June 24, 2013
Eric Sprott: Physical Demand for Gold and Silver is Draining Supplies
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
June 14, 2013
Eric Sprott: Physical is Going to Dominate the COMEX
"I think the plan was, let’s knock the hell out of gold and let’s get people to cave on owning gold. The interesting thing was the exact opposite happened. There is not a data point on gold where we don’t see changes in demand by 100%, or even many hundreds of percent.
Whether it’s US Mint sales of gold in April, I think they went up by 1,000%, the Canadian Mint sales are up 128%, we see Chinese data where I think the number was up 300%. I think the World Gold Council said that India would import at least 100% more than they did last year (during the same period) in the second quarter.
So we see all of these numbers are in hundreds of percent change, whereas the supply of gold from the mining side will probably be down. The supply of recycled gold will be down significantly with the price having come off here. So I think that this raid totally backfired, and unleashed a torrent of buying.
And ultimately the physical is going to dominate the COMEX price as determined by a bunch of guys trading paper ... I would encourage everyone to, one, hold tight, two, if they can, increase their position.” - Eric Sprott via a recent King World News interview
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
Whether it’s US Mint sales of gold in April, I think they went up by 1,000%, the Canadian Mint sales are up 128%, we see Chinese data where I think the number was up 300%. I think the World Gold Council said that India would import at least 100% more than they did last year (during the same period) in the second quarter.
So we see all of these numbers are in hundreds of percent change, whereas the supply of gold from the mining side will probably be down. The supply of recycled gold will be down significantly with the price having come off here. So I think that this raid totally backfired, and unleashed a torrent of buying.
And ultimately the physical is going to dominate the COMEX price as determined by a bunch of guys trading paper ... I would encourage everyone to, one, hold tight, two, if they can, increase their position.” - Eric Sprott via a recent King World News interview
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
June 13, 2013
Eric Sprott: Huge Decline in GLD
"We've seen this huge decline in GLD because it’s actually the last bastion of supply to satisfy this demand. So I don’t regard the GLD losing gold as a sign of weakness whatsoever. It’s not institutional investors getting out of GLD. It’s the (gold from) GLD being shipped over to the East and someone spinning it as a weakness, and I totally disagree with their conclusion. In fact I think it’s quite a sign of strength. I would like all of the gold out of the GLD to disappear and let’s see what happens after that.” - Eric Sprott via a recent King World News interview
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
May 14, 2013
Eric Sprott: A Rude Awakening In Metals
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
April 18, 2013
Eric Sprott; “Gold And Silver, The Greatest Sale In History”
“I’ve always imagined that gold would hit a new high by the end of this year, over $1,900, so that is what I think,” Mr. Sprott said in an interview on Tuesday.
Mr. Sprott believes the yellow metal is safer than paper money, which can be printed by governments. He backs that up with his own investments, saying a few months ago that he has about 80 per cent of his money in the precious metals sector.
“I think [gold] will end up for the year, just like in 2008 ... because in a financial crisis, you don’t want your money in a bank,” he said.
He compared the current pullback to 2008, when the price of gold fell 30 per cent in eight months amid the financial crisis to $712 an ounce, only to rally to $873 by the end of the year and more than $1,900 by September 2011.
Mr. Sprott expressed his resolve for gold a day after prices nosedived nearly 10 per cent.
Mr. Sprott asked his investors to stay the course on a conference call Tuesday, and even encouraged the purchase of more physical gold and silver as global investors flee from risky assets and commodity prices tumble.
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
Mr. Sprott believes the yellow metal is safer than paper money, which can be printed by governments. He backs that up with his own investments, saying a few months ago that he has about 80 per cent of his money in the precious metals sector.
“I think [gold] will end up for the year, just like in 2008 ... because in a financial crisis, you don’t want your money in a bank,” he said.
He compared the current pullback to 2008, when the price of gold fell 30 per cent in eight months amid the financial crisis to $712 an ounce, only to rally to $873 by the end of the year and more than $1,900 by September 2011.
