2010 – Your Last Chance
Friday, January 15th, 2010The economy is in the can but our politicians keep telling us that we have bottomed out and are on the upward swing. They point to rising prices in home sales and in a stock market that has been volatile but generally upward for several months. All true. But the mega-trend that is behind all that improvement is the $100 billion that the government is investing in the economy each quarter as a function of the ARRA. Actually, it is more than $100 billion because there is still funds left over in the TARP funding that is being spent and there are other funds, like the $33 billion for the war effort, extension of unemployment funding, jobs creation programs, state subsidies, etc., that are being invested in the economy. In the worst of times, the economy will show some improvement if you dump that much money into the markets.
Unfortunately there are some huge problems with this plan. Here’s why.
The ARRA - American Recovery and Reinvestment Act - of 2009 is supposed to invest $767 billion into the economy within a 2 yr period. That works out to be about $100 billion per quarter. It’s working. The economy is making a slow recovery. Jobs are returning slowly. Banks are lending again, a little. Cars are selling again, sort of. Inflation has not jump too much. The dollar has not been devalued by much, yet. The fact that we are spending $100 billion per quarter into the economy has a lot to do with this “recovery” but there is a huge problem with this tactic. Virtually all of the ARRA money is deficit money - money over and above what we have collected in taxes. In January 2010 alone, we added $680 billion in deficit spending. The national debt is well over $12 trillion today and will climb to over $14 trillion within the period of time that the ARRA is active. Even the CBO predicts we will conservatively add $9.1 trillion by the end of this decade (2010-2019). That will put the national debt at over $21 trillion.
This is a huge problem that is not getting the attention it deserves because it is something that has a slow development and a slow impact but like the lava in a volcano or the water in a flood, it moves slow but has devastating effects. This debt is real and it has its consequences. The debt represents borrowed money on which the government pays interest. In 2009, we paid $383.7 billion of interest payments on the national debt - that is just over 3% on the total amount. That is also 12.79% of the approx. total $3 trillion collected in taxes for 2009. That payment on the debt rises to $671.5 billion by 2019 or about 16.65% of the total taxes expected to be collected in that year.
Two problems with these estimates: One is that the expected taxes to be collected in 2019 is based on a fixed rte improvement of about 3% per year between now and then. Because of reasons you will see below, that is probably not a true estimation. 2009 taxes collected were 12.9% lower than 2008 - not 3% higher. A more realistic estimate is that tax income will rise thru 2010 and then decline for several years before rising again. The net gain between 2009 and 2019 might be closer to 1.5% - if it is positive at all.
The second problem is that, as we will see below, interest payments on the debt paid out might be higher because of inflation. It is very likely that all this deficit spending will devalue the dollar and increase inflation making the payments cost more. Rather than an average of about 3% interest payments, it is much more likely to be about 5% or more.
When you recalculate the total interest paid in 2019 using these projections, we will pay out 30.2% of the total taxes collected.
But wait there’s more…..
The national debt number that everyone works with is the debt owed by the General Fund. That is the working capital of operations within the government. Any deficit to that amount represents funds spent over and above taxes collected. That is exactly the definition of the various Trust Funds within the government. We have $800 billion in the Federal Pension Trust Fund (FPTF) for the retirement payments to the military and civil service. This Trust Fund is money that was collected and set aside for the federal employee pensions but then the actual money was spent by the government - leaving essentially an IOU in the FPTF. There is no bucket of money anywhere containing that $800 billion and set aside for the federal employee pensions. It is simply a certificate that says that at one time the total excess collected and not paid out in pensions was $800 billion but Congress paid it out in other expenses. So this is an amount that also must be paid back and because of COLA adjustments, has an ongoing increase to it.
But Wait There’s More….
There is, in fact no money in any of the “trust funds” that are “managed” by congress. The $280 billion in the Medicare Trust is also gone. The $3.1 Trillion in the highway trust fund is also gone. The $1.7 trillion of the Social security trust fund is also empty as it every other trust fund in our government.
The demand for payments OUT of these trust funds is growing at a rate much faster than inflation or in the growth of the economy. For instance, the needed major infrastructure projects that would otherwise be paid for by the highway trust fund far exceeds the current trust fund balance. In fact, the repair or replacement of just the bridges in the US that need immediate attention exceeds the amount in the trust fund now.
The payout from the Federal Pension Trust Fund, the Medicare and Social security Trust fund all are expected to rise very rapidly over the next 10 years as the 74 million baby boomers retire. For instance, the $1.7 trillion trust fund money plus all the money collected in SS taxes between now and just 5 years from now will be entirely gone by 2018 unless SS benefits are significantly cut. The average 9% rise in medical costs plus the 280 billion Medicare trust fund money plus all the money collected in Medicare taxes between now and just 5 years from now will be entirely gone by 2016 unless there is a significant cut in Medicare benefits.
