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THE POST-ELECTION BUSH EFFECT

It was a nasty campaign season for the presidential elections with constant derogatory comments coming from each candidate. To put it succinctly, I’m very glad to see most of the name calling and mud-slinging behind us. The big picture I walked away with brought clarity to my mind that we live in a much divided America. There appears to be a growing gap between rich and poor, tax cuts or no tax cuts, pound the war drums versus stop the killing, more welfare and war spending versus growing deficits, and all the other major points of difference. It seems to me a great number of people around the world have viewed U.S. global aggression as something from our policy makers, not the general populace. With our endorsement of Mr. Bush, I believe we have sent the message to the world that we are OK with the current policies of increased spending for war. As a country we must take ownership of the policies of the Bush administration. From a very broad perspective the financial markets are now saying the re-election of President Bush is generally good for the stock market, bad for the bond market and the U.S. dollar, and inversely good for precious metals. The bottom line says we get bigger debts and deficits for our country as a whole.

The big issue moving forward will be higher government debt levels that need to be funded by savings from the rest of the world. “Bush is unambiguously bad for U.S. treasuries if he continues his policies,” said John Richards, a strategist in Tokyo at Barclays Capital. “Heavy military spending policies and tax cuts at home becoming permanent mean a major expansion in the federal deficit.” A second opinion came from Bill Gross of PIMCO when he commented, “We’re looking at $400 billion plus (deficits) as far as the eye can see; that’s a negative for the bond market.” Our weakening economy and need for increased borrowing should work to lower the value of the dollar as foreign investors continue to shy away from U.S. assets. Capital inflows to the U.S. have been declining for seven months now. If the inflows continue to slow we got problems…if inflows ever become net outflows, the dollar could be wiped-out in short order.

The biggest disappointment from all the campaign rhetoric is that many of the real issues were simply glossed-over with political correctness and message discipline from the media. One of the real voices for freedom in the USA is Congressman Ron Paul who writes a weekly column called “Texas Straight Talk,” and his comments dated October 25^th are not the same things you heard from the two presidential candidates. It’s a quick read, so here it is.

Government Debt- The Greatest Threat to National Security
October  25, 2004

Once again the federal government has reached its “debt ceiling,” and once again Congress is poised to authorize an increase in government borrowing.  Between its ever-growing bureaucracies, expanding entitlements, and overseas military entanglements, the federal government is borrowing roughly one billion dollars every day to pay its bills.

Federal law limits the amount of debt the U.S. Treasury may carry, and the current amount-- a whopping $7.4 trillion-- has been reached once again by a spendthrift federal government.  Total federal spending, which now exceeds $2 trillion annually, once took more than 100 years to double.  Today it doubles in less than a decade, and the rate is accelerating.  When President Reagan entered office in 1981 facing a federal debt of $1 trillion that had piled up over the decades, he declared that figure “incomprehensible.”  At its present rate of spending, the federal government will soon amass $1 trillion of new debt in just one year.

Government debt carries absolutely no stigma for politicians in Washington.  The original idea behind the debt limit law was to shine a light on government spending, by forcing lawmakers to vote publicly for debt increases.  Over time, however, the increases have become so commonplace that the media scarcely reports them-- and there are no political consequences for those who vote for more red ink.  It’s far more risky for politicians to vote against special interest spending.

Since 1969, the federal government has spent more that it received in revenues every year.  Even supposed single-year surpluses never existed, but were merely an accounting trick based on stealing IOUs from the imaginary Social Security trust fund.  Remember that the total federal debt continued to rise rapidly even during the claimed surplus years.  Since Congress is incapable of spending only what the Treasury takes in, it must borrow money.  Unlike ordinary debts, however, government debts are not repaid by those who spend the money-- they’re repaid by you and future generations.

The federal government issues U.S. Treasury bonds to finance its deficit spending.  The largest holders of those Treasury notes-- our largest creditors-- are foreign governments and foreign individuals.  Asian central banks and investors in particular, especially China, have been happy to buy U.S. dollars over the past decade.  But foreign governments will not prop up our spending habits forever.  Already, Asian central banks are favoring Euro-denominated assets over U.S. dollars, reflecting their belief that the American economy is headed for trouble.  It’s akin to a credit-card company cutting off a borrower who has exceeded his credit limit one too many times.

