Eric Roseman's Eruptions: Stocks, Global Markets and Commodities BLOG

Curious about China’s Dollar Sabre-Rattling

Montreal, Canada

In the absence of a major stock market decline or another financial institution blow-up this summer it’s probably a safe bet to start nibbling at foreign currencies again.

The U.S. Dollar Index (see enclosed chart) broke important support levels last month but is now oversold on a short-term basis. Any dollar rally at this stage of the economic cycle should be tepid at best. The economy is stuck in a de-leveraging process that will take a few years to unwind coupled by scant bank lending in an environment of cash hoarding. This is not a macro environment that will boost U.S. short-term interest rates any time soon.

The United States and probably China, to some extent, desire a weak American dollar to boost domestic inflation. U.S. CPI is still contracting and in May declined for the third straight month to its lowest level since 1955. A lower dollar helps to grow inflation – a desperate commodity right now.

This morning, China launched another currency salvo claiming the world should look “for alternatives to the U.S. dollar.” Such utterances won’t boost the buck but instead likely help facilitate a decline. Interesting how China would slam the dollar when she holds about 35% of all Treasury bonds in circulation.

On Tuesday, I began buying small positions for my managed accounts in Canadian dollars and Norwegian kroner. Gold remains 5% of my portfolio for now.

Though I remain cautious about commodities this summer, including oil and gold, I like the CAD and NOK currencies because of their relatively stronger balance sheets; Norway, in particular, smarts a 10.5% budget surplus-to-GDP ratio – the highest among industrialized nations. This compares to rapidly rising or skyrocketing budget deficits across the major economies since late 2007. And Canada, though now in budget deficit, sports a small deficit compared to its overall economy.

What about the euro? The single European currency is probably better than the dollar but not by much. I prefer gold, NOK and CAD.

Several peripheral euro-zone economies are now in deflation and major trading partners to the East are in desperate need of bank capital. I’m still predicting some sort of blow-up in the Baltic Republics or the Balkans this year. Any macroeconomic collapse in these regions will hit the euro and the emerging markets new “bubble” hard.

The precious metals should rally if the dollar continues to weaken. But, like I said earlier, I’m just “nibbling” at foreign currencies here to build fresh positions that are part of a long-term accumulation strategy for my dollar-based accounts. Any sell-off in risk-based assets this summer – highly likely ahead of earnings guidance and a 40% post-March rally – will drive the dollar higher. That’s when I’ll add to my existing foreign currency holdings.

Gold and silver, however, remains hostage to traditional summer weakness in the commodities complex; gold is especially vulnerable near-term because jewelry demand has collapsed and any outflows from gold-related ETFs will drive the price sharply lower. I’m looking to re-enter gold around $875 to $850 and silver around $14.

It strikes me as fascinating that China is denouncing the dollar again. Something is cooking in Beijing and Washington whereby policymakers probably welcome a weaker dollar.

This should be another very exciting summer marked by renewed volatility, especially in the currency markets, which have been largely range-bound for the last four weeks.

Have a good weekend. See you on Monday.

Sell Dollars on Next Rally…

Oslo, Norway

This is my second visit to Norway since May. Oslo is a great city and a superb walking town. Just 100 meters from my hotel is the Norwegian Parliament building and from there a great “Handler Ømradet” or shopping area littered with all sorts of interesting things to see and buy.

I’ve always been fascinated by Scandinavia and its rich history. I first visited the Nordic region in 1996 when I established a private banking relationship for my investors in Copenhagen. Today, that relationship has grown as Jyske Bank Private Banking represents about 20% of my total assets under management.

I’m in Norway this week to explore asset management potential. This is a country where investors get into bed with foreigners very slowly, especially after the Bernie Madoff fraud and other international fiascos. Norwegians take their time before making an investment – something many of us can learn from to avoid painful and costly mistakes later.

Norway's currency now ranks as one of this year's best-performing major currencies in Europe and isn’t far behind the Brazilian real for the world’s top currency title. In 2009, the Norwegian kroner is up about 10% and has appreciated 8% against the EUR. The British pound has surged 12% in 2009 but only after crashing in 2008; the pound remains a bad bet over the next several years amid a flood of debt issuance to finance its almost insolvent banking sector.

In a world laced with debt-infested currencies the kroner probably has the best balance sheet. Norway is sitting on bulging trade surpluses – mainly because of oil and gas exports – and is home to the world’s largest national pension scheme valued at roughly $350 billion dollars. If you’re looking for a model currency then Norway fits the bill. The country has a positive trade balance and a budget surplus. This is why the currency is strong.

