The Hidden, Historic Bubble That Could Burst Any Day

Of course we're talking about...

...all at once now...

Muni bonds!

Yay! Of course, municipalities far and wide have no way to pay back their increasing deficits amidst falling tax revenues.

Of course you knew this already, being an astute reader and no doubt a contrarian thinker. But the mainstream press is even starting to catch on.

The Contra Costa Times reports:

Declining income from property, sales and other taxes coupled with growing pension obligation debts and the residual effects of the financial meltdown are inflating a dangerous bubble in the $3 trillion to $4 trillion public bond financing market.

If the bubble bursts, agencies will be unable to borrow, and would cancel or postpone public projects such as school construction or building roads and highways. At worst, governments could default and upend the historically safe municipal bond market.

"This is the most serious municipal debt crisis in U.S. history, including the Depression," said Denver-based attorney Jeff Cohen, who represents bond issuers and buyers. "Arizona has huge problems. So do Nevada, Illinois, New York and New Jersey. And California has the same credit rating as Kazakhstan."

Small to mid-size public agencies, in particular, have been hit hard, said Cathy Spain, director of the Center for Enterprise Programs at the National League of Cities.

Not only has public agencies' income dwindled, but they can't even buy the bond insurance that would lower their borrowing costs. Most of the bond insurance companies, who participated in the mortgage-backed securities shenanigans, spiraled out of business during the bank meltdown.

Get your popcorn ready - this should be a doozy!

Also check out Robert Prechter's thoughts on why you should run, not walk, from these "safe" muni bonds.

Why Socialized Healthcare Will Sink America

It's ironic that folks who identify themselves as free market proponents lament Obama's plans for socialized healthcare in America. We already have socialized healthcare in the US.

There is very little that's laissez faire about the American healthcare system. The entire market is strangled by red tape, bureaucracy, and stupid rules.

Result: the least efficient healthcare system in the world.

A true representation of a laissez faire industry in America is high technology, which, by no coincidence, is constantly innovating and producing untold amounts of wealth for the US. We are fortunate that most of our elected representatives do not understand technology, and, thus far, have not been able to pass enough red tape laws to kill the industry.

Healthcare is a joke, and could very well be the final straw that bankrupts our government, if we do indeed go the way of national healthcare. For more on the current mess, let's turn to one of our favorite economic minds - Bud Conrad...

***

Why Healthcare Is Killing America
by Bud Conrad, Editor, The Casey Report

Healthcare is the biggest segment of our economy. In the debate over who should pay for what or, increasingly, for whom, most people don't stop to understand just how large a portion of our society's money is dedicated to healthcare.

For some perspective, as a share of GDP, the U.S. spends about twice that of other advanced nations. This is an important reason why the U.S. is increasingly uncompetitive in global manufacturing. It is, for instance, the most important factor (besides poor management) that General Motors and Chrysler are going bankrupt.

Going forward, the situation is guaranteed to get worse. The Obama administration is committed to major reform to cover the 40 million people not now covered by insurance. Once everyone has insurance, with many paying nothing at all for coverage, patients won't care what it costs, and the system will quickly spin out of control.

And it's already out of control. I recently spent one day in the hospital due to a broken arm, which cost on the order of $100,000. Remarkably, that eye-opening amount still doesn't include the ambulance, the doctors, the x-rays, the CT scans, or the anesthesiologist. I'm still getting bills. The system is far more broken than is widely understood, unless you have had a recent bad experience.

Projections for healthcare are particularly problematic because of the demographics of so many people born just after World War II. Soon, there will be less than three people in the workforce for each retired person. That will result in huge taxes on the few workers to supply the expensive end-of-life medical care for the retirees (and it is in the latter years where medical expenses really begin to rack up).

This bubble was predicted and a government trust fund was set up. Unfortunately, as is typically the case, the government couldn't keep its hands off the money, and so it has already been spent. The outlook is not good. In fact, in just over 10 years from now – by 2020 – the demands on the government for Social Security and Medicare will get so high that they cannot be met. And it gets worse from there.

It's a safe bet, based on history, that the government will once again try to print its way out of the problem – but all that will do is further destroy the dollar and drive interest rates up even more. Just to be clear, this is not just about a government program gone awry, but as much or even more so a demographic problem – which makes it all the more intractable.

Don’t wait to be saved by the government; take your life – and your asset protection – in your own hands. For example, by playing one of the most obvious and inevitable trends and Bud Conrad’s favorite investment for 2009. Click here to read the full report.

Chinese Students Laugh Geithner Out of Town

US Treasury Secretary Tim Geithner visited Beijing on Monday…with a straight face, he reassured the Chinese government that its large holding of dollar assets are safe.

Then, still deadpanning, Geithner reaffirmed his faith in a strong US currency.

That broke the ice, as his student audience burst our into large laughter.

See if you can read Tim's schtick with a straight face:

"We have the deepest and most liquid markets for risk-free assets in the world. We're committed to bring our fiscal deficits down over time to a sustainable level.

"We believe in a strong dollar ... and we're going to make sure that we repair and reform the financial system so that we sustain confidence," he said.

Read the full piece at GATA.org...

Here's another great Geithner gem - a good old fashioned Saturday Night Live spoof:

Great Quote on Why Government Can't Create Wealth

"You cannot legislate the poor into freedom by legislating the wealthy out of freedom. 

What one person receives without working for, another person must work for without receiving. 

The government cannot give to anybody anything that the government does not first take from somebody else. 

