Tuesday, 2 June 2009

More Sense In One Issue Than A Month of CNBC
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Tuesday, June 2, 2009

  • The 768 billion worries keeping China up at night...
  • Geithner's been called into the bank president's office...
  • How the "French model" of economics is the envy of the world...
  • Rob Parenteau on the fiat currency doomsday machine...and more!

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    France's Moment in the Sun
    by Bill Bonner
    London, England


    "You ain't seen nothin' yet!"

    Actually, we've seen so much already that it's hard to believe there's more coming. But there's sure to be more...and we have a feeling it will be worth the wait.

    Yesterday, for example, GM filed for Chapter 11 bankruptcy protection. It couldn't pay its bills. GM was once the strongest corporation on the planet. But it has been around for nearly 100 years. Heck, everything wears out eventually...even a '55 Chevy.

    "Obama Nationalizes GM," says a triumphant headline in France's La Tribune.

    Triumphant?

    Yes, according to the papers, Obama may have been handed the keys to GM...but the old jalopy is worn out. The French say the whole US economic model is ready for the junkyard. More on the French...and the French model, below...

    First, let's stick with the USA.

    The Dow rose 221 points yesterday - to 8,821... Investors think the worst is over.

    Everything is going up. Copper is up 65% so far this year. Oil is up 53%. Soybeans are up 22%. Stock markets are up about 30% worldwide. And gold is 12%. In this company gold is a laggard!

    Copper has risen so much, say the papers, because China is buying all it can get. What it is doing with the stuff we don't know; maybe it is stocking up at what it believes are low prices.

    Maybe it is hedging its bets. China has the biggest pile of Treasury bonds in the world - $768 billion of them. That's 768 billion reasons to worry. Because each T-bond is denominated in dollars...and while everything else is going up, dollars are going down. Yesterday, the dollar touched a new low against the euro for this year - at $1.42.

    T-bonds are down too - minus 5% for the year. It would not be at all surprising for the Chinese to be stockpiling oil, gold, copper and all the other inflation hedges they can get. Their dollar-denominated bonds may go down...but their commodities and gold would go up. Overall, they'd come out even. You can also hedge your own nest egg with commodities. Find out how in tomorrow's webinar...by registering here.

    Yet this week, Mr. Tim Geithner - the big banks' main man in Washington - is in China trying to reassure the Chinese that America takes its financial obligations seriously. That's something we never expected to see either. America may have the strongest economy on earth. But if the commies stop financing it, we're out of business.

    So Geithner is in China, hat in hand, like a major debtor called into the bank president's office. Geithner, of course, has no choice. He has to go...and say what he has to say. He will use all the right words. He will show the appropriate seriousness...he will smile when it is called for...and put on a grave face when he needs to.

    The trouble is, there's little he can do to help the Chinese. They want him to protect the dollar and the bond market. That's something he can't do.

    "It will be helpful if Mr. Geithner can show us some arithmetic," said Yu Yongding, a former advisor to the Chinese central bank.

    Yes, we'd like to see that arithmetic too. How do you add $1.75 trillion in deficits...pay for it with funny money from the Fed...and still come out even on the value of the dollar? There's no arithmetic we know of that works in the Chinese favor. Right now, the numbers...and the logic of the situation...are telling us that feds aim to create inflation. Instead of trying to keep prices under control...they're trying to get them to go up. That's yet another thing we didn't expect to see!

    The US government is less concerned with protecting foreign lenders than it is with getting the US economy back to its old E-Z money ways. Cheap money is what people want. Cheap money is what the feds are trying to give them.

    To strengthen your hand against the ravages of cheap money you may want to consider investing in gold. Here's one option that offers an exceptionally low cost way to get aboard...read more here.

    Today - will wonders never cease! - the US is pushing its phony money all over the world. The Chinese, meanwhile, are champions of financial integrity. Just wait until they give up on US bonds...then, we'll really see something we ain't seen yet!

    And, Bill will continue in a moment, but first, more news from yesterday's guest host...

    "Yesterday's rally brought us to another pivot point... 2009, take two," reports Ian from today's 5 Minute Forecast.

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    "The Dow and S&P 500 climbed 2.5% yesterday, bumping the broader index into the black for the year, with the Dow close behind. Tech stocks crossed this break-even point long ago, as the tech-heavy Nasdaq is up almost 15% year to date.

    "It takes a 'special' kind of market to rally over 2% the day GM sold the farm. So what's gotten into traders this week? In a word: manufacturing.

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    "The ISM's measure of American manufacturing scored 42.8 in May, the group reported yesterday. That's its fifth straight monthly rise and the best reading since September 2008. At the current rate, the index will be out of the sub-50 contraction range by the end of summer... reason to buy the S&P 500 hand over fist, evidently.

