Courtney Smith

The Currency War is moving from a war of attrition to a much hotter war.

The recent elections in Greece, France, and Germany showed that Europeans are getting tired of talk of austerity and instead want growth.

On one level, they are right. All of the solutions to the Euro Debt Crisis have been focused on reducing government spending and raising taxes. In fact, it is very important to reduce the government’s share of the economy because that is where the debt is being piled up. The debt has reached unsustainable levels in many countries and only reducing spending can there be a possibility that the debt will not continue to grow.

Many countries have been promoting the idea that raising taxes is necessary to balance the budget. Nothing could be worse in this environment. It is an economic truism that raising taxes on something reduces whatever is being taxed. Thus raising taxes on income will result in less income in society.

This then leads to a vicious cycles of reducing tax income which causes more calls for even higher taxes which leads to less income and so on.

It would be better to lower taxes to increase the income in society which then leads to higher tax revenue to the government which helps to reduce the debt of the government.

The problem with the current rhetoric is that governments, led by France and possibly by Greece, want to also devalue the euro. They will put increasing pressure on the European Central Bank (ECB) to ease further to help devalue the euro.

As my friend Philip Wittmann said, there is nobody in Europe that doesn’t want to see devaluation. Increasingly, we are seeing rhetoric that devaluing the euro is a key part of the plan to get Europe back out of the crisis.

The recent G-8 meeting had the President of the US pushing Europe hard to go to “pro-growth” policies which will give the Europeans air cover to devalue their currency.

Actually, devaluation does nothing to increase an economy. The cheaper currency helps exporters export more so they are happy. But all imported goods, including oil, become more expensive which means that fewer of these goods are bought thus reducing the economy. Basically a wash.

In addition, inflation increases when a country devalues which then causes the central bank to tighten which reduces the economy further. In other words, the devaluation actually harms the totality of society but helps exporters.

Nonetheless, the prevailing orthodoxy, lead by the International Monetary Fund, and blessed by all major governments is that devaluation will help boost an economy.

The desperation of the Europeans means that they will now be more aggressive in devaluation.

Look for the euro to go to parity with the dollar over the next couple of years. Sell euros.

There have only been two times in history where the price of platinum has been less than gold. Right now is only the second time this has happened.

Platinum has “always” sold for more than gold because the supply of platinum is only a fraction of that of gold. This scarcity creates a higher valuation for platinum.

I think that we have this incredible anomaly for two reasons.

Gold has become a monetary instrument again. This has increased the demand for gold beyond the previous levels of demand. In fact, the demand for gold has become less rational than I have seen since probably 1980.

Platinum, on the other hand, is relatively suffering because of the weak global economy. Platinum is both a precious metal and an industrial metal. The industrial side of platinum is showing weak demand. And its value as a precious metal is being overwhelmed by the demand for gold.

I think that the advent of the big gold ETFs, like GLD, has led to irrational demand for gold that is pushing gold up too far in relation to platinum.

This irrational situation will eventually end and rationality will prevail.

I want to buy platinum and sell gold.

The platinum contract is for 50 ounces while gold is for 100 ounces. So you need to do two platinum contracts for every one gold contract.

Here is another analysis by Andy Waldock:
(October 26, 2011) The next time someone asks you if you’d rather have an ounce of gold or, an ounce of platinum you might want to think about your answer. Platinum’s relative value to gold has plummeted over the last two months. In fact platinum is currently $140 less per ounce than gold. This is the lowest value I could come up with using the entire history of the platinum and gold futures markets.

There have basically been three periods when platinum traded at a discount to gold. All three of these periods were characterized by fearful economies. The first period from ’80- ’83 saw platinum bottom at $131 less than gold. We also had a total of 6 quarters of negative GDP growth during this period. The second period was ’91-’93. We only had two quarters of negative GDP during this period. We are currently in our third period of platinum’s discount to gold and we’ve had four consecutive quarters of negative GDP finally ending in the second quarter of 2009.

The three periods of platinum’s discount have averaged more than 15 months in duration. The historical sell off in this market fits right in with the volatility we are growing used to. Therefore, we must focus on the underlying dynamics to predict the next range of volatility.

All three of these periods have been defined by recession, declining consumer confidence and household deleveraging. Perhaps the clearest measure of this is through the Federal Reserve Board’s Household Debt Service Ratio data. This measures how much debt American’s carry relative to their disposable income.

