God*mmit... I’m an American

by Bill Bonner

It is early spring in the southern hemisphere. A fresh warm breeze blows across the Rio Plata. Trees along Buenos Aires’ broad boulevards are budding out. Cherry trees are in bloom. Here and there, groups of American tourists peer in shop windows. Birds sing. Lovers stroll arm in arm. It looks as though it might be the beginning of something.

Americans abroad have a mixed reputation. They are loud. They dress badly. And they have a superior attitude that foreigners take for arrogance. But they tip better than Europeans.

In our trip through Argentina, we were no different, no better. None of us had bothered to learn Spanish properly. We spoke it badly, if at all. We expected the locals to speak English…and often commented on how bad the hotel clerks’ command of our mother tongue was, hardly noticing that it was still far better than our knowledge of Spanish.

We Americans are not mean spirited or pompous about it; still, unconsciously, we expect a little deference…a little obsequiousness…a little bowing and scraping in our direction. After all, we are the imperial race. We are the alpha nation. We have the most popular culture. We have the most powerful military. We have the money.

“Why do so many Americans hate the French,” asked a member of our party. The answer is obvious: the French refuse to bend. The unmitigated Gauls actually turn up their noses at American tourists and make them feel like bumpkins. The French don’t dispute that our army could whip their derrieres, if it came to it. They concede, too, that the average white American probably has more money in his pocket than the average Frenchman. But neither of those things counts, say the French; what matters is culture and French culture is superior.

“God*mmit…I’m an American,” says the ugly tourist. He is convinced that the frogs, the Huns, and the A-rabs are all incompetent and uncivilized. He is the heir of his English cousins, who used to say: “The wogs start at Calais.” He demands better service than they give each other. He can’t understand why they can’t seem to do things the way they do back in the states…can’t pick up the trash…and can’t be trusted. Why do they drive old cars? Why don’t they have more ATM machines? How come they are always taking passport numbers and demanding papers; don’t they know that freedom is the way to go?

He is convinced, too, that the whole world yearns to be just like him, and that it is just a matter of time before they succeed. This conceit is so deeply felt he is not even aware of it. Besides, he sees more evidence of it every time he takes a trip abroad. He leaves the airport in London and sees McDonald’s along the way. He reads the classified in Paris and sees apartments advertising their ”American style” kitchens. He picks up a menu in Buenos Aires and finds he can order an American breakfast. He goes to the Far East and finds familiar brands everywhere he looks (he may not even realize that they are made there…not in America).

He judges the quality of everything he sees by how American it is. Is the toilet paper soft…just like it is at home? Do the shops take credit cards, just like they do in Flagstaff? Are the roads paved as well as they are in Michigan?

If not, they soon will be, he tells himself; for he is convinced that the whole world is going his way. At least, that is what we thought on this trip to Argentina. The country is big, beautiful and cheap. Surely, Americans will want to live here. The Atlantic coast of Argentina is just like the Carolinas…but empty. The far northeast is like Utah or Montana…but at a third the price. And down in San Martin, isn’t it just like Aspen…as it was in 1965?

But won’t Americans find Argentina too, well, foreign? Not at all, down on the pampas they are becoming just like us back on the Great Plains. Soon, we will be able to live as comfortably in Patagonia as in Pennsylvania.

At the peak of an imperial cycle, the imperialists always seem to delude themselves. Looking at the world, they see neither a glass half empty nor one half full, but one spilling over. The Romans spread out all over their empire, building villas in France, in England, and out on the banks of the Black Sea. The Moorish empire reached its peak in the eighth century. Then, too, they were making plans for new mosques in Poitiers, just before they were chased from the country. And all over Africa, you see the ruined houses of the European imperialists who colonized the country. “I used to have a farm in Africa,” they still tell people.

The trouble with being on the top of the world is that the world turns, and there is nowhere to go but down. In national economies and markets, as in the movement of the planets, there are small cycles and big cycles. The world turns, and also revolves around the sun. Day follows night; winter follows summer. National pride is self-correcting.

Argentina recently had a dark night of crisis…one of many in a long season of bad weather. The 1930s brought Peronism - a popular brand of socialism - to the country. The nation’s politicians shot the country in the foot, and then in the leg. By the 1980s, they had the gun to their heads – with inflation running at 1,000 percent, per year and war with the English. One problem lead to another and in the 1990s, intending to stop inflation, the Argentine currency was pegged to the dollar, but at too high a rate. The economy collapsed again; much of the middle class was ruined.

But in 2002, the sun peeked over the horizon and began what might be not only a new day, but a new season. Since the second quarter of 2002, the country has seen 12 consecutive quarters of growth, with GDP shooting up at twice the rate of America’s ”recovery.” We put the word in quotes to signal that we think there is something fishy about it. America’s dawning prosperity came without pain or sacrifice. Americans never stopped borrowing and spending in the recession of ’01-’02; they merely borrowed and spent even more coming out of it. See, they said to the world, our economy can’t be beat. Because, god*mmit, we’re Americans. But the recovery was phony. There was never much of a correction to recover from. So, when the time for an upturn came, all consumers could do was to borrow more money and go further into debt. They had never stopped spending, so they had no money saved.

South of the Rio Plata, on the other hand, the recovery seems to be real. Here is an economy that seems to be getting back on its feet, after a long spell on the sickbed. The recovery is driven not by debt, but by real savings…and not by consumption, but business investment, which rose recently at rates as high as 11.2% per quarter. Consumers couldn’t lead a recovery in Argentina even if they wanted to. Who would be foolish enough to lend them money? Credit card debt is extremely limited. And if you want to buy property down here, we were told, “you have to pay cash.” Or, if you have good credit, you may get a bank willing to finance half of the price.

Not surprisingly, real estate is not very expensive. Apartments on Buenos Aires’ most fashionable streets sell for about a quarter of what they would fetch in Paris, London or New York. Out in the boondocks, prices fall even further. How much would you expect to pay for a vineyard/winery in the Napa Valley? Out in Salta Province, one is available at a price that must bring tears to the eyes of a California vintner: 1,000 acres of mature vines for only $1.5 million. And there, he would pay only $10 a day for a good worker, and only $2.50 for a steak dinner.

North of the Rio Grande a homebuyer needs only a pulse. He will pay $25 for dinner, and at least $50 a day for labor. His $1.5 million will barely buy a trailer.

In both Argentina and in the United States, there is a light on the horizon. But on the pampas is the light of dawn. In America, alas, it is probably evening stretched out across the sky…like an emperor’s corpse on a viewing table.

Bill Bonner

Courtesy The Daily Reckoning

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

India's Big, Big Pockets

India’s most overlooked asset class is changing - for the better.

by Sala Kannan

A trip to a real estate agent’s office in Chennai, India, was quite an eye-opener. We arrived five minutes early for our appointment. Outside the agent’s office building, we saw a man in white pants and a white shirt. He was lazily pacing up and down, his white flip-flops slapping loudly against his feet.

I rolled down our car window and asked him, “Is this Mr. Natesan’s office?”

“Natesan, yes,” he replied in English.

“Is he in? He’s supposed to show us some properties.”

“Myself Natesan.”

OK, I thought to myself, flip-flop man here is our real estate agent. Natesan was a small man with an ample handlebar mustache. And his white flip-flops were at least two sizes too big. And really loud.

“Follow me, madam, I show you land,” he said.

“Sure, but don’t call me madam.”

“OK, madam,” he replied, and flip-flopped to his motorbike.

In just four decades, India will be the most populous nation on Earth. India’s middle class alone will be 983 million strong by 2015. And already, one half of India is under the age of 25. Now that is a powerful dynamic. And India’s demographics alone will be its greatest asset. This is a young and increasingly wealthy nation. Natesan will be selling a lot of houses.

“See that house, madam? Big cinema star living there,” Natesan explained as we stood on an empty plot of land under the afternoon sun. Many wealthy Indians and Indians abroad have bought land or built beachfront houses in this part of Chennai.

“Everyone got big, big pockets, madam, plenty money. Business being good.” Big pockets, indeed. India’s net income has doubled in the last 10 years. Everything is more affordable. In fact, India is the second largest mobile phone market on Earth. It is also home to the world’s second largest two-wheeler market.

“Past years, clearing title not important, madam. But now we are being very careful. Lot of foreigners coming to live here.” Natesan explained as we walked a sandy pathway by the beach to another property.

In recent years, Natesan’s trade has changed. Unclear titles, poor building standards and ridiculous tenancy laws have historically plagued Indian real estate. That is why foreign investors have stayed away. Today, Natesan maintains better records and goes to great lengths to ensure that the title on a property is clear. The government is even considering computerization of land records.

Foreign direct investment is now allowed in real estate. And the sector is truly coming of age - financial institutions have filed for permission to introduce $1 billion worth of real estate mutual funds in India.

Does all this activity mean the Indian real estate market is in a bubble? Scarred by the devastating collapse of the dot-com era, we in the United States like to cry bubble at any asset that’s appreciating in value.

But there is a difference between a bubble and a robust market. Let’s compare India with the United States. Are Indians consuming more house than they can afford? No. In India, the ratio of the total value of mortgages to the GDP is only 2%, whereas it is 52% in the United States. That means in the United States, for every $100 we produce, we owe $52 as mortgage. Indians, however, owe just $2.

Has Indian home buying sent prices through the roof? Hardly. Over the last 10 years, real estate prices have almost remained the same in India, with the exception of a few large cities like Bombay and Bangalore. Median real estate prices in the United States, however, have risen nearly 15% in the last 12 months alone.

Are Indians taking out mortgages simply because rates are low? Interest rates are a healthy 4.3%, an 18% decrease from 2001. In the United States, interest rates were slashed a whopping 83% since 2001. Indians are using higher incomes (far more than lower rates) to buy homes.

The Indian housing market, unlike the United States’, is not thriving on an artificially propped-up fiscal structure. Growth in the housing sector has been mainly income driven and only partially interest-rate driven. Indian net income has increased nearly 100% over the last 10 years.

As Marc Faber puts it, “The most overlooked asset class is Indian real estate, because it is so difficult to develop, given the regulatory environment. The world still has lots of opportunities, and real estate in some unusual areas is an attractive proposition.” India is now trying hard to ease its regulations and encourage foreign direct investment.

