July 29 (Financial Times) — You go to the cinema or the theatre to see the stars perform. What happened on Thursday in the US House of Representatives was that hardly any of them turned up, the real drama was all offstage and the play never got to the final act. No wonder the national audience wants its money back.

Rarely has Washington’s theatre of the absurd been seen in such sharp relief as in the “debate” over Speaker John Boehner’s bill to cut spending enough to raise the debt ceiling for a few miserly months. The probability is that this bill, whatever its ultimate fate, has not a prayer of passage in the Senate. But posturing in Washington, sometimes known as the “optics”, is now a minor art form.

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Fed Audit Confirms US Central Bank is Lender of Last Resort to the World

The market is understandably largely focused on the contentious debt ceiling wranglings this week, but somewhat behind the scenes, the market is also rejecting last week’s agreement to provide a second bailout for Greece. The alleged support in the House for the Boehner debt proposal evaporated late on Thursday, forcing the speaker to withdraw plans for a vote and return to the drawing board for further tweaks. Of course there was little hope that the House plan would pass the Senate anyway, and the tweaks are likely to make the proposal even less palatable to the Senate and the President.

Meanwhile, yield spreads in Europe have been retracing the narrowing that occurred in the wake of the EU summit, as the respite is contagion risks is proving brief indeed. Andrew Balls of PIMCO worried this week that the efforts by eurozones leaders to fight contagion are “too little” and “too late.”

Auctions this week in Italy and Spain didn’t go so well, with both experiencing higher than expected refinancing costs. Moody’s placed Spain’s Aa2 sovereign debt rating on review for a possible downgrade on Friday. Belgian 10-year yield spreads hit a record wide 179bp; Greek 2-year yields surged to 33.05%; and even Denmark CDSs jumped by nearly 20% overnight. We’ve noted in past commentaries that the span between relief associated with official attempts to mitigate the EU debt crisis and a return to crisis mode is getting shorter and shorter, but less than a week is wholly unprecedented. Faith in the ability of governments and international agencies to resolve these crises, both in Europe and here in the US is eroding rapidly and a global crisis of confidence appears to be at hand.

Through all of this — and largely unnoticed — the GAO released the details of their audit of the Fed. What little coverage it did get focused on conflicts of interest centered on the discovery that employees and contractors of the Fed were allowed to own stock in companies receiving aid from the central bank. However, the bigger deal in my opinion was that the Fed authorized more than $16 trillion in largely secret lending during the financial crisis without one bit of Congressional oversight.

The report is entitled GAO-11-696 FEDERAL RESERVE SYSTEM: Opportunities Exist to Strengthen Policies and Processes for Managing Emergency Assistance. It’s a long title and a long report, but the recommendations of the GAO are summed up in a single paragraph:

While creating control systems at the same time that the emergency programs were being designed and implemented posed unique challenges, the recent crisis provided invaluable experience that the Federal Reserve System can apply in the future should the use of these authorities again become warranted. Going forward, to further strengthen policies for selecting vendors, ensuring the transparency and consistency of decision making involving the implementation of any future emergency programs, and managing risks related to these programs, the Chairman of the Federal Reserve Board should direct Federal Reserve Board and Reserve Bank staff to revise Reserve Banks’ formal acquisition policies and procedures to provide additional guidance on the steps staff should follow in exigent circumstances, specifically to address soliciting as much competition as possible, limiting the duration of noncompetitive contracts to the period of the exigency, and documenting efforts to promote competition.

The GAO seems generally nonplussed by the extraordinary size and scope of the Fed measures, the lack of any oversight, and the fact that a large percentage of US funds went to foreign banks and businesses. I suspect it was simply the GAOs responsibility to compile the facts, not to pass judgement. I would hope that once there is ultimately a deal on the debt-ceiling, lawmakers in Washington would have something to say about that astounding $16 trillion figure.

One thing is abundantly clear though — as both the US and Europe unravel under the weight of oppressive debt burdens — the US Federal Reserve is the lender of last resort to the world. That is a reality that should not be discounted by neither the individual investors, nor our Representatives in Washington as we continue our march toward the precipice that is another global financial crisis.

I posted this graph of the US monetary base earlier in the week because it is so terribly telling. My fear is that we haven’t seen anything yet.

July 29 (The Wall Street Journal) — Gold futures soared to record territory after data showing weaker-than-expected U.S. growth prompted a flight to safety.

The U.S. economy grew at 1.3% in the second quarter this year, well short of the 1.8% growth forecast by economists. The government’s first quarter growth reading was slashed to a paltry 0.4% from a previous estimate.

