The Daily Reckoning

Since I am known as something of a gold bug, a lot of people write to me about gold, but since I am a paranoid lunatic, I don’t read their letters, mostly because I now call myself Marvelous Macho Grande (MMG), figuring that an established alias could potentially come in handy when the prices of gold, silver and oil shoot higher and higher as inflation in consumer prices starts going parabolic as a result of the despicable Federal Reserve creating so, so, so much money, especially so that the despicable federal government can borrow and spend that selfsame so, so, so much money.

So, you can see how a dramatic, romantic new name like Marvelous Macho Grande (MMG) would perfectly suit a guy like me, which is a guy with a theoretical massive coming increase in wealth from investing according to The Mogambo Perfect Portfolio (TMPP), which uses the Austrian school of economics (see Mises.org) and the last few thousands of years of history as Absolutely Compelling Reasons (ACR) to invest in gold, silver and oil when the government is acting so insanely bizarre, as does ours now, blithely deficit-spending a monstrous 11% of GDP, now with a national debt nearing a heart-stopping 100% of GDP, and allowing the Federal Reserve to continue to create So Freaking Much (SFM) money that, like creating too much money always does, it creates booms and bubbles that predictably, inevitably, unstoppably, disastrously go bust, leaving you, sadly, worse off than before.

So, you can see how I am not in the mood to answer emails from people who, deep down in their hearts, are pleading, “Oh, please help me, Masterful Mogambo Guru, or Marvelous Macho Grande (MMG), or whatever in the hell your name is this week: Sadly, I have not been following your terrific advice to buy gold, silver and oil as the One True Way (OTW) to end up with a lot of money without working for it, and now I need one of your famous Secret Investment Plans (SIP) to make up for lost time, else I am reduced to being the widow of a rich Nigerian banker who needs to sneak $100 million out of Nigeria and into your country. In that case, I will give you $50 million after you give me your bank account number and $5,000 in cash to pay various fees, expenses and bribes.”

Alas, I don’t have $5,000 to invest in this terrific opportunity to make a quick $50 million, as likewise there are no Secret Investment Plans (SIP), although I have spent a lifetime looking for one.

Fortunately, constantly buying gold, silver and oil is always the smart thing to do when your stupid, desperate, half-witted, corrupt, clutching-at-straws government is acting like all the other stupid, desperate, half-witted, corrupt, clutching-at-straws governments that created too much money and destroyed themselves over the last 4,500 years.

And if you don’t believe me, then maybe you will listen to the famous Richard Russell of the Dow Theory Letters, who writes, “Investors sometimes get caught up in the day to day and week to week movements in gold and silver. Don’t waste your time or energy on that, just accumulate. Standing in front of us is the greatest transfer of wealth in history. When the dust settles, those holding the gold will make the rules.”

And “just accumulate” sounds so easy because it is so easy, which is why I say, as I always say until you are tired of hearing me say it, “Whee! This investing stuff is easy!”

The Mogambo Guru
for The Daily Reckoning Australia

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Zero Hedge

Seeing Past The Hologram, by Mike Krieger of KAM LP

There is no distinctly American criminal class – except Congress.

- All quotes by Mark Twain

We Need Real Confidence to Return, Not Confidence in a Ponzi Scheme

Last week I pointed out that what I got from Banana Ben’s speech in Jackson Hole was that he realized any major public statement of interference in markets was too risky at this point following his announcement at the last meeting to keep the balance sheet steady by reinvesting MBS proceeds into treasury securities.  The operative word in this sentence being “public.”  Anyone that believes this means the Fed and government will just take a back seat and do nothing behind the scenes is deluding themselves.  Washington D.C. and the Fed still fail to comprehend how to increase standards of living in the real world, rather they remain completely addicted to the short-term buzz of printed money heroin as it flows through the house of cards they have created.  They also think that the only thing that really matters in an economy is “confidence.”  As Madoff can attest to, that is indeed the case when you are running a ponzi scheme and since the U.S. government is basically that I can understand where they are coming from.

