The following is an excerpt from an article written by Clyde C. Harrison of Brookshire Raw Materials. The reason I am sending this out, is because I have been yammering on about these trends for a while now, and Mr. Harrison has done an incredible job of stating more simply and eloquently what I have been blathering on about, but not quite so eloquently.

Summary of this of course is: The future is commodities, energy, and GOLD and SILVER. I just saw a Youtube of Ron Paul on CNBC saying we should abolish the Fed and shift back to a gold standard. I am not sure how realistic abolishing the Fed really is, although I do kind of like the idea. Shifting to a gold standard, well now we are talking. Do you realize that if you take the current M3 money supply, and divide it into the number of reported gold ounces the US Treasury owns, that it would make the price of gold $51,470 per ounce?

The worlds economies and societies have shifted back and forth from Fiat money to real money (gold and silver) in a cycle that repeats itself through history over and over, with no exceptions. The world is currently realizing (again), that Fiat isn’t all that wonderful. Whichever government shifts to a gold standard first, will end up with the worlds next reserve currency. Totally my opinion.

Here is an excerpt, my own emphasis added in bolds.

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The Financial Center of Gravity is Shifting

Don’t just look at the stars – be one

Clyde Harrison

Mar 24, 2008

Excerpt:

As the US moved from capitalism to socialism, many third world countries were moving toward capitalism.

Today, 1 billion people in the world, G-7, use two thirds of the world’s raw materials. Over 5 billion use the other third. Many are pursuing capitalism; China, India, Russia, Brazil and Vietnam. In China, to be rich is glorious. In the US, if you’re rich, you’re attacked. In China there is no capital gains tax and no corporate tax. Money and talent go where it’s treated well.

Today, it’s easier and cheaper to start and operate a business in China than in the land of the free, where we are free to pay tremendous federal, state and local taxes, free except for the mountains of regulations; like who you employ, how you pay them, how you operate your business all the way to what you do in your own home with your own children. Regulations are destroying jobs and creativity.

Is it any wonder that China is growing at 12% and America at 2%?

In my opinion, the raw material market, energy, agricultural and base metals are only in the second inning of a nine inning bull market.

30 years of restrained and neglected natural resource supply is being overwhelmed by demand. The lead times to create more supply are measured in years. Three billion people in emerging nations have discovered capitalism.

Capitalism is easy to understand, it’s nature with a balance sheet.

The difference is in nature. If you fail, you are eaten. Under capitalism you go broke. I like capitalism better.

Today, China is booming. They have declared the national bird to be the construction crane. In the last five years China went from exporting oil to the second largest importer in the world. The emerging market countries will go from walking, to bikes, to motorcycles, and to autos. They will need oil and gas, chemicals, forest products and metals. At $1.00 per hour they are deflating manufacturing costs, but as they become more successful, they will throw away their bicycles and buy motorcycles and eat better, increasing the demand for raw materials.

China and India are transforming their economies from poor agrarian nations to the newest industrial powers, replete with heavy industries, mass transportation and higher education. Rising from these giant new economies will come millions of new consumers, the very people who are already straining the natural resources of the earth.

In 1900, the US started to industrialize. We were using one barrel of oil per person per year. By 1970, we were using 27 barrels per person. In 1950, Japan started to industrialize, they were using 1 barrel per person. By 1970, they were using 17. In 1965, South Korea started to industrialize. They were using one barrel per person per year. By 2000 they were using 17. Today, China uses 1.3 barrel per person per year and India uses .7.

In 1950, Japan per capita income was 18% of the US, today it’s 96%. In 1965, South Korea’s per capita income was 16% of the US, today it’s 56%. India and China have 2.5 billion consumers, 9 times the US. The US uses 25% of the world’s energy, China and India use 8%. India and China have 280 people per car. The US has 2 people per car. Last year, China produced and sold the same number of autos as the US. Eighty percent were purchased with cash.

Real incomes are just beginning to rise to levels that create large demands for consumer goods. Between 1950 and 1970, Japan’s urban population increased 70%. Personal consumption increased 600%.

What is occurring today in China, which contains just over 1/3 of the citizens of the emerging nations: China currently is 40% urban, 60% rural. The US is 97% urban and 3% rural. China has 20% of the world’s population and 7% of the world’s land. China’s grain imports will grow from 14 million tones today to 57 million tones in 2020.

China was the largest economy during 27 of the past 30 centuries. China currently consumes 47% iron ore, 32% aluminum and 25% of the copper. China currently consumes 6 million barrels of oil per day. The US consumes 25 million barrels per day. China has almost five times the population of the US and will some day consume more oil than the US.

To date most of China’s growth has been on the east coast. 800 million Chinese live in rural China today and 40 million a year are moving to the city for the better life.

China wants to halt this migration by bringing the better life to the whole country. To accelerate this, they have a number of infrastructure construction projects in effect. All the projects are scheduled to be completed in 5 years.

$200 billion dollars for 500 power plants. They are currently completing 4 power plants per day.

$200 billion dollars for railroads to the west.

$30 billion for a 300 mph bullet trail between Shanghai and Beijing.

$65 billion for 97 new air ports.

$40 billion for subways in 15 major cities.

$300 billion for 10,000 miles of new expressways.

The $900 billion in construction in China will be paid for by US taxpayers, not out of their kindness to strangers, but in interest on the money we have borrowed from China. Now add Egypt, Russia, Brazil, Vietnam and you begin to understand why I started a raw materials fund.

The mergers of the giant producers today do not create one more ounce of supply. It won’t be long and they will be merging the junior mining companies. Years into this bull market, and still the cheapest place to drill for oil and mine metals is the stock exchange.

Today, 1 billion people consume two thirds of the world’s raw materials. 5.6 billion people consume the other third and they are becoming more successful. The industrial revolution involved 300 million people. The emerging nation revolution involves 3 billion.

There is no need to connect the dots, they over lap.

Lead times to create raw materials are measured in years. In Canada $80 billion in infrastructure has been committed to production of the tar sands. The goal is to produce 3 million barrels a day by 2015. At $85, oil is a bargain liquid. It costs 10% less than bottled water, it’s one third the cost of milk, one fifth the cost of beer and only 2% of the cost of Jack Daniels. TaTa, the Indian car company has produced a $2,500 automobile. Hundreds of thousands will be sold in the 3rd world. That demand will increase the price of a gallon of gas one dollar in the next three years because of increased demand.

Phelps Dodge is opening a new copper mine. It took 12 years of paper work to receive federal approval.

In China:

Company: “We found copper.”

Government: “Start digging. What can we do to help?”

Company: “We need a road.”

Government: “You got it.”

China’s growing at 12%, the US at 2%. Money goes where it’s treated well.

Currently oil companies who search for oil at great risk earn 9 cents per gallon. The US Government, at no risk, takes 51 cents per gallon.

The political systems of G-7 are at a great disadvantage, stuck with unfunded liabilities and debt. Current politicians are unwilling to cut spending growth. The Chinese have a 30 percent savings rate and 1.4 trillion US dollars to purchase real assets.

Demand for raw materials has increased. In many cases, the capacity to produce raw materials has declined dramatically in the last 20 years. Tops and bottoms are creatures of extreme. Markets rise above all expectation and then go higher and then fall further than common sense suggests. The most desirable investments for the future might not be in cyber space but back to the basics.

I believe we are only at the start of the largest bull market in history for raw materials.

By the end of this bull market, there will be a bounty on caribou, you will be able to see an oil rig from every beach and they will be digging a coal mine in Al Gore’s yard.

As you climb the ladder of financial success, check to make sure it’s leaning on the right wall. I believe raw materials will be one of the best investments for the next 10 to 15 years.

Clyde C. Harrison
Brookshire Raw Materials

Buy Gold and Silver Bullion

Alex’s notes: This is an outstanding article on inflation. Understanding what inflation truly is holds the key to understanding what is happening in our economy, and how wealth will be transferred to a select few over the next decade.

Inflation Is Baked Into the Cake
By David Galland
17 Mar 2008 at 03:45 PM GMT-04:00

STOWE, Vt. (Casey Research Advertorial) — The word “inflation” covers two different concepts, and it’s important to keep them separate. One concept is monetary inflation, which is when the supply of money increases faster than the supply of goods and services. The other concept is price inflation, which is an increase in the overall level of prices for goods and services.

The relationship between the two is the relationship of cause and effect. Monetary inflation causes price inflation. But while almost everyone sees price inflation when it happens, few people notice the monetary inflation that is causing it. And so they tend to blame the producers of goods and services for higher prices – rather than the money-creating government that is the true culprit.

And make no mistake, as government spending continues on a steep ascent, piling up debt, there is no question that the government has to continue creating money like there’s no tomorrow. This situation is not unique to the U.S. Quite the opposite: the adoption of fiat monetary systems is now universal.

The results of over three decades of unhindered monetary creation are increasingly being felt in a rising tide of price inflation, whether it be the 7.4% increase in producer prices reported by the U.S. in the most recent quarter, or the news just out of China that consumer price inflation now tops 8% and is worsening … or, in the most extreme example, Zimbabwe, where the utter lack of restraint by an insane dictator now burdens that economy with an inflation rate of over 100,000% annually.

The Casey Research Global Inflation Survey

To get a better sense of things, Casey Research recently conducted a survey of the world’s top 30 economies, broken down on a region-by-region basis. The snapshot below offers a glimpse at the big picture.

Commodities on the Rise

Most pundits focus on commodities as a central culprit in today’s higher price inflation. Why are commodity prices rising? There are many reasons, most importantly: supply and demand fundamentals, speculation and a weakening U.S. dollar, the “universal currency” in which oil, gold and many other commodities are priced.

Of those factors, supply and demand and speculation are fairly fluid. Which is to say they can vary over time based on politics (a threat to cut off oil sales by Venezuela, a war in the Middle East, legislation favouring biofuel production) or for more technical reasons (power shortages impacting mining in South Africa, or the shutdown of the Gulf of Mexico during a hurricane). This relatively short-term variability largely neutralizes the value of these factors as predictors of future inflation. Simply put: who can know the unknowable?

Instead, we look to longer-term trends. In that regard, two are apparent. The first has to do with the concept of “peak” commodities. While it has been Marion King Hubbert’s theory of Peak Oil that has received the most attention, credible arguments can also be made for peak metal (the dearth of major new discoveries), and even peak food. While these arguments have merit, they were beyond the scope of our survey, other than noting them as potentially rising in significance over time.

The second long-term trend is, in our view, of immediate consequence and worth a more detailed discussion: per above, the limitations and risks inherent in the fiat monetary systems now in universal favour around the world. It is this fiat monetary regime – the attempt to manage monetary policy based on flexible guidelines, and without the anchor previously provided by a gold standard – that we believe is the single most important driver of the rising price inflation now apparent around the world.

Losing Control

Simply, while the central banks of a handful of countries are (just) managing to contain inflation through restrained monetary and fiscal policy, the vast majority are finding the task politically inexpedient and are losing control. While we may point with some well-deserved derision at Mr. Mugabe’s comedic attempts to paper over his inflation with yet more paper, all nations are currently making the same errors, albeit at differing levels of failure.

To understand this point, we share a simple but accurate way of thinking about inflation as the result of too much money chasing too few goods. On that front, the chart just below paints a picture of the largely unfettered global growth in money since the early 1970s plotted against industrial production, a proxy for “goods” in their many varieties.

That chart begins to get under the hood of the problem, but one further view is necessary to understand what happened in the early 1970s that unleashed the tidal wave of money. The chart below presents a ratio of the above two measures, and includes a marker indicating President Nixon’s cancelling of the link between the U.S. dollar and gold in 1971 as the likely trigger. Once this anchor was removed, all that remained was a pure fiat monetary system.

While cancelling the gold standard was a U.S. policy decision, its impact was felt around the world. That is because of the historic Bretton Woods agreement struck between representatives of over 40 countries in 1944, as World War II came to an end.

Leveraging its position as “last man standing” following the devastating war, the U.S. pushed forward a wide-ranging set of agreements – the net result being that, from that point forward, the U.S. dollar would be the de facto global reserve currency, with all the nations of the world pegging their currencies to the dollar. New institutions, including the International Monetary Fund and the International Bank for Reconstruction and Development, were fathered at Bretton Woods, but they were nothing more than enforcers for the new regime, ensuring that the other countries stayed in line, buying and selling dollars as needed to maintain a stable peg.

For its part, the U.S. guaranteed gold convertibility at $35 “forever.”

But as is inevitable when dealing with governments, “forever” really means “for as long as it is politically expedient.” When it became inconvenient, in the late 1960s when the French under Charles de Gaulle decided that they’d prefer to have the gold, Nixon cancelled convertibility.

Once President Nixon cancelled that convertibility, which took effect in 1971, the world’s central bankers, left with no other immediately obvious or more viable alternative, continued using the U.S. dollar as a key component of their reserves. It also continued to be used in international trade, to price globally traded commodities, such as oil. Yet the end of gold convertibility represented a fundamental change; from that point forward the creation of U.S. dollars and, by extension, all of the world’s currencies, was restrained by nothing more than political expediency.

It is our contention that the size of the politically motivated governmental spending, spending which has no “hard” limiting factor or defined discipline, will continue apace and, in fact, significantly worsen due to compounding interest on government borrowing and the coming wave of irrevocable social commitments – on Social Security and Medicare in the U.S., for example. Against the backdrop of a global fiat monetary regime, the only limitation to government spending is that which the politicians believe will be politically unacceptable to a population. This is, generally speaking, no real limitation at all, given that the public is now apathetic about, and numb to, the real world implications of large numbers.

Inflation: Baked in the Cake

In light of the cause and effect between monetary inflation and price inflation, and given the clear findings in our “Global Inflation Survey,” we can only conclude that inflation in both its commonly understood forms is now baked into the proverbial cake.

As investors, that keeps us focused on gold, the world’s longest-serving form of money and an investment we have been profitably beating the drum about since 1999. Importantly, a quick scan now finds that gold is rising against a large number of currencies. This is a very useful view of the current inflation trend in that it demonstrates that the trend has expanded considerably beyond just a weakening U.S. dollar, and is now affecting fiat currencies around the world, almost without exception.

Are we seeing the end of the experiment in fiat monetary systems? It’s too early to say one way or another, but it’s not too late to shift at least some percentage of your portfolio into gold and, for leverage, gold shares.

© Casey Research, LLC. 2008

David Galland is the managing director of Casey Research. The above was excerpted from the Casey Research Global Inflation Survey. The full 38-page survey, which includes commentary by Casey Research Chairman Doug Casey and an interview on the inflation/deflation debate with Casey Research Chief Economist Bud Conrad, is available on request.

By Paul Craig Roberts
March 13, 2008

I’ve been watching the dollar die all my life. I sometimes think I will outlast it.

When I was a young man, gold was $35 an ounce. Today one ounce gold bullion coins, such as the Canadian Maple Leaf, cost more than $1,000.

Our coinage was silver. Our dimes, quarters, and half dollars had purchasing power. Even the nickel could purchase a candy bar, ice cream cone or soft drink, and a penny could purchase bubble gum or hard candy. If a kid could collect 5 discarded soft drink bottles from a construction site, the 2 cents deposit on the returnable bottles was enough for the Saturday afternoon movie. Gasoline was 32 cents a gallon. A dollar’s worth was enough for a Saturday night date.

Our silver coinage was 90% silver. People sometimes melted coins in order to make silver spoons, known as coin silver, which can still be found in antique shops. Except for the reduced silver (40%) Kennedy half dollar which continued until 1970, 1964 was the last year of America’s silver coinage. The copper penny departed in 1982. As Assistant Secretary of the Treasury, I opposed the demise of America’s last commodity money, but I couldn’t prevent the copper penny’s death.

During World War II (1941-1945), nickel was diverted from coinage to war, and the US mint issued a wartime silver (35%) nickel.

It is not easy to find items to purchase with today’s US coins, but the silver coins of the same face value still have purchasing power. The 10 cent piece of my youth contains $1.42 worth of silver at today’s silver price. The quarter is worth $3.55, and the half dollar contains $7.10 of silver. The silver dollar is worth 15.2 times its face value. These are just the silver values of coins that might be worth far more depending on condition and rarity. The silver in the wartime nickel is worth $1.10, which is 22 times the coin’s face value. Even the copper penny is worth 2.5 cents.

When I was a young man enjoying travels in Europe, the German mark or Swiss franc traded four to one US dollar. The euro, which is today’s equivalent to the mark or franc, costs $1.55.

People who haven’t accumulated much age have little idea of the corrosive power of “acceptable” inflation. Unlike gold and silver, fiat money has no intrinsic value. When money is created faster than goods and services it drives up prices, thus driving down the value of the money. If freely traded currencies are excessively printed or if inflation, budget deficits, and trade deficits drive currencies off their fixed exchange rates, prices of imports rise as the foreign exchange value of the currency falls.

Today the US, heavily dependent on imports, is subject to double-barrel inflation from both domestic money creation and decline in the dollar’s foreign exchange value.

The US inflation rate is about twice as high as the government’s inflation measures report. In order to hold down Social Security payments, the government changed the way it measures inflation. In the old measure, inflation measured the nominal cost of a defined standard of living. If the price of steak rose, up went the inflation rate. Today if the price of steak rises, the government assumes that people switch to hamburger. Inflation doesn’t go up. Instead, the standard of living it measures goes down.

This is just one of the many ways that the government pulls the wool over our eyes.

With the dollar value of the euro rising through the roof, today a vacation in Europe is far more costly than in the past. Thanks to China, so far Americans have been sheltered from the greatest effects of the dollar’s declining value. Our greatest trade deficit is with China. The prices of the goods from China have not risen, because China keeps its currency pegged to the dollar. As the dollar goes down, China’s currency goes with it, thus holding down price rises.

The resignation of Admiral William Fallon as US military commander in the Middle East probably signals a Bush Regime attack on Iran. Fallon said that there would be no US attack on Iran on his watch. As there was no reason for Fallon to resign, it is not farfetched to conclude that Bush has removed an obstacle to war with Iran.

The US is already over stretched both militarily and economically. An attack on Iran is likely to be the straw that breaks the camel’s back.

