In the last few months, there has been a very strong correlation between the dollar and the stock market.  It seems that when the dollar is down, the stock market is up, and vice versa.  This means that the main driver of the stock market right now is monetary policy.  It also means there is somewhat of a correlation right now between gold and the stock market.  A weak dollar is benefiting both.

If you are invested in the stock market, then monetary policy is the most important thing to pay attention to.  Forget about company earnings or balance sheets.  Maybe for individual stocks it is something to pay attention to, but for the broad market, it is the words and actions of the Fed that is driving it.

Right now, it seems that everyone is expecting QE2.  This is the second round of “quantitative easing” or money creation.  The big looming questions right now are how much and for how long.  Another question is what form it will take.  Will the Fed just buy bonds the old fashioned way?  Or will the Fed try something different for a “shot in the arm” for the economy.  Either way, it will be horrible policy, but it will affect the dollar and the stock market.

It will be interesting to keep watching this correlation.  If the stock market and the dollar start moving down together, then watch out.  It is unlikely that we will see them move up together.  Let’s see what Bernanke and the Fed actually do in the coming weeks.  We have heard a lot of talk up to this point, but we haven’t seen much action.

China has made incredible progress over the last 30 years.  China still has a communist government or at least that is what it is called.  It is still communist in some aspects.  In other aspects, it is less communist than many western governments, including in the U.S.  China does not have the Americans for Disabilities Act.  While the economy is still centrally planned in many ways, there is also less red tape in many areas compared to the U.S. and other so-called democracies.

China has been inflating at a high rate in the last several years.  China has a property/ real estate bubble that may be worse than what happened in the U.S. a few years ago.  Although the economy in China has grown tremendously and many people there have a higher standard of living for it, some of the recent prosperity is also illusory.  China cannot defy the laws of economics any more than any other country.  China’s boom will turn into a bust.

The Chinese government has already announced an interest rate hike to control inflation.  There is no other choice unless they are willing to risk hyperinflation.  The Austrian business cycle theory tells us that a reduced inflation rate will lead to a bust.  China is not immune to this.  China will face its very first recession/ depression, unless you consider almost the entire 20th century as one big great depression.

If you are considering buying Chinese stocks, don’t.  You would be better off to short the market.  There are ETFs to do that now.  The only problem is timing.  That is always our problem.  China is going to experience a major downturn, but we don’t know when.  It will likely be soon, but does that mean in one month, one year, or five years?  My bet is that it will be less than five years.  It is harder to say if it will be in the next year.

Don’t be surprised when China does crash.  The Austrian business cycle theory does not just apply to the U.S.  While much of China’s prosperity has been real, we can’t ignore that some of it is illusory and will come crashing down.  That’s what happens when you have a central bank managing a fiat currency.

There have been stories the last few days on Obama’s commission to reduce the deficit.  Of course, this is to reduce the deficit, not the debt.  It is like running up $10,000 a year in credit card debt and saying that you are cutting back next year and you will only run up $5,000 in credit card debt without paying it off.  The balance that you owe actually increases, even though you say that you are cutting your spending.

The federal debt is nearing 14 trillion dollars.  The yearly deficit is well over 1 trillion dollars.  If Obama could cut the deficit to 500 billion dollars, he could say that he cut the deficit by more than half.  The problem is, the national debt keeps getting bigger and bigger.  This was the same game that Bush played while he was in office (although the numbers were a bit smaller).  Bush promised to reduce the deficit in half by 2008.  That was in his first term.  He left office having signed the TARP bill, the biggest bailout in history.

The only way Obama is going to reduce the deficit with any significance, let alone the debt, is if the government goes completely broke and the Fed refuses to print more money because of the threat of hyperinflation.  Only then will Obama have a chance at getting anywhere near a balanced budget.  And technically speaking, the budgets do come from Congress, so it isn’t even up to Obama completely, although he could certainly have influence.

Even if the Republicans win big next week, don’t expect much to change.  Most of the Republican politicians have vowed not to touch Social Security or Medicare.  Of course, they wouldn’t dare touch their precious wars or any part of foreign or military expenditures.  They could eliminate the entire rest of the budget and that would barely balance the budget.  In other words, expect massive deficit spending until the Fed refuses to inflate and interest rates rise.  Then we will see something out of Greece where the politicians will have no choice but to cut spending.

