The aaii.com sentiment index has consistently shown bulls at about 50% lately. Last week’s thestreet.com bull/bear profile showed bulls beating bears 61-23.

While this generally reflects overbought conditions, it takes bulls to make a bull market, so who knows, it may continue for awhile.

I’ve never seen a sentiment level this extreme since the bearish extremes we saw in February/March 2009. Likewise, the AAII.com sentiment survey index has consistently shown extremely bullish readings the past few weeks: http://www.aaii.com/sentimentsurvey/

Generally, the contrarian approach would be to take the opposite trade and short the market, but you never know when QE3 will be announced….

When it became clear that Greece would default without a bailout, Europe rushed to its rescue and inked out a massive ‘we will bailout each other’ plan. Some genuine austerity has taken place in European countries since then, so perhaps the bailout will hold. However, in many countries, citizen resistance to austerity is keeping the welfare state intact.

A great comparison is England and France. If England is able to axe 500,000 government workers and reform its welfare system, it may very well open the path towards genuine economic growth, not sclerotic sub 1% growth. By reducing the size of government, it may even (gasp) allow the country to lower taxes.

In contrast, France nearly melted down when it raised the retirement age from 60 to 62. While some change is better than no change for France, tiny changes like this will simply keep the current welfare state system alive on the respirator until the next crisis hits. While the country struggles, it will continue with a slow growth environment.

We have a similar situation in the United States too. Entire states are bankrupt, and it is just a matter of time until the default risks kick in. It is mainly the ridiculously high pension benefits paid to public workers that is the problem, and these will gradually get worse as more retire over the next decade. What will likely happen is these states will enact incremental austerity. They will raise taxes here and there, gain some small concessions from the unions, and try to stave themselves off from bankruptcy.

This is a recipe for continuing to kick the can down the road and achieving, at best, 1% long-term growth. Instead, I hope that some states and countries just continue being grossly profligate.

Let France keep its retirement age at 60. Let it continue to have ridiculous pensions. Let it go bankrupt. Hopefully, the world will see what happens and will learn a lesson. Since no one seems to have learned socialism doesn’t work with the failed experiments in Cuba and the USSR, we need to see socialism fail…again. Apparently, the low growth rates of Japan and Western Europe are not enough for people to think that entitlements don’t come without cost…we need to see a major country fail in dramatic fashion for people to learn a lesson.

Let California elect Jerry Brown as governor. While he is not a radical leftist, I really doubt he will force any concessions from the public unions over the next few years. Let California continue paying exorbitant pensions to the unions, and let it go bankrupt. We just hope there is the will in Washington to resist a bailout, or else we will just start a bigger problem.

But his living standards slowly crumbled along with Japan’s overall economy. First, he was forced to reduce trips abroad and then eliminate them. Then he traded the Mercedes for a cheaper domestic model. Last year, he sold his condo — for a third of what he paid for it, and for less than what he still owed on the mortgage he took out 17 years ago.

“Japan used to be so flashy and upbeat, but now everyone must live in a dark and subdued way,” said Masato, 49, who asked that his full name not be used because he still cannot repay the $110,000 that he owes on the mortgage.

The article goes on about how people have learned to downsize. An underlying theme is that young people no longer strive to strike it rich and be flashy; they just do their best to get by.

Sound familiar to what is occurring in the US?

Of course, the NYT, being a liberal rag, totally missed the point on why Japan has stagnated. Little mention in the article was paid to the fact that Japan has done stimulus plan after stimulus plan, increased the size of government, raised taxes, and done as much monetary easing as they could. The NYT just describes the deflation as being self-perpetuating, no mention to the fact that the Japanese government has continued to swallow up more and more of the economy.

Government has grown so much in the US, and so steadily, that we have already become Japan before even realizing it. We will continue to have slow growth and poor job prospects as we inch closer and closer towards the socialist realm of the spectrum.

Japan, while not a vibrant economy, is not a third world one yet either. However, with a government debt in excess of 200% GDP and a government entirely dependent on paying less than 2% interest for most of its debt, avoiding a currency crisis shouldn’t be taken for granted in Japan.

