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The Biggest, Baddest Bubble of Them All

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I wrote the following on November 4th, 2008:


It’s election day, and I may as well try to fuse economics and politics for a moment.  Personally on an economic basis, I don’t think this election means that much.  Consider this post at RealMoney from earlier this year:

David Merkel
Cultures are Bigger than Economies, Which are Bigger than Governments
1/7/2008 1:19 PM EST

To start this off, I don’t fit neatly on the political spectrum. I am an economic libertarian, socially a conservative, but utterly against the recent wars that we have pursued. I also think that we need to find a way to dismantle the two party system, but that will never happen. So now you have enough to disregard me if you like.

I don’t think the primaries make any difference at all. The three leading Democrats are all very alike. It doesn’t matter which one wins the primary. The Democrats would have their best chance with Obama, because general elections tend to be won on (sadly) which candidate is more likeable.

As for the Republicans, there are differences, but not to any great degree on likely economic policy. I say “likely economic policy” because none of their differential policies are likely to survive if one of them wins the general election. Any Republican win is unlikely to have that much of a mandate.

There are differences between the Republicans and Democrats on economic policy, but this is where my headline comes into play: “Cultures are Bigger than Economies, Which are Bigger than Governments.” Given the mismanagement of our government, particularly with respect to entitlement programs, though also costly wars, future governments will have less wiggle room. Raise spending, cut taxes? Go ahead and try. No surprise that the US Dollar continues to fall. Outsiders will eventually tire of funding US deficits in US currency.

The Republicans will leave the micro-economy more free than the Democrats, but aside from that, I don’t think the election matters much, at least as far as economics goes. There may be other reasons to vote for one side or the other, but pocketbook issues rank low for me, and in this election, the payoff from the differences will not be big.

Now, cultural change, in the unlikely event that it would occur, is another matter. But American history has been replete with big shifts before, and the economy and politics get dragged along. Perhaps the question to ask is what will be the next big shift in American culture? I don’t have any read on that now, but then, when it happens, it is often fast.

Position: none

Our biggest bubble, which is still inflating, are the debts of the US Government, both explicit and those not accrued for.  We are going to have a difficult time borrowing in the present for all of these new bailout/stimulus/pork programs.  Our debts are getting deeper, not shallower.

Consider this graph from this article at Clusterstock:

We may have a slight breather from the increase in total debt recently (2006-7), but it is going up in the near term.  My view is that we need delevering, and that will be a big theme in coming years once the government tires of the new policy of shifting private debts onto the public balance sheet.

Now, I’m still dubious that the bailout policy will work.  Reasons:

When a foreign holder of Treasuries is willing to give up 40 basis points of yield on a 10-year T-note yielding 3.80%, so that they can get paid off in Euros if there is a repudiation of US Treasury obligations, there is significant uncertainty over the creditworthiness of the US Government.  (That’s just an example, there are other reasons to enter into such a CDS.)

Now, the debt-to-GDP graph above doesn’t take into account pension and entitlement underfunding/non-funding.  From another comment at RealMoney:

David Merkel
Digging a Hole to China (So We Can Borrow Some More)
10/28/03 08:26 AM ET
With a gracious assist from one of our readers at Economy.com, here is the link I promised yesterday. The report does not break out one final number — one has to look at the “balance sheet” on page 58, and the “Statements of Social Insurance” on page 65, which they count as an off balance sheet liability, and add them up. It looks like this (in USD):

  • Net Liability: $6.8 trillion
  • Soc Sec, Pen & Dis: $4.6 trillion
  • Medicare, part A: $5.1 trillion
  • Medicare, part B: $8.1 trillion
  • Total: $24.6 trillion

This doesn’t take into account the value of land and certain less tangible assets that the U.S. Government has. It also does not take into account the considerable operating and capital lease liabilities, deferred maintenance, or liabilities for the GSEs, and other lending guarantee programs of the federal government.


That $24.6 trillion figure was from September 2002. As of September 2007, it would now be around $50 trillion. ( Here’s the link to the 2007 figures.  New figures out in two months.)  By the way, thanks Mr. Bush, for being such a reformer of Social Security and Medicare. You added on another $10 trillion of unfunded liabilities that future generations will have to fight over bear in your prescription drug program.  You have been the most damaging president on economics since Nixon.  (Sorry, I lost my cool. :( )

That $50 trillion does not count in state and corporate underfunding of pensions and benefits.  Oh, and with the fall in the markets, they want a bailout also.

Who doesn’t want a bailout?  The US Government can just borrow some more to aid us on our way to prosperity.  Those debts and unfunded promises will have to be paid someday, either through taxes, inflation, or repudiation (total or external).  The economic mess at that point will be far worse than it is today for all those who rely on the US Dollar.

Our problems in the US are larger than our politics.  It goes down to our very culture, borrowing from the future to take care of the present.  It is true for our Government, and many corporations and individuals.  The pain will come, the only question now is what form it will take.


Bringing this to the present, the 2011 Financial Report of the US Government under alternative assumptions, which are more realistic than the baseline, has the net liability of the US Government at $61 trillion.  To make the number a little more understandable, that’s $200,000 for every man, woman and child in the US.  Now, maybe many of these promises will be repudiated.  After all, Social Security is a statutory right, not something enshrined in the constitution.  Congress can change it whenever it likes.

But there are political costs to every decision, and what is a liability to one is an asset to another, but not always vice-versa.

The biggest bubble, waiting to pop, is that of government and central bank omnipotence.  We will find out soon enough the limits of the power of the government.  It won’t be pretty when it’s done.  Just be grateful that you don’t live in the Eurozone or China — the US will come through the crisis better off than them because of our relative flexibility in dealing with problems.

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David Merkel

David Merkel

2010-present, David is working on setting up his own equity asset management shop, tentatively called Aleph Investments. From 2008-2010, he was the Chief Economist and Director of Research of Finacorp Securities. He did many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, he was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, he was a leading commentator at the investment website RealMoney.com. His background as a life actuary has given him a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that he deals with in this blog. All of these goals rely on the help of Jesus Christ and his readers.
David Merkel

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