Beached Whales and Economic Omens

“Oil has climbed to a record-high $82 per barrel. Why is the price rising?

“The Peak Oil paradigm is beginning to gain traction. I have discussed Peak Oil extensively and often in my investment letter, Outstanding Investments. I have taken quite a bit of heat for this view – from many quarters – but I have stood with the concept through thick and thin.

“And now, if you still don’t want to hear it from me, no less an authority than America’s first Secretary of Energy and former Director of Central Intelligence James Schlesinger recently noted at an international conference on the subject of energy, ‘The battle is over, Peak Oil is now accepted as inevitable, and the debate only becomes as to when.’

“This is a remarkable statement, coming from one of the most ‘inside’ of U.S. political insiders. Here are the long-term trends that you should expect to see…”

Byron King
October 2, 2007

Beached Whales and Economic Omens

Back to Short Fuse, sitting at gate C11 at the Atlanta airport…


Views from the Fuse:

We’ve been sitting in the Atlanta airport since 5:30 AM, waiting for our connecting flight to Baltimore. There has been little to do but write, and listen to the local news. Today’s top story? Britney has lost custody of her kids to “K-Fed”…and of course, the recent record close for the Dow at 14,087.55.

Yesterday’s surge in the Dow was…er…surprising. It seems a bit sad when we are rallying on bad news, keeping our fingers crossed that more unfavorable data will spur the Fed to continue cutting rates.

“Negative surprises on bank balance sheets will far outweigh any benefits they receive from Fed rate cuts – benefits that tend to restimulate the credit creation process only after a very long time lag,” Strategic Investment’s Dan Amoss tells us.

“On the subject of further Fed rate cuts, the financial markets are flashing many glaring signs that monetary inflation is spiraling out of control. So Fed Chairman Bernanke will have a chance to demonstrate to the world that he deserves the reputation as the ultimate ‘inflation fighter.’ With gold and commodities soaring, and most global stock markets either approaching or blasting through July peaks, he may decide to put further rate cuts on hold for the time being.”

So does a new record high for stocks mean that we’re out of the woods? Has the worst of the credit crunch passed? Did the market really “absorb” the losses from the credit squeeze? The commentators on the news channel we can’t help but listen to while we sit here seem to think so…but we aren’t entirely convinced…and neither is Dan Amoss.

“Once a bubble pops, the companies at the center of it usually try to take their lumps in a single quarter, often referred to as a ‘kitchen sink’ quarter. By cramming losses and write-offs into a single quarter, they try to give Wall Street the perception that the bad news is out of the way and nothing but blue skies are ahead.

“But like technology companies after the tech bubble peak, it’s very hard to believe that banks will be able to cram all their bad news into upcoming third-quarter earnings results.”

Dan has his Strategic readers positioned to profit no matter what craziness occurs in the markets…in fact, Strategic Investment warned about the stock market bust of 2000-2002 one full year in advance and the housing market collapse back in 2004 two years before it happened.

The fact that hundreds of thousands of homeowners across the nation are bracing themselves for mortgage rate resets is also cause to believe that the credit crunch has not yet found its bottom. The Boston Globe reports that in Massachusetts, more than 9%, or about 10,000 homeowners, are facing high mortgage payments – and experts believe that many of these stretched homeowners will be adding to the already record-breaking number of foreclosures in the state.

If the total value of these loans in Massachusetts is $2.45 billion…imagine what the total value of all the adjusted rate loans across the United States is. We’re no mathematicians, but we bet the number is pretty big – and pretty scary.

Luckily, The Survival Report’s Mish Shedlock has crunched the numbers, and tells us that over $1.8 trillion in loans are headed for ‘reset’ this year alone.

To quote our Commander-in-Chief: “That’s trillion with a ‘T’. That’s a lot of money.”

“Over $100 billion more of these loans were written in 2006. That means more resets in 2008. With years of financial ‘healing’ to follow,” continues Mish.

“It’s no wonder George McCarthy, a Ford Foundation economist, calls the option ARM boom ‘a neutron bomb.’ Because, he says, ‘It’s going to kill all the people but leave the houses standing.'”

We are en route to south of the River Plata, where we will be reporting on the latest news from Argentina.

What’s new in the financial world today? Well, we don’t have today’s news, so we’ll have to comment on yesterday’s news.

