And one other thing. Inflation reduces the debt burden. Right now, debt is crushing the private sector…and the whole economy. But it will soon crush the public sector too. Nouriel Roubini says government debt is a \u201cticking time bomb.\u201d He\u2019s right.
\nThat\u2019s why the government would love to have some inflation. Trouble is, inflation is harder to conjure up than you might think.
\nThe more we see the Geithner, Bernanke, Summers team in action, the more convinced we are that the nation is headed for serious trouble.
\nAlan Greenspan was a knave, no doubt about it. But he understood how money worked. He was even a follower of Ayn Rand and a member of the libertarian \u2018collective\u2019 in New York. When he joined the president\u2019s council of economic advisors, Rand was on the scene. She said she had \u2018her man in Washington.\u2019 Trouble was, her man was a sell-out. His convictions were no more solid than ocean foam. They disappeared as soon as he got to the capitol. After that, he spoke in gobbledygook sentences that no one could decipher…and played the game.
\nHere at The Daily Reckoning we don\u2019t particularly like sell-outs, hypocrites and turncoats. We have our principles. And we wouldn\u2019t turn our back on our own convictions. Not for less than, say, $10,000.
\nThe current team, on the other hand, are not sellouts. They\u2019re fools. They really have no idea what is going on. They think the problem with the economy is that consumers and bankers have gotten the jitters. They believe that a lack of demand is the root cause of a weak economy. So, all they have to do is to replace the missing private demand with demand from the government.
\nAnyone who bothered to think about it seriously for a few minutes would see that demand is not what causes an economy to grow…or what makes people prosperous. People always have demand for goods and service. Demand is always, theoretically, unlimited. It\u2019s the purchasing power that is lacking.
\nAnd purchasing power comes from earnings \u2013 both accumulated and current.
\nThe key to a real recovery is to increase earnings \u2013 not increase demand/consumption. How do you do that? Well, if you\u2019re a government economist, you can\u2019t do a bloody thing but get out of the way. You have to let private businesses find ways to make money…which they then share with their employees.
\nThink Summers, Bernanke and Geithner will get out of the way? Not a chance…
\nEconomic Recovery: Demanding More Purchasing Power originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a \"uniquely refreshing\" perspective on the global economy, investing, and today's markets.
\nBased upon theory and evidence, the Conservative Economist presents a case that the negative correlation of the dollar and gold has been a weak, on-and-off phenomenon, subject to degradation. This conclusion augments the theory presented in a companion essay published last week, For Whom the Gold Bell Tolls, which illustrates how central bank and fiscal interventions can be overwhelmed by an instinct to hoard. After credit booms, holders of capital distinguish between money and money substitutes, discounting the value of the latter while the former retains or increases in value.
\nDiscounting is a form of inflation, but it differs from inflation associated with monetary expansion seen when leverage is increasing systemically, wherein all forms of money lose value equally, and demand for credit exceeds demand for money. If we are on the downside of a credit boom rather than still amid a continual rise, then we should expect such differentiation between gold and money substitutes to develop, and the correlation between the dollar and gold’s price changes to diminish.
\nNot being willing to be responsible for poor decisions when managing someone else’s capital, most on Wall Street are evidence-based investors. The most famous was Long-Term Capital Management (LTCM), which back-tested spread data and bet using massive leverage that standard deviations would rarely be exceeded, or not by much. Nassim Taleb shattered the orthodoxy of such risk modelers by discrediting the assumption of the normal distribution, instead preferring Gaussian models, which in nature are more typical. Despite setbacks such as LTCM or more recently, the statistical arbitrage category of hedge funds, money is still largely guided by normal distribution analyses. Such capital therefore is a reservoir that could be directed at new trends once they are apparent.
\nAustrian economists, of which I am unreservedly one, discount empiricism altogether but rely on theory (backed by historical analysis of human actions). This school of economics finds that fractional reserve lending promotes credit bubbles, which create horrific clusters of error by businessmen, and of course, investors – particularly those reliant upon usually “reliable” empirical data. With due respect to the shortcoming of making assertions based upon short-term data, this discussion nonetheless makes use of correlation data to reveal subtle changes to the tone of trading since the financial crisis walked on the world’s stage in late 2008. These changes might act as guideposts at what may be another inflection point in the market and counter popular attribution of causes for the new trends.
\nFrom this Austrian’s theoretical point of view, the bubble today rests not in the gold market, but in the buildup of credit, which in a fiat monetary system happens in tandem with an increase in the broadly measured money supply (M3) during the upswing. M3 includes many types of what an Austrian would call money substitutes, usually paper units created by banks through deposit lending, which begets more deposits. Moreover, since the world’s currencies are pyramided atop the dollar as a reserve and dollars are created through this process, these currencies represent a derivative of a derivative of base money.
