December 8, 2023

Archives for February 2009

California & Congress Implement Discredited Depression Era Policies

Irony Everywhere

Supposedly we learned certain lessons from the depression of the 1930’s.  Experts agree that two of the worst policy decisions during the depression were to raise taxes and erect trade barriers.

Knowing that something is wrong and still doing it are two entirely different matters.

Congress Wants a Trade War

As the world-wide recession deepens, protectionist sentiments are rising. The House of Representatives’ version of the economic stimulus bill contains a provision that only American-made steel and other products be used for the infrastructure projects. Wrapped in the cloak of “Buy American” patriotism, the Senate version of the bill contains even stronger anti-free-trade provisions.

This Buy American momentum is bad economics, and by threatening to destabilize trade and capital flows, it risks turning a global recession into a 1930s-style depression. Asked about Buy American on Tuesday, President Barack Obama told Fox News that “we can’t send a protectionist message.” He said on ABC News that he doesn’t want anything in the stimulus bill that is “going to trigger a trade war.” He’s right.

Hostility has been no less evident in Europe and China. The European Union has said that it will not stand by idly if the U.S. violates its trade agreements and its obligations to the World Trade Organization. The risks of retaliation and a trade war are very real.

In 1930, just as the world economy was sinking as it is today, the U.S. Congress passed the Smoot-Hawley Tariff Act, which essentially shut off imports into the U.S. Our trading partners retaliated, and world trade plummeted. Most economic historians now conclude that the tariff contributed importantly to the severity of the world-wide Great Depression.

Later, as one of his last acts, President Herbert Hoover made the situation even worse by signing a “Buy America Act” requiring all federal government projects to use American materials. (That act is still on the books although it was weakened during the 1980s.) We must avoid repeating the disastrous mistakes of the past.

This is beyond idiocy and provides further proof that whatever action the government takes to “help” us is certain to hurt us.  The president does not want a trade war and he probably knows that trade wars are a bad thing.   Talk is cheap Mr. Obama – show some leadership and DO the right thing; politics as usual will not help us in this crisis.  If there was any intellectual honesty in Washington, a “buy American” provision would have never been added to the stimulus bill.  Political gamesmanship may have won someone a few votes; the economic cost to the Nation could be incalculable.

California to Close Budget Gap (With New Taxes)

Democrat Darrell Steinberg, the state Senate leader, expressed confidence that another Republican senator would join the two who have committed to vote with the Democratic majority in approving a budget that would raise taxes and cut spending.

In addition to the revenue increases, it proposed cutting $15 billion in spending, including $8.6 billion from education and $1.4 billion from payroll costs, to be achieved in part by furloughing 200,000 state workers at least one day a month. The plan also called for $11 billion in borrowing and $700 million in tax breaks for large corporations.

The impasse has revolved around a bill, out of the nearly 30 in the budget proposal, that would generate $14 billion in revenue by temporarily raising the sales tax by one percentage point, increasing the gasoline tax by 12 cents a gallon, and adding a surcharge of up to 5% on income taxes, among other steps.

Despite an unemployment rate approaching 10% California raises taxes and thus implements the same failed tax policies of the 1930’s.   Considering the further impact of job cuts, pay freezes and pay cuts it is no surprise that many people can barely make ends meet.   Washington’s response is a $10 a week tax cut stimulus!  Bizzaro World economics in action here.

California has to take the worst action possible at the worst possible time because they have no options left.   The one positive in the budget bill is that spending cuts covered part of the deficit rather than higher tax increases.  Despite California’s dance on the edge of bankruptcy, few people realize the full impact that deleveraging will have on California and the nation.  It will takes years of reduced spending, higher taxes and plain old fashioned frugality to restore the sound financial footing that is necessary to launch real economic growth.   Politicians promising a quick turnaround based on social spending stimulus programs are apt to shortly discover the ugly side of impatient constituents.

Nikkei – Black Hole Or Buying Opportunity?

Has Japan Been Pulled Into A Black Hole?

According to Einstein’s theory of general relativity, a black hole is a region of space in which the gravitational field is so powerful that nothing, including electromagnetic radiation can escape its pull after having fallen past its event horizon.   Recent accounts of Japan’s economic woes are beginning to sound like a black hole event.

Japan’s Economy Goes From Best To Worst On Export Slump

Feb. 17 (Bloomberg) Gross domestic product shrank an annualized 12.7 percent last quarter, the Cabinet Office said yesterday. The contraction was the most severe since the 1974 oil crisis and twice as bad as those in Europe or the U.S.

The credit crisis that crippled the U.S. financial system may have also knocked out the props that supported Japanese growth between 2002 and 2007: a U.S. consumer-spending bubble and a cheap yen. The speed of the deterioration has taken companies by surprise.

Since then, industrial production plunged at the steepest pace in 55 years in the fourth quarter, and unemployment rose at the fastest rate in 41 years in December. Panasonic Corp., Pioneer Corp., Nissan Motor Co. and NEC Corp. announced a combined 65,000 job cuts in the past month.

Devastating Effects

The end of easy credit in the U.S. will lead to a “quantum downward shift” in consumer spending in the world’s largest economy that may have long-term and devastating effects on economies that have relied on it, according to Allen Sinai, chief global economist at Decision Economics Inc. in New York.

Worst Isn’t Over For Japan

TOKYO — Japan’s economy contracted at its fastest pace in nearly 35 years during the final quarter of 2008 — and is likely to underperform other major nations early this year as demand for its goods collapses.

Japan’s gross domestic product shrank by 3.3%, or an annualized pace of 12.7% during the quarter, the government said Monday, a steeper decline than contractions of 3.8% reported for the U.S. and 5.9% in the euro zone for the same period. The world’s second-largest economy was slowed by a staggering 14% decline in exports and diminished capital spending by companies.

Japan’s economy is facing “without a doubt, the worst crisis since World War II,” said Economy Minister Kaoru Yosano.

