Borrowed Time

We’re still focusing on the Federal debt limit which Congress (the opposite of progress) is supposed to be addressing. Despite the impending limit on debt issuance (we supposedly hit the limit on Sunday, May 15th) Congress took their usual spring break and returned to start discussing this area. There are several initiatives in this regard being talked about. There is the ‘gang of six’, three Republican Senators and three Democratic Senators, trying to hammer-out a bi-partisan compromise on the direction of the budget and they will have a version of the new debt limit. There is a group made up of Vice President Biden and the leadership of the House and Senate who are working on the budget. Lastly, there is a rump group in the House that wants to avoid raising the debt limit at all and they are talking about several avenues of avoiding going even deeper in debt.

It is this last alternative that intrigues us. According to some members of this cabal of mostly freshman Representatives, there are ample ways for the US Treasury to limit the amount of outstanding debt and even reduce the volume of debt. Selling assets is one way we could do that. All that gold in Fort Knox would fetch a pretty penny these days, but, still only a fraction of the cash it will take to meet all the promises we have made to ourselves.

There is land a plenty all across the country, but especially in the West that could be auctioned-off. We have buildings, courthouses, old military bases and parks that we could shed. There must be a way to raise a few billion. We could privatize a few things. Selling the Tennessee Valley Authority or Bonneville Power might fetch enough to keep the government in chips for a day or two.

But, it did lead us to look at the budget, which you can find at (the whole world can see just how poorly we spend our government monies, it’s kind of embarrassing). This year, we are borrowing roughly 43 cents of every dollar we spend, after borrowing 37 cents of every spent dollar last year and 40 cents the year before. The last time we got anywhere close to this level of spending was World War II. In fact, almost 60% of the cumulative debt will have been incurred in the last three years. (Well, at least we got bin Laden.)

It is amazing how much we spend on stuff, for example the Federal justice system gets just 1.58% of the spending, roughly $58 billion. That covers the FBI, the US Marshal’s Office, the Supreme Court, all the other Federal courts, the Attorney General’s area, the Federal prisons and even the cost of supplying lawyers for indigent defendants. As you may have guessed, the big dollars are in what the government budget refers to as Income Security. Social Security is the big number here, over 20% of the budget. But, Federal employee retirement expense is over 3.5% of the budget and projected to rise forever. Recently Federal retirement has been exceeded by unemployment expenses, but once the recovery cuts that budget item, retirement will be bigger, again. Federal retirement expenses already exceed Veteran’s benefits of all types.

What we really wanted to bring up is that the government actually makes money doing some stuff. One part of this was mortgage credit, which in good times was the cash that Freddie Mac and Fannie Mae sent to the government after their own huge expenses and politicking costs. “Other Advancement of Commerce” which is a catch-all for commerce-related programs including the Small Business Administration and myriad others, actually made money too. We’re starting to rethink our free market position on some government activities (no, just kidding).

The other big area that seems to pay for the Feds is their financing operations. When they advance money on some contract or program, that money has to be invested in Treasury securities until it is actually spent. So, these trust funds earn interest while they are waiting to be used. The granddaddy of those would be the Social Security Trust Fund, but there are others, lots of others. These trust funds hold enormous amounts of Treasury debt, most of which is in SLGs (slugs, short for state and local government) which are non-traded Treasuries that carry below market interest rates. Regardless, they earned $118 billion last year and will earn almost that much this year.

Once the Social Security ‘benefit’ to the budget turns into a bust about 2037 or thereabouts, that item starts to drop rapidly and then turns into a negative number as they have to borrow money to pay benefits. We have to fix this mess long before that happens. We’re living on borrowed time, figuratively speaking that is.

Issue of the Week

Greece is back in the news. It seems that all that austerity they were supposed to be implementing hasn’t been enough to turn their budget situation around. It was rumored last week (once again) that Greece would either voluntarily exit the Euro or be kicked-out. Everyone denies this as even a possibility, but it does have certain attractive facets. It was also widely rumored last week that some fix of the Greek debt situation would be required regardless. The most commonly discussed options were either an involuntary extension of the maturity of outstanding debt or a reduction in the coupons. Either way, current debt holders would take a bath on their bonds. The same is essentially what would happen if the Greeks decided to dump the Euro in favor of the good old drachma. During the exchange, the current debt holders would get burned on the exchange rate, reducing the value of their bonds now and paying them off with inflated drachmas later.