 I agree that confidence is a huge part of any healthy economy; however, I do not define confidence in the way these arrogant bureaucrats do.  They think confidence comes from rising asset prices, including stocks and homes.  They think this is enough to spark growth in the real economy.  This is nonsense.  The confidence that is needed more than anything else today is two-fold.  First, confidence that there is the rule of law and there will be the rule of law in the future.  The second is that the money issued by the government will maintain its purchasing power over time.  As I have made clear on various occasions, I do not have confidence in either of these things based on how the government has responded to the crisis.  I do not like buying physical gold.  I do not like feeling the need to write these emails every week to warn people.  I wish I could employ capital into businesses and the real economy.  I hope that one day I will be able to do so, but at the moment I do not trust my government and I certainly don’t trust the fascist Federal Reserve.  So I will hoard what I have as the government prints and let the storm pass me by.  I am not the only one.  People are collectively starting to understand this.  So what happens when the big, smart money takes itself out of the investment and capital allocation game because they don’t trust anything?  What happens when the government’s response to this is to print money to keep up the spending habits of people with no jobs or people with government jobs that produce no goods for the economy?  You get the worst case scenario and that is exactly what is staring us straight in the face.

Is a Trade War with China Coming?

The quicker the dollar is devalued the better.  This is not to say that I think dollar devaluation is a good thing.  It is to say we are past the point of avoiding it.  We could have taken the pain in 2008, but instead it was extend and pretend all over again.  Now the debt and promises are too big.  The behind the scenes manipulations are too entrenched.  There is no avoiding a devaluation relative to things people need (food and energy) and capital goods that are imported.  The best thing would be to get it over with and then change policies and restore the rule of law.  The problem with this is that the main currencies the dollar needs its major adjustment against are those in emerging Asia and China.  What has prevented the realignment from happening in a quick and healthy way is China’s refusal to allow the yuan to appreciate.  This creates a situation where Central Banks throughout emerging Asia take steps to prevent their “free-floating” currencies from adjusting either.  If China does not change its policy I fear that what we are looking at a trade war with China after the November elections.  I think Congress and the Administration will start to introduce aggressive policies to discourage Chinese goods and encourage goods made at home.  Think it can’t happen?  We are a lot closer than you think.  This all goes back to my “think local” theme.  While I am inherently a fan of free trade we do not have free trade in any sense whatsoever.  We have policies that are geared to advantage the multi-national corporations at the expense of the U.S. citizen.  The U.S. consumer has merely been spending borrowed money.  This gave an illusion that the U.S. was benefiting from the global multinational corporate rigged market whose model mainly thrives on companies moving abroad to exploit the labor arbitrage caused by a combination of what was a labor surplus (no longer it seems) and a rigged currency.  As more people realize this, more pressure will be placed on politicians and ultimately this will overpower the corporate lobbyists and a trade war of sorts will begin.  Then the chaos could really ensue as we engage in a trade war with our biggest creditor!

Seeing Past the Hologram

The past couple of weeks have been extraordinarily interesting and some of the moves appear to be extremely important.  Although a lot of people like to point to the treasury market and then extrapolate out as to what this means to equities and the ability of the government to increase spending, I think this is the most USELESS market in the world to watch.  If anything is a hologram and a PR tool it is the U.S. treasury market.  How can people with a straight face come out and extrapolate anything from a market where the Federal Reserve is buying the debt of its own government!  The Fed is merely the fiat drug dealer to a government addicted to spending and false promises.  The equity market is the second most useless market in my opinion.  There is no doubt in my mind that a huge part of the government’s “strategy” to build confidence is to keep this thing from doing what it should be doing.  Thus, I am not surprised at all that since I last wrote the S&P500 was +1.6%, -1.5%, flat, and then +3.0%.  So what you have seen is high volatility with no real direction.  How can anyone have confidence this that thing is for real?

So what markets do I watch?  I get the most from the FX markets and the commodity markets.  While these markets are no doubt manipulated heavily as well, I think this is where the players that really understand the macro are playing.  The first currency I check in the morning is the dollar/yen.  The reason for this is that the yen is back to the highs of 1995 and if it does not stop appreciating around this level I think the Bank of Japan is going to absolutely panic.  While the yen has not broken higher yet as market participants are afraid of such intervention, unless the BOJ does something extreme soon the market may test their resolve and push this thing further.  I guess the main point I am trying to make is that with the Chinese yuan NOT strengthening and the yen threatening to break out we could be in for some major fireworks.  Meanwhile Japanese 10 year government bond yields have really started to spike lately (chart GJG10 Index on Bloomberg).  Something big is happening in the land of the rising sun.  In the back of my head I think that any panic move from the BOJ could be the spark that breaks government bond bubbles globally and ushers in a period of massive global commodity driven inflation as every country tries to devalue their way to prosperity.  Essentially, a fiat money version of the 1930’s beggar thy neighbor policies.  When this begins the rush into gold and silver that we have seen thus far will look like a trickle.  I don’t think people will be able to find supply anywhere near the quoted price on comex (or as some like to call it “crimex”).

