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Extra!  Extra!  Read all about it…

“Treasury prices rallied Tuesday after the Federal Reserve delivered on more bond buying, announcing that it will buy more long-term Treasury securities to help keep the U.S. economic recovery on track and avoid deflation.”

Wall Street Journal – August 10, 2010, 4:52 P.M. ET

What recovery?  From our lofty perch at Global Speculations, where we continually sift through reams of economic and market data for discussion over our favorite cocktail, we don’t see one.  Judging by many of the news articles we’ve been reading neither does a growing segment of the mainstream media.  But that’s beside the point.

Ben Bernanke Used Car Salesman

¨Have I got a deal for you!¨

The great and powerful Oz, that is the Federal Reserve, in its inimitable wisdom, has decided to continue its strategy of trying to stimulate the economy by buying treasury debt and mortgage backed securities (you know…real estate debt).  The general logic behind the madness is twofold.  First, by buying U.S. treasuries and mortgage backed securities from the Treasury or financial institutions, it will load them up with cash which they are free to lend or invest into the market place.  Second, by buying U.S. treasuries and mortgage backed securities they will maintain or drive up the value of this debt while at the same time driving down interest rates.

In theory, this makes lots of liquidity and debt available at low interest rates which will stimulate business and consumption and thus by extension, the economy.  This in turn helps to maintain asset values (which serve as collateral for debt) and insure that the colossal mountain of debt hanging over the economy like Damocles’ sword will remain serviceable.  Or so the story goes.  There are a lot of question marks in our minds about how you posture an economy for long term growth by pyramiding one mountain of debt on another, but that’s not the moral of today’s commentary either.

To digress still further, we’re not even sure why deflation (a decrease in prices) is something to be feared.  Isn’t a stronger currency that makes stuff cheaper a good thing?  Unless of course you are a lender, which, not to put too fine a point on it, the Federal Reserve is.  They are in fact, the lender of last resort.  A strengthening currency and falling asset prices creates a set of mutually reinforcing risks to a lender´s loan portfolios.  It means falling asset prices, which of course are the collateral securing the loans. It means that borrowers will be paying their loans back over time with dollars that are increasingly worth more than the dollars they borrowed in the first place.  It doesn’t take long for borrowers to figure this out.  You can google articles on the growing trend of home owners and commercial real estate borrowers walking away from their mortgages. There is even a new trend on the rise.  Borrowers who still have good credit but own property that is underwater are now applying for loans for new smaller properties before they hand back the keys to the bank.  Make no mistake, the Fed doesn’t hate deflation because it’s bad for the economy, they live in mortal fear of it because it’s the angel of death to the lending community´s gargantuan loan portfolios.

So much for introductions.  Although all of this is interesting and important to understand, the reason the crew at Global Speculations tracks this issue with great interest is because of its likely impact on our investment portfolio.  We are monitoring the gradual convergence of three hulking global economic storms into what appears to us as a perfect storm bearing down on commodity prices.

Storm number one is the rapidly urbanizing and industrializing economies of Asia.  We don’t have to tell you that a lot of people live in this part of the world and they are on a mission to improve their standard of living.

The second storm is the challenge in natural resource industry to meet growing demand.  It takes a great deal of time, capital and credit for natural resource companies to develop the production capacity and infrastructure required to meet rapidly growing demand.  This reality puts long term upward price pressure on the entire spectrum of commodities.  This is the mega-trend of the 21st century we see unfolding, despite current economic weakness in the major developed economies of the west.  In fact there are indications that supply is actually falling across many commodities.  There are many reasons for this with the most prominent being the disappearance of cheap and easy to access commodities.  The low hanging fruit is dwindling.  Prices will have to rise much higher to justify the effort to supply more.

The third storm front, which will turbo-charge pressure under commodity prices, is the avalanche of money and debt being pumped into the economies of the developed western world to stave off economic Armageddon.  The bottom line is quite simple.  if the volume of money available to buy stuff is increasing exponentially along with the demand, while at the same time the actual production of stuff remains the same or declines, then explosive pressure builds under the price.  It’s simple.  The tricky part is figuring out how to profit from the converging storms.  The FED´s latest actions may prolong the inevitable for a while but balance sheet trickery will only make the eventual price spikes more dramatic and for many more painful.

This is why your editors at Global Speculations are positioning ourselves and our Premium Subscribers in investments that are sitting right in the pathway of the storm.

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