By Bill Bonner
April 21st, 2008

Capitalism is a panacea, after all. It cures symptoms of affluence as well as poverty.

We file this report from Manchester… where, according to legend, the industrial revolution began. Modern tools, steady money, and fossil fuel were put together, creating so much gas, it lifted mankind out of the mud of the Middle Ages and carried him aloft. Thrifty Scottish economists - notably Adam Smith and Adam Ferguson - saw what was happening and took note of the moral lesson: by foregoing the satisfaction of current consumption, savings could be invested in factories, machines, and new discoveries that increased the output from human labor.

In the same amount of time, thanks to his new tools, a workingman could produce more things. And, soon, the things made him rich. According to MeasuringWealth.com, during the second half of the 18th century, the typical British workingman earned about 60 pounds per year. It took only 4.25 pounds sterling to buy an ounce of gold, so he earned the equivalent of 14 ounces of gold, which is worth about 6,622 pounds sterling at today’s rates. A century later, in 1971, to be exact, his earnings had risen to the equivalent of 49 ounces of gold per year - or about 23,000 pounds sterling at today’s rate.

(Readers who are good at math will already be asking questions. The average wage in Britain today is only 23,177. In terms of gold, wages have gone nowhere for the last 37 years.)

But whatever wonder James Watt and the people of Britain’s industrial heartland wrought, their descendants in America have worked another one; in the midst of the greatest financial and technological boom ever, they have managed to actually reduce the value of their own labor.

Yes, dear reader, this week we turn our weary eyes away from the poor, the weak, and the huddled masses struggling to keep up with the price of rice… and focus on people who are struggling to keep up with their credit card payments. Here is a group of people upon whom nature piled so many blessings, she crushed the wit out of them. And, their wealth is being squeezed out too.

The United States of America has rich farmland, from sea to shining sea. Still, it is a net importer of food. In fact, it is a net importer of practically everything that can be moved. Every day that goes by it receives about $2 billion more of these moveable objects than it sends out in exports.

Prior to the Nixon administration, such an imbalance could not persist for very long; but however much God blessed America - with her purple mountains majesty and her fields of golden grain - was nothing compared to the way she was favored by the post-1971 monetary system.

“As ye plant, so shall ye reap,” it saith in the Bible. But in the period from 1997-2007, Americans could reap without planting. They could consume without earning. They could invest without saving, and spend as much as they wanted without running out of money. They were the world’s luckiest people - they had the world’s reserve currency… and access to the whole world’s credit.

The miracle that fundamentally altered the world monetary system happened on August 15, 1971, when Richard Nixon “closed the gold window,” at the U.S. Treasury. Before then, every nation’s currency was anchored to gold. Governments settled their imbalances in yellow metal; since each unit of paper currency represented an option on the treasury’s gold, it forced officials to be wary of issuing too many. But after August, 1971, the world’s monetary system upped anchor and sailed with the tide. Now, it all floats on a sea of paper money - and no one knows what’s beneath the dark ocean surface.

The Chinese merchant who sold widgets and geegaws to spendthrift Americans could not use dollars to pay his wages. He needed local currency. So he traded his dollars for yuan. And where did the Central Bank of China get enough yuan to buy up trillions of dollars? It had to create them. All over the planet, as the world’s stock of dollars rose… so did its inventories of local currencies. And then, what could it do with its dollars? Before 1971, it would have presented them to the U.S. Treasury and received one ounce of gold for every 41 paper dollars. In order to protect the nation’s gold, central bankers would have taken away the punch bowl and turned out the lights. Rates would have gone up; foreigners would have been encouraged to hold dollars (rather than exchange them for gold); Americans would have been discouraged from spending dollars - effectively stifling U.S. consumer spending and bringing the current account back into balance.

Then, in 2001, the U.S. financial authorities, led by Alan Greenspan, thought they faced a crisis. They panicked - giving Americans even more credit rope. With nothing to stop it, the supply of cash and credit rose at an even faster rate. And thus it was that Americans wrapped their good fortune around their necks like a noose. Instead of practicing the virtues that had made them rich - saving money, building new factories and learning new skills - they borrowed even more heavily than before.

