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The Battle of the World Financial System Drags
On |
by Bill Bonner
London, England
The rally may end any day, but it didn't end yesterday. Stocks rose 127
points, as measured by the Dow. Oil closed at $66. Gold rose $2.50.
We said we were doing some serious thinking this week. Maybe it is the
season. But more and more, our thoughts become grayer. Less black. Less
white. Less hard. Less soft.
A few years ago, it looked to us as though the world financial
system had gone to war. We cheerfully awaited the victory parade.
We figured Mr. Market would whup the feds good and hard. It hasn't happened
so far.
On one side, are the forces of a natural market correction...following a
long, long period of expansion. The easier money gets, the more people tend
to misspend and mis-invest it. Then, inevitably, their mistakes must be
corrected. That's what bear markets and recessions are for.
But the feds don't like bear markets or recessions. And at
least since the Keynes outlined his general theory back in the early 20th
century, they've believed that they don't have to put up with them. Keynes
took a page from the Old Testament. Government should act like an
enlightened Egyptian Pharaoh, he didn't say, but should have. It should run
surpluses in the fat years and deficits in the lean years...thus flattening
out the pattern of boom and bust.
Pharaoh was no dope. He stored up grain for seven years, when the harvests
were bountiful. Then, when the seven lean years came, he released the grain
to the people. Problem solved.
Keynes believed that modern government could do the same thing. But Pharaoh
was not running a democracy. He had no voters to answer to. So, if he wanted
to store grain in the fat years, he could do so.
In theory, the US government could do the same. But, in fact, it never runs
significant surpluses. There are too many people who want too much bread and
too many circuses. And you don't win votes by denying the voters
what they want. So, in practice, the feds run deficits even in the
fat years! Last year, before the downturn really started to bite, the US
federal government ran the biggest deficit in history - nearly half a
trillion dollars.
Now, let's imagine how that would work for a bad Pharaoh. He would give out
grain in the fat years. This would encourage farmers to produce less grain.
Then, when the lean years came, Pharaoh would have no grain to give
out...and the farmers would have less grain stored up themselves, since they
grew less during the boom years. The famine would be worse than ever.
Then, if we can imagine that Egypt was trading with China at the time,
perhaps Pharaoh could borrow grain from the Zhou dynasty to help ease the
peoples' pain. Perhaps he could mortgage the pyramids. Whatever, he - and
the Egyptian people - would have been in much better position if he had done
as Joseph told him in the first place...lay up stores in good times, draw
then down in bad times. How difficult is that?
But Bernanke didn't see the famine coming. Neither did Geithner. Or
Greenspan. Or any of the other savants Pharaoh interpret his dreams. None of
them expected hard times. None of them warned the public. None of them
encouraged the government to save money for the recession. Nassim Taleb asks
why Bernanke was reappointed after he clearly failed the most critical test.
But heck...the federal government is an equal opportunity employer.
Employees aren't let go just become they're incompetent.
Anyway, getting back to our thoughts...
..it looked like a battle to us - between the forces of inflation (the
feds)...and the forces of deflation (the market). But battles usually have
clear winners. One side is master of the field and the other retreats. One
side is victorious; the other is defeated.
Alas, some wars produce no hosannas of success...and no wailing widows of
failure. Some end in draws...or in confusion...or in disgrace and bankruptcy
for both sides.
Like the bad Pharaoh, the feds saved nothing. Now, they
have to try to work their Keynesian magic on credit. This puts them in a
weak position; like a government that wages war on borrowed money. They can
continue their campaign only as long as lenders allow them. They can't wage
the war as effectively as they'd like. Then again, maybe they can't lose it
as spectacularly as they might.
For the moment, their credit is still good. The bond market foresees an
inflation rate of less than 2%. Bankers, taking money from the government,
are happy to lend it back to them.
But the forces of the correction are giving up little ground. While stocks
rally, the real economy remains in a funk.
"Sharp drop in start-ups," is a news headline from
yesterday. New business start-ups are a major source of new jobs. Bad omen.
Even glamour publisher Conde Nast is forced to make cutbacks. It has told
employees that they may not spend more than $1,000 a night when they are
traveling.
A Pimco economist says savings rates are still going up...and may exceed 8%.
This represents hundreds of billions of dollars taken out of the consumer
economy. Oddly, while it makes the slump worse, it also helps finance the
government's battle against it. Savers buy US debt (albeit indirectly).
So, the battle is still going on...and the outcome is still in doubt.
[We may not know how this battle is going to turn out, but we do know one
thing: it most likely won't turn out well for you...which is why we have
made a financial defense strategy available to our readers - free of charge.
