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Wednesday, November 3, 2010

If you can't convince them, confuse them...(Update at bottom)

So with the election uncertainty out of the way the street can digest the news of the night. The biggest news in my opinion is the wresting of control of the House of Representatives from the Democrats. Whether the occurrence will be a good thing or a bad thing economically only time will truly tell, however, one thing is certain the most radical parts of the “Obama Agenda” are now D.O.A., even Charles Krauthammer expressed as much. It is highly unlikely that we will get damaging policies like cap and tax or wasteful policies that produce little in the way of economic growth like “Cash For Clunkers”.

The risk now is that we get no compromise on anything and we have a house that puts forward items only to have the Senate let it die or both houses of congress actually do cooperate but their ideas get vetoed      by President Obama. Either way unless we approach another crisis I do not believe that there will be much action working together. Moreover, while the Republicans are talking a good game of deficit reduction I have only seen proposals that cut roughly $100 Billion from the inexorable growth of the budget. Additionally, the projections of reducing the deficits made by the Obama administration made assumptions that have not been met and therefore the deficits will continue and probably get worse. The administration made the assumption that 1) Unemployment will peak at a little over 8%, 2) we will not get a double dip but a recovery, and 3) unemployment will decline.

Let’s address the issues regarding the situation. Essentially we are trapped in a vicious cycle regarding the economy. To start with unemployment obviously exceeded 8% and is holding well over 9%. Yes we have had a recovery but it is the weakest post “recession” recovery at least since after WWII and sorry folks a 2% GDP growth will not cut it to create or save 250K jobs a month needed to get close to being on track.  Although it is true that while unofficial ADP is reporting that 43K jobs were added in the private sector in October which was better than their prediction of -39K, however, it is still a far cry from what we need to begin to get the car out of the ditch. There is a positive spin being put on the ADP figure as it shows a net 60K job surprise, but once again we need bigger and more regular surprise to get the motor running instead of trying to maintain stall speed

While it is true that the ECRI leading economic indicators have ticked up they are hardly robust and could be misleading since we have just gone through an inventory build which normally precedes a growth spurt. The problem this time is the inventory build has occurred just as indications abound that show the consumer who drives 70% of our economy is pulling the purse strings tighter not just here but in places all over the world.  Various articles give clues that things going forward are not so rosy such as “LCD TV companies see falling prices as demand down”(consumer demand),  “Pulte’s Losses Reaches $995.1 Million” (Housing demand), “Biogen to Cut Workforce by 13%”(Not helping unemployment and even in a strong field like biotech) there are other examples dear reader but you get the picture.

Yet even in this economic environment given the employment picture reports of surveys showing increases planned by consumers for the upcoming holiday season are likely to be over inflated. In this period of uncertainty I find it hard to believe that we will see the projected rise in spending. I know my family is not spending as much this holiday season nor is anyone I communicate with. I believe that the rosy predictions are just that and retail will be disappointed with the actual number being far less than predicted in this article. Moreover, what the consumers do spend on will be subject to heavy discounting to get bodies in the door and move merchandise.

In an interesting side note stemming from the G20 we have policy decisions coming out that appear to be making news but do nothing to fix the picture. An article, “South Korea's Lee says trade deal key test of U.S. will” details an agreement that would allow the US to increase exports to Korea which would be beneficial for our trade deficit; however, it also adds more imports from Korea. Based upon 2009 numbers Korea imported $28.6 Billion while it exported to the US $39.2 Billion. This supposed pact increases US exports to Korea by $10.7 Billion (using the high estimate) while Korea will export and additional $6.9 Billion (also the high estimate). So looks great and while it may spur some employment here in the US depending on the sectors impacted if they are not highly automated or have excess capacity at the moment unless my math is faulty it still leaves the US with a trade deficit of $6.8 Billion with Korea although it is an improvement of $3.8 Billion compared to 2009; but this makes for good press!

