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Thursday
Apr012010

Lihir Gold Limited Up on Bid Rejection

Lihir Gold Chart.JPG

Chart courtesy of StockCharts.com

From the above chart we can see that Lihir Gold Limited (ASX: LGL) and (NASDAQ:LIHR) (TSX: LGG) has jumped recently on the news that a take over bid has been rejected and the stock closed yesterday at $3.62 in Toronto, but as we can also see it has been a volatile ride so far and is not one for the faint hearted.

Lihir Gold considers its gold assets to be top draw having produced 1.124 million ounces in 2009. Going forward they see Papua New Guinea and West Africa producing around 1.45 million ounces from 2012 to 2016.

Lihir have also announced the appointment of New CEO:

Leading gold miner Lihir Gold Ltd (LGL) has appointed former BHP senior executive Graeme Hunt as Managing Director and Chief Executive Officer.

LGL Chairman Ross Garnaut said Mr Hunt was the ideal candidate for the CEO role, possessing strong leadership skills, wide mining industry knowledge and extensive experience in strategic development.

A metallurgist by training, Mr Hunt, 53, previously spent 34 years with BHP Billiton. Starting as a metallurgical trainee in 1975 at the Port Kembla Steelworks, he advanced his career through a variety of roles, eventually becoming President of the global Iron Ore division from 1999 to 2006, and then President of the global Aluminium division in 2006 and 2007. His final role at BHP was as President of Uranium, including responsibility for the Olympic Dam Expansion. He left BHP in March last year.


To read the article in full please click here.



For disclosure purposes we do own shares in this company but we are monitoring its progress and we could well become buyers in the near future. If any of our readers have an interest in this Lihir Gold and would like to add their own comments to this article they would be very appreciated by the team here.

According to Google Finance, LGL on The Australian Stock Exchange has a market capitalisation of $10.22 billion with 2.53 billion shares outstanding, a P/E ratio of 49.48. Lihir Gold has a 52week high of $4.05 and a 52week low of $2.41.

There is also plenty of exposure with this stock as it is listed on less than 4 stock exchanges so this stock must be appearing now on a silver screen near you right now.

Lihir Gold Limited (LGL) is a public company, with approximately 2.53 billion shares on issue. The stock is listed in Australia, United States, Port Moresby and Canada on the following stock exchanges:

Australian Securities Exchange (ASX)
Symbol: LGL
www.asx.com.au

NASDAQ Stock Exchange (NASDAQ)
Symbol: LIHR
www.nasdaq.com

Port Moresby Stock Exchange (POMSoX)
Symbol: LGL
www.pomsox.com.pg

Toronto Stock Exchange (TSX)
Symbol: LGG
www.tsx.com

Have a sparkling weekend.

Stay tuned for updates in this fast moving market…

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Thursday
Apr012010

High River Gold 31 March 2010 Update

HRG Logo 31 July 2009.JPG


Chris Charlwood has very kindly sent us this missive updating us on the current state of play over at High River Gold Mines Limited (HRG) which we hope that you find interesting and informative.

March 31, 2010            (All numbers below are approximate and in C$)
 
High River Gold (HRG.TO) today announced that their audited financials for 2009 will be released 2 weeks late on April 15th. Based on previous release dates, the Q1 2010 numbers should be released one month later on May 15th.  In today’s release (linked below), management did provide enough information for us to make the following calculations:
 
1)    $126.7M cash flow from operations for 2009 less $86M for the first 9 months confirms  $40.7M in Q4 cash flow from operations – up from $33M in Q3.
2)    The $82.1M in cash and equivalents at the end of 2009 covers 98% of the current $84M of debt.
3)    HRG’s third party investments at current market values stand at $64M, therefore, the company had a net surplus of $62M at 2009 year end after allowing for all debts.
4)    HRG revenues for first 9 months of 2009 were  $263M, therefore, Q4 revenues were $100M to total $363.3M for the year.
5)    Gold production was 241,781 oz in the first 9 months, therefore, 94,555 oz (85k oz attributable to HRG) were produced in Q4 to total 336,336 oz for the year (303,000 attributable to HRG).
6)    HRG’s gold production made up approx. 57% of Severstal’s total gold production for 2009 (533k oz).
7)    Q1 2010 cash flow from operations (already complete) should again be $40M+.
 
