Week of August 11, 2008

Monday, August 11, 2008, 1:48 PM

Dollar surge may end commods supercycle (August 10 – Reuters LONDON)

The debate over a possible end to the dollar's
seven-year downtrend will take centre stage this week as the supercycle
in oil and commodities runs out of stamina, helping stocks and bonds in
times of slowing economic growth. A rising dollar and falling oil
prices create a virtuous circle and help risky assets as they ease
inflation pressures, giving central banks rooms to fight the
one-year-old credit crisis with interest rate cuts.

such optimism, world stocks, measured by MSCI, stayed last week well
above the 21-month low hit in July even though financial firms and
other corporates unveiled more damage from the credit crisis.

markets look considerably perkier than a few weeks ago. Their recovery
has been helped by a softer oil price, encouraging a revival in risk
appetite," said Michael Dicks, head of research at Barclays Wealth.

This is
exactly why I say I smell a rat in the recent dollar strength and
commodity weakness. It was just too convenient by half for the world’s
central banks, who desperately needed:

1) Inflation
to abate so that they could keep interest rates at unnaturally low
levels. Since commodity inflation is the one the voters tend to
experience most painfully, a big commodity collapse was just what they

2) Paper
assets, especially stocks and bonds, to rally, so that crippled bank
balance sheets could be stabilized, if not repaired.

And, hey,
they magically got both. As the article above makes clear, it is
considered a “virtuous circle” when people rush back into risky assets
and out of “things” like oil, which tend to call into question the
utility of central-bank-managed money as a store of wealth.

The well respected blog commentator Michael Shedlock (“Mish”) disagrees with this line of thinking,
stating, “Here's the deal for dollar bears: The dollar rallied because
it was damn good and ready to rally. Those with their eyes open spotted
fundamental reasons in advance. Those who did not, blamed
intervention.” However, Mish has a very strong bias towards deflation
as what the future will hold (while I am more agnostic on that matter),
and this colors his analysis somewhat. In my mind, the fundamental
reasons weighing against the dollar are more numerous and larger than
those supporting the dollar. Our interest rates are lower than Europe
(a negative), our trade balance is still $50+ billion to the negative
each month, we are fighting two very expensive wars, and our federal
fiscal deficit is set to hit $500 billion next year.

None of
these are what I would term good fundamental reasons for a dollar
rally. In the absence of fundamental reasons, I seek other reasons.

That, plus
the fact that the currency markets are widely known to be regularly
interfered with by central banks. They say they do it, they (sometimes)
tell us after they do it, and they use hidden proxy banks to do their
bidding. I am of the mind that if someone says they are going to do
something, admits they do it, and then I see signs that it happened, I
tend to think that maybe they did it.

Of course, I could be wrong and Mish could be right. I’m keeping my mind and my eyes open.


There's a new land grab starting in America.
Foreign money, which up to now has focused its attention on investing
in iconic commercial real estate - like Barneys New York and the
Chrysler Building - is now moving to scoop up tens of thousands of
discounted foreclosed homes across the country.

One sovereign
fund, said to have earmarked $29 billion to purchase foreclosed
residential real estate, recently hired a West Coast mortgage broker
and is starting to search for bargains, The Post has learned.

Well isn’t
this just dandy. Foreign central banks buy our bonds and drive down our
interest rates. This sets the stage for a housing bubble that causes a
lot of people to get into trouble buying more house than they can
afford. Now the same countries are stepping back into the mess buying
US properties for ~50 cents on the dollar with the same money that they
originally used to drive down interest rates. The circle is complete.

I, for one,
am not at all happy with the prospect of selling our domestic assets
(houses!) to foreign “sovereign wealth funds” (read: recycled oil and
trade deficit money). The price of our overspending would seem to be
the loss of our homes to the very people we bought too much from on
credit. While I am normally a big a fan of consequences, this sticks in
my throat.

Three major US naval strike forces due this week in Persian Gulf (Aug 11 – Debka)

DEBKAfile’s military sources note that the arrival
of the three new American flotillas will raise to five the number of US
strike forces in Middle East waters – an unprecedented build-up since
the crisis erupted over Iran’s nuclear program.

This vast
naval and air strength consists of more than 40 warships and
submarines, some of the latter nuclear-armed, opposite the Islamic
Republic, a concentration last seen just before the US-led invasion of
Iraq in 2003.

