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Wednesday, June 15, 2011

Benny and the Debts...

I feel like starting this missive with the best opening line of a book ever written, “it was the best of times and it was the worst of times”. This is the message that one can take away looking at the landscape of our economy and world these days. For everything that is going well there appears on the scene something to suggest that things are not well. Surely, if you are the average Joe times could be better, of course, if you are of the “Bankster” class times have never been better. We are living in tumultuous times dear reader I did not have to tell you that as you are living it every day too.

On a daily basis one sees and hears different pieces of information that shapes your and countless other investors opinions. The media in particular does a great job of trying to only accentuate the positive therefore when negatives appear on the scene everyone has the ability to act like Cpt. Renault in the film “Casablanca” when he is informed that there is gambling going on in Rick’s Café American. Everyone fakes a gasp and says, “I am shocked, shocked I say, to find out that there is gambling taking place here”.
I think that we as Americans are a very optimistic people and try always to look on the bright side , which many would agree is part of what gave rise to the original  American can do spirit that built the country. The problem right now is multifold and part of the issue in my opinion is that American’s have not been leveled with for so long that the political class fears and rightly so that if they did the ire of the American people would run them out of town on a rail rather than allow them to truly do what is needed to right the ship. Americans in the past have risen to any occasion and made sacrifices for the public and world good without hesitation when they both understood the problem at hand and collectively decided to address it.

Today’s problems are so large and complex that even if the government and politicians were honest with the people as to size and scope I am not sure that any of us mere mortals could wrap our minds completely around the issues. We talk about budget deficits in the Trillions of Dollars but I would venture to guess that most people cannot even fathom what a Trillion dollars really is or the estimated $100 Trillion if you include the “unfunded liabilities” of Uncle Sam. Of course if you want to see a person’s eyes not only glaze over but pop out of their heads try and inform them that the OTC derivatives market has a notional value which has continually grown and is approaching a Quadrillion Dollars. To most people numbers like a trillion seem like monopoly money which in essence is what the currency is being turned in to at this rate. To help visualize $1 trillion, if you took the $14T  deficit and created stacks of $1 bills the resulting pile would extend approximately 882,000 miles or roughly 3.6 round trips from the earth to the moon.
Today the big news is that there is rioting in the streets of Greece as the people there are protesting the perceived draconian austerity measures. Suddenly the markets have decided that based on an issue that has been brewing for over a year it was time to melt down and send the Euro off the deep end there by floating the Dollar. So mind you the Dollar has responded and has shot straight up from just below 75 on the DXY in parabolic fashion to 75.65. Although even as the Euro lost ground against the Dollar the “almighty” buck surrendered some of its strength to the “Swissie”. Ultimately I see the EU debt situation as bullish for gold and silver since it sends yet another vote of lack of confidence in debased paper currencies and that the debts will have to be repudiated or inflated away. Deflationists argue that repudiation of debt is deflationary and that may be but what is driving the precious metals is a loss of faith in the value of currency and the ability of governments worldwide to manage the economy. If you don’t trust the debt or the government issuer why would you want to hold the currency that debt is denominated in? This is what will ultimately undo the dollar in my opinion.

Today ‘s news comes to us from Greece, but baring another EU event possibly involving Spain which would be like a 9.0 on the Richter scale vs Greece will be the US debt ceiling debate. The debt ceiling debate appears to me as a lose-lose situation.  If the congress approves the debt limit without real cuts and a real plan the markets will perceive that as there is no will to fix the US’s fiscal house. Of course the media is out in full force snagging sound bites from the likes of Mr. Intelligentsia Joe “three letter word J-O-B-S” Biden, who is prognosticating that a deal will be reached in time. I don’t know about you dear reader, but this is all suspect to me and harkens back to pronouncements of the sub-prime debt crisis being “contained”.

It seems to me from reading the various articles coming out on an hourly basis that at least the politicians are talking, but they appear to be miles apart on substantive issues and are coming at the problem from opposite sides talking at each other but not to each other. We are asking many of the same people who got us in to this mess in the first place to figure a way out, of course they never saw it coming so expectations had better be low. Alex De Tocqueville, a French Political thinker in the 1800’s, recognized that we would ultimately reach this point in his famous quote, “The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money.” We are at the cross roads now and Congress is out of money so the republic teeters on the razors edge.
Neither Democrats nor Republicans have demonstrated a real ability to compromise on the issues that keep them apart, although I do wish they would. One positive note is that the Republicans may have decided to suspend subsidies for corn based ethanol which should have been done a long time ago and would have reduced the fire under corn prices and other corn dependent commodities. The point is while it is  a good start it is hardly a core issue but is being touted as some sort of major victory in getting to a deal, which it is not.
 It looks like that best that we can hope for is some sort of compromise that is a “Wimpy” solution, in the words of the famous Popeye character, “I’ll gladly pay you Tuesday for a hamburger today”. The discussions revolve around maintaining spending in exchange for spending cuts at a later date like after Nov 2012. One must recognize that the spending cuts will never come even if they put penalty clauses in the bill as there will always be some way around it like an emergency that puts off the cuts yet again. It also appears that the solution is to cure the debt issue by more debt now and less later, which will only make matters worse. Of course it would be helpful if anyone really knew what was being discussed but I guess like everything else that passes for commonsense these days we will have to pass the debt limit resolution to find out what is in it, a la Nancy Pelosi.

