Daily Dispatch: Off Balance Sheet, Out of Mind - August 04, 2009

August 04, 2009 | www.CaseyResearch.com

August 04, 2009 | www.CaseyResearch.com

Off Balance Sheet, Out of Mind

Dear Readers,

As David noted yesterday, I, Chris Wood, will be taking over the duties of this Daily Dispatch for the rest of the week. But don’t worry, dear readers, while I lack David’s talent for prose, I will receive ample support in this endeavor from the rest of the Casey Research team. So, you’ll be in good hands.
Now, let’s get to it.

Off Balance Sheet, Out of Mind

By Chris Wood

The U.S Treasury's Financial Management Service recently released its monthly Statement of Receipts and Outlays for the United States Government.

For the first time ever, the Treasury reported a deficit above $1 trillion -- $1.086 trillion, and that’s with three big-spending months left to go in the current fiscal year.
To put things in perspective, the reported federal deficit for all of 2008 was $455 billion. At the time, that was a record. But it is less than 42% of the borrow-and-spend total at this year's nine-month mark.

As shocking as that seems, it’s not even the real deficit story. Most of the real deficit is hidden by the Treasury's accounting methods.

For one thing, the annual budget deficit supposedly refers to the difference between government receipts and outlays. But sly politicians sometimes remove a spending item from the regular budget and then bring it back as a supplemental appropriation. Supplementals are real costs that add to government debt, but they don't get counted in the reported deficit. For example, during fiscal 2008, the federal government’s net operating cost (the government’s “bottom line” – the difference between revenue and cost) was $1,009.1 billion, but the budget deficit was reported as “only” $454.8 billion.
But it gets much worse.

To quote John Williams’ Shadow Government Statistics: “Those [2008] numbers, however, did not account for the annual change in the net present value of unfunded Social Security and Medicare liabilities, except in discussions and footnotes. Counting those changes, as a corporation would for its pension and healthcare liabilities for retirees, the 2008 annual deficit was $5.1 trillion [compared to the reported figure of $454.8 billion], versus $1.2 trillion in 2007 [compared to the reported figure of $162.8 billion]. Such showed total U.S. obligations – gross federal debt outstanding plus the net present value of unfunded liabilities -- at $66 trillion, roughly 4.6 times the level of reported U.S. GDP, and greater than total estimated global GDP.”

How is the government able to avoid admitting such staggering real deficits?
Congress has written its own accounting rules. They call for “cash accounting,” similar to the way you track what comes into your checking account and what goes out. That shows how well you're handling today's bills, but it tells nothing about how well you're preparing to pay tomorrow’s bills – especially if you've made a lot of big promises.

Making big promises is one of the things governments do well, and cash accounting lets them disregard each year's growth in the eventual cost of making good on those promises. In the case of the U.S. government, cash accounting allows the build-up in promised pensions for civil servants and military personnel, to cite one giant example, to simply be ignored. Overlooked. Passed over in silence. The build-up of future Social Security and Medicare liabilities is handled the same silent way. For the government, cash accounting isn't just an accounting method, it's a denial method.

Generally Accepted Accounting Principles call for companies and institutions with annual revenue of $1 million or more to use accrual accounting, a method that reflects the build-up of liabilities. For a public company, it would be illegal to publish financial results based on anything else. But for the federal government, with receipts and outlays in the multiple trillions every year, using the no-tomorrow method of cash accounting is business as usual.

The Deflationists

(This just in from David.)
Earlier this month, our friend John Mauldin ran two articles, pretty much back to back, that make the case why the current crisis must end in deflation, not the inflation we see. As a number of you, dear readers, wrote in to ask our opinion on their arguments, we thought we’d do just that. Below, our own Terry Coxon, one of the four horsemen co-editors of The Casey Report, responds.

(To view the original articles, click here for Hoisington’s article or here for Jensen’s article).

