Sunday, March 28, 2010

Where To Now?

Approximately now, the Fed has definitively embarked upon the next tightening cycle. Looked at from a long term nominal or inflation-adjusted perspective, the U. S. economy has not performed well for some time. Measures of consumption, such as cars sold, do not reflect wealth accumulation. Thus when the economy was so weak that to sustain the appearance of strength coming out of the 2001 recession, houses were routinely sold for almost nothing down and with ridiculously low lending standards, and autos were almost always bought on credit, the signs of economic malaise were clear.

The "escape" from the abyss in fall 2008 was unsurprising. Be not impressed by the "heroism" or "brilliance" of the economic doctors in that time. All they did was socialize the losses onto you and me and reward the insiders. Plus they printed money. In other words, they took the Japan solution to a banking crisis rather than the 1990s Swedish solution.

There is no telling if consumer prices are going to go into a period of stability or even decline a la Japan. What makes more sense is that the U. S. is a decade out of phase from Japan. Increasingly we are already seeing that the funding of new Federal debt is domestic rather than foreign. If that continues, America will be following the Japan scenario in that regard as well.

The headlines are going in the MS tout resumption of job growth in March. Whether all of that is from Census hiring we won't even be sure of till revisions occur. What is certain is that small business is not hiring, though it has largely stopped firing. With housing activity not on a clear upward path if not on a downward path, despite all the support, we are left with the prospect of a post-credit crunch economy.

This in turn is one in which frugality continues, and Gallup continues to show consumers just not spending on elective things and workers just not seeing any net hiring at their firms.

The biggest mistake investors can make is to key their stock and bond valuations off of unnatural zero interest rate policies. This failed them in the last cycle and will fail them again. Last time around, Fed funds only got to 5.25%, at most equal to inflation if not below it-- and things collapsed. This is a sign of severe instability, in that the economy could not even survive imposition of a positive real rate of interest on Fed funds. So far, it looks like a replay of that. The Fed is behind the curve on inflation again and will keep that stance longer than inflation hawks want, until real progress is made on the employment front, and there is a huge hiring boom to go for the rate of unemployment to drop. That rate, of course, lags hiring as people re-enter the labor force after giving up and thus not being counted as unemployed for a period of time.

Given a weaker foundation this time and the certainty-- not the unfounded worry-- of financial instability in various spots across the globe -- investors are well advised not to take the Soma of comfort in low interest rates and keep much invested in assets which they would sell at a lower price were another bear market to start tomorrow from such matters as a bursting bubble in China or a bank failure or sovereign default in Europe, or a major rise in Treasury borrowing rates in America.

The feeling here is that the political zeal in the Obama administration suggests that the gold and bond markets will need to react, and more robust political opposition in Congress needs to materialize, before fiscal prudence becomes government policy.

This argues for gold as a core permanent (for now) holding of all investors. If the economy starts shooting up, as may happen one of these quarters based on ECRI and the Conference Board numbers, then silver and platinum may go to new highs for the cycle (new all-time highs for platinum) and outperform gold. If we have economic slowness (no double dip required) first even though the Fed is still "loose", just less loose than recently, though, then gold is the only precious metal than can continue up in price due to its status as an alternative, globally accepted store of value.

In two hundred years, which is more likely to remain a store of value: the Federal Reserve Note, or gold?

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