And now their houses are being foreclosed and their bills are coming due. Worse, the value of their most important asset - their time - is being marked down with the dollar. According to our source, the typical American workingman in the late 19th century was already earning considerably more than an Englishman - 25 ounces of gold per year, rather than 14. He, too, became much richer as the industrial revolution progressed. By 1971, he was earning the equivalent of 82 ounces of gold, worth $76,000 today. But then he forgot his lessons. He stopped saving… his income fell… and his dollar dropped. Adjusting the average hourly wage for consumer price inflation, he earns slightly less today than he did during the Carter administration. Adjusting his wages to the fall of the euro, we find the average American earns less than the average Frenchman. And adjusting his wages to gold and we see he has lost a half century of wage progress. Today, he earns only the equivalent of 40 ounces of gold - or only about $38,000.

Bill Bonner
The Daily Reckoning Australia

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by gjohnsit
Sun Apr 20, 2008 at 02:43:24 PM PDT

After more than a year of a housing bust, and eight months of a credit crunch, its hard to believe that the real estate market could get much worse. With suburbs turning into ghost towns, major Wall Street banks going under, and people losing their homes right and left, you would naturally think that we must be near the bottom.

And yet, if you look at the raw numbers you realize that the real estate market could get much worse. In fact, it is likely to get much worse in the coming years.

You don’t have to believe me. Look at the numbers for yourself.

* gjohnsit’s diary :: ::
*

The Boston Federal Reserve released a working paper about five months ago that pointed out in blunt language what was the leading cause of foreclosures in this country.

homeowners who have suffered a 20 percent or greater fall in house prices are about fourteen times more likely to default on a mortgage compared to homeowners who have enjoyed a 20 percent increase.
[…]
Cash flow problems at the household level, driven by job loss, for example, play a role, but only when HPA is low. For example, in 2001, a serious recession generated record numbers of delinquencies, a sign that many households had problems making payments, and also record numbers of foreclosures. However, the records were opposites; a high number of delinquencies, but a low number of foreclosures.

The paper goes on to explain how the easy lending of 2004-2007 induced millions of risky borrowers into the housing market with little or no down payments (aka “no skin in the game”). Thus making them vulnerable to negative equity when a real estate downturn strikes.

So is negative equity a big problem? You tell me.

Homeowner equity as a percentage of household real estate in America has dropped to just 47.9% as of December 2007. That’s the lowest number on record.

Moody’s Economy.com estimates that 8.8 million homeowners — about 10.3% percent of all U.S. homes — will have zero or negative equity by the end of this month. Another 10-15 million households are at risk of becoming “upside down” if prices continue falling.

“It’s grim, and it’s going to get grimmer.”
- Michael Youngblood, managing director at FBR Investment Management Inc.

Before I go any further, I want to point out that most of these numbers are more than four months old now. In the last four months the real estate market has gotten much worse (along with the economy). The only current numbers is this screenshot from Washington Mutual.
Notice lines 5, 6, and 7.

The trends in homeowners going delinquent on their mortgages by more than 60 days, and ending up in foreclosure, is unmistakable.
So who are these homeowners? Would you be surprised to discover that they are not subprime homeowners? They are from a strata of mortgage borrowers known as Alt-A, which is one step above subprime. (In fact, 92.6% of the mortgage pool shown above was originally rated AAA.) It is this group that I want to examine today.

“The folks who say the housing market will stabilize anytime soon must be smoking some really strong stuff.”
- Dean Baker, co-director of the Center for Economic and Policy Research in Washington

First of all, let’s define what Alt-A is.

“Alt-A” loans, also called “nontraditional” mortgages, are typically offered to borrowers with credit scores between 620 and 700 and include interest-only loans, option ARMs, “no-doc” loans, those requiring little if any income documentation, and others.