When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that my dear friend, is about the end of any nation. You cannot multiply wealth by dividing it."

~~~~ Dr. Adrian Rogers

Editor's note - Guess what percentage of our country is a net receipient from the Federal Government...meaning they receive more in handouts than they pay in taxes?

Over 50% (!)  Uh oh...

Does the thought of government handouts make your stomach turn?  You'll love The Market For Liberty, which we reviewed here earlier this week.

Anyone See $1 Trillon? The Fed's Looking for It

This video's a doozy - Rep. Alan Grayson asks the Federal Reserve Inspector General about the trillions of dollars lent or spent by the Federal Reserve and where it went, and the trillions of off balance sheet obligations.

Further reading:

• Demand for US Treasuries Poor in Latest Auction
• How Bad Will the Financial Crisis Get?
• Why Gold Will Soar Past $2,000

Demand for US Treasuries Poor in Latest Auction

Yesterday, yields on 30-year US Treasuries skyrocketed on poor demand in the latest bond auction.  Yields jumped from 4.1% to 4.3%.

Tough to imagine why demand would have been so lackluster - maybe it's the fact that the US government will never be able to pay any of this debt back?  That is, without printing it?

Last month Marc Faber told Bloomberg that bond yields bottomed for good on December 18, 2008 - and he now expects them to rise for the next 15-20 years.

So is this breakout finally the cue to short long-term US Treasuries?  In the short term, I could see rates heading lower once again, if one of the following two things happen:

• The Fed steps up their purchases of long term debt.  In the long run this is highly inflationary and won't work, but in the short term they could drive rates down.
• And end to this bear market rally could once again trigger the "flight to safety" trades - which previously buoyed US debt and the dollar, at the expense of everything else.

Long term this appears to be a no-brainer, as interest rates should head to the moon.  It's just the apparent obviousness of the whole thing that gives me hesitation from putting this trade on right now.  I am considering picking up some TBT for my Scottrade account, and just doing a "buy and hold" on it.

Shout out to our buddy Brian Hunt at The Daily Crux for his coverage of this story.

Further reading: Doug Casey says Treasuries are the next bubble to burst.

How Bad Will The Financial Crisis Get?

How bad can the current financial crisis get, and how long will it last?  Casey Research's Chief Economist, Bud Conrad, tackles this question, crunching the numbers produced by two leading economists who took a broad sampling of banking crises.  The information is presented in an insightful and informative way as only Bud can.  I hope this helps round out your thought process about the depth of the current crisis.

Bad, Worse, or Worst?

An assessment how serious the current crisis is likely to get

By Bud Conrad, Chief Economist, The Casey Report

It’s time to call the global crisis what it is: the worst financial collapse since 1929. That’s no surprise to subscribers of The Casey Report, who have been amply warned over the last five years. But now even government officials, after trying to ignore the facts on the ground for the last couple of years, are admitting the truth of the matter.

Now that it’s here, we turn our attention to trying to discern, “How bad can it get?” and “How long can it last?”

While such questions can never be answered with anything approaching absolute certainty, there are methods that can be used to assess what may lurk over the horizon. With that goal in mind, this article focuses on – and then expands upon – the recent work of two economists who painstakingly analyzed a substantial number of previous banking and currency crises in an attempt to derive potentially useful lessons. I have then taken their data and applied them to the current circumstances to see where we are, relative to those other experiences.


The Data

The data are from a study called “The Aftermath of Financial Crises” by Carmen M. Reinhart of University of Maryland and Kenneth S. Rogoff of Harvard University. In their study, the authors summarize the results of a broad sampling of banking crises, with between 13 to 22 crises analyzed for each of the variables.

The Reinhart/Rogoff study is based, in turn, on data extracted from an even more comprehensive study of events in 66 countries, titled “This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises,” by the same authors.

I’ve summarized the findings from the latest study in the table below:

The economic measures in the left column show how far the U.S. situation has deteriorated so far. The next columns show the average historical deterioration and the worst case of the crisis analyzed.

I then applied these data to calculate the levels that the U.S. could reach if it followed the path of the historical examples. The projected level is based on the measure analyzed, either from the peak prior to the downturn (e.g., the S&P 500) or from the bottom prior to the downturn (e.g., the lows in unemployment). Thus, as you can see in the table here, the S&P 500 has already dropped from its October 2007 peak of 1565 down to 766. If this crisis were to end up being only “average,” then it would drop to 690.

If, however, the worst case of a 90% drop were to occur, as it did in Iceland last year, then the S&P 500 would trade down to the shocking level of 157. For further reference, if the current crisis were to cause the stock market to fall as sharply as in the Great Depression, the S&P would touch 469.

Duration of Crisis

As you can see in the summary table below, it took 3.4 years, on average, for the stock market to fall from the peak to the bottom. In the worst case, it took five years. With the recent peak in the S&P 500 occurring in October 2007 – just one and a half years ago – the crisis is likely to have some time to go before reaching even an average duration. More specifically, if this crisis turns out to be just “average,” we would not expect to see the low before the first quarter of 2011.

Crisis Horizon: Some Conclusions

The global economic situation continues to deteriorate on all fronts (see charts below).

Housing prices are down 28% from their bubble peak in 2006 but still have a ways down to go to get back to their pre-bubble levels. Even an average downturn will mean that housing remains a problem for several more years. Unless, of course, the government steps in to stave off those resets… a “solution” that carries with it a separate set of problems, making things worse. We continue to expect very serious problems in the commercial real estate sector.

The stock market is approaching a 50% decline, the average of what has been observed in past crises. Further slowing in U.S. corporate activities and profits means additional increases in unemployment, establishing a negative feedback loop that pushes corporate profits – and stock prices – even lower.

The only growth trend at this point is in government bailouts, which are in high gear, indicating we’ll experience the serious growth of outstanding debt seen in other crises. The elevated levels of government borrowing required to fund that spending are absorbing all available credit from foreigners, directly competing with business in need of the new financing that will be required to expand the economy. The combination of declining business activity, coupled with declining levels of household income, will result in declining tax revenues, increasing the budget deficit beyond the size of the new bailout programs. State and municipal governments across the nation are already being confronted with large shortfalls in their budgets, shortfalls that will only widen as the crisis worsens.

The combined business slowing and jobs contraction assure that the GDP will decline. Components of GDP having to do with necessities like food and shelter will continue to bump along regardless of the economic conditions, but the lack of growth in GDP could extend for years as it did in Japan and as it did after the 1929 stock crash.

Inflation/Deflation

Given that we are currently in a deflationary phase, it is easy to dismiss the case for inflation – and many do. We think that is a mistake. Even a summary tabulation of the unprecedented increases in government debt at this relatively early stage in the crisis make a compelling case for higher inflation, if for no other reason than that it shows clear intent on the part of the government to spend “whatever it takes” to offset the deflationary forces now stalking the land.

The research paints a dismal story of years of economic stagnation. In our view, the trend is now firmly established for dollar debasement, a debasement that will eventually overwhelm the deflationary pressures from collapsing asset values. Therefore, don’t listen to the happy faces on CNBC spouting off, for the umpteenth time since this crisis began, that now is the time to jump back in and buy stocks. It isn’t.

Be extremely skeptical when you hear some pundit pronouncing that this piece of short-term good news or another is an “all clear” signal. Until we start seeing a systematic improvement in the economic fundamentals – for example, an upward movement in consumer confidence – the only signal the economy will be hearing is that of a runaway train coming straight at it.

