Puplava:
>>At the current rate of spending the government will need to borrow close to $1 trillion every eighteen months. Forget about surpluses; they existed only in the fictional world of government accounting. The US is a debtor nation and the amount of money that it needs to operate is now growing at a monumental rate.<<
The Great Debate
In Washington it has become the main debate between the two major political parties: how to revive the economy after a boom turned into a bust. There isn’t much difference between the two sides economically. Both parties believe in monetary and fiscal stimulus. In essence both parties adhere to flawed Keynesian economic principles. The Democratic philosophy is to raise taxes and spend more money. The Republicans believe in lowering taxes and spending more money. One side emphasizes welfare; the other side defense. That is the essential difference between the two parties. Both parties are Keynesian in their belief that the government should run deficits in lean times in order to stimulate the economy. However, both sides have forgotten the surplus side of Keynesian economics, which calls for the government to run surpluses during the good times. The surpluses during the good times are to be used as savings for a rainy day when the bad times come. The problem is that there were never any surpluses. The only surpluses came from the social security trust fund, which the government borrowed, spent and then issued IOU’s.
Throughout the 70’s, 80’s, and 90’s the U.S. government continuously ran budget deficits. The result is that our national debt will reach $6.4 trillion by the end of this month. The Treasury sent a memo that went unnoticed by the financial media last month. The memo states by the end of January or early February, the debt ceiling will have been reached. In less than eight months the US government has borrowed $450 billion. In June of last year Congress raised the debt ceiling by $450 billion from $5.95 trillion to $6.4 trillion. The money has now been spent and it will be necessary to raise the debt ceiling even higher. At the current rate of spending the government will need to borrow close to $1 trillion every eighteen months. Forget about surpluses; they existed only in the fictional world of government accounting. The US is a debtor nation and the amount of money that it needs to operate is now growing at a monumental rate.
In addition to the government’s borrowing needs, which are running close to $500 billion every seven months, the US is also borrowing $500 billion annually from overseas investors to finance its longstanding trade deficits. If that isn’t enough to scare you, the money supply as represented by M3 grew by over $500 billion last year. We are now expanding the money supply by over half a trillion a year, the government is borrowing over half a trillion a year, and we are borrowing half a trillion a year to finance our trade and current account deficits. Something is wrong here and it is surprising that Washington and Wall Street see nothing wrong with these facts.
Synthesizing What Other People Think
I spent the holidays reading every business and investment magazine forecast for the upcoming year. Everyone is convinced that the economy, corporate profits and the stock market will be up this year. The economic assumptions are based on continued consumer spending and increased business investment. The consumer who is tapped out with debt is expected to go even deeper into debt in order to maintain consumption. Business profits that have been trending down since 1997 are expected to pick up this year, which experts believe will lead to an investment and capital spending boom by business. The thought is that higher profits will lead businesses to take on risks by spending more money on new plants and equipment. Businesses will continue to cut costs by reducing payroll meaning more people will lose their jobs this year on top of the 2 million jobs that have already been lost in manufacturing since this downturn began in 2000. These fired workers are expected to go deeper into debt by borrowing more money and then go spend that borrowed money on consumer goods. This kind of thinking is one reason why Wall Street and Washington have gotten all of their economic and financial forecasts wrong over these last three years.
This leads me back to the current economic debate going on in Washington as to how best to stimulate the economy. The Democrats are emphasizing consumption versus savings and investment. This is the standard Keynesian prescription, which places emphasis on consumption versus savings and investment. Economics in this country today emphasize consumption versus savings and investment. Instead of savings we have substituted debt in its place. Our tax laws encourage debt accumulation. Interest on debt is deductible. A company can borrow money and deduct the interest it pays to bond holders as an expense. On the other hand, if the company pays a dividend, it gets no deduction and must pay tax on that dividend. The dividend that it pays out to its shareholders is then taxed again, so the dividend is taxed twice while the interest payment is deductible. Many people on the Left see nothing wrong with taxing the same income twice.
Spending Our Way to Deeper Debt
This policy of treating debt more favorably than savings is one reason why there is so much debt in this country. There is an abundance of corporate, government and consumer debt that is now reaching epic, even biblical proportions. As a country, the US is borrowing and printing over $2.5 trillion a year. Debt and printed money have been growing at double-digit rates since the mid-90s. This figure is growing faster and even larger and threatens the entire financial system. The financial system will eventually collapse from the weight of this debt or the US will turn into another banana republic as its currency becomes worthless.
The problem goes back to the Great Depression where this country changed its economic course. We went from a society that saved, invested and had a strong manufacturing base to a society that borrows, spends, and consumes. It is one reason that economic growth rates have slowed down in this country during the later half of the last century. It is also the reason why the US has become the largest creditor nation in the world, absorbing nearly 80 percent of all of the world’s savings to support our voracious appetite for consumption. We don’t save, we don’t invest, and we don’t make many things anymore. Instead of saving we borrow money. Instead of investing in new plant and equipment, we buy other companies or merge with them. Instead of manufacturing things, we consume them. It is this kind of thinking that is making the recovery so fragile, the financial markets so volatile and the financial system so perilous. This issue will be addressed in more detail in this week’s Storm Update.
