VICTORY BY REJECTION

On January 19, 2010, Republican U.S. Senatorial candidate Scott Brown delivered a shocking blow to the Massachusetts Democratic Kennedy stronghold in what is described as massive political rejection. It could represent the first shots in a revolution in American and even democratic politics heard around the world. In Lexington, on April 19, 1775, the antecedents of some of these very Massachusetts citizens fired the first shots of a revolution against an arrogant and abusive English government that heralded the American Revolution—a political earthquake that reverberated around the world.

In 1773, the English government imposed a deceitful import tax on tea to help recoup the cost of victory in the French and Indian War. The British colonists were not fooled and at the ‘Boston Tea Party’ destroyed three shiploads of tea rather than pay the abusive tax. Over two centuries later, many believe that Scott Brown rode to his stunning victory on the back of the current Tea Party Movement—a popular reaction opposing big government’s arrogant and abusive treatment of ordinary Americans by their government.

Commentators quickly attributed Brown’s victory to deep disapproval of President Obama’s Health Plan and that it may herald a major support switch to Republican candidates at the coming mid-term elections. Apparently, it has caused near panic among Congressional Democrats. The Health Plan has been shattered. In a drive to find scapegoats, banks have been threatened with massive, knee-jerk regulations. Support for Fed Chairman Bernanke has eroded, threatening his re-nomination.

Meanwhile, Republicans are exhilarated by the prospects of landslide electoral victories. However, this confidence may be premature, ignoring certain key factors.

First, this was a ‘special’ election. Democrats and even Independent Democrats had the rare chance of expressing frustration, anger and disapproval of Obama’s strategy without threatening their President or their party’s Congressional majority. It was like a schoolboy being presented with an opportunity, under cover of darkness, to kick an unpopular master in the backside and get away unrecognized.

Second, both Republicans and Democrats should ask themselves whether the Massachusetts upset arose from a general disapproval of the Democratic ideal or from factors possibly even more powerful.

A prestigious poll undertaken by Harvard, The Washington Post and the H. J. Kaiser Foundation has determined that there was significant voter anger against Democrats in Washington with some two thirds of voters in the special election feeling that America has been taken seriously off track.

While many Democrats and Independent Democrats are disillusioned or even angry, Brown captured only three quarters of the vote achieved by Obama in 1999. Furthermore, seventy-five percent of Democrats interviewed felt that Brown should work with Democrats to improve their policies with Republican input, especially on health care.

In short, it appears that the majority of voters who crossed over did so to send a message to their own party bosses, not because they liked the Republicans.

Third, Brown is a Republican with considerable local legislative experience. He was elected as the representative of many who want him to work with Democrats. When he takes his seat in Congress, he will feel very powerful pressures seeking to make him become a delegate of the Republican Party. Very few, of those ‘groomed’ by the Party, survive politically by resisting the Party.

Fourth, Brown eclipsed his opposition largely with the support, especially on the Internet, of the Tea Party Movement—a group which believes passionately and energetically in small government, lower taxes and enhanced individual freedoms. But the Republican Party has shown clearly that, since President Reagan, it has rejoined the Democrat party as a party of big government, high taxes and diminishing individual freedom. There is a risk of serious voter disillusion unless Brown proves to be an astute statesman—in short, an exceptional man.

Being popular, the Tea Party is potentially extremely powerful. But who will control it? Will it be Republicans, Libertarians, or people more representative of ordinary voters’ deep-seated wishes to be left alone with less government and less taxation? Already, the Republicans have moved in. But the rift remains; will Republicans understand the underlying message that most Americans want small government. If so, Brown’s Massachusetts’s victory could have both national and worldwide implications.

ASLEEP AT THE CONTROLS

On November 5, 2009, an Army major killed twelve people and wounded thirty others in a shooting spree. An act by an individual rather than a group, it epitomized the evolving more dangerous form of decentralized terrorism. However, possibly to avoid scaring people, President Obama refrained from terming it a terrorist act.

On Christmas Day, a Jordanian passenger failed in yet another act of individual terror to bring down Northwest flight 253. Reluctant to warn Americans of this new type of individual terror, Obama branded the astounding security breaches as merely “a systemic failure” by government agencies. However, no blame was attached to any individual or government department.

His reaction to the similar “systemic failure” of the banking system, an event both financed and inspired by government laxity, was in stark contrast. With the banks, the President acted politically by imposing a highly discriminatory fine on selected profitable banks that were all supervised and highly regulated by government agencies. It was akin to blaming the aircrew and passengers for the Christmas Day attack.

