aeolus

What would I like to see happen? I'd like to see them let these people go bankrupt, let the bankrupt go bankrupt, stop bailing them out. There are plenty of banks in America that saw this coming, that kept their powder dry and have been waiting for the opportunity to go in and take over the assets of the incompetent. Likewise, many, many homeowners didn't go out and buy five homes with no income. Many homeowners have been waiting for this, and now all of a sudden the government is saying: "Well, too bad for you. We don't care if you did it right or not, we're going to bail out the 100,000 or 200,000 who did it wrong." I mean, this is outrageous economics, and it's terrible morality.

Part two:

U.S. debt is one option in addition to gold and other government debt, Luo, head of the training center at the banking regulator, was quoted as saying in an interview with the news agency late yesterday. If the U.S. government issues too much debt in its efforts to revive the economy, all Treasury holders will suffer losses, he added, the Chinese-language report said.

Investors across the world now seem to be taking refuge in US government treasuries. Is that a safe thing to do?

No, for several reasons. First, interest rates on long-term paper in the US are starting to rise, so the price of government T-notes and T-bonds will likely fall from here. More worrying though is the risk of a US default.

The US government owes over $110 trillion, when aggregating all of its commitments. It is very over-indebted, and the price of default insurance is rising because the market perceives a growing risk of default.

Also, it is likely the US government will need to borrow $2.5 trillion this year because its revenues will decline as the economy weakens and it's spending rises as a result of the weakening economy, which brings up another worrying point. The Federal Reserve will need to monetise much of this debt, which will further debase the dollar and cause more inflation.

The only solution the US government seems to have for all the financial troubles is borrowing more and throwing them at the problems. It also wants its citizens to borrow more...

It is not going to work. Too much debt is the problem. We had the boom, and now we are getting the inevitable bust. Because debt is the problem, it is impossible for more debt to also be the solution.

The US government is terribly misguided. Fortunately, people know better. They have therefore cut back on spending and increased savings in order to help prepare for the tough times the US - and indeed, much of the world - is facing in the months ahead.

On the Gold Standard:

You seem to be a great believer in the Gold Standard. What are the advantages of a currency system based on the Gold Standard?

Gold is indeed the standard. It always has been and always will be. It is the numeraire by which all goods and services are measured because gold is money. The advantage of the classical gold standard is that it provides an external discipline on the creation of currency.

If too much currency is created by bank lending and the government printing press, the economy heats up, and the currency becomes overvalued. So gold leaves the country for other countries and other currencies where it can purchase more.

The classical gold standard provides a very natural mechanism that controls the expansion of credit, and therefore the value of currencies. The big imbalances today in world trade occur simply because there is no mechanism to bring order and balance to world trade.

The huge sovereign wealth funds amassed today by many countries could never have happened under the classical gold standard.

Under a gold standard, if people think the paper money printed by government is losing value, they have the right to switch to gold. Fiat money -- i.e., currency with no intrinsic worth that government has decreed legal tender -- loses its value when government creates more than can be absorbed by the productive real economy. Too much fiat money results in inflation -- which pools in certain sectors at first, such as housing or financial assets, but ultimately raises prices in general.

Inflation is the enemy of capitalism, chiseling away at the foundation of free markets and the laws of supply and demand. It distorts price signals, making retailers look like profiteers and deceiving workers into thinking their wages have gone up. It pushes families into higher income tax brackets without increasing their real consumption opportunities.

In short, inflation undermines capitalism by destroying the rationale for dedicating a portion of today's earnings to savings. Accumulated savings provide the capital that finances projects that generate higher future returns; it's how an economy grows, how a society reaches higher levels of prosperity. But inflation makes suckers out of savers.

If capitalism is to be preserved, it can't be through the con game of diluting the value of money. People see through such tactics; they recognize the signs of impending inflation. When we see Congress getting ready to pay for 40% of 2009 federal budget expenditures with money created from thin air, there's no getting around it. Our money will lose its capacity to serve as an honest measure, a meaningful unit of account. Our paper currency cannot provide a reliable store of value.

Well worth reading the whole thing.

