simply not practical to think that the Federal government can skim 45% of the nation's $8.4 trillion in income to fund the bloated, corrupt and inefficient $3.7 trillion Federal budget.
How about those soaring corporate profits? If we taxed 100% of the $1.5 trillion corporate profits, then we could close the $1.5 trillion budget deficit. But then Wall Street would have nothing to support those sky-high stock valuations.

Near Overthrow of a Dictator is the Only News, So Likely to be Another Meltup Day

Since the only news is that of Gaddafi near overthrow, and not much else, the market is using this as an opportunity buy again. S&P futures are up about 20 points on just the news of imminent ouster of the Libyan dictator. Even Europe loved the news, rallying at the beginning of the European market open. They are getting a one-day reprieve from their woes. However, nothing can save them from the fact that they have dug for themselves a debt bottomless pit.

European Debt Woes Weigh on Stocks

Marco Rubio: "It's the Debt, Not the Debt Ceiling!"

"The real problem here is not the debt LIMIT; the real problem here is the DEBT!" -- Florida Sen. Marco Rubio

Fascinating Debt/Economics Presentation From a Biblical Ethical Perspective

Bad Debt Everywhere -- Even in China

This, too, will be ignored on Wall Street.

Go Figure! Euro Strengthens on Greek Debt Downgrade

Jim Rogers: Worse Crisis Coming Because of Debt

Legendary investor Jim Rogers, CEO of Rogers Holdings, offered a very glum outlook on the U.S. economy yesterday. According to him, we’re headed for a crisis worse than 2008, the Chinese Yuan will soon be safer than the dollar, and Fed Chairman Ben Bernanke will probably institute another round of money-printing, or QE3.
“The debts that are in this country are skyrocketing,” he told CNBC. “In the last three years the government has spent staggering amounts of money and the Federal Reserve is taking on staggering amounts of debt.
“When the problems arise  next time…what are they going to do? They can’t quadruple the debt again. They cannot print that much more money. It’s gonna be worse the next time around.”
He later added, “The U.S. is the largest debtor nation in the history of the world. The debts are going through the roof. Would you keep lending money to somebody who’s spending money and not doing anything about it? No you wouldn’t.”
Because of that, he said the Chinese Yuan will be a safer currency bet than the dollar. And what may even better is gold and silver: he’s hoping the price goes down on both so he can “pick up the phone and buy more.”
He’s also convinced Ben Bernanke, who he calls a “disaster,” will institute another round of quantitative easing, essentially printing money, later this year.
“They’re gonna bring it back because [Bernanke will] be terrified and Washington will be terrified,” he said. “There’s an election coming in November 2012. Washington’s gonna print more money.”
According to him “draconian” cuts will be needed to control U.S. debt:

Rogers comments come as a new poll reveals nearly half of Americans expect another Great Depression in the next 12 months.

Examples of How U.S. Is Buried In Debt

(Reuters) - President Ronald Reagan once famously said that a stack of $1,000 bills equivalent to the U.S. government's debt would be about 67 miles high.
That was 1981. Since then, the national debt has climbed to $14.3 trillion. In $1,000 bills, it would now be more than 900 miles tall.
In $1 bills, the pile would reach to the moon and back twice.
The United States hit its legal borrowing limit on Monday, and the Treasury Department has said the U.S. Congress must raise the debt ceiling by August 2 to avoid a default.
The White House is trying to hammer out a deal with lawmakers to cut federal spending in exchange for a debt-limit increase.
Most people have trouble conceptualizing $14.3 trillion.
Stan Collender, a budget expert at Qorvis Communications, said the biggest sum most Americans have ever handled -- in real or play money -- is the $15,140 in the original, standard Monopoly board game.
The United States borrows about 185 times that amount each minute.
Here are some other metrics for understanding the size of the national debt and United States borrowing:
* U.S. Treasury Secretary Timothy Geithner has said the United States borrows about $125 billion per month.
With that amount, the United States could buy each of its more than 300 million residents an Apple Inc iPad.
* In a 31-day month, that means the United States borrows about $4 billion per day.
A stack of dimes equivalent to that amount would wrap all the way around the Earth with change to spare.
* In one hour, the United States borrows about $168 million, more than it paid to buy Alaska in 1867, converted to today's dollars.
In two hours, the United States borrows more than it paid France for present-day Arkansas, Missouri, Iowa and the rest of the land obtained by the 1803 Louisiana Purchase.
* The U.S. government borrows more than $40,000 per second. That's more than the cost of a year's tuition, room and board at many universities.
"That usually gets their attention," Doug Holtz-Eakin, who was chief White House economist under President George W. Bush, said in an email. "I have two kids, so every 10 seconds, the feds borrow more than I paid lifetime."
* The Congressional Budget Office projects the total budget deficit in fiscal 2011 at about $1.4 trillion.
"The net worth of Bill Gates, roughly around $56 billion, could only cover the deficit for 15 days," said Jason Peuquet, a policy analyst with the Committee for a Responsible Federal Budget. "The net worth of Warren Buffet, roughly around $50 billion, could only cover the deficit for 13 days."

David Stockman on Debt: "We've Run Out of Runway"

Regarding deficits created during the Reagan presidency:

"The essential distinction is that we had a clean balance sheet then - $1 trillion of national debt. Today we have $14 trillion in national debt.  We have used up all the runway, so to speak."

