Spend to Insanity

As I have mentioned numerous times in previous entries, the market was pricing in a huge spending windfall in the U.S. Below are some numerical figures to quantify just how much this is going to cost. My highlights of the author's entry are marked in bold.


Notes from TSG Weekly Market Watch
Written by Matt Blackman

Source: Trading System Guru

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Have policy makers lost it?

Tough times call for drastic measures as we have experienced first hand of late but is there a limit to how much money policy makers can give away? And it is obvious the majority are strongly in favor of using the same policies to get us out of this mess that put us in this situation in the first place. It reminds me of that famous definition of insanity – doing the same thing and expecting a different result.

The federal budget deficit, estimated at around $450 billion for 2008, is projected to grow to $1.2 trillion in 2009 and that is without any more new spending or bailout initiatives. There is little doubt that with a Democratic President, Senate and Congress at the helm, Mr. Obama’s American Recovery and Reinvestment Plan estimated to cost $775 billion (so far) will most certainly grow in size. And it is equally likely that other programs will follow. Let’s do the math. At $1 trillion we are facing a budget deficit of 8% of GDP and that assumes GDP growth holds steady, which is not the case. But be that as it may, this size deficit would be a first in U.S. history. A shrinking economy and expanding bailout costs means the final ratio could be significantly higher. What does that mean?

First, Treasury will have to sell foreigners a lot more of its securities. At a deficit of $1.2 trillion, it would mean roughly three times more than last year. Are foreigners willing to pony up another $1.2 trillion in a deteriorating economy even if they are able? When our Asian sugar daddies finally pull the plug, they will leave a debt-ridden cash junkie behind and we all know what happens when demand exceeds supply. The cost of money goes up and the bigger the need, the faster the cost will rise as debt rapidly becomes a much more challenging habit to maintain.

So while spending like there is no tomorrow to stem the tide of bankruptcies and foreclosures may seem like a good idea on first blush, it is a plan that has the potential to produce some short-term gain in exchange for serious and very expensive long-term pain.

When that happens, expect to see the word ‘risk’ to gain a big pant-load more respect.

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Analysis:
The long-term 20-year U.S. bonds will need to fall in time. Its mini-rise since November 17th will need to be challenged, once the foreign money flows away from U.S. government debt. This will not happen immediately, since foreign investors are finding it difficult to look for alternate holdings. It can be seen that since the US dollar has rallied, gold (an alternate holding to the USD) has fallen, and the 20 yr. bond is still holding up, this scenario has yet to play its course.

See TLT Chart.