Honestly, I'm still laughing at this video.  If you haven't heard of Nigel Farage (I hadn't until a few days ago), you can read about him here.  In the video, Farage discusses his rather direct and unadulterated views on the euro crisis, as well as what he perceives as a lack of leadership on the issue...to put it kindly.

What I like most about Farage is that he unflinchingly points a finger at the fact that behind the euro crisis there lies an attack on national sovereignty, as individual nations are brought to their knees to account for their financial misdeeds.  In doing so, these nations are co-opted into accepting increasingly harsh financial terms and conditions passed down by the European Union.  While it's justifiable to say these countries should answer for their financial profligacy, you have to wonder at the opportunism on the part of the EU, given that nearly every country is guilty of this same profligacy to some extent or another.  Nonetheless, as the euro crisis unfolds, expect to see more countries broken economically and subsequently neutered by the EU.

Wondering what might lie ahead in 2012?  Check out this article, which details why the coming financial meltdown will be worse than 2008.  The author does a great job analyzing the European Union debt crisis, in particular.

We’ve all heard the countless cries by our leaders and government officials about “ending poverty,” “waging the war on poverty,” and “eliminating poverty for future generations.”  They claim that if we just give them more of our wealth, more of our earnings, then we can finally, once and for all, put an end to poverty.

Meanwhile, the very system we live under, and which our government preserves and protects at every turn, continues to create poverty for millions of Americans – a system which in turn, supports and funds those leaders telling us to sacrifice more for the good of all.  That system is called the “monetary system.”  

You’re probably not familiar with this term, not only because it’s never mentioned in the mainstream media or in your school textbooks, but also because when you think of our economy you think of capitalism.  This is not surprising since we’ve been conditioned to think we live in a capitalist society.  And to some extent, we do.  But the problem is, by thinking of it that way and describing it by that one word alone, we omit an important aspect of the overall system that governs our economic livelihood.

Now, the term monetary system is quite broad, and so we need to look closer at what that really entails.  In general, a monetary system is any economic system that assigns goods and services a value that is exchangeable through a medium such as paper (fiat) money, gold/silver, or other means.  Capitalism per se does not imply the use of money – rather, it traditionally refers to things like the free market exchange of goods and services and private property rights.  Thus, it is important that we separate capitalism and the monetary system in our minds in order to understand the true nature of the overall system we live under.

The use of money to govern transactions within a capitalist system is not a bad thing in and of itself.  In fact, if the money has intrinsic value (such as gold or silver), this can improve the integrity of the overall economy by ensuring that the monetary value remains stable and intact, versus fluctuating significantly over time.  An example of such fluctuation would be the US dollar (a fiat currency not backed by anything of value), which has lost over 90% of its purchasing power in the last century.  (Indeed, most of this erosion in value occurred after 1971, when the dollar was unhinged from the gold standard.)

The US monetary system, of course, is based on the use of fiat money, which can be created arbitrarily through policy decisions originating from the Federal Reserve System.  In conjunction with this capability, the employment of “fractional reserve banking” provides further flexibility to the monetary system, and encourages the creation of money from, essentially, nothing.  Simply put, fractional reserve banking is when banks only maintain a portion or fraction of customer deposits in reserve, while using the remainder to originate loans and thus create higher amounts of interest income.  The amount of money the bank must retain in reserve is called the “reserve ratio.”  Traditionally, US banks have maintained a reserve ratio of 9 to 1, meaning for every dollar kept on deposit, $9 can be lent out.

The practice of fractional reserve banking is actually detailed in a booklet issued by the Chicago Federal Reserve Bank (one of the 12 regional banks under the purview of the Fed), called Modern Money Mechanics.  While I think it’s worth reading the entire 40 pages of this document, this quote should suffice as a summary:

“The purpose of this booklet is to describe the basic process of money creation in a ‘fractional reserve’ banking system. The approach taken illustrates the changes in bank balance sheets that occur when deposits in banks change as a result of monetary action by the Federal Reserve System - the central bank of the United States….The illustrations in the following two sections describe two processes: first, how bank deposits expand or contract in response to changes in the amount of reserves supplied by the central bank; and second, how those reserves are affected by both Federal Reserve actions and  other factors.”

