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December 8th, 2008
As the credit crisis deepens and morphs into uncharted waters, a little perspective is necessary on what it is costing, in both dollars and human terms. You may have seen the mind-numbing comparisons with other massive government expenditures of the past. These statistics were inflation-adjusted, courtesy of Jim Bianco of Bianco Research. The credit crisis, with $4.6 trillion committed (and perhaps just getting started) already has cost roughly one trillion dollars more than World War II ($3.6 trillion). The Marshall Plan to rebuild Europe after the war cost a mere $115 billion. The Louisiana Purchase was a ridiculous bargain at $217 billion ($15 billion originally). It appears that the piper has finally arrived to be paid for the unlimited debt creation since 1971 and the middle-class is already tapped out.
Keepers of the American Dream
The American middle-class, the hard-working keepers of the American Dream, has been in distress for 35 years, slowly losing ground and purchasing power. The current credit crisis may prove to be the greatest challenge to the middle-class way of life. Adding astronomical debt to existing debt will not solve our problems.
The first chart below, Median Household Income since 1945, is the one the public sees in the media. It shows household income marching ever upward, a symbol of unbridled American prosperity. The truth is that inflation has made prosperity, especially for middle-class Americans, far more elusive.
Desperation and Necessity
The struggles of the American middle-class since 1970 become very clear when looking at the next two charts. Their buying power has plunged when you factor in the massive loss of buying power of the US dollar. Over this 35+ year period, both spouses were forced into the workplace to keep the family afloat. It also explains the massive growth in consumer debt and lack of personal savings. The middle-class was not necessarily acting irresponsibly. It was acting out of desperation and necessity.
Clearly many in the middle-class (and elsewhere) have added debt too recklessly. But prices have inexorably grown faster, year after year, than the growth of real middle-class income. In addition fixed costs for the American family (mortgage costs, insurance, child care, health care, etc.) are much higher as a percentage of income than they were 35 years ago.
Sources: CensusBureau.gov, The Financial Help Center.com
Sources: CensusBureau.gov, MeasuringWorth.com
Sources: CensusBureau.gov, Barchart.com
Median Income Devastated by Inflation
Divided by the CPI (which has been understated for decades) the "adjusted" Median Household Income has barely grown at all since 1973. When measured in terms of ounces of gold instead of dollars, median income has plunged. This chart shows median income peaked in 1970, when it would buy 240 ounces of gold. The devastating inflation of the 1970's sent real median income down to its low in 1980, where it could only buy 29 ounces of gold. One can see the current direction of "real" median income since 2001, and we haven't even felt the eventual inflationary effects of the credit crisis. As we stand today, the Median Household Income can buy approximately 65 ounces of gold, one of the lower levels since 1945.
Home Equity on the Decline
One key source to fill the gap of falling wage growth was home equity. Quite simply, Americans have been slowly transferring ownership of their homes to the banking system over the last 50+ years. These figures would look much worse if the roughly 1/3 of homes owned "free and clear" (mostly by seniors) were removed from the data, but you can see the trend is toward less equity and more debt. This is not a sign of a prospering middle-class.
Historic Turning Point
The availability of easy credit the last two decades was a key mechanism to keep the middle-class above water. Now the easy and available credit is going away, and with it much of the quality of life of the middle-class. The early 1970's was clearly an historic turning point for millions of Americans. With the 1971 severing of the gold-backed dollar by the Nixon Administration, the fate of the middle class was sealed. Unlimited fiat money creation led to unlimited debt and a rapidly depreciating dollar. Middle-class "real" wage growth would never again keep up with "real" inflation, especially in key areas such as health care and college tuition, which have greatly exceeded the stated rate of inflation.
Do you think the strapped middle-class family feels better when hearing that inflation is "only" 4%, instead of 11.6%, as measured prior to 1983? Not likely. Understated inflation does not help remove the sting of declining purchasing power. It just adds to the confusion and desperation. The pain is still real, even as trust in government continues to decline. With the current world-wide deleveraging, inflation rates are coming down, for the short to medium term. With trillions upon trillions of government debt soon to flood the financial system, inflation will not be gone for long.
Inflation or Deflation - Middle Class Loses
Be it a hyperinflationary or deflationary scenario in the coming years, the middle-class will suffer. Either from a massive loss of buying power (hyperinflation) or explosive debt burdens (deflation). Eventually, foreign creditors will likely bolt the dollar for something with more enduring value; i.e. gold. It would be a good idea, whether you are middle class or not, to prepare by accumulating some gold while it is still relatively cheap and somewhat available.
The US dollar has been the global monetary standard since the Bretton Woods Agreement in 1944. Unfortunately, the dollar has not been a good store of value since Nixon severed the dollar's link to gold in 1971. The Federal Reserve has always functioned as the lender of last resort, and is now becoming the "spender of last resort." Unprecedented debasing of the US currency could be on our horizon.
Pawns in a Chess Game
While fulfilling its classic role as the backbone of the American economy, the middle-class also is the unwitting pawn in the complex chess game of global finance and government excess. The problem with being a pawn is that one has no control of the game, or its outcome. Historically, the middle-class is always the group to feel the greatest pain and reap the fewest rewards from the machinations of Wall Street and Washington. The period dead ahead will be no exception. The extraordinary debt levels will only make matters worse.
The middle-class has been under growing pressure for over 30 years, as its purchasing power has been steadily under attack. Things will very likely get worse before we see any light. The middle-class must retrench even further. But it must also search for a store of value as its dollars buy less and less. It is my belief that once the severe de-leveraging is finished, the commodity sector, particularly gold, will serve as that life raft. The struggling middle-class, and everyone else for that matter, will need something to stay afloat if the USS dollar slowly sinks in the murky seas of the global currency markets.
The Way Forward
Historically, one great quality of America is resilience. It is my sincere hope that out of this crisis will emerge a more rational way forward. I believe the best way forward for our country would be a system of honest money; a new currency backed by gold that would enforce discipline on government spending and allow families to plan and save for their futures. And it might just provide our children and generations unborn their own shot at the American Dream. We owe them that much.
The stock markets shot higher for a second straight session Monday as investors bet that President-elect Barack Obama's plans to increase infrastructure spending will help lift the economy back to health. The major market indexes jumped more than 3 percent, and the Dow Jones industrials' nearly 300 point advance gave the blue chips their highest close in a month.
The Dow Jones Industrial Average rose 298.76, or 3.46 percent, to 8,934.18, its highest close since it finished at 9,139.27 on Nov. 5th. The Standard & Poor's 500 index advanced 33.63, or 3.84 percent, to 909.70; and the Nasdaq composite index jumped 62.43, or 4.14 percent, to 1,571.74. It was the ninth advance in 11 sessions for the Dow and the S&P 500.
Oil futures surged 7% Monday, buoyed by expectations that the OPEC oil cartel may deliver a substantial cut in production as well as by U.S. President-elect Barack Obama's pledge of massive new infrastructure investment to revive the economy. Crude oil for January delivery surged $2.90, or 7.1%, to end at $43.71 a barrel on the New York Mercantile Exchange. Earlier, the contract hit an intraday high of $44.70 a barrel.
Gold and other metals futures rallied Monday, getting a boost from soaring oil prices, weakness in the U.S. dollar and President-elect Barack Obama's pledge of a massive new infrastructure investment to buoy the U.S. economy. Gold for February delivery rose $17.10 to end at $769.30 an ounce on the New York Mercantile Exchange.
Originally posted Dec 8, 2008 on FinancialSense.com.
ABOUT THE AUTHOR
Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and I encourage you to complete your own due diligence when making an investment decision.
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