Profiting from the World's Economic Crisis E-Book

Bud Conrad

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 578

Veröffentlichungsjahr: 2010

Beschreibung

PROFITING FROM THE WORLD'S ECONOMIC CRISIS In Profiting from the World's Economic Crisis, author Bud Conrad, Chief Economist for Casey Research, predicts a rough road ahead for us--due to economic imbalances that have built up over the past decade--but reveals how you can prosper during these difficult times by tracking global market trends and finding investment opportunities that match those trends. With this book, Conrad outlines the long-term direction of our economy as driven by increasing U.S. government and trade deficits, oil prices, Social Security and Medicare obligations for baby boomers, the credit crisis, and the weakening dollar. He also examines why some of the government's actions--such as bailing out banks and curbing interest rates--fail to address more serious, long-term issues such as too much debt. The crisis we have entered is not a typical business recession, but, instead, a major deleveraging which is the biggest shift since the Great Depression. The stagflation of the U.S. economy will present great challenges on a global scale. And since no market travels in a straight line, you need to be positioned correctly, with the right investments, to protect yourself and profit from the twists and turns you'll inevitably face in today's turbulent economic environment. Profiting from the World's Economic Crisis deftly addresses how to gain your financial footing during these difficult times by highlighting global investment opportunities--such as gold, interest rates, currency, and commodities--that are likely to help you profit in the coming years. Visit www.caseyresearch.com

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Table of Figures

List of Tables

Acknowledgements

Introduction

How This Book Is Organized

Part One - ECONOMIC FORCES

Chapter 1 - The Budget Deficit Drives the Growth of All Debt

The Budget Reflects the State of the Nation

Federal Budget Spending

Taxes and the Federal Budget

Federal Budget Borrowing

How Will the Deficits Be Funded?

History Puts the Credit Crisis in Perspective

Historical Projections Have Underestimated Deficits

The Components of Government Spending

How Government Debt Compares to Inflation in Other Countries

Conclusion

Chapter 2 - The Trade Deficit and U. S. Dependency on Foreign Investments

The United States Is the Largest Debtor

The Connections between the Trade Deficit and the U.S. Economy

The Connection between Home Mortgages and the Trade Deficit

Implications of a Falling Trade Deficit

Trade Deficits and Government Budget Deficits

The Effects of the Trade Deficit

Trade Imbalances Hurt the Dollar Status and Set Up Foreign Investors

Connecting the Trade Deficit, Budget Deficit, and the Fed

Sources to Watch

Custody Accounts at the Federal Reserve

What Will Be the Effect of the Increasing Trade and Budget Deficits?

Conclusion

Chapter 3 - The Big Costs of Health Care, Social Security, and the Military

Health Care and Social Security Costs

Social Security Will Drag Deficits Lower

Defense Spending Is Continuing to Grow

Conclusion

Part Two - FINANCIAL CRISIS RESPONSE

Chapter 4 - The Federal Reserve Prints Our Money (Stop the Presses!)

What Is the Fed? A Private Profiteer or a Government Agency?

Who Benefits from the Fed?

How Is the Fed Affecting Our Investment Horizon?

The Fed Is Out of Control

How Did the Fed Pay for Its Big Expansion?

Money Creation at the Fed: Is There Any More to It Than Dropping Money from Helicopters?

How the Fed Really Creates Money

How Effective Is the Reserve Requirement at Controlling Money?

So Why Are We Seeing Deflation in Stocks and Houses Now?

Foreigners Are Partners in Our Credit Supply

The Government Is Supporting the Economy Rather Than the Dollar

Federal Reserve’s New Inflation Policy

Who Will Buy All the Treasuries?

When Might Deflation Turn to Inflation?

Political Implications of Egregious Fed Spending

The Fed May Be Acting Beyond Its Intended Authority

Conclusion

Chapter 5 - The Importance of Debt for Predicting Our Economy

Our Debt Has Grown Way Beyond What Our Economy Can Support

Our Money Is Debt Today

Debt and Money Have Grown Together

Credit Flows Predict Economic Crisis

Credit Expanding and Contracting Defines Our Financial Future

Economic Effects of Debt

Where Is the Inflation?

Managing the Overextended Debt Leads to Inflation

The Implications of the Bursting Debt Bubble

Conclusion

Chapter 6 - The Big-Picture Model of Our Economy

Equilibrium Is an Illusion: The Underlying Structure of Financial Systems

The Overview Model

The Virtuous Cycle of Growth

The Vicious Cycle of Destruction

Seeing the Relationships in the Data

Conclusion

Part Three - RECESSION OR DEPRESSION?

Chapter 7 - What Can the 1929 Great Depression Teach Us about Today’s Crisis?

Comparing the Stock Market during the Depression with the Current Economy

Comparing Prices and the Money Supply during the Depression with the Current Economy

Comparing Industrial Output during the Depression with the Current Economy

Comparing the Value of Gold during the Depression with the Current Economy

Comparing Interest Rates during the Depression with the Current Economy

Comparing Publi Debt during the Depression with the Current Economy

Comparing the Price of Oil during the Depression with the Current Economy

Comparing Corporate Bond Rates during the Depression with the Current Economy

Comparing Unemployment during the Depression with the Current Economy

Comparing the Producer Price Index (PPI) during the Depression with the Current Economy

Comparing Housing Growth during the Depression with the Current Economy

Comparing the Trade Balance during the Depression with the Current Economy

Comparing Excess Reserves at the Fed during the Depression with the Current Economy

Conclusion

Chapter 8 - What the United States Can Learn from Japan’s Lost Decade(s): 1989-2009

Japan’s Lost Decades: How Japan’s Economic Bubble Burst after 1989

Quantitative Easing Is What You Do after Cutting Rates to Zero

Comparing Quantitative Easing in Japan and the United States to 2009

Trade Deficit and Surplus Are Opposite Between the United States and Japan

Comparing the National Government Deficits of Japan and the United States

Lessons from the Japanese Experiment

Investment Implications in Japan

Chapter 9 - What the United States Can Learn from German and Other European ...

China’s Currency and Economic Expansion Actions Today

Chinese Money and Credit Spike Upward

Other Countries’ Inflation after Big Government Deficits

Currencies No Longer in Circulation

Looking at Other Financial Crises for Similar Characteristics to the United States

Review of What We Learned from the Currencies of the World

Conclusion

Part Four - INVESTMENT OPPORTUNITIES

Chapter 10 - The Stock Market May Be Dead for Another Decade

A Stock Market Model

Long-Term Cycles

Dividend Yield Gives an Idea of Valuation

Looking at Stock Market Sectors Gives Clues about Which Sectors May Be Overvalued

Earnings by Sector Reveal the Drivers of Performance

Conclusion

Chapter 11 - Energy in the 21st Century: The End of the Petroleum Age

Peak Oil

Discovery of New Oil Is Key, but It’s Not Happening

Supply Is Constrained

Hubbert’s Curve and the Timing of Peak Oil

Natural Gas

Coal and Uranium Will Be the Major Energy Sources of the Future

Putting the Scenario Together

Perspective from a Nobel Laureate

Forecasting Energy Prices

Conclusion

Chapter 12 - Food, Grain Trading

Grains: Tight Supply Drove Prices Higher Worldwide

Pricing Model for Grains

Ethanol

Cattle and Hogs

Conclusion

Chapter 13 - The Demise of the Dollar

U.S. Dollar Exchange Rates and Purchasing Power

What’s Driving the Dollar?

