Market Watch - November 21, 2010
The retail public is back. They are bullish and heavily invested in stocks, probably because there is not much yield on bonds. High grade stocks pay more in dividends than bonds pay in interest, and stocks "have the potential to increase in value". Unfortunately, the market is not priced for gains—it is priced for losses. The yield on the Dow Jones Industrial Average is 2.5%, substantially below the historical Dow yield of 4.3%. If the Dow, currently priced at 11,000 points, was to sell at its average long term dividend yield of 4.3%, the market would be priced at 6,400 points instead of 11,000 points (11,000 x .025 = $275 ÷ .043 = 6,400). 6,400 points is a more realistic value for the current Dow than 11,000 points.
Question: It's logical that the market would be priced substantially lower based upon historical financial information. With chronic unemployment, the destruction of our purchasing power, government deficit spending, and softness in the housing market from foreclosures, how can the Dow be priced at almost double its historical averages?
Answer: The government's plan is to keep the market as high as possible and to keep people hoping that all is well with the market. By this latest round of money making (called QE2 to confuse citizens), there is a huge additional amount of money available for investment purposes. The Fed has made sure that interest rates remain very low, so that bonds are not an enticing investment. Bonds yield virtually nothing. The public is currently more interested in the yield they can get on high quality stocks. Of course, this volume of "money making" out of thin air by the Fed, is highly inflationary. Simply put, inflation is the over production of currency (money).
Question: Over production of currency sounds very simple, and if it's that simple, why can't we just quit over producing currency?
Answer: Eventually we will be forced to economically; however, for as long as our politicians can do so, they will create money out of thin air to fulfill their promises to the electorate. And the promises always relate to citizens who either cannot, or will not, support themselves. For example, unemployment compensation is paid to 8, 850,000 people; food stamps are given to 42,390,000 people, social security and the Medicaid/Medicare programs cost $1,305,000,000,000 annually, or 9% of GDP. None of these payments are authorized by The Constitution as being part of the Federal Government's responsibilities.
Question: What are the federal government's financial obligations in the future, and how do we plan to pay down our debt?
Answer: Taking the last question first, we have no plans, absolutely no plans whatsoever to pay down the national debt. As far as future obligations are concerned, both the comptroller of the currency and the Treasury Department have verified that our future obligations exceed $50 trillion. That estimate has currently been blown out of the water by Boston University economist Warren Koplikoff (previously quoted in this column) who now writes that our obligations exceed $200 trillion, not $50 trillion. Professor Koplikoff writes in the September issue of the International Monetary Fund's journal as follows: "The U. S. fiscal debt is huge. Closing that fiscal gap by taxation would require an immediate and permanent doubling of our personal income taxes, our corporate taxes, and all other federal taxes. Let's get real, the U. S. is bankrupt".
Question: While things seem a little bleak based upon the above, certainly this country would not default on its debt. Or would it?
Answer: The government is already defaulting on the debt by making a conscious effort to decrease the value of the dollar through inflation so that government debts paid off in the future will be paid in much cheaper dollars. While it seems unlikely that great economies like the United States could default on its debt, Hapsburg, Spain defaulted on its debt 14 times between 1557 and 1669. They also suffered from terrible inflation. Pre-revolutionary France was spending 62% of the states income, on debt service alone, by 1788. The Ottoman Empire interest costs rose from 15% of the budget in 1860 to 50% of the budget in 1875, and the English empire in the 1930s had interest payments consuming 44% of the budget. The United States is currently marching right straight down that path.
Question: Is there a solution, and if so, what is that solution?
Answer: There is a solution and it is very logical. It is simply to cut back spending so that spending matches revenue. We should get rid of the Federal Reserve System. Put the power to coin money, and create debt, back on the Congress as The Constitution provides. Finally, a resumption of commodity money, like gold and silver, which was recently called for by Robert Zoellick, current president of the World Bank, would immediately contain both excess government spending, and inflation.
Question: Wouldn't that require the taking away of a huge percentage of the powers of the federal government?
Answer: Yes it would.
Question: So the only way to do that is to have all republican's in power?
Answer: Absolutely not. We have been getting the same thing with Democrats and Republicans for the last 100 years. The only difference is that the legislation you get with the Republicans is less onerous, and less costly, than what we get with the Democrats. Both parties promote anti-Constitutional legislation, and both parties primary goal is to remain in power. All the wars of the last century were started with a democratic president in office, and the wars of this century were started with a republican president in office. Both parties are committed to perpetuating their own power, to staying in office, and to convincing the people through any convenient set of lies available, that "their" party will do the best for the people. The truth of the matter is that the theory behind the three branches of government, (executive, legislative and judicial) is that the primary responsibility of these branches of government is to "uphold The Constitution". Each branch is to provide checks and balances on the other in order to ensure The Constitution is not subverted.
Question: If both the democrats and the republicans are hurting this country, how do we find a group of people that can change things?
Answer: We have spent so many years talking about liberals and conservatives that we have no clue what a liberal, or what a conservative, really is. We need to change our outlook towards political parties by developing within the existing parties a pro-Constitutional outlook towards government. If you could clearly define that a party was pro constitutional, and opposing parties were anti-Constitutional, the public might have more of an opportunity to determine who will represent them as The Constitution dictates they are supposed to be represented.
Question: Isn't the Federal Reserve System the savior of last resort?
Answer: No, the truth of the matter is that the Federal Reserve is broke, too. The Federal Reserve balance sheet published before the 2008 meltdown showed loans in 2007 of $915 billion, and a capital position of $37 billion dollars, or capital of 4% of the Fed's loans. That is a deadly ratio of risk to capital. After the 2008 meltdown and the purchase by the Fed of all of the toxic assets offered by the banks, automobile companies, insurance companies, and so forth, the Fed's loans ballooned to $2,235,000,000,000 (trillion) against capital of $51 billion, or a capital ratio to loans, of only 2.3%. In other words, the present Fed cannot have toxic (under-performing or un-performing) assets of more than it's capital of $51 billion, or the Federal Reserve System, like many member banks of the last two years, would be totally bankrupt, not technically bankrupt like they are now.
Bringing this down to a personal level, we can ask ourselves if we had the same capital ratio in our families, could we survive. For example, let's say that we as a family had capital of $100,000. To be comparable to the Federal Reserve System; we would have indebtedness of $4,350,000 against our $100,000 of capital. Now, this is a terrible situation for a family which would, with those numbers, be bankrupt. Well, the Fed is in a better position than the family because if they run short of cash, they simply print more. The printing of money becomes an obligation of the people. So the college professors who run the Fed bail the government out by simply printing more money and laying the liability on the public. If the debt is never repaid, which there are no plans to do, then the public will simply pay interest charges on that debt from cradle to grave. In the last 21 months, the Fed has created $2.5 trillion of new money out of nowhere. The purpose: so they could buy the toxic assets that failed from the banks, the insurance companies, and whoever else they bailed out.
The wise investor will stay out of the market, pay down debts, and raise as much cash as possible. The current stock market is priced for failure.
Caveat Emptor
George Rauch
November 21, 2010
