What Next?

Sorry for the pause in blogging, friends. I have been very busy getting the yacht ready to sail for Spain and have had poor Internet connection since around May.

One would think, from the media, that the problems are behind us but I urge you to look at the fundamentals. Jobs are being lost. Tax revenue is falling. The Government is printing money. Government debt is increasing. The economy is shrinking. And on Friday the Bank of England stated categorically that the problems are not behind us and continued with another £50 billion print run on QE.

My advice is keep your belt tightened until you can see a real recovery.

What about Gold?

The question facing the long-term investor in gold is "when are the supplier nations (the manufacturing and commodity nations) going to demand payment in gold, or gold-backed currency"? The answer lies in the nature of the relationship that exists between supplier and user, which is symbiotic and mutually beneficial. Neither can prosper without the other; what is good for one is good for the other....up to a point. This holds true only while both parties are benefiting but as soon as either party ceases to benefit, the relationship must end.

At this time, the US dollar is holding up strongly; given dollars, you can buy anything you want. As a store of value, it is -- today -- perfectly good. So the supplier nations are still happy to be paid in dollars (or any other currency that can be exchanged for dollars on the open market). However, there is considerable concern that the dollar will lose its value by combination of deliberate actions by the Fed and factors largely outside the control of the USG (principally high levels of debt and insufficient assets).

The Euro has been exposed as a currency in at least as bad a situation if not much worse than the dollar. The Swissie is too small and needs to be linked to the EUR for trading reasons. This only leaves gold for the time being - in due course another currency might emerge and take over the baton from the dollar but that is some way off.

At this time there is no real alternative to gold as an alternative means of payment.

Presently, the value of the dollar is being supported entirely by fashion and confidence. If people lose confidence in the dollar, it will become unfashionable to hold it and its value will fall -- maybe very quickly indeed. Timescales? That's the $64,000 question but when it happens - if it happens - it will most likely happen very quickly over a period of days or weeks rather than weeks or months.

Has G20 altered the medium to long term outlook?

The main things that were agreed at the G20 summit were:-

1. The world's financial system is in a pickle
2. There will be a new 'world order' passing more influence from the US and developed countries to eastern countries
3. More central bank support is required
4. The IMF will have more money to lend probably by selling part of its gold
5. China is not happy about US QE as that is likely to devalue the dollar, and China has massive dollar holdings in treasuries

Meanwhile, the unemployment rate in the US rises to 8.5% with forecasts of 10% or more, to follow. Obama says that bankruptcy is the best way out for GM. US Treasuries fall. British Airways traffic fell 7.4% last month. UK house prices fell 1.9% in March.

I don't really think that this week has done anything for the current crisis. The publicity and support from central banks probably helped to push the stock markets a little bit higher but they show signs of wanting to fall back again. I'm afraid that the whole thing was a rather pointless waste of everyone's time -- principally because everyone had their own agenda and had already decided on the outcome.

Public Sector workers will always be paid well

It is being said that the Brown government is maintaining public sector pay rises because it is frightened of the unions. That isn't really the point. In times of unrest and dissatisfaction any government, particularly one that has poor support and popularity, has to shore-up its power base by looking after Government workers. That's why public sector workers are getting their indefensible and deeply unpopular pay rises while the private sector continues to cut pay and shed workers.

This will continue to cause real resentment in society, particularly as more and more private sector workers and pensioners suffer further cuts. This Government policy, while perfectly traditional, is likely to cause the most resentment in the usually laid-back middle classes.

G20 -- Obama and Brown marginalised

Obama and Brown are being increasingly marginalised by the rest of the world in pushing for further fiscal easing. The Chinese premier, the EU and King, Brown's own head of the UK central bank are all against further stimulus. Last night Brown seemed to be pulling back. This is from this morning's FT...

He [Brown] appeared to respond to pressure from Alistair Darling, his chancellor, and Mervyn King, Bank of England governor, in conceding on Wednesday there was little room for Britain to announce a second wave of tax cuts or spending increases.

Speaking in New York, he sought to shift the political focus from a fiscal stimulus to other mechanisms intended to kickstart the economy, amid forecasts that the UK deficit could rise to 11 per cent or 12 per cent of gross domestic product next year.

