The Dow rose 155 points on Friday. And today, stocks are rising in Asia. Oil is over $74. Gold rose $13 on Friday… to close at $954. And the dollar is killing us softly… sinking to $1.43 per euro on Friday.

Stocks and oil are at their highest levels so far this year. With such profits at hand people figure they don’t need the dollar. Investors run to the safety of the greenback when financial storms approach. But now… they think it will be clear sailing.

“Worlds bankers suggest rebound may be under way,” says a headline at the New York Times.

Is the world economy really recovering? Should you buy stocks now to take advantage of this new bull market?

You already know the answer, don’t you, dear reader.

After a fall comes a bounce. And along with the bounce come a lot of silly ideas. You see how it works? “Markets make opinions,” say the old timers on Wall Street. When stocks are going up investors find reasons why they are going up. Pretty soon, they’ve convinced themselves that they’ll go up forever.

But bounces do not last forever. They aren’t giant turtles… they’re moths. After a few months of flitting around bright lights, they dry up. When exactly this summer of winged love will end, we don’t know. September or October is our guess. But we have little doubt it will come to an end soon.

Ultimately, stock prices depend on earnings. People compare the rate of return they can get from stocks to what they can get from other investments. Rising earnings signal higher rates of return, so investors pay more.

During the great credit expansion of 1945-2007, businesses could anticipate, generally, rising earnings. People were buying more and more things on credit. In a national economy, businesses pay wages and then the employees use the wages to buy products. The wages are a ‘cost’ to the business… but they are also the source of business revenue. When sales come from credit, on the other hand, businesses have the revenue but no wage cost. Profits go up.

Now, the cycle has turned. Businesses still have the wage cost. But instead of using the money to buy things, the employee uses it to repay loans for purchases made last year or the year before. Now the business has the cost but not the revenue.

As they say in the economic textbooks: bummer.

The process of de-leveraging will be slow. Maybe 5 years. Maybe 15. Maybe 25. It will up and down… with high unemployment (businesses will cut their wage costs as sales fail to recover)… low prices (at least in real terms)… low profits… and slow growth, or none at all.

Is that bad? No, not at all. It’s good. Economies need to adjust to the new realities of the post-credit bubble world. It will take time. And with the world’s financial authorities fighting it every step of the way… it could take a LONG time. As we’ve explained in these Daily Reckonings, government is a profoundly conservative, parasite-protecting enterprise. It cannot draw forth the future – it has no idea what the future will be. Instead, all it can do is to try to recover the past. That’s the idea of the ‘recovery’… to try to coddle, protect and pay-off yesterday’s success stories. From Wall Street to welfare… governments attempt to prevent correction.

And more thoughts:

*** The Obama administration announced that it expects $9 trillion in deficits over the next 10 years. One of the great mysteries of our time is: where will the money come from? As we pointed out last week, even if every dollar of US savings is applied to the task, the feds will still be short. And if they make up the difference with funny money – from their quantitative easing scam – the Chinese vigilantes are likely to get cheesed off and dump their US Treasury bonds.

The evidence shows that the Chinese…and other Asians…are already trying to lighten up on their US debt holdings. This from the New York Times:

“Figures released by the Treasury Department this week indicated that China reduced its holdings of Treasury securities by $25 billion in June, the most China had ever sold in a month.

Monthly figures can be volatile, and can be revised, so it is risky to draw conclusions from one month’s data. In May, China increased its holdings by $38 billion, according to the Treasury figures.

“Nonetheless, the decline highlighted a fact… Asia’s appetite for Treasury securities is not growing as fast as it once did. That means the United States will have to turn to other buyers, including American citizens, who are now saving as they did not do during the boom years, to finance the deficits… In the first half of 2009, China and Hong Kong acquired only 9 percent of the more than $800 billion worth of Treasuries that were sold.

“ Japan, which was replaced by China as the largest foreign holder of Treasuries last year, has been a larger buyer this year, taking up 11 percent of the new supply of Treasuries.

“Ownership of US Treasuries by China, Hong Kong, Japan, South Korea, Singapore, Taiwan and Thailand — since 1994 — rose to 25 percent, from less than 8 percent. Since then, as budget deficits in the United States grew, the share has fluctuated within a narrow range. In June, it was 24.7 percent.”

If Asians don’t finance US debts, who will? We don’t know… But the fewer bonds Asians buy… the more they are bought with funny money by the Fed. And the more the Fed buys with funny money the fewer Asians want to buy with real money.

How will this end? Badly…we keep saying. There is no way out. Either the feds cease spending more than they can raise honestly, by taxation and reasonable borrowing. Or, the system runs into chronic, mega deficits…like the chronic deficits in the private sector during the bubble years. Then, it blows up.

That is why we caution readers against the dollar and against Treasuries. Most likely, they will both go up this autumn…as investors flee to safety from the next market downturn. But the chances of them blowing up completely are too great. That’s why we stick with gold – even though we would not at all be surprised by a period of weakness in the gold market.

