When I first started making more money than I was spending, I asked my partner to recommend someone to help me do my taxes. “You should speak to Sid,” he told me. He does my taxes and he’s good. Plus, he got rich as an accountant, and that’s not easy to do.”

Sid was his father-in-law. He must have been in his 60s back then, in the early ‘80s, but he looked older. He was tall and gaunt with an angular face and thin gray hair. He was shocked when he discovered how little I knew about money.

Perhaps for that reason he adopted an avuncular attitude towards me. He advised me on taxes, but that was just the beginning. He quizzed and lectured me on sales and marketing and business communication. And he advised me on investing, too.

“Why are you spending all that money on art?” he would exclaim. “It’s just decoration! Just pictures on the wall!”

He failed to dissuade me from collecting art, but he was a big influence in helping me develop a philosophy of wealth building. “You’re making good money now, kid,” he said after I received my first big dividend. “But if you’re not smart, you can lose that much and more with a single stupid move.”

Sid had been a very aggressive businessman (as was his son-in-law). But when it came to investing, he was a conservative as one can be. He bought for himself and recommended to me only two asset classes: triple-A municipal bonds and Treasury bonds.

“What about stocks?” I frequently asked him.

“Stocks are for shmendriks and schmucks,” he’d howl. “Bonds! Buy bonds!”

The Corona Economy, Part IV

War, Debt, and the Eve of Destruction 

“I found this national debt, doubled, wrapped in a big bow waiting for me as I stepped into the Oval Office.” – Barack Obama

In Part I of this series, we looked at our government’s financial situation the way an investor would look at the financials of a business. The conclusion: From a P&L and balance-sheet perspective, it looks awful.

In Part II, we saw how much worse those financials are going to be at the end of this year: a bigger deficit (by $6+ trillion), a smaller GDP (by about 20%), a much larger debt (around $30 trillion).

In Part III, we rued the fact that these facts are not understood by 98% of the voting public, and are misunderstood and/or ignored by 80+% of our elected officials and the media that report on what they’re doing.

And in case you’d want to be one of the 2% of the population that does have at least a basic understanding of how money works at that level, we provided an introduction to US fiscal and monetary policies (as we understand them). Today, we continue where we left off.

The Idiot’s Guide to Monetary and Fiscal Policy in the US (continued)… 

When our government spends more money than it takes in, it covers the difference (the deficit) by borrowing money. It does that through its Treasury, which sells bonds (government IOUs) for the dollars it needs for its overspending.

Treasury bonds are attractive to savers and investors for two good reasons. (1) They are generally considered risk-free because they are “backed by the full faith and credit of the US government. And (2) as “fixed-income securities,” they provide the investor (bond buyer) a guaranteed return paid out on a predetermined basis.

Guaranteed returns by the world’s largest and “strongest” economy? Of course there will be a big demand for T-bonds. Individuals want them. Banks want them.  Pension funds want them. Even foreign countries want them. Not necessarily as a primary investment, but as an asset they can count on when everything else is in flux.

Whether the bond buyer is a retired plumber or a sovereign nation, Treasury bonds promise a solid foundation for any portfolio, providing a sense of security that’s the next best thing to gold. Think about it. Holding T-bonds is like owning a share of America! So long as America doesn’t declare bankruptcy, those IOUs will pay off.

A Wee Bit of History 

The history of US debt is the history of its wars. Before the Civil War, the national debt was relatively modest, because before then there was no income tax. Wars were funded with sales taxes and the like.

The Civil War changed that. Between 1860 and 1866, the debt rose from $64.8 million to more than $2.7 billion, approximately $42 billion by today’s standards. To keep the nation whole, President Abraham Lincoln pushed debt to nearly 30% of gross domestic product and introduced the first income tax in American history.

After that, every war led to ever-higher debt levels. WWI elevated the national tolerance for federal debt, bringing it to $27 billion. More importantly, Woodrow Wilson changed the way debt was approved. Congress’s previous approach was to approve each bond sale individually. Wilson introduced the “debt ceiling,” whereby the US Treasury was told how much it could borrow overall and the administration was allowed to manage the sale of individual rounds of debt. This law has remained in place ever since.