The U.S. dollar, of course, has been heading to the relics of history since Nixon closed the gold window almost 38 years ago this summer. With the exception of a few big counter-trend rallies in the 1980s and 1990s, the dollar has been progressively hitting newer lows every decade. No wonder; out of control spending, two military conflicts and a seemingly never-ending budget deficit don’t bode well for the American dollar. Yet despite all of this overwhelming data the dollar might just be at the cusp of another big bear market rally.

Longer term, no rational investor can make a compelling for the dollar. Yet it seems plausible that if the United States was the first to enter a hard recession in December 2007 that it might also emerge out of recession before any other country, except China and India. The dollar has been pounded over the last few weeks and is oversold. I’m also not so sure why the EUR and other currencies are rallying because they’re just as bad. Yes, the dollar is a total drunk but so are her other trading partners; it’s just a question of how much each currency has consumed at the bar. Since last year it’s been Happy Hour – everyone is piling on debt.

The dollar is therefore likely to post a major counter-trend rally this summer or fall – fooling a lot of investors. This is especially true if the stock market and other risky investments begin to falter again; the dollar would recover rather quickly as short positions are rapidly closed.

As profit-taking eventually sets in this summer I suggest unloading dollars for Norwegian kroner and Canadian dollars. I don’t especially like the EUR or the Swiss franc. I also think most Brazilian assets, including the real, are overbought. The Aussie and kiwi are okay but Norway and Canada offer stronger balance sheets. I’m also a long-term oil bull – something Australia does not produce, unlike Norway and Canada (oil sands and natural gas).

Don’t dump dollars now. At some point later this year or even this summer investors will have another chance to sell dollars for NOK and CAD. Also, don’t forget about gold, which is also likely to crack and possibly test $900 or $850 before finally breaking the $1,000 an ounce level for good. Gold is by far the best monetary value (no one else’s liability) in a world filled with currency drunks, bulging deficits and ultimately, serious inflationary consequences once central banks kill deflation.

Loonie Best of the Drunken Bunch as Canada’s Balance Sheet Stands Above the G-7

As risk returns to global markets since March, the Canadian dollar along with a host of other foreign currencies, including commodity currencies, has surged versus the American dollar. In May, the Canadian dollar logged its strongest month versus the U.S. dollar in more than a decade gaining 8.5%.

Over the same period, the loonie has also proved to be highly correlated to crude oil; commodities posted their best month in May since July 1974 with oil prices surging 30%.

To be sure, the Canadian dollar is overbought at these levels and will probably correct lower along with commodities at some stage this summer as profit-taking finally emerges following big gains in stocks, speculative and investment-grade debt and commodities since March 9.

But Canada does have its share of problems in 2009.

Red ink has started to emerge following years of budget surpluses while in some provinces, namely Ontario, have amassed big deficits amid a manufacturing recession and General Motors’ recent bailout. Ontario’s budget deficit has already surged 31% this year compared to 12 months earlier.

Canada is now poised to record its first budget deficit in more than twelve years.

According to the Department of Finance the estimated deficit for 2008-2009 stands at C$2.25 billion dollars or double January’s projected C$1.1 billion dollar shortfall.

The global credit crisis has hit Canada’s manufacturing belt in Ontario and Quebec particularly hard with unemployment rates above the 8% national average through April.

Government revenues are also on the slide.

Tax receipts in March dove 20.8% in Canada led by a stunning 46.8% plunge in corporate tax revenue. In the first quarter Canada’s gross domestic product, or GDP, contracted 5.4%.

Canadian trade is also taking it on the chin this year. The country’s current-account deficit for the first three months of 2009 was a negative C$9.1 billion dollars, up from a revised C$7.8 billion dollars in the fourth quarter. The first quarter trade deficit was the largest since Statistics Canada first began compiling records back in 1946.

The federal government now projects a C$50 billion dollar deficit in 2009. Though that’s certainly nothing to sneeze at it certainly pales to the gargantuan C$1.9 trillion dollars estimated by the U.S. Congressional Budget Office for fiscal 2009. Other countries, mainly in the G-7, are also on course to record huge deficits as a result of monster-sized fiscal spending; the United Kingdom, in particular, will probably borrow more than the entire size of the British economy over the next 12 months.

And yet despite all the challenges facing Canada amid the worst destruction in credit since the 1930s, the country is the best of the G-7 bunch.

In both absolute and relative terms, Canada looks much better than other major economies with a manageable debt level and a strong inventory of raw materials should the global economy recover.

Versus the U.S. dollar, the loonie is a far better store of value as the former amasses record budget deficits for the next several years to pay for seemingly never-ending bailouts and, eventually, a second round of stimulus spending.

Over the next several months or sooner, the loonie is also likely to fetch more than the U.S. dollar or break par value once again.

