First and foremost, Europe’s problems stem from a difference in competitiveness among European countries, and you can’t solve it by lending money to the less competitive countries. The solution is to deflate wages and prices in the south, and inflate in the north. But given Germany’s history, it will never inflate.

Proof that the ECB does not understand the problem lies in the December agreement among European countries that each country could have a structural deficit of no more than half a percent of GDP. If a deficit goes above 3% of GDP, the country would be sanctioned. This agreement is awaiting ratification by all countries. When you agree to a prescription like this and you are uncompetitive, your currency is terribly overvalued, you can’t devalue, and your interest rates are too high, that is a recipe for depression. It is an economic death sentence, worse yet is that several countries won’t ratify it, and their financial markets will be repriced accordingly. They will then exit the Euro, and the world will witness the turmoil escalate to the next level.

Greece is bankrupt, yet it has no capacity to devalue its currency by the required 50% to try to recover. When the Greek banking system goes bust, people will realize that the Greek private sector is also bust and worse yet is that banks in other countries will be in trouble, requiring nationalization (government takeover). Governments don’t have the funds to pay for nationalization, thus they will be forced to issue more debt.

There are three main problems in Europe. The first is that most of the banks are massively insolvent, because they have 30 times their capital invested in the second problem, which is the sovereign debt of countries that are incapable of paying the debt. If the banks have to write down the debt to what its real value is, or what it soon will be, then they will be bankrupt on a scale far worse than 2008. Countries cannot operate properly without functioning banking systems.

The third and largest problem I hinted at early in this blog post is the massive trade imbalances. I have written recently in blog posts that Germany exports products to the peripheral European countries, which run trade deficits. A country cannot reduce private sector leverage and deficits (balance its budget), and run a trade deficit all at the same time. Folks, it’s no different for a country than it is for an individual, you must run a cash flow surplus if debts are going to be reduced.

Greece runs a 10% trade deficit, when one considers the leveraged nature of their government two things must happen, the first is cutting budgets, the second is raising taxes, both of which will cause their economy to continue to shrink, it’s a vicious spiral that will ultimately suck in all of Europe – the world’s largest economy. As I have said in the past, if you want to fix governmental and banking systems problems, the first thing you have to do is stop rewarding the bad behavior. In our example, governments keep kicking the can down the road avoiding the unthinkable, which simply makes the unthinkable a larger, more global problem.

We estimate that a long and painful period of debt restructuring and austerity is in store not only for Europe, but global markets as the world’s largest economy sabotages growth in all other economies around the world. In a separate future blog post I will discuss the ridiculously high 2012 GDP estimates currently endorsed by all the major investment banks, for now let’s simply say that these estimates currently at 3-3.5% will likely be reduced to 2-2.5% in the coming months, and ultimately we believe the Europe effect will sap 1% of the 2-2.5% reduced GDP forecasts.
A long only stock and bond asset allocation strategy will likely be impaired on both fronts in 2012.

Be Well.

On everyone’s mind today is the EU crisis which is certainly part of a developed world crisis brought on by too much debt that must be deleveraged, a process that will take many years in both the EU and the U.S. I often hear comments from people about how small Europe really is and they believe this is not really our problem, but theirs to solve – let’s discuss.

The EU debt crisis is leading to greater fiscal austerity and is rapidly pushing most of Europe into recession. As was the case with subprime mortgages, this is not someone else’s problem and it is certainly not an isolated event. The EU nations combined constitute the single largest economy in the world and they are major importers from both the U.S. and other emerging nations often discussed as hot growth economies. A significant reduction in EU imports will have a major impact on global GDP. In addition, as European banks take necessary steps to strengthen their balance sheets and raise capital, they will impair credit availability and world trade.

A major domestic investment bank just estimated that the EU crisis could cut U.S. GDP by 1%, stating that a reduction in the lending of foreign banks to U.S. counterparties could have a meaningful impact on U.S. growth. France’s third largest bank, Credit Agricole SA, is leaving 21 of the 53 countries in which it operates. Germany’s Comemerzbank is negotiating to transfer suspect assets to a government owned “bad bank”. This is likely just the tip of the iceberg, as massive loan losses can severely impair the ability of the European banking system to function.

