Search results matching tag 'GDP'

US Economy to Get a Hollywood Makeover

GaryHalbert — Tue, 30 Apr 2013 20:53:00 GMT

IN THIS ISSUE:

1. About the US Bureau of Economic Analysis

2. Major GDP Calculation Revisions Coming in July

3. Research & Development Becomes Capital Investment

4. Artistic Originals – Art, Movies, TV Shows, Books, Etc.

5. Changes Needed, But Can Be Tricky in Practice

6. Hanlon Investment Management Luncheon

Overview

You may have heard that the government is going to make some major changes in how our Gross Domestic Product is calculated later this year. Your first thought might be that this is no big deal. However, I will argue today that it is a very big deal, the biggest in a decade, and you need to know why. So I hope you read what follows with more than a passing interest.

Last week, the Commerce Department’s Bureau of Economic Analysis (BEA) announced it will be making some significant revisions to the way it calculates Gross Domestic Product in late July. This change is somewhat controversial in that it is expected to add a whopping 3% to GDP in one fell swoop in the last week of July. That’s about $1,500 worth of extra goods and services for every person in the US!

The reason for the changes is the fact that our economy increasingly depends on the production of intangible goods, and we need to recognize that the production of ideas is an important form of investment. So in the future, the BEA is going to count a company’s research and development as a form of investment just like the purchase of a new office building. And the creation of a lasting work of art – a painting, a movie, a television series, etc. – that can be sold year after year will, likewise, be treated as a capital investment.

Since the US GDP is increasingly made up of intangible assets, some of these revisions probably make sense. Yet the caveat is that intangible things such as R&D and art are far more difficult to value precisely. We’ll discuss the upcoming GDP revisions coming in July and whether or not such changes are a good thing, as we go along.

But I would be remiss not to first mention last Friday’s encouraging “advance” GDP report. The Bureau of Economic Analysis estimated that 1Q GDP rose 2.5% (annual rate). Although the increase of 2.5% was below the pre-report consensus, it was a welcome relief from the mere 0.4% growth in the 4Q of last year.

About the US Bureau of Economic Analysis

The periodic US Gross Domestic Product estimates that are released monthly are arguably the most watched economic reports on the planet. Before we delve into the sweeping changes that lie ahead for how GDP is calculated, let’s take just a moment to understand what the BEA is and how it operates.

The BEA’s mission is to provide the most timely, relevant and accurate information on the US economy. The BEA's GDP estimates are key ingredients in how we make critical decisions on a wide range of issues including monetary policy, tax and budget projections, business investment plans, etc., etc.

The BEA is part of the US Commerce Department and is widely considered to be non-partisan. The Director of the BEA is Steve Landefeld, who has served in that position since 1995 under both Republican and Democratic presidents. Mr. Landefeld has presided over a number of GDP revisions, which typically happen every five to six years.

Major GDP Calculation Revisions Coming in July

The revisions slated to be revealed in late July, however, are said to be the most significant in more than a decade, not only for the changes themselves but also due to the fact that they are expected to instantly add about 3% to the overall size of GDP.

According to last Friday’s advance estimate of 1Q GDP (+2.5%), the US economy topped $16 trillion for the first time ever ($16.010 trillion) according to the BEA. If the revisions coming at the end of July are as large as expected, that will mean that GDP will instantly swell by almost $500 billion to near $16.5 trillion. That’s the equivalent of adding another Pennsylvania to our economy!

In addition to the sheer size of the changes, these revisions will be applied all the way back to 1929. Even the BEA admits that it is “re-writing US economic history,” much as Hollywood writers and directors remake old movies (more on that below).

GDP seeks to capture the value of all goods and services produced within the US in a given period (quarterly). The BEA generally does this by measuring the value of goods purchased by consumers. The BEA calls these purchases “Personal Consumption Expenditures” or the PCE Index.

The logic goes like this: When you buy a washing machine, the price you pay captures the value of the work of everybody in that chain of labor and the cost of materials that went into creating that washing machine. That includes the sales clerk who sold it to you, the trucker who delivered it, the factory worker who assembled it, the marketing staff that created the advertising, the raw materials used to build it and the salaries of the executive officers who run the company that made it.

But when the washing machine company invests in long-lasting assets – such as a factory or a package of accounting software – it contributes to GDP in a different way that is referred to as “fixed investment” that is expected to have a payoff over a long period of time. This spending is treated differently than the routine expenses involved in producing a specific product.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Research & Development Becomes Capital Investment

The single biggest change to the GDP methodology in July will be the inclusion of R&D as a capital investment instead of just a cost of producing goods. Initial estimates show that this R&D change will add a little more than 2% to overall GDP starting in 2007 (the base year of the new methodology). About two-thirds of that increase in GDP will come from the private sector and around one-third from government.

Brent Moulton, head of national accounts at the BEA, put it as follows: “The world economy is changing and there’s greater and greater recognition that things like intangible assets are very important in the modern economy and play a role similar to tangible capital that was captured in the past.”

The changes will have a ripple effect. The new methodology will make corporate profits look larger, as companies will no longer be counting net R&D after depreciation as a cost. BEA Director Steve Landefeld said that the inclusion of R&D was just the beginning to help get a more accurate picture of growth. “You need to go further in this exploration of investment in intangibles. R&D – the scientific and engineering stuff – is just a piece of the puzzle.”

Artistic Originals – Art, Movies, TV Shows, Books, Etc.

The Internet Movie Database (IMDb.com) may not seem like a natural source of information for the BEA, but its researchers scoured through film studio records as far back as the 1920s to build a database on the history of investment in movies.

The result is not only an estimate of the capital value of all America’s movies, TV programs, plays, books, greeting card designs, etc., but also a fascinating picture of how their importance to the economy has changed over time.

A film or book or TV series is often produced in one year but may be enjoyed for many years thereafter. For example, it is estimated that the popular sitcom SEINFELD has generated $3.1 billion in revenue since it went off the air in 1998.

Another example is George Lucas, the writer, producer and director of the popular STAR WARS movies. His company spent a lot of money to create these films. It owns the copyright and has made money for many years afterward on that investment. The same is true for a lot of “intellectual property.” For example, when Apple researchers develop the next iPad, or Stephen King writes a new science fiction novel, it will be an upfront investment that will likely have a long payoff.

So starting in July, the BEA will treat the creation of artistic works as longer-term capital investments, not unlike factories, equipment or software. In the current system, the value of the economic output of a Star Wars movie would only show up in GDP over decades to come, in the form of personal consumption expenditures like movie tickets and DVD sales. With the new revisions, that value will show up in GDP sooner.

Preliminary research by the BEA puts investment in artistic originals at $70 billion for 2007, so that figure will go into GDP (how they arrived at that figure is not clear). These figures may ignite some controversy because they will amount to the first official estimate of the value captured from copyright laws.

New Pension Accounting Changes, Finally

The change with the most counterintuitive results is pension accounting. At the moment, the BEA counts what companies actually pay into a defined benefit pension plan as wages, and ignores whether the plan is in deficit or surplus. After the new change, it will measure what companies have actually promised to pay.

Measured federal government spending on pension benefits will fall because it has funded its plans better, while state and local government benefit spending will rise because they have promised considerably more than they have paid in.

This change will also result in an instant increase in GDP estimated at about $30 billion in 2007 (the base-year). But wait, aren’t many pension plans woefully underfunded? Yes, but under the new rules, the GDP effect is based on what an employer should have paid to fund pension benefits, not what was actually paid. Thus, GDP is positively affected because it will measure employers’ promises going forward.

Having a BEA estimate of the size of pension deficits and their cost could prompt an important shift in the political debate over the future of defined benefit plans. In any case, changing pension fund accounting to reflect employer promises seems like a good idea.

Other Changes of Interest

Some other changes are technical in nature but are still important. For example, the BEA plans to change how commercial banks measure the cost of running customer accounts. Currently, the BEA does not account for services provided by commercial banks for which no specific fees are charged – such as clearing checks, distributing funds, protecting deposited funds, etc. The BEA believes this will make the price of banking services less volatile.

Another update will be to treat all of the costs of buying a house – such as attorney fees, stamp duty (document tax), etc. – as investment rather than spending. That is expected to add about $60 billion to GDP for base-year 2007. At present, only real estate agent commissions are capitalized.

And the BEA will also speed up the depreciation of those commissions, writing them off over the average 12 years that people stay in a house, instead of over the expected 80-year life of the structure. As a result, the change will lower net savings and corporate profits.

I could go on, but these are the highlights of the GDP revisions coming in late July.

Changes Needed, But Can Be Tricky in Practice

The new GDP revisions coming from the BEA probably make sense in most cases, especially as our economy increasingly moves from tangibles to intangibles. But valuing many intangibles can be tricky in practice.

When calculating the value of an investment in a truck, we rely on the market price of trucks. When calculating the value of an investment in a new building, we rely on the market price of the land, labor, and the material it takes to construct it.

But research and development and artistic originals aren’t commodities that can be priced like a bushel of corn or an ounce of gold, both of which are traded daily on exchanges around the world. So most likely, the BEA will be forced to value intangibles based on the most recent price paid for that investment, product or service, which could vary greatly. This is where it becomes risky.

For example, there’s no guarantee that an expensive movie is more valuable than a cheap one, and there’s no reason to believe the amount of money spent on a research program is a proper assessment of its value. In effect, this will leave us with the conclusion that a wasteful R&D undertaking adds as much or more to the economy than a thrifty and effective one.

The difficulty of properly valuing these intangible investments is one reason other countries generally haven’t counted them as capital goods. But in a digital, ideas-driven economy, intangibles are increasingly important. The 3% increase in overall GDP coming in July may not be a game changer, but it’s definitely more than a rounding error.

Simply ignoring intangibles gives a misleading picture of the state of the economy, and the new system probably is a step forward. But it is controversial in that valuing intangibles can be difficult and thus susceptible to error (and manipulation). An economy dominated by the output of bushels of wheat and tons of steel is relatively easy to measure, whereas a modern service and information economy simply isn’t.

At the end of the day, we know that measuring economic output involves a good deal of approximation – even using today’s BEA methodology and assumptions. There will be even more approximation when the revisions go into effect in late July. Only time will tell if the new revisions give more or less accurate data.

The question is, will the BEA’s GDP estimates continue to be the most watched economic reports on the planet after the revisions in late July? Time will tell. With the information I have presented today, you will at least be in a better position to judge.

Finally, it will be most interesting to see how the Obama administration and the Democrats will react to this large 3% jump in the size of GDP at the end of July. Follow me here. We just learned that 1Q GDP went up 2.5% (first estimate) in the 1Q (annual rate). Let’s say it goes up 2% in the 2Q. Then the BEA plugs in this huge one-time revision which adds 3% on top of the 2%, thus making the number 5%. That’s a big number!

Will Obama and the Dems try to fool the public by saying the economy is now growing at a rate of 5%, or will they be honest and point out that most of that increase was due to a historical one-time GDP revision? You can bet I will follow-up, depending on whether they try to “spin” it to their advantage!

Hanlon Investment Management Luncheon

We are hosting a lunch seminar in Austin on May 8th featuring Hanlon Investment Management, a Registered Investment Advisor managing apprx. $3.5 billion in assets. As I noted in my January 8 E-Letter, Hanlon’s Managed Income Strategy is an innovative approach with the potential to increase your returns with an eye on capital preservation.

If you live in the Austin area, or will be in Austin on Wednesday, May 8th, call Joanne at 800-348-3601 to reserve your spot. The lunch seminar will be at the Westin Hotel in The Domain at 11:30 AM. This is also an opportunity for me to meet you personally – I always love to meet my readers and clients. Seating for this event is limited, so I urge those in the Austin area to reserve your spot as soon as possible. I hope to meet some of you there.

Wishing you honest economic data,

Gary D. Halbert

One In 5 Households Now On Food Stamps.

ChuckButler — Mon, 29 Apr 2013 17:02:07 GMT

.........But First, A Word From Our Sponsor..........

There's no smarter way to buy gold or silver

Ready to buy some gold? Or maybe even silver? You'd be wise to consider the NON FDIC-INSURED1 Metals Select SM Account from EverBank. It delivers everything you've been searching for-lower costs, ultimate convenience, and flexible options.

-Choose from coins, bars or unallocated metal -No storage or annual fees on Unallocated Accounts -Low account minimums of $5,000 for Unallocated Accounts and $7,500 for Allocated Accounts

To learn more and view important disclosures go to: https://www.everbank.com/personal/precious-metals.aspx?referid=11808

......................................................

In This Issue.

* U.S. GDP disappoints.

* Currencies & metals rally.

* Kiwi gains VS dollars U.S & A$.

* PIMCO likes Norwegian krone fundamentals..

And, Now, Today's Pfennig For Your Thoughts!

One In 5 Households Now On Food Stamps.

Good day. And a Marvelous Monday to you! Well, I told you on Friday, that the rain was coming our way, and we had a rain soaked weekend, but, I didn't know it was going to be so darn cold, and raw. We're almost to May, folks! This is not supposed to be what the weather is like for this time of year! But, all my complaining won't change anything, so I just need to settle down, and take it one day at a time, eh?

Sort of like what we've done with the Eurozone for almost a year now, for it was about a year ago, that I started telling you that the relative calm was coming over the Eurozone, and that the threat of a major sovereign default was dissipating. But, we had to take it one day at a time, for around every corner there lurked a debt ridden country and their problems obtaining financing. And now one year later, not much has changed in the Eurozone. The problems have moved from Italy and Spain to tiny Cyprus, but no matter how time Cyprus is, these occurrences remind the markets that the Eurozone and euro is not out of the woods.

Speaking of Italy. it now appears that their political mess is going to get worked out, and to reward them for working that out, Italy's bond auction today saw their borrowing costs drop to the lowest level in over 2 years! This news has really goosed the euro by about 1/2-cent this morning. And with the euro moving higher, it allows the other currencies to also get off the porch and chase the dollar down the street.

OK. The markets really were not happy with Friday's U.S. data and the reaction or response to Friday's print of 1st QTR GDP, which did not meet the consensus for growth at 3.2%, instead printing at 2.5%... Now. 2.5% growth is far better than the .4% that the 4th QTR printed. Right? Yes! But is it sustainable? Well, in my opinion, no. I think what you have to do, is look under the hood here. I looked at something called domestic final sales, which to me is nothing more than a measurement of domestic demand, and that component was up 1.9% in Q1. And that's right in line with what it has been for the past two years! So. Inventory accumulation was up big. Is any of this registering with you like it is me, that it's not sustainable? Add in the increased taxes on consumers, and the proof that the economy is already slowing down, from recent economic data, and I think you'll agree that this strong showing (relative to what we've seen in the past 5 years) is a one-and-done.

And maybe that's why the markets were not enamored with the number. But, the more likely reason was that it was just like the reaction to a stock of a company that has good earnings, but. doesn't meet expectations. The markets expected 3.2% growth, and they didn't get it.

On Friday morning, I told you that the Chinese renminbi / yuan had been allowed to appreciate to a record level (a 19-year high VS the dollar). OK. So there I was reading Dennis Gartman's letter on Friday morning, that always arrives just as I'm sending the Pfennig to the legal beagles for approval, and I see he's talking about the Chinese renminbi / yuan. Let's listen in. "We note that the dollar is making new multi-year lows relative to the Chinese renminbi. The Obama Administration, just as the Bush Administration did all too often during its tenure in office, has complained bitterly that China's currency is "undervalued" and thus gives China a huge advantage in global trade, but clearly that argument is losing its validity. if it had any to begin with. Since the spring of last year, the renminbi / dollar rate has gone from 6.40 to 6.1650, or a 3.7% increase in value. In a world of foreign exchange, a sustained movement over the course of one year of this sum is material. However, we shall expect to hear nothing from the Treasury, or from Commerce, regarding this shift and will instead hear that China has to do even more to stabilize global trade."

