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Stimulus-Caused" Deficits? "Fatal" Unfunded Liabilities? Think Again, and Again.

By Jon Nadler       Printer Friendly Version Bookmark and Share
Oct 12 2010 8:46AM

Good Morning,

The US dollar recovered from the eight-month lows it touched on Monday, rising another 0.22 this morning to reach 77.73 on the trade-weighted index. Such a bounce helped dent crude oil values somewhat  more as Tuesday trading got underway (down 86 cents to $81.35 per barrel) and it took some of the energy out of advances in copper prices (down 1% this morning). Fed meeting minutes will be subjected to minute parsing later today, in an forward-looking-backward-glance attempt to guess what the US central bank might have up its sleeve, come November.

Although similar patterns were becoming manifest during the late afternoon hours on Monday, they did little to stanch a recovery from the morning lows seen the in gold and silver markets. The yellow metal finished 60 cents from the top end of its Monday range, (at $1,355.50) after having paid a few milliseconds’ worth of a ‘corrective’ visit to the sub $1,340.00 area. However, bullion retraced steps to the $1339.90 marker in early Tuesday action, with a $13.00 drop on the back of the aforementioned stronger greenback. Market opening levels had gold quoted near $1,345, silver still above $23.15 and platinum and palladium off by $3 each art $1,679.00 and $583.00 per ounce.

Marc Faber apparently shifted gears all of a sudden and declared that the US dollar and interest rates will both begin to rise within the next 90 days. The world is heading for a ‘major inflection point’ said he, as he then advised an audience ready to hear more doom and gloom from the original doom & doomer to…get ready for a …boom – in stocks (!).

Curiously, no mention was made of what gold might do in an environment of rising interest rates and dollar values (though we know what it ‘normally’ does under such conditions). Surely, $2K gold is still in his visions? After all, so is $X-thousand gold in others’ crystal balls. X= pick a number, any number, and then spin the wheel.

Ultra-bullishness in gold and corresponding super-bearishness in the US dollar (Marc Faber now excepted) remains the overwhelming order of the speculative trading day, but that kind of unanimity in sentiment raises certain…questions (addressed in this Marketwatch video by Barron’s contributor Mike Santoli). The bullish percentages (even higher at 98% in gold and 97% in silver than those noted by Mr. Santoli) confirm that which we pointed out in Monday’s article; namely, that they are at unsustainable extremes.

The greenback’s slump (and expected further erosion on the heels of a yet-to-come easing) has been the single most identifiable catalyst for the feeding frenzy in certain ETFs that are geared towards emerging markets, commodities, and precious metals. In the case of gold and silver, pretty much the only identifiable factor. That is precisely the type of finding that should raise concerns, but is falling on bullish-inebriated ears. Such type of ‘hot’ money can, and does, move at warp speed when conditions appear unfavorable to those who direct its flows. Look no further than last Thursday’s mini-meltdown in metals amid spiking volumes in the GLD.

The Fed’s Vice Chairperson, Janet Yellen reaffirmed that which such one-way bettors already should know but appear not to; that their temporary gift of monetary accommodation will be taken away. Invoking the words of former Fed Chairman William McChesney Martin, Ms. Yellen said policy makers need to “take away the punch bowl when the party is getting out of hand.?

That is not an ‘if’ kind of matter but obviously, only a matter of ‘when.’ The current Fed stance is quite obviously stokinga build-up of leverage and excessive risk-taking in the financial systemobserved Ms. Yellen on Monday. The Fed will keep its benchmark federal funds rate near zero through the beginning of next year, and end 2011 at 0.5 percent, according to a Bloomberg survey. My punch bowl runneth dry inside of twelve months.

The Fed V.C. went a step further than merely alluding to the removal of said punch bowl in due course. She mentioned the “R? word as well (as in –gasp!-: R egulation). Regulation aimed at averting bubbles before they become a threat to the system. That kind of “risk-management,? coming to a market theatre near you, is also a matter of time and not of debate, as it turns out.

