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July 31, 2011
Issue 158  -  Political Theater
Well, well, well, we finally have a "deal."  This, like almost everything else in Washington is irrelevant.  Not only did they push off all the heavy lifting into the out years, but the amounts we will "save" are almost laughable.  Oh, and there were tax increases that will come later. 

The deal’s details (Financial Times)

By James Politi in Washington

Domestic spending

The first tranche of the deal – which will be enacted immediately – involves cutting 7bn from domestic discretionary spending over 10 years. These are funds that need to be approved every year by Congress to run a wide range of government programmes and agencies. About $350bn of those cuts will hit the Pentagon budget. The cuts are made through the establishment of caps on spending for every one of the next 10 years. For the 2012 fiscal year, which begins in October, that limit is set $7bn below current levels.

Additional savings

The deal instructs a new congressional committee to identify a further $1,500bn in deficit reduction during the next 10 years. The 12 members of the panel will be chosen by party leaders and will make their recommendations by November 23. A vote in the House and Senate on the proposal will be fast-tracked to avoid procedural delays or filibusters and will occur before the end of the year. Savings from the largest mandatory spending programmes such as Medicare are likely to be considered by this panel, along with tax reform.


If the committee fails to reach agreement, automatic spending cuts will generate $1,200bn in additional deficit reduction. Of that, $500bn would come from the defence budget, while the remainder would come from across-the-board reductions in other areas. There are some exceptions though: Social Security, Medicaid, unemployment insurance and veterans benefits are all excluded from the “sequester”. Medicare cuts to beneficiaries would also be protected, but Medicare payments to providers – from drug companies to hospitals and doctors – would not.

Balanced Budget Amendment

A vote on a balanced budget amendment to the constitution would be required in both the House and the Senate after October 1 but no later than the end of the year.

Debt ceiling

The US debt ceiling is effectively increased by a sufficient amount to carry the US through to the beginning of 2013. The first tranche of the borrowing authority hike will be passed immediately – and the second will be enacted after the joint congressional committee’s recommendations are passed. If the committee fails and the trigger kicks in, the debt ceiling will be raised through a convoluted procedural mechanism designed by Mitch McConnell, the Republican leader in the Senate. This would only require the support of one-third of Congress.

The average cut over the next 10 years is 91 billion.  How much is the yearly budget now?  $3.7 trillion, give or take.  So all this haggling was over a 2.4% cut in spending.  Really?  Can you really expect things to get better by cutting 2%?  If you were in big financial stress, would cutting 2% do anything?  Unlikely.
The sad part is that there weren't actually ANY cuts at all.  A little background first.  In 1974, there were several changes made to the budget process.  One of them was the idea of automatic increases.  Congress wanted to increase spending without a big fight, so they implemented a system where certain budget items rise no matter what.  Congress also established the Congressional Budget Office.  The CBO is the entity that does all the scoring of the budget proposals.  They are "independent" and supposedly provide unbiased analysis.  The concept of unbiased in Congress is an oxymoron.  Certain members of Congress hold sway with the CBO and receive better "scores."
Another thing that was established in 1974, and this is where we get to the lack of cuts, was the idea of a budget cut without a cut.  Here's how it works.  Since the increases in budget items are now automatic, if we cut the automatic increase, that is now an official "cut."  For instance, if social security payments were set to rise by 2%, and let's say that was to equal $12 billion, and they lowered the increase to 1%, then they can claim they cut $6 billion in spending. 
Of course this is completely loony and no other entity in the world would even THINK about calling that a cut.  However, that doesn't stop congress from crowing about the cuts they made and how they saved the day.  Nothing could be further from the truth.  Oh, and this bill that was approved, didn't even get put online until 1:45 AM on the day of the vote.  What happened to the 3 day rule?  We had $20 billion in the bank to pay bills so there was NO imminent default, so that was a lie.  There are going to be all kinds of secret goodies that were added to this mess that will be revealed over the next couple weeks.  Par for the course. 
The bottom line is we are insolvent and this did virtually nothing to fix that.  Here is a great picture showing just how much the national debt is in $100 bills. 
Of course this doesn't count the unfunded liabilities like medicare, government pensions and social security.  Adding those would at least make the pile SIX TIMES bigger!  The idea that we are now "on the right track," as some politicians were saying is laughable. 
There is nothing "fixed" and in fact things are worsening:

Food Stamp Use Surges By Most In Years As Alabama Foodstamp Recipients Double In May

But wait, there's more. Digging into the numbers reveals something pecuiliar: virtually the entire surge in monthly SNAP participation is due to one state alone: Alabama, which saw those living on foodstamps jump from 868K to 1.762MM. That's 36% of Alabama's population. Is this merely a grand rehearsal for the Jefferson County bankruptcy? Did the state see a mass surge in foodstamp use as hundreds of thousands are trying to game the system in advance of what will be an apic Chapter 9? And if yes, what does that mean for all the other states which will promptly follow in the footsteps of Jefferson County, and for US foodstamp participation?