We can translate this summary to mean one thing: banks create money out of nothing.  By illustration, we can see how fractional reserve banking accomplishes this:

Bank A receives a deposit of $10 million from a customer.  It places $1M in reserve (according to its 10% reserve ratio requirement), and then lends out the other $9M to Bank B, collecting interest payments from Bank B.

Bank B puts $900,000 in reserve (again, 10%), and lends out the other $8.1M to Bank C, collecting interest from Bank C in the process.

Bank C puts $810,000 in reserve, and lends out the remaining $7.2M to Bank D, while collecting interest from Bank D.

…And so on, until approximately $90M (nine times the original $10M) has been created, loaned, and monetized into interest payments for all banks involved in the transaction.  Thus, you can see how $1 of actual “wealth” (I use quotes because even the original fiat money deposit has no intrinsic value) becomes $9 of artificial money.

There are two things that are very pernicious about this.  First is the simple fact that money that never existed in the first place is used to make even more money, through the payment of interest.  Second, and more insidious since it is unseen and intangible, is what I would call the “debt-to-wealth gap” that is created by the monetary system and fractional reserve banking.  Here’s what I mean by this:

There are only so many goods and services that can be produced or performed, and subsequently sold in the marketplace.  In other words, there is a physical, tangible limit to it (however large and unquantifiable it may be to us).  At the same time, the creation of money from nothing is dislocated from this reality, since the money is created artificially and arbitrarily, when compared to the actual value of all the goods and services available in the marketplace.

In other words, there is simply more available debt than available wealth.  The ease with which new and virtually endless amounts of debt/fiat money are created is the reason why there is so much more available debt than wealth.

Again, the catalyst for this is relatively simple to understand -- through our monetary system and the use of fractional reserve banking, debt is generated rapidly and artificially.  Conversely, wealth (for the vast majority of us) can only be generated through the exertion of labor over time.

Think of it this way: in one day’s time, assuming I placed no limits on you from a credit perspective, how much debt could you get into in that one day?  Probably a whole lot.  A house purchase, a trip to the Ferrari dealership, maybe a new yacht – you could easily be millions of dollars in debt in the span of 24 hours.  Now in that same one day’s time, how much wealth could you create?  If I gave you one whole 24 hour span to generate wealth from scratch, how far do you think you’d get?  Probably nowhere, and it would have nothing to do with your aptitude.  Simply put, the creation of wealth would take time, energy, and effort that would far exceed one day’s time.

This surplus of debt compared to available wealth comprises the debt-to-wealth gap.  So what, you might be thinking…what does this have to do with you, or the poverty problem I referred to in the beginning of this article?

Here’s why it is directly relevant to you: you cannot function in our economic system without getting into debt.  It’s virtually impossible.  If you are able to pull it off, it probably means you’re living something unlike the “American dream.”  You certainly don’t have a house, and you probably don’t have a car.  You most likely never went to college.  In other words, all of the trappings of the American lifestyle are unavailable to you – until you take on that debt load.

Once you’ve taken it on, you must generate enough cash flow to service that debt.  In other words, you need a job.  Now of course, we all need cash flow for the necessities of life, but the kind of job, frequency of how often we must perform that job, and length of time we must keep that job changes considerably when we have a mortgage, car loan, student loan and other debt payments to service.  It’s one thing to truly work to pay for the basics (food, rent for shelter, medical care when needed), but another thing entirely to work to cover the trappings of the American lifestyle we’ve been conditioned to believe are “necessary” (nice house, two cars, vacations, yearly wardrobe changes, sundry electronic gadgets, other luxury items, etc.).

In other words, the availability – and more accurately, the necessity – of debt, turns us into indentured servants, who must hold jobs whether we like them or not in order to function economically.  Furthermore, when that imperative is combined with the illusion that we must continue to spend/consume in order to achieve the “American dream,” the average person’s debt load rises considerably.

And what about the poverty issue I mentioned at the beginning of this post?  How does the system create poverty purposefully?  Now that you understand the monetary system and fractional reserve banking, it’s easy to see how.  Let’s look at it through a rudimentary example:  

Say a bank has a home loan portfolio totaling $100 million.  It created these loans off of just 10% of that figure, or $10 million (so there is only $10 million of actual deposits at stake here).  The other $90 million is artificial debt created through fractional reserve banking.  Now let’s say of the $100 million, $15 million worth of loans is spoiled by foreclosures and bankruptcies.  Let’s see where that leaves the bank:

$10 million of initial capital, turns into…
$100 million of loans, with an average of 7% interest a year yielding…
$7 million a year in interest income…
With only $15 million of the total loan portfolio gone bad.

