CNBC anchor to his colleague: 'Dick, oh my God, you're not going to believe this, it's just come in on the wires. "US government to take over Goldman Sachs (GS)".
Dick goes pale, undoes his tie, and starts hyperventilating. 'It's over, the whole shooting match, we're cooked. I just can't believe it...it's the end of capitalism. Sell everything.'
'Wait Dick, just hold on there, they just issued a correction; now it says "Goldman Sachs to take over the US government'.
Dick recovers his composure. 'Jeez, you had me going there, so what they paying?'
Probably not a lot as it happens. The CBO has just forecast a $500bn US fiscal deficit for 2009; the current US national debt is $9.3trn or 64% of GDP and rising at a billion dollars a day. The CBO estimates a $2.3trn increase in national debt over the next decade, even before factoring in the GSE bailout (which will have to be consolidated in the national accounts). Interest payments are now the fourth largest Federal expenditure item; mandatory items like Medicare are well over half the total spend and this will grow rapidly as the dependency ratio rises (the number of social welfare beneficaries to tax-paying workers). PIMCO among others (and how they must be smiling after mugging the US government on subordinated GSE debt, $1.7bn is a nice payday) expect deficits to test $1trn within a few years.
And all these appalling numbers assume that the Bush tax cuts will expire in 2010; under a McCain administration they may continue; independent analysts expect the Obama tax cuts to cost $3trn over ten years and the McCain ones $4trn. What neither has the guts to tell the American public is that taxes will actually have to rise on that time frame, and the US will have no choice but to consume less, and save and invest substantially more. Wall Street, Detroit, and a queue of other other failing industries are looking to feed at the seemingly bottomless Federal bailout trough, but as I wrote in The People's Republic of America this will fatally undermine the ruthless dynamism of the US economy, its crucial comparative advantage over Asia and Europe.
Right now, America's greatest export is IOUs, container loads of which are shipped to China, Russia and the Middle East daily, but the GSE crisis was hastened by the dumping of agency debt by China in particular, and was a sobering indication of how the US is fast losing control over its economic destiny. The relative levels of government debt are less the issue than the fact that it can't be funded by domestic savings, unlike almost all other developed nations. At some point, sooner rather than later, there will be a funding crisis which will see yields spike higher, perhaps triggered by a likely spate of financial crises among US hedge funds and regional banks.
The chart below from PerotCharts.com summarises the deteriorating medium term fiscal outlook; anybody buying a 30 year Treasury at these yields had better have their eyes wide open (and their heads tested?).
Meanwhile, my skeptical view of the Fannie (FNM) & Freddie (FRE) bailout has proved correct; the US stock market is technically in very poor shape, and likely to replicate the crash we have seen in emerging markets and commodities, all down 30-50% from their peaks. We see 90% negative volume down days like the 280pt fall Tuesday, but on the rallies like the 290pt rise on Monday the positive volume balance is barely 60%; in other words, only the bear moves show conviction. As I've said many times before, I expect we will see a typical 30% peak to trough bear market before this is over, implying sub 1100 on the S&P and sub 10,000 on the DJIA.
I remain defensively positioned, being 100% liquid with puts on key indices 5-10% below current levels.
Disclosure: Long SPY put options at 10500 and 1000
