Opinion: Is It Twilight in America?

U.S. political leaders must confront the ugly reality that the most fundamental economic problem America faces is a severe lack of private savings.
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In 1984, Ronald Reagan's campaign said, "It's morning in America." The idea was very compelling to voters, and he was re-elected in a landslide. Americans love the beliefs that this country always has its best days ahead of it, that their children will have a better life than they did, that things are always going to get better in the long run.

This kind of optimism is a wonderful thing. It's part of why we've been able to do so many great things as a country during the past three centuries. Unfortunately, optimism alone will not solve our current problems. What we need at this point is a heavy dose of reality and honesty from our nation's leaders, even if that means telling people things that will be very unpleasant to hear.

What do I mean specifically? For example, the most fundamental economic problem we face is not a credit crunch, or unemployment, or falling home prices, or a stock market crash. All of those things will naturally correct themselves over time. Of course, that assumes our economy stays capitalist, which at this point may not be true.

In any event, the most serious economic problem we face is a severe lack of private savings and sustainable income generation to support the expenses of our government and the private standard of living for our citizens.

For example, even with historically low interest rates, the ratio of our consumer debt payments relative to income is at an all-time high. The Bureau of Economic Analysis reported in December that savings from current income for most Americans may be zero or negative when financial outlays are financed by borrowing.

How bad would things get if interest rates were to rise? This will eventually happen since rates can't go below zero. The only long-term solution to this problem is to increase the earnings and savings of Americans. To accomplish that, we need more investments both in our capital stock and in people through additional education and job training.

We have been avoiding the consequences of too much debt, too much spending, too little income and too much speculation for many years due to increasing leverage and appreciating assets such as homes and stocks.

Now that these and other financial assets have been falling for the past year because of deleveraging, we are only beginning to realize how weak and fragile our economy is without constant asset inflation. This is a very scary thought for most people to comprehend, and politicians don't want people to think about it. But the problem is not going away, and it is getting worse every day that we ignore it.

Americans and our government need to focus on real savings, the kind that involves earning more than we spend, borrowing less, and avoiding speculating on assets that do not generate any significant amount of income just because the asset price is inflating because of another bubble.

How can we start to fix this? First, the government needs to stop trying to stimulate private consumption, additional borrowing, and speculation on stocks, houses, commodities, and credit instruments. Instead, they should be trying to stimulate savings and long-term investments that can create more sustainable income such as new technologies, modernized manufacturing plants, infrastructure, education, job training, energy independence, and debt reduction. Part of moving in that direction involves normalizing interest rates up to a level that is at least above the rate of inflation as soon as possible.

In my opinion, concerns about long-term deflation in America are unfounded. There may be some short-term deflation for a few quarters due to a severe recession combined with a collapse in commodities. However, long-term inflation is determined by increases in the money supply, which is continuing to grow even now during the recession, the commodity bust, and numerous bank failures that also cause the money supply to shrink.

The Fed is basically printing so much money that it is staying ahead of what would naturally be a short-term deflationary period as the economy tries to adjust from years of rampant asset and commodity inflation.

After this downturn runs its course -- probably over the next few quarters -- all of this excess liquidity created by the Fed is going to cause a tremendous surge in inflationary pressure. At that point, the Fed will either need to dramatically raise interest rates to fight inflation or allow a collapse in the purchasing power of the dollar and a stampede out of U.S. assets by foreign investors.

Neither of those choices is going to be very appealing. In the unlikely event that this recession lasts for several years and we have real deflation, our zero- interest- rate policy may be appropriate, but it is even more important that the government promote savings and debt reduction. This is because in a deflationary economy the value of debts actually increases over time because cash appreciates against almost all other assets except precious metals.

The current government policy of free money combined with encouraging Americans, who largely have no savings and spend more than they earn already, to borrow and spend even more seems too bizarre not to be intentional.

The Fed's real objective here is to promote a combination of fear mongering about deflation to justify keeping interest rates at zero, while at the same time promoting as much inflation as possible in an attempt to orchestrate a massive stealth devaluation of the U.S. dollar and short-changing of all foreign investors in U.S. assets.