Obama’s deficit commission is going to recommend tax increases.  It is easier for them to do that than to recommend any serious cuts.  They are going to recommend getting rid of certain deductions and tax credits.  This is a tax increase.  Let’s see if the Tea Party and the rest of the American people resist.  In order to resist successfully, they must advocate spending cuts.  It can’t be little things, although that would help.  We have to see massive cuts to military spending and a reduction in entitlement benefits.  The easiest reduction there would be is to raise the age that you can collect Social Security and enroll in Medicare.

I don’t know if the Tea Party and the rest of the American people have it in them yet.  We need massive spending cuts.  It will be painful, but not as painful as what hyperinflation would feel like.

Oil has actually been a boring investment over the last several months or more.  It has seemed to stay around $80 with a fairly narrow trading range.  While certain days might seem volatile, overall the volatility has been low, especially after the extremely high volatility of a few years ago.

If the economy takes another downturn (likely), then oil and oil related investments could easily go down in price in the short-term.  Although most people continue to use gasoline for their cars in a recession, some people might cut back.  It is also consistent that commodities tend to go down in price during a recession/depression.

There is a good argument to be made for higher oil prices in the longer term.  There is more worldwide demand than in the past, but a worldwide depression might dampen that.  Also, there is always the threat of more war.  Luckily, talk of war with Iran has calmed down, but if anything did happen there, the price of oil would explode.

The most likely scenario for a rise in the price of oil is simply from inflation.  If the Fed goes through with another round of monetary “stimulus” and price inflation becomes more significant, then oil will likely go up.  A weakening dollar and high price inflation will favor a higher oil price.

Whether you are investing in options/futures or if you are buying oil ETFs or oil company stocks, the price will depend on what the Fed does and also whether the Fed/government force or encourage the banks to lend.  Just like the price of gold or silver, the oil price will eventually depend on the actions of the Fed.

Robert Wenzel, of EconomicPolicyJournal.com, wrote a piece the other day on Harry Browne.  He says that despite his passing, Browne is the best money manager around.

This is a short article and well worth the read.  I couldn’t agree more with his comments.  Wenzel also recommends that everyone keep at least half of their investments in a setup like the permanent portfolio, as outlined in Harry Browne’s book, Fail-Safe Investing.  I completely agree and that is for advanced investors.  For conservative investors or investors who don’t know what they’re doing, I would recommend closer to 100% being put in a permanent portfolio.

Harry Browne was a clear writer and a clear thinker.  His investment advice is as good today as it was many years ago.  And as Wenzel points out with his discussion with Lew Rockwell, Harry Browne’s book, How You Can Profit From the Coming Devaluation, is a great easy-to-read book.  It lays out the Austrian business cycle with pure simplicity.

There was an article the other day on LRC that talked about shorting bonds.  The author says that the bond market is the next big bubble.  He also has suggestions for mutual funds and ETFs that short bonds.  If you haven’t already, you should read the article.

Overall, there is not much to disagree with in the article.  The author makes a great case and lays out a number of true and relevant facts.  There is just one problem and that is the main problem for students of Austrian economics who invest.  The problem is timing.

There were libertarians/Austrians predicting a crash in the housing market or a crash in the stock market 5 years before they actually happened.  There were Austrians predicting that gold would spike up in price in the 1990’s.  These were accurate predictions, but far too early.

I can predict right now that China will have a major recession/depression.  They have a bubble economy.  Some of their growth has been real, but some of it is also artificial and illusory.  This is because of the Chinese central bank inflating.  They will eventually face a choice of hyperinflation or recession/depression.  They will choose the latter.  The Austrian business cycle theory tells us this.  It won’t be a surprise.  The problem is, again, timing.  Maybe the boom will last a few more years before we see the bust.

It is the same with government bonds.  It is likely there is a bubble.  It is likely we will see much higher interest rates in the future.  But we are also competing against the Fed with endless money.  The Fed can and will buy bonds.  In the long run, this will cause interest rates to rise due to the inflation premium.  In the short run though, it can actually drive rates down.

