China's Economic Strategy To Become The World's Biggest Superpower

China is taking advantage of the global recession to position themselves to eventually become the world's number 1 superpower. They are lending out massive amounts of money to countries like the US, and stockpiling gold in order to prepare for the possible fall of the dollar. Tony Straka from The Prudent Investor explains China's economic strategy and why we should all be watching very closely.

Shocked by the fact that lamestream media and Twitter are all about Michael Jackson's death from what appears to be a drug overdose, I enjoy being the spoiler for a world that seemingly does not know how to set its priorities anymore. While 33 of the 42 commercial media I regularly read headline with Jacko, it is Chinese media that published the truly important news of the day.

Here's the executive version of Chinese economic news picked from the English language People's Daily Online.

1. China takes public ownership as the main body and the other (issue) is to adhere to the common growth of economy belonging to diverse forms of ownership.
2. The People's Bank of China (PBoC) will stick to an appropriately easy monetary policy but will ensure reasonable growth in money and credit, the central bank said yesterday.
3. New credit in the first half of 2009 will definitely surpass 6 trillion yuan, and some experts even predict the figure to be up to 6.5 trillion yuan. This means that total credit in the first half of this year will be more than the total amount invested in any year since China was founded.
4. China should buy more gold because the dollar is poised for a fall and the metal is needed to support the greater international role envisaged for the yuan, a senior researcher with the ruling Communist Party said.

You can now go back to watch CNN's US propaganda broadcast and remain in the "don't worry, be happy" camp which still has a solid majority in the Western world. Or would you prefer to gather a little more intel on the next #1 power in the world? Then read on.
Bullet point #1 appears to point to a struggle of ideologies in the Chinese communist party. Chinese entrepreneurs certainly favor a more liberal business climate but one must not forget that there is still a gap as wide as the Amazon river between the Ferrari driving riches in towns and a rural hinterland where oxcarts and bicycles remain to be seen as signs of prosperity. In order to prevent social upheaval China needs to bridge this gap or it risks falling apart. The anonymous commenter in the People's Daily reminds the world that China still favors a hands-on approach:

Taking public ownership as the mainstay is a fundamental principle of socialism. In a socialist country like China, where people have become masters of their own destiny, it is imperative to keep public ownership of means of production as a basis of the socialist economic system. So, adherence to public ownership as the main body is of vital importance in giving play to the superiority of the nation's socialist system, increasing the nation's economic strength and promoting social harmony in the country.

Pointing out, that 26 of the 500 largest companies in the world as of 2008 are state-controlled Chinese corporations, the most populous nation on earth insists that it is not so much about ownership-ideology but about keeping up a harmonious people.

In a nutshell, it is imperative and essential to consolidate and develop the public ownership economy, to encourage, support and guide the growth of the non-public sector economy, and to maintain the right to equal access of property resources, so that a brand-new situation will emerge, in which all economic sectors will "vie with each other" on an equal footing so as to spur their economic activity for mutual advancement.

Confronted with a global economic downturn China's central bank made it clear this week that it will emphasize an easy monetary policy to keep its economy humming despite declining exports. In a stark contrast to the indebted western world China sits on roughly $2 trillion in assets, enabling it to conduct stimulus policies no country in the Western hemisphere could afford. Read their opinion on bullet point #2 in their own words as it also signals a concern about the environment:

In a summary of the conclusions drawn at its second-quarter monetary policy committee meeting, the central bank said yesterday that it would ensure reasonable growth in money and credit but would strictly control lending to polluting, energy-intensive industries...
"The top priority at the moment is to stop the explosive growth in lending at the end of the month and quarter," China Banking Regulatory Commission said in a recent notice to lenders, pointing to the phenomena of banks racing to offer loans before June to meet their half-year lending targets.

The Eastern dragon so far performs much better than any recession-stricken nation in the West, where money supply has rocketed to potentially fatal (hyper inflationary) levels. Covering bullet point #3 in their own words, China plays its monetary muscle.

People's Bank of China Monetary Policy Committee recently held a regular meeting on the second quarter of 2009. The conference studies the orientation of monetary policy and measures for the coming future, concluding that we need to implement moderately easy monetary policy and maintain the continuity and stability of policies to guide a reasonable growth in monetary credit.
It is learned that in the first five months, RMB loans increased by 5.84 trillion yuan. June figures have not yet been released, but according to past experience, new credit in the first half of 2009 will definitely surpass 6 trillion yuan, and some experts even predict the figure to be up to 6.5 trillion yuan. This means that total credit in the first half of this year will be more than the total amount invested in any year since China was founded.

2 Ways Through a Recession: China Can Afford It Because of Savings
Show me a Western country that could shell out a trillion Euros/dollars from its full pockets! There is no such thing. All stimulus packages Western politicians promise are only backed by the hope of future tax payments. China can dive through a recession on its savings whereas the so called first world has nothing else to show than debts that are enough of a burden for the two next generations.

Wouldn't we all love to have the same economic discussion as the Chinese where economists argue whether the economy has bottomed out at a growth rate of 6.1% in Q1 2008 or whether one should be skeptical about a possible GDP growth rate of 9%?

Diving into recent history (i.e. this blog's archive) China can actually see the global downturn as a benefit that helps keeping the economy from overheating. BTW, why are we actually concerned with "overheating" economies? Don't we all want to become rich by tomorrow? But I won't digress, this is an entirely different discussion best to be had over a bottle of good plum wine.

Let's better proceed to bullet point #4: China's growing role in forex markets.
Reuters staffers Zhou Xin and Alan Wheatley direct my attention to the fact that China sees a much bigger role of gold in global currency policy after surprising the world with the fact that it had domestically purchased gold and now sits on a hoard of 1,054 tonnes after publishing a figure of 660 tonnes since 2003.

Buy Gold Before China Buys It All

The communist party's chief economist told Reuters the following strategic goals (found on GATA's website):

China should buy more gold because the dollar is poised for a fall and the metal is needed to support the greater international role envisaged for the yuan, a senior researcher with the ruling Communist Party said on Thursday.
Li Lianzhong, who heads the economic department of the party's policy research office, said China should use more of its $1.95 trillion in foreign exchange reserves to buy energy and natural resource assets.
Speaking at a foreign exchange and gold forum, Li also said that buying land in the United States was a better option for China than buying U.S. Treasury securities.
"Should we buy gold or U.S. Treasuries?" Li asked. "The U.S. is printing dollars on a massive scale, and in view of that trend, according to the laws of economics, there is no doubt that the dollar will fall. So gold should be a better choice."

Following the nuances of Chinese official-speak it is clear that China sees itself superior in monetary policy but is left with a problem it shares with all creditors in the world: Its forex reserve stash consists mainly of unbacked Federal Reserve Notes (FRNs), a fiat currency backed by nothing else than the belief it will buy you the same amount of goods and services in the future as it did in the past.

China takes appropriate steps at its own rhythm to secure a bigger role for the Yuan in the future. Looking at the Yuan's slow revaluation so far China has made good on its promises to the bankrupt USA.

The Reuters story sums it up correctly:

Li cited the high share of gold in the foreign exchange reserves of the United States, Italy, Germany, and France to argue that China's gold holdings, which account for about 1.6 percent of its reserves, are too small.
China does not disclose the composition of its currency reserves, but bankers assume around 70 percent is held in dollar assets.
China is the largest single holder of U.S. Treasuries, with $763.5 billion at the end of April, according to U.S. Treasury data.
Analysts say this data set understates the true number as it does not capture paper bought through dealers in London or elsewhere.
Li said a second reason for buying more gold would be in anticipation of the yuan one day becoming a reserve currency.
The yuan is not convertible on the capital account, meaning it cannot be freely traded for other currencies for financial transactions that are not related to trade. This rules out the yuan's use as an international reserve currency, for central banks would not be able to convert it quickly if necessary.
But in a very preliminary step toward that goal, China is paving the way for greater use of the yuan beyond its borders.
The People's Bank of China has arranged currency swap deals with six countries since December totalling 650 billion yuan ($95 billion) so that trade and investment with China can be conducted in yuan, not dollars.
And China will soon allow selected firms in the southern province of Guangdong that trade with Hong Kong to settle their transactions in yuan, or renminbi.
"If the yuan should go international or become a reserve currency, China needs more gold to back that," Li said.

One must not forget that China's political state supports long term strategies for which Western leaders who want to get reelected every 4 years have no leeway.
Reuters fills in here very well too:

When the yuan does become an international currency, which Li acknowledged was a long way off, he said the composition of the SDR should be reformed to include the Chinese currency.
Ideally, in the long term, the SDR would be made up of the dollar, euro, sterling, yen, and yuan, each with a weighting of 20 percent, Li said.
The SDR is currently made up of the dollar (with a weighting of 44 percent), the euro (34 percent), the yen (11 percent), and sterling (11 percent)
The four currencies in the SDR, which must be convertible, are those issued by fund members with the largest share of global trade. The weights assigned by the IMF are based on the value of exports and the amount of reserves denominated in those currencies.
The composition of the basket is reviewed every five years. the next review is due in 2010.

Rest assured that the dragon will blow some hot air down the Western world's spine in the run-up to this review.

This was reposted from Tony Straka's blog, The Prudent Investor.

Obama's Proposal For Requiring Bank "Funeral Plans"

An arguably much needed change outlined in the Obama administration's financial regulation overhaul proposal is the requirement of a "rapid resolution plan". This would provide the government with important information in the event that a systemically important financial institution faces collapse. For more, see the following post by economist Mark Thoma, author of Economist's View.

No disagreement with this. The failure to have dissolution plans for systemically important institutions on the shelf and ready to go turned out to be costly, so credible dissolution plans are certainly needed. However, the argument seems to assume that too big and too interconnected firms cannot be avoided, something I'm not ready to concede:

A sound funeral plan can prolong a bank’s life, by Anil Kashyap, Commentary, Financial Times: Buried within the 88-page Obama administration proposal to overhaul financial regulation is an overlooked option called a “rapid resolution plan”. It mandates that systemically important financial companies be required regularly to file a “funeral plan”: a set of instructions for how the institution could be quickly dismantled should the need to do so arise. ... It could be implemented now, without the need for legislative action. Regulators should do so immediately.

The first benefit is that regulators would gain a stronger negotiating position with a dying institution. Throughout this crisis the authorities have had to intervene without knowing exactly what hidden traps might emerge if a bank were to be closed down. The bankers know this and can exploit the fear of the unknown to press for bail-outs.

It is remarkable that such rules do not already exist. ... The crisis has shown us that the sudden unwinding of a large, complex financial institution is terrifying for the financial system. ...

A second immediate benefit would be to force bank managers to think much more carefully about the complex financial structures they have created. If bankers had to explain every single step needed (and the associated consequences) to shut down their subsidiaries in all the various jurisdictions in which they operate, they would have a big incentive to simplify their organisations. ...

Over the medium term, there would be additional benefits. The headline component of the plan would be the requirement for banks to estimate the number of days it would take to shut down. Banks that require longer to close would have to hold more capital. This would place management under serious pressure to improve their plans...

Senior members of the management team and the board would have to understand the funeral plan. Crucially, they would be forced to sign off on its accuracy. This might also lead to closer scrutiny of new products or lines of business if they jeopardised an orderly unwinding. ...

This proposal is far from a cure-all. One big problem is that resolution rules themselves, especially when multiple legal systems are involved, are quite complicated. But the plan has an extremely high benefit-to-cost ratio and could be put in place right away. ...

This post was republished from Mark Thoma's blog, Economist's View.

Is It Okay To Not Pay The Mortgage If You Are Significantly Underwater?

With large numbers of homeowners in the US underwater on their mortgages, more individuals are choosing to walk away from their mortgage even if they can afford to pay it. It may make financial sense if mortgage principal is $500,000 when the home is valued at $400,000, but is it right to not pay back a loan under these circumstances? The following post from The Mess That Greenspan Made, explores that question.

The Economist looks at the phenomenon of U.S. homeowners who can pay their mortgage, but who choose not to. Apparently, changing cultural norms are playing as big a part on the way down as they did on the way up for the U.S. housing market.

New research based on a survey of 1,000 homeowners suggests that one in four mortgage defaults are “strategic”—by people who could meet their payments but who choose not to. The main drivers of strategic default are the scale of negative equity, and moral and social considerations. Few would opt to renege on their mortgage if the equity gap were below 10% of their home’s value, the authors find, partly because of the costs of moving. But one in six would bail out if loans were underwater by a half.
...
Anger about bail-outs of banks or carmakers does not weaken the moral barrier to default. But people who live in neighbourhoods where home repossessions are frequent are more likely to welsh on loans. Homeowners who know someone who has defaulted strategically are 82% more likely to say they would do so, too. The likelihood of strategic default rises more quickly once the rate of local home foreclosures reaches a critical level. That hints at a vicious cycle of foreclosures that both depress home prices and weaken the social and economic barriers to further defaults.

Cocktail party chatter sure has changed dramatically in the last four or five years - from discussions of "$10,000 a month in appreciation" to how to "walk-away".

This blog post can also be viewed at The Mess That Greenspan Made.

Are The Positive Economic Signs Artificially Created?

Could the signs of economic improvement be a mirage created by the artificial propping up of the economy by unprecedented government intervention? James Picerno from The Capital Spectator explains why we should be suspicious of numbers like the 1.6% increase in disposable personal income.

One day we'll look back on 2009 and wonder what all the confusion was about. All will become clear and we'll know when the recession ended, when the bull market began anew and how and why the cycle turned. Meanwhile, we're wondering if the data du jour can be trusted.

Judging by the numbers of late, clarity is upon us, or so it seems. Income and spending are up among consumers. What's not to like? If this keeps up, we'll be back to the good old days by, oh, let's say the third week of September.

As for what we know today, disposable personal income jumped 1.6% last month on a seasonally adjusted basis, the Bureau of Economic Analysis reports this morning. That's the biggest monthly gain in a year. Not bad for what we've repeatedly been told is the deepest recession since the Great Depression.



That's only half the fun. The government also advises that personal consumption expenditures gained 0.2% in May, the best since February.

Is it a miracle? No, it's just your tax dollars at work. As the BEA noted in its press release today, "the pattern of changes in personal income and in DPI reflect, in part, the pattern of increased government social benefit payments associated with the American Recovery and Reinvestment Act of 2009." In other words, the guys and gals in Washington continue to print money and distribute it, creating a revival that otherwise doesn't exist. The extent of the government's intervention can be surmised once we recognize that wages and salaries actually fell by 0.1% last month.

There are two ways to interpret the news. The optimistic view is that the government's stimulus efforts will steady an otherwise anxious consumer. By putting more money into his pocket, the incentive to spend is heightened and the odds improved that a return to old consumption habits is near. The government payments are a bridge until the day when the private sector can resume more of the burden of financing consumption.

The darker view is that government-financed consumption is a tenuous lifeline that's a pale replacement for the real McCoy. As such, the burning question is one of asking when the labor market will revive? By that standard, there' still reason to be cautious about the remainder of 2009. The recession may be technically over, as we've discussed. But even making that leap of faith offers no short cut to good times.

The job market, after all, is typically the last to show convincing signs of recovery. For that reason, the National Bureau of Economic Research shuns employment trends for putting official dates on business cycle turning points. Minting new jobs, in other words, is usually the response to other economic stimuli. Conventional recoveries, then, don't begin with the labor market. Then again, this isn't a conventional business cycle.

Clearly, the government has moved heaven and earth to keep the economy afloat. Ours is an era of triumph for public-financed consumption. In both magnitude and timeliness, no government has ever acted with greater speed and depth in keeping the forces of contraction at bay. But that raises a question of whether Washington can keep the engineered consumption going long enough to wait for a bonafide economic recovery. We'll have an answer, perhaps soon. But at the moment we're still knee-deep in the first great macroeconomic experiment of the 21st century.

This blog post can also be viewed at The Capital Spectator.

Who Should Be Blamed For Big Bonuses

Many Americans are outraged right now of the report that Goldman Sachs is planning to pay out record bonuses. Although Goldman Sachs denies the report, many are asking how this could possibly happen. Martin Hutchinson from Money Morning explains who deserves the blame.

It’s been in the news the last couple of days. Goldman Sachs Group Inc. (NYSE: GS) bankers are headed for record bonuses. The Financial Times reports that bankers’ pay in the London market is already right back to 2007 levels and going higher. Banks are poaching each others’ best staff, and are offering huge pay packages to staffers willing to make the leap.

It’s enough to make you succumb to the Two Minutes’ Hate.

But let’s face the truth. As egregious as salary escalation seems - coming as it does on the tail of the worst U.S. banking crisis since the Great Depression - the reality is that this is the U.S. government’s fault. After all, it was the U.S. Federal Reserve and the Obama administration that created all the bailouts and the special-loan-subsidy schemes for banks that would otherwise have been on their last legs.

In a truly free market, ex-Citibankers (NYSE: C) would be on every street corner of Manhattan - selling apples - and that would properly hold down the pay of those bankers still lucky enough to have a job.

The sudden rebound in demand for bankers is a symptom of overall market conditions right now. The U.S. stock market is way up from its lows, there are three Chinese initial public offerings (IPOs) due to come to market this week (one of them for a company with no earnings), the volume of home mortgage refinancing has been running at record levels, the FHA index of home prices has dropped only 0.3% this year and the volume of new corporate debt issuance is also high. Commodity prices are well off their lows, and oil prices are again close to $70 a barrel, which would have been considered an excessively high level only three years ago. That’s not a picture of a financial market - or a global economy - in deep recession.

Far from it.

To some extent, this is good news. A revival of the financial system and its ability to finance businesses and home purchases is exactly what the huge monetary and fiscal stimulus was meant to produce. A modest revival in world trade, as inventories cease being wound down and Chinese production ramps up again, is also a necessary precondition for economic recovery.

As the banking bonus news suggests, however, much of the activity is coming in some pretty funny places, where the excesses of the past decade were concentrated and where you wouldn’t expect to see such a quick revival.

That gives us a clear indication of just what the problem is. Because bankruptcies weren’t allowed to happen back in September and October - as they would have in a free market - there are more institutions in the market than there should be, Citigroup and Merrill Lynch most notable among them.

Moreover, in a true free market, the entire credit-default-swap (CDS) business - a product that caused $180 billion of losses to the financial system through American International Group Inc. (NYSE: AIG) - would be nothing but a smoking ruin. But in the market we are living in, those $180 billion worth of losses have been transferred to the tab of the taxpayers of America.

With Citigroup and Merrill Lynch bankers mooching around on street corners, financial sector salaries would be forced down to a more reasonable level. As it is, the few unemployed unfortunates who worked at Lehman Brothers are not enough to depress the market. Likewise, credit default swaps have caused huge pain to the unfortunate employees of Abitibi-Bowater Inc. (NYSE: ABH), General Growth Properties (OTC: GGWPQ), and Six Flags Inc. (OTC: SIXFQ), each of which went bust partly because their creditors were playing in the CDS market and had no incentive to find an alternative to bankruptcy. Had CDS caused the pain they should have to financiers, the product would no longer exist, to the considerable benefit of the rest of us.