It is a con game of epic proportions, and it could work if foreign investors are dumb enough to allow themselves to get pennies on the dollar for their dollar denominated investments. However, if it doesn't work and foreign investors wise up to this game, the U.S. will face an economic Armageddon that will make the past year look mild.

Why would that happen? The U.S. economy needs to import several billion dollars a day from abroad just to keep the light on. If foreigners turn off that spigot of cash, even if they don't dump their existing U.S. assets, our economy will collapse. An even more extreme possibility is that there is an international revolt from the dollar as the world's reserve currency.

If that happens, we could no longer just print as many dollars as we want with minimal consequences. We could ultimately have to default on our debt like Argentina, Russia, or Ecuador. I do not predict that happening because the U.S. is too big for the world to allow it to default, but my point is that we are entering a world that will no longer allow us to make believe that printing dollars is free. There will be a cost to all of this money printing, and that cost is going to increase.

How can this be prevented? In addition to normalizing interest rates, the government can radically change tax and spending policy to encourage private savings and investment in small businesses, new technologies, energy independence, infrastructure, education, job training and modernization of our manufacturing sector.

This would involve shifting from an income tax to a consumption tax, providing tax breaks for companies to invest in research and long-term projects, government spending on infrastructure and investment in technologies for the future. It will also need to involve spending restraint, such as cutbacks in things like corporate welfare for poorly run companies, entitlement handouts like Medicare and unnecessary farm subsidies.

Until we start moving in that direction, investors holding most of their assets in dollars should avoid any long-term bonds and instead short some long-term Treasuries through buying an exchange-traded fund such as

Ultra Short Lehman 20+ Treasury ProShares

(TBT) - Get Report

and hold some gold and silver through buying an ETF such as

PowerShares DB Gold Double Long ETN

(DGP) - Get Report

. Investors should avoid most stocks except for some very strong and unleveraged multinational companies that sell health care products and consumer staples. This can be done through buying an ETF such as

Consumer Staples Select Sector SPDR

(XLP) - Get Report

, which holds such companies as


(KO) - Get Report


Philip Morris

(PM) - Get Report


Wal-Mart Stores

(WMT) - Get Report


Colgate Palmolive

(CL) - Get Report


Health Care Select Sector SPDR

(XLV) - Get Report

, which holds pharmaceuticals like


(PFE) - Get Report



(MRK) - Get Report


Johnson & Johnson

(JNJ) - Get Report

. These companies would benefit from a weakening dollar and a flight to relatively defensive names by investors. Ultimately, all of the major currencies will follow the dollar into devaluation to stay competitive, so I don't believe that holding a lot of foreign currencies is going to be very helpful in the long run.

As President-elect Barack Obama tries to channel Franklin Delano Roosevelt with his recent statements, he should remember that this is not 1933. At that time, America was the world's largest creditor nation. We are now the world's largest debtor. Also at that time, Europe and Asia were both in the process of disintegrating as a result of revolutions, fascism, socialism, and ultimately World War II. This situation left America as the strongest country in the world.

If you look at when the stock market actually ended its bear market that began in 1929, it was actually within a month after Pearl Harbor. Of course the market bottomed back in 1933. But if you look at when the new bull market began, it wasn't until January 1942 and coincided directly with the entry of the U.S. into the wars in Europe and Asia. I do not see any similar circumstances globally that will benefit America, nor do I see the benefit of being the world's largest debtor instead of the world's largest creditor.

Obama today faces a much more serious challenge than FDR ever did. Hopefully, his administration will rise to that challenge, and maybe America will somehow get lucky. I don't know. What I do know is that it is not helping for our nation's political and financial leaders to keep writing checks that they can't cash and lying to the American people about the financial solvency of our nation and how we're going to turn things around.

We aren't going to save ourselves economically with more borrowing and spending and speculating. That much should be clear to everyone at this point. History will judge our current leaders very harshly if it turns out that they presided over the twilight and ultimate decline of our great country because they were either too afraid or too ignorant to face up to our real problems and take action to start correcting them.

Christopher Grey is a managing partner of Third Wave Partners. He currently has no positions in the stocks mentioned in this article. This article should not be interpreted as personal investment advice or a recommendation to buy or sell any security. Interested readers may contact the writer by e-mailing cg@thirdwavepartners.net or visiting the company's Web site, www.thirdwavepartners.net.