One Step Forward, Two Steps Back

The Daily Reckoning PRESENTS: You should feel very honored, dear reader. Our very own “Extreme” Ian has taken a break from writing press releases, fighting crime, and generally making women all over Baltimore swoon; just to bring you: A Layman’s Look at Bush’s New Plan to Balance the Budget. Read on…


Last week, for no particular reason, I did something I knew would make me cringe. President Bush addressed the nation after his first cabinet meeting of 2007 and I watched every minute. Regardless of your political stance, it’s hard to disagree that the typical Bush press conference involves some sort of tongue twisting episode that is too glaring to ignore. To my delight, he managed to say something so interesting that I practically begged Addison Wiggin to let me write to you this week, dear reader.

Before we reveal GW’s latest grand scheme, allow me to burden you with a brief disclaimer: Unlike my colleagues here at The Daily Reckoning, I would never dare call myself an expert in much of anything, especially economics. The majority of the figures in this essay (while honest) were calculated on either the back of an old envelope or the edges of a bar napkin, and my words carry only the clout of – in a word – a rookie. Regardless, you have my promise, faithful readers, I wouldn’t dare lead you anywhere beyond my own capacities.

With that in mind, back to Mr. Bush and his recent “eureka!” moment.

“One area where we must work together…is that…we gotta make sure we spend the people’s money wisely,” said Mr. Bush, as if he expected a mix of applause and gasps of awe. President Bush said this as a segway into introducing his new plan to balance the budget by 2012 – which I’ll be speaking of in just one moment. But first, we owe it to ourselves to briefly recollect the current administration’s history of “spending the people’s money wisely.”

During the first term of his presidency, in a period of less than 24 months, George W. Bush and Congress accrued more national debt than any other administration during the first 200 years of American independence…combined! Since his inauguration, President Bush has presided over the accumulation of over $3 trillion in debt, an increase of well over 60% since the Clinton administration. Bush and company are the sole reason why Douglas Durst, son of the eccentric mogul Seymour Durst, turned his father’s famous Times Square debt clock back on in 2002 after nearly two years of surplus. Similarly, a Library of Congress report in September 2006 estimated the War on Terror to cost $549 billion by the end of the 2007 fiscal year – a war claimed by the BBC to be the world’s most expensive military effort since WWII. The War on Terror may, or may not, be a moral and worthwhile venture. Whether you stand on one side of that fence or the other, we can all admit that it has been a very pricey undertaking.

We could go on and on, but you get the point. “Spending the people’s money wisely” would be a first for the Bush administration.

In the same press conference, President Bush announced a new government-spending plan. Through continued “pro-growth economic policies” and “spending restraint” Bush plans on unveiling a budget proposal next month that he claims will balance the federal budget by 2012. Eager for details, I was disappointed to watch the president drone on for the remainder of the press conference with politics as usual.

Lucky for us, The White House Office of Management and Budget (OMB) was kind enough to publish a few documents in 2006 aimed at helping folks like you and I learn how the most profligate president in history plans on reining it in – all without raising taxes, of course.

The OMB Overview of the President’s 2007 Budget is a quick read…three pages in length and written in simple terms. By all means, feel free to follow along:

At the heart of Bush’s plan to balance the budget is a gradual step down of the national deficit. Through a variety of very lofty sounding goals (extending economic expansion, increasing competitiveness, limiting spending, removing trade barriers, etc.) the OMB plans to gradually bring down the deficit as % of GDP. 2006 saw a hefty 3.2% deficit ($432 bil) and the OMB aims to chop that down to 2.6% in 2007, then to 1.4% in 2009, and presumably to 0% by 2012. Hmmm…what are the odds of that?

After pouring through several other much less readable congressional reports, a few figures don’t make a very good case for the success of Bush’s plan. First, as you may have guessed, the GWB administration has averaged a deficit far higher than their future goals – 2.7% over their seven-year stint. The current 40-year historical average is hovering around 2.3% deficit per the GDP. So in order for his plan to work, the president and his congress will have to drop 0.4% just to reach an average largely unbreakable by 40 years of their predecessors. Then, in less than 2 years, they will have to reduce the 2.3% deficit almost in half – a percentage of the GDP this administration has never even come close to attaining. And finally, after being out of office for four years, the Bush administration will reduce this already seemingly unattainable deficit to zero – using either voodoo spells or telepathy, I can only assume.