I thank Dennis Gartman for allowing me to use his excellent view of how we treat China, even though they have gone about allowing their currency to gain VS the dollar for the past 8 years (except 2008). I read Dennis Gartman almost every day.

OK. So. The Currencies and metals are stronger this morning. Again we've had to take this stuff one day at a time for some period of time now, given the way the markets change their minds on a dime. One day, they believe something, and the next day something else. And then when we get down to an annual review, there hasn't been much movement at all. But, in reality, for a diversified investor that's using currencies and metals as a diversification tool to have a portion of their investment portfolio outside of the dollar, not much movement is like manna from heaven.

Gold is up $10 this morning. You should have seen the way Gold flip-flopped from positive ground to negative ground and back on Friday. Or maybe you're a Gold watcher, and you saw it. I bet if you're a Gold watcher, you're a Gold watcher, watching Gold go around. (did you start singing? I bet you did!) Then you were worn out completely by the end of the day! I have a story for the TTWT section in today's letter, that plays well with just why investors look to own Gold. But you'll have to wait, that is unless you skip ahead, because I've got more to talk about this morning before I head to the Big Finish.

Well. Looky at the New Zealand dollar / kiwi this morning. Trading over 85-cents! WOW! The kiwi has been gaining not only VS the U.S. dollar, but also against its kissin' cousin across the Tasman, Aussie dollar (A$). This HUGE move by kiwi was fueled by the Reserve Bank of New Zealand (RBNZ) leaving rates unchanged but talking hawkish, and. the slower than expected U.S GDP report last Friday. One of the reason kiwi is gaining against A$'s is that as we've talked about for some time now, the markets are pushing the Reserve Bank of Australia (RBA) to cut rates, while the same markets believe the RBNZ has room to hike rates. Right now there's a 50 BPS spread in official cash rates (that's 1/2%) in favor of the A$, but that spread could be narrowing as we move through 2013, and that's what's got kiwi moving against the A$.

Of course, we've talked about the RBA and the markets will to have them cut rates this year, and Chuck's point of view that a rate cut is not needed in Australia. So, we don't have to get into that again, but just remember, that I've put it all out there for everyone to view, and in my opinion no rate cut is needed in Australia. We'll see if the RBA has the intestinal fortitude to stand up to the markets.

The A$ is up by 1/2-cent this morning, as it gets dragged along with the rest of the currencies. I say dragged along because the threat of a rate cut is hanging over the A$ like the Sword of Damocles right now. And the fact that the IMM futures positions showed a 20,000+ drop in long A$ positions last week. The rest of the currencies only had what I would call, modest gains or losses from the previous week's holdings. So, the A$ is going to have to work hard to get through this gauntlet of bad news.

Well. I saw this story headline flash across my screen this morning, and since it caught my eye, I was assured that you would want to see it too! HA! Here's the headline: "PIMCO Makes AAA Rated Norway in Retreat the Favorite". So, the story goes on to talk about how the Norwegian krone hasn't really performed well this year, but that hasn't stopped PIMCO from taking a flyer on the krone. Let's listen in to Thomas Kressin, head of European Foreign Exchange at PIMCO. "From a relative domestic fiscal position and relative interest rate position, Scandinavian currencies still look appealing. We are reconsidering entering a long position." And then the boys and girls over at Citigroup issued a statement that "the krone is more attractive than the euro"

Now, doesn't that ring a bell? Which reminds me of an old joke. Any way. Isn't this the stuff I've been telling you for some time now about the Norwegian krone? That one day, the markets will wake up, have a V-8 moment, and realize that the krone's fundamentals are far better than those of the euro, and the krone should not be tarred with the same brush used on the euro? I certainly hope so, because I think I've said it and written it so many times that I'm sure some people think I've lost it, for I keep repeating myself.

Well, the U.S. data cupboard gets restocked today, with two of my fave reports. Personal Income and Spending. Right now, the "experts" believe that Personal Spending will be flat for March, and given the rot on the economy's vine starting with March, I would have to think the "experts" will get it right this time. That could mean that Personal Income is greater than Spending, which doesn't happen that often folks.. But it certainly would be great if it did!

The rest of the week is chock-full-o-data, ending with the Jobs Jamboree on Friday. Between now and Friday, we'll see stuff like the S&P Case/Shiller Home Price for Feb (such old data, eh?) Consumer Confidence, the ISM Manufacturing Index, Vehicle Sales, and a Fed FOMC rate decision on May 1st. So, buckle up, this could be like Mr. Toad's Wild Ride this week.

Then There Was This. This is the story that I said earlier today played well with the reason to look to own Gold. This was sent to me by colleague, Aaron, who found it on CNSNews.com. The latest available data from the United States Department of Agriculture (USDA) shows that a record number 23 million households in the United States are now on food stamps.

The most recent Supplemental Assistance Nutrition Program (SNAP) statistics of the number of households receiving food stamps shows that 23,087,886 households participated in January 2013 - an increase of 889,154 families from January 2012 when the number of households totaled 22,188,732.

The most recent statistics from the United States Census Bureau-- from December 2012-- puts the number of households in the United States at 115,310,000. If you divide 115,310,000 by 23,087,866, that equals one out of every five households now receiving food stamps.

As CNSNews.com previously reported, food stamp rolls in America recently surpassed the population of Spain. A record number 47,692,896 Americans are now enrolled in the program and the cost of food stamp fraud has more than doubled in just three years."

Chuck again. Sad but true, eh? And the Gov't keeps recruiting people to enroll in the program. Do I need to say more about that's not how I was raised, or my dad, or my grandfather? Oh well, it is what it is, right?

To recap. The Currencies & Metals are stronger this morning as the tide has shifted back in their favor after a weaker than expected GDP print on Friday. Kiwi is outperforming the A$ these days, as rate outlooks for the two country are narrowing the spread that currently exists. PIMCO thinks the Norwegian krone is a buy, and Citigroup likes the krone's fundamentals. And Dennis Gartman shares his thoughts with us on China.

Currencies today 4/29/13. American Style: A$ $1.0345, kiwi .8555, C$ .9860, euro 1.3085, sterling 1.5525, Swiss $1.0650, . European Style: rand 9.00, krone 5.8180, SEK 6.5360, forint 228.75, zloty 3.1630, koruna 19.6495, RUB 31.08, yen 97.75, sing 1.2340, HKD 7.7615, INR 54.24, China 6.2208, pesos 12.09, BRL 1.9985, Dollar Index 82.16, Oil $93.35, 10-year 1.66%, Silver $24.41, and Gold. $1,476.12

That's it for today. Well, after beating the #6 and #5 teams in the state Thursday & Friday nights, Andrew and Alex's water polo team ran into a real problem playing the #1 & #2 teams on Saturday. But they finished 4th in the Tournament, and head into the state playoffs this weekend. Alex did score 3 goals this weekend, so good for him! It was so rainy and cold this weekend, that it didn't seem like a weekend at all! Our Blues start the playoffs at home tomorrow night against the defending Champion, LA Kings. Go Blues! It was spooky driving along our river road the other day, with the flood water lapping up against the curbs. But! I think it's supposed to dry up and warm up this week! YAHOO! And with that. I hope you have a Marvelous Monday!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

All Three Anti-Dollar Assets On The Rise.

ChuckButler — Fri, 26 Apr 2013 03:29:00 GMT

.........But First, A Word From Our Sponsor..........

There's no smarter way to buy gold or silver

-Choose from coins, bars or unallocated metal -No storage or annual fees on Unallocated Accounts -Low account minimums of $5,000 for Unallocated Accounts and $7,500 for Allocated Accounts

To learn more and view important disclosures go to: https://www.everbank.com/personal/precious-metals.aspx?referid=11808

......................................................

In This Issue.

* U.K. 1st QTR GDP beats estimates!.

* Merkel wishes for higher rates for Germany.

* Riksbank gets on Chuck's bad list.

* Gold physical demand continues to soar..

And, Now, Today's Pfennig For Your Thoughts!

All Three Anti-Dollar Assets On The Rise.

Good day. And a Tub Thumpin' Thursday to you! My beloved Cardinals got their brooms out yesterday and swept the Nationals in Washington D.C. The Cardinals have to be persona non gratis in Washington D.C. given the 9th inning rally last year to knock the Nationals out of the playoffs, and now this sweep. A better day for me yesterday, but today has started out on the wrong foot, with me oversleeping by an hour this morning! UGH! So. no time to dawdle. Let's go to the tape!

Well, the dollar seems to have exhausted its bias that it held earlier this week, and the green/peachback looks very iffy this morning. The currencies, led by pound sterling, (when was the last time I said that!?) are taking liberties with the dollar, along with the Commodities led by Gold and Oil, the two anti-dollar commodities. There was more rot that was exposed on the U.S. economy's vine yesterday, and a record low fixing in the Chinese renminbi. All this has ganged up on the dollar this morning, and the bias the dollar held earlier this week to buy, has gone bye-bye.

OK. so what lit the fire under the pound sterling? Well, grasshopper, I'm glad you asked! 1st QTR GDP for the U.K. printed stronger than expected, thus showing the markets and the world that austerity can be implemented and some growth eked out after all. U.K. 1st QTR GDP printed at a whopping (NOT!) +.3%, but the forecasts were for a .1% rise, so it came in stronger than expected, and would put annual growth above 1%, which doesn't sound like anything to write home about, but in this day and age in the U.K. a greater than 1% GDP for 2013, will be celebrated, for sure!

But, I'm not here waving a flag for pound sterling folks. The U.K. has far too many problems to sort through, before the currency can be added to my roster of currencies that have strong fundamentals. But it's nice to see "cable" have its day in the sun.

The Aussie dollar (A$) has climbed back above $1.03 once again. I told you the other day that the recent history saw the A$ bounce higher every time it slipped. And here we go once again! I think that this rebound in the A$ is coming about over the fact that the Chinese, after a couple of days allowing the renminbi / yuan to weaken, have pushed the trading band envelope pretty aggressively since. As I said above, the renminbi has been pushed to record level VS the dollar. I know that waiting for renminbi gains is like watching paint dry. but they are there folks. The renminbi has gained 1% so far this year, and over 2% in the past 12 months. Slow and Steady.

Yesterday in the U.S., Durable Goods Orders printed a very weak number for March's report. Durable Goods Orders (DGO) dropped sharply in March, falling -5.7%, thus adding to the economic reports we've already seen for March that have really shown that a spring swoon for the economy is going on right now. There were some components of the DGO report that the perma-bulls in the U.S. will point to and walk around like 20-game winners. But to me, you can always find something that spins the story your way. Shoot Rudy, I guess I do that myself, so there!

The point I'm attempting to get to here is this. The U.S. economy is slowing down just when the Fed Heads are talking about removing stimulus. But, I believe that "talk" will all fade away soon, and replacing the talk about removing stimulus, will be talk about extending it. Now, that's what I thought all along would happen, but when the Fed Heads began to gain numbers of fellow Fed Heads that agreed with the tapering of the stimulus, I began to squirm in my seat. But, now things are heading back to "way Chuck sees them".

The price of Gold is up about $15 this morning, pushing toward $1,450. I had a reader send me a note, and asked me to explain in the Pfennig, why paper gold if it is not backed by physical gold holds more pricing weight than the actual physical supply/ demand of Gold. I the market being deceived? Ahhh. grasshoppers, yes it is. And the reason the paper trades pushed the price of Gold downward so viciously, was because of the size of the paper trades. When you can write a naked short ticket without fear of regulators throwing you in jail, you go for the gusto! So, that's how that happened.

But Gold has been picking up the pieces folks. and this morning sits at a 10-day high. as physical demand has taken over, for how long before the paper shorts return no one knows, but physical demand is very strong right now. For example, the U.S. Mint is reporting that through the first 23 days of April, they have sold more Gold Coins than in any month since December 2009! And April's figure so far of 196,500 ounces of Gold sold, is triple the number in March.

Here's a cool chart that I found on one of my fave web-sights, Zerohedge.com. You'll have to go to the Pfennig blog site to view it though, as the text letter doesn't carry the ability to post charts, etc. simply go to: www.dailypfennig.com to see it.

Did you hear what German Chancellor Angela Merkel had to say yesterday? I found it to be very interesting. She commented that "higher ECB rates would be better for Germany". Don't for one minute think that those comments weren't intended to send a message. Ok, let me set this up. recall last week, I told you about Bundesbank (Germany's central bank) President, Weidmann, jawboning rates lower? Well, Merkel decided that he needed to be corrected, and so she made the comments about higher rates being better for Germany. And like last week when Weidmann made his comments and the euro got sold, Merkel's comments have boosted the euro by 1/2-cent this morning. Good for her!

And then something I saw come across the screens this morning really bothered me. Sweden's Riksbank issued a statement and in the statement they predicted that the currency's recent gains are coming to an end. What? What the heck are you doing Riksbank? I guess the exporters got to you too. sadness here. as I always liked the Riksbank. but no longer if they are going to willy nilly make statements like that!

Well, I told you at the top that the price of Oil was higher. The price of Oil has steadily moved higher all week from $88, to $89, and now this morning to nearly $92. Remember. Oil, along with Gold, and euros, are the anti-dollar trades. So, when all three of these are rising at once, you know the bias to buy dollars has gone bye-bye. at least for now.

The markets all change so swiftly these days, as trader and investor sentiment is the driving force, and not fundamentals. The one-day swings in currencies, and Gold are something that never used to be seen, as the moves were driven by fundamentals only. now sentiment that reacts, most times with a knee-jerk, to news, that's so readily available from all corners of the world, drives the near-term prices. Of course fundamentals will eventually prevail. but day-to-day, sentiment that has reacted to news stories, is what drives prices so crazy.

Then There Was This. I saw this on Ed Steer's newsletter this morning, of which he pulled from Moneynews.com, and I just had to use it in the TTWT section. It's an interview with Robert Shiller. "The 32-year decline of interest rates and inflation may soon end with a thud, says Yale economist Robert Shiller.

Interest rates have been declining for decades now," he writes in The New York Times. "Clearly, that cannot continue on the same track for another 10 years, because rates would have to turn negative."

As for inflation, it can rise. It's easy to imagine that both [inflation] and interest rates will rise substantially, creating a bonanza for homebuyers who have already locked in low rates. And because rates are so low now, they could climb a lot once they turn."

As I said in January of 2007...call me in 2013 and I'll let you know if the bottom is in for the U.S. real estate market. Yes, it is...but with the country on the edge, it's the last thing I would be spending my money on, as I would be looking for a way to get that money out of the country. So the next 10 years might replicate the 1960's and 1970's, when inflation and interest rates kept rising."

Chuck again. I think Mr. Shiller hits the nail on the head with his thoughts on inflation and interest rates.

To recap. The bias to buy dollars has faded, and the anti dollar assets of Oil, Gold and euros are all stronger this morning. The U.S. economic spring swoon continued to show more rot on the vine with a -5.7% plunge of Durable Goods Orders in March. That news, and the news that China had fixed the renminbi / yuan at 19 -year highs VS the dollar, really has the currencies and commodities pushing the dollar down today.

Currencies today 4/25/13. American Style: A$ $1.0325, kiwi .8545, C$ .9780, euro 1.3075, sterling 1.5445, Swiss $1.0605, . European Style: rand 9.0815, krone 5.8515, SEK 6.5740, forint 230.30, zloty 3.1750, koruna 19.8070, RUB 31.18, yen 99.15, sing 1.2375, HKD 7.7640, INR 54.22, China 6.23, pesos 12.14, BRL 2.001, Dollar Index 82.50, Oil $91.86, 10-year 1.70%, Silver $23.30, and Gold. $1,445.41

That's it for today. There was something I was saving for the Big Finish and now I've forgotten what I was going to say! UGH! If I dawdle here long enough it will come back to me. but, since I overslept this morning, I don't have time to dawdle! Andrew and Alex's water polo team pulled an upset last night, scoring two late goals to beat DeSmet, a team they haven't beaten in eons! They were very happy afterwards. I leave Alex little notes every morning while his mom is gone, I'm sure he finds them to be dumb, but I don't care. But one thing I tell him in each note is the same thing I say to you.. Have a Great Day! I hope you have a Tub Thumpin' Thursday!

