East of Eden

"Gentleman, you had a helluva first day."
--Viper (Top Gun)

One of the first official statements out of the new treasury secretary's mouth was that the Obama administration believes that China manipulates its currency. In fairness to Secretary Geithner, officials linked to previous administrations have voiced concerns about the yuan's value as well, although their words were less edgy. Chalk it up to a rookie mistake of the tongue.

But singling out China is amusing because all countries manipulate currencies through both words and deeds. For instance, U.S. officials have chronically jawboned a strong dollar policy (while in the background enacting policies destined to weaken the USD). Some countries 'peg' their currencies to others in an attempt to mitigate market forces. Overt manipulation comes in the form of currency market intervention, which by definition changes the monetary supply/demand dynamic to something other that established by market forces.

In a global economy of fiat currencies, the preferred choice of policymakers over time is to weaken your currency versus others, thereby increasing the attractiveness of your products in the eyes of foreign buyers. Such a policy encourages exports.

As China's export industries have grown, more outsiders have accused them of artificially weakening their currency to support mercantilist export policy. Of course, determining just what constitutes 'artificial' is in the eyes of the beholder. After all, how do you objectively value pieces of government-issued paper, particularly when all nations are engaged in similar programs aimed at devaluing their currency--the so called 'race to debase?'

In China's case, American bureaucrats should be careful for what they wish. The day China decides to let the yuan substantially appreciate, there's a real chance of capital flight away from, and perhaps out of, the U.S. towards Asia. Many smart cookies are getting long the yuan because they think such a trend is likely regardless of whether the Chinese government intentionally moves to strengthen it. Moreover, fewer cheap Chinese goods coming into the U.S. would put upward pressure on domestic prices, which could fan inflationary flames currently simmering under $ trillions of government sponsored economic stimulus programs.

The correct policy, of course, is to get our own house in order. The fact that we continually look outside our house for causes and remedies speaks volumes about our internal capacity for effective problem solving.

no positions

One Honest Man

I'm not expecting to grow flowers in a desert
But I can live and breathe
And see the sun in wintertime
--Big Country

Once again, Ron Paul frames our situation. Many people take issue with the hands off solution, claiming that many people will be hurt. As Congressman Paul notes, however, failure to properly cope with the problem now leads to more pain, perhaps even fatality, down the road.

Due to ignorance, politically driven greed, or perhaps reflexive response to threat, we're placing a gigantic bet with our childrens' future on what reasoned analysis suggests is a long shot bail out attempt.

Mr Paul continues to be the only elected official in Washington who can clearly articulate this position and back it with action. While numerically not much, he provides a beacon of hope for liberty.

Freeze Frame

I could see it was a rough-cut Tuesday
Slow-motion weekdays stare me down
--J Geils Band

Not a bad portrayal by Glenn Beck of what's being done to our currency. To increase credibility and legitimacy, I would have cited the specific data series I was working with, as monetary measures exist. I believe he's using the adjusted monetary base kept by the St Louis Fed.

Central to this situation is the Fed's exploding balance sheet. The current data suggest no end to the money printing trend any time soon.

My memory's prolly failing, but this presentation is the first I can recall where a mainstream media talking head has voiced concerns about the inflationary basis of the Fed and its consequences.

Hopefully it won't be the last.

Perhaps more people are catching on, as gold is back on the move. It's trading at $925 this am, and approaching an important level technically.

position in gold

Search Party

"What is this madness?"
--Arthur (King Arthur)

Mainstream media discussions where panelists interview Ron Paul resemble some weird plot where no matter how plainly the interviewee answers a question, the panel just doesn't seem to get it.

In reality, of course, the panelists just don't like the answers they're getting.

Pay down debt, save, cut taxes, reduce government spending, protect liberty. If we continue to put off such actions? Borrowing from straight shooter Tristan, then we'll never make it.

Tickle Me Elmo

We always wish for money
We always wish for fame
We think we have the answers
Some things ain't ever gonna change
--John Waite

Not sure I've ever felt this bullish on energy--the commodities more so than the stocks. Couple supply destruction with our increased propensity to blanket the globe in fiat confetti and the secular story seems quite bullish from where I sit.

While the time horizon for my thesis is measured in years, it does appear that crude's trying to put in a bottom around these levels.

A technical tell of a change in tone would be if/when price decisively creases near term resistance at about $50.

position in oil

Seismic Moment

I've been feeling so much older
Frame me and hang me on the wall
I've seen you fall into the same trap
This thing is happening to us all
--Crowded House

Nice missive by Andrew Jeffery on the urban myth surrounding central banking. Perhaps the greatest misperception of all is that central banks impart stability to the financial system.

