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I
am beginning to feel a bit like one of the French unfortunates stumbling
through the fog in the Ardennes, circa 1914. Except that, instead of Germans
full of deadly intent coming at me in the gloomy forest, it is a flock of
black swans.
As
it was for the French in the Ardennes, the number of problems – then
Germans, now black swans – is becoming overwhelming.
Consider
just a little of what we as investors, and as individuals looking forward to
retirement in accommodations more commodious than a shipping box, must
contend with:
- The
Euro-Stone. Despite all the bailouts and bluster flying about
Europe, the yields in the wounded “piiglets”
of Greece, Portugal, etc. have failed to soften to more tolerable
levels. Worse, yields in the fatter PIIGS of Spain and Italy are
hardening. This is of no small import to the German and French banks,
which together are owed something like US$2 trillion by the porkers. At
this point, it is becoming clear that the eurozone’s
systematic flaws doom the euro to continue trending down until it
ultimately takes its place in the pantheon of failed monies.
- The
Yen Has Lost Its Zen. This week the Japanese
government again began intervening in currency markets because,
remarkably, the yen has been pushed to highs against the dollar. This in
a nation with a government debt-to-GDP ratio that is better than twice
the also horrible ratio sported by these United States.
That
ratio ensures that Japan’s long struggles will continue, burdened as it
also is with the aftermath of the deadly tsunamis and the ongoing drama at
Fukushima. Adding to its woes are the commercial challenges it faces from
aggressive neighbors, and maybe worst of all, the demographic glue trap it is
stuck in, with fewer and fewer young to pick up the social costs of the old.
Toss in the waterfall plunge in Japan’s much-vaunted savings rate
– formerly a big prop keeping Japanese interest rates down – and the
picture for Japan is anything but tranquil.
- China’s
Crucible. There are many reasons for being optimistic about
the outlook for China, including a large and hard-working populace. But
there is one overriding reason to expect a big bump in the path to China’s
emergence as the world’s reigning economic powerhouse.
Simply,
it’s a capitalistic country with a communist problem.
Now,
in the same way that some people believe in leprechauns or any of dozens of
other magical beings, some people believe that an economy can be successfully
commanded just as a captain commands the crew of a Chinese junk cruising
along the coast. It’s a fantasy.
While
the comrades in charge have done quite well – largely by getting out of
the way of natural human actions – they are fast reaching the limits of
their ability to navigate the shoals. As I don’t need to tell you,
China is a massive country, with hundreds of millions of people capable of
every manner of human strengths and frailties. But if they share one
interest, it is in a job that allows them to keep their rice bowls full and a
roof over their heads. Said jobs don’t come from government dictate
– at least not on a sustainable basis – but rather by the messy
process of free-wheeling commerce… and the more free-wheeling, the
better.
In
the July edition of The Casey Report,
guest contributor James Quinn discusses the very real challenges facing
China, not the least of which is that in the latest reporting period,
official Chinese inflation popped up to 6.4%. Even more concerning was a 14%
rise in the price of food.
Scrambling
to keep employment high while also keeping inflation low, the Chinese
government is throwing all sorts of ingredients into the mix – building
ghost cities, raising interest rates, stockpiling commodities, clamping down
on dissent, hacking everyone – but in the end, the irrefutable laws of
economics must prevail. And so the Chinese government will have to atone for
the massive inflation it unleashed in 2008, and for the equally disruptive
misallocations of capital that are the hallmark of command economies.
While
the blowup in China will wreak havoc in world markets, including many
commodities, a bright side for gold investors is that the country’s
rising inflation should help keep the wind in the sails of monetary metal.
It’s no coincidence that the World Gold Council’s latest data
show investment demand for gold in China more than doubling in the first
quarter of this year.
- Uncle
Scam. Then there is the United States. Casey Research
readers of any duration know the fundamental setup… The political
avarice that dominates both parties… The fear and greed of John Q.
Public and his steady demands that the government do more… The
scam being run by the Treasury and the Fed to provide the funny money to
keep the government running… The cynical attempts by certain
politicians to stoke a class war… The cellars full of toxic paper
at the nation’s financial institutions… The outright
corruption and deceit of the various government agencies as they twist
and torture the data to fool the people into supporting them in their
scams.
But
there’s a growing problem: An increasing number of people and
institutions are coming to understand just how intractable the problems are.
