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David A. RosenbergDecember 14, 2009
 Chief Economist & Strategist Economic Commentarydrosenberg@gluskinsheff.com+ 1 416 681 8919
 
MARKET MUSINGS & DATA DECIPHERING
Breakfast with Dave
WHILE YOU WERE SLEEPINGIN THIS ISSUE
• While you were sleeping —economic data overseasleft much to be desired• Frugality them far fromover, in fact, it has justbegun• The next wave of instability … sovereigndebt• The blame game — inPresident Obama’s latestweekly address, heblames the banks forluring borrowers into themyriad of products during  the credit bubble• Why we see the Bank of Canada not raising ratesfor a very long time• A second look at U.S.retail sales — overall, thelevel of retail sales is stillon a downward path• U.S. consumer sentimentimproves, but still very low• No capitulation! For everydollar the public invests inequities, it puts in twodollars into bonds• Major shift in attitudes towards housing too• The taxman! The U.S.government is becoming increasingly creative in itsquest to raise money tofund its fiscalinterventions• Utility in utilities• Could Q4 U.S. real GDPgrowth come in at 5%?Equities for the most part are bid, and so are government bond markets. TheU.S. dollar is a tad off this morning, and commodities, for the most part, arefirmer. Helping on the risk front was the news that Abu Dhabi will step in to saveDubai World’s debt problems.However, the economic data from overseas left much to be desired. While theJapanese Tankan business sentiment index improved in Q4 (up nine points, to-24), it remains deeply in negative terrain and came in well below expected.Japanese businesses said they still intend on slashing capex in the next threemonths. (Not only that, but consumer confidence dropped in November for thefirst time in 11 months.) Japanese businesses also said they intend to slashcapital spending. This is still happening after the country’s credit bank assetbubble burst nearly two decades ago.Eurozone October industrial production fell 0.6% MoM, and in the U.K. we sawhome prices decline 2.2% sequentially in December (Rightmove survey).This is a busy week ahead in the U.S. — the FOMC meeting on Tuesday-Wednesday (some other central banks meet as well, including the BoJ, and BoCGovernor speaks Wednesday afternoon at 1 pm) and tons of data — 10 in totalsouth of the border.
FRUGALITY THEME FAR FROM OVER
The household sector is, in fact, telling you that. Floyd Norris ran with afascinating article in the Saturday NYT titled
 Americans Owe Less. That’s Not AllGood
. In fact, the deleveraging process is highly deflationary. The article cites asurvey conduced in November showing that households intend to boost theirsavings rate to 15% (from 5% now) before the recovery begins. From ourestimation, such a boost in the savings rate would be equivalent to a twopercentage point drain in baseline GDP growth over the past five years. So, thisnotion that the Fed is going to be pulling some sort of “exit strategy” actuallyseems like a bit of a joke.The low hanging fruit in coming months, quarters, and years will be buying thefront end of the yield curve and those Eurodollar strips or Fed futures contractsduring those periods (ie, when a piece of above-expected data comes out orwhen a Fed bank president of little or no consequence comes out with hawkishremarks) when the markets price in Fed (or Bank of Canada) tightening. Thehistory of post-bubble credit collapses is that when the central bank takes rates to zero, they stay there for a very looooong period of time.
Please see important disclosures at the end of this document.
Gluskin Sheff + Associates Inc.is one of Canada’s pre-eminent wealth management firms. Founded in 1984 and focused primarily on high net worth private clients, we are dedicated to meeting the needs of our clients by delivering strong, risk-adjusted returns together with the highestlevel of personalized client service. For more information or to subscribe to Gluskin Sheff economic reports
,
visit www.gluskinsheff.com
 