Asked at a Wall Street event about Mr King’s warning against a big new fiscal stimulus, Mr Brown said: “If you put that question to Mervyn King, he will say ... that we've got to be ready to take the action that is necessary to restore [economic] growth.”

Beware, this isn't quite the U turn you thought. This does NOT rule out further Quantitative Easing, in fact it almost rules it in. What happened is that yesterday's gilt auction (these are new 40 year Government bonds being auctioned off) failed to find enough buyers. This is very unusual and is a signal from the world's financial community that British debt isn't as safe as it could be. Since the only way that Brown can finance his proposed tax cuts and public spending rises is by borrowing, that's why he appeared to be pulling back last night but be clear, this does not rule out QE. QE is the most dangerous of the stimulus methods being used and has the risk of causing inflation. There have been many press reports in recent days that strongly suggest we are in an inflationary phase already with consumer prices rising, auto manufacturers putting up their prices significantly, and distributors announcing that once present stocks have been sold, prices will rise due to a fall in the value of the Pound.

What worries the world right now is that the US (and the UK) will inflate (devalue) away their debt. But maybe that's the only option open to them? That's why there will be considerable interest in some new reserve currency. It has to happen, and happen fairly soon. I think that it will probably be based on some kind of gold standard because there is no other way that isn't too contentious -- at least, not until the Dollar crisis plays out and the world's next obvious choice as a reserve currency emerges (the Yuan?).

I leave you with this thought. Large heavily-populated towns and cities in the USA would become literally uninhabitable without air conditioning and cars to carry people around. Imagine the consequences. They need oil in very large quantities. If Obama is going to inflate away US debt by devaluing the Dollar then clearly imported oil is going to be very much more expensive - by a factor of five times or more, taking it to truly unaffordable levels, for air conditioning. It is unthinkable that the administration hasn't already figured this out, so what are their plans?

China and US Treasuries - Update

The present position is that the US and the UK have started a policy of printing money (QE). Both governments claim that this is to counter deflationary pressures in their economies. I do not believe that there is any monetary deflation -- while prices are falling for a few things, overall, there is underlying inflation in the economies. It seems likely that the US and the UK are intent on inflating away their debt. If that is the plan, then the likely target is an 80% devaluation of the US Dollar and British Pound. The GBP/USD pair could remain fairly constant, of course. It does not seem likely that the EU can retain a strong Euro in this scenario and that will have to be devalued, also.

We are already seeing the USD decline on fears that this is the case (and gold has been rising on the same fears). Today, the Chinese have stated that China will continue to buy Treasuries despite the warnings given by the Premier Wen Jiaboa a fortnight ago. I presume that this is an attempt to stabilise the value of the USD. One assumes that there must be a tremendous dialogue taking place between Chinese and US officials constantly and the comments made public are simply the tip of a huge iceberg of discontent.

I don't see how this is going to change US or UK fiscal policy; the policy of QE, i.e. printing money to inflate away the debt, has not been halted. We would have been told, for certain, as nobody is very happy with that policy in any case.

For now, it is all happening behind the scenes but the really important issue facing us now is inflation. The recession is happening and it will get much deeper. House prices will continue to plummet. Firms will continue to go bankrupt, workers laid off (the motor manufacturers are in terrible trouble as are most banks), and tax revenues will continue to fall. This will make it impossible for either the US or UK governments to manage without 'printing' money.

I am only posting when I have something that either confirms or changes the overall outlook. I don't want this blog to become a micro-economic commentary -- there are plenty of those and many of them are excellent (and a few cranks, it must be said).

China and US Treasuries

China has warned the USA to maintain the value of the USD 'or else'.

It's a warning shot across the bows. China is worried that too much QE will devalue the currency, as a result of monetary inflation. The USA is in a horrible pickle right now; China is in a position to bring the USA to her knees, if she wanted to. Would the Chinese want to?

Do the Chinese prefer to work in factories, often no better than sweat-shops, or rake-over piles of European refuse for recycling, to keep the US and EU citizens in the comfort to which they have become accustomed? One hopes that they realise their station in life and being merely Chinese they should be glad of the opportunity to serve their betters. Some people say that the Chinese are getting fed up with it and would like to spend some of their own hard-earned that is presently being used to prop-up western economies. If they tried to do that there would be a run on treasuries that would make the Dutch Tulip Bubble and Dot Com Bubble look like diurnal trading swings.