\nWhat does it mean if the world’s major currencies weaken relative to the dollar? In any minor fluctuation it would merely indicate a global preference of businessmen to invest in the United States, or in dollar-denominated projects. When the internet craze was sizzling, money was drawn to Silicon Valley, which once required dollars when technology talent and manufacturing resided close to corporate headquarters. Now that signs of deleveraging have been abundant since 2008, the interpretation is that a rising dollar signals more demand for money itself, with electronic Federal Reserve Notes acting as an imposter for gold. Gold was once at the center of all things monetary, as confirmed by tales such as the Celtic leader Brennus demanding his weight in gold be paid by the inhabitants of Rome in exchange for being left to live after the city’s sacking in 390 B.C, and its role was usurped only in recent times.
\nArmed only with theory, an Austrian economist doesn’t know precisely when or if we have reached a turning point. Sometimes such flashes of insight are apparent solely from the preposterousness of contemporaneous explanations of economic happenings. And, in For Whom the Gold Bell Tolls, I explain that the third (and most powerful) phase of the gold market might begin once correlation-driven investors see the dollar’s influence on gold wane.
\nLack of clarity is a hallmark of inflection points, until after the fact, when fundamentals seem obvious. Almost overnight a strong consensus behind a falling dollar faded, and in contention for the next trend are a variety of opinions for the economic future: inflation, deflation, V-shaped recovery, double-dip. In the U.S. and Europe, where banks are “all loaned up,” hoarding could generate demand for traditional, debt-free money (gold) in the face of deflating asset prices – particularly for real estate. But symptomatic of an earlier stage of fiat lending excess, developing nations such as those in the BRIC region have produced robust credit growth in the aftermath of the 2008 crisis, rekindling traditional inflationary depreciation of the value of money there. Monetarily one side wants to contract; the other expands, but in both cases governments have opened up the throttle.
\nWhen two weather fronts collide, who knows what kind of storm might develop. Quite a bit of stored energy rests within Wall Street’s correlation models, so let’s get a weather report:
\nThe “X” pattern in Figure 1 below illustrates the falling dollar (in white) and the rising gold price (in orange) evident over the past seven years. If you are a trader and you think the dollar has bottomed, you rejoice in the news of deteriorating credit among the PIIG countries (Portugal, Ireland, Italy, & Greece), and bet against gold accordingly.
\n![\"\"](\"http://dailyreckoning.com/files/2010/02/Figure-1.-Trade-Weighted-Dollar-Gold-1990-2010.-Courtesy-Bloomberg.gif\" "\\"Figure")
Figure 1: Trade Weighted Dollar & Gold, 1990-2010. Courtesy Bloomberg.
\nBut in Figure 2 below one has to wonder about the strength of the inverse relationship, and whether it is stable over very long time periods. The correlation is weak to begin with, with an R2 (R2 is the correlation squared) being just 0.30 from 2002-2009, roughly when the “X” pattern was evident. But from the beginning of 2009 to the present, the correlation has deteriorated, producing an R2 of only 0.13.
\nThe empirical data suggest an already weak causality may be slipping close to nil, and eyeballing the general trends of gold and the dollar prior to the internet bubble makes one wonder if we might drift back into a long period when other determinants of the gold price could surface that are more important.
\n![\"\"](\"http://dailyreckoning.com/files/2010/02/Figure-2.-Trade-Weighted-Dollar-Gold-Regressions-2002-2009-2009-2010.-Courtesy-Bloomberg.gif\" "\\"Figure")
Figure 2: Trade Weighted Dollar & Gold Regressions, 2002-2009 & 2009-2010. Courtesy Bloomberg.
\nIn 2008, on the margin capital flowed in an increasingly bearish direction, and eventually the system collapsed. Recent willingness to bet on a strong dollar and weaker gold prices seems to repeat this sentiment. The interest-carry and reflation trades were strongly in vogue as long as the dollar was in freefall. Now that the dollar might rise, it is logical that base metal prices would be at risk.
\nBut what if gold is detaching from the relationship, as suggested by the breakdown in correlation that began in 2009? What if during 2009 some of the correlation money had gone long base metals and equities, but carved out gold as less appealing in a recovery? With this lessening correlation and an emerging characteristic of being a safe haven against an unpredictable end result of unprecedented monetary and fiscal stimulus, whether it be inflation, deflation, or an inflationary depression, such realignment is logical. Although gold hit an air pocket in late 2008 during the credit crisis, it was the only asset to hit new highs after the dust settled, and oddly it was preferred by those who anticipated a deflationary collapse in the banking system or hyperinflation – opposite ends of the spectrum!
