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The price of gold has so far defied the "deflation scare" in bond markets…

SO FAR, the prospect of Japanese-style deflation spreading to other G7 industrialized nations hasn’t scared off the hard-core gold bugs, writes Gary Dorsch at Global Money Trends.

In New York, the yellow metal is still changing hands above $1200 an ounce, or nearly double the levels that prevailed five years ago. Intuitively, one could expect that the Gold Investment market would thrive in an environment of near zero-percent interest rates, coupled with massive monetization of government debt by central banks, and bailouts of the banking oligarchs.

The US Treasury issued $165 billion of fresh debt during July, and so far in the first 10 months of fiscal 2010 (ending Sept 30th) the shortfall has totaled $1.17 trillion. July’s deficit marked the 22nd straight month of red ink for the US government, the longest string on record. If the US economy slips into a "double-dip" recession, it could weaken tax revenues. Thus the Fed’s sleight of hand, announced last week, in shifting maturing debt in mortgage-backed bonds into Treasury bonds.

US President Barack Obama has made a last-minute pitch for aid to financially struggling states. Obama and the Democratic led Congress aim to send $16 billion for Medicaid and $10 billion for schools in order to prevent states from defaulting on their debts.

US states could face budget shortfalls of more than $120 billion this year. Thus, the Fed could soon be in the business of bailing out individual US states, and not just Washington and banksters. For Gold Bullion bugs, more government debt equals more printing of US Dollars by the central bank. Bernanke didn’t authorize a new round of money printing last week, just a shuffling of paper money already in circulation. Yet a resumption of full-scale Quantitative Easing still looms on the horizon.

Deflationist enthusiasts, rushing to gobble-up Japanese government bonds, also face a major price risk that could lead to severe losses, and within a relatively short period of time. On August 11th, Japan’s Ministry of Finance sold ¥2.4 trillion ($28 billion) of five-year JGB’s with a 0.30% coupon, the lowest in seven years.

The auction attracted bids that were 4.7 times the volume on offer, the highest since 2005. That compares an average bid-to-cover ratio of 3.47 from the past 12 auctions. Note that Beijing has been a buyer of ¥1.7 trillion ($20 billion) of JGBs so far in 2010.

Still, traders are mindful of the bursting of the JGB bubble in mid-2003, when yields quadrupled within four months as prices sank.

Traders were lured into bidding-up JGBs until the 10-year yield had fallen to a historic low of 0.43%, under the influence of the Bank of Japan’s hallucinogenic QE-drug. However, JGB yields suddenly reversed and surged sharply higher to 1.65%. JGB losses continued to mount through 2006, when the BoJ scrapped its QE-scheme, and 10-year yields climbed to 2%.

Someday, it might dawn on bullish speculators in US Treasury debt that the fear of a deflationary spiral is just a propaganda ploy, devised by central banks, to drive down the cost of financing government debt. If you think there’s deflation in the air, look around you. Prices are not falling for basic services, food, or energy. However, the American middle class is under siege from slumping home prices and cuts in wages and medical benefits.

But as John Maynard Keynes used to say, "The market can stay irrational longer than you can stay solvent…"

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Source:Gold Price Defies Deflation Scare

How should investors prepare for the US mid-term elections…?

NOW THAT many US primaries are past, and the November 2010 mid-term elections are less than five months away, it is worth taking a look at what policy changes we might expect from the next US Congress, writes Martin Hutchinson at Money Morning.

Both the political and economic worlds have changed one hell of a lot since the last elections, in 2008. Thus, even though US President Barack Obama is slated to remain in office until at least 2013, the Congress elected in November will be very different from the one that was elected in November 2008.

The results of the primaries have already given us a lot of information about US voter intentions. Voters have rejected two sitting senators (Arlen Specter, D-PA, and Robert Bennett, R-UT), which suggests a general dislike for incumbents. On the other hand, moderate-Democrat Sen. Blanche Lincoln, D-AR, won her primary handily, defeating an opponent who’d enthusiastically backed the policies of the current Democrat-controlled Congress, the Obama administration, and the unions.

That suggests that the moderate-Democrat policies represented by the 1990s Clinton administration still have appeal with US voters. As an overall entity, however, government is viewed with disdain – or even outright contempt.

Taken together, for instance, the stunning January victory of little-known Scott Brown, R-MA, plus the current 63% approval in opinion polls for repealing the new national healthcare plan, suggest that the rapid expansion of government attempted by President Obama and the current Congress is very unpopular.

