Reality is immune to human fantasy

This truism is no more prevalent than now as we witness Ron Paul’s rise in the polls in both Iowa and New Hampshire to front runner status. All of the usual pundits in the usual media outlets are attempting to discredit a potential Paul victory in Iowa by calling it meaningless. This is irritating and predictable; however, it gets worse. The governor of Iowa has now joined in on this fantasy. From Politico:

Leading Republicans, looking to put the best possible frame on a Paul victory, are already testing out a message for what they’ll say if the 76-year-old Texas congressman is triumphant.

The short version: Ignore him.

“People are going to look at who comes in second and who comes in third,” said Gov. Terry Branstad. “If [Mitt] Romney comes in a strong second, it definitely helps him going into New Hampshire and the other states.”

What country do we live in again? This ain’t America…. not even the America I was taught about in public school. Discrediting an election (caucus) merely because you disagree with the results is something Hugo Chavez does. It is not something we do in America. At least I thought we didn’t. Do these Ron Paul detractors really believe this behavior is acceptable? If the majority (or plurality) of people in your state vote for someone you don’t like how can you say it doesn’t count?

This effort at undermining their own process by making these comments has more danger of discrediting the election than Ron Paul winning. Hopefully Iowans and others see through this poppycock and vote without its influence.

The reality of Ron Paul should be no match for those naysayers living in fantasy land calling him an anti-semite, racist, and worse. It seems to me that once your foes start calling you names rather than debate you on your positions then you’ve already won.

During Paul’s 2008 campaign I wrote that I didn’t think America was quite ready for Ron Paul. Here in 2012, America just might be ready for him and the harsh reality he brings. We are going broke. We need to cut spending. We need to cut taxes. We need to bring our troops home from overseas to defend this country. We need to end all foreign aid. Yes, including Israel. Give them back their sovereignty.

If you fear a Ron Paul presidency just take a deep breath, calm down, and read the Constitution. That’s his platform. If you still think he’s too extreme then realize that there are 2 other branches of government that will be operating to limit his extremism. That’s a major reason we have the judiciary and legislature, checks and balances. If any other candidate wins, nothing will change. We’ll keep going down the spending death-spiral to our own demise. I’m not a big fan of demise. I’m voting for Ron Paul. Are you?

RIP Ron Smith.

This evening President Obama presented his latest plan to “stimulate” the United States economy;  this time, to the tune of $447 billion.  This stimulus is to be completely paid for by undefined savings at a future, undetermined date.  By now, as a nation, we’re all probably quite numb to this and a proposal of this nature doesn’t elicit the same level of anxiety and fear that it once may have.  However, what should really frighten each of us is the outrageous question posed by Mr. Obama in defense of his proposal:

Nice interview, though I wish Paul would choose more optimistic words when he speaks. All of this “I’m afraid there will be people in the streets like we’ve seen in other countries” talk is worrying Grandma and Grandpa voter out there. It reminds me of my penchant for jokingly yelling “WE ARE ALL GOING TO DIE!” at the top of my lungs while going over the first big drop on a roller-coaster. You know, just for fun. Of course, Ron Paul is being serious and he’s right. I just don’t know if that is earning him the kind of votes he needs to rise even further in the polls.

http://www.youtube.com/watch?v=3vFkcjwZOA8

The following essay is presented as an educational service of the Downsize DC Foundation …

By Jim Babka, Perry Willis, and James Wilson

On Monday, August 15, billionaire Warren Buffett argued in an op-ed for the The New York Times that his taxes should be raised. He claimed that giving the Federal State more of his money would be a good thing.

We disagree. We think Mr. Buffett’s investments do more social good than his taxes do. Here’s why…

None of Mr. Buffett’s companies use force to compel people to do business with them, but everything The States does relies on coercion. This automatically makes Mr. Buffett’s investments better than his tax payments. In addition….