"We have piled our national balance sheet with so much debt that the government is at the very edge of a huge solvency crisis that isn't going to be addressed unless both parties dramatically change their position, and I see no sign of it.  So we're going to have a gong show. Year after year after year of these debt ceiling crises, maybe they will be solved for a month or two, and then we will go right to the next."

by Axel Merk at FT.com:



Imagine a country that spends and prints trillions to patch up any problem.

Now imagine another country where there is no central Treasury, meaning that bail-outs are less easy, and which has a central bank that has mopped up liquidity over the past year, rather than engage in quantitative easing.

Why does it surprise anyone that the latter, the eurozone, has a stronger currency than the former, the US? Because of peripheral countries’ debt refinancing issues? And the potential for contagion? These are real and serious issues, but in our assessment, they should be primarily priced into the spreads of eurozone bonds, not the euro itself.

Think of it this way: in the US, Federal Reserve chairman Ben Bernanke has testified that going off the gold standard during the Great Depression helped the US recover faster than other countries. Fast-forward to today: we believe Bernanke embraces a weaker currency as a monetary policy tool to help address the current state of the US economy. What many overlook is that someone must be on the other side of that trade: today it is the eurozone, which is experiencing a strong currency, despite the many challenges in the 17-nation bloc.

A year ago, the euro appeared to be the only asset traded as a hedge against, or to profit from, all things wrong in the eurozone. This was partly driven by liquidity, because it is easier to sell the euro than to short debt of peripheral eurozone countries; and as the trade worked, others piled in. As the euro approached lows of $1.18 against the dollar, the trade was no longer a “safe” one-way bet and traders had to look elsewhere. As a result, the euro is now substantially stronger, yet peripheral bond debt is much weaker.

The one language policymakers understand is that of the bond market. A “wonderful dialogue” has been playing out, encouraging policymakers to engage in real reform. Often minority governments have made extremely tough decisions. Ultimately, it us up to each country to implement their respective reforms; political realities will cause many to fall short of promises, resulting in more bond market “encouragement”. Policymakers hate this dialogue, of course, but must respect it.

Any country may default on its debt. The problem is that it may be impossible to receive another loan, at least at palatable financing costs. Any country considering a default must be willing and able to absorb the consequences, which is an overnight eradication of the primary deficit.

That’s why it is in Greece’s interest to postpone any debt restructuring until more reform has been implemented.

The risk/reward consideration of a default is likely to be more favourable a few years from now. The banking system has already had time to prepare for a Greek default, among others, unloading securities to the European Central Bank. Politics may cause an earlier default, but Greece would be shooting itself in the foot, as an important incentive for further reform through the carrot and stick approach of the European Union and International Monetary Fund is taken away. Moreover, why refuse the easy money?

Debt reduction in principle is certainly possible. Belgium in the 1990s had a debt to gross domestic product ratio of about 130 per cent and has since taken it down to about 98 per cent. The Belgium caretaker government appears easily capable of continuing the country’s prudent fiscal path.

Portugal’s main challenge is that it is a small country with a weak government, but it is capable of living up to its commitments.

Spain is a major country that has had a housing bust – nothing new in modern history. Given Spain’s low total debt to GDP and an assertive approach to overhauling its banking system, we sometimes compare Spain to Finland. In the early 1990s, Finland had a housing bust, as trade with the Soviet Union ended, followed by a banking system implosion and soaring unemployment. Both Finland then and Spain now have low debt-to-GDP ratios. It may be easier to implement reform in Finland (and Finland had a free-floating currency), but Spain has a real economy and ample resources.

Ireland is trickier, because a default may be an attractive political consideration. However, we would be more concerned about fallout to sterling, given the exposure of the British banking system, than the euro.

In the US, the day investors come to accept the reality that inflation, rather than fiscal discipline, is the path of least political resistance may be the day the bond market won’t be as forgiving. Unlike the eurozone, where consumers stopped spending and started saving a decade ago, the highly indebted US consumer may not be able to stomach higher interest rates. The large US current account deficit also makes the dollar more vulnerable to a misbehaving bond market than the eurozone.

In the medium term, we are far more concerned about risks to the US dollar than those posed by the Greek drama to the euro.

Axel Merk is president and chief investment officer of Merk Investments

Rep. Paul Ryan: "Catastrophic Trajectory" and Shared Scarcity or Renewed Prosperity

