Deflationary Depression and Purging To Come

Bob Chapman
International Forecaster
June 3, 2010

We believe an inflationary depression began in February of 2009, and little has changed. Since then factory output has increased, as have inventories and other outward signs, such as retail sales. We believe that one-year spurt is ending, unless a new stimulus program is put in place. This past week we saw a $78 billion addition to unemployment benefits and Larry Summers has said they need an additional $200 billion. In order to keep the economy going sideways a total of another $800 billion will be needed. The Fed may have cut back the creation of money and credit to zero, but it is still dishing out trillions to domestic and foreign banks, which can only affect the domestic economy in a residual way. The key is real personal income. Including government programs it has fallen $500 billion over the past 16 months. In addition real unemployment remains at a high of 22-3/8%. That is U-6 less the birth/death ratio. This terrible dilemma is a first and is surprising in as much as government addition to income has gone past 18% for the first time ever. We expect that part of the reason for both situations is the perpetual drag of free trade, globalization, offshoring and outsourcing, which has continued unabated.

Over the past several months we have seen a decreasing number of new unemployed, but last month those official figures rose.

There is no question that the $800 billion stimulus has come to an end. During the past 16 months $200 billion of that $800 billion has shown up in consumer spending. The rest has raced through the economy and the result is a budget deficit in the vicinity of $1.8 trillion.

Over the past several months we have seen a decreasing number of new unemployed, but last month those official figures rose. That to us was the signal that the growth in employment had ended as well as the mini-recovery. We will know better the situation when May’s figures are released. The small increase in non-farm payroll tells us our appraisal of offshoring and outsourcing is correct. We predicted the effects of offshoring and outsourcing in 1967, but, of course, no one was listening.

Small business’ contribution has been zero. Many of these businesses are failing and most cannot get loans. We expect that condition to persist indefinitely, which means job stability is nowhere to be seen in the immediate future. In spite of bogus government figures the economy is not growing and won’t grow. Unless the system is totally purged in a classic way there will never be any recovery.

Sooner or later the deflationary depression and purging will come. The economy is stagnant and that is with an $800 billion stimulus program and $2.3 trillion in spending by the Fed, some of which had to have entered the economy. Just think of where we would be without both additions. With stimulus, over the past year, we have only seen an average of 2.38% growth. This is certainly a very weak “recovery,” especially in view of the tremendous amount of money and credit injected into the economy.

As a result excessive spending is over. Over 70% of Americans expect to be savers and to lower their credit card balances; that is those who are still employed. We see consumers back at about 70% of GDP. Without stimulus we see much lower figures; with stimulus only 68% at best can be maintained.

Manufacturing is climbing yet employment in the sector is stagnant. That means people are working much harder to keep worker productivity at a very high abnormal level. This is all well and good, but who will buy the products produced? Exports did well through March, but we have to believe the much stronger dollar will make US exports at least 15% more expensive and those of the euro zone 15% less expensive. Exports make up 20% of GDP.

Even with auto and appliance incentives sales are still under the weather. We have also just seen an end to housing purchase incentives. All indications are we are headed toward a flaccid economy without major stimulus. Business will find out again how dangerous it is to listen to your government. The residential housing inventory is again going to build this time to a real three-year inventory overhang. We expect 20% lower prices over the next year. These are not the things recovery is made of.

As we look forward we see money supply plunge to the same levels of the 1930s. This is the same thing the Fed did between 1929 and 1933. We have zero interest rates, but they really only help the large borrowers and those with AAA ratings. In the first quarter $300 billion was removed from the economy, or a contraction of 9.6%. By the way that proves the upward move in gold and silver have not been the result of anticipated inflation, but by other factors, such as Europe’s problems. We cited the fall a year ago of European M3 and M4 like figures, and as usual, no one was listening. We, as you can see, have had the same result in the US. These reductions obviously were well coordinated. In addition, the assets of institutional money market funds have fallen at a 47% rate, the sharpest drop ever. Part of this Fed move is for banks to raise capital asset ratios as the Fed removes and overpays them for their toxic assets, which the taxpayer gets to pay for. That in part is why banks won’t lend to small and medium-sized companies, and this is why there cannot be a recovery. The banks, Wall Street, and insurance companies are selectively being bailed out, irrespective of the consequence to the US and European economies. Unfortunately, we are following the path of the “Great Depression.” That means gold and silver are being purchased in a flight to quality. Yes, we believe inflation is on the way in bigger numbers, but unless things change dramatically it won’t be long before that inflation is overcome and deflationary depression takes hold.