\nRecently some have argued that the credit problems of the PIIGS are inconsequential, because their economies when combined compare in size to a modest American state. This observation is just as true as the explanation that the sub-prime mortgage crisis would be contained because it was not large. However, both thoughts confuse cause and effect. Small troubled sectors don’t cause unleveraged systems to implode. They are symptoms of a credit bubble beginning to unwind, which depending upon how large it had been inflated to begin with, would make those trifles just be the first of many to fail.
\nAn outcome of gold regaining its sea legs and sprinting to new highs could be consistent with acceptance of drastically lower collateral values, which could not be papered over with idle bank reserves or the endorsement of historical cost over mark-to-market accounting.
\n
Figure 3: Trade Weighted Dollar and Gold Correlation Time Series 2000-2010. Courtesy Bloomberg.
\nWhat could trigger this scenario? Again, the movement of correlation-driven money could. Notice in Figure 3 above that while on average correlation between gold and the dollar might be weak, in reality the average is made up of periods of strong negative correlation punctuated by sharp breakdowns when the relationship actually went into positive correlation, or mere spikes within negative territory. Note, too, that key moments like the green spike in late 2005, early 2009, and the three spikes in 2001-2002 preceded sharp rallies in gold. These moments undoubtedly are ones in which investors were forced to acknowledge new realities about the economy, financial markets, and gold’s role in it.
\nIt may be premature to say that the correlation may be headed into another green spike. It may even end its upward thrust somewhere below the zero correlation line. But either way, the reduction in correlation that started in 2010 in Figure 3 or the lower R2 evident in the regressions from Figure 2 might be telling us that gold’s uniquely hitting new highs after the meltdown of 2008 may signal not a bubble in gold, but a spreading awareness that the real bubble is in credit, be it privately created or born from Keynesian stimulus. And if that is the case, this conclusion is so far from the mainstream that the massive amount of energy stored in correlation-based investment pools could dramatically recalibrate the relationship between the relatively minute gold market and the considerably larger stock of fiat currency.
\n[For more of William W. Baker's financial commentary you can visit his website here: The Conservative Economist.]
\nBeginning of the End originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a \"uniquely refreshing\" perspective on the global economy, investing, and today's markets.
\nThere was never any question that the extraordinary policy maneuvers of 2009 would begin to be unwound in 2010. But the culmination of events in Europe, China and the United States over the last two months have brought this all to a head very early on in 2010. Profit taking after large, sustained bull runs is a natural reaction of investors to a bout of increasing uncertainty and higher risk recognition.
\nOn the US equity side, the Institute for Supply Management (ISM) manufacturing index has a history of tracking the year-over-year rate of change of the S&P 500. Over the past three decades, a reading on the ISM above 45 has been associated with positive capital gains on the S&P 500. A reading above 50 (like last week\u2019s 58.4) has been associated with equity market gains above the long-term historical nominal average of 10-12%.
\n![\"Manufacturing](\"http://dailyreckoning.com/files/2010/02/DRUS02-08-10-2.gif\" "\\"Manufacturing")
For this to be the onset of the next avalanche in equity prices, we would need to see the ISM composite index falling like a rock from its January high. That outcome seems unlikely with inventory rebuilding just beginning to kick into gear and leading economic indicators still on the rise.
\nEquity Market Correction a One Quarter Event originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a \"uniquely refreshing\" perspective on the global economy, investing, and today's markets.
\nMany of us think that a superpowerful, prosperous nation like America will be a permanent fixture dominating the world scene. We are too big to fail. But you don\u2019t have to delve far into the history books to see what has happened to other once-dominant powers. Most of us have witnessed seismic political shifts in our lifetime. In 1985, Mikhail Gorbachev settled into his job as the Soviet Union\u2019s young and charismatic new leader and began acting on his mandate to reenergize the socialist empire. Seven years later that empire collapsed and disappeared from the face of the Earth. Gorbachev runs a think tank in Moscow now.
\nIn a sense, the larger world is starting to resemble the nasty and brutish life that long has characterized the corporate world. Just ask Jeffrey Immelt, chairman and CEO of General Electric. Of the twelve giants that made up the first Dow Jones Industrial Average in 1896 \u2013 all of them once considered too big to fail \u2013 only GE remains. The other towering names of the era \u2013 the American Cotton Oil Company, the US Leather Company, the Chicago Gas Company, and the like \u2013 all have faded away. And as GE stands against the winds of today\u2019s financial challenges, ask Immelt whether there is such thing as a company that is too big to fail.