Economic Club of Chicago Remarks as Prepared for Delivery by Paul Ryan
May 16, 2011
Thank you so much, Anne, for the kind introduction.
I want to thank you all for inviting me to speak. It was especially gracious of you to host me, even though I’m a Packers fan and I assume most of you are Bears fans.
But that doesn’t mean we can’t work together. As chairman of the House Budget Committee, I stand ready to do whatever it takes to help you re-sign Jay Cutler.
I’m here to talk about the economy today – about the need to get four quarters of strong, consistent performance.
That wasn’t another Jay Cutler joke, I swear. It could be, but it’s not.
I’ll come to the point. Despite talk of a recovery, the economy is badly underperforming. Growth last quarter came in at just 1.8 percent. We’re not even creating enough jobs to employ new workers entering the job market, let alone the six million workers who lost their jobs during the recession.
The rising cost of living is becoming a serious problem for many Americans. The Fed’s aggressive expansion of the money supply is clearly contributing to major increases in the cost of food and energy.
An even bigger threat comes from the rapidly growing cost of health care, a problem made worse by the health care law enacted last year.
Most troubling of all, the unsustainable trajectory of government spending is accelerating the nation toward a ruinous debt crisis.
This crisis has been decades in the making. Republican administrations, including the last one, have failed to control spending. Democratic administrations, including the present one, have not been honest about the cost of the tax burden required to fund their expansive vision of government. And Congresses controlled by both parties have failed to confront our growing entitlement crisis. There is plenty of blame to go around.
Years of ignoring the drivers of our debt have left our nation’s finances in dismal shape. In the coming years, our debt is projected to grow to more than three times the size of our entire economy.
This trajectory is catastrophic. By the end of the decade, we will be spending 20 percent of our tax revenue simply paying interest on the debt – and that’s according to optimistic projections. If ratings agencies such as S&P move from downgrading our outlook to downgrading our credit, then interest rates will rise even higher, and debt service will cost trillions more.
This course is not sustainable. That isn’t an opinion; it’s a mathematical certainty. If we continue down our current path, we are walking right into the most preventable crisis in our nation’s history.
So the question is, how do we avoid it?
The answer is simple. We have to make responsible choices today, so that our children don’t have to make painful choices tomorrow.
If you look at what’s driving our debt, the explosive growth in spending is the result of health care costs spiraling out of control.
By the time my children are raising families of their own, literally every dollar we raise in revenue will be paying for three major entitlement programs.
Some of this is demographic – every day, ten thousand baby boomers retire and start collecting Medicare and Social Security.
But a lot of it is simply due to the fact that health care costs are rising faster than the economy is growing. Revenues simply cannot keep up.
It’s basic math – we cannot solve our fiscal or economic challenges unless we get health care costs under control.
The budget passed by the House last month takes credible steps to controlling health care costs. It aims to do two things: to put our budget on a path to balance, and to put our economy on a path to prosperity.
I am here today to stress the point that these goals go hand in hand. Stable government finances are essential to a growing economy, and economic growth is essential to balancing the budget.
The name of our budget is The Path to Prosperity.
See, right now, we’re finally having a debate in Washington about how to address our fiscal problems. But we’re still not having the debate we need to have.
To an alarming degree, the budget debate has degenerated into a game of green-eyeshade arithmetic, with many in Washington – including the President – demanding that we trade ephemeral spending restraints for large, permanent tax increases.
This sets up a debate in which we are really just arguing over who to hurt and how best to manage the decline of our nation. It is a framework that accepts ever-higher taxes and bureaucratically rationed health care as givens.
I call it the “shared scarcity” mentality. The missing ingredient is economic growth.
Shared scarcity represents a deeply pessimistic vision for the future of this country – one in which we all pay more and we all get less. I believe it would leave us with a nation that is less prosperous and less free.
To begin with, chasing ever-higher spending with ever-higher tax rates will decrease the number of makers in society and increase the number of takers. Able-bodied Americans will be discouraged from working and lulled into lives of complacency and dependency.
Worse – when it becomes obvious that taxing the rich doesn’t generate nearly enough revenue to cover Washington’s empty promises – austerity will be the only course left. A debt-fueled economic crisis will force massive tax increases on everyone and indiscriminate cuts on current beneficiaries – without giving them time to prepare or adjust. And, given the expansive growth of government, many of these critical decisions will fall to bureaucrats we didn’t elect. 
Shared scarcity impedes economic growth, results in harsh austerity, and ends with lost freedom. 
In a recent speech he gave in response to our budget, President Obama outlined a deficit-reduction approach that, in my view, defines shared scarcity. The President’s plan begins with trillions of dollars in higher taxes, and it relies on a plan to control costs in Medicare that would give a board of 15 unelected bureaucrats in Washington the power to deeply ration care. This would disrupt the lives of those currently in retirement and lead to waiting lists for today’s seniors.
Now in criticizing the President’s policies, I should make clear that I am not disputing for a moment that he inherited a difficult fiscal situation when he took office. He did.
Millions of American families had just seen their dreams destroyed by misguided policies and irresponsible leadership that caused a financial disaster. The crisis squandered the nation’s savings and crippled its economy.
The emergency actions taken by the government in the fall of 2008 did help to arrest the ensuing panic. But subsequent interventions – such as the President’s stimulus law and the Fed’s unprecedented monetary easing – have done much more harm than good, in my judgment.
In the aftermath of the crisis, we needed government to repair the free-market foundations of the American economy, as it did under Reagan in the early 1980s, by restraining spending… keeping taxes low… enforcing reasonable, predictable regulations… and protecting the value of the dollar.
Instead, leaders in Washington embarked on an unprecedented spending spree… enacted a deeply flawed overhaul of financial rules… passed a new health care law that raised taxes by $800 billion… and encouraged a sharp departure from a rules-based monetary policy, which created even more economic uncertainty. 
In the 2010 election, the voters sent a message: This isn’t working. Washington needs to try something else.
We know what that something else must be, because we know what has always made growth possible in America. We need to answer that call for new economic leadership by getting back to the four foundations of economic growth:
First, we have to stop spending money we don’t have, and ultimately that means getting health care costs under control.
Second, we have to restore common sense to the regulatory environment, so that regulations are fair, transparent, and do not inflict undue uncertainty on America’s employers.
Third, we have to keep taxes low and end the year-by-year approach to tax rates, so that job creators have incentives to invest in America; and
Fourth, we have to refocus the Federal Reserve on price stability, instead of using monetary stimulus to bail out Washington’s failures, because businesses and families need sound money.
Let me deal with each in order.
The first foundation, real spending discipline: it’s pretty simple. You can’t get real, sustainable growth by continuing to pile on the debt. More debt means more uncertainty, and more uncertainty means fewer jobs.
The rating agency S&P just downgraded the outlook on U.S. debt from “stable” to “negative.” That sends a signal to job creators. If S&P is telling them that America is a bad investment, they’re not going to expand and create jobs in America – not at the rate we need them to.
Mounting debt also threatens our poorest and most vulnerable citizens, because those who depend most on government would be hit hardest by a fiscal crisis. We have to repair our safety net programs so that they are there for those who need them most. This starts by building on the successful, bipartisan welfare reforms of the mid-1990s.
Our reforms save the social safety net by giving more power to governors to create strong, flexible programs that better serve the needs of their populations. Most important, they make these programs solvent. 
As we strengthen welfare for those who need it, we propose to end it for those who don’t. We end wasteful corporate welfare for those such as Fannie Mae and Freddie Mac, big agribusinesses, and others that have gotten a free ride from the taxpayer for too long.
All of these steps are necessary to getting spending under control. But they are not enough. We cannot avert a debt crisis unless we directly address the rising cost of health care.
Getting health care costs under control is critical, both for solving our fiscal mess and for promoting growth. One reason that many people aren’t getting raises is that rising health care costs are eating into their paychecks.
