"The U.S. is in an untenable position - between a rock and a hard place - in an inescapable debt trap - where the options are, at best, dire - either hyperinflation or a deflationary depression! It would seem that all we can do is ride out the storm in a boat laden with gold" said Jeff Nielson (BullionBullsCanada.com) in a recent speech* going on to say:
"The U.S.'s severe debt problems are exacerbated by its $70 trillion in unfunded liabilities to fund the social 'entitlements' of the mass of baby boomers who will be retiring by the tens of millions in the next few decades and there is absolutely NO likelihood of the U.S. government ever reducing those entitlements. Any attempt to do so would cause severe economic disruptions and civil unrest."
Nielson maintained that there are numerous practical reasons why the U.S. will make no attempt to alleviate the dire situation.
1. A Looming Pension Crisis
His first reason was the looming pension crisis "where it is estimated that U.S. pensions were underfunded by about $3 trillion as of the end of 2008 and even after the recent rally in U.S. equity markets that pension deficit still amounts to roughly $2 trillion. Thus, even if the U.S. government could somehow make full pay-outs on the entitlement programs which U.S. seniors will be relying upon, they would still have to raise an additional $2 trillion just to maintain their standard of living not to mention the consumption level which this consumer economy relies upon for its very survival. Why? Because, with over 40% of Americans having less than $10,000 in savings, Americans are more dependent today on these entitlement programs than any other generation of Americans in history."
2. A Further Collapse in House Prices
"With 75% of the 'assets' held by retired and soon-to-be retired Americans consisting of real estate," said Nielson, "they will need to dump roughly $2 trillion of real estate onto the U.S. market - the most over supplied real estate market in history - in order to maintain their standard of living. To preclude such an event the U.S. government has been desperate to 're-inflate' the U.S. housing bubble - at any cost - to buoy up American 'real estate' accounts and bail out the banks holding the mortgages on houses in foreclosure. Nevertheless, I believe the U.S. will see a second housing bubble because:
1. the U.S. Federal Reserve has taken the interest rate all the way down to zero - and left it there.
2. millions of U.S. houses have either been held off the market by U.S. banks or are tied-up in U.S. foreclosure proceedings. Both such actions have artificially reduced "inventories" of unsold homes by at least 50% putting in place a (very) temporary 'bottom' in prices.
3. the U.S. government agencies which are responsible for 90% of all new mortgages, have, once again, lowered their lending standards. In fact, when the government buyers' 'credit' is factored in, more than half of all U.S. homes purchased in 2009 had zero down-payments.
4. the Federal Reserve has been buying up every U.S. mortgage bond in sight given the record default rates which currently exist in the U.S. In fact, more than 25% of all U.S. mortgage holders have "underwater" mortgages and 15% of all U.S. mortgages are currently in default and/or foreclosure - an all-time record.
5. buying all these bonds with newly-printed dollars has temporarily kept U.S. mortgage rates several percent lower than they would have been without this hidden and very expensive taxpayer subsidy. This has resulted in the Federal Reserve absorbing more than $2 trillion of bonds and securities which - to be polite - are of extremely dubious value and the moment the Fed stops buying up all these debt instruments, U.S. mortgage rates will shoot higher."
Nielson made the point that with all of the aforementioned "occurring at a time when millions of option ARM mortgages are about to reset, and more than 40% of the millions of Americans holding these mortgages have been making minimum payments, it follows that when these mortgages reset, borrowers could see their monthly payments not merely increasing by 40% or 50% per month, but by up to several times their current payments."
"In addition", Nielson went on, "These millions of mortgage resets are occurring at the same time that long term unemployment in the U.S. is at its highest level in at least 70 years, and U.S. 'real' housing inventories are at their highest levels ever. As such, once this second collapse begins, there will be no means of stabilizing the market because, as I see it;
1. Interest rates can literally only go higher
2. U.S. homeowners have less equity in their homes than at any time in history
3. Retiring baby boomers will have to dump $1 to $2 trillion of real estate onto this market just to partially fund their under-funded retirements - and much more than that if entitlement programs should have their benefits slashed."
