August 2009


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Target $103.50 [+/- $0.20]

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Buying @ $101.97

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gld

On a chart [technical] basis GLD is looking decidedly bullish. With the September effect on stocks in wide discussion through blogoland, gold is entering it’s seasonal [historically] upswing period.

If gold should break through the $1000/oz barrier and successfully retest that as support, gold could be off to the races again after being asleep for the last few months.

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*Abolish Central Banks
*Return to Gold Standard
*Allow interest rates to rise to market levels
*Cut back on all Welfare expenditures [eventually eliminating them]
*Allow liquidation of capital
*Withdraw US troops from Iraq/Afghanistan
*Eliminate subsidies & pork

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Essentially almost the complete opposite of what is currently taking place. The current solutions will not work in the longer term, and aren’t even working in the short term, so why bother?

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So Chinese policymakers have had to choose between policies that boost employment in the short term while making the overcapacity problem in the long term worse and, on the other hand, force a more efficient adjustment in the domestic imbalance while increasing job losses.

Until now, Beijing had come down resolutely on the side of boosting employment. It had shifted a massive amount of resources, mainly through the banking system, into new investment in infrastructure and new production facilities. This created jobs and boosted consumption, but it did so by expanding current and future production even faster, only worsening the domestic imbalances and making China even more reliant on US consumption.

It probably had no choice. As in nearly every major economy, the first instinct of policymakers since the crisis began has been to enact measures to slow unemployment growth. If unemployment grew too quickly and caused consumption to fall, it could easily tip the economy into a long-term and irreversible contraction.

But there was always a limit to how far Beijing should push. It could continue spending like crazy on good and bad projects to keep workers employed, but if all this spending simply increases capacity faster than it raised consumption, the net result would be an unsustainable debt burden and a more difficult reckoning.

That is why we should welcome the signs that Beijing may be reaching the limits of its investment push. The government believes that it has created enough momentum to avoid the worst consequences of the global crisis and the contraction in the export markets, but it is also stepping back from creating a worse crisis.

China inflated at the opposite end from the US. The US because it had no choice, the banking system being on it’s knees, had to inflate via government deficits handed directly to the consumer.

China however could inflate through control of the banking system, directly to the producers. Thus China continued to expand stages of production, which, with more roundabout capitalistic processes increases the supply of products.

This opposite end bailout, is actually quite a good thing if the products being produced are in demand. The problem is, are the products being produced in demand?

How to know?

The market reallocates capital into product production via profit margins. The higher the profit margin, the more capital and resources will be attracted, thus increasing supply, bringing prices down and contracting profit margins, which prevents further investments.

When a government allocates capital and resources, it approaches the problem from a different perspective. China, as the article alludes has approached the problem from unemployment. This then could have a very different outcome.

Labour is more effective in productive processes that are closer to consumption goods. Thus by placing the emphasis on employment we have the following potential problem. That labour has been allocated to the stage of production that is more efficiently served by capital, thus the profitability will be seriously compromised leading to potential losses, which will affect stockmarket valuations. Or, that the labour has correctly been allocated to stages nearer to consumption goods. The effect being similar to the US stimulus.

If so, the effect will be similar to the US. That is as consumer demand stabilises, supply will be falling as current inventories are drawn down, while no replacement supply is forthcoming due to prior liquidations of unprofitable capital.

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From the chart, it would appear that the US consumer is exhibiting currently an increased preference for cash, and/or, China is not actually producing products that the US consumer wants or needs. On a fundamental basis, the Chinese economy is in as bad shape as any other. Those looking for a China led recovery and leadership out of the recession are looking at the wrong tree.

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It looks unlikely that I’ll get my price @ the CLOSE, so I’ll buy any dip at tomorrows OPEN circa $103.00 – $102.75

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Approaching the CLOSE, I’m looking at buying LONG @ circa $103.00 to $102.75 and exiting tomorrow circa $104.00

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After being sacked from GreenFaucet, missing out on his national exposure via the MoneyShow, my newest main-man, is going back to school.

Starting today, I will be extremely busy. I am preparing for my first day of school on August 31st. As you know, I will be starting a new shrink program. I have many, many reasons to do this, but I have no idea why I really chose to go back to UMD. I’ve been having recurring dreams for over a year telling me that I have to go “find something”. Who knows what that is, but my dreams or visions are usually correct. Say what you want, but I’m not crazy. I executed the delegation of my responsibilities in all of my businesses yesterday, except for my personal trading and anything that’s internet-related

What’s going to happen to his $70M Hedge Fund? Will he continue to run it? Will his investors be happy that their money is taking a lower marginal utility than a psychology education? I thought he was already an expert in psychology?

I’m all for education, but surely you can gain an education without actually bothering to collect the piece of paper at the end of it. It’s not like he needs a job after all, hell son, he earns circa $30M.

Or, is he wrapping up the Hedge Fund, returning the investors money, Kermit and Miss Piggy will be delighted with their returns, although disappointed that the gravy train has derailed, and returning to school for some lessons in socialisation?

How exciting.

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Mish is still arguing for deflation.

One of the more common beliefs about the operation of the U.S. economy is that a massive increase in the Fed’s balance sheet will automatically lead to a quick and substantial rise in inflation. [However] An inflationary surge of this type must work either through the banking system or through non-bank institutions that act like banks which are often called “shadow banks”. The process toward inflation in both cases is a necessary increasing cycle of borrowing and lending. As of today, that private market mechanism has been acting as a brake on the normal functioning of the monetary engine.

I agree that may be a common belief. It is however incorrect. The conclusion of the author is also incorrect.

