Debt Crisis Back in Greece, U.S.Has Borrowing Problems Too

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.


The markets are telling us that the Greek debt crisis, which has supposedly been solved numerous times, is still with us and getting worse. Interest rates on Credit Default Swaps on Greek bonds hit a record 495 basis points on April 21st. While Greece is at the end stage of a sovereign debt problem, the U.S. is at the beginning. Some U.S. corporate bonds have recently had lower interest rates than equivalent treasuries indicating that the market believes those companies are in a better financial position than the U.S. government.

The problems that have arisen in Greece are those that occur when a government borrows too much money relative to its GDP. Eventually the interest payments on the debt become overwhelming and default becomes inevitable. Default can take place in two ways however. It can be a simple failure to make interest payments on bonds or it can result from a major inflation of a currency. With inflation borrowers get the nominal amount of money due them, but that money doesn't have the same purchasing power. Since Greece is part of a currency union and can't print its own money, it can only default by not paying off its bonds. The U.S. on the other hand, can print all the money it wants to so it can only default through inflation.

Up to now Greece has had no problem borrowing money. The problem is that the interest rate it has had to pay in the last several months is so high that it undoes the effect of budget cutting measures taken to get its fiscal house in order. The recent EU and IMF proposed 45 billion euro aid package makes funds available for Greece, but didn't do so in a manner that would lower Greece's interest payments. Unless Greece gets access to large amounts of credit at well below market rates, there is no possibility of it avoiding default. Even if it does, sovereign default in all likelihood will simply be delayed.

So what are the implications for the U.S.? The U.S. is not much more fiscally responsible than Greece is, but is does have the reserve currency of the world and a very big printing press. The U.S. can get away will a lot more than Greece does before an irreversible credit disaster begins. In the last few years, the national debt in the U.S. has been skyrocketing because of the Credit Crisis and the recession that followed. It was  estimated in the proposed 2010 federal budget that that the U.S. will owe slightly more than  $14 trillion by the end of the fiscal year. Debt service was listed as $164 billion.

Based on the budget figures, the U.S. is paying approximately a 1.2% interest rate on its national debt. Could interest rates get any lower than that? Not likely, especially considering that Federal Reserve has kept short term rates around zero. If interest rates return to a more normal, but still relatively low four or five percent, debt service would rise to around $600 billion, without any further increases in borrowing. U.S. federal debt is continually increasing by large amounts however. If 1970s interest rates return, debt service would eventually rise to around $2.4 trillion for the current debt, which is approximately the total estimated revenue for the federal government in 2010. Long before that happened, money printing would be a major source of revenue needed to run government operations on a day to day basis - and hyperinflation would become unavoidable.

The market has been sending hints lately that it is not happy with the U.S. fiscal situation. Interest rates on corporate bonds from Berkshire Hathaway (BRKB), Proctor and Gamble (PG), Johnson and Johnson (JNJ), Lowe's (L) and Abbot Laboratories (ABT) have been lower than equivalent U.S. treasuries at some point in the last few months. Corporate interest rates should never be lower than government rates, at least in theory, because corporations are supposed to be riskier than a government. The market is telling us that it sees things the other way around. Investors should consider this a long-term warning.

The euro (FXE) of course sold off on the latest developments in Greece, but did not make a new low. The market may therefore have already priced in the full impact, at least for the moment, of debt problems in the eurozone. There are more potential problems there in Portugal, Ireland, Spain and Italy however. Whether the market will continue to see those as more significant than the debt problems in the U.S. is still an unanswered question.

Disclosure: Not relevant.

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.

Euro Zone Support Package Doesn' t Solve the Problem

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 many press reports over the last two months about a possible bailout for Greece, euro zone leaders seem to have finally come up with a plan to handle the crisis. The plan however will only be used as a last resort, is limited to loans at market interest rates, and requires unanimous agreement from all member countries before aid can be granted. Euro zone countries would provide about two-thirds of the loan money and the IMF the remaining third. Given the restrictions, the support package is likely to have limited impact.

While no loan amount has been specified, unofficial sources indicated that 22 billion euros was the proposed amount. Greece has to borrow 20 billion euros in April and May alone. Greece has not had problems borrowing money so far, but has had to pay high interest rates to do so. The high rates are causing problems because more money has to go to debt service and this means less money for other government spending elsewhere. The country has already been plagued with riots because of its enactment of budget cuts and higher taxes. The euro zone support package though doesn't lower borrowing costs for Greece. It only assures that Greece will be able to continue to borrow in case no one else will lend to it. Essentially the euro zone, along with help from the IMF, has established a policy of acting as a lender of last resort for its sovereign entities.