On the contrary, over the long haul, central bank interventions impart tremendous stresses on market landscapes. At some point, the potential energy built up by these distortions turns kinetic. We're experiencing the energy release from one of these policymaker-induced earthquakes currently.

For perspective on just how extreme central bank intervention has become, check out this video.

We'll need to recalibrate the Richter scale for this one.

Consumption Function

I must've dreamed a thousand dreams
Been haunted by a million screams
But I can hear the marching feet
They're moving into the street
--Genesis

Increasingly policymakers spin current and future economic stimulus packages as 'investments.' As part of his recovery plan, for example, President Obama proposes that we invest in modernizations that would make three quarters of all federal buildings more energy efficient.

Spinning government expenditures as investment is not new; it can be traced back to at least the original New Deal. 'Investing' has a durable, learned ring that helps policymakers and citizenry rationalize the spending.

But spending is what it is, as government expenditures represent consumption. Investment comes from voluntarily allocating a portion of savings towards capacity for producing more resources tomorrow. Currently, of course, we have no savings to allocate. Moreover, government spending results from a process of obtaining resources from citizenry in a coercive, rather than voluntary, manner.

The appropriate solution to a debt and spending problem is to reduce debt and save. Such a solution, of course, is lost on policymakers.

Rather than investing in federal building improvements per President Obama's plan, we would be better off divesting the government buildings themselves. Proceeds could be applied towards reducing the deficit. Size of government (read: capacity for further spending) would shrink. And resources would return private hands where, over time, they are more likely to be productively put to work.

Not likely, I know, as our course seems fixed on achieving a destination of squalor.

Fantasy Farm

Well I came across a child of God, he was walking along the road
And I asked him tell where are you going, this he told me:
Well I'm going down to Yasgur's farm, gonna join in a rock and roll band.
Got to get back to the land, set my soul free
--Crosby, Stills & Nash

Jim Rogers lays out his case for commodities once again, and the negative drag likely to be imparted on paper financial assets (i.e., stocks and bonds) by monetary and fiscal policy.

Peter Schiff adds the inflationary ramifications of current policy on gold, oil, et al (bullish) and the US dollar (bearish).

Sprinkle in current optimisim with the incoming administration, and it sure feels like conditions are forming for a big 'reflation trade'--particularly in 'stuff.'

positions in gold, oil

Yippie Kai Yaye

"The only thing better than blowing up 100 billion dollars worth of gold is making people think you did."
John McClane (Die Hard With a Vengeance)

Strong $40 move in gold today, which puts bullion right around $900. Things look very nice technically after today's quadruple top breakout in PnF land.

Should the yellow dog clear $935, then an assault on last spring's $1000 high would be in sight.

position in gold

Head Start

Make it up as we go along
Feet on the ground
Head in the sky
It's ok I know nothing's wrong--nothing
--Talking Heads

Want to evaluate how sharp mainstream media talking heads are? Get them yapping about economic issues and listen to most reveal just how ignorant they really are.

One who, in my view, passes this acid test pretty well is Glenn Beck. Considers both sides of the trade, studies history, conclusions driven more by reason than by politics. Also very grounded in the principle of liberty.

Two recent interviews of interest: with Peter Schiff, with Ron Paul. Both raise the spectre of extreme inflation, perhaps a la Weimar. I've been allocating more attention in this direction as well.

The proposed mechanism: Large industrialized debtor nation needs money>>taps credit markets in huge size>>foreign lenders load up on debtor country bonds>>economic and fiscal conditions worsen>>as foreign lenders increasingly perceive risk of not getting paid back, debtor nation is cut off from credit markets>>debtor nation begins to 'monetize' debt (read: printing money)>>currency gets devalued>>creditors dump debtor nation's bonds>>monetary printing presses shift into hyperdrive>>currency craters>>real interest rates and prices rocket.

Given our massive debtor status, current economic trajectory, and political resolve to do 'whatever it takes' to 'save' the economy via stimulus, it's difficult to ignore the extreme inflation possibility.

I've been assigning higher probabilities to this scenario by the day. And positioning accordingly.

Round Trip

Just wait till tomorrow
I guess that's what they all say
Just before they fall apart
--New Order

Ugly day as banks really fell apart, with BKX down 20% on the day.

With today's performance, the BKX completes an amazing round trip that finds in back at early 1995 levels.

Combine the Royal Bank of Scotland (RBS) near insolvency with today's State Street (STT) earnings warning, and perhaps market participants are connecting dots towards what may be the inevitable nationalization of the banking system. The Bank of England seems ready to roll.

