Business & Money

Ivan's War

by Bill Bonner

Was ever there a group of people so hapless, so luckless...so witless?

There they were, up to 30 million of them in the heartland of Eurasia, some 6,000 years after civilization had begun, 20 centuries after the birth of Christ, 200 years after the Industrial Revolution had begun, and during the living memory of many people reading this reflection. They drove automobiles. They talked on telephones. They listened to Debussy and Chopin on record players. They tuned into the radio, ate food that came in tins, used condoms, and enjoyed nearly painless dentistry...at least in Moscow.

How did these poor Soviet grunts get themselves into such a fix?

And here, we add an aggravating detail. These men thought themselves not backward, but in the very vanguard of human progress. They were men who had chosen to follow the prophets Vladimir and Josef into the land of scientific socialism. Gone were the old traditions. Gone were the old rules. Thrown out the door were the old religions. Now, the Soviets had a new religion of collectivism, new rules shaped by the communist party, and new traditions enforced by the Narodnyi Komissariat Vnutrennikh Del (NKVD) or the People's Commisariat for Internal Affairs.

Readers may have relaxed by now, like parishioners at a sermon who see the preacher’s accusing finger pass them by, but not so fast. While the victims in today’s essay are the Soviets, the protagonists - the dramatis personae - of our theme include us all. We may not be communists, or Russians, or soldiers, but we stand on two legs along with them, and breathe the same air.

When war with Germany began, the Soviet soldier found himself in a no man’s land. In front of him was the Wehrmacht, which was, at the time, the best attack force ever put into the field. The German army would most likely kill him or take him prisoner. If he were taken prisoner, he would almost certainly die, partly because the Germans wanted him dead, and partly because they had no way to keep him alive. They had not prepared for the millions of Soviet troops who would fall into their grasp. They had no food to give them and no barracks to lock them up in. Instead, prisoners were often left out in the open, surrounded with barbed wire and used for target practice until they finally collapsed of hunger and exposure.

In back of him, his prospects were not much better. Behind him, Stalin’s police had put up “blocking battalions.” Described as an additional line of defense, these troops were meant to shoot their own comrades if they tried to retreat. “Not a step back,” Stalin had said in his secret order number 227.

Between the Germans and the blocking battalions, there was almost certain death.

“The rates of loss were ...extravagant,” writes Catherine Merridale in “Ivan’s War.” “By December 1941, six months into the conflict, the Red Army had lost 4.5 million men. The carnage was beyond imagination. Eyewitnesses described the battlefields as landscapes of charred steel and ash. The round shapes of lifeless heads caught the late summer light like potatoes turned up from new-broken soil. The prisoners were marched off in their multitudes. Even the Germans did not have the guards, let alone enough barbed wire, to contain the 2.5 million Red Army troops they captured in the first five months. One single campaign, the defense of Kiev, cost the Soviets nearly 700,000 killed or missing in a matter of weeks. Almost the entire army of the pre-war years...was dead or captured by the end of 1941.”

Behind these amazing figures is a long story. The Bolsheviks believed they had the secret recipe for a better world. A mood of confidence, of positivism, of rationalism, and of world improvement had settled over Russia. It required destroying the old institutions, relationships, customs, attitudes, traditions and religion. Naturally, not everyone was cooperative. Well, said Lenin, “you can’t make an omelette without breaking some eggs.” So, the shells were cracked with rifle butts.

“Theirs was no ordinary generation,” Merridale continues, referring to the Soviet troops. “By 1941, the Soviet Union, a state whose existence began in 1918, had already suffered violence on an unprecedented scale. The seven years after 1914 were a time of unrelenting crisis: the civil war between 1918 and 1921 alone would bring cruel fighting, desperate shortages of everything from heating fuel to bread and blankets, epidemic disease, and a new scourge that Lenin chose to call class war.

The famine that came in its wake was terrible by any standards, but a decade later, in 1932-3, when starvation claimed more than 7 million lives, the great hunger of 1921 would come to seem, as one witness put it, ‘like child’s play.’ By then, too, Soviet society had torn itself apart in the upheaval of the first of many five-year plans for economic growth, driving the peasants into collectives, destroying political opponents, forcing some citizens to work like salves. The men and women who were called upon to fight in 1941 were the survivors of an era of turmoil that had cost well over 15 million lives in little more than two decades.”

This campaign to improve the world included getting rid of experienced military officers who were from the wrong class - as most were. It also involved such an ambitious program of careful central planning that nothing worked properly. You’d think that even a government employee could figure out that soldiers needed rifles, but many went to war without them. Nor did they have proper food, shelter, sanitation or clothing.

Fortunately, from a central planner’s point of view, without weapons or training they were usually killed before they starved to death. Little things were missing, too. The soldiers were ordered to go places, but there were no maps to show them how to get there. Only the Germans had maps. Soviet tanks were equipped with radios, but without an adequate code system, Germans could listen in on their tactical discussions. And the high command in Moscow could think of no other tactic other than the frontal assault, and regarded camouflage as cowardly.

By February 1942, three million soviet soldiers had been captured. The Red Army had also lost 2,663,000 who were killed in action. The math was bad, even for a country as large as Russia; for every German who was killed, 20 Soviet soldiers died.

And here, we pause and we wonder. We take our man as we find him, but we cannot quite believe he is the dumb ox he appears to be. There were more than five million armed men at any given time in the Red Army. They could have turned on their incompetent and merciless leaders if they had wanted to. Instead, the lined up and marched to their own slaughter, many of them, perhaps the majority, believing that it would help make the world a better place.

Even now, according to Merridale, they sit around shabby old soldiers homes and congratulate themselves. They beat the fascists! They saved the Proletarian Revolution! Thus, they lived almost their entire lives under the heel of an even more delusional and murderous regime, but didn’t seem to notice.

Here, too, people don’t seem to notice that much of what they take for granted, future generations will take for absurd. The dollar is worth something. You can get rich by spending. Debt doesn’t matter. The American Empire is at war with “insurgents.”

People will believe anything ...even if it kills them.

Bill Bonner

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).

In Bonner and Wiggin's follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is - an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount - just click on the link below:

"Now Perhaps Someone Will Listen!"

Gold, Dollars and Oil: Life During Wartime

by Dan Denning

When I got back from my excursion to the Far East in late 2004 and sat down at my desk in London to write up the story, I emphasized three major trends that would create danger and opportunity for investors. First, the bull market in energy (oil, gas, electric, nuclear) was going to be one of the longest and strongest you and I would see in our investment lifetimes.

The big drivers are the growth in demand from China and India. Since then, of course, through the work of Whiskey & Gunpowder editor Byron King, we’ve seen how Peak Oil - the exhaustion of all the world’s cheap, easily recoverable oil - is driving up energy prices even higher and faster than I thought, and also has complicated things geopolitically.

Second, the general rise of Asia into the developed world was causing huge demographic and economic dislocations - and creating enormous investment opportunities as Asian economies began to consume as well as produce, to spend as well as save.

Third, I wrote that the rise of the East was accompanied by the simultaneous collapse of the ruling currency regime of the last 30 years, the dollar standard. This last point is still so inconceivable to many people that they refuse to entertain the possibility. Too much would have to change. Too much wealth would be destroyed. Too many vacations would have to be canceled. Yet the inexorable rise of gold shows that this revolution in money is slowly but surely eroding the dollar’s status.

Iran Nuclear Threat: Possible Effects

The current situation with Iran doesn’t change any of those three main trends. It accelerates them, however, and adds the dangerous new element of nuclear holocaust to the table. Let’s be clear about one thing, though: Even if Iran developed a nuclear device tomorrow, it would not likely be the sort of thing they could put on a missile and fire off to Tel Aviv…or Rome…or London. It would be a large, unwieldy thing that they might be able to put on a jetliner. (Incidentally, Iran recently announced the resumption of commercial flights to the United States.)

Still, it’s not a secret anymore what Iran is trying to do. The question is, can anyone stop it? Another question is does everyone really want to stop it? I would argue that both China and Russia, though they might be deeply uncomfortable with having a nuclear Iran, see it as an enormous strategic blow to the United States and a key element of their respective energy alliances with Iran. China and Russia, in other words, are more than willing to let the world’s nuclear club expand. Doubtless, they feel like they’d have some measure of control over Iran, especially since both countries have helped Iran with its weapons program. Whether they will have any control or not remains to be seen.

Let’s leave aside all the speculating about if the United States or Israel can or will attack Iran. I have no idea. Nobody does. In analyzing the whole situation, I found it useful to head to the bookshelf and dust off a copy of Paul Kennedy’s The Rise and Fall of the Great Powers: Economic Change and Military Conflict from 1500–2000. I’m going to quote from a few sections that I think help explain how what’s playing out across the globe today is a result of both globalization and Peak Oil.

Unfortunately, if we follow Kennedy’s analysis, it’s very bad news for America and for Americans who fail to understand what’s motivating our main economic and strategic competitors. Emphasis added is mine. In the introduction, Kennedy writes:

“The triumph of any one Great Power in this period, or the collapse of another, has usually been the consequence of lengthy fighting by its armed forces; but it has also been the consequence of the more or less efficient utilization of the state’s productive economic resources in wartime, and, further in the background, of the way in which that state’s economy has been rising or falling relative to the other leading nations, in the decades preceding the actual conflict. For that reason, how a Great Power’s position steadily alters in peacetime is as important to this study as how it fights in wartime.”