Economic data already signal more deterioration. Industrial output is expected to drop by around 20% during the first quarter, a government survey says. After tumbling by a record 35% in December, exports sank 46% from a year earlier during the first 20 days of January.

Japan doesn’t have much room for further fiscal stimulus. It has the most debt in the world, coming to 157.5% of annual GDP in the fiscal year starting in April.

Japan Heads For Worst Postwar Slump

Jan. 30 (Bloomberg) — Japan headed for its worst postwar recession as factory output slumped an unprecedented 9.6 percent in December, unemployment surged and households cut spending.

“Japan’s economy is falling off a cliff,” said Junko Nishioka, an economist at RBS Securities Japan Ltd. in Tokyo. “There’s really nothing out there to drive growth.”

The International Monetary Fund said this week that Japan’s gross domestic product will shrink 2.6 percent this year, the bleakest projection for any Group of Seven economy except the U.K. That contraction would be Japan’s worst since World War II.

“We’re in a very grave situation,” Economic and Fiscal Policy Minister Kaoru Yosano said in Tokyo today. “Japan is being hit by this wave of weakening global demand.”

Japan’s Economy – No End in Sight?

Turning to the immediate news in off the wire the situation in Japan apparently went from bad to worse and then onto horrendous in Q4 2008. The latest data points from December are thus quite staggering as will also be detailed below.

Add to this that the debt to GDP ratio is already running at alarmingly high levels, Japan finds itself in a situation where, despite policy makers’ best intentions, the room to manoeuvre is very small. Or as Edward succinctly puts it;

This is the real core of the problem that Japan faces in 2009, that previous fiscal policy did not attack the growing fiscal deficit in the good times, so there is little room to manoeuvre in the bad ones. Which is why the Japan economic outlook in 2009 is grim, grim and nothing but grim.

On the fiscal front the steps are also fundamentally sound I think, but once again Japan is constrained on the debt side and especially of the fact that before a single penny can be spent on the crisis at hand the fiscal authorities need to issue a handsome portion of paper just to cover the primary budget deficit. In terms of the immediate outlook for Japan it is consequently dire.

Do The Japanese Read The News Reports?

Reports on the recent economic news from Japan cited above have included the following words or phrases: “most severe, plunged at the steepest pace, quantum downward shift, devastating effects, collapses, staggering, worst crisis, deterioration, worst postwar recession, unprecedented, falling off a cliff, bleakest, very grave situation, horrendous, staggering, alarmingly, grim, grim and nothing but grim, dire.”

The Japanese readers of these news reports might consider a rendezvous with a black hole as a better option than facing the future.  Is this really a time of desperation or is it the point at which the news can’t get worse, so it has to get better?   Acquaintances of mine who have recently been to Japan report that trains still work, planes still fly, people still go about their business, the streets are crowded and Japan Inc is open for business.  To evaluate the situation further, let’s examine how the horrific economic news has impacted the Nikkei 225.

NIKKEI 225 Ignores Horrific Economic Stats

If we look at the price action of the Nikkei 225 there appears to be a glaring disconnect from the current litany of bad news.  The Nikkei appears to have already discounted today’s bad news last year when the average fell 47% from its June 2008 high of 14490 to the October low of around 6868.   To date, the Nikkei refuses to pierce the October lows and now stands at 7670, almost 12% higher than the October 2008 low.   I am not a chart technician, but this type of price/news divergence is usually a positive sign.  If the Nikkei can stay above last year’s lows, perhaps investors have already discounted the worst.  Conversely, should the Nikkei start posting new sub 7,000 lows, it might be “lights out”.  Time will tell.

Long Term Factors To Consider:

-the Nikkei is already off 80% from its December 1989 high and has perhaps discounted the worst that can happen.

-a multi year double bottom may be forming at current price levels.

-the most fundamentally bullish factor may be that the Japanese government has reached the limits on its borrowing capacity, thus precluding the continuation of costly and ineffective stimulus plans (see Japan’s failed strategy). With the government no longer able to subsidize failed enterprises, free market forces can now accomplish the restructuring necessary to rebuild Japan’s economy.

-logical minds have made a persuasive case that the United States is now following the same failed policies that did not work in Japan for the past 20 years.   If this is the case, the United States needs two decades, deficit spending of $30 trillion and a Dow Jones at 2800 to achieve the same economic status that Japan has today.

Government Bond Buyers Demand Higher Yields

Massive Government Borrowing Raises Repayment Doubts

As governments worldwide attempt to sell massive amounts of debt, investors are beginning to question whether they are being properly compensated for default risk.  The assumption that government debt is risk free is being re-evaluated as debt service payments increase to an untenable percentage of government revenues.   Bond purchasers are further unnerved by the fact that there appears to be no end in sight to  mounting government deficits as nearly every sector of the global economy demands loans and cash bailouts.  Meanwhile, the collapse in corporate profits and massive job layoffs guarantees drastically lower government revenues at the same time that borrowing needs are escalating.

Recent events indicate that the capital markets may be unable or unwilling to fund unlimited government debt sales.

Threat To Government Debt

As countries compete for trillions of dollars of funding, markets are questioning long-held assumptions about the risk-free status of government bonds, and whether their ratings can weather the storm. Moody’s has waded into the debate by dividing its 18 triple-A countries into three categories.

At the top are 14 “resistant” triple-As, whose ratings aren’t being tested by the crisis, including Germany, France and Canada. The U.S. and the U.K. rank second as “resilient” triple-As. They face shocks to their economic model and very large contingent liabilities, but Moody’s thinks they can adjust.

Spain and Ireland, meanwhile, are “vulnerable,” based on their lack of ability to rebound. Ireland’s rating already has a negative outlook. Standard & Poor’s has downgraded Spain.

All of the sovereigns face mounting debt-to-GDP ratios, as debt issuance balloons and economic output declines.

Under Moody’s stress scenario, involving a further growth shock and permanently higher interest rates, interest payments for the U.S., U.K. and Ireland as a share of general government revenues would rise above 10% by the end of 2011 from 6.1%, 5.3% and 2.8%, respectively, at the end of 2007. Spain’s indicator would rise to over 5% from 3.9%.