Sacrificing the Dollar for the Economy

Was the Fed Intervening for the Dollar? Federal Reserve Swaps

Global Enthusiasm for the Dollar Wanes

Oil Countries Are Turning Inward

Is the Euro a Viable Alternative to the Dollar?

How Gold Stacks Up against the Dollar

How Stocks Compare to the Dollar

Where Could the Dollar Go?

Putting the Trends Together

Investment Recommendations: Advice for Traders

Conclusion

Chapter 14 - Interest Rates: The Trade of the Decade

How the Growth of Public Debt Has Affected Interest Rates

Government Credit Expansion Is Huge

The Debt Trap

Health Care Is Bankrupting the United States

The U.S. Treasury Debt Is Short Term

Tax Receipts Are Falling

Other Central Banks, Money Expansion

The Fed Pushes Mortgage Rates Down by Buying Mortgage-Backed Securities

A Close-Up Look at Commodity Price Inflation and Rates

Interest Rates Rise as the Dollar Falls

International Interest Rates and Currencies

Interest Rates as Best Investment Opportunity

Conclusion

Chapter 15 - Gold Is the Only Real Money

How the Price of Gold Reflects the Macroeconomic Forces

Gold Was Used by Central Banks to Back Their Currencies

How Gold Moves with Other Parts of the Economy

Gold Supply and Demand

Investment Demand Drives Price

Summarizing Some of the Gold Supply and Demand Forces

Gold Leasing and Forward Hedging

The Seasonality of Gold Demand Also Affects Prices

How to Invest in Gold

Valuing Gold Mines Based on Gold in the Ground

Futures Contracts

Investing in Other Metals: Silver, Platinum, and Palladium

Predicting the Price of Gold for the Decade

Conclusion

Part Five - PUTTING IT ALL TOGETHER

Chapter 16 - Forecast for the Future

The Crisis Horizon in Pictures

Combining the Average-Case and Worst-Case Scenarios of What Might Happen to the ...

What Should You Do

Summarizing the History

Chapter 17 - Looking Over the Horizon to See the Best Investments

How Debt Affects the Currency and the Real Economy

Currency and Financial Problems

Who Will Buy Our Government Debt?

The Real Economy and Its Tepid Growth

International Currency Crisis

Predictions

Predictions for 2010

About the Author

Index

Table of Figures

Figure 1.1 How to Turn $35 into $166,000+, from 1970 to 2009

Figure 1.2 Structure of the Book Profiting from the World’s Economic Crisis

Figure 1.1 Money Has Grown Much More Than Industrial Production

Figure 1.2 Money (World Reserves) Divided by Production Is 20 Times 1970 Level

Figure 1.3 The U.S. Government Debt Will Explode over the Next Two Decades to 800% of GDP

Figure 1.4 The Actual U.S. Deficit Is at a Record $1.5 Trillion

Figure 1.5 Federal Budget Spending Reaches Toward $4 Trillion in 2009

Figure 1.6 Tax Receipts Reached Only $2.1 Trillion

Figure 1.7 Buyers of U.S. Government Debt: Agencies and Trusts, Foreigners, Private Domestic, Fed

Figure 1.8 How the Total Federal Government Debt Will Grow with the Help of the Fed

Figure 1.9 Government Borrowing Takes Over from Private Borrowing

Figure 1.10 How Federal Government Spending and Taxing Increased during the Last Century

Figure 1.11 Federal Outlays and the Deficit Jumped in World Wars—Just Like They’re Doing Now

Figure 1.12 U.S. Deficit Projections Became Worse Each Year

Figure 1.13 Health Care Spending and Interest on Debt Are Increasing to Levels that Our Government Can’t Support

Figure 1.14 The Federal Debt/GDP Level Suggests Inflation Could Be Much Higher

Figure 2.1 The U.S. Current Account Deficit is the World’s Biggest

Figure 2.2 U.S. Trade Balance Accumulated to $7 Trillion

Figure 2.3 Our Trading Partners Hold Half Our Government Debt

Figure 2.4 The Budget Deficit Gives the Public the Money for the Trade Deficit

Figure 2.5 U.S. Consumer Supports the U.S. and World Economy by Borrowing

Figure 2.6 Trade Deficit and Foreign Investment Move Together

Figure 2.7 The Entire Federal Deficit Was Purchased by Foreigners from 1996 to 2008

Figure 2.8 The Correlation between Mortgage Borrowing and the Trade Deficit

Figure 2.9 How U.S. Consumer Saving Has Decreased Since 1959: U.S. Consumers Spend All They Earn

Figure 2.10 Both U.S. Trade and Investment in the United States Have Dropped in Crisis

Figure 2.11 U.S. Trade Balance Declines with Foreign Investment Decline

Figure 2.12 Federal Deficit Remained Smaller Than the Trade Deficit so Foreigners Could Finance Federal Budget Deficit, until 2009

Figure 2.13 How U.S. Manufacturing Jobs Were Lost as the U.S. Imported More Goods, 1939-2004

Figure 2.14 The United States Imports More Capital Than Any Other Country with China the Biggest Supplier

Figure 2.15 How the United States Went From Biggest Lender to Biggest Borrower: The Accumulated Trade balance became Negative in the 1980s

Figure 2.16 Claims by Foreigners on U.S. Tangible Assets

Figure 2.17 Holdings by Foreigners of U.S. Assets

Figure 2.18 Reporting Banks’ Cross-Border External Positions

Figure 2.19 The U.S. Trade Deficit Feeds Our Budget Deficit and the Fed Feeds the Money Supply

Figure 2.20 Foreign Investment Flows into the United States Turned Negative in 2009

Figure 2.21 Foreigners Stopped Buying Long-Term Securities

Figure 2.22 Foreigners Continue to Buy Treasuries, T-bills, and Agencies

Figure 2.23 Foreign Purchases of T-bills Jumped as the Credit Crisis Accelerated in 2008

Figure 2.24 How Foreign Purchases of U.S. T-bills Helped Drive Rates to 0% by 2009

Figure 2.25 Foreign Investment Withdrawal Caused Two Crises in U.S.