Iran Nuclear Threat: The War on Terror

If you date the war on terror to its beginnings, you could conceivably go back to the Iranian hostage crisis of 1979–80. But let’s use Sept. 11 as our start date. Since that time, how efficient has the United States been at using its productive economic resources? Not very, as I have mentioned ad nauseam. That’s because America continues to consume more than it produces. Debt has driven a boom in American consumption right alongside a war that doesn’t seem to interrupt the daily life of many Americans. If countries rise or fall based on the efficient use of productive economic resources, then China, with its 9.9% growth, is rising and America, with GM’s $8.6 billion loss last year, is not. America has been falling relative to China and India for the last 10 years. Kennedy continues:

“The relative strengths of the leading nations in world affairs never remain constant, principally because of the uneven rate of growth among different societies and of the technological and organizational breakthroughs which bring greater advantage to once society than to another. For example, the coming of the long-range gunned sailing ship and the rise of the Atlantic trades after 1500 was not uniformly beneficial to all the states of Europe - it boosted some much more than others. In the same way, the later development of steam power and of the coal and metal resources upon which it relied massively increased the relative power of certain nations, and thereby decreased the relative power of others.”

My first essay for Whiskey & Gunpowder, “The Birth of Cultural Siege Engines,” made the simple observation that nuclear proliferation would alter the world’s political structure by making it nearly impossible for one country to invade another. Such as it is, this might actually reduce the incidence of war. It might also mean a very nasty but realistic situation where dictators and tyrants are free to terrorize their populations without fear of being toppled by invasion. After all, King Jong Il is around because he has nuclear weapons. Saddam Hussein will be executed sometime this year because he did not.

Iran Nuclear Threat: Economic Strategy

In historical context, nuclear weapons are the long-range gunships of the Atlantic. They are the great military equalizers. With the technological breakthroughs on the nuclear black market, you can expect more nations to get them. In a strange way, their spread might also dilute their leverage. Once everyone has them, there will be no urgency to get them. Military competition will turn back to economic competition.

For America, this means that we are less likely to be able to use our military as a means to achieve our economic strategy. True, aircraft carriers and long-range bombers still give America the unique ability to project force anywhere in the world. But a nuclear weapon and the means to deliver it, that’s really an army of one isn’t it? How well will America compete now that its great growth is behind it? And what about China and India? They will be boosted, in Kennedy’s terms, by the proliferation of nuclear weapons to the extent that global competition will be more economic than military. And of course, resource-rich countries will enjoy the greatest rates of growth and have the largest advantages of all:

“Once their productive capacity was enhanced, countries would normally find it easier to sustain the burdens of paying for large-scale armaments in peacetime and of maintaining and supplying armies and fleets in wartime. It sounds crudely mercantilistic to express it this way, but wealth is usually needed to underpin military power, and military power is usually needed to acquire and protect wealth.”

Here we just find more somber questions for America. America’s productive capacity is being systematically dismantled and shipped to China. If you don’t make anything, how can you sell it? And if you can’t sell it, what will you use to pay for your military? Without the means to generate wealth, how will America maintain its power? By selling bonds to our strategic adversaries? Come again?

In an energy-scarce, nuclear-abundant world, the surest ticket to wealth, and thereby to power, is energy. Those who have it - Russia, Iran, Venezuela - have tremendous leverage - provided they can survive as nation-states. Those who don’t - America, the United Kingdom, Western Europe - will find themselves not only less wealthy but less powerful. The free ride to power, luxury, and apathy that the Peak Oil age provided the West is emphatically, undeniably over.

Kennedy writes of this weakening of national power, “If, however, too large a portion of the state’s resources is diverted from wealth creation and allocated instead to military purposes, then that is likely to lead to a weakening of national power over the longer term.” You might add that if states’ resources and capital and their creative energies are diverted and devoted to buying and selling houses and filling them with trinkets bought on eBay, national power is weakened. The consumption lifestyle to which America has grown addicted does not produce capital. It does not produce wealth. It does not produce power:

“In the same way, if a state overextends itself strategically - by, say, the conquest of extensive territories or the waging of costly wars - it runs the risk that the potential benefits from external expansion may be outweighed by the great expense of it all - a dilemma which becomes acute if the nation concerned has entered a period of relative economic decline.”

If there have been benefits to the war in Iraq, cheap oil is not one of them. The war is not paying for itself with Iraqi oil exports. That war is not paying for itself at all. It has become a major and costly national undertaking, at just the time when America finds itself on the wrong side of the wealth = energy = power equation and in the fight of its economic life with rising powers India and China.

Kennedy writes:

“The strengths and the weaknesses of each of the leading powers are analyzed relatively, in light of the broader economic and technological changes affecting Western society as a whole, in order that the reader can understand better the outcome of the many wars of this period.”

In the last few years, we’ve seen how the broader “economic and technological changes” of globalization are making the world more competitive and changing social structures everywhere. Indeed, many of the great social and economic institutions on which the postwar world was built are falling like dominoes…GM, the pension system, the United Nations, the dollar standard…the beat goes on. In fact, about the only thing preventing this migration of wealth and power IS the dollar standard.

It allows America to fund its wars and consumption with a depreciating currency. It is a tremendous advantage Kennedy does not ignore:

“Since the cost of standing armies and national fleets had become horrendously great by the early 18th century, a country which could create an advanced system of banking and credit (as Britain did) enjoyed many advantages over financially backward rivals.”

England survived its many wars with France largely because of the creation of a funded national debt, the issuance of bonds whose interest was paid by the efficient collection of taxes. The modern warfare state is simply not possible without “an advanced system of banking and credit,” and that, for now, is exactly what is keeping America afloat. The world still wants our bonds. China has nearly $800 billion in currency reserves, its resource war chest.

But how long will this advantage last? I suspect a lot will have to do with the price of oil. As oil rises in dollar terms - whether from geopolitical tension or the growing realization that Peak Oil is real - the run on the dollar will grow. Hard assets like gold won’t just be fashionable: They will be indispensable to wealth preservation.

Soaring gold and oil prices will be accompanied by soaring interest rates and inflation. The convenient fantasy world where prices don’t rise and the dollar doesn’t lose purchasing power will collapse. One day, Americans will wake up and find that the money in their wallets buys three-quarters or half as much as it did the day before. The dollar will have lost status. America will have lost power. And in the new world that emerges, possession of energy, not a printing press, will be the key to wealth.

Dan Denning

Dan Denning is the editor of Strategic Investment, one of the most respected "big-picture" investment newsletters on the market. A former specialist in small-cap stocks, Dan has been at the helm of Strategic Investment since 1999 - where, drawing from his network of global contacts, he has designed an investment strategy that takes into account global political and economic trends.

The above essay has been adapted from this month’s issue of Strategic Investment. Click to learn more about this highly-regarded investment newsletter.

Peak Oil and the Sorry State of the Union

by Byron King

In his State of the Union speech, President Bush said, "America is addicted to oil," and set a goal of replacing 75 percent of the nation's Mideast oil imports by 2025 with ethanol and other energy sources.

Who is he kidding?

Saudi's Ghawar field is close to being in irreversible decline. The Saudis are only managing to maintain current oil production volumes by virtue of a massive seawater injection program that pumps more than seven million barrels of salt water per day into its oil fields. This pumping helps to maintain production pressures in the oil reservoirs, but is also the source of formation damage due to the presence of oxygen and bacteria in the seawater. By 2025, Saudi will still export oil, but far less oil than now and each tanker will be of such value as to require its own armed escort.

United States Peak Oil: Iran and Iraq

Iran is not quite at its production peak, but within 20 years, even the most optimistic estimates forecast that Iran will cease to be a net oil exporter. (This may also have something to do with Iran's desire to develop a nuclear program.)

And Iraq? By 2025, Iraq may be an oil exporter, not to mention an eastern province of Iran. But considering the looming and inevitable decline in daily world oil production, who will be able to afford whatever gets exported? (Hint, do you speak Chinese?)

The point is, on the other side of Peak Oil, the United States will be fortunate to receive any oil at all from the Mideast, let alone the Bush goal of only 25% of current (or forecasted) imports. The planners, who are connecting the dots of the past, and mechanistically extrapolating out into the future with no allowance for Peak Oil, are living in a fantasyland. They are planning, if anything, for the failure of the American economy and the attendant decline of American civilization.

Still, our Mr. President raised the subject. To recall an old phrase: "What does the President know, and when did he know it?" If G.W. Bush is onboard with Peak Oil, he failed to bring up the subject with specificity in his State of the Union speech and give the concept the publicity and credibility that such a speech would merit. Then again, maybe the president saw the movie A Few Good Men. Maybe he is imitating Jack Nicholson's character, a colonel in the Marines, who said, "You want the truth? You can't handle the truth." Maybe, to Mr. Bush's way of thinking, he is just doing the best that he can.

There are people who plan for the long term. There are Japanese companies with 100-year business plans. Can anyone predict what the world will be like in 100 years? No. But these companies, reputedly, intend to be around when the next century rolls over. One way or the other. It might be the founder's great grandchildren, but they will be around. As the saying goes, "It's not the plan, it is the planning." (This is a famous quote from General Eisenhower that is painted on the wall of every staff college of the U.S. military.)

United States Peak Oil: Strategy

Strategic planning, operational planning, tactical planning...they all have their place in this world. It is not that things will follow exactly the plan. It is that you have at least planned something and thought things through. You have identified your challenge. You have considered your "desired end state," and determined which pathways might get you there. There are many roads from which to choose, so ya gotta choose. What are you going to do? You need to marry-up your resources to your action plan. What do you need in order to accomplish your mission? You need to identify what you need, and how you are going to get it. And you have to consider the alternatives along the way.

You need to think in terms of "what if this?" and "what if that?" And then you act, starting tomorrow morning, knowing full well that the next day, some freaking damn thing will occur to screw you all up. But at least you have a plan for this as well. And whoever has the better plan, the United States, China, Russia, the European Union, or the Bolivians...they are going to be left standing at the end of the day.

