EU and UK: Raise Taxes and Cut Stimulus

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Europeans seem bent on acting like lemmings to the sea and jumping off an economic cliff. Not only are the eurozone and UK raising taxes and cutting spending, they want the rest of the world to follow their lead and will try to get this to happen at the next G-20 meeting in late June.

Why anyone would want to follow European countries on economic matters is a real puzzle. The EU's recent handling of the Greek debt crisis will be recorded by history as one of the major episodes of government ineptness of our time (and there is really stiff competition in that category).  Instead of dealing with the problem immediately and decisively by instituting dollarization and removing Greece from the currency union, EU leadership let the matter fester until it blew up. They then tackled the problem with an approximately one trillion-dollar bailout. The EU approach to economic problems seems to be: Why institute a simple cheap solution when an expensive difficult one is available? It's enough to make one ponder if EU policy meetings resemble a multi-lingual idiot's convention.

Over the weekend German Chancellor Angela Merkel stated that she was going to push for a swift exit from fiscal stimulus programs and a focus on debt reduction at the next G-20 meeting. It was German foot dragging on the Greek debt crisis that caused the euro to lose 20% of its value in six months. With a record of success like that, of course the rest of the world should be eager to copy Germany's economic policy ideas. Earlier in June, Merkel's cabinet unveiled substantial budget cuts and tax hikes. France did the same thing recently as have other eurozone countries. Merkel is also spearheading the drive for an international financial transaction tax with the money being used for future bailouts. The possibility that there shouldn't be government bailouts of financial institutions or that the financial institutions that might be bailed out should pay the tax themselves and not their customers seems to have eluded Merkel. Of course, financial centers like London and New York would shoulder a disproportionate amount of the burden, so it is the ultimate socialist solution - get the other guy to pay. Perhaps Merkel isn't as economically challenged as seems to be the case.

Conditions don't appear to be much better in the UK, although we won't find out until Tuesday, June 21st when an emergency budget will be announced by the Conservative-Liberal coalition government. The UK is part of the EU, but not part of the eurozone so it is not obliged to follow the 3% budget deficit to GDP limit imposed there (not that the eurozone countries themselves follow this rule). Like their fellow EU members, suddenly the Brits woke up and realized they had massive deficits (they should have been reading the papers, it's been reported there on a regular basis). Large spending cuts and tax increases are on the table. Even then, the UK's budget deficit could reach 10.5% of GDP in the 2010-11 fiscal year (still less the U.S. number for 2010). It is thought the VAT (value added tax) will be raised from 17.5% to 20.0%. There have been rumors that the capital gains tax rate will be raised from 18% to 40%. If this occurs, money will flow out of British markets at a prodigious rate.

If what's going on in Europe sounds familiar to Americans, it should. These were essentially the economic policies of the failed Carter administration in the late 1970s. During that era, the U.S. economy was chronically weak and the stock market went nowhere. This economic program instituted today could have far worse consequences. The global economy was severely damaged by the Credit Crisis and is still in a very fragile state. It is likely to go into a tailspin.  The predictable follow up will be a return to spending. This scenario happened during the Great Depression after Franklin Roosevelt tried to balance the budget after the 1936 election and the U.S. economy and stock market tanked. If elected officials today are determined to repeat the mistakes of the past, investors should take note and act accordingly.  
 
Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

A China in a Bull's Shop

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


After its own stock markets closed on January 12th, the PBOC (People's Bank of China) ordered a boost in the yuan reserve requirement ratio for banks by half a percentage point. U.S. stocks immediately sold off on the news, gold dropped $15 in only minutes, and the U.S. dollar also declined. The market viewed this as the beginning of a tightening cycle on the part of the Chinese. While analysts are debating this, it is almost certainly true. Claims that China beginning to tighten monetary policy now will be able to head off future inflation however are grossly overstated and can be put in the category of wishful thinking.

When it comes to bank lending, China has the opposite problem of the United States. Banks in the U.S. have yet to start lending again despite half a dozen support and giveaway programs from the Federal Reserve and Treasury Department that are meant to encourage them to do so. Bank lending in China is surging out of control though. Lending in the first week of 2010 was greater than the entire month of November 2009, which in turn was already strong. Analysts claim that PBOC's move will remove 200 to 300 billion yuan from the banking system. Bank lending in the first week of this year was 600 billion yuan, so the drop in liquidity caused by the new rules represents taking away half a week of lending. That should be about as effective as trying to take down an elephant with a fly swatter.