Inevitably, we are going to have to pay the price for all the bailouts. The financial sector will eventually shrink to its proper size, as will its members’ earnings. CDS will eventually be sharply restricted, to prevent their holders from forcing random companies into Chapter 11. Interest rates will have to rise, to accommodate the huge debt-funding needs the government has incurred. Money will have to be kept tight, to pay for the indulgences that Fed Chairman Ben S. Bernanke granted during the bubble, as well as for the even greater-indulgences of the bust.

Which is probably why you don’t want to hold U.S. stocks right now.

This article was reposted from Money Morning. You can also view this article at Money Morning's investment news site.

Greenspan Says Stock Market Recovery Could Lift Economy

Alan Greenspan, writing in the Financial Times, argues that a continued recovery by the stock market could lift up the economy. A healthy stock market helps supply banks with capital for lending, increases household spending, and spurs new capital investment, he argues. See below for more on Greenspan's thinking.

Maybe there was a Greenspan put after all?:

Inflation - the real threat to sustained recovery, by Alan Greenspan, Commentary, Financial Times: The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen. Previously capital-strapped companies have been able to raise considerable debt and equity in recent months. Market fears of bank insolvency, particularly, have been assuaged.

Is this the beginning of a prolonged economic recovery or a false dawn? There are credible arguments on both sides of the issue. ...[T]he crisis will end when ...[there is] a stabilisation of home prices or a further rise in newly created equity value available to US financial intermediaries...

Global stock markets have rallied so far and so fast this year that it is difficult to imagine they can proceed further at anywhere near their recent pace. But what if, after a correction, they proceeded inexorably higher? That would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending. Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment. Leverage would be materially reduced. A prolonged recovery in global equity prices would thus assist in the lifting of the deflationary forces that still hover over the global economy.

I recognise that I accord a much larger economic role to equity prices than is the conventional wisdom. From my perspective, they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance sheets. ...

Stock prices, to be sure, are affected by the usual economic gyrations. But ... a significant driver of stock prices is the innate human propensity to swing between euphoria and fear, which, while heavily influenced by economic events, has a life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but major causes of it. ...

He also gives his view of the future inflation threat. I'll just note that I quite agree with Greenspan's assertion that he accords "a much larger economic role to equity prices than is the conventional wisdom."

This was reposted from Mark Thoma's blog, Economist's View.

Why Are Republicans Attacking The Republican Fed Chairman?

Why would Republican law makers want to attack Bernanke, a Republican appointed by President Bush? If Bernanke resigns, Obama could appoint a Democrat as Fed Chairman. Economist Mark Thoma from Economist's View, attempts to explain this counter-intuitive strategy.

The GOP is targeting Bernanke as "a champion of government intrusion and an ally of President Obama":

G.O.P. to Paint Bernanke as Ally of Big Government, by Edmund L. Andrews and Louise Story, NY Times: In a peculiar role reversal, Republican lawmakers are mounting a ferocious attack on the Republican chairman of the Federal Reserve, while Democrats are coming to his defense.

Ben S. Bernanke ... will be grilled on Thursday by the House Oversight and Government Reform Committee about his role in orchestrating Bank of America’s controversial takeover of Merrill Lynch late last year.

The House investigation is heavily colored by partisanship. President Obama is proposing to give the Federal Reserve formidable new powers to regulate giant institutions, including Bank of America, that could pose risks to the financial system.

Republicans, along with some Democrats, argue that the Fed already has too much power.

Unhappy about the huge bank bailouts that the Fed arranged with the Treasury Department during the Bush administration, many Republicans are even more displeased that Mr. Bernanke is now working hand-in-glove with the Obama administration.

The result is a set of dueling narratives and agendas, all of which will be on full display when Mr. Bernanke testifies on Thursday. ...

Despite Mr. Bernanke’s Republican roots, and the fact that President Bush nominated him to be Fed chairman, the Republican memo prepared for the hearing on Thursday describes Mr. Bernanke as a champion of government intrusion and an ally of President Obama. ...

I don't think this is an attempt to negatively influence Obama's decision on Bernanke's reappointment as Fed chair as some have been hinting because that would not be in the GOP's best interest. There are open positions on the Federal Reserve Board, so even if Bernanke didn't resign as is customary in the event he was not reappointed - and nothing says he must - Obama would still be free to appoint a new Fed Chair from outside the present Board membership.

Obama would certainly appoint someone who shares his regulatory vision, and that person would likely be confirmed (e.g. someone like Janet Yellen would likely be confirmed even if there was lots of grumbling), so I don't see how the appointment of a new Fed chair would do anything but strengthen the support for the type of regulatory oversight the administration envisions. That's not what the GOP wants.

Instead, this looks much more like an attempt to by the GOP to maintain its usual anti-regulatory, anti-government stance by arguing that the Fed should not to be trusted with the powers envisioned in the proposed regulatory reform legislation. So the real goal is the Fed as an institution, Bernanke is simply the target being used to make that the point. E.g.:

The vast extent of the Fed’s actions in the past two years to commit trillions of dollars in government money to support the economy has raised significant concerns on Capitol Hill, some of which will be aired on Thursday when Bernanke testifies before the House Committee on Oversight and Government Reform.

Congressional investigators have been looking into the Fed’s role in encouraging Bank of America to purchase Merrill Lynch... Rep. Darrell Issa (R-Calif.), ranking member on the Oversight Committee, said on Wednesday that the Fed engaged in a “cover-up” and hid details about the merger, completed in January 2009, from other federal agencies.

Meanwhile, lawmakers from both parties are raising questions about Obama’s proposal to grant the Fed broad new powers to prevent another crisis.

Those concerns could make the next confirmation process far more contentious than the six that have occurred in the last two decades.

And:

Sen. Jim DeMint (R-S.C.) said, “It won’t be my decision whether he is held over or not, but right now I’m concerned that they have lost their independence and are too cozy with Treasury.”

It looks like we are going to get some version of a strategy that has the GOP saying that given what happened to the financial system, of course we need more oversight and regulation of the financial system. But any particular piece of legislation that is proposed will be fought tooth and nail by the GOP as being far too intrusive, granting the government too much power, and generally going far beyond what is needed to solve the problem. The fact that the will for reform will diminish with time works in their favor, and if they can string things out long enough with this strategy, the result will be that the legislation eventually passes in a much weaker form, or it won't ever pass at all.

Just ignore them. Altering a few words:

The Republicans, with a few possible exceptions, have decided to do all they can to make the Obama administration a failure. Their role in the financial regulation debate is purely that of spoilers who keep shouting the old slogan — Government is always the problem, never the solution! — hoping that someone still cares.

This article was reposted from Mark Thoma's blog, Economist's View.

Warren Buffett Shares His Wisdom On The Current Economic Environment

The amazing Warren Buffett says he likes to spend $5 on lunch, but lunch with Buffett can cost much more. Last year a Chinese businessman bid $2.1 million to have lunch with Buffett. However, you can get some of Mr. Buffett's wisdom for free in the following post.

Berkshire Hathaway CEO Warren Buffett talks with FOX Business Network’s Liz Claman about expensive lunches, his Goldman Sachs investments, the economy, and more.



Some highlights from the Oracle of Omaha after a $5 hamburger...

On whether he will cash out of Goldman Sachs:

No, no, no. I will keep those Goldman warrants right through their full -- they've got four and a quarter years or so to run. But I think we'll make a lot of money out of those.

On the possibility of the United States losing its AAA Rating:

As long as you're issuing money and you're issuing debt in your own currency, you can print money. The U.S. -- no, I think we will have a AAA for not only as long as I live, but as long as you live, which is more important.

Here's part 2...


On whether unemployment will continue to rise:

It’s going higher—business has not bounced back. We have not come off the bottom yet. It will work out in the end. Since 1776 it’s been a mistake to bet against America . America solves its problems. How soon, nobody knows. But we have not come off the bottom yet. And it will work out in the end.

On inflation in the United States :

What we’re doing raises the probability significantly of very significant inflation down the road—not this year or next year or the year after that, but we’ve taken actions and they were appropriate actions… it will have consequences and nobody knows exactly what they will be and how effective we will be at draining a system we’ve been flooding, but the probability of significant inflation has gone up.

Housing Metrics Improved In May But Could Be Temporary

There are some positive numbers coming out of the housing market from May. Sales of existing home prices rose, inventory decreased, and median sales price rose. But will this improvement last in the face of rising mortgage rates? Tim Iacono elaborates on the latest numbers.

The National Association of Realtors reported slightly higher sales of existing homes last month, up 2.4 percent to a seasonally adjusted, annualized rate of 4.77 units in May after a downwardly revised total of 4.66 million units in April.



Inventory declined modestly as the months of supply metric fell from 10.1 months to 9.6 months, still about double the historical average.

The median sales price rose 3.8 percent in May to $173,000, but the year-over-year change worsened to a decline of 16.8 percent. The realtors' trade group also reported a sharp decline in the number of distressed sales, falling to about one-third of all sales versus the 40 to 50+ percent in recent months.

The increase in sales was less than expected due to "poor" appraisals (i.e., ones that come in too low for the bank to confidently make a loan), NAR Chief Economist Lawrence Yun noting:

Lenders are using appraisers who may not be familiar with a neighborhood, or who compare traditional homes with distressed and discounted sales. In the past month, stories of appraisal problems have been snowballing from across the country with many contracts falling through at the last moment. There is danger of a delayed housing market recovery and a further rise in foreclosures if the appraisal problems are not quickly corrected.

It sounds as though not being familiar with the neighborhood might be a good thing if the aim is to get an objective appraisal and that using distressed sales is exactly the right thing to do since these dominate overall sales activity in many areas.

You just can't win as a real estate appraiser in the 21st century...

Importantly, the now two-month long move up in home sales has occurred during a time that mortgage rates were "freakishly" low. In May, the national average for a 30-year fixed-rate home loan was just 4.86 percent, up slightly from the 4.81 percent average in April, but significantly below the current rate of closer to 5.5 percent.

Next month's report should be full of intrigue regarding if and how higher mortgage rates are affecting the sales of existing homes.

This article can also be viewed at Tim Iacono's blog, The Mess That Greenspan Made.

Preventing Regulators From Favoring Commercial Interests

Is Obama's proposal for regulation doing enough to prevent regulators from acting in the best interest of financial companies? That is the question that is posed by WSJ columnist Thomas Frank. Economist Mark Thoma responds to Frank's criticism.

Thomas Frank says the administration's regulatory overhaul plan is not putting enough emphasis on the problem of regulatory capture:

Obama and 'Regulatory Capture', by Thomas Frank, Commentary, WSJ: ...We have just come through the most wrenching financial disaster in decades, brought about in no small part by either the absence of federal regulation or the amazing indifference of the regulators.

This is the moment for a ringing reclamation of the regulatory project. President Barack Obama is clearly the sort of man who could do it. But ... a white paper his administration released on the subject last week ... uses bland, impersonal explanations for the current crisis. Regulatory agencies were ill-designed... Their jurisdictions overlapped. They had blind spots. They had been obsolete for years.

All of which is true enough. What the report leaves largely unaddressed, however, is the political problem. ... The people who filled regulatory jobs in the past administration were asleep at the switch because they were supposed to be. ...

The reason for that is simple: There are powerful institutions that don't like being regulated. Regulation sometimes cuts into their profits... So they have used the political process to sabotage, redirect, defund, undo or hijack the regulatory state since the regulatory state was first invented.

The first federal regulatory agency, the Interstate Commerce Commission, was set up to regulate railroad freight rates in the 1880s. Soon thereafter, Richard Olney, a prominent railroad lawyer, came to Washington to serve as Grover Cleveland's attorney general. Olney's former boss asked him if he would help kill off the hated ICC. Olney's reply ... should be regarded as an urtext of the regulatory state:

"The Commission . . . is, or can be made, of great use to the railroads. It satisfies the popular clamor for a government supervision of the railroads, at the same time that that supervision is almost entirely nominal. Further, the older such a commission gets to be, the more inclined it will be found to take the business and railroad view of things. . . . The part of wisdom is not to destroy the Commission, but to utilize it."

The George W. Bush administration elevated this strategy to a snickering, sarcastic art form. It gave us a Food and Drug Administration that sometimes looked as though it was taking orders from Big Pharma, an Environmental Protection Agency that could never rouse itself from the recliner, an energy policy that might well have been dictated by Enron, and a Consumer Product Safety Commission that moved like a rusty wind-up toy.

And it created a situation where banking regulators posed for pictures with banking lobbyists while putting a chainsaw to a pile of regulations. ...

Misgovernment of this kind is not a partisan phenomenon, of course. Democrats have been guilty of it as well as Republicans. ... Yet today we talk around this problem, with its nose-on-your-face obviousness, as though it didn't exist. It's not until page 29 of the Obama administration's densely worded white paper that you find a reference to "regulatory capture," and then it is buried in a list of items to be considered by a future Treasury working group. ...

[T]he administration must go further. ... After all, the Bush team was only able to install the dreadful regulators it did because the governance of federal agencies was rarely a topic of public debate in those days. Mr. Obama should make it an unavoidable subject, something that future politicians will be required to address. The issue cries out for it. And the nation, for once, is listening.

I see this a little bit different. I think the regulatory capture that helped to open the door for the current crisis had more to do with the adoption and promotion of free market ideology and the culture that ideology brought about within the regulatory bodies than to direct capture by regulated industries.

The financial industry certainly promoted the free market, self-healing, self-regulating approach since it coincided with their interests in shedding regulatory constraints, and they also aided politicians who promoted these ideas. Those politicians, in turn, made appointments to key positions within regulatory agencies that were designed to further this ideology and that, too, contributed to the changing culture within the regulatory bodies.

But the idea that, in almost all cases cases markets will self-correct and self-regulate, and that society is best served with a hands off approach to these markets, did not originate within industry. It came from a dominant strain of economic thought supported by theoretical models and empirical evidence. Without the support of these models, the empirical evidence, and the many economists who carried the message - and most of the profession did - it would have been much more difficult for industry to successfully promote the "deregulation is good for everybody always and everywhere" within the political and regulatory arenas.

I don't want to be mistaken here, I still believe that most markets function well with minimal regulation, and that a hands off approach is generally best. But I hope we have learned that financial markets are not among the markets for which this is true. I also hope that, as a profession, we will be more receptive to the idea that markets can fail, and can do so catastrophically, that we will build models that help us to better understand how to minimize the risk that markets will break down, and more importantly that we will interpret data with this in mind. All of the data in the world is useless if you cannot see, refuse to see, or cannot accept what it is trying to tell you.

This article was reposted from Mark Thoma's blog, Economist's View.

Why A 'Jobless Recovery' Is Likely

Yesterday the World Bank warned of a long and painful recovery in most developed economies, echoing Bernanke's hints of a "Jobless Recovery". Martin Hutchinson from Money Morning gives 4 reasons that suggest a painfully slow economic recovery. See his argument below.

When the Labor Department recently reported that U.S. payrolls fell by 345,000 jobs in May - the lowest total in eight months - commentators were suddenly spotting “green shoots” of economic recovery virtually everywhere they looked.

Given that more than $800 billion of federal money has been earmarked for U.S. “stimulus” projects, one would actually expect that the frightening job losses of the past six months would quickly reverse, and that the U.S. economy would soon start creating the 3 million jobs that U.S. President Barack Obama has promised.

Unfortunately, that has not been the case.

That’s not to say that the outlook is for a Great Depression, an economic reversal in which a country’s output plummets by 25% or more from its peak level. While the current U.S. recession may well be the “worst since the Great Depression,” it’s becoming clear that the peak-to-trough output decline will be something like 5% - worse than the recessions of 1973-75 and 1980-82, both of which saw output declines of about 3.5%, but not all that much worse.

After all, the money supply has not been allowed to collapse as it did during the 1930s and there has been no repetition of the infamous Smoot-Hawley Tariff Act, though the “Buy America” provisions in the original stimulus outline and the corresponding “Buy China” provisions in China’s corresponding package indicate that “Smoot-Hawleyism” still lurks just beneath the surface.

However, the following four factors make it almost certain that the U.S. economy will be slow:

• Record-low interest rates make it impossible for the U.S. central bank to use rate cuts to jump-start growth.

• The huge U.S. budget deficit will force the federal government to continue its heavy borrowing - potentially “crowding out” private-sector players seeking loans to finance their own growth.

• The growing size and influence of the U.S. public sector.

• And an over-growth of government regulation.

Let’s consider each one.

First and foremost, the U.S. Federal Reserve has loosened money supply inordinately over the last year, with short-term interest rates at 0.00% and money supply growth at 15% per annum. Thus, there is no Fed loosening available to spur employment.

Interest-rate-sensitive sectors - especially housing and construction - are likely to remain depressed for years. These sectors are major employers of low-skilled and semi-skilled labor, which will not be picking up their normal slack.

A second adverse factor is the exceptionally large federal budget deficit - expected to reach $1.85 trillion, or 13% of the U.S. economy, in this year alone, according to the nonpartisan Congressional Budget Office (CBO). That deficit will stretch several years into the future, thanks to the stimulus package and various bailouts initiatives.

In the short term, these rescue-oriented provisions have helped U.S. employment, not the least by allowing federal and state governments to do some hiring. But in the longer term, the federal borrowing they have caused will restrict the private sector’s access to the capital markets. That will hinder small businesses in particular. Indeed, the private sector will find it difficult to fund capital expansion, and again the result is likely to be a dearth of hiring.

A third adverse factor is the expansion of the public sector itself. To some extent, it does not matter how budget deficits are financed; the important consideration is the transfer of resources from the private sector - allocated by the automatic optimization of the so-called “price mechanism” - into the public sector, where no such considerations apply.

It’s not just a question of government itself; it’s now clear, for example, that Chrysler LLC and General Motors Corp. (OTC: GMGMQ) are to be controlled by the government - with subsidies - at our expense.

When General Motors announces, as the company did Wednesday, that it will build automobiles on the basis of an assumed oil price of $100-$120 per barrel, one sees at once a politically motivated strategy; GM will cease making the large cars that in the past have been its principal source of profit. If oil prices average $50 or less, as is perfectly possible in a long period of sluggish global growth, General Motors will be a mess - and will need to be bailed out by us again.

The late William F. Buckley Jr. once claimed that 500 names chosen at random from the Boston telephone book could do a better job of running the country than Congress; I wouldn’t mind betting that such a random selection would also make a better job of running General Motors than the government.

Related to the growth in government is the growth in regulation. For example, President Obama’s “cap-and-trade” plan to address global warming will impose a new tranche of costs on the U.S. economy, without any great offsetting spurs to employment. In areas such as energy production and heavy industry, employment will be depressed by the additional cost burdens those areas bring, as well as by the simple difficulty of complying with the new regulations.

To see where a larger state sector and more regulation can lead, one need only look at the European Union (EU). Whereas U.S. unemployment was below 5% for much of the last decade, the lowest rate reached since 2000 was 8.8% in the EU. What’s more is that certain areas of the EU have much worse records than this.

In Spain, for example, unemployment was close to 20% for much of the 1980s and 1990s, and has now soared once again to no less than 18.2%. The EU is not ensconced in a Great Depression and Spain remains a relatively wealthy country; nevertheless, the rigidities in the European system are such that unemployment remains persistently high, with adverse social effect, such as the rioting in the Paris banlieus.

