“We sat on a balcony in Cannes, France, discussing the probable fate of the American housing market. The balcony belonged to Dr. Kurt Richebächer, as did the prescient predictions I heard that day.

“‘The American housing market is in serious trouble,’ Dr, Richebächer insisted at the time. ‘It is one the verge of a major collapse.’

“The date was October 14, 2005, and at that time, the housing boom was still booming…and almost no one imagined that the good times would end very soon. But Richebächer did not refrain from predicting imminent disaster.

Kurt Richebacher
September 13, 2007

Read on below…”
When the Roof Caves In…

And now some news from Short Fuse in the City of Angels…

————–

Views from the Fuse:

Curiouser and curiouser…with the dollar at all-time lows against major currencies, and gold at all time highs, it’s as if the Fed has already made their rate cut. Why are they acting this way? Is it just on speculation that the Fed will cut rates…or is it due to something else?

“The reason the markets are acting this way,” writes The Survival Report’s Brian McAuley this morning, “is because the Fed has ALREADY lowered the rate.”

No, this is not a “conspiracy theory”. If you look at the daily average Fed funds rate since August 8 (two days before the you-know-what hit the fan), there have only been two days that the rate has been over the official target of 5.25%.

“During every other day over the past month, the actual fed funds rate has been maintained well below the official target. In fact, the average fed funds rate since Aug. 10 has been 4.96% – 29 basis points below the official target of 5.25%.

“So while everyone seems to be wondering if the Fed is going to lower the fed funds rate at next week’s FOMC meeting, the Fed has actually already lowered rates by over a quarter of a percentage point over the past month. This is one reason why we are already seeing the dollar trade lower against other major currencies and gold rally.”

And it looks like people in Texas were taken a bit off guard last night, as Hurricane Humberto smacked the coast with 85 mile an hour winds.

“This little fella came out of nowhere… Humberto went from a low pressure system, to tropical depression, to Category 1 hurricane in less then 24 hours,” writes Addison in today’s issue of The 5 Min. Forecast.

“Humberto rolled right through the Total SA, Valero, and Motiva oil production facilities. All told, these plants refine almost 1 million barrels of oil per day. The storm produced no noticeable strain on prices… at least, no more than low supplies of the black goo are already exerting.

“Still, if you’re a Bulletin Board Elite subscriber, your Atlantic storm repair and reconstruction play made a nice jump.  Gunner’s been intensely watching NOAA reports… hurricane woes alone shot up his penny stock 11% yesterday.  Humberto might jack it up again, and a system about 930 miles east of the Lesser Antilles is already making news.”

“Greenspan blamed for double bubbles,” says a headline in the NY Post. At last…finally…they’re on to the old humbug.

Of course, Greenspan is not really responsible – at least, not alone – for today’s huge credit bubbles. As Ben Bernanke explained, there was a lot of money coming into the world financial system from other sources. The Asians, for example, seem to know how to make money but not how to spend it. Thus are they left with billions of dollars of savings. And when the price of oil rose from under $20 to over $70…it put a lot of money in the hands of oil producers. What could they do with all that extra money but put it into investments? And whose investments were better known, more liquid, and more universally accepted than those that were quoted in U.S. dollars?

Naturally and inevitably, people who earned dollars…or who had dollars…or owned dollar-based assets…or who printed up the dollar bills themselves…thought they were hot stuff. Everyone wanted what they had. Prices on Wall Street went up. Wall Street bonuses soared. Hustlers started up hedge funds…private equity funds…and funds of funds to grab some of the loose change.

All this money coming into the United States drove down interest rates. But it wasn’t just the foreign savers who drove down U.S. rates…and it wasn’t just the foreigners who were stuffing American capital markets with cash. After the mini-correction of 2001-2002, Alan Greenspan and George W. Bush panicked. Greenspan cut rates to “emergency” low levels… the lowest rates since the Great Depression…and the federal government jacked up spending while cutting taxes. The result was the biggest wad of new cash and credit ever to come into world capital markets.

What happened next? Boom…Bubble…now, B…ust?

Yesterday, the price of oil hit a new record high at $79.91. Meanwhile, the dollar fell to a new record low – at $1.39 to the euro (EUR). Wheat hit a new record high of $9 a bushel – twice what it brought a year ago. And the commodity index registered a new high too. Gold, the ultimate measure of paper currency destruction, held steady…despite estimates that the U.S. money supply has been growing at a fantastic 50% annual rate – following the market shock in the summer!

So much new cash and credit…so little real wealth!

Pity the poor American householder. Just a few months ago he had people lining up to lend him money. Now they’re on the phone wanting it back! He had gotten used to refinancing. But now refinancing is tough…and more expensive.

He goes to the grocery store and finds his bread and breakfast cereal have gone up in price. He gets his health care bill and finds it rising faster than his income. He drives into the gas station – he’s shocked by how much it costs to fill up his tank. He hears on the news that the government says inflation is under control…the federal budget is balanced…and all is well. But then he looks at his own cost of living and realizes that the feds’ numbers are nonsense – they merely left out two of his biggest expenses – food and fuel…and they cheated on the others.

And as for Bush Budget…

…he’s sure the feds are pulling a fast one there too. Look at the numbers more carefully, says Fortune Magazine, and you find a deficit of more than $400 billion…

…and then, he discovers that his adjustable rate mortgage is going to be reset.

Get ready for a ‘deluge’ of resets, says Reuters. So far, only about a third of the subprime ARMs of 2005 and 2006 have been reset… the crest of the wave is still ahead.

Home sales have already crashed…and forecasts are being revised downward every week. They’re already at a 15-year low in Southern California.

And now, the “housing slump is starting to pinch the economy,” says an item at San Francisco Gate. Shopping malls are feeling the pain, adds the New York Times.

And in Detroit, some 700 houses are to be auctioned off between September 21st and 23rd. These houses have been on the market for more than a year. The banks and mortgage lenders who own them are desperate to get them off the books. So this should be interesting…finally, we’re going to see houses marked to market. Some are expected to go for as little as $5,000.

Well, at least the cost of housing is going down…at least in Motown.

Here in London, the Financial Times reports that property prices fell in August – for the first time in two years. Property bulls argue that Britain is a small island and that there is a shortage of housing. Yet, there are said to be about 850,000 empty properties in England alone.

Finally, a sarcastic letter from a Dear Reader. Our comment follows:

“The analogy you revived, about the Pope having no power to back up his condemnation of the Nazis was especially poignant.

“The brilliant insight you’d expressed about these Islamists is truly revealing. Without standing armies under a governmental hierarchy, they’re about as much a threat as that stupid, self-absorbed, impotent Pope

“By pointing out the obvious fact that all this ridiculous waste of money and effort in trying to route them out and neutralize their activities is so much a mindless goose-chase, you have encouraged me to consider some sort of political pressure to realize an even greater economy!

“Think of it! Let’s all get together to force governments worldwide to eliminate the hugely wasteful expense involved in dispatching millions of dangerously hapless, bumbling police officers from endlessly meandering around the planet, needlessly poking into everyone’s private lives to find criminals. After all, without armies under structured governmental control, criminals are nothing more than an infrequent incidental inconvenience. Who should care if a fairly large proportion of them acquire machine guns, shoulder fired rocket launchers and caches of sophisticated explosives? Any chance that they’ll get their hands on enough biological or radioactive agents to affect more than a few thousand people every few years, is so slim that any level of concern is completely overblown! No armies…no governments…no problem!

“Surely, we could eradicate more than half of the losses of money attributable to criminal activity! We can just absorb the initial cost, and save trillions. The whole thing has demonstrably proven to be a failed effort, after all. Tens of thousands of years, we’ve been futilely trying to eliminate crime! For what? We’ve still got them slinking around in the shadows. Hell, any people affected were bound to die at some point anyway. It’s all so obvious, isn’t it? Just ignore it!

“How about it? You sign over all the proceeds of your publications to me, and I’ll immediately get to work on it! People need to wise up! Let’s join forces and help them see the light!”

Our dear reader presumes that we are opposed to fighting crime. Not so. It was a crime to bring down the World Trade Center. The cops should have gotten on the case and brought those responsible to justice.

Armies are made to fight armies – to protect the state. Cops are on the beat to fight criminals, and to protect individuals and individuals’ property…unless you live in a Banana Republic or a police state – where the army pretends to fight criminals…but actually controls the homeland population.

But we do not want to join the argument. We merely want to understand why people think the way they do. What is clearly a mistake to us…is clearly a necessity to someone else. And both of us have the same facts before us. Why the difference of opinion?

More to come…

Bill Bonner
The Daily Reckoning

When The Roof Caves In originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas. Recently Agora Financial released a video titled "What Causes Gas Price to Increase?".

AN UNPRECEDENTED SPECULATIVE SPREE

A study recently published by the Bank for International Settlements (Monetary and Prudential Policies at a Crossroad?) says:

“Financial liberalization is undoubtedly critical for the better allocation of resources and long-term growth. The serious costs of financial repression around the world have been well documented. But financial liberalization has also greatly facilitated the access to credit… more than just metaphorically. We have shifted from a cash flow-constrained to an asset-backed economy.”

Though we basically agree with the analysis and the conclusions of the study, we radically disagree with the one sentence that “Financial liberalization is undoubtedly critical for the better allocation of resources and long-term growth.” The indispensable first condition for proper resource allocation at a national as well as global scale is avoidance of excessive money and credit creation. In many countries, and in particular in the United States, they are excessive as never before.

If Mr. Bernanke complains about irregularities of M2, this is nothing in comparison with the fact that credit and debt growth in the United States has exploded for more than two decades. When Mr. Greenspan took over at the helm of the Fed in 1987, outstanding debt in the United States totaled $10.5 billion. In less than 20 years, this sum has quadrupled to $41.9 billion. In reality, this significantly understates the rise in debts because, for example, highly leveraged hedge funds with trillions of outstanding debts are not captured. In 1987, indebtedness was equivalent to 223% of GDP, which was already pretty high. Lately, it is up to 317% of GDP.

In actual fact, there used to be a very stable relationship between money or credit growth and GDP or income growth until the early 1980s. Growth of aggregate outstanding indebtedness of all nonfinancial borrowers – private households, businesses and government – had narrowly hovered around $1.40 for each $1 of the economy’s gross national product. Debt growth of the financial sector was minimal.

The breakdown of this relationship started in the early 1980s. Financial liberalization and innovation certainly played a role. But the most important change definitely occurred in the link between money and credit growth to asset markets. Money and credit began to pour into asset markets, boosting their prices, while the traditional inflation rates of goods and services declined. The worst case of this kind at the time was, of course, Japan.

Do not be fooled by the sharp decline in consumer borrowing into the belief that money and credit has been tightened in the United States. Instead, borrowing for leveraged securities purchases (in particular, carry trade and merger and acquisition financings) has been outright rocketing, with security brokers and dealers playing a key role. Over the three quarters of 2006, their net acquisitions of financial assets have been running at an annual rate of more than $600 billion, more than double their expansion in the past.

Federal funds and repurchase agreements expanded in the third quarter at an annual rate of $606.3 billion, or an annual 26%. The main borrowers were brokers and dealers. During the first three quarters of the year, their assets increased $427 billion, or 27% annualized, to $2.57 billion. A large part of the money came from the highly liquid corporations. There is no reason to wonder about low and falling long-term interest rates.

All this confirms that financial conditions remain extraordinarily loose. Even that is a gross understatement. Credit for financial speculation is available at liberty. Expectations for weaker economic activity only foster greater financial sector leverage. Why such unusually aggressive speculative expansion in the face of a slowing economy?

The apparent explanation is that the financial sector intends to make the greatest possible profit from the coming decline of interest rates, promising further rises in asset prices against falling interest rates. While the real economy slows, the leveraged speculation by the financial fraternity goes into overdrive. Principally, there is nothing new about such speculation. New, however, is its exorbitant scale.

Before leading his jumbo-sized delegation to Beijing, Henry Paulson, U.S. Treasury secretary, cautioned against expecting any big breakthroughs from the visit. And so it has turned out. The meeting produced plenty of statements about the desirability of improving relations, but nothing concrete to do so.

Of course, the Chinese are in a very strong position with the central bank holding more than $1 trillion of bonds in its portfolio, mostly denominated in dollars. According to reports, the American visit was initiated by Mr. Paulson in an effort to contain rising Sinophobia in the U.S. Congress, which increasingly blames China for America’s economic problems, from its huge current account deficit to stagnating real incomes. In other words, those troublemakers, not the trade deficit, are the problem.

One cannot say that U.S. policymakers and economists have been preoccupied with worries about possible harmful effects of the exploding trade deficit. They appear obsessed with the conventional wisdom that free trade is good and must always be good under any and all circumstances, as postulated in the early 19th century by David Ricardo.

Ricardo exemplified this by comparing trade in wine and cloth between Portugal and England. Portugal was cheaper in both products, but its comparative advantage was greater in wine. As a result, according to Ricardo, Portugal boosted its production and exports of wine. In contrast, England gave up its wine production and could produce more sophisticated goods. In both countries, living standards rose.

For sure, it appears highly plausible that American policymakers feel they are following Ricardo’s logic. Only they are disregarding some caveats of Ricardo’s. For equal benefit, first of all, balanced foreign trade is required. “Exports pay for imports” was a dogma of classical economic theory. Ricardo, furthermore, disapproved of foreign investment, with the argument that it slows down the home economy.

With an annual current account deficit of more than $800 billion, the U.S. economy is definitely a big loser in foreign trade. To offset this loss of domestic spending and income, alternative additional demand creation is needed. Essentially, all job losses are in high-wage manufacturing, and most gains are in low-wage services. In essence, the U.S. economy is restructuring downward, while the Chinese economy is restructuring upward.

Considering that Chinese wages are just a fraction of U.S. or European wages, it appears absurd that the Chinese authorities deem it necessary to additionally subsidize their booming exports by a grossly undervalued currency, held down by pegging the yuan to the dollar.

In the U.S. financial sphere, the year 2006 has set new records everywhere: records in stock prices, records in mergers and acquisitions, records in private equity deals, record-low spreads, record-low volatility. Manifestly, there is not the slightest check on borrowing for financial speculation. There is epic inflation in Wall Street profits.

One wonders what can stop this unprecedented speculative binge. Pondering this question, we note in the first place that the gains in asset prices – look at equities, commodities and bonds – have been rather moderate. To make super-sized profits, immense leverage is needed. We think the speculation is unmatched for its scope, intensity and peril. Plainly, it assumes absence of any serious risk in the financial system and the economy. The surest thing to predict is that the next interest move by the Fed will be downward.

In our view, the obvious major risk for speculation is in the economy – that is, in the impending bust of the gigantic housing bubble. Homeownership is broadly spread among the population, in contrast to owning stocks. So the breaking of the housing bubble will hurt the American people far more than did the collapse in stock prices in 2000-02. For sure, the U.S. economy is incomparably more vulnerable than in 2001. Another big risk is in the dollar.

Regards,

Dr. Kurt Richebächer
for The Daily Reckoning
March 20, 2007

Editor’s Note: Dr. Richbächer has found the best investments to protect your portfolio, no matter what lies ahead for us in 2007.

Dr. Kurt Richebächer is the editor of The Richbächer Letter. Former Fed Chairman Paul Volcker once said: “Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong.” A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as “the man who predicted the Asian crisis.”

Yesterday, the markets seemed to return to ‘normal’ – or, at least to what is taken for normal by today’s investors. That is to say, things that were already over-priced became more overpriced. And investors who were already over-stretched, reached a little further.

Time heals all wounds…and wounds all heels. Got a problem? One way or another, time will solve it. Something not right? Someone getting away with something? Don’t worry…time will take care of it.

And if we can’t sort out what is going on in the financial markets, time will have to do it.

The Dow rose 115 points. “Investors regain risk appetite and put subprime fears on back-burner,” says the Financial Times.

And regaining an appetite is a good thing when you are sick. But we are not so sure it is a good thing when you are about to explode from overeating.

And if time can heal things…it can rot them too.

“Oh time…won’t you spare me over another year? I’ll give you my gold coins. I’ll give you my stocks. How ’bout my beach house?

“I’m not asking much. Just make my face look like it did in ’68…just let me buy a gallon of gas for 25 cents, like I did in ’72…just let us stay up all night and howl at the moon like we did in ’82…just make my dotcom stocks worth what they were in ’99…

“That’s not asking too much is it?”

Yes, you can ignore time, but it won’t ignore you.

Time sorts out everything and everybody. Nothing and nobody is missed. You can’t hide from it. You can’t escape it. You can’t outrun it. You can’t make a deal with it.

If only we could arrange time…chivvy it into place where we want it, we could have ourselves a bit of fun.

We would set the highway traffic back to the levels of ’50s. And our automobiles back to the ’50s too…but then, let’s put 21st century technology under the hood. We don’t want to have to fool with carburetors like we did back then.

And consumer prices; let’s put them back into the early ’60s too…before the first big wave of inflation hit. We recall buying a hamburger at The Little Tavern in Annapolis for 25 cents. Another quarter got us a Coke.

And what did it cost to go to the movies? We can’t remember, but we think it was about 60 cents a ticket. Everything was cheap. Of course, it didn’t seem cheap back then. So, since we’re rearranging the sequence of things, let’s set incomes at 2007 levels.

And let’s go back to the Eisenhower era to find a political system we can live with. There were real conservatives back then – people who were reluctant to spend the public’s money…and reluctant to meddle in the public’s affairs. Now, we have only phony conservatives – people who preach ‘conservatism’ while pushing the most activist agendas since FDR.

“Turn the desert tribes of Mesopotamia in to Dixie Democrats?” the old timers would have joked. “Why not turn them into Baptists too? Ha ha…”

Meanwhile, the front page of the USA Today tells us that this latest attempt to remake the world in our own image is running into problems. A few months ago, Iraqis held up their purple fingers and proudly supported democracy. But now that they’ve had some experience with it, a new poll shows that the majority of them are against it. Only 43% think democracy would be good for Iraq. The rest have other ideas.

By contrast, a majority of Iraqis think it is ‘acceptable’ to kill U.S. soldiers. These are the same people – at least, according to the fiction of it – that U.S. soldiers are trying to protect. Take them out of the picture, said America’s president last night, and the Iraqis might start killing each other.

