Japan's Economy Grows at 1.3%

So much has happened in the past three weeks; pretty unbelievable, eh? Gold traded above $1,800 and then got smacked down, the US credit rating was downgraded a notch, the debt debacle worsened, Italy and Spain are getting tarred with the same brush used for the bailed out countries of Greece, Ireland, and Portugal, and so much more…

The markets gyrated like a young Elvis Presley… It was one day “this worked” and the next day “it didn’t”… Out in San Francisco the stock analysts were banging the drum to buy more stocks while they were cheaper… I have to believe they’ll still be saying the same thing come December…

Well… This morning, the currencies are looking up a bit, as Asia had a strong session, and Europe is better bid this morning. Gold is $5 weaker this morning, while silver is up 25-cents… You know, for 7 of the last 10 years, silver outperformed gold… But who was brave enough to step in front of the runaway bus that gold was last week when it soared to $1,810? Well, the CME raised the margin requirement on gold and that turned gold around, well… That and the two days of afterhours trading that really smacked gold in the kisser.

Remember in early May, when silver soared to $50, and then had the stuffing knocked out of it, by not one, not two, but three separate increases of the margin requirements in the same week! So, we all know that raising margin requirements works… Back in the heydays of the irrational exuberance, I used to write then that if the Fed Chairman at the time, (Greenspan) really wanted to water down the irrational exuberance (his words for the stock market, not mine) all he had to do was raise the margin requirements on stocks… Just to tell you how long I’ve been at this… When I first started in a margin department of a stock brokerage, the margin requirement was 65% initial, and 35% maintenance… That was moved to 50% and 25% in the mid-’70s…

Sorry… I got carried away there with some history… But now we all know that raising the stock margin requirement would have worked! Well that and moving interest rates to where they needed to be (UP!), and other things…

So… Tomorrow, Germany’s Chancellor, Angela Merkel, and France’s President, Sarkozy, are going to meet again… This is getting to be, well, if it weren’t so serious, it would be funny… These two meet, and they come out of the room with another plan to save the Eurozone… These two have already warned everyone not to expect a “big bang” tomorrow… So, maybe these two leaders are meeting to simply play a game of gin rummy!

In my humble opinion, what these two need to be discussing is the issuance of a “Eurozone bond”… I’ve said this from the beginning of the Eurozone problems, and if they had done so, we’d be past all this now…

Talk about getting the stuffing knocked out of it… The Swiss franc (CHF), which last week was the belle of the ball, this week is back to scrubbing the floors. Combine the Swiss National Bank’s (SNB) intervention to weaken the franc, and the backing off of the markets on the Eurozone picture, and the franc received the “old one-two”… So, all that talk about pegging the franc to the dollar, or euro (EUR), has been put away for now, and hopefully never to be taken back out again!

Japan’s economy grew at 1.3% in the last quarter… Not bad for Japan! Not good in the whole scheme of things… But at least their economy grew! Of course, Japan is in the same boat as the US with regards to a weak economy. And ever since the US decided to cut their interest rates to the bone, and then begin implementing stimulus packages, and quantitative easing, they’ve been on the same path the Japanese followed for over two decades… Remember when I used to tell you that we were turning Japanese, yes, I really think so?

Can you come to grips with that awful thought of us spending two decades trying to get out of this funk? I came to grips with it 7 years ago, when I first began to notice the movements of the yield curves of the two countries, and then had it cemented with the first stimulus package…

Well… While I was in Vancouver three weeks ago, the Brazilian government decided to pull the kitchen sink away from the wall, and get ready to throw it at investors… They implemented a tax on dealers in Brazil that short dollars and buy real (BRL)… This really stopped the real in its tracks, which is what the tax was intended to do. Now… I’m waiting for the “unintended consequences” so… what happens if this new tax really scares away investors, and the real begins to slip in price? Won’t that shake the inflation foundation of Brazil? Yes, it will… And interest rates will have to be hiked even higher than they are currently… What will that do to their economy? Unintended consequences….