    "Construction spending unexpectedly rose from the void too, popping 0.8% in April. According to yesterday's Commerce Department release, that's the biggest gain in eight months. Like the ISM's, this gauge is still on its knees, down 10% from this time last year. But also like with the ISM's...better to buy now and ask questions later...right?

    "Alas, the only truly positive manufacturing data yesterday came from China. The red nation reported its manufacturing purchasing managers index (like our ISM) scored 53 in May, its third straight month of expansion."

    If you want to make sure you get Ian's insight from The 5 - in its entirety every Monday through Friday - you can...by subscribing to one of Agora Financial's paid publications. One such fortune-building read is Wayne Burritt's Easy Money Options...available here.

    Now back to Bill, continuing his thoughts from London:

    The French think they were right about everything. Iraq, for example. The French have deep ties to the Arab world. They knew Iraq would be a tar baby for the US - just like Algeria had been for them. You pick it up...you can't put it down.

    But Congress and the administration not only ignored the French (as they had when Charles DeGaulle advised against intervention in Vietnam in the early '60s - it was a "rotten country," he said) they accused France of cowardice, dumped good bottles of Bordeaux down the drain and renamed French fries 'freedom fries.'

    Remember the jokes? When a bomb blew up a Spanish train, France raised its color-coded Terror Alert system...from mauve for "Collaborate" to chartreuse for "Run and Hide."

    And remember what Anglo-Saxon economists said about the French economy? It was 'sclerotic'...it was a 'museum'...first, it was tied up by labor unions and then the socialist politicians did kinky things to it.

    But every dog has his day, and now the French are enjoying a delicious moment of schadenfreude.

    The frogs stayed out of Iraq...avoided a housing bubble...and side- stepped a credit crisis.

    And now, the "French model" for managing an economy is the envy of the world. At least, that's what you might think if you read The Economist. A recent issue has Sarkozy on the cover...looking confident and pleased with himself. By contrast, Britain's Gordon Brown and Germany's Angela Merkel look as though they needed a drink.

    What's the 'French model?' It's a system where the state meddles heavily in the economy. Health care, education and public transport are all government enterprises. And political cronies, rather than entrepreneurs, run key businesses.

    Heck the French don't even have a word for "entrepreneur," as George W. Bush pointed out.

    It seems to work fairly well. The health care system functions fairly well - while taking a smaller percentage of GDP than in the US. The trains run on time (except when there is a strike). Grammar and secondary schools are probably better than in the US; the universities are probably worse. And many of France's private businesses are world leaders - Air Liquide, Danone, LVMH, to name just a few that come to mind.

    And so far, France has suffered less from the worldwide financial meltdown than any of its rivals. The last time we were in Paris, the restaurants seemed as full as ever; taxi cabs were as hard to get as ever; and Paris property had barely come down at all - at least, officially.

    "I'm not so sure..." said a colleague in Paris. "I've been looking for an apartment for the last year. A year ago, there was almost nothing available in my price range. Now, I'm seeing lots of places. I looked at one last week. It is listed at $340,000 - about what it would have been a year ago. But the agent told me that the seller would probably take $275,000. If they're telling me that right off-the-bat, I figure it might go for $250,000."

    Until tomorrow,

    Bill Bonner
    The Daily Reckoning

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    The Daily Reckoning PRESENTS: Many experts believe that we have reached a pivot point in financial markets. Rob Parenteau is among them and wants to alert you to what he sees shaping up. Read on...


    Entering a Crux
    by Rob Parenteau
    San Francisco, California


    In our younger days, when we used to rock climb, this was known as the crux - a move or series of moves that were particularly dicey and could leave you dangling from the end of rope 20-30 feet lower in a dazed state if you failed to finesse them.

    As we have documented in recent weeks, the list of US macro series showing stable nominal levels over the past 3-4 months continues to increase. These include

    1. Retail sales
    2. New orders for durable goods
    3. Imports of materials and finished goods.

    That is not what usually happens in a debt-deflation dynamic, which cumulatively builds on itself.

    Our read always has been that the wave of debt-deflation dynamics building last year would provoke a massive policy response. While home price deflation is still ripping, and headline consumer price indexes are showing mild deflation, it appears the debt-deflation risk is being contained by extreme fiscal and monetary measures.
    "...unless the commercial banks start putting some of their $1 trillion in cash holdings into Treasuries (thereby picking up net interest income to rebuild profitability and balance sheets), the Fed will be forced into taking steps that imply a ceiling in Treasury yields is in place."

    Stability is better than free fall, but it is not the same as expansion, and we believe equity investors have shoved valuations high enough over the past three months that they now require signs of economic growth, not just stability, to carry equity indexes higher. We think the odds of them getting that could improve after we get past the auto production and dealer downshift later in the summer, but the rise in Treasury yields is becoming alarming.