Greenspan likes to define bubbles as 'irrational exuberance'. If lending someone hundreds of times more than they could repay in several generations isn't 'irrational', I don't know what is! The flood of funds into Treasuries from other asset classes can fairly be described as 'irrational exuberance' so yes, we have a Treasuries bubble. The odd thing about bubbles is that most of us don't perceive them to be bubbles until they have burst....there is always some rationale such as "there's a shortage of land...", "people have to have somewhere to live so house prices will always rise in the long term and at most will only fall back a few percent.....". The thing about houses is that at least you own them (unless they are mortgaged). People just refuse to sell until they have to, and that makes the decline slower. Treasuries, on the other hand, are simply an IOU. If 'I' looks as though he might default on paying 'U' then U want out, and out fast. Or if 'I' decides to repay 'U' in a currency that has devalued by x%, again U want out.

I don't believe that the Chinese want this. What the Chinese (and almost everyone else) want and are working towards, is a return to 2006/7. They want to turn the clock back. Quantitative Easing is about resuming lending, trying to turn the clock back. In my opinion that is unlikely to happen.

I think that we do have a Treasuries bubble and that it is about to burst. Cash or gold are good places for the proceeds right now unless you have the risk-appetite for very dodgy debt?

19th February 2009

Updates to this blog have been sparse recently because while there has been a lot of activity, there has been very little real news.

I will only post when I have a message that suggest some change in direction or some material confirmation that things are moving as forecast.

The world's economy has been going in much the same direction. Governments are now printing money in wholesale quantities.

Here in the UK we are entering a bizarre period of 'spin'. I'm not sure that it is 'spin' in the accepted sense. It is blatant lying. So blatant one wonders how anyone will fall for it. We have the Bank of England telling us that it is acting to prevent deflation, while reporting increasing inflation! Press surveys suggest that retail price inflation is higher than it has been for decades and anecdotal evidence confirms that everyone sees rising prices and falling income as the biggest problem today.

While crude oil has fallen from $140 per barrel last summer to $34 today, domestic fuel and road fuel prices are still at very high levels, and are starting to edge back UP again, while the oil spot market is trending down. Who is creaming off this profit? It is hardly likely that Government would sit back and allow this to happen unless it was in Goverment's interests. Government is grossly underfunded as a result of falling income tax, capital gains tax, property taxes, fall in VAT due to falling consumer spending and massive increases in expenditure on bailing out lame duck banks, and other industries, as well as massive increases in social security and Jobseekers' allowances.

I suggest that the only plausible explanation is that Government has colluded with the oil industry to share the 'bonanza' between them. No other explanation fits the facts.

The paste below has come from the Bank of England website....

