September 16, 2011
Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

1. Crisis Avoided … Again.
Central banks around the world joined hands on Wednesday to provide the needed liquidity to save several European banks from immanent bankruptcy.  Japan, China, Germany, France and the U.S. are allowing ECB and or related banks direct access to what are being termed as swap funds (loans).  Details as to the amount of funds in question have yet to be determined, but it appears that another blank check has been written, once again at the expense of taxpayers.  Apparently, the cause for alarm was that several European banks were not availing themselves of enough U.S. dollars to cover international dollar-based transactions as lately, interbank lending has been paralyzed with fear.  Although there is some credence to this claim, we believe that the $575 million loan to two unnamed Euro banks and or the $2B trading loss recorded by UBS during the week may have precipitated the intervention.

This is not an unfamiliar situation as it compares to the same kind of actions taken by the Fed prior to the Bear Stearns dilemma, which, of course, preceded a much broader market collapse in 2008.  So it begs the question …what risks are the central banks aware of behind closed doors to be so quick to come to the rescue, and with such overwhelming resolve?  Time will tell, but we have more than a sneaking suspicion that the risks apparent are contagious and due to spread globally, hence the ease at which this central bank accord was reached.

2. Don’t Worry, Inflation Is Balanced.
Markets were up across the board (except in China) at home and abroad on the mind numbing notion that money printing is the answer to all our problems – ignoring the fact, of course, that printing is the source of all our problems, but this is a different matter.  Globally, stocks jumped anywhere from 3 to 6% on the news, aided by a tremendous amount of short covering.  Remarkably, bonds and currencies (including the dollar) remained buoyed despite the promise of more dilutive liquidity.  Commodities on the other hand were off about 2% on the week, with gold and silver trading down 3% and 2% respectively, while oil rose 2.26% – following the logic that safe havens are no longer needed since prosperity has been “restored.”

Suffice it to say, the party in the market completely ignored a host of bad economic news released during the week.  Retail sales figures for August rose an underwhelming 0.1%. If expressed in real terms, this figure would have been much worse as gas station sales were up 20.8%. In addition, the CPI for August rose 0.4% (MoM) vs. expectations of 0.2%.  Obama’s job plan, in which he plans to spend $477B to be financed by tax hikes of $421B (in part by taxing income on municipal bonds), is economically flawed and yet continues to go unrecognized by the market.  Further beyond the public eye was an approved debt deal in Jefferson County Alabama that apparently avoided the largest municipal bankruptcy in U.S. history; the Jefferson County Commission voted 4-1 Friday to accept terms which included a $1.1 billion concession from creditors.  JPMorgan Chase & Co., who arranged most of the debt, will take the biggest loss. Taxpayers will also bear the burden of rate increases of as much as 8.2 percent for sewer services – more debt deals to come in other states we think…

It would have been more convenient for the Fed and other central banks of world to wait for commodity prices to ease a bit more in this contraction now underway before “hitting the gas” on monetary policy.  The fact that they didn’t, or couldn’t, postpone this particular intervention makes it all the more disturbing as it reveals two things: the problems are far worse than expected, and they are global in scope.  Printing more money, however, has not and will not cure the undertow of bankruptcy issues inherent in sovereign debt and various ECB banks.  If past is prologue, new liquidity may find its way to the stock markets first before performing the more crippling act of raising commodity prices from their already critical level.  If you recall, it was the inflationary pressures that caused the recent spate of riots and insolvency issues abroad. Implementing more QE at present without the needed break in these pressures will serve only to intensify the pain and quicken the arrival of the next downturn.  Hold on to your hats!

Have a great weekend.

David McAlvany
President and CEO
David Burgess
VP Investment Management