The European Commission (EC) recognized this problem as early as the 1980s, and has been gradually pushing Europe towards the more open U.S. labor market, with only moderate success.

Because of over-loose money, excessive budget deficits, growing government and impending regulation, it is thus unlikely that the U.S. economy and its job market will bounce back as quickly as it has in the past.

The investment “takeaway” from this is obvious, I fear: A substantial part of one’s money should be invested in the free-market economies of East Asia, where regulation and taxation are lower, so even though a recession has also hit, recovery is likely to be much more robust.

This article can also be viewed at Money Morning's investment news site.

Big Week For US Dollar and Euro

How will the sell off of a record $104 billion in US Treasury notes affect the strength of the dollar? Meanwhile in Europe, Germany is facing a record debt of it's own. Forex expert Kathy Lien tells us what we should watch for this week in the foreign exchange market.

German business confidence improved marginally which should have been bullish for the euro, but unfortunately the most actively traded currency pair in the forex market has remained under pressure throughout the European and U.S. trading sessions. So if the EUR/USD is not responding to economic data then what is driving it lower?

Five factors:

1. U.S. Treasury Auction

One of the big focuses of foreign exchange traders this week is the massive Treasury auction. The U.S. government will be issuing a record $104 billion of 2 year, 5 year and 7 year Treasury notes between Tuesday and Thursday. The reason why currency traders are watching these auctions is because of its scale and also because it will shed some light on investor’s willingness to fund the U.S.’ large and growing budget deficit. The auctions will be a big hurdle for the U.S. dollar this week because if demand comes up short, the dollar could get hit but it is not that simple because at the same time, weak demand could drive up yields, which is dollar positive. Either way, over the next couple of days, there will be a lot of focus on the Treasury auctions.

2. First ever 12 month ECB refinancing

The ECB refinancing is the biggest story for the EUR/USD this week because the 12 month offer is seen by bond traders as a quasi quantitative easing effort by the ECB because the operations are most likely going to be collateralized by government bonds which can then be posted as collateral to the ECB for funding. Although ECB President Trichet warned that their monetary policy actions can be easily unwound if needed, he also said that policy makers must remain alert despite signs that the slump is decelerating because “there are still risks of a sudden emergence of unexpected financial turbulence.”

3. Fears that German Debt Could Explode

As for Germany, Deputy Finance Minister Werner Gatzer said that total new debt could exceed EUR100 billion next year, which would be much larger than this year’s record financing needs of EUR80 billion. Looking ahead, we could see further weakness in the EUR/USD if Tuesday’s PMI figures fall short of expectations. Despite the improvement in business confidence, which was driven entirely by the expectations component of the report, current conditions remain weak.

4. Comments from ECB President Trichet

Although ECB President Trichet warned that their monetary policy actions can be easily unwound if needed, he also said that policy makers must remain alert despite signs that the slump is decelerating because “there are still risks of a sudden emergence of unexpected financial turbulence.” These bearish comments came after ECB member Nowotny said this morning that interest rates could remain unchanged into 2010.

5. Tuesday’s PMI numbers

However in the near term, weaker economic data could keep the EUR/USD pressured. German industrial production, factory orders and retail sales have all declined which could prevent a meaningful pickup and possibly even deterioration in manufacturing and service sector PMI.

This article can also be viewed at Kathy Lien's foreign exchange blog.

Why Deflation Is More Likely Than Inflation

While many fear the possibility of inflation, Alan S. Blinder, Princeton professor and former economic adviser to President Clinton, explains why he is not worried about inflation. He argues that deflation is currently a greater danger. To learn why see the following from Economist's View.

Alan Blinder isn't worried about inflation:

Why Inflation Isn’t the Danger, by Alan S. Blinder, Economic View, NY Times: Some people with hypersensitive sniffers say the whiff of future inflation is in the air. ... Concluding that the Fed is leading us into inflation assumes a degree of incompetence that I simply don’t buy. Let me explain.

First, the clear and present danger, both now and for the next year or two, is not inflation but deflation. ... Core inflation near zero, or even negative, is a live possibility for 2010 or 2011.

Ben S. Bernanke ... and his colleagues have been working overtime to dodge the deflation bullet. To this end, they cut the Fed funds rate to virtually zero last December and have since relied on a variety of extraordinary policies known as quantitative easing to restore the flow of credit. ... But quantitative easing is universally agreed to be weak medicine compared with cutting interest rates. So the Fed is administering a large dose — which is where all those reserves come from.

The mountain of reserves on banks’ balance sheets has, in turn, filled the inflation hawks with apprehension. ... Will the Fed really withdraw all those reserves fast enough as the financial storm abates? If not, we could indeed experience inflation. Although the Fed is not infallible, I’d make three important points:

• The possibilities for error are two-sided. Yes, the Fed might err by withdrawing bank reserves too slowly, thereby leading to higher inflation. But it also might err by withdrawing reserves too quickly, thereby stunting the recovery and leading to deflation. I fail to see why advocates of price stability should worry about one sort of error but not the other.

• The Fed is well aware of the exit problem. It is planning for it... It might miss and produce, say, inflation of 3 percent or 4 percent at the end of the crisis — but not 8 or 10 percent.

• The Fed will start the exit process when the economy is still below full employment and inflation is below target. So some modest rise in inflation will be welcome. The Fed won’t have to clamp down hard.

...But if the inflation outlook is so benign, why have Treasury borrowing rates skyrocketed in the last few months? Is it because markets fear that the Fed will lose control of inflation? I think not. Rising Treasury rates are mainly a return to normalcy.

In January, the markets were expecting about zero inflation over the coming five years, and only about 0.6 percent average inflation over the next decade. The difference between then and now is that markets were in a panicky state in January, braced for financial Armageddon; they have since calmed down.

My conclusion? The markets’ extraordinarily low expected inflation in January was both aberrant and worrisome — not today’s. As long as expected inflation doesn’t rise much further, you should find something else to worry about. Unfortunately, choices abound.

This post can also be read at Economist's View.

What Decreasing Continuing Claims Mean For The Economy

Could the unexpected decline in continuing claims be evidence that the economy is turning around? Looking back at data from past recessions can uncover patterns that foreshadow the end of a recession. Kathy Lien has found such a pattern that may be good reason for optimism.

We had a number of surprises in U.S. economic data this morning including the Philly Fed index and leading indicators, but the biggest surprise was definitely the decline in continuing claims. Since the beginning of the year, continuing claims, which measures the number of people continuing to claim unemployment benefits rose week after week, forecasting the rapidly rising unemployment rate. Initial jobless claims are important as well, but they can be noisy and volatile.

There are 2 reasons why continuing claims has fallen - 1) people who have been on the unemployment rolls for a long time are falling off because they are no longer eligible for unemployment benefits 2) less companies are firing and more companies are hiring. I think that the latest improvement is a combination of both but regardless, a peak continuing claims always coincides with an end to the recession.

In the following chart, I have highlighted the trend of continuing claims at the end of each U.S. recession over the past 3 decades. As you can see, claims have always stabilized or peaked at the end of the recession. The lag between the end of the recession and the official peak in claims has ranged from 0 to 3 months.



This leads to the question of how the dollar performs after a recession. I did some research into this a month ago and posted my take on FX360.com (How Does the Dollar Perform after a Recession?):

In the past 30 years, there have been 3 recessions. The most recent lasted from March 2001 to November 2001, a period of 8 months. The one prior to that was in the early 1990s which lasted from July 1990 to March 1991. The current recession has been most commonly compared to the recession in the 1980s, which started in July 1981 and lasted until November 1982, a period of 14 months. We thought it would be interesting to see if there was a consistent trend in dollar after recessions and unfortunately based upon the limited data set of 3 recessions, we have found that the only pattern is the weakness of the dollar against the Japanese Yen 12 months after the recession. When the 2001 recession ended, the dollar traded higher against both the euro and Japanese Yen for the first 3 months but then gave back its gains over the next 8 months. In the 1990s, the dollar traded higher against the euro but lower against the Japanese Yen the first 3 months after the recession ended. The dollar fell further against the Yen but recovered its losses against the euro over the next 8 months. In the 1980s, the dollar fell in the first 3 months after the recession and continued to fall over the next 8 months against the Yen but recovered its losses against the euro.

This post can also be viewed at Kathy Lien's blog.

Healthcare Reform Could Push The US Over The Edge

Kenneth Rogoff, Harvard professor and former chief economist of the International Monetary Fund, warns that expensive healthcare reform could lead to a financial crisis worse than we are currently experiencing. However, University of Oregon economics professor Mark Thoma disagrees with the assumption that reform would necessarily increase costs. See the following for a summary of Rogoff's commentary and Thoma's response in the following post from The Economist's View.

Kenneth "The Hawk" Rogoff:

America should also look to its fiscal health, by Kenneth Rogoff, Commentary, Financial Times:
America desperately needs a better framework for providing healthcare and Barack Obama’s administration is right to press on for change... Yet given the explosion of the federal debt, it is extremely important to craft a plan that will not excessively risk the government’s own fiscal health. The risks cannot easily be overstated.

The US government is already entering a prolonged period where it is extremely vulnerable to a loss in investor confidence from the Chinese and other main holders of its Treasury securities. Foreign investors are rightly concerned about the deeply ingrained reluctance of Americans to tax themselves. The last thing the US needs is to be viewed as one giant California, rich but unwilling to pay enough taxes to fund the services its citizens demand. A sharp rise in taxes to pay for healthcare initiatives could potentially weaken the credibility of the government’s promise to raise taxes as needed to pay off debtors. ...

[I]n principle, fixing the imbalances in the Social Security and, especially, the Medicare programmes could provide a powerful offset to the huge increase in debt burdens visited by the financial crisis.

Unfortunately, the idea that healthcare reform will alleviate debt problems rather than exacerbate them is far-fetched..., many proposed healthcare reforms are more likely to worsen the government’s budgetary health than to improve it. This should hardly be surprising, given that a main purpose of reform is to help provide better care for Americans who cannot afford insurance.

Higher taxes to pay for healthcare are also likely to reduce US growth, making it far more difficult to escape the debt trap. This comes at a time when other policy initiatives, such as tackling environmental degradation and income inequality, are also likely to imply higher tax burdens... In addition, the continuing weakness of the financial sector weighs on growth, and it is by no means clear yet when and how some semblance of normality will be restored. ...

All of these considerations appear to underscore the importance of finding ways to keep the new health plan from being overly burdensome, and to avoid unduly optimistic projections on efficiency savings. Healthcare reform is no substitute for finding a credible path to fiscal sustainability. ...

Make no mistake, the US and much of the developed world is in a frighteningly precarious fiscal state. ... It is a disgrace that the world’s richest country cannot provide reliable basic care for its poorest citizens. But if the politics of reform produces too extravagant a plan when the nation’s fiscal health is already so weak, the US may experience a form of financial crisis even more virulent than the one it is recovering from. Any healthcare plan would then be dead on arrival.

Setting the fear mongering about the future aside - and there's no evidence in long-term interest rates that financial market participants are worried about these issues - here are a few things to keep in mind when thinking about health care reform First, it is not a demographic problem. This graph is from a CBO presentation on this point, and is fairly self-explanatory:



Second, rising health care costs is not just an issue for Medicare and Medicaid, the same rise in costs is also projected to hit private sector health care. Again, from the CBO:



Projected Spending on Health Care Under an Assumption That Excess Cost Growth Continues at Historical Averages (Percentage of GDP)

Going back to the question of the effect of health care reform on the long-run budget, though expanding coverage will expand increase the total amount of medical care that is provided, and hence increase costs, there seems to be some confusion between expanding overall coverage and simply moving the dividing line between the public and private sectors upward so that the public sector expands and the private sector contracts by the same amount. Changing the dividing line, all else equal, simply changes how the bills are paid, it has no effect at all on the overall health care burden that people face (it moves the dividing line in a graph like the one above showing the public and private sectors explcitly without changing the total area). So it's hard to see why higher taxes driven by this type of a change would have the negative economic effects Rogoff is worried about.

But he is more worried that expanding the size of the public sector both by moving the dividing line up and by including more people - the latter in particular - will increase increases health care costs and add to the debt burden, which in turn would require higher taxes. Is that true? It would if the only effect of the expansion of the public sector was to increase the number of people receiving care, and his claim that costs won't fall, or at least not by much, presumes this is how it will work. But when we look at other countries that have substantially expanded the public sector we see lower costs - on the order of 50% lower - and no reduction in the quality of the care that people receive. That's a huge reduction in costs, a reduction large enough to allow a significant expansion of coverage without increasing costs at all. I don't think we'll reduce costs by that magnitude, 50% seems like a lot to hope for, but it does imply that it's possible to reform the system without compromising quality or experiencing the dire consequences Rogoff fears.

This article has been reposted from the Economist's View. The full post can also be viewed on the Economist's View.

Adjustable Rate Mortgages Could Fuel The Next Wave Of Foreclosures

The record number of foreclosures may not include a large pool of adjustable rate mortgages that are scheduled to increase in the next few years. This ticking time bomb could cause an aftershock of foreclosures hitting the market in the future, even after the current wave ends. Dan Rafter from Mortgage Roadmap explains.

I'd like to think that we've seen the worst of the foreclosure crisis. I'd like to think that we'll be seeing fewer homes fall into foreclosure, and fewer homeowners missing their mortgage payments.

I'd like to think all that. Unfortunately, I can't.

What I really think is that the number of housing foreclosures is only going to rise in the coming months. And, unfortunately, many economic analysts agree with me.

A story in the Miami Herald focuses on the plight of homeowners who during the housing boom took out option adjustable rate mortgages. In these type of loans, borrowers can decide to pay less than what their monthly balance is. The difference is simply added to borrowers' outstanding loan balances.

The big problem — other than the fact that too many borrowers have delayed paying down the principal on their mortgage loans by using these products — is that many of these option adjustable rate mortgages are set to adjust to higher interest rates between 2009 and 2012. Many homeowners won't be able to make the higher monthly mortgage payments that result. At the same time, they won't be able to refinance because they won't have paid off enough on their home loans.

Because home values have fallen drastically over the last two years, many homeowners with these mortgage products will actually owe more on their homes than what they are worth.

Some financial experts believe that the wave of foreclosures we'll see from these loans will rival or better the wave we're seeing now.

This, of course, is just more bad news for an industry that's already reeling.

This article can also be viewed at Mortgage Roadmap.

Why Hyperinflation Is Unlikely

While there have been concerns about hyperinflation of late, there hasn't been much evidence of actual inflation. Tim Iacono from The Mess That Greenspan Made argues that we will probably never see an annual double-digit inflation rate. See the following article to find out why.

Some looked at the inflation statistics released by the Labor Department earlier today and said, "See? Deflation is here!"

Others looked at the same set of price data and replied, "See? Inflation is stirring".

They can't both be right, but they can both be wrong (or at least early).

The annual rate of inflation, measured against the price level of May 2008 (back when gasoline and other commodity prices were soaring), came in at less than minus one percent causing deflationists around the world to rejoice, yet stop short of getting out the bubbly.

Why?

Because, so far, this deflation is the Japanese variety, a wimpy version of the much more serious double-digit deflation as seen in the 1930s which, unfortunately, most deflationists fail to understand is no longer within the realm of the possible, unless of course we go back to something like a gold standard instead of printing up new money by the trillions of dollars to replace the dollars that are being vaporized in the ongoing waves of credit destruction.

Then again, since the Consumer Price Index has been effectively neutered by a 25 percent weighting of owners equivalent rent that, while purportedly representing homeownership costs, instead serves to dampen reported inflation. No matter what home prices or mortgage payments do, owners equivalent rent always seems to rise at an annual rate of two percent (even when home prices are falling by ten times that amount) serving as an anchor on the government inflation data.

Due to owners' equivalent rent, the U.S. may never see another double-digit annual rate of inflation - positive or negative.

These days, as far as government reported inflation is concerned, it's all about energy prices and, there, those seeing deflation have something to look at.



Most of the year-over-year change in the overall consumer price index is either directly or indirectly related to the energy price peak last summer and comparisons to it, serving to distort whatever meaning the price index still contains.

But, the intriguing aspect of this morning's report on consumer prices is that you can see in-flation in the data too. After all, gasoline prices have soared more than 70 percent from about six months ago demonstrating the very real difference between $35 a barrel oil and the much more dear $70 type.

Inflationists (and the much more rabid "hyper-inflationists") look at this recent rise in energy prices and figure it to be a sure sign of things to come, what with all the government money printing that has occurred lately - a lot of the newly printed money seems to be going into the black goo.



Anything that doubles in price over a six month period should grab your attention and, whether or not crude oil prices remain lofty in the months ahead is anything but assured, but it's important to remember that present day oil prices are still more than 200 percent higher than the average of the last few decades.

That was the era of modest inflation that many people naively think we're about to return to.

But, that period was really just a fluke.

Never again will the world have cheap, plentiful oil at the same time that clothes, electronics, and other goods are produced at cut-rate prices in the East, only to be sold in the West, and subsequently included in the West's inflation data.

Those seeing inflation in today's data see a world where prices are very different than they were in the latter years of the 20th century, the late-2008 plunge in prices being just a temporary setback to the inevitable higher prices to come.

In the scheme of things, what happened from early-2008 to early-2009 will probably prove to be quite irrelevant - either a blip that quickly fades from memory or a blip that is eventually dwarfed by other much larger blips.

It's way too early to tell.

However, what is quite easy to discern after the last year or so of price data, is that we've entered a very different world of consumer prices and even owners' equivalent rent may not be able to dampen the effects of the price moves in the years ahead.

We probably won't know for sure until sometime in 2010 whether we'll get debilitating deflation or hyper-inflation, though both remain unlikely, at least in my view.

The current inflation numbers are largely meaningless and anyone who reads too much into them does so at their own peril.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

A Period of Economic Transition

With the prevailing wisdom pointing toward an economic recovery in the near future, the economy is likely entering a transitional period. The longer than average recession will probably mean a longer than usual transitory period. James Picerno from The Capital Spectator discusses what this transitory state could look like.

Flat to a slight upside bias. That about sums up the prevailing state of inflation at the moment, based on this morning's latest from the U.S. Bureau of Labor Statistics.

Seasonally adjusted consumer inflation rose 0.1% last month, up from zero the month before and a modest decrease in March. On its face, that's good news, as it suggests that the risk of deflation, if not quite passed, is looking more and more like a shadow of its formerly threatening self. Meanwhile, inflation as a clear and present danger also remains thin as an imminent menace.

We are in a transitory state, passing from severe danger to something less so. Anything's possible, of course, especially in the current climate. But barring some extraordinary and largely unexpected event, we're likely to press on through what we'll call a pre-recovery period, when the economic numbers improve relative to the recent past yet the numbers don't quite show the traditional bounce that typically accompanies the end of recessions.

"The economy seems to be out of intensive care," says David Shulman, senior economist at UCLA Anderson School of Management. "The freefall stage in dropping output and employment seems to be over, but the economy is still sick."

