Wednesday, July 27, 2011

What Both Parties are not Telling Us About the Budget and the Deficit

Lets compare our home budget to the Federal Budget. Say our gross income is projected to be $100,000 which is subject to State and Federal income taxes; after which we have $70,000 to spend. Through the next 12 months, assuming we don’t have to replace the roof or the car, we have $70,000 to spend and that is it. We could take out a home equity loan and/or take our credit cards to the max but once we max out everything, if we can’t make the payments we have to file bankruptcy.

Now let’s look at what the Federal Government does under its “Baseline Budgeting.”  It starts off with the concept that its budget is based on an increase in annual spending of 7% regardless of the income the government receives.

The basic principle of how long it takes money to double is to divide 72 by the rate of return. If you earn 7% and divide 7% into 72 it will take just over 10 years to double your money.

The same principle applies to how long it will take the federal budget deficit to double. With Congress using a 7% increase as a baseline, the annual budget deficit will grow from $14 trillion this year to $28 trillion in 10 years. If we look at the deficit plans on the table, they are projecting a $1.2 to $2.4 trillion reduction over the next 10 years, if everything stays the same. If we take the higher savings of $2.4 and everybody keeps their promises the deficit will not be $28 trillion, but perhaps $26 trillion up from $14 trillion. Yes with $2.4 trillion in real budget cuts the deficit will just about double in 10 years, so how did we make any progress on the deficit?

These plans, which are reported to be budget cuts, are merely a reduction in the growth of the deficit. As I said in the July 6th Blog “You do the Math,” we are currently spending $1.4 trillion annually. If we take the $2.4 trillion over the next 10 years that will average $240 billion a year in reductions. That is only if Congress stays to its commitment to reduce $2.4 trillion. With a baseline budgeting process using the $1.4 trillion, a 7% increase the next year will add $98 billion more to the deficit this year.

Now lets go back to our home budget. How will you find the money to pay for the increases of 7% in your budget each year for the next 10 years if you have no credit left? The bottom line is, you can’t. Remember you read it hear, next year when you hear, that the budget deficit is higher than it is this year. I believe that Congress wants to keep us in the dark about the reality of what is going on in Washington.

I want you to call your Congressperson or Senator and ask him/her about “Baseline Budgeting” and see if he/she can tell you what it is and what the deficit will be next year.

Dan Perkins

Debt Crisis to Constitutional Crisis

Debt Crisis to Constitutional Crisis

On Monday I saw the video of a recent speech by the President to his base and I believe he sent up a trial balloon and he got a great response for his base, but nothing from Congress. He suggested that if we got down to the last minute and the Congress fails to act he might raise the debt ceiling on his own through the use of the Executive Order.

I will admit that he said this jokingly, but he said it I believe to test the waters and see what reaction he would get from the hill. To the best of my knowledge he got no reaction from either party. Perhaps both parties know of the speech and do not believe that the President would do such a thing. I do not believe that he said it if he wasn’t thinking about it and the possibility of the use of the Executive Order.

So, if we come down to August 2 and the President has nothing to sign from the Congress he may well sign and Executive Order to raise the debt ceiling on his own. My guess is that he would go on TV and tell the American people that he has been diligently working with the Congress to solve the debt problem and the Congress is so split that they will never pass a debt limit extension and so as President he is using his powers and is signing an Executive Order to raise the debt limit to prevent a default by America.

He fully understands that the constitutional right to raise the debt limit rest in the Congress, but for the good of the country, to protect social security benefits and to pay our soldiers among other debts of the country he was force to act because of the inability of the Congress to act.

I know that some in Congress will be outraged and I understand and appreciate their outrage, but perhaps my action will unify the Congress to come up with a fair and balanced approach to the deficit problem and get me a bill I can sign.

As outrageous as this seems in my mind it could happen.

Dan Perkins

Monday, July 25, 2011

Will the Outcome of the Budget Battle Signal the Demise of the Democratic Party?

I warned you to watch the bond market and the direction of interest rates for an indication of the possible outcome of the deficit deal. Up until the middle of last week the bond market was suggesting, based on the level of interest rates, that there would be a budget deal. As of the close on Friday I’m no longer sure there will be a deal by August 2nd.
During the American Civil War there was a “high water mark” which the Confederacy reached and then started it’s long decline to surrender. At the time the high water mark happened nobody knew that it had been reached. The Civil War “high water mark” was the bloody angle in the third day of battle at Gettysburg,
Perhaps the Democratic Party reached its high water mark with the passage of the universal health care legislation. We are at a stale mate in direction as to how to solve the debt and deficit problems in the United State. The Democratic Party says they are willing to make budget cuts but the “rich” have to pay more. They say they want the tax increases now and will make the budget cuts over the next 10 years. This idea is like the Ole Miss direction play in football. Try and convince your opponent that you are going one direction and then go in the opposite direction.
In the past when we have had one of these confrontations the Republicans have been the party to cave and they may well cave again this time. They seemed to have staked out the ground that insists on cutting expenses and not raising any new taxes.
If the Republicans hold their ground and the Democrats agree to entitlement cuts the President will lose his base and the Democratic Party will start to decline from the “high water mark.” If the Democrats lose the Senate and the White House in the next election it will be based on the Democratic failure to respond to the public need to restrain the budget. How can we tell Greece, Spain, Portugal, Ireland and Italy that they must adopt austerity programs while we continue to spend and spend and get deeper and deeper in debt ourselves? Is that a misdirection play on the part of the United States?
As much as I hate to say it, I do not think we will find a solution by August 2. I know that everybody knows the outcome, or they think they know the outcome if we fail to act. The ground that has been staked out by both parties will not allow them to give in and find a solution. The one question that lingers in my mind is do they care if we default? Would Democrats rather see the country go in default rather than give up their entitlement programs? I think so. Would Republicans rather hold the line on tax increases at the expense of the country going into default? I think so.
I think, in either case, the great social programs that started with FDR are history and it is only a short amount of time before it all unfolds right in front of us. As I said before, watch the yield on the 10-year T-Bond as we get closer to the deadline.
Dan Perkins

Sunday, July 10, 2011

Does the Glitter have a little Tarnish?

