Global Economy

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Let’s face it, European countries are bankrupt. First it was Greece and Ireland. Now it’s Portugal. Pretty soon it’ll be Spain and Italy.

Politicians will never admit there’s a problem. Portugal’s prime minister just said that they don’t need any financial assistance. Just like Greece’s prime minister said last March, he claims they want to help themselves out of this mess. And like Ireland’s minister of foreign affairs said last November, there’s no need to panic. Of course a couple of weeks later both prime ministers came begging for aid. Portugal will probably do the same.

Everyone wants someone else to bail them out, and pay for their transgressions.  And other nations are rushing in to buy the sovereign debt – using freshly minted money of course. Maybe these saviors know that their own balance sheets are somewhat murky and hopefully someone else will return the favor in the future?

After all, printing more money to buy another country’s debt is a splendid idea. Keeps the world economy chugging along without having to deal with any of the difficult issues. Like reducing debt. (I’ve never quite understood the notion of solving a country’s excessive debt problem by rolling it over in to more expensive debt. But financiers make money selling debt, so that’s what economists (who secretly harbor dreams of working on Wall Street) will advise the governments to do). But there is a crisis of sorts and whenever there is a crisis anywhere, people flock to the US and to the relative safety of US treasuries.

Everyone and their mother seem to be making financial and investment predictions for the rest of 2011. So I’ll do the same.

1. For the first half of the year the US dollar and government bonds will appreciate – especially against the Euro.

2. Also during the first half of 2011, Gold and Silver prices will drop from their spectacular highs as the US dollar appreciates. But I think Gold prices will stay above $1000/ounce.

3. But eventually, probably during late-summer, people will realize that all the major countries are printing money and using it to prop up failing countries and companies by buying debt, the US dollar and treasuries will slide. And Gold and Silver prices will start to rise again.

4. This collapse in treasuries will be precipitated by multiple bankruptcies in the municipal bond markets.
In the past 2 years, 15 municipalities have filed bankruptcy. According to a recent article in WSJ:

Mr. Bernanke downplayed the notion that many state and local governments run the risk of defaulting and that the municipal bond market could be headed for turmoil. The muni market, he says, has been functioning “reasonably well,” with lots of bond issuance and liquidity in trading. “We’re not seeing extraordinary stress,” he says. Some analysts have been warning that a crisis is looming in the muni market. Mr. Bernanke described these warnings as overly pessimistic. He also said the Fed, which has some limited authority to buy short-term municipal debt, has “no expectation or intention to get involved in state and local finance.” If states are to be bailed out, he said, “it would have to be Congress.”

Isn’t that exactly what he said right before Fannie Mae and Freddie Mac went bankrupt? Let’s face it. There will be a muni-bond meltdown, and Bernanke will scare congress into bailing them out. Bernanke is just a bare-faced liar. Actually, he got tired of being called a bare-faced liar which is why he sports a beard. But regardless, the only reason he brought it up is because it is an issue that will become pertinent within the next 18 months.

Incidentally, previous Fed Chairman, Alan Greenspan, said exactly the same about the housing bubble back in 2005. That it wasn’t an issue and there was nothing to be worried about. As an economist, he should have seen it was a bubble, of his own creation.

This collapse of muni-bonds will scare the pants of regular Americans and foreign investors. As the last bastion of fixed income for the retired, the wealthy and global pension-funds, muni-bond defaults will trigger a major panic. Citizens and investors will realize that they’ve been hoodwinked by the government and Wall Street, and they can’t trust either of them.

5. This will cause a flight to gold and silver, possibly the last and most intense run in this bull market.
I predicted back in December 2005 that “the US is going to enter a period of inflation and recession brought on by the trade & budget deficit and precipitated by the devaluing dollar” and that at $508, it was a great time to buy gold. I still believe it is. If you haven’t already established a position, make sure you buy both gold and silver on dips. If you don’t know how to buy, read through the previous posts on gold and silver. Hopefully, this major rush in gold will not trigger the complete collapse of global currencies. And if it does, it’s still a few years away, so it’s not an 2011 prediction.