The prospect of false starts in the data looks quite high in the months ahead. The good news on one day will be reversed by bad news the next, and quite a bit of treading water at other times. The transition state that carries us from recession to growth, in short, will last longer than usual. The evidence will be particularly obvious in the lagging indicators, employment being the most conspicuous example. Indeed, the labor market is still shrinking and will probably continue to do so in the months ahead, perhaps followed by an extended bottoming-out period over several quarters. The economy's capacity to create jobs is likely to come later and be more tepid than has typically been the case following the end of recessions in the post-war era.

Extending the medical metaphor, Bruce Kasman, chief economist for JPMorgan Chase, predicts in BusinessWeek.com yesterday that "the economy will return to growth but not to health."

Last week we wrote of the "technical end" of the recession and our expectation that NBER would eventually get around to declaring the downturn's finish at, well, right about now, give or take a few months. That's good news relative to the recent standard of economic activity. But the technical demise of the recession isn't likely to bring easily recognizable good news on Main Street anytime soon.

As frustrating as that outlook is, it's even more hazardous than is generally recognized. If we're facing an unusually long transition period, there are specific risks linked to this abnormal state of affairs. That includes figuring out how and when to adjust monetary policy to balance two conflicting forces: deflation and inflation. As the former gives way, the latter isn't likely to suddenly pop out and yell "boo." Nonetheless, the future inflation risk isn't trivial, given the massive liquidity that's been created of late and the historical lessons that go with fiat currencies. As we discussed on Monday, the elevated risk this time around will be one of deciding magnitude and timing in adjusting monetary policy going forward. That's always a challenge, although it's likely to be especially problematic in the quarters ahead. Tightening monetary policy too soon may risk choking off a nascent but weak recovery; waiting too long to raise interest rates may give inflation a solid foundation to thrive, an especially troubling thought, given the massive amount of debt incurred over the last 12 months or so.

Overall, economic analysis faces unusually tough times in reading the incoming data and drawing reasonable conclusions about the implications for the future. As a basic example, our proprietary index of economic indicators, published in each issue of The Beta Investment Report, is currently flashing a robust sign of recovery, although this may be misleading because much of the rise has come from monetary policy and, so far, isn't convincingly corroborated in the real economy.

In short, interpreting the economic outlook promises to be quite difficult going forward, much more so than usual. Beware: The risk of false dawns is rising.

This post can also be viewed on capitalspectator.com.

George Soros and Robert Reich: How To Reform The Financial System

Two very smart financial minds, legendary currency trader George Soros and former Secretary of Labor Robert Reich, share how they would reform the financial system. The people in charge of this momentous task would be wise to listen to what Soros and Reich propose. See the following post by Economist Mark A. Thoma from The Economist's View.

First, Robert Reich:

The Three Essentials of Financial Reform, by Robert Reich: As the White House unveils its long-awaited proposals to prevent another Wall Street meltdown in the future, keep a lookout for three essentials. Without them the Street will revert to its old ways as soon as the coast clears. ...

1. Stop bankers from making huge, risky bets with other peoples’ money. At the least, require they back their bets with a large percentage of their own capital, and bar them from raising money off their balance sheets through derivative trades. Also require they take their pay in stock options or warrants that can’t be cashed in for at least three years, so they’ll take a longer-term view. Best of all would be a requirement that investment banks return to being partnerships and the capital on their books be their own, not yours or your pension fund’s. When investment banks were partnerships, every partner took an active interest in what every other partner and trader was doing. The real mischief started once they started selling shares to the public.

2. Prevent any bank from becoming too big to fail. Separate commercial from investment banking... Combining the basic utility with the casino only made bankers far richer and subjected you and me to risks we didn’t bargain for. If separating commercial from investment banking isn’t enough to bring all banks down to reasonable size, use antitrust laws to break them up.

3. Root out three major conflicts of interest. (1) Credit-rating agencies should no longer be paid by the companies whose issues are being rated; they should be paid by those who use their ratings. (2) Institutional investors like pension funds and mutual funds should not be getting investment advice from the same banks that profit off their investments... (3) the regional Feds that are responsible for much bank oversight should no longer be headed by presidents appointed by the region’s bankers; non-bankers should have the major say, and the regional presidents should have to be confirmed by the Senate.

..[T]he big bankers will fight every one of these with all guns blazing, and their lobbyists in full force. ... Bottom line: Genuine financial reform will be almost as difficult to achieve as real universal health care. Immense private interests are amassed against the public interest in both cases because staggering amounts of money are at stake. ...

Second, George Soros:

The three steps to financial reform, by George Soros, Commentary, Financial Times: ...I am not an advocate of too much regulation. ... While markets are imperfect, regulators are even more so. ... Three principles should guide reform. First, since markets are bubble-prone, regulators must accept responsibility for preventing bubbles from growing too big. Alan Greenspan ... expressly refused that responsibility. ...

Second,... we must also control the availability of credit..., we must ... use credit controls such as margin requirements and minimum capital requirements. ... Margin and minimum capital requirements should be adjusted to suit market conditions ... to forestall ... bubbles.

Third, we must reconceptualise the meaning of market risk. The efficient market hypothesis postulates that markets tend towards equilibrium and deviations occur in a random fashion...

But the efficient market hypothesis is unrealistic. Markets are subject to imbalances... If too many participants are on the same side, positions cannot be liquidated without causing a discontinuity or, worse, a collapse. In that case the authorities may have to come to the rescue. That means that there is systemic risk ... in addition to the risks most market participants perceived prior to the crisis.

The securitisation of mortgages added a new dimension of systemic risk. Financial engineers claimed they were reducing risks through geographic diversification: in fact they were increasing them by creating an agency problem. The agents were more interested in maximising fee income than in protecting the interests of bondholders. ...

To avert a repetition, the agents must have “skin in the game” but the five per cent proposed by the administration is more symbolic than substantive. ...

It is probably impractical to separate investment banking from commercial banking as the US did with the Glass Steagull Act of 1933. But there has to be an internal firewall...

Finally, I have strong views on the regulation of derivatives. The prevailing opinion is that they ought to be traded on regulated exchanges. That is not enough. The issuance and trading of derivatives ought to be as strictly regulated as stocks. ... Custom made derivatives only serve to improve the profit margin of the financial engineers designing them. In fact, some derivatives ought not to be traded at all. ... Consider the recent bankruptcy of AbitibiBowater and that of General Motors. In both cases, some bondholders owned CDS and stood to gain more by bankruptcy than by reorganisation. It is like buying life insurance on someone else’s life and owning a licence to kill him. CDS are instruments of destruction that ought to be outlawed.

Third, in response to this, and more generally to the recent argument that calls to extend regulation to the shadow banking sector are unfounded because this sector had nothing to do with the crisis (which is incorrect), for the second time recently here's well-know socialist sympathizer Robert Lucas, the Nobel prize winning economist at the University of Chicago. It seems he also favors extending regulation to the unregulated banking sector:

The regulatory structure that permitted these events to occur will have to be redesigned... The regulatory problem that needs to be solved is roughly this: The public needs a conveniently provided medium of exchange that is free of default risk or "bank runs." The best way to achieve this would be to have a competitive banking system with government-insured deposits.

But this can only work if the assets held by these banks are tightly regulated. If such an equilibrium could be reached, it would still be possible for an institution outside this regulated system to offer deposits that are only slightly more risky but that also pay a higher return than deposits at the regulated banks. Some consumers and firms will find this attractive and switch their deposits. But if everyone does, the regulations will no longer protect anyone. The regulatory structure designed in the 1930s seemed to solve this problem for 60 years, but something else will be needed for the next 60.

And you don't need everyone to switch, just enough to create systemic risk.

This article has been reposted from the Economist's View. The full post can also be viewed on the Economist's View.

China Keeps Their Word: Sells Off US Treasuries

As advertised, China has decreased their holdings in US Treasury securities according to US government data. This decline actually started in April and ended a long trend by China of increasing US Treasury holdings. For more on this see the post below by Tim Iacono from The Mess That Greenspan Made.

Brad Setser over at the Council on Foreign Relations offers the following illustrative graphic along with three quick points about the April decline in treasury holdings by the Chinese:




While the net decline of some $4 billion is not all that significant in the scheme of things, there has been a dramatic change to the "second derivative" of their U.S. debt accumulation in recent months (a "rate-of-change" yardstick that has been increasingly popular lately), a development that is well worth noting.

This report in CHINADaily adds a few insights:

For the first time in 11 months China's holdings of US Treasury bonds fell - to $763.5 billion in April, US government data showed.

The figure, down from March's $767.9 billion, was the lowest since June 2008.

They do not include US Treasury bond holding in Hong Kong Special Administrative Region, which climbed to $80.9 billion in April from $78.9 billion the previous month.

The decline in the China holding "seems to stem from net selling of Treasury bills," said Chirag Mirani of Barclays Capital Research.

Now, those are not words that any U.S. policymaker wants to see appearing in the same sentence - "net selling of Treasury bill" and "China".

It's all about funding our huge deficits to perpetuate life as we've all come to know it...

As the largest holder of US Treasury bills, which are crucial to funding Washington's multi-trillion-dollar recovery plans, China had expressed concerns recently over what it called the safety of its dollar-linked assets.

US Treasury Secretary Timothy Geithner traveled to Beijing about two weeks ago to reassure Chinese leaders, saying their money is "very safe" despite the US budget deficit, which he pledged to cut.

There's been lots of intrigue in FOREX markets lately, with the BRIC countries (Brazil, Russia, India, and China) meeting today without the U.S. even in an observer role and recent comments from China citing concern about the greenback with a Japanese finance minister voicing strong support for the dollar.

Most puzzling are comments from Russia where they first sided with the Chinese, then showed support for the U.S. currency at last weekend's G8 meeting. Today, according to this AP report, Russian President Dmitry Medvedev said the world needs new reserve currencies.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Should Obama Scale Back Efforts To Fight The Recession?

Now that an economic recovery looks imminent, some individuals are calling for less monetary intervention to stimulate the economy. This probably stems from worries that the current monetary policy will lead to dangerous financial repercussions in the future. Should the Fed and government scale back their expensive efforts to fight the recession, now that a recovery seems close? James Picerno from The Capital Spectator tackles this topic below.

New York Times columnist Paul Krugman writes today that it's too early to begin removing the monetary stimulus engineered by the Federal Reserve.

"A few months ago the U.S. economy was in danger of falling into depression," he notes in his column. "Aggressive monetary policy and deficit spending have, for the time being, averted that danger. And suddenly critics are demanding that we call the whole thing off, and revert to business as usual. Those demands should be ignored. It’s much too soon to give up on policies that have, at most, pulled us a few inches back from the edge of the abyss."

He may be right…or not. Debating the correct monetary policy is always topical in real time, and always unclear. As it happens, the stakes are unusually high in the current debate. The future, however, isn't necessarily any clearer, nor is it apparent that the Federal Reserve has suddenly transformed itself into an institution with omniscient powers.

Following the 2000-2002 bear market, the Federal Reserve decided that unusually low interest rates were necessary—for several years! Even though the economy had obviously recovered and was expanding at a healthy clip in 2003 and 2004, the central bank kept the price of money excessively low. The error didn't necessarily inflame inflation risk, but it did contribute to excessive investment in, among other areas, real estate by creating abnormal incentives for borrowing. Nor was this the first time that the Fed misjudged monetary policy.

Now we're faced with another potentially far-reaching decision on monetary policy. It's tempting to proclaim that all's clear and so it's timely to do this or that. But history reminds that what's obvious looking ahead may turn out differently after the fact.

Prudence suggests that there's no reason why monetary policy must go from one extreme to another overnight. If the central bank had full transparency about the future, and that spilled over into complete clarity about monetary policy in real time, there'd be a case for sharp, dramatic changes to the interest rates. But ours is a world of constantly grappling for perspective, day by day, using imperfect information that's out of date. Our forecasts are, at best, only partly reliable and so our policy responses must evolve rather than lurch from one regime to another.

With that in mind, it's clear that interest rates should rise going forward, but there's a great debate about how far they should rise and when the ascent should commence. Since we don't really have a good answer, we must hedge our bets. On the one hand, we can't let inflation out of the bag. Given the massive liquidity injections of late, and the inflation-prone history of fiat currencies, this is no idle threat.

At the same time, the risk of continued economic weakness shouldn't be dismissed either. There are reasons to be hopeful that that recession may be over, but it's still far from clear that the recovery will be robust or even long-lasting, as we discussed on Friday.

Navigating between these two extremes is the only reasonable strategy for mere mortals at this point until we have a better handle on discounting the economic future. Perhaps we'll have a clearer view in the weeks ahead; perhaps not. That said, the risk of maintaining the status quo for monetary policy still look minimal. But unless the next few weeks offer compelling evidence otherwise, it'll be soon time to begin raising rates, albeit marginally if only to show the market that the Fed is serious about fighting inflation in the future, if necessary.

Should we raise Fed funds to 1% next week? Of course not. But neither can we rule out a target rate adjustment to 0.25%-to-0.5% next month or perhaps the month after. Perhaps that will suffice for six months or longer, depending on what the data tell us.

If Churchill was a central banker he might advise that gradualism is the worst possible approach to monetary policy in a world of uncertainty—except when compared to everything else.

This post can also be viewed on capitalspectator.com.

Home Depot Raises Expectations As Consumer Confidence Grows

Home Depot raised profit expectations as consumer confidence continued to grow for the fourth straight month. Retail sales also exceeded expectations, which could mean that consumers are more optimistic about the economy. This could expedite economic recovery as consumers account for over two-thirds of US economic activity. For more, see the following post from our friends at Money Morning.

Are consumers’ happy days here again, or are the recent signs that growth in sales, confidence and an overall improvement in the economy just a mirage?

Confidence among U.S. consumers rose this month for a fourth straight time, according to the Reuters/University of Michigan (UM) preliminary index of consumer sentiment. The index increased to 69, which is less than what was forecast but still the highest level in nine months. May’s index was 68.7.

“Confidence is slowly but surely coming back,” James O’Sullivan, a senior economist at UBS Securities LLC told Bloomberg News. “In the next few months we should see more follow-through in the labor market, which in turn should give confidence a further boost, which in turn should lead to a sustained recovery in consumer spending.”

Another report from Investor’s Business Daily and TechnoMetrica Market Intelligence’s “Economic Optimism Index” shows consumer confidence rose to 50.8 this month from 48.6 in May. A figure above 50 indicates optimism, while one below 50 reflects pessimism.

“Consumer confidence is building on the momentum that it picked up in April, reflecting the strength we are seeing in the stock market," Raghavan Mayur, president of TechnoMetrica unit TIPP said in a Reuters interview. "Across the board, there is an optimistic feeling that the economy is recovering.”

The rise in consumer confidence is not just idle talk-consumers are backing it up at retail with their wallets.

Retail sales in May increased by 0.5% over April following four straight drops, according to a Commerce Department report released last week. Economists were anticipating a 0.2% gain, according to The Associated Press. The general merchandise, food stores and restaurant categories were the ones in the sector that posted significant gains.

Retailers like The Home Depot, Inc. (NYSE: HD) reflect consumers’ confidence and the increase in sales. The home improvement chain raised its forecast for the year, saying its profit would anywhere from flat to a 7% drop. It previously gave guidance that profits would be down 7%.

But the optimism should be tempered, as the “rules of engagement” will be different in the post-recession economy, according to Deloitte Strategic Advisor Richard Hyman.

Big financing promotions, which propelled a lot of consumer spending in the last 10 years, is all but gone now that credit is tighter, according to Hyman.

“Consumers were also able to spend more because of the easy availability of credit, most notably through mortgage equity withdrawal and they responded by buying more items,” Hyman said. “These conditions underpinned retail growth for the past 10 years but have now disappeared. However, it’s worse than that. They will clearly not return once the recession is over.”

The worst economic downfall has produced scars on the spending habits of consumers, and it’s likely that when the dust clears, most will demonstrate they have learned their lesson about reckless spending.

“This will produce polarization: needs-driven spending will gravitate towards retailers able to tick the most important consumer boxes like price and convenience,” said Hyman. “Although it will remain the engine of retail growth, wants-driven spend will slow and consumers will be much more choosy.”

This article has been reposted from Money Morning. You can view the article on Money Morning's investment news website here.

Japan Voices Faith In US Dollar

Despite Chinese students laughing at Tim Geithner's assurance that China's assets were "very safe", the Japanese government is voicing faith in the US dollar. But does the Japanese government really believe this or is this just political posturing. Tim Iacono from The Mess that Greenspan Made discusses this in the following post.

Comments such as those made by Japanese Finance Minister Kaoru Yosano as reported by Blooomberg earlier today on the subject of the attractiveness of long-term U.S. debt make you wonder where the Pacific island nation might be 60 years from now, independence-wise, as they seem to have made little progress since the end of World War II.

In preparation for this weekend's G8 meeting, Yosano noted that Japan has "complete trust in the fact that the U.S. views its strong-dollar policy as fundamental", going on to emphasize the point by characterizing said trust as being "absolutely unshakable", adding the final punctuation that they "have complete faith in U.S. economic and fiscal policy".

It's not clear if this statement is more naive than it is laughable - it is certainly as laughable as the notion that we Americans have a strong-dollar policy at all.

Recall that, for years, U.S. Treasury Secretaries (with the notable exception of Paul O'Neill who, not coincidentally, didn't last very long) have been parroting the official government line that "a strong dollar policy is in the national interest". This belies the reality that actions taken at all levels of government since the bursting of the Nasdaq bubble almost ten years ago, particularly the actions of the central bank, make plain that no one stateside really cares about the value of the dollar.

Naturally, as we all learned very painfully last year, when oil prices get too high there is an outpouring of concern about the value of the dollar, emotions that are quickly overwhelmed by the ripple effect of a lower dollar when nearly all the world's business arrangements are transacted in greenbacks.

That has been a fundamental part of the problem with the global economy for some time now, a fact the Mr. Yosano appears to be blissfully unaware of along with more recent developments like nations such as China, Brazil, Russia, and others who are now loudly objecting to the status quo of dollar hegemony.

Surely, some policymakers in Japan are now mindful of the fact that they've hitched their wagon to what is now clearly the wrong horse in the 21st century. You'd think that you'd at least hear rumblings of discontent along with the rest of the world rather than blind obedience.

Granted, they must now feel a bit like Donald Trump's bankers where it is becoming clear that it would be much more painful to let nature take its course, opting instead to do what they can to help make things go along as they have been for years, but at some point, you have to say enough is enough.

Neither the Donald's business model, nor that of the U.S. is sustainable.

Back in the 1980s, when Japan was at their post-WWII peak, the U.S. was derided for not looking past the next quarter while the Japanese had long-term plans.

What's their long-term plan for business relations with the U.S.?

To hope and pray that Americans will continue to buy Toyotas and Hondas well into the 22nd century?

Japan has one of the largest economies in the world but, apparently, one of the tiniest backbones, the dependence on U.S. military power to secure energy supplies and a deference for no military of their own making them beholden to the whims of the U.S. twenty years after their economic miracle proved to be little more than a U.S.-style bursting asset bubble.

At what point do the Japanese assert their independence again?

They ought to at least start asking a few questions...

