The Privateer 2010 Volume - Late January Issue - Number 646

THE PRIVATEER:
The Private Market Letter
GLOBAL REPORT
For The Individual Capitalist.

Published since October 1984.

POLITICAL “ECONOMISING” IN PRACTICE
25 issues per year
© 2010 - All Rights Reserved “After you’ve had a gigantic debt bust, the next phase is sovereign deficit
PUBLISHER: struggles. ...For the next few years, this is going to be a major issue.”
William A. M. Buckler (Steve van Order - Calvert Funds - Bethesda Md)
P.O. Box 2004
Noosa Heads, Qld. 4567
Australia True enough, as the “balance sheet” of pretty well every sovereign
http://www.the-privateer.com
government in the world makes clear today. But as 2010 gets into full
capt@the-privateer.com swing, the long-neglected science of “political economy” is being
resurrected to make sure that the world looks at some nations as being at
Phone: +61 7 5471 1960
the end of their deficit ropes and studiously neglects others.
COPYRIGHT:
Reproduction in any manner In its original formulation and intent, “political economy” was the study of
without permission is a breach
of law and property rights. the inevitable and inexorable overlap between politics and economics and
the place of both as a subset of the study of ethics. Today, ethics has been
Permission hereby given to
quote short excerpts - provided thrown to the four winds in politics - and in the areas of economics which
full attribution is given: are under direct political control. Which is to say most of them.
© 2010 - The Privateer
http://www.the-privateer.com A Quick Aside - It’s Getting Tough Out There:
capt@the-privateer.com
(reproduced with permission)
On January 27, US Treasury Secretary Tim Geithner is scheduled to
SUBSCRIPTIONS: appear before the House Committee on Oversight and Government
In AUSTRALIAN Dollars
Reform. In late 2008 at the time of the AIG bailout, Mr Geithner was head
Trial: 5 issues (once only) $A 25 of the New York Fed. The “reformers” have belatedly become interested
Six-Month: 12 issues $A 100 in the New York Fed’s decision to pay the trading partners of AIG 100
Annual: 25 issues $A 180
Two-Year: 50 issues $A 300 cents on the Dollar for the AIG-issued credit default swaps they held.
Australian residents: Please They want to question Mr Geithner as to why the New York Fed instructed
add 10% for GST
AIG NOT to report this action in filings they made by law to the Securities
Subscribe at our website: and Exchange Commission (SEC). Mr Geithner’s defenders are adamant
www.the-privateer.com/sub.html
that he is not involved because he was not aware of the New York Fed’s
instructions to AIG. Whether this will satisfy the “reformers” remains to
be seen. What it actually amounts to is one more example of politicians being “economic” with the truth.

Assuming Mr Geithner navigates this congressional testimony successfully, he is scheduled to travel to

Canada to attend a February 5-6 meeting of the G-7. This meeting is being held in the “city” of Iqaluit
(the capital of the territory of Nunavut) which is located on the south coast of Baffin Island. A more
isolated location with a more inhospitable climate in February is difficult to imagine, let alone find. One
thing is certain, this G-7 meeting will not be plagued with many “protesters”.

Modern Politics Is The Art Of Gilding The (Wilting) Lily:

From almost every political “pulpit” available anywhere, a message is going out. “Ignore what your eyes
tell you about the REAL state of the economic world. We’re here to fix it - and keep on fixing it.”
The Privateer - Number 646 Page 2

Frame The Questions - Not The Answers:

In matters of law, whether prosecuting or defending, there is an old adage adhered to faithfully by
luminaries of the stage, screen and written word like Horace Rumpole, Perry Mason and Dismas Hardy.
Never ask a question if you don’t already know the answer. This rule is also adhered to in politics. Lots
of lawyers go into politics and in many countries, including the US, all politicians are known as
“lawmakers”. In the days of genuine “political economy”, the great goal of politics was the creation of a
nation ruled by laws, not by men. Today, the politicians make the laws (hence the popular euphemism
“lawmaker”) and only ask or answer questions about these laws under duress.

Of course, the “lawmakers” do not write or read the laws, they simply pass them, usually along party
lines. The centrepiece of Mr Obama’s “program” is the health care bill. In its present form, it is about a
foot thick when printed out - 2000 pages and nearly 500,000 words long. The US Constitution in its
original form can be printed out in its entirety in eleven pages. Even an issue of The Privateer is bigger
than that. And the Constitution with all 27 amendments included is 18 pages long.

No one person wrote the health care bill or any major piece of modern legislation. And no one person,
least of all any of the “lawmakers” now wrangling over it, will ever read the bill. Modern laws are not
designed to be read or understood. They are designed to be wide open conduits through which ANY
action which is deemed necessary to confront ANY situation can be deemed “legal”.

And this is how politicians everywhere frame the questions. “What is legal”? “Anything we make a law
about.” “What is needed to confront any political or economic situation?” “Whatever is legal.”
“Who decides that?” “We do!” “On what basis do you decide?” “On the basis of the ‘national
interest’.” “Who decides what that is?” “We do!”

That about covers it, and has for decades now. There’s only one problem. It doesn’t “solve” anything.

