Dave from Denver...

Avoiding The Fiscal Cliff = QE To Infinity

There is no reason to expect that renewed efforts at federal budget deficit reduction will result in anything more than the usual smoke and mirrors, further increasing, not reducing, long-term U.S. sovereign-solvency risk. In reality, the U.S. economy has not recovered, and no recovery is pending. Consumer liquidity remains severely impaired, and broad business activity continues to falter anew. As a result. the actual federal budget deficit going forward will be much worse than the relatively rosy numbers being used as the basis for government negotiations - John Williams, www.shadwostats.com

Everyone can draw their own conclusions about how this so-called "fiscal cliff" situation will play out, but the only way it can possibly be "resolved" is by postponing the inevitable. As Williams states: "Accordingly, global market reaction—to a severely deteriorating outlook for U.S. fiscal conditions—increasingly should reflect massive flight from the U.S. dollar and movement into gold and the stronger Western currencies."

The big news yesterday was the fact that a couple of "official" - supposedly professional - organizations issued a statement proclaiming that if the U.S. goes off the fiscal cliff that it would lead to a recession. This revelation would be funny if it weren't so completely pathetic. Talk about understating the obvious. Notwithstanding the fact that on a real inflation basis, not Govt CPI basis, our economy has remained in contraction since at least 2008, if Congress and the President were to allow the "fiscal cliff" mechanism to occur, it would throw our system into economic armegeddon. I went over the numbers earlier this week as to why this would be the case.

The truth is that not only will the fiscal cliff scenario be kicked down the road like the proverbial "can" (anyone know if that's supposed to be a beer can or a soda can? Maybe a can of beans?), but the increasing chasm between expenses and revenues will have to be filled with even more Treasury debt issuance. Tautologically, this means more QE. More QE means even higher prices for gold and silver. The reason more QE will be needed is the same reason the Fed has continued and expanded QE since its inception in 2008: 1) the banks need liquidity or they will collapse; 2) the Treasury needs a new source of cash or interest rates will go to the moon.

To address the Treasury funding requirements, I've got a graph from Zerohedge which shows the steady decline in foreign Treasury purchases since 2009:

Foreign funding of Treasury paper has declined by 55% since 2009. I have not seen this fact reported anywhere in the mainstream media. It should come as no shock, however, as foreign investors are not idiots. They know that money printing devalues the dollar, so they want less of it. China has somewhat maintained its level of Treasury buying lately, but that's because if they are perceived as fleeing the dollar, the dollar would collapse and China would be, in a sense, shooting itself in the head financially. That will change eventually.

The decline in foreign participation in Treasury auctions has been replaced by the Fed's participation, aka QE. The next chart, which I hypothecated from www.clusterstock.com, shows this fact nicely:

This is an interesting chart. Not only does it show graphically the fact that the Fed is increasing the size of its balance sheet by buying Treasuries in order to make up for the loss in foreign participation, but it shows the concomitant correlation of the price of gold. The orange line shows the projected growth in the Fed's balance sheet if it just maintains the existing QE policy. The red line shows the trajectory of the Fed's balance sheet if it implements the highly telegraphed next phase of QE. Everyone can draw their own conclusion as to the expected trajectory for the price of gold under the "red line" scenario.

And the truth is, the red line scenario is the expected policy move given what is already written on the chalkboard in terms of the giant locker room on Capitol Hill. What about when the impending debt ceiling increase has to be increased again by next summer? See where this is headed? QE to infinity.

The metals/miners market seems to have reverted from "sell the rallies" to "buy the dips." What's even more interesting, the metals have had more days recently in which they go higher when the S&P 500 is getting hit. I think the hedge fund margin calls related to the mini-crash in AAPL have run their course, so I think the SPX will get a trading bounce here and the metals will move with it. As the media hype and political show connected to "The Cliff" intensify, the stock market has a lot of downside risk and I fully expect a portion of the money that leaves stocks will flow into the metals.