Mr. Sprott expressed his resolve for gold a day after prices nosedived nearly 10 per cent.
Mr. Sprott asked his investors to stay the course on a conference call Tuesday, and even encouraged the purchase of more physical gold and silver as global investors flee from risky assets and commodity prices tumble.
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
April 05, 2013
Eric Sprott's April Commentary: Caveat Depositor
Eric Sprott of Sprott Asset Management is out with his April commentary entitled, "Caveat Depositor." In it, he delves into the Cyprus situation and the macro effects moving forward.
Caveat Depositor
by Eric Sprott & Shree Kargutkar, Sprott Asset Management
“If there is a risk in a bank, our first question should be: ‘Ok, what are you the bank going to do about that? What can you do to recapitalise yourself?’ If the bank can’t do it, then we’ll talk to the shareholders and the bondholders. We’ll ask them to contribute in recapitalising the bank. And if necessary the uninsured deposit holders: ‘What can you do in order to save your own banks?’” – Jeroen Dijsselbloem, March 26, 2013 1
A deal has just been struck with Cyprus. However, it was not the deal that Cyprus saw other countries receive. This was not the deal received by Greece, Italy and Spain. There were no bailed out banks in the aftermath. There was no transfer of risk from over-levered banks to the taxpayers. The risk was pushed back onto the banks. Their equity was wiped out. Their bondholders were wiped out. Their uninsured depositors saw their accounts raided for additional liquidity. It wasn’t just that the rules of the game had changed, the game itself changed. By raiding the depositors’ accounts, a major central bank has gone where they would not previously have dared. The Rubicon has been crossed. Going forward, this is expected to be the “template” for dealing with risky, over-levered banks and the countries which support them.
For the first time since the crisis began, we are faced with a new paradigm, or a “template”, for how a major central bank will address weakness in the financial sector. While the old template involved “bailing out” through transfer of risk from the corporate sector to the taxpayer, the new template calls for “bailing in”, whereby the risk is contained within the affected institution at the expense of equity holders, bond holders and finally the depositor.
How does the new template affect you?
This “template” is already being applied to the “too big to bail” banks in other developed countries around the world. A statement in the joint paper published by the FDIC and the Bank of England in December 2012 reads:
“An efficient path for returning the sound operations of the G-SIFI to the private sector would be provided by exchanging or converting a sufficient amount of the unsecured debt from the original creditors of the failed company into equity. In the U.S., the new equity would become capital in one or more newly formed operating entities. In the U.K., the same approach could be used, or the equity could be used to recapitalize the failing financial company itself—thus, the highest layer of surviving bailedin creditors would become the owners of the resolved firm…. Such a resolution strategy would ensure market discipline and maintain financial stability without cost to taxpayers”.
2 Note the lack of the phrase “uninsured depositors” in this context, which opens the doors for both insured and uninsured depositors to be affected. In a similar vein, Canada’s recently released budget addresses the same problem. Page 144 of Canada’s Economic Action Plan 2013 reads: “The Government proposes to implement a – bail-in regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital. This will reduce risks for taxpayers.”
3 Likewise, New Zealand’s Open Bank Resolution policy allows for a “bail in” of afflicted banks by wiping out the equity holders first, the bond holders second and finally forcing a haircut on the depositors.
4 Over-levered banks are not a recent development. We are faced with a banking crisis, seemingly once every generation. In a majority of cases, the bad banks were allowed to fail and newer, stronger banks took their place. However, the recent modus operandi of the central banks and policy makers allowed over-levered banks to get even bigger, rewarded risk taking with bailouts and let the inherent problem of unsustainability fester.
We carried out the exercise of taking the largest banks, or in other words, the “too big to fail” banks in the G7 countries and added up their assets in relation to the host country GDP. For the layperson, a typical bank’s assets are primarily composed of the loans they have originated while the liabilities are primarily composed of deposits they have accepted. With the exception of the US, all G7 countries have banking systems that have become larger and in some cases dwarfed their respective economies.