Less Bread = More Circuses:

On January 13, the heads of the top Wall Street banks were ushered into a “hearing room” in Washington
DC to confront what is called the “Financial Crisis Inquiry Commission”. The man in the hot seat was
Mr Lloyd Blankfein, the chief executive officer of Goldman Sachs, the major beneficiary of the
government bailout which was instituted in panic in September 2008 and has been going forward without
stint ever since. According to most of the US financial media, Mr Blankfein and his colleagues from the
other too big to fail banks were there to “apologise” for their actions, the ones which are said to have led
to the crisis in the first place.

The chairman of the Commission, Mr Phil Angelides, began predictably enough. “People are angry”, he
intoned. “Mea (sorta) culpa” - replied all the bank chiefs. Mr Blankfein claimed that the banks were
blindsided and never saw the collapse coming. He said what actually happened was like four hurricanes
hitting the east coast of the US at the same time, something that nobody could predict in advance.

These people, it must not be forgotten, are “in charge” of $US TRILLIONS. The bankers are in charge of
lending it into existence. When they judge that the demand for loans is insufficient, they are in charge of
inventing new ways to create assets out of thin air. The politicians who have plunked them in the hot seat
(to delay the day when they occupy it themselves) are in charge of the bankers. They pass the laws and
sit on the committees and oversee the “regulatory agencies”. Yes, they are “lobbied”. Yes, they rely on
the “special interests” for the funding they need to get elected. But once they are elected, they and no one
else makes the laws. Almost all politicians and most of the really big bankers have long since come to the
view that ANYTHING is possible as long as one has the power to make it so by passing a law.

But when the people get “angry”, the circus comes to town. There are a lot of them playing these days.
The Privateer - Number 646 Page 3

Ode To A Grecian Deficit:

With apologies for taking the author so unabashedly out of context:

“THOU still unravish'd bride of quietness,
Thou foster-child of Silence and slow Time,
Sylvan historian, who canst thus express
A flowery tale more sweetly than our rhyme ...”
(Ode To A Grecian Urn - John Keats)

Ah, would it were still so. But alas, it is not. Not being of so poetical a bent as the esteemed Mr Keats,
CNNMoney came up with a much more prosaic headline on January 18: “Greece is the Word”.

And so “Greece” has been throughout the world of financial reporting ever since Fitch (one of the big
three US ratings agencies) downgraded its sovereign debt way back on December 8 last year. As is the
case in all ratings downgrades, the debt load of Greece had not “suddenly” become unsupportable on
December 8, but Fitch knew precisely what it was doing.

In the second week of January, the Greek government auctioned a paltry Euro 1.6 Billion worth of
government debt paper. The yield on the six-month paper rose to 1.38 percent. In November 2009, the
month before the ratings downgrade, it was 0.59 percent. Yields on ten-year Greek paper hit 6.00
percent, 270 basis points (2.7 percent) above the yield on equivalent maturity German debt paper. Before
the ratings cut, the “spread” had been about 155 basis points. The yield curve on Greek sovereign debt
paper is flattening with short-term rates rising faster than long-term rates. Over December as a whole, the
volume of Greek sovereign debt traded on the secondary market fell by more than 65 percent while three-
year bond yields soared 94 basis points (or 24.2 percent) from 2.94 percent to 3.88 percent.

The Empty Urn:

The Greek government IS in dire financial straits. The budget deficit for 2009 was 12.7 percent of GDP
while Greece’s national debt hit 113 percent of GDP. In “normal” times, these numbers would be
horrendous. But of course we are not living in normal times. The Greek numbers are still high, a little
higher than the equivalent US numbers and a bit lower than the UK numbers.

Greece is now being castigated for blowing their budget deficit out above the 3.00 percent maximum
mandated for all nations which use the Euro. This is absurd, since there is not one Euro nation (including
Germany) whose deficit has not long since exceeded that “limit”. Under duress as rates on all types of
debt including sovereign debt blow out, the Greek government has promised to bring their annual deficits
back under the 3.0 percent “limit” by 2012. No other European nation has done that.

The plan put forward to the European Union by Greek Prime Minister Papandreou is said to address the
biggest threats to Greece’s creditworthiness - “chronically weak fiscal institutions, the slow erosion in
competitiveness and an ageing population”. There are very few nations in the world which do not share
ALL those problems. The US and UK, for example, most definitely share all of them.

No matter, Greece is today the headline nation. The IMF was there last week and reported on what had
NOT been discussed, namely an IMF loan. Mr Trichet of the European Central Bank has ruled out any
kind of bailout for Greece. European politicians have professed shock and horror at the recent revelation
that the former Greek government was “fudging the numbers” and grossly under-reporting the size of
their annual deficits. Of course, no other national government would think of doing such a thing.