The second foundation addresses the growing scourge of crony capitalism, in which Washington bureaucrats abuse the regulatory process to pick winners and losers in the private economy.
Congressional Republicans continue to advance reforms that stop regulatory bureaucrats from strangling job growth and innovation with red tape. We’ve advanced legislation to stop the EPA from imposing job-destroying energy caps on American businesses.
We’ve advanced legislation to revisit the flawed Dodd-Frank law, which actually intensifies the problem of too-big-to-fail by giving large, interconnected financial institutions advantages that small firms do not enjoy.
But most important, we propose to repeal the new health care law and its burdensome maze of new regulations. It’s bad enough that the law imposes an unconstitutional mandate on every American; it also imposes new regulations on businesses, which are stifling job creation.
Let me share with you a figure that serves as a devastating indictment of the new health care law: So far, over 1,000 businesses and organizations have been granted waivers from the law’s onerous mandates. These waivers may prevent job losses now, but they do not guarantee relief in the future, nor do they help those firms that lack the connections to lobby for waivers.
This is no way to create jobs in America. True, bipartisan health care reform starts by repealing this partisan law.
The third foundation recognizes that we cannot get our economy back on track if Washington tries to tax its way out of this mess.
The economics profession has been really clear about this – higher marginal tax rates create a drag on economic growth.
As the University of Chicago’s John Cochrane recently wrote: “No country ever solved a debt problem by raising tax rates. Countries that solved debt problems grew, so that reasonable tax rates times much higher income produced lots of tax revenue. Countries that did not grow inflated or defaulted.”
Higher taxes are not the answer.
Finally, the fourth foundation calls for rules-based monetary policy to protect working families and seniors from the threat of high inflation.
The Fed’s recent departures from rules-based monetary policy have increased economic uncertainty and endangered the central bank’s independence.
Advocates of these aggressive interventions cite the “maximum employment” aspect of the Fed’s dual mandate – its other mandate being price stability.
Congress should end the Fed’s dual mandate and task the central bank instead with the single goal of long-run price stability. The Fed should also explicitly publish and follow a monetary rule as its means to achieve this goal.
These are our four foundations of economic growth. And the House-passed budget starts the long, arduous, and necessary process of restoring these foundations and building a prosperous future.
We lift the crushing burden debt by cutting spending and reforming those government programs that drive the debt. We reduce the deficit by over a third in the first year of our budget, putting an end to the era of trillion-dollar deficits. The House-passed budget doesn’t just put the budget on a path to balance – it actually pays off the debt over time.
We can’t achieve this goal by simply rubber-stamping increases in the national debt limit without reducing spending in Washington.
Speaker Boehner made this clear in a recent speech at the Economic Club of New York: If the debt ceiling has to be raised, then we’ve got to cut spending. The House-passed budget contained $6.2 trillion in spending cuts. For every dollar the President wants to raise the debt ceiling, we can show him plenty of ways to cut far more than a dollar of spending. Given the magnitude of our debt burden, the size of the spending cuts should exceed the size of the President’s debt limit increase.
The House-passed budget also gets health care spending under control by empowering Americans to fight back against skyrocketing costs. Our budget makes no changes for those in or near retirement, and offers future generations a strengthened Medicare program they can count on, with guaranteed coverage options, less help for the wealthy, and more help for the poor and the sick. 
There is widespread, bipartisan agreement that the open-ended, fee-for-service structure of Medicare is a key driver of health-care cost inflation. As my friend Jim Capretta, a noted health-care policy expert, likes to say, Medicare is not the train being pulled along by the engine of rising costs. Medicare is the engine – and the rest of us are getting taken for a ride.
The disagreement isn’t really about the problem. It’s about the solution to controlling costs in Medicare. And if I could sum up that disagreement in a couple of sentences, I would say this: Our plan is to give seniors the power to deny business to inefficient providers. Their plan is to give government the power to deny care to seniors.
We also disagree about how best to deliver the tax reform that Americans have long demanded from Washington.
Here’s a quick story about tax policy. Twenty-five years ago, GE CEO Jack Welch introduced himself to this very club by saying, “I represent a company that doesn’t pay taxes.”
I guess some things never change. 
We have to broaden the tax base, so corporations cannot game the system. The House-passed budget calls for scaling back or eliminating loopholes and carve-outs in the tax code that are distorting economic incentives. 
We do this, not to raise taxes, but to create space for lower tax rates and a level playing field for innovation and investment. America’s corporate tax rate is the highest in the developed world. Our businesses need a tax system that is more competitive.
A simpler, fairer tax code is needed for the individual side, too. Individuals, families, and employers spend over six billion hours and over $160 billion per year figuring out how to pay their taxes. It’s time to clear out the tangle of credits and deductions and lower tax rates to promote growth.
The House-passed budget does that by making the tax code simpler… flatter… fairer… more globally competitive… and less burdensome for working families and small businesses.
By contrast, the President says he wants to eliminate deductions, but he also wants to raise rates. That includes raising the top rate to 44.8 percent. That would amount to a $1.5 trillion tax increase on families and job creators.
The President says that only the richest people in America would be affected by his plan… Class warfare may be clever politics, but it is terrible economics. Redistributing wealth never creates more of it.
Further, the math is clear – the government cannot close its enormous fiscal gap simply by taxing the rich. This gap grows by trillions of dollars each year, representing tens of trillions in unfunded promises to future generations that the government has no plan to keep.
There’s a civic side to this as well. Sowing social unrest and class envy makes America weaker, not stronger. Playing one group against another only distracts us from the true sources of inequity in this country – corporate welfare that enriches the powerful, and empty promises that betray the powerless.
Those committed to the mindset of “shared scarcity” are telling future generations, sorry, you’re just going to have to make do with less. Your taxes will go up, because Washington can’t get government spending down.
They are telling future generations, you know, there’s just not much we can do about health care costs. Government spending on health care is going to keep going up and up and up… and when we can’t borrow or tax another dollar, we’ll have to give a board of unelected bureaucrats the power to tell you what kind of treatments you can and can’t receive.
If we succumb to this view that our problems are bigger than we are – if we surrender more control over our economy to the governing class – then we are choosing shared scarcity over renewed prosperity, and managed decline over economic growth.
That’s the real class warfare that threatens us – a class of governing elites picking winners and losers, and determining our destinies for us.
We face a choice between two futures. We can continue to go down the path toward shared scarcity, or we can choose the path of renewed prosperity.
The question before us is simple: Which path will our generation choose?
In 1979, my mentor, Jack Kemp, captured the essence of why we must choose the path to prosperity:
“We can’t progress as a society by using government to diminish one another. The only way we can all have more is by producing more, not by bickering over how to share less. Economic growth must come first… for when it does many social problems tend to take care of themselves, and the problems that remain become manageable.”
You know, there’s a question I get a lot from people at town halls. When you go around the country showing people a chart that shows that our debt is on track to cripple our economy, people start to ask you whether any plan, even a plan like the House-passed budget, can save America from a diminished future.
They say, Congressman Ryan, I know you have to sound optimistic in public. But in private, do you really think there’s anything we can do to save this country from fiscal ruin? Or should we just be bracing for the worst?
It’s a difficult question. It’s one that gives me pause. Frankly, it’s one that keeps me up at night.
But the honest answer is the one I’m about to give to you: Nobody ever got rich betting against the United States of America, and I’m not about to start.
Time and again, just when it looked like the era of American exceptionalism was coming to a close… we got back up. We brushed ourselves off. And we got back to work – rebuilding our country, advancing our society, and moving the boundaries of opportunity ever forward.
We can do it again. America was knocked down by a recession. We are threatened by a rising tide of debt. But we are not knocked out. We are America. And it is time to prove the doubters wrong once more – to show them that this exceptional nation is once again up to the challenge. 
Thank you.