Governments around the world are finally beginning to realize the gravity of the risk that exists in their banking sectors. The EU has decided to build upon the new template of the “bail-in” regime. The US, UK and Canada have all followed suit. This puts the onus squarely upon the depositor. The depositor is a lender to the financial institution that he banks with. However, most depositors naively assume that their deposits are 100% safe in their banks and trust them to safeguard their savings. Under the new “template” all lenders (including depositors) to the bank can be forced to “bail in” their respective banks. Several G7 countries already have provisions that allow troubled banks to be bailed in using depositor accounts. We have been vocal about our concerns over the state of the global financial system for the better part of the decade. The Greek tragedy is now being played out in Cyprus with a new twist as depositors have been unwillingly turned into sacrificial lambs. Given the size of the banking sector in most G7 countries and the burgeoning government debts, the ability of the governments to bail out their banks is severely constrained, especially considering the political headwinds that exist today. For this reason, we strongly believe that real assets trump a fiat currency in a “savings” account. It is not our intention to be alarmist here, merely to say, “caveat depositor”. "
Footnotes: 1 Import Export Stats – US Census Foreign trade: http://blogs.ft.com/brusselsblog/2013/03/the-ftreuters-dijsselbloem- interviewtranscript/ 2 http://www.bankofengland.co.uk/publications/Documents/news/2012/nr156.pdf 3 http://www.budget.gc.ca/2013/doc/plan/budget2013-eng.pdf 4 http://www.centralbanking.com/central-banking/official-record/2257939/rbnzarticle- says-open-bank-resolution-helps-keep-banks-in-line
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
Caveat Depositor
by Eric Sprott & Shree Kargutkar, Sprott Asset Management
“If there is a risk in a bank, our first question should be: ‘Ok, what are you the bank going to do about that? What can you do to recapitalise yourself?’ If the bank can’t do it, then we’ll talk to the shareholders and the bondholders. We’ll ask them to contribute in recapitalising the bank. And if necessary the uninsured deposit holders: ‘What can you do in order to save your own banks?’” – Jeroen Dijsselbloem, March 26, 2013 1
A deal has just been struck with Cyprus. However, it was not the deal that Cyprus saw other countries receive. This was not the deal received by Greece, Italy and Spain. There were no bailed out banks in the aftermath. There was no transfer of risk from over-levered banks to the taxpayers. The risk was pushed back onto the banks. Their equity was wiped out. Their bondholders were wiped out. Their uninsured depositors saw their accounts raided for additional liquidity. It wasn’t just that the rules of the game had changed, the game itself changed. By raiding the depositors’ accounts, a major central bank has gone where they would not previously have dared. The Rubicon has been crossed. Going forward, this is expected to be the “template” for dealing with risky, over-levered banks and the countries which support them.
For the first time since the crisis began, we are faced with a new paradigm, or a “template”, for how a major central bank will address weakness in the financial sector. While the old template involved “bailing out” through transfer of risk from the corporate sector to the taxpayer, the new template calls for “bailing in”, whereby the risk is contained within the affected institution at the expense of equity holders, bond holders and finally the depositor.
How does the new template affect you?
This “template” is already being applied to the “too big to bail” banks in other developed countries around the world. A statement in the joint paper published by the FDIC and the Bank of England in December 2012 reads:
“An efficient path for returning the sound operations of the G-SIFI to the private sector would be provided by exchanging or converting a sufficient amount of the unsecured debt from the original creditors of the failed company into equity. In the U.S., the new equity would become capital in one or more newly formed operating entities. In the U.K., the same approach could be used, or the equity could be used to recapitalize the failing financial company itself—thus, the highest layer of surviving bailedin creditors would become the owners of the resolved firm…. Such a resolution strategy would ensure market discipline and maintain financial stability without cost to taxpayers”.
2 Note the lack of the phrase “uninsured depositors” in this context, which opens the doors for both insured and uninsured depositors to be affected. In a similar vein, Canada’s recently released budget addresses the same problem. Page 144 of Canada’s Economic Action Plan 2013 reads: “The Government proposes to implement a – bail-in regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital. This will reduce risks for taxpayers.”