On February 4, 2010, a Jordanian double agent suicide bomber murdered the operatives of a CIA outpost in Afghanistan. Again, an alertness failure was to blame. The suicide bomber’s advance on the outpost, with one had in his pocket should have been an immediate red flag.

These examples illustrate a series of failures, not just by operatives but also by government. However, no government department or official has been blamed. Historically, as Harry Truman knew, organizational failure necessary starts at the top.

In addition, while former President Bush’s announcement of a “War on Terror” sounded good, it has proved to be a major strategic error, based upon little more than wishy-washy thinking. It has affected fatally the entire multi trillion dollar counter-terror operation undertaken to safeguard American citizens.

First, while it is possible to identify a person, such as Hitler or a group like the Nazis, as an enemy, it is almost impossible to galvanize a force or nation into fighting and ‘ism’, like terrorism. It is like trying to deliver a knockout blow to a free-floating balloon.

Second, research indicates that the primary cause of terrorism and particularly suicide attacks is enemy occupation.

There was a moral excuse and wide international support for a massive but swift, surgical search and destroy mission against the Taliban, followed by a quick exit. Instead, President Bush was persuaded to initiate an air war, unsupported on the ground and of insufficient strength. The enemy, underestimated, undetected and unbeaten, merely melted into the population rather than face a conventional battle against superior force.

In Iraq, the unjustified attack was viewed widely as based upon falsely inflated intelligence data. Furthermore, the forces deployed were too small to ensure rapid success and exit. The effect was that public appetite for war support was eroded severely.

In Afghanistan and Iraq, the U.S. led allies were viewed as invaders. The image of occupiers fanned rather than subdued the flames of terrorism. Many terrorists left for Yemen and Somalia to carry the battle further a-field.

Third, it is increasingly apparent that little thought was given to any cost benefit analysis of the operations. Instead, over reliance was placed on faulty intelligence, a gross underestimation of enemy capabilities and an incredible lack of awareness of terrorist motivation. It led to an arrogant assumption of easy victory and resulted in unnecessary casualties and costs.

The costs of the War on Terror are huge. For example, the $1 trillion estimate of the abortive invasion of Iraq is widely believed to become more like $3 trillion when long-tail expenses such as medical resettlement of the wounded are included.

Finally, there are the hidden costs of counter terror. The high cost, both direct and indirect of airport passenger and cargo searches must be added to the threatened loss of potential sales in shopping malls. In the face of a likely deep recession, this is bad news.
By giving the impression of being an occupier, Presidential actions have fanned anti-American feelings and the resulting terrorist threat to the American homeland. Facing such danger, there will likely be severe political costs for any President perceived as ‘soft’ on defense or asleep at the controls.

KING CASH DETHRONED

The government would have us believe that cash has been dethroned and no longer is king. Meanwhile, even U.S. stock and bond markets have held up at least in nominal terms, and some with double digit returns. So why hold cash?

In theory, the short answer is to ask whether it is credible that the government’s plans are or will prove successful in stimulating real economic growth while averting hyper stagflation and a financial collapse. In practical terms, the answer is more complex and involves a crucial definition of cash.

Despite the protestations of Fed chairman Ben Bernanke, it is generally agreed that the great asset boom of the mid 2000’s was caused by the Fed’s injection of an unprecedented and massive amount of excess paper dollars into the economy. The result was a threatened collapse of the international financial system and worldwide depression.

To avoid a financial and economic disaster, the Fed, and other central banks embarked on huge rescue stimulus measures involving the issue of trillions of yet more synthetic dollars and the upward manipulation of key statistics and supposedly free markets in real estate, bonds and equities.

The Fed makes no secret of its massive cash injections borrowed on behalf of future generations and deployed in the manipulation of the real estate and bond markets.

However, the Fed is less than open about its efforts to manipulate downwards the price of gold and how Greenspan’s Plunge Protection Team’s uses large, targeted purchases of forward options to manipulate equity markets upwards. Prices have risen on unusually low volume, another possible indication of manipulation.

With these manipulations, do buoyant U.S. stock and bond prices represent reality or merely a temporary finger in the dyke?

Buoyed by increased holiday season retails sales, government claims its measures have instilled new confidence amongst certain consumers. Equities and bonds in retirement plans are up and the rate of increase in unemployment has fallen. But how long can it be before reality dawns on the massive government debts, manipulated markets and the issuance of trillions of synthetic dollars? And, when reality dawns, what then?

