Rub A Dub Dub (Three Men in A Tub)

There is only one difference between a bad economist and a good one: The bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and more importantly, those effects that must be foreseen. The bad economist pursues a small, present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.

Frederic Bastiat (1801-1850)

OUT OF THE BLUE

Both Gold and the U.S. Dollar fell hard and people jumped for their OLD but not so safe haven - so Bonds rose three quarters of a point. However, Muni Bond funds got hammered. There were 108 new 52 week lows on the NYSE Thursday, with over 80% of them Municipal Bonds Funds. Are the sheeple finally waking up to the dangers our there? Many companies with significant cash on their balance sheets hold large positions in Bonds and/or Bond Funds, including BIG chunks of Municipal Bonds. Watch out for Insurance Companies. By their nature, financial institutions hold significant positions in Muni's. Could the huge number of suddenly plunging Muni Bond funds be the TRIGGER for the crash that I have been looking for? I have been waiting and warning about Muni's hitting the fan, as 46 States and most local governments are in BIG financial trouble and they cannot print money like the Fed can. Let's not forget about the Muni Bond insurers like AMBAC as they are about go the way of the rating agencies.

I think the TOP might be finally in for both stocks and bonds. Now, we just have to wait for a few more experts to realize it. The decline will seem to come out of NO WHERE so in the meantime; don't let all the media hype dissuade you.

China's Central Bank raised short-term interest rates for the second time in three months. The 25 basis point hike to 5.81% puts the world on notice that China is worried that inflationary pressure are getting out of hand with Inflation surging to a 28-month high of 5.1%

However, controlling inflation is not as simple as most central bankers seem to think. A 5.1% interest rate in a country with a strong currency is a powerful magnet that will flood that country with foreign investment, negating the simplistic effect of just tightening interest rates by ¼%. Are you watching Mr. Bernanke and maybe learning something?

China is hardly alone in this shift toward higher rates. Other central banks around the world with strong currencies like Norway, Switzerland, Canada and Australia are also trying to control Inflation and the, unintended,negative side effects of US easy money by their raising rates as well.

I hope the world soon discovers that only Free Markets can keep an economy and the world on an even keel, but I am not holding my breath.

WILL THE US DOLLAR MAINTAIN ITS STATUS AS THE WORLD'S ONLY RESERVE CURRENCY

India and Iran just dropped the use of US Dollar in their oil dealings and so has Japan. And so it begins: Russia and China may have also drop the US dollar as payment for oil and so have Brazil and China. The replacement would be the Japanese Yen and the Emirates Dirham, according to London's Asharq Al-Awsat, the switch could help any country avoid American retaliation for dealing with the Iranians. (is this another UNINTENDED consequence of fooling with the FREE MARKET?)

BACK HOME

Over the next eight months, the Federal Reserve will be buying $600 billion (close to 7% of all outstanding Treasuries) about equal to the amount of NEW debt that the Federal Government will be issuing over that same time period. The Fed has already taken short-term rates down to zero, pushing income-seeking investors and savers to higher yielding (Higher Risk) and longer duration (riskier) bonds (munis) and stocks. With the magic of QE2, the Fed wants to (in the face of the SUPPLY & DEMAND LAWS OF ECONOMICS) drive long-term rates down and thus push all Treasury investors (short or long) towards higher risk assets. The Fed also hopes that low interest rates will nudge businesses to invest and to hire. The value of any asset is the present value of its future cash flow. But they will fail, as they release the INFLATION GENIE out of the bottle. They are ignoring all of the unintended consequences. Besides, what good are low interest rates if you can't get a loan? Why, Blowing Up Bubbles (Bond and Stock Market) of course.

"In theory, there is no difference between theory and practice. In practice there is." Yogi Berra. It's too bad that Bernanke doesn't have Yogi's common sense.

In theory, lower interest rates decrease the rate that businesses use to discount future cash flows -Increasing the value of future cash flows- and the Fed is betting on that. In practice, however, the fickleness of artificially lowered interest rates leads to speculation and inflation which is not lost on business decisions. Rising government debt and an overheated money printing press doesn't generate a lot of confidence about the future. High government debt eventually leads to Inflation, higher taxation, higher interest rates and slower growth.

A FUNNY THING HAPPENED ON THE WAY TO NIRVANA: The Fed's recent actions have thus far resulted in exactly the opposite results (higher rates) to what they had intended: And that is only after the 1st month.

As sure as night follows day, higher interest rates are inevitable: The only question is HOW HIGH and HOW SOON?

