ALERT - March 16, 2009

JOHN WILLIAMS’ SHADOW GOVERNMENT STATISTICS

A L E R T

March 16, 2009

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Swiss Franc’s Relative Strength Persists
Despite Official Debasement Efforts

"Absolute Confidence in Soundness" of U.S. Treasuries Is Hype

Far From Over, U.S. Economic Downturn Still Is Unfolding

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PLEASE NOTE: This Alert primarily is intended as a review of the Swiss franc circumstance. It also touches briefly upon new themes being put forth by the spinmeisters in Washington and on Wall Street, as to how the economy has bottomed and really was not as bad as the Fed, the Treasury and President Obama had been advertising, and as to the soundness of U.S. Treasury securities. The new themes will be addressed in detail in the pending newsletter (due later this week/next weekend). A Flash Update will follow the release of the February CPI report on Wednesday, March 18th.

– Best wishes to all, John Williams

Broad Outlook Remains Unchanged. The U.S. economy remains in a severe, deepening recession, which likely will attain depression status this year (depression defined by SGS as a peak-to-trough contraction in inflation-adjusted GDP of more than 10%). Recent strength in the U.S. dollar has been due largely to systemic stresses on dollar demand, not to underlying economic fundamentals. In the months ahead, efforts by the Federal Reserve to debase the U.S. dollar likely will take hold, resulting in much-higher inflation and eventual heavy dumping of the dollar and dollar-denominated assets. Such ultimately should evolve into a hyperinflation, with the U.S. dollar and U.S. Treasuries effectively becoming worthless. Over the long haul, the best hedges against this circumstance remain physical gold and assets outside the U.S. dollar, in currencies such as the Swiss franc and the Canadian dollar.

Usually, when government officials find themselves having to make public assurances as to the strength of a currency, financial market or economy, the area being jawboned is in serious trouble and facing imminent turmoil.  Last week, U.S. President Barrack Obama publicly had to assure Chinese Premier Wen Jiabo that China’s investments in U.S. Treasuries and other dollar-denominated assets were sound. Accordingly, the U.S. fiscal crisis may be coming to a head in the global markets. Where China is looking for reassurances on U.S. fiscal activity, Mr. Obama’s happy comments may be about all that is forthcoming. It is not likely that an administration dedicated to the rapid unfunded growth of the federal government would undertake a serious effort at actual deficit containment. The U.S. also is not likely to issue debt in other currencies. Any appeasement of China’s legitimate financial concerns most likely will be, or is being handled in the context of compromising global political needs.

Also last week, official commentary on the U.S. economy shifted to the plus-side, with suggestions that the economy not only had bottomed, but that the economy really was not that bad to start with, and/or that the recession will end this year. The underlying economic fundamentals remain as bleak today as they were two weeks ago. Consider, for example, this morning’s report of an 11.2% annual contraction in February 2009 industrial production (deepest downturn in 51 years). Nothing has changed other than the Administration has decided to attempt to boost public confidence in the economy. 

Accordingly, there is increased risk of massaged, happier economic data in the months ahead. In the event of surprisingly strong month-to-month reporting in a given series, assessing the impact of prior-period revisions and considering the magnitude and patterns of year-to-year change should help keep the numbers in appropriate perspective.

Swiss National Bank Moves to Debase the Franc. As discussed the in the March 9th Alert, "the worst elements to date of the systemic-solvency and economic crises may be about to unfold." Possibly foreshadowing that was the March 12th announcement by the Swiss National Bank (SNB) of its latest efforts to debase the value of the Swiss franc, including direct market intervention to weaken the franc against the euro. Citing recession and deflation risks, SNB cut interest rates and announced it would purchase private-sector Swiss-franc bonds in an effort to boost systemic liquidity and to weaken the franc versus the euro. According to the Financial Times (March 13), currency traders confirmed Swiss central bank selling of francs, and the U.S. dollar rallied by more than three-percent as a result.

