2.8.10

The more I think about how things have transpired in the financial markets (and economy) over the past few years, the more I am convinced that the next major crisis – that of debt funding and spiraling interest costs consuming tax revenue – which will lead to uncertainty over the value of paper currency, will hit us quite suddenly.

Of course there are people who have smartly analyzed the problem, and are warning us about the repercussions. However, the majority – including those holding power – are not listening. It seems that we are set to push the proverbial envelope, right to the limit. By adding debt, and increasing government spending, during a time of economic weakness, it would appear that developed countries around the world are following wise Keynesian thinking – that the “G” in the demand equation, i.e. government spending, should increase to ’smooth over’ the rough patches in the economy.

This time however, we have gone past ‘zero hour.’ I wrote last year regarding an interview of Marc Faber where he stated that we have arrived at Zero Hour - the point when adding $1 dollar to debt spending adds ZERO to GDP (to our economy). We have been pushing on a string since then.  To be more precise, according to a recent NBER research report put out by Rogoff and Reinhart (WSJ commentary), it takes SIX dollars of debt spending to add $1 dollar to GDP. And amazingly, because government knows nothing else, they keep at this racket. Basically, all they’ve done, besides bailing out big banks, is keep overbloated municipal governments alive for one more year.

As Marc Faber outlined in one of his recent Gloom, Boom, and Doom Reports Monthly Market Commentaries, according to BusinessWeek, the manufacturing sector lost over 5m jobs over the past decade, but government, including state and local, added 2.2m jobs. We are adding tax revenue draining jobs, not tax revenue creating jobs.

What we will continue to see is more and more of our depreciating tax revenue going to simply pay interest. What many think is that this problem will continue to grow slowly until action is taken  – I disagree here. I think this problem will grow slowly for a little while, then suddenly, investors the world over will decide it is too risky to own US government debt, and interest rates will spike as investors try to sell off low yielding US treasuries, further exacerbating the interest cost problem. Then Moody’s will downgrade US debt (after the fact), and the the US currency will be sold off.

A corollary issue is the massive mountain of future debt which we call “unfunded entitlement liabilities.” Just like future pension costs needed to be funded by either investment growth or contributions or both, Medicare and Social Security need to be funded (all from contributions). This will further weigh on our credit rating and global confidence in our fiscal situation.

At this point, our currency will likely lose value vis a vis resource currencies (Canada, Australia, Brazil, Norway) and natural resources will cost more in US dollars. As an aside, I read an article last night in the Wall Street Journal which said the US is tied with Papua New Guinea as taking the longest for a resource mine to be permitted and opened (7 **** years! – no wonder we have to import everything). And of course, we block these attempts which would be likely good paying union jobs. So we will continue to import resources from other countries at increasing costs.

Also, government will continue to look for justification to find newer and “more creative” tax revenues to help feed itself. Personally I enjoy it when we elect politicians and they promise ‘creative’ solutions to our problem and basically it’s usually new taxes in new places – many times I feel we could hire junior high students to get that same “creativity.”

In summary, you will face:

1. Rising borrowing costs – as rates rise, you will not be able to refinance your home likely for 15 years or more. Your credit card finance charges will spike as will the cost of car loans, student loans, and business loans.

2. Your taxes will increase – inability to bail out local governments could likely cause a property tax “adjustment.” Income taxes will rise and as a note, the likely ’solution’ to the ponzi scheme that is social security will be that oft used “both” solution – both BENEFIT CUTS and HIGHER TAXES. And government won’t go down without a fight – before we start getting rid of the bureaucracy, government will attempt to increase taxes to keep government jobs, but this will further contract the economy as productive people, facing higher taxes, decide to WORK LESS. Furthermore, if your boss is one of these people, she may decide to lay you off to use your salary expense to cover her increased taxes.

3. What you buy gets more expensive – as the problems laid out above cause our currency to lose value to the currencies of producing countries, they producers will demand more and more of our increasingly worthless fiat currency to buy their food, their iron ore and nickel, their oil, their copper. Your quality of life, already hampered by higher taxes and higher cost of debt, will be hindered by higher costs of living.