Admittedly, the euro zone has to trod a very narrow path in the extent of its aid to member countries. If Greece were the only member in trouble the situation wouldn't be so delicate. The Credit Crisis has devastated Europe, just as it has the rest of the world. The more economically marginal countries have suffered the most. Greece is merely the canary in the coal mine. Ireland just released fourth quarter GDP figures indicating that its economy shrank at a 5.1% annualized rate. GDP contraction there in 2009 was the largest on record and that includes all the years of the Great Depression in the 1930s. Italy's GDP dropped 5.1% in 2009. Official figures indicate that Spain's economy was 3.6% smaller for the year. Portugal, which just had its debt rating downgraded by Fitch, claims that its GDP was down a mere 2.7% in 2009.

While all of these numbers are bad, they could actually be even worse. The media reported that Greece shocked markets and other EU nations when it admitted it falsified its statistics to make its budget deficit look much lower than it was, even though the numbers was obviously impossible. The original Greek government figures projected a budget deficit to GDP ratio of 3.75% for 2009 and below 3% (the euro zone target for members of the currency union) for 2010. Greece also claimed that its GDP would increase by 1.1% in the midst of the severe global downturn that was taking place last year (as of now it looks like GDP dropped 2.0%). While these fantasy figures were treated as reality at EU headquarters, the OECD didn't buy them. Long before the Greek government admitted to the truth, it estimated that the budget deficit to GDP ratio would be 6% in 2009. So far, it looks like it will actually be 12.7% - around 250% higher than initially claimed by the Greek government. If such outrageous fabrications could be accepted, would 50% or even 100% errors be discovered?  Greece is not the first country to lie about its economic statistics. Only the very naive would assume that there aren't many other countries doing the exact same thing. Moreover, Greece only got caught because it turned itself in.

Denial on the part of euro zone governing bodies is what has lead to the current crisis with Greece. In order to avoid future problems, the euro zone needs to assure the integrity of the numbers produced by its member countries, so no other major surprises will take place. There also needs to be a more formal mechanism to establish economic equilibrium among member nations as well. The potential trouble spots in the euro zone are characterized as relying excessively on consumer spending, having weak public finances, and relying on foreign capital to supplement low savings rates. Interestingly, this is also an excellent description of the United States.

Disclosure: None

NEXT: U.S. Consumer Spending: Not Inidcating Economic Recovery

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.

U.S. Stock Market in the First Quarter of 2010

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.


Today is quadruple witching, a once every quarter event that takes place on the third Friday of March, June, September and December. On these dates, contracts for stock index options, stock index futures, stock options and single stock futures all expire. While media reports usually focus on volatility during the expiration date, far more important is the trading that takes place in the proceeding weeks. Prices will tend to move to minimize the value of outstanding options due to hedging, if not for other reasons. A negative outlook in February seems to have led to a nice rally in U.S. stocks during March.

Stocks started the year off with a mildly bullish tone and hit a peak in mid-January. The Nasdaq and Dow Transports hit a high on January 11th, the Dow Jones Industrial Average on January 14th and the S&P 500 and Russell 2000 on January 19th. All the indices sold off into February on news of reductions in liquidity from the U.S. Fed and restrictions on bank lending in China. The moves withdrew very little money from the global financial system however. The world's markets are still awash in liquidity. The U.S. dollar was also rallying during this time and since the stock market rally began in March 2009, the dollar and stocks have tended to move in opposite directions.

Stocks then started rallying off their February lows in a stronger dollar environment. This pattern first became evident recently in December 2009 when the trade-weighted dollar rallied strongly and so did stocks during the month. It would perhaps be more accurate to say the euro experienced significant weakness during these periods because of the crisis in Greece (the euro represents over half of the trade-weighted dollar). December represented a shift in trading patterns for the U.S. dollar and stocks for the current the rally.  Investors should note if the strong-dollar strong-stock pattern continues. While it was common in the 1990s, the opposite has been the case for much of the 2000s.

All the major indices hit new current year price highs recently. The Russell 2000 was the first on March 2nd, followed by the Nasdaq on March 5th, and the S&P 500 on March 12th. The Dow Transports hit a new high on March 10th before the Industrials hit a new high on March 17th. New highs are of course generally bullish.  Small caps have been doing best in the rally. This indicates higher risk tolerance on the part of investors and is also something that happens in inflationary environments. Small caps outperformed during the second half of the high-inflation 1970s following the deep recession of 1973 to 1975.