There’s other evidence, too. Take the proposed "cap-and-trade" environmental legislation: As drafted, it would give government huge new powers over the economy. The upshot? It’s out of favor.

None of this means the Republicans will sweep the country. For one thing, memories of the inept Bush administration and the corrupt GOP Congress of 2004-2006 remain fairly fresh. Furthermore, while the Tea Party movement has aroused considerable enthusiasm, voters appear to be developing doubts about its radicalism and sometimes "nutty" views.

Thus, the likelihood is for considerable Republican gains – but not outright dominance.

In the US Senate, it’s almost impossible when only 17 Democratic Senate seats are up for re-election for the Republicans to go from 41 to 51, thereby giving the GOP the 10 additional seats it needs to get a majority (ties would be broken by Vice President Joe Biden – in favor of the Democrats).

Even if the popular mood favored Republicans strongly enough, too many of their candidates have weaknesses that could lose them some apparently winnable races. For example, Sharron Angle, who won the Nevada primary to run against the apparently vulnerable Senate Majority Leader Harry Reid, D-NV, is a Tea Party candidate whose views and past statements make her vulnerable to attack from the well-funded Reid.

Over in the House of Representatives, removing incumbents in large numbers is similarly quite difficult. The greatest turnover in a midterm election since World War II was 54 seats – which occurred in 1946 and again in 1994.

Thus, excited Republican calculations of a possible swing of 80 to 100 seats are just not realistic. For the Republicans to get the 270 seats that such a turnover would imply might be possible if they already had 210 to 220 seats. It is not realistic from the GOP’s starting position of 179 seats (the Democrats have 255 seats, and two are vacant).

A Republican pickup of 39 seats – which would give it a bare majority – is certainly possible, although I place the odds at less than fifty-fifty.

It seems equally unlikely that the GOP will gain less than 25 seats or so. Thus, the 112 th Congress is most likely to be close to evenly divided, but partisan – with fewer "blue dog" moderate Democrats than there are right now, and very few floor-crossing Republicans. Either President Obama will control both chambers of Congress, albeit with small majorities, or Congress will be split, with a Republican House and a Democratic Senate, again with small majorities.

With President Obama remaining in office, the Republican "wish list" will not pass. But the Democrat wish list will also be in trouble. The US budgetary position will be dire, so large new spending programs will be impossible. Taxes will increase, beyond the reversal of most of the 2001 tax cuts. However, whatever the Deficit Commission reports in December, it’s very unlikely that the huge revenue-raising device of a value-added tax (VAT) will be granted to a Democrat president by a Congress where Republicans are strong.

However, it is possible that the two sides will compromise on a moderate carbon tax, which would have the dual virtues of combating global warming and raising revenue. To force the Republicans to agree to this, President Obama will be able to use the threat of EPA regulation of carbon emissions.

The recent healthcare legislation will remain in force, coming into effect on schedule, although very likely subject to partisan fights. The big battle here will arise in 2013, as the legislation’s major changes take effect in 2014.

Since 2007, it has been impossible to get trade agreements through Congress; this will not change, so the Colombia and South Korea Free Trade Agreements will remain in limbo. Other protectionist actions are likely – in moderation.

The banking legislation passed this year will not be significantly amended, but there will be a massive partisan battle over what to do with Fannie Mae and Freddie Mac. These housing finance behemoths each continue to absorb $100 billion in taxpayer money ach year, and no significant reform has been attempted by the current Democrat-led Congress.

So if anything, this outlook for the Congressional elections underscores just how intractable the US budget deficit will remain, with an annual shortfall in excess of $1 trillion that will refuse to budge, unless the US economic recovery really takes off. And that’s not likely to happen.

The massive financing needs of the federal government will "crowd out" the private sector in the bank and bond markets, so small business investment will be low, unemployment will remain high and economic growth limited.

Equally, the chance of an economic crisis will probably be lower than with the current Congress. Policies will be moderate and a consensus between the President, Congress and the Bernanke Fed will agree to postpone problems until after the 2012 Presidential election. Interest rates will remain low, resulting in rising inflation.

It’s not a very pretty picture, but it involves less structural change in the US economy than if the current Congress had been re-elected. There will be no "new" New Deal – a program that would result in additional sharp increases in government involvement in the economy.

For US investors, the best haven is probably gold – and emerging market stocks.

