When an entity has no savings and the entity spends more money than it gains in revenue it must be going into debt.
This basic truth applies to people, households, businesses, governments and any other organization.
Many people and most governments don’t particularly care about this fact. Spending today and paying for it in the future is more politically popular than saving and fiscal discipline.
A great example of this recklessness and the ensuing crisis is Illinois. But the dire warnings aren’t coming from some fringe blog or conspiracy theorist. They come from Illinois Comptroller Susana Mendoza.
“I don’t know what part of ‘We are in massive crisis mode’ the General Assembly and the governor don’t understand. This is not a false alarm,” said Mendoza, a Chicago Democrat. “The magic tricks run out after a while, and that’s where we’re at.”
As of today the state of Illinois has a payment backlog of $15.1 billion. It’s not because the state isn’t making the payments fast enough. It’s because the state of Illinois doesn’t have the money to make the payments.
Illinois hasn’t had a budget in 2 and a half years. The state’s debt has the lowest credit rating of any of the United States.
It’s also very telling what “solutions” are being proposed. Raising taxes and printing money.
Mendoza channels her inner Yellen stating: “Once the money’s gone, the money’s gone, and I can’t print it.”
The answer is never that there has been financial recklessness and irresponsibility. The answer is never that spending should be reduced. It’s borrow more, print money and raise taxes.
Illinois is a preview of the United States
The borrow, print and tax is a tired set of plays from an old playbook that doesn’t work. But I think it’s the same set of strategies the Federal United States government has been and will continue to use. The main difference is that the Federal government has a virtual printing press and can monetize the debt. Illinois doesn’t have it’s own currency that it can create more of out of thin air.
When the US Federal government has a debt that is due, they can issue more debt (US Savings Bonds, Treasuries, etc) and they find a willing buyer in the United States Federal Reserve as well as private investors and other governments.
When the Federal Reserve buys US government debt it is very harmful to the economy and it’s the reason why the US dollar has lost most of it’s value.
But knowing the playbook the government uses allows you to pick appropriate defensive plays. Insolvent governments try to raise taxes so investing in tax advantaged retirement vehicles is smart.
The government inflates the money supply so invest in assets like gold and silver that can’t be devalued by money printing.
Some folks like Simon Black even recommend US citizens getting a second passport so that if things get really bad, one can simply leave the country.
I’ll be keeping an eye on Illinois. It’s a example of how a government will react when it’s insolvent. I think it will look very similar to what the US will do when it’s debt problem hits the fan. The X factor is that Illinois does not have a printing press, so the effects of fiscal recklessness are much harder to paper over (pun intended). But the printing press only delays the inevitable. If a government could print wealth then Zimbabwe, Venezuela and Weimar Germany would be the richest countries in the world.
There is a story in the Old Testament (or Torah) in which a man named Noah was instructed by God to build a large boat (called an Ark) in order to save himself, his family, and a lot of animals from a flood that would cover the entire earth.
Although it’s not clear exactly where Noah resided before the flood, and he must have had access to large quantities of lumber, there is reason to believe that he lived in a rather arid environment. We’ll call it the desert.
Put simply Noah was building a giant boat, on land, in the desert. He must have looked rather foolish. But Noah had good reason to believe building the Ark was a good idea and he built it in spite of what I can imagine would have been a lot of derision and mockery from his contemporaries.
Now, I’m not saying for a minute that the next financial crisis is going to be a biblical, extinction level event equivalent to the great flood in the bible. There are a lot of enterprising folks around the world and if the economy crashes and the government stays out of the way, entrepreneurs will be able to provide solutions to whatever problems ensue. Life will go on, even if it is painful for some or even many people.
But the point is, it sometimes takes courage to go against the common wisdom of the day and make some prudent preparations. If other people knew what Noah knew, I’m sure they would have been building boats as well.
As I’ve said before it’s important to have some moderation. After all, the excessive debt, spending, and general recklessness has gone on for some time, and could continue for some time to come. There is no reason to panic or go live in a bunker.