Few things in this world are more scripted than a U.S. President’s State of the Union address. By comparison, the Oscars are a little-old-lady Bingo game down at the fire hall. The entire resources of the U.S. federal government are at the disposal of Herr POTUS. If el Presidente says "X," then the next day there are small armies of federal employees power-pointing "X." If el Pres. says "Y" in the SOTU address, then...you get the picture.

The U.S. Navy, for example, has a 50-year plan. Why? It is because we are building ships with a useful life of 50 years. What will the world look like in 50 years? Beats me; beats anybody. But I bet that you will see U.S. Navy nuclear-powered aircraft carriers floating on the waters of the world. The Navy is inventing its own future, Congress permitting and appropriating. They are designing berthing compartments and kitchen sinks, not to mention nuclear reactors and gear reduction systems and catapult systems, for sailors who will not be born for another 25 years. And when the time comes, these young lads & lassies will be sleeping and washing up, and sailing and shooting airplanes, off of something that some guy designed at a drafting table in Newport News, like, maybe, yesterday.

United States Peak Oil: Reduction of Dependence

Yes, we have been hearing this "We will have to reduce our dependence on foreign oil" B.S. for 30 years. And for 30 years, it was easier to let the daily oil markets dictate that the nation did not have to get serious. What were we going to do, put a $4.00-per-gallon tax on gasoline and kill the driving-based economy? Sorry, guys. Democracy gave you Hamas in Palestine, and Ahmadinejad in Iran, right? Well it also has given cheap gas in the United States for the past century. It was fun while it lasted. Now, Mother Nature is at the door, telling you that it's payback time. Uh-oh.

So, we had our $8.00-per-barrel oil in the 1980s, and our $10.00-per-barrel oil as recently as 1999. We sprawled all over the land, from sea to shining sea, paving over the amber waves of grain, running condos up the sides of purple mountains, and laying out housing tracts where the deer and the antelope used to play. We choke the land with Interstates from the Redwood Forests to the Gulf Stream Waters. This land was made for you and me, huh?

And we plugged a hell of a lot of stripper wells along the way, too. So long to those marginal barrels, at three or five units per day, times 100,000 wells.

Now we see and hear G.W. Bush, who is pals with Matt Simmons and Richard Rainwater (ahem...), saying we are going to reduce out oil imports from the Mideast by 75% in the next 20 years. We never heard Herr Clinton say that...did you? Or if he did, he was just trying to pick up some cute girl, sitting in the front row wearing a wet T-shirt that said "No Blood For Oil" (Whatever works, right Slick?). Considering the reality of Peak Oil, G.W. Bush's statement is a freaking no-brainer. Finally ("Hallelujah!!"), the Bush Administration gets it right, even if it may well be for all of the wrong reasons.

Wisdom may come late, but it seldom never arrives.

Then again, maybe Bush is talking alternative energy for the right reasons, but sometimes a president just can't tell people what is going on. Why did the United States decide, almost overnight, to implement the Safeguard Antiballistic Missile System in late 1968 and early 1969? Did it have anything to do with Soviet submarine K-129, and its abortive nuclear strike at Pearl Harbor? Do you think that President Johnson or President Nixon could have come out and said, "Hey, we almost got nuked on March 8, 1968, by some Red Star Rogue (hey, catchy title...), so we need an ABM system.” Sorry, there are some factual secrets that you just have to keep.

This applies to motive as well. Why alternative energy? Why now? Hmmm. The gears are turning, slowly maybe. But they are turning. I can hear the medulla oblongata, grinding away in the Oval Office. "I cannot really say 'Peak Oil.' The only people who know what it is are a bunch of too-smart people at the margins. Besides, whatever I say, it won't be enough for them. And I have to talk to the center. And we all know how stupid they are out there in the center.

“The lumpenproles in Florida cannot even push a stick through a piece of paper on election day. Do I want to lay the Peak Oil gig on them? It will be panic-city. What will happen to the stock markets if the masses wake up and realize that their 401(k) funds are invested in utter trash, in an economy whose long-term business model is just plain busted.

“Besides, we have 60 Minutes peddling all that crap about how the Alberta tar sands are our salvation. People are confused, and I cannot hold school for the entire freaking country during a one-hour SOTU speech. So, I will say as much as I can get away with, and not get myself assassinated by the...well, I'm not supposed to even think about those people."

Something is going on. Something big.

Byron King
The Daily Reckoning

P.S. Not all nations suffer equally in the event of a crude crisis. Since the United States accounts for roughly 25% of the oil being consumed, even a minor shortfall in the production and distribution of oil around the globe portends disproportionate economic downsides here in America...

For all but a few knowledgeable investors, that is. Discover how you can stay informed and ahead of the upcoming "Petrocalypse."

Oil Apocalypse

Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. He is a regular contributor to the free e-letter, Whiskey and Gunpowder, which covers resources, oil, geopolitics, military history, geology and personal freedom. To get your free subscription, visit Whiskey and Gunpowder.

Strong-Arming The Seesaw: Estonia's Trading Hub

The Daily Reckoning PRESENTS: Accompanied by his new Estonian wife, our favorite resource expert, Kevin Kerr, spent the holidays sharing Christmas cheer with his in-laws. But being a commodities fanatic, he, of course, also jumped at the chance to check out new trading opportunities in one of Eastern Europe's busiest seaports. Read on...

by Kevin Kerr

Diminutive and beautiful, the Republic of Estonia has always been an easy target for the region's bullies. Suffering a long history of heavily armored invaders such as Germany and Russia, the tiny republic has endured as a colonial territory for nearly a thousand years.

Estonia's main attraction to invading armies is its seaport, Tallinn. Extremely deep and ice free, Tallinn has been a major hub for shipments between the Baltics, Russia and the West.

Even as Estonia tries to grow a high-tech industry, the port continues to serve as the primary source of economic growth. Through it flows 30 millions tons annually - some 75% of it cargo. And the thing you really need to know is that the biggest moneymaker is oil.

And Estonia's biggest oil carriers are Pakterminal and Estonian Oil Service (EOS). Bringing up the rear as No. 3 is Eurodek. All of these heavy fuel oil operators are headquartered in Muuga Harbor, which is part of the Port of Tallinn.

By posting record profits, Pakterminal, EOS and Eurodek have attracted a slew of regional competitors. As the shares of the pie grow smaller, we can expect this market to sustain growth of approximately 7%.

Originally, the railroads carried crude from the Russian oil fields. Since then, the facilities have evolved with the times. Today, Estonian oil terminals handle more profitable shipments of refined products.

The lone holdout is Lonessa AS. It is owned by Nordic Terminals BV, which in turn is a holding of Taurus Petroleum Ltd. Unlike other regional terminals that are connected to the Russian pipeline system, crude shipments are carried by rail through Estonia to Tallinn. That has not deterred Lonessa from building a new $30 million oil terminal in Tallinn, however, in February 2005.

Quoted in InternationalReports.com, of The Washington Post, Lonessa's director John Madsen said: "We decided two years ago that it would be an extremely good idea to go through Estonia... Tallinn has the best port in the Baltic States; it's deep, ice free and accessible. Access for big ships is, of course, extremely important. This is a very competitive business, and big ships means lower transportation costs per ton. Every cent that we can gain is important. Our terminal will be dedicated to crude oil, because that's the Taurus business. However, having said that, we will build the terminal according to the most modern standards and make it flexible, which means we will install the tanking capacity so that it could take fuel. Maybe Russia cuts off the supply one day. We are preparing for that as well."

While a $30 million expansion for a U.S. oil giant would barely draw a second glance, Lonessa's current project makes it one of the five biggest investments in Estonia - ever! What Lonessa will get for its money is a terminal with a 3 million ton annual capacity, most of which will be fuel oil. That amounts to 12.5% of Estonia's 24 million tons shipped through the port last year.

Seesawing oil prices have impacted global profits, but it's surprising that among the Baltic countries, Estonia fared better than most. Estonia's oil transport industry, and economy in general, have stood up well against market forces.

Unfortunately, other former Soviet states are getting hit hard by geopolitical shockwaves. The bare-knuckled fight between Russia and the Ukraine over natural gas prices has dominated oil-industry headlines. And the consensus is that Russia is trying to pound the Ukraine into submission after it elected pro-Western President Viktor Yushchenko last year. The Ukraine finally threw in the towel to Russia's price gouging - leaving it vulnerable to a major economic meltdown. By ending subsidized natural gas prices to the Ukraine, Russia stands to extract an extra $1 billion in lieu of political influence.

Now we can expect similar Kremlin strong-arm tactics in other former Soviet states that have turned pro-West, pro-NATO and pro-European Union. Among them are Estonia, Georgia and Moldova.

Taking it straight from the horse's mouth, Russia's Finance Minister Alexei Kudrin recently told the RIA Novosti news agency, "The time when we built relations by quasi-subsidizing neighboring economies is gradually passing. We must think about our own interests."

As with many things Russian, subtlety takes the form of a baseball bat on the negotiating table.

In its negotiations with the Ukraine, Russia's nationalized Gazprom proposed that natural gas should jump from $50 to $160 per 1,000 cubic meters, which would pile on nearly $1 billion to Ukraine's annual bill for heating homes and powering factories.

Finally, in December, Gazprom said that it was sick and tired of what it characterized as foot-dragging. It said that if no deal were reached, Jan. 1, 2006, would see an extreme form of capitalism at $200-230 - the same price Russia obtains in Western Europe.

As I tuned into the news the other night here in Estonia, my wife Katrin translated for me. "Ukraine has wasted time in these talks, and now there can be no talk of $160," Alexander Medvedev, deputy chairman of Gazprom, said on Russian television. "The market situation has changed, and it's continuing to change."

In short, the message is that any pro-Western Baltic country still lives in the shadow of the Kremlin - just the way Russia wants it.

