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Investing in Hard Assets Critical as Next Major Economic Breakdown Looms

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Sovereign debt levels are out of control. Consider getting money out of the system and into assets like gold, silver before the onset of a massive financial-currency-debt crisis.

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Who Will Buy All the Bonds?

With Japan now focusing on rebuilding itself, and China seemingly now in the grips of a housing bust that could prove to be one for the record books, given the enormous price-to-income gap that was allowed to develop, it would seem that the financing needs of the West will not be met by the East.

One important way to track how this story is unfolding is via the Treasury International Capital (TIC) report that comes out every month. The most recent one came out on April 15th and was quite robust, with a very large $97.7 billion inflow reported for February (the report lags by a month and a half).

On the surface things look 'okay,' although not especially stellar, given a combined US fiscal and trade deficit that is roughly twice as high as the February inflow. But digging into the report a bit, we find some early warning signs that perhaps all is not quite right:

Net foreign purchases of long-term securities totaled a lower-than-trend $26.9 billion in February, reflecting $32.4 billion of foreign purchases offset by $5.5 billion of domestic purchases of foreign securities. Inflows slowed for both Treasuries and equities with government agency bonds and corporate bonds posting outflows.

When including short-term securities, the February data tell a different story with a very large $97.7 billion inflow. Country data show little change in Chinese holdings of US Treasuries, at $1.15 trillion, and a slight gain for Japanese holdings at $890 billion. It will be interesting to watch for change in Japanese Treasury holdings as rebuilding takes hold.

Only $26.9 billion, or 28%, of that $97.7 billion, was in long-term securities, reflecting a trend first outlined for us in our recent podcast interview with Paul Tustain of BullionVault whereby fewer and fewer participants are willing to lend long. Everybody is piling into the short end of things, not trusting the future. The concern here is that when interest rates begin to rise, financing costs will immediately skyrocket, because too much of the debt is piled up on the short end.

Also in the TIC data cited above, we need to reiterate that it is for February, and the Japanese earthquake hit on March 11. The next TIC report will be somewhat more telling, but even then only partially, and so it is the report for April (due to be released on June 15) that we're really going to examine closely. Our prediction is for a rather large dropoff due to Japan's withdrawal of funds.

With the Fed potentially backing away from the quantitative easing (QE) programs in June, the US government will need someone to buy roughly $130 billion of new bonds each month for the next year. So the question is, "Who will buy them all?"

Right now, that is entirely unclear.

Budget Fiasco

Sadly, the budget "cuts" proposed so far in Washington DC are too miniscule to assist in any credible way, and they practically represent a rounding error, given the numbers involved. The Obama administration has proposed $38 billion in spending reductions. (I hesitate to call them "cuts" because in many cases they are merely lesser increases than previously proposed).

Congress OKs big budget cuts - bigger fights await

April 14, 2011

WASHINGTON – Congress sent President Barack Obama hard-fought legislation cutting a record $38 billion from federal spending on Thursday, bestowing bipartisan support on the first major compromise between the White House and newly empowered Republicans in Congress.

The Environmental Protection Agency, one of the Republicans' favorite targets, took a $1.6 billion cut. Spending for community health centers was reduced by $600 million, and the Community Development Block Grant program favored by mayors by $950 million more.

The bipartisan drive to cut federal spending reached into every corner of the government's sprawl of domestic programs. Money to renovate the Commerce Department building in Washington was cut by $8 million. The Appalachian Regional Commission, a New Deal-era program, was nicked for another $8 million and the National Park Service by $127 million more.

For the record, these "cuts" work out to ~$3 billion less in spending each month, or less than the amount the Fed has been pouring into the Treasury market each business day for the past five months.

The fact that a major write-up on the budget finds it meaningful to tell us about specific $8 million cuts (that's million with an "m") tells us that we are not yet at the serious stage in these conversations. After all, $8 million is only 0.0005% of the 2011 deficit, and even the entire $38 billion is just 2.3% of the deficit and slightly under 1% of the total 2011 budget.

How much is $38 billion?

  • Less than two weeks of new debt accumulation (on average)
  • About two weeks of Fed thin-air money printing, a.k.a. QE II

In other words, it's a drop in the ocean.

It is this lack of seriousness that is driving the dollar down and oil, gold, silver, and other commodities up. It is the reason we will be watching the TIC report for clues that foreign buyers and holders of dollars are getting nervous about storing their wealth with a country that is increasingly seen as unable or unwilling to live within its means. It explains why the IMF has been finger-wagging so much of late.

Somehow the US federal government managed to increase its expenditures by 30% from 2008 to 2011, but is now struggling to reduce the total amount by just 1%.

That, my friends, is an out-of-control process, and the 1% in 'cuts' is simply not a credible response to a very large problem.

Conclusion

There are two entirely, completely, utterly different narratives at play here. One of them is that the economy is recovering, policies are working, and the vaunted consumer is either back in the game or close to it. The other is that the world is saturated with debt, there's no realistic or practical model of growth that could promise its repayment, and the level of austerity required to balance the books is so far beyond the political will of the Western powers that it borders on fantasy to ponder that outcome.

If we believe the first story, we play the game and continue to store all of our wealth in fiat money. If we believe the second, we take our money out of the system and place it into "hard" assets like gold and silver because the most likely event is a massive financial-currency-debt crisis.

The IMF, the World Bank, the BIS, and numerous other institutions with access to $2 calculators have finally arrived at the conclusion that there's still "too much debt" and that it cannot all be paid back. And they are now alert to the idea that the predicament only has two outcomes: Either the living standards of over-indebted countries will be allowed to fall, or the global fiat regime will suffer a catastrophic failure.

China is unlikely to ride to the rescue of the West, although it may have some time yet to help out a few of the smaller and mid-sized players, such as Spain.

Editor's Note: Chris Martenson is an economic researcher and futurist specializing in energy and resource depletion.

No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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