For American investors, gold, the Canadian dollar and the Norwegian kroner are among the best currency plays for the next three years and beyond.

The United States will have to keep interest low in the absence of organic domestic consumption, a long-term housing bust and the implications of the governments’ socioeconomic bailout of roughly 35% of U.S. GDP since 2008 – mainly in banking. Credit will be slow to return to pre-2007 levels while demand for debt accumulation remains virtually non-existent as consumers grow frugal for the first time since the 1970s.

Canadians, however, should accumulate gold with the loonie at these high levels. Gold prices have been declining versus the Canadian dollar since March but that trend is only temporary; since 2005 gold prices have appreciated versus all currencies, including the loonie. Apart from gold, only the Norwegian kroner offers a better balance sheet than Canada with tremendous oil surpluses and the world’s largest national state pension fund.

Canada has been fortunate. The country has not suffered a bank bailout, maintains a relatively strong balance sheet compared to its biggest trading partner and has mountains of commodity wealth to feed the world as inflation finally rears its ugly head once central banks finally defeat deflation and the ongoing destruction of credit.

Commodity Currencies Overbought Since March

Some of the biggest trend reversals in global markets since March have occurred in foreign exchange markets. As risk reversion has returned with a vengeance over the last several weeks many commodity currencies have lit a fire against the American dollar.

But the biggest movers against the dollar and the euro since March are also the same currencies that should be avoided following huge gains. These include the Brazilian real, Norwegian krone, Swedish krona, Canadian dollar, Australian dollar, New Zealand dollar and the South African rand.

With global capital markets now drunk with big gains since the lows on March 9, investors would be wise to avoid dumping the U.S. dollar at these levels ahead of another sell-off later this spring or summer. Stocks have now entered a period of seasonal weakness starting in May and significant profit-taking will probably drive the dollar and Treasury bond prices higher over the short-term.

One of the worst-performing commodity units since last July belonged to the Australian dollar (shown below).



The Aussie was smashed to bits starting last summer along with other commodity currencies and hit a trough in late 2008. At just shy of par value vis-à-vis the U.S. dollar in mid-2008, the Aussie tanked more than 40% late last year before recovering about half that loss since March.

The Australian dollar is now up 7.4% against the U.S. dollar in 2009. Other currencies like the Norwegian krone have surged 8.8% while the Brazilian real is up 10.8%. The top performer in the commodity league this year remains the South African rand, up 11.6%.

The major premise behind the impressive rally for many foreign currencies since March is the return of risk aversion or leverage. The cost of funds in the United States is almost zero percent; the dollar is rapidly becoming the next Japanese yen carry-trade whipping boy.

Though I can’t quantify exactly how much borrowing has returned to the financial system, it’s obvious to me at this point that investors are embracing too much risk at this stage of the economic cycle. The Dow, S&P 500 Index and other averages violated important support levels on March 8. This is not a new bull market.

Investors are incorrectly assuming that domestic demand, consumption and household balance sheets are now in the process of recovering, which is dangerously not the case. What we have now is massive global monetary stimulus finally feeding its way into the real economy as statistics go from outright disaster to just plain old bad. This justifies the 37% advance by the S&P 500 Index since its March 9 low; but it won’t justify broader gains from these levels because corporate earnings will continue to struggle in the absence of organic consumer-driven demand.

Yet I suspect all of this government spending, now in the process of being discounted by the stock market and Treasury bonds, will eventually exhaust itself because Treasury bonds and mortgage rates are now rising sharply since mid-April coupled with sharply higher oil prices. The market will begin to discount this soon.

The U.S. and European financial systems remain heavily leveraged and many segments of credit still rely on government support. This remains a highly uncertain economic environment and I think investors would be wise to avoid the hype and protect their capital for the most part. It’s just incredibly hard to believe that we’re back to the good old days again when deflation is now officially in town for the first time since 1955 and most companies don’t have pricing power.

If the global unwinding of leverage is indeed unfinished then the American dollar is not through completing the last phase of this bear market rally that began in July 2008.

Volatility Crashes but for How Long?

The big action in global markets since early March remains largely confined to trends in equities. As fears of an extended global market meltdown have receded since March, the VIX, or CBOE Volatility Index, or fear gauge, has collapsed a cumulative 28% since March 2.

Outside of stocks, barely anything is really moving at all, including government bonds, most corporate bonds, commodities and even currencies.

The lack of volatility in currency markets has been especially mysterious considering the relationship between the dollar and risk adversity since the onset of the credit crisis almost 20 months ago. As markets bled, investors dumped risky assets and piled into the dollar amid a wholesale liquidation of risk; the dollar has been rising only because institutions have been flooded with investor redemptions, which generated aggressive dollar accumulation.