Disclaimer: I’m short a Euro ETF, long gold and silver (bullion and mining stocks). None of this should be construed as investment advice.

Gold closed at a record high today of $1,237/ounce but surged to nearly $1,250/ounce in intraday trading. The gold ETF, GLD, also reported record inflows this week of $2.3 billion dollars. The ETF also disclosed a record 1,185 tons of gold as distrust in global fiat currencies pushed investors to seek more tangible assets. Gold has hit a high against every major currency, with the exception of the Canadian dollar.

gold-record-price-2010-1250-ounce

Buoyed by gold’s action, silver has also seen some price movement. After dropping as low as $15.13 in February 2010, it has jumped nearly 30% to 19.52. (Silver prices hit $19.70 today in intraday trading).

Seems like Marc Faber was right about gold being a bargain at $950/oz! Since that post about 2 years ago, gold prices are up about 29% versus the S&P 500 which is down about 8%.

After hitting a high of $1.51 just six months ago, the euro broke the $1.30 level and is currently trading at $1.28. Greece’s inability to repay its debts has dragged down the euro and proposed austerity measures have led to rioting.

 euro-vs-dollar-may2010

After European Union eventually bails out Spain, Portugal, Ireland and Italy the euro might trade on parity with the dollar!

I wish I hadn’t been so quick to close my long position on the EUO May $21 calls last week!

With the financial crisis and currency devaluation, the long term prospects for gold are still looking good too.

One of my favorite investors, Nassim Nicholas Taleb, founder of Empirica investment management funds and author of Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, was recently quoted on Bloomberg advising every single human being to short the US Treasury bonds. While this news is about a week old, I thought I’d still comment on it given the fact that it’s a pretty strong statement and that I recently exited a similar paired-trade.

Taleb said investors should bet on a rise in long-term U.S. Treasury yields, which move inversely to prices, as long as Bernanke and White House economic adviser Lawrence Summers are in office, without being more specific. Nouriel Roubini, the New York University professor who predicted the credit crisis, also said at the conference that the U.S. dollar will weaken against Asian and “commodity” currencies such as the Brazilian real over the next two or three years.

The Fed and U.S. agencies have lent, spent or guaranteed $9.66 trillion to lift the economy from the worst recession since the Great Depression, according to data compiled by Bloomberg. Bernanke, who in December 2008 slashed the central bank’s target rate for overnight loans between banks to virtually zero, flooded the economy with more than $1 trillion in the largest monetary expansion in U.S. history.

President Barack Obama has increased the U.S. marketable debt to a record $7.27 trillion as he tries to sustain the recovery from last year’s recession. The Obama administration projects the U.S. budget deficit will rise to a record $1.6 trillion in the 2011 fiscal year.

“The problem we have in the United States, the level of debt is still very high and being converted to government debt”, Taleb said in an interview with Bloomberg Television. “We are worse-off today than we were last year. In the United States and in Europe, you have fewer people employed and a larger amount of debt”.

Moody’s Investors Service Inc. said on Feb. 2 that the U.S. government’s Aaa bond rating will come under pressure in the future unless additional measures are taken to reduce budget deficits projected for the next decade.”.

Do I believe him? Absolutely. So why did I exit my highly profitable trade? Several reasons. During times of global economic uncertainity, there has always been a flight to quality. We saw this during the financial meltdown in 2008, where US Treasury prices soared and yields tanked. Right now, there is uncertainity in Europe regarding the debt of Greece, Portugal, Ireland, and Spain. People are worried this might have lasting consequences on the Euro as a viable currency. These fears are probably overblown, but until everything settles down and we have more clarity, there will be a flight to quality, which means that people will sell the Euro and flock to US Treasuries.

At least thats my hypothesis and I sold all my positions (except Berkshire Hathaway), shorted the Euro and also the S&P500. The one thing I didn’t do is go long the US Treasuries, since inherently I feel Nassim Nicolas Taleb is correct. At some point, I’ll most likely re-enter my short US Treasury trade, but in the meanwhile I happy to see how the European Union handles the issues of excessive debt.