The numbers paint a dark picture… but it is in crises like today’s where unusually good opportunities arise for investors. Take our investors, for example, who made money shorting financials over the last year. The Casey Report focuses on recognizing and analyzing market trends way ahead of the investing crowd – a strategy that has already provided its subscribers with up to four-digit returns. The latest edition includes an update on the analysis you’ve read above. Try it risk-free for 3 full months, with our 100% money-back guarantee: click here to learn more.

Also by Bud Conrad:

• Battle of the Flations: Which Will Prevail?

What if...There Had Been No Government Bailouts?

Oh what a wonderful economic world it may be right now, had the government not felt the compelling need to "do something."  Casey Research's Terry Coxon reviews the government's "helpful" actions over the past couple of years, and asks the question - what would have happened if they had done nothing?

Nothing
By Terry Coxon, Editor, The Casey Report

We don’t yet know how many trillions will be swallowed up by the government’s rapidly breeding herd of stimulus-bailout-help!help! measures. But additional bold steps are sure to come, some already in R&D and others to be invented on the fly to answer each new wave of bad news. Expect price tags suitable for proving how serious and determined the authors are.

The doubts that meet each new plan – does it really need to be that big... hasn’t something like that been tried before... is it smart to keep wrong-headed decision makers in high places... isn’t too much debt at the heart of the problem... if you don’t know what causes inflation, are you sure you know what causes babies – are all answered with the same rhetorical question: “We can’t just do nothing, can we?”

Yes, we can. But we won’t, because the decisions about our wealth and our freedom are being made by career politicians, for whom stepping aside is the only truly unacceptable plan. Nonetheless, even though the idea of government doing nothing in the face of credit crisis, bank insolvencies, and recession has been reduced to a hypothetical, such a policy deserves a little exploring, since it can tell us something about where all the big-dollar solutions coming out of Washington are likely to lead.


Background

It’s possible to train people to be crazy. If you’re acquainted with a psychotherapist (socially, of course), ask him to explain how it’s done. Training people to be crazy wasn’t what the U.S. government set out to do when it ended the dollar’s convertibility to gold in 1973. But it turned out to be one of the results.

Untethered from the gold standard, the Federal Reserve was free to create new dollars whenever it saw fit. But the policy it drifted into wasn’t steady inflation, day in and day out, it was rescue inflation. The Fed would step up the expansion of the money supply whenever it saw a risk of widespread defaults in credit markets. The unintended effect was to train both lenders and borrowers, by repeatedly rescuing them from damaging defaults, to appraise financial risk unrealistically and to regard what is in fact a source of danger as a manageable nuisance. It made the managers of financial institutions functionally crazy, and the longer rescue inflation continued, the worse they got. (When you read about investment bankers running a business with 30-to-1 leverage and tell yourself, “Those people must be crazy,” you’ve got it about right. But they weren’t born that way. They were trained.)

That’s how the credit crisis was nurtured. And here is what the government has done about it so far.

August 2007. The credit crisis is just going public. Commercial banks, investment banks, and other financial institutions are waking up to the reason they were getting such great returns on junk paper – it really is junk. To ease the shock, the Federal Reserve begins a vast and unprecedented program of swapping out Treasury securities from its own sizeable (nearly $1 trillion) investment portfolio in exchange for the embarrassing and worrisome securities that seem to be paralyzing the lending departments of the banks that own them. A novel approach, and not really inflationary, since no new cash is produced.

September 2008. Lehman Brothers informs the Federal Reserve that the novel approach, admirable though its inventiveness might be, isn’t working and drops dead in front of Ben Bernanke’s desk. The Fed abandons the hope of a non-inflationary remedy and begins a vast and unprecedented program of expanding the monetary base (buying Treasury securities and other IOUs in the open market with brand-new dollars).

October 2008. President Bush signs a vast ($700 billion) and unprecedented bailout bill. It has been sold to Congress as a measure to help banks survive and keep lending, but the details are vague in the extreme, leaving the secretary of the Treasury with the authority to use the money for almost anything, including, if he should find it advisable, “for carrying on an undertaking of great advantage; but nobody to know what it is.”

Other vast and unprecedented programs have followed, including tens of billions for any car company willing to drive (not fly) to the teller window, hundreds of billions to get messy home mortgages house-trained, and unspecified mega-billions for Timothy Geithner’s proposal to unburden banks of bad assets through a plan of great advantage but nobody to know what it is.

And today, 21 months after the doctors started scribbling prescriptions, most markets continue down, the economy is still shrinking, and worries are still growing.

Now roll the tape back to August 2007. What would have happened if the U.S. government had simply kept its long-standing commitments (in particular, protecting FDIC-insured deposits and preventing the money supply from shrinking) and otherwise had done nothing? No good-asset-for-bad-asset swaps, no wild expansion in the monetary base, no bailouts, no arranged marriages with taxpayer-financed dowries for failing institutions.

Nothing.

If that sounds extreme, perhaps you’ll find it a little more acceptable if I put it this way: what would have happened if George Bush, Ben Bernanke, Nancy Pelosi, Harry Reid, Barney Frank, and Barack Obama had done nothing?

It would have been spectacular, a mass die-off of the incautious. Bear Stearns, Morgan Stanley, and other practitioners of ultra leverage, including perhaps Merrill Lynch, would have folded. When you borrow to carry $30 of investments for each $1 of company capital, it only takes a 3.4% drop in the prices of your assets to put you under water. And when you’re getting that 30-to-1 leverage through overnight borrowing, even a whiff of doubt can make it impossible to roll over your financing from one day to the next. Either way, you’re out of business.

From there, the trouble would have fanned out. The firms just pronounced dead were counterparties to trillions of dollars in derivatives. The investors on the other side of all those deals (largely banks, insurance companies, and other brokers) would have been left holding the bag. Some of them would have failed, and all that survived would have been left weakened and living in fear.

Growing mortgage losses would have forced Fannie and Freddie (and also Countrywide Financial) into bankruptcy, which would have turned their trillions in outstanding bonds into junk debt, doing great injury to the banks, insurance companies, and other investors that held them. Citibank and Wachovia would have gone under. And with Fannie, Freddie, and Countrywide gone, the biggest sources of mortgage money would be unavailable, which would have turned the housing market from a corpse into a mutilated corpse. AIG, which had turned itself into a sink of follies by insuring other companies against losses on junk debt, would also have joined the departed – and the companies that had been depending on AIG credit insurance would have gotten sorted out between the failed and the merely damaged.

Bank of America, having been spared the irresistible invitations to acquire Countrywide and Merrill Lynch, might be in much better shape than it is today.

With a hundred-car pile-up in the financial sector, lending to businesses and consumers would have shriveled, and the rest of the economy would have slipped into a depression. No more General Motors. No more Chrysler. Ford maybe.

And those are just the big names. Tens of thousands of other companies would have gone out of business. Most others would have laid off workers. The unemployment rate would have moved deep into double digits. With so many companies cutting inventories to raise cash for survival, the wholesale price index would have gone off a cliff, and the consumer price index also would have slumped.

It’s an ugly picture, with pain and hardship for millions of people and grave worries for the rest. But before you start preparing thank-you notes for the good people in Washington who’ve acted so boldly, consider this:

If they had done nothing, the whole sorry business might be over by now. Without the promise of rescue and blow-softening, events would have moved quickly. The collapse of the overleveraged financial companies would have started soon after credit market jitters began in August 2007. (Leverage built on overnight borrowing invites swift justice.) The disaster in the financial sector might have been over by the end of that year or soon after. The year 2008 would have seen the wave of layoffs and bankruptcies in operating companies and the fall in wholesale and consumer prices.

