We are More Vulnerable than We Know and It’s Getting Worse

by Kevin D. Freeman on February 4, 2015

Russia is imploding and China is slowing. The dollar is seemingly stronger than ever. Capital is rushing to the United States. So what’s the problem?

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First, we are much more vulnerable than anyone wants to admit. Our Federal debt has risen from about $10.5 trillion at the end of 2008 to over $18 trillion today. [Note that the $18 trillion is total Federal debt while the Chart above shows only Federal debt held by the public. Various government agencies hold the difference. This does not mean the other debt is meaningless, however. Social security holdings, for example, are basically IOUs used to support future payments owed to participants. Sadly, the $5 trillion in IOUs held as Intragovernmental Holdings are a fraction of the $100 trillion+ in unfunded liabilities that will have to be paid out over time. So, even the IOUs are seriously insufficient. And, according to the Center on Budget and Policy Priorities, “When Social Security needs to start cashing in its holdings of Treasury securities to meet its benefit obligations, the federal government will have to increase its borrowing from the public, or raise taxes or spend less. That will be a concern for the Treasury…” But that’s another story.]

We aren’t yet feeling the impact of the official debt because the government is still enjoying a “teaser” interest rate. It is kind of like when a credit card company offers a 2% interest rate to take on a new card and more debt. When the teaser runs out, however, the shock begins. In our nation’s case, the Federal Reserve has purposely driven interest rates down to help prime the economy. As a result, the net interest cost on our debt is just a little over $200 billion per year at present. But, according to the White House and Congressional Budget Office estimates, that cost will rise to over $800 billion in 10 years. Keep in mind that these estimates are likely understating the cost. They assume the U.S. dollar remains the reserve currency of the world and that U.S. government debt always receives preferential interest rates. They also assume no recessions.

These assumptions deserve serious scrutiny. Enemies and adversaries alike, are targeting our economy and it is almost impossible to imagine that we will remain recession free given the potential for global turmoil. While an economic slowdown might keep interest rates lower (assuming the dollar remains a strong currency), a recession could require substantially higher spending, greatly worsening the deficit. Basically, the Congressional Budget Office states that the debt trajectory is unsustainable based on present trends. And that is using optimistic assumptions.

Just stop for a moment and take the White House/CBO estimates at face value. In 10 years, the cost of interest will exceed our national defense spending. It will also exceed non-defense discretionary spending. It will be second only to the mandatory spending of Social Security, Medicare, and Medicaid. This is an extraordinary vulnerability and it is being virtually ignored as a risk by the Administration. Now, imagine what happens if any of the three assumptions fails. Things get substantially worse very quickly.

This is not unnoticed by our challengers. That is why their focus is economic warfare. Consider this acknowledgment regarding the recent Russian Spy Case (from ValueWalk.com):

Russia Still Trying To Spy On the US: DOJ

February 2, 2015

Statement from former federal prosecutor

According to Annemarie McAvoy, a Fordham Law professor and former federal prosecutor, the latest case indicates Russia is still undertaking “economic warfare” against America.

‘We have to be concerned about the economic warfare end of this. That’s what worries me,’ she explained, referring to the serious cyberattack on Sony Corporation Pictures involving the movie ‘The Interview.’

McAvoy also noted the arrests are another sign the that the spy game has changed as nations are looking for information to use to attack businesses and/or the economy of another nation. ‘It’s not looking for military secrets. That’s almost passe now,’ McAvoy said.

Second, we do have to be concerned about cyber-economic warfare. A massive computer hack on the economy would be devastating. Or, a loss in reserve currency status which drives interest rates higher. Or, any number of other economic attacks ranging from the pesky to the systemic. 

How do you explain the Russians, facing their own currency collapse, rapidly buying gold? Under normal circumstances, a nation would sell gold to shore up their currency or make up for the loss in oil revenue. Not Russia. They are buying massive amounts of gold. Do they know something? This from the Financial Times (FT) on January 29:

Russia accounted for about one-third of central banks’ gold purchases last year as the country spent more on the metal than at any time since the break-up of the Soviet Union amid escalating tensions with the west and a collapse in the value of the rouble.

The article goes on to explain that this gold buying spree is to diversify away from the United States dollar. It points out that this is unusual behavior. The last time the ruble was in turmoil (1998), the Russian government SOLD 118 tones of gold. This time, they are buying hand over fist. China has been buying gold as well and may even be hiding their purchases. And, FT notes that other Central Banks have joined the gold buying spree with a huge increase over 2013 purchases and the second most gold bought in any year since the collapse of the gold standard in 1971.

The Russian government feels the support of the people, even expecting Russians to eat less if necessary to support the regime. Of course, the government did just lower Vodka prices. Russia has been building up the military, especially nuclear forces. China and Russia are building space warfare capabilities. And, there are some serious people who believe that the Russian economy is in a better condition than most people believe. From True Economics and Constantin Gurdgiev on January 17:

Central Bank of Russia released full-year 2014 capital outflows figures, prompting cheerful chatter from the US officials and academics gleefully loading the demise of the Russian economy.

The figures are ugly: official net outflows of capital stood at USD151.5 billion – roughly 2.5 times the rate of outflows in 2013 – USD61 billion. Q1 outflows were USD48.2 billion, Q2 outflows declined to USD22.4 billion, Q3 2014 outflows netted USD 7.7 billion and Q4 2014 outflows rose to USD72.9 billion. Thus, Q4 2014 outflows – on the face of it – were larger than full-year 2013 outflows.