I don’t
normally post ‘news’ items from Debka (which I consider to mainly be a
form of propaganda), but this seems to provide confirmation of other
rumors that I was tracking down this weekend concerning a very large
naval flotilla heading towards the Middle East. What is left unsaid in
this article is that the arriving ships are meant to replace departing
ships. However, if that does not come to pass, then this will be the
largest naval presence since, uh, well, since the 2003 attack and
invasion of Iraq.

This bears watching.

Credit default swap market under scrutiny (Aug 10 – IHT)

Credit default swaps, known as CDS's, allow
investors to bet on a company's prospects or hedge against possible
default by an issuer whose debt they hold. If a default occurs, the
party providing the credit protection - the seller - must make the
buyer whole on the amount of insurance bought.

At the urging
of Eric Dinallo, the New York State insurance superintendent, Merrill
Lynch agreed two weeks ago to unwind $3.7 billion of insurance it had
bought on the mortgage-related obligations. Merrill received $500
million from XL Capital to close out the insurance contract that one of
its former subsidiaries, Security Capital Assurance, had written.

The Credit
Default Swap market is now more than $60 trillion in size. Of course,
because each transaction offsets the other, the whole thing should sum
up to zero at any given time. That is, if I am on the buying side of $1
trillion in protection (+1) and you are on the selling side of that $1
trillion (-1), then we could add those up and they’d equal zero. The
problem comes in when the market for those derivatives changes in your
favor, and you think that your position is now worth $200 billion while
my position is worth -$200 billion. You go ahead and merrily mark up
your portfolio to reflect this large gain and tell your happy clients
how much they have “made,” while I am busy gnawing my fingernails
knowing there is no way I could ever pay that amount.

That’s what
has been outlined here. Merrill Lynch thought it had a $3.7 billion
dollar stake on some CDS insurance it had bought, but only received
$500 million or 13% of what it thought it had. IF this is typical,
there are LOTS of companies out there sitting on “profits” (possibly
already reported to shareholders) that do not exist because they cannot
and will not ever be paid. This is called “counterparty risk,” and I
have yet to see any financial statements that deduct an amount for this


than 1/3rd of all houses bought over the past 5 years are worth less
than their mortgage values, and there’s a big disconnect between house
prices in general and what home owners think theirs is worth. The trade
deficit provides a perfect example of an egregious Fuzzy Number, while
one commentator thinks what we need is “A Good Depression.”

One Third of New Owners Owe More Than House Is Worth (August 12 - Bloomberg)

Almost one-third of U.S. homeowners who bought in
the last five years now owe more on their mortgages than their
properties are worth, according to, an Internet provider of
home valuations.

For those who bought at the 2006 peak of the housing market, 45 percent are now underwater, Zillow said.

homeowners who need to sell, this is a gravely serious situation,"
Humphries said in an interview. "It can also be harmful to communities
where the number of unsold homes adds more to inventory and puts
downward pressure on prices."

one-third of all homes bought in the last five years underwater on
their mortgages, we can be pretty sure that the remaining two-thirds
are not sitting on much of a gain. Assuming an average of 5.5 million
homes sold each of those five years, that’s a total of 27.5 million
homes with their noses either under or barely above the water line. The
statistics are relentless and unambiguous – house prices are falling in
a way that’s never been experienced before within our country, unless
you count Atlanta shortly after Sherman’s arrival.

As I have
long maintained, this is a once-in-a-lifetime credit bubble we went
through, and the bursting is not likely to be contained by any
simplistic efforts like the shoveling of money into Wall Street banks,
which seems to be the favored approach of the US Congress, Treasury and
Federal Reserve.

And through
all of this, even with the news being consistent and unidirectional, we
find that a majority of US homeowners have not yet gotten the message
(see next).

Most Homeowners Believe Their House has Recently Risen in Value

The housing downturn has been under way for a while
now, so it's hard to believe that many homeowners could still think
their homes are appreciating these days.

Yet a recent survey
from found that 62% of homeowners believe their home's value
has increased or stayed the same in the past year. They can't all be
right: According to Zillow, 77% of homes in the United States actually
declined in value during the same time.