U.S. stocks can continue to do well as long as liquidity is being pumped into the financial system. Liquidity is the driver of prices and not the economy as the mainstream media constantly reports. Liquidity shows up first in the markets and later on in the economy if everything works according to plan. The Japanese in the 1990s and 2000s found that this Keynesian style plan didn't always work however. If things get too bad because too many excesses have built up in the financial system, the liquidity fix is no longer effective. U.S. investors also need to realize that money has flowed out of Europe and into the U.S. and a resolution of the Greek crisis will cause funds to flow out of the U.S. and back into Europe. Moreover, actions the Chinese take can also impact U.S. stock prices. China raising interest rates would be a negative for U.S. markets. Revaluing its currency upward would also shake things up.

Disclosure: None

NEXT: Who Really Benefits From the U.S. Healthcare Bill

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 Dollar, Euro, Gold, Oil, and Treasuries

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.


Problems in Greece are still impacting the market with the seemingly never-ending on-again off-again possible bailout. Some resolution, even if temporary, is of course inevitable. Problems in the euro zone have set the tone for U.S. dollar and euro trading for almost four months now. These have in turn affected U.S. long-term treasuries, gold and oil. Long-term treasuries and oil have been trading in a sideways pattern since around May 2009. Gold sold down and has been in a sideways trading pattern since December. The U.S. dollar has temporarily broken a long-term downtrend and the euro a long-term uptrend because of the Greek crisis.

The U.S. trade-weighted dollar(DXY)traded down to its 50-day moving average recently and then bounced sharply off of it. The 50-day is above the 200-day, having made a bullish cross in mid-February. It seems that the trend indicators are trying to reconfirm the uptrend. On the flip side, the euro's(FXE)technical picture is the mirror image of the dollar. The 50-day moving average made a bearish cross of the 200-day in mid February. The price rose toward the 50-day recently - an expected move since the 50-day tends to act as a magnet on the downside as well as on the upside. The euro though didn't even reach the 50-day before a sharp drop. Trend indicators look like they are moving to reconfirm the downtrend

Gold (GLD, IAU, SGOL) is apparently trendless at the moment and trading around its 50-day moving average, which is above the 200-day moving average in a bullish configuration. The price pattern seems to be forming a triangle on the charts. A break out could take place either on the upside or downside. Seasonals for gold tend to be weak in late spring and early summer. As seasonals weaken for gold however, they strengthen for oil . Oil (DBO, USL, USO, OIL) is also trading in a sideways pattern and looking for a breakout. The bullish 50-day cross took place between late June and late July 2009 depending on which proxy is being considered. Oil has been stuck in a trading range since last May and needs to break out of that range, the top of which is around $83 a barrel for light sweet crude.

The 30-year Treasury interest rate ($TYX or ^TYX) has been in bullish pattern since May 2009 with the 50-day trading above the 200-day. It has gone nowhere fast during that time period, trading in a sideways pattern on the chart. Technically, it has extremely strong resistance from a 30-year downtrend line in interest rates. A rally in interest rates on the long-term treasuries (and sell off in the bond price) doesn't look imminent at the moment based on the technical picture. When it does, bullish trades on long-term treasury interest rates can be made through TBT and TMV.

Sideways trading (also known as basing) shouldn't surprise investors. It is the norm and not the exception. Most of the time markets are trendless and you need to be a short-term trader and willing to enter and exit your positions quickly to make money under those circumstances. Trends (either up or down) are where the real money is made. You can't make them happen however, you just have to watch and wait until they come along.

Disclosure: None

NEXT: U.S. Stock Market in the First Quarter of 2010

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.

Fed Sends a Message With Discount Rate Hike

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.


The U.S. Fed raised its discount rate after the market close on Thursday, February 18th. The rise in rates from 0.50% to 0.75% was characterized by the central bank as further normalization of the Fed's lending facilities. While the Fed's discount rate action is mostly symbolic, it raises the question of when the historically ultra-low fed funds rate will be normalized. As would be expected, the U.S. dollar rallied and gold sold down on the news.

