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The Coming Euro Bail

The Coming Euro Bail

The Coming Euro Bail

Financial volatility and political incoherence have been the order of the day on the continent.  However, with the German vote today there are distinct signs that a political consensus has taken shape in Europe. Now the job is to create a TARP like facility to stabilize the banking system and the sovereign debt crisis. As we see things, it looks likely that trillions of Euros will be injected into recapitalization of weak European banks.  Funds would also be earmarked for buying the government debt of the three weakest countries ? Greece, and perhaps Ireland and Portugal ? for probably 50 percent of face value. Private owners, primarily the banks, would take the losses.  One major goal of the plan is to try and keep contagion away from Spain and Italy, which would be massively expensive to bail out.

Cash for the bailout would be funneled through instrumentalities such as the European Central Bank, the European Financial Stability Facility, and the European Investment Bank.

This development is to be welcomed. Until recently, many authorities in Europe have been acting as if their heads are stuck in the sand. They have tried to assure the markets about the health of European banks and that no bailout was needed by for Europe’s weakest members. The pretend game has been absurd, and market participants have long been aware of the charade. Politicians lie to suit their own needs but financial markets know better and by and large ignore the foolishness.  The public, in Europe and globally, is learning to do the same.

Information has been leaked out to the financial markets in recent days indicative of a credible and large (2+ trillion Euro) plan.  Should this materialize, as we think it will, you can expect major rallies in global stock markets and in gold.  From our side, we will try to determine when this will happen, and communicate our findings to you.

 

U.S. Job growth- Go the Reagan Route

The President and Congress are not in harmony on many important issues these days.  One thing they are in tune on is this: American job growth is a priority.  Their ideas for making this happen, however, have not worked.

We suggest taking a page from former President Ronald Reagan’s playbook. During the 1980s he created a tax regime for new investment which eventually led to the biggest economic miracle that the U.S. had seen for a long time: a high-tech boom that came a few years after he implemented a cut in the capital gains tax and new rules to stimulate capital formation.

In our opinion, it was this plan which incentivized the capital investment that created the technology and internet booms. This plan opened the door for the venture capital industry to grow and attract more investors. As it grew, the industry funded the tech revolution and the creation of many new companies. Whole new enterprises emerged, such as internet search engines, web portals, internet security, social media, mobile telephony, software and hardware technology and much biotechnology.

The new industries created many jobs for creative and highly-skilled workers. They cut costs for companies all over the world and improved the global flow of information and communication. U.S. computer scientists, other cutting edge scientists, and many engineers enjoyed a big increase in their personal standard of living, while immigrants with a background in technology flocked to the U.S. to satisfy the demand for expertise; which improved the overall national standard of living.

Eventually, many of the companies financed by venture capital went public. The capital gains taxes spawned by this incentive were massive. When paid, the revenue allowed subsequent presidents, starting with President Clinton, to balance the budget and create a robust job market for technology workers.

These actions worked superbly back then…and we believe something similar would work now. We are not alone in this view. It is also the view of Nobel Prize winning economist Robert Lucas of the University of Chicago, who the majority of economists believe is the most influential U.S. macroeconomist of the last 40 years. He is not of the left or of the right. He prefers to remain in his academic roost and write books that have shaped economic thinking for decades. He does not work with politicians of either party.  He has stated he voted for President Obama in 2008. More importantly he stated in a recent interview that “if you want to stimulate growth in investment, productivity, and income, cut taxes on capital.”

We agree. Why do we agree? Because people and businesses plan ahead.  As Dr. Lucas pointed out decades ago, businesses hire people because they think that they will be able to make money when their project comes to fruition. If the administration and Congress want to stimulate employment, they need to act to lower taxes on capital investment.  We’ve said this before. We’re saying it again…and so is a transcendent Nobel Prize winner.

President Obama and Congress are arguing about taxes. Some say increase taxes, and some say cut taxes. Whatever is done, they should strongly consider tax cuts for capital investment.

When businesses have ideas for expansion, and capital to pull it off, they hire people. They produce newer and better products and services. This is the action plan that would solve the problems of the U.S., Europe, and Japan. All three ailing regions need to think in these terms.

 

Brazil Institutes Protectionism -A Big Mistake

Recently Brazil’s finance minister announced a major tax on cars and parts made outside of the Latin free trade block. Why such an unwise move?

The bottom line: cars are 60 percent more expensive to build in Brazil than in China.

Protectionism doesn’t work.  It is far better to improve the economy and make it more competitive than to stimulate sloth and inefficiency by putting up protectionist barriers. The old saying still rings true: “Competition is for the competent.”

Even land purchases in Brazil have fallen under the influence of protectionism.  When foreign sovereign wealth funds or foreign companies seek land they face a limit on the amount they can buy. As a result, billions in foreign agriculture investments are being lost. Investors recently have been shunning Brazil and these behaviors are part of the reason.

Brazilian Bovespa Index (5 year chart)

Courtesy of Bloomberg

The Plight of the Volcker Rule

A few weeks ago we reported on the Volcker Rule as a critical action necessary to restrict banks from involvement in the kind of speculative investment activity that contributed to the current financial crisis.  The rule was created by the former U.S. Federal Reserve Chairman Paul Volcker and is contained in the Congressional financial and consumer protection overhaul legislation.

