A Melman Minute — January 5, 2010

Several days ago, I wrote about a vision based on watching film from the giant tsunamis of late 2004 which suggested the economic trauma of 2007-2010 was only a prelude to a giant tsunami of worse news to follow at some future date. Well, it appears another tsunami is developing in the immediate time frame and that is a tidal wave of good economic news. We suddenly appear to be hearing little other than stories about prosperous times ahead.

For example, just this morning we have learned that consumer spending during the December sales period was not just strong, but actually rose at the highest rate during the past five years. Many categories including luxury items such as jewelry and high-tech 'toys' were aggressively purchased by armies of consumers. Comments such as the following from Michael McNamara, president of research and analysis at Spending Pulse were typical: "Overall holiday sales were strong. This is the longest sustained improvement since the recession."

The marketplace also received a positive jolt when payroll processing firm ADP reported a stunning gain of 297,000 jobs during December, , far in excess of most expectations, and that number has reinforced the concept that the giant economy of the USA is truly gathering strength. The official government figures for December employment will be released early Friday morning.

It was also reported that Factory Orders in the USA grew strongly during the month of November, rising by 0.7% in that month and analysts contend the rate of growth would have been even larger had it not been for a decline in volatile aircraft orders. The same report from the US Commerce Department also noted that demand for iron and steel rose a sharp 21.7% that month, suggesting that factories are gearing up to produce more autos and appliances in the months ahead, which also suggests an improvement in expectation for the housing construction industry.

However, we believe there is a very important consequence to all this positive economic data and it is well illustrated by the above chart. In our opinion, as soon as economic strength appears to be truly taking hold, fears of a general rise in inflation frequently lead to a similar rise in interest rate expectations and that is apparent from the chart which shows trading in the United States Treasury's 30-year bond contract over the past five trading days. Please note that the contract traded within a normal range during most of the past week, but suddenly plunged early this morning at the opening, just after ADP made its jobs announcement.

The pattern of expecting rising interest rates if prosperity leads to inflation is not singular to the USA alone. As the European economy begins to emerge from its depths over the past few years and as policy-driven inflation begins to take hold, similar fears have arisen within the European Economic Community as well. Recent readings show that price inflation has now risen above the European Central Bank's guidelines for the first time in more than two years, leaving that central bank with a difficult quandary. If European economic policy continues to be both fiscally and monetarily stimulative, that might provide support for the economy, but it also could drive visible inflation upward to the point where the credibility of the Euro's future purchasing power is brought into question.on.

However, if European central banks do NOT continue with stimulative policies, then whatever economic gains have been achieved could be put at high risk. The particular situation in the UK is even more perilous since that nation is now imposing an increase in their "Value-Added-Tax" (VAT) from 17.5% to 20% which will automatically lead to yet another 2.5% increase in the purchase price of all items included in their price indexes.

Such are the problems facing economists in many of the world's more powerful nations as we enter this important year.

Problems of another sort are plaguing the American political system as President Obama and the incoming inundation of Republican lawmakers appear to be at loggerheads in terms of policy. While the President appears to clearly prefer continued stimulation of the economy and expansion of the government's role in virtually every segment of society, the Republican newcomers have been espousing precisely the opposite policies, namely to curtail spending and rein in virtually every governmental regulatory apparatus.

A Wall Street Journal study addressed this situation in an article entitled "Battle Lines Form Over Government Role" and, in our opinion, that headline precisely states the nature of the problem; that there are seriously divergent views between Keynesians and Free Market (Austrian) advocates and it will be difficult, it not impossible, to reconcile their points of view. The article informs us that incoming House Majority Leader Eric Cantor of Virginia, "...outlined Tuesday the House Republicans' plans for the opening weeks of Congress, saying they would include spending cuts and scrutiny of Obama Administration regulations."

The apparent first target of the newcomers will be the almost automatic increase in federally-financed highway spending every year since the mid-1990s. But the Republicans are faced with a political quandary of their own. While their most avid "Tea Party" supporters are pressing for such cuts, other supporters such as the various Chambers of Commerce across America do NOT advocate such spending cuts, fearing they might lead to diminishing prosperity.

By the way, and of some true importance, the Congressional elections were not the only important elections which took place last November. Republicans also made strong gains in a number of states Attorney Generals offices and it is now becoming apparent that among those newcomers, they are taking dead aim on President Obama's medical care initiatives, collectively known as "ObamaCare."

Florida's Attorney General, Pam Bondi, summed up Republicans' concerns in an op-ed piece noting, "No legislation in our history alters the balance of power between Washington and the states as much as ObamaCare does." She stated that the method of passing these measures into law through procedures rather than opens voting appears to be unconstitutional as does the federal government's ability to enforce individual purchase of a consumer item such as private health insurance.

Florida is one of 20 states that have filed joint court challenges against the new health laws.

The stage is set for controversy and uncertainty in the months ahead. Historically, such considerations have frequently been positive for the world of precious metals.

Markets this morning have been mostly mixed and, as of 9:45 AM PDT, the Dow Jones Industrials are ahead by about 45 points while Canada's YSX Index is down by 25. Precious metals are recovering from strong selling yesterday and early this morning as gold bottomed near $1,360 but has rallied to about $1,380 while silver traded as low as $28.60 before rallying back up to just under $29.40. Base metals are slightly higher on balance with lead showing particular strength while mining share indexes have also moved off their early lows and are now down only about one percent this session. Crude oil has recovered to just above $90 per barrel, the US Dollar is higher in currency trading and, as noted, long-term interest rates are sharply higher.

All quotes US$ unless otherwise noted.

Next Melman Minute scheduled for Friday, January 7, 2011

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