What is notable in the financial world is just what you’d expect: the dollar is losing its value, after Ben Bernanke’s paternity test came to light. The results, announced two weeks ago, made it clear that Bernanke is heir to Alan Greenspan, not Paul Volcker. That is, the Bank of Ben Bernanke will not fight inflation…instead, it will battle deflation to the bitter end.

Of course, we all knew that…but he could have been subtler about it. The Fed might have cut rates by only a quarter of a point. Instead, choosing to take rates down to 4.75%, the Fed chief left no doubts: the bank will take its lead from Alan Greenspan’s easy money era…not Paul Volcker’s tough love therapy.

As a consequence, the dollar is setting new records…

…never before has it been so low against the euro (EUR)…

…never before has it bought so few commodities…

…never before has it bought so little oil…

And the last time it bought so little gold was 27 years ago.

That last bit of information sends a shiver down our spine – because we still recall those wayward days. It made us think:

Gold turned around on almost the very day that Ronald Reagan was inaugurated. We attended his inaugural ball, sure that the trends of the last 20 years would certainly last a few more years. Consumer prices had been rising steadily…and were now going up at 12% per year.

And gold had gone from $41 an ounce at the beginning of the ’70s, to more than $800 by the time the ’79 election results were in. How were we to know that that trend had run its course?

The new man at the Fed, Paul Volcker, meant business. The country had seen what stagflation would do to it. It had had enough. Even economists recognized the need for a change. Easy money policies were out of the question; the bond ‘vigilantes’ already had their eyes on M3, the broadest measure of the money supply. And consumers were ready to ditch the dollar. Volcker knew he couldn’t hope to go along and get along. He had to jack up rates to save the dollar; recession be damned!

As we explained last week, Volcker sent rates up over 20%. The economy went into its worst recession since the ’30s… But it worked; and the price of the dollar – measured in gold – rose for the next 20 years. Woe to the “gold bugs” who stuck with it…

…but wait, suppose the gold bugs actually did stick with it? Suppose they looked up on August 16, 1971 and read the handwriting on the wall. The day before, Richard Nixon had “closed the gold window” at the Treasury. Henceforth, you could rap on the glass all you wanted. Even if you were Charles de Gaulle, you still wouldn’t be able to trade your paper dollars for the gold you were promised.

This was a major default. And it clearly augured more bad things to come. Now that the dollar was no longer anchored to gold, the entire world money system – which was anchored to the dollar – was adrift. And you didn’t have to tell us gold bugs what that meant. It meant that the dollar would soon be worthless. Every time governments tried paper – pure paper – currencies, it was just a matter of time before the paper money sank to a value less than the paper itself.

But, dear reader, we bow our heads…remembering what idiots we were. “It’s Not That Simple,” is a motto that is so useful…and so profound. It should be recalled by every investor. And it should be branded onto the foreheads of everyone running for public office.

And here we are 27 years later. The dollar is falling against almost everything but U.S. residential real estate. The loyal gold bug has made 18 times his money. And gold is still going up…it’s rising against almost everything. And now, with gold back to where it was when the “Evil Empire” was still a going concern, is it time for another major switcheroo?

Probably not. This bull market in gold has only been running for seven years. Another big reversal in gold/dollar would imply that the fundamental equilibrium between the two was unchanged and immutable. It would imply that the dollar is fundamentally solid…and that our prejudices against paper money are wholly unfounded.

Alan Greenspan famously remarked that while he was running things, he made sure to pretend that the U.S. dollar was still connected to gold. He says he ran the Fed as if we were still on the gold standard.

How could this be? The U.S. money supply has been increasing at double-digit rates for many years. The last figure we saw was an annual rate of 14% – for the increase of M3.

The world’s available gold, by contrast, only increases by 1% to 2% per year.

And now, the new man at the Fed has a different problem. Now it is hard money policies that are out of the question. The feds have even stopped reporting M3 – hoping that the bond vigilantes won’t notice. Americans have too much debt; they can’t afford to protect the dollar. Interest rates of 10% would ruin them. Interest rates of 20% would probably lead to revolution.

The one major asset category that is bucking the trend is housing. Everything else is going up, in dollar terms. Housing is still too expensive for most Americans – but on the other hand, it is remarkably cheap to foreigners.

