Thursday, February 24, 2011

The Fed And DC's Next Move

I don't think many realize the complicated, twisted, interconnected situation we are in right now and figuring out how all of this plays out is beyond difficult.  A vast majority of those in risk assets right now have been conditioned for two years that you buy anything and just hold it.  Don't sell, don't buy protection, just sit on hands while fully invested. The longer this game goes on the smarter they feel.  They are truly oblivious to the world around them.

Anyone who has traded long enough knows the worst thing that can happen to you when starting out is to make money.  You begin to think things are easy and ignore the warning signs.  As Bill Fleckenstein says, "nonsense becomes knowledge."  Those who have not participated in this market or worse tried to short this market are frustrated beyond words right now.  We spend our days studying why the market is wrong and arguing with those who are "right."

I truly believe we have an amazing opportunity ahead of us.  The fiat currency based, debt fueled, rampant fraud financial system is near collapse.  The ponzi scheme has outlived its shelf life.  As investors, the opportunity is to make a lot money.  As a society, the opportunity is to reset our moral and financial compass.  Recession is a normal part of the economic cycle.  It is no different than a forest fire that results from excessive, unsustainable growth.  Not until the excess is removed, can new life form.

Depressions are to a society, what recessions are to an economy.  Talk to anyone from the great depression and you see someone who values money, hard work, the little they have in their lives.  Our society has lost its moral and financial compass.  We need a reset.  Since the 2008 financial crisis we have not removed the excess in our economy. Consumers have not learned how to live within their means.  We are literally using debt to pay debt.  We may have finally run out of a greater fool to hold up the system.

If you are in cash and not participating I think time is better spent understanding the world we truly live in.  I suspect in the not so distant future we will look back at this time as the quiet before the storm.  We know about the headwinds.  We know the banks are insolvent.  We know the economy is on life support.  The question is though, what course does the Fed and Federal government choose to take us on.  As hated as Bernanke is, he understands the tough choices facing him.  As political as DC is, they understand their endless budget deficit game is coming to an end.   Those in power do not go down without a fight, without deceit, without one last effort to hide the truth.  Every week we witness a different regime in the Middle East being brought down, yet their strategy to hold onto power is no different.

Gold and silver are the new flight to safety trade.  They have replaced the USD and possibly US Treasuries.  The Fed and Federal government must face the threat of losing reserve currency status and higher, uncontrollable interest rates beyond one year maturity.  The printing press cannot be removed.  Bernanke and DC are capable of anything to retain power.  Keynes believed "gold was a barbarous relic."  The demand for gold and silver is so strong that future markets are in historic backwardation.  The Comex is literally ready to blow up and JPM is massively short silver.

The Middle East is erupting right now.  Regimes are changing and the threat to oil, the fuel of the global economy is rising.  Every passing day countries are slowly moving military assets into the region.  The global economy will do all it can to protect the flow of oil.  Iran will not sit and watch the world move in while their own people revolt.  Al Qaeda is losing importance in the region and desperately wants another base to operate out of. Israel is facing renewed threats from Hamas and Hezbollah.

The US is experiencing its own revolution.  Although peaceful, that can change fast. Wisconsin was the beginning but protests have spread to other states.  The global revolution started in Tunisia and very quickly grew throughout the Middle East.  Never underestimate the power of those with nothing.  They will fight to the end for they have nothing else to lose.

China is fighting massive inflation and eventually another Tiananmen square.  Bernanke is exporting inflation and hoping that will pressure the Chinese to strengthen the RMB. Their choice is either high inflation or weaker growth.  Bernanke wants jobs back from China.

  • If the Fed continues QE they risk pushing bond yields to unsustainable levels.  
  • If the Fed ends QE, who will buy treasuries?  Ending QE will take pressure off China to revalue the RMB something neither Bernanke nor DC wants.
  • If the Fed continues QE they will strengthen gold and silver which will put more pressure on those like JPM and on the future of the fiat currency system.  
  • If Fed ends QE there will be no stimulus left for the economy and it will double dip just like it was going to last summer.
  • If the Fed continues QE they will raise interest rates putting more pressure on bank balance sheets, on the 500 trillion interest rate derivative market and choke off what little demand is left in the economy.
  • If the Fed ends QE they will no longer be able to inflate the US economy.

This post has become far too long as this is no easy question to be answered.  Do we see war in the Middle East?  Are gold and silver the best long term investments?  Will the global revolution move fast enough to stop more reckless moves by world leaders?  I'll leave you with Hank Paulson's quote about the 2008 financial crisis for comfort on our leaders ability to make the right decisions.

"We had no choice but to fly by the seat of our pants, making it up as we went along."


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