A Report on the Tax Deal Effects

The news yesterday was all about the tax deal. Did President Obama drop the ball completely? He was against extending the tax cuts. How come he caved in? Will he alienate his voter base?

Or did he just pull a fast one on the Republicans? The tax cuts/unemployment benefit extension deal is a kind of “stealth stimulus,” say some commentators. It will stimulate the economy, with no need for another vote on Capitol Hill. The Tea Party people were dead set against any further stimulus. But there it is.

“Obama tax move lifts hopes for growth,” says The Financial Times. It will even eliminate the need for more QE, said one hopeful commentator. The dollar will be stronger as a result.

Stocks went up 13 points on the Dow yesterday – nothing at all, in other words. But gold fell $25.

But so far, bonds are telling us a different story. Yields on the 10-year T-note are over 3% – at 6-month highs. The feds have pledged to buy more than $800 billion worth of government bonds. And still prices go down. Go figure.

What we figure is that investors are wary. At least a fair number of them must be thinking what we’re thinking – that the authorities don’t know what they’re doing…that they are going to lose control of inflation…and/or that the economy is going to collapse despite all their stimuli and money printing.

The effect of the tax deal (assuming it is passed) will be to increase government spending and lower government revenues. That will produce a federal budget deficit, according to official sources, of more than 8%. Meanwhile, the states are looking at huge deficits of their own. With muni bonds falling, they will have a hard time raising more money and may be pushed into bankruptcy – roughly the same drama that is on the European stage.

While bonds fall, commodities soar.

“Investors pile into commodities,” says The Wall Street Journal.

Hmmm… They must be worried about inflation…or maybe they’re just speculating. It looks to us as though the feds are creating yet another bubble.

It’s a set-up, dear reader. Watch out for commodities and stocks. And oh yes, watch out for bonds too.

Bill Bonner
for The Daily Reckoning

The Daily Reckoning