Unlike the Ukraine's spanking, Gazprom plans to continue subsidizing natural gas prices for Belarus, for which it charges $47 per 1,000 cubic meters. Russia's party line is that prices are kept low because Belarus has allowed Gazprom to own a gas pipeline there and to lease the land it uses long-term. Many political analysts, however, attribute the friendly pricing to the country's firm political alignment with Moscow. The leader of Belarus is a puppet dictator himself, whose strings (or chains) are pulled (or yanked) by the Kremlin.

But puppetry aside, the real market force here is bartering. The Ukraine pays most of its natural gas bill by allowing Gazprom to use Ukrainian-controlled gas pipelines for about 80% of Gazprom's exports to Western Europe. This gives Ukraine potential leverage in the negotiations; Ukraine's Yushchenko has ruled out any interruption of gas to Europe. Still, the battle is just warming up.

For example, radical Ukrainian politicians and analysts have suggested pressuring Russia into renegotiating a lease for Ukrainian bases used by Russia's Black Sea naval fleet. A lunatic fringe has gone so far as to remove Russia's early-warning radar systems from Ukrainian territory. Given that such a move is possibly illegal, a more businesslike approach to the negotiations would likely prevail.

In fact, Yushchenko has said he would accept a gradual transition to market prices, but not the kind of sudden, drastic increase proposed by Gazprom. We wait to see how this saga further unfolds.

In the meantime, a $1 billion increase in natural gas could nearly cripple the Ukraine's slow-growing economy. The country's chemical and metal industries, which are heavily dependent on natural gas, would be particularly devastated.

The Kremlin has no reason to be charitable or cooperative. It knows quite well that a backlash to higher home heating bills could undermine the Ukraine's parliamentary elections in March. In the end, "comrade" could be the new operative word in the Ukraine later this year.

With 15 years of experience, Kevin Kerr is a true veteran of the commodities markets. A licensed commodities trader since 1989, he's worked the trading pits in Chicago and New York with legends like Paul Tudor Jones, and he's even traded commodity derivatives in London. Over Kevin Kerr's career he's dealt with everything from cotton to currencies to oil and natural gas.

Kevin Kerr's unparalleled expertise in futures and commodities has made him a regular contributor to news outlets like CNN fn, CNBC and Marketwatch, where he's been quoted in over 500 articles.

The Butch Cassidy of Banking

The Daily Reckoning PRESENTS: This coming Tuesday, January 31 will see Greenspan pass the torch to Ben Bernanke as the head of the Federal Reserve. Let's take a quick look at the job Helicopter Ben will be taking over...

by Bill Bonner

"Alan Greenspan is the greatest economist of our time...probably the best central banker of all time."

Thus saith a French economist this morning interviewed on a radio talk show this morning. Your editor, also a guest on the show, was asked to respond. What follows is not what he said (because when he is called upon to speak in public he tends to hem and haw like a teenager asking for a date.) But this is what we intended to say:

"Yes, we agree. Alan Greenspan is probably the best central banker that ever lived...in the sense that Butch Cassidy was a great bank robber or Mrs. Purdy ran a great bordello. What is great about him is that he really understood central banking and appreciated it; the way a swindler admires a really good flimflam."

"What you have to remember," we began, gravely, "is that a central bank cannot work miracles. It cannot turn water into wine. It cannot make the blind see, nor heal the sick. When we speak of the central bank 'creating prosperity,' for example, we are either exaggerating or outright lying. The lilies at central bank toil not, neither do they spin. They plant not. They harvest not. They manufacture not. They invent not. 'Not' is what they do best...except when it comes to the nation's stock of money. There they put their shoulders to it.

"But what can they do? They are typically thought to control the quality of money. This, of course, is what they are supposed to do. And in Europe, more or less, that is what Jean-Claude Trichet does. But central banking in Europe is a slightly different métier from central banking in the United States. Bill Clinton jokingly wished he could create an Alan Greenspan Inc. and sell it on the NYSE. So high had Greenspan's stock flown, Clinton knew he'd get rich on options and warrants. Who would suggest such a thing for Trichet? Who even knows his name or would recognize him a lap-dance bar? The man labors in relative obscurity...if not absolute and perpetual darkness.

"How he must envy Alan Greenspan! The American Fed chief's picture is on the cover of every magazine...on the front page of every newspaper...and on the evening news, too. Le Monde commented earlier in the week that Greenspan was 'the prototype for the great leader of the 21st century.'

"Why such a big difference between the European's central bank chief and his American counterpart? We have an answer. It is because the euro-functionaire does the job he's supposed to do. Europe is a mixture of many different economies. It cannot easily agree on a common economic policy. The most it can ask of its central banker is that he not destroy the group's common money.

"Not so over in the imperial homeland. There, Mr. Greenspan casts a much bigger shadow across the world stage. He is not merely a bit player but the lead...the protagonist...the one who outsmarts the villain and wins the heart of the leading lady. And he is the one with the big guns in his hand. America's Fed-head is charged not merely with protecting the dollar, but also with assuring full employment, hiking-up property prices, doling out low-cost credit, re-electing all public officials; he must finance all wars, pills and hurricane clean-ups, and a low-fat chicken in every pot. He has what is known as a 'dual mandate' - he must control the nation's economy and its money at the same time.

"But there is a place where the whole folderol washes up every time. A central bank can protect the value of the currency; Trichet is proving it. But when it is asked to do more than that, the currency swiftly goes down the drain. Let us explain: The only thing a central bank can control directly is the nation's money. It can control either the quantity of it, or the quality. The quality is controlled by resisting the impulse to issue too much money, but resisting the impulse to create too much money is exactly what nobody wants. Politicians, consumers, merchants, investors and two-bit grifters all want more money, not less. "Thus, even the most prudent and responsible central bankers inevitably allow a bias to creep into their management of the country's money. When crises threaten they quickly cut rates and pump up the money supply. When crises don't threaten any more, they drag their feet in tightening up. We saw this happen with Alan Greenspan's Fed recently. The recession of 2001 brought brisk treatment - rates were lowered like a leper's body into a grave. But when the time came to put rates back up, it was done gingerly...by tiny 'baby steps' over what seemed like an eon.

"And that is why activist central banking is nothing more than a fraud. If the object were only to have stable money, the bankers would simply fix the price of the currency to gold and no banker's bilious face would appear on the cover of Time. They'd all be as anonymous as Trichet. Alan Greenspan said so himself, before he arrived at the Fed. And yes, once settled in the cushiest chair at the Fed, Alan Greenspan made central banking work...but only for him.

"The job, as we have come to know it, is better than 'Survivor' when it comes to creating celebrities. The only thing it does better is creating money. And the only thing you can be sure of is that the money it creates will lose value and continue losing value until it has none left. At that point, even lepers won't want to touch it."

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).

In Bonner and Wiggin's follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is - an empire built on delusions.

What’s Next for The Stock Market?

by Eric Ross, Ph.D.

In my New Year’s article on the subject of the US economy and the vagaries of the stock market “ The Faltering Stock Market, Inverted Yield Curve, and Brisk Monetization” we looked at two major economic indicators likely to keep the bulls corralled: the energy prices, mostly oil and gas, and the inverted yield curve, historically associated with the faltering economy and falling markets.

As expected, at the beginning of the year a lot of money was put into the market to be burned quickly (see “ Paper Money as Alternative Fuel ”), and after the initial surge in the beginning of January, the market dropped, in one day, on Friday, January 20, below its December highs, the bull’s rude awakening. Many of the market’s leaders, YHOO, MOT, INTC, GOOG, GE and C, the market’s bellweather stocks, those which determined the market’s mood year in and year out, dropped within the last few days a good deal, and on high volume, gapping down in the morning each time.

The Dow's loss Friday was its biggest percentage drop since May 2003, and the first drop of more than 200 points since March of 2003. Google, today’s one-stock-bubble, dropped from over $460 per share to $399 in less than a week.

Iran withdrew its foreign reserves from the European banks on Friday, an estimated $50 billion worth, supposedly to prevent potential UN sanctions against its continued nuclear weapons aspirations, and the Nigerian guerrillas blowing up oil pipelines sent the price of oil surging to the levels above $68, with that new line in the sand after which a recession is a virtual certainty, $70 per barrel, being within a day’s reach. The yield curve, which I believe is worth watching, even despite assertions that “this time it’s different”, inverted meanwhile some more.

In November 2004, the U.S. Congress approved an $800 billion increase in the nation's $7.384 trillion debt limit, the third increase in the government's borrowing limit since President George W. Bush came to office. At the end of 2005 the Treasury Secretary John Snow said US could face the prospect of not being able to pay its bills by mid-February 2006, unless Congress raises the government’s borrowing authority, now capped at $8.18 trillion. “At that time, unless the debt limit is raised or the Treasury Department takes authorized extraordinary actions, we will be unable to continue to finance government operations,” Snow wrote. Looks like more fiat money coming up…

Iran seems to be hell-bent on waging a currency war against the US dollar, and the US economic might. If the Iranian Oil Exchange successfully goes into operation, and there’s actually some real oil being bought and sold there, the need for the Dollar reserves in the countries patronizing their exchange would subside, and along with it – the dollar would fall. It is not at all certain that oil traders would go into Teheran, where the exchange would operate under Shariat laws, to strike deals. You can’t blame a trader who would be fearful to lose an arm and a leg, literally, if some mullah judge deems his business acumen offensive to the Muslim law. Yet, the Chinese, Indian, and Japanese oil traders might be just desperate enough to grab the discount, if any is offered, to take such risks.

“The Fed is almost done, ” the pretext under which the markets surged in the first couple of weeks of January 2006, might be just the same pretext they used to drop like lead balloons on January-20^th, 2006. The problem is that historically the markets grow while the Fed is at the end of the cycle of raising the interest rates and they correct for as much as 10% on average for the twelve months that follow the “end point” of the Fed’s cycle of raising the interest rates.

