We have spent the last few days holding back tears…

Michael Jackson! Robert MacNamara!

And now our heart goes out to Nantucket Island. Word came this morning that the rich are not living it up like they used to. The New York Times reports that it’s the slowest summer on Nantucket locals have ever seen. There are over 600 properties for sale – and none of them are selling. Even at discounts of up to a third off! Restaurants and bars are offering discounts too – anything to lure in the customers.

Here at The Daily Reckoning, we champion lost causes. We join the diehards. And we take up the banner of despised, persecuted minorities everywhere. So we are aggrieved by the plight of the rich. They’ve lost $10 trillion in the downturn, according to our estimates. They’re being blamed for every sin and crime, from teen-pregnancy to shopping on Sunday. Fashion has given them its fickle finger – their big houses, big cars, and big carbon footprints are as out-of-style as spats. And just yesterday, a press report told us that Congress was considering a surtax on the rich – to be slipped into the latest health care bonanza. No wonder they’re having such a bummer of a summer.

Sniff…sniff…

Our oldest son, Will, proposes to open up our private family office as a kind of support group for the rich. His father cleverly off-loaded the burden of managing the family money (such as it is) onto his strong, young back. Will figures there must be thousands and thousands of readers facing the same challenges he is…more on this in future issues.

Yesterday, the Dow rose 14 points. Oil fell to $60. Gold lost $19.

According to the headline in the Financial Times, the International Monetary Fund says the recession is ending. Digging deeper into the story, we find that the IMF thinks the recovery may be “weak” and may require more stimulus to get consumers spending again.

As usual, the bank is wrong about everything. There is no recession; it’s a depression.

And it’s not ending; there is no recovery in sight. And more stimulus won’t cause consumers to spend more money.

“It’s really not very complicated,” we told our audience of publishers in London yesterday. “We’re in a depression. Not a recession.”

Sometimes when you are giving a speech, words come out more self-assured than you expected. The occasion calls for confidence…oratorical certainty, not doubts and nuances. Out come fully formed sentences – often elegant or powerful in themselves – that you barely recognize as your own. You listen…surprised at how clever the speaker is.

“It’s a depression. And it will remain a depression until this huge pile of debt accumulated over the last quarter century has been paid down. Until businesses and banks that are no longer viable have gone broke and been restructured. Until consumers have real money to spend – not just more credit. Until those things happen, there is no way for a genuine recovery to take place.

“For more than half a century, the driving force of the world economy has been the willingness of English-speaking consumers to go further and further into debt. That permitted businesses to expand sales and profits.

“Now, that trend – that lasted longer than the lifetimes of most of the people in this room – is finished. Consumers aren’t going further into debt. Bankers aren’t lending them more money. Their houses aren’t going up in price…so they have nothing to borrow against. It’s over. And now, after working your whole careers in a growing economy…you have to figure out how to survive in a declining one. ”

We could have gone further. But our listeners were already looking a little blue.

Or we might have provided evidence that consumer credit is contracting…not expanding. The feds have put trillions into the financial system. And that’s where it stays. The banks don’t lend because consumers can’t borrow. Their houses – the major source of collateral for the middle class – are going down in price. The Financial Times is on the case; it reports that consumer credit fell again in May, for the 4th month in a row. “Delinquencies at record high,” says another FT headline.

We might have explained that not only is the shift from credit expansion to credit contraction the biggest thing to come along since WWII…there’s also a major shift of wealth and power taking place. The Anglo-Saxon commercial (and military) empire has peaked out. The wealth and power of English speakers has been expanding, relative to the rest of the world, for the past three centuries. That trend, too, seems to have come to an end.

Lord Rees-Mogg invited us for lunch at his favorite gentlemen’s club – the Garrick.

It is our favorite too. A club originally founded for actors and writers, it was the club in which Dickens and Thackeray had a legendary feud. More recently, Prince Charles dined in a private room with intimate friends. And now your editor goes there for lunch from time to time.

It is a grand old building…with ornate trimmings…hung with paintings of great actors and theatre scenes. The place seems perfect for a conversation about monetary policy. It is as old as the South Sea Bubble…and a monument to an industry of make-believe.

William made an interesting point.

“The Obama team doesn’t seem to know what it is doing on economic matters, does it? They had a good man on the team – Paul Volker. He was the only one who really knew what he was doing. And they seem to have edged him out.

“This is a very bad sign. It was Volker who saved the day the last time the US dollar seemed to be headed for the scrap heap. This time, it looks as though they have no intention of saving it.”