\nI love to read history books for the lessons they offer. After all, as the homily goes, if you don\u2019t learn from history, you may be doomed to repeat it. Great powers rise and fall. None has a covenant to perpetuate itself without cost. The millennium of the Roman Empire \u2013 which included five hundred years as a republic \u2013 came to an end in the fifth century after scores of years of gradual decay. We Americans often study that Roman endgame with trepidation. We ask, as Cullen Murphy put it in the title of his provocative 2007 book, are we Rome?
\nThe trouble is not that we see ourselves as an empire with global swagger. But we do see ourselves as a superpower with global responsibilities \u2013 guardians if not enforcers of a Pax Americana. And as a global power, America presents unsettling parallels with the disintegration of Rome \u2013 a decline of moral values, a loss of political civility, an overextended military, an inability to control national borders, and a growth of fiscal irresponsibility by the central government. Do these sound familiar?
\nFinally, there is what Murphy calls the \u201ccomplexity parallel\u201d: Mighty powers like America and Rome grow so big and sprawling that they become impossible to manage. In comparing the two, he writes, one should \u201cthink less about the ability of a superpower to influence everything on earth, and more about how everything on earth affects a superpower.\u201d
\nA superpower that is financially reliant on others can be vulnerable to foreign influence. The British Empire learned this in 1956, when Britain and France were contesting control of the Suez Canal with Egypt. The Soviet Union was threatening to intervene on Egypt\u2019s side, turning the regional dispute into a global showdown between Moscow and Washington. The Eisenhower administration wanted to avoid that, and the United States also happened to control the bulk of Britain\u2019s foreign debt. President Eisenhower demanded that the British and French withdraw. When they refused, the United States quietly threatened to sell off a significant amount of its holdings in the British pound, which would have effectively destroyed Britain\u2019s currency. The British and French backed down and withdrew from Suez within weeks.
\nThe US dollar has never come under a direct foreign attack (though its vulnerability is growing). A direct foreign attack would result in a dramatic move away from the dollar. That would lead to a significant decline in its value, as well as higher interest rates. This is often referred to by economists as a \u201chard landing.\u201d In lay terms, it\u2019s more like a crash landing. Still, Americans have become intimately acquainted with the shocks of financial instability. Americans of a certain age still vividly recall the depths of the Depression in the 1930s and the chaos of inflation and long gasoline lines during the oil shock of the 1970s. We will also remember the financial collapse that began in 2008, and we pray for nothing worse. Some of our smartest financial thinkers are praying right along with us. \u201cI do think that piling up more and more and more external debt and having the rest of the world own more and more of the United States may create real political instability down the line,\u201d investor Warren Buffett has said, \u201cand increases the possibility that demagogues [will] come along and do some very foolish things.\u201d
\nRegards,
\nDavid Walker
\nfor The Daily Reckoning
What the Past Tells Us originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a \"uniquely refreshing\" perspective on the global economy, investing, and today's markets.
\nThe Dow was up 10 points. After being down 100 points. Gold fell $10.
\n\u201cClearly we have entered the worry, fear camp,\u201d said one pro.
\nUnfortunately, today\u2019s action was not as clear-cut as we would like. There was no bounce back. And no further decline. Our guess is that stocks will probably trend downward for a long time. Most likely, the long-awaited \u2013 at least by us! \u2013 resumption of the bear market has begun. We\u2019ve had our crash. We\u2019ve had our bounce. Now, we\u2019ll take the long slide down to the ultimate, final, this-is-where-it-stops end.
\nListening to the radio this morning, the announcer told us that only \u201cessential\u201d government employees had to report for duty this morning. We wondered if any of them really were essential. Surely, not the fellows who are watching after the African horned beetle. Surely, not the ones who are designing a new health care overhaul for the nation. Surely, not the ones who are coming up with a revision to subsection 4.503.02 of the Internal Revenue Code dealing with unlicensed backdated further codicils of provisions dealing with gifts to one-armed wonton turners who are beneficiaries of insurance policy proceeds upon which sufficient basis has been revoked because they failed to read the fine print. Or something like that.
\nTake out all the non-essential federal employees? Who\u2019s left?
\nAnyone? Probably a couple guys in the Pentagon who make sure the Canadians are not amassing troops on the border.
\nBut that is another subject, isn\u2019t it? Not exactly. The federal payroll is the only payroll in the nation that is expanding. Government is a growth industry. Just about everything else is in decline.
\nWait. The latest number from the feds tells us that joblessness declined by 0.3% last month. Do you believe that, dear reader? Where\u2019s the SEC when you need it? Aren\u2019t the feds misleading investors \u2013 intentionally?
\nThere was another ad on the radio this morning asking for census takers. More federal employees! Why not get the non-essential employees to count people?