At the current $.71 share price, the market cap is approx. $567M on 799.2M shares outstanding. On annualized Q4 cash flow of $162.8M, the shares are trading at  approx. 3.5 times. As all mining operations showed improvement in Q4, it is hard to imagine any further write downs in 2009, therefore, the financials, once released, should show a significant Q4 and annual  profit based on the cash flow from operations.
 
The Troika shares become free trading on April 2nd after a 4 month hold period. It has been leaked to the papers that Severstal may acquire these 150M shares from Troika at $.76 - double their purchase price -  increasing Severstal’s ownership in HRG to just under 70%. This would be good for minority shareholders as once they are acquired by Severstal they become part of majority and then cannot be voted in any future amalgamation transactions. Severstal recently mentioned in a Bloomberg article (linked below) that they no longer intend to buy out minority shareholders of HRG and that they may take Severstal Gold public with the stakes they own. They claim that Severstal Gold is worth $3.9B. On a production basis only, this would suggest that HRG should be valued at $2.22B (57% of total) or $2.78/share.
 
Royal Gold  recently announced that HRG was trying to meet the production tests as stipulated in the financing agreement with HRG. We are expecting an announcement shortly as to whether HRG has passed these tests. If so, then  all of HRG’s third party shares worth $64M (currently pledged for the loan) could become available to the company. The $62M surplus at end of 2009 (after covering all debts) plus Q1 2010 cash flow of  $40M + provides the company with over $100M capital to fund the planned $27M in exploration and feasibility programs, the extraction program at  Irokinda and Zun-Holba and some of  the start up capital for putting the multi-million oz. Bissa project into production in future.
 
Once the Royal Gold tests are met, the Troika shares repurchased and year end financials released, it would make sense for HRG management and Severstal to make efforts to increase the HRG share price in preparation for  the potential Severstal Gold IPO.
 
References:
 
2009 Financial Highlights
http://finance.yahoo.com/news/High-River-Gold-Announces-ccn-1679400699.html?x=0&.v=1
 
Bloomberg article on Severstal Gold
http://www.bloomberg.com/apps/news?pid=20601082&sid=aSrIu8dlhuQU
 
Severstal 2009
http://www.severstal.com/files/3358/2009_results_final.pdf   
 
Chris Charlwood
Retail investor
RainerC7@gmail.com
604-718-2668





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Wednesday
Mar312010

Bond Market: “It’s Safer to Lend to Buffett than Obama”

Obama and Buffet.JPG

By Chris Wood, Casey Research

A few weeks ago, the Federal Reserve released the new Z.1 Flow of Funds document, which covers flows and outstandings through the fourth quarter of 2009.

What does the document reveal?

You guessed it – more of the same reckless behavior that got us into this mess in the first place.

While households and businesses were able to shed debt across the board, increases in local, state, and federal debt outstanding were enough to bring total debt outstanding to a new all-time high, over $34.7 trillion, if you can believe it.

Consider some of the salient statistics from the Z.1 document:

Total household debt outstanding shrank by an annualized 1.2% in the fourth quarter, while total business debt outstanding declined at a 3.1% annualized clip.

Combined, total household and business debt outstanding fell to $24.535 trillion, reflecting an annualized decline in the fourth quarter of 2.1%.

State and local government debt outstanding climbed by an annualized 4.7% in the fourth quarter, while federal government debt outstanding increased at an annualized rate of 12.6%.

Combined, state, local, and federal government debt outstanding grew to a record-breaking $10.168 trillion, reflecting an annualized increase in the fourth quarter of 10.7%.

So, while consumers and businesses are acting at least somewhat more responsibly, governments at all levels grow more reckless every day. And don’t think this has gone unnoticed by others.

At the federal level, we can see that the bond market is growing increasingly wary of the government’s spendthrift and “kick the can” attitude.

A March 22 article from Bloomberg titled “Obama Pays More Than Buffett as U.S. Risks AAA Rating” reveals that two-year notes sold in February by Warren Buffett’s Berkshire Hathaway yield 3.5 basis points less than Treasuries of similar maturity.

While 3.5 basis points is not a huge amount (100 basis points equals one percentage point), the simple fact that the bond market is saying that it’s safer to lend to Warren Buffett than Barack Obama is telling.

