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Joel Bowman, with a few quick words
from Taipei, Taiwan...
We’re approaching one tenth of the way through this new century and
already the world is getting a taste of things to come...
The world’s temporary reserve currency, the US dollar, has shed roughly
one third of its purchasing power against a basket of major paper
competitors this decade. Gold, having begun the millennium in the dumps,
has roughly quadrupled against the greenback over that same period. And
stocks, after peaking back in 2007, are down about 7% for the same
period.
Booms...bubbles...busts of epic proportions...
In short, the era was everything except what Federal Reserve
Chairman Ben Bernanke thought it would be: an era of “Great Moderation.”
In fact, it would be hard to think of a more incorrect way to describe
the times we live in.
We carry wars into the new decade, too. There are wars on terror, on
unemployment, on the economy and, yes, even on the weather. That’s not
to mention the carry-over wars from political rally posters of yore;
wars on drugs and poverty, wars so poorly-fought, grossly-mishandled and
ill-defined that they’ve become permanent taxes rather than popular
election talking points.
Then there’s the war being waged between the forces of inflation and
deflation, with the market pulling in one direction and the Feds yanking
in the other. And that’s where we begin today’s musing. In the issue
that follows, Dan Amoss, Puru Saxena and Daily Reckoning
founder, Bill Bonner, talk us through the epic battle being waged in The
War of the ’Flations.
First up, Dan Amoss, editor of the Strategic Short Report,
described the scene in yesterday’s 5-Minute Forecast...
“Now that fears of a deflationary spiral have waned, a rising Treasury
note yield is bearish for stocks. Rising Treasury yields increase
mortgage rates and decrease the attractiveness of rate-sensitive stocks
like utilities, banks, and REITs.
“A rising trend in Treasury yields is especially dangerous,” continued
Dan, “when you consider that the biggest threat to the economy in 2010
is the backlog of mortgage foreclosures that have yet to work their way
through the system. As these homes work their way through the system, it
will be another deflationary shock to the banking system. In this
deflationary shock, I doubt we’ll see Treasury yields move anywhere near
their 2008 lows. Higher Treasury yields will keep pressure on interest
rate-sensitive stocks, while the continued deflationary pressures in
housing will keep pressure on credit-sensitive stocks.
“All of this adds up to a much more hostile environment for the stock
market than we’ve seen in 2009. With valuations high, long-term interest
rates heading up, and credit stress still an issue, the environment for
short selling is growing more favorable.”
And now, over to Hong Kong where Puru Saxena has a few
thoughts...
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The Daily Reckoning
Presents: |
Can the world’s governments mop up their
liquidity spills before it’s too late? Do they even want to? Most people
think their central banks are trying to protect their nations’
currencies – probably because that’s the line they feed the public. But,
as usual, what we’re told ain’t necessarily so. In today’s issue guest
essayist, Puru Saxena, offers a few words on the consequences of
“competitive devaluation.” Please enjoy...
The Debt Bomb
By Puru Saxena
Hong Kong, China
Make no mistake; the developed world is drowning in debt and there are
only two viable options – a global economic depression or very high
inflation. It is our contention that the policymakers have chosen the
latter option and over the following years, we will experience the
trauma of severe inflation.
Look. The American government is staring at total obligations of US$115
trillion, America’s debt-to-GDP ratio is off the charts and the American
public is also up to its eyeballs in debt. Under this scenario, you can
bet your bottom dollar that the American establishment will try to
reduce this debt overhang through a process known as monetary inflation.
If you have any doubt whatsoever, take a look at the chart below, which
captures the incredible expansion in America’s monetary base.
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As you can see, over the past two years, the
monetary base in America has expanded from US$827 billion to an
astonishing US$1.93 trillion! Until now, this surge in the monetary base
has not produced a highly visible inflationary impact...yet.
But it is notable that America is not alone in pursuing inflationary
policies. All over the world, the developed nations are printing money and
debasing their currencies. In this era of globalization, no country wants
a strong currency and everyone is engaged in competitive currency
devaluations. This massive money and debt creation will cause an
inflationary boom over the coming years.
In fact, those who erroneously believe that deflation is unavoidable
should review Figure 2, which highlights the mind-boggling expansion in
the balance sheets of various central banks. As you can see, America is
not the only nation guilty of printing money; the Europeans have also
jumped on this train to Inflationville.