3 Likewise, New Zealand’s Open Bank Resolution policy allows for a “bail in” of afflicted banks by wiping out the equity holders first, the bond holders second and finally forcing a haircut on the depositors.
4 Over-levered banks are not a recent development. We are faced with a banking crisis, seemingly once every generation. In a majority of cases, the bad banks were allowed to fail and newer, stronger banks took their place. However, the recent modus operandi of the central banks and policy makers allowed over-levered banks to get even bigger, rewarded risk taking with bailouts and let the inherent problem of unsustainability fester.
We carried out the exercise of taking the largest banks, or in other words, the “too big to fail” banks in the G7 countries and added up their assets in relation to the host country GDP. For the layperson, a typical bank’s assets are primarily composed of the loans they have originated while the liabilities are primarily composed of deposits they have accepted. With the exception of the US, all G7 countries have banking systems that have become larger and in some cases dwarfed their respective economies.
Governments around the world are finally beginning to realize the gravity of the risk that exists in their banking sectors. The EU has decided to build upon the new template of the “bail-in” regime. The US, UK and Canada have all followed suit. This puts the onus squarely upon the depositor. The depositor is a lender to the financial institution that he banks with. However, most depositors naively assume that their deposits are 100% safe in their banks and trust them to safeguard their savings. Under the new “template” all lenders (including depositors) to the bank can be forced to “bail in” their respective banks. Several G7 countries already have provisions that allow troubled banks to be bailed in using depositor accounts. We have been vocal about our concerns over the state of the global financial system for the better part of the decade. The Greek tragedy is now being played out in Cyprus with a new twist as depositors have been unwillingly turned into sacrificial lambs. Given the size of the banking sector in most G7 countries and the burgeoning government debts, the ability of the governments to bail out their banks is severely constrained, especially considering the political headwinds that exist today. For this reason, we strongly believe that real assets trump a fiat currency in a “savings” account. It is not our intention to be alarmist here, merely to say, “caveat depositor”. "
Footnotes: 1 Import Export Stats – US Census Foreign trade: http://blogs.ft.com/brusselsblog/2013/03/the-ftreuters-dijsselbloem- interviewtranscript/ 2 http://www.bankofengland.co.uk/publications/Documents/news/2012/nr156.pdf 3 http://www.budget.gc.ca/2013/doc/plan/budget2013-eng.pdf 4 http://www.centralbanking.com/central-banking/official-record/2257939/rbnzarticle- says-open-bank-resolution-helps-keep-banks-in-line
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
March 15, 2013
Eric Sprott: Real 2012 US Deficit $6.9 Trillion
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
Eric Sprott: Canada has no Gold
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
March 02, 2013
Eric Sprott: Is the West Dishoarding Its Sovereign Treasure
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
February 28, 2013
Sprott: Is the West Dishoarding Its Sovereign Treasure?
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
February 17, 2013
Eric Sprott Precious Metals Round Table
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
February 05, 2013
Eric Sprott Expect from Gold this Year
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
January 26, 2013
Eric Sprott On Ignoring The Obvious
Ignoring The Obvious
Not a day goes by without hearing about the fiscal cliff, the debt ceiling or another political deadlock. We would not disagree that some of these are important issues that need resolving but, in the grand scheme of things, they are relatively superficial.
As we all know, central banks around the world have been frantically expanding their balance sheets. While exceptional times might warrant exceptional measures, Figure 1 below paints a rather troubling picture. The monetary base, the amount of money in circulation in the economy, has expanded at an incredible pace. Since the mid-80s, the U.S. monetary base had been very stable at around 5-6% of GDP. Through fractional reserve banking, this amount was sufficient to maintain annual inflation around 2-3%. With the banking system collapsing in 2008-2009, it was necessary for the Fed to increase the monetary base. However, banks are now in much better shape than they were in that period and the benefits of monetary expansion seem to be waning.