The dollar hardly looks like it needs saving now. It rose slightly yesterday. Generally, throughout the crisis of the last six months, the dollar has been favored as a safe haven.

Yesterday too, prices of gold and commodities fell – in dollars. The greenback rose against cotton, coffee, silver – just about everything.

Why is the dollar so (seemingly) strong right now? Master FX Options’ Bill Jenkins believes it is because the United States isn’t facing the same sort of ‘social upheaval’ that the Eurozone has.

“Across the Eurozone riots and outbreaks of violence have been touched off by escalating economic problems and disagreements between members and neighbors. People involved in civil unrest are a multifold problem. First, they have too much time on their hands because they are not working. Jobless citizens, especially in a heavily socialist culture, are a continual drag on the system. Second, it costs money to keep repressing social upheaval — presenting another drag on the system. Additionally, the passions and fears of men being what they are, such activities tend to draw in more normally productive folks as the snowball gains speed and volume.

“Here in the United States, we are not facing such difficulties (yet). This means a more reasonable system of work and distribution of goods and labor. All in all, this is good for a culture, the body politic and the economy. As a result, it also breeds greater confidence in the currency. And when all is said and done, investment money will go where there is a reasonable likelihood of return, even if the return may be lower.

“This is what has been good up to this point in the recession/depression for the US dollar. And if this continues to unfold over the next year or two in similar fashion, this would still produce US dollar strength compared to the euro simply by the ‘fear factor.’

“Additionally, as I have tried to show, the situation in Europe is actually more severe than in the United States. I believe in the end that will make them copy, at least percentage wise, the same devaluing practices that have happened here. Should that occur, it would once again be advantage-USD.

“However, when I look at the dollar, I wonder if what we have done may be past the point of no return, the point of repair or recovery. The next generation may well find that the US dollar has gone the way of all fiat currencies before her. What will replace it? I can’t say. But in the present environment, more shocks to the system will ultimately favor the dollar… at least for the time being, because it is supported by stability. And in unstable times — stability draws the highest premium.”

Though the dollar doesn’t look like it needs saving right now, there are two things going on…two things that appear contradictory…and which lead investors to make big mistakes. On the one hand, the world economy is contracting – which is naturally deflationary. Demand goes down…prices go down…the currency in which prices are quoted goes up. On the other hand, the people who control the currency are doing all they can to cause it to go down. The Congressional Budget Office tells us that the US national debt is rising by about $1 trillion per year. It will hit $12 trillion this fall. By next fall, it will be at $13. The interest alone this year is $565 billion – about 4% of the nation’s total output.

The last time the United States overspent on anything approaching this scale was during the ‘guns and butter’ years – the 1960s. Lyndon Johnson wanted a war in Vietnam and a Great Society at home. He got both. He also got inflation. Inflation rates hit double digits in the late ‘70s. The dollar seemed to be going the way of all paper money – to nothing.

But “Tall Paul” Volker was called to the Fed. He said he was going to snuff inflation…and he meant it. Against widespread criticism – his effigy was burnt on the steps of the Capitol – he took the yield on 10-year T-notes all the way to 15%. The economy entered its worst recession since the Great Depression. Politicians howled. The press roared. Everyone seemed to want Paul Volker’s head. But Reagan backed him up. And he beat inflation and saved the dollar.

But that was then. This is now. Now, the country is far deeper in debt…with a much weaker economy…and much stronger rivals. Not even Paul Volker could play Paul Volker’s role this time.

Until tomorrow,

Bill Bonner

The Daily Reckoning

This article originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets. Follow the Daily Reckoning on Twitter.

No Recovery in Sight

U.S. consumer credit fell for the fourth straight month in May, the Federal Reserve reported late yesterday. Credit inched down at an annual rate of 1.5% during the month — a $3.2 billion drop to a total consumer debt load of $2.52 trillion. Coupled with the previous three months, we’re now experiencing the biggest and longest consumer deleveraging since 1991. We even have a somewhat respectable savings rate — 6.9%, the highest since 1993.

While we welcome this deleveraging, it still doesn’t seem legit. With unemployment at a 26 year high and the sudden disappearance of easy-money credit, we wonder if this balance sheet restoration is a matter of choice… or if the lowly American consumer is just playing the hand he’s been dealt.

Then there’s this chart:

“To be clear, the household and business sector debt reduction is still in its early stages and has been dwarfed by the massive deleveraging of the financial sector itself as the so-called ‘shadow banking system’ has either collapsed or moved onto the Fed’s balance sheet.”