Since the $15 million of bad loans is fake money anyway, the bank doesn’t care, since it never had that money to begin with.  Its loan portfolio is generating $7 million a year, which across a 30 year standard mortgage period yields the bank revenues of over $200 million.  Ultimately, the bank turned $10 million of seed capital into over $200 million…do you think it cares one bit about the $15 million in bad loans (which really translates to foreclosed homeowners, homeless people, etc.) it perpetrated along the way?  Of course not – it’s just the cost of doing business.

The bottom line is, the bank doesn’t care who goes bankrupt or forecloses – the bank simply cares that enough debt is created to generate enough interest income for it to be profitable.  If it overshoots the mark on debt creation, and individuals go bankrupt/lose their home, it matters not – it simply performs a write-down of the loan on its books and moves on.  It was fake money anyway – it never existed in the first place.

The key for the banking/monetary system is to continue creating enough debt to generate enough interest to continue to be profitable and aggregate more wealth.  The collateral damage along the way, in the form of impoverished/bankrupt/homeless individuals, is simply the byproduct – the remainder off of the proverbial mathematical equation – that is tolerated in the overall process.

Using this premise as a backdrop, I would go on to assert that the entire 2007-09 housing collapse was nothing more than the rabid creation of debt in order to fuel more interest payments into the system, with zero regard for how many loans went bad or homeowners were devastated along the way.  Why would this matter, when the banking system knew the government would step in, bail them out and cover the losses?

But put the recent housing market crash aside for a moment.  The real problem is this: the monetary system is on its last legs.  Eventually, there is too much debt created, and no one left to service it.  And when not enough entities can afford to take on debt, then the debt creation begins to grind to a halt.  And when debt creation grinds to a halt, interest payments decrease and profits begin to shrink.  The outstanding debts remain, but there’s less profit to offset it and make the process worthwhile for lenders.

We are seeing this breakdown in the monetary system in the news every day, when we read about bank failures, rising foreclosures and shrinking home sales, states going under financially (i.e., California), entire countries going bankrupt in the EU due to systemic financial failure (i.e., Greece, Ireland, etc.), and the rising ranks of unemployed who’ve been victimized by the system and will never return to the same standard of living they once had.

Once you understand that the system you’re living within places you into servitude, creates poverty knowingly and purposefully, and is impossible to get ahead within, as an individual you begin to realize that your financial and investing priorities must adapt to such realities.  Ultimately, the monetary system needs to change, as it simply does not serve the interest of the vast majority of the people.  When we make such a claim, and it’s a significant one, we need to do so with the full and accurate knowledge of what the system actually is and how it operates, and only then can the proper reforms be put in place.

“Printing money doesn’t deliver a triple-A rating.” -- David Beers, S&P Head of Sovereign Ratings

So the inevitable finally occurred this weekend -- Standard & Poor’s (S&P), one of the the three major credit rating agencies, downgraded the United States’ AAA rating to AA+.  Since the decision was announced, there’s been much wailing and gnashing of teeth at the audacity of S&P for insinuating the US should no longer hold the highest rating possible.  “How dare they” has pretty much been the refrain the last couple of days.

I say, what took them so long?  I mean, let’s face it -- the long term fiscal outlook for the US is awful, simply put.  Consider the following:

-- There’s virtually zero chance the US will ever pay back a single dime on the principal it owes on the national debt.  If I told you I had a couple of credit cards, I max them out all the time, and I never do anything but make the minimum interest payments every month and never pay into the balance, how eager would you be to lend money to me?  Probably not so much.

-- The US has $14 trillion of debt today, but this doesn’t take into account the trillions more coming due at the end of this decade and beyond for all the entitlement programs (Medicare, Medicaid, Social Security).  (I’ve read everything from approximately $50 trillion to over $200 trillion as the total cost of these programs.)  If the Congress and President can barely agree on how to cut $2 trillion (as part of the debt ceiling deal), then what are the chances they can deal with these enormous long term debt obligations?