Here’s an interesting article by Dominic Frisby about Venezuela’s devaluation, the effect on a country’s currency and the relation with gold prices.

Gold bugs are forever telling you to buy gold because it is ‘nobody else’s liability’. It’s become one of those hackneyed phrases that has almost lost its meaning.

But recent events in Venezuela give us a nice illustration of what that phrase really means. And there’s a stark, but important message for savers everywhere.

Inflation is currently running at 27% in Venezuela. That’s just the official figure. You can expect the real number to be considerably higher.

Earlier this month, the Venezuelan president Hugo Chavez, devalued the bolivar by half, from 2.15 per US dollar to 4.30 per dollar. There will be a second peg, subsidised by the government, of 2.60 bolivars per dollar for essential imports such as food, medicine and machinery.

This devaluation has effectively doubled the cost of imported goods and halved the Venezuelan people’s purchasing power in a single stroke. Savers – though I doubt there are that many given the country’s precarious situation – will have had half of their wealth effectively wiped out overnight.

Chavez is doing it, he said on state TV, ‘to boost the productive economy, to reduce imports that aren’t strictly necessary and to stimulate exports.’ But that won’t be the effect. All his actions will do is discourage people from working at all. Leaving aside the moral issue of whether government should have the power to do that (and, largely speaking, with our modern system of money and credit, they do), many Venezuelans will now ask themselves: ‘What is the point of my working at all, if the proceeds are going to be devalued so suddenly?’

But any Venezuelan who happened to have converted some of their wealth into gold would be protected from these government foibles – at least, as much as is possible under the circumstances. [LOD”s note: Not only gold and silver, but even real estate would hold its price in an event like this. Over the long term, real estate matches inflation, and to some degree population growth]. Chavez cannot suddenly devalue gold by half to ‘boost the productive economy’. So the proceeds of that individual’s labour would have been preserved. The purchasing power of gold against essential goods such as food, energy and shelter remains unchanged – in fact it’s probably risen.

I remember backpacking across South America in the early ’90s. Venezuela was one of the wealthiest, most advanced nations on the continent. It’s such a shame to now see the country on Hayek’s The Road to Serfdom, or, worse still, to Zimbabwe.

“Chavez”, writes Daniel Cancel on Bloomberg, “is trying to maintain spending for his 21st century socialist revolution as South America’s largest oil exporter fails to emerge from its first recession in six years. The government is seeking to stem its falling popularity and the highest inflation rate among 78 economies tracked by Bloomberg, ahead of parliamentary elections scheduled for September.”

Well, isn’t our own government doing the same thing? Haven’t they boosted spending over the last three years in an attempt to stem falling popularity ahead of an election? Isn’t quantitative easing an elaborate form of currency devaluation? The effect of their actions has been that sterling has been losing its purchasing power. It buys us considerably less food, energy, medicine, industrial goods and anything else you care to mention (except mass manufactured goods from Asia) than it did five years ago.

It even buys us less foreign currency, as the chart below – which shows sterling against a basket of foreign currencies – shows. (I’ve drawn on that white line highlight the market direction) The only reason sterling has not fallen further is that other foreign central banks have been doing the same things to their own money. It is a race to the bottom.

british-pound-against-basket-of-currencies.ashx

Our currency has devalued many times before. Anyone who remembers 1976 can tell you about the sterling crisis then. Financial markets were losing confidence in the pound. (I believe that loss of confidence is coming again. If sterling drops below $1.57 against the dollar, look out below).

The UK Treasury could not balance its books, while Labour’s strategy emphasized high public spending. The newly-elected prime minister, Jim Callaghan, was told there were three possible outcomes: a disastrous free fall in sterling, an internationally unacceptable siege economy, or a deal with key allies to prop up the pound while painful economic reforms were put in place. What will David Cameron be told should he win in the summer? The parallels to today are uncanny.

In more recent memory, we have had the sterling lows of March 1985 (when we almost hit parity with the dollar), then another crisis with ‘Black Wednesday’ in October 1990, when we were forced to drop out of the European Exchange Rate Mechanism.