Figure 2.26 Foreigners Selling off Record Amounts of Agency Debt in 2008 Brought Fannie and Freddie Collapse

Figure 2.27 Foreigners Stopped Buying Corporate Debt in 2008

Figure 2.28 Foreign Purchases of U.S. Equities Track with Stock Prices

Figure 2.29 Foreign Central Bank Buying U.S. Treasuries Moves Opposite Rates

Figure 2.30 The Dollar Weakens with the Budget and Trade Deficits

Figure 3.1 Medicare Costs Will Rise from Both Aging and New Medical Procedures

Figure 3.2 Medicare Will Bankrupt the Country

Figure 3.3 Components of Gross Domestic Product

Figure 3.4 Health Care Cost Per Capita in the United States Is Double Other Countries

Figure 3.5 Federal Budget for Health Care Grew from 2% in 1962 to 25% Today of Outlays

Figure 3.6 Social Security Will Drag Deficits Lower Once Trust Fund Surplus Is Exhausted

Figure 3.7 There Won’t Be Enough Workers to Fund the Baby Boomers’ Retirement

Figure 3.8 Total Economic Costs of Iraq and Afghanistan Wars

Figure 3.9 Wars Bring Government Spending Which Brings Inflation

Figure 3.10 Federal Debt Jumped in Wars

Figure 3.11 China and Hong Kong Have Acquired $1 Trillion of Treasuries Mostly Since 2000

Figure 4.1 Federal Reserve Credit Easing Policies

Figure 4.2 Federal Reserve Liabilities Grew from Deposits

Figure 4.3 Monetary Base Jumped Like Never Before from Bailouts

Figure 4.4 Money Is Growing, but Not Like the Monetary Base

Figure 4.5 Banks Cut Back Loans, Despite Fed Easing

Figure 4.6 Three Models of Federal Reserve Money Creation

Figure 4.7 Money Market Funds are Bigger than M1

Figure 4.8 Banks Meet Reserve Requirement with ATM Cash

Figure 4.9 The Fed Switched from Noninflationary Actions to an Inflationary Policy in Mid-2008

Figure 4.10 The Federal Reserve Will Have to Buy Treasuries to Fund the Deficit

Figure 5.1 Debt as a Percentage of GDP Is at Record-High Levels

Figure 5.2 Economic Growth Moves with Credit Growth

Figure 5.3 Economic Growth and Money Growth Have Moved Together for a Century

Figure 5.4 Debt and Money Grew and Collapsed Together in the Current Crisis

Figure 5.5 Private Debt Growth Collapsed in This Crisis as Government Debt Jumped to Bailout Problems

Figure 5.6 Debt, Money, and Economic Growth All Move Together

Figure 5.7 Household Debt Has Grown More Than Income, Especially After 1980

Figure 5.8 Government, Businesses, and Households Borrow from Financial Institutions and Foreigners in a Balanced Credit Market

Figure 5.9 Borrowing and Lending Flows Were Disrupted in the Credit Crisis

Figure 5.10 How Debt Drives Employment

Figure 5.11 Consumer Credit Has Declined the Fastest Since WWII

Figure 5.12 How Debt Contributed to Growth of GDP

Figure 6.1 The Virtuous Cycle of Growth

Figure 6.2 The Vicious Cycle

Figure 6.3 Stocks and GDP Tend to Move Together

Figure 6.4 Stocks Had Two Big Bull Markets: 1929 and 2000

Figure 6.5 Real Stock Prices Reveal Big-Picture Cycles

Figure 6.6 Stocks Were the Biggest Percentage of GDP in 1929 and 2000

Figure 7.1 Although the Patterns of 1920 and 1990 Overlap, We Are Not in a Depression Now

Figure 7.2 Stocks of 1921 and 1990 Overlap, with a Similar Pattern

Figure 7.3 CPI Moved Up Now, But Down in 1930

Figure 7.4 Comparison of the M1 Money Supply from 1920-1939 and 1990-2009

Figure 7.5 M1 CPI from 1920-1940 Moved Down Together

Figure 7.6 Money Stock Dropped during the Depression Like No Other Time

Figure 7.7 Currency Rises Now and in the 1930s Are Similar

Figure 7.8 Industrial Output Dropped More in the 1930s Than in the 2000s

Figure 7.9 Gold Inventories Grew after the Depression

Figure 7.10 The Fed Rate Moved Up in 2006, But Stayed Down in 1936

Figure 7.11 Comparison of the Ratio of Debt to Industrial Production in 1920-1940 and in 1990-2010

Figure 7.12 Comparison of the Price of Oil in 1920-1939 and 1990-2008

Figure 7.13 Moody’s Corporate Bond Rates Rose During the Depth of the Depression in 1932—as They Did in 2008

Figure 7.14 Comparing Unemployment from 1925 to 2009

Figure 7.15 How Commodities Prices Rose Dramatically after Going Off the Gold Standard in 1971

Figure 7.16 Housing Investment as a Percentage of GDP: The Housing Bubble in the Years before 1929 Was Even Bigger than in the 2000s

Figure 7.17 The U.S. Trade Balance, from 1919-2009: In the 1930s, the U.S. Enjoyed a Positive Trade Balance, But It Is Negative Now

Figure 7.18 How Excess Reserves at the Fed Grew to 100% during the Depression but Reached 700% by 2009

Figure 8.1 Japanese Stocks, from 1970-2009: The Bubble Peaked in 1990

Figure 8.2 Japanese Real Estate Also Peaked in 1990

Figure 8.3 The Number of Loans Outstanding by Private Financial Institutions Shows How Japan’s Debt Bubble Burst in 1990

Figure 8.4 Japan’s Loan Growth Collapsed from 18% Annual Growth in 1989 to No Growth

Figure 8.5 Japan’s Economy Was Flat after 1990 Burst

Figure 8.6 Japanese Domestic Goods Prices Dropped from 1980 to 2003

Figure 8.7 Japan’s Debt Jumped while the United States’ Was Flat in Terms of Percentage of GDP

Figure 8.8 Japan’s Example of Quantitative Easing

Figure 8.9 Japan’s Quantitative Easing Achieved a Zero Interest Rate

Figure 8.10 Excess Reserves Boosted Japanese Stocks

Figure 8.11 Japan’s Monetary Base Increase Did Not Move Currency

Figure 8.12 Japan’s Quantitative Easing Didn’t Hurt the Yen

Figure 8.13 Positive Current Account Kept Yen Strong

Figure 8.14 Japan’s Interest Rate Has Been the Lowest of the Major World Economies

Figure 8.15 Japan’s Quantitative Easing Was Funded by Buying Government Securities

Figure 8.16 Japanese Banks Bought Government Bonds

Figure 8.17 Government Deposits at Bank of Japan Declined

Figure 8.18 As Deposits Dropped after 2006, the Bank of Japan Extended Loans

Figure 8.19 The Bank of Japan Increased Foreign Currency Assets

Figure 8.20 U.S. Excess Reserves Are Triple Japan’s to 2009

Figure 8.21 Japan’s and the United States’ Expansions Are Similar in Terms of Percent of GDP

Figure 8.22 The Bank of Japan’s Asset Expansion Was Less than the U.S. Federal Reserve’s

Figure 8.23 Japan’s Current Account Is a Surplus whereas the United States’ Is a Deficit

Figure 8.24 Japan’s Current Account Is Much Higher than Its Trade Surplus

Figure 8.25 U.S. Annual Deficit Is Growing Much Faster than Japan’s

Figure 8.26 Japan Took a Decade to Ramp its Deficit to U.S. Level When Compared as % of GDP

Figure 8.27 The Yen Has Been Strong As Stocks Fell. Will this Reverse?

