Market Watch - December 21, 2003
YES
The Feds policy of lowering interest rates and flooding the economy
with new money has worked. Unemployment is stable and appears to
be improving. The government’s tax cuts have provided incentive
to taxpayers to spend money, which has added cash flow to our economy.
The government deficit of $600 billion for the fiscal year just
ended also provided cash flow to the economy, as did additional
funds voted by Congress to wage war in the Middle East. This fiscal
year will be helped along by additional defense spending, which
will create more new jobs, and by the new prescription drug program.
The stock market’s advance/decline ratio has been solid this
year on the up side. The Dow has increased 40% in value the last
fourteen months. The public is back in stocks; the government has
fought off deflation and won. The Dow Jones Industrial Average and
The Dow Jones Transportation Average have confirmed each other’s
recent new highs. The market has regained more than 50% of its bear
market loses.
The rest of the world will continue to cooperate with America to
insure drastic economic calamity does not occur. America’s
economic health is paramount because the US GDP represents 1/3 of
world GDP, and the dollar represents 70% of all the world’s
monetary reserves.
The bear market is dead, and we are on the cusp of a new bull market.
The whole world revolves around US consumer spending, which represents
2/3 of our own GDP. The consumer has been spending this year. While
the spending has produced unheard of trade deficits, “what
goes around comes around”. Our trading partners that have
been accumulating dollars have been recycling those dollars back
into the US by purchasing our treasury bonds. Their purchase of
our treasury debt helps fund the deficit, keeps the system going,
and sustains the inter-dependant and cooperative nature of our “new
world order”.
NO
America has seen the apex of its power. Our power was built upon
a free economy, which helped build a strong currency.
The dollar has been in a nose dive since late 2002. A collapsing
dollar puts pressure on all nations we trade with and all countries
who settle international debts with dollars.
In 1944 when the dollar replaced gold for settling international
debts, 80% of the world’s monetary gold reserves were owned
by America and used to back the dollar.
There were three reasons the dollar
became the world’s reserve currency.
| 1. | The world was in a state of destruction, and in 1944 it was not certain who would win the war; | ||
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| 2. | The dollar was fully convertible into gold to settle international accounts; and | ||
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| 3. | The dollar was in great demand in 1944 to settle international transactions. |
Until recently there was no alternative to the
dollar for settlement of international transactions. For the first
time in fifty years, a viable alternative, the euro, is available.
All free economies are manufacturing money out of thin air to cover
their government’s deficit spending with nothing other than
paper promises. No material offsetting value like gold and silver
is in the picture, which means there is increasingly more money
available to purchase a limited supply of the world’s goods
and services. Mathematically, the price of goods and services will
increase to meet an increasing supply of money – this is what
we call inflation.
One would logically conclude, if all free economies are manufacturing
money, that when everything is sorted out, the US economy will maintain
its relative position. That logic fails because the US economy is
the tail that wags the dog, and while US spending keeps the world’s
economy chugging along, US spending is built upon debt and nothing
else of any substance. We have lost our manufacturing base, and
we have become a knowledge-based economy. We will never again be
the dominant industrial power. Cash flow in our economy has improved
only because the government’s program of manufacturing money
and creating artificially low interest rates has pushed up the demand
for assets like gold and real estate. The increase in real estate
values, which for the last eight years has exceeded an increase
in inflation by an unheard of 35%, has encouraged people to borrow
money and spend rather than save and be frugal. The increase in
real estate values has been accompanied by attendant increases in
debt.
As the dollar continues to break down, those countries holding dollars
as a reserve currency will look for alternatives, like the euro.
There was a small article in the Wall Street Journal in early December
pointing out that Moody’s Investors Services would consider
reducing the US government’s AAA debt rating to AA within
the next 12 to 24 months unless government spending, and our trade
deficit, are brought under control. Such a rating decrease would
cause interest rates to soar and increase the cost of carrying our
debt. Foreigners would be discouraged from further purchasing our
debt as the value of the dollar decreases. The lower the dollar
goes, the more foreigners will lose by holding dollar backed securities.
They will look to accumulate an alternative currency, like the euro,
which enjoys a positive, rather than a negative, trade balance.
The US government spends annually more than $20,000 per family unit.
Government debt of almost $7 trillion, coupled with private debt
exceeding $34 trillion, together amount to debt of half a million
dollars per family unit in this country. Just the cost of annual
government expenditures, and the need to service existing debt,
are two things that must be built into our product prices in this
country before enough goods and services can be sold overseas to
ameliorate our trade deficit. It is simply not realistic to assume
we can price our products competitively, and compete in world markets,
with such financial burdens built into our product pricing. We are
competing against countries with inexpensive labor resources that
will be able to out price us for the next several generations.
CONCLUSION
At this writing, the large money supply, M-3, is going down. Retail
sales, which support 2/3 of our economy, are disappointing. Summarized,
this means that in spite of the Fed’s flooding the market
with money, consumers are finally either saying “no”,
or they are tapped out, borrowed to the hilt, and cannot, or will
not, borrow anymore. A reduction in spending, at best, will provide
us with the “stagnation” that existed in the late 1970’s
and early 1980’s.
The probability that the dollar will continue to go down and be
rejected by other countries is far greater than the probability
that the dollar, with no substance and no backing, will come back.
A continuing decline in the dollar will negatively affect US stock
markets that are already the most overvalued markets in history.
It appears
the current run-up in the stock market is a bear market correction
of previous lost ground, which corrections historically average
1/3 to 2/3 of values lost. This looks very much like the mini bull
markets that occurred in 1967/1968, and 1970/1971, all of which
were promoted by a tidal wave of new money created by the Fed.
Caveat Emptor!
George W. Rauch
December 21, 2003