Two Alternative and More Meaningful Measurements of GDP

by Rob Arnott of Agora Financial:


Gross Domestic Product is used to measure a country’s economic growth and standard of living. It measures neither. Unfortunately, the finance community and global centers of power are wedded to a measure that bears little relation to reality, because it confuses prosperity with debt-fueled spending.
Washington is paralyzed by fears that any withdrawal of stimulus, whether fiscal or monetary, whether by the Administration, the Fed, or the Congress, may clobber our GDP. And they’re right. But, GDP is the wrong measure.
Without an alternative, we will continue to make bad policy choices based on bad data. Eventually, our current choices may wreak havoc with our future prosperity, the future purchasing power of the dollar, and the real value of U.S. stocks and bonds.

What is GDP?

GDP is consumer spending, plus government outlays, plus gross investments, plus exports minus imports. With the exception of exports, GDP measures spending. The problem is GDP makes no distinction between debt-financed spending and spending that we can cover out of current income.
Consumption is not prosperity. The credit-addicted family measures its success by how much it is able to spend, applauding any new source of credit, regardless of the family income or ability to repay. The credit-addicted family enjoys a rising “family GDP”—consumption—as long as they can find new lenders, and suffers a family “recession” when they prudently cut up their credit cards.
In much the same way, the current definition of GDP causes us to ignore the fact that we are mortgaging our future to feed current consumption. Worse, like the credit-addicted family, we can consciously game our GDP and GDP growth rates—our consumption and consumption growth—at any levels our creditors will permit!
Consider a simple thought experiment. Let’s suppose the government wants to dazzle us with 5% growth next quarter (equivalent to 20% annualized growth!). If they borrow an additional 5% of GDP in new additional debt and spend it immediately, this magnificent GDP growth is achieved! We would all see it as phony growth, sabotaging our national balance sheet—right? Maybe not. We are already borrowing and spending 2% to 3% each quarter, equivalent to 10% to 12% of GDP, and yet few observers have decried this as artificial GDP growth because we’re not accustomed to looking at the underlying GDP before deficit spending!
From this perspective, real GDP seems unreal, at best. GDP that stems from new debt—mainly deficit spending—is phony: it is debt-financed consumption, not prosperity. Isn’t GDP, after excluding net new debt obligations, a more relevant measure? Deficit spending is supposed to trigger growth in the remainder of the economy, net of deficit-financed spending, which we can call our “Structural GDP.” If Structural GDP fails to grow as a consequence of our deficits, then deficit spending has failed in its sole and singular purpose.¹
Of course, even Structural GDP offers a misleading picture. Our Structural GDP has grown nearly 100-fold in the last 70 years. Most of that growth is due to inflation and population growth; a truer measure of the prosperity of the average citizen must adjust for these effects. Accordingly, let’s compare real per capita GDP with real per capita Structural GDP.