Paul Craig Roberts [email him] was Assistant Secretary of the Treasury during President Reagan’s first term. He was Associate Editor of the Wall Street Journal. He has held numerous academic appointments, including the William E. Simon Chair, Center for Strategic and International Studies, Georgetown University, and Senior Research Fellow, Hoover Institution, Stanford University. He was awarded the Legion of Honor by French President Francois Mitterrand. He is the author of Supply-Side Revolution : An Insider’s Account of Policymaking in Washington; Alienation and the Soviet Economy and Meltdown: Inside the Soviet Economy, and is the co-author with Lawrence M. Stratton of The Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice.

This letter was written by Warren Buffet back in January of 2004, but it is more applicable to today than ever. For those of us Americans wondering what the heck has happened, Mr. Buffet explains quite well what has occurred in simple terms.

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Squanderville versus Thriftville (Warren Buffet)

fortune ^ | oct 2003 | Warren Buffet

Posted on 01/07/2004 8:35:03 PM PST by dennisw

By Warren E. Buffett, FORTUNE

I’m about to deliver a warning regarding the U.S. trade deficit and also suggest a remedy for the problem. But first I need to mention two reasons you might want to be skeptical about what I say. To begin, my forecasting record with respect to macroeconomics is far from inspiring. For example, over the past two decades I was excessively fearful of inflation. More to the point at hand, I started way back in 1987 to publicly worry about our mounting trade deficits — and, as you know, we’ve not only survived but also thrived. So on the trade front, score at least one “wolf” for me. Nevertheless, I am crying wolf again and this time backing it with Berkshire Hathaway’s money. Through the spring of 2002, I had lived nearly 72 years without purchasing a foreign currency. Since then Berkshire has made significant investments in — and today holds — several currencies. I won’t give you particulars; in fact, it is largely irrelevant which currencies they are. What does matter is the underlying point: To hold other currencies is to believe that the dollar will decline.

Both as an American and as an investor, I actually hope these commitments prove to be a mistake. Any profits Berkshire might make from currency trading would pale against the losses the company and our shareholders, in other aspects of their lives, would incur from a plunging dollar.

But as head of Berkshire Hathaway, I am in charge of investing its money in ways that make sense. And my reason for finally putting my money where my mouth has been so long is that our trade deficit has greatly worsened, to the point that our country’s “net worth,” so to speak, is now being transferred abroad at an alarming rate.

A perpetuation of this transfer will lead to major trouble. To understand why, take a wildly fanciful trip with me to two isolated, side-by-side islands of equal size, Squanderville and Thriftville. Land is the only capital asset on these islands, and their communities are primitive, needing only food and producing only food. Working eight hours a day, in fact, each inhabitant can produce enough food to sustain himself or herself. And for a long time that’s how things go along. On each island everybody works the prescribed eight hours a day, which means that each society is self-sufficient.

Eventually, though, the industrious citizens of Thriftville decide to do some serious saving and investing, and they start to work 16 hours a day. In this mode they continue to live off the food they produce in eight hours of work but begin exporting an equal amount to their one and only trading outlet, Squanderville.

The citizens of Squanderville are ecstatic about this turn of events, since they can now live their lives free from toil but eat as well as ever. Oh, yes, there’s a quid pro quo — but to the Squanders, it seems harmless: All that the Thrifts want in exchange for their food is Squanderbonds (which are denominated, naturally, in Squanderbucks).

Over time Thriftville accumulates an enormous amount of these bonds, which at their core represent claim checks on the future output of Squanderville. A few pundits in Squanderville smell trouble coming. They foresee that for the Squanders both to eat and to pay off — or simply service — the debt they’re piling up will eventually require them to work more than eight hours a day. But the residents of Squanderville are in no mood to listen to such doomsaying.

Meanwhile, the citizens of Thriftville begin to get nervous. Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville.

At that point, the Squanders are forced to deal with an ugly equation: They must now not only return to working eight hours a day in order to eat — they have nothing left to trade — but must also work additional hours to service their debt and pay Thriftville rent on the land so imprudently sold. In effect, Squanderville has been colonized by purchase rather than conquest.

It can be argued, of course, that the present value of the future production that Squanderville must forever ship to Thriftville only equates to the production Thriftville initially gave up and that therefore both have received a fair deal. But since one generation of Squanders gets the free ride and future generations pay in perpetuity for it, there are — in economist talk — some pretty dramatic “intergenerational inequities.”

Let’s think of it in terms of a family: Imagine that I, Warren Buffett, can get the suppliers of all that I consume in my lifetime to take Buffett family IOUs that are payable, in goods and services and with interest added, by my descendants. This scenario may be viewed as effecting an even trade between the Buffett family unit and its creditors. But the generations of Buffetts following me are not likely to applaud the deal (and, heaven forbid, may even attempt to welsh on it).

Think again about those islands: Sooner or later the Squanderville government, facing ever greater payments to service debt, would decide to embrace highly inflationary policies — that is, issue more Squanderbucks to dilute the value of each. After all, the government would reason, those irritating Squanderbonds are simply claims on specific numbers of Squanderbucks, not on bucks of specific value. In short, making Squanderbucks less valuable would ease the island’s fiscal pain.

That prospect is why I, were I a resident of Thriftville, would opt for direct ownership of Squanderville land rather than bonds of the island’s government. Most governments find it much harder morally to seize foreign-owned property than they do to dilute the purchasing power of claim checks foreigners hold. Theft by stealth is preferred to theft by force.

So what does all this island hopping have to do with the U.S.? Simply put, after World War II and up until the early 1970s we operated in the industrious Thriftville style, regularly selling more abroad than we purchased. We concurrently invested our surplus abroad, with the result that our net investment — that is, our holdings of foreign assets less foreign holdings of U.S. assets — increased (under methodology, since revised, that the government was then using) from $37 billion in 1950 to $68 billion in 1970. In those days, to sum up, our country’s “net worth,” viewed in totality, consisted of all the wealth within our borders plus a modest portion of the wealth in the rest of the world.

Additionally, because the U.S. was in a net ownership position with respect to the rest of the world, we realized net investment income that, piled on top of our trade surplus, became a second source of investable funds. Our fiscal situation was thus similar to that of an individual who was both saving some of his salary and reinvesting the dividends from his existing nest egg.

In the late 1970s the trade situation reversed, producing deficits that initially ran about 1 percent of GDP. That was hardly serious, particularly because net investment income remained positive. Indeed, with the power of compound interest working for us, our net ownership balance hit its high in 1980 at $360 billion.

Since then, however, it’s been all downhill, with the pace of decline rapidly accelerating in the past five years. Our annual trade deficit now exceeds 4 percent of GDP. Equally ominous, the rest of the world owns a staggering $2.5 trillion more of the U.S. than we own of other countries. Some of this $2.5 trillion is invested in claim checks — U.S. bonds, both governmental and private — and some in such assets as property and equity securities.

In effect, our country has been behaving like an extraordinarily rich family that possesses an immense farm. In order to consume 4 percent more than we produce — that’s the trade deficit — we have, day by day, been both selling pieces of the farm and increasing the mortgage on what we still own.

To put the $2.5 trillion of net foreign ownership in perspective, contrast it with the $12 trillion value of publicly owned U.S. stocks or the equal amount of U.S. residential real estate or what I would estimate as a grand total of $50 trillion in national wealth. Those comparisons show that what’s already been transferred abroad is meaningful — in the area, for example, of 5 percent of our national wealth.

More important, however, is that foreign ownership of our assets will grow at about $500 billion per year at the present trade-deficit level, which means that the deficit will be adding about one percentage point annually to foreigners’ net ownership of our national wealth. As that ownership grows, so will the annual net investment income flowing out of this country. That will leave us paying ever-increasing dividends and interest to the world rather than being a net receiver of them, as in the past. We have entered the world of negative compounding — goodbye pleasure, hello pain.

We were taught in Economics 101 that countries could not for long sustain large, ever-growing trade deficits. At a point, so it was claimed, the spree of the consumption-happy nation would be braked by currency-rate adjustments and by the unwillingness of creditor countries to accept an endless flow of IOUs from the big spenders. And that’s the way it has indeed worked for the rest of the world, as we can see by the abrupt shutoffs of credit that many profligate nations have suffered in recent decades.

The U.S., however, enjoys special status. In effect, we can behave today as we wish because our past financial behavior was so exemplary — and because we are so rich. Neither our capacity nor our intention to pay is questioned, and we continue to have a mountain of desirable assets to trade for consumables. In other words, our national credit card allows us to charge truly breathtaking amounts. But that card’s credit line is not limitless.

Buy Gold and Silver Bullion

While there are a number of plausible reasons for gold stocks lagging of late, we have come to the conclusion that the true explanation reaches much farther into the past. It’s that the managements of the gold producers have only recently escaped the state of fear they operated under during gold’s 20-year bear market.

Consider: as recently as the year 2002, gold was still trading near $280. Against that number was a cash cost of around $250 per ounce for a typical company. That cost figure is about as low as the number could go, and it was the response of an industry beaten down and huddling in a trench.

Caution lingers after the reason for it has gone. As gold began its upward move in 2002, it did so against the backdrop of an industry still in mothballs and still run by managers whose primary skills were cost cutting and frugality. This is important on a number of fronts.

1) Having been trained in the acid bath of razor-thin margins, management was intensely skeptical about gold’s rally. They suspected it might be just another bear market trap, ready to punish unwary optimists who parted with cash to ramp up production.

2) In the hunkered-down years, miners focused on the higher-grade, easy-to-mine material that gave them the best shot at turning a profit, however small that might be. And being in survival mode, they were extremely cautious about buying new equipment or maintaining a large workforce. Employee rosters were reduced to the bare minimum.

3) Because staying in business was such an urgent goal, they were willing, even eager, to sell future production at a set price — a perfectly rational strategy in a bear market, because it at least assured they would receive a price that covered the known costs.

With all these factors taken together, it’s easy to understand why the industry was slow to respond when gold started rising. In fact, it was only in February 2003, with gold trending over $350, that Barrick Gold Corp., the world’s largest gold miner, began the expensive process of unwinding its hedges. And it wasn’t until November of that year that the company announced it would stop forward selling altogether and would eliminate its entire hedge book.

Once the turning point came – when management finally realized the bull market was for real — the industry began to scramble to catch up. Which, in a choo-choo industry like mining, means hiring and training lots of people, buying or refurbishing the equipment needed to reestablish production on second-tier deposits, upgrading facilities, building expensive new mills, etc., etc. And, of course, dealing with the challenge and expense of unwinding hundreds of millions of dollars worth of forward hedge contracts.

The rebuilding of the gold mining industry, in short, really only began in earnest over the past few years.

As would be expected, the costs associated with rebuilding the industry sent big hits to the bottom line, resulting in the kind of ugly financial metrics that repel institutional investors.

The metrics were not at all helped by the shift away from high-grade ore, because the lower the grade, the more the material you have to dig, hoist, haul and process, meaning increased production costs. In addition, the industry rebuild occurred against a backdrop of generally rising inflation and a falling dollar, which helped push the cash cost of production up by more than double from the mothball years, keeping the miners unattractive as investments.

By contrast, the base metals companies, which had hit bottom earlier, near the end of 1998, had already emerged from the mothball stage, thanks to increasing demand from China and elsewhere. They were, as a result, well on the road to recovery when the big price increases for base metals kicked off in 2004. So, while the gold miners have been widely shunned as ugly ducklings in recent times, the base metals sector has been enjoying salad days, reflected in multi-billion mergers and acquisitions and, of course, sharply higher share prices.

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Alex’s Notes: This is an excellent article. Richard Russel does an outstanding job of highlighting golds history, the way it has been de-monetized and swept under the rug of the American conciseness, and the way it is again rising to eminence.

This reminds me of what one of my mentors has said to me; “When the common man is buying, the generationally wealthy are selling, and when the common man is selling, the generationally wealthy are buying.” The wealthy have been buying gold and silver for a half dozen years, because they know where this is heading. One only need study the cycles of history to know what will happen. Short trends of two, four, even five years do not tell the story. But if you study gold over fifty years…a hundred….several thousand…a pattern will emerge that is shocking.

Gold will continue up, yes we will see sharp pullbacks, in fact those pullbacks will frighten a great number of investors out of their holdings just as they did in the last bull market, but the long trend here is going to be up. We have a long way to go until the Dow / Gold reaches parity. Exciting times indeed.
Russell: Gold, the great drama

Richard Russell
Dow Theory Letters
Mar 5, 2008

Extracted from the Feb 29, 2008 edition of Richard’s Remarks

The Great Drama Unfolds — Gold coins can be a bit difficult to handle. They are heavy, they are visible, and must be stored in a safe place. But for most people, gold coins (actual gold in one’s possession) has one great advantage — you’re not tempted to sell your coins on every decline or correction in gold. For this reason, many people have done better holding a smaller number of Krugerrands or American Eagles than have larger traders who have moved in an out of gold in an attempt to “beat the market.”

Some History — In January 1980 gold topped out at a price of 850 US dollars per ounce. Down goes gold — down and down, year after year until gold reaches a low of 256 in August of 1998.

There, despised and ignored, gold sinks to its historic bear market low. From its ignominious low of 256, a new primary bull market is born. But 28 years of decline has soured the US public on gold. If they are interested at all, they abide by the wise men of the government and the Federal Reserve. “Gold is history,” they are told. “Gold is a story whose time has past.” “Gold is a relic from another era, a useless metal used in fancy dentistry and in jewelry.

Under a cloud of disinterest and false tales, gold starts up again. Slowly, almost surreptitiously, gold rises to 300, then to 400, to 500 and 600. Nobody is interested. Some of the old gold mining stocks move higher. They pay no dividends. Nobody is interested in them. Names from the past appear and are taken over. Dome Mines, Homestake and Campbell Red Lake. Skeletons dancing into view and then disappearing.

Gold works its way still higher. A few people remember that gold is money, and they suggest that gold be purchased. But frequent sharp declines and occasional deep corrections frighten the early buyers of gold. They take their profits. Nevertheless, the metal reaches the 700s. A small group of admirers known facetiously as “gold-bugs” urge their followers to buy gold. “It’s cheap,” insist the gold-bugs, “gold is as cheap as dirt — buy it.”

Then, in January 2008, gold does the impossible. It breaks out above its old 850 peak-level of 1980. After 28 years of being held back, gold bursts is chains and breaks free. Gold pushes above 850 into space never seen before by the yellow metal. It’s like a prisoner who, having been held in a dungeon for 28 years, suddenly escapes from the darkness of his cell and emerges into the glare of sunlight.

Twenty-eight years of compression has been released. The advance above the 850 level is still quiet, almost eerie — but relentless. “It’s speculative nonsense,” growl the analysts, “it’s manipulation by a crazy element that is living in the past.” But gold continues to work higher. By February gold is nearing the thousand-dollar-an-ounce mark.

In the meantime, silver, the other monetary metal is pushing towards twenty dollars an ounce. Silver, that sold as low as 23 cents an ounce in 1932, is now selling close to twenty dollars an ounce. “Lowly silver at twenty bucks a pop, I don’t believe it.”

In the meantime, the US is dealing with an incredibly difficult situation. The nation is straining under the onus of a potential housing collapse. The new Federal Reserve Chairman, Ben. S. Bernanke, is fearful that the housing disaster will send the nation into recession and worse — deflation. Bernanke is well aware that the two thirds of US families own their own homes, and that consumer buying is responsible for 70 percent of the Gross Domestic Product of the US. On top of everything else, the great banks of the US are in trouble. Bernanke must save the banks and he must hold back the forces of deflation.

But good Lord, what about inflation? The Fed has made its decision. Their first task is to keep the US out of the grip of recession. This allows gold and silver to further express themselves. The lid is off 28 years of compression and imprisonment. The great bull market in precious metals pushes higher. In the background, twenty central banks from around the world print their fiat paper in an orchestrated effort to insure prosperity.

Meanwhile, the great gold bull has broken free of its chains. A strange and unprecedented union of forces has emerged. The US public is unaware of the great phenomenon that is playing out before their eyes. Somewhere ahead, the US public will enter the bull market. Will it be in 2008, in 2009, in 2010? The timing, as we might suspect, is known only to the mysterious gods of the market.

http://www.321gold.com/editorials/russell/russell030508.html

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On July 24, 1998, Alan Greenspan stood before the House Committee on Banking and Financial Services and said, “Central banks stand ready to lease gold in increasing quantities should the price rise.”

That is exactly what the gold carry trade consists of. It is the process in which central banks lease out gold bullion to be sold on the open market to suppress prices.

Here’s the thing: The large majority of these transactions take place on the London Bullion Market (LBM). This is an over-the-counter (OTC) market in which there is little-to-no transparency. A number of organizations have conducted studies on the amount of gold lending that takes place. Some of the organizations include Gold Fields Mineral Services (GFMS), the World Gold Council (WGC), and Virtual Metals (VM). As a result of the lack of transparency, the numbers reported in regard to gold leasing vary slightly from one another. For the sake of argument, I will be using the most conservative figures reported.

This may be the most significant piece of the gold bull puzzle that will push gold to $2,000 and beyond. I will dig in and share my in-depth research with you, starting with how the process is carried out, then going into the market impacts of the gold carry trade, and concluding with the future of the market for gold leasing.

How Does the Gold Carry Trade Work?

Gold leasing takes three different forms: direct leasing, central bank swaps, and forward hedging.

Direct Leasing

I am going to run through this in a simple step-by-step process. Central banks don’t directly take their bullion to the market and lease it out. They use a vehicle called a bullion bank (BB).

Although bullion banks are numerous, some of the more well known are Barclays, Goldman Sachs, JP Morgan, Bank of America, UBS, and Citibank.

The central banks loan gold to the BBs at a rate of approximately 1%. The BBs take it to the LBM and sell it on the open market. The BBs take the cash from selling the bullion and in turn buy Treasuries.

So if the story were to end here, the bullion banks would just walk away with a net 4% return. But it doesn’t end, because they only have the leased gold for a certain length of time. They eventually have to give the gold back to the central banks, but now they are at risk of price swings in a very volatile market.

The answer to their problem is to go long the futures market. Essentially, they buy futures contracts to hedge their risk. In other words, they secure gold for delivery at a specific price, on a specific date in the future. Once they buy their futures contracts, it doesn’t matter what the price action of gold is.

In a perfect scenario, after the gold lease rate and price risk hedging, the bullion bank will walk with a modest 1–2% gain. The central banks will receive a return on their gold, keep the price of gold suppressed in order to keep real inflation suppressed, and get a boost in the demand for Treasuries. It’s a win-win situation for both the bullion and central banks.