In other words, Alt-A loans are where the mortgage lenders were their most creative in getting risky mortgage borrowers into homes they may, or may not, be able to afford. The option ARMs are a particularly bad problem.

According to a December 2006 Fitch Ratings report, almost 90 percent of people who got an Option ARM in 2006 used little or no documentation and more than 90 percent were suffering from negative amortization.

Industry insiders estimate at least 60 percent of Option ARM borrowers make only the minimum monthly payment. A Jan 22 issue of “Mortgage Strategist” a research note from investment bank UBS, estimated up to 80 percent pay the bare minimum.

“If you continue to make the minimum payments, a $600,000 loan can become a $750,000 loan within a couple of years,” Fiserv’s Dombrowski said. “You may have good credit, but now you’re in a trap.”

Negative amortization is an even worse condition than negative equity.

With falling house prices, selling is difficult for Option ARM holders as they would net far less than they still owe their lender — even supposing they can sell in a slow market.

As they owe far more than the house is worth and the market has been hit by a credit crunch, they also can’t refinance.

“People have no idea what we’re in store for. It’s going to get a hell of a lot worse.”
- Richard Bitner, mortgage analyst

So the next logical question is: How big is the Alt-A problem?

The best way to address that is to look at the raw numbers from the New York Federal Reserve (December 2007).

The best way to do this is to compare Alt-A numbers to subprime numbers. That way you have a reference.

Total subprime mortgages U.S.: 3,303,991

Average subprime balence U.S.: $180,872

Total subprime owner-occupied U.S.: 3,002,660

The significance of this number is to show that subprime borrowers were not speculators. Thus they are fighting to keep the roof over their head.

Percent subprime owner-occupied with at least one late payment in last 12 months U.S.: 37.6%

A huge percentage of them are having difficulty keeping current with their mortgage payments.

Total subprime with no or low documentation U.S.: 985,005

These are generally known as “liar loans”.

Total subprime with cash out refinance U.S.: 1,630,869

More than half of these mortgage borrowers immediately extracted cash from their homes. That makes it hard to sympathize with these people when they ask for a bailout.

Average subprime loan to value at origination U.S.: 84.93%

Almost all of the subprime loans in recent years were 100% mortgages, or something close to that. This makes them vulnerable to negative equity.

Now let’s look at Alt-A’s.

Total Alt-A mortgages U.S.: 2,384,592

Slightly smaller than subprime, but…

Average Alt-A balence U.S.: $299,117

Alt-A mortgages are nearly twice as large as subprime mortgages.

Total Alt-A owner-occupied U.S.: 1,722,861

Nearly 28% of Alt-A homes are not owner-occupied (aka speculators). Only about 9% of subprime loans aren’t owner-occupied. If you don’t live there you are much more likely to walk away from a home you can’t afford.

Number of Alt-A mortgages with a current payment U.S.: 1,499,030

This is a very scary number. This means that 37% of all Alt-A mortgages are delinquent. However, very few of them were delinquent by more than 60 days. Thus we are looking at the early stages of massive foreclosures in Alt-A’s.

Percentage of Alt-A with no or low documentation U.S.: 73.1%

Alt-A is the home of the “liar loan”, unlike subprime where less than 30% were liar loans.
Now put “liar loan” together with “speculator” and you get a witches brew of trouble.

Percentage Alt-A with cash out refinance U.S.: 38.2%

They didn’t extract their equity quite as fast as the subprime borrower, but a large percentage of them did.

Average Alt-A loan to value at origination U.S.: 89.85%

That means that even more Alt-A borrowers, nearly all of them, used 100% mortgages than subprime borrowers did.

Putting it all together

Most variable rate subprime mortgages were 2-28’s or 3-27’s. That means a two or three year “teaser” rate, then their mortgages get adjusted to market rates.
The variable rates for Alt-A mortgages were generally 3-27’s and 5-25’s. Thus the interest rate adjustments on their mortgages haven’t started hitting yet, unlike the subprime market.