But some day, there will be a point in which governments will no longer be able to borrow and spend money beyond what the economy is producing. The United States in particular cannot continue to borrow money at low interest rates forever. When the marketplace equalizes and goes back to a normal level, a lot of the wealth people thought they had will no longer exist.
That’s why it makes sense to take some steps to consider building your own financial ark. I’ve written about various ways to do this, such as gold, value stocks, holding some cash and maybe even taking a chance on some cryptocurrencies, even though right now they are at the high side of their historic ranges. Silver, which I don’t write about that often, is also significantly undervalued in my opinion.
Some people will say owning gold is crazy. They’ll say cryptocurrencies are a large bubble or ponzi scheme (they could be right about that). They’ll say that buying stocks at all time highs is the only way to go. They’ll say that bonds are safe. They’ll say it’s impossible to beat the market and that if a stock is undervalued there is a good reason for it. They’ll say the dollar will always be relatively strong and that the US debt is manageable.
But that is head in the sand thinking. It’s dangerously naive. Being aware of the risks is important and it’s also important to take some practical steps to protect yourself.
Some people may think you’re silly for building an ark in the middle of the desert, but when the waters start rushing in, you’ll be glad you did.
Some people think the United States economy is doing well. The unemployment rate is low. Major US stock indices continue to rise.. There has not been hyperinflation of consumer prices.
So one might be tempted to think the economy is doing pretty well and everything is good and normal. I don’t think this is accurate but I think it is important to look at some of the measures that do seem to support the view that the US economy is on strong ground.
The following are some facts that people will point to when they say that everything is fine.
Stocks are Up
US Stock investors have been handsomely rewarded since the lows of the 2008 financial crisis.
Led by darlings such as Apple, Alphabet (Google), and Amazon, the NASDAQ composite has reached new all-time highs.
The S&P 500 has been on a tear, also making new highs without any significant corrections.
The Dow Jones Industrial average is also making new highs.
The Dollar is Relatively Strong
Despite unprecedented central bank intervention and record US debt the US Dollar Index is holding.
US GDP Continues to Rise
United States Gross Domestic Product continues to climb.
The unemployment rate is below 5%.
But if you look a little deeper than the headlines there are systemic problems in the United States economy.
A lot of People Aren’t Working
Labor Force Participation is at levels not seen since the 70s. And no, it’s not because of baby boomer’s retiring. Labor force participation from those age 25-54 has dropped from 82.8% in 2004 down to 80.9% in 2014. Participation from those age 65 and older has increased from 14.4% in 2004 up to 18.6% in 2014. Source: https://www.bls.gov/emp/ep_table_303.htm
Just because the unemployment rate is low doesn’t mean people aren’t unemployed. If someone is unemployed for long enough, they simply drop off. If someone is fired from a good paying salaried position, and they get two new part time jobs, that is considered a net job gain.
United States GDP Growth is Slowing
The growth rate of US GDP has been trending down.
US Debt is Growing
US National debt is up to nearly $20 trillion, not counting the unfunded liabilities of Social Security and Medicare. Source:
It is politically impossible to cut spending. As Simon Black recently pointed out:
In 2016, for example, the government spent $2.87 trillion on Defense, Social Security, and Medicare, plus an additional $433 billion paying interest on the debt.
That totals over $3.3 trillion, which is more than they collected in tax revenue.
In other words all spending on the department of energy, education, homeland security, everything else besides defense, social security and medicare could be cut completely and there would still be a budget shortfall.
I believe it is politically impossible to cut social security, medicare or defense spending in the United States.
The Debt to GDP is Rising
The debt to GDP ratio is at levels not seen since the United States was fighting a World War in the 40s. Source: https://en.wikipedia.org/wiki/File:Public_debt_percent_of_GDP.pdf
State Pension Funds are Underfunded
The majority of State Pension funds are underfunded.
Social Security and Medicare are Underfunded
This isn’t some alarmist drivel. The people in charge of the Social Security and Medicare Trust Funds are issuing statements like following:
“Both Social Security and Medicare face long-term financing shortfalls under currently scheduled benefits and financing.”