The worst performing major currency, however, belongs to the Japanese yen, down over 14% since hitting an 11-year high earlier in March. The Japanese economy certainly doesn’t deserve a strong currency considering a whole range of economic data has literally crashed since January.

If risk is re-entering global markets then the U.S. dollar should be next on the firing line as investors move out of low-yielding Treasury bonds and sell dollars in the process. This should benefit hard assets, including oil and gold as investors once again seek to hedge their dollar assets from fears of rising inflation over the next 36 months.

Yet the U.S. Dollar Index (see below) is still hanging in there and remains above its important 200-day moving average but below its 50-day moving average. If the U.S. Dollar Index breaks below 81.70 then it’s quite probable the dollar will have peaked in the post-2007 credit crash.



Other assets, including crude oil – the largest single constituent in commodities indices – has also been confined to a trading range over the last few weeks. Crude oil has been unable to decisively break above $55 a barrel on this rally following a low of $33.87 earlier this year.

One of the most interesting market anomalies exist in the government bond market. Volatility has been markedly low even though investors have been selling Treasury bonds to buy stocks.

The United States, along with several other countries, is now heavily engaged in quantitative easing, which is basically a fancy term that equates to long-term inflation creation through debt monetization. Even though the Fed has been aggressively buying back Treasury debt over the last few weeks, yields on the entire range of Treasury debt has actually climbed, not declined.

If the Fed was not buying back Treasury debt over the last few weeks it’s highly probable that the entire Treasury yield curve would have steepened much further; hopes for an economic recovery – confirmed by the ongoing equity market rally since March 9 – should be accompanied by rising, not declining Treasury yields and therefore much higher volatility.

Volatility is now approaching an attractive level for speculators. The VIX can now be traded as an exchange-traded-note, or ETN, in the United States (symbols VXX and VXZ) while providing an easy route for investors to hedge their portfolio risk from the next correction. From its all-time high of 80.86 last fall, the VIX is now down 53%.

With the economy likely to be mired in a sluggish state over the next few years amid a deep credit deflation, investors would be wise to build some portfolio protection following a 30% gain for stocks since March.

Swiss Franc Devaluation Triggers New Currency Wars in 2009

Nobody wants a strong currency. That’s the central theme over the last 20 years and especially since the emergence of the credit crisis and the ensuing global economic recession – the deepest since 1982.

The Swiss franc is now the latest victim of this year’s currency wars and the Japanese yen will follow shortly as the global exchange rate mechanism comes undone in spectacular fashion. On Thursday, the Swiss National Bank (SNB) stated that it sought “quantitative easing” in order to depress the franc and keep deflation from accelerating. The franc thereafter tumbled 3% against the dollar.

In their quest to remain export competitive, global currencies continuously devalue against each other, causing all sorts of trade imbalances, currency volatility and, ultimately, inflationary consequences. That’s the history of foreign exchange markets since Nixon broke the gold window in August 1971.

With painful regularity, currencies have devalued violently vis-à-vis the dollar since July 2008 when the buck emerged as a false “safe haven” among global investors as global de-leveraging blew wide open. The dollar, of course, is not a “safe haven” but instead the recipient of massive inflows by institutional investors seeking to raise liquidity and meet almost unprecedented investor redemptions. This entire process, a phenomenon in currency markets, has indeed pushed the dollar to multi-year highs against a range of currencies everywhere – except Japan.

Last week, I mused about being disenchanted with paper currencies because they all seemed to be celebrating like a bunch of drunks – devaluing against each other and reducing our long-term inflation-adjusted purchasing power. The whole currency system is a joke with units everywhere down 10% or more over the last few months and in many cases, off more than 20% since last July. That’s not a prescription for global exchange rate stability. It’s a prescription for inflation.

I’m disappointed the Swiss relented to deflation. I also think the SNB was pressured heavily by the European Union (EU) to let some air out of the Swiss franc because regional economies in neighboring Eastern Europe are getting pounded – largely because of leveraged loans tied to the Swiss franc to fund domestic mortgages.

Now the Swiss join a parade of other currencies devaluing in order to stem deadly deflation. My argument last week for heading into the franc to protect my purchasing power has now been thrown out the window. No currency is worth its salt.

Over the last several years I’ve continuously recommended gold for long-term investors. It’s the only currency outside of the credit system that’s nobody else’s liability. It’s portable, liquid and, like the old adage goes, “an ounce still buys a man a good suit.”

Eventually, the Japanese will join the Swiss and depress the yen. Central banks haven’t been active in foreign exchange markets since 2004 before last week yet I suppose it’s only a matter of time before the Japanese begin a new round of intervention. The high yen is killing the Japanese economy.