-- The US economy is headed in the wrong direction, and perhaps permanently so.  The option of growing our way out of the debt problem, by being more productive and increasing the nation’s Gross Domestic Product (GDP), is looking more and more like a pipe dream.  Job growth is stagnant, with nearly one out of every two unemployed persons out of work for six months or more, and the eventual need to raise taxes will stifle job growth even more as businesses retrench.  Since our “productivity” relies heavily on consumer spending, a slowing economy and more limited borrowing ability (as a result of the credit downgrade) will further hamper any rise in GDP.  As GDP remains level and debts rise, our overall debt-to-GDP ratio will soar, a key aspect of the S&P decision.

To back up for a second, it’s important to understand what S&P is actually rating.  The grade they assign indicates the likelihood that the entity issuing the debt will pay back the obligation. At the same time, the rating tells the debt purchaser how much risk it is assuming in the transaction.  So the rating is intended to synopsize the long-term debt outlook for the entity being rated.  As the rating declines, debt purchasers can demand higher yields (interest rates) on the debt in order to compensate for the higher risk associated with the debt issuer, thus making it costlier for the issuer to borrow money.

What does this all mean to us as individuals in the US economy?  Well, as the US government’s borrowing costs rise, banks will raise their interest rates commensurately to keep up with the trend.  When banks raise their rates, this will affect everything from mortgages, to school loans, credit cards, personal loans, car loans and so forth.  You will eventually pay more interest to borrow money compared to today.

The credit downgrade signifies a sad day in our country’s history.  Once a great economic power, we’re now left in a position where our debt instruments are no longer considered the safest available.  We held that status for 94 years (since 1917), and never held a rating below AAA -- until now.   Some will have the urge to blame this development on the President, or his predecessor, or this Congress -- but the bottom line is the problem has been fomented over numerous decades.  Only now are we seeing a symbolic representation of this decay in our fiscal position as a nation.

Unfortunately, it probably won’t stop here.  With our long term debt outlook deteriorating year over year, S&P has indicated more downgrades may be coming.  With our debt-to-GDP ratio  projected to hit 101% ten years from now, such a development would warrant another downgrade, this time to AA status.

The best advice I could give right now is to liquidate as much debt as possible, as quickly as possible (assuming you have any).  While the downgrade’s effects could take years, you won’t be able to time when those effects hit, so you need to be protected well in advance.  In addition, as always, review your portfolios for exposure to assets that would most likely be weakened by the downgrade, such as the US dollar and US Treasury bonds, and hedge or short (bet against) these positions appropriately.  Again, the effects won’t come overnight, so you have to decide when the timing works best for you and your particular situation.

What are your thoughts on the downgrade?  Please leave a comment below or contact me directly.

Back on May 26, I blogged about how the raising of the debt ceiling is a foregone conclusion.  I podcasted on it last week as well.  I'm posting this brief article as simply an update for those of you who weren't as tuned into the debate back then (I don't blame you, this stuff is painful to watch/follow), but now find themselves drawn into the inanity of it all.

Building on the May 26 post, I assert here that Congress never had any serious intention of reforming anything with our national debt or deficit as a result of the debt ceiling situation -- and this is precisely why the ceiling would be raised.  No hard decisions would be induced, no tough medicine for anyone to swallow.  In the absence of that, the outcome is clear: the government as a whole -- Congress and President -- would collectively find a way to delay the inevitable, yet again, and thus make that inevitability that much more painful when it finally arrives.

Don't get me wrong -- there was some tough talk that initially appeared promising.  Talk of a "grand bargain" that would cut $4 trillion of spending over the next several years; proposals that would initiate the difficult yet necessary job of reforming our bloated entitlement programs; and claims of politicians being willing to finally make the tough calls and in turn, receive heat from their respective political party.

And yet now we're told that the fallback plan, presented by Republican Senator Mitch McConnell, which would allow the President to have the ad hoc authority to raise the debt limit autonomously and then allow a symbolic series of votes on it by the Congress in order to record opposition, is gaining steam as time runs out to the August 2 deadline.

Surprise.  The government has failed to act responsibly, again.

But isn't that how the story always ends?  So there are really no surprises here, just more of the same as the country's finances swirl into the depths of the toilet.

To the Congress, I'd like to issue the following challenge going forward: instead of debating who you are going to tax to make up for your mistakes, or debating whose social program you're going to cut to reduce spending (however necessary either of these actions may now be), how about turning the debate towards limiting your own powers to create these messes in the first place?  Here are some points of debate I challenge Congress to take up:

-- Institute term limits on all Representatives and Senators.  Remove the incentive that drives politicians to make a career out of lying and stealing.