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July 29 (Politico) — President Barack Obama said Friday that Democrats and Republicans are not far apart on an agreement to raise the debt ceiling, but they must forge a compromise that can survive votes in both the House and the Senate.

“There are plenty of ways out of this mess, but we are almost out of time,” he said from the Diplomatic Reception Room of the White House.

…The bill put forward by House Speaker John Boehner (R-Ohio) “does not solve the problem and … has no chance of becoming law,” Obama said, as he urged bipartisan compromise.

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July 29 (MarketWatch) — Gold futures traded at a record Friday, thriving on the bad news about the U.S. economy and after House leaders postponed a vote on the U.S. debt plan. Gold for December delivery added $16.10, or 1%, to trade at $1,632.10 an ounce on the Comex division of the New York Mercantile Exchange. It earlier traded as high as $1,637.50 an ounce.

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July 29 (USAGOLD) — Gold is pressuring record highs again after speaker Boehner’s plan to pass legislation that would allow the debt ceiling to be raised disintegrated last night in the House. It would seem that yesterday’s rumors that Congressmen affiliated with the Tea-Party were falling in line behind the speaker were unfounded.

On top of that, it was revealed this morning that the economy continues to slow, and all-but came to a standstill in Q1. The Washington Post’s Ezra Klein summed it up succinctly in a tweet this morning: “The economy is terrible and Congress is a mess.”

Meanwhile, the situation in Europe continues to deteriorate with spreads continuing to widen back out as confidence in the second deal to save Greece remains on the wane.

• US Q2 GDP +1.3%, below market expectations of 1.7%, vs big negative revision from 1.9% to just 0.4% in Q1.
• US Q2 ECI +0.7%, above market expectations of 0.5%, vs 0.6% in Q1.
• Moody’s placed Spain’s AA2 rating on review for possible downgrade.
• Eurozone HICP decelerated to 2.5% y/y in Jul, below market expectations of 2.7%, vs 2.7% in Jun.
• German retail sale +6.3% m/m in Jun, well above market expectations of +1.6%, vs positively revised -2.5% in May.
• UK Nationwide home prices +0.2% m/m in Jul, above market expectations; -0.4% y/y and outlook remains negative.
• UK GfK consumer confidence -30 in Jul, below market expectations of -27.
• South Korea industrial production +6.4% y/y in Jun, below market expectations of 7.0%, vs negatively revised 8.1% in May.
• Taiwan Q2 GDP 4.88% y/y, above market expectations, vs 6.2% in Q1.

July 29 (The Wall Street Journal) — Rising signs of strain emerged across financial markets on Thursday as investors pulled out billions of cash out of money-market funds, in turn driving the funds to rein in lending in short-term markets.

Financial markets have become increasingly alarmed at the deepening divide in Washington and the potential that the U.S. could be downgraded by credit-rating agencies or, worse, default on its debt.

Banks, meanwhile, are scrambling to design emergency plans to avoid a trading logjam in the huge markets for Treasurys and short-term funding facilities if Congress fails to raise the U.S. borrowing limits by next Tuesday’s deadline.

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July 29 (The Hill) — House Republican leaders have postponed indefinitely a vote on Speaker John Boehner’s (R-Ohio) debt limit bill after they could not persuade enough Republicans to support the measure.

“No vote tonight,” the third-ranking House Republican, Majority Whip Kevin McCarthy (R-Calif.), told reporters after leaving Boehner’s office shortly before 10:30 p.m. The move throws into upheaval the desperate push in Washington to raise the nation’s $14.3 trillion debt limit to avert a national default on Aug. 2.

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PG View: Rumors that freshman Republicans were falling in line seem to have been unfounded. Tick-tock…

July 28 (King World News) — When asked about gold Hathaway remarked, “Basically you have a very orderly rate of increase. If you go back to 1979 gold doubled in a single year, well it hasn’t doubled in any year in the last ten years. So as this move is ending it’s conceivable to me that you are going to see a doubling of the gold price from some higher level, but I feel very good about the sustainability of the current action in the gold price.

Gold is up (roughly)13% year to date, if you tack on another 10% in the second half that is not unsustainable in terms of the macro picture that I see. What’s going to drive it (gold) crazy is when institutional buying starts to take place, and we really haven’t seen that (accelerated) sovereign wealth and (accelerated) central bank buying. That still lies out there and that’s the fuel that’s going to get the gold price up to numbers that I’m almost afraid to mention on air or in print.”

