Joel Bowman, with a few quick words from Taipei, Taiwan...
We're approaching one tenth of the way through this new century and already the world is getting a taste of things to come...
The world's temporary reserve currency, the US dollar, has shed roughly one third of its purchasing power against a basket of major paper competitors this decade. Gold, having begun the millennium in the dumps, has roughly quadrupled against the greenback over that same period. And stocks, after peaking back in 2007, are down about 7% for the same period.
Booms...bubbles...busts of epic proportions...
In short, the era was everything except what Federal Reserve Chairman Ben Bernanke thought it would be: an era of "Great Moderation." In fact, it would be hard to think of a more incorrect way to describe the times we live in.
We carry wars into the new decade, too. There are wars on terror, on unemployment, on the economy and, yes, even on the weather. That's not to mention the carry-over wars from political rally posters of yore; wars on drugs and poverty, wars so poorly-fought, grossly-mishandled and ill-defined that they've become permanent taxes rather than popular election talking points.
Then there's the war being waged between the forces of inflation and deflation, with the market pulling in one direction and the Feds yanking in the other. And that's where we begin today's musing. In the issue that follows, Dan Amoss, Puru Saxena and Daily Reckoning founder, Bill Bonner, talk us through the epic battle being waged in The War of the 'Flations.
First up, Dan Amoss, editor of the Strategic Short Report, described the scene in yesterday's 5-Minute Forecast...
"Now that fears of a deflationary spiral have waned, a rising Treasury note yield is bearish for stocks. Rising Treasury yields increase mortgage rates and decrease the attractiveness of rate-sensitive stocks like utilities, banks, and REITs.
"A rising trend in Treasury yields is especially dangerous," continued Dan, "when you consider that the biggest threat to the economy in 2010 is the backlog of mortgage foreclosures that have yet to work their way through the system. As these homes work their way through the system, it will be another deflationary shock to the banking system. In this deflationary shock, I doubt we'll see Treasury yields move anywhere near their 2008 lows. Higher Treasury yields will keep pressure on interest rate-sensitive stocks, while the continued deflationary pressures in housing will keep pressure on credit-sensitive stocks.
"All of this adds up to a much more hostile environment for the stock market than we've seen in 2009. With valuations high, long-term interest rates heading up, and credit stress still an issue, the environment for short selling is growing more favorable."
And now, over to Hong Kong where Puru Saxena has a few thoughts...
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The Daily Reckoning PRESENTS: Can the world's governments mop up their liquidity spills before it's too late? Do they even want to? Most people think their central banks are trying to protect their nations' currencies – probably because that's the line they feed the public. But, as usual, what we're told ain't necessarily so. In today's issue guest essayist, Puru Saxena, offers a few words on the consequences of "competitive devaluation." Please enjoy...
The Debt Bomb By Puru Saxena Hong Kong, China
Make no mistake; the developed world is drowning in debt and there are only two viable options – a global economic depression or very high inflation. It is our contention that the policymakers have chosen the latter option and over the following years, we will experience the trauma of severe inflation.
Look. The American government is staring at total obligations of US$115 trillion, America's debt-to-GDP ratio is off the charts and the American public is also up to its eyeballs in debt. Under this scenario, you can bet your bottom dollar that the American establishment will try to reduce this debt overhang through a process known as monetary inflation. If you have any doubt whatsoever, take a look at the chart below, which captures the incredible expansion in America's monetary base.
As you can see, over the past two years, the monetary base in America has expanded from US$827 billion to an astonishing US$1.93 trillion! Until now, this surge in the monetary base has not produced a highly visible inflationary impact...yet.
But it is notable that America is not alone in pursuing inflationary policies. All over the world, the developed nations are printing money and debasing their currencies. In this era of globalization, no country wants a strong currency and everyone is engaged in competitive currency devaluations. This massive money and debt creation will cause an inflationary boom over the coming years.
In fact, those who erroneously believe that deflation is unavoidable should review Figure 2, which highlights the mind-boggling expansion in the balance sheets of various central banks. As you can see, America is not the only nation guilty of printing money; the Europeans have also jumped on this train to Inflationville.
Now, we are aware that many prominent commentators are still calling for deflation. "After all," they argue, "how can inflation be a problem when bond yields are so low?" Well, these deflationists seem to be missing the point because the US Treasury market is no longer an entirely free market. We would argue that the Federal Reserve's intervention is largely responsible for keeping bond yields artificially low. Over the past several months, the Federal Reserve has purchased most of the net new issuance of Treasury securities. The American central bank is engaged in this desperate act in order to keep interest-rates low. However, it is buying these Treasuries by creating money out of thin air. This is inflationary.
