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Investing in a Political Malaise

Why investors are pushed towards low-yielding Treasuries...

FOLLOWING a long and drawn-out political debacle on both sides of the Atlantic, the developed economies remain embedded in a crisis that the political systems are unable, or unwilling, to resolve, writes Julian Phillips at 

The leaders of the developed world are capable, competent men who have what it takes to surmount the debt crises that are consuming confidence day by day. So why don't they?

Fitch Ratings gave the United States until 2013 to come up with a "credible plan" to tackle its ballooning budget deficit or risk a downgrade of the country's coveted, AAA rating. The ratings agency revised the outlook from stable to negative on the US credit rating after a special congressional committee failed last week to agree on at least $1.2 trillion in deficit-reduction measures. 

The committee failure made it unlikely that any meaningful deficit plan will be adopted next year, increasing the fiscal burden on the next administration that will be elected in late 2012, Fitch said. Fitch said the chance of a downgrade is "slightly greater than 50%".

With unemployment still hovering around 9%, it is likely that Federal Reserve policymakers will consider further monetary stimulus in an effort to give growth some support and to lower the risk of another US recession. While it may appear to be capable of stimulating growth, it will decrease the value of the US Dollar both internally and internationally. 

The German bond auction, last week, and Italy's bond auction were poorly received with Italian 2-year bond yields rising to 7.8% from 3.45%. The International Monetary Fund is not in talks with Italy to provide financial assistance. It does not have the resources to do so either. This week, Italy had to pay nearly 8% for its loans.

Belgium's credit rating has been cut by Standard and Poor's to AA from AA+. The Belgian state's capacity to prevent an increase in general government debt, which we consider to be already at high levels, is being constrained by rapid private sector deleveraging both in Belgium and among many of Belgium's key trading partners 

Standard & Poor's could change the outlook for France's triple-A rating to negative within the next 10 days. 

France's ratings outlook is currently stable with S&P, but there have been rumors for months of a possible downgrade by one or more of the ratings agencies.

Moody's said it could downgrade the subordinated debt of 87 banks across 15 European Union nations on concerns that governments would be too cash-strapped to bail out holders of riskier bank debt in times of stress. Most of the ratings to be reviewed were in Spain, Italy, Austria, and France. 

The review could lead to an average potential downgrade of subordinated debt by two notches, and junior subordinated debt and Tier 3 debt by one notch. Moody's believes that systemic support for subordinated debt in Europe is becoming ever more unpredictable due to a combination of anticipated changes in policy and financial constraints. 

Nations affected by review were listed as Austria (nine banks), Belgium (three), Cyprus (two), Finland (three), France (seven), Italy (17), Luxembourg (three), Netherlands (six), Norway (five), Poland (one), Portugal (two), Slovenia (two), Spain (21), Sweden (four) and Switzerland (two). Moody's also warned that the risk to ratings on subordinated debt could extend outside the borders of the European Union.

Banks and ratings agencies are sounding their loudest warnings –the Euro area risks unraveling unless its guardians quickly intensify efforts to beat the two-year sovereign debt crisis. European finance chiefs prepare to meet this week, yet again, but hopes are barely discernible. Moody's said this week the "rapid escalation" of the crisis threatens all of the region's sovereign ratings. Europe has accumulated too much public debt. It is in deep disagreement about the way forward. Its banks are short of capital and have difficulties funding. It has lost most of its internal growth dynamic. And bond investors have lost trust, draining away in droves and causing a liquidity crisis with the ECB wishing to stick to its purity and Germany sticking to its guns.

So far, all we have are deepening sovereign and bank funding problems, governments being replaced, growth a lost dynamic, and despair the general currency. So it isn't too difficult to see a final EU crisis moment approaching in which markets cause asset prices to collapse, and there isn't sufficient public support to keep things afloat (never mind reform and regain market trust). And that moment, by all omens, may be neigh. So 2012 could, for all in the developed world, be another 2008 or 1998, as an EU disruption. 

With the mental capacities, the power and control, why aren't politicians resolving financial crisis? This is an easy question to ask, but the answer is far from simple. Take the concept of democracy. This is a structure espoused as the answer to all ills, pushed forward by the developed world, in particular. What is democracy in the context of today's crises? 

It's an institution that requires all people over a certain age (with very few exceptions) to state their support for a very few, selected individuals usually belonging to one of around three political parties to vote for one of this small number of choices that they feel will carry out their wishes as defined by the party's manifesto. Parties decide their manifesto ahead of elections that take place around five years at a time. 

