Monday, September 29: Week in Review

The $700 billion bailout proposed by the Bush Administration took center stage last week…though a definitive agreement on the shape of that bailout proved elusive by week’s end. On the plus-side, as the days wore on, what initially appeared as an urgently needed mega-amount gradually morphed into an issue requiring closer scrutiny. On the minus-side, it has brought into sharp national focus how fiscally reckless the USA government has been in managing the national economy.

Before recapping last week’s numbers, which incidentally were positive for precious metals, let’s put that “$700 billion in Bailout Money” into better perspective for non-economists. You will then see why the political outcome (or even the lack of an outcome) will influence all markets in the weeks and months ahead.

• This amount of money equals $2,295 for every American of all ages (USA population = 305 million).
• The amount of US currency in circulation is $836 billion.

In any event, this bailout, as proposed, would almost double the amount of currency in circulation, and accelerate the dollar’s continuing depreciation. The fact is, the USA became a Net Worldwide Debtor in the mid-1980’s, and it has deteriorated every year since. This Net Debtor status is the accumulated effect of decades of issuing paper money to cover the country spending more money than it was earning. This hasn’t been a problem, until now. The bill collector is calling.

An old college economics professor once summed up global economics in a sentence when he said “A country can either spend itself rich or save itself poor”. Since 1982, the USA has been spending itself pretty rich. The rest of the world has now accumulated 9.4 trillion US dollars, of which $6.7 trillion represents our spending deficits that have been financed by other countries.

“Decades from now, political economists will marvel at the fact that Socialism was brought to the USA not by unshaven Bolsheviks wearing sleeveless denim vests but by bankers wearing pin-stripped suits and two-toned British dress shirts, with cufflinks. “ --- Jonathan Cavuoto, CEO, First National Bullion

Here’s a simple explanation of how that US$6.7 trillion accumulated --- using China as an example, in 2007 alone, the USA sold $65 billion in goods and services to China while China sold $321 billion of goods and services to the USA. That means a trade deficit of $256 billion.

In practical terms, no country with a trading surplus with the USA can allow US dollars to start flooding their local economies. In the example with China, therefore, these US dollars are gathered up by the Central Bank of China, and its branches. These US dollars then become centrally managed and deployed. With the passage of time, the sheer volume of US dollar investments grew, and grew, and grew…to the point where risk assessment was either overlooked or deemed irrelevant altogether.

Wall Street became quite adept at securitizing the consumer purchases these trade deficits were creating. Securitization is the process of creating a security out of an asset…a security that can be sold and traded, again and again. First, mortgages were securitized (liabilities to consumers but an asset to the bank), and initially sold mostly to US pension funds and insurance companies.

Then, using that architecture, home equity lines, auto loans and credit card balances were securitized…and starting in 2005, more aggressively sold to overseas investors (banks and insurance companies). It was the odd-man-out-overseas investor that did not have some financial stake in the great USA. By 2006, Lehman Brothers and Merrill Lynch (MER) had more offices in Europe and Asia than in the USA!

It is impossible to estimate how much of that US$6.7 trillion overhang is tied up in the current financial crisis --- probably not much, yet. The reason is that these are creditors that have yet to demand repayment…and when they do, the government may have no choice but to print more dollars to pay those overseas creditors off.

Where this ends up is far from over…the smart conclusion for individual investors at this point is to realize that we are in for a period of extended economic realignment, a realignment that will affect as much as half the American population. The country will not feel as rich (meaning access to capital) as it once did. This doesn’t mean the end of the investment world…just a re-assessment of how you go about investing.

If that re-assessment does not include physical ownership of precious metals like silver and gold, then permit us to suggest that your re-assessment is incomplete. Here are some historical numbers:

On the broader market, Gold opened at $881 last week, traded as high as $912 on Friday and as low as $866 on Thursday. Closing last week: $885, up $23, or 2.7%, for the week. Silver opened the week at $13.00, traded as high as $13.81 on Thursday and as low as $12.78 on Monday. Closing last week: $13.47, up $1.06, or 8.5% for the week.

As a proxy on depreciation of paper money – Ten years ago, the Dow Jones Average could purchase 26 ounces of gold. Today, the Dow could purchase 12 ounces of gold, a rate of depreciation similar to the US dollar’s trading devaluation in foreign exchange markets. And finally, our QUOTE OF THE WEEK, especially fitting this edition, from author and Time magazine contributor Joel Stein, in an editorial in the Los Angeles Times on September 26th:

Even though I understand so little about economics that much of my long-term investments are tied up in Costco products, I feel pretty sure that letting Congress give Treasury Secretary Henry Paulson $700 billion to buy super-crappy mortgages is not the right call. Sure, like any American, when I see a photo on the Internet of an adorable little investment bank and find out it's at risk of being put to sleep, I want to throw in $2,000 to $3,000 of my own money to adopt it. But instead of jacking up inflation, letting the dollar sink further and paying higher taxes so we can keep up cheap borrowing - which is what this plan amounts to - I think we need to let those who made bad loans get burned. We need to accept that credit will dry up and that maybe - for just a bit - we'll have to stop buying more than we can afford.

Comments

[Kelly Liebe...:]

"It is impossible to estimate how much of that US$6.7 trillion overhang is tied up in the current financial crisis --- probably not much, yet. The reason is that these are creditors that have yet to demand repayment…and when they do, the government may have no choice but to print more dollars to pay those overseas creditors off."

It may be that these creditors will immediately take the dollars they get and buy gold or silver... why hang on to a currency that everyone knows will devalue daily? These countries carrying billions of debt are not ignorant.
They are planning ahead -just like we need to.
do yourself a favor and put some of your potfolio in precious metals.

2008 Sep 29 10:14 AM

[ussmls7:]

The US Mint has stop sales 2 times in Gold 1 oz coins,this has not got a whole lot attention in the MSM,I wounder why? But yesterday, TV news shows said they should of bought Gold to shore up their position! Its funny now to see the same people that put Gold down,now singing another tune! Americans better wake up fast,because of the supply side has not kelp up with demand & it will get tighter!

2008 Sep 30 09:53 AM