Chuck Butler

President

EverBank World Markets

1-800-926-4922

1-314-647-3837

Austerity is a Consequence, not a Punishment

JohnMauldin — Mon, 22 Apr 2013 21:45:00 GMT

The Bang! Moment
The Purpose of Debt
Austerity Is a Consequence, Not a Punishment
San Francisco, Carlsbad, Tulsa, Nashville, and Brussels

Two seemingly different questions and comments from readers and friends crossed my path the last few days, but I saw a definite connection between them. The first question was, Why do we pursue austerity when it seems not to work? And then many readers wrote to ask this week, What do I think about the real problems that are surfacing in the Rogoff and Reinhart assertion that debt above a ratio of 90% debt to GDP seems to slow economic growth by 1% (especially since I have quoted that data more than a few times)? We'll deal with each question separately and then see if we can connect the dots.

The first question comes from correspondence I have had with Ms. Aga Barberini, who works in the investment world in Milan, Italy. She came there from Poland some 20 years ago. The first part of her note contains the question on austerity, but I'll pass along more of her letter, as I think it will give us all some insight into the seeming chaos that voters are facing in choosing a path for Italy. (And I hope my editors leave some of the charming grammar in her letter. You can almost hear the musical tones of her Italian English.)

I am worried for Italy, too. When I came here 20 years ago Italy was beautiful and rich; it was very good for a girl from Eastern Europe. Nowadays a lot of Italians go to Poland and settle down.

I guess it's going to get worse, the austerity will be tighter. Please tell me why should we go ahead with austerity when IMF last month came out saying that for every point of tax lifting in Italy we lose 2.5 points of GDP? First they said that the tax lifting would produce only 0.5 points of GDP slip, now they say they were wrong.

The political chaos is lasting. My husband says, why don't we vote for the comedian in June (as it is almost sure we are going to vote again soon)? Sure, Grillo is right in a lot of things and would clean the politics a lot. (By the way, did you know that the oldest bank in the world, Monte dei Paschi di Siena's mess is reaching 20 billion euros? They took away the money doing ... the bank transfers ;-) The Banka d'Italia didn't see; CONSOB, the Italian SEC, didn't see...). But how can a serious person vote for the comedian?

But I say sometimes the one who is good for the revolution isn't necessarily good to rule the country. Do you remember the guy called Lech Walesa? Thanks to him the communism [in Poland] was fallen – we all agree. Polish people were so thankful to him that we appointed him for the first democratic president. Than we found that he didn't have enough background to rule the country and enough culture to represent us on the international stage.

I will vote Berlusconi again. I can't stand communists even if they call themselves "the left."

(Sidebar: I was in Siena last summer and visited the ancestral home of the bank mentioned above, the world's oldest, founded in 1472. I marveled that any bank could last so long. At the Palio last summer we met one of the senior managers of the bank. It turns out that it was local politicians who ran the board of the bank, and now the authorities are saying management hid the problems from them.)

So let me try to answer you, Aga.

Austerity has come to have a rather bad name of late. The complaint is that it just doesn't work. Which is somewhat like complaining that the roof is leaking because someone else hassn't fixed it. If by "working" we mean that austerity is supposed to produce growth, then of course it doesn't work. By definition, austerity means you are reducing a fiscal deficit, and doing so will reduce growth in the short term. That begs the question, why would you want to do that? Don't we want growth? Let's look at why a country might need to endure austerity.

"Austerity" is now the name we give to the situation where a government has to limit its spending during an economic downturn or recession. The governments of the developed world amassed huge sovereign debts in the course of what is known as the Debt Supercycle. As interest rates fell, borrowing to finance consumption and spending became easy. But now that decades-long supercycle has ended.

One way of looking at the problem of swollen sovereign debt is to tsay that it goes back to Keynes (although one cannot actually blame the current problems on his economic theory). Keynes argued (roughly) that when there is a normal business-cycle recession a government should spend money to counterbalance the private-economy slowdown. That means that the government should borrow money and run fiscal deficits to help boost spending and the economy. According to his theory, this would make the recession not as deep and help bring the economy back to recovery sooner.

This was tried after World War II in numerous countries in the developed world, and it seemed to work. "We are all Keynesians now" is a famous phrase uttered by Milton Friedman and attributed to US President Richard Nixon. It is popularly associated with the reluctant embrace of Keynesian economics in a time of financial crisis, by individuals such as Nixon, who had formerly favored less interventionist policies. (The phrase was first attributed to Milton Friedman in the December 31, 1965, edition of Time magazine. In the February 4, 1966, edition, Friedman wrote a letter clarifying that his original statement was, "In one sense, we are all Keynesians now; in another, nobody is any longer a Keynesian.") (Wikipedia)

The problem that arose was that most countries rarely followed through on the second part of Keynes's prescription, which was to pay back the debt when times were good. Rather, the debt just continued to accumulate. But, because interest rates were dropping, the size and cost of the debt became less of an issue.

The Bang! Moment

And, as Rogoff and Reinhart showed through their massive data collection and work on sovereign debt crises, published in This Time Is Different and elsewhere, debt is not a problem until it becomes one. And then it reaches a critical mass and you have what they called the Bang! moment.

I want to review some of their work, which will help us understand the reasons for austerity, but first let's deal with the controversy of the moment. There has been some considerable debate this week among economists about a paper Rogoff and Reinhart published after they wrote their book. Recent detailed work suggests the analysis in that paper is flawed and that there are actual programming errors in their spreadsheets. My inbox almost exploded the last two days as friends and colleagues sent me links to multiple sources talking about the problems with Rogoff and Reinhart's work and asked for my thoughts. Given that I find This Time Is Different one of the more important books of the last decade, let me provide some context.

In 2010, economists Carmen Reinhart and Kenneth Rogoff released a paper, "Growth in a Time of Debt." Their main result was that "… median growth rates for countries with public debt over 90 percent of GDP are roughly one percent lower than otherwise; average (mean) growth rates are several percent lower." The work suggested that countries with debt-to-GDP ratios above 90 percent have a slightly negative average growth rate.

This has been one of the most cited stats in the public debate during the Great Recession. Paul Ryan's Path to Prosperity budget states that their study "… found conclusive empirical evidence that [debt] exceeding 90 percent of the economy has a significant negative effect on economic growth." The Washington Post editorial board takes the R&R conclusion as an economic consensus view, stating that "… debt-to-GDP could keep rising – and stick dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth." (from the Next New Deal site and many other links sent to me)

Next New Deal (nextnewdeal.net) had this analysis:

In a new paper, "Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff," Thomas Herndon, Michael Ash, and Robert Pollin of the University of Massachusetts, Amherst successfully replicate the results. After trying to replicate the Reinhart-Rogoff results and failing, they reached out to Reinhart and Rogoff, and they were willing to share their data spreadhseet. This allowed Herndon et al. to see how how Reinhart and Rogoff's data was constructed.

They find that three main issues stand out. First, Reinhart and Rogoff selectively exclude years of high debt and average growth. Second, they use a debatable method to weight the countries. Third, there also appears to be a coding error that excludes high-debt and average-growth countries. All three bias in favor of their result, and without them you don't get their controversial result.

(You can get further details at http://www.nextnewdeal.net/rortybomb/researchers-finally-replicated-reinhart-rogoff-and-there-are-serious-problems. And there are other sources here and here.)

I and many others who are concerned about the growth of debt quoted that research. As we approach that 90% level in the US, it has become a prominent feature in certain circles. But I want to emphasize that The Rogoff and Reinhart paper mentioned above is a later work than their book. To my knowledge, no one is disputing the work in their book. Their book, This Time Is Different, is basically just an analysis of their very large and masterful accumulation of data about sovereign debt crises.

For the last two weeks I have talked about economists and their use of data. I pointed out that inflation as measured by the CPI is an average for the country and not reflective of any one person's actual experience.

Something similar can be said about the later work of Rogoff and Reinhart. Yes, there was an unfortunate formula in one cell of their rather complex spreadsheet; but more importantly, they made assumptions about what is important and what is not in creating their analysis, and the assumptions in their model gave one set of results. If you make different assumptions, you get other results that show that 90% is not all that bad. Just as economists argue about how we should compute inflation, there will now be arguments about what the debt-to-GDP numbers really mean. I am willing to bet that by this time next year we will see several studies, all arriving at different conclusions.

But in any case, whether in their original work or in the later paper, R&R describe a problem with excessive debt that is true on average. Actual experience shows that in some countries debt will create a problem at quite low levels, while Japan climbs toward 250% debt to GDP (and will get there all too soon) and hardly anyone blinks. Different pokes for different folks.

I'm going to toss in a quick note as I sit here in Hong Kong waiting for my next plane. I read the Financial Times while on the way up here from Singapore. There were several articles that seemed to rejoice in the fact that Rogoff and Reinhart's later paper has some flaws. They jumped on those errors to discredit the whole idea of austerity, the association between too much debt and a lack of growth, and the need to bring one's fiscal house into order. Why pursue austerity when it does not lead to growth, which everyone knows is the only real way to deal with debt?

You can almost hear the critics wanting to dismiss Rogoff and Reinhart's entire book, which clearly establishes the link between excessive debt and sovereign debt crises – a pattern that has played out some 266 times over the last few centuries, if I remember correctly. The point is that there is no magic number that says "This far and no farther." There is a mythical line where confidence and trust is lost, but no one knows where that line of demarcation is until it is crossed. And right up until the last minute, there are always those who look for ways to add more debt, who assure us, "This time is different." But it never is. A country can restore its fiscal house to order, pay back its debt, and grow its way out of the problem over time; there are numerous examples. But continuing to grow that debt-to-GDP number is to court a disaster that looms right in front of you.

If politicians want to keep the borrow-and-spend party going "just one more election cycle" and if no one takes away the punchbowl, the Bang! moment will most certainly arrive. That is the clear lesson of history. It is almost irrelevant whether that number is 90% or 120% or 80%. It will be a different number for each country, depending on the confidence that investors have in the ability of a country to pay back its debt. Investors in sovereign debt are almost by definition the most risk-averse investors there are. You do not invest in a country's debt to increase your risk exposure; you expect to get paid. There are other factors at play in determining the critical threshold, too: What was the purpose of the debt? How fast is the economy growing?

Can Italy, beset by recession, high unemployment, and a political crisis, grow its debt-to-GDP to Japan's 240% level? I think any serious observer would say no. Can it get to 130%? 140%? Maybe. We will not know until it's too late whether Italy or any other country (Spain, Japan, France, or the US) has more debt than the market is willing to absorb. But that is a line any politician should want to avoid crossing.

To cobble together an understanding of why Italy needs to deal with austerity – and to give Aga a good answer – we first need to revisit something I wrote in my own book, Endgame. One of the most important sections of Endgame is a chapter in which I review (and compare with other research) This Time is Different and include part of an interview I did with Rogoff and Reinhart. This chapter turned into a real economic epiphany for me, because the R&R data confirms other research about how things seem to go along swimmingly, and then the end comes all at once – the Bang! moment. Let's review a few paragraphs from my book, starting with a paragraph from the interview I did:

KENNETH ROGOFF: It's external debt that you owe to foreigners that is particularly an issue. Where the private debt so often, especially for emerging markets, but it could well happen in Europe today, where a lot of the private debt ends up getting assumed by the government, and you say, but the government doesn't guarantee private debts, well no they don't. We didn't guarantee all the financial debt either before it happened, yet we do see that. I remember when I was first working on the 1980' Latin Debt Crisis and piecing together the data there on what was happening to public debt and what was happening to private debt, and I said, gosh the private debt is just shrinking and shrinking, isn't that interesting. Then I found out that it was being "guaranteed" by the public sector, who were in fact assuming the debts to make it easier to default on.

Now back to the book [quoting Rogoff and Reinhart]:

If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is.

Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short-term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a government's policies, a financial institution's ability to make outsized profits, or a country's standard of living. Most of these booms end badly. Of course, debt instruments are crucial to all economies, ancient and modern, but balancing the risk and opportunities of debt is always a challenge, a challenge policy makers, investors, and ordinary citizens must never forget.

And the following is key. Read it twice (at least!):

Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence – especially in cases in which large short-term debts need to be rolled over continuously – is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! – confidence collapses, lenders disappear, and a crisis hits.

Economic theory tells us that it is precisely the fickle nature of confidence, including its dependence on the public's expectation of future events, which makes it so difficult to predict the timing of debt crises. High debt levels lead, in many mathematical economics models, to "multiple equilibria" in which the debt level might be sustained – or might not be. Economists do not have a terribly good idea of what kinds of events shift confidence and of how to concretely assess confidence vulnerability. What one does see, again and again, in the history of financial crises is that when an accident is waiting to happen, it eventually does. When countries become too deeply indebted, they are headed for trouble. When debt-fueled asset price explosions seem too good to be true, they probably are. But the exact timing can be very difficult to guess, and a crisis that seems imminent can sometimes take years to ignite.

How confident was the world in October of 2006? John was writing that there would be a recession, a subprime crisis, and a credit crisis in our future. He was on Larry Kudlow's show with Nouriel Roubini, and Larry and John Rutledge were giving him a hard time about his so-called "doom and gloom." "If there is going to be a recession you should get out of the stock market," was John's call. He was a tad early, as the market proceeded to go up another 20% over the next 8 months. And then the crash came.

But that's the point. There is no way to determine when the crisis comes.

As Reinhart and Rogoff wrote:

Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! – confidence collapses, lenders disappear, and a crisis hits.

Bang! is the right word. It is the nature of human beings to assume that the current trend will work itself out, that things can't really be that bad. The trend is your friend … until it ends. Look at the bond markets only a year and then just a few months before World War I. There was no sign of an impending war. Everyone "knew" that cooler heads would prevail.

We can look back now and see where we have made mistakes in the current crisis. We actually believed that this time was different, that we had better financial instruments, smarter regulators, and were so, well, modern. Times were different. We knew how to deal with leverage. Borrowing against your home was a good thing. Housing values would always go up. Etc.

Until they didn't, and then it was too late. What were we thinking? Of course, we were thinking in accordance with our oh-so-human natures. It is all so predictable, except for the exact moment when the crisis hits. (And during the run-up we get all those wonderful quotes from market actors, which then come back to haunt them.)

The Purpose of Debt

Countries and governments, small and large, can go into debt for numerous reasons. As noted above, Keynes advocated going into debt during business contractions. But there are different types of debt.

There is debt that is used to build productive assets such as roads, airports, bridges, schools, and civic centers.

Then there is debt that is used for current consumption. When debt creates assets, future generations at least get some benefit when they have to participate in paying the loan back. In the case of current consumption, they get none. In essence, debt applied to consumption is spending today rather than spending in the future. You are borrowing money to spend on goods and services in the "now," with the promise to pay for that consumption later.

Next week, if all goes right, I am going to borrow money to buy two apartments in a high-rise in Dallas that will become, after we do a little remodeling, my future home. I will get an asset that I hope to pay off in about ten years. If I am lucky, that asset will then be worth more than I paid for it.

That is different from borrowing money to go on a vacation or to buy food or other goods that will have no future value.

