Is a US dollar dump underway?

Zero Hedge notes the US Federal Reserve provides a weekly update known as the H.4.1.

Observers of the Federal Reserve's Custodial Treasury account follow these updates with keen interest. Recently they have been somewhat perplexed.  There has been a continued, weekly selloff of $56 Billion of US Treasury's.

Is the continued drop an asset rotation - under duress or otherwise - out of bonds and into stocks, to prevent the collapse of the global ponzi? Or, as Zero Hedge pondered, has the dreaded D-day in which foreign official and private investors finally start offloading their $2.7 trillion in Treasurys with impunity arrived?

Recall that a few months ago China has made it abundantly clear it will sell its Treasury holdings, the only question is when.

The most recent came out on January 4th and a further $17.7 billion has been "removed" from the Fed's custodial Treasury account.

The alarm bell that is going off her is that in six consecutive weeks, foreigners have sold off more government bonds in a sequential period of time than ever before. It means that someone, somewhere is very displeased with US paper, and, far more importantly, they want to make their displeasure heard loud and clear.

It is an interesting development worth watching.  The consolidated outflow notional is now a record high $77 Billion (beating the previous record of $52 Billion). Should the selloff accelerate, look for the Federal Reserve to have to step in.

The real question is what they are converting the USD into? And how much longer it will go on for?

The last thing the US can afford is a wholesale dumping of its Treasury's. The traditional diagonal rise in foreign holdings of US paper has not only pleateaued, but it is in fact declining: a first in the history of the post-globalization world.

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Interesting US currency development.

I have talked about gold on this blog in the past.

In North America there are those who eschew gold/silver as an investment and claim that "gold's only use today is as an inflation hedge as record debt depresses currency values, until fiscal order is restored."

They are right. The problem though is that people are starting to realize that it is going to be a long, difficult time until 'fiscal order' is restored.

As you peruse the blogosphere, articles can be divided into one of two sides of a philosophical fence. On one side the argument that we are slipping into deflation. The other, inflation.

I guess you could say it appears I sit on the fence. A deflation/inflation symbiotic relationship, if you will.

The problem is to look ahead and assess how things will play out. After that you make you decisions on how best to prepare for what is coming.

On July 8th I made a post about the austerity/stimulus debate. To me, there is no debate... there will be a second round of massive stimulus.

And because of that I would suggest that you will see the Euro roar back towards a high and the US Dollar will sink to new lows because. I think it's unavoidable because the financial condition of the USA dwarfs the problems of Europe.

Inflation and hyperinflation are always the product of a loss of confidence in currency. All hyperinflation in modern history has occurred for one reason, and one reason only. That is loss of confidence in currency.

Loss of confidence in a currency can be brought about by many reasons, but there is one constant factor. When hyperinflation has occurred in modern history EVERY economy involved was decimated as and when it occurred.

Everyone talks about the world wide economy falling into deflation. The fear is that the US Federal Reserve is out of ammunition to fight deflation.

Oh?

I disagree.

The US Federal Reserve can (and will) do Quantitative Easing to infinity. Nothing can restrict them on this. And the European Central Bank will not be far behind in following their lead.

You can argue all you want about deflation, but the next response by the US Federal Reserve is not that hard to predict (Bernanke has already written about it - his famous speech on the matter is where the nickname 'Helicopter Ben' came from).

With the next round of currency printing (QE2), you will in all probability see another $2 trillion in currency printed.

'Loss of confidence' is what is driving the interest in gold.

And that 'loss of confidence' is starting to manifest itself in the United States itself.

In mid-Michigan they are starting to take matters into their own hands. As ConnectMidMichigan reports, "New types of money are popping up across Mid-Michigan and supporters say, it's not counterfeit, but rather a competing currency. Right now, you can buy a meal or visit a chiropractor without using actual U.S. legal tender."

Minted by private mints, people are to buy and sell goods with pure silver coins. In one simple act they have completely bypassed the destabilizing influence of the domestic currency printers known as the US Federal Reserve.

