February 18, 2011

There is a great scene in the movie The Fugitive. Harrison Ford’s character, Dr. Richard Kimble, is on the run. He is an innocent man found guilty of murdering his wife and he has been sentenced to life in prison. Dr. Kimble is being pursued by one of the best trackers alive, Marshal Sam Gerard, played by Tommy Lee Jones. After a lengthy chase, Kimble comes to the end of a tunnel only to discover he is perched high above the river below. His only escape would be to jump into a raging waterfall and river below. It's an impossibly long jump and he doesn't want to do it. When Dr. Kimble looks back at the entrance to the tunnel he sees his pursuer, out of breath. The despondent Dr. yells desperately, "I didn't kill my wife!" Frustrated and pained, the Marshal yells back, "I don't care!"

 “I don’t care” is the same troubled response most Tea Party members give when they are told that not raising the national debt will cause a catastrophe. Most people believe this kind of attitude is irresponsible. It would be if that were all there is to it. But first ask yourself, aren’t the repercussions of raising the national debt also irresponsible? Wouldn’t allowing runaway deficits lead to "catastrophe" as well? Isn't it just a question of who will bear the brunt of the pain from ignoring present deficits?

And finally, is there is a reasonable solution that could head off the coming train wreck? According to news reports, "Pennsylvania Senator Pat Toomey has a proposal for how to deal with the national debt that South Carolina Senator Jim DeMint calls a 'game changer.' What is Toomey’s proposal? Refuse to raise the debt limit and avoid default on the national debt by requiring interest on the debt to be paid first out of revenues before money is spent on any other programs. Toomey wrote recently in the Wall Street Journal, 'I intend to introduce legislation that would require the Treasury to make interest payments on our debt its first priority in the event that the debt ceiling is not raised.' Senator DeMint supports Toomey in this endeavor and has been urging fellow Republicans to 'do everything they can to block an increase in the debt limit.'

In his op-ed, Toomey points out that since only about 6.5% of all projected federal government expenditures will go to pay interest on the national debt, and since tax revenue is projected to cover about 67% of all government expenditures, the federal government has available ten times the revenue it requires to service fully the debt. Contrary to the scare tactics of big-government acolytes who insist the sky will fall if the federal government cannot add more to the national debt, there is absolutely no reason to default on the debt if the debt limit is not raised. Refusing to raise the debt limit would mean that after the debt service is paid, Congress would have to get serious and make substantial cuts to other federal spending to avoid having to borrow money."

But wont massive cuts in government spending increase unemployment and throw the economy into another recession? Nobel Prize winner in economics, Art Laffer, puts the government spending cuts debate into perspective: "After World War II, the U.S. cut federal government spending dramatically. In 1945, federal government spending as a share of GDP peaked at 31.6%, and by 1948 it was down to 14.4%. Private real GDP for the three years 1946, 1947 and 1948 grew at a 7.5% annual rate. So much for the idea that cutting government spending hurts the economy."

Let me add to this by looking at what would happen if we cut government spending and as a result eliminated government jobs. I think government sector jobs are generally inferior to private sector jobs. Cut a government job and you usually cut a meaningless overpaid position, and even worse, a position that was subsidized by the taxpayer. Cutting a government job is often more like cutting a tax liability. Conversely, create a private sector job and you create a more productive job at no one else's expense.

Government employees are usually intelligent, well educated, and skilled. Firing government employees will force them to look for employment in the private economy. What are employers having difficulty finding? Skilled, intelligent workers, who will show up on time and do the job. By transferring jobs away from the government sector to the private sector we will be transferring skills that are badly needed, and reduce the tax burden on both the tax payer and the private sector.

Does anyone really believe that if we cut teachers and engineers from the federal government’s payroll, that there will be no demand for teachers and engineers? Demand for these services won’t change much. What will change is who will determine the pay of these workers, the market or government. And the private sector would hire only the competent and fire the incompetent--something the government is unwilling to do.

This coming battle over the debt ceiling is going to be messy. I know politics may overtake economics in the end. But the least that we should accept is major concessions from the big government spenders. We need to put all the pressure we can on them. Perhaps one way of doing this is to get all the spending cuts we can, and then pass the debt ceiling increase with a provision; that it cannot be increased again. That would give notice to all politicians that the day of reckoning is at hand. It would also establish a fixed period of time in which to achieve a balanced budget.

But let's look at the worse case scenario. What would happen if the US did default on its creditors? This question needs to be raised and answered. What if those that vote against raising the debt limit actually get their way? Will it cause catastrophe? Will everything come tumbling down? Think about it. Cities and states have contracted with unions to fund up to 100% of benefits--a deal that they cannot pay for. Bankruptcy would allow the cities and states to default on union contracts. A default by states--and if allowed the federal government--would require a renegotiation of the terms of contracts. This needs to happen. So on the domestic side, default doesn't sound too bad.