Austerity Is a Consequence, Not a Punishment

But borrowing against the futureis what Italy has essentially done, Aga. Just like other countries all over the world, Italy borrowed for consumption and ran up a rather large debt. And then the crisis came, and lenders were not as willing to provide Italy money at low rates. That is the nature of investors who buy government bonds: if they perceive higher risk, they want higher rates.

The crisis arrived, and Italy lost cheap access to the bond market. The ECB had to step in and begin to buy bonds to lower their rates. But Italy had to promise to lower its deficits, and the way to do that is called austerity.

Italy is in a currency union called the Eurozone. A currency union cannot allow its members to run up debts beyond what the market is willing to finance, or the whole currency union will collapse. The central bank (in this case the ECB) can only print so much money before inflation and valuation becomes an issue. If the ECB allows Italy to run whatever debt it wants to, then it must allow everyone else the same privilege.

Eurozone officials may elect to help a smaller state like Greece paper over some of its problems, but at the end of the day countries must be able to handle their own debts you are going to keep your currency union up and running.

Italy must deal with austerity because if they don't they will lose access to the bond market. They ran up a huge debt and now must figure out how to pay it back. They borrowed money to spend, on the pledge that future generations would pay for it. Unfortunately, the future is now.

Yes, Germany and other countries could lend the Italians money, but they have their own problems. Egan Jones, the only truly independent rating agency, downgraded Germany this week. The Dutch too are having "issues," as my kids would say. Europe in general seems to be slipping into recession.

Some would argue that the ECB should just fire up the presses and print money, as Japan is going to do. Outright monetization. But that approach is highly problematic. Why should Finland want to see that happen if they are not also running large deficits? What about countries with lower debt ratios? The documents everyone signed when they joined the euro dictated that each country would be responsible for its own debt and that the ECB would not monetize debt.

It is one thing for a country to fall on hard times and for its fellow currency-union members to agree to help, but it is another thing to make that help open-ended. Italy has come a long way toward getting back to a sustainable fiscal situation in the last few years. I know it has been hard. I have always maintained that Italy has its own fate in its own hands. Aga, if you just cut the number of cars and drivers you provide to every small-time politician, you could eliminate about 20% of your deficit. Everyone in Italy knows there is a lot of waste and corruption. That is why a comedian like Grillo can get almost 25% of the vote!

The neo-Keynesians are right about this. In the short term, austerity will result in less growth. All but the mathematically challenged will agree with that. The scholarly literature seems to suggest that the short term is about 4-5 quarters, but that estimate is based on averages for a number of countries. Whether the actual interval is longer or shorter, it means that austerity will not produce growth in the short term. And if you have to cut 1-2% a year for several years, then that means little or no growth for those years. But the reason you have to do it is that you did not reduce your debt during the good times.

Austerity is a consequence, not a punishment. A country loses access to cheap borrowed money as a consequence of running up too much debt and losing the confidence of lenders that the debt can be repaid. Lenders don't sit around in clubs and discuss how to "punish" a country by requiring austerity; they simply decide not to lend. Austerity is a result of a country's trying to entice lenders into believing that the country will change and make an effort to restore confidence.

If Italy or any other country does not inspire confidence, then it must suffer the consequences when it loses access to the credit markets. Sure, the ECB or the IMF could lend you money, but their members are essentially investors as well. If there was unlimited money available, I can think of a country or two that might choose to run 10% and then 20% deficits. Why choose to tax when you can borrow and not repay? That is what politicians would all love to be able to promise.

Argentina has pursued such a policy for almost a century. After multiple devaluations, their currency is now a fraction of one billionth of a cent of what it was 100 years ago. It is rather hard to operate as an investor or businessperson in such an environment. One of the reasons why Italians wanted to get into the euro, Aga, was to take away from your politicians the opportunity to run up large debts and then devalue. The lira was a byword for fleeting value, not a currency for long-term investment.

You avoid austerity by not borrowing and consuming in the first place. After the market loses confidence, your choices are rather stark. If you default, then you are clearly out of the market for some time and suffer a very quick and deep recession as the government loses its ability to pay the salaries of government workers, provide healthcare, etc. If you elect to try to keep borrowing, you will have to implement a change in policy that will restore confidence – or find someone who will lend you money on better terms. Bluntly speaking, Germany and the EU might do that for Italy for a while but not unless they see the country actually controlling its deficit.

The problem Italy now faces is that any government that is elected will have to make hard choices. Trying to reverse the austerity already agreed to will almost certainly result in loss of access to the bond market. Is it possible to develop a plan to cut spending at a slower pace? Sure, if you can get the rest of the EU to agree, at the same time that Spain, Portugal, Greece (and soon France) all want the same policies.

If Italy were in control of its currency, might it make sense to print a little in the meantime, as the US, Great Britain, and Japan are doing? There is certainly a school of thought that says yes. But in a currency union of multiple countries that are all at different places on the economic journey, it is almost impossible to have a one-size-fits-all monetary policy. If the spigot is opened for Spain, Italy, et al., then Germany and others get inflation. That is a tough sell to German and Finnish voters (among others).

You cannot force the rest of Europe to fund your deficits. You can negotiate with them to try to lessen the severity of the crisis, but there is no pain-free path ahead from where Italy is today, Aga. Your debt to GDP is 126% and rising. Without ECB support, you would have already lost access to the bond market. If you want to stay in the euro, you just have to deal with it.

By the way, leaving the euro would be a VERY expensive option. The "new lira" would drop in value like a stone in Lake Como (Italy's deepest lake, for those not familiar with it, and one of the most beautiful lakes in the world). The cost of borrowing would skyrocket. The banks would be bankrupt overnight, requiring massive infusions of new currency that would further drive the lira down. You are frustrated with politicians now, Aga? What would it be like in the chaos of a depression? No one can manage well in such an environment. There would be no good choices, only a choice among disasters.

Tiny Cyprus might choose in the next few weeks to exit the euro. With bank accounts frozen and the economy shutting down, they might feel they have no choice. Pay close attention to what happens; it will not be pretty. (As an aside, I am seriously tempted to go to Cyprus in late June, just to see the country firsthand. I will be in Europe between speaking gigs and have not yet decided where to go.)

Italy must first of all choose a government. Cleaning up its political corruption and wasteful spending would be a good move, but even clean new politicians (if there is such a thing) will be faced with the same economic choices. Which, I should note, is roughly the same choice voters everywhere are faced with.

The US is also approaching an uncomfortably high debt level. It was less than ten years ago that I was writing about what the US investment market would look like with no government debt. Yes, that possibility now seems a distant memory, but we were paying down the US debt that fast. And then came the Iraq war and larger deficits and a Republican Congress that got drunk on spending increases. Cheney told them that deficits don't matter, and they took it to heart. They doubled down on debt.

If the US had entered the 2008 crisis with little or no debt, we could have spent that $1 trillion a year (or even several trillion and made Krugman and McCulley ecstatic), and no one would have really cared, from a total debt perspective. (We would have cared what the money was spent on). But we didn't. We squandered our surplus with new programs and spending. We borrowed and consumed. We wasted the good times by running up even more debt. And now we are close to paying a price.

So, Aga, I don't have any easy words for you, but I do think Italy will pull through. I will visit your country again and again in the future, because I love Tuscany. But if you can take comfort in the company of others in similar situations, then there are a host of countries in the developed world that are going to have to face austerity in one form or another. That is just what happens when you reach the end of the Debt Supercycle. You are no longer left with merely difficult choices; they are more like very tough, bad, and disastrous. The worst choice is not dealing with the problems as soon as possible. I only hope my own country can make the difficult choices soon, before we too are faced with a crisis.

San Francisco, Carlsbad, Tulsa, Nashville, and Brussels

I finish this letter in the Singapore airport before I begin the rather long journey back to San Francisco, where I will rest and recover from jet lag at the Fairmont, one of my favorite hotels over the years. I speak in SF Monday morning before heading back to Dallas and my "home hotel" for a week. As noted above, I am buying a property as my primary residence and had to move out of my leased home early, so I'm between places. As I have promised, when the deal for the new place gets done, I will write about my experience – the terms and negotiations and why I decided to buy now after all these years.

This is a bit of a first for me, as I fly to Hong Kong to catch a plane to San Francisco. I will leave very early Friday morning and arrive late on Thursday night, crossing the international date line and arriving the "day before" I left, getting back the day I lost coming here.

My Strategic Investment Conference is almost here. I am so looking forward to catching up with old friends. And I'm just as excited about the exchange of views we will have on how to navigate the coming economic transitions. It seems everyone is on the "short Japan" side of the boat, including me. Is the boat listing, or is there still room for others? The debate on whether there is a bubble in the US bond market will be intense. Europe will be a hot topic. China, too. Will the US see 3% growth this year or fall further behind?

And underlying our discussions will be an intense debate about the future of world growth and stability. I have purposely sought out thought leaders who steer independent courses. Kyle Bass, Niall Ferguson, Nouriel Roubini, Drs. Lacy Hunt and Gary Shilling, David Rosenberg, Charles and Louis Gave, Anatole Kaletsky, and Paul McCulley will all be there, among others. You can see the entire line-up for the May 1-3 conference (co-sponsored with Altegris Investments) right here, plus see highlights from last year's conference. There are still a few spots left, so I encourage you to register and join me and my friends as we think about our future. I think this is clearly the best investment conference of its kind this year, and I, along with Jon Sundt and his team at Altegris, am proud to be able to offer it to you.

I continue to be impressed with Singapore. This city/country just works. I was able to take a few hours and tour their magnificent Garden Domes. The entire place is a marvel of human engineering and vision. I want to return for an extended visit and explore the amazing variety of plants and trees they have assembled from the world's cloud forests. They built an indoor, 115-foot-high waterfall system and replicated a cloud forest that you can walk through.

Every time I come here there are new towering buildings and projects to reclaim land from the ocean. A sustainable future is a constant theme. Low taxes and a climate that is ideal for business have made this nation a center for commerce. Issues here and there? Sure, this is a human enterprise, and we come with built-in issues, but the problems are positive ones.

They are calling my flight, so it is time to hit the send button. Charley & Lisa Sweet, my long-suffering editors, will have extra work cleaning up this week's letter, but I don't think the plane will wait for me to go through it one more time.

Have a great week, and come see me in Carlsbad.

Your ready to read on the way home analyst,

John Mauldin

subscribers@mauldineconomics.com

Tax Day!

ChuckButler — Mon, 15 Apr 2013 21:41:50 GMT

In This Issue.

* Gold & Commodities plunge!.

* Commodity Currencies take it on the chin.

* It's all about the so-called U.S. recovery.

* Chinese GDP weakens to 7.7%.

And, Now, Today's Pfennig For Your Thoughts!

Tax Day!

Good day. And a Marvelous Monday to you! Well. it's Tax Day. April 15th! The day snuck up on me, even though I saw it coming. My tax guru, is probably shaking his head at my excuses but, that's what I'm here for. to entertain! HA! Traditionally, I begin the April 15th Pfennig with some lyrics to Tax Man by the Beatles, but since I did that for the Sunday Pfennig & Pfriends, I won't repeat it today. Instead, I'll go with, Supertramp's, Give a little bit. There's so much that we need to share, So send a smile and show you care.

Well. the Big story from Friday was the major take down of Gold. I had to leave even earlier than usual on Friday for a doctor's appt, and as I was walking out of the office, Jen said, "hey Chuck, Gold is down $80". I about dropped to the floor! What the heck is going on here? I then told the desk that I read a research report that was tying Gold's performance to the Japanese yen, but I wasn't putting much into that report. I then brought up the Goldman call to short Gold that was made earlier in the week. And then left for the doctor's office. Later in the day, I checked the markets and saw that Gold, Silver, Copper, and Oil were all taking it on the chin. A bad day at Bedrock for sure!

Well, the selling doesn't look to be over just yet, Gold is down another $80 this morning, and fell below $1,400 at one point overnight. Well. I just have this to say, which might get nixed. the manipulators really went "all-in" this time with their attempt to scare moms and pops out of Gold and back into stocks / dollars. They've scared the daylights out of just about everybody, that isn't a true believer of Gold this time. But they've really got the ball rolling for them right now, I see them pushing the Commodities lower and lower until somebody says "uncle".

I find this all to be wrong. very wrong. Telling the people that the U.S. economy has turned the corner, and is on a strong rebound, so there's no need to own hedges like Commodities and Currencies. That's like telling kids to go ahead and ride their bikes in the street without checking for cars first. Take away the Gov't activity from your 2% GDP and you've got nothing. or as Edwin Starr used to sing. Nothing, absolutely nothing, say it again!

Some of the selling of Commodities overnight can be attributed to the weaker GDP report that printed in China. China's first quarter GDP printed at 7.7%... That's 7.7% growth, folks, that's not a misprint! Unfortunately, 7.7% was weaker than the 4th QTR print of 7.9%... and the Chicken Littles came out in force! The sky is falling, the sky is falling! And the markets listened. I find this to be totally out of line, and unwarranted, but. the markets are never wrong, eh?

So, not only are the hard Commodities getting sold like funnel cakes at a State Fair, so too are the Commodity Currencies. The Aussie dollar (A$) is down over $1 this morning. I always highlight the A$ because as I've long pointed out, I call the A$ the proxy for global growth. And if global growth is going to take a hit because China's GPD weakened, then the weakness is going to show up in the A$ first, and foremost.

And to add to all this madness going on in the Commodities and Currencies, guess which currency, besides the dollar, is rebounding? Yes. it's the Japanese yen! After touching 100 briefly late last week, the yen is back to a 97 handle this morning. Now that's not going to make the Bank of Japan (BOJ) and the Japanese Gov't very happy to see yen rallying like that! But not to worry. I would think that this rally will be short-lived for yen, but then when the markets are being manipulated, who knows? Only the shadow knows.

And then on the other hand. maybe the Japanese leaders won't be so uptight about the gains in yen, as we head into a G-20 meeting this week. The last thing the Japanese leaders wanted to hear from the other 19-members is that they were not going to sit by idly and allow Japan to drive their currency weaker. So, now, if someone brings up yen weakness, Japanese leaders can point to the currency and say, "hey, look, it's rallying!"

The rest of the currencies are holding up OK. most of the blood in the streets is in the Commodity Currencies. In fact, this is a good illustration of what I've been talking about for a couple of years now with the Dollar Index. It doesn't include the Commodity Currencies of A$'s, kiwi, and a few others, so all the time that those currencies were kicking tail and taking names later the Dollar Index didn't reflect that. And now that they've gotten the stuffing knocked out of them the Dollar Index doesn't reflect that either!

So. it's not a pretty day in the currencies and commodities today. It's all about the U.S. economic recovery and the dollar, folks. The recovery that recently saw the participation rate in the labor force drop to a 1979 low of 63.3%... the recovery that has seen pockets of a housing rebound, only as long as the "shadow inventory" isn't released on the housing market. the recovery that saw Retail Sales for March fall -.4%, the recovery that saw the March Manufacturing Index fall from 54.2 to 51.3, the recovery that continues to need zero interest rates, and bond buying to the tune of $85 Billion per month. I could go on, but what good does that do? The markets don't listen to me.

Ok. so, recall that last week, I told you that the President finally presented his version of a 2014 budget. and I told you that spending was going to increase by 6%... the total spending in the budget was $3.78 Trillion. I just saw that the Gov't expects to collect $2.7 Trillion. Ooops! Isn't the revenue supposed to be equal to or greater than the expenses? This one has an over $1 Trillion dollar hole in it! But don't let that get in the way of a feel good story about reducing deficit spending $1.8 Trillion over the next ten years. (yeah, I want to see that happen, because I doubt it will!)

The U.S. data cupboard has very little for us to view today, except the Total Net TIC Flows (net foreign purchases), which used to carry a lot of weight, but then joined Jared and went on a diet. Tomorrow the data cupboard begins to get restocked with things like Industrial Production and Capacity Utilization, Building Permits and even the stupid CPI.

