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I.O.U.S.A. Worth a Peak, er Peek
Pete Peterson, the former Treasure Secretary and co-founder of The Blackstone Group, has donated $1 Billion of his IPO receipts to a fund devoted to trying to save America from drowning itself in debt- a sort of super-Common-Cause (of which he was also a co-founder). One project of the fund is a traveling road show of “Town Meetings” on the subject of America’s apparent desire for financial self destruction. Another is the recently released feature documentary on the subject called I.O.U.S.A. which has a lot of Town Meeting footage and which I just saw today.
The film has slick production values. Even though it’s half hour’s worth of content is shoe-horned into a 1 hour and 25 minute film I’d still encourage anyone to see it, especially investors, because the problems it highlights truly are scary and we all should focus more on them as investors and just plain citizens. It specifically suggests that the U.S. is now on the brink of meeting the same fates as the Roman and British empires partly because of fiscal irresponsibility.
The hard content features an historical review of how our national debt became engorged going back to the Founding Fathers. It notes our generally consistent practice of promoting savings and repaying national debts that were required by military crises, once the crisis is resolved - until recent times. It pounds on the foolish idea of Ronald Reagan (abetted by the now discredited “Laffer Curve”) and particularly Bush 43 that lowering tax rates would actually raise government revenues. (Fact: it reduces government revenues as common sense tells us it would.) The film gives what seemed to me to be grudging credit to the fine work of the Clinton administration in balancing the budgets and creating surpluses. All of that information is presented is as non-partisan a fashion as the facts could possibly permit.
I found two aspects of the film particularly noteworthy. First, it highlights the role of unfunded off-balance-sheet liabilities as key to the U.S. debt problem. On a near-term basis, social security surpluses have been offsetting budget imbalances to a major degree during the past 25 years. But social security is starting to provide less cushion every year and will cross over to cash flow negative in 2015, just seven years from now. When the even larger looming problems of Medicare and Medicaid are added the projected national deficit and debt, the numbers begin to look truly horrific.
The second astounding part of the film - to me - is its lack of virtually any reference to oil as a problem, other than in general terms as contributing toward the trade deficit. But there is no mention of the impending Peak Oil problem. The fact that at the same time that Social Security turns cash flow negative in 2015 the country will also be fighting the gigantic problems caused by Peak Oil (which looks to be here sometime in the 2010 - 2012 time frame) is perhaps too much reality even for this film to contemplate. Or maybe Peterson does not understand Peak Oil. But for those of us who are focused on the impact of Peak Oil, the meaning of Peterson’s film is even more trenchant.
The film makes a stab at trying to impress the audience with the danger of massive debt owed to foreign countries, but it could have done a better job, I thought. The key to that concept is that a county’s currency value is a function of both trade and financial flows. That is, when a country begins to run a trade deficit, the consequent reduced value of its currency tends to correct trade imbalance by making its goods more affordable to foreigners and making foreign goods less affordable to be imported.
But when a country runs massive trade deficits for many years, as the U.S. has been doing, a large amount of currency in the hands of foreign governments can stop the trade deficit re-balancing from righting the currency value because foreign holders of the currency may lose confidence and begin to reject increased levels or even current levels of ownership of the currency. That creates more sellers of the currency among government and financial institutions that can more than offset a better trade balance among buyers and sellers of real goods.
In fact, this is exactly what seems to have been happening to the U.S. dollar recently. We are starting to see a reversal of the trade imbalance as more goods are starting to be made in the U.S. and fewer goods imported, due to the fallen value of the dollar (and the high price of oil which makes transporting goods more expensive). Nonetheless, there are so many dollars in the hands of the Chinese, Japanese and oil exporters that those countries may continue to sell dollars, driving down the currency, even as the actual supply and demand for products begins to favor U.S. domestic producers. Thus, financial flows can overwhelm trade flows to distort the value of a currency far in excess of what “purchasing power parity” would suggest is the “right” level.
The problem of too many dollars in foreign hands is exacerbated greatly by the high price of oil given America’s need to import about 14 million barrels of the stuff every single day. In fact, oil could cause a vicious cycle of selling the U.S. dollar to occur. That would happen if the price of oil goes higher and keeps growing. At some point there will be so many dollars held by oil exporting countries that some of them may try to lower their dollar exposure regardless of the value of the dollar. That would tend to drive the dollar lower, which would raise the price of oil (which is denominated in dollars), thus putting even more dollars in foreign hands and thus creating even more desire on the part of foreigners to sell their dollars…which would lower the value of the dollar further and increase the dollar value of oil further, etc., etc.