Dave Gillie, owner of Gillies Coney Island Restaurant in Genesee Township talks about it in the article.

"Do people have to accept dollars or money? No, they don't," Gillie said. "They can accept anything they want or they can refuse to accept anything."

The U.S. Treasury Department says the Coinage Act of 1965 says "private businesses are free to develop their own policies on whether or not to accept cash, unless there is a state law which says otherwise."

And in Michigan, they are starting to use things other than US dollars.

"I sell three or four (of the non-US government silver coins) every single day and then I get one or two back a week," said Gillie.

Gillie also accepts silver, gold, copper and other precious metals to pay for food.

The is a trend starting. Gold is starting to be used as money. For food... and to load up your gas tank.

So why is there interest in these competing currencies?

I would suggest that events are clearly pointing to a point where QE2 is unavoidable and with it will come a crisis of confidence in the US dollar.

It means inflation and a spike in the value of gold/silver.

To me it seems you want to position yourself to take advantage of these two, apparently unavoidable, trends.

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Debt Market Update: Market 'downgrades' US from Triple A

Healthcare in the US grabs the news the morning, but the real story is this piece from Bloomberg this morning.

Two-year notes sold by the Warren Buffett's Berkshire Hathaway Inc. in February yield 3.5 basis points less than US Treasuries of similar maturity.

Meanwhile debt issued by Procter & Gamble Co., Johnson & Johnson and Lowe’s Cos. also traded at lower yields in recent weeks.

This, folks, is what one chief fixed-income strategist described as an “exceedingly rare” event in the history of the bond market.

It means that key corporate debt now trades for lower yields than U.S. bonds of similar maturity.

We're at one of those historic moments in the credit market, when U.S. government bond yields are clearly no longer considered one of the safest investments in town.

It is a defacto move by the debt market to downgrade the value of US debt in advance of the 'official' ratings provided by agencies such as Moody's and Standard and Poor's.

Whatever credit ratings firms may say, markets have now made it pretty clear that the U.S. is far from a risk-free debtor. It's as if markets are already moving yields ahead of a potential cut to the AAA-rating.

And regardless of whether the credit ratings firms actually cut America's rating, the reality is that the old risk-free rating is essentially gone; even it still officially remains... the markets have figured it out.

(Note: this post is the second one today, in addition to the one directly below)

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A slow motion train wreck...

So many topics to touch on... but only so much time in the day to sit down and talk about them.

So today I will focus on American events.

Bank Failure Friday returned last week when the FDIC released information regarding the first US bank closure of 2010 – Horizon Bank of Bellingham, Washington.

You can't really hit much closer to home (in relation to Vancouver) than Bellingham (Blaine is too small).

But it's the size and scope of the closure that is so astounding. If it is indicative of things to come it will be a very rough year for our American cousins and the FDIC.

According to the FDIC, Horizon Bank had $1.1 billion in deposits and balance sheet assets of $1.3 billion; yet the FDIC’s estimated cost to close the bank is $539.1 million.

Say wha???

That means the real market value of Horizon’s assets is believed to be about $561 million – 41.5% of the value claimed.

Ay carumba!

As has become the norm, the FDIC had to enter into a loss-share transaction with respect to $1.0 billion of the assets purchased, meaning there is significant concern the assets will turn out to be worth even less than presently estimated.

This cost of closing this bank amounted to 49% of the value of Horizon’s deposits – the highest relative cost seen so far in this crisis.

By way of comparison, the cost of closing the first three banks in this crisis (in late 2007) was about 5.7% of deposits.

Perhaps you now have a keener appreciation of the importance of the FDIC's 'Interest Rate Advisory' for banking institutions.

That's the FDIC's stern warning for US Banks to prepare to "manage interest rate risk." Soaring rates will further depress market values which will further undermine the real worth of the bank's assets and balance sheets.

It does not bode well for the year ahead and we will watch the banking developments with keen interest this year.