What is worrying is that our current deficits, debts and spending are all at far greater levels than during any of the previous crises. So many toxic assets have been transferred from the balance sheets of banks to governments, that sovereign debt default – not just here, but throughout the Anglo-Saxon economies – is now a major risk.

You can read the entire article on moneyweek.

So Why should you care?
If you invest in US companies that do business with Venezuela, then your portfolio returns will definitely be adversely impacted. US companies that do business with Venezuela like Haliburton are likely to feel the impact of this currency devaluation. Haliburton CEO just announced that they may face a $30 million loss in the 1st quarter because of this.

While I liquidated almost my entire stock portfolio at the market open this morning (including Harvest Natural Resources which does business in Venezuela), I’m still keeping my gold and silver coins!  Talking the about market, its risen 50% since the March lows of last year. I might even go short some weaker stocks on any market bounces too.

[St Gaudens Double Eagle 1 Oz Gold Coin]

St Gaudens Double Eagle 1 Oz Gold Coin

Today Gold hit an intraday price of $1005/ounce. While not a record, it’s definitely a historical moment, with this event occurring for only the sixth time in history.

We can only speculate as to why the run up to a $1000 so quick but some of the likely reasons are:

  • The continued monetization of US debt and resulting devaluation of the dollar
  • The ability for 1/6th of the world’s population (the Chinese) to now buy gold
  • The Indian Wedding season is about to begin soon and this is when Indian’s start buying gold jewelery
  • The Chinese government has been buying gold on the sly. Well maybe not so secretly. They even encouraging their citizens to buy silver and gold
  • The Chinese government just agreed to buy $50 Billion of IMF Bonds denominated in SDR (Special Drawing Rights), a mixture of various currencies, which might be a signal that the US Dollar is losing its status as the world’s reserve currency

The only question is whether this rally can last. In the long term, the answer seems obvious, but the short term is anyone’s guess. However, I think $1000 gold is here to stay.

Here’s a news clip from nearly 4 weeks ago, about how and why China is moving away from US denominated assets and buying tons of gold instead. It looks like the Chinese believe there’s a threat of inflation looming.

Now there’s absolutely no reason to mimic the investment strategies of one of the world’s largest creditors to the USA, but if you think they’re doing a good job of managing their economy you might want to give it some thought.

WSJ had an interesting article on New Zealand Prime Minister, John Key. A former foreign-exchange trader, he takes supply-side approach to the global recession.

“We don’t tell New Zealanders we can stop the global recession, because we can’t,” says Prime Minister John Key, leaning forward in his armchair at his office in the Beehive, the executive wing of New Zealand’s parliament. “What we do tell them is we can use this time to transform the economy to make us stronger so that when the world starts growing again we can be running faster than other countries we compete with.”

That idea — growing a nation out of recession by improving productivity — puts Mr. Key and his conservative National Party at odds with Washington, Tokyo and Canberra. Those capitals are rolling out billions of dollars in stimulus packages — with taxpayers’ money — to try to prop up growth. That’s “risky,” Mr. Key says. “You’ve saddled future generations with an enormous amount of debt that then they have to repay,” he explains. “There is actually a limit to what governments can do.”

In the 1980s, New Zealand’s government implemented a wide-ranging program of economic liberalization, including deep reductions in tariffs and subsidies, and privatization of state-run industries. The plan, nicknamed “Rogernomics” after then-Finance Minister (now Sir) Roger Douglas, was akin to Reaganomics, and the island nation grew smartly.

But while the U.S. and Australia broadly continued their economic liberalization programs under both right- and left-wing governments, New Zealand didn’t — until now. Over the past nine years, Helen Clark’s left-wing Labour government rode the global economic expansion and used the revenue surge to expand government welfare programs, renationalize industries, and embrace causes like global warming. As a result, the economy stagnated while Australia took off.

Mr. Key’s program focuses first on personal income tax cuts, which — given that the new top rate, as of April 1, will be 38% — are still high, especially when compared to Hong Kong and Singapore. “We just think it’s good tax policy to lower and flatten your tax curve,” he says. “People will move in labor markets and they look at their after-tax incomes.”

