Three separate news items of the last week point to the serious trouble we may face in the next financial crisis. At present, all things seem pretty good. The stock market is at record highs. The President just returned from his Asia trip with multiple promises of new business for American companies. Tax cuts are (hopefully) on the horizon.
Before we rush to extravagance this Christmas, we should at least pause to consider a few cracks underneath the celebration trophy. There are some serious global and domestic issues that highlight our vulnerability. All of them can and should be addressed. Unfortunately, very few have shown the sobriety to properly examine, let alone deal with them.
News Item #1: Total Federal Debt Now Exceeds 100% of our GDP
While the economic horizon does indeed look brighter (thanks in no small part to regulatory reform), we still have a massive Federal debt problem. [For the sake of this discussion, we will conveniently ignore the even more serious problem of unfunded entitlements and focus on the much smaller reported Federal debt. But it is important to recognize that this is simply the tip of an extremely large iceberg. We have discussed the entitlement problem and will do so again.] But the big pronouncement recently was that our Federal debt now exceeds 100% of GDP. The total is well above $20 trillion.
It has long been held that the 100% of GDP mark reflected a serious debt problem. It is made more serious if the debt seems to be accelerating. It is even worse if the acceleration happens in a period of very low interest rates. It is even worse to accelerate debt when the economy is not in recession. Finally, it is understandable if the debt is building when a nation is at war or undertaking some massive programs like infrastructure development.
The problem is that we aren't in the midst of a major war. In fact, defense spending is below what it should be. Add to that the fact that the infrastructure needs a lot of repair and none of that has been covered in current budgets. And, the economy is growing and tax revenues are at all-time high levels. And interest rates are low so interest expense is not busting the budget. The reality is that we are living with the massive bloat created by the Obama Administration after the last financial crisis coupled with historically lower rates of economic growth.
In the year 2013, the government warned that our total Federal debt might exceed 100% of GDP by the year 2024. They were right, of course, but the excess happened sooner than projected. Now, we know that some observers will want to exclude the intra-government debt (debt the government owes itself). Yes, it is true that the Social Security Administration holds a lot of U.S. Treasury bonds and many argue that's not real debt. But it is, especially if we are ignoring future government promises because those who depend on Social Security really do expect to be paid. That debt better be good. In addition, some argue that foreign holdings of our debt shouldn't count because foreigners use our debt as their permanent currency reserves. This argument also fails, however, because foreign holders don't view these holdings as reserves as much as they consider them IOUs from us to them. And they fully expect to be paid and may plan to call the IOU sooner than we'd like. Or, they might use the debt as a weapon against us.
Any business person understands that our Treasury debt is real debt. A perfect example is mentioned in this week's BARRONs:
With U.S. debt as a percentage of GDP above 100%, there's a risk that we might try to inflate our way out of it, which would boost bond yields
November 11, 2017
… Richter says that debt as a percentage of gross domestic product stands at 105%. He adds that Fitch Ratings has estimated that the figure will rise to 120% in 10 years. One corporate leader who opposes adding to this national burden is Howard Schultz, executive chairman of Starbucks. "It's insanity. It's not right," he said at The New York Times Dealbook conference last week …
Estimates are that our total Federal debt will exceed $25 trillion in 10 years and that is wildly optimistic. Total debt was just above $10 trillion when President Obama took office in 2009. In other words, we added $10 trillion in debt, basically doubling the amount in less than a decade with low interest rates and a growing economy. So it shouldn't be at all difficult to imagine a $5 trillion jump over the next 10 years. In fact, that is very likely a serious understatement, especially if we experience a downturn with higher interest rates. Every 5% increase in rates on a $20 trillion debt equals an extra $1 trillion per year in deficit.
This is not simply an academic worry. A debt crisis will hammer every American, especially those who depend on either the government or pensions. We will cover the pension crisis in detail in a future post but the risks are very high.
On the positive side, renewed private-sector economic growth based on tax cuts and regulatory reform could greatly help offset some of the serious debt risks we face. But we will need to act soon or the explosion of the debt bomb could prove catastrophic. The Bible teaches that "A prudent man foresees danger and prepares while the fool goes blindly on and suffers the consequences." [Found in both Proverbs 22:3 and 27:12.] Now, while things seem okay is the time to prepare.
News Item #2: The Leak on a Plan for UAE to Attack Qatar Using Financial Weaponry
The Intercept is an online news publication made famous by publishing the national security leaks of Edward Snowden. Last week they published another significant document with global security implications. It is purportedly a presentation of a plan taken from the email of the Ambassador from the United Arab Emirates (UAE) to the United States that outlines a plan of attack against Qatar.
We've already explained how Egypt, Saudi Arabia, Bahrain, and the UAE have lined up against Qatar to force an end to support for the Muslim Brotherhood. We have also discussed Qatar's role in the 2008 financial collapse via an ownership stake in Barclays Bank. This document, however, shows the tables turned with Qatar on the potential receiving end of a severe form of Economic Warfare.
The basis of the alleged plot was to destroy Qatari credit and currency, ultimately removing the World Cup from the nation. As you read the 3-stage plot, you will recognize the use of many of the things we discussed in the book Secret Weapon: How Economic Terrorism Brought Down the U.S. Stock Market and Why It Could Happen Again. There are lots of similarities including the spreading of rumors, the use of a European bank, the role of Credit Default Swaps, and the attacks on currency.