Declining sentiment can be measured by the amount of debt we carry relative to our expectations for economic growth.
Debt is the first thing that is shed as the economy sours and we may be nearing the bottom of this debt shedding cycle. Prior to the personal debt explosion of the 2000′s, American’s debt to disposable income tended to trade in a range of 10.5% to 12%. While this may seem like a tight range, consider the effects of your own personal debt varying by nearly 15% and you’ll get an idea of what that range feels like to the average American consumer. The debt boom peaked in Q3 of 2007 at nearly 14% of disposable household income. Currently, we have pulled back to just over 11%. This puts us near our historical trough levels. However, it is important to remember that trends tend to overshoot on the downside just as much as they do on the upside. Therefore, I would expect to set a new record trough in terms of household deleveraging some time in 2013.
This is one of the rare opportunities to watch a truly macro economic trade made in the commodity markets. The industrial demand for platinum is fueled by the government’s mandated shift to ultra low emission vehicles (ULEV’s) as well as the global growth of the auto industry, which is heavily based on platinum use in catalytic convertors. Furthermore, the speculative nature of the gold market’s rally will eventually fall of its own weight when some degree of certainty manifests itself in the global markets.

The average ratio of gold to platinum is more than 1.5 times. This ratio is obviously negative at the moment as we are currently at an historical low. I expect resolution of the European banking crisis and a resumption of normal business operations to quickly snap this market back to a normal pricing structure. Once this happens, the market should continue to build a base as individual populations work their own debt issues out. Finally, I expect to look back in time and be grateful to have seen this once every 10 years opportunity well in advance of the market’s turn.
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October 26, 2011
Andy Waldock
Commodity & Derivative Advisors, LLC
P.O. Box 484 Sandusky OH
419-624-0777
commodityandderivaiveadv.com

The European Debt Crisis dwarfs the problems of the US in 2008.

Here is how Forbe’s Magazine Editor-in-Chief writes, “Germany and France keep postponing the reckoning on Europe’s sovereign debt crisis. But their whistling past the graveyard approach is making a 1931/2008 crackup more probably. Their handling of this crisis will be a textbook example of timid, narrow-minded, intellectually bankrupt leadership. The Germans especially have taken the approach of simply throwing money at dicy debtors in the hope that the problem will magically disappear. They refuse to face the fact that Greece will default and that Portugal, Spain, and Italy are nearing the cliff’s edge.”

Here are five actions to solve the crisis right now:

1. End mark-to-market accounting on sovereign debt. Allow banks to use accrual or investment accounting on this debt. The question each bank has to ask themselves is whether or not the debt will be paid. They should argue that it will be as long as the debt payments are current. If debt payments are current, then the asset should be marked at purchase price. This means that the debt will not impact their balance sheets and they will stay solvent. But clearly Greece will default. The banks will then work out a repayment plan through changing the interest rate, amortization rate, or size of the loan to make it work out. This will cause a hair cut on the value of the loan but it will be far smaller and far more manageable.
2. Slash government spending. The UK is doing a remarkable job here. Greece is saying they are going to do it but never actually do. Government overspending is the cause of this crisis and this must happen to solve it.
3. Slash taxes. You get less of something when you tax it. So raising taxes on, say, income simply reduces the amount of reported income in a society. One solution to the crisis is to increase growth in society to create higher tax revenue and to support laid off government workers. Lower taxes to promote economic growth. But won’t that cut government revenue just when they need it most. No, experience shows that government income booms when taxes are cut.
4. Shift to a flat tax. One of the main problems in countries like Greece and Italy is not the level of taxes but that nobody pays them. Shifting to a flat tax solved this problem in many countries like Russian, Estonia, and Bulgaria. Flat taxes are much harder to avoid and people tend to be more compliant when the tax is small and fair. This will dramatically increase government revenues.
5. End Basel II. Basel II is the accord engineered by the Bank of International Settlements (BIS) which is usually called the central bank for central banks. This accord was and is a major cause of the debt crisis in the US and Europe. The accord is meant to be a unified agreement for major countries as to what is good capital and how much reserves should be posted for different asset classes. Basel II stated that the two best classes of investments that banks could own were mortgages and sovereign debt! So major global banks did what they were supposed to do: they rushed out and loaded the boat with mortgages and sovereign debt! So what are the most toxic investments that caused these two massive crises? Mortgages and sovereign debt! Thanks BIS! Stalinist central planning has never worked and this is just another example. Far better to let banks figure out what is safe and what is not. That allows the global banking economy to be far more diversified and therefore far less prone to systematic failures.

There are far more ways to solve this stupid crisis, but that is a start! Will they happen? I doubt any of them will happen because all of them require that governments give up power.

I will miss him. Check out this video to understand why.