So, what’s going on? CNNMoney inadvertently gave it away in their “Greece is the word” piece. “The
US Dollar ...started to rally against the euro in December just as ratings agencies were being
downgraded”. What a lovely “Freudian slip” that is. No matter, the ratings agencies got the job done.
The Privateer - Number 646 Page 4

Delaying The “Main Attraction”:

On the one hand, we have Greece solemnly promising to reduce their annual budget deficits from nearly
13 percent down to 3 percent of GDP in three years. This is clearly impossible without all but
dismantling the present government. On the other hand, we have China doing all the things that Greece
did to get them into their current predicament while being looked to with hope and gratitude by all the
same eminent economists and financial analysts who are castigating Greece. China, after all, is
universally seen as the nation to lead the world back to the sunlit uplands of economic “growth”.

In the middle, to give one example, is the IMF itself. Please remember that the IMF is a child of the
Bretton Woods agreement with its elevation of the US Dollar to global sole reserve currency status.
Please remember also that the IMF is headquartered in Washington DC. And finally, remember that the
US has always been the only country that can, all by itself, veto ANY major decision taken by the IMF.
Such decisions require an 85 percent majority of the votes of the members. The US by itself controls
17.09 percent of IMF votes. The next biggest “quota” is held by Japan - at 6.12 percent.

So what is the IMF saying about the newly-emerging financial angst being directed at Greece (and the
other European Union “Club Med” nations) and at China? Managing Director Dominique Strauss-Kahn
has recently assured the world that while the Greek fiscal problem is “serious ...I don’t think that would
lead to the fragmentation of the euro zone.”

As far as China is concerned, the IMF is parroting the party line. Mr Strauss-Kahn again. “As the role of
China in the global economy becomes bigger, it’s fair to expect the Chinese currency to play a bigger
part.” On January 19, the Chinese government announced a ban on major bank lending for the rest of the
month. Within 48 hours, the Dow had dropped more than 300 points with all other major stock markets
following. It would seem that “the role of China in the global economy” has become very big indeed.

And what of the rest of the world - tacitly including the US, of course? Mr Strauss-Kahn said that they
shouldn’t unwind their stimulus measures “too soon” because that could push their economies back into
recession. Greece is expected to cut its budget deficit - starting NOW - by more than 75 percent in three
years to guard against “the fragmentation of the Euro zone”. China (and mainland Asia) is expected to
continue to absorb the debt paper created to “stimulate” the rest of the world while “floating” their
currency so that the rest of the world has a place to retreat to, just in case the “stimulus” doesn’t work.

Floating Above The Fray:

Back to Washington DC - which was floating above the fray until January 19. On that day, there was a
Senate election in Massachusetts (see Inside The United States) and the wheels seemed to fall off as the
Democrats lost their overriding majority in the Senate and Mr Obama’s legislative program hit a potential
wall. Or at least some parts of it did, notably the already mentioned “health bill”.

When it comes to “stimulus”, little has changed. Mr Obama’s budget plan for 2011 is due on February 1.
The Defence Department portion of it will be $US 708 Billion, by far the biggest request ever. On top of
that, Mr Obama will be “requesting” $33 Billion for Afghanistan and Iraq. To pay for this, and the rest of
the budget, the Treasury’s debt limit must be raised. On the day after the Massachusetts election, Senate
Democrats proposed to increase the limit by $US 1.9 TRILLION to $US 14.294 TRILLION. They need
60 Senate votes to pass this request. There are no longer 60 Democratic Senators.

Whatever the final amount of the debt limit rise, it will be necessary to keep US interest rates VERY low
in order to service it. With this in mind, Treasurer Geithner’s successor as New York Fed President,
William Dudley, has come out and said that the Fed must keep short-term rates at present levels - “at
least six months” or “...it could be as long as a year from now, two years from now. It’s going to depend
on how the economy develops.” Contrast this with what Greece is being forced to do.
The Privateer - Number 646 Page 5

“Every State Is In Play”:

This is actually the headline of a Yahoo News story describing the rising fear in both US political parties
in light of the huge upset in Massachusetts. If we “upgrade” the word “state” in the headline to mean
“sovereign nation”, we have a pretty accurate picture of the world today.

In the US, the entire political “landscape” is said to have changed fundamentally and overnight. What has
happened is merely that Americans in one state have been given the opportunity to make their displeasure
known in the only way that most politicians ever notice. They have voted down a long-standing
incumbent and, in so doing, passed judgement on what is going on in their national capital.

And it is in the national capital cities of the world, from Ankara to Zagreb, where the last bastion of the
political mechanism of “govern today - pay tomorrow” still holds firm. Only the debt of sovereign
nations still holds a patina of fiscal inviolability, and even that is fraying badly at the edges.

Every state is indeed in play. To the extent that they have blown out the amount of their existing
government debt to try to “stimulate” their way our of the GFC, their sovereign fiscal position is suspect.
In this context, the US leads the world. While Japan is in a worse debt position, its debt is held inside the
country. The European Union has 16 members which use the Euro, several of which are in dire financial
straits. The US has fifty states which use the Dollar, ALL of which would already have collapsed
financially had they not been propped up by “stimulus” from Washington DC. And no other nation on
earth is in a position where more than HALF its sovereign debt paper is owned by foreigners.