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Source:Investing Ahead of the Mid-Term US Elections

Vote for gold, not the distraction of Glenn Beck & Goldline vs. Congressman Weiner…

GOLD is already the political of asset classes. So it was certain to happen at some point in this multi-year – if not multi-decade – bull run.

Because we all have a choice – "a choice between the natural stability of Gold and the honesty and intelligence of the members of government," as the playwright and early Socialist George Bernard Shaw put it.

"With all due respect for those gentlemen, I advise you, as long as the capitalist system lasts, [to] vote for Gold."

The weary humor is Shaw’s; the italics are ours. Because a little over a century later, gold is performing as advertised…surging to untold records as politicians worldwide refuse to be honest or intelligent about anything much. But capitalism – or at least, the right to property, which is where it begins – needs to persist for gold’s "natural stability" to retain any use.

Hold that thought as we take a trip to the circus…

"Goldline formed an unholy alliance with conservative pundits to drive a false narrative," alleges Anthony D.Weiner, Congressman for New York’s 9th district, in his extraordinary attack on Fox News and the major US coin dealer recommended by the apparently $32 million-per-year Glenn Beck.

Never mind that, according to Weiner’s own website, he was last seen on the House floor asserting that "The Republican Party is a wholly-owned subsidiary of the insurance industry." This isn’t about Weiner’s tabloid metaphors. It’s about the "false narrative" allegedly put about by Beck – and thus Goldline, according to Brooklyn and Queens’ man in Washington – to sell gold at horrible mark-ups by "playing off public fears" of inflation.

"On numerous occasions, Glenn Beck has dedicated entire segments of his program to explaining why the US money supply is destined for hyperinflation with Barack Obama as president. He will often promote the purchase of gold as the only safe investment alternative for consumers who want to safeguard their livelihoods. When the show then cuts to commercial break, viewers are treated to an advertisement from Goldline…"

Gasp! Horror! There’s a salesman on American TV…!

Whatever the rights or wrongs of one self-promoting showman attacking another in a formal presentation stamped "House of Representatives", it was only a matter of time before the rabid anti-rabid-right of rabid US politics took issue with Beck’s foaming-mouth advertorials. And luckily for the watching media, the sideshow makes a great distraction – "Look! Punch and Judy!" – from the very live, very threatening politicization of all investment decisions.

Australia’s absurd "super profits" tax of 40% on mining firms, for instance, looks horribly contagious, even if it’s the axiom of George Bernard Shaw’s tip. Because if the world’s second most expensive cost-per-ounce gold producers can bear it, why not lower-cost regions as well…?

The need to grab cash from captive producers is universal, and unlike hedge funds, mining projects can’t relocate. Claimed as some kind of primeval patrimony by tax-hungry politicians – even pasty Anglo-Saxons down under, like prime minister Kevin Rudd – the last decade’s surge in raw material prices clearly invites "resource nationalism". Indeed, it’s a major risk worldwide reckons Evy Hambro, son of British gold-mining magnate and banking heir Peter, and manager of BlackRock’s $14bn World Mining Fund.

Yes, Hambro’s got vested interests here, just like Glenn Beck. But does that make him a shill, merely voicing a view to extend his own income…?

"Equities aren’t the only source of revenue governments will seek to tap," writes Alen Mattich in his Wall Street Journal blog. "Any assets that can be valued relatively easily – and any income flows, whatever their source, that governments can get their hands on – will be a temptation for the taxman.

"Is, say, a levy on gold – everybody’s favorite safe haven – impossible?"

Mattich says a globally-agreed sales tax on Gold could prevent money from slipping through government hands. Which would be true, if only he didn’t underestimate London’s grasp on global gold trading. VAT on gold won’t make a comeback here any time soon. Not in the wholesale bullion market. Not with China now the world’s largest gold-mining nation, fifth largest central-bank holder, and second-largest consumer market. The UK has none of those things. It owns the gold market, and thus taxes the trading revenues earned in London, by historical convenience alone. So while the new Lib-Con coalition looks set to be as dishonest and stupid as every other government since George Bernard Shaw and before, it’s unlikely to be quite that unintelligent just yet. Surely.

More broadly, however, a special tax on private gold-owners’ gains may soon appeal pretty much everywhere. Long-time holders were early and right in spotting the financial crisis ahead – and nobody likes a smart-arse, remember. Even more recent buyers are also showing notable gains, and most notably against the fast-sickening Euro, too. So while "It was probably a mistake to allow gold to rise so high," as Paul Volcker, chairman of the Federal Reserve when gold peaked at $850 an ounce in 1980, once famously said, it’s German and Greek politicians who must now be wondering why Europe’s central-bank gold sales ended without having a gold tax ready and waiting to keep milking the metal.

