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It
took the statisticians of the National Bureau of Economic Research almost a
year to confirm what the rest of us already knew, that the US registered a
significant decline in economic activity, thus officially entering a period
of recession. While I am pleased that the members of NBER take their duties
seriously, thereby ensuring that they don't leap to any hasty conclusions, I
only wish that similar moderation could be displayed by their colleagues at
the Fed and the Treasury.
Unfortunately,
the facts prove otherwise. Three months before the recession was officially
declared, Paulson and Bernanke have embarked on the largest bailout program
ever conceived with the blessing of a lame-duck president and a complicit
Congress - a program which so far will cost taxpayers $8.5 trillion. This
staggering sum encompasses: loans backed by worthless assets ($2.3T), equity
investments in bankrupt companies with negative net worth ($3.0T), and
guarantees on crumbling derivatives and other hollow collateral ($3.2T).
Back
in September I was stunned that Paulson was able to make his case and win the
support of Congress for a $700 billion bailout package (more than the total
war spending in Iraq to date).
How
could Americans (or more accurately, their representatives) agree to give
such a broad mandate with so few checks and balances? Have we become
completely numb?
While
I realize that many of our compatriots have been running large credit card
balances and interest-only mortgages with little thought as to how they would
repay their debt, one would expect a little more restraint when dealing with
the financial future of the largest economy in the world.
Operating
under the assumption that our largest financial institutions are "too
big to fail", in the span of a few weeks we went from pledging to spend
$1 trillion to $3 trillion - a commitment which then grew to $5 trillion
before ballooning to a staggering $8.5 trillion.
At
the rate we are going, we will be dealing with double digits - in trillions-
before the end of the year.
And
while all off that money is not yet spent, make no mistake - these are real
commitments with serious liabilities attached to them.
I
have heard the argument that an equity infusion is not the same as spending
money. While I would agree that in an arms-length transaction this might
actually be the case, our government is definitely paying a large premium.
What is the real value of Citicorp or AIG? Since they are quasi-bankrupt (and
would be totally bankrupt without massive injections from the Fed), a
reasonable businessperson might pay a token price for their equity and the
assumption of their enormous liabilities. Before doing so however, a buyer
would have to see some significant value in buying these entities as a
continuing business. In most cases, a buyer would not want to assume the
company's liabilities but would prefer to buy selective unencumbered assets
in a bankruptcy proceeding. Any money our government pays above what a
reasonable person would pay in an arms-length transaction is real spending
and should more accurately be called a grant.
While
defenders of the too-big-to-fail policies argue that providing guarantees is
not the same as granting money, the reality is that these guarantees are
necessary to prevent the collapse of financial institutions currently lacking
the necessary collateral to meet their loan covenants. Should their loans be
called, we could actually find out the real value of their assets. The fact
is that in-spite of Paulson's and Bernanke's efforts, deleveraging is already
happening. Although at a slower pace, one asset class after another is being
adjusted down towards its intrinsic value, which is usually not much. Make no
mistake; many of these guarantees will eventually be called in by lenders. In
due time, unless our government is able to inflates its way out of this
bottomless pit, it will have to honor most of these guarantees.
So
how does $8.5 trillion dollars compare with the cost of some of the major
conflicts and programs initiated by the US government since its inception? To
try and grasp the enormity of this figure, let's look at some other financial
commitments undertaken by our government in the past:
As
illustrated above, one can see that in today's dollar, we have already
committed to spending levels that surpass the cumulative cost of all
of the major wars and government initiatives since the American Revolution.
Recently,
the Congressional Research Service estimated the cost of all of the major
wars our country has fought in 2008 dollars. The chart above shows that the
entire cost of WWII over four to five years was less than half the current
pledges made by Paulson and Bernanke in the last three months!
In
spite of years of conflict, the Vietnam and the Iraq wars have each cost less
than the bailout package that was approved by Congress in two weeks. The
Civil War that devastated our country had a total price tag (for both the
Union and Confederacy) of $60.4 billion, while the Revolutionary War was
fought for a mere $1.8 billion.
In
its fifty or so years of existence, NASA has only managed to spend $885
billion - a figure which got us to the moon and beyond.
The
New Deal had a price tag of only $500 billion. The Marshall Plan that enabled
the reconstruction of Europe following WWII for $13 billion, comes out to
approximately $125 billion in 2008 dollars. The cost of fixing the S&L
crisis was $235 billion.
The
best deal ever for a government program was the Louisiana Purchase, a deal
with the French that gave us 23% of the surface of today's US for only $15
million ($284 million in today's dollars). Why couldn't Paulson and Bernanke
display the financial acumen of a Thomas Jefferson?
How
will our country repay its debts? The current bailout represents 62% of our
GDP. Our current deficit of almost $11 trillion may exceed our GDP next year.
Recently
the Treasury has been able to place new debt; investors have liquidated
equities and bonds and sought refuge in the relative safety of the dollar and
government bonds.
As we
move forward however, our government will need to attract trillions of
dollars annually to fund its programs and commitments. The foreigners who
have financed our irresponsible spending for many years will no longer be
able to afford it, let alone finance more of our reckless behavior.
As a
matter of fact, several countries have already announced their own bailout
packages to prop up their domestic economy. And, unlike during WWII, when
Americans invested their savings to support the war effort and fund our
government's deficit, our citizens are in debt themselves with no savings
left to invest.
In
the near future, the Fed will have no choice but to turn on the printing
presses and start operating them around the clock to create the money that
can't be raised in the capital market.
These
actions will lead to a significant debasement of the dollar and a major
appreciation of gold and all commodities (real assets).
Once
this inflationary cycle starts, foreigners will realize that their
investments in T-bills are depreciating rapidly. There will be a massive
exodus that will put more pressure on the dollar and on interest rates. Our
weakened US economy will be faced with the rising cost of capital and a
painful period of stagflation. Trillions of dollars will have been wasted.
Our government will have mortgaged America and the ensuing debt will have to
be paid by future generations.
Not a
very bright picture, to be sure, but the Casey Research team strongly
believes that there are opportunities in every crisis. Preserving your assets
and even profiting in times of crisis by making the trend your friend is the
focus of Casey's flagship publication, The Casey Report. We have helped subscribers get positioned in
commodities in the late '90s, buy grains in 2006, and short financial stocks
18 months ago... resulting in double- and often triple-digit returns.
Olivier Garret
Caseyresearch.com
Olivier Garret is CEO of
Casey Research, LLC., one of the nation’s oldest and most respected
organizations dedicated to providing independent investors with unbiased
research on opportunities to earn extraordinary profits by being just ahead
of the crowd.
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