One Can’t Eat Promises - Or Government Policies:

On January 19, the Chinese government announced that they were “freezing” the lending of their major
banks for the rest of the month. The world’s financial markets promptly swooned. The US Dollar
temporarily soared. Commodities (including precious metals) were sold off. Everybody, everywhere and
most particularly in the US, retreated to the “safety” of sovereign debt instruments.

China is being counted on to be the very big engine that COULD - pull the world out of its economic and
financial malaise. China cannot do it any more than the US could. The Chinese government is now
providing unmistakable evidence that they realise this. They are trying desperately to let the air out of a
financial juggernaut of their own making without pulling their own economy down around their ears.

Franz Pick called government debt paper “guaranteed certificates of future confiscation” in the late
1970s. That’s a long time ago. What else can this paper be when the only means any government has of
servicing and ultimately repaying the debt they incur is the present and future ability of their subjects to
produce REAL economic goods?

In the US, state governments are now sitting on unfunded liabilities (pension and medical benefits for
their public employees) to the tune of some $US 3 TRILLION. On a national level, the latest November
2009 trade deficit was $US 34.6 Billion, the highest since January 2009. The December 2009 deficit run
by the federal government was $US 91.9 Billion - almost double the December 2008 deficit. Over the
first fiscal quarter of 2010, Washington DC ran a deficit of $US 389 Billion - 17.1 percent higher than in
the first quarter of fiscal 2009. The deficit for fiscal 2009 as a whole was officially $US 1.4 TRILLION.
Add 17.1 percent to that and you get $US 1.64 TRILLION for fiscal 2010.

Political Economising?:

Economising is what national governments everywhere are NOT doing. Nor, except for peripheral
nations, is there any prospect of them doing so. What we are left with is a frenzied and global effort to
pretend that sovereign debt default remains “unthinkable”. Time to start thinking about it - seriously.
The Privateer - Number 646 Page 6

INSIDE THE UNITED STATES

THE DREADED FORTY-FIRST VOTE

On Tuesday, January 19 there was an election in the state of Massachusetts to fill a Senate seat left vacant
by the recent death of Edward Kennedy. In “normal” times, Americans would hardly have noticed and
few of the voters in Massachusetts would have bothered to show up at the polling booth. After all,
Massachusetts is said to be a “liberal” (read Democrat) stronghold and the Kennedy clan has held the
Senate seat ever since John F Kennedy first won it back in 1953. In what is being called an “epic”,
“monumental” and even “unprecedented” (one of Mr Obama’s favourite words) upset, the Democrat
“incumbent” Martha Coakley was soundly defeated by her Republican challenger Scott Brown. In an
election which has swiftly gained national importance, the voters of Massachusetts took the opportunity
to get rid of the incumbent, something all Americans should do at every opportunity from now on.

Alarmed at the polls, President Obama suddenly decided on a “day trip” to campaign for his candidate on
Sunday (January 17). That didn’t work. The Massachusetts powers-that-be thought - up until almost the
last minute - that a state which had returned Kennedys for almost 60 years was safe. It wasn’t. The
Democratic party thought they were going to have a safe majority in both House and Senate at least up
until the mid-term elections this November. It turns out that they were wrong. And there’s the rub.

The 60-Vote Rule:

Under the Constitution of the United States, a 60-vote majority in the Senate allows the majority party to
push through “debate” on major legislation without delays or filibusters intervening. Further, many
presidential nominations must be approved by 60 percent of Senators - that’s 60 votes.

The Democrats no longer have those 60 votes in the Senate once Senator Brown becomes the 41st
Republican in that house. This does not mean that the legislative agenda of the Obama administration is
dead and buried. What it means is that the Republican minority can choose any part of it for public
debate. It also means that if they choose, the Republican minority can repudiate any Obama appointee
sent to them for confirmation. It doesn’t mean they WILL do this, it merely means that they CAN.

When In Panic, Fear Or Doubt ...:

...Run in circles, scream and shout! This aptly describes the goings on in Washington DC in the few days
following the Massachusetts election. The sequence of events since January 19 is quite breathtaking.

For weeks, there had been no set date for Mr Obama’s State of the Union address, traditionally given in
the last week of January. The White House was waiting until Mr Obama had a health care plan to crow
about. Suddenly, it has been announced that the address will take place on January 27, the same day that
Treasurer Geithner is up in front of Congress to explain what happened during the AIG bailout. As for
the health plan - the latest political analysis from Washington DC is that it is dead - all 2000 pages of it.

The Democrats have “suggested” a $US 1.9 TRILLION increase in the Treasury’s debt limit. In return
for passing ANY increase, key Senators want to establish a statutory budget commission which could
order spending cuts binding on the US Congress. Mr Obama wants to create a commission by executive
order. Such a commission could be ignored by Congress. This has led to an impasse. Another impasse is
possibly shaping up over the confirmation of Mr Bernanke for his second term as Fed Chairman.

Ex Fed Chairman Paul Volcker has been advocating a return to rules which prevent Wall Street banks
from trading their customers’ money for their own benefit. This plan was formally endorsed by President
Obama on January 21. And finally, Barney Frank, the head of the House Financial Services Committee,
has proposed that Fannie Mae and Freddie Mac be abolished and a “new” mortgage system established.
The Privateer - Number 646 Page 7

INSIDE CHINA - AND JAPAN

CHINA SWELLS - JAPAN IMPLODES

Over the past two weeks, China has hit world number one status in three different but related areas.