Another major domestic headwind is consumer spending in the U.S. Despite a modest improvement in recent economic releases, consumer spending has been propped up by a decrease in the household savings rate from 5% of disposable personal income (DPI) in June to 3.5% in October, disturbing when one considers that most U.S. households have much savings to make up after the economic destruction of recent times. In order to deleverage debts, the savings rate will have to rise with the associated negative effect on spending. Consumers will also be restrained by the slow rise in incomes brought on by continuing high unemployment, lack of credit and low house prices.

GDP growth for 2012 is likely to be pressured by tightening fiscal policy. The number of tax and spending measures expiring at year end may reduce GDP by an estimated 1.7%. If Congress can come together on the payroll tax cut the GDP reduction would likely come in around 1%. Am I the only one disgusted by the absence of economic motivation and service to our country from both the Senate and Congress? Political motivation is an expected part of this process, but it should not be the ONLY motivation our chosen leaders pursue. In this season where parents tell their children Santa’s watching, I wish to express to politicians that voters are watching, we are looking for an overhaul of the power we allow our chosen leaders to wield, we are going to demand results accountability.

Jumping to reliability I would like to drop a huge bomb on you, economists have pretty much no idea what will happen next year! Economic forecasting is very much like driving fast at night. Thanks to your headlights you can see what’s coming a few hundred feet in front of you, but you can’t see beyond that. And if you’re going too fast, by the time you see the curve or deer (black swan), it’s probably too late.

What analysts and economists do have is a general idea of what will probably happen next year. They base their forecasts on an understanding of what has happened in prior years, with a bias toward what has happened in very recent years. In other words they conclude that next year will be pretty much like the last few years.

Given the confidence with which most analysts and economists speak, it’s easy to forget that their performance track records suggest that they have no idea what will happen. Think I’m being too harsh on this mostly hard working group of men and women? The long term average growth for the economy is 4%, this is also precisely the number economists always predict that the economy will grow at in the future, because it gives them the best odds of being generally right (or at least not too embarrassingly wrong).

The headwinds are daunting, volatility is excessive, and thus opportunity is closest at hand, it may come in the form of a short term stock market run, moves in physical commodities, or interest rates – but come it will.

Happy Holidays!

Recently the ECB announced that instead of Greece filing for bankruptcy, all parties who owned Greek debt would suffer a 50% loss to their capital – thus debt balances were reduced by 50% – this was an attempt to prevent contagion in the financial system; we are very concerned about the unintended consequences of these actions.

First, remember that all governments will continue to need to sell bonds as a refinance measure for increasing deficits and existing debt which is continuously maturing; the risk of default on this debt is managed by institutional debt buyers thru several credit derivatives including Credit Default Swaps (CDS). The ECB’s declaratory 50% haircut to debt levels along with a lack of contractual remedy in the recently struck October 26 agreement for substantially higher minimum capital ratios for the banks substantially increases the odds of a serious credit contraction.

If support for Greek growth in the form of debt forgiveness coupled with tougher capital rules causes European banks to stop lending, the eurozone economy will be the victim of these policy initiatives.
Unfortunately, this issue is addressed in just one line of the 15-page document, and all it says is that, “National supervisors must ensure that banks’ recapitalization plans do not lead to excess deleveraging.”

The lack of any mention of how supervisors are supposed to prevent this outcome suggests a complete lack of understanding among those who drew up the agreement. This is because this is not an issue that can be resolved by national bank inspectors.

Banks will try to raise capital ratios by deleveraging; not raising fresh capital.

Shrinking the balance sheet is synonymous with calling in loans. While that would present no problem if carried out by only one or two institutions, it could trigger a sharp credit crunch in the broader economy if the entire banking sector goes down that road.
This is exactly what the large Italian Bank Unicredit (10,200 branches in 22 countries) announced today:
“…Proactive balance sheet management and ring-fencing of non-core performing assets in a €43bn (RWA) run-off portfolio. With around 80% of the portfolio expected to run-off by 2015, the ring-fencing initiative will free-up substantial capital and liquidity during the Plan’s implementation period.”
In other words, Unicredit is going to massively reduce its risk in an attempt to meet capital and liquidity requirements.

