Is the U.S. Becoming a Banana Republic?

by The Curmudgeon


"This is the United States of America; weíre not some banana republic. This is not a deadbeat nation. We donít run out on our tab. We're the world's bedrock investment, the entire world looks to us to make sure the world economy is stable. We canít just not pay our bills." President Barack Obama said last month. You can watch a video of Obama's statement here.

 

What's a banana republic anyway? Wikipedia's definition seems to be the most contemporary use of the term:"A political science term for a politically unstable country whose economy is largely dependent on the export of a single limited-resource product, such as bananas. It typically has stratified social classes, including a large, impoverished working class and a ruling plutocracy that comprises the elites of business, politics, and the military. This politico-economic oligarchy controls the primary-sector productions and thereby exploits the country's economy."

 

A National Review article had this to day about the U.S. drifting toward becoming a banana republic (contrary to Obama's statement above):

"When youíre the guys who print the global currency, you can run up debts undreamt of by your average generalissimo. Raising the debt ceiling (many times) suggests that spending more than it takes in is now a permanent feature of American government. And no one has plans to do anything about it. Which is certainly banana republic-esque."

"As the old saying goes, bank robbers rob banks because thatís where the money is. But the smart guys rob taxpayers because thatís where the big money is. According to the Census Bureauís latest "American Community Survey," between 2000 and 2012 the nationís median household income dropped 6.6 percent. Yet in the District of Columbia median household income rose 23.3 percent. According to a 2010 survey, seven of the nationís ten wealthiest counties are in the Washington commuter belt."

"But Washington does nothing but government, and it gets richer even as Americans get poorer. Thatís very banana republic, too: Proximity to state power is now the best way to make money. Today, the ambitious man finds a big money-no-object bureaucracy that likes to splash the cash around and there builds his lobbying group or consultancy or social media optimization strategy group."

In January 2013, The Atlantic published an article titled: Is the U.S. on the Verge of Becoming a Banana Republic? Here's an intriguing quote from that piece:

 

"So really, it's pretty unfair to suggest that failure to raise the debt ceiling would make the United States a banana republic. Most banana republics have their affairs in much better order than that."

 

Does that imply that the economic affairs of the U.S. are WORSE than that of a banana republic? The comments below the article express very interesting reader point of views that transcend Congressional battles over raising the debt ceiling.

 

In an e-mail to clients, Jonathan Lewis, chief investment officer at Samson Capital Advisors listed the Top 5 Ways to Know if a Country Might Be a Banana Republic:

1. There is a flight from your T-bill market because the government might not be able to pay its debt.

2. Corporate debt looks more attractive than debt issued by the government.

3. The government canít release data on the economy because the government workers who collect and distribute the data have been furloughed.

4. The leaders of the country have lost the ability to compromise and discuss important policy matters in an open, fact-based manner.

5. Important futures exchanges begin to aggressively haircut your government debt when it is used as collateral for futures contracts.

 

Victor Sperandeo ("the man for all markets") compares the U.S. to Hong Kong in this essay:

"In 1903, the total U.S. government spending (federal, state, and local) was 3% of GDP. It recently got to over 44% and has declined to about 41% - still incredibly high. Up until 1913 income taxes did not exist. The maximum personal income tax rate has changed dramatically (up and down) since then. Currently, the top individual income tax rate is the top rate is 39.6 % + a Medicare tax of 2.35% or 3.8% for the self-employed."

"For comparison, Hong Kong government spending is only 9% of GDP (Source: World Bank) and the maximum income tax rate is 15% - with a 0% capital gains tax (Source: Inland Revenue Dept-GovHK). In addition, business registration fees for 2013-14 are waived."

Notes:

1.There's also the dreaded and draconian Alternative Minimum Tax (AMT) in the U.S. that hits ever more Americans - in lower tax brackets -who have to pay a much higher tax rate, as many deductions on 1040 Schedule A (e.g. state taxes and miscellaneous expenses) are disallowed under AMT.

2.Other countries are taxed higher (and some lower) than the U.S., as you can see from this table.

Sperandeo continues, "My view is that U.S federal spending should be reduced to 15% of GDP with HK equivalent taxes, much less government regulation and a return to the constitution law.I'm afraid it is only a dream as it likely will never happen."

Commenting on whether or not the U.S. is a banana republic, Victor wrote:

"I cannot agree that the US is a banana republic today or even close to it.True, the U.S. primarily exports one dominant product - "paper fiat money."But in truth, the U.S. is headed for a monetary crash, which will truly wreak havoc on the global economy. That will result in hyperinflation, in my view.But right now, the U.S. is a former great free country that is going from the Welfare State to Socialism."

The Mother of All Conundrums?

The CURMUDGEON is very confused about how a country with such a dysfunctional government (with never ending rancor, acrimony and hostility in our nation's capital) and a relatively weak economy can still have: 1.) a stable currency and 2.) an incredibly strong stock market.

1.Well known economist Henry Kaufman said this week, ďThe U.S. dollar is the key reserve currency, and there is no immediate alternative to it. Not the yen, not the euro, not the Chinese currency.Ē

Floyd Norris pointed out in his Saturday's NY Times column:

 

"The U.S. borrows in its own currency, and it borrows at extremely low interest rates. It also borrows under its own laws, an often overlooked advantage. Such a situation makes default ó or at least involuntary default ó impossible because the government can print dollars if need be. The value of the dollars it repays may be less than the value of the dollars it borrows, but that is a risk the lenders accept."

But if threats of debt default become acceptable in pursuit of partisan political advantage, then Norris believes "the unique position of the United States could erode or even vanish."

2.Norris' Saturday column was even more of an eye opener!Norris notes that near the end of 2010 (when QE went into effect), the United States began to do better than most markets, and that advantage accelerated in the summer of 2011 and then again (after QE infinity was announced) in Sept. 2012.This past Wednesday, exactly six years after the peak, only two of the 15 largest stock markets in the world were higher than they had been at the 2007 peak: Switzerland and the U.S. Over all, the index for stocks outside the United States was 22% lower than it had been on Oct. 9, 2007, while the U.S. was up 7% from its pre-crash all-time high.This can be seen in the chart at this link:

 

Closing Comment:

The CURMUDGEON leaves it to readers to form their own opinion about whether the U.S. is becoming a banana republic, based on the comments and checklist noted above.

We invite readers to email an explanation of why -with all the negatives in the economy and government- the U.S. stock market has outperformed almost all others since Oct 2007.Could the market's strength and resiliency be due entirely to the Fed's ultra-easy monetary policies?Could the U.S. equity market be manipulated -by big players buying stock index futures and high volume ETFs?

Comments are also invited on whether the U.S. $ will continue to be the world's reserve currency- even with its exponentially increasing debt, with seemingly endless budget and debt ceiling battles.

 

Till next time.....................

 

The Curmudgeon
 ajwdct@sbumail.com

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.