The 10% barrier is crucial, as above this level debt service costs start to limit governments’ options. Double-A-rated Italy’s indicator was 10.7% at the end of 2007. Rome has admitted it can only respond in a limited way to the crisis because of its debt burden.

Japanese Bonds Fall With Rising Debt Sales

Feb. 16 (Bloomberg) — Japan’s 10-year bonds fell the most in a week on concern the government will spend more to revive an economy that shrank last quarter by the most since 1974.

Ten-year yields climbed from near a two-week low after the Cabinet Office said today the economy contracted at an annual 12.7 percent pace last quarter. Japan may expand its stimulus plans by 30 trillion yen ($323 billion)

Australian bonds also fell today as Prime Minister Kevin Rudd’s government steps up debt sales to finance economic packages. Australia’s government is selling as much as A$24 billion ($15.6 billion) of bonds by June 30 as it increases spending to avoid the nation’s first recession in 17 years.

Korean Auction

The South Korean government’s auction today of 10-year bonds failed to attracted sufficient demand for a second consecutive month. The government raised 584 billion won ($409 million) at the sale today, less than the 800 billion won it was seeking.

Japan’s debt burden is the largest among G-7 nations relative to GDP, according to data compiled by Bloomberg. Italy’s debt is equal to 117 percent of GDP, while the other five countries are below 70 percent, the data show.

Obama’s Promises Of Open Ended US Borrowing Deters Buyers

The Wall Street Journal notes that:

Prices of government bonds started to fall Friday, ahead of the vote by the House of Representatives that approved the $789.5 billion stimulus package. This decline could be the beginning of the capitulation the market has been bracing for since the administration of President Barack Obama took over, with promises of a recession-era boom in government spending.

No sooner had lawmakers reached a compromise on this spending program than yet another began to take shape, this time to help homeowners avoid default on their mortgages. Though the dimensions of this package are unclear — details are expected Wednesday — the bottom line is unequivocal. Each new rescue plan signals an expansion of government borrowing and more bonds flooding the market, which absorbed a record $67 billion last week.

As we can see from the chart of the TLT, a proxy for the government long bond, the bond market has been selling off dramatically for weeks as the size of the stimulus package became clear.  Major foreign buyers of our debt, such as China, are bluntly questioning our ability to repay.  It is obvious to logical minds that there are constraints and consequences to a government’s determination to borrow money beyond its capacity to service the debt.   South Korea and Germany have already had failed bond auctions, with insufficient investor demand to buy all the debt offered.  Italy is so indebted already, it has given up trying to sell additional debt.  Rational investors do not lend money to borrowers judged incapable of servicing and repaying debt.


US interest rates will continue to rise as Congress talks of further huge government borrowings.  Higher borrowing costs will severely strain government budgets.  The banking industry, corporate America and John Q Public all are demanding funding, bailouts and tax breaks.   Congress’s promises to bailout everyone and to “spend us into prosperity” with borrowed money will lead to financial disaster.  The out of control borrowing and spending will eventually result in the need for a bailout of the United States.  At that point, the issue of default by the United States will no longer constitute an academic discussion – it will be real and the cost will be unimaginable.   Hopefully, the ruling elite will not bring us to this final stage of national ruin.

Stanford Financial Investigated

Investors Flunk “Too Good To Be True” Test Again

“You only find out who is swimming naked when the tide goes out” – Warren Buffet

The tide has been going out for several years now and we are discovering that many of the biggest players never owned bathing attire.   Tight credit and massive erosion in asset values have exposed the mismanaged or fraudulently run operations that previously papered over their flaws with more credit.    Investors in Stanford Financial, who apparently ignored the common sense rule of “if it’s too good to be true it’s probably not” are likely to be in for a massive shock of reality this week.

According to BusinessWeek, The Stanford Group may hold as much as $50 billion in assets.

Is Stanford’s Financial Offer To Good To Be True?

Financier R. Allen Stanford makes investors an enticing offer: He sells supposedly super-safe certificates of deposit with interest rates more than twice the market average. His firm says it generates the impressive returns by investing the CD money largely in corporate stocks, real estate, hedge funds, and precious metals.

But skeptical federal and state regulators are now taking a hard look at Stanford’s operation—especially those CDs, whose underlying investments seem questionable. Over the past 12 months, the stock market and hedge funds have lost huge amounts of value even as Houston-based Stanford Financial Group continued to pay out above-average returns and claimed to have boosted the assets it oversees by 30%, to more than $50 billion.

BusinessWeek has learned that the Securities & Exchange Commission, the Florida Office of Financial Regulation, and the Financial Industry Regulatory Authority, a major private-sector oversight body, are all investigating Stanford Financial. The probes focus on the high-yield CDs and the investment strategy behind them. According to people close to the investigations, the three agencies are also looking at how Stanford Financial could afford to give employees large bonuses, luxury cars, and expensive vacations. Selling CDs typically is a low-margin business.


In the wake of Bernard Madoff’s alleged $50 billion Ponzi scheme, regulators and investors around the world are increasingly jittery about money-management firms that promise consistently higher-than-normal returns.

Stanford’s CDs, which require a minimum investment of $50,000, offer tantalizing interest rates. The current rate on a one-year CD is roughly 4.5%, according to the bank’s Web site. The average at U.S. banks is about 2%, notes research firm (RATE). A year ago, the offshore bank sold five-year CDs that yielded 7.03%; the industry average hovered around 3.9%.

The firm suggests in marketing material that it can offer substantially higher rates because the bank benefits from Antigua’s low taxes and modest overhead costs, among other factors. The bank invests in a “well-diversified portfolio of highly marketable securities issued by stable governments, strong multinational companies, and major international banks,” the marketing literature says.

But Stanford Financial and its affiliated bank, both of which are owned by Allen Stanford, offer few details about the nature of those holdings. According to the bank’s 2007 annual report, stocks, precious metals, and alternative investments—such as hedge funds and real estate—account for 75% of the bank’s portfolio.