Already, the Fed and other central banks are discussing exiting their stimulus measures.

America is still the largest consumer market in the world. Therefore, any failure in a U.S. economic revival will affect even emerging markets, some of which have shown stellar returns over the past year.

Some important economists, including Paul Krugman, believe that a double dip recession is more likely that not.

If recession hits again, real estate and equities are likely to fall sharply. At the same time, interest rates are poised to go higher, threatening bonds.

In recession, cash normally becomes king. But with a weak dollar and low interest rates, how safe is dollar cash?

Evaluating cash involves two important factors. First, sophisticated investors differentiate between income and capital gains, only for tax purposes. They look for total return, or income and capital gain combined. Portions of most appreciated financial assets can be sold to provide income, even at a tax advantage over dividends or interest receipts.

Second, cash can be held in several forms, including U.S. dollar bank deposits, money funds, Treasuries, foreign currency, gold and silver.

Over ten years, the U.S. dollar has fallen against a compendium of currencies, many depreciating fast, by some 30 percent. Against the Euro, it has fallen by about 50 percent. Against gold, it has fallen by some 280 percent. Therefore, holding U.S. dollars in cash or near cash, such as Treasury Bills, risks significant erosion in real terms.

Currency markets notoriously are volatile. For most people, investing in foreign currency cash should be done through professionally managed funds. However, only accredited investors can participate in the enhanced returns of trend hedge funds.

Interestingly, the Government does not permit the holding of cash in the form of gold and silver, or ‘real’ money, in retirement accounts.

However, investors deciding to hold their wealth in the form of appreciating currency deposits and in precious metals likely will be well placed to cope with currency debasement, hyper-stagflation and financial collapse. In short, the cash held as ‘real’ money could prove to be not just a king but an emperor!

It is generally accepted that a solid infrastructure is an essential ingredient of a modern, economically successful economy. It also is accepted that America’s infrastructure is in a state of advanced decay, needing $1 trillion to restore it to health. Some economists assert that for each trillion dollars spent on infrastructure, some 3.5 million real, wealth-generating jobs are created.

Therefore, if the Government were to spend $1 trillion on bringing U.S. infrastructure up to standard and a further $1 trillion on improving it, would cerate some 7 million jobs. This would restore both full employment and the economy.

Faced with this opportunity, it is amazing that the President appears intent upon perusing a debt financed, multi trillion spend on entitlements such as education and health. While jobs will be created, they will be wealth consuming and a drag on the economy. Furthermore, it is highly likely that the massive spend on nationalized health actually will decrease the standard of health care in America, not raise it. How can this be?

In 1993, P.J. O’Rourke in addressing the Cato institute said, “If you think health care is expensive now, wait till its free.” The experience of Great Britain, Canada and Massachusetts provides stark evidence of the truth of this statement.

Democrat Representative Barney Frank claims that Obama’s new health program will be financed by defense cuts and tax increases. But he hesitates to mention that when, in the mid 1960’s, the Government came to Congress to finance Medicare, they gave cost projections of $10 billion over 25 years. The actual costs proved to be over ten times that estimate at $107 billion over 25 years.

In view of this evidence how can Obama expect people to believe that his new health plan will “save money”? The truth is that it is likely to emerge as an unprecedented economic drain on all Americans.

America already has the world’s best health system. Why change it?

Admittedly, there is the serious problem of some 5 percent of Americans who wish to have medical insurance but are unable to pay for it. Surely, short of an uneconomic nationalized health system, a combination of refundable tax credits and tax deductions could be designed to cover this coverage gap.

As President Reagan remarked: “Government is not the solution to our problem; government is the problem.” Anyone seeing FEMA’s antics following Hurricane Katrina will shudder to think of a Government interloper coming between them and their doctor.

With deep, tax financed pockets, any Government sponsored health insurance plan soon will undersell the private, for-profit plans. Naturally, people will migrate to the cheaper Government plan, bankrupting the private sector and eventually leaving the Government as the only option.

Armed with this state monopoly power, the Government then will be empowered to dictate, not just negotiate, both the price of drugs and procedures. The best medical parishioners will move to profitable free markets abroad, followed by key divisions of the major drug companies. Just as in Canada and the UK, the standard of health care will fall dramatically with breakdowns and massive consumer frustration as waiting lists lengthen dramatically and the standard of care diminishes. The end result will be a rapid rise in unnecessary deaths. Indeed, the Obama plan envisages already a major increase in euthanasia counseling!

