Chinese bailing out Greece

http://www.reuters.com/article/idUSATH00570720101002

On the surface, this article seems benign enough: China, flush with cash reserves, wants to bail out Greece--and by extension, the Euro zone, in order to maintain Europe's consumption of Chinese exports. They intend to do this with the purchase of soon-to-be-worthless Greek bonds, an IOU issued by a bankrupt government (sound familiar?). Fine.

But let's think a couple moves ahead, as the Chinese rarely make a move without surveying the landscape several years down the road. Like their developing world peers, the Chinese are getting increasingly nervous with their overweighted holdings in US Treasury bonds, as the Fed continues to feverishly devalue the USDollar. Selling US Treasuries with abandon would only undermine the value of Chinese holdings, increasing selling pressure and plummeting the value of said US bonds.

The solutions? Buy tangible assets supportive of their growing industrial base, including securing natural resources and resource companies in the energy and metals complex. Another solution? Buy the Euro. How? Through the Greek back door (no pun intended).

Of course, the Chinese will put on a varnished exterior, bailing out a valued customer, and buying assets from a trading partner--and all of that will be true, as they aim to increase market penetration in the Euro zone. But the ulterior motive is to find another resting place for their bulging reserves, as they slowly divest their US Treasury holdings.

Meanwhile, Congress and US Treasury Secretary Geithner cry "Wolf" and whine about Chinese currency manipulation. If the US really wanted the Chinese to stop devaluing the yuan, the Fed should stop devaluing the USDollar. But of course, that won't happen because the Fed needs to feed the Congressional beast.

And as the Chinese and other sovereign funds further divest of US Treasuries, interest rates will inevitably rise, as bond buyers demand higher yields to compensate for rising default risk. This will undermine any interest rate-suppression effects of further quantitative easing. Which means QE will fail--again.

And around and around we go, circling down the drain.

Inflation vs. deflation

The battle between equities giant Warren Buffett of Berkshire Hathaway and PIMCO's Bill Gross, the biggest bond fund manager, will be decided on whether inflation or deflation win out going forward. Buffett has increased his position in short-duration Treasuries, betting that inflation will cause longer-dated Treasury bond yields to rise. Gross is betting that long-term T-bond yields will continue to decline, as global economic growth declines, causing deflation.

http://www.zerohedge.com/article/buffett-vs-gross-or-inflation-vs-deflation-who-right

My guess is that both will be right. Long-expiry T-bond yields will continue to decline short-term in a low-growth environment, and demand for credit will be muted. However, as economic conditions continue their descent, central banks worldwide will inject liquidity in an attempt to stimulate their economies. The opposite effect will occur, as paper currencies are further debased, diminishing the standard of living for billions. Monetary stimuli will inevitably increase the prospects of inflation, especially if the velocity of money accelerates. The bond vigilantes will sense weakness in various foreign currencies, pushing up sovereign debt yields.

With the global economy intractably connected, sovereign debt crises will leapfrog from country to country, eventually reaching the shores of US, while the reserve status of the US Dollar will come into question.

Forecast for 2009 and beyond

Equities will bottom this year, while housing may bottom 2010--best-case. The dollar will break down further, and when the market realizes that, gold will rise. When the market recovers with a false rally, inflation will kick in, prompting gold's rise. Gold is not like most commodities--it is a currency of real value--a hedge against inflation. There is usually a year lag before inflationary fiscal and monetary policies kick in. In other words, money supply M is in place for inflation, but inflation will remain subdued until banks start lending (increasing money velocity V). And banks can't lend right now, despite huge capital injections because they are hoarding cash to strengthen their crippled balance sheets. Not sure when that will happen (banks lending to each other, to businesses, to individuals, etc.), but it's gotta happen at some point. Either that, or the whole banking system collapses, and we go back to barter....maybe the muslims are right. Even in that worst-case scenario, gold will hold its value--what other paper currency will hold its value in an Armageddon scenario--the USDollar?

Either way, gold will rise--it's not a matter of if, it's a matter of when. This downturn will be worse than the 1973-74 deep recession, when gold increased 2325%. I don't think it will be as bad as the Great Depression of the 30's, when we had almost 25% unemployment. Even in that deflationary environment, gold went up 69%. So if we are closer to a repeat of the Great Depression, you are right, gold may languish around the $500/oz to $1000 range , up from its 1999 low of $253. But if a full-fledged recovery occurs, a 2325% spike translates to a price of $5882. Realistically, the 1980 $850 peak, deflated in today's dollar indicates a $2400 price.