"Our survey reveals a
wide gap between the perception homeowners have about their own home's
value and the realities of a market in which three-quarters of homes
declined in value in the past year," said Dr. Stan Humphries, Zillow
vice president of data and analytics, in a statement. "We attribute
this gap to a combination of inattention and a fair bit of denial that
causes people to believe their home is insulated from the woes of the
market that affect others, but not them."

In the survey of
1,361 homeowners, three out of four expect their home value will
increase or stay the same in the next six months, yet 42% expect values
in their neighborhood to drop. Four out of five homeowners expect the
amount of foreclosures will increase or stay the same in the next six
months, compared with the last six months.

Sounds like a serious case of Lake Woebegone Syndrome (LWS) has infected the land (“where all the women are strong, all the men are good-looking, and the children above average, and…”). So 75% of homeowners expect their house
to stay the same or rise in price, but 42% expect their neighbor’s
house to drop in price. This statistic alone tells me we have a long
way to go in the unfolding of this particular drama. My earlier
estimate of a housing bottom in ~2015 is looking good.

U.S. Trade Gap Unexpectedly Narrows to $56.8 Billion Aug. 12 (Bloomberg)

The U.S. trade deficit unexpectedly narrowed in
June as the biggest jump in exports in more than four years overcame
record imports of petroleum.

The gap shrank 4.1 percent to
$56.8 billion from a revised $59.2 billion in May that was smaller than
previously estimated, the Commerce Department said today in Washington.

After eliminating the influence of price changes, the trade
deficit narrowed to $39.1 billion, the lowest since December 2001, from
$43.5 billion in May. Those are the numbers used to calculate gross
domestic product and may prompt economists and the government to
increase their estimates of second-quarter growth.

Okay, I
think that the dropping of our trade deficit is a good thing, but I
want to draw your attention to another egregious example of a Fuzzy
Number. Check out that last paragraph above, which says, “After eliminating the influence of price changes, the trade deficit narrowed to $39.1 billion…”.
If the trade deficit was adjusted down from $56.8 billion to $39.1 billion, this means $17.7 billion was “adjusted away.” Huh?

That’s a 31%
drop. The funny thing is that import inflation is reported as being
only 20% at the same time. The reason for this discrepancy?

1) Boosting reported GDP.
By subtracting a big inflation number from imports, GDP can be claimed
to be higher, because we are apparently importing less and exporting

2) Claiming lower inflation.
By reporting a separate and different and lower number for import
inflation, the actual rate of inflation is hidden from view and doesn’t
overly interfere with US bond markets.

How can they do both at once? Easy - they think nobody is paying attention or cares.

America needs a 'Good Depression' (August 11 – MarketWatch - Paul Ferrell)

Most economists predict it'll take till 2010 to
burn off our excess housing inventory. RGE Monitor say Fannie and
Freddie bailouts aren't working; they'll soon be "profoundly insolvent"
and need to be "nationalized." Treasury Secretary Henry Paulson has no
long-term plans, he's a caretaker, plugging holes, anxious to get back
to Wall Street's money machine, running out the clock till he turns
over the catastrophe he enflamed to a new bunch of politicians and
their armies of 42,000 greedy lobbyists.

Lessons learned?
Zero. Why? Wall Street, Washington and Corporate America are a
one-trick pony with one narrow-minded strategy: Economic g-r-o-w-t-h,
bull markets, megabonuses. In good times they tout "free markets." But
when greed bombs, these big babies throw free market "principles" under
the "Reagan Revolution" bus as their lobbyists go whining to Congress
for megabillion taxpayer bailouts and access at the Fed casino's
discount window to siphon off more taxpayer money. What hypocritical

Wall Street and its co-conspirators are doing such a
miserable job, America needs a new strategy: Stop all the short-term
"hole-plugging." Let go and let an old-fashioned "Good Depression" do
the job that our happy-talking leaders refuse to do. Let it clean house
and reawaken America to basic values. Otherwise a "Good Depression"
will turn into a new "Great Depression."

I happen to
agree with Mr. Farrell on this one. I am quite a bit annoyed, if not
irate, that the same Wall Street titans who lecture everyone within
earshot about “free markets” and the need to keep “government from
interfering” with their financial innovation are the same ones who
shamelessly demand bailouts as soon as it looks like they are going to
have a bad quarter or two.

My solution?
Easy. All bailouts come with a stipulation that all profits recorded
during the boom years are returned to the Treasury, including
management bonuses, and that any company receiving a bailout cannot
keep the same C-level management team in place.

