Tipping Points

There have been a number of tipping points in the past ten years.  The 9/11 attack, the Afghanistan and Iraq wars, the subprime financial crisis to name a few.  These events and others have received exaggerated news coverage.  However, there are other tipping points that have occurred that will be more important in the longer run.

Tipping point #1:  Social Taxes in the US are no longer in surplus.  Social Security payments were taken into the general budget to obscure the extent of budget deficits in the 1970s.  It has taken more than 30 years to expose the folly of this policy (supported by both parties).  Now our gargantuan budget deficits are exaggerated even more as general revenues will be required to make social payments. 

Tipping point #2:  Japan is often used as an example of how a country with very large budget deficits and debt (over 200% of GDP)that can remain financially viable.  Japan's ability to finance its debt is driven by three factors. 1) The Japanese have historically been great savers. 2) Japan runs large trade surpluses. 3) Japanese debt is purchased by Japanese citizens.  The mechanism that purchases Japanese debt is the Japanese Postal Service.  Savers put their money into accounts, and the Service purchases government debt.  The Japanese population is aging rapidly, and retirees are drawing down their postal accounts.  The Japanese Postal Service assets are in decline.

Tipping point #3: China is a trade and investment juggernaut.  Over the past 20 years, it has been directly or indirectly responsible for most of the growth in global trade.  Cheap labor has made Chinese goods very competitve the world over, and China has generated vast trade surpluses.  These surpluses have been used to purchase many resources and the debt of other countries...especially the US.  Despite large trade surpluses with the US, China is now running trade deficits.

These tipping points have occurred in the three largest economies.  All of them have a common effect.  They increase the need to sell bonds, and they reduce buying power for bonds.  Bonds have been a great investment over the past year or two.  Deflation lowers interest rates and increases the value of bonds.  This happy result depends on the perception that fiat currency will retain its value.  Be ready for the day that that perception changes. 

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