This week I read about the first country to have its debt devalued: Russia. Its rating went from BBB+ to BBB. A small bit of news. And yet it was on the front page of the December 9th Financial Times.
What immediately struck me about it was... a possibility... granted just a possibility, but the fact that it could happen was alarming to me. A possibility of what could happen next: that more countries could have their credit rating devalued. Of course it would probably be places deemed inconsequential at first: Iceland, Hungary, Ukraine, Argentina, the "troubled economies". But it could start a cycle of devaluations, capped with a devaluation of the US debt.
One reason is that our deficit for 2008 will not be $400 billion (as has been our yearly deficit under Bush), or the newly projected $900 billion, but double or triple that.
This can be deduced from looking at what the states are reporting. They are not just a little off their projected revenue, they are way off. If California is any indication - and they are at least a good chunk of the national population - we can expect a huge shortfall in income tax revenue nationwide. (We already know a lot of companies won't be providing much tax revenue this year!)
Why is the official number so far off? Well, one reason is that they've failed to adjust for the downturn from 2007 to 2008. 2007 was actually a pretty good year. The amount collected for FY 2007 reflected a lot of things: farmers were making good money, there were a lot of people working, and the Dow was trading between 13k and 14k.
But if you fast-forward to today, with the market at 8,600 and a lot of people out of work, you start to see a glaring problem. The expenditures in 2008 were huge, besides the usual defense spending and debt-servicing, we gave $350 billion to banks, "stimulus" checks to taxpayers, trillions given, promised, or backed from the Treasury, and the FDIC was tapped repeatedly for massive amounts.
I can understand it's good to stay optimistic-- to help the market-- but by lying about the deficit now, the problem is going to be even worse when it shocks the market mid-next year. If you don't think they lie about deficit projections, look at the yearly projections since Bush took office. You will see them project balanced budgets! According to them we'd be running surpluses for a few years now. The truth is, they knew they were being overly optimistic. (I think they ran deficits on purpose to keep the dollar weak).
The "perfect storm" is a domino effect of cash not circulating... a domino effect, which started with the housing bubble and then the subprime loans and then the banks and then the markets... and now government entities. Governments? Yes... already cities, states, and public utility companies are having trouble raising money. A basic utility with good credit was scrambling this week to get a backer for a 12% bond. And the deficits in many places have gone from bad to cataclysmic. Many city and state credit ratings are at (or headed for) junk status.
Obama has great intentions wanting to shock the economy into submission. Many European countries are planning the same thing, a major cash infusion. But no money thrown at the problem will bring us out of it. There is no "thawing", from what I've seen.
Even if the US doesn't get a downgrade-- the situation is bleak. Already South America is not going to have anyone to finance the majority of their needs in 2009, because that money is being redirected to America, to "invest" in our increased debt-load here. That could come back in a bad way- considering how markets interact--
What Obama needs to do is clearly establish access -- and real money-- to government entities that need money. If banks aren't willing to loan to government entities, let individuals! Give regular investors a return. Make it clear that Madoff-like scandals are not the norm, and "fake money" is fake money, but real money is real and investments will be paid out. This means, not spending more, but balancing the budget, spending within our means, even if it is painful. It means raising taxes, and eliminating unnecessary spending immediately.
If nothing is done, other things will follow: protectionism, depression, and possibly, food shortages. In the depression, the crop failures worsened the depression. This time, the problem could be a lack of food worldwide. Already, when oil peaked, there was a huge food shortage problem in many corners of the world. Expensive oil can make food expensive everywhere (as we saw earlier this year).
If this diary sounds depressing... It's not meant to be. I think the problem is still just a possibility and can be averted. But we can't spend our way out of it. That's naive. We can't get our way out through the banks. It was the banks that brought down everything in the Great Depression. The most sound policy is to tighten everything up-- not loosen it. Loosen a battered ship... and it goes down.
Just some thoughts.