If our assessment is correct, somewhere down the road, the Federal Reserve will lose its battle and T-bond yields will soar. As more and more bond investors wake up to the looming inflationary menace, they will start demanding a higher rate of return on their capital. When that happens, the dyke will break and the Federal Reserve will become irrelevant.
America has run out of choices. If the Federal Reserve does not inflate away this mountain of debt, the biggest sovereign default in history is guaranteed. Now, given the ability of the Federal Reserve to create confetti money, we are convinced that it will opt for the inflationary solution. Inflation would certainly make America's debt more manageable, but it would also dilute the purchasing power of the dollar. Of course, this inflationary agenda is not a secret and this is why many creditor nations with huge reserves are beginning to diversify away from the American currency.
In the past, when inflationary episodes spiraled out of control, hard assets were the prime beneficiaries and this trend is likely to remain intact in this inflationary episode. If our assessment is correct, over the coming years, stocks, precious metals, commodities and real estate will appreciate in value versus paper currencies. Furthermore, on a relative basis, we expect precious metals and commodities to outperform all other asset-classes. Conversely, we anticipate that cash and fixed- income instruments will probably turn out to be the worst assets to own over the next decade.
Bearing in mind the looming inflationary nightmare, we urge you to protect your purchasing power by allocating capital to precious metals and commodities-related businesses. Finally, we suggest that you consider allocating a portion of your capital to the fast-growing economies in Asia, like China, India and Vietnam. Such investments should prosper during the low-growth, high-inflation environment to come.
Joel's Note:Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription from www.purusaxena.com.
Puru is also the founder of Puru Saxena Wealth Management, his Hong Kong based firm, which manages investment portfolios for individuals and corporate clients. He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs.
And now over to Bill Bonner, who has today's reckoning from Ouzilly, France...
"It's not that simple!"
We wish it were easier, simpler...more predictable. We wish there were a reliable road map. Will someone please give us an owner's manual!
What are we talking about? Stocks...the economy...the gold market?
No, we're talking about life!
"Your children are all at a transitional age," explained a neighbor last night. "They don't know what they are going to be doing in life...or how to do it. So, they need a lot of support. I don't know whether they need advice, exactly....and it's probably better not to give it in many cases...but they need to know you are there."
But where are we? More on that below...
Meanwhile, we return to our dreary métier on a dreary day. We are looking back at the year almost finished, and trying to figure out what lies ahead. The surprise of 2009 was that the stock market didn't turn down again. Stocks worldwide were cut in half. Then, they bounced. A textbook, classic bounce...Normally, you'd expect the bounce to peak out after 5 or 6 months. This one hasn't...yet. Our guess is that it will...
Of course, we could be wrong...
The 'classic' depression...a la Japan...comes about when an economy needs to make some fundamental changes. It discovers that a lot of what it has been doing was wrongheaded. Assets, valued at bubble levels, need to be marked down. People need to find new jobs; because the old ones no longer make sense. Businesses need to be restructured and retooled. Households, typically, need to stop spending and pay down debt.
This process is long and hard. The story of bubbles always begins cheerfully enough. But it always ends at Chapter 11, in long workouts...painful write-offs...and court cases.
"Recession Begins Flooding into the Courts," says a headline in yesterday's New York Times..
If this were a classic depression, we could anticipate another leg down in the stock market...more unemployment...and on-again, off-again growth over the next few years.
Our guess still is that it IS a classic depression...and that we should see stocks go down...along with all the other phenomena that usually accompany a depression.
But, it's not that simple.
Because there are a lot of other things going on too. The feds are hell-bent on avoiding a painful restructuring of the economy. First, they made sure the bankers got their bonuses. The banks deserved to go bust...and the people who ran them should have been fired. But the fix was in from the beginning.
Then, they turned to consumers. The feds are using every trick they have to lure consumers back into bubble mode – buying things they don't need with money they don't have.
Is it working? Well, the results are mixed and confusing. Every day seems to bring more noise. Today, for example, we learn that spending is up 3.6% this holiday season. We have to wonder...how could that be? Fewer people have jobs. Those who have jobs are working fewer hours and earning less money. And the bankers – bless their greedy little hearts – are not passing on the feds' cash to consumers. Consumer credit is going down at the fastest pace since the Great Depression. So, how can consumer sales go up? We'll just have to wait to find out.