The banks, however, are fighting the reform.  They are trying to dilute the requirement that would minimize their leveraged bets on the direction of markets for stock bonds and commodities. This increases the chance that the taxpayer will have to bail them out once again.

Overall, the overhaul restrictions of the Dodd-Frank bill are too heavy-handed in many respects.  However, the Volcker Rule in our opinion represents the best part of the bill and hopefully will prevail over banking greed.  If it becomes diluted, the results, once again, may be harmful for taxpayers.

A recent article in the Wall Street Journal sheds light on one of the ways the banks are trying to lobby around this issue. To quote from the article, “Banks could be allowed to continue making risky bets with their own capital, according to a draft version of the so-called Volcker rule that dilutes the provision’s original ban on proprietary trading.”  Link to Volcker Article


India watch

India’s economy is moving along at a strong and steady clip.  The GDP will rise by over 7 percent in 2011 and will probably do the same next year. As we have been reporting, India has enacted multiple interest rate hikes in the past few months to combat a strong and rising inflation rate. Inflation stems from many causes, primary among them a steep increase in agricultural prices.

The good news for India has been a fortuitous combination of strong monsoon rainfall and minimal flooding. The result is a bumper summer crop of most farm products. Looking ahead, the rivers in northern India are full for a good winter crop.  With its very warm climate, India can produce more than one crop per year in most of the country. Increased agricultural production will moderate inflation at least temporarily.

 

Summary

If the optimists are to be believed, Europe will come to grips with its critical financial problems and conduct a massive restructuring of the banking system and bail out the irresponsible countries that overspent. If the pessimists are correct, the world is a mess and will stay that way.

We are moving toward the optimistic side.  We see that Europe is finally recognizing that the all-is-well charade is no longer working. Investors are too smart and more cynical than in the past.  Moreover, information travels fast these days. European banks need capital.  If they get it, investors may see a sizeable stock market rally in much of the world.

Gold remains a good long term buy in our opinion. Remember to buy the dips and take some profits on the rallies.

 

Thank You

We thank you for reading our newsletter and look forward to hearing from you. To request information about Guild Investment Management services and offerings please call (310) 826-8600 or email us at guild@guildinvestment.com.

 

Our Recommendations

  Date Date Appreciation/Depreciation
Investment Recommended Closed in U.S. Dollars
Commodity Market Recommendations      
Gold 6/25/2002 Open +395.6%
Corn 4/20/2011 8/3/201 -6.3%
Oil 2/11/2009 8/3/2011 +157.1%
Corn 12/31/2008 3/3/2011 +81.0%
Soybeans 12/31/2008 3/3/2011 +44.1%
Wheat 12/31/2008 3/3/2011  +35.0% 
Currency
Recommendations
     
Long      
Canadian Dollar 9/13/2010 9/21/2011 +2.2%
Long      
Chinese Yuan 9/13/2010 9/21/2011 +5.8%
Long      
Swiss Franc 9/13/2010 9/21/2011 +12.1%
Long      
Brazilian Real 9/13/2010 9/1/2011 +6.4%
Long      
Singapore Dollar 9/13/2010 8/3/2011 +10.9%
Long      
Australian Dollar 9/13/2010 6/29/2011 +14.1%
Long      
Thai Baht 9/13/2010 6/22/2011 +6.5%
Short      
Japanese Yen 4/6/2011 7/27/2011 -9.7%
Short      
Japanese Yen 9/14/2010 10/20/2010 -3.3%
Equity Market
Recommendations
     
U.S. 9/14/2011 9/21/2011 -2.3%
India 4/6/2011 9/21/2011 -21.6%
Malaysia 6/29/2011 8/3/2011 +0.1%
U.S. 6/29/2011 8/3/2011 -4.6%
Japan 2/15/2011 8/3/2011 -9.5%
Australia 2/15/2011 6/22/2011 -0.9%
Canada 3/24/2011 6/22/2011 -7.1%
Colombia 9/13/2010 6/22/2011 +2.6%
Malaysia 4/6/2011 6/22/2011 +0.8%
Canada 12/16/2010 3/11/2011 +7.9%
U.S. 9/9/2010 3/11/2011 +18.1%
South Korea 1/6/2011 3/3/2011 -2.9%
Colombia 9/13/2010 2/2/2011 +3.9%
China 9/13/2010 1/27/2011 +5.0%
India 9/13/2010 1/6/2011 +7.9%
Chile 9/13/2010 12/16/2010 +8.9%
Indonesia 9/13/2010 12/16/2010 +9.5%
Malaysia 9/13/2010 12/16/2010 +1.3%
Peru 9/13/2010 12/16/2010 +32.2%
Singapore 9/13/2010 12/16/2010 +4.8%
Thailand 9/13/2010 12/16/2010 +11.9%
       
Bond Market
Recommendations
     
       
 30 YR Long Term      
U.S. Treasury Bond 8/27/2010 10/20/2010 0.0%