A realistic view of the actual debt and an honest estimate of the rise in cost and the expected tax income would show that in less than a decade, we will likely accumulate in excess of $25 trillion in national debt and will be paying out more than $1.25 trillion in annual interest payments or better than 1/3 of the total annual taxes collected. That means that rather than the usually 2% or 3% reduction in the annual increase in spending, our government would have to reduce actual spending by more than 30%. That is something that they have never even considered and certainly have nave done. In fact, basic economics says that our economy could not survive such a major decrease in funding for entitlement and military spending programs.
But wait, there’s more.
As bad as this is, it is unfortunately, not the worst of it. First you have to appreciate the really really bad timing of the ARRA. The following is a list of the confluence of events that will all take place over the next 15 years:
1.Since 2005, it is not just the government but the US population has spent more than they made in income. A net negative savings rate. It has continued every year since at increasing amounts of negative savings. The economists refer to it as wealth spending and it comes primarily from credit cards and home mortgages. People borrowing to pay bills for items over and above their income. The ones most affected are the baby boomers. This latest economic crisis may change the attitudes back to a positive savings but it also may be too late. Retiring boomers don’t have time to save enough to cover retirement so they will rely on the equity in their homes and investments ….precisely the two assets most impacted by the current economic crisis.
2. 74 million baby boomers are retiring right now at a rate of 10,000 per day. That will increase to over 20,000 per day by 2015. All of them want social security; many will need it because they have no savings. Applications for SS benefits are up 23% in 2009 over 2008 and the rate of increase is growing. This increase is remarkable because the oldest boomers (those born in 1946) do not reach full retirement age until 2011. What this reflects is the massive numbers that are taking their retirement money at age 62 because they either need the money or they have retired early. If all or even a significant part of the boomers do this, then all of the timetables you see below will have to be moved back by several years.
3. As many as 70% of the boomers are expected to sell their MacMansions (homes over 2,000 sq ft) and second homes (1 in every 4 boomers owns a second home) over the 2012 thru 2025 period - putting more than 650,000 homes on the market per year over and above the amount that is historical normal roll-over. This means that home prices will plunge and stay down until we burn off this excess which is estimated to take 10 to 15 years. During that time, new home construction will be reduced, wood sales will drop, furniture, rugs, construction jobs, etc. everything related to that industry will also trend downward for a decade or more. In the meantime, the demand for low cost housing ($600/mo including utilities and taxes) will skyrocket but are nearly non-existent today and currently there are no plans to provide them. These homes have the lowest profit margins and there are very few investors that are willing to build “projects” like this. Only the government would be motivated to invest in such massive low-income housing projects and they may not have the money to do so.
4. The social security fund will collect $10 billion LESS than it pays out in 2010 and $9 billion less in 2011. This is the first time that such deficit spending has occurred and it is happening far sooner than anyone has ever projected. According to the CBO, it will go positive from 2012 thru 2015 but that is based on the CBO projections that the economy will make a continuous recovery over all of that period. And then it will go negative permanently - in fact, it may be as much as 75 years, if ever, before it will go positive again. The reason for it going negative for so long is that there will be so many retired people receiving SS and Medicare than there are working people. When the SS started, there were more than 25 workers for every person receiving benefits. In 2018, that will fall to less than 2 people. The taxes that two people pay will not cover the benefits for one person. However, the average boomer will get $1100 per month in SS - not enough to live on for most.
5. The boomers put more that $7 trillion into the stock market over the past 25 years. As much as 30% of that was lost as a result of the current economic crisis. This loss means that boomers will be withdrawing money sooner, faster and will run out quicker than they had planned. What was not lost will be used to fund their retirement. This means that the stock market will stop receiving the huge inputs of funds and will begin paying out huge amounts in dividends and cashed out stocks. To be able to fund these withdrawals, companies will have to completely alter their financial priorities - cutting R&D (always the first to be cut out), cutting any new growth or expansions, cutting back on all non-essential expenses, and reducing their work force. Jobs lost during this crisis will not come back for a lot of industries. Those jobs that do come back may not last long as they will be cut as soon as the effects of no more TARP, ARRA or other government investments and as lowered consumer spending is felt.