But banking isn't the only story you should pay attention to.

Last Friday also bore witness to the stunning announcement that another 661,000 jobs were lost in the United States.

This at the height of the Christmas hiring period.

The broad U6 category of unemployment statistics rose to 17.3% (that's adding all the Americans who did not show up in 'official' statistics because they have stopped looking for work).

That is the stat that really matters. It means that December was the worst month for US unemployment since the Great Recession began.

Can you see what is coming next?

The home foreclosure axe usually drops for homeowners a year or so after people lose their job, and exhaust their savings. After six months they drop off the unemployment rolls. Six months from now that axe will start dropping.

That's what 2010 is going to be all about Charlie Brown. And that's despite the fact that foreclosures are already setting new records.

Realtytrac says defaults and repossessions have been running at over 300,000 a month since February in America. One million American families lost their homes in the fourth quarter. Moody's Economy.com expects another 2.4 million homes to go this year.

Meanwhile commercial real estate is a disaster. Check on this article in Time magazine.

"It's not that everything's fine in the commercial real estate business. Everything's awful and will probably get more awful. But unlike 2008's Wall Street panic, this particular financial unraveling looks as if it will play out over a period of years, not weeks."

Headlining the news is Tishman Real Estate in New York City. They will miss payment on a commercial loan of over $5 billion on a massive New York apartment complex, the 2nd largest default in commercial real estate loans in history.

As this unfolds, California declares an economic emergency. They are the biggest concern but there are another 40 states in deep trouble. Hawaii can't even afford to hold a congressional election.

Meanwhile apartment vacancies hit record highs.

Really?

Riddle me this... if foreclosures are skyrocketing... and rental vacancies are soaring... where are the people going?

Does it suprise you that homelessness is rising dramatically?

And then there is consumer credit. Consumer credit in the US last month dropped a record $17.5 billion.

This despite the fact that many cash-strapped US homeowners are doing exactly what their UK counterparts are doing: "New research from Shelter, the homeless charity, [suggests] that as many as 1 million people have used their credit cards to pay mortgage bills or rent demands in the past year."

And what is that going to lead to?

"You would have to be relatively desperate, at least in the short-term, to go down this route. Many of those people are likely to end up defaulting on their credit card bills, or on their mortgages, or both," quotes the article.

Against this backdrop, does anyone really think American quantative easing is going to end in March?

All the talk about the US Federal Reserve draining the excess reserves is comical. That's why gold shot up on the weekend.

And that's why it's going to shoot even higher. Watch the next big spike to take the metal to over $1,650 an ounce.

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Santa Baby?

Double dipping today so you get two posts for the price of one (make sure to see the post below this one on 79.9% interest rates).

Wandered over to Garth Turner's site and caught this post on Economic Forecasting.

Garth is very bullish on the strengthening of the US dollar. He opines that with all the troubles in the world (Dubai, the European basket cases of Greece, Italy, Iceland et al), the US dollar is still the global reserve currency and perceived to be the safest of safe havens offering total liquidity and shelter from debt storms.

He insists there will be no double-digit inflation in the States, "no matter how damn much money they print" and that the US dollar will strengthen based on a growing realization stateside about the severe threat presented by the continuing accumulation of debt.

Turner notes there is "a growing political appetite to (a) raise taxes and (b) slash Washington’s spending. In some form, both of these will happen, especially if Republicans win a few key seats next year. This will be very bullish for the greenback, even though it means more years of slow growth."

Turner also says that Washington has hundreds of billions in bonds to sell each year – the majority to offshore investors. Thus the US has a huge incentive to stabilize the dollar and the easiest way to do that is with monetary policy and a quick little rate hike.

But will that do the trick? Or is there a looming problem that Bernanke and Co. have failed to plan for?

We've talked about it here before, the fact that the United States (and other western governments) need to borrow a massive amount of money to fund their deficits.

