Michael Pento’s Market Commentary
The Fed’s lucky streak of luring bond investors with low interest rates may be drawing to a close. Nevertheless, the extended period of low borrowing costs has bred a new breed of investor. To the bulls and bears, we can now add the ostriches – those who bury their heads in the sand of declining debt service ratios while refusing to face up to intractable levels of total US government debt. If these ostriches were to actually look at the numbers, they would realize that it is their investments which are made of sand.
As the issuer of the world’s reserve currency, the US government has enjoyed the benefits of low interest rates despite its inflationary practices. When we run a trade deficit with a country like China, they have a strong incentive to ‘recycle’ the deficit back into our dollars and Treasuries. This practice has hidden what would otherwise be much higher borrowing costs and much lower purchasing power for the dollar. This artificial price signal allows people like Paul Krugman to claim that the Obama Administration’s stimulus programs should be much larger. Because our yawning fiscal deficits have not driven bond yields significantly higher, he sees no reason to curtail spending. Krugman wants to spend like its World War III, and then has the nerve to call those worried about the budget mindless zombies!
Krugman is just one partisan Democrat shouting at mirrors, but the misunderstanding has struck the right-wing as well. Last week, in a debate with me on CNBC’s The Kudlow Report, Brian Wesbury, Chief Economist of First Trust Advisors and writer for The American Spectator, claimed that our $9.3 trillion national debt is of little consequence because our GDP is a far greater. However, he failed to note that our $14.7 trillion of GDP only yields about $2.2 trillion in revenue for the Treasury. To fully access that entire GDP, the government would have to raise all tax brackets to 100% without producing any reduction in output or decrease in revenue. This is, of course, preposterous. As was demonstrated in the 1970s, even small increases in marginal tax rates have a substantial negative impact on output. A healthier appraisal would center on the fact that our publicly traded debt is now 422% of our annual tax revenue.
Wesbury did mention that if the government could not raise revenue to pay off the bonds, it could simply monetize the debt with few significant consequences. Apparently, paying back one’s creditors in worthless paper is not technically “default” to an economist.
So neither Krugman nor Wesbury, both intelligent, highly educated economists, see our current course leading to imminent crisis. Unfortunately, both have been led astray by the low debt service ratio which has masked our economy’s underlying insolvency. To see through the haze, you have to look at the numbers behind this so-called “deleveraging consumer” and then look at the debt of the nation.
The data point most utilized by those who espouse the idea of a healthy consumer is the household debt service ratio (DSR), a metric that relates debt payments to disposable personal income. This figure peaked at 13.96% in the third quarter of 2007; it has since dropped by 15%, to 11.89%. It is hard to see this as a significant amount of deleveraging, especially when looking at longer term trends. But it gets worse! Most of that modest decline is simply a function of lower interest rates, which have made debt easier to bear. Total household debt has gone down much less. This figure peaked at $13.92 trillion in Q1 2008, and has since declined only 3.5% to $13.42 trillion. How’s that for deleveraging?!
It’s also worth noting that back in the first quarter of 2008, most homeowners were sitting on a pile of home equity to offset that debt. Today, most of the equity has vanished, yet the debt still remains.
When looking at the national debt, the situation is even more depressing. At the end of 2006, total debt held by the public was $4.9 trillion. According to the Treasury Department, the average interest rate paid on that debt was 4.9%. Therefore, the annualized interest payment at that time was $240 billion. At the end of 2010, our publicly traded debt has increased to $9.3 trillion, but the average interest rate on that debt has plummeted to just 2.3%. So, despite an 87% increase in debt in just a 4-year time span, the annualized debt service payment actually fell 11% to $213 billion. Krugman and Wesbury look at this and see progress.
Meanwhile, the average maturity on our debt has declined to 5.5 years. Compare that with the UK’s gilts, which average about 14 years, or even to Greece’s bonds, which average about 8 years. Falling interest rates and reduced durations have merely given the illusion of solvency to the US as compared to these other ailing sovereigns.
By 2015, our publicly traded debt is projected to be at least $15 trillion. Even if interest rates simply revert to their average level – not a stretch, given surging commodity prices and endless Fed money printing – the debt service expense could easily reach over $1 trillion, or about 50% of all federal revenue collected today. Just imagine what would happen if rates were to rise to the level of Greece, nearly 12% on a 10-year note, as opposed to our current 10-year yield of just 3.5%. I bet Athens, Georgia wouldn’t look much better than its namesake. Don’t forget: as interest rates rise, GDP growth slows, sending the debt-to-GDP ratio even higher.