Now, I’m not saying that all that will happen… Please notice I said, “What happens if”…

To date, everything the Brazilian government has done to drive away investors hasn’t worked… So, the jury is still out on this attempt… But I think in the end, the Brazilian government will kill the Golden Goose by raising the tax rate so high, that no one will want to deal in real…

US Treasuries are sure soaring… But… I don’t know if you saw this or not, but last week’s auction of 30-year Treasury bonds, didn’t go so well… The bid to cover ratio was awful! So… The 10-year may be seeing the bulk of buying, the longer bonds aren’t doing so nicely… And, I have to believe that those people flocking to 10-year Treasuries for “safety”, will be looking at losses by next year…

And when all that money that was dumped into Treasuries begins to leave in droves, where will it go then? Stocks? Hardly think so… I truly believe that the only place for this money to go will be to gold… (And silver, of course)… The currency that everyone will want to own belongs to China, with Singapore coming in second…

One of my all-time fave writers, former colleague, and friend, David Galland, had this to say last week in his Casey Dispatch:

As our own Bud Conrad explains in detail in the current edition of The Casey Report, the Treasury market is now the largest bubble on the planet. How big a bubble can be understood by comparing the record-low rates just mentioned against the record size of the US debt and its record deficits.

This is the part where it gets exciting – at least if you are paying attention.

Once the pin hits the bubble – and that pin is the inevitable price inflation that pushes today’s negative real yields even deeper into the red – not only will the world’s central bank be scrambling for a new home, but so will a tsunami of money coming out of bonds, the world’s largest financial market by a wide margin.

As to where that money may go, you can rest assured it won’t be the yen – which is in almost as much trouble as the euro or the renminbi – at least not as long as the communists are still in control.

Which leaves gold, the all-time indisputable champion of money.

Already we have seen a big swing in central bank reserves of gold, with the bankers collectively switching from being net sellers of millions of ounces of gold annually as recently as 2008, to being net buyers. They’ll be buying more.

OK… Back to the task at hand… The Aussie dollar (AUD) continues to be the proxy for global growth… When there are threats to global growth, the Aussie dollar takes a hit, and when it looks like there’s a chance for global growth, the Aussie dollar rebounds (as it has this morning, with the strong Asian session). As it should have, the Aussie dollar rebounded last week, when the US Fed announced that they would keep interest rates at current levels for the next two years… The positive rate differential that the Aussie dollar enjoys over the US, Japan, and even Europe, should underpin it… That, and the word from the Reserve Bank of Australia (RBA) that they will not slash interest rates…

I mentioned China above… The question I’ve been most asked in the past three weeks is, what “one” currency would you own? Well, to me, the Chinese renminbi (CNY) represents the new “Challenger to the dollar” for reserve status… The yen (JPY) was the challenger in the ’80s, the euro was the challenger in the first decade of the new millennium, and now it’s China… Yes, they’ve got a lot of work to do regarding the distribution and deliverability of their currency, but those things will come, folks… They will come… in due time.

Then there was this… World Bank President, Robert Zoellick, isn’t feeling like the world economy is on terra firma these days… Let’s listen in… “I think we are entering a new danger zone. I think that confidence in economic leadership has been slipping and it will be important that the primary economic actors take steps both short and long term to restore that. Unless the economic leadership gets ahead of the problem in its different dimensions then you’ll see the lack of confidence will lead it to spread, and it will spread to players that should otherwise be able to sustain their policies and get beyond the crisis.”

I know that sounds like a bunch of gibberish, but I think Zoellick is taking aim at the US first, and foremost here… As explained in the film I.O.U.S.A., one of the deficits we have is a leadership deficit… An economic leadership deficit… And Zoellick is taking aim at that here…

To recap… The news from Japan overnight is that their economy grew at a faster pace than forecast, and that set the Asian session moving in the right direction. That good feeling carried over to the European session this morning, and so, the currencies are better bid. Gold is off $5. But, does that represent a bargain price? Probably!

Chuck Butler
for The Daily Reckoning

The Daily Reckoning