Out of Thin Air
One day everything can be fine. Sun shining, cash registers ringing, birds singing in the trees. The next day, you’re in a horror story—and no one knows where it came from.
That’s what happened in the 1952 novella The Birds. You might recall a Cornish farm worker waking up in the middle of the night. Incessant tapping on the window; him opening it. Feeling something cut his hand. Seeing a bird fly away. The sound returning, worse this time. Birds smashing through the windows in his children’s room, clawing and biting them before he can drive them away.
The next day, everything seems normal. Claims of bird attacks seem far-fetched. But flocks of gulls begin amassing on the waves, then rising silently over the Cornish coast. The family barricades itself in its home, learning from the wireless that avian violence is happening all across England. The birds attack, diving, hurling, clawing, pecking, destroying and killing.
An analogy might be drawn between the fiction of Daphne du Maurier and the reality of the American economy. Everything seems fairly normal. We’ve had a scare or two, but most of us still have jobs, commerce is still taking place, politicians are still arguing on Capitol Hill. The world is still going round. But something wicked this way is coming.
And even though many people see the birds on the horizon, we are not preparing at all for them.
Bad Signs
Have we forgotten Lehman Brothers? When Lehman collapsed and shattered the financial world in 2008, many analysts labeled it a “black swan.” Black swans are dramatic upheavals that were never even imagined to be possible; anciently, black swans were thought not to exist. Yet in hindsight, their existence was clear.
Before 2008, who would have thought a revered 158-year-old banking icon would not only collapse overnight, but trigger a meltdown threatening virtually every major bank on the planet? With modern finance, those things just weren’t supposed to happen. Surely it was a once-in-a-millennium accident.
In fact, we made this black swan. Looking back, we can see how our irresponsibility created this monster. And we should have seen it coming. But in its wake, we sadly—yet predictably—absolved ourselves of the need to make real changes.
Instead of getting to the root of the financial crisis, America doubled down on the very things that caused the crisis in the first place. The Federal Reserve had encouraged banks to increase lending. Now, led by Congress, it actually went out and gave the banks money at zero percent interest so they could lend it directly to homeowners—and even to the U.S. government—at 4 to 5 percent or higher. When that didn’t prove “stimulative” enough, the Fed actually began printing up money out of thin air to keep the government running.
“The day after,” it appears to have worked. The stock market is recovering, the economy is adding jobs again, and fewer banks are failing. While these are good signs, this is exactly what should be expected from a multitrillion-dollar effort to prop up the economy. Debt always feels good at first. But eventually, it catches up with you.
Just as Nat Hocken noticed that the birds were strangely agitated the day before he was attacked, we should have already picked up on the warning signs, like the political budget battles. Republicans and Democrats claim they want to take a chainsaw to the trunk of America’s enormous debt. But all they are actually doing is clipping a few twigs off, and ignoring the new $14.6 trillion debt tree we have planted.
America has staved off debt collapse—but in the process, it has made itself far more vulnerable to unexpected shocks. The economy is now so unstable, there is a growing fear that in the future, even turkeys are going to become black-swan catastrophes. And because America’s debt levels are now so big, the next crisis could be deadly.
Millions of homeowners across America can attest to what happens then. When the interest payments catch up with you, and/or an unexpected event causes you to miss a payment, the skies get dark pretty quickly. The same thing is true nationally. Once America’s lenders suspect the nation can no longer handle its multiplying debt, they will call in their loans. Then our debt problems will come home to roost.
What will that mean for you? Massive tax increases, social services cut to pre-Great Society levels. For most people, retirement will be a dream as unrealistic as finding a job. And the rioting won’t be limited to Wisconsin.
Black Swans Are Gathering
Following the 2008 economic meltdown, the world as we knew it ended. “Never in anyone’s career have there been so many problems in the world,” said Jean-Francois Tardif, former manager of the Sprott Opportunities Hedge Fund. “I think you have to change your belief system—we’re in a different world.”
Things have changed. America has long enjoyed its position as the world’s financial cornerstone. Dollars symbolized wealth, security, power, even happiness. But with America printing billions of them out of thin air, they are in danger of becoming lethal to the balance sheets of those who continue to hold them. Investors are concerned about the risks of America’s debt load—and the sustainability of the dollar as the world’s reserve currency.
On April 18, Standard & Poor’s Ratings Service downgraded its outlook on America’s ability to pay its debt from “stable” to “negative.” It was the first-ever downgrade for America. Just a few years ago, it would have been virtually unthinkable from an establishment organization.