Which begs the question: will Obama be the first president under whose rule total foodstamp usage hit 100 million? Surely, by then there will be a Nobel price for destroying one's middle class better and faster than any communist in the history of the world, so at least there will be something to memorialize it with.

So 36% of all people in Alabama are on food stamps and things are going to start getting better??!?  Really?  Does anyone believe this?  Food stamp recipients surging is not, and I may be wrong, an indicator of economic growth.  If better days were ahead, would gold be surging as it is?  It doesn't look like other countries believe things are getting better:
Emerging world buys $10 billion in gold as West wobbles
 7:52am EDT

By Amanda Cooper

LONDON (Reuters) - Central banks of emerging market countries such as Korea and Thailand have added more than $10 billion of gold to their reserves this year in a sign of waning faith in the West's benchmark bonds and currencies like the dollar and the euro.

International Monetary Fund data for June on Wednesday showed Thailand bought gold for the second time this year, raising its reserves by nearly 19 tonnes to over 127 tonnes, while Russia bought another 5.85 tonnes, bringing its reserves to 836.7 tonnes, the world's eighth largest official stash of the metal.

So far in 2011, emerging market central banks have bought nearly 180 tonnes of gold, more than double the roughly 73 tonnes purchased by central banks globally in the whole of 2010.

The spot price of gold has risen by more than 17 percent this year to a record $1,672.65 an ounce, driven chiefly by investor concerns over the impact on the developed world's economy of its debt burdens and sluggish growth.

Mexico has been the largest buyer of gold in the year to date, with $5.3 billion worth of purchases, or 98 tonnes of gold, followed by Russia, which has bought 48 tonnes, worth $2.6 billion at current prices.

Earlier this week, Korea confirmed it had bought 25 tonnes of gold in June and July.

"Central banks evidently do not regard the price level as too high and are diversifying their currency reserves. This was the first purchase of gold for the Korean central bank in over ten years," said Commerzbank metals analyst Daniel Briesemann.

"Gold's high-altitude flight still appears to be supported by many factors and an end to the boom soon is not in sight."

In the euro zone, smaller economies such as Greece, Portugal and Ireland have already sought emergency funding, while concern is mounting over the finances of some of the region's larger members such as Spain and Italy, driving the euro to record lows against the safe-haven Swiss franc.

The United States averted an unprecedented debt default on Tuesday after lawmakers reached an eleventh-hour deal to raise the country's borrowing limit, although severe doubts remain about the economic outlook, stripping 6 percent off the value of the dollar .DXY this year.


The U.S. economy is also likely to lose its top-notch credit rating as ratings agencies are increasingly discomfited by the weight of the twin trade and budget deficits and the country's patchy growth.

A downgrade will almost certainly push up yields on U.S. Treasury notes as their value falls, which could prove unwelcome to the major investors in U.S. debt such as the Chinese government, which holds nearly $900 billion in Treasuries.

The trend among central banks, particularly those with large foreign exchange holdings, to diversify some of their portfolios into gold from currencies has been well established over the last couple of years.

"The market generally expects central banks with growing reserves and small gold holdings to buy gold," said Jesper Dannesboe, senior commodity strategist at Societe Generale."

"So I don't think that is particular surprising, but it does support the bullish story (for gold)," he said.

Central banks are expected to remain net buyers of gold this year and the most likely buyers will be those with the biggest reserves and relatively small bullion holdings, such as China.

The Chinese central bank is the sixth largest official owner of gold, yet its holdings account for just 1.6 percent of its $2.5 trillion total reserves.

The IMF data showed Russia, Kazakhstan, Greece, Ukraine and Tajikistan also added to their reserves two months ago and feature among some of the bigger bullion buyers this year.

Kazakhstan's reserves rose for the third time this year, by 3.11 tonnes in June to 70.434 tonnes, Taijikistan's reserves rose 0.04 tonnes to 3.036 tonnes and Greece and Ukraine added 0.03 tonnes each, bringing their official holdings of gold to 111.506 tonnes and 27.744 tonnes, respectively.

Russia has added to its gold reserves every month for the past five years, according to the IMF's data.

