The Government Finance Bubble

What are we really dealing with here? First of all, the system is suffering through the breakdown in contemporary “Wall Street finance.” As wrenching and destabilizing as it continues to be, this process should be differentiated from outright financial collapse. Confidence in Wall Street “money” (their previously perceived safe and liquid securities/instruments) has been shattered. Myriad sophisticated Credit instruments have been discredited and thus will no longer provide a viable mechanism for system Credit expansion. Importantly, however, confidence has been sustained for system “money” more generally.

As I’ve noted in previous writings, analysts made a momentous blunder earlier this decade when they mistook the collapse of the technology Bubble (and attendant recession and corporate debt problems) for the onset of “deflation.” Reflationary policymaking without regard to the nature of inflationary consequences proved disastrous. We’re about to repeat this error.

Ignoring the Acute Inflationary Bias unfolding in mortgage finance was the greatest mistake in both analysis and policymaking from the ill-fated 2001-2004 period. It should have been clear at the time that rates were way too low and mortgage finance way too loose. This was especially the case when compared to the rapid pace of home price inflation. Most regrettably, the strong inflationary biases that had taken hold in the mortgage and housing marketplaces (“Bubbles”) were too easily exploited as a monetary policy expedient for systemic reflation. Excess in some local housing markets was viewed as a small price to pay for thwarting systemic deflationary pressures.

Despite today’s histrionic fixation on “deflation,” current dynamics have some similarities to the post-tech Bubble period. Granted, the collapse of Wall Street finance is of much greater scope and consequence than the bursting of the tech Bubble. Yet I would counter that The Burgeoning Bubble in Government Finance is poised to make the Mortgage Finance Bubble appear tiny in comparison.

There has been no run on bank deposit “money;” not with the FDIC, Treasury, and Federal Reserve there to backstop confidence. The marketplace’s love affair with agency debt runs unabated – compliments of federal government receivership and guarantees. Money market fund assets are right at record levels, confidence bolstered by Fed and Treasury assurances. And despite the prospect of a $1 TN borrowing requirement this year, the Treasury can still tap liquid markets for short-term funds at about 20 bps. The Fed’s balance sheet has ballooned, although nothing to compare to the unfolding explosion of Trillions of Treasury borrowings, obligations and guarantees (both implied and explicit).

The Government Finance Bubble is enormous and powerful - and should be anything but underestimated. Akin to the previous Bubble in Wall Street finance, the epicenter of this Bubble is here in the U.S. But I would argue that this unfolding Bubble dynamic has greater potential to engulf the entire world than even U.S.-style mortgages and derivatives did starting back around 2002. Welcome to the new world of synchronized stimulus, deficits, and reflationary policymaking. I don’t believe true systemic deflation (as opposed to collapsing asset Bubbles) is a high probability scenarios as long as the Government Finance Bubble is rapidly inflating. All bets are off, however, if confidence in government debt falters. The worst case scenario – that should be avoided at all costs – is a massive inflation of government claims that sets the stage for a devastating bust.

It is imperative for policymakers to ensure that the Government Finance Bubble does not follow in the footsteps of the runaway excess associated with Wall Street/mortgage finance. Yet it’s clear that policymaking (monetary and fiscal) is setting a course to guarantee just such an outcome. And, as has been the case for some time now, markets are keen to fall in love with – and aggressively accommodate – whatever might be the Bubble of the Day.

The Wall Street/Mortgage Finance Bubble ran to such incredible extremes that its subsequent implosion has created the near ideal backdrop for the explosion of Government Finance (as the tech implosion did for mortgage finance). Some notable pundits espouse throwing “Trillions” at the problem in hopes of finding a solution. They fail to be appreciated that Trillions today will only create the need for ongoing Trillions. But this is the nature of vulnerable inflationary booms. The solution is always incorrectly gauged as a shortage of money, Credit and spending.

There is hope that massive government reflation will reinvigorate the asset markets and resuscitate Wall Street finance. I view this as highly unlikely - and these lofty goals incredibly dangerous. It is more likely that the historic Bubble in private-sector Credit creation – with its focus on myriad sophisticated instruments, structures and leveraging – will recover little of its former power and glory. In past episodes of financial turmoil, our policymakers would simply entice private sector financial operators (notably the Wall Street firms, hedge funds and bond fund managers) with alluring borrowing costs, spreads and speculative profits. Strong inflationary biases permeated Wall Street finance, the leveraged speculating community, and U.S. asset prices more generally. Accordingly, almost on demand, private-sector Credit creation would quickly evolve into the main source for fueling system (i.e. asset) reflation. Moreover, asset price inflation was the focal point for perceived wealth creation and economic stimulus.

