Starve the Beast

Dear Reader,

Due to back-to-back meetings – ugh – I’ll only be hanging around for a short while this morning before turning the podium over to Vedran Vuk.

Before dashing, though, I wanted to share with you an interview with David Stockman, Ronald Reagan’s budget director.

Lately Stockman has been getting a fair amount of coverage for his views that (a) the government’s debts are reaching critical proportions, and (b) part of the solution is to let taxes rise back to pre-Bush levels… which is to say, suck another 2 trillion dollars out of the pockets of American taxpayers over the next 10 years (CBO estimates).

While Stockman makes a lot of sound points in the interview that I will share, I remain steadfast in my objection to raising taxes now, or ever.

But what about the deficit?

Stockman is right that, at approximately $100 billion a month in new Treasury issuance, it’s dangerous and fast reaching a tipping point. Something must be done.

Yet in his dire assessment of the situation, he admits that Congress will ignore even the weak-soup spending cuts recommended by the presidential commission appointed to make those recommendations. And, of course, he’s right: after a brief flurry around the initial release of the commission’s findings, there has been almost zero further coverage.

With Congress steadfast in its resistance to politically unappealing spending cuts – at least of any real substance – should the burden shift to taxpayers?

Some might say it’s the taxpayers benefiting from all the government spending. So it is logical that they should pay up.

And add that it’s also the taxpayers who keep voting the spendthrifts back into office. Another reason they should pay up.

Ignoring the whole fairness issue that is shunted aside under the mob rule of a democracy – for instance, that almost half of Americans are net recipients, while the other half aren’t – the only possible solutions to the deficit that make sense, at least to me, are:

• Starve the beast – cut taxes. Sure, that will cause hardships, but focused in those sectors of the economy bloated by the government’s largess – e.g., sectors that would not exist (biofuels) or would have remained “right sized” (the military).
  
  
• Renegotiate U.S. debt. There’s no question of the U.S. actually making good on its many debts at this point, something that many people already recognize – and everyone soon will when interest rates begin to move up. So, why pretend?
  
  As eventually happens with every bankrupt business, it’s time to call a timeout and begin the process of renegotiating with creditors. Of course, owners of trillions of dollars of U.S. Treasuries will be disadvantaged and most unhappy as a result. But, hey, it’s not like they didn’t have access to a ton of information that should have warned them off from loading up on debt issued by the world’s largest debtor, by a wide margin.

Those two options are the straight-up ways of dealing with the unpayable U.S. debt – but that’s not how this is going to be resolved.

What is actually going to happen is that the government is going to continue to spend money it doesn’t have for as long as it can, borrowing it on the cheap from suckers to the extent that it can, and then turning to the Fed when it can’t.

This inflation of the money supply may, in the short to medium term, appear to have a beneficial effect on the economy – small signs of which are cropping up here and there, for instance in the price of oil (energy and economic growth are closely correlated). But the sturdy seeds of currency debasement are already in the ground and beginning to sprout.

As the strategy of premeditated debasement is the softest of all the hard choices to be made – because it stretches the pain out over time – I have little doubt it is the strategy that will continue to be used. That I am not alone in this view can be seen in the tenacity of precious metals prices.

Viewed from a slightly different angle, by investing in inflation hedges, I can mitigate the damage inflicted on my family by politicians pandering to the proletariat and paying off the well-positioned profiteers whose penthouses have been padded with the patronage produced by their political connections.

One cannot, however, duck taxation – at least not without the very real risk of losing one’s liberty. In my view, providing cover for the government’s insane excesses by raising taxes – especially in the absence of sharp and mandatory reductions in government spending – is an insult.

But other than his views on taxes, Stockman’s interview is worth watching.

Here’s the link.

Speaking of inflation hedges, readers of any duration know that we often jump up and down about buying precious metals-related investments on pullbacks. The latest pullback provides a useful illustration on that point.

You may recall that I mentioned on November 17 that I couldn’t resist picking up shares in a junior explorer that is almost certainly sitting on a large economic deposit, but that had been knocked back along with the rest of the sector during the correction (and it wasn’t alone – a slew of high-quality companies suffered as well). That particular company was listed as an International Speculator recommendation as a “Buy on Weakness under $2.70.” On November 17, the day I picked up more shares, I paid just shy of $2.60 per share. Today, those same shares are selling for $4.50 – a 73% gain in less than two weeks.

If you haven’t yet built your own precious metals portfolio, please don’t start wildly chasing the markets or stocks. But don’t wait another minute to begin building a clear understanding of which companies offer tangible values… because only then will you recognize a bargain when it appears.

Not to be a broken record, but a no-risk trial subscription to our International Speculator now in its 29th year, is absolutely the best way to go. As your 3-month trial comes with a 100% money-back guarantee, letting the opportunity to prepare now for the next correction pass you by makes zero sense – at least not to me. In any event, here’s the link.

Now it’s on to Vedran Vuk, but as his first article deals with the Black Friday shopping phenomenon, I wanted to share a quick video of the madness that takes place. As you’ll see when you watch this collection of footage from the opening moments of Black Friday shopping, there’s an eerie resemblance to the sorts of scenes you’d normally expect to find in movies of the zombie genre. Here’s the link.