The Dow rose 29 points yesterday. Gold went up $3. We would like to see both of them go down. Then, we would sure our 'classic depression' hypothesis is correct. In the meantime, we're watching...waiting...and wondering...along with everyone else.
And more thoughts...
We reported that the US government would need to roll over $2.5 trillion worth of debt next year. We probably erred. The number was right, but it was meant to be over the next two years. During the next two years also, worldwide, banks need to roll over $7 trillion. Whether it is over one year or two years, we're talking big money.
Most people who bother to think about it are coming to the conclusion that this is very inflationary...and very bullish for gold. They think the Fed will need to "monetize the debt" directly, or indirectly. One way or another, they say, the central bank will have to increase the volume of money so that the government can finance its deficits.
Paul Krugman, Nobel Prize winner in economics, suggested that the Fed add another $2 trillion to the nation's monetary base, partly to accommodate federal borrowing...and, he believes, to stimulate employment.
This idea is widespread. Richard Koo, one of the few economists to understand the Japanese depression and what awaits the US, thinks along similar lines. The US economy is going into a depression, like Japan; the government must spend huge amounts of money in order to keep GDP from falling.
Japan's top man shocked the nation last week when he announced the largest budget deficit ever. The government will spend about $1 trillion – a new record. And it will collect less than half that much in taxes. Meaning, most of what the Japanese government spends is borrowed – something the Japanese haven't done since the days when Americans were dropping bombs on them.
The Japanese government is doing what it should do, says Koo. It is replacing missing private spending with public spending. So doing, it has avoided a drop in GDP and employment. Throughout its 20 year slump, Japan's GDP has never fallen below the peak set in 1989. Nor has unemployment ever risen above 6%. Bravo!
Thanks to this new budget, Japan's national debt will reach a new record...nearly 200% of GDP. The Japanese have a lot of private savings, but they also have a lot of public debt. And what have they gotten for it? Well, they have kept people employed....and have allowed the private sector to pay down its debts. Or, to put it another way, they have lived through a classic depression fairly comfortably. Instead of forcing the banks to fess up to their mistakes and clean up their balance sheets, the Japanese government saved them. Instead of allowing big companies to go broke...and other companies to take their places...the Japanese propped up the 'brain dead' firms...and kept them alive with taxpayers' money. Result? A depression that should have been over in, say, 5 years...has been stretched out to 20. And now the Japanese face a public debt that is bound to cause them big problems in the years ahead.... What kind of problems?
Well, Japan is going broke... just like the US.
But we will save that for another day... You editor is on the move again... Most of his children are already in the US...or headed in that direction. He is following them.
Yes, dear reader, after 15 years in Europe, your editor is headed back to the US. He will take up residence in Bethesda, Maryland. Why Bethesda? Why not the ol' family farm near Annapolis? Because...
Our youngest child, Edward, has another year and a half of high school. But he's done all his education in French...and in France. Putting him into an American high school would be a big shock. Yes, he'd probably adapt without any trouble. But we figure he might as well finish up in the same system he began – the French school system. Fortunately, there's a French lycee in Bethesda, Maryland. It's where French diplomats send their children. From what we hear, it's not a bad school.
But why follow the children to the US?
Here's the way we look at it. The children are all starting out in life. There will be a couple of years in which we MIGHT be of help to them. After that, it will be too late. They will have set their course in life, for better or for worse.
Most likely, there's probably not much parents can do. We give advice when it is asked for. We try to anticipate problems. We look back at our own experience and try to warn the children against falling into the same traps.
Does any of this really make any difference? We don't know. But we have been working on these children for the last three decades. This may be the last time we have any influence at all. Beyond that, it may be helpful to them to know that we are on the same continent...and ready to help out, if the occasion arises.
So, for the next two years – more or less – your editor will make Bethesda his home. Back in the USA...
What will it be like living in the US again after all these years? Has the country changed? Have we changed?
About The Daily Reckoning: Now in its 10th anniversary year, The Daily Reckoning is the flagship e-letter of Baltimore-based financial research firm and publishing group Agora Financial, a subsidiary of Agora Inc. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas. Published daily in six countries and three languages, each issue delivers a feature-length article by a senior member of our team and a guest essay from one of many leading thinkers and nationally acclaimed columnists.