This article originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets. Follow the Daily Reckoning on Twitter.

The Great Deleveraging, Chapter One

Good day…and a Tub Thumpin’ Thursday to you! I’m late, I’m late! I don’t believe I ever heard the alarm go off this morning! I overslept by more than an hour, and will still be here more than an hour before any sign of someone else! But! That puts me behind by more than an hour today…I’ve got to play catch-up! So, let’s get this Tub Thumpin’ Thursday going!

G-8 never had the opportunity to shoot fireworks because China’s leader had to return home to deal with the street riots going on in his country. So, the call for a replacement for the dollar as the reserve currency will have to wait for another day! And, with that news, the dollar got to remain in the sunlight, and bask in the glory of being the reserve currency and so-called “safe haven” another day…

There was added risk aversion yesterday when it was reported that an Australian shipment of coal to China was cancelled. This sent bad vibes through the markets for the currencies and commodities with the thought that China was putting the brakes on their buying of raw materials, and that their recovery had not taken hold like many had believed…

However, overnight, calmer heads have prevailed. It was my opinion when I heard that news yesterday, that it was simply one bad shipment to a customer that was having difficulties…not ALL OF CHINA! And then overnight the data came out…this was one shipment, maybe 150,000 tons of coal. Australian coal shipments to China on a monthly basis run about 3 million tons! I truly believe that Australia’s trade with China is on terra firma, and this was a one-off deal that went bad. I also believe that the sell-off of the Aussie dollar (A$) was completely overdone.

I don’t know this to be a fact, but given the relationship of the Asian investors and the A$, I would think the Asian investors to be licking their chops to have the opportunity to buy the A$ at these lower levels! Buy on the dips, right? Don’t I always say that to be a prudent investment strategy?

Of course it didn’t hurt that U.S. stocks rebounded yesterday a bit on the news that Alcoa’s losses weren’t “as bad as expected”. Talk about setting the bar low! It’s not like ALCOA didn’t still have a LOSS! But, don’t get me started on this mental giant thought process that has a grip on stocks these days, “Oh, don’t worry, you only burned down 1/2 of the house, I would have expected it to all burn down!”

I’ve got to leave that alone before I really burst! Let’s see, what can get my mind off of that subject…OH! The Bank of England (BOE) just announced that they would keep rates unchanged. Well, my goodness, what else would we expect them to do? Their base rate is .50!

Here in the United States, the Obama administration is trying desperately to nip in the bud, the whispering campaign for another stimulus package. “No one in the administration is talking about a second stimulus at this point,” said Robert Nabors, deputy director of the Office of Management and Budget. However he also mumbled something about how the president is not “ruling anything out”…

I don’t care what they say. I’ll believe it when I see it…and I still believe that the government will believe that another stimulus is needed…

One of the discussions that I had with my fave economist the other day was about “delaying the inevitable”. I’ve talked about this before, but for new readers, I thought I would give them a dose of “Chuck’s Thoughts” this morning. (HA! As if they don’t get that every day!)

This “delaying the inevitable” is all about the TARP (Troubled Asset Relief Program) and how it all did was allow bad banks to continue to be bad banks longer, with toxic waste in their portfolio. This, even in the face of a suspension of the mark-to-market rules! Bad banks should have been sent packing, then. And now, all we’ve done is let them hang on to cause even more collateral damage!

OK…back to the daily discussion…

It looks as though the auction of $35 Billion in 3-year Treasuries went smoothly, which is another reason the dollar was strong yesterday. Every time one of these auctions go smoothly, the “deficits don’t matter” crowd all point and say, “See, we told you, that foreigners will always come to the auction to buy Treasuries, so it doesn’t matter what we run the deficit up to.”

Right! You just keep thinking that, and see where it eventually gets you! Ty sent me a note yesterday from an article he was reading, that plays nicely with this discussion… So…let’s see what’s going on!

“For now, the Treasury continues to find takers for government savings bonds at low interest rates. But somewhere between here and infinity lies a point at which American debt reaches unsustainable proportions, at which investors will balk at continuing to finance the American expenditures absent a higher return on their investments. Then, everything could change quickly, with interest rates soaring and the value of the dollar plummeting, as foreign investors lose faith in its fundamental value.

“We’re running this $10 trillion gamble that interest rates aren’t going to rise,” said Kenneth S. Rogoff, a former chief economist at the International Monetary Fund and now a professor at Harvard. “If they do, we could end up in a very difficult situation.”