Mr. Buffett’s companies must serve their customers, or go bankrupt. By contrast, Statist programs almost always receive increased budgets when they fail. Thus, businesses have an incentive to use resources wisely, while The State has incentives to waste resources. This is why money spent by The Coercive Sector (The State) tends to have less social utility than money spent by The Voluntary Sector (businesses and charities).

In short, businesses tend to be pro-social because they serve society, while The State tends to be anti-social, because it’s wasteful and coercive.

When Mr. Buffett says that he should pay more taxes, he is really saying that he should have less money to invest. Looked at correctly, this is the same as saying that he wants to stop doing social good, and start doing social harm.

We also want to point out that Mr. Buffett is being a hypocrite. If he thinks The State should have more of his money, then he should write them a check.

But instead of putting his money where his mouth is, he asks Congress to take other people’s money. This suggests to us that Mr. Buffett is really pandering to the mob. He doesn’t REALLY believe the Federal State can use his money more wisely then he can. But he may believe that his op-ed will win applause from Left-Statists who have an unquenchable lust for other people’s money. This bit of brown-nosing may even be beneficial for Buffett’s business!

Mr. Buffett is also scamming us in another way. He wants us to believe that wealthy Americans have been doing less to fund the Leviathan State. He wrote in The New York Times….

“Since 1992, the I.R.S. has compiled data from the returns of the 400 Americans reporting the largest income. In 1992, the top 400 had aggregate taxable income of $16.9 billion and paid federal taxes of 29.2% on that sum. In 2008, the aggregate income of the highest 400 had soared to $90.9 billion… but the rate paid had fallen to 21.5%”

We say that Mr. Buffett is using percentages in order to deceive. Here’s how those percentages work out in terms of dollars….

• In 1992 the top 400 wealth generators paid $4.9 billion in taxes.
• In 2008 the top 400 wealth generators paid $19.5 billion in taxes.

Can you see how Mr. Buffett’s scam works? The percentage of income paid in taxes went down, but the amount of taxes paid in dollars actually ROSE, by a multiple of 4 in 16 years! This is a staggering rate of return. It’s unlikely that Mr. Buffett’s investments grow that much. But then again, actually having to earn money is much harder than taking it from people at the point of a gun the way The State does.

When Mr. Buffet tries to make you think that society’s top wealth creators are paying less in taxes, he is simply being a con-man.

Mr. Buffett should stop trying to harm society by asking Congress to take other people’s money. Instead, Mr. Buffett should tend to his own knitting, because his investments do more social good than his taxes ever will.

D o w n s i z e r – D i s p a t c h

Official email newsletter of DownsizeDC.org, Inc. & Downsize DC Foundation.

by John Browne, Senior Market Strategist at Euro Pacific Capital

The basic unwillingness of politicians to face economic and financial realities has caused the United States and European Union to face currency collapse. The politicians are content literally to paper over the problem with massive amounts of newly printed currency. This means that savvy investors, facing major real losses, are turning increasingly to gold. In essence, even though currencies are no longer on a gold standard, they are increasingly being “redeemed” for gold in the marketplace.

For decades, fiscally irresponsible US Administrations have gradually reduced the world’s richest nation, with a currency perceived as ‘good as gold,’ to the position of the largest global debtor, with a debased currency. Furthermore, US stock markets have offered little real return. Indeed, the Dow stands just below 11K, down over 3K points from its all-time high on October 9, 2009. Discounting for inflation shows a loss close to 4K points, or a fall of over 25 percent from its all-time high. Meanwhile, equities in emerging markets have often shown handsome returns.

The recent political wrangling in Washington has damaged the financial credibility of the United States, prompting a long overdue debt downgrade by ratings house Standard & Poor’s. This removes a fundamental pillar supporting the dollar as the global reserve asset of choice.

In Europe, the unwillingness of politicians to face the fatal structural flaws within the euro is encouraging a fear-driven economic recession, sovereign debt defaults, a banking crisis, and, potentially, a currency collapse. This is hurting the euro’s formerly bright prospects of replacing the dollar as global reserve.

