Monday, October 14, 2013 - Canned Goods and Cigarettes

Canned Goods and Cigarettes

by Sinclair Noe

DOW + 64 = 15,301
SPX + 6 = 1710
NAS + 23 = 3815
10 YR YLD + .01 = 2.69%
OIL + .12 = 102.14
GOLD + .10 = 1274.30
SILV - .07 = 21.37

Earlier today President Obama warned that if the standoff is not resolved by Thursday’s deadline to raise the debt ceiling, “we stand a good chance of defaulting.” And then he postponed a scheduled meeting with congressional leaders. That's the good news.

No, seriously, that's the good news; Senate leaders were closing in on a deal to raise the federal debt ceiling and end the 2 week old government shutdown, so the president stepped aside to let the legislators work a deal.

Senate Majority Leader Harry Reid said on the floor that he was “very optimistic” about what he called the “constructive, good-faith negotiations” aimed at avoiding the nation’s first default on its debt. Senate Minority Leader Mitch McConnell said he expected that “we’re going to get a result that will be acceptable to both sides.”

Of course, if they don't reach a deal by tomorrow, you might want to stock up on canned goods and cigarettes; there's a good chance cigarettes will be more valuable than gold in the debt-pocalypse. And the meltdown could start prior to the actual deadline of Thursday; folks will wait it out tomorrow, but before the close of the markets on Wednesday, if there is no deal, it could get ugly. So stock up on the canned goods and cigarettes tomorrow.

If this whole mess seems surreal, it is, but that doesn't mean you know how it works. So, allow me to provide the Readers' Digest version of everything you need to know about the federal deficit.

When the government spends more than it collects in tax revenue it must borrow to finance the difference. The national debt now stands at $16.7 trillion dollars; that's the total amount the federal government has borrowed throughout the years to finance cumulative cash deficits; plus the money it owes to itself, primarily the Social Security Trust Fund. The publicly held debt is owed to a wide variety of investors, including international investors, domestic private investors, the Federal Reserve, and state and local governments. The federal government has carried debt throughout its history. Typically the nation has run up deficits during wars and recessions, but then paid down the deficit when the war ended or the economy recovered. In recent years however, sharp increases in deficits have driven the debt to historic levels even as government spending was poised to explode to care for an aging population.

The debt ceiling sets a legal limit on borrowing by the federal government. Legislation to raise the debt limit usually leads to some partisan political posturing but little real drama. The past few years have been different. The United States hit its 16.7 trillion debt ceiling in mid-May. Treasury Secretary Jack Lew started to borrow from retirement funds from federal workers, a move that has bought a few months before he hits a point where he will be unable to borrow more to continue to pay the nation's bills. If Congress does not vote by Thursday to raise the limit, Secretary Lew says the government will default on its obligations.

House Republicans have demanded a number of concessions in exchange for granting the Treasury an additional year of borrowing authority. Among their concessions demanded for not shutting down the government was the repeal of the Affordable Care Act, also known as Obamacare; they then merged the shutdown concessions into the debt ceiling concessions, only to slowly but surely abandon those concessions as they realized they were running into a brick wall; The next concession to fall was a one year delay in implementation of Obamacare; which they have now abandoned as impossible; then a demand for repeal of the medical device tax which was a part of Obamacare, and nobody quite understands it or care about it unless you happen to sell medical devices. President Obama says he will not negotiate over the debt limit. Congress passed the spending measures that racked up the debt and now they have to pay the bills.

In its effort to extract concessions from Democrats in exchange for opening the government, the GOP has faced a fundamental strategic obstacle: They don't have the votes. A majority of the members of the House have gone on record saying that if they were given the opportunity to vote, they would support what's known as a "clean" continuing resolution to fund the government, in other words a resolution that deals only with the debt ceiling and doesn't have all sorts of concessions tacked on.

But a funny thing happened right as the government was shutting down; on September 30, the House Republicans passed a measure that prevents anyone other than the Speaker of the House from bringing the clean CR to a vote. Which means Speaker John Boehner is the only person who can bring this mess to a vote in the House of Representatives, and Boehner is still holding out for something; nobody knows exactly what, but it might involve cigarettes.

Now, you might think there is no rational reason to shut down the government to preclude what is essentially a Republican-designed health law, first pitched by Newt Gingrich in response to HillaryCare, the original version of ObamaCare was actually created by the Heritage Foundation, and then implemented by a Republican governor in Massachusetts, only to be abandoned in pursuit of a White House run, which ironically resulted in a less than winning 47% of the vote. The conservative health care plan that would create the conditions for finally attaining universal health coverage in the United States, a goal that all the other advanced nations have achieved decades ago. In particular, the alternative to “Obamacare” proposed by the GOP is nonexistent, and basically means leaving millions of Americans without proper medical care.

On top of that, the shutdown, together with the previous sequestration, and the overall contractionary fiscal stance, will most likely make the very slow recovery even slower, maintaining an unnecessarily large portion of the labor force unemployed.

The debt ceiling, which we are still approaching, even if at a slower pace because of the shutdown, will make matters even worse. How much worse? Nobody knows; somewhere between bad and debt-pocalypse.

And then this afternoon, came word of progress, maybe, sort of. Wall Street traders were optimistic that a deal might be reached; there was a quick round of buying that pushed the major indices into positive territory. We may get a deal, maybe not, but again, if nothing is worked out by tomorrow afternoon, it's probably a good idea to load up on canned goods and cigarettes, and maybe some single malt Scotch.

Three Americans were awarded the Nobel prize in economics Monday for work that helped answer this crucial question: What determines the prices of an asset, whether a stock, bond or a house?

The winners of the $1.23 million prize were Eugene Fama and Lars Peter Hansen of the University of Chicago and Robert Shiller of Yale. Their work has led to everything from low-fee index mutual funds to a deeper understanding of why home prices can become irrationally high, as they did in the last decade.

Fama and Shiller are considered direct opposites in their views of how markets sort out the prices of financial assets. Fama is a father of the "efficient markets hypothesis," the idea that because markets are very good at incorporating all known information about the value of an asset, it can be a fool's errand to try to predict in what direction the price of a stock or bond will go. Shiller is a leading proponent of the idea that markets, driven as they are by human psychology, can create large and sustained mispricings, such as in the late 1990s when excessive optimism drove the stock market into bubble territory. He is a student of "behavioral economics," the study of how quirks in human psychology can create results that traditional economic theory would not predict.

Fama's "efficient markets hypothesis" holds that investors can do just as well or better by investing in stock index funds as they can by trying to time the market and pick individual stocks. Anything they think they know about the future prospect of a company, in other words, is almost certainly already reflected in its share price.

Shiller challenges some key aspects of the efficient markets hypothesis. In a 1981 paper, for example, he demonstrated that stock prices are much more volatile than the underlying trends in the dividends they pay would suggest. He went on to show that periods when stock prices are high relative to corporate earnings tend to be followed by periods of below-par returns, and vice versa.

Hansen built on Shiller's work in important ways by using new statistical methods to test what exactly was driving all that stock price volatility. Hansen's work established more strongly the idea that the mispricings Shiller identified had to do with fluctuations in how much appetite for risk people had. When times are good more investors are willing to pay high prices for assets, and when times are bad, investors become more cautious. Today Shiller said the Federal Reserve's economic stimulus and growing market speculation were creating a “bubbly” property boom.

So, it just seems like a prudent thing to load up on canned goods and cigarettes and Scotch. Better safe than sorry.