These are somewhat inconvenient truths. If Congress and Americans were generally aware of them, Obama’s health plan would die. Is that why is he pressing ahead so fast? Does he have a hidden political agenda, geared more to social engineering more than to the health of either the U.S. economy or its citizens? Is he trying to replace Medicare solely to eliminate the Government’s massive debts to all those Americans who for many years have paid into Medicare?

America is at a crossroads. Somehow, the economy must be restructured to ensure that we, as a Nation, consume less than we produce. Spending on entitlements must be reduced as a proportion of Gross National Product and investment in production increased.

If the Administration spends wisely, rather than politically, it could restore both the American economy and the American people to health. If not, Americans will feel far worse.

There is increasing pressure in Congress to audit the Fed. The Fed is resisting strongly asserting that such an audit would interfere with the Fed to an extent that threatened it constitutional independence.

In this growing constitutional struggle it is in the vital interest of America that both Congress and the Fed recognize the most important distinction between ‘transparency’ and ‘independence’. A failure to do so could result in catastrophe for the dollar that would be felt by all Americans and many others throughout the world.

FED FACES LOSS OF LIBERTY

In the Fall of last year, Congress was ‘persuaded’ as a matter of urgency to vote $700,000,000,000 for the Troubled Asset Recovery Program, or TARP. It was the largest money vote in history. Now, Congress is concerned that TARP money has been misspent and that the Federal Reserve Board is deliberately concealing many recipients. Some politicians feel the Fed has managed a giant slush fund on behalf of the Administration and that its resistance to Congressional demands for full disclosure amounts to a political cover-up.

There is increasing pressure in Congress to audit the Fed. The Fed is resisting strongly asserting that such an audit would interfere with the Fed to an extent that threatened it constitutional independence.

In this growing constitutional struggle it is in the vital interest of America that both Congress and the Fed recognize the most important distinction between ‘transparency’ and ‘independence’. A failure to do so could result in catastrophe for the dollar that would be felt by all Americans and many others throughout the world.

By late 2008, it was clear that many of the banks such as Citi and Bank of America, shadow banks like Goldman Sachs and Morgan Stanley and other financial institutions such as AIG, had behaved more like casino gamblers than as bankers doing business in the ‘old fashioned way’.

All this had happened under the eyes of the Fed.

The Fed, or central bank, was established in 1913 as a private bank. This ‘independence’ from Politics was and rightly remains of key importance. Throughout most of recorded history, gold has proved to be an effective break on the abuse of excessive spending by governments.

Since the progressive erosion and ultimate abolition of the gold standard in 1971, the only effective break on excessive Government spending has been an independent central bank.

Today, with Government spending far in excess of revenues and in amounts of many trillions of dollars, the independence of the Fed is of increasing importance.

Under former Fed chairman Alan Greenspan the Fed compromised its vital independence progressively and became a virtual arm of the Bush Administration. It led to an explosion in Government spending and a doubling of U.S. Treasury debt to $10 trillion, excluding more than $30 trillion dollars of off-balance sheet debts. The result was the largest asset boom in history.  The lure of cheap, easy money drew in even the most prestigious names in finance. By mid 2007, the bursting real estate bubble burst, threatened the world’s financial system.

By mid September 2008, even inter-banking lending had tightened and bank credit evaporated. The recession was about to be turned into a severe depression by a lack of credit.

Although deeply resented by the public, the Government rightly concluded that, in the national interest, the banks had to be rescued to save the economy.

As its name implies, TARP relief was designed originally to enable the U.S. Treasury to purchase or insure ‘troubled assets’ such as residential or commercial mortgages along with any obligations, securities or other instruments related to them. The aim was to relieve the banking system of these so-called ‘toxic assets’ and restore banking liquidity and lending.

Subsequently, however, the Administration decided that any purchase of toxic assets would establish the reality of a ‘real’ price causing many related toxic assets to be ‘marked down to market’, threatening further mayhem. The Administration decided to retarget TARP spending towards banks and ‘others’. The vagueness of this Fed spending on behalf of the Administration has caused Congress to feel it was ‘bounced’ into approving TARP, to become alarmed and to demand a full audit.