In the end, the dollar will also join the bar and get slammed with other currencies. For me, gold remains at the forefront of monetary responsibility, inflation protection and, above all, truth in a world duped by fiat paper.

Japanese Yen and U.S. Dollar in Bubble Territory

Since the emergence of this credit crisis more than 19 months ago, the Japanese yen and the U.S. dollar have charged ahead vis-à-vis all foreign currencies. And over the last 12 months, both currencies are even higher against gold. Recently, the dollar began to rally versus the yen.

Both currencies are also among the most overvalued units in the world, offering almost no yield while intoxicated by high debt levels. In my book, both currencies are short-sale candidates as this credit crisis draws to a conclusion over the next 6-12 months. Once risk aversion returns, the dollar and yen will fall very rapidly.

The death of the carry-trade – borrowing in cheap and low-yielding yen and reinvesting those proceeds into higher yielding currencies – resulted in a wave of yen buying until recently as traders scrambled to reduce risk.

The Japanese economy has slowed sharply over the last six months with double-digit losses recorded in exports, manufacturing, industrial production and Q4 GDP – the worst batch of statistics since the early 1970s. Why would I buy the yen?



Yet unlike the overvalued yen, Japanese stocks are incredibly cheap. Stocks in Tokyo have been cheap for years and keep getting cheaper every day, ravaged by this bear market. Stocks traded on the Topix sell at roughly a 20% discount to book-value and yield almost 3.5%. No other major market offers better value.

But the yen should be avoided. Along with the dollar, both currencies are now in bubble-land, mired by poor economic fundamentals and high debt levels.

The U.S. dollar is the beneficiary of an accounting phenomenon tied to a desperate flight to cash and redemptions by institutional investors. There is no such thing as the dollar being a “safe-haven” currency. Rather, the dollar is at the epicenter of this financial disaster and, I suspect, it will crash once this crisis finally ebbs.

The beginning of the end of American financial hegemony has commenced as the United States emerges as a much weaker economic power since 2008. Gargantuan Treasury issuance, more Obama New Deals, the reluctance to let bad banks fail and poor economic growth for the next several years are a recipe for an eventual dollar crisis.

Since most investment accounts and funds are denominated in dollars worldwide, the crash in global capital markets since late 2007 has accelerated the flight to liquidity; it has nothing to do with a new bull market for the dollar. Historically, bull markets for the dollar or most currencies, for that matter, don’t begin with interest rates at 0%. I can’t think of any other currency in the world that offers such bad economic fundamentals other than the Zimbabwe dollar.

As the dollar eventually heads lower again once this seemingly never-ending global panic concludes, I plan on hedging my dollar-based portfolio into Canadian dollars or Swiss francs. I’m already holding 10% in gold and will increase that position to 15% should it break below $850 on this correction. I have little faith in most currencies, central banks or governments. Indeed, central banks have lost control of the financial system and investors should protect themselves accordingly.

Euro Bull Market Declared Over as Eastern Europe Crashes

Since January the economies of East and Central Europe, including the Baltic Republics and the Balkans, have started to rapidly deflate as banks crash, stock markets collapse and local currencies plunge. In many ways, what’s happening now across Eastern Europe, including Russia, is reminiscent of the Asian economic depression that began in Thailand in July 1997.



Punch-drunk amid easy credit in the 2002-2007 period, regional economies aggressively borrowed from abroad, mainly from Austria and other EU members that included leveraged mortgage loans tied to low interest rate currencies like the Swiss franc. That strategy has violently backfired since last summer as investors fled risky assets en masse.

In some East European countries, Swiss franc-denominated mortgages comprised more than 50% of all outstanding mortgage loans; combined with plunging local currencies this year the cost to service those loans has surged as foreclosures and defaults skyrocket.

Auf Wiedersehen Bull Market

After a multi-year bull market against most major currencies since 2002, the euro is now hemorrhaging since last July as Europe’s economic miracle comes undone with lightening speed. The euro’s decline pales compared to the outright plunge of numerous currencies in emerging Europe, especially since mid-January.

Eastern Europe’s largest economies – core manufacturing hubs for many Western European companies – have seen their currencies crash almost 20% versus the euro already this year as funding concerns grow louder amid a rapid acceleration of deflation across local economies. In December, Hungary received assistance from the International Monetary Fund (IMF). Now governments in the region, including the Austrians, are pressuring the European Union (EU) and specifically, Germany, to open its vast purse strings to save Eastern Europe from collapse and preserve the euro.