Black Friday, a Welcome Reminder

By Vedran Vuk

I hope that your Thanksgiving was as pleasant as mine. I spent most of it reading a book on Chinese trade relations with Africa and studying alternative methods for calculating the weighted average cost of capital for financial modeling purposes. But in between these exciting activities, I managed to do some early Christmas shopping.

For the first time on a Black Friday, I woke up at 5 AM for a door-buster at the local Walmart. I had my eyes set on a $90 portable DVD player specially marked down to $40 – a perfect Christmas gift for my brother-in-law. I figured that an hour or two of my sleep was certainly worth the experience of participating in this uniquely American tradition, not to mention the $50 savings. And I’m glad that I went – least of all because of the DVD player. Black Friday was a much-needed reminder of what a completely messed-up nation we live in.

As you can imagine, the early-morning Black Friday crowd at the Baltimore City Walmart wasn’t exactly high society. But nonetheless, the parking lot was filled with shopping carts lugging enormous flat-screen TVs. Other carts were loaded almost two feet over the rim with appliances, electronics, and other gadgets. In the parking lot I thought it was bad, but in the store it was worse. Carts were stuffed with two and even three giant TVs at a time. In the line next to me, one guy purchased a total of four gargantuan flat screens. And I’m not talking about well-off folks here.

Not every place around the world is like this. Being originally from Eastern Europe, the attitude there is completely different. If you can’t afford a TV, you don’t buy a TV. That’s it. Can’t afford a house? You rent or live with a relative. Can’t afford a car? You get a bike and ride the public bus. People generally live within in their means. Sure, access to credit is more difficult there, but nonetheless, it’s more than just the credit line.

Regardless of the current economic crisis improving or not, I just can’t see the values of our society maintaining the U.S.’s economic dominance in the long run. A small minority of entrepreneurs and hard workers are pulling the load for the whole country. Everyone else wants everything for the least work possible. And leveraging oneself to the hilt isn’t the exception, it’s the norm. On the other hand, our international competitors have impressive savings rates and will work their hands down to the bone –whether at the factory or on the keyboard to build a better life. In my opinion, China is only beginning to emerge as a world economy. Sure, it may have a bubble in the short run, but if China continues to liberalize, there could be a lot more growth ahead. Over the last century, Japan’s phoenix-like growth should give us an inkling of what’s possible for China – if the country plays its cards right.

And now for some thoughts on the politics of central banking…

The Basics of Political Macroeconomics

Over the past few months, I’ve discussed the politicization of macroeconomic policy. Geithner’s demands for China to raise rates are certainly troubling. Unfortunately for him, bully-boy threats seem to be paying few dividends in international monetary policy. But now Geithner claims that congressional leaders who want monetary policy to focus on price stability instead of full employment are politicizing the Fed as well.

At first blush, the claim seems hard to deny, but it really isn’t. In fact, one could argue that a focus on price stability would reduce the politics behind monetary policy. Further, the academic literature does not warn against all politics in monetary policy. It simply warns against politics deciding interest rates and the money supply (like Geithner’s prodding of China’s rates). Essentially, don’t let politics decide the speed of the printing press. Bernanke, a well-respected academic, should fully understand this distinction.

There’s nothing wrong with a bill that redirects the Fed toward price stability. Plenty of central banks have taken the same steps. The Fed could still dictate monetary policy as it sees fit.

Further, we have a clear example with the European Central Bank, which primarily focuses on price stability. Would it radically politicize the Fed to adopt a sensible ECB policy? I think not. In fact, the European Central Bank in many ways reduced politics in central banking with this policy as well as others. Previously, European governments could spend like crazy and finance themselves through a printing press. But with the creation of the ECB, monetary policy was placed into the hands of several countries, instead of only one.

Unfortunately for the ECB, they didn’t get rid of all political problems. Sure, a country couldn’t print a bunch of euros by itself. But this doesn’t mean that the country wasn’t going to run itself into the ground anyway – hence the bailouts. But even here, there is an important advantage to the ECB system. Numerous countries must decide whether to bail out the PIIGS and by how much. The countries in trouble don’t decide alone.

Similar systems and problems already exist in the U.S. Think about California as an example. Every American is extremely fortunate that California is not allowed to print its own U.S. dollars. If they could, the dollar would be going through hyperinflation by now. The fact that other states must ultimately bail out California is the last restraint on this bureaucracy gone mad.

Changing Fed goals can have negative consequences – but not because it’s a politicization of the money supply. Politicians will not decide interest rates. With price stability as the key goal, things may even be less political. After all, the unemployment rate is inevitably tied to the fates of many congressmen and the president. And as a short-term monetary stimulus can reduce unemployment, it’s impossible to ignore the political significance of targeting the unemployment rate. On the other hand, price stability isn’t a political issue unless serious inflation takes hold. No one is going to call their congressman because the inflation rate is 3.5% instead of 2.5%. But if unemployment doesn’t change by a single percentage point this year, there will be some very unhappy constituents out there.

In the past few years, the Fed has become much more powerful. Where was the Treasury to warn us about the dangers of politicization then? The very fact that politicizing the Fed is only mentioned when the Fed’s powers are threatened lets you know exactly how political monetary policy has already become.