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Chief Economists Agree: The End Of The Recession Is Near

The chief economists of Standard & Poor and IHS Global Insight both predict the economic decline to end in a few months based on several leading indicators. One of these indicators is the surge of stock market indexes, including the second best 13-week performance of the Dow Jones Industrial Average. For more on this see the following post from Money Morning.

A new economic index predicts that the current recession will end in September and be followed by a mild recovery – the latest in a series of upbeat reports that have helped prolong a strong run-up in U.S. stock prices.

This latest indicator – the USA Today/IHS Global Insight Economic Outlook Index – uses an array of 11 forward-looking financial and economic indicators to gauge inflation-adjusted gross domestic product (GDP) grow. Seven of the 11 were positive in May, USA Today reported yesterday (Thursday).

The conclusion, according to IHS Global Insight (NYSE: IHS) Chief Economist Nariman Behravesh: “We’re two or three months away from an upturn.”

According to an analysis of the indicators, three important things are happening right now:

• The interest-rate yield curve is steepening, which is often an indicator of future economic growth.

• Orders for so-called “big-ticket” items – expensive equipment used to build machinery, roads or buildings – are still well below their year-ago levels, but have been increasing of late.

• Stocks are in a bull market – which can be very promising, since share prices tend to advance six months to a year ahead of an economic upturn. Share prices have zoomed 30% in three months.

Standard & Poor’s Inc. Chief Economist David Wyss agreed with the assessment that the economic decline will probably end in the months to come, but says substantial uncertainty remains.

“We see a bottom in the fall, but there’s a lot of risk attached to that," Wyss told USA Today.

U.S. Federal Reserve Chairman Ben S. Bernanke recently talked about the economy’s “green shoots” – early indications of growth. But he’s also talked about a “jobless recovery” – a rebound in which growth returns, but companies don’t resume hiring. In an economy where the unemployment rate is 9.4% – the highest point since 1983 – and still growing, the prospects of an economic resurgence without any new jobs is problematic to say the least.

The Fed’s "Beige Book" report, released Wednesday, looks at the country’s regional economies and says the overall U.S. market remained weak in April in May, even with signs that the downturn may be easing.

Such continued signs of weakness continue to stoke concerns among consumers.

Other bullish indicators have surfaced.

This Dow’s No Dog

The 13-week rally the Dow Jones Industrial Average has experienced off its March lows is the most powerful surge that index has seen since the Great Depression. If we look to history, stocks should continue to rally over the next three months, Hugh Johnson, chairman of Johnson Illington Advisors, told MarketWatch.com last week.

According to Johnson’s research, the 13-week stretch from March 9 through May 29, which saw the Dow soar 28.3%, has been bested only once - by the 40.8% run-up the Dow enjoyed in the 13 weeks that followed its hitting a bottom in May 1932. The Dow surged an additional 3.1% last week.

Going back to 1900 - in any given quarter (13 weeks) - there have been only 18 cases in which the market surged 20% or more, Johnson said.

Looking at the trends, the odds are strong that the Dow will be higher three weeks from now, and that means the odds are strong that the index will be higher three months from now, Johnson says.

“I say this with the utmost confidence and my fingers tightly crossed: This is the start of a new bull run,” Johnson said. “Based on history, who knows where we’re going to be four weeks from now? But in 12 weeks, the odds are we’ll be 3.8% higher.”

That can’t be guaranteed, however, since there has been at least case where stocks had a huge quarter, only to plunge afterward: In May 1929, the Dow zoomed 26% in 13 weeks – and then nose-dived 38.9% in the 12 weeks that followed.

For investors who feel the Dow is too narrow an index to really measure investor sentiment, another investment research group has pinned its research to the Standard & Poor’s 500 Index, which gained 30% from its March 9 low.

On Monday, Bespoke Investment Group LLC looked at six prior rallies since 1928 in which the S&P 500 gained 30% or more in a three-month-period.

“While some have called the current rally a once-in-a-lifetime event, the reality is that the S&P 500 advanced by nearly 31% following the Russian debt default and the collapse of Long-Term Capital Management,” Bespoke wrote in its research note. “Compared to what has occurred over the last two years, that whole period seems quaint now.”

In the seven rallies of 30% in three months studied, the S&P had posted additional gains two thirds of the time both three months later and six months later. But the returns weren’t huge – the average additional return in the subsequent three months was 3.36%, and in the subsequent six months was only 1.92%. Compare that with the average return for the S&P 500 for any six-month period since 1928: 3.3%.

Standard & Poor’s Wyss says a major remaining wild card is the European banking system, which is wrestling with loan losses in Eastern Europe. Couple that with the ongoing corporate credit worries and the continued consumer caution and there are definitely some reasons for any rebound in the U.S. economy to be tepid, at best.

Concedes IHS’s Behravesh: “We’re not out of the woods, yet.”
This article has been reposted from Money Morning. You can view the article on Money Morning's investment news website here.

Watchout: The Bankers May Be Let Loose

With several banks getting permission to buy their way out of the TARP program, will it mean these institutions will be back to their old ways of doing business? Will the executives at JP Morgan and Goldman Sachs have too much power now that there is less competition? Tim Iacono from The Mess That Greenspan Made discusses why the executives at these banks are looking forward to the day when they can get out of "time out" and be free to spend half a million on a "company retreat" without everyone finding out and questioning their ethics.

Jonathan Weil at Bloomberg examines the implications of "life as we knew it" being restored to at least some portions of Wall Street and comes away wanting.

Lock up the booze, and hide your wallet. America’s most powerful, too-big-to-fail banks are turning in their TARP money. And you know what that means: It’s party time again on Wall Street.

Ten U.S. banks gained permission this week to buy back $68 billion of shares they issued to the government under the Troubled Asset Relief Program. And thank goodness for that. For eight months, they endured the twin nuisances of mass hysteria and populist scorn for blowing taxpayer money on employee bonuses and junkets. Now they can tell the rest of the country to kiss off. There’s nothing Barney Frank can do about it.

Finally, the richest bankers and traders at Goldman Sachs, Morgan Stanley and JPMorgan Chase can stop asking what their country can do for them, and start dreaming again about what they can do for themselves with their banks’ money. Biking to work is out. Helicopter commutes to the Hamptons will be back in. The opportunities are limitless. They’re free at last.

If the government succeeds in somehow restoring the "normal" operation of our pre-2008 financial system, then, we will all have truly failed.

Yet, that has clearly been the goal and, sadly, it looks increasingly as though it just might work, the prospect of even more power and influence being concentrated in fewer and fewer companies such as JP Morgan and Goldman Sachs perhaps being the desired result all along.

Mr. Weil continues...

What these masters of the government rescue need now is a shopping list -- a 10-step program to restore their remorseless, reptilian souls and help them rediscover the unique thrill that can come only from being paid millions of dollars to provide services that are of no value to greater mankind. This brings us to our first agenda item:

No. 1: Reinstate the bonuses. Start with the top guys. That means you, Lloyd Blankfein, John Mack and Jamie Dimon. America is back. All we need is a little confidence. And there can be no confidence without the hope, however faint, that one day the son of some unemployed auto worker can grow up to make millions advising his dad’s old company on its next Chapter 11 filing. Just keep repeating this line: We need to retain our best talent, or else we’ll wind up the next AIG.

No. 2: Raise the bonuses. Because you can. Don’t worry that Timothy Geithner at Treasury might unveil some new, vague “best practices” for banker compensation. They’ll never stick. Your lobbyists can fix that.

No. 3: Relax your rules on corporate expense accounts. Scores, which I’m told is Manhattan’s finest adult-entertainment hot spot, has re-opened after a two-year hiatus. A happy customer is a loyal customer. Tell your bank’s traders to say Howard Stern sent them.

It goes on from there - office decorating, private jets, junkets, etc. - all thoroughly depressing, unless of course you work at JP Morgan or Goldman Sachs.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Save Thousands By Converting Your IRA To A Roth IRA in 2010

New rules beginning on January 1st, 2010, will allow you to convert your existing IRA into a Roth IRA regardless of your income level. This could potentially save you thousands or even hundreds of thousands in taxes. For more on this see the following article by Dr. Steve Sjuggerud from Daily Wealth.

"Thank God for Obama," my accountant, Hank Hurst, said to me yesterday...

"I know people are out of work. But accountants like me have never been so busy, thanks to all the new and potential tax changes and regulatory changes."

Hank went on about these changes. What interested me the most is a government boondoggle... a program that can save you hundreds of thousands of dollars in your tax money.

For this to make sense for you, you have to answer "yes" to these three questions:

• First question: Do you expect U.S. federal income tax rates in the future will be higher than today?

The answer should be obvious... At the trajectory we're on, with massive government debts (not to mention future health care and Social Security liabilities), higher tax rates are a certainty.

• Next question: Do you believe capital gains tax rates and dividend tax rates in the future will be higher than today?

Obviously, this should have the same answer as the first question.

• Last question: Do you think inflation in the future will be higher than today?

This should be obvious, too... At the rate our government is "printing" money and spending it, future inflation is a foregone conclusion.

If you answered "yes" to these three things, then you should seriously consider getting in on this deal. Here's the story:

The U.S. government needs your money now. So it's willing to do something foolish to get your money today, instead of waiting until you retire. The government has created a loophole that allows us to exploit its desperation for cash.

If the government were smart, it would wait, and take $400,000 from you in the future instead of asking for $40,000 today. But it needs money now, and it'll take what it can get.

So starting on January 1, 2010, ANY American, regardless of income, can convert his IRA to a Roth IRA with no penalties. You have to pay income tax due, but you get a special "grace" period until April 15, 2013 to fully pay it.

When you do this conversion, all your money grows tax-free... It can grow to millions, and the government can't tax it ever again.

If you believe those three questions above should be answered "yes," then you're beating the government at its own game. Let me show you...

Let's say you have a traditional IRA with $100,000 today. That might grow to $1 million in 20 years. At that point, you'd have to pay nearly $400,000 in taxes to get the money out (using a 39.6% income tax rate). But the joke is on you... because a good portion of the "gain" on your investment will probably be from inflation.

If you take this deal and convert your traditional IRA to a Roth IRA, then you have to pay $40,000 in taxes by April 2013. But if you've got the cash elsewhere, you don't have to take it out of your IRA. So in 20 years, $100,000 will turn into $1 million, with no taxes due at the end. The $40,000 today is the cost of not paying $400,000 in taxes in the future.

Now that's a simple example. Most people contribute yearly, and then withdraw yearly when they retire – they're forced to withdraw money annually by law in a traditional IRA. That way, the government can collect its taxes. But in this Roth, you already paid your taxes. You can take your money out any time... no penalties, no taxes.

This deal is not right for everyone. If you're close to retirement age already, or if you expect to be in a low tax bracket when you retire, it probably doesn't make sense for you.

But if you're younger... and you're worried about big government and inflation... it's the best way I know to beat the government at its own game. Instead of getting taxed on inflation, you can use inflation to your advantage. Your money "inflates" tax free in your Roth IRA.

There are a lot of ins and outs here. And the big risk, I'm afraid to say, is if the government changes the rules. Also, I'm not a tax advisor – far from it! So don't take it from me. Do your homework. Talk to your tax man (or talk to mine... you can reach Hank by e-mail at info@hurstcpa.com).

If you believe higher taxes and higher inflation are in your future, then this 2010 Roth deal is worth considering.

Dailywealth.com offers a free daily investment newsletter which focuses on contrarian investment opportunities.

Should Private Equity Groups Be Allowed To Own Banks?

With several banks in disparate need of capital, could the government change regulations to allow private equity groups to own banks? Despite long-standing regulations that separated the banking industry from higher-risk companies, a series of events have been set in motion that could lead to a change in the near future. Shah Gilani from Money Morning discusses how the stage is being set for such a change to occur.

U.S. banking-industry regulators have long understood that there needed to be a carefully delineated separation between such low-risk activities as deposit-based banking, and much higher-risk activities as investment banking.

But the regulatory walls that separated the two have been steadily dismantled through the years, an intentional act that had the unintentional consequence of helping spawn the worst financial crisis since the Great Depression.

Not unlike the Depression era Glass-Steagall Act, which was enacted to keep FDIC-insured commercial banks separate from the riskier businesses of investment banks and securities broker-dealers, regulators determined that bank ownership should be limited to bank holding companies. The Bank Holding Company Act of 1956 further ensured separation of commerce and banking by prohibiting bank holding companies from engaging in non-financial activities. The essence of the regulations was to prevent banks from failing by not allowing owners to deplete bank resources by diverting them to prop up other businesses they owned or controlled.

Setting the Table for Trouble?

In 1998, in what many experts agree was the starting line in the race to worldwide financial collapse, Citibank Inc. merged with Travelers Group, which owned the Solomon Smith Barney and Shearson investment-banking and securities broker-dealer businesses, to create what is now Citigroup Inc. (NYSE: C). It was a move marked by extraordinary bravado that was made in direct contravention of the existing Glass-Steagall and Bank Holding Company acts.

The flaunted marriage was subsequently blessed a year later when an ocean of lobbying money floated the Gramm-Leach-Bliley Financial Modernization Act, which repealed parts of Glass-Steagall and circumscribed regulations in the Bank Holding Company Act.

The merger that created Citigroup was touted as necessary to compete with other universal banks. Now private equity is touting its burgeoning coffers and the distressed state of undercapitalized banks as a marriage whose time has come – as well as one that will benefit the U.S. economy. Not unlike Citibank and Travelers forcing legislative changes after the fact, private equity is pushing hard against every law and regulation standing in the way of its ultimate prize. The push began more than a year ago and under the weight of last summer’s devastating events finally succeeded in getting a first foot in the door last Sept. 22.

That day, according to a series of memos prepared by powerhouse law firm Simpson, Thacher & Bartlett LLP, the U.S. Federal Reserve issued a long-awaited policy statement that details the new terms under which investors can take stakes in bank holding companies without having been deemed to have acquired actual “control” – which would force the investor to become a bank holding company, too. Those three changes consisted of:

* An investor who will have a seat on the bank holding company’s board could now own as much as 24.9% of the outstanding voting shares of the bank holding company, an increase from the prior limit of 10%.
* An investor could not own as much as 33% of the total equity of a bank holding company – versus the prior limit of 24.9% – provided that the investment does not include ownership of 15% or more of any class of voting securities of the target company.
* And the investor would now be permitted to actively attempt to influence certain governance matters of the bank holding company and was no longer be required to be a completely passive investor.

As if that weren’t enough, on Dec. 22 of last year federal banking regulators adopted a shelf-approval process to facilitate bidding by private equity funds on failing and failed depository institutions Simpson, Thacher said.

“In order to increase the pool of bidders … federal banking regulators recently adopted special pre-clearance procedures to enable parties that do not already own an insured depository institution, most notably private equity funds, to qualify as bidders,” the law firm wrote in a memo.

Up Steps Private Equity

And while private equity firms without a doubt appreciate the openings they’ve been given, none of the shops want to become bank holding companies. The reason: A firm that’s labeled as a “bank holding company” is also deemed to be a “source of strength” to the banks it owns or controls. That means the holding company has to make available its resources to support its banks. Private equity companies don’t want to expose their vast pools of capital to any one investment. Just as Cerberus Capital Management LP refused to put any more money into its failed Chrysler LLC investment – leaving taxpayers to bail it out – firms are loathe to be put into a position to support a bank holding with anything more than what was deemed as a suitable capital investment at the outset.

Just last spring, for instance, The Blackstone Group LP (NYSE: BX) was sued by one of its prospective investment targets when it backed out of buying credit-card processor Alliance Data Systems Corp. (NYSE: ADS). Blackstone’s concern was over conditions imposed by the Office of the Comptroller of the Currency, which required Blackstone to provide at least a $400 million backstop to support Alliance Data’s credit-card bank, which is regulated by the OCC.

"No private equity firm wants to [be labeled as a “source of strength” to companies it controls] since it is an unlimited call on capital," Hal Scott, a Harvard Law School professor who also serves as director of the Committee on Capital Markets Regulation, recently told CNNMoney.com.

The Committee on Capital Markets Regulation recently published a series of regulatory recommendations, including one that would have regulators remove restrictions on private equity firms owning banks.

This article has been reposted from Money Morning. You can view the article on Money Morning's investment news website here.

Expectations Of Inflation Rising

Expectations of inflation are on the rise, fueled by the high level of US debt and the weakening dollar. One sign that inflation is on the horizon is that the futures market is predicting that the Federal funds rate will increase to 1.2% by this time next year. For more on this, see the following post by James Picerno from The Capital Spectator.

Arthur Laffer advises in today's Wall Street Journal that it's time to "Get Ready for Inflation and Higher Interest Rates." The market's been telling us no less, as we've been discussing now for some time. Although the deflationary risk has been front and center since the financial crisis erupted last fall, the bigger challenge has always been the next phase, once the Federal Reserve succeeds in driving away the D risk.

One need only review the market's changing forecast of inflation in recent months to recognize that the future isn't likely to look like the past. In charts we've been posting semi-regularly, such as here and here, the trend is clear: pricing power is returning. Yes, it's coming off an extraordinarily low base, which exacerbates the relative comparisons. But there's no question that the central bank has been using extraordinarily potent measures to resuscitate inflation from the grave. As we've been saying all along, we have every confidence that Ben Bernanke and company will be successful.

The market is increasingly of a mind to agree, as indicated by rising interest rates this spring in government bonds. The benchmark 10-year Treasury, for instance, now yields 3.86%, as of last night—161 basis points above 2008's close, according to data from the U.S. Treasury.

Meanwhile, the futures market is predicting that by this time next year, Fed funds will be at ~1.2%, up from the current target rate of 0-0.25%, as our chart below shows.



So far, the rise in rates and rate expectations is a good thing, as it suggests that economic equilibrium is returning and the appetite for risk is on the mend. But at some point it's time to start soaking up the massive liquidity that the Fed has created in the past year. Reasonable minds can debate on exactly when to begin and how far to go, but at some point, and perhaps fairly soon, the monetary equivalent of mopping up must commence.

Laffer's skeptical that reversing the liquidity injections will be reversed in a timely manner, if at all. "Alas, I doubt very much that the Fed will do what is necessary to guard against future inflation and higher interest rates," he writes.

We're not quite so pessimistic, although the history of central banking certainly offers plenty of reason to remain cautious on expecting that politically tough decisions will come easy. Indeed, one must be cognizant of the incentives that infuse a world of fiat money and mounting deficits and the political path of least resistance. As Milton Friedman once said, "Inflation is the one form of taxation that can be imposed without legislation."

This post can also be viewed on capitalspectator.com.

How To Profit From Silver

Silver, like gold, is a highly volatile investment with wild swings in value. However if you believe that inflation, or even hyperinflation is likely, then silver may be a good commodity to consider right now. Brian Hunt from Money Morning discusses why silver is a compelling investment right now and how you can profit from it.

Late last month, one world’s greatest speculative profit plays made an important breakout move.

This speculative investment is the tiny group of mining stocks that operate as pure plays on the price of silver.

If investment assets were all patients in a mental ward, bonds would be the guy who sits silently in the corner and stares out the window. Stocks would be the guy who wanders the hall and mumbles to himself. And silver would be the guy they keep in the padded room all day.