*** On Friday night, we went to a ‘dinner in white’ at a nearby chateau. It was a jolly affair, at an ancient chateau entirely surrounded by a moat.

We set up our table, alongside the others. We gathered for drinks. We saw old friends. And then we prepared for dinner.

Why “white?” The dinner marks the occasion of the Assumption of the Virgin. It’s held each year in this rural area of France. Everyone brings a full dinner service – table, chairs, candles, etc. etc. Then, after setting up outside, under the stars… there’s a twist. Couples switch around so that your editor ends up having dinner with a woman to whom he is not married.

Having dinner with someone else’s wife can be a delight. At least, you have nothing to argue about. But how much of a delight it is depends entirely – or perhaps mostly – on chance.

In our case, we were trebly lucky. In front of us was a charming woman who turned out to be a relative of many people we already knew. So we kept up a lively conversation about cousins, uncles, aunts… family tragedies… and upcoming marriages. On our right, was a cute woman with a bright smile and a friendly manner. On our left, was another charming woman with a shrewd, fast wit.

Time passed quickly. We crossed swords with the woman on our left – over education policies. We chatted with the woman in front of us – about family, the weather, local trends, food and whatever. We flirted with the woman on our right:

“Do you come to these dinners often,” we asked.

“About as often as you do,” came the reply, “once a year.”

“Well, the dinners suit you. You look very nice in white.”

“Thanks… but I really don’t have any choice. It’s a ‘dinner in white,’ after all. If I had a choice, I’d wear black.”

“Why… because you have a black, cruel heart? Or is it because you are in a sad mood? I hope not. And if so, perhaps I can cheer you up by telling you joke. How many Belgians does it take to change a lightbulb?”

“I’ve heard that one.”

“Then why does the guy from Belgium go to sleep with one full glass of water next to his bed and one empty glass?”

“I don’t know… why?”

“Because he never knows if he’ll be thirsty or not when he wakes up in the night.”

“Oh…”

Source: The Future Will Come

Popular government has two major parts. One part is fraud. The other is larceny. As to the first, it is like a professional wrestling match – full of lurid threats, spilled beer, sacred cows, gaudy uniforms and self-delusions; the fans feel their private parts shrink when their man loses. If he wins, they feel they are winners too. But it is the other part, the more rational part – a balance of larceny and bribery – that interests us today.

Serge Dassault miscalculated. One of the richest men in France, he was stripped of his position as mayor of a Paris suburb this week. A court found he had made cash payments to voters in Corbeil-Essones, east of Paris, which could have influenced the outcome of a mayoral election.

We stand dumbfounded…mouths wide open…our fondest hopes for the progress of humanity dashed to pieces. How could an experienced, well-informed man of mature age and sound finances, have made such an amateur’s error? He bribed the voters unfairly – that is, with his own money – but apparently not enough of them!

Mr. Serge Dassault, meet the late Mr. Bongo. France included in its ‘mission civilisatrice’ the cultivation of various public officials throughout Africa. Bongo was one of them.

The moment when destiny stuck her nose into Mr. Bongo’s affairs was probably in 1964, when Mr. Bongo had gotten himself into the post of Minister of Tourism in the government of President Mba. That year was the one chosen by Jean-Hilaire Aubame to launch a coup against Mba’s regime, which saw both Mba and Bongo confined together until French troops came and bailed them out. Being locked up with the president of a country can be good for your career; at least it was for Bongo. His ties to Mba were strengthened by the ordeal, says the TIMES, and he was subsequently made Vice-President, succeeding to the top post itself when Mba’s last cartridge had been spent.

The TIMES described Bongo as “one of the world’s richest heads of state.” The Financial Times provided details: “An indictment…listed 39 properties, mostly in the chic 16th arrondissement of Paris, nine cars worth nearly $2 million, and 70 bank accounts.”

And so the familiar question: “how is this possible?”

Mr. Bongo’s percentage of Gabon’s output must have been substantial. He took over the government of Gabon in 1967 at the age of 31, making him the world’s youngest head of state. “For the next two decades,” continues the obituary, “Bongo was able to rule Gabon almost as a personal fiefdom. With a relatively small population and benefiting from abundant natural resources – principally oil, but also uranium, manganese and timber….”

The man mastered both carrot and stick. With revenue from Gabon’s natural resources flowing into his coffers, he was able to hand out lavish favors. “He placated students in 2000 by providing hundreds of thousand of pounds for the purchase of the computers and books they were demanding,” says the TIMES. He could spend his own money when it suited him too – for he had so much of it. And when the working classes took the streets in 1990, he had plenty of goons in uniform to beat them with sticks.

Bongo did not suffer from the typical financing problem of modern democracy. When you rob Peter to pay Paul, Peter gets cheesed off about it. The next thing you know he’s voting against you or plotting a coup. That is why it is better to bribe Paul with money Peter never earned. And do it on a large scale. That is how Bongo won an election as recently as 2005 with nearly 80% of the vote. Not even Obama can match that.

