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 21, 2010 - - - - - As we noted in this space last Friday, former Federal Reserve Chairman Alan Greenspan has just authored a widely-published study warning that the economic underpinnings might be in worse shape than generally assumed.  What struck us about his article was that it was not of the "don't blame me" nature, but appeared instead to be a serious study aimed at providing objective, valuable information.  For that reason, we have given this article our serious attention. Mr. Greenspan first offers his explanation of why there has been no panic to date among the general public when he states, "Despite the surge in federal debt to the public during the past 18  months - to $8.6 trillion from $5.5 trillion - inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued.  This is regrettable, because it is fostering a sense of complacency that can have dire consequences."  (Our emphasis) He then explains how the federal government has been able to finance debt without a concomitant rise in interest rates.  "...the unexpected default of Lehman Brothers in September 2008 created a collapse in global demand that engendered a high degree of deflationary slack in our economy.  The very large contraction of private financing demand freed private saving to finance the explosion of federal debt."  Our interpretation of his implication is that as soon as private demand picks up significantly, that slack will vanish. He then turns to the gap between the government's borrowing demands and the ability of the private debt markets to handle those demands.  He states that there had always been an excess available, but dramatic changes have been taking place, most notably in the fact that public debt in the USA, as a percentage of Gross Domestic Product, has been rising rapidly and with each increase, the gap between the productive economy's ability to finance government debt and the scope of such indebtedness is steadily diminishing.  As it diminishes, the US government and the Fed have been turning more toward Fed-financed debt, rather than true borrowing. Greenspan describes such dollar-creating debt as being free of credit risk, since the government can and will likely continue to authorize additions to that debt to refinance maturing loans and to fund future deficits.  But the case is different with interest rate risk.  "The U.S. government can create dollars at will to meet any obligation, and it will doubtless continue to do so.  U.S. Treasurys (bonds and notes) are thus free of credit risk.  But they are not free of interest rate risk.  (Our emphasis) What has been the most important factor in avoiding such risks to date?  Greenspan then turns to the Euro crisis as the most important factor.  He reports the situation regarding risk evaluation for U.S. government dollar-denominated securities was rising, "...until the unexpected Euro-zone crisis granted a reprieve to the U.S."  How did it do this?  By convincing multitudes around the world that U.S. government dollar-denominated debt instruments represented a 'safe-haven' and international investors then bought such paper in record volumes, driving up the quotes on Uncle Sam's debt instruments which forced interest rates downward. How much longer will this reprieve lat?  "I grant that low long-term interest rates could continue for months, or even well into next year.  But just as easily, long-term rate increases can emerge with unexpected suddenness."  Greenspan then turns to what we regard as a vital ingredient of the entire debacle, which is just how fundamental has been the change in attitude over time among both the American public and American fiscal authorities.  "In the 1950s, as I remember them, the U.S. budget deficits were no more politically acceptable than households spending beyond their means.  Regrettably, that now quaint notion gave way over the decades, such that today it is the rare politician who doesn't run on seemingly costless spending increases or tax cuts with borrowed money...The federal government is currently saddled with commitments for the next three decades that it will be unable to meet in real terms." Greenspan is not optimistic for the future, unless dramatic changes are to be made.  First, he notes that, given the apparent lack of high interest rates combined with recent strength in the Greenback, the consequences of massive deficits are not apparent to the public and so, "...the budget constraints of the past are missing."  And what of the U.S. Dollar?  "It is little comfort that the dollar is still the 'least worst' of the major fiat currencies." Regarding the rise of gold to new record highs, the once strong advocate of a currency of gold notes, "But the inexorable rise in the price of gold indicates a large number of investors are seeking a safe haven beyond currencies." At the conclusion of his article, he points out, "The United States, and most the rest of the developed world, is in need of a tectonic shift in fiscal policies.  Incremental changes will not be adequate...Our policy focus must therefore err significantly on the side of restraint." ............ Unfortunately, it appears that Greenspan's fears that such a policy shift may not take place appear to be well-founded, that the current gaggle of political leaders may have no appetite for restraint.  In this morning's Toronto Globe and Mail financial section, "Report on Business", there is an in-depth study authored by Jeremy Torobin, which is headlined, "Canada, U.S. split on road to recovery:  Harper urges deep cuts, while Obama stresses caution on ending global stimulus measures."  Mr. Torobin then informs us that, "...he (Mr. Harper) is stressing the need for countries to move quickly, by next year at the latest, to slash deficits.  But Mr. Obama warns that weak demand could make the world slip back to recession, and he emphasizes the need for some countries to continue to spend - and that if a double-dip (renewed recession) comes, governments might have to intervene again."  (Our emphases) It is our belief that two closely-related themes seem to emerge from this information.  In the first case, that of Greenspan's article, the only fact that has allowed the U.S. to escape the consequences of massive debt financings has been the sudden re-strengthening of the U.S. Dollar in relation to the troubled Euro, an 'escape hatch' that cannot be sustained unless fundamental changes are made quickly to restore debt sanity to the U.S.  In the second case, President Obama, the de facto leader of the free world, says he wants no part of such sanity.  Now, please look at the multi-year charts of both long-term interest rates and the U.S. Dollar Index. It appears clear that a major trend change away from the general 30-year bond rally, accompanied by generally declining rates, has not yet taken place.  At the same time, the DX chart suggests that a major base could be forming which indicates a strong possibility that the Greenback may break out to the upside, and, therefore, the chart pattern and the apparent fundamental information may not be in accord. ............ Financial markets this morning opened stronger on the basis of news that China was at long last going to allow their currency, the "Yuan', to trade a little more freely and on that announcement, securities markets in Asia, Europe and North America traded higher.  As of 10:20 AM PDT, both the Dow Industrials and Canada's TSX Index were up about 60 points.  Given the concept that some of the tension has been removed from the world's currency markets by the Chinese announcement, gold is undergoing one of its typically sudden declines, off by about $16 to just over the $1,240 mark while silver is also lower, trading near $18.80.  Industrial and base metals are moderately ahead but mining share indexes have turned to the downside by about two percent.  Crude oil has given back earlier gains and is now close to unchanged while long-term interest rates are up a bit while the U.S. Dollar remains little changed. - - - - - All quotes US$ unless otherwise indicated. Next Melman Minute scheduled for Wednesday, June 23, 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.