But wait…these OMB folks are intelligent individuals. This plan sounds quite ambitious, but shouldn’t we give them the benefit of the doubt? After all, these are the same top budget officials who predicted back in the end of 2002 that the War in Iraq’s total cost wouldn’t exceed $50-60 billion (that’s a near miss by about 1000% and counting for those of you keeping score at home).

Although, to be fair, I would have never been able to guess how much the War on Terror would cost. Even the very smart people of the U.S. government are allowed to miss their mark from time to time. Who knows…this time around, the OMB might hit the nail right on the head. But there lies our other bone to pick with the president’s 2007 budget plans: even if they work exactly as planed, these plans are still likely to leave us worse off than we are today.

Let’s say Mr. Bush and Congress are able to gradually reduce the federal deficit. According to OMB projections, it would ring to the tune of something like this (using very conservative calculations):

End of 2006: 3.6% Deficit as per GDP = $432 Billion deeper in debt
End of 2007: 2.6% Deficit as per GDP = $354 Billion in the hole
End of 2008: 2.0% Deficit as per GDP = $272 Billion balance due
End of 2009: 1.4% Deficit as per GDP = $190 Billion in the red
End of 2010: 0.7% Deficit as per GDP = $95 Billion squandered
End of 2011: 0.0% Deficit as per GDP = $1.34 Trillion total amassed debt (at least!) between 2006-2012

With the current negative balance coming in somewhere around $8.86 trillion, this brave new world of fiscal restraint and pro-growth economic policy will put the United States well over $10 trillion in debt by the time the books are balanced in 2012. Keep in mind; this is if everything goes exactly as planned!

As I’ve admitted before, my calculations, despite their sincerity, are quite basic. However, the more you think about it, the more you may realize that the lack of depth in these figures makes them far more daunting.

For example, none of these projections (and not even GW’s) include the massive amount of cash owed to limited liabilities like Medicare, Medicaid, and Social Security. Former Treasury Secretary Paul O’Neal bravely estimated that these programs could one day cost the United States over $44 trillion in entitlements. If you care to investigate further, look for a chart-filled report on the OMB site called The Nation’s Fiscal Outlook. My favorite is the graph in the Social Security section entitled “Current Trends are Not Sustainable.”

Also, all of the above dollar figure estimates from 2008-2012 were derived using the 2007 projected GDP. In other words, as the economy grows, so too will the size of the deficit as percentage of the GDP. Thus, billions more dollars are unaccounted for in my primitive breakdown.

And that’s not all. Billions, if not trillions of dollars are hypothetically owed in interest payments to owners of U.S. Treasuries and bonds. They could cash them in whenever they want, and the falling value of the dollar (11% to the euro in 2006 alone) would give them good reason to act quickly.

By the way, when we say “they” we mean mostly China and Japan. They have quietly amassed the largest stockpile of American debt on the planet – over $1 trillion in Treasury securities according to the Treasury Department. Think they will wait to cash in until $50 can’t even buy a bowl of miso soup?

Lastly, President Bush is entitled to billions of dollars in “off-budget” expenses, such as urgent wartime funding. While this money seems to appear out of nowhere whenever it is needed, rest assured, it will be owed to someone, someday.

So where does this leave us?

Well…one could assume that, despite the president’s recent posturing, we will continue spending in the same manner as the first seven years of the Bush administration. If so, The Congressional Budget Office projects the United States to be just short of $12 trillion in debt by 2012 – not including all the expenses listed above, of course.

We could also put our faith in our president, and trust that he will deliver on his promise to lower the deficit and balance the budget by 2012. If that does come to fruition, our debt will still be at least $10 trillion (which looks even scarier with all the zeros – $10,000,000,000,000.00)

Don’t get me wrong; saving $2 trillion is a pretty sweet deal. That much money could be the catalyst for some fantastic changes.

But are we really better off?

Try as I may…I can’t say yes. Anytime a politician, especially the president, addresses his people with words like “balanced budget” and “fiscal restraint” we can’t help but be enticed by the lure of making up lost ground. But the truth, as it seems to me, is that even though Bush’s plan for our fiscal future is a step right direction, we are still moving backwards.