At any rate, this is a thought provoking article that would be fun to discuss with interested friends and neighbors.



US Government reports
a massive budget deficit on the back of rising outlays and shrinking
receipts, more evidence of a consumer-led recession is reported as
retail sales shrink, and reports of a massive hedge fund accident can
possibly explain the weird market behavior of late.

August 13

U.S. Budget Deficit Hit $102.77 Billion in July (August 13 – WSJ WASHINGTON)

The U.S. government's budget deficit nearly tripled
in July from a year earlier, pushed in part by aftershocks from failed
financial institutions. The Treasury Department on Tuesday said the
government ran a monthly deficit of $102.77 billion in July, up 182%
from $36.45 billion in July 2007.

Outlays were $263.26 billion
last month, up 27% from July 2007's $206.89 billion. Spending rose on a
$15 billion disbursement by the Federal Deposit Insurance Corp. to
cover deposits at failed financial institutions.

Government receipts were $160.49 billion, down 6% from the $170.44 billion recorded in the same month a year earlier.

Outlays were
up 27%, and receipts were down by 6%, compared to last year. This is
horrendous performance. I like to track receipts (taxes) because they
are the least subject to statistical revisions and manipulation. They
are what they are. With receipts down by 6%, it is pretty safe bet that
we are already in a recession, making the BEA’s recent claim that our
economy is expanding something of a joke.

confluence of higher spending (a slam-dunk in an election year) and
lower receipts is the exact sort of double whammy that I have been
keeping my eye out for. Why? Because this creates additional borrowing
needs by the government that will be especially tricky to fulfill
if/when the recession causes foreign investors and central banks to
have fewer dollars to loan to us. Fewer loans means fewer Treasury
bills and notes bought, which means higher interest rates, which means
lower economic activity, which means … (start at beginning and repeat
until all the bad debt is rinsed away).

Also of
interest in this piece, and something I was not aware of, is that FDIC
actions count as part of the federal budget deficit. Since they seem
to, I now wonder whether FDIC receipts have been counted in the past as
having lowered the budget deficit? I will have to look into this a bit

U.S. Retail Sales Fall for First Time in Five Months (August 13 – Bloomberg)

Sales at U.S. retailers dropped in July for the
first time in five months as record gasoline prices and tighter credit
reduced automobile purchases.

The 0.1 percent drop followed a
0.3 percent gain the prior month that was larger than previously
reported, the Commerce Department said today in Washington. Sales
excluding automobiles rose 0.4 percent, less than anticipated.

sales drop came even as the Treasury distributed tax rebates as part of
the government's fiscal stimulus plan. Consumer spending, which
accounts for more than two-thirds of the economy, is likely to keep
fading, hurt by rising unemployment, falling property values and
elevated fuel costs.

The Labor Department reported separately
that prices of imported goods rose 1.7 percent in July from the
previous month, after a 2.9 percent increase in June.

were little changed after the reports, with benchmark 10-year notes
yielding 3.89 percent at 9:21 a.m. in New York, from 3.90 percent late

Lots of
interesting tidbits here. First, according to even government
statistics we are in a bit of a sales slump. I say it that way because
I take all government economic statistics with a grain of salt. But
even with that grain of salt, the reported drop in sales is directly in
alignment with what my contacts out in the retail world are telling me.
Second, I find the disconnect between the massive import inflation
(running between 20% and 35%) and the ever-complacent Treasuries to be
a source of amazement and amusement. Who is buying ten-year bonds that
are paying a fraction of the reported rate of inflation? My bet is on
non-economic payers (central banks) rashly attempting to maintain the
status quo, more than on private investors making careful decisions.

Big liquidation triggers hedge-fund turmoil (August 9 – MarketWatch)

The liquidation of a big hedge fund or
investment-bank trading portfolio is wreaking havoc in some parts of
the hedge-fund business, managers and investors said Thursday. Black
Mesa Capital, a hedge-fund firm that uses computer models to track down
investment ideas, said that at least one large hedge fund or investment
bank is liquidating "massive" trading portfolios, according to a letter
the Santa Fe, N.M.-based firm sent to investors Wednesday.

warning is causing disruptions and triggering big losses among other
so-called market-neutral hedge funds, Black Mesa said in its letter, a
copy of which was obtained Thursday by MarketWatch.

something is amiss in the markets that few in our strategy, if anyone,
have experienced before," Black Mesa's managers, Dave DeMers and
Jonathan Spring, wrote. DeMers declined to comment Thursday.