And with good reason.

As the chart that follow shows us, silver prices are subject to fast, wild swings - up or down. You see, silver trades a little like a precious metal, meaning that it moves wildly when people get worried about a market crash or inflation. But silver is also an industrial metal, so it can trade up or down in line with changes in global manufacturing activity.



Okay, so you now know that silver can move crazily. Now realize the firms that focus on silver mining are pure madness. Their profit margins and asset values fluctuate with more volatility than silver itself. Take one of the largest and best-known silver companies, Silver Standard Resources Inc. (Nasdaq: SSRI).



When the global credit crunch hit last year, Silver Standard saw its share price plunge from $42 to less than $8 - a drop of more than 75% in just three months. But after investors warmed back up to mining stocks, it took the same amount of time to nearly triple in value.

And that brings us back to the present day.

Just last month, Silver Standard saw its shares blast to a fresh nine-month high. The global economy is getting "less bad" - and the aggressive bailout plans that are being rolled out throughout the world have most smart people scared to death of inflation. That’s driving the price of "real assets" - like silver - to the moon.

So the next time you’re looking around for an "inflation trade," consider going long on a company like Silver Standard - or taking a position in the iShares Silver Trust Exchange Traded Fund (ETF) (NYSE: SLV).

If the government’s “funny-money” scheme turns out badly, these positions have a long history of providing gigantic gains in virtually no time at all.

This article has been reposted from Money Morning. You can view the article on Money Morning's investment news website here.

Home Equity Distress Hurting Small Businesses

Many small business owners have had a rough time during this recession. Not only do they face lower sales but home equity loans, that were once a crutch against cash shortfalls, have become increasingly difficult to come by. Tim Iacono from The Mess That Greenspan Made discusses how falling home values have forced small business owners to seek alternative routes for funding.

Of all the dumb things that people did with their home equity money a few years ago when the housing bubble was fully inflated, buying a Hummer H2 was, by far, the dumbest.

Spectacularly stupid home renovations (like adding a separate room to your house for your cat) would probably come in second and big screen TVs, elective surgery, and lavish vacations would be a bit further down the list.

But, some of the more interesting uses for the money "extracted" via home equity loans, from a historical perspective at least, were those individuals who used these funds to start businesses.

Naturally, if you borrowed against your house at the peak of the housing bubble to start up a home improvement business, that decision probably hasn't panned out all that well given the dearth of new granite countertop installations these days but, if, for example, you always wanted to ditch the cubicle life and run a used book store, then maybe that decision would have met with some degree of success.

What's funny about this now bygone era, what was surely a "once-in-a-lifetime business funding opportunity", is that it was exactly opposite the time honored relationship between small businesses and home equity going back decades.

It used to be that borrowing against your home was not only uncommon, but a clear sign of distress in one's personal finances, as in "Poor Ted and Alice down the street had to take out a second mortgage to keep their business afloat".

Earlier in this decade, people sat around, perplexed, trying to decide what to do with all that home equity that was just sitting there, waiting to be "tapped" as homeowners were constantly reminded by the likes of Citibank, and many of those who didn't see the point in buying a hideous gas guzzler or adding a wing on to their house took the plunge and struck out on their own.

Running your own business is, after all, the American dream.

But, as they are finding out today, running a small business is tough during a recession, a point that is made clear in this LA Times story about a number of individuals in Southern California, including the Arnolds below, who have made some major lifestyle adjustments recently.

In better economic times, Santa Clarita mortgage broker Fred Arnold relied on a home equity line of credit if his cash flow was uneven and he needed to cover payroll.

But when home sales crumbled last fall, there was no such backstop for the business. His home was still worth more than the mortgage, but his bank was retrenching and had shut down the credit line. So Arnold sold his house, used some of the proceeds to keep his business afloat and bought a smaller home.

"I thought about cashing out my retirement money and the college savings for the kids, but that wasn't the way to go," Arnold said.

He and his wife are happy in the smaller home, Arnold added, and his home loan business is on more solid ground, thanks to a recent wave of refinancings.

It seems that the Arnolds are the exception to the rule when it comes to home equity financing of small business operations these days and the piece goes on to talk about a wave of small business failures as a result of declining home prices and tighter lending standards.

This is yet one more striking example of how radically things have changed in the U.S. over that last few decades when it comes to the public's attitude toward debt.

Instead of home equity being an infrequently tapped source of funds to "rescue" small businesses during economic downturns, it has now become a source of small business distress as owners had come to rely on this funding for the the normal conduct of business, a source of funds that was anything but guaranteed.

Digging out from the easy-money era takes new twists and turns almost every day.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Can Obama Convince The World To Buy US Debt?

As the government plans to sell $65 billion in notes and bonds this week, we will see whether Obama, Geithner, and Bernanke were able to renew the confidence of overseas investors in America's ability to repay debt. Will countries like China and Saudi Arabia continue to buy US debt? Peter Schiff from Money Morning discusses this in the following post.

Just last week, Team Obama took its financial-crisis dog-and-pony show on the road. U.S. Treasury Secretary Timothy F. Geithner went to China. Federal Reserve Chairman Ben S. Bernanke visited Capitol Hill. And President Barack Obama, himself, embarked on a Mideast tour that started in Saudi Arabia.

This full-court press is not coincidental, and comes just as the federal government began unloading trillions of dollars in new U.S. Treasury obligations. The coordinated charm offensive is meant to assure the world-at-large that the United States can repay these obligations - without destroying the dollar.

Given the renewed weakness in the dollar and the recent expressions of concern from China-our largest creditor-about the safety of its current holdings, this is no easy sell. Not only must our leaders convince holders of our debt not to sell what they already own, U.S. officials must persuade these same foreign investors to back up the truck and buy a whole lot more. The hope is that a Dream Team - consisting of a charismatic politician, a skilled Wall Street banker with longstanding ties to China, and a respected Fed chairman - can close the deal. However, no matter how slick the sales pitch, no amount of lipstick can dress up this pig.

The most obvious fear the trio must address is that oversized deficits will persist indefinitely. Reading from a carefully scripted rebuttal book, all three proclaim that as soon as the stimulus revives our economy, the government will take all necessary steps to reign in the deficits that result. Bernanke’s testimony showcases this rhetorical shift. The Fed chairman claimed that catastrophe has been averted and that the recession is nearly over. As a result, he advised Congress to now focus on debt management. How he expects U.S. lawmakers to do that was left unexamined.

Setting aside the fact that the recession is far from over and that the stimulus will actually weaken the economy in the long run, Bernanke’s words were less a practical guide to Congress than a bromide for our foreign creditors. Meanwhile, President Obama carefully peppers his speeches with calls for Americans to live within their means, to save more and spend less, to produce more and consume less. But nothing in the government’s current fiscal or monetary policy will encourage such behavior. In fact, the objective of economic stimulus is to prevent such changes from taking place!

The laughter of Chinese students that greeted Secretary Geithner at Peking University shows how ridiculous this spiel sounds overseas. Actions speak louder than words, and the actions of the Obama administration are deafening. Multi-trillion-dollar deficits, bailouts, nationalizations, quantitative easing, and grandiose plans for government-provided healthcare, education, and alternative energy, render all of the administration’s claims of future prudence meaningless. If our leaders will not make tough choices now, why should anyone believe they will do so later, when those choices will be even harder to make?

Of course, it’s not just major holders - such as China and Saudi Arabia - that need to be convinced. Since the largest holders are already in so deep, they have the greatest short-term incentive to play ball. While throwing good money after bad is certainly a lousy investment strategy, it is politically expedient as it delays the need to officially acknowledge losses.

The spin is designed to keep all the smaller, more nimble holders from dumping their U.S. Treasury securities. The major holders can publicly pledge their commitment to Treasuries, while they privately planning their exit strategies, as long as they feel that the smaller holders won’t spook the market by front-running their trades.

However, once the psychology turns, there is no way to stop the rush for the exits. Remember how quickly the secondary market for subprime mortgages collapsed? One day, investors were lining up to buy; the next day, the stuff couldn’t be given away.

Make no mistake about it, we are issuing subprime paper and no amount of political spin can alter that reality. Bogus credit ratings aside, I think the world already knows this and it’s just a matter of time before someone admits it.

In the meantime, by continuing to lend, our creditors merely supply us the shovels to dig ourselves into an even deeper economic hole. Their credit enables our government to grow when it needs to shrink, finances bailouts of companies that should be allowed to fail, and enables a nation that should be saving and producing to continue borrowing and spending. As a result, the more money the world loans us, the less capable we are of paying it back. I really wish the world would stop doing us favors, as neither party can afford the consequences.

For a timely example, just look at California. With an unmanageable $20 billion deficit, California recently asked Washington for a bailout. With none immediately forthcoming, California was forced to make real and needed budget cuts. The hard choices, which will benefit California in the long run, would not have been made if federal funds had been committed. We all should be so lucky.

This article has been reposted from Money Morning. You can view the article on Money Morning's investment news website here.

Senate Bill 61 Could Lower Debt Of Struggling Homeowners

For struggling home owners on the verge of foreclosure who are asking where their bailout is, they may get some help in changes to the Chapter 13 bankruptcy law. Senate Bill 61, if passed, could help homeowners stay in their homes. For more on this see the following post by Diana Golobay from HousingWire.

As shocking as it is, the story of the pay-option adjustable-rate mortgage (ARM) has become old news: A borrower buys a huge home worth $1m with a mortgage that seems too good to be true at little more than $2,500 per month.

After the bills start coming in, however, the borrower realizes it really was too good to be true. The bill had only prompted the minimum due, even though the total amount payable was more like $5,000. The bank conveniently loaned the borrower the remainder each month and tacked it onto the principal.

Then the monthly rate reset. The pile of debt that initially grew bit by bit now swells into a mountain.

And the borrower? Stuffed under too many helpings of debt, underwater on the home and losing any chance or hope to refinance.

Some groups, like the mortgage loan restructuring business segment of the Law Offices of Joseph R. Manning, Jr., promise relief through mortgage modification (although what can be said about the success of these efforts when the mortgages are already too deep underwater to qualify for refinance is unknown).

Sean Reynolds, the managing director of the legal office’s restructuring business, calls pay-option ARMs the next wave of defaults plaguing the luxury home market — where many of these ARMs cropped up, as the average borrower couldn’t afford them any other way. The law office is even prepared to go after lenders, brokers and servicers that violate borrowers’ rights, according to a media statement.

Without getting into what responsibility the borrowers are expected to take in the origination process, it’s understandable that home owners would attempt to do something about all that debt, regardless of whether they can actually repay it.

It’s no wonder that consumers who took out pay option ARMs, subprime mortgages and other heaping helpings of debt are finding themselves in dire straits. With already expensive mortgage payments about to explode with reset rates, some home owners might even have to pass debts from one form to another to make ends meet each month.

One such option, credit card debt, is showing signs of the strain as some home owners are forced to use credit cards for living expenses after the mortgage payment wipes out a substantial portion of monthly income.

TransUnion.com, one of the major US credit bureaus, found the average bank card borrower’s debt inched up 0.82% to $5,776 in Q109 and is up 4.09% from the year-ago quarter. Meanwhile, the bank card delinquency rate of borrowers 90+ days past due on one or more of their cards rose 1.32% in Q109 and is up 9.1% from the year-ago period.

“As the recession entered its sixth quarter, we saw continued increases in average bankcard balances, as consumers struggled to meet repayment obligations in a job market that continues to deteriorate,” says Ezra Becker, director of consulting and strategy at TransUnion’s financial services group, in a media statement today.

With the US unemployment rate now up to 9.4%, some borrowers that had relied first on refinanced mortgages and then on credit cards to get by may soon find themselves facing an unhappy alternative: foreclosure, repossession or bankruptcy.

In May alone, US consumer bankruptcy filings were up 37% from the year-ago levels, according to the American Bankruptcy Institute (ABI). The total volume of filings in the month — 124,838 — stayed roughly level with April’s volume — 125,618 — although Chapter 13 filings made up 27% of all consumer cases in May, above the April rate.

A Chapter 13 case allows the debtor to keep his or her possessions and property, and to pay creditors under a budgeted plan. And, if Senate Bill 61 eventually goes through, a Chapter 13 debtor might also qualify for his or her bankruptcy judge to forgive — or “cram down” — a portion of the home mortgage balance or otherwise modify the mortgage to ensure affordability of payments going forward, again passing the debt further away from the borrower.

“As consumers continue to face increasing levels of unemployment and rising foreclosure rates, bankruptcy filings will continue to accelerate as families seek financial relief from the tough economic climate,” said ABI executive director Samuel Gerdano in a media statement.

With the ABI predicting more than 1.4m new bankruptcies by year-end, it seems like the cycle will continue to unwind as long as the housing market stumbles along toward bottom.

This article has been reposted from HousingWire. View the article on HousingWire's mortgage finance news website here.

How Much Gold You Should Own

Ben Bernanke recently warned congress of the consequences of overspending which could include inflation. If you think inflation will accelerate in the future, it may be a good idea to consider gold to offset the affect of inflation on your investments. For more on this, read the following article by Dr. Steve Sjuggerud from Daily Wealth.

You often hear "You need to own gold!" But how much is the right amount?

You don't want to own too little gold and have the purchasing power of all your savings shrink dramatically. You can't afford that. But you don't want to be an end-of-the-world nutcase either.

Well, one of the world's shrewdest investors – Jean-Marie Eveillard – has 10% to 12% of his extremely successful investment fund allocated to gold and gold plays...

Jean-Marie Eveillard's First Eagle Global Fund beat the stock market every year this decade. What's more, he's done it conservatively... He doesn't take big risks. Over 30 years, he's proven to be one of the most successful mutual fund managers ever.

So what's Jean-Marie Eveillard recommend buying today?

"After equity markets have gone up 35%-40% or more over the past three months, ideas that are immediately appealing are few," he told Bloomberg news today. But he did have one big idea... gold.

Right now, his fund is about 10% invested "in gold and gold mining securities," he said.

His explanation is simple: "It's insurance to protect against the fact that current policies by the American government and the Fed are potentially wildly inflationary."

Jean-Marie likes gold because he expects the Fed will leave interest rates near zero for a very long time.

The Fed will "stay pat until the politicians give them the green light to raise rates, which will take quite a while. As long as unemployment is very high, politicians will be reluctant to push up short-term rates."

When I got into investing nearly 20 years ago, Jean-Marie was already a legend. After doing my homework, his First Eagle Global Fund was one of the very first investments I ever bought. (Back then, it was called the SoGen fund... it still uses its old symbol, SGENX.)

Jean-Marie started managing the fund in 1979. If you had invested $10,000 in the fund back then, it would be worth roughly $500,000 today. (Heck, I should have kept my money in there!)

His "big idea" now is very simple. Gold pays no interest. And money in the bank pays nearly no interest. You can print money. But you can't print gold. If the Fed keeps interest rates near zero for the foreseeable future, the obvious outcome is that it will take more slips of paper (dollar bills) to buy an ounce of gold.

He believes his clients' money should be about 10% or so allocated to gold and gold investments. What's right for your situation? That's up to you. But if you're substantially under or over the legendary investor's gold allocation, then you ought to consider getting more in line with him...

Dailywealth.com offers a free daily investment newsletter which focuses on contrarian investment opportunities.

Yale Economist to Housing Optimists: Not So Fast

There has been a lot of optimism of late about the housing market showing signs of price stabilization with many investors looking forward to a rebound. But Yale economics professor explains why the housing decline may not be over. See the following post by Tim Iacono from The Mess That Greenspan Made.

In this NY Times op-ed, Yale economics professor and housing market guru Robert Shiller splashes some cold water on the recent housing market fervor in such places as Arizona.

Why Home Prices May Keep Falling
Home prices in the United States have been falling for nearly three years, and the decline may well continue for some time.

Even the federal government has projected price decreases through 2010. As a baseline, the stress tests recently performed on big banks included a total fall in housing prices of 41 percent from 2006 through 2010. Their “more adverse” forecast projected a drop of 48 percent — suggesting that important housing ratios, like price to rent, and price to construction cost — would fall to their lowest levels in 20 years.

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient.

A national home price decline of 48 percent would imply a decline of, what, about 80 percent in Phoenix? That may be a very efficient and rational market.

He goes on to explain why home price declines go on for much longer than most people really understand, especially those who think they're snapping up such bargains today.

Several factors can explain the snail-like behavior of the real estate market. An important one is that sales of existing homes are mainly by people who are planning to buy other homes. So even if sellers think that home prices are in decline, most have no reason to hurry because they are not really leaving the market.

Furthermore, few homeowners consider exiting the housing market for purely speculative reasons. First, many owners don’t have a speculator’s sense of urgency. And they don’t like shifting from being owners to renters, a process entailing lifestyle changes that can take years to effect.

Among couples sharing a house, for example, any decision to sell and switch to a rental requires the assent of both partners. Even growing children, who may resent being shifted to another school district and placed in a rental apartment, are likely to have some veto power.

In fact, most decisions to exit the market in favor of renting are not market-timing moves. Instead, they reflect the growing pressures of economic necessity. This may involve foreclosure or just difficulty paying bills, or gradual changes in opinion about how to live in an economic downturn.

This dynamic helps to explain why, at a time of high unemployment, declines in home prices may be long-lasting and predictable.

It used to be conventional wisdom that, unless you were financially strapped, once you became a homeowner you would forever be a homeowner. If you were transferred from one town to another, you'd put your house up for sale, go out to the new place, look around for a few days, buy a house, and move in.

That seems to be changing and one of the most important reasons is that people can't sell their existing houses - at least not at the price they want.

It will be interesting to see if the U.S. housing bust fundamentally changes the way Americans think about home ownership.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Data Shows Reasons To Be Optimistic on Economy

Are the subtle signs of an improving economy, such as decreasing jobless claims, enough to warrant optimism? Or should investors be cautious until we see employers actually increase hiring and the unemployment rate decrease? According to The Capital Spectator, we should be both cautious AND optimistic.

In early March we asked: When Will It End? At the time, we argued that watching the weekly squiggles of new filings for jobless benefits was a productive effort for estimating when the cycle would turn.

The reasoning is that a careful study of history shows that initial jobless claims have a habit of peaking concurrently or just ahead of the technical end of the recession, as defined by the National Bureau of Economic Research. Waiting for NBER to proclaim the downturn's denouement isn't practical, since the organization takes its sweet time on such matters. Watching initial jobless claims, then, may be a more timely reading of what comes next for the business cycle. It shouldn't be analyzed in a vacuum, but as part of a broader review of leading economic indicators it's a valuable tool for discounting the future.

Today's jobs report, along with yesterday's update on jobless claims, offer another round of data releases for thinking that our counsel in March is still valid. Although the economy shed lots of jobs again last month, the decline was relatively mild compared to the magnitude of losses in the recent past. Nonfarm payroll employment fell by 345,000 in May, or roughly half the average monthly decline for the prior 6 months, the Labor Department reports.