You all know that CPI is getting changed again, right? And if you're thinking that this time they'll get it right, and throw out all the hedonic adjustments that are made to the index, so that the cost of living increases to fixed incomes will rise, then you would be wrong. No, the Gov't in its infinite wisdom (NOT!) is going to be ratcheting down the CPI, with MORE hedonic adjustments! So. we've got that going for us, eh?

Then There Was This. Well. I sure stirred up the crowd with my Sunday Pfennig & Pfriends article on taxes. Lots of comments. and that's a good thing! It shows people are thinking! And after all is said and done, that's my goal. to get people thinking. so. in an effort to keep that going, here's a snippet from somebody that I admire greatly. Doug Casey. Hey! I realize that he's not everyone's cup-o-tea, but when he speaks, I always feel he's speaking to the masses. and they should be listening! So. here's a snippet from Doug on the U.S. debt. it's quick, so don't blink or you'll miss it!

"The ethical thing to do would be for the U.S. to declare bankruptcy. The next generation will be turned into indentured servants, and people who buy government debt deserve to be punished and taught a lesson. Look, this is an academic point that I'm making. I know that [the U.S. debt] is not going to be defaulted on tomorrow morning. I'm just putting the thought out there so people can think about these things in a new unit of time, and try to think about it rationally." - Doug Casey

Chuck again. I feel the same way about the stuff I write regarding how the U.S. will use cheaper dollars and higher taxes to deal with their debt, and how China is working toward removing the dollar as the reserve currency.These things aren't going to happen today, tomorrow, or next year, but in time, and people should think about these things in a new unit of time.

To recap. the trap door was sprung on Gold / Commodities on Friday. The selling was strong, and pushed Gold down to levels it hadn't seen since March of 2011. The markets are going with the theme that the U.S. economy is recovering and there's no need for hedges. Gold and Commodities are getting sold again this morning, so there's blood in the streets, and the commodities and commodity currencies are badly in need of a tourniquet! Chinese 1st QTR GDP weakens to 7.7% from 7.9% the previous qtr.

Currencies today 4/15/13.. American Style: A$ 1.0410, kiwi .8475, C$ .9790, euro 1.3080, sterling 1.5335, Swiss $1.0765, . European Style: rand 9.07, krone 5.7360, SEK 6.3955, forint 225.10, zloty 3.1475, koruna 19.7750, RUB 31.37, yen 97.80, sing 1.2370, HKD 7.7625, INR 54.62, China 6.2454, pesos 12.14, BRL 1.9695, Dollar Index 82.26, Oil $88.48, 10-year 1.71%, Silver $23.73, and Gold. $1,406.40

That's it for today. I sure caught up on my much needed sleep this past weekend, and then the weather was finally spring-like! YAHOO! Spent the day Saturday by driving 50 miles back and forth a few times to watch the Lindbergh Flyers play in a water polo tournament. The results weren't what son Andrew was looking for, but they played some good teams, and hopefully learned a bit. Cardinals couldn't pull out the sweep of the Brewers yesterday, UGH! The kids and grandkids were at the house yesterday, and we got to spend the day outside. My two grandsons were pretty funny with their buckets of water. I got started a bit earlier this morning, but still am running late! UGH. Oh well, I thank you for reading the Pfennig, and hope you have a Marvelous Monday!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Investing in a Low-Growth World

JohnMauldin — Sun, 17 Feb 2013 23:59:00 GMT

The jury – unless you are the Fed and Ben Bernanke or the Congressional Budget Office, which cannot make lower growth assumptions without really blowing their deficit projections out of the water – is pretty well in on GDP growth: it’s going lower. Ed Easterling and I wrote a recent Thoughts from the Frontline on multiple pieces of research suggesting slower future growth. We asked the question, “So what about stock prices; will they follow suit?” Our thought was that, over time, they would.

Not so fast, says Jeremy Grantham in today’s Outside the Box. He was part of the cabal of researchers suggesting slower future GDP growth whose work we used as the basis for our analysis. Longtime readers know that I think Jeremy Grantham (who heads GMO, which now manages $106 billion – see GMO LLC for more wonderful GMO team research) is one of the smartest men on the planet as well as one of the best investors. With his usual thoroughness, Jeremy makes the case, based on in-house research, that both stock-market returns and corporate earnings growth are negatively correlated to GDP growth. At the same time, he’s not overselling his thesis:

For the record, there is also: a) a moderate relationship between higher-priced countries (on Shiller P/E and price/book) and future underperformance; and b) a tendency for more rapidly-growing countries to be overpriced. Therefore we can deduce a logically appealing (but statistically weak) tendency for overvaluation to contribute a second reason for the market underperformance of more rapidly growing countries. (Please notice how carefully said that is.)

He goes on to reiterate important points he has made over the past few months about the effect of growing resource costs on growth, and then adds:

The main new point I wanted to make was that resource costs are treated like GDP increases. Hence, prior to 2002, steadily falling resource costs were treated as a debit when of course steadily lower costs were a great help to well-being and utility. We calculated that adjusted GDP actually grew 0.2% a year faster than stated. Conversely, since 2000, rising costs were a detriment, not a benefit, as shown in GDP. Treated correctly as a negative, resource costs would have reduced real growth by 0.4% a year. This squeeze on growth will continue as long as resource costs rise faster than the growth rate of the balance of the economy.

Always careful of the ground he stands on, Jeremy then throws in a very important caveat to say:

… it is worth remembering that we don’t really know what caused resource prices to spike from 2002 to 2008 so impressively. This was a much bigger price surge than occurred during World War II! Indeed, it may easily turn out that the resource price rises will squeeze future GDP growth substantially more than our estimates.

Or not.

In any case, a careful reading of Jeremy’s work is always instructive. This one is an important think piece, as the direction and magnitude of future GDP growth will be critical as we make business, retirement, and investment decisions. Simply talking past performance is risking your future on the unlikely prospect that the future will look like the immediate past.

I am personally doing a lot of thinking and research on this topic. I strongly suspect that other significant factors will arise to play havoc with projections, in both fantastically positive and uncomfortably dire ways. I am more and more seeing the future as very “lumpy,” that is, quite uneven as to how it will affect individuals and even entire countries. For those who espouse more equality in incomes and outcomes, this is not your optimal scenario. But even with all the “lumpiness,” the average person will be much better off in 20 years – though “average” will cover a much wider spread of outcomes than it does even today. But rather than launch into that book now, we’ll let Jeremy take over.

Have a great weekend. I am enjoying being at home this week. I will be in Palm Springs at the California Resource Investment Conference, February 23-24. My good friend Grant Williams, who writes the blockbuster Things that Make You Go Hmmm… and the Mauldin Economics' Bull’s Eye Investor letter, will be there, as will the best resource investor I know, Rick Rule, along with my favorite data maven, Greg Weldon. There is a full two-day slate of speakers. The event is free to investors and is always fun, and it’s a great time of year to be in California (hate the pensions, love the weather). Come see us! You can read all about it and register at the Cambridge House website.

Your looking forward to catching up this weekend on my reading analyst,

John Mauldin, Editor
Outside the Box

subscribers@mauldineconomics.com

Investing in a Low-Growth World

By Jeremy Grantham

This quarter I will review any new data that has come out on the topic of likely lower GDP growth. Then I will consider any investment implications that might come with lower GDP growth: counter intuitively, we find that investment returns are likely to be more or less unchanged – a little lower only if lower growth brings with it less instability, hence less risk. Finally I will take a look at the reaction to last quarter’s letter, specifically about my outlook for lower GDP growth.

Recent Inputs on a Low-Growth Outlook

Some information came out after the 4Q 2012 Letter or was missed by us and is worth mentioning. First, the Congressional Budget Office slashed its estimate of the U.S. long-term growth trend from 3.0% to 1.9%! Given the source and the magnitude of the adjustment, I think it is fair to say that their number is “close enough for government work” to our 1.5%. At least it is within negotiating distance. Next, a report from Chris Brightman of Research Affiliates actually came out a week before ours and concluded that long-term GDP was 1.0%, a number that really corresponds to our 1.5% because his report has no reference to our two special factors, resources and climate, which take our 1.5% to 0.9%. I was encouraged by the solidness of his research. It also led me to an article in the Financial Analysts Journal (January-February 2012) by Rob Arnott and Denis Chaves. Rob has been writing about the effects of age cohorts on investment returns for almost as long as I can remember, with the central idea that older people are sellers of assets – houses as well as stocks – that younger members of the workforce buy. But they also include the aging effect on GDP growth, which he shows taking a real hit in all developed countries (except Ireland). They are commendably careful in suggesting that their model may be wrong. When or if you read this article, you will certainly hope that it is indeed wrong, for their models estimate from past experience a far greater drop in GDP growth than our work assumed last quarter. And they certainly attacked that aspect in far greater detail than we did. We had included in our report the effect of aging on the total percentage of the population of working age: there are simply fewer workers and more retirees in the distribution. But Rob and Denis (sorry for the liberty) introduce the incremental idea, apparently provable, that older workers lose productivity, no doubt much more in heavy manual work than, say, in writing this. But definitely alas, including all activities with dire consequences, they argue for productivity and GDP growth.

Would Lower GDP Growth Necessarily Lower Stock Returns?

This is where I break ranks with many pessimists because I believe theory and practice strongly indicate that lower GDP growth does not directly affect stock returns or corporate profitability. (At least not in a major way for, as we shall see later, there may be some indirect or secondary effects that may very modestly lower equity returns.)

All corporate growth has to funnel through return on equity. The problem with growth companies and growth countries is that they so often outrun the capital with which to grow and must raise more capital. Investors grow rich not on earnings growth, but on growth in earnings per share. There is almost no evidence that faster-growing countries have higher margins. In fact, it is slightly the reverse.

For there to be a stable equilibrium, assets, including entire corporations in the stock market, must sell at replacement cost. If they were to sell below that, no one would invest and instead would merely buy assets in the marketplace cheaper than they could build themselves until shortages developed and prices rose, eventually back to replacement cost, at which price a corporation would make a fair return on a new investment, etc.

The history of market returns completely supports this replacement cost view. The fact that growth companies historically have underperformed the market – probably because too much was expected of them and because they were more appealing to clients – was not accepted for decades, but by about the mid-1990s the historical data in favor of “value” stocks began to overwhelm the earlier logically appealing idea that growth should win out. It was clear that “value” or low growth stocks had won for the prior 50 years at least. This was unfortunate because the market’s faulty intuition had made it very easy for value managers or contrarians to outperform. Ah, the good old days! But now the same faulty intuition applies to fast-growing countries. How appealing an assumption it is that they should beat the slow pokes. But it just ain’t so. And we at GMO have (somewhat reluctantly for competitive reasons) been talking about it for a few years.

Exhibit 1

GDP Growth Unrelated to Stock Returns

Exhibit 1, shown by us before, shows the moderately negative correlation between GDP growth by country along with their market returns. This is shown for the last 30 years only and for developed countries only, but in earlier work we went back a hundred years for some developed countries and looked at emerging country equity markets as well and all had the same negative correlations. (See Ben Inker’s white paper, “Reports of the Death of Equities Have Been Greatly Exaggerated: Explaining Equity Returns”, August 10, 2012, at www.gmo.com [registration required].) When I asked my colleague Ben Inker if this was for the same reason that growth companies underperform – that they are overpriced – Ben came up with another completely sufficient explanation (in about 10 seconds): the faster-growing countries, at least for the last 30 years, have simply had more slowly-growing earnings per share. This is shown in Exhibit 2. For the record, there is also: a) a moderate relationship between higher-priced countries (on Shiller P/E and price/book) and future underperformance; and b) a tendency for more rapidly-growing countries to be overpriced. Therefore we can deduce a logically appealing (but statistically weak) tendency for overvaluation to contribute a second reason for the market underperformance of more rapidly growing countries. (Please notice how carefully said that is.)

Exhibit 2

Earnings Growth Is Negatively Correlated with GDP

Would Lower Real Rates Lower Stock Returns?

Economic theory can’t get everything completely wrong, and perhaps one thing economists have gotten partly right is that the risk-free rate has some relationship to the growth rate of the economy. If that rate approaches zero, there is clearly less demand for new capital; in fact, given accurate depreciation accounting, there would be zero net new capital required. It is also easy to see the risk-free rate settling at something around nil. The risk premium, however, might be little affected. The demand for risk capital – e.g., to replace an old plant, resulting in no new net growth – would still require that the investor expect an adequate return. If it looked likely to be less than that, he would of course withhold his capital until inevitable shortages pushed up profits enough for the corporation to get a satisfactory return, as we have often discussed.

However, and I bring up this complicated issue with trepidation, it does seem possible that in a world with both lower growth and a lower risk-free rate that the risk premium might also drop a little. A lower growth world might plausibly be less volatile because managing a world where the apparent growth is 1.5% (and real growth is 0.9%) is likely to be easier to stabilize than one (as from 1870 to 1995) appearing to grow at 3.4% but actually growing at 3.6%, almost four times higher. (Another way of stating my negative 0.5% resource adjustment, by the way, is to say that the economy’s costs are growing at 1.5% but that its utility – or something closer to utility than GDP anyway – is only growing at 0.9%.) If returns to equity holders are to fall, then P/Es must paradoxically rise to bring yields and total returns down. Yet, as always, equities have to sell at replacement cost. Therefore the books have to be balanced by returns on equity falling. This after all seems reasonable – if returns on T-Bills drop and returns to stockholders drop, then a system in balance would suggest that returns on corporate investment also drop. This adjustment would likely be modest and should only occur if a lower-growth world were to become less likely, which is far from certain, merely plausible.

Reflections on Our Work on Lower-Growth GDP

With a few months to reconsider the data, old and new, I would have framed last quarter’s issue on declining growth differently to emphasize how routine, even friendly, most of our inputs were. The main new point I wanted to make was that resource costs are treated like GDP increases. Hence, prior to 2002, steadily falling resource costs were treated as a debit when of course steadily lower costs were a great help to well-being and utility. We calculated that adjusted GDP actually grew 0.2% a year faster than stated. Conversely, since 2000, rising costs were a detriment, not a benefit, as shown in GDP. Treated correctly as a negative, resource costs would have reduced real growth by 0.4% a year. This squeeze on growth will continue as long as resource costs rise faster than the growth rate of the balance of the economy. Further, as the percentage of the GDP taken up by resources has recently more than doubled (2002 to 2012), the squeeze on the balance of the economy would also be doubled even if the rate of cost increases stayed constant. Last quarter I estimated that continued increases in resource costs from now to 2050 would lower GDP growth by 0.5%. To prevent that 0.5% effect from accelerating as the share of resources in GDP rises, the rate of resource cost increases must decelerate from the recent 7% a year to a much more modest 2% a year by 2050. (By then, of course, it might well be over the current 7% ... it is just not knowable.) As one can see, this is not nearly as draconian an assumption as it might initially appear to be and in this context it is worth remembering that we don’t really know what caused resource prices to spike from 2002 to 2008 so impressively. This was a much bigger price surge than occurred during World War II! Indeed, it may easily turn out that the resource price rises will squeeze future GDP growth substantially more than our estimates.