I can take no credit for this blog idea. It came as a result of a discussion with a client. That client sent me an e-mail saying he was thinking about selling out his equity funds in a brokerage account and using the proceeds to purchase gold. He was very concerned about what might happen with the debt ceiling if congress and the president can’t agree and we go past August 2nd with no settlement.

I want to interrupt this story for just a moment. I have grave concerns that while the leadership may come up with a deal it is no guarantee that the full house and Senate will vote to agree with the leadership. No one is talking about the possibility that the plan might not be confirmed. The president and both parties leadership agreed on a plan to deal with the financial crisis three years ago but do you remember the House didn’t carry the motion. We have a Republican controlled house with a lot of Tea Party congressmen who may vote the bill down.

Meanwhile back to our story. My client is concerned about inflation, the falling value of the dollar and the possibility of default on government paper. He feels like he needs some protection and buying gold will give him the ability to pay for food and other necessities. So he ended his note to me asking me what I thought about his idea, I did a great deal of thinking and decided that all of you could perhaps benefit from my thoughts.

My most immediate idea was to suggest the GOLD Exchange Traded Fund (ETF) IAU. The price was just over $15 on this past Friday. The ETF is a way to own physical gold on a shared basis. I sent my client this first idea and he came back to me that he wanted to own the bullion not share in a fund. So, I went to work to see what I could do for him. My research showed that bullion was the lowest cost to own. I found the non- numismatic coins have the least costs and the highest liquidity. So, I concluded that the non-numismatic American Eagle coin has the most liquidity and it is legal tender,  sort of. At the time of this posting the spot price for gold was $1,541.60 and the best price I could find on the web for a one ounce American Eagle coin was $1,895. So the coin has a 20% premium to the spot price of gold. Seems a little rich.

Next I went to to see what they had to say about the cost to buy and sell gold. I did a little deep diving on the site on the risk and disclosure section there is a subhead called Our prices and it says the following: “There is a price differential or "spread" between our selling price (the "ask" price) and our buy-back price (the "bid" price). This is often referred to as a "transaction cost." A typical spread on our most common bullion coins (e.g. Canadian Maple Leaf or South African Krugerrand gold coins) may range from approximately 5% to 20% depending on the coin though spreads may increase based upon market conditions, availability and demand. Our spread on semi-numismatic coins, rare or numismatic coins and rare currency currently ranges from 30% to 35%. To illustrate how this spread works, consider the following example. If the spread on a coin is 35% and Goldline's ask/sell price is $500 for the coin, then Goldline's bid/buy price is $325. Your coin must appreciate more than $175 to earn a profit. If you choose to sell your coin back to Goldline, you must also pay a 1% liquidation fee. Purchases of less than $1,500 are subject to a small lot fee of $15.”

If you buy gold for $1,545 and the American Eagle is selling for $1,895,  gold  must rise to almost $1,900 for you to break-even. All the time it takes for your investment to break even you will be making nothing, no dividends. Now let’s go back to the question of paying for things and I’m going to be a little absurd. You walk into the quickie mart to buy gas and coffee. Are you going to give the guy behind the counter an American Eagle? I don’t think they have a slot in the cash register for American Eagles. Is he going to give you gold in change or American dollars? My guess is American Dollars which just what you are trying to avoid. Most likely you will have to go to a coin store and sell your coin for dollars if they are open when you need to exchange and they are buying the day you need to sell.

Now the next issue is what do you do with these American Eagles once you own them? Do you have a safe installed in the house to keep them secure? In the case of this client I know they have two homes. Will they get a safe in each house?  Will they carry the coins in the car as they travel and take it into the hotel room or put it in the hotel safe? My guess is that they would want to substantially increase their homeowner’s policy for the amount of gold they own. I don’t know how much it costs to insure say $150,000 in gold coin or if the insurance company will even insure that amount of gold.  Perhaps you take them to the bank and put them is a safe deposit box. That would work as long as the bank is open when you need to get your coins.

I’m not trying to discourage you from buying gold. In almost 40 years in this business I have seen many gold waves come and go and many people get burned. In our example you need gold to move $300 just to break even not counting insurance, taxes, or transaction fees. Buying gold should not be viewed as an investment but as a hedge or insurance. You buy insurance on your house and even if you never have a significant claim, was it worth the insurance? Yes.

If you are looking at gold as an investment then I believe there are far better ways to invest than in gold.

Dan Perkins 

Sunday, July 3, 2011

You do the math and see how close we are to a deal on the debt limit.

This past week we found out 2 numbers from the President on he wants to settle the budget deficit and to raise the debt ceiling. The first is he wants $400 billion in new taxes and the second he is willing to cut $1 trillion from the budget over the next 10 years. Now look below at the spread sheet from the CBO which shows the projected deficit for 2011 is $1.4 trillion.

So here is the math $400 billion over 10 years is $40 billion per year of new taxes if it happens. A $1 trillion reduction in the budget over 10 years is $100 billion per year. If we get $40 billion in new tax revenue we will reduce the $1.4 trillion annual deficit by $60 billion or $5 billion per month. If we are running a $120 billion a month deficit then $5 billion a month doesn't even begin to solve the problem that my children and my expected grandson will have to pay if they have any money left.

You have better math send me a comment.

Watch the bond market over the next few weeks and it will tell you the likelihood of meaningful reform.

Dan Perkins