6. The national debt will cause two major problems that are economic inevitabilities: (1) the value of the dollar against foreign currencies will drop and (2) inflation will skyrocket to all time highs. This will mean that all foreign goods will increase in cost with the most effect being felt in the price of fuel - gasoline, heating fuels, airline fuel, etc. Rising transportation costs will cause almost everything else to rise. A really serious consequence that could happen is that OPEC decides to change from using the dollar as their base currency to using the EURO. Right now, all oil, worldwide is purchased and sold using the value of the dollar as the currency. If OPEC decides that the dollar is too inflated or to over-extended, then they might very well switch over to the EURO. This has been a threat for the past 10 years and has been stopped only because of the threat of Iraq, Iran and other Middle East unrest. We have bought the allegiance of Saudi Arabia by giving them sweetheart deals on military aircraft and other weapons and protected them with our Navy and Air Force. If they decide they are now strong enough, their enemies are weak enough or that we cannot provide any real benefits, then they will switch to the EURO or to gold. Either way, the devaluation of the dollar against other currencies will make the price of oil climb to over $10/gal. or more.
7. All 74 million boomers will want Medicare and a drug program. The current health care reform will add to that cost by adding those 15 million lower income people that did not contribute as much to their taxes as the middle and upper class. This is expected to add at least $1 trillion to the total bill that is already projected to vastly exceed income to cover the costs.
8. Because of the economic crisis, negative savings, loss of equity, stock market drop and rising costs - many boomers will try to remain in the work force but they will mostly compete with younger workers for service industry jobs at the bottom of the salary range. When many businesses will not be expanding, the job market will be saturated - forcing many to draw welfare, food stamps, fuel, training, housing, unemployment and other subsidies - adding to the costs of both state and federal government entitlement programs. This is over and above the payouts to entitlement programs like social security, Medicare, seniors prescription drug programs and other national subsidies. The sheer volume of old people (mostly baby boomers) will strain every social service program in every town, city, state and nationally to beyond their ability to respond. Projections that you will never see from the government include an estimated 20 million people might be homeless by 2020 - up from 3.5 million in 2005.
9. Unemployment will hit over 10% in 2010 and is expected to lower in 2011 and beyond - according to the government. But of course, that is what you’d expect them to say. After the ARRA and TARP and other government investments stop, job creation will stop and job losses will begin again. But what we hear about as unemployed is not at all accurate. They only count those that are unemployed and actively seeking employment and are doing so with the help of the government. Those that have taken jobs only to hold them over until they can get a better job, those that have stopped looking because they have exhausted all possibilities, those that are seeking jobs outside of the government programs and those that are doing handyman, maid or other private work because they cannot find other work are all no counted. In the future, the massive number of old people that will have to work because their social security does not cover basic living costs - will not be counted in the unemployment figures. Real unemployment in 2010 is probably closer to 14% or 15% of the working population and despite investments and other efforts; unemployment is likely to grow to over 20% by the peak of the boomer retirement era - in 2020.
Now - why is all this not apparent right now? Because we are pumping $100 billion into the economy every 4 months. The ARRA money is hiding the fact that tax receipts in every state in the union are not covering expenses. It is hiding the fact that the SS fund is running a deficit right now. It is hiding the fact that the housing market is already saturated with “toxic assets” even before the boomers start selling in mass. All that plus we are recoiling from a huge financial loss and we are still ONE year away from the first boomers (born in 1946) reaching full retirement at age 65.
What will happen in 2012, when they have spent all the ARRA money? How fast will the impact of all of the above inevitable events take to bring the economy into a 10+ year depression? Ask Chris Dodd and Byron Dorgan - they can see that the Ship of State is being held afloat by band-aids and threads and is leaking badly. They are abandoning the Ship of State before they are grouped among those that will be either blamed for causing this problem or held accountable for fixing it. It going to be a helluva mess.
At the beginning, I said that 2010 is your last chance. During 2010, when ARRA and TARP and other government investments are still being paid out - while the inflation has not yet taken hold - while most of the boomers are still working and while we have not yet experienced a major devaluation of the dollar - the economy will grow. The market will climb and you can make some money in the market. It will be volatile and it almost certainly will not last for all of 2010 but this is your last chance to make an investment in which the objective is more than preservation of the principle.
Probably in the early part of the 4th quarter, the speculators that will try to jump the gun on inflation and reduced government spending will begin bailing out of the market and into gold or other cash equivalents. Gold in late 2010 and for the next several years will be rising massively. As long as the basic economy does not completely collapse, gold will be the safe haven for several years to come. I for one will be moving into gold in the third quarter or perhaps even sooner. I will also be carefully picking stocks and commodities that I will be selling short and buying long on to take advantage of this inevitable set of events. When I did this coming into the Y2K event in 1999, I made a fortune. This will be the same kind of opportunity but much bigger and it won’t be over in a few weeks. That means that there are dozens of opportunities to make tons of money if you simply are willing to open your eyes and see the mega-trends that are really driving what is happening.