Stanford’s CDs lack the government insurance that backs certificates issued by U.S. banks.

The financials of the offshore bank are audited by a tiny accounting firm (14 employees) in Antigua called C.A.S. Hewlett & Co.

The offshore bank’s seven-member board of directors is dominated by Stanford insiders, family, and friends.

Stanford brokers who sold at least $2 million of CDs in a quarter kept 2% of the assets, says Hazlett. That’s much more than competitors generally pay their sales forces on such investments. “The primary thing they cared about were CDs,” says Hazlett. “That was all they talked about in meetings with brokers.” But the high yields “never made any sense to me,” he adds. “I never understood how they could generate the performance to justify those rates.”

Funding Commitments Pulled, CD Redemptions Delayed, Assets Invested In Illiquid Securities

An offshore bank at the center of two U.S. federal investigations recently curtailed financing commitments to two small American companies, regulatory filings show.

Some Stanford International representatives have been recently advising clients that they can’t redeem their CDs for two months, a person familiar with the matter said.

But SEC filings show that the Antigua bank also holds majority stakes in a handful of thinly traded American firms.

Stanford Financial Gets More Scrutiny – FBI and SEC Investigate

An investigation into wealthy financier R. Allen Stanford’s operations is intensifying, with the FBI looking into his financial group in the U.S. and regulators in Antigua scheduled to visit his bank there.

Another person familiar with the investigation said the SEC has been looking at the certificate-of-deposit business since at least 2007.

Those people say the agencies now are focusing on certificates of deposit, which are marketed by the financial group’s wealth-management arm and sold by Mr. Stanford’s Antiguan bank. The CDs offer unusually high returns; for example, as of Nov. 28, a one-year, $100,000 CD paid 4.5%.

“The first thing that grabs your eye is the business model,” says Alex Dalmady, an analyst who unveiled concerns about Stanford International Bank in the magazine VenEconomy Monthly but isn’t involved in the investigation. “Taking deposits and playing the stock market — this is way too risky. “

Stanford Blames “Disgruntled Workers”

Feb. 13 (Bloomberg) — R. Allen Stanford, the billionaire chairman of Houston-based investment firm Stanford Group Co., blamed “former disgruntled employees” for stoking regulatory probes into his firm.

Stanford Group pushed its financial advisers to steer clients’ money into the offshore CDs, paying a 1 percent bonus commission and offering prizes including trips and cash for the best producers, according to four former advisers who asked not to be identified.

Marketing material for Stanford Group CDs raised red flags, said Bob Parrish, a financial planner and accountant in Longboat Key, Florida.

The use of the term “CD” to describe the investment was misleading because most investors associate it with a safe, FDIC- insured instrument, Parrish said.

SIB describes the CDs in its disclosure statement as traditional bank deposits. The bank doesn’t lend proceeds and instead invests in a mix of equities, metals, currencies and derivatives, according to its Web site and CD disclosures.

Warning Signs Ignored By All

Yields offered at twice the market average, offshore accounts, huge commissions paid to brokers to draw in more cash, SEC investigation since 2007, extravagant corporate lifestyles, assets invested in hedge funds, real estate, stocks and alternative (illiquid) investments which have all fallen 40 – 50% in value, frantic efforts to raise additional funds, previous regulatory investigations and risky business model.  It is not hard to see the ending to this story.  Once again regulators and investors have shown extraordinary carelessness and disregard of information that was readily available for scrutiny.

This is probably not another Ponzi scheme similar to Bernard Madoff.  It seems more like a case of poor asset management leading to large losses which management then attempted to cover up with additional investor funding.   The end result, however, will be the same as for those who invested with Madoff – a significant loss on their investments.

Notable Links – Gold’s Tipping Point, US Follows Japan’s Failed Strategy

Some Clear Thinking On Credit And Government Policies

Confidence More Important Than Gold

by Axel Merk | February 11, 2009

In a rare interview with Western media, Wen Jiabao, the Chinese premier, told the Financial Times (see,

‘Confidence is the most important thing, more important than gold or currency’

Why is it that such wisdom comes from the leader of China, but is absent from the leaders of other countries? Do other presidents and prime ministers intentionally play a backstage role, letting their Treasury secretaries or finance ministers communicate with the public to avert blame when policies fail? That suggests that the leadership may not have all that much confidence in the programs they are promoting; or more likely, the leadership does not understand the issues.

Investors and entrepreneurs take risks in search of profit opportunities. In contrast, in times of crisis, many avoid risks and hoard cash in an effort not to lose money. Except, of course, if your bank or the currency you hold the cash in goes down the drain. When confidence even in cash erodes, gold thrives. The slogan for crisis investing so dreaded by governments is:

‘Gold is the most important thing, more important than confidence or currency’

Governments dread investors flocking to gold because it shows a lack of confidence in riskier alternatives available. Gold’s attraction is that its value cannot go to zero; that it has no counter-party risk; gold over the millennia has shown to be a store of value. But economies do not grow when gold is hoarded: capitalism requires risk seekers.

But what about all those folks who need to have a bailout? Something obviously went wrong as individuals and businesses took on too much credit. The solution, however, is not to prop up a broken system by stuffing even more credit down the throat of those who couldn’t handle the credit in the first place. The solution is to allow an orderly write off of investments and loans that have gone wrong. Most mortgages are non-recourse loans, meaning homeowners could simply hand over the keys to their homes and walk away from their debt. As a result, financial institutions would think twice before making a loan to such borrowers in the future.

What it comes down to is that just about all policies proposed deal with propping up a broken system rather than initiating the reforms necessary. Credit plays an important role in modern economies, but throwing more credit at those who are over-extended is not the solution. Quite

Present government policies are aimed at coercing the public into taking risky investments so that they don’t lose the purchasing power of their hard earned cash. The reason that’s done is so that all the debt can be served. We can do better than that. If we had less debt, we would be more concerned about preservation of purchasing power. But because the government also has tremendous debt, the interests of governments and savers are not aligned.

