1985 Now
Deficit (amount of spending over revenue) $.25T, 6% GDP $1.3T, 10% GDP
Debt 45% GDP $14T+, 90%+ GDP
CBO (clowns in government who forecast future budget, deficits, debt) did NOT factor in a possible recession in next 10 years, but did assume 4%/yr. GDP average for 2011-2014. A bit optimistic. These are the clowns who also gave the erroneous forecasts for Obamacare.
Can you believe: 5/6 of budget = Entitlement programs, defense, and interest we have to pay on debt. It is HIGHLY improbable that Entitlement programs won't get slashed to reduce debt and deficits. A MUST if we want to live.
Slashing debt and deficits hard to do when 45% of population pay NO TAXES. The wealthy can't come close to helping us climb out of debt by increased taxes alone. Middle class MUST be taxed too. Even then, Entitlements must be reduced.
Government tends to mitigate pain to those in trouble and the middle class INSTEAD of doing what must be done to reduce debt. Mitigating pain is a coverup that leads to much worse effects down the road. Handouts are killing us. Hard to take away and more and more want them. Just why do we continue to extend unemployment benefits? To mitigate pain. Result, we go further in debt to pay the extensions.
Large deficits lead to higher interest rates sometime in future: Need to sell more Treasury bonds to spend=>higher supply of bonds=>lower price of bonds (supply & demand)=>higher interest rates (interest moves opposite bond prices)=>higher mortgage, student loans, car loans, all loan rates=>affect stabilization of housing market=>less people can qualify for a loan. Also higher rates=>slow economy (both commercial and government will spend more on interest leaving less to put toward growth objectives)=>weaker job market.
To mitigate pain during these tough times, the FED will intervene and buy government debt (Treasury Bonds), called monetizing debt, =>increases money supply (inflation)=>devalues dollar=>longer-term inflation. [Note: if banks do not lend money out, then the money supply never makes it to the people and inflation is not yet seen -- as it is now]
Each 1% of GDP rise is about 30-60 basis pts rise on loan rates. The higher of the range happens when debt is high.
To detect when inflation kicks in:
1. Watch for increase in Commercial Loans (i.e., when private businesses begin to borrow). This is the C&I stat at the federalreserve.gov site.
2. Also watch for increase of consumer debt. Their appetite will not increase until unemployment falls. Thus, watch unemployment.
3. When the supply of debt (bonds, notes, etc. by government selling) shrink an demand for bank loans picks up, inflation has started.
4. Track Demand at Treasurydirect.gov/ri/ofgateway which lists the number of buyers by type. The type is important to understand whether domestic use is picking up or foreigner are still the predominant buyer. Foreign buyers have been keeping our inflation in check.
5. Watch Bid-to-Cover ration to understand how many request for bonds there are compared to how many can be satisfied. Higher ratio means higher demand. A ration around 2.4 has been norm. When it starts to trend down, this indicates that banks are loaning more to consumers than to the government. We haven't seen this trend yet because: of conviction of Fed to keep short-term rates low [yesterday, they reiterated that short-term rates will be same until to 2014], lingering risk aversion, concern over Euro.
6. We RELY on foreign investors to satisfy our 90% and growing GDP debt! Watch Indirect Bidder % after the bond auctions at the Treasury site. Higher = more foreign interest. Norm is around 30%. If 15-20% for consecutive auctions it is a sign that domestics are taking over and inflation becomes reality soon.
Fed Short-term rates affect Long-term rates. Yields spread is difference between short and long rates. Norm is about 2%, and 3% for overnight rates to long-term.
Inflation signals:
1. Unemployment decreasing [note: inflation LAGS job growth by at least a year. Normally when inflation is 3% job growth will be <1.5%; If > 1% then there are more jobs than people. watch non-farm job reports 1st Friday of month at bls.gov/ces] which casues
2. Increase in Wages
3.Manufacturing Capacity Utilization >>80% means manufacturing can't keep up with demand and prices rise. [federalreserve.gov/releases/g17]
4.Money Supply grows too fast [federalreserve.gov/releases/h6/current/h6.html]. NOTE: there are long lags between money supply increase and inflation. In '60s it took 4 years. Watch M2 > 6% .
5. Fed Actions, like monetizing debt will increase money supply if banks loan out the money [federalreserve.gov/releases/h41/current/h41.htm balance sheet should now be shrinking from 2.3T. If not, look for inflation.
NOTE; Despite lags in inflation, the market react sooner anticipating the future.
How to play the market:
- Some sectors are more resilient to inflation: ENERGY, HEALTHCARE, TECHS
- Avoid UTILITIES, CONSUMER DISCRETIONARY, FINANCIAL
- Some are disasters in inflation: retailers, particularly specialties (consumer discretionary)
- Search Internationally where other areas do not have high deficits and debt, like Australia, Canada, Hong Cong, Germany and Emerging Markets which are even better than U.S. at this time. Australia has good banking system AND natural resources. U.S. stocks that are predominantly foreign markets are good too, like INTEL (90% foreign sales)
- Avoid U.S. Bonds. Some International Bonds okay which may be played via fund or ETF
- Understand demographics play. Consider emerging markets because they have a higher under 15 year old vs over 65 year old ratio. The U.S. actually does have a higher 15 vs. 65 too, but not as high. Japan is bad.
- Commodities rise in inflation AND when $ is weak AND when demand is high (driven by emerging markets). GOLD is good play , as is OIL which always rises with rates and weak $
- Avoid stocks with P/E >>normal (15) for previous 12 months. BUY when <<15. Note, 15 is normal today and will change with inflation. e.g., in high inflation, 9 may be normal.
Koesterich states inflation not a threat for 1-2 years.
Thus, getting to his suggested 10% in commodities can be done over time. Buy on dips when other factors affect the price [weak dollar, demand]. COPPER may be good for long time. Note: inflation does not mean interest rate rise. This can happen independently.
Some historical numbers of returns:
Stocks Commodities
High Growth, High Inflation 12% 20%
High Growth, Low Inflation 16% 10%
Low Growth, High Inflation 5% 24%
Low Growth, Low Inflation 3% - 6%
China will continue to have high demand of commodities and 5/6 of overall word demand increase has been emerging markets.
Commodities also increase when supply is short or costs increase. Mining is getting more costly [new and deeper], as is oil drilling [deeper]. Note, natural gas is abundant [avoid]. Precious metals tend to increase when doaal decreases. Copper increase with demand for building. Agriculture increases with bad weather.
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