\nWe don\u2019t have a separate count, but we wouldn\u2019t be a bit surprised to find that the feds\u2019 unemployment number hides as much as it reveals. After all, as near as we can tell, we\u2019re still in a period of private sector de-leveraging. That means fewer jobs. The mistakes of the bubble era must be un-done. Jobs must be eliminated. And employment won\u2019t rise again until the private sector can find ways to put people back to work at a profit.
\nBut how?
\nEssential Employees in the Government Growth Industry originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a \"uniquely refreshing\" perspective on the global economy, investing, and today's markets.
\nI bring this up because I recently got a \u201ctime to re-subscribe\u201d notice from The Wall Street Journal, which has been, over the years, consistently denying that there is any inflation in anything, and thus suggesting that \u2013 with such a benign economic milieu, which keeps interest rates down \u2013 you should run out and buy stocks and bonds right away, using, one presumes, the WSJ to keep up with the news.
\nThe interesting thing about the supposed competence of the WSJ in seeing inflation is that a subscription to the paper now costs $385 per year, whereas as early as the middle of 2004 it cost $338 for a TWO-year subscription. So The Wall Street Journal, as oblivious and clueless as ever, has seen its own prices more than double in 5 years, which comes out to a compounding of 14.87% increase per year, but yet they can\u2019t see inflation in prices? Hahahaha!
\nAnd you would think that the official estimate of price inflation, 2.7%, as reported in their own Barron\u2019s magazine, would ring a few bells at someplace other than at the Mogambo Bunker Of Extreme Paranoid Hostility (MBOEPH), where I have alarms going off all the time, signaling huge increases in prices, which is important because it makes the plight of the poor more desperate, a situation made more \u201cup close and personal\u201d when you realize to your horror that there a LOT of poor people all over the place \u2013 millions of them! \u2013 and you could not possibly afford enough ammunition to defend yourself against them all. Yikes!
\nAnd not only that, but your supply logistics are compounded not only by the fact that all of these poor people getting poorer and more desperate because prices are always rising, but also because there are a lot of people who were NOT previously poor who are NOW poor, or soon will be, thanks to rising prices, which means that you should be constructing a fortified bunker of your own from which to pour awesome firepower to repel these starving morons who are getting what they so richly deserve for voting for the idiotic, deficit-spending politicians that they so greedily, and so stupidly, elected, year after year, decade after decade, until my throat is sore from screaming in outrage.
\nWhen it comes to actual proof of a coming inflation that is going to destroy the world, instead of just me loudly running my mouth about it, where the only good news is that The Mogambo (me!) can rise from the ashes to assume full dictatorial powers and a huge salary-and-benefit package to re-establish the gold standard and real prosperity to America, one need only look at the last two pages of The Economist magazine, where we find, among the 40 biggest economies in the world, that all of them have inflation in consumer prices! Well, all of them except Singapore (where inflation is zero), Taiwan (negative 0.2%) and Japan, where prices are supposedly falling at 1.9% a year.
\nThis is such an important thing that I get interviewed about it a lot, and the inexperienced interviewer usually steps into my trap when I ask, all smiles and sweetness, \u201cWould you like to know where inflation comes from?\u201d
\nIf the reporter says, \u201cYou ended that sentence with a preposition.\u201d, then I will spare them my explanation about the origins of inflation, as it shows that they are pretty smart and will soon figure it out for themselves, and in the meantime we can change the topic of conversation to the important subject of how some little squirt comes in here and insults me, right to my face, about some stupid fine point of grammar, and how I maybe ought to take my stapler and tack a piece of paper that says \u201cDon\u2019t insult The Mogambo!\u201d to their damned foreheads as a way of remembering not to do that ever again.
\nAlso, some of the time, they ask, \u201cIs there anywhere I can sit where I don\u2019t have to smell your breath or your feet that are gagging me out?\u201d but most of the time they merely want to know from where inflation comes, and then I am ready!
\nI leap to my feet with a theatrical flourish and thunder, \u201cIt comes from an increase in the money supply, you moron! How in the hell did you think that it is possible for the prices of all things to go up without more money to pay for it all? Velocity of money? Hahaha! Don\u2019t make me laugh, you miserable little halfwit!\u201d
\nWhen they sit there, stunned at the vicious attack, then I am ready to hit them with the big one! With a theatrical turn to the last page of The Economist magazine, I show that of the 40 biggest countries in the world, 39 of them are running a negative \u201cBudget balance as a % of GDP\u201d! Huge deficits! Up to an enormous 4% of GDP in Britain, and now 11% (a monstrous $1.6 trillion) in the USA.
\nOnly Norway is running a budget surplus, which means that those 39 moron governments are going to spend more than they get, and to keep from having to raise taxes to get the money (boo!) or borrow that money from taxpayers/consumers (boo!), their idiotic, corrupt central banks (boo!) are going to let the banks create the money (boo!) necessary to buy those bonds! Hahaha! What a scam!
