Thursday, September 12, 2013

Economies, National Debts and Gold

A general optimism prevails in the United States and Europe that the economies have finally turned the corner and growth is resuming. In the U.S., automobile sales are up and the housing industry has been improving, but there are many negatives which show overall optimism is unwarranted. In Europe, too, there have been modest improvements—some negative growth factors have become less negative—and there is a general feeling that the bailouts of Greece and other countries are working well. Below we explain some less favorable facts about the U.S. and Europe which cannot be ignored. They pose continuing problems.

United States
The rate of economic growth declined over the past year to 1.6% from 2.8%. The employment figures released on September 6 showed August added 169,000 jobs, not enough to keep up with the growth in population. Moreover, the figures for June and July were revised downward by 74,000 jobs. June figures were also revised downward a month ago as were those for May. At the recent rate of hiring, employment won't get back to pre-recession levels for more than eight years. Of the new jobs created in August, a disproportionate number were low-paying ones in retail sales and restaurants.

Unemployment declined in August from 7.4% to 7.3%, but this was mostly due to the increase in the number of people who had stopped looking for work because they don't believe they can find a job. If they were counted as unemployed, the unemployment rate would be near 10%. There were also 7.9 million Americans who wanted full-time work but could only obtain part-time work. If these were included with those who have stopped looking for work, the rate would be 13.7%.

August was the 40th consecutive month in which more unemployed workers left the labor market than found jobs. Should we be asking “Is the economy going up or down?” In August the number of people reporting they had jobs—a separate survey from the payroll calculations of employment—fell by 115,000. Four years after the official end of the recession, in 2009, there are still 1.9 million fewer jobs than at the peak in 2008. And even though price inflation is now very low, workers' pay still isn't keeping up with it. According to Labor Department data, the average hourly pay for a non-government, non-supervisory worker, adjusted for price increases, declined to $8.77 from $8.85 at the end of the recession in 2009.

The labor participation rate includes those working plus those looking for work. In August this measurement was the lowest since 1978. This number has continued to decline throughout the so-called recovery from the recession. This recovery has been the slowest and longest from any recession in our history—in spite of the $831 billion stimulus program which was supposed to create economic growth.

One must question whether that stimulus program aided growth or retarded it. According to the Congressional Budget Office, every job created by the stimulus program cost the taxpayers between $500,000 and $4 million. Not only was the stimulus program ineffective, it added to the national debt, which retards future economic growth.

The euro-zone economy in the second quarter grew at a rate of 0.3%, compared to the previous quarter, ending six consecutive quarters of contraction. That is far too sluggish to overcome still-rising debts and massive unemployment, which is still over 12%. Charles Wyplosz, economics professor at the Graduate Institute, Geneva, says, “If we had 3 or 4 years of growth at 2% to 3% annually then we would probably get out of the woods...But I don't know where such growth would be coming from.”

The euro-zone economy is still 3% smaller than in early 2008 when the economic crisis hit. In many countries far more businesses are failing than are being founded, and there is more firing than hiring. And countries who received bailouts are not doing as well as anticipated and may require further aid, adding to their debts, as we explain below.

In August, Greece reported budget data showing a surplus compared to last year's steep budget deficit. But the economy contracted by 4.6% in the second quarter, and unemployment was still over 27%. The country's GPD has declined for 20 straight quarters as the nation's recession drags on for six years.

German Finance Minister Wolfgang Schauble said Greece will need a third bailout in order to avert bankruptcy. Der Spiegel reported the German central bank expects new outside financial aid will be necessary for Greece by the beginning of 2014 at the latest.

Greece's debt-to-GDP ratio is expected to reach 176% this year, far above the 120% the International Monetary Fund accepted as “sustainable.” But even the 120% level is double that of the European Union's monetary pact, which states member nations must limit their debt-to-GDP ratios to 60%.

The 120% level is highly suspect. As we pointed out in our book The Impending Monetary Revolution, the Dollar and Gold an IMF report in December 2011 said that a small shock to this “accident prone” program could send “debt on an ever increasing trajectory.” A lower growth rate, smaller privatization receipts, higher interest rates than assumed, or a worse budget performance could leave Greece's debt-to-GDP at 159% in 2020, said the IMF. A report in 2011 by three economist at the Bank for International Settlements concluded that the threshold for sustainable debt was a debt-to-GDP ratio of 85%—not 120%—based on studies of 18 countries from 1980 to 2010. Remember, too, that it was the revelation that the Greek ratio had gone to 113.4% in 2009 that triggered the Greek crisis.

The IMF engaged in “arithmetical gymnastics” to arrive at a debt-to-GDP for Greece of 120% for 2020. The Wall Street Journal has noted that it is only because the IMF “accepted these mostly fictional debt outlooks” that it and the other contributors to the Greek bailout now stand to lose money. The IMF even tossed out its own rule against lending to countries whose debt isn't “sustainable in the medium term.”

