Monday, November 21, 2011

The Financial Labyrinth; The Stupid Committee; Bullish on Gold

The Financial Labyrinth
While on our coin adventure in Baltimore, my 7 year old son Nathan and I, went back to the hotel for a little R&R. What does he decide to watch on tv? No, not the Cartoon Channel, but a History Channel show about Greek mythology and the myth about the dreadful and dark Labyrinth on the Island of Crete. In a strange sort of way Greece and all of the debt laden countries of Europe today are seemingly trapped in a Labyrinth and about to be devoured by a debt monster. Some things never change.
The European conundrum drags on. After a few days of being away from the paper markets and seeing brisk activity at the Baltimore coin show, it's back to the reality of watching these fiat markets. As more panic sets in to sell a bunch of euro debt-junk, I picture a long line of cars waiting to go through the tolls. The wait is getting so bad that two cars at a time are trying to go through. Watch for signs of further disorder in the European bond markets in the week ahead. There's only about a Trillion in Italian bonds that need redistributing. Yikes.
I've said in the past that the euro in its present form is a goner. The big guns are now chiming in. The math says it, the setup and other problems make it a certainty that there is no certainty in the euro. When a guy like  Warren Buffett comes out of the woodwork and gives a thumbs down, there's trouble as in spike (not a nail) in the euro's coffin. Read here:
What moves are left in the Chess game? The king should have died but is still moving around on the board on "hopes" something can be done.  Every little piece of "hope" news that has come out is akin to the opponent repeatedly checking the king and the king stepping away to the net square for brief relief. Seems like it's time to fish or cut bait as in either European mass unity/disunity/accord/discord to unite and print new euro bonds like mad, or call the whole EU thing off due to irreconcilable differences. IMHO the real key holder is Germany. If they walk, we're going to see some very negative stock market action. There is good reason for Germany to walk. It is solvent and its is adverse to monetizing debt through printing. Yes, they still remember the Weimar inflation/social disaster that ignited a variety of problems that led to the rise of you know who in the 1930s. Yes, without Germany, the euro forces could still go the route of printing and give themselves a little more time, but printing to add to debt that is already bad debt is not the way to go.
When and how the euro is taken off life support is the question. Markets in general will be pummeled for a time and it could be that since the markets are discounting mechanism that much of the dump will come ahead of the actual demise of the euro. We could see a circuit breaker type event day for Wall Street. Even our dear friend gold could take a shellacking since the fiat bunch are well trained to sell everything and flock to the dollar.
Printing euro bonds, we know, would be a temporary stop gap, but if they can do it they sure will. But Angela has got to be paying attention to what is happening to her ilk Spain. We are seeing the winds of change. The socialists are getting ousted in favor the conservatives. Spanish Voters Set to Throw Out Socialists in Election. Germany's Merkel has got to be pay close attention. In the end, she's out to protect her own neck and though she is pretty much a communist, she will not risk the wrath of the German people over debt monetization. Remember, the Germans just recently completed paying reparations for WWII and also recently experienced a more than $1 bill to unify with East Germany. The people there, as far as I can tell, are not in the mood to bailout all sorts of  distressed countries. The recent whispers are not surprising: the Germans are already readying a supply of paper d-marks in preparation for the demise of the euro as me know it.

Some of the canaries are still flying around, meaning not dead yet, but their fate might not be too positive. Here's an indicator to watch. The TED spread. Wiki has a quick definition for those who are not familiar: “The TED spread is the difference between the interest rates on interbank loans and on short-term U.S. government debt ("T-bills").” It's on the rise again. Not a positive. The trouble with this indicator is that it can slowly rise and then boom – it skyrockets. At 50 basis points, the spread is at its maximum historic norm which usually averages around 30 bps. During the last crisis, TED ballooned to 200 basis points. Keep at eye on it.

The EIB bond spread (European investment bank bonds) went berserk on Friday. A Bloomberg terminal grab from Zero Hedge. My goodness...