So as you can see dear reader the economy is not on as strong footing as the Mainstream Media and the Government would like you to believe and everything is being spun with appositive bias whether it deserves it or not or is solid evidence or hearsay. As I had mentioned in earlier posts dear reader you need to look between the lines and think for yourself. On caveat is that don’t automatically assume that just because things are not great that the market can’t rally; there were many rallies even midst of the “Great Depression” and there will be rallies now too. The fact there are rallies does nto give a buy and hold signal instead they will be opportunities for trades which could last weeks or even months or to lighten up on positions.

On to the Side Show Du Jour being the FED meeting. Today’s trading will have all eyes on the FED and its decision. The street is expecting a QE2 of $500 Billion according to Jan Hatzius of Goldman which I believe is what all the MOPE has prepared us for. The key will be the language that follows the announcement and I believe that the FED will leave this as an open ended policy that can be adjusted as things go so they can and will monetize at will. Moreover there is an article by Jon Markman a where he quotes Hatzius as saying that the 0% to .25% interest rates are 700 basis points to high to achieve the FEDs goal of inflation and employment which means that rates would have to go to -7% to achieve the stated goal. He further goes on to state that to achieve this end the FED and Government could use various tools to drive this 1) Fiscal Policy like tax cuts and infrastructure spending(we know how well that worked at stimulating), 2) Asset purchases (think treasuries or any asset that can carry a dollar sign) and language or MOPE regarding the commitment to the policy .

In an October 22 Release Hatizus stated a .75 basis point cut in the benchmark rate would require asset purchases of $1Trillion, so by this logic to get to negative 7% the FED would have to purchase $9.3 Trillion in assets. A purchase or purchases of that magnitude will not happen, but the message is clear that we are headed for the FED to use it is tool box to drive rates negative. A $1 Trillion purchase would drive rates negative and $500 Billion will put them in shooting range. If the FED is to leave things open ended as many believe then the QE2 could over time be much larger than the $500 Billion and who knows where rates will be. In the meantime the inflation rate as reported by the BLS is 1.1% so we already have negative real rates of return on short term money. If the FED does succeed in driving rates negative the negative real rate of return will climb up the duration ladder and force the long end down and the price up giving one last juicing of the bond market. The Dollar is going to be sacrificed on the altar of ritual currency debasement as to spare the economy. This is a dangerous gamble and if pushed to far will cause a loss of confidence in both the Dollar and the FED. Whereas inflation itself is a monetary event a hyperinflation is a market or crowd event and a loss of confidence in one or both pillars of our economic system could easily unleash a money velocity that no one in this country has ever experienced. All the big talk and all the Roubini’s, Krugman’s and Geithner’s don’t seem to grasp that a hyperinflation is not a monetary event or a debt event it is a psychological event where people just want to get rid of currency as fast as possible lest it lose value in the palm of your hand minute by minute.  I pray the FED can thread this needle because from everything I have hear from relatives who lived through the Hungarian hyperinflation of the Pengo (the Hungarian monetary unit of that period) it was awful and many lives were wrecked beyond repair. Additionally, all the talk of hyperinflation could never happen here either because we are so smart we can prevent it or my favorite because it never has before is just plain wrong. Think back dear reader of all the things that have happened over the past decade many had never happened before or could not have even been imagined to happen; but they did happen and so could anything unexpected in this nonlinear world we find ourselves in today.

The Bottom line is that the current environment is supportive of higher gold and silver and commodity prices and on our current trajectory the more actions taken by both the Government and the FED to fix the problems the more supportive it is for “things” over paper. Dear reader you should note that things can include stocks especially those that are involved in tangible areas or produce items people must have.  So if at 2:15pm when the FED makes their announcement the markets shoot up or drop down in the long run this is irrelevant instead  you will need the protection of “things”, which under current policies will only become more valuable, be wise and take advantage of any declines to rid yourself of paper and be leery of debt instruments as well as personal debt.

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