As you have seen the titans of banking and Wall Street savaged the market on 5/6, and again are in the process of doing so, to convince Congress not to audit the Fed and to give it tyrannical monopoly powers to run America. Congress is being threatened. They are being shown the power of the Fed and its owners, if they do not do what they are being paid to do. It shows you the power of Goldman Sachs, which controls 72% of all NYSE trades and can move the market at will by front running all orders and by restricting all credit into the system. Isn’t this what derivatives are all about? They totally control all markets and it has to end. That is why you have to unseat almost all the incumbents in Congress and the Senate and bring this monopoly to an end. The Working Group on Financial markets” has to be disbanded and “Executive Orders” have to be terminated. The “Imperial Presidency” has to end if we are to continue to have a democracy. How can you have markets recovering every time they fall, as if by magic? You cannot have manipulation of markets, as we have experienced in gold and silver since 1988. We wrote our first article on the subject in August 1988 in the “Bull & Bear,” which David still publishes. How can we continue to have SEC authorized rule breaking by allowing naked shorting?

How can we allow corporations to carry two sets of books and mark assets to model? What is wrong with American businessmen and our representatives? They allow this to go on supposedly for the better good, as they stuff their pockets with cash. Now they want to allow a Federal Reserve monopoly, what is wrong with these people? What has happened to our country? The Illuminists who run our country from behind the scenes do whatever they please and it has to stop. Our country has become the laughing stock of the world, as Europeans and Asians, as well as Latin Americans rush to buy gold and silver. They cannot get rid of dollars and euros fast enough. Obviously some people are waking up, but not more than 2% of Americans. In Wall Street and banking if you do not roll with the establishment you get destroyed. Look at what we have had to put up with for 50 years. Look at what happened to Bear Stearns, Lehman Brothers and countless others who you have never heard of. Most people on Wall Street know what is going on, but they won’t talk about it. They do not want to be ostracized or run out of business. We as well can assure you Wall Street and banking owns the SEC, CFTC and most of the House and Senate.

It was a year and one-half ago we told you that $800 billion in stimulus wasn’t enough. That is now proving to be the case. Get ready for another liquidity barrage, called quantitative easing. It will also mean real interest rates will rise again. The backbone of most all nations of the world is debt not gold, silver or a basket of commodities. Greece is being blamed, but all told, 19 nations are on the edge of bankruptcy. In fact, central banks in these countries are among the biggest speculators. In the euro zone countries cannot print money so they sell bonds in spite of the rules of the bailout. Many are having a hard time selling bonds. Thus other nations are secretly doing so.

There is talk of another Northern European currency backed by gold. If that happens the dollar will fall because it won’t be able to compete. Those in the southern tier will have to return to their own currencies and do as Argentina did ten years ago. Those long dollars do not get too comfortable. The corporatist fascist corrupt model will fail because it is already bankrupt, as will many other countries.

Last week was another mixed week for most markets. The Dow fell .06%; S&P rose 0.2%; the Russell 2000 rose 1.9% and the Nasdaq 100 rose 1.6%. It was a week of “Hail Mary” finishes. That is averages reversing in the last hour of trading. Broker/dealers rose 0.2%; cyclicals 1.7%; transports 2.2%, as consumers fell 0.5% and utilities 0.1%. High tech rose 1.2%; semis 1.9%; Internets 1.7% and biotechs 1.1%. Gold bullion rallied $37.00, the HUI 5% and the USDX rose 1.7% to 86.78.