-- Make an unbalanced federal budget illegal.  (Perhaps a Constitutional amendment would achieve this, though I'm not sold -- Congress already ignores most of the Constitution anyway.)  Cut off the temptation to rack up deficit after deficit in every budget year.

-- Abolish the Fed.  It's stated objectives are twofold: stable prices and low unemployment.  Grade for each of these: F and F.  Dollar has lost 90+% of purchasing power since the Fed's inception -- I don't call that price stability; and numerous boom/bust cycles fueled by Fed monetary policy have created too-long periods of high unemployment.

I look forward to your comments and questions on the debt ceiling debate.

These guys are good.  Really good.

They know how to steal, and when they do it, they call it something so innocuously confusing, you don't even realize what's actually going on.

I mean, when the Federal Reserve steals your money, they practically have you thanking them for doing it.  I'm serious.

Before I explain to you the most creative and insidious manner in which the Fed steals your money and repurposes it, allow me to back up for a second:  How much did you learn about the Fed in school?  Do you even remember it being mentioned more than once or twice?  Did you even come close to being told how it operates, how it accomplishes its obtusely stated objectives?  Have you ever wondered why you were taught next to nothing about it?

I'm almost 100% sure of the way you'd answer those questions.  You see, not teaching us anything about this institution has helped maintain the disguise placed on its operations.  A great example of this is "quantitative easing," which is a fancy way of saying "creating more money that never existed before."  It's important we pay attention to the language being used here, and not view it as semantics.  We can inadvertently come to believe something that's not true, simply by being told that something over and over again.  The key is to go behind the language and truly understand what it’s referencing.

So when we take time to explore what the Fed is actually doing on a day-to-day basis, we discover the theft that is taking place right before our eyes.  And so I come to the subject of today's post: recently, I've been reading more about another one of the Fed's operations, something called a "central bank liquidity swap," or CBLS as I'll abbreviate it here.

Sounds great, doesn't it?  Sounds official, like something that central banks need to do, right?  I mean, on the surface, nothing suspicious here...

Let's look at what a CBLS really is.  First I'll use an analogy, then describe the operation in actuality.

The Analogy:

Let's say there are two people, person A and person B, and each holds something of value.  Person A holds object X, and person B holds object Y.  Object X is actually owned by someone else (call them person C), who's left it in A's possession to look after.  Thus, person A has no emotional attachment to the object, just a stated intention to look after it.

On the other hand, person A looks favorably upon person B, at least for this moment in time, and wishes to convey favor upon B for whatever reason.  Even knowing that object Y is less valuable than object X, and knowing Y may very well depreciate in value while X appreciates in value, the two objects are exchanged for each other nonetheless.  Now person A holds object Y and person B holds object X, creating an imbalanced exchange in favor of person B.

The terms of the exchange allow person B to do whatever he pleases with X; however, person A must hold onto object Y for a stated period of time.  This is all well and good -- until one day, person B comes to A and states that object X has been lost, and he does not have anything left to exchange in return to make up for the loss.  However, he tells A that he enjoyed using object X while it lasted.  Thus, things shake out as follows:

Person A is happy, because he had no attachment to object X, and was able to fill person B's need at the time.
Person B is happy because he had the opportunity to attain and use something of higher value than what he started with, and once lost, had no emotional attachment to it anyway.
Person C should be pissed...but has no clue that Object X is gone.  In fact, person A has convinced C that all is well, nothing's changed, and Object X is in good hands.

(Person A is the Fed.  Person B is another central bank.  Person C represents you and I.)

In Actuality:

The Fed maintains what are called swap lines with many other central banks, allowing it to execute CBLS's whenever it needs to.  Many of these swap lines were emplaced in 2007, shortly before the 2008 financial crisis went into full bloom.

A swap line works like this (I'll use the euro as the example currency here):

Assume the Fed is executing a CBLS on August 1.  On that day, the European Central Bank (ECB) sells euros to the Fed at the prevailing USD-EUR exchange rate, after which the Fed deposits the appropriate amount of dollars into the ECB’s account at the Federal Reserve Bank of New York.  Commensurately, the ECB deposits the appropriate amount of euros into the Fed's account with the ECB.  In essence, the two central banks have swapped currencies.