As well as statements like:
Under the intermediate assumptions, DI Trust Fund asset reserves are projected to become depleted in the third quarter of 2023, at which time continuing income to the DI Trust Fund would be sufficient to pay 89 percent of DI
scheduled benefits. Therefore, legislative action is needed soon to address
the DI program’s financial imbalance. The OASI Trust Fund reserves are
projected to become depleted in 2035, at which time OASI income would be
sufficient to pay 77 percent of OASI scheduled benefits.
I haven’t even touched on consumer debt, state debt, low home ownership, and low savings per capita.
The US Economy isn’t Fine
So despite headlines like the low unemployment rate and stock markets making new highs that seem to indicate a recovery from the 2008 financial crisis there are systemic issues in the US economic system. I don’t think that the United States will be able to continue to borrow and spend without consequences. The fact as the United States has a printing press and the world reserve currency doesn’t mean it can borrow and spend forever.
There are ways to protect yourself but you have to be aware of the problems.
I’ve written about problems with the United States dollar and the US economy.
I’ve been influenced by folks like Peter Schiff and Simon Black. To say the least these guys are not bullish on the US economy. I think they’re right and I think it’s wise to listen to what they say, be aware of the risks, and determine what course of action makes sense for your unique situation.
But while things aren’t great, particularly for those on fixed incomes without assets or investments, there hasn’t been a significant stock market correction and the US dollar is still relatively strong. Does that mean that people like Peter Schiff or Simon Black are wrong? Does that mean I’m wrong?
Things aren’t getting better. The underlying problems remain and only get worse. Governments have tremendous debt, interest rates are distorted, governments continue to spend recklessly, central banks are out of control and asset prices are inflated.
In the face of these problems I think there are two mains risks when it comes to behavior that fall on opposite ends of a spectrum. To willfully embrace either of these mindsets and their resultant behavior is, I think, crazy.
The First Kind of Insanity: Doing Nothing
Proud as a Peacock
On the one hand there is a person who does not take the risks seriously because they don’t think there are any significant risks.
People with this mindset believe that the United States can manage it’s debt. They laugh at anyone who suggests the recovery isn’t real or that the stock market growth isn’t based on sound fundamentals.
Subscribers to this attitude think the United States is the richest and freest and greatest country in the world and that $20 trillion in debt and trillions in unfunded liabilities is not a problem. They think the US government can just print money or increase taxes or grow the economy and everything will be fine.
Folks with this type of attitude hold their savings entirely in dollars and US-centered assets. They are comfortable being heavily invested in US stocks. They believe that government promised programs will be there for them when they most need them.
They can’t envision a world in which the United States isn’t the dominant world superpower. They can’t imagine the US dollar not being the world reserve currency.
This mentality is common in those who are blissfully unaware of the lessons of history and the facts of math.
This is the peacock mentality. People with this mentality strut around and deny there are any problems and so do nothing to protect themselves.
An Ostrich Hiding
Similar to the peacocks of the world there are people who realize there are problems with the economy but still choose not to do anything about it. Maybe they think there isn’t anything they can do about it. They think if the dollar falls and the stock market crashes then they have no choice but to go down as well. They’re either unwilling to learn about alternatives or simply don’t think alternatives exist.
They also might willfully ignore anything suggesting there are problems. If pressed they would concede that another 2008 or 2000 crisis are possible and that government debts won’t be repaid, but they really don’t want to think about it.
People with this type of attitude don’t have the misplaced confidence of the peacocks but they make the same choice not to take any decisive action to protect themselves.
They stick their head in the sand. This is the ostrich mentality.
A Second Kind of Insanity: Living Life around Anticipation of Crisis
But at the same time I think there is a risk of having a bunker mentality. This attitude that crisis is imminent and the sky will fall any day now. Individuals who think this way might go 100% into cash. Or go 100% into gold. Or go 100% into guns and food. Or they take huge risks trying to short the stock market.
A Turtle in it’s Shell
But I think this attitude of going into one’s shell is not particularly helpful. It’s hard to accomplish anything or live a fruitful life when you’re hunkered down and metaphorically looking over your shoulder all the time. This is the turtle mentality.
