More Dollar Doom

“It seems that over the past few years, much of the financial industry loaded up on bad debt instruments. I will not even dignify this rotten paper by calling it some sort of ‘investment,’ because there was and is essentially nothing to back it up. There are entire portfolios filled with sub-prime loans, initiated via ‘no documentation’ loans against over-appraised buildings on the far side of the railroad tracks. In other words, these are worthless loans that will never see a dime of repayment. In many cases, these loans are evidence of economic crimes.

“When the banks and investment houses acquired these bad books of business, the risk models that they used were pure guesswork. In the real world, engineering has made complicated structures like bridges and skyscrapers safer over time. But the so-called modern ‘financial engineering’ has done nothing of the sort in the economic world. It all goes to show that just because the human mind can come up with an idea, it does not mean that people should act on it, let alone back it with their funds.”

Now over to Short Fuse, reporting from Ellicott City, Maryland…


Views from the Fuse:

Here at the DR, it’s no secret we are contrarians. We write about things that the mainstream media doesn’t report…one of us was the last person in the free world to have a cell phone…and most of us get our coffee at the anarchist bookstore next door to our office in Baltimore.

So what if there’s a Starbucks on every corner? No way would we succumb to the corporate America brainwashing. Pumpkin-spice lattes? No thanks; I can get my free-trade Ethiopian coffee while skimming a book about Emma Goldman and listening to some guy play the didgeridoo.

That is, until someone introduced a…um…certain DR editor to Americanos. You can definitely get these at any coffee shop in the world, but the Starbucks barista doesn’t even bat an eye when you order your venti Americano with an extra shot (that’s five shots for those of you keeping score at home.)

Sadly, this editor has become addicted. She searches out Starbucks – not that they are all that hard to find – once, twice, sometimes three times a day. And there is always a line. Which is why it’s surprising to read that fewer coffee drinkers are getting their fix at Starbucks (NASDAQ:SBUX).

“The 1 percent drop in traffic at stores open at least 13 months marked the first time the company has seen such a decline,” reports the AP.

“Starbucks stock has fallen more than 40 percent over the past year, as the company has grappled with higher dairy costs, increased competition and economic woes that appear to have forced customers to pare back on their lattes and Frappucinos.”

Well, higher dairy costs is easy enough to explain…among other factors, everyone’s favorite fraud, ethanol, has pushed the price of livestock feed up to all-time highs, making the price of dairy, meat, and other daily staples higher to boot.

Ethanol is not the answer, our energy guru Byron King tells us time and time again. We have to search out other alternatives. This is why Byron has launched our newest service, Energy & Scarcity Investor.

He believes that the concepts of “energy” and “scarcity” will dominate the way our country views the social, political and economic landscape for years to come.

“We can benefit and profit enormously from building investment models around these key concepts,” Byron tells us.

“At the same time, many of the best investment opportunities of the future are still in the early, if not embryonic technical and business stages. Thus we are looking for small companies with large growth potential.

“Many of the investment ideas that we will explore involve some risk in the form of companies with thinly traded stocks. Due to their small size and float, I would not recommend many of these companies in my other service, Outstanding Investments.

“In Energy and Scarcity Investor, I can fully explore the possibilities of riskier investments – and bigger profits.”

You can find out for yourself what Energy & Scarcity Investor is all about – but hurry…there’s only a limited amount of reports that Byron can release…and 20% are already spoken for.

But we digress. Getting back to fewer people heading into Starbucks…could this have anything to do with consumers feeling the sting of higher prices?

“If you ask the quants at the Bureau of Labor Statistics (BLS) they’d tell you ‘no way!'” says Addison over at The 5 Min. Forecast. “In October, the BLS number crunchers reported yesterday, consumer prices (CPI) only increased 0.3%.”

“‘The talking heads are saying that yesterday’s CPI data show tame inflation,’ comments our resource man Kevin Kerr, proving there’s much more to Kevin’s world than soybeans, oil and orange juice futures.

“‘But some simple analysis will show you that inflation is there; it’s just invisible to the BLS. And the longer the BLS ignores it, the bigger the bull market in gold, silver and commodities will be.'”