President Franklin Roosevelt made a big “contribution” to raising our debt through the New Deal, elevating borrowing to over $40 billion to fight the war against the Great Depression — nearly doubling the national debt when he took office.

WWII was the next big step in the history of US debt, with the government spending more than $323 billion ($5.8 trillion in today’s money) to defeat Germany and Japan. Much of that money was borrowed. And between 1940 and 1946, US debt climbed from $42 billion to $269 billion, much of it held by individual Americans in the form of Treasury bonds.

But between 1965 and 1978, two more “wars” dramatically boosted the national debt. One of them, from 1965 to 1975, was the Vietnam War. The other one began in 1966 when Lyndon Johnson signed the Medicare program into law. Like the Vietnam War, it was a battle we would not win. But unlike the Vietnam War, the costs of fighting it have never ended or even diminished.

Since then, the national debt has not stopped growing. It grew under President Reagan and under George H.W. Bush and Bill Clinton. (Although the rate of growth slowed considerably after Clinton got Congress to enact tax increases early in his first term.) In the year 2000, our government went into the new millennium with a debt of $5.65 trillion.

Debt slowed a bit in the 1980s and 1990s. Then, on Sept. 11, 2001, President George Bush Jr. spearheaded yet another war – the war on terror. But the invasions of Afghanistan and Iraq were not funded by additional taxes. They were funded by debt, growing at a rate of $400 billion to $500 billion per year.

The Great Recession of 2008 brought deficits beyond the $1 trillion mark. And under Obama, that continued, although it did diminish by more than half during the second half of his presidency.

Then, in 2018, Donald Trump was elected president. Many hoped he would reduce spending, but that didn’t happen. Instead, he oversaw a deficit increase to $1.3 trillion during his first full year in office.

And now we have the war on COVID-19.

Bartering for Dollars 

All of these wars since the Civil War have been funded by government debt. Initially, it was private citizens and businesses (and wealthy industrialists) that bought that debt. But in recent decades, it was foreign countries – countries like Germany, Japan, Saudi Arabia, and China – that were producing budget surpluses and looked at Treasury bonds as a safe haven for their extra dollars.

Germany was an early buyer of bonds. Japan became one soon thereafter. As the years passed, other countries became big buyers. When Saudi Arabia discovered it was sitting on an ocean of oil, it could think of no better way to save its excess dollars than by parking them in T-bonds, backed by the full faith and credit of the USA. After China abandoned government ownership of all businesses, it rapidly became a net surplus economy as well. And it, too, invested its extra dollars in US Treasury bonds.

Which is why you’ve probably heard some people say that the US dollar (and, actually, the American economy) has been supported in the last two decades by Germany, China, and Saudi Arabia.

But surpluses come and go. And about 6 years ago, China changed its priorities vis-a-vis saving its surplus wealth. It continued to buy Treasury bonds, but it also began to buy large amounts of gold. And perhaps more importantly, it began a massive investment in its own infrastructure and overseas ambitions.

“Luckily” for our government, large financial institutions (and particularly hedge funds) began buying (and trading) billions in US debt at the time. This increased the supply of dollars bidding for the T-bonds and, thus, kept the rates down to reasonable levels.

But in the last year, this supply of dollars diminished. That, and the continuing reduction in demand from China, put the Treasury in a terrible situation. If the supply got too small – less than the demand for dollars (our deficits) –  it was possible that the Treasury couldn’t keep up with its payments. That would mean a literally bankrupt USA. And that would mean the end of the world’s economy, as we know it.

In Greek tragedy, the hero is sometimes saved by a deus ex machina – i.e., an intervention by the gods. For America, that came in the form of the Federal Reserve. To make up for the reduced demand from bonds from our traditional buyers, the Fed began buying bonds itself.

Now you may be wondering how the Fed can afford to buy bonds. After all, it is a semi-autonomous central bank that is required by law to balance its books.

