“DOUBLE DIP” SCENARIO RESULTS IN GREATER INFLATION AND HIGHER GOLD PRICES, PREDICTS ROSLAND CAPITAL’S SENIOR ECONOMIC ADVISOR JEFFREY NICHOLS
NEW YORK (June 8, 2010) – Jeffrey Nichols, Senior Economic Advisor to Rosland Capital (www.roslandcapital.com), had the following commentary based on recent market activity and the week ahead:
After last week's employment report from the U.S. Bureau of Labor Statistics showing little private sector job growth, many business economists and financial journalists are once again talking about a "double dip" or renewed downturn in U.S. business activity. As readers know, we've long held the view that the U.S. economy would sink back into recession or, at best, a long period of sluggish growth insufficient to produce any meaningful gains in employment. 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 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 paints a gloomy picture of a stagnating 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 retail sales, industrial production, construction spending, and other economic indicators. In addition, there are other good 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.
The U.S. economy very much depends on consumer spending, spending that typically accounts for 65 to 70 percent of gross domestic product. But consumers are in no shape 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 as a precaution in uncertain economic times. People see high unemployment and the increasing duration of unemployment, many have friends and neighbors who have been laid off, and many are anxious about their own job security.
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."
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 also 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 conduct their businesses 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 have been shunned by the big banks that don't want the risk and by their community banks that don't have the ability to lend as they once did.
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 benefited mainly higher income brackets, remain controversial and are unlikely to be extended by Washington.
Finally, in my catalog of recessionary forces confronting the U.S. economy is the impact of Europe's sovereign debt crisis. Despite assurances to the contrary from European finance ministers and central bankers, there is just no way the rolling sovereign debt crisis will not push the continent into recession or much slower growth than anticipated a few months ago. For one thing, just as in the United States 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 if only because the market will be shrinking.
In addition, the steep depreciation of the euro vis-a-vis the U.S. dollar that has occurred in the past few months means that American exporters will be less competitive with European business, not only in Europe, but in other markets around the world -- and the contribution to growth that may have come from America's international trade will also be that much less.
You may be asking: "What does all of this have to do with gold?" Well, actually a lot . . . and in ways that may be surprising since many economists and gold analysts think a weak economy must be bad news for the yellow metal.
Disappointing business conditions in the United States will have serious detrimental consequences for the Federal budget deficit, for U.S. Treasury funding requirements and the bond markets, for U.S. monetary policy, and for the U.S. dollar -- 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: Since the interest cost on Treasury debt is itself a major expense item in the Federal deficit, the deficit itself 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 what ever word you like, in doing so, the Fed is devaluing, depreciating, and debasing the dollar. And the flip side of this is higher inflation and a higher gold price.
To arrange an interview with Jeffrey Nichols, please contact Liz Cheek of Hill & Knowlton at (212) 885-0682 or firstname.lastname@example.org
About Rosland Capital
Rosland Capital LLC is a leading precious metal asset firm based in Santa Monica, California that buys, sells, and trades all the popular forms of gold, silver, platinum, palladium and other precious metals. Founded in 2008, Rosland Capital strives to educate the public on the benefits of investing in gold bullion, numismatic gold coins, silver, platinum, palladium, and other precious metals. For more information please visit www.roslandcapital.com.
About Jeffrey Nichols
Jeffrey Nichols, Managing Director of American Precious Metals Advisors and Senior Economic Advisor to Rosland Capital, has been a leading precious metals economist for over 25 years. His clients have included central banks, mining companies, national mints, investment funds, trading firms, jewelry manufacturers and others with an interest in precious metals markets.
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Contact: Liz Cheek