Maybe foreigners will start moving to Killeen, Texas – the cheapest major town in America – to buy their retirement houses. We wondered what life was like there. Here, a dear reader, tells us:

“Well, since you asked about Killeen, I’ll be glad to share what little I know. I grew up about one hour’s drive northwest of Killeen, and I’ve been to it and through it on a number of occasions.

“Killeen is nestled right up next to Fort Hood, which, before the breakup of the USSR, was the largest military base in the free world. So, needless to say, the community is influenced by a large presence of U.S. Army members and families.

“Austin, Texas is only about an hour and a half south of Killeen, so you’d have big-city entertainment (and urban sprawl beginning about 45 minutes north of there).

“There are two reservoirs near Killeen for fishing, and once there you’d find yourself on the edge of the ‘Hill Country’ as we Texans call it, where the geography is mostly rolling hills, pastures, and some medium-sized trees. And yes, I checked; there is a Starbucks. You might even get the chance to see a rodeo.

“All in all, it would be a fine place not to live. In fact, I’ve been itching to get out of the Dallas-Ft. Worth area and back out to the country, so if you needed someone to look after the place…”

And here a dear reader tells us what “ground rush” is really all about:

“I know what ‘ground rush’ means. On Christmas Day, 1944, I was shot down in my P-51 over Frankfurt, Germany. I hadn’t been watching my tail very carefully and I was jumped by 6 or 8 ME-109’s and shot down.

“Bailing out of my burning plane I found myself spinning violently as I fell but, as I had long planned, I let myself fall before opening my parachute until suddenly, as I tumbled face down, the ground came rushing up at me. We’re taught to open our parachutes in three steps: first, look at the ring on your left shoulder (One), then grab it (Two) and pull it hard (Three), but with the ground rushing up at me I instinctively grabbed the ring without looking and yanked it. As I tumbled head over heels the chute streamed out between my legs and opened with a tremendous jerk – so much so that my eyes blurred and I went limp from the shock.

“Within no more than two or three seconds, my feet hit the ground, but being so limp I had no injuries. The parachute was open for such a short time that I was reported ‘probably dead’ by a pilot in a nearby plane, and no German soldiers came to look for me, but I was soon captured anyway, managed to escape, and was again captured two days later. I spent the last four months of the war in a German prison camp. Yes, I know what ‘ground rush’ means… While I’m at it, let me say how much I appreciate your wry, endearing (if repetitive) Daily Reckonings – especially your snippets of family life.”

Another dear reader writes from the state we didn’t live in before we started not living in Florida:

“Just to reinforce what you are saying:

“1. New car sales are down in Maryland 5% this year with the biggest decrease in the last three months.

“2. Listings of houses-for-sale in the counties surrounding Baltimore have increased nearly 200% over the past two years.

“3. Gas and electricity rates increased by 50 percent effective June 2007.

“4. Our new governor wants to increase taxes by about $1.2 billion dollars (more if slots legislation does not pass) and part of that is to increase the sales tax from 5 to 6%.

“How long can this go on before something crashes?”

It is worth noting that tax receipts go down at the end of a credit expansion. People have less in income and capital gain to tax. So, the government has less money to spend. At least, the state and local governments have less. The feds have that little technology…the printing press.

And finally, a little snippet of family life.

Maria took us to see the Southwark Theatre where she will begin her career as an actress. She has the lead role in You Can’t Take It With You, which opens on October 23rd and runs through November 17th.

“You have to start somewhere,” said Maria, as she pointed to the theatre.

She was pointing down an alley underneath the railroad tracks, to one of those huge, brick caverns built in the last century. There was a chain-link fence. Beyond it was a sign that proclaimed “Southwark Theatre” with an arrow pointing to the left.

“Well, it’s not Broadway. But the director and the cast are serious. And if it does well, they’ll take it to the West End,” Maria said, enthusiastically.

Dear readers who find themselves in London while the play is running are encouraged to go see it. Be sure to burst into loud applause when the leading lady appears…that’ s our little girl! Also, be sure to look for your author in the front row.

You Can’t Take It With You by the way, is an American play from the ’30s. Jimmy Stewart starred in the movie version, which won two Oscars.

Bill Bonner
The Daily Reckoning

The Daily Reckoning