And the investment is coming. Driven by the information technology and outsourcing booms, more and more foreign companies are setting up shop in India. Five million square feet of retail space is being developed. And over $25 billion will be spent on urban housing.

At the end of our meeting, I told Natesan I would keep in touch. He dusted the sand off his feet and perched on his motorbike. “This is better than America, madam,” he yelled as he drove off.

Sala Kannan

P.S. Real estate is not the only overlooked asset class in India. I have found at least three other undiscovered and under researched investments in India. And these aren’t the overvalued outsourcing and IT plays everyone is chasing after. I am working on a special report right now. Watch this space for more India insights...

From India and a graduate of the University of Cambridge, Sala Kannan boasts connections with economists and industry insiders worldwide. An expert on global economic trends, she's especially well versed in developing nations, such as India, Brazil, Argentina and China.

Courtesy of The Daily Reckoning

A Fool And His Money

Courtesy The Daily Reckoning: The similarities between a certain card game and investing are undeniable - especially when you look at the players on both sides of the comparison.

by Justice Litle

“Paradoxically, perfect market efficiency leads to markets becoming inefficient.” - Lee Thomas III, Pimco global bond strategist

“It’s immoral to let a sucker keep his money.” - Canada Bill Jones, 19th century poker player

Investing has many similarities to poker. For example: A small minority of professionals take the lion’s share of profits. The house takes its cut from all comers with ironclad regularity. Odds allow for confidence, but never certainty - there is no hand that can’t be beaten, no hand that cannot win. Both games are heavily influenced by luck in the short run, yet dominated by skill and consistency in the long run. And success is rarely the result of any one large decision; it is rather the result of countless small decisions, built into an accumulated edge over time.

The typical poker player reverts to the style he or she is most comfortable with in live play. This lack of variation gives the professional an edge, highlighting the best way to take the amateur’s money. Poker predators usually assign one of three classifications to their prey: Maniac, Rock, or Calling Station. Of these three, the Calling Station is prized as the most reliable source of funds. The Maniac is dangerously aggressive, and often too hot; the Rock is notoriously tight-fisted, and usually too cold; but the lukewarm Calling Station is just right.

A passive aggressive type, the Calling Station has no grasp of strategy, yet feels compelled to participate. He or she is happy to call the majority of bets, rarely raising or taking control of the hand. Analysis is minimal, actions robotic. The Calling Station’s attitude can be summed up as, “I don’t really know what I’m doing, but I’m just glad to be here.” A streak of good cards will occasionally reward this hapless style of play, but odds inevitably prevail over time. The Calling Station thus provides a steady stream of revenue for those who understand the importance of strategy and put it to use.

On Wall Street, the investing equivalent of the Calling Station is the Passive Indexer - the individual who seeks to unthinkingly mimic the performance of the Dow Jones or the S&P 500. Like his poker equivalent, the Passive Indexer is either unaware that strategy exists or unconvinced of its necessity - just happy to be a part of the action, hoping that luck or providence will provide a decent retirement. (Of course, the Passive Indexer is frequently encouraged to believe that providence is all he needs. This is rather like wolves encouraging sheep to believe the forest is safe.)

By contrasting the modest returns of passive indexing with the subpar returns of mutual funds, index touts pull off a neat trick: they make the bad look good by comparing it to worse. Adding insult to injury, many large mutual funds are actually “closet” indexers, charging for active management yet hugging the benchmarks anyway. This is like starting at the bottom and digging a hole.

In essence, passive indexing is the equivalent of a dog chasing its own tail. Selected companies grow larger as sums of indexed money robotically swell their market caps. As valuations rise, the indexers are encouraged by the boost. The process repeats in round robin fashion, with little thought for the objective worth of the companies receiving these blind inflows. Few question this puzzling lack of logic, thanks to a triumph of circular reasoning: the Efficient Market Hypothesis assumes that all valuations are intrinsically self-justified. This academic diktat reinforces the torrent of not just dumb, but brain-dead money. Most of us know the crucial economic benefit of a stock exchange is rational and efficient capital allocation, but we forget that rationality presupposes intelligent thought. As passive indexing gains in popularity, the principle of rational capital allocation is turned on its head and thrown out the window.

Those who defend passive indexing invariably point to stocks’ historical uptrend. But like the Calling Station on a temporary winning streak, indexers overlook the cyclical tendencies of the market, putting too much emphasis on an extraordinary run of good cards.

The market actually spends more time going nowhere than going up, with the typical bear cycle measured in decades. Whether things work out in the long run is a moot point for those with retirement needs close at hand. As Lord Keynes famously noted, in the long run we are all dead.

Alternative asset managers - who pursue absolute returns rather than relative ones - are required to post the prominent disclaimer “PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS,” or some variation of such, on their investment materials. Ironically, the Passive Index claque relies on just such an outlawed guarantee to make their case. They want you to believe that buy and hold is safe as milk. (In the current real estate climate, “safe as houses” has lost all meaning.) Worse still, the indexers lean on history for support without actually consulting it. By ignoring the ramifications of market cycles, massaged data like the Ibbotson study (the most famous bit of agitprop supporting “stocks for the long run”) proves fundamentally dishonest. A more rational assessment, assisted by the chart above, would go something like this:

If historical market patterns offer guidance, we are probably heading into a period of sideways to down markets that could easily be ten years or more in duration - hardly the time to be passive.

On the other hand, if historical patterns do not offer guidance - that is to say, if “this time it’s different” and/or past performance does not guarantee future results - then the case for passive indexing no longer exists.

Is there ever a time to seek general exposure to stocks? Certainly. When valuations are low, pessimism is high, and interest rates and inflation have hit cyclical peaks, it’s probably a good time to be a broad market bull. In the stagflated seventies, the PE Ratio for the S&P 500 flirted with single digits, inflation ran rampant, and a determined fed chairman took interest rates to sky-high levels. Volcker’s victory over inflation, and the long march towards price stability that followed, set the stage for the great bull of 1982-2000.

Here in 2005, we are at the opposite end of the spectrum. Price stability is crumbling. The twin specters of inflation and deflation lurk. Government expenditures are skyrocketing. The reckless expansion of credit has been unprecedented. Liquidity-driven stock valuations cling to stubbornly inflated levels. All these excesses need to be worked off before general conditions can be considered truly bullish once again. A long-term sideways to down cycle is required.

But the news is not all bad. There will be plenty of opportunity afoot, even with the broad markets going nowhere. Savvy investors made good money in the thirties and the seventies, and they will have similar opportunities in the coming cycle. Some sectors will shine even as others languish. There will always be a handful of companies making money hand over fist. Volatility will provide ample trading opportunities on the short and long side alike. It will be a stock picker’s market, and very much a trader’s market... but not a passive indexer’s one.

Justice Litle

P.S. I do know of one asset that will never be affected by stock prices, bond prices or currency fluctuations - and it’s available to a small percentage of savvy investors at a 98% discount. There is really no way to lose with this - when there is a surge in natural resources - you will already be positioned to profit. When there is a bull market in the small-cap market - you will already be invested. Want to know more? See here:

Save Up to 98% - No Matter What the Market Doe

Castles in the Air

Courtesy The Daily Reckoning: Two separate news events late in August tell you all you need to know about the course of the low-intensity economic battle between the United States and China: China is winning. Dan Denning explains...

by Dan Denning

First, the Chinese have not given up their determined pursuit of scarce energy assets. Chinese National Petroleum Corp. - China's biggest oil producer - succeeded in its $4.2 billion bid to buy Petro Kazakhstan. Petro Kazakhstan is a Canadian company, but most of its 150,000 barrels of production per day come from Kazakhstan, which is considerably closer to China than Canada.

This is simply Round 2 of China securing energy reserves closer to its borders. The CNOOC bid for Unocal was first, and failed. But the Chinese strategy hasn’t changed. The second, successful, bid is more evidence that the bull market in resources is being driven as much by national strategy as it is by economic scarcity.

And in winning the bid, the Chinese beat out their Indian rivals on the subcontinent. It’s bad news for India, because China has an additional $700 billion in currency reserves with which to conduct its global campaign for resource security.

While the Chinese patiently execute their strategy for economic competition with the United States, I’d be remiss if I didn’t note the joint military exercises conducted by China and Russia in August, dubbed “Peace Mission 2005.” Over 11,000 Russian and Chinese forces coordinated a mock invasion of a restive country. The exercises took place on eastern China’s Shandong Peninsula, which is well north of Taiwan.

But make no mistake about the several messages being sent by both China and Russia. First and foremost is always Taiwan. A recent report published in the China Daily newspaper quoted a government report concerning the social instability sparked by a growing gap between rich, urban coastal dwellers and poor, rural farmers, who have not benefited from China’s sudden prosperity. “China's growing income gap is likely to trigger instability after 2010 if the government finds no effective solutions to end the disparity,” the article concluded.

This is the kind of instability that puts pressure on a government. Faced with domestic pressure, most governments create a straw-man foreign enemy — in this case, Taiwan. One way of viewing the exercises with Russia is as a reminder that the communists in Beijing are willing to turn any domestic instability into an excuse to attack Taiwan.

However, I’m sure the Chinese would prefer not to attack Taiwan militarily, at least not yet. And the Chinese would prefer to put diplomatic and economic pressure on the United States, not spark a military conflict. Enter the Shanghai Cooperation Organization, a group that includes Iran, India, Russia, Pakistan, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan.

These countries were invited to watch the exercises. And in the future, this is just one of the ostensibly diplomatic groups China will employ to exert subtle pressure on the United States. China recognizes it is in a long-term, nonmilitary conflict with the United States for scarce economic resources. China has gone about securing resources through careful alliances and agreements. Of course, China also does a great deal of business with U.S. consumers. But in the long term, China sees the United States, and perhaps rightly so, as its chief global economic rival. All of the actions of the Chinese government indicate this is the case, and that the government will do all it can to win this low-intensity economic war.

While China takes the reality of peak oil production seriously, the second important news item from August shows that Americans are still behaving as if it were possible to get rich buying houses from one another. However, the news on the housing front was mixed.