The Fed cannot do anything with the euros it receives; it simply holds them until a certain maturity date, say September 1.  On the other hand, the ECB is allowed to use the dollars it received however it sees fit: loan them to European member banks, or possibly to EU governments whose finances aren't in very good order (i.e., Greece).  On September 1, the Fed receives dollars at the same exchange rate that prevailed on August 1 (not the exchange rate of the date the funds are returned), and conversely, the ECB receives euros.  In addition, the ECB pays a market-based interest payment to the Fed.

See anything wrong with this picture?

1) The Fed is accepting a currency it can't do anything with, so the asset is effectively frozen.  Meanwhile, the other central bank (the ECB in my example) is able to freely invest, loan and otherwise utilize the dollars it receives.

2) What if the dollar strengthens during the wait period of the swap?  The Fed would not benefit from that strengthening since the original exchange rate is in play, not the exchange rate on the date of funds returned.  You might say to that, "well can't the opposite happen, and the dollar weakens during the wait period, which would benefit us in the exchange?"  To that I'd say yes, but...the problem is the Fed is taking the risk of lost appreciation on the dollar, but they are not consulting with any elected official (and certainly not with you and I) as to whether our funds should be risked in this fashion.

3) What if the other central bank can't return the dollars to complete the exchange?  To continue my example from above, what if the ECB loans the money to an EU country such as Greece; Greece uses the money to shore up its balance sheet, but then falters and fails to repay the ECB loan; Greece's default roils the markets and EU banking sector, creating another financial crisis a la 2008; subsequently, the EU defaults on the currency exchange with the Fed.  Effectively then, taxpayer money was siphoned off to Europe, with no return of those funds at the end of the swap agreement.  While such a scenario is unlikely due to the apparent robustness of the ECB/EU, I would not say it's impossible (look at the 2008 crisis for a fractal representation of what is possible), and of course not all swap agreements are made with central banks as viable as the ECB.

I guess if I had to boil this down even further, I'd say that the Fed can take our money, give it to another country, never get it back, and then never tell us about it.

It's called a "central bank liquidity swap."  Sounds harmless enough to me...

Nothing more, nothing less.  The ongoing debate in Congress about whether the debt ceiling should be raised or left at the present level of $14.3 trillion or so is in and of itself a waste of taxpayer money.  We all know the outcome, but for some reason we have to go through the motions of acting like our elected officials are going to actually do something about this problem.  The reality is, the debate will go on for as long as it possibly can (about another 10 weeks or so until the limit is breached), and then the ceiling will be raised.

(The debt ceiling, or limit, is established in law, and is the cap that the government puts on its borrowing level.  The limit currently stands at $14.3 trillion.  To date, standard procedure for Congress when reaching the debt ceiling is simply to raise it.  It’s like the limit on your credit card, only every time you reach it you just call your bank and they raise it some more, so you can keep on borrowing and spending.)

I’m saying it here, now, on May 26 on my blog -- there is a 100% chance the debt ceiling will be raised.  I don’t need to watch any news clips, review and analysis of Congress’ machinations, or anything of the sort.  It’s a done deal already, before we even arrive at the ceiling.

Why?  Because our country is addicted to debt/consumption/borrowing/spending.  We’re not going to stop spending.  The public demands it.  Congress needs it for reelection.  Our economy thrives off of it.  It will go on, until it can’t go on anymore.

One great piece of evidence of this fact is the recent discussion on the Paul Ryan (Republican representative from Wisconsin) budget plan, which included the controversial proposal of turning Medicare into a voucher program for individuals under age 55.  Generally speaking, this means that instead of the government picking up the tab for your medical bills, you’d be given a lump sum subsidy to allocate towards insurance coverage of your choosing.  My understanding is that if the subsidy didn’t cover the bill, you’d be left to pay the difference.  Of course, the phase-in for the under 55 crowd would theoretically allow for those individuals to make other arrangements to augment their Medicare subsidy, while those over 55 would still be covered under the old program as they’d have less (or no) time to adjust to the new program.

Say what you will about the Ryan proposal -- I don’t know it inside and out, and even then I can say that I’m sure it’s far from perfect.  But if it’s nothing else, it attempts to do what no other plan seems to be willing to do, and that is to make the hard choices necessary to change a program that simply can’t exist in its current form.  Medicare has to change -- the question is, do we change now and suffer the pain, or change later and incur even more misery as the problem morphs into a crisis.  (I say “change” and not “fix” because we can’t say whether the Ryan plan would actually fix the program. Unintended consequences of his plan could simply leave us with a new set of dilemmas to face, which is often the case whenever the government gets involved in anything.)

