Paying the Piper

by Michael Lombardi, CFP, MBA

Here are three important concerns about the economy I want to share with my readers this morning:

For the fiscal year that will end this September 30, 2009, the U.S. budget deficit will reach $1.8 billion. (I remember when the Bush Administration reached its first $500-billion annual deficit and I thought that was a lot). Government debt is increasing so rapidly that the U.S. Treasury has asked Congress to increase the government statutory debt limit past the current $12.1-trillion maximum.

Interest rates rise and decline in long-term trends. Since the early 1980s, interest rates have fallen. In fact, we have just come off a 27-year cycle of declining interest rates. There is only one way for interest rates to go, and that is up. While most analysts expect the Fed to keep interest rates down right into 2010, it is a safe assumption that any spike in the inflation rate will send interest rates higher.


The U.S. is very dependent on foreign countries buying our bonds, the proceeds of which are used to finance our deficit. With our total debt increasing so rapidly, how long will it take before foreigners start having real concern over our bonds? More specifically, at some point, foreigners may demand higher interest rates on our bonds as an incentive to keep buying them.

Have you ever heard the saying “paying the piper?” In this case, it means that there is a severe price we will have to eventually pay for this massive monetary stimulus program. Every action in the economy has an eventual reaction. The risks to the U.S. are very clear: too much debt; the viability of the U.S. dollar as a world reserve currency; and higher interest rates.

These are real concerns all my readers should know about and be prepared for. Unless the gas peddle is soon eased on the monetary stimulus, we could be headed for another economic crash.

Michael’s Personal Notes:

In a commentary in “The New York Times” yesterday, Warren Buffett had words of caution for the Administration. Buffett warns that the mass of monetary stimulus pumped into the economy to save it could have severe side effects. This is exactly what I have been writing about in PROFIT CONFIDENTIAL over the past few weeks. I’ve never seen a monetary action not have side effects. After months and months of reduced interest rates, an expanding money supply, and increasing debt, all these monetary incentives will have a widespread effect on the economy if they are not reined in soon. We could be going from one financial crisis to another.

Where the Market Stands:

The Dow Jones Industrial Average sits five percent higher than it did when it started the year and 43% higher than its March 9, 2009, low. Yes, from the depths of the March bear market low, the Dow Jones has regained 43% of its losses. While most retail investors have missed the boat on this rally, we have seen many stocks double in price.

But the stock market these days is confusing the heck out of short-term analysts and day traders. Monday, the market fell sharply when Companies, Inc. (NYSE/LOW) missed earnings expectation. On Tuesday, the market rallied when The Home Depot, Inc. (NYSE/HD) reported better-than-expected earnings. And this morning, futures are pointing to a weak day, as news spreads that China’s Shanghai Composite Index has entered a bear market.

I tend to see the news as an excuse as to why something has happened — not the reason something is going to happen. The bottom-line question: Is the bear market rally over? My answer is no. We still have a very good chance of the Dow Jones breaking through the psychologically important 10,000 level.

What He Said:

“I see the coming recession as being deep and difficult, because U.S. consumers do not have the savings to spend their way out of the recession. The same thing happened in Japan. The Japan example proved that, when consumer confidence is shattered, even zero percent interest won’t spur consumer spending. The same thing could happen here.” Michael Lombardi in PROFIT CONFIDENTIAL, August 23, 2006. Michael started talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.