Market Watch - May 11, 2010
The first rumor floating around about last week’s market selloff of 1000 points was that an order was placed requesting the sale of a billion shares of a stock, rather than a million shares of the stock. That was baloney. Nothing like that happened. Last week was an example of the continuing uncertainty that will exist in the markets until the U. S. government gets its spending and taxing policies under control. Look at the chart.
| Country | 2009 Deficit as a % of GDP |
| Ireland | 14% |
| Greece | 13.6% |
| Spain | 11.2% |
| United States | 11.1% |
| Italy | 10.4% |
| Portugal | 9.4% |
These countries have budget deficits as a percent of their GDPs in excess of 9%. To put this in perspective, let’s say that U. S. deficit expenditures of 11.1% of GDP last year, was based on an economy with a GDP of $100. State, local and federal government would spend $35, more or less, from taxes, leaving $65 in the economy. However, the $35 was not enough for our federal government, so they borrowed another $11 to meet their operating expenses in 2009. If the government was a family, the family would be broke, because the family does not have the power to print money. The government simply goes to the Federal Reserve System and says “I need another $11 to meet operating expenses”, and the Fed acquiesces. The reason the Fed acquiesces is because the fed is totally dependant upon two things to stay in business: (1) big central government, and (2) a handful of private banking institutions that are “too big to fail”. This accommodation to government excess spending requests, shown in the chart, is encouraged by the central banks, because that is how they make money.
Deficit spending is, furthermore, encouraged by the banks that are “too big to fail” because they are the ones that sell government securities. They make a market in government securities, and they hold hundreds and hundreds of billions of dollars in government notes and bonds every hour of every day of the year.
As long as we have spending like this, the markets will remain jittery. The market’s questions really mirror our own:
| 1. | How will the government get the budget balanced? |
| 2. | At whose expense will this budget correction be, and how much will it cost in additional taxes? |
| 3. | Is the government merely going to lie to us and go about their merry ways as they have over the last 40 years? |
| 4. | Can we find enough leaders in the House, and in the Senate, whose egos are not so bloated by their power, that they will be able to vote to get America under control again? |
| 5. | Will interest rates continue to go up for many years as the bond market is now indicating? |
The answer to the above questions will give us an idea of which way the market can be expected to move over the next several years. So far there are no proposals on the table to curb any of this spending except for the European Economic Community “legislating” to Greece that they must reduce their deficit from 13.6% of their GDP to 3% of their GDP. That’s how socialistic governments solve their problems, and that is probably the best the U.S. government will do. Legislation like that means people have accepted the right of the government to spend money in excess of existing tax revenue.
So the solution insures what, above all else? It guarantees a continuation of big government in all countries that accept solutions like the above. And as usual, the government is not the solution to the problem; the government caused the problem to begin with. Continued government solutions to problems only breed more government and additional future problems.
During the last month it has become increasingly difficult to sell government bonds without higher interest rates being offered. The bond market sees clearly that all of this deficit spending is going to cause inflation over the long term, seemingly forever. Investors are therefore not willing to buy any kind of long term government paper (15-30 years) without an adjustment for inflation in the interest rates of the bonds purchased--meaning higher interest rates! We have had a 30 year bull market (bonds going up in price and interest rates going down), and it looks like the bull market in bonds is over. The amount of financing, and refinancing, of government debt, is so great that it continues to compete with the private sector for investment capital, thereby pushing up interest rates.
Increased interest rates not only hurt the housing market, and business in general, but the government will end up paying a lot more in interest expense, potentially adding to future deficits. Unemployment will remain high and profits will be squeezed putting further pressure on the tax receipts of the federal government. The greatest growth industry the last 40 years has been government. Over 40 years we have accumulated a phenomenal $11.4 trillion of debt, in a $14.3 trillion economy. None of this money went into bricks and mortar, or anything of substance that produces profits. It has all been used to buy votes, and it has all been used for welfare of one form or another.
Last months Market Watch Article was titled Beware of the New Bull Market. There is a quote from that article that is pertinent now: “The market has so many dislocations, even though it is going up, it remains dangerous. In spite of the “crash” we have had over the last few years, the stock market lows have not degenerated to historic bear market values”.
The above is more pertinent now than it was 30 days ago. On Friday, May 7th, the Dow closed at 10,380 points, 48 points below its year-end 2009 close of 10,428 points. We have lost all stock market gains this year in one week of market activity. Debt is the current consumption of future earnings. We are complicating our children’s and our grandchildren’s financial futures by allowing our government to behave in this irresponsible manner. And it’s crippling the stock market.
The dollar is likely to lose its reserve status (the dollar represents 65% of the world’s monetary reserves). Sovereign countries, with their own problems, do not want to fund our deficits any longer. And while nobody really believes the U. S. would renege on their debt, it already has. When Nixon closed the gold window in 1971, and refused to ship to France the gold that we owed them as a result of their excess holdings of dollars, we broke a long standing contract with all countries.
During 2000-2009 we had the worst stock market degeneration in our history, greater even than the 1930s. During that time we lost our manufacturing base. We built up a $54 trillion mountain of unfunded liabilities; Medicare, Medicaid and Social Security. And that was before this new healthcare legislation that has not been funded, and that nobody knows how to fund. There’s literally no money out there. During those years the U. S. maintained its standard of living through credit, and borrowing, from other countries, and while that still is the case, it is a process that is no longer sustainable.
And guess what? Recently, behind closed doors, with no cameras or press releases, President Obama signed a bill increasing the U. S. debt ceiling to $14.29 trillion from $11.53 trillion.
Stay in cash and see what happens. Gold investments are a terrific hedge with all the inflation and future economic problems we are facing. Remember, gold is not going up in price as it buys the same thing per ounce it did 100 years ago. The purchasing power of the dollar is going down. An investor with a good cash position is always able to cover their current needs, plus make good investments when they become available. The stock market is currently a very risky investment. Better to stay in cash, or cash equivalents, than risk much money in this already dangerously overpriced and volatile market.
Caveat Emptor
George Rauch
May 11, 2010
