I think that the most important economic news item this month was made a few Sundays ago when both Tim Geithner and WH Chief of Staff Daley went on the Sunday talk shows to warn of difficult economic times ahead. This is from the same White House that obviously had top-notch information when Mr. Obama, in early March 2009, suggested that people might just want to buy stocks (famously referring to profit and earnings ratios). By July 1983 and July 1995, were the Reagan and Clinton teams warning of tough times ahead, or were they thumping their chests taking credit for resurgent economies? This is not how a president wants to begin a re-election effort.
Now let’s fast forward a bit to the latest on the budget/debt ceiling mess.
It sure looks as though the politicians have had prolonged infomercials. (The process evokes Bismarck’s admonition that one should watch neither the making of sausages nor laws if one wants to hold one’s lunch down.) Of course, most Americans wish the pols would stay out of our faces and enjoy a summer vacation. What will these public servants do? Well, looking at the alleged conservative party’s proposals, they will continue with “Keynesian” policies of “supporting” the economy. And of course the Fed will play its assigned role.
The Chicago Fed National Activity Index 3-month average is already around the level at which recessions often begin (see last chart on the second column of page 2).
So, I’m putting matters together and saying that the Demopublican party is preparing for yet another period in which private credit demand is going to stay restrained and the Feds will “do their part” and issue lots more debt. What are the investment implications?
This would suggest that the upcoming months are conducive to a “going-Japanese” interest rate scenario. Weak economy and recession fears, declining stocks, fears of more price inflation, etc., unpredictable interest rate moves on the long end but with expectations of Fed tightening continuing to be pushed back. If the economic weakness is global, then the only currencies to really trust are gold, which trades as a currency in such times, and the quasi-gold-backed Swiss franc. Economically sensitive commodities such as oil would be dangerous. Silver would be as usual unpredictable given that it trades both as a currency (money, at least potentially so) and as an industrial commodity.
Strangely, we know from the past 15 years both in the US and Japan that government bonds have tended to rise in price (decline in yield) as large deficits continue. For example, Treasury borrowing rates did not fall in the period of government cash surpluses in the late ’90s through 2001, and rates have fallen as deficits have soared. Can this situation continue? Well, if the choice is earning nothing on cash or something on an intermediate-term bond, choose your poison! In Japan, people got used to the low rates and accepted lower and lower rates on longer duration bonds. Investors did however resist with increasing determination lower rates on the 30-year bond there, and this issue has provided the best cash return for them year after year. So, interest rates are a confusing mess to analyze and forecast in the US given that the US is not Japan and could in theory move more toward hyperinflation than toward price stability even if economic activity continues to decelerate.
So as we enter the historically worst consecutive two months of the year for the stock market, the set-up reminds me of the 2007-8 period: Generally high stock prices, massive optimism earlier in the year by stock market participants, high reported earnings, high commodity prices, depressed construction activity. We had stagflation beginning in 2007, interrupted only by the liquidation spasm following the Lehman-AIG fiasco period. That trend remains in force.
What if the economy takes off, perhaps related to all the recent massive money creation and perhaps surprising even the Washington crowd? Then gold will probably do fine, just as it did in the strong economy in 1978-80 until Fed tightening finally turned short-term interest rates strongly positive. Bonds will become ”sells” on a trading basis, but their downside risk may be minimized by the mind-set of the Fed, which will work as hard as possible to keep rates “too low”. Financials will turn on a dime, perhaps with BofA stock (“BAC”) going again from a dog to a star. The financial stocks do tend to predict the economy.
Several gold-oriented bloggers have pointed to this week’s expiration of options on gold futures as suggesting a “bear raid” on gold by powers that be to force weak hands to sell their gold rather than actually own the futures contract. So far, that activity has been muted (if it exists at all). Bloggers have also been suggesting that the equivalent of a global short squeeze may be brewing in both gold and silver.
In any case, having been a happy participant in the bull(s–t) stock market of the late 1990s, I continue to see structural similarities between the precious metals’ action over the past decade and the almost uninterrupted 25-year bull market in the NASDAQ beginning December 1974. The top was always higher and farther away than you thought was reasonable. In this analogy, it may only be 1984 in the precious metals bull run with years to run. Who can know?
The decline of the financial position of the Federal government of the United States of America is an earthquake with much larger global financial effects than the seismic events in Japan, New Zealand, Chile and Haiti the past couple of years. Are the euro, yuan, ruble or yen ready to replace the dollar as the North Star of finances? Some amalgamation of them all? Is the global Dow a suitable replacement?
My answer is, of course, “No” to the above questions, which is how it goes with rhetorical questions.
Only gold can step once more into the breach caused by the problems caused by the difficulties of the economy and official finances of the United States. The gold standard movement has even gained support within the Neo-con movement:
The Weekly Standard is out this week with a serious piece touting the virtues of a gold standard. (Perhaps it will change its name to “The Weekly Gold Standard”. (But as some point TWS has to understand that a perpetual warfare state is constrained by a gold standard as much as is a welfare state.)) Just as the amazing aspects of the tech-communications revolution revealed itself gradually, picking up converts steadily, I both hope and increasingly believe that the virtues of sound money that cannot be printed at will by central banks is following a similar trajectory. In that case, both gold and silver bullion prices will climb walls of worry, and one day cocktail party talk amongst doctors and dentists will involve the latest hot precious metals mining stock.
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