A simple process would have brought the contraction to an end. With the prices of most things falling, the real value of the money in everyone’s pocket would be rising. That would continue until large segments of the population came to feel cash rich and started spending. Dollars appreciated in value, not dollars newly printed, would finance the recovery.

And it would be a thoroughly healthy recovery, because the bankruptcy proceedings that came before it would remove the billion-dollar bunglers of recent years from positions where they can make expensive mistakes. Decision making about the allocation of capital would fall to the survivors, who, by their survival, had proven their ability and readiness to decide wisely.

There is precedent for this. In the depression of 1920-1921, for example, wholesale prices fell by nearly one half, and most of that fall occurred in a period of just six months. It was a violent experience, with widespread bankruptcies, but it was over in a year and a half. It ran fast because the government did so little to try to stop it. Nancy Pelosi hadn’t been born yet.

So much for the hypothetical. Instead, with all the government efforts to make things right, we have:

• An economy that continues to contract;

• A continuing mystery as to which banks are solvent and which are not;

• Financial institutions still under the control of individuals who’ve proven they should be doing something else;

• Car companies on apparently permanent life-support at taxpayer expense;

• A retarded decline in housing prices that is extending, by years, uncertainty as to how severe mortgage losses are going to be;

• A flock of new government programs that will continue to soak up billions of dollars per year long after the recession is over;

• A vast and unprecedented (that again) increase in the basic money supply, which is jet fuel for price inflation;

• A vast and unprecedented increase in peacetime government borrowing, which, when the recovery begins, will trap the government in a choice between letting interest rates rise (and risk choking off the recovery) and continuing to inflate the money supply (and kiss runaway price inflation on the mouth).
  

Yes, it does seem cruel to do nothing when disaster is unfolding. But consider the likely consequences of the alternative.

Doing nothing might be appropriate for Washington at this point in time… but it is not what you should do as an investor. Making the trend your friend is the strategy that will get you through tough economic times like this and provide you double- and triple-digit returns.

The Casey Report focuses on emerging trends to profit from even in highly volatile markets – whether it’s shorting stocks squarely in the way of the accelerating economic avalanche or investing in commodities that stand to gain big in the coming months. Test it now risk-free with our 3-month, 100% money-back trial… click here to learn more.

How Big Will the 2009 Budget Deficit Be?

It's scary to think that the $1.8 trillion deficit estimate for 2009, issued by the Congressional Budget Office (CBO), could be wildly conservative.  But if you pick apart each assumption made by the CBO - as Casey Research CEO Olivier Garret does in this guest article - you'll see that this estimate is really a best case scenario.  Bottom line, this will accelerate the governments need to inflate.

Widening Deficits
By Olivier Garret, CEO, Casey Research

On March 20, 2009, the bipartisan Congressional Budget Office (CBO) released its latest forecast in an effort to take into account the impact of the recently released Obama budget. The verdict? A whopping $1.8 trillion deficit for 2009, approximately four times larger than the all-time record established in 2008 ($455 billion).

The concerns raised by this latest forecast are many:

1. A mere two months ago, the CBO’s estimate for 2009 was “only” $1.2 trillion. They have already grossly underestimated a deficit that will most likely continue to balloon in the coming months.
   
2. While the new administration has focused its attention on the spending side of the budget, it has paid little attention to the other side of the equation. What will happen when tax revenue comes in much lower than current projections?
   
3. Even ignoring the likely expansion of the projected deficit, where will we get the $1.8 trillion needed to cover the CBO’s estimated deficit? Foreign investors? Higher taxes? Or that old standby, the printing presses?
   

Buried in the latest CBO forecast are numerous reasons to be alarmed, chief among them the authors’ admission that they have no idea what the future holds for the economy. They state:

“Both the magnitude of the contractionary forces operating in the economy and the magnitude of the government’s actions to stabilize the financial system and stimulate economic growth are outside the range of recent experience. The forecast assumes that financial markets will begin to function more normally and that the housing market will stabilize by early next year. The possibility that financial markets might not stabilize represents a major source of downside risk to the forecast. ”

To cover themselves when their forecasts fall flat, the CBO members offer the following caveats:

“Households’ and businesses’ confidence is also difficult to predict.”

and

“CBO’s forecast incorporates the middle of the range of the agency’s estimates of ARRA’s impact on GDP and employment, that range is quite large.”

These statements are somewhat disconcerting when we remember that in January 2008, it was this same CBO that predicted the U.S. government’s fiscal year deficit would be $250 billion. What did we end up with? A $455 billion deficit. They weren’t even close.

What also worries us is that while the CBO clearly states that its forecast includes the impact of the currently approved programs, it fails to take into account any further bailouts of various industries, any new stimulus packages, or any additional programs proposed by the administration.

While the current CBO forecast is the result of very scientific economic models put together by a multitude of experts, our economists at Casey Research question many of its basic assumptions by applying the same logic that allowed us – more than three years ago -- to correctly predict the subprime crisis and its expansion into a widespread financial disaster. We knew then that the models supporting the valuation of many derivatives were flawed, even as other analysts were claiming that real estate values were never going to decline and that securitization of subprime mortgages could magically eliminate default risk.

Applying this basic logic, let’s look at some of the core assumptions in the CBO forecast:

The Consumer Price Index is expected to drop from +3.8% in 2008 to -0.7% in 2009 (good news), while unemployment is projected to grow from 5.8% in 2008 to 8.8% in 2009 (it could be worse). The cost of borrowing record amounts of money will decline from 1.4% to 0.3% for the 3-month T-bill and from 3.7% to 2.9% for the 10-year T-bond (convenient).

In The Casey Report our Chief Economist Bud Conrad compared data from the current recession with those of serious crises in the past. His conclusions? Although the impact of the current financial turmoil has been serious, we are nowhere near the average bottom experienced in other serious recessions.

The unemployment rate is expected to bottom at 8.8% in 2009 (we are almost there), only two years after the start of the current recession. Unfortunately, history tells us that these forecasts may be far too optimistic. Looking at trends of the past, on average, unemployment peaked about four years after the start of a serious recession. In the worst case, the peak occurred 11 years after the start of the decline.

In addition, a rate of 8.8 % unemployment would look pretty good if compared to the figures in past crises. Historically, the average bottom was reached at 11%, while the worst-case scenario saw 27% unemployed.

Currently, Gross Domestic Product has only contracted by 1.5% (conveniently, the CBO estimates the GDP’s contraction to bottom at precisely 1.5% in 2009 before expanding again in 2010). What does history tell us? In previous recessions, the GDP dropped by 9.3% on average and by 28% in the worst case.

Based on its projected 1.5% reduction in the GDP, the CBO estimates that tax revenue will fall by as much as 13.4% (with part of this decline due to planned tax reductions for lower-income Americans). A more realistic, 5% reduction in GDP could have a far greater impact on revenue and cause a significant increase in the deficit.

To properly calculate the decrease in tax revenue, the following factors must also be considered:

1. A 5% drop in GDP equates to a much greater drop in tax revenue. Tax receipts are based mainly on income, and most companies will see a far greater than 5% decline in net income for a 5% decline in sales; 
   
2. As incomes go down, many taxpayers will drop into lower brackets, thereby dropping the average tax rate collected;