Meanwhile, yesterday's update on initial jobless claims shows that new filings fell again last week, dropping to 621,000. That's still high and on its face the one number implies the recession rolls on. On the other hand, the trend of late offers some encouraging clues. As our chart below illustrates, last week's claims are still well below the peak of 674,000 that was set back in the final week of March. By virtue of its general decline over the past two months, modest though it is, the jobless claims indicator continues to predict that the recession has ended. We can't be sure, of course, at least not yet. But for the moment, there's mounting reason for hope, which is bolstered by today's jobs report.



Of course, the technical end of recession, especially one as painful as the current one, isn't easily forgotten. Indeed, while the leading indicators point to recovery, the lagging indicators, as expected, continue to get worse. Unemployment, for instance, rose last month to 9.4% from 8.9% in April. More of the same is probably coming.

In terms of people's lives, the official end of the recession is likely to have little meaning for many months or even quarters. The signal that Joe Sixpack is looking for—the creation of new jobs—is still probably a ways off. Nonetheless, a thousand-mile journey must begin with the first step, and so an economic recovery necessarily begins quietly, starting with the end of the recession.

We're not completely confident that the contraction has ended. Indeed, the fall in jobless claims, although obvious so far, isn't fully convincing. A dip below the 600,000 mark, however, would help tip the scale in favor of optimism. Nonetheless, the trend so far can't be denied, at least not today. Anything's possible when it comes to the slippery business of projecting economic trends in the short term, but the odds that it's over are rising, or so the numbers suggest.

Keep in mind that jobless claims are but one of several forward-looking indicators predicting revival. In the June issue of The Beta Investment Report, we report that our proprietary index of leading indicators continues flashing a strong signal that recovery is near, or at least that the downturn's momentum is lessening.

Even if the recession is over, and one day it will be, there remains the bigger question: What magnitude of rebound awaits? On that point we remain quite wary. One reason is that if a rebound is underway, the shift implies a new set of challenges lurking in the future, starting with the issue of debt, interest rates and inflation, all of which threaten in the medium- to long-term outlook.

But for now, let's savor the moment. There are a few extra data points that offer reason for mild optimism. Monday, of course, is another day.

This post can also be viewed on capitalspectator.com.

Mortgage Rates Skyrocket

Momentum in the housing market may have been killed by the steep mortgage rate increase in recent weeks. The sudden jump could keep first-time home buyers sidelined since the .4 percent increase can mean a significant jump in monthly mortgage payments. For more on the mortgage rate increase see the following post by Kelly Curran from HousingWire.

For the second consecutive week, mortgage rates rose, driven by an increase in bond yields, according to Freddie Mac’s (FRE: 0.76 0.00%) Primary Mortgage Market Survey.

Thirty-year fixed-rate mortgages increased to an average 5.29% with an average 0.7 point in the week ending June 4, marking the highest rate recorded since the week ending December 11, 2008.

The 15-year fixed-rate mortgage averaged 4.79%, up from last week’s 4.53% average, but well below the 5.65% average a year ago at this time.

One-year Treasury-indexed ARMs climbed from 4.69% last week to 4.85% this week, while Five-year ARMs also jumped, from 4.82% to 4.85%.

“Rates are substantially higher than they were a couple weeks ago, when many would-be borrowers were floating instead of locking,” said Bankrate.com’s Holden Lewis. “They were gambling that mortgage rates would decline further or stay the same. They Lost.”

Bankrate.com conducts its own rates survey each week. This week, Bankrate found benchmark 30-year fixed-rate mortgage rose 20 basis points to 5.65%, while the 15-year fixed-rate mortgage rose 20 basis points to 5.06%.

This article has been reposted from HousingWire. View the article on HousingWire's mortgage finance news website here.

Productivity Increase Exceeds Expectations

You may not be very surprised that productivity rose, given the 5.7 million jobs lost since the recession began in December 2007, but it was still good to hear positive economic numbers. The American worker exceeded expectations but can this build momentum for economic recovery? Jason Simpkins from Money Morning discusses what the latest job numbers can mean for the economy.

Worker productivity rose in the first quarter, as companies cut costs by shedding workers and extracted more output from remaining employees. Analysts are hopeful that the increased efficiency will help slow rate of job cuts, which also appear to be easing from their formerly torrid pace.

Productivity, a measure of worker output by the hour, rose at a revised 1.6% annual rate in the first quarter, the U.S. Labor Department reported today (Thursday). That’s double the 0.8% estimated last month and a vast improvement over a 0.6% drop in the fourth quarter of 2008.

The gain in productivity was largely the result of job cuts and fewer hours worked by employees. U.S. employers have already shed 5.7 million jobs since the recession began in December 2007. Hours worked by employees plunged at a 9% annual rate in the first quarter, according to the Labor Department report.

The tighter payrolls and increased productivity led to a jump in corporate profits, which surged 3.4% in the first quarter from the previous three months - the first gain in almost two years. And now that businesses have found away to boost their productivity and widen their profit margins, analysts are hopeful that the labor market will stabilize.

“Businesses are far advanced in their objective of cutting jobs and controlling labor costs,” John Herrmann, chief economist at Herrmann Forecasting LLC, told Bloomberg News. “That suggests that the pace of job cuts should slow materially.”

A separate report from the Labor Department today showed fewer workers filed new claims for jobless benefits for the third straight week. Initial claims for unemployment benefits fell to 621,000 in the week ended May 30, a decrease of 4,000.

The data also showed that continuing claims - the number of people staying on benefit rolls - fell by 15,000 to 6.74 million in the week ended May 23, the first decline in 17 weeks.

Still, jobless claims remain historically high, as does the unemployment rate, which stood at 8.6% in April. U.S. Federal Reserve Chairman Ben S. Bernanke said earlier this week that unemployment is likely to increase, and a report tomorrow (Friday) may show that the unemployment rate climbed to a 25-year high of 9.2%, Bloomberg reported.

“The downshift in claims continues but progress is painfully slow and claims at their current level are still consistent with massive declines in payrolls,” Ian C. Shepherdson, chief U.S. economist of High Frequency Economics, told the AFP.

Shepherdson doesn’t expect jobless claims to reach the 450,000 level until next year.

“Feeble green shoots don’t stop companies laying off staff, still less actually [start] to hire again,” he said.

This post can also be viewed on moneymorning.com.

How The "Cap And Trade" Bill Will Affect The Economy

The Waxman-Markey bill, or the "Cap and Trade" bill, would require companies to acquire permits in order to release carbon dioxide. However critics of the bill think that it would have an adverse affect on business because of the costs involved. Chris Mayer from Daily Wealth discusses how the bill would affect the economy if it is passed into law.

Right now, the so-called Waxman-Markey bill is snaking its way through the greasy halls of Congress.

"Waxman-Markey" is the name given to the new "cap and trade" bill designed to limit America's carbon emissions. It looks like it's the most expensive thing to hit the economy since the financial crisis began.

Even the normally mild-mannered Wall Street Journal called it "one of the most ambitious efforts to re-engineer American social and economic behavior in decades, presenting risks and opportunities for a wide array of businesses from Silicon Valley to the coal fields of the Appalachians."

First off, the stated objective of cutting carbon emissions by 83% by 2050 will go down in history as outrageous – akin to when Who drummer Keith Moon drove his Lincoln Continental into the pool at the Holiday Inn. I think members of Congress must be smoking the same thing Moon was.

To show you how patently ridiculous such a goal is, I turn to Questar's CEO, Keith Rattie. Questar is an oil and gas company. Rattie is an engineer. He has been in the business since the 1970s. He walks us through the basic math in a speech he made at Utah Valley University on April 2 called "Energy Myths and Realities." Rattie uses Utah as an example:

Utah's carbon footprint today is about 66 million tons per year. Our population is 2.6 million. You divide those two numbers and the average Utahan today has a carbon footprint of about 25 tons per year. An 80% reduction in Utah's carbon footprint by 2050 implies 66 million tons today to about 13 million tons per year by 2050. If Utah's population continues to grow at 2% per year, by 2050, there will be about 6 million people living in our state. So 13 million tons divided by 6 million people equals 2.2 tons per person per year.

Question: When was the last time Utah's carbon footprint was as low as 2.2 tons per person? Answer: Not since Brigham Young and the Mormon pioneers first entered the Wasatch Valley and declared, 'This is the place.'

You can extend this math over the whole country – a growing mass of 300 million people. To meet the Waxman-Markey bill's goals would mean we have to go back to a carbon footprint about as big as the Pilgrims' at Plymouth Rock circa 1620.

So I think the bill is absurd. I think it is also a great blow to what is left of American industry. But this is the way the world works. Politicians do dumb things. We have to play the ball where it is. And that means we have to figure out who wins and who loses.

Here are some thoughts along those lines...

Agriculture
Agriculture, for whatever reasons, is exempt from the new rules. So farmers don't have to worry about those manure pools out back or the flatulent cows emitting methane all over God's green meadows. Those big tractors? Burn up that diesel! Agriculture is a winner by virtue of not losing, like a hockey team that skates to a tie.

Steel
Big loser. U.S. Steel, AK Steel, and even foreign steel companies with U.S. operations all get a big kick in the family jewels on this one. Steelmaking emits all kinds of carbon dioxide. The worst-case scenario here is that the U.S. simply won't be making steel at some point in the future. The plants will all go to Brazil. China is already the biggest steel producer in the world. Now we just handed the country a bunch of new business. Avoid big steel in the U.S.

Oil refiners
Losers. This is an industry in which it is hard to make money most of the time as it is. Now, under the new bill, refineries are really screwed. Basically, they are on the hook for about 44% of U.S. carbon emissions. They would be among the biggest buyers of carbon emission allowances. I think with one stroke of the pen, the U.S. government just made the U.S. refining industry that much smaller. Lots of these older refineries will just have to close. U.S. imports for gasoline will rise.

I think the refinery industry already sees the writing on the wall. This is one reason why Valero, the biggest U.S. refinery, has been quick to get into the politically favored ethanol business. It's also expanding overseas. Avoid the refineries.

Trading desks
Winners. It figures. As if the government doesn't help financial firms enough, it is going to hand them a nice tomato in trading carbon credits. The head of Morgan Stanley's U.S. emission trading desk said: "Carbon, while relatively small, is a critical piece of our commodities offering." So some financial firms with trading desks in carbon get a nice little payday.

To sum up, this is only the beginning. At the end of the day, this obsession with carbon footprints means that Americans are going to have to pay a lot more for products that use fossil fuels. It means we are going to pay a lot more for energy. Obama and his crew can draw up whatever fantasies they want, but they can't repeal the laws of economics, which, like forces of nature, win out every time.

So there will be plenty of losers. But I'm an optimist... and I expect to find plenty of winners to take advantage of Waxman-Markey. For now, I recommend you steer clear of the losers I just described.

Dailywealth.com offers a free daily investment newsletter which focuses on contrarian investment opportunities.

Should We Worry About Inflation?

Ben Bernanke was on Capital Hill yesterday warning congress that too much deficit spending could harm the economy while downplaying concerns of inflation. It is Bernanke's job to control inflation, but will he be able to keep inflation low with $2 Trillion in deficit spending this year? James Picerno from The Capital Spectator discusses whether we should worry about inflation now.

Inflation's still not a risk but arguably neither is deflation. We're not quite ready to officially claim that the D risk has been vanquished, but we're close. As it turns out, we're not alone.

The bond market is increasingly inclined to turn the page on the fear that a deflationary spiral may threaten. But if the deflation risk is passing, as it seems to be, the change doesn't mean that inflation is back. There's no switch that turns one off and the other on as cleanly as flicking on a light.

The ebb and flow of the economy is a process, an evolution. What we're seeing now, or so it appears, is a transition from a heightened risk of deflation to the absence of that risk, which isn't to be confused with inflation. At least not yet. There's no law that says inflation must quickly follow deflation. But neither is there any force that prevents one from turning into the other. Much depends on what the central bank does; not today but next month, next year and beyond.

Inflation, when it does bite, tends to creep up on you, slowly, quietly, working its way into the economy virtually unseen. It doesn't suddenly arrive one day with fanfare and press releases. More typically, the crowd wakes up one day and realizes that inflation is back. The good news is that there are usually early warning signs. Interest rates, money supply, commodity prices, and so on. The challenge is figuring out in real time what constitutes a legitimate warning vs. noise.

For the moment, the market's telling us that deflation's a fading hazard. As the chart below shows, the implied inflation rate in the bond market (based on the yield spread between the nominal 10-year and inflation indexed Treasuries) was just under 2% as of last night's close. That's still comfortably below the 2.5% rate that prevailed before the financial system ran amuck starting last September. But it's also up sharply from the near-zero levels of December and January.

That's not necessarily surprising or even troublesome. Fearing the worst last fall, the Fed quickly dropped short rates to near zero. The medicine appears to be working, which is to say that Bernanke and company are engineering higher prices. But it's the momentum we fear. Not necessarily today, but down the road.



Some commentators say that all the talk of inflation is premature and perhaps misguided. In his column last week in The New York Times, Paul Krugman advises readers that "when it comes to inflation, the only thing we have to fear is inflation fear itself."

That's a reassuring thought, but unfortunately it runs contrary to the historical record. Maybe this time is different, but we don't know. But the past is certainly clear. Except for a few extraordinary examples to the contrary, inflation has been the norm. For the most part, it's been manageable, although sometimes it spins out of control, as it did in the 1970s and early 1980s. Recessions, of course, have a habit of pounding inflation back into the ground. Even after the current downturn ends, its after-effects are likely to put a lid on pricing pressures and so there's reason to be sanguine about future inflation threats.

The ever-trenchant Martin Wolf advises in his FT column today that there's no economic basis to fear inflation, at least not now. "The jump in bond rates is a desirable normalization after a panic," he writes. "Investors rushed into the dollar and government bonds. Now they are rushing out again."

The question, of course, is when is it safe to start worrying about inflation? The implied inflation rate for the next 10 years is roughly 2%. That's low by historical standards and if it stayed there for the next generation the central bank could claim a well-deserved victory in maintaining price stability, at least by the standards of the 20th century.

But no one knows if inflation will rise to, say, 2% and stay there or keep climbing. Again, much depends on what the central banks do from here on out. One can make an economic case that exploding government debt and massive liquidity injections aren't destined to raise inflation pressures, as Wolf and others explain. That's a reasonable view, but if you're charged with protecting assets, such claims that all's well aren't entirely persuasive.

The bond market, along with the gold and forex markets, are discounting the future and all its risks and they're telling us that the risk of higher inflation is on the march. It's quite possible that the markets are wrong and so inflation will remain a shadow of its former self. Let's hope so. But there's no way of knowing for sure. Strategic-minded investors should hedge their bets. Inflation may remain benign, but it may not. The markets are struggling to put a price on this uncertainty.

In any case, it's the trend rather than the absolute levels that worry investors. Estimating the true rate of inflation is always a contentious subject. But while we can all argue over the numbers, the trend is less obscure, and it's the trend that has some of us worried. Taking out a bit of insurance, then, seems reasonable. Should we bet that house on higher inflation? Of course not. But neither should we discount it entirely. It may be different this time, but 300 years of central banking keeps us wary on buying into yet another argument that a new era has arrived.

This post can also be viewed on capitalspectator.com.

Major Banks May Report Toxic Assets As Profits

Banks that bought "toxic assets" from failed financial companies like Wachovia, WaMu, and Countrywide may be able to report huge profits on their financial statements due to an accounting loophole. This loophole allows banks to report income based on projected future earnings on these loans. Investment Director of Money Morning, Keith Fitz-Gerald explains why this window-dressing could make the major banks look much healthier than they actually are.

Remember the infamous leaked Vikram S. Pandit memo we wrote to you about awhile back that suddenly saw Citigroup Inc. (NYSE: C) turn a profit on nothing more than vapors?

Stay tuned: We’re about to see more of these puffed-up profits. JPMorgan Chase & Co. (NYSE: JPM), Bank of America Corp. (NYSE: BAC) and PNC Financial Services Inc. (NYSE: PNC) will reportedly be booking as much as $56 billion in windfall profits using similar financial chicanery in the months ahead.

Sadly, millions of investors will likely interpret this as a sign that the U.S. financial sector is once again a viable “profit” play - when the reality is that Wall Street hasn’t learned a single darned thing from the financial crisis and is up to its old tricks once again.

This time around, the biggest U.S. banks - including JPMorgan, BofA, and PNC - will employ an obscure accounting rule to magically transform the “toxic debt” that they obtained from such “zombie banks” as Wachovia Corp., Countrywide Financial Corp., National City Corp., and Washington Mutual Inc. (OTC: WAMUQ) into actual income.

Yes, you heard me correctly - income. It makes me furious. This is kind of a corporate accounting version of “the dog ate my homework.” Only this time around, the joke is on us - the taxpayers - since we’re the ones who are bailing these bozos out.

Called “accretable yield,” these mega banks will book income on loans that have “reduced credit quality” by recognizing - hang with me on this one, it’s tough to believe - the value of the bonds on their balance sheets and the cash flow those securities are expected to earn. Please understand, we’re not talking about cash that’s already been earned, and not cash in the bank … we’re talking about cash flow those banks are expected to earn.

Talk about making a silk purse out of a sow’s ear. This is an obscene abuse of the accounting system - whether it’s legal or not. No wonder nobody ever went broke using accrual accounting. These guys need to be forced to recognize the money they have actually earned - not the amount they can account for using clever financial trickery.

To understand just how absurd this actually is, let’s take a close look at JPMorgan Chase - which alone reportedly stands to reap as much as $29 billion in windfall income. It started when JPMorgan literally bought WaMu from the dumpster (technically acting as something called “the receiver”) last year for $1.9 billion, and was allowed to mark the toxic debt that came with it down to “fair value” - which was 25% less than the $118.2 billion it was officially carried on the books for, or $88.65 billion. But now, the bank says that those same debts may appreciate by some $29.1 billion over the life of the loans. That’s before taxes and expenses, of course.

According to Financial Accounting Standards Board (FASB) rules, buyers such as JP Morgan Chase carry these loans on their books at fair value. Then, as borrowers repay those loans they are allowed to book profits. Therefore, by keeping the value of the loans low, the profits on such a small base are obviously king-sized.

The incentive, as I noted when I reviewed a similar tax loophole regarding BofA’s Countrywide Financial purchase back in February, is to write down the value of the loans so aggressively that they are practically worthless. That way, when the buyer folds them into its business, the returns are huge.

JPMorgan’s spokesman, Thomas Kelly, told Bloomberg News that “the accretion is driven by prevailing interest rates.” That said, JPMorgan said first quarter gains from the WaMu loans resulted in $1.26 billion in interest income and made it possible for the bank to reap additional potential income of $29.1 billion.

The other factor that’s not being talked about - at least openly - is the impact that an economic turnaround could have. You see, the eroding economy contributed to the erosion in the value of the securities. Conversely, when U.S. economic activity picks back up, we could see an accompanying improvement in the value of these securities being carried on the company’s balance sheet.

In an April 22 interview with Bloomberg, Wells Fargo & Co. (NYSE: WFC) Chief Executive Officer Howard I. Atkins said that “to the extent that the customers’ experience is better or we can modify the loans, and the loans become more current, that could help recapture some of the write-down.”

That will lead to massive “profits.”

In other words, if the government is successful in reducing mortgage rates and the housing markets stabilize, the banks get to make up entirely new numbers and “bring more of [the loans] current” which is bank speak for being able to assign whatever brand new values they can to the very same toxic slime these same banks wrote down only months ago during the purchasing process.