A New Measure of Prosperity

Real per capita GDP has recovered to within 2.5% of the 2007 peak of $48,000 (in 2010 dollars). So, why do we feel so bad? For one thing, after two recessions, we’re up barely 6% in a decade. Furthermore, this scant growth is entirely debt-financed consumption. The real per capita Structural GDP, after subtracting the growth in public debt, remains 10% below the 2007 peak, and is down 5% in the past decade. Net of deficit spending, our prosperity is nearly unchanged from 1998, 13 years ago.
As a diagnostic for why this has happened, let’s go one step further. Few would argue that a healthy economy can grow without the private sector leading the way. The real per capita “Private Sector GDP” is another powerful measure that is easy to calculate. It nets out government spending—federal, state, and local. Very like our Structural GDP, Private Sector GDP is bottom-bouncing, 11% below the 2007 peak, 6% below the 2000–2003 plateau, and has reverted to roughly match 1998 levels.
Figure 1 illustrates the situation. Absent debt-financed consumption, we have gone nowhere since the late 1990s.
Figure 1. Real GDP, Structural GDP, and Private Sector GDP, Per Capita, 1944-2011

Source: Research Affiliates
As the private sector has crumbled, and Structural GDP has lost 13 years of growth, tax receipts have collapsed. Real per capita federal tax receipts have tumbled to levels first achieved in 1994, and are fully 25% below the peak levels of 2000.² The 2000 peak in tax receipts was, of course, bolstered by unprecedented capital gains tax receipts following the wonder years of the 1990s. But this surge in tax receipts fueled a perception—even in a Republican-dominated government!—that there was money to burn, as if the capital gains from the biggest bull market in U.S. stock market history would continue indefinitely!
What does this mean for the citizens and investors in the world’s largest economy? If we continue to focus on GDP, while ignoring (and even facilitating) the decay of our Structural GDP and our Private Sector GDP, we’ll continue to borrow and spend, mortgaging our nation’s future. The worst case result could include the collapse of the purchasing power of the dollar, the demise of the dollar as the world’s reserve currency, the dismantling of the middle class, and a flight of global capital away from dollar-based stocks and bonds.
None of these consequences is likely imminent. But, few would claim today that they are impossible. Most or all of these consequences can likely still be avoided. But, not if we hew to the current path, dominated by sheer terror at the thought of a drop in top-line GDP.
After World War II, the U.S. Government “downsized” from 43.6% of GDP to 11.6% in 1948 (under a Democrat!). Did this trigger a recession? Measured by GDP, you bet! From 1945 to 1950, the nation convulsed in two short sharp recessions as the private sector figured out what to do with all the talent released from government employment, and real per capita GDP flat-lined. But, underneath the pain of two recessions, a spectacular energizing of the private sector was underway. From the peak of government expenditure in 1944 until 1952, the per capita real Structural GDP, the GDP that was not merely debt-financed consumption, soared by 87%; the Private Sector GDP, in per capita real terms, jumped by more than 90%.
Was the recent 0.5% drop in GDP in the United Kingdom a sign of weakness, or was this drop merely the elimination of 0.5% of debt-financed GDP that never truly existed? Spending dropped by over 1% of GDP; Structural GDP was finally improving!
We must pay attention to the health—or lack of same—for our Structural GDP and our Private Sector GDP before they lose further ground.

Conclusion

Government outlays were not reined in by either political party for most of the past decade. Real per capita government outlays now stand some 50% above the levels of just 10 years ago, even with Structural GDP and Private Sector GDP down over the same span. Federal spending is more than 40% of the Private Sector GDP for the first time since World War II.
Even our calculation of the national debt burden (debt/GDP) needs rethinking. Is the family that overextends correct in measuring their debt burden relative to their income plus any new debt that they have accumulated in the past year? Isn’t it more meaningful to compute debt relative to Structural GDP, net of new borrowing?! Our National Debt, poised to cross 100% of GDP this fall, is set to reach 112% of Structural GDP at that same time, even without considering off-balance-sheet debt.³ Will Rogers put it best: “When you find yourself in a hole, stop digging.”
While many cite John Maynard Keynes as favoring government spending during a recession, he never intended to create structural deficits. He recommended that government should serve as a shock absorber for economic ups and downs. He prescribed surpluses in the best of times, with the proceeds serving to fund deficits in the bad times, supplemented by temporary borrowings if necessary. And he loathed inflation and currency debasement, which he correctly viewed as the scourge of the middle class.
GDP provides a misleading picture and a false sense of security. Instead of revealing an economy that we all viscerally know is weaker than a decade ago, it suggests an economy that is within hailing distance of a new peak in prosperity for the average American. Top-line GDP has recovered handily from its lows, on the back of record debt-financed consumption. But, our Structural GDP and Private Sector GDP are both floundering. Focusing on top-line GDP tempts us all to rely on ever more debt-financed consumption, until our lenders say “no más.”
The cardiac patient on the gurney has had his shot of adrenaline and is feeling better, but he is still gravely ill—more so than before his latest heart attack—as these two simple GDP measures amply demonstrate.

