The Black Swan in the Perfect Storm

The Black Swan is Arithmetic. She is coming and she is already here. In Detroit, you see her in the debris of a once great American city.

The Perfect Storm is the confluence of events that will wreak economic havoc on America. It need not have anything to do with the current debt ceiling controversy. Most don't see it coming. For them, it will bring shock and awe.

Nassim Nicholas Teleb is credited with developing the metaphor -- based on the sudden discovery that all swans are not white -- of the black swan, to refer to widely unexpected events that come as a surprise to most, and change everything.

Below are several of the Perfect Storm fronts, samples of how an increasingly desperate regime is likely to respond as the storm builds, and a brief glimpse into the coming storm damage to America.

The Converging Fronts of the Perfect Storm

Quantitative Easing (QE) will continue. This artificial economic stimulation may go on through the 2014 elections, particularly if Vice Chair of the Board of Governors of the Federal Reserve, Janet Yellen, succeeds Ben Bernanke. In a November 2011 speech, Yellen described the difficulties of disconnecting QE from an economy experiencing a recovery "that has been less vigorous than desired or expected." Her solution: "I believe it is crucial for emerging market economies, particularly in Asia, to take further steps to boost domestic demand, providing support for their own growth and that of the global economy." Translation: The solution to America's economic problem is a change in the Asians' consumption habits.  

As interest rates rise from near zero and USD (U.S. dollar) devaluation continues, inflation will increase, as will the cost of servicing the federal debt. Imagine all your credit cards are maxed out, and you struggle to just make the minimum interest payments. Then, you get a notice from the banks stating that their interest rates are going up three percent. Or, five. Maybe seven.  You look at your household budget for what can be cut. Seeing all the cuts are painful, you photocopy money. You go to jail - unless you're the Fed.

One or more of the Big Three credit rating agencies (Moody's, Standard & Poor's, and Fitch Ratings) drop their rating on U.S. securities, again, and then again. Meanwhile, the USD continues to lose value. This slows the already declining international demand for U.S. securities, and pushes up the interest rates required to make their purchase more appealing to customers. Increased interest rates make debt service more costly. It's a cascade to the drain.

In a trend already underway in some country-to-country commercial exchanges, the USD moves closer toward the end of its role as the world's reserve currency. Over time, a new standard will develop -- a basket of major and emerging-market currencies, plus the IMF's Special Drawing Rights (SDRs), and perhaps gold, too. Central banks across the globe holding piles of USDs begin to flush them out of their systems. The value of the USD declines further with the flushing.

The U.S. eventually faces the approach of sovereign debt default. David Stockman argues that there will always be enough federal tax revenue to service the debt; hence, sovereign debt default will "never happen".  A very smart man -- he's probably right, but then "never" is a very long time.

The debt service cost -- just paying the interest on the government's credit cards -- for the first 11 months of FY 2013 was $395,845,239,236.39. That excludes a "change in the accounting method for the Department of Defense (DOD) market-based securities, a one-time adjustment of $75 billion decreased the Interest Expense on the Public Debt for the month of July."

The literal point of default doesn't have to be reached to have a major negative impact on the economy. If you're driving with the red light on your fuel gauge indicating you're low on gas, you slow down. Same for the economy.

Federal Storm Preparation

As the perfect storm approaches, the regime will address it the only way it knows how -- as a revenue, rather than a spending, problem.

And, as the regime becomes more desperate, unwilling to make cuts to anything other than the military, it will look for opportunities to increase revenue, all the while being indifferent to, or ignorant of the negative economic impact of taking more money out of the private sector and transferring it to the government.  Like throwing gas on a fire to put it out, it has the opposite effect.

Here are prototypical examples, not literal predictions, of an increasingly desperate regime:

  • One-time tax on all IRA account balances as though they are current income, without deleting future taxes on gains from the remaining balance, but removing tax credits for subsequent losses;
  • Reduce the face value on all short-term (2-3 years) Treasuries if redeemed at maturation, plus subtract interest gained from the pay-out, unless, that is, the holder renews their T-bill at the same rate of interest as at the last renewal, or purchase, whichever is lowest;
  • Forgive student loans to placate young voters disaffected by the unexpected - to them -high cost of their health insurance under the ACA;
  • Offer federally-subsidized, reduced-interest loans for first-time "poor" home buyers;
  • Remove tax-exemption on debt incurred by major municipalities (over 500,000 residents);
  • Remove interest deductions on all mortgages over $300,000;
  • Require 401Ks, IRAs and Pension Funds to have a certain portfolio percentage in Treasuries;
  • Accelerate the schedule of required minimum withdrawals from IRAs to kill the stretch IRA concept and boost tax revenues;
  • Install a national federal sales tax at 1% on all goods and services (soon rising to 2%, and then up);
  • Remove the tax-exempt status of all non-profit organizations, including churches and charities;
  • Collect a yearly tax on the endowments of religious and educational institutions (For example, Harvard University received $650 million from the federal government during their last fiscal year. At the end of 2012, Harvard's endowment was $30,745,534,000 - #1 among universities. It's time to tax Harvard. It's only fair.);
  • Eliminate deductions for state income tax payments;
  • Install a yearly tax on vehicles based on miles driven (a 2011 CBO suggestion);
  • Install a minimum tax rate of 50% on all former members of Congress for five years after leaving federal service and joining think, lobbying firms, and PACs.

The Coming Storm Damage

Accurately predicting the Perfect Storm damage is impossible, but the convective outlook for the U.S. economy is high risk.

Minimally, it includes: a significantly reduced standard of living for all but the most wealthy whose income is not dependent on government expenditures; increased and sustained urban lawlessness; dramatic reductions in defense spending; significant decreases in wealth transfer payments (fewer welfare programs and smaller checks); higher U3 and U6 unemployment numbers as cooking-the-government's-labor-books become more transparent and the American economy goes part-time.  

In the meantime, the gunge -- defined as any atmospheric obstruction that limits visibility for storm-spotting -- is thick in the old media, with its fog of updates on the government shutdown. The constant drizzle of dueling talking heads in the debt-ceiling debate. The low hanging cloud over the huge, new, welfare program that comes at the worst possible time - not that there's a good time for Obamacare.  

It's all gunge, and the media is full of it.

But it doesn't matter to the Black Swan. She is Arithmetic. Impassionate, indifferent, apolitical stone-hearted Arithmetic. She is here; she is coming.

And all the King's horses, and all the King's men, can't make one plus two, add up to ten.

[Hat tip: Steve Bartin]