Bottom line for an oil investor: the perilous condition of U.S. fiscal imbalances is likely to push the value of oil in dollar terms higher over time, which tends to generate stagflation in the U.S. As it does so, the risks to owners of U.S. stocks as an asset class become greater. Eventually, with a high enough price of oil, a general stock market crash seems likely. We are already seeing a tendency for stocks to rise or fall in inverse relationship to the movement in the price of oil.
The film has slick production values. Even though it’s half hour’s worth of content is shoe-horned into a 1 hour and 25 minute film I’d still encourage anyone to see it, especially investors, because the problems it highlights truly are scary and we all should focus more on them as investors and just plain citizens. It specifically suggests that the U.S. is now on the brink of meeting the same fates as the Roman and British empires partly because of fiscal irresponsibility.
The hard content features an historical review of how our national debt became engorged going back to the Founding Fathers. It notes our generally consistent practice of promoting savings and repaying national debts that were required by military crises, once the crisis is resolved - until recent times. It pounds on the foolish idea of Ronald Reagan (abetted by the now discredited “Laffer Curve”) and particularly Bush 43 that lowering tax rates would actually raise government revenues. (Fact: it reduces government revenues as common sense tells us it would.) The film gives what seemed to me to be grudging credit to the fine work of the Clinton administration in balancing the budgets and creating surpluses. All of that information is presented is as non-partisan a fashion as the facts could possibly permit.
I found two aspects of the film particularly noteworthy. First, it highlights the role of unfunded off-balance-sheet liabilities as key to the U.S. debt problem. On a near-term basis, social security surpluses have been offsetting budget imbalances to a major degree during the past 25 years. But social security is starting to provide less cushion every year and will cross over to cash flow negative in 2015, just seven years from now. When the even larger looming problems of Medicare and Medicaid are added the projected national deficit and debt, the numbers begin to look truly horrific.
The second astounding part of the film - to me - is its lack of virtually any reference to oil as a problem, other than in general terms as contributing toward the trade deficit. But there is no mention of the impending Peak Oil problem. The fact that at the same time that Social Security turns cash flow negative in 2015 the country will also be fighting the gigantic problems caused by Peak Oil (which looks to be here sometime in the 2010 - 2012 time frame) is perhaps too much reality even for this film to contemplate. Or maybe Peterson does not understand Peak Oil. But for those of us who are focused on the impact of Peak Oil, the meaning of Peterson’s film is even more trenchant.
The film makes a stab at trying to impress the audience with the danger of massive debt owed to foreign countries, but it could have done a better job, I thought. The key to that concept is that a county’s currency value is a function of both trade and financial flows. That is, when a country begins to run a trade deficit, the consequent reduced value of its currency tends to correct trade imbalance by making its goods more affordable to foreigners and making foreign goods less affordable to be imported.
But when a country runs massive trade deficits for many years, as the U.S. has been doing, a large amount of currency in the hands of foreign governments can stop the trade deficit re-balancing from righting the currency value because foreign holders of the currency may lose confidence and begin to reject increased levels or even current levels of ownership of the currency. That creates more sellers of the currency among government and financial institutions that can more than offset a better trade balance among buyers and sellers of real goods.
In fact, this is exactly what seems to have been happening to the U.S. dollar recently. We are starting to see a reversal of the trade imbalance as more goods are starting to be made in the U.S. and fewer goods imported, due to the fallen value of the dollar (and the high price of oil which makes transporting goods more expensive). Nonetheless, there are so many dollars in the hands of the Chinese, Japanese and oil exporters that those countries may continue to sell dollars, driving down the currency, even as the actual supply and demand for products begins to favor U.S. domestic producers. Thus, financial flows can overwhelm trade flows to distort the value of a currency far in excess of what “purchasing power parity” would suggest is the “right” level.
The problem of too many dollars in foreign hands is exacerbated greatly by the high price of oil given America’s need to import about 14 million barrels of the stuff every single day. In fact, oil could cause a vicious cycle of selling the U.S. dollar to occur. That would happen if the price of oil goes higher and keeps growing. At some point there will be so many dollars held by oil exporting countries that some of them may try to lower their dollar exposure regardless of the value of the dollar. That would tend to drive the dollar lower, which would raise the price of oil (which is denominated in dollars), thus putting even more dollars in foreign hands and thus creating even more desire on the part of foreigners to sell their dollars…which would lower the value of the dollar further and increase the dollar value of oil further, etc., etc.
Bottom line for an oil investor: the perilous condition of U.S. fiscal imbalances is likely to push the value of oil in dollar terms higher over time, which tends to generate stagflation in the U.S. As it does so, the risks to owners of U.S. stocks as an asset class become greater. Eventually, with a high enough price of oil, a general stock market crash seems likely. We are already seeing a tendency for stocks to rise or fall in inverse relationship to the movement in the price of oil.