The pace of the economy is not accelerating

The last few Market Watch articles have focused upon the dangers of the market. The posture in which the market currently exists, although called a bull market, is so expensive that the public is set up for great losses. Here we are at the beginning of June, and the S&P 500 is no higher than it was in early February, yet look at all the publicity on how great the market has been doing over the last four months. It’s just more Federal Reserve Bank/Wall Street/federal government misinformation. There is only one reason the market remains at these levels: QE2. The Federal Reserve’s continuous manufacturing of money ($19 billion per week) and the placement of that money in the large banks stops in June. Will the market go up, or will the market go down? Or will the government figure out some other way to manipulate the market and call it something besides “QE3”? If the market begins to go south, count on the latter.

This is not a time to be accumulating stocks. This is a time to remain liquid, if possible. In spite of what you hear from the government and Wall Street, half of the stocks in this country are selling below their 50-day moving averages. The housing industry remains a disaster. Except for providing brokers with more money with which to speculate in the stock markets, QE2 has failed to provide what the government hoped it would, which is acceleration in the pace of the economy. Businesses are still not borrowing, bond yields are unrealistically low and inflation will probably be off the charts in a couple of years.

Systemic economic problems
Fifty years ago, you took responsibility for your own family. Now, the family is the government’s responsibility. Fifty years ago, you could trade $1 for one silver dollar. Now it takes $45 to buy that same silver dollar. Fifty years ago, the federal government had virtually no debt and large reserves of gold backing our currency. We now have almost $15 trillion of debt, and the constitutional strings of money being backed by gold and silver have been cut. Fifty years ago, the government was far less invasive because there were fewer rules and taxes.

There is one number that sticks out like a sore thumb: Fifty years ago, less than 5% of births were out of wedlock; today, it’s 44%. This has moved lockstep with the increase in size of government services.
Government services are why we are so far in debt. Our 50-year experiment with government services, such as health care, unemployment compensation and Social Security (with government employees having better benefits than we do), has left us flat broke.

Welfare payments go to the most dysfunctional portion of our income earners. Giving money for no work in return does not work, and that is why the Constitution specifically forbids the social services that have gotten us into trouble. These social services have gotten every great country, and every great society, into trouble. They all went bankrupt. It’s so easy to see how it happens:

1. A country becomes economically successful because the merchants can work freely within the existing legal environment;

2. The contest then begins for government to help us share the country’s economic success “with those of us who are less fortunate”;

3. An entirely new economic class of people develops who become “experts in government”;

4. This new economic layer develops into an economic class devoted to figuring out how more money can come to the government through taxation and borrowing. Their future does not depend on a reduction in the size of government;

5. The government class gains enough power over time, so the banks’ greatest deposits are government deposits and that Wall Street’s biggest and most profitable clients are government agencies, such as Freddie Mac and Fannie Mae, both bankrupt. With the banks’ largest customers being government agencies, banks are going to support a large government.

All of the above can only be accomplished with collusion between the large banks and government. This consolidation of economic power is, at this point, too much for our economy to overcome. It’s confusing to the point where the public cannot even understand the real problems. Let’s make it simple by breaking down some of the numbers involved in today’s U.S. economic system:
 
1. U.S. government debt    $14.4 trillion
2. U.S. GDP    $14.6 trillion
3. Current year U.S. government
expenditures    $3.8 trillion
4. Current year U.S. government
tax income    $2.2 trillion
5. Amount U.S. must borrow
this year    $1.6 trillion

Let’s focus on the last number, the $1.6 trillion needed to supplement tax shortfalls, representing 11% of our GDP. This is 73% more expenditures than our tax revenues of $2.2 trillion. It’s simply unsustainable.

U.S. runs biggest Ponzi scheme
Our own federal government has become the world’s biggest Ponzi scheme:

1. The biggest bond funds (run by Bill Gross) no longer have any government securities in their portfolios.
2. Meredith Whitney (Fortune’s 50 most powerful women in business) estimates 50 to 100 U.S. cities will declare bankruptcy within the next 18 months.

3. The Fed can’t sell $19 billion of debt securities each week in order to meet expenses, so it buys debt from itself.  

4. Thirty percent of the states’ welfare money comes from the federal government, and the government is about out of its ability to raise additional cash. In turn, 40% of the welfare paid to cities is paid by the states. The states, too, are out of cash.

This is a perfect Ponzi scheme, and it is mathematically doomed to fail, which must be reflected in the stock market.
 
Conclusion
The market is highly overpriced for current dysfunctional economic conditions and for the current economic outlook. The Keysian theory of quantitative easing is that it will accelerate the pace of the economy. It’s not happening! The Dow could lose 4,000 points and still be overpriced for what we are facing.

It’s better to be safe than sorry in an environment like this. The cautious investor will remain safely on the sidelines and watch this mess unravel. The bold investor will allocate more of his assets to gold and silver as a hedge against the decreasing purchasing power of the dollar.

Caveat emptor.

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