'Tis Only My Opinion!

The election of a U.S. President in 2008 will have an effect on the investment climate for 2008 and beyond depending upon investor’s perception of fiscal, tax, domestic and foreign policy issues.

In looking at the investment climate for 2008, there are several areas of concern including:

At the end of 2007, the world economy despite the problems arising from the financial system strains continues to move forward with world GDP rising to $39.1 trillion in 2007. The growth of world GDP in the last decade is shown in the following chart.

Growth rates in the so-called BRIC (Brazil, Russia, India and China) developing countries remain at relatively high levels versus the G-7 developed countries.

Clearly, the U.S. still dominates world GDP with the next four countries combined only equaling U.S. GDP in 2006. China has been widely believed to have the fastest growing

GDP of the top 5 countries. However, a recent study concludes that the economy of both China and India may in fact be 40% smaller than the World Bank and IMF data suggests.

Gross domestic product based upon market exchange rates for selected countries in 2006 according to the World Bank is shown in the following chart.

Since 2000, the growth of GDP in the U.S has been relatively stable as shown in the following chart as prepared by the Ministry of Truth.

A major component for the U.S. growth during this period is the increase in productivity that continues to occur. A 2004 study by the New York Federal Reserve Bank stated:

U.S. productivity growth has accelerated in recent years, despite a series of negative economic shocks. An analysis of the sources of this growth over the 1995-2003 period suggests that the production and use of information technology account for a large share of the gains. The authors project that during the next decade, private sector productivity growth will continue at a rate of 2.6 percent per year, a significant increase from their 2002 projection of 2.2 percent growth.
(NY Federal Reserve, December 2004 Volume 10, Number 13)

Since 2000, the growth in productivity in the U.S. has never been negative in any quarter.

On average, the growth in productivity has exceeded 2.5% since 2000.

Alan Greenspan often used the gains in productivity as reasons for various Federal Reserve decisions. However, there is reason to suspect that the GDP data provided by the Ministry of Truth is less than accurate. The use of hedonic and seasonal adjustments has historically inflated the data. John Williams’ Shadow Government Statistics (SGS) (http://www.shadowstats.com) is perhaps the best source to see what is actually happening to various statistics reported by the Ministry of Truth. According to SGS,

“Upward growth biases built into GDP modeling since the early 1980s, however, have  rendered this important series nearly worthless as an indicator of economic activity.”

In 1991, the U.S. switched its primary reporting from the Gross National Product (GNP) to GDP. SGS states that “The related Gross National Product (GNP) is the broadest U.S. economic measure and includes the GDP plus the balance of international flows of interest and dividend payments. For net debtor nations such as Guinea-Bissau and the United States, GDP usually will show the stronger growth than GNP, since the outflow of interest payments does not get charged against economic activity. … Put in perspective as of the "final" estimate of second-quarter 2004, annualized real GDP growth was 3.3%, down from 4.5% in the first quarter, while GNP growth for the same period was 1.9%,down from 3.9%.”

One of the more significant changes to GDP inflation was made in 1996, when the deflator was shifted from fixed-weighted to a chain-weighted basis. The lower the inflation rate that is used to deflate the GDP, the higher will be the resulting inflation-adjusted growth. Again according to SGS,

“One of the deflation stars is the computer. While computer prices have come down over time, the quadrupling and re-quadrupling of memories provided with a standard computer have, through hedonics and quality adjustments (see Installment III on the CPI), enhanced the decline in prices used in deflating computer consumption in the GDP. According BEA deflators, $1,000 computers bought in 1990, 1995 and 2000 would cost $48.63, $95.84 and $526.58, respectively, today.”

The hedonic adjustments account for some of the most interesting changes. As the speed of computer chips increased while prices of computer chips were decreasing, the BEA actually increased the GDP component for computers such that the total sales of the computer industry were only about 65% of the value shown in the GDP calculations.

The GDP numbers prepared by SGS present a different picture of the strength of the U.S. economy than those prepared by the Ministry of Truth. Whereas the Conference Board’s Index of Leading Indicators and the Economic Cycle Research Institute (ECRI) are just now suggesting that a recession is coming, the SGS numbers tell us that we have been in a recessionary environment for some time.

Many countries in the developed world, and particularly, Japan, the Russian Federation and the European Common Market countries have birth rates which do not provide for increasing population growth without immigration.

The fertility rate has a high correlation to the GDP per capita of a country as shown in the following chart. A higher GDP per capita equates to a lower fertility rate.

Population is a function of the fertility rate and the death rate. Malnutrition and lack of health care along with war can affect a country’s population growth. The following chart shows the top ten countries with the highest death rates.