Wondering what
caused the mysterious melt-up in stocks and meltdown in commodities?
This article could provide the explanation. If the large hedge fund in
question is supposedly liquidating “massive positions," and they
happened to be long-commodities and short-stocks, then this could
explain what we’ve seen lately.

It is also possible
that this could have been triggered by the sudden counter-trend
movement (rise) in the dollar. At any rate, hedge funds have several
trillion dollars in direct deposits to work with, but they are
leveraged anywhere between 10 times and 40 times (or more) depending on
the outfit. So they are controlling a pool of investments/assets that
are at least as large as the entire US yearly economic output, and
possibly the entire world.

It wouldn’t take much
to create some serious ripples in the water, if one (or more) of them
‘blew-up’. At any rate, this is a pretty good article and worth a read.


data is solidly saying that we are not yet near the bottom and that
we’ll know we are there because house prices in 2008 will more closely
resemble those in 2000. Inflation in the US is at a 17-year high, while
state pension funds want permission to make up for lost growth by
tossing money in hedge funds. Also, the loss of Georgia cements
Russia's energy monopoly over the west. Ouch.

August 14

U.S. Foreclosures Rise 55%, Bank Seizures Reach High (August 14 - Bloomberg)

Banks repossessed almost three times as many U.S.
homes in July as a year earlier and the number of properties at risk of
foreclosure jumped 55 percent as falling prices made it harder to sell
or refinance.

Bank seizures rose 184 percent to 77,295, the
steepest increase since reporting began in January 2005, RealtyTrac
Inc., an Irvine, California-based seller of foreclosure data, said
today in a statement. More than 272,000 properties, or one in 464 U.S.
households, got a default notice, were warned of a pending auction or
foreclosed on.

"It's getting worse," Rick Sharga, RealtyTrac's
executive vice president for marketing, said in an interview. "The
number of properties that have been foreclosed on by the banks and
still haven't sold is the highest we've ever seen."

The numbers:
1 in 464 households receiving foreclosure notices for the month
translates into 1 in every 38 households entering foreclosure this
year. As you drive along the road passing houses, count to 38 and put a
big red mental “X” over that house. Next, 77,294 bank seizures
translates into nearly 1 million homes being repossessed for the year.

So that
means that whatever “existing home sales numbers” you read about need
to be reduced by 20%-25% to account for the fact that they were “sold”
to a bank and not to a homeowner.
Most importantly, there is no sign in this data that we are yet at the bottom, or even near it.
The trend is down and getting steeper.

Against this backdrop, we have the US government still claiming that the US economy is expanding. That is highly unlikely.

Housing Rebound in Cleveland Signals Bad News for U.S. Market (Aug. 14 - Bloomberg)

The good news in the worst housing slump since the
Great Depression is that the market in Cleveland is recovering. That's
also the bad news.

A housing revival in this city of 438,000
on the shore of Lake Erie may portend deeper drops in U.S. markets.
Prices for entry level homes in Cleveland had to tumble 37 percent from
a September 2005 peak to an almost 11-year low in March before enticing
first-time buyers. That may be a sign that U.S. markets with the
biggest price increases during the 2000 to 2005 boom have much further
to fall before stabilizing, said David Blitzer, chairman of Standard
& Poor's Index Committee.

As I wrote
about last year, the most probable ‘floor’ for house prices is either
exactly where they were at the start of the bubble or perhaps a bit

Cleveland is
already there, and had to get there before seeing a positive sign in
its housing sales statistics. This process will be repeated in numerous
other communitie, regardless of whether they ‘saw a big run up’ or not.

Consumer prices see biggest on-year jump since 1991 (August 14 – MarketWatch)

U.S. consumer prices jumped a greater-than-expected
0.8% in July, marked by big increases in energy, food, clothing,
lodging and cigarettes, the Labor Department reported Thursday.

the past year, consumer prices were up 5.6%, the biggest on-year
increase since January 1991. The CPI has surged at a 10.6% annualized
rate in the past three months, the second-worst spike in inflation in
the past 26 years.

This is a horrible rate of inflation, even watered-down as it is by statistical trickery.