"Out of thin air money" is like heroin, initially the high is terrific (short term), but the list of accompanying side effects are long term and cumulative and are always worse than the disease it was supposed to cure. It is difficult to know in advance all the side effects and unintended consequences, (that is why they are referred to as unintended consequences) more importantly, it has already resulted in a substantial decline in the dollar, stagflation, lower, if any, economic growth, reduced lending and inevitably, much higher interest rates. Inflation will show up not where the Fed wants it - in house prices - but in higher prices for Gold and Silver, commodities, especially food and gasoline (which they do not include when calculating inflation), clothing, electricity - all of which could kill consumption. QE2 will actually result in higher interest rates since investors are expecting more bonds being offered and because higher inflation will demand higher rates.

The Fed's manipulation of short and long term interest rates creates a long term problem for ours as well as the world's economies. When the Free Market is not allowed to discover what interest rates should be, we lose the single most powerful and important advantage that allows Capitalism to work while Socialism and Communism cannot: The "Invisible Hand" traffic signals that tell everyone what must be done to keep the world's economies operating smoothly no longer work. In the long term, QE2's success is impossible since the best it can do is delay the inevitable while making the outcome much worse than it would otherwise have been, as all the unforeseen, unintended side effects come home to roost.

By using smoke and mirrors, the Fed wants to create targeted asset bubbles, praying that the wealth effect will make people feel wealthier and spend their phantom gains. But the paper wealth will vanish as bubbles burst (they always do) and real wealth, along with the phantom wealth, will be destroyed leaving a situation that is much worse than anyone could possibly imagine. We will replay Japan's folly of the last 20 years only much worse because they have a surplus in their balance of trade and thus owe all their debts to themselves. Unlike us, they have the world's highest savings rates and the Yen is not the world's reserve currency.

Just like the Real Estate and Dot.Com Bubbles, there is always an initial giddy phase bliss when playing the "bigger fools game". But that lasts only until the bubble bursts and all the phantom money disappears...The Fed doesn't want anyone to be in cash, they want you to reach for yield and speculate - but don't you dare. In the absence of good investment opportunities, the worst thing you can do is take advice from the FED. Lucky for us there are still a few excellent safe haven investment opportunities: Gold and Silver.

QE1 VS. QE2 - THEY ARE VERY DIFFERENT!

Modern societies have fractional reserve banking systems where for every new dollar deposited into the banking system $10 can be lent out; increasing the money supply by $10. This system functions fine as long as bank's losses are manageable and depositors believe in the safety and security of their money. In other words, they expect their deposits to be there tomorrow. However, even in the absence of any losses, if the presumption of banking system safety is broken and depositors fear for their funds and withdraw their money, then even the best, most conservatively run bank that has zero loan losses can and will go bust. This is what is called a run on the bank. Because of financial leverage, banking is one of the few industries where (false) perception may lead to reality. Remember, when trust is lost, one dollar withdrawn from the Banking System causes $10 worth of loans to be called in reversing the power of the fractional banking system by shrinking the money supply by $10.

The Federal Reserve System was established in 1913 following (what in my opinion was a contrived crisis) the 1907 Bankers' Panic, a recession and collapse of several banks that led to runs on the country's banks. Then the all knowing, all-powerful JP Morgan directed a coalition of banks that backed the banking system and stopped the nationwide run. This created the excuse for the creation of the FED whose main job was to be the lender of last resort to avoid future banking panics. However, creating an institution that does its job only a few times a century was impractical, so the FED through; the back door was given additional responsibilities to Regulate banks, Maintain stable prices and Maintain full employment. All of which sounds great, except that they work at cross purposes to each other at times and what it really is was A LICENSE to ROB THE PUBLIC and control the idiots in Congress.

In the midst of the 2008 financial crisis, to prevent the freezing up of the US financial system and possible bank runs, the Fed put in place QE1 - it purchased trillions of dollars of, dubious worth, mortgages and agency debt. This resulted in $100's of billions going to the gang of thieves led by Goldman, J.P Morgan, Morgan Stanley et al as well as to foreign banks. Not only did they bail them out, but then they loaned them trillions of dollars at zero interest, which they immediately bought 4% FHA Government Guaranteed Bonds. This created false profits for the banks and allowed the taking of billions of dollars in bonuses for doing nothing. (They certainly were not lending). Meanwhile, they keep the public's ire off themselves by focusing on the only bonuses that deserved to be paid, that of the working, minor executives at AIG (who should never have gone Bankrupt) who had accepted lower salaries to work out AIG'S derivative problems. But QE2 is drastically different from QE1, which bailed out the too Big To Fail Banks and allowed then to steal the business of the ones that did fail. QE2 is designed to bail out the too big to fail Government. But can one bail itself out by printing counterfeit money? Especially since they are not even addressing their problems let alone fixing them. We will soon find out.