But politicians in modern, developed democracies are now bribing voters on a breathtaking scale – protecting their bank accounts, shoring up their houses, giving them jobs and health care. In the US alone total US government debts, obligations and commitments now come to $112 trillion. Congressmen risk neither jail nor insurrection. Cometh the old question; how do they get away with it?

Currently, 50% of every dollar spent comes from borrowing. This week brought news that the developing countries – led by China – are still adding to their positions in US Treasury bonds. The funds are spent immediately. The payer and the payee – neither of whom vote in current US elections – can worry about settling the debt later. What a marvelous invention is inter-generational government debt, funded by foreigners! Even Mr. Bongo, RIP, must have been impressed.

Enjoy your weekend,

Bill Bonner

Source: Kleptocracy in America

Captain’s Log: Year of our Lord 2009, 6th day…

We have landed on a strange and wonderful watery planet – the third planet in orbit around the sun, a minor star in the Milky Way galaxy. Well, they say it is watery planet. Where we are, it is icy. But the locals say it warms up and the ice melts. We’re suspicious; maybe it’s just hype to attract tourists.

But what is strange about this planet is that its inhabitants all seem to play a game of make-believe, in which they all agree to believe things that every one of them knows is untrue. What is wonderful about it is that it seems so easy to make money here; there’s a fool on every corner just waiting for the chance to get rid of his wealth.

Recently, humans – the race that inhabits this place – believed that their lodges and living quarters would become more and more valuable – even though it was obvious that their houses deteriorated every day, as a consequence of solar radiation, wind erosion, liquor spilt on the carpets and other natural phenomenon. Then, on the back of this remarkable delusion, they built an entire world economy…including extravagantly complex financial instruments which the wisest among them called “weapons of mass financial destruction.”

Someone seems to have cut the power to that illusion a few months ago, so now they are taking up a new one: that if people are given more pieces of green paper they will all be richer.

Yesterday, the Dow – which measures stock prices in the United States – fell 81 points. But analysts say the technical indicators are still almost all positive; they think the US is beginning a major rally…or perhaps a new bull market.

The auto industry, meanwhile, reported terrible news. Sales fell 36% in December; GM (NYSE:GM) sold fewer vehicles than in any December in 49 years.

Oil rose $2 yesterday; amid all the gloom and doom, the oil price is moving up to nearly $50. Bond yields are rising too, along with the dollar. And gold fell $4 yesterday – for no particular reason.

Today’s press – the means by which delusions are shared and propagated – tells us that the government of this world’s richest nation, called the United States of America, is planning a “stimulus package” of something on the order of $1 trillion. What’s the package expected to stimulate? The idea is to get more of these pieces of paper into citizens’ hands, so that they will be encouraged to act as though they were wealthier. It doesn’t seem to bother anyone that the source of the misery of which so many now complain was the fact that, in the past, so many acted so much wealthier than they really were. Nor does it seem to disturb the collective fantasy that this stimulus plan is being created, more or less, by the same class of people who neither saw anything wrong with the last fantasy nor mentioned to anyone that it was going to collapse.

“Hopes pinned on rate cuts and fiscal packages,” says the headline in the Financial Times, a leading source of financial hallucination. It explains how the aforementioned U.S. government intends to cut taxes in order to put those aforementioned pieces of green paper into consumers’ hands.

Further in the paper, another headline – “Reports of $300 billion Obama tax cuts lift mood” – tells us that the public is getting in the spirit of the new fantasy even before it is officially launched.

“Optimism about central bank and government efforts to revive the global economy helped improve investor risk appetite yesterday,” continues the article.

“Fed Officials Endorse Big Stimulus to Battle US Recession,” adds another source – Bloomberg.

What a marvelous place! Every day is magic on this planet. Every day is a new day…with no memory of what happened the day before…nor any thought to what will happen tomorrow. People are ready to believe whatever makes their day more enjoyable…no matter how absurd.

Anyone who bothered to think about this ‘bailout’ plan for two seconds could see that it is a hoax and a scam. Those pieces of paper are not really wealth…they merely represent wealth. But since the U.S. government has no wealth in reserve – indeed, it is famously borrowing to make ends meet already – it can only pass out wealth to one person by taking it from someone else. It talks of ‘tax cuts,’ but we have heard nothing of spending cuts. So, what the global consequence must be is an increase in pieces of green paper – or let us say, demand for wealth – with no actual increase in wealth itself. It is just a shared illusion, in other words.

But we have to say too, after visiting this planet for a few weeks, we have fallen in love with it. We feel so superior. Almost everyone we talk to is a dope.

Besides, where else in the universe is it so easy to make money? As you know, dear reader, the easiest way to make above-market profits is to help the fools part company with their money. What other planet has so many fools?