And we shouldn’t be too cavalier about our debt situation in the US too.

Democracy Is Destroying The US

Honestly, the title was much better than the article. After a few paragraphs pointing out the difference between liberty and democracy, the article then lambasts the Federal Reserve.

The points about democracy and liberty are interesting though. People often confuse the two, but they are remarkably different. A democratic republic just means the people making the laws are voted in by the majority of other people. The people making the laws very well could frame those laws to decrease liberty and freedom, and lately the trend (by increasing the size of government) essentially does that.

I’d take it a step further and say that a central problem with democracy is that the average person has no clue about economics and the potential unintended consequences of government action. There’s a reason why politicans are clamoring to raise taxes on the rich: most people aren’t rich. If you look at both the national level and state level, politicans are going after the minority. Obama is asking for taxes on those who make $200k-$250k or more. States are targeting similar groups. Oregon already passed a proposal to raise taxes on corporations and $200k+ taxpayers, there is a pending vote in Washington State to create an income tax to target those that make $200k-400k+ a year, and a few states passed higher taxes on the rich.

Why the ‘rich?’ It isn’t so much economics; it’s because most people aren’t rich. No one actually wants to pay higher taxes, but people figure if they can get more government services and have someone else pay for it, why not? Combine getting free government services with generally envy and the recipe for legislators is simple. The trickle down effect of fewer jobs and fewer high paying jobs due to lower growth are a few steps passed most people’s economic comprehension, especially politicians.

Hyperinflation Part II: What It Would Look Like

This article is from a few month’s ago, but I think it’s a good read for anyone. It doesn’t examine what causes hyperinflation or when it could happen. Instead, it simply shows what life is like under hyperinflation. If you are worried we could have hyperfinlation in the US eventually, it’ll serve you well to learn how to survive it from past history. Hint: real estate isn’t the best investment. Try toilet paper, canned food, and cars with good gas mileage.

The 10-year yield is now at 2.40%, something we have not seen since the depths of the recession in January 2009.

Of course, this is all due to speculation the Fed will ramp up QE2. It will buy government bonds (hence buy now since a sucker will buy later). Since the monetary base is expanding, fears of dollar devaluation are driving up metals and stocks.

I suppose it all makes sense, but it also doesn’t. If the dollar devalues (or we have inflation), those bonds are going to go down in value (as investors will want more yield). Especially given that many buyers of US treasuries are foreigners, they would be especially concerned about a drop in the dollar.

Even if the Fed buys treasuries, if it really will dismantle the dollar in the process, there will be more net sellers and the yields will rise. That or the Fed will buy so many treasuries that we’ll actually have a hyperinflation scenario as everyone will flee the dollar (even though treasury yields will stay low).

But, alas, that’s not happening. I do think demand for treasuries are born largely out of fears of a douple dip deflation risk more so than hoping to sell high to the next sucker (the Fed). Last time the Fed announced QE, treasuries rallied but then got brutalized as the recession ended and hopes of economic growth resurfaced.

The markets may stay sidewise for a few months. However, I think we’ll stop seeing all assets go up. Stocks may continue to rise, bonds may continue to rise, gold may continue to rise, but I doubt all three will.

From the article:

“U.S. states are among the cheapest sovereign credits in the world,” said Patrick Brett, a Citigroup banker who marketed the Illinois securities overseas. “You’re actually picking up a good amount of spread for arguably better credits relative to equivalently rated corporates and sovereigns.”

International ownership of U.S. municipal bonds jumped 37 percent in the first half of the year from the end of 2009 to $83 billion, a Sept. 17 Federal Reserve report shows. Spurring the growth are Build America Bonds, created by President Barack Obama’s economic stimulus program to finance public-works projects. More than $140 billion of the debt has been sold in the 17-month-old market. About a quarter may have been bought overseas through June, said Matt Fabian, an analyst with Concord, Massachusetts-based Municipal Market Advisors Inc.

“The more types of investors you have, the better the overall market,” said Fabian, based in Westport, Connecticut.