“Pasta Panic Strikes Italy” says a headline from Fortune magazine.

Oh my, dear reader…this is getting serious.

“If prices continue to rise, I would not be surprised if we began to see food riots.” So said Jacques Diouf, director general of the UN’s Food and Agriculture Organization only weeks ago.

Maybe we should call Monsieur Diouf and ask his prediction for the stock market.

Yesterday, we learned about a mob stampede in China. Three people were killed in a mad rush for cooking oil.

Today, we get this:

The pasta makers of Parma have their tortellini in a twist over the spiraling price of wheat, reports Fortune.

“The price of wheat is up 60% this year, and in Italy they’re taking to the streets…the price of pasta, which has jumped about 20% this year for some varieties, touching off a nationwide protest. But the story behind the price hike is a global saga involving agricultural policies, commodity-market speculation, the growing use of ethanol as an alternative fuel, and Australian drought.”

Oh? Is that what it is?

Somehow Fortune overlooked something. It overlooked probably the most important reason food prices are soaring – a reason that has nothing to do with the weather.

We return to Fortune:

“Yes, the price of wheat has risen, but it has simply gone back to 1985 levels…” says Rosario Trefiletti, hinting of conspiracy. Trefiletti is president of the Federconsumatori consumers’ association in Rome. He called a pasta strike in September.

“The government can’t impose lower prices,” says Carlo Pileri, who heads another consumer group, “but it can do moral suasion.”

Which government is he talking about? The same one whose policies and predilections caused prices to rise in the first place?

Fortune continues:

“Rising bread and flour prices have sparked protests across drought-stricken Morocco, where the wheat crop dropped by 76% this year. Public disturbances have also been reported in Yemen, Niger, and the Ivory Coast.

“And it’s not just wheat that’s soaring. Milk prices are at record highs, and rice is up too. … In Japan, where the government is the sole importer of wheat, bread prices have gone up for the first time in two decades. Russia, Ukraine, and Kazakhstan have imposed restrictions on their wheat exports to ensure that their domestic markets don’t lose out in the rush by traders to make money abroad.

“The big winners in all this, at least for now: American wheat farmers. Production is up about 14%, while exports, aided by the weakening dollar, are expected to rise more than 25% this year. Stocks are at their lowest level since the late 1940s. Best of all, prices have jumped to an average yearly price of $249 a metric ton for hard red winter wheat, more than double what it was in 2000.”

Daily Reckoning readers will note the coincidence immediately. You say wheat has more than doubled since 2000? Well, what do you know…so have oil and gold. No droughts bedevil gold miners. No farm policies hamper roughnecks. Isn’t it remarkable that all are going up together…as though levitated by an unknown, unseen force?

Well, not that remarkable. Oil, gold and food are reacting, first and foremost, not to a shortage of rain on the underside of the earth, but to a surfeit of cash and credit all over it.

Not since The Flood has the planet seen such liquidity. The United States buys things it can’t afford with money it doesn’t have. It simply prints extra dollars and exports them to its trading partners. These countries, in turn, print their own currencies to buy up the dollars. They end up with huge piles of dollars in their vaults. This year alone China has added $367 billion to its horde of foreign reserves (mostly dollars). All this money does what money does. It buys things. Typically, the more money on hand, the more of it you need to buy something.

Nobody complained, not as long as asset prices were rising. But now we’re beginning to see more and more long faces. Now asset prices aren’t all rising. Instead, it is pasta that is going up.

But here is where the pasta story gets sticky. If the flood of liquidity is so huge…how come houses are going down? And how come banks and financial firms are reporting such large losses?

Everyday brings new reports of losses and a new acronym. The latest is SIV, which for the benefit of readers with real lives, stands for Structured Investment Vehicle. Turns out, the money market funds have put a little of their cash into SIVs. For the first time ever, the funds may “break the buck,” meaning, they might not have a dollar’s worth of assets for every dollar investors gave them. This would be a big disappointment to many investors; they gave their money to the money funds because they believed they were ‘safe’…and they were hoping to get their money back in the same condition it left them.