This week’s Merkel-Sarkozy summit meeting amounted to nothing constructive. The most popular topic was instituting a Tobin tax on forex transactions. This would, of course, drive financial markets out of the EU to more friendly environments. But more importantly, it leaves the major structural issues of a two-speed Europe unaddressed.

With nothing achieved by the EU’s ruling Franco-German axis, European banks are correctly seen as increasingly vulnerable to further EU sovereign debt defaults. Of course, former communist Merkel and her French ‘poodle,’ the socialist Sarkozy, will find no problem in transferring toxic bank assets to the public purse. But it will require more market anguish before they dare to do it. Once this happens, the euro will be locked on the same railway to devaluation as the dollar.

China’s yuan has strong fundamentals, but is not properly situated to vie for a place on the world stage. It is neither backed by hard assets nor freely floating. Though this policy is changing, it is not yet a true alternative to the dollar as it maintains a fixed exchange ‘band’ to restrain its true value.

Naturally, private investors and foreign central banks are turning to the very monetary instrument that they never should have abandoned: bullion gold. That is why the gold price is rising in $50 leaps per day, with only small corrections. Gold is being re-monetized. [Learn the difference between rare and bullion gold in Euro Pacific Precious Metals' new special report, free for download HERE. Please note: Euro Pacific Capital and John Browne are not affiliated with Euro Pacific Precious Metals.]

Still, despite our continued warnings, and perhaps motivated by yield or a misplaced sense of safety, some investors still are tempted into dollars and US Treasuries, driving them to negative real yields of up to three percent. This may prove to be one of the largest financial traps in history, potentially devastating the savings of many investors. It reflects a fundamental investment strategy flaw.

It has been held that most wise investors should look not at yield and capital appreciation, but at total return. The only need to differentiate between yield and capital growth is for tax purposes. Some investors avoid gold still, because of its lack of yield. This can be a costly mistake when gold’s meteoric capital gains are taken into account.

Some are skeptical because of the performance of silver during the spring. However, it must be remembered that silver is still up some 125% year-over-year. The drop from $50 to $35 was directly related to an unprecedented triple-margin hike by the Chicago Mercantile Exchange. The exchange made the same move against gold, but the yellow metal shrugged it off through buoyant demand.

Indeed, while silver is temporarily hobbled by worries of global depression and a corresponding drop in industrial demand, gold appears to have no such reservations. Silver may ultimately surge well past gold as the emerging markets prove themselves able to stand on their own despite an ailing West. But gold is a pure monetary trade, and its signal is indisputable.

As long as politicians continue to paper over their problems by issuing more fiat money, gold will regain its crown as the king of monetary instruments.

Paul Krugman sounded the war cry this Sunday on Fareed Zakaria’s program Global Public Square. After all, he asserted, only spending equivalent to another World War could lead us back to prosperity. That, and a healthy dose of inflation.

Krugman argued that inflation would address our debt problem by reducing our bill in current dollar terms and that the Second World War was a giant stimulus plan that actually worked. Thankfully, he added the refrain, “Hopefully we don’t need a world war to get there,” but I sensed a tinge of regret in his voice. After all, the Keynesian economist’s favorite pastime is seeing people waste their lives digging holes in the ground or sacrifice their lives in war. Both acts create economic growth according to the topsy-turvy logic of men like Krugman.

The truth is that wars are a miserable misallocation of capital and usually leave financial ruin in their wake. The US did not boom in the ’50s because we fought World War II, but because we resoundingly won. It was the byproduct of having an unscathed manufacturing base, solid infrastructure, an intact military, most of the world’s gold, and the only reserve currency.

The logical implication of Krugman’s arguments remains that working in productive employment is not at all necessary. If this is true, why not have people just save gas and stay home? The government could simply borrow and/or print money and send it to foreign countries that are dumb enough to produce goods and services for US consumption. Christina Romer, former Chair to Obama’s Council of Economic Advisors, also sided with Krugman in a commentary posted in Sunday’s New York Times finance section. In it, she pontificated on the lessons to be learned from the Great Depression, saying: “It would be a mistake to respond by reducing the deficit more sharply in the near-term. That would almost surely condemn us to a repeat of the 1937 downturn.” This misdirection demonstrates her lack of understanding of what causes economic depressions in the first place.