http://www.bankofengland.co.uk/publications/inflationreport/ir09feb.pdf


INFLATION REPORT PRESS CONFERENCE
Wednesday 11 February 2009
Opening Remarks by the Governor
The UK economy is in a deep recession. Monetary, fiscal and financial policy have all
responded vigorously to that prospect. But the length and depth of the recession will
depend to a significant extent on developments in the rest of the world, where a severe
economic downturn has taken hold. Growth in the advanced and emerging market
economies fell sharply towards the end of last year. And world trade is contracting rapidly.
As in the UK, the scale and synchronised nature of the downturn around the world has
been driven by two factors – a further tightening of credit conditions following failures in
the international banking system, which means that lending, especially to companies, is
still slowing, and a collapse of confidence, or “animal spirits” in Keynes’ description, that
is leading to falls in spending and production. Restoring both lending and confidence
will not be easy and will take time.
In many countries, governments have now taken significant measures to improve
conditions in financial markets and support lending. Three weeks ago, the UK
Government announced a five-point plan to restore the flow of lending. One of the five
points is the creation of an asset purchase facility operated by the Bank of England and
aimed at increasing the availability of corporate credit. The Bank of England will open
its facility to make purchases later this week. In due course, the plan should help to
alleviate credit conditions for corporate and personal borrowers. But even when all of the
measures are in place, it will take time for banking and credit market conditions to
improve and longer still before they begin to have a noticeable impact on activity.
To cushion the downturn in spending, policymakers around the world have cut interest
rates and loosened fiscal policy. At home, the MPC has cut Bank Rate from 5% to just
1% in the space of five months. To some degree, the effect of those reductions has been
blunted by the problems in the banking sector. But monetary policy is by no means
2
ineffective and, when combined with the sharp fall in sterling of more than a quarter
since the summer of 2007, the fall back in commodity prices, and the easing of fiscal
policy, will provide a significant boost to demand.
The Committee’s latest projection for GDP growth is shown in Chart 1 (GREEN
CHART) on page 7 of today’s Report. The projection is based on the assumption that
Bank Rate moves in line with market expectations, which when the Report was finalised
were for Bank Rate to fall to around ¾% in the middle of this year, before rising back to
around 3% by the end of the forecast period. The central projection is for output to
decline in the first half of this year, so that four-quarter growth falls further in the near
term. It is markedly lower than the projection in November, as a deteriorating labour
market and increased uncertainty weigh on consumption, companies run down their
stocks and scale back investment spending, and the weakness in world demand restrains
export growth. Further ahead, output growth increasingly responds to the substantial
policy stimulus, an improvement in the availability of credit, and a reduction in the trade
deficit as expenditure switches towards home-produced output.
At present, CPI inflation remains well above the 2% target. The Committee’s latest
projection for future inflation is shown in Chart 2 (RED CHART) on page 8 of the
Report, again on the assumption that Bank Rate follows the path implied by market
yields. The near-term path of inflation is uneven, reflecting changes in energy prices and
the temporary cut in VAT. But in the medium term, inflation falls well below the 2%
target, as a substantial margin of spare capacity more than outweighs the waning impact
on import and consumer prices from the lower level of sterling.
The prospects for economic growth and inflation remain unusually uncertain, not least
because of the extraordinary events of the past few months. The Committee judges that
the balance of risks to the path for GDP is very much to the downside, reflecting in large
part uncertainty about when lending and confidence will recover. But the risks to
inflation are more broadly balanced, reflecting the possibility that the sharp depreciation
of sterling may push up on inflation by more than the Committee expects.
3
At its February meeting the Committee judged that an immediate reduction in Bank Rate
of 0.5 percentage points to 1% was warranted. Given its remit to keep inflation on track
to meet the 2% target in the medium term, the projections published by the Committee
today imply that further easing in monetary policy may well be required. That is likely to
include actions aimed at increasing the supply of money in order to stimulate nominal
spending. So let me assure you that, with the full range of instruments at its disposal, the
Monetary Policy Committee can and will take action to return inflation to the target and
so ensure that economic growth will again match its potential.

So, we will "take action to return inflation to the target and so ensure that economic growth will again match its potential?"

Welcome to part of reality. They try to persuade you that price rises = economic growth. Actually, price rises = theft. Theft from those who hold cash of any kind. Inflation robs the saver and rewards the debtor. The UK is a nation of debtors and hyper-inflation is the tool that they are using to write off those debts.

So, maybe you are not 'wealthy' in the accepted sense? Why should you care?

If you have a pension fund of any kind, an endowment policy on your mortgage or any 'insurance' policy that you expect to mature then you should assume that it will be valueless when you expect to collect.

This will happen the way policy is going today. Those who have invested and saved are going to lose everything. The only hope is for people to make their views clear to Government and stand up for themselves. Today, this hard-working, honest, backbone of society, is standing in a field waiting to be shorn.

Update

There are some key issues surfacing this week:-

Inflationary (i.e. price rise) indications are increasing
The Rouble is in terrible trouble -- security of energy and 'detente'
Bank 'earnings' are rising -- this is public money being used to bolster the banks' balance sheets
Japan has declared a major problem with industrial sales
Obama's holiday has ended. Rather earlier than the usual 100 days.

The world's central banks are now using Quantitative Easing (=printing money) and reducing interest rates to try to reverse the trend. Meanwhile the trend line continues to take a sharper fall.

I will try to post again this week with some analysis and opinion but meanwhile keep an eye on these issues.

Update

While governments continue to say that we are in an unprecedented situation, their solution is "stimulus".

Stimulus means borrowing sums or money that nobody on the planet can even begin to grasp. Nobody has ever spend such sums before. It's like the suburban family suddenly deciding to stimulate their lives by going out on a $5,000,000 spending spree. What are they going to spend the money on? And why? Leave aside who is going to pay it back.

You can be sure that this money will not pass seamlessly through the hands of the fat cats.

