Sunday, September 30, 2018

A Critical Look at the U.S. Economy

The stock market has been soaring, unemployment is low, and there is some improvement in wages and corporate earnings, though significantly less than from other recession recoveries. But there are other issues here that should be of concern. First of all, it should be noted that stocks are at lofty levels that marked the tops of major bull markets preceding the Great Recession, the “” (tech stock) bubble in 2000, and the crash of 1929. In the third quarter of 2008, U.S. household debt peaked at $12.7 trillion; today it is $13.3 trillion, 20 percent higher than five years ago. Since 2008, Student debt has more than doubled, to $1.5 trillion. Delinquent auto loans have risen 53 percent, to $1.2 trillion, with 6.3 million borrowers being 90 days or more late on auto loan payments. These delinquencies have been increasing steadily since 2011 and are now the highest in 15 years.

Total global debt—sovereign, corporate and household debt—spiked 75 percent in the past decade. During this period total corporate debt rose 78 percent to $66 trillion, and nonfinancial bonds rocketed 172 percent, from $4.3 trillion to $11.7 trillion. A recent report by McKinsey says 40 % of U.S. companies are rated one notch above “junk” or lower. And the Bank for International Settlements says 10 percent of the legacy companies in the developed world are “zombies,” meaning earnings before interest and taxes don't cover interest expenses. That is what zero interest rates and quantitative easing will get you: more debt and lower credit quality.

Because of the recent Great Recession, Ben Bernanke, then chairman of the Federal Reserve, set the Fed on a course that more than quintupled it's 2008 balance sheet by 2018 by buying long term bonds and mortgage-backed securities. He explained this “unconventional” monetary policy of easy money would lead investors to shift out of bonds and into the stock market and real estate. Supposedly, this would raise household wealth, which would increase consumer spending and strengthen the economy. Instead, this Fed policy inflated price bubbles in stocks and residential housing that produced trillions of dollars in losses when those bubbles burst and household wealth nosedived. As Martin Feldstein, former chairman of the Council of Economic Advisers under President Reagan, put it: “In short, an excessively easy monetary policy overvalued equities and a precarious financial situation.” During the Great Recession, the real estate industry lost $7 trillion, the stock market crash added another $11 trillion in losses, and retirement accounts lost $3.4 trillion.

Those gigantic losses stimulated a politically tolerable solution but failed to provide an economic solution, which is why so many economic metrics are now worse than in 2008, setting the stage for another major crash. Every borrowed dollar since 2008 has generated only 44 cents of economic output. The GDP has increased 35% since 2008, but the national debt has increased 122%. Now the national debt is over $21.5 trillion, compared to $9.5 trillion in 2008.

Though there has been no link between gold and the dollar since 1971, gold prices factor into such things as the relative desirability of holding dollars, interest rates on U.S. treasury securities, the price of oil, and political considerations. For example, whether the dollar is strong or weak is likely to influence the prevailing sentiment for buying gold.

Central banks are buying gold for their reserves at the fastest pace in 6 years, adding 264 tonnes to their holdings in the January-to-September 2018 period. That includes 9 tonnes by Poland, the first European Union country to buy gold in the 21st century. The biggest buyers were Russia, Turkey, and Kazakhstan, accounting for 86 percent of central bank buying. “Egypt bought gold for the first time since 1978, while India, Indonesia, Thailand and the Philippines re-entered the market after multi-year absences. The Reserve Bank of India added 8 tonnes of gold, buying for the first time in almost nine years, and then added another 7 tonnes by the end of August,” according to the World Gold Council. The people of India, avid fans of gold, value it for religious and ceremonial purposes as well as aesthetic, sentimental and monetary reasons. They are estimated to own 20,000 tonnes of gold in jewelry, coins and bars.

After President Nixon severed the last link between the dollar and gold in 1971, he sent Secretary of State Henry Kissinger to negotiate a deal for buying Saudi Arabian oil. Saudi Arabia lies in a violent part of the world, where wars, revolutions and assassinations occur more often than in most other parts of the globe. In 1973 the U.S. offered to sell Saudi Arabia, then the world's leading oil exporter, airplanes, tanks, and other weapons and provide U.S. military protection to the ruling family and the government. All the U.S. asked in return was that Saudi Arabia's oil be sold only for dollars and that surplus revenue available for investment by the Saudis from oil sales, after deducting for the needs of government, would be invested in U.S. Treasury securities. Such a deal! By 1975 all of OPEC (Organization of Petroleum Exporting Countries) members agreed to the same deal.