So the financial system is stressed. No rocket science there. The primary push back to the euro's demise comes from banks and insolvent players (the countries) who want to continue to sell their debt no matter what the cost of fresh funny "munee" is. Banks on both sides of the Atlantic face huge liabilities. Its not just the potential for $300 bln in losses directly from bad loans for trans Atlantic banks (read some of our biggest in the U.S, as in the usual suspects), it is also the more than $1+ tril in derivatives that are tied to the bad loans. These numbers are in the realm of bank killer territory. This is a battle of epic proportions and the death of the euro will be a huge reality check for the many. especially in Europe. It will answer that mystery question that most have. How is money valued? (I get that a lot, and from smart people too).

The Stupid Committee
And if all of this wasn't enough to add to the investment gloom, we have our own bunch of monkeys in Washington – The Super Committee, failing to engage in good representative representing. Their task was to forge an agreement to at least show a pretense for fiscal rectitude, although their original goals actually included NO plan for cutting our debt, only to cut the rate in which it grows, which is complete folly to begin with. But I digress. Bottom line, we're back to the threat of another debt downgrade by S&P as the nation will go on some sort of politically concocted fiscal autopilot as we have now crossed the $15 trillion official debt number – which is actually quite a bit higher if you include off budget items, the insanely bloated Fed balance sheet, etc. Just sayin'. This time S&P may be joined by  Moody's ad Fitch.
There's little doubt in my mind that we are about to see some interesting fireworks not only in the markets but to societies. Because of its people, its size, resources, etc., the long term outlook for America should be bullish (should be, but we are almost as divided as the nation was in 1860); there may be many pieces to pick up to resume that bullish U.S. Outlook. I'll just briefly mention that our consumerist driven system has a symbiotic relationship with China. Our success with the far east will be more important than ever in the years ahead. Even if the American way of consumption (2/3rds of our GDP), is turned upside down for a time due to system difficulties, China and Asia cannot be ignored in the future. In a post euro and eventually a post dollar hegemony world, everyone will still need to not only get along in the sand box, but will need to be healthy.Economic balance and the madness of giant trade deficits and surpluses must arise from whatever happens in the financial world. That would be a huge positive outcome. However, China and Asia have been shifted to the back burner (at least in financial news coverage although there were some Yuan headlines tis weekend). If Europe finances do collapse and there is an ensuing major economic downturn across the pond, what impact does that have on China and thus the U.S? Yes, we are global in a village sort of way. That's a far more important question that we will explore in future blog posts.
Ultimately, as the fiat paper world is unraveled. gold and other metals will be standouts. Central banks know this, and according to the World gold Council stepped up gold purchases in the last quarter. While it may not become part of regular main street transactions, some form of a monetary gold standard of exchange is going to be necessary to bring a modicum of economic balance back. But there is a catch. If you look back historically to periods of the gold standards of the late 19th century, money supplies could vastly change, banks could fail and economies could suffer (real business cycles as opposed to the perpetual growth models of large corporations and what the Fed has wrongly attempted to do to 'save' the economy). That is to say, a gold standard will only work if society can live within its means. That could be a gut wrenching time of transition for the West and for those who supply many of the goods.

Economist Nouriel Roubini was harping over the weekend about the gold standard and bank failures in the 1930s. He is exactly right. Bingo. It was a reduced gold standard by that time, but there was still gold backing. What went wrong, Nouriel? Fractional Reserve Banking. I don't think Nouriel understand this and I will be responding to his tweets later today. As long as there is Fractional Reserve Banking where the bank receives, as an example, $1 from a saver and then lends out $10, the system is geared toward failure no matter what the backing. The future will not be allowing Goldman Sachs to be levered 40 to 1. That stuff must go away. The flip side of this coin, is that the world will eventually come to realize that fiat currencies are just no good. There will be gold backing, BUT other major reforms will also have to be implemented.

In other words, pay no heed to the smoke and fire of the short term. Gold is a keeper for the medium and long term. Whether the system comes to its senses, or we go hyper inflation Mad Max, gold will always be there and will always have value.

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