Wednesday, March 9, 2011

Are We Broke?

If Michael Moore says that we are not broke, that can only mean one thing: we’re broke. You can bet the house on it.

Let’s say that you’re driving along in your car and the fuel gauge is telling you that your car is flat out of gas.

Now, Michael Moore comes along and says that you can’t be out of gas because the car is still running.

A simple-minded soul might say that, in point of fact, the car is really still running. Unfortunately, the car is running on fumes. It is postponing the inevitable, but you know that the inevitable is coming up fast, around the next turn. Ignore it at your peril.

Give some credit to Michael Moore. In the past people who disseminated propaganda posited that if you keep repeating a lie, over and over and over again, eventually everyone will accept it as truth.

In the new, improved Michael Moore version, if you want to disseminate a really big lie, you put it in the mouth of a really big liar.

Progress, don’t you think?

Anyway, Michael Moore does not decide whether or not we are broke. That decision belongs to no less an entity than the bond market.

Let’s say that you are living off of credit. Your credit cards are maxed out, but the bank is still accepting your charges. It’s good that they accept your charges, because once they stop, you will not be able to pay the rent or to buy food.

And you say to yourself that as long as the bank keeps accepting your charges, thus, extending you more credit, you are not broke.

Of course, if there is no way on God’s green earth that you will ever be able to pay what you are borrowing, then, strictly speaking, you are broke. You're running on fumes.

The question is not whether the bank will stop giving you credit, but when.

When it comes to larger entities, like governments, the credit card is the bond market and the bank is the people who are buying your bonds, thus, lending you money.

If it happens one day that people decide that they do not want to lend you any more money, or that they will only lend you money at a far, far higher interest rate, then you will have a problem. You might be forced to pay much higher interest rates, or you might default on your debt, or else you might cut back severely on your spending.

Several years ago, well before the recent financial crisis, a very prescient friend of mine announced over dinner: “One of these days a bond auction is going to fail.”

In bond auction the government sells bonds, thus borrows money, and the lenders buy or don’t buy depending on the interest rate. The auction sets the rate at which the government can borrow.

If such an auction fails, that can mean that not enough people will lend us enough money at a reasonable interest rate. At that point we can withdraw the offer, thus, not borrow, or we can pay the much higher interest rate.

Of course, we cannot go out and interview the bond market. The closest we can get is to examine the thoughts of the man who probably has the most intimate relationship with it. That would be William Gross the bond maven at PIMCO.

In a recent interview Gross outlined a rather dire scenario. Our debt is so large, the cost of financing it is so large, and entitlements are so completely out of control that we should, in his words, prepare ourselves for much higher interest rates and a declining standard of living. Link here.

As you may know America cannot really pay its debts. It is keeping the engine running by printing money, thus, inflating the currency. Given the exalted status our dollar enjoys as the world's reserve currency, we have the privilege of paying our debts back with cheaper money. We are defaulting on some of our debt, but in a nice way.

If you’re a foreign investor and you earn 3% interest by investing in American bonds, and if the decline of the dollar means that you lose 5% on the purchasing power of your money once it is translated back into your local currency, then you are not going to lend America very much money, except at higher interest rates.

But if the dollar weakens compared with foreign currencies, that also means that it cost more to buy things at places like Walmart or Costco. This will translate into a generally lower standard of living.

As they say, enjoy it while it lasts, but America, like Michael Moore, is running on fumes.


Anonymous said...

TO: All
RE: Heh

I'm looking forward to a video of some fat guy, e.g., Michael Moore, standing on a roof top, waving a machete and declaring he's going to "cut someone's throat", a la Charlie Sheen, when reality finally begins to sink in through all that fat between his ears.


P.S. However, I'm not holding my breath on that one....

Anonymous said...

P.P.S. There's a LOT of 'fat' takes a while for reality to 'sink in'.....