A Melman Minute — January 7, 2010

One of the themes we have stressed during the past couple of years is the fact that governments at many levels are truly strapped to the limits to pay both for the services they provide as well as finance interest and principal repayments on their indebtedness. As a result, we anticipate continual upward pressure on tax rates for some time into the future.

An excellent case in point is now occurring in the State of Illinois where that government is expected to run a $13 billion deficit in the coming year. Given that calamitous state of affairs, many observers in the all-important municipal bond markets have been reluctant to purchase Illinois debt paper, making it difficult to finance capital improvement projects. Well, as we might have expected, the Illinois government just announced it was considering a plan to almost double the State's Income Tax rates from a minimum of 3% to 5.25%. Although the specific rate increase numbers are still being negotiated, there appears to be little question that a significant tax increase is in the offing.

While that may please the cadre of bond buyers who, at first glance, appear satisfied that the increased revenues from such increases will indeed improve the state's finances and thereby enhance the security of future bond purchases, we would suggest they take a deeper look for, in fact, any tax increases by the government can only be paid by diminishing the net discretionary purchasing power of the consuming public, with a resultant slowing of the economy and a diminishment of a variety of tax revenues.

This is yet another phase of the problem we refer to as being "caught between a rock and a hard place", whereby one seeming solution only leads to further problems.

We would offer our opinion that the only genuine solution to the problem is for government to spend less, then reduce expenditures further and then cut them once again. Finally, we would opine, they would reach a level where expenditures were below legitimate revenues and the process of genuine repayment of existing debt might take place. However, we would also offer the opinion that the public would never tolerate such a solution, given their eight-decade long education that government is the perpetual source of public-welfare 'goodies'.

It is this conflict of public demand versus economic realities that we believe will lead to an array of massive difficulties in the time period ahead and why we believe that a monetary storm of some severe magnitude awaits us. It is the expectation of that coming storm that is one of the most important bases upon which we continue suggest the holdings of monetary precious metals for both investment and insurance purposes.

And so, we were treated to the spectacle of Greece resolving the difficulty of too much currently due indebtedness by acquiring enormous new levels of debt, but with interest payments on the new debt stretched out somewhat into the future. Such, in our opinion, are the caliber of 'solutions' now being offered by the international economic community. Nevertheless, the problem appeared to be resolved and international markets reacted in a somewhat positive manner.

In our view, we recall words that Winston Churchill told the British Parliament in 1938 during the debate on Chamberlain's Munich Accord which temporarily allayed fears of an immediate continental war, "...I do not begrudge our loyal, brave people...the long, spontaneous outburst of joy and relief when they learned that the hard ordeal would no longer be required of them at the moment." But then he added this stern warning, "...But this is only the first sip, the first foretaste of a bitter cup which will be proffered to us year by year..."

We at TMR believe there is a genuine comparison between the international economic community's relief at the comparatively easy resolution of the Greek monetary crisis and the British public's relief at the apparent solution to the threats of war which stalked Britain in mid-1938. However, like Churchill's warning that, in fact, a defeat and not a triumph had been inflicted on the Western World, we hold to our belief that you cannot resolve debt with debt and attempts to do so will lead to much greater crises down the road.

An overnight statement by Greek Prime Minister George Papandreou brought this line of thought to mind when he sought to assure the international bond market that all was indeed well in terms of Greece repaying its lenders. We would disagree and offer these reasons. First, it appears unlikely Greece will be able to impose all the 'austerity' measures they have promised in order to balance their government's budget without intolerable levels of public unrest and rioting. Second, the interest rate Greece is being forced to pay, such as over 12 percent for 10-year paper, means the problems will get worse, not better, as interest costs rise inexorably into the future. Third, the Greek economy is not expanding rapidly, but, instead, appears to be contracting which will likely require the addition of further increments of debt, thereby exacerbating and not resolving the problems.

We can only wonder how much longer the stronger European nations such as Germany and (relatively speaking) France will be willing to pour their national wealth into the Greek government's coffers. We are of the opinion that their patience is already wearing thin.

Gold's recent action, including a spike sell-off this morning down to as low as $1,352 has raised fears that something stronger than a normal correction is about to hit the metals and other commodity markets, since many commodity trading charts have been hit by waves of selling.

When we look at the chart of gold over the past few months, this selling has indeed been relatively sharp. However, both long-term and intermediate-term rising trendlines remain intact and, therefore, we continue to be positive - for the long term - on the precious metals.

Part of our thinking relating to the forecast published at this site on December 31 is that price action during the first half of the year will likely be somewhat choppy and indecisive, but monetary difficulties will gradually accrue and, in our opinion, the second half of 2011 should have more bullish activity.

Markets this morning are reacting to some negative employment news just issued by the US Department of Labor which showed a job growth of only about 100,000 rather than a significantly higher number which had been expected. Gold has rallied from its morning lows and, as of 9:30 AM PST, it had recovered to about $1,370 while silver, platinum and palladium also improved. Base metals are slightly lower on balance with copper down to about $4.30 per pound and mining share indexes are up moderately. Crude oil has fallen to just above $88 per barrel, long term interest rates have declined sharply and the US$ is stronger in currency trading.

Financial markets have turned 'south' with the Dow Industrials down by almost 80 points and Canada's TSX Index is off by about 40.

All quotes US$ unless otherwise noted.

Next "Melman Minute" scheduled for Monday, January 10, 2011.

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