Although our low estimate of future GDP growth attracted attention and plenty of opposition, it was only produced as a necessary backdrop to show the potential significance of our two new points: the large deduction for a cost squeeze from resources (0.5%) and a very slight but increasing squeeze from climate damage (0.1 rising to 0.4 after 2030), which latter deduction is considered almost ludicrously conservative by that handful of economists that study the costs of climate change. Our work on the traditional aspects of GDP growth was approached by us as a necessary chore; we were not looking for trouble. Consequently, we tried to keep it simple by using the obvious data sources. “Where on earth did GMO get its pessimistic population data?” ran one complaint. Well, would you believe the U.S. Bureau of Census? And as for productivity, we extended the 1.3% average for the last 30 years out for 30 more years. This is clearly a very friendly assumption given: a) the recent 1.3% in productivity growth of the last 30 years had declined a lot from its 40-year surge of 1.8% after World War II; and b) the fact that the segment of much higher productivity – manufacturing – has declined to a mere 9% of total labor from 19% in 1980 and continues to decline. Even my one override, -0.2% a year for the next 18 years as a result of much-reduced capital spending, seems, based on econometric modeling, to be a very modest debit. For there to be so modest a negative effect needs capital spending to drift back toward normal in the relatively near future. And even then this -0.2% effect was exactly offset in our forecast by a +0.2% bonus for the unanticipated surge in fracking activity and the ensuing burst of momentarily cheap energy. So why the fuss? The resource debit merely reflects the remarkably odd GDP accounting that counts an unfortunate surge in necessary costs as a benefit, and the remaining 1.5% is merely reflecting recent data. Higher growth assumption, Mr. Bernanke should be aware, must prove longer-term improvements in productivity or, tougher yet, increased labor input.

Short-Term Behavioral Impacts on the Market from Lower GDP

Of course, in the short term there are always temporary behavioral responses. If GDP growth drops unexpectedly, corporations might easily be caught mis-budgeting or overexpanding (although this current ultra-cautious U.S. corporate system, which only reluctantly makes capital investments, is unlikely to be caught out too badly), and perhaps more importantly investors may be shocked by continuous revenue warnings, which might cause the market to sell off. Recent corporate announcements, while usually still claiming exceptional profit margins and generally hitting earnings targets, are increasingly missing revenue targets and issuing future revenue warnings. We must admit, though, that recent revenue warnings have not stopped the market from rising, nor has the unexpectedly slightly negative growth for the fourth quarter GDP.

Within sectors there would quite likely also be a shift in preferences. Growth stocks might seem relatively more attractive: “If the system isn’t growing, the least I can do is pick a few companies that clearly are still growing.” Perhaps quality franchises would also become more appealing with the logic being that at least in the transition to lower top-line revenue growth, competition would become more severe and, hence, defensive moats even more than usually desirable.

Engineered Low Interest Rates

The Fed’s negative real rates regime, designed to badger us into riskier investments in order to push up equity prices and grab a short-term wealth effect (that must be given back one day when least comfortable and least expected), has gone on for a long and, for me, boring time. This low interest rate period is serving, therefore, as a sneak preview of what a permanently lower rate regime might look like (although any permanently lower rates reflecting lower GDP growth would be by no means as low as these engineered rates that we are currently experiencing). So what are some of these effects? The artificially low T-Bill rates first work their way slowly up the curve. Next, the most obviously competitive type of equities – high yield stocks – begin to be bid up ahead of the rest of the market, as has happened. “I’ve just got to squeeze out some higher rates somewhere, anywhere,” is the pension fund plea. Then, this low rate competition begins to filter into other securities, historically sought after for their higher yields: higher-grade real estate, where the “cap rates” slowly fall; and, unfortunately, also forestry and farmland, mainly of the larger and more standard varieties that appeal to institutions, which show declines in their required yields, i.e., their prices rise. The longer the engineered rates stay below true market rates, the higher asset prices become until, yes, you’ve got it, corporate assets begin to sell way over replacement cost. Then, if the heart of capitalism is still beating at all, a long period of over-investment begins and returns are bid down and everything moves into balance, often helped along if asset prices get too high, as in 2000 and 2007, by a good healthy market crunch. (This strategy will be seen in future years as archetypical of the Greenspan-Bernanke era: badger and bully investors into taking more risk and eventually pushing assets – houses or stocks or both – far over replacement value, followed eventually, at long and hard-to-predict intervals, by exciting crashes. No way to run a ship, but it does produce an environment that contrarians like us, who can take a few licks, can thrive in.)

Stock Option Culture Messes Things Up

The normal capitalistic response described above runs smack into the new tendency for corporations to either sit on money or buy stock back (regardless of how expensive it may be!), which works in the opposite direction to create shortages, drive prices up, and, as a by-product, lower job creation and GDP growth. So where does this all come out? You tell me. All that I know is: a) if we in the U.S. don’t invest, others will and it will, in the longer run, definitely end badly; b) that even if there is a lower-return world in the future it is still better to own the cheaper assets; and c) it behooves buyers of “cap rate” type assets like real estate to realize that the current low rates are flattered by current Fed policy, which will, like everything else in life, pass away one day, leaving them looking overpriced. It can’t be too soon for me. In the meantime for us at GMO it means emphasizing care and maintaining a heightened sense of value discipline, not only in stock selection, as the whole world is once again bid up over fair value in a way so typical of the post 1994 era, but also in forestry and farmland. GMO has investments in those areas too and recognizes the need to sidestep overpricing by emphasizing the nooks and crannies. Fortunately there are more nooks and deeper crannies in forests and farmland than there are in almost any other area, certainly including stocks.

Danger of the Fed Overestimating Growth

This doesn’t really fit in with a quarterly letter emphasizing important good news, but being about the Fed, I have to make an exception. The Fed appears to be still assuming a 3% growth rate for future U.S. GDP. It would be safer and more confidence-inspiring, now that Bernanke appears to take his responsibility for growth seriously, that he at least have a reasonable growth target (preposterous as that notion is to me that the Fed should or even could affect long- term growth simply by messing about with interest rates). The growth in available man-hours has definitely declined by about 1% a year, yet Bernanke’s assumption for our GDP’s normal trend growth appears unchanged at its old 3%. Ergo, he must be assuming an offsetting rise of 1% in productivity. But why? We should treat these assumptions quite seriously for this is famously (for me) and painfully (for all of us) the man who could not see a 33⁄4-standard- deviation housing market, and indeed protested that all was normal, etc., etc., etc. (Dear handful of niggling readers, this 33⁄4-standard-deviation event is calculated on the assumption of a normal distribution, as is often done in investing, even though we [especially at GMO] know this is not true but is just a convenient statistical device. In fact, we at GMO know quite a bit more on this topic for we have studied more or less all assets for as long as we can find data and we have found a remarkable total of 330 “bubbles,” 36 of which we call “major, important bubbles,” which we define as 2-standard-deviation events, given the same assumption. Well, a 2-sigma event should occur every 44 years in a normally distributed world and they have occurred every 31 years. This is much closer to random than we had previously thought. Yes, financial asset data is fat-tailed; that is, there are more outlying events than are found in a normally distributed series, but they are not extremely fat-tailed. They show up as 2-sigma events but occur as often as 1.8-sigma events would occur in normal distributions. Extrapolating, we can assume that Bernanke’s 33⁄4-sigma housing bubble would occur, adjusted for our fat-tailed real-life history, not every 10,000 years, but somewhere more like 1 in 5,000 years! I previously used “a 1-in-1,200-year event” as a casually selected very large number to describe the 2006 housing bubble. But under challenge, these current numbers are more accurate. No, this does not mean we have 10,000 years of data or even 5,000. It is just statistics, full as always of assumptions, which in this case we hope approach rough justice. What it does definitely mean, though, is that it was extraordinarily unlikely that the extremely diversified U.S. housing market would shoot up like it did and, frankly, even more remarkable that Bernanke and his timid or incompetent advisors could miss it. This is a doubly amazing miss because his and Greenspan’s policy caused this bubble in the first place!) In comparison, his willingness to target an unrealistic 3% level for GDP growth is statistically a microscopic error, a picayune mistake. Unfortunately, though, in the hands of probably the most influential man in the global economic world, it is an extremely dangerous one. I like the analogy of the Fed beating a donkey (the 1% growing economy) for not being a horse (his 3% growing economy). I assume he keeps beating it until it either turns into a horse or drops dead from too much beating! Fine-tuning economic growth, an impossible job for the Fed anyway, is hardly likely to get any easier by badly overstating trend-line growth. It seems nearly certain, therefore, that the Fed will keep trying to whack the donkey for far too long. The likely consequences of this policy are, to be frank, over my head, but my colleague Edward Chancellor will address them briefly if I can nag him effectively.

Investment Implications

Courtesy of the above Fed policy, all global assets are once again becoming overpriced. This reminds me of the idea sometimes attributed to Einstein that a workable definition of madness is constantly repeating the same actions but expecting a different outcome! But, as always, asset prices are not uniformly overpriced: emerging markets and, we believe, Japan are only moderately overpriced. European stocks are also only a little expensive, but in today’s world are substantially more risky than normal. The great global franchise companies also seem only moderately overpriced. Forestry and farmland, which is not super-prime Midwestern, is also only moderately overpriced but comes with our nook and cranny sticker attached. But much of everything else is once again brutally overpriced. Notably, U.S. stocks (ex “quality”) now sell at a negative seven-year imputed return on our numbers and most global growth stocks are close to zero expected return. As for fixed income – fugetaboutit! Most of it has negative estimated returns on our data, and longer debt, as always, carries that risk that may be slight in any period, but is horrific if it occurs – accelerating inflation.

When one combines the apparent determination and influence of those who do the bullying with the career risk and short-termism of the bullied and the desire of the general public to believe unbelievable good news, these overpricings can go much further and the Fed can win another round or two. That’s the problem. A clue to timing would be when we begin to hear more passionate new era arguments: profit margins will always be higher; growth will snap back to 3% for the developed world; and new ones I can’t think of ... maybe “when the discount rate is this low the Dow should sell at, perhaps, 36,000.” In the meantime, prudent managers should be increasingly careful. Same ole, same ole.

GDP Report Tanks – Is A Recession Looming?

GaryHalbert — Tue, 05 Feb 2013 23:43:00 GMT

IN THIS ISSUE:

1. Goldman Sachs Issues Upbeat Report on USA

2. US Economy Disappoints in the 4Q

3. Fed Sets Record Straight – More QE

4. Pew: Government Threatens Personal Rights

Overview

We will cover a lot of ground today. We begin with a new report from Goldman Sachs which argues that the US economy will remain the strongest in the world for many more years. The report rebuts claims that America is a nation in decline. Quite the contrary, say Goldman analysts who claim that there is a growing “awareness of the key economic, institutional, human capital and geopolitical advantages the U.S. enjoys over other economies."

This rosy report from Goldman Sachs flies in the face of other predictions from respected sources that say the US faces another financial crisis in 3-5 years as I reported last week. Apparently, the analysts at Goldman don’t find it scary that our federal debt is exploding. We will look at some of the details from the Goldman Sachs report below.

The upbeat Goldman report was delivered before last Wednesday’s shocking news that the US economy actually declined in the 4Q for the first time since 2Q 2009. While there are reasons to believe that the advance estimate of 4Q GDP (-0.1%) will be revised upward in subsequent reports, the surprise GDP report was not the only bad news in the last few weeks. We’ll take a look at the latest economic reports as we go along today.

From there, we turn our eyes to the Fed. In December, there were rumors that some members of the Fed Open Market Committee were having doubts about the Fed buying a record $85 billion a month in bonds and mortgages indefinitely. Some even predicted that the FOMC might vote to end such purchases by the end of this year.

Those rumors were wrong. At its first policy meeting of the new year, the FOMC made it clear that it will continue the $85 billion in monthly purchases until the unemployment rate falls to 6.5% or below. That news sent stocks soaring once again.

Finally, we look at a new poll from Pew Research Center which found – for the first time ever – that a majority of Americans believe that the government is a threat to personal rights and freedom! I will summarize this new poll which is loaded with interesting data.

Goldman Sachs Issues Upbeat Report on USA

I am occasionally criticized for being too negative on the state of affairs in America ranging from moral decay to the left-leaning electorate to the sub-par economy and certainly to the explosion in our national debt. My conclusion has been that the country is on the road to ruin, and it’s only a matter of time before it happens.

In last week’s E-Letter, I pointed out that The Bank Credit Analyst predicted that the US will hit the proverbial “debt wall” within the next five years at the latest, and perhaps as early as three years from now. With the exception of our politicos in Washington and liberal pundits such as Paul Krugman, most everyone knows that our federal debt trajectory is unsustainable.

But what if we’re wrong? What if America is not “going to Hell in a hand-basket” as many like to say? What if America’s best days lie ahead? Who thinks that?

In a recent report to clients, analysts at Goldman Sachs argue that the United States still has the world’s strongest economy - and will have for years. There is a growing “awareness of the key economic, institutional, human capital and geopolitical advantages the U.S. enjoys over other economies,” contend Goldman's analysts.

As proof, they deploy voluminous facts. For starters, the US economy is still the world’s largest by a long shot. Our Gross Domestic Product is almost $16 trillion, “nearly double the second largest (China), 2.5 times the third largest (Japan)." Per capita GDP is about $50,000; although 10 other countries have higher figures, most of the countries are small such as Luxembourg.

[Per Capita GDP is a measure of the total output of a country that takes the gross domestic product and divides it by the number of people in the country. The per capita GDP is especially useful when comparing one country to another because it shows the relative performance of the countries. A rise in per capita GDP signals growth in the economy and tends to translate as an increase in productivity.]

Next, Goldman points to our surplus of natural resources. In a world ravenous for food and energy, the United States has plenty of both says Goldman. Our arable land is five times China’s and nearly twice Brazil’s. The advances in "fracking" and horizontal drilling have opened vast natural gas and oil reserves that, until recently, seemed too expensive to develop. The International Energy Agency predicts that the United States will become the world's largest oil producer - albeit temporarily - by 2020.

In turn, the oil and gas boom bolsters employment. A study by IHS, a consulting firm, estimates that it has already created 1.7 million direct and indirect jobs. By 2020, there should be 1.3 million more energy jobs according to IHS. Secure and inexpensive natural gas also encourages an expansion of US manufacturing, Goldman argues. That’s another plus.

Poorly skilled workers are often counted as a US economic liability. Goldman sees it differently. American workers will remain younger and more energetic than their rapidly aging rivals. By 2050, workers’ median age in China and Japan will be about 50, about 10 years older than the median age in America. Moreover, the United States attracts motivated immigrants, including “highly educated talent.” A Gallup survey of 151 countries found the United States was the top choice for those wanting to relocate, at 23%. The next highest was the United Kingdom at only 7%.

Finally, Goldman expects the United States to remain the leader in innovation. America performs the largest amount of research and development (31% of the global total in 2012) and has more of the best universities (29 out of the top 50, according to a recent British ranking).

Up to a point, this is convincing. America’s strengths have been underestimated. Compared with Europe and Japan – the world’s other enclaves of affluence – our prospects are brighter. But the Goldman report, which advises investors where to put their money, is an incomplete guide to the future. It may explain why US stocks have recovered to near pre-crisis records, but it does not dissuade the widely-held view that America is a “nation in decline.”

Think of that old saying: the best horse in the glue factory. That may be the situation America finds itself in today, what with our national debt surging above $16 trillion. Or think of it this way: If your neighbor’s house burns down and only half of yours does, you are relatively better off than your neighbor – but you’re much worse off than you used to be.

It's in that sense that America’s prospects exceed Europe’s and Japan’s. But this advantage doesn’t erase the huge economic losses suffered by millions of Americans. There are still eight million fewer people in the US workforce than before the financial crisis of 2007-2009. The mainstream media never acknowledges this fact, but it’s true.

Look at the number of young people who are unemployed or under-employed. The unemployment rate for “millennials” (ages 18-29) is around 13%, the highest since WWII. According to Census Bureau data, about 25% of millennials still live with their parents or relatives, also the highest level since WWII.

Then there is the entitlements crisis. More Americans are on welfare than ever before. More people get food stamps than ever before – a record 47 million people as of the end of September last year – double the amount from a decade earlier. I could go on but based on these metrics, most Americans reasonably conclude that our country is in decline.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

US Economy Disappoints in the 4Q

Gross domestic product was expected to be weak in the 4Q, but no top economist thought that the change from the 3Q (+3.1%) would be negative. None of the 24 economists surveyed for the Dow Jones consensus estimate forecasted a negative growth rate. The median expectation was for 1% growth in the 4Q with estimates ranging from 0.3% to 2%.

