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Longboat Key Wednesday, Mar. 3, 2010 9 years ago

Market Watch: The Depression is not waning

by: George Rauch

A neighbor of mine asked me recently if I was going to write another depressing article. While I floundered around and said, “I hope not,” the facts are the facts. Market Watch’s job is not to cheer people up, but rather to place before them critical components affecting our economy that do — or will — affect their investments.

There have been good times to write about over the last several decades, however, the outlook is not good now even though the Fed, Wall Street and our politicians continue to encourage us to “see the bright side.”
There is nothing “bright” about these economic dislocations. They have been brought about by government debt, by excessive rules and regulations placed upon business and by the inability of government to keep itself under control. 

The last decade ended in no job creation; no economic gains for the average family; no gains for homeowners; and no gains from stocks. Additionally, at these already bloated price-earnings ratios on the Standard and Poor’s Index of 500 Stocks, all mathematical studies show that, at best, over the next 10 years, the most one can expect for return on his investment is 5% annually, including dividends, a return that’s probably less than inflation.

The following problems must be solved before renewed growth can favorably affect our economy. 

1. The multi-trillion-dollar debt of the U.S. is so insane that it can never be paid off by raising taxes. More importantly, it continues to increase with no end in sight, and the interest on the debt is rising and compounding at a relentless pace. The Federal Reserve has held interest rates down about as long as it can in order to keep the government’s interest costs down, but the market is now refusing to accept these bonds at artificially low interest rates.

Interest rates have therefore been rising, and with all the dollars the Fed has added to the money supply, the potential for inflation is enormous. A 1% increase in interest rates costs the U.S. government $120 billion per year.

2. The U.S. dollar is the world’s reserve currency. Not only are countries now rejecting dollars, but there is not enough cash in the world’s economic system to absorb the $3.5 trillion financing of U.S. debt required over the next 12 months.

With the government’s domestic policy of massive credit expansion, artificially low interest rates and the takeover of private banks and automobile-manufacturing companies, the value of the dollar will continue to drop against other currencies. The world’s Treasury bond buyers know the government has no option but to print more paper money. That solution compounds our current economic problems.

3. There are now more women working than men; 50% of families are divorced; 70% of children living below the poverty level are born out of wedlock; there are six people available for every new job created; the percentage of the American population in jail is the highest in the world; and being grounded in a religion is less of a family priority. That host of social problems is going to continue to create an enormous economic drain upon our system.

4. Expansion requires borrowing from the private sector. Individuals and corporations are not borrowing, but, rather, they are saving and building up cash. The government wants us to spend, and American consumers are saying ‘no’ They have been burned enough, and they are determined to continue to build up savings and keep themselves comfortably solvent. There will be a shortage of capital for expansion if building cash remains a priority. 

5. The jobless situation is worse than the 10.2% the federal government publishes. Most economists agree that the number approaches 20% unemployment when consideration is given to those who are underemployed and those who have stopped looking for a job. With six people available for each new job in the economy, it will take years of growth at a high rate to absorb the unemployed.

Although the U.S. economy has witnessed high rates of growth in the past, that growth was not frustrated to the extent we are today with government debt, exorbitant taxes and the sheer size of this government. One in seven mortgages is delinquent, up from one in 10 a year ago. Household debt to GDP was 65% 14 years ago, and today it is 100%.

6. We need 10 million jobs to get back to 5% unemployment, the rate we had before all of this began. Creating 1.5 million jobs a year is necessary just to absorb young people coming into the labor market. If we begin to produce jobs at the rate of 300,000 a month, the amount in the late 1990s during the strongest job growth in our history, it would take more than four years to dig ourselves out of this hole. 

7. In 2000, gold closed at $274 an ounce. Each year through 2010 gold has closed at a higher price than the previous year, and it now stands at $1,124 an ounce. Similar rises in gold have historically meant one thing: Gold is not rising in value, but, rather, paper currency’s purchasing power is decreasing relative to gold. If the Dow Jones Industrial Average closed at a new record every year for 11 years in a row, it would be all over the newspapers. Gold-price increases, however, mean the dollar is depreciating in value, and we seldom read about the tremendous rise in the price of gold. Governments hate gold. Central banks hate gold. They hate it because the gold standard sets limits upon government lending, as well as government spending. 
Ludwig von Mises, the great Austrian economist wrote, “There are no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved.”

Our current situation bears out the validity of von Mises’ bedrock thought. We have tried to solve all of our government-created economic disasters by expanding credit — and government — further. There is little hope for stocks and bonds, with the mass of major problems and hurdles to be overcome listed above.

Not only have we failed to slow down the credit expansion and the continuous printing of new dollars, we cannot get our own government spending under control to the point where revenues and expenditures are balanced, or ever will be balanced.

With all of these variables, we don’t even know if this economy can be pulled out of its current tailspin without a complete restructuring. A complete restructuring would entail getting rid of the Federal Reserve System; reducing the size of government dramatically, returning to a disciplined monetary standard such as gold and/or silver; and privatizing huge programs that eat cash such as Social Security, Medicaid, Medicare and so forth.

The government is not empowered to be participating in most of the programs it is participating in now.
Cash is king. Sit on the sidelines, enjoy living in Florida, build up your cash and make sure our politicians’ behavior matches that which is demanded of them by the Constitution. 

Although these facts may not be “upbeat,” digestion of them could position an investor well. Accumulating cash will put the wise investor in good shape to participate in another economic boom when it occurs.

Caveat emptor.

George Rauch, Longboat Key, is chief executive officer of Bradenton-based General Propeller and a former Wall Street investment banker.

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