Two-year T-bills fell 1 bps to 0.75%; 10-year notes 5 bps to 3.30% and the 10-year German bund 2 bps to 2.68%.

Freddie Mac 30-year fixed rate mortgages fell 6 bps to 4.78%; the 15’s fell 3 bps to 4.21%; one-year ARMs fell 5 bps to 3.95% and the 30-year jumbo rose 5 bps to 5.64%.

Fed credit fell $15.3 billion to $2.324 trillion, up 11.6% ytd and 12% yoy. Fed foreign holdings of Treasuries and Agency debt jumped $9.6 billion. Custody holdings for foreign central banks rose $111 billion ytd, or 9.3% or 12.6% yoy.

M2, narrow, money supply rose $43.9 billion to $8.573 billion.

Money Market fund assets rose $5.2 billion to $2.849 trillion. Year-to-date funds are off $444 billion, after a 1-year decline of $940 billion.

The House passed a bill on Friday that would end a tax break for executives of investment funds, leaving hedge funds, private equity firms and venture capitalists scrambling to ease the effects of the bill before it is taken up by the Senate next month.

It seeks to change the tax treatment of “carried interest,” which is the portion of a fund’s investment gains taken by fund managers as compensation. Under current rules, carried interest is taxed federally at a rate of 15 percent because it is treated as a capital gain. That contrasts with the tax rate on ordinary income, which can be as high as 35 percent.

So, it appears that wise-guy welfare might be repealed. However, wise guys made one of their best investments ever by bribing Congress with hundreds of millions of dollars. In return, wise guys garnered tens, if not hundreds, of billions of dollars in compensation.

Companies sold the least amount of bonds in a decade this month as concern Europe’s sovereign debt crisis will slow the global economy drove up relative borrowing costs by the most since the aftermath of Lehman Brothers Holdings Inc.’s collapse. Borrowers issued $66.1 billion of debt in currencies from dollars to yen, a third of April’s tally and the least since December 2000.

Yields on junk bonds rose to the highest since December relative to Treasuries. Spreads widened 27 bps yesterday to 724 bps, the highest since Dec. 9. That’s up from a low this year of 542 basis points on April 26. High-yield debt has lost 4.6% in May, on pace for the first drop in 15 months. ‘We’re seeing high yield under a lot of pressure here,’ said Nicholas Pappas, the co-head of flow credit trading in the Americas at Deutsche Bank. ‘There is a flight to quality to solid investment-grade companies.’ The percentage of corporate bonds considered in distress surged this week to the highest since 2009 as investors dumped debt of the neediest borrowers. Some 17% of junk bonds yield at least 10 percentage points more than Treasuries, up from 9.2% last month. The jump is the biggest since the distress ratio rose 11 percentage points in November 2008.

The U.S., Spain and Greece are among developed nations whose borrowings put them in a ‘ring of fire’ amid sovereign debt concerns, said Pacific Investment Management Co.

The Netherlands has experience with controlling water: 2,000 miles of dykes preventing the sea from flooding the country’s nether regions have taught the Dutch a thing or two about hydroisolation and spillover control. Unfortunately, as the last 40 days or so demonstrate so amply, neither the US nor the UK have the faintest clue how to stop the GoM oil spill which is now entering into the realm of the surreal. Which is why it may be time to learn from those who do know something about the matter. Zero Hedge has received the following proposal from Van Den Noort Innovations BV, which asserts it can get the GoM oil spill under control within days, and it doesn’t even involve nuking the continental shelf.

The US ISM Manufacturing index fell to 59.7 in May from April’s 60.4; remaining above market expectations of a decline to 59.0. The Prices Paid index fell to only 77.5 from last month’s 78.0, an upside surprise on an expected fall to 72.0.

Construction spending in the U.S. rose in April by the most since 2000 as demand related to the end of a tax credit spurred builders to break ground on more houses. The 2.7 percent increase brought spending to $869 billion, after a revised 0.4 percent gain in March that was more than previously estimated, Commerce Department figures showed today in Washington. Economists projected no change for April, according to the median forecast in a Bloomberg News survey.