But with the accelerated debasing of the dollar in concert with other currencies, inflation is already in place. The definition of inflation is an increase in money supply, not necessarily the Consumer Price Indicator, the official government statistic. An increase in CPI is a symptom of inflation, not the source. It is a combined result of an increase of money supply flowing into the economy. Prices increase when more money supply chases scarcer assets. Having said that, the CPI is notoriously underreported as money supply growth is in the double digits, while CPI remains under 4%. The reason why it is underreported is another topic, but it does not match money supply growth.

So the targets above will trend higher if we take into account money supply growth--the very definition of inflation. Gold has increased almost 4-fold since 2001--another way to interpret the data is that the USDollar has been devaluated by almost 75% during that period. If that trend continues (and it looks like it will accelerate as the Fed and Treasury continue to print dollars ad nauseum to the tune of trillions of dollars), the current deflation of asset values will eventually yield to inflation--perhaps even hyperinflation.

The result will be higher taxes to pay for these government-sanction bail outs, and the debasing of the USDollar. Despite rhetoric that the government is interested in a strong USDollar, their actions speak otherwise. It makes sense because inflation is a form of taxation without legislation (Milton Friedman). It is more politically expedient to slowly, stealthily tax the population than to let unemployment increase and recessions deepen. Congressmen and the Administration aim to get re-elected. Hence the bailouts. Inflation allows the government to slowly tax the population under the radar, while at the same time, lower their massive debt obligations with deflated dollars (a $10 trillion debt becomes smaller as inflation eats into the principal). If I owe someone $10, but if 10% inflation kicks in, that debt is only $90 in today's dollars a year from now--and declines going forward. Propping up failing businesses is politically populist, but ultimately detrimental to the overall economy--it lengthened the Great Depression, and it's kept Japan's economy in decline for 19 years. It's a form of rewarding bad businesses, while taxing its productive businesses--it's misallocation of financial resources. Would you rather have GM manage your investments, or Google? Well, the government is investing in the GM's of the world--or any other industry that is insolvent, and in the process, taxing its citizens and profitable industries.

The problem is that hyperinflation reduces the purchasing power of consumers and invisibly reduces corporate profits. Our standards of living decline. These bailouts just defer and exacerbate our huge debt problems, but politically, Keynesian economics is the government's only option. We are past the point of no return, as we sink into a death debt spiral. Our financial crisis was caused by overleveraged debts gone bad, by consumers, businesses, local and state governments. Now the federal government is compounding that billion dollar problem into a trillion dollar problem (their own, in this case). That solution has never worked. When interest rates rise (they are at all-time lows), that trillion dollar debt only accelerates, forcing the government to accelerate money supply again, further debasing our currency. US Treasury bondholders, bidding up prices in a flight to safety, will get crushed when interest rates rise. The biggest buyers of said bonds--Chinese and Japanese sovereign banks and funds, will be net sellers, no longer willing to prop up our deficits, while earning 0% for the privilege. Besides, they will need to prop up their own economies. The US Treasuries market will be the last bubble to burst, and this time there will be no backstop, as the US government itself will be insolvent. The Fed can control the short end of the curve, but the long-term bond market dwarfs any government reserves, and is more influenced by market expectations of inflation, not government central bank intervention. The Fed and Treasury can only prop up 30-year T-bonds for so long, before the dam breaks. We are at the mercy of China, Japan, and the Arabic petrodollars. All 3 entities have explicitly warned the US government that they will no longer be buyers of US Treasuries. The Saudis are already in the process of creating their own exchange, creating their own currency for trading oil, as they realize their reserves denominated in USDollars have been a losing proposition. The Chinese and Japanese are also retreating in US Bond purchases. Interest rates will have to rise to attract new demand.