If history has any predictive value, this would spell a market decline into the Fall of 2006, with hopefully some market skyward fireworks by the end of the year.

What does it all mean for a man on the street? – The main thing is not to be suckered into any speculative “investment vehicles” which you do not know or understand well enough. There’s no telling what the market will do on any given day, rather than that it is more uncertain now than ever. Unless you’re an experienced, sophisticated investor building option spreads, and doing commodity swaps, in today’s uncertain and volatile stock markets, a money market fund risk-free rate of a little over 4% should be good enough for a great many investors, as most of them did much worse than that in 2005. Keep in mind that the short-term rates, such as 3-months or 6-monts, are most likely higher (thus more advantageous to investors) than the long-term rates of 2-5 years.

About the author: Dr. Eric Ross is a management consultant and an adjunct professor in the North East. He holds an MBA in Finance and Ph.D. in Information Sciences and is a member of the International Honor Society in Business Administration. He is a full-time father to an adorable 7-year-old boy, and an ardent researcher of economic, political, and financial “mega trends.” He can be reached at Eric.Ross.Phd@Gmail.com

Eight Steps to Fix Your Broken Credit

MAROTTA ON MONEY

by David John Marotta

Part three in a three-part series on monitoring and managing your credit

Debt problems destroy your credit history and isolate you from a host of economic privileges and opportunities. If your credit report was a wake up call to get out of debt, you may be wondering what to do next. The first step to stop the hemorrhaging is simply to not borrow another penny until you are completely out of debt. The rest of this article will only benefit those in debt willing to make this commitment.

Avoid dealing with "credit repair firms". Don�t waste your time opening new accounts. Moving won't help either. Your credit history will gradually repair itself.

Do whatever it takes. Ask your mother-in-law to hold your credit cards while you are getting out of debt.

The first and most important step to getting out of debt and reestablishing good credit is to admit your past mistakes. No one has ever been able to overcome their problems until after they have first admitted them. Yes, this is the hardest part, but also the beginning of the way out.

Now, to get out of debt, here are the steps. Walk carefully.

TOTAL YOUR DEBTS AND REDUCE YOUR RATES

1. List your debts. List WHO you owe money, the AMOUNT you owe, and the INTEREST RATE you are paying. Most people who are in debt avoid looking at these statements. The truth is often difficult to face, but facing this information honestly is important.

2. Call every place you owe money. This is especially important if you are delinquent in your payments. Let your lenders know you will be trying to pay off your debt and ask for their assistance. Ask them for a lower rate of interest. Negotiate. Ask them for a payment schedule you can actually pay. Lenders are not gentle with over-spenders who have to be wrestled to the mat for payment. But they are surprisingly kind to those who call promising to pay and asking for help.

3. If possible, consolidate all your debt into the lowest possible interest rate. You can get information on low-rate, no-fee credit cards at www.cardtrak.com. Consider consolidating with a credit card that offers several months with little or no interest. These can give you some grace period to reduce your debt.

4. If you can't consolidate everything to one low interest rate, pay as much as you can on the debt with the highest interest rate while paying the minimum on everything else.

5. Put your high interest rate cards someplace safe. Ask your mother-in-law to hold them. Do whatever it takes. These are not to be used while you are getting out of debt. It doesn�t matter what wonderful perks are offered for using these cards. They are never worth the cost, trouble and heartache they caused your family.

PAYDOWN YOUR DEBTS

6. Try to reduce your fixed expenses and use the difference saved each month to pay off your debt. Eliminate features on your phone or drop channels from your cable plan. Read this column for regular tips on budgeting for ways to live proportionately within whatever amount you earn.

7. Make one-shot reductions in your debt. Hold a yard sale and use all the proceeds to pay down your debt. Pay cash for everything and use all your change to pay down your debt. Take an evening job or use all of a spouse's income for the next few months to pay down your debt.

8. Take drastic measures until debt-free. No eating out. No movie rentals. No discretionary spending. Realize that some people live on half of what you make. They use 65% of that for their regular expenses, save 15%, put 10% away for large purchases, and give 10% away to charities. If they can do that, you can live without cable television and gym membership until you are out of debt.

Is financial freedom worth it? The choice is yours.

Marotta Asset Management, Inc. of Charlottesville provides fee-only financial planning and asset management. Visit www.emarotta.com for more information. Questions to be answered in the column should be sent to questions@emarotta.com or Marotta Asset Management, Inc., One Village Green Circle, Suite 100, Charlottesville, VA 22903-4619.

Sifting Through Your Own Credit Dirt

MAROTTA ON MONEY

by David John Marotta

Part two in a three-part series on monitoring and managing your credit

Credit bureaus track your financial moves closely. They are in business to find the financial dirt many living on the edge of credit worthiness would rather keep buried. Better credit has a financial value and companies are not likely to take your word for it. But since mistakes are made, you have a stake in reviewing your credit report for inaccuracies or strange activities that could mean you have been the victim of identity theft.

The Fair Credit Reporting Act and the Fair and Accurate Transfers Act (FACT) now entitles you to review your credit records once a year for no charge. You may request your annual credit report from each of the three credit reporting agencies, TransUnion, Experian, and Equifax.

Credit bureaus charge to see your credit score. Save your money.

To request your credit reports, visit the central source online at www.annualcreditreport.com or call 1-877-FACT-ACT. We suggest staggering your credit checks throughout the year. If you and your spouse each request a copy of your credit separately, you can check one of your reports every two months.

Five factors are considered when calculating your overall credit worthiness: your previous credit history, your current level of indebtedness, the length of time your credit has been in use, the types of credit you have, and your pursuit of new credit. A mathematical model determines your credit score, based on these factors.

Your free credit report will not include a copy of your credit score. To see your score, you will need to pay the credit bureau. Unless there is an over-riding cause, save your money. You can learn everything you need to know about your credit by a careful review of the free portion of your report.

Check each part of your credit report carefully to ensure its accuracy. The reporting agencies do not all have the same information. But what they collect falls into four main categories: personal information, account information, inquiries, and alerts.

Part one lists your personal information. You should see your social security number, date of birth, current and previous addresses and employment history. Your age, gender, ethnicity, and location do not affect your credit in anyway.

Part two catalogues all of your account information. Your accounts are likely divided up into accounts in good standing and those which are past due. For each account listed, you will see your account number, contact information for the lender and the type of account�whether the account is a mortgage, revolving (credit card), or an installment account. The date the account was opened, the payment history, current payment status, account balance, and credit limit will also be listed.

Closed accounts will continue to appear on your report. Check the status of the accounts you requested to be closed. Next, for open accounts, look at the account activity section. Do your balances match your records? Do you have any accounts you thought closed but remain open? What about the payment history?

Part three lists all of the inquiries into the status of your credit. Inquiries into your credit history may negatively impact your credit score. "Hard" inquiries are those you initiate by filling out a credit card application or by authorizing an employer to see your credit history. Hard inquiries can negatively affect your credit if it appears you are quickly expanding your credit beyond your means. "Soft" inquiries are those made by companies for solicitation purposes or from current lenders checking on the ongoing credit health. Soft inquiries do not affect your credit.

Part four may be called "alerts" or "potentially negative items." This part of your report can wreck your credit score. If you have been turned over to a collection agency or if you have any public records such as bankruptcy, tax liens, foreclosures, lawsuits, or garnished wages on file, these will be listed in this section.

Under FCRA rules, you may dispute the inaccuracy with the credit reporting agency, and the credit reporting agency must investigate the dispute and respond to you within 30 days. Information which is incomplete, incorrect, or unverifiable must be removed from your credit history within 30 days. Agencies may not report negative information which is older than seven years, or ten years for bankruptcy. For more information on dispute procedure, visit www.ftc.gov/credit.

Eight Steps to Fix Your Broken Credit
Sifting Through Your Own Credit Dirt
Learn What Credit Stalkers Know About You

Learn What Credit Stalkers Know About You

MAROTTA ON MONEY

by David John Marotta

Part one in a three-part series on monitoring and managing your credit

With Christmas come and gone, you may be dreading the sight of credit card bills. Regardless of your credit card debt, the new year is a good time to check your credit history. What you don�t know about your own credit history may kill your opportunities for future borrowing.

If you plan on applying for a new job or applying for a credit card, car or home loan, you may want to check your credit report first. A 2004 report by the U.S. Public Interest Research Group found one in four credit reports have serious errors which could significantly lower your chances of being approved for a loan or credit card.

Beware of bogus credit companies claiming to offer free credit reports in order to gather your personal information.

Employers and potential creditors will look at your credit report as an indication of your character and credit-worthiness for short and long-term loans such as a credit card, car loan, or a home loan. Even if you think you have good credit, begin the new year by checking the facts on your credit report anyway. Your credit report will outline your full credit history. And, it can help you verify you have not been the victim of identity theft.

Establishing good credit or bad credit takes time. As does fixing errors which appear on your report. Discovering these problems while sitting in your bank�s loan office is no way to win.

An amendment to the Fair Credit Reporting Act and the Fair and Accurate Transfers Act (FACT) now requires each of the consumer reporting agencies to provide you with a free copy of your credit report once each year. To get a complete look at your credit report card, you�ll need to request a copy from each of the credit reporting bureaus, Equifax, TransUnion, and Experian.

Your credit report includes both personal and credit repayment history. Included in the personal information section is your name, address, social security number, current and previous addresses, and employment history. I recently checked my credit history and discovered that one of the digits of my social security number had been incorrectly entered on an account. It was listed as an SSN alias in the report.

