Please, click here to read this article in pdf format: november-10-2009

I did not write too much in October (I was traveling). But as soon as I got back, on October 21st, I went pretty much against the standard research, saying I was bullish on the S&P500, in USD terms. Since then, I have many times explained why, under specific circumstances, I was bullish both on the S&P500 and on gold. I wrote:

On Oct. 21st : “…Should this be bullish on equities? I think I would be a bit of a contrarian if I said it would. (…) should we not be bullish again on the S&P500? In USD terms? I think I should…”

On Oct. 29th : “…In general, if this correction continues, it may present us with an opportunity to step in. For now, the general economic backdrop remains constructive in my view, and although the new home sales figures or oil inventories disappointed today, I see these issues anecdotal and it would be naive to expect a recovery process to go unidirectional, from the lower left to the upper right…”

On Nov. 2nd : “…The week is starting on bad news (…) As long as central banks and governments of the G-8 “play it cool”, quiet and do not screw up with unnecessary hostile rhetoric, the market should take profits, the late longs should get their lesson and things should get back to normal (…) Personally, I don’t give a lot of probability to a catastrophic scenario, because it is hard for me to believe that so much political reputation will have been put on the line to arrive to November and make a false move that brings down the house of cards…”

On Nov. 3rd , I framed the problem along two main lines: Historical context and logic. My conclusion was a question to the reader: “…Therefore, my question to you is: “What makes you think monetary authorities will either pull the plug (=let interest rates increase) or recklessly accelerate the monetization of fiscal deficits (=let the USD or GBP plunge)?…”

On Nov. 4th , I anticipated the news that would come this past weekend, from the G-20 meeting: “…In my view, yesterday’s action was all about the fear that the Fed will have no alternative but to delay any increase in rates. It may be as simple as that…”

On Nov 5th , I reiterated my thesis on gold and on Nov. 6th, I further wrote: “…The trade is simply out of “money” and into everything. Money is here described as the medium of indirect exchange. Money is being debased and given the slack in the system, there is a case for still being long Treasuries. This will only help exacerbate the low interest rate period and the imbalances created by it. Are we therefore out of the woods with the correction in stocks? Personally, I want to see the S&P500 close above 1,066pts, for three consecutive days. Yesterday was one of them…”

Finally, last Friday and today, we closed above 1,066 on the S&P500. But are we really out of the woods?
The answer is not simple. In the short term, I am confident we are. In the not too long term…not so much. Money, as we know, has three functions: It serves as a medium of indirect exchange, a store of value and a unit of account. Since March, money has started to lose its usefulness as a unit of account. There is no longer a way to measure value objectively. But analysts tell us that stocks are “ahead of themselves” or “overvalued”. There is no point in trying to measure their value when we have no real benchmark. For instance, the USD lost 1+% intraday against gold yesterday, or 1.81% against the CAD.  In one day! How can we be sure of what value is these days? Furthermore…why bother?
The erosion on the “unit of account” function of money has been slow but steady. In the past days, it accelerated. When money definitely loses the unit of account function, it can no longer store value. Therefore, value is to be found in other things: real estate, commodities, etc. This process is what mainstream economists call “asset bubbles”. The problem is that with the loss of these two functions, economies become inefficient, because relative prices are distorted and resources are misallocated. Governments will continue to enforce their notes as medium of indirect exchange, but capital will not be created, unemployment will not decrease and growth will not appear. Is there a way out of this? Yes, through sustainable fiscal budgets.

I no longer want hear central bankers talk about exit strategies. I don’t want to hear Finance ministers talk about taxing the financial system or expanding their respective stimulus programs. What we need to hear is that every Parliament or every Congress engages in serious debates to CUT COSTS and NOT INCREASE TAXES. Taking the path of higher taxes has never led anywhere. So far, I have not heard any Member of Parliament or Representative come publicly saying he/she proposes to cut costs. Therefore, in the long term, we are definitely not out of the woods.