The bottom line is that if the debt ceiling gets raised without real and tangible cuts it will just be an affirmation that the US views itself exempt from the laws of economics and the net result will be very dollar bearish.  Of course the flip side is that if they do pass a debt limit extension and there are cuts that are viewed as either unrealistic or to shallow the signal is also sent that the US government is not serious about fixing their fiscal house.
It appears that aside from a couple media photo ops, both sides are so far apart and neither will sacrifice their sacred cows so any compromise reached will be convoluted and market reaction most likely will be negative. If no agreement is reached then I believe that the markets will not take kindly to a US defacto default on the debt and it would make future borrowing by Uncle Sam more difficult and by far more expensive while throwing the markets in to turmoil. Furthermore, it would cause a rise in interest rates right at a time when trillions in short term government debt needs to be rolled over thereby exacerbating the deficit problem by increasing funding costs.

All in all this is quite a pickle we have ourselves in. No matter whose plan you look at the cuts called for are too small without having some inflation and a most importantly a growing economy. The Ryan plan looks to cut $4 Trillion over 10 years or $400 billion per year where as the Obama plan is looking at $333 Billion or $4 T over 12 years. This sounds great but if interest rates rise then much of the supposed savings will be chewed up by increased borrowing costs. Moreover, once the CBO scores the passed plan we are likely to find out that it doesn’t live up the reported figure, just like the supposed $38 billion in savings which the CBO scored out as a fraction of that amount. The bottom line is we need to make very deep and painful cuts and raise taxes on all citizens, even those who make very low incomes need to pay something. Save your hate mail I am not talking about taxing the poor to death, but everyone created this mess and it will require everyone to get out of it. Moreover, if one does not have any skin in the game it is easy to vote for increased deficits or taxes because you simply don’t care as it does not impact you since you do not pay, that is how we get systems so out of whack. To quote Alexis de Tocqueville, “in other words, a democratic government is the only one in which those who vote for a tax can escape the obligation to pay it.

This debt limit debate comes with the backdrop of an economy that appears to be weakening and has other factors hindering it like today’s report of the largest 1 month gain in inflation since 2008. The talking heads paraded out on CNBC still discuss things like the economy is healing when the Leading Economic Indicators are trending down and unemployment creeps up remaining stubbornly high. In my opinion the view that the economy is in recovery is not based in reality and nothing more than whistling past the graveyard, reminding me of the “green shoots” and 2nd half recovery mantra that never materialized.
The markets have been struggling with a spate of poor economic news and the knowledge that QE2 or Quantatitive Easing 2 ends on June 20th. The reality is that the economy has been on FED life support for many months and now the support is being removed. I don’t know if “B52 Ben” actually believes that the economy won’t act just like an individual who is on life support and then has it removed or he just needs an excuse to come riding in on his white horse with some form of monetary rescue. The current state of the economy is not unlike economies of the past that required support and would fail under their own weight. I have written many times of the French Assignat and how each time the French economy of the late 1700’s would stumble they would print more until that no longer worked.

Just like the French of the Assignat period we must face the same lesson and if QE by that name or any other stops then things could get real hairy, with the markets tanking, higher unemployment and another round of confidence lost. The stakes are high as misplaying this hand by both Congress and the FED could easily lead to the recognition that neither Congress nor the FED has control over the economy or a solution to what ails it.
The net result is that one may see a spike up in the dollar not because it is worth more but because assets are being liquidated and that causes an artificial demand for dollars as they transition to other areas. As this spike occurs would be an optimal time to either purchase high quality stocks at low prices or take advantage of what will likely be a sharp but short drop in precious metals.  Ultimately when the Dollar and other currencies are debased you will be glad to have precious metals.

You need to think of precious metals like you do home insurance. You buy home insurance not because you want or think your house will burn down, but because if it does you are able to rebuild. One needs to view precious metals in the same way but you are insuring your financial house not your physical dwelling. I have heard since I began buying the metals back in 2001 that it is overvalued and what a horrible investment it is etc.. None of this deterred me as I believe in monetary history extending beyond the 40 years or so of Keynesian economics and based upon what I see happening precious metals will not find their value against paper money but instead paper money will continue to debase against the metals. Until I see serious efforts to stem the debt creation and a move back toward fiscal sanity I will continue to hold and add to my precious metals positions.  Dear reader to leave you with a positive parting note I will reiterate yet another Tocqueville quotation that gives me hope for our country going forward. The greatness of America lies not in being more enlightened than any other nation, but rather in her ability to repair her faults.  Let us hope that we put aside the partisan bickering, insane policies and can get the repairs done as quickly as possible!

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