Figure 8.28 Japanese Interest Rates Collapsed Along with Stocks

Figure 8.29 Rates Dropped with the Strong Yen. If the Yen Falls Rates Could Rise

Figure 9.1 German Hyperinflation in Currency Circulation Was Matched by Its Growing Debt, Rising Prices, and Declining Exchange Rate

Figure 9.2 German Inflation in Gold and Silver

Figure 9.3 Germany’s Deficit Drove Inflation, from 1919-1923

Figure 9.4 Germany Was Running Deficits of 60+%, from 1919-1923

Figure 9.5 The U.S. Dollar Was Strong Against China’s RMB until 1994, but Declined after 2005

Figure 9.6 China’s Money Stimulus Replaces Its Slowing Exports

Figure 9.7 China Stimulus Caused Money to Jump in 2009

Figure 10.1 Recessions Brought S&P 500 Earnings Drop

Figure 10.2 The Earnings Yield from Stocks Tends to Move Up and Down with the 10-Year Treasury Bond Interest Rate

Figure 10.3 S&P 500 Earnings and Interest Rates Indicate Stocks Are Fairly Valued

Figure 10.4 Stocks Show Cycle When Viewed in Real Terms

Figure 10.5 Stocks’ Dividend Yields Reveal When Stocks Are Overvalued and Undervalued

Figure 10.6 The Market Capitalization Share of the S&P 500 by Sector

Figure 10.7 S&P 500: Financials Were a Disaster

Figure 11.1 U.S. Oil Reserves Are Only 2%, Whereas the Middle East Has 62%

Figure 11.2 World Oil Supply Has Been Flat for Four Years

Figure 11.3 OPEC Reserves Jumped One Time and Are Now Flat

Figure 11.4 How Per-Capita Wealth Corresponds to Oil Consumption in Various Countries

Figure 11.5 Existing Oil Field Production Decline Must Be Replaced by Discoveries

Figure 11.6 There Will Be a Peak in Discovery That Precedes the Peak in Production

Figure 11.7 Oil Discoveries from 1850-2006: The Peak Years Were in the 1960s

Figure 11.8 Oil Production Outstrips Discovery Rate

Figure 11.9 Oil Discoveries by the UK Since 1930, Projected to 2050

Figure 11.10 Oil Production and Forecast for the U.S. from 1900 to 2050

Figure 11.11 Projected Decline of Regular Oil and Natural Gas Liquids Around the World, after 2010

Figure 11.12 World Natural Gas Supplies by Region Show Limited North American Reserves

Figure 11.13 Alternative Energy Sources Are Still Relatively Small

Figure 11.14 How New Energy Sources Will Need to Supplant Decreasing Oil and Gas Production, as World Energy Demand Continues to Increase

Figure 11.15 Crude Oil Price Spiked and Crashed in 2008 and Looks to Go Higher

Figure 11.16 Price Projection for Crude Oil

Figure 12.1 Oil and Gold Rose Much More Than Corn over the Last 100 Years

Figure 12.2 Stocks Worldwide of Coarse Grains, Wheat, Soybeans, and Rice Are in Short Supply

Figure 12.3 Corn World Usage to Stocks Justified Higher Price, but No Longer Bullish

Figure 12.4 Wheat World Use to Stocks Indicates Price Is High

Figure 12.5 Soybean World Use to Stocks Does Not Support High Price

Figure 12.6 Rice World Use to Stocks Is Tight, But Price Seems High Enough

Figure 12.7 Ethanol Usage Is Approaching the Amount Used for Animal Feed

Figure 12.8 Beef Inventories Are Lowest in Years

Figure 13.1 Exchange Rates Show Weaker U.S. Dollar

Figure 13.2 How the U.S. Dollar Declined against Most Currencies after 2001

Figure 13.3 The U.S. Dollar Will Purchase Only $.20 of What It Did in 1971

Figure 13.4 How a Budget Deficit Often Damages the Value of a Country’s Currency

Figure 13.5 Currency Composition of Official Foreign Exchange Reserves (COFER)

Figure 13.6 Central Bank Network of Swap Lines

Figure 13.7 The Dollar Rose in 2008 as the Fed Swapped with Central Banks

Figure 13.8 T-bills Held by Foreigners Jumped with Currency Swaps

Figure 13.9 U.S. Current Account Is Much More Negative than the Euro

Figure 13.10 Gold Rises as the Dollar Weakens

Figure 13.11 Stocks Sometimes Do Better with a Weak Dollar

Figure 13.12 How Far Could the Dollar Drop?

Figure 13.13 The U.S. Dollar Index (DX) Futures Contract Has Fallen Since 2001

Figure 14.1 U.S. Interest Rates Are as Low as in the 1950s

Figure 14.2 Real Interest Rates, after Removing CPI, Are Low

Figure 14.3 Inflation Drives Interest Rates

Figure 14.4 Corporate Bonds’ Spread Jumped in 2008, Indicating Fear of Default by Corporations, but Has Come Back to a More Reasonable Level

Figure 14.5 Treasury Yield Curve Is High Because of the Very Low Fed Funds Rate

Figure 14.6 Federal Debt Growth Has Moved with Interest Rates until Recently

Figure 14.7 Banks Stopped Lending, Slowing Money Growth despite Fed Programs to Stimulate

Figure 14.8 Government Interest Expense Compounds if Rates Rise

Figure 14.9 The Cost of Social Security and Medicare, Combined

Figure 14.10 Government Receipts Dropped 25% Since 2008, Which Could Cut Revenues by $600 Billion

Figure 14.11 Central Banks of the World Are Inflating

Figure 14.12 Foreigners Stopped Buying Mortgage Debt

Figure 14.13 The Fed Sold Off Treasury Bills and Bought Mortgage-Backed Securities

Figure 14.14 Fed Buying Mortgage-Backed Securities Drives Mortgages Down

Figure 14.15 Commodity Research Bureau Prices Collapsed in Recession, but Are Now Reflating

Figure 14.16 Recession Brought Commodity Prices Drop Along with Interest Rate Drop, Which Are Now Turning Back Up

Figure 14.17 Credit Default Swaps Have Declined from Their Extreme at the Height of the Panic in Late-2008

Figure 14.18 Short-Term Interest Rates Have Collapsed Across the Planet

Figure 14.19 Global Inflation Is Down

Figure 14.20 Comparison of the Real Short-Term Interest Rates of the United States, Japan, and the EU

Figure 14.21 The 3-Month Treasury Bill Rate Has Not Been This Low Since the Depression

Figure 15.1 The Price of Gold Often Rises during Recessions

Figure 15.2 The Big Picture Shows that Inflation, Interest Rates, and Gold Prices Move Together

Figure 15.3 In Inflation-Adjusted Real Terms, Gold Has a Long Way to Go

Figure 15.4 Central Banks’ Foreign Exchange Reserves Could Never Be Redeemed for Gold

