The National Debt - A Few Comments

In August, I wrote an article titled "America's Trojan Horse" (which can also be found listed along the right-side of the homepage.)

This article had to do with various facets of our national debt, many unexplored. Here is an excerpt that I would like to further comment upon:

"The first of these concepts is that the financial markets have allowed us to grow and perpetuate our debt loads, absorbing this debt issuance at reasonable, if not low, interest rates. While this continual absorption of ever-increasing debt at lower rates is counterintuitive, it has nonetheless occurred. Why this counterintuitive event has occurred is largely unknown. Although it appears to be a long-term market anomaly (a propitious one at that) it might also be a concatenation of short-term market anomalies. The latter supposition is certainly a troubling facet to ponder, as it would likely make our ability to sustain such debt levels more tenuous."

Here is a long-term monthly chart of the 10-year Treasury yield. As one can see, the trend in yields has been down:



Chart courtesy of Stockcharts.com

Various economists have recently stated the national debt is at roughly $6 Trillion, or roughly 40% of GDP. They view the "danger point" as the national debt to GDP ratio of 100%, meaning that we can incur an additional $8 Trillion in national debt (to roughly $14 Trillion) before reaching the 100% level. Given that $8 Trillion in additional national indebtedness would likely take a few years to incur, it would appear based off of this reasoning that we have some time before the 100% "danger point" is reached. I don't agree with these figures (IMHO the actual level of debt is far higher) as well as the line of reasoning. No one really knows at what time or level the national debt hits a critical level.

It currently appears that the amount of the national debt is "tolerable" and is not causing undue concern in the markets. Metrics that cause me to draw this conclusion include the subdued level of interest rates on government debt (as seen by the above chart), seemingly low price levels of the sovereign credit default swaps of the United States, and a general lack of concern shown by the public and Congress, despite ever-increasing deficits that appear to be heading for at least $1 Trillion annually for the foreseeable future. It wasn't too long ago that a $500 Billion annual deficit was considered exceedingly high.

However, is this national debt level really as "acceptable" as it appears? Do we have a number of years at current deficit levels before we hit the "danger point?" When we do approach the "danger point," how long will we have before there are repercussions, and how serious will these repercussions be?

These questions are difficult to answer, as they appear contingent upon a number of complex, interrelated factors. I have some theories as to how and when the "danger point" will be reached, as well as the repercussions. However, these theories are still in the "formative" stages and thus I do not wish to explicitly specify a number or timeframe.

However, I will say that I am led to believe that the level of national debt, as well as our present propensity to accrue it, is not as "tolerable" as it may appear. In other words, I believe the "danger point" and subsequent repercussions may be reached sooner than the consensus believes.

If this "danger point" does present itself relatively quickly, of course it would have ramifications in many areas. Stimulus-based deficit spending, as well as other deficit spending, could likely become prohibitive. As well, other tangential effects could include higher interest rates. Furthermore, there may be a sudden need to actually reduce significant portions of the national debt.


SPX at 1087.27 as this post is written

Investment Frauds

In June I wrote a post about investment frauds. That post can be found here:

http://economicgreenfield.blogspot.com/2009/06/madoff-fraud-are-there-more.html

Since that June post, there have been a number of investment frauds uncovered. Of course, none have rivaled the size of Madoff's; however, they haven't been small either.

Perhaps the most disconcerting aspect of these frauds is that most appear to be unsophisticated. This could signal that there are many more that have yet to be uncovered, as the "bar" or "barriers to entry" for committing sizable investment frauds seems to have been set low.

I do believe there are many investment frauds, of different types, waiting to be uncovered. Sadly, the vast majority of these frauds should have never happened if proper due diligence was performed by investors. For whatever reason, a sense of wariness towards many of these investments seems to have been nonexistent for whatever reason.

While a discussion of due diligence is beyond the scope of this blog post, many of these frauds possessed similarities which should have instantly raised suspicions.




SPX at 1097.96 as this post is written

"Underwater Mortgages" Statistics

Yesterday The Wall Street Journal published an article titled "One in Four Borrowers Is Underwater."

The story contains a variety of statistics with regard to homeowner equity and home ownership issues. It gives a good overview of the situation, and this facet of the residential real estate situation is not pretty. As the headline states, 23% of all mortgage holders are "underwater," i.e. they owe more on their mortgages than the underlying house is worth.

There are several reasons that this situation is important. A couple include:

-These statistics are being generated despite the fact that there has been massive intervention and stimulus programs directed toward residential real estate. The majority of intervention and stimulus programs in some way, either directly or indirectly, are aimed toward supporting housing. It is highly disconcerting that we have such a dire situation despite such outsized intervention efforts. We, as a nation, have committed, both directly and indirectly (via various "guarantees") an epic amount of money toward this problem.

-As I have stated before, I do not believe that we have even come near the bottom of residential real estate prices. To the extent that residential real estate prices fall from here, this "underwater mortgage" situation will be exacerbated. A resumption of falling house prices would fuel many other problems, including the temptation of homeowners to commit "strategic defaults."