Swiss trade may be dominated by the euro sector, but on a pure currency volume basis in 2007 (Bank for International Settlements), 43% of Swiss franc currency transactions were against the U.S. dollar, 22% of the transactions were versus the euro. As the systemic-solvency crisis intensifies anew, the U.S. Federal Reserve is poised to begin direct monetization of U.S. Treasury debt in an effort to boost money supply growth and U.S. inflation. Having previously raised that possibility, the Fed could be planning to announce imminent monetization fromt this week’s FOMC meeting. If so, the Swiss action might be a preemptive effort to minimize some flight-to-safety boost of the franc from expanded dollar-debasement efforts.

The Swiss franc is a currency I have used regularly as an example of a good, ultimate hedge against the terrible collapse eventually looming for the U.S. dollar. Despite the actions of the SNB, the Swiss franc remains a primary hedge against all the issues plaguing the U.S. currency and eventual hyperinflation. The franc’s relative strength versus other major currencies has been weakened, but its relative ranking still remains at or near the top of major currencies versus the U.S. dollar. As a direct indicator of such, the SNB has had to intervene in the markets in order to depress the franc. Intervention against the pressures of underlying fundamentals usually is a losing proposition, with limited long-term effect. Indeed, the fundamentals still strongly favor the Swiss franc over the U.S. dollar.

As discussed in the March 9th Alert, the U.S. economic, fiscal and systemic conditions generally are relatively much worse than among its major trading partners. As to Switzerland, consider that it runs both fiscal and trade surpluses, versus the horrific budget and trade deficits of the United States. On the fiscal side, Swiss Confederation debt runs about 4% of GDP and is shrinking (hence the buying of private sector debt), while U.S. gross federal debt is about 77% of GDP and likely will top 90% by calendar year-end 2009. As of January 2009, year-to-year growth in broad money supply M3 was 2.8% in Switzerland and 12.0% (SGS) in the United States. (SGS February estimate is 9.9%).

[Corrected Text] Dollar touts have been talking up the risks of the banking crisis versus Switzerland’s smaller GDP. While the bank liabilities indeed are significant, usually there is at least some offset in assets. As of December 2008, Swiss banks were reported with total assets of CHF 3.12 trillion versus liabilities of roughly CHF 2.95 trillion, with liabilities roughly six-times the level of GDP. In contrast, in December 2008, commercial banks in the United States were reported with total assets of USD 12.2 trillion versus liabilities of USD 11.1 trillion, with liabilities roughly 78% of GDP.  Although the Swiss liabilities-to-GDP ratio is much higher, again, assets do more than offset the liabilities.

Underlying currency fundamentals for the Swiss franc not only outshine those of the United States, but also those of most of other major currencies. Accordingly, the Swiss franc continues to hold its relative top ranking versus the greenback, euro and pound sterling. Dampening intervention by the SNB likely will have limited lasting impact.

Of great importance to the ultimate strength of other currencies relative to the U.S. dollar is that the U.S. government effectively was bankrupt coming into the current systemic and economic crises, with $65 trillion of obligations, including outstanding debt and the net present value of its unfunded liabilities. The extreme fiscal imbalance was built up over years of deliberate fiscal abuse by U.S. politicians. With its obligations standing at more than four-times the size of U.S. GDP, and greater than total global GDP, the U.S. faces few practical options beyond meeting its debts by running the currency printing press. The eventual hyperinflation will be seen primarily in the United States, which not so coincidentally also is ground zero for both the systemic-solvency and economic crises.

Week Ahead: CPI. The key report this week is Wednesday’s (March 18th) release of February CPI. With gasoline prices up for the month, expectations (Briefing. com) are running around a 0.3% seasonally-adjusted monthly gain. Such should be enough to keep the annual CPI-U inflation rate hovering above zero. Annual inflation would increase or decrease in February 2009 reporting, dependent on the seasonally-adjusted monthly change, versus the 0.17% monthly increase seen in February 2008. The difference in growth would directly add to or subtract from January’s annual inflation rate of 0.03%.

A weaker than expected showing could intensify pressures on the Fed to accelerate its monetization of U.S. Treasuries. The next FOMC meeting concludes the day of the CPI release.

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