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Tuesday, August 3, 2010

A Crowded Trade....Part 1

If you have ever lived through a hurricane, dear reader, you will understand the concept I am about to introduce. When a hurricane is first predicted there are many warnings and people are advised to seek shelter. For most people at least in the New England states where I reside, this means battening down the hatches and staying inside away from windows and possibly a little praying.  The storm hits and it generally consists of huge winds and driving heavy rains. One can hear the wind howl at frightening levels as the rain whips against the outside of the structure sounding similar to standing below Niagara Falls. The windows shake and rattle and depending on the age and build of your specific structure the wind causes strain that makes it seem as if the edifice is groaning.  Occasionally a branch is heard snapping or some unsecured object crashes about outside as it becomes a projectile. This almost apocalyptic scene goes on for much longer than one would care to live through. Suddenly, one becomes aware that the winds have died and it is eerily quiet outside. If one were to peer or venture out at this time you would notice an unnatural stillness to the sky and landscape. Welcome to the “eye” of the hurricane.  You have made it through one side of the storm system’s swirling winds in to the calm center but dear reader we are only half way complete. The back side of the storm has yet to hit. I know you are asking yourself how this relates to investing. Well I am sure that many of you have heard the news of a coming “double dip” recession in the cards, which is the backside of our current financial hurricane. Right now we are in the “eye” of this financial hurricane and the backside is getting ever closer. I do believe that we unfortunately will experience a dreaded double dip, however, I see it as playing out differently than many of the articles I have been reading which say the same thing.



The preponderance of opinion out there from economists and those who write on the subject ranging from perma-bear Robert Precheter of Elliot Wave, Nouriel Roubini the famous NYU economist, Bill Gross the PIMCO bond king, Paul Krugman of the New York Times and  St. Louis FED Chairman James Bullard is that deflation is the big problem and final outcome. It is going to be deflation so we must act! Everywhere I look this is the refrain that we are in, at, or near deflation and being the contrarian it doesn’t seem right to me. It is no different than everyone in a canoe trying to stand on one side of the boat…well you know what happens then.  My sense is that we are experiencing the asset deflation right now. I can tell you from personal experience that we have inflation in everything you need be it at the super market, insurance, taxes or the doctor's office, although if you could eat you plasma tv which is going down in price one might not agree. I do believe that the seeds are being planted for an inflationary environment that will be difficult to control.



If we look at the players involved in the monetary and fiscal policy of the United States you can deduce the likely policy options and their intended and potentially unintended consequences; to quote the writer Clare Boothe Luce, “no good deed goes unpunished”.   We start with the Congress, which has neither the stomach nor moral compass to do the right thing. Of course doing the right thing at this point is beyond the scope of their collective comprehension, since the problems loom so large that there is no easy painless fix to the nation’s woes, that would make them look like heros with out impacting the masses. The environment at the moment is one of pass the blame, silly statements and charges of discrimination/racism, not exactly an breeding ground for positive solutions.  Politics aside Congress has demonstrated that they cannot reign in their spending. Just recently the congress passed the “Pay Go Act” that meant if congress wanted to spend some amount of money that was not part of the budget they either had to find a new revenue source or make cuts to existing programs to fund the new item. The ink on said act was barely even dry when the congress passed a bill increasing spending without paying for it and continues to do so.  Sure the Congress and President will cut small items like 100 million from budgets, which sounds like a large number but in terms of the US budget is miniscule, at the same time using both on and off budget items they will shell out billions of dollars for various spending initiatives especially if they justify it as “emergency”. Look at the facts, the world has grown more unstable economically and politically by the day so if you think they can’t come up with an emergency rationale to spend even more, then I have some prime swamp land in Arizona for you to buy.

We are in the middle of an election season and many if not all who are up for a vote in November are feeling vulnerable so it would be political suicide for them to not “bring home the bacon”or run on platforms that are unpopular but would be economically intelligent.  This is because the political class sees the government as the primary driver of the whole country, while paying lip service to the private sector. So even as the “TEA party” protests spending, the congress will find a way to do just that, spend. In the mind of the government it is the savior and must spend, tax, and create new regulations since we cannot help ourselves.  Calvin Coolidge once said, “The business of America is Business”, today however it might be apropos the say “the government is the business of America”.  The congress will not be denied until it is just impossible for them to get money to spend, but I believe that is still down the road quite a bit, for reasons that I will take up in another article.



Moving on to the Federal Reserve we have a Chairman in Ben Bernanke, who claims to be a student of the “Great Depression”, but only appears to have studied its symptoms not its causes. It is a kin to a doctor trying to treat a broken bone with aspirin because it will help the pain while never finding out what causes the pain or dealing with setting the bone. Bernake’s solutions while ingenious are not addressing the underlying economic problems only delaying the ultimate outcomes. He believes that money and credit expansion are the only tools to solve the problem.  From his own writings it is learned that he feels the FED did not act fast enough or create enough money/credit to stave off the great depression. He believes that all ills can be cured by monetary expansion as evidenced by his famous speech in which he said that the FED stands ready to deal with the economy and has a tool called a printing press. He further went on to emphasize that the newly created money could even be dropped by helicopter if needed, which is how he gained the nickname “Helicopter Ben”. So the solution for excessive money printing and debt creation is more money printing and debt creation, like detoxing a heroin addict with larger doses of heroin.  Add to this the Board of the Federal Reserve has appointees William Dudley of New York ,Eric Rosengren of Boston, Janet Yellen from San Fransicso, Peter Diamond of MIT, and Sarah Bloom Raskin from Maryland all of whom align with Bernake’s view of monetary policy. Perhaps the last coffin nail is that of James Bullard the St. Lous FED President, who in the past had been a deficit hawk and concerned about inflation ramifications, but is now more concerned with deflation and has hinted at further easing  and no interest rate rises until 2012.     To be continued....

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