Only one of the top 10 is located outside of Africa. Of the G-8 countries, only the U.S., the Russian Federation and Japan rank among the top ten counties with the highest population as shown in the following chart.

Unless carefully regulated, immigration both legal and illegal from undeveloped countries with different ethnic and religious cultures will dramatically change the political situation in many developed countries, particularly, in the European Common Market.

With globalization, corporations have found it profitable to move jobs to lower cost countries. Manufacturing jobs which were highly unionized in the U.S. over the years became for hourly workers high-paying jobs for relatively low-skilled workers. Manufacturing jobs peaked in 1980. Since then, manufacturing jobs gradually declined until 2000 when the downward trend accelerated. The following data is through 2006.

Goods producing Jobs, NSA 1950-2007

While many have been concerned about the decline in manufacturing jobs, the decline in the Goodsproducing category has not been as great. This category includes not only manufacturing  but also natural resources and mining and construction sectors. Again the chart shows a peak in 1980 and a second peak in 2000 before a more gradual decline began. It  should be interesting to see what the slow-down in home construction does to the data in the next two years. As the two charts clearly show, however, U.S. jobs in the goods-producing (e.g., Adam Smith’s definition of wealth production) is clearly waning from foreign competition.

For the first nine months of 2007, the following table shows the relative value of U.S. exports.

As globalization and NAFTA were implemented during the last part of the 20th century, the U.S. economy increased its dependence upon the service sector. In 1950, the service sector  had about 25 million jobs. Since then, service sector growth has followed almost a straight upward-trending line. Employment growth in the service sector can be seen in the following chart.

Service Sector Employment, NSA 1950-2007

Jobs in the government sector are not classified as service sector employment. The government sector continues to take a larger share of GDP to finance the ever-increasing government  spending programs.

The following chart shows the relationship of government spending and taxation in relation to GDP. Recent data has increased the numbers slightly.

As the size of government at all levels has expanded, the growth of government jobs has followed as shown in the following chart.

Federal, State and Local Government Jobs, NSA 1950-2007

Although the number of government employees continues to increase, the percentage of government employees of total U.S. Employment has fell in the period from 1992 to 2000. In 1992, the percentage of government employees was 14.7%. By 2000, the percentage had fallen to 12.8% of the workforce. If those working in education are excluded, the percentage fell from 9.2% in 1992 to 7.4% in 2000.

According to the Household Survey published in November 2007, non-farm employment was 137.684 million. Of these, 22.233 million, or 16.1% were government workers. During the last seven years, government employment as a percentage of the total workforce has reversed the decline that began in 1992.

A basic fact that is often overlooked by most investors is that a country builds up its wealth, or foreign reserves, by exporting more goods and services than it imports. A positive trade  balance helps increase the value of a country’s currency. During the 19th and the first half of the 20th century, the U.S. increased its foreign reserves by having a positive trade balance. Since 1952 the international reserve position of the U.S. has fallen from 50% of the world’s total to a 2.4% ratio - - a 95% drop. The decline continues.

Beginning in the 1980’s, the U.S. position as a net exporter of goods and services changed. In less than 20 years, the U.S. moved from being the largest creditor nation on earth to the world’s largest debtor nation. For the past 30 years the U.S. increasingly has been unable to adequately compete internationally to balance its trade with the rest of the world to export sufficient goods to balance and pay for its imports. Massive deficits soared. Even the information technology sector is negative, and for the first time food imports exceeded exports.

The chart above shows the tremendous deficits racked up in our international trade account since 1959. In 2006, the net trade deficit exploded to $836 billion and 2007 will be slightly less.

A fiat currency system that is now used by the U.S. is dependent upon the trust and credibility relationships of a very complex market.

The U.S. dollar index has been under a great deal of pressure under the combined weight of the governmental and trade deficits which currently require approximately $2 billion/day to finance from foreign sources.

The U.S. dollar index peaked in January 2002 at 122 and has been falling every since. During the five years preceding the peak, the U.S. dollar index fell over 35% to an all-time low of 74 in November 2007.

In August, the financial confidence of various financial instruments associated with highly complex and relatively non-marketable securitization instruments was called into question when the U.S. housing market began to show serious signs of trouble. As a result, financial markets came under serious strain and the resulting shoring up of the world’s financial markets has required central banks to infuse over $800 billion of new money into the world’s financial system. Of course, this was simply fiat currency which, by definition, will increase inflation further.

A major problem facing the U.S. is the question of national sovereignty and the role of the U.S. Constitution in protecting the citizens of the U.S. Since the founding of the country, there have been many attempts to erode the sovereignty of the country and to decrease the protections afforded to U.S. citizens by the Constitution and the Bill of Rights.