The U.S. economy has attracted investment for so long because it has been a fair place to conduct business in. Gaining the confidence of investors takes decades to build, but is easily destroyed. The U.S. must focus on reform to avoid some of the excesses from happening again; not simply prop up a broken system. So far, all we see is governments throwing money at the problem. We may be able to sum up our current policies as

‘We don’t know what we are doing, but we are doing a lot of it…’

This article is well worth a full reading.

Politicians do what they do to stay elected whether it makes sense or not.  We tell ourselves that we are not making the same mistakes as Japan did with its economy but we are deluding ourselves.   We are employing the same failed policies that the Japanese politicians tried.  Instead of letting free market forces work, the government is attempting to keep an over leveraged system functional by providing more credit to those who have shown no particular ability to repay what they owe already.  This strategy does nothing to build a strong economic system going forward.  The president is predicting a “lost decade”.   We will be fortunate indeed if a real turnaround comes that soon.  Japan is now close to starting  its third “lost decade”.

Courtesy Yahoo Finance

More Thoughts On Gold

Is the gold market telling us that an economic catastrophe is imminent?

It certainly might seem as though it is. By late morning Eastern time Wednesday, an ounce of the yellow metal was ahead by more than $30 from where it closed Tuesday.
But it doesn’t take much of a historical memory to appreciate that gold’s message is far more inscrutable.
Consider, for example, that gold traded for nearly $1,000 per ounce last July, compared with the $945 level at which bullion was trading Wednesday morning. That’s a very telling contrast: Though things weren’t all brightness and light last summer,
Even so, gold was higher then than now. Why?
This question becomes even more pertinent upon realizing the federal government’s actions since last July have been a textbook illustration of the inflationary behavior for which Ben Bernanke earned his nickname of “Helicopter Ben.” Yet, curiously, gold — the ultimate inflation hedge — is lower today than then.

A good point is made as to why gold is not higher than it was a year ago.  Every market price implies an equilibrium of buyers and sellers.  Despite the obvious bad news reasons why gold should be higher, in theory, it is not.  Perhaps investors are still in the denial stage from an economic perspective, preferring to believe that this is another routine recession.  There will be a tipping point where denial turns to loss of confidence and gold will be avidly sought as a refuge for capital.  At this juncture, the buyers will vastly outnumber the sellers.

Welcome To Washington Mr.Geithner – More Evidence of “We don’t know what we are doing, but we are doing a lot of it”

Feb. 11 (Bloomberg) — That’s it? That’s all Geithner had to offer?

It is amazing that this far into the financial crisis, we are still stumbling along, still so reluctant to tackle the problems facing the financial system and the economy.

Rather than offer the kind of comprehensive solution he had promised, Treasury Secretary Timothy Geithner yesterday served up a plan for banks and the financial system that was long on platitudes and short on specifics.

And that’s being kind. There were no specifics. There were only vague promises of programs and details to come.

And the specifics? “We are not going to put out details until we have the right structure,” Geithner said.

If that’s the case, it’s not clear why Geithner bothered to speak yesterday. If his goal was to calm markets, it didn’t work, especially since investors were hoping that he would simply agree to take all the bad assets from banks and reflate the financial system in one fell swoop.

And what of the herd of ailing banks that pose systemic risks to the global financial system? Rather than euthanize those that can’t survive, Geithner plans to continue coddling them.

This is the sort of float-all-boats thinking that led to Congress’s misguided stimulus package. It represents a false hope that there is still a way for the country to muddle through this crisis without having to accept a new norm in terms of asset prices, lifestyles and expectations.

That’s not likely to happen. And it’s why the Obama administration’s first, grand effort to fix the nation’s economic ills probably won’t be its last.

Any future economic recovery will be despite the government’s actions.

Notable Links

Living Beyond Yours Means – California’s Economy Gets Worse

California’s Pain Is Only Beginning

BIG SUR, Calif. — As Sacramento squabbles over the state’s $42 billion deficit, Californians are getting a bitter taste of what’s to come after the steep budget cuts that are inevitable when legislators and Gov. Arnold Schwarzenegger finally hammer out a deal.

Some world-famous parks like Pfeiffer Big Sur State Park may not open this year. After-school programs in low-income areas are being scuttled, putting high-risk teens on the street just as police forces are being cut. Schools are closing classrooms, and some highway projects have ground to a halt. The state may not be able to monitor some sex offenders as required under law.

Other states face budget cuts too, but California’s budget mess stands out for its size. Its deficit is projected at $42 billion by mid-2010. Since Gov. Schwarzenegger declared a fiscal emergency 14 weeks ago, he and lawmakers have been deadlocked over how to close the gap. Democrats want tax increases and moderate spending cuts; Republicans seek deep cuts and no tax increases; the governor wants a combination.

The governor’s office warned Tuesday that if no budget deal is reached by Friday, the state would send layoff warnings to 20,000 workers. Gov. Schwarzenegger also said he intends to cut 10,000 jobs through layoffs and attrition to save $750 million over 17 months.

If it’s true that California sets the trend for the nation, we can all expect more economic pain.  California has discovered the limits of the theory that a government can borrow and spend its way to prosperity.  It will be interesting to see what outcome the state arrives at with its budget process.  Raising taxes would be self defeating and borrowing more would be total lunacy.  The last option result of cutting spending is already being deployed and will likely continue, putting a further drag on the state’s economy.  The era of reduced expectations is slowly dawning on California.

China Becomes Nervous Over US Debt Holdings

China Needs US Guarantee for Treasuries

Feb. 11 (Bloomberg) — China should seek guarantees that its $682 billion holdings of U.S. government debt won’t be eroded by “reckless policies,” said Yu Yongding, a former adviser to the central bank.

The U.S. “should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way,”  He declined to elaborate on the assurances needed by China, the biggest foreign holder of U.S. government debt.

Benchmark 10-year Treasury yields climbed above 3 percent this week on speculation the government will increase borrowing as President Barack Obama pushes his $838 billion stimulus package through Congress. Premier Wen Jiabao said last month his government’s strategy for investing would focus on safeguarding the value of China’s $1.95 trillion foreign reserves.