On the downside, sales of existing homes fell off the record pace in June by 2.6%. That said, 2005 sales of existing homes are still on track to eclipse 7 million. Yet the median price of an existing home is now over $218,000, and it went up in July. Could it be that rising prices are starting to price out certain new buyers from the existing home market? It could be.

Even the upside isn’t so up. July new home sales jumped 6.5%, to a 1.41 million pace for the year. That was the good news. The bad news is that the median price for new homes fell 4% for the month. A study by National City Corp. showed housing prices in at least 53 American cities were “extremely overvalued.” But let me just give you some insight from here on the ground in Superior, Colo.

I’m staying with my older brother and his wife before I leave for Australia in November. They live at the end of a cul-de-sac in a relatively new neighborhood that’s grown up near the enormous FlatIron Crossing shopping center outside Denver. It’s nearly a perfect example of the consumption economy at work. People buy expensive houses with low interest rates, cash out some equity, and head to the mall.

The only problem is house prices aren’t inevitably going up. A flier from a local real estate agent showed the list and final sale prices for a dozen new homes in the areas. Only two of the 12 homes sold for the original list price. The “Cabernet” and “Chardonnay” models seemed to fare the worst. One “Chardonnay” model, a four-bedroom, four-bathroom, 3,100-square-foot monster, originally listed at $525,000. Its final sale price was $397,500.

If you’re doing the math at home, that’s a hefty 24% discount to the list price. Still, nearly $400,000 for a home isn’t exactly cheap. Yet this is further evidence that the frothy mentality that has sent home prices to the boiling point may finally be cooling off.

Will it just cool off, or will it pop, with all the gory consequences to the stock market and the economy I’ve predicted? Well, the economy is a lot more dependant on the housing sector - for employment and retail sales - than many people realize. That doesn’t even include what might happen to regional banks that own a hefty slice of mortgage debt should home prices fall radically. Yet as I showed, all that has to happen is for home prices to grow less fast for retail sales to grind to a halt.

This is what happens when you gear an entire economy to wealth accumulation through rising stock and house prices. Of course, those are assets everyone should own in order to get or preserve wealth. But only when you can buy them at a good price.

In a low-interest rate-driven economy, rampant speculation, not patient wealth building, becomes the name of the game. As easy as the money came with low rates, I fear it will go away just as easily with high rates. All of which means that owning the right stocks - companies with durable competitive advantages and pricing power and good management - is more important than ever.

Dan Denning

P.S. What's the one thing absolutely set to go up when the U.S. stock market...the economy...real estate...the dollar...and even the U.S. job market all come crashing down? In a word...it's volatility. When markets go haywire, there's a lot of it. And that's the fact that could make a lot of investors very rich. Be one of those smart investors...read my new report:

The One Thing Certain to Go Up

Is Copper Popping Its Top?

The Daily Reckoning: There is no such thing as knowledge in investing - the best we can hope for is a preponderance of evidence, and as Carl Waynberg shows us, theories are constructed to be destroyed...

by Carl Waynberg

A few months ago at our monthly editorial confab, I had the gall, the stones to disagree with the resident metal heads about the direction of copper. They were long-term bullish every one, so, natch, I was bearish. My argument was pooh-poohed with several dismissive waves, which I interpreted as middle fingers sandwiched between superfluous digits - and why not? After all, what the hell do I know? My “expertise” is small-, micro-, and nano-cap equities, not commodities!

But that’s precisely the point: To paraphrase Socrates, I know one thing, and that is that I know nothing. Even with my so-called area of “expertise,” I always rely on research to guide my opinion, not opinion to guide my research. And when my small-cap research takes me, as it often does, into unfamiliar territory, that scientific approach - the idea that there is no such thing as knowledge in investing, that the best we can hope for is a preponderance of evidence, that theories are constructed to be destroyed, etc. - is imperative.

A couple days after that meeting, I sent my argument - an excerpt from an earlier GRIP missive - to Agora Financial’s metal heads, where it landed with a dull ping. True, as is always the case, my bearish inclination toward copper - indeed most base metals (except for nickel and zinc) - was primarily a function of disdain for the consensus opinion. Momentum strategies work short-term, but over the long-term, investors are much better served by taking the road less traveled, which would not describe the present commodities environment.

My earlier opinion vis à vis copper, based on evidence not emotion and excerpted below, holds true months later:

“Three years ago, metal bulls were an extinct species and rock-bottom base metal prices and threats of a global recession presented little enticement to miners to develop new properties. Three years ago, the characterization ‘metal bull’ was an oxymoron, an anachronism fit only for fuddy-duddies.

“Today, the label is a badge of honor. Today, with global demand percolating and metals prices setting new highs, metals bulls roam the ranges of Wall Street freely, graceful bulls in China’s shop of demand. From the New York Mercantile Exchange to the London Metal Exchange (LME) to the Shanghai Futures Exchange, metal bulls are so prevalent, many investors - common institutional investors like pension funds and other late-to-the-party investors - risk stepping in it in a big way.

“Last year, it was metals bears that were in hibernation. Goosed by global growth, demand for metals, especially on the part of China, was so great and stocks so depressed that metal bears did well to remain scarce. Prices could only go up, it was thought, and go up they did. Copper rose 37% last year, aluminum 21%. Lead, tin, and zinc also managed double-digit price advances. Nickel was the only metal to post a decline for ’04, but its average price during the year was nonetheless 44% above its 2003 levels.

“Because it takes many years to develop a new mining property, the lack of exploration and development that was the norm three years ago is, even today, reflected in inventory levels, which, for most metals, remain near 15-year lows. So long as supplies remain low and demand remains high, today’s bullish metals prices can be sustained.

“There is some evidence, however - slowing global growth and, consequently, demand for base metals and increased production on the part of miners thanks to seductively higher prices - to suggest most base metals have peaked.

“In the case of copper - last year’s base metals market star and the metal that tends to lead the way for the others - there is also the threat from high oil prices. Both China and the United States are net energy importers. With crude oil at record price levels, consumers in both countries will be forced to curb their spending on high-ticket items, like automobiles and washing machines, which use copper wiring, further dampening demand.

“In addition, you have promises from copper producers - Phelps Dodge, Freeport-McMoRan, BHP Billiton, Codelco and others - to increase production. No surprise, then, that the International Copper Study Group raised its projections for copper production by 3.2% to 17 million tonnes over the next three years. The increase in output and concomitant decrease in demand will eventually close the copper deficit. Over the long-term the price of copper is unsustainable, as the copper market moves from what has been a tight supply over the past few years to a surplus in 2006.”

Since I wrote this, the price of copper has added roughly 20 points, but warehouse levels have risen by three-fold as demand has fallen 2.1% year-over-year, while copper production has increased 5.1%. My suggestion at that June meeting that the confluence of higher energy prices, slowing demand, and increased production would result in a copper surplus was met with derision, but just a few months later, copper market analysts are no longer asking if there will be a surplus but how much that surplus will be.

According to an article published in Tuesday’s Platts, Peter Hollands, an analyst at Bloomsbury Minerals Economics, said “China was actively exporting and de-stocking, and the stocks of the Chinese traders who were in difficulty had also been released into the market,” resulting in unexpected additional availability of 10,000-15,000 metric tonnes. Mr. Hollands, a relative copper bull, who does not see an economic slowdown to the extent that others do and who predicts a paltry year-end surplus of roughly 10,000 metric tonnes (though he admits a surplus of any size would impact copper’s price negatively), admitted: “There is a worry that the market could be tipping toward a surplus, and I am aware of downside price risk.”

One UK-based analyst, who was not named in the article, took the middle road between two surplus predictions, pegging the shortfall at 100,000 metric tonnes for the second half of the year and twice that for 2006. “The analyst said the physical market was very dull and some cathode consumers had reported 30% decreases in demand for some of their products, while others reported drops of 10-15% in demand,” the article said.

ABN Amro’s Nick Moore cited a recent International Copper Study Group, which indicated that while demand from China, India, and the Russian Federation remained high, seven of the world’s top copper consumers experienced slowing demand in the first half of the year. In light of China’s active exportation and de-stocking, Mr. Moore’s question as to how much copper China is really consuming, as opposed to simply storing away, seems like an answer disguised as a question. Mr. Moore told Platts that many copper analysts were predicting a surplus as high as 1.5 million tonnes for 2006-2008 - the high end of surplus estimates.

Mr. Moore characterized the “price for the pleasure of buying copper” as “‘dislocated’ from the reality of copper supply and demand’” and the copper market as “lethargic.”

Even Australia’s Macquarie Bank, a copper bull, sees copper moving into a surplus next year, though it won’t admit that the size of the surplus is enough to justify the bearish stance embraced by many market analysts recently.

It’s worth noting that even the smallest surplus prediction would represent a considerable change in copper levels from the first half, which saw a deficit of 219,000 metric tonnes.

Of course, the bigger message in all this is that we as investors always do well to at least question conventional wisdom - if not dismiss it entirely - because conventional wisdom is almost always wrong. That’s something you can bank on - at least until it becomes conventional wisdom.

Carl Waynberg

Courtesy The Daily Reckoning

New Orleans: Greed and Obfuscation in America's Atlantis

by Jim Amrhein

The City That "Fair" Forgot

ONCE AGAIN, September finds our nation sifting through the rubble, death, and carnage of a great catastrophe. A mighty hurricane has drowned New Orleans in what will surely prove to be the nation's most devastating disaster, perhaps not in loss of life (that title belongs to the San Francisco earthquake of 1906), but most certainly in dollars, number of displaced people, loss of property, and national economic paralysis.

Before I weigh in with my thoughts on the matter, I want to say this: Like my fellow Whiskey columnist Mr. Shedlock, I also send my condolences and sympathy out to any whose lives have been directly touched by Hurricane Katrina. Even though I'm not one of those unfortunate souls myself, I am nevertheless deeply saddened on many levels by this cataclysm. And not to diminish the loss of life or property, but it seems like more than just a city has been washed away by this storm….

Among these things are journalistic objectivity, all known (remaining, I should say) standards of political restraint, and one of the great traits that has heretofore been a hallmark of the American spirit: our unity and solidarity in time of crisis.

Instant Obfuscation -- Just Add Water!