Since every country in the world was either buying or selling oil, they were all dealing in dollars because oil was priced in dollars. These “petrodollars” gave support to the American currency, but that is now all but gone. As a result of fracking, horizontal drilling, deep-water drilling, and the discovery of new oil fields all over the world, neither Saudi Arabia, nor the United States nor any other nation can set the price of oil—and the currency—irrespective of what is happening in the industry all over the globe. Japan is buying oil from Iran priced in Japanese yen. India buys oil from Iran in rupees. Russia agreed to the sale of $400 billion of natural gas to China over the next 30 years with the gas priced in Chinese yuan, not dollars. China also has agreements with at least 23 other countries for bilateral trade agreements in currencies other than the dollar. The BRICs (the large developing nations of Brazil, Russia, India and China) have agreed to trade in each others currencies rather than using the dollar as an intermediary. Australia, South Korea, Turkey and Kazakhstan have agreed to conduct trade in currency swaps of their own respective currencies. Germany has agreed to trade with China in yuan and euros. The importance of the dollar is receding from the position it held since the 1970s. 

 That may help to explain the world's central banks increased purchases of gold, aligning their assets with what they see as a growing trend. Since the formation of the European Union in the 1990s, there was a concerted political effort to phase out gold in the international monetary system and replace it with a fiat currency, the euro. The euro experience has shown that an unlimited ability to print money with no backing cannot replace the effectiveness of a tangible monetary asset, gold. Central bank buying of gold now may be recognition of that. But it may also reflect the historical importance of gold in four central bank agreements. The first Central Bank Gold Agreement took place in 1999.  At that time, central banks held nearly a quarter of all gold held above ground, about 33,000 tones.  The second gold agreement (CBA2) took place in 2004. CBA3 followed in 2009 and CBA4 followed in 2014. The first clause in each of these four agreements began: “Gold will remain an important element of global monetary reserves.” In one of its first pronouncements, the ECB governing council decided the capital subscriptions of euro-zone members would be paid partially in gold, (with the balance determined by a formula of other currencies and the population and GDP of the countries.) For many years the central banks and the International Monetary Fund sold gold in the belief the future world money would be fiat currency. That policy began to change about a decade ago.

When it became possible to buy oil with something other than dollars, there was less demand for dollars that could go to buying U.S. treasury securities to finance America's deficit spending. What else could foreign governments do with the dollars they acquired for U.S. trade deficits? Since 1971, they couldn't convert them for U.S. Treasury gold—but that was changing with the establishment of the Shanghai Gold Exchange. Unlike the gold markets in New York and London—which deal primarily in paper contracts for future delivery, which seldom occurs—the SGE deals in the physical metal for immediate delivery. Countries which could not exchange their dollars for gold from the U.S. Treasury could now trade those dollars for actual gold on the Shanghai Gold Exchange.

When I wrote my book, I concluded that the two possibilities for the future were severe depression or runaway inflation—or possibly both, with one bringing on the other. But I figured the possibility of runaway inflation would so frighten our monetary managers that they would try to avoid that at all costs. Now, however, I think they are somewhat more likely to do what they have done since 2008: simply print more money. There is also the possibility that they would lose control of interest rates, which in turn could bring about hyperinflation.

There is also the question of what will happen to the $6 trillion that are held by foreigners. Nations' central banks have been holding them as reserve assets because they were needed to buy oil, but they are no longer needed for that. Would the central banks be better off trading them for gold? Or yuan? Or stocks, bonds, ETFs or real estate?

When the Federal Reserve buys bonds from the U.S. Treasury, it creates—out of thin air—a corresponding deposit in one of the large commercial banks where the Treasury has an account. The money from that deposit gets into circulation when the government spends it by buying something with it, for which the seller makes a deposit in his own account. The seller then spends the money from his account to buy something else, and the process of sales and deposits is repeated as the money is circulated in accounts throughout the economy.

