Friday, July 29, 2011

Your Money and the US Debt Crisis

Fact: we continue to spend far more than we take in revenue.

Fact: if this was a private individual, eventually people would stop supplying them with credit.

Fact: Giving warring political factions, unable to make sacrifices that would affect their chances of re-election, but being fully willing to ask others to do such, how much is the US Legislative Branch really committed to cut spending.

Prime Example: Ethanol subsidies-- It takes as much energy input to produce corn ethanol as you get out of it, thus turning corn into fuel merely takes food off the world's table, creating higher commodity prices, while having no effect on the price of oil, and money out of taxpayers' hands ... A bill to remove ethanol subsidies passed the house, but didn't pass in the Senate because of some two faced explantions by both Republican's and Democrats that, "now is not the time to make America less energy independent." Then they turn around and vote against money for real energy research, saying "leave it to the private market to develop that," while the Chinese continue to zooooom ahead in the field. What a joke.

Rex Tillerson, CEO of Exxon Mobil, calls corn ethanol, "moonshine," and I have to agree with him. The same does not apply to Brazalian Sugar Cane ethanol which produces more energy than is used to produce it.

Scenario 1: (worst case) Now let's say John Boehner can't control his Tea Party Children, and somehow the US Defaults. Psychologically, this will be a dagger to the heart of investors and stocks will plunge- 20-35% is certainly possible, maybe more, who knows. The likelyhood of this, granted is low, but at this point not out of the question.

Scenario 2: (best case and most likely) Congress will make the oh so hard choice of delaying the difficult decisions and voting to raise the debt cap to a number that will be reached sometime in 2013. The stock market will rally a couple percent, and smiles will abound on Wall Street, at least for a few moments.

Scenario 3: (US avoids default, but ... (certainly a possibility) ) But wait. Let's put ourselves in the position of China. Your friend, Mr. America, who used to really wealthy, a leader, who you willingly lent money to, suddenly underwent a crisis where he said, "Dude, I might not be able to pay you anything man." At the last second he gets bailed out, and then goes right on spending money faster than you are able to supply it. How much more are you willing to lend him? Especially, when your friend Moody's, who's a supposed expert on who is a good and bad risk, says, "Ahem, I'm not lending Mr. America anymore money. At least not at the 3% interest he's paying."

So, you, China, says, give me 4%, no wait, 5% ... Mr. America, unless he wants to default, because his idiot brain is under the influence of politics, and can't stop spending, but also won't raise taxes, has to accept those terms.

What does that mean for Main Street America? Higher interest rates, on everything. Credit cards, adjustable rate mortgages, etc. Suddenly Main Street's spending drops off completely as they can't rely on others to bail them out, cannot print money; manufacturers produce less, people are laid off, recession (at minimum) As it is right now, interest rates are at all time lows. As interest rates rise, the dividend yields offerred by companies looks less attractive, and stocks dip 10-20% .

The other possibility is the Fed continues to print money (QE3) and we undergo 1970's like inflation along with a recession, whiping out the value of savings accounts.

Additionally, stocks are near multi-year highs. There are some reasons for this, mainly out of the tech sector (Google, Apple, Amazon, and even Microsoft continue to make awesome products that increase the quality of life, which is TRULY what creates wealth and drives the market upwards) but aside of these, and other leading companies, I have to say, the market, without even including the sorry state of the US Government, is slightly overvalued.

Given the risk of being in the market, the potentially huge downside versus what I perceive to be limited updside, I have to state that at minimum you should protect yourself with stop losses, and start raising cash. Stay out of the market for now! It just makes sense.
Addendum: i have received afew emails from people who ask, "Rich, if the scenario that the US doesn't default is most likely, and the market jumos a couple percent, wouldn't we want to be in the market??"
Response: No, because the downside outweighs the upside. Small upside, versus big potential downside. If this was a casino, even if you get dealt blackjack, you're still on the sucker end of the table. (in my opinion)
If you have thoughts, feel free to comment below, or email me. Please feel free to donate if I give something of value, +1 the blog when logged into your gooogle account, forward this, or subscribe/follow!