\nIn summary, to make sure they know how important this is by how close my face is to theirs and how I am so close that our noses are almost touching and they can feel drops of spittle hitting their scared little faces as I shout, \u201cWe\u2019re freaking doomed by the creation of too much money! Do you understand that, you whimpering little moron? Doomed!\u201d
\nIt is usually about this time that reporters and interviewers recover find that they want to leave because they have \u201cenough\u201d material, which they do, but they don\u2019t even realize it. Morons.
\nInflation: Ignoring Doesn’t Make it Go Away originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a \"uniquely refreshing\" perspective on the global economy, investing, and today's markets.
\nFirst off, the nation\u2019s largest company, Toyota, was forced to issue a recall for automobiles on three continents after it was revealed that the brake pedal on certain models had a tendency to \u201cget stuck.\u201d Consumers have become rather attached to the brake accessory on modern automobiles and didn\u2019t take kindly to Toyota\u2019s technical oversight. The company was forced to issue a worldwide public apology…then added that it will shut down five assembly plants in the US.
\nThen there was the somewhat embarrassing news \u2013 in the same industry, no less \u2013 that China has overtaken Japan as the world\u2019s largest car manufacturer.
\nAnd, of course, there was that other stroke of bad fortune when ratings agency Standard & Poor\u2019s threatened to downgrade the Japanese government\u2019s credit rating, noting that Prime Minister Yukio Hatoyama is moving too slowly to reduce the nation\u2019s soaring debt levels.
\nBad luck in threes, you say? Hmm…
\nYour editor is gallivanting around Tokyo at present, enjoying the spoils of the deflationary spiral but ruing the stubbornly strong local currency. Prices continue falling…but the yen refuses to give an inch, even under threat of credit downgrades. Even so, a room that once went for \xa530,000 can now be had for a fraction of that amount. Restaurants and retailers engage in ruthless price wars in an attempt to stimulate demand from persistently frugal Japanese consumers. And, while Tokyo is by no means a \u201ccheap\u201d city to visit, it\u2019s decidedly more affordable than it would have been back in the bubble years, before The Land of the Rising Sun underwent one of the most dramatic deflationary periods in modern economic history. Last year, while consumer prices among industrialized economies recovered about 1.3%, they fell almost 2% here in Japan.
\nBut as Japan\u2019s appetite slows, the rest of Asia grows ever hungrier. Along with South Korea, this tiny stretch of islands currently commands an inordinately large share of the world\u2019s natural gas supply. Now, that trend is changing. As Chris Mayer observed in his essay “Liquid Natural Gas: The Next Resource Boom?” there are new players in the demand for this clean-burning fuel…and new ways to profit by investing in it…
\nJapanese Car Trouble originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a \"uniquely refreshing\" perspective on the global economy, investing, and today's markets.
\nThursday we are scheduled to see the retail sales numbers for January along with the weekly jobs data. And on Friday, the only piece of data we will get is the U of Michigan confidence number, which is expected to show a slight improvement. So with no \u2018major\u2019 reports scheduled for the week, the dollar will likely stay in a fairly tight range.
\nOnly three currencies managed to move higher versus the dollar Friday, the South African rand (ZAR), Canadian dollar (CAD), and Norwegian krone (NOK). These are all commodity currencies; and will continue to benefit from a stronger global economy. The rally of the South African rand was helped by a statement made by one of their central bank members who suggested that the South African economy was basically unaffected by the global recession. South African Central Bank Deputy Governor Xolile Guma suggested that rates may be heading higher in South Africa, as further stimulus measures weren\u2019t needed.
\nAnother commodity-based currency, the Brazilian real (BRL), managed to hold steady versus the US dollar on Friday, and is beginning to move higher in European trading. I read a news story this morning that suggested Brazil\u2019s biggest banks are betting on interest rate increases by mid-March. The Brazilian central bank will be meeting on March 17th, and many now believe it will become the first Latin American country to raise rates. If rates do move higher in March, it will be the first increase since September of 2008. An interest rate increase will make it very hard for the government to keep a lid on the appreciation of the Brazilian real.
\nHigher interest rates are one of the reasons Pimco\u2019s co-chief investment officer El-Erian has been suggesting investments in Brazil. El-Erian has been trumpeting Brazilian bonds as one of his top picks for 2010. Interest in these bonds is heavy, as they were one of the top topics of conversation among investors at the Orlando Money Show. Chuck mentioned them in a couple of his presentations, and attendees were eager to learn more about these short-term bonds with pretty good yields. I know the phones were busy on the desk Friday, and many of these calls were probably people wanting to talk to Don Ries regarding these short-term Brazilian bonds. If you are interested, just call the desk and Don will give you the details, but please be patient, the yields on these bonds shouldn\u2019t be falling dramatically over the next few days.