The bulk of your report outlines your current lines of credit, your payment history, and any potentially negative items such as companies who have denied your requests for credit. It also lists companies who have requested your credit history and any companies you have authorized to view your credit for business or insurance purposes. Review this information for accuracy.

To request your free credit reports, visit the central source for free on-line credit reporting at www.annualcreditreport.com. From that site, you can view a copy of your credit report from one or all of the bureaus. Or, call toll-free (877) FACT-ACT to request your free annual disclosure from the agencies. Your report will be mailed to you within 15 days.

For verification purposes, you will be asked a series of security questions. In my case, I was asked how much my mortgage payment was each month, what county I lived in and the make and model of my car.

Beware of bogus credit companies claiming to offer free credit reports. Entering the wrong web address may land you at a bogus credit reporting site. These sites claiming "free" credit reports may be a trap to garner your personal information. Remember, there are only three official credit reporting agencies.

Each of the three credit bureaus will try to sell you a detailed report of your credit. Some offer credit reporting packages for as little as $5.95 or as much as $68.70. You do not need to purchase these products. Proceed carefully on the websites and click only on the free credit report offer.

To get the maximum benefit, stagger when you check your free reports throughout the year. Your spouse is entitled to free credits reports as well. By alternating with your spouse, you can check your shared credit every two months.

Schedule for checking your credit reports
January	You request a report from TransUnion
March	Your spouse requests report from Equifax
May	You request a report from Experian
July	Your spouse requests a report from TransUnion
September	You request a report from Equifax
November	Your spouse requests a report from Experian

You may be entitled to more than one free credit report this year. If you were denied employment or insurance, if you are on welfare, if you have been a victim of identify theft, if your request for credit has been denied, or unemployed and plan on looking for a job within the next 60 days, you may request a second free credit report from each credit bureau.

Looking Up... Down on the Pampas

The Daily Reckoning PRESENTS: Investing in any country is a gamble. Not only have you know idea what cards might turn up, explains Bill Bonner, you also have a sneaking suspicion that the dealer may have one or two up his sleeve. Read on…

by Bill Bonner

As unlikely as it seems, we were once called upon to advise a foreign government.

Out on the vast plains of Eastern Europe lies a miserable nation called Belarus. After the break-up of the Soviet Union, the party hacks who ran the place saw the need to do things differently. But that is where their ideas began to piddle out. All they could think of was to bring in “experts” from the West to tell them how to “reform” their economy. It is a measure of the sloppiness of their approach that your editor was rounded up to offer his opinion. It is a measure of your editor’s persuasiveness that, to this day, Belarus remains the most forlorn and backward nation in Eastern Europe.

But today’s Daily Reckoning essay is not about Belarus, nor Eastern Europe. It is about a place in which we have recently developed a keen interest…not the steppe, but the pampas. Investing in any country is a gamble. Not only have you know idea what cards might turn up, you also have a sneaking suspicion that the dealer may have one or two up his sleeve. But the burden of this little reflection is that Argentina may be worth a bet.

We only mention our Belarus experience because it illuminated us. We realized that we might as well be giving culinary advice to cannibals.

“Well…you would probably rather have some canard a l’orange,” we might suggest. “Pity you don’t have any canard…or any oranges.”

An economy is a natural thing. Each one has to follow its own course. All public officials can do, generally, is make sure private property is protected by the courts, and otherwise get out of the way - eliminating all the many restrictions, taxes, permits, prohibitions, pay-offs, and emoluments that inhibit commerce. This, of course, is the last thing public officials want to do, and it could only have been done in Belarus over the dead bodies of the people we were advising. Which would have been fine with us, but we had no means of laying them out or preventing their friends from returning the favor. So, the whole trip was a preposterous farce.

Before WWII, Argentina was one of the world’s richest countries. “As rich as an Argentine,” was a common expression in England. Between the wars, the English gentry, down on their luck but up on their manners, hoped to marry off its daughters to prosperous Argentine planters. Some did.

But then, Argentina slipped into a puddle of socialist do-goodism from which it never was able to climb out. Economic growth was spotty. Inflation was chronic. Rules were imposed to prevent this…stop that…and inhibit something else. Labor restrictions made it hard to employ people even during boom periods. But in 1989, the country seemed to hit bottom. Inflation hit 3000% that year. Soon after, the Argentines were told to get to work and stop complaining.

By 1997, the country was growing at a 9% rate, but there were problems. The country was consuming and investing more than it produced. And the curious system of international finance tempted Argentina to borrow even more. Fund managers bought emerging economy debt based on an index of borrowers. This had the perverse consequence of increasing the availability of credit to the nation that borrowed the most. That is, as Argentina borrowed more and more, it became a bigger part of the index of emerging market debt. Why people pay fund managers to follow the indices, we don’t know, but that’s what they did. The more Argentina owed, the more the fund managers wanted to buy its bonds.

It was no easier for Argentina to resist the lure of easy credit in the ‘90s than it has been for America in the 2000s. By the end of the period, Argentina’s foreign indebtedness approached $150 billion. That would be peanuts for the United States, but it was a lot of money for a country like Argentina. A few smart fund managers saw the disaster coming (Asian central banks, take notice.) They sold off Argentina’s bonds. Pretty soon, the country was in crisis again, unable to make its debt payments. In December 2001, riots and looting broke out. President De la Rua decided that it would be better to stiff the foreign creditors than to further annoy the locals with austerity measures. Before the month was up, Argentina made history with the biggest debt default ever.

There are a lot of ways to ruin an economy. Argentina has experimented with most of them. It has devalued its currency, and revalued it. It has pegged it, and then knocked down the peg. It has regulated, controlled, inspected, taxed and confiscated. Following the 2001 crisis, earnings fell by 30% - with half the nation slipping below the official poverty line. What is remarkable is that the Argentine economy has survived at all.

We have been favored with a letter from a Daily Reckoning reader, resident in Argentina, who puts the country’s financial history into perspective for us:

“I am 72 years of age and am writing you from Argentina. It is well worthwhile to study what happened in Argentina over the years. This country goes crazy about every five years or so. It has been my painful experience that it is better to be a debtor than a creditor when this time comes around. When the crunch comes somehow, debtors who are in the majority always seem to be protected by politicians who need their votes. I don't see why this will not also be true in America.”

Nor do we.

In September, the Argentine economy reported its 37th consecutive month of GDP growth. It is growing about 7.3% this year, 5.6% projected for next year.

“The government has been incredibly lucky,” says Luis Secco, a Buenos Aires consultant.

And here we find the big difference between the United Sates and Argentina. If a country such as Argentina does well, it has luck to thank. North of the Rio Grande, people thank neither the stars nor the fates. Instead, they salute their Fed chief and pat themselves on the back.

Argentine economists have even tried to quantify their good fortune with a “luck index” - said to measure the impact of global economic conditions. The index hit a high of 9.8 (on a 10-point scale), last year. This year, it is expected to be around eight.

Meanwhile, the government budget is in surplus (before interest payments). Foreign currency reserves are increasing. Foreign debt, as a proposition of GDP, has fallen below 40%. Inflation is below 10%. The trade balance is positive. And the economy is growing twice as fast as America’s.

But what America has in most abundance - confidence and credit - Argentina lacks. Just try to buy a house in Buenos Aires or a ranch out in the country. No one will offer you credit. While Alan Greenspan comments on the solidity of the U.S. economy, Argentine officials speak about their economy’s fragility. While American economists look ahead and see only progress, Argentine economists look ahead and see hesitation and backsliding. They warn of inflation. They warn of social upheaval.

While Americans see a glass half full, Argentines see one that is bone dry.

We do not know how to cure Argentina’s economic problems. But we have evidence that confidence is not permanent, but cyclical. Having been so low for so long, we expect to see it turn up on the pampas. In America, on the other hand, confidence and asset prices are likely to go in the other direction.

Bill Bonner
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).

In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is - an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount – just click on the link below:

Now Perhaps Someone Will Listen!

The Dollar Hit Parade

The Daily Reckoning PRESENTS: The greenback still reigns supreme, holding sway over all other paper currencies - for now. Justice Litle explains how the dollar is still holding on as the world’s reserve currency...

by Justice Litle

There are only a few ways for the bull market in gold to play out, and supposedly a fixed ending in all cases. The yellow metal’s dollar price will violently launch into orbit at some point, arc into a near vertical crescendo and ultimately burn itself out supernova style. Either that or a long, drawn-out grind - a steady sloshing higher over the course of years, punctuated by occasional hiccups and countertrends to keep us on our toes. Or perhaps a combination of both, in homage to the disco era - a multiyear rise capped off with a blaze of glory.

But no matter how it happens, gold will eventually return to Earth. The fixed ending is a return to normalcy, which in gold’s case equates to dormancy. After all, what goes up must come down. Right? It’s only logical. That is what everyone expects. Yet what if, this time, the future doesn’t look like the past? What if gold were to climb to new highs, breaking the $1,000 an ounce barrier, and never return from whence it came? With apologies to Thomas Wolfe, what if the bankers can’t go home again?

Now that would be something.

It is usually the case that the greater the stake in a specific outcome, the less freedom one has to connect the dots. But the ability to foresee a wide range of possibilities, including the extreme and the unexpected, is a hallmark of the exceptional trader or investor. When asked what traits made him so successful, legendary hedge fund manager Bruce Kovner observed, “I have the ability to imagine configurations of the world different from today, and really believe it can happen.” In that spirit, we lay the groundwork for our golden scenario... and one cannot hardly discuss the outlook for gold without first considering the dollar.

In spite of all the pessimism and diversification talk of recent years, IMF figures show that dollars still make up roughly two-thirds of the world’s foreign exchange holdings. Eat your heart out, Charles de Gaulle. It’s good to be king.

So why is the dollar so popular? What gives America free reign to settle debts in its own currency, print more of it at will and impose its fiscal whims on the rest of the world? There are five elements currently supporting the dollar as world reserve currency. We will now discuss each in turn.