If you short bonds now, what will happen if it takes two or three years to play out?  What if rates go down?  Can you afford to wait it out?  Even if rates stay steady, you will be paying fees for a mutual fund or ETF.

If you are going to short bonds, I would suggest you do it carefully.  I don’t usually like to look for confirmation with investments because you miss out on the easy money.  In this case though, I would look for some confirmation.  At least wait until we see some substantial price inflation.  With an investment like gold, it is easy to buy and hold.  Shorting bonds is a little trickier and you should be cautious about doing it.

There was an article on LewRockwell.com today.  It is reprinted from the Economic Collapse Blog.  LewRockwell.com (LRC) is the best libertarian site there is (IMHO).  The second best site is the Mises Institute, which was founded by Lew Rockwell.  It is rare that I disagree with anything significant in the daily articles on the Mises Institute.  I find a little more disagreement at times on LRC.  Lew Rockwell will publish articles on his site if they are informative, even if they are not pure libertarian.

In reading this article today, I actually was wondering if the whole thing was sarcasm.  I was waiting for a punchline at the end saying, “just kidding”.  I think it is a serious article.  I will never take anything seriously written by the “Economic Collapse Blog”.  There are a few things right in the article.  Even a blind squirrel gets a nut once in a while.  Overall, it is horrible.  The person who wrote this piece just doesn’t know what he is talking about.

He says that a significant percentage of young Americans can’t tell you what a trade deficit is.  Yet, I’m not sure that whoever wrote this can define it.  He sure doesn’t understand it.

Then he quotes Warren Buffett, that free market capitalist (now that is sarcasm).  Buffett is quoted as saying that the trade deficit is a bigger threat than the federal budget deficit.  I presume the author agrees, or he wouldn’t have quoted it.  If he understood anything, he would understand that the trade deficit wouldn’t really matter if there were no budget deficit.  The Chinese wouldn’t be buying U.S. treasuries because the U.S. government wouldn’t be selling any if there were no budget deficit.  The only way a trade deficit would occur then is if the Chinese invested in the private sector.  Now why is that so bad?

Then the author (or maybe authors) goes on to sound like a pure leftist/socialist blaming China for the problems created by the U.S. government and Federal Reserve.  He says China doesn’t play fairly.  They keep their currency lower than it should be.  I guess it should be whatever this author determines it should be.  He says it is a subsidy to China’s exporters.  What he doesn’t mention is that it is also a subsidy to American consumers.

If the U.S. had a stable money (like gold) and the government was small with a balanced budget, then it wouldn’t really matter what China did.  This author doesn’t understand any of this.  Of course, he has to add in the typical leftist line that we need “fair trade”.  That is never defined.  It is whatever he thinks is fair.

This is a lesson.  LRC is a great site and very informative.  But you have to be careful what you read anywhere.  I will never trust anything written by the Economic Collapse Blog.  This piece is garbage.

Ben Bernanke (a.k.a. Helicopter Ben), chairman of the Federal Reserve, has been in the news quite a bit lately.  There is a lot of speculation on QE2 (quantitative easing 2).  QE1 occurred 2 years ago when the Fed more than doubled its balance sheet, mostly by buying toxic assets.

Bernanke is not being specific on what the Fed might do.  He says that he is worried about a lack of inflation.  I guess that means he thinks the average American should be paying higher prices for food and gas than what they are currently paying.

It is hard to imagine that Bernanke is a dumb guy.  Maybe he does or maybe he doesn’t understand Austrian economics.  He is certainly a political person, but anyone who gets to that position would be.  The president, congress, and bankers would not allow someone in that position who is not political.  They want somebody who is going to toe the establishment line.

I think Bernanke knows the threat of another major session of quantitative easing (money creation).  The Fed more than doubled the monetary base two years ago and this has not led to high price inflation because most of the money has remained on reserve.  The banks are not lending it out.  If the Fed creates even more money and triggers price inflation, it might lead to the money already created being lent out.  This could be doubly disastrous for price inflation.  I think he understands that the Fed has to be careful.