This is what's known as the scared money.  This is what those who are protecting their assets are doing.  There is no way the U.S. is going to "grow" out of this.  The hole is so deep that a growth rate of 5+% would be required for YEARS.  That just isn't going to happen.  Especially with realities like this:

Job Cuts Surge 59% In July, Highest Since March 2010 As Hiring Intentions Plunge

Those looking for an optimistic early look of this Friday's NFP (nobody cares about the ADP any longer) should probably avoid the Challenger lay off data just released. As Bloomberg summarizes, U.S. planned firings up 59% Y/y in July to 66,414, led by pharma, retail; largest number in 16 months. The number includes Merck’s plan to cut ~13k jobs. This 3rd consecutive increase; “seems to provide additional evidence” recovery has stalled, according to CEO John A. Challenger. New Jersey (where MRK is based) led states, with 13,330 cuts, followed by Michigan. Employers also announced plans to hire 10,706 after prior month’s 15,498: this is just barely better than the lowest number this year printed in May when just 10,248 businesses announced intention to hire, and well off the 72,581 highs in February. Bottom line: subzero NFP print coming?

We need HIRING, not layoffs.  How in the world can we get things cranked up with more and more people on unemployment and food stamps?  This biggest problem in the near future is refinancing our debt.  With the passage of this deal our interest rates dropped in a counterintuitive way.  I view this as a flight to safety of stock sellers and eventually will reverse.  Higher interest rates will be the death knell to any recovery.  In fact, the first signs of higher interest rates are there to see:
China Debt Agency Downgrades U.S. Bonds
China's Dagong Global has cut the credit rating on U.S. sovereign debt to A from A+, Chen Jialin, general manager of the international department at the firm told CNBC on Wednesday. The agency has also put the U.S. on negative outlook.

The decision came despite the U.S. raising the debt ceiling and averting a default, and even as both Fitch and Moody's re-affirmed the U.S.'s Triple-A rating.

An A rating puts the U.S. five notches below Triple-A and at the same level as Russia.

Explaining its decision Dagong said the debt deal had not changed the general trend in which the increase in debt outpaced the increase in GDP and tax revenue.

Dagong said that while the increase in the debt ceiling matched the cuts, "there is an eight-year difference between the two objectives."

According to the firm, the U.S. needs to cut its fiscal deficit by at least $4 trillion within the next 5 years to maintain its current debt size.

China's central bank, meanwhile warned on Wednesday that the Treasury market was likely to be choppy and urged the U.S. to act "responsibly" on the debt situation.

It was the first official reaction from the country since the debt crisis began. China is the largest creditor to the U.S. and has foreign exchange reserves of $3.2 trillion, about two-thirds of which are in dollar-denominated assets.

Dagong's ratings cut though is unlikely to have any major implications in the bond market, given that most investors rely on ratings from the big three firms - Moody's, Standard & Poor's and Fitch.

Franklin Templeton, which manages $734 billion in assets, including $303 billion in fixed income, also said Dagong's ratings lacked transparency.

"The challenge with that rating agency out of China is that there's not a lot of transparency and so it's a little difficult to take too much out of that," Michael Hasenstab, senior vice president and portfolio manager in the international bond department at the firm told CNBC on Wednesday.

Hasenstab, however, said Dagong's action raised an important issue that politicians had been unable to deal decisively with the debt issue and the bruising political fight had hurt confidence in the U.S.

"(The) process, I think, has unnerved the markets and unnerved the world," he said.

Remember, the lower your rating, the higher interest rates you must pay to your lenders.  The U.S. will be facing this in the very near future.  Moody's has us on "watch," which means a downgrade is probably in our future from them.  Artificial means and trickery can only hold the rates low for so long.  At some point they will go higher and at that point gold and silver will save your bacon.  Hope you've got yours.
GORO  (closed $24.82, down $2.80, average price paid $6)
Mexus Gold  (closed $.19, flat, average price paid, $.22) 
Tug had transmission issues.  Looks like they are repaired and the boat is headed north once again.
Alexco Resource Corporation -  AXU  (closed $7.44, up 1.14, recommended at $7.90)  
Stocks    (Current status, out, sold on March 18)
Didn't add this week, market looks like it's ready to fall further, so I'll wait it out.  On a large drop of 5+%, I'd put 10% of funds into the SP500 with a plan to buy more and more all the way down to a bottom which should happen in 2012-13.
Physical Gold  (Closed $1,616,  up $22,  average price paid $395)
Absolutely on fire and I believe it is just getting started.
Physical Silver  (Closed $38.49,  down $0.78,  average price paid $5.31)
Subdued in relation to gold, but look for a surge this summer.  I foresee a new all time high by fall. 
This week's video shows how nature always wins.  Have a great week!