Here’s how Tom Dyson explains it:

“The Fed doesn’t ‘inject’ money supply into the economy. Instead, it ‘trades’ it or ‘swaps’ it via transactions with the entities it’s giving the money to. So, for example, if the Fed wants to give the government some fresh money, the government must give it some Treasury bonds. If the Fed wants to give a bank some fresh money supply, the bank must give it something in return.”

It’s called “quantitative easing.” And that’s how the Fed balances its books. It sits on a pile of collateral representing every dollar it has printed and “traded” for something.

Tom again: “Basically, the Fed is a bank that makes huge loans and takes collateral. And the collateral serves as its capital base.”

That is all good and dandy so long as the Fed can unwind these trades when the economy has stabilized by returning the collateral and receiving the dollars back. But recently, the Fed has moved into uncharted territory – making loans whose collateral is questionable, at best. For example, the Fed has recently started accepting the equivalent of junk bonds as collateral. There’s even talk of the Fed purchasing equities with its printed money.

Quantitative easing, as it was done after 2008, was a way for the Fed to help the banking system and lift the stock and bond markets. Back then, the Fed was giving dollars to banks and helping them grow. This was great for the banks and for Wall Street, but it wasn’t good for the economy because the great majority of those QE dollars remained within Wall Street.

About a year ago, the Fed began doing something it hadn’t done since April 1942. It agreed to monetize the government debt. The government’s need for dollars was at all-time highs. But because the usual buyers of T-bonds (foreign countries and, more recently, hedge funds) were reducing their buying, a crisis developed in the Repo Market – a critical market where the government finances itself with short-term loans. There was a “shortage of dollars,” as many analysts put it. A dangerous thing.

So what the Fed did was step into the gap and start buying T-bonds. Billions and billions of T-bonds daily to prevent interest rates from skyrocketing, which would then skyrocket US debt payments and put the Fed on the verge of bankruptcy.

As Tom put it:

“There are no more lenders. So the Fed is now being forced to assume the role of ‘lender of last resort’ to the Treasury… financing the US twin deficits and monetizing the Treasury’s debt. All with printed money!”

Quantitative easing is problematic for many reasons, but it didn’t erode the value of the dollar after 2008 because the stock market went bullish and stayed bullish until this year. The world and its economists, its politicians and its journalists took the rise of the stock market and the modest (3%) rise in GDP as a sign that the US economy could be trusted again. But what the Fed is doing now is different. It is not trying to save Wall Street. It is trying to save the Treasury itself. As Tom put it, this new strategy is “Project Argentina.” [See “Worth Reading,” below.]

On Friday, I hope to finish this series of essays on The Corona Economy. I’ll talk about how this new desperately-seeking-recovery strategy will put our government in an impossible situation that can only be resolved by a miracle or a long and devastating economic depression. And how you can both gird yourself against economic disaster and, at the same time, invest in the miracle that could be.

This essay and others are available for syndication.
Contact Us for more information.

“Credit is a system whereby a person who can not pay gets another person who can not pay to guarantee that he can pay.” – Charles Dickens

K and I were in LA for two weeks at the end of February. We were visiting two of our three kids and our four grandkids. If you’ve ever spent time with toddlers and preschoolers, you know they are always drooling, sneezing, and coughing. And often their parents are too. (Well, not the drooling.)

This is because young children are incredibly good at catching colds and the flu, and very good at spreading them. Typically, they infect their parents, who are also relatively young and healthy. Then their parents spread the cold or flu to everyone they come in contact with.

Thus, it didn’t surprise us to be showing symptoms of the flu when we returned to Florida early in March. We spent a week with symptoms. Normal for me. K usually recovers more quickly. And we thought nothing of it.

Two weeks later, when I began researching the coronavirus, I wondered if we might have caught it. But we had been in LA several weeks earlier than it was said to have started there. So I ruled out that as a possibility.

At the beginning of April, I was reading articles suggesting that the virus might have come to America significantly earlier than the experts had been saying. I speculated that it could be true. We now know it was.

Two recent autopsies proved that the virus was in LA in January, as the victims died on or about February 5. And several more reports confirmed it, with cases identified in late January and early February.