Today's Post-Credit Bubble Backdrop and The Nature of the Government Finance Bubble ensure quite atypical dynamics (and analytical surprises). For one, the flow of finance to the asset markets will be insufficient to reinvigorate asset inflation (post-Bubble realities of burst confidence, altered market psychology, impaired Credit mechanisms and economic angst/dislocation). This is critical analysis. It was the strong inflationary biases throughout the asset markets that fostered the self-reinforcing Bubble in private-sector Credit. And private-sector Credit was behind past inflationary financial and economic Bubbles - that have left the system today so fragile (and pundits clamoring for more inflation!). Structural realities dictate that Government Finance cannot simply enter the fray and miraculously make things right. A moderate amount of stimulus would be expected to assist the post-Bubble economic adjustment, while inordinate government Credit inflation and market intervention will only work to compound systemic fragility.

The public sector is now essentially on its own when it comes to stoking this bout of reflation. Moreover, it is being called upon after a couple of decades where private-sector Credit grossly inflated home prices, securities values, various other asset prices, household incomes, consumer borrowing and spending, corporate profits, and government receipts and expenditures. The Government Finance Bubble is being called upon to reflate with little assistance from private Credit, while at the same time it is faced with a Deeply Maladjusted Economic Structure still overly dependent upon inflationary Credit expansion. Throwing mega-Trillions at our distorted economy is just asking for trouble.

It is in this context that I fear that the Trillions of Government Finance spent to save the world from “deflation” will, in the end, require perpetual needs for Trillions more. There will be no kick-starting asset Bubbles or a return of private-sector Credit excess. Instead, it will be a case of throwing repeated doses of government-directed finance/purchasing power at the system. Temporary but fleeting economic boosts will then require only stronger doses of artificial stimulus.

We’ve commenced a new cycle dominated by government electronic printing presses in all their various forms. The inflationary consequences will be a different variety than we’ve grown accustomed to from previous reflations. But the bottom line is – and there’s ample history to support this view – that once the “printing presses” get humming along it’s going to be darn difficult to slow them down.

You are right but not complete. Wall Street Finance is not breaking down and never will. This is baloney and it seems everybody is painting with a broad brush. Here are the main problems:

1.The government allowed the creation of the Federal Reserve as an INDEPENDENT body free from government control yet still allowed to print money and controlled by an astonishingly small number of banking interests and allowed them to run monitary policy for this supposedly “free nation” and all based on just fiat of the goverment that doesn’t even control the Board. The government does not back its money with hard assets and hasn’t since Nixon took us off the gold standard.

2.The government sold out the U.S. manufacturing base on the altar of “globalization” which the American People never really signed on for. Ross Perot was right and NAFTA was just another nail in the coffin of the American manufacturing base. Remember the giant sucking sound that Ross talked about? Well it’s here. In the name of national security, there was never a reason to cow tau to a few powerful companies at the expense of thousands of medium sized businesses that anchored thousands of towns and jobs and protected our national independence and self-sufficiency.

3. The government forced banks to relax standards and loan to unqualified investors so they could enjoy the pride of homeownership.

4. The government failed to regulate the creation of more and more derivative instruments while allowing a marketplace for these instruments and the increasing profits they produced to flourish unchecked including MBOs, CDOs, CLOs and especially Credit Default Swaps that allowed hedge funds to buy insurance policies on things they didn’t own.

5. The federal and state governments created deficit spending and never stopped it. They adopted it as a way of life...a way for career politicians who wanted permanency instead of common good, to hand out favors in perpetuity without having to ever say “No”. Deficit spending should have ended in the 1980’s and we should have been on a 20 year austerity program to pay off the national debt. We didn’t do it and it may result in the collapse of the dollar, our standard of living and our very way of live.

6. The government ignored warnings of foreign oil dependence yet went forward with accomodating Detroit and Houston by keeping all things oil instead of SERIOUSLY developing alternatives including Nuclear Power, Clean Coal, Solar, Bio and other alternative sources.

7. Americans are having their enginuity hamstrung and their dreams compromised through unbearable taxation to fund this incredible walk down the wrong path. Instead of admitting we are on the wrong path we throw more and more money at it.

8. The United States needs to reassess it’s role in the world. We do not need to free 30MM people in Iraq. If they needed to be free, they would have taken it upon themselves. We did. We do not need to send billions of dollars in foreign aid to countries that don’t like us so we can be “popular”. What we get is countries who take our money and still don’t like us.