It seems that a better strategy, if the Fed wants to increase price inflation (whether they actually think it will help or whether it is for political reasons) would be to force the banks to lend.  At least this would more likely prevent a hyperinflation scenario.  We can’t be sure why Bernanke is not being specific.  We can’t be sure if he is dumb enough to start another round of money creation.  I just can’t imagine that he is dumb enough to completely jeopardize the dollar.  Hyperinflation would destroy him as much as every other American.

Right now, the Fed is not inflating.  The monetary base has gone down slightly.  We’ll continue to watch the charts more than what is being said.

There are protests currently going on in France because government officials want to raise the retirement age.  Of course, nobody seems to ask why the government determines the retirement age in the first place.  Shouldn’t it be up to each individual to determine at what age they will retire?  The problem, once again, is government.  In this case, it is government involved in the retirement/pension business.

It is actually kind of amusing watching these protests, as long as they aren’t too violent.  These people don’t understand TANSTAAFL – there ain’t no such thing as a free lunch.  They have been deceived into thinking that the government would take care of them and now the system is blowing up in their face.  They simply want to repeal the laws of economics.

It is comforting to know that there are no signs of protests like these in the U.S.  I would rather see tea party protests (even if some are uninformed) than protests asking for more government.  Maybe we’ll see protests when discussions get more serious about raising the age for Social Security and Medicare.  Still, let’s hope it isn’t anything like the welfare mentality in France and other parts of Europe.

It is not to say that we shouldn’t feel a little bit sorry for some of these people.  They have been forced to pay into the horrible system and they have continually been told, probably their whole life, that government would take care of them in their old age.  It is naive of people to believe this and perhaps irresponsible, but it is a shame.

It is fun to watch these struggling governments in some ways.  It is particularly fun when you have some leftist/socialist in power, whether in Europe or in a state like New York or California.  In California, why not hope that the Democrat will win.  That way, when budget cuts are the only choice left, it will have to be done by a leftist.  There is nothing better to see the unions, government workers, and welfare slugs out there protesting against a leftist governor that they put into office.  The governor is left with no choice (since there is no Federal Reserve at the state level), but the protesters expect him or her to repeal the laws of economics.

Enjoy the scenes over the next few years.  Governments will continue to be forced to cut back.  The day of reckoning has finally arrived.  Politicians can no longer promise the moon and the sun to everyone.

Being a libertarian, there is a lot to be pessimistic about.  The federal government is running a 1.5 trillion dollar yearly deficit.  This would have been unheard of even 3 years ago.  The unfunded liabilities (mainly Medicare and Social Security) are in the neighborhood of 100 trillion dollars, an amount so ridiculous there is no point on thinking about it.  The Fed more than doubled the monetary base in late 2008 and early 2009.  Politicians are as crooked as ever and government keeps getting bigger and bigger.

Understanding Austrian economics is an advantage in that we can understand that there is a lot more trouble on the horizon.  The economy tried to correct itself in 2008 by flushing out all of the bad investment that had previously occurred due to Fed policy and big government.  Instead of allowing the correction, the Fed and government have provided massive stimulus with bailouts and fresh money.  This not only prolongs the problem, but it makes it much worse.  The next correction, if allowed to happen, will be even worse.  Sometimes it seems that ignorance is bliss.

With all that said, there is reason for hope.  The biggest threat to the politicians and big government is the truth.  The truth shall set you free.  With today’s communication technology, particularly the internet, the truth is getting out there more and more.  Politicians can’t get away with as much as they did in the past.  People are starting to understand economics.  Not everyone believes the Keynesian lies.  Not everyone believes that more government spending and more debt will solve our problems.  In fact, we are almost at a point where even a majority of Americans don’t really believe it anymore.

There is going to be a lot of pain and turmoil in the coming years.  But there are a lot of reasons to be optimistic for the long-term.  It is hard to think that we will be worse off 20 years from now than we are today.  There are no guarantees, but human beings generally want to be free.  Get rid of the propaganda (which the internet is helping to do) and the seductiveness of socialism fades away.  People want to be able to own their own property and control it how they want.  People want to be able to keep the fruits of their labor.  If enough people feel this way, big government will not continue.  There are only 535 congressmen and 1 president.  There are over 300 million people living in the U.S.  If enough of those 300 million plus people feel strongly enough about freedom, then it won’t matter who is elected or how they try to govern.