A country is unable to exist if that the country can not maintain and control its borders. Since its founding the U.S. has rarely had to use force to maintain its North American contiguous borders. The Mexican-American War which ended in 1848 was the last real war fought over the contiguous borders.

President George Bush tried to push through Congress an amnesty bill which was rebuffed as citizens throughout the U.S. urged their representatives to defeat it. Clearly, the electorate was becoming upset about the problem of illegal immigration and its costs to the taxpayer.

In September 2006, Congress passed a $34 billion homeland security funding measure which was meant to secure the nation’s ports and strengthen border patrols. The funding bill includes $1.2 billion as a down payment on the new fence, which is planned to extend along about a third of the 2,000-mile Mexican border.

``The first obligation of the government is to protect the nation. If you can’t protect your borders, you can’t do that,” said Representative Harold Rogers , Republican of Kentucky and chairman of the House Homeland Security appropriations subcommittee.

Unfortunately, Mexico objected, the Vatican objected, and environmentalists complained that a fence would be a problem. Of course, it would to illegal immigrants, drug smugglers, and possible terrorists and possibly some wildlife.

Nevertheless, the clamor raised by these groups against the fence was enough so that $3 billion needed to fund the entire 2,000 mile fence was left out of the funding bill for FY 2008.

The number of illegal immigrants used by the government authorities in 1996 was about 12 million according to the Pew Hispanic Center which used Census Bureau data to make the estimate. There are about 7.2 million undocumented workers in the U.S., or about 5 percent of the country’s work force, the Pew report said. It estimated that illegal immigrants fill a quarter of all agricultural jobs, 17 percent of office and house cleaning positions, 14 percent of construction jobs and 12 percent in food preparation

However, the US Border Patrol union Local 2544 in Tucson, Arizona says the total number of illegal immigrants in the U. S. in May 2006 was between 12 and 15 million. In 2006, Bear Stearns researchers Robert Justich and Betty Ng reported that as many as 20 million illegal immigrants were in the U.S. – more than twice the official Census.

Since its founding, the U.S. has the most accommodating immigration policy of any nation in the world. Prior to the 1970’s, the majority of immigrants to the U.S. were assimilated into the American culture and the English language within the first or second generation.

The diversity movement which began in the 1960’s has seen a gradual erosion of the assimilation idea and a break-down of the melting pot concept. The decision to print ballots in multiple languages coupled with the English as a second-language courses are factors in the erosion process.

Still immigration for the U.S. is an important aspect of growth. Unfortunately, immigration has become a process of regulations that have hampered those seeking legal entry into the country. The immigration rules also have failed to largely discriminate between those who have skills and wealth which the nation requires and others. As a result, illegal immigration, particularly, from Mexico and Latin America has become a major problem.

In fact, the Mexican government has widely encouraged illegal immigration to the U.S. as a method to regain sovereignty over portions of the U.S. ceded under the Mexican Cession, in which the territories of Alta California and Santa Fe de Nuevo Mexico were ceded to the U.S. under the terms of the Treaty of Guadalupe Hidalgo. Illegal immigration from Mexico has provided seasonal workers for the agriculture and construction industries and that has benefited the U.S.

However, many studies of immigration are concerned with the extra costs imposed upon various governmental entities by illegal immigrants. One of the major concerns for many is the anchor baby.

Babies born to illegal alien mothers within U.S. borders are called anchor babies because under the 1965 Immigration Act, they act as an anchor that pulls the illegal alien mother and eventually a host of other relatives into permanent U.S. residency.

The 14th Amendment to the U.S. Constitution reads in part:

“All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and the State wherein they reside.”

The original intent of the 14th Amendment was clearly not to facilitate illegal aliens defying U.S. law at taxpayer expense. Current estimates indicate there may be over 300,000 anchor babies born each year in the U.S., The correct interpretation of the 14th Amendment is that an illegal alien mother is subject to the jurisdiction of her native country, as is her baby.

Many have interpreted the 1965 immigration Act as changing the Constitution and the 14th Amendment.

In 1866, Senator Jacob Howard clearly spelled out the intent of the 14th Amendment by writing:

“Every person born within the limits of the United States, and subject to their jurisdiction, is by virtue of natural law and national law a citizen of the United States. This will  not, of course, include persons born in the United States who are foreigners, aliens, who belong to the families of ambassadors or foreign ministers accredited to the Government of the United States, but will include every other class of persons. It settles the great question of citizenship and removes all doubt as to what persons are or are not citizens of the United States. This has long been a great desideratum in the jurisprudence and legislation of this country.”

As a result, the country is now faced with correcting the anchor baby interpretation and declaring anchor babies citizens of the country where the mother is a legal citizen. The inability to control borders and the rising militancy of the Mexican illegal immigrants has created calls to building fences between the U.S. and Mexico to prevent and/or slowdown the tide of immigration.

