Moody's Has It Absolutely Wrong

July 18, 2011

There will be a market reaction to passing or not passing the debt limit. But it is time to start thinking about this problem as adults rather than as political party advocates. Moody’s comments the past few days are a prime example.

Moody’s, the credit agency has stated they are likely to downgrade America’s AAA credit rating if the debt limit is not raised.

Today, Moody’s stated that America should get rid of the debt limit ceiling altogether because it gives them a reason to downgrade our credit rating. This is not only illogical; it’s symptomatic of the way politicians, economists and pundits think. They almost always attack the symptom rather than the cause.

What Moody’s should be saying is that the Congress needs to pass a law that forces politicians to reduce the debit ceiling by some percent every year until our budget is balanced. Our problem is not the current debt ceiling. Our problem is that our budget is not balanced and on an unsustainable path upward.

There are two major reasons we spend too much.

One, the party out of office attacks the party in office for spending too much and the party in power defends the spending. When election results change, so do the positions of the parties. Congress has raised the debt ceiling 140 times since it was enacted in 1917.

By the way, the debt ceiling was created by President Wilson in order to pacify the opposition that he would not spend too much on WWI.

Two, we refuse to debate the cause of our problems. We only debate the amount of money we will spend on the symptom. For example:
1.Why does America with 5% of the world’s population spend about as much as the rest of the world does on defense? Is America responsible for most of the world? If it’s to protect democracy, why doesn’t Switzerland spend more?
2.Why hasn’t poverty been eliminated after trillions have been spent on the poor? Is poverty simply a percent of the population? Are the government and the population an enabler? Is our education system failing us? Etc. etc.
3.Why do we worry about the consumer price index (CPI)? It is only a symptom. Inflation is not a manipulated, mathematical index; it’s the increase in money supply. Should we be increasing the money supply?

I could give you a thousand examples but I think you got the idea. We need to change the way we think. Once we identify the real cause of the problem, we should be able to get consensus on how much to spend solving the problem.

By the way, America has defaulted on our debt five times starting in 1776. Also, the Federal Reserve can buy bonds to fund the government forever and never have to default on the “Public” debt (public debt is what we are talking about.)

Are Bonds (Fixed Income) at a Tipping Point? Part Duo

The first of November, my Market Update asked if bonds were at a tipping point because they were not responding as Fed Chairman Bernanke wanted (lower interest rates, lower dollar and increased commodity prices.) I also said that we would know more within the next few months.

Since then, the 10 year Treasury has moved down very slightly or about 20 basis points (0.20). However, the yield curve has steepened (short rates down and long rates higher.) Not what Bernanke wanted (unless he wanted to make the environment for bank profits better.)

The dollar has been rising not falling. But the problem is that other countries are not going to simply sit back and let the U.S. devalue the dollar (to improve exports), so they have responded by devaluing their currency in order to compete. This currency war can’t go on forever, but in the meantime, it is destructive.

Commodity prices are about the same.

It seems that there is no definitive answer yet, but there is a lot of new money going into the banking system and the banks have three choices of what to do with the money:

1.Sit on these new assets and collect the overnight interest rate from the Federal Reserve, or
2.Lend this money out to companies and individuals who want to borrow money. There is not much of this going on because banks are sitting on nearly a trillion dollars of excess assets, (maybe banks don’t want to lend or maybe borrowers don’t want to borrow.) or
3.Buy assets with this money (bonds, stocks, commodities, foreign investments, etc.) Contrary to what many people think, banks do not need to lend money to borrowers to make profits, they can invest the money here and abroad, wherever they can make the most money.

Another thing that seems to be going on here is that we have not seen much inflation (by government statistics) in spite of all the new money that’s been created. The reason many people think is that inflation will not happen until those trillions of dollars in excess assets get turned into trillions of dollars of credit.

So, think about this, if the economy does turn around or people think it has turned around; and suddenly want to use credit, would those trillions of dollars of credit turn into instant inflation? If so, that may not be good for the bond (fixed income) market as investors will want to be paid for the inflation risk.

Cash For Clunkers: Another Valuable Lesson

As you know from my previous article on, “Cash for clunkers,” it helped the targeted group but hurt many other groups. This is often the case when the government (we) examine a problem: we focus on the group or thing we want to help with a short-term solution; and we are generally blind to the short- and long-term consequences of our decision on everyone else. This is a typical government and hopefully not business or personal approach.

Now, in recent article in CNN Money titled: “Clunkers: Taxpayers paid $24,000 per car” based on an analysis done by Edmunds.com; the article also illustrates an excellent example of how to determine the success of a program (a decision) by looking at a seemingly complex problem and breaking it down into simple, measurable ways in order to measure its “success” (the correct decision.)

Edmunds.com compared the sales of luxury cars and other cars not covered by the program to determine a relationship between the two groups. Then, they projected what sales would have been during the “promotion period” and afterward. The auto industry agreed with those numbers. Based on this, they estimated that cash for clunkers resulted in an additional 125,000 cars sold that wouldn’t have been sold. Therefore, 125,000 cars sold at a cost of $3 billion (the government budget) amounts to $24,000 per car.

It also resulted in a bigger drop in October sales that would not have been as deep without the government program.

Now we know the impact this government program had on new car sales. But more than that, this analysis is a great learning tool. First, it was (in concept) a simple way to measure the effectiveness of this program; and gave us the ability to make a course correction (to our original decision) so we don’t repeat this program again ---in spite of the government and auto industry telling us how successful it was.

Here is the new question: Do you think the government will look at this data and analysis when the pressure builds again for the government do something to save the auto industry?

Also, what does this tell us about the probability of success in the about to be extended and expanded “buy a house and get taxpayer money “ program.”