The IMF worries that without another bailout, Greece will be unable to repay what it owes the IMF from the previous bailout. The IMF now says Greece's longer-term debt targets cannot be met without forgiveness of some of the nation's debts. It insists it will not forgive any repayment of its loans to Greece but is pushing for the European countries who were partners in the bailout to do so—so that Greece will have enough money to repay the IMF's portion of the bailout! You can imagine how that has gone over with those countries! Germany, Finland, Austria and others have stated the IMF should take its share of any losses along with the euro-zone governments.

After declaring the need for additional debt relief for Greece, the recent IMF report noted: “Risks remain to the downside, mainly from lower growth and potential fiscal and privatization slippages.” It emphasizes that the Greek government has failed in almost every instance to hold up its end of the bailout bargain. For example, privatization of state assets is now expected to yield €22 billion through 2020, less than half what was predicted in March 2012.

Greece's debt and growth problems are too big to ignore for long, notes Gabriel Sterne, senior economist at Exotix investment banks. “These are a couple of cans that are perhaps too heavy to kick down the road.”

While Greece and other troubled countries have undertaken austerity measures that cut spending and reduce social benefits in order to salvage their economies, France's socialist President Hollande has done just the opposite. He increased the government budget deficit, raised the minimum wage, and lowered the minimum retirement age from 62 to 60, reversing the raise by former president Nicolas Sarkozy.

Hollande's government increased taxes by over €7 billion euros ($9.3 billion) and added €20 billion to the budget while cutting spending by only half that amount. Next year's budget proposes €6 billion in new taxes. Business investment has fallen every month since Hollande took office 15 months ago. A Markit Purchasing Managers Index over 50 shows economic growth, below 50 shows contraction. France's PMI dropped further, to 47.9 from 49.1. French unemployment, now above 10%, has increased for the 23rd month in a row. France's debt-to-GDP ratio, which was 31% in 1980, 57% in 1994 is now over 90%, the highest of any European country not receiving a bailout.

The IMF in August urged Hollande to scrap the new taxes, saying France's failure to grow the economy will have “significant outward spillovers” into other euro-zone economies.

Spain's GDP declined 0.1% in the second quarter. Though modest, this was the eighth consecutive quarterly contraction.

Spain's unemployment rate fell for the first time in two years. But the drop of almost a percentage point still leaves the rate above 26%—well over twice the euro-zone average. Furthermore, the decline doesn't really indicate an upturn in the economy because more people stopped looking for work than found jobs. Almost all the jobs created came from coastal areas where summer vacation jobs are concentrated. Jobs continued to be lost in sectors like manufacturing and construction.

Spain's debt-to-GDP ratio—which was only 36% in 2007 and Spain had a triple-A credit rating—is expected to be over 100% by 2015, according to the IMF.

Italy's debt-to-GDP ratio is on course to be over 130% for 2013. The nation would need an annual average economic growth of around 3% over the next 20 years just to reduce its debt-to-GDP ratio to 90%. How can this be done in a nation that since 1999 has averaged only 0.5% growth annually?

The number of Italians living below the poverty level has increased by 14% in the last two years.

Portugal would have to increase its average economic growth to as much as 6%—nine times its average since 1999—in order to cut its debt ratio to 90%.

Portugal needs €14 billion in 2013 and €15 billion in 2014 to repay creditors, according to the “troika” managing the bailout (the European Central Bank, the European Commission and the IMF). Portugal will need a second bailout on top of the original €78 billion of the first bailout.

Cyprus is widely expected to need more money. It's economy is in a free fall despite its €10 billion bailout. Analysts say the bailout forecast of an economic contraction of 8.7% this year is far too optimistic. Unemployment is already at 17.3%, well above the bailout forecast of 15.5%. While people are allowed to make limited cash withdrawals, 90% of the deposits at the nation's largest bank are frozen during restructuring. Capital controls isolate the country from the rest of the euro zone. Most small businesses are operating on a cash-only basis.

Why National Deficits Matter
Nobody can ever get out of debt by borrowing successively larger sums to cover successively larger debts. Neither can governments. Eventually debts are repaid or the borrower goes bankrupt. In the U.S. the Federal Reserve prints money enabling the federal government to spend it today by borrowing from our children and grandchildren. They will be obligated to pay it, but they will never be able to do so. The federal gross national debt is now approaching $17 trillion. (It is projected to be $17.2 trillion by the end of 2013.) At $17 trillion, the U.S. debt-to-GDP ratio is 106%. According to the IMF, meeting America's obligations will require an immediate and permanent 35% increase in all taxes and a 35% cut in all government benefits. That's not going to happen. It can't happen. Instead America will be bankrupt. By 2025, entitlement spending and debt payments are projected to consume all federal revenue. And having the Fed print vastly more money to pay our obligations will not solve the problem; it will merely bring inflation that destroys the value of the dollar.