Interestingly, the Governor of the Bank of China just came out with a couple of thoughts on that issue.

He said that it is "getting harder for governments to buy United States Treasuries because the US's shrinking current-account gap is reducing the supply of dollars overseas."

The economic crisis of the last year has played havoc on global trade.

And with with every country (especially China) keeping things going by printing money and implementing stimulus projects of their own to build bridges, roads and other internal projects; those countries are running out of non-domestic cash.

Internal infrastructure stimulus projects may fill the void at home brought about by the collapse in global trade, but they don't bring in western cash.

Exports do. And China's exports are down dramatically.

Without vibrant global trade, there aren't enough US dollars flowing in.

Where do you think China has been getting all those US dollars to plow into buying US Treasuries?

This is about to become a huge, critical issue for the United States. Now that Treasury monetization is ending, the US needs to constantly find foreign buyers of its debt to fund unsustainable deficits.

Foreign buyers who have US dollars.

According to Shanghai Daily, this could be a big, big problem.

Bank of China's Zhu Min said,

• "The United States cannot force foreign governments to increase their holdings of Treasuries. Double the holdings? It is definitely impossible."
  
  "The US current account deficit is falling as residents' savings increase, so its trade turnover is falling, which means the US is supplying fewer dollars to the rest of the world. The world does not have so much money to buy more US Treasuries."

And that's the crux of it: in cranking up the printing presses to create trillions of assorted securities, the US Treasury has soaked up the world's dollars.

And since US banks are sitting on all this money in the form of bank excess reserves and not lending, these excess reserves can not be used to buy Treasuries and MBS. This would be literal monetization as opposed to the figurative one which is what Quantitative Easing has been.

Since none of the money is flowing out to the world (aka China), the world is running out of dollars with which to buy Treasuries.

Holy Catch-22, Batman.

This looming problem is discounted by some critics who point out that China still has trillions in foreign exchange reserves.

But China has been selling mortgage backed securities at a furious rate... and it hasn't been buying treasuries. China's Treasury holdings have been flat at exactly $800 billion since May 2009. China has been doing what millions of high frequency traders have been doing: focusing on short term investments which can be liquidated instantaneously.

In essence Zhu Min is saying that the US should no longer rely on China for funding its bottomless deficits. And because of that Zhu told an academic audience that it was inevitable that the dollar would continue to fall in value because Washington would continue to issue more Treasuries to finance its deficit spending.

If that's the case, things are about to get much worse as the Fed has no choice but to turn the monetization machine on turbo... a development which will drive the US dollar far lower than anyone cares to admit.

Garth Turner insists the US will never allow it's dollar to drop, but America may not be able to control that destiny anymore.

Ertha Kitt crooned in her holiday classic, "I'm filling my stocking with a duplex, and cheques... sign your 'X' on the line"

But it appears China has no plans to hurry down the American chimney tonight.

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Carefree

The rebellion against the U.S. dollar is gathering steam and in the latest development Russia's central bank has announced it is diversifying out of the US dollar and into several currencies - including Canada.

A senior Bank Rossii official in Moscow triggered a sharp gain for the loonie Wednesday and contributed to the U.S. dollar's slide to a 15-month low when the Bank signalled its intention to add the Canadian dollar, and possibly one or two other currencies, to its foreign exchange reserves – the third-largest in the world.

At one point last night Gold had shot up to $1,195 an ounce on the news.

Such a shift brings Russia into line with the currency diversification strategies being weighed or launched by China, Indonesia and a handful of other major central banks holding vast amounts of U.S. Treasuries.

It's another sign of what's to come.

There is no denying that the long-term trend toward currency diversification is acquiring more urgency over growing worries that soaring U.S. government deficits will eventually trigger a nasty bout of inflation. That, in turn, would severely erode the value of dollar holdings in central bank coffers around the world.

Currency specialist David DeRosa, president of DeRosa Research of New Canaan, Conn said, “there's no sign of inflation right now, but if you are a foreign central bank holding a lot of U.S. dollars, you should be concerned about whether or not the dollar is going to be destroyed by future inflation.”