The discount rate is not an important factor in control of money supply, but is the Fed's mechanism for getting money to banks when they are in crisis, either individually or because of a systemic shock. During the Credit Crisis the Fed created a number of new programs to temporarily accomplish this goal. Five of those programs were ended on February 1st. Another one, the TAF (Term Auction Facility), will have its final auction on March 8th. Prior to the Credit Crisis, the discount rate was usually a full percentage point above the fed funds rate. Even with the recent rise, it is only half to three-quarters point higher. We are still not yet back to the way things were pre-Credit Crisis. Fed Chair Bernanke has been saying the U.S. banking system was fixed for many months now. If that is the case, why has he waited so long to get the Fed's operations back to the way they have been historically when there is no crisis?

The last time the Fed began a major policy change was with a move in the discount rate. The Fed first cut this rate by 50 basis points in August 2007. One month later, it started lowering the fed funds rate and continued doing so until instituting its current zero to 0.25% rate policy in December 2008. While Bernanke's signature approach is to change the discount rate first, the time lag is likely to be longer than one month this time. Members of the Open Market Committe may already be losing their patience for ultra-low rates however. The Kansas City Fed Governor dissented at the January meeting on the fed's message of "exceptionally low levels of fed funds rates for an extended period". He wanted language that indicated something briefer.

Higher U.S. interest rates are of course bullish for the dollar. Although the U.S. will have to raise rates by 0.50% to be higher than Great Britain's rates, by 1.00% to outdo the euro zone, and by 3.75% to challenge Australian rates. The U.S. trade-weighted dollar continued its rally on the Fed news and is flirting with nine-month highs. The euro on the other hand fell as low as 1.3443 on the news. Technically, the dollar confirmed its rally with the 50-day moving average moving above the 200-day - a classic buy signal.  The euro has the opposite chart pattern and the 50-day average having dropped below the 200-day earlier this month. Gold held up better than expected. February is a month of strong seasonal buying for the metal and this has provided enough buying pressure to prevent significant drops for now.

Disclosure: No positions.

NEXT: Greece's Statistical Lies - Are the Numbers Any Better in the U.S.?

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.

China Worries About Inflation, The EU Needs to Worry About Growth

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.


The Chinese just announced a second increase in reserve levels for their banks. The first increase took place less than a month ago. That announcement was the earliest of three major withdrawals of liquidity from global markets. The other two were the U.S. Fed closing down five of its Credit Crisis liquidity injection programs on February 1st and the Bank of England temporarily halting its quantitative easing (read money printing) program shortly thereafter. Stocks and commodities started selling down with the first Chinese announcement and continued selling off with the others. Global markets got hit again with the second announcement and adding to their worries was a poor GDP report coming out of the euro zone.

China has been leading the world out of the global recession. This hasn't occurred by magic. It has engaged in a huge amount of stimulus to reeve up its economy. While doing so it also froze the value of its currency, the yuan, and this has kept it tremendously under valued compared to a free market price (some estimates are that the yuan should be 40% higher, even a greater amount is possible). Economic stimulus and undervalued currencies are both in and of themselves inflationary. The combination of the two in large amounts can be explosive. So China is understandably trying to lower liquidity in its economy by reigning in bank lending. While these efforts are minimal so far, traders are anticipating more serious efforts down the road. Food inflation is a particular danger for the Chinese and too much of it can risk political destabilization. Food prices are already rising in many parts of the world and reached over 19% in next-door India at one point in December.

While the Chinese have probably engaged in the most significant stimulus measures globally for any sizable economy, the euro zone has not been as nearly aggressive. While the U.S. lowered its funds rate to zero, and the UK to 0.5%, the interest rates in the euro zone were only dropped to 1.0%. Less stimulus in the euro zone means less inflation in the future, but also means less economic recovery now. Fourth quarter GDP figures came in at 0.1%, indicating overall growth is flat. Leading economy Germany had a zero percent quarter over quarter growth rate. Much troubled Greece's economy sank 0.8% from the previous quarter. Italy was down 0.2%. For all of 2009, the size of the 16-nation euro zone economy fell 4%. Growth in the 27 member EU (a number of countries in the EU don't use the euro) was also only 0.1% last quarter. No matter how you look at it, Europe is economically weak.

In mainstream media reporting of Europe's predicament, one major news service stated, "the recovery in the third quarter now appears likely to have been due to temporary factors like government spending boosts, a build-up in inventory levels and car scrappage schemes that pay people to trade in old cars". The exact same factors have boosted GDP in the U.S., although that wasn't mentioned. The U.S. reported 1.4% quarterly GDP growth for the last quarter of 2009 and this was triumphed in news coverage. Investors can expect that number to be revised downward as was the case with the original third quarter figure. Greater stimulus in the U.S. has been one reason that American GDP numbers have been better than in Europe. Another reason is that the U.S. is willing to engage in more blatant manipulation of its economic statistics.It's a lot easy to 'fix' the economic numbers after all than it is to actually fix the economy.