Nielson maintained that the above "will not only undermine the U.S. housing market for many years to come, but any reductions in U.S. entitlement programs will directly make the next collapse of the U.S. housing sector that much more severe - because it would force the sale of much more real estate."
3. The Future Cost of Interest Payments and "Unfunded Liabilities"
Nielson reminded his audience that "the Obama government has already admitted that over the course of this decade more than 50% of every new dollar of debt will be consumed in interest payments on old debt. Those interest payments, alone, will exceed $1 trillion/per year before the end of this decade. Added to this will be roughly $2 trillion per year of "unfunded liabilities", which will now have to be funded. This means that over the course of this decade, the U.S. government will have to come up with an additional $3 trillion/year - above and beyond all current spending programs. This will roughly double U.S. government spending, and roughly quadruple current deficits.
Even the largest tax increases in history could only fund, at most, about 10% of this spending-gap. This means either cutting trillions per year in government spending which would be impossible to do, or simply printing-up trillions and trillions of new dollars to pretend to 'pay' those bills. This, in turn, guarantees hyperinflation."
4. The On-going Political Paralysis
"The budgetary constraints which I have just discussed," said Nielson, "have all been of the 'economic' variety but it is U.S. political constraints which are an even bigger obstacle in beginning to address the massive, triple-problem of U.S. insolvency: debts, deficits, and liabilities."
Nielson pointed out that "decades of gerrymandering have transformed roughly 80% of U.S. electoral districts into the permanent holdings of one or the other of the two U.S. political parties. As such, the candidates of the favoured party are essentially guaranteed seat for life and this eliminates any incentive for them to produce positive results for their own constituents - other than bringing home the 'pork'. As a result, partisan politics has taken precedence over any, and all, other considerations in the U.S. and regretfully, the #1 rule of partisan politics is to never allow the party in power to accomplish anything good of significance.
The one exception to this scenario of total indifference is the American Association for Retired Persons (AARP) which is not only the largest voting bloc in the U.S., but it is comprised of the only segment of the U.S. electorate which has a consistently high "turn-out" in every election. Not surprisingly, their two most important issues are Social Security and Medicare - the two social programs which are 100% certain to bankrupt the U.S. economy. Barring a complete "metamorphosis" of the entire U.S. political system, these "unfunded liabilities" are essentially carved in stone, since they are the only issues where doing something unpopular could threaten the security of the sitting politician and this leaves current and future U.S. governments with nothing but terrible options."
Nielson maintained that the current situation demands that the government either:
1. Fully 'fund' all these entitlement programs by printing up countless trillions of new dollars - which is the only possible way to cover those entitlements 100% or
2. Slash entitlements - and lose their own cushy positions - which would suck trillions of dollars out of the economy and result in a debt-implosion which would "make the death of the former Soviet Union look like a picnic."
"If the U.S. does not commit to one or the other of these actions the U.S. will likely suffer the worst of both worlds - hyperinflationary depression", he concluded.
5. The Preference for Hyperinflation
Nielson sees hyperinflation as more than just soaring prices. He sees it as "a crisis of confidence with respect to the currency in question, and the beginning of a death-spiral for that currency" going on to say: "When a currency starts to rapidly lose value the government is forced to print up vast quantities of new currency to subsidize the depleted wealth of its citizens - so they literally do not starve to death. Then, that excessive money printing leads to an even more rapid rate of devaluation for the currency, and this vicious circle gets more and more severe. In virtually every example in history, such currencies effectively go to zero."
Nielson maintained that "hyperinflation likely is the inevitable course on which the U.S. is headed. Not only is the Federal Reserve under extreme pressure to continue to print countless trillions of new dollars, but hyperinflation 'solves' the twin problems of massive, current debts and completely unpayable entitlement programs. The debts would get 'paid' and the entitlements would be 'funded'. That being said, the paper money used to do this would have only a minute fraction of its former value because, since hyperinflation causes a currency to move toward zero, all debts and liabilities expressed in that currency also become effectively worthless. As such, a very strong argument can be made that the U.S. will choose the informal 'default' of a hyperinflation, rather than suffer a formal default - and a resultant debt-implosion."