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Now, we are aware that many prominent
commentators are still calling for deflation. “After all,” they argue,
“how can inflation be a problem when bond yields are so low?” Well, these
deflationists seem to be missing the point because the US Treasury market
is no longer an entirely free market. We would argue that the Federal
Reserve’s intervention is largely responsible for keeping bond yields
artificially low. Over the past several months, the Federal Reserve has
purchased most of the net new issuance of Treasury securities. The
American central bank is engaged in this desperate act in order to keep
interest-rates low. However, it is buying these Treasuries by creating
money out of thin air. This is inflationary.
If our assessment is correct, somewhere down the road, the Federal Reserve
will lose its battle and T-bond yields will soar. As more and more bond
investors wake up to the looming inflationary menace, they will start
demanding a higher rate of return on their capital. When that happens, the
dyke will break and the Federal Reserve will become irrelevant.
America has run out of choices. If the Federal Reserve does not inflate
away this mountain of debt, the biggest sovereign default in history is
guaranteed. Now, given the ability of the Federal Reserve to create
confetti money, we are convinced that it will opt for the inflationary
solution. Inflation would certainly make America’s debt more manageable,
but it would also dilute the purchasing power of the dollar. Of course,
this inflationary agenda is not a secret and this is why many creditor
nations with huge reserves are beginning to diversify away from the
American currency.
In the past, when inflationary episodes spiraled out of control, hard
assets were the prime beneficiaries and this trend is likely to remain
intact in this inflationary episode. If our assessment is correct, over
the coming years, stocks, precious metals, commodities and real estate
will appreciate in value versus paper currencies. Furthermore, on a
relative basis, we expect precious metals and commodities to outperform
all other asset-classes. Conversely, we anticipate that cash and fixed-
income instruments will probably turn out to be the worst assets to own
over the next decade.
Bearing in mind the looming inflationary nightmare, we urge you to protect
your purchasing power by allocating capital to precious metals and
commodities-related businesses. Finally, we suggest that you consider
allocating a portion of your capital to the fast-growing economies in
Asia, like China, India and Vietnam. Such investments should prosper
during the low-growth, high-inflation environment to come.
Joel’s Note: 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 from
www.purusaxena.com.
Puru is also 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.
Copyright © 2005-2009 Puru Saxena Limited. All rights reserved.
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And now over to Bill Bonner, who has today’s reckoning from
Ouzilly, France...
“It’s not that simple!”
We wish it were easier, simpler...more predictable. We wish there were a
reliable road map. Will someone please give us an owner’s manual!
What are we talking about? Stocks...the economy...the gold market?
No, we’re talking about life!
“Your children are all at a transitional age,” explained a neighbor last
night. “They don’t know what they are going to be doing in life...or how
to do it. So, they need a lot of support. I don’t know whether they need
advice, exactly...and it’s probably better not to give it in many
cases...but they need to know you are there.”
But where are we? More on that below...
Meanwhile, we return to our dreary métier on a dreary day. We are looking
back at the year almost finished, and trying to figure out what lies
ahead. The surprise of 2009 was that the stock market didn’t turn down
again. Stocks worldwide were cut in half. Then, they bounced. A textbook,
classic bounce...Normally, you’d expect the bounce to peak out after 5 or
6 months. This one hasn’t...yet. Our guess is that it will...
Of course, we could be wrong...
The ‘classic’ depression...a la Japan...comes about when an economy needs
to make some fundamental changes. It discovers that a lot of what it has
been doing was wrongheaded. Assets, valued at bubble levels, need to be
marked down. People need to find new jobs; because the old ones no longer
make sense. Businesses need to be restructured and retooled. Households,
typically, need to stop spending and pay down debt.
This process is long and hard. The story of bubbles always begins
cheerfully enough. But it always ends at Chapter 11, in long
workouts...painful write-offs...and court cases.
“Recession Begins Flooding into the Courts,” says a headline in
yesterday’s New York Times.
If this were a classic depression, we could anticipate another leg down in
the stock market...more unemployment...and on-again, off-again growth over
the next few years.
Our guess still is that it IS a classic depression...and that we should
see stocks go down...along with all the other phenomena that usually
accompany a depression.
But, it’s not that simple.
Because there are a lot of other things going on too. The feds are
hell-bent on avoiding a painful restructuring of the economy. First, they
made sure the bankers got their bonuses. The banks deserved to go
bust...and the people who ran them should have been fired. But the fix was
in from the beginning.
Then, they turned to consumers. The feds are using every trick they have
to lure consumers back into bubble mode – buying things they don’t need
with money they don’t have.