Gold Swaps

Gold swaps are very similar to direct leasing. The difference is that gold swaps usually take place between two central banks. These types of transactions occur in two different forms.

The first is very simple. Essentially, two central banks swap gold reserves and then carry out the action of direct leasing of each other’s gold. The reason for this is that it just adds more confusion for the accounting of the leased gold.

The second is slightly different. This transaction occurs when one central bank exchanges gold for currency with another central bank. Like gold leased to the BBs, a future date and price are set for the redelivery of the gold back to the initial central bank.

The IMF says of this type of gold swap, “Typically, both parties will treat the transaction as a collateralized loan.” Or the CB leasing the gold doesn’t remove the gold from its balance sheets, and the CB receiving the gold doesn’t add it to its balance sheet. As far as accounting goes, no transaction has even taken place. The gold market is flush with new supply and would beg to differ that a transaction hasn’t taken place.

In other words, the CB receiving the gold loans it out on the market while it is still on the balance sheet of the initial central bank. One might refer to this practice as double-counting the reserves.

Forward Hedging

Forward hedging is a form of gold leasing practiced by gold producers. The most famous of these is Barrick Gold, but there are many other producers who partake in forward hedging.

Forward hedging is when a producer presells gold on the spot market that has yet to be extracted from the earth. Most of the buyers want delivery of physical gold. So the producer leases gold from a CB, with the idea that it will pay the CB back with future production.

The problem is that these producers often sell their gold at suppressed prices on the spot market and they often sell more gold then they can produce.

On the note of Barrick, did I mention that it has recently been sued for price fixing and price manipulation of the gold market? Barrick and its bank JP Morgan have admitted to price manipulation and that they have worked with the central bank in this process.

Implications of the Gold Carry Trade

The gold carry trade has one main goal, and that is to add huge amounts of supply to the market in order to suppress the price of gold. Although there are other added bonuses along the way for the participants, the main reason for suppressing the price of gold is so the world doesn’t know the true value of worthless fiat currencies.

I would like to use some statistics to inform you as to the implications of gold leasing on the market for gold. Remember that I will use the most conservative numbers I could find.

In 2005, according to GFMS, gold leasing was estimated to have added 2,970 tonnes of supply to the market. In that same year, jewelry demand was 2,700 tonnes, world investment was 736 tonnes, and official central bank sales were 656 tonnes. Over the last 10 years, average mine production has run at an estimated 2,500 tonnes per annum. So the amount of leased tonnage exceeded all of the above-mentioned statistics.

Remember that central banks are not required to report at all on their transactions of loaned gold. So those 2,970 tonnes of extra supply were also counted in central bank reserves, or they were double-counted.

Central banks are the largest holders of gold tonnage, estimated to have around 30,000 tonnes. So they have loaned out approximately 10% of their total reserves.

How Long Can This Go On?

If you are looking at this in a practical way, you probably came up with the exact questions I did when I first started to read about the gold carry trade. When the gold enters the market via a BB, it all has to be bought back at the end of the lease contract. Doesn’t that put us back at square one with the amount of supply in the market negating any long-term implications?

The answer would be yes if there were just a couple of transactions. But there are several gold leasing contracts signed every day. All the supply is constantly being recycled in and out of the market and there is always fresh gold being leased into the market.

The length of a gold leasing contract can extend anywhere from one month to several years. This allows for the central banks to analyze these markets and best time their transactions and how long they will be, in order to suppress the price of gold.

So can this go on forever? Definitely not, and the implications of the gold carry trade coming to end will bring with it the most spectacular price actions ever seen in the gold market.

Let me tell you why the gold carry trade will not be sustainable forever. It’s very simple. All we have to do is look at the step where bullion banks have to buy back the gold sold on the spot market in order to pay back the central banks.

In order for this to be profitable for the BBs, the price of gold has to experience very limited gains during the time the gold is leased out. Or the price of the futures contract purchased by the BB has to be near enough to the price of gold when the bullion bank initially unloaded the leased bullion on the spot market. If the price of gold heads too high, it will not be profitable for BBs to partake in being the intermediary for such transactions.

All we have to do is look at the fundamentals for gold and we realize very quickly that the price of gold is definitely going to go higher one way or another, which will disallow future leasing in the gold market. You are probably well aware of the fundamentals: Every one of the major economies of the world printing money at a rate of over 10% per annum; the Mount Everest of debt from both budget and trade deficits; an inevitable recession here in the U.S.; the inability of the U.S. to raise interest rates, due to the complete mess of the housing market; rising energy costs putting downward pressure on the U.S. dollar and increasing inflation in every other aspect of the economy; mine supply at historic lows; a possible U.S. policy that would include trade protectionism against China; and, last, but definitely not least, a U.S. Federal Reserve whose main goal is to create credit by keeping interest rates below the rate of inflation (negative real interest rates).

Fundamentals are fundamentals, but there has been some action in the International Monetary Fund (IMF) recently on this very topic. Before I go any further, I just want to let you know that I don’t trust the IMF any further than I can throw it. And I don’t really expect any timely results from its actions. What is important is that the notion of the gold carry trade is coming forefront. Here’s what’s going on in the IMF.

Hidetoshi Takeda of the IMF’s statistics department recommended in early 2006 that all loaned gold be excluded from the central bank’s reserve figures. The IMF’s committee on reserve assets considered Mr. Takeda’s paper and came to the conclusion that a new definition of gold reserves excluding loaned gold needs to be officially documented. It also stated that unallocated gold loans should be disallowed. Nothing recommended in Mr. Takeda’s proposal was rejected. Full details of his report can be read here: http://www.imf.org/external/np/sta/bop/pdf/resteg11.pdf

The IMF continued its research regarding the issue and made another report with a similar conclusion. What does this all mean? Well, the IMF is currently working on another official proposal to be worked through the system making it necessary to make all loaned gold public information and to exclude loaned gold from reserve accountings. The IMF currently “encourages” central banks to record gold loans/swaps, but does not “require” the recording.

If everything goes perfectly, and I don’t believe that it will, we could see these actions implemented by the IMF at the end of 2008. As I said, it seems like a far reach, but the more people become aware of the gold carry trade, the sooner it will come to an end. And I don’t like to put my bets on the IMF to make progress with in the accounting of leased/swapped gold, but it DOES have the power to change how central banks report the reserve holdings of gold.

The eventual unwinding of the gold carry trade, whether it be from the IMF or just market fundamentals, will bring amazing action to the gold market. Remember that gold leasing didn’t begin until after the precious metals run from 1979–1980. For the bull market in gold to continue, it will need to overcome the barriers set by central banks’ leasing of gold. But when this does occur, the floodgates will open and we can expect to see the price of our favorite yellow metal skyrocket.

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U.S. Rep. Ron Paul, R-Texas, got the better of Federal Reserve Chairman Ben Bernanke in an exchange yesterday during a hearing of the House Financial Services Committee.

Paul observed that inflation is an increase in the money supply, and he quoted estimates that the U.S. money supply has been exploding lately — estimates Bernanke did not attempt to contradict. This explosion in the money supply, Paul said, is currency debasement that expropriates savers. He asked Bernanke how it could be justified.

Bernanke replied that the Fed’s statutory mandate is price stability rather than money supply.

Whereupon Paul cited the sharply rising Producer Price Index.

Bernanke answered that he prefers to go by the Consumer Price Index. (Maybe because it is more aggressively manipulated by the government?)

Paul countered that even the CPI has turned up sharply lately.

The best Bernanke could do was to acknowledge that the Fed is concerned about that — concern that seems likely to manifest itself shortly in a strange way, with more reductions by the Fed in official interest rates, pushing them even farther below official inflation and expropriating savers even more to rescue the banks and financial houses that lately defrauded the world with the Fed’s connivance.

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Problems In Credit Markets Continue:

February 21 – Financial Times : “Credit markets were thrown into fresh turmoil yesterday as the cost of protecting the debt of US and European companies against default surged to all-time highs. The sharp jump, which rivalled the market swing at the height of last summer’s credit shake-out, came as investors unwound highly leveraged positions in complex structured products. The move was in part prompted by fears of further unwinding as investors rushed to exit before conditions worsened. ‘There’s a domino effect taking place,’ said Mehernosh Engineer, credit strategist at BNP Paribas. ‘We are unwinding three years of excesses in the space of three days.’ The cost of insuring the debt of the 125 investment-grade companies in the benchmark iTraxx Europe rose by more than 20% to as high as 136.9 basis points… That compares with about 51bp at the start of the year.”

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This isn’t some unexplained phenomenon. Martians have not invaded the US Treasury. There are real, measurable reasons behind the dollars demise, and its not rocket science.

Many of you may not remember when gasoline was .25 per gallon. There was a time, if you do not remember or were to young to remember, that this was the case.

Some people think the value of gas has really gone up ten times since then, but has it really? Or is there some other, sinister power at work here?

Interestingly, when you could buy four gallons of gas for a dollar, we also had a very different type of money.

The USD once upon a time was ‘backed’ by gold and silver, which meant that you could take a ’silver or gold certificate’ (what our money used to be called) and hand it in at the US Treasury, the the Treasury was required to give you silver or gold for it.

Todays systems is very different. If you pull a dollar bill out of your pocket, and you look at the top, you will see that is says “Federal Reserve Note”. What does that mean? Well a note, in financial terms, is a promise to pay something of value at a later time. The question here is, pay what?

Today, if you took your Federal Reserve Note to the US Treasury, and asked them to give you ’something of value’ for your ‘Note’, what do you think would happen? They would probably call the police and have you carted off, is what would happen.

So back to the point of the article, why is the Dollar Collapsing in value? The answer is, that because the dollar is no longer backed by anything of value, then the government can create as much of it as it wants, as you can see by the chart below:

So what affect does this have on the Dollar’s Value? Well simply, whenever there is more of something it is worth less. One of the fundamental requirements of money is that it remains scare. If Dollars were as common as rocks lying on the ground, they wouldn’t be worth very much now would they?

We see this taking shape in the form of less demand for Dollars, all around the world. OPEC is in discussions of de-pegging from the dollar, oil producing nations are starting ask for payment in oil in currencies other than the dollar, China has indicated it intends to diversify is national reserves out of Dollars and into other assets, and you have Trillions of Dollars in newly created Sovereign Wealth Funds, whose sole purpose is to buy hard assets around the world with ’surplus’ Dollars before the Dollar becomes worthless. It has gotten so bad, in fact, that the Dollar, once honored and coveted in China, is now seen as your neighbors garbage.

It can’t be that bad, you say. Well actually, it can. The chart below shows how far the purchasing power of the Dollar has fallen since 1913 when we created the Federal Reserve System:

So if you think about it, its not that gasoline, food, real estate, vehicles, etc have actually gone up in value, perhaps its more like your dollars buy much less than they did even 4 years ago, so maybe it takes more dollars to buy the same thing?

So now that you have me really depressed you might ask, what the heck is the solution?

The solution dear reader lies in gold and silver. Gold has retained its purchasing power for thousands of years, while governments have messed with various currencies that go up and down in value. An ounce of gold thousands of years ago would clothe a man very well. Today, and ounce of gold will also clothe a man quite nicely.

If you really want to preserve your wealth, take a serious look and investigate gold.

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The Dow currently trades 13% below its all-time record high. For some further perspective into how the stock market is actually performing, today’s chart presents the Dow divided by the price of one ounce of gold. This results in what is referred to as the Dow / gold ratio or the cost of the Dow in ounces of gold. For example, it currently takes 12.9 ounces of gold to “buy the Dow.” This is considerably less that the 44.8 ounces back in the year 1999. When priced in that other world currency (gold), the Dow is in the midst of a massive eight year bear market!

Historically, a full cyclical bull run in gold (we are in one now, it started in 2000) is usually topped out  when the DOW/Gold ratio hits parity, or very close to it. In other words, the time to sell gold is either:

a) When the price of the dow comes down to match the price of an ounce of gold
b) The price of gold rises to meet the DOW
c) A combination of the two (most likely scenario).

For those thinking we are topped out in gold, we have a lot farther to run yet.

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Money Tales

A precious metal that’s not just an investment but a worldview too

By Rob Baedeker, Special to SF Gate

Last week, gold hit a record high of $958.40 an ounce. In 1959, the average price of gold was around $35 an ounce. That’s the year Burton Blumert opened his Camino Coin Company in Burlingame.

To the outside observer, it would appear that the rise of gold is a success story for long-time dealers and investors like Blumert and his clients. And in many respects it is. As Blumert told me on the phone from his home in El Granada, “I retired at the top of my game.” (After giving the Camino Coin Company to a long-time employee last year, Blumert, 79, stays peripherally involved, helping out occasionally when needed).

But there is, so to speak, another side to the coin. “If you want a dismal view of the future, talk to a gold dealer,” Blumert adds. The high price of gold may represent a handsome return on investment, but it’s hardly been a steady ascent, and for Blumert and other “goldbugs” it’s also an ominous sign.

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by Bob Chapman
The International Forecaster
Thursday, 18 February 2008

The following are some snippets from the most recent issue of the International Forecaster. For the full 20 page issue, please see subscription information below.

…

The Illuminati have a huge problem. They have buried it and no one in the media is talking about it, at least not in the correct order of magnitude. They are quaking with fear as they consider the possibility of this problem being unleashed. The problem lies in the Land of the Rising Sun, or should we call it the Land of the Sinking CDO. You have already heard the tripe about there being about $400 to $500 billion of CDO and other asset-backed derivative losses worldwide, and we have already shown you that these losses are way understated and that the delays in their recognition are downright fraudulent. We also showed you that total losses on asset-backed bonds and derivatives could be as much as $4 trillion in this past issue of the IF, and that does not include the tens of trillions in potential losses in credit default swaps and interest rate swaps. So why does Japan represent a potential ground zero for the biggest financial catastrophe of all time? You saw our previous report that of the $400 to $500 billion of potential losses admitted to so far, $150 to $200 billion of those losses may have Japanese banks as their “proud” owners. Yet we don’t hear a peep from Japan.

We have Citigroup, Northern Rock, SocGen, UBS, IKB, Merrill, JP Morgan, Morgan Stanley and many others from the US and Europe who have already written off over a hundred billion with sovereign wealth fund bailouts of 75 billion and some being on their way to partial or even total nationalization, but not so much as a hiccup emanates from Japan. Could it be that Japan is also undergoing a catastrophe somewhere along the lines of George Romero’s “Night of the Living Dead?” Well, if Japan has 30 to 40 percent of the paltry $400 to $500 billion that has been admitted to, what if they have 30 to 40 percent of the $4 trillion. That could wipe out their entire forex surplus, the largest in the world, and take the whole financial system down with it when it goes. Where’s the connection to the rest of the world financial system? You need look no further than the Ultimate Yen Death-Star. When the magnitude of these losses are finally grasped by the Japanese and foreign investors alike, the Nikkei isn’t just going to tank, it is going to be vaporized! And when all that liquidation occurs, guess what happens. Everyone sells their equities and corporate bonds and toxic waste and gets yen and Japanese bonds in return (along with truckloads of gold).

That will drive the yen and gold into the ozone and the carry trade and yen shorts into the deepest, darkest depths of Mordor! Your looking at a sub-100 yen and the biggest financial double-whammy of all time as the toxic waste ignites the Ultimate Yen Death-Star in a thermonuclear pyrotechnics display that will be remembered for millennia. The hapless Japanese bankers must be sick as they gather together to discuss these problems. This is not just about saving face. They are completely and utterly terrified! We suspect wakizashi short swords may be in short supply in the not too distant future. Sepuku anyone? All that liquidity, over a trillion dollars of carry trade bets, plus leverage, will be totally drained from the system in a matter of days, and stock markets worldwide would crash and burn like the Hindenburg. This would make 1929 look like a drop of water dripped into an Olympic-sized swimming pool. Oh, and incidentally, any sovereign wealth funds or other investors who try to bail out any of these banks, investment banks and bond insurers in Japan or anywhere else in the world is a first class moron. By the time this whole thing plays out, those who try to bail these flim-flam operations out may well never see so much as a penny of their investment back again. They may as well load 100 dollar bills into earth movers and then back them up and dump them into the cauldron of an active volcano for a crispy critter Crane confetti cookout! What idiots! How about buying billions in gold instead, knuckleheads?!

Silver and oil were the big performers this week and supported gold well as it yawned at the IMF news that its perpetual gold sale was on again. Spot silver went on a rampage to a new 27-year high of 17.60 on Tuesday after gold came close to testing its all-time high on Monday, hitting about 927, only $10 per ounce short of a breakout. Oil finished the week strongly by peaking out at 96.67 and settling at 95.50. Gold and silver will consolidate along with resource stocks in the near term and we see new records being set in the weeks ahead. And don’t forget that the IMF sales, even if approved, will not take place until well after this seasonal rally is over. Economic new is simply abysmal and precious metals are going to continue to shine under these circumstances. We note that some 3000+ contracts of February gold futures are still open as of Thursday’s close. Could it be that someone is holding out for delivery? We’ll have to see. That would be a nice test case of 10 metric tonnes. Large specs must seriously start to consider building cash to demand some physical delivery. Central banks are all insolvent. Their gold is parked and it ain’t goin’ nowhere. Let’s get radical!

The Fed’s interest-rate cuts last month have failed to lower borrowing costs for many companies and households. That means soon there will be one or probably two more ½% cuts.

Taxpayers should ask Congress why they are bailing out borrowers, lenders, investment banks, bank and brokerage houses who all committed fraud?

There are urgent proposals before Congress and the neocons for a bailout of the banking, investment banking and insurance industries. This would allow them to keep profits and lay off the losses on the public. There is more than $1 trillion in loses still to be accounted for. You can be sure our Parliament of Whores will sell us out again.

Market adjustments worldwide triggered by the real estate and CDO (Collateralized Debt Obligations) and SIV (Structured Investment Vehicle) collapse and the credit crisis has triggered the loss of $5.2 trillion – 50 of 52 share indexes worldwide ended January lower.

Wait until the investors and Wall Street see the write-offs over the next two years and the drop in earnings as a result. In January the Turkish market fell 22.7%; China 21.4%; Russia 16.1%; India 16%; Paris 12.3%; London 8.9% and New York was off 6%. Just under half of the major markets lost more than 10% of their value. The FTSE in London lost 9% and 16.5% over the past three months. Paris lost 15.3% over the past three months.

