US Deficit and future HyperInflation

[nwsteve]

Just watched CNN's IOUSA special. Pretty staggering when you hear if you immediately repealed all three of Bush tax cuts, stop all Iraq war spending and cut the Defense spending by 10% the most you could hope to get is a 15% reduction in federal deficit.
As Obama and company attempt to spend our way out of the "recession", it is pretty clear at some point, the tide will have to reverse and tax rates rise and inflation will ramp up.
During the last experience of run-away inflation in the 70's, I recall federal bonds offering interest rates above 12% for 30 yr money and mortgage rates at 12+% if you could get a bank to lend(and that is when banks actually used lending standards). Now we hear the Chinese probably do not want any more of our debt (they and the Japanese hold about half /2/3 I recall of our debt).
The 70's decade is what keeps coming to mind with low market growth and lost of principle value due to inflation.
With that preamble, what does an ER do to protect his principle and try to get enough growth to stay with even a 4% w/d strategy?
A couple stategies bouncing around in my head include an accelerated conversion of IRA to Roth and pay the lower current tax schedule while there is one (of course that assumes the Fedsdon't remove the no tax on Roth withdrawals).
Perhaps reduce equity exposure below 50% to stay in low risk/short duration cash equivalents. Wait until the inflation monster takes off and then buy fed bonds once they have double digit yields.
Anyone want to share how they see "dancing" through the next 3-5 years investment environment??
Thanks
Nwsteve

 

[ESRBob]

Just watched CNN's IOUSA special. Pretty staggering when you hear if you immediately repealed all three of Bush tax cuts, stop all Iraq war spending and cut the Defense spending by 10% the most you could hope to get is a 15% reduction in federal deficit.

I'd love to see data on this, because it feels 'off' to me. One reason might be that the Afghanistan and Iraq wars I have heard are not considered part of the budget, and therefore savings from it would not strictly speaking reduce our spending and annual defecit?

There are all sorts of ways to slice and dice the billions... for an alternative look at the defense budget as a percentage of the total federal budget, here is an intriguing piechart. Not vouching for them, only offering it to give an alternative viewpoint. They say fully-considered 2009 defense spending will be about 1.4T or 54% of the federal budget.

Here's a recent succinct summary from AP on the sizes of our deficits: 1.2T projected now for 2009 (out of a total projected 2.65T federal budget), plus an additional Trillion+ over the next 2 years if the Obama stimulus is enacted. Total deficit now over 10 Trillion.

What happens when they stop wanting our government bonds?!

Still, to the OP's point, if the budget deficit is so vast, saving even a big % of spending in one area may not make much of a reduction in the deficit. Still, a trillion here, a trillion there -- it starts to add up.

 

[Rustic23]

Google National debt percent of GDP.
You find it was the lowest during the Reagan administration. It was about 120% in 1946 after WWII and rebuilding Europe. In fact it was greater than 100% from till at least 1948. It is running about 70% now.

Now, I know that is not all the story, but if it was that much bigger in WWII and we came out of it without hyper inflation, I don't see why we should fall into it today.

 

[brewer12345]

Commodities, baby. If we hit stagflation, it will be the way to go. That and hard assets, preferably financed with fixed rate debt.

Frankly, I think every retiree's portfolio should include a modest dollop of commodity exposure, whether via commodity futures or commodity producer equity/fund. It provides good inflation protection for exactly these sorts of scenarios.

 

[nwsteve]

Here is a link to the IOUSA info--it is actually a movie I.O.U.S.A.: The Movie You can watch a 30 minutes highlights. Not sure if you can get all the hard data ESRBob was looking to see but they do include a lot of graphics in the movie, including the 70% of GNP debt load as of today---forget what gets added with the 1.2T "relief" spending. The magnitude of the numbers, the path we are one makes some pretty ugly scenarios for the future. The Kondreif Longwave forecasters are looking for a Dow to bottom near 5000 and probably 10 years of little economic growth.
The CNN special showed it with an hour of commentary and the authors.
I agree commodities are a solid play with hyperinflation and they are an asset class that should hold value. Maybe a ETF or two--materials. One question mark with commodities is if the global economic situation is poor who is going to buy??
Nwsteve

 

[nwsteve]

Check out the other clips at the movie site--they have a lot of the data that was discussed.
Here is a link that points out the deficit is really a 53 Trillion event when you add in all the unfunded obkigations for SS, Medicare ABC&D
YouTube - I.O.U.S.A. Bonus Reel: A $53 Trillion Federal Financial Hole
Nwsteve

 

[samclem]

There are all sorts of ways to slice and dice the billions... for an alternative look at the defense budget as a percentage of the total federal budget, here is an intriguing piechart. Not vouching for them, only offering it to give an alternative viewpoint. They say fully-considered 2009 defense spending will be about 1.4T or 54% of the federal budget.

