Gold, Treasurys and Dollars—Oh No!

The S&P500 failed to reverse the prior week’s decline.  Although it closed the week with a small gain (less than half a percent), the market was skidding downward most of the week.  Such a failure–moving higher and then closing lower–is a bad sign for bulls.  It suggests that the buyers are running out of steam.

While the data flow was light, the results were meaningful.  Housing starts and permits (which were some of the key reasons behind the green shoots propaganda) fell dramatically–not only reversing the prior month’s gains, but diving to all time lows.  Initial claims did not behave as needed to support the glimmers of hope message–it stayed in the mid-600K range.  And continuing claims hit another consecutive record; at 6.66 million, they’re about to breach 7 million–astounding given that they were only 3 million about a year ago.

The technicals suggest that a strong topping formation has developed on the daily charts.  And more ominously, volumes have been growing stronger on down days while dropping on up days.  Volume seems to be confirming a downward direction in price.

In the macro world, several key indicators have taken a turn for the worse.  Gold priced in U.S. dollars has been soaring over the last three weeks, closing above $960 an ounce at the end of the week.  The U.S. dollar, as measured against the major currencies, has been falling.  And the ten year Treasury’s have been collapsing; after bottoming around 2% at the end of 2008, the ten year is almost 3.5% today.

Why is this worrisome?  Because these markets provide important feedback to the Fed and to the President and Congress; these markets offer clues about the limits on the amount of monetary and fiscal stimulus that the rest of the world–our creditors–will put up with.

And so far, these clues are not positive. 

If the Fed prints too many dollars (quantitative easing), or keeps the cost (interest rates) of the dollars too low, or overspends fiscally (runs huge deficits and amasses colossal debts), then our creditors will rightfully protest that that they’re incurring too much credit risk (default risk stemming from getting paid back in a debased U.S. dollar).

What will they do?  Buy gold, sell Treasury’s and sell the U.S. dollar. 

Recently, when asked by Congress what’s the limit of the Fed’s balance sheet, Ben Bernanke replied, essentially, that he did not know what the exact limit is.  Well, the markets are now stating–quite clearly–that the Fed’s monetary measures and the government’s fiscal overspending are nearing a limit.

The dilemma for the government is this:  if the measures are curtailed now, then our economy would surely resume it’s free-fall.  But if the measures continue for much longer (or if they’re increased), then the world could turn away from the U.S. as it would from any typical banana republic; this would also cause the economic free-fall to resume.

Oh no.

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