The need for seasonal workers can be met through a temporary worker visa program where documented workers are granted temporary access to the U.S. with a clear understanding that they will not remain in the country. A business that uses seasonal workers should be required to monitor temporary workers along with the Department of Homeland Security to ensure that the workers return to their country of origin upon the expiration of the temporary worker visa.

Another aspect of the immigration problem is that over half of all graduates of our engineering and professional schools are foreign students. In many cases, after graduation they are required to return to their native country rather than remaining in the U.S. and becoming a citizen. As a result, the faculties of many of our leading scientific institutions of learning are now also foreign natives. Those that do not stay in the U.S. return home and improve the ability of foreign owned companies to compete with the U.S. in not only business but also in education.

Twenty years ago, the best students in the world from China, Japan and the European Union were coming to the U.S. In the last five years, universities in those countries have seen those students staying home as the quality of education has improved.

Implementation of the North American Free Trade Agreement (NAFTA) began on January 1, 1994. When NAFTA is fully implemented, it promised to remove most barriers to trade and investment among the United States, Canada, and Mexico. Under NAFTA, all non-tariff barriers to agricultural trade between the United States and Mexico were eliminated at the start.

Despite its name, the primary purpose of the North American Free Trade Agreement (NAFTA) was not to facilitate trade among separate sovereign societies. Rather, it was to promote an integrated continental economy and establish the rules to govern it. Americans were promised that NAFTA would generate large numbers of net new good jobs. Instead, over a million jobs that would otherwise have been created were lost, and wages were pressured downward for a large number of workers with less than a college education.

NAFTA was sold as a way for the U.S. also to increase its trade with Mexico and Canada. Obviously, the following chart suggests that the NAFTA promise of increasing the trade balance was wrong as the only beneficiaries of NAFTA are Mexico and Canada.

The U.S. trade deficit with both countries has increased since the implementation of NAFTA in 1994 as shown in the following chart.

The NAFTA Superhighway (also known as the trans-Texas corridor) was launched in 2005 by the heads of state of Canada, Mexico and the U.S. at a summit in Waco. The highway is part of a broader plan advanced by a quasi-government organization called the “Security and Prosperity Partnership of North America,” or SPP.

The SPP was not created by a treaty between the nations involved, nor was Congress involved in any way. Instead, the SPP is an alliance of foreign consortiums and officials from several governments. One principal player is a Spanish construction company, which plans to build the highway and operate it as a toll road. But don’t be fooled: the superhighway proposal is not the result of free market demand, but rather an extension of government managed trade schemes like NAFTA that benefit politically-connected interests.

The real issue is national sovereignty. Once again, decisions that affect millions of Americans are not being made by those Americans themselves, or even by their elected representatives in Congress. Instead, a handful of elites use their government connections to bypass national legislatures and ignore our Constitution – which expressly grants Congress the sole authority to regulate international trade.

The ultimate goal is not simply a superhighway, but an integrated North American Union – complete with a currency, a cross-national bureaucracy, and virtually borderless travel within the Union. Like the European Union, a North American Union would represent another step toward the abolition of national sovereignty altogether.

The baby boomer generation is now beginning to leave the U.S. work force as the following chart shows. As a result, the U.S. fertility rate barely maintains the population level largely due to the number of abortions that are performed each year. Population growth is therefore heavily dependent upon immigration from other countries.

As the baby boomer generation moves towards retirement, the demand on social security, Medicare and Medicaid will grow resulting in either increased taxes on social security or a reduction of benefits.

As previously mentioned, a major problem facing the U.S. is the growth of the diversity cult versus a nation which prided itself on being a “melting pot.” The melting pot enabled immigrants to becoming almost an invisible part of the national fabric.

As the diversity movement gained strength, divisions began appearing in the nation’s culture, voting patterns, schools, and other aspects of society. Diversity programs have created a nation that is becoming more divided every year.

For years, BLS has changed the methodology for calculating the CPI and PPI numbers. Inflation, as reported by CPI is understated by roughly 7% per year. This is due to recent redefinitions of the series as well as to flawed methodologies, particularly adjustments to price measures for quality changes. Since May1996, the CPI calculation has been modified at least 14 times. Each modification resulted in lowering the reported CPI. As a result, the reported data fails to portray real-life inflation. Core CPI does not include food and energy which are two of the basic requirements to survive. The result is that those policy-makers who rely upon the reported CPI and PPI data to make decisions are making bad decisions.

The following chart through November 2007 shows the differences in just three of the CPI calculations followed by Williams. The BLS calculated the CPI in September 2007 at 2.2% versus SGS’s 10+%. Since September is the month used for many Cost of Living adjustments (COLA’s), the discrepancy reduces governmental and private pension outlays.