Even given the spending on Iraq and Afghanistan, is defense spending really the source of our problem? (Source) As a percent of GDP, our defense costs are still less than 1/2 of what they were at the height of the Cold War and Vietnam.

National Defense Spending as a Percentage of GDP, 1962-2007

brewer12345 wrote:

Commodities, baby. If we hit stagflation, it will be the way to go. That and hard assets, preferably financed with fixed rate debt.

Just to school me up--should we expect commodities to do well during a period of stagflation? While I understand they would hold their value in a period of inflation, if economic activity was significantly reduced, I'd expect demand for many commodities to also be in the toilet. No?

 

[samclem]

During the last experience of run-away inflation in the 70's, I recall federal bonds offering interest rates above 12% for 30 yr money and mortgage rates at 12+% if you could get a bank to lend(and that is when banks actually used lending standards).

It's easy to imagine/hope for 30 year Treasuries going to 15%, then having another recovery with low interest rates and we'd live like kings because we had the foresight to buy when the rates were high. But if we think people are pessimistic now, how will they be when interest rates are 15+%, inflation is only a point or two less than that, and foreigners don't want US bonds anymore? Every day we'll see editorials confirming the death of the has-been US economy, and they'll have data to back it up. It will take a brave soul to buy fixed rate LT US Treasury bonds (or any other fixed interest product) knowing that the US might just keep cranking up the money supply. After all--just because we recovered last time and we experienced decades of tremendous growth doesn't mean it will happen again.

 

[clifp]

I thought most commodities did very well during the 70s. I know that Real Estate and precious metals had nice run, not sure about industrial metals and such.

I caught a few minutes of the CNN special when channel surfing from the football game. I was impressed to see young people in the Concord coalition protesting.

 

[NW-Bound]

I would think emerging 3rd-world countries will take up the slack and be the new commodity sink. Can't Australia, Canada and Brazil be traders with China, India, and numerous other little countries, leaving the US standing on the sideline? I am no economist here, just wondering what role Americans have offered, other than the big consumer sink for goods produced elsewhere. Will foreigners learn that they too can be consumers as well as producers?

 

[dex]

Google National debt percent of GDP.
You find it was the lowest during the Reagan administration. It was about 120% in 1946 after WWII and rebuilding Europe. In fact it was greater than 100% from till at least 1948. It is running about 70% now.

Now, I know that is not all the story, but if it was that much bigger in WWII and we came out of it without hyper inflation, I don't see why we should fall into it today.

After WWII the rest of the world was in ruins and poor. So although the US retooled for consumers commodity prices were low and wages were held in check due to the millions of men returning from the war. Also, tax rates were higher crimping demand and helping to pay off the debt. There were also price controls and rationing. Britain's didn't totally end until 1964 - sugar. So, we are not in the same position today.

We are creating the next bubble. We just do not know what it will look like or when it will happen.

I'm guessing we not go directly to high inflation - the first stop might be a dollar crisis - international dumpting or oil not priced in dollars. That would cause the Fed to raise rates to protect the value of the dollar - possibly, causing a recession and higher prices on everything we import - which is a lot.

Investments - commodity funds, foreign stocks, foreign currencies.

 

[samclem]

I suppose one way of insuring against high interest rates/inflation is to short LT US Treasuries. That can be done via the Rydex Index Govt Long Bond Strategy-C (et al) (RYJCX), but the costs are very high (ER and other costs over 4% per year). Those are heavy and recurring dues to pay, and it would be speculation, not investing.

 

[Koolau]

Anyone want to share how they see "dancing" through the next 3-5 years investment environment??
Thanks
Nwsteve

Maybe invest in gold and lead?