Against the sagging euro, many of the regions’ once fast-growing economies in East and Central Europe are now in the midst of significant economic contraction and sharply declining currencies. Credit spreads have surged, credit default swaps are widening and rapidly dwindling foreign-exchange reserves in the region threaten market capitalism, which, until recently, served as a model for emerging economies in the post-1991 Communist era.

Austrians Plea for Euro Zone Bailout

A fresh full-scale banking crisis affecting Western European institutions is now accelerating this month with Austrian banks on the hook for €278 billion ($354 billion) to Eastern Europe – the largest exposure among euro-zone members. Western banks are saddled with $1.6 trillion dollars’ worth of Eastern European loans, mostly tied to banks in Austria, Germany, Italy, France, Belgium and Sweden, according to the Bank of International Settlements.

Austrian bank losses are enormous and the cry for help couldn’t be louder. Austria has been the most aggressive investor in Eastern Europe over the last decade. Local banks rank as the largest investors in the Czech Republic, Hungary and Romania ($142 billion dollars) with several Austrian banks now attempting to secure government guarantees – including Raiffeisen Zentralbank, one of the largest lenders in the region along with Erste Bank.

Emerging European Collapse

Whereas the Austrians -- harboring strong historical trading ties to the region -- were heavily exposed to Eastern European banks, Swedish banks lent heavily to the Baltic Republics. Lithuania, Latvia and Estonia are also fiercely contracting since October with banks struggling to maintain solvency. Other countries in the region, including Ukraine, are barely solvent and require additional IMF funding while Kazakhstan’s largest bank saw on run on its deposits earlier this week. The list goes on and on with several other markets in trouble as funding gaps widen in an environment of tight credit and shrinking bank capital.

Teutonic Shift as Euro Must Survive

Germany, the euro zone’s largest economy measured by output, is now at the forefront of the crisis since earlier this month. Over 25% of Germany’s exports head to Eastern Europe – a vital market for her multinationals. As the region heads quickly into a full-blown fiscal and currency crisis, Germany, and, possibly, even France might have to bailout the former Soviet satellite states that are part of the wider European Economic Area (EEA).

German finance minister, Peer Steinbrueck, breached the subject on February 18, stating “some of the 16 euro nations are getting into difficulties and may need help.” He went further, adding “Germany would act if fellow euro members got into financial trouble.”

The markets are screaming for an Eastern European rescue and fast. Thus far, European deficits have ballooned with more than $1.5 trillion dollars committed to fiscal spending packages, including bank rescues and partial or full government bank nationalization.

Credit spreads for the most troubled economies in the region continue to rise vis-à-vis German bunds, the euro zone’s largest and most liquid government bond market. And it’s not just Eastern Europe that’s feeling the pain; several high deficit countries in the euro zone, including Greece, Ireland, Italy, Portugal and Spain have seen their financing costs rise on the heels of credit downgrades or failed bond auctions.

Inevitably, the Germans will finance most of a pan-European rescue for the weakest economies, especially those already part of the single currency euro zone. That’s because the euro’s viability is at stake; the Germans would rather keep the most vulnerable euro zone members a part of the single currency. The consequences of losing one or more euro zone members would imply higher funding costs for healthier members while probably devastating the economies of those members that abort the euro as financing costs skyrocket.

The endgame for the Europeans is inevitably higher long-term interest rates for all government bond markets. Like the United States, the Europeans will spend a record sum of capital in 2009 and 2010 to fund unprecedented fiscal spending plans and bank bailouts. This includes the Germans, who have now abandoned their mantra of fiscal responsibility to save the euro zone from near financial ruin.

Germany might have been reluctant at first to participate in a broad based European rescue effort. That tone has decidedly changed since January as the Merckel government unloads a tirade of spending ultimately leading to the first German budget deficit in decades.

Now Europe watches and waits for the Germans to come to the rescue. The future of the euro depends on Berlin’s quick response.

Canada Swings from Budget Surplus to Deficit Amid Crisis

Just twelve months ago Canada was basking amid a commodity boom accompanied by a bull market in the Canadian dollar, which actually surpassed par-value against the American dollar in late 2007.

In the span of just six months, the Canadian economy has come unglued in a bad way as exports plunge, manufacturing slides deeper into recession and commodity prices collapse. The Canadian dollar, which hit a 7% premium above the U.S. dollar in late 2007 at C$0.93 cents, tanked more than 20% last year.

Canada, which was mired in a string of deficits starting in 1975 finally cleaned house under former finance minister and prime minister, Paul Martin. By 1995, Martin took Canada into budget surplus.

Canada, however, ranks among those countries in the G-7 with the highest ratio of total bank deposits to liabilities, according to Credit Suisse. Only Japanese banks have a higher ratio. At 70%, that figure is high and exceeds the United States and Europe, excluding the UK, by more than 20%.