The cause of the Great Depression in the 1930s and the Great Recession beginning in December 2007 were one and the same – an over-leveraged economy. Easy money provided by the banking system eventually brings debt in the economy to an unsustainable level. At that point, the only real and viable solution is for the public and private sectors to undergo a protracted period of deleveraging. The ensuing depression is, in actuality, the healing process at work, and is marked by the selling of assets and the paying down of debt. Unfortunately, our politicians today are focused on fighting the natural healing process of deleveraging by promoting the accumulation of even more debt.

During this latest economic contraction, the Federal Reserve has taken interest rates to near 0% for the past 2 ¾ years, and it has just promised to keep them there for an additional 2 years! Meanwhile, the Obama administration is leveraging up the public sector to record levels in an effort to re-leverage the private sector. The government’s philosophy is tantamount to sticking a frostbitten man in the freezer so he won’t have to suffer the pain associated with the thawing of his extremities.

During the Great Depression, real GDP plummeted 32%. The Great Recession, through which we are still struggling, began in December 2007, according to the National Bureau of Economic Research. But, in contrast to the 1930s, GDP during this recession shrank only 3.6% from the fourth quarter of 2007 through its low point in the second quarter of 2009.

The contraction in GDP during the Great Depression was the direct result of consumers paying down debt and selling off assets. Household debt as a percentage of GDP reached nearly 100% in 1929. To put that number in perspective, household debt did not go back above 50% of GDP until 1985. And it was not until the first quarter of 2009 that household debt once again approached the 1929 level.

Between the start of the Great Depression and the end of World War II, household debt fell from 100% to just above 20% of GDP. Getting there was a painful process, but such de-leveraging was the only real cure for an economy swimming in debt. Thanks to government efforts to carry on our debt-fueled consumption binge, during today’s Great Recession, household debt has barely contracted at all – it has only been reduced to 90% of GDP as of Q1 ’11.

To make matters even worse, during this current crisis our government’s response has been to dramatically increase its own borrowing. At the start of the Great Depression, gross national debt was 16% of GDP. It peaked just below 44% when the Depression ended. While the national debt did increase significantly during that period, it was still relatively benign compared to other Western governments. The US entered this current Great Recession with gross national debt equal to 65% of GDP. It has since exploded to 98% of GDP!

US federal debt did rise dramatically during World War II, topping out at 120% of GDP in 1946. But consumer debt plunged concurrently. So, while Washington was adding debt to fight and win a global war, households were taking the necessary steps to ensure their balance sheets were well prepared for the aftermath of the battle.

Today, for the first time in our history, gross national debt and household debt are both at least 90% of GDP.

Mr. Krugman and his allies believe that we can grow our way out of this recession like we have in the past few. Unfortunately, we’re dealing with a completely different animal. In every past recession, the government, under the guidance of Keynesians, decided to put off deleveraging in return for artificial growth. Well, that tab has come due.

Since these economists keep trying to spend like it’s World War III, we are moving inexorably closer to causing Great Depression II. If policymakers and mainstream economists fail to understand that the progenitor of a depression is debt, they will also be unable to provide a genuine solution. Instead, by pushing public debt past the point of our creditors’ willingness to lend, they may ensure that this next Great Depression will be accompanied by runaway inflation. If history is any guide, this is a truly lethal combination.

To an extent not fully appreciated by the investing public, financial markets are influenced by human emotion just as much as they are by economic data, corporate earnings, and dividend yields. Of all human motivations, fear is perhaps the most powerful. When people get scared, the “fight or flight” instinct forces us to take action.