A VICODIN ADDICTED NATION

Unfortunately, Bernanke's arsenal is missing the most important tool of all; the "FREE MARKET" tool that lets the market and the economy correct itself. This tool is called Free Market Laissez Faire Capitalism. Unfortunately, this tool will not be used as it will inflict short term pain, something for which Americans have no tolerance for. After all, the most prescribed drug in the US is the painkiller Vicodin. Regrettably, this is why QE2 is unlikely to be the last QE. As its effect wears off (assuming it succeeds at all), then QE3, QE4 and so on will follow. The US, like Japan, will be locked into unsustainably low interest rates: However, Japan is a lender while the USA is the world's largest borrower.

It's always gratifying when the mainstream media picks up on a theme you've been banging the drum on for months and even years, and is that ever happening now. Is it any wonder then that a large group of prominent economists just published an open letter to Ben Bernanke, begging him to stop the madness before it's too late? However it gives me no satisfaction, since I was praying that I was wrong this time. I really do NOT want to see a DEPRESSION: But I must "calls em as I sees em"

The rising opposition to the Fed is further evidence that the global money war I've been warning about has not only started, but is intensifying. This is proof positive that my previous advice (to buy Gold, Silver and TBT on weakness and to stay away from both long-term Treasuries and long-term debt of any kind, especially municipals), has been right on target.

There is a growing deep distrust and resentment of the Government - which isn't a surprise since it was Government actions that created the currency crisis years ago, destroying a large chunk of the country's REAL wealth. But that wasn't always the case. Up until the Obama election, the Government was largely seen as a protector and provider of last resort. But that is not how the U.S. government is currently seen. Following a major currency crisis, if history is any guide, the Government becomes a competitor. It fights with its citizens for an ever increasing larger piece of a shrinking pie and its appetite is insatiable.

How do you battle against a larger and more powerful entity? Again, using history as a guide, most of the people that I have met and read about who lived through the GREAT Depression or Argentina's last currency crisis did so by hiding their wealth. They sent it overseas or bought GOLD and buried it in their back yards. They didn't keep it in the banks for fear of confiscation and/or special taxation (sound familiar?) So the money never makes its way into the economy and growth is always less than what it could and should have been. This is exactly what happened here between 1933 and 1947 when there was no new net private investment until 1947.

Key policymakers are giving rare, on-the-record interviews about QE2's benefits, while simultaneously trying desperately to blunt the criticism coming from foreign central bankers, some domestic lawmakers, prominent, economists, activist groups and the people in general.

Muni investors are worried that federal support for state and local governments could wane now that the political winds (no bailouts) have shifted in Washington. They're also concerned that we could see a fresh upswing in MUNI BOND issuance, driving up interest rates given the rapidly deteriorating municipal finances. Meredith Whitney is predicting over 100 Muni defaults this year alone.

But clearly the cost of borrowing is now not only beginning to go up for Uncle Sam, but it's also rising for State and Local Governments all over the country. Wrecking havoc with everyones projections and finances.

HOW NOW DOW

I apologize, the FED has become the buyer of first and last resort for the stock market as well as the bond market. Although I have been talking about just that for the Bond Market and secondarily for the stock market, it just didn't register. So, no matter how many SELL signals I was getting over the last year, the FED kept every beginning selloff from turning into a crash, letting the long term consequences of their actions be damned. Maybe they don't realize what the long term consequences of printing $1.5 Plus trillion, year in and year out are. Especially since the Government's longest horizons are never more than 1 ½ to 2 years. Nevertheless, the overbought indicators keep registering record new highs (sell signals). The fact that institutional cash is at ALL TIME RECORD LOWS of 3.4% (NO BUYING POWER) seems to make no difference, as volume keeps shrinking and the percentage of Speed and Program Trading is now over 75% of all trading telling us that the public has NOT come back into the market yet. And if history is any guide they won't be back for at least 10 years or until 2016.

Stocks typically take their time at major tops, but once they top, the subsequent decline is vicious. This is the situation we are in now. The Dow Industrials and S&P500 closing high tops remain from January 5th. All that we are waiting for is for supply pressure to rise sharply and that should occur soon. These indicators are rarely faked out. Patience should be rewarded. Once they turn to sells, a multi-week decline should follow, one that takes off 8% to 12%of the averages during its first leg down.