Published and Edited by: Bob Chapman
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Congressman Ron Paul
February 13, 2008

Madam Speaker,

I rise to speak on the concept of competing currencies. Currency, or money, is what allows civilization to flourish. In the absence of money, barter is the name of the game; if the farmer needs shoes, he must trade his eggs and milk to the cobbler and hope that the cobbler needs eggs and milk. Money makes the transaction process far easier. Rather than having to search for someone with reciprocal wants, the farmer can exchange his milk and eggs for an agreed-upon medium of exchange with which he can then purchase shoes.

This medium of exchange should satisfy certain properties: it should be durable, that is to say, it does not wear out easily; it should be portable, that is, easily carried; it should be divisible into units usable for every-day transactions; it should be recognizable and uniform, so that one unit of money has the same properties as every other unit; it should be scarce, in the economic sense, so that the extant supply does not satisfy the wants of everyone demanding it; it should be stable, so that the value of its purchasing power does not fluctuate wildly; and it should be reproducible, so that enough units of money can be created to satisfy the needs of exchange.

Over millennia of human history, gold and silver have been the two metals that have most often satisfied these conditions, survived the market process, and gained the trust of billions of people. Gold and silver are difficult to counterfeit, a property which ensures they will always be accepted in commerce. It is precisely for this reason that gold and silver are anathema to governments. A supply of gold and silver that is limited in supply by nature cannot be inflated, and thus serves as a check on the growth of government. Without the ability to inflate the currency, governments find themselves constrained in their actions, unable to carry on wars of aggression or to appease their overtaxed citizens with bread and circuses.

At this country’s founding, there was no government controlled national currency. While the Constitution established the Congressional power of minting coins, it was not until 1792 that the US Mint was formally established. In the meantime, Americans made do with foreign silver and gold coins. Even after the Mint’s operations got underway, foreign coins continued to circulate within the United States, and did so for several decades.

On the desk in my office I have a sign that says: “Don’t steal – the government hates competition.” Indeed, any power a government arrogates to itself, it is loathe to give back to the people. Just as we have gone from a constitutionally-instituted national defense consisting of a limited army and navy bolstered by militias and letters of marque and reprisal, we have moved from a system of competing currencies to a government-instituted banking cartel that monopolizes the issuance of currency. In order to introduce a system of competing currencies, there are three steps that must be taken to produce a legal climate favorable to competition.

The first step consists of eliminating legal tender laws. Article I Section 10 of the Constitution forbids the States from making anything but gold and silver a legal tender in payment of debts. States are not required to enact legal tender laws, but should they choose to, the only acceptable legal tender is gold and silver, the two precious metals that individuals throughout history and across cultures have used as currency. However, there is nothing in the Constitution that grants the Congress the power to enact legal tender laws. We, the Congress, have the power to coin money, regulate the value thereof, and of foreign coin, but not to declare a legal tender. Yet, there is a section of US Code, 31 USC 5103, that purports to establish US coins and currency, including Federal Reserve notes, as legal tender.

Historically, legal tender laws have been used by governments to force their citizens to accept debased and devalued currency. Gresham’s Law describes this phenomenon, which can be summed up in one phrase: bad money drives out good money. An emperor, a king, or a dictator might mint coins with half an ounce of gold and force merchants, under pain of death, to accept them as though they contained one ounce of gold. Each ounce of the king’s gold could now be minted into two coins instead of one, so the king now had twice as much “money” to spend on building castles and raising armies. As these legally overvalued coins circulated, the coins containing the full ounce of gold would be pulled out of circulation and hoarded. We saw this same phenomenon happen in the mid-1960s when the US government began to mint subsidiary coinage out of copper and nickel rather than silver. The copper and nickel coins were legally overvalued, the silver coins undervalued in relation, and silver coins vanished from circulation.

These actions also give rise to the most pernicious effects of inflation. Most of the merchants and peasants who received this devalued currency felt the full effects of inflation, the rise in prices and the lowered standard of living, before they received any of the new currency. By the time they received the new currency, prices had long since doubled, and the new currency they received would give them no benefit.

In the absence of legal tender laws, Gresham’s Law no longer holds. If people are free to reject debased currency, and instead demand sound money, sound money will gradually return to use in society. Merchants would have been free to reject the king’s coin and accept only coins containing full metal weight.

The second step to reestablishing competing currencies is to eliminate laws that prohibit the operation of private mints. One private enterprise which attempted to popularize the use of precious metal coins was Liberty Services, the creators of the Liberty Dollar. Evidently the government felt threatened, as Liberty Dollars had all their precious metal coins seized by the FBI and Secret Service this past November. Of course, not all of these coins were owned by Liberty Services, as many were held in trust as backing for silver and gold certificates which Liberty Services issued. None of this matters, of course, to the government, who hates to see any competition.

The sections of US Code which Liberty Services is accused of violating are erroneously considered to be anti-counterfeiting statutes, when in fact their purpose was to shut down private mints that had been operating in California. California was awash in gold in the aftermath of the 1849 gold rush, yet had no US Mint to mint coinage. There was not enough foreign coinage circulating in California either, so private mints stepped into the breech to provide their own coins. As was to become the case in other industries during the Progressive era, the private mints were eventually accused of circulating debased (substandard) coinage, and in the interest of providing government-sanctioned regulation and a government guarantee of purity, the 1864 Coinage Act was passed, which banned private mints from producing their own coins for circulation as currency.

The final step to ensuring competing currencies is to eliminate capital gains and sales taxes on gold and silver coins. Under current federal law, coins are considered collectibles, and are liable for capital gains taxes. Short-term capital gains rates are at income tax levels, up to 35 percent, while long-term capital gains taxes are assessed at the collectibles rate of 28 percent. Furthermore, these taxes actually tax monetary debasement. As the dollar weakens, the nominal dollar value of gold increases. The purchasing power of gold may remain relatively constant, but as the nominal dollar value increases, the federal government considers this an increase in wealth, and taxes accordingly. Thus, the more the dollar is debased, the more capital gains taxes must be paid on holdings of gold and other precious metals.

Just as pernicious are the sales and use taxes which are assessed on gold and silver at the state level in many states. Imagine having to pay sales tax at the bank every time you change a $10 bill for a roll of quarters to do laundry. Inflation is a pernicious tax on the value of money, but even the official numbers, which are massaged downwards, are only on the order of 4% per year. Sales taxes in many states can take away 8% or more on every single transaction in which consumers wish to convert their Federal Reserve Notes into gold or silver.

In conclusion, Madam Speaker, allowing for competing currencies will allow market participants to choose a currency that suits their needs, rather than the needs of the government. The prospect of American citizens turning away from the dollar towards alternate currencies will provide the necessary impetus to the US government to regain control of the dollar and halt its downward spiral. Restoring soundness to the dollar will remove the government’s ability and incentive to inflate the currency, and keep us from launching unconstitutional wars that burden our economy to excess. With a sound currency, everyone is better off, not just those who control the monetary system. I urge my colleagues to consider the redevelopment of a system of competing currencies.

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http://www.house.gov/paul/congrec/congrec2008/cr021308h.htm

Through your gas tank into the hands of the United Arab Emirates.

From Mish’s Blog:

Dubai in 1990

The same street in 2003

Dubai 2007

Dubai is said to currently have 15-25% of all the world’s cranes.

The Dubai Waterfront.

When completed it will become the largest waterfront development in the world.
All of this was built in the last 5 years.

The Palm Islands in Dubai

New Dutch dredging technology was used to create these massive man made islands. They are the largest artificial islands in the world and can be seen from space. Three of these Palms will be made with the last one being the largest of them all.

The Palm Islands in Dubai

Upon completion, the resort will have 2,000 villas, 40 luxury hotels, shopping centers, movie theaters, and many other facilities. It is expected to support a population of approximately 500,000 people. It is advertised as being visible from the moon.

The Palm Islands in Dubai

The World Islands

300 artificially created islands in the shape of the world.
Each island will have an estimated cost of $25-30 million.

The Al-Arab hotel in Dubai

The worlds tallest hotel. Considered the only ‘7 star’ hotel and the most luxurious hotel in the world. It stands on an artificial island in the sea.

Hydropolis, the world’s first underwater hotel

Entirely built in Germany and then assembled inDubai, it is scheduled to be completed by 2009 after many delays.

The Burj Dubai

Construction began in 2005 and is expected to be complete by 2008. At an estimated height of over 800 meters, it will easily be world’s tallest building when finished. It will be almost 40% taller than the the current tallest building, the Yaipei 101.

Downtown Dubai rendition 2008-2009

More than 140 stories of the Burj Dubai have already been completed. It is already the worlds tallest man made structure and it is still not scheduled to be completed for at least another year.

The Al Burj

This will be the centerpiece of the Dubai Waterfront. Once completed it will take over the title of the tallest structure in the world from the Burj Dubai.

The Burj al Alam or The World Tower

Upon completion it will rank as the world’s highest hotel. It is expected to be finished by 2009. At 480 meters it will only be 28 meters shorter than the Taipei 101.

The Trump International Hotel & Tower

The Trump Tower will be the centerpiece of one of the palm islands, The Palm Jumeirah.

Dubailand

Currently, the largest amusement park collection in the world is Walt Disney World Resort in Orlando, which is also the largest single-site employer in the United states with 58,000 employees. Dubailand will be twice the size. Dubailand will be built on 3 billion square feet (107 miles) at an estimated $20 billion price tag. The site will include a purported 45 mega projects and 200 hundred other smaller projects.

Dubailand Rendition

Dubailand Site Location

Dubai Sports City

A huge collection of sports arenas located in Dubailand.

Currently, the Walt Disney World Resort is the #1 tourist destination in the world. Once fully completed, Dubailand will easily take over that title since it is expected to attract 200,000 visitors daily.

The Dubai Marina

The marina is an entirely man made development that will contain over 200 highrise buildings when finished. It will be home to some of the tallest residential structures in the world. The completed first phase of the project is shown.

Most of the other high rise buildings will be finished by 2009-2010. The Dubai Mall will be the largest shopping mall in the world with over 9 million square feet of shopping and around 1000 stores.

Ski Dubai

Ski Dubai already open, is the largest indoor skiing facility in the world. This is a rendered image of another future indoor skiing facility that is being planned.

Some of the tallest buildings in the world, such as Ocean Heights and The Princess Tower, which will be the largest residential building in the world at over a 100 stories, will line the DubaiMarina.

Other Facilities (Not Shown)

The UAE Spaceport would be the first spaceport in the world if construction ever gets under way.

The Dubai Metro system will become the largest fully automated rail system in the world.

The Dubai World Central International Airport will become the largest airport in size when it is completed. It will also eventually become the busiest airport in the world, based on passenger volume.

There are more construction workers in Dubai than there are actual citizens.

Disclaimers and Credits

This amazing set of images came from a reputable source. It is impossible to know if any have been doctored in Photoshop but a check on Snopes shows these are likely to be the real deal. Obviously some are artists renditions.

Snopes Check

Ski Dubai Snopes

Infinity Tower Snopes

Solid Silver Car Snopes

Not solid silver but it sure looks like it.

Sky Tennis Snopes

Andre Agassi plays sky tennis

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I keep yammering on about inflation, because there are alot of bozo’s our there (see: Market Analysts) who keep telling people to trade in FOREX. Heres the deal, if there is a ship in the center of a fleet of ships and it is sinking in inflation (picture the USA), and there are a bunch of other ships around it and they are sinking as well, then it doesnt matter which ship the rats jump to, its still going down the crapper!

The only solid ground right now is in commodities! Gold, Silver, Energy, and Food. 15 year run.

The United States is the center of the deflationary economic slowdown, inflation is more of a worldwide phenomenon. Inflation rates in China, for example, are higher than they are in the United States. Prices of apartments in Buenos Aires…subway tickets in Paris…hamburgers in Singapore – everything is going up.

In the past, inflation has always had a national identity card. The inflation of the ‘20s was concentrated in Germany, where hyperinflation wiped out the middle class and set the country on the road to ruin. Investors…like Jewish refugees 10 years later…had to move their savings to France or England to escape it. Likewise, in Argentina, the inflation of the ‘80s was easily avoided – just put your money in a Miami bank.

Traditionally, the dollar was a haven for people wishing to protect themselves from inflation – even though the dollar itself was losing value rapidly . In 1935, a U.S. dollar had about the same purchasing power as a U.S. dollar from 1800. Then, it began a steep decline…erasing 95% of its value over the next 70 years. Still, people with money usually preferred to keep their money in dollars, rather than in…say…australs or zlotys. The dollar may have been losing value, but at least it was doing so in a gentle, “controlled” manner.

But times have changed. Now, there’s a new kind of inflation – it is practically everywhere…in every country…and it risks spinning out of control. That is why gold is hitting new highs – against almost every currency…and every other market…in the world.

News came yesterday, that the Fed has quietly lent some $50 billion to member banks using a new method – an “auction facility” that allows banks to put up unconventional collateral. The government no longer reports a figure for M3, the broadest measure of the money supply, but shadow analysts say it is going up at 15% per year – about six times faster than GDP growth.

Most of this money ends up outside the United States. That’s where most U.S. Treasury debt ends up too. The dollar is America’s leading (and highest margin) export. This has forced foreign central banks to create more of their own currencies to buy up the dollars; otherwise they would face a competitive disadvantage, in that the dollar would fall against their local currencies, making their exports more expensive on the world market.

And so, the whole world is being smothered in paper. Paper dollars…paper euros…paper rand…paper cordobas…paper money of all sorts. Where can the investor go to get away from this paper? What can he buy to protect himself from inflation? How can he get some air?

That’s right. Gold. And it’s why this bull market in gold could be even bigger than the last one. Then, in the late ‘70s, it was primarily the U.S. dollar that suffered from inflation…and primarily Americans, and perhaps Arab oil exporters, who were buying gold. The Russians were still building cars that didn’t run. The Chinese were still recovering from their Great Leap Forward of the ‘60s and dismantling their backyard steel mills. And the Indians weren’t even awake yet.

Now, the whole world is different. It is full of more paper money than ever before…and full of billions of alert people who will want to protect themselves from it. They might try stocks…or property…or Rembrandts…but traditionally, the surest, simplest solution is gold.

For those of you out there thinking that the yellow metal is too expensive to buy now, you are halfway right. But youre a smart cookie, and you will see a good opportunity for what it is. Get a FREE Beginners Guide to Gold and Silver Investing, and register to receive a crash course in why some people will benefit while others are losing their shirts, and a little known secret on how to seriously cash in on gold.

Jeremy Grantham says he thinks housing prices in the United States will go down 20% to 30% from their peak. That’s a potential loss to Americans’ implied wealth of as much as $6 trillion. This is part of what leads Financial Times columnist Martin Wolf to describe the coming slump in the United States as the “mother of all meltdowns .”

Wolf refers to the work of New York University economist Nouriel Roubini, who argues that the housing decline will put 10 million homeowners upside down, with more mortgage than house. It will lead to collapsing credit…defaults…and huge losses to lenders. It will also bring about a big cutback in consumer spending and unavoidably push the United States into a deep recession.

One of the wild cards of the doomsday scenario is the performance of the derivatives market. No one knows exactly what is in some of these instruments…and no one knows how they will hold up in a crisis.

One thing we do know here at The Daily Reckoning is that they will not hold up as expected. We know that because the assumptions behind them were, fundamentally, nonsense. The most sophisticated mathematical model in the world is not worth a campaign promise if the theory behind it is wrong. And the idea that you can model future prices on the basis of past prices with any predictive reliability is simply wrong. Speaking loosely, it is the problem noticed by Heisenberg when was trying to observe and measure atomic particles at the same time…or ethnologists when they are watching savages gootchy goo. The act of observation causes distortions. As soon as you notice “stocks outperform bonds over the long-term,” for example…you cause a distortion in the stock market. People buy stocks, expecting better performance. Buying drives up prices. Then, higher initial prices bring lower rates of return over the long run.

Using Black-Scholes pricing model…and other sophisticated tricks…the salesmen proved that they could produce higher yields with lower risk. The models, of course, depended on the future being like the past. But never before had investors been offered such opportunities to distort the price curve!

The derivative market exploded in the 2001-2006 period, with annual rates of growth (from memory) of nearly 100%. But then, subprime debt blew up…and buyers started asking questions. In 2007, the derivatives market fell apart. And so far this year, new derivative sales are off 93% from the year before. CDOs, SIVs, Monolines…they’ve all had big trouble.

“Many CDOs could be worth less than 5 cents on the dollar,” Strategic Short Report ’s Dan Amoss tells us. “Final values won’t be clear until the loans supporting these securities go through the default and recovery process.

“Many Wall Street firms cannot simply confess their final losses, because delinquencies have just started picking up from generational lows. Also, these firms may soon discover that the insurance covering defaults of their CDO holdings is worthless.”

And now comes the Financial Times with more trouble. “CPDOs are at risk,” say the FT . What are CPDOs, we had to ask? They are Constant Proportion Debt Obligations…a kind of derivative on a derivative…a bet on the derivative index.

Not knowing anything about them ourselves, we turn to someone who does for an opinion:

“If these [structured products] do get unwound en masse, the effect on the market will be horrible,” said credit strategist Barnaby Martin at Merrill Lynch. “Between $1,000bn and $2,000bn of synthetic CDOs have been issued over the last four years. Any unwinding will likely be crammed into a much shorter time period.”

Bottom line is, we have a ways to go before its all clear, and when ships cant see the harbor through the fog, smart captains buy Gold and Silver.

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Alex’s Notes: Ok, one more quip about inflation and then Ill stop. For today.

• The People’s Bank of China is rumored to want money-supply growth of 15% per year, down from the current 18% plus;
• India’s broad M3 money-supply is rising 22.4% per year;
• Singapore’s money-supply increased by 14% in 2007;
• Britain’s broad M4 measure of money has expanded by 12.3% since Jan. ‘07;
• Western Europe is “enjoying” monetary inflation of 11.5% per year, three times the central bank’s target;
• Last year saw 16% money-supply growth in Australia, 13% in Canada, and 22% in Saud Arabia;
• The US money-supply – if the Fed still reported M3 – is now guess-timated to be showing 15% annual expansion.

An excerpt from: http://www.dailyreckoning.com.au/inflation-recession/2008/02/11/

Buy Gold and Silver Bullion

My first attempt at Scathing Satire (I hope I don’t spoil the effect!)

