first majestic silver

The Emperor Has no Clothes (Bursting of the Money Bubble)

April 10, 2006

The financial markets have been hit by numerous shocks from the Middle East to Katrina, Rita, Wilma and now potential oil shocks stemming from political upheavals in Nigeria, Venezuela and Iran; but the real and so far unperceived risks to world markets is that the speculative bubbles (Stock, Bonds, Real Estate) and especially the institutional and Hedge Funds "carry trades" that have developed as a consequence of American monetary policy; which will surely unravel as the Federal Reserve policy of steadily increasing interest rates eventually begins to take affect, precipitating the inevitable crash that always follows an over-extended Boom (Bubble).

During the NASDAQ bubble of 1998-2000, US interest rates rose from 4 to 6 1/2% bursting the bubble. From June 2001 to June 2004 interest rates dropped to and stayed at a 45 year record low of 1 %: Which after the normal 6 to 18 month lag effects resulted in the unleashing of speculative capital flows to asset classes that here-to-fore had not played a role in the prior technology and stock market bubble. Among the first of the many bubbles that US monetary policy has spawned was in East Asia. America could not continue to finance a Trade deficit of over 6% of GDP with only 1 % yields, without a great deal of help. So East Asian central banks, in an attempt to maintain their currency exchange ratios (so as to maintain their exports) have intervened heavily to support the dollar, which has naturally caused a much faster monetary growth and capital spending boom in all of South East Asia especially China, exporting deflation around the world while turning China into the world's largest consumer of industrial raw materials. The ensuing commodity boom is now pushing inflation world wide.

American monetary policy has also had a dramatic impact on many other asset classes. There were significant price gains since mid 2003 in emerging market debt, government bonds, real estate, equities and especially Junk bonds: Stock Markets around the world are breaking out into new all time high territory: Doesn't anybody wonder why, especially when it comes to a Europe, which is still mired in stagflation. Analysts are using the most nonsensical of arguments to justify these rises as well as in predictions of the further good times to come; reminiscent of their idiocy during the period preceding the 2000 market top. Mean while Wall Street and the Banks are earning huge profits. The financial services sector now accounts for more than 32 % of the market capitalization of the Standard & Poor's 500, up from less than 10 % during the late 1980s.

Doesn't anyone realize that Takeover Frenzies are always coincident with market tops and are not buying opportunities?

The borrowings of primary government bond dealers has tripled to over a $ trillion during the past five years. Issuance of high-yield (Junk) bonds rose to over $215 Bn in 2005, a level above the 2000 bubble peak of $200bn and is well on its way of being surpassed by the end of 2006. American households refinanced $3.5 Trillion of mortgage debt during 2003 and over $4Trillion in 2004 and an estimated over $5.5 Trillion in 2005; compared that with the measly $2.5 Trillion during 2002 and the previous peak of $750billion in 1998. American residential real estate prices have also increased at an average 18 % compounded annual rate; Using a 20% down payment that amounts to a 90% annual rate of return on capital, compared that with gains of 6-8 % during 2003 and 2002. Trees cannot grow to the sky.

US monetary policy has produced tremendous distortions in the rest of the world's economy as well; South Africa now has the largest currency market in the developing world. Its trading volume is now equal to 24 % of its GDP, compared with only 4 % for Thailand and 2 % for Brazil. The Rand's trading volume has increased nine fold during the past decade. South Africa also has a swap market nearly three times as large as its GDP. The size of South Africa's currency and swap market is a by-product of surplus global liquidity, which has been attracted by South Africa's high money market yields of 8 to 9 % and it's Gold. The large interest rate differential has produced a Rand carry trade - investors borrowing in dollars to invest in the Rand or Rand-denominated assets, has driven the Rand/Dollar exchange rate from nearly R14 to the dollar in late 2001 to R6 to day eliminating the profitability of many gold mines and forcing their shut downs.