So you tell me: when a bunch of large mortgage holders with liar loans on speculative homes they don’t live in, that are experiencing negative amortization, have their loans reset to much higher rates in a market with falling home values, what do you think they are going to do?

This should scare everyone here, because of the real estate and mortgage bond market is already on the scary edge of bankruptcy from the subprime mess. What will the Alt-A Crisis do when it hits?

I have uploaded the PDF version of Dr. Edwin Vieira’s speech at the recent GATA conference.

Dr. Vieira is likely the foremost expert on Constitutional Money in the entire United States. He holds four degrees from Harvard University, and has taken several cases to the Supreme Court and prevailed.

You can view Dr. Viera’s address at the GATA conference here: http://www.rapidtrends.com/downloads/edwinvieira-gata2008.pdf

As many of you know, the Gold Anti-Trust Action Committee (GATA) just had a conference in Washington DC. For those of you who follow GATA’s work, you know that they have accumulated an overwhelming body of evidence that points to the ‘management’ of the gold price.

I have had mixed feelings over the likelihood of such a conspiracy, and until I can prove something or at least be able to use available evidence to form an educated opinion I tend to dis-believe such things. However, one thing I can say after attending the conference this weekend, is that there are some very suspicious interactions on the part of the Fed, the Treasury, and the IMF when dealing with GATA.

Specifically, GATA has requested through the Freedom of Information Act, information that supports the governments’ claims of the current physical gold reserve of the United States. One thing that I find very curious is that to date the Fed, and Treasury have failed to produce any materials in response to this request.

Now, maybe I am just being cynical here, but I think most folks who have any common sense would agree that if the government does not want the public to have transparency into an issue, it is usually because it is being naughty, and there is something that they don’t want the public to know. For the life of me I cant see why there would be anything to keep secret, even if it is a National Security issue, unless of course the gold isn’t there anymore, in which case it would very well indeed be a National Security issue. Now of course if the gold IS gone, then it just supports GATA’s assertion that it has been used to suppress the gold price for decades.

I will recap what I got from each speaker in brief:

Dr. Edwin Vieira Jr., The Foremost Authority in the United States on Constitutional Money –

• Only a return to Gold and Silver can stabilize our currency.
• Desperate people start to ask questions, and shortly thereafter that, assign blame. If our politicians want a long and successful career ( or life ) they should be aware of this.

Reginald Howe, Golden Sextant Advisors LLC –

• Out of all commodities, gold is the one best suited for use as money
• The ‘gold price’, should actually be termed ‘exchange rate’ as with all currencies
• Central Banks are now lending gold at negative lease rates, effectively paying institutions to sell gold into the market
• Since the day the gold window has been closed, the Supreme Court has refused to hear any case challenging the current monetary system

James Turk, Goldmoney –

• The Chinese are indeed buying gold, using intermediaries and proxies to do so
• Chinese Proverb: Wisdom begins by calling a thing its proper name. Gold is not an investment, it is money.
• Do not put dollars into gold expecting a return, expect preservation of purchasing power. To get a return, it implies there must be a risk, and gold has held its purchasing power better than anything else in history.
• We are looking at huge problems, possibly as soon as this summer.
• Be prepared for Capital Controls in the US soon.

Peter George, Trinity Asset Management -

• Many hedge funds are having liquidity issues right now, when they see a bid, they are hitting it.
• It will take 10 years to bring new ultra-deep mining operations at 5000meters or deeper online.
• Since 1994 virtually all commodities have gone vertical and pulled away from gold.
• Goldfields has the largest un-hedged position in the WITS Basin, which holds an approximately 40,000 more tons of gold.
• Anglogold Ashanti is hedged $7Billion
• Barrick is hedged $9Billion
• Oil will go to $500 a barrel in time

Adrian Douglas, Market Force Analysis

• Gold is the investment opportunity of a lifetime.