This brings me to silver which potentially experienced a game changer last week.  I can’t remember the last time silver bounced back almost immediately after every attempted raid.  I am starting to wonder how much physical silver is available.  What we do know is that Central Banks do not store silver to manipulate markets.  Even if it doesn’t break out right now, there is no asset in the world that has more upside than silver.  Don’t buy SLV either.  Buy physical silver not something with JPM as a custodian. 

I also continue to watch food prices very closely.  Wheat, which has come off of its high now seems to have found a base at a price that is 50% higher than the end of June.  Corn prices are threatening to break above resistance at levels 30% where they were at the end of June.  Rice looks like it could have a long way to go on the upside as it is only 20% off of its June low.  If I were a foreign government I would be using this opportunity to buy every single grain of rice I could in order to feed my people when things get dicey in the months ahead.  After strong performance in recent months lean hogs and live cattle also look set to make another push to the upside.  How people in the investment world still focus on the government inflation statistics is beyond me.  It was the rampant commodity inflation, trucker strikes and food riots that played a key role in ending the game in 2008.  This is because it forced the emerging markets to raise rates and cool growth as the Western world imploded under a pile of debt.  It seems the whole play is starting again and people remain focused on deflation.  Deflation in some things yes I agree (discretionary things like homes, technology, stock prices, etc), but not in the things you NEED to buy!!!

Onto oil which is also exhibiting some strange moves.  The Asian benchmark Tapis has not experienced the recent volatility and weakness that WTI has and is currently trading at $80/b.  The Asian price is the one I really pay attention to since that is where the demand growth resides.  The spread between the two now is back above $6/b, which is toward the high end of the range for the past two years.  This tells me that one price is wrong and the spread should narrow.  Given what I think about currency debasement and lack of appropriate investment in the space I think WTI should rally.  We shall see…

A Primer on the Federal Reserve

For those that read my commentary on the Federal Reserve as an immoral an fascist institution and think to themselves “what is this guy talking about,” I have attached a video from G Edward Griffith (the author of The Creature from Jekyll Island).  It’s a great description of how the Fed was formed and who it answers to when push comes to shove.  http://video.google.com/videoplay?docid=6507136891691870450#

Also in case you weren’t aware of the power grab that the “Financial Reform” legislation allowed the Fed, read this Bloomberg article. 

http://www.bloomberg.com/news/print/2010-09-02/bernanke-meets-buffett-in-new-role-conceived-to-protect-markets.html

All the best,
Mike

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The Daily Reckoning

Before we get stuck into today’s financial world, a request: please don’t store petrol in your garage. A reader took us to task for suggesting that last week in our survivalists “to own” list. It was just a list. But her point is well taken. Petrol doesn’t keep well. And you may need it later to burn all your paper money and furniture to keep warm. So store it somewhere safe, if you’re going to store it at all.

But perhaps all this talk of a Long Depression is premature. We’ve just finished revising and remaking our case for D2 (the Second Great Depression) in the latest issue of Australian Wealth Gameplan. We were all set with a fairly conventional analysis of the macro-economic scene when we decided to scratch the whole thing and re-write it from a long-term historical perspective.

Usually these attempts are either incredibly stimulating and provocative or really boring for everyone else to read. Hopefully it won’t be boring. But our main point is that when you’re living in the middle of one, a long depression probably doesn’t feel like it. It feels like every day things might get better. But they don’t, at least not for a long while.

You certainly wouldn’t suggest Australia is in the middle of Long Depression based on yesterday’s current account deficit figures. Boy howdy, were they good! The current account deficit went from $16.5 billion in the March quarter to just $5.6 billion in the June quarter. As a percentage of GDP, the current account deficit is now at its smallest level in about 30 years.

Go iron ore!

Go coal!

Go!

The improvement in Australia’s terms of trade is what accounted for the big jump. Record prices for iron ore and coal increased what Australia got paid for exports. And import prices – what Australia pays for the things it buys from the rest of the world – did not grow as fast. Presto. Change-o. Record low current account deficit.

Naturally, a record jump in the terms of trade – 12.5% for the quarter and 24.5% for the year – is the sort of spike that would convince us export prices have peaked and the Chinese real estate crash is imminent. Based on the Economic Statement in published in July, the government is counting a record-high terms of trade to support revenues, bring down the debt, and spur mining investment (despite the MRRT).

Speaking of the government, apparently there still isn’t one. You might have expected this lack of political certainty (clarity about the future rate of taxation on mining companies) to be negative for the share market. But apparently Aussie investors – and maybe their leveraged global contemporaries – are drinking from the big jug of Kool Aid Ben Bernanke and the Fed have brewed.