The Fed is not the solution to every economic and social woe and trying to hide real problems (eg. structurally high unemployment and rampant poverty, unsustainable income inequality and exploding government liabilities) with money printing achieves nothing constructive.
FIGURE 1: U.S. MONETARY BASE AS A % OF GDP
Employment
First, while we are supposed to be in the midst of an economic recovery, about one in five Americans are on food stamps (Figure 2). As the chart below shows, this measure of poverty has been fairly steady for the past year. We also find it hard to reconcile this data point with the headline unemployment numbers, which seem to be improving. We prefer a more comprehensive measure of unemployment, commonly referred to as U6, which includes discouraged workers and those working part time against their will. By this measure, we see that “Total Unemployment” has come down, but remains extremely elevated at around 14% of the labour force. Moreover, food stamps and “Total Unemployment” tend to move together. If food stamps users stabilize at current highs, we believe that it is a sign that the natural unemployment rate in the U.S. economy is now significantly higher than it was pre-crisis.
FIGURE 2: EMPLOYMENT IS NOT AS GOOD AS IT SEEMS
Income Inequality
Second, income inequality has been growing steadily since the mid-1980s. Figure 3 shows the share of total U.S. income earned by the middle class and the top 5% of households. As of 2011, the top 5% of households brought home over 22% of all income generated in the country, whereas the middle 20% of households (quite literally the middle class) got less than 15%. Coupled with the unemployment picture, this shows that a majority of the U.S. population has been losing ground to the most wealthy. In a society that relies on consumption for 70% of its economic activity, this certainly does not bode well for the future, since the wealthiest traditionally do not consume much of their income. To top it off, the recent “fiscal cliff deal” just reduced disposable income further by increasing payroll taxes by 2% for all those working, putting additional strain on the working class and their discretionary spending dollars. (See Figure 3).
FIGURE 3: SHARE OF AGGREGATE INCOME RECEIVED BY HOUSEHOLDS
Source: U.S. Census Bureau, Current Population Survey, Annual Social and Economic Supplements
Government Obligations
Another obvious problem is the liabilities of the Federal Government. The current cash reporting basis that the Department of the Treasury uses, vastly understates its deficit and future liabilities. Some estimates put the current unfunded liabilities of the Federal Government at about $222 Trillion and show an increase in the deficit from 2010 to 2011 of around $11 Trillion, which represents about 70% of the U.S. total GDP.1
Simple back of the envelope calculations can be made using the Treasury’s “Financial Report of the United States Government – 2012”, which comprises a detailed breakdown of its future financial obligations for health care, social security and other government services.2 This reporting is similar to what every corporation is mandated to calculate for the purposes of U.S. GAAP reporting.
Of course, accounting can always be “massaged” to improve one’s situation. This problem is most acute when there are many assumptions, like for pension and benefits accounting (a.k.a. social security and Medicaid/Medicare). ShadowStats makes the necessary adjustments and finds that for 2012 alone, the deficit amounts to $6.9 Trillion.3 This represents about 45% of annual GDP. While laudable, the current haggling by policy makers for a meager $2 Trillion in deficit reduction over 10 years represents only the tip of the iceberg.
A significant part of these deficits is caused by current and future health care spending. The Deloitte Center for Health Solutions recently published a report entitled “The hidden costs of U.S. health care: Consumer discretionary health care spending”, in which they analyze the many components of health care spending and how those expenses are underreported in official numbers. Figure 4 shows their estimates for total health care spending by age group for 2010.
FIGURE 4: TOTAL HEALTH CARE COSTS BY AGE - 2010, $ BN
Source: The hidden costs of U.S. health care:
Consumer discretionary health care spending, Deloitte
Source: US Census Bureau 2012 National Population Projections,U.S. Department of Commerce: Bureau of Economic Analysis, U.S. Department of Labor: Bureau of Labor Statistics & The hidden costs of U.S. health care: Consumer discretionary health care spending, Deloitte
According to the Deloitte study, about 60% of those costs are borne directly by households and the remaining 40% by the public sector (30% to Medicare and Medicaid). This means that households, of which the majority is either poor or in the declining middle class, will face an even larger squeeze in their discretionary spending.