We paraphrase one of the smartest of the humans, George Soros, who puts it this way: ‘The way to make profits is to find the premise that is wrong and bet against it.’ As far as we can tell, almost every major premise is wrong…or at least the over-arching premise of this new post-bubble era is as loony as the one that preceded it. Just as you can’t really get rich by borrowing and speculating… you can’t recover from a bust-up by borrowing and speculating more.

But heck, we don’t make the rules down here on Planet Earth…we just try to have some fun with them.

*** As we were saying, making money seems so easy here…especially now. There are companies that are in the business of pulling valuable minerals out of the ground that you can buy for less than the resources they own – even at today’s depressed prices. There are companies that drill and pump oil – still the major source of energy on Earth – you can buy now for only a couple times their annual profits. In Germany and Japan – two of the most productive and competitive nations on the planet – companies sell for what would normally be bargain prices… significantly less than book value. And emerging markets can now be bought at giveaway prices; considering that these economies still expect rapid rates of growth over the next 10-20 years, these could turn out to be fortune-builders for the next generation.

One of the easiest, surest ways to make money now is to buy high yield corporate bonds and sell low-yield U.S. Treasury bonds. When their last fantasy crashed, earthlings rushed to the apparent safety of U.S. government debt, forsaking the debt of their private enterprises. This pushed yields on the government debt to such low levels as had never been seen before…while yields on bonds rated C or worse rose over 30%. Of course, we have no particular opinion on what these yields should be, but it seems very likely that the “spread” between the two debt classes – now at a 100-year high – will narrow.

“If you’re looking at junk bonds,” adds Jim Paulsen of Wells Cap Management, “you have never had this kind of value before.”

But while we are talking about the bonds, an even surer bet to us is that U.S. government debt will decline in value. There is no theory that we know of that allows Treasury bonds to go up while the supply of them increases at such a rapid rate. Next year, the feds will borrow between $1.5 and $2 trillion – as much as 4 times the largest previous deficit in history. That means there will be a lot more U.S. Treasury bonds offered for sale. This increased supply is bound to put downward pressure on bond prices.

And we’re suspicious of those little green pieces of paper too. When you turn in a government bond, they give you green pieces of paper. But those are the same pieces of paper that they’re handing out all over town. According to the only theory we know, as supply increases – ceteris paribus – prices decrease. In this case, as they increase the number of those pieces of paper each one represents less and less wealth. The more pieces of green paper, the less each one is worth, in other words. And as we understand the earthling’s current delusion, they will intentionally increase the number of pieces of green paper until they go down in value. Yes, that is the purpose too, not only to put more ‘money’ in consumers’ hands…but to put out so many pieces of green paper that they go down in value. Why? They want to make sure consumers won’t be tempted to save them. Weird, huh? But it’s just another peculiar feature of the present dementia universalis on Planet Earth; humans believe they will all be richer if people spend their money, rather than hold onto it. Of course, every one of them knows it isn’t true; but they believe it anyway: that the more they consume their wealth the more wealth they will have. Like we said: super weird.

But it leads us to an investment that – under the circumstances – seems like a no-brainer. The only thing that bothers us is that so many earthlings seem to favor it too. Since humans are so prone to error, it makes us question our own judgment.

“US Treasuries are my least favorite asset,” says Mohamed El-Erian with Pimco. “My least favorite asset is US Treasury bills…and I don’t like the dollar either,” say Tim Bond of Barclay’s Capital. “Outside of a Treasury bond,” adds the aforementioned Jim Paulsen, “it is a remarkably good time to buy risk assets.”

Yet despite the agreement of these humans, we still think most of the species have seized onto a premise that is wrong – that dollar-based U.S. Treasury debt equals financial safety.

How do you bet against that premise? Probably the easiest way is to buy a more traditional form of money – which humans place at number 79 on their periodic table, gold. Believe it or not, over a long, long time gold has been extremely reliable. An ounce of it buys about as much bread in A.D. 2009 as it did in A.D. 9. As this present delusion blows up, humans will probably turn back to gold to protect their wealth.

As we said, the U.S. government is determined – ‘hell-bent,’ some would say – to keep consumers spending those little green pieces of paper. They have a plan to bring this about – at a cost of a trillion or so more of them. If this plan does what they hope it will do, prices will begin to rise. In fact, almost all asset classes will rise in price – especially gold. Shrewd investors will seek protection from inflation by buying gold – causing the price of the yellow metal to rise.

If the plan fails to work, on the other hand, the feds will continue emitting pieces of green paper, which will eventually call into question the value of the paper itself. Either way, probably the surest bet on the blue planet is that the price of gold will go up.

How high? Who can say? But we will be very surprised if it doesn’t at least equal – on an inflation-adjusted basis – its highest price ever, set in January of 1980. Then, it sold for $875. Adjust that price to today’s consumer price level and you get a price over $2,400.