Earlier this year, it wasn’t the nominal level of debt that suddenly sent euroland into insolvency, but rather a spike in debt service payments. Right now, the US national debt is the biggest subprime ARM of all time. Much like homeowners who thought they could afford a mortgage that was 10 times their annual incomes, Messrs. Krugman and Wesbury are blinded by deceptively low current rates of interest. These ostriches won’t poke their heads up to see the writing on the wall: low rates and quantitative easing cannot coexist for long. As rates continue to rise, the reality of US insolvency will be revealed.
By Peter Schiff
There is an old adage on Wall Street: no one rings a bell to signal a market top or bottom. Yet, I have found that bells do ring; it’s just that few people know exactly what sound to listen for.
Perhaps the biggest and most liquid of all markets is for US government bonds. That market has been rallying for almost thirty years. The bull can be traced back to 1981, when Treasury bond yields peaked at about 15%. At that time, high inflation and a weakening dollar had justifiably squelched demand for Treasuries. Even the ultra-high interest rates were not enough to attract buyers.
Michael Pento’s Market Commentary
Despite the fact that the S&P is up over 80% in the last 21 months, US financial firms are currently tripping over each other in their zeal to raise their S&P 500 and GDP targets for 2011. JPMorgan’s chief US equities strategist, Thomas Lee, came out on December 3rd with a target of 1425 on the S&P for 2011, which would be a 15 percent gain. Barclays Capital last Thursday released a 1420 estimate. Not to be outdone, Goldman Sachs also recently released its forecast, and it sees a more-than-20 percent increase next year, to 1450. Meanwhile, PIMCO’s idea of a “new normal” has translated into a 2011 GDP forecast raised from 2-2.5% to 3-3.5% due to “massive” government stimulus.
In the midst of this collective ‘hurrah,’ very little attention is being paid to what is going on over in the bond market. With my due condolences to Fed Chairman Bernanke, the yield on the 10-year Treasury note has increased from 2.33% on October 8th to 3.29% today. And, if there is any notice at all given to that recent run-up in yields, it is merely explained away as a sign of robust growth returning to the economy.
In reality, growth doesn’t cause an increase in interest rates; it is either lack of savings or inflation that is responsible. To refute the ‘robust growth’ reasoning, turn your attention to the fact that the spike in yields just happened to coincide with the news that the unemployment rate jumped to 9.8% in November.
A slightly broader explanation for the surge in borrowing costs might be the failure of the Bowles-Simpson deficit commission to implement any cost cutting measures. Or, perhaps it was the intimation from Bernanke himself that QE III may already be under construction in his infamous interview on 60 Minutes. Or, maybe it is the fact that the $150.4 billion November budget deficit was the highest total for that month… ever, and was the 26th straight month of red ink! I often wonder to myself, where in the midst of all this good news do I summon a bearish attitude?
I think it’s pretty clear that ‘robust growth’ is going the way of ‘green shoots’ and knickers – right into the dustbin of history.
So, what will the increase in interest rates – ignored by all of Wall Street – actually mean for the economy in 2011?
For starters, the National Home Price Index already fell 2% in the third quarter of 2010. On a national basis, home prices are 1.5% lower year-over-year, and 15 out of the 20 cities measured were down over the last 12 months. On a month-over-month basis, 18 cities posted a price decline in September, compared to 15 MoM drops in August, and just 8 cities experiencing price reductions in the July report. Therefore, home prices, which were already headed lower before this recent spike in mortgage rates, are set to take another tumble downward. According to Freddie Mac’s weekly survey of conforming mortgages, the average rate on the 30-year fixed is at its highest level in six months. 30-year rates averaged 4.61% for the week ending Dec. 9, up from 4.46% last week. It’s the fourth week in a row that the mortgage rate has increased. The ramifications for the real estate market and bank lending are clear. Lower home prices will send more mortgages under water and force many more homes into foreclosure. Higher borrowing costs will lower the demand for borrowing and place more strain on the capital of lending institutions.
On top of that, household debt as a percentage of GDP still stands at a lofty 91%. It should be clear that with near double-digit unemployment, the last thing consumers can now tolerate is a significant increase in debt-service payments.
The rising cost of money is even worse news for the federal government and its chronically ballooning debt problem. According to the Federal Reserve’s Flow of Funds Report, total non-financial debt reached an all-time high of $35.8 trillion in the third quarter of 2010. In fact, household debt, business debt, and government debt increased at a 4.2% annual rate last quarter.
To put that record level of nominal debt into perspective: in 1980, the total non-financial debt-to-GDP ratio was 144%. In the height of the credit boom, at the end of 2007, that figure was 226%. Today, the figure stands at a mind-blowing 243%! So you can forget about all that deleveraging talk. The US is in fact still leveraging up, both in nominal terms and as a percentage of GDP.