And as countries move away from investing in the US dollar, how long before bond vigilantes begin pushing interest rates up on government debt?

The spectre of rising interest rates and it's effect on Canadians with mortgages has been the focus of the media for the last couple of weeks. You have also seen the Governor of the Bank of Canada, bank presidents, and economists of all strips coming out with statements of concern.

Perhaps they are noticing that in the United States, nearly one in four homes with mortgages are in an 'underwater' position (the home is valued for less than the amount their owners owe the banks holding their mortgage loans.

You can rest assured that none of those US homeowners were the least bit concerned with the first homes starting going under in 2006. But as the domino's started to fall, it dragged the rest of the nation down with them.

Wither the Canadian Alfred E. Neuman's out there who are piling on maximum debt with 5% down and huge 35 year amortizations. Are they worried?

What of the bidding wars these hyper-extended buyers are triggering. Yesterday's news brings reports of a return to condo line-ups and buying frenzy's again.

And what of the potential impact on everyone else who bought in the last five years... is the looming crisis registering in their collective psyche yet?

Mortgage rates are going to shoot upwards. And it will be the buying class of 2009 who will be be the first domino that takes down the rest.

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The Great Reflation

Scanning the worldwide news clippings today, the main topics of interest are Gold, the US Dollar and Interest Rates.

Early last night Gold spiked to $1,140 US per ounce and the Dollar index dropped well below 75.

In the wee hours of this morning, the Dollar index is back up and Gold hovers at $1,130.

We do live in interesting times.

The stock market was up again yesterday as US Federal Reserve Chairman Ben Bernanke gave no indication that he would take actions to back up his stated preference to promote the Dollar.

It seems almost unanimous that the market's recent upswing has all been about a weak dollar and ample liquidity.

But there seems to be a fine line being walked here.

"A steep slide in the dollar would be the death knell for the great reflation engineered by the Fed. But the Fed chairman's concerns about the currency's current level are not yet serious enough for him to abandon his interest-rate policy," said Jean-Baptiste Pethe of Exane BNP Paribas.

Ahh, yes... that's what they are calling it now. The Great Reflation.

It brings to mind this interesting quote from Benjamin Anderson, Chief Economist of Chase National Bank published in the New York Times on April 1930:

“Cheap money is a stimulant, also an intoxicant. If the dose is large enough, a substantial temporary effect can be brought about, but headaches follow. If the matter really were that simple, everybody could be an economist, and only the perversity of central banks would keep us from endless prosperity. Merchants and manufacturers will not be induced to increase borrowings, since interest on money borrowed is only one small factor in total costs. But if merchants and manufacturers will not use cheap money, speculators will.”

And that's what's driving the Great Reflation... speculators who are using the cheap interest rates to their advantage.

The money that got pumped into the US economy by the Fed over the past year didn’t get anywhere near “merchants and manufacturers” or small businesses that are now the backbone of the US economy.

Speculators are borrowing at 0% plus or minus short term, and are “playing/gaming” the stock market with much of that money.

One of the bubbles forming again is in oil prices. So perverse is the emerging scenario that you have the US taxpayer advancing money to speculators so they can game the oil market so that US taxpayers must pay more for oil (!).

San Francisco Fed President Janet Yellen made an interesting comment on Tuesday in Hong Kong. She opined about whether monetary policy should be used to lean against "potentially dangerous swings in asset prices. The answer is far from clear, because the use of monetary policy for these ends necessarily compromises the attainment of other macroeconomic goals."

It would appear those 'other macroeconomic goals' involve around creating new bubbles to get themselves and of our current hole - a hole dug by the creation of the 2001 - 2006 bubble.

But how long until it becomes necessary to move to defend the Dollar by dramatically raising interest rates?

We shall see.

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Prelude to Real Estate Armageddon?

March 12th, 2009.