The Golden Mean
Aristotle and the ancient Greek philosophers spoke of a golden mean. The idea that the correct course of action or virtue is the middle path between two extremes. For example, courage is the golden mean between recklessness and cowardly inaction.
The key to sanity in an insane financial world is decisive, measured and purposeful action when it comes to preparation. Two extremes when it comes to investing would be on the one end of the spectrum shorting the S&P 500 with one’s life savings. On the other end would be buying a 3x bull S&P 500 ETF.
But just because I believe US stocks are in a bubble doesn’t mean I’m going to go with the extreme of shorting the market. It does mean that I’m going to limit my exposure to US stocks and be very selective about which stocks I own.
When it comes to dollars the two extremes would be 100% in dollars or 0% in dollars. But just because I think dollars are overvalued and will continue to lose value doesn’t mean I have to go to the extreme of 0%. It doesn’t mean I go 100% into gold or I only own precious metals and cryptocurrencies. I actually advocate holding some cash. Emphasis on some. I also earn money in dollars and invest in value stocks.
This applies to attitude as well. Being negative and pessimistic isn’t going to do anyone any good. Thinking everything is awesome and always will be isn’t a very good approach either. But there are still many great businesses in the US and there is lots of opportunity in the United States and in the world.
The United States has problems. Lots of economies around the world have problems too. There are going to be winners and losers. Many promises that have been made will be broken. But in the midst of all this there is tremendous opportunity. The important thing is to remain calm, take some practical steps to protect yourself and live your life.
Starting in October of 2008 gold made a run from 680 US dollars per ounce up to and over $1920 in September of 2011 for a gain of 182% in less than 3 years. Gold traded sideways and down for the next year and a half until April of 2013 when it crashed down to the low $1300s. For the next few years gold trended down in a falling wedge pattern. Gold was negative for years 2013, 2014, and 2015.
The recent multi-year low of $1045 was logged in December 2015 and I believe this price is the new bottom for the gold market.
Below is a chart of the gold market with my comments. Click the link if you’re not familiar with reading candlestick charts.
2016 was a positive year for gold even though a lot of the gains were surrendered in November. On the whole for 2016 the yellow metal was up over 9%. It’s my opinion 2017 will continue this trend of gains in extension of a new multi-year bull market.
Gold is up over 11% in 2017. It started the year around $1,155 per ounce and is currently trading over $1,290.
Gold still Undervalued and US Dollars are Overvalued
Despite these positive moves I still believe gold is significantly undervalued at this price.
Paltry efforts at “tightening” at the United States Federal Reserve notwithstanding interest rates are at historic lows. There is also record debt and unfunded liabilities paired with an unbalanced budget. The United States Federal Reserve balance sheet remains over $4 trillion. Globally interest rates are also historically low and debt is high. There are even negative interest rates in Europe and Japan. Geopolitical risk of war in North Korea and Syria may have caused the most recent bump in precious metals price.
President Trump has recently done a 180 on several issues. He told the Wall Street Journal the dollar “is getting too strong.” He has also warmed to Janet Yellen and has stated: “I do like a low-interest rate policy, I must be honest with you.”
The Recent Past of Gold
Last week gold made a strong move up through the 200 day moving average (the solid light blue line above is the 200 day simple moving average.
My Predictive Guesses as to the Price of Gold
The following are my guesses/predictions as to where the price of gold will move over the next year. I’m not recommending anyone buy or sell gold based on these predictions.
Gold has been trending upward since the December 2015 bottom. I think gold will make a new intermediate high between 1400 and 1425 in the fourth quarter of 2017. From that peak it should drop back down to 1260 sometime in mid-2018 perhaps around June.
Of course if there is another 2008-style crash or a hot war in the middle east then all bets are off.
The dashed purple line is my predictive guess as to the price of gold
Longer term I expect gold to make a new high above $1920 within the next four to eight years.
Although there is no substitute for physical possession of a percentage of one’s precious metals I also think it is vital to have some gold stored offshore.
The most cost effective way to own physical gold offshore, particularly for investors will less capital, is through Goldmoney.
I personally own several grams worth of gold via Goldmoney and I’ve been extremely pleased with the service.