The fact that Fed Chairman Bernanke is resisting a full independent audit while protesting openness has rightly aroused intense suspicion in Congress. Recently, Bernanke took a public stance in threatening Congress that disclosure could lead to increased interest rates and the potential loss of America’s triple ‘A’ credit rating. The fact that these two issues would result not from disclosure but the massively excessive level of Government debt has served only to fuel Congressional suspicions.

Congressional anger is now such that the vital ‘independence’ of the Fed is becoming threatened in the name of ‘disclosure’.

Such an event might suit the political purpose of President Obama by placing the Fed, with its ability to print unlimited amounts of fiat money under Presidential ‘control’. It would allow any president total power over the Nations money. Furthermore, dispersal of such money could remain largely hidden, making it potentially the largest slush fund in history.

Clearly, it is morally and constitutionally indefensible for the Fed to resist full ‘disclosure’. On the other hand the ‘independence’ of the Fed has never been more vital to the ultimate security and freedom of all Americans from dictatorial martial law.

The independence of the Fed has nothing to do with its accountability. Its obligations for disclosure will make it a stronger not a weaker institution. Congress should be mindful of this.

Last week, leaders of the ‘Group of Eight’ of the most important economic powers (G-8) met in Italy to discuss the global economy. Looming large on the agenda was expected the Chinese initiative to have the U.S. dollar replaced by a new international currency as the world’s Official ‘Reserve’ Currency. As the G-8 convened, the Chinese Finance Minister, ****, was recalled due to an outbreak of domestic civil unrest. While the disruptive issue of changing the reserve status of the U.S. dollar was not reached, it remains hanging over international monetary affairs. Why is it so important to Americans? Furthermore, is it as damaging to America as it may at first appear?

The role of an official reserve currency is not widely understood, still less the privileges it bestows.

Reserve currencies have existed for centuries and financed most international trade. As currencies were minted in valuable metals, like gold, the international bankers’ choice of ‘Reserve’ status was based upon the reliability of the gold content of the coins. The French Franc, the Dutch Guilder and the British Pound were among the leading reserve currencies of the eighteenth and nineteenth centuries. The latter dominated; hence the title ‘Sterling’, or strong, attributed to it.

Following the abandonment of the gold standard in World War I, Sterling was selected as the first paper ‘Reserve’ currency. With the emergence of America as an economic super power, the U.S. dollar competed increasingly with the Sterling.

Following World War II, the U.S. dollar was deemed ‘as good as gold’. In 1944, the Breton Woods Agreement established the U.S. dollar as the undisputed official ‘Reserve’ currency, convertible into gold by central banks (the Gold Exchange Standard). This gave America four great economic privileges.

First, as the main trading currency, almost all commodities, including gold, were priced in U.S. dollars. Most non-American buyers had to sell their own domestic currencies in exchange for dollars to buy commodities. This was particularly important when, in 1973, OPEC agreed to American demands, in return for defense assurances, that it would accept only dollars for its oil. This placed a major support level under the value of the U.S. dollar.

Second, as most world trade was both denominated and conducted in U.S. dollars, central banks favored holding U.S. dollars, rather than other currencies, as part of their gold and foreign exchange reserves. This added further buying and political support for the U.S. dollar from nations anxious to avoid erosion in the value of their reserves. It gave the dollar added support.

Third, as America both sold it exports and paid for its imports in U.S. dollars, it was possible for the international value of the dollar to be insulated significantly from the effects of massive trade deficits.

Finally, as the currencies of most countries were either fixed or floated against the U.S. dollar, the United States was able indirectly to set international interest rates to suit its own economy, often to the disadvantage of its competitors.

These huge economic privileges enabled successive American Governments both to sell vast amounts of dollar denominated debt to foreigners and to run massive budget and trade deficits.

When President Nixon broke the Gold Exchange ‘Window’ in August 1971, American governments were able to run even more profligate economic policies. These culminated in the greatest asset boom in history being financed under Bush and Greenspan. It is the explosion of this boom that now threatens a major depression.

In recent months, politicians have blamed bankers, ‘shadow’ bankers and hedge funds managers for America’s current economic woes.  

However, it is clear that massive Congressional entitlement spending so distorted America’s economy that it became dependent on wealth consuming consumption rather than on wealth producing production, with higher paid American jobs exported on a massive scale.

Furthermore, the historic increases in Treasury debt have rendered America the largest debtor country in history. This has encumbered the earnings and living standards of future generations. It also has robbed every American by eroding the value of the U.S. dollar. The Administration’s cure for this excess of Government debt and spending appears to be more of the same.