First, it was announced on January 16 that China’s foreign exchange reserves had swelled by a record 23
percent in 2009 to reach the equivalent of $US 2.4 TRILLION, by far the highest in the world. Several
other equally mind-boggling numbers were announced in tandem. Over 2009, Chinese banks extended a
total of 9.59 TRILLION Yuan (just over $US 1.4 TRILLION) in new loans. As a result of this lending
orgy, China’s M2 money supply numbers are stratospheric. The annualised increase in December 2009
was 27.7 percent, following on from a record increase of 29.7 percent in November.

Second, China has overtaken the US as the world’s largest auto maker as 2009 auto sales jumped 46
percent to hit 13.6 million vehicles. By comparison, US auto sales slumped by 21 percent to 10.4 million,
the worst result since 1982. The US has been the number one auto maker in the world for more than 100
years. Not any more. And China’s auto sales are still accelerating. The December 2009 figure was up 92
percent on December 2008.

Third, China has overtaken Germany and become the world’s largest exporter. Chinese December
exports leaped 17.7 percent year-on-year, giving a total for 2009 of the equivalent of $US 1.20
TRILLION. Germany’s equivalent figures for 2009 were 816 Billion Euros or the equivalent of $US 1.17
TRILLION. The difference? China’s annual growth is still in double figures while the German economy
officially contracted by 5.0 percent in 2009.

Add all this up and what is the sum? China had a credit expansion of 30 percent in 2009. House prices in
the largest cities (Beijing and Shanghai, for example) were up 60 percent plus in 2009. On January 20,
Chinese banking authorities ordered banks to confine lending for 2010 to 7.5 TRILLION Yuan, down
21.8 percent from official 2009 levels. This order came after Chinese banks lent 600 Billion Yuan in the
WEEK of January 11-15 (multiply THAT by 52). The attempted transition from an export to a consumer
led economy has led to a blowout in debt and money supply reminiscent of Japan at the end of the 1980s
and in excess of anything the US experienced at the height of their stock and real estate bubbles.

The World’s Biggest Debtor - Japan:

Go back and read the quote with which we began this issue of The Privateer. The biggest sovereign debt
accident waiting to happen in the world is Japan. The reason is simple. The global “debt bust” is only
about three years old and only became unavoidably visible with the onset of the GFC in mid/late 2007.
Japan’s “debt bust” is about to enter its third decade following the stock market AND property market
collapse which began in the first quarter of 1990. For two decades, Japanese monetary and fiscal policy
has been an open book on how NOT to “fight” recession. The rest of the world’s monetary and financial
powers that be have certainly read the book but have learned nothing from it. Instead, they are making all
the same mistakes that led Japan to two decades (and counting) of economic malaise.

Japan’s debt to GDP ratio is by far the worst in the world, dwarfing such picayune debt traps as the 113
percent of GDP debt ratio that Greece has been pilloried for in recent weeks. Japan’s ratio is projected at
227 percent of GDP this year and compounding. Conservative projections at current rates put it at more
than 250 percent of GDP by mid decade.

For twenty years, the GARGANTUAN savings pool inside Japan has allowed the government to borrow
at what amounts to a zero rate of interest. The savings are used up. Japanese households are no longer
buying Japanese government bonds. Foreign investors stopped buying them years ago. Japan has two
choices - stop borrowing or continue to service the debt (for a while) by selling off foreign reserves.
The Privateer - Number 646 Page 8

INSIDE THE EUROPEAN UNION

STIFFENING UPPER LIPS IN BRITAIN

While the rest of Europe and much of the rest of the world is wringing their hands (at least in public) over
the dire situation in which Greece finds itself, some very worrying developments have taken place at the
other end of the “continent” in the UK. These are even more worrying given the fact that the Brown
Labour government must call an election by June this year in the midst of an economic and fiscal
wasteland. Over recent days, the consequences of the “policies” which have brought Britain low have
burst forth in the government’s official numbers.

A Record Jump In “Inflation”:

On January 19, Bloomberg reported that the UK “inflation rate” in December 2009 had jumped by the
most since records began. For the month, UK consumer prices increased 2.9 percent year-on-year. That
doesn’t sound like much on the surface. But the 2.9 percent rise was a full 1.0 percent more than the rise
in the previous month and has exceeded the Bank of England’s (BoE) “target” rate of 2.0 percent.

The most curious part of the report was the blank assertion that records for UK price inflation go back to -
wait for it - 1997. Surely the UK had price movements before 1997? Or was there perhaps a “different”
method of calculating them before 1997? At any rate, the 1.0 percent rise month-on-month was the
biggest in 13 years. Worse, the “core” rate (which excludes energy, food, alcohol and tobacco prices)
jumped to 2.8 percent year-on-year.

