Market Watch - December 18, 2015
The winds of war are blowing all over the world. There is no end in sight of wars in the Middle East.North Korea, Iran, Russia, and China’s aggressive behavior is already leading to confrontation. NATO is placing additional forces throughout the Balkan states, Poland, and Romania in order to check Russian aggression in Europe. The world sees further military confrontation. It’s evident in the markets. The U.S. dollar has had a rapid rise in value the last few weeks as foreigners convert their currency into safer U. S. dollars.
In addition to military aggressiveness, many of these country’s economies are having grave difficulties. There have been major currency devaluations this year. Devaluations lead to competitive devaluations to ensure a country’s currency remains the cheapest. Often, financial woes lead to hard feelings among governments, resulting in military conflict.
The United States is uniquely positioned to prosper in the next several years with, or without, further conflict around the globe. There is tremendous demand for U.S. goods. The outlook for the stock market is excellent. The over-leveraged U.S. bond market looks good, too, because conflict around the world creates demand for dollar-based instruments. That demand props up the value of our currency, and securities, in relation to the rest of the world’s markets.
Question: Is the U.S. actually positioned to prosper from the rest of the world’s problems?
Answer: Yes, pretty much as we were positioned to prosper in the middle of WWII. By 1943 all U. S outstanding obligations were covered 100% by gold in the vaults of the Federal Reserve Bank in New York, and Fort Knox, Kentucky. The rest of the world was desperate, broke and hungry. Our farmers were setting crop yield records. Industry was running at full force and supplying war materials for the rest of the world, for which they could not pay, except for an I.O.U. That put the U.S. in a position to influence the Bretton Woods Conference, and the dollar became the world’s reserve currency. This was quite logical because the dollar was then known to be “as good as gold”. The rest of the world was broke, and they had already transferred their gold reserves to U.S. vaults in settlement of debts.
We are again in that unique position. We control the world’s money supply. Our factories are booming and employment is strong. The rest of the world is in strife. Since WWII the U.S. has created, and controls, the UN, the IMF, the World Bank and NATO. Controlling the world’s monetary system, and key political institutions, puts us in a position to prosper.
Question: If our dollar is priced high relative to other currencies, won’t U.S. corporations be unable to sell their production, especially weapons?
Answer: Theoretically, these devaluations will hurt U.S. corporate sales; however, according to the London Guardian, the Pentagon is involved in wars in more than 100 countries around the world. Our military representatives are so outstanding that they have become our best salesmen. Everybody wants U.S. weapons, mainly because they are the most dependable.
Question: Is our economy facing any challenges?
Answer: Two. The last fifty years there has been a dramatic increase in government expenditures. The government is an increasing percentage of our GDP. Since government takes and does not produce, the larger the government is, as a percentage of our economy, the more it costs us to produce goods and services in the private sector, just to pay taxes to support the government. This tends to make our products less competitive in world markets. That is one of our greatest risks. The chart shows government has increased in size to 38% of our GDP. That puts tremendous pressure on the private sector to pay the increasing cost of government through additional taxation.
Government Expenditures as % of GDP - 50 Years (Trillions) |
|||
Year |
GDP |
Governemnt Expenditures |
% of GDP |
1964 |
$.7 T |
$.2 T |
28% |
2014 |
$17.2 T |
$6.7 T |
39% |
The other great risk is public debt, approaching $20 trillion. That crushing debt load is currently being carried by the demand of foreigners looking to place their money in dollar-based securities for safety. The current outlook does not appear dangerous for either the dollar or our economy. However, great amounts of debt can bury an economy if things turn south, as we’ve seen in other countries this year. Earlier this year, during the crash of the Russian Ruble, Apple had more cash than Russia! If demand for U.S. debt decreases, we wouldn’t be able to continue to sell debt to cover government’s excess expenditures.
Question: Household savings have increased to 8% of income from 2% in 2008. Savings groups are lobbying Congress for higher rates in order to receive a better return on their capital. How will the government be able to pay higher interest on their outstanding debt if they already borrow several hundred billion dollars annually to pay interest on existing debt?
Answer: An increase in the cost of interest would significantly increase the government’s deficit, and hence increase borrowing. With $20 trillion of debt, an increase in interest expense of 2-1/2% would cost the government an additional $500 billion annually in interest payments. That is an area of friction between savers (especially retired savers) and the government. It’s in the government’s best interest to keep interest rates as low as possible. Savers want a “market” return on their capital. They feel government has rigged interest rates on the low side for their own benefit, because the government’s interest payments are among their greatest budgetary items.
Conclusion
Discord around the world has caused people to move money and assets out of troubled countries. The safest place to be is dollar based investments.
The Everyday Price Index (EPI) dropped 3.6% this year, which is deflationary. In addition to the drop in the EPI, the average wage earner is taking home 4.6% more this year than last year, all of which translates into a significant increase in cash available to the average household. That bodes well for consumer spending, approximately 67% of our GDP.
The U.S. has added 2.8 million new jobs this year and there are currently 4.9 million job openings. Our 143 million employed is a record, which is logically followed by record household net worth of $86 trillion, an astounding 30% of the world’s estimated net worth.
Times are very good. The table is set for continuing U.S prosperity. Coupled with a huge increase in the availability of cash to the consumer, the outlook for 2016, at least, and probably for the next couple of years, is very good.
Carpe Diem.
George Rauch
December 18, 2015
