A Melman Minute By: Leonard Melman   NOTE: In order to complete Mr. Melman's forthcoming book on the essential fundamentals of the developing international financial crisis and its relationship to gold and silver, new "Melman Minutes" will be posted only three times per week, each Monday, Wednesday and Friday. Since the work has been expanded to include potential solutions to the growing list of seemingly insoluble dilemmas, the working title of the book has been revised to 'REVERSING THE WAY IN!"   MELMAN MINUTE - May 28, 2010 - - - - - Quite suddenly, we are beginning to see a barrage of stories relating to a condition which most people never consider, namely visible price deflation.  Several indicators appear to point to this as a potentially devastating problem for governments in particular. One of the key indicators we keep track of is the various categories of money supply, particularly the "three M's", M-1, M-2 and M-3.  All are showing us that something unusual may be happening.  While M-3, the widest accepted definition of money supply is no longer 'officially' published by the U.S. government, private economists keep track of the component categories and are able to reconstruct a 'de facto' replica of what M-3 would be if still officially reported.  According to their calculation, M-3 is suddenly contracting at a rapid rate.  In fact, their findings were sufficient for the U.K. Telegraph to headline an article, "US Money Supply Plunges at 1930s Pace as Obama Eyes Fresh Stimulus", and the story quotes International Monetary Research economist Tim Congdon as noting, "...the descent in the money supply is frightening...the plunge in M-3 has no precedent since the Great Depression..." The other two widely-followed "M" indicators are also showing a dramatic change from rapid growth during the period 2001-08 toward virtual stagnation from mid-2009 forward.  The actual numbers for M-2 showed annual growth rates peaking at above 10% in 2008, but have now recently retreated barely one percent. The deflation argument received additional support when the U.S. Department of Commerce reported that Retail Prices for April actually declined by 0.1% - an astonishing statistic when one recalls the huge levels of economic stimulus that have been added to the economic structure since mid-2008.  One might have expected such measures to stimulate huge increases in consumer economic activity.  They obviously have not. One of the results of low inflationary - or outright deflationary - expectations is the government financial authorities are unlikely to raise interest rates and that could have a pair of profoundly negative long-term economic consequences.  Low rates discourage savings and it is savings that provides the soundest basis for future investment.  Also, low interest rates result in diminished discretionary spending as stored financial assets earn minimal returns - and it is low discretionary spending that is one of the factors which are retarding economic growth. Which leads to the following dilemma for government leaders.  If they keep interest rates low, discretionary spending is retarded and savings are discouraged, both of which have negative long-term consequences.  However, if interest rates are raised, two powerful forces - neither of them desirable - would be unleashed. In the first case, given the mountain of US government debt which has just passed through the $13 trillion level earlier this week, any increase in interest rates would also increase the amount of interest the government must pay out, thereby increasing deficits at a time when that could have undesirable political consequences, to put things mildly. In the second case, higher interest rates could also easily result in slowing down specific industries such as home-building and auto sales. And so, we watch closely for clues regarding the next direction of monetary policy, recognizing that either direction could have hazardous implications. We would estimate that if deflation combined with low interest rates prevails, governments could find themselves with declining tax revenues, thereby exacerbating the size of future deficits as well as the ability to finance their own operations, outside of the requirement to increase the artificial creation of Federal Reserve Notes.  In such circumstances, we would likely remain positive about the monetary precious metals, but negative regarding the base metals and other industrial commodities. However, if the government goes ahead and risks rising inflation and higher interest rates in order to follow an exceedingly stimulative monetary policy, then, in our opinion, we would expect both metals categories to perform well. Truly, we believe the evolution of monetary policy over the next several months could have dire consequences for millions around planet Earth.  In the meantime, it would appear prudent to keep a portion of your monetary assets in short-term, secure instruments. One clue regarding the direction of policy will be interest rates on relatively short term government debt.  Bearing in mind that interest rates fall as the quote on these notes rise, it can be seen that rates on these widely-followed instruments have varied dramatically through the last decade.  As Greenspan's policy of lowering rates to offset the stock market's plunge began to take hold in 2000, rates began to fall sharply until late 2003, at which time they began to rise through mid-2006 - until the real estate market began to show signs of evident weakness.  Policy was then dramatically reversed until those rates reached effective 'zero' near year-end 2008 and they have held in that area since.  We believe a drop in the quote on notes to below 107 would signal an important change in direction of interest rate policy. ................   As of 10:00 AM PDT, financial markets opened slightly lower, held firm for a while, and then began to decline with the Dow Industrials and Canada's TYX Index each down by about 100 points.  Both precious and base metals are moderately lower; crude oil is falling once again; interest rates moves have been quiet; and the U.S. Dollar is slightly stronger in currency trading.  Mining share indexes are down by about one percent so far. - - - - - All quotes US$ unless otherwise indicated. Next week's Melman Minute schedule will be determined by Internet availability as we will be traveling in northern Quebec on an analyst tour of several rare earth and lithium mining projects.  We will post them as the opportunity arises until this coming Friday when we plan to return to our normal schedule.   ◄  Previous Minute                                                                                                        Next Minute  ►
		DISCLAIMER The information presented above is based on data which we believe to be from reliable sources, but the accuracy of which cannot be guaranteed.  Any opinions or predictions contained herein are those of the editor and are likewise offered also for information purposes only. Any investment decisions should be made only following consultation with registered investment professionals.