Nielson laid out in no uncertain terms that "History is clear: the devastation of hyperinflation will destroy the wealth of average Americans to an even greater degree than through suffering the ravages of a deflationary implosion - although the former would preserve the "paper empire" of the Wall Street banks who have been dictating U.S. economic policy. As such, is there really any doubt as to what direction the government, unduly influenced by the country's financial oligarchy, is going to take?"
6. The Current Deflationary Environment
In order to delay inflation from ravaging the U.S. economy, however, Nielson believes that "the U.S. government is currently playing a very dangerous game - essentially starving the entire U.S. economy of capital. Bank lending is falling at the fastest rate in U.S. history because the banks are refusing to lend money to U.S. businesses, despite their promises to do the exact opposite. They prefer to keep most of the bail-out money 'on deposit' at the Federal Reserve in what is literally nothing more than a 'savings account'. That's where the Federal Reserve has been 'borrowing' the money to buy up trillions of dollars of worthless U.S. mortgage bonds. The rest of the bankers' money is then used to 'play the markets' with their proprietary trading", concluded Nielson.
7. The Lack of a Vibrant Economy
Nielson believes that those who insist that the 'mighty' U.S. economy will 'bounce back' as it always has in the past - that the U.S. will "grow" its way out of its huge debt/deficit crisis - don't seem to realize, with more than 50% of every new dollar of U.S. debt simply being interest payments on the old debt, that the U.S. economy will not be able to grow much, if at all - let alone at the above-average rate which is required just to produce enough revenues to service all that debt.
The U.S. economy is supposedly growing at more than a 5% rate, which is equivalent to an "economic boom" for any economy other than China's, said Nielson but "to borrow an old line: "where's the beef?" U.S. government revenues for all three levels of government are plummeting downward at an accelerating rate, so how can the economy be "booming" if no one is generating any tax receipts for the government? The fact is that, with the U.S. carrying the heaviest debt-load in its history, and an ever-larger portion of every dollar consumed just paying interest, the overall U.S. economy would have to be operating at a higher rate of activity than has been 'normal' in the past just to achieve average growth. Can anyone really suggest that the U.S. economy is currently stronger than normal?"
A Debt Trap in the Making
Nielson concluded his remarks by saying, "With the U.S. economy currently carrying over $60 trillion in total public/private debt just raising U.S. interest rates only 1% would drain an extra $600 billion per year out of the U.S. economy in additional interest payments - an equivalent drop of 5% in U.S. GDP - and that would be the case even before factoring in the 'multiplier effect' of sucking that much money out of the economy - and every 1% hike would inflict a similar, but compounded, amount of damage on the U.S. economy. Frankly, it is very likely that even a 1% increase in current U.S. interest rates would be enough to send the U.S. economy into an immediate deflationary spiral."
Nielson concluded in another article (http://www.safehaven.com/article/17682/nielson-the-end-game-is-either-hyperinflation-or-debt-implosion-got-gold) I wrote recently about his views that, "In a deflationary implosion or a hyperinflation scenario, some (and perhaps all) paper currencies will go to zero. In contrast... gold and silver will represent the ultimate "stores of value" - and thus the best protection from the events which lie ahead." All the more reason, given Nielson's opening remarks that, "The U.S. is in an untenable position - between a rock and a hard place - in an inescapable debt trap - where the options are, at best, dire" that we "ride out the storm in a boat (portfolio) laden with gold." As to exactly what percentage of gold you should have in your portfolio to protect yourself from such an eventuality see: http://www.munknee.com/2010/07/how-much-bullion-would-equity-investors-need-to-hold-to-insure-against-inflation/.