Like I've said in this forum before about other subjects, I'm not an expert at much of anything -- just a regular guy who calls 'em like he sees 'em. And the way I see it (the way a lot of others seem to be seeing it, too), the federal response to Katrina has left a lot to be desired, especially in the early stages. But to be clear before I get started: I'm not arguing that point, nor would anyone who's attempting to be even remotely objective.

However, there's something else I see, too: That it seems like all the mainstream media are looking to blame the current presidential administration for every aspect of this catastrophe, from insufficient preparedness, to slow and inadequate relief, to the lack of law and order -- even the hurricane itself. Yes, some pundits (including lawyer/enviro-activist Bobby Kennedy Jr.) are actually pointing to the White House as the REASON for the disaster, citing global warming "caused" by the United States not signing onto the corrupt Kyoto Protocol being the genesis of Katrina….

Now don't get me wrong: I'm not defending the Bush environmental policy. I'm just pointing out the ludicrousness of that assertion. We could argue until the next Ice Age about what constitutes appropriate measures to limit CO2 emissions, but I'd hope that no matter WHAT your views are, you couldn't possibly be so extreme or naive to believe that short of an all-out nuclear war, our nation (or the entire human race, for that matter) could alter the Earth's climate drastically -- or even measurably -- within the span of any U.S. president's term. It simply can't happen.



Beyond this, a lot of news sources have been trumpeting the assertion that the Bush administration is also responsible for the New Orleans levees being subpar because of funding earmarked for their improvement being diverted (no wordplay intended) to the war in Iraq. And according to recent articles in The Washington Post and other sources, the Bush administration's budget did indeed fall well short of what state and federal officials requested -- and what ongoing levee-bolstering programs the U.S. Army Corps of Engineers called for….

However, what you WON'T find front and center in the article -- or in any one of the multitude of others I've seen on the subject -- is the fact that even if these entities had gotten the full amount of requested funding, their plans wouldn't have been anywhere near complete by the time Katrina loosed her wrath. Nor would the levee program they designed have saved New Orleans even if it had been complete. At a full-blown Category 4, the storm was stronger than what even the government's most ambitious levee proposal in history had anticipated.

So if anything, the administration's reduction in funding for levees that would've been overrun anyway actually saved tens of millions of dollars -- and on a project that wouldn't have saved a single life, building, or political reputation.

Hearing that anywhere in the headlines?

Sound Byte Booby-Trap "Diverts" From Historic News

As if any further evidence is needed pointing to a rather extreme bias in the media's disaster coverage, I offer this: Remember reading the huge headlines over the last few days about how President Bush "accepted responsibility" for the lackluster federal response to Katrina?

Now, how many of you know that the root of this story that's all over the media was Bush's brief answer to an off-topic question an Associated Press reporter asked at a White House press conference -- a gathering in which newly elected Iraqi President Jalal Talabani spoke at length and in encouraging terms about the future of his nation?

That's right: The press were gathered ostensibly to report on and ask questions about a historic meeting between the presidents of the world's most prominent and fledgling democracies -- and the first question out of the gate was something very close to this: "Shouldn't the United States, in the aftermath of Katrina, be worried about our ability to respond to natural disasters or terrorist attacks?"

Not: "What's in store for the future of Iraq?" Or: "Does an Iraqi democracy mean the region's Shiites and Kurds need no longer fear oppression?" Nor even something as pointed as: "How long until the United States is out of Iraq for good?"

No, question No. 1 was about a natural disaster, and it was aimed not at informing or reporting the solutions to that disaster, but at assigning blame for it. Plus, we got a 500-word story picked up by most every major news service about the president's three-sentence response -- the headline was a real beaut, too: Bush Takes Responsibility for Blunders.

Nowhere in the AP story did it mention the HUGE NEWS that new Iraqi President Talabani characterized the liberation of Iraq as the "right decision," stated that the new Iraqi Constitution is among the best ever written, and implored all the journalists in the room to come see with open eyes and minds all the good things that are happening in that formerly oppressed nation. Other than on a lone NPR broadcast of highlights from the actual conference, I didn't read or hear any of this anywhere….

So do you think the mainstream press is milking the Katrina story to advance its own political aims -- and to overshadow encouraging news about the war they so vehemently oppose? You be the judge. But from where I'm sitting, it's obvious that Big Media have a big agenda (the Katrina story is just the latest evidence of it): to undermine the current presidential administration and to paint the Iraq war in as unfavorable a light as possible.

Now don't misunderstand me. I'm not saying that I agree or disagree with the Iraq war, or that I even support President Bush. That's not the point of this piece. I'm only saying that we're not hearing in the major news sources an anywhere-near-balanced or complete reporting of anything that involves this administration. That includes Katrina, Iraq, Rovegate, you name it. There have been major omissions and factual errors in almost all of it.

Think about it: If the media are so biased and deluded as to ignore the monumental history that's being revealed at a press conference right in front of them in order to garner a 10-second sound bite that can be spun into a confession of responsibility for a NATURAL DISASTER, what makes anyone think what they're telling us about the disaster itself is the gospel?

Forcing "Black and White" Angle Gives Black Eye to Credibility

Here's yet another example: To hear many in the mainstream media tell it, the Bush administration was intentionally slow in organizing relief because the victims were poor and black! This is a ridiculous assertion on so many levels as to be laughable -- chief among them the fact that no presidential administration would ever be so stupid as to risk the appearance of being racist. Yes, the administration was slow to react to Katrina in some key ways, but race played no part in the reasons for that, I'm certain.

But do we hear a balanced attack in the news? Are any in the major media hypothesizing that the overwhelmingly Democratic leadership of the state of Louisiana intentionally sacrificed those poor, black victims by holding up their requests for federal disaster aid just to make the Republican administration look bad?

For the record, I don't actually believe this -- but it's no more absurd a notion than the idea that Bush dragged his feet because the victims weren't his own color!

It brings up another good point, too: States have to formally request federal disaster aid before they can receive most types of it. If what I've heard is correct, short of an invasion or armed revolt (an argument could be made that the Big Easy's seemingly overnight transition to a semi-anarchic state would have qualified), the president can't just send in the Army or National Guard like the mainstream talking heads would have us believe. Apparently, it's a bit more complicated than that….

Of course, this fact is hardly making headlines, either.

Lastly on this point, I don't remember all this hubbub about insufficient federal aid last year when Florida was slammed four times in rapid succession by storms. Hell, if there had been a federal relief effort back then of the scope the mainstream's clamoring for now, it would have been called nepotism, or favoritism to a red state! So why such a blame frenzy now? Could it be because the left-leaning media -- not to mention many politicians on both sides of the fence -- have found a way to capitalize on catastrophe to serve their own ends?

For me, the bottom line is this (not that I'm the first to have said this -- I'm definitely not): It isn't the media's job to shape public opinion, only to report the FACTS that shape it. Instead of serving as the watchdog "fourth branch of government" that keeps our rights intact and the government from becoming hopelessly corrupt, the mainstream media has assumed the role of policy maker and agenda driver. Under the guise of information, it has become a political entity of its own.

What they don't realize is that they're shooting themselves in the foot: Their obvious bias makes it more likely that involved, thinking people like you and me will grant the current administration greater quarter or benefit-of-the-doubt than perhaps they deserve. After all, since we aren't getting all the facts straight up, we're left certain of only one thing: that much of the mainstream media is full of BS!

Of course, anyone with two eyes and half a brain has already concluded this long ago. The coverage of Hurricane Katrina is just the latest and most egregious example. And thankfully, the American public is starting to see this en masse. Newspaper circulations are way down almost across the board, as are subscriptions to the bigger news weeklies. The Big Three networks are seeing their clout eroded by relative newcomers FOX, CNN, and others (not that they're the paragons of objectivity, either). The Internet is helping, too. People are starting to realize that there are more sources of information out there than there have been in the past.

And that's a good thing.

Greed Begets Need

Enough about the media. Back to New Orleans, which has for years been nicknamed "the city that care forgot," owing to its mix of both opulent glamour and extreme decadence. How morbidly appropriate a moniker now, given the systemic failure at all levels to deal with Katrina's wrath. The most obvious question, of course, is this: Why wasn't New Orleans better prepared for the disaster everyone knew was coming someday?

As surely as those in San Francisco know that one day the Big Rumble will hit (they've taken extensive steps to both prepare for it and minimize its potential for damage, by the way) and as surely as Florida's coast and the Outer Banks of North Carolina know how to brace for a hurricane, no one except the most clueless tourist could possibly have been unaware of the potential for massive, catastrophic flooding in New Orleans -- a city that's BELOW SEA LEVEL and surrounded on all sides by three bodies of water, including one of the largest rivers on Earth.

True to its reputation, New Orleans was clearly gambling on its very existence.

And although the extent of the federal government's lack of decisive action after the flooding is almost universally agreed upon (and might one day be cataloged by an independent investigation), this will change no aspect of the fact the New Orleans itself was utterly unprepared. It simply forgot to care.

Of course, the politicians in that district didn't forget to care about bringing a $400 million Harrah's casino to town in the late 1990s. Nor did they forget to construct the state-of-the-art Aquarium of the Americas on the waterfront. And they definitely didn't forget to build the Superdome, one of the largest indoor event venues in the world, right in the downtown area….

What they DID forget to do was such unsexy, nonheadline-grabbing things as bolster levees; improve highways and escape routes; and stock up on medicine and disaster-related supplies, buses and boats. They also clearly forgot to MAKE A DECENT PLAN. Like Florida, the Outer Banks, the Chesapeake Bay region, towns along Tornado Alley, cities on the San Andreas Fault, or those located in blizzard zones, the Big Easy -- more than any of these others, perhaps, should have had better plans in place and had them drilled into both residents and emergency personnel until it was automatic.

That would have been the difference between a lawless, desperate city without hope and a city whose resourceful people were prepared to improvise, adapt, overcome, and look after their neighbors in a time of crisis they all knew was coming. No amount of federal disaster aid can change the fact that New Orleans' longtime leadership sold their own people down the river -- literally -- in favor of big-money projects designed to promote tourism, sports revenue, casino gaming, the Mardi Gras experience, and just about anything else that could put money into the city's coffers. Pure greed.