“In talks with Clinton, China will ask for a guarantee that the U.S. will support the dollar’s exchange rate and make sure China’s dollar-denominated assets are safe,” said He in Beijing. “That would be one of the prerequisites for more purchases.”

“The biggest concern for China to continue buying U.S. Treasuries is that if Obama’s stimulus doesn’t work out as expected, the Fed may have to print money to cover the deficit,” said Shen Jianguang, a Hong Kong-based economist at China International Capital Corp., partly owned by Morgan Stanley. “That will cause a dollar slump and the U.S. government debt will lose its allure for being a safe haven for international investors.”

The Chinese are correct to worry about the value of their US Treasury holdings.  It is becoming more obvious by the hour that the huge spending proposals coming out of Washington guarantee that the Fed will be printing money.  The Chinese may currently not be able or willing to liquidate their holdings in Treasuries.  The one certainty here is that the Chinese appetite for additional US debt securities will greatly diminish going forward.

Real Estate Long Way From Bottoming

The Reality Behind Real Estate

by Michael Pento, Delta Global Advisors, Inc. | February 10, 2009

Much has been written lately about the beginnings of a recovery in the real estate market. Just last week housing bugs (investment “bugs” are not exclusive to those who only love gold) were cheering the latest data point which they claimed as evidence the market is making a comeback.

So with all this good news out there, why am I still projecting a continuation of falling home prices? Inventories, especially the key reading of vacant homes for sale. The reason the number of vacant homes for sale is more salient than those that are occupied is that a home sitting vacant is much more likely to stay on the market until it is sold, regardless of price (as opposed to occupied homes, with owners who might simply pull the listing if they don’t like the price). Because the owners of so many unoccupied homes are banks, they are especially motivated to hit the bid on a property.

The reason there is an intractable level of homes for sale clearly stems from the faltering economy, which is causing massive layoffs and skyrocketing unemployment. The rate is currently 7.6%, a 17-year high. This compels homeowners (many of whom owe more on their home than it is worth) to walk away from their properties. After all, how much motivation do home owners need to abort if they are already upside down on the home and now find themselves without a job?

Home prices and mortgages rates may have to fall well below historical levels in order to clear away the massive buildup in inventories, and it’s a condition which may need to exist for a protracted period of time before home price stability can occur.

Healing takes time, but that is not part of our new administration’s plan to fix the real estate market. Instead, like his predecessor George W. Bush, the Obama team feels it is better to artificially prop up home prices at an unsustainable level rather than have them retreat to a price that can be supported by the free market. But then again, isn’t this just more evidence that the idea of free market capitalism is being trampled—by both parties.

The Government will waste huge amounts of resources trying to fight free market forces and fail in the end.  Attempts to establish artificial market prices has never worked and it will not work now.

PIMCO Demands That Fed Print Money

PIMCO Says World Faces Second Wave of Economic Crisis

Feb. 11 (Bloomberg) — Pacific Investment Management Co., which runs the world’s biggest bond fund, said the global economy faces a “second wave” of turmoil unless governments adopt larger spending plans.

“The economic setback is still in its early stages,” Koyo Ozeki, head of Asia-Pacific credit research at Pimco’s Tokyo office, wrote in a report on the firm’s Web site. “Any further decline in housing prices could accelerate the downturn, intensifying the pernicious feedback loop and possibly leading to a second wave in the financial crisis in the next six to 12 months.”

Bill Gross, Pimco’s co-chief investment officer, said on Feb. 5 the Federal Reserve will have to buy Treasuries to curb yields as debt sales increase.

“To overcome that second wave, governments worldwide would have to spend vast quantities,” Ozeki wrote. “The resulting erosion in their finances would increase the risk of dangerous side effects.”

It sounds like the largest bond fund in the world is getting so nervous about their bond holdings that Bill Gross is calling on the Fed to print money via the purchase of Treasuries.   We are reaching a very dangerous point in the nation’s finances when there seems to a consensus that printing money is the only solution to our economic woes.  The free market solution of restructuring and bankruptcies is being avoided at all costs.  Expect a long drawn out economic nightmare.

What is the end result of printing money?   See The Zimbabwean Dollar – The Point of No Return – this may be our future.

Japan’s GDP Down 50% In One Year?

Titanic Sails Again to Sink Deck-Chair Economy

Feb. 11 (Bloomberg) — NEC Corp. started a trend that will forever change Japan.

The nation’s largest personal-computer maker on Jan. 30 said it will fire more than 20,000 employees. That announcement would have been shocking enough had it not opened the floodgates. Since then, Panasonic Corp. said it will cut 15,000 jobs. Nissan Motor Co. is cutting 20,000.

Even during the darkest days of the 1990s — deflation, bank failures, public bailouts — companies avoided mass layoffs. NEC’s precedent seems to have made it fashionable to do just that. What’s next? Sony Corp. firing 50,000 people in Tokyo?

The psychological blow to Japan’s already skeptical consumers is sure to deepen the recession at a speed few thought remotely possible just two months ago.

“Japan’s recent economic decline is faster than that of the U.S., which has been experiencing the worst financial crisis in a century,” Kazuo Momma, head of research and statistics at the Bank of Japan, said in Tokyo on Feb. 9.

Momma said the world’s second-largest economy may have shrunk at an “unimaginable” speed last quarter. Gross domestic product fell at an annual 11.7 percent pace in the fourth quarter of 2008, according to the median estimate of 23 economists surveyed by Bloomberg News. That would be the steepest decline since 1974.

At this rate, Japan’s GDP gets cut in half in about a year.  The social and economic devastation we are experiencing will test governments worldwide.  Based on the governmental “solutions” we have seen so far, I would not be optimistic.   See the next link for what our future may look like.

Is There A Possibility For Optimism?