3. If businesses/individuals anticipate a decrease in income for the coming year, it can be expected that they will not pay their full quarterly payment obligations, instead taking the risk of estimating what their exact tax liability will be;
4. Some taxpayers may be in such dire financial straits that they are unable to pay their taxes or quarterly estimates;
5. After the losses accumulated in 2008, investors are unlikely to be paying much in the way of capital gains taxes for 2009 and probably for several years to come;
6. The underground economy – signified by an increase in cash transactions not reported to tax authorities -- tends to thrive when recession hits. People have an extra incentive to save their precious dollars and are willing to take more risk, rather than hand over their money to the government. 
   

In the midst of the Great Depression, the 1931 federal tax revenues had fallen by 52% from their 1929 highs. While we do not expect anything that dramatic in 2009, it would not be unrealistic to see a 20% to 25% reduction in cash flow from tax collections this tax season. Such a drop would pose significant challenges given that spending commitments are off the charts and climbing.

From September 2008 to January 2009, the monetary base more than doubled from $800 billion to $1.7 trillion, while M1 increased by 15%. Since then, the Fed has committed to buying an additional $300 billion in long-term Treasury bonds and to printing whatever it will take to jump-start the economy.

Is it reasonable to forecast zero inflation and historically low interest rates for this year and the foreseeable future?

While the credit freeze of the fall of 2008 triggered powerful deflationary forces, especially in commodities and real estate, we expect the impact of monetary expansion to have a measurable inflationary effect as early as the second half of 2009.

The U.S. government needs to roll over $2,596 billion of outstanding Treasury bills and notes coming due in 2009 before it can add any new borrowing to finance the expected deficit. In previous years, foreign investors have invested most of their trade surpluses – to the tune of $200 billion to $500 billion per year – in Treasuries and agency debt. We cannot expect this trend to continue as we go forward, especially given that China, Japan, and the Middle East are experiencing a sharp decline in their exports and have indicated that they will have to support their own economies with massive stimulus packages. These actions will further reduce their propensity to buy U.S. debt. The Treasury Department recently reported that in January 2009, international sales and purchase of U.S. assets showed a net outflow of $148 billion. This could be a sign that “the times, they are a-changin’.”

Assuming that foreign investments will not represent a large source of financing for the $4 trillion plus of U.S. Treasuries our government needs to sell this year, we will be forced to rely on domestic institutional and private investors. The problem here is that a great deal of institutional and private money has already fled from riskier categories of assets into lower-yielding Treasuries. If anything, these funds will be looking for higher-yielding investments as soon as possible.

In the absence of sizeable increases in tax revenues, it is quite clear that the lion’s share of the planned sales of Treasuries in 2009 cannot be met by demand from the market. Either the Treasury will have to raise interest rates significantly, or the Fed will need to step in very aggressively to support the planned auctions. Our expectation is that both will happen. Auctions will fail and the Fed will step in. The market will react to more printing by anticipating inflation and demanding higher interest rates. Once the cycle starts, it will be very hard to pull interest rates back.

We continue to stand by our December forecast that the 2009 budget deficit is more likely to widen to levels between $2.5 and $3 trillion rather than the CBO’s $1.8 trillion forecast. We also believe that inflation could start setting in as early as Q3 of 2009 and will accelerate sharply by 2010. Treasury rates will start climbing and the era of cheap money will end, making it harder for overleveraged consumers, businesses, and governments to service their debt.

Monetary devaluation will be the only way for the U.S. government to shift the cost of irresponsible spending into the future. Our politicians are betting on the fact that this will happen after the next elections, thereby allowing them to continue to blame others for their reckless stewardship of the economy.

***

Even tough economic times like these can provide great opportunities to profit if you know what to look for… but with today’s highly politicized markets, it is essential for any investor to closely follow the goings-on in Washington. Our brand-new, FREE special report Obama’s Newer Deal, Part 2 tells you all about the president’s Stimulus Plan, its impact on and implications for your personal life and finances. Don’t miss it – click here now!

Why Obama's Stimulus Package Is Doomed to Failure

On Wednesday I came across this fascinating analysis about the debt spiral the US now finds itself in, written by Professor Antal E. Fekete at the San Francisco School of Economics.  I asked Prof. Fekete permission to republish his article here, and he was kind enough to grant my request.

Hope you enjoy this piece.  Prof. Fekete has a very unique perspective, and presents an extremely well thought out argument.  I always try to read thorough analysis that counters my current way of thinking, to challenge my assumptions - this piece sure did that, and I hope it does for you as well.

Copyright © 2009
A. E. Fekete
All rights reserved

THE MARGINAL PRODUCTIVITY OF DEBT

Why Obama's Stimulus Package Is Doomed to Failure

Antal E. Fekete

Professor of Money and Banking

San Francisco School of Economics

E-mail: aefekete@hotmail.com

Paper mill on the Potomac

The paper mill on the Potomac is furiously spewing up new money. According to the manager of the mill, as indeed according to the Quantity Theory of Money, this should stop prices from falling and the economy from contracting.

In this article I present an argument why this conclusion is not valid. On the contrary, I shall show that new money created on the strength of a flood of new debt, is tantamount to pouring gasoline on the fire, making prices fall and the economy contract even more. The Obama administration has missed its historic opportunity to stop the deflation and depression inherited from the Bush administration because it entrusted the same people with the task of damage-control who had caused the disaster in the first place: the Keynesian and Friedmanite money doctors in the Fed and the Treasury.

Watching the wrong ratio

The key to understanding the problem is the marginal productivity of debt, a concept curiously missing from the vocabulary of mainstream economics. Keynesians take comfort in the fact that total debt as a percentage of total GDP is safely below 100 in the United States while it is 100 and perhaps even more in some other countries. However, the significant ratio to watch is additional debt to additional GDP, or the amount of GDP contributed by the creation of $1 in new debt. It is this ratio that determines the quality of debt. Indeed, the higher the ratio, the more successful entrepreneurs are in increasing productivity, which is the only valid justification for going into debt in the first place.

Conversely, a serious fall in that ratio is a danger sign that the quality of debt is deteriorating, and contracting additional debt has no economic justification. The volume of debt is rising faster than national income, and capital supporting production is eroding fast. If, as in the worst-case scenario, the ratio falls into negative territory, the message is that the economy is on a collision course and crash in imminent. Not only does more debt add nothing to the GDP, in fact, it causes economic contraction, including greater unemployment. The country is eating the seed corn with the result that accumulated capital may be gone before you know it. Immediate action is absolutely necessary to stop the hemorrhage, or the patient will bleed to death.

Keynesians are watching the wrong ratio, that of debt-to-GDP. No wonder they constantly go astray as they miss one danger signal after another. They are sailing in the dark with the aid of the wrong navigational equipment. They are administering the wrong medicine. Their ambulance is unable to diagnose internal hemorrhage that must be stopped lest the patient be dead upon arrival.

Melchior Palyi's early warning

In the 1950's when the dollar was still redeemable in the sense that foreign governments and central banks could convert their short-term dollar balances into gold at the fixed statutory rate of $35 per ounce, the marginal productivity of debt was 3 or higher, meaning that the addition of $1 in new debt caused the GDP to increase by at least $3. By August, 1971, when Nixon defaulted on the international gold obligations of the United States (following in the footsteps of F.D. Roosevelt who had defaulted on its domestic gold obligations 35 years earlier) the marginal productivity of debt has fallen below the crucial level 1. When marginal productivity fell below $1 but was still positive, it meant that total debt (always 'net') was rising faster than GDP. For example, if the marginal productivity of debt was ½, then $2 in debt had to be incurred in order to increase the nation's output of goods and services by $1. An increase in total debt by $1 could no longer reproduce its cost in the form of an equivalent increase in the GDP. Debt lost whatever economic justification it may have once had.