Only a significant change in monetary policy is going to have any impact on future economic numbers. Central bank interest rates are either zero or close to zero in most major economies. Raising that number half a point, a point, even two points still indicates an easy money policy. Even that is not going to happen in the foreseeable future. China itself uses interest rate hikes to cool down its economy and last did so in 2007. It has yet to start a new tightening cycle. Starting that cycle won't be enough to stop inflation either. Inflation is an insidious phenomenon that takes years to work its way through an economy. There is as much as a four-year lag between a period of easy money and a first peak in the inflation rate. That takes us at least to 2012. In the 1970s U.S., money supply expansion peaked in 1971 and inflation peaked nine years later in 1980. Trying to control inflation after money expansion has occurred doesn't work, unless severe measures are used.

Governments also fail to control inflation because they fail to focus on the cause. In China's cases, they froze their currency at the beginning of the Credit Crisis, so it is extremely undervalued. Keeping a currency at too low an exchange rate is highly inflationary. When inflation shows up in China in the not too distant future, the key to stopping it will be to significantly value the yuan upward. Other measures will prove to be ineffective, but like most government throughout history, China is likely to take the easy way out and avoid taking the necessary steps needed to reduce inflation.

As an interesting aside to China's bank announcement, it should be noted that the yen is selling off against the U.S. dollar. Almost every other currency is rallying against the dollar and some very strongly. It is quite clear that this was part of some central bank maneuver to drive down the yen. The large drop in the price of gold, which took place in minutes on the 12th, also required a large amount of capital backing it. Central banks have that large amount of capital. This ordinarily would have rallied the U.S. dollar strongly, but didn't. Manipulating the gold market is one of the old reliable techniques governments use to support the U.S. currency. Central bank actions rarely impact the markets for too long if there is no fundamental support backing up their moves. When the U.S. stops borrowing and printing money and raises interest rates substantially, real support for the dollar will exist. Until that happens, the long-term downtrend will continually reassert itself.

Disclosure: Long gold.

NEXT: 2009 Retail Sales Deconstructed

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Common Roots of Hyperinflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Rating agency S&P lowered its outlook for Spanish government debt on December 9th. Fitch lowered its long-term debt rating for Greece to BBB+ from A- the day before. In the eurozone, there are concerns about Portugal also being in trouble, although Portugal's debt to GDP ratio is no worse than the United States and a case can be made that the U.S. is actually in much worse shape - the U.S. has a large money printing press however and Portugal does not. No country can compare to Japan however with its debt to GDP ratio currently over 200%. An examination of the CIA Factbook figures for 2008 estimated that only Zimbabwe had a worse debt to GDP ratio than Japan's. Zimbabwe also had the second largest hyperinflation in world history.

The roots of all hyperinflations are governments not being able to fund their operations. Government's first borrow money to do so and this can go on for years or even many decades (the more powerful the government, the longer it can live off of borrowed money). At some point, the credit either starts to run out or the expenditures get so high that the amount that can be borrowed is no longer enough. It is then that governments resort to printing money (not literally done in advanced economies where money is simply created by pressing the enter button on a computer) and this devalues the currency. The devaluation is the result of simple arithmetic. Currency increasing at a faster rate than the size of the economy means each unit of currency is worth less and it takes more money to buy any given good or service than it would have otherwise. The price rises that result are consumer inflation. Many economists do not use this obvious definition of inflation, which is one reason why their inflation predictions are frequently highly inaccurate. Central banks particularly don't like it because it would prevent them from engaging in politically popular, but potentially disastrous monetary policy.

The Credit Crisis has led to a lot of money printing (frequently referred to as quantitative easing) globally and this is taking place after decades of increased borrowing in most countries. While money printing will lead to inflation, it only leads to hyperinflation when it spirals out of control. The preconditions for this are that borrowing power has been maxed out (which is now the case for many countries, but was not true in the 1970s and this is why it was possible to tame inflation back then) and it no longer becomes politically possible to match government expenditures with revenues. In the modern era, this is always a problem during wars since no state is capable of raising enough money through taxes to pay for any major or prolonged military effort (the U.S. accounts for over 40% of global military expenditures by the way). Contemporary democracies also get caught between the need for large outlays for social expenditures and the resistance of rich individuals and corporations to paying the taxes necessary for funding them, so they compromise and give both sides what they want. This problem is by no means brand new. It is essentially what lead to the hyperinflation in Germany in the early 1920s.