The Fed is not the only central bank increasing its money supply in this manner. Other central banks are doing the same thing with their national currencies in the hope of stimulating growth in their economies. Japan is a prime example, having employed this and other “stimulative” policies for more than two decades with poor results. Those decades are called the “lost decades.” From 1991 to 2011 Japan's annual economic growth averaged less than one percent. It now has a debt-to-GDP ratio of 250%, the highest in the world, and more than three times what it was (65 %) in 1990 when the first of its ten stimulus programs began. But that hasn't stopped Japan from trying larger doses of the same failed policies.

Shinzo Abe was elected prime minister of Japan in large measure on his campaign for monetary easing. In 2013 he said, “Countries around the world are printing more money to boost their competitiveness. Japan must do so too.” He called for more aggressive action along the lines of the Fed and the European Central Bank. That was his prescription for a degree of “needed” inflation to bring Japan out of two decades of economic stagnation and avoid the growing fear that deflation was now a greater threat than inflation. Whereas the Fed buys only U.S. Treasury securities, the central bank of Japan would henceforth buy at the market more than twice the amount of new bonds issued by its government, and it would buy not just government bonds but stocks, ETF's (exchange traded funds), and real estate funds. These purchases would increase Japan's money supply just the way the Fed increases the U.S. money supply by buying U.S. treasury securities.

Other central banks were particularly interested in common stocks. Easy money policies made stock prices look cheap, and with near zero interest rates on government securities, buying common stocks at least offered the prospect of higher yield. The five largest central banks raised their financial assets in ten years from less than $4 trillion to $14.6 trillion.

Swiss National Bank purchased a record $17 billion in US equities in just the first quarter 2017, bringing its total U.S. equity holdings to an all time high above $90 billion, about 30% more than at the end of 2016.The Swiss National Bank bought almost 4 million shares of Apple stock in the first three months of 2017. It owned more publicly-owned shares of Facebook than founder Mark Zuckerberg, whose holding was worth almost $24 billion. SNB also has over $1 billion each in Exxon Mobile and Johnson & Johnson stocks. SNB is the world's eighth largest public investor. The bank of Japan is a top-five owner of most of the 81 companies in Japan’s Nikkei Stock Average, and it owns 62 percent of the domestic ETF market. If countries around the world are printing more unbacked money, the potential for runaway inflation increases since there is no limit on the amounts they may print. Perhaps this is the reason the world's central banks have greatly increased their purchases of gold.

The conditions favoring gold as the world's reserve currency have altered significantly, and the dollar will not be the world's reserve currency forever. Petrodollars cannot save the dollar from depreciation as they did in the decades following the agreements with Saudia Arabia and other OPEC countries, and Saudi Arabia is no longer the undisputed leader in the oil industry as it once was. Saudi Arabia now exports more oil to China than it does to the U.S. China is accumulating gold as fast as it can, not only domestically but by investing in foreign gold producers and buying prospective properties. And it is helping finance Saudi production of new oil wells. For example, it financed the giant oil refinery in Saudi Arabia at the port city of Yanbu that processes 400,000 barrels of crude per day.


Friday, August 31, 2018

Nature is the Greatest Polluter

We began our posting on this blog on June 29, 2017 with this question: In a room 20 feet by 20 feet with a ten foot ceiling, how many matches would you have to light for the air in that room to have the same percentage of carbon dioxide as the atmosphere from the annual emissions of all the automobiles (about 800 million) in the world? The answer is provided by Ivar Giaever, a Nobel laureate in physics, The answer is one match. Incredible, isn't it? Even if the number of automobiles doubled, mankind's carbon dioxide emissions would still be trivial to our survival or that of the planet; our answer would simply require one more match. Of course, if people understood this they wouldn't support regulating fossil fuels to prevent global warming. Ergo, the need for global warming alarmism, a campaign of exaggeration and warnings of dire consequences unless the government acts. It's a tactic used over and over again to enlarge the scope of government controls.

Terpenes are natural pollutants emitted by pine trees. These hydrocarbons react with oxygen, the oxides of nitrogen and ozone to produce the same effect over the Great Smokey Mountains, the Blue Ridge mountains and many other heavily wooded areas. Professor Harold J. Paulus explains:

Pine forests exude particulate hydrocarbons that react photo-chemically with light to produce haze. The Blue Ridge Mountains in Appalachia are topped by this haze. It looks very beautiful over the trees, but if it were anywhere else, it would look like car exhaust.”