But, seriously. Burns and Koltikoff discuss the 50 to 60 trillion figure in their book on the Coming Generational Storm. They seem to think that many other countries will be in the same or worse shape as the US because of the rapidly shifting demographics.

I too wonder how to protect from inflation/hyperinflation. We just don't know what other issues could be superimposed on the inflation issue. Political instability, stagnant or receding economy, government intervention, taxes, gummint spending,...

Diligent diversification seems advisable, but it doesn't guarantee that a portfolio wouldn't be drastically reduced by run away inflation.

 

[brewer12345]

Just to school me up--should we expect commodities to do well during a period of stagflation? While I understand they would hold their value in a period of inflation, if economic activity was significantly reduced, I'd expect demand for many commodities to also be in the toilet. No?

Look at the historical record. I believe that period predates the DJ-AIG commodities index (what PCRIX tracks), but there was an older commodities index (Bridge-CRB, I believe) that gives a proxy for the period. Raddr has has done very good work on his site to show what returns for commodities were in high inflation, low growth times, and they were about the only thing that did well, IIRC.

 

[ESRBob]

Have always advocated and carried a 5% slug of commodities, but agree that it's been worrisome (and trashed) by threat of downturn.

back to OP, and re SamClem's post from Heritage, I think there is a lot of obfuscation foisted on us by the feds when it comes to the budget, and thus the budgets and deficits can always be made to look smaller than they are. Never mind the unfunded liabilities for Medicare etc which are huge but at least I think widely-recognized. I am more concerned about having a full accounting for what actually gets spent in Washington each year, and on what purposes.

I am not against defense spending, but I think it's important to know that the defense budget is one of the great obfuscation areas: for instance, (and I'm learning some of this recently), the "Defense Budget" that we hear about is really just the core budget that covers this year's spending on salaries, operations, new equipment and maybe a few other items that get you, on various estimates, to something like 600 Billion. That's the number that plugged into the Heritage graph showing defense spending as a modest % of GDP.

What this number doesn't include is a supplement for 'The War on Terror" which pays for the cost of the Afghanistan and Iraq wars -- expenses above and beyond I guess the normal salaries and operations costs from a non-war base year. That number is generally reckoned at around 200 Billion but it doesn't show up as defense spending in the budget, and I am not even sure it shows up in the federal budget generally since it's considered an 'allocation for an extraordinary item'. Sort of like how you might hew to your own household budget and not count some big outlays for some new specific tragic thing happening as part of your budget. Understandable but not accurate, especially when it goes on for several years.

But more, there are a raft of other expenses most of us would consider military-related that don't make it into the defense budget. Things like retired military pensions, VA benefits, shares of NASA or Homeland Security budgets. Together these can have the effect of as much as doubling actual spending on "Defense" from the published budget number.

All this means that military spending as a percent of GDP or as a percent of the total budget can be made to seem small when it might not be as small as we think.

There's a whole 'nother raft of obfuscation going on when it comes to 'balancing the budget' but we'll leave that for another year as we're so deep in the hole now nobody's even trying to suggest fiscal prudence.

 

[samclem]

It is true that there are a lot of different ways to bend/interpret/frame the numbers The Heritage Foundation didn't include all the costs of the wars in Afghanistan and Iraq, but some other figures include all the monies spent rebuilding the Iraqi infrastructure and providing security for those efforts as "defense" costs, where we'd normally think of those types of expenses (in other countries) as foreign aid/foreign assistance. Also, watch for "defense expenditure" figures which include "Global War on Terror" (GWOT) expenditures--a look under the rug will show that this pile of money is spent on all kinds of Homeland Security stuff, conference roms, etc that has nothing to do with the DoD. Regarding costs of military retirements, etc, I think it's fair to exclude those if we are trying to determine trends of military spending for the last 50 years, for two reasons:
1) They weren't included in the basket of "defense spending" in previous decades, so they'd have to be added in to get a true "apples to apples" comparison/trend. For example, at the peak of the Vietnam war, the 9.5% of GDP number did not include expenses for military retirements.
2) These costs include legacy costs from the Cold War and previous US wars (e.g. the force structure that caused these retirement expenditures was from decades past). It's a bill we keep on paying, but might not be relevant to how much we should spend next year on defense (except that it should serve as a warning of bills to come for decades in the future if we increase force structure).