Figure 15.5 World Central Banks’ Gold Reserves Dropped from 70% to 10% over 60 Years

Figure 15.6 Central Banks Sold Gold despite Currency Growth

Figure 15.7 The Total Gold Reserve Value Is Only $930 Billion for the World’s Top 15 Central Banks

Figure 15.8 Central Bank Reserves Preceded Gold’s Price Rise

Figure 15.9 Gold Rises as the Dollar Weakens

Figure 15.10 Oil and Gold Tend to Move Together

Figure 15.11 How Gold Production Has Slowed and Is Small Compared to Total Inventory

Figure 15.12 Global Annual Gold Production

Figure 15.13 Gold Mining Costs Have Risen

Figure 15.15 Gold ETF Holdings, in Tonnes

Figure 15.16 Central Bank Lending through Banks Adds Gold to Current Market

Figure 15.17 Gold Mine Unwinding Hedge Returns Gold to Central Bank

Figure 15.18 Net Dehedging Is Taking Less Supply

Figure 15.19 Central Banks Are Not Selling as Much Gold

Figure 15.20 Gold Stocks Tend to Rise More in Winter

Figure 15.21 In the Last Decade, Gold is Up Almost 300% while Stocks are Down

Figure 15.22 Gold Stocks Rise More than Gold But Are More Volatile

Figure 15.23 Projecting the Price of Gold to 2016 Suggests It Could Reach $3,000/oz

Figure 15.24 Gold Could Rise to $6,000 in the Decade

Figure 15.25 The Price of Gold Could Rise to $7,000/oz by 2016 (Linear Scale)

Figure 15.26 The Price of Gold Could Rise to $7,000/oz by 2016 (Log Scale)

Figure 15.27 The Price of Gold Could Rise to $3,000/oz or $7,000/oz (Linear Scale)

Figure 15.28 The Price of Gold Could Rise to $3,000/oz or $7,000/oz in a Decade (Log Scale)

Figure 15.29 Gold Could Reach $22,000 If It Rises as Fast as It Did to 1980

Figure 16.1 S&P 500 Has Already Collapsed to Average Crisis Level

Figure 16.2 Housing Prices Can Take Years to Decline SOURCE: Standard and Poors.

Figure 16.3 Unemployment Could Jump over the Decade

Figure 16.4 U.S. Federal Debt Is Likely to Jump from Crisis

Figure 16.5 GDP Falls in Serious Crisis

Figure 17.1 Federal Debt Growth Moves with Inflation

Figure 17.2 Federal Debt Growth Added to Federal Reserve Monetary Base Growth Shows the Size of Stimulation

Figure 17.3 Federal Debt Holders of $8 Trillion of Treasuries Held by the Public

Figure 17.4 Federal Debt Could Double with Higher Rates

Figure 17.5 The Total of All U.S. Debt Stopped Growing Abruptly in 2009

Figure 17.6 Growth in Private Debt Moves with GDP

Figure 17.7 CBO Projects Interest Rates to Rise

Figure 17.8 Unemployed and Unemployment Rate with Forecast

Figure 17.9 Debt and Deficits Are Too High for Many Countries

Figure 17.10 International Investment Position, Net is Positive for Exporters

Figure 17.11 Bud Conrad’s Predictions for 2009

List of Tables

Table 2.1 Sovereign Wealth Funds Are Big Players

Table 4.1 Government Bailout Programs

Table 4.2 Asset and Loan Losses from Peak

Table 9.1 A Summary of Four Big Inflations

Table 9.2 Currencies That Are No Longer in Circulation and Why

Table 9.3 Summary Statistics of Other Currency Crises Compared to the U.S.

Table 11.1 Geophysicist Hubbert’s Projections for When the World Will Run out of Oil

Table 15.1 Valuation Table

Table 16.1 How Other Serious Financial Crises Affected the Economy

Table 16.2 What Could Happen to the U.S. Economy If It Follows the Path of Other Historical Crises

Table 16.3 Projecting the Time to the Bottom, from the Peak, for Various Aspects of the U.S. Economy

Table 16.4 Combining 75% of the Average and 25% of the Worst-Case Scenarios to Get a Single Scenario

Table 17.1 Bud Conrad’s Predictions for 2010

Copyright © 2010 by Albert G. Conrad Jr. All rights reserved.

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Library of Congress Cataloging-in-Publication Data:

Conrad, Bud.

Profiting from the world’s economic crisis : finding investment opportunities by tracking global market trends / Bud Conrad.

p. cm.

Includes index.

eISBN : 978-0-470-62744-0

1. Financial crises-United States. 2. United States-Economic conditions-21st century. 3. United States-Economic policy-2009- I. Title.

HB3722.C686 2010

330.973-dc22

2009051050

To my children Darlene Friedley and Daniel Conrad.

Acknowledgments

First and foremost, I wish to thank my friend and mentor, David alland, who encouraged me to develop my ideas in publishing newsletters for Casey Research. He has honored me by calling our work a partnership. While I tend to think in arcane economic and engineering channels, he is able to bring material to a much more understandable level for the public. The chapters of this book are more valuable as they are made more understandable by his contribution in forming the final written page. I encourage readers to check out our offerings and extensive ongoing free material at www.caseyresearch.com.

I also want to thank Doug Casey who liked my charts at one of the big conferences and brought me into his then expanding organization of newsletters and financial services. Olivier Garret, CEO, gave me encouragement when needed. I can’t say enough for the hardworking professional and support people around the globe of our organization.

I want to especially thank many readers of my articles and people who have heard my talks and debated the scenarios to bolster the important conclusion about where our system is going. Ruth Mills, crash-integrated these many interconnected and supportive analyses into this cohesive explanation of our economic system, and without her support the book wouldn’t have come together. I was helped greatly in the early stages of editing by Richard Scheck, and one complicated chapter by Doug Hornig who also provided encouragement.

I also want to thank family and friends including my daughter Darlene Friedley who hasn’t seen much of me for a year, and my son Daniel Conrad who took time from his challenging responsibilities at Google to mentor me and build the basic structures of the book with a white-board. Also, thanks to my significant other who encouraged me regularly, Phoebe Newlove. Bruce Janigian gave me early advice and Bob Dickey encouraged me as he has for most of my lifetime.

Introduction

The global financial collapse will affect all your investments, and you need protection.

That, in a nutshell, is what this book is about. This book will help you understand the forces behind the global financial collapse, how our government leaders helped create this new reality, and how you can comprehend the current market forces so you can make better investment decisions beyond the recommendations of traditional Wall Street advisors.

This book explains the big-picture forces that will drive paper currencies to ruin. The train is already on the track, steaming toward a bridge that is out, and the U.S. dollar—which has been the bedrock of the world’s currencies—is the train that will crash into the canyon of no confidence in our lifetime.

My goal in this book is to explain how this catastrophe will unfold, as it destroys wealth around the world for those who believe their governments when they say that the situation is “at a bottom” or “showing green shoots of recovery.” Believing such comforting lies will lead to destruction of your personal wealth.