The trouble with Greek debt is that there is no way the Greeks can afford to pay them off. The degree of austerity needed to bring the Greek budget into some semblance of balance with the current high financing costs would crush their economy. So, the debt holders will have to shoulder some of that pain alongside the Greek tax payers and the Greek civil servants and Greek retirees. There will pain all the way around.

The reason no one is willing to pull the plug on this disaster is that banks today hold a disproportionate amount of the debt. If you force the banks to recognize that this debt isn’t worth what they paid for it, you start another round of worrying about whether the banks are sound. So, if you have to pump money into the banks, you may as well pump money into Greece instead and maybe the money will do some actual good. But, the Greeks seem to be a bottomless pit of needs. So, maybe pumping the money into the banks and letting Greece fail is the better solution. But, right now, the plan seems to be to take most of the debt onto the balance sheets of the various European states and the international aid providers (International Monetary Fund, World Bank, etc.). Once they hold most of it, we can address what it is really worth and take the hit. Oh, and once Greece is done, we’ll do Ireland, Portugal and all the rest as well.

Does anyone wonder now why we keep thinking that having governments decide these things isn’t such a good idea?

Economic News

The US Trade Deficit rose to a 9-month high in March as oil imports rose in dollar terms, swamping a record high for US exports. As we have mentioned before, our trade deficit is predominantly because of energy imports. Ex-energy imports we run slight trade surpluses or small trade deficits. But, oil means we are prone to deficits as far as the eye can see. Luckily for us, most of that oil demand is satisfied by Canada, Mexico and Venezuela, with a little bit from Nigeria and the Middle East. Our exports of grains and other food products hit records while exports of manufactured goods also rose substantially.

April retail sales rose less than expected. After the weather impacted winter, it was widely expected that once spring hit the East Coast that retail sales would show a bounce-back. It didn’t work-out quite that way. Gains of 0.5% with focused largely in gasoline sales.

Producer Prices rose the expected 0.8% for April. Energy prices were a major source of strength for prices, but there was widespread price pressure across a range of commodities. Core PPI, which excludes the volatile energy and food segments, rose 0.3%.

Consumer Prices rose in April by 0.4%. Increases in energy prices were key to this advance. The less volatile core CPI, which excludes food and fuel prices, rose a more modest 0.2%. In the last 12 months, CPI has grown 3.2%.

Consumer sentiment rose to an unexpectedly high level in April. The latest reading of 72.4 compares to the 69.8 in March.

Weekly Stuff

It was kind of a difficult week to summarize. The first couple of days were pretty good, but then it turned ugly as the week progressed. Stocks weren’t all that far from their prior week’s close by late Friday, but they were well ahead when we opened on Wednesday, so it felt worse than it actually was. So, this is what a correction/consolidation feels like?

Foreign stocks had it worse as the risk-off trade continues to hit that area harder than the US blue chips. The dollar gaining over 1% makes that look worse than maybe it really was, though. Most of the European markets fell on renewed Euro break-up fears, while Japan fell on their own issues. The emerging markets were mixed with gains in China, Hong Kong and Singapore while Brazil and Mexico dropped. Korea followed Japan lower.

US Treasury Bonds were down slightly, while corporate bonds edged higher and high yield rose. Foreign bond markets were largely firm, with broad participation in the upswing, despite the dollar headwind.

Real estate securities were mixed, US REITs were up slightly to unchanged while foreign prices dipped a little.

Commodities were quite mixed as well. Even within categories there was mixture. Energy prices were mixed with crude higher and product prices and natural gas lower. Food prices were mixed with grains largely down and livestock most higher. Precious metals were mixed with silver down while most others were up. Seems like old times.

Have a great week.

Karl Schroeder, RFC, CSA

Investment Advisor Representative

Schroeder Financial Services, Inc.