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July 28 (Commodity Online) — 1) Global financial uncertainties: Deteriorating US economic data and deadlock over the $14.3bn debt ceiling negotiations, Europe’s sovereign bond crisis, and hints from the Fed that additional policy stimulus may be on the horizon, all fuelled the rally.

2)Energy Inflation: The rapid rise in energy prices over the first half of this year, the fall-out from the Japanese earthquake and tsunami disasters as well as the end of QE2 have dented growth and sparked fears that the US may not be in a soft patch but rather entering a double dip recession.

3) Eurozonde Debt: Investors also focused on problems in the Eurozone, where risks of contagion from the Greek debt crisis also supported investment activity in gold. While disagreement over a Greek bailout plan continued Moody’s downgraded Ireland’s government paper to below investment grade (to junk status, from Ba1 from Baa3).

4)QE 3 possibilities: However, the key catalyst to drive gold over the $1,600-level was news that the Fed was considering further policy easing. The release of minutes from the FOMC’s June meeting revealed that various members were, dependent upon further weakening in the job market, in favour of fresh stimulus so long as inflation remained in check. On 13 July Bernanke in testimony before Congress made a statement long awaited by Gold investors: “On the one hand, the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support.

According to Jeff Nichols, the present gold rally “..is just the beginning of gold’s next great leap upward, a move that very likely will carry the metal to $2000 an ounce in 2012 — with prices still headed higher, quite possibly to $3000, $4000, and maybe even $5000 an ounce by the mid-to-late years of the decade.”

JK Comment: Its not hard to understand why Nichols places such a high nominal target for the gold price over the next decade. Quite simply, its hard to envision how the catalysts that drove gold to all time high over the past week have any real chance of reversing. It seems, if anything, they are intensifying. Five years ago, a financial event like the European debt crisis, the debt ceiling debate or energy price shocks due to political upheaval in the Middle East would have been big news. Yet, ever since our own financial crisis, it seems these major catalysts are occurring closer and closer to one another, perhaps diminishing their individual “shock factor”, but collectively fueling a rapidly accelerating pace of ascent in the gold market. As our debt ceiling debate carries on, I find myself concluding that though an agreement may be reached, we will very likely be doing nothing more that kicking the can down the road, leaving ourselves to the very same conversation in the not too distant future. The same can be said of the European debt crisis. And the one consistent theme seems to be that each time these issues come back around, they are bigger and more problematic than our previous encounter with them. Though achieving the $3000, $4000, $5000 levels in gold over the next decade could be perceived as overly bullish….permanently resolving all of these intensifying and increasingly frequent problems is even more far-fetched.

Gold Eases on Latest Debt Ceiling Optimism

July 28 (USAGOLD) — Gold has adopted an easier intraday tone on the latest market rumor about a debt ceiling compromise. It is also looking increasingly like the freshman Republicans in the House are falling in line behind Speaker Boehner. The House plan is likely to be voted on early this evening, although there is still no Democrat support in the Senate. Without some converts in the Senate, the Boehner plan has little hope of reaching the President’s desk. Today’s vote is an exercise in futility that will bring us another day closer to the deadline for a default set by Treasury Secretary Geithner.

James Rickards, Senior Managing Director for Market Intelligence at Omnis, Inc., suggested yesterday that if Geithner had initially projected calm we might be in a better position today with respect to a likely downgrade. However, in setting a hard deadline and saying that the implications of failure to raise the debt ceiling in a timely manner would be “catastrophic,” Rickards believes that Geithner has effectively “forced the raters’ hand.” If the Treasury Secretary of the United States is projecting panic, perhaps there is reason for panic. On the other hand, without a deadline and a sense of urgency, one can be reasonably sure that Congress would not be acting with any urgency either.

Talk about the President invoking the 14th Amendment has also escalated this week. The Constitution says the validity of the US government’s debt “shall not be questioned.” So, some lawmakers believe the President can circumvent Congress and raise the debt ceiling, or suspend the debt ceiling altogether. The White House has said recently that after consulting with counsel, that they did not perceive this to be a viable option.

As the debate rages on, it’s important to remember that whether a compromise is reached on the debt ceiling or not, spending cuts — which are a part of both the Democrat and Republican plans — may well prove to be devastating to the fragile economic recovery. As PIMCO’s CEO Mohamed El-Erian pointed out in a Wednesday Op-Ed in the Washington Post, “In this political mess, already-weak business and consumer confidence is being dealt a further blow. Companies with massive cash holdings now have yet another excuse to stay on the sidelines.”