Consternation spiked in the City on this news, as did predictions that the BoE would be the first “major”
central bank to raise interest rates. Ex colonies don’t count, we suppose, given the fact that the Australian
central bank has already raised rates three times and there is some expectation for a fourth rise in
February. The consensus is that the BoE will begin to raise rates from their present level of 0.5 percent
by June - which just happens to be the “deadline” for the national election.

A Central Banker Speaks:

In the evening of the day when the latest UK price inflation data was released, Melvyn King, the governor
of the BoE, gave a speech at Exeter University. His message was not encouraging. “The patience of UK
households is likely to be sorely tested over the next couple of years. ...there is little scope for growth in
real take-home pay, which may remain weak even as output recovers.”

Britons have long been masters of understatement. The latest UK price inflation numbers show an annual
rise which is double the rise in average earnings. The UK has only managed to keep its official
unemployment numbers in single figures (it is officially 7.9 percent) due to falling salaries and huge
numbers of employees accepting part-time work in order to have a job at all.

Mr King is not up for imminent confirmation as is Mr Bernanke. He can clearly see the looming onset of
sovereign debt crisis/default spreading far beyond the present headline nations of Greece, Spain, Portugal
and Italy. On January 18, the UK Treasury confirmed that Prime Minister Brown was considering doing
away (temporarily, of course) with the rule that deficit spending must be kept at or below 40 percent of
the size of the economy. On the same day, Mr King proposed a “merger” of the G-20 and the IMF. He
pointed out that unless politicians everywhere get together in an international body dedicated to
“monetary reform”, another big downwards lurch in the global financial crisis is inevitable.

Mr King doesn’t want a “Bretton Woods II”, regarding that as “wholly impractical”. He does want an
international body with the power to “vote on decisions”. The US doesn’t want that and will oppose the
idea. The US still holds the controlling vote in the IMF. They won’t give it up easily.
The Privateer - Number 646 Page 9

AUSTRALIAN REPORT

AUSSIE OF THE YEAR - AND - OH HENRY!

In our previous issue (Number 645 - published on January 10), we mentioned the selection of Ben
Bernanke as Time magazine’s “person of the year”. Picking people of the year is a popular pastime in
the global media and the Aussie media is no exception. On January 23, the Weekend Australian picked
their “Australian of the year”. He was, to nobody’s great surprise, Prime Minister Kevin Rudd.

If we go back to the beginning of the 1970s, the only Aussie Prime Minister that the Australian has not
thus honoured is Paul Keating. Gough Whitlam got the gong in 1972, Malcolm Fraser in 1977, Bob
Hawke in 1983 and John Howard a bit belatedly in 2001. We say “belatedly” because Mr Howard had
been in office for six years before being so honoured. The other Prime Ministers were awarded early in
their tenures. But Mr Rudd has come in for special kudos because of the “daunting crisis” he is said to
have overcome. Mr Rudd did this, according to The Australian, by “approving a series of unprecedented
financial stimulus packages to taxpayers and giving sweeping guarantees to the nation’s banks.”

In other words, Mr Rudd and his government did what every other major government in the world did.
But while the Heads of State of many other nations which followed identical policies are being pilloried,
Mr Rudd is being “feted”. What’s the difference? Simple! In the case of Australia, the policies appear to
have “worked”, at least so far. The Aussie central bank has raised rates with impunity. Aussie
unemployment is 5.5 percent - “a figure close to the modern definition of full employment” according to
The Australian. And Australia has not (yet) recorded an official quarter of negative economic “growth”.

Why has it all “worked”, so far, for Australia? There are two reasons. First, Mr Rudd inherited minimal
government debt and a budget that had been in surplus for the best part of a decade from his predecessors.
Second, China continued to buy Aussie resources in a big way throughout 2009. The government surplus
is gone and China is now pulling back from its out-of-control stimulus. It won’t “work” much longer.

Time To Look For More Revenues:

As reported in our previous issue, Australian production did not rise in 2009, it fell - while spending at all
levels rose 50 percent faster than income. This was worrying those in charge of “funding” the
government. So, throughout the year, the Henry Commission of inquiry into tax, income support and
retirement income was working away behind the scenes in Canberra. Every time part of their work saw
the light of day, Aussie taxpayers blanched. They are about to go stark white.

The Melbourne Age has reported that the Henry commission recommends that Australians be allowed to
“swap” their superannuation payouts for a government-guaranteed lifetime income. Australians already
have a “government-guaranteed lifetime income” and have had it since April 1909, more than a century
ago. It is called the “old age pension”. Superannuation must be paid on behalf of employees by all
Australian employers. It is described by the government as “an effective way to save money for your
retirement”. It is in fact a form of “forced savings” - with employers being the ones forced. It was
conceived as a means of easing the burden on future government revenues by making Aussies save a part
of their wages - the part which their employees don’t pay them but instead “contribute” to their Super.

Aussie Super is a LARGE pool of money and investment assets. The Canberra government would sorely
like to get their hands on it. Hence the proposal that Aussies give up their super in return for a glorified
old age pension. If this proposal becomes law, the government would get the money NOW and only have
to worry about paying the “lifetime income” as, if (and when?) Aussies qualify for it.