The data provided by SGS is probably more valid than that prepared by the Ministry of Truth. The following two charts make a case against the Ministry of Truth calculations.

Still the Ministry of Truth insists that inflation remains at an annual rate of 4.3% as of November 2007.

During 2007, the value of the U.S. dollar continued to fall against most major currencies. Large trade and fiscal deficits combined with the financial strains in the system caused by the securitization of questionable packaged loans created an environment where the dollar continued to drop against most currencies. The U.S. dollar index chart indicates a drop of over 35% since the peak in January 2002 and almost 10% in 2007.

As the twin deficits have mounted since 1980, the amount of U.S. Securities held by foreigners has increased. As of October 2007 over $2.3 trillion of U.S. Securities were owned by foreign interests. In March 2006, the Bank of Japan (BOJ) began a program to slowly reduce its major holding of U.S. Treasury securities. Although BOJ has not stopped purchasing U.S. Treasury securities, the total has fallen from 618.1 billion to $591.8 billion in the twelve months ending in October 2007.

Clearly, the desirability of U.S. Treasury securities is waning as the dollar falls. The amount of interest received from the securities does not offset the decrease in value from the falling U.S. dollar.

The following table shows the major foreign holders of U.S. Treasury securities through October 2007.

The U.S. Constitution grants to Congress in Section 8, “the power to lay and collect taxes, borrow money on the credit of the United States, and to coin money, regulate the Value thereof, ….”

U.S. coins have changed many times since the Coinage Act of 1792, which adopted the dollar as the standard monetary unit. Silver dollars have been minted and issued at various times since 1794. Dollar coins were discontinued in 1935, then resumed in 1971 with the introduction of the silver-less Eisenhower dollar. Coins are still issued by U.S. Mint, a part of the U.S. Treasury. Silver certificates, authorized in 1878 and issued in exchange for silver dollars, accounted for nearly all of the $1 notes in circulation until November 1963, when the first $1 Federal Reserve notes were issued.

Since then, however, the only paper money printed in the U.S. are the fiat-money notes of the Federal Reserve System which contain the following:

More than 99 percent of the total dollar amount of paper money in circulation in the United States today is made up of Federal Reserve notes. The other small part of circulating currency consists of U.S. notes or legal tender notes still in circulation but no longer issued.

The Federal Reserve System was created in 1913. The preamble to the Federal Reserve Act said:

The Federal Reserve Act requires that adequate backing be pledged for all Federal Reserve notes in circulation. U.S. Treasury securities, acquired through open market operations, are the most important form of collateral and provide backing for most of the value of the currency in circulation. Some other types of collateral the Federal Reserve holds are gold certificates and certain eligible instruments such as notes, drafts, and bills of exchange.

The major players pushing for the Federal Reserve were mostly individuals with a vested interest in the financial community who wanted to restraints on banking and currency contained in the U.S. Constitution. Not surprisingly, most of the individuals involved were also affiliated with either directly or indirectly with financial institutions located in Europe.

Under the Federal Reserve System, the value of a U.S. dollar has certainly been elastic! Prior to the formation of the Federal Reserve, a dollar bill could be redeemed in either gold and/or silver. Today, it can only be redeemed in more fiat-paper, the value of which can only be guessed. However, since 1914, the fractional-banking system initiated by the Federal Reserve System has seen the value of that dollar drop to less than 5 cents as measured by the CPI.

The following chart shows the inverse relationship between the value of the U.S. dollar and the federal debt.

Even before the financial problems of the international banking system arose in the second half of 2007, the role of the U.S. dollar as the world’s reserve currency was being challenged.

Since the sub-prime mess became evident in August 2007 with the seizure of the commercial paper market in Europe, Canada and the U.S., the Federal Reserve along with other central banks have added over $750 billion in new fiat money into the system. Even with the additional capital, the lack of trust between various financial entities has caused considerable tension among participants world-wide. Of course, the addition of these funds will lead to higher inflation by definition.

The melt-down in the derivatives has seen increased concern about rating agencies and their methods, the value of reinsurance guarantees, and the usefulness of derivatives to offset risk.

With the price of gold bullion increasing 31% during 2007 and closing at an all-time yearly high of $834/oz., it would appear that not only are some central banks refusing to decrease their holdings of the reserve metal but are actually increasing their reserves.

Likewise, individuals, primarily, those in the Middle and Far East have started to increase their holdings of gold bullion also. What effect these decisions will have on the value of fiat money as represented by the Federal Reserve notes and the dollar’s role as a reserve currency can not be quantified. However, it should be safe to say that the long-term effect will not be positive.