This week, the Senate voted on the Ryan plan and defeated it.

So we needn’t look any further than the Ryan plan to understand the spending addiction is too great, too deep-seated to be undone now.  As an individual investor, you should be planning for scenarios that include continued high levels of government borrowing and spending into the foreseeable future.  Commensurate with that, your planning would then include rising interest rates, a weakening dollar, rising commodity prices, and even eventual replacement of the dollar as the world’s reserve currency.

The one thing you don’t need to waste your time with is following the debt ceiling debate.  It’s theater, pure and simple.  Republicans, who appear to be holding fast to the notion that they’ll vote against a raise in the debt limit unless significant spending cuts are instituted, will ultimately bow to the political pressure associated with being responsible for cutting off the gravy train of spending and consumption.  Democrats will allege that Republicans want to cut off funding for critical social programs (such as Social Security and Medicare), and that’ll do the trick to derail any serious discussion on spending cuts and the debt ceiling.  

Mark your calendar for early August -- that’s when the debt ceiling will be raised.

Earlier this week, the Standard & Poor’s (S&P) credit rating agency issued a downgrade on the United States’ debt outlook.  The US debt rating, which had stood at AAA stable, was modified to AAA negative.  We’ll look at what that means specifically in a moment, but conceptually it means one thing: the downward slide economically continues unabated for the US, and hard times lay ahead.

The implications of the rating change are worth noting, but first some background is in order. The big credit rating agencies, like the S&P, have a scale which implies the level of creditworthiness for the particular item being rated.  Ratings could apply to a variety of things, from countries, to public and private corporations.  For the S&P, the ratings range from AAA (the highest rating possible) to D (the worst possible).  Along with those letter-based ratings, a qualifier can be attached to the rating, such as positive (an upgraded rating is likely), negative (a downgrade is likely), or neutral (a change in rating is uncertain).

When the S&P noted that US debt is now AAA negative, what it was actually saying is that within the next couple of years there is a reasonable likelihood (about a one-in-three chance) that the US credit rating will be downgraded from AAA to AA. 

The fact that it has come to this is sad.

Once the greatest economic power on the planet, we have now effectively had our credit score lowered due to the untenable financial situation we now find ourselves in.  If we are indeed downgraded to AA, our costs for borrowing money (interest rates) will rise in all categories.  Home loans, credit card interest rates, school loans, personal loans -- all of these modes of borrowing will become more costly to the borrower.

Why does this happen?  It happens because with a downgrade in credit rating comes a reduction in confidence by our lenders (namely, other countries) that we will be capable of making good on our interest and principal repayments.  Thus, they will charge us more for the money they lend us.  It is the price we must pay for showing the world we cannot effectively manage our own finances.

Think of it in terms of how individuals are dealt with when it comes to credit.  Person A has a very high credit score and displays a stable and healthy financial situation to his credit card company -- when he applies for a credit card, he receives a rate of say 8%.  Person B has a lower credit score and displays a less stable financial outlook -- when he applies for a credit card, he receives a rate of 12%.  Simply put, the credit card company is saying that they have more confidence Person A will repay his balance than Person B. 

One of the reasons cited for the S&P downgrade was the fact that it did not believe a political resolution to the US debt and deficit problems was achievable in the near term.  I agree wholeheartedly with this assertion.  The government had been squabbling over its 2011 budget several months past the point where it should have already had a budget in place, and the numbers they argued about ranged from the $30 to 100 billion mark.  

Problem is, the fiscal challenge that really matters, the one that S&P believes is outside the ability of our government to address, is in the $50 to 75 trillion range.  How can we have faith that the government will solve a $50 trillion problem when it can’t agree on a $100 billion problem?

We can’t.  There is no evidence that the political representation we have in place, on all sides of the aisles, in all political parties, has the collective will to come back to the American people and say:  “We promised you too much.  We can’t afford it.  We are reneging on our promises.”

Which party will step forward first and take away your Social Security?

Which party will step forward first and tell you that you no longer will receive Medicare?

