Pacifica Partners' Financial Post

Weekly Column - July 12th 2010

One of the most important signposts

for investors is to look for extremes in consensus thinking. For example, at the

beginning of the year, investor enthusiasm levels were high, markets were

betting on a "V shaped" recovery and worries about the economy's future were

fading fast -- at least on Wall Street.

Today, the boat has tilted to the

other side as investors have all but surrendered to the idea of a double dip

recession or even according to some economists, we are in the "Great

Depression". Seldom have we seen a more heated debate amongst economists about

how to best respond to the recent bout of unexpected bad economic data points,

stubborn unemployment in most countries and the issues surrounding Europe.

On one end of the spectrum, the

economists advocating a Keynesian solution (akin to FDR's New Deal) are calling

for more government spending and stronger monetary policy actions to get things

moving. They argue that in the long run, the increased expenditures will be

cheaper than the impact of not doing more today.

Listening to this raging debate

leaves one with the impression that both sides have valid arguments. However, it

seems that the majority of nations have opted to go the route of cutting back

spending, ensuring that deficits are reduced and by doing this, they hope to

placate the bond markets.

Players in the bond market have

often been given the name "Bond Vigilantes" because of their willingness to

enforce their own brand of justice on countries that they deem to be too

profligate in their spending habits. They try to impose their discipline by

forcing interest rates up in countries that are deemed to be risky. As Europe is

finding out now, they carry a big stick.

When Bill Clinton was first elected

to the presidency, he was furious upon being told that the bond market would not

take kindly to a stimulus bill he wanted. As his close political adviser James

Carville said: "I used to think that if there was reincarnation, I wanted to

come back as the president or the pope or as a .400 baseball hitter. But now I

would like to come back as the bond market. You can intimidate everybody."

At this point, it would seem that

the bond vigilantes have succeeded in forcing governments to reduce their

spending which should help to keep the much feared inflationary firestorm on the

distant horizon for a little longer than expected.

The great fear is whether or not

the bond vigilantes will ever turn their attention to the US. So far, one of the

beneficiaries of the troubles in Europe has been the US -- money has flowed back

to the US and into US bonds -- forcing interest rates to decline substantially.

This has helped to bring down US interest rates. The offset is that the

borrowing demand still remains lackluster.

At the recent G20 meetings, Barack

Obama was almost alone in advocating more spending to ensure the recovery takes

hold. He is in a better position to call for that as the US bond market has had

a favorable run as investors panicked and flocked to the safety of US Treasury

bonds. But it will not always be that way if present spending trends in the US

do not improve. At some point, the bond vigilantes will begin to dole out

justice in the US -- that could make the European crisis look like a warm up.

The one bright aspect to this is

that as Winston Churchill once said -- "Americans always try to do the right

thing after they've tried everything else." The same can be said for Europe --

they seem to have only found fiscal discipline after the bond market demanded

it.

Pacifica Partners Capital

Management
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Surrey, BC, Canada
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Tel: 6o4.576.8908
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