A Crack In The Dam

March 27, 2009 Gold Stocks, Inflation, Politics No Comments

Signs of future inflation are beginning to appear like a crack in a dam. At first glance as you walk by a crack in the dam, there is very little water, so why worry? Buy gold before the crack widens because buying gold will protect you from the flood that is coming.

The markets are trading down this morning and the dollar is headed up on a warning from the German finance minister. The DOW is currently down, 120 at 7,804, the NAS down 26 at 1,561, the dollar is up 1.15 (1.49%) at 85.27, while gold is down $10.50 at $923.70.

German Finance Minister Peer Steinbrueck warned that the Euro could suffer if members failed to respect the European Union’s stability and growth pact, which requires budget deficits to be below 3% of gross domestic product. Reuter’s reported Steinbrueck’s comments from speech to parliament in Berlin.

“Germany, as a member of the E.U., has a massive interest in the credibility of the stability and growth pact, which as you know is not taken so seriously by some. If it is not taken seriously, I am telling you, the Euro will have trouble one day in terms of its own credibility and stability.”

This immediately put pressure on the Euro and sent the dollar up. This is a knee jerk reaction to the problems of the Euro that foreshadows what is coming down the pike for the dollar. By purchasing their own debt, both the UK and US have been flooding their economies with liquidity. As I have discussed many times over, this is an extremely inflationary move brought about by utter desperation on behalf of the central banks of these countries. As of this date, we have not seen any rise in the US CPI, but the UK inflation rate unexpectedly rose to 3.2% in February. This is a harbinger of the danger that is rolling toward the US economy.

Government Intervention In The “Free” Market

When governments purchase their own debt, they artificially force down interest rates to a level below what the market demands. This drives investor’s away from debt sales because the return does not represent the risk that is in the market. On Wednesday, the government of the UK held an auction to sell 1.75 billion pounds of bonds (which they call gilts). There were not enough buyers at the auction so the they couldn’t sell all of the gilts. The failure to sell them all, sent interest rates up in the UK as investors demanded higher yields. The UK couldn’t sell them all because their participation in “quantitative easing” is devaluing the pound. The UK was one of the first countries to announce that they were going to try to lower their interest rates by buying their own debt.

This is exactly what the Obama administration announced last week when they said they would buy $300 billion in US treasuries. The pattern is all too clear. We are headed down the road to massive inflation and by the time it shows up in the numbers, it will be too late to slow it, let alone stop it.

It is inevitable that the currencies of those governments that implement “quantitative easing” will decline and interest rates will have to rise in order to bring back foreign investors. For the U.S., it is imperative that we have foreign investors to allow us to run the deficits we currently have, let alone the huge deficits that have been proposed by the current administration. It is only a matter of time. It is no longer a question of if, it is a question of when.

If interest rates don’t go up, investors will buy fewer and fewer of the offerings, which will force the government to buy more of it’s own debt which is highly inflationary and ultimately would lead to a failure of the currency. A Catch 22 of sorts. The most likely scenario will be a combination of both. The government will buy it’s own debt and let interest rates rise, because no one will have to stand up and lead, there will be less political fallout until things get really bad. Kick the can down the road to the next generation.

These actions only buy time, they do not go to the root of the problem which is the derivatives bubble and the debt that fighting it is generating. The vacuum in leadership that we are currently experiencing will only exacerbate the problem.

Take advantage of any dips to buy gold and gold stocks. Nothing goes straight up or straight down, so there will be plenty of opportunities to accumulate. Ignore the crack in the dam at your own peril.

Till next time, good luck and good trading!