Will the Dam Burst?

The S&P500 dropped for the fourth consecutive week, slipping 0.7% last week.  The strong volume confirmed the selling, as did the VIX (or fear) index which rose 6%.  

The macro data were mixed.  Consumer spending rose, but less than expected.  Incomes were better than forecast.  ISM Manufacturing was better; ISM Non-Manufacturing was worse.  Construction spending fell more than consensus estimates, but factory orders were better.  Initial claims again disappointed, rising to 480,000 when they were expected to fall to 455,000.  Non-farm payrolls showed a loss of 20,000 jobs when most economists called for a slight rise.  The unemployment rate fell to 9.7%, but primarily because more people–who’ve lost their jobs–simply left the workforce and were thus not counted as unemployed.  And in a footnote, the government announced that in 2009, 1.2 million more jobs were lost than formerly reported in monthly payroll releases. 

Technically, the charts–daily and weekly–are broken.   The multi-month uptrend is now over.  This means that many traders will look at short-term rallies as opportunities to put on short positions with improved risk/reward profiles. 

The selling continued last week, in part, because of fears that government fiscal spending may spark funding crises.   This time, Greece and Portugal got most of the bond market’s attention.  Late last year, Dubai sparked a minor panic.  Going forward, the list of other countries, which have amassed enormous sovereign debt loads, is ominously long:  Spain, Italy, Ireland, Germany, the U.K., many Eastern European nations, Japan and the U.S.

Compounding the damage from these enormous debt loads, trillions of dollars of toxic assets–that are not marked to market–are infesting these nations’ financial sectors.  When one adds in the hundreds of trillions of interest rate and credit derivatives sitting on top of all the debt, it becomes clear that the world’s governments are trying to hold back a huge set of forces, forces that had swamped the private sector in 2008 and early 2009.

And so the question becomes, will the collective efforts of the world’s governments be able to contain these destructive forces?  This question is even more important because, while the private sector could always count on the public sector to bail it out should a crisis arise, there is obviously nobody left to bail out the world’s governments should they fail to contain the destructive forces.

The odds are not high that the dam will hold.  At first, the good news is that not all the dams will burst at once.  The dams in Dubai or Greece or Portugal will break first.  This will create a torrent of capital out of these states to their savior states and the U.S.

Later, perhaps several years  from now, the dams of the larger, savior, states will start to break.  Think the U.K., Japan and even Germany.  Even more capital will then rush to the U.S. and the dollar, temporarily making the U.S. seem like it’s a safe harbor from all the destruction.

But finally, the U.S. and China will follow.  Like the largest ships in a naval fleet, these two aircraft carriers will take aboard the frantic capital from all the other sunken states, only to ultimately suffer the same fate–they will both sink as well. 

Only then can the rebuilding begin.  The looting by the fiat-controlling elites will end.  There will emerge a new order, where the productive sector of the economy will dominate and restrain the financial sector, at least for a while, a very long while.

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