On top of that is a proposal to divert the mining royalties presently levied by the Australian states to a
“mining resource rent tax” of 40 percent which would go straight to Canberra.
The Privateer - Number 646 Page 10

THE GLOBAL MARKET REPORT

ANOTHER DECADE OLDER AND (MUCH) DEEPER IN DEBT

Ten years ago, in the early days of January 2000, the world (and the US in particular) was a very different
place to what we see today. Recent years had seen their share of financial and market earthquakes.
Russia had defaulted on its sovereign debt in 1998. The whole of Asia had been rocked by a market crisis
in 1997-99. Argentina was in the throes of living through the all but utter destruction of its banking
system and currency. But global markets, for the most part, had sailed above the fray. The US Dollar had
been steadily rising since the mid 1990s. The US stock market was on a tear, the Dow sporting gains of
well over 100 percent over the previous five years. Copious government revenues had shrunk the annual
federal deficit to the point where the Clinton administration was even claiming surpluses.

At midnight on December 31, 1999, the one potential hazard to this prospect of perpetual prosperity had
been exposed as a non-event as the Y2K “bug” proved harmless. There was not a cloud on the horizon as
far as Wall Street and the global financial establishment was concerned. On January 14, 2000, the Dow
closed at an all time high of 11722.98, having risen 1700 points or 17 percent over the previous three
months. US investors were unanimously expecting 20 percent annual stock market returns - in perpetuity.

On January 14, 2000, the Dow closed at 11723. By late January, it was below 11000. By late February, it
was below 10000. In March 2000, the Dow was joined by the S&P 500 and especially the Nasdaq.

Fast forward to January 2010. In stark contrast to the position ten years earlier, US government deficits
are gargantuan and growing. So are (in proportion) the deficits of every other major nation. But because
this borrowed “money” is being used to rescue the world's banking and “market” systems from doom,
most market players still think that all is well. On January 19, 2010, the Dow closed at 10725. It had
risen by 63.8 percent in just over ten months - since March 9, 2009. By January 22, the Dow had tumbled
552 points or 5.1 percent to 10173. Stock markets everywhere had followed the Dow down.

The contrast between January 2000 and January 2010 in terms of US government spending excesses is
stark. The similarity between market action in January 2000 and January 2010 is ominously close. But
ten years on, the scope for market rescues which “worked” ten years ago is simply not there.

China - Massachusetts - And The “Volcker Plan”:

Two seminal events took place on January 19. In China, the government announced that it was banning
any new lending from its major banks until (at least) the end of the month. In Massachusetts, the
Republican party won a 41st seat in the US Senate. By doing so, they ended the ability of the Obama
administration and the Democrat House and Senate majority to railroad bills through Congress with
minimal or no debate. Two days later, on January 21, Goldman Sachs reported their biggest ever
quarterly profit - just under $US 5 Billion for the fourth quarter of 2009. On the same day, President
Obama faced the media with ex Fed Chairman Paul Volcker at his side and proposed a plan to curb the
“too big to fail” banks from trading “on their own account” and to force them to give up their stakes in
hedge funds and private equity firms. The combination of these events led directly to the market falls.

In the US, and in most other nations, the market falls were led by the financial sector as the possibility
arose that the major banks will face curbs on the risk-free trading they have been indulging in as a bonus
from their “too big to fail” status. On top of that, there is the threat to the “business as usual” aspect of
the ties between Washington DC and Wall Street. And behind the scenes, there are nascent concerns that
the nation which is financing all this - China - is about to pull the punch bowl away.

But underneath it all is the stark fact that is not even being seen - yet. A global economy based on credit
creation cannot survive unless it continually expands to maintain the ability to service existing debt.
The Privateer - Number 646 Page 11

No Ammunition Left In This Shot Locker:

A comparison of what the US government did at the beginning of the 21st century with what they are
capable of doing today should make the difference in the situation starkly clear.

At the end of 2000, the newly-elected Bush Treasury was projecting that the US government would have
paid off ALL outstanding Treasury debt by “2011 - 2013". Today, that debt has more than doubled and
the most optimistic predictions see $US 1 TRILLION annual deficits stretching into the indefinite future.
In 2001 the US government got what all governments under financial duress seek. It got a war. Even
better, it was a war against an imaginary opponent, a war on “terror”. Within 18 months, it also had two
real wars, one in Afghanistan and the other in Iraq. Today, those two wars are still going on with the US
military and intelligence community already stretched to the breaking point as recent events concerning
Yemen and the Haiti earthquake make only too clear.

Ten years ago, the Fed could do what it has always done, lower interest rates to the vanishing point. The
Fed funds rate hit 1.00 percent in mid 2003 and stayed there until mid 2004. Today, the Fed funds rate
has been at ZERO percent for well over a year. Ten years ago, a systemic bailout was not required. All
that was required was to let the US Dollar fall, which it commenced to do in early 2002. Today, the US
and the world have already been through more than two years of the biggest systemic bailout in history.
The US Dollar, meanwhile, hit post 1971 fiat currency era lows in late 2007. With the exception of an
explosive rally in late 2008/early 2009 as the world "deleveraged" out of $US assets, the US Dollar has
been below 80 on the trade-weighted USDX ever since.