Things have become so bad that other countries, such as China, Russia and the OPEC nations, holding massive amounts of dollar denominated Treasury and other debt, are seriously concerned. Hence, China has moved to initiate a new international ‘Reserve’ currency. The threat to America is clear.

American politicians clearly are unprepared to face the political costs of recession. They likely will spend without limit to protect their seats, increasingly threatening American living standards.

Remarkably, the vast size of Treasury borrowing has highlighted two previously unimaginable possible limits to Government borrowing—the possible loss of America’s triple ‘A’ credit rating and a catastrophic hike in interest rates.

Now, the specter of losing the great privileges of the dollar’s ‘Reserve’ status may cause an initiative wherein the U.S. dollar once more represents sound finace and a store of value.

Most Americans could not figure out why employment was falling at the rate of some 500,000 jobs per month while politicians, Wall Street and many media commentators were assuring them that ‘green shoots’ were appearing in the economy. These ‘green shoots’ also provided justification for a climb of some 40 percent in stock markets. This was in the face of a fall in corporate earnings of some 38 percent. Americans found it odd that if the economy was improving why unemployment was rising with few jobs to be found.

Until very recently, politicians and economists dispelled concerns about rising unemployment by describing it as a ‘lagging’ indicator and asserting that the economy was already ‘bottoming’. 

Unlike some of its predecessors, the current recession has its roots not in interest rate movements but in sub-prime lending which, in turn, generated massive cuts in consumer spending. Therefore, it is becoming increasingly clear that unemployment is not a ‘lagging’ indicator, but a ‘leading’ one.

Lending to those who either are unlikely or unable to finance a loan is known as sub-prime lending. Short of some unusual event, almost all sub-prime lending is destined for default.

Predatory lending occurs when agreed upon terms include hidden or unknown provisions favorable to lenders. The borrower, unaware of the true loan terms, seeks to profit from an increase in the underlying asset price. The lender, on the other hand, hopes for default, resulting in the seizure of the underlying security. These predatory lending practices by banks and others have resulted in many Americans losing their homes.

Some four years ago, the Bush-Greenspan era of cheap, easy money spawned the greatest and most irresponsible asset boom in history. Based largely on real estate, sub-prime lending lay at its epicenter.

Sub-prime lending was dangerous to the extreme. Indeed, it was so risky that many lenders, such as banks, tried to distance themselves from borrowers. The ‘securitization’ of real estate loans and their ultimate triple ‘A’ rating spread the largely unseen virus throughout the international finance system, which was too big to fail.

Adjustable Rate Mortgages rate increases triggered defaults and the price of real estate stalled. Collapse cascaded and the whole pack of financial cards teetered and tottered on the edge of a financial abyss.

In the face of facing plunging home values, depleted retirement funds and tightening credit, consumers understandably were scared. They cut spending and tried to increase their savings, even at historically low rates of return.

The fall in consumer spending caused business sales to drop. This, in turn, resulted in commercial layoffs as a ‘lagging’ indicator of recession.

There are now some 15 million Americans ‘officially’ unemployed or about 10 percent of the workforce—the highest figure for 26 years.

Worse still, the ‘official’ unemployed figures are only the tip of the iceberg. They do not include the very long-term unemployed who are no longer eligible for unemployment benefits. Furthermore, the official numbers do not include those laid off who, in desperation, have accepted part-time or ‘odd’ jobs at much reduced wages.

If these ‘marginally’ unemployed are included to reflect reality, the total is almost 30 million, or 20 percent of the work force. This alarming number is only 10 percent below the crisis level of the Great Depression.

Although the ‘true’ figures were not disseminated widely, those still employed worry that they may receive a ‘pink slip’ at any time. The fear of future unemployment has encouraged consumers to cut back even further on spending, trying to save.

Most previous recessions were caused by an increase in interest rates. The resulting downturn in employment therefore, was a lagging indicator of both recession and recovery.

This recession, on the other hand, was caused by a sub-prime inspired credit crunch which caused American consumers to cut spending as a ‘leading’ indicator. Therefore, for the economy to pick-up, consumer spending must revive. This cannot happen while severe unemployment threatens.

Unusually, therefore, employment is now a ‘lead’ indicator of recovery.

Knowing this, it is odd that the Administration would choose this precise moment to level higher taxes, such as ‘Cap and Trade’, on American corporations discouraging new hirings.

There is talk of more financial stimulus, increased entitlements spending and a possible massive bailout of California and other states. Heralding more taxes, this will serve to lower consumer morale still further.

