As a financial advisor, I have the benefit of taking the temperature of mom and pop investors sentiment when I meet with clients. I get to hear about their concerns for the economy and stock market first hand. Lately, I get asked often about my thoughts on gold and commodities and when I think the whole house of cards will come crashing down because of all the printing we are doing as a nation. I assume that most individual investors who read Seeking Alpha have pondered these same questions themselves, or at least come across authors having purported as much. So let's take a look at debunking some of these myths.
Printing Money Does Not Create Wealth
'The US will collapse because the US is printing money. As everyone knows, printing money does not produce wealth.'
Marc Faber, who needs doom in order to sell subscriptions to his Gloom, Boom and Doom report, likes to say, "If debt and money printing equaled prosperity, then Zimbabwe would be the richest country.”
Seems logical, does it not?
Let's pretend we start a useless government agency (not hard to pretend, I know) that hires 10,000 people to do nothing more than pick their ear and report on their experience. I agree, this in fact is useless and non-productive, a seeming waste of money. The government prints money to fund this agency and pays these useless workers.
Is that money wasted and gone forever, and wealth never to be created?
The example I like to give is that the Sovereign US Government can start this totally useless agency, yet the money will eventually flow to those who create wealth. Therefore, printing can eventually lead to wealth creation. Sounds absurd, I understand, but keep reading. Money is demanded by capitalists in the current monetary system because it allows them to stay out of jail for not paying their taxes in US Dollars, while at the same time providing a better lifestyle for their family.
How will the "wasted" money get into the hands of the wealth creators? If the new ear pickers go into their communities and spend it at local businesses, the printed money goes from useless employees, into the accounts of productive businesses (of course the producers get less after layers of tax bites). So the act of spending printed dollars itself will get those dollars into the hands of businesses who are able to create wealth.
By true wealth creators, I am talking about the modern day alchemists who turn something worthless like oil, into something valuable like gasoline.
I try to stay away from businesses who leech the system of wealth creation when I invest. Entertainment companies for example do nothing to create wealth in America. These businesses would not exist unless producers created wealth, which in turn allows that wealth to be spent on these types of businesses. I am a big believer of going through your portfolio and ridding yourself of the leeches. Spend money with the leeches, but don't invest in them. They do not create wealth, they take it.
So the answer is, yes, printed and worthless money eventually flows into the hands of those who create wealth, but, because of taxes and mis-allocation, it is not very efficient on the journey there. Is it fair? Absolutely not. Is it wrong to start an agency like this? Absolutely.
But to argue that government spending is all a waste and the money spent ends up being vaporized, is wrong. Government spending, even wasteful spending, is someone's income. Food stamps become the income of Safeway and Albertson's. Employees who work there get paychecks, and the shareholders get dividends. That money ends up being spent as well. Again, not fair to some who are productive, but also not a waste. If you run a productive business, chances are you too have received some of this "stimulus" money. If you are that against government spending, go to great lengths to make sure you don't let any of that money get into your hands, and then watch your business struggle.
They are all cash cows, and most all of them get over 90% of their revenues from government spending.
They spend money on stuff that kills people and blows things up. Not very "productive".
Yet, those businesses are gushing cash. Other businesses and investors lent them money, which they use government spending to pay back. So that debt from investors is now those investors' income, which comes from government spending. Government spending = debt investors' income. These defense companies buy technology and metal from somewhere to make their weapons. Therefore, those that sell them technology and metal get paid from revenues that come from government spending.
There are 412,000 people who work for these 4 companies. Assuming they average $50,000 per year in income, that is about $20.6 billion in income. Where does that $20.6 billion go? Some goes to taxes, of which some gets wasted. But those taxes pay teachers, build roads in neighborhoods, pay for police etc. It also gets spent at the local grocery store, hardware store, invested in other companies (which produce and employ). Another $2.5 billion gets paid out in dividends. I know some of my clients get that money. Those dividends get spent somewhere in our local community.
How about the pay of the 2.3 million soldiers? That is "wasted" government spending. But it is income for those 2.3 million soldiers. That is roughly what, $100 billion? It seems like "spending", but is in fact income that gets spent at all the places mentioned above. So the spending gets into the hands of businesses.
So the hard answer, as much as I hate it, is yes, government spending does end up flowing throughout the economy.