And I did not even mention money printing – Ben Bernanke, the “student of Gutenberg” as Marc Faber calls him, will try to print us to prosperity. This will be seen as a strong negative in the eyes of the global market and further weaken the value of the US Dollar. Typically, excessive debt and money printing are the signs of a weak economy and the process can be seen easily by studying Zimbabwe (one of the most extreme examples) or numerous South American countries over the past 3 decades.

Your Action Plan

If you agree with my assessment and want to consider ideas to protect yourself, and ideas that make prudent financial sense in general most of the time, here is what you should contemplate doing:

1. Rising Debt Costs – this may seem straightforward, but please put a plan to eliminate debt that is subject to variable interest rates. If this problem hits suddenly, this could be very bad for you. Any debt that is variable and CALLABLE, you want to eliminate. Also, as prudent planning, you want to start building a cash horde – if you have sizable savings, you may want to consider a diversified currency cash horde.

2. Rising taxes  – there are many, many ideas to consider here. Let me share a few. property taxes might be one of your biggest expenses. Analyze your town’s budget and see if there is a large pension shortfall and if operating expenses are trending much higher than tax revenue. if so, you may want to take the drastic step and move (or at least lower your housing costs if they are too high a percentage of your income  – i.e. over 25-30%)! For investments, moving more retirement money to the Roth, either through conversion or contribution, could make sense. You have to carefully analyze this situation though and consult a tax expert before acting. There may be no way of hiding from higher income taxes if you are a higher earner – you will likely become the bogeyman of 2011 or 2012. There are ways to be creative but you should seek the advice of an expert before acting.

3. Rising costs and loss of purchasing power – owning real assets has been one way to shield oneself from the ravages of currency depreciation since in theory, 1 pound of copper should hold its value across countries even if the dollar drops. For example, if 1 pound of copper costs $3 US, and it costs 18 Yuan Chinese, then if the dollar falls 50% so that copper now costs $6 US, it will still only cost 18 Yuan Chinese, thereby protecting the value of your wealth – from currency loss of value!

Of course buying 20,000 pounds of copper might be an inconvenient way to store $60,000 worth of wealth so we often use precious metals to more conveniently protect against inflation and price increases. And as mentioned above, a diversified currency basket might be a wise way to hold currency. Whether you do this through mutual funds, owning a bank account in a foreign country, or with the many trading instruments available today, I couldn’t say what was best for you – consulting with a professional might be your easiest way to find out.

I have also recommended many times, here and in person with people that they TAKE ACTION to control their living costs. Where you will likely feel the pervasiveness of cost increases the most are your home-related costs – water, heat, and electricity. Consider solar heating/electricity, well water, wood stoves and the like to potentially ELIMINATE living expenses. At this point, if you can do this, you will only have to worry about property taxes and food when it comes to rising prices (I know what you’re thinking – “only” he says).

For college students, and I will be mentioning this when I address some Tufts University seniors in March, don’t be afraid to look globally for a career. Asia in particular has a lot of growth ahead of it and with that, many job opportunities. Of course if you work hard and become skilled at a particular task, you could likely find work anywhere.

For children, since you have time, consider collecting silver coins! (or gold if your allowance is more than $300/wk). Most importantly, fluency in a global second language could be quite helpful. Also, fluency in a niche language might be helpful if you want to separate yourself from the pack. For example, learning the language of the rising tigers like Vietnam, or perhaps an Indian dialect, could, coupled with US education, expose nice career opportunities to you.

Bottom line – you have to think. Unfortunately, American culture and government have “sheepified” us all. We are taught to be dependent, that it’s someone else’s fault, that there’s nothing we can do. It often takes strength AGAINST the tide of opinion, to make it in the world. But if you live the USA, you (and I) have no excuses. We have food, clean water, shelter, education and decent health for the most part. If you ever start feeling sorry for yourself, think about what life would have been like had you been born in a third world country.

As I wrote last week, you’re supposed to go for it! You see the writing on the wall – the national debt, the deficits, the taxes, the cost of entitlements – take action, protect yourself, and please don’t be a sheep.