Regrettably, the stage appears set for recession to shrink into depression. Given classical economic lags, it is unlikely that the economy will recover until about 2012. This will mean a stock market decline lasting for some three years.

The increasingly hard times ahead mean that casual or ‘odd’ jobs will replace real jobs at least for some time. What is needed is for the Administration to begin spending massively on much needed infrastructure projects.  When this happens, real jobs will be created, consumer spending will increase, and the economy will improve.

How odd that, in theory at least, the answer appears so simple.

In September 2008, the financial world faced the equivalent of a nuclear meltdown. However, things appear to have improved recently on the economic front. Consumer confidence has risen, companies are shedding labor at a slower rate and stock markets have rallied by some 37 percent despite the fact that “better than expected” corporate earnings have fallen by some 38 percent. A reaffirmation of faith in the economy has accompanied this apparent upswing.

However, two weeks ago, Great Britain, one of the few nations never to have defaulted on its debt, was put on ‘credit watch’. The bond markets reeled in shock taking U.S. Treasury bond yields up 1.5 percent for the year, portending a general increase in interest rates. Attention suddenly focused on the possibility that even the United States might lose its prized triple ‘A’ credit rating. In addition, the U.S. dollar plunged, placing yet further calls for defensive interest rate hikes.

In addition, there was growing appreciation of the fact that America has to refinance some $2.5 trillion of its debt this year. This is in addition to about $2 trillion of new debt. Taken together, this $4.5 trillion of potential financing is sending ripples of fear throughout the Treasury bond market.

Last week, China voiced concerns about the U.S. dollar and asked the U.S. Treasury for ‘special’ guarantees. If given, will they eventually be extended to private investors?

All in all, has the American economy really improved or has the situation actually worsened?

Aside from massive Government aid and some important accounting changes that allowed Wall Street to continue ‘hiding’ its toxic assets, what else has changed?

Citizens’ funds have saved Wall Street for the time being from a catastrophic bank run and immediate bankruptcy. In addition, the Government has borrowed and created trillions of dollars to save non-banks such as AIG, GM and Fannie Mae. Furthermore, trillions of additional dollars are being injected into the economy. It is understandable, therefore, how the sanguine and the economically blinded could have believed self-interested investment professionals who preached that the good times had returned. But what is the reality?

The stock market revival and the continued strength in the bond markets was predicated largely on the hope that governments around the world could raise enough money to halt a recession which has already slowed world trade by 80 percent and claimed over 10 percent of American jobs. It was assumed that the full faith and credit of governments and particularly that of the U.S. Treasury was limitless. The basis of optimism appeared to be that government entitlement and corporate subsidy spending or socialism would mean money for all.

History shows that socialism feels good initially. But as Winston Churchill observed, “Socialism is the philosophy of failure, the creed of ignorance and the gospel of envy.” Simply put, it is impossible for everyone to be given money that has not been earned by successful economic effort.

International currency and government bond markets are not comprised exclusively of private institutions that can be ‘pressured’ by politicians. They are largely influenced by governments. Creditor nations such those as China and Japan are powerful players. Indeed, these two countries alone hold some $2 trillion, or approaching 20 percent of the U.S. Treasury market. Should these countries become more concerned about a potential rise in U.S. inflation, they might sell their long Treasuries to move to short dated ones. This would devastate long dated Treasury prices, sending yields sky high and with them mortgage rates.

Should investors become unnerved as to the continued triple ‘A’ credit rating of U.S. Treasuries or the stability of the U.S. dollar, the resulting massive defensive selling could cascade towards a catastrophic fall in U.S. Treasuries and U.S. dollar values. This would not just hinder the Government’s ability to borrow; it could halt it for a time. The effect on the massive proposed stimulus packages would be devastating to the Administration.

The Government is well aware that an increase in U.S. interest rates would stop any economic recovery in its tracks and cause stocks and bonds to plunge.

International faith in America’s finances is ebbing away. With it, America’s ability to raise credit also is falling fast. Without a ready access to credit, the Government would be severely hampered in its entitlement spending.

Taken in isolation, the situation is bad enough. But America is not the only massive borrower. Most nations now face an era of major deleveraging. The cash that many governments need to borrow to stimulate their economies is in decreasing supply.

With declining investor faith in the economy, the U.S. Treasury is in increasingly severe competition for scarce funds. That competition will most likely result in higher interest rates and even the imposition of exchange controls, both of which would help drive the world further towards depression.