Outside those elections, individuals have little or no choice in politics. Therefore politicians gear their actions to achieving the most popularity just ahead of those dates. This allows unpopular actions to be taken early in the term of elected politicians and for popularity to be garnered close to the elections. So the extent of the individual choice is very limited and occasional.

But something has gone very wrong with this system in the EU and the USA. currently. The result of elections in so many developed world nations has left nations with such a fine balance of power on the political front that governments are not able to govern effectively. In the US the Republicans and Democrats have managed to stalemate each other to the extent that they can get little governing done on the budget deficit. So strong are party politics, that the interests of the nation they govern have been sidelined. Party politics have transcended national interests. The same is true in the Eurozone, where government over-borrowing has been allowed against the European Union to which they swore allegiance. Even in the midst of the worst crisis the E.U. has faced, national politicians are failing to rise over national and party politics to save the Eurozone from individual or collective insolvency.

As one EU politician so aptly put it, "We know what to do, but the problem is getting re-elected after we've done it". 

So now we wait in this limbo of indecision, with little prospect of change coming. When will they act? Again democratic politics has a specific influence over their actions. When a politician acts to resolve a problem that requires unpopular measures, he rarely stays in power, victim of the unpopularity of voting support. When voters feel the pain of those problems, their attitudes change. 

Now their only hope is political action to remove that pain. Now unpopular measures are acceptable to the electorate, desperate to feel relief. In fact if these work, then the politician that imposes such measures is hailed a hero in his land and is likely to be re-elected. We're now waiting for the pain to strike. 

You can be sure it will strike before the next US Presidential elections. The skill of the President is to make sure the oppositions takes the blame. The skill of the oppositions is to make sure the President takes the blame. Both hope the electorates are gullible enough to support them and not to blame the system that rules them and to push for a change of system.

Contrast this with a system that believes it knows its people's wishes better than they do themselves, such as China. There the rule of government is almost complete, allowing them to manage the economy and monetary system without oppositions and with only muted criticism. A look at the economy of the two tells its own tale. Nevertheless citizens in China place their trust is savings and in particular gold, not the government systems.

With political considerations set far above financial ones, only the explosion of confidence in national money will swing political considerations behind financial ones. This seems and easy answer, but it isn't. The ailments of the financial system extend to its very structure: the banking system. The longer it takes to resolve the financial crises, the worse it gets. Once the decay in confidence has passed a certain point, it's impossible to fix. 

Then there needs to be a restructuring of the system. The worse the level of confidence, the more radical the re-structuring needs to be. The more re-structuring there needs to be, the stronger the hold of government over its nation needs to be. That means there will need to be an overwhelming dominance of one party or another so as to avoid the current developed world impasses. To date, the performance of developed world political parties falls short of inspiring such support.

So what does an investor do?

In the developed world he can hop from one investment to another in the hope he has found some special formula that will save his wealth. Once this fails he may turn to another. For instance he may turn to US Treasuries as the ultimate of liquid markets or cash (at the short end). But Treasury prices at all end of the Yield Curve have never been so high, so capital appreciation is not expected. Yield increases would mean falling prices and losses if one bought now. But this is the tree trunk of the fictional currency system, so there's nowhere else to turn.

Buying Gold?...

JULIAN PHILLIPS – one half of the highly respected team at – began his career in the financial markets back in 1970, when he left the British Army after serving as an Officer in the Light Infantry in Malaya, Mauritius, and Belfast.

First he worked in Timber Management and then joined the London Stock Exchange, qualifying as a member and specializing from the beginning in currencies, gold and the "Dollar Premium". On moving to South Africa, Julian was appointed a macro-economist for the Electricity Supply Commission – guiding currency decisions on the multi-billion foreign Loan Portfolio – before joining Chase Manhattan and the UK Merchant Bank, Hill Samuel, in Johannesburg.

There he specialized in gold, before moving to Capetown, where he established the Fund Management department of the Board of Executors. Julian returned to the "Gold World" over two years ago, contributing his exceptional experience and insights to Global Watch: The Gold Forecaster.

Legal Notice/Disclaimer: This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold Forecaster/Julian D.W. Phillips have based this document on information obtained from sources they believe to be reliable but which it has not independently verified; they make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster/Julian D.W. Phillips only and are subject to change without notice. They assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, they assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this report.

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