Wednesday, 3 August 2011

The Worst is Yet to Come

Business Mirror

Constantly being accused of being a wild and crazy optimist, (especially about the Philippines), for once I thought I would share some very negative thoughts.

All the nonsense talk these past two weeks about the possibility of the US not paying its debt was foolish. First, the US government takes in all the money it needs each month to pay its international “credit card” bills. Thank goodness, because the US owes the Philippines about $50 billion that the Bangko Sentral loaned to Uncle Sam. Oh sure, the US only pays the minimum monthly payment but that is just enough to avoid default.

Second, the real issue was and is the amount of debt, not the monthly installments. Here the situation is much more serious. It is only a matter of time before the sovereign credit-rating agencies lower the US AAA rating. Completely inevitable.

Money, international capital, is like a gold-digger, only interested in the next high-profit opportunity. While the global markets breath a silly sigh of relief that the US will not default, the rating agency Moody’s has already said “The ‘limited magnitude’ of both debt plans put forward by congressional leaders would not put the nation’s AAA credit rating back on solid footing,”

The conversation about the credit rating is simplified to “Can they pay their bills?” It is not about paying the bills as much as it is about total financial solvency. I have a neighbor that pays six or seven credit cards and loans each month. And every month he goes farther and farther into debt, just like the US government. It is not a matter of being “broke.” It is a matter of using a lot of your income to pay your debt and, most significantly, spending borrowed money. My neighbors borrow money to pay the school tuition.

The US government borrows 43 cents for every dollar that it spends. Why did the US need to raise the debt ceiling (credit-card limit) by $2 trillion? Because in the next 18 months it will spend about $5 trillion; $3 trillion it takes in from taxes and $2 trillion it borrows. Not a sustainable situation.

Yesterday the peso rose to 41.997 to the dollar. Expect to see peso appreciation continue. When (not if) the US credit rating is lowered, lenders will want a higher interest rate. That will put more dollars into the global financial system and the value of the dollar will continue to fall.

Two years Obama and his band of economic fools believed that the US economy was suffering from a liquidity problem. That is, they thought that there was not enough money in the financial system so they lowered interest rates to zero and told the banks to lend out very cheap money to get economic activity going. Two years later there is very little lending and almost no economic activity.

The latest revised economic figures almost ignored during the debt talks show that the US economy grew by a total of 1.6 percent in the last four quarters. Not 1.6 percent per quarter; 1.6 percent total. And the US needs in excess of 2-percent annual economic growth just to keep from going down more.

It was not a liquidity problem; it was a solvency problem. The US was not broke, meaning out of money. The US was and is insolvent, bankrupt, owing more money than it has assets. And the banks would not and will not lend money to individuals and businesses that are insolvent.

It is like my neighbor asking for some cash until he gets paid on the 15th. Sorry partner. Your paycheck coming on the 15th is already spent and the only way you are going to be able to pay me is to borrow from someone else. That is the US financial situation, both public and private, and it can only get worse because there is so little wealth-creating business activity going on.

Overall, Europe is in worse financial shape than the US. But the US is the big dog while Europe is the sick little puppy. And this is the important thing to consider.

The US, Europe and China are economically joined. It is not going well for China. China’s purchasing manager’s index (PMI) fell to a 29-month low in July to 50.7 percent. The PMI measures if companies business (production, new orders, employment) is “better,” “same,” or “worse” than the prior month. A reading of below 50 says business activity is decreasing.

The next 12 months are going to see a further deterioration of the US economy bringing a lower dollar and higher unemployment. The worst is yet to come for them.

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