The Slow Unraveling of the Big Debt Society

By Duru

May 1, 2005

If Greenspan thinks the persistence of low long-term rates is a "conundrum", he needs to spend some more time with the Republican Party. Just when I thought I heard something that sounded more like the Republican governance I had grown to know in the land of the "loony lefties", they serve up a smack-down with an untraditional twist. Last week, Bushie finally admitted that Social Security benefits will have to be cut to keep the system solvent. But instead of an across-the-board slash and burn, Bushie's current proposal actually maintains benefits for the bottom 30% of wage earners and steadily cuts benefits the higher up the wage scale you go. Cynics claim this contortion represents the beginning of the end of the system: the folks with money will slowly lose interest in a program that looks more and more like welfare…especially when they are forced to rely more on their personal savings accounts than government benefits. I would typically plant myself firmly in this camp, but I am more distracted by another potential mood shift. I think Bushie and his party have finally signaled that they are for real in reducing the country's dependence on ballooning liabilities, that is, debt. As Social Security has grown over the decades, we have essentially continued to make larger and larger promises that the country simply cannot maintain. We can choose to either let the money run out at some point or try to act now. It seems the time is now….because the folks who will get hit the hardest by social security reform are the very folks who vote the least…the youngsters. While the issue will be hard-fought up and down the aisles of D.C., at least politicians need not worry about facing immediate reprisals from the constituents who should care the most. Someone has got to take one for the team…sorry Hip Hop Generation!

Greenie is also trying to unravel the big debts our nation has piled on by gently hiking short-term interest rates back up. I am sure he is quite shocked to see how speculative the housing market has become despite his consistent claims that housing is too "sticky" to provide the flipping opportunities prevalent in the stock market. Turns out that Americans are more creative than Greenie originally believed! When real money is at stake, anything is possible. As we approach another week of Fed drama, we find ourselves on the edge of 3% short-term rates and long-term rates (10-year Treasury) fading back toward 4%. Over the past two years, long-term rates have bounced around a lot, but they have essentially gone nowhere. The bond market is demonstrating it has little faith in the staying power of current economic growth. The stock market's woes this year add more lead to the balloon. If the Fed insists on pressing ahead with its rate hike program in this game of chicken with the markets, it very well could spin the economy back into recession (or at least an extra-soft "soft-patch"). I believe the Fed must press on given their desire to maintain consistency and their newfound religion on inflation. I believe this even though gold and all manner of commodities have swooned deeply recently. Needless to say, May should be another extension of the manic drama we have come to know and hate.

What I see overall is that, slowly but surely, Americans are finally being asked to choose and make difficult decisions. We popped the biggest bubble in history and got a recession that generally felt more like a "soft patch" than genuine economic malaise. The Feds printed money as fast as possible, the Republicans cut taxes as deep as possible, and the military bombed as many bad guys as possible. This potent combination allowed folks to feel secure in every way possible to continue shopping for everything from fancy clothes to homes almost without interruption. Now we are hearing that we can no longer afford Social Security as it now stands. We are being told we cannot afford to let the real estate market spin too much further out of control. We are being told that we can no longer consume oil (at least foreign oil) in massive amounts. We are being told that we are importing too many goods from China and India. We are being told that the Federal government's debt is growing at an unsustainable pace. Our big industrial companies are crying out their case that the nation's healthcare system is spiraling out of control. Could a few high-profile bankruptcies force us to finally take substantive action on healthcare (which is supposedly an even larger problem than Social Security)? Could the spread of hotspots around the globe also demonstrate that America can no longer afford to speak as the sole authority on policing the world's bad guys? North Korea is the little nuke that will not go away, and Iraq is probably no closer to stability than it was a year or two ago. We are pretty much incapable of directly intervening in the genocide in Sudan. Heck, we still have not tracked down old man Bin Laden! Tough choices and admissions indeed.

Meanwhile, back on Wall Street, the Dow Jones valiantly holds onto the 10,000 level as it continues to flirt with a complete breakdown below the 200 DMA. The S&P 500 teeters as well. The NASDAQ has already essentially failed. The game of chicken with the Fed is reaching a dramatic end-game. The old street adage says that you sell in May and stay away until the Fall. A stubbornly hawkish Fed could be all the push we need to end the market's current hesitation for fulfilling this promise. The pain could take on all new lows faster than we can imagine right now. A Fed that cries "uncle" could spark a massive party that will surely ignite the Fed's worst fears on inflation. Stay tuned….and be careful out there!

© DrDuru, 2005