Hey, you think so, Kenneth? My goodness, we have a new “Mr. Obvious!” I would think that we are already in a very difficult situation, given the fact that when the you know what hit the fan the U.S. had no war chest to use, like China did… Why? Because we didn’t think “deficits mattered”. Dealing with problems from a position of strength, it would have made a HUGE difference from the get-go!

However, having said that… I believe that a larger problem is still on the horizon for the U.S. and the “deficits don’t matter” flag wavers. It’s not going to happen overnight…it’s going to be a slow, dragged out, problem that goes on for years, and then finally snaps! I’m talking about the entitlements and the retiring baby boomers… And more specifically when I’m talking about entitlements, I’m talking about Medicare!

The Big Boss, Frank Trotter, showed me a graph that he came across from the Concord Coalition the other day that illustrated this. While I wasn’t shocked, having seen this all in the movie I.O.U.S.A. and in the book of the same name, there it was again staring me in the face…

The reason I tell you all this, is that the current administration has no other choice but to allow the dollar to weaken considerably over the years so that these deficits that “didn’t matter” can be paid off with cheaper dollars… And it won’t be this administration that has to deal with it. That’s why this one and the previous one aren’t concerned about the size of the national debt…

Ok, enough of all that. I didn’t mean for this to be gloom and doom! Let’s move on…

The data cupboard has the Initial Weekly Jobless Claims for us to view today… I expect for the weekly number to remain above 600,000, and the Continuing Claims to have risen. Though this all sounds bad, the markets have become comfortably numb with this unemployment data… It will take something really BIG to slap the markets in the face and say WAKE UP!

And then, finally: The Japanese yen has really been on a tear this week as the risk aversion crowd dominated the markets. I find it very strange that Japan is considered a “safe haven” currency, given their national debt problems. And their once “Ace in the hole” the Trade Surplus, is taking on water. But, this is what the markets do, and they are never wrong! However, there’s a roadblock ahead for the yen, as it trades with a 92 handle this morning… And the roadblock is in the form of the Bank of Japan. (BOJ). It was reported that last night the Bank of Japan issued a statement to the markets that “they were checking FX levels.”

That’s Central Bank parlance especially coming from the BOJ, for… We don’t want the currency to get any stronger, and we’re just letting you know that we’re ready to intervene if you don’t settle down.  Sort of like when grandma would tell you that if you didn’t settle down she would send you to the woods to find your switch… Believe me you only didn’t settle down once!

And when the Risk Traders come back and push the Risk Aversion crowd to the back of the room… Again, we’ll see yen sell off again… So be careful here!

Currencies today 7/9/09: A$ .7845, kiwi .6305, C$ .8650, euro 1.3980, sterling 1.6260, Swiss .9250, rand 8.11, krone 6.4925, SEK 7.8590, forint 196.70, zloty 3.1150, koruna 18.55, yen 92.90, sing 1.4580, HKD 7.75, INR 48.71, China 6.8317, pesos 13.47, BRL 2.00, dollar index 80.21, Oil $61.29, 10-year 3.39%, Silver $12.95, and Gold… $915

That’s it for today. I got the news from the eye specialist yesterday regarding my left eye. The tumor and the fluid on the eye is gone, they successfully shrunk it and removed it. Unfortunately it left a ring of “stuff” on my eye, and my eyesight from that eye will never get any better. Of course, I still have my right eye, so I’m not completely bummed. My cutie little granddaughter, Delaney Grace came by to see me yesterday, she wanted me to come “sit by her.” She’s almost 2 now, and saying her ABC’s, and singing songs, and she showed me how she knew her right from left now. Such a little joy to be around…I’ll get to spend a whole week with her in about 10 days when we all go on vacation together. Can’t wait! Well, my lateness has put me way behind this morning, I had better get going. Don’t forget…today is going to be a Tub Thumpin’ Thursday no matter what!

This article originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets. Follow the Daily Reckoning on Twitter.

Risk Returns — Slowly

If you are a new Junior Mogambo Ranger (JMR), then you may be unaware that the “Gaaahhh!” appended to the foregoing paragraph is a secret coded signal, and according to the highly secret Mogambo Highly Secret Code System (MHSCS), the three “a’s followed by three “b’s after the original “g” is a secret code, a “highly secret” secret code, that means “Some moron is jerking monetary policy around willy-nilly, and that kind of stupidity is so highly dangerous that not even professionals should try this at home, which means that you should be buying gold, gold, gold!”