What about more stimulus spending? Politicians will certainly clamor for this as a solution, but it won't work. Obama's colossal $831 billion stimulus bill didn't work; it made the problem worse by further ballooning the national debt. More and larger stimulus programs would do the same. Economist John Maynard Keynes claimed spending—for anything—was the driver of the economy and that government spending produced a multiplier effect as dollars were, in turn, spent over and over throughout the economy. But Hunter Lewis, Keynes biographer, says, “There is no evidence” that spending ever cured a recession, and Keynes “wasn't particularly interested in evidence.”

Harvard Professor Robert Barro, who has done extensive research on Keynesian multipliers, has written, “What few know is that there is no meaningful theoretical or empirical support for the Keynesian position.” Obama's stimulus bill was based on a Keynesian multiplier of 1.5, meaning the GDP will increase by $1.5 for every dollar of additional government spending. This multiplier was stated by administration officials trying to sell the stimulus bill to Congress and the public, and it is stated specifically in the First Quarterly Report by the Council of Economic Advisors on the subject; but there is no evidence that multiplier is valid. Among other research on this subject, my book cites the work of Barro and Redlick, who found a multiplier effect of 0.4 to 0.7, and of Professor Gerald Scully, who found a multiplier of 0.46 in his analysis of 60 years of federal outlays. If the multiplier really were larger than 1.0, the GDP would rise even more than the rise in government spending! The U.S., Greece and other spendthrift countries wouldn't be going broke, they'd be getting richer the more they spent! The reality is that the multiplier is always less than 1.0. The money that is spent over and over again in the private sector from government programs always adds less to the GDP than the cost of the programs. If that money were not preempted by government stimulus spending, it would be spent (or saved/invested) multiple times in the private sector, too—and more effectively.

Hunter Lewis says, “Keynes completely ignores the issue of how you are investing. For him, not only is any investment equivalent to any other investment, but spending is equivalent to investment.” You can see why this is appealing to Barrack Obama as it was to Franklin Roosevelt, who popularized Keynes' ideas.

The great economist Ludwig von Mises wrote way back in 1944, in his book Omnipotent Government,
All governments are firmly resolved not to relinquish inflation and credit expansion. They have all sold their souls to the devil of easy money. It is a great comfort to every administra­tion to be able to make its citizens happy by spending. For public opinion will then attribute the resulting boom to its current rulers. The inevitable slump will occur later and burden their successors....Lord Keynes, the champion of this policy, says: 'In the long run we are all dead.' But unfortunately nearly all of us outlive the short run. We are destined to spend decades paying for the easy money orgy of a few years.”

All the world's central banks now operate on Keynesian principles. The Fed, the European Central Bank, and the central banks of Japan, Switzerland and China have printed an astounding $10 trillion since 2007, tripling the size of their combined balance sheets.

With uncertainty plaguing national economies and the future value of their money, people are continuing to turn to gold as a way for safeguarding their future. Two important trends in this are evident in the second quarter. The first, which is a continuation of a trend evident for some time, is a desire for the buyers of gold to take physical possession of it. This means a preference for physical possession of jewelry, coins and bars rather than holding gold ETFs, shares in gold mining companies, or coins or bars held in financial accounts. The second is the way increased private buying has more than made up for a decline in central bank buying.

After the sharp decline in April, gold prices seem to have bottomed. On balance, the second quarter showed very positive signs. Jewelry showed a multi-year high as lower prices generated a surge of demand from consumers, particularly in China and India. In China, demand hit a record 385.5 metric tons in the second quarter. That was double the figure from a year earlier and well above the 294.3 metric tons of the first quarter, which occurred before the big price drop in April. Overall, world gold jewelry demand increased 37% and reached 575.5t, the highest volume in five years and in value terms 20% higher than the second quarter 2012.

Gold demand in India in the second quarter was up 70% year on year to 310t despite continued government efforts to curb enthusiasm for the metal. Jewelry was up 52% to 188t, and retail bar and coin sales set a record at 122t, up 116%.

Worldwide, the second quarter showed record demand for coins and bars to 508t, up 56% in value terms. Counter to this, there were outflows from ETFs; however, SPDR Gold Trust, the largest gold ETF, in August reported the first net increase in purchases in two months.

The world's central banks' purchases of gold slowed to 71.1t, down 56% on the previous year but nevertheless marking the tenth consecutive quarter of purchases. I would have expected more central bank buying; however, it must be noted that China has not reported its central bank purchases of gold since 2009. Despite its silence, China is known to have added gold to its central bank holdings from mines it owns within the country as well as from foreign countries allowed to operate gold mines in China.