A slow down in the Chinese economy will have a strong impact on the Western industrialized nations. Much of the improvement that has taken place since the depths of the Credit Crisis in the fall of 2008 has been because of increased demand from China.  The economies in the U.S., UK, Japan and Europe are still very weak. Based on recent actions, the powers that be in the US and UK seem oblvious to this. European leaders seem to be no sharper. Proposed austerity programs in the troubled euro zone economies - Greece, Ireland, Italy, Portugal and Spain will only cause further economic contraction. The fix for the Greece's debt problems - details are still forthcoming - is likely to be a win/lose situation.

Investors should expect that industrialized countries will be on inflation watch for a while longer. At some point even the incredibly oblivious U.S. Fed Chair Ben Bernanke will realize that there are still economic problems that have yet to be solved. More stimulus will follow. Stimulus is what has been behind the global market rallies that began in March 2009. Reduction of stimulus is what is behind the sell off that started in January. Investors should watch for signs that stimulus is returning. Until then, stock and commodity prices are likely to be pressured.

Disclosure: No positions.

NEXT: China is Selling Its U.S. Bond Holdings

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.

World Economic Leaders Need IQ Bailout

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.


There are few things investors can count on during our current era of financial turmoil. One of them is the unerring obliviousness and incompetence of the world's elected leaders and central banks. Somehow they both manage to find the highest cost, least effective solution for every Credit Crisis problem they try to solve. Moreover they usually don't bother to act until every dog in the street has been aware of the problem for some time. There was more than enough support for this view on both sides of the Atlantic today.

There was a summit meeting in the EU today, where the leaders of the 16-nation block struck a deal, at least in principle, on assisting Greece with its debt problems. No details of the rescue package were forthcoming, but there were suggestions of some form of loan program. This is enough to open up the Pandora's box of 'moral hazard', but probably won't be enough to fix the problem - at least not with the initial measures. The final cost for any help to Greece will be much more than early expectations and this will pale in comparison to the cost of future bailouts for other member states such as Spain and Italy.

The whole scenario currently taking place in the EU should seem vaguely familiar to Americans. The much maligned TARP bailout program was initially only supposed to be loans, so it wasn't really costing the taxpayers anything. A number of other bailout programs mushroomed around it and by some estimates reached $11 trillion in promised money (compared to $700 billion for TARP).  While it has been claimed that some TARP money was returned, it is not clear how much actually was. When Citibank announced it was paying back $20 billion (of the $45 billion it received), the U.S. government agreed to give it a $38 billion tax break. It's not clear how many similar deals were worked out to shift the burden from a loan program to a direct cost for the American taxpayer, who after all would have to pay extra taxes to make up for the federal government tax breaks given to the big banks.

While the EU leaders were busy sowing the seeds of future financial disaster for their currency union, the ever out of touch U.S. Fed chair Ben Bernanke was testifying on Capitol Hill about a proposed exit strategy from his easy money policy. As a reminder, Bernanke didn't realize that subprime loans would cause a problem, didn't realize the U.S. was in a recession months after it had begun, and didn't realize that not bailing out Lehman would lead to a possible collapse of the world financial system. Now he doesn't realize the recession and economic problems caused by the Credit Crisis are still not over.  At least he's consistent.

Those who think the U.S. economy is healthy only have to look at the state of the housing market. Almost one in three borrowers have mortgages that are for more than the value of their property. As of November 2009, 5.3% of U.S. home mortgages are three or more months behind in their payments. A year earlier in 2008, it was only 2.1%. In 2009, 2.8 million mortgage holders received a foreclosure notice. Current estimates are this number will rise as high as 3.5 million in 2010. Fannie Mae and Freddie Mac, both nationalized by the U.S. government, have just announced that they will buy back troubled loans contained in securities they have sold to investors (this is a major bailout for the big money players, although the mainstream media did not report it as such). Last year, the Obama administration pledged to cover unlimited losses for both companies through 2012. Draining liquidity from an economy with these conditions in the housing market would send the U.S. into a major depression.