And Buffett is not the only one enjoying this safer than “risk free” rate on his notes. Procter & Gamble Co., Johnson & Johnson, and Lowe’s Cos. debt also traded at lower yields than Treasuries of similar maturity in recent weeks, a situation former Lehman Brothers Holdings Inc. chief fixed-income strategist Jack Malvey called an “exceedingly rare” event in the history of the bond market.

Rare as this situation may be in historical terms, we expect to see lots more of it in the future.
When conventional investments are not the safe haven anymore they used to be, gold is the way to go. Being a traditional inflation hedge, gold’s value has never gone to zero. Learn all about where to buy physical gold and how to store it – plus prudent, gold-related investments that can give you up to 1:4 leverage – by clicking here.


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Tuesday
Mar302010

Census Numbers Uncensored

Dept of Commerce.JPG

By Vedran Vuk, Casey Research

The Census aims to be every man’s hero. It promises an economic stimulus, a reduction in unemployment, and greater funds for every community. Of course, the reality is much closer to a game of musical chairs with your money. And guess who will be left standing?

The most immediate impact of the Census is that it distorts unemployment rates. With 1.2 million hired temporarily during the fall, the Census is already skewing the unemployment numbers in the government’s favor. Specifically, the fall data shows unemployment at 9.8% (Sept), 10.1% (Oct), and 10% (Nov).

Who can forget the hoopla over the November reduction from 10.1 to 10? To government officials, it was as if the clouds had parted after a relentless hurricane, “proof” that the massive stimulus spending was working.

This one-tenth-of-a-percent drop was exalted as the beginning of the end for the recession. Of course, a closer look at the numbers revealed that the decrease was largely explained by those leaving the workforce and dropping  out of the government’s statistics. Similarly, the January drop from 10 percent to 9.7 percent was praised as a sign from the heavens, a sign that was subsequently tarnished by February’s slight increase in unemployment.

In an attempt to get a clearer picture of the effect from the Census on unemployment data, we evenly subtracted the 1.2-million Census bump across fall’s unemployment rates and found the new numbers ringing in at 10.1% (Sept), 10.4% (Oct), and 10.1% (Nov). If a one-tenth-of-a-percent drop in November was a reason to celebrate, then a three-tenth-of-a-percent October upward revision is a reason to cringe.

In the months ahead, expect the same number games.

The Census already hired 1.2 million workers in the fall, as mentioned earlier; now they’re planning  for another 1.2 million in the spring. February began with an additional 15,000 Census workers; the hiring will peak in April-May with 800,000 workers hired in just two months. The peak alone is projected to temporarily push unemployment downward by half a percent.

Digging a bit deeper, we find that this year, 723,000 door-to-door Census takers will be needed in comparison to 2000’s 604,000, a 16.6 percent increase despite the lack of an equivalent rise in the population. 

The hiring numbers are pushed upward by the low total working hours per employee. On average, each temporary Census employee will work 19 hours a week for six weeks. But “work” may not be the most appropriate word. The Census estimates that only 47.8 million houses will require a Census worker to visit. Divide this by 723,000 census takers to get 66 houses per worker. Since each temp will be employed for six weeks, this translates into less than two houses visited per workday.
 
The spending side of the Census equation doesn’t make much sense either. According to a Census Bureau press release, mailing back the form costs the government only 42 cents, while visiting a house costs 56 dollars.

Why does it cost 56 dollars to visit just one house! Even with repeat visits, this seems a lot. Imagine that pizza delivery were this expensive.
 
This wasted money will go toward boosting the GDP by 0.1% and 0.2% during Q1 and Q2, followed by equivalent declines in Q3 and Q4. Some parts of the country will get more than others, according to various pay rates. The Washington D.C. Census office offers $20 per hour, San Francisco $22, and Anchorage, Alaska, pays the most at $25 per hour. On the lower end, Tupelo, MS, pays $10.50; Beckley, WV, $10.75; El Paso, TX, $12.75 per hour.

With some exceptions, large metropolitan areas will receive higher pay rates.

And what about money allocated through Census data? The Census marketing campaign has claimed that filling out the Census will help your community. Certainly, in 2007, nearly $436 billion were redistributed through the aid of Census data. But helping the community might be stretching it – unless one considers welfare payments as “helping the community.” Examining the long list of programs reveals that little will help net taxpayers, other than road-building projects.