The decline in the marginal productivity of debt has continued without interruption thereafter. Nobody took action, in fact, the Keynesian managers of the monetary system and the economy stone-walled this information, keeping the public in the dark. Nor did Keynesian and Friedmanite economists at the universities pay attention to the danger sign. Cheerleaders kept chanting: "Gimme more credit!"

I learned about the importance of the marginal productivity of debt from the privately circulated Bulletin of Hungarian-born Chicago economist Melchior Palyi in 1969. (There were altogether 640 issues of the Bulletin; they are available in the University of Chicago Library). Palyi warned that the tendency of this most important indicator was down and something should be done about it before the debt-behemoth devoured the economy. Palyi died a few years later and did not live to see the devastation that he so astutely predicted.

Others have come to the same conclusion in other ways. Peter Warburton in his book Debt and Delusion: Central Bank Follies That Threaten Economic Disaster (see references below) envisages the same outcome, although without the benefit of the concept of the marginal productivity of debt.

The watershed year of 2006

As long debt was constrained by the centripetal force of gold in the system, tenuous though this constraint may have been, deterioration in the quality of debt was relatively slow. Quality caved in, and quantity took a flight to the stratosphere, when the centripetal force was cut and gold, the only ultimate extinguisher of debt there is, was exiled from the monetary system. Still, it took 35 years before the capital of society was eroded and consumed through a steadily deteriorating marginal productivity of debt.

The year 2006 was the watershed. Late in that year the marginal productivity of debt dropped to zero and went negative for the first time ever, switching on the red alert sign to warn of an imminent economic catastrophe. Indeed, in February, 2007, the risk of debt default as measured by the skyrocketing cost of CDS (credit default swaps) exploded and, as the saying goes, the rest is history.

Negative marginal productivity

Why is a negative marginal productivity of debt a sign of an imminent economic catastrophe? Because it indicates that any further increase in indebtedness would necessarily cause economic contraction. Capital is gone; further production is no longer supported by the prerequisite quantity and quality of tools and equipment. The economy is literally devouring itself through debt. The message, namely that unbridled breeding of debt through the serial cutting of the rate of interest to zero was destroying society's capital, has been ignored. The budding financial crisis was explained away through ad hoc reasoning, such as blaming it on loose credit standards, subprime mortgages, and the like. Nothing was done to stop the real cause of the disaster, the fast-breeder of debt. On the contrary, debt-breeding was further accelerated through bailouts and stimulus packages.

In view of the fact that the marginal productivity of debt is now negative we can see that the damage-control measures of the Obama administration, which are financed through creating unprecedented amounts of new debt, are counter-productive. Nay, they are the direct cause of further economic contraction of an already prostrate economy, including unemployment.

The head of the European Union and Czech prime minister Mirek Topolanek has publicly characterized president Obama's plan to spend nearly $2 trillion to push the U.S. economy out of recession as "road to hell". There is absolutely no reason to castigate Mr. Topolanek for this characterization. True, it would have been more polite and diplomatic if he had couched his comments in words to the effect that "the Obama plan was made in blissful ignorance of the marginal productivity of debt which was now negative and falling. In consequence more spending on stimulus packages would only stimulate deflation and economic contraction."

Hyper-inflation or hyper-deflation?

Most critics the Obama plan suggest that the punishment for the bailouts and stimulus-packages will be a serious loss of purchasing power of the dollar and, ultimately, hyperinflation, as evidenced by the Quantity Theory of Money. However, the quantity theory is a linear model that may be valid as a first approximation, but fails in most cases as the real world is highly non-linear. My own theory, relying on the concept of marginal productivity of debt, predicts that it is not hyperinflation but a vicious deflation which is in store. Here is the argument.

While prices of primary products such as crude oil and foodstuffs may initially rise, there is no purchasing power in the hands of the consumers, nor can they borrow as they used to in order to pay the higher prices much as though they would have liked to do. The newly created money has gone into bailing out banks, and much of it was diverted to continue paying bloated bonuses to bankers. Very little, if any of it has "trickled down" to the ordinary consumers who are squeezed relentlessly on their debts contracted in the past.

It follows that price rises are unsustainable, as the consumer is unable to pay them. As a consequence the retail and wholesale merchants are also squeezed. They have to retrench. Pressure from vanishing demand is passed on further to the producers who have to retrench as well. All of them are experiencing an ebb in their operating cash flow. They lay off more people, aggravating the crisis further as cash in the hand of the consumers is diminished even more through increased unemployment. The vicious spiral is on.

But what is happening to the unprecedented tide of new money flooding the economy? Well, it is used to pay off debt by the people who are desperately scrambling to get out of debt. Businessmen in general are lethargic; every cut in the rate of interest hits them by eroding the value of their previous investments. In my other writings I have explained how falling interest rates make the liquidation value of debt rise, which becomes a negative item in the profit/loss statement eating into capital that has to be replenished as a consequence. Worse still, there is no way businessmen can be induced to make new investments as long as further reductions in the rate of interest are in the cards. They are aware that their investments would go up in smoke as the rate of interest fell further in the wake of "quantitative easing".

Self-fulfilling speculation on falling interest rates

The only enterprise prospering in this deflationary environment is bond speculation. Speculators use new money, made available by the Fed, to expand their activities further in bidding up bond prices. They pre-empt the Fed: buy the bonds first before the Fed has a chance; then turn around and dump them in the lap of the Fed. This activity is risk-free. Speculators are told in advance that the Fed is going to move its operations from the short to the long end of the yield curve. It will buy $300 billion worth of long dated Treasury issues during the next six months, and probably much more after that. Speculation on falling interest rates becomes self-fulfilling, thanks to the insane idea of open market operations of the Fed making bond speculation risk-free. Deflation is made self-sustaining. (For another view of risk-free bond speculation, see the article by Carl Gutierrez' in Forbes mentioned in the References below.)

Note also the crescendo of the dumping of equities and the desperate attempt to redeem toxic assets by private parties, sending the demand for cash sky high. The dollar, at least the Federal Reserve note variety of it, will be increasingly scarce. Rather than falling through the floor as under the hyper-inflationary scenario, the purchasing power of the dollar will soar. You say that Ben Bernanke and his printing presses will take care of that? Well, just consider this. The market will separate vintage Federal Reserve notes from the new issues with Bernanke's signature on them. In a classic application of Gresham's Law people will hoard the first, bestowing a premium on it relative to the second variety, which will fall by the wayside.

Bernanke can create money but cannot make it flow uphill

Already some tip sheets openly advise people to hoard Federal Reserve notes in amounts up to twenty-four months of estimated household expenditure, while cleaning out all deposit accounts. Depositors are urged to forget about the $250,000 limit on deposit insurance, which is rendered literally worthless as the resources of the F.D.I.C. have been hijacked by Geithner and diverted to guaranteeing the investments of private parties that were foolish enough to buy into toxic debt at the behest of the Obama administration.

Karl Denninger envisages unemployment in excess of 20%, with cities going "feral" as showcased by downtown Detroit (see References below).