\nI got a chance to do some research on the flight home from Orlando, and was surprised by some economic data that I ran across in The Economist magazine. As you all are aware, the debt problems in Greece have really gripped the markets lately. The mainstream news media has, in my opinion, blown this whole Greece thing way out of proportion. Chuck continues to try and explain how the problems in Greece are no more of a threat to the EU than the problems in California are to the US (more thoughts on this from Chuck in a second). But back to the data which was a real eye opener for me on the plane…
\nThe Economist had a chart that compared economic data for over 50 developed countries. Which country do think had the worst budget balance as a percentage of GDP in 2009? Greece? Spain? No, it was the UK!! Yes, Britain\u2019s budget deficit was 14.2% of their GDP in 2009 according to The Economist. This compares to Greece, which had a budget deficit of 13% of GDP, and Spain, which ran a deficit of 11.8% of GDP in 2009. The combined euro (EUR) area had a budget deficit of just 6.9% of GDP, but from all of the media hype you would think the debt problems with the PIGS was so massive that a default was all but guaranteed. The data shows that investors should be more concerned about the debt levels in the UK than those in Greece or Spain!
\nAnd do you know the only other country that reported a double-digit budget deficit as a percentage of GDP for 2009? It was the US, which ran a deficit equaling 10% of GDP. Yes, the US is one of only four countries with a double-digit deficit. Even Venezuela had a better deficit number than the United States. But you won\u2019t read much about it in the press; they are too busy concentrating on the destruction of the euro and the problems with the PIGS.
\nAs I mentioned earlier, Chuck had to spend an extra night down in Florida and he sent me these thoughts to share with readers this morning:
\n\u201cHere I am in my hotel room, Saturday night. The Money Show ended today, with my last presentation only drawing about 50 people, in a HUGE room… It really made me re-think my decision to stay the extra day to do that presentation! For, here I am, everyone else has gone home, and I\u2019m left to my thoughts… Uh-Oh, I hear you saying… And you should! For I am going on a long diatribe to discuss what I feel to be one of the grossest misunderstandings by people/investors/markets… EVER!
\n\u201cOh, sure, this would have to be quite the misunderstanding to be greater than: the tech bubble, the housing bubble, the raping and pillaging of our hard earned money with unconstitutional taxes, and so on… So, maybe, I\u2019ll have to pull that statement back a notch or two!
\n\u201cThe misunderstanding I\u2019m talking about here is the complete ignorance of what is going on in this country, and why one country gets knocked around for having problems that are miniscule when compared to the other country that gets rewarded!
\n\u201cFirst… I\u2019m going to quote my friend, David Galland, regarding deficits…
\n\u201c\u2018One stark and sobering way to frame the crisis is this: if the United States government were to nationalize (in other words, steal) every penny of private wealth accumulated by America\u2019s citizens since the nation\u2019s founding 235 years ago, the government would remain totally bankrupt.\u2019
\n\u201cAnd this.
\n\u201c\u2018Furthermore, with the budgetary equivalent of a straight face, the Office of Management and Budget reports in its long-term, inter-generational budget projection that the United States government will experience massive, non-stop deficits for the next 70 (SEVENTY) years, requiring the issuance of tens of trillions of dollars of additional debt. The OMB does not project even one year of surplus during the entire seventy year budget period.\u2019
\n\u201cNow… I\u2019ll quote Bloomberg…
\n\u201c\u2018Jan. 20 (Bloomberg) \u2013 Everyone seems to know the current path of federal fiscal policy is a deathtrap over the long term. What\u2019s peculiar is the relative inattention to the balance sheets of state and local governments.
\n\u201c\u2018Hidden behind accounting fictions, the politically unspeakable reality is that public employee pension systems are under-funded by more than $2 trillion. Add more than $1 trillion in unfunded health-care benefits for retired public employees, and state governments face protracted structural deficits ranging from challenging to insurmountable.\u2019
\n\u201cSo… Now we know that the deficit path we are on, is NOT going to change… And that the states in the US are in deep dookie!
\n\u201cAnd that brings me to the trade that has been going on for two months now, regarding investors all over the world, punishing the euro, for the problems of the states called Portugal, Italy, Greece, and Spain, or… The so-called PIGS! The Euro-state that most investors point to is Greece… Which, as I told you on Friday, accounts for 2% of the Euro-zone\u2019s total GDP…
\n\u201cA friend of mine, at THE Business newspaper of the world, sent me a note on Friday, and said, \u2018Hey, Chuck … Was just reading today\u2019s Pfennig and saw your comment about the size of Greece compared to EU, and the size of California compared to the US.