Conclusion
To conclude, 20% of the population is on food stamps, an ever increasing gap between the wealthy and the rest and ever-increasing health care spending are all deep rooted and immensely important problems that get a ridiculous fraction of the attention that they deserve. The impact of these issues on both government finances and future economic growth are enormous.
As we discussed, the purpose of asset purchases by the Fed might no longer be improvements in the real economy, but rather a more subtle financing of U.S. government deficits. However, in the long run, expanding the money supply inevitably leads to inflationary pressures. Luckily for the Fed and the U.S. government, there is so much slack in the labour market that inflation might be years away. And, if we are right about the long run unemployment rate being structurally higher, then the Fed has all the room it needs to continue Quantitative Easing (QE) to infinity. This might allow them to continue to hide the true financial position of the government for many years to come.
Nonetheless, the rising GAAP deficit and the sheer size of the U.S. Federal Government’s liabilities to its citizens makes it clear that one day or another, services (health care, social security) will have to be cut. Financial alchemy can hide reality, but it does not provide any tangible services.
Europe’s (unresolved) experience with its debt crisis provides an insightful window into the future. Austerity measures in Ireland, Portugal, Spain and Greece have caused tremendous pain to their citizens (25% unemployment rates) and wreaked havoc in their economies (double digit retail sales declines).
Source: Zerohedge
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
Not a day goes by without hearing about the fiscal cliff, the debt ceiling or another political deadlock. We would not disagree that some of these are important issues that need resolving but, in the grand scheme of things, they are relatively superficial.
As we all know, central banks around the world have been frantically expanding their balance sheets. While exceptional times might warrant exceptional measures, Figure 1 below paints a rather troubling picture. The monetary base, the amount of money in circulation in the economy, has expanded at an incredible pace. Since the mid-80s, the U.S. monetary base had been very stable at around 5-6% of GDP. Through fractional reserve banking, this amount was sufficient to maintain annual inflation around 2-3%. With the banking system collapsing in 2008-2009, it was necessary for the Fed to increase the monetary base. However, banks are now in much better shape than they were in that period and the benefits of monetary expansion seem to be waning.
The Fed is not the solution to every economic and social woe and trying to hide real problems (eg. structurally high unemployment and rampant poverty, unsustainable income inequality and exploding government liabilities) with money printing achieves nothing constructive.
FIGURE 1: U.S. MONETARY BASE AS A % OF GDP
Source: Federal Reserve Bank of St. Louis, U.S. Department of Commerce: Bureau of Economic Analysis
Employment
First, while we are supposed to be in the midst of an economic recovery, about one in five Americans are on food stamps (Figure 2). As the chart below shows, this measure of poverty has been fairly steady for the past year. We also find it hard to reconcile this data point with the headline unemployment numbers, which seem to be improving. We prefer a more comprehensive measure of unemployment, commonly referred to as U6, which includes discouraged workers and those working part time against their will. By this measure, we see that “Total Unemployment” has come down, but remains extremely elevated at around 14% of the labour force. Moreover, food stamps and “Total Unemployment” tend to move together. If food stamps users stabilize at current highs, we believe that it is a sign that the natural unemployment rate in the U.S. economy is now significantly higher than it was pre-crisis.
FIGURE 2: EMPLOYMENT IS NOT AS GOOD AS IT SEEMS
Source: U.S. Department of Labor: Bureau of Labor Statistics
Income Inequality
Second, income inequality has been growing steadily since the mid-1980s. Figure 3 shows the share of total U.S. income earned by the middle class and the top 5% of households. As of 2011, the top 5% of households brought home over 22% of all income generated in the country, whereas the middle 20% of households (quite literally the middle class) got less than 15%. Coupled with the unemployment picture, this shows that a majority of the U.S. population has been losing ground to the most wealthy. In a society that relies on consumption for 70% of its economic activity, this certainly does not bode well for the future, since the wealthiest traditionally do not consume much of their income. To top it off, the recent “fiscal cliff deal” just reduced disposable income further by increasing payroll taxes by 2% for all those working, putting additional strain on the working class and their discretionary spending dollars. (See Figure 3).