It’s almost certain that Unicredit won’t be the last, and so there’s about to be a big vortex sucking credit out of Europe.

Solutions to the Eurozone Debt Problem in our opinion will likely be framed around four possible outcomes. (hence we wonder if leadership is present to recognize the correct choices at the correct times).

1. The Germans can take their export surplus, taxes, and savings and pay for the deficits in the southern zone until such time as they can be brought under control. Or they can bail out all banks across Europe – the European banking system operates differently than US banks in that they use their excess cash to buy European Government debt (oops, the banks are now seriously undercapitalized because the debt is still held on the books at cost, but worth considerably less). Why would Germany bail out banks across Europe? They need the exports, and a customer without a banking system cannot buy your goods. Politically this option won’t fly.

4. Problem countries leave the Eurozone. If this option is chosen and it is not managed in a highly organized fashion, the financial chaos will reverberate around the globe.

Where’s the leadership opportunity you may ask? Well, none of these options are pretty paths and will mean a banking crisis and potentially long term recessions – that is of course only if many of the most optimum choices are made!

OK, I cannot end on that note, at Alpha Fiduciary we spend a great deal of time focused on asset class diversification – but for the short duration of this report I want to focus on a different type of asset allocation – allocation of capital to Entrepreneurs and free market capitalism!

Let’s look at a fictitious restaurant business in need of a new strategy to improve its results.

Would you wipe out 50% of the businesses debt? Perhaps give it a government loan of $1,000,000 to spend on the restaurant? If you did, it’s likely the few frequenting customers would see nice new furniture and fancy plates. This may present an improved look, but the business will likely just fail with new furniture and plates!

Put a CEO like Ray Kroc (founder of McDonalds) in charge of that business and he will innovate modern franchising and return the money ten times.

It is not how much you spend; it is what you spend it on. So how do you get the money to a Ray Kroc or a Steve Jobs instead of a bureaucrat? It is called capitalism – the efficient allocation of capital. Our problem today is not a “balance sheet recession” (that’s our symptom), it is that capitalism is broken, due to moral hazard from enormous government intervention and Fed stimulus. The wrong people have the capital. They are not the Ray Kroc’s, the guys who earned it hamburger by hamburger.

Substitute any business for the above scenario including the management of the global credit system, and I can assure you creative hard working people if allowed to operate in a capitalist system will fix it by giving the customer exactly what they want at a price they are thrilled to receive it at!

Be well.

“The situation feels increasingly like one that has little chance of materially improving until some extreme pressure is on the correct people to act. It may or may not come to a head this week, but the signs are not good that we can avoid an extreme situation emerging soon”.

This morning LCH Clearnet increased overnight the amount of collateral to be posted as initial margins on trades. They have used a tiered approach: 0-3 months at 3.5%, 9m to 3.25 yrs at 4%, 4.5% increase from 3.25 to 7 yrs, and finally 5% increase from 7yrs to 30 yrs, and index linked go from 9% to 14%.

We participated on two conference calls early this morning to discuss the ramifications of this move by clearing houses and surmise that while this is not the haircut increases being feared in the European markets over the last few days, this is clearly removing liquidity from the system and implies about e5.5bn of cash to be posted on top of what was posted yesterday. One thing is clear, there are a lot of sellers on the sidelines in Italian bonds and the news is creating more margin selling while the only proper buyer for Italian debt is the ECB, and despite their average clip size, they have so far failed to keep yields from spiking past the key 7% level where most experts consider sustainability a low probability outcome.

One key takeaway from both conference calls this morning was that American and Asian investors are still far too hopeful of a great solution in Europe. Even with Berlusconi’s resignation the last few weeks have shown disappointing actions out of Europe and lots of promises and few hard facts about a solution.

Three potential outcomes were discussed on the call as follows:

1. A coalition based on Berlusconi’s old coalition would ally the parties that supported him, and reach out to a few smaller parties. This coalition has already shown support for EC/ECB/IMF austerity measures, but many fear it will not do a job much better than Berlusconi. Under this scenario bond yields are not expected to decline – a decisive negative for Italian borrowing costs.