Unlike the United States and other European banks, Canadian financial institutions didn’t go whole-hog on mortgage derivatives or subprime loans over the last several years. In Canada, a prospective homeowner actually needs a job to support his mortgage payments and must typically put down a 25% deposit – not exactly the keen requirement in the United States before the subprime crisis surfaced in 2007.

Canadian banks, however, did suffer large losses on asset-backed commercial paper starting in late 2007 with a few hundred billion dollars written off bank balance sheets.

Still, despite harboring one of the lowest leveraged economies in the industrialized world, Canada is highly reliant on Asian demand for its raw materials and, of course, U.S. consumption, which is responsible for more than 85% of Canadian exports.

Canada is now in a recession. Economic growth has stalled, the loonie has declined by a third since its peak and exports climbed only 3% in November compared to a year ago.

After reveling in a string of impressive budget surpluses for more than a decade, the Harper Conservative government announced its 2009 budget yesterday – sinking Canada into its first deficit hole in more than ten years as a result of rapidly declining economic growth, rising unemployment and a housing boom gone bust.

Canadian finance minister, Jim Flaherty, announced a series of big spending initiatives to spur the economy. Canada will spend C$165 billion dollars ($135 billion) on infrastructure projects across the country, tax breaks for companies and individuals while extending unemployment insurance for the more than 2.3 million out of a job.

Canada is entering a recession with the best relative balance sheet among the world’s largest economies. Despite Ottawa’s first budget deficit in more than ten years, the banking system remains relatively strong with none of its major six banks requiring government support or bailouts – at least not yet.

If this economic downturn persists beyond 2010 and commodities don’t recover, Canada will probably head back into the economic abyss circa 1970s. China is a major consumer of her raw materials along with the United States and both economies don’t look set to rebound until 2010 at the earliest. That spells more trouble for Canada and, possibly, a banking crisis that has yet to hit her financial markets.

My 2009 Mini Q&A

Over the last several weeks I’ve received numerous questions from Sovereign Society subscribers, including individuals who frequent this daily blog.

As we start 2009, I thought this would be an ideal forum to collect some of these important questions and attempt to give you my best conclusions. I can’t reprint all of these inquiries; yet I’ve compiled several I think are excellent questions from our members.

Overall, I don’t like forecasting. I generally believe it’s a total waste of time and most consensus estimates ahead of 2008 ended in the basement with the majority of analysts dead wrong about the economy, the market and just about everything else.

I have to admit that I never expected the markets to crash, the banking system to go bust or the dollar to skyrocket in the midst of the worst financial crisis in 75 years. To be fair, I think most pros failed to make accurate predictions.

Question: I’m a retired investor living on income. Prior to the big rally in Treasury bonds, I held most of my savings in short-term Treasury’s and bank term deposits. But with short-term rates under 1% and government bonds yielding a pittance, I’m nervous. What should I do to supplement my income?

Comment: This is perhaps the most challenging environment for retirees in more than a generation. With money-market funds yielding almost nothing, Treasury bonds yielding around 2% and bank CDs paying under 1%, retirees must supplement their income.

My advice is to take a small portion of your savings, say 20%, and scatter that sum across a dozen or more investment grade corporate bonds. I emphasize “investment grade” and not junk debt. Investment grade debt includes anything rated BBB or better in my book and, to make it easier, I would stick to issues rated A- or higher.

The Dow Jones Corporate Bond Index now yields 6.90% -- down from its post-crash high yield of 8.87% in early October. Still, investors can tap into non-financial bonds like IBM, Johnson & Johnson, Wal-Mart and Kraft Foods – all paying 5.5% or more. Or, look at corporate bonds issued by America’s largest banks, including JP Morgan Chase, Goldman Sachs, Well Fargo and US Bancorp. These banks won’t default.

A good strategy to keep things simple is to buy a laddered portfolio of corporate bonds ranging from two years all the way to seven years. This should at least give your nest-egg a boost and if you feel comfortable with this formula, then increase your position to say 35% of your portfolio. But remember, don’t go whole-hog; at some point over the next 12 months, perhaps later, Treasury bond prices will get smashed and long-term rates will head higher as the government expands credit to the Moon. Keep your powder dry.

Question: Do you think we’ll avoid another Great Depression? Despite all the money thrown at the markets since late 2007 we’re still in the midst of a severe credit contraction and the global economy has literally fallen off a cliff since October.

