Thursday, May 28, 2009

BOND prices and a possible Gold Tsunami...

It is no secret to investors that the US 30-year "long" bond has risen in value for 28 years.

It has certainly also been noticed that this almost one-third century trend has recently reversed - with the reversal confirmed by a break in the long-term-trend-defining 65-week moving average this very week.

The implication is that bond prices could now fall, and interest rates rise, for the next one-third century or so.

The cause, of course, is the massively inflated, bloated, still over-valued US dollar.

The rate of change in the bond market is typically glacial, though do remember that even glaciers have periods of rapid movement - when the weather is very cold or very hot.

However, the key point here is that bonds will soon cease to be the outperforming investments that they have been for the past 3 decades. Additionally, it has grown increasingly obvious that general equities are in a long-term bear market.

What then will investors turn to for preservation of the value of their holdings?

You know and I know that gold is a store of value in uncertain times.

The reversal in the long-bond trend is a seismic event in the investment world. The tremors will be felt far and wide for decades to come.

The falling bond price is the seismic shift that will ignite the gold tsunami.

With both bonds and equities in decline, gold remains the only secure vehicle in the investment world. Other investments may rise, but only gold possesses the combined qualities of relative strength (its time is now) and security (gold is no one else's obligation and thus is not subject to possible default).

Tsunamis begin with a deep undersea earthquake. The disruption in the ocean depths is transmitted to the surface, giving force to the giant waves that later crash to shore at the ocean's perimeter.

The collapse of the 30-year bond price is the earthquake.

The price of gold is the tsunami.....!!!

PhD economist Marc Faber says:

“I am 100% sure that the U.S. will go into hyperinflation.”
On the other hand, Boston Federal Reserve Bank President Eric Rosengren said last Thursday that the risk of deflation is currently more of a concern than inflation. And Henry C K Liu, writing in the Asia Times, argues that inflation and deflation are really meaningless terms:
The conventional terms of inflation and deflation are no longer adequate for describing the overall monetary effect of excess liquidity recently released by the US Federal Reserve, the nation's central bank, to deal with the year-long credit crunch.

This is because the approach adopted by the Treasury and the Fed to deal with a financial crisis of unsustainable debt created by excess liquidity is to inject more liquidity in the form of both new public debt and newly created money into the economy and to channel it to debt-laden institutions to reflate a burst debt-driven asset price bubble.

The Treasury does not have any power to create new money. It has to borrow from the credit market, thus shifting private debt into public debt. The Fed has the authority to create new money. Unfortunately, the Fed's new money has not been going to consumers in the form of full employment with rising wages to restore fallen demand, but instead is going only to debt-infested distressed institutions to allow them to deleverage from toxic debt. Thus deflation in the equity market (falling share prices) has been cushioned by newly issued money, while aggregate wage income continues to fall to further reduce aggregate demand.

Falling demand deflates commodity prices, but not enough to restore demand because aggregate wages are falling faster. When financial institutions deleverage with free money from the central bank, the creditors receive the money while the Fed assumes the toxic liability by expanding its balance sheet. Deleverage reduces financial costs while increasing cash flow to allow zombie financial institutions to return to nominal profitability with unearned income and while laying off workers to cut operational cost. Thus we have financial profit inflation with price deflation in a shrinking economy.

What we will have going forward is not Weimar Republic-type price hyperinflation, but a financial profit inflation in which zombie financial institutions turn nominally profitable in a collapsing economy. The danger is that this unearned nominal financial profit is mistaken as a sign of economic recovery, inducing the public to invest what remaining wealth they still hold, only to lose more of it at the next market meltdown, which will come when the profit bubble bursts.

Hyperinflation is fatal because hedging against it causes market failures to destroy wealth. Normally, when markets are functioning, unhedged inflation favors debtors by reducing the value of liabilities they owe to creditors. Instead of destroying wealth, unhedged inflation merely transfers wealth from creditors to debtors. But with government intervention in the financial market, both debtors and creditors are the taxpayers. In such circumstances, even moderate inflation destroys wealth because there are no winning parties.

Debt denominated in fiat currency is borrowed wealth to be repaid later with wealth stored in money protected by monetary policy. Bank deleveraging with Fed new money cancels private debt at full face value with money that has not been earned by anyone, that is with no stored wealth. That kind of money is toxic in that the more valuable it is (with increased purchasing power to buy more as prices deflate), the more it degrades wealth because no wealth has been put into the money to be stored, thus negating the fundamental prerequisite of money as a storer of value.

This is not demand destruction because decline in demand is temporarily slowed by the new money. Rather, it is money destruction as a restorer of value while it produces a misleading and confusing effect on aggregate demand.

Thinking about the value of any real asset (gold, oil, and so forth) in money (dollar) terms is misleading. The correct way is to think about the value of the money (dollars) in asset (gold, oil) terms, because assets (gold, oil, and so on) are wealth. The Fed can create money, but it cannot create wealth.

