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The debt crisis that has
taken down banks and even countries threatens more than 100 American
municipalities this year. According to Meredith Whitney who works as a US
research analyst, local and state debts are the biggest concerns to the US
economy today. It is large enough to derail economic recovery. She said that,
"There's not a doubt on my mind that you will see a spate of municipal
bond defaults. You can see fifty to a hundred sizable defaults - more. This
will amount to hundreds of billions of dollars' worth of defaults".
American states and cities have a total
debt load of around $2 trillion. New Jersey government Chris Christie
summarized it clearly, "We spent too much on everything. We spent money
we didn't have. We borrowed money just crazily. The credit card's maxed out,
and it's over. We now have to get to the business of climbing out of the
hole. We've been digging it for a decade or more. We've got to climb now, and
a climb is harder." Cities from Madrid to Detroit are struggling to pay
off even just basic services such as street cleaning.
Ms. Whitney's comments are likely to
put focus on municipal bonds. She is ranked as one of the most influential
women in American business. While working for Oppenheimer, a New York
investment bank, she predicted that Citibank will cut its dividends. Although
she suffered from a lot of criticisms then, her analysis proved to be correct
as the bank was forced to seek government bail-out. Ms. Whitney has since
started her own consulting firm.
Deficit Already Affecting Public Spending
American states have spent almost $500
billion more than tax revenues. In addition, they face another $1 trillion
hole in pension funds. Already, Detroit is cutting road repairs, cleaning
services, police, and lighting expenditures which affects 20% of the
population. The city has suffered from nearly two decades of decline due to
US auto outsourcing. It no longer generates enough wealth to provide services
to its 900,000 inhabitants.
Meanwhile, Illinois is suffering from
similar ills after spending twice as much as it generated in tax. It is
already six months behind on creditor payments. It owes $400 million to the
University of Illinois alone and has 21% chances of defaulting on its debts.
According to CMA Datavision which is a derivatives information company, this
percentage is more than any other state.
Other states such as California and
Arizona are also taking steps to solve their debt problems. California has
raised university tuition fees by 32% while Arizona sold its Supreme Court
and state capitol buildings before leasing them back. Florida is another
state that may be hit by a default; this state is the center of a real estate
boom that went best recently.
Philip Brown, the managing director of
Citigroup in London said that, "It's all part of the same parcel: public
sector indebtedness needs to be cut, it needs a lot of austerity and it hit
the central government first, and now is hitting local bodies." Unlike
banks and other financial institutions "cities are their own".
According to Andres Rodriguez-Pose, a professor of economic geography at the
London School of Economics, "cities will have to pay for their debts,
and in some cases they will have to carry out dramatic cuts, such as
Detroit's."
If there is a city that best symbolizes
distressed local finances, it is Vallejo in California. Vallejo is a former
US navy town located near San Francisco. It has entered into Chapter Nine
bankruptcy protection in 2008 and the effects are still resonating up to this
day. The city is trying to negotiate with the unions, which has refused to
accept a plan to cut salary two years ago.
Vallejo has a population of around
120,000 but it carries $195 million in unfunded pension obligations. The town
does not have enough local industry to sustain its finances; property tax
collection dropped dramatically upon the collapse of the real estate market.
Vallejo is given a C rating by Standard & Poor, the lowest level. US
cities are more susceptible to defaults than their European counterparts
because it relies mainly on municipal bonds while European towns depend on government
bailouts and bank loans.
Gold Expectations for 2011
Now, let's take a look at long-term
gold chart (courtesy of http://stockcharts.com) to see how bullion fared
this week:
For some time, gold has tried to break
the upper border of the rising trend channel. Gold prices have been wavering
from $1,340 to $1,423 since October 5 with a general upward slope. It has
often just fallen by a fraction below the rising trend line. There are signs
that a break-out could be seen soon. We take into account that gold is quite
bullish at the onset of a new year. The $1,600 target still seems realistic
for the early part of 2011.
2010 ended on a high note for precious
metals. Gold ended the year at $1,421 an ounce while silver is at $30.91 an
ounce. Overall, gold prices rose by 30% in 2010 while silver leaped 80%.
Prognostications abound in 2011. These forecasts consider the outlook for
currencies, inflation, and interest rates in the world's largest economies.
We'll examine some of the trends that may influence gold prices:
Gold prices tend to rise in times of
projected or actual inflation due to the bullion's status as a "safe
haven" asset. Investors who are seeking an asset that reacts favorably
to currency devaluation and inflation typically move some of their wealth
into gold.
Right now, the Fed is more concerned
about deflation rather than inflation. As such, they show little reluctance
to flood the US economy with dollars. Meanwhile, countries such as India and
China want stronger economic growth. The result of this is higher inflation.
China's prices are now 5.1% higher compared to a year ago while India
projects an inflation of 5.5% by March 2011.
But the correlation between high
inflation and high gold prices isn't set in stone. Although more inflation
will initially favor high gold prices, the countervailing policy of keeping
interest rates to control inflation sometimes makes interest-bearing
instruments more attractive. As of now, however, rates are not high enough to
have an impact on gold prices.
Historically, the first two months of
the year are good for gold. Buyers seek back the gold positions they shed
going into the New Year. The continuing inflationary concerns can further
support prices in 2011. The Reserve Bank of India said that inflation is not
slowing down as quickly as desired. In the US, there are reports that
companies are experiencing higher costs for staffing and/or materials, but
these costs are not yet being felt by the customers.
According to Frank Holmes, the CEO of
US Global Investors, "The two pillars of gold are, in any country's
currency, are negative real interest rate and deficit spending." Mr.
Holmes believes that low interest rates won't go away anytime soon as this
would be "catastrophic" to the financial system.
Thank you for reading.
Rosanne Lim
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