Boomers – Your Crisis Has Arrived

by James Quinn
February 10, 2009

“There is a mysterious cycle in human events. To some generations, much is given. Of other generations, much is expected. This Generation has a rendezvous with destiny.” Franklin Roosevelt – 1936

President Roosevelt was correct. The generation he was speaking to was already dealing with the worst financial crisis in the history of the United States, the Great Depression. By 1945, over 400,000 of this generation had lost their lives. Another 600,000 men were wounded. Much was expected and much was sacrificed. Every generation has a rendezvous with destiny. The generation that won World War II passed the ultimate test and proceeded to produce the next generation, the Baby Boom Generation. Their rendezvous with destiny is underway. Will it be a rendezvous with history that results in World War III, the collapse of the Great American Republic, dictatorship, or a return to the original Constitutional principles upon which this country was founded?

Based on the foolish actions of most politicians in Washington over the last thirty years, I fear for the future of our country. I don’t think the politicians in Washington comprehend the state of affairs. I sense the mood of the country turning. Fear, anger and disillusionment are the prevalent themes. Change is coming, but it is not the change that Barack Obama campaigned for. It will be forced upon us by circumstances beyond any one person’s control. While we are hurtling towards our summit with destiny, Congress continues its path of pork barrel spending, short term solutions, party politics, and condemning our children and grandchildren to a lower standard of living. The “leaders” of this country are using the tried and true method of using fear to ram through their $900 billion tax on future generations. President Bush used the same fear tactics to launch his invasion of Iraq. I see a similar success story with the coming stimulus package. Maybe the coming crisis will ultimately lead to Great Leaders rising to the occasion.

Another insightful writing by James Quinn with some very profound thoughts – well worth reading the full text.

When Does Gold Break Out To The Upside?

Investors Bet Gold To Reach $1,000

Feb. 10 (Bloomberg) — Gold speculators have increased their bets this year by 24 percent that prices will reach $1,000 an ounce by April.

Open interest in options that allow the holder to buy gold at $1,000 by April surged to 9,934 contracts as of Feb. 6 from 8,005 at the start of the year on the New York Mercantile Exchange’s Comex division. Mounting financial turmoil is boosting demand for the precious metal as a haven. Since Jan. 15, the price of the option has almost doubled, outpacing the 12 percent gain in gold futures.

Gold has gained for eight straight years and soared to a record $1,033.90 an ounce in March as mounting bank losses and a declining dollar increased demand for the metal as a store of value. Financial turmoil may push the price above that record to $2,000 as traders buy the metal as a haven, said Eric Sprott, the Canadian money manager who last year predicted banking stocks would collapse.

“The focal point is $1,000,” said Philip Gotthelf, the president of Equidex, who correctly predicted in October crude oil would fall below $40 a barrel. Gold above $1,000 is a “warning signal to central banks that people have already lost faith in currencies,” Gotthelf said.

My only question is why gold is not already selling at $5,000.  Once the $1,000 barrier is decisively breached, expect a massive gold rally with up moves of hundreds of dollars a day.  Gold is a thin market and the price will move accordingly.

Banks Restrict Mortgage Lending To A+ Customers Only

Latest Changes Eliminate More Borrowers From Mortgage Market

As written previously, for those without impeccable credit, adequate income and loan to value below 70%, the low advertised rates are not available.  See All Time Low Rates For A++ Borrowers Only and Few May Benefit From Lower Mortgage Rates.

Much more stringent underwritten guidelines for mortgage approvals were issued today by a major bank as follows:

Important Update Regarding Revised Minimum Credit Score for All Loan Products, Effective Immediately

Effective for locks on or after Tuesday, February 10, 2009, the minimum credit score requirement for ALL loan products is 640. This includes the following loan programs:

· Agency Loan Program

· Agency Affordable Lending Program

· Portfolio Affordable Housing Program

· Texas Cash Out Refinance

· FHA 203b (FHA),

· Veterans Administration (VA), and

· Rural Development (RD) Guaranteed Rural Housing (GRH) Program

Additionally, the following applies:

· a minimum credit score of 640 will be required for ALL scoreable borrowers regardless of the LTV/TLTV.

· A minimum credit score of 640 will be required for all traditionally underwritten and AUS (DU/DO and LP) processed loan transactions, regardless of the AUS approval or recommendation.

These new guidelines are far more restrictive than Fannie Mae, Freddie Mac and FHA guidelines.   The bank and mortgage company guidelines are the ones that really matter because a consumer cannot directly apply to the agencies for a mortgage.

Pricing on mortgages can be described as chaotic.  Guideline changes such as the ones instituted today are basically a message from the banks that the mortgage business is unprofitable to them.   Every customer is seen as a future default.  Simply put, the banks do not want new mortgage business, which is why virtually every major bank has eliminated their wholesale lending operations.   The mortgage bankers who sell their loans to the agencies or larger banks are restricted in lending activities by the lack of warehouse lines of credit.  All of the above factors combined have severely restricted mortgage lending and disrupted the established channels for mortgage lending.  A perfect borrower with a loan to value under 70% can still reap the full benefit of lower rates; all other borrowers will find it very difficult to qualify.

The Fed can buy mortgage backed securities and treasury bonds by the trillions to lower mortgage rates, but with the lending intermediaries either unwilling or unable to make new mortgage loans, the benefit of any rate reductions will be severely limited to  A++ customers.   The borrowers who need the benefit of lower rates the most will see the least benefit since many do not qualify under current guidelines.

Is The Economic Panic Justified?

Act In Haste, you know the rest…

How many of us have had a make a fast decision when panicked or stressed?   How many times have we heard, “I wish I had thought things out a little more before acting”?

Are we now about to make a poor and panicked decision as a nation?  I am extremely dubious of anyone who tells me that I must act on an imminent catastrophe and that I must do it quick, no questions asked, no thinking allowed.   I chose not to live with the consequences of such an ill conceived process.

We can agree that the economy is contracting.  The value question is what, if anything, should we do about it?    The corrective forces of a free market economy are not pleasant but they are necessary. The creative destruction of a recession wrings out the excesses that caused the bust and lays the groundwork for future sustained growth.    Poorly run and unprofitable companies die.   Capital is redirected to new healthy enterprises rather than being used to subsidize zombie operations.   Attempts to stop these self correcting economic mechanisms of capitalism are self defeating.