The first critical element is security, provided in the form of military and economic dominance. Charles and Louis-Vincent Gave, of research house GaveKal, theorize that the world’s reserve currency is primarily held as a form of insurance in the event of crisis. Based on this theory, GaveKal has come up with four key requirements, as follows:

Attribute #1: “The issuing country must be dominant militarily. And here the logic is simple: One holds a reserve currency for random crisis events. Wars are random crisis events. One wants to ensure that, in case of a war, one is able to buy the best possible weapons... and be sure that the weapons will be delivered.”

Attribute #2: “The issuing country must be dominant technologically (see above).”

Attribute #3: “The issuing country must be dominant agriculturally so that in case of a random crisis, reserves can be morphed into food to feed local populations.”

Attribute #4: “The issuing country must be mature financially (i.e., have developed financial markets) so that in a random crisis, the afflicted country has the ability to raise money in the financial markets.”

By this reckoning, the dollar is more than just a paper liability of the U.S. government; it is backed by the best-in-class physical strength of the U.S. military and the best-in-class financial strength of the U.S. economy. This provides a sense of security to smaller countries facing greater exposure to the dangers of political unrest, military conflict or economic shock. When the local unit of exchange is being buffeted this way and that like a dinghy in a hurricane, it is good to have a stash of dollars on hand.

The security factor also underlines why the euro, the yen and the yuan are all pretenders to the throne. While they have sufficient economic heft, Europe and Japan do not have the ability to project military power of any real significance, let alone the capability to challenge the U.S. militarily. And while China is making headway on the military front, the Middle Kingdom’s financial structure and capital markets have nowhere near the depth, breadth and stability that would be required to support reserve currency status for the yuan.

The second element underpinning the dollar as world’s reserve currency is universal acceptance. One could accurately rehash the old credit card slogan: “Greenbacks - they’re everywhere you want to be.” Whether you are a tax accountant in Togo, a spice merchant in the Maldives or a drug runner for the Albanian mafia in Montenegro, you probably accept American money. There is no greater testament to the dollar’s widespread acceptance than the enthusiastic endorsement of organized crime. Got a hundred dollar bill in your wallet? It probably has traces of cocaine on it. The dollar also acts as a go-between for parties who would have trouble conducting transactions otherwise. If I have shekels and you have kopeks, it might be tough to do a deal - I cast a dubious eye on your medium of exchange, and you on mine. If we make the transaction in dollars, however, our problems are solved. The dollar thus acts as a go-between for less liquid currencies, greasing the wheels of world trade.

The third element supporting the dollar is the network effect, where the value of something increases in proportion to the number of users. The more widely circulated dollars become, the more people are willing to use them, reinforcing their competitive advantage as a medium of exchange. Eventually, the dominance of the marketplace is so strong that it becomes very hard, if not impossible, for competitors to find a real foothold. The phenomenon can be described in slang terms with the expression, “Them that has, gets.”

Fourth in the dollar hit parade is America’s willingness to act as spender of last resort. You have probably heard pundits refer to the United States as the “engine of growth to the world.” Issuing the world’s reserve currency gives America huge privileges, chief among them fiscal autonomy, and with those privileges come responsibilities. In times of gloom, the leader is expected to step up, running deficits if necessary, until global growth gets back on track. Those who see America’s current account deficit as benign argue that this is exactly what the United States has been doing of late: spending more to make up for anemic demand elsewhere. Just being a responsible global citizen, thanks very much. A large chunk of America’s spending power is due to creative financial innovations and deep capital markets; Europeans, on the other hand, are not nearly as adept at turning their homes into spending cash while still living in them. As more exporting countries rely on the prodigious appetite of the United States, more and more dollars find their way into global circulation.

Last but not least, a significant element propping up king dollar’s throne is plain old inertia. When things have been done the same way for a very long time, it is hard to introduce change. An example that immediately comes to mind is the popular engineering anecdote entitled “standards last forever,” in which specifications for the space shuttle are traced back to the wheel spacing on a Roman war chariot. So many essential goods and services are priced in dollars today, and so many transactions are conducted in dollars by tradition, that it would be nearly impossible to coordinate a mass switchover.

So how might the king be toppled? There is precious little to work with in terms of past example. The Economist observes the last regime change:

“The pound was king during the era of the gold standard. But in the years after 1914, Britain switched from net creditor to net debtor, and by the 1920s, the dollar was the only currency convertible to gold (although the pound returned to gold in 1925). Two costly wars and two episodes of currency devaluation in Britain later, the dollar was unchallenged as the world’s chief reserve currency.”

It arguably took two world wars and a global depression to dislodge the pound. That is a fairly tall order; no wonder the consensus belief is that king dollar will maintain his throne. But for all the elements working in its favor, the reign of America’s world-beating currency has a large strike against it: The profligate policies of America itself. While it took a series of extraordinary events over the space of decades to dislodge the pound, Britain never spent others’ money with the wild abandon America has shown.

To put it bluntly, the United States has taken a jackhammer to its financial credibility. The U.S. consumer is happily in hock up to his eyeballs, betting on further housing appreciation to bail him out, while the accelerating pace of U.S. government spending boggles the mind. The current administration appears to have less grasp of financial responsibility than a 16-year-old girl set loose with her father’s credit card.

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).

To read Justice Litle’s latest report, see here: Energy = Wealth

Energy Infrastructure: In The Aftermath (II)

The Daily Reckoning PRESENTS: In the final installment of this two-part essay, Justice Litle explains what effect this year’s volatile hurricane season will have on consumer and government spending. Read on...

IN THE AFTERMATH, PART II

by Justice Litle

"Everybody came in here with every car they had and took everything we had in the ground."

- Kip Neuhart, Chevron station manager, Marietta, Ga.

As the linchpin of the global economy, much depends on the American consumer. With consumer spending representing more than two-thirds of U.S. economic activity, and consumer import consumption the engine that keeps Asia humming, money to spend and willingness to spend it are critical for turning the fiscal merry-go-round. In this regard, Katrina has had a sharp financial and psychological impact.

Consider the shift in perception of gasoline prices. An editorial cartoon from a few months back does a good job of illustrating the difference between then and now. A carefree motorist fills up his SUV at the gas pump, whistling aimlessly, with electrodes attached to the back of his head. Two scientists observe from behind a one-way mirror. One is manipulating a large dial - the price of oil listed in $10 per barrel increments - as the other takes notes. The first scientist has a look of surprise and concern as he tentatively turns the dial toward $60. The second scientist frantically observes, “It’s not having any effect!”

Fast forward to the present: That carefree, “what-me-worry” mood is long gone. It has been replaced with anger, anxiety and fear as prices break the $3 per gallon mark nationwide, with outliers as high as $6 reported at gas stations in the Southeast. There is real pain at the pump. The governor of Georgia has publicly denounced gas gouging, President Bush has asked drivers not to horde gas and fears of shortage become self-fulfilling prophecy as anxious drivers blitz their local filling stations and run them dry. The long lines of the ’70s have returned, and a few illiterate politicians from Hawaii and Florida have even called for the reinstatement of price controls. (Hopefully, they will be muzzled or ignored.)

Things were already looking precarious before Katrina, with the consumer savings rate in negative territory, discretionary income dwindling and energy prices high enough to cause fresh concern. The disruption of Gulf Coast production did not create a new problem. It merely kicked an existing one into overdrive.

While gasoline prices will ease a bit as initial panic dies down and excess driving is curtailed, there is another psychological bogeyman waiting in the closet: natural gas.

Natural gas futures were already challenging all-time highs before the disaster struck. They have since gone into orbit on concerns that commercial storage inventories may not be enough for a cold winter ahead.

From a psychological perspective, the unknown often generates more anxiety than the known. Consumers are already dealing with shock and awe as they fill up their gas tanks. Now they have to endure a more frightening question: How high will the heating bills be this winter? It’s impossible to know, and there are many months to dwell on the question...before we find out just how cold the coming winter will be.

As consumers adjust to these new realities, the instinct to cut back may finally kick in. We are likely to see the savings rate tick up over the next few months, as anxious consumers brace themselves for a further body blow this winter. This shift in sentiment could put further pressure on the retail sector as discretionary income erodes, and a slowdown in import consumption may put economic pressure on Asia, as well. Of course, if China starts to feel the pain due to consumer slowdown, the complimentary Treasury purchases that have kept interest rates low and home values high may grind to a halt.

“At some point, the sense of confidence in capital markets that today so benignly supports the flow of funds to the United States and the growing world economy could fade. Then some event, or combination of events, could come along to disturb the markets, with damaging volatility in both exchange markets and interest rates.”

- Paul Volcker, “An Economy on Thin Ice”

“What we are looking at... is one of the biggest U.S. public finance projects of all time.”

- Joe Mysak, Bloomberg columnist

As a result of Katrina, the pace of government spending will increase rapidly. At the same time, the Federal Reserve is facing increased political pressure to pause in its campaign of interest rate hikes. This combination is likely to weigh heavily on an already weakening dollar, as foreign creditors look on with growing concern. (All this with a vulnerable Asia in the background, no longer so anxious to provide vendor financing.)

This is not a criticism of the coming rebuilding efforts, or a denial of the need for federal assistance in time of disaster. It is simply an observation that the bill is coming due at a time when U.S. finances are decidedly shaky. Government officials have promised whatever it takes in terms of federal funds, and estimates have consistently estimated, with some suggesting Katrina could ultimately cost more than the wars in Iraq and Afghanistan combined. This comes on top of more than $100 billion in estimated economic damage, with long run energy costs still unclear. Not to mention federal assistance for a million displaced individuals. Meanwhile, fiscal conservatives are disgusted with the lack of political will to cut back pork in other areas as we are hit with these massive expenditures.

