Who will go broke?

July 27, 2017

Pat Heller

My 2015 prediction is coming to pass. It’s going to affect your finances, your cost of living, possibly the value of numismatic items and the prices of gold and silver.

Two years ago, the Governmental Accounting Standards Board adopted new requirements that state, county and local governments and government school districts would be required to post on their balance sheets the net present value of unfunded liabilities for employee pensions and retiree healthcare benefits. The first fiscal years where this requirement would apply were those ending June 30, 2017.

Back then, I predicted that when these requirements took effect, you would see the first of these financial statements coming out around the beginning of August 2017. Further, I forecasted that when these financial statements started to come out showing that these governments and school districts were largely either insolvent or bankrupt that the public would start to really take notice of the poor state of the U.S. economy.

That is exactly what is starting to happen.

Last week, the local newspaper in Port Huron, Mich., published an article about how the city’s finances were deteriorating. In 2014, the city’s government made pension contributions equal to 62 percent of payroll. For 2017, the pension payment is equaling 86 percent of payroll. It will almost certainly be higher in the future.

This story is just one of the first drips of what will soon be a flood of similar stories from almost every state, county and local government and government school district across the entire United States.

In order to begin serious funding of these past unfunded liabilities, these agencies will pursue one or more of the following steps:

• Seek higher taxes (such as Illinois’ recent 32 percent increase in the state income tax).
• Sharply cut expenses (including elimination of jobs).
• Negotiate retroactive cuts in promised pensions (as has been happening in jurisdictions in California) and retiree health care benefits, or if unsuccessful, to unilaterally repudiate or default on some or all of these promises.
• Try to borrow in order to postpone payments further into the future.
• Encourage the federal government to continue to inflate the money supply so that existing obligations can be paid off in devalued currency.

Since the federal government has massive unfunded liabilities for Social Security and for Medicare, it is virtually certain that it will continue to inflate the money supply. This will have the effect of driving down further the value of the U.S. dollar (as of early last week the U.S. Dollar Index had fallen 7 percent thus far in 2017).

Any of these actions will have effects that will reduce the average American’s standard of living. When taxes go up, people’s after-tax income declines. So, spending will be curtailed, which will lead to the elimination of some jobs. When governments cut spending, some of this will be achieved through staff reductions or elimination of contracted services. When current and future retirees see their benefits cut, that will also lead to lower consumer spending.

If governments succeed in increasing their borrowings to help pay off unfunded liabilities, that will reduce credit available to create jobs in the private sector. Because of the massive amount of borrowing activity, it is virtually certain that interest rates will rise, which increases the costs of governments at all levels as well as in the private sector. That will further reduce funds available to maintain existing job levels.

The Federal Open Market Committee at the Federal Reserve Bank states that it is its policy to seek a 2 percent annual increase in consumer prices. Any increase in consumer prices will reduce the funds that consumers have available to pay for the necessities of life. As this occurs, that will lead to an even greater reduction in spending for discretionary items.

That these effects hurting the U.S. economy and the value of the U.S. dollar will come to pass are virtual certainties. What is uncertain is how fast these changes will occur. As people anticipate that their wealth is declining the longer they hold U.S. dollars, the faster they will seek to acquire safe haven assets such as bullion-priced physical gold and silver coins and ingots. Such a shift in consumer and investor spending could accelerate the decline in the dollar’s value and the American economy.

I don’t have a crystal ball telling me how the decline of the U.S. economy and dollar will impact numismatic coins. As people try to rein in their discretionary expenses, there will certainly be lower demand for many of the less expensive collector coins. This would likely lead to lower prices. Yet, even in troubled times there will be some who are financially well off who will enjoy the opportunity to acquire genuine numismatic rarities at current or perhaps even lower price levels.

So, what does this analysis mean for numismatic collectors and investors in precious metals?

I suspect there will be a number of numismatic niches that will suffer lower demand and price drops. It would not surprise me if one niche to suffer will be for modern U.S. coins that are marketed at prices well above their bullion value.

I also expect that those who own bullion-priced physical gold and silver coins and ingots will fare better through the economic troubles than the average person.

Twenty years ago, the Far East experienced a major currency crisis. The people in the nation of Indonesia were the hardest hit. Those who held all of their wealth denominated in the Indonesian rupiah currency pretty much became destitute. In contrast, Indonesians who owned significant quantities of physical gold and silver saw their standard of living largely unaffected or even improved. This is a lesson for Americans to keep in mind now.