During 2007, earnings of U.S. based corporations were at all-time record levels. Multinational concerns benefited from strong overseas economic growth and a declining dollar. However, a disturbing trend is appearing in the growth rate of those earnings as shown in the graph below.

After-tax profits for the third quarter were lower than the second quarter and the year-to-year growth rate fell almost to zero. The decline occurred despite the increased earnings of multi-national corporations indicating that profit levels for corporations without overseas operations were in decline. If corporate earnings fall, tax revenues and the level of the stock market are likely to become negative.

In the U.S. in FY 2007, corporate income taxes provided 14.4% of total federal government receipts. Individual income taxes and social security, Medicare and Medicaid taxes accounted for about 79.2% of federal government receipts. All other types of federal government receipts accounted for less than 6.4%.

Although corporate income taxes are a relatively small amount of total taxes collected by the federal government, they are also responsible for creating the jobs that account for most of the individual income taxes. Hence, the direction of corporate profits is important to overall tax revenues. The following chart shows the data for FY 2007.

Politicians have been very conscious about hiding the burdens that the programs which they have enacted. Most citizens actually believe that President Clinton actually ran a budget surplus and balanced the budget during a couple of years in Office.

The following graph shows the stated federal budget surplus or loss commonly used in the media for the period 1970-2007 as prepared by the Congressional Budget Office. The reader should note that the CBO data is not prepared using GAAP accounting methodology nor is the data required to be audited.

A look at the chart would suggest that the country had a surplus beginning in 1998. If that is true, why did the national debt go up in each year that a budget surplus was reported? The answer is that “statistics and lies are a politician’s best friend.” The deficit/surplus reported by the CBO and the debt reported by the U.S. Treasury are shown in the following table from 1990 to the present.

Note that in 2000 when the reported surplus was the highest, the national debt actually increased.

In 2002, Congress passed a law requiring the Treasury Secretary to prepare a report based upon GAAP accounting principles each year. In the 2006 report, Secretary Paulsen admitted by the accounting records off 14 of the 28 major departments of the federal government were in such poor shape that they would not pass an audit.

The U.S. Treasury issued in December the 2007 Financial Report of the U.S. Government. On page 32, the following comment should make citizens ready to throw out all politicians.

"[The report's measure of the long-term U.S. fiscal gap] totaled approximately $53 trillion as of September 30, 2007 ... an increase of more than $32 trillion from about $20 trillion as of September 30, 2000. This translates into a burden of about $175,000 per American or approximately $455,000 per American household."

The reliability of any of the data provided by the Ministry of Truth is doubtful. Even with the Sarbanes/Oxley act, the FY 2007 Financial Report failed to meet get a clean audit letter. From page 11 of the report comes this quote:

“The Government Accountability Office (GAO) is responsible for conducting the audit of the Government’s financial statements. For FY 2007, GAO has again issued an audit opinion ‘disclaimer’, as it has in each of the past eleven years, on the consolidated financial statements for the fiscal years ended September 30, 2007 and 2006. This means that the auditors did not have sufficient information to determine whether the financial results were reliable. Material weaknesses in internal control and other scope limitations resulted in conditions that prevented GAO from forming and expressing an opinion.”

However, in FY 2007, 19 of 24 of the most prominent agencies earned unqualified opinions on the financial statement audits.

And the agencies that received the disclaimers were among the largest of the government.

Hence, the true state of affairs of the federal government is difficult to assess … yet the bonds of the U.S. Treasury are classified as “AAA.” You have to wonder about the intelligence of rating agencies … a private corporation without a clean audit opinion would face serious rating problems.

Nevertheless, the report submitted showed that the real status of the government was quite different than the data portrayed above as shown below.

For example, in FY 2006, the formal cash-based deficit declared by the CBO was a paltry $248.2 billion. The Treasury GAPP report showed a much higher deficit of $4.6 trillion even when 50% of the government’s major departments could not be given a clean bill of health on their accounting. Somehow a GAPP deficit twenty (20) times the CBO reported deficit seems to me to be slightly misleading.

The situation at the state and local levels is also difficult largely because of many of the same reasons. Municipal and state accounting is almost incomprehensible to the average well-educated citizen. While many state and local government get state income taxes from corporate and individual payers, sales taxes and real estate taxes are highly important revenue sources.

The decline in home values coupled with a slowing in retail sales has caused many taxing entities to worry about collapsing revenues. Nationwide, the slump in housing prices and construction is hurting sales tax collections because people are buying fewer construction materials and home furnishings such as appliances and furniture. Sales tax revenue rose 3.3% in  the first half of 2007, the smallest increase since 2002. Three reports released since Dec. 1 each found that states' deficits are growing rapidly and that the housing market crisis is a major cause of evaporating tax collections. The latest report issued on Dec. 18 by the Center on Budget and Policy Priorities found nearly half the states are predicting budget shortfalls over the next 2 fiscal years, with 13 indicating a deficit will likely occur when the new fiscal year begins July 1, 2008. CBPP estimates deficits, cumulatively, could hit at least $23 billion.