Simple dangers prompt simple responses. If we unexpectedly encounter a bear on our driveway, we immediately run into the house and call animal control (or, in the country, grab the shotgun). But it’s harder to know what to do when financial danger stalks the stock market. To be honest, most investors are clueless. Is that really a bear? Is it dangerous? What qualifies as a house?

When confronted with fear AND confusion, investors tend to look around to see what other people are doing – hoping that others know something they don’t. This is a big part of our natural and instinctive drive to seek safety in numbers. When financial markets panic, investors follow the herd. If the herd does something illogical, like buying US Treasuries when they pay almost no yield and when the government is essentially bankrupt, it is evidence that people have decided to seek safety in numbers.

But here’s the thing: this herd doesn’t have a leader. As much as we would like to think that there are rational, or sinister, individuals who decide where the herd goes and how fast it will take to get there, in reality, we just have a center of gravity around which the herd coalesces. Individuals may make an impact but the mass has a mind of its own. The center of gravity does move, but it tends to do so glacially.

As a result, we can expect that market movements in the current correction will largely resemble past corrections. However, there will be slight differences, which should be studied intently to determine where the center of gravity is drifting. It’s particularly important to notice where the herd is seeking safety.

Yesterday’s sell-off in the US markets saw the the S&P 500 lose 4.8% of its value. The Dow’s loss was, at 513 points, the biggest one day drop since December 2008. It capped a horrific 10-day plunge that knocked more than 10% off stock prices overall.

The carnage has many investors queasily recalling the nightmare days of the credit crunch of 2008. In one particularly brutal phase of that crisis, between December 16, 2008 and March 9, 2009, the S&P 500 sold off more than 25%. Fear drove investors to seek safety in traditional havens. During that time, the US dollar rallied by 8.4% while foreign currencies sold off heavily, including a 9% dip in the Australian dollar and a 3% haircut for the vaunted Swiss franc. Gold rallied 7.4% during that period, but failed to beat the dollar’s run up.

The next major correction in stocks showed a slightly different result. Between April 23, 2010 and July 2, 2010, the S&P 500 dropped 16%. During that time, the dollar rallied just 3%. Notably, this time around, the Swiss franc did not sell off, but rather rallied by about 1%. More importantly, gold rallied nearly 5%, taking from the US dollar the title of “fear asset of choice.”

These trends have gained momentum in the current sell-off. From April 29, 2011 to August 4, 2011, the S&P 500 lost 11.3%. During that time, the dollar managed just a skimpy .3% gain. Meanwhile, the Swiss franc jumped almost 13% and gold surged 5.6%. It does appear that the crowd has changed at least some of its assumptions. It no longer runs blindly into US dollars. It considers other options.

There are many theories as to what moves the herd’s center of gravity. Here, I don’t think it’s much of surprise. Since 2008, a steady drip of news stories have highlighted the staggering indebtedness of the US government, the unwillingness of its policymakers to confront the crisis, and the stubborn persistence of economic stagnation in the face of growing inflation. Although the dollar is still regarded as a place to go when the going gets rough, that opinion is not as strong as it was in the days before our economy imploded and our government became the economy itself.

I would expect the broad trends outlined here to continue. As economic data continues to disappoint, look for the stock market to continue to fall. If the drop goes too far too fast, look for an early launch of the next round of quantitative easing. QE3 may help stabilize stock prices, but it will further erode confidence in the US dollar. As a result, when the next panic hits, look for the dollar to perform that much worse than it did this time around.

Although the dollar’s doom is clearly written on the walls, the center of gravity in the financial world has moved very slowly and will likely continue to do so. Fortunately, for our readers, the direction of the movement is clear. Thus, we are positioned well in front while Wall Street brings up the rear.

The reliance upon the U.S. dollar as the world’s reserve currency and “safe haven” asset has created a perverse, but deeply entrenched, mindset among global investors. In fact, many believe the major financial players have no alternatives to owning U.S. debt and dollars. They argue that the market for U.S. dollars and Treasuries is the only financial pool large enough to handle the massive liquidity that sloshes around the globe on a daily basis. This idea makes a mass exodus from U.S. debt holdings seem impossible. This provides a nice explanation why the U.S. Treasury bonds can rally even while the government openly flirts with default and ratings agencies issue downgrades. But just because an illogical event occurs habitually does not mean it is logical or tenable.