John Embry, Sprott Asset Management –

• This is the best opportunity I have seen in 45 years in the investment business

In summary, by hearing views from almost every sector that touches the gold and silver markets such as mining, fund managers, analysts, attorneys, constitutional law experts, private bullion custodians, it appears obvious that there is indeed something fishy going on with the price of gold. The only players that affect the gold markets who didn’t have anything to say was the Fed, the Treasury, and the CFTC. How curious.

This is all fine and good of course, because I own gold and silver, so when this whole thing does come unglued and make the Enron scandal look like romper room on Paxil in comparison, some of us will be getting quite rich.

Got gold yet?

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Good afternoon my friends, this is a great article pointing out exactly the problem the US is facing, perhaps soon to be other western countries as well, and just goes to show you there is no time to sit on the duff allowing dust to collect.

Its a very good time to maximize our diversification of income and ‘buy low’ so we can ’sell high’ later. Notice the players buying gold right now? The top 5%. They are not the top 5% because they are stupid, they are the top 5% because they know when and where to put their money.

The flip side, who is selling their gold? The average person, which comes perfectly in line with what my mentor Simon Heapes always says: “the generationally wealthy always buy when the majority is selling, and sell, when the majority is buying”.

———————-

How long can the median US household hold out in this recession?
Eric Janszen, President iTulip, Inc.
April 15, 2008

,…We read every day about the credit crunch. As bank lending standards tighten along with the credit standards of credit card companies, households’ access to credit is declining. As the economy slows en unemployment rises, incomes fall as well.

How long can the median US household hold out in this recession?

Ready for this?

The median US household if deprived of credit due to tighter lending and income due to job loss has enough savings to finance 18 days of cash flow, down from 30 days in 2001.


Eighteen days of liquidity based on media household cash flow

You want to know, Who are the people in line selling their coins and jewels? Here is your answer: they are the North Americans whose real wages crashed at the end of 2007.

Trend of rising inflation and stagnant wages accelerated in Q4 2007

Of course they are selling gold and jewels! They’re in debt. They’re broke. Yet everything they buy, from gas to food – and now even the items they are used to getting from China for next to nothing – is getting more expensive.

Inflation Hedges: Who is buying and why?

Obviously, gold prices can’t go up if everyone is selling. Who is buying gold to drive prices up over $900 while the median household is forced to sell gold to raise cash?

The answer: hedge funds, mutual funds, ETFs, investment banks, and financial advisors whose clients are in the top 5% of the net worth group. While median real income growth turned negative last year as the chart above shows, if you dig deeper into the incomes numbers by wealth group you can see that of the real incomes of top 5% increased 16% while real incomes for the bottom 95% declined. Only the top 5% of income earners experienced real gains since 2005.

Wage inflation? Yes. But whose?

Conclusion

In the 1970s the lines around the block were North Americans buying gold and silver to protect their savings from the ravages of inflation. Today the lines are of sellers, not buyers. The tragic difference between the 1970s stagflation and today’s is that where the average North American had savings then to convert into gold and silver to protect, today after 25 years of debt-serf neo-feudalism they instead have debt. Yet all the Fed can do to fight the forces of debt deflation unleashed by the collapse of the housing and mortgage bubbles is to print money and allow the dollar to depreciate further.

Here is the combined result.

Household and business cash flow squeezed by inflation and falling demand

Anyone who expects anything but the equivalent of an economic face plant to result from the Dual Cycles of Demand Destruction is either a dreamer or an apologist for the system that created this mess. In a recent interview with Australian economist Steve Keen we were treated to a bold prediction that the only policy solution that will allow US households to pay down their debts is – ready? – a conscious monetary policy of wage inflation.

We are living through the final chapter in a story of misguided, ideology based economic policy that started in the early 1980s. The story of its dissolution has not and will not covered by the MSM. Tomorrow, April 9 at 3PM I will join Henry Blodget and Barry Ritholtz at the HedgeWorld/Reuters AdvicePoint event at the New York Athletic Club where I will explain to money managers why reading the FIRE Economy media is bad for your their client’s financial health. See you there.

Eric Janszen
Founder & President
iTulip, Inc.

————————

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