Is it working? Well, the results are mixed and confusing. Every day seems
to bring more noise. Today, for example, we learn that spending is up 3.6%
this holiday season. We have to wonder...how could that be? Fewer people
have jobs. Those who have jobs are working fewer hours and earning less
money. And the bankers – bless their greedy little hearts – are not
passing on the feds’ cash to consumers. Consumer credit is going down at
the fastest pace since the Great Depression. So, how can consumer sales go
up? We’ll just have to wait to find out.
The Dow rose 29 points yesterday. Gold went up $3. We would like to see
both of them go down. Then, we would sure our ‘classic depression’
hypothesis is correct. In the meantime, we’re watching...waiting...and
wondering...along with everyone else.
And more thoughts...
We reported that the US government would need to roll over $2.5 trillion
worth of debt next year. We probably erred. The number was right, but it
was meant to be over the next two years. During the next two years also,
worldwide, banks need to roll over $7 trillion. Whether it is over one
year or two years, we’re talking big money.
Most people who bother to think about it are coming to the conclusion that
this is very inflationary...and very bullish for gold. They think the Fed
will need to “monetize the debt” directly, or indirectly. One way or
another, they say, the central bank will have to increase the volume of
money so that the government can finance its deficits.
Paul Krugman, Nobel Prize winner in economics, suggested that the Fed add
another $2 trillion to the nation’s monetary base, partly to accommodate
federal borrowing...and, he believes, to stimulate employment.
This idea is widespread. Richard Koo, one of the few economists to
understand the Japanese depression and what awaits the US, thinks along
similar lines. The US economy is going into a depression, like Japan; the
government must spend huge amounts of money in order to keep GDP from
falling.
Japan’s top man shocked the nation last week when he announced the largest
budget deficit ever. The government will spend about $1 trillion – a new
record. And it will collect less than half that much in taxes. Meaning,
most of what the Japanese government spends is borrowed – something the
Japanese haven’t done since the days when Americans were dropping bombs on
them.
The Japanese government is doing what it should do, says Koo. It is
replacing missing private spending with public spending. So doing, it has
avoided a drop in GDP and employment. Throughout its 20 year slump,
Japan’s GDP has never fallen below the peak set in 1989. Nor has
unemployment ever risen above 6%. Bravo!
Bravo?
Thanks to this new budget, Japan’s national debt will reach a new
record...nearly 200% of GDP. The Japanese have a lot of private savings,
but they also have a lot of public debt. And what have they gotten for it?
Well, they have kept people employed...and have allowed the private sector
to pay down its debts. Or, to put it another way, they have lived through
a classic depression fairly comfortably. Instead of forcing the banks to
fess up to their mistakes and clean up their balance sheets, the Japanese
government saved them. Instead of allowing big companies to go broke...and
other companies to take their places...the Japanese propped up the ‘brain
dead’ firms...and kept them alive with taxpayers’ money. Result? A
depression that should have been over in, say, 5 years...has been
stretched out to 20. And now the Japanese face a public debt that is bound
to cause them big problems in the years ahead.... What kind of problems?
Well, Japan is going broke... just like the US.
But we will save that for another day... You editor is on the move
again... Most of his children are already in the US...or headed in that
direction. He is following them.
Yes, dear reader, after 15 years in Europe, your editor is headed back to
the US. He will take up residence in Bethesda, Maryland. Why Bethesda? Why
not the ol’ family farm near Annapolis? Because...
Our youngest child, Edward, has another year and a half of high school.
But he’s done all his education in French...and in France. Putting him
into an American high school would be a big shock. Yes, he’d probably
adapt without any trouble. But we figure he might as well finish up in the
same system he began – the French school system. Fortunately, there’s a
French lycee in Bethesda, Maryland. It’s where French diplomats send their
children. From what we hear, it’s not a bad school.
But why follow the children to the US?
Here’s the way we look at it. The children are all starting out in life.
There will be a couple of years in which we MIGHT be of help to them.
After that, it will be too late. They will have set their course in life,
for better or for worse.
Most likely, there’s probably not much parents can do. We give advice when
it is asked for. We try to anticipate problems. We look back at our own
experience and try to warn the children against falling into the same
traps.
Does any of this really make any difference? We don’t know. But we have
been working on these children for the last three decades. This may be the
last time we have any influence at all. Beyond that, it may be helpful to
them to know that we are on the same continent...and ready to help out, if
the occasion arises.
So, for the next two years – more or less – your editor will make Bethesda
his home. Back in the USA...
What will it be like living in the US again after all these years? Has the
country changed? Have we changed?
Don’t know...but going to find out...
Regards,
Bill Bonner,
for The Daily Reckoning
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