Ian Mathias
for The Daily Reckoning
January 11, 2007

P.S. Bush told Americans on last night that 21,500 extra troops were needed to help “break the cycle of violence” in Iraq and hasten an eventual withdrawal. On the heels of this stern speech urging his congressional counterparts to limit spending, this sort of undertaking doesn’t bode well for pinching any pennies…Dubya will ask Congress for $5.6 billion for extra deployment and another $1.2 billion for rebuilding and jobs in Iraq.

But I guess no one really expected Bush to pull out of Iraq quite yet…after all, as Bill and Addison put it in their bestseller, Empire of Debt, in this stage of empire, we have “embraced perpetual war.”

To get your own copy of Empire of Debt, see here:

The Most Feared Book in Washington – Now in Paperback!

Editors Note: “Extreme” Ian Mathias is a proud member of the PR/Marketing team here at Agora Financial and The Daily Reckoning. When he is not rock climbing or fighting off ninjas with his bare hands, Ian spends most of his days interpreting the latest news with the help of your favorite DR columnists and spreading the Daily Reckoning’s message through press releases, direct mail, and whatever else he can weasel his way into. His PR writing has been syndicated in media outlets across the nation – including the Associated Press, Yahoo!, Forbes, and MSN.

“Greenspan: U.S. Economy Moving Upwards.”

Here is our old Fed chief, the Maestro himself, Alan Greenspan, back in the news. The man can’t seem to help himself.

“‘The U.S. economy is, overall, moving upward and showing signs of accelerating again,’ former Federal Reserve Chairman Alan Greenspan told Japanese Finance Minister Koji Omi, a Japanese Finance Ministry official said on Monday,” runs the report by Reuters.

Well, that’s good enough for us. If Alan Greenspan says the economy is strengthening, it must be so.

And apparently, it is!

The news today is surprisingly good…at least, it is surprising to us.

“Mortgage applications skyrocket last week,” is another Reuters report.

Builders report a drop in cancellations too.

And here, look at this: Oil fell another $1 yesterday – to close at just $54. Boone Pickens famously remarked that we would never see oil below $50 in our lifetimes. Maybe he was right…but, “Never Say Never,” is good advice for almost everyone.

We remarked that we may ‘never see gold below $600 – ever.’ We could come to regret that too…but for the moment, at least, gold is doing better than the industrial commodities, such as copper and lead.

What is going on? How come oil and copper are deflating…while gold remains at $613? A guess: gold is only useful as jewelry…and money. It is most useful as money precisely when paper, and other forms of money, become less useful. When does paper money lose its usefulness? When you can’t trust it. When can’t you trust it? When there is so much of it that it loses its value.

Readers will be quick to think of ‘inflation’, but currency can lose its value in other ways. What we have now is a huge burst of ‘liquidity’ – buying power that is not focused on consumer items. This liquidity is used to buy financial assets, not soap. As a result, consumers do not rush into gold to protect their purchasing power. Instead, investors rush into gold to protect their capital.

The Treasury Department has stopped reporting M3 – which would tell us how much currency is in circulation. Other sources, though, keep tabs on it. tells us that M3 is increasing at an annual rate between 10% and 11% – or about three times as fast as the economy itself. But M3 is not the only source of liquidity. Foreign governments need to try to keep up with the dollar, by issuing more of their own paper. And derivatives, leveraged debt and other gimmicks in the financial industry have the effect of adding billions of extra sops to the system. The Economist estimates that liquidity itself has been on the rise at 18% annually for the past four years.

The question we pose: Why is gold doing better than other commodities? Our guess is that investors are a little nervous. Liquidity comes and liquidity goes, they know. The arrival of it is greeted with cheers and smiles. The going tends to be a sad affair, like leaving a lover at the train station. The investor wants to have something to turn to, just in case she doesn’t come back.

MarketWatch wonders: Is the commodity boom over? For their answer, they turn our own Kevin Kerr:

“Outstanding Investments co-editor Kevin Kerr seemed to be hinting at this in a hotline recently: ‘As I step over the bodies on the trading floor in the gold and oil pits, it becomes clear that 2007 is going to be a rough year for commodities traders. Commodities started out the New Year on a rather aggressive note, with investors sinking prices for gold and oil in a move that actually makes sense, given all the issues the market will be forced to contemplate this year.’