Naturally - and I think you can see where I’m going with this - the more these guys wrote down these securities as part of the acquisition process, the higher they can write them “up” in the months ahead - and the more powerful the “profit” surge we’ll see.

Not surprisingly, JPMorgan wouldn’t comment when I called - nor would any of the other big banks - so it’s especially difficult to get to the bottom of exactly when this will come to a head and how much of an outsized “manufactured” profit we could be looking at.

But we can guess as to their motivation:

• First, the banking industry remains in a state of chaos. Despite widespread attempts to calm things down, the banks don’t trust each other and the public trusts them even less. So profits - whether illusory or not - would go a long way to reestablishing some sense of the ordinary.

• Second, to the degree that the banks remain on the federal dole and their balance sheets a wreck, the ability to add new earnings is a lifesaver. Not only does this practice give them the ability to smooth out earnings, but it also arguably makes their stock more attractive because of the apparent “growth” potential that exists going forward. Never mind that the growth is nothing more than a paper shuffling and some fancy accounting; under FASB regs, this practice is completely legal.

• Third, because newly accreted earnings will flow directly to income and the banks have stockpiled a huge war chest of write-downs, financial institutions maintain a substantial buffer that can be used at their discretion whenever they need to goose their earnings. One brokerage house chief financial officer told me privately years ago that it was his goal to maintain enough of a buffer that he could swing earnings by as much as 10% in any given quarter - depending on what the company “needed.”

Now for the trillion-dollar question: What can we do about this?

Sadly, when it comes to changing the legally approved accounting nonsense component, the answer right now is “not much.”

While an investor wanting to capture this “growth” could buy shares in the banks or in any one of a half a dozen financial exchange-traded funds (ETFs), I think a better choice is to buy LEAP options on each of the banks. Not only are long-term options frequently mis-priced, but the risks for any investor buying them are strictly limited to the capital used to buy them and the returns can be proportionately higher for options buyers than for the straight-stock alternatives available at the moment.

And those profits are real enough for me - even without accretion.

This article has been reposted from Money Morning. You can view the article on Money Morning's investment news website here.

Think Your Gold ETF Really Invests In Gold? Better Check The Small Print

Several analysts are bullish on gold right for reasons such as the threat of inflation or potential weakening of the dollar. However if you want to invest in gold ETFs be careful. Not all ETFs are created equal. According to Toni Straka from The Prudent Investor some ETFs hold paper contracts and claim no liability of the third party's management of the gold.

Does your favorite precious metals exchanged traded fund (ETF) or exchange traded commodity (ETC) really invest in bullion all time? Or does it rely on paper contracts where a third party poses a counter party risk to a varying degree? Not everything marketed as a way to safely invest in precious metals truly shines under the spotlight.

To my knowledge there is only one group of precious metals ETFs, managed by Swiss Zuercher Kantonalbank (ZKB) - sorry, no English language information found - that always holds the 4 fund's funds in 100% gold, silver, platinum or palladium. This limits the only risk to the size of cash holdings that are unavoidable for short periods when the ETFs adjusts bullion holdings during trading hours.

I have checked a few other liquid European and US ETFs, but this appears to be the only safe way to own allocated gold besides holding it physically. Within the European Union there appear to be no restrictions to buy/hold/sell these ETFs, others please check local regulations.










GRAPH: Read from this gold chart whatever technical indicators you prefer. The fundamentals have never been stronger for a long gold strategy. Chart courtesy of kitco.com

Read more about investing in gold here at wikinvest.

Most, if not all other precious metals ETF/ETC come with some sort of a counter party risk.

Checking the prospectus (PDF)of global heavyweight SPDR , risk factors beginning on page 10 give room to "don't blame me, blame the next one in the food chain" finger-pointing games like this quote from page 13,

If The Trust's gold bars are lost, damaged stolen or destroyed under circumstances rendering a party liable to the Trust, the responsible party may not have the financial resources sufficient to satisfy the Trust's claim.

Check out the 4 pages of risk factors yourself and find more quotes hinting at a counter party risk. SPDR may also accept non-standard gold bars without checking their genuineness by its management.

Click here for a SPDR chart who reported record holdings of 1,124 tonnes or 36,460,190 ounces as of today. But it is not 100% gold according to the fine print.

A price below spot gold stems from expenses paid for after selling some gold.
Basically the same applies to Europe's popular XETRA gold ETC, traded in Frankfurt. Check out the prospectus starting at this disclaimer page. Always remember only to enter security classes when you fully understand them. Xetra gold is basically a permanent zero bond without a coupon, covered by gold and claims on gold.

As ZKB's precious metals fulfill my requirements I have not looked further. If you come across more ETF/ETCs that truly hold the gold/silver/platinum/palladium themselves down in the vault, please let me know in comments.

DISCLAIMER: I am in no way affiliated with ZKB and I cannot confirm the rumor that ZKB headquarters is sinking under the weight of its ETF holdings in its vaults. Long gold positions.

This article has been reposted from The Prudent Investor. The full post can also be viewed on The Prudent Investor.

Prime 40-Story Commercial Building In New York City Sells For $100,000

Imagine buying a commercial property for $500 million and later having to walk away with virtually nothing. That is what happened to Harry Maclowe who defaulted on a loan on a prime commercial skyscraper in the heart of New York City. Values of commercial real estate are plummeting and buildings are being sold at unbelievable discounts (the John Hancock Tower in Boston was recently sold for just over $20 million). For more on this story see the following article by HousingWire.

As we all know by know, times are tough. Signs of it are found everywhere we look - from flagging real estate prices to job losses and everything else in between. However, when a 40 story skyscraper in the middle of New York sells for a measly $100,000 we can’t help but wonder what in the world is going on.

The tower is positioned right on a prime corner of real estate, close to the Museum of Modern Art and close to the Rockefeller Center and Central Park.

The building or tower mentioned here is the 1330 Avenue of the Americas building. The tower sold for nearly $500 million three years ago. When owner Harry Maclowe defaulted on his $130 million loan last year the tower was auctioned off last month for the ridiculously low price of $100,000 to a Canadian pension fund.

Distressed properties are an investors dream come true since they are to be had for bargains. In these economic down-times we see billions of dollars worth of distressed real estate auctioned off for next to nothing. Many developers are left in the leach as they fall behind in their mortgage payments and their tenants leave. With banks and lending institutions being very cautious in granting loans these days, people find it hard to finance their shortcomings.

However, despite the great price buyers are getting for these distressed properties there is usually a condition attached to them. Buyers will have to take on the existing debt connected to theses properties.

Dan Fasulo, a managing director at Real Capital Analytics said: “Just imagine in a residential market, if there weren’t 80 percent loans available for everyone. If everyone had to buy their houses in cash, the values of houses would plummet everywhere. That’s happening on a massive scale on the commercial side.”

Analysts expect many more of these auctions as more foreclosures will hit the shores in the U.S. This will dramatically reduce the worth of prime real estate all around and some even speculate it will level many office tower markets. Talk is that many of these properties in danger of foreclosure have actually been marketed at over-inflated prices and now that the market has crashed they will “feel” the full brunt of it first hand.

Real Capital Analytics, which tracks commercial real estate transactions, counted over $86 billion worth of distressed properties in the country as of April, over $6 billion in Manhattan.

Source: Boston Times

This post can also be viewed on overseaspropertymall.com.

Real Estate Biggest Gainers And Losers In The First Quarter

Despite the global financial crisis some countries have managed to show small growth in their real estate market while others have tumbled significantly in the first quarter of 2009. Which countries have managed to overcome the global economic turbulence? The following article by Overseas Property Mall takes a look at the biggest gainers and losers of the first quarter and a housing outlook by Knight Frank Global.

The Q1 Knight Frank Global House Price Index 2009 hasn’t shown surprising results in the scheme of the global financial crisis. Some of the key highlights has seen Israel as the top performer with a 10.9% growth rate, followed by the Czech Republic with 9.9%.

On the contrary, the worst activities were seen in Dubai, Latvia and Singapore. Dubai recorded average price falls of 32%, Singapore 23% and Latvia 36% loss. On a quarterly basis, Dubai was the biggest loser with -40%.

In terms of best performing markets, Thailand with a 2.7% lift in values, Israel with +2.6% and Switzerland with +2.1% were showing promising results.

However, according to the Q1 report, a full 30% of the sources usually reported on had not returned their Q1 data at the time of writing the Knight Frank Global House Price Index.

Despite some of these markets having seen a rise in values, economists believe that the outlook for the global markets is still grim. Head of international research, Knight Frank, Nick Barnes said:

The world’s housing markets remain under intense pressure with little real evidence of any of the hoped for ‘green shoots’ and even the improvement in performance shown in some countries in the last quarter may yet turn out to be a false dawn according to some commentators. Recent projections from the Organization for Economic Co-Operation and Development (OECD) do little to promote a more optimistic viewpoint – GDP growth is forecast to drop by an average 4.3% in the OECD area in 2009 while by the end of 2010 unemployment rates in many countries will reach double figures for the first time since the early 1990s.

The inescapable trend is that the worst and most widespread economic recession since the 1930s continues to batter housing markets across the globe. Rising unemployment and concern among those still in jobs, added to constrained credit conditions, means that buyer demand for housing remains suppressed and confidence is low in most markets which is inevitably having a negative impact on house prices. There is sporadic evidence of buyers snapping up relative bargains, however of those buyers in a position to move, many are still waiting for clearer signs that markets are approaching the bottom of the cycle. Moreover, in a falling market, sellers are usually forced to a greater or lesser extent which means that opportunities to buy are greatly reduced and transaction volumes correspondingly low.

Against this backdrop, it is perhaps unsurprising that of the official sources used in the Knight Frank Global House Price Index, 14 (equating to 30% of the total index) had not reported Q1 data at the time of writing this report. We can only surmise that the data collection bodies have either been unable or unwilling to publish the data to timetable – perhaps a reflection of the ailing health of their respective residential property markets?

Of the first quarter data which we have received, Israel was the top performer over the 12 month period ending Q1 2009 recording growth of 10.9%, followed by the Czech Republic at 9.9%. The better performing markets tend to be smaller and with fewer structural imbalances. The worst performers were Latvia and Dubai who recorded a fall in average prices over the period of, respectively, 36% and 32%. Singapore also reported a hefty 23% drop in values while a further five countries also returned double digit declines.

On a quarterly basis, 69% of the countries from whom we received Q1 data reported a drop in prices compared to 82% in our Q4 2008 index. However, on an annualized basis, 72% of countries showed a fall in values compared to 59% in Q4. Given the high proportion of “absentees” for Q1, however, it would be potentially misleading to jump to too many hasty conclusions, although over half had shown annual and / or quarterly price falls at the last time of reporting. Nonetheless, the shorter term future direction of most underlying economies suggests that the world’s residential markets are likely to continue to suffer for some while.”

The UK saw a loss of values of - 16.5%, followed closely by the U.S with -16.9%. This resulted in a rank fall of 10 places from Q1 2008 to Q1 2009 for the UK and a respective loss of 4.5% year-to-year.

Biggest price rises, first quarter 2009

1. Jersey up 5.6%
2. Finland up 4%
3. Thailand up 2.7%
4. Israel up 2.6%
5. Switzerland up 2.1%

Biggest price falls, first quarter 2009

1. Dubai down 40.0%
2. Singapore down 16.2%
3. Estonia down 9.9%
4. Norway down 6.2%
5. Denmark down 6.1%

To see the full list of ranks click here.

This post can also be viewed on overseaspropertymall.com.

How Obama's Stimulus Plan Could Cause A Deeper Recession

Interest rates have been on the rise and Obama's Stimulus Plan that has increased the government deficit may be the culprit. According to Reuters "The U.S. Treasury must sell a record net $2 trillion in new debt in 2009 to fund a $1.8 trillion projected fiscal deficit, resulting from falling tax revenues, an economic stimulus package and sundry bank bailouts." Martin Hutchinson from Money Morning argues why increasing interest rates can be very bad news for the economy.

Could the massive Obama stimulus plan end up hurting the U.S. economy?

It’s long been a worry, and now it’s beginning to seem possible.

The latest housing reports suggest that the recent rapid run-up in 10-year Treasury bond yields may be having an unhealthy effect on the U.S. housing market. That tells me that - although home prices are back to their long-term average in terms of earnings - we may not yet be close to the price bottom.

If that’s true, it’s very bad news. A further substantial decline in housing prices would destabilize the U.S. banking system again, because of all the mortgage debt in it, which would cause a very nasty “second leg” economic downturn. That would have one very ironic further implication: U.S. President Barack Obama’s $787 billion stimulus package - intended to help the U.S. economy push back the recession - would instead have succeeded in pushing it deeper into the mire.

A month ago, it appeared that the housing market might be in the process of bottoming out. The ratio of house prices to average incomes - which peaked at about 4.5 to 1 in 2006 - had fallen 33% from that apex, which brought the ratio close to its long-term average of 3.2 to 1, according to an S&P/Case-Shiller Index report. While interest rates remained low and government-backed home financing was readily available, it appeared the forces pushing up house prices (low interest rates and accessible financing) might soon come into balance and then dominate the forces that push home prices down (an inventory overage).

The jump in interest rates - from 2.07% on the 10-year Treasury bond in December to around 3.65% today - has weakened the case for a stabilization of housing prices. Mortgage rates, which were far below their levels of the last 30 years, have moved back above 5% — even for “conforming” mortgages. Thus the Mortgage Bankers Association index of new mortgage applications was down 15% in the latest week. Meanwhile, new home sales have merely stabilized at very low levels of an annual rate around 350,000 - compared to more than 2.0 million at the peak of the market, while the latest price statistics suggest that price declines continued to be quite rapid in March, and possibly even accelerated slightly.

This interest-rate increase does not currently seem to be caused by expectations of inflation, which has remained around 2% annually, although oil, gold and other commodity prices have ticked up. Instead, it seems to have been caused by the exceptionally high demands being made on the government bond market by the U.S. federal deficit, which is expected to total about 13% of gross domestic product (GDP), or more than $1.8 trillion, this year.

It’s not surprising that such a blip should have occurred this month; federal tax receipts are at their peak in April, as companies and individuals pay their taxes due, so the beginning of May saw a resumption of mammoth U.S. Treasury funding needs after a month’s pause.

If interest rates continue to increase, the effect on the already-weak housing market could be severe, as housing “affordability” would be reduced in a period in which prices were declining and unemployment was rising. That, in turn, could have a self-reinforcing downward effect on prices, as home inventories bloat further, and buyers hold back.

Currently, according to the S&P/Case-Shiller 20-city house price index, prices are down 32% from their peak, but remain 40% above 2000 levels, while consumer prices are only 24% above those of 2000. However, 2000 was not a “bear-market” year; prices had already enjoyed several years of rapid recovery from their early-1990s low. Should rising interest rates cause prices to continue falling to 2000’s level (another 28% decline), then on average every 80% mortgage undertaken since May 2002 (when the index first went above 125% of 2000’s level) would be underwater, having an owed principal amount that exceeds the actual current market value of the house. That would cause a surge in mortgage defaults more severe than any yet seen, extending far into the prime mortgage category - and probably causing the U.S. banking system to implode once again.

The stimulus-package funds, which began flowing in April, may actually induce some GDP growth this quarter. At the very least, the Obama administration infusion should hold the economy to a very minimal decline in GDP.

However, if interest rates keep rising, the effect of further housing-sector weakness and the wobbling banking system would overwhelm any stimulus benefits, and would cause a second “dip” in this recession - one that’s far worse than the first. The stimulus would, in that event, have proved counterproductive, killing the very economic recovery it was supposed to have stimulated.

Rising interest rates will have adverse effects on all countries with large budget deficits, the most notable of which are Britain and Japan. The effects would be harsh enough to actually prevent those countries from recovering from their own recessions.

For investors, the remedy is clear: Look to invest in countries that have produced only modest stimulus packages, and whose budget deficits are currently the smallest. In the invaluable statistical section of The Economist, a number of countries are projected to have budget deficits of less than 3% of GDP in 2009, in spite of their recessions.

At that level, deficits are easy to finance, and do not force up interest rates, so economic recovery should be relatively rapid.

Let’s take a look at some of those countries in question:

Canada:
Budget deficit forecast of 2.5% of GDP. Americans are fond of sneering at Canada for its high public spending and sluggish growth. Well, Canada’s public spending as a percentage of GDP peaked in the early 1990s and since 2000 the country has run budget surpluses. In 2009, Canada is forecast to have public spending lower than the United States, when provinces and states are taken into account, and to continue lower than its arch rival (the United States) for the foreseeable future. I wrote a few weeks ago about investment opportunities in the Canadian energy sector; those opportunities are even more compelling with the continued rise in the oil price to current prices of more than $62 a barrel.

Denmark Finland and Switzerland
Wealthy European countries with healthy budget positions - deficits of 2.5%, 2.6% and 2.0% of GDP, respectively - will recover more quickly than their neighbors, because they have kept their economies in balance.
Brazil
Probably the best of the lot, with a projected budget deficit of only 2% of GDP, inflation of 4.4% and bond yields of 11.8% — meaning it can indulge in a little monetary expansion if it needs to. Brazil will also benefit if inflation returns (as I expect it to), because that will push up the prices of its commodities exports.

So there you have it. Maybe the U.S. bond market and housing market will stabilize, and the American economic recovery will proceed smoothly - nothing is certain. But investments in Canada and Brazil, in particular, will protect you against the possibility that the U.S. situation doesn’t improve.

This article has been reposted from Money Morning. You can view the article on Money Morning's investment news website here.

Foreign Economies Could Distance Themselves From The Dollar

It is no secret that many countries would like to decrease their dependency on the dollar. For instance, BusinessWeek says China owns $2 trillion in dollar assets and could be a big loser if the dollar was weakened. According to foreign exchange currency expert Kathy Lien, several nations may take action to distance themselves from the dollar in the coming months.

The U.S. dollar has weakened significantly driving many of the major currencies to the highest level in months. Here’s a table illustrating the significance of today’s moves. I expect at least another 2 percent decline in the U.S. dollar against the key currencies (Short and Long Term Outlook for U.S. Dollar).

The fact that USD/JPY is not participating in today’s rally indicates that investors’ distaste for dollars rather than their risk appetite is driving the dollar lower. The modest gains in Dow futures and the sharp rise in gold prices confirm that investors are bailing out of dollars. In my interview with Fox Business 2 days ago, I talked about how the one takeaway from the concern about the credit worthiness of the U.S. is the need for diversification.











Yesterday, a Brazilian official said that the BRIC nations (Brazil, Russia, India and China) could take unilateral action to reduce their dependency of dollars at their summit next month. Brazil has already begun to replace the dollar bilaterally in their trade with China and unfortunately this trend could continue with other nations following suit in the coming weeks and months. The one thing that the financial crisis has taught investors large and small is need for diversification and no one wants to sit with baskets full of dollars waiting for S&P to make an announcement. Sovereign Wealth Funds are taking this to heart which could create a fresh supply of dollars.

This post can also be viewed on kathylien.com.