Cutting the corporate tax rate — which is now 30% — isn’t as crucial just now as keeping liquidity flowing, Mr. Key argues. “A lot of [companies] won’t pay tax if they don’t make money,” he reasons. “So they might be slightly less focused on corporate tax in the immediate future. Longer-term, they will be.” Why? Corporate money is “mobile.” “If you really are out of whack with the prevailing corporate tax rates, and there’s been a global shift toward countries lowering their corporate tax rate, then you’re not likely to attract capital, or you’re likely to lose capital.” Mr. Key and his coalition partner, the ACT Party — Mr. Douglas’s party — want to eventually align personal, trust and company tax rates at 30%.

But ultimately, Mr. Key says his biggest fear is rising inflation on the back of rising money supplies. “Economic theory will tell you that inflation is going to rise — and that inflation will be exported around the world. . . . In the short term, I’m not criticizing U.S. policy: I think inflation is probably the thing that’s going to be necessary to get them out of the current issue. [Federal Reserve Chairman Ben] Bernanke sort of signaled that. But longer term, inflation is cancerous to your economy.”

Another person who agree that spending doesn’t help bring us out of the recession is Peter Schiff. He thinks that reducing the size of the government is what will do that job. He also think that letting the big financial firms fail would actually help the economy!

Gerald Celente runs The Trends Research Institue and has been analysing economic news and data and predicting trends for over 20 years. He advocated buying gold in 2001 when it was under $300/oz and has been accurate in a lot of his predictions.

Right now he’s predicting a revisting of the Great Depression era with huge vacancies in commercial real estate, large amounts of unemployment, a spike in gold prices. He also thinks we’ll see a surge in crime rates and a tax revolution with a revolt against property taxes first followed by school taxes. He thinks Obama’s promise for change is hokum and has no faith in his economic stimulus plans. On the bright side, he doesn’t believe this is the end of the world and says that a new technological revolution similar to the internet in the early 90s will bring us out of it.

Check out this very interesting video:

One person who obviously doesn’t believe him is Elliott Spitzer. He just bought a $180 million office building in Washinton DC, just down the street from the now infamous Mayflower hotel. He paid about $42 million in cash for this acquisition!

Eliott Spitzer is quoted as being optimistic about the real estate market!

May be I’ve been posting too much doom and gloom in the recent past. Do I really think we’re on the cusp of a global financial meltdown? No, I do not. But Telegraph does. Here’s an excerpt from an article which says the meltdown has already started:

If mishandled by the world policy establishment, this debacle is big enough to shatter the fragile banking systems of Western Europe and set off round two of our financial Götterdämmerung.

Austria’s finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria’s GDP.

“A failure rate of 10pc would lead to the collapse of the Austrian financial sector,” reported Der Standard in Vienna. Unfortunately, that is about to happen.

Europeon banks may face write-downs of $25 Trillion dollars! In compaison, Nouriel Roubini’s estimate of $1.8 Trillion in write-downs for US banks seems like chump change.

Whether it takes months, or just weeks, the world is going to discover that Europe’s financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus.

Under a “Taylor Rule” analysis, the European Central Bank already needs to cut rates to zero and then purchase bonds and Pfandbriefe on a huge scale. It is constrained by geopolitics – a German-Dutch veto – and the Maastricht Treaty.

But I digress. It is East Europe that is blowing up right now.

The sums needed are beyond the limits of the IMF, which has already bailed out Hungary, Ukraine, Latvia, Belarus, Iceland, and Pakistan – and Turkey next – and is fast exhausting its own $200bn (€155bn) reserve. We are nearing the point where the IMF may have to print money for the world, using arcane powers to issue Special Drawing Rights.

This doesn’t sound very encouraging. If there was ever a time to start investing in gold coins, it’s now! If you can’t afford gold, you might want to consider silver coins. Silver prices have been on a tear over the past 3 months. The graph’s been up linearly over 40%!