To look at our future, see Iceland--the country imploded, their banks froze up, as their debt exploded in a massive unwinding of leverage. The US Treasury will lose its AAA credit rating, driving up interest rates further. Eventually, the government will default, unable to meet its debt obligations. Guns and gold--if you think I am joking, ammo prices have doubled in the last year. The gold market is pausing, yet holding up while equities re-test their November lows. But once reality hits, it will rise. Not sure what the trigger event will be--another big bank failure, WWIII (Israel is discussing bombing Iran), Pakistan/India posturing, California insolvency (all State employees will start receiving IOU's next month, as California has run out of cash). Arnie has been unsuccessful with the state legislature on resolving a budget expected to be $42 billion short, and if unable to receive a Federal bailout, state employees will be unpaid).

http://www.sco.ca.gov/eo/...2008/12/pr08069letter.pdf

The 1991 riots will be like a walk in the park when cities and counties cut back on basic services like law enforcement and fire protection. I know one city in LA county has lost 60% of their detectives already--even as crime is soaring. Rape case samples are already extended out to 10 years for DNA results. I visited a coin dealer who had exactly one $20 St. Gaudens double eagle to sell. Gold bullion buyers are demanding physical delivery instead of cash settlement, causing spot prices to carry a premium above forward futures delivery contracts--the first time this has ever happened on the Comex gold futures exchange. Sure, the downside is a 30% temporary drop in price, but the upside is 100 - 800% potential upside. Not one stock mutual fund gained in 2008. Gold was the only asset class that gained last year--up 6%--and that was a bad year for gold. It was also the 8th consecutive year of gains. The Nasdaq plunged 80% after the tech bubble. The S & P lost 40% again last year. Treasury bondholders did well in a false flight to quality, but once they figure out tying up your money for 30 years yielding 2.6% is a losing proposition, they will flee that market as well. T Bills yielding 0% will prove problematic as an inflation hedge. Stocks have retreated to 1998 levels, and are headed lower. What else is left? Meanwhile, gold has already quadrupled in this decade.

The reason why financial planners and brokers (gee, they've given good advice over the years) don't advocate gold is because clients purchasing gold don't generate fees for them. Gold ETF's generate some commissions, but overall, there is no incentive for investment and commercial banks to pimp gold. Having said that, many conservative advisors do recommend clients keep 10% of their portfolio in gold bullion, preferable over paper securities (ETF's, futures contracts, gold mining shares). Storing bullion is inconvenient, but it's part of a diversification strategy. Once more people realize this, some sideline cash will be deployed to purchase precious metals, base metals, soft commodities, and dividend-yielding equities. Companies with leading market share, moat-like pricing power, strong balance sheets (loads of cash, no debt), high profit margins, and increasing dividend payouts on cash flow, will thrive in a market where access to debt is increasingly difficult.

Treasury Bonds--the next bubble?

I'm short longer-maturity T-Bonds. It's the last bubble, and bond holders are going to get crushed. I don't know if it's tomorrow, next month, or next year, but tying up your money for 30 years, and getting 2.6% for the privilege is going to prove problematic. It pisses me off that the Fed and Treasury can act unconstitutionally with no oversight, saddling us taxpayers with trillions of toxic debt. WTF? Having said that, I gotta do what I gotta do to protect myself.

Keynes is dead: the Fed thinks they can control the economy. All they've done is create one bubble after another--all unintended. Monetary easing created a tech bubble, at which point, Greenspan declared irrational exuberance and popped the bubble. He then did an emergency reflating to avoid a deep recession, and thus created a real estate bubble. Then he raised interest rates 17 times, popping that bubble. And now they are reflating like there is no tomorrow, deploying quantitative easing to try to save the world economy (bailing out broken industries), but in the process, creating a Treasury note bubble. The Treasury is printing so many dollars they are outsourcing to the Swiss the printing process--they've run out of domestic capacity! This will be the last time helicopter Ben and machine gun Hank will be able to hoodwink foreign investors. When investors flee in droves away from what they thought was safety (US government IOU's), they will flock to other vehicles, whether it's high-grade equities or the currencies of last resort: gold, silver, and the yen. Or their mattress, which will prove problematic when deflation turns into hyperinflation. Interest rates will soar, as investors (many of them foreign sovereign funds) will demand higher rates of return. Think 1970's...

Investors will continue to lose fortunes watching CNBC and Fox News. They report facts ex post facto. Debating whether GM should be bailed out or not is banal. The money has already been made or lost a year ago, before the 90% plunge in GM's share price. That's why buy and hold doesn't work. Our central banks are manipulating the markets with each intervention. It'll only drag out the inevitable recession. Japan did the same thing. Their Nikkei stock index in 1990 was 39,000. Today, in 2008, it stands at 9,000. And our credit default swap problems are orders of magnitude bigger and worse. Stop the bail outs. Let 'em fail. Quit trying to give good money from competent people (taxpayers) to incompetent people (GM and the UAW). The incompetents will just piss it all away again.

