Suburbistan: Here Comes the Fiscal Firestorm

“With the median home price rising by 26% in the past five years – while young adults’ income has gone up less than 10% – people in their twenties are playing an endless game of catch-up. Buying a home isn’t even in the cards since prices in many urban areas where young people go to start their careers have more than doubled.”

– Vanessa Robertson, MSNBC

“While there are exceptions in industries less subject to intense competition, G.M. is like many other once impregnable American corporate titans in arguing that reducing the burden of caring for retirees has become essential to compete against foreign companies with lower benefit costs and domestic rivals with younger work forces and less generous benefit packages. With retirees living longer and accounting rules forcing companies to more honestly reflect their full costs on their books, the corporate-sponsored social contract is no longer sustainable.”

– Eduardo Porter and Mary Williams Walsh, The New York Times.

Over five years ago, Addison Wiggin and I sat at our desks in Baltimore and had a right good laugh over the term Suburbistan. We knew the boomers would begin retiring soon. We knew the government wouldn’t have the money to pay for it. We knew that when you pit a generation of young taxpayers against a generation of retiring pensioners, you’d get some conflict.

But Suburbistan?

Is it really possible that when cities, states, and the federal government can no longer pay their bills or keep their promises, you’ll see more strident political fights between the generations? More conflict?

If you leave it up to politicians, you can almost guarantee it! Just ask Hillary Clinton. She spent a few days shilling for votes at the United Auto Workers Convention, where delegates sought a Marshall Plan for the U.S. Auto Industry.

Don’t get me wrong. I think America has made a serious strategic error selling off its industrial assets, or allowing them to rust away, to say nothing at the loss of real manufacturing skill that’s accompanied the loss of three million jobs to China and India. Part of this is the auto industry’s inability to adapt to a world where labor is cheap and oil is expensive. The UAW is complicit in its own demise.

But what does this all mean?

Do you remember what it was that caused oil to bounce off $25 in 2003? Following the commencement of hostilities in Iraq, the oil price fell. But then it started climbing. And it kept climbing. And it’s still climbing.

What happened?

Somewhere along the way, markets realized that something important had changed in the world. It wasn’t just speculative traders and geopolitical traders. It wasn’t just the loss of Iraqi production and the growth of Chinese demand. It was, for lack of a better word, a silent tipping point.

Since then, we’ve begun to discuss and absorb the realities of the global energy market, namely the likelihood that global oil production has peaked, and that from here on out oil is going to be harder to find and costlier to get out of the ground.

This year could be the year where we see a silent tipping point in American politics. It will be a point of no return, where interest rates rise as America’s borrowing costs no longer seem so easily manageable. Political rhetoric will be more strident, as it was at Corretta Scott-King’s funeral. After all, it’s an election year.

But more than that, people will begin to feel in their guts that not everyone is going to get through this equally. Do the maths, as the British say. They don’t add up. America can’t pay for all its guns and all its butter.

To meet its borrowing needs, the American government has re-introduced the 30-year bond. There’s a market for the longer-term bonds. And they help the government finance its projects. But the gap between what the American government spends and what it receives in revenue keeps growing.

According to a recent Reuters articles by Pedro Nicolaci da Costa (great name), “If the budget gap continues to grow as a percentage of the total economy, some worry the long-term attractiveness of the United States as an investment destination could be tainted as investors fret over the country’s ability to manage its debts.

“Ballooning deficits could also create trouble for consumers down the line if foreign investors lose their affinity for U.S. assets, forcing a spike in interest rates.”

You’ve heard this before, so it’s not news. But this year is different. And yes, this time is different. The U.S. Treasury market is the most liquid on the face of the planet. It’s the natural destination for the world’s surplus savings and capital.

But that is exactly what seems to be changing before our eyes. Foreign creditors are realizing that while the return on U.S. bonds is getting better all the time with rising rates, it might not be as safe as it looks. And with major global energy projects to invest in (see below), investing in hard assets and energy might be a much better destination for global savings.

If and when that happens, it will set off a domino effect in American political and economic life. It will unleash Suburbistan, as American government – at all levels – is unable to borrow in order to pay for the promises it’s made to a population that now demands government “help.”

What will happen? Will payroll taxes be increased? Will GM and Ford get bail-out packages from the next president?

Those are all stories we’ll be following in the next two years. But I’m pleased to report that there is an investment solution to this problem. One thing we can be certain of is that as political strife in America increases, so will volatility on the stock markets.

Dan Denning
The Daily Reckoning