first majestic silver

Is America Going Broke!

March 4, 2005

It certainly was a dramatic front page for the most recent issue of MacLean's Canada's weekly magazine (Canada's version of Time/Newsweek). If one were picking up this story or you would have thought of it as normal. Instead it is coming from Canada's national magazine that is about to celebrate its 100th anniversary. It may be media for the masses but the message gets across to a completely different audience.

The story begins in the office of the Comptroller General of the United States, David Walker. He says bluntly that "the United States of America's public finances are a shambles". And "they're getting rapidly worse". America has a $43 trillion (including unfunded liabilities) problem. With GDP approaching $11trillion that is almost a Debt/GDP ratio of 4 to 1. Even at the height of the Great Depression it only reached 2.5 to 1. America is addicted to debt. But its very survivability and the financial survivability of the world is dependent on this not turning into a problem. The major question is can it avoid becoming a problem?

Alan Greenspan certainly thinks so. As head of the most powerful central bank in the world he oddly stated that he wanted to be Fed Chairman during the Kondratieff winter as he believed he could beat it. So how is he doing? Well on the surface pretty damn good. Throughout the late 1990's and thus far through the early part of the new century the Fed has provided a never ending stream of liquidity with money supply seemingly endlessly growing somewhere between 6 to 10% (or between 1.5 to 2.5 times the rate of economic growth) and certainly since 9/11 interest rates have been artificially maintained at exceptionally low levels. Indeed as we and many others have pointed they are negative.

But all that excess liquidity due to the expanding money supply and artificially low interest rates has to go somewhere. And somewhere is into speculative activity in bonds, stocks, houses and for the really big players (banks, investment dealers and hedge funds) leveraged plays utilizing derivatives. Now the whole thing has gotten so big it is almost at the point where it can't afford to fail. Because if it fails the entire world's financial system is at risk not just America's.

As MacLean's points out when George W. Bush came to power in 2001 the forecast from the Congressional Budget Office was for federal surpluses of $5.6 trillion over the next 10 years. While that was probably overstated (some estimate closer to $2.2 trillion over the 10 years) it was at least a surplus. No more. Massive tax cuts of which they are trying to make them permanent coupled with massive spending increases primarily for Homeland Security and War have turned those paltry surpluses into massive deficits now totalling over $400 billion annually and climbing. To date the various wars have cost over $157 billion and it is has no real end. As one pundit pointed out we could have ended world poverty for that amount.

Of course the $43 trillion debt is the estimated cost of unfunded liabilities such as Social Security, Medicare and Medicaid. The Federal Reserve Flow of Funds Accounts shows debt of $23.6 trillion outstanding at the end of the 3rd quarter 2004 that included $4.3 trillion for the Federal Government, $9.9 trillion for the consumer of which 73% is mortgages and $7.7 trillion for corporate America. The Federal Government can add another $3.4 trillion for the cumulative trade deficit for a total of $7.7 trillion. The States add another $1.7 trillion and the financial institutions add $11.7 trillion. Ten years ago the debt stood only at about $13 trillion so it has about doubled.

Some of the numbers tossed around are quite disconcerting. The Economic Policy Institute estimates that by 2014 all government revenue would be consumed by just 4 areas: health care for the elderly and poor, Social Security for retirees, National Defence and interest on the debt. Forget about education, transportation, justice and the environment. At some point in the future debt payments would consume the entire budget. Something would have to give.

Alan Greenspan has expressed concern about the deficits. "The consequences for the US economy of doing nothing could be severe". Could be? So what did the market do? It yawned. Greenspan went on to support the plan of privatizing Social Security a pet plan of the Bush White House that is meeting a decidedly very cool reception. Privatization of Social Security is estimated to cost $1 to $1.5 trillion over the next decade. That's adding to the deficit not subtracting even if after that it starts to pay back.

Greenspan has even hinted strongly that the upcoming elderly are going to have to do without considerable of the benefits that have accrued to today's seniors. Some of course would do just fine but the vast majority would fall into permanent poverty burdened with the huge consumer deficits that currently exist. He worries that the current budget is clouding the economic outlook "especially in the longer run" without "major deficit reducing actions" by Congress.

Of course the Bush White House has proposed major deficit cuts but it comes at huge expense to the domestic economy and to the benefit of the Defence Department, War, and Homeland Security whose budgets would actually rise. A picture of the future? Soldiers and Security? That is the picture of what many a Latin American dictatorship looked liked without the war but certainly the soldiers and security. The vast majority of their populations lived in poverty while at the top a ruling elite and the wealthy lived behind the protection of the soldiers and security. With growing walled private suburban developments patrolled by private police America appears to be already on the way there.