And with the public focused on equities, they will always lose. Hint: they should be following indicators from two much bigger markets--fixed-income and forex, watching their capital flows. Central bank interference is causing different asset classes to move parabolically up and down. They're debasing the US Dollar in the process, and sending most of us to the poorhouse.

The return of the gold standard? Why gold is poised to explode...

Blue-collar, white-collar, manufacturing, services, etc.---it doesn't matter what type of jobs--the more the merrier, altho it would be nice to have higher-skilled job growth.

If you think about it, who invented the internet? (No, it wasn't Al Gore). It was a British scientist educated in Switzerland (or it was a Swiss educated in the UK). But as far as monetizing the technology, most of the $$ were generated here, as well as accompanying technologies and services. It's okay to be a consumer-oriented economy, as long innovation continues domestically.

I think that's what dawg was sarcastically inferring--we can't go backwards.

To be honest, the only way we go back to real economic growth--without inflation and the abuse of leverage, is to go back to the gold standard. History has shown time again that when sovereign governments abandon gold-backed currencies, paralyzing hyperinflation becomes the unintended consequence down the road. With fiat currencies, central banks are permitted to print money unjudiciously--most of the time to try to dampen deep recessions (sounds familiar?). Deflation and avoidance of The Great Depression category 5 is the concern du jour, but the Coming to Jesus day will arrive soon enough, and we will all pay for these bailouts, literally with higher taxes and a higher cost of living (and accompanying lower standard of living).

Think about it: with our reserve banking system, a 20% run on demand deposits would make every single one of our major banks insolvent. This is not just a mortgage crisis, a credit crisis, etc.--it's a crisis of confidence. And with flimsy fiat, finance-based economies, confidence is everything (since there is no gold backing up the currency).

Of course, resetting of a new gold standard would mean a level of around $1500/ounce, which would cut everybody's cash accounts in half, but that's what it would take. It happened in the early 30's, when FDR declared gold would be set at $35/oz, instead of the previous $20/oz. The federal government then went on to confiscate all individually held gold (with the exception of wedding rings), or citizens risked 10 years of prison and a $10,000 fine. All that gold is now at Fort Knox. This was due to the profligate Treasury printing presses during the easy money 20's, which in turn caused the Great Depression of the 30's. (See any parallels?).

I could go on and on about what's going on with the currency and gold markets right now, with the manipulation and placating of short-sellers, but I'll summarize with this: if JP Morgan and Citibank are openly predicting $1500/oz gold for next year, and if they are accumulating gold bullion as we speak (as are Dubai, Saudi and Chinese governments), then why are they selling short gold? Could it be they want to keep its price artificially low, in order to boost their purchases? Thing is, it's a dangerous parlor game, as short sellers have to deliver against futures contracts, and there are rumors that these shadow contracts entail no deliveries. But that is precisely why the two major banks are accumulating physical gold bullion, because when the shorts are covered (i.e. gold explodes upward in price), their inventory will (partially) offset their losing sales contracts.

Another compelling case for gold: The Treasury is printing trillions of dollars for bailouts--equal to half the US GDP. What happens when you have oversupply of a commodity--including a local currency? It removes scarcity, plummeting that currency. What happens when your currency is devalued? Gold soars--it's a mathematical reality, not some wild rantings of a gold bug.

Look, gold has been the absolute worst investment vehicle from 1980 - 2000.

But in the 70's, it was the absolute best--even with inventory costs taken into account. Gold went up 23-fold in that decade. Gold mining shares went up twice that level. If many prognosticators are saying this run is much worse than 73-74 and 78, what does that say about the price of gold? Does anybody think post-2008 will be a replay of the roaring 80's and late-90's stock market booms? Or are we headed for a very subdued 70's-like stagflation scenario? You decide.

BTW, the Big 3 is old news, despite the headlines. I called their demise 18 months ago, and their shares are down a nice 98%. It's done, finito. The next shocks will be a result of de-leveraging and the precipitous decline of most currencies and US long-term debt. Whoever buys US 10-year notes or Treasury bonds is going to get crushed. Taking on all that risk (after all, one could argue the US government is insolvent), and yet earning 2% on your money? When inflation rears its ugly head, and interest rates are in the double digits, those bonds will be worth less than Monopoly money.