Silver Stock Report
by Jason Hommel, February 14, 2008

On this Valentine’s day, let us remember and pay a tribute to all people who love the Government, and while we are at it, let’s pay tribute to the Government itself by buying a T-Bill!

Thank goodness most of America and the rest of the world still loves the Federal Government of the United States and the Federal Reserve enough to continue to hold about $30 trillion worth of bonds that are paying, on average, about 5% while inflation is about 17%.

Such Fed-loving bond holders clearly approve of all the spending habits of the United States government, by their actions of holding bonds, and willingness to lose 12% of their capital per year, and must fully approve of the institution known as the Federal Reserve.

Surely, their willingness to sustain a guaranteed loss of 12% of their capital each year shows their utmost support of the government and Federal Reserve.

Bondholders’ loyal support is all the more evident given the clear alternative of owning gold, which has risen for 7 years in a row, and 36% this last year. Let us also not forget their staunch and fervent willingness to overlook silver, which has risen in price for 5 years in a row, and which went up 24% in the last year.

Clearly, the people’s willingness to sustain such losses, and avoid such gains in the precious metals, goes to show the unwavering support of the actions of the Federal government, the approval of all Federal tax rates, the war on Iraq, and continual rejection of that antiquated document known as the Constitution.

For how else could the U.S. government pay for all that it does not take in through taxes, except through the willingness of the people and other nations to finance the deficit spending?

The U.S. government should also thank the Chinese central bank, the Japanese central bank, and all other central banks that hold U.S. treasury obligations, for their similar commitment of monetary support for all U.S. policy decisions. We can forget what other nations say when they criticize, because we all know that actions speak louder than words, and by their actions of holding U.S. Treasury bonds, they clearly support the U.S. government’s actions.

Clearly, the people who have held silver from $5/oz. to $17/oz. don’t know what they are doing. They sit around wearing tin foil hats, and discuss conspiracy theories. Surely, the bulk of them never went to college, nor could they find any real jobs, which is why they sit on silver. Yes, they must also hate mankind for failing to invest in real businesses that could create jobs and more tax revenues; and instead, they hoard their wealth to themselves like greedy misers.

Yes, silver investors must be fools for holding real silver. It’s just so economically backwards to invest in physical silver, when you could, instead, buy paper futures contracts which promise to deliver silver in the future at some fixed time and price, which allows potential silver investors to make so much more money by putting down only a fraction of the amount to control so much more silver, and earn so much more money using the wonders of modern finance to leverage the gains. Surely, there is no risk involved in going long futures contracts in a consistently rising market of silver prices, and certainly no risk of a delivery default, as the markets are regulated by consumer watchdog organizations like the Federal Government’s Commodities Futures Trading Commission (CFTC).

There has never been a delivery default in the past in silver at the NYMEX, and so, there clearly could never be on in the future either, despite the fact that the silver market has the highest concentrated short position, higher than in any other commodity.

Also, the integrity of the silver futures market is beyond reproach, because they have measures in place to limit delivery of physical silver to no more than 1.5 million ounces of silver in any single delivery month, which will prevent any major market defaults or disruptions to trading activity by paper longs who foolishly insist upon excessive delivery of the real product.

Further, as each individual trader is limited to holding no more than 1500 futures contracts in silver, which is 7.5 million ounces, the market regulators are poised to prevent any manipulation of the silver prices by any foolish and unpatriotic billionaires who attempt to corner the market in silver.

Finally, if any trader tries to buy more than 150 contracts in silver, their identity must be made known, so that the world’s most trusted and respected government can determine who is foolishly trying to corner the silver market.

Of course, what fool would do the foolish work of buying unleveraged silver and doing the heavy lifting, and risky and expensive storing of silver, when they can contract out that “dirty work” by buying the silver exchange traded fund, (ETF), SLV instead, so much more easily by pushing a few buttons on a keyboard by using any standard online brokerage account? There’s certainly no risk of broker failure, or the ETF sponsor failure, or custodian failure, or sub custodian failure, not in silver. And while the silver EFT charges a fee for their services of lifting, storing, and securing people’s silver for them, they certainly earn their keep by keeping full control of that silver within the major banking system.

Finally, if anyone were so foolish as to be disloyal to the current empire and actually try to buy real silver, they will likely be stonewalled by all the loyal major brokerage houses, who will convince them of the futility of trying to buy silver. After all, the customer can be told that the spread between the bid and ask prices is too wide to be safe, let alone make a profit, and the commissions are too high for the customer, and too low for the broker to even bother with. Besides, customers can always be scared away from silver by mentioning mysterious and unquoted “assay” fees, and “shipping” fees, and “handling” fees. And if they can’t be convinced by their full service broker, to avoid buying silver, then the brokerage house can sell them silver certificates, or “unallocated” or even “allocated” silver, in addition to charging them storage fees!

And, of course, you can no longer get silver from any bank, not since silver ceased from being circulating coinage years ago.

True, there are U.S. Silver eagles, but they only mint about 10 million ounces per year of those, which is negligible in terms of modern finance; so if anyone tried to corner that market, the U.S. government would be well on to such unpatriotic trickery.

And yes, there is that somewhat unregulated network of coin shops around the nation, but that rag tag group of misfits couldn’t finance their way out of a paper bag to support a run on silver. Besides, that group proves its usefulness to the establishment by buying more silver from the public than they sell to the public, and dumping the excess back to the refineries to be wisely used by industry, so there’s no danger of a paper monetary collapse being fomented among that “outlet” of silver and gold.

Yes, the U.S. financial system is perfectly fine. There is no risk of financial collapse, nor any need to worry about any dollar decline, since the people trust the U.S. more than any other system, and any other thing. Besides, any significant dollar decline would make U.S. exports cheaper, which would be a great boost to the U.S. economy, which would, in turn attract further investment into the freest and most prosperous nation on earth, which, of course, would support the dollar, and thus keep anything bad from ever happening.

Yes, that’s why I’m unemployable. I’m just not good enough at lying to write such nonsense to support the nonsense of the current empire.

Mostly Insincerely (but if you know how to read between the lines, you know that I’m very sincere about all of the facts mentioned above),

Jason Hommel

Beginners Guide to Gold and Silver Investing – Free

by Doug Noland

For the week, the Dow dropped 4.4% (down 8.2% y-t-d) and the S&P500 fell 4.6% (down 9.3%). The Transports declined 2% (up 3.1%), and the Morgan Stanley Cyclical index sank 5.5% (down 7.1%). The Morgan Stanley Consumer index declined 2.3% (down 7.6%), and the Utilities slipped 3.1% (down 8.3%). The small cap Russell 2000 fell 4.3% (down 8.8%), and the S&P400 Mid-Caps declined 3.6% (down 7.5%). The NASDAQ100 dropped 4.4% (down 14.9%), and the Morgan Stanley High Tech index sank 5.1% (down 14.6%). The Semiconductors were hammered for 7.9% (down 14.3%). The Street.com Internet Index fell 4.5% (down 11.4%), and the NASDAQ Telecommunications index was hit for 4.4% (down 12.1%). The Biotechs dropped 4.5% (down 7.6%). The rally in financials reversed abruptly. The Broker/Dealers sank 8.1% (down 6.1%) and the Banks 8.4% (down 0.7%). Although Bullion was up $17.50, the HUI Gold index declined 1.7% (up 8.4%).

Three-month Treasury bill rates rose 9 bps this past week to 2.22%. Two-year government yields sank 13 bps to 1.93%. Five-year T-note yields declined 5.5 bps to 2.685%, while ten-year yields rose 5 bps to 3.64%. Long-bond yields jumped 11 bps to 4.42%. The 2yr/10yr spread ended the week at 167 bps. The implied yield on 3-month December ’08 Eurodollars sank 16 bps to 2.36%. Benchmark Fannie MBS yields jumped 12 bps to 5.20%, this week under-performing Treasuries. The spread on Fannie’s 5% 2017 note widened 3 to 56 bps and Freddie’s 5% 2017 note widened about 3 to 57 bps. The 10-year dollar swap spread increased 3.2 to 66.5., the highest level since year-end. Corporate bond spreads were wider, with an index of junk bonds this week 16 wider.

Investment grade issuance included Verizon $4.0bn, Wachovia $3.5bn, United Health $3.0bn, Kinder Morgan $1.45bn, Sysco $750 million, Ace Ina Holdings $300 million, and Ecolab $250 million.

Junk issuance included Forbes Energy $205 million.

Convert issuance included AAR Corp $225 million, Chiquita Brands $200 million, and Radisys $55 million.

Foreign dollar debt issuance included British Sky Broadcasting $750 million.

German 10-year bund yields declined 5 bps to 3.86%, while the DAX equities index declined 2.9% (down 16.1% y-t-d). Japanese “JGB” yields dipped one basis point to 1.415%. The Nikkei 225 sank 3.6% (down 15% y-t-d and 24.7% y-o-y). Emerging equities markets were weak, while debt markets were weaker. Brazil’s benchmark dollar bond yields surged 30 bps to 5.99% (high since September). Brazil’s Bovespa equities index fell 2.0% (down 7.5% y-t-d). The Mexican Bolsa dropped 2.3% (down 4.8% y-t-d). Mexico’s 10-year $ yields rose 11 bps to 5.23%. Russia’s RTS equities index sank 5.0% (down 18.3% y-t-d). India’s Sensex equities index fell 4.3% (down 13.9% y-t-d). China’s Shanghai Exchange rallied sharply early in the week before the exchange closed for the holidays (down 12.6% y-t-d).

Freddie Mac posted 30-year fixed mortgage rates dipped one basis point this week to 5.67% (down 61bps y-o-y). Fifteen-year fixed rates declined 2 bps to 5.15% (down 87bps y-o-y). One-year adjustable rates fell 2 bps to 5.03% (down 46bps y-o-y).

Bank Credit declined $42.1bn during the most recent data week (1/30) to $9.291 TN, reversing a majority of the previous week’s $74.2bn increase. Bank Credit has posted a 28-week surge of $647bn (13.9% annualized) and a 52-week rise of $961bn, or 11.5%. For the week, Securities Credit sank $52.9bn. Loans & Leases rose $10.9bn to a record $6.879 TN (28-wk gain of $554bn). C&I loans gained $5.5bn, with one-year growth of 22%. Real Estate loans rose $8.4bn (up 7.4% y-o-y). Consumer loans declined $3.8bn. Securities loans fell $6.3bn, while Other loans added $7.1bn. Examining the liability side, Deposits declined $27.9bn.

M2 (narrow) “money” supply jumped $37.6bn to a record $7.529TN (week of 1/28). Narrow “money” expanded $66.7bn over the past four weeks, with a y-o-y rise of $432bn, or 6.1%. For the week, Currency slipped $0.7bn and Demand & Checkable Deposits declined $9.0bn. Savings Deposits jumped $29.1bn, and Small Denominated Deposits gained $3.9bn. Retail Money Fund assets rose $14.3bn.

Total Money Market Fund assets (from Invest. Co Inst) surged another $46.3bn last week (5-wk gain $248bn) to a record $3.315 TN. Money Fund assets have posted a 28-week rise of $777bn (56% annualized) and a one-year increase of $978bn (41%).

Asset-Backed Securities (ABS) issuance slowed to about nothing this week. Year-to-date total US ABS issuance of $25bn (tallied by JPMorgan) is down 60% from comparable 2007. No Home Equity ABS deals have been sold thus far, compared to $38bn in comparable 2007. There has been less than $1bn of CDO issuance year-to-date, compared to $17bn this time last year.

Total Commercial Paper declined $8.6bn to $1.848 TN. CP has declined $375bn over the past 26 weeks. Asset-backed CP fell $9.9bn (26-wk drop of $393bn) to $802bn. Over the past year, total CP has contracted $163bn, or 8.1%, with ABCP down $252bn (23.9%).

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 2/6) increased $7.3bn to a record $2.118 TN. “Custody holdings” were up $61.2bn y-t-d, or 25.8% annualized, and $320bn year-over-year (17.8%). Federal Reserve Credit declined $2.9bn last week to $861.7bn. Fed Credit has contracted $6.1bn y-t-d, or 11.7% annualized, while expanding $20.2bn y-o-y (2.4%).

International reserve assets (excluding gold) – as accumulated by Bloomberg’s Alex Tanzi – were up $1.355 TN y-o-y, or 27.2%, to a record $6.331 TN.

Global Credit Market Dislocation Watch:

February 8 – Financial Times (Michael Mackenzie and Henny Sender): “Fears about corporate and commercial property debt reached new heights in the US and Europe on Friday as investors liquidated holdings in a sign of spreading credit turmoil. The markets were gripped by worries that economic weakness would affect corporate profits, leveraged buy-outs and commercial property. This represents an escalation of the crisis that began with concerns about US subprime mortgages. The trading was particularly heavy in leveraged loans – used by private equity firms to finance deals. Mutual funds that invest in these loans have been hit with redemptions, forcing them to dump some of their holdings. Hedge funds that bet on the likelihood of buy-out deals happening have been among the casualties. The turmoil has also put pressure on banks and other investors who are holding $200bn of leveraged loans that they had been hoping to sell. Kevin Cronin, portfolio manager at Putnam Investments, said: ‘The overhang of bank debt from last year’s leveraged buy-out activity is becoming more problematic. ‘Loans are being liquidated at distressed prices and banks are looking to reduce risk.’”

February 8 – Bloomberg (Abigail Moses): “The risk of companies defaulting soared to a record on speculation collateralized debt obligations packaging credit derivatives are being unwound, according to traders of credit-default swaps. Contracts on the benchmark Markit CDX North America Investment Grade Index jumped 4.25 bps to 128.5…the highest since the index started in 2004, according to Deutsche Bank AG. The Markit iTraxx Europe index rose 5.5 bps to a record 97.75, according to JPMorgan Chase & Co. ‘There is speculation structured products are being unwound,’ said Jim Reid, head of fundamental credit strategy at Deutsche Bank…”

February 5 – Financial Times (Stacy-Marie Ishmael and Henny Sender): “The leveraged loan market begins the week in ‘disarray’ following the collapse of efforts to syndicate $14bn of the debt used to finance the $27.8bn buy-out of Harrah’s Entertainment, bankers say. The group of banks backing buyers Apollo Management and Texas Pacific Group are having trouble selling on the leveraged buy-out debt to third parties. With the bulk of the debt remaining on their books, the banks are sitting on a sizeable loss. The freeze in the debt market means they now face larger potential losses on other big buy-outs…and will be more desperate to get out of the financing commitments on those deals. Banks are already saddled with more than $150bn of unsyndicated debt, most of it LBO related, according to S&P… Virtually every loan-backed buy-out deal done in the past few months is trading well below 90 cents on the dollar… The prospect of massive losses took its toll on the group of banks arranging the Harrah’s financing. Credit Suisse…sold about $1bn of its share of the debt ahead of the agreed schedule, infuriating the other banks… ‘There is no contractual obligation,’ this person added. ‘We cannot concede control over our own capital.’ That may be the pattern in future deals. ‘The Harrah’s precedent frees other underwriters to deal with situations as they see fit,’ noted S&P’s Weekly Wrap. ‘The market is in total disarray,’ said the head of debt capital markets at one major Wall Street firm. Another senior banker involved in the deal added: ‘The last 10 days have been the worst ever. There is a complete buyers’ strike.’”

February 8 – Bloomberg (Kabir Chibber): “Banks sitting on $160 billion of unsold leveraged loans may have to write down more losses after a plunge in the value of the debt, according to Bank of America Corp. analysts. Credit-default swaps showed the risk of leveraged buyout loan delinquencies rose to the highest on record today. Collateralized loan obligations that package the debt will be under pressure to wind down as the value of their assets falls, analysts led by Jeffrey Rosenberg wrote…”

February 5 – Financial Times (James Mackintosh and Paul J Davies): “Loans backing leveraged buy-outs are trading at levels not seen since the buyers’ strike of last summer, because a number of hedge funds and leveraged credit funds have been forced into firesales. Traders said loans used by private equity groups to support buy-outs had plunged in value as bank proprietary trading desks refused to buy them from these funds. A series of hedge funds that were big owners of leveraged loans have been frozen in the past six months, because severe losses and investor withdrawals threatened their survival. The past two months had seen the sale of loans by these and other funds that were hurt by banks making higher margin calls, traders said. They added that lists of assets being sold would be circulated after funds missed margin calls… ‘The amount of paper for sale is far outstripping the buying power of the market the moment,” said one hedge fund manager. ‘Every time one of those lists [of assets for sale] circulates, the market drops another point.’”

February 6 – Financial Times (Aline van Duyn, Michael Mackenzie and Paul J Davies): “Standard & Poor’s… is warning that the move could be damaging for banks with direct exposure to the insurers. S&P said the potential losses for banks triggered in the event of downgrades for the bond insurers would mainly be through the hedging arrangements that the bond insurers have provided on the least risky tranches of collateralised debt obligations. Bond insurers have hedged $125bn of subprime-related CDOs, S&P said. Although S&P did not specify which banks were most exposed, it noted that Citibank, Merrill Lynch and CIBC had all reported hedges on the so-called supersenior tranches of high-grade CDOs and had recently taken reserves for counterparty risk. ‘The value of those hedges has increased as the value of the underlying CDOs has fallen and can be presumed to be 40% to 60% of the notional amounts,’ said Tanya Azarchs, analyst at S&P. ‘More reserving may be necessary to reflect the increase in counterparty risk, if the ratings on guarantors are lowered.’”

February 7 – Financial Times (Paul J Davies): “Fitch Ratings is poised to downgrade some of the safest AAA-rated slices of complex pools of corporate credit derivatives by up to five notches after a review of its rating criteria for collateralised debt obligations… Yesterday it published a draft of its new methodology for market feedback. Fitch expects to implement the changes on March 31 and begin issuing ratings to new and existing deals.”