In contrast, understanding and protecting yourself with reasonable measures will lead you to financial survival. Being ahead of the curve, and armed with the insights of this book, can lead to big personal profits. Here’s why you need to read this book:

• To understand why inflation is coming!

• To learn how to identify the best investment sectors—and why this is more important than simply picking individual stocks.

• To understand how we got here, to see where we are going, and to invest wisely.

• To see how a system model, that emphasizes the cycles caused by feedback, gives better predictions than steady-state equilibrium models used by economists.

• To learn how to review charts and know where data can be found for predicting the big trends and making investments.

• To understand how the historical experiences of the Great Depression, Japan after 1990, and Germany confirm the parallels and differences to today’s crisis.

• And to get my reasons for investment recommendations for today: gold, oil, higher interest rates, energy, food.

As an economist with both an MBA from Harvard and a bachelor’s degree in electrical engineering from Yale, and as a successful investor for 25 years, I’ve written this book by drawing on all aspects of my experience, education, and work. That includes my work as Chief Economist for Casey Research, which has produced valuable research and more than a dozen newsletters for investors for 30 years (including The Casey Report, Casey’s Energy Opportunities, Casey’s Gold and Resource Report, and Casey’s International Speculator—see www.caseyresearch.com for details on these and to avail yourself of the free information there including my favorite, the Daily Dispatch).

I emphasize data to confirm the realities, and I am specific about what to look at, so you can accurately measure what is driving our economy. I’ve used my investment experience to develop models that you can use to predict specific measures to make successful investments. Because I have such a different approach, I was able to predict the current crisis back in 2006. And at the beginning of 2009 I predicted that gold would go to $1,150; that crude oil, then trading at $45, would go to $80; and that the 10-year Treasury would go from 2.2 percent to 4 percent—all of which happened—along with a number of other economic measures like the budget and trade deficit.

The key to the future is really quite simple: Paper money is a CONFIDENCE game that will end with your cash being worth only the paper it is printed on. This is the book’s fundamental thesis: that the paper dollar will collapse in my lifetime, eventually requiring the issuance of a new currency. The financial collapse we are now experiencing is far from over. It will become the largest financial crisis the United States has ever faced. Because the United States is at the center of the world economy, this crisis is affecting all nations. The imbalances are so big that there is no way to return to stability through normal means.

But a simpleminded, long-term projection is not adequate in the short term, because the swings up and down are big, and they get in the way of a straight slide to the bottom. It can be seen that governments, central banks, sophisticated investors, and psychology all take their turn at affecting the shorter-term ups and downs. All these need to be dealt with, and I offer a framework to interpret the world events as we ride this roller coaster of short-term fluctuations toward the longer-term destruction of the dollar itself.

The paper money systems of the world are not based on any promise of convertibility to any tangible commodity, like gold. Yet they have been used to define the value of everything we buy and sell. Without the limitation of redemption (in gold), governments can create wealth for themselves by paying new money to their special-interest supporters. When they do so, they decrease the wealth of others. Printing money does not change the value of the planet and the things in it. But the claims on those things change, and those who control the bigger share of those resources do change.

Even casual observers know that something is up, and their discomfort is justified. They know they aren’t getting anything from the bailout of big banks by government, and they wonder who is benefiting. My analysis shows how large the bailouts have become and how this will affect all of us in the years ahead. I anticipated the huge government bailouts because I understood that the recession from overleveraged mortgages would be very damaging, and I could see how politicians would be predisposed to appease their powerful financial supporters from Wall Street.

However, this book doesn’t focus only on the simple direction of complete paper money collapse. I provide both the big picture of what’s happening to our economy, and I drill down to the details of what is important and how to analyze particular sectors. Most people think of investments only in terms of stocks and bonds, but this is short-sighted; you also need to consider and weigh the benefits of investing in commodities, real estate, currencies, and interest rates. Obviously, there are a lot of relationships, but when you see how the big forces of government spending, dollar collapse, and inflation all interconnect, then the related collection of investment recommendations becomes a clear picture that is simple to understand.

To help you understand the interrelations of the financial landscape, and to explain just how extremely stressed the economic positions of the world have become, I’ve created hundreds of charts and graphs to prove my points throughout the book. I created these charts to show you what is really going on in the financial markets around the world, and how that will affect your future. I provide a model for whether the stock market is overvalued or undervalued, and I give criteria for selecting gold mining stocks. I provide a model for trading grains that is unique.

My approach is different from the traditional theoretical economic models because I explain why markets go to such cyclic extremes. My explanation confirms what traders already understand: Markets are dynamic, follow trends, form bubbles, and collapse. The point is that markets are normally continually moving through cycles just like a pendulum, and are not in equilibrium, which is the basis of most economic models. Economists allow for shocks as if they were some surprise, but they miss the point that the economic pendulum is normally swinging back and forth and is not static. This difference is at the heart of understanding how the system works. I’ve used my electrical engineering training to look at the relationships and include the feedback of self-reinforcing systems that move in vicious and virtuous cycles.

Making the big decisions is what this book is about. It can help you identify the correct investments to have in your portfolio. Many investors just want to know what the best stock to buy today is, and Wall Street pundits give out that advice daily. But stock picking is really a small part of overall investing success. The bigger returns are made from being in the right market at the right time. I like being specific, so Figure 1.1 shows just how wildly successful an investor could have been making the right decisions only once for each of the past four decades:

• Suppose you had invested in one ounce of gold, costing only $35, in 1970.

• Then, suppose you had used your profits to buy Japanese stocks during the 1980s.

• Then, suppose you had invested those proceeds in the NASDAQ during the 1990s.

• Finally, suppose you had used those proceeds to invest again in gold.

As you can see from Figure 1.1, if you had made the above decisions during the last four decades, that single initial investment of $35 would have grown to more than $166,000. That was with no leverage and only four trades. Certainly, no one actually met that goal, because Figure 1.1 was developed in hindsight. For comparison, if you had invested the $35 in the S&P 500, you would only have $457. You would have done a little better hanging on to gold, which is now more than $1,000. The point is to emphasize the value of knowing the right sectors for focus for the times presented. And that is my goal for this book: to help you understand these big-picture cycles, so you can capture those profits.

Figure 1.1 How to Turn $35 into $166,000+, from 1970 to 2009

As the value of paper currencies decrease over time, your investments need to get in front of that inevitability by avoiding long-term holdings denominated in currencies, like bonds or annuities. Instead, I recommend that you hold physical assets like agricultural products, energy, or gold. (Alternatively, for example, you can profit by being in debt in dollars that you pay back after they have lost purchasing power.) Why, when, and how are the subjects of the rest of this book.

How This Book Is Organized

Figure 1.2 is a roadmap of the interconnected chapters of this book. I’ve divided the book into five parts as listed on the left side. Chapters are identified in boxes with the number following the name. The arrows give the logical flow of the intellectual thread through the chapters. For example: the budget deficits lead to the trade deficit, and health care and war expand government expenditures to the point of requiring big responses from the Federal Reserve. You may be tempted to jump to the concluding chapters to see how to invest, but that shortcut would miss understanding how the foundational forces and historical perspectives lead to those conclusions. Instead of reading the last chapter as if just eating one meal, I recommend learning how the system works to provides guidance for investment decisions, so you will be able to feed yourself for a lifetime.

