Strategic Investment

James Dale Davidson is attending a conference in London.

Instead of your weekly Abundance essay, James’s research team has assembled some important crisis alerts to keep you informed as the global meltdown continues.

These alerts outline three of the most important – and bankable – market trends to be aware of in 2009.

James will continue to write his weekly Abundance letter on his return later this week.

To your continuing success,

Will Bonner

Publisher,

Abundance

P.S I’d love to hear your thoughts on Abundance. Is it useful? Relevant? Just send me a mail at info@abundanceletter.com

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Crisis Updates

*** “The ‘crack cocaine’ of our generation appears to be debt. We just can’t seem to get enough of it. And, every time it looks like the U.S. consumer may be approaching his maximum tolerance level, somebody figures out how to lever on even more debt using some new and more complex financing.”

- Jeff Saut, chief investment strategist, Raymond James & Associates, September 2007

The current economic crisis is a debt crisis, plain and simple. And it cannot be properly dealt with by getting into more debt.

Nevertheless, this is precisely the path the Bush and Obama administrations decided to take the country on.

The recent turmoil has commonly framed as a “credit crisis.” But credit’s necessary corollary, debt, has always been the real issue.

At the centre of this massive debt crisis has been the U.S. Federal Reserve under Alan Greenspan and his successor, Ben Bernanke.

Over the past two decades, the Fed created and sustained the country’s chronic debt addiction by unprecedented monetary expansion. This massive monetary expansion fueled an extraordinary economic boom. But it was a false boom, because it was built on debt rather than real capital.

The scale of the debt expansion was monumental.

When Greenspan took over the Fed in 1987, public and private debt in the U.S. totalled $10.5 trillion. Following his departure from the Fed in 2006, this figure had more than quadrupled to $43 trillion. By 2007, public and private indebtedness was three times bigger than the nation’s GDP.

Ominously, but disregarded by both Washington and the Fed, the previous record of public and private indebtedness to GDP was set in 1929.

Subprime mortgage debt, in August 2007, was the first part of this sprawling debt bubble to fall. But this debt collapse was by no means contained to the housing market. By their very nature, housing bubbles, involve banks and the whole financial system. And the subprime debt collapse triggered a highly volatile series of subsequent debt collapses and near debt collapses that we are still experiencing today as aftershocks, almost two years after the subprime component burst.

It is odd, then, that the federal government’s response to this debt crisis should be to pile on more debt. And yet that is exactly what it is doing.

President Obama’s budget will double the national debt in five years and triple the national debt in ten years. Meanwhile, the Fed is sustaining interest rates at near zero. And it is simultaneously pumping new money into the economy under the new euphemism of “credit easing.”

Worse still, both the government and the Fed are committed to do “whatever it takes” to ‘fix’ the economy. This means they will continue to try to borrow and print their way out of trouble, regardless of the long-term consequences.

*** So where does this leave you and your savings and investments?

There are three likely long-term consequences of the current trend in government spending and Fed money-printing.

1) Higher gold prices

According to commodities expert Byron King, investors are flocking to gold (and silver) right now. And that’s because investors don’t trust the world’s governments or paper currencies.

This can be seen in the gold holdings of ETFs.

This from Byron:

By the end of 2008, gold holdings of ETFs reached a record level of 1,090 tonnes, according to the World Gold Council (WGC). Thus, ETF holdings now exceed those of Switzerland and many other large and important nations. (Check the listing below.) In the fourth quarter of 2008, investors purchased ETF gold interests representing 96 tonnes of gold. (Far more than the total gold reserves of Australia.) This followed the purchase of an unprecedented 145 tonnes (more than the reserves of Saudi Arabia) in the previous quarter, according to the WGC. These are astonishing levels of demand, where there was almost none just a few years ago.

(The full article can be found here .)

This rush to gold will only increase as government-created inflation takes hold.

Three of the world’s smartest investors now see U.S. inflation as inevitable.

Warren Buffett recently said the following about the government’s attempts to stimulate the economy with Keynesian spending programs: “We are certainly doing things that could lead to a lot of inflation. In economics there is no free lunch.”

Investment guru Marc Faber also sees the government creating inflation. Faber echoes Buffett’s conviction that the Fed will be unable to put the inflation genie back in the bottle when the economy starts to turn around: “The massive money printing we have and the massive deficits we have now will make it difficult when there are some price pressures for the Federal Reserve to actually increase interest rates.”

Meanwhile, commodities bull Jim Rogers says it’s not just the U.S. government that’s responsible for inflationary policies.

“Governments are printing money everywhere, borrowing stupendous amounts,” he told Bloomberg. “Throughout history that has led to problems… and it will this time too.”

2) Devaluation of the dollar

According to Casey Research’s chief economist Bud Conrad, this fiscal year’s $1.75 trillion budget deficit will, by the time all is said and done, come in a lot closer to the $2.5 trillion.

This is hugely inflationary.

Right now, the dollar is strong, thanks to the massive flight to safety that has occurred recently.

But inflation has already ravished the value of the dollar. And that will only increase as the government, under Barack Obama, cranks up spending rates to historic proportions.

Today, $250,000 will only buy you 77% of what it would have in 1998. And just 56% of what it would have in 1988.

According to legendary investor Doug Casey, “A decade from now, given the inflation rate we expect, the dollar’s purchasing power will erode by another 50%, and probably a lot more than that. In fact, at the current rate of money creation, by the time the dust settles, $250,000 might be the annual wage commanded by burger flippers.”

(For more of Doug’s analysis of the fate of the dollar, follow this link .)

The bottom line is that Obama’s spending programs will require massive Treasury issuances. And the only way to absorb these issuances will be for the Fed to flood the market with dollars.

3) The bursting of the U.S. Treasuries bubble

The massive debt collapse we have witnessed recently has, to a degree, been mopped up with the help of U.S. government debt.

The federal government has been able to plug holes in the banks by issuing debt and handing over the money it raises to the banks to plug the leaks on their balance sheets.

Investors have seen U.S. Treasuries as a safe haven to park their cash. This has facilitated the government’s spending programs. But this confidence in Treasuries is unsustainable for three reasons.

This from Louis Basenese at Investment U:

• First, because the government can’t get away with near zero yields forever. Investors will eventually demand a respectable return on their money. Especially foreign governments. In the last quarter alone they increased their U.S. debt holdings by 12%, according to Bloomberg . To load up even more will require additional compensation.
• Second, because inflation is around the corner. Never has a world government spent (or planned to spend) so much and avoided it. The only way to curb the resulting inflation will be for the Fed to abruptly reverse course, and begin raising rates at the first signs of an economic recovery.
• Bottom line, the only way for rates to go from here is up, which means bond prices will head the opposite direction.

(Follow this link to read more from Louis.)

These three trends are all long term. Keep an eye out for more updates from Abundance to find out how to play them for profits.

To your success,

The Abundance Research Team

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