Worse because the US saves so little due to the mentality of spend today because interest rates are so low that it does not encourage saving that in order to finance the debt the US is increasingly dependent on the savings of foreigners primarily Japan and China. One major problem in this equation though is that Japan and China are economic rivals to the US. As China becomes wealthier it flexes its military muscles with military second only the US.

So where is all this going to lead? Even the MacLean's article premised that within 25 years the US economy could look like the Russian economy at the beginning of the millennium one in a permanent state of depression. It is clear that the US debt problem can in essence never really be solved and that there may even be at some point in time debt default. That would be horrendous for the world as the US is considered the world's top credit. But that reputation is becoming stretched as foreigners will at some point become increasingly concerned with financing the US's debts. After all even Bankers get nervous when they see no progress at the other end and the day they get nervous is the day we all should be very nervous. The US's foreign policy, trade and security could become compromised by the fact that foreign countries hold the chips.

While many scoff at the thought the US may default or become hostage to some foreign country even the best of them admit its debt are unsustainable. Some believe that debt is good because it goes a long way to keeping the economy greased through fiscal spending and that the US helps the world by buying their goods. Debt is good is their cry. This is just wishful thinking on their part because as we noted you eventually become hostage to your bankers. Ask Argentina how they felt when the IMF came knocking and told them how to run their country. As one wag suggested how do you threaten China over Taiwan when China doesn't have to push a nuclear button they just have to push the sell button on the massive amounts of US debt they hold and there goes the US Dollar and US bond market.

History is full of empires that thought their rule would last forever. But in the end it was the mountain of debt that did them in coupled with massive currency devaluations. All the great empires Greece, Rome, Spain and even Britain all collapsed under the weight of debt, currency devaluation and the massive costs of maintaining an empire. Of course what this circle does is bring one back to an area that MacLean's never broached. Not once did MacLean's mention that Gold and Silver have been currencies for three millennia and they have never lost their value. But then the conclusion is still only grasped by a few. That money in order to be worth something must be something of real value. Paper is worth nothing more than the price of the paper. And that includes stocks and bonds as well as they are ultimately just paper.

All sorts of sincere people are proposing solutions but the trouble with it all is that they are merely band aids. Raising taxes, sales taxes, luxury taxes, rollback of taxes are anathema to the Republicans that are bizarrely running up the record debts. But then if you decrease sources of taxes through tax cuts but continue to spend then there is of course no way to finance it except borrowing. And to slash thousands of support programs will just throw thousands if not millions into poverty. Debt just keeps growing and the consumer seeing no responsibility in government also continues merely on his spending spree with a piece of plastic. But again history has shown that ultimately the debt collapses and is uncollectible. Debt is merely a number written on a piece of paper.

Complacency abounds everywhere right now and no more so then the head of the world's key central bank Alan Greenspan. When asked what would happen to the economy if foreign banks began selling US Treasury bonds in large volumes, he said he didn't expect it would cause a surge in interest rates.

"Our general conclusion at this is we do not perceive that it is a really significant problem for our domestic economy" Greenspan said. Uh! Soothing words but in barely 8 months Greenspan will finally fade off into retirement. Since Greenspan has been the head soother now for upwards of 18 years he has successfully put America to sleep. They and the world could wake up to one hell of a hangover and with it all of the negative ramifications of debt collapse. As David Walker pointed out there has been little progress to show for his efforts. He says in the conclusion to the MacLean's article "You can lead them to water, but they have to drink. And they better starting drinking fast - and soon."

For the rest of us keep the Excedrin handy and keep some real money as in Gold and Silver handy too.

Charts and technical commentary by David Chapman of Union Securities Ltd. 69 Yonge Street, Suite 600, Toronto, Ontario, M5E 1K3 (416) 604-0533, (416) 604-0557 (fax) 1-888-298-7405 (toll free) email [email protected]

David Chapman is a director of the Millennium Bullion Fund

The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. Neither David Chapman nor Union Securities Ltd. take responsibility for errors or omissions which may be contained therein, nor accept responsibility for losses arising from any use or reliance on this report or its contents. Neither the information nor any opinion expressed constitutes a solicitation for the sale or purchase of securities. Union Securities Ltd. may act as a financial advisor and/or underwriter for certain of the corporations mentioned and may receive remuneration from them. David Chapman and Union Securities Ltd. and its respective officers or directors may acquire from time to time the securities mentioned herein as principal or agent. Union Securities Ltd. is an independent investment dealer and is a member of the Toronto Stock Exchange, the Canadian Venture Exchange, the Investment Dealers Association and the Canadian Investor Protection Fund.

David Chapman regularly writes articles of interest for the investing public. David has over 40 years of experience as an authority on finance and investments via his range of work experience and in-depth market knowledge.

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