And if you look at the bottom of the MHSCS entry, you will see the Three Best Mogambo Action Recommendations (TBMAR) to respond to this situation are “Buy gold and silver. Hole up in a bunker. Trust no one.”

Now you know why I spend such an inordinate amount of time locked inside the Mogambo Hopefully Impregnable Bunker (MHIB), although it does not explain why the price of silver is so low as to be absolutely ludicrous, what in the hell any of this has to do with silver in the first place, or why I spend so much of my time telling other people to buy silver to take advantage of these low, low, insanely-low prices when I should take the advice given to me so, so many times by so, so many people throughout my life, which is to “Shut your Stupid Mogambo Mouth (SMM),” especially since I recall that the alternative was usually a veiled threat in the form of a “knuckle sandwich” to stick in my SMM.

I think that the reason that I cannot keep the secret of silver being so under-priced to myself is because it does not matter! Nobody is going to listen to me anyway, and that means that I can keep buying silver at these low, low prices until finally reality catches up with the silver market, and when it does, I will be Sitting Mighty Pretty (SMP) with more money than I ever imagined, and people will say, “Why didn’t you tell us to buy silver, too, so that we, would have a lot of money, too? Or at least have enough to buy dinner instead of having to stand here, broke and hungry, watching you stuffing your Stupid Mogambo Face (SMF) with succulent appetizers, entrees and desserts, and watching pieces of food are falling out of your mouth, down your chin, bouncing off of your shirt, and into your lap; you are a disgusting, filthy pig!”

Ted Butler, independent silver market observer, has never commented on my seeming lack of table manners or has actually told me “Shut your Stupid Mogambo Mouth (SMM),” and if you call him up to verify it, he will immediately reply “What? Who is this? What’s a Mogambo?” before hanging up, which ought to prove it to everyone’s satisfaction as it does mine!

Anyway, Mr. Butler has been a long time looking at the obvious manipulation in the silver market with just a few “players” actually controlling the price so as to, I figure, run a scam, and up to now it has been up to Mr. Butler to identify the blatant criminality in the Comex futures market, while it has been up to me (as the other member of the team) to call all the people involved in the scam a bunch of “lowlife scumbag thieving cheating lying pieces of crap” and demand that they all be taken out and shot or given prison terms of 150 years each, ala Bernie Madoff, who was also a “lowlife scumbag thieving cheating lying piece of crap.”

But while I am doing this, see, I am buying more and more silver more and more cheaply and Mr. Butler is, I assume, buying more and more silver more and more cheaply, and everyone who has looked at the insane imbalances in silver are buying more and more silver more and more cheaply since the price of silver does not rise even though the purchasing power of the dollar is in a downward trend, thanks to the seemingly-impossible amounts of federal government borrowing and deficit-spending that will be financed by the Federal Reserve creating the seemingly-impossible amounts of money and credit to loan to the government.

But those halcyon days may be over, as things may be changing, as Mr. Butler notes that “On June 24, the US Senate Permanent Subcommittee on Investigations issued a 247-page report entitled, ‘Excessive Speculation in the Wheat Market’ where they found that ‘the CFTC failed to uphold commodity law, by allowing large index traders to hold long positions in wheat well above the proscribed speculative position limits of 6,500 contracts.’” The Senate found that the CFTC “failed to uphold commodity law”!

The problem, beyond mere criminality and fraud, is that traders with large positions can cause prices to be distorted, which Mr. Butler phrases, “If a futures market position grows too large it will affect the underlying cash market.”

He goes on that this is serious business, in that “The report indicated that the large long positions of index traders caused the price spike in wheat and other markets last year” by which they intend to remedy the situation by recommending “that the CFTC scale back their permission to hold positions above the limits, and lower those limits if necessary.”

In wheat, Mr. Butler says that there are “roughly 25 to 30 long index traders operating in the Chicago wheat market at any time,” which is plenty enough to prevent collusion, and even so, “the Senate report concludes that in wheat the limit should be no more than (the existing) 6,500 contracts and perhaps 5,000 contracts.”

And if you are thinking, “How did the report determine this number of contracts?” he explains that while it seems kind of arbitrary, “the 6,500 contract position limit in wheat is equal to 32.5 million bushels (5,000 bushels per contract). The total US annual wheat crop is 2 billion bushels. World annual wheat production is ten times that, at over 20 billion bushels. Therefore, the position limit of 6,500 futures contracts represents 1.6% of the total US wheat crop (32.5 million bushels vs. 2 billion bushels).”