Figure 1.2 Structure of the Book Profiting from the World’s Economic Crisis

Part One takes a fresh look at the major problems that led to the current global financial crisis in three chapters on our federal budget deficit; the trade deficit; and the costs of health care, Social Security, and the military. Projections confirm how intractable the deficits will become.

Part Two describes how the Federal Reserve is responding and how it will have to accommodate even more because of the expanding problems laid out in Part One in order to keep the government running. Chapters 4 to 6 look at how the Fed is, essentially, just printing money; how this crisis is fundamentally a debt crisis; and how all aspects of our economy interrelate with each other in a systematic view.

Part Three provides historical perspective for confirmation of the interpretation of where our system may be headed. Chapters 7 to 9 search for lessons we can learn from parallel events. First, we’ll look at how the current financial crisis really compares to the Great Depression. Then we’ll look at what our current crisis has in common with how Japan’s bubble burst in 1990. Finally, we’ll look at the extreme currency collapse, primarily in Germany, but also in other countries.

Part Four covers investment opportunities, in stocks, energy, food, the dollar itself, interest rates, and gold. You can read these chapters in any sequence, but I’ll give you a preview of my short-term preference: it’s gold.

Finally, Part Five provides two chapters that use the ideas of the book to provide a forecast of financial predictions for the next decade, and predict how I think the investments will perform in 2010.

The journey of this book is as much a “Show You How” as it is an “Explanation of Why.” Join with me as I navigate through the dangerous waters of complex economic systems to bring to you a clear vision of how the ship will sail over these rough seas. If we have the bearing right, we will know how to follow the inevitable, to protect ourselves, and to reach the safe harbor of exceptional profits.

The key recognition that I hope this book can bring to both casual observers and more intensely curious analytical investigators is that the overall economic system is in such serious crisis that individuals (that means you) must actively pursue protection from what will be the demise of the dollar as we have known it for the last 200 years.

The conclusion of this book identifies how the major forces that are driving financial collapse can be used to recommend future investments. You will see how the ongoing structural shifts that are already in place will wipe out the purchasing power of trillions of paper dollars from unsuspecting participants who do not understand the dollar collapse that is coming in the decades ahead.

Read and grow rich!

Part One

ECONOMIC FORCES

Parts One and Two of this book lay the foundation that will be used for making investment recommendations in Part Four. The budget deficit, the trade deficit, and the underlying problems of our health care, military costs, and interest costs, all combine to build the serious imbalances that will drive our future.

All of these items are so interrelated that it is almost difficult to put one before the other, but I start (in Chapter 1) with what I believe is the most fundamental—namely the federal government budget deficit. It is the budget deficits that will affect the dollar the most. Chapter 2, on the trade deficit, explains how interrelated foreign investment is to our government debt. Chapter 3 describes health care, Social Security, and the military, which are the biggest items that are causing the problems of the budget deficit. Because they are so insurmountable, you see how extremely problematic is the hand that has been dealt our leaders, and you will be able to conclude where the argument about inflation versus deflation has to go.

This is pretty heavy reading, but it will be worth your effort, because it will position your outlook for decades to come.

Chapter 1

The Budget Deficit Drives the Growth of All Debt

The goal of this book is to provide you with the tools to invest wisely and protect yourself against the mismanagement of our monetary systems by our government. Our money is produced by our government, so understanding how government deficits are the root of money creation puts you a step ahead in understanding where the value of our money is likely to go. This chapter explains how our government spends money, collects the taxes, and more important, makes up the difference by creating new money when big deficits arise.

To put this in perspective, I begin by looking at the largest aggregate of the world quantity of money as identified by the International Monetary Fund (IMF), called Total Reserves plus Gold at Market, and I compare that against industrial production in Figure 1.1. It shows how the creation of paper money by all the central banks in the world has grown much more rapidly than industrial production. What that means in the long run is that the paper money will decrease in its purchasing power as the governments produce more and more paper.

Figure 1.1 Money Has Grown Much More Than Industrial Production

Figure 1.2 shows the result of dividing the quantity of money by the amount of industrial production. If money were growing at the same rate as production, the ratio would be a straight line across the graph. It’s no surprise that governments have been printing much more money than we have been producing goods, but it is informative to notice that the increase in quantity of paper money in the world dramatically increased after the United States went off the gold standard and stopped trading gold for dollars after 1971.

There was a time when money was based on a measure of gold or silver, but that is not so today. Today, money is debt. For confirmation of that, consider that the dollars held in your wallet are called Federal Reserve Notes and are officially a liability on the Fed’s balance sheet.

Those Federal Reserve Notes were issued against the assets of the Fed, which until recently has mostly comprised federal government debt—namely Treasuries and an historical artifact of a pittance of gold. Of late, much of those Treasuries have been replaced by toxic paper purchased as part of the broader bailout.

Figure 1.2 Money (World Reserves) Divided by Production Is 20 Times 1970 Level

In this chapter, my purpose is to pick apart the components of U.S. government debt in such a way that by the time you’re finished reading, you’ll be in the top 1 percent of Americans in understanding the depth of the crisis we are now facing. I start with the debt issued by the central government because this is the central driver for creating new money. Government debt is called Treasuries, or more specifically T-bills, Treasury Notes, and Treasury Bonds, depending on the length of the term, and it is basically the result of government borrowing when it spends more than it collects in taxes.

The increase in government debt allows the increase in household and business spending, which leads to the growth in personal and international debt. It is the continual growth of our debt that has gotten us to the place of overleverage, which will now unwind with many difficulties.

It is correct to think of government debt as the mother of all debt because it starts the whole bubble process by first creating the money and liquidity that allows the private sector to spend and get into more debt. Ultimately, it is the combined debt of the government that weighs on the intrinsic value of the currency it is denominated in.

If you find this concept a bit confusing, don’t worry: These days, most people, including economists, do not have a clear idea what money really is. The lack of any clear understanding of what a dollar is (or therefore what it’s worth) stacks the deck in favor of those in control of the currency. Simply, breaking away from a gold standard (or any tangible link for that matter) set the table for the world’s biggest confidence game—a game that is growing bolder with each passing day.

The Budget Reflects the State of the Nation

Every year, the president and Congress go through an elaborate budget process to decide how much the government will spend and tax. The Congressional Budget Office (CBO) analyzes the president’s proposal and gives its own estimate of its financial impact. Figure 1.3 shows the CBO’s long-term estimates for the ratio of government debt to the size of the economy. The government’s own projections show a clear trend for huge government budget deficits and ever-increasing levels of outstanding debt.

This projection into the future reflects the “alternative fiscal scenario” representing what is likely to occur if today’s fiscal policies continue. This projection is based on a reasonable set of assumptions and does not include any of the many big proposals now being floated, including universal medical care and “cap-and-trade (i.e., the U.S. government’s proposal to control pollution by requiring CO2 polluters to put a limit on their emissions—to “cap” them—in exchange for rights that they can trade in the open market).