Debt destroys U.S. sovereignty, because the American economy now depends on the actions of foreign governments.  While we brag about our role as world superpower in international affairs, we are in truth the world’s greatest debtor.  Like all debtors, we are not truly free.  China and other foreign government creditors could in essence wage economic war against us simply by dumping their huge holdings of U.S. dollars, driving the value of those dollars sharply downward and severely damaging our economy.  Desmond Lachman, an economist at the American Enterprise Institute, states that foreign central banks “Now have considerable ability to disrupt U.S. financial markets by simply deciding to refrain from buying further U.S. government paper.”  Former Treasury secretary Lawrence Summers warns about “A kind of global balance of financial terror,” noting our dependency on “the discretionary acts of what are inevitably political entities in other countries.” 

Ultimately, debt is slavery.  Every dollar the federal government borrows makes us less secure as a nation, by making America beholden to interests outside our borders.  So when you hear a politician saying America will do “whatever it takes” to fight terrorism or rebuild Iraq or end poverty or provide health care for all, what they really mean is they are willing to sink America even deeper into debt.  We’re told that foreign wars and expanded entitlements will somehow make America more secure, but insolvency is hardly the foundation for security.  Only when we stop trying to remake the world in our image, and reject the entitlement state at home, will we begin to create a more secure America that is not a financial slave to foreign creditors.

Now this is one politician who calls a spade a spade. Forget about political parties…just think of our current political policies. We just keep digging our hole deeper and deeper and I keep asking myself where the plan is to correct the enormous imbalances. Potential solutions were not a focus of the campaign dialogue. I’m also making a big deal about this because we are now up against the federal debt limit and we have a huge round of treasury auctions scheduled for next week. Our government is so broke (bankrupt) that they must raise the debt ceiling by November 18^th or stop many of the normal government functions because they will have no cash. In mid-October the Treasury Department suspended investments in a federal employee pension fund to keep the government below its borrowing limit. The Treasury has already said that due to the debt limit constraints, it does not have the capacity to settle the 4-week bill auction scheduled to be held on November 16^th.

Next week the Treasury will be conducting another quarterly refunding for a total of $51 billion, roughly half the borrowing needs for the fourth quarter. For the first quarter of 2005 the government expects to borrow the record sum for one quarter of $147 billion. For next week the Treasury will auction $22 billion in three-year notes on Monday, $15 billion in five-year notes on Tuesday, and $14 billion in ten-year debt on Wednesday to raise a grand total of $3 billion of new cash for the government to spend. The balance of $48 billion from the auctions will be used to pay off maturing debt.

You see, the government never pays back any of the money they borrowed in the past…they just keep borrowing more to pay the old debt plus any new money that’s needed. Remember this is happening at a time when the federal government’s income is reduced due to lower tax receipts. If we ran our households in the same manner, bankers would laugh if we went in to see them every three months to re-liquefy our checking accounts with new cash and consolidate all the credit card debt. The Treasuries’ “refunding” takes place like clockwork in the middle of every quarter and will continue every quarter because we do not have the capacity to pay off our debts. In fact, according to Ron Paul the government has not lived within their means since 1969. Every year since ’69 the feds have spent more money than they could generate in revenues, and the trend continues to accelerate. We are the biggest debtor nation in all of world history.

The rationalization from the other side goes something like this quote from the Seattle Post-Intelligencer in an article that ran on Tuesday. “The administration and congressional Republicans say the most important measure of the deficit is that the 2004 shortfall was an estimated 3.6% of the total economy. That is well below the 6% figure set in 1983 under President Reagan. It looks like they’re digging pretty deep to go back over 20 years to find a bad year for justification of record deficits. This is a very big deal because this is the primary reason the dollar will be under pressure for the entire foreseeable future…until something bad enough forces our policy makers to produce the changes necessary to correct the excessive government spending.

In my mind the markets are doing more or less what I expected with a Bush victory. Stocks have been the beneficiary of an administration that is considered business friendly. The Dow Jones Industrial Average followed through today by adding another 177 points to close at 10,314, the NASDAQ Composite gained 19 points to 2,023, and the S&P 500 added another 18 points to close at 1,161. The bulls are on a mission to move stocks higher to get any kind of decent close for the year. All in all it has been a rough year for stock investors and you can be sure the mutual fund boys will do all they can for window dressing to close out the year. The last thing they want is for investors to get cautious and start pulling money out of mutual funds.