Oh, if only we could rewind the tape. If only we could go back to the Eisenhower era when U.S. presidents still had wit and charm! Yes, those were the good old days – at least they seem pretty good looking now, from a half a century later. America was still a free country, as near as we can recall. No phony wars against terror…no Sarbanes…no Oxley…no Hillary…no George.

And who was chairman of the Federal Reserve in 1956? Who knew? Who cared? The dollar was still linked to gold. You could trust it. America was the world’s biggest factory…the world’s biggest creditor…the world’s biggest exporter…the world’s fastest growing economy. All people cared about was that ‘Ike & Dick’ were ‘Sure to Click’ – no kidding, we have an old campaign button.

Of course, public life was as full of humbug as it is now…but the humbug seemed more innocent, less intrusive…and ultimately, more humane.

But enough of this reminiscing…no point to it. Time cuts deals for no one. Not even for the New York Stock Exchange.

More news:

————–

Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…

“I’ve long said that Aussie was an 80-cent currency, and I noted to the people on the desk yesterday that it was oh-so-close to that level, and I hoped it didn’t disappoint us like sterling did when it got oh-so-close to the 2.00 level.”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig

————–

And more thoughts, views, ideas…

*** Let’s see. According to the press reports, three things helped investors chow down again.

First, Chinese stocks took off. After a brief and feeble panic-attack a couple of weeks ago, the Shanghai stock exchange is as fat and happy as ever. The index is nearly in record territory again.

Second, a whole new selection of merger and acquisition targets was added to the menu. How could investors resist? All that delicious, syrupy, rich sauce floating around! There is even talk of a major acquisition in the gold mining sector. Barrick is said to have its eye on Newmont whose shares are expected to bring in the mid-50s.

And third, investors are coming to terms with the whole subprime issue. Tim Harris, a strategist at JP Morgan, put the matter in perspective:

“It is estimated that the U.S. mortgage market is worth some $10,000 billion, approximately 10 percent of which is cumulatively classified as subprime; 12-15% of which may be in or approaching distress/default.”

No biggie, in other words. But wait! Ten trillion dollars is still a lot of money. And 10% of it is still $1 trillion…and 15% of $1 trillion is still $150 billion. Who’s got $150 billion to lose?

And the problem – again, according to the press – is the risks now overflowing into other segments of the mortgage market – notably into Alt-A and Jumbo loans. The same stretch for profit that led lenders to make loans to people who couldn’t pay them back…led investors to buy the loans packaged as debt-back securities…along with high priced stocks in a communist country…and a great deal more. They will keep stretching until something snaps, we figure. Maybe it already has.

Time will tell.

*** The shift to the Asian economy is happening faster than anyone predicted – yes, even you humble editors at The Daily Reckoning.

Take for instance, a friend of ours who provided research for the best-performing hedge fund (between 2000 – 2005) in New York. 18 months ago, he pulled most of his money out and invested – guess where? – in Shanghai.

Barely two years later, he has made seven times his money with his Far East investments…and the hedge fund in New York is just breaking even.

This kind of story is popping up more and more – clearly, China has widespread opportunities for investment right now…the question is: where, exactly, do you put your money? And how do you sift through the global market concerns to find good, solid investments?

Well, this year, at our annual Agora Financial Wealth Symposium, we are going to try and help answer any questions or concerns you may have about investing in the Far East. This year’s topic is “Rim of Fire: Crisis & Opportunity in the New Asian Era.” You can think of it as Basic Training for global investing. You’ll get a complete perspective on how a rare confluence of politics, business, globalization, and the age-old forces of supply and demand could make Asia the profit opportunity of a lifetime. And by the time you leave, you’ll be equipped with an array of strategies and specific actions you can take to start grabbing some of those profits for yourself.

[Ed. Note: The Symposium will be taking place at the beautiful Fairmont Hotel in Vancouver, British Columbia, July 24 - 27. And if you sign up now, you'll receive the early bird special - $200 off the regular cost of admission.

Call Agora Travel at 800-926-6575 to be added to the list right away.]

*** And the opportunities for major gains don’t stop with just China – India is another influential player in the global economy right now. Again, the question remains – how do you profit?

Why not put everything you learned at this year’s Agora Financial Wealth Symposium to the test? Join Addison and Mt. Vernon Research Investment Director, Karim Rahemtulla on The Asian Tiger Investment Tour of India.

This tour, which will take place October 25 – 27, will take you through the major business hubs in India – Mumbai, Hyderabad, Bangalore…and more. You’ll travel with your experienced hosts in first-class style, staying at the finest hotels and enjoying some of the best food India has to offer – all the while learning how to position yourself to profit in Asia.

Secure your seat now – call Agora Travel at 800-926-6575, or email at info@agoratravel.com

*** The dollar! Is anyone paying attention? The greenback is slipping. But in all the commotion hardly anyone seems to notice. We checked this morning and found the euro priced at nearly $1.33.

What could go wrong? Well, the dollar could continue slipping.

Now, let us imagine that you have the world’s biggest stash of money, which today is more than $1 trillion. No one ever had such a big pile. But let us imagine that the money isn’t really yours. You have been put in to manage it on behalf of the People’s Republic of China. And if you lose it, the people aren’t going to be very happy.

Now, about 70% of that money – $700 billion or so – are in dollars.

You have already gone on record as saying you intended to diversify out of dollars. You expect to do it in an orderly way. But with the dollar going down, you realize that when you finally do diversify you’re going to get less for your dollars than you could get now. In fact, if the dollar falls 5 cents against the euro, you have effectively lost 5% of your dollar holdings – or $35 billion. Hmmmm…what will the people say?

What if the dollar goes down 10%? Hmmm…now you’re talking serious money.

Of course, this is not the first time we have posed this question: Why don’t the people with serious money at stake move to protect themselves? And how come the dollar has, so far, resisted our predictions. With a current account deficit at 6% of GDP, it seems obvious that the dollar must fall. So must it fall when the carry traders unwind their trades. Many borrowed yen to buy dollars. When they get out of their positions they will have to sell dollars and buy yen. The dollar should fall. But it doesn’t. Or it hasn’t. Yet.

There is always tomorrow. Time will sort it out.

An Unprecedented Speculative Spree originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas. Recently Agora Financial released a video titled "What Causes Gas Price to Increase?".

CORPORATE AMERICA TO THE RESCUE?

With some consternation, we have been reading that Fed officials think the U.S. economy is a lot sounder today than it was at the end of 2000 and in early 2001, when the Fed abruptly reversed course and began a string of rapid interest rate cuts. One can only wonder about its reasoning. What we see is a doubling of the U.S. trade deficit, the complete collapse of personal and national saving and an unprecedented borrowing deluge that created the most anemic GDP growth in the whole postwar period.

During the five years 1995-2000, nonfinancial debt growth by 32.4% went together with 22.2% real GDP growth. In the following five years 2000-05, nonfinancial debt grew by 47.3% and real GDP by 13.4%. There has been an atrocious deterioration in the relationship between debt growth and economic growth.

In his speech on the Economic Outlook on Nov. 28, Chairman Ben S. Bernanke said:

“A reasonable projection is that economic growth will be modestly below trend in the near term but that, over the course of the coming year, it will return to a rate that is roughly in line with the growth rate of the economy’s underlying productive capacity.

“This scenario envisions that consumer spending – supported by rising incomes and the recent decline in energy prices – will continue to grow near its trend rate, and that the drag on the economy from the motor vehicle and housing sectors will gradually diminish.”

To everybody’s surprise, Mr. Bernanke indicated he was more afraid of inflation than of an economic slowdown. What, actually, would happen if he expressed some fears about an economic slowdown? He would unleash an undesirable torrent of speculation anticipating the coming rate cuts. It is one of the many bad ideas of Mr. Greenspan that central banks should foreshadow to the public their next policy moves. It only plays into the hands of speculators.

While admitting that “the correction in the housing market could turn out to be more severe and widespread than seems most likely at present,” Mr. Bernanke added:

“Economic growth could rebound more vigorously than now expected. The solid rate of job growth, the decline in the unemployment rate and the healthy pace of capital investment could be signals that underlying fundamentals are stronger than generally recognized. Moreover, to date, there is little evidence that the weakness in housing markets is spilling over more broadly to consumer spending or aggregate employment. If these trends continue, growth in real activity might return to a pace that could intensify upward pressures on resource allocation.”

Pondering the U.S. economy’s performance in 2007 ultimately boils down to two main questions: first, whether the housing downturn will seriously hurt consumer spending;  and second, whether capital spending by Corporate America will promptly come to the rescue when consumer spending slows.

In our view, the first eventuality is highly probable, and the second is highly improbable. The first of the two assumptions is simply commanded by the recognition that the housing bubble over the last few years has been the economy’s main driving motor, against pronounced weakness in business capital investment. Sharply rising house prices provided the collateral, which enabled private households to embark on their greatest borrowing-and-spending binge of all time.

Those “wealth effects” from house price inflation, manifestly, played the key role in fueling the soaring home equity withdrawals. But the thing to see now is that to stop this easy credit source, it is enough for house prices to flatten. In fact, the curb to this borrowing-and-spending binge has started with a vengeance.

The fact is that private households have drastically curbed their mortgage borrowing. It amounted to $672.7 billion in the third quarter 2006, sharply down from $1,223.6 billion in the same quarter of last year. That is, consumer borrowing almost halved. It amazes us how little attention this fact finds.

It means that the most important credit source for spending in the economy is rapidly drying up, even though money and credit remain, in general, as loose as ever. It is drying up because the decisive lever of this borrowing binge, rising house prices, has broken down; most importantly, this lever is not under the control of the Federal Reserve.

A sharp decline or even cessation of such borrowing essentially indicates an impending sharp retrenchment in consumer spending. Mortgage equity withdrawal peaked at an annual rate of about $730 billion, or 8.1% of GDP, in the third quarter 2005. One year later, in the third quarter 2006, it was sharply down to $214 billion.

This, too, represents a pretty steep decline. Yet it seems to have had little effect on consumer spending, which rose 3.9% in 2004, 3.5% in 2005 and 2.9% in the third quarter of 2006. For the bullish consensus, this is instant proof of its prior assumption that the downturn in the housing market will not spill over more broadly to consumer spending or aggregate employment. The truth is that consumer spending has been squarely hit.

But to realize this, it is necessary to look at total spending by the consumer on consumption and residential investment. The latter was down 11.1% in the second quarter and 18% in the third quarter 2006, both at annual rate. Combined, the two components of consumer spending in the third quarter had slowed to an annual rate of 2%, the slowest growth rate since the past recession, against a 3.8% increase in 2005.

In 2005, real GDP rose $345.1 billion, or 3.2%. Private households increased their total spending by $312.2 billion, of which $264.1 billion was on consumption and $48.1 billion was on residential building. Together, the two components accounted for 91.8% of GDP growth. This spending boom compared with current income growth by just $93.8 billion, or 1.2%. Thus, less than one-third of the rise in consumer spending was funded by current income growth and more than two-thirds was derived from additional borrowing. To us, this seems an unsustainable pattern.

Considering the dramatic reversal in the housing bubble, a virtual collapse of consumer borrowing is definitely in the cards for the United States. Compensating for this big loss in spending power will require a sharp surge in employment and income growth. Some recent employment numbers have been somewhat better than expected. But they are not nearly as good as would be necessary to offset the impending further sharp decline in consumer borrowing. Importantly, there is no acceleration in comparison with last year.

The median price of a new single-family home fell 9.7% year over year in September – the largest percentage decline since December 1970. The median price of an existing single-family home fell 2.5% year over year – the largest decline in the history of the series.

How likely is it that this housing downturn will be milder than average, as the consensus assumes? A rule of thumb says that the fierceness of a downturn tends to be rather proportionate to that of the prior upturn. By any measure, this was America’s wildest housing boom. We owe the following chart to Paul Kasriel of Northern Trust. It measures the dollar volume of single-family home sales to GDP. In 2005, it reached a record high of 16.3%, almost double the median percentage of the entire series dating back to 1968.

For us, the most obvious, and also most simple, measure of spending excess is associated increases in credit and debt. Between 2000 and third quarter 2006, the mortgage debt of U.S. private households soared from $4,801.7 billion to $9,497.4 billion. In barely six years, it has, thus, almost doubled.

We have been reading with utter amazement that stronger employment and income growth will offset the negative effects of the downturn in homebuilding. By available official numbers, the housing bubble – including directly related businesses such as furniture, mortgage finance and real estate – has created about 850,000 new jobs, about 30% of total job growth. Most of these jobs are sure to disappear.

Regards,

Dr. Kurt Richebacher
for The Daily Reckoning
February 1, 2007

Dr. Kurt Richebacher is the editor of The Richebacher Letter. Former Fed Chairman Paul Volcker once said: “Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong.” A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as “the man who predicted the Asian crisis.”

How do you say ‘bubble’ in Mandarin? The Shanghai exchange has gained 200% in the last 18 months. In Singapore, the stock market nearly doubled last year. And yesterday, the Dow hit a new record too.

And in Bozeman, Montana, it is a dash for trash. On Blixseth!

Mr. Tim Blixseth, whom we mentioned yesterday, is building what is easily the gaudiest cabin in the Montana woods…and perhaps the most expensive house in the whole world.

But, for making headlines, he has plenty of competition. Everything is soaring.

Oil rose to over $58. Gold shot up to $657. And Mr. Jim Wilson of Missouri won a Powerball pot of $254 million.

We were thinking of all this money this morning; it is the Age of Mammon, for sure. Which is why we have our Crash Alert flag still flying. Things don’t go up this sharply without them going down sharply, too – in a crash for example.

But don’t worry, say the experts, all this new sophistication in the financial markets (they have computers now!) makes crashes a thing of the past.

And yet, the Financial Times report from earlier this week troubled our sleep:

“‘There is now such creativity of new and very sophisticated financial instruments…that we don’t know fully where the risks are located,’ said Jean-Claude Trichet, head of the European Central Bank. ‘We are trying to understand what is going on – but it is a big, big challenge.’”

If the head of the second most powerful banking cartel in the world can’t make sense of it, what hope is there for us? We don’t know. But we have an obligation to our dear readers to try. So, for the last three days we have done nothing else…pausing only to pray and burn incense to the credit gods.

Do all these new financial instruments really reduce risk…or do they increase it? First, we have to master the peculiar dialect in which this subject is discussed. Swaps, securitized debt, alphas…you have to understand the language of the high priests before you can enter the temple. Then, when you get inside, you discover that the whole religion is nothing more than hocus-pocus.

After about 20 seconds of reflection, we realized that the answer, for once, lay not in the details, but in the generalities. The particular formula by which a specific derivative contract is constructed only affects the particular participants. But the phenomenon as a whole affects the entire world financial system. $450 trillion is a lot of money. In fact, it’s nearly 15 times world GDP. What it represents is more leverage and higher asset prices. Both make the financial world riskier.

Let’s look again at how it works. The feds make money and credit available. This reduces the cost of borrowing…and boosts up asset prices. Thereby, a man’s suburban castle rises in price, and he is able to ‘take out’ a little cash, by increasing his mortgage. This money gives him the wherewithal to buy a new car, made in Japan. The man himself is now immediately placed in a riskier position; he owes more money than he did before.

And then comes Goldman Sachs, which borrows the same money from the Japanese – at very low interest rates – and uses it to, say, finance the leveraged buyout of Equity Office Properties by the Blackstone Group. However much Equity Office Properties owed on its real estate holdings, the new owners are sure to owe more. That’s how leveraged buyouts work; the purchase is made on credit. The effect, once again, is to increase the risk in the system. If you own a commercial building in full, you can sit out a downturn in the business cycle. All that happens is that your income goes down. But if the building is leveraged, you have to pay interest on the debt. And if the interest is high enough…and your income falls low enough…you go broke.

Consider the aforementioned Mr. Blixseth, who is bringing more of the world’s good things to Bozeman, Montana. He is building a luxury ski chalet that he plans to sell for $155 million. What kind of a man would be able to buy it? Maybe someone who just got a wad of cash that didn’t exist before… someone who owned Equity Office Properties and just stuck it to a group of investors for $38 billion! But even buying bricks, mortar, and Italian granite countertops can be a risky proposition. The price of the house could go down. There’s a lot more risk inherent in a $155 million house than there is in one at $155,000.

But that’s not the end of it. The $155 million house can be a financial asset too – it can be used to secure a position in stocks, bonds, or private equity. And the debt used to acquire Equity Office Properties can also be traded, repackaged, sliced, diced and baked in a pie. Then, it too can be counted as an asset and placed in leveraged portfolios, passing around more risk. And as liquidity rises, people not only make more and bigger bets, but riskier ones. It is a classic bubble, where too much money chases too few decent investments. As Martin Fridson points out, the lowest-rated credits – Triple-C or below – which made up just 2% of the junk debt market in 1990, are now closer to 20%.

Still, here are the experts telling us that the financial system is actually less risky – because these fancy new products ‘disperse’ risk. Besides, they say, nothing bad has happened thus far; so, probably nothing ever will.

What do they take us for? The only reason nothing has gone wrong is…that nothing has gone wrong. We are living through the biggest credit expansion in history. When it ends, plenty will go wrong.

But will it ever come to an end? Yes, dear reader, everything does…

Which is why we keep our Crash Alert fluttering on the mast…

More news:

————–

Eric Fry, reporting from Laguna Beach, California…

“… ‘Subprime’ refers to borrowers with relatively poor credit – i.e., borrowers who cannot qualify for a traditional ‘prime’ or ‘conforming’ mortgage…”

For the rest of this story, and for more market insights, see today’s issue of The Rude Awakening

————–

And more thoughts…

*** “Personal debt levels reach a record 140% of income,” says the Daily Telegraph, speaking of the English. In 1980, the paper explained, the level was only half as high. The Telegraph might have been speaking of almost any country in the English-speaking world. The leading financial regulator in the United Kingdom, the FSA, warned yesterday that debt levels were becoming dangerously high. Mortgage repossessions rose 65% last year. “There is a risk that consumers could be unprepared for a weaker economic environment…,” said the FSA.

What has happened in the Anglo-Saxon economies? Several things: First, the financial industry in these countries has been extraordinarily innovative and aggressive – always finding new ways to lure people into debt. Second, these economies are more closely allied with the United States and the U.S dollar. The steady loss of purchasing power in the dollar, and the threat of consumer price inflation, has led people to spend rather than save. Finally, the Anglo-Saxon culture, along with the English language, has become the imperial standard. But it is a late-stage imperial culture, dominated by a ‘get it now’ emphasis on money, status and material well-being.