The concept of a social security trust fund is a lie perpetuated upon the American public by its leaders. For years, the excess social security funds generated have been used to off-set the general pay for general operating expenses and replaced with non-marketable IOU’s in the trust accounts instead of marketable assets with no funds budgeted to repay the trust funds. Congress has been raiding the Social Security surplus for over twenty years and has now spent $1.9 trillion of Social Security money on other government programs. According to the Social Security Administration, Social Security will continue to run surpluses until 2017 at which time benefits will exceed revenues.

As of September 2007, the stated federal  debt totaled $9.0 trillion of which the Treasury Department indicated that $3.7 trillion was owned to various trust funds including social security.

With the baby boomer generation starting to retire, the outlays for social security will increase in the coming years. There have been many commissions studying how to “save social security.” Yet, despite all the study, nothing has been achieved except that the politicians continue to raid the various trust funds including social security to reduce the CBO’s stated cash deficits.

In the 15 year period from 1991 to 2006, the cumulative Surplus cash taken from the social security trust fund increased by $1.54 trillion as shown in the graph.

Time is running out for solving the problem facing social security, Medicare and Medicaid. Annual cashflow deficits will begin to climb rapidly, soaring to $100 billion in 2015 and $500 billion in 2025.

Defenders of the current system claim that these huge shortfalls are not a cause for concern because money in the Social Security Trust Fund can be used to finance all promised benefits until 2032.

Politicians have promised voters benefits and have not had the courage to provide funding for them. At some point in the future, taxes will have to be increased, retirement age decreased, or benefits slashed. Of course, the whole Ponzi scheme also could just crash at some future point.

During the middle of 2006, various factors including rising interest rates and increasing levels of unsold homes came together that lead Strategic Investing to begin shorting the home-builders and the support components to the housing industry.

At the beginning of 2008, the following charts show the current position of the housing industry and it looks like the industry might remain dormant for a couple of years. Housing starts have been falling since January 2006 and a rebound is not likely in the near future has housing permits have also declined.

In an effort to shore up their finances, several major home-builders have reduced their inventories of raw land. It is one of the major truths for home-builders that as long as they can get construction financing, they will continue to build. In the last five months, many small builders have withdrawn from the market as their lines of credit with their suppliers have disappeared.

In fact, during the past 60 days, several national home-builders have been placed on a cash-only basis or worse from their suppliers. It would not be a surprise to see a few publicly-traded homebuilders go into bankruptcy during 2008.

Sales of new homes peaked in July 2005 and each month since then has seen an increase in the number of months of supply on the market. As of November 2007, there was a 9.3 month supply of new homes to be sold despite many major builders offering major upgrades free and/or discounting houses by up to 30% in some areas from original sales prices.

The supply of existing homes is also at record levels despite a market which is beginning to show signs of price deterioration. Existing home sales peaked in August 2005 and have now fallen to about 60% of the August 2005 level. Inventory of existing home has now climbed to 10.8 months as of November 2007.

Mortgage interest rates have hardly changed during the period from 2005 to now although the increased credit standards instituted after the sub-prime situation became a problem has reduced the ability of many potential owners to qualify for mortgages.

Many prospective homeowners are on the sidelines watching real estate prices fall. Also, as delinquency rates and foreclosures continue to rise, the pressure on the real estate market will increase.

Despite all the political grand-standing, the over-built housing industry which provided a large percentage of all new job growth during the first seven years of this century, do not look for an easy solution to the industry’s problem.

Pressures on real estate prices have caused the home-owners ATM refinancing machine to freeze-up, and the decreased wealth effect could have serious repercussions for consumer spending as increased costs for food and energy take an increasing share of disposable income in the next few years.

Consumer spending accounts for about 70% of the U.S. GDP. If the ATM home-owners window has closed and standards for credit increased, the ability of consumers to increase their debt levels to finance a life-style which is beyond the consumer’s income level would appear to be in jeopardy.

Personal income (real disposable income) has seen anemic growth during the last two years as globalization has held down wage increases. For 2007, real disposable income has grown at only 2.1% or less than the Ministry of Truth’s reported CPI of 4.3% as of November 2007.

The growth of consumer credit continues at a record pace despite the real estate problems as consumer try to maintain their life-style without reducing spending. In seventeen years, the amount of consumer credit has jumped almost three-fold as shown in the chart.