Endnotes

1. A “correct” measure would subtract all new debt that is backed only by future income, lacking collateral. Very little private debt lacks collateral, and very little public debt is backed by anything other than future income. So, for simplicity’s sake in this article, we subtract only net new government debt.
2. Despite no change in tax rates since 2003, this situation is often blamed on the perfidy of the affluent, not the evaporation of capital gains, hence capital gains taxes. We should recognize that the enemy is not success, it is poverty. But, when we rue the latter, we too often blame the former.
3. See the November 2009 issue of Fundamentals, entitled “The ‘3-D’ Hurricane Force Headwind,” for more details on the daunting levels of off-balance-sheet debt. Our debt/GDP ratio may be poised to cross 100% of GDP this fall, but our GAAP accounting debt burden is already well past 400% of GDP and well past 500% of Structural GDP.

We've Reached Debt Saturation

Gordon Long is another favorite. He always gives me a different perspective that I need to heed.


From Gordon T. Long of Tipping Points
Debt Saturation & Money Illusion
Most of the clearly evident financial problems that surround us today stem from one cause - Debt Saturation.

Most, intuitively, sense this to be a correct assessment but few can either prove it or articulate it to the less sophisticated. Let me arm you to be the "Nostradamus" amongst your friends and colleagues in explaining the problem and what the future therefore foretells.

However, let me make it very clear, this will not make you popular. Smart maybe, but highly likely to make you unwanted at the social gatherings of the genteel.

The first thing you will need in your role of 'all seeing' is the back of an envelope, or a somewhat clean napkin at your next luncheon. You will need only a few simple facts to go along with your prop.

THE FACTS MAME, JUST THE FACTS!

First, if you could total the world's balance sheets you would find that it would approximate $200 Trillion. In putting together this total you would discover that 75% of all financial assets are debt assets worth $150 Trillion. To most of us, debt is the epitome of a liability. To banks, however, it is not. It is considered an asset and recorded as such a banks ledger. Your liability is their asset.

The historical debt payment over a long period of time is 6% per annum. The Federal Reserve's dividend payment to its holders of capital was originally established in 1913 at precisely this 6% and is still accrued accordingly. Remember also, in a fractional reserve, fiat based banking system money can only be loaned into existence.

Today we have approximately $9 Trillion (6% of $150T) in annual debt payments that must be absorbed annually by increased productivity of the working classes.

Consider that the US Economy at approximately $15 Trillion is 25% of the global economy. Therefore the global economy approximates $60 Trillion ($62T officially, but we will use round numbers so we don't lose anyone in the arithmetic).

The working class therefore has to increase productivity by $9T divided by $60T or 15% annually to absorb the current global usury charges.

In the last few years of explosive debt growth we have passed the point of the global economy being able to grow and improve productivity at a fast enough rate, not to be literally consumed by this existing debt burden.

Unfortunately, it gets worse.

One of the problems in using GDP as a measure of growth is that it includes government spending. In the case of the US, it is approaching 25% of the output of the country. Within that, approximately $3.7 Trillion is $490B in interest payments or 13% of US expenditures. This actually means that there is an additional 3% that must be added to the 15% or nearly 18%.
   
This is called Debt Saturation.

DIMINSHING MARGINAL PRODUCTIVITY.

A very unpopular chart to deficit spending hawks is the chart showing the change in GDP as a ratio to the change in debt. The easiest way to understand this chart is to consider how much the economy will grow for every dollar of increased debt. As you can see, the effect of increased debt has been steadily losing its ability to increase economic growth and since the financial crisis has decidedly turned negative.

Increased debt is now counterproductive to the growth of the economy because the economy simply does not have sufficient productive investments to absorb it. We may have plenty of investments but they are mal-investments. They are investments that simply cannot pay the debt financing utilized.

The Korean Times recently illustrated that despite a booming Asian environment, technology firms are now struggling to cover interest payments. One in three firms on the Kosdaq failed to earn sufficient money to cover interest payments in 2010.  The interest coverage ratio, otherwise dubbed times interest earned (TIE), refers to the measure of a firm’s ability to honor its debt payments. 280 out of 876 Kosdaq-listed outfits, or 32 percent, could not reach the benchmark reading of one in the interest coverage ratio. 

TELLTALES OF DEBT SATURATION:

1- Non Performing Loans

The mal-investment is just too large to contain and is showing up in ever-increasing levels of non-performing loans. This is despite rolling over loans at false asset values.

Non-performing bank assets are increasing globally! The above chart from Reggie Middleton's BoomBustBlog graphically depicts this indisputable trend. What is this signaling three years after the financial crisis?

The rise in the above US non-performing assets is alarming. It reflects a 9.5% change since 2005. Everything is not at all well in the US banking sector.

Equally concerning is what is happening in Central and Eastern Europe where the change is 7%.  I personally consider Central and Eastern Europe to be the unaddressed 'sub-prime' problem of Europe. I suspect it will eventually replace the PIIGS in financial media news coverage.

2- Chronic Unemployment

The money lenders look at unemployment in a different fashion than the average person and would have us easily confused by its adjustments, birth-death models and other deceiving statistics. To them it is not about how many of our  fellow citizens are unemployed, but rather simply how many net new jobs are being created to pay for the annual usury assessment fee of the $9 Trillion we previously discussed. Herein lies their problem.