Government cannot improve one individual’s situation without taking away from another. Just as it does for any government program, this applies to money allocated by the Census. This helps the community about as much as mugging somebody on the street. Hey, someone in the community got the money, right?

Distortions in unemployment rates aren’t the only things in store this year. It’s time to tally up the dependents on the welfare state, redistribute some income, and fudge the economic numbers. All in a day’s work at the Census – or should I say, half a day’s work.

For more in-depth evidence that the government figures are anything but rosy – and what you can do to protect your wealth – read the current issue of The Casey Report, including Chief Economist Bud Conrad’s analysis whether the U.S. debt crisis has reached a “Point of No Return.” Get more details here.





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Tuesday
Mar302010

An Interview with the Whistle Blower Andrew Maguire

CFCT Silver Coin.JPG



Andrew Maguire & Adrian Douglas Discuss What Could Be the Largest Fraud in History - Andrew is an independent metals trader turned whistle blower at the center of a storm for exposing what could be the largest fraud in history involving countries, banks and government leaders.



Adrian Douglas Board of Director from GATA, the man who Andrew reached out to joins in this interview where they discuss a fraud so extraordinary and so unimaginable that it is the kind of thing that only happens in hollywood thrillers. They also discuss the CFTC sponsored meeting on metals which was an unmitigated disaster because it additionally exposed the fraud on a grander scale.

Please click here to listen to this fascinating interview conducted by King World News




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Sunday
Mar282010

CFTC whistle blower injured in London hit-and-run: Coincidence?

GATA Logo.JPG


There a couple of youtube clips here of Bill Murphy of GATA (Gold Anti-Trust Action committee) Speaking to CFTC about manipulation in the precious metals market to a sadly dis-interested panel. Bill produces a rabbit out of the hat in the form of a whistle blower who strangely enough is the victim of a hit and run accident the following day.

The following are two clips of Bill in action that you might like to take a quick look at:

Clip 1

Clip 2

then follows this article on the GATA web site:



Dear Friend of GATA and Gold:

London metals trader Andrew Maguire, who warned an investigator for the U.S. Commodity Futures Trading Commission in advance about a gold and silver market manipulation to be undertaken by traders for JPMorgan Chase in February and whose whistle blowing was publicized by GATA at Thursday's CFTC hearing on metals futures trading --

http://www.gata.org/node/8466

-- was injured along with his wife the next day when their car was struck by a hit-and-run driver in the London area.

According to GATA's contact with Maguire, board member Adrian Douglas, Maguire and his wife were admitted to a hospital overnight and released today and are expected to recover fully.

Maguire told Douglas by telephone today that his car was struck by a car careening out of a side road. When a pedestrian who witnessed the crash tried to block the other driver's escape, the other driver accelerated at the pedestrian, causing him to jump out of the way to avoid being hit. The other driver's car then struck two other cars in escaping. But the other driver was caught by police after a chase in which police helicopters were summoned.
We'll convey more information about the incident as it becomes available.

CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.

So, is it just a coincidence or are the people at GATA starting to upset a few people?

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Thursday
Mar252010

White Knights for Greece

Greece.JPG



BNN takes a look at the FX reaction to the French and German agreement to help Greece finance its debt, with additional aid from the IMF, with Sebastien Galy, senior currency strategist, BNP Paribas, worth a quick watch, just click on BNN, above.


The plan, which would appear to be driven by the French and German governments has three pillars to it:

1. Bi-lateral aid from the EU states for Greece if absolutely needed, and help from the International Monetary Fund.

2. Financing should be at the market rate, easier for Greece, plus clean up the balance sheet etc.

3. Review of the monitoring of the fiscal side within Europe

4. Belt tightening and near term pain across the union.

Originally the EU states were not to fund other states, so rule changes within the EU are now be required, lots of negotiation still to be done.

One of Doug Casey's saying is that “if it is falling, push it” and Jim Rogers, who said the other day that it would be better to eject Greece as that would show that the EU means business and then the Euro would strengthen, he added that it would be good for all concerned.

However, where would it stop, there appears to be 5-6 countries in the same sort of mess that Greece is in, so they could be picked off one at a time if the Union were to eject Greece, which is not going to happen.

This looks set to run and run, so the Euro could come under more selling pressure and thus more upward pressure on the US Dollar, possibly capping golds progress, we shall see.