\n\u201c\u2018Did a bit of research for you and… California\u2019s economy is about $1.6 trillion (as of January 2007), according to US Dept. of Commerce. US economy, according to CIA fact book, is about $14.25 trillion on 2009 estimates.
\n\u201c\u2018Thus, California is about 11% of the US economy \u2013 roughly speaking, given that the dates are slightly mismatched, and who knows how accurate these government organizations are.
\n\u201c\u2018But any event, it\u2019s clearly much bigger than Greece\u2019s impact on the EU.\u2019
\n\u201cSo… California, which I would consider to be bankrupt \u2013 for crying out loud, the state sent IOU\u2019s to people last year instead of cash for their tax returns \u2013 is 11% of the US problem… But we have to add to that, the research we went through above… The states of New York, Michigan, Illinois, and so on! This is a debt debacle, folks!
\n\u201cNow… I\u2019m not saying that the PIGS problem isn\u2019t a big deal… It is! But bigger than the US problem? NO!
\n\u201cSo… The dollar should not be rewarded… And neither should the euro… But the problem here is that these are the two most liquid currencies in the world… So, the normal trade is to sell one, and buy the other, as they are the offset currencies to each other… So… I would think that you would take the lesser of two evils, don\u2019t you?
\u201cOR… If that doesn\u2019t float your boat, you probably are eligible to join the legions of people who are finding that gold is the best replacement for either!
\n\u201cThank you for your time this time till next time… \u201c
\nI always appreciate it when Chuck sends me his thoughts; he asks me to phill in for him, but then ends up writing most of the Pfennig for me anyway! I think he is bang on with his thoughts on the misdirection the administration and the media is pushing on the US citizens. They have used the problems with the PIGS to try and take our attention away from those right here at home. So far they have been successful, but double-digit budget deficits in the UK and US will eventually force us to stand up and take notice. The administrations of the UK and US will eventually have to deal with these budget problems, and their currencies will be taken to the woodshed just as the euro has been taken down recently.
\nBrazilian Rate Hike in March? originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a \"uniquely refreshing\" perspective on the global economy, investing, and today's markets.
\n“\u2026 the second number, buried deeper in the budget\u2019s projections, is the one that really commands attention: By President Obama\u2019s own optimistic projections, American deficits will not return to what are widely considered sustainable levels over the next 10 years.
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“In fact, in 2019 and 2020 \u2014 years after Mr. Obama has left the political scene, even if he serves two terms \u2014 they start rising again sharply, to more than 5 percent of gross domestic product. His budget draws a picture of a nation that like many American homeowners simply cannot get above water.
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“For Mr. Obama and his successors, the effect of those projections is clear: Unless miraculous growth, or miraculous political compromises, creates some unforeseen change over the next decade, there is virtually no room for new domestic initiatives for Mr. Obama or his successors.
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“Beyond that lies the possibility that the United States could begin to suffer the same disease that has afflicted Japan over the past decade. As debt grew more rapidly than income, that country\u2019s influence around the world eroded.”
\nSanger is concerned about the projections, and yet despite the coming crisis the largest, and perhaps most paralyzing, problem has been to turn \u201cthought into political action.\u201d Read more of his perspective in New York Times coverage of how deficits may alter US politics and global power.
\nThe Budget That Forecasts America’s Decline originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a \"uniquely refreshing\" perspective on the global economy, investing, and today's markets.
\nOf what particular importance are the tools China is stockpiling? Well, from the New York Post, Arthur Herman reminds us of how one simulation of economic conflict unfolded:
\n“Last March, the Pentagon held its first-ever economic-warfare war game, with China as the putative opponent and with economists and bankers (including from UBS) helping out.
\n“Details of what unfolded are still classified. However, sources told Fox Business News that the scenario played out as planned. That was the good news.
\n“The bad news is that China won.
\n\u201cToday, some experts argue that rational self-interest will prevent China from waging this kind of economic warfare, because crippling the US would also severely wound its own economy. However, on an issue like Taiwan or Japan, rational judgment can take a backseat to national pride, and the desire to reverse old humiliations.\u201d
\nChina won that economic conflict simulation and would likely be an even stronger opponent today. With the new US budget, “42 cents of every dollar the federal government spends will have to be borrowed.” Without a doubt, it is China and Japan that support over 40 percent of that Treasury debt.
\nYou can read more details about this potentially mutually destructive behavior in the New York Post on how America’s number one creditor possesses the ultimate weapon.
\nPentagon’s Economic War Game With China “May Spell Disaster” originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a \"uniquely refreshing\" perspective on the global economy, investing, and today's markets.
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