*** Next week, we will have another opportunity to laugh at the rich. Christie’s and Sotheby’s will auction off some incredibly trivial paintings at incredibly high prices. A self-portrait of Andy Warhol hamming it up for a photographer is expected to bring $3 million. Another hideous portrait by Francis Bacon should sell for a similar amount. And there are also works by Gerhard Richter, Picasso, Twombly, and many others.

*** The frogs have succumbed to the spirit of the age. We’re having lunch with two hard-boiled smokers later today – will they light up despite the new ban? We’ll see. The French usually have the good sense to ignore the law; public smoking may still survive in the land of Liberte.

“C’est la merde…” said a taxi driver. “Everything is forbidden. Everything. I’m sick of it.”

Soon, we fear, people will not be allowed to smoke in private either.

But how do the health police know the world will be a better place without the smell of cigarette smoke? In the old days, a man sentenced to death would get a chance to smoke a cigarette before the firing squad shot him dead. Or, a man wheezing with a critical chest wound on the battlefield would ask his buddies for one last smoke. The U.S. army gave out cigarettes; it settled nerves. Our own father reported that he couldn’t have waged war in the Pacific islands without the help of the Philip Morris Company.

And how could you discuss Sartre or Foucault, without cigarette smoke to blot out the imbecilities of it? How could Marlene Dietrich have appeared so seductive, without a cigarette dangling in her hand? Or, Humphrey Bogart…what would he have been without smokes? Bacall might have paid no attention to him.

Thousands of people die because of tobacco, say the meddlers. True. But how many survive without it? It is never a question of whether…but only when.

Cigarettes have surely hastened millions to an early grave…but who measures the good they might have done? Who can tell, except the smokers themselves?

We have never smoked a cigarette, but we are thinking of taking it up just to find out.

Corporate America to the Rescue? originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas. Recently Agora Financial released a video titled "What Causes Gas Price to Increase?".

MONETARY ANARCHY

The encouragement of mere consumption is no benefit to commerce because the difficulty lies in supplying the means, not in stimulating the desire for consumption; and production alone furnishes those means. Thus, it is the aim of good government to stimulate production, of bad government to encourage consumption.

- Jean-Baptiste Say, A Treatise on Political Economy, 1803

From discussing politics back to discussing economics. Just as before, though, it remains a dialogue among the deaf. The great majority of economists has its eyes stubbornly focused on apparently positive features for the U.S. economy, like the sharp fall in the oil price, abundantly available liquidity, tame inflation, low and falling interest rates and strong profits.

A minority of economists, in contrast, keeps just as stubbornly stressing that the economy’s famous gross imbalances and structural distortions and the associated debt explosion are inexorably undermining economic growth. In this view, the ongoing housing downturn will finally abort U.S. growth and drive the economy into recession, with major adverse spillover effects on consumer borrowing and spending.

Generally, however, optimism distinctly prevails about the U.S. economy. It is not the old buoyant optimism. Yet it is optimism in the sense that some true malaise, like a crash in the asset markets and a recession, let alone a deep and prolonged recession, are absolutely out of the question. Thanks to its superior dynamism and flexibility, the U.S. economy has time and again bounced back smartly from periodic downshifts, and so it will again.

Let us start with the hard facts. For six, seven and more months, U.S. economic data are overwhelmingly surprising on the downside, and moreover, the surprises have been going from bad to worse. Real GDP has successively fallen from 5.6% in the first quarter of 2006 to 2.5% in the second and 1.6% in the third.

That’s bad enough, but what rescued the latter quarter from total disaster was a rather quixotic statistical event. While auto firms slashed their output, it soared in the real GDP account, owing to sharp price cuts on gas guzzlers. In this way, falling vehicle output contributed fully 0.72 percentage points to third-quarter real GDP growth, after subtracting 0.31 percentage points. The price index for gross domestic purchases increased 2% in the third quarter, compared with an increase of 4% in the prior quarter.

It is an old wisdom that the scale of the boom excesses essentially determines the severity of the following process of economic and financial readjustment. It has been comfortingly argued that the U.S. housing boom of the last few years has been less fierce than prior booms, which all ended without steep price declines.

Certainly, there are different possibilities of measurement. For us, the most important, and also easiest, measure of excess is the associated credit expansion. The use of credit in the wake of this housing bubble has been simply bizarre, outpacing all past experiences by far. Over decades until 2000, outstanding total mortgages accumulated to $4.8 trillion. In the second quarter of 2006, they amounted to $9.3 trillion. Mortgage growth over the last five years was almost equivalent to its growth over the prior five decades.

The second highly important point to see is that this housing boom was the first one in the United States to impact the economy at a vastly broader scale than just the building activity. As private households, using the rising house prices as collateral for mortgage equity withdrawals, stampeded as never before into debt to finance additionally other kinds of spending, the whole economy developed into an outright bubble economy.

New single-family homes and multifamily homes rose in 2005 from a trough of fewer than 1.5 million units in recession year 2001 to a postwar high of 2.2 million units. Over the same period, the constant quality price index for new homes rose 30%, and the purchase-only price index of existing homes published by the Office of Federal Housing Enterprise Oversight (OFHEO) rose by 50%.

Boosting the net worth and the borrowing facilities of private households, this drove consumer spending to persistent considerable excess over income growth. In correlation, personal saving plummeted into negative territory, unprecedented for an industrialized economy.

It was a boom that plainly went to extraordinary excess in various ways. As a rule, this suggests a very severe aftermath of painful corrections. The first effects of the housing bust have definitely been bigger and more abrupt than most experts had expected. Yet hopes are riding high for a benign adjustment. To quote Federal Reserve Vice Chairman Donald L. Kohn from a recent speech: “The economy will grow at a moderate pace for a while, somewhat below the rate of increase of its potential, and then growth will begin to strengthen.”

Among his comforting arguments were first, the overbuilding in 2004 and 2005 was small enough to be worked off over coming quarters; second, this situation stands in sharp contrast to some past downturns in the housing markets that followed actions by the Federal Reserve to tighten credit conditions; third, as the inventory overhang in residential building and automobiles are worked off, economic growth should pick up again.

Mr. Kohn does not even mention that through the cash-out refinancing boom, this housing bubble had unprecedented spillover effects on the economy as a whole. In 2005, private households raised $1,080 billion through mortgages. Of this amount, they only spent $95.1 billion on higher residential building. Spending on goods and services rose altogether by $539.9 billion, against an increase in disposable income by $354.5 billion. In other words, about one-third of the increase in consumer spending depended on mortgage borrowing.

Actually, it strikes us how promptly the change in the housing market has impacted mortgage borrowing. It peaked in the third quarter of 2005 at $1,225.9 billion at annual rate. Falling steadily, it was down to $819.6 billion in the second quarter of 2006. This sharp decline was, however, to a small part offset by higher consumer credit.

Mr. Kohn stresses that monetary conditions remain quite supportive of borrowing and spending. Clearly, interest rates are so low that they exert zero restraint on borrowing. But more importantly, falling house prices no longer remain supportive for such borrowing. Remarkably, the sharp decline in new mortgage borrowing since the third quarter of last year has occurred even though house prices were still rising, albeit at sharply slowing rates. As the price climate is sure to deteriorate for some time to come, it seems a reasonable assumption that this initial sharp slowdown in mortgage borrowing has some way to go yet.

While this suggests further sharp falls in house prices, this may well take some time to materialize, because the housing market is notoriously sluggish in its reactions. In contrast to financial markets, its initial response to a change in the market situation is not in price, but on how long unsold homes stay on the market until the prices are lowered to realize desired sales. Sellers tend to resist downward price adjustments as long as they can. Instead, the market becomes illiquid. For sure, lenders will notice and adjust their lending conditions.

Mr. Kohn also takes comfort from the fact that the present housing downturn, in sharp contrast to past ones, is not caused by credit tightening. As he rightly stresses, “The Federal Reserve has returned short-term interest rates only to more normal levels and long-term rates are unusually low relative to those short-term rates.” We think, though, that he is drawing a totally false conclusion. All downturns caused by tight money were followed by vigorous recoveries. A downturn happening despite low interest rates and loose money seems to us the most worrying kind.

Regards,

Dr. Kurt Richebächer
for The Daily Reckoning

Editor’s Note: Dr. Richebacher has found the best investments to protect your portfolio, no matter what lies ahead for us in 2007.

Dr. Kurt Richebacher is the editor of The Richebacher Letter. Former Fed Chairman Paul Volcker once said: “Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong.” A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as “the man who predicted the Asian crisis.”

We have gone from one of the world’s least livable cities to one of its most livable ones. Melbourne is 11 hours from Bombay, by air – but it seems like a different planet. Bombay is what is known in economics literature as a ‘third world hellhole.’ Melbourne, on the other hand, could be any city in America – if any city in America were this clean, safe, and modern. Founded in 1835, Melbourne’s fortunes were made by the Victorian gold rush of the 1850s.

“The difference between Australians and Americans,” said colleague Dan Denning, living in Melbourne for the last year, “is a consequence of geography. As Americans made their way from the coastal settlements into the interior they found rich farmland almost wherever they went. They could just go west…and things got better and better.

“But the first Westerners in Australia got dumped out at Sydney Harbor…they almost starved…and then they discovered that they lived on the edge of a huge desert. They explored the country, but found that most of it was uninhabitable. Over every hill was another disappointment.

“In America, the rough, individualistic frontier spirit paid off. A man could hack out his own ground and make his own way in the world. But Down Under, the climate and the earth were less yielding. They had to stick together; and lower their expectations.”

Asked to define what it meant to be an Australian last week, the Prime Minister, John Howard, said it meant ‘mateship’ and ‘having a go.’

“Australians seem more fatalistic…more resigned to accept what comes their way,” said Dan.

What has been coming their way in the ‘lucky country’ has been almost all good lately. There has been no recession here for more than 15 years. Real estate prices have soared. Even where they seem to be backing off from recent highs, there has been no financial trouble. Just when the property boom seemed to come to an end a huge boom in commodities took over.

Perth – the center of mining activity in Western Australia – is still a boom town. Property prices there have gone up more than 40% in the last 12 months. Perth must be an extraordinary place. It is far from everything – the most remote major city in the world.

We’ve never been to Perth, but Melbourne has a familiar feel. It reminds us of Vancouver, with which it vies for the title of the ‘world’s most livable city.’ Both cities are tidy, mostly low-crime, attractive, and easy to get around. Both cities have solid, old-money, sober and respectable British-style administrations with large groups of dynamic new-money immigrants. Both cities are quiet, orderly, civilized, and modern – everything that Bombay is not.

“It’s all based on credit, just like in America,” said one of our Dear Readers last night. We held a cocktail reception for Melbourne-based DR sufferers…more turned up than we expected. “It will have to end sometime, but you can go broke waiting for a downturn in Australia. And then, when you give up waiting, it will hit hard.”

“Yes, look at the big buildings downtown,” said another reader. “They’re almost all big banks. The banks made a fortune lending to consumers…and then to the natural resource industry. One boom after another, it really is a lucky country…except of course that there’s no water and it’s on fire.”

Firefighters have been battling a huge blaze not too far from Melbourne for several weeks. Forest fires in other parts of Australia too are burning up houses…and sending a pall of smoke all over Southeast Asia. Yesterday, the papers reported that two big fires had come together to produce an immense blaze. Thousands of firefighters, bulldozers, and fire trucks are doing what they can to contain it. But it looks at though it will just have to burn itself out.

“Yes, the whole country has always been dry, but now it’s drier than ever,” our guest continued. “The only solution I can see is desalinization on a massive scale. We’ve got plenty of sea-water…I mean, we live on an island…”

More news:

————–

Eric Fry, reporting from Laguna Beach, California…

“…Betting against a year-end stock market rally is a little like betting against tomorrow’s sunrise. Even so, we think this might be a bet worth taking…against a year-end stock market rally, that is…”

For the rest of this story, and for more market insights, see today’s issue of The Rude Awakening

————–

And more thoughts…

*** The dollar looked like it was stabilizing…even strengthening…then along came our old Fed chief, Alan ‘Bubbles’ Greenspan with an opinion. The buck could stay weak for years, he said.

“I expect that the U.S. dollar will continue to drift downwards until there will be a change in the U.S. balance of payments,” said the former maestro.

And then, wouldn’t you know it, the currency markets acted as if Mr. Greenspan knew what he was talking about.

Despite strong employment numbers, says the report in the Australian Financial Review, “U.S. dollar weakness returned.”

One thing we like about traveling around is that we get different points of view. But one thing we notice now is that no matter where we go…we get the same story. Property prices are up…share prices are up…everyone wonders what keeps the boom booming…and everyone is pretty sure that it will continue.

As to the U.S. dollar…that too is generally viewed with awe and admiration. How it stays up no one knows…but everyone is sure it won’t come crashing down. Instead, they all imagine a period of ‘dollar weakness’ that will be good for the U.S. economy.

But dollar weakness threatens the entire world economy – not just the United States. The Chinese sell their products to Americans who are able to buy because their dollars are still relatively strong. When the dollar goes down, so does their purchasing power.

*** Meanwhile, in the housing market, there are signs of trouble ahead. Barron’s reports:

“One of the largest providers of mortgages to borrowers with marginal credit, abruptly closed its doors earlier this week. Moreover, derivatives based on the lowest tier of sub-prime mortgage securities have been plummeting in price in recent days, sending the cost of insuring against these loans’ default sharply higher.”

At the same time, more and more mortgages are becoming more and more dangerous to the people who pay them.

As recently as three years ago, only eight out of every 1,000 Californians who took out a mortgage chose a ‘pay option’ model. By 2005, one of every five new mortgages was of the ‘pay option’ variety. More recently, the number has risen to one of every three.

The genius of the ‘pay option’ mortgage is that it allows a homebuyer the option of not really buying his house. Instead, the ‘pay option’ gives the buyer the option of not paying, which means that the interest he should have paid is added to the principal. Or, another way to look at it, is that the money he should have paid is subtracted from his equity. So every day that the buyer fails to bring his interest payments up to par…he owns less of his own house.

In other words, the ‘pay option’ gives the new homeowner the option to short his own house.

Why would buyers do such a thing? Well, who knows?

We have a theory, however. In the 20th century, politics were the rage. The ‘isms’ were the great fashion of the time. And people believed so fervently that one ‘ism’ or another would make the world a better place, that they were ready to kill…or die…for them.

Now, no one cares too much about ‘isms’…all they care about it is getting rich. And they are so eager to get rich that they are willing to go broke trying.

So, a man buys a house…hoping it will make him rich. Then, he ‘takes out’ equity, using these handy get-rich mortgage devices – such as the ‘pay option.’ Unless his house goes up in value faster than he can spend the money he’s taking out – his equity goes down. Finally, he is living in a house in which he has no equity at all – or even a mortgage greater than the house value itself.

Few house buyers have any experience with a bear market in housing. Imagine their surprise when the home they expected to make them rich actually drags them to the poorhouse.

Monetary Anarchy originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas. Recently Agora Financial released a video titled "What Causes Gas Price to Increase?".

SUICIDAL TRADE DEFICIT

On the surface, it seems that there are diametrically different views at work in the markets. While the rising bond prices and the falling commodity prices apparently suggest underlying distinct economic bearishness, the sudden surge in stock prices and persistent record-low credit spreads appear to reflect very optimistic expectations about the economy.

The turn in the bond market started in June with yields of 10-year Treasury notes at 5.25%. A decline to 4.7% generated a 5% return for investors within just three months. Annualized, this comes to a return of 20%. Take further into account that there is generally heavy leverage involved, multiplying this return between 10-20 times.

Considering further that this rate of decline of long-term rates has occurred against the backdrop of a firmly inverted yield curve, implying that expenses of carry trade exceed current yields, the strength of this move seems a bit surprising. The quick capital gains, though, have richly offset these interest expenses – for the time being. But to maintain these highly leveraged positions, it will need at least one of two things: either a further sharp fall in long-term rates providing new capital gains or rate cuts by the Fed reducing the costs of carry trade.

More surprising is the new bull run of the stock market in the face of an economic slowdown. Approaching recessions have always tended to depress stock markets in expectation of falling profits. Well, there is a tremendous difference between past and present experience.

Past recessions were all triggered by true monetary tightening, hitting both the economy and the markets. The current economic downturn is unfolding against the backdrop of unmitigated monetary looseness. While the Fed has raised credit costs from unusually low levels, it has done nothing to tighten credit. Its expansion has kept accelerating.

Credit demand has been running wild for consumption, housing and financial speculation. There is just one striking and ominous exception: Corporate credit demand for fixed investment remains zero. Corporations, too, have been borrowing heavily, but for mergers, acquisitions and stock buybacks, not for productive investment.

In 2005, nonfinancial corporations spent $136.8 billion less than their cash flow from retained profits and depreciations on capital expenditures. Simultaneously, they spent $363.6 billion on mergers, acquisitions and stock buybacks. Given their moderate cash surplus, one has to assume that the stock purchases were generally financed with borrowed money.

It is certainly reasonable to regard the strong trend of corporate stock purchases as an early negative indicator of investment intentions. Principally, there are two different ways for corporations to expand and to raise profits. One is the old-fashioned way of organic growth through creating new plant and equipment. The other is to purchase economic growth and higher earnings through mergers and acquisitions by going more deeply into debt.

What, then, has been happening more lately to mergers and acquisitions? In short, they have gone crazy. During the first quarter of 2006, they hit an amount of $558 billion at annual rate, and in the second quarter another $554.8 billion.

This compares with continuously weak capital investment. In the first quarter, it was $2.7 billion below cash flow, and in the second quarter, $43.2 billion above cash flow. There is an interesting comparison with the year 2000. Then, capital expenditures of nonfinancial corporations exceeded their cash flow by $310.8 billion, compared with net stock purchases of $118.2 billion.

We would say that these figures indicate a continuous, rather dramatic change in corporate policies of expansion away from new capital investment and toward “purchasing” growth and earnings. It started in the 1980s. It strongly intensified during the 1990s, and during the last few years has gone to extremes.

Stating this, we primarily have the long-term development in mind. But in the same vein, we are pondering what is going to happen to business investment in the short run, when consumer spending slows, or even slumps, in the wake of the bursting housing bubble. The generally highly optimistic expectations and forecasts about investment spending taking over from consumption as the driver of the economy greatly puzzle us.