Daily Reckoning readers who wish to take advantage of this terrestrial phenomenon should buy gold. If you wish to increase your risk and profits, you could buy the double ETF, giving you twice the gain from each dollar gold goes up. After all, this will probably be the last bubble…the biggest bubble of our lifetimes. For gold bugs, it is now or never. Those who really want to go for broke should mortgage their old houses and sell their young children to raise extra cash.

This advice is free. Of course, it is worth no more than you paid for it. All we ask is that if it doesn’t work out, please don’t rub our noses in it. We’ll feel bad enough.

Source: Bet Against a False Premise…Buy Gold

This from Investment U:

Media pundits keep reminding us how tough 2009 will be economically. Nevertheless, I predict this will be a good year for the stock market.

How can this be?

The stock market is a leading indicator. It generally falls before consumers and investors realize just how bad the economy is.

It also recovers long before economic activity picks up. Perversely, that means stocks often plummet during good economic times and rally during recessions… or worse.

In the January issue of The Oxford Club Communiqué, for example, I note that:

• In the 13-month recession in 1926-27, the market went up 41.1%.
• In the eight-month recession in 1945, it went up 19.5%. In the 11-month recession in 1948-49, it went up 15.2%.
• In the 10-month recession in 1953-54, the stock market went up 24.2%.
• In the 10-month recession of 1960-61, it went up 20.3%.
• In the 16-month recession in 1981-32, the market went up 14.6%.
• And so on.

The stock market doesn’t always rise during a recession, of course. And right now is particularly tricky because there is simply no precedent to today’s economic mess. We’ve never seen a real estate/mortgage crisis create a meltdown in the credit markets this way. Nor have we seen the Federal Reserve take such extreme measures to set things right.

However, investors can take some reassurance from one of the best – and most accurate – buy signals in the stock market. Here’s how it works…

20th Century Investing – Buying High-Yielding Stocks

Investors in the first half of the 20th century found that if you did nothing more than buy stocks when their yield exceeded the yield on Treasuries – and sell them when the yield on Treasuries exceeded the yield on stocks – you would have been in for every major rally and out for every major correction.

The returns were huge – and the system made sense. Stocks are riskier than bonds, market participants reasoned, so they should yield more to compensate for greater volatility and the likelihood of occasional losses.

The system worked like a charm until 1958. Then stopped cold. Stocks never yielded more than Treasuries for the next 50 years.

Public companies began using their cash flow to fund operations and acquisitions rather than paying out dividends to shareholders. With stock yields sharply lower, most analysts reasoned that the indicator was dead, that the yield on stocks would never again top bonds.

But after more than five decades, they have…

The S&P Yields More Than Treasuries For The First Time In 51 Years

Beginning on October 13, the 3.74% yield on the S&P 500 exceeded the yield on the 10-year Treasury for the first time since 1958.

If history is any guide, that means stocks are an excellent long-term buy and Treasuries – which have become a complete bubble (and table-pounding sell) in my estimation – are due for a long period of relative underperformance.

Don’t get me wrong. U.S. economic growth is likely to be negative over the next 12 months. But – shocking and surprising most investors – stocks should do well. And high-dividend paying stocks – especially those outside the troubled financial sector – may perform best of all.

One caveat, however. When focusing on yield, buy only healthy dividend-paying companies – those with rising sales and earnings – and reinvest those dividends for maximum total returns.

Source: The Best Stock Market Buy Signal In 51 Years

This from Investor’s Daily Edge:

The chart below is only one month old. But in their recent flight toward safety, investors have driven the yield of the 10-year Treasuries down to 2.13 percent – below the three percent shown in the chart.

That rate doesn’t even keep up with the rate of inflation.

On the other hand, parts of the stock market are throwing up some hefty yields. Take a look at these…

Source: Wachovia/Bloomberg/FactSheet market data as of November 28, 2008.

Most of these companies are master limited partnerships (MLPs). They have to give shareholders 90 percent of their cash earnings every quarter. So the better they do, the better you do.

They’re offering anywhere from 10 percent to over 26 percent yields (coming from some of the exploration and production MLPs). Of the categories above, I really like the large-cap pipeline MLPs. Their revenues come from fees. They don’t go up and down with the huge swings in the price of oil and gas.

That makes a big difference. Though we’re using 4-6 percent less fuel now than at this time last year, the price of oil has dropped 74 percent and the price of natural gas 26 percent. The revenues of these big and well-established companies are very stable. And so are the dividend checks they give out.

It’s a great alternative to the measly returns of government bonds.

Source: Outlandish Yields from Solid Companies

This from Today’s Financial News:

The old saying that cash is king is not as true as it used to be. With so many investors fleeing the turbulent markets, billions of dollars in cash are sitting on the sidelines, with investors looking to stash their stockpiles in any safe place they can find.

The American government has been the go-to repository. As the safest of them all, Treasury bonds are seeing huge demand. But with demand comes increased prices, and with increased prices comes dwindling interest rates.