As I have written previously (my other Real Estate posts are under the "Real Estate" Category listed on the right-hand side of the home page) the real estate issues facing this country are severe, very complex, and not well understood.



SPX at 1107.71 as this post is written

Ron Paul On The U.S. Dollar

One of the facts that Ron Paul frequently quotes is that since the Federal Reserve's inception (it was created in 1913) the U.S. Dollar has lost more than 95% of its purchasing power.

I wonder how many people are actually concerned by this occurrence? I hardly ever hear this discussed among people or by the media.

They should be very concerned, however...



SPX at 1105.61 as this post is written

Another Thought On Gold

A November 20 Wall Street Journal article stated that Gold's January 1980 record high would have an inflation-adjusted equivalent of $2,290/oz.

I find it amazing that even after the long parabolic rise we have seen in Gold since 2001, we are still far short of that inflation-adjusted price. On an "all things considered" basis one would have thought that Gold would have performed stronger over the last 30 or so years. The Gold price really went into submission from 1980-2000.

I think it underscores the fact that at least from a historical perspective of the last few decades, it has been very important as to when Gold is purchased.

I mention this as Gold appears overdue for at least some type of correction. The recent price action, resulting with Gold now at $1169 (December futures) has been strongly parabolic.

I think that many factors are now in play that will generate considerable volatility in Gold's price going forward.

Gold's price should be very interesting to watch, and I think it carries great significance on a number of fronts.



SPX at 1106.24 as this post is written

Two Notable Developments

I would like to highlight two notable developments that have lately arisen.

Both have to do with interest rates on short-term US Government securities - the 3-month bill and 2-year note.

First, a chart of each of these securities' yields. Shown is a daily chart from January 2008 to the present, in LOG scale to show detail:





Charts Courtesy of StockCharts.com

As one can see, yields on each have fallen dramatically lately and now are near or at levels last seen during the height of the Financial Crisis during Q4 2008. During that time, investors aggressively moved into these securities as they were perceived to be a "safe haven."

The most common reason given for the recent yield movements on these securities is that there is high demand driven by needs for year-end portfolio adjustments and similar motives - i.e. the movements are "benign" in nature.

I do not necessarily concur with these "common" rationales, especially in a market environment where there have been myriad danger signals exhibited, of which I have previously written. While I am not certain this drop in yields is due entirely to a "flight to safety" (i.e. as purported "safe haven" securities) as in 4Q 2008, I suspect it is a least a major driver.

If indeed some or most of this yield movement is being caused by investors' fears, it would be most odd in that these securities are reflecting heightened fears while a broad array of securities don't appear to be reflecting such fears as measured by their price movements.

To illustrate, here is a simple comparison between the three month Treasury Yield and VIX (seen below in red) since 2008. I will use VIX as a general "fear" proxy. Note the inverse correlation during 4Q 2008 and the lack thereof now:



Chart Courtesy of StockCharts.com

Another aspect of this dropoff in yields bears comment. Why would a rather large class of investors settle for minuscule yields, at a time when major asset classes have done very well over the last few months?

"The markets" don't always make sense - and this appears to be an outsized example...



SPX at 1091.38 as this post is written

Is Gold Experiencing A Bubble?

One of the questions that frequently arises with Gold's recent strong performance is "Is Gold in a bubble?"

Before I make some comments concerning this question, here is a long-term monthly chart of Gold for reference:



Chart Courtesy of StockCharts.com

Anytime a security acts as strongly as Gold has, it is natural to suspect a bubble. This is especially true with Gold's price currently, as many people don't understand the complexity of the factors that can drive Gold's price.

As I have previously noted in various blog posts (which can be found under the "Investor" Category on the right-hand side of the home page) Gold's price can be very hard to predict. To a greater extent than other securities, there are many different, hard-to-quantify factors that can drive the Gold price.

Furthermore, the market for Gold is relatively small in relation to other asset markets, so investment flows both in and out of Gold can be magnified.

Is Gold in a bubble? Given the aforementioned, I would hesitate to make an affirmative declaration. This is not to say that it is not overvalued or "ahead of itself." As I wrote in a September 25 post, "I like Gold's properties. However, I don't believe that the economic factors now in existence support a strong Gold price, from an 'all things considered' basis."

Perhaps the greater question should be whether various asset classes are currently experiencing bubbles, and whether Gold is just one of a few (or many) classes in such a condition. In effect, is Gold's price strongly (positively) correlated to that of other asset classes, and if so, why?


SPX at 1091.01 as this post is written

Interesting Comments From Liu Mingkang

Here is a link to a November 16 Wall Street Journal article titled "China's Blunt Talk for Obama":

http://online.wsj.com/article/SB125826103009548975.html

I found this to be particularly interesting:

"Liu Mingkang, chairman of the China Banking Regulatory Commission, said that a weak U.S. dollar and low U.S. interest rates had led to "massive speculation" that was inflating asset bubbles around the world. It has created "unavoidable risks for the recovery of the global economy, especially emerging economies," Mr. Liu said. The situation is "seriously impacting global asset prices and encouraging speculation in stock and property markets."



SPX at 1109.80 as this post is written