The sophomoric reasoning behind the dollar “exceptionalism” argument is like assuming a stock can never fall unless a significant portion of shareholders decide to sell. In reality, a buyers strike is all that is needed to puncture a market. If the U.S. experienced just one disastrous Treasury auction, prices could nose-dive and yields could skyrocket across the board on all U.S. debt.

But the problem doesn’t just lie with the United States. Investors around the world are finally beginning to understand that central bank’s thirst for creating inflation, in order to keep their banks and governments solvent, will never be quenched.

This week, the Swiss government took action to weaken the surging franc by lowering interest rates and printing currency. The franc was pushed down briefly, but then snapped back. It’s hard to keep a good currency down. Similarly, the Bank of Japan announced that it won’t stand for Yen appreciation much longer and would likely soon intervene to buy dollars and weaken the Yen.

Meanwhile, problems at the overly indebted countries just get worse. Italian and Spanish debt yields are now following the upward spiral of Greek bonds (and hitting multi year highs). Italian ten-year notes have surged from just above 3% in late 2010 to well over 6% today. For a country whose debt to GDP ratio is currently over 120%, a doubling of interest rate expenses spells disaster.

Enter Jean Claude Trichet who will certainly use his printing press to buy much of the weakening Italian debt that is now festering on the balance sheets of the biggest European banks. But the size of the bailouts needed to deal with Italian and Spanish debts will be several orders of magnitude greater than those needed for Ireland or Greece. Anticipating a massive increase in the Euro money supply, investors are flocking to gold to protect themselves from currency debasement.

Adding fuel to the gold fire is the recent debt deal reached in Washington. The disgusting agreement virtually assures that over the next decade the U.S. will add an additional $8 trillion in public debt, an increase of nearly 80% in ten years! The back-end-loaded deal will cause the amount of deficit reduction to be just $21 billion in 2012 and $42 billion in 2013.

But even this modest debt reduction depends on rosy assumptions from Washington that are always wrong. For example, the Obama administration predicts GDP growth will average well over 3% for the coming decade. But the annualized GDP growth in the first half of 2011 was just 0.9%. That means the actual deficit and debt figures will be far greater than the projections. Given the immediate increase in borrowing needs, and the obvious slowing of the tepid “recovery,” there can be little doubt that the next round of quantitative easing will be launched sooner rather than later.

The incompetency of U.S. credit rating agencies has long been suspected. But their actions in the wake of the debt ceiling agreement now confirm them as liars. After threatening to downgrade U.S. credit if Washington failed to cut $4 trillion in spending, neither Moody’s, Fitch nor S&P had the courage to carry through, despite the fact that the total cuts would amount to only half their requirements. But a credit rating downgrade on Treasuries did come-from China. The Dagong Global Credit Rating agency cut the credit rating on U.S. sovereign debt to A from A+, 5 notches below AAA. And since the Chinese are the biggest foreign buyer of Treasuries, their opinion counts.

This week, more evidence of U.S. stagflation emerged. The ISM manufacturing and non-manufacturing reports showed a slowdown in new orders and employment and the ADP report showed that the U.S. lost 7,000 goods-producing jobs in July. Other data releases showed that layoffs surged 60% last month to a 16-month high. Meanwhile, YOY consumer prices are up 3.6% and M2 money supply is up 7.5% YOY and rising at a 14.6% annual rate in the last quarter. As the problem with stagflation becomes worse, international investors will avoid the U.S. dollar and U.S. debt at an ever increasing rate.