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Wednesday
Mar242010

Gold Prices Drop Today

Gold Price Change 25 March 2010.JPG
The Kitco Gold Index


US Dollar Chart 25 March 2010.JPG

Gold prices dropped today by around around $15.00/oz as the above chart shows and as we can see the main driver behind the fall was not the actual selling of gold but the appreciation of the dollar. As we have long said gold prices are to a large extent an inverse play against the fortunes of the US Dollar.

The dollar would appear to have risen on the back of further depreciation of the Euro, which is being hampered by the uncertain outcome of the Greek situation in terms of their sovereign debt, a large part of which is about to be rolled over during April and May. The problem is that those who carry this debt will want a correspondingly high rate of return in order to shoulder the risk involved, which Greece can ill afford.

Will the European Union act as a union or will Germany hold out and refuse to allocate German funds to their European partners. There is always the danger that if they do cough up, then it could be become contagious and open the flood gates for the other debt laden members of the union to come banging on the door for a similar type of financial support.

In the short term the battle for the $1100/oz barrier will continue and may take some time to resolve, however, over the longer term we are firmly in the camp of the gold bull. The perpetual printing of paper money will indeed be its own downfall and gold will go on to rule supreme.

This shake out will make many investors nervous and some will sell their holdings. This has been the situation all the way up from the $260/oz level, a run up, a sell off, consolidation, and guess what? Another run up.

Usually at this time of the year gold prices hold up fairly well through March, April and May, yes its a big generalization and is not cast in concrete so it could well be different this time. For now we are sticking with our core positions as they are holdings for the long term, however, you may wish to lighten up, its entirely your call, we can only tell you what we are doing with our money and as you know we do get it wrong from time to time.

At this time we also need to keep an eye on the broader markets as a sell off is still a possibility which begs the question of whether our trusty miners are tied to gold prices or are they tied to the stock market?

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Wednesday
Mar242010

Help! I’ve Been Taxed and I Can’t Get Up

Tax joke 25 March 2010.JPG

By Jeff Clark, Senior Editor, Casey’s Gold & Resource Report

Like many of you, the passage of the healthcare bill wasn’t met with the popping of champagne in my house. I found myself chanting “Uncle Sam, Uncle Sham” as the day wore on. Higher taxes and other major changes are headed our way. And yet, I think there’s something in the bill that’s even more dastardly.

If you’re a supporter of the bill, you’d point to its benefits: Poor adults will get Medicaid. Low-income families will get federal subsidies to buy insurance. Small businesses may get tax credits. Kids will be able to stay on the parents’ policy until they turn 26. Seniors get additional prescription drug coverage. People with pre-existing medical conditions can’t be denied or dropped.

While no one is really against any of those things, the elephant in the room (or boa constrictor in the bed) is how those things are going to be paid for. Here’s how: the “wealthy” will pay higher taxes; businesses with 50 or more employees will have to insure them or pay a penalty; individuals will have to pay a fine if they don't buy insurance; premiums will rise for many who already have insurance; and seniors with Medicare Advantage policies could lose those plans or pay more to keep them.

Regardless of how you feel about the bill, the fact is that taxes are going up, and not necessarily just on the “wealthy.” The healthcare plan will cost $940 billion over the next decade, almost $100 billion a year.

I haven’t read the 2,407-page bill (almost twice as long as the Gutenberg Bible), but there are plenty now who have. Here’s a summary I compiled, from various sources, that outlines the tax ramifications of what is now the law of the land.

Assuming the Senate passes the package of changes, the biggest tax increases will be in Medicare payroll taxes. Those take two forms, both starting in 2013:

Singles earning more than $200,000 and couples earning $250,000 will pay 0.9% more on wages and self-employment income.

All investment earnings will be taxed an additional 3.8%. This includes capital gains, dividends, and interest, the first time in history the Medicare tax is applied to them.

But keep in mind that the Bush tax cuts expire at the end of this year, which will push the Medicare tax on capital gains to 23.8% in 2013 on these earners. Dividends, currently taxed at the top rate of 15%, will be taxed as ordinary income, with the top rate scheduled to rise to 39.6% (from 35%).

