Iron Bulls and Budget Fudges

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What is the best thing about stocks right now? That they’re stocks!

That is, the best thing equities have going for them is that they’re not bonds, commodities, money market funds, or any kind of fixed income investment. Why?

Well, investment guru and Dow Theory Editor Richard Russell reckons that stocks are getting a bid because the yield on everything else – in real terms – is negative. The price you pay for safety is to lose purchasing power day by day. That’s not saying much for safety.

But it’s hard to understand exactly what the equity and bond markets are telling us right now. So let’s take it apart one piece at a time. We think the bond market is badly miscalculating on the likelihood of inflation. But let’s deal with something more tangible first, like steel.

You can’t have steel without iron ore. And you can’t have a resource boom without an iron ore boom. Just ask the government. It’s counting on soaring prices for iron ore and coal (along with soaring volumes) to deliver an extra $6 billion windfall to Federal coffers, according to today’s Australian Financial Review. The bullish forecasts from Treasurer Wayne Swan show the government cutting its deficit next year and returning the nation’s finances to surplus by 2012-2013 when the new bill of attainder becomes the law of the land.

By the way, we know the new Mineral Resources Rent Tax (MRRT) is not technically a bill of attainder in that it does not declare the miners guilty of super profits and tax/punish them accordingly. But the spirit of the law is, at best, dubious.

It’s never a good – nor are we sure it’s even legal in Australia – to pass laws that target specific groups. And in any case, the best and fairest laws are those that establish general rules that apply to everyone equally. Equal just under law, anyone?

But back to the world hematite and magnetite. The government’s forecasts for a big tax haul are based on an improving terms of trade (where Australia gets more for what it exports and pays less for what in imports) and high iron ore and coal prices. But ye gads, what’s this? China could iron ore imports for the first time since 1998 to help curb asset price inflation?

Does it seem a little dangerous to you to base the nation’s spending priorities on projected double digit growth rates in commodities whose demand has grown arm and arm with the global credit boom? Commodities are volatile and cyclical enough as it is. But basing Australia’s Federal finances on the sustainability of China’s boom in fixed asset investment seems like…a really big punt.

By the way, if you’re scoring at home, iron prices are off 40% in the last three months, according to Stephen Wyatt on page 25 of today’s AFR. Wyatt says, “Iron ore is being hit particularly hard as demand for steel around the world and in China hits the wall…Demand in China has been hurt by tightening government policy, moves to curb exports, traders’ large steel inventories, signs of weakness in construction locally and global car sales, and waning stimulus spending and lending.”

That’s a pretty comprehensive list.

About the only thing supporting steel prices…and bond prices…and stock prices…and house prices…is the prospect of more quantitative easing. And that brings us to what the markets may or may not be telling us. It sounds to us like, “stocks are the least bad asset for what’s coming.” But what’s coming?

More quantitative easing, says U.S. interest rate analyst Jim Grant, editor of Grant’s Interest Rate Observer. Grant told Bloomberg television that when the Fed meets tomorrow, “I think the first order of business will be to try once more to print enough dollars to make something happen in the U.S. economy.”

That could take a lot of money. More than the $1.75 trillion the Fed created to support mortgage-backed and Treasury bonds. But in theory, the only real constraint to the Fed’s ability to expand its balance sheet and buy assets is political. If the United States Congress takes away the Fed’s right to manage the nation’s money, or expressions concern that in supporting asset prices the Fed is also destroying the currency, well that might slow the Fed down.

But in the meantime, the world is running out of puff. All that stimulus money has failed to generate or sustain a real lasting recovery in the real economy. It was just funny money doing busy work to keep asset prices up. What’s so surprising is that so many people still believe – as we think our new friend Rory Roberston believes based on his comments a few weeks ago – that tinkering with interest rates actually supports assets that are clearly not productive.

Come to think of it, the belief that the manipulation of interest rates is what produces long-term economic prosperity is, in fact, the extreme position. But it’s the one held by all academics and suits on Wall Street and Washington. These are the same morons and imbeciles we referred to yesterday.

By the way, we copped it a bit for taking the low road and calling the people who don’t understand that gold is money imbeciles. But they are. So we’re not going to apologise for it. Sometimes you have to call things by their right names. And the people denigrating the value of gold and silver now and telling you not to worry because the Central Bankers are in charge will have a lot to answer for when we learn that money printing can’t support asset prices forever.