    While there were no failed auctions this week, longer-dated Treasury bond yields continue to back up not just on supply issues, but also as private portfolio preferences have moved toward riskier assets and, in some cases, into inflation hedges on the bet the Fed will be forced to monetize the growing fiscal deficit.

    Our view has been unless the commercial banks start putting some of their $1 trillion in cash holdings into Treasuries (thereby picking up net interest income to rebuild profitability and balance sheets), the Fed will be forced into taking steps that imply a ceiling in Treasury yields is in place. The only other way out we can see is if the US macro news flow relapses and private portfolio preferences shift back to less risky assets, which puts equity indexes at risk of a sell-off.

    So from a strategic point of view, we believe equity investors want and need to see stronger economic and earnings results to drive indexes higher, while bond investors need just the opposite to calm Treasury yields down. In addition, through near-zero interest rate policy (ZIRP) and quantitative easing (QE) approaches, the Fed has been trying to push private investors into riskier asset classes while the Treasury's debt issuance calendar implies they need private investors to prefer owning Treasury bonds, which are generally not the asset of choice in an economic recovery scenario.

    In other words, we have contradictory crosscurrents here. If the Fed doesn't intervene to slow or halt the Treasury yield backup, there is a chance the stabilization in unit home sales will wither away. If the Fed does step up QE operations to halt the Treasury yield rise, professional investors taking the "green toilet paper" view will continue to sell dollars and buy commodities. Down the line that implies higher energy prices for consumers and higher input prices for manufacturers, neither of which we would consider growth supportive developments.

    Our concern is the green toilet paper contingent has the Fed in a corner for the moment with a trade that initially could look self- fulfilling, along the lines of the infamous Soros 1992 trade against the British pound and the Bank of England. At the moment, we honestly cannot see an easy resolution unless some Goldilocks growth path (not too hot, not too cold) develops, but we would we need to monitor this one very closely.

    To wit, we can envision the following scenario feeding on itself.

    You cannot have

  • A central bank pursuing near ZIRP and QE, which, after all, are designed to trash cash and force private investors out the risk spectrum into equities, corporate bonds, mortgage bonds, lower rated debt, etc...

  • And have the Treasury issuing loads of public debt at the same time from a massive fiscal ease designed to reaccelerate the economy without expecting Treasury yields to increase...
  • unless the central bank and commercial banks are willing to soak up Treasury issuance with money creation, or unless the Treasury can get away with "underfunding" - that is, direct monetization of the deficit. There is a policy incompatibility problem, in other words, or at least really incoherent expectations management.

    And that puts the Fed on the spot. Do they choose to cap Treasury yields by explicitly stepping up QE operations and buying more Treasury bonds in the open market (or possibly more mortgage-backed securities, to thereby decouple mortgage rates from rising Treasury yields)? Or do they just let Treasuries find their own equilibrium, accepting the risk the economy may relapse again as 10-year US Treasury yields sail through 4%?

    Let's say Helicopter Ben Bernanke decides he does not want to take the tail risk of setting off the next Great Depression. He doesn't want to go there because he has already exhausted his bag of unconventional monetary policy tricks and he knows he will have to come up with even crazier policy moves, like buying equities outright or making direct loans to companies, if he faces a relapse in economic activity. That means if he flinches, some investors will take that as a sign to increase their short dollar/long commodity trades...

    which feeds inflation fears...

    encouraging more investors to sell existing Treasury holdings to the Fed...

    which creates more "monetization" of public debt...

    and more short dollar/long commodity trades...

    eventually begetting more intervention by foreign central banks trying to defend the dollar and thereby prevent their own currencies from kiting higher by creating their own money to buy dollars...

    which transmits inflation fears out of the United States into a wider range of countries...

    creating a fantastic, self-fulfilling feedback loop.

    Stepping back, one could see this as a doomsday machine for fiat currencies...Shades of Soros 1992, when he took on the Bank of England and broke the pound, except this one is larger scale, with much more at stake.

    We intentionally avoid sensationalizing our analysis - the world is a wild enough place without all the hype. But we feel it important to flag this one for you, because we can see how this dynamic could feed on itself... and we know professional investors have been trained over the serial asset bubble years to flock toward such trades... and we can see how policymakers may be checkmated by professional investors.

    Regards,

    Rob Parenteau
    for The Daily Reckoning

    P.S. If you aren't already a subscriber to the newly revamped Richebächer Letter, now is the perfect time to join. See here for all the details.

    And, current subscribers to The Richebächer Letter should be on the lookout for an invitation to the first Richebächer Society event, scheduled for July 20 at the Fairmont Hotel Vancouver in British Columbia. It will coincide with the 2009 Agora Financial Investment Symposium.

    We encourage members to register to attend both events. Please click here for more information on the Agora Financial Investment Symposium, and expect more details on the Richebächer Society meeting soon.

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