The Fiscal Storm Clouds Are Gathering

May 13, 2009 · Posted in Strategic Insight

There have been a number of news stories in the last few days that are starting to point to a us fiscal crisis occurring sooner rather than later.

1) Interest rates are still rising though they have come back in the last few days. Mortgage rates specifically are not coming down as hoped for by the Fed. This is a big problem as the economy cannot stand further rashes of housing defaults when adjustable rate mortgages re-set. The Fed’s program of buying up mortgage debt and quantitative easing by buying US treasuries is not having the desired effect at the levels they are executing it. Look for the Fed to dramatically increase their purchases of mortgage and Treasury debt in the coming weeks.

2) The government has revealed that April tax receipts were in deficit for the first time ever. The article is HERE. Think about that. In the month when all of the tax checks are received from taxpayers who owe the government money, our government still had a net outflow of funds. In addition, they raised the projected deficit for the year by $89 billion. A drop in the multi-trillion problem and likely one that does not remotely account for the latest tax receipt data but nonetheless it extends a worrying trend. We are hemorrhaging money.

3) The Treasury revealed yesterday that Social Security and Medicare are both in a bad state of affairs with each program running into deficit years earlier than predicted due to the economic crisis. We expect that President Obama will attempt to plug the gap through taxes or program cuts neither of which will be favorable to the economy. That is what happens when problems are left to fester for decades - no choice is a good choice. Every choice entails pain.

4) Corporate chiefs are starting to raise the flag on real interest rates being too high and threatening growth. In an economy as fragile as ours that is a big deal.

5) Unemployment is at 8.9% and rising, though at a slightly reduced rate than previously. This exceeds the stress test levels and the budget assumptions. The net effect will be lower growth and far lower tax receipts coupled with higher draws on state and local government funds. Look for more state and local governments to star crying for help. Also look for more pension plans, governet and private, to take hits as the older, unemployed worker finding no job available starts drawing early retirement as their only option.

6) Our recently rising stock market has not resulted in a stable dollar. In fact, the dollar has continued downwards. Money is flowing out of the US now from both stock and bond markets.

In summary then we are on a clear path for dramatically higher deficits than have been projected, even those were exorbitant compared to what we have seen in the past. Borrowing costs are rising and set to rise dramatically cutting off both private investment and governments ability to spend and borrow. The Fed’s reaction is almost assuredly to be one of ramping-up their debt purchase programs and in essence, printing money to do so. This is hugely inflationary and significantly dollar negative.

When does this reach “crisis” proportions? The answer is not an easy one but we will propose that events could turn negative far more quickly than expected. Jim Rogers, the noted investor and commentator has predicted a currency crisis as early as this fall. What is significant is that Rogers describes himself as the worst market timer in history and rarely makes any timed call. We believe that the markets reaction to the next announcement of the Fed increasing their quantitative easing targets will be key. Last time interest rates dropped like a stone on the announcement and gold rose. If rates instead rise on the next announcement we will know that real trouble is starting as that will imply flight has started from US Treasuries.

As of 05/12/2009 we are holding:

Ivanhoe Mines IVN

Silver Wheaton Corporation SLW

iShares Silver SLV

Long Sadia (Brazilian meat packer) SDA

Long Australian Iron Ore Supplies to China through Fortescue FSUMF

Long AgFeed Inc FEED

The following posts are relevant:

How the US Dollar Will Lose Reserve Status

Commodities Update 04/30/2009

Chinese Gold British Debt

Brazil

China Part 4 - Playing the Dragon

China Part 3 Global Hard Assets

Commodities

China: Part 2 - Bonds, Dollars, and Inflation”.

“The Fed and The Bond Market - Will Intervention be Effective?”

“The Coming Bond Debacle”

Fundamental Trends

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