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Gold, Goodwill, And Growth

Gold, Goodwill, And Growth

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Published by michael s rozeff
Goodwill on a government balance sheet in the form of tax increases can seemingly remedy insolvency, but since it reduces growth, the remedy may prove fruitless. Governments have backed themselves into a corner by attempting to stimulate growth with Keynesian and neo-Keynesian policies. Inflation still appears to be their policy of choice to resolve their problems.
Goodwill on a government balance sheet in the form of tax increases can seemingly remedy insolvency, but since it reduces growth, the remedy may prove fruitless. Governments have backed themselves into a corner by attempting to stimulate growth with Keynesian and neo-Keynesian policies. Inflation still appears to be their policy of choice to resolve their problems.

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Published by: michael s rozeff on Jun 08, 2010
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Gold, Goodwill, and Growth
 by Michael Rozeff A correspondent suggested to me an idea about government balance sheet goodwill that’s worthsharing. That led me to a few further thoughts about gold and economic growth. The basic idea behind all of this balance sheet analysis is simple. A stronger balance sheet of the governmentmeans a stronger fiat currency and a lower price of gold in that currency, other things equal.If we look at the balance sheet of the United States (meaning the national government), it appearsthat the assets are worth less than the liabilities. I used as an example that the $2.2 trillion of current tax revenues might grow for 2 percent forever and be discounted at a 4.5 percent rate.This gives a present value of $90 trillion. But we read that government liabilities may exceed this by $60 trillion or even more. (See, for example, Laurence J.Kotlikoff ’s paper “Is the UnitedStates Bankrupt?)The suggestion made was that maybe there is an intangible asset being left out, which isgoodwill. That's a useful way to think about balancing the balance sheet. In this case, if the totalassets (tangibles and intangibles) and liabilities are 150 trillion, then 60/150 = 40 percent. This isa large share of intangibles, which suggests its existence may be questionable.What’s in this goodwill? More taxes. One such intangible asset is the government’s capacity toraise taxes. When people worry about the government seizing assets in 401k accounts or forcingsuch accounts to buy United States bonds, they are envisioning this missing government asset.Kotlikoff mentions a national retail-sales tax. Others mention value-added taxes. These are allexamples of ideas to make the government balance sheet balance by increasing the assets, asopposed to explicitly cutting down the government’s promised liabilities, or making thegovernment’s real payouts be less than the promised amounts by defaulting.Higher taxation is a double-edged sword, for any significant tax increase will lower economicgrowth and cut the growth rate of tax revenues. It may enourage more government spending. Itseems to me that such a step will weaken the balance sheet overall.A government tax increase is a government asset, but it’s a taxpayer liability. The taxpayerseither will pay for the promised government benefits or else they won’t get them, which meansgovernment defaults on its promises. There are no other ways left except to invade some other nation and steal its wealth.Balance sheets balance. The United States balance sheet will balance, one way or another.We can invert the problem of the imbalance in another way. At what perpetual growth rate of national income would the assets be worth $150 trillion? The answer is just a tad under 0.03. Inother words, if the U.S. economy grows at 3 percent forever and if the discount rate for taxes is4.5 percent, then the United States’ balance sheet balances. The tax revenues then have a presentvalue of 150 and so do the liabilities. Apparently, Kotlikoff and others who look at thedemographics and the promises made by the government do not find that growth will be
sufficient to fund the promises and debts made. Notice that they exclude contingent liabilities,and they made their estimates before the depression hit and before the United States jacked up itsspending.Long-term growth is very important. That is why I focused on it in several earlier articles.Investing is paradoxical. It depends on a continuing series of short-term decisions andconsiderations, but insofar as these decisions look at fundamentals, the focus is on long-termmatters. Present values discount the entire future. One has to look at the long-term future in anyfundamental valuation approach, even if one is deciding whether to buy or sell every day of theweek.Let us say that the government share of economic activity grows, as it is projected to do in theUnited States. In my view, that lowers growth, because government spending is inefficient or wasted. Capital cannot grow if savings are absorbed by government and dissipated on pyramids.Lower growth undermines the currency.In this balance sheet approach, a change in the politics that points to pro-private sector growth policies will solidify government finances, and that will strengthen the dollar and weaken gold. Iam watching the Obama commission on fiscal reform due to report in December. So far therehave been no news reports that leak any trial balloons.There is an argument to be made that the world economy is the appropriate way to analyze this.All the major fiat currencies are to some extent related through central banking connections andcoordination of the major governments. The world price of gold matters, not just the price indollars. In this case, we should be thinking about a world balance sheet or a balance sheet thatconsolidates the major countries. Global growth, global tax revenues, global government balancesheets, and global inflation all matter.In this approach to understanding gold, gold’s price depends on the strength and weakness of themajor fiat currencies, and they depend on government finances, especially tax revenues, whichdepend on economic growth. And all of this is filtered through what market participantsEXPECT. Psychology is important.The stronger that the politicians feel the pressures of having to maintain the welfare state in order to satisfy voters who vote for it, or the more able they are to impose the welfare state – however one looks at this – the less likely are they to stand by and let the deflationary forces work themselves out. All the major countries (China, Japan, US, UK, France, Germany) have foughtthe depression for several years with greater spending and more inflation. The European CentralBank joining in of late is a MAJOR event.The first reaction of the governments to the economic slowdown was to preserve the welfarestates and even to use the crisis as an excuse to enlarge them, as Rahm Emanuel made explicit.Their first reaction was instinctive: save the banking system. That’s central to the structure of existing governments. They could not even bother to count the costs. Furthermore, all the major governments have a kind of cartel of governments, which is why there are so many supra-

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