Market Watch - Ocotber 22, 2010
To understand today's economic problems; investors must come to grips with four major economic events that currently dominate our economy:
| 1. | Softness in the housing market from foreclosures and lack of cash; |
| 2. | Chronic unemployment; |
| 3. | Destruction of purchasing power; |
| 4. | A tanking US dollar. |
(1) Softness in the Housing Market. The banks are now in the real estate business. Housing starts have been less than usual coming to an annual average of 600,000 housing units over the last 2 years. That represents tremendous under-building, as a healthy economy will produce about 1.5 million new housing units annually. Under-building cannot be rectified until about 4 million foreclosures are settled. There has been a continued drop in mortgage loan applications. When loan applications begin to increase, the housing market will move towards a healthier environment.
(2) Chronic Unemployment. Economists point out that productivity is decreasing. Those productivity decreases usually occur when labor is exhausted and companies are booking heavy overtime hours. Labor is tired. New hires decrease overtime costs, and stresses, and productivity begins to increase again. However, there is now almost no overtime, and recent productivity decreases are most probably small employers (who employ most of the nation's workers) who are simply keeping people on the payroll. These are skilled workers who have been long term employees. Therefore, if this is correct, there is likely to be a long period of time with the economy improving in which no noticeable new employment will occur. Instead, the productivity of currently employed workers will increase until they can no longer handle the increased workload. Real productivity will decrease then, and we will see an uptick in employment. We are currently a long way from such an event.
(3) Destruction of Purchasing Power. The next 12 months will require financing and refinancing, of U. S. government excess expenditures, and outstanding debt, of $4.5 trillion. This will put pressure on the dollar. As the Federal Reserve continues to add trillions of dollars to the national debt, inflation from those excess dollars will cause a further depreciation in our buying power.
(4) Tanking U. S. Dollar. Since June 1st, the dollar has decreased in value by 23%. The current total national debt of the U. S. exceeds $13 trillion. With a depreciating U. S. dollar, and historically low interest rates, no returns exist on debt. The public's knowledge of how much new money needs to be created, has caused foreign investors to lose interest in the dollar. The primary Middle Eastern Gulf oil suppliers are planning a new currency in which to trade oil to get away from using dollars. China has also announced that its currency will become convertible soon. China holds only 1.6% of its $2.5 trillion in monetary reserves in Gold. The free world's average gold reserves are 10.7% of their country's monetary base. China is now the world's largest producer of gold, and China's government is adding gold to its reserves as quickly as possible. For China to reach just the world's average in gold of 10.7% of their reserves would require them to purchase 3 full years of production based upon last years gold production of 2500 tonnes, a cost to China of $100 billion per year. China's dollar reserves are $1.5 trillion. At a present market value of $1400 an ounce for gold, China would need to use only 20% of their dollar reserves, or $300 billion, to reach the world's average of 10.7% gold in their reserves. That will continue to put upward pressure on the price of gold. As the price of gold increases, the purchasing power of the dollar decreases.
The Government's Solution to our Problems
The government has declared that the solution to our problems is to continue to keep interest rates very low and to continue to print as much money as necessary in order to "properly" stimulate the economy. In other words, business as usual. The government will continue to make the same mistakes they have made since the founding of the Federal Reserve System in 1913. The problem here is the government is again deceiving the public. The "stimulus funds" that the government is now producing are not to supplement lack of cash in the private sector, but rather, provide cash to keep government employees "gainfully" employed. The truth of the matter is that the government lacks tax revenues to carry on business as usual. What the public has not yet figured out is that there is much less tax revenue in this bad economy to support government spending. Thousands of tax paying businesses are out of business, and thousands of business owners who remain in business are no longer paying income taxes because they are not making any money (income). So while the government would have us believe that this current round of "quantitative easing" (government euphemism for printing money) is for the private sector, the "stimulus" is simply to sustain existing federal government employees. Private sector businesses have had to lay people off—the federal government has not laid anybody off or closed any of the unproductive or unnecessary departments that drain the nation's resources.
Permanent Solution
Thomas Paine wrote a book called Common Sense which inflamed the Colonists into wanting individual liberty and freedom from the shackles of the English Government. He wrote about central banking and paper currency as follows: "Money when considered as the fruit of many year's industry as the reward of labor, sweat and toil, is not to be sported with, or trusted to, the airy bubble of paper currency". 100 years later, Baron Rothschild said: "Give me control of a nation's money supply, and I care not who writes the laws". It has been 39 years since President Nixon severed the backing of the U. S. dollar from gold and silver, or what The Constitution called Commodity Money. The Federal Reserve is now the most powerful institution in the United States. It makes money out of nothing, and it's so secret that Congress cannot even get an audit of the system. Why? Because thinking economists know that economic progress is a result of saving and investment, not creation of money out of nowhere to pay for something nobody earned through sweat and hard work. Consumption at the expense of savings reduces our ability to create wealth and lowers our standard of living. The trade off for 40 years of financial exuberance, and debt increases, is deflation, deleveraging, and a lowering of our standard of living. The Fed's creation of money, called fiat money, meaning money made out of paper with no gold or silver backing, is immoral and evil. The only power evil has is the power to destroy itself. Money creation by the Fed is in the process of destroying itself. Evidence? Look at the depreciation of the dollar's purchasing power since 1971 when Nixon severed the dollar from gold and silver. Historically, fiat money has lasted only 40 years in all economies who have tried using fiat money. Coincidently, we are now in our 39th year, and look at this mess.
Conclusion
The Dow Jones Industrial Average currently yields 2.5%. Charles Dow wrote that dividend yields of 3.5%, and less, means stocks are too expensive and should be sold. In fact, if one had sold stocks when yields decreased to 3.5%, an investor would have avoided every bear market over the last 100 years. In the stock market, gains come from buying values at the right price. With world over-production of goods, and a lack of cash to purchase those goods, the price of goods will continue to decrease. The big gains in bull markets come from expanding price-earnings ratios. And the big losses in bear markets result from decreasing price-earnings ratios which is what we have experienced over the last few years. Our 27 year old bull market ended in 2007. Historically, bear markets last 1/3 to1/2 of the preceding bull market. Yields at the bottom of bear markets go to 6%, or more, on stocks, and price-earnings ratios get as low as 6 to 8 times earnings.
The task ahead is to hold on to whatever wealth we have. The winner in a bear market is he who loses the least. Build up cash and add to gold and silver investments when excess cash is available. The stock market has nowhere to go, and gold and silver continue their dramatic increases in price. While cash currently pays no yield, cash has two terrific values: (1) security, and (2) opportunity to buy investments on the cheap as this vicious bear market continues.
Caveat Emptor
George Rauch
October 22, 2010