FIGURE 3: SHARE OF AGGREGATE INCOME RECEIVED BY HOUSEHOLDS
Source: U.S. Census Bureau, Current Population Survey, Annual Social and Economic Supplements
Government Obligations
Another obvious problem is the liabilities of the Federal Government. The current cash reporting basis that the Department of the Treasury uses, vastly understates its deficit and future liabilities. Some estimates put the current unfunded liabilities of the Federal Government at about $222 Trillion and show an increase in the deficit from 2010 to 2011 of around $11 Trillion, which represents about 70% of the U.S. total GDP.1
Simple back of the envelope calculations can be made using the Treasury’s “Financial Report of the United States Government – 2012”, which comprises a detailed breakdown of its future financial obligations for health care, social security and other government services.2 This reporting is similar to what every corporation is mandated to calculate for the purposes of U.S. GAAP reporting.
Of course, accounting can always be “massaged” to improve one’s situation. This problem is most acute when there are many assumptions, like for pension and benefits accounting (a.k.a. social security and Medicaid/Medicare). ShadowStats makes the necessary adjustments and finds that for 2012 alone, the deficit amounts to $6.9 Trillion.3 This represents about 45% of annual GDP. While laudable, the current haggling by policy makers for a meager $2 Trillion in deficit reduction over 10 years represents only the tip of the iceberg.
A significant part of these deficits is caused by current and future health care spending. The Deloitte Center for Health Solutions recently published a report entitled “The hidden costs of U.S. health care: Consumer discretionary health care spending”, in which they analyze the many components of health care spending and how those expenses are underreported in official numbers. Figure 4 shows their estimates for total health care spending by age group for 2010.
FIGURE 4: TOTAL HEALTH CARE COSTS BY AGE - 2010, $ BN
Source: The hidden costs of U.S. health care:
Consumer discretionary health care spending, Deloitte
FIGURE 5: U.S. POPULATION 65+ YEARS
Source: US Census Bureau 2012 National Population Projections
What is striking - but not that surprising - is the very large increase in health care costs faced by seniors. The report cites that “Seniors and Baby Boomers account for 64 percent of health care costs, but comprise only 40 percent of the U.S. population.” For seniors, total health care costs represent, on average, approximately $30,000 per person per year. Other estimates by Carnegie Mellon University professor Paul Fischbeck (although a bit dated) show that these annual costs increase dramatically as people age, reaching as much as $45,000 for 80+ year olds.4 Considering that GDP per capita was about $46,800 in 2010 and the income inequality mentioned earlier, these are figures that would put most households in dire straits.
Also, structural trends will lead to an ever greater share of the nation’s income being dedicated to health care. Figure 5 above shows the evolution of the U.S. population for the 65+ age group, as forecasted by the U.S. Census Bureau. The U.S. will end up with a steadily increasing segment of its population (from 13% in 2010 to 20% in 2030) composed of persons aged 65 and over. This matters for two important reasons. First, this means a smaller workforce contributing to GDP growth and paying taxes to support government programs. Second, and this is related to the first point, this trend will put tremendous pressure on social security and health care spending in the country, thus leading to structurally higher deficits.
These facts are by themselves troubling, but coupled with the population trends described in Figure 5, they become alarming. To illustrate the impact of overall population aging on total health care costs, we use the per capita numbers implied by the Deloitte study and apply them to the U.S. Census Bureau projections for all age groups. While we believe that those numbers fundamentally underrepresent health care inflation, we inflate per capita costs for each age group using the average “medical care” component of the U.S. Department of Labor Consumer Price Index. Finally we assume a 4% nominal GDP growth, which some might argue is overly optimistic when taking into account the smaller workforce we discussed earlier. In any case, Figure 6 shows the results of our simulation.
