Please, click here to read this article in pdf format: november-17-2009

The week started on a highly “accommodative”, inflationary tone. During the weekend, we had the Asia-Pacific Economic Cooperation meeting and yesterday, Fed’s Chairman Bernanke gave a speech in New York.  Both forums contributed to the obvious notion that monetary policies will remain accommodative in the US and the countries that have decided to import US inflation (i.e. Brazil, Canada, Russia, China). With the weekend news, the positive GDP numbers from Japan and Retail Sales figures released at 8:30am yesterday, everything took a lift from the big tide: Oil, gold, equities, treasuries, corporate credit…

Investors seem to have lost perspective here and, as year-end approaches, the need to show performance by fund managers is taking us to new highs. Is this dangerous? Not necessarily. From where I see things, I am gradually coming across debt refinancings that no longer target longer maturities for the sake of delaying the Day of Reckoning, but which seek to facilitate acquisitions, mergers or simple restructurings. That is a good thing, as long as resources diverted in that direction are based on the right premises, one of which is their price outlook. I sincerely hope this is the case for the energy, transportation/logistics and mining industries.

On another note, I believe there is a piece of news that market participants may have discounted. On November 12th, the Federal Deposit Insurance Corp. (FDIC) approved the final rule on prepaid assessments. In short the FDIC, “…voted to require insured institutions to prepay slightly over three years of estimated insurance assessments…” (Refer: http://www.fdic.gov/news/news/press/2009/pr09203.html ). According to the FDIC, “…Payment of the prepaid assessment, along with the payment of institutions’ regular third quarter assessment, will be due on December 30, 2009. The FDIC estimates that it will collect approximately $45 billion from total prepaid assessments. The payments will come from the industry’s substantial liquid reserve balances, which as of June 30, totaled more than $1.3 trillion, or 22 percent more than a year ago…”

Think about this for a moment… The US government is bankrupt, issuing debt that is placed at foreign official institutions to avoid the scrutiny of the laws of supply and demand. On the other hand, it issues a guarantee for deposits in its financial system, for which it charges a premium of $45BN.

How can the also bankrupt financial system afford the premium? It credits the FDIC with funds from its Reserves account at the Fed. But…where did the funds that are currently allocated to Reserves come from? The US government provided them through its stimulus programs. How did it do so? By issuing more debt!

If this is not the Ponzi scheme of all schemes, then I do not know what is. What is one left to conclude? When individuals engage in these transactions, they end up in jail. When governments engage in them, are their financial systems strengthened? As far as I know, the last country to take this path was Argentina, under the Menem and later the De La Rua administrations. If my memory works well, Argentina’s financial system also had a reserve ratio in the order of 30%. Everybody knows how the story ended in 2002.

True, the US has considerably more resources than Argentina, but at the end of the day, we all have to buy, sell, pay and collect. Of course, gold is now trading at $1,140+/oz. Why would it not?