I think the rising cost of money will become the story of 2011. Its effect on consumers, the real estate market, and government borrowing costs will be profound. Apparently, most major brokerage firms have no fear of soaring interest rates causing our economy to implode. However, it’s clear to me that the bond market has already started to crack due to inflation and massive oversupply from the Treasury. Prudent investors should think twice before overlooking what could be the initial holes in the biggest bubble in world history – the full faith and credit of the United States.
By Peter Schiff
This week Washington displayed the kind of “bipartisanship” that will bankrupt our country and wreck our currency. Coming at a time when both parties say they want to address our long-term fiscal imbalances, the compromise extension of the Bush era tax cuts should be a wake-up call to anyone who somehow expected the American leadership to ever have an “adult conversation” about the country’s long term economic health.
Michael Pento’s Market Commentary
This past Sunday on the CBS program “60 Minutes”, Americans received a massive dose of mendacity from our Fed Chairman. Mr. Bernanke’s shaky delivery, and even shakier logic may cause faith in America’s economic leadership to evaporate faster than the value of our dollar. In particular, Bernanke delivered two massive distortions:
Lie #1 – The Fed isn’t printing money. Bernanke stated: “The amount of currency in circulation is not changing…the money supply is not changing in any significant way. What we’re doing is lowering interest rates by buying Treasury securities.” Given that it is the Treasury Department’s Bureau of Engraving and Printing, not the Fed, that actually prints paper money, his statement is technically correct while substantively false. However, Bernanke is buying bank assets with Fed credit. With such an arrangement, printing becomes unnecessary.
According to gentle Ben, credit created to buy something should not be considered money and has no affect on asset prices? But if that’s true, why is he concentrating his buying in the middle of the Treasury yield curve. His stated purpose is to boost bond prices and lower yields in order to stimulate borrowing and aggregate demand. So pushing up bond prices is an act of inflation. Bernanke similarly contradicts himself by saying that he isn’t creating inflation, while at the same time claiming that his easing campaign is designed to boost asset prices to combat the phantom of deflation.
And by the way, the Fed is causing money supply to increase significantly. The compounded annual growth rate of M2 is over 7% in the last quarter. Apparently in the eyes of the Chairman, a 7% annualized increase in the broad money supply isn’t considered significant.
Lie #2- Bernanke is “100 % confident” that, when necessary, the Fed can control inflation and reverse its accommodative monetary policy. He stated, “We’ve been very, very clear that we will not allow inflation to rise above 2 percent. We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time.” He failed to mention that the Fed doesn’t have the will to drain money from the system, without which all tools are useless. The Fed has consistently demonstrated its unwillingness to take the appropriate actions when necessary. In claiming he is 100% confident in his ability to control inflation, Mr. Bernanke ignores the record that during his tenure he has misdiagnosed the economy.
In June of 2006, Bernanke culminated his inflation fighting efforts by raising the Fed Funds target rate to 5.25%, after CPI inflation reached 4.2%. But that interest rate was enough to help burst the housing bubble and to spark an international credit crisis. Bernanke was completely unaware that the Fed actions had created an economy that had become completely addicted to artificially-produced low interest rates and inflation.
Shortly after the collapse of the real estate market and the ensuing truncated deflationary-depression, Bernanke took interest rates to near zero percent. But if the Fed was ever really serious about unwinding excessive leverage, the time had clearly arrived. Instead, the U.S. economy has become more addicted to free money than at any other time in our history.
Commodity prices are soaring once again and the real estate market, banking sector, and the overall economy cling precariously on the arm of government induced bailouts and low interest rates. Even worse, our government has massively increased its level of debt, which now stands at just below $14 trillion. Once the rate of inflation eclipses the Fed’s 2% target rate, which appears likely, how then will the Fed raise rates to contain it? Could the economy then withstand an increase in the cost of home ownership? Most importantly, when will Mr. Bernanke find it politically tenable to dramatically increase debt service payments for the Federal government? In truth, there is never a convenient time to have a severe recession or a depression. Unfortunately, reality can be extremely inconvenient.
Bernanke was accurate in saying that the economy is not expanding at a sustainable pace. Of course, his prescription was the same as it always is; print more money in the misguided belief that inflation will lead to growth. As such, he indicated that it’s possible that the Fed may actually expand bond purchases beyond the $600 billion announced last month. (Remember that the $600 billion comes after the $1.7 trillion that has already been printed, which failed to produce anything much beyond a weaker dollar). Therefore, the country can look forward to yet more inflation, continued anemic GDP growth, a poorer citizenry, and a vastly lower standard of living.
On the bright side, the next segment on 60 Minutes outlined some of the new social networking capabilities being created by Mark Zuckerberg and Facebook. In other words, although our economic misery will likely increase, it should become much easier to share the bad news with friends.