Yes, the honest and intelligent thing would be to make like Volcker and raise interest rates. Defending the value – and thus use – of money would ensure the vital liquidity it brings to life’s everyday choices. Seeking to devalue it instead, however, government will increasingly lose votes to gold. Expecting some kind of political fight-back is only prudent. But what?

Vietnam’s 2008 ban on gold imports merely spurred smuggling, plus new record highs in domestic gold prices. India’s increased gold tariffs early this year gave the same boost to Nepalese smugglers, too. Most idiotically, a tax-grab was attempted – but foiled – in Europe last summer, when Rome turned on the Bank of Italy’s national gold hoard!

Worded to catch all non-industrial holdings, but solely aimed at the central-bank vaults, Silvio Berlusconi’s "Anti-Crisis" Gold Law met unflinching opposition from both the Banca’s chief, Mario Draghi, and his big bruising friends up in Frankfurt at the European Central Bank. Now the ECB is just one U-turn away, however, from printing money to finance government debt, making the current record-high Gold Prices sharply ironic, not to say prophetic. The Bank of Italy, meantime, has joined France and Germany in ignoring losses on those government bonds held by commercial banks – losses that would otherwise force them to raise cash to boost their capital reserves. And Germany has broken ranks with the rest of Europe…enforcing new "short selling" bans on financial stocks, and extending it verboten to "speculate" against Eurozone debt inside Deutschland’s borders.

Things are growing quietly desperate, in short. Your personal finances are set to become very political, not least if you have something to lose. Sorry, something to share. For the good of the state, you understand. Sorry, for the good of the country…if not the world.

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Source:Gold Gets All Political

First asset deflation, then price inflation. How to defend wealth amid the "melt up"…?

SO HOW ABOUT that…? asks Dan Denning in his Daily Reckoning Australia.

For two days running after land-mark healthcare legislation passed the US Congress, stocks in New York made a new 17-month high. The market likes it when uncertainty is lifted from the horizon. It’s now clearly all down-hill from here.

We jest. Back in Baltimore earlier this month, at dinner, it was argued by one and all that stocks might be a good bet to beat inflation. Or, put another way, if you’re going to beat inflation, you’re more likely to beat it in stocks than cash.

This is not a value-based argument. But it IS an argument for why nominal gains in stock markets are not inconsistent with rampant or even hyper inflation. We’re not saying that’s what’s going on right now. And of course, in our one-two Big Crash dance card, asset deflation precedes the Melt Up.

But it’s hard to call the rally since last March’s lows anything else but a melt-up. Stocks aren’t cheap now. And they are pricing in a lot of future earnings growth. In a world where the private sector and businesses are deleveraging and where credit growth – excepting the public sector – is shrinking, the fuel that generates earnings and income growth is running out.

Not that sovereign bonds are any safer. Another point that came up at our dinner earlier this month is that certain high-quality corporate bonds would be better bets than certain faltering sovereign bonds. Or as Bloomberg reports, "The bond market is saying that it’s safer to lend to Warren Buffett than to Barack Obama."

If you judge executives by their ability to deliver regular and outstanding returns on equity and capital, the above point is self evident. Buffett has a long track record of delivering high returns on net tangible assets. This partly explains why the yield on two-year notes sold by Berkshire is 3.5 basis points lower than the yield on a two-year US Treasury note.

Buffett generates cash from his assets and borrows sparingly for sensible acquisitions of good businesses which he has meticulously valued (most of the time). The Federal Government is not a corporation. But its chief asset is probably its tax slaves, whom it is currently in the process of flogging for more money to pay for more new programs which the country can’t afford.

The trouble is, as Moody’s points out, when you flog your tax slaves in order to simply pay interest on money you’ve already borrowed, you move "substantially closer" to losing your AAA credit rating. Moody’s predicts that, "the US will spend more on debt service as a percentage of revenue this year than any other top-rated country except the U.K. America will use about 7 percent of taxes for debt payments in 2010 and almost 11 percent in 2013."

Does this mean short-term capital flows – as Greece plays out in slow motion – will favour Dollar-denominated assets that are:

1. not long-term government bonds; or
2. are stocks…?