And now come the rating agencies – Moody’s and Fitch were mentioned in the report (better late than never!) – threatening to downgrade much of the paper that has been so joyfully traded for so many happy years. In particular, the news accounts say that MBIA (NYSE:MBI) and Ambac (NYSE:ABK) will be hit hard…and that an estimated $200 billion will be disappear from the bond market as a result.

As we’ve been saying…a hundred billion here…a hundred billion there…pretty soon, you’re talking real money.

Shareholders of MBIA and Ambac are already feeling like they’ve lost real money. If we remember the numbers correctly (we’re now in Luton Airport, outside London, waiting for a plane to Ireland), they’ve lost about half their money so far this year.

“You think that’s bad…” said a friend at lunch yesterday. “I sold my business at the end of the dotcom boom. One thing led to another…and I ended up with shares in E-Trade (NASDAQ:ETFC). It never occurred to me that these guys had leveraged their balance sheet with a lot of dodgy debt. I only realized it on Monday, when the price was more than cut in half.”

Despite vigorous denials, E-Trade was said to be facing bankruptcy. Investors weren’t taking chances; they were dumping the stock.

“But it’s funny,” continued our friend, who is also in the financial trade, “we find that our clients have no real appreciation of what is going on. They only judge by the last few years. If a stock was trading at 100, and now it’s 95, they think it is a bargain. Same thing for houses. You get a little bit of a price decline, and people think they have a good investment opportunity. The idea of a bear market…or a credit deflation…never enters their minds.”

That is part of the answer to the question posed above. Why don’t declining levels of liquidity in the credit markets immediately sink farm prices and/or asset prices? That is a good one, dear reader. You probably think you’ve nailed us with it. Not at all. We have an answer. After a night spent somewhere between inebriation and prayer, we have an explanation.

Of course, part of the answer is right there. Investors are still believers. Sentiment has a kind of momentum of its own. Bullishness persists, even as the warning signs multiply.

A fuller answer comes in a familiar metaphoric form: The tide has turned, we think. And when the tide turns, sailors on the high seas barely notice. There is still plenty of water beneath them. But out on the edges…in the shallow marshes…and the tidal flats – the liquidity disappears. Many marginal subprime borrowers…and his marginal subprime lenders…already find themselves high and dry. House prices are falling. Hedge funds and financiers are losing money. Relatively few people feel the water moving between their toes. But soon, the outgoing ebb will be more apparent to everyone. The middle class will begin to come up a little short at the end of the month…companies will see their profits fall…investors will sell their stocks…and savers will begin to look at their dollars, pounds and euros and wonder what they are really worth.

In the meantime, marginal investments dry up…while scarce resources – oil, gold and wheat – continue to sop up the extra liquidity.

Elizabeth called yesterday with an update from Paris, which is suffering from an outbreak of “manifestations.”

“Well, I had to do something; and I love it,” was her answer.

Our question was: why do you bother?

Elizabeth has found herself in a situation that will be familiar to many readers. After 20 years of raising children, the work seems almost done. Three have completed college. One is in college now. That leaves only two at home, one of whom is headed (we presume) to college next year. Only one teenage boy will remain at home.

So Elizabeth has begun a new career; she has gone back to school, studying history at the Sorbonne.

“There’s a strike going on. Well, it’s a kind of strike. I rode my bicycle to school yesterday morning. A line of policemen stopped me. They said the university was shut down because of ‘disturbances.’ I didn’t quite believe them. So, I asked if I could keep going and see if my classes were still being held. He looked at me as if I was crazy…but let me through. I tried the door. It was locked.

“It is not clear who is striking and who is not. And nobody seems to know why they are striking. They say they are protesting the fact that the university is being privatized. But the government has no plans to privatize anything. The whole idea is unthinkable in France. The government says it doesn’t know what the strikers are talking about. The protesters aren’t students, by the way. They’re trade unionists who have a gripe with Sarkozy. Some of them got into fights with the students who wanted to go to class.

“I’m trying to get to school very early…before the protesters block the doors. I just hope I don’t get locked in.”

Have a nice weekend,

Bill Bonner
The Daily Reckoning