DOHA : Qatar is investigating an alleged attempt to manipulate its currency during the early weeks of a Gulf political crisis, now in its sixth month, a government spokesman said Sunday.
The director of Qatar's government communications office said an unnamed global financial institution — partly owned by United Arab Emirates investors — had been instructed to stop trading Qatari riyals across Europe and Asia. Saif al-Thani's claim is the latest development in an increasingly complex and bitter crisis. Since June 5, Qatar has been diplomatically, politically and economically boycotted by the UAE, Saudi Arabia, Bahrain and Egypt over charges Doha supports terrorism. Doha denies the accusations. "If this financial warfare is true, it is disgraceful and dangerous not only to Qatar ‘s economy but the global economy," Thani told AFP. "One of the financial institutions stopped trading in riyals for a few days and it was only when we reached out to them" that it resumed, he said.
Qatar's intelligence agencies are carrying out an investigation and "have engaged with law enforcement officials in the relevant jurisdictions", he said. The Qatari claim comes just days after The Intercept, a US-based investigative website, said it had uncovered a UAE plot to "wage financial war" on Doha. It claimed leaked emails belonging to the UAE's ambassador in Washington, Yousef al-Otaiba, revealed a complex plan to attack the riyal through bond and derivatives manipulation. The plan allegedly aimed to destabilise Qatar ‘s economy to the extent that it would have to give up the right to host the football World Cup in 2022. Al-Thani said Qatar had become aware of the currency issue in July but was revisiting the issue following recent media reports. "Definitely they are attacking 2022 in one way or another," he said.
Let's be clear. This is a real plot with huge implications. Most of the world has ignored just how serious this really is. Ignoring this would be like ignoring aircraft carriers before Pearl Harbor. The reality is that this is a new form of warfare and most of the world knows it.
News Item #3: China and Russia Explain Why They Plan to Dethrone the Dollar
On November 9, a hardline Turkish news outlet favored by Erdogan, Yenisafak.com, published an article that describes a looming currency war between Russia and China on one side and the United States on the other. Clearly, the Turkish position is pro-China/Russia. Here are some critical excerpts (emphasis added):
The Peoples' Bank of China has announced a payment-versus-payment (PVP) system for Russian ruble and Chinese yuan transactions to reduce currency risks in their trade. The most likely risk these days of course would be from the U.S. Treasury, for financial warfare to damage Russian-Chinese trade which is becoming very significant in volume and value. By December it should reach a 30 percent rise over 2016. Yet there is more to this seeming technical move by China and Russia than meets the eye.
China plans to introduce similar PVP systems for yuan transactions with other currencies based on China's Belt and Road initiative (BRI) . . .
The fact that the dollar remains the most significant foreign central bank reserve currency, still 64 percent of all world reserves, gives the U.S. government an extraordinary advantage. Since 1971, the U.S. has run budget deficits for 41 of 45 years. In 2009 the U.S. deficit was $1,400 billion! In 1970 the U.S. deficit was $74 billion.
For other countries this is an enormous disadvantage. Their U.S. dollar treasury bond investments for their own central bank reserves are becoming worthless paper.
China and Russia, as well as Turkey, with their dollar reserves, finance the U.S. military budget by buying U.S. bonds and bills that allow the Treasury to finance that deficit without raising interest rates. The cynical irony is that the U.S. military budget is financed by other nations' need to hold dollar reserves against potential currency wars by Washington.
If countries of Eurasia including Turkey and Iran turn to bilateral arrangements like China and Russia to settle trade, bypassing the U.S. dollar, the dollar domination as world reserve currency will decline. Other currencies will rise, with the gold-backed Chinese yuan and gold-backed Russian ruble leading the way . . .
What China and Russia are doing is not about attacking the U.S. dollar to destroy it. That is highly unlikely and would benefit no one. It's rather about creating an independent alternative reserve currency or currencies for other nations wanting to protect themselves from the ever-more frequent financial attacks by the U.S. Treasury and Wall Street banks and hedge funds–a gold-backed alternative. [The entire article can be found at yenisfak,com.]
Basically, this is an attempted moral justification for China and Russia to go after the dollar. It is clear that our adversaries view their holdings of U.S. dollars as supporting our military. It is a direct linkage between our currency and our ability to wage war. It is also a connection between Turkey, Iran, Russia, and China. All that's missing is North Korea from the list, although they don't have the currency reserves to really participate.
Of course, this isn't really new. We have been warning that Putin has been plotting this for some time, encouraging China, Iran, and now Turkey to follow suit. The Chinese admitted as much in an edition of Qiushi magazine, the official house organ of the Communist Party.
Putting the Three News Items Together
Given our rapidly rising debt, it should be clear that we are vulnerable to a financial attack. And, we must be aware that financial attacks are real and being contemplated. Finally, we have a clear recognition in Turkey that many nations resent the dollar's hegemony and are plotting against it. Unfortunately, despite the fact that this should be obvious, those pledged to protect are nation appear oblivious to this very clear, very present danger.
The good news is that there are steps we can take to protect our nation IF we recognize the threat as real. The problem is that it is simply too easy to keep going until something breaks badly. Let's not make that mistake again. That's why we must get our debt under control and take the necessary eight steps to Make America Great Again.