We’ll see. But when US investors get nervous and flee home to the US Dollar, what happens then? And when US and UK banks get into capital self-preservation mode, doesn’t that leave Australia in the vulnerable position of being a capital importer in a world where the cost of capital is going up?

For now, the whole thing makes us nervous. And if the bulls are happy to rush in where nervous angels fear to tread, more power to them. And let’s not forget the elephant in the room: property.

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Source:Asset Melt Down & Melt Up

Why President Obama’s soft-money legacy could run a decade from now…

For the U.S. PRESIDENT, nominating Fed governors is a little like nominating Supreme Court justices, writes Martin Hutchinson for Money Morning.

Since they serve a 14-year term, you get the chance to shape the US Federal Reserve for a decade after your administration ends. What’s more – even though Fed governors are subject to confirmation by the US Senate – you’re far less likely to have trouble getting them through than you do with the Supremes.

That’s why US President Barack Obama’s current chance to nominate three out of the seven Fed governors is legitimate front-page news – and isn’t merely the "inside baseball" trivia that occupies much of the daily business section. Probably two of those three governors will still be serving in 2020, long after President Obama has published his memoirs.

The bottom line? One of President Obama’s legacies will be a "soft money" Fed.

Peter Diamond, one of the three names the White House announced last week, is high quality by any standards. He’s an MIT economist, with several important economic theorems to his name. He will prove to be very useful in a crisis, if only for his ability to figure out the best course of action – even as he’s being badgered by lobbyists and politicians.

Diamond is also an expert in behavioral economics, which means he won’t be too seduced by fancy mathematical models resting on obviously false assumptions like economic rationality. However, on monetary policy he’s an unknown quantity.

A second nominee, Sarah Raskin, is a regulatory specialist, currently Maryland’s commissioner of financial regulation. Monetarily, she is also something of unknown quantity, though the odds are she would tend towards the soft money wing on the Fed. Maryland has always had that kind of reputation, rather the opposite of Boston.

The third – and most important – of President Obama’s probable nominees is Janet L. Yellen, currently president of the Federal Reserve Bank of San Francisco. With 30 years as a monetary economist, three years as a Fed governor in the 1990s, and now six years at the San Francisco Fed, she’s unquestionably qualified. Yellen is even married to an economics Nobel-winner (George Akerlof), with whom she’s published numerous research papers.

But here’s the rub. Yellen has a reputation as a "soft money" supporter, and recently said the rate of inflation was "undesirably low". Even more alarming for anyone trying to save for the future, she believes that in 2004 – her first year in the job – the US economy was in danger of deflation.

In this view, Yellen echoes the beliefs of her new boss, Federal Reserve chairman Ben S. Bernanke. To see why that’s a cause for alarm, consider where inflation actually stood at that point, six years ago…

Reported consumer price inflation in 2004 was 3.3%, but 30% of that figure comprised "owners equivalent rent" or OER, an artificial construct imported into the Consumer Price Index (CPI) in 1980.

Replace the 2.5% rise in "owners equivalent rent" with 2004’s actual 16.2% rise in US home prices, and the actual living-cost inflation being experienced by consumers comes to 7.4%.

The upshot: Deflation was actually the last thing the Fed should have been worrying about at that time. And if the Fed’s policy team is still going to be blathering on about deflation when inflation soars past 7%, we’re in trouble. Unfortunately, it looks like that’s the way it’s going to be unless Diamond turns out to be a secret Paul Volcker clone.

With these three new governors – plus Bernanke and Bill Dudley, president of the New York Fed – the soft-money advocates are going to have a pretty solid majority of the policymaking Federal Open Market Committee. The FOMC establishes target rates that help determine overall US interest rates, and the soft-money majority looks certain all the way through the end of 2012.

But with the US federal budget deficit well above 10% of gross domestic product (GDP), the chances are high that by the end of a four-year period of very low interest rates we will have locked in an inflation rate that makes the 1970s look tame. Maybe we can avoid the Weimar Republic’s 1923 hyperinflation rate of a trillion percent a year, but we’re heading in that direction.

Now more than ever, Gold Bullion, oil and commodities look like a good bet. The same holds true for gold, energy and other commodity-producing companies whose reserves are in politically solid locations.

With three years of "soft money" ahead of us, the crude oil and Gold Price could get pretty much to nosebleed level. You probably want most of your money outside the United States, as well – we have enough exposure to these crazy policies just by living here.

Ready to Buy  Gold…?

Source:Stuffing the Fed with "Soft Money" Friends