This means that the tax on dividends could go as high as 43.4% when the new Medicare tax goes into effect in 2013. (Obama has proposed a top dividend tax rate of 20%, so if Congress enacts his proposal, the top tax rate for dividends would “only” rise to the 23.8% level in 2013.)

You may think you’ll escape this tax if you’re not “rich.” But it’s those darn Unintended Consequences politicians never seem to think about that could still sting you. For example, the 3.8% Medicare surtax could snag you if you happen to sell some real estate for a big gain.
The other major tax increase is the one imposed on health insurance plans that are more generous, the so-called “Cadillac” health plans. And this tax increase doesn’t just apply to high-income earners; those state and union workers that lobbied for better health coverage instead of big pay increases are going to find they’re included with the “rich” in a new excise tax. Starting in 2018, family insurance plans valued at more than $27,500 ($10,200 for individuals) would pay a 40% tax above that level.

Ouch.

And there’s other ways you’ll be taxed, particularly through the magic of “passing it on to the consumer.”

For example, pharmaceutical manufacturers will pay an annual fee based on their market share starting in 2011; same for health insurers, starting in 2014. A 2.3% excise tax on the sale of medical devices will start in 2013. A 10% excise tax on indoor tanning services goes into effect this July.

How will all these businesses afford the additional tax? They won’t. You’ll pay it, through higher prices.

Further, were you one of those who incurred medical expenses above 7.5% of your income, thus allowing you to deduct them? That ceiling will be 10% starting in 2013. (It remains 7.5% for those over 65.)

There’s more, most of it in the form of greater restrictions, increased penalties, and higher fines on various entities, businesses, health plans, or individuals. But what I especially cringed at was this: the bill vastly expands the responsibilities of, and gives greater strength to, the IRS. The agency will hire as many as 16,500 additional auditors, agents, and other employees just to enforce all the new taxes and penalties. 

Specifically, the bill will empower the IRS to do the following: verify citizens have “acceptable” health care coverage; impose fines up to $2,085 or 2% of income (whichever is greater) for failure to purchase “minimum essential coverage”; confiscate tax refunds; and increase audits.
The upshot is that this will force many taxpayers to be more conscientious of monitoring their income and tax withholding.

Perhaps most damaging to the government’s plans is if the bill leads some to ask the Ayn Rand/Atlas Shrugged questions: What if I just stop being productive? What if I stop working once my income approaches the threshold? What if I invest less so that I stay under the limits?
And last, here’s the time bomb that could trump the tax concerns: none of these taxes are indexed to inflation. Since the bill fails to index to inflation the exemption threshold for the Medicare taxes on both earned and unearned income, it’s almost certain many taxpayers will get to these tax levels a whole lot quicker than they think.

What this essentially means is there is now more incentive on the part of the government that we have inflation. If inflation reaches 10% at some point, which is below the 14%+ rate it hit in 1980 and far below any hyperinflationary level that’s possible, the $100,000 earner gets to the magical $200,000 level in seven-and-a-half years. From the government’s perspective, it makes the printing of money a lucrative affair.

Yes, higher taxes are coming. But with the government’s built-in incentive for inflation, along with the reward that comes from getting more citizens to higher tax rates, many may find the tax issue an annoying mosquito bite compared to the alligator chomp of inflation. And high inflation affects every citizen, regardless of income or tax rate. Those who think they’ve escaped the cold may find they’ve walked into a freezer.

With this added push to inflate, our investment strategy for the foreseeable future is now clear: We must invest in assets that not just keep up with inflation but outpace it.
All wise citizens do tax planning. Have you done inflation planning?

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Tuesday
Mar232010

Battle for the Budget

By Bud Conrad, Editor, The Casey Report

Recently the Congressional Budget Office (CBO) published its scoring of President Obama's budget for the next 10 years. It shows a budget deficit of $9.8 trillion. That is just shy of $4 trillion worse than the CBO’s baseline budget, a budget that includes only the laws as currently enacted, with no estimates of any new programs lawmakers may add that worsen future projections.

That our budget is out of control is no surprise, but the charts I present here should provide some perspective of just how dangerous this set of budget estimates could turn out to be. The first chart below shows the amount of red ink in each year for the two CBO estimates.