This has resulted in a steady move into tangible assets – gold,
especially – that are not the obligation of any government. And
it’s not just individuals and money managers moving into gold, but central
banks as well. That is an absolute sea change from the situation even a few
years ago.
Meanwhile,
with the Treasury unable to borrow since May, a backlog in government
financing needs has built up. Which begs the question: With the Fed standing
aside (for the moment), where is the government going to find all the buyers
for the many billions of dollars worth of
Treasuries it needs to flog in order to keep the scam going?
If
I were a conspiracy theorist, I might look at the sell-off in equities this
week, triggered as it was by nothing specific, and see a gloved hand
operating behind the curtain. After all, nothing like a good old-fashioned
stampede out of equities to send billions chasing after “safe”
Treasuries… which has been exactly the case this week.
Regardless,
with the crossroads for hard choices now behind us, the global economy finds
itself at the top of a long hill… with no brakes.
From
here on, it will increasingly be every nation for itself – meaning a
return to competitive currency devaluations and, in time, exchange and even
trade controls.
And
we will see a return of the Fed to the markets. On that topic, I will once
again trot out a chart from an article by Bud Conrad that ran in The Casey Report a couple
of years back.
I
do so because it shows what I think is a very strong corollary between what
occurred in Japan after its financial bubble burst and what is now going on
here in the U.S. (and elsewhere). As you can see, as a direct result of the
Japanese central bank engaging in quantitative easing, the Japanese stock
market bounced back strongly. But then, when the quantitative easing stopped,
the market quickly gave back all its gains.
If
I had the time and the resources to whip up a chart overlaying the
quantitative easing here in the U.S. of late versus the equity markets, I
would. But I don’t, and so will delve into that fount of all
information – the Internet – and grab a chart constructed by
someone else (in this case, Doug Oest, managing
partner of Marquette Associates – thanks, Doug!)
As
one can readily see, the Japanese experience is indeed a corollary to
what’s happened here, with QE pushing the stock market higher.
Conversely, until the Fed comes back in, equities could be in for a rough
ride. Likewise, when the Fed returns with the next round of QE, stocks could
put in a very nice rally.
Some conclusions:
- The
Fed will have to roll out another round of quantitative easing. And
it will likely have to once again provide swap lines to the European
central banks as it did in 2008 – though this time around, a
belligerent Congress is watching the Fed’s every move, so it may
not be able to move as quickly as it would have otherwise. In the end,
however, given there is less than nothing being done on the front of
fiscal policy, it will fall to the Fed to once again ride to the rescue.
But it will do so on a lame horse.
- A
delay by the Fed to act could help the Treasury, at least temporarily. Per
above, the U.S. government has to move a boatload of paper by the end of
this year. If it wants to avoid the dire consequences of having to pay
out higher yields in order to attract sufficient buying, it will have to
find a lot of demand in a hurry. Should the Fed sit on its hands a bit
longer, especially in the face of the escalating euro crisis, the
resulting turmoil in global equity markets could provide the necessary
demand to clean up the backlog and keep the U.S. government operating.
(In
July’s Casey Report,
Bud Conrad dissects the situation and comes to some startling
conclusions… and an emerging profit opportunity.)
- The
return of the Fed may signal the beginning of the end. In
the face of broad weakness in the global economy and in most
commodities, the fact that gold has held up so well is a clear
indication that there has been an intrinsic change in the gold market.
Barbarous relic no more, it has clearly been returned to its
longstanding role as sound money – unique and increasingly valued
when compared to the fiat competition.
This
role will only become more crucial as the world’s desperate
nation-states fire their currency cannons in the war to remain viable. The
Fed’s return to Treasury markets will be, in the rear-view mirror of
future history, seen to be a seminal event – the beginning of the end
of the current fiat monetary system.
Simply
put, too much of a good thing is too much of a good thing. And make no mistake, the decades of operating under a fiat monetary
system have been a very good thing for the political classes and their
pandering cronies.
Those
good times are coming to an end.
[Savvy investors can still make money
in a crisis… often the returns are even greater when times are tough.
Learn all about the smart money’s way of crisis investing and Bud
Conrad’s profit opportunity mentioned above – with a risk-free
trial subscription to The Casey Report.]
David Galland
Managing
Editor, Casey Research
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