Thanks for sending the two deflation articles, one from Hoisington Investment Management and one from Niels Jensen via John Mauldin. They’re well done, but I’m still not buying it.
The Hoisington article traces through the mechanics of how increases in the monetary base and then increases in the money supply normally give a temporary stimulus to the economy and – and concludes that the normal chain of cause and effect isn’t working this time. The article cites the unwillingness of shell-shocked banks to lend and thereby turn the increase in the monetary base into an increase in the money supply, and also the reluctance of a nervous public to spend any new money that comes its way and turn the cash into demand for goods and services.
The Niels Jensen piece tells essentially the same story but in a less mathematical fashion.
The center of the deflationist argument is that while the government can create new money, it can’t force anyone to spend it. And once deflation sets in, no one will want to spend it. Motivated by fear and also by the thought that everything will be cheaper tomorrow, everyone will want to hoard cash.
The strength of that argument is also its weakness. The longer a deflation continues and the more tenacious it seems, the more government will print, which will make the eventual inflation that much more severe. Reluctance by banks to lend won’t prevent this. Even if every loan officer in the country posts a big “No” sign on his door, the newly created money will still reach businesses and consumers via government deficits financed by Federal Reserve purchases of debt. The resulting portfolio imbalance that most businesses and households will see (so much cash, comparatively so little of other things) will at some point lead people to spend, which will switch the system from deflation to its opposite.
The question to ask is not whether there will be inflation or deflation. The question is how long the recent deleveraging and deflation will continue before people start spending the newly created cash and set off a roaring inflation. The virtual certainty of high inflation ahead and the great uncertainty as to the timing are compelling reasons to make gold and cash your two biggest holdings.

One thing I have learned over the years is that it is very easy to fall in love with a position. To avoid becoming unprofitably starry eyed, it is essential to constantly review your work and the assumptions it leads you to. Which, I am happy to say, we do with great regularity. If you ever come across a well-reasoned argument that runs contrary to ours in some unique way, don’t hesitate to send it to my attention at david@CaseyResearch.com.

Greenspan: How Things Change

Former Fed Chair Alan Greenspan can these days be characterized (based on his policies while at the Fed and interviews since then, including one two days ago on ABC, linked here) as a Keynesian-Monetarist mix of an economist. Remember, his loose monetary policy helped create the quagmire we find ourselves in today. But things weren’t always this way. He used to display much different economic thinking when he was a younger man, before the powers of a central banker tainted him.
One of our astute readers, Cliff from Alabama, sent along the following excerpt from Greenspan’s essay “Gold and Economic Freedom,” which appeared in Ayn Rand’s “Capitalism: The Unknown Ideal” in 1967 and The Objectivist in July 1966.

… But the opposition to the gold standard in any form – from a growing number of welfare-state advocates – was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending (the hallmark of the welfare state). Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale… Thus, government deficit spending under a gold standard is severely limited.
The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which – through a complex series of steps – the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold…
The law of supply and demand is not to be conned. As the supply of money increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy’s books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.
In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold… The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. This is the shabby secret of the welfare statists’ tirade against gold. Deficit spending is simply a scheme for the ‘hidden’ confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.

Speaking of gold, the only financial asset you can own that isn’t someone else’s liability, we’ve got a brand-new letter you might want to check out. It’s called Casey’s Gold and Resource Report – a leaner, meaner, quicker version of BIG GOLD: more focused, more actionable information, and more metals. For more information, please click here.
Seats Still Available

Our first-ever Casey Research Energy & Special Situations Summit is scheduled Sept 18-20 at the beautiful Westin Tabor Center in Denver. Featuring an all-star cast of experts on all things energy – as well as special situations in rare earths, potash, and more, this summit will put you solidly in the know on the critical energy sector and, more importantly, the many serious opportunities now available.

The schedule is still being finalized, but you can view it by clicking here… and learn more about the event by clicking here.
See you in Denver!

And (as David says) that, dear readers, is that for today. As I sign off, I see the S&P 500 is below 1,000 (but just barely), gold is right at $960/oz., crude is just above $71/barrel, and the dollar is down on the euro at $1.4420.
Until tomorrow, when we discuss the reality behind the numbers in the most recent GDP report and the coming VAT tax, if time permits, thank you for reading and for being a subscriber to a Casey Research service!
Chris Wood
Casey Research, LLC

Article Title	Source	Last Comment Date
Daily Dispatch: Odd Choices - August 25, 2009 0 comments	Casey Research	August 25, 2009
Daily Dispatch: Watch Out Below - August 21, 2009 0 comments	Casey Research	August 21, 2009
Daily Dispatch: Stuff in the Fan - August 17, 2009 0 comments	Casey Research	August 17, 2009
Daily Dispatch: J'Accuse! - August 13, 2009 0 comments	Casey Research	August 13, 2009
Daily Dispatch: Croatia - August 10, 2009 0 comments	Casey Research	August 10, 2009

Thread Tools
Show Printable Version Email this Page
Display Modes
Linear Mode Switch to Hybrid Mode Switch to Threaded Mode

Daily Dispatch: Off Balance Sheet, Out of Mind - August 04, 2009

What do you think? Your comments are welcomed.

EDITORS' PICKS

MOST POPULAR ARTICLES

Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)

User Name		x
Password		Remember Me?