Through a combination of incompetence and greed, the federal government has placed itself in a position of checkmate. There is no way to finance its budget deficits without devaluing the dollar or causing interest rates to rise. With $10.6 trillion in debt, $8.5 trillion in new money created or given away in 2008, and multiple years of trillion dollar deficits planned by Obama, government has no way to fund its extravagances without either printing a lot more money or borrowing unprecedented sums.
This means that either Treasury bonds will crash, or the dollar will suffer significant devaluation relative to foreign exchange or precious metals, especially gold.
Market forces are telling the world to shed unproductive assets and shrink capacity, yet central banks and governments around the world, in particular the U.S., are refusing to listen. Rather than allow markets to snap back to sustainable equilibrium from previously artificial highs, the federal government clings to the notion that forcibly shuffling resources, propping up asset prices, and diluting the money supply will magically save the day.
There are consequences to everything. The consequences of shuffling resources (taxing productive ventures and doling out those resources to failing ones, i.e. bailouts) are stunted growth for good businesses and propagation of bad ones. Artificially propping up asset prices means that those who are generally less competent remain the custodians of society’s capital, and diluting the money supply inflates aways everyone's wealth over time, particularly harming the poor and middle class.
For decades the federal government has gotten away with this reshuffle and inflate game, but the pawns are drowning, the rooks helpless, and the knights ready to turn on the King. Perhaps this is overly dramatic. Clearly, I doubt the capability of the Federal Reserve, Congress, and Obama to “fix” the economy; rather, I strongly believe they are destroying it by forcing us all to drink this Keynesian Kool-Aid. However, whether or not the economy recovers amidst this historic central government action, there are two phenomena we can exploit to our advantage:
- Short the US dollar
- Short US Treasuries
In “When will the great Treasury unwinding begin?” I show how government debt has been bid to unsustainable levels and will likely fall. The one concern I see stated all too often is that the Federal Reserve will keep buying Treasuries to artificially depress interest rates. This will, it is claimed, keep bond prices inflated. The one undeniable counter to this is that government must somehow fund its $1.2 trillion estimated 2009 deficit. It cannot do this by issuing and then buying the same bonds. It can only raise revenue by selling bonds to other parties, or by diluting the money supply by cranking up the printing presses. There are no other options. There you have it - we have the government in checkmate!
The likely outcome is that they will try to do both. That is why I am heavily shorting both 30-Year Treasury bonds and the dollar. Both assets will likely lose as the government becomes increasingly desperate and the world’s biggest buyers realize there are better alternatives available. Make your bets now before it becomes treasonous to bet against Big Brother!
Disclosure: Long UDN, short TLT, long GLD.