The U.S. experience in the Credit Crisis shows that once you start bailouts, there is potentially no end in sight for how many there will be, nor any limit to the final cost. The disaster precipitated by not bailing out Lehman Brothers also indicates that you must bail out everyone once you start the process. Of course, bailing out no one is the other option. Half and half measures don't work and produce the worst results at the greatest costs. The EU seems not to be aware of this lesson. Maybe they're getting their advice from Ben Bernanke?

Disclosure: No positions

NEXT: China Worries About Inflation, The EU Needs to Worry About Growth

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.

Economists and Governments Pave the Way for Global Inflation

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.


In a just given speech at the London School of Economics, famed economist Joseph Stiglitz stated that the U.S. and UK should keep on spending and printing money to prop up their economies. Stiglitz apparently did not mention that recent hyperinflation basket case Zimbabwe followed this same approach. Meanwhile, plans for either an EU or German bailout of Greece continue to swirl about, taking the EU down the road of Moral Hazard and truly huge future bailouts for its member states. Government spending, bailouts, and money printing all go hand in hand.

The Stiglitz speech will be seen as a historically significant event. Stiglitz is not some minor, unknown economist, but is an insider's insider. Stiglitz is a winner of a Nobel Prize in Economics, former Chief Economist at the World Bank, former Chair of the Council of Economic Advisors, and has held economic professorships at a number of top universities. In his speech, he essentially stated that it is impossible for the US and UK to default on their debt because they have unlimited ability to print money. While this is certainly true, it is also simplistic, self-destructive, and immoral.

Money printing erodes the value of a currency and governments that engage in it are acting dishonestly since it is essentially legalized counterfeiting. Yes, they will give their lenders back the same nominal amount of money as was originally given to them, but lenders won't be able to buy as much with it as they could have previously. Lenders usually catch on to this scam pretty quickly and demand increasingly higher interest rates to compensate for the loss in value of the government bonds they are buying. Needing to pay more interest, the government then prints more money. An inflationary spiral results and the government can't stop the printing because doing so risks an economic collapse.

Stiglitz's approach is hardly original. This is the strategy that every country in history has followed that has experienced hyperinflation. Zimbabwe is only the most recent example; there are dozens of others in the last hundred years, with Greece being one of them. In all cases, the only thing that stopped the inflation was when the money printing stopped. This was most blatantly demonstrated in Zaire in 1997 when the government couldn't pay the outside printer of its currency. It received no new paper money and its hyperinflation ended abruptly. The Weimar Republic in 1920s Germany managed to stop its money printing by creating a new currency (a common solution) and backing it with hard assets. Top German economists during the Weimar Republic backed the government's money printing plans, just as Stiglitz is doing today for the U.S and the UK. 

While the U.S. and UK are well along on their money printing agendas, the EU has lagged behind. The impending bailout of Greece will help them catch up. Greece, in and of itself, is not that big. It is only 2% of the euro zone economy. The implications of a bailout for the future are enormous however. There are a number of other countries in the euro zone that will need their own bailouts. While Ireland, Portugal and Spain are on the list, the most serious problem by far is Italy. Italy is perhaps one year behind Greece in the deterioration of its financial condition. Its economy is approximately the same size as the UK's. How is it possible to bail out an economy that large?  How much money would have to be printed to accomplish this? It would take quite a lot obviously and the euro would be damaged considerably.

We are living in times when almost every government is engaging in policies that will devalue their paper currencies. Hard assets unquestionably become more valuable under such circumstances. How much the U.S. dollar, the British pound, the euro and the yen devalue in relationship to each other remains to be seen. The Japanese have the worst debt to GDP ratio of any major economy in the world and are approaching levels last seen in Zimbabwe. The UK and the US have been the biggest money printers so far, but the euro zone might catch up and surpass them. The best approach for investors would be to avoid keeping any significant amount of liquid assets in any of these currencies.

Disclosure: No positions.

NEXT: World Economic Leaders Need IQ Bailout

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.

Will EU Accept Greece's Trojan Horse of Debt?

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.


International markets are looking for resolution to the debt crisis in Greece. European Union leaders have a summit meeting on February 11th and either a debt restructuring or a bailout of some type is on the wish list of traders. Whatever happens however will only be at best a temporary solution that will delay the day of reckoning for the global financial system. In the short-term, it will not undo the damage done to the euro nor to the stocks and commodities that have been impacted by the currencies current drop.

