European Crisis = U.S. Crisis

Economic data is coming in mixed today. While initials jobless claims dropped to the lowest level since July 2008, median home prices fell to a 7-year low. With such conflicting data, the question naturally arises: Will the U.S.  economy recover, especially without real estate leading the way?

To get a glimpse of what awaits us, we should turn to Europe. Ireland continues to make headlines with its IMF-induced austerity measures, which I  don’t think will prevent Ireland from defaulting on their debts. Ireland basically has 2 choices: 1) outright default, and 2) attempted austerity followed by a severe Depression. Option 3, default via devaluation, is just not possible given the current Euro currency arrangement.

The risk in Ireland is that confidence in the banking system collapses. If this occures, the economy will be further depressed, which will force even more layoffs in the public sector. The problems with having such a bloated public sector are coming to the fore. When you cut government spending to promote austerity, you are concurrently creating massive unemployment, which in turn depresses tax revenues. The non-stop talk about IMF-imposed austerity measures is cute, but it won’t work because it’s way  too late. EU nations must devalue and restructure debts. Before then, we are likely to see a contagion spreading to peripheral Euro nations. What do you think gold is going to do when this happens? I’m patiently waiting for the inevitable defaults while our genius leaders run around like headless chickens.

The U.S. is headed down a similar path, with the main difference being that the U.S. can devalue at will. This takes a deflationary Depression off the table. Rising debt service costs as a percent of revenue will create a flight out of U.S. bonds, like it always does in history, whether we are talking about Pre-Revolution France or Post-WWII Great Britain. In order to close the budget gap, I can virtually guarantee our leaders will propose higher taxes. Taxes are already rising, but very insidiously; after all, how many of you keep track of rises in State payroll taxes? Everyone is focused on Federal income taxes as if they were the be-all and end-all of taxes. What about effective property tax rates? What about the coming rise in health care costs for employers?

The ironic thing is that higher taxes will make our budget problems worse! In a depressed economic environment, you need to promote investment. There needs to be some sort of mechanism by which debt can be converted to equity. Why is our government enacting programs that will undoubtedly lead to a capital flight out of America? It makes no sense.

On the other end of the spectrum, cuts in government spending are going to create massive spikes in unemployment followed by further declines in real estate. What does this mean? It means the equity people were planning to use for retirement will disappear, which means they will be hesitant to spend. It means the economy will be caught in a self-reinforcing downward spiral. It means confidence will eventually collapse. Our leaders have taken us down a road to perdition that is irreversible. I can guarantee that most policy responses will be ill-conceived.

Anyway on a brighter note, just wanted to wish everyone a Happy Thanksgiving! Even admist all this chaos, there is plenty to be thankful for.  I’ll be back on Friday.

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European Crisis = U.S. Crisis