As ESRBob hinted, there might be an agenda behind the information provided at the link in his previous post, coming as it does from something called "The War Resister's League."

Here's another perspective from The Council on Foreign Relations which includes some of the "other costs." I'msure they have their agenda, too.
(Bold added)
"Total military spending (including spending on support and operations inside Iraq and Afghanistan, as well as operations tied to the “Global War on Terrorism,” all of which are budgeted separately from the U.S. defense budget) remains relatively modest compared to historical levels. During World War II, defense spending rose to levels as high as 37.8 percent of U.S. gross domestic product (GDP). Even including war-spending supplements and terror-war expenditures on top of the normal defense budget, today that number comes to about 6.2 percent of GDP.

 

[ESRBob]

Thx, SamClem. If the fully-loaded figure is 6.2% of GDP, that doesn't sound 'bad' in the big scheme of things. No silver bullets on the fed budget front, I suspect. It's one of those things that ERs can be a little detached from as a group not footing a huge share of the bill. Still as citizens looking out for the overall health of the commonwealth (and our kids and grandkids welfare) the sheer growth in spending (and deficits) has to be a general concern.

 

[atlas888]

I am very concerned about future rate of inflation, given the massive cost of the bailouts, growing deficits from existing and future spending programs, the cost of the war, etc. The frustrating thing is that, being a responsible saver, you are hurt in more ways than one by irresponsiblities that brought about the present financial crisis. Interest rate for your savings now dropped to almost zero. It is not even enough to keep up with the present rate of inflation. You still have to pay tax on the interest income and that decreases the actual yield even more. The money being put into stock dropped almost 40% last year. It is more if you go back more than one year. There is really very little option to grow the nest egg now. We are lucky if the nest egg is not disppaering fast. Now we are talking about future big drop in those value when inflation kicks in in earnest.

 

[nwsteve]

Part of my "concern" is with all the confusion in data and the unlikelihood that real data is positive, tbe "real" deficit and hence inflationary pressure will be much worse than even the implications from IOUSA movie suggests.
One other point regarding deficit. After WWII most of the deficit was owed to ourselves. Currently the Chinese and Japanese own approx 2/3 of outstanding paper. There is already indication the Chinese are substantially reducing their appetite for more. Pretty classic economics, have to increase interest rates to attract buyers when no one shows up to buy debt. Then you get even more inflation pressure and currency risk. Next decade is looking like a humdinger for sure. I keep hoping someone is going to point out some offsetting positive scenarios for the next five years. Anyone??
Nwsteve

 

[tomintucson]

Regarding promising investments, a few months back I heard an investor say, "Forget about gold. I'm long canned goods!"

 

[calmloki]

http://www.pgpf.org/resources/PGPFCitizensGuide.pdf

Graphs and numbers and such from the IOUSA film.

Quotha:

What You Can Do As Individuals​

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Establish a personal budget and stick to it.​

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Formulate a financial plan that considers the following questions:​

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What are my short- and long-term personal financial objectives?​

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What major milestones do I need to prepare for (e.g., education,
family, retirement)?​

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When do I see myself retiring and how much do I need to save
and invest in order to retire at a comfortable level that can be
maintained over time?​

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Put that personal financial plan into immediate action.​

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Become more responsible in decisions to spend and use credit,
save for the future and invest savings wisely.​

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Teach children the importance of planning, saving, budgeting,​

investing, and making responsible use of credit.

 

[Gardnr]

Commodities, baby. If we hit stagflation, it will be the way to go. That and hard assets, preferably financed with fixed rate debt.

Frankly, I think every retiree's portfolio should include a modest dollop of commodity exposure, whether via commodity futures or commodity producer equity/fund. It provides good inflation protection for exactly these sorts of scenarios.

Yep, and they're certainly "on sale" right now.

 

[samclem]

Still as citizens looking out for the overall health of the commonwealth (and our kids and grandkids welfare) the sheer growth in spending (and deficits) has to be a general concern.

Amen to that! And here's hoping we all remain vigilant for changes in terms that signal some funny things happening behind the curtain: When the government is doing it and we or our kids will be picking up the tab, it hurts regardless of the label. "Expenditure" = "Investment" = "Stimulus" = "Normal growth"