That day of reckoning will come. But for now, get ready for some more inflationism (quantitative easing). Tomorrow, how do you get ahead of the curve and prepare for the next big wave? That and other mixed metaphors coming soon!

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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10 Comments on "Iron Bulls and Budget Fudges"

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SV
Guest
Hmm, I note you rarely apologize (only once on my memory) so no surprise here. Pity though you need the low road to make your point. I might be an imbecile, but I always thought money must be a legal tender, accepted as payment for goods and services. Do you accept the payment for your paid publications in gold? Until you do, let’s just say that gold can become money, but is not there. Some other “imbeciles” in your readership, not just me, struggle to understand: 1) how a gold-based system can work in practice, in electronic world, 2) how… Read more »
Paul Frost
Guest

SV,you need shell out a few bargwans,gold,or even electrical dollars and get yourself a fishing rod buddy.You may be taking this stuff a little too seriously.

Paul Frost
Guest

As for you Dan.Great work as usual.Just keep blowin’which every way the wind blows.The answer my friend is blowin’ the wind

Dion
Guest
SV: “Some other “imbeciles” in your readership, not just me, struggle to understand: 1) how a gold-based system can work in practice, in electronic world, 2) how it will work together with fractional reserve banking, Have anyone seriously explored the negatives of gold-based money? If gold money is the solution, is not worse than the problem, by any chance? Throughout centuries, gold content in the coins steadily reduced, why? ” 1) A gold-based system can work in practice in an electronic world because the paper/electronic money would have gold backing, it would in fact work exactly the same as today,… Read more »
SV
Guest
Dion, the minute you settle for electronic, paper and other representation of metals, you have the trust problem. Someone needs to reconcile all the money representation throughout the entire financial system, to the underlying commodity. Who? Can they be trusted? And if they can, why bother with commodity at all – reconcile it to a fixed, pre-agreed amount, or any other goalpost. As for fractional reserve, erm… – you put your gold bullion into the bank, the bank says you can always have them back, goes and lends it out. When you come to get your bullion back, bank gives… Read more »
89peterg
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they aren’t imbeciles if they win and get what they want in the end, even if it is war without end and enslavement of the general populous. they are idiots too if they are being used by others , unaware, and to achieve the same end. … gold is useless as a store of value when it can be produced in large volumes and cheaply in, for instance , a particle accelerator (didnt the Russians make diamond years ago – not cheap though). maybe Helium 3 would be rarer until space travel is cheap….inlfated manakins, high pitched squeely voices, first… Read more »
Dion
Guest
SV, If you’re degree is in mathematics then this should be really simple. Gold has INTRINSIC value. Paper does not. Fractional Reserve banking & interest rate manipulation is what causes the business cycle. Symptoms of this are: Consumer inflation Malinvestment in all sectors People getting loans with no collateral Unemployment Globalisation I don’t know what you’re referring to in regards of a religion. Economics is simple. And I’m stating theory. In 1970 it cost one ounce in the form of a silver dollar (999 pure) for 4 gallons of fuel for your car. Today, it still costs that one ounce… Read more »
Ned S
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Governments cheat their citizens and creditors. Governments cheat other governments. Having a gold standard doesn’t magically change cheats into honest entities. It’s even just possible the system may be better as it is??? – Potentially less dishonest … In that this way at least, anyone who is even half awake knows he is dealing with cheats; Rather than giving the cheats the extra veneer of respectability that the opportunity to masquerade as honest entities behind a gold standard has historically afforded them. But having said that, Yeh sure, convert your own personal ‘hard earned’ into bullion if you reckon it… Read more »
Dion
Guest
Ned, I agree with you. A gold standard is like having a baby pitbull on a leash. Fractional reserve fiat is like having a full grown pitbull on steroids roaming the park, you know it’s just a matter of time before someone gets bitten. CPI (measured correctly) in western countries is averaging 10%-15%. On paper money, you’re looking at about a -10% yield. Real inflation is even more than that, completely out of control. Of course debt deflation is going on at the same time though, stagflating the economy to a certain degree. However, I’m up 40% in 12 months… Read more »
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