This Week's Markets

Are we in another economic crisis?

Over the last 75 years voters have learned that government might can be brought to bear on almost any economic problem and it gets be solved. Think of the recessions of the 1980s and 1990s. Think of the Great Depression. (Even though it has been proven that government intervention actually prolonged the Great Depression; people think that the government actually reduced it.)

As a result, voters have grown to expect that government can create a relatively riskless society. When things get bad people get scared, government steps in and everything becomes okay. There is a catch however. There is a price to a riskless society. Society is not inherently riskless. Having a special daddy that steps in when times are bad and takes away risk can be a costly affair.

The devil in the details is that in every emergency the government grows in size and stays larger than it was before. It typically stepped in and borrowed other people's money, applied the fix, and worried about the bill and its increased size of the economic total later. Eventually however the cost of doing this accumulates to the point where the bill cannot be paid. That time is visible on the horizon.

We are finding out the limits to the cycle. Eventually, government grows to the point where it will have difficulty making its interest payments. How do we know we are fast approaching it? On one hand there's common sense. On the other hand there are credit rating agencies like Standard & Poor's who offer opinions to investors when common sense has been exceeded. They run the numbers and tell us whether we are safe or out at the plate. We are rounding third base now. First base was it getting its share from taxes. Second base was it borrowing what it thought it should have. Third base is when it borrows to meet its interest payments. S&P and the markets are telling us that it is well down the road to reaching its limit.

Has our government finally run out of other people's money?

This is not something that just appeared last Friday. Financial analysts saw this coming months ago if not years ago. S&P had warned that it was likely coming if the debt ceiling bill lacked meaningful spending cuts. The market reaction is likely program trading not based upon fundamentals, but on trading tactics. I do not think we are in another financial crisis. We are just extending the previous one. Stay conservative.

Regards,

Chris Gerber, CFA

As always, if you have any questions or would like to talk please feel free to call our office at 952-230-1340. I look forward to hearing from you.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Just Sign Here, Sir, to Co-Sign this Loan

Can you remember the last time, if ever, that you co-signed a loan? Did you have misgivings? If so, it may have been for good reason. There is everything to lose and nothing to gain. The other party gets the cash and you accept the risk. What is good about that? Sometimes it can help a child get started in life. Co-signing is certainly the exception to the rule - often for love - but not the norm.

Actually, you and the rest of us have co-signed trillions in loans for the US Government and you are likely doing more co-signing as you read this. In the next few days you are about to co-sign another big one as the debt ceiling is raised. Offering some perspective on our current co-signing scoreboard...The Bureau of Economic Analysis says that government spending has risen to 37% of our GDP (all economic transactions summed up) up from 27% in 1960. If the trend they see continues, we will be at 50% in less than thirty years. Our increase in national debt amounts to 100% of our GDP today up from 42% in 1980. It's obvious we're co-signing like there is no tomorrow. So, what happens from here?

We have two choices:

1. We continue business as usual which will increase our debt dramatically. Some feel this will lead to a tipping point soon where so few people pay for the debt.  According to the Tax Foundation, 51% of Americans pay no federal income taxes and the top 5% pay approximately 60% of all federal income taxes. This does not include other taxes like state, local, property, and sales taxes.
2. We implement some sort of austerity program that is actually meaningful and the world regains confidence in your and my ability to make interest payments on the loans we have cosigned. Many will scream when their "benefits" are reduced, though. Politicians do not like conflict from voters.

As you can imagine, this is a difficult topic to broach. It actually reaches into politically incorrect territory bordering on public policy and fundamental ideologies. I'm going to let you wrestle with those topics while I focus on the economic effects of our options.

We do not have far to look to see what happens when we don't increase the debt ceiling. We also do not have far to look to see what happens if we do not begin addressing our long term borrowing.

Without raising the debt ceiling it's a cinch that there will be literally millions of government employees and private suppliers laid off. We will likely have depression level unemployment within a couple of months. For this politically repugnant reason alone, I think the odds are that we will see a debt ceiling increase by the deadline. This relieves the short-term pressure, but it does nothing for the actual issues, like unemployment. Unemployment in this country would be at depression levels now were it not for the artificial stimulus packages. Think back to 1932 and 1933 when unemployment was at approximately 25%. Now think to today. The Bureau of Labor Statistics calculates the national unemployment rate six ways: U1 through U6. You normally see U3. This does not account for those underemployed and if you have worked at all during the week that they accumulate the numbers you are considered employed. That number at the end of June was 9.2%. U6 on the other hand adjusts for those who are part-time and underemployed. That number at the end of June was 16.2%. This is a much more accurate representation of our unemployment rate. Also know that people who stay home to raise a family or help around the house are considered employed for the purposes of these calculations. Let’s compare the 1930s to now.

In the early 1930s the unemployment rate was approximately 25%. There was not a government safety net and families stood in soup lines. Today, there is a safety net. Families no longer have to stand in soup lines, they just receive cash. The lion’s share of the cash is borrowed. Excess federal government borrowing (not state and local) over the last couple of years has amounted to about 9% of our economy. Imagine if that 9% was not borrowed. It is not a stretch to imagine that perhaps 9% of those now employed would become unemployed. If this estimate were to pan out, taking away the safety net could easily cause unemployment to jump to around 25%. This adjustment to make the two eras comparable is likely not too far off.

Without a debt ceiling increase, within a few weeks normal interest payments may not be made on federal debt. As you can imagine, this will send a message to borrowers that the United States government is no longer a risk free borrower. Lenders he will need increased interest to compensate them for increased risk. Existing bonds issued by the government will drop in value as new government bonds are issued with higher interest. The three major credit rating agencies will probably carry out on their threat to lower their AAA rating on US debt. Standard & Poor's has warned of a rating downgrade even if the debt ceiling is raised. Without a credible plan to reduce the federal government's budget deficit they feel risk is higher. The fallout does not stop there.

Many large banks are reviewing contingency plans according to the Wall Street Journal. For them, decreased portfolio values have far-reaching effects. Increased interest costs, decreased loan initiating ability, increased investment portfolio risk all impact them. Insurance companies might be in a similar situation. Mapping long-term assets (guaranteed cash flows from US government debt) to guaranteed liabilities (money that absolutely, positively has to be paid, like death benefits) becomes not so easy. Economy-wide impacts will affect most of the prices you pay from your car payment to your house payment to the food in your refrigerator.

This is obviously a very important issue that I am following. It has had an effect on how we invest and will continue to have one for the foreseeable future.

As always, if you have any questions or would like to talk please feel free to call our office at 952-230-1340. I look forward to hearing from you.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.