But what about paying back China and our foreign debt holders? This is obviously where everyone's concern for a potential crisis is focused. We can amortize or suspend interest payments. It's not as if it hasn't been done before. Almost every nation on earth has done the same to us. Not only have other nations suspended or amortized interest, they have outright defaulted on most or their entire debt to the United States.

In the 80's several Latin American countries defaulted on their debts. Brady bonds were issued to amortize the debt, which was a form of default. In 1998 Russia defaulted on it's WWll debt to us, paying us only 10 cents on the dollar. That was an actual default. And even England got low interest rate loans from America after WWll and only paid them back recently. In real terms the bill paid was almost nothing. This was a de facto default. If America did anything similar would this mean American's having to pay higher US interest rates, and getting less, or even no more credit from abroad? Very possibly!

But isn't that just what we need? If we cannot stop our reckless borrowing and spending, a forced default on the national debt will place limits on borrowing once and for all. Increased interest rates would curtail reckless consumption. A lack of new credit from abroad would force us to live within our tax receipts. Overconsumption, mal-investment, and the misallocation of resources created by irresponsible government borrowing would necessarily end. Is this the "catastrophe" we face? Perhaps it is just what the doctor ordered.

You have to wonder if the "full faith and credit" promise of the United States to stand behind all its borrowing subsidized by the American taxpayer is just another case of "too big to fail" thinking. Perhaps this is the ultimate moral hazard. Maybe this absolute guarantee should end. Maybe the possibility of failure as part of the risk took when lending and borrowing, should apply to government just as it does with other financial institutions. Perhaps it is precisely this that will allow us to get our fiscal house in order.

Put me down as a "NO" on raising the national debt.

Market Update:

I am a devoted viewer of Fast Money on CNBC. As a trader, as well as an investor, I have a lot of respect for those that provide their views to the public while trading their own money on a daily basis. These folks are winners year after year at making money. Their views come direct from the trading floor and they provide up to date information on the hot spots of the market, and the major movers of the day.

That is why I made special note of what Guy Adami, said on Friday last week. He said that silver is showing unusually strong chart patterns; that the market seldom gives you this much time to sell the top; and that the silver chart is setting up for what might be a parabolic move to the upside. (Note the move in silver this week versus gold.)

That, may just be another opinion, and might in itself not be worth much, except Adami is a bear on gold and silver and has been for some time. Put that together with James Turks recent article arguing that silver is still in stage 1 of a 3 stage move. He says it will not move into stage 2 until it breaks it's old high of 50 dollars an ounce, which he believes will occur this year. One has to at least consider the possibility of such a move.

I was around when the Hunt Brothers tried to corner the silver market. The factors that took silver to those heights were abnormal and I have not been one of those looking for a repeat performance of that kind. It took silver to unrealistic heights.

However...there is an unusual thing happening in the futures market right now. There is a thing called backwardation where the forward months sell at higher prices than the back months. This is not only backwards, it is upside down. It only happens when there is more demand for delivery than is available. So the price is forced up forcing more silver to come onto the market by enticing willing sellers.

Such was the case when the Hunt Bros tried to take delivery of huge quantities of silver. There is a huge short position on silver today and we may be seeing the beginning of a serious short squeeze occurring. How will this affect my trading strategy? It wont. Silver is making 30 year highs as we speak. I am already heavily weighted to silver. I intend to raise my stops as the stocks I hold move higher. But should anything like what Adami and Turk think might happen -- happen, well, it should be a hell of a ride.

It is discipline and a planned strategy that one can depend on year in and year out. If the exceptional happens, so be it. The discipline of "cut losses quickly and let profits run", protects you on the downside, but allows you to make the most of the unexpected runaway market if and when it happens. It is rules and a trading strategy based on a trading discipline that protects me from theories -- even mine -- and is reality based not opinion based.

What's great about the traders on Fast Money is they know this. They don't care what anyone says or thinks, including themselves. They remain objective, agnostic, and reality based. That's why they are successful traders.

There was a lot of news and volatility in my portfolio this week, but in the end the porfolio was up markedly. Among notables were Copper Fox and Silver Corp, both up over 20% on Thursday and up substantially again today.

Copper Fox broke into new yearly highs. It now takes the number two spot in my portfolio. CDE and SLW both ran with the rise in silver and were among the best movers of stocks this week. SLW is up over 7% today as I write this. RBY fell on confusion over the actual drilling results reported recently and bears watching.

Portfolio by weight:

Coeur d'Alene Mines

Copper Fox Metals

Silver Wheaton

Rubicon Minerals

US Silver Corp

Lexam

Dennison Mines

Rochester Resources LTD