The problem in Greece is neither new nor exceptional for the EU. The conditions of the currency union in the euro zone have been violated from day one. The Maastricht Treaty set a limit for budget deficits of 3% of GDP and a 60% limit for the debt to GDP ratio of participating countries. The euro was launched in 1999 and replaced individual country currencies in 2002. Germany itself, the economic powerhouse of Europe, had a budget deficit of at least 3.7% between 2002 and 2004. France also violated the treaty conditions within the first three years, as did Portugal. The Netherlands did so in 2003. Initially Greece appeared to be in compliance, but was later accused of manipulating its statistics (a historical commonplace for fiscally irresponsible governments) and later admitted that its budget deficit averaged 4.3% between 2000 and 2004.

The euro currency union actually helped countries reduce their budget deficits by lowering their borrowing costs. When the debt to GDP ratio becomes large, reducing interest payments can reduce the budget deficit considerably. This phenomenon benefited Italy tremendously. Interest rates on Italian government bonds fell from around 12% in 1994 to 4% in 2004. It also improved the situation in Belgium. Belgium's debt to GDP ratio was 134% in 1993, but only 90% in 2008. It has never gotten anywhere close to the 60% limit. Italy's debt to GDP ratio in 2008 was 106% and is growing rapidly. It will not be long before it reaches Greece's 120% level. Yet, the market is focused more on Portugal with an 85% ratio - equivalent to the official numbers in the United States (the actual numbers are similar to Greece's) and Spain which has only a 66% debt to GDP ratio.

The EU rules don't have any provisions for bailing out one of the members of the currency union. Such legal niceties though can easily be ignored during a crisis. The EU executive committee has furthermore previously maintained that no bailout of Greece will be needed. Mid-day on February 9th however, news was released stating that the euro zone countries have decided in principle to aid the debt-stricken country. Reports indicated that the EU authorities were considering a range of possible actions, but no specifics were given. The euro of course rallied strongly on the news.

The euro has traded down from a high around 1.51 to the U.S. dollar in late November to the 1.36 level on February 5th. It is trading well below its 200-day moving average at the 143 level. The 50-day moving average, also at the 143 level, is about to cross the 200-day and trade below it, giving a classic bear trading signal.  The euro will not be able to recover from this technical damage overnight. Nevertheless, sharp counter rallies are inevitable since short positions on the euro have reached a record. This will create conditions for a nice longer-term rally in the future, but a period of volatility is more likely first. Commodities, particularly the precious metals, and U.S. stocks tend to trade with the euro, so investors should expect them to follow this pattern as well.

Disclosure: No Positions

NEXT: Economists and Governments Pave the Way for Global Inflation

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.

Currency Markets - California Dreaming is Greek to Me

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.


The trade-weighted U.S. dollar has been rallying since early December 2009. Except for a sell off after the beginning of this year, the rally continued because of trouble in the euro zone centered around Greece. The euro, representing more than 50% by weight of the basket of currencies that make up the trade-weighted dollar, hit a seven-month low and lost more than 7% of its value from its recent high. It takes a huge leap of logic to think that fiscal troubles in the euro zone are bigger those in the United States, but this is what the mainstream media has dished up as the explanation for what is going on. The invisible hand of the ECB (European Central Bank) manipulating the currency markets would offer a more rational explanation.

Greece represents 2% of the euro zone economy, compared to California which represent 13% of the U.S. economy. Both are in fiscal trouble. Neither can print their own money to get out of that trouble because they are both part of currency unions. While it is generally not recognized, U.S. states are de facto part of a currency union for the dollar, which was established in the 1800s. Their fiscal problems should be considered as analagous to european countries that are part of the euro zone. California is essentially in default and is only being kept afloat by constant cash infusions from a number of federal stimulus programs. It represents a much bigger drain on the U.S. dollar, than Greece does for the euro.

Selling the euro and buying the U.S. dollar because of the fiscal profligacy of countries like Greece is also absurd considering that the U.S federal government is just, if not more profligate, than the most fiscally irresponsible euro zone countries. It is considered outrageous that Greece had a budget deficit that represents 13% of its GDP. The 2011 U.S. federal budget submitted by president Obama on February 1st has a deficit of 11% of GDP (U.S. GDP figures are grossly overstated). For every dollar the U.S. intends to spend in 2011, 40 cents will have to be borrowed or printed.  Does that sound like a country that is protecting the value of its currency?