Central bankers are savvy enough to know that while they can create money, they cannot create wealth. To bind money to wealth, central bankers must fight inflation as if it were a financial plague. But the first law of growth economics states that to create wealth through growth, some inflation needs to be tolerated.

The solution then is to make the working poor pay for the pain of inflation by giving the rich a bigger share of the monetized wealth created via inflation, so that the loss of purchasing power from inflation is mostly borne by the low-wage working poor and not by the owners of capital, the monetary value of which is protected from inflation through low wages. Thus the working poor loses in both boom times and bust times.

Inflation is deemed benign by monetarism as long as wages rise at a slower pace than asset prices. The monetarist iron law of wages worked in the industrial age, with the resultant excess capacity absorbed by conspicuous consumption of the moneyed class, although it eventually heralded in the age of revolutions. But the iron law of wages no longer works in the post-industrial age in which growth can only come from mass demand management because overcapacity has grown beyond the ability of conspicuous consumption of a few to absorb in an economic democracy.

That has been the basic problem of the global economy for the past three decades. Low wages even in boom times have landed the world in its current sorry state of overcapacity masked by unsustainable demand created by a debt bubble that finally imploded in July 2007. The whole world is now producing goods and services made by low-wage workers who cannot afford to buy what they make except by taking on debt on which they eventually will default because their low income cannot service it.

All the stimulus spending by all governments perpetuates this dysfunctionality. There will be no recovery from this dysfunctional financial system. Only reform toward full employment with rising wages will save this severely impaired economy.

How can that be done? Simple. Make the cost of wage increases deductible from corporate income tax and make the savings from layoffs taxable as corporate income.


The next leg DOWN.....

Collapsing home prices and credit markets continue to put downward pressure on consumer spending, forcing the Federal Reserve to take even more radical action to revive the economy.

Last week, Fed chief Ben Bernanke raised the prospect of further monetizing the debt by purchasing more than the $1.75 trillion of Treasuries and mortgage-backed securities (MBS) already committed. The announcement sent shockwaves through the currency markets where skittish traders have joined doomsayers in predicting tough times ahead for the dollar.

Foreign central banks have been gobbling up US debt at an impressive pace, adding another $60 billion in the last three weeks alone. That’s more than enough to cover the current account deficit and put the greenback on solid ground for the time being. But with fiscal deficits ballooning to $3 trillion in the next year alone, dwindling foreign investment won’t be enough to keep the dollar afloat. Bernanke will be forced to either raise interest rates or let the dollar fall hard.

Export-led nations are looking for an edge to revive flagging sales by keeping their currencies undervalued. But the strong dollar is making it harder for Bernanke to engineer a recovery. He’d like nothing more than to see the dollar tumble and reset at a lower rate. That would reduce the debt-load for homeowners and businesses and send consumers racing back to the shopping malls and auto showrooms.

Perception management is a big part of stimulating the economy. That’s why the financial media have been airbrushing articles that focus on deflation and shifting the attention to inflation. It’s an effort to kick-start consumer spending by convincing people that their money will be worth less in the future. But deflation is still enemy number one. Rising unemployment, crashing home prices, vanishing equity and tighter credit; these are all signs of entrenched deflation.

Bernanke faces three main challenges to put the economy back on track. He must remove the hundreds of billions in toxic assets from the banks’ balance sheets, reignite consumer spending to offset the sharp decline in aggregate demand, and fix the wholesale credit-mechanism that provides 40 percent of the credit to the broader economy.

Treasury Secretary Timothy Geithner has taken over the distribution of the remaining TARP funds, and created a new program, the Public-Private Investment Partnership (PPIP), for purchasing toxic mortgage-backed assets. The PPIP will provide up to 94 percent “non-recourse” government loans for up to $1 trillion of assets which are worth less than half of their original value at today’s prices. The Treasury’s plan is an attempt to keep asset prices artificially high so that the losses will not be realized until they’ve been shifted onto the taxpayer.

Here’s how John Hussman of Hussman Funds summed up Geithner’s PPIP: “From early reports regarding the toxic assets plan, it appears that the Treasury envisions allowing private investors to bid for toxic mortgage securities, but only to put up about 7% of the purchase price, with the TARP matching that amount -- the remainder being “non-recourse” financing from the Fed and FDIC. This essentially implies that the government would grant bidders a put option against 86% of whatever price is bid. This is not only an invitation for rampant moral hazard, as it would allow the financing of largely speculative and inefficiently priced bids with the public bearing the cost of losses, but of much greater concern, it is a likely recipe for the insolvency of the Federal Deposit Insurance Corporation, and represents a major end-run around Congress by unelected bureaucrats.