If you dropped into our little corner of the world wide web that day you would have seen this post titled 'All New Ground'.

• Increasingly it is becoming clear we are living in a once-in-a-multi-generational time...We have never had this much debt, this type of real estate decline or such a rapid collapsing of employment all convergent with a worldwide financial meltdown and a rapid withdrawal of consumer spending.
  
  And because the entire world has been drawn into this maelstrom, the US Dollar continues to hold it's value...
  
  [But] a great many economists are concerned that the only solution that the US government seems to have for the current financial troubles is to print more and more dollars... [which] is set to trigger a collapse in the value of the dollar against real things such as gold and oil, if not against the other paper currencies.
  
  If that happens, the fear is that we will enter the next, much more serious stage of the financial crisis, in which falling currencies will push up long-term interest rates, which in turn will crush what's left of the world's financial system.
  
  If the dollar falls in value to the point where no one wants to hold it, North America will feel a tsunami of accelerating inflation as their currency buys less and less. And this time around "inflation has the potential to be worse than the double-digit rates of the 1970s", said Warren Buffet.
  
  So where are we headed? Is the inevitable result a currency crisis of historic proportions? It's all new ground.
  

History unfolds slowly. Seven months later, are we at the precipice of seeing this prediction play out?

The last few weeks have seen the start of that US Dollar crisis. And yesterday, that crisis racheted up a notch when it was revealed that, over the last three months, banks put 63% of their new cash into euros and yen - not the dollar.

This is almost a complete reversal of the dollar's onetime dominance for reserves.

According to Barclays Capital, the dollar's share of new cash in the central banks around the world was down to 37% - compared with two-thirds a decade ago.

Currently, dollars account for about 62% of the currency reserve at central banks, the lowest on record said the International Monetary Fund.

Investors and central banks are snubbing dollars because the greenback is kept too weak by zero interest rates and a flood of greenbacks in the global economy.

According to the New York Post, "Economists believe the market rebellion against the dollar will spread until Bernanke starts raising interest rates from around zero to the high single digits, and pulls back the flood of currency spewed from US printing presses."

Think about that statement for a moment.

"Raising interest rates from around zero to the high single digits."

That's 8% or 9% - which means your standard five year mortgage will run you 10% - 12%.

Remember last week we talked about how California had to raise the yields on it's debt sale to sell it's bonds?

This morning the impact of these moves in the bond market hit us here in Canada.

Each of Canada’s big banks this morning is increasing the cost of taking out a mortgage. While there were some differences in the details of changes made by the banks to their mortgage rates, the announced hikes put all their five-year fixed closed rates at 5.84%, an increase of 0.35 of a percentage point.

That's an overnight hike of 7% to five year mortgage rates.

And that's without any prompting from the Bank of Canada - whose historic low rate of 0.25% remains intact.

Why? Because the cost of money in the bond market is rising.

The stage is being set for an unavoidable outcome. And when people look back at 2009 they will look at this date as the day we began our march to Real Estate Armageddon.

Today's Independent newspaper in the UK notes that, "the willingness of foreigners to hold dollar assets as opposed to, say, euro assets has allowed American citizens to consume beyond their means for many years. Of course, it wasn't just the Chinese and the Russians who were lending to the US. Others did so via their purchases of US mortgage-backed securities (MBS). But if the collapse in the MBS market exposed the first chink in American economic armour, a rejection of the dollar as the world's reserve currency could expose an even bigger hole. If other nations begin to believe the US is happy to allow its currency to plummet, they may all head to the exit at the same time.

A dollar collapse would be a disaster all round. It would drive up the cost of borrowing in the US. It would leave the international monetary system short of stability and long of fear. It would unleash economic upheavals on a similar scale to those seen in the 1970s."

And you remember the 1970s, don't you? A period when interest rates floated for much of the decade from 11% to 21.5%

Interest rates that high in this day and age will trigger real estate Armageddon here in Greater Vancouver.

Guaranteed.