Watch out! Low interest rates in the US and Europe have also encouraged a large carry trade in other currencies. The volume of currency trading in Australia and New Zealand is now 35 per cent of GDP compared with 27 per cent for the US and 18 per cent for Europe. As with South Africa, investors have flocked to the south Pacific in search of higher yield, turning the currency markets into a global gambling casino.

The Fed's has continued to stick to a very loose monetary policy in the face of 15 consecutive ¼% Discount rate increases; partially because, until recently, US employment growth and the core inflation rate were subdued. Greenspan did not see any risk of a liquidity bubble in the US, at least not while he was still in office and partially because margin debt (money borrowed from brokers to buy shares) has remained below 5 % of GDP, compared with 18 % on the eve of the 1929 stock market crash.

US banks also have behaved seemingly more prudently this time than during previous booms: They have securitized their potentially bad loans and sold them off to pension funds, mutual funds and insurance companies. (But in the end somebody must always pay) As a result, America has had only 23 bank failures since 2000, compared with nearly 500 during the early 1990s, when banks experienced large losses on Real Estate. So far so good, however, history teaches us that they (the Banks) always get caught holding the bag (making excessive poor credit loans to the latest fad, read real estate and take-overs): What will happen to all those sub prime, and 125% over equity mortgage loans, not if but when, the Real Estate Bubble bursts? The liquidity induced buoyancy of the US economy has emboldened first Greenspan and now Berenanke to open the door to increase interest rates, but most likely they will not reach real positive rates (above the inflation rate) until well after Greenspan retires (he may be the only one that realizes there is a lag effect to these policies). Should the latest inflation figures continue then the Discount rate will have to rise to at least 6.5% before it would become a positive rate of interest (1.5% above the inflation rate). Is the USA and the World prepared for the consequences of 8 to10% plus mortgage rates?

What happens to the US Budget deficit once they have to carry their massive debt ($8.4 Trillion) at 7 to 10% instead of 3%? The Government can't wait to issue more of their new 30 year maturities fast enough, so as to lock in current low long term rates which have only just recently pushed above 5%. Does any one even think about it let alone realize what these consequences could be?"

After listening to the latest comments of Wall Street's and the Media's talking heads I was reminded of the fairy tale, "The Emperor Has No Clothes"


Do not despair: Regardless of all the possible troubles that have been outlined luckily we are also faced with a no risk opportunity to not only protect our wealth but to make a whole lot of money in the process. BUY GOLD.

Every situation always has at least two possibilities:

If the talking heads are right and the FED stops raising rates and both the Stock and Real Estate markets continue making new highs, (a stretch at best) then for certain commodities and inflation will continue to be pushed into the stratosphere, as the world wide boom continues on its merry old way carrying Gold to ever higher highs.


The FED continues its policy of ¼ point increases until they inevitably overshoot the so called proper target rate, as has occurred every other time in our history, and they precipitate a financial collapse followed by the inevitable Recession/Depression that naturally follows on the heels of all Bursting Bubbles accompanied a crashing US$. Again sky rocketing the price of Gold.

To despair is to be in a bad situation with no where to turn and no possibility of escape. Fortunately although we as individuals cannot change the situation we can protect ourselves. To be fore warned is to be fore armed. We are definitely living on borrowed time, with May being the outside date for a market top.


Regardless which situation unfolds Gold will go significantly higher: It has to go above $2200/oz just to get back to its previous 1980 high in real terms. So get out of debt, sell all real estate except the home you live in and buy gold and gold stocks, Silver although riskier might outperform gold, so you can buy some silver as well. Just in case Hillary wins in 2008 and becomes the FDR of the 21st century it might be a good idea to buy Gold Coins for cash and keep them under your bed or in your safety deposit box.

Good Luck and God Bless


Aubie Baltin CFA, CTA, CFP, Phd. (retired)
Palm Beach Gardens, FL
[email protected]


April 10, 2006

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