Government is always the ultimate source of inflation. Government can create inflation via injecting a credit expansion through the banking system, which is the preferred route. Or the government can inject it directly to the consumer via increasing government debt through the Welfare system, Cash-for-clunkers, Shovel-ready, etc. This expansion of government debt is shown.

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Government through increasing deficits are replacing producer debt. That the consumer is deleveraging is a myth. Consumer debt has fallen only fractionally. Thus the chart that most vividly depicts the liquidation of capital and debt is this chart.

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Higher stages of production are being liquidated. This liquidation will reduce the supply of goods and services. With government maintaining consumer demand, the mismatch of falling supply and steady demand will create CPI inflation.

The link between Fed actions and the economy is far more indirect and complex than the simple conclusion that Federal asset growth equals inflation. The price level and, in fact, real GDP are determined by the intersection of the aggregate demand (AD) and aggregate supply (AS) curves. Or, in economic parlance, for an increase in the Fed’s balance sheet to boost the price level, the following conditions must be met:

1) The money multiplier must be flat or rising;
2) The velocity of money must be flat or rising; and
3) The AS or supply curve must be upward sloping.

The economy and price changes are moving downward because none of these conditions are currently being met; nor, in our judgment, are they likely to be met in the foreseeable future.

Here we encounter the Keynesian aggregates which are an insiduous fallacy. Keynesian theory is responsible for the fallacy of the consumer represents 70% of GDP. This is simply incorrect. Keynes had no understanding of capital theory.

If we use coffee as an example in a very simplified manner. Ignoring the sugar and cream that might be added, the cup to drink it from, the spoon to stir it with, the manufacture of the ship, train, truck and warehouses and final retail store.

*Coffee beans are grown + harvested
*Transported via shipping, rail, truck
*Processed + packaged
*Transported + sold

We can see four stages of production in a very simplified progression. Thus the production = 4:1 That is to say consumer consumption is only 25% of the total consumption. This is true because one producers production is another producers consumption, with consumer goods and values driving all the pricing inputs.

Thus the aggregate demand and aggregate supply curves, are just so much nonsense. They grossly overestimate the importance of the consumer in deriving GDP figures, while grossly underestimating producer consumption.

The credit contraction driven by the banking system is destroying higher stages of production, thus the contraction in GDP is actually in % terms far higher. However, by supporting the consumer, the shrinkage of supply and demand is not proportional, thus the mismatch will eventuate in a CPI inflation that will most likely exceed the 1970’s fiasco.

It also clearly demonstrates why unemployment is climbing higher. With the destruction and liquidation of capital as higher stages of production disappear, so the labour component is released.

The low interest rates, artificially placed by the Federal Reserve have the effect of raising the value of capital. Thus, the stockmarket, the market for capital, rises. Until interest rates rise, lowering the value of capital, the market will continue to rally, albeit in a jumpy and volatile fashion.

To reduce unemployment, you need high interest rates. Exactly this was the solution in the 1970’s. Inflation forced interest rates to the 20% mark. At that level, employment started to pick up, and the value of the market plunged. As interest rates peaked, and started to decline, so the stockmarket started it’s epic secular bull run.

Conventional wisdom regarding money supply suggests there is massive pent up inflation in the works as a result of the buildup of those reserves. The rationale is that 10 times those excess reserves (via fractional reserve lending) will soon be working its way into the economy causing huge price spikes, a collapse in the US dollar, and possibly even hyperinflation.

However, conventional wisdom regarding the money multiplier is wrong. Australian economist Steve Keen notes that in a debt based society, expansion of credit comes first and reserves come later.

The expansion of credit is growing at epic levels through government spending via debt, and now outright printing.

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Total U.S. debt as a percent of GDP surged to 375% in the first quarter, a new post 1870 record, and well above the 360% average for 2008. Therefore, the economy became more leveraged even as the recession progressed.

An over-leveraged economy is one prone to deflation and stagnant growth. This is evident in the path the Japanese took after their stock and real estate bubbles began to implode in 1989. At that time Japanese debt as a percent of GDP was 269% (Chart 5).

Mish rather makes my argument. However until the government, like the banks, implodes, which will take longer because they can actually print money, we shall see stagflation. High inflation, with low growth, a replay of the 1970’s.

The five month, 50% rebound in the S&P 500 was certainly spectacular. However, the more important question is where to from here?

Take a look at Japan’s “Two Lost Decades” for clues.

Creative destruction in conjunction with global wage arbitrage, changing demographics, downsizing boomers fearing retirement, changing social attitudes towards debt in every economic age group, and massive debt leverage is an extremely powerful set of forces.

Bear in mind, that set of forces will not play out over days, weeks, or months. A Schumpeterian Depression will take years, perhaps even decades to play out.

Thus, deflation is an ongoing process, not a point in time event that can be staved off by massive interventions and Orwellian Proclamations “We Saved The World”.

Bernanke and the Fed do not understand these concepts, nor does anyone else chanting that pending hyperinflation or massive inflation is coming right around the corner, nor do those who think new stock market is off to new highs. In other words, almost everyone is oblivious to the true state of affairs.

Mike “Mish” Shedlock

Well one of us is certain to be wrong. While I agree that deflation will be the ultimate endgame if nothing is done, in the immediate future, inflation is the name-of-the-game.

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Just saw this on Barry’s blog. He seems to be measuring the “Secular Bear Market” from 2008. I would disagree and actually measure it from March 2000. If we take a look at a much longer term chart.

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The secular bear measured thus has quite different %declines, %rally with only the trading range, if there is one to be decided.

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