2. A coalition of centrist “technocrat government”. This could produce a government more amenable to reforms that encourage growth and improve governance. Markets would likely approve of this kind of coalition and bond yields are expected to decline by 50-100 bps – still a difficult cost structure for Italian debt.

3. General elections are called after Berlusconi’s resignation (which will take place once the 2012 budget is passed next week) for January at the earliest. This would be the worst case scenario for the markets.
Traders, across the financial markets will likely stay transfixed on Italian bonds the balance of this week. Italy is the third largest debtor nation, and as of this writing has not demonstrated that it is serious about reining in spending, this has now been complicated by concern over future forms of government and whether sufficient time exists for beneficial changes to be implemented. Until the markets see that leadership can be quickly assembled and will enforce austerity packages, yields and tensions are likely to rise.

Italy remains a key unresolved component in the European debt crisis and we will of course provide future updates as needed until the specific risk is abated.

Be Well

The specific path exhibited above is the level of nominal GDP in 2007 (pre economic collapse) extrapolated forward at 4 ½% per year. You may think of this number as the sum of real potential GDP growth of 2 ½% and inflation as measured by the GDP deflator of about 2%. The specific number matters less than the Fed’s willingness to target a path that is anchored to a point like 2007, when the economy was near full employment, and that they indicate they will pursue this target aggressively.
So the question is why this move? Goldman sees it as a natural extension of the Fed’s dual mandate – price stability and full employment, bent more towards full employment. Many economists will find this a pretty sexy idea, as they have spoken of the benefits of nominal growth GDP (NGDP) targeting for some time.
Advocates of NGDP targeting claim that it would achieve greater macroeconomic stability because when recession hits, real output falls but prices tend to adjust more slowly. This means that by targeting nominal GDP, central banks could smooth output fluctuations better. They could also react more appropriately to supply shocks. As an example, take an economy that is hit by a negative supply shock through high oil prices depressing output and raising inflation. An inflation targeting central bank may be compelled to tighten policy, worsening the slump in output, whereas one mandated to hit NGDP would be more flexible.
Perhaps a bit forward thinking, but I think a major consideration of this type of strategy appears in the case where a positive supply shock through productivity enhancing new technology boost real GDP growth while lowering inflation. An inflation targeting central bank would respond by easing monetary policy, which could produce asset bubbles, whereas a NGDP targeting central bank would hold steady. The most visible effect of a nominal GDP (NGDP) policy would be more volatile inflation, but overall a less volatile economy.
Perhaps Goldman’s greatest selling point for this type of Fed strategy is that it believes a shift towards this kind of policy could bring down unemployment much faster than the current path foresees.

There are of course considerations extraneous to the Fed which could influence its decision to pursue an NGDP strategy. For one the political will for asset purchases may be a difficult sell given the public seems to be favoring a deficit and ultimately debt reduction approach. In addition many people believe that an overhaul of the United States tax system is the first step toward improving the unemployment problem in that on the global stage our current tax structure is less favorable to employers than many other global structures available to them. I have obvious concerns about the government potentially increasing its daily role in the economy and interfering with the free hand of the markets and economic forces at hand. Will the government successfully manage the delicate balance of intervention versus allowing the markets to float freely?

A tremendous level of faith must be placed in a government to regulate its own actions, perhaps of some solace is the fact that Americans are no longer content as long as gas and Big Mac’s cost under $5, think less about the details of uprisings such as occupy Wall Street and more about the big picture – Americans are increasingly frustrated with both political parties and willing to organize beyond the traditional “vote the offending party out next time”. Americans want solutions to the difficult problems they live with day to day, will these actions produce benefit? Stay tuned.
This week we will see a significant flow of economic data beginning with the Empire Fed survey, and Industrial Production on Monday, Tuesday’s Producer Prices, and Wednesday’s Housing Starts, and Fed Beige Book. Thursday Jobless claims will be reported (estimate 404k), as well as existing home sales – estimated to decline 2.5% after the 7.7% jump in August.
While all of this economic data will certainly catch the eyes of investors, they will likely be more focused on Europe news, as Sarkozy and Merkel have promised a solution on banks and debt within just a few days.