In fact, whether Aussie investors are reacting to the prospect of Quantitative Easing from the Fed or not, it’s pretty clear that not having a government is not a negative for share prices. Long live the status quo!

But on this issue of the Fed, the relevant question is how QEII would operate. We were going to write “work,” but we’re certain it’s going to fail inasmuch as its ultimate aim is get credit flowing again in America. The Fed is pushing households and businesses to do something they’ve decided they don’t want to do: borrow and spend.

If the aim of QEII is to get consumer spending back up to 70% of American GDP so it can drive global growth and restore the status quo ante the Global Financial Crisis, it will fail and gold and other tangible assets will keep going up. But if the goal of QEII is to buy corporate stocks and bonds to make everyone feel richer so that they might behave with more fiscal irresponsibility, well doggone it, it might just be crazy enough to work!

By work, we mean it might create a bid for stock prices, what with everyone knowing the Fed is there to buy. In fact, it would probably be a very good time to be a seller with the Fed on the other side of the trade. Maybe that’s why everyone’s buying now, so they can sell to the Fed later.

Of course, there’s a long way to go between speculating about QEII will manifest itself and the Fed actually buying stocks outright. But just as a journey of a thousand miles begins with a single step, so also does the destruction of a currency begin with baby moves.

And finally, about that list of things to stock up on for Long Depression, what do you reckon was at the top of most people’s lists? Salt! It was followed closely by sugar, soap, silver, bullets, and booze.

We got many notes on the subject and have read them all. We’re not able to reply to each one personally, but thanks for all the effort. We’ll compile a master-list and make it available later this week. Meanwhile, here was one of our favourite notes:

Hi ,

On reading your list I thought it appropriate to add rifle etc to the list , particularly as you have bullets on the list. I’d also add the Bible, the Koran, and the Talmud, with appropriate iconography should someone with bigger guns happen by.

I’d also add antibiotics, condoms (you can hope while you despair).

Did I mention a phrase book with simple to pronounce invitations, “To come in into my storage unit for bouncy bouncy” ?

If none of that was of use…I’d then do the unthinkable…invest in a Managed Fund!!

Regards,

HB

Dan Denning
for The Daily Reckoning Australia

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With the consumer in the doldrums, residential investment unlikely to rebound in the near future, and government stimulus constrained by political gridlock, it’s hard to see where the sources of aggregate demand will be. I’m going to extend Jim’s search for silver linings in the latest GDP release.

A Growth Decomposition

One possibility is that domestic investment will take up some slack. As several observers have noted, corporations have been making substantial profits and have the wherewithal to invest, and yet are not. Of course, depressed investment in plant and equipment was true before the recession, in 2006 and 2007, so it’s unclear why it should take the lead now.

One reason to think that nonresidential investment would take off is that gross investment is rising (17.6% q/q SAAR, roughly twice what MA forecasted back on 8/12), and contributed 2 ppts to GDP growth. Before anybody thinks this is some pollyana-ish prediction, I’ll note that the rise only makes sense given the catastrophic and persistent decline in this category during the recession. Given depreciation, the real private nonresidential capital stock has probably been flat (recently released BEA data indicates that this series was flat going from 2008 to 2009, which is pretty remarkable). This observation links up with the negative (mechanical) contribution of imports on GDP growth that has been remarked upon.

Figure 1: Real GDP growth (blue), and contributions of Non-residential investment (red), exports (green) and imports (orange), SAAR, in percentage points. Source: BEA, GDP 2010Q2 2nd release.

The Composition of Imports and the Prospects for Exports

I think it’s of interest to examine the components of the growth in imports since the trough, and what that implies for future growth. As I pointed out in a previous post, a large share of increase in imports is in the capital goods category.

Figure 2: Change in imports since 200Q2, in billions of Ch.2005$, SAAR. Source: BEA, GDP 2010Q2 2nd release, and author’s calculations.

Most observers focused on the surge in consumer goods imports, but considering slightly longer term trends, one sees a larger component associated in investment, presumably to build future production capacity.

Another observation is that exports have been contributing (once again, in a mechanical sense) to growth since the end of the recession (which I am assuming occurred at 2009Q2), although given vertical specialization, it’s unclear how much.