Once the preconditions for hyperinflation exist, a major economic shock can then become the precipitating incident. Governments will always assume that the problem is temporary and the economy can be righted quickly through a little money printing. In deep economic shocks like that depression in the 1930s and the Japanese banking crisis in the 1990s, and the Credit Crisis today, this is not the case. The problem will take at least a decade and possibly multiple decades to solve. The possibility for long-term money printing then exists (the U.S. did not engage in this in the 1930s). Zero or close to zero interest rates will mask the damage that is being created. This is what has allowed Japan's government finances to spiral out of control (combined with a huge pool of personal savings of the Japanese people that it could tap into) and is now enabling the U.S. and UK to do the same. At some point though interest rates have to rise and when they do, interest payments on the national debt can equal or exceed the government's tax receipts. The game is up long before that occurs however with a hyperinflationary spiral becoming inevitable. For this reason, it is now no longer possible to solve a future inflationary problem by raising interest rates to high levels as was done in the U.S. at the end of the 1970s. This approach now would be disastrous.

The U.S national debt increased by a $1 trillion in 2008 and $1.9 trillion in 2009. The damaged economy and the after effects of the Credit Crisis are likely to keep the increase elevated for many more years. After that, increased outlays from Social Security and Medicare caused by the Baby Boomers retiring will kick in, so there will be no respite. At some point the whole scheme will fall apart. When interest rates rise well off the zero level, this will be the tipping point that means that an inflationary spiral has started.

Disclosure: Not applicable.

NEXT: Short Bonds When Retail Sales Improve

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21


This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Silver Breaks Out of Trading Range

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Our Video Related to this Blog:

Precious metals had a spectacular rally on Monday. While spot gold was up 1.9% on the day and hit another all time high at $1140.80, spot silver and palladium were the stars, rising 5.6% and 5.7% respectively (platinum was up 4.2%). At more than one point silver was up over a dollar and ended trading at 5:15PM New York time up 98 cents to close at $18.42. Silver has been stuck in a trading range between $16 and $18 since September and this was the first decisive break and first close above that range. Trading volume on the EFT SLV was approximately double normal levels and was highly supportive of the move up.

Now that silver has made its move higher, the spot price needs to stay above $17.70 (the low for the day) to maintain the breakout. The reason silver was stuck at the $16 to $18 level was because of a band of resistance at those prices established in March to July 2008. There is a further resistance point around $19.00 that still needs to be taken out. After that, a test of the 2008 high just under $21 will be possible. Some more consolidation should be expected around those levels and this is likely to take place in December. Silver and gold are seasonally strong in the early part of the year though and tend to form intermediate tops in March or April, so a move to the $25 area, long-term resistance from the late 1970s, is a target price for silver next spring.

As the precious metals continue to rise, you will hear more and more talk about a bubble. Ignore it. One well-known market guru said gold was in a bubble just yesterday. While gold and silver will eventually be in a bubble, this is a long way off. They are in bull markets. The two should not be confused. The simplest way to distinguish the two is by the price patterns and extent of the rallies. Bubbles have spectacular price rises that have been preceded by long multi-year continual rallies. Silver had a price collapse from almost $21 to under $9 in 2008. It is rallying up from the bottom. This is not a bubble pattern. Gold is up 53% off of its bottom from last year. When it was in a bubble at the end of the 1970s, it went up 400% the last year. Silver was up 1000%. When you see price rises like those in a single year, that is when you need to worry about a bubble. Until then, the trend is your friend.

The other nonsense floating around the media concerning the precious metals is they are not at inflation-adjusted highs and this is somehow a negative. Is it really? The same could have been said about U.S. stocks in the 1980s. Stocks had a major rally from those levels until they reached their inflation adjusted highs in the 1990s. Then, stocks had an even bigger rally after they reached this level. When an asset isn't trading at its inflation-adjusted high, this is a reason to invest in it because it means big profits can be made. Gold and silver have been reminding us of this almost every day lately.