That is good news for everyone. It means that the actual lethality rate of COVID-19 is, indeed, much less than the case fatality rate. In fact, a recent antibody study suggests that 5% or more of the LA population is or has been infected. And that means, as I’ve been saying from the beginning, the lethality rate is just a fraction of 1%.

And this is hopeful news for me and K. Those flu symptoms we had in early March might just have been a dose of coronavirus that our adorable grandkids were kind enough to give us. I’ll let you know after my serology test next week. Meanwhile, back to my exploration of the Corona Economy…

The Corona Economy, Part III

What the Media and Our Representatives Don’t Understand 

Last Monday and Friday, we talked about the general state of the US economy. We took a look at its P&L and balance sheet and concluded it was a bankrupt enterprise that is losing money at an astonishing pace.

2020 will be a watershed year for the US. In terms of the usual data points that measure economic health, it has already neared or surpassed numbers that are as bad as we’ve seen in 100 years.

Unemployment is as high as it was in the Great Depression. The GDP is shrinking quickly. Government spending is at historic highs. Tax revenues are tumbling by the trillions. The federal debt is $24 trillion and will grow by $6 trillion to $10 trillion by the end of the year.

Those are scary statistics. And not just for Americans. Notwithstanding efforts by some countries to achieve economic independence in energy and other vital resources, the global economy is inextricably connected. When any country in the world sneezes, the rest of the world catches cold.

Few in Washington or in the mainstream media are alarmed about this. The attitude seems to be: We’ll deal with it after we defeat the coronavirus.

In fact, an ethos has spread that is disturbing. Being worried about the economy means you don’t care about human life. I see a parallel to the way they responded to the threat of the virus in its early stages. “It’s nothing to worry about,” they said. “We should go about our daily lives without concern.” (It was not just the administration that took this position in January and February. It was the pols and reporters from both sides of the aisle.)

It’s only gotten worse since then. The reportage of the pandemic has been politicized. The right presents hopeful new data as reasons to open up the economy. The left interprets the data darkly and insists that the closure should continue.

One hopes a crisis would bring people together. The Corona Crisis seems to have done that in Italy and Sweden and some other European countries.  But in the US, the divide is wider now than ever. And the animosity is higher.

So we stay in lockdown to slow the virus and, therefore, insure a second and possibly third outbreak. And we spend trillions of dollars we don’t have to “protect” American businesses and workers, even though all the spending is putting us on the brink of an economic collapse.

And yet, economic collapse (which is happening at an exponential rate) is not being discussed with the alarm it deserves – particularly among left-leaning pols and the mainstream media. Some of that is surely due to political animosity. But I think a bigger problem is the widespread ignorance of the way our government gets and spends money. This is true generally of the population at large. But what’s disconcerting is that the ignorance is widespread among the politicians that do the spending and the media that report on it.

A Simple Question 

This takes us back to where we left off on Friday. We know that our government is broke. We know it doesn’t have huge stockpiles of gold and silver or even dollars. So is it able to pay for the $6 trillion to $10 trillion deficit we are putting ourselves into right now?

It’s a simple question. I recently posed it to a few of my smart and educated friends. I’m talking about doctors, lawyers, business executives, and college professors. None of them had any idea.

That’s understandable. In most colleges, economics (let alone government fiscal policy) is not a required course. But you’d think that government officials that vote on spending bills and reporters and columnists that write about government spending would be well-versed on the subject.

I don’t think they are. In fact, I believe most of them haven’t the foggiest idea about how our fiscal and monetary policies work.

But you don’t need to understand these things to be a politician, a political reporter, or a columnist. Nor do you need to understand them to be able to function in almost any career.

I believe I could have had pretty much the same career I’ve had as an entrepreneur and business consultant without a background in fundamental economics. But I do think that the experience of running a business and trying to squeeze a profit from it for many years has given me a good understanding of some of it. Such as:

* There are several ways to make money: You can earn it, you can steal it, or you can be given it. The first is the best of the three because it won’t land you in jail and because it’s not dependent on the kindness of strangers. You are in control of how much money you make.

* The only way to earn money is to exchange something for it – your time, your expertise, or something you own.