With soaring debt-to-GDP ratios in Japan, Western Europe and America, the desirability of owning precious metals will grow as investors realize the fiat currency system’s days are numbered. Those holding U.S. dollars and U.S. debt will feel the biggest brunt of the change. But it is always darkest before the dawn. As a result of the carnage the re-establishment of gold as the world’s reserve currency is, hopefully, only a few years away.

by Peter Schiff, CEO of Euro Pacific Capital, and host of The Peter Schiff Show, broadcasting live from WSTC Norwalk CT from 10am to noon Eastern time every weekday, and streaming at

By supposedly compromising to raise the debt ceiling, Congress and the President have now paved the way for ever higher levels of federal spending. Although, the nation was spared the trauma of borrowing restrictions, the actual risk of default existed solely in the minds of Washington politicians.  But the real crisis is not, nor has it ever been, the debt ceiling. The crisis is the debt itself. Economic Armageddon would not have resulted from failure to raise the ceiling, but it will come because we succeeded in raising it. This outcome falls along the lines that I had forecast (See my commentary, “Don’t Be Fooled by Political Posturing” from July 9th).

Both parties are now pretending that the promised cuts in spending outweigh the increase in the debt limit. But the $900 billion in identified cuts are spread over a decade and are skewed toward the end of that period. There are an additional $1.4 trillion in cuts that the plan assumes will be identified by a bi-partisan budget committee. But similarly empowered panels in the past have almost never delivered on their mandates.

More importantly, none of these “cuts” are actually binding. There is plenty of time for future Congresses to reverse what was so laboriously agreed to over the past few weeks. My guess is renewed economic weakness will be used to justify ultimate suspension of the cuts. In addition, most of the spending reductions were already scheduled to take effect before this agreement. So what did we really get?

The Congressional Budget Office currently projects that $9.5 trillion in new debt will have to be issued over the next 10 years. Even if all of the reductions proposed in the deal were to come to pass, which is highly unlikely, that would still leave $7.1 trillion in new debt accumulation by 2021. Our problems have not been solved by a long shot.

Essentially, the structure announced today allows both political parties to talk about reform without actually changing anything. To underscore that point, the deal involves less than $25 billion in immediate cuts! This is less than a rounding error in a $3.8 trillion dollar budget. This is politics as usual.

Even these estimates are based on rosy economic assumptions that have no chance coming to fruition. For example, for the current fiscal year, Washington estimates GDP growth at 4%. But actual growth for the first half of 2011 is below 1%!  If our government is over-estimating our current year’s growth by a factor of 4, how accurate could their forecasts be ten years into the future? A more honest assessment of likely economic performance would reveal future budget deficits spiraling out of control.

Some might say that the primary goal of this deal was to avoid the dreaded credit rating downgrade. Unfortunately, the deal addresses none of the ratings agencies’ stated grievances. If they fail to follow through on their downgrade warnings, the rating agencies will lose whatever credibility they have left. For political reasons, the downgrades may not come right away, but they are inevitable. But as has happened so often in the past, by the time the tardy downgrades arrive, the market will have likely already rendered its verdict.

The debt ceiling itself merely represents a self-imposed limit on US borrowing. Since Congress can vote to raise the limit, its existence has been more of a political nuisance than an actual barrier. The operative factor is not how much we allow ourselves to borrow, but how much our creditors are willing to lend. That type of ceiling can’t be raised by an Act of Congress. Once our creditors come to the conclusion that they have lent beyond our capacity to repay, they will be very reluctant to lend more. As trillions in short-term Treasuries mature, the dwindling pool of buyers will demand higher rates of return to compensate them for the risk. But our government is in no condition to afford those higher rates without gutting the rest of the budget.

Last week, it was revealed that despite Obama’s warnings that a default would immediately occur if the debt ceiling were not raised, the administration had already agreed to prioritize interest payments to avoid default. Such preferential treatment is only possible because current interest rates are so low and debt service represents only about 10% of total revenue. When the pool of willing lenders evaporates, net interest payments could quickly consume more than 50% of federal revenue. This is particularly true since rising rates will also plunge the economy into a recession that will substantially reduce revenues – even as debt payments surge.