The actual number from the Commerce Department last Wednesday was -0.1% (annual rate) for the 4Q. The big surprise in the report was a 22.2% plunge in defense spending in the 4Q. Had it not been for the decline in defense spending, GDP would have been +1.27. While there are reasons to believe that the advance estimate of 4Q GDP (-0.1%) will be revised upward in subsequent reports, the surprise GDP report was not the only bad news in the last few weeks.

The unemployment rate in January ticked up to 7.9%. The economy added 157,000 new jobs (about average), but because more people were actively looking for work in January, the headline rate went up slightly. The new jobs numbers for November and December were revised up significantly.

Consumer confidence unexpectedly plunged in January. The index fell from 66.7 in December to 58.6 in January. This was far below the pre-report consensus of 65.1. The Conference Board which maintains the index summarized the report as follows:

“Consumer Confidence posted another sharp decline in January, erasing all of the gains made through 2012. Consumers are more pessimistic about the economic outlook and, in particular, their financial situation. The increase in the payroll tax has undoubtedly dampened consumers’ spirits and it may take a while for confidence to rebound and consumers to recover from their initial paycheck shock.”

On the bright side, durable goods orders rose a better than expected 4.6% in December. Retail sales rose 0.5% in December, also better than expected. Industrial production rose 0.3%. Housing starts were also above expectations at 954,000 units in December.

The disappointing 4Q GDP report led many investors to wonder if we are headed into a new recession. Recessions are generally defined as two or more consecutive quarters of negative GDP, and some worry that we could be back in a recession if 1Q GDP is also negative.

However, as noted above, the 4Q GDP report will be revised two more times just ahead, and most economists believe those revisions will lift the number slightly into positive territory. Most forecasters are predicting 1-2% GDP growth in the first half of this year.

With $16 trillion in debt, a recession could unfold just about any time, but I don’t see it coming in the first half of the year.

Fed Sets Record Straight – More QE

In December, there were rumors that some members of the Fed Open Market Committee (FOMC) were having doubts about the Fed buying a record $85 billion a month in bonds and mortgages indefinitely. Some even predicted that the FOMC might vote to end such purchases by the end of this year.

The Fed’s balance sheet is approaching $3 trillion now and could swell by another $1 trillion this year. Fed Chairman Bernanke believes that this unprecedented buying by the Fed will help push intermediate and long-term interest rates down, and therefore help the economy. Of course, there is widespread disagreement about the latter.

The Fed wrapped up its first FOMC meeting of 2013 last Wednesday. The policy statement released after the meeting made two things very clear. First, the Fed is clearly concerned about the slowdown in the economy in the 4Q. The statement noted that the inflation rate is running below expectations and hinted of disinflation.

Second, the statement once again made it clear that the Fed will continue its monthly purchases of $40 billion in mortgage-backed securities and $45 billion in longer-term Treasuries indefinitely, or at least until the unemployment rate falls to 6½%. Many forecasters believe that could mean another two years of Fed purchases.

The FOMC voted 11-1 in favor of continuing the $85 billion in monthly securities purchases. So despite rumors to the contrary, the Fed has no plans to halt these purchases… for better or worse.

Pew: Government Threatens Personal Rights

Even though President Obama was re-elected, trust in the federal government remains mired near a historic low, while frustration with government remains high. And for the first time, a majority of the public says that the federal government threatens their personal rights and freedoms.

The latest national survey by the Pew Research Center, conducted January 9-13 among 1,502 adults, finds that 53% think that the federal government threatens their own personal rights and freedoms while 43% disagree.

In March 2010, opinions were divided over whether the government represented a threat to personal freedom; 47% said it did while 50% disagreed. In surveys between 1995 and 2003, majorities rejected the idea that the government threatened people’s rights and freedoms.

The growing view that the federal government threatens personal rights and freedoms has been led by conservative Republicans. Currently 76% of conservative Republicans say that the federal government threatens their personal rights and freedoms, and 54% describe the government as a “major” threat. Three years ago, 62% of conservative Republicans said the government was a threat to their freedom; 47% said it was a major threat.

By comparison, there was little change in opinions among Democrats; 38% say the government poses a threat to personal rights and freedoms and just 16% view it as a major threat.

The survey found continued widespread distrust in government. About a quarter of Americans (26%) trust the government in Washington to do the right thing just about always or most of the time; 73% say they can trust the government only some of the time or that they can never trust the government.

Just 20% of Americans say they are basically content with the federal government; 58% say they are frustrated while 19% say they are angry. For the most part, these views have changed little during Obama’s presidency. However, the percentage saying they are content with government sank to a low of just 11% in August 2011, following protracted negotiations between the president and congressional leaders over raising the debt ceiling.

Finally, opinions about Congress, while little changed over the past year, also remain very negative. As shown in the chart above, just 23% offer a favorable opinion of Congress, while 68% express an unfavorable view. Favorable views of Congress hit 50% in spring 2009 but subsequently have plummeted.

For two decades between 1985 and 2005 Congress was generally viewed more favorably than unfavorably. The low point during that period came in the fall of 1995 – just prior to the government shutdown of that year – when 42% offered a favorable opinion of Congress.

Not anymore!

Best regards,

Gary D. Halbert

Candidates for 2013 Gold Stock of the Year

DougCasey — Sat, 02 Feb 2013 00:08:00 GMT

By Jeff Clark, Senior Precious Metals Analyst

Is your precious-metals portfolio ready for 2013? We want to get positioned in the best performers ahead of the industry's next big move to maximize profit while minimizing risk.

Some readers may question if gold stocks really have snapped out of their funk. We could discuss this topic for many pages, but the bottom line for us at Casey Research is simple: if you believe gold and silver prices are going higher, then equity prices will follow.

Precious metals are headed higher for reasons we've outlined before: intractable levels of government debt, reckless deficit spending, and worldwide money printing. GDP growth won't be near strong enough to meet future liabilities, and neither politicians nor the public will agree to austerity measures that will be austere enough. Gold and silver will move higher as the value of currencies declines as governments attempt to pay existing and future obligations.

With that in mind, some stocks will certainly do better than others. Recall 2011, when gold continued higher while stocks as a group performed poorly. However, there were still profits to be made…

You can see that while the equity ETFs performed poorly last year, select producers still returned big gains. This is why it pays to be picky.

We won't always be right about which companies will be a given year's trophy, yet there are definitely steps we can take to improve our odds. As 2013 swings into gear and you review your precious-metals portfolio, keep the following in mind…

Keep share performance in context. Don't sell a stock whose share price has "underperformed" during a period of bearish market sentiment, unless there are also serious operational difficulties that deserve the discount. While some of our picks did poorly last year, I'm convinced we have the best of the best in our portfolio. We'll advise, of course, if we think a company should be sold, but many of our weaker performers simply haven't had their day in the sun yet.

Don't chase last year's results. Last year's winner is unlikely to also be this year's champ.

Keep buying physical gold and silver. The metals have advanced every year since 2001 (save silver in '08 and '11), and we fully expect this trend to continue. That means the bullion you buy today should be selling for a higher price by year-end 2013 and entails less risk.

Gold and silver should be viewed as money. We believe serious inflation lies ahead from ongoing currency dilution, making it highly likely we'll someday use precious metals to maintain our standard of living.

Buy now before prices break out of their trading ranges.

Focus on only the strongest companies. Experienced and proven management, robust production growth, low costs, a strong balance sheet, and operations in low-risk political jurisdictions define a solid company. Owning companies that meet these criteria gives us the best shot at owning a 2013 winner, while mitigating risk.

Diversify your picks. Don't put all your money in one or two stocks. If you already own several strong gold miners, determine if you need to adjust your portfolio so that the risk – and potential reward – is spread around.

Today it's more important than ever to own the right gold stocks; but between market volatility and increasing political uncertainty in several major gold-mining nations, how can an investor separate the best gold stocks from the rest? You can get started for free right here.

Chairman Bernanke keeps the money flowing...

ChuckButler — Thu, 31 Jan 2013 17:47:14 GMT

In This Issue.

* FOMC decides to keep the presses running...

* Growth in the US drops during the 4th quarter...

* Mixed data keeps the euro steady...

* RBNZ maintains a stable path...

And, Now, Today's Pfennig For Your Thoughts!

Chairman Bernanke keeps the money flowing...

Good day. Chuck got out of town right on time, as the temperature fell through the floor yesterday, dropping from a high of over 70 degrees on Tuesday to a low in the single digits yesterday. This change in temperatures became very apparent to me as I walked to my car last night without a coat (I have to learn to check the forecast before going to bed!). The Money Show kicks into full gear today, so if you live anywhere near Orlando I would suggest heading over to the Gaylord hotel to see the 'Chuck and Frank' show; both of them will be sharing their vast knowledge on the currency and metals markets with the attendees. And best yet, the show is FREE!

Bernanke and his buddies on the Federal Open Markets Committee decided to keep the free money flowing into the markets during the meeting which ended yesterday. Ok, the money is free but at these low rates it is as close to free as you can get. As I wrote yesterday, many in the markets were a bit worried that the FOMC would start closing the spigot on the flow of money, but Chairman Ben and his compatriots decided there are still too many risks in the economy to suggest an early ending to QE3. It will be interesting to see if an early end was even discussed, after news of a 50/50 split during the last meeting shook up the markets during January. The central bank left its statement unchanged saying that it planned on holding target interest rates near zero as long as unemployment remains above 6.5% and projected inflation stays below 2.5%. "Growth in economic activity paused in recent months in large part because of weather-related disruptions and other transitory factors," the FOMC said in their statement.

So the Fed is blaming 'weather related disruptions' for the poor growth numbers in the 4th quarter. I know Sandy was devastating for many on the east coast, but could it be the cause of a negative GDP during the 4th quarter? Yep, GDP as reported by the Commerce Department yesterday morning dropped at a .1% annual rate during the last quarter of 2012. This was the worst performance for the US economy since the second quarter of 2009 when the US was still in a recession. You may not have heard about that poor GDP number, as the bad news was buried by the media. I read through several different sources of news each morning, and several of these 'news summaries' didn't even mention the 4th quarter drop in GDP. I finally found a mention of it on page 6 of an 8 page story on the US economy, and even this story seemed to brush the number aside, stating the Fed believes growth will resume in 2013. But economists certainly didn't do a very good job of projecting the 4th quarter number, with estimates ranging from gains of .3% to 2.1%, so why should we think they can predict what the number will be going forward. Another story I read pointed out that this was just the 'first reading' of the GDP numbers for the 4th quarter, and that this number will be revised in February and March (I can't wait to see what creative revisions the folks over at the Commerce Department come up with for this one!)

But I believe the negative numbers needs a bit more attention. While the Fed blamed the pause in economic activity on the weather, a look at the GDP data shows a big plunge in defense spending was what caused the negative GDP number. According to the report, the decline in government outlays and a smaller gain in inventory subtracted 2.6 percentage points from growth. Consumer spending was actually up, causing the equity cheerleaders to suggest the negative number is not by any means a recessionary signal. But wait, aren't there another $1.4 trillion of government spending cuts waiting to be forced into place as of March 1st? I know these cuts won't be immediate (if they get accomplished at all) but it certainly isn't an indication that government spending will adding to the GDP numbers in the coming months.

The other data which was released yesterday morning here in the US was a bit more positive, as ADP reported a pickup in employment for the first month of 2013 and another report showed Personal Consumption here in the US increased 2.2%. Purchases of durable goods, including cars and trucks, climbed at an impressive 13.9% rate, the most in two years. And after tax income rose at an 6.8% annual rate from October through December, the biggest increase since the second quarter of 2008. All indications that the US consumers are starting to recover. But I still worry about the US recovery going forward, as the increase in payroll taxes and decrease in government spending will probably combine to threaten the US recovery.

On the other side of the pond, the data was a bit mixed coming out of Europe. On the positive side, figures released from the European Commission showed executive and consumer sentiment in the euro area climbed in January to the highest level in seven months. Another report showed German unemployment unexpectedly declined in January. The number of people out of work fell by 16,000 surprising economists who had predicted the number of out of work Germans to actually increase by 8,000. But a report released later in the day showed German retail sales fell more than economists had expected last month. Sales in Europe's largest economy fell 1.7% in December, following a revised .6% increase in the prior month. The poor sales numbers had the euro bears coming out of the wood work questioning the resilience of the nascent recovery in Europe.

All of this mixed data left the currency markets largely unchanged on the day. The euro began yesterday morning slipping a bit, but the common currency quickly recovered after the Fed statement. Most of the currencies ended the day fairly close to the levels at which they began.

The RBNZ left rates unchanged, but sounded a slightly more hawkish tone in the statement following their meeting which pushed the kiwi higher vs. the US$. "House price inflation has increased and we are watching this and household credit growth closely," RBNZ Governor Graeme Wheeler said in a statement. "The bank does not want to see financial stability or inflation risks accentuated by housing demand getting too far ahead of supply." Wheeler went on to suggest the New Zealand economy is firmly on the road to recovery, "We expect economic growth to strengthen over the coming year, reducing spare capacity and bringing inflation slowly back towards the 2 percent target midpoint."

Governor Wheeler is certainly indicating the next move in rates will be higher, which would be great news for holders of the kiwi. The New Zealand currency has traditionally been a favorite of 'carry trade' investors, and it is especially popular with the Japanese looking for higher yields. With the BOJ looking to push the yen lower, I would think the kiwi will continue to see investment flows which should keep the currency well bid. Kiwi's sister currency, the Australian dollar, didn't fare as well yesterday as it slid against most of the majors. The fall in the Aussie dollar was mainly due to a hesitancy of investors to be putting on more 'risk' trades as the data out of Europe and the US was somewhat mixed.

Today we will get more data to show the status of the US economy as we closed out the year, with Personal Income and Spending along with the weekly job numbers. Surveys suggest the personal income and spending numbers will show slight increases (a positive indication) while the weekly jobless claims are expected to have increased by 20k last week. Tomorrow we will have another big day of data here in the US with the release of January's payroll numbers including the Unemployment rate which is expected to remain at 7.8%. We will also get data showing how the industrial recovery in the US is going with the ISM Manufacturing index, ISM prices paid, Total vehicle sales, Construction spending, and the U of Mich. Confidence numbers. Should be plenty to talk about in tomorrow's Pfennig!!

Then there was this.. It is another great day at EverBank! We released our earning information after the equity markets closed last night, and the numbers certainly seem to support our claim of another great day. EverBank Financial Corp announced the full year and fourth quarter 2012 financial results yesterday, which showed continued growth and earnings. There were many highlights but adjusted diluted earnings per share was $0.34 in the fourth quarter 2012, a 13% increase from $0.30 in the third quarter 2012, and a 3% increase from $0.33 in the fourth quarter 2011. For the full year 2012, adjusted diluted earnings per share was $1.27, a 14% increase from $1.11 in 2011. I think Mr. Clements, our Chairman and Chief Executive Officer, summed it up best by saying "EverBank is pleased to have completed a historic year for our Company as we executed on our strategic plans, raised significant growth capital and closed two material acquisitions. Our fundamentals remained strong in the fourth quarter as we benefited from continued loan and deposit growth, credit quality improvement and robust noninterest income. We believe we are well positioned for growth and success in 2013."

You can read all about our company and our latest earnings release at https://www.abouteverbank.com .

