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 - June 9, 2010 - - - - - Two associated items of particular interest crossed our desk this morning.  In one case, we received word that Senate Democrats are now proposing to more than double the tax rate on private equity hedge funds.  In the other case, we have just read a column written by David Warren and published in the Ottawa Citizen newspaper which suggests that the economic future might not be a bed of roses. Among other subjects, Warren's column deals with the negative results of over-taxation, relating his material to the "Laffer Curve."  As readers might recall, the Laffer Curve was the invention of economist Arthur Laffer and dealt with the reality that revenues from taxation actually were reduced when rates rose above the level where they would deter profit-producing activities.  As Warren points out, "...The underlying reason is plain.  As tax rates rise, the return on additional effort diminishes.  On the other hand, the effort to conceal income, or move it offshore, increases." Given the reality that the proposed increase in hedge fund tax rates noted above is only one of a multitude of such proposals to raise taxation, it is apparent to us at TMR that the political establishment appears to be much more interested in catering to the popular desire to "soak the rich" rather than conducting their law-making work in accord with sound economic principles. We find it reasonably easy to predict that as taxation rates on various human activities continue to rise, the revenue to governments from those sources will decline - thereby exacerbating the future impact of governmental deficits.  Ironically, in his recent testimony to Congress, Fed Chairman Bernanke issued a warning that the recent massive federal budgetary deficits could continue well into the future and noted that President Obama's forecast deficit for fiscal 2011 was $1.6 trillion.  He also noted that because the current recovery could be somewhat below historic norms, further stimulation of the economy would likely be required which, of course, would worsen the deficit picture. This apparently insoluble dilemma is one of the major reason why we believe that insurance positions in gold and silver appear reasonable and cautious for the prudent investor.  Of course, we also repeat our warning that no investment positions should be taken without prior consultation with registered investment professionals. ............... We note with interest an article just published in the financial magazine "Bloomberg Business Week" which deals with the strength of the presumed recovery.  Their conclusion is that there are valid questions regarding its strength and one of their key points is that while an observer would normally expect pricing strength to enter the market as business conditions improve, there has been little evidence of such activity so far this year.  In fact, the opposite condition appears likely to be true. As the publication notes, "...Bargains are everywhere in America these days.  Men's shirts and sweaters were 3.4% cheaper this April than a year ago.  Prices also fell for eggs, peanut butter, bananas, potatoes, hotel and motel rooms, cosmetics, curtains, rugs, tools, and lawn care."  They also note that the American Consumer Price Index rose just 0.9% during the past twelve months and, "...that's the smallest increase since January 1962 when JFK was President." Another troubling feature about this 'recovery' is similar in nature.  We would normally believe that if the recovery was progressing in a typical fashion, the demand for workers would be growing and wage rate increases would be much more forthcoming than during the recession.  However, that has not been the case as we learn, "...annual growth of average annual earnings fell from 3.5% in April 2007 to 1.6% this April."  The article also points out that this recovery might be sub-standard because the previous recession was so severe that the industrial complex is littered with over-capacity and an abundant supply of quality labor left over from massive layoffs and downsizing which took place from 2007-09. All of this suggests to us that there is a lingering danger of at least a temporary spate of actual price deflation as well as a recognition by governmental authorities that they may very well be forced (by their own interpretation) to maintain strong stimulative fiscal policies, despite the implication that such policies will add to future deficits, not correct them. .................. Another serious problem looms on the horizons and we have just seen yet another example of what could become a major crisis in the months and years ahead.  In this case, we are referring to the wretched financial conditions of numerous state, provincial, city, county and municipal governments.  That latest one to make headlines is Central Falls, Rhode Island as it joins previously bankrupt Vallejo, California by acknowledging that they are now unable to pay their current bills nor provide for future contracted retirement benefit programs. As the Wall Street Journal just noted, "...Central Falls, a small and deeply-rooted Rhode Island city, has handed control of its finances to a receiver, a rare step that many in the $2.8 trillion municipal bond market are watching to see how stressed municipalities may deal with deepening fiscal problems."  They inform us that the city, "...is struggling with growing budget deficits and the need to pay interest on about $17 million in general obligation debt...It's a common story in towns and cities across the country..."  (Our emphasis) As has been common in stories of this nature for the past several years, the underlying root problem has been over-generous contracts awarded to civil service unions during good times which can no longer be afforded.  We are told one of the goals of a receiver would be, "...to rework union contracts, bond payments and other obligations..." We can only imagine the thinking in Washington - and other national capitals faced with similar situations in their home countries - that a flood of such defaults must be avoided at all costs.  Therefore, we believe that economic stimulation will grow, not diminish, and the ultimate result will be to increase inflationary pressures over time.  Ergo, we maintain our suggested positive outlook on gold and silver in preference to the more basic raw commodity items such as base metals. One important commodity is Crude Oil and the chart indicates it might be headed higher, at least over the short term.  We have recently been studying new information on Crude which will be discussed in our next Melman Minute, scheduled for this coming Friday. In the meantime, we are witnessing one of the financial marketplace's period rallies this morning, this one based on news of improving Chinese exports data.  As of 10:00 AM, the Dow Industrials were ahead by about 100 points while Canada's TSX had gained more than 60.  Precious metals were down sharply, but base metals - which have recently been moving counter to the precious metals - are up sharply on the Chinese information.  Crude oil is up by almost $3.00 to just under $75 per barrel while mining share indexes are close to unchanged with negative precious metals and positive base metals performances offsetting each other.  Long term interest rates have moved higher while the US Dollar Index is down by about 50 basis points. - - - - - All quotes US Dollars unless otherwise indicated. Next Melman Minute scheduled for Friday, June 11, 2010.   ◄  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.