Before we all go out and buy Cali long-term bonds, let’s also remember these states pension liabilities almost ensure bankruptcy, unless their pension funds somehow return 10% a year every year.

To give an idea how absurd that is, if the Dow managed to return 10% year every year since its 1932 low (so you’re buying at a very good time), it would be at 69,500 right now.

States like California and Illinois will need to default one way or another. Absent rampant inflation, they will either need to default on their bonds, somehow default on their pension liabilities and still pay on their bonds, or get the feederal government to bail them out (and perhaps put the federal government at risk for default).

With more and more foreigners buying municipal bonds, the urge to screw the foreign guy will make simply defaulting on the bonds the easiest path traveled.

While treasuries initially sold off during the rally and yields went higher, things have quickly reversed. Over the next month or so, I expect either treasuries to resume selling off or the Dow to dip back to 10,000 or so, in line with the treasury market.

The stock market has played ping pong between June and September so far, with a Dow range of about 9800-10600 after May’s decline. Right now, we are at the general peak in terms of sentiment/stock levels during the ping pong match. Of course, at some point, the market will break out of this range on the upside or the downside…

Let’s break down the Clinton Defense bit by bit and debunk several common myths:

“The Republicans took a budget surplus and turned it into a budget deficit”

While it’s true that Bush was a miserably poor president who was fiscally reckless by getting us into an unnecessary war, creating an entirely new bureaucracy of ‘Homeland Defense,’ and creating a Medicare entitlement that will help bankrupt the country, claiming that Clinton got us a budget surplus is misleading. The reason we had a temporary surplus was because of a stock market bubble that ushered in an enormous amount of capital gains tax revenue. Just look at the CBO statistics. Notice how capital gains revenue jumped by about $50 billion during the late 90′s compared to the mid 90′s? That will certainly help fill a budget deficit, especially when factoring in the ‘wealth effect’ caused by capital gains leading to a stronger economy, more spending, and other taxes as a result.

Furthermore, Obama’s deficits makes Bush look like frugal. Jacking up the deficit a trillion dollars over your predecessor and then claiming it is all Bush’s fault truly takes some cajones. Two wrongs also don’t make a right. I could go on…but I think you get the point.

Tax rates were higher during Clinton, but we had a stronger economy

This argument is so shallow it seems it would come from a 13 year-old, except most Congressmen still believe this argument. During Clinton, we were in an economic boom, so any tax increase would simply lower the amount of economic growth (which was already high). Growing at 3% instead of 5% is still growth and still ‘good’ to many people, though the economy could have still been better. However, going into -2% GDP growth instead of flatlining means going from bad to worse and 10% unemployment to 12% unemployment.

Furthermore, during Clinton, we had this fantastic invention that just came online called the Internet….unless some major technological breakthrough happens, I doubt we can bank on major technological advances and a stock market bubble to power through the economy.

Clinton also did the following which are anathema to the current Congress:

1. He expanded free trade (NAFTA) thereby reducing the costs of goods and services for the average American. This helped create the strong dollar.
2. He lowered capital gains taxes in his second term.
3. He decreased the overall size of government and helped eliminate much of welfare (with the strong prodding of Republican Congressmen).
4. He did not attack businesses with increased regulation and burden them with a new health care mandate.

Furthermore, if you look at most of history, a tax increase generally spells disaster, especially during hard times. The most apt comparison to today are the tax increases by FDR in 1937 that led to the double dip during the Great Depression, and Hoover’s tax increases in 1932 that helped tank the already floundering economy.

Divided government is good for the economy since those idiots in Congress can’t get anything done. Little was done during the Clinton years and little will be done in 2011-2012

In general, I agree with this statement by economic bulls. However, the problem is that we do not face a discretionary spending crisis. Rather, it is the mandatory entitlements set up by Bush, Obama, and decades of fiscal insanity. As boomers approach retirement, the demands on Medicare and Social Security will balloon and will exacerbate our structural deficit.

Divided government means there will be no solution for this, and we will become closer to the fiscal endpoint like Greece and other fiscally irresponsible countries. Except, unlike Greece, we are too big to bailout…