Thus far, our economy has actually been spared the worst due to the temporary strength in the dollar and the recent desirability of our Government's debt. These movements derailed the short-term performance of many of my investment recommendations (though clearly not to the extent alleged by my critics) and threw a life-line to the downing U.S. economy. The demand for U.S. Treasuries has led to one of the sharpest dollar rallies on record, which has helped bring about just as pronounced a decline in commodity prices. As a result, although consumer income has fallen, so too have prices and interest rates...

In addition to cushioning the blow for us, the dollar rally has exacerbated the pain abroad. As money has rushed to our aid it has created a global credit crunch. The rest of the world is not only dealing with losses on toxic U.S. credit instruments but is also shouldering the burden of financing our new borrowing as well. As foreign currencies have fallen, foreign consumers have not received as large a windfall as Americans have from falling commodity prices.

In effect, Americans have been using these life-lines to pull the rest of the world into the stormy seas. However, there are signs that those holding the lines are about to cast them adrift. The dollar rally has run out of steam, gold has clearly broken out, and commodity prices are moving back up. 2009 is already the worst year ever for US. Treasury bonds and foreign stock markets are once again outperforming ours...

If foreign capital does not continue to pour into Treasuries, interest rates and consumer prices in the U.S. will soar. At that point, we will finally be confronted with the real crises that I have long predicted. When the day of reckoning arrives our policy response will be critical. If we continue on the course our new President has mapped out, the catastrophe will far exceed the scope of any he hoped to avoid.

I recently discovered, however, that the excellent charting site StockCharts.com allows you to chart this for up to a 3 year period:

This looks a whole lot different than the traditional, dollar denominated S&P 500 chart. A couple of notes on the S&P/gold chart above and the one previously posted:

• The price of gold in the StockCharts version is based on a "continuous contract" of gold, whereas my chart was based on the London PM fix.
• My chart went back further. I would still like to input data going much further back but again that will take a lot of time. If anyone is interested in splitting up this work, or better, in writing a program to scrape the data from the web and drop it into a .csv file, let me know.
• The point of measuring the S&P 500 (or anything) in terms of gold is that gold has a very stable value over long periods of time, whereas the value of a dollar is quite volatile.

Back to the charts. The dollar-denominated version looks like the U.S. equity market has bottomed, or is bottoming. The gold-denominated version is downright scary. Would you buy that if it were a stock? Gold has been quite strong even in the face of recent dollar strength (gold and the dollar typically move in opposite directions). If the dollar rolls over, look out below.

Which brings me to my working thesis on the market.

As Bob Pisani of CNBC has repeatedly pointed out of late, the market rallies when the dollar goes down. Again, gold and the dollar tend to move in the opposite directions; eventually one or the other has to give. We have a couple of potentially very big catalysts for dollar weakness and a U.S. equity rally coming very short soon-- namely, the passage of the stimulus package and the Fed announcement of the latest bank rescue.

I expect the reaction in the equity markets (as measured in dollars) and in the press to these two events to be very positive. We will likely see a significant rally off of this. So stocks (again, measured in dollars) get a boost. Risk appetite will improve, thus reducing the recent "safe haven" appeal of the dollar.

However, how exactly are these "bullish" measures to be paid for? We've reached the stage where the only two politically realistic options are monetization (i.e., inflation) or debt default. Either one of those alternatives has catastrophic implications for the dollar, meaning that gold (in dollar terms) should go way, way up. This should by far outweigh the nominal (dollar-denominated) increase in equity values. So expect the S&P/gold chart to keep falling, and fall dramatically.

I'm aggressively adding to my positions in physical gold, gold miners and commodities on this thesis. This will likely take years to play out, but I expect that when it's all over people will look back at 2008-2009 as the period when the dollar's demise became irreversible. Of course, there is a (long and painful) way out of this mess, but our "leaders" lack the courage, insight or integrity to allow to happen.

UPDATE: Mr. Indispensable's announcement of the new Treasury plan may be pushed back to Tuesday. WSJ has the latest here.

UPDATE (12 Feb 2009): Well we didn't get much of a bounce in equities from the announcement of the plan. I guess I underestimated how badly Geithner would flub it. That said, the overall thesis, that the S&P 500 as measured in gold will continue to fall.