I agree, we need to focus more on getting that money into the hands of the citizens, rather than Wall Street, who blow it. There are reforms that need to happen as well. If you read some of my past articles, I am VERY against POMO and the manipulation going on in our markets. I say use that $600 billion and give it to Main Street. Don't just prop up asset prices "higher than they otherwise would be" (Fed member quote).
The government should spend more - and tax less. Build roads with the money. Instead of paying 99 weeks of unemployment insurance for people to sit around and watch TV, pay unemployed workers to go to school so that they can keep their skills up and become productive for society again.
Find ways to manufacture things here, not China. A lot of what happens now is the government spends money here, and then that money flows to people who send it to China by buying Chinese stuff. Now China has the money to buy and build cities made for 1.7 million people in which no one lives.
Government spending is not always bad. Unfortunately, with the plutocracy we are heading towards, the spending gets filtered through the Wall Street crooks first, and not Main Street. Spending does not need to stop, per se, but what it gets spent on needs to change.
Businesses and Foreigners Will Stop Accepting US Dollars
For some reason it is just assumed that the marketplace will all of a sudden stop accepting paper US dollars. Gold bugs are storing up precious metals for the day when they will only be able to buy and barter with precious metals. If the US keeps printing, it does seem logical that this could actually happen.
No. Not anytime soon.
There is this funny little thing that keeps us from being truly free men. Taxes. Grocery stores don't have the luxury of deciding to exist on barter as some would have you believe. It's not that they don't desire such situations, but the government mandates they continue to accept paper money by force. The US Government has determined that taxes are to be levied on owners of property and services, and those taxes will only become extinguished in the form of paper dollars. Failure to submit to this monster will require time in prison. So under the motivation to not spend time in jail, citizens work tirelessly, offering labor and goods in exchange for paper dollars so they can feed the tax monster. I am not saying I approve, but it is the system in which we currently live. Thus, individuals and businesses who can create wealth are forced to figure out ways to obtain paper dollars. Capitalism allows a small carrot of incentive in that the more dollars you can obtain by productivity, the better lifestyle you can live, even though taxes go up with the higher income.
Will foreigners stop accepting US Dollars? Not unless they plan on ceasing sales into the world's largest market. How then will the world stop using them?
America Will Soon Not Be Able to Afford the Interest on the National Debt
"A major depression is inevitable for America because decades of growing debt-financing by consumers, businesses, and state and (especially) federal governments have undermined the health of the economy, giving the appearance of wealth when in fact there is poverty. The enormous private and public debts bring the law of compound interest into play, and it takes no great mathematician or economist to figure out that those who live beyond their means for too long must finally reach the point at which they not only cannot pay off their debts, they can't even pay the interest on them—or find anyone willing to lend enough to cover the interest." (www.ecalvinbeisner.com/reviews/BurkettReview.pdf)
The statement in quotations above is based on doom and gloom from Larry Burkett in his book about the coming financial earthquake back in 1990! How similar to what we hear being sold today as fact.
He was wrong 20 years ago, and his new worry-wart cohorts will be wrong the next 20 as well.
Burkett prophesied that America, by the turn of the century, would have so much debt that they could not afford the interest on the debt. Since his book made this claim, the debt has doubled. Now the current doom and gloom crowd is saying, yet again, that we will not be able to afford the interest on the debt. They conclude impending collapse is right around the corner. We are warned foreign confidence in the US Dollar will cease, and they will sell Treasuries indiscriminately, causing an epic collapse in our bond market which leads to 'economy-choking' higher interest rates. High interest rates, of course, will supposedly mean the US Government can't afford the interest on the outstanding debt because it is so large.
As the saying goes, "The more things change, the more they stay the same."
Other versions of fear and doom might sound similar to these:
"In their ill fated attempt to get something for nothing the Fed is going to cause a currency crisis and a massive surge in global inflation. The price we will all pay when the house of cards comes crashing down again will be multiples more expensive than last time.
"The problem is debt. Hyperinflation is the result of a government debt spiral. At some point the debt becomes so large that a nation can't even service the interest on the debt. At that point there are only two options. Either default or inflate."
Oh me, oh my, the sky is falling! It must be time to hoard gold (GLD)!
My advice? Cancel your doom and gloom subscriptions. The US Government is not revenue constrained. For those who want to find out why, I highly encourage you to read: Understanding Modern Money by L. Randall Wray. You will realize Dick Cheney got it right when he said "Deficits don't matter," (at least while there is a capacity utilization gap - once that gap is filled, then they will matter) and will rest well knowing the US will not default through non-payment, nor hyper-inflation. Worry about the deficits once factories are at capacity. At that point, the government will use their tools (taxes, rates) to slow down the economy.