To stress one important point, which appears to be generally overlooked: Some rise in capital spending is not enough. Given its much smaller share of GDP than consumer spending, it needs a very strong rise to offset even a minor decline in consumer spending.

While the markets seem to reflect highly conflicting views about the U.S. economy’s outlook, we nevertheless presume one underlying common view, and that is the perception of very little risk of a possible recession because the Fed would, in any case, swiftly act to head off any gathering weakness. What matters from this perspective both in the bond and stock markets are impending rate cuts.

In essence, this is in line with the conventional thinking that the U.S. Great Depression of the 1930s, as well as Japan’s prolonged malaise since the early 1990s, could have been avoided by prompter monetary easing. Whoever believes in this is entitled to be bullish both on stocks and bonds.

U.S. stock prices received their lift since June/July mainly from lower oil prices and lower long-term interest rates. To keep heading higher, it will now need sufficient earnings growth. After an unusually steep rise in profits during 2005, analysts are predicting more of the same. Our focus is on aggregate profits, as calculated and reported by the Bureau of Economic Analysis within the National Income and Product Accounts (NIPA).

The customary way of making forecasts of economic developments is to extrapolate the recent past. Profit growth in the United States during the last two years has been at its best for the whole postwar period. Profits of the nonfinancial sector in 2005 have jumped to $900.1 billion, from $584 billion in 2004 and $411.8 billion in 2003. These figures compare with a profit peak of $508.4 billion for the sector in 1997 and a profit low of $322.0 billion in 2001.

If you look at the profit development of U.S. corporations over the last 10 years, you will see that it is an awkward picture. Profits fared very poorly during the “New Paradigm” years of the late 1990s, presumably a time of excellent economic performance. No less astounding is their sudden steep rise in the course of 2005, from $624.2 billion in the fourth quarter of 2004 to $1,027.7 billion in the first quarter of 2006, happening while the economy distinctly slowed.

The irony is that after a strong rise during the first half of the 1990s, profits abruptly turned down during the “New Paradigm” years of the late 1990s. For six years, from the recession year 1991-97, the nonfinancial sector’s profits had soared from $227.3 billion to $508.4 billion. As a percentage of GDP, these profits had risen from 3.8% to 4.9%.

While “New Paradigm” ballyhoo and stock prices flourished after 1997, business profits, as officially measured, suddenly slumped. As a percentage of GDP, they were a little higher at the height of the dot-com bubble than in the recession year 1991.

Coming to the recent recovery years, we must point to some irritating observations. On the surface, it looks like a fabulous profit development. From recession year 2001 to 2005, profits of businesses in the nonfinancial sector have more than tripled, from $322 billion to almost $1,100 billion. It was the best profit performance of all time.

However, this good-looking total consisted of two extremely different parts. It was in the first quarter of 2004 that profits exceeded their peak of 1997 for the first time. From there, they shot up almost vertically. Typically, it has been inverse that the very first years of recovery were best for profits.

Regards,

Dr. Kurt Richebacher
for The Daily Reckoning
November 14, 2006

Editor’s Note: Dr. Richebacher has found the best investments to protect your portfolio, no matter what lies ahead for us in 2007.

Dr. Kurt Richebacher is the editor of The Richebacher Letter. Former Fed Chairman Paul Volcker once said: “Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong.” A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as “the man who predicted the Asian crisis.”

Stocks have been climbing a ‘wall of worry,’ yesterday’s International Herald Tribune informs us confidently.

Funny.

We don’t see a wall of worry. Not even a hedge of hesitation…a dyke of doubt…or a curb of concern.

When stocks begin a major bull market, the old-timers like to say they ‘climb a wall of worry.’ Why is that? Because when investments are ready to rise in a serious way, they have to be cheap to start with. And when they’re cheap, investors worry that they will get cheaper.

Going from cheap to expensive is the essential trip of a bull market. But if they’re not cheap…they can’t go as far…and you don’t get as much of a run.

Stocks are only a bargain after they’ve sold off – usually for a long time. So investors are very aware that they can go down in price. In fact, at the beginning of the biggest bull markets – ’49 and ’82 – investors hadn’t known anything but falling prices for the previous two decades. Naturally, they were worried.

Are they worried now? Not so’s you’d notice. Volatility is again near record lows. Put options (which protect investors from the downside by allowing them to sell – to ‘put’ – the stocks to a buyer at a previously-agreed price) are extremely cheap. And the news is almost all positive – little inflation, high earnings, record employment figures. The IHT even tells us that consumers are still spending money like water – despite the fact that the housing bubble tap has been turned off. “Holiday sales marginally higher,” adds Reuters.

Where are they getting the money? We don’t know. But the papers tell us that the economy is strong, with plenty of liquidity. We’ll have to wait for a detailed plumbing analysis to find out for sure. There are three possibilities…either the impact of the housing slump hasn’t hit the householders yet…or it’s not really as bad as we think it would be…or the economy is somehow providing consumers with new sources of spending money.

We’ll see – one way or another.

Meanwhile, there hasn’t been much financial news for the last few days. Gold is holding at around $625. The Dow is biding its time over 12,000. Bonds are at the top of the range marked out in the rally that began in July.

The markets seem to be waiting…watching…and wondering what to do next. What are they waiting for? Our guess is that they are hanging around waiting for news from the property market. Or maybe they’re just hanging around.

There is no doubt that the decline in housing has the potential to whack the whole economy very hard. But there is no sign of it yet.

Of course, major tops take a lot of time – years – to fully form. And, in the meantime, the housing market seems to be shimmying around on the peak. Prices are sliding almost everywhere – according to press reports – and are down substantially already, especially if you include the value of sellers’ incentives.

And here comes a report from an economist who has studied the buying habits of baby boomers. It turns out that boomers are no more likely to buy a second house than their parents; there are just more of them. In 1998, 14% of people over 50 had a second house. Now 15% have a second house.

Do you have a second house, dear reader? If not, don’t despair. In a year, you’ll probably be able to get one cheaper. So cheap, you might be able to afford a third…

More news:

———————

Byron King reporting from Pittsburgh…

“…Forgive me if I call them tar sands, dear readers. I know that the marketing people want to call them “oil” sands, because it is better for the real estate values. After all, would you rather have oil on your land or tar?…”

For the rest of this story, see the most recent issue of Whiskey & Gunpowder

———————

And more views:

*** Ethanol is most likely not going to be the solution everyone is looking for in the search for the next alternative energy.

In fact, according to Justice Litle, “If Paul Revere were a present-day oil executive, he’d be driving his Mustang through the streets, shouting: ‘The diesels are coming!’ While diesels dominate Europe, with more than half the domestic market, they have mainly been restricted to trucks, 18-wheelers and other commercial vehicles in the United States.

“With October’s arrival of ultralow-sulfur diesel, which reduces sulfur content by 97%, diesel is set to cross the Atlantic in a big way. Automakers are gearing up for the change, with Mercedes in the lead and Honda a serious contender. Mercedes’ new diesel leaves Lexus ‘in the dust,’ Fortune reports, and Honda has clean-diesel cars in the works for 2008.”

One of the big technologies of the future will be liquefied coal, whether the diesel engine wins over the public or not. While oil supplies run low, there is still enough coal to last for over 300 years – and new advances in this field have figured out how to clean up the pollution aspects of coal…and found a way to make it power your SUV. Coal is going to play a key role in our energy future. The safest way to profit is to own some coal and wait for the price to go up. It will.

*** “Can’t you be more positive?” asked a reader last week. “It always seems so gloomy.”

But we are not gloomy at all. And as for positive…we are bullish on a number of things: gold…Japan…Argentina…commodities. Speaking of Japan, yesterday the Japanese reported annual growth running at two percent. Not flying…but still twice what analysts had expected.

What do we know about Japan? Nothing, really. But after a 16 year slump, and with it’s closest neighbor having the fastest-growing economy on the planet, we figure Japan is ready for a comeback.

*** We flew into Liberty International Airport in Newark yesterday, and then on to Boston, after lining up for an hour – waiting to get approved and earched…and to turn in our toothpaste and toenail clippers.

I was just wondering: has any terrorist ever been stopped by all these anti-terrorist measures? Does anyone know?

Europe seems generally more relaxed about terrorism; but that’s probably because Europeans have seen so much more of it. The IRA, the Red Brigades, the ETA…terrorists have been blowing things up in Europe for years. None of them, so far as we know, were deterred by Colgate peppermint flavor.

*** “Jules, how do you like it here in Boston?” we asked our guitarist son last night. Jules did his first year of college at St. John’s College in Annapolis. Now he’s in a big school and in a big city.

“Well, it’s nicer in some ways,” he replied. “I have a lot more choice about what I can study. But there are also more typical U.S. students; they just seem to want to have a party and get drunk. They’re not very serious. The serious students I’ve met are all foreigners…and there are a lot of them.

“Of course, they’re not all that grown-up either. My roommate is Korean. He came in the other night carrying one of his friends. He just tossed him on the bed and left. And then the friend tried to throw up in the drawer of our dresser. They say the Koreans are the hardest drinking of the Asians. But that was the first time I saw it up close. Too close. But still, he seems like a decent guy.”

Suicidal Trade Deficit originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas. Recently Agora Financial released a video titled "What Causes Gas Price to Increase?".

RESTRUCTURING THE U.S. ECONOMY- DOWNWARD

The deficit country is absorbing more, taking consumption and investment together, than its own production; in this sense, its economy is drawing on savings made for it abroad. In return, it has a permanent obligation to pay interest or profits to the lender. Whether this is a good bargain or not depends on the nature of the use to which the funds are put. If they merely permit an excess of consumption over production, the economy is on the road to ruin.

- Joan Robinson, Collected Economic Papers, Vol. IV, 1973

Finally, the greatest boom in American housing history is going bust. The impact on the economy has only just begun to be felt. Demand for homes is sharply down, while the number of vacant dwellings is ballooning – up more than 40% for existing homes and more than 20% for new homes year over year. At issue now is the severity of the impending bubble aftermath.

It does not seem, though, that there is a lot of worrying around. There appears to be a widespread belief that the U.S. economy is now out of trouble because the Fed decided not to raise interest rates. We presume the following interpretation:

1. This is not just a pause, but the end of all rate hikes.

2. In the absence of an overheating economy, inflation is yesterday’s issue.

3. Steady or lower interest rates will boost the stock market.

4. As the Fed no longer tightens, the possibility of a hard landing can be dismissed.

5. Abundant liquidity continues to underpin the markets.

Treating bad economic news as good for the financial markets, Wall Street is running wild with more aggressive speculation. “The world economy is on track to grow at a 5.1% rate this year, but the risk of a severe global slowdown in 2007 is stronger than at any time since the September 2001 terror attacks on the United States,” said the International Monetary Fund in a report to finance ministers, mentioning two possible triggers: a sharp slowdown in the U.S. housing market or surging inflationary expectations that would force central banks to raise interest rates.

Taking this forecast into account, the sudden plunge of commodity prices may not be totally surprising. On the other hand, prices of risky assets and mortgage-backed securities have, despite the obvious problems in U.S. housing and consumer finance, held steady. Stock prices of U.S. lenders up to their necks in subprime, interest-only and negative-amortizing mortgages have been rising 5-10% since late August. Since hitting bottom in June, emerging stock markets have rebounded 20%. Developed international markets have risen by 12%, and U.S. stock markets by around 8%. A vertical slide by the yen since May suggests that yen carry trade is back with a vengeance.

Given the growing talk of impending recession in the United States, all this may appear rather surprising. The underlying rationale seems to be the assumption that this recession will be just another soft patch forcing the Fed to what the speculative community likes most: a return to easier money.

There is talk of recession, but definitely no recession scare. Popular perception appears to trust that the U.S. economy will again prove its outstanding resilience and flexibility. And are the balance sheets of private households not in excellent shape, as rising asset valuations have vastly outpaced the rise in liabilities over the years? The possible scary parts of the new development, a deeper recession and a precipitous decline in economic growth, have not yet come to the fore.

Over the past five years of recovery from the 2001 recession, U.S. economic growth has been “asset driven,” according to colloquial language. More to the point, protracted sharp rises in house prices served private households as the wand providing them with prodigal borrowing facilities to increase their spending. For years, it was the economy’s single motor. The Fed estimates that mortgage equity withdrawals exceeded $700 billion, annualized, in the first half of 2006.

In 2005, the last full year for which data are available, new borrowing by private households amounted to $1,241.4 billion. Now compare this with the following spending and income figures. Disposable personal incomes grew $354.5 billion in current dollars and $93.8 billion in inflation-adjusted dollars. Spending increased $530.9 billion in current dollars and $264.1 billion in chained dollars.

We have presented these figures to highlight the paramount importance of the large equity extractions on the part of private households for U.S. economic growth during the U.S. economy’s current recovery. Plainly, it prevented a much deeper recession. Absence of any wealth gains could have easily induced private households to do some saving out of current income.

For the consensus, the U.S. economy’s shallow recession in 2001 is the most splendid justification of Mr. Greenspan’s repeatedly expressed idea that it is better to fight the bubble’s aftermath with easy money than to prick it in its prime. This is plainly a gross misjudgment, because America’s shallowest recession was followed by five years of the shallowest economic recovery, with unprecedented large and lasting shortfalls in employment, income growth and business fixed investment.

Actually, there have been major changes in the U.S. economy’s pattern of employment and resource allocation, but altogether changes for the worse, not for the better. These structural changes are bound to depress U.S. economic growth in the long run.

The striking feature of the housing bubble – distinguishing it diametrically from an equity bubble in this respect – is its extraordinary credit and debt addiction. The reason is that it requires borrowing for two different purposes: first, for driving up house prices; and second, for the cash out of the capital gains. Every single dollar for this purpose has to be borrowed.

Since end-2000, American households have offset their badly lacking income growth with an unprecedented stampede into indebtedness, up so far by $5.3 trillion, or 77%. But as soaring house and stock prices added a total of $15.6 trillion to the asset side of their balance sheets, households miraculously ended up with an unprecedented surge in their net worth from $41.5 trillion to $53.8 trillion in the first quarter of 2006.

Referring to this fact, Fed Chairman Bernanke noted in a speech on June 13 that “U.S. households overall have been managing their personal finances well.”

Manifestly, the rapid creation of the housing bubble in 2001 did prevent a deeper recession. But this should raise the further question of how the housing bubble and its financial implications have affected the U.S. economy from a longer perspective. In other words, are they in better or worse shape today than in 2001 to weather the aftermath of the housing bubble? Our answer is categorical: Underlying cyclical and structural conditions have dramatically worsened.

In 2001, the Greenspan Fed could cushion the fallout from the bursting equity bubble with the creation of the housing bubble. This time, manifestly, there is no alternative bubble available to be inflated to cushion the fallout from the housing bubble. Rather, there is a high probability that the popping housing bubble will pull the stock market down with it. That is the first ominous difference between 2001 and today.

The second ominous difference is that the economy and the financial system have accumulated structural imbalances and debts as never before in history. Vastly excessive borrowing for consumption and speculation has turned the U.S. economy into a colossus of debts with a badly impaired capacity of income creation.

And finally, equity and real estate bubbles are very different animals, of which the latter is manifestly the far more dangerous. In its World Economic Outlook of April 2003, the International Monetary Fund published a historical study, titled When Bubbles Burst, and explained differences in the effects between bursting equity and housing bubbles. It stated, in brief, the following:

First, the price corrections during housing price busts averaged 30%, reflecting the lower volatility of housing prices and the lower liquidity in housing markets. Second, housing price crashes lasted about four years, about 1 1/2 years longer than equity price busts. Third, the association between booms and busts was stronger for housing than for equity prices… Fourth, all major bank crises in industrial countries during the postwar period coincided with housing price busts.

The severe cases of bursting housing bubbles badly affecting the banking systems in the late 1980s were in England, the Nordic countries and Switzerland, not to speak of Japan, where, however, commercial real estate played the key role.

Regards,

Dr. Kurt Richebächer
for The Daily Reckoning
October 26, 2006

Editor’s Note: The Good Doctor has found the only five investments you’ll need in 2006 – and one of them is a mighty hedge against the forces of dollar weakness and inevitable inflation. At the very least, it will help protect your money from the boneheaded inflationary policies and programs of the Federal Reserve – especially under new Fed Chief Ben “Printing Press” Bernanke.

Former Fed Chairman Paul Volcker once said: “Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong.” A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as “the man who predicted the Asian crisis.”

Those darn Asians are saving so much money – someone has to borrow it.

Thank God for Americans! Without our willingness to consume more than we produce, the whole planet might go into recession.

That, dear reader is Ben Bernanke’s idea of the real problem in the world – a ‘global savings glut.’

He is right…in a way.

One could, after all, describe the Battle of the Little Big Horn as ‘General Custer’s men helping the Sioux recycle their surplus arrows.’

But, there would be more to the story. And there is more to this.

One part of the story Ben Bernanke fails to tell is that of the rising role the oil exporters play. As the price of oil rises, so do cash surpluses in the hands of oil producers – such as Saudi Arabia and Russia. This year, the total amount of net oil exports are expected to rise to over $800 billion – about the same amount as America’s current account deficit. Last year, Asia’s current account surplus came to $263 billion, while the oil exporters brought in $242 billion. And this year, the oil exporters should enjoy a current account surplus greater than Asia – around $311 billion.

And so we have to ask – what do they do with all this money? Truth is, nobody quite knows. Some of it, of course, is traceable. While China now has $1 trillion in official dollar reserves, so do the oil exporters. Hundreds of billions more are unaccounted for.

But here’s a thought. If the fundamentals are as weak as we say they are, why are the Dow and the dollar so strong?

Ergo, much of it must be finding its way into the world’s leading brand-name investments – namely dollar-based assets, including U.S. stocks.

A recent report from UBS Investment Research helps explain it. “Sustained high oil and gas prices are giving oil exporters a financial status previously reserved for Asian central banks. Their reserves, however measured, are growing rapidly and their influence over the [United States] and other capital markets has grown in tandem.”

Imagine you are controlling a huge pile of money for Nigeria or Norway or any other oil producer. Are you going to invest in start-up car wash franchises? Or strip malls on the outskirts of Omaha? No sir. You’re going to buy T-bonds…and the Dow!

