Thursday, December 13, 2012

December 13, 2012

Washington's Grand Illusion: The Fiscal Cliff
by Damon Geller
December 13, 2012

By now, we've all been scared to death with talk of the country going over the "fiscal cliff" without some kind of budget deal being struck by year's end.  While this kind of talk is great at driving up media ratings and getting politicians airtime, the simple fact is "the fiscal cliff" being discussed is nothing more than Washington's Grand Illusion.  Why?  Because the factors that drive our fiscal policy will not change regardless of whether a budget deal is struck by year's end.  As a result, we are already riding an unstoppable train toward $28 trillion in debt – an unsustainable burden that will cripple our economy, destroy our currency, and slash our paper investments.  And no last-minute budget compromise is going to stop that.  The bottom line?  There is only one thing saving you and your money from launching over the fiscal cliff.

The Clock Is Ticking

At midnight on December 31, 2012 the terms of the “Budget Control Act of 2011” will go into effect.  This means simply that more taxes go into effect as well as spending cuts that were agreed upon as part of the debt ceiling debacle of 2011.  In other words, these measures are necessary just to keep us on track to (only) add $1.5 trillion per year for the next 6 years to our already massive and unsustainable U.S. debt.  Rather than follow this path, the politicians and the media will now pitch the American people that this is a horrible idea because it will “slow growth and GDP” and that any slowdown is bad.   They will tell you that if things slow down, we won't be able to fix unemployment, real estate prices will fall, the stock market will tank, people will be depressed and won’t spend money, and we’ll go “back into recession” (as if we ever recovered).   They are right about the outcome – whether that’s bad is up for debate and obviously depends where your wealth lives.

So, what will happen to your wealth with or without a compromise?  That’s the million dollar question.  Either way, I'll put this in common sense terms, because we’re not here to speculate – we’re here to help offer some helpful suggestions how to protect your wealth in the event of either scenario.

Scenario #1:  No Compromise

The Terms of the 2011 Budget Control Act take effect and growth slows even more.  This causes the devaluation of stocks, real estate and oil  and a “flight to safety” as investors go “risk-off.”   One might assume the dollar may rise, but there’s a major hole in that theory.  When politicians fail, confidence in this country and its leadership drops.  When confidence drops, credit agencies drop our credit rating.  It’s a 2008-type scenario with the difference being the Fed is printing dollars as fast as possible to stave off deflation in favor of inflation.  That will cause the dollar and paper-based investments to plummet.  How much?  In 2008, everything besides dollars and gold dropped 25-35%.  Used car, stock portfolio, your home…  30% drop in 2008.  Remember the debt-ceiling debacle in 2011?  The U.S. lost its AAA rating for the first time and gold went from $1500-$1925 in 10 weeks while other assets fell.  One thing is for certain, even if the politicians fail to reach an agreement, this upward trajectory of debt, gold and gas will not change.  If this happens, like in 2008, gold preserves wealth very well while other “asset classes” drop.

Scenario #2:  Compromise Reached

Some budget cuts and some tax breaks are agree upon, yet the Fed continues to print money at a breakneck pace for all of the same reasons mentioned above.  That doesn't change even if we avoid a budget impasse. To ponder the outcome in this scenario, just think back to 2009-2010 when the Fed initiated QE1 and QE2.  The result was a tremendous devaluation of the U.S. dollar and a precipitous rise in hard assets like gold.  But today, even with a compromise, we're facing worse inflation because we’ll have QE3 happening alongside less budget restraints (more spending) and less taxes (less revenue), so fiscal  deficits will grow even faster than before!

Damned If We Do or Don't

So as you can plainly see, not much changes for your investments or your investment strategy regardless of either scenario.  That's why all this talk about a fiscal cliff is nothing but a distraction from the real issue:  the Fed’s balance sheet and U.S. debt are what determine our path, not the state of the real economy. So whether or not politicians agree to be fiscally irresponsible and strike a deal to spend more with less revenue, or they do not come to an agreement and we follow the same trajectory we’ve been on, here’s what we're looking at:

All debt-data is January 1st and gold-price data is based on the monthly average for the month of January:

  • 2008 US Debt = 10.7T, Gold = $875/oz.
  • 2009 US Debt = 10.6T, Gold = $855/oz.
  • 2010 US Debt = 12.3T, Gold = $1,100/oz.
  • 2011 US Debt = 14T, Gold = $1,360/oz.
  • June 2011 US Debt = 14.3T, Gold = $1500/oz.
  • May 2012 US Debt = 15.6T, Gold = $1650/oz.
  • Oct 2012 US Debt = 16.2T, Gold = $1750/oz
And here’s where we’re going:
  • 2013 US Debt = 17T, Gold = $1,875/oz.
  • 2014 US Debt = 18.5T, Gold = $2,200/oz.
  • 2015 US Debt = 20T, Gold = $2,600/oz.
  • 2016 US Debt = 21.5T, Gold = $3,100/oz.
  • 2017 US Debt = 23T, Gold = $3,575/oz.
  • 2018 US Debt = 24.5T, Gold = $3,800/oz.

And so on, with many outside shots of inflation breaking out, banking systems imploding, currencies failing, or any host of black-swan events that could speed this trajectory.