At the moment of
this writing, bonds are up on the news when they should be down (a
lot), and gold is down more than $17 on the day it was instantly
crushed upon the release of this news. That has been happening a lot
lately and is a mysterious bit of behavior for the most classic
inflation hedge of them all.

The “reason”
that will be given in the newspapers is that the dollar went up,
because high inflation makes it more probable that the Fed might,
someday, maybe, raise interest rates, which would be dollar-supportive.
Of course, lost in this logic is the behavior of the stock market,
which should be reacting badly to the prospect of rate hikes and a
stronger dollar, but which is
rocketing up right now instead.

Even more oddly, bonds should be down hard on the news of inflation and the prospect of a rate hike, but they are not.

At any rate, the
odd sinking of commodities over the past few weeks (given the reports
of rampant, world-wide inflation) is not likely to help inflation
readings go down much any time soon. When things like lodging,
cigarettes, and clothing are headed up, it takes a long time for a
decline in the price of commodities and fuel to work their way into
those products.

Georgia: A Blow to U.S. Energy (August 13 – Business Week)

The sudden war in the Caucasus brought Georgia to
heel, reasserted Russia's claim as the dominant force in the region,
and dealt a blow to U.S. prestige. But in this part of the world,
diplomacy and war are about oil and gas as much as they are about
hegemony and the tragic loss of human life.

Victory in Georgia
now gives Russia the edge in the struggle over access to the Caspian's
35 billion barrels of oil and trillions of cubic feet of gas. The
probable losers: the U.S. and those Western oil companies that have bet
heavily on the Caspian as one of the few regions where they could still
operate with relative freedom.

At the core of the struggle is
a vast network of actual and planned pipelines for shipping Caspian Sea
oil to the world market from countries that were once part of the
Soviet empire. American policymakers working with a BP-led consortium
had already helped build oil and natural gas pipelines across Georgia
to the Turkish coast. Next on the drawing board: another pipeline
through Georgia to carry natural gas from the eastern shore of the
Caspian Sea to Austria—offering an alternate supply to Western Europe,
which now depends on Russia for a third of its energy.

It’s pretty much
a given now that when the US cares about some country’s democracy being
threatened, there is oil somewhere in the story. Here we learn that
Georgia is an extremely important transit location for the riches of
the Caspian Sea to make their way to the West.

seems equally likely that that West badly miscalculated, in fostering
the impression that it would provide some support to the Georgian
political leadership in any conflict.

States Double Down on Hedge Funds as Returns Slide (August 14 - Bloomberg)

Public pension funds in the U.S. are increasing
bets on high-risk hedge funds and real estate in an attempt to fill
deficits in retirement plans and make up for their worst performance in
six years.

South Carolina's retirement system adopted a plan
in February to invest as much as 45 percent of its $29 billion in hedge
funds, private equity, real estate and other alternatives, from nothing
18 months ago.

The Common Retirement Fund [NY state], whose
2.6 percent gain in the year ended March 31 was its worst since 2003,
is authorized to invest as much as a quarter of its assets in
alternative investments. The fund doesn't have a deficit.

funds, which manage at least $2.45 trillion in assets, are trying to
plug deficits and reverse losses that New York-based Merrill Lynch
& Co. says averaged 5.1 percent in the year ended June 30.

Oy. This is
depressing. State pension funds are seeking permission to place as much
as 45% of pension assets into hedge funds, in a desperate bid to boost
returns. I don’t know where they find such bad ideas. Hedge funds are
largely unregulated and are the very definition of risk. On balance and
over time we might expect them to return something pretty close to
zero, as some will win and some will lose. A net zero game.

But in the world of
pensions, where continuous compounded returns in the vicinity of 8%-10%
per year are assumed, a negative 5.1% return is a gigantic disaster. It
completely wrecks the miracle of compounding and immediately creates
the need to “do something,” like either put more money in, or seek a
risky, higher-yielding form of speculation.

The winners here?
Hedge funds. They have a 20/2 fee structure meaning that they take 20%
of all positive returns and 2% of principal, no matter what. Lose a
bunch of money? Oh well, they still take the 2%. Heads they win, tails
you lose. In aggregate, there is simply no way for everybody to make
such outlandish returns in the market.