Sales boosted by a government incentive of as much as $8,000 helped reduce the number of unsold new houses in April to the lowest level in more than three decades, spurring housing starts. While government construction also increased for a second month, spending may be limited by tighter state and local budgets.

“The turn in housing is encouraging,” Michael Englund, chief economist at Action Economics LLC in Boulder, Colorado, said before the report. “We’ve cleared away enough new homes inventories that at least we can add some construction. Non- residential construction is still quite weak.”

The gain in April was the biggest since August 2000. Estimates of 53 economists surveyed by Bloomberg ranged from a drop of 1 percent to an increase of 2 percent, after a previously estimated gain of 0.2 percent in March.

Construction spending decreased 11 percent in the 12 months ended in April.

Private construction spending rose 2.9 percent, the most since July 2004. Homebuilding outlays jumped 4.4 percent, the biggest gain since October 2009. Private non-residential projects increased 1.7 percent, the most since September 2008 and led by factories and power facilities.

The IMF has announced its gold reserves declined to 2,966.4 in April from 2,981.5 tons in March, a 15.1 ton decline. And while the IMF sold well over half a billion worth of gold in April, Russia was once again taking advantage of what some are calling fire sale prices, bulking up its gold holdings by 5 tons, which increased from 663.7 to 668.7. Russia has now been adding gold every month since February. As has long been known, in 2009 the IMF announced it would sell 403.3 tons of gold, of which 212 was purchased in prearranged deals by India, Mauritius and Sri Lanka. This means the IMF, after accounting for all disclosed sales, has 152.1 tons of gold left to sell from its original quota. Bloomberg discloses who has been doing the most buying recently: “Central banks and governments added 425.4 tons last year to 30,116.9 tons, the most since 1964 and the first expansion since 1988, data from the World Gold Council show. Official reserves may expand by another 192 to 289 tons this year, according to CPM Group, a research and asset-management company in New York.” Keep your eyes on Russia: “Russia’s central bank bought 142.9 tons of gold last year, raising its holdings of the metal by 29%, RIA Novosti reported last month, citing Bank Rossii’s annual report submitted to parliament.

Tuesday spot gold rose $12.70 to $1,224.80, as July rose $12.40. Spot silver rose $0.13 to $18.54, as July rose $0.01. Gold traded as high as $1,229 in London. Physical gold dictated prices in spite of strong selling. Gold open interest fell 10,394 contracts to 547,525. Silver OI rose 472 contracts to 120,952. The HUI traded higher earlier, but the outside month for silver just couldn’t hold its gains. The HUI fell .69 to 454.39, whereas it should have been up about 8 to 10 points. The XAU lost .91 to 173.02. Government was again unsuccessful in suppressing gold. They brought the Dow back from minus 150 to plus 80 to off 112. The S&P fared worse, off 168 and Nasdaq 208 Dow points. The euro hit a low of $1.21, and Larry Summers stepped in and drove it back up to $1.23. It closed off .0088 to $1.2236. There was plenty of bad news. Israel, Turkey, Syria, Iran, China, North and South Korea, Greece and most of Europe; then in California, Illinois, Pennsylvania and many other states. Canada raised interest rates. Italy is even being questioned regarding their financial situation. One European bank sold 3,645 ounces of gold last week worth 3 million euros. The IMF again sold 14.4 tons of gold in April. They said they would never sell into the market. This shows you what their word is worth. Wholesale premiums on British sovereigns have jumped from 3.5% to 7% in just one month.

The yen fell .0036 to .9106; the pound rose .0158 to $1.4646; the Swiss franc fell .0003 to $1.1564; the Canadian dollar fell .0024 to $.9485 and the USDX rose .20 to 86.79. The 10-year T-note closed at 3.30%.

Oil fell $1.70 to $72.27, gas fell $0.04 to $1.98 and natural gas fell $0.11 to $4.24. Copper fell $0.06 to $3.05, platinum fell $0.90 to $1,548.50 and palladium fell $3.85 to $453.45. The CRB Index fell 2.41 to 252.39.