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An Ominous Sign?

.
UPDATE: Gold closes at record high $1,039.70 after touching $1,045.00 earlier in day.

We've talked about it often.

The US dollar's status as the world's reserve currency is the only reason the United States has been able to play fast and loose with it's finances and treasuries without triggering hyper-inflation and a dollar collapse.

But with each passing month, critics claim the status of the dollar as the Globe's de-facto reserve status is being threatened.

Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars

And now one faithful reader sends us news of another signpost on the road to calamity.

This morning's London Independent newspaper is reporting that Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading.

If true, this represents one of the most profound financial changes in recent Middle East history.

The Independent reports that these plans have been confirmed by both Gulf Arab and Chinese banking sources in Hong Kong. According to the Independent, Gulf Arabs – along with China, Russia, Japan and France – will end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.

Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.

The decline of American economic power linked to the current global recession was implicitly acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis may be a recognition of changed economic power relations," he said in Istanbul ahead of meetings this week of the IMF and World Bank. But it is China's extraordinary new financial power – along with past anger among oil-producing and oil-consuming nations at America's power to interfere in the international financial system – which has prompted the latest discussions involving the Gulf states.

Some analysts believe this may help to explain the sudden rise in gold prices and sets the stage for an extraordinary transition from dollar markets within nine years.

One blogger we read dismisses the Ridiculous Hype Over Secret Oil Meetings.

Mike 'Mish' Shedlock says, "Pricing oil in Euros (or even sillier - a basket of currencies) will not cause anything to happen. If pricing unit changes do happen, they will be a result of sentiment changes in regards to existing dollar hegemony and not the other way around. Dollar Armageddon is not coming over a pricing unit, nor did the US invade Iraq for that reason. The story is nothing but meaningless hype."

Either way, gold futures at the time of this posting are up to $1025.70 per ounce.

Volitiliy reigns supreme.

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Unintended Consequences

The 1956 Suez Crisis is one of the most important and controversial events in British history since the Second World War. It has come to be regarded as the end of Britain's role as one of the world powers and as the beginning of the end for the British Empire.

The Suez Canal was opened in 1869, having been financed by the French and Egyptian governments and technically the area surrounding the canal proper was sovereign Egyptian territory. The canal, however, was strategically important to the British and hence to the other European powers.

To Britain, the canal was the ocean link with her colonies in India, the Far East, Australia, and New Zealand.

In 1875, the British government took de facto control of the canal proper, finance and operation. The 1888 Convention of Constantinople declared the canal a neutral zone under British protection.

At the outset of the 1950s, Great Britain was the predominant foreign power in the Middle East. The area’s vast oil reserves prompted Britain to consolidate and strengthen its position there. However, throughout 1955/56 Egypt pursued a number of policies that would frustrate British aims throughout the Middle East, and resulted in increasing hostility between Britain and Egypt.

In the summer of 1956, Egypt nationalized the Suez Canal.

Britain decided to take military intervention against Egypt, however direct action ran the risk of angering Washington and damaging Anglo-Arab relations. Therefore Britain concluded a secret military pact with France and Israel to regain control of the Canal.

At the end of October, British/French/Israeli forces seized control of the Canal.

The US attempted to force a cease-fire on Britain, Israel, and France with a UN Security Council resolution. Britain and France, as permanent members of the Council, vetoed these resolutions.

In response, US President Eisenhower ordered his Secretary of the Treasury to prepare to sell part of the US Government's Sterling Bond holdings. The US held these bonds in part to aid post war Britain’s economy and as partial payment of Britain’s enormous World War II debt to the US Government, American corporations, and individuals.

Britain's Chancellor of the Exchequer advised the Prime Minister that the United States was fully prepared to carry out this threat. He also warned his Prime Minister that Britain's foreign exchange reserves simply could not sustain a devaluation of the Pound that would come after the United States' actions; and that within weeks of such a move, the country would be unable to import the food and energy supplies needed simply to sustain the population on the islands.