More to come shortly!

Be Well.

Alpha Fiduciary has been monitoring a growing minority of economists who believe that there will be a double-dip recession largely because of the insurgence of high unemployment and the still faltering housing market. The notion of a “jobless recovery” has been around since the recession of the 1950’s and 1960’s. It is a concept built on a simple idea: employment lags during a recession but is always part of a recovery cycle. Production rises as businesses see the end of a downturn and anticipate improving sales. They are reluctant to hire new workers until a recovery is confirmed, but once it has been, hiring picks up.
The 2008 recession was (if it’s over) different from any other both in depth and its causes. This recession was a balance sheet recession triggered by a downturn in housing prices, which robbed many people of their primary access to capital. That access evaporated along with their access to credit. Consumer buying power vanished and businesses cut inventory and production, joblessness rose, and finally consumer confidence plunged.

The depth of this recession was so severe that in some months more than 500,000 people lost their jobs. The unemployed now number well over 14 million and more gravely, over 6 million people have been out of work for over 27 weeks so they may no longer be eligible for unemployment benefits in early 2012. This segment of the population has already begun to add to the number of indigent Americans and will continue to do.

The second dip of the recession, according to economists and the federal government, is likely to begin within the next two quarters. Alpha Fiduciary has been of the opinion that unemployment would be a long term structural challenge to this recovery as unemployment claims have been running well above expectations, recently passing 400,000 almost every week. The four week average of initial claims rose to 414,740 this week. August unemployment figures showed the economy added no jobs last month.

To conclude our discussion about jobs, the federal, state and local governments are in no position to lend assistance to businesses, most of which lack access to capital. President Obama has just proposed spending $447 billion on job creation, but the Republican drive for austerity will likely keep the President’s proposal from becoming law. Banks are also not prepared to lend to small businesses, especially those with modest balance sheets – a problem given that companies with fewer than 100 workers have traditionally been the largest creators of jobs.

The bottom line for employment is that we are in a state of low level disequilibrium, and we cannot shift to a state of high level equilibrium (consumers spend because employers hire, employers hire because consumers spend) until the balance sheet problem is addressed. This will require debt restructuring and potentially mortgage restructuring. This will be difficult to achieve as banks deal simultaneously with exposure to debt in Europe.

While it would be nice to be able to close this discussion with “here is how this ultimately plays out” that is of course not possible. We at Alpha Fiduciary believe continued volatility in the financial markets will provide both challenges and opportunities depending on one’s investment strategy; you can count on us to provide our insights at the appropriate intervals.


Be well.

Our regular readers may remember our prior posts (June 16, 2011 Special Update, July 26, 2010 The EU Stress Test that wasn’t, and May 26, 2010 Greek debt crisis on verge of “going Global” by Pimco’s El-Erian) predicting that some EU banks would likely have trouble raising capital. And given the “web of debt” in which troubled EU countries and banks all own each other’s debt, the ability to raise capital would be critical in the event of defaults, as banks holding restructured debt would themselves be forced to recapitalize.

The truth of the matter is that many of the world’s governments currently lack credibility with investors, and until politicians stop kicking the can’s down the road and they allow inevitable events such as Greece failing and exiting the EU to occur, we will simply postpone at great cost that which must occur for healing to begin.
As to the US, domestic banks have little direct debt exposure to PIIGS debt. Though they do have some $200 Billion counterparty risk to European banks, including $10 Billion from Greece. Greece has suffered a loss of 60 Billion Euro’s in private sector bank deposits, for which it has turned to the European Central Bank to fund. Italy on the other hand has suffered no loss of deposits yet, but spooked the markets last week when it too turned to the ECB for aid.

In the absence of leadership investors globally are left to react fearfully to the headlines of any particular day. While I am at it, let’s be clear that despite Warren Buffet’s now famous quote about fear and greed, fear is a useful emotion and one that each investor should pay attention to. Fear is your brains way of asking you if you have a credible plan, don’t answer yes to that question carelessly.