The privilege of loaning your cash to Uncle Sam is no longer a profitable one. Give the government a few thousand bucks for the next few years and it will hand you a couple of nickels to rub together. As the value of the dollar declines because of these low interest rates, the situation only promises to get worse.

That is why hordes of investors are turning away from the bond market and once again tossing some money into the gold market. Gold prices made significant moves last week and are on the rise once again this week. As I write, gold is trading for close to $840. That means the precious metal has tacked on roughly $100 since its November lows.

Hurricanes are tough to predict

If you want to know which way gold prices are headed, it depends on who you ask. Some analysts say, $1,000, $1,500 or even $2,000 an ounce is just around the corner. Others say the fundamental value in gold is waning fast and bearish investors should watch for $600 or even $500 per ounce.

As the world’s economy strengthens, the bears will be right. But in the meantime, the declining dollar, the high-risk equities market and fears of government supported inflation are going to propel gold’s prices dramatically higher.

There are multiple ways to take advantage of the price hikes. The simplest would be to buy a gold-based ETF like SPDR Gold Shares (NYSE:GLD).  But if you want to magnify the potential gains, use the leverage created by investing in a gold miners like Goldcorp (NYSE:GG) or Barrick Gold (NYSE:ABX). Their current valuations look quite cheap if gold starts to soar.

But with so much uncertainty in the economy and the government ready to re-write the economic textbooks, investors must be aware of the increasing risks. In an ill-informed attempt to “jolt” the American economy back into high gear, the government could easily force gold prices off their track and into a canyon of deep declines.

Source: The Gold Debate Heats Up

This from Money Morning:

The British government this week unveiled a stimulus plan that will boost that country’s budget deficit to $181 billion (118 billion pounds), the equivalent of 8.0% of gross domestic product (GDP). U.S. President-elect Barack Obama’s stimulus plan, when combined with the recession, may raise the U.S. federal deficit to $1.2 trillion, or 8.0% of U.S. GDP.

This raises the question: If it’s so easy to stimulate an economy, why don’t we do it all the time? Don’t such large deficits cause problems?

The 4-1-1 on Stimulus Packages

There is no question economic stimulus is popular. Economist John Maynard Keynes originally proposed it to counter the Great Depression, and it is now used as a panacea every time the economy suffers even the mildest hiccup. The Economic Stimulus Act of 2008 – a $150 billion stimulus the Bush Administration unveiled last spring – is an example of this: It was proposed before the economy had suffered a negative quarter and it provided a modest short-term blip to consumer spending, making the second quarter of 2008 the best of the last four.

It also increased the federal deficit by an estimated $152 billion. And it did nothing, whatsoever, to solve the problems of housing finance failures, bank illiquidity and deep recession, though it may have postponed the actual onset of recession for about three months – the sharp downturn appears to have begun in July, the month after the stimulus package ended.

There are two reasons stimulus packages are popular:

• Politicians like excuses to spend more of our money.
• And the public is made to think that they are bound to work, because politicians and the media promote it as a one-sided thing. So, it seems obvious that if government spends more money – or cuts taxes – the economy is bound to improve.

When One’s a “Crowd”

What people don’t realize is that the money has to come from somewhere. Take Spain, where the government had previously been running a budget surplus. In such a case, a stimulus package is unlikely to do much damage, because it will cause only a modest deficit.

If, as is normally the case, the capital market is flowing freely, with investors worldwide buying U.S. bonds, then borrowing money for a stimulus package would at least do little harm, because capital inflows into the United States will just increase commensurately, so worthwhile projects still will get financing.

However, if the capital markets are even moderately tight (and they are more than moderately tight at present), then a stimulus package can be very damaging – perhaps even doing more harm than good. If it consists of extra spending, then the borrowing that’s done to finance those expenditures will “crowd out” private sector spending or investment. The sponsors of the stimulus package had better be very sure that their spending is well directed.

Keynes’ favorite scheme – employing people to dig holes only to fill them in – would make matters worse, not better. In the world of government budgets, the “hole” is deficit spending. The deficit is filled in – financed – with borrowed money.

Unfortunately, the money borrowed to fill in the budgetary hole would make matters worse, not better, because the money the government borrows would result in less money being available to invest in the rest of the economy. The little bit of money that was left over for private sector players to access would, naturally, command a higher interest rate, making the additional investments much more costly.

With a government-spending stimulus, nobody can be sure what is optimal, because the market is not involved, and government, once increased, may be very difficult to rein back.

Last spring’s tax-rebate stimulus package probably made things somewhat worse.

The tax rebates were spent by the recipients, who devoted their resources in ways that, at least to them, seemed optimal. But there is no long-term increase in the size of savings because U.S. consumers already save too little for economic health. So, draining some large portion of $150 billion from the savings pool to feed additional consumption was not sensible.

One other point regarding the tax-rebate stimulus: There is a school of thought – espoused by the folks who produced the acclaimed documentary “I.O.U.S.A.” that these rebates, by significantly slashing the government’s revenue, badly exacerbated the country’s debt burden.

