The divergent voices and opinions of Karl Denninger, Warren Buffett and PIMCO (the world's largest bond manager) are beginning to come together on an issue that is reaching critical mass: the value of the dollar and interest rates. Buffett's banana republic comment this past week about deficits and monetary policy got some attention. But much of it was drowned out in yesterday's happy fest of talk about economists' "estimates" that the recession may be bottoming out, Chairman Bernanke's positive comments at the banker summit held at Jackson Hole, Wyoming and the recently released housing data (house sales are not crashing as fast as they were this time last year). As I mentioned Thursday, the spin at work in the news cycle is dizzying.
There are some very important events unfolding in the markets right now that portend disaster for the U S economy. Denninger makes the following observations (emphasis mine):
We can defend the dollar which will cause interest rates to rise significantly, choking off false growth and forcing the defaults being hidden to the surface, or we can continue an economic policy that fosters fraud and deceit. If we do the latter we will continue to see revulsion for all forms of dollar-denominated debt and like a creeping case of gangrene it will travel from the corporate and agency space, eventually infesting US Treasuries as well.
The only remaining question is whether the monetary and fiscal authorities will amputate the gangrenous hand or whether they will allow sepsis to set in and kill the entire nation - including its currency and potentially the government.
Before you dismiss me as some off-the-wall Internet kook, you might want to consider that in addition to those of us who have been pounding the table for the last couple of years on these points, we now have both PIMCO and Warren Buffett adding their voices to our chorus.
Floyd Norris at The New York Times notes those Asian appetites for U S bonds may be waning:
As the United States rolls up record budget deficits, Asian countries are showing a reduced willingness to finance the debt.
Figures released by the Treasury Department this week indicated that China reduced its holdings of Treasury securities by $25 billion in June, the most China had ever sold in a month.
Monthly figures can be volatile, and can be revised, so it is risky to draw conclusions from one month's data. In May, China increased its holdings by $38 billion, according to the Treasury figures.
Nonetheless, the decline highlighted a fact shown in the accompanying graphics: Asia's appetite for Treasury securities is not growing as fast as it once did. That means the United States will have to turn to other buyers, including American citizens, who are now saving as they did not do during the boom years, to finance the deficits.
It will come as no surprise that American savers are no different than Asian investors in their view of U S Treasury bonds: neither likes these bonds as an investment right now because the interest rates the bonds pay are unrealistically low and the likelihood of future massive rate increases spells big losses for them if they buy now. It must be said that Fed Chairman Bernanke has one of the most difficult sales jobs in history facing him right now. He must put a happy face on U S economic prospects every morning because he is forced to sell several trillion in U S debt to investors anywhere and everywhere this year, something that can't be done by showing up at work with a frown on your face. Hence the happy talk that is coming to look more like a job preservation tactic than honest discourse (remember, Larry Summers wants Bernanke's job).
U S fiscal and monetary policy is at a critical juncture right now. Having faced a crisis of monumental proportions earlier this year and late in 2008, there are difficult decisions to be made. As Denninger noted, President Obama and Congress can kick the can down the road (do nothing but borrow and spend) or they can administer the medicine the patient requires: strict monetary and fiscal policy that brings a halt to printing money, outrageous spending programs like ObamaCare, Cap&Trade, the Stimulus Legislation and the establishment of realistic goals. This will mean serious near term pain but long term gain for all taxpayers. Reagan did this in 1981-1983 by doing the following:
- He instructed Federal Reserve Bank Chairman Volcker to constrict the money supply.
- He bullied Congress into a massive tax cut that put additional cash in tax payer's pockets on a consistent basis (every payday a stimulus check arrived in the form of more take home pay).
- He sent a clear signal to Congress that with the exception of Defense budgets, massive new spending programs would come under political attack.
It must be repeated that Reagan did not pursue these goals with impunity. His fiscal and monetary policy cost him the 1982 mid term elections, but the results of those policies created an economic boom of staggering proportions. What we are witnessing today is a stark example of the difference between political courage (Reagan) and political hubris (Obama/Reid/Pelosi).
There still is a window of opportunity to avoid the catastrophic effects of the current monetary and fiscal policy. The question is if there are still enough Americans out there that remember what it was like in 1979 - 1982:
- 20% prime rate
- 13% inflation
- 11% unemployment
- Lines at gas stations that stretched for miles (if the station was actually open).
The challenges today are much more serious. Our economy is larger, the borrowing needs are greater and aggregate consumer debt is disproportionately larger. There is only one way to revive a consumer driven economy such as this: reasonable government spending caps and massive tax reductions. The trolls scoff at the tax reduction idea because they never acknowledged their success in the 1980's; however, these same trolls must be challenged to give an example of a better, more effective and more efficient way to put money in the consumer's pocket in light of the fact that we live in a consumer driven (70%) economy.