I have no inclination to bottom fish this group, as the nationalization scenario could take equity (and associated dividends) to zero.

no positions

Strange Days Indeed

Everybody's runnin' and no one makes a move
Everyone's a winner and nothing left to lose
There's a little yellow idol to the north of Katmandu
--John Lennon

Blog bites on a weird market day. UK closer to bank nationalization after this weekend's Royal Bank of Scotland (RBS) bailout (failure). Subsequently, Pound is getting, er, pounded. BKX off another 12% (we're looking at a BKX 27 handle today). Dollar rallying 1%+ on top of this news. And gold rallying over 2% despite the USD strength.

Most peculiar, mama.

position in gold

Free Market Riot

If I told you what it takes
To reach the highest high
You'd laugh and say nothing's that simple
--The Who

My sister and I were chatting last night about the conclusion, drawn by many, that 'free markets' are the cause of our economic and social problems.

To assess the validity of this conclusion, we first need to define what free markets are. Free markets are social phenomena where people engage in unencumbered economic exchange.

Exchange is the result of contracts between buyers and sellers, and there is no outside interference on who contracts with whom. Sometimes the contracts are implied and informal, such as in the instance of the purchase of a pack of gum from a grocery store. Julie agrees to give one dollar to Krogers (KR); KR agrees to give one pack of Wrigley's Spearmint gum to the Julie.

Sometimes the contracts are explicit and formal, such as in the instance of the purchase of a home mortgage from a bank. The Smiths and a Wells Fargo (WFC) representative co-sign an elaborate set of documents in which the Smiths agree to pay 4.75% interest annually over 30 years to WFC; WFC gives the Smiths $200,000 today so that the couple can buy their dream home today.

Government's primary role in free markets is to preserve individual property rights, particularly as expressed via the contractual agreements between buyers and sellers.

The other key feature of free markets is capitalism. In capitalistic systems, productive capacity is privately owned. The owners decide what and how much to produce. Government has no say in the matter as long as property rights are not violated.

A common misperception about free markets is that the balance of power is tilted towards the producers--and in particular 'big business.' It is thought that capitalists can exploit the system since they control the means of production.

In free markets, however, the real power rests with consumers, not producers. Consumers, through their daily purchasing decisions, send signals to producers on what constitutes value. Producers must respond, or be driven out of business by others who satisfy buyers' needs with better products priced more efficiently.

It is therefore not monopolistically-minded producers nor government planners that determine the structure of production in free markets. Instead, it is consumers who solve society's basic economic problem of how scarce resources are allocated.

Freedom of choice, the bedrock of liberty, drives free market systems.

Unfortunately, the system described here exists in construct only. It is likely that few of us have experienced truly free markets on a large scale in our lifetimes.

All modern markets are interventionist in nature. Outside entities, primarily in form of government agencies, interfere with the contracting and production mechanisms to produce outcomes that, by definition, differ from those that would be obtained by free market actors.

Those who blame our problems on extant economic configurations are correct. But these configurations are not based on freedom. Instead they are based on interventionist measures that are driving us into the ground.

More the flawed nature of interventionism in future missives.

no positions

Common Sense

You're the kind of person
You meet at certain dismal dull affairs
Center of a crowd, talking much too loud
Running up and down the stairs
--Rolling Stones

Many folks don't care for Peter Schiff because he just lays out there--well reasoned thoughts with little concern for politics. Of course, that's why I like him.

He saliently observes that a healthy economy does not depend on credit. Rather, it depends on savings. In the long run, credit is limited by the stock of savings.

Since U.S. savings have been pathetically low, is it any surprise that credit has been drying up?

So policymakers continue to noodle over how to jam more credit into a system with no savings to back it up. And how to increase government's role in 'fixing' things.

Look out below.

Reach for the Sky

And I ran, I ran so far away
I just ran, I ran all night and day
I couldn't get away
--Flock of Seagulls

Given the bizarre nature of our present economic situation, I've thought to myself several times, "Jeez, you couldn't write fiction this good."

However, I think Ayn Rand did just that over 50 yrs ago.

Recent WSJ piece citing Atlas Shrugged has me (finally) putting this book in the queue. Observations in this article seem spot on to me, btw.

Toll Road

"I'm sorry, Mr President. I don't dance."
--Jack Ryan (Clear and Present Danger)

President-elect Obama outlined his economic stimulus plan in a speech at George Mason University last Thursday. The venue strikes me as ironic since George Mason was a staunch Anti Federalist who refused to sign the Constitution out of concern that it granted too much power to central government.

Current estimates size the plan at about three quarters of a trillion dollars but rest assured this won't cap the cost.