At that point, prioritizing interest payments would mean deep sacrifices in the rest of the federal budget – including Social Security, Medicare, and the Armed Forces. The question then becomes: will US politicians really be willing to take the political heat that would emerge from prioritizing interest payments to foreign creditors over payments to American voters?

I expect that as soon as our creditors decide that they are no longer willing to lend to us at ultra-low rates of interest, we will refuse to repay what they have already lent.

Besides default or major cuts to domestic spending, inflation provides the only other means for the government to deal with this intractable crisis. Because of its political palatability, inflation is, in fact, the most likely outcome. Once we go down that path, we risk high inflation turning into hyperinflation, which would decimate the remainder of our economy. So, as our leaders congratulate themselves for saving the nation, the reality is that they may have just sold it down the river.

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by John Browne, Senior Market Strategist at Euro Pacific Capital

Although I believe gold still faces a very rosy future, an agreement in Washington that avoids default and growing concerns of a global economic slowdown could create significant near-term headwinds for gold investors.

While the dysfunction of the US government is on stark display over the debt ceiling negotiations, other areas of the world show similar policy confusion. In the European Union, great doubts exist as to how the leaders will be able to stem the tide of serious sovereign debt contagion without inviting recession and an uptick in inflation. In China, commentators seem to lack confidence that the economy can maintain its impressive growth rate if its major trading bloc partners fall back into recession. This uncertainty has created a level of financial fear that has contributed to gold’s run up to more than $1,600 per ounce. However, this also means that any weakening of these fears could lead to a pull back in gold. An agreement in Washington, however meaningless, may be such a trigger.

Evidence has grown that the United States government has no real intention of curbing its spendthrift ways. By next Tuesday, Congress will likely reach some sort of pallid agreement that will involve a short-term agreement to raise the debt ceiling just enough to postpone an imminent fiscal crisis until after the 2012 election. This will, of course, be another case of kicking the can down the road – and will only further compound the very problems that have helped send gold soaring. Still, any agreement that prevents an immediate default on Treasury debt will be greeted with great relief in the markets. The good feelings may spark a short-lived rally in stocks and sell-off in gold.

Another near-term hurdle for gold will be the dawning realization that recession may take hold once again in many regions around the globe, most notably in the US and eurozone. To the extent that these recessions are deflationary, they could drag on the gold price.

Despite the agitation of the freshman Tea Party members of the US House of Representatives, there appears little or no serious discussion about curbing the rise of runaway government spending that is acting as a crippling parasite on the US economy. Similarly, the punitive nature of the present so-called sovereign debt rescue packages in the eurozone likely will fan the flames of recession in Europe. To the extent that these downturns are not met with new money-printing, they could hypothetically hurt the gold price.

This is especially true if the implosions among Western economies impede the growth of China. For now, it appears China’s breakneck growth is indeed slowing, but it is neither clear what role their export markets play in this nor how quickly they will be able to shift to a domestic-consumption model.

In normal times, these deflationary forces could present long-term problems for the gold price; however, these are not normal times. Rather, we believe the stage is being set for the currency catastrophe we have long forecast. In our calculation, the sovereign debt problem likely will increase. Eventually, even suddenly perhaps, it will lead to a currency crisis. This may cause a temporary capital shift from the euro into the US dollar, temporarily correcting the current dollar slide. But very quickly, I expect investors would realize that the US dollar itself is most vulnerable. As it is the international reserve currency, this might very well threaten a currency collapse and a surge in the price of gold.

In summary, gold appears set on a very strong upward path. However, in the short term, if global recessionary forces re-emerge and/or investors become euphoric over the US dodging a debt default, gold could face a significant price correction. If governments inflate wildly in a futile attempt to avert a pending depression, leading to stagflation, as we expect, then gold should rebound in price.

This should not be construed as an appeal for investors to sell their gold and try to time their way back into the market. Rather, I would suggest that there may be some discounted opportunities in the coming months. Hold on tight for turbulence ahead, and keep your bearings fixed on your intended destination.