Disclosure: Long gold and silver.

NEXT: U.S. Inflation Reports - Contradictions and Absurdity

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Commodity Shortage Disaster in the Making

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

The government is planning on doing something about those pesky speculators that keep driving up the price of commodities. Even though this has been tried thousands of times previously and has NEVER worked - and even though we have the example of the complete economic collapse in Eastern Europe that this behavior caused - and even though last falls ban on short selling of financial stocks didn't prevent their prices from falling off a cliff - this will not discourage the U.S government from creating a new mess in the commodities markets. It is true that some people never learn and it appears that many of them get elected to political office or work as regulators.

The CFTC (Commodity Futures Trading Commission) announced yesterday that it will hold hearings this month and next to explore the need for government-imposed restrictions on speculative trading in oil, gas and other energy markets (even though natural gas is at a multi-year low and oil is 60% off the high it reached one year ago). The CFTC can also set restrictions for other commodities as well and can change margin requirements for trading (and this is also being bandied about). ETFs, which are used as investing vehicles by small investors, were especially singled out for restrictions.

It has been pointed out that insiders like the floor traders and commodity trading firms in Chicago are unlikely to be impacted by the CFTC proposals that are supposed to be protecting the public and not the industry. For those not paying attention, commodity prices nose-dived before this news was released, not after. Probably just an amazing coincidence and not the insiders getting the word before the public (if you believe that, I have a bridge in Brooklyn that I'd like to sell you). It is quite clear that if anyone gets disadvantaged from changes in CFTC policy, it is meant to be the small investor who relies on ETFs and not the big players.

Political pressure is being put on the CFTC by senators Bernie Sanders, who is a Socialist even though the media describes him as an independent and Bryon Dorgan, the biggest economic ignoramus in congress -and that's really saying something, and congressman Bart Stupak from Michigan who wants lower oil and gas prices to protect the state's auto industry (or what's left of it). Attempts to control oil and gas prices were last tried in the U.S. in the early 1970s when Nixon imposed wage and price controls. Oil producer profits were cut to such an extent that U.S. oil production dropped substantially. The U.S. which had been self-sufficient in oil up to 1969, then became extremely dependent on foreign sources. OPEC was then blamed for the shortages and big price hikes that followed, but it was U.S. policy that made it all possible. Did the government blame itself? Of course not! It was those rapacious speculators and evil foreign forces that made it happen. Historical analysis of past inflations shows very clearly that without exception speculators and foreigners are blamed for inflationary price rises that originate with government printing too much currency and then attempting to limit the mess it engendered with price controls. This scenario has played out hundreds, if not thousands, of times. This time will be no different.

The forces of economics can no more be banned by government action than gravity can be outlawed. So what is likely to happen? Since commodity trading is not limited to the U.S, but large active markets exist in London, Tokyo, Hong Kong, Singapore and up and coming Dubai, expect trading to increasingly move to those places. Dubai in fact wants to capture more commodity trading business. When U.S. policy hands this to them on a silver platter, except to hear how those scheming Arabs stole this activity from the U.S. ETFs also exist in the English, Canadian and Australian markets (and some others), that American small investors can get access to. Investment money will simply move out of the U.S. - at least until the government tries to impose capital flow restrictions to prevent this (expect this at some point in the future).

If prices of oil are held down temporarily (and it will only be temporarily) by CFTC restrictions or other government action (yes, this will be coming) you can expect shortages in gasoline, heating oil and diesel. There were long gas lines in the 1970s for good reason. While people had to wait a long time and sometimes could only gets a limited quantity of gas, they still got some gas. Heating oil was in danger of running out in certain places - like Minnesota - as well. Things could get much worse this time, since shortages are the only thing you can rely on from price controls. Even worse, prices always wind up higher than they would have been if the price controls had never been imposed in the first place.

One more piece of advice. In case the U.S. government does decide to outlaw gravity and some politician tells you it's safe to jump off the capital building. Make sure you reply, "You first".