In concert with US actions Saudi Arabia started an oil embargo against Britain and France. The U.S. refused to fill the gap until Britain and France agreed to a rapid withdrawal. The other NATO members refused to sell oil they received from Arab nations to Britain or France.

On November 6th, 1956 the British Prime Minister announced a cease fire, warning neither France nor Israel beforehand.

Fast forward to 2009.

America’s Achilles heel is its astonishing level of debt. China, Japan and Russia are the three largest holders of its treasuries and bonds.

Will it be the situation in North Korea, Iraq, Iran, Afganistan, or… ?

And when it comes, will America fold like the British did? Will the USA capitulate to Chinese or Russian foreign policy threats?

Or will a US President, eager to find a way to default on America’s insurmountable debt, provoke an incident to which America will opt to eat the tremendous financial pain and hardship (ie. plunging dollar, massive inflation) the selling of the treasuries would initiate?

History is rife with such unexpected twists and turns. And America finds itself in an unprecedented financial position.

War ended the Depression created by the 1929 crash. It doesn't take a Machiavellian mind to see the possibilities here.

In yesterday's profile of the MacLeans magazine article, the headline was "the U.S. is about to go broke and they’ll take us down with them."

Unfortunately that sentiment is all too true.

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The Great Inflation Debate (Part 2)

Continuing from yesterday...

The Chinese, the Japanese and the Russians have three of the biggest piles of US bonds in the world.

What would you say if you owned $800 billion worth of bonds? Wouldn't you tell the world what a great investment they were?

...and then sell them quietly, when no one was looking?

Most observers fear this exact scenario. And if it starts to happen the US Federal Reserve will be forced to do what they don't want to do. They'll have to buy their own bonds in great quantities to keep rates down. Then, they'll have to buy more...because others will be selling them. Finally, they'll have to monetize a huge percentage of them...ultimately causing inflation rates to soar.

That's the scenario you don't ever hear the US Federal Treasury talking about. Sure they say they can yank the stimulus money quickly if the economy turns around. But that is only one scenario that scares inflationists. There are many others.

And last week Peter Schiff outlined some of those other concerns in an article in Canada's MacLeans Magazine. You can read the full article here. I highly encourage you to take the time to read it.

From the article:

• Many scoff at the idea that China will suddenly say “no more” to buying U.S. debt. After all, the two countries have had a mutually beneficial relationship for years. China lends money to the U.S. and the U.S. buys masses of consumer goods from China. What’s more, it’s a long-standing relationship and many doubt that China would want to upset the status quo. Schiff sees no logic in that argument. “That they’ll keep lending indefinitely makes about as much sense as the argument that real estate prices have been rising, so they’ll rise forever,” Schiff says. “Nothing that is unsustainable will go on forever.”
  
  But the thing is, China doesn’t have to entirely cut off the U.S. to cause problems. Even if China decided to pull back slightly there would be consequences. The U.S. would still find itself short of the cash it needs to pay its bills, and like a homeowner who misses a mortgage payment, it would have to find that money somehow.
  
  Regardless of precisely how and when this all unfolds, the dollar will inevitably become less valuable and interest rates will rise as the U.S. scrambles to attract new lenders. That will translate into inflation and higher interest rates for the average person, too. The cost of living will go up and the value of people’s savings will decline. Canada would likely get dragged into the mess too, just as it was affected by the current downturn in the U.S. The question is how severely this will all hit.

Finally there is the law of unintented consquences.

That's the wild card element that scares inflationists the most.

We'll look at that tomorrow.

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Email: village_whisperer@live.ca
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Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Two Economic Clips worth watching.

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The first is CNBC's "The Call" and discussions of the US Dollar falling to it's lowest levels of the year.

The second is Peter Schiff discussing the last week of the stock market where three significant events occurred simultaneously for the first time: Stock prices fell, bonds fell and the trade weighted US dollar fell.




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Email: village_whisperer@live.ca