Safe Havens Through the Looking Glass

By: Chris Temple | Tue, Mar 2, 2010
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For some time now, the most knowledgeable and principled of investors have been perplexed, to say the least, by what the markets have recently defined as "risk" and "safe havens." I speak of that trend of the recent past that has witnessed the majority of investors fleeing to the U.S. dollar (and, more often than not, Uncle Sam's debt securities) during times of fear and stress in the markets, and running from any other asset class they deem a "risk asset," including gold.

Time and again we've seen headlines such as this one, from a Dow Jones Newswire story: "NY Gold Falls as Dollar Draws Safe Haven Bid." And when the coast seems clear to investors, we get the corollary, such as these comments from a story on just mere days ago: "Risk appetite pushed gold prices higher as U.S. investors returned after a long holiday weekend...Also supporting gold's rally are continued talks over a European Union bailout for Greece..."

Wait just a minute, Alice. Shouldn't gold have risen if investors were looking for safety? If they have an appetite for risk, why aren't they selling gold, and buying something else? Things are getting curiouser and curiouser around here, Alice...

Yes, folks, it does seem so often that we're in some kind of financial Wonderland; a land where down is up, right is is "risk"...and the fiat U.S. dollar is a safe haven. As fears have grown in recent months over sovereign debt issues -- first in Dubai, then in Greece, now in the U.K. and, tomorrow, God-only-knows-where -- little has changed in this equation. The dollar's rally that started back in early December has broadened; indeed, as I wrote just the other day, it may well be on the verge of yet another leg higher. And gold -- which, not by coincidence, peaked at about the same time the greenback's run started -- is about $100 off its all-time high (this after rallying from a level that was the better part of $200 below the December peak.)

What has so many nearly blind with rage over this lunacy is that -- whatever everyone else's woes -- the United States in nominal terms is by far the biggest deficit spender on the planet. Indeed, America's credit rating has also been called into question; early last month, Moody's warned that the United States' Triple A credit rating will come under pressure unless meaningful steps (and I'm sure they did not mean the laughable measures the president just announced to purportedly freeze some federal spending) are taken to tackle the U.S. budget deficit. Based on current estimates (and even they will likely prove too rosy) America's reported deficit has now lurched above 10% of GDP, the first time that's happened since World War 2.

Yet lately, the markets have aggressively bid up the dollar. And Treasury yields have settled down -- even at the long end of the market -- as money pours into America's paper (or computer entries, if you prefer.) And really adding insult to injury, on those days of late when fears over Greece or whatever else have been particularly acute the one currency that has conspicuously been in even greater demand is the yen; a currency whose owner, Japan, has even worse debt issues than does America!

How did we ever get into this Wonderland anyway, where the dollar (and yen) are safe havens?

One elementary answer was given by CNBC's Rick Santelli, one of the only sober and worthwhile personalities of that Wall Street propaganda network always worth listening to. Faced recently with this paradoxical question of why it is that traders want U.S. paper amid a whole world of exploding debts and deficits, Santelli quipped, "It's only because there's more flies on the other piles around us." Such is the market's perception, in any case.

Underneath that present situation, it's critical to remember that the overwhelming majority of traders and investors decidedly do not think like, say, a Dr. Ron Paul or an even more vociferous hard money advocate. Think about this for just a second, folks, and let it sink in a little...

Most of these people could far more quickly recite for you the list of who just got tapped for the upcoming TV series "Dancing with the Stars" than they could tell you where (if at all) the U.S. Constitution speaks of money. They'll have no trouble telling you who won the last 10 Super Bowls; but they have no idea what Thomas Jefferson ever had to say about banking. They'll wave the flag -- and pray -- at the beginning of a Nascar race; but they can't quote a SINGLE Church father over nearly two millennia, all of whom have been virtually unanimous in their condemnation of EXACTLY the kind of usury and fractional reserve system we have today.

A system which has as its logical end these very kinds of Wonderland markets.

Forgive what some might view as oversimplifications; but I hope I've made a point. THESE are the kind of folks who make up markets; folks just as lied to and blinded by the Establishment as everyone else. Is it any wonder that they can't tell the difference between what's really safe, and what will inevitably prove fleeting?

