Market Watch

The retail public is back. They are bullish and heavily invested in stocks, probably because there is not much yield on bonds. High-grade stocks pay more in dividends than bonds pay in interest, and stocks have the potential to increase in value. Unfortunately, the market is not priced for gains — it is priced for losses. The yield on the Dow Jones Industrial Average is 2.5%, substantially below the historical Dow yield of 4.3%. If the Dow, currently priced at 11,000 points, were to sell at its average long-term dividend yield of 4.3%, the market would be priced at 6,400 points instead of 11,000 points. That number is a more realistic value for the current Dow.

With chronic unemployment, the destruction of our purchasing power, government deficit spending and softness in the housing market from foreclosures, how can the Dow be priced at almost double its historical averages?

The government’s plan is to keep the market as high as possible and to keep people hoping that all is well with the market. By this latest round of moneymaking (called QE2 to confuse citizens), there is a huge additional amount of money available for investments. The Fed has made sure that interest rates remain low, so that bonds are not an enticing investment. Bonds yield virtually nothing. The public is more interested in the yield they can get on high-quality stocks. Of course, this volume of “moneymaking” out of thin air by the Fed is highly inflationary. Simply put, inflation is the overproduction of currency.

Overproduction of currency sounds simple, and if it’s that simple, why can’t we just quit overproducing currency?

Eventually we will be forced to economically; however, for as long as our politicians can do so, they will create money out of thin air to fulfill their promises to the electorate. And the promises always relate to citizens who either cannot, or will not, support themselves. For example, unemployment compensation is paid to 8.85 million people; food stamps are given to 42.39 million people; Social Security and the Medicaid/Medicare programs cost $1,305,000,000,000 annually, or 9% of GDP. None of these payments is authorized by the Constitution as being part of the federal government’s responsibilities. 

What are the federal government’s financial obligations in the future, and how do we plan to pay down our debt?

Taking the last question first, we have no plans whatsoever to pay down the national debt. As far as future obligations are concerned, both the comptrollers of the currency and the Treasury Department have verified that our future obligations exceed $50 trillion. That estimate has currently been blown out of the water by Boston University economist Warren Koplikoff, who now writes that our obligations exceed $200 trillion, not $50 trillion. Koplikoff writes in the September issue of the International Monetary Fund’s journal as follows: “The U.S. fiscal debt is huge. Closing that fiscal gap by taxation would require an immediate and permanent doubling of our personal income taxes, our corporate taxes and all other federal taxes.
Let’s get real, the U.S. is bankrupt.”

Although things seem a little bleak, certainly this country would not default on its debt — or would it? 

The government is already defaulting on the debt by making a conscious effort to decrease the value of the dollar through inflation, so that government debts paid off in the future will be paid in much cheaper dollars. Although it seems unlikely that great economies like the United States could default on its debt, Hapsburg, Spain, defaulted on its debt 14 times between 1557 and 1669. Pre-revolutionary France was spending 62% of the state’s income on debt service alone by 1788. The Ottoman Empire interest costs rose from 15% of the budget in 1860 to 50% of the budget in 1875, and the English empire in the 1930s had interest payments consuming 44% of the budget. The United States is currently marching right straight down that path.

Is there a solution?

There is a solution: Cut back spending so that spending matches revenue. We should get rid of the Federal Reserve System. Put the power to coin money and create debt back on Congress as the Constitution provides. Finally, a resumption of commodity money, such as gold and silver, would immediately contain both excess government spending and inflation.

Isn’t the Federal Reserve System the savior of last resort?

No, the truth is that the Federal Reserve is broke, too. The Federal Reserve balance sheet published before the 2008 meltdown showed loans in 2007 of $915 billion and a capital position of $37 billion, or capital of 4% of the Fed’s loans. That is a deadly ratio of risk to capital. After the 2008 meltdown and the Fed’s purchase of all of the toxic assets offered by the banks, automobile companies, insurance companies and so forth, the Fed’s loans ballooned to $2,235,000,000,000 against capital of $51 billion, or a capital ratio to loans of only 2.3%. In other words, the present Fed cannot have toxic (under-performing or un-performing) assets of more than its capital of $51 billion, or the Federal Reserve System, like many member banks of the last two years, would be totally bankrupt — not technically bankrupt like they are now.

In the last 21 months, the Fed has created $2.5 trillion of new money out of nowhere. The purpose: so they could buy the toxic assets that failed from the banks and whoever else they bailed out.

Advice: The wise investor will stay out of the market, pay down debts and raise as much cash as possible.
The current stock market is priced for failure. 

Caveat emptor!

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