British Prime Minister Gordon Brown’s Nov. 24 stimulus package involves primarily a temporary reduction in Value Added Tax (equivalent to a sales tax). At first glance, that was a surprising move, since the British government is from the left-of-center Labor Party. However, the reality was that after 11 years of Labor Party leadership, the budget was way out of balance even at the top of a boom, and the public had grown very tired of Labor’s public spending excesses – hence a “stimulus” of yet more spending would have caused even the placid British to start throwing things.

Obamanomics 101

President-elect Obama’s economic advisor, Austan D. Goolsbee, stated on Sunday that the stimulus “had to be a big number in order to get people back on track and startle the thing into submission.”

That is a little alarming, because the resulting budget deficit could startle into submission the bond markets as well as the recession. That would cause a flight from U.S. government debt and the dollar, reducing U.S. living standards, raising interest rates and possibly even causing the rating agencies to downgrade U.S. government debt.

A stimulus package of $1 trillion, the high end of what has been mentioned, would almost certainly be too much – especially since it’d come after the Treasury Department’s $700 billion Troubled Assets Relief Program (TARP), which is fueling bank takeovers, and not expansionary lending, and the follow-on $800 billion credit-market stimulus unveiled yesterday (Tuesday).

On the other hand, Obama plans a middle-class tax cut, which gives the money to those who have least benefited from boom of the past few years (prior to the financial crisis) and keeps it away from Congress’ profligate spending barons who would waste it on bridges to nowhere and other pork-barrel projects.

Furthermore, Obama’s healthcare plans and New Energy investment plans have both been blessed by the electorate, so presumably people actually want them. Moreover, he is talking of spreading the stimulus over a period of 2 years, which would presumably reduce the immediate borrowing requirement and ensure that the economy was genuinely into recovery before the stimulus ran out.

The market currently wants a stimulus package and trusts President-elect Obama. He thus has a major opportunity to implement some of the spending plans he favors, while keeping the market happy. That’s a rare opportunity, but he should be careful not to take for granted the market’s welcome.

Source: Government Stimulus Programs Not Always the Hoped-For Panacea

This from the The Sovereign Society:

The US and other major economies have rescued the financial sector.

The threat of imminent bank failures across the industrialized countries has all but ended at this juncture. That’s good news for global investors, depositors, businesses and individuals alike following weeks of financial market turmoil that culminated into a global stock market crash last week.

But just how the government and the private sector will mesh is another story.

The US and the Britain are now the most aggressive lenders and owners of their domestic banking systems. And how they direct and manage these companies will dictate not only the fortunes of shareholders, but the future of global investing.

I’ve got a bad feeling about government in the private sector; so the sooner the government finishes its job stabilizing and recapitalizing the banking sector, the better.

For now, we’re stuck with a financial services sector that largely falls directly under government control for the first time since the Great Depression.

Debt ratios will now skyrocket everywhere, as every country — including Germany — opens their purse strings in a huge way to accommodate bank liquidity and lending.

We will have a different financial marketplace going forward with far more government regulation and control. I’m sure George Orwell, author of 1984, is spinning in his grave right now.

One thing is for sure: Global long-term interest rates — especially US bond yields — are going to rise significantly over the next three to five years.

In addition to death and taxes, I’d bet higher long-term rates are almost a 100% guarantee in this life after the tidal wave of government guarantees and bailouts of the financial sector.

Funding costs will surge for the Treasury, and I’ve got to believe the Chinese, Japanese and other big holders of Treasury paper will want higher interest rates to compensate for holding heavily indebted US paper.

Though the Fed can manipulate the short-end of the market, it can’t control the long end. And that’s where investors can look to make money as long-term interest rates eventually rise once deflation is finally quashed.

The systemic risk to the financial system is now behind us. That’s the good news.

The bad news is that consumers and companies along with the rest of the real economy will continue to feel strained by tepid economic conditions, still weak interbank lending and lousy corporate earnings for at least the next six months.

Source: Solvency Attained, But at a Huge Price

This from Bloomberg:

“We have seen some kind of decoupling between Treasuries and the stock market this week,” said Karsten Linowsky, a fixed-income strategist in Zurich at Credit Suisse Group. “Treasuries aren’t benefiting so much anymore from the increasing risk aversion. People have started to worry about how much these rescue packages will influence the supply side.”

Former New York Federal Bank trader John Jansen writes this on Seeking Alpha:

The US market has always represented the ultimate safe haven venue, yet this morning according to my screen at about 700AM New York time, the yield on the 2 year note was actually several basis points higher than where it closed late yesterday. Indeed, the yield on every Treasury issue is higher than the level at which it finished in late trading yesterday.