9. The government has no program for immigration. We need to secure our borders and kick the illegals out. If you come in here illegally and get a pass from the government then you will always be a cheat. Let them stand in line. We have far too many hispanics from the south in this nation at this point to make it good for national security. We need to look at the levels of imigration as we did earlier in the 20th century so that the populace becomes more comprised of an equal number of immigrants from all parts of the world who have only their ingenuity, love of this nation and longing to be free as their commonality.

If you want to blame someone for all of this. It’s the government. If you want to fix the problem, here’s the long term answer:

1. Get rid of the Federal Reserve and tie our dollar back to a hard asset (The US has five times the gold of any other nation).

2. Redefine Globalization with tax code revisions for imports that even out the playing field for the American manufacturing base. There is no reason in terms of liberty and national security that American shouldn’t make everything we possibly could want and need, here at home. The world will cry “protectionism”. Let them. Our largest companies will cry “markets are being closed to us overseas”. Too bad. Why do 60MM Americans have to go without jobs or work at Olive Garden part time because 20-50 companies want to grow fat and rich by exploiting the third world.

3. Regulate the mortgage industry by eliminating adjustable rate mortgages. In their place, 10% minimum down on a house and the adoption of the 50 year fixed rate mortgage for those who can’t afford a home.

4. Eliminate all derivatives in the financial markets except futures for qualified individuals (that means corn futures for corn farmers, energy futures for airlines, etc.) This means you would have to apply for and be approved based on a true economic hedging need to be able to trade a specific futures contract. Stamp out derivative speculation.

5. Eliminate deficit spending through a constitutional ammendment and write into law a national and state debt payback program over the next 20 year. If you bring in a dollar in revenue, 30 cents goes to the debt, 60 cents is what you get to run the government on. Sure it will be tough, and so is quiting heroin. There is no difference between the two. Besides, things right now are getting tougher by the week. The difference is, on the far side of it, one nation would be strong, the other will be on its knees. Care to guess which nation we are right now?

6. If you want a stimulus? Make it an energy stimulus. Build 80 Nuclear Power Plants. Build Desalanization Plants across our shores. Develop ANWAR. Develop Wind and Solar farms. Use biofuel as a short term solution. Give Ford, GM and Chrysler as much bail out money as possible but only for electric car development divisions. Give them tax free status for those divisions. Let the gasoline divisions die a slow death prolonged by our bio-fuel program until we don’t need them anymore.

7. Flatten out the tax rate. No American should pay over 20% of their hard earned income for the services this nation and its states provide. A flat Federal Tax of 15% and a flat state tax of 4% should be written into the constitution. Not enough money? Too bad. Cut fat, cut wasteful spending cut services. The same goes for our businesses. Want to stop companies from moving off shore? Give them this flat tax and it will stop.

8. Eliminate foreign aid. If a foreign nation wants help from the United States, let them ask for it with a specific proposal. Let them put it be for us using a national referendum system where we vote on it every two years with our congressional elections. If they can’t wait. Too bad. End our military industrial complex designed to be watch dog for the world. Have the greatest defense force in the world but do not project. Close all but the most strategic bases over seas and make it clear that if you attack the United States, our new policy will be total annihilation followed by permanent possession of your country, wealth and treasure. If we defeat you, you will become a permanent part of the United States. End of story.

9. Finish the border fence. End talks of amnesty. Deport the illegals. Limit the HB-1 visas and tell companies that want them, to start a training program for their needs. Heavily penalize off-shoring of jobs to India etc. Limit the ability of foreign students to train here without staying by giving limits and incentives for these students. Revise the current immigration guidelines to be more equitable based on all nations and the national ethnic make up. We want to be a reflection of the entire world, not just Latin America.

It must be made clear again that this nation was not created to grow and grow and grow and grow. We are there now. The new frontier is not out there. It is right here. We just need to clean it up and run it well.

These nine steps would turn us into the freeest, most self-sufficent, most well run nation in the history of the world. It would make a country where all are employed and doing very well thank you. Our companies might reach limits but that’s ok.

Innovation is not finding ways to get the country to compromise itself so you can sell more and more crap to people overseas who can ill afford it. Nor is it, co-opting foreign workers, taking them far from their homes, letting them live in polluted slums for slave wages so we can buy crap cheap at Walmart.

Our goal was and always has been, to be a free people unencumbered by foreign potentates and an over-reaching government. We should all be free to pursue our interests and know that we are safe and soundly run. That is not what we are but with these steps it is what we would be. It would be hard to get there with a lot of pain but so is losing weight and getting in shape. It requires true, honest communication but I believe if you spelled it out to the American people. Those who truly want this nation to be what it was intended to be, which I believe is the vast majority, would back the program through the hardship to get to the other side.

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