“Make no mistake -- we are selling off our future and the future of our children to prevent the bondholders of U.S. financial corporations from taking losses. We are using public funds to protect the bondholders of some of the most mismanaged companies in the history of capitalism, instead of allowing them to take losses that should have been their own. All our policy makers have done to date has been to squander public funds to protect the full interests of corporate bondholders. Even Bear Stearns bondholders can expect to get 100% of their money back, thanks to the generosity of Bernanke, Geithner and other bureaucrats eager to hand out the money of ordinary Americans.” (John Hussman, “The Fed and Treasury -- Putting off Hard Choices with Easy Money, and Probable Chaos,

The second part of the Fed’s plan is to fix the wholesale credit-mechanism, which means restoring the securitization markets where pools of loans are transformed into securities and sold to investors. Until Bernanke is able to lure investors back into purchasing high-risk debt-instruments comprised of student loans, mortgage securities, auto loans and credit card debt, the credit markets will continue to sputter and growth will be flat. Structured-debt creates the asset base which is leveraged though traditional loans or complex derivatives. Credit expansion maximizes profit, inflates asset prices and establishes the structural framework for shifting wealth to financial institutions via speculative asset bubbles. This is the basic financial model that US banks and financial institutions hope to export to the rest of the industrial world to ensure a greater portion of global wealth for themselves and a stronger grip on the political process.

Bernanke’s Term Asset-backed Securities Loan Facility (TALF) provides up to $1 trillion in non-recourse loans to financial institutions willing to buy AAA-rated debt-instruments backed by consumer and small business loans. So far, the response has been tepid at best. For all practical purposes, the market is still frozen. Bernanke knows that there will be no recovery unless the credit markets are functioning properly. He also knows that the TALF won’t succeed unless he provides guarantees for the underlying collateral, which are loans that were made to applicants who have no means for paying them back. Bernanke’s guarantees will cost the taxpayer billions of dollars without any assurance that his plan will even work. It’s a complete fiasco.

From the Federal Reserve Bank of San Francisco Economic Letter, “US Household Deleveraging and Future consumption Growth” by Reuven Glick and Kevin J. Lansing: “More than 20 years ago, economist Hyman Minsky (1986) proposed a ‘financial instability hypothesis.’ He argued that prosperous times can often induce borrowers to accumulate debt beyond their ability to repay out of current income, thus leading to financial crises and severe economic contractions.

“Until recently, U.S. households were accumulating debt at a rapid pace, allowing consumption to grow faster than income. An environment of easy credit facilitated this process, fueled further by rising prices of stocks and housing, which provided collateral for even more borrowing. The value of that collateral has since dropped dramatically, leaving many households in a precarious financial position, particularly in light of economic uncertainty that threatens their jobs.

“Going forward, it seems probable that many U.S. households will reduce their debt. If accomplished through increased saving, the deleveraging process could result in a substantial and prolonged slowdown in consumer spending relative to pre-recession growth rates. Alternatively, if accomplished through some form of default on existing debt, such as real estate short sales, foreclosures, or bankruptcy, deleveraging could involve significant costs for consumers, including tax liabilities on forgiven debt, legal fees, and lower credit scores. Moreover, this form of deleveraging would simply shift the problem onto banks that hold these loans as assets on their balance sheets. Either way, the process of household deleveraging will not be painless.” (The Federal Reserve Bank of San Francisco Economic Letter, “US Household Deleveraging and Future consumption Growth” by Reuven Glick and Kevin J. Lansing)

The economy is in the grip of deflation. Commercial banks are stockpiling excess reserves (more than $850 billion in less than a year) to prepare for future downgrades, write-offs, defaults and foreclosures. That’s deflation. Consumers are cutting back on discretionary spending; driving, eating out, shopping, vacations, hotels, air travel. More deflation. Businesses are laying off employees, slashing inventory, abandoning plans for expansion or reinvestment. More deflation. Banks are trimming credit lines, calling in loans and raising standards for mortgages, credit cards and commercial real estate. Still more deflation.

Bernanke has opened the liquidity valves to full-blast, but consumers are backing off; they’re too mired in debt to borrow, so the money sits idle in bank vaults while the economy continues to slump.

In an environment where businesses and consumers are rebuilding their balance sheets and paying off debt, there’s only one option; inflation. Bernanke will keep interest rates low while increasing monetary and fiscal stimulus. The ocean of red ink will continue to rise. Still, the system wide contraction will persist despite the Fed’s multi-trillion dollar lending programs, quantitative easing (QE) and Treasury buybacks. The “Great Unwind” is irreversible; the era of limitless credit expansion is over.

David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates, believes that the equities markets have undergone a “gargantuan short-cover rally” and that stocks will retest the March 9 low, which was a 12-year low for the S&P 500 Index. Rosenberg said he doesn’t expect the economy to recover in the second half of the year.

“I’m seeing no revival of consumer spending in the second quarter,” Rosenberg said. (Bloomberg)

The conditions that supported the explosive growth of the last decade no longer exist. The credit markets are in a shambles, the banking system is hanging by a thread, and the consumer is out of gas. Traders are clinging to the slim hope that the worst is over, but they could be mistaken. There’s probably another leg down and it will be more vicious than the last.....

The Final Conquest; Corporate Frankensteins

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