You can reflect on the words separately, but I did want to highlight a couple of passages here [emphasis mine].

"There is no doubt that the cost of this plan will be considerable. It will certainly add to the budget deficit in the short term. But equally certain are the consequences of doing too little or nothing at all, for that will lead to an even greater deficit of jobs, incomes, and confidence in our economy. It is true that we cannot depend on government alone to create jobs or long-term growth, but at this particular moment, only government can provide the short-term boost necessary to lift us from a recession this deep and severe. Only government can break the vicious cycles that are crippling our economy - where a lack of spending leads to lost jobs which leads to even less spending; where an inability to lend and borrow stops growth and leads to even less credit."

The notion that we can borrow and spend our way out of a borrowing and spending problem is, of course, folly. The only-government-can-get-us-out-of-it claim elevates the imprudence.

Perhaps the most noteworthy passage is near the end [again, emphasis mine]:

"That is why the time has come to build a 21st century economy in which hard work and responsibility are once again rewarded. That’s why I’m asking Congress to work with me and my team day and night, on weekends if necessary, to get the plan passed in the next few weeks. That’s why I’m calling on all Americans - Democrats and Republicans - to put good ideas ahead of the old ideological battles; a sense of common purpose above the same narrow partisanship; and insist that the first question each of us asks isn’t 'What’s good for me?' but 'What’s good for the country my children will inherit?'"

If we truly had our kids' best interest in mind, then we would not be borrowing from their future by levering up the risk today.

By following the path of government intervention under the belief that it will lead us to the solution of our problems, we can be confident of this: Our children will surely pay the toll for our misdirection.

Phase Change

"You're afraid of our fleet. Well, you should be. Personally, I'd give us one chance in three. More tea anyone?"
--Captain Marko Ramius (Hunt for Red October)

Are the probabilities shifting from deflation towards severe inflation? For some time now, I've assigned greater chances of deflation than extreme inflation. The massive debt overhang from the popping of a worldwide credit bubble has favored prolonged credit contraction.

However, one can't ignore the gargantuan amount of monetary stimulus being created by central banks around the world aimed at reversing the deflationary trajectory. The coordinated nature of this action, designed largely to prop up asset prices (and thus mute the mother of all margin calls), is truly unprecedented and must be respected.

What's on my mind today is the lagged cause and effect nature of monetary intervention. Typically, when monetary policy is altered, it takes 6-18 months for economic effects to be realized. As such, just because we haven't observed inflationary effects from all this intervention yet doesn't mean we won't. Because the printing presses weren't really ripping till last Fall, we shouldn't expect significant consequences of these actions till this Spring at the earliest--and perhaps much later.

One thing's for sure. Financial markets will sniff building inflationary pressures out ahead of their material appearance.

In my personal forecast of macro conditions over the next couple of year, I'm dialing up the chances of extreme inflation:

extreme inflation 50%
'normal' inflation 20%
deflation 30%

I'm rebalancing my portfolio accordingly to better reflect inflationary possibilities. Mainly, I've been decreasing cash and adding to commodity positions. Given the sector's pounded down nature--and it's increasingly attractive (in my view) fundamentals, I've been particularly focused on energy-related commodities, using ETF and ETN instruments such as DBE, DBO, and RJN.

The idea is to boost chances of preserving purchasing power in a world that's tilting more towards a fiat money confetti-fest.

position in DBE, DBO, RJN

Tax Back Act

Should five per cent appear too small
Be thankful I don't take it all
'Cause I'm the taxman, yeah I'm the taxman
--The Beatles

Having never met a tax cut I didn't like, I'm hesitant to criticize President-elect Obama's tax cut proposal.

But people should be questioning whether this plan is really a tax cut. From where I sit, the definition of a tax cut should be government returning wealth to individuals--wealth that was rightfully each individual's in the first place. Lacking those funds, government should subsequently reduce its spending in kind.

In President-elect Obama's case (and in cases previously such as President Bush's various tax rebates), government does not intend on reducing spending. On the contrary, proposed 'stimulus' plans aim at dramatically stepping up outlays. These programs cannot be funded from the deeply red current budget.

So, to fund the proposed $300 billion in tax cuts, government has to either a) borrow money, or b) print it.

The result is more debt or currency debasement--neither of which returns wealth to the citizenry.

Until tax cuts are paired with commensurate reduction in government spending, it's hard to objectively view such initiatives as much more than programs of inflation.

Saving Grace

When it's all mixed up
Better break it down
In the world of secrets
In the world of sound
--Tears for Fears

Mr P reminds us that we can't get out of a debt problem by taking on more debt. While self-evident, it seems we're constantly in need of this reminder.

