Gold and the Double Dip
Source: Jeffrey Nichols, NicholsOnGold (6/29/10)
"Many business economists are talking about a renewed downturn in U.S. business."
Longer term, we see years of "stagflation" for the United States and European economies—with sub-par economic growth, unacceptably high unemployment, and a troubling rise in inflation led by higher prices for many commodities, much like we saw in the 1970s.
Stripping away the contribution to growth from temporary stimulus programs (like the recently expired tax breaks for first-time home buyers) and the positive effects of business inventory accumulation in the fourth quarter of last year and the first half of this year leaves a gloomy picture of a stagnating economy.
Stimulus Winds Down—So Does the Economy
Indeed, as Washington's stimulus spending winds down and with inventories shifting into neutral, the economy will stall and very possibly sing back into recession—and, before long, this will be apparent from the monthly statistics for consumer spending and retail sales, industrial production, construction spending, employment, and other economic indicators.
In addition, there are other more fundamental reasons to fear a renewed U.S. economic downturn—or, if we are lucky—maybe not an official recession but years of sluggish growth that feels much like a recession to most of us.
Consumers on the Rocks
The U.S. economy very much depends on consumer spending, spending that typically accounts for 65%–70% of gross domestic product. But consumers are in no shape—emotionally or fiscally—to continue their high-life spending of recent decades. Instead, consumers are beginning to spend less and save more, reducing debt to rebuild household balance sheets after years of excessive borrowing.
Many households are saving more as a precaution in uncertain economic times. We hear or read day after day about high unemployment, the increasing duration of unemployment and the recent loss of unemployment benefits to the long-term unemployed. Across the country, we have friends, relatives and neighbors who have been laid off—and many of us are anxious about our own job security.
To make matters worse, many households have seen a big decline in their personal assets—a loss of wealth associated with the fall in home prices, and lower stock prices on Wall Street that have eaten away at retirement savings. Feeling less wealthy, even if losses are unrealized, leads to less spending and more saving—what economists call the "wealth effect."
Borrowers Need Not Apply
Some consumers who might wish to continue their old habit of borrowing and spending are finding that credit is no longer so readily available. For one thing, they can't borrow against the home equity because the fall in house prices has reduced or erased their unrealized gains in the value of housing.
For another, lenders have become risk-averse and are lending less to consumers, not only on home-equity loans but on credit card lines of credit. In general, banks are lending less as some have become more cautious and others that would typically lend in their local communities have become insolvent and shuttered by banking regulators.
Similarly, small- and medium-size businesses are also unable to borrow as they must to finance inventories, to grow, and to hire new workers. And, it is these businesses—not the large "Fortune 500" corporations—that are historically the engines of growth for the U.S. economy. Large businesses have access to credit, either from the big banks or directly from financial markets where they can issue commercial paper or longer-term bonds. But, smaller businesses cannot access capital markets directly—and they have been shunned by the big banks that don't want the risk and their community banks, which don't have the ability to lend as they once did.
State and Local Fiscal Drag
As if reduced consumer spending were not enough, we are now seeing a developing crisis in state and local government finances. States like California, Texas, New York and many others are suffering steep declines in their tax revenues—and must cut back sharply on their spending and increase taxes and various user fees. Layoffs, furloughs and reduced hours for many public-sector employees are just beginning to bite. Not only is the direct contribution to business activity affected, but the contribution to consumer spending from garbage collectors to prison guards to teachers and others employed or formerly employed by states and local governments will also be a drag on the overall economy.
The last thing a contracting economy needs is a tax increase—but it looks like one is coming. The tax cuts enacted almost a decade ago during the Bush administration will be expiring later this year. These tax cuts, which benefitted mainly higher income brackets, remain controversial and are unlikely to be extended by Washington.
No Help from Europe
To make matters still worse, Europe's sovereign debt crisis and the contractionary fiscal policies being adopted across the continent will have significant repercussions on our side of the Atlantic and around the world.
Despite assurances to the contrary from European finance ministers and central bankers, the rolling sovereign debt crisis will push the continent into recession or much slower growth than anticipated a few months ago. For one thing, just as in the U.S., heightened economic uncertainty will cause consumers and businesses to cut back on spending. For another, the policy prescription being imposed on or pursued by one country after the next is to cut back on government spending and increase taxes—hardly the tonic to keep an economy out of the recessionary abyss.
America's exports must suffer not only because the market will be shrinking but the U.S. dollar has lost competitiveness against the euro—not only in European markets but in countries around the world where American exports must compete with European exporters. As a result, the contribution to growth that may have come from America's international trade will also be that much less.
Gold—the Last Man Standing
What does all of this have to do with gold? Well, actually a lot—and in ways that may be surprising—as many economists and gold analysts think a weak economy must be bad news for the yellow metal.
Disappointing business conditions in the U.S. will have serious detrimental consequences for the Federal budget deficit, U.S. Treasury funding requirements and the bond markets, U.S. monetary policy, the USD and Wall Street—all of which will benefit gold.
This "double-dip" scenario of renewed recession—or merely slower-than-expected growth—means that the Federal Reserve, America's central bank, will maintain near-zero short-term policy interest rates for longer than most market participants generally anticipate.
At the same time, future Federal budget deficits will be bigger than now projected by the Obama administration and Congressional Budget Office economists. Their optimistic projections are based on growth in tax revenues that simply will not materialize.
Bigger-than-expected Federal budget deficits will further erode confidence in the dollar—and make the U.S. Treasury's job of selling its debt that much harder. Foreign central banks, sovereign wealth funds and other institutional investors that typically buy our debt and fund our deficit will be less willing to do so. . .and will require higher interest rates to compensate for the greater perceived risk in holding dollar-denominated securities.
This can become a vicious cycle or sorts: Because the interest cost on Treasury debt, itself, is a major expense item in the Federal deficit, the deficit will be that much bigger as a consequence of rising borrowing costs. And buyers of Treasury debt will be that much less willing to take on more and more of our debt.
All of this puts more pressure on the Federal Reserve to monetize a growing share of Federal debt—in other words, to print more money. Choose whatever word you like; but, in doing so, the Fed is devaluing, depreciating and debasing the dollar. And the flip side of this is higher future inflation and a higher gold price.
Gold and the Double Dip