The Cost of Fighting

Although I suspect the politicians will come to some sort of agreement, I can only hope it doesn’t come at the last possible minute after much bickering.  This is dangerous because of the corrosion of confidence issue (like 2011), another possible credit-rating loss, and massively volatile markets as the drama unfolds.  I see politicians finally making an agreement to allow some tax breaks and some spending.  But which party “wins” is completely irrelevant to your money.  Seriously, your wealth doesn’t care whether the Right cuts more spending or the Left cuts more tax breaks.  Your wealth cares that, with an agreement in place, inflation will accelerate even faster with less to inhibit it; and as a result, the deficit will grow.

As a result, money printing will accelerate at a much faster pace in order to service that debt and keep interest rates low, which will further drive up the debt.  Under this scenario, you can take the numbers above and move them forward faster in time because the budget projections will now go out the window.  One can assume this is better for stocks, better for real estate, far better for gold (which is really the only win-win in both situations) and may keep the banking system from some very rough times.

Save Yourself from the Real Fiscal Cliff

The Bottom line is that because gold doesn’t care about inflation or deflation – it attaches itself to other variables.  It becomes the best protector against the current fiscal cliff situation in either outcome.  It also offers possible huge upside as it’s priced far below its 2011 high of $1925, despite the fact that we’ve added over $900 billion in debt since last September and the Fed has started yet another round of easing and money printing.   If you want a real no-brainer preservation asset moving into another round of very uncertain times, gold is bar-none the safest bet with the greatest upside potential.  The math is all there.  You can look at the Fed policy math, the debt-based math or the historical perspective on these types of fiscally-driven debates, and you can see clear-as-day that it has become increasingly important to have exposure to hard tangible assets that live outside the banking system and stock market, and that right now offer the lowest risk profile with great upside.

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The Republicans Have Failed the Nation
by Erick Erickson
December 13, 2012

Over the next couple of years, Barack Obama wants to raise the national debt to $18.9 trillion or so.

John Boehner, Mitch McConnell, and the congressional Republicans want to raise the national debt to $18.4 trillion or so.

The present leadership of the Republican Party has gone from making the case that government is the problem and the American people are the solution to making the case that Democratic controlled government is the problem and Republican controlled government is the solution.

By giving up on making the case that government is the problem and pivoting to “Democrats are the problem,” the Republican Party has failed the American people. Historically, when parties lost, their leadership went and hid for an appropriate amount of time under a rock after an acceptance of blame and a resignation.

The present Republican leaders in Washington, instead of hiding under a rock, have taken to standing on the rock and demanding conservatives self flagellate. Neither John Boehner nor Mitch McConnell are visionaries. They are survivors. They survive by recognizing the biggest threat to them and trying to befriend it or neutralize it.

Right now, both see conservatives as their biggest threat, not Barack Obama. Why? Because while Barack Obama maintains the White House, John Boehner and Mitch McConnell maintain their positions of power. They exist for power, not for vision. The visions they articulate are routinely backpedaled. Remember the pledge to nowhere the House Republicans concocted in 2010 as a second coming of the Contract With America? Within two months of returning to the majority they’d already ditched their pledge faster than a frat boy fleeing a one night stand. Only conservatives wish to hold them accountable for their breach of trust, thus conservatives are the threat.

The very same Republican leadership who paved the way for the rise of the Democrats in 2006 through moral opaqueness on the role of government in the lives of Americans now seek to shut up and shut out the conservatives who continue to loudly point out that the size and scope of the federal leviathan has grown too unwieldy. More troubling, with the removal of the several of the critics within the party from key committees and a clear message that loud voices of conservatism will not get plumb committee assignments, the incoming freshman class and even the current conservative leaders in the House of Representatives have rolled over.

Let us not kid ourselves. The Republicans intend to strike a last minute deal to cave. They will. They are going blind in the bathroom over the idea of bifurcating tax cuts so Barack Obama can veto the tax cut for high income earners and let the rest slide through. It is, as usual, a too clever by half compromise from the GOP, which has spent more time out negotiating itself to the left than negotiating with the Democrats.

The compromise is no longer the issue. It will happen.

The issue is that the Republican leaders who will be in charge in January are the Republican leaders who were directly complicit in the construction of the fiscal cliff and were directly complicit in getting us already to $16 trillion in national debt. Democrats are not to blame; both parties in Washington are.

Obsequious praise for small government does the Republicans no good when they too are in favor of big government in their actions. And having two leaders as the face of the party who have both been in Washington since 1986 does no good restoring credibility when these multi-decade residents of the swamp wink and smile that they really do think Washington is the problem.

Is it any wonder the American people have come to the conclusion that government isn’t so bad when the party of small government keeps expanding it too? The leaders of the party are the message, not the words. And the message does not resonate because they do not practice what they preach.

Until the Republicans change their message, they will keep losing. Changing the message means changing the men. Will 16 Republicans in the House be brave enough to stand up and say the party needs a new Speaker of the House?

This is not about the compromise. This is not about the fiscal cliff. This is not even about removing Amash, Huelskamp, Schweikert, and Jones. This is about beginning again anew — a process that cannot happen when the faces of the Republican leadership have been in Washington since 1986 expanding government while preaching the need for limiting it.

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