Standard of living improves over time by investing capital towards productivity improvement and innovation. This capital comes from saving a portion of real income.

The progression works like this:

savings->investment capital->productivity improvement->higher standard of living

Current government 'stimulus' programs that require borrowing from others or simply printing money to fund projects have no place in this progression because they are not savings.

Until we save, we'll lack true investment capital and standard of living will consequentially suffer.

Don't get distracted by eloquent arguments to the contrary. It's really that simple.

Pyramid Plunder

All the old paintings on the tombs
They do the sand dance don't you know
If they move too quick
They're falling down like a domino
--Bangles

Ponzi schemes have scored lots of mainstream media attention recently due to the ongoing Madoff saga. The idea behind a Ponzi, or pyramid, scheme is that early members are 'funded' by newcoming contributors who at some point are left holding the bag. It's a way to commit fraud.

At purportedly $50 billion, the Madoff scheme is being billed as the largest Ponzi in history. It's not even close. The size of the Madoff fraud pales in comparison to many government-run Ponzis.

The classic example is Social Security. Like Madoff and his early 'investors,' current Social Security recipients are being funded by taxes taken from today's workers (who resemble the latecomers to Madoff's scheme). There are no 'reserve' Social Security assets as these have previously been withdrawn and spent elsewhere. As more and more folks seek to draw from Social Security in the future, there is no way that there will be enough fresh inflows from new contributors to cover all users. At some point, late arrivers to the system will be screwed.

So, while government officials howl that the Madoff situation 'obviously' suggests that markets need more oversight, hopefully the irony is not lost on you.

For these same bureaucrats preside over the largest Ponzi portfolio in the world.

Break Lights

Ain't got no regrets
And I ain't losin' track
Of which way I'm going
Ain't gonna double back no
--Lou Gramm

Looks like we've achieved resolution on that flag pattern. Friday's strong new year's opening session found major market indexes breaking out.

The S&P 500 Index (SPX) appears to have some upside running room. Looks to me that next meaningful resistance is SPX 1000ish.

no positions

Goal Tender

All is quiet on New Year's Day,
A world in white gets underway
--U2

While 2008 was a rough year from a financial perspective, I was fortunate to accomplish two personal goals. All remaining non-mortgage debt, including credit cards and car loan, was extinguished. There are few better feelings than paying off loans. Debt reduces freedom.

I was also able to build a significant cash reserve--enough to cover more than a year's living expenses. While it doesn't yield much, cash is king in a deflationary environment. It doesn't go down like risky assets do. Those with high cash positions get relatively richer during deflationary events, plus they are better able to take advantage of fire sale asset prices.

It's my view that many people don't have enough cash on hand to fund current needs and opportunities. Instead, folks pour excess cash into deferred retirement accounts, or into illiquid assets like housing. Then, if something comes up, people have no money. So they resort to, yep, borrowing and debt. Cash facilitates freedom and flexibility.

When setting financial goals for a new year, I avoid setting numerical net worth or ROI goals. I'm not a fund manager who needs to report quarterly results to shareholders. Thus, there is no need to live and die by results that in the short term are subject to market vagaries.

The financial goals I can control are those related to saving and asset allocation. Here are three primary goals for 2009.

Mortgage. One outstanding loan stands between me and total debt freedom: my mortgage. I want to pay off my house by the end of 2011. For 2009, the goal is to reduce my mortgage by 25%. I commenced juiced up mortgage payments last November.

Cash. As late as a couple weeks ago I intended to continue building cash at a rigorous pace in '09. Listening to Jim Rogers over and over now has me hesitant to build dollar reserves too aggressively. Government printing presses are in overdrive trying to stem the deflationary tide. If (big if, perhaps) they are successful, then we may witness inflation unlike anything we've seen in our lifetimes. The dollar would be eviscerated in this scenario. Soooo, I'm setting a modest goal of 15% increase in cash in 2009. Excess cash will be applied towards the mortgage paydown project, or towards more hard assets like gold--particularly at sub $1000 bullion.

Commodities. Again, Jim Rogers' relentless message has colored my thinking. Potential for a weakening dollar and commodity supply shortages has me wanting to increase my exposure in 2009. My primary vehicle along these lines has been gold, but giving the recent collapse in industrial commodities, I want more exposure here--particularly to oil and energy. I started adding commodity ETFs late last year. Currently, my non-metal commodity exposure stands at about 5% of liquid assets. In 2009, I'd like to get this to 10%.

Happy New Year to all and best of luck in '09.

positions in gold, oil