Yet, when asked about the warning from s&p, U.S. Treasury Secretary Timothy Geithner said there was “no risk” that the United States would ever lose its aaa credit rating. He said Congress would exercise discipline and raise the debt ceiling. He then went on to say that if it were up to him, he would raise the debt ceiling as high as possible so investors would not worry about not getting paid back.
Raise the debt ceiling as much as possible? Take on even more debt? Does this sound like someone who is facing grim reality?
With each extra dollar of debt, the economy becomes more susceptible to the types of shock that could prevent payment.
By the end of fiscal year 2011, the federal government is projected to have spent more than $420 billion on debt interest payments. All told, America is expected to borrow around $1.6 trillion to pay its budget bills this year. That means one out of every four dollars America is borrowing is going to pay the interest on its borrowed money.
I repeat: America is borrowing money—at interest—to pay the interest! Try doing that with your credit cards and see how long you last.
Making the situation all the more dangerous is the fact that the $215 billion spent on interest in the first half of fiscal year 2011 was incurred with the lowest interest rates in U.S. history! The Federal Reserve has artificially manipulated interest rates down to almost zero, but it will not be able to hold them there indefinitely. And as interest rates rise, interest payments will skyrocket. If rates bump up just 1 percent, America’s interest payments will soar by $125 billion per year! If interest rates rise to 5 percent (where they were as recently as 2007), America will be forced to pay over $1 trillion per year in interest! And if rates are forced back to where they were in the 1970s and ’80s, interest payments will consume $2 trillion per year.
With projected tax revenues of only $2.1 trillion this year, the debt may soon consume most of the government’s money.
As long as the debt grows, the debt payments will multiply and multiply and multiply, pecking away at America’s financial system. Eventually, something will have to give. Will the government default on its debt? Will it try to cheat creditors through inflation? Will taxes go sky high? Will Medicare and Medicaid be slashed? Each choice comes with serious social and economic consequences.
America’s debt has become a massive economic albatross.
Trumpeting in the Night
In March, one of the world’s largest private bond investors revealed that it would no longer lend money to America. Bill Gross, manager and co-founder of the $1.2 trillion Pimco bond funds, revealed that his premier Total Return Fund sold all of its U.S. government treasuries—a couple hundred billion dollars’ worth. It was a shocking announcement. Then it was revealed that Gross had gone even further and was actively short selling American bonds.
Gross isn’t alone. Others also believe that the world’s largest debt market is a giant bubble ready to burst.
On April 18, the People’s Bank of China again warned that China would eventually diversify its monetary reserves away from U.S. treasuries. This diversification may involve selling more than a trillion dollars’ worth of U.S. dollar assets. China lent it—now it wants it back.
According to Gross, America is conducting a Ponzi scheme. Its “quantitative easing” program is simply creating money out of thin air to pay debts. As that program ends in June, Gross says it will be D-Day for government bonds—which means, watch out.
That is why Gross, the Chinese and other insiders are so pessimistic. America’s borrowing needs are the biggest in history, yet its ability to pay its debts relies on more borrowing—or printing money Zimbabwe-style. Once the Fed is done juicing the market, interest rates will jump, and treasuries will plummet in value.
Everything in debt-addicted America will become costlier. Jobs will be lost. Taxes will rise. Funding will disappear. Government debt payments will soar, the economy will grind to a halt and tax revenues will fall. Remember: The government’s only source of income is you. That means you will ultimately pay the price.
The New White Swans
But a debt collapse isn’t the only black swan on the horizon. There are many more ominous birds in plain sight: terrorism, $100-per-barrel oil, $5-a-gallon gasoline, home values still dropping, banks leveraged on depreciating houses, revolutions in the Middle East. Greece, Portugal and Ireland facing bankruptcy, the eurozone on the precipice, Japan’s earthquake aftermath, China’s growing military (ultimately funded by U.S. taxpayers). These are only the swans we can see. What about unexpected disasters? Are we immune from those?
America’s economy is now so weak that it won’t take much to trigger the next crisis. In America the Precarious, so-called black swans may soon become as ordinary as white swans.
Our financial system is addicted to selfishness, impatience and greed, manifested in debt. Our dollars are made out of nothing more than paper, and backed with nothing but shaky confidence. They are as ubiquitous as birds, and we are completely exposed to them. When the next swan event hits, our economy could be devastated. And we will be looking at the worthless digits in our bank account in a whole new way. We should be able to see it coming, but for some it will seem as though it came out of thin air.