Paper Dollars Are Worthless and Backed By Nothing
Dollars are just worthless pieces of paper. It has no value by itself and is today backed by nothing. I agree with this argument. Consider this though: Oil in and of itself is also worthless. It is just sticky goo that could ruin the environment if it ends up in the wrong place.
Only in the hands of a company that knows how to create wealth can oil have any actual value.
A company that takes resources which have been given freely to us by God, converting them into something useful and productive, is worth more than gold. Gold is a store of value, but it does not create wealth just as paper dollars do not create wealth. Oil, lumber and coal, by themselves, are worthless too. While oil is useless by itself, when a company like Exxon Mobil (XOM) or Chevron (CVX) figures out a way to take this free and useless commodity out of the ground and turn it into gasoline, they in turn have created wealth by making something that was useless, useful. Modern day alchemy at work. Investors reading this can feel confident investing in these types of companies, knowing that all money flows to them eventually. Any company that makes something out of nothing is a wealth creator. Your only job is to figure out what price you are willing to pay for the profits the company generates.
So like oil, dollars by themselves are worthless until an event takes place creating demand. The event that causes worthless oil to be in demand is when a company turns it into gasoline. The event that causes worthless paper dollars to be in demand is the prosecution process for failing to pay taxes.
Every Fiat Currency System Eventually Fails
I hear (and used to believe myself), that the fiat currency system is about to collapse because all fiat currency systems in history have collapsed. Here are a few examples of such claims:
Some of our own dear Seeking Alpha writers claim as much also:
The problem is, these proponents are comparing apples with oranges. Never in history has the entire world been on a coordinated, floating exchange-rate, fiat-currency, system. Therefore, do they really have anything with which to compare today's situation?
Fiat currencies have collapsed in the past because countries print money to pay debts which are denominated in foreign currencies. If the US Government owed trillions in Euro denominated debt, and then printed US Dollars to buy Euros in order to satisfy those debts, the value of the US Dollar would collapse, as we would be forced to flood the world with dollars and soak up Euros. Ellen Brown does a fantastic job in explaining why the US situation will not end like Zimbabwe or Germany.
Sorry to say gold bugs, but Zimbabwe we are not.
Printing Money Will Cause the US Dollar to Lose Reserve-Currency Status
These words are usually stated as a matter of fact, rather than conjecture. Well known newsletter writer Porter Stansberry warns almost daily, "The world has officially entered what we believe will be the final chapter of the U.S. Dollar's reign as the world's reserve currency. " (www.thedailycrux.com/content/4751/Porter_Stansberry)
It is assumed that the rest of the world will stop accepting payments in US Dollars overnight for business transactions, and only if we subscribe to their information service will we be able to protect ourselves and family using their timely advice.
Will the US Dollar lose the coveted reserve currency status from all the printing going on?
Not any time soon.
The US economy is still the biggest in the world by a large margin. The military, which we are not afraid to use, is the most powerful. Until another country holds title to either one of these claims, our reserve currency status will likely remain intact. While it feels as if China will surpass us soon as they maintain their rapid growth, they are still many trillions of dollars in GDP away. Think about this - if the US is the world's largest customer, and China has become richer by selling to us, is China really going to tell us which currency we can spend? Don't we dictate what currency we are willing to give them? Who is truly in charge? If China stops accepting dollars, could we not easily find a group of other nations to do business with? Would us dumping China as a business partner not cause other nations to line up to take China's place? Would any of these other nations refuse to do business with us in US Dollars?
Until China or another country surpasses us as the world's largest economy or strongest military, loss of our reserve currency status is not imminent, as sellers of fear would like you to believe.
Granted, China is growing at roughly 10% a year, and we are only growing at 3%. I get that. Let's do the math though and see if we should worry. If China is a $6 trillion economy, growing at 10%, they grow by $600 billion a year. If we are a $14 trillion economy growing at 3%, we grow by $420 billion a year. In this close to reality example, China is closing the gap at $180 billion a year. At this rate - it will take China 44 years to even match the US in GDP. Can they continue to grow at 10% a year, while their largest customer grows at 3% for 44 straight years? We are a far cry from no longer being the largest economy. The biggest economy in the world should be blessed with the reserve currency.