In July 1995 some 200 scientists completed a month-long field study of how ozone forms over a city with smog. The study involved six laboratory-equipped airplanes, weather balloons, 100 air-sampling ground stations and wind-measuring radar. Flying over the Nashville area, researchers noticed a big difference in flying over green fields and flying over thick oak forests around the city. Over the forests, there were markedly higher levels of isoprene, a highly reactive gas given off by the trees. Isoprene has an ozone effect just like the evaporation of gasoline.

Although ozone levels in the lower atmosphere are widely blamed on automobiles, three scientists at Michigan State University reported in 1989 that ozone measurements taken at twenty stations in Michigan between 1871 and 1903—when there were no automobiles—reveal ozone patterns that are the same as today. Furthermore, EPA's own five-volume study of ozone could find no adverse effect of ozone on human health.

In 1978 the EPA suppressed a scientific study showing that up to 80 percent of air pollution was caused by plants and trees rather than cars and smokestacks. If you have an average-size suburban lawn, the grass in your yard emits more hydrocarbons every year than your automobile. Following a suit filed under the Freedom of Information Act to pry out the report, EPA officials told John Holusha of the Washington Star that the report was suppressed because it “possibly would confuse hydrocarbon control strategy.” Associated Press International charged that EPA officials pressured the scientist involved to “put the data in a perspective that could be defended by EPA.”

Forests alone emit 175 million tons of hydrocarbons annually—more than six times the total from all man-made sources. And 2018 saw vast areas of the U.S. consumed by forest fires—nearly all of natural origin—which put vastly greater quantities of hydrocarbons into the atmosphere.

Van Nostrand's Scientific Encyclopedia says that the Augustine Volcano, which erupted in 1976, “may have injected 289 billion kilograms of HCL (hydrochloric acid) into the stratosphere. That is about 570 times the 1975 world production of chlorine and fluorocarbons.” The amounts of chlorine emitted into the atmosphere in millions of tons per year are: seawater 600; volcanoes 36; other natural sources 13.4, resulting in a total of 649.4 million tons. Compare this to man-made CFCS of 0.75 megatons per year, and we see that the alleged man-made increase amounts to 0.75/650= 0.0000115 percent.

Scientist Linwood Callis of NASA's Atmospheric Sciences Division studied a variety of factors causing ozone destruction, including sunspot cycles, volcanoes, tropical winds, and highly energetic electrons. He concluded: “CFCs come in a very poor last as the cause for lower levels of global ozone.”

According to Dr. William Pecora, former Director of the United States Geological Survey, just three volcanic eruptions in the last century (Krakatoa, Indonesia, 1883; Katmai, Alaska, 1912; and Hekla, Iceland, 1947) produced more particulate and gaseous pollution of the atmosphere than the combined activities of all the men who ever lived. And the modern era has been one where volcanic activity has been relatively quiet. There have been eras in which it has been at least ten times greater. The spectacular explosion of Krakatoa is often thought to be an exception, perhaps the worst disaster in the earth's history. However, there have been at least 18 volcanic explosions as large or larger than Krakatoa just since the year 1500. When Mt. Pinatubo in the Philippines erupted in 1991, it blasted 30 million tons of sulfur dioxide into the stratosphere. It blew 2 million tons of chlorine into the stratosphere in a single day. At that rate, it put the chlorine equivalent of all the CFCs produced in the entire world in 24 hours into the stratosphere every minute. Great though the Pinatubo eruption was, it was dwarfed by the Laki volcanic eruption on Iceland in 1783-84, which emitted 147 million tons of sulfur dioxide.

As for wind, it ranks with volcanoes as one of the two largest sources of pollution today. Analysis of the Greenland ice sheet shows that when some of its layers were formed thousands of years ago, the atmosphere contained forty times as much dust as it does today. What the world's industries emit is truly trivial by comparison.

Man is an insignificant agent in the total air quality picture,” says Dr. Pecora. “Those individuals who speak about restoring our inherited environment of pure air, pure rain, pure rivers, pure coastlines and pure lakes never had a course in geology. Natural processes are by far the principal agents in modifying our environment.”