It is hard to play the role of fiscal hawk in the face of human suffering. The natural moral instinct is to give with compassion and expect the government to spare no expense in restoring order. The problem is not the financial realities of disaster relief, but rather the fiscal excesses that came beforehand, putting the country in such an untenable financial position in the first place. Nothing has been put aside for a rainy day. The credit card of last resort is already loaded with charges. Nature’s misfortune has compounded the ill winds of poor financial planning.

At the end of the day, America has essentially borrowed $2 trillion from the rest of the world and spent it in mostly nonproductive ways. The Fed fueled this binge and facilitated a gold rush in paper assets (what else do you call $400,000 condos that don’t yet exist?). To the degree that real estate appreciation is fueled by borrowed dollars, the appreciation is not real wealth, but rather a temporary loan from overseas creditors. Consumers are not using these generous loans to start productive businesses with an aim for future return on investment. They have been swapping houses, monetizing their mortgages and living it up on the proceeds. When that money has to be paid back, America will have little to show for it. The only way out will then be to manage the dollar downward, which in turn triggers a deliberate erosion of purchasing power for all those holding dollars and dollar-linked assets. The consequences of fiscal profligacy may be long delayed, but ultimately cannot be denied.

The inevitability of a managed dollar descent is not in question. In fact, it is a key piece of the “optimistic” scenario for a soft landing. America has all but admitted that its fiscal rehabilitation plan hinges on inflating its way out of trouble, a “burn the bag holder” scenario. Only an issuer of the world’s reserve currency could get away with such a brazen plan - and probably not more than once.

Reserve currency or not, no credit line reaches to the sky.

It is a foregone conclusion that America’s net borrowings from foreigners will eventually cease, and then head into reverse as fiscal imbalances sort themselves out. When this happens, the dollar will begin its slide in earnest, and moneymen the world over will pray that the descent is an orderly one.

No central bank stands to gain from a free-fall scenario in which the world reserve currency plummets. But if things start getting precarious, it could easily become every financier for himself. As Jesse Livermore dryly noted, in times of crisis, the bankers do not stand around saying, “After you, my dear Alphonse.”

Hopefully, the destabilizing event that former-Fed Chairman Volcker hypothesized was not a natural disaster. Hopefully, we are not already making our way down the slippery slope.

Justice Litle

P.S. Still, if the final-straw event (or combination of events) has not yet arrived, the hour is surely coming, and Katrina may have hastened it.

But you can protect yourself - and even profit - from this scenario. Find out how here:

Energy = Wealth

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).

Energy Infrastructure: In The Aftermath (I)

The Daily Reckoning PRESENTS: In part one of this two-part essay, Justice Litle looks at an existing problem - energy infrastructure - made worse by Hurricanes Katrina and Rita.

IN THE AFTERMATH, PART I

by Justice Litle

There is a common saying among strategic planners: “Hope for the best, prepare for the worst.” In Katrina, we have seen the worst, or close to it - and not just in terms of physical destruction.

The stories range from heart-rending to gruesome. The level of human suffering was staggering, with thousands of Americans subjected to conditions resembling a third-world combat zone. And the idea of a great city washed away is almost too big, too alien, to fathom.

In the deluge of news and commentary following Katrina’s wake, Bloomberg columnist Joe Mysak offers particular insight:

“This is a story being told on the ground right now, in hundreds of stories detailing human misery, particularly of the poor. But you know what? All those little stories don't give you the big picture any more than the obsessive, agonizing stories of individual casualties in Iraq tell you about what's really going on over there. Individual human tragedies offer insights into the human condition, not into what's going to happen next.”

This is not meant to trivialize the scope or seriousness of suffering, but to put it in context. The bigger picture cannot be distilled into sound bites, and will take time to reveal itself. As long-term investors - not to mention participants in the global economy - we have a vested interest in trying to make sense of what the aftermath will bring.

There is open debate as to the long-term effects Katrina will have. The most optimistic argue with a straight face that natural disasters have a “net positive effect” on corporate profits. This may be true in certain past cases, but not when an energy crisis is embedded in the mix.

The real viewpoint distinctions were made before the storm took shape. Observers and commentators can be placed in two groups: those who believed we were already in a dangerous place pre-Katrina and those who thought things were fine before the hurricane struck. For those in the concerned camp, the greatest natural disaster in American history has sped things along, moving the world closer to an inevitable endgame that was already on its way.

There are three areas in which Katrina has created urgency by magnifying an existing issue: energy infrastructure, consumer spending and building inflationary pressures. Today, we will look at energy infrastructure, and at the other two issues in the second part of this essay, to come next week.

“Americans have taken cheap energy for granted for years...Now it’s coming home to roost.”

- Robin West, PFC Energy Chairman

When it comes to rebuilding and upgrading the nation’s energy infrastructure, America has been hitting the snooze button for too long. The devastation in the Gulf Coast is a painful wake-up call. Prices have eased somewhat with the release of emergency reserves from the IEA and SPR, but the long-term horizon is still unclear. For quite a while, we have had the luxury of postponing action; now we are forced to take emergency measures in the face of a catastrophe.

America’s energy infrastructure is cracked and strained, patched together with duct tape, outdated in some areas and pushed to the breaking point in others. Power grids are in dire need of upgrade and replacement; fuel distribution networks are inadequate and subject to disruption; desperately needed refineries and liquid natural gas terminals have fallen victim to excessive environmental regulation, stifling government procedure and, worst of all, a nearly impenetrable wall of NIMBY/ BANANA style politics (Not In My Back Yard; Build Absolutely Nothing Anywhere Near Anybody).

The problem can be described on one level as “out of sight, out of mind.” Basic necessities are often taken for granted. In normal times, none of us thinks too much about the electricity that runs our homes, the water that pours from our faucets or the gasoline that fuels our cars. When the flow is disrupted, however, we notice very quickly.

The same benign neglect applies to the hidden web of energy infrastructure that makes modern life possible. As long as things are working, we don’t pay much attention. If the system is being put under increasing strain, we don’t notice - until something goes wrong. But the old cliché, “If it ain’t broke, don’t fix it” is very bad advice in this area. The farther infrastructure lags behind growth, the more disruptive it is when the creaking framework breaks down. The fewer fail-safes in place, the greater the likelihood of a small disruption causing big problems. And that is where we are now: Stomach-lurching volatility in fuel prices is the result of small demand shifts at the margin, thanks to a ”lack of slack” in the system.

The climate for capacity increase and capital investment has been stymied by one of the biggest flaws in the political process: an overwhelming bias toward short-term time horizons. There is little political incentive to address long-term problems hidden from the public eye. On the other hand, there is usually strong incentive to seize on the popular “quick fix” whose long-run effects are hidden or postponed. Furthermore, those who benefit from sound policies are typically the unorganized silent majority, whereas anti-energy special interests (think NIMBY) are organized and vocal. Last but not least, the pool of political dollars is always finite - so issues without immediate political resonance are ignored. The system works against common sense. Promises are made without analysis, favors are doled out without foresight and the eventual mess is left to be cleaned up on someone else’s watch.

This logjam of neglect and aggressive special interests requires a jarring shock to be broken through. That shock is now upon us. Daniel Yergin of Cambridge Energy Research Associates makes an argument for why Katrina’s aftermath has created an “integrated energy disaster”:

“What makes it an integrated crisis is that the entire energy supply system in the region has been disabled, and that the parts all depend upon each other for recovery. If the next weeks reveal that the losses are as large as some fear, this would constitute one of the biggest energy shocks since the 1970s, perhaps even the biggest. Unlike the crises of the ’70s or the Persian Gulf crisis of 1990-91, this does not involve just crude oil: It includes natural gas, refineries and electricity.”

Fortunately, as of this writing, the assessment of the situation is a little less pessimistic (though there are still plenty of unknowns). It looks like damaged ports and refineries may be brought back on line faster than feared, and worst-case scenarios may yet be avoided. The most intractable problem may be rebuilding communities to which the tens of thousands of displaced oil workers can return. Wage costs will no doubt have to rise sharply in efforts to convince them back. Regardless of details, we have learned a powerful lesson here; wake-up calls don’t come much stronger. Hopefully, the point has been driven home strongly enough to dislodge the special interest groups who fail to see the gravity of the situation. Yergin expands on what needs to be done:

“This more expansive concept of energy security requires broader coordination between government and the private sector; more emphasis on redundancy, alternatives, distributed energy and backup systems; planning and prepositioning of vital supplies (“strategic transformer reserves” for electric substations); and methods that can quickly be applied to promote swift market adjustment. As with the August 2003 blackout, this crisis underlines the need for modernization and new investment in the energy infrastructure that supports our $12.4 trillion economy.”

All these elements were critical pre-Katrina, and circumstances would have demanded implementation sooner or later. But now that public awareness is high - and the dangers of complacency are thrown into stark relief - the timetable will be accelerated. There is a lot of work to do, and no avoiding it. In the event of a recession, energy prices may fall as global demand slows. But even then, energy security would be critical as ever, as businesses and consumers would show more sensitivity to price shocks in the midst of a downturn.

A wave of rebuilding is coming, and it will encompass more than what was destroyed. There will be expansions, upgrades, new technology and new safeguards put in place. The Gulf of Mexico will be rebuilt to Category 5 standards. Legislation pressing for new refineries and new LNG terminals will finally gain the upper hand. New avenues will be explored. Uncle Sam will be whipping out the checkbook, big time. The situation demands it.

Justice Litle

Part II

P.S. In the second part of this essay, I’ll look at the effect that this hurricane season has had on consumer spending and increased inflationary pressures. In the meantime, check out my latest report - you could find out how to actually profit from this global energy crunch. See here: The Story of Energy

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).