Greece has submitted a plan to the European Union (EU) for slashing its budget deficit to 3% by 2012 - the maximum allowed by the EU. While many people think that this is unlikely to happen, the U.S. has no intention whatsoever of slashing its budget deficit to that level in 2012 and will be fortunate if it is even lower than current levels. As for California, there seems to be no path to fixing the problem there without a massive federal government bailout - and it is only one of several U.S. states that have serious fiscal problems. Yet, the markets are selling the euro and buying the U.S. dollar because the U.S. is viewed as being in better fiscal shape that the euro zone? Perhaps I missed something when I took Logic 101.

Disclosure: None

NEXT: Withdrawal of Liquidity Threatens Second Global Meltdown

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.

Gold Rallies Off Support; Inflation Threat Hasn't Gone Away

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.


Gold had a strong rally the first trading day of February. This rally was significant for two reasons. First gold hit a significant support level last Friday and needed to bounce at that point if it is going to form a double bottom. Secondly, assets in bull markets should rally the first few trading days of the month. Despite a barrage of press coverage during the last several weeks, the threat of inflation hasn't diminished, nor are the world's governments likely to return to fiscal and monetary responsibility for many years into the future. Gold will continue its long-term rally until that happens.

The Credit Crisis has forced the U.S. and a number of other industrialized countries to risk either a long prolonged recessionary period or massive inflation. Modern democracies will always chose inflation because the voters will turn on any government that allows a recession to continue for a long time (unemployment rates will be what voters make their judgment on, not manipulated GDP numbers). While the Obama administration spent the last three weeks trumpeting deficit control, the 2011 proposed budget submitted by his administration on February 1st indicated deficit out-of-control instead. While there were supposedly an item here and an item there that would save $20 billion or so in the next many years, this is laughable. The budget deficit for fiscal 2010, which ends this Sept 30th, was revised downward on January 26th by $150 billion and then upward by $190 billion on February 1st. These people can't predict 10 days in advance, let alone 10 years and yet the mainstream press treated their multi-year predictions as something that should be taken seriously instead of as an item worthy of the comic pages.

Gold was also selling down because the trade-weighted U.S. dollar has been rallying since early December. The dollar rally first began because Japan and China were acting in concert to drive down the Japanese yen. In January, the euro has had the major sell off because of fears of a sovereign default by Greece. There is a real risk of this, but can the ECB let Greece default? It should be kept in mind that Greece represents only 2% of the euro zone economy. The euro has fallen by over 7% against the U.S. dollar because of the crisis. A sovereign default in Greece is likely to be much more costly than a bailout and so a bailout should be expected. It will also only be more expensive as time goes on, so an obvious question is why have the ECB leaders avoided it so far?  When this problem is resolved, both the euro and gold will rally strongly.

The press has also released items lately that are obviously meant to drive the price of gold down. The most interesting of these concerned comments made by legendary investor George Soros at the recent Davos conclave. Speaking about the excess money creation and govenment spending taking place globally, Soros said that gold would be the ultimate bubble because of these. Soros did not indicate that the bubble he foresaw was going to peak anytime soon, although the press slanted its coverage to indicate otherwise. Gold rose 25% in 2009 versus around 400% in its last year of the 1970s rally. Bubbles end in massive rallies and we have an approximate measurement of how large that rally amount is for gold because it previously ended a bubble three decades ago. When investors see gold going up several hundred percent in one year, they should worry about gold being in a bubble that is about to burst. Before then, they shouldn't. Expect to continually hear that gold is in a bubble for the next several years, especially every time it hits a new high.

In the short-term, gold is not out of the woods just yet. Investors should watch the $105.00 level on GLD. Any significant break of this would indicate that  GLD will drop to its 200-day moving average, which is around $100.00 and that spot gold would test the $1000 level. Silver would also break down from its trading range, roughly between the $16 to $19 an ounce level for spot (slightly lower for SLV). Seasonals are generally strong for both gold and silver in February, but weak in late spring. In any given short-term period, price drops are possible because of temporary liquidity restrictions from the central bank or government policy changes. Investors should particularly watch out for the increase in capital gains taxes that will take place in the U.S. on January 1, 2011. Many American long-term holders of the precious metals have big profits and if they want them taxed at a lower rate, they will have to sell before the end of 2010. Bargain hunters should take advantage of this as well as any other major sell offs in the precious metals. Gold has maintained its value for over 5000 years; paper currencies are usually lucky if they last 100 years.

Disclosure: Long gold and silver.

NEXT: Currency Markets - California Dreaming is Greek to Me

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.