Now all the money's gone, and they need someone to blame. They gambled and lost.

An American Atlantis?

Right now, instead of finger-pointing, we as a nation should be banding together. Oddly, it seems like we're choosing sides instead of taking action. Some cities are turning away "refugees" from New Orleans, while many Americans seem to be adopting a "not my problem" or "serves them right" stance. This feels un-American to me, and is in stark contrast to the post-Sept. 11 unity that marked the terrorist attacks in 2001. No doubt this is a response to our own politicians and media engaging in a massive "blame game," instead of rallying toward coordinated solutions. I can hope that's what it is, anyway….

And unlike a lot of others I've been reading (who suggest we just let the Big Easy die), I feel that it's absolutely vital to rebuild New Orleans -- and to do it RIGHT this time.

Why? Because in my opinion, no other city in the United States is as distinctly American as New Orleans. Nope, not even New York. The Big Easy is the quintessential melting pot. Since its origins, the city has been a tempestuous, yet strangely tolerant mix of French, Indian, Spanish, English, black, white, Christians, pagans, pirates, rich, poor, merchants, scholars, farmers, fishers, and every other kind of person imaginable since long before the Statue of Liberty ever stood or "melting pot" became our informal national brand.

Even the very tenuousness of the city's existence in the face of possible imminent natural catastrophe embodies the spirit of early America: a ragtag bunch of survivors of every stripe, building a rich and prosperous life even as they're beset on all sides by hostile forces -- and forced to improvise, adapt, and tolerate for their very existence.

Besides, no place has contributed more to our nation's culture -- our art, music, written word, and our very beliefs about tolerance and equality -- than this icon of the American South. And as much of a tragedy it is to lose it for a time to the mighty waters of the roiling Mississippi, it would seem even more of one to let New Orleans go forever, along with all that it signifies….

I say this: As we are rebuilding the Twin Towers site after Sept. 11, let us rebuild the "city that care forgot" in a way that's permanent and everlasting, so that future generations can live and visit there and learn its lessons…

And so that "laissez-les bon temps rouler!" may once again be heard in deadly delta.


Jim Amrhein

Contributing editor,
Whiskey & Gunpowder

Why Has Gold Been Soaring Recently?

by Mike "Mish" Shedlock

The short answer is the yield curve is starting to widen, Congress is going on another spending spree, the market thinks rate hikes are nearly done, and the Fed is likely to print more money for more government handouts. That combination is more important than a U.S. dollar that has somehow held together in the face of the above.

Let's take a look at the long version.

On Friday, Sept. 16, Reuters reported, "Bush Rules out Tax Hikes to Pay for Katrina":

"President George W. Bush, facing alarm from conservatives over the soaring cost of post-Katrina rebuilding, said on Friday the U.S. budget could handle the expense and he would not raise taxes to pay for it.

"'It's going to cost whatever it costs,' Bush said at a joint news conference with Russian President Vladimir Putin as estimates circulated in Washington the cost could hit $200 billion, exceeding the cost of the Iraq war.

"Responding to concerns among fiscally conservative Republicans, Bush said his administration would work with Congress to make sure the money was wisely spent and that he would look elsewhere in the budget to make offsetting cuts.

"'But I'm confident we can handle it, and I'm confident we can handle our other priorities. It's going to mean that we're going to have to cut unnecessary spending,' Bush said."

The president made clear raising taxes was not an option to help cover the costs:

"'We got to maintain economic growth, and therefore, we should not raise taxes,' Bush said, noting Americans were already paying 'a tax in essence' because of higher gas prices. 'And we don't need to be taking more money out of their pocket.'"

I do not know about you, but isn't "It's going to cost whatever it costs" just a little too nonchalant for something that might cost up to $200 billion? Given that we are still wasting money like mad in Iraq, I doubt it catches the waste over there; but then again, underestimating the stupidity of the government is seldom a wise thing to do.

As for, "It's going to mean that we're going to have to cut unnecessary spending," gee, don't we have a Republican Congress and a Republican president? Given that is the case, why is it we have "unnecessary spending" in the first place? Could that be because Bush has signed every appropriations bill ever sent to him? Where is this party of reduced government spending, smaller government proponents, etc.? Perhaps the simple explanation is that for all practical purposes, we do not have either a Republican Congress or a Republican president.

The only person being honest was White House economic adviser Allan Hubbard who offered this comment: "There's no question that the recovery will be paid for by the federal taxpayer and it will add to the deficit."

Perhaps President Bush should get together with Tom DeLay (R-Texas) when it comes to "unnecessary spending." After all, on Sept. 14, The Washington Times reports, "DeLay Declares 'Victory' in War on Budget Fat":

"House Majority Leader Tom DeLay said yesterday that Republicans have done so well in cutting spending that he declared an 'ongoing victory,' and said there is simply no fat left to cut in the federal budget.

"Mr. DeLay was defending Republicans' choice to borrow money and add to this year's expected $331 billion deficit to pay for Hurricane Katrina relief. Some Republicans have said Congress should make cuts in other areas, but Mr. DeLay said that doesn't seem possible."

At this point Mish has two questions:

1. Mr. President, is Tom DeLay off his ever-loving rocker, or are you?

2. Mr. DeLay, is President Bush off his ever-loving rocker, or are you?

Clearly one of you is clueless. Who is it?

Given that the budget deficit before Katrina was over $330 billion, and given that President Bush has yet to veto an appropriations bill (or any bill for that matter), I vote that both Bush and DeLay are clueless.

The Washington Times continues...

"'This is hardly a well-oiled machine,' said Rep. Jeff Flake, Arizona Republican. 'There's a lot of fat to trim.... I wonder if we've been serving in the same Congress.'

"American Conservative Union Chairman David A. Keene said federal spending already was 'spiraling out of control' before Katrina, and conservatives are 'increasingly losing faith in the president and the Republican leadership in Congress.'

"'Excluding military and homeland security, American taxpayers have witnessed the largest spending increase under any preceding president and Congress since the Great Depression,' he said."

Meanwhile, The Associated Press is reporting "Katrina Ushers in Return of Big Government":

"The era of big government is back. President Bush is presiding over what is sure to be the most expensive government relief and reconstruction operation in U.S. history.

"With estimates of the federal tab ranging up to $200 billion for rebuilding New Orleans and other storm-ravaged Gulf Coast cities, Bush and his Republican allies in Congress are casting aside budget discipline....

"Hurricane Katrina also opened the floodgates to proposals in Congress building on a host of long-cherished Republican themes. These include proposals for school vouchers for storm-displaced children, more federal support for 'faith-based' organizations engaged in hurricane relief, as well as business-friendly 'enterprise zone' tax credits for enterprises that rebuild in stricken areas, and eased environmental and labor-protection requirements....

"'The fact of the matter is when our nation faces these type of emergencies, it unfortunately requires us to deficit spend. It's nothing that anybody in Washington, or anywhere for that matter, likes to do, but it's necessary,' White House counselor Dan Bartlett said ahead of Bush's Thursday night speech to the nation.

"Some fiscal conservatives are expressing alarm.

"'It is inexcusable for the White House and Congress to not even make the effort to find at least some offsets to this new spending,' said Sen. Tom Coburn (R-Okla.). 'No one in America believes the federal government is operating at peak efficiency and can't tighten its belt.'

"Government failures at the federal, state, and local levels are being widely blamed for the anarchy and loss of life in the early days after Katrina slammed into the Gulf Coast on Aug. 29.

"'Yet now everybody says government is the answer. It's baffling,' said Ronald D. Utt, who studies federal public works spending for the conservative Heritage Foundation."

Mish apologizes for having more questions, but here they are:

1. Given that the era of big government is back, just when did it go away?

2. Why should "faith-based" organizations get any federal money?

3. Why does it take a disaster to tighten one's belt?

4. Why not tighten ahead of time, so money is there in case of a disaster?

5. Government has proven without a doubt that it is the problem, not the answer, so why is there clamoring for more government now?

The AP continues:

"Sen. Edward M. Kennedy (D-Mass.) proposed that Congress create a Gulf Coast Redevelopment Authority, modeled after the Tennessee Valley Authority, to oversee the reconstruction. TVA, created during the Depression as an independent federal agency, is widely credited with the revitalization of the seven-state Tennessee Valley region.

"Other lawmakers have called for a domestic version of the Marshall Plan that helped revive Europe after World War II, or something akin to President Franklin D. Roosevelt's Work Projects Administration, which put millions of unemployed people to work mainly on road, bridge, and dam projects during the Great Depression of the 1930s."

Obviously, there is nothing like a disaster to get idiots chirping on both sides of the aisle. These people want to help. At least I think they do. But barring an unexpected and extremely unlikely mass rush of congressional sanity, the best thing they can do is nothing.

On that note, we should all be praying that Congress does nothing, since Barron's is now asking, "Will Congress Bail out Gulf Coast Bondholders?":

"House Speaker Dennis Hastert, the Illinois Republican, says that Congress is seriously considering a federal bailout of municipal bondholders affected by the vicious storm. Many cities and authorities that were in the path of Katrina may be unable to meet interest payments come Oct. 1, because they can't collect the taxes needed to meet these obligations. The federal government is mulling some kind of guarantee, valid through the end of 2006, that would keep the issuers from defaulting....

"The bailout idea appears to have originated with the National Association of Bond Lawyers in its Sept. 7 letter to both the Department of the Treasury and the Internal Revenue Service (Re: Hurricane Katrina Relief and Rebuilding-Municipal Market Needs)....

"Bond lawyers quickly found allies in Louisiana Republican Rep. Jim McCrery [R-La.] and Mississippi Republican Sen. Trent Lott. McCrery says bondholders never anticipated Katrina and should get federal help.

"[Fixed-income expert David] Kotok has some problems with McCrery's logic. If Congress were to follow through, then it might create an implied federal guarantee for bonds issued by other high-risk communities, he says.

"The perception that Uncle Sam would protect bondholders from Mother Nature would distort the market's risk-reward pricing mechanisms. In effect, all bonds in communities along the San Andreas fault or in Tornado Alley would trade as if fully protected against natural catastrophes. This would pave the way for projects that otherwise wouldn't be built."