February 8 – Financial Times (Gillian Tett): “Earlier this week I chatted with a jet-lagged US financier. Like many of his ilk, he is flitting around the Middle East and Asia trying to extract finance from sovereign wealth funds and other investment groups. His latest travels have delivered a surprise: some funds are quietly getting cold feet about the idea of putting more capital directly into western banks, he says. ‘There is a backlash building,’ he muttered… This is striking stuff. In recent months, many equity investors have taken comfort from the idea that sovereign wealth funds could ride to the rescue of Wall Street… Thus far $40bn-60bn-odd worth of injections have been promised to groups such as Merrill Lynch and Citi, depending on how you measure the promises. But having stepped into the breach so visibly late last year, some funds are now getting jitters. In China, for example, there are rising complaints that funds are foolish to shovel cash directly into risk-laden US banks when they could be using it in better ways, such as purchasing western commodity or manufacturing groups. ‘The Chinese are worried they are turning into [the source of] dumb money,’ says one well-placed Asian financier, who partly blames the trend on the Blackstone saga, which produced significant paper losses for the Chinese investors. Meanwhile, in the Middle East, the latest round of Federal Reserve interest rate cuts has created unease.”

February 5 – Bloomberg (Jody Shenn): “Buying and selling of collateralized debt obligations based on mortgage bonds, high-yield loans or preferred shares has ground to a near-halt, traders said at the securitization industry’s largest conference. ‘We’re definitely in a period of very low liquidity at the moment, which has actually been dropping precipitously in the last few weeks,’ Ross Heller, an executive director at JPMorgan Securities Inc., said…”

February 5 – Bloomberg (Pierre Paulden and Bryan Keogh): “Less than a year after Apollo Management LP paid $6.6 billion for real estate broker Realogy Corp., bond prices show the deal may be worthless. Debt used to finance the April purchase trades at 61 cents on the dollar, and derivatives tied to the securities indicate an 80% chance that…Realogy will default. Apollo, the private-equity firm run by Leon Black, put up about $2 billion of cash to buy the owner of Coldwell Banker and Century 21, borrowing the rest… Falling bond prices are jeopardizing private-equity returns after easy access to cheap debt fueled a record $1.4 trillion of leveraged buyouts in 2006 and 2007.”

February 4 – Financial Times (David Oakley): “Heavily indebted European and US companies face growing financial difficulties because they cannot refinance their borrowings owing to the continuing closure of the credit markets. Companies’ inability to borrow is raising the spectre of defaults, particularly among the most highly leveraged companies in sectors, such as property, that have been hardest hit by economic uncertainty. A big source for refinancing in Europe was the high-yield bond market, which has been closed since July, the longest closure since 2003. The European leveraged loan market is also at a standstill, with only a handful of deals priced in the past month and $64bn in loans still awaiting syndication, according to Dealogic…” Willem Sels, head of credit strategy at Dresdner Kleinwort, said: ‘The closure of the high-yield bond market is approaching a point where it will become a problem for some companies. There does come a time when a company can no longer postpone the need for refunding.’”

February 6 – Financial Times (Daniel Pimlott): “CB Richard Ellis, the world’s biggest real estate adviser, has cautioned that forced sales of property around the world would jump in the last six months of this year if the credit market turmoil did not improve. Brett White, chief executive of CBRE, told the FT that distressed sales of commercial property would rise if borrowers could not refinance loans after borrowing had become more expensive in the wake of the credit squeeze. ‘The issue is that loans come due. A lot of people have shorter-term loans and its going to be hard to replace them,’ said Mr White. ‘The longer it goes on, the worse it gets.’ Sales of commercial property have slowed dramatically since August, as the market for commercial mortgage-backed securities (CMBS) has dried up. CMBS made up 25-30% of all commercial real estate lending in the US at the height of the market last year… But December issuance of CMBS was down nearly 75% from its peak in March… Volumes of US office properties sold dropped 42% in the final quarter of 2007…”

February 6 – Bloomberg (Pierre Paulden): “The default rate for high-yield, high-risk bonds will rise ninefold this year from 2006, said Edward Altman, the New York University professor who created the Z-score mathematical formula that measures a company’s bankruptcy risk. Altman predicts 4.64% of the $1.1 trillion in junk bonds outstanding will default this year, up from 0.51% at the end of 2006, Altman said…”

February 5 – Bloomberg (John Glover): “Fitch Ratings may downgrade collateralized debt obligations by as many as five levels under new criteria the company plans to introduce by the end of March. The biggest cuts are likely to be made to CDOs based on credit-default swaps that aren’t actively managed. So-called static synthetic CDOs that currently have the top AAA ranking are likely face downgrades of an average five grades… CDOs holding high-yield assets will be cut as much as three levels for the portions first in line for losses, said the ratings firm.”

February 4 – Financial Times (Henny Sender and Aline van Duyn): “Leading private equity firms are unlikely to participate in any recapitalisation of Ambac and MBIA, increasing the pressure on banks to come up with a rescue package for the bond insurers. A number of firms, including Bain Capital, Carlyle Group, Kohlberg Kravis Roberts and TPG, have looked at investing in the cash-strapped groups… These investors have all concluded that the risks are far too great, according to people familiar with their thinking. The decision puts more pressure on the banks to provide rescue financing for Ambac and MBIA.”

February 5 – Bloomberg (John Glover): “Fitch Ratings may downgrade all of the $220 billion of collateralized debt obligations it assesses that are based on corporate securities because of rising losses. The…company may lower the notes by as much as five levels after failing to accurately assess the risk of debt that packages other assets, according to guidelines proposed by Fitch today. CDOs with AAA grades that are based on credit-default swaps and aren’t actively managed may face the steepest reductions.”’

February 4 – Bloomberg (Abigail Moses): “Banks in Europe may cut sales of collateralized debt obligations as much as 50% this year as mounting subprime mortgage losses prompt investors to shun the securities, Moody’s… said. Sales of CDOs, securities that pool bonds and loans, rose 11% to a record 112.8 billion euros ($167 billion) in 2007, analysts led by Florence Tadjeddine…wrote…”

February 4 – Bloomberg (Laura Cochrane): “Moody’s… may cut the ratings on A$83 billion ($75 billion) of Australian mortgage-backed bonds linked to PMI Group Inc. on concern the U.S. home-loan insurer will find it harder to pay claims. Moody’s is reviewing the ratings on bonds tied to loans insured by the local unit of PMI… They account for about 45% of the A$180 billion mortgage-backed bonds issued in Australia…”

February 5 – Bloomberg (Shannon D. Harrington): “Primus Guaranty Ltd., a manager of $23 billion in credit-default swaps, posted its biggest loss after writing down the value of guarantees it has on mortgage-backed securities… The fourth-quarter loss was $403.8 million…”

Currency Watch:

The dollar index rallied 1.6% this week to 76.67. For the week on the upside, the Mexican peso gained 0.3%, and the Taiwanese dollar 0.1%. On the downside, the South African rand declined 4.1%, the Norwegian krone 2.4%, the Swedish krona 2.4%, the Danish krone 2.2%, the Euro 2.2%, the British pound 1.4%, the Australian dollar 1.4%, and the Swiss franc 1.4%.

Commodities Watch:

February 8 – Bloomberg (Tony C. Dreibus): “Wheat rose to a record for a third day on the Chicago Board of Trade as the U.S. forecast its lowest inventories in 60 years. U.S. stockpiles will drop to 272 million bushels at the end of May, 6.8% less than expected a month ago and down 40% from the prior year, the Department of Agriculture said… Inventories will be the lowest since 1948 when farmers grew less and shipped more wheat overseas to help rebuilding countries after World War II…”

February 4 – Bloomberg (Angela Macdonald-Smith): “Coal jumped to records at Australia’s Newcastle port and South Africa’s Richards Bay as snowstorms in China, power cuts in the southern African nation and floods in Queensland reduced output. Power-plant coal prices at the New South Wales port climbed $23.09, or 25%, to $116.44 a metric ton… Coal at Richards Bay rose $12.20, or 12%, to $111.30 a ton…”

It was a huge week for commodities. Gold jumped 1.9% to $923 and Silver 2.1% to $17.33. March Copper surged 7.5%. March Crude jumped $2.78 to $91.74. March Gasoline rose 3.1%, and March Natural Gas jumped 6.8%. March Wheat surged 16% to a record high. The CRB index gained 3.1% to a new all-time record high (up 4.7% y-t-d). The Goldman Sachs Commodities Index (GSCI) jumped 4.1% (up 1.6% y-t-d and 42% y-o-y).

China Watch:

February 5 – The Wall Street Journal (Gordon Fairclough and Loretta Chao): “Transport and power disruptions caused by unusual winter storms across much of China’s heartland are beginning to ease, but the scale of the dislocation shows how close the country’s racing economy is to hitting physical-growth limits… ‘Electricity consumption has been growing rapidly,’ Tan Rongyao, a spokesman for the State Electricity Regulatory Commission, said… ‘The shortage of power-generating coal has become enormously acute.’ Gu Junyuan, chief engineer of the electricity commission, said total demand for electricity in China increased 20.2% annually between 2001 and 2007. Installed generating capacity, on the other hand, grew by about 18.5% a year over the period.”

Japan Watch:

February 7 – Market News International: “Japan’s foreign reserves hit a record $996.04 billion at the end of January, rising for the eighth consecutive month and surpassing the previous record high of $973.37 billion marked at end of December, the Ministry of Finance said Thursday. The country’s forex reserves remain the second largest in the world, next to China’s, which is estimated at $1.43 trillion at the end of the third quarter 2007.”

February 8 – Nikkei: “After announcing price increases on some items, Kirin Brewery Co., Nissin Food Products and other food and beverage companies saw demand surge before the hikes took effect… Kirin Brewery in October announced it would lift prices on Feb. 1. January shipments of beer and beer-like beverages shot up more than 50% on the year, ‘for probably the first time ever,’ said a company official… Instant noodle makers uniformly bumped up prices by 10% or so last month, preceded by announcements in the fall. Since there was a three- to four-month lead up to the hikes, demand ballooned over that period….”

Asian Bubble Watch:

February 5 – Bloomberg (Francisco Alcuaz Jr.): “Philippine inflation accelerated to the fastest pace in 15 months in January as prices of food, water and services rose, reducing the central bank’s scope to cut interest rates. Consumer prices climbed 4.9% from a year earlier…”

India Watch:

February 8 – Bloomberg (Anoop Agrawal): “India’s foreign-exchange reserves rose $4.36 billion to a record $292.7 billion in the week ended Feb. 1…”

February 8 – Bloomberg (Pratik Parija): “Imports of wheat into India, the world’s second-largest consumer of the grain, may climb 68% this year, supporting prices that are at a record.”

Unbalanced Global Economy Watch:

February 8 – Bloomberg (Greg Quinn): “Canada added 46,400 jobs in January, more than four times as many as anticipated… The unemployment rate fell to 5.8% from 6% the previous month, returning to a 33-year low set in October…”

February 5 – Bloomberg (Fergal O’Brien): “European retail sales fell the most in at least 13 years in December as higher food and energy costs prompted consumers to rein in their Christmas spending. Retail sales in the euro area declined 2% in December from a year earlier, the biggest drop since at least January 1995…”

February 4 – Bloomberg (Ben Sills): “European producer-price inflation accelerated in December to the fastest pace in a year, boosted by surging energy costs. Factory-gate prices increased 4.3% from a year earlier…”

February 5 – Bloomberg (Steve Scherer): “Italy’s inflation rate in January surged to the highest in at least 11 years, driven by rising energy, transportation and food costs. Consumer prices calculated by European Union standards rose 3.1% from a year earlier…”

February 5 – Bloomberg (Ben Sills): “Industrial production in Spain, which accounts for a seventh of the economy, posted the biggest contraction in more than five years in December as slower European growth curbed demand for Spanish goods. Production at factories, farms and mines fell 2.4% from a year earlier after adjusting for the number of days worked…”

February 8 – The Wall Street Journal (Christopher Emsden and Edith Balazs): “Accelerating inflation is driving interest rates higher in Eastern Europe, even as borrowing costs on the western side of the continent are coming down. The Czech National Bank on Thursday raised its core interest rate by a quarter of a percentage point to 3.75% in an effort to fight inflation, which hovers near six-year highs. The move followed similar rate increases in Poland, Romania and Serbia in recent days, and the dashing of hopes for a rate cut in Hungary, as inflation gallops across the continent. The main drivers of inflation in the east are the same as in the west: rising food and energy prices. Inflation rates are also above central-bank targets in the euro zone and in the United Kingdom… But along with higher food and energy prices, the economies of the east are also seeing spill-over into so-called second-round effects, such as wage increases to compensate for higher prices. Those second-round effects threaten to keep inflation rates at higher levels in Eastern Europe for a longer period of time…”

February 8 – Bloomberg (Marketa Fiserova and Andrea Dudikova): “Czech inflation accelerated faster than expected in January to the quickest pace in more than nine years because of government increases in taxes, rent and healthcare fees. The inflation rate rose to 7.5% from 5.4% in December…”

February 7 – Bloomberg (Ott Ummelas): “Estonia’s inflation rate rose to a near 10-year high in January, led by an increase in taxes on fuel, alcohol and tobacco, boosting concerns that high consumer prices may help undermine economic growth. The inflation rate increased to 11%, the most since April 1998, from 9.6% in December…”

February 5 – Bloomberg (Alex Nicholson): “Russian inflation accelerated in January to its fastest pace in 30 months as oil and gas prices surged, fueling consumer demand. Consumer prices rose an annual 12.6% in January from 11.9% in the previous month…”

February 7 – Bloomberg (Alex Nicholson): “Central Bank Deputy Chairman Alexei Ulyukayev said the Russian economy is showing signs of ‘overheating,’ the Interfax agency reported… High consumer demand and an ‘imbalance’ between wage growth and productivity are ‘symptoms of overheating…’”

February 4 – Bloomberg (Tracy Withers): “An index measuring Australian consumer prices rose at the fastest annual pace in 20 months in January, reinforcing speculation the central bank will increase interest rates tomorrow. Prices climbed 3.9% from a year earlier, breaching the 3% limit of the central bank’s target, according to a monthly gauge released by TD Securities Ltd. and the Melbourne Institute…”

February 5 – Financial Times (Raphael Minder): “Canberra on Monday warned that Australia was facing a ‘very substantial’ inflation problem as data from China, Singapore and Indonesia pointed to inflationary pressure from rising food, energy and housing costs. ‘The inflation genie is out of the bottle,’ said Wayne Swan, Australia’s treasurer… ‘We’ve got an inflation problem to deal with, and deal with it we will.’ His comments followed news that Australian house prices rose by 3.2% in the fourth quarter of last year, bringing the increase for the year to 12.3%… In Singapore, which has also seen a property boom, Lee Hsien Loong, the prime minister, forecast the inflation rate could exceed 5% this year, compared with a previous government forecast of between 3.5% and 4.5%. In Indonesia, the central bank forecast that inflation this year would be between 6% and 6.5%… In China, most economists expect inflation to breach 7% this quarter… China has also been hit by a sharp rise in coal prices, which in Asia reached a high of $124 a tonne, up more than 30% in the past week.”

February 5 – Bloomberg (Tracy Withers): “New Zealand’s wages unexpectedly grew at a record pace in the fourth quarter as a labor shortage prompted companies to pay more to retain employees. Wages for non-government workers, excluding overtime, increased 1.1% from the third quarter…”

California Watch:

February 4 – Bloomberg (Jeremy R. Cooke): “California will borrow $3.2 billion this week to help close a deficit that led Governor Arnold Schwarzenegger to declare a state fiscal emergency. California is seeking to attract buyers by selling bonds with shorter maturities and some of the highest credit ratings, the type of debt favored by investors concerned the value of insured and lower-rated debt might weaken further. The sale, California’s first offering of deficit bonds since a fiscal crisis in 2004, follows a week when long-term municipal bonds fell and two of the largest planned offerings were canceled.”

Central Banker Watch:

February 5 – Bloomberg (Jacob Greber): “Australia’s central bank raised its benchmark interest rate by a quarter point to an 11-year high, saying a ‘significant slowing in demand’ is needed to cool the fastest inflation since 1991. Governor Glenn Stevens and his board increased the overnight cash rate target to 7%…”

February 4 – Bloomberg (Gabi Thesing): “European Central Bank Governing Council member Klaus Liebscher said the ECB will do what is needed to prevent a price-wage spiral from accelerating inflation. Liebscher said that at 3.5% inflation in Austria is ‘clearly too high,’ according to a statement published by the Austrian Central Bank… Compensating workers for the increased cost of living with higher pay increases and one-off payments would lead to a ‘price-wage spiral, higher budget deficits, higher taxes and in the end lower competitiveness.’”

Bursting Bubble Economy Watch:

February 4 – Bloomberg (Scott Lanman): “The Federal Reserve said it became tougher for U.S. companies and consumers to get loans in the past three months, particularly to buy real estate. Most lenders anticipate more delinquencies and losses this year, assuming ‘economic activity progresses in line with consensus forecasts,’ according to the central bank’s quarterly survey of senior loan officers… About 80% of banks raised standards on commercial-property loans, a record since the Fed began seeking information on the subject in 1990… ‘It’s definitely a broader-based tightening than we’ve seen before,’ said Edward McKelvey, senior U.S. economist at Goldman Sachs… ‘The economy is weakening and weakening in a pretty substantial way.’”

February 8 – The Wall Street Journal (Robin Sidel, Sudeep Reddy and Jane J. Kim): “America’s love affair with credit cards may be headed for the rocks. Credit-card delinquencies are rising across the nation, a sign that some Americans are at the end of their rope financially. And these mounting delinquencies, in turn, have prompted banks to tighten lending standards, keeping people who have maxed out their cards from finding new sources of credit. The result could be a sharp pullback in consumer spending that would further weaken the slowing U.S. economy. Such a pullback may already be taking shape… Sinking home prices have made it much harder to convert home equity into cash for living expenses. At the same time, plastic has pushed into every corner of American life, making new inroads that worry some economists and card issuers.”

February 4 – Market News International (Kevin Kastner): “Banks tightened lending standards across the board on all types of mortgage and commercial loans as concerns about credit quality in the near term made banks more cautious as demand for these loans declined… The outlook for loan quality in 2008 was bleak, with 70%-80% of U.S. banks expecting a deterioration of mortgage loan quality this year, including prime mortgages. In addition, 75%-80% of banks anticipated a deterioration in C&I loan quality. About 55% of U.S. banks reported tighter lending standards for prime mortgages, compared with 40% in…October. This percentage pales in comparison to the nearly 85% of banks that reported tightening lending standards on nontraditional mortgages and the 71% of banks that reported tightening standards on subprime mortgages.”