Get it here.]
More news, from The 5 Min. Forecast:
"Pop quiz: what happened a year ago today?" writes Ian Mathias in today's
issue of The 5. "Here's a hint:
"The House put the kibosh on the first rendition of 'The Emergency
Economic Stabilization Act of 2008' - Former Treasury Sec'y Hank Paulson's
three page request for a $700 billion blank check for his buddies on Wall
Street.
"'Investors' threw a tantrum, crashing the Dow 777 points - it's biggest
point loss in history. Approximately $1.2 trillion in Wall Street
shareholder value was wiped out, also a record. This day a year ago, the
real market pain began. The S&P fell about 20% over the next two weeks.
"The House eventually passed a package - aimed at cleaning up 'toxic
assets' on big Wall Street balance sheets, but also rife with pork barrel
spending. A year later...the stock market has recovered, Congress has
spent plenty o'money, but has anything been done to stave off future CDO
or mortgage-backed calamity? No.
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"Time and clever accounting has put us deservedly back to square
one...right? Or, as Addison argues in his
latest investment report, is this the 'biggest financial
swindle in world history, engineered by none other than Wall Street and
Washington, DC.'"
And back to Bill, with more thoughts...
Our own Addison Wiggin was interviewed by The Daily Bell on his
beginnings at Agora (working on an old laptop on a desk he shared with your
editor in Paris), whether or not the West can save itself - and on this
'war' between inflation and deflation.
On the latter, here's what Addison had to say:
"'Deflation now, inflation later' is a mantra we've adopted at
The Daily Reckoning. The Federal Reserve, through it's program
of quantitative easing, is busting the seems of it's own balance sheet in
order to fight a deflationary trend in the West. At some point, the tide
will shift. Mr. Bernanke assures the world he's watching inflationary
indicators like a hawk. We have our doubts whether those indicators will do
him any good. As Paul Volcker, the great inflation slayer of the early
1980s, said when we interviewed him for I.O.U.S.A. 'Once inflation
gets started, it's very hard to stop. And there's a strong flavor of that at
the moment.'
[To read Addison's full interview,
see here.]
"Global trade rose at its fastest rate in more than five years in
July," The Financial Times reports, "suggesting the
economic recovery is feeding through into commerce."
"I've been worried about the effects of protectionism in shutting off
different markets and making a weak economy even worse off," says colleague
Chris Mayer. "Commodity markets especially need open markets to function
well. The EU, for example, just put a 40% tariff on Chinese made steel pipe.
That's not good for steel pipe demand and hence, the steel makers and the
commodities that go into steel. If we see widespread adoption of such
measures, we'd have to re-think some things.
"But so far, it looks like we've got a recovery of some kind in global
trade. When I look at the global economy, many of the bright spots stem from
surging trade along old trade routes (such as China and Arab world)."
[For more from Chris, and to learn about a resource breakthrough that could
change the face of America's dependence on foreign oil,
see here.]
Racehorse prices are in freefall, says a report out yesterday. But
collectible cars are still doing well.
Yesterday, we saw someone drive by in a huge, gaudy pink Cadillac
from the 1960s. It had magnificent fins and enough chrome to
stagger a blind man. In it were a middle-aged man and woman, looking very
comfortable and proud. They were traveling in style...in a rolling
sculpture.
Old cars are not only holding their values, they're still going up. But not
all old cars. Detroit's muscle cars have been falling in price for the last
three years. Not very green?
Until tomorrow,
Bill Bonner
The Daily Reckoning
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|
The Daily Reckoning
Presents: |
At present, there is a lot of confusion amongst
the investment community and opinion is divided as to whether we will
witness inflation or deflation. Puru Saxena looks at both sides, below...
Inflation is Our Future
by Puru Saxena
Hong Kong, China
On one hand, the deflationists are claiming that given the extremely high
debt levels in the West, further inflation is impossible. On the other side
of the argument, many proponents of inflation are calling for Zimbabwe style
hyperinflation. In this business, everyone is entitled to their opinion;
however it is my contention that we will get neither deflation nor
hyperinflation. If my assessment is correct, once business activity
picks up, our world will have to deal with high inflation.
Although I have great sympathy for the deflation crowd, given the reckless
attitude of the central bankers and their ability to create debt-based
money, I do not believe deflation (contraction in the supply of money and
total debt) is very likely.