Comment: I think we’ll avoid another Great Depression but only because government will nationalize or partially nationalize key industries. Without government intervention, the free market would have resulted in massive failures and a total collapse of the banking system and the broader global economy. There’s no doubt in my mind that the government made a big mistake not rescuing Lehman Brothers last September. Once you’re bailing out major banks, then do it right. But in all honesty, we don’t know what transpires behind the Fed’s walls or the Treasury’s. There’s some crazy buddy system in progress with special interests influencing government policy. The government doesn’t give a damn about you or me. What they care about is protecting their interests. That’s why we must protect our assets and, in the end, I believe gold will triumph above all paper money, especially against the dollar.

I don’t advocate government intervention; but these are not normal times and the consequences might have resulted in the death of capitalism and perhaps the emergence of a new social order, similar to what occurred in post-Weimar Germany in the 1920s. Harsh economic times usually result in a new socio-economic regime. If the Fed and Treasury fail to rescue the credit system, then we might face similar consequences. The world as we know it will come to an end.

It’s hard to know exactly what goes on behind the Federal Reserve’s closed doors and at the Treasury’s. Thus far, government efforts have been bold since the October crash, including major central banks worldwide. Major credit indicators have indeed improved since November but the housing market – the crux of the crisis – is still in a freefall. Housing must stabilize before this severe recession ends.

In my eyes, it seems that bailouts and backstops are not addressing the real problem; most TARP money is ending up in bank coffers again and, in most cases, these institutions aren’t lending. The core of this credit crisis lies with the consumer and with housing. If you’re going to fork out several trillion dollars to fix or remedy this crisis then give the money to the consumer – not the banks. The consumer is in a severe bear market with personal assets plummeting over the last 18 months, including real estate, stocks, most bonds and now, possibly his or her job might be next on the chopping block.

Give consumer households $50,000 or more and allow them to clean-up their busted balance sheets, keep their homes (service mortgages) and pay off installment debt. You might not agree with me and, in all fairness, it’s against the tenets of the Sovereign Individual; but what good will all this money do if it’s basically squandered by government and ending up in the pockets of reckless bankers again? I have serious doubts about how the government is dealing with this crisis and I don’t think Obama’s spending package will help much at all despite perhaps growing the economy for a few quarters.

Question: What about the banks? With governments now standing behind their biggest financial institutions, is the worst over?

Comment: The global banking system, for all intents and purposes, is effectively bust or bankrupt. This is especially the case in the United States, Europe and, to a lesser extent, in Japan. More than a dozen emerging market banks are totally bust, including Iceland, the Baltics, Hungary, Romania, Bolivia, Ukraine, Ecuador, Argentina, etc. Not a pretty picture.

I think we’re more than 75% through the worst at this juncture. Governments now stand behind the largest banks in each country and, in some cases, even guarantee entire deposits until 2010 (e.g. European Union). I wouldn’t worry about the largest banks failing at this point. The worst is now behind us.

Question: I know you’re a big gold bug, but isn’t the euro a strong currency and do you think it’s a better hedge against the dollar than gold? Is it too late to purchase gold coins and, if not, where would you suggest I buy coins?

Comment: I have absolutely zero faith in the U.S. dollar and other currencies, including the euro or yen. In the end, all currencies will decline vis-à-vis gold and, in fact, since 2005 the world’s currencies have been losing their relative value to gold bullion. Despite big moves by the yen and euro over the last several years, they pale against gold.

Increasingly, the average man in the street will realize that paper money is not protecting his purchasing power and will revolt against fiat money. At Sovereign Society, we’ve driven home this message since our first year of publication in 1997. Gold is the only asset in this world that isn’t someone else’s liability; with U.S. interest rates effectively at 0%, paper money now competes with gold, which also pays 0% interest. In a zero percent world, which asset would you rather own? I think the answer is obvious.

The government’s enormous spending plans to rescue the financial system and bailout almost every ailing industry assures dollar destruction because the Fed is now on course to print money like never before to quash deflation. We all better hope and prey that the Fed can drain excess bank liquidity very quickly when this credit crisis ends. If not, we’ll have some serious inflation – much worse than what we saw prior to July 2008.

I think every investor should hold at least 10% of his assets in physical gold. This means coins, wafers or bars. Getting gold coins today is difficult because the U.S. Mint has stopped selling Eagles since last summer while other dealers are complaining about tight supplies amid booming investor demand. I suggest KITCO (www.kitco.com) or First Federal Coin Corporation (www.govmint.com).

Also, I would not hold or store all of my physical gold at my home domicile. I strongly suggest parking some of your gold in Switzerland, too. Remember, you must report assets outside of the United States and Canada.

I’m convinced we’ll see some sort of government confiscation of gold again just like we did in the 1930s. Back then, FDR did allow Americans to hold a maximum of 100 ounces. I’m not so sure the next confiscation will be so generous.

I hope you found this helpful. See you tomorrow.