Getting back to the markets for this year, stocks received a nice bounce on Thursday due to a higher ISM report. However, that report was highly skewed by seasonality’s and defense spending. The Institute for Supply Management’s Index for non-manufacturing slipped last month from 57.4 to 54.7. The index represents the service side of the economy and has remained above 50 for the last 11 months. A reading above 50 indicates the service sector is still expanding while a reading below 50 indicates contraction. Demand rose for real estate, health-care and business services while demand contracted for wholesalers, public administration and utilities. Last week’s ISM report on manufacturing and this week’s report on service shows that the economy continues to grow albeit at anemic rates.
Wall Street Buoyed on Hope
Stocks got a nice boost today from hopes that the President’s plan to stimulate the economy and the financial markets will include tax cuts and the elimination of the double taxation of dividends. Money poured into the markets today as volume increased to the upside. Indeed, Wall Street is hoping that this will be the year that the stock market finally goes positive after three back-to-back years of double-digit losses. There have only been three times that stocks have lost money for investors three years in a row. The Street forgets that there was actually one time when stocks fell four years in a row back in 1929-1932. Wall Street is betting that this year will not be a repeat of the disastrous years of the Great Depression when the Dow lost up to 90 percent of its value.
So far in this bear market the Dow has lost 29 percent, the S&P 500 has lost 42 percent, and the Nasdaq is down over 73 percent. What is not mentioned by the financial industry or the financial media is that real P/E ratios on the S&P are still running close to 50. The dividend yield is only 1.7 percent. Furthermore, corporations carry more debt off their balance sheet ($3 trillion) than is reported on financial statements. In addition to debt, corporate assets are grossly inflated by worthless goodwill accumulated from mergers and acquisitions. Many of those acquisitions and mergers were made at grossly inflated prices, creating billions of worthless goodwill on the balance sheet. During the 1950’s assets on the balance sheet consisted of real assets. Real assets such as property, plant, and equipment made up close to 80 percent of a company’s assets. Today that figure has fallen down to around 53 percent. The rest is questionable goodwill, which is one reason why nobody talks about real earnings anymore. Much of that worthless goodwill is being written off in the form of huge impairment or restructuring charges. This is why there is such a great emphasis on pro forma numbers. The real numbers look horrible and would make stock prices look more overvalued than what is actually reported to the investment public.
For the moment, there is hope in the air that 2003 will be a much better year for investors. The markets are now moving on hope and better things to come. This is similar to last year before the middle of the month when economic reports and earnings confessions begin. And of course this year there is the carryover strike in Venezuela and the upcoming war with Iraq. I suspect that the markets will rally short-term on hope and hype and then fall hard as reality sets in when earnings reports, confessions, sins of omission, and other vagaries of the economy and the political landscape start to set in. But this is a new year and stocks rose in anticipation of better things ahead. The Dow gained 2 percent, the S&P 500 rose 2.3 percent, and the Nasdaq rose 2.5 percent. The main impetus behind today’s rally was the possible elimination of the double taxation of dividends. Stocks that pay high dividends such as food, tobacco, energy, utilities, and financials were big winners. Fund managers and yield-hungry investors were big buyers of dividend paying stocks in anticipation of the President’s economic stimulus package, which is hoped to include a dividend tax break.
On top of the possible good news on taxes, investors were buoyed by Wall Street strategists who boosted their forecast for stock market returns this year. Morgan Stanley’s Byron Wein predicts that the stock market will return more than 25 percent during the first half of the year. Banc of America’s investment strategist Thomas McManus believes the Nasdaq will return 30 percent this year. Most experts are expecting a big year for the stock market and economy, so the message for investors is to buy stocks now while they are still cheap. Even though they have been wrong for the last three years, they believe they will be right on their predictions this year. After all, it is rare that stocks go down four years in a row; this is the third year of a Presidential election cycle, etc. etc.
In addition to the run up in high paying dividend stocks such as utilities, energy, and financials, tech stocks rose after the Federal Communications Commission said it would drop its plans to require local phone companies to rent out their networks at cheap rates to competitors.
Volume picked up to 1.4 million shares on the NYSE and 1.55 billion on the Nasdaq. Market breadth was positive by 24-8 on the big board and 22-11 on the Nasdaq. The VIX fell by .57 to 27.41 and the VXN dropped 2.26 points to 43.45. The lower volatility levels indicate that fear is leaving the market, which is another contrary indicator that we are getting closer to a top.
Overseas Markets
European stocks rose, led by oil companies on expectations they'll benefit from higher crude prices. Royal Dutch Petroleum Co. and Total Fina Elf SA gained. The Dow Jones Stoxx 50 Index added 0.5 percent to 2530.74. It erased a loss of as much as 1.4 percent during the afternoon as Deutsche Telekom AG and Vodafone Group Plc, which make up about 7.5 percent of the benchmark, rose.
Asian stocks rose, led by Toyota Motor Corp., Samsung Electronics Co. and other companies that rely on U.S. sales, on optimism President George W. Bush's stimulus plan will boost growth and spur demand in the world's largest economy. Japan's Nikkei 225 Stock Average climbed 1.6 percent in its first day of trading this year to 8713.33.
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