Human efforts are so puny compared to those of nature that man has a difficult time doing serious environmental damage even when he tries. The gigantic fires from the more than 700 Kuwaiti oil wells deliberately torched by Saddam Hussein's government produced “insignificant” damage to the global environment, according to scientists at University of Washington and the National Center for Atmospheric Research in Boulder, Colorado. Their study concluded those fires had effects on air quality and some aspects of the weather in the Gulf but insignificant effects globally. Yet those fires produced 3,400 metric tons of soot per day—about 13 times the soot emitted daily from all combustion sources in the U.S. And those fires emitted sulfur dioxide at a rate equal to 57 percent of emissions from all electric utilities in the United States, an area 600 times larger than Kuwait.

For several decades the overwhelming factor of Mother Nature's pollution has been ignored in favor of political and ideological agendas that have perverted science and substituted scare tactics in place of truth that would benefit both the environment and the human condition.

Most of the above comes from my book MAKERS AND TAKERS: How Wealth and Progress Are Made and How They Are Taken Away or Prevented.  Abundant references can be found therein.

Monday, July 30, 2018

Welfare Programs, Promises, Pensions and Problems

Everyone knows that Social Security and Medicare are underfunded. They can only provide the benefits they have promised by borrowing from future taxpayers who are obligated to pay for them. And these programs will never be fully funded because the obligations are growing faster than the public's ability to pay for them. The nation's economic growth cannot keep up with the politicians' promises. But what the public doesn't realize is that beneath the gigantic funding gaps in these federal programs there are several levels of promised benefits that are similarly underfunded. These include state pension liabilities, city and county pensions, teachers' pensions, and pensions of private corporations, including those supported by the Pension Benefit Guarantee Corporation—which itself is underfunded and has indicated it will likely have to go out of business in a few years.

The PBGC has two kinds of programs: single-employer (light blue on graph) and multiemployer (dark blue). Both have lost billions of dollars, with the multi-employer programs being by far the biggest losers. A report by the PBGC projects it will run out of funds in 2022, which is close to the Congressional Budget Office projection of 2021. The CBO projects that almost $9 billion of additional funds would be needed to continue paying guarantees to multiemployer plans through 2024.

 A recent analysis by Wirepoints shows that between 2003 and 2016, accrued liabilities (what the states owe) grew more than 50% faster than assets in 28 states and more than twice as fast in 12 states. New Jersey grew 4.3 times faster than GDP, Illinois (3.32 times), Connecticut (3.18), New Hampshire (3.46) and Kentucky (3.08). The Wall Street Journal notes that the “solution” is always to raise taxes but “no tax hike is ever enough because benefits keep growing faster than revenues...The only salve to state pension woes, as the Wirepoints study notes, is to reign in current worker benefits.”

The PBGC supports 71 penniless union pension funds, but the payouts are often down to about one-third of what the worker is due. The average Local 707 retiree was getting $1,313 a month from the union pension fund, but the average monthly take home is now $570.

Writing in the San Diego Union-Tribune, Dick Vorkmann says, “Almost every public pension plan is underfunded, some severely so. Illinois and Connecticut have only 35 percent of their liabilities covered by assets. San Diego County, at 77 percent funded, has an unfunded liability of $3.3 billion. San Diego City‘s unfunded liability is $2.1 billion....[Under the current system] taxpayers don’t pay for the cost of the pension being earned by employees in that year, but rather just pay for the pension checks to the current retirees who worked many years ago. Then, years from now, taxpayers will pay for the pension costs of the public employees working today. This is what our Social Security and Medicare systems have become: unfunded pay as you go plans. And that is why there is concern that these systems will go broke in the not too distant future.”

Dallas has the fastest-growing economy of America’s 13 largest cities. Last year, the Dallas Police and Fire Pension Fund paid out $283 million and the city put in just $115 million.

The Manhattan Institute’s Josh B. McGee reports that teachers’ pension plans, which cover more people than all other state and local plans combined, have at least a $500 billion difference between promised benefits and money set aside to fund them.

Standard & Poor's 500’s biggest pension plans face a $382 billion funding gap. Of the 200 biggest defined-benefit plans in the S&P 500, based on assets, 186 aren’t fully funded. They simply don’t have enough money to fund current and future retirees. U.S. private pensions overall have only 82% of the funds necessary to meet their liabilities. That's a U.S. $3 trillion shortfall.

Ania Zalewska, professor of finance, University of Bath, concludes: “The pension industry is already in a deep financial crisis and could well be the trigger for another global financial and economic meltdown.