For the benefit of all readers, I am going to state the obvious that to begin to address our debt, we must first fully solve our deficit, which Republican and Democrat Congressman failed to make material progress on recently, given that 65% of the smaller than required spending cuts they passed were pushed out to 2013. Once again in the absence of leadership….

Goldman Sachs just slashed (about time) third and fourth quarter 2011 GDP estimates to 1%, and 1.5% respectively. It is almost incomprehensible that post recession and with two massive Fed induced quantitative easing programs in our rear view, that the US economy is expected to grow sub 1.5% in the second half after sub 1% growth in the first half of 2011.

The credit crisis which began at the consumer level, then elevated to the banking level, has officially infected the Federal level, yet many Americans still choose to listen to and entrust their wealth to the same conflicted institutions that paved the way to these formidable challenges we now face.

Let’s focus on what investors must do to survive the effects of poor leadership and bloated governments. First and foremost you absolutely must abandon your primary belief that opportunity only exists in stocks and safety in bonds. Second you must abandon your belief that you want performance in each quarter and recognize that performance over a 1-3 year period will be much better if you don’t force yourself or your wealth managers to “do something”. Embracing a new correct paradigm will reward investors as the balance of this decade produces devastating results for those who prefer adherence to a stocks, bonds, and cash mentality.

As world governments employ increasingly bold actions, which are likely to fail to achieve lasting improvement, until leadership becomes fashionable, Investors should expect increased volatility and rolling trending patterns across all asset classes. Some asset classes must be shorted to be useful, while others must be owned long with a disciplined approach to loss mitigation. All of which must be reevaluated in a rapidly evolving economic climate.

A portfolio rooted in global assets, directionally and tactically managed across the asset class spectrum is simply the best way for investors to mitigate headline risks and promote calm thinking in an otherwise shaken investor universe, where the extraction of returns will evade novice and professional investors alike if they cling to old paradigms.

Portfolio’s rooted in new correct paradigms have significantly outperformed the old stocks, bonds, and cash yellow brick road of investing paradigm thus far in 2011. You will recognize those investors who have embraced the new paradigm as those focused on the financial welfare of friends, family, and acquaintances when fear grips those who did not, on the journey thru the balance of this decade.

Be well.

I will go one leap further and speculate that the “clean up” costs incurred by our government for the financial mess enabled by S&P and other rating agencies, contributed to the list of factors that ultimately led to weakening our government’s financial position. Which in turn lead to our rating downgrade and whatever contagion events that may lie ahead for us.

The ultimate toll for these actions will likely be felt by all of us whether we are debtors or savers in this economy. Most people have a basic understanding that if the cost of credit for risk free borrowers were to increase, then surely every other debtor will find that the cost of credit rises accordingly.
Household debt has risen sharply since 2008 even while consumers are largely eschewing debt. That said, it tends to increase during tough times according to Milton Friedman’s “Permanent Income Hypothesis”, where he stated that consumer debt could be expected to rise during periods when incomes are low, and to fall during periods when incomes are high.

Many households are increasingly relying on debt to make ends meet, and potentially rising credit costs will further damage consumer sentiment, and leave many families particularly vulnerable to rising food and energy costs. The effects of this rating downgrade will likely be felt ultimately in the form of more workforce reductions as companies adjust to reduced sales and increased credit costs themselves.

Consider that S&P’s actions will harm debtors and savers alike, given that many savers keep a portion of their wealth in money market funds. It is possible that short of explicit government action, a decrease in the value of US Treasuries could cause some money market funds to break the buck, causing nervous investors to withdraw their funds. A move I would dissuade given that it’s unlikely these funds would remain below a dollar for very long.

It ‘s highly likely that large money center banks, often thought of as too big to fail, will get downgraded following the US Government downgrade. These banks currently enjoy higher credit ratings than they would if not for the perception that they would be bailed out by the government if they get in trouble. If the US’s debt is riskier, so are the banks backed by the US. This could very well cause the most thinly capitalized banks to become distressed.

While on the topic of banks, I should point out that banks aren’t required to hold any capital against US Treasuries because these assets are considered risk free. Assuming these assets are no longer risk free, will banks have to set aside capital for these assets? Capital not adequately available today. There is a staggering amount of collateral currently in use for all sorts of obligations, including margin loans, derivatives, and other short term loans.