This time, all the “stimulus” measures which have rescued the global financial system from every
previous downturn - including the one which began ten years ago - has been tried. More, they have been
piled on to a degree never before approached. A week ago, most of the financial and political powers that
be thought they were working. Not any more.

“Curing” The Disease By Killing The Patient:

A week ago, the English-speaking financial press in particular continued to point at Greece as the latest
example of fiscal and financial mismanagement. There is a long tradition of this. In the current financial
“crisis”, the “finger” has swung from Iceland to the Baltic nations to the “Club Med” members of the
European Union before homing in on Greece. Japan too is now being mentioned more and more
frequently as a nation where government debt is out of control. The UK does get a look in on occasion as
the nation which is leading the race towards insolvency. And even the US is mentioned. On January 12,
Fitch warned that the US government must start to cut spending - “to save its AAA rating”.

What all of this ignores is a simple fact put forward eloquently by Doug Noland in his latest Credit
Bubble Bulletin: “...there are tens of Trillions of marketable securities out there - and their value depends
greatly on the ongoing creation of Trillions more.” Precisely. The US is still the engine room of the
global credit money system. Any slackening in the creation of credit for the SYSTEM - not necessarily
for the people who are forced to live within it - would starve the system of fuel and, in time, kill it dead.

It Has Come Down To This:

On January 23, President Obama endorsed a “deficit task force” to come up with a plan to curb the
spiralling US deficit. Mr Obama had wanted to create such a government body by executive order so that
its findings, if any, would not have to be voted on in Congress. The “force” he has now endorsed was the
one proposed by Senators as their “price” for increasing the Treasury’s debt limit. If and when proposals
are made by this task force, they WILL have to be voted on by both House and Senate. Within minutes of
Mr Obama making this announcement, influential Senators had informed him that Mr Bernanke WOULD
be confirmed in Senate hearings late next week. Quid pro quo (something for something)?
The Privateer - Number 646 Page 12

Deal Now - Implement Later:

Two months ago, the Democrat majority in the US Senate was pushing for an immediate $US 1.6 - 1.8
TRILLION increase in the Treasury’s debt limit. They didn’t get it, the deal foundering on the demand
for an independent “deficit task force” to be set up as part of the legislation lifting the limit. Instead, the
Senate passed an “interim” $US 290 Billion limit increase (to $US 12.394 TRILLION) on December 24.

On January 19, the Democrats lost their stranglehold on the Senate and all hell broke loose. Now, the
Democrats are proposing a $US 1.9 TRILLION increase in the Treasury’s debt limit (to $US 14.294
TRILLION) in return for a deficit task force whose findings must be voted on by all sitting members of
both houses. But here’s the “out clause”. The (bipartisan) task force will indeed be brought into being
and will go behind closed doors to “study” the issues. But it will not report on any findings until AFTER
the mid-term elections this November. And any recommendations it makes will not be voted on until the
new US Congress convenes early in 2011.

The LAST thing that any sitting member of Congress wants to have to vote on - IN PUBLIC - is any
measure to genuinely cut government spending and/or genuinely raise taxes. This particular Congress
won’t have to vote on it, but unless something VERY big changes later on in the year, the next one will.
In the meantime, world and US markets are left in the situation they dread most - chronic uncertainty.

Recent Events:

Before or after January 19? The sudden swoon of global stock markets has already been discussed. To
that can be added the other usual events - falling prices for so called “risk assets” including but not
limited to commodities, raw resources and precious metals. The global financial powers that be have not
yet discovered a way to create more of these out of thin air. So they have done the next best thing, they
have created paper surrogates for them which they can create at will in the futures markets.

Politically, the global spotlight has swung from the “periphery” to the centre. The focus on the problems
of Greece et al have abruptly faded into the background as the political logjam in Washington takes centre
stage. Meanwhile, the secondary prices of US Treasury debt paper - which were threatening to break
below their decade-plus uptrend two weeks ago - have stabilised. As has the US Dollar, for now.

Gold:

For MUCH more on Gold - please see Gold This Week (GTW):
http://www.the-privateer.com/subs/goldcomm/gold.html

What’s Next?:

Almost anything imaginable! The only certainty is that the US political calendar is jam packed as seldom
if ever before over the time between now and our next publication date on February 7. On January 27,
Treasury Secretary Geithner fronts a Senate committee on his role (as Governor of the New York Fed) in
the AIG bailout. That evening, Mr Obama gives his State of the Union address. While all this is going
on, over at the US Senate, a bill must be debated raising the Treasury’s debt limit. There is no guarantee
that the bill will pass since many powerful Senators are dead set against the proposed “deficit task force”.

Mr Bernanke’s tenure as Fed Chairman runs out on January 31. Over the weekend, there was a lot of
press ink spilled on the chances that he would NOT be confirmed. But that was before Mr Obama made
the deal we have reported on. As yet, there is no news that a vote on this has been definitely scheduled.
Late January Issue - Number 646 William (Bill) Buckler
Published: January 24, 2010 © 2010 - All Rights Reserved