Ms. Yellen’s (cryptic) message read as follows: “We know that market participants won’t take kindly when limits are set precisely in those markets that are most exuberant, the ones in which they are making big money. Even so, discretionary interventions will inevitably play a part in macro-prudential supervision.? While we won’t venture a guess as to ‘macro-prudential’ and its meaning, it is pretty clear which markets have been most ‘exuberant’ (see dollar shorting, for one).

On the other hand, something that is eminently clear is the ‘macro-imprudent’ flow of huge sums of the Fed’s supply of ‘easy money’ into certain niches. Take the equities of a region such as Asia, for example. Plenty of spec funds have (taken positions in Asia, that is), and that seems to be the trouble-in-the-making. The rush of cheaply available US dollars has engendered performance and then some, in the region’s markets. But it is precisely that inflow of hot money that has some Asia watchers staying up at night. Or, all day in other parts of the world, while it is night in Asia.

A sudden U-turn in the pattern of global liquidity flows could – in the opinion of UBS strategists- have ‘devastating consequences’ for the region’s economic growth (not to mention its markets). Think Hong Kong, think India. Think China, South Korea, Singapore, and even Australia. Just don’t think what might happen when/if money gets up and leaves those markets.

Not to mention the very shares within those markets that have been lifted to the price stratosphere by ultra-cheap carry-trade-flavored greenbacks; Jiangxi Copper, Yunnan Tin, Newcrest Mining, Rio Tinto, Cnooc, Aluminium Corp. of China – you get the idea of the sector in question…

HSBC economist Fredric Neumann cautions that:?The set-up for Asia is sweet, but hardly sustainable. Easy money is available in the West, and everyone wants a piece of the East. The result: Capital keeps pouring into the region. “It was only a short two years ago, after all, when markets froze up and left locals scrambling for dollars across the globe. Lending into Asia from Western banks has soared again over the past year. This cash is especially at risk of being suddenly withdrawn. Local market liquidity can thus quickly dry up, with devastating consequences for economic growth.?  

Noted economist and professor James K. Galbraith (yes, that last name does sound familiar, but…) recently delivered a presentation at Harvard in which he addressed some of the issues at hand as regards the US economy and its current and possibly future state. Mr. Galbraith shed some much needed debunking light on at least a couple of market/urban myths that appear to preoccupy many a scared investor these days.

While in no way painting a deep-pink or rosy picture of the current or future state of affairs in the US economy for his audience, Mr. Galbraith did lay to rest a few of the scarier skeletons being trotted out by the less-than-savvy newsletter marketing machines and freshly-minted “financial advisors? these days. Namely, said Mr. Galbraith, “please understand that:?

  1. Overwhelmingly, the present deficits are caused by the financial crisis. The financial crisis, the fall in asset (especially housing) values, and withdrawal of bank lending to business and households has meant a sharp decline in economic activity, and therefore a sharp decrease in tax revenues and an increase in automatic payments for unemployment insurance and the like.
  1. According to a recent IMF staff analysis, fully half of the large increase in budget deficits in major economies around the world is due to collapsing tax revenues, and a further large share to low (often negative) growth in relation to interest payments on existing debt. Less than ten percent is due to increased discretionary public expenditure, as in: stimulus packages. This point is important because it shows that the claim that deficits have resulted from “overspending? is false, both in the United States and abroad.

Mr. Galbraith went on to observe that “The [real] financial tragedy facing the American middle class is therefore the destruction of the notion that houses embody net wealth.? He also notes that in recent years we have been subjected to a rising cacophony of nonsense about a looming financial crisis; i.e., we are told, future unfunded entitlements will bankrupt our government as the baby boomers retire.  

Not so fast. As Mr. Galbraith noted, “There is nothing alarming about this. Just as the public debt can be eternal, and need never be paid off, a net debt position for Social Security and Medicare can likewise be eternal as well, since the government's net deficit is balanced by the nongovernment sector's net surplus. Spelling out the balance sheet in full for "the nation" would be good financial- reporting practice. And in this case, it would usefully reduce the scare-content of claims that focus on liabilities without acknowledging the corresponding assets.?

So, while [economic] Halloween appears to have made an early appearance in some publications, it may be useful to parse the presentation made by Mr. Galbraith last week. Reading it might just shift some perceptions and turn a few scary visitors lurking in your mailbox into wannabe…trick - sters. Save the candy for others.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



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