Nothing like a bunch of bond lawyers asking for a federal bailout because their clients underestimated the risks of a bunch of municipal bonds, is there? No doubt such a relief package will be stated to benefit Aunt Martha, who has just one muni in her portfolio, while the real beneficiary is some large bank holding thousands of those municipal bonds.

The worst problem is the moral hazard this would create for all municipal bonds. If the government is going to bail out every disaster and every bankruptcy, then bonds have no implied risk, and everyone will be jumping into them.

NO! The very best thing Congress can do on this issue is nothing. Don't get your hopes up. When it comes to spending and big government, this Congress and president have no bounds.

Of course, no story could be complete without the likely next Fed chairman chiming in with a bunch of nonsense. Let's take a look at what $Ben "Helicopter Drop" Bernanke has to say in this piece, entitled, "Katrina's Economic Hit Palpable":

"Hurricane Katrina will hurt the U.S. economy in the short run, but bright long-term prospects mean the Bush administration can push ahead with its reform agenda, a top White House economic adviser said on Thursday.

"'In the shorter term, the devastation wrought by Hurricane Katrina will have a palpable effect on the national economy,' White House economic adviser Ben Bernanke said in prepared remarks for delivery at the National Press Club. But he said private-sector forecasts were for healthy long-run growth.

"Bernanke said the White House intends to continue pursuing policies that make the economy able to withstand shocks and that will keep growth on track.

"'These policies include making tax relief permanent, reducing the budget deficit by limiting spending, strengthening retirement and health security through efforts like Social Security reform... and enhancing energy security,' Bernanke said."

Yep, nothing can stimulate gold more than cutting taxes while dramatically increasing spending. Those holding major positions in gold thank you, Mr. Bernanke, President Bush, and Congress, for a nice 1-2-3 punch.

If none of that has scared you into gold yet, perhaps this will. In a nationally televised address, President George W. Bush said, "As long as I sit in this chair, all future catastrophes will be planned by me."

Mike Shedlock / Mish

The Fed's Wild Imagination

The Federal Reserve and the 'global savings glut'

by Kurt Richebächer

In his testimony to Congress on July 20, 2005, Mr. Greenspan declared it quite likely that the world is currently experiencing a global savings glut. Agreeing with Ben Bernanke, he mentioned this glut as one of the factors behind the so-called interest conundrum, i.e., declining long-term rates despite rising short-term rates.

Having read a lot from the Fed’s luminaries, their inability to distinguish between rampant global credit excess and a global savings glut does not surprise us. In this view, the Federal Reserve has come to the rescue of a world where excessive saving is threatening depression by eliminating savings.

Attracted by superior rates of return on U.S. assets, investors around the world have been scrambling to pour their excessive savings into direct investments, stocks, bonds and real estate in the United States, in this way financing the resulting huge U.S. trade deficit.

While this explanation may seem to make sense, there is one big snag: Not one word of it is true. First of all, in reality, private foreign investors have drastically curbed their investments in the United States. According to the Bank for International Settlement - the international organization of the world’s central banks - Asian central banks financed 75% of the U.S. current account deficit in 2004.

First, private capital flows into the United States have slumped. Without the massive interventions by the Asian central banks, the dollar would have collapsed long ago.

Second, the dollars with which these central banks have been buying U.S. Treasury and agency bonds have definitely nothing to do with Asian savings. Evidently, the central banks are recycling the dollars, no more, no less, which they receive from U.S. trade and capital flows. These dollars have come into the central banks’ possession through their interventions in the currency markets, to prevent a rise of their currencies against the dollar.

To speak of a global savings glut as a possible cause of the surprisingly low U.S. long rates in the face of these blatant facts is truly the height of insolence and absurdity. That this opinion comes from the leading figures of the Federal Reserve is more than shocking.

True, Asian countries have very high savings rates. For China, it is reported to be as high as 45% of disposable income. But this does not necessarily imply an existing savings surplus be lent to America. The bulk of available savings in China domestically is locked up in an even higher domestic investment ratio.

Looking at the global financial system, a straightforward fact to see is that central banks have been amassing foreign exchange reserves at an accelerating pace since the early 1970s. Rising in several large waves, their main source is plainly the soaring U.S. trade deficits.

Having no use for dollars in general, the first dollar recipients in the surplus countries sell them to their banks against their own currencies. These banks, in turn, found ready dollar buyers in firms and investors around the world, wanting to acquire direct investments or other assets in the United States, at least until 2000. Since then, though, capital inflows on private accounts into the United States have drastically receded, while U.S. trade deficits have exploded. In order to prevent a rise of their currencies against the dollar, central banks had to step in as buyers of last resort.

Apparently, it is not widely realized that this big shift in dollar recycling from private accounts to central banks essentially has far-reaching monetary implications for the participating countries and even for the world economy and world financial markets. Buying dollars, the central banks credit the commercial banks in their country with interest-free deposits.

Now, the critical point to see is that the banks, on their part, regard these deposits as their liquid reserves to be used for profitable lending or investment. Inundated with liquid reserves by the dollar buying of their central bank, the commercial banks in these countries embark on faster credit expansion. Shifting the rising surplus of liquid reserves between them, they create credit for consumers, businesses and speculators many times the amount of the liquidity injection by the central banks.

Our focus in particular is on China. As in the United States, the resulting credit deluge is boosting components out of proportion to the whole economy. In China, however, the specific components are real estate and manufacturing investment, while in the United States, it is consumer-spending excess.

What the Asian central banks truly recycle is the U.S. credit excess. But in flooding their banking system through the dollar purchases with liquid reserves, they transplant the virus of credit excess to their own economies. For U.S. policymakers and economists, this is a reasonable and sustainable division of labor. The U.S. economy runs on wealth creation through asset inflation with a high rate of consumption, while China and Asia run on wealth creation through saving and investment with a high rate of investment.

We are fearful of this development, because it affects more or less all industrialized countries with high wage levels. In this way, overconsuming America is force-feeding the rapid mutation of China’s backward economy into a first-class manufacturing power. When China’s credit and investment boom started, in 2000-01, its central bank had foreign exchange reserves in the amount of $165.4 billion. Today, they exceed $700 billion.

We are wondering what is worse for the whole world, China’s further rapid manufacturing growth or a disastrous hard landing. Observing the same monetary and economic follies as in the late 1980s in Japan, we consider the second possibility highly probable.

A persistent, sharp slowdown in China’s imports strikes us as ominous. The general comforting explanation is inventory liquidation. But how to explain, then, the continuous oil and commodity boom? We suspect speculation far more than economic growth as the reason.

With all the talk about a savings glut, we feel obliged to make some remarks about the subject. First, please take another look at the Wicksell quote on the first page, stating, “The supply of real capital is limited by pure physical conditions, while the supply of money is in theory unlimited.” “Supply of real capital” is actually a synonym for available savings.

At an international conference in 1953 about savings in the modern economy, with many heavyweights in economics in attendance, the famous former chief economist of the Fed E.A. Goldenweiser gave a rare precise definition of saving. He said: “Saving means the withdrawal of sufficient resources from the production of consumption and services to have enough for maintenance, expansion and improvement of the plant.” Then, he complained, “that ever since Wesley Mitchell’s Business Cycles there has been a tendency to concentrate too much on the monetary expression of economic developments, and it has become reactionary to think in physical terms.”

From the macro perspective, “saving” provides the physical resources for the production of capital goods in that consumers abstain with part of their income from consumption. Of course, this also involves money flows, but saving’s decisive distinguishing feature is the partial abstention from current consumption to make real resources available for the production of capital goods.

It is ludicrous, therefore, when American economists claim that rising asset prices, increasing consumption, should by counted as saving. When we read decades ago that Mr. Greenspan, long before he became Fed chairman, had expressed precisely this view, he was once and for all finished for us as a serious economist.

The world economy seems to be flooded with liquidity. But there are two diametrically different kinds of liquidity: earned liquidity and borrowed liquidity. The former comes from surplus income or savings; the latter comes from credit and debt creation.

In a country with virtually zero savings like the United States, any liquidity essentially arises from debt creation. This is really fake liquidity depending on permanent, prodigious borrowing facilities, presently the housing bubble. Once this bubble evaporates or bursts, the U.S. economy loses its chief liquidity source - with disastrous effects on asset prices.

The crucial question concerning the U.S. economy is whether it is slowing or accelerating. As explained in detail, we see a lot of fudge in the recent economic data. Our main critical consideration is that a self-sustaining recovery would absolutely require a strong rebound in business investment. But that is not in sight. On the other hand, the turnaround in the housing bubble is only a question of time. A fairly short time, we think.

The consensus expects that the U.S. economy has the "soft spot" behind it and will surprise positively. We expect shocking economic weakness. All asset prices, depending on carry trade, are in danger, including bonds.


Dr. Kurt Richebächer

The Fed has remained irrationally confident in the U.S economy - because they can’t afford from American consumers to see the truth - that the basis for this confidence is a shamelessly fraudulent farce of trumped-up statistics. Fortunately, Dr. Richebächer isn't afraid to tell the truth. For all the facts, see his new special report:

Statistical Deceptions

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."

Ready to Run

Should we care that China has revalued its currency, the yuan, by approximately 2.1%?

by Justice Litle

"Global inflation, interest rates, bond yields, house prices, wages, profits and commodity prices are now being increasingly driven by decisions in China. This could be the most profound economic change in the world for at least half a century." - The Economist

"There is great disorder under heaven...the situation is excellent." - Mao Zedong

Is it the tip of the iceberg, or merely a tempest in a teacup? Should we be pleased and relieved by Beijing's move - as Washington so clearly seemed to be on hearing the news - or should we be worried, fearing what may come next?

Concern is warranted, but there is little point in worrying. The purpose of worry, after all, is to spur some sort of productive action. Global currency movements are complex, but the action to take in response to the yuan revaluation is simple: If you haven't done so already, buy gold. Not as a knee-jerk response to a single announcement, of course, but as a calculated and farsighted response to what is coming.

China's revaluation of the yuan is the equivalent of a hairline fracture in the Hoover Dam. On first glance it appears, to be nothing serious... and yet it is the beginning of something deadly serious. Over time, the hairline fracture will grow. A network of cracks will spread. And the dam itself will eventually burst. We don't know when the climax will occur, but we do know the endgame has begun.

