A Melman Minute — August 31, 2011

It is truly amazing how often we see the same errors being repeated over and over again. This morning’s news wires present us with two examples to illustrate the principle.

In the first case, there is virtual agreement across all economic sectors that one of the root causes of the economic trauma of 2007-10 was a drastic reduction in residential real estate mortgage lending qualifications. Loans were being made in excessive amounts to borrowers who simply did not have the ability to repay their obligations in a timely manner and, as a result, loan losses on mortgage debt rose to stupendous levels, threatening the very survival of many banks and other mortgage lenders.

One might think that everyone involved from lenders to government regulators would have taken a solemn vow to never let such a cascade of judgemental errors ever take place again, but the news media this morning informs us that political pressure is brewing to reinvigorate a toxic mix which shows disturbing similarities to what occurred in the past. According to a Wall Street journal editorial published this morning, “...The Obama Administration repeats mistakes of the past by intimidating banks into lending to minority borrowers at below-market rates, all in the name of combating “discrimination.” The article tells us that, “...The weapon is a ‘fair lending’ unit created in early 2010, led by special counsel Eric Halperin and overseen by Civil Rights Division head Thomas Perez.”

In essence, the new focus is not so much on individual lending practices, which can be easily defended in court, but rather an attack by government if, “...the cumulative effect of their actions implies discrimination.” One might readily ask how a corporation can defend itself against an ‘implication’.

As might be expected, many lenders are truly fearful of being openly attacked by government, thereby incurring both public odium as well as massive legal and punitive expenditures. Therefore, “...many companies are simply rolling over paying (fines) once they realize the extent of this possible PR horror show.”

Our own opinion is simple. Obama won his election, not by the widely presumed landslide, but by a razor thin margin of but 53% of the popular vote. However, he did poll virtually 100% among minority voters and they constitute fully 12% of the electorate. Therefore, it is absolutely essential that he repeat 2008’s performance in the election of 2012 if he is to have any chance of re-election. In our opinion, it appears clear that enacting special lending benefits to minorities could be of great advantage when next year’s election takes place.

What it might do to the economy is another story if lenders now begin to approve a new barrage of sub-standard loans.

The second case of history repeating itself involves major car manufacturers, in this case GM. As competition for auto sales heated up in 2007 and 2008, we saw numerous examples of price discounting which reached the point where auto manufacturers were actually selling their vehicles at below cost in order to maintain market share. As a result, profits turned to losses and one manufacturer after another saw the price of their shares obliterated and ultimately, they had to be rescued by government in order to simply survive.

As a result, we find it to be of more than just general interest to read in a Bloomberg News Service article this morning that GM announced that in order to increase market share in China’s competitive auto market, “...General Motors Co. is sacrificing profit margins to maintain market share in China, cutting prices of low-cost minivans by as much as 15% to offset slowing sales...”

Our only question is “Do these people never learn?”

The relevance to our general subject of precious metals prices is this: The economic calamities visited on all of us during the “Great Recession” were brought about, at least to a large extent, by the enormous number of sub-standard mortgages as well as the government spending hundreds of billions to rescue auto manufacturers from their economic woes.

If the very actions which brought about these terrible difficulties are now being re-enacted, it seems reasonable to suggest that yet another round of similar problems may be quietly building in the background, ready to break out in renewed furor down the road. Should that happen, we believe it is quite possible that the subsequent rally in gold, silver, platinum and palladium could be powerful indeed.

Speaking of not learning from experience, there was yet another troubling announcement from the Obama Administration yesterday. Union-driven high labour costs among civil servants have been identified as a proximate cause for many of the budgetary problems now being faced in America and many other nations; costs which have jeopardized the very foundation of international economic structures. One could therefore expect governments to now tread softly and restrain any influences toward even higher budgetary costs for their civil service workers.

However, we have now learned that President Obama has just selected a labour economist, Alan Krueger, to be chairman of the White House Council of Economic Advisors. Mr. Krueger has a history of recommending higher wages as a means of advancing economic activity by putting more purchasing power in the hands of workers and their families. He is also an advocate of reducing some taxation and expanding government borrowing (and deficits) to advance infrastructure improvements.

We have two immediate reactions. One is that this sounds to us to be a continuation of the very policies which have already brought about a tremendous expansion in the debt and deficits of the American government and which have led to undermining the soundness of their entire governmental debt structure. The other is that Mr. Krueger appears to us to be an advocate of true Keynesianism, a philosophy of economics which we believe has proven itself to be of questionable value, to put things mildly.

And so, we find it hard to ignore the conclusion that just when America and the world need new ideas (unrestricted free markets? enhanced liberty?) we are to receive a massive dose of ‘same old – same old’.

One other topic is worth discussing. While inflation figures of the past month have been relatively dormant, a true renewal of base material price increases appears to be taking place; one which we believe will lead to rising visible price inflation in coming months. We have noted a sudden increase in base metals prices along with a dramatic recent increase in the price of important grains which form a huge part of the world’s basic foodstuffs.

Copper prices have begun to surge once again, rising from about $3.82 per pound to almost $4.20 as this is written and the rate of price increase appears to be accelerating. We have also noted strong recent increases in nickel, lead and zinc prices as well. All of these metals are important to our international industrial economic structure and we believe they cannot increase for long before they will likely have an effect on pricing actions by manufacturers, then distributors, then retailers.

The rise in the price of corn, a grain used in many nations as their primary foodstuff, has been remarkable. After a period of ‘cooling off’, corn has suddenly surged back to levels near the highest ever recorded. Just as we saw previous food riots in Mexico as the cost of corn for tortillas soared, it appears likely we may see the same level of social unrest once again – a level which governments cannot safely ignore – but what can they do about it?

While it appears that we may have entered a period of relative quiet in several markets, at “The Melman Report” we believe that the underlying foundations of the world economic structure remain at risk of severe problems, a condition which history suggests should accrue to the benefit of the precious metals.

As of 9:30 AM PDT, financial markets in Canada and the USA have been trading to the plus side with the Dow Industrials and the TSX Index presently ahead by about 90 points each. Gold is holding in the mid-$1,830’s while silver is trading at just under $41.00 per ounce. The base metals are showing good gains on average while mining share indexes are close to unchanged for the morning, still lagging the actual metals in terms of relative performance.

In other markets, crude oil, long term interest rates and the US Dollar Index are all close to unchanged this morning at present.

All quotes US$ unless otherwise noted.

Next Melman Minute scheduled for Friday, September 2 when the latest US employment figures for the month of August are scheduled to be released.

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