To recap. Bernanke and the FOMC indicated they will keep the printing presses rolling through all of 2013. A report showed US GDP actually dropped .1% in the 4th quarter, mainly due to a decrease in govt. spending. Data out of Europe was mixed, with German unemployment decreasing, confidence rising, but Retail sales falling. All of this left the currency markets mostly unchanged. The RBNZ left rates unchanged but sounded a slightly more hawkish tone which helped boost the Kiwi in spite of it being a 'risk off' day. There is a plethora of data releases here in the US today, and even more tomorrow which should give the markets plenty to trade on. And finally, it was another great day at EverBank as we released our 4th quarter earning information yesterday.

Currencies today 1/31/13: American Style: A$ $1.0413, kiwi .8373, C$ .9975, euro 1.3554, sterling 1.5798, Swiss $1.0973. European Style: rand 8.9535, krone 5.4902, SEK 6.3640, forint 215.96, zloty 3.0961, koruna 18.9232, RUB 30.0725, yen 91.00, sing 1.2379, HKD 7.7565, INR 53.225, China 6.2190, pesos 12.7138, BRL 1.9851, Dollar Index 79.32, Oil $97.74, 10-year 1.98%, Silver $32.05, and Gold $1,675.47.

That's it for today. Big game college basketball game here in St. Louis tonight as the Basketball Billikens will be taking on Butler who are ranked in the top 10. I think a couple of the guys on the desk are heading over to watch the game. I will be heading home and trying to get some sleep as I had a late night last night attending a High School Hockey playoff meeting which ran long. My son's hockey team got a pretty low seed in their playoff bracket, so this first round of games will be tough. The good news is if they get can get past this first round they should have a fairly easy path right to the finals. First hockey playoff game is Friday night; GO REBELS!! With that I will hope everyone has a Tub Thumping Thursday and thank you for reading the Pfennig.

Chris Gaffney, CFA
SVP & Director of Sales
T. 314-951-1619
EverBank World Markets
8300 Eager Road, Ste. 700, St. Louis, MO. 63144 EverBank.com

Chris Gaffney, CFA
Vice President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Obama Claims We Don’t Have A Spending Problem

GaryHalbert — Tue, 15 Jan 2013 21:00:00 GMT

IN THIS ISSUE:

1. Yes, Mr. President, There Is A Spending Problem!

2. Lots of Disgusting Pork In The Fiscal Cliff Bill

3. Another Debt Ceiling Battle Looms In February

4. Obama Could Resort To The 14^th Amendment

5. The Trillion Dollar Coin – Haven’t Heard About This?

6. “Continuing Resolution” To Fund The Government

Overview

There’s a lot to talk about this week. A lot of my contemporaries are offering their predictions for the New Year. But with our nation now over $16 trillion in debt and annual budget deficits over $1 trillion, I don’t think there is any way to accurately predict what will happen this year. Another financial crisis could rear its ugly head just about any time.

Most of the forecasters I subscribe to expect economic growth to average only 1-2% in the first half of 2013. Most believe that 4Q GDP fell sharply from the 3.1% rate in the 3Q of last year, largely due to fears about the fiscal cliff. They also expect growth to improve modestly in the second half of this year to 2% or slightly higher. That’s not too optimistic.

One reason is that the end of the payroll tax holiday on December 31 means that workers’ pay went down by 2% on January 1, thus adding more headwinds to the economy this year. A person earning $50,000 a year before taxes, for example, will pay an additional $1,000 or more to the government this year.

Add to that the fact that we are sure to have another nasty debt ceiling battle next month, which will once again be unsettling to consumers who drive the economy. We all remember the fiasco in the summer of 2011 when the Dow plunged over 2,000 points. For these reasons and others, at least the first half of 2013 could be very dicey.

Actually there are three debt battles – the so called “trifecta” – that lie ahead. In addition to the debt ceiling battle, there is also the sequester/automatic spending cuts on March 1 and the “continuing resolution” to fund the government in the absence of a formal budget passed by Congress. That happens in late March. We will look at all three of these upcoming battles below.

Today we’ll also touch on the pork-laden fiscal cliff bill that passed on New Year’s Day. And we will ponder the question of whether the US has a “spending problem” or a “taxing problem.” Let’s start with this last one first.

Yes, Mr. President, There Is A Spending Problem!

You may recall that during the recent fiscal cliff negotiations, President Obama and House Speaker Boehner met at the White House with the hope of agreeing to some kind of budget deal. That meeting flopped. Afterward, Speaker Boehner reported that at one point Obama told him that the US does not have a “spending problem.”

You’re probably thinking: How could the president possibly say that? After all, Obama’s own Debt Commission stated clearly in its final report that the US has a serious spending problem that is the driving force behind the nation’s debt crisis. Here’s what the report said:

"Even after the economy recovers, federal spending is projected to increase faster than revenues, so the government will have to continue borrowing money to spend. Over the long run, as the baby boomers retire and health care costs continue to grow, the situation will become far worse. We should cut all excess spending — including defense, domestic programs, entitlement spending, and spending in the tax code.”

The Commission was hardly breaking new ground here. Indeed, anyone who has looked at the explosion of the national debt in recent years can quickly see that out-of-control spending, not insufficient revenues, is the main problem. As the chart shows, even with the $620 billion in tax hikes Obama won during the fiscal cliff fight, plus the $500 billion in new ObamaCare taxes starting this year, spending will continue to outstrip revenues as far as the eye can see.

By 2022, federal revenues will top 19% of GDP, which is significantly higher than the post-World War II average. But spending will exceed 22%, and keep climbing. Meanwhile, the Government Accountability Office (GAO) report concluded that spending is "on an unsustainable long-term fiscal path" and blamed entitlements.

And countless Congressional Budget Office reports have documented how, if left unchecked, federal entitlement program spending and the interest on our debt will soon swamp the entire budget. So in addition to not reading his own his Debt Commission report, apparently Obama didn't read any of the other reports noted above either.

Just after his big victory on the fiscal cliff bill, the president warned that higher income Americans are going to get even more tax increases just ahead. Just when the Republicans thought the tax battle was settled, Obama, Harry Reid and Nancy Pelosi threatened even more big tax increases on “the rich” – that is, families making over $250,000 a year. This time, they’ll probably go after popular tax deductions such as home mortgage interest, charitable giving, etc. Another tax battle is coming, count on it!

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Lots of Disgusting Pork In The Fiscal Cliff Bill

You’d think that Congress would have kept the fiscal cliff negotiations as simple and tight as possible. The size of the deficit, the threat of automatic spending cuts, and the need for a last-minute tax deal deserved everyone’s full attention. And yet, the Congressional Budget Office breakdown of the bill shows that there were all sorts of pork buried in the fine print, benefiting everyone from filmmakers to rum distillers.

The problem is so-called “tax expenditures,” which are basically ways to subsidize various kinds of activities through tax breaks (as opposed to direct payments). The fiscal cliff deal consists of three parts – personal taxes, business taxes and energy taxes – and each includes its own giveaways. Many of these were simply increases or extensions of tax expenditures that already existed. But why were they snuck in as part of the fiscal cliff bill?

Here are just some examples of the beneficiaries of the pork that was in the fiscal cliff deal:

Motorsport Racetrack	Movies & TV
Native Americans	Caribbean Islands
Foreign Investors	Puerto Rico & Samoa
Electric Motorcycles	Biodiesel/Other Green Fuels
Algae Fuel	Asparagus

All told, the fiscal cliff law designed to reduce the deficit, added $74 billion in new spending and tax expenditures.

Sadly, most Americans don’t know about any of this. Most of the pork mentioned above was snuck into the fiscal cliff bill in the Senate. With the December 31 deadline already eclipsed, enough Republicans in the House felt they had no choice but to vote for the bill on New Year’s Day. This is really discouraging! No, disgusting!!

Unfortunately, the $51 billion Hurricane Sandy relief bill now making its way through Congress is also loaded with pork. Of the $51 billion in the bill, reportedly almost half of that money is “earmarked” for new federal spending – complete with a list of all the federal agencies that will receive new money – under the guise of Sandy relief. This, too, is really disgusting!

Finally, even if Obama did understand the magnitude of the spending crisis, it’s doubtful that Congress would deliver a solution. The shameless game of “if you scratch my back, I’ll scratch yours” essentially precludes a reasonable solution to this problem. No wonder congressional approval ratings are near all-time lows!

Another Debt Ceiling Battle Looms in February

On Dec. 31, 2012, the US officially hit its current authorized borrowing limit – also known as the debt ceiling – of about $16.4 trillion. Treasury Secretary Geithner informed Congress in late December that he will be able to avoid breaching the limit through “extraordinary measures,’' but only for a couple of months at best.

This sets up a renewal of the conflict in 2011 that brought the country within days of default and led to the first ever downgrading of the federal government’s credit rating. Congressional Republicans insist that they will continue to demand, as they did in 2011, that any increase in the debt limit be tied to significant spending cuts. But President Obama has said that this time he will not negotiate over the debt limit. On New Year’s Day, he threatened:

“I will not have another debate with this Congress over whether or not they should pay the bills that they’ve already racked up through the laws that they passed… If Congress refuses to give the United States government the ability to pay these bills on time, the consequences for the entire global economy would be catastrophic – far worse than the impact of a fiscal cliff.”

The president’s position appeals to his liberal allies, who fear another round of compromises by Mr. Obama. But it once again sets the stage for a nail-biting standoff that economists warn could lead to a damaging financial default and doubt from investors about the ability of the country to pay its obligations.

Credit rating agencies like Moody’s and Standard & Poor’s have warned that the looming debt ceiling battle could result in even further downgrades to the nation’s credit rating. But the financial imperative for an increase in the debt limit comes at a time of increasingly sour relations between the president and his Republican adversaries in the House.

A spokesman for House Speaker Boehner confirmed that his heels are equally dug in:

“The speaker told the president to his face that everything you want in life comes with a price. That doesn’t change here.”

So, the stage is set for another gut-wrenching political battle that should be in full swing by the middle of February when some believe that the extraordinary measures by the Treasury to keep the government afloat could be exhausted. This will almost certainly not be good for the stock markets. The Dow plunged over 2,000 points in 2011 during the debt ceiling battle.

Given that President Obama has vowed not to negotiate ever again on the debt limit, he may decide to go on a road trip, using the “bully pulpit” in an effort to convince the public that another fight over the debt ceiling risks another economic crisis. Public polls after the last debt ceiling fight suggested that most people blamed Republicans for the threat of a shutdown.

Obama Could Resort to the 14^th Amendment

Since President Obama has vowed that he will not play the “debt ceiling game” with the Republicans anymore, many on the left are arguing (once again) that he should bypass the Congress altogether and unilaterally raise the debt limit based on provisions in the 14^th Amendment to the US Constitution.

The 14^th Amendment, which was adopted in July 1868, was meant to ensure the payment of Union debts after the Civil War and to disavow Confederate ones. But it was written in broader terms: “The validity of the public debt of the United States, authorized by law, including debts incurred for payments of pensions and bounties for services in suppressing insurrection or rebellion shall not be questioned.”

Some have suggested that a sitting president could invoke this passage of the 14^th Amendment to unilaterally increase the debt ceiling without Congressional approval. It has been considered often in the past, but no president has ever actually done so. The Supreme Court has never formally ruled on this question, but has indicated that this law was clearly intended for the post-Civil War period and is not relative to the present day.

Fortunately, White House press secretary Jay Carney has said that President Obama has no plans to unilaterally raise the current debt ceiling based on the 14^th Amendment.

The Trillion Dollar Coin – Haven’t Heard About This?

The 14^th Amendment also includes provisions which allow the US government to mint new coins to pay for its debts under certain conditions. While there are more current laws in place to regulate how much paper, gold, silver or copper currency can be minted and circulated by the government, there is nothing so clearly stated when it comes to platinum.

The Commemorative Coin Authorization and Reform Act of 1995 allows the government to issue platinum coins in any denomination it chooses. The law says the Treasury Secretary "may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time."

The idea was that a Treasury Secretary might authorize the creation of a commemorative eagle coin, for instance, to be put on sale for collectors. But the law inadvertently gave the Treasury Secretary more broad authority when it comes to minting new coins, especially platinum coins.

The idea to mint new platinum coins, presumably in large denominations, has received a lot of attention since President Obama vowed recently that he would not engage in further negotiations with Congress over the debt limit and would bypass lawmakers entirely if necessary. This has spawned serious discussions on how far the president might go in bypassing Congress.

At one point last week, the Obama administration felt obligated to respond. White House Press Secretary Jay Carney said, “There is no Plan B, there is no backup plan. There is Congress’s responsibility to pay the bills of the United States,” responding to questions about the trillion-dollar coin at a news conference.

But Mr. Carney did not initially rule the idea out explicitly, deferring later questions to the Treasury Department. That left a few supporters hoping that in one of his last acts in office, Treasury Secretary Tim Geithner might trot out a shiny platinum coin emblazoned with “In God We Trust” and a 1 with 12 zeros behind it.

The idea here would come from exploiting a 1997 law, as noted above, that allows the Treasury to “mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, the power to mint, say, a $1 trillion coin, or even a $5 trillion coin.” [Emphasis added]

Believe it or not, some on the left – including Nobel Prize winning economist Paul Krugman – are arguing that President Obama should authorize the minting of $1 Trillion platinum coins as a way to deal with our exploding debt. Here’s how it would work in theory.

Assuming Congress won’t approve raising the debt ceiling, the Treasury could begin minting new platinum coins that would be handed over to the Federal Reserve, which would use the new coins as collateral for making large new loans to the government to pay its bills. As noted above, there is even talk of minting single new platinum coins with a face value of $1 Trillion. I kid you not!

I seriously doubt that this will happen. But the fact that it is being talked about in serious circles is alarming. Don’t believe me? Just Google “trillion dollar coin” and see what you find. You’ll be surprised!

Continuing Resolution To Fund The Government

As you probably know, the Senate has not passed a federal budget, as required by law, in over three years. In the absence of a budget, Congress funds the government by way of a “Continuing Resolution.” If a formal appropriations bill (budget) has not been signed into law by the end of the fiscal year, Congress is called upon to pass a joint resolution to continue funding federal programs at current or reduced levels.

Continuing resolutions have been used for more than 135 years. In only four cases since 1975 has Congress passed all appropriation bills before the beginning of the new fiscal year. On September 28 of last year, President Obama signed into law a continuing resolution to fund the government for six months. That resolution ends on March 27 when yet another budget dilemma will unfold.

Standoffs between the president and Congress or between political parties complicate the budget process, frequently making the continuing resolution a common occurrence in American government. Federal agencies, including the military, are disrupted by the periods of reduced funding. With non-essential operations often suspended, many agencies are forced to interrupt research projects, training programs or other important functions.

Conclusions – What To Do Now

So, in addition to the debt ceiling battle next month and the sequester/automatic spending cuts on March 1, we have the threat of another continuing resolution fight before the end of March. This can’t be good for the investment markets!

The US credit rating was downgraded for the first time ever in 2011 as the debt ceiling battle played out. The rating agencies are already threatening a further downgrade this time around. Again, this can’t be good for the investment markets.

As noted earlier, the Dow Jones plunged over 2,000 points in the summer of 2011 when the last debt ceiling battle unfolded and the government faced a shutdown. The S&P 500 Index lost over 16% of its value in May – September of 2011 as the debt ceiling battle played out. Could it happen again? You bet!

But next week, I’ll show you an alternative way to position part of your portfolio into a strategy that actually gained over 17% in May – September of 2011 during the debt ceiling battle and finished the year 2011 with a net gain of 18.9%. This same strategy has gained an average of 19.9% over the last five years, with a worst losing period (drawdown) of only 12.9%.

As always, past performance is not necessarily indicative of future results.

Sound interesting? I thought so. Be sure to read next week’s E-Letter.

If you don’t want to wait, call one of our Investment Consultants at 800-348-3601.

Best New Year’s wishes,

Gary D. Halbert