“Meanwhile, co-editor Kerr is excited about another g commodity: cocoa, which he thinks will be up 20%-30% this year.”

More news:


Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…

“We’ve been told by various people who should know better than to spout off stuff like ‘deficits don’t matter’ for so long now, that U.S. consumers are believing it… Believing it so much that they’ve decided to build their personal debts too.”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig


And more thoughts…

*** We had a recent reminder of just how risky the world can be. You wouldn’t know it from reading the financial news…or checking on the latest prices. Investors seem to think that nothing can go wrong.

But something went wrong in Venezuela this week. Hugo Chavez announced that he would nationalize phones and utilities. This news hit hard. The Caracas stock exchange doubled last year. This year, it was already up 19%. But on Tuesday, it suffered its biggest drop ever. The currency, meanwhile, lost 54% in the last six months.

And another little something went wrong in Thailand, too. There, a military coup replaced the elected government a month ago. No one seemed to care about that, but the generals didn’t seem to know what they were doing. First, they imposed capital controls…then, when the stock market crashed, they reversed themselves. Yesterday came more of the same – new limits on foreign ownership, apparently meant as a punishment to the former president.

These two little incidents probably mean nothing on their own. So, we’ll wait for something bigger. Trillions of dollars worth of bets are on the table – derivatives, credit default swaps, securitized debt in various forms, equities, bonds, leveraged this and borrowed that…even works of ‘art.’ We can’t wait to see what happens to these bets when something really goes wrong.

*** “Of course, no one knows what will happen,” said an Irish fund manager at lunch yesterday. “But we look at the long run. And over the long run what we see is that the world’s population is expanding…people in Asia are getting richer…and millions of people – mainly in Asia – want to eat better. They want to eat more like westerners. There is, for example, a big difference between the way people eat in China and the way they eat in Taiwan. In Taiwan they get nine times as many of their calories from meat as they do in China. In China, people don’t eat much meat. They just don’t have the resources for it. But, the experience of Taiwan shows what the Chinese are likely to do when they are able. They will want more meat.

“The problem with meat is that it takes more resources…more land, more water…per calorie. That’s why poor countries typically stick to rice and grains, while in rich countries they eat steak.

“As they get richer, people in Asia will want to increase meat production. But in China, for example, it won’t be easy. They just don’t have the available land or water. Water is a big problem in China. Most of the country is very dry. And the water resources they do have are not used very well. So, they find that they have to use their water for producing food with a relatively high nutritional value per gallon of water used – mainly fresh vegetables.

“What this means is that they will have to buy their grains…and their meat. And since meat relies on grain…at a time when more and more of the world’s grain crops are being eyed for their energy production…it is a fair bet that over the very long term, and in fact, not such a long term, you can expect grain prices to go up. And we think they are going to go up a lot.

“But how can an investor take advantage of this insight? Ah, that is the problem with soft commodities. We studied it at some length. What we found was that there are very few companies that are in the business of producing soft commodities. Farmers tend to be private holdings. And farmers don’t tend to think about their businesses as though they were publicly traded vehicles. Ask a farmer in England what his return on capital is and you will get a blank stare. He makes a living. But he doesn’t think about it as a business. And he doesn’t think of the farm as a capital asset, which is probably a good thing, because his actual return on capital is probably very low. And now in England – and probably much of the rest of the world – the buyers of these big farms are not agro-businesses, they’re just rich people who want to have a place where they can go for relaxation…or something solid to hang onto if the financial economy falls apart. This is probably less so in America than it is in England and Ireland, where we have a culture of wanting to own land. In America, people don’t seem to care about owning land so much.

“You could try to take advantage of the rise in soft commodity prices by using the futures market. But the cost of storing grains and other foodstuffs for the future is just too high. Mice get in the bins…things rot…the containers are expensive…it’s really not a very practical way to invest in this trend.

“We eventually realized that we had to buy the farms. So, we looked around the world to try to find the best buys in farmland…that is, we wanted to get the most production per dollar invested. What we found was that Argentina gave us the best returns. We’ve invested $50 million in Argentina farmland. So far, it seems to be working out for us.”