Is this the beginning of the end for the dollar and the Treasury market? Is this the first sign of the bursting of the bubble in Treasury securities? That market, in a sense, represents the ultimate bubble, as it exists at the whim and caprice of foreign investors who have, as participants in a Faustian bargain, financed our war(s) and our lifestyle so generously over the last decade. Maybe even that bizarre construct is crashing about us as we speak.

I can only say that with financial markets in full retreat and full meltdown, it is thoroughly uncharacteristic for prices of Treasury coupon securities to be lower.

Is this really the first sign that US is no longer seen as ‘too big to fail’? Well, don’t say we didn’t warn you. This from a Bill Bonner article published on Contrarian Profits last month:

US Treasury bonds are unique. They depend on the value of the dollar…which the issuer itself controls. But as the war between Mr. Market and the feds continues, the US Treasury will have a harder and harder time maintaining the value of the dollar. Because wars are costly. The feds will have to stretch the dollar farther and farther in order to meet the expense. Eventually, the elastic dollar will snap…and bonds investors will have their turn. Bonds will crumple over too…

– Interests of taxpayers “protected,” according to Fed statement. “Loan is collateralized by all the assets of AIG.” “Loan is expected to be repaid from the proceeds of the sale of the firm’s assets.” 

– “The US government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.” 

– Here’s a scary thought, says the WSJ: What if the US government runs out of rescue cash? What if investors lose their appetite for Treasury bonds?

That thought likely lay behind Ben Bernanke and Henry Paulson’s hesitation to aid AIG, though finally the Fed seemed ready to cough up in a truly big way last night. Even those who closely follow the credit crisis probably expected to see banks and savings institutions heavily laden with mortgage debt end up on the triage pile — not an insurance company known for its pioneering work in China, its giant aircraft leasing business, and the like.

– “What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy,” says The New York Times, “but A.I.G.’s role as an enormous provider of financial insurance, which effectively requires it cover losses suffered by other institutions in the instance of defaults of securities that they have purchased. That means A.I.G. is potentially on the hook for securities that were once considered safe.”

– It would have been a chain reaction,” said Uwe Reinhardt, a professor of economics at Princeton University quoted in the paper. “The spillover effects could have been incredible.”

–  An AIG bankruptcy would dwarf that of Lehman Brothers (NYSE:LEH), says William Patalon III. “The diversified insurance-and-asset-management firm is much bigger than Lehman, with $110 billion in annual sales last year and an employee roster of 116,000 people. An AIG failure would impact many more average consumers than the Lehman debacle, as some of AIG’s biggest units include commercial life insurance and retirement planning.”

– Credit default swaps and mortgage business to blame, says WSJ.

– The AIG bailout is burying some other pretty stirring news… like the crash in Russian stocks. This from the FT:

Russia’s two main bourses, RTS and MICEX, said on Wednesday they were suspending trade until further notice from the state’s main market regulator as shares continued to tumble one day after their steepest decline in more than a decade.

Russian stocks had continued to slide on Wednesday morning even as the government unveiled new anti-crisis measures to pump up to $29.5bn in extra budget funds into the three main state-controlled banks.

– The worse things get on Wall Street the better the Vanguard Short-Term Bond Index ETF (AMEX:BSV) looks says Andrew Snyder at Today’s Financial News. This high-yield bond fund is one of the safest places to park your cash right now.

– “It’s during times like this when all those guys you read about (Buffett, Templeton, et al.) made their best investments,” says Chris Mayer.

This from the 5 Min Forecast:

During times like this, there are no ‘safe’ stocks, in the sense that the prices can’t go down. Nearly everything goes down when the market averages fall 20% or more. Anyone tells you to buy safe stocks, hit ’em over the head with a book. There are a lot of great companies out there, I certainly agree. And many great buys. But they are safe only insofar as their businesses are highly unlikely to suffer some permanent impairment – like a bankruptcy or major loss.

– Crude oil is getting hammered. Prices dropped below $90 a barrel, and are now at just over $94 a barrel.

– That AIG is the sponsor of one of the largest commodities index isn’t helping matters. The DJ-AIG commodity index has about $30 billion in derivatives that track the benchmark, says the FT. The index fell 2.7 per cent to its lowest level since September 2007.

– Eric Fry at Rude Awakening says commodities will rebound. Stupidity and greed can wipe out stocks (see above); they can’t wipe out commodities…

A hypothetical portfolio that contained half S&P 500 stocks and half commodities would have lost 9.75% during the month of September, so far. That performance would rank as the fourth worst monthly performance of the last 50 years. In other words, these are strange times indeed.

But even though commodity prices have retreated substantially from their all-time highs, they will rebound eventually. By contrast, the financial sector has wiped out more than one trillion dollars of investor wealth…and that wealth is gone for good.

So at the risk of repeating ourselves, we will repeat ourselves anyway: we like commodities, at least for the long haul, if not also for the short haul. We like commodities because supplies are limited and demand is not. But we also like commodities because they lack CEOs and executive management teams. We like commodities because greed and stupidity cannot destroy their value.