The bottom boundary of the textbook rising Bearish Wedge trend-channels for Wave 5 of WAVE II or WAVE B has been breached, but not decisively. Until the market breaks them decisively, I cannot confirm a top is in. Also of note is that the RSI has reached levels only seen at the three highs preceding 2010's previous declines. The DJII would have to fall below 11550 and the S&P500 below 1250 to produce the kind of sell off I have been anticipating, which thus far the Plunge Protection Team as been able to thwart.

You should already be long a few of your initial short positions that you could have taken on Jan,5th and Wednesday morning. Now it's time to wait for the breakdown or buy more puts into any new 100 point rally next week. REMEMBER TO USE STOPS SINCE ANYTHING CAN HAPPEN.

GOLD & SILVER

Fortunately for us we know exactly what to do to:

  • Protect, and
  • Profit, from what's coming.

As far back July of 2001, I started recommending that an ever increasing portion of our liquid reserves be invested in GOLD & SILVER (and their securities). For the last 10 years, Gold has appreciated an average of 20% per year, Rising from a low of $251 to $1,342. And guess what? You ain't seen nothing yet. During the PM's last Bull Market, their last month appreciated 162% and that was during a time when both the US economy and the Dollar were both a lot stronger and in far less danger than they are today.

"I'm increasingly convinced that $30,000 to $50,000 per ounce for Gold will be seen in this lifetime, especially as fiat currencies based on nothing are abandoned for mediums that more directly represent a real monetary asset, like Gold and Silver bullion"...

- James West, a regular respected contributor to GOLD-EAGLE.com

However I am sticking to my $6,250 projection. You can believe what you want.

Both before and during the 2006 and 2008 selloffs as well as all through December 2010, I urged NOT selling your core PM positions and using any $50 to $100 drops in the Gold prices as a golden opportunity to buy more. A lot of you are quite pleased that you heeded my advice. As far back as 2005, I predicted, based on my work and calculations, that this Gold Bull Market would last a minimum of 16 years with a target of $6,250. Well, nothing has changed except Gold and Silver's fundamentals continue to improve on virtually a daily basis.

A LOOK BACK INTO THE PAST

Between August 1979 and January 1980, a simple 5-month span, Silver skyrocketed 450%! Gold's last 162% Blow Off only took 16 days. With less than 3% of all portfolios having any investment in Gold at all, this Golden Bull is barely a teenager and still looking forward to a long life to come.

The major difference between Gold, Silver and all other commodities is that Gold and Silver have an intrinsic monetary value that all other commodities as well as stock market evaluations lack. Besides only Gold and Silver are Superior goods. (Demand increases as price increase)

Have Gold and Silver reached their lows for this latest correction? Probably NOT but to tell you the truth I don't rightly know. Or care (How do you predict a short term swing in a manipulated market) But what I am certain of is that the manipulators, after having had a tremendously profitable 20 years (1980 to 2000), have by now given back all their ill gotten gains plus and are now sitting on losing positions in the $100's of billions and will soon be forced to cry UNCLE. (FED and Treasury come bail us out). Then watch the fire works.

Earnings - Because of Gold and Silver's price increases during the 3rd and 4th quarters, their companies will be reporting MUCH HIGHER revenues and profits in January and I have every expectation that they will continue to do so into the first and subsequent quarters of 2011 as well.. Should sales/profits rise as high as I expect them to, will Wall Street finally start to BELIEVE??? BUT then that's their problem.

WHAT TO DO NOW? For at least the next five years, continue with our present strategy of buy GOLD and SILVER and their mining stocks on weakness. Sitting on the fence gives me a pain in the you know where.

 

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GOOD LUCK AND GOD BLESS

STAY THE COURSE: All of my long term readers were not surprised by the shenanigans of the last few weeks. It was discussed and called for in my last few letters. There are rarely any major surprises once you analyze recent political events with an open mind and without pre-conceived Ideological positions. The most frequent mistakes I usually make are ones of timing. I seem to continually underestimate the stupidity and ignorance of our Keynesian Economists and Politicians who are continuously lying to the public.

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UNCOMMON COMMON SENSE
Aubie Baltin CFA, CTA, CFP, PhD.
2078 Bonisle Circle
Palm Beach Gardens FL. 33418
aubiebat@yahoo.com
561-840-9767
In the Aztec language the name for gold is teocuitlatl which means "excrement of the gods."

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