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“To reorganize preexisting debt is not enough; a continuing flow of new credit must be secured to enable the heavily indebted countries to recover. Commercial banks cannot be counted on. They should not have provided credit for balance-of-payments purposed in the first place; they have learned their lesson and would be unwilling to lend even if they did not suffer any losses on their existing commitments. Balance-of-payments lending ought to be the province of an international lending institution that has the clout to insist that countries follow appropriate economic policies.

At present, the major internal problem in the heavily indebted countries is inflation. As long as the servicing of foreign debt generates large budget deficit there is little hope of curbing it. But once the debt burden is reduced, domestic reforms would have a better chance of succeeding. With less inflation real interest rates would rise, flight capital would be encouraged to return, and perhaps even foreign capital could be attracted once again.

To provide an adequate flow of new credit, the World Bank (or a new institution designed for the purpose) would need a large amount of capital. At present, the political will to make the necessary capital available is missing; any enlargement of international financial institutions would be perceived as a bailout for the banks or for the debtor countries or for both. A comprehensive scheme that would require both creditors and debtors to contribute to the limits of their abilities ought to be able to overcome these objections. The new loans would not go to service the existing debt; they would serve to stimulate the world economy at a time when the liquidation of bad debts is having a depressing effect and stimulation is badly needed.”
                                          George Soros, The Alchemy of Finance

Commentary & Analysis
Decision time: are you running with the bulls?

I poked a bit at James Turk yesterday, asking whether he was right to think gold will benefit from a flight-to-safety bid in the wake of a sovereign default. I think he could be wrong. But he is right about something. I went to his website yesterday, after writing about him, and read an article on the solvency of the ECB. Turk makes a lot of great points so I thought I would share the article with you. You can read it here.

Felix Zulauf recently came out with a market prediction. Relative to equities, he thinks we could see 20% downside from the levels of mid-May. Where might that take us? Here is a chart of the S&P 500:

Using 1325 as our mid-May starting point, a 20% slide would take us to 1060; I’ve marked it with the red line. It seems like a reasonable technical target since it corresponds to congestion where past support came into play. But considering how crazy everyone is getting over the recent slide, a move to 1060 would be huge.

First, though, the S&P 500 needs to break beneath its 200-day moving average – it’s testing that level now (orange). But there’s a good chance that level gives way to more downside since not even the 38.2% Fibonacci retracement level has been reached yet.

When I was talking with Jack last week he mentioned he’d watched a segment of Larry Kudlow’s show – Kudlow was super bullish on stocks, apparently. His reasoning seemed to lie with robust earnings growth and relatively solid balance sheets of US companies.

Okay, fine. But does the earnings trend have the potential to keep up its pace? And if it does, will it be immune to a definancialization trend that might be sparked by the expiration of QE2, the expiration of political order in Greece, the expiration of Chinese grow-to-the-moon expectations, or all of the above?

Many are adamant that the end of QE2 will not mean the end of Federal Reserve easy-money policy. Indeed, rates will likely be kept low for months after the June 30 expiry. A reader of ours, in response to Currency Currents yesterday, emphasized correctly the fact that gold is being supported by low interest rates. Indeed. Since gold boasts no yield, it becomes an even more attractive investment in a low-yield environment. And assuming interest rates don’t change much, my call for a liquidity-driven move out of gold could likely be short-lived relative to other commodities and risk assets.

But I do think a potential liquidity-driven collapse is a more pressing issue today.

Here is a comment from a piece of research we received yesterday:

The European banking system now stands unprotected from the threat of a Lehman-type credit event. And since the European banking system is 62% of global banking in terms of balance sheet size (and 75% of the world’s largest 50 banks), the implications for the entire global financial system are obvious. We are facing the possibility of a sudden “de-globalization” of global finance.

Of course, we know this is the worst nightmare of globalizationist authorities around the world. They will do everything in their power to prevent such a “de-globalization” and specifically the impact such expectations would have on financial markets. [As a side note, I received a comment from a reader yesterday who was disgraced by the English and grammar I used in Currency Currents. He gave me no examples of my apparent butchering of editorial language, but perhaps he was really just disgraced by the fact that I make up tricky words like ‘globalizationist’ and ‘definancialization.’ Too bad.]

The point here, which I am reiterating from yesterday, is that the financial system is very tightly coupled. Remember that authorities thought the subprime fiasco and the housing bubble could be contained and managed. But that was not exactly how things went down, was it?

So as we look to markets we should be very cautious, careful not to jump the gun simply because this looks like an excellent buying opportunity.

Some other analysis I read this morning compared the recent decline and current investor sentiment with the corresponding period last year. Last year, as it turned out, offered up a very nice buying opportunity. Here is the forecast that accompanied the analysis:

This is a setup, in our opinion, for a very strong equity run in the near future. It could be that we have to retrace briefly before the push higher ensues, but as we mentioned above, the wait will not likely be a long one. A quick fall and an equally quick drive higher to new highs – or a grind from current levels to new highs – is what we expect. In either case, we anticipate that the great mass of investors will arrive at a place of zero confidence in the future of equities. That, of course, will occur moments before the bulls begin to run.

You go ahead and run with the bulls. I’ll be sure to catch up …