Frankly, I thought yesterday would be the end of this little stock rally once I started to see bond prices moving higher. For the first hour of trading today stocks were under pressure, but energy prices began to tumble giving stocks a breath of fresh air. Crude oil came down more than 4% to close at $48.75 a barrel, natural gas tumbled more than 6% to close the day at $8.22 per million BTU’s, and heating oil fell 3.7% to $1.37. This all makes for some good spin with sound bites on CNBC, but don’t expect to get too much relief from falling energy prices…global competition for resources will not allow prices to fall much further.

The chart of the U.S. Dollar Index is looking ugly with the recent break below 85. Today the index made a fresh closing low at 84.64 with the euro at $1.286, yen at $0.9442, Swissie at $.8428 and the Canadian dollar stronger at $0.8276. Most analysts have been anticipating a near-term bounce for the dollar from oversold conditions, but it’s not happening. The rest of the world is now beginning to see the past omnipotence of the U.S. dollar fade as they begin to recognize the structural difficulties we face.

So stocks are getting a relief rally with the uncertainties of the elections out of the way and the dollar is getting clobbered as the fundamentals would dictate, but the real anomaly right now is the strength in the bond market. Yesterday the price of the ten-year note fell below channel support during intra-day trading, but reversed to close higher for the day. With stocks rallying and a huge supply of Treasury notes hitting the market next week, one would expect bond prices to be under pressure. Today’s price action in Treasuries was also strange in that the shorter maturities sold off while someone was in there buying the long end of the curve. The five-year note was down by 0.1%, the 10-year was virtually unchanged, and the 30-year bond gained almost 0.2%. Today short-term interest rates moved higher and long-term interest rates moved lower, thereby working to flatten the yield curve. There certainly appears to be some conditioning prior to the auctions next week.

The only thing I have been able to find that justifies bond prices moving higher is the anticipation that we could get a bad employment number tomorrow from the Labor Department when they announce job creation for the month of October. The consensus forecast is for 175,000 new jobs. A big number should send bond prices tumbling, while a soft number would support bonds and put pressure on stock prices.

The last major item the bond market will need to consider is the meeting of the Federal Reserve scheduled for next Wednesday. It is widely expected the Fed will raise another 25 basis points to put the fed funds target rate at 2.0%. I read today’s mixed movement in treasury prices as confirmation the Fed will move short rates higher and will do everything in their power to keep money in U.S. Treasuries, even if they have to support the long end themselves. The lower rates on the long end could also be a signal pointing to further economic weakness.

The December gold contract settled $5.40 higher today at $430.80 and December silver added $0.21 to close at $7.37 an ounce. As I said earlier, many investors and analysts have been looking for a near-term dollar bounce that would coincide with a little bashing by the short-sellers in the metals pits. Based on the Commitment of Traders, this is also the time when the commercials usually roll the specs over to trigger avalanche selling as stops are taken out. The pattern has clearly changed. It is quite possible the shorts are trapped right now because of the weakness in the dollar. The $430 level is still being defended vigorously by the short interests in gold, but we’ll see how much longer they can hold the line. The consolidation in gold and silver for most of 2004 has developed a very solid base to launch the prices much higher. Sure we could see gold pull back to test $412 or even $405, but it won’t change a thing. Once the $430 level is taken out decisively, $500 gold isn’t far away. Similarly with silver, once we take out the prior high at $8.35, the door is opened for much higher prices.

If the current move in gold and silver continues higher, many investors that sold their shares looking for a pull-back will be faced with chasing their favorite mining shares. This is a great reason to have a portion of your portfolio committed to holding long-term positions that you don’t plan to trade. I also have a portion of my portfolio that I use for trading positions in gold and silver. Some say the only way is to buy and hold while other say the only way to invest in gold is to trade actively…why not take the best from both worlds. I have a great deal more I want to write about investing in precious metals and mining shares along with the pros and cons of different trading strategies. I’ve been trading the PM’s for about six years now, and have learned a great deal using various strategies. I’m down to “fine tuning” what works well for me as we prepare for the next leg up. Study the fundamentals of gold and silver and you will gain a much higher confidence level to STAY LONG and be considered one of the STRONG HANDS in the precious metals sector. This bull market is still very young!

Have a Great Evening!

Mike Hartman

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