And to the effect that US speculative markets influence world markets, “Relative to the total world wheat crop, the 6,500 position limit represents 0.16% of the total 20 billion bushel crop”, which pretty much rules out any global plots, schemes or scams to corner the wheat markets.

On the other hand, things are ripe for plucking, because “In silver, there are no hard position limits in force. There used to be, but the CFTC allowed the COMEX to replace hard position limits many years ago. Instead, now there is an ‘accountability limit’ of 6,000 contracts.”

The trouble is that “Since there are 5,000 ounces in a COMEX futures contract, the accountability limit is equal to 30 million ounces”, which means that “Whereas the position limit in wheat was 1.6% of the US crop, the accountability limit in COMEX silver is almost 52 times larger, at more that 83% of total US mine production (estimated at 36 million oz by the USGS).”

As for the chance to stick it to the whole world, “While the position limit in wheat was 0.16% of the world wheat crop, the COMEX accountability limit is 28 times larger, at 4.5% of the world silver mine production (660 million oz. per the US Geological Survey).”

The point of all of this is that the Happy Days for the slimy insiders in the silver futures and options market, and those glorious days when you and I could buy ounce after ounce silver at these low, low, unheard-of low prices, are almost certainly all gone, now that the Senate has found willful corruption, and so the day will soon come when silver, free from the slimy manipulations of insiders that one could even argue violate the 14th Amendment, will rise, perhaps a dozen-fold, in price, re-establishing the 16:1 ratio of silver to gold, which will also be, almost certainly, up.

At that point, which you will know from the newspaper headlines proclaiming, “The Mogambo was right! We’re freaking doomed!” the population of the world will be divided into people who either say, “Oh, of course I am so smart that I always saw the inexplicable and unsustainable 70:1 ratio of silver to gold, which is far outside the historical ratio of 16:1, but I was just waiting for the perfect moment to make my move into silver and I, like all the other experts, missed the boat because of some excuse, and people who followed our advice missed the whole thing and did not make a dime”, or they will be the other people, the ones who were buying silver the whole time and who were now saying, “Whee! This investing stuff is easy!

This article originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets. Follow the Daily Reckoning on Twitter.

A Master Stroke of Silver Manipulation

At present, the investment community is divided as to whether the world economy faces
hyperinflation or deflation. Some observers are convinced that the central banks’ printing
press will take the world towards hyperinflation whereas others believe that the ongoing
contraction in American private-sector debt will result in outright deflation. So, what will
the future bring?

It is my contention that we will get neither hyperinflation nor deflation.

What is more likely is that over the coming months, we will get another deflationary
scare. Any sell-off in the markets later this year will be met by an even larger stimulus
from the policymakers and this will ultimately result in high inflation.

So, I maintain my view that due to the unprecedented policy responses around the globe,
the world’s economy will face high inflation over the medium to long-term. And the
general price level will double over the coming decade.

In the near-term however, we will probably get another period when the market will
(once again) become concerned about the prospects of a lengthy economic contraction. It
is conceivable that the ‘green shoots’ hype currently doing the rounds will soon be
replaced by more economic worries as a second wave of foreclosures hits America
later this year. So, it is possible that before year-end, we will witness large corrections in
stocks and commodities. Conversely, we are likely to see big rallies in U.S. government
bonds, U.S. Dollar and Japanese Yen.

This near-term vulnerability in the markets is the reason why I have recently liquidated
my ‘long’ positions in resources and emerging markets and gained a heavy exposure to
long dated U.S. Treasuries. In my view, a defensive investment stance is prudent at this
juncture, as it will protect our capital and allow profit from the expected contraction.
Once the pullback in the markets is complete, I will liquidate my positions in U.S.
Treasuries and re-invest our capital in our preferred holdings in energy, materials, mining
and emerging Asia.

Look. In the business of investing, the tape never lies and it is worth remembering that
Wall Street is littered with the graves of those who got married to one particular outcome
and then held on to their ill-conceived notions. At this point, when private-sector debt
contraction in America is locking horns with central bank inflation, I prefer to have an
open mind. Therefore, I am maintaining a defensive near-term investment position. If the
market corrects over the following weeks, I will be in a position to profit from such a
decline. On the other hand, if the major indices simply consolidate here and break above
the recovery highs recorded last month, then I will have no hesitation in changing my
defensive investment position. Put simply, I am currently watching and waiting
patiently for the market to reveal its hand.