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To get a visual interpretation of just how big these budget deficits have become, I plotted the long-term history, then tacked on the CBO evaluation of the president's proposal. Knowing the propensity of governments to spend more than they promise makes one question if the large improvement shown in the dotted line will actually occur. Even if nothing changes, however, the results look like they could be very damaging for other aspects of our economy.


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One aspect of the CBO projections that is difficult to defend is the expectation that inflation will stay incredibly low. In the next chart, I present the same sort of long-term history, coupled with the projection, for the Consumer Price Index (CPI).

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In the next chart, I put together two of the most important measures: the three-month T-bill interest rate and the deficit expressed as a percentage of the gross domestic product (GDP). Both history and projection are shown.

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The most important observation is just how disastrous the current deficit is in the historical context, even after rationalizing it by dividing it by the GDP. I overlaid the two series to show that higher deficits in the past tended to occur along with higher interest rates.

As you can see, we now have a significant anomaly, with the budget deficit at its worst in half a century, while interest rates remain near their lows for the period. A closer look at history shows many divergences, to the point that in the short term these two series tend to bounce in opposite directions. That is probably because when the economy shows weakness, the government expands its spending and collects lower taxes, so the deficit becomes worse. Thus, in the short-term cycle of a few years, these two measures often move in opposite directions.

But the situation we face now is much bigger than anything we've seen since the 1950s. The government bailouts and stimulus are at record levels, and the special actions of the Federal Reserve have driven interest rates close to 0%. It is my expectation that both inflation and interest rates will rise dramatically because of these large deficits.

I also think the projected interest rates are much lower than what I expect the deficit would require. As foreigners and others recognize how seriously indebted the U.S. government is becoming, they will expect higher interest rates to compensate for the debasement of the currency.

The budget analysis goes further in calculating the expected growth of the economy, which ranges from 2 to 4% over the years. Those are not large numbers for real GDP, but there is no expectation of another recession during the decade. If the economy didn't grow, tax revenue would be less, and the budget deficit would be worse.

While interest rates are expected to rise as shown in the chart above, the projections expect that they roll over and stop rising at around 5%. That is contrary to my expectations that they will be much higher, and even perhaps closer to 10%, by the end of the decade. If they are, the cost of funding the outstanding government borrowing escalates rapidly because the increased interest has to be added to the debt so that the debt grows even more.
The problem from the onset of this crisis has been the debt, and that continues to be the case.

Leaving aside the above two adjustments that could make the budget deficit worse, it’s helpful to look at the outcome with the given assumptions and see where it leads. Perhaps the most problematic result is that the debt of the federal government held by the public grows from $7.5 trillion in 2009 to $20 trillion by 2020. Such big numbers are hard to understand, though you can get some sense of things by considering that the government is intending on almost tripling the debt in just 11 years. The ratio of this outstanding debt to the GDP gives a flavor of how dangerous the situation has become. As Ken Rogoff and Carmen Reinhart have indicated in their new book, when we approach 90% government debt of GDP, we have serious potential for a currency crisis. As you can see, we are well on our way to those levels, even without assuming the two adjustments above.

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How will the deficit be funded?

The question arises who will service the rising levels of debt. Clearly the taxpayers are on the hook for all these projections, with more to come. So the question becomes whether the tax base can grow fast enough to provide support for servicing the debt. The CBO gave us two series for the tax base. One is Domestic Economic Profits, and the other is Wages and Salaries. The basic assumption is that these are the main revenue streams that can be taxed by the government to fund its expenses. I added these two series together and divided by the GDP to determine if the tax base is growing more rapidly than the economy. Unfortunately, but as expected, the orange line in the above graph shows that the tax base only grows about as fast as the economy itself. That's not surprising, but the contrast to the rapid growth in debt will be a serious source of problems, as the only way the debt can be sustained will be through increasing the tax rates, and probably quite dramatically.

The latest set of budget predictions will probably be wrong, and not just because the assumptions are too optimistic, but because there is a relatively high probability that something will go off track to cause a major shift before the 10 years are completed. Unfortunately we are not preparing ourselves for such problems, and so I would interpret the CBO projections as being far too rosy.

Bud Conrad is the chief economist at Casey Research, and crunching numbers like these is his daily bread. It also enables him, together with the rest of the Casey Report team, to accurately forecast what’s in store for the U.S. economy… a skill that subscribers to The Casey Report have come to highly appreciate. Learn more about what the future holds and how to profit by clicking here.



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