I must also remind you good folks here that the sheer volume of the U.S. dollars created in the recent past has itself contributed to the current demand for them. Over time, it is true -- and has been with the dollar -- that a monetary inflation will lead to the currency being worth less. But there are times such as now when some factors will work counter to that. Specifically, we have had in the recent past the so-called dollar carry trade. Investors used many of these cheap dollars -- borrowing and/or selling them short -- to fuel purchases of other assets, including the once (and future) safe haven, gold.

They entered these trades in particular since the financial debacle of late 2008 in the belief that times were going to be GOOD again. Gone were the fears of a "second Great Depression." Ditto for worries over an implosion of the markets and payments systems themselves. Led by China, the world is going to shake off the memories of that near-death experience, and be off to the races for many more years of growth. Or, so they have thought.

But as more evidence has emerged that this Pollyannish view is premature at best, the carry trade has begun to reverse itself somewhat. And if I'm right -- and we have more market and economic headaches still ahead of us -- it will continue to reverse, leading to more gains for the dollar and more losses for most everything else.

At some point -- and I know not when -- this carry trade will be unwound, and traders will look at America's currency on its own merits, and not as a "refuge" they almost have to buy to reverse losing trades or avoid trouble elsewhere. When that time comes, I seriously doubt that the greenback will be anybody's safe haven. Sure, for now (if largely by default) Obama, Bernanke and the Congress can run up the debt to their heart's content, with little real resistance. But it won't always be that way.

Economist and author Niall Ferguson wrote an especially good op-ed piece on this subject in the February 11 Financial Times. He said in part, "...For the world's biggest economy, the US, the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the 'safe haven' of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008.

"Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase 'safe haven'. US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941..."

He -- and Barron's columnist Jacqueline Doherty, who made a similar point in that paper's February 15 edition -- reminds us that the U.S. has potentially fifty versions of a "Greece" to deal with in the days to come. Just one of those -- California -- has the eighth largest economy in the world; a bit bigger than Greece! It is likewise a fiscal basket case. And -- whereas there are some doubts as to how much or how long Europe's help for Greece might be -- there is NO doubt that, today, Uncle Sam would come to California's aid if push came to shove.

With the prospects growing of a marked slowdown in China, a double-dip recession in America, more economic malaise and political wrangling in Europe and the revelation of more financial time bombs, we are likely to see a repeat of the market environment of late January (punctuated by margin calls on oil, gold and other trades) , if not that of late 2008. Risk assets will be shunned. Traders will need to be liquid; and liquid in the alleged safe haven, primarily, of U.S. paper. So, our Wonderland market environment seems certain to go on for a little while longer.

At some point, though, even America's paper will be appropriately shunned; together with everyone else's. The carry trade and other, related market forces will no longer be sufficient positives for the greenback to overcome the negatives of America's own exploding debt. Indeed, if I'm right and the economy loses a pulse again, future already-grim debt projections will really go off the charts, as they did in the wake of the Great Recession's first dip. Then it will seem as though America's pile has drawn most of the flies.

By that time, the same traders who have generally been so blind in accepting Establishment market orthodoxy will have had their faith shaken further; perhaps, this time, to its breaking point. They will take the attitude of "a pox on ALL your fiat currencies." They will want gold; not as a "risk asset," but as real, honest money. They will want other commodities of use; energy most likely at the top of the list (indeed, I believe that the day is fast approaching when we will have broader, commodity-linked currencies issued by those nations with the most viable resource bases and governments.)

We'll be treated to glimmers of sanity along the way, as one trader, and then another, is fortunate to have the scales fall from their eyes. In just the last few days, in fact, gold has managed to catch some bids along with the dollar. Indeed, the yellow metal has hit new all-time nominal highs now in both euro and sterling, as citizens in the European countries and Great Britain figure out that some gold in their portfolios might be a good idea in today's world after all.

Just today, in fact, I saw this headline in a Bloomberg story after the markets' close: "Gold Climbs in New York on Alternative Investment to Currencies"

Maybe that is the exit sign from Wonderland over there in the distance...



Chris Temple

Author: Chris Temple

Chris Temple, Editor
The National Investor

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