“In the business of investing, the tape never lies and it is worth remembering that Wall Street is littered with the graves of those who got married to one particular outcome and then held on to their ill-conceived notions.”

Coming back to the subject of this essay, the reason that I don’t foresee immediate
hyperinflation is because the velocity of money is currently weak. In other words, at least
for the moment, the private sector in America isn’t participating in Mr. Bernanke’s
inflation agenda. Despite the fact that Mr. Bernanke has injected a massive amount of
reserves in the banking sector, this money is currently sitting as excess reserves within
the American banking system. The fact that this money isn’t being lent out rules out
immediate hyperinflation. However, once the American economy stabilizes and the
velocity of money picks up, these excess reserves will trigger a massive inflationary
wave.

As far as deflation is concerned, I am of the view that the policy responses and our fiat-
money system will ensure that the purchasing power of cash will continue to
diminish over the medium to long-term. In fact, I am willing to bet that cash will
probably be the worst performing ‘asset’ over the coming decade. Remember, in today’s
monetary system, central banks and governments the world over are free to create money
out of thin air and this will prevent outright deflation in the global economy.

It is worth noting that in the past six months alone, China’s commercial bank credit has
expanded by a whopping US$1 trillion! Figure 1 highlights the surge in Chinese bank
lending. Furthermore, credit is also expanding frantically in other Asian nations. So,
contrary to the West, monetary policy is still alive and well in the developing nations and
this factor also rules out outright deflation in the global economy.

Figure 1: Explosion in China’s bank credit

Source: Bank of China

In my opinion, rather than hyperinflation or outright deflation, we will witness elevated
inflation after the American economy has stabilized. In the interim however, investors
should be prepared for another deflationary scare and the associated market panic.

Regards,

Puru Saxena
for The Daily Reckoning

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Hyperinflation or Deflation?

Of course, it’s no shocker that things got tough in the first quarter. But what of the most recent three-month stint, during the best of the sucker rally? “The No. 1 driver of delinquencies is job loss,” hints ABA’s chief economist, James Chessen. “When people lose their jobs, they can’t pay their bills. Delinquencies won’t improve until companies start hiring again and we see a significant economic turnaround.”

So practically no one expects the unemployment rate to stop its accent until at least 2010. And just as many are willing to admit there are boatloads of souring loans still on bank balance sheets. Hmmm….

While certainly better off than the U.S., Canada could face a consumer debt crisis of its own, reports the Bank of Canada. In its biannual Financial System Review, the BoC said yesterday that “There has been a further deterioration in the financial position of the Canadian household sector.” The average ratio of debt to income has hit a record level for Canadians… household debt there is averages roughly 140% of disposable income. Here in I.O.U.S.A., it’s closer to 170%. Suffice to say neither ratio is desirable. 

We don’t want to say too much here, but when it comes to a few select Canadian financials, our short analyst Dan Amoss has his finger on the trigger. Stay tuned for more.

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The Coming U.S. (and Canadian?) Loan Crisis

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The Long Road to Ruin

“Thank God for Rule 16!”

Late yesterday, the Senate majority put the kibosh on a last-hour provision in the 2010 spending bill that would audit the Fed. Not because it’s a bad idea… but because of the arcane Rule 16, which prohibits policy legislation from being added to spending bills. (The kind of “rule” that’s only evoked when the majority gets uncomfortable.)

“The Federal Reserve will create and disburse trillions of dollars in response to our current financial crisis,” said Sen. Jim DeMint, who spearheaded the failed audit addition. “Americans across the nation, regardless of their opinion on the bailout, want to know where the money has gone.” Under his proposed plan, the Government Accountability Office would take a look into the Fed’s discount window lending, various funding “facilities,” bank bailouts and agreements with foreign players. 

Shame on Mr. DeMint for such an outrageous request. Down-to-the-wire appropriations should be reserved for truly exigent causes… like protecting the makers of wooden arrows designed for use by children.   Why bother wasting the time of the GAO with a simple audit of the most unaccountable monetary body in the world? 

You can watch Mr. DeMint get what’s coming to him here.   Ron Paul’s bill — that other shameful attempt to audit the Fed — now has 249 co-sponsors in the House. Wonder what brand of parliamentary fine print Barney Frank or Nancy Pelosi might summon to quash that one.

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Idiocracy in Action

Anyway, I keep hearing some doofus or another prattling on and on about deflation, and how prices will be going down and how this is a terrible idea, sort of like saying, “Shopping during a sale means you will pay lower prices, and that is bad for you!”