The internet has had a profound impact on the increase in productivity. Schumpeter's creative destruction is an engine running at full throttle. Vast swaths of jobs are being made obsolete through the adoption of new technology. The 'clerical' industry has almost disappeared in the span of 15 years through operational innovations such as supply chains. This has been tremendous for corporate profits allowing them to maintain highly leveraged balance sheets. The problem is that it has been solely at the expense of real job growth. No matter what a corporation does to make money, it eventually comes down to a consumer having the money to pay for the goods or services it produces.

We have reached the saturation point where we have insufficient real income growth to maintain the leveraged balance sheets of corporations. Government social nets are becoming burdened with making up the difference in either transfer payments (i.e.45 Million on food stamps in the US) or subsidies ( North Africa paying 28% of country budgets toward food subsidies for the unemployed population to survive). There are examples everywhere if you care to look. I have written extensively on this in my series on Innovation and in articles such as "Fearing the Gearing".

3- Money Velocity Doesn't Increase with Money Printing
Debt Saturation occurs when aggregate income no longer supports debt burdens. When governments print money, eventually Money Velocity increases as people incorporate inflation expectations into their buying behavior. When we examine the Federal Reserve's Money Velocity statistics we see that something is very different this time.

Despite increases in MZM, M1 and M2 money velocity maintains its downward slope with little suggestion of wanting to reverse trend.

We presently have inflation in what people NEED along with shrinking real disposable incomes. Since people must pay for their NEEDS with short term money (cash, check or credit card), there is little ability for them to adjust to inflation when they are living from paycheck to paycheck. If their disposable incomes were higher they would stockpile and turn their money over faster.  Additionally, money as a multiplier would flow through our society. Instead, today the money does not move through multiple hands but is returned almost immediately to the banks as debt payment, since most intermediaries are also burdened with debt.

WHAT YOU MUST BE AWARE OF
First, You must understand the impact of  mal-investments and the brake that debt is now applying to the Global Economy.
World Real GDP, adjusted for inflation on a year-over-year basis has plummeted. According to the World Bank this growth indicator has gone negative with the world's real GDP actually shrinking Y-o-Y.

The global growth engine has not only stalled but has clearly hit an unexpected brick wall.
Secondly, You must understand the significance of the stalled and possibly fatally ill  "Shadow Banking" Credit Engine.

Similar to moving about on an airplane or train it is hard to determine the speed you are traveling, because you have a limited frame of reference. In a casual conversation with your fellow travelers it is easily forgotten or unnoticed that you are moving at a rapid speed. This is the situation we find ourselves in as the Shadow Banking System fails to rebound and the debt it once created is not being replaced. The liabilities of the Shadow Banking System are shrinking. These leveraged liabilities are now shrinking the global money supply despite every effort of central banks to combat it. The Central Banks are losing the battle. Like glacial tectonic shifts they are undermining the abilities of financial institutions to continue to carry and roll-over non performing debt. 

Finally, You Must be Aware of: "Money Illusion"

The overlay below of the Nominal and Real (ShadowStats inflation-adjusted) Dow illustrates the concept of Money Illusion, the tendency of people to think of currency in nominal, rather than real, terms. Below the Dow series is the Consumer Price Index (CPI) from 1913 and with estimates for the earlier years.

The above chart reflects what is actually going on in the financial markets. The secular bear market that began in 2000 is still underway. Since the 2009 lows we are experiencing a Cyclical Bull Market counter rally that is to be fully expected as part of a Secular Bear Market.

The chart above is adjusted for inflation based on published CPI numbers. If ShadowStats inflation numbers are used, as is the case in the above chart, then the chart to the right would more clearly resemble longer term secular bear markets already experienced.
CONCLUSION

There is nothing magic in any of this and it has all been well documented, unfortunately by the Russians when they studied the capitalist system to identify its fundamental weaknesses. The Kondratieff long wave shows that the capitalist system suffers the build up and purging of debt on a generational basis on the frequency approaching 55 year cycles. We have extended this natural cycle by means of un-natural acts which I have written about in my extensive "Extend & Pretend" series of articles. Even in the days of old the king resorted to "jubilee" to cleanse the system. Of course we are much too sophisticated for such a simple solution today.

We have papered over the realities of "Too Big to Fail" by not allowing the proven tenets of capitalism to work. We have Anti-trust laws under the Sherman act to address 'too big', Control Fraud Laws to address questionable ethical behavior for the sake of profit (like mortgage fraud, liars loans etc) and Bankruptcy laws to liquidate failed enterprises to force debt holders to take haircuts and swap debt for equity. Instead we allow the prevalent game of Regulatory Arbitrage to run without restriction or detection.  Existing laws are not being exercised in an attempt to protect what amounts to the emergence of a crony capitalist system. Benito Mussolini had a somewhat different world for the merging of corporate and government interests that I will leave for readers to recollect who have a historical penchant. It is not a word easily digested in the polite 'cocktail chatter' of today's genteel upper middle class.

Welcome to Kondratieff's Long Wave Cycle

FORETELLING THE FUTURE

In your new role as 'Nostradamus' to your friends you can safely predict a decade ahead to be a secular bear market in financial assets, in real terms. Nominal values may not show this clearly but it will be very evident in the reduced standard of living most Americans will experience.

You are going to have to work harder and harder, for less and less to survive at a lower and lower standard of living.

This will all be required to support the annual $9T debt bondage we have assumed as our politicos add additional 'stimulus' to a suffocating and debt saturated global economy.