I would expect junk bonds to sell off now as many institutional investors sell the riskiest side of their bond holdings. Perhaps the most surprising result of this downgrade may end up being a rally in US Treasuries! It would not surprise me if Treasuries rallied as investors increasingly seek the safety and liquidity of Treasuries over other asset classes. The Federal Reserve would likely be the buyer of last resort, further expanding its balance sheet while buying from any forced sellers of Treasury assets.

S&P downgraded Japan’s credit rating back in 2002. Many investors figured it would mean that Japanese bond prices would fall and interest rates would rise, rates did rise, but not as much as doom Sayers thought. Betting against Japan’s bonds became known as the “trade of death” because it doomed so many people.

I believe S&P’s downgrading of the US credit rating was intended to send a not so subtle message to a dysfunctional Congress, which has failed to produce credible results. But is the potential burden which will be placed upon every American by S&P more justified than the virtual inaction of Washington?

Be well,

The stakes in this battle are enormous as the debt ceiling deadline looms and credit rating agencies are threatening to cut debt ratings not just on the U.S., but every AAA rated financial entity in America, including insurers, if there’s no debt deal. The lion’s share of sound bites you are hearing in the media from both sides of the political isle are nothing more than theatre and I will even go so far as to say that it punctuates the point that while you may have voted for your elected officials, they do not work for you – they are life time politicians and this is their daily work.

Yes, they will miraculously find a workable solution at the eleventh hour that will ultimately have no chance at solving the real problem – which is that too many people depend on the government for subsistence and the bills for these benefits far exceed the revenue that the government brings in. Oh I know I have dramatically over simplified the problem in a narrowly focused statement. I will try to broaden it out – politicians around the globe have promised too much, for too long, to too many people and that is why governments around the globe are insolvent! Folks, our government has a spending problem more than a revenue problem. Governments around the globe need to shrink so that they do not consume such a large share of each nation’s productive growth.

What is the debt ceiling?

The debt ceiling represents a limit on the amount the U.S. Treasury is allowed to borrow to manage the national debt (the total amount currently owed by the U.S. government). Before World War I, Congress often approved the terms of individual debt instruments issued by the Treasury to pay for spending authorized by Congress, including maturities, interest rates, and the types of financial instruments used. Eventually, members decided in 1939 to set an overall limit on the total amount the Treasury could borrow to pay the nation’s bills without congressional authorization.

An increase in the debt limit does not authorize additional governmental spending; only Congress can approve future spending. However, Treasury officials have said that if the limit is not raised, the government would not be able to pay bills that have already been incurred. According to the Congressional Research Service (an arm of Congress), the debt ceiling has been increased 78 times since 1960 (10 times just since 2001), under both Democratic and Republican administrations.

The national debt has two aspects. Debt held by the public occurs when investors buy debt instruments sold by the Treasury to finance budget deficits and pay bills; it represents almost two-thirds of the current debt. Debt held by government accounts is created when the Treasury borrows from government accounts such as the Social Security, Medicare, and Transportation trust funds.

The presidents’ idea that raising taxes will increase governmental revenue has been tried and disproved many times before. Many years ago a popular president was asked how to cut spending without over burdening wealth producers and throwing grandma into the street. His advice: “Our true choice is not between tax reduction on the one hand and the avoidance of large federal deficits on the other”, this Democrat said. “It is increasingly clear that an economy hampered by restrictive tax rates will never produce enough revenues to balance our budget just as it will never produce enough jobs or enough profits”

He went on. “In short, he said, “it is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the tax rates now.” And that is exactly what John F. Kennedy did. The 35th President of the United States delivered those remarks to the Economic Club of New York on Dec 14, 1962 and he made good on his pledge. As a result, federal tax revenues went from $94 Billion 1961 to $153 Billion in 1968 as Kennedy cut the capital gains tax and slashed the top marginal tax rates from 90 percent to 70 percent.

But our current tax rates are much lower than 70 percent today, you are probably saying… when one considers all of the taxes one pays from real estate, to sales, usage taxes, payroll taxes, estate taxes, we are not living in a period of low tax rates.