That’s why George W. Bush can go on TV and tell the rubes that the economy is doing great. Just look at the Dow! Look at long-dated Treasuries! Look at the dollar! Yes, look. But then look again. People are not really getting richer when foreigners lend them money or buy up their factories and businesses. While Asians have been able to pay for higher priced oil with their own exports of manufactured goods, and Europe, too, has been unhurt since it exports luxury goods while limiting its consumption of oil, the biggest loser from the trend is the United States, says the UBS study.

But as oil exporters’ assets rise, so does America’s current account deficit. Oil costs money, and the United States – with no way to pay for it – sells off its assets and borrows money. The U.S. current account position, at minus $800 billion, tells us in bright, shining red letters, how fast Americans are going broke; it almost doesn’t matter what the level of the dollar or the Dow is.

Think about it. The global money system is now supposed to be a gleaming, state-of-the-art machine – with so many hedge-funds…so many derivatives…so many investors and so many investment opportunities – all now shock-proofed against the accidents that damaged them a few years ago.

But all the different people in all different places with their fingers wrapped around so many different instruments, still all read the Economist, the Wall Street Journal and the Financial Times. And they all attend the same conferences…and all think much the same things. On top of that, the decisions that really affect world markets are made by very few people…and we know who they are: they control Asian and oil exporters’ surpluses.

So it boils down to this. It will only take those few people, in deciding to dump the dollar or to change the whole picture…overnight.

More news:

————–

Mike Shedlock, reporting from Illinois…

“…Enquiring minds might be wondering how it is remotely possible for a government bond fund to be up only 2.16-2.5% so far this year. After all, anyone parked in three-six-month Treasuries would be up 5% annualized or so…”

For the rest of this story, and for more market insights, see today’s issue of Whiskey & Gunpowder

————–

And more views…

*** Are oil importers’ great surpluses just a fluke? Not likely, says the UBS report. Oil consumption is rising at a 2% annual rate – or about two million barrels per day. Meanwhile, oil from existing fields is being sucked out at the rate of four million bpd. So, six million bpd need to be discovered and brought on line in order just to stay even. But new discoveries have topped out. There is less new oil being discovered now than there was in 1930. And if projections are correct, production will soon begin to fall…and keep falling into the indefinite future.

So, the real question is: what will the oil exporters do with their money? How long will they continue to use it to support U.S. consumption? We don’t know the answer, but the UBS researchers suggest an insight. Consumption typically lags. It begins after the money comes in – with some delay. (We add that it continues after the money runs out – with some delay).

Many of the oil producers, Russia for example, have a long history of financial troubles. Others, such as Saudi Arabia, are well aware that the oil market goes through busts as well as booms. Both experiences make producers reluctant to increase spending recklessly. But if the oil revenues persist, the producers will get used to it and, like a woman whose husband has gotten a big raise, soon get used to spending it. Either way, prospects do not look good for homeland financial assets. If producers’ incomes fall, they will have less money to recycle into dollar assets. If producers’ incomes remain steady, they will soon find other things to do with it.

*** The latest news falls on ears that don’t hear. “The total costs of the war, including the budgetary, social and macroeconomic costs, are likely to exceed $2 trillion,” says the Milken Institute Review.

When we reported that the war in Iraq could cost $1 trillion or more the news was brushed off. Of course, we had no idea what we were talking about; we were just passing along estimates that appeared in the papers.

No one believed the war could cost that much. Donald Rumsfeld had put a price tag of only $50 billion on the war. One trillion – 20 times as much – was simply unbelievable.

But now a Nobel Prize-winning economist from Columbia, Joseph Stiglitz, has come out with a figure 40 times that of Rumsfeld’s guesstimate.

Of course, the Secretary of the Treasury is entitled to make an error in math. We all do. But a 4,000% over-run is a bit much – even on a government program.

*** “You know why we don’t live in Miami?” asked a friend at dinner last night. “Because it’s just not the same. I mean, America has changed a lot in the last 20 or 30 years. I remember when I was a student in Nyack, New York, and the Nixon Impeachment was going on. At the time I was very impressed with America.” Our friend comes from Venezuela and now lives in Madrid, we should note.

“Because, the senators on the impeachment panel seemed smart…and honest. Sam Irvin, for example. He was an educated man with a real sense of integrity and history. Or at least you got that impression watching him on television. And there they were considering throwing Nixon out of office because his henchmen broke into the Watergate to steal political secrets. It was not much of a crime. Really nothing, when you think about it. Nobody was hurt. And Nixon didn’t even authorize it. Still, he tried to cover it up…and got caught. And the whole thing made me think – great, here is a government that really works the way it is supposed to. America is where I want to live.

“But I don’t know if it is me…or it is the politicians. But now when I hear a U.S. Senator speaking on TV, I cringe. Because he is so stupid, and obviously pandering to the voters. And now you have a president who has committed terrible crimes. He misled the entire nation in order to attack Iraq; he got more than 2,000 American soldiers killed; wasted billions of dollars, and he allowed U.S. employees to torture people. And now you have U.S. Senators debating on how much torture should be allowed. It’s really unbelievable.

“I still have an apartment in Miami…but I really don’t like being there; I don’t want to have to listen to those guys.”

*** “It’s amazing how much things change, even in a single lifetime,” continued our friend. “When I first came to Madrid it was a horrible city. It was dead, near the end of the Franco years. It was not a place you would want to be. But Caracas was just the opposite. It was lively…prosperous…there was art, music. It was a great place to live.

“Now, it’s just the opposite. Madrid is booming. It’s unbelievable how much this city has changed. Construction cranes are everywhere. They’re building new roads, new apartment buildings, new shops. It’s a wonderful place to live now. And back in Caracas, it’s depressing. There is so much crime you’re afraid to go out on the street. There is no building going on. There is not much life of any sort…the whole place is dirty and depressing…and nothing works the way it is supposed to.

“Of course, much of that is the fault of Chavez. He’s made a mess of the place.”

*** Madrid is a very nice city. We went to a restaurant on Tuesday night and had some of the best meat we have ever tasted.

“Oh…these people are a little fanatical about meat,” explained our companions. “They buy their meat in Galicia, where they know how to raise it properly. But they don’t think the Galicianos know how to butcher it properly. So they send it to another area to have it prepared.

“You know…you have to be a little fanatical to really get the best…”

Restructuring the U.S. Economy – Downward originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas. Recently Agora Financial released a video titled "What Causes Gas Price to Increase?".

PAST BUBBLE EXPERIENCE WAS DIFFERENT

What is the difference between those housing bubbles of the 1970s and the late 1980s and the U.S. housing bubble of today? There are four decisive differences.

First, those past housing bubbles developed in a generally inflationary environment of rising consumer and producer prices. Central banks tightened their monetary reins to fight inflation in general.

Second, those bubbles were pure price bubbles in the sense that house prices rose faster than the general price indexes. There were no major repercussions on the economy.

Third, what the United States and many other countries are experiencing today is completely different from a house price bubble. Rising house prices are used as collateral to finance extraordinary borrowing-and-spending binges that virtually dominate economic growth in these countries. In 2005, consumption and residential building accounted for 92% of U.S. GDP growth.

Fourth, disclaiming that the rapidly rising house prices reflect inflation, the Federal Reserve has readily accommodated them. Rather, it hailed and celebrated the rising prices in a very positive sense as welcome “wealth creation.” The declared intention of the rate hikes since mid-2004 was not to fight inflation, but to normalize short-term interest rates. Policymakers and economists openly invited and encouraged people to prime the bubble and to make as much use as possible of the borrowing facilities it offers.

Has Mr. Greenspan ever realized that he has turned the U.S. economy into a bubble economy? Who else among former and present policymakers and top economists on Wall Street has realized this? Some certainly have. In Japan, even policymakers frankly used this word in public. But in America, everybody painstakingly avoids this admission.
In order to eschew mentioning the dirty word, a new definition has come into general use. U.S. economic growth is neither “bubble driven” nor “debt driven”; it is “asset driven.” It is a term especially invented for the American public to convey the good feeling that the U.S. economy is creating assets, while in reality, with its consumer borrowing-and-spending binge, it is consuming its capital, reflected in falling investment and soaring foreign indebtedness.

The first task, of course, is always to identify undesirable increases in asset prices, emphasis on “undesirable,” classified as “asset bubbles.” In this respect, Mr. Greenspan made his famous remark: “But bubbles generally are perceptible only after the fact. To spot a bubble in advance requires a judgment that hundreds of thousands of informed investors have it all wrong. Betting against markets is usually precarious at best.”

Now compare this trivial talk of the world’s leading central banker with the reasoned assessment by economists in a study by the International Monetary Fund (IMF), titled “Monetary Policy, Financial Liberalization and Asset Price Inflation,” published in the World Economic Outlook of May 1993:

“Financial liberalization, innovation and other structural changes in the 1980s created an environment in which excess liquidity and credit were channeled to specific groups in the markets. This includes large institutions, high-income earners and wealthy individuals, who responded to the incentives associated with the changes. These groups borrowed to accumulate assets in the global markets – such as real estate, corporate equities, art and commodities such as gold and silver – where the excess credit apparently was recycled several times over.”

And here is a crucial part of the conclusions of this study:

“To the extent that asset price changes are related to excess liquidity or credit, monetary policy should view them as inflation and respond appropriately. There is nothing unique about asset markets that would suggest that asset prices can permanently absorb overly expansionary policies, without leading to costly real and financial adjustment.

“Actually, the study explicitly and precisely pinpoints the key feature of asset price inflation. It is “a credit expansion in excess of the expansion of the real economy.” In 2005, a credit expansion of $3,335.9 billion in the U.S. economy was matched by nominal GDP growth of $752.8 billion and real GDP growth of $379.1 billion.

In the United States, credit growth since the 1980s has developed increasingly in excess of GDP growth. During the past five years of recovery, though, this discrepancy has widened to extremes that defy economic and financial reason.

We regard this escalating gap between credit and GDP growth as a very serious, however completely unrecognized, problem, and it is rapidly escalating. In the first quarter of 2006, credit expanded by $4,386.5 billion annualized.

The first obvious question is about underlying causes. This news essentially says that an ever-greater proportion of the credit expansion is for purposes other than spending in the economy, which would correspondingly add to GDP growth. Ominously, more and more credit generates less and less GDP.

The most conspicuous cause is, of course, credit-financed asset purchases. In a country without domestic savings, any asset purchases inexorably depend on credit creation.

A second major cause is the trade deficit. To compensate for the implicit extraction of spending and incomes in favor of foreign producers, additional credit expansion is needed to create spending for domestic producers.

And a third rapidly growing cause of America’s unprecedented thirst for credit, as we have repeatedly explained, is certainly Ponzi finance. A large and growing part of the borrowing binge reflects the capitalization of unpaid, rapidly compounding interest.

According to the available figures, barely one-quarter of the credit expansion is for GDP growth and three-quarters for these other purposes.

The question to ask in the face of these facts, of course, is whether this runaway credit expansion in relation to grossly lagging GDP and income growth is sustainable. For sure, it is not. All this prodigious borrowing and lending has been undertaken in the grossly flawed assumption that rising asset prices, rather than rising incomes, will some time in the future take care of interest payments and repayments.

Assuming the normal rule that debts have to be serviced and amortized by future income, the great mass of American consumers could never afford the debts they have incurred in recent years. For many, the borrowing has even been the substitute for lacking income growth. In real terms, in 2005, this was 1.2%, well below its growth rate of 1.9% during recession year 2001. Given the reported sharply slower employment growth, further deterioration is clearly on its way.

Regards,

Dr. Kurt Richebacher
for The Daily Reckoning
September 26, 2006

Editor’s Note: The Good Doctor has found the only five investments you’ll need in 2006 – and one of them is a mighty hedge against the forces of dollar weakness and inevitable inflation. At the very least, it will help protect your money from the boneheaded inflationary policies and programs of the Federal Reserve – especially under Ben “Printing Press” Bernanke.

Former Fed Chairman Paul Volcker once said: “Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong.” A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as “the man who predicted the Asian crisis.”

Poor Bernie Ebbers. His number’s up. The man drove up to the Oakdale Correctional Complex in Louisiana yesterday. He got out of his Mercedes and joined the former governor of the state, Edwin Edwards, in the federal pen. Hizonner faces 10 years in the hoosegow for extorting money out of riverboat casinos. Ebbers got 25 for his role in a telecom scandal. Accountants working under his direction took some whole numbers out of the operational columns, they say, and slipped them into the capital budget.

Both men did naughty things, we don’t deny it. But putting poor Bernie behind bars for a quarter of a century for some financial hanky-panky seems excessive. When it comes to numbers, after all…anyone can make a mistake. The things are downright slippery.

Just look at poor Brian Hunter. He would tell you. The man was making $75 to $100 million per year, as an ace energy trader. He was so good that even the savviest players in the industry wanted in on his game. Both Morgan Stanley and Goldman Sachs had invested money with Hunter’s employer, Amaranth Advisors, the $9 billion hedge fund that blew up last week.

What went wrong? Hedge funds are supposed to be good at numbers, after all. They hire people with advanced degrees in mathematics simply to make sure they’ve calculated the odds correctly and offset their risks with their expectations in a logical manner.

“Somebody was not monitoring this correctly,” said one pro, referring to the extraordinary bet that Hunter placed on gas prices, a bet so large that at one time, he held about 10% of the global market in natural gas futures.

As far as we can tell, these are the numbers in a nutshell: Hunter was long. And investors were short as much as $6 billion.

“It appears we have had a major malfunction,” might have been another way to put it. But that famous understatement has already been taken. That was on January 28, 1986…with 50 million TV viewers watching. It was the day the spacecraft Challenger exploded into smithereens.

Nobel prize-winning physicist Richard Feynman described the NASA catastrophe as an institutional failure. The scientists and engineers at NASA, he charged, has been upstaged by bureaucrats who had been allowed to “pervert standards.”

But in the financial world, standards are perverted so easily they must have a twisted gene to start with. [See the letter from a dear reader, below, about slipping standards during the Roman era credit collapse. "Rigor at the outset," says Tacitus, speaking broadly about financial affairs, "becoming negligence at the end."]

That’s why we can’t help but feel sorry for Brian Hunter. Like Ebbers, he came from nothing to make a fortune. He went to college in Alberta, where he was a star at mathematics, of course, specializing in financial models. But the poor 32-year-old had barely gotten used to being extraordinarily rich and extraordinarily talented, when a very ordinary little slip-up with numbers derailed his extraordinary career.

We are reminded of the now legendary Nick Leeson whose rags-to-riches rise also came apart over some mundane, barely noticed figures…figures of eight, in his case.

Leeson, the working class son of a plasterer, who failed his final math exam, made such an impression at Britain’s prestigious Barings Bank that he was quickly promoted to the trading floor and then given a new operation in futures markets on the Singapore Monetary Exchange (SIMEX) where he began pulling in millions for Barings by gambling on the movement of the Japanese stock market (Nikkei Index). The whiz kid seemed to have it altogether. By the end of 1993, he had made more than £10m for Barings – nearly 10 percent of its total profit that year.

What Barings didn’t know was that Leeson, by now both Chief Trader and also in charge of settling accounts in the office (jobs that were usually done by different people), was hiding his mistakes in an account, numbered 88888, for which the company was liable. By December 1994, the numbers in 88888 had piled up…to over half a billion. A desperate Leeson then placed his most desperate bet – that the Nikkei would not fall below 19,000 points. It would have been a reasonable assumption under ordinary circumstances. But then came one of those fat tail events that give bell curves their shape – on January 17, 1995, a 7.2 earthquake hit Kobe in Japan and the Nikkei crashed by 7% in a week.

Leeson’s gambling spiraled out of control as he piled on more and more debt hoping to push the index back the other way. Most of the $1.3 billion he eventually lost for Barings came from trying to cover up what had happened.

On the verge of turning 28, the whiz kid could take it no more. Leaving a scribbled apology, he fled with his wife to Borneo and then to Frankfurt, where he was caught.

The numbers then looked pretty bad: The futures market was in shock, a 233 year-old bank to the Queen was bust; more than a thousand bank employees were out of jobs; and investors were wiped out.

And all for a string of single digits. Ordinary insignificant set of numerals – 88888.

More news, from our currency counselor…

————–

Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis:

“I’m not even going to get on my soapbox regarding this U.S. Consumer Confidence soaring. All I’ll say is that they didn’t ask me! I would give them a thing or two to think about regarding a lack of confidence!”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig

————–

And more thoughts…

*** “Time to read up on the Panic of 1837,” says our Pittsburgh man, Byron King. “One of the more cogent observers of the time was Ralph Waldo Emerson, who was trying to uphold the old standards and protest against the easy morality of the new age.

“‘This invasion of Nature by Trade with its Money, its Credit, its Steam, its Railroads,’ he complained, “threatens to upset the balance of man, and establish a new universal monarchy more tyrannical than Babylon or Rome.’

“Interesting that Emerson comments on ‘Railroads.’ His pal Henry Throreau once said, ‘Men do not ride on railroads. The railroads ride on us.’

“Emerson actually welcomed the Panic of 1837, as a wholesome lesson to the new monarchs of manufacturing: ‘I see good in such emphatic and universal calamity…’

“He saw the Panic of 1837 as the taking-down of the juggernauts of finance, the destruction of the moneychangers in the Temple, vengeance against those who traded nothing for something, and who sucked off of the honest toil of the working people of the world. Emerson was a champion of old fashioned hard work, the mechanical arts, of raw creation, of molding useful things from the soil and rock of the earth…

“‘The American workman who strikes ten blows with his hammer, whilst the foreign workman only strikes one, is as really vanquishing that foreigner, as if the blows were aimed at and told on his person.

“‘I look on that man as happy, who, when there is question of success, looks into his work for a reply, not into the market, not into opinion, not into patronage. In every variety of human employment, in the mechanical and in the fine arts, in navigation, in farming, in legislating, there are among the numbers who do their task perfunctorily, as we say, or just to pass, and as badly as they dare, – there are the working men, on whom the burden of the business falls, – those who love work, and love to see it rightly done, who finish their task for its own sake; and the state and the world is happy, that has the most of such finishers. The world will always do justice at last to such finishers: it cannot otherwise.

“‘He who has acquired the ability, may wait securely the occasion of making it felt and appreciated, and know that it will not loiter. Men talk as if victory were something fortunate. Work is victory. Wherever work is done, victory is obtained.’”