Just as you can be sure that foreign aid does not usually reach the poor.

History will show that this exercise will enrich the least worthy while doing nothing for the ordinary people, or the nations taking part in it. Use whatever influence you have to find out to whom this money is going and demand accountability.

Sadly, I fear that it is a lost cause. Forget the rhetoric today from the Fed about deflation being a threat. They have to say that to justify continued 'stimulus' - money being borrowed by the public to give to those who are already very rich.

If you haven't already done so, get out of bonds, Treasuries, stocks and shares and into cash. Then immediately invest in physical gold.

Gaza, Russia, and Bank Bailouts

Israel's unilateral ceasefire last night was an excellent development marred by reports that the Palestinians are still firing missiles into Israel. From an outsider's point of view, tragic though this conflict is, it is turning out to be of no great international importance. Clearly the Arab world has no stomach for a fight on this issue at this time. That is truly excellent news; a great relief.

Meanwhile with oil at the mid $30s the oil producers are in deep poo. While Saudi, Iran and other Middle Eastern fields can produce profitably at well below this price, the high oil prices of last year was a bonanza that most of them have already spent. Few offshore fields can pump profitably at these levels and the Russians are very badly hit. There will be a battle and those with the cheapest production costs will win. That competition will hopefully keep oil prices down for the time being and this will help world economies.

The problem with under-capitalised banks is surfacing again. in the UK they are talking about a £200 billion bailout. Be aware that the bailout is not just to provide money, it is to provide solvency. Banks' collateral bases are decreasing in value as debts go bad and shares fall. Income will be falling as the economy continues to plunge. It is a self-tightening screw since the inability of the banks to lend is harming the very economy that the banks need to be growing.

Governments have got to realise that you cannot push on string. It is one thing to make funds available for potential borrowers and another thing to make them borrow it. No prudent company, large, small or even self-employed, is going to borrow if by doing so they dig themselves deeper into the hole. Companies have realised that this isn't a 'blip' or a short-term pullback, this is the start of a world depression the like of which has not been seen since the 1930s. The scale of this depression is likely to be far larger than the '30s, affecting more people and more industries. The danger of loss of social cohesion and civil unrest is high and the consequences frightening particularly for the rather genteel, street-dumb folk who inhabit most of Europe and the USA.

Monday 12th January 2008

While Gaza remains the principal issue internationally, a significant fall in the price of oil today suggests that the market is not expecting Gaza to result in a wider conflict. The oil market is very close to ME affairs and while market prices are not generally a good barometer of international tension (they tend to be panicky, over-reactive and based on a short-term perspective) the oil market is different.

So cautious optimism on Gaza -- at least from the viewpoint of the west. I don't have a clue how the poor folk involved on the various sides are going to resolve their differences.

So we are back to much of the same news. Progressively gloomy reports from companies. Consumers spending less. Banks lending less. House prices and sales volumes falling. Industrial output falling. Stock markets falling. Unemployment rising. In such a scenario, with the UK and, later perhaps, the EU, starting their own versions of Quantitative Easing (printing money), we can predict with near certainty government revenue shortfalls on an unprecedented scale.

In you private and business lives, expect taxes to rise and -- most importantly -- existing taxes to be assessed and collected with an enthusiasm and rigour that you have never seen before. This might be the time to consider a tax accountant even if you haven't had one before.

Meanwhile, stock markets are likely to continue their decline, as will interest rates and currencies will continue their 'race to the bottom'.

Never before has gold looked like such an excellent investment. At the time of writing, spot is at $845. I expect it to continue its rise in the very near future.

Gaza

The situation in Gaza continues to dominate. The position is that while almost everyone is sympathetic to the Israeli need to stop Hamas from lobbing missiles into her country, nobody wants Israel to rock the boat by doing anything about it.

We are starting to see serious polarisation around the world and countries will align with whom they wish to align. East vs West.

Everything else, for the time being, is noise. A Middle East war would be the most calamitous event possible. Oil supplies severed, and spread of hostilities from the ME to Asia and Eastern Europe.

Oil and gold should gain. It should be GBP and CHF positive and possibly quite good for military stocks in the USA.

Gaza, Rouble and Russian Gas

The key issues to watch are Gaza, the Rouble and Russian gas supplies. For the next few days everthing else is just noise. Make no key financial decisions until these issues become clearer.