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Melman Minutes - By Leonard Melman
MELMAN MINUTE March 12, 2012

One of my favourite sayings is "Pay attention to what he DOES, not what he SAYS."  That same saying can be applied to our world of economics, particularly as it relates to what the financial leaders are SAYING about resolving the problems of Greece and what the actual bond markets are DOING in reaction to the latest series of machinations.


What we have been told is that the latest creation of the European Central Bank, namely a 500 billion Euro fund to help refinance Greece's bonds on which they are unable to promptly repay principal and interest, will allow Greece to regain a sounder financial footing.  What the actual bond markets are saying is a version of "just a minute"!


The bond market is an excellent example of a pricing mechanism.  When the market has confidence that a particular bond represents a sound investment with confident anticipation of proper repayment of principal and interest exactly as scheduled, it is inclined to pay a full price - usually expressed as 100 cents on the dollar of face value - for such an instrument.  To the degree that such confidence is replaced by doubts, the price the market is willing to pay for the face value of such a bond drops.  Also, as that value drops, the resultant interest rate payable to new owners rises.


With that in mind, please note that the bond market has already begun pricing a new series of Greek bonds which will shortly be issued as part of the scheme to repay a portion of the old ones which are now in default.  Considering the above, if the market had confidence in the scheme's eventual success, the new bonds would be priced at 100 cents on the Euro, but that is not the case.  In fact, the new issuance of bonds is already being discounted to abysmally low levels.  Advance trading has established a range of only 15 to 27 Euro cents of face value, depending on the individual bond's size, maturity, etc.


Traditionally, only the lowest quality of bonds in the 'junk' category are priced at such low levels, meaning that there is a widespread feeling that Greece's problems are not at all resolved for anything other than the immediate future, if even that has been successfully accomplished.  As Adrian Miller, Senior VP of GMP Securities LLC told the Wall Street Journal, "...The market is telling you that it's built in the probability that we will be having another restructuring within the next twelve months." 


One of the major concerns which is clearly troubling the financial markets is exactly how the Greek government is to successfully repay debt when it is being sundered by a deepening economic contraction, one which appears to fully meet many the historic criteria for a full-blown "Depression" as it struggles with an economy contracting at almost eight percent per year, unemployment in excess of twenty percent, youth unemployment of close to fifty percent and a decimated real estate marketplace.  The unanswered question is exactly what could be the source of sufficient revenues to both support the nation's elementary government service requirements while at the same time properly servicing debt.


There are no evident answers and, therefore, we are seeing such dismal performance for that country's new debt offerings.


Greece is only one of a series of difficult situations, some of which may have been postponed but few, if any, have been truly resolved in any sustainable manner.


For example, we note that China is beginning to provide more data which indicates that its miracle economy may indeed be showing signs of strains.  The latest piece of information notes that China has just suffered the greatest balance of trade (BofT) DEFICIT in its history.  For well over a decade, the only trade figures coming out of China have detailed BofT surpluses whereby China has sold more value to the rest of the world than it has purchased, but this past month of February, China reported a BofT deficit of $31.5 billion.  Additional negative information such as weak growth in car sales and a continuing steep drop in property sales suggests that all is not well within the world's second largest economy. 


If China is truly entering a slow-growth or no-growth economic phase, that could set off deep concerns among those companies and countries now exporting a host of raw materials to China and could indeed be the harbinger of slowing economic development for such nations as Canada and Australia - both heavy exporters of natural resources.


There are other concerns as well which have only recently hit the world's news wires.  Slovakia has just concluded their national elections and the victors turned out to be that nation's leftist Social Democratic Party which ran on a platform of questioning the need for austerity as well as high taxation for both corporations and those who are among that nation's wealthiest citizens.


We can only wonder if the Slovakian election represents a renewed trend within Europe back toward the kind of socialist philosophy which demands continuation of services to the public regardless of cost or financial stability.  If that is the case, we would suggest that a wave of new national defaults may be in the offing in the not-too-distant future and perhaps one of those nations might be once-mighty France where President Sarcozy is now trailing Socialist candidate Francois Hollande in the upcoming presidential race in that nation.


There is clearly a drawing of battle lines building in many parts of Europe.  On one side we find those who wish to impose fiscal austerity in the form of diminished government services and expenditures in order to bring debt under control while on the other side are those who believe that austerity inflicts the greatest harm on those who can little afford such consequences and, therefore, strike out for a continuation of all manner of government services regardless of the economic consequences.


In my personal opinion, a long hot summer of struggle will take place in the months ahead and it is our belief at The Melman Report that the forces of socialist action will gain the upper hand as the year progresses.


During the past months, terrorism and conflict in the Middle East has taken something of a back seat to the troubles fomenting in Europe, but that may change due to a pair of specific incidents, both occurring within Afghanistan.  One was the inadvertent burning of several copies of the Koran which resulted in frenzied protests denouncing America and the West and the second just took place over the weekend when an American soldier is reported to have single-handedly slaughtered sixteen Afghani citizens, most of them women and children.


I believe the combination of both incidents may serve to convince the American people to simply demand an early exit of all American troops from Afghanistan without delay, just as they are serving to strengthen demands of Afghanis for the Americans to get out now and forever.


If that is indeed the early result, then questions must be raised regarding the long-term stability of the region where the forces of Al Qaeda and other such organizations might have a much freer rein to re-build their forces and thereby increase their ability to disrupt tranquility inside and outside of Afghanistan.


The list of problems seems to be almost endless and the potential long-term harm may be compounded by the forthcoming American general election this November as few candidates - including President Obama - would likely be willing to take the kind of decisive action which might alleviate the difficulties but which also might anger high numbers of voters.


As of 9:00 AM PDT financial markets in North America are diverging with the Dow Industrials up by about 20 points while the TSX Index is down by more than 60, thanks to lower resource quotes.  Precious metals are trending lower with gold down by about $8 to just above $1,700 while silver is off by more than 40 cents to near $33.80 per ounce.  Base metals are slightly lower on balance while mining share indexes are down by more than one percent.


In other markets, crude oil is off by more than one dollar to near $106 per barrel, the US Dollar is close to unchanged in currency markets and long term interest rates are trending lower.




All quotes US$ unless otherwise noted.


Next Melman Minute scheduled for Wednesday, March 14, 2012.  



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