*** “And now, as promised, more on America’s growing balance of payments problem. For the first time in 90 years, the United States is paying more to foreign creditors than it gets in payments from its overseas investments. The difference grew to $2.5 billion in the second quarter of 2006. This, according to the Wall Street Journal, was the equivalent of a quarterly debt payment of about $22 for each American household, “a turnaround from the $31 in net investment income per household it received a year earlier.”

Still peanuts. But going in the wrong direction fast.

“Our net international obligations are coming home to roost,” says Catherine Mann, a senior fellow at the Institute for International Economics.

“Since the end of 2001, when the current economic expansion began, the nation’s consumption, investment and other outlays have exceeded income by a cumulative $2.9 trillion – the largest gap on record. That current-account deficit contributes directly to the nation’s total foreign debt, the value of all the U.S. stocks, bonds, real estate, businesses and other assets owned by non-U.S. residents. As of the end of 2005, total U.S. foreign debt stood at $13.6 trillion – or about $119,000 per household. Net foreign debt, which excluded the $11.1 trillion value of U.S.-owned foreign assets, was $2.5 trillion.

“Foreigners’ willingness to lend at low rates has also encouraged Americans and their government to borrow and spend. By buying U.S. Treasuries, foreign investors put up more than four-fifths of the $1.3 trillion the federal government has borrowed since 2001 to help pay for tax breaks, the new Medicare prescription-drug benefit and wars in Afghanistan and Iraq. Over the same period, foreigners put more than $700 billion into various types of U.S. mortgage-backed securities, providing the money for millions of Americans to buy new homes — or extract cash from their existing homes to spend on goods such as washing machines and Hummers.”

*** And finally, a dear reader writes:

“I believe I have found a Roman parallel to the housing bubble for your Daily Reckonings. In the course of my thesis research I came across this passage in Tacitus’ Annales relating to a ‘credit crunch’ in 33AD:

‘The Senate passed a measure requiring two-thirds of loaned money to be reinvested in Italian real estate to prevent the collapse of land prices resulting from the sale of assets to repay loans. Tiberius himself later offered 100m sesterces on loan for three years to ease the credit crunch.

From Tacitus: “Meanwhile a powerful host of accusers fell with sudden fury on the class which systematically increased its wealth by usury in defiance of a law passed by Caesar the Dictator defining the terms of lending money and of holding estates in Italy, a law long obsolete because the public good is sacrificed to private interest. The curse of usury was indeed of old standing in Rome and a most frequent cause of sedition and discord, and it was therefore repressed even in the early days of a less corrupt morality. First, the Twelve Tables prohibited any one from exacting more than 10 per cent, when, previously, the rate had depended on the caprice of the wealthy. Subsequently, by a bill brought in by the tribunes, interest was reduced to half that amount, and finally compound interest was wholly forbidden. A check too was put by several enactments of the people on evasions which, though continually put down, still, through strange artifices, reappeared. On this occasion, however, Gracchus, the praetor, to whose jurisdiction the inquiry had fallen, felt himself compelled by the number of persons endangered to refer the matter to the Senate. In their dismay the senators, not one of whom was free from similar guilt, threw themselves on the emperor’s indulgence. He yielded, and a year and six months were granted, within which every one was to settle his private accounts conformably to the requirements of the law.

“Hence followed a scarcity of money, a great shock being given to all credit, the current coin too, in consequence of the conviction of so many persons and the sale of their property, being locked up in the imperial treasury or the public exchequer. To meet this, the Senate had directed that every creditor should have two-thirds his capital secured on estates in Italy. Creditors however were suing for payment in full, and it was not respectable for persons when sued to break faith. So, at first, there were clamorous meetings and importunate entreaties; then noisy applications to the praetor’s court.

“And the very device intended as a remedy, the sale and purchase of estates, proved the contrary, as the usurers had hoarded up all their money for buying land. The facilities for selling were followed by a fall of prices, and the deeper a man was in debt, the more reluctantly did he part with his property, and many were utterly ruined. The destruction of private wealth precipitated the fall of rank and reputation, till at last the emperor interposed his aid by distributing throughout the banks a hundred million sesterces, and allowing freedom to borrow without interest for three years, provided the borrower gave security to the State in land to double the amount. Credit was thus restored, and gradually private lenders were found. The purchase too of estates was not carried out according to the letter of the Senate’s decree, rigour at the outset, as usual with such matters, becoming negligence in the end.’”

Past Bubble Experience Was Different originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas. Recently Agora Financial released a video titled "What Causes Gas Price to Increase?".

A TIGHTENING FARCE

There is total detachment from the bad news that is pouring out of the economy. For several years, the booming housing market has made the difference between recession and recovery for the U.S. economy. Zooming house valuations provided private households with the collateral that allowed them to replace the missing income growth with a borrowing binge.

But as the housing market is sagging, this major source of higher consumer spending is plainly drying up, and most obviously and importantly, income growth is by no means catching up.

In 2005, real disposable incomes of private households in the United States increased $93.8 billion, or 1.2%, while their debts grew $1,208.6 billion, or 11.7%. Total consumer spending on goods, services and new housing accounted for 92% of real GDP growth.

The U.S. economy’s recovery from the recession in 2001 has been its slowest in the whole postwar period, and in addition, it has been of a most unusual pattern. Real GDP rose by 11.7% over the four years to 2005. Within this aggregate, residential building soared by 35.6%. Consumption gained 13.4% and government spending 10%. The big laggard in domestic spending was business nonresidential investment, up only 3.6%. Net exports year for year were increasingly negative.

Most economic data have softened, with the downtrend accelerating. In the face of this fact, it could not be doubted that Mr. Ben Bernanke and most others in the Federal Reserve were anxious to stop their rate hikes. In question was only whether they would dare to do so in view of the high and rising inflation rates. They dared. They even disappointed those who had predicted the combination of a declared “pause” with hawkish remarks about fighting inflation.

In its statement, the Fed conceded:

“Readings on core inflation have been elevated in recent months, and the high levels of resource allocation and of the prices of energy and other commodities have the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative of monetary actions and other factors restraining aggregate demand.”

When the Bureau of Labor Statistics (BLS) reported on Aug. 16 that the CPI in July had seasonally adjusted, advancing 0.4%, following a 2% rise in June, both the bond and stock markets responded with strong rallies. What, apparently, had made it so exciting in the eyes of the consensus was the fact that these bad figures had remained in line with distinctly unoptimistic predictions. Never mind that during the first seven months of 2006 the CPI has risen at a 4.8% seasonally adjusted annual rate, compared with an increase of 3.4% for all of 2005.

It is, of course, perfectly true that monetary tightening impacts the economy and its inflation rates with a pretty long delay. The trouble in the U.S. case is that there never was any monetary tightening. There were many small rate hikes, and the Greenspan Fed had probably hoped that the higher costs of borrowing would exert some restraint on credit demand. But it has not happened. It was a vain hope.

The fact is that the credit expansion has sharply accelerated during these two years of rate hikes instead of decelerating. During 2004, when the Fed started its rate hike cycle, total credit, financial and nonfinancial, expanded by $2,800.8 billion. In the first quarter of 2006, it expanded at an annual rate of $4,392.8 billion.

Over the two years of so-called monetary tightening, the flow of new credit has effectively accelerated by 56%. In 2005, credit growth was $3,335.9 billion. Over the whole period of rate hikes, it had steadily accelerated from quarter to quarter. Borrowers and lenders, apparently, simply adjusted to the higher rates, trusting that there would never be serious tightening.

True monetary tightening would have to show first of all in declining “excess reserves” of banks relative to their reserve requirements. These have remained at an elevated level during the rate-hike years of 2004-05.

In 1991, when the Fed tightened, credit expansion slowed sharply from $866.9 billion in the prior year to $620.1 billion. A sharp slowdown in credit expansion in 2000 to $1,605 billion also happened, from $2,044.7 billion the year before. Yet this still represented very strong credit growth in comparison with the years until 1997.

Like all central banks, the Federal Reserve has two levers at its disposal to stimulate or to retard credit and money creation. The big lever is its open market operations, buying or selling government bonds, thereby increasing the banking system’s liquid reserves. The little lever consists of altering its short-term interest rate, the federal funds rate, thereby influencing the costs of credit.

It is most important to distinguish between the two instruments. True monetary tightening has to show inexorably in a slower credit expansion throughout the financial system. There is one sure way for a central bank to enforce this, and that is by curtailing bank reserves through selling government bonds.

The other lever at its disposal, as pointed out, is to influence credit costs. But the influence of the central bank on credit costs begins and ends with altering its short-term federal funds rate. During the past two years, the Fed has raised its federal funds rate from 1% to 5.25%. But long-term rates hardly budged. To the extent that borrowers shifted from the low short-term rate to the long-term rate, they encountered higher borrowing costs. But at the long end, interest rates rose less than the inflation rate.

Here are still a few other credit figures illustrating the Fed’s monetary tightening since mid-2004. Total bank credit expanded, annualized, by $957.0 billion in the first quarter of 2006, against $563.5 billion in 2004. For security brokers and dealers, the two numbers were $611.3 billion, against $231.9 billion; and for issuers of asset-backed securities (ABSs), they were $663.3 billion and $322.6 billion. This is monetary tightening à la Greenspan.

Monetary tightening has one purpose: to curb credit expansion fueling the excess spending in the economy and the markets. By this measure, Greenspan’s monetary tightening since 2004 has been a sheer farce. During these two years, he presided over a sharply accelerating credit boom, for which the reason is also obvious.

To equate rising short-term rates automatically with monetary tightening can, therefore, be a gross mistake. Later on, we shall explain that this is the great error of the monetarists in assessing the development in 1929 and following years. Borrowing exploded during 1927-29, despite the Fed’s rate hikes, and then literally collapsed after the stock market crash.

It can be argued that rate hikes in the past have generally worked. Yes, but the central bankers of the past never forgot to tighten bank reserves. Tighter money to them meant tighter credit, and it always showed in sharply shrinking credit figures. So it also has, in the past, in the United States. But this time, the diametric opposite has happened.

There was reserve easing. Money and credit, moreover, only became significantly more expensive at the short end. All the time, there was nothing in this to slow the housing bubble and the associated borrowing binge. Rising house prices easily offset the effect of rising short-term rates.

Does this mean that the economy can continue to grow as before? No, not at all. All excesses, if not stopped, are sure to exhaust themselves over time. That is no less true for economies than for the human body. In our view, the housing bubble is finished not because credit has become tight, but because the borrowing excesses are running against natural barriers.

One such natural barrier is the affordability of housing and the limited number of greater fools who are able and willing to pay these inflated prices. At some point, excess supply will exceed demand. We read from reliable sources that in June, sale offers of existing single-family homes were up 35%, while actual sales were down 6.5% versus a year ago. So the year-over-year “excess” supply was 42.2%.

Affordability is way down, units offered for sale are way up and price appreciation has all but stopped. It is a radical change in the market situation, which, however, has so far impacted economic activity only moderately.

Past experience with housing bubbles suggests that the first effects are in the steep fall of actual sales and in the lengthening of time until sales materialize. The markets become illiquid. Until sellers capitulate and accept lower prices, it can take a long time. In this way, apparent price stability becomes increasingly treacherous over time.

Present American folklore has it that a protracted slump in house prices is impossible. Let us say for many people it is unthinkable. And that is precisely one reason why this housing bubble could go to such unprecedented excess. The little historical knowledge we have about bursting housing bubbles is from a study published by the International Monetary Fund in its World Economic Outlook of April 2003. It presents past experience in a very different light. Here are some excerpts on decisive points:

“To qualify as a bust, a housing price contraction had to exceed 14%, compared with 37% for equities. Housing price busts were slightly less frequent than equity price crashes… Most housing price busts clustered around 1980-82 and 1989-92, while equity price busts were more evenly distributed across time.

Housing price crashes differ from equity price busts also in other three important dimensions. First, the price corrections during house price busts averaged 30%, reflecting the lower volatility of housing prices and the lower liquidity in housing markets. Second, housing price crashes lasted about four years, about 11/2 years longer than equity price busts. Third, the association between booms and busts was stronger for housing than for equity prices.”

An important theme running through the foregoing analysis is that housing price busts were associated with more severe macroeconomic developments than equity price busts. Coupled with the fact that housing price booms were more likely (than equity price booms) to be followed by busts, the implication is that housing price booms present significant risks. For this, the authors give the following reasons:

“Housing price busts have larger wealth effects on consumption than the equity price busts…

“Housing price busts were associated with stronger and faster adverse effects on the banking system than equity price busts… All major banking crises in industrial countries during the postwar period coincided with housing price busts.

“Price spillovers across asset classes matter, as evidenced by the fact that housing price busts were more likely associated with generalized asset price bear markets or even busts than equity price busts.

The authors then give a fourth reason, which was true in the past, but in which the situation in America today radically differs:

“Housing price busts were associated with tighter monetary policy than equity price busts, reflecting the fact that most housing price busts occurred during either the late 1970s or the late 1980s, when reducing inflation was an important policy objective. The disinflation increased the real burden of debt, which exposed inflation-related overinvestment and associated financial frailty.”

Regards,

Kurt Richebächer
for The Daily Reckoning
September 13, 2006

Editor’s Note: The Good Doctor has found the only five investments you’ll need in 2006 – and one of them is a mighty hedge against the forces of dollar weakness and inevitable inflation. At the very least, it will help protect your money from the boneheaded inflationary policies and programs of the Federal Reserve – especially under Ben “Printing Press” Bernanke.

Former Fed Chairman Paul Volcker once said: “Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong.” A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as “the man who predicted the Asian crisis.”

Nothing fails like success.

As recently as a half-century ago, the American stood like a colossus in a New World…young, free, healthy; and a creditor to the rest of the world, which owed him not only money…but liberty, for he had lent his muscle, his oil, his manufacturers – and even risked his life to win World War II for the Allies.

“What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?” asked Adam Smith.

Here at The Daily Reckoning headquarters, we too are occasionally beset with bouts of debt-free happiness. But we count on our natural gloominess to get us through.

But…what about people who have more debt than any one else…whose health suffers from too much sustenance…and whose conscience is encumbered with a bloody war made on people they didn’t even know, for a purpose no one knows? Can they expect happiness?

As to their conscience and health, we have no opinion. But as to their debt we have many.

Fallen into our hands is a report from the CIA, ranking nations in order of their current account balance. The current account, we remind readers, is like the operating statement of a business or an individual. Income must exceed outflow or your upkeep is your downfall. The difference between what comes in and what goes out, if it is positive, accumulates as though it were a profit. If it is negative, it builds up – but not necessarily, in the form of debt.

So what do we see? The country with the best position is Japan – with a current account balance of plus $165 billion. China is in the number two position, with almost as much. And here we pause to give readers a chance to gasp. China – a country run by communists – has the second best current account balance in the world. Figure that. In other words, Marxism…at least as practiced in the Middle Kingdom…has proven no bar whatever to capitalist success.

But we will move on…

Germany is the third most ‘profitable’ country in the world – with a positive current account balance of $115 billion. Then the list goes into various oil producers, watchmakers, and assorted national curiosities…such as Algeria…with – would you believe it – has an $18 billion surplus! Even tiny Hong Kong ended last year nearly $20 billion to the good.

But between Swaziland and the Comoros (which, we believe is an island nation somewhere off the coast of Africa) the figures make the kind of transformation that can only be likened, in the material world, to going from light to darkness, or in the sentient world, from life to death. That is, they go from positive to negative. The numbers which were such a comfort to Germany and such a delight to Japan become an embarrassment.

Poor Burkina Faso, perhaps the most God-forsaken hole on the surface of the whole planet, suffers a $438 million deficit and still manages to hold its head up in public.

“Hey, wait a minute,” said a friend at a dinner party recently, “Burkina Faso is not so bad. My wife and I love to go there for desert trekking. There is nothing there…no restaurants…no hotels you’d want to go to…no theatres…not much of anything. But out there in the natural world… in the desert, there is a quality that is sublime. I wish I could describe it to you…but you have to see it for yourself.”

That said, at least Burkina Faso is far from the worst on the CIA’s list. The rest of Africa follows…and then come the Banana Republics of Latin America…and finally, guess who makes the end of the line-up? Guess who has the worst current account deficits in the entire world? Guess which countries spend more than they earn – regularly and spectacularly?

Last in line are the nations of the Anglo-Saxon, English-speaking debt-based empire! New Zealand has a deficit of nearly $10 billion. Then, South Africa…and India…and Australia all have deficits too. Among the major former colonies of the British Empire, only Canada seems to have any sense. It runs a surplus. The others are all debtors. The UK itself is third from the bottom with a $57 billion negative current account balance.

For no reason we can think of, the penultimate on the list is Spain. And then comes the worst of all…the United States of America, with a current account balance of a minus $829 billion.

Add up all the deficits of the entire world and you get a figure barely half of the U.S. total.

The U.S. economy makes up a quarter of the world total…that it should have more than half of the world’s current account deficits is a spectacular success – only made possible by its great wealth and status.

And here, in yesterday’s news, comes the latest: “Record $68 billion trade deficit in July,” reports Bloomberg.

Nothing fails like success.

More news:

————–

Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…

“The U.S. July Trade Deficit printed at a new record of $68 Billion!!!!! That beats the old record monthly Trade Deficit, which printed at $66.5 Billion almost a year ago.”

For the rest of this story, see today’s issue of The Daily Pfennig

————–

And more thoughts…

*** What’s up? What’s down?

Since the World Trade Towers went down, the Dow has gone up – 17%. Even the NASDAQ has gone up 9%.

But what has really gone up is gold – up 210% since 9/11/01 …and oil – up 250%.

What will be down, or up, over the next five years?

Ah, dear reader, you are toying with us. You know we don’t have any idea. It is not given to mortals to know their fate.

“Of course, I don’t know either, ” said our friend Philippe in Paris yesterday. “But I know what worries me. You look at what is happening in America. The mortgage lenders have given out money to almost anyone who can breathe…on these exotic mortgages that actually punish the borrower in the future…and we know that the borrower didn’t really know what he was getting into. So what? If the homeowners can’t make their payments, well, the lenders get what they deserve, right? No…because they’ve sold the mortgages on…they’ve been packaged as leveraged derivatives in MBOs…Mortgage Backed Obligations.

“And these mortgages have then been bought by institutional investors who try to get a little extra performance. They buy them along with junk bonds. And they don’t worry about risk anymore since people have been protected against default for so long – because interest rates have been going down. When rates are going down you can almost always refinance a loan at a better rate…so you don’t ever have to own up to the fact that you can’t really repay it. So, even insurance companies and hedge funds and retirement funds have these mortgage-backed securities.