What has all this got to do with the marginal productivity of debt? Well, once it is negative, any further addition of new debt will make the economy shrink more, increasing unemployment and squeezing prices. Bernanke can create all the money he wants and more, but he cannot make it flow uphill.

Bernanke is risking something worse than a depression

The newly created money will follow the laws of gravity and flow downhill to the bond market where the fun is. Risk-free bond speculation will further reinforce the deflationary spiral until final exhaustion occurs: the economy will collapse as a pricked balloon. Instead of hyperinflation and the destruction of the dollar, you've got deflation and the destruction of the economy.

Denninger says that the "death spiral" will lead to fire sales of assets in a mad liquidation dash and, ultimately, to the collapse of both the monetary and political system in the United States as tax revenues evaporate. He opines that probably not one member of Congress understands the seriousness of the situation. Bernanke is risking something much worse than a Depression. He is literally risking the end of America as a political, economic, and military power.

Indeed, the financial and economic collapse of the last two years must be seen as part of the progressive disintegration of Western civilization that started with government sabotage of the gold standard early in the twentieth century. Ben Bernanke, who should have been fired by the new president on the day after Inauguration for his part in causing irreparable damage to the American republic may, in the end, have the honor to administer the coup de grace to our civilization.

March 28, 2009

References

No Time for T-Bonds by Carl Gutierrez, March 28, 2009, www.forbes.com

Bernanke Inserts Gun in Mouth, by Carl Denninger, March 20, 2009, http://market-ticker.denninger.net

Debt and Delusion: Central Bank Follies That Threaten Economic Disaster, by Peter Warburton, first published in 1999; WorldMetaView Press (2005)

Has George Soros Lost His Mind?

Reuters reporting on George Soros' testimony at the U.S. Conference of Mayors - whatever the hell that is:

Soros said the United States needed "radical and unorthodox policy measures" to prevent a repeat of the Great Depression of the early 20th century that include recapitalizing banks and writing down the country's accumulated debt.

Also, he said, it should create more money to offset the collapse of credit and then rapidly pull that cash out of the system when inflation emerges. The government would have to be very nimble in the timing of such moves, he said.

"If they are successful...the deflationary pressures will be replaced by the specter of inflation and the authorities will have to drain the excess money from the economy almost as quickly as they pumped it in. Of the two operations the second one is going to be, politically, even more difficult than the first," he said.

Is Soros - freaking - insane? Has this ever worked in history? Just once???

Hang on, it gets even better:

At the same time, the $700 billion financial bailout known as TARP for Troubled Assets Relief Program had been carried out in a "haphazard and capricious way" and "without proper planning," he said.

"Unfortunately it was misused and the way it was done has poisoned the well. It has created tremendous ill will toward putting up more money," Soros said.

I was stunned as well, when $700 billion was misspent by the bright bureaucrats in our Federal Government.

Let me ask you a question - last time you went to the Post Office to mail a package - how long did you wait?

Well those are the SAME DAMN BUREAUCRATS in charge of allocating this slush fund!

Why are people shocked when things our government does don't work out as planned? They NEVER work out as planned!

That's what the free market is for. (Check out John Stossel's excellent 20/20 piece about the limitations of government, and the power of the free market - highly recommended).

Now George Soros is not stupid - he's one of the most successful speculators of all-time.

So has he just lost his mind?

Have years of socialist dreaming finally penetrated and damaged his cranium?

Or is he just screwing with us common folk?

Obama's Newer Deal: A Free Special Report from Casey Research

This guest article about Obama's Newer Deal, courtesy of Casey Research's David Galland, includes a free special report on the Obama administration, and what it means for your investments. Enjoy!

Obama, Keynes, and Pragmatism
By David Galland
Managing Editor, The Casey Report

On several occasions of late, I have read or heard the phrase, "We are all Keynesians now," an erudite way of expressing the idea that the free market is dead. And that the fate of the global economy now relies almost entirely on pragmatic measures yet to be taken by governments, most notably that of the United States.

Given that the word "pragmatic" is often used to describe President Obama, it appears that the man of the hour has arrived just in the nick of time.

Not to be a spoilsport, but there is much wrong with this latest entry in the thick and well-worn journal labeled “Popular Delusions.”

First and foremost, the idea that the world's largest debtor nation should be stood up as role model is laughable. That is like hiring the town's serial bankrupt to run the bank. Putting aside the irony, the inherent conflict of interest destroys any U.S. credibility as an honest broker in the current scenario.

Secondly, while the incoming team has done a superior job of spinning pragmatism into the Obama brand, it is another thing altogether to actually demonstrate the quality when the shoe leather hits the fast-moving pavement.

And, if you think about it, even the word defies definition. I have heard Obama supporters comment lately that “if the private sector won’t spend money, then the government has to.” Like beauty, pragmatism, it seems, is in the eye of the beholder. In the current context, what Team Obama might consider pragmatic – soaking the successful, slapping on an energy tax, revving up the money engines ever higher – might be considered by others to be very un-pragmatic.

Even so, adopting the optimistic spirit of America’s new era, we’ll credit the incoming president and all those who surround him as pragmatics, in the sense that they are the best sort of men and women who can be counted on to make intelligent and, well, pragmatic choices in the face of a rapidly eroding global economy.

Unfortunately, no sooner do we hand Team Obama a laurel than we have to point out a rather large and ugly fly in the otherwise nicely scented ointment. It is this: if the word pragmatic isn’t used as an adjective in direct association with the word “dictator,” then it becomes all but meaningless.

That’s because even if Mr. Obama is a pragmatic, the same can hardly be said of the American public, which, according to the law of the land, are the purported owners and – through the ballot – operators of the economy.

To use one easily understood example, a pragmatic president might look at the insurmountable obligations hanging over the Social Security program and decide that, at the least, some form of means testing might be applied to recipients. But the voting bloc of American elderly, readily ginned up into an elevated emotional state by the AARP and other special-interest groups, assures that anyone proposing even modest modifications to the program will be loudly shouted down and find themselves in heavy waters come the next election.

And I’m not referring just to the next presidential election cycle, which won’t kick off for another two years… but to the next congressional election of November 2010, less than two years hence. In that election, 1/3 of the Senate and 100% of the House of Representatives will be up for grabs.

With only history as my guide, I’m going to hypothesize that few of Mr. Obama's supporters in Congress, avid though they may be, will be willing to make their reelection campaigns more difficult by supporting unpopular legislation… no matter how pragmatic.

Sure, maybe they’ll inch a little way out on the limb during a brief honeymoon period, but once the 24-hour-news-as-entertainment channels start in with a vengeance, cracks in the coalition of collectivists will begin to appear and Team Obama will turn from making “hard choices” to the “easy giveaways” the American public requires in exchange for continuing to support his party come November 2010.

After that, we move seamlessly into the next presidential election cycle, and things will go downhill from there.

Of course, this situation is not unique to the Democrats – rather, it is an intractable and, in time, terminal disease of our late-stage democracy itself.

The Keynesian Fallacy

Even ignoring the near impossibility of organizing consistent and sensible government policies in a rapidly degrading democracy, the whole idea that a government can effectively manage an economy – Keynes’ central theme – just doesn’t hold water. Despite hundreds and maybe thousands of experiments along those lines, none has shown any real durability.

