Wednesday, December 05, 2007

The Great Race to Zero

A little break from my 2008 predictions to take note of yesterday’s surprise interest rate decrease by the BoC.

While a 25pt decrease is not a big issue in of itself, it is a huge sign that the BoC is going to join the U.S. Fed in a series of competitive rate cuts to devalue the dollar in what I’m calling the “Great race to Zero”.

Why are they doing all this?

They claim that its simply an attempt to stave off an impending recession but in reality this is about saving a financial system that is all but dead. My bet is that the Fed will lower rates down near 2% by the next U.S. election but you will see the spread between the Fed rate and the street rate will grow giving the Banks a larger profit margin. The Banks will basically be fleecing those who can still pay their bills in order to cover off bad debts; the slight improvements in the street rates will hopefully decrease total value of defaults, making the potential 500 billion in bad mortgages somewhat smaller.

At the same time low interest rates will weaken the U.S. dollar and pump in liquidity in an attempt to inflate their way out of both Government debt and onerous public entitlements. Imagine that each time inflation rises by 10% you tell the public inflation is only 3%. This means inflation (even with a cola clause) is good for the Government and the management of its liabilities because they get to pay with freshly created/devalued dollars. What good is a promise of a $1000/month pension when after inflation it won't buy you more than 1 buggy of groceries.

In reality the U.S. is creating money at the blistering rate of 14%, making the real cost of living is far higher than stated by Gov. Shadow Government statistics claims CPI is really over 10%. Have no doubt Canada's stats are just as biased/corrupted/massaged/just plain wrong!

A low dollar will create export jobs, price imports higher and hopefully lower trade deficits.

“Surely you overreact?” you say.

No I don’t think I do. The U.S. Federal Gov has about 56-60 trillion in real debt (if they used the same accounting standards they demand from businesses) or about 3.5 x GDP
Add in municipal, state, business and personal debt and the U.S. tops out near 100 trillion dollars or about 7.5 time the U.S. GDP

That’s problem #1

Problem # 2

Housing: 2 more years of mortgage resets are still ahead which means 2 more years of foreclosures which could total 400-500 Billion in the subprime class alone, some higher quality paper may also take a hit including business loans, prime mortgages, and credit cards. If banks are in trouble now how will they fair when more of this paper goes bad. A perfect example is the desperation of Citi which sold 4.9% of itself (the max allowed without Federal approval) offering a staggering 11% interest.

Problem 3.

Derivatives: 400 Trillion dollars worth of unpricable paper, 90% of which trades in back rooms with no regulation certainly sounds like trouble to me. These guys are shady and manipulative when we can see what they are doing and yet they are trading 6 times the value of the world GDP in mystery paper. What’s next financial pixie dust to sprinkle on your portfolio?

Martin Weiss from Weiss Market Analysts has a great article on "Money Panic" that
states 5 of the biggest U.S. banks have exposure to credit risks that range from Wachovia’s mere 89% of their total capital to JP Morgan whose credit exposure is a whopping 388% of their capital. A 26% default rate is all that is needed to wipe out all of JP Morgan’s Capital.

We are on the verge of a fundamental change, nothing is certain and nothing is safe. The U.S. is desperate and is trying to wiggle out of financial troubles by screwing its debtors, citizens who save, citizens and employees who are owed medical coverage, pensions or welfare. The rapid and purposeful devaluation of U.S. debts is in effect a declaration of economic war. The U.S. is saying “Screw you Guys, we are paying our debts with half priced dollars and you’ll like it”

The BoC has taken the challenge and lowered rate ensuring that our citizens will also suffer the ravages of inflation, lowering the price of our wares for export, raising the prices of imports and taxing our savings by devaluing them. Of course this will give the Fed Reserve motivation to lower more and faster in order to stay ahead of the curve.

Inflation management is supposedly the goal of the BoC but its actions and explanation says economic stimulus is more important, screw the real costs of such a policy. It does however support my stance on buying silver and gold. The entire situation strengthens my belief that a major Fiat currency or three will be destroyed in the next 5 years.