Actually, it is not the falling prices that are bad, but that the falling prices means that producers are losing money, which means that some, many, or most of them will go out of business, firing everybody, wiping out investors, thereby reducing supply until it meets the level of demand.

Actually, the deflation-hawks say that this falling of prices is so bad, so terribly bad, that we should fall to our knees and pray that prices rise, which really scares the hell out of me because I have read a lot of things in two main categories in my life: Hate mail and economics tracts, and they have one thing in common, which is that in neither do you ever read something as stupid as advocating inflation in consumer prices.

In fact, most of theoretical economics is actually dedicated to preventing inflation in consumer prices and what to do if inflation appears! Hahaha! What a kick in the head, huh? Hahaha!

And my paranoid panic about inflation is because inflation in consumer prices is what destroys countries because the people rebel against starvation and deprivation when they can no longer afford food and energy, and it destroys families because somebody (like, for instance, the father) finally, one day, just snaps at the constant demands from his, for example, wife and, for example, kids, who are all persistently yammering yammering yammering about how they have to have you give them more money, always more and more money, just because, “things cost more and more” like I can just wave a magic wand to make money appear in my wallet and that is why I am here at home watching TV instead of being down at Nasty Natasha’s paying off my bar tab and getting hammered running up a new one.

Naturally, my instinct is to jump up and grab them by the collar so that I can scream in their faces, droplets of Disgusting Mogambo Spittle (DMS) spraying out and hitting their stupid faces, “No, no, no, you moron!” and shaking a Financial Times piece at them that reads “Concerns Mount Over Sharp Rise In Food Costs”.

That news that food is costing more is Very, Very Bad (VVB) to someone whose income is limited, as it means that the person must either buy less food, or buy the same amount of food but less of something else like electricity, which shoots the hell out of the argument of the “deflation-hawk” morons that falling prices for their overpriced, bubble-assets is worse than rising prices for food and energy (where oil is back over $70 per barrel), or the JOC -ECRI Price Index which is up a whopping 4.1% in the last week alone! One Freaking Week (OFW)!

And this doesn’t even count the inflation in other costs, such as how my health insurance went up by another 8.8%, taking me to over $13,000 a year in premiums, which doesn’t count the $2,000 deductibles that my wife and I must each pay, or the co-pays, which means I am out of pocket over $15,000 a year before they start picking up any of my needed medical costs!

I was thankful that Bill Bonner here at The Daily Reckoning did not comment on how my health insurance premiums probably reflect the immense amount of professional help that I desperately need, even though my policy obviously does not cover the category of “mental illness” enough to do me any good, and instead writes that my clinically hysterical over-reaction to inflation is destined to get worse, as “The US money supply growth was fairly constant for the last 45 years. Then, under pressure from the stimulus/bailout programs, it exploded. Art Laffer says it is meaningless to compare it to anything in our history; nothing like this has ever happened before. He argues that inflation this time could be much worse than the inflation of the ’70s, when the prime rate hit 21.5%. This is a new era!”

And while this may be a “new era” for most things, I’m betting that the “buy gold when your government is acting like spendthrift, corrupt morons” philosophy that has served the “old era” of the last 4,500 years of human history so well will continue to do so now, which makes it all so easy that I happily say, “Whee! This investing stuff is easy!”

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Deflation Hawks Pray for Inflation

Maybe we lack sufficient imagination, but this approach does not strike us as a plausible exit strategy from the broken global growth model. It is a stopgap measure at best, designed to buy time, with fingers crossed that global demand gathers enough speed by year-end. We thought Asia faced some serious macro challenges at the beginning of this year, and we see no reason to change our mind yet.

China, undoubtedly, has extraordinary potential, and we would not for a moment disregard the desire of Chinese leaders to achieve the status of the next global hegemon. The fact of the matter is that until China is prepared to accept currency appreciation, and thus prepared to reorient its growth strategy away from export-led development without simply putting up redundant capacity or building up speculative inventory stocks, its goal is likely to remain elusive…

Asia’s production structure needs to recalibrate for a slower Western consumer growth profile, and that inevitably must involve steps that scrap excess capacity and allow new domestic demand sources to flourish. When we see it, we will be happy to flag it. In the meantime, using bank credit to keep production going and stuffing inventories in warehouses looks like a precarious gambit, at least from the vantage point that Dr. Richebacher cultivated over his career.

This article originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets. Follow the Daily Reckoning on Twitter.

The Chinese Commodity Conundrum