For sure, in this post-bubble environment, American consumer debt
continues to contract, but this is being more than offset by the expansion
in federal debt. Over the past year alone, federal debt in America
has surged from US$9.645 trillion to US$11.813 trillion. In other words,
during the past twelve months, American federal debt has risen by a shocking
24.47% and it now stands at 83.52% of GDP! Now, given the ability of the
American establishment to essentially create dollars out of thin air, I have
no doubt in my mind that it be able to inflate the economy. However, this
will come at a huge cost and the victim will be the American currency.
In fact, the recent weakness in the US dollar is a sign that central- bank
sponsored inflation has started to dominate the private-sector debt
contraction in the West. Furthermore, over the past few weeks, various
governments have issued US dollar-denominated debt and this suggests that
the carry-trade is back in vogue. In a startling move, Germany recently
announced that it plans to borrow money in US dollars!
Now, given the ongoing federal debt inflation, debasement of paper
currencies, sky-high budget deficits and competitive currency devaluations,
the macro-economic environment has never been better for precious metals.
Yet, both gold and silver continue to frustrate the bulls by staying
below the record-highs recorded in spring 2008.
So, what is going on here? Have we already seen the end of the precious
metals bull-market or are we about to witness an explosive rally? Before I
attempt to answer this question, I want to make it clear that even though
gold failed to better its all-time high during last autumn's panic, it was
the only asset, (apart from US Treasuries) which stayed relatively firm. And
looking at the various markets today, gold is the only asset that is
flirting with its all-time high. So, whether you like it or not, gold
deserves some credit for fulfilling its role as a safe haven.
|
"...when macro-economic uncertainty was high and inflationary
expectations were running out of control, gold turned out to be a
fantastic asset to own. If my take on the macro-economic situation
is valid, then we are in such a period now and gold must form a part
of every investment portfolio." |
|
Now, unlike some of the die-hard gold bugs, I don't believe that gold is the
ultimate asset to own at all times. Without a doubt, there have been times
in history when gold has proven to be a lousy investment. For instance,
between 1980 and 2001, the nominal price of the yellow metal fell by an
astonishing 70%. This horrible price action spawned an entire generation who
grew up hating gold and up until a few years ago, the vast majority
considered gold a barbaric relic.
However, during other periods in history, when macro-economic uncertainty
was high and inflationary expectations were running out of control,
gold turned out to be a fantastic asset to own.
If my take on the macro-economic situation is valid, then we are in such a
period now and gold must form a part of every investment portfolio.
You may remember that over the past year, central banks have injected
trillions of dollars into the banking system and it is only a matter of time
before inflationary expectations start spiraling out of control. Up until
now, this 'stimulus' money hasn't permeated through the economy in the West
but once money velocity picks up, prices will start rising and the
investment community will become very concerned about inflation.
When the deflation scare abates and people start protecting the purchasing
power of their savings, capital will start to flow towards precious metals.
Long-term clients and subscribers will recall that about two years ago, I
highlighted gold's tendency to rocket higher every other year. Figure 1
captures this trend perfectly and you can see that since the outset, gold's
bull-market has been punctuated by lengthy consolidations and the yellow
metal has surged to a new high every alternate year.
Figure 1: Is gold about to shine?
|
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So, if gold remains in a bull-market and its trend consistency is
intact, its price should surge over the following months.
Conversely, if the price of gold fails to climb above its all-time high
before year-end, it should start to ring alarm bells as this would open up
the possibility that the bull-market may be over. Remember, certainty does
not exist in the investment world and savvy investors should remain open to
all outcomes.
Now, given the uncertainty in the world today and the ticking inflationary
time-bomb, my view is that gold will soon embark on its north-bound journey.
So, I suggest that investors hold on to gold and the related mining
companies which will probably continue to perform well until next spring.
As far as silver is concerned, it has always been a high-beta play
on the direction of gold. If the next up leg in gold's bull-market
materialises, the price of silver will also head towards the heavens.
Accordingly, investors may also want to allocate a portion of their
investment portfolio to silver bullion and silver producing companies.
Regards,
Puru Saxena
for The Daily Reckoning
Editor's Note: In a good year for gold, silver could bring
in some pretty major gains. Find out how to include this precious metal in
your portfolio.
See here.
Puru Saxena is the founder of Puru Saxena Wealth Management, his Hong Kong
based firm, which manages investment portfolios for individuals and
corporate clients. He is a highly showcased investment manager and a regular
guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio
programs.
Puru Saxena publishes Money Matters, a monthly economic report,
which highlights extraordinary investment opportunities in all major
markets. In addition to the monthly report, subscribers also receive "Weekly
Updates" covering the recent market action. Money Matters is
available by subscription here. |