February 6 – Bloomberg (Carlos Torres): “The increase in U.S. unemployment that’s jeopardizing economic growth is being driven by a drop in the number of people working for themselves, government figures indicate. Hours worked by the self-employed dropped at a 15.5% annual pace in the last three months of 2007, the biggest decrease in 15 years, according…the Labor Department. The decline ‘is probably related to the housing downturn, since one in six workers in construction is self-employed, twice the average for all industries,’ said Patrick Newport, an economist at Global Insight… The number of people running their own businesses dropped by 365,000 last quarter, compared with the same period in 2006…”

GSE Watch:

February 7 – Dow Jones (Michael R. Crittenden): “The downturn in the housing market and the increasing reliance on Fannie Mae and Freddie Mac to provide liquidity to the mortgage market is taking its toll on the two firms, their regulator said… ‘Public disclosures indicate that Freddie Mac will report annual losses for the first time in its history and Fannie Mae for the first time in 22 years,’ James Lockhart, director of the Office of Federal Housing Enterprise Oversight, said…”

February 7 – Dow Jones (Michael R. Crittenden): “The increases in mortgage loan limits included in the U.S. economic stimulus package have been hailed as a major step in dealing with a stubborn housing crisis. But even Fannie Mae and Freddie Mac… have said the measure carries some challenges. As a result, it remains to be seen what effect the change will have. ‘(The higher mortgage limits) only are relevant if investors accept them,’ Stanford Group analyst Jaret Seiberg said… ‘If investors balk, the new powers will not help the market.’ …The legislation would increase the conforming loan limit to a maximum of $729,750… The size of loans the Federal Housing Administration can insure would also be increased to $729,750 for high-cost areas, in the hopes of replacing some of the subprime and adjustable-rate mortgages at the root of the current housing crisis… Once again, instead of thinking of ways to further protect the American taxpayer, we are actually considering ways to further expose them for the benefit of those making healthy six-figure salaries,’ Sen. Richard Shelby… said… James B. Lockhart III, director of the Office of Federal Housing Enterprise Oversight, told the Senate Banking Committee… that increasing the conforming loan limit presents ‘new challenges’ for Fannie Mae and Freddie Mac. ‘Jumbo loans would present new risks to the already challenged GSEs. Underwriting them successfully will require new models, systems and tough capital allocation decisions,’ he said.”

MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
February 8 – The Wall Street Journal (Nicole Gelinas): “Fitch Ratings, while telling investors last Friday to expect additional ‘widespread and significant downgrades’ on $139 billion worth of subprime loans, has cited a new factor in their ‘worsening performance.’ ‘The apparent willingness of borrowers to ‘walk away’ from mortgage debt,’ the analysts noted, ‘has contributed to extraordinary high levels of early default’ on loans issued during the 18 months before the mortgage bubble burst. It expects losses to reach 21% of initial loan balances for subprime mortgages issued in 2006 and 26% for those issued in early 2007. Such behavior, where not precipitated by willful fraud, shows that American homebuyers supposedly duped by their lenders aren’t so dumb. They’re perfectly capable of acting rationally without political interference.”

February 7 – Financial Times (Paul J Davies): “As the bond insurers, or monolines, have seen their seemingly rock-solid AAA ratings begin to buckle, worries have grown about what downgrades for these companies might mean for banks. Now, one particular type of trade done between banks and monolines is being seen as an extra hidden danger. These so-called negative basis trades were done in large volumes in recent years. They allowed both banks and monolines to book apparently ‘free money’ and saw monolines writing guarantees on each other. If they have to be unwound, it will be a costly business for all involved. The real problem is that almost no one has any idea how significant the profits taken on these trades might be. These trades were profitable because a bond could pay out more in interest than it cost to buy the insurance available in the derivatives market to protect the holder against default. In the world of structured finance, a bank would buy a bond, get it guaranteed, or wrapped, by a monoline to support the bond’s AAA rating, but then also pay another monoline to write a default swap on the first monoline, to guard against it defaulting on its guarantee. The difference between what the bank paid for the insurance and what it received in yield from the bond could be pocketed as ‘risk-free’ profit – and in many cases banks took the entire value of that income over the life of the bond upfront. One senior industry insider admits that billions of dollars worth of these trades were done… Bob McKee, an analyst at Independent Strategy, a London research house, believes that up to $150bn worth of CDO business done by the monolines could be negative basis trades. Standard & Poor’s…said it believed some of the CDOs hedged by bond insurers were part of a strategy of “negative basis trades” The problem is that if monolines are downgraded and their protection becomes ineffective, profits booked up-front need to be reversed. Restating earnings is a very tricky area for investment banks – not least because the traders involved will have long ago pocketed their bonuses.”

Mortgage Finance Bust Watch:

February 7 – Bloomberg (Andrew Frye and Erik Holm): “MGIC Investment Corp., the largest U.S. mortgage insurer, is scaling back coverage in California, Florida, Arizona and Nevada to reduce losses on loans. The company will offer fewer policies to homebuyers who don’t have top credit scores… The insurer will also tighten standards in parts of 14 other states… In the high-risk regions, MGIC will no longer back so-called Alt-A mortgages where borrowers don’t provide full documentation. It also won’t insure mortgages on condominiums for more than 90% of their value.”

February 7 – Bloomberg (Bob Ivry and Jody Shenn): “Joe Ripplinger took out a $184,000 mortgage in 2006 and makes his payments every month. Now he owes $192,000. The 66-year-old Minneapolis house painter has a payment- option adjustable-rate mortgage. It allows him to write a check for $565 a month even though he owes $1,300. The difference is added to the mortgage, and when his total debt reaches $212,000, or after five years have passed, his monthly minimum will jump to about $2,800, which he can’t afford. ‘We’re barely making it right now,’ Ripplinger said. The estimated 1 million homeowners with $500 billion of option ARMs are beyond the help of interest-rate cuts by Federal Reserve Chairman Ben S. Bernanke… ‘We call them neutron loans because they’re like a neutron bomb,’ said Brock Davis, a broker with U.S. Express Mortgage Corp. Three years later the house is still there and the people are gone.’”

February 6 – Financial Times (Bernard Simon): “GMAC, the financial services group owned by Cerberus Capital Management and General Motors, is considering the sale of at least part of Residential Capital, its troubled mortgage lender, ResCapafter a hefty fourth-quarter loss. GMAC posted a net loss of $724m, a sharp reversal from a profit of $1bn a year earlier. ResCap’s loss grew to $921m from $128m while earnings from motor vehicle financing slipped to $137m from $593m. Both the US automotive and mortgage businesses have been squeezed by rising funding costs and problems in the subprime sectors. However, Robert Hull, chief financial officer, said the increase in automotive delinquencies and losses remained “relatively mild” and in line with previous economic downturns. GMAC reported a 2007 loss of $2.3bn compared with a $2.1bn profit the previous year. Its results would translate into a net loss of at least $300m for General Motors, well above analysts’ forecasts.”

February 6 – Financial Times: “It is never wholly reassuring when a company commits to support one of its divisions ‘to the extent it doesn’t hurt our other businesses’. But then GMAC, the financing arm of General Motors that is 51%-owned by Cerberus Capital Management, has little choice when it comes to ResCap. Losses at the mortgage business overwhelmed small fourth quarter profits in GMAC’s other operations. ResCap has not turned a profit since the third quarter of 2006 and has lost a cumulative $4.5bn since.”

Real Estate Bubbles Watch:

February 7 – Bloomberg (Hui-yong Yu): “Construction in central Seattle rose last year, with $1.1 billion worth of projects completed, 44% more than the year before, and a further $3 billion of projects was under way, the Downtown Seattle Association said. The value of commercial and residential projects under construction was up 30% from 2006.”

February 8 – Bloomberg (Brian Swint): “U.K. housing repossessions reached the highest since 1999 last year and will increase further this year as banks curb lending and the economy slows, the Council for Mortgage Lenders said.”

Muni Watch:

February 5 – Bloomberg (Michael Quint): “U.S. securities regulators are examining whether municipal governments should publicly disclose when periodic auctions used to set rates on some of their debt fail to attract enough bidders, a spokesman for the SEC said. About $270 billion of municipal auction bonds have interest rates that are determined by bidding that typically occurs every seven, 28 or 35 days. When there aren’t enough buyers, as has occurred in recent months, the auction fails and bondholders who wanted to sell are left holding the securities… ‘A failed auction makes the bond an illiquid security, and that certainly affects investors,’ said Lance Pan, director of research at…Capital Advisors Group, which manages about $7.5 billion of short-term investments.”

Fiscal Watch:

February 5 – Financial Times (James Politi): “The US administration on Monday blamed the slowdown in the economy for a ­projected increase of the budget deficit to a near-record level of $410bn this year, or 2.9% of gross domestic product. The expected jump in the deficit was announced as George W. Bush sent to Congress a $3,100bn federal budget for 2009 – the last and largest of his eight-year presidency… The spending plan, which is likely to set off an intense tug-of-war with Democrats who control Congress, includes a 7.5% increase in funding for the military to $515bn and a cut of about $200bn over five years in government healthcare programmes such as Medicare… The new budget estimates that the deficit will rise from $162bn, or 1.2% of gross domestic product, in 2007, to more than double that amount, or $410bn, in 2008, and $407bn in 2009.”

February 5 – Financial Times (Demetri Sevastopulo): “US military spending continues to soar with the Pentagon yesterday asking Congress for a record $515bn to fund the armed services in fiscal 2009. The military base budget funds everything from military salaries to big-ticket weapons, but does not include money for the wars in Iraq and Afghanistan. The $515bn request represents a 7.5% increase from last year, and translates into the 11th consecutive annual increase for the defence department.”

February 6 – Dow Jones (John Godfrey): “The U.S. federal government amassed a $90bn budget deficit in the first four months of the fiscal year that began Oct. 1… That deficit is nearly double the $48 billion shortfall amassed during the same time period in the previous fiscal year… According to the CBO, federal receipts will likely grow, year-to-year, 3.3%. That’s down from roughly 7% growth in revenue the year before, and growth rates exceeding 10% the two preceding years. While payroll taxes through January grew about 6.9% over the same time period last year, individual income taxes grew just 4.4% and corporate income taxes shrank 10.1%, the CBO said. In contrast, federal spending through the first four months was 8.7% higher than during the same time period last year.”

Speculator Watch:

February 7 – Bloomberg (Jenny Strasburg and Katherine Burton): “Hedge-fund managers lost an average of 1.8% in January as stock markets around the globe got off to their worst start since 1990. The biggest losers were managers who buy and bet against stocks, known as long-short funds, which fell 4.1%, according to… Hedge Fund Research Inc.”

February 6 – Bloomberg (Tom Cahill and Katherine Burton): “SRM Global, the hedge fund run by former UBS AG trader Jon Wood, fell about 30% this year as of Jan. 18… The drop followed a loss of about 30% in 2007…”

Crude Liquidity Watch:

February 5 – Bloomberg (Yon Pulkrabek and Matthew Brown): “Gulf states including Saudi Arabia and the United Arab Emirates will be forced to revalue their currency pegs this year following the dollar’s declines and the Federal Reserve’s interest-rate cuts, said Bear Stearns Cos. Five Gulf nations lowered interest rates last week in step with the U.S. to keep their links to the dollar even as inflation accelerates… ‘It’s going to be very difficult for central banks in the region to have adequate control of monetary policy, and hence inflation, when the Fed is slashing rates left, right and centre and the dollar is slumping,’ Steven Barrow…wrote…”

February 7 – Bloomberg (Will McSheehy): “Gulf states including Saudi Arabia and the United Arab Emirates, which control $1.8 trillion of wealth, may control ‘the third global currency’ by 2020, according to Dubai economist and former Lebanese minister Nasser Saidi. ‘The common Gulf Cooperation Council currency can emerge as a global currency that other countries of the region, other Arab and central Asian economies, could peg their currencies to,’ Saidi, chief economist for the Dubai International Financial Centre, said…”

At the Heart of Deepening Monetary Disorder:
Unedited

It was an eventful week for indications of the real economy’s (waning) soundness. At 15.2 million annualized, January vehicle sales were the weakest since October 2005 (that followed more than a year of very strong sales). A larger-than-expected increase in weekly initial unemployment claims (356k) pushed continuing unemployment claims rose to the highest level (2.785 million) since late 2005. The ABC/Washington Post weekly Consumer Comfort index sank a notable 6 points this week to negative 33, the lowest reading since the early nineties.

Importantly, this week’s Federal Reserve survey of senior bank-loan officers provided confirmation both that bankers have become much more cautious in lending and that borrowers have lost enthusiasm for taking on more debt. Moreover, any indication of general tightening of bank Credit takes on major significance today due to the seizing up and breakdown of Wall Street finance. Inarguably, what erupted last year in subprime has now evolved into a broad-based and severe Credit tightening. Notably, 80% of banks tightened Credit for commercial real estate lending and better than a third tightened commercial and industrial (C&I) Credit. It is worthwhile excerpting directly from the Fed’s survey:

“In the January survey, significant numbers of domestic respondents reported that they had tightened their lending standards on prime, nontraditional, and subprime residential mortgages over the past three months; the remaining respondents noted that their lending standards had remained basically unchanged. About 55% of domestic respondents indicated that they had tightened their lending standards on prime mortgages, up from about 40% in the October survey. Of the thirty-nine banks that originated nontraditional residential mortgage loans, about 85% reported a tightening of their lending standards… compared with about 60% in October…”

“About 60% of domestic respondents…indicated that demand for prime residential mortgages had weakened over the past three months, and 70% of respondents…noted weaker demand for nontraditional and subprime mortgage loans over the same period… About 60% of domestic respondents indicated that they had tightened their lending standards for approving applications for revolving home equity lines… Regarding demand, about 35% of domestic banks…reported that demand for revolving home equity lines of credit had weakened over the past three months.”

“About 10% of respondents — up from about 5% in…October — reported that they had tightened their lending standards on credit card loans… About 30% of respondents noted that they had reduced the extent to which such loans were granted to customers who did not meet credit-scoring thresholds… About 15% of domestic banks — up from about 5% in…October — indicated a diminished willingness to make consumer installment loans… About one-third of domestic banks — up from about one fourth… — reported that they had tightened their lending standards on consumer loans other than credit card loans… Regarding loan demand, about 35% of domestic institutions, on net, indicated that they had experienced weaker demand for consumer loans of all types…”

“About 80% of domestic banks reported tightening their lending standards on commercial real estate loans over the past three months, a notable increase from the October survey. The net fraction of domestic banks reporting tighter lending standards on these loans was the highest since this question was introduced in 1990…”

“In the January survey, one-third of domestic institutions…reported having tightened their lending standards on C&I loans to small as well as to large and middle-market firms over the past three months. Significant net fractions of respondents also noted that they had tightened price terms on C&I loans to all types of firms… Compared with domestic institutions, larger net fractions of U.S. branches and agencies of foreign banks reported having tightened lending standards and terms on C&I loans…”

With Wall Street’s securitization markets basically closed for business and even bank Credit Availability now tightening meaningfully, January’s collapse in the ISM Non-Manufacturing index should have been less of shock to the markets. After all, the services-based U.S. economy is primarily finance-driven, and our financial system is floundering.

The ISM Non-Manufacturing index unexpectedly sank 12.5 points to 41.9 (below 50 indicates contraction), the lowest level since October 2001. Expectations had the index slipping only a point or so to a still expansionary 53. Instead, New Orders dropped more than 10 points to 43.5, while the Prices component dipped ever so slightly to a disconcerting 70.7. Alarmingly, the Non-Manufacturing Employment index sank to 43.9, the lowest reading since the 43.9 registered in the month subsequent to the 9/11 terrorist attacks. This report corroborates the recent dismal jobs report, where “Service-Producing” job growth collapsed from December’s 143,000 (5-month average growth of 138,000) to January’s 34,000.

It is worth noting that, despite the bursting of the technology Bubble, the Non-Manufacturing index remained above 50 (at 50.7) through February 2001. But as Credit problems engulfed the corporate debt market, the Employment component proceeded to drop 6.4 points in 11 months to fall to 44.3 by early 2002. Remarkably – and indicative of breadth and severity of the unfolding Credit Crises – the Non-Manufacturing Employment index sank 7.9 points just last month. Meanwhile, the ISM Manufacturing Employment index declined 4.7 points in two months to its lowest level since September 2003. The Bubble Economy is now clearly suffocating from insufficient Credit. In particular, the unfolding Corporate Credit Crisis has begun to impact jobs, incomes and the overall economy.

It was, as well, an eventful week for indications of the soundness of the U.S. and global financial systems. On the inflation front, major commodities indices (including the CRB and the UBS/Bloomberg Constant Maturity) surged to record highs. Platinum jumped 7% this week to a record on tight supplies and power shortages in South Africa. Lead gained 5%. Copper jumped 7.5% (biggest gain in almost a year), increasing y-t-d gains to almost 16%. Palladium rose to the highest price since 2002. Sugar rose 5% on Friday, and I’d be remiss not to note crude’s 4% one-day surge.

But when it comes to spectacular moves, wheat takes the cake. Prices surged to yet another record high (up 30% y-t-d), as forecasts have U.S. stockpiles falling to the lowest level since 1948. Global supplies are said to be the lowest since 1978. Alarmingly, wheat increased the 30 cent daily limit in Chicago trading for five straight sessions, with Bloomberg reporting this week’s 16% gain as the “biggest in history.” Prices are now up 140% y-o-y. Along for the ride, soybeans rose 4% this week to a near-record ( U.S. inventories at 4-yr low), increasing one-year gains to 80%. Corn prices gained 2% (having doubled in the past two years), also trading at record highs. Production and inventory concerns saw coffee prices rise 5.8% this week to the highest level since 1999. Cocoa gained 3.8% this week (37% 1-yr gain).

The question remains: How much will the Chinese, Indians, Russians, American consumers and others be willing to pay for wheat and other vital commodities? For energy? For stores of value such as gold, silver and the other (increasingly) precious metals in an age of unregulated, unrestrained, unanchored, electronic-based, securities-based, and market-driven global “money” and Credit. With trillions of dollar liquidity sloshing vagariously around the global financial “system”, there is clearly more than ample high-octane inflationary fuel to destabilize markets for myriad essential things of limited supply. And, increasingly, there is talk of problematic margin calls and derivative-related issues impacting commodities trading conditions. The talk is of trading dislocations and nervous “bankers” pulling away from the financing of hedging activities in various markets. Or, in short, we are witnessing a precarious ratcheting up of Monetary Disorder – in a multitude of key markets and on a global basis.