So I believe that the S&P understands this dilemma that’s facing our government, and is reacting accordingly.  I strongly believe that within the next few years we will see a full downgrade to a AA rating, and perhaps even lower as the situation worsens.  

I think the main thing you can do for yourself, for you and your family’s finances, is to examine how much those finances are tied to the cost of borrowing.  In other words, what debts do you have and how quickly can you liquidate them to reduce your exposure to the worsening credit posture of the country you live in.   Obviously, the less you are reliant on credit, the better off you’ll be.  Of course, the problem here is that as our costs of living rise, and wage growth falls behind that curve, it will be necessary for more and more people to rely on credit in order to stay afloat.  It is this squeeze that will become the biggest concern for individuals and families over the next decade. 

I’m pulling for the rebels in Libya.  I mean, who wouldn’t?  Moammar Qadhafi just seems like the kind of guy who’s easy to despise.  Anyone ruling a country for 30+ years is bound to have built up some ill will, and sometimes you just need a change.

One lesson potential rebels in other countries might want to learn from this whole Libya affair is that you need to take control of an oil field or two.  Once you do that, and the flow of oil starts to come into question, well now you’ve got the whole world’s attention.  Including gas-guzzling Americans who have no desire to pay $4 or $5 a gallon.

So, on cue, the US has intervened in the crisis along with a UN coalition of forces, ostensibly to save Libyan lives.  With that as our motivation, we may have another ten or so revolutions we need to intervene in right now, but I digress...interestingly, our intervention in Libya is well-timed with the spike in gas prices...but I digress again.

The real point of this article is that we cannot afford to get involved in another war, no matter how short it is.  Unfortunately, this one won’t be short, no matter what we’ve been told.  I’m reading reports that NATO and UN forces aren’t even clear on what the goal is (sound familiar?  Vietnam?  Afghanistan?  Pretty much any war in the last 50 years?).  

The problem is, we’re broke, as any country that produces $14 trillion in GDP but owes $75 trillion over the next decade would be, and headed for bankruptcy as a nation.  Getting involved in more military operations was the last thing we needed.  We’re in denial -- we think we can keep putting these tabs on the national credit card without consequence.

I know that there are people who will say we had to do something to help the rebels before they fell to Qadhafi, and I admit that a part of me is happy to see him stopped before killing anymore of his own people.  But these kinds of thoughts are of the visceral nature and they fail to take into account the larger picture and predicament we find ourselves in economically as a country.  Consider the following metrics provided by the Washington Post:

-- Tomahawk cruise missiles cost about $1-1.5 million apiece.  We’ve already fired 161 of them.  Cost = $161 million.

-- B-2 stealth bombers cost $10,000 per flying hour.  We’ve already flown 25 hours of sorties.  Cost = $250,000 + fuel costs + combat pay for pilots.  (I’m sure we’ll fly a few more sorties before this is all over.)

-- The Center for Strategic and Budgetary Assessments released an estimate that the Libyan no-fly zone could cost $100 million to $300 million per week.

-- The combination of navy ships and US warplanes deployed to Libya cost in the neighborhood of $75 million to operate.

Whether you think these numbers are large or small, and whether you think intervention is justified or not, the bottom line remains the same -- we continue to spend money we do not have, borrowing it from future generations and leaving them with the bill plus interest.

Bipartisan statements rejecting the decision to involve the US in Libya have been issued ever since, but I continue to be amazed at the amount of rhetoric decrying our spending levels while the spending continues to rise.  How is it that so many lawmakers can come out against spending, yet continue to spend?

Furthermore, at $100 to 300 million a week, how long will this drag on?  How many weeks will we remain in Libya?  What’s the goal?  Save the rebels?  Remove Qadhafi?  Change the regime to a democracy-loving republic?  Sound familiar?  We’ve already tacked on trillions to our national debt with the wars in Iraq and Afghanistan, and now we’ve added a third potential quagmire to the list.  

Who is our obligation to first? Future generations of Americans, or Libyan rebels?  Why do the Libyan rebels come before our children and grandchildren?  Why are they being made to fund the Libyan revolution, when they don’t even have a say in it?    

I’ll end with a prediction: one year from the date of this post, the US will still be expending funds on the Libyan situation, whether that be due to military operations, aid to rebels, or whatever.  The cost will extend well beyond what we’ve been told, and the staggering sum we’re left with will be paid by you and I, our children and grandchildren.