Only with the change in the composition of the U.S. population, total health care costs are forecasted to go from 22% of GDP in 2010 to over 30% in 2040. These are huge numbers! To put them in perspective, in 2011 total U.S. GDP was $14,500 Billion, so an increase from 22% to 30% of GDP would represent a $1.2 Trillion increase in health care spending in that year. If we increase the health care inflation rate by only 100bps, we calculate that by 2040, the share of GDP attributed to health care will jump to 40%.
FIGURE 6: HEALTH CARE SPENDING AS A % OF GDP
Also, structural trends will lead to an ever greater share of the nation’s income being dedicated to health care. Figure 5 above shows the evolution of the U.S. population for the 65+ age group, as forecasted by the U.S. Census Bureau. The U.S. will end up with a steadily increasing segment of its population (from 13% in 2010 to 20% in 2030) composed of persons aged 65 and over. This matters for two important reasons. First, this means a smaller workforce contributing to GDP growth and paying taxes to support government programs. Second, and this is related to the first point, this trend will put tremendous pressure on social security and health care spending in the country, thus leading to structurally higher deficits.
These facts are by themselves troubling, but coupled with the population trends described in Figure 5, they become alarming. To illustrate the impact of overall population aging on total health care costs, we use the per capita numbers implied by the Deloitte study and apply them to the U.S. Census Bureau projections for all age groups. While we believe that those numbers fundamentally underrepresent health care inflation, we inflate per capita costs for each age group using the average “medical care” component of the U.S. Department of Labor Consumer Price Index. Finally we assume a 4% nominal GDP growth, which some might argue is overly optimistic when taking into account the smaller workforce we discussed earlier. In any case, Figure 6 shows the results of our simulation.
Only with the change in the composition of the U.S. population, total health care costs are forecasted to go from 22% of GDP in 2010 to over 30% in 2040. These are huge numbers! To put them in perspective, in 2011 total U.S. GDP was $14,500 Billion, so an increase from 22% to 30% of GDP would represent a $1.2 Trillion increase in health care spending in that year. If we increase the health care inflation rate by only 100bps, we calculate that by 2040, the share of GDP attributed to health care will jump to 40%.
FIGURE 6: HEALTH CARE SPENDING AS A % OF GDP
According to the Deloitte study, about 60% of those costs are borne directly by households and the remaining 40% by the public sector (30% to Medicare and Medicaid). This means that households, of which the majority is either poor or in the declining middle class, will face an even larger squeeze in their discretionary spending.
Conclusion
To conclude, 20% of the population is on food stamps, an ever increasing gap between the wealthy and the rest and ever-increasing health care spending are all deep rooted and immensely important problems that get a ridiculous fraction of the attention that they deserve. The impact of these issues on both government finances and future economic growth are enormous.
As we discussed, the purpose of asset purchases by the Fed might no longer be improvements in the real economy, but rather a more subtle financing of U.S. government deficits. However, in the long run, expanding the money supply inevitably leads to inflationary pressures. Luckily for the Fed and the U.S. government, there is so much slack in the labour market that inflation might be years away. And, if we are right about the long run unemployment rate being structurally higher, then the Fed has all the room it needs to continue Quantitative Easing (QE) to infinity. This might allow them to continue to hide the true financial position of the government for many years to come.
Nonetheless, the rising GAAP deficit and the sheer size of the U.S. Federal Government’s liabilities to its citizens makes it clear that one day or another, services (health care, social security) will have to be cut. Financial alchemy can hide reality, but it does not provide any tangible services.
Europe’s (unresolved) experience with its debt crisis provides an insightful window into the future. Austerity measures in Ireland, Portugal, Spain and Greece have caused tremendous pain to their citizens (25% unemployment rates) and wreaked havoc in their economies (double digit retail sales declines).
Source: Zerohedge
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
January 22, 2013
Eric Sprott Video: Silver to Outshine Gold as the Investment of This Decade
Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.
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