What are the prospects for continued growth in exports? I use a standard error-correction specification:

Δ exp _t = β ₀ + φ exp _t-1 + β ₁ y _t-1 + β ₂ r _t-1 + γ ₀ Δ exp _t-1 + γ ₁ Δ exp _t-2 + γ ₂ Δ y ^*_t-1 + γ ₃ Δ y ^*_t-2 + γ ₄ Δ r _t-1 + γ ₅ Δ r _t-2 + u _t

Where exp are log real exports of goods and services, y^* is log foreign real GDP, and r is the log real trade weighted value of the dollar. The real foreign GDP variable is export weighted, through 2009Q4. I extended the series for 2010Q1-Q2 using GDP growth rates from the Economist and trade weights accounting for over 80% of US exports. The dollar index is the Fed’s broad index, deflated by CPI. This specification is discussed in greater detail in this post.

Estimating this over the 1973Q4 to 2010Q2 period, one obtains a specification with an adjusted R² of 0.35, SER = 0.020. The implied long run income elasticity is 1.81, the long run price elasticity is unity, while the rate at errors correct is approximately 8.3% per quarter. All the long run coefficients are statistically significant, using Newey-West standard errors. Box Q-statistics for 4 and 8 lags fail to reject the no serial correlation of residuals null.

I use the estimated specification to forecast starting 2010Q2, out to 2010Q3. The actual and forecasted (log) values are shown in Figure 3:

Figure 3: Actual log exports of goods and services, Ch.2005$, SAAR (blue), forecast (red), and plus/minus 1 standard error band. NBER defined recession dates shaded gray, assumes trough at 2009Q2. Source: BEA, GDP 2010Q2 2nd release, and author’s calculations.

This forecast is consistent with exports contributing about 2.8 percentage points (SAAR) to overall growth in 2010Q3. The increase in real exports is 24.4% q/q on an annualized, substantially above Macroeconomic Advisers’ forecast of 12.2% (8/12/2010). The predicted growth is being driven by the close correlation between the growth rates of exports and rest-of-world GDP, illustrated below.

Figure 4: Scatterplot of log first differences of real exports against rest-of-world GDP, 1970Q3-2010Q2. Source: BEA, GDP 2010Q2 2nd release, Federal Reserve Board (70Q3-2009Q4), and author’s calculations.

The adjusted R² for this simple bivariate relationship is 0.23.

I don’t want to make too much of this specific estimate based on the estimated ECM; the one standard error bound encompasses a 13.8% increase, close to the MA number.

What about the longer term? Clearly, in a time of tremendous uncertainty regarding growth prospects, it’s foolhardy to try to project further into future. But one can see what firms abroad anticipate, by looking at what they’re importing from us (i.e., what we’re exporting). Figure 5 depicts the increases since 2009Q2.

Figure 5: Change in exports since 200Q2, in billions of Ch.2005$, SAAR. Source: BEA, GDP 2010Q2 2nd release, and author’s calculations.

The substantial increase in capital goods exports suggests to me that foreign producers are ramping up investment in anticipation of renewed growth. Of course, those expectations could very well prove very wrong (i.e., I have no slavish adherence to rational expectations).

Policy Implications

None of the foregoing should be construed to mean I think we’re not in a rough patch. [0] In particular, there’s not much to indicate resumed consumption growth, and government spending on goods and services is stagnant (real state/local spending 2.3% less than peak at 08Q3, even while population has risen 1.5% in log terms). (I.e., “fiscal mindlessness” persists) At the same time, monetary policy authorities are strangely reluctant to further extend expansionary monetary policy even as deflation appears more likely. [1] [2] So while the international economy might add some pluses, consumption behavior and policy [3] is exerting contractionary forces on the economy. Finally, returning to domestic (nonresidential) investment, aggregate demand has to be sustained in order to keep investment spending up; I’m pretty dubious tinkering with the user cost of capital will do the trick (see here).

Interesting side fact: The magnitude of the (absolute value of the) contributions of exports and imports to GDP is unprecedented in the past forty years. That outcome is consistent with increasing vertical specialization, discussed here and here.

Figure 6: GDP growth (blue), and contributions of exports (red) and imports (green), in percentage points. NBER defined recession dates shaded gray, assumes trough at 2009Q2. Source: BEA, GDP 2010Q2 2nd release.

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THE PRICE OF GOLD held in a tight range as London re-opened after the Summer Bank Holiday on Tuesday, slipping $3 an ounce to $1235 as world stock markets fell again to near the end of August some 6% down on the month.

Silver prices reversed an earlier 1.5% drop to trade back at $19.12 an ounce.

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Crisis-oriented mentality remains pervasive on this last day of August and it will be interesting to see how the gloomy emotional state of global investors will reflect in the markets when full participation resumes in them in about one week’s time following summer’s holidays.

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