Figure 1.4 takes a closer look at the actual deficit and how fast it has been growing, and this chart should raise alarms all by itself. As of November 2009, the difference between tax receipts and government outlays for the last 12 months was $1.5 trillion. That is approaching four times the largest previous budget deficit.

Figure 1.3 The U.S. Government Debt Will Explode over the Next Two Decades to 800% of GDP

SOURCE: Congressional Budget Office: The Long-Term Budget Outlook, June 2009.

Figure 1.4 The Actual U.S. Deficit Is at a Record $1.5 Trillion

SOURCE: U.S. Treasury.

The deficit is the difference between spending outlays and tax receipts. The expansion of spending is the bigger cause of the deficit.

Federal Budget Spending

A breakdown of federal government spending, shown in Figure 1.5, reveals the two biggest sectors as national defense and human resources. Human resources includes Social Security and Medicare, both of which are growing dramatically. Defense has also grown with the invasions of Iraq and Afghanistan.

Taxes and the Federal Budget

Individual income taxes are the biggest source of federal government revenues, with another big contribution coming from Medicare and Social Security-related taxes. Importantly, total tax revenues of $2.2 trillion fall well short of the government’s almost $4 trillion annual budget, as shown in Figure 1.6.

Figure 1.5 Federal Budget Spending Reaches Toward $4 Trillion in 2009

SOURCE: Midsession Review OMB, August 2009.

Figure 1.6 Tax Receipts Reached Only $2.1 Trillion

SOURCE: Midsession Review OMB, August 2009.

For the federal government to spend more than it taxes, it has to borrow the difference. The mechanics are that the Treasury sells interest-bearing T-bills, notes, and bonds. The buyers of those Treasury instruments are in effect lending the government the money needed for current spending priorities, in exchange for a yield to be paid over time.

Federal Budget Borrowing

Figure 1.7 describes who is lending money to the U.S. government so that it can continue its large-spending programs, which are bigger than the taxes. If we understand who are the sources of the money, we can better understand whether the government can continue these huge deficits if some of these parties can’t step up to the plate, as they have in the past.

Figure 1.7 Buyers of U.S. Government Debt: Agencies and Trusts, Foreigners, Private Domestic, Fed

Let’s take a closer look at each group shown in Figure 1.7.

• Private Domestic Buyers: The American public are major purchasers of Treasuries. During World War II, it was considered patriotic to buy government bonds to support the war effort. Today, these purchases are driven more by risk aversion and the desire to earn a “safe” yield.

• Foreign and International Investors: In the 1990s, a new dynamic emerged, as foreign and international investors became a major new purchasing force for U.S. government debt. As a result, increases in government spending were no longer reliant on U.S. households making the decision to set aside savings in order to buy Treasuries. As you can see in Figure 1.5 on federal government spending, when the government was offered cheap money in seeming endless quantities—money that originated from a consumption-mad U.S. public and recycled through the foreign suppliers back to the Treasury—it began spending with both hands.

• The Federal Reserve System: The Fed is another regular buyer of U.S. government debt. Although this is traditionally small in comparison to the other sources of funding, the Fed’s Treasury purchases are disproportionately important because those purchases expand the nation’s money supply. It is notable that the Fed was a seller of Treasuries in 2008, a result of essentially swapping its “good” Treasuries for hundreds of billions of dollars worth of suspect mortgage-backed and other asset-backed paper from troubled financial institutions.

• Agencies and Trusts: Finally, Figure 1.7 shows how agencies and trusts are a large component of government debt, although this debt is materially different in that it reflects debt owed to the government itself. This category arose based on the government’s contention that a reserve should be accumulated to cover the Social Security and Medicare obligations assumed for the large group of retiring baby boomers.

Agencies and Trusts Explained

To meet this demographic challenge, the necessary accounting entities were established and regulations put into place to collect the funds to build these reserves. These reserves are considered obligations of the government, owed to the government, to be tapped as necessary to provide the considerable—and eventually overwhelming—entitlements due under Social Security and Medicare.

The problem is that the funds supposedly being set aside for retirees are not there! Sure, the trust funds are there, but the money is already spent on a wide variety of programs, from defense to paying interest on the government’s many debts. I repeat: There is no money in them. At this point, the accounting entities hold nothing more than nonmarketable securities that are correctly viewed as Treasury bills that can’t be sold to anybody. The money collected for Social Security and other programs is put in the trust funds where the surplus after paying retirees’ current benefits is used to buy the government debt. That is the portion of Figure 1.7 identified as Agencies and Trusts. The Social Security Trust surplus decreases the amount of the deficit and the amount borrowed from the public.

Ahead of the onslaught of the retirement payouts, these trusts have built up funds in excess of their immediate spending requirements. That will change as the large wave of baby boomers reach retirement and begin to draw down these accounts in earnest—at which point the government will find itself faced with yet another huge demand on funds it doesn’t have.

The Total Public Debt of the government is $12.5 trillion. Not including these Trust Funds leaves the amount of Federal Debt Held by the Public at about $7.5 trillion. When the government runs a deficit of $1.5 trillion, that is added to the Debt Held by the public. If the Trust Funds grow, that is added to the Total Public debt.

How Will the Deficits Be Funded?

It’s clearly important to understand how the future deficits will be funded. Having just examined the primary buyers of the Treasury instruments, I can now attempt to project which of these buyers are able and likely to step up their purchases in order to provide the fuel for the government’s planned ramp-up in deficit spending.

The President’s Office of Management and Budget (OMB) has provided an estimate of the size of federal government debt out to 2013 (see Figure 1.8). Let’s take a look at each of the four components of this chart:

• U.S. Private Domestic Holders: In my analysis, I assume that U.S. private domestic holders can probably increase their holdings moderately now that households are consuming less and saving more, and financial institutions have money to invest in Treasury paper.

• Foreign and International Investors: Important foreign holders, notably the Chinese, Japanese, Russians, and Indians (among others), have openly announced their decision to cut back on further purchases and their existing holdings of U.S. government debt. Further, the source of funds previously allocated to their purchases—trade surpluses—have fallen sharply with the recession. As a consequence,

Figure 1.8 How the Total Federal Government Debt Will Grow with the Help of the Fed

SOURCE: Office of Management Budget and author’s estimate of Fed portion.

going forward, foreign buying is unlikely to increase, and it will likely shrink.

• Agency and Trusts: These are really not a part of the equation at this point, but they reflect programs on “auto-pilot” and are quickly headed to the point where they will negatively impact the deficits, rather than helping to alleviate them.

• The Federal Reserve: Adding this all together (and I am being conservative in my assumptions), there are simply not enough buyers to cover the accelerating federal deficits. That leaves the lender of last resort—the Federal Reserve—as the only remaining candidate to satisfy the government’s massive funding needs. There is no viable alternative. The likely effect of that massive new money creation is reflected in projection to the right of the dashed line in Figure 1.8.