JFK had another famous quote “economic history teaches us that when confronted with weakness the proper remedy is to grow, not suffocate the economy.” During the Reagan years, our President cut taxes but doubled revenues.

Congress shame on you for wasting precious time instead of implementing solutions to our problems, history has taught us how to solve our current problems. Here’s an idea, I have told anyone who would listen to me many times over the past three years that the solution to our current fiscal malaise both individual and governmental is a massive tax rebate. That’s right, a rebate of taxes paid over the past two years to every tax payer! Think of how many homeowners would have been spared foreclosure, how many more auto’s that would have been sold (no GM bailout possibly!) the point is that the stimulus that we called QE1 was in fact necessary, but a tax rebate instead of the failed QE2 would have been far more effective in that it would have been applied to the wound – those consumers who owned homes turned upside down as their home equity vanished, and those consumers who would have used that weakness as a buying opportunity, but couldn’t get a loan as shell shocked banks chose not to lend.

There is a real need for a solution that takes cash out of government hands and puts it into the hands of those who can best determine how to save, spend, and invest it for their best benefit.

Any business owner can tell you that onerous government regulation is costly and burdensome to running a business, and is usually the result of politicians campaigning and winning elections on platforms which are effectively closing the barn doors after the horses have escaped.

Urge your representatives to support the Cut, Cap, and Balance petition and further urge them to shrink government if you believe increasing your taxes is not the answer to our nation’s fiscal problems. I believe we have a relatively short window to achieve these critical few objectives so that we may pass to our children the same wonderful opportunities that were presented to us and that make the United States of America the greatest republic of all. Do not allow yourself to see the grass as being permanently greener on the other side of the fence, what we have is worth fighting for – if it weren’t we would not have so many people from other parts of the globe trying to bring their talents and families future to America!

Be well.

“IEA in Paris announced this morning a release of 60 million barrels from OECD inventories. The implications of this extraordinary action are not positive. Let’s first take a look at the most recent global production data, which shows the large downward move of supply coming into March 2011, from the loss of Libyan oil. IEA is pointing to this loss of supply as the prima causa for its decision. | see: Global Crude Oil Production in mbpd (million barrels per day) 2004-2011.

While some asset markets, perhaps global stock markets, may take comfort from the lower price of oil over the next 90 days, the intermediate term realities, implied by this action, are rather worrisome. I will list a few here:

* We know that Saudi Arabia did not rescue the oil market this spring, as was originally anticipated. Both the Financial Times and Gregor.us covered this issue originally in February. By April, it was clear that Saudi did not make up the Libyan loss. Thus, the IEA inventory release implies that whatever extra supply Saudi Arabia can offer, it is either too sour or heavy to bring down the price of global diesel, or Saudi can only pump extra oil for short periods of time. In my view, both of these factors are in play.

* Releases of oil from inventory are counter intuitively bullish, not bearish, for prices. While oil prices no doubt will be rocked for several months now, releases such as these only highlight the fundamental problem at hand: structurally restrained supply. For example, the OECD could have turned to non-OPEC producers within their sphere of influence and asked them to produce more. But Non-OPEC producers, accounting for 57% of total global supply, have no spare capacity. The oil market is going to figure this out more quickly than most imagine.

* By knocking price down, the IEA is threatening the vast quantity of marginal supply that has come on stream the past two years. Much of this oil is broken free from shale, drilled at great depths in oceans, or converted from oily dirt (tar sands). To the extent that price is knocked down by such actions, this will affect the future development plans of those Oil and Gas producers who’ve been engaged in bringing the world its new, high-priced supply. I target the $80.00 level as the price point not where supply is taken offline, but where future marginal supply of any substantial note is at risk. Again, the oil market is going to do this math and it will not take long to run the calculations.

Today’s release of inventory is confirmation that the era of permanently constrained supply is now very much with us. Because industrial economies are simply machines that convert energy inputs into useful work and services, today’s action is also a reminder that the dream of higher growth in conjunction with lower oil prices is now a backward looking view, nostalgia for a past that’s no longer possible.”