“And do you realize that there are now some $250 TRILLION of derivatives on the loose. And one institutional investor thinks it is protected because it owns derivatives from another institution…which owns derivatives from yet another. They are all holding each other’s paper. And I wonder what will happen when the guy with the mortgage can’t make his payments. Credit has been inflating for the last 25 years. What happens when it deflates? The whole thing is going to meltdown.”

As we explained yesterday, the way to make money from investments is not by guessing right about the future, but about guessing right about the odds. Most investors tend to miscalculate. They systematically over-rate the odds that what happened in the recent past will continue to happen in the near future. What’s more, the majority of investors want to think for themselves, so long as they are thinking what everyone else is thinking. Whatever the great mass of investors believe – no matter how absurd – is what the individual investor tends to believe.

Which means that the investor who thinks a little differently has an advantage. Again, it is not that he is more likely to be right. It is just that the odds are in his favor, whether he is right or wrong. If the great mass of investors has bought into a position…almost by definition it has paid too much. Because nature does not distribute her favors according to mass demand. If the real odds that it will rain tomorrow are one in two, there is a 50% chance it will rain…it doesn’t matter how many people think the odds are two in three. The investor who bets against the majority opinion is likely to win.

A Tightening Farce originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas. Recently Agora Financial released a video titled "What Causes Gas Price to Increase?".

BY FAR THE WEAKEST RECOVERY

Trying to assess the situation and further growth prospects of the U.S. economy, the first important fact to see is that the U.S. economic recovery since November 2001 has been by far the weakest in the whole postwar period. Just a few tidings composed by the Economic Policy Institute in Washington:

First, inflation-adjusted hourly and weekly wages today are below where they were at the start of the recovery in November 2001; second, median household income (inflation adjusted) has fallen five years in a row and was 4% lower in 2004 than in 1999; third, total jobs since March 2001 (the start of the recession) are up 1.9% and private jobs 1.5% (at this stage of previous business cycles, jobs had grown 8.8%); fourth, the unemployment rate is low only because several million people have given up to look for a job.

And here are some cursory remarks on our part: First, job growth has steeply fallen during the last three months, from 200,000 in February to 75,000 in May; second, all the job growth has come from the artificial net birth/death model, implying that it is booming among small new firms not captured by the payroll survey, while slumping in existing firms; third, private household indebtedness since 2000 has soared by 70%. This compares with an overall increase in real disposable personal income by 12%.

According to the popular GDP accounts, consumer spending in the first quarter has burst by a record rate of 5.2%. That is the fact on which everybody happily focuses. Few people realize, first of all, that this is an annualized figure. The true increase against the prior quarter was 1.3%.

In any case, though, it is a grossly distorted figure. The ugly reality of the first five months of 2006 is that the consumer-spending boom of the past few years has effectively broken down. But to realize this, it is necessary to look at the sequence of monthly data. Here they are, from the same source as the GDP numbers, the Bureau of Economic Analysis (BEA):

By these figures, measuring spending and income growth from month to month, consumer spending in the first quarter has increased 0.6%, or 2.4% annualized, less than half the 5.2% as reported in the GDP accounts. As we have stressed several times before, the big difference between the figures arises from the fact that the GDP measures changes in averages. The big increase in consumer spending happened in reality in November/December 2005, resulting in a large “overhang” for the following quarter.

To detect a recent change in trend, it is necessary to focus on the changes from month to month, as above. For May, reported retail figures showed an increase by 0.1% before inflation. With a monthly inflation rate of 0.3%, total real spending should be at a minus.

This sudden weakness in consumer spending has an obvious reason. The spending bubble on consumer durables – that is, on autos and housing durables – is going bust. It was largely spending borrowed from the future to be implicitly followed by payback time.

For us, this rapid, steep decline in the growth of consumer spending is the first decisive consideration to expect in the United States’ impending serious recession; and remarkably, this is happening with record credit growth and even before the housing bubble is truly bursting.

That this most important fact goes completely unnoticed says something about the depth of research. Moreover, this sharp slowdown in consumer spending strikingly conforms to the downward shift in the growth of real disposable personal incomes. In 2005, it was already down to 1.3%. So far in 2006, it is zero.

Under these miserable income conditions, the strength of future consumer spending manifestly depends on the possibilities of ever-higher cash-out mortgage refinancing against rising house prices. It hardly requires any intelligence to have realized by now that this is flatly impossible.

Looking at the accelerating credit expansion, we are, as a matter of fact, more than doubtful that the slowdown in the economy and the housing bubble has anything to do with the Fed’s rate hikes. What crucially matters for both is the current credit expansion, and that keeps accelerating. But the problem is that more and more credit creates less and less economic activity, as measured by GDP.

The unrecognized problem in the United States is that economic growth driven by a housing bubble is extremely credit and debt intensive. It needs, firstly, heavy borrowing to drive up the house prices and, secondly, further heavy borrowing to turn the resulting capital gains into cash. Put this together with minimal or now zero real disposable income growth and you have something like a credit Moloch devouring credit and leaving less and less for economic growth.

Yet we are sure that the U.S. economy’s extraordinary debt addiction has other reasons unrelated to the housing bubble. One is the huge trade deficit, and the other is extensive and rapidly increasing Ponzi finance.

The American consensus view holds that the trade deficit, however large, does not matter because foreigners easily finance it. This view reveals the total absence of any serious analysis of related domestic income and debt effects. The obvious first major harmful economic effect is that domestic producers lose an equal amount of domestic spending and income creation to foreign producers, and that today in a staggering annual amount of more than $800 billion, equal to about 7% of nominal GDP.

Such persistently large and growing income losses from the trade deficit would have pulled the U.S. economy into recession long ago. It has not happened because the Greenspan Fed, by way of loose and cheap money, provided for a compensating increase in domestic demand through additional credit creation. It succeeded, true, but the thing to see is the additional credit and debt creation. This was justified with low inflation rates. Ironically, the import boom in the trade deficit has been very helpful in suppressing U.S. inflation.

Yet there is still a second major harmful effect to the trade deficit that American economists completely ignore. Implicitly, the alternative demand created by the looser U.S. monetary policy is different from the demand that emigrates to foreign producers. The big loser is the export industries in manufacturing. The gains, via the surrogate demand, have been in consumer services and goods.

In essence, the trade deficit alters the economy’s structure in a negative way. The losing manufacturing area is the sector with the highest rate of capital formation, and therefore also the highest rate of productivity growth. For good reasons, it also pays the highest wages. Consider that U.S. manufacturing lost 3 million jobs in the past few years. To be sure, the trade deficit is not its only reason, but unquestionably a major one.

Pondering the U.S. economy’s unusually high addiction to credit and debt growth in relation to GDP growth, we are sure of another evil factor – Ponzi finance. Principally, every increase in spending brings about an equivalent increase in incomes. But this is not true in three cases of spending: first, spending on existing assets; second, spending on imports; and third, Ponzi finance.

Ponzi finance means that lenders simply capitalize unpaid interest rates. Ponzi finance creates credit, but it is bare of any demand and spending effects in the economy. In the conventional American view, balance sheets of private households are in their very best shape because increases in asset values have vastly outpaced the sharp increases in debts. So Americans see no problem.

With such great optimism about the U.S. economy still prevailing, it is a safe assumption that lenders have been more than happy to capitalize unpaid interest rates as new loans, at least until recently. As widely reported, lending standards have been extremely lax for years. Nevertheless, there is bound to come a point where Ponzi lending stops.

The crucial difference is in the ghastly difference between runaway debt growth and nonexistant real disposable income growth as the income component from which debt service has to be paid. In 2000, consumer debt growth of 8.6% compared with real disposable income growth of 4.8%. During the first quarter of 2006, private household debt growth of 11.6%, annualized, compared with zero real disposable income growth.

These numbers suggest that, in the aggregate, all debt service occurs through Ponzi finance. Essentially, borrowing against existing assets is required to service debt. Another striking evidence of extensive Ponzi finance is the unusually large difference between rampant credit growth and much slower money growth. Capitalizing unpaid interest rates adds to outstanding credit and debt while adding nothing to bank deposits (money supply).

To get an idea of the actual extent of Ponzi finance, we make a simple calculation. Total outstanding debts in the United States amount to $41.8 trillion. Assuming an average interest rate of 5%, this implies an annual debt service of about $2 trillion. This compares with an increase in national income before taxes of $616 billion in 2005. Consumer incomes are even stagnant.

Under these conditions, the only question is the severity of the impending U.S. recession. In this respect, we are a great believer in the axiom of Austrian theory that every crisis is broadly proportionate to the size of the excesses and imbalances that have accumulated during the prior boom. Our basic assumption is that the American consumer is bankrupt when house prices fall 20 – 30%.

The most important thing to realize is that the spending and debt excesses that have accumulated in the U.S. economy and its financial system on the part of the consumer during the past 10 years are altogether of a size that vastly exceeds the potential for debt service from current income.

With stagnant real disposable income and double-digit debt growth, the American consumer is caught in a vicious debt trap. What, then, makes most people so optimistic of further economic growth? Apparently, there is a widespread view that households have sufficient equity cushions in their balance sheets to not only weather any storm ahead, but also to continue higher spending.

In our view, the most important thing to see is the fact that the consumer has accumulated debts at a level vastly exceeding his abilities of debt service from current income. Probably many never had any intention of such kind of debt service. The general idea, certainly, has been to settle debt and debt service problems simply by selling later to the highly appreciated greater fool. That is what most economists take for granted.

What all these people overlook is, first of all, the vicious dynamics of Ponzi finance through compound interest on unproductive indebtedness. During 2000, total financial and nonfinancial credit and debt growth amounted to $1,605.6 billion. In 2005, it had accelerated to $3,335.9 billion; and in the first quarter of 2006, it has run at an annual rate of $4,392.8 billion, and this now with zero income growth. Note that this debt explosion has happened with little change in GDP growth.

Given this precarious income situation on the one hand and the debt explosion on the other, it should be clear that at some point in the foreseeable future, there will be heavy selling of houses, with prices crashing for lack of buyers.

As to the level of asset prices in the United States, an additional comment is probably needed. Normally, the money for asset purchases comes from the savings out of current income. In the U.S. economy, with savings in negative territory, all asset purchases essentially depend on available domestic credit and capital inflows. Buying assets on credit used to be the exception. In America today, it is the rule. For good reasons, the Fed is fearful to make money truly tight; it would crush the markets.

A study by the International Monetary Fund published in 2003 under the title “When Bubbles Burst” examined the differences in economic effects between bursting equity bubbles and bursting housing bubbles. It left no doubt that the latter are the far more dangerous specimen:

Housing price crashes differ from equity price busts also in three other important dimensions. First, the price corrections during house price busts averaged 30%, reflecting the lower volatility of housing prices and the lower liquidity in housing markets. Second, housing price crashes lasted about four years, about 1 1/2 years longer than equity price busts. Third, the association between booms and busts was stronger for housing than for equity prices.

The situation today in the United States reminds us strongly of late December 2000. At its previous meeting in November, the Federal Open Market Committee directive had called future inflation the economy’s greatest risk. But then, all of a sudden, the bottom fell out of the economy. At its next meeting, on December 19, the FOMC changed the bias, declaring that the risk of economic weakness was outweighing the risk of inflation.

Two weeks later, Jan. 3, 2001, shocked by worsening economic news, the Fed dropped its funds rate, through a conference call, by 0.5% – twice the usual rate.

As we have stressed many times, the U.S. economy today is incomparably more vulnerable than in 2000. All the growth-impairing imbalances in the economy – the trade deficit, the savings and incomes shortage and the debt levels – have dramatically worsened.

Very rapid interest rate cuts and prompt massive government deficit spending succeeded in containing the recession. The phony “wealth effects” derived from the escalating housing bubble became the key source of demand creation in the United States. But the unpleasant longer-term result of the new policies was an unusually weak and lopsided economic recovery, particularly seeing drastic shortfalls in employment and income growth.

Regards,

Dr. Kurt Richebächer
for The Daily Reckoning

Editor’s Note: The Good Doctor has found the only five investments you’ll need in 2006 – and one of them is a mighty hedge against the forces of dollar weakness and inevitable inflation. At the very least, it will help protect your money from the boneheaded inflationary policies and programs of the Federal Reserve – especially under new Fed Chief Ben “Printing Press” Bernanke.

Former Fed Chairman Paul Volcker once said: “Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong.” A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as “the man who predicted the Asian crisis.”

“Fed’s Rate Ruling May Fail to Lift U.S. Stocks as Economy Slows” is the information-packed headline from Bloomberg yesterday.

The financial media thinks it has it all figured out. The Fed will not raise rates today.  And investors, who have already discounted the end of rate increases, will sell shares on the news.

Each era produces its own inimitable theatre – complete with its own heroes, stars and villains. As recently as the 1980s, the world of finance looked to the money supply figures for entertainment. When the new numbers came upon the stage, the audience hissed and booed if they were high, and applauded if they were low. Everyone knew that the money supply was the key to inflation. And everyone knew that controlling inflation was the key to the stock market and the economy.

Now, it is a new era, and the old M3 is so much yesterday’s idol that it has disappeared from the financial news. The feds no longer even announce the numbers…who claps or boos?

Thus has Mister Alan Greenspan transformed the role of the U.S. central banker – previously a bit player on the international financial scene – into a stellar combination…something of the order of Britney Spears’ acting talent crossed with Brad Pitt’s skill as a heart-surgeon. The amalgamation, of course, is likely to prove fatal to the economy.

Thus has Ben Bernanke, former chieftain of the Princeton economics department, sprung into the saddle. The world turns its eyes to him – as if he were Geronimo and Agent 007 combined…a man on whom its fate depends.

His immediate challenge is the one we have described often enough in these daily reckonings. The consumer finally appears to be exhausted. As Ms. Clinton tells us, he cannot work harder or borrow more; he surely cannot save less. His spending power is being undermined – in the lingo of economics – both structurally and cyclically.

Structurally, he faces two billion Asians who have jumped into the global labor pool and would be only too delighted to earn, say, one-tenth as much as the average American.  Cyclically, he stares at his own balance sheet, dripping in red. Egged on for years by Alan “Bubbles” Greenspan, hordes of consumers have been hooked into the bad habit of pressing down on the debit side of the ledger for ready cash. Now, the hapless lumps owe more money to more people than any society ever did. With fuel, housing, education and health bills soaring, they rummage through their pockets only to find they have nothing more to spend.

Even an economist of Mr. Bernanke’s rank can put two and two together. The U.S. economy is nearly 70% consumer spending. When consumers can no longer spend in the style to which they’ve become accustomed, you get a slowdown…a slump…even a genuine recession. It is that simple.

And, the very same price increases that cut into Mr. Average American’s spending money, have also cut into the options Mr. Bernanke, as chief banker, now has.

A central banker, after all, is a magician more than a juggler or sword-swallower. His trade is just as gaudy as theirs, but it uses more legerdemain. Shaking easy money into the economy like confetti, he tricks it into thinking it is richer than it really is. Sales go up; investment increases; the economy booms. But, as Milton Friedman predicted, eventually the additional money drives up prices and people come to realize that they’ve been had. Adjusted for inflation, they’re no better off than they were before. Then, they stop investing, cut back on spending, and the economy stagnates – even as prices rise. The banker thrusts his arm into the credit hat for one last rabbit and comes up empty-handed.

A slowing economy with prices on the rise, better known as “stagflation,” is what you get after easy credit loses its magic.

What can a poor central banker do? What he needs is another hand, but a three-handed banker has yet to appear. Meanwhile, Bernanke can use his one hand to raise rates and fight inflation, or to lower them and fight stagnation.

But not both.

This week, the Fed’s price-fixing committee is scheduled to meet again, and the financial press is abuzz with speculation. What will the Fed do? Raise rates or lower them? The smart money is betting that it will do neither. Instead, the worthy professor is likely to sit on both hands and hope, by some miracle, that he has just the perfect fed funds rate already.

Two bits of news seal the Fed’s course, say the papers: The latest employment report came up 25,000 jobs short. And, British Petroleum closed the pipeline bringing oil from Alaska because it was rusty.

What these two tidbits tell us is something we already knew: the U.S. economy is soft and getting softer. What these two morsels tell the Fed, on the other hand, is that it better not try to raise rates any higher, for, in all probability, it has already piled on that back-breaking 25-basis-point straw.

The show goes on…

More news from the experts at EverBank…

————–

Chris Gaffney, reporting from St. Louis:

“Since a pause has already been priced into these markets, a pause followed by a very hawkish statement or an increase by 0.25%, could give the U.S. dollar support.”

Be sure to read the full issue of today’s Daily Pfennig.

————–

And more random summertime thoughts…

*** Oil trades at nearly $77, and gold is up to around $646.

Are investors rediscovering safety in things that come out of holes in the ground, rather than things that come out of printing presses? Maybe, dear reader, maybe.

*** Property in Britain, as in the United States, seems ready to go down. Still, it has not.  According to the Land Registry, prices are 7.7% higher this year than last, led by our old neighborhoods in London, Kensington and Chelsea, with an 8.6% gain and an average selling price of 808,585 pounds (about $1.5 million).

*** Michael Milken says China’s economy will overtake the United States in this century. Maybe. Even so, the United States will have enjoyed a good run. It took the number-one place in about 1900, shouldering Great Britain out of the way. Since then, it has been the world’s leading economy…and now, its reigning empire.

*** “It’s time,” Addison reports from on the scene in Cannes, France. “The good doctor poked me in the shoulder last night at dinner. ‘It’s time for the United States to collapse,’ he said, with a satisfied smile on his face. ‘The world needs to heal.’”

In a normal economic expansion, Dr. Richebächer contends, credit expansion is roughly equal to the nation’s savings. As 2005 was the first full year in which the U.S. consumer saw a negative savings rate since 1933, the rate of credit expansion should have also been negative.

Au contraire, Dr. Richebächer estimates that for every dollar of GDP produced in the United States last year, over four dollars of credit was created. “We haven’t seen such a bubble as this one since the 1920s. The only difference is…this time it’s much worse,” says the good doctor.

[Ed. Note: We have more on the lopsided "recovery" in today's guest essay…below. And, we'll have more from Addison tomorrow. He's in Cannes helping Dr. Richebächer pull together his magnum opus for publication with the Agora imprint at John Wiley & Sons. It is scheduled for release early next year.]