Gold has been valued across cultures for thousands of years. It has no counter party risk and I believe it is an excellent defensive holding.
I wanted to flesh out the idea that my Caribbean Cruise was a microcosm of the global economy.
Basically Americans spend US dollars to consume goods and services while the rest of the world works to provide those goods and services in exchange for dollars.
One problem with this arrangement, at least for the people of the world who aren’t US citizens, is that the US dollar is no longer backed by a solvent and productive economy.
Another problem is that a lot of the loans American use to acquire dollars are provided by the very countries who also provide the goods and services.
In other words what are these countries getting in exchange for providing goods and services? IOUs.
These IOUs are promises to pay from a group of people and a country that has more debt that any country or people in the history of finance.
In the movie Dumb and Dumber, main characters Harry and Lloyd spend hundreds of thousands of other people’s money. But hey, they kept IOUs so they could pay them back! (both were unemployed)
So what will happen?
The US dollar will continue to lose a significant portion of it’s remaining value and American’s standard of living will continue to fall while the standard of living for the rest of the world will eventually rise once they stop selling their goods and services in exchange for overvalued US dollars.
This has been happening for a while, but people still have faith in the dollar and the other fiat currencies around the world are being devalued by their respective government even faster than the dollar.
So dollars are the cleanest dirty shirt.
But will this continue forever? Will Americans be able to continue to borrow at low rates and live beyond their means while the rest of the world foots the bill?
I doubt it.
The World Reserve Currency
The US dollar is the world reserve currency which means that many things that are traded on the global market are priced and bought and sold with US dollars.
It also means I was able to buy a Hawaiian shirt in Honduras, go snorkeling in Belize and buy drinks in Mexico at a low cost using US dollars.
Using China as an Example
Why do countries put up with this lopsided arrangement?
It has everything to do with history and perception. I touch on this some in another article downfall of the US dollar. But the short version is that the US was the most powerful and dominant country after World War II and the currency reflected this strength.
The result was that critical goods like oil were priced in dollars.
Countries like China therefore need dollars in order to buy oil.
Meanwhile the American consumer wants goods and services.
So in order to get dollars China produces goods and services that are then sold to Americans for dollars.
Back when the majority of Americans had a lot of savings and the dollar had more value this worked fine.
But the US began producing less while simultaneously consuming more resulting in trade deficits.
In 2015 the US imported $497.8 billion in goods and services from China and exported $161.6 billion to China. Thus the U.S. goods and services trade deficit with China was $336.2 billion.
You can’t consume more than you produce (which is what a trade deficit is) without losing money and as time passed the US consumer found his savings depleted.
About half of Americans have zero net worth.
But China has an large portion of it’s economy built around American consumption and the world associated dollars with strength and prosperity.
So China loans money to the American consumer to pay for the American to buy the things China produces.
This works for the time being because the US is the most powerful economy in the world and the dollar is the world reserve currency.
So of course the American will pay back the Chinese producer! Or so the thought goes.
It’s the ultimate vendor financing: China provides the goods and services as well as the loans to pay for the goods and services.
Meanwhile the US government has also taken on monstrous amounts of debt and has devalued the dollar.
So the IOUs the Chinese producer already has are worth less and less each year.
How long before the Chinese producer begins to seriously doubt if the US consumer will ever pay back the IOUs?
Once this doubt takes how long before the Chinese producer stops providing the loans to buy the goods and services?
When this happens prices will have to rise and it will be harder for Americans to buy goods and services.
This process is explained in more detail in an excellent book that I recommend. The book is written by Peter Schiff and is called “How an Economy Grows and Why It Crashes“.
Two beers, four mixed drinks and chips and salsa for under 20 USD. Compliments of El Cial La Ceiba in Cozumel, Mexico. It wasn’t just the two of us imbibing though!
This is basically what I was witnessing on my Caribbean Cruise.
I was able to spend my higher valued US dollars for goods and services provided by peoples outside the US who wanted dollars.
It is a great benefit that Americans have had for some time but will it continue forever?
I don’t think it will.
I think there are lots of opportunities to position oneself to avoid getting destroyed as the dollar continues to lose value.
Thats why I created this website.