But why worry, the perma-bulls say. After all, the consumer is getting along famously, the dollar is still the world's reserve currency and Asian exporters have no better place to stash their cash than Treasury bonds.

Before answering the perma-bulls directly, it's helpful to recall the natural human tendency of projecting trends out to infinity. For a combination of psychological and empirical reasons, it's the easy thing to do. Thus, real estate investors currently expect house prices to rise for the next decade - and by "decade," they really mean "as far into the future as we can imagine." Just as '90s investors expected dot-com stocks to rise ad infinitum, '80s investors had Japan, '70s investors had inflation, '60s investors had the Nifty Fifty, and so on. The pattern of extrapolation excess appears consistent, going as far back as market history records. Good or bad, if a trend dominates the period for long enough, it is eventually assumed to have no end. Whether the masses believe in infinite trends or not, they often act as if they do.

This is an odd thing, because market history so clearly teaches the opposite. With very few exceptions, even the longest trends tend to end, often abruptly. Bull and bear markets have life spans, just like people. As do empires.

In May of 1925, Chancellor of the Exchequer Winston Churchill made these closing remarks to Parliament: "If the English pound is not to be the standard everyone knows and can trust...the business not only of the British Empire but of Europe as well might have to be transacted in dollars instead of pound sterling. I think that would be a great misfortune."

Prophetic words. Why did the pound sterling give way to the dollar, and the British Empire to the United States? There are two ways to answer the question.

The first way is to look at 20th-century specifics. World War I devastated Europe and spurred a massive wealth transfer to the United States, with the same dynamics roughly repeated in World War II. Meanwhile, the United States drew strength from a massive influx of immigrants, the rise of industrialization on a grand scale and a powerful advantage in natural resources - with a brilliantly conceived political system and a unifying ideology to hold it all together.

The second way to consider Britain's fall and America's rise is within the sweeping context of history. Simply put, the sun was bound to set on the British Empire at some point, for reasons that were bound to come about. Change eventually dislodges incumbents; it was only a matter of time before the order of things shifted. In the same light, predicting an eventual sunset for United States hegemony is not necessarily pessimistic or controversial. The inevitability of change is an idea rooted in long-term historical observation, not moral pronouncement or value judgment.

For all the talk of China's rise, it is not a given that one superpower will simply be replaced by another, either. It may be that multiple countries come to share the 21st-century world stage, with none gaining a clear and permanent advantage. No one knows exactly how things will unfold. We can say with certainty, though, that the old order of things is passing. Globalization is remaking the world in ways that few expected - and in many ways, these changes are the results of success, not failure. The creation of 2 billion new capitalists (in China and India) is an incredibly positive development in the long run. But in the short run, massive change creates turmoil and upheaval - and the more it is resisted, the more chaos is created in the transition.

This is where the role of gold comes in. But first, a bit of history.

Joseph Schumpeter, of "creative destruction" fame, noted, "Economic progress, in capitalist society, means turmoil." Looking back at the economic and monetary history of the world, or even just the considerably shorter history of the United States, we can see that Schumpeter's observation is all too true. Historically, long periods of peaceful expansion have been the exception, and turmoil and upheaval more the rule.

Financial crises are far more common than many might expect, and the basic workings of international finance are far older than many might realize. The technology has changed, but it's the same old game - like toddlers learning to walk, countries and capital markets mature through a series of blunders, bruises and mistakes. For example: in the 19th century, the United States Treasury nearly went broke multiple times. The fledgling superpower was bailed out more than once by bad weather in Europe, allowing U.S. farmers to export their bumper crops in exchange for precious gold reserves.

The 1860s introduced the joys of fiat money, with inflation eroding the value of the greenback more than 60% by the Civil War's end. In 1890, an emerging market disaster unfolded in Argentina, threatening to bring down Barings Bank, cripple the Bank of England and bankrupt America for good measure (the Yanks pulled through, but it was a close call). The crisis had all the elements we are so familiar with today: speculative boom, hot money withdrawal, international bailout, global backlash. Ironically, the principal players involved - Barings Bank and Argentina - saw fit to revisit their crisis roles a century later (Barings brought down by Nick Leeson in 1995, Argentina by sovereign debt default in 2001). J.P. Morgan was the Alan Greenspan, George Soros and Robert Rubin of his day - probably with more influence than all three men rolled into one.

As for calculated currency movements and mercantilist foreign exchange policies, Europe had been playing the game for centuries by the time the 20th century rolled around. The difference today? Scores are kept with electronic blips on computer screens, rather than gold and silver reserves. And yet, just in case, the gold reserves remain.

In terms of monetary policy, the last century was a gigantic, ongoing experiment (which still continues today). Before and after World War I, belief in the gold standard reigned supreme. Peter Bernstein captures the mood in his excellent (though somewhat critical) book The Power of Gold:

"The international gold standard shimmers from the past like the memory of a lost paradise, embodying all the nostalgia of the Victorian and Edwardian eras - stability, harmony, respectability. The glow attached to this nostalgia is not based in myth but stems from vivid reality. From the end of the American Civil War to the outbreak of World War I - a brief period of only 50 years - the international gold standard acquired a mystique that radiated far beyond the simple discipline that it imposed on its members. The control of gold over the affairs of human beings has never been so absolute, nor the worship of gold by hardheaded financiers and statesmen so humble."

It was only with the onset of the Great Depression that the standard-bearers wavered as the ideas of John Maynard Keynes gained traction and persistent hoarding caused gold to lose its glitter. Keynes argued that the traditional gold standard policies of austerity and fiscal rigidity had only made the Depression worse. While political leaders preached of belt tightening and sacrifice for the sake of sound money, Keynes took the opposite tack, urging the government and the people to forget about gold and open their wallets. His "paradox of thrift" explained how actions that are rational for the individual can yet prove devastating to the economy: It is good for families to save rather than spend, but if all families cut back their spending at once, the economy is worse off:

"Suppose we were to stop spending our incomes altogether and were to save the lot. Why, everyone would be out of work... Therefore, oh patriotic housewives, sally out tomorrow into the streets and go to the wonderful sales which are everywhere advertised. You will do yourselves good - for never were things so cheap...And have the added joy that you are increasing employment..."

What government must do, Keynes further argued, was to act as a counterweight to the business cycle, spending money when times were hard and saving money when times were good. Spending money in hard times, of course, requires running persistent deficits, potentially substantial ones. Such an idea was considered sacrilege at the time.

More than 15,000 banks (!) failed in the four years following the '29 crash (with the Federal Reserve nowhere in sight). An environment like this naturally encouraged more hoarding of the yellow metal, with seemingly no safe place to put the last of one's money. Into the breech stepped the recently elected President Roosevelt. Public surrender of all gold and silver was required, in exchange for paper notes, as declared by the Emergency Banking Act of 1933. (It is hard, if not impossible, to imagine such a brazen act being pulled off today.) FDR then took the apostasy further by declaring the right to adjust the dollar/ gold ratio as he saw fit, prompting at least one fiscal observer to declare "the end of Western civilization."

But Western civilization kept plugging along, and after a managed creep upward, the price of gold was fixed at $35 per ounce in 1934. There it stayed for almost four decades, through the Second World War, the establishment of Bretton Woods, the challenge of De Gaulle and the rise of Keynesian policy. Indeed, around the time Nixon finally shut the gold window in 1971, he uttered frighteningly appropriate words: "We are all Keynesians now."

Justice Litle


Justice Litle is an editor of Outstanding Investments. He has worked with soybean farmers, cattle ranchers, energy consultants, currency hedgers, scrap metal dealers and everything in between, including multiple hedge funds. Mr. Litle also acted as head trader for a private equity partnership, and made contributions to Trend Following: How Great Traders Make Millions in Up or Down Markets, a popular trading book by Mike Covel (FT/Prentice Hall)

Justice Litle is also a member of an elite group that meets occasionally to debate and discuss the new trends in the financial world and investment ideas - among other things. This monthly gathering includes the cream of the crop of financial minds - and for a limited time, the Agora Financial Reserve is open to the public at a 98% discount. Get your invitation here: The Birth of an Elite Club

The Importance of Doing Nothing

The impulse to ‘do something’ to help the victims of Hurricane Katrina is so great among the masses in the United States, no one dares to stand against it – no matter what the cost. Bill Bonner explains why sometimes inactivity is the best way to deal with this type of situation…

By Bill Bonner

The nation’s newspapers and TV blabbermouths have been in full-throated yelp against inactivity. In the wake of the New Orleans inundation, they surf for sound bites. In those crucial hours, local officials “did nothing,” they say. Federal officials, too, including the highest official, were nowhere to be seen, doing nothing.

Nothing. Nada. Zilch. The null category gets no respect. The hollowness of it is repulsive. The emptiness of it is unbearable. Even nature is said to abhor a vacuum. The poor man who has nothing to say is a pariah. He is like the investment advisor with nothing to recommend, save cash. He will get no work as a hedge fund manager; he will not drive a fancy car, nor live in a beach palace at the Hamptons.

And zero? For centuries the number couldn’t even be found. Mathematicians didn’t know what to make of a number that was not a number at all; but an absence of numbers, a graphic display of nothing… a round, empty hole.

And pity the poor renters. While everyone else has been getting rich, the renters have been left behind, stranded… like people who showed up too late at an airline counter in Duluth just before a snow-storm, doomed to spend a weekend there.

Imagine the conversations between husband and wife:

“You did nothing! This was the biggest housing price boom in American history, and we missed it. Now, we’ll never be able to afford to buy a decent house.”

Few things are as damnable as inaction. In politics, it is cause for recrimination. In marriage, even the Catholics allow for annulment in case of non-consummation. In finance, it is cause for regrets. In war, it is cause for firing squads. In conversation, an absence of words is embarrassing. When a man stares you in the face and says nothing, you assume he is thinking something dreadful. Unless he smiles; then you think he has lost his mind.