There are, however, few caveats to these figures that Western analysts of the Russian economy tend to ignore. These are:

  • USD 19.8 billion of outflows in Q4 2014 were down to new liquidity supply measures by the CB of Russia which extended new currency credit lines to Russian banks. In other words, these are loans. One can assume the banks will default on these, or one can assume that they will repay these loans. In the former case, outflows will not be reversible, in the latter case they will be.
  • In Q1-Q3 2014 net outflows of capital that were accounted for by the banks repayment of foreign funding lines (remember the sanctions on banks came in Q2-Q3 2014) amounted to USD16.1 billion. You can call this outflow of funds or you can call it paying down debt. The former sounds ominous, the latter sounds less so – repaying debts improves balance sheets. But, hey, it wouldn’t be so apocalyptic, thus. We do not have aggregated data on this for Q4 2014 yet, but on monthly basis, same outflows for the banking sector amounted to at least USD11.8 billion. So that’s USD 27.9 billion in forced banks deleveraging in 2014. Again, may be that is bad, or may be it is good. Or may be it is simply more nuanced than screaming headline numbers suggest.
  • Deleveraging – debt repayments – in non-banking sector was even bigger. In Q4 2014 alone planned debt redemptions amounted to USD 34.8 billion. Beyond that, we have no idea is there were forced (or unplanned) redemptions.

So in Q3-Q4 2014 alone, banks redemptions were scheduled to run at USD45.321 billion and corporate sector redemptions were scheduled at USD72.684 billion. In simple terms, then, USD 118 billion or 78 percent of the catastrophic capital flight out of Russia in 2014 was down to debt redemptions in banking and corporate sectors. Not ‘investors fleeing’ or depositors ‘taking a run’, but partially forced debt repayments.

Let’s put this into a slightly different perspective. Whatever your view of the European and US policies during the Global Financial Crisis and the subsequent Great Recession might be, one corner-stone of all such policies was banks’ deleveraging – aka ‘pay down of debt’. Russia did not adopt such a policy on its own, but was forced to do so by the sanctions that shut off Russian banks and companies (including those not directly listed in the sanctions) from the Western credit markets. But if you think the above process is a catastrophe for the Russian economy induced by Kremlin, you really should be asking yourself a question or two about the US and European deleveraging policies at home.

We cannot be so arrogant as to assume that Russia is prepared to capitulate. In fact, we know that Putin has a plan to upend the current American-led orderWe also know that China has a long-term plan to displace both our military and economy. According to Sinologist Mike Pillsbury, the very long-term plan has been “replacing the U.S.-led world order with a Chinese communist-dominated economic and political system.” The strategy was designed as a 100-year program and was launched in 1955 so we are about 60% through it. For decades, according to Pillsbury, the Chinese government has systematically fooled and undermined America. Now, China is officially the world’s largest economy according to the IMF and the strategy appears to be succeeding.

No wonder China, India, and Russia are demanding a greater global voice. Translation? They no longer want America calling the shots in global economic governance. Consider this from Yahoo News on February 2nd:

Beijing and Moscow, allies and then adversaries during the Cold War, have found common ground internationally and often take similar stands at the UN Security Council where they have permanent veto powers.

They have also forged increasingly closer economic ties as China is hungry for the vast hydrocarbon resources of Russia, which is seeking stable markets as it has felt the bite of Western sanctions over its annexation of Crimea and fighting in eastern Ukraine….

Under Xi, China has been pursuing a bigger say in the global economy, winning support in November from Asia-Pacific economies for a roadmap for a vast new free trade area that could rival US plans for the region.

China is also aiming to set up an Asian infrastructure lender seen as a counterweight to Western-backed international development banks, and has backed plans to reform the International Monetary Fund that would give emerging economies a greater say in the institution.

Following the foreign minister’s meetings in Beijing, Swaraj said: “We have shared interests in governance reform of the international financial system.”

China has expressed support for Russia amid its economic crisis and is careful to avoid criticising the country over the conflict in Ukraine, consistently calling on all sides to reach a political settlement.

Switzerland, characteristically neutral, is happy to work with China. Their latest currency deal is said to take a “serious swipe at the dollar.” Should we worry that the Swiss see the handwriting on the wall?

Should we be concerned that Belgium is repatriating 200 metric tons of gold? Isn’t this the same Belgium that had been the world’s largest buyer of Treasury bonds? Do they know something?

Don’t forget that ISIS and other radical Islamic jihadists have planned to destroy our economy as well.

The bottom line is that even if there were not serious global challenges coming, our own spending and debt put us in a weakened position, growing weaker over the next decade. Allies and enemies alike are more than aware and appear to be preparing for the day when we no longer lead the world. Some are hastening that day as rapidly as possible.

What can you do? For one thing, we need America to become fiscally sound. This requires political fortitude. Second, we need to recognize the economic war underway. We can’t remain so arrogant as to imagine we have a permanent position as leader of the world. Finally, we have to return America to our spiritual roots. Faith in God provides the fortitude required to compete and win this war.

The same advice applies at the personal level. You should get your fiscal house in order. You should prepare your economic life and investments with the awareness of the economic war underway. The book Game Plan; How to Protect Yourself from the Coming Cyber-Economic Attack can be a starting point in this regard. Finally, you should seek God for His help. Jesus said, as recorded in Matthew 6:33, “Seek ye first the Kingdom of God and His Righteousness, and all other things will be added unto you.”

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