NEXT: Government Price Controls in the Making

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21


This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Market Backdrop for 2009 - the Big Picture

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

Let's recap what took place in took place in the market in 2008. It was a year of huge price variation. Below the price ranges of the major indices and commodity ETFs:


DJIA ----------- 7392.77 low---13338.23 high
SP500 -----------741.02 low --- 1471.77 high
Nasdaq ---------1295.48 low--- 2661.50 high
Russel 2000 ------371.30 low ----768.46 high
Oil (the ETF) -----19.38 low ------88.15 high
GLD --------------66.00 low-----100.44 high
SLV----------------8.45 low------20.73 high

The end of the year is always a good time to look at the big picture for the indices as well. As we have mentioned in this blog several times, the 200 month simple moving average is a key support level that it rarely violated. The last two times this has happened was in the mid 1970s, when it occurred for around 6 months and in the first half of the 1930s, when it lasted for a few years. At the end of 2008, all the major indices violated their 200-month moving averages in the last 3 months of the year. The Dow Jones and Russell 2000 have not closed below it on a monthly basis however, while the S&P 500 and Nasdaq have had 3 closes below this line. For the market to indicate that it is becoming healthy again, the indices need to move above the 200-month moving average and stay above it as happened in the 1970s (even then it still took many years before a major bull market began again).

The monthly charts also indicate that at the very least some sideways consolidation is necessary for awhile before any longer lasting move up is likely to take place. There can be tradeable rallies in this sideways pattern, which lasted around 8 months in 2002/2003. The indices also have a tendency to double or triple bottom and this is particularly true for the S&P 500. If you look at a longer term chart, you will see a double S&P bottom so far in 2002 and 2008 (and a double top in 2000 and 2007). The S&P making a triple bottom (and even a triple top in the future) is something that should be considered.

Best of luck with your trading in 2009.

NEXT: What We Learned from the First Trading Day of 2009

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Muriel Siebert Discusses the Credit Crisis

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

At the January 9, 2008 meeting of the New York Investing meetup, I had the pleasure of interviewing stock market legend Muriel Siebert. In 1967, Siebert became the first woman to have a seat on the New York Stock Exchange. In the mid-1970s, she was appointed Superintendent of Banking for New York State. No bank failed under her tenure. In her more than 50-year career on Wall Street, Muriel Siebert had personally witnessed almost the entire post World War II financial era. She had seen it all and had done it all.

Highlights of the this historical interview with Muriel Siebert have been condensed to three eight minute videos, which can be seen at:
http://www.youtube.com/watch?v=UHxRCNd0HSI
http://www.youtube.com/watch?v=bZLsD2DHvLw
http://www.youtube.com/watch?v=_tL2bOmkMwo

In the interview, Siebert indicated that things had changed considerably since the 1970s, the last period of high U.S. inflation. The U.S. had lost its dominant economic status and emerging economies around the globe were not as dependent on it as that had been previously. She also pointed out how their growth was creating a voracious demand for commodities and the wealth transfer from rising commodity prices enabled the takeover of major U.S. financial institutions by commodity producing countries like the Gulf states. She was not sanguine about the prospects for the U.S. dollar, pointing out that the U.S. needed to cut the deficit considerably to support it and the consequences of doing so would be severe.

Siebert said the she had seen nothing like the subprime crisis during her long career on Wall Street. She thought the abuses had been so extreme and damaging that some people involved in creating the problem should go to jail. Siebert asked, "Where were the regulators?; "Where were the rating agencies?"; and cited mortgage brokers as being key players in generating the large quantity of irresponsible loans. The subprime crisis wasn't the only thing she thought we had to worry about either. She mentioned the collapse of private equity and how this had helped juice the market up and that its loss would cause the stock market to fall.

Siebert pointed out the similarity between how Enron hid its financial activities and the banks had done so in the 2000s by pushing their subprime activities off-shore and off-balance sheet. She stated that under Sarbanes-Oxley that audits should be complete by March 31st and a clearer picture of just how extensive the damage was would begin to emerge. Her opinion was that no one really knew how big the problem was. Siebert mentioned the large amount of derivatives that now exist and the complete lack of regulation for them. She thought the we need global security regulation that should be instituted on a similar model as global banking regulations that are now in place. Siebert thought that there was too much leverage in the system and said this was what really scared her, although she concluded that she didn't see a 'total' collapse of the financial system.

NEXT: Central Bankers Gone Wild

Daryl Montgomery

Organizer, New York Investing meetup

For more about us, please go to: http://investing.meetup.com/21