 
December 14, 2009
– BREAKFAST WITH DAVE
 
Also check out
Shoppers Check Out Private Store Brands
on page A10 of theInvestor’s Business Daily and
’Tis The Season to be Frugal
on page A11. Alsohave a look at the very sad front page article in today’s WSJ (
For America’sSantas, It’s Hard to Be Jolly With the Tales They’re Hearing: In Hard Times, Kids Ask for Bare Essentials; Shoes, Eyeglasses and a Job for Dad
). All signs of thesepoint to deflationary times and when deflation hits the ‘golden arches’ (except inyour waistline), you know that this is a secular, and not merely a cyclical shift inbehaviour.
We are seeing the earlystages of the debtdeleveraging process inthe U.S.
Indeed, McDonald’s just said that it’s going to start offering ‘breakfast for abuck’ on its national menu starting in January. Even more on the deflation theme can be found on page B1 of today’s NYT —
 As Prices Fall, Blu-Ray Playersare Invited Home
.
HOW FAR INTO THE DELEVERAGING PROCESS ARE WE?
Early innings. From the peak, the level of nonfederal debt has deflated by $260billion. Some of this has been either paid down, written off, modified, defaultedon or some combination of the four. No matter.As Chart 1 illustrates, and employing Bob Farrell’s first Market Rule on the time-honored trend towards mean reversion, this develeraging process that began twoyears ago is really in its infancy stage. The current level of U.S. outstanding nonfederal debt is $27 trillion, which is astounding both in absolute terms andeven more so relative to nonfederal GDP — a 206% ratio. It is down fractionallyfrom the 208% peak, but here is the rub. If mean-reversion means that we getback to some norm of the 1990s, then we are talking about the need to extinguish$8 trillion of nonfederal debt. The only question is how this happens, not if. If we’re talking about mean reverting to the very stable trend of the 1960s and1970s, then the credit contraction is very likely to exceed $11 trillion.
Total U.S. nonfederal debtis down $260bln from thepeak, but, as a share ofGDP, it is still aphenomenal 206%, whichis nowhere near the morenormal level of 140% wesaw in the 1990s
Either way, this process of debt elimination is ongoing and will likely last for years.Along the way we will see the federal government test the limits of its balancesheet to smooth the transition and it will be long-term Treasury yields that willdetermine when enough is enough in terms of Washington’s fiscal largesse. Justas the Canadian bond market delivered the same message to the Chrétien/Martingovernment in the mid-1990s that ushered in a multi-year forced era of budgetaryrestraint and anemic domestic demand. Until the U.S. gets its balance sheetunder control, and monetization of the debt is likely one key strategy, the trend in the gold price will remain in one direction and that is up.
Page 2 of 16
 
December 14, 2009
– BREAKFAST WITH DAVE
 CHART 1: DEBT DELEVERAGING HAS BEGAN
United States: Total Nonfederal Debt to Nonfederal GDP Ratio
(percent)
60801001201401601802002205255586164677073767982858891949700030609Current = 206%Level back in the late'60s/Early 80s
≈
120%Level back in the early1990s
≈
142%
 
Source: Haver Analytics, Gluskin Sheff 
THE NEXT WAVE OF INSTABILITY — SOVEREIGN DEBT
The reason why gold is back to a four-week low is because the bull tradebecame very overcrowded and the yellow metal was ripe for correction after aparabolic move, but what a buying opportunity this is going to prove to be. Of course, the U.S. dollar has recovered from the abyss, but only for now. While thegreenback has re-emerged as a safety-valve, what makes gold special is that itis not responsive to global economic shifts or is it any government’s liability.
The reason why gold isback to a four-week low isbecause the bull tradebecame very overcrowdedand the yellow metal wasripe for correction after aparabolic move, but what abuying opportunity this isgoing to prove to be
The situation in Europe is troubling — fiscal concerns are mounting, not just inGreece and Ireland (where deficit ratios are north of 9%) but also the U.K., Spainand Portugal (though Ireland did come out with a very austere budget last week).Greek two-year bond yields soared over 100bps in the wake of last week’sdowngrading to BBB+.Banking sector risks are also higher in Europe than in the U.S.A., and this alsomay explain the recovery in the U.S. dollar and selloff in the Euro. But let’s notforget that we finished last week with three very poor U.S. Treasury auctions andcredit default swaps on Uncle Sam’s debt are also beginning to rise discernibly.Bond yields have broken out technically and it will be interesting to see how thiscombination of higher market rates and a countertrend rally in the U.S. dollarfilters though into a more jittery equity market, notwithstanding the prospects that we will soon see consensus upgrades to Q4 GDP forecasts.While the major averages closed higher on Friday, volume was down across theboard (sliding 10% on the Nasdaq and 4% on the NYSE). Moreover, the Nasdaqyet again failed at the 2,200 threshold — a key technical non-confirmation over this bear market rally.Nobody put it better than the S&P’s Howard Silverblatt did in an interview with the FT — see page 18 of the weekend edition:
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