There have been some examples, however, of long-term free market successes, the most powerful being the early, laissez-faire days of the United States. There are lesser examples such as Dubai in recent decades, or Hong Kong under the British – economies where the operating manual was thin and almost entirely supportive of wealth creation and free markets. Were they perfect? No, because there is no such thing as a perfect world. But in terms of creating the wealth needed for a society to advance to a more refined stage, they performed exceptionally well.

In sharp contrast, today’s freshly minted Keynesians call for increased penalties on success and a steep ramping up of regulation, the very opposite of the prescription needed.

There is another problem with the utopian aura now surrounding Team Obama, and it’s simply that government doesn't produce anything tangible. So when it comes time to "manage" the economy, government is left with only a couple of tools. One is to force you and me to use our time and capital for purposes they view as important. Bush, for example, felt invading Iraq was a priority. Naturally, Team Obama has a slate of fresh ideas on the best use of your money, and say they want even more of it. I take umbrage at the notion that I should open my wallet even further for "the public good," especially when the perceived public good so often runs contrary to my own beliefs. For instance, on principle, I am against war – it is always the innocents that suffer the most. And I am against the creation of new and expensive regulatory structures, a government specialty.

The other tool available to Team Obama is, of course, the creation of money. And we are now hearing a steady drumbeat that we the people should pay no attention to the deficits for the next few years.

To which I can only wonder, “Isn’t that exactly what’s been going on for the last eight years?”

It sure seems that way, considering the unprecedented levels of debt already overhanging the economy.

***

There has rarely, if ever, been a period of time where the economy of the U.S. has been more politicized. Today it is not enough for an investor to paw through the fundamentals and correctly identify the best – or worst – sectors or even individual companies to be invested in or to avoid. Success depends equally, and maybe even more so, on correctly anticipating what actions the government is likely to take (or not) in regards to any particular enterprise. Take GM, for example, whose rise or demise depends to a large part on the question whether the government will prop it up.

The FREE special report Obama’s Newer Deal by Casey Research analyzes the economic and political climate of the incoming Obama administration, providing a “weather forecast” that can help you prepare your assets for a rainy day. Get it now – no cost, no obligation – by simply clicking here.

Is It (Finally) Time to Short US Treasuries - And Make a Fortune?

Do we finally have the opportunity that many of us have been waiting for...the mouth watering chance to short US treasuries?

First, a quick review of the fundamental facts, which we have discussed at length in this space.

On October 19, we outlined 7 Reasons to Short US Treasuries - and then we promptly went short long-dated US Treasury Bonds - both via the futures markets, and via ETF's.

Then on November 12th, we were pleased to read a separate analysis about shorting treasuries from Market Folly, one of our favorite sources of financial information, that came to the same conclusion - namely that interest rates are going to the moon.

Everything looked good, and even our buddy Jim Rogers was on the same side of the trade. We were so excited, we shorted a second contract quickly, dreaming of pyramiding our way into riches.

But a funny thing happened on the way to the penthouse - the financial world as we know it temporarily ended, and US Treasuries soared to all-time highs!

So what happened to our master plan? We had to cover our short position - before we ended up in the outhouse - and even Jim Rogers had to cover his!

All because a historic flight to safety sent the world heading for the cozy confines of US Treasury Bonds!

A big hat tip to Tom Dyson at DailyWealth, who made a very prescient call on November 24th that it could take some time for Treasury bonds to actually fall.

So what now? Today I took a quick peek at the 10-Year Treasury Note chart, and was delighted to see - dare I say it - a potential peak forming?

Is this the beginning of a historic collapse - and shorting opportunity? Or will the flight to safety continue into the 1st half of 2009 - propelling Treasuries to even greater heights!

Has anything changed in this short case fundamentally, since our original thesis was formed? Well, let's see:

• The US Federal Reserve started printing money as fast as it can - can you spot the trend in this chart?
• And we've been bailing out every incompetent US company, to the tune of $8.5 Trillion!
  

I'd say our thesis for skyrocketing interest rates is still intact!

Of course, the market is always the final arbiter of who's right and who's wrong. So, we wait. For 10-year chart to break one way or the other - thus we're not short - just yet!

Editor's Note: You can also read and discuss this article on Seeking Alpha.

Why eBay is the Best Indicator of Gold's Fair Value

We've discussed before how the paper market for gold can easily be manipulated - including recently that three US banks allegedly account for the majority of all net short positioning on the COMEX.

In the following article, the editors of Big Gold, a Casey Research publication, discuss how gold prices on eBay are the best indicator of the true price of gold. And they believe current prices are a steal.

The eBay Index
The one place that shows you how much gold is really worth
By the editors of BIG GOLD

Anyone who has watched the price of gold lately must have felt that something was off. While public demand for bullion coins went through the roof and major bullion dealers ran out of coins to sell, the spot gold price was flat, teetering between the upper 700- and lower 800-dollar range.

Managing Editor Jeff Clark of BIG GOLD wrote in the November 2008 newsletter:

Many dealers are out of 1-oz. coins, and not just here in the U.S. Londoners have been queuing up in front of coin shops; German suppliers are refusing new orders; demand exceeds mint capabilities in Canada, Australia, and South Africa; and Switzerland is working around the clock. If you’re fortunate enough to locate a source of coins, expect to pay an unusually high premium over the price of spot gold -- in the U.S. perhaps 10%, 15%, or more -- triple the normal level. Even then you may have to wait eight weeks or longer for delivery.

According to the laws of supply and demand, shouldn’t the spot price have skyrocketed?

Whatever the reason that it didn’t – hypotheses bounced around on the Internet ranged from deleveraging to governmental price manipulation – the BIG GOLD editors managed to find an unexpected indicator of the true value of gold that seems to be more reliable than the spot gold market itself…

The eBay Index.

Just like The Economist with its Big Mac Index or its modern cousin, CommSec’s iPod Index, both of which explain and compare the purchasing power of currencies, online auction house eBay makes an excellent yardstick for the true value of, well, just about everything.

In recent years, politics and economics seem to have entered an unholy alliance, thus increasingly obstructing the view on causes and effects in the markets. eBay, on the other hand, is the free market at its best and simplest. In other words, a seller’s item is worth exactly what a prospective buyer is willing to pay for it.

In April of this year, when the U.S. Mint rationed one-ounce, 2008 Silver Eagles to its thirteen authorized buyers, those same Silver Eagles sold on eBay for $25 apiece… nearly 50% over the then-spot price of $16.80.

Along the same lines, a few weeks ago, when gold was at $750/oz, one-ounce Gold Eagles got bids of $1,000 on eBay… a premium of 33% over spot price.

At the time of this writing, the availability of bullion coins has slightly improved, and major bullion dealers like Kitco.com have resumed offering some of their standard bullion products. Even though inventories are still selling like hotcakes, at least there is an inventory – and the eBay Index has reacted accordingly. Right now, with spot gold at $852, 2008 Gold Eagles are fetching bids of $876 on average… a premium of only 2.8% over spot.

This is a Christmas gift. It means any investor concerned about the government’s out-of-control printing of dollars has a window of opportunity to buy gold bullion at reduced markup. You can, at the moment, buy gold while both it and the underlying premiums are cheap. The eBay Index demonstrates that premiums can spike any time and without notice.

And since the editors of BIG GOLD recommend keeping 33% of your portfolio in gold bullion, it is well worth watching the eBay Index to gauge how high gold prices should be at any given time. For it is almost certain that the spot market will follow the Index sooner rather than later. Buy gold now before eBay signals premiums are expensive again.

***

Deflation today + government responses = inflation tomorrow. This means you would be well advised to own some physical gold, as well as crisis-proof stocks of major gold producers and quality ETFs. BIG GOLD is the monthly advisory for the prudent investor, focusing on precious metals investments that are safe havens in times of crisis. Learn more about it here.