Tuesday, 21 April 2009
Just got back from our trip to the ranch. (About which, more below...)
As near as we can tell, the financial world conveniently remained on hold while we were gone. As of Sunday night, little had changed. Gold, stocks... economists... politicians – they’re all about where we left them. That is to say, the bear market rally on Wall Street continued. The feds continued to pervert the economy with their bailouts. Economists continued to call a spade a petunia. And politicians and commentators continued to blab and bluster about nothing.
But yesterday, the rally on Wall Street got smacked in the chops. The Dow fell 289 points. Oil dropped to $45. Investors were selling stocks – mostly financials – and turning to the dollar and gold for safety. The dollar rose to $1.29 per euro. Gold returned to $887.
The most important fact still sits like an alien spaceship on the White House lawn – so monstrous and dumbfounding that people don’t know what to make of it... so they simply ignore it. The US government is spending $13 trillion – nearly an entire year’s output – to ‘fix’ the problems caused by the worldwide financial meltdown. Of course, they can’t actually fix anything. Companies that are losing money are still going to be losing money. Investors are still going to take losses on stocks and bonds that were overpriced. Bad debts are still bad. Bad investments are still bad. A kiss is still a kiss. A smile is still a smile. Time goes by just like it always did.
But this $13 trillion of extra spending is bound to have some big effect. What?
A Financial Times article (written by one of Obama’s advisors) makes a guess (hard to follow... but worth the effort):
“The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president’s budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.
“There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions.
“The key fact is that inflation rises when demand exceeds supply. A fiscal deficit raises demand when the government increases its purchase of goods and services or, by lowering taxes, induces households to increase their spending.
Whether this larger fiscal deficit leads to an increase in prices depends on monetary conditions. If the fiscal deficit is not accompanied by an increase in the money supply, the fiscal stimulus will raise short-term interest rates, blocking the increase in demand and preventing a sustained rise in inflation.
“So the potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money. This inevitably happens in developing countries that do not have the ability to issue interest-bearing debt and must therefore finance their deficits by printing money. In contrast, when deficits do not lead to an increased supply of money, the evidence shows that they do not cause sustained price increases.
“A primary example of this was the sharp fall in inflation in the US in the early 1980s at the same time that fiscal deficits were rising rapidly. Inflation fell because the Federal Reserve tightened monetary conditions and allowed short-term interest rates to rise sharply.
“But now the large US fiscal deficits are being accompanied by rapid increases in the money supply and by even more ominous increases in commercial bank reserves that could later be converted into faster money growth. The broad money supply (M2) is already increasing at an annual rate of nearly 15 per cent. The excess reserves of the banking system have ballooned from less than $3bn a year ago to more than $700bn (€536bn, £474bn) now.
“The deep recession means that there is no immediate risk of inflation. The aggregate demand for labour and goods and services is much less than the potential supply. But when the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit.”
Inflation? When? How much?
No one can say.
Maybe not for a long time. But when it comes... it will take our breath away.
More news... Desperately seeking the "alpha investor"…
“The stock market could stay low for a lot longer to come,” notes Theo Casey of The Fleet Street Letter. You see, cheap fundamentals count for little if nobody is buying the stocks. The stock market needs a leader, an "alpha investor", a key element to stock market momentum according to the "sociology of ownership". The general idea here is that, at any given time, the market has an "alpha investor" that can tell you a lot about the way the market is trading and, perhaps more importantly, how market dynamics are likely to change.
“… hedge funds were the previous market leader. Alas, now these "sophisticated investors" are haemorrhaging money and are forced to sell their stocks. “The establishment of a new leader is crucial. If no one picks up the baton and supplants hedge funds as the alpha investor, there will be no bull market.
“Establishing the buyer of stocks will not only tell us when the next bull market will come but it will also tell us which stocks will do best. Sovereign wealth funds will err towards banks and mining shares where as conventional investment funds will start with defensives. “In any case, our position as contrarian investors is to find those good positions now before the big players come in. We are well placed to profit from future rallies and, in the meantime, while the market trades sideways, we are making money from some of the best dividend paying stocks in the market.”
Editor’s note: Theo Casey is investment director of The Fleet Street Letter. Click here to see the team’s latest predictions and how to position yourself to both profit and protect your wealth.
And more thoughts...
*** We got up before dawn. We kissed Maria, Anna, and Marta... gave Jorge a manly hug... got in our pickup truck and took off. We looked back and waved... and then we were off... down the tree-lined driveway... out between the stone walls... and on our way.
The drive to Salta airport began badly. We had barely left the house when we almost got stuck on the mud. Even with 4-wheel drive, we sank into mud up to the axels. It didn’t seem like we were going anywhere.