The other problem with inaction is that there is never any excuse for it. Stalin’s generals, charged with inaction during the early days of the German assault on Moscow, might have explained that they were busy with their mistresses, or attending a child’s birthday party. Either excuse would be perfectly satisfactory to a civilized man, for both were better than killing people in order to defend the Soviet Union. But Stalin was scarcely civilized. And while the Soviet Union was abominable, Hitler seems to have offered something even worse. But how could they know that?

And how could the poor husband know that house prices would rise? Of course, he could not; but his wife nevertheless holds him responsible, as if he not only saw the train coming, but intentionally failed to get on board.

No, dear reader, inactivity is almost always unpardonable. But here, nevertheless, we say a kind word for it, maybe two. First, we point out that doing nothing is usually the best course of action, especially in public affairs and investments. Second, we deny the possibility of ‘doing nothing’ in any case.

Since the entire world nurses a prejudice against inaction, the burden of proof is clearly on us. So, let us bend to our work like a field hand, knowing that our labors will be many, our rewards few.

In public affairs, as in private ones, there is a powerful compulsion to ‘do something.’ The problem on the Eastern Front was not really caused by inaction, but by Hitler’s desire to ‘do something.’ After the invasion and capitulation of France; and after the Battle of Britain, he found himself with time on his hands. Western Europe was buttoned up, from Poland to Spain; he was master of all and everyone. Only Britain held out. But he had not the means to invade Britain, so his eyes wandered across the map – as Napoleon’s had done many years before - and saw Russia.

He would have been much better off staying home. Then, Stalin’s generals could have continued to bounce their mistresses on their knees, and hand out candy at birthday parties. Inaction would have begotten more inaction, in other words. And the world might have been a better place.

And now we read in the news that the administration and Congress have finally sprung to action on the bayous. They are going to spend more than $50 billion! That the money will be almost certainly squandered seems to trouble no one. That every penny of the money could otherwise be better spent by the people who earned it, bothers neither conservative nor liberal. The impulse to ‘do something’ is so powerful, no one wants to stand against it.

But our beat here at The Daily Reckoning is money. Are you ever better off doing nothing with your money? The answer falls in our lap like a ripe cocktail hostess: Of course.

Warren Buffett holds billions in cash. He is probably the best investor who has ever lived. If he cannot find anything better to do with his money than to leave it in cash – effectively doing nothing with it – how can the average lumpeninvestor expect to do better?

Is this the time to buy stocks? Probably not. Stocks are still relatively expensive. The idea is to buy low and sell high later. When stocks are high already, there is no alternative; you must do nothing.

Is it time to buy bonds? Again, probably not. Bonds are expensive, too; yields are low. Will they become even more expensive? Will yields go even lower? Maybe. But we cannot predict the future. All we can do is look at the present and the past. We know, from past experience, that bonds have become more expensive almost every year for the last quarter of a century. At today’s prices, you are not likely to make money in bonds, especially corporate and junk bonds. It is better to do nothing.

But there is always real estate, isn’t there? Since 2001, investors have made such rapid advances in the property market they would have made Guderian or Rommel envious. In the late summer of 1941, Guderian, the leading proponent of panzer-led blitzkrieg warfare, was racing towards Moscow. The man could not bear inaction; he took to the offensive even against his Fuhrer’s orders. On the other side, the Russians were full of action themselves. Guderian faced Zhukov, who was beginning to understand how to beat the panzers. You know what happened next: Action produced reaction. Finally, the whole campaign ended in a bloody mess.

But it is still sunshine for America’s house buyers. Should you join them while the getting is still good? Or should you do nothing? ‘Do nothing,’ is our advice. Most houses are too expensive. You will get more for you money as a renter. Most likely, you will be able to buy later…at better prices.

“You are either long or short,” said our old friend Mark Hulbert, 20 years ago. “There is no such thing as a hold.”

What Hulbert was describing was the impossibility of inaction in the investment world. You may like to do nothing, but you can’t. If you do not buy stocks, you buy something else. ‘Nothing; cannot exist; it has no meaning. If you have money, you must have it in some form. You must be ‘long’ something. You may be ‘long’ cash, as Buffett is, but that is just as much a something as being ‘long’ property or stocks.

The real question is not whether you will do something or nothing, but: What will you do? When all major asset classes are expensive, the sensible thing to do is nothing. But since you can’t do nothing, our advice is to do as little as possible.

The trouble with cash is that it is much more something than nothing. Dollars are a gamble. They are IOUs issued by the world’s biggest debtor. Despite nearly a hundred years of decline, the dollar is still expensive in our view. That is, they still buy something, but that they will buy less in the future is practically assured. Buffett hedges this gamble by buying foreign currencies. But it is still a gamble.

A more perfect ‘nothing’ is gold. It is a sort of anti-asset. It pays no interest. It issues no press releases. It offers no guidance on quarterly earnings; it has no earnings. It does no mergers, no acquisitions and it never restructures. It hires no celebrity CEOs. It offers no discounts. It makes no excuses. But it is the thing that goes up when other assets, including dollars, go down.

Gold is as close to ‘nothing’ as you can get. Buy it.

Bill Bonner
The Daily Reckoning

Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

To order your copy of Financial Reckoning Day at a discount, see The Daily Reckoning's bookstore: Financial Reckoning Day

Are We Headed for a "Credit Derivatives Event"?

by Mike "Mish" Shedlock

Here is a recap of the current state of affairs.

In "Are You Missing the Real Estate Boom?" we noted Saxon Capital openly discussing both "credit events" and the "perfect storm" in an investor conference call. This is what Saxon Capital was saying:

• "At the point in time WHEN the credit event comes, AND IT WILL we will be very well placed to take advantage of what happens next"
• "I am concerned about the level of capital" of our competitors "to service the bonds as those portfolios age"
• "Should real estate on the west coast flatten out I would be worried about a credit event"
• There are people that will buy a 100% Loan to Value (LTV). We do not have that product we do not believe in it. We want the stated income borrower to actually have some skin in the game"
• We can now offer those products but "We have no intentions of putting those loans in our portfolio... We are going to pass them thru to other investors"
• Question: and you think that is a good strategy thinking this is The Perfect Storm you are describing?
• Answer: "As long as the market is willing to provide that credit... they attempt to deliver the customer as much cash as possible with the least amount of investigation or effort...That's what drives our customer... In order to get the customers we want we need to be able to offer those products"
• Question: "Since I have known you, you have been bearish on the industry ... now you are saying I want to be more like people offering products that are unsustainable. I am struggling with that"
• Answer: "The only difference is that I do not intend to put those in my portfolio... and the day that I can't sell these (to someone else) is the day that I stop offering them".

We also noted that Fannie Mae's restatement is such a big task, that Fannie expects to hire some 1,500 consultants by year's end to accomplish the mission.

In Derivatives cannot take the pressure Brad DeLong comments on a Financial Times report as follows:

• "There is now about eight times the number of outstanding futures contracts as bonds eligible and available to fulfill them."
• "In June, some large holders of the June 10-year Treasury futures contract, including Pimco, demanded settlement -- taking delivery of actual bonds -- instead of, as usual, rolling their positions into the next contract. The scramble to find the necessary notes was made worse by the fact that one account, possibly the hedge fund Citadel, already held the bulk of the cheapest notes to deliver."
• "The real problem is that the US economy is just too leveraged. Starting with the housing industry, the country is too dependent on derivatives markets to create the illusion that interest rate risk can be conjured away. The technical problems of the 10-year are just another early warning sign of this fundamental weakness."

As a result of that mishap CNN Money reports an Investor charges Pimco with manipulation.

An investor has sued money manager Pacific Investment Management Company, claiming the firm manipulated the price of June 10-year Treasury futures contracts on the Chicago Board of Trade.

The suit filed in the U.S. District Court for Eastern Illinois in Chicago, which claims Pimco violated the Commodity Exchange Act, is seeking class-action status. Chiu is accusing Pimco of creating a manipulative "short squeeze," which causes short-sellers to pay inflated prices to cover their positions because the entity that owns large amounts of a given security withholds the securities from the market.

The shortage of 10-year Treasury notes led to the millions of dollars of investment losses in June, as short sellers scrambling to cover their positions had to buy back the bonds at high prices to fulfill their obligations.

Chiu's complaint charges that, during the period in question, there were only about $10 billion to $13 billion of the "cheapest to deliver" 10-year Treasury notes available to satisfy the June futures contract, while the value of these outstanding contracts was as high as $170 billion. The complaint alleges that this "artificial scarcity" of bonds caused the price of the futures contracts to increase, generating a profit for Pimco.

Let's backtrack for a moment and consider a time When Genius Failed.

When Genius Failed, by Roger Lowenstein, is the detailed history of the rise and tragic fall of Long-Term Capital Management(LTCM). LTCM was a hedge fund that brought the financial world to its knees when it lost $4 billion trading exotic derivatives.

Roger Lowenstein explains how Long-Term became arrogant due to its success and eventually leveraged $4 billion into $100 billion in assets. This $100 billion became collateral for $1.2 trillion in derivatives exposure!

In 1998, Russia defaulted on its bonds- many of which Long-Term owned. This default stirred up the world’s financial markets in a way that caused many additional losing trades for Long-Term.

By the spring of 1998, LTCM was losing several hundred million dollars per day. What did LTCM’s brilliant financial models say about all of this? The models recommended waiting out the storm.

By August 1998, LTCM had burned through almost all of its $4 billion in capital. At this point LTCM tried to exit its trades, but found it impossible, as traders all over the world were trying to exit as well.

With $1.2 trillion dollars at risk, the economy could have been devastated if LTCM’s losses continued to run its course. After much discussion, the Federal Reserve and Wall Street’s largest investment banks decided to rescue Long-Term. The banks ended up losing several hundred million dollars each.

What became of the LTCM founders?
They went on to start another hedge fund.

In Thoughts on Volatility we discussed the explosive use of all kinds of credit derivatives including

• Credit Default Swaps (CDS)
• Collateralized Mortgage Obligations (CMO)
• Collateralized Debt Obligations (CDO)
• synthetic CDOs

You might wish to review that article for to see just what is being traded and why.
Here is a snip:

Synthetic CDOs have become hugely popular because they offer almost infinite ways for banks, insurers, hedge funds, and many other money managers to speculate on credit spreads-the spreads between different debt markets, between the debt of different issuers, between different classes