* The best way to have that exchange is on a voluntary basis, with everyone free to buy or sell as they wish. This is called a free market. A free market, therefore, is the best way to create economic growth.

There is one more way to make money: You can borrow it and invest it and have the investment pay off the loan and leave you with a profit.

This is a standard practice of at least half the businesses in the US and the rest of the world. Some make the borrowing (debt-financing) work for them. Some don’t.

The trick to making debt-financing work is to invest the money in something that has a good chance of being profitable. That’s why investing in infrastructure generally makes sense for businesses and for economies. But spending borrowed dollars to pay for spending is generally a terrible idea.

You know this from your personal experience. You have friends and family members that are always maxed out on their credit cards, always hiding from their creditors, always getting into more and more debt because they borrowed money they couldn’t possibly pay back.

This is the core problem with the solvency of America right now, and it’s why it’s so important to understand how our government spends the trillions of dollars it doesn’t have.

The Idiot’s Guide to Monetary and Fiscal Policy in the US 

I’m hardly an expert in economics. And my understanding of fiscal and monetary policy has come very slowly over many years. In fact, before writing these Corona Economy essays, I asked Tom Dyson, a colleague who understands this subject much better than I do, to give me a refresher course. “Explain this to me as if I were one of your children,” I said. “Actually, no. Your kids are super-smart. Explain it to me as if I were a really dumb version of your kids.”

And he did.

Tom began by pointing out that there are two federal systems that operate together: the fiscal policies of the government and the monetary policies of the Federal Reserve, our central bank.

The fiscal system is what I was talking about on Friday. It’s how our government gets and spends its money. On the get side is tax revenue. On the spend side is everything our representatives vote for to get themselves elected: military spending, social spending, spending to support our businesses, foreign aid, etc.

If, in any particular year, the government spends more than it gets from taxes, it creates a deficit. If it spends less than it gets from taxes, it creates a surplus. (This is the fiscal counterpart of profit and loss.) In theory, we should want the fiscal system to balance the budget every year – or, in good years, to create a surplus.

In fact, since WWII, we’ve had a lot more years with a deficit than a surplus. I’ll get to that in a moment.

The Mechanics of Debt 

When the government runs a deficit, it has to cover that deficit somehow. The way that’s normally done is with debt. The Treasury posts a sign saying, “We need dollars. Anyone out there want to lend us some?”

This is done through Treasury bonds, which are basically loan contracts. [See “Did You Know?” below.] The person who buys the bonds is the lender. The government is the borrower. And as with most loan contracts, the borrower (government) promises to pay back the lender (bond purchaser) the amount of the loan plus interest.

If, for example, the government spends a billion dollars more than it makes in taxes, it must sell a billion dollars’ worth of Treasuries to make up the difference.

And if the government continues to runs deficits and sell bonds to cover them, it’s going to get deeper into debt.

The problem with growing debt is the same for the government as it is for businesses and consumers. The government has to pay interest on it. If the debt is great and the interest it has to pay is high, the government can find itself in a position where it’s forking over a large percentage of its income (from tax revenues).

A Potentially Catastrophic Problem… or Is It? 

This is a crude example, but it is essentially the problem that the US government has right now. It has been deficit spending almost every year for the past 70 years, and at the rate of more than a trillion dollars every year for at least 10 years. It has a debt of $24 trillion now and a loss in tax revenues of maybe $4 trillion. Add to that another $4 trillion to $6 trillion that it will be spending on the Corona Crisis, and its overall debt is likely to be $30+ trillion over the next few years.

But is that really a bad thing?

Common sense would tell you it is. But there are economists that will argue it’s nothing to worry about. At an interest rate of 1%, it’s “only” $35 billion. Our tax revenues can easily cover that.

Maybe. But what if our lenders – all those people, businesses, and countries that have been lending us that money (buying Treasury bonds) for so long – decide they don’t like the fact that the US has so little collateral. What happens if our credit dries up?

In fact, that’s already happened. You’ve probably read about it. It happened in what they call the repo market.

We’ll pick up on that next time.