If Money Printing is Good, Then Just Print Enough To Give Everyone $1 Million
If printing is not a big deal, then why not just print away? The doom and gloomers jump to the conclusion that if I think printing won't cause the collapse of America, it must be a good thing. So why not seek more of that good thing? The answer is simple.
There is a limit to the productive capacity of the economy. If the government printed money to buy 40 million cars, and gave that new money to Americans under the auspice it only be spent on automobiles, Americans could do one of two things, buy cars or sit on the cash. If the capacity of the world's auto manufacturers is 20 million cars, and the government printed enough money to buy 40 million cars, the market's ability to produce only 20 million cars would be overwhelmed by car demand - thus creating a price surge. In a perfect environment, this price surge would bring demand in line with production. If the demand happened overnight, we could be certain that the price of a car should, at a minimum, double overnight. 20 million cars would be produced because that is the capacity of the market, but the price would double to soak up the new money that was printed to buy 40 million cars at yesterday's prices. Of course, new wealth could be created from all of this printed money if other firms decided to take free resources, like iron ore, and convert it into steel to make more cars to meet this demand.
So the answer to how much money printing we can handle is this: how much demand for goods will the printing create for the economy? If everyone received $1 million but took a vow to never spend it and instead put it under their mattress, I doubt prices would move much, because the demand is not there. If the economy gets to maximum production, then new money in the system via demand will cause the rise of prices across the board.
We are seeing some of this happen now with food prices in certain areas of the world. Capitalism will, over time, right this ship though. Farmers will see the ability to make more money selling beans and wheat, and will invest in planting more acres for these crops. They will purchase technology that will help reap more crop yield per acre. Right now there is an imbalance, but it won't last. The doom and gloom crowds will have you believe that this current "crisis" is permanent, causing the collapse of society as we know it. No need to fear, but in the meantime while the imbalance is in place, buy the businesses that turn the commodities into wealth. Don't buy oil itself, but Exxon or Chevron. Don't buy wheat or soybeans, buy fertilizer companies which allow farmers to produce more wheat and agriculture, companies like Potash (POT). But always make sure the current profitability of the company is worth investing in. If you invest with the idea that the crisis will be without end, you may end up overpaying for a stock.
7/6/11 Update to the above paragraph:
Despite excessively wet conditions, a scramble to get corn seeded in key growing areas that was fueled by high prices has set the stage for a potentially record-large corn crop, and conversely a smaller soybean crop, according to the report issued Thursday by the U.S. Department of Agriculture.
"There are some big surprises in this report," said Karl Setzer, commodity Trading Advisor for MaxYield Cooperative in West Bend, Iowa. "All in all, what this shows us in the quarterly stocks report, we are not using grain at the pace we thought we were."
USDA said farmers planted 92.282 million acres with corn this spring, above an average trade estimate for 90.767 million acres and well above the USDA's June 10 forecast of 90.700 million acres.
The department estimated quarterly corn stocks as of June 1 at 3.670 billion bushels, above an average trade estimate for 3.302 billion and compared with 4.310 billion a year ago.
Traders said the fact that farmers were able to get so much corn in the ground despite flooding and heavy rainfall through the U.S. Midwest underscored how recent high prices pushed farmers to plant corn over soybeans despite the adverse conditions.
"Getting this much acreage planted is a surprise," said Shawn McCambridge, an analyst with Prudential Bache Commodities.
(Looks to me like the proof a few months later is in the pudding. Farmers - seeing higher prices for corn - are planting much more corn, thus crushing the price of corn. So much for never ending higher corn prices for the rest of our lives.)
After asking that question, remember these quotes:
"The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it... But though labour be the real measure of the exchangeable value of all commodities, it is not that by which their value is commonly estimated... Every commodity, besides, is more frequently exchanged for, and thereby compared with, other commodities than with labour."
- Adam Smith, The Wealth of Nations, 1776
"What is a cynic? A man who knows the price of everything and the value of nothing."
- Oscar Wilde, Lady Windermere's Fan, 1892
If you subscribe to a newsletter that only measures the price of gas, without understanding the the amount of time spent to labor for it, and uses it to try to scare you, I say go ahead and cancel that doom and gloom subscription and save yourself some money.
Fear for the collapse of America is unwarranted and rooted in misunderstanding of the monetary system which we live under today. We are not Greece.
Disclosure: I am long CVA.