In seeking to resolve this debt, spending and taxes impasse, we risk undermining an already tepid recovery. If that happens we may return to recession; with its attendant higher unemployment and greater debt as tax revenues continue to contract. We have painted ourselves into a corner from which there is no easy means of escape. The temptation as always will be to kick the can down the road, perpetuating the policies that got us into this predicament in the first place. This is tantamount to give the US more debt ceiling clearance by digging the hole that we’re in ever deeper; which will make it harder to get out of the hole down the road.

July 28 (Bloomberg) — Trading of credit-default swaps insuring U.S. Treasuries soared almost 80 percent as the deadline nears for plans to cut the nation’s budget deficit and raise the $14.3 trillion debt limit to avoid default.

Traders bought and sold 41 contracts in the week through July 22, insuring a daily average of $250 million of U.S. debt, up from $140 million during the past month, according to the Depository Trust & Clearing Corp. The country was the tenth most traded among the 1,000 entities tracked by DTCC, with 1,063 outstanding trades covering $4.9 billion of debt — a third of the total on German bunds.

Failure by President Barack Obama and congressional leaders to reach a debt agreement may force the government to delay bond payments, causing a credit event that would trigger insurance payouts. The parties are struggling to reach a compromise before Aug. 2, the date Treasury Secretary Timothy F. Geithner said the government will run out of options.

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July 27 (The Hill) — Intense pressure from House Republican leaders on their members appeared to build momentum Wednesday for Speaker John Boehner’s (R-Ohio) debt-limit bill, despite conservative doubts and a wall of opposition from Democrats.

“Get your ass in line,” the Speaker told Republican lawmakers in a conference meeting Wednesday, as his proposal to grant President Obama a limited increase in the $14.3 trillion debt ceiling faces a nail-biter of a vote on Thursday.

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PG View: It could be an interesting day: Will the freshman Republicans get in line, or hold their ground?

July 28 (USAGOLD) — Gold remains underpinned as global stocks succumb to rising worries over the US debt ceiling impasse and persistent eurozone jitters. The euro sank and Bund and Gilt futures rose on safe-haven flows after a weak Italian bond auction resulted in a sharp rise in refinancing costs. Indicating once again that last week’s summit and proposed deal on Greece largely failed to stem contagion worries.

The House will consider Speaker Boehner’s debt package today. Whether it has enough votes to pass the House remains in doubt. It is widely perceived not to have the necessary votes to clear the Senate.

The Democrat controlled Senate prefers a deal put together by Majority Leader Reid, which is widely perceived not to have the necessary votes to make it through the House. And the band played on…

China’s SAFE says they will continue to gradually diversify their estimated $3.2 trillion in FX reserves “and continue to optimise the holdings based on market conditions.” China’s reserves are presently about 60% allocated to dollars. If the intent is to diversify, chances are they are looking to pare back dollar holdings. I would also point out that China has displayed a distinct penchant for gold in recent years.

• US initial jobless claims -24k to 398k in the week ended 23-Jul, below market expectations of 415k. Previous week revised higher to 422k.
• Canada average weekly earnings +0.5% in May, +3.3% y/y; nonfarm payrolls -15k
• Reuters poll suggests BoE will hike in Q1-12, but QE2 likely if economy doesn’t improve (see CBI data for this week).
• UK CBI retail survey reflected weakening expectations.
• Eurozone ESI confidence 103.2 in Jul, below market expectations, vs positively revised 105.4 in Jun.
• German unemployment change -11K (SA), rate unchanged at 7.0%.

July 27 (Financial Times) — The cost of buying insurance against a default by the US rose to a record on Wednesday, in a sign of growing unease that gridlock in Washington over raising the federal debt ceiling may result in the Treasury failing to pay interest to bondholders.

The market for buying and selling insurance on the creditworthiness of the US is thinly traded, denominated in euros and dominated by European and UK banks in London. But trading in so-called credit default swaps has picked up as the threat of a default has grown.

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July 27 (Finacial Times) — Gold prices rallied to a fresh nominal high on Wednesday as the stalemate over the US debt ceiling persisted ahead of the August 2 deadline. Without a deal, the US may be forced to default to creditors next week.

Investors are concerned because US debt markets have usually been seen as “risk-free”. Even if a deal is reached to raise the debt ceiling, the US could still lose its coveted triple A rating status. These worries pushed investors into gold.

“Gold, along with a few select currencies, is increasingly the “go to” asset as investors seek it out for.

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