By Peter Schiff
Today’s payroll report severely disappointed on the downside and left economists scratching their heads to explain the weakness. The explanation, however, is plain as day. As I have been saying for years, the US economy will not create jobs as long as the Fed keeps interest rates artificially low, and Congress keeps stimulating spending and consumer debt, punishing employers with mandates, regulations, and taxes, crowding out private investment with massive government borrowing, and preventing market forces from restructuring our out-of-balance economy.
By Peter Schiff
If you’ve spent enough time in the gold community, you might be under the impression that the most imminent threat to the average American isn’t terrorism or unemployment, but rather gold confiscation. Starting with the fact that FDR confiscated gold during the last Great Depression, and continuing to the quite accurate forecast that we are headed into an even Greater Depression, unscrupulous coin dealers have been pushing investors to buy expensive “numismatic” or “collectible” coins that they claim would be protected from government seizure. The only problems are that the original motive for confiscation no longer applies and the “protection” offered by major coin dealers wouldn’t actually help you keep your gold.
The following article was written by Mary Anne and Pamela Aden for the December 2010 edition of Peter Schiff’s Gold Letter.
Gold is in full gear too, barely looking back over the last two years. It has practically doubled since the heat of the financial crisis (see Chart 1).
By Peter Schiff
Given the opposing views of the potentially parsimonious new Congress and the continuously accommodative Federal Reserve, there is a movement afoot among Republicans to eliminate the Fed’s “dual mandate.” Prior to 1977, the Fed only had one job: maintaining price stability. However, the stagflation of the 1970s inspired politicians to assign another task: promoting maximum employment. This “mission creep” has transformed the Fed from a monetary watchdog into an instrument of social policy. We would do well to give them back their original job.
Michael Pento’s Market Commentary
Certain deflationists have recently gone on record saying that the increase in the Fed’s balance sheet is meaningless with regard to creating inflation because our central bank can’t print money, it can only create bank reserves. The problem with their view is that it both disregards the definition of money and ignores the process of creating bank reserves.
Money is commonly defined as “a medium that can be exchanged for goods and services and is used as a measure of their values on the market, including among its forms a commodity such as gold, an officially issued coin or note, or a deposit in a checking account or other readily liquefiable account.” The Fed creates a “readily liquefiable account” when creating excess bank reserves, so it is also creating money. Since inflation is properly defined as an increase in the money supply, the Fed unquestionably creates both money and inflation when it creates reserves.
The deflationists’ error is to suppose that because the amount of currency has not grown, the money supply hasn’t grown. But the Fed never creates currency – all the printing is handled by Treasury; instead, it creates bank deposits which are held at the Fed. In ignoring this “base money,” the deflationists make no distinction between having the Fed’s balance sheet at $800 billion or $3 trillion. Doing so is a huge mistake for both making investment decisions and predicting asset price levels.
In short, for deflationists to be correct, they must contend that only money which is currently in circulation can be considered inflationary, i.e. lead to rising prices. Therefore, they must also believe that all increases in demand and time deposits should not be included in the money supply and should not be considered inflationary. This isn’t just wrong, it’s grossly wrong.
Not only do the Fed’s monetary additions increase the money supply, but the effect can be vastly multiplied through the fractional reserve system.
Also, the process of creating bank reserves always first involves the purchase of an asset by the central bank. The Fed issues electronic credits to banks in exchange for bank assets, including Treasuries. Its purchases drive up the demand for those assets, bringing about rising prices. In fact, Bernanke has clearly stated that the purpose of his “quantitative easing” program is to raise the rate of inflation, which in his mind is too low.
What the Fed is accomplishing is a reduction in the purchasing power of the US dollar. It creates inflation by vastly increasing the money supply and thus, lowers the confidence of those holding the greenback. If international confidence in the dollar is shaken, most dollar-based asset prices will increase — with the exception of US debt.
Deflationists also ignore the rise in prices that is occurring because of the potential insolvency of the US government. It is not dissimilar to what happened to Enron shares. Once the accounting scandal broke, the purchasing power of Enron shares plummeted. It was not because of an increase in the number of shares outstanding, but because of an epiphany on the part of investors that the company was totally bankrupt. Logically, shares representing a stake in a doomed company lost all of their value. Likewise, aggregate prices will soar if global investors lose confidence in the dollar due to the realization that the US is incapable of servicing its debt.
Whatever the deflationists may claim about the money supply, the objective indicators are not looking good for Uncle Sam. The dollar’s decline is abundantly evident when compared to gold, commodity prices, other currencies, real estate, and the list goes on. The national debt now stands at over $13.7 trillion, some 94% of GDP. Either due to an insolvent currency backed by a bankrupt nation or because of the Federal Reserve’s endless money printing, I have no doubt that the deflationists have it completely wrong.