Two articles worth the read that consider these points are linked below.

Overact, Overthink

The Obama Administration is overthinking the current recession because, in a panic, its economic team sees no light at the end of the recessionary tunnel. This is despite the fact automatic stabilizers such as falling energy prices, falling home prices, falling interest rates, and diminished wage pressures are already beginning to reinvigorate the economy. Accordingly, the Journal’s editorial is correct that the Obama fiscal stimulus package is way overdone. The only fiscal stimuli that should be considered are ones that can get right into the pipeline through the rest of 2009 and ones that stabilize the housing market.

This observation leads naturally to the concern that the Obama administration is likewise overreacting to the credit crisis. This crisis does not require massive loan guarantees, big bad banks, or, the deity help us all, nationalization. Instead, the crisis really requires only one solution: Reducing the rate of home foreclosures. Most of the toxic assets on bank balance sheets represent mortgages gone — or going — bad. Focusing singularly on stability in the housing market would go a long way towards restoring these balance sheets and opening back up the credit spigot urgently needed by American business.

Accordingly, it will be exceedingly interesting as to how the bond market reacts first to the fiscal stimulus and then to the Big Bang solution to the credit crisis scheduled to come out this week from the Obama administration. At the long bond dives in price and goes up in yields, that’s a big bet that the Big Bang will be highly inflationary.

The End of Wealth Creation

The Roman Empire

The rise and fall of the Roman Empire is a classic example of Return On Investment (ROI). Rome essentially funded conquest through pillage, bringing rich treasures of gold and silver back to Rome. During the early years of the Empire, the ROI on conquest was very good and Rome prospered. It had plenty of coin to fund its Legions. As the years went by, however, it became more difficult to find lands worth conquering and the travel costs to send a Legion to remote lands increased. The ROI of conquest began to falter, and Roman Emperors finally concluded additional conquests were not worth the cost. Years of wealth creation came to an end. The Roman Empire shifted its attention to wealth preservation.

The Deterioration Of GDP

The American economy has an embedded structural problem. Our economic focus has shifted to the preservation of wealth. This is not a prediction of the future. It is already happening. The following chart shows the annual change in Current Dollar Gross Domestic Product (GDP) from 1968 – 2008. Note that current dollar GDP seldom exceeds 2% after Q2 of 1984. For the last 20 years, the average has been just over 1.2%.

This is why I am furious at the intellectually challenged thinking that has gone into the proposed “stimulus” bill. It does much to transfer wealth. It does a woefully inadequate job of providing the opportunity to create substantial new wealth.

Our government is currently trying to artificially elevate American Real Estate values and sustain economic activity by spending several trillion $$ of taxpayer money on “bail-outs” and “stimulus” packages. Although money flow will surge for a time, these efforts will ultimately fail because they do not address the fundamental underlying problem – we have slipped into preservation mode. If we want these programs to be successful, they have to either create wealth, or facilitate the creation of wealth. (Reference 2)

Saks “Gets It” – Starbucks Not Quite There

Brutal Days For Retailers

Retailing has suddenly become a lot more complicated than simply planning how many more stores to open next year and projecting sales increases.   Today, the toughest job is surviving. Job losses, pay cuts and lack of credit have turned the once profligate American consumer into a modern day Scrooge.   Many consumers have cut back on all but the essentials – frugality has become a necessary virtue.   Retailers that over expanded with borrowed capital  will not last as they discover that cash flow does not cover debt service.

The great American retailers that will survive have already adapted to the new age of frugality.  Consider Saks Fifth Avenue and Starbucks, both of whom market their goods at the higher price points.

Saks Upends Luxury Market With Strategy To Slash Prices

When Saks Fifth Avenue slashed prices by 70% on designer clothes before the holiday season even began, shoppers stampeded. “It was like the running of the bulls,” says Kathryn Finney, who says she was knocked to the floor in New York’s flagship store by someone lunging for a pair of $535 Manolo Blahnik shoes going for $160.

Saks’s deep, mid-November markdowns were the first tug on a thread that’s now unraveling long-established rules of the luxury-goods industry. The changes are bankrupting some firms, toppling longstanding agreements on pricing and distribution, and destroying the very air of exclusivity that designers are trying to sell.

Sak’s risky price-cut strategy was to be one of the first to discount deeply, rather than one of the last.  Sak’s chief executive says his actions were done to “make sure that the company survives”.  Last Thursday, Saks said January sales fell nearly 24%.

Saks will survive but its strategy is putting many of its smaller competitors out of business since they cannot compete with the massive discounts Saks is offering.  Saks also recognizes the risk of discounting to their future sales.  How many customers will pay $3,000 for a “designer luxury good” in the future, when they can now buy such an item for $900?   Discounts of 70% make one feel foolish to have overpaid so much even when times were good.

Starbucks Plays Common Joe

Starbucks Corp., which built a coffee empire on its premium image, wants to convince customers that its drinks aren’t that expensive.

The company said Monday that it’s selling discounted pairings of coffee and breakfast food for $3.95, a type of promotion long used at fast-food chains. It’s the first move in an aggressive campaign to counter the widespread perception that Starbucks is the home of the $4 cup of coffee.

The move shows how premium brands are trying to reposition themselves for a prolonged economic downturn.

“I strongly believe we are going to be in this environment for years,” Howard Schultz, chief executive of Starbucks, said in an interview. “It is a reset of both economic and social behavior.”

Asked whether Starbucks is considering simply reducing drink prices, Ms. Gass said: “Today, no. But never say never.”

Mr Schultz is correct.  This is a new world for retailers and you adapt or you go under.  Starbucks has cut costs in its operations over the past year but has not cut product prices.   If sales continue to decline Starbucks will be forced to discount, just as Saks is doing.   Expect to see price cuts coming soon on your favorite Starbucks beverage.