People have faith in those who pay their bills. As the Government increases its debts and fails to meet its obligations, not much more than ‘little faith’ can be expected.

The International Monetary Fund (IMF) warns of a serious economic slump. Meanwhile, Fed Chairman Ben Bernanke assures audiences that the U.S. recession will ease in the second quarter of 2009 ending flat in 2010. He also maintains that inflation is not a present concern. Remakably, while corporate earnings, the classic driver of share prices, have fallen by some 37 percent, stock markets have risen by almost the same percentage. Many investors feel more confident because of Bernanke’s stance. The real question is whether this confidence is based on reality?

The American consumer is in shock and hoarding cash. The evidence shows a deepening world recession, not a looming recovery. Worse still, there is a growing sense that inflation will soon explode, creating the worst of all worlds—economic stagnation accompanied by financial inflation, or stagflation!

Recently, the IMF warned that historic evidence shows that when a recession is accompanied by a financial crisis and appears as an internationally ‘coordinated’ downturn, it is usually both more severe and longer run.

In the first quarter of 2009, the mighty American economy shrank by an annual rate of 6.3 percent. The economy of Germany, the world’s largest exporter, fell by 14.4 percent, bringing the 16 country Eurozone economy down in the same quarter.

Among the ‘tiger’ economies of the Far East, the situation is even worse. In the first quarter of 2009, Japan, the world’s second largest economy, contracted at the alarming rate of 15.2 percent. Japan’s exports, accounting for some 18 percent of its economy, have declined 47 percent. In addition, the economies of Singapore and Thailand now are contracting at over 20 percent a year.

On the optimistic side, some observers point to an apparent pick-up in the Chinese economy as a result of its $700 billion stimulus package. But, with some 80 percent of this package already spent, Chinese exports are down by almost a quarter, leaving some 40 percent of China’s factories closed.

With these figures in mind, it will come as no shock to learn that the Baltic Dry Index, perhaps the most accurate measure of international trade, has fallen by some 80 percent. What is surprising is that world stock markets remain buoyant in face of the increasing evidence of a looming worldwide depression.

Partial evidence of worsening world trade is the large number of protectionist measures being undertaken by major trading nations. Economists now believe that similar restrictions taken in the early 1930’s led to increased contraction of approximately one third of world trade.

Today, there is one major strategic imbalance in world trade. Led by the United States, the consuming nations are over consuming, depleting their wealth and establishing destabilizing deficits. Led by China, the producer nations are concentrating on exporting to the exclusion of building domestic demand. They are accumulating vast and unbalanced trade surpluses.

In addition to being unbalanced towards over consumption, the consumer nations also are grossly over borrowed. To restructure, they must undergo the political pain of deleveraging. But political leaders have little appetite for such healthy pain and resort to delaying the inevitable by administering the drug of government spending. When this money is spent on boosting consumption and entitlements rather than invested in infrastructure projects, it leads inevitably to inflation and currency devaluation.

Major governments currently are injecting trillions of dollars into their economies in a desperate attempt to avoid deleveraging and the restructuring of their economies. Until recently, the current level of government spending would have been considered incredible.

The U.S Government has deployed some $3 trillion to revive its financial system. Approaching socialism, the Administration now is dispersing trillions of dollars into the economy in an effort to save a multitude of corporations, including some now defunct companies. This will not only delay deleveraging but will also render American companies increasingly noncompetitive.

Despite tax revenues falling by some $180 billion into deficit this year, government spending nevertheless will increase over five fold from last year. Already, the budget deficit is running at some 13 percent of GDP.

Massive government spending without doubt will cause some temporary pockets of growth. But, money which is ‘borrowed’ for non-investment, also represents massive latent inflation, which, in turn, will exert explosive upward price pressure on gold.

America now faces economic stagnation on the one hand and high latent financial inflation on the other. When inflation eventually emerges, the economy most likely will experience hyper stagflation.

The crucial problem with stagflation is that the cure for economic stagnation includes reduced interest rates and increased government spending which fuels even more financial inflation. Conversely, the cure for inflation, higher interest rates and a reduction in government spending, leads to deeper stagnation.

Normally, the price of gold falls and rises as the balance of battle sways between stagnation and inflation. However, in the coming environment, a third and novel element will likely be experienced—the onset of financial panic!

There is only one true hedge against currency depreciation, inflation and hyper stagflation—gold.