“Boy is this stupid... to get stuck in the mud in the middle of a desert,” said Elizabeth. But the rivers are running high and wide in Salta province... about which more later in the week.
When we arrived back in civilization... or at least back in Salta, Argentina... we were happy to see that nothing much had changed.
Just as well. We didn’t want to write much about the financial world anyway.
Up in the Andes, the world of money seems a million miles away. Especially at roundup time. Nobody has any money... and nobody seems to need it.
But the subject came up anyway. We discovered that one of our Dear Readers – lovely and cultivated, like all our dear readers – lives next door. (About 45 minutes away.) Her husband, a large wine producer, brought up the subject:
“My investments weren’t hurt directly. I don’t like buying stocks and bonds. I don’t want to check stock prices. So I invest in my business... or in art. Things I know about... things I like.
“But what is happening in the wine business is that the upper middle part of the market is downscaling. The upper end is okay. People who spend more than $100 for a bottle of wine don’t really care that much. It’s an incidental expense. Sales at the upper end are okay. They’re okay at the bottom too. A guy loses his job, he figures a cheap bottle of wine is a good way to forget his worries. But in the middle, people are watching their expenses closely. So when they go to a restaurant, they order a cheaper bottle of wine. Or they don’t go out to eat at all. They invite friends over to the house... and go to liquor store and pay a few dollars for a bottle of wine that would have cost them $30 in a restaurant. The market between $50 and $100 has collapsed.”
The wine market is probably similar to many other markets. The middle class is downsizing. They need to save money. They’ve got to cut expenses any way they can. So, instead of buying a $75 bottle of wine, they buy one for $29. Instead of buying a new car every three years, they wait 5 years. Instead of staying at the Ritz, they stay at the Marriott.
When we went to Buenos Aires, we used to stay at the Four Seasons – which was fairly cheap by international standards. Now, with the worldwide financial meltdown, we’re looking for savings just like everyone else. So this year we stayed at a little hotel in the Palermo Soho section of town called the Ultra... which also happens to be near our Daily Reckoning outpost down here.
As you may know, we are very interested in Argentina. If there is any mistake in finance that the Argentines haven’t made, we don’t know what it is. So, we study the history of the Argentine economy to try to figure out what to expect next in the rest of the world. We maintain a little staff or researchers and writers down here to help.
The Ultra is not the Four Seasons. It is barely a single season... maybe from January to June. Still, it is not a bad place to stay – especially if you want to save money – and available for about a third of the price of the Four Seasons. In a global financial meltdown, it is a good way to save money.
Palermo Soho is a young, hip, stylish part of the city. The streets are cobblestoned. Practically every other building is a fashionable clothing store or a restaurant. It’s a bit like the area of Los Angeles inland from Venice Beach – but more lively and interesting.
On our way to the ranch, too, we saved money. We typically stay at a Starwood hotel in Cafayate. This time, we found another hotel nearby – not quite as nice, but less than half the price. We also flew a different airline – the Brazilian airline TAM, rather than British Airways. It was cheaper and just as nice. The only problem was we had to stop over in Sao Paulo before going on to Buenos Aires.
Your editor could probably afford to stay at the Four Seasons or the Starwood Hotel if he wanted. But he is getting in the spirit of the depression. If he can save a buck... he is happy to do so. There must be millions... billions... of others doing the same thing.
*** News from the currency markets…
“The Euro looks set to weaken further and at this stage any rallies are likely to be sold as European officials continue to show signs of disagreement over policy,” writes Tom Tragett, of Forex Trade Alert.
“In addition to the EURUSD, I will be paying close attention to the EURCHF (euro versus Swiss franc). The market has once again slipped back to test the 1.5100 region. The support at 1.5050 continues to hold but a breakdown through this level will be watched closely by the Swiss National Bank (SNB). I am very much in their camp on this pairing but given the weakness in EURUSD, there may be more mileage in a long USDCHF position.”
Editor’s note: Currency market veteran, Tom Tragett, runs the Forex Trade Alert service, dedicated to seeking short-term profit opportunities in the Forex market. He’s looking to trade soon – if you want to follow his every move, then click here for details.
Recommended Research Reports – click link below to access time-sensitive details now:
- What you can do to protect yourself as the pound is crushed.
- How you could pick up a recession bargain – with massive bounceback potential – for pennies!
- This discreet financial fellowship is showing its members how they could protect their wealth and grow their investments in 2009 – here’s how you can join them now.
- Could this region be IMMUNE to the credit crisis? Discover the oil deal of the decade...
P.S. If you enjoyed this article you can find out more about our free email, The Right Side by clicking here.
