It's a Bailout World

Technical Scoop (01/31/2009)
Protectionism is a serious issue and we are seeing more and more signs of it. While the arguments against protectionism are sound, and have proven over and over again to be economically disastrous, we fully expect that it will happen again. We couldn't help but notice numbers that said international air freight plummeted 22.6% in December from a year earlier. This number was described as shocking by industry people and is suggesting that world trade could be in a free fall.

The situation is as serious as anything we have ever seen. Bailout packages have already totaled hundreds of billions. New York University economist Nouriel Roubini (aka Dr. Doom), who wrote extensively about the coming financial collapse, has predicted that global banking sector losses could go as high as $3.6 trillion, of which $1.1 trillion will be U.S. banks and investment dealers. Mr. Roubini has declared the global banking system borderline insolvent, especially if this estimate is realized. The massive bailout injections that have already occurred will nowhere near cover these losses; hence the "good bank" and "bad bank" scenario to take the bad toxic loans off of the books of the financial institutions and hand them to the taxpayer.

We suppose the financial institutions might be saved but it will bankrupt the taxpayer or cause hyperinflation because of the printing of huge amounts of money. It is already forecasted that the U.S. will run annual deficits of at least $1.2 trillion, which could reach $2 trillion. It could last for at least two years. The financing needs of the U.S. will be astronomical. It is not clear where the money will come from, especially given that the U.S. receives the majority of its financing from foreign sources. While Japan and Germany might be friendly towards the U.S., the U.S. is also dependent on unfriendly nations such as Russia, China and mid east oil exporters.

Some may come from increased savings, as the savings rate of the North American consumer is showing recent signs of rising from near zero to around 2%. But it is a Catch 22, especially if the U.S. consumer returns to previous savings levels of 10%. Increased savings will find their way to purchasing U.S. Treasuries at the expense of expenditures in the economy. Retail sales, already collapsing, will continue to fall.

The Fed has indicated a willingness to buy U.S. Treasuries but this is in the realm of printing money. Couple this with quantitative easing, the bailouts and the stimulus packages and risks of protectionism, and all this will lead to massive currency debasement (a method of defaulting on debt). It also risks an inflationary spiral. There will then be only one thing that will be safe, and that is gold. We are already seeing record highs for gold in Canadian dollars, British pounds, euro and Russian rubles (and a host of other currencies). It is only a matter of time before we see it in U.S. dollars and yen, as well.

It is a bailout world, but who will bail out the countries (the U.S. and Britain, in particular) when they go down and almost certainly face downgrades on their debt. Nobody. Investors must take steps to protect themselves. The situation is now turning far more dire.

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