At the Heart of Monetary Disorder, we have a leveraged speculating community increasingly on the ropes. January was a tough month for the hedge fund community. In particular, it appears the (over-hyped) “long/short” (holding both long and short positions) and (over-hyped) “quant” funds had an especially tough go of it. To begin the New Year, last year’s favorite stocks (i.e. technology, emerging markets, energy, and utilities) were hammered, while the heavily shorted sectors have significantly outperformed (i.e. homebuilders, banks, retailers, “consumer discretionary,” and transports). The yen and Swiss franc (currencies traders had shorted to finance higher yielding “carry trades”) have rallied. Even the dollar has rallied somewhat. Many speculators have been (caught) short commodities, having expected negative ramifications from the bursting of the U.S. Credit Bubble. Others have been caught over-exposed to emerging equities and debt markets. And, increasingly, it appears various trades throughout the complex corporate Credit arena have run amuck.

Friday, various indices of corporate credit risk moved to record highs, including the previously stalwart “investment grade” sector. Leveraged loan prices fell to record lows late in the week, as talk of further bank and hedge fund liquidations captivated the marketplace. While the status of the (“monoline”) Credit insurers is now a central focus, behind the scenes there is increasing angst at the prospect for a disorderly unwind of various leveraged trading strategies in corporate Credits and Credit derivatives. “Synthetic” CDOs (collateralized debt obligations) – pools of Credit default swaps and other derivatives – are especially vulnerable and problematic for the system. In short, the Corporate Credit Crisis took a decided turn for the worse this week. There is, with the economy sinking rapidly and the leveraged speculating community faltering abruptly, little prospect at this point for stabilization. The downside of the Credit Cycle is attaining overwhelming momentum.

The Wall Street punditry seems to go out of its way to get things wrong. The latest talk is that the market will simply look over the “valley” and begin focusing on a recovery from what will be, at worst, a brief and mild recession. The relative strong performance of the banks, retailers, homebuilders, and transports is accepted as confirmation of the bullish view. I’ll instead take the view that the recent major squeeze in the heavily shorted stocks and sectors is only further destabilizing and indicative of dynamics troubling to the leveraged speculating community and the Credit system more generally. “Hedges” have stopped working, creating a backdrop of angst and forced liquidations.

Despite last year’s subprime collapse and mortgage turmoil, the leveraged speculating community overall chalked up another stellar year of performance. Actually, the “community” in total likely boosted returns with bets against subprime and mortgage Credit more generally. Certainly, the hedge funds profited nicely from shorts on the financial and consumer sectors. Ironically, the initial stage of the bursting of the Credit Bubble proved a favorable backdrop for many of the major players and the community in general. The deluge of industry inflows ran unabated through much of the year, a crucial dynamic that masked rapidly developing fragilities and vulnerabilities. These flows were surely critical in supporting speculative trading positions away from the mortgage bust.

In particular, I believe the general backdrop delayed a problematic unwind of leveraged and highly speculative positions in corporate Credits (securities, derivatives and other “structured products”). Shorting mortgage-related Credit last year provided a convenient mechanism for hedging corporate Credit and equity market risk. Meanwhile, the combination of profitable (mortgage bust-related) shorts and hedges – in concert with industry fund inflows – emboldened the speculators to press their (huge) bets on technology, energy, the emerging markets, global equities, and other speculative Bubbles. The relative resiliency of the U.S. corporate Credit market and global markets through 2007 played a critical role in delaying impending economic and stock market adjustment.

Well, I believe the dam broke in January. The leveraged players were hit with losses from all directions. Their long positions were immediately slammed with simultaneous bursting Bubbles round the globe. Meanwhile, a rush to unwind positions led to upward pressure on the heavily shorted sectors, only compounding the leverage speculating community’s predicament. Last year fostered an extraordinary dynamic of ballooning “crowded trades,” and January saw the bursting of this multifaceted Bubble.

The leveraged speculating community has suffered the occasional tough month – last August providing a recent case in point. Each time, however, performance quickly bounced back. In true Bubble fashion, each quick recovery from a setback emboldened all involved; industry fund inflows not only never missed a beat – they accelerated. Yet a strong case can be made today that this (historic) Bubble has now burst – that last year was the “last gasp” before succumbing to New Post-Credit Bubble Realities. I don’t expect performance to bounce back, while I do foresee a flight away from the leveraged speculating now beginning in earnest. With “crowded trades” unraveling virtually across the board, marketplace risk is now escalating significantly for leveraged strategies in general. Systemic liquidity issues and dislocated market conditions have created an environment where there is seemingly no place to hide.

Importantly, a leveraged speculating community “unraveling” would prove a death blow for myriad sophisticated trading strategies and risk models, with enormous ramifications for systemic stability. There are unmistakable “Ponzi Dynamics” involved here worthy of a few Bulletins.

Going forward, I expect a foundering leveraged speculating community to be At The Heart of Deepening Monetary Disorder. The initial victims appear the fragile global equities market Bubbles and the U.S. Corporate Credit market. Forced deleveraging of hedge fund corporate debt and derivatives is in the process of creating a massive overhang of securities to sell, in the process profoundly curtailing Credit Availability and Marketplace Liquidity throughout. The ramifications for our finance-based Bubble Economy are momentous. As an economic and financial analyst (as opposed to “fear-monger”), I feel it is imperative to highlight that it is more “technically” accurate to categorize the unfolding scenario in the historical context of an economic “depression” rather than “recession.” This is certainly not shaping up as a short-term inventory-led economic adjustment or “mid-cycle” slowdown. Instead, we have now entered the very initial stages of what will likely prove a deep, prolonged and arduous adjustment to the underlying structure of our Credit and economic systems.

Beginners Guide to Gold and Silver Investing – Free

http://www.prudentbear.com/index.php/CreditBubbleBulletinHome

Antal E. Fekete
Gold Standard University
aefekete@hotmail.com

Tertium datur

People tend to think in terms of black-and-white. Many of my correspondents think that either hyperinflation or deflation is in store for the dollar; tertium non datur (no third possibility given). I would say tertium datur. The third possibility is a hybrid of hyperinflation and deflation. I described this scenario in my previous article “Opening the Mint to Gold and Silver”. It is possible, even probable, that we shall witness collapsing world trade and collapsing world employment together with competitive currency devaluations, as the three superpowers compete in trying to corner gold. The lure of gold is very strong. “There is no fever like gold fever” and, contrary to conventional wisdom, governments are especially susceptible.

A large part of the problem is that the Central Bank is helpless in the face of bond speculation. The Fed is no Sorcerer. It is the Sorcerer’s Apprentice. It can pump unlimited amounts of “liquidity” into the system, but cannot make it flow uphill. As we shall see, new dollars flow to the bond market causing a lot of mischief there, instead of flowing to the commodity market as hoped by the Fed.

Up to now leading commodities have outperformed gold. That could change. A select few commodities might continue in the bull-mode for a time, although gold could easily beat them. Most other commodities might go into a bear-mode similar to that of the commodity markets of the 1930’s. If that’s what was in store, then most investors would be totally lost. They would be navigating without a compass. There would be endless debates whether the country is experiencing deflation of hyperinflation. Your motto in this hybrid scenario should be: “expect the unexpected”.

Of course, the Fed will keep printing dollars like crazy. Few of them, if any, will go into commodities. Indeed, most of the newly created dollars will go into bond speculation. Why? Because commodity bulls are running into headwind and face grave risks. By contrast, bond bulls enjoy a pleasant tailwind. Bond speculation is virtually risk-free. Under our irredeemable dollar bond bulls have a built-in advantage. The Fed has to make periodic trips to the bond market in order to make its regular open-market purchases of bonds to augment the money supply. In order to win, all the bond speculator has to do is to stalk the Fed and forestall its bond purchases. This is the Achillean heel of Keynesianism: it makes bond speculation inherently asymmetric favoring the bulls, and that will ultimately derail the economy on the deflation-side of the track.

Uncle Sam in agony

Russia is not as enigmatic as China. The Russians’ game is gold. China is the big unknown. It looks as if China prepares to corner silver. Will the Chinese force a silver standard on their trading partners? It is quite possible that their pile of paper profits in silver is already so huge that they can well afford to gamble. They find trading T-bonds most profitable. Indeed, theirs is the greatest U.S. T-bond portfolio ever, anywhere. They can overwhelm any opponent bidding against them. Just think about it. The financial destiny of the U.S. is in China’s hand. The good news is that the Chinese have vested interest in keeping the bond bull charging. They also have a vested interest in keeping the dollar on the life-support system. The bad news is that the Chinese insist that it is their finger that must be on the switch. Here is an incredible sight, the U.S. being under the thumb of China. Not because the Red Army is a match for the U.S. military, but because Uncle Sam has voluntarily put his head into the noose. The Chinese ask: why fight shooting wars when you know that your antagonist is painting himself into a corner anyhow? They know that Uncle Sam will sooner or later start crying: “Uncle!” in agony. They have all the marbles. The marbles of saving. The marbles of producing. The marbles of silver. Maybe, one day, they will also have the marbles of gold.

The Logarithmic Law of Deflation

Most economists are ignorant of the mathematics of depressions. They have certainly never heard of what I call the Logarithmic Law of Deflation. It states that halving interest rates brings about the same proportional increases in bond prices, regardless at what level the halving takes place. It makes no difference whether you go from 16% to 8% or from 2% to 1%, the value of long-term bonds will increase by about the same factor. It can be seen that a much smaller drop in interest rates could bring about the same proportional increase in bond prices, provided that the rates are low enough.

Why is this important? Because it gives away the secret of the deadly deflationary spiral. It is wrong to describe Fed action as cutting interest rates. We should think in terms of the Fed halving them. The bull market in bonds can go on indefinitely under the regime of the fiat currency. People assume, wrongly, that the Fed will run out of ammunition when the rate of interest is approaching zero. The bond-bull will run out of breath. Not so. The Fed will never run out of ammunition. The lower the rate, the smaller cut will do. The Fed can halve interest rates any number of times without ever reducing them to zero. The bond-bull will never run out of breath.

“Gigolo of science”

The trouble is that the bond-bull is the root cause of depressions. Falling interest rates create capital gains for bondholders, yes, but these gains do not come out of nowhere. They come right out of the capital losses of producers. They are the very stuff out of which depressions are made. The serial cutting of interest rates by the Fed is the grave-digger of the economy: it causes wholesale bankruptcies in the producing sector. The large-scale dismantling of the producing sector in America during the past twenty-five years is a direct consequence of the regime of falling interest rates. Production stopped as a result of the financial sector siphoning off capital from the producing sector. Industrial jobs were exported as there was no capital left to support them at home. This shocking truth was never investigated by mainstream economists, sycophants of Keynes. They did not want to expose the gravest error of their idol in confusing a low interest-rate structure with a falling one. Keynesianism is the gigolo of science (Ayn Rand).

“Moral cannibalism”

As the example of Japan shows, we are not looking at a ditch into which the Japanese economy has stumbled. We are staring a black hole in the face, the black hole of zero interest. It can suck in the Japanese economy. It can suck in the economy of the United States. It can even suck in the entire world economy. It is powered by the regime of the irredeemable dollar, and the Fed’s policy of serial interest-rate cuts.

Ayn Rand called the confiscation of gold in 1933 by F.D. Roosevelt “moral cannibalism”. As I have shown elsewhere, the epithet is apt. The removal of gold as the chief competitor of government bonds was one of the main causes of the Great Depression in triggering, as it did, a protracted fall in interest rates. (The other cause was the deliberate manipulation of interest rates lower by the Fed.) The latter-day equivalent of moral cannibalism is risk-free bond speculation by the banks, perpetuating the bull market in bonds. It is made possible by the open-market operations of the Fed that have been clandestinely and illegally introduced and, by now, have become the mainstay of the management of fiat currencies. The result is another protracted fall in interest rates. Could they herald another Great Depression?

What American Century?

There is an historical lesson to learn here. The twentieth century was not the “American Century” as advertised. The sun started setting on America as early as 1913 when, in imitation of the Europeans, Americans embraced the idea of a central bank. An earlier attempt to establish a central bank in the United States was found contrary to the Constitution, and the Bank’s charter was not renewed. But by 1913 the visionary admonition of Thomas Jefferson was totally forgotten.

“If the American people ever allow the banks to control the issuance of their currency, first by inflation, and then by deflation, the banks and corporations that will grow up around them will deprive the people of all property, until their children wake up homeless on the continent their fathers conquered. The issuing power of money should be taken from banks and restored to Congress and the people to whom it belongs. I sincerely believe that the banking institutions having the issuing power of money are more dangerous to liberty than standing armies.”

In less than a generation after 1913 adventurers invaded America’s institutes of higher learning and exiled monetary science, replacing it with a hodge-podge of dubious nostrums. America’s economy and finance started to be run on a completely false theory. Gold, and the power to create and to extinguish money was taken away from the people. It was given to the banks.

Operating on the basis of this false theory Americans scrapped the foundations of the international monetary system: they threw out positive values (such as that of gold and silver) and replaced them with negative values (such as debts and deficits). As a consequence, outstanding debt can no longer be reduced through the normal course of retirement. Total debt can only grow. In no time at all America has turned itself from the largest creditor into the largest debtor nation of all times. Not only did the U.S. government allow its debt to grow exponentially; it also allowed it to accumulate in the hands of America’s adversaries. At the same time America’s industrial heartland was dismantled. Well-paid industrial jobs were exported and replaced by low-paying service jobs.

Hedging versus gambling

The United States is like a train running downhill without brakes. The derivatives monster is the proof of that. It has its own dynamics, but it cannot be grasped without a solid understanding of gold. Under the gold standard interest rates, and hence bond values, were stable. In fact, that is the main excellence of a metallic monetary standard: it makes interest and foreign exchange rates stable. There are no derivatives markets on interest and foreign exchange rates, because the lack of volatility makes trading unprofitable. Under a metallic standard “bond trading” is an oxymoron, as is “bond insurance”. Private issuers of debt must set up a sinking fund that will buy up all bonds offered in the market below par. People buy bonds as a vehicle of saving. Today, you would have to be insane if you wanted to buy bonds as a vehicle of saving.

Why then are bonds still in demand? They are in demand because they are by far the best vehicle of gambling. As I shall now show, under the regime of irredeemable currency, speculation in bonds is risk-free.

When the gold standard was thrown to the winds, interest rates started gyrating and bond values were totally destabilized. After all, bonds promised to pay principal and interest in terms of a currency of uncertain value.

Mainstream economists betrayed their sacred duty of searching for and disseminating truth. They started preaching the false gospel that it is possible to take out insurance against losses in the bond portfolio. However, the thesis that bond futures can be used for purpose of hedging the bond price (in exactly the same way as wheat futures can be used for the purpose of hedging the wheat price) is an outright lie. Only those price risks can be hedged where the price variation is nature given, as in the case of agricultural commodities. If the price variation is artificial, that is, subject to government and central bank manipulation as are foreign exchange and bonds under the regime of irredeemable currency, then it is preposterous to talk about hedging. One should talk about gambling instead of hedging. As in the casino, the so-called hedger is placing a bet against the house, in this case the central bank, whose job it is to manipulate the price.

The Derivatives Monster

The derivatives tower is just a layered pyramid of “bond insurance”, so-called. Nobody asks the question whether insuring bond values is possible in principle. As I have stated, it is not. Insurance means spreading the risks over a larger population than that needing compensation. Insurance is the very opposite of gambling where the player wants to increase his risks in the hope of a large payoff, not to decrease it.

Now think of an inverted pyramid delicately balanced on its apex. The apex represents the bond market (layer 1). The next layer is bond insurance (layer 2). But since the value of bond insurance is inherently even more unstable than that of the bond, it is in need to be insured as well (layer 3). And so on it goes. The pyramid is growing at an exponential rate as the need for reinsurance keeps increasing.

There are several problems. First of all the whole idea is hare-brained, much the same as the idea of “operation boot-strap”. A soldier, no matter how strong he is, cannot lift himself by his own boot-straps. Similarly, you can’t insure bond values without an anchor. The second problem is that the slightest hitch at any layer will bring down the house of cards. The principle of insurance assumes that no tornado will destroy all the insured homes simultaneously. The same assumption cannot be made about bond insurance. The volume of outstanding bond insurance is much higher than the existing supply of bonds. It is even larger than the existing money supply (and goodness only knows that it is very large.) Therefore it is a physical impossibility to compensate insurance-holders in case of global trouble. If any doubt arises at any level about the validity of the insurance policy, the whole Ponzi-scheme collapses. The Derivatives Monster is meant for simpletons.

The Presidential election year of 2008

I find it frightening that none of the Establishment candidates for the presidency even vaguely refer to the on-going self-destruction of the nation’s monetary and banking system. Like an ostrich they ignore the problem. A presidential election year should be a great opportunity for the nation to discuss its most urgent problems and take remedial action wherever necessary. In this election year the country is blessed with the running of a competent and upright candidate who sees and understands the problems involved, and is willing to engage in a public discussion of the gold standard as a way to avert national and world economic disaster. This candidate is Dr. Ron Paul, a physician who did not go into politics with the idea of making money or accumulating power. He went into politics as Cincinnatus*, patriot and hero of the old Roman republic. When Cincinnatus was drafted to become consul, the messengers who came to tell him about his new dignity found him ploughing on his small farm. He answered the call, but after solving the problems of the nation he declined the offer to become dictator for life. He returned home to pick up the plough again.

Already in 1985 Ron Paul called for the opening of the U.S. Mint to gold and silver as a way to stop the threatening monetary and banking crisis in his address The Political and Economic Agenda for a Real Gold Standard. If the country had listened to him then, people would have been spared of the economic pain of 2007, and the possibly much greater pains that may be in store.

Ignorance or lust for power?

Not one among the Establishment candidates is willing to take up the challenge of Ron Paul, thus depriving the electorate of a singular opportunity to learn about the dangers threatening the Republic. We are left wondering whether their ostrich-like behavior is due to ignorance, or to lust for power.

The electorate cannot make an informed decision in November without understanding the current monetary and banking crisis and its connection to gold. It is not too late to have a great debate on the gold standard and on the consequences of maintaining the irredeemable dollar standard in the face of an escalating monetary and banking crisis. Labor leaders and captains of industry should demand an answer to all those questions that the representatives of the financial press refuse to ask of the candidates.

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