The consumer is a very important part of the economy. It would appear that increased lending standards, higher inflation coupled with a relatively weak increase in disposable personal income will cause consumer demand to slacken in the upcoming year. If it does, the outlook for a lengthy recession increases.

The Presidency is held by a Republican at the moment and the longest-running political campaign in history is in progress. On January 3rd, the Iowa vote will start the Presidential selection in earnest.

However, perhaps, a more important election will be the Congressional elections in which all 435 members of the House of Representatives will be re-elected and one-third of the Senate.

In the House, there are currently 233 Democrats, and 202 Republicans. The last election saw the balance of power in the House swing from the Republican party to the Democratic party.

The Senate currently has 51 Democratic senators including two who are not officially party members (Lieberman and Sanders). In the Senate, there are twelve Democrats up for re-election and twenty-one Republicans.

Since all spending begins in the House of Representatives, the promises of Presidential hopefuls should be taken with a grain of salt. However, if the Democrats prevail and increase their voting blocs with a Democratic President, expect many changes to be enacted.

The Bush tax cuts will probably be rescinded. An increase in environmental spending will find advocates. Regulations on business will increase. The deficits of the federal government will increase even more than under the current administration although a partial military draw-down could be an offset.

The end-result is that the dollar will not be defended and allowed to continue to devalue as the only method the academics and politicians can abide is to “inflate or die.” Unfortunately, it might also become “inflate and die.”

Because the Ministry of Truth has massaged with seasonal and hedonic adjustments, U.S. economic data during the past two decades, the lawyers who comprise the majority of our politicians are unable to grasp the real world. Believing that unemployment is only 4.4% when it actually is running closer to 8.0%, or that the cost of living is increasing at only 4.3% when the real world is over 10% will cause politicians to make choices that don’t solve the real problem.

The changes in many data series from the Federal Reserve System, the Bureau of Labor Statistics, the Department of Commerce, and the Department of Treasury have created data which has lost any sense of comparison with history.

The elimination of M3 reporting by the Federal Reserve is just one instance where available data of increasing inflation was suppressed. Fortunately, SGS and others have been able to compute the information. Through November 2007, the annual Money Supply Growth of M3 is running at about 16% … a rate that would cause many sleepless nights if reported.

Another instance is the Consumer Price Index. Changes in the compilation of this series since 1996 have occurred fourteen times. Prior to July 1996, the previous change occurred during the Reagan administration. As SGS points out in the following graph, the government through November 2007 is reporting the CPI increasing at a 4.3% annual rate. SGS’s CPI calculation using the methodology from 1980 shows a 12% annual rate.

A decision based upon increases in the CPI of 4% will be somewhat different if the decision was based upon 12%.

We have three simple rules for investment success that have stood the test of time since we began investing over 50 years ago. They are;

· Optimists make more money than pessimists!

· Only invest in companies with increasing sales and earnings!

· Cut your losses quick!

· The Ministry of Truth

· Interest rates – US dollar

· Middle East & Terrorist Events

· Supply/Demand Equation of Energy Sources

· China unrest/growth picture

· Asset Expropriation

· Abrogation of Contracts

· Stalemate in Congress

· Stagflation or Recession?

· White House cut 2008 forecast to 2.7%

If a substantial portion of those holdings were used to fund sovereign wealth funds that invested outside the U.S., or were used to conduct financial raids against the U.S., the outlook for U.S. equity and bond markets would be very difficult. As long as those funds are used to “Buy America” while it is on sale via a falling dollar, the economy might muddle-through without a prolonged recession.

During 2008, the following sectors should continue to out-perform the market:

· Energy

· Industrial Raw Materials

· Infrastructure Builders

· Agribusiness including commodities

· International

o ETF’s

o Asset-based companies w/o political risk

· Technology

o Medical devices

o Geriatrics

· Entertainment

· Consumer Staples

· Alternate Energy

o Ethanol www.ethanolproducer.com/plant-list.jsp

o Biomass www.biomassmagazine.com/

o Solar www.seia.org/

o Wind www.windenergys.net/

· Nuclear

o Uranium www.uraniumproducersamerica.com/

· RFID www.rfidbusiness.org/

· Nanotechnology www.ianano.org/

The URL’s provide links for further research about the industries and specific trends and companies within each group.

Four sectors are also of interest but are of much higher risk from either governmental regulations and/or fiscal manipulation. These sectors are:

· Energy/Utilities

· Healthcare

· Precious Metals

· Real Estate/Home Builders but probably too early – wait until later.

· Petrobas (PBR)

· Comp Vale Do Rio (RIO)

· Potash Corp. (POT)

· Mosaic (MOS)

· Vimple Communications (VIP)