*** China is a good bet to replace the United States; it is growing very quickly, with wages rising 15% – 20% in a single year. But India is a good bet, too. Colleague Lila Rajiva updates us:

“The India investment story is still hot, but to avoid pitfalls, investors should stay tuned to the nuances. In a recent Forbes piece, for instance, Carl Delfeld, head of the global advisory firm Chartwell Partners, had an explanation of why the Indian tiger might soon be mauling the Chinese dragon. Delfield gives the usual reasons – the Indian tradition of property rights and legal protections, widespread familiarity with English among educated people, a stock market that goes back to 1870, a young population (50% under the age of 25), and growth that is more balanced and less dependent on foreign investment.

“Delfield is right on all counts, but there’s one crucial thing he doesn’t mention. And that is that the Indian population has a high level of technical skill in a number of fields. Computer technology has got the most press so far, but investors should know that India also has an enormous pool of well-trained finance professionals, lawyers, and doctors that it hasn’t yet fully tapped. In contrast, low-wage labor, which is more important to manufacturing, seems to do better in China. That could be partly because India’s low-wage workers have to contend with rigid local labor laws. Or, it could be because of weak primary education and facilities.

“But whatever the cause, the divergence between high-wage professionals and low-wage workers is something to mull over when picking Indian investments. Industries and sectors that depend on skilled professionals are simply a better bet. This means computers and information technology, of course, but it also means financial services, pharmaceuticals, and consulting.

“This angle of the Indian-growth story leaps out at you when you look at something like the Forbes list of the 40 richest Indians. It included 27 billionaires this year, more than double last year’s number. The “fat 40″ had a total net worth of $106 billion. That’s up from $61 billion last year, and more than two and a half times what China’s fattest cats are worth ($26 billion).

“Now, check this out. Of the Indian 40, an astonishing one-third makes his money, all or mostly, from information technology, telecommunications, and the media. Their companies include such familiar names as software exporter Wipro, and media giant Zee TV, of course. But, you also see less well-known players, like the Internet casino company, PartyGaming. And, notice that almost one-quarter of these richest 40 Indians are involved in medicine in some way – from Ranbaxy, the pharmaceutical giant, to hospital chain, Fortis.

“That’s the big clue for investors looking for sectors and stocks likely to outperform. Stick with India’s professional knowledge base. Delfeld, for instance, recommends Dr Reddy’s Laboratories (NYSE: RDY) and HDFC Bank (NYSE: HDB). But there are also lesser-known IT stocks, like Satyam Computer Services (NYSE: SAY). And, in medicine, you could look at a generics producer, such as Cipla – or Dabur, which makes herbal products.

“In India, pick the professionals…”

*** A reader writes with a complaint:

“Your remarks re: Mel Gibson are offensive to Jewish readers. Yes, it is a free country and Mel Gibson can say whatever he wants to say, but when a celebrity makes racist remarks, he should be held accountable. Your editor should rethink his statement on this issue.”

We’re so happy we were able to offend someone. We were worried that we were losing our touch.

By Far the Weakest Recovery originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas. Recently Agora Financial released a video titled "What Causes Gas Price to Increase?".

The Anglo-Saxon countries have been the high-growth economies among the industrialized economies. By definition, strong economic growth implies that domestic investment exceeds domestic saving. Actually, Mr. Bernanke and others have repeatedly justified the capital inflows with the fact that capital investment exceeds domestic saving.

On the surface, this is true. But this description represents a grotesque distortion of the economic reality. What has truly happened in the United States and the other English-speaking countries is that private households, in response to inflating house prices, have slashed their savings even faster than businesses slashed their capital investments. As a result, minimal investment exceeds nonexistent domestic saving. This explains their stronger economic growth.

To illustrate this with a comparison: In France, the personal saving rate is hovering lately at around 11.4% of disposable income, literally the same level as in 2000. This stability in savings has prevailed despite sharp rises in house prices because everybody in France regards this as inflation, not as saving. Living systematically beyond one’s means is not a way of life in France and many other countries.

In the United States, personal saving over the same period has slumped from 2.3% of disposable income to -1.6%. The key point to see is that the stronger growth of the Anglo-Saxon countries had one single overriding reason, and that was to boost consumption at the expense of savings. If the United States had the savings rate of most European countries, it would be in depression.

Now to the U.S. economy. With zero savings and runaway credit expansion, the United States ought to have sky-high interest rates. Thanks to large bond purchases by the Asian central banks and the virtually limitless availability of carry trade in dollars and yen, implemented by the two central banks, U.S. long-term interest rates have held at absurdly low levels. On the surface, interest rates are determined in the markets. In these two countries, they are heavily manipulated by the central banks.

Strikingly, the Fed’s 16 rate hikes over the last two years have done nothing to curb the recorded domestic credit expansion. Yet dollar carry trade, which also has played an important role in funding highly leveraged asset purchases, is dead in the water, simply because short-term rates have caught up with long-term rates. Astonishingly, the bond market has only minimally reacted.

Barely noticed, the U.S. credit machine ran amok again in the first quarter of 2006, revealing the Fed’s tightening as a farce. Nonfinancial credit expanded $2,914.0 billion, annualized, up from the prior quarter’s $2,434 billion. Together with an increase in financial credit by $1,479.2 billion, the total adds up to $4,392.8 billion.

Compared with an increase by $827 billion in 2000, credit and debt growth has quadrupled. Total outstanding indebtedness rose to $41.8 trillion, equal to 334% of nominal GDP and 376% of real GDP. In the first quarter, $4.30 of additional debt was added for each dollar added to nominal GDP growth and $7.50 additional debt for each dollar added to real GDP growth. Until the late 1970s, this credit-to-GDP ratio had held at a steady rate of 1:1.4 for over 30 years.

In a country without domestic savings, the money for such a runaway credit expansion must implicitly come from credit creation through the domestic financial system and foreign investors and lenders.

Strikingly, in the first quarter, U.S. commercial banks boosted their "net acquisition of financial assets" by a blistering $957 billion, annualized, as against $791.1 billion in 2005 and $472.4 billion in 2000. Net acquisitions of security brokers and dealers surged at an annual rate of 28%, to a record $611 billion. Foreign net acquisitions of financial assets in the United States rocketed to $1.492 billion, against $889 billion in the prior quarter.

Sorry for all the figures, but knowing them is of greatest importance. They contain the solution for the famous "conundrum" of stable U.S. long-term interest rates defying all the rate hikes. There were rate hikes, yes, but measured by the pace of the credit expansion, there has not been the slightest monetary tightening. Instead, the Fed has accommodated runaway and permanently accelerating credit growth.

Nevertheless, as explained, the rate hikes at the short end of the yield curve have cut off the dollar carry trade. But it has been replaced through sharply accelerating U.S. domestic bank credit expansion, and further highly leveraged carry trade in yen, but perhaps also in euro and the Swiss franc and bond purchases by Asian central banks.

Of course, rate hikes are generally applied to put a brake on credit growth and price inflation. The fact that in the United States the credit expansion sharply accelerated exposes the rate hikes as an outright sham. The point is that the Fed kept the banking system liquid enough to continue an aggressive credit expansion.

In the case of private households, the lure of higher house prices has plainly more than offset any restraint from higher interest rates, what a central bank ought to take into account. We doubt that they ever wanted true significant restraint in borrowing and spending, because they are afraid of it happening. They want lower inflation, but not lower spending.

Household debt expanded in the first quarter of 2006 to $1,333.9 billion, annualized, a new record. Business debt soared by $864.3 billion, up from $611 billion in 2005. Financial credit jumped by $1,479.2 billion, against $1,036.7 billion in 2005. Any talk of credit restraint is absurd.

Yet the most important credit source for economic activity during the past few years is running out of steam, not because monetary conditions have become tight, but because the delivery of collateral for higher borrowing against rising house prices has slowed sharply in line with their sharp slowing. Popular year-over-year comparisons, by the way, are deceptive. What matters are the recent changes.

Purchasing power currently spent comes from income or credit. In times of yore until 2000, U.S. private households got their purchasing power, like everywhere else in the world, overwhelmingly from current income, provided by increases in employment and real wages. During 1995 to 2000, overall real disposable incomes rose over 4% per year on average.

Yet since the early 1980s, there has been a steadily growing resort by households to borrowing, as reflected in a steadily falling savings rate. After 10% of disposable income at that time, it was down to only 2.3% in 2000.

From then on, the relationship between income growth and debt growth has radically reversed. Debt growth has escalated ever faster in comparison to income growth. Real disposable income growth, even though heavily bolstered through tax cuts, averaged only 2.7% until 2004. In 2005, absent new tax cuts, it grew a mere 1.3%. Over the first four months of 2006, it has been zero.

This recovery of the U.S. economy since November 2001 has been dominated by an unprecedented consumer borrowing-and-spending binge. In the first quarter of 2006, consumer debts had risen 70% from 2000, against an increase of real disposable incomes by 12%.

American policymakers and economists find it convenient to speak of "asset-driven" economic growth, in contrast to the "income-driven" growth pattern of the past. First of all, we object to this juxtaposition. "Asset-driven" is a euphemism for "bubble-driven," because what matters is not the existence or creation of assets, but their soaring prices celebrated as "wealth creation." The second utterly negative point to see is that this asset price inflation has been manifestly driven by ultra-cheap and loose money and credit, and not by saving and investment.

Since 2001, surging house prices providing ballooning collateral for consumer borrowing plus massive fiscal stimulus have been instrumental in offsetting the contractive effects of the bursting equity bubble and in generating the following recovery, but a recovery of gross failings.

With short-term rates now up to 5% and the housing bubble slowing down, the possibilities of borrowing are bound to shrink. To nevertheless maintain further increases in consumer spending, much stronger income growth will be needed either through higher real wage rates or higher employment.

What are the chances? In brief, employment and income growth are worsening. First of all, wage growth is barely matching the rise of the inflation rate. So everything depends on stronger employment growth.

This, however, dramatically deteriorated in April and May. Instead of an expected 400,000 new jobs over the two months, the reported gain was a miserable 208,000, even though the Bureau of Labor Statistics (BLS) fabricated record phantom job growth through its dubious "net birth/death" model – 271,000 for April and 211,000 for May. Yet even including these 482,000 phantom jobs, the reported figures are flatly awful, implying further income stagnation, if not worse.

With these numbers, the BLS is apparently making the ridiculous assumption that employment growth among new small firms outside its survey must be booming, while sharply falling in the economy as a whole, captured by its survey. It is always amazing how readily the consensus accepts such manifest nonsense. Wishful thinking prevails over serious analysis.

Looking at the monetary aggregates, something else strikes us as most ominous, and that is the difference between record-strong double-digit credit and debt growth and record-low growth of the money supply. M1 and M2 gained 3.2% and 4.9% over the last quarters. Adjusted for CPI inflation, this was close to zero for M1 and up just 1.3% for M2. We regard this as ominous because credit stands for debt, while money supply stands for liquidity.

Recently, we made an inquiry among American friends, posing to them the question whether there is any thought or talk in public of a possible recession in the United States. It occasionally pops up in the press, we learned. But the consensus opinion, in particular on Wall Street, flatly discards it as a possibility. It was precisely the answer we had expected.

It is a historical fact that American policymakers and conventional economists have never foreseen a recession. In 2000, the Fed hiked its rate twice during the first half, just before the economy began its slump. Equities already had started to crash in March. Reading several reports with forecasts published in late 2000, among them the OECD Economic Outlook, we found nowhere the slightest hint of a coming recession.

There seems to be a general conviction, cultivated not just by Mr. Greenspan, that the U.S. economy has become virtually immune to recession. It is widely seen as just a bursting of strength due to ingrained "flexibility" and "dynamism." In addition, there is, of course, unbounded faith in the virtuosity of the Fed to avoid a serious recession with swift action.

Regards,

Dr. Kurt Richebächer
for The Daily Reckoning
August 3, 2006

Editor’s Note: The Good Doctor has found the only five investments you’ll need in 2006 – and one of them is a mighty hedge against the forces of dollar weakness and inevitable inflation. At the very least, it will help protect your money from the boneheaded inflationary policies and programs of the Federal Reserve – especially under new Fed Chief Ben "Printing Press" Bernanke.

Former Fed Chairman Paul Volcker once said: "Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong." A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as "the man who predicted the Asian crisis."

"Anxiety Rises as Paychecks Trail Inflation," says the New York Times.

"Home loan demand at 4-year low," adds Bloomberg.

"South Florida House Sales, Prices Fall," notices the Inman Real Estate News. In Broward County, for example, sales fell 25% in July, compared to a year ago.

A credit bubble is typically followed by a credit collapse, which is the last thing a central banker wants. But we read the headlines and see it coming:

"Goodbye, condo mania," adds Kiplinger’s.

"At $222,000, the nationwide median price of a condo is once again less than that of a single-family home ($222,700). Condos had been appreciating more quickly than single-family homes because they are concentrated in high-cost metro areas, where prices were rising rapidly. As home prices cool in overheated urban markets, the drop in condo prices is likely to be more precipitous."

The consumer economy depends on consumers with money in their pockets – or at least a line of credit. For the last five years, that line of credit has run directly from increases in house prices. Now that house prices are no longer going up, consumers are running out of spending money. Particularly hard hit are companies that offer middle-class luxuries: Starbucks, Whole Foods, Red Lobster, Cheesecake Factory. And, let’s not forget the loan companies: Countrywide Financial and Capital One, for example.

Bankruptcy, ruin, revolution and death. People spend their whole lives trying to avoid crises that are either inevitable or actually beneficial.

The Roman Empire lasted for hundreds of years, but it did so only by heaving itself out of the ditch every so often – with civil wars, mass murders, coups d’etat, rebellions, insurrections, revolutions. Blood ran in the streets of Rome often – long before the city was sacked by barbarians.

Now, it is the modern financial world that faces ruin. Having inflated the money supply, the Bernanke Fed attends rising consumer prices like Joan of Arc waiting for a match.

But what can they do about it? The Fed has stopped reporting increases in broad money supply, M3, and has redefined the word ‘inflation’ so as to exclude prices that are going up. It has also increased short rates by 450 basis points – the sharpest increase since the ’60s. But while it publicly fights inflation, its real enemy is deflation. So, while M3 goes unreported, M2 tells us that the money supply has exploded at a 10% rate over the last 10 weeks. The Fed is desperately trying to avoid deflation by making more money and credit available.

Poor Ben Bernanke. The poor man confronts a world in ARMs way. The adjustable rate mortgage was an innovation that helped the housing industry sell houses to people who couldn’t really afford it. Now, those same people – millions of them – face automatic increases in their housing costs. From Palm Beach comes news that "Easy-to-get loans cause thousands to lose homes." From the West Coast we get a similar story: "Lenders take notice as defaults are rising; Homeowners feel pinch of adjustable rate loans." From coast to coast, mortgage defaults are running 72% ahead of last year.

Our advice to the Fed chief: relax. Yes, the economy is going into a slump. Yes, millions of people will go broke. But look on the bright side: we wouldn’t have bankruptcies, revolutions and death if we didn’t need them.

More news from The Sleuth….

————–

Jonathan Kolber, our emerging technology expert, offers this report:

"A bold project has begun in the Australian Outback to build a huge tower that will capture the sun’s energy in a far more efficient way than conventional solar cells or windmills…"

This article appears in the latest issue of The Sleuth.

————–

And more views from Bill…

*** A friend of a friend wrote in the Times of London and left us feeling poor. If you have between one million and two million pounds in total assets, wrote publisher Felix Dennis, you are just "comfortably poor." In order to be "comfortably wealthy," you need between five and 15 million. And you are only rich by Felix’s standard once you have over 75 million pounds. To be "truly rich," as he is, you need between 200 and 400 million.

Felix also explains why most people never really make a lot of money. It is because they are fearful of failure, says he. He cites the case of a friend who had a choice – either take over Dad’s auto dealership or get a Ph.D. in biochemistry. The Ph.D. conferred respectability and security, but in no way would it lead to real wealth. The auto dealership, on the other hand, was neither respectable nor secure. It was a wildcard. Most likely it would go nowhere. But, there was the off-chance of building it into a really successful business.

The friend chose the Ph.D. and always wondered whether she should have instead taken the more daring path.

*** Speaking of auto dealerships, America’s auto businesses are straining to keep up with Asian competitors. "Big 3 see sharp decline in sales," says an AP report. "Ford’s Second Quarter Loss More than Doubles," adds MSNBC. And here’s the coup de grace from the New York Times: "Toyota U.S. sales edge past Ford’s."

How would old Henry Ford feel? The company he began, which set the standard for the automotive industry for nearly 50 years, has now been beaten on its home ground by a competitor from Japan!

But don’t worry about it, dear reader. Remember, we’re number one. We think; they sweat. We have given up on the old industrial-age industries. Let the Asians have them. Now, we’re dominating the new post-industrial enterprises. Let’s see…nobody lends money more aggressively than we do. And we make movies. And high technology. Nope, we have a net trade deficit in the high-tech sector. Oh…yes…we sell more debt than anyone. Yes, we’re number one in debt. No question.

*** Finally, the news from Ouzilly…

It’s cold and rainy. We wear sweaters and watch the skies, hoping for a ray of sunshine.

Last evening, we gathered in the library for an apéritif before dinner, as it was too cold and wet to stay on the porch.

"Poor Mel Gibson," said a guest. "When you’re a star, you really have to stay sober. Otherwise, you go shooting off your mouth and they make a federal case of it."

We have not read the press reports, but we gather that Mel got into trouble with the thought-police after saying naughty things about the Jews. We don’t know what he said, but we sympathize. We can’t think of a single group we haven’t said something naughty about – even our own group, whoever they might be.

But so what? We can say what we want. It’s a free country…

"’It’s a free country,’ – remember that expression?" began our old friend Doug Casey at Vancouver. "Nobody says that anymore. Because they know it’s not true. Now, you’ve got government agents and busybodies breathing down your neck 24 hours a day. "

Big-mouth Mel has had to issue the ritual apologies, tell the press he didn’t mean it, and insist that his remarks were taken out of context. We’ve even heard that he is going into "therapy."

Now, you can’t even get drunk and howl anymore…

A Credit Machine Running Amok originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas. Recently Agora Financial released a video titled "What Causes Gas Price to Increase?".