The losers here? Taxpayers.


an extremely odd coincidence, the worst commodity slam in 25 years
happened the same week that the highest inflation reading in 17 years
was reported. A great radio interview explaining the credit crunch is
linked, and the Economist discusses the next mortgage crisis in our
windshield – the Option ARM. The ECB is slammed as the European economy
crumbles, but I point out some crucial differences in the level of
honesty in their reporting vs. the US GDP pronunciations. Read on...

Gold, Oil Slump, Leading Commodities Plunge to Four-Month Low (August 15 - Bloomberg)

Aug. 15 (Bloomberg) -- Gold plunged below $800
an ounce, heading for the biggest weekly slide in more than 25 years,
and oil, wheat and sugar slumped as the dollar's rebound reduced the
appeal of commodities after a six-year boom.

Reuters/Jefferies CRB Index of 19 commodities tumbled as much as 2.7
percent to 379.07, the lowest since March 20, as silver, soybeans and
corn lead the drop. A rally this month in the U.S. currency has curbed
the appeal of dollar-priced raw materials as a hedge against inflation,
and demand for commodities may be hurt as an economic slowdown spreads.

This has been an
absolutely brutal week for commodities, especially gold and silver,
which are my personal favorites. To say that this has been a brutal
week for me, too, would not be a stretch. You see, I love to analyze
things, and when things line up and make sense, I’m happier than when
they appear to be nonsense.

Consider the happy coincidence
that, in this same week, we saw inflation surge to a 17 year high and
commodities take their biggest weekly plunge in 25 years. I mean, who
writes these scripts? Further, the explanation that a 4% rise in the
dollar explains a 25% drop in some commodities simply stretches
credulity past the breaking point.

Something else is afoot,
that is plain. The most compelling explanation to me is that central
banks, seeking a higher dollar and lower inflation, kicked this whole
run off, but that it is now morphing into something they did not
intend. If one or more major hedge funds has not been destroyed in this
run (not to mention a few thousand farmers and silo operators), I will
be shocked. It could have some ripple effects that will begin to show
up in the next few weeks.

Unintended consequences; it’s the law.

Asteri's Goldman Says Credit Crisis `Only Now Beginning'
(August 15 – Bloomberg)

The above is a link to a radio interview
between a Bloomberg host and Mr. Goldman, who is a lively and clear
orator. I really liked the way Mr. Goldman made clear that the
so-called "credit crisis" is no such thing…yet. The credit crisis has
not yet arrived, because major banks are contractually obligated to
provide lines of credit to companies that are busy drawing those down.
The credit crisis erupts when those loans are due to be renewed. He
claims that banks do not have the balance sheets they need to extend
that credit, and therefore, the worst effects remain in front of us.

Ticking time bomb
(August 14 – Economist)

OPTIMISTS, look away now. Prices in America’s
housing market may have slumped, but the pain for a significant subset
of homeowners has barely begun. Even at Barclays Capital, which spotted
some of the improvements mentioned in the previous story, there is
still concern. The bank’s Nicholas Strand says that roughly 1.4m
households, most of them in California, hold a particularly nasty type
of adjustable-rate mortgage called the “option ARM”. Although the
overall value of option ARMs is lower than that of subprime loans—some
$500 billion, according to Mr Strand, compared with about $1 trillion
in subprime loans—their sting is more venomous.

The option ARM
allows borrowers to pay less interest than the formal rate for a
limited period (the vast majority of customers choose this option). In
return, the unpaid interest is added to the original loan, a process
soothingly called “negative amortisation”.

Last year, I
said that you’d be hearing a lot more about Option ARMs in the future.
Well, here come the stories. They are an even larger disaster in the
making, due to their curiously inappropriate design, which lets banks
record the payments the homeowners are not making as profits, even as
the loan balance simultaneously climbs. But that’s just for a while.
Then the mortgage payment will be ‘recast’ to a new, higher level.
These recast amounts will continue to grow larger and larger until they
peak in 2011 at 80%.

That’s right, the average payment on the
average Option ARM will be 80% higher than today’s payment, roughly
coinciding with the bottom of the housing bubble. Bad combo.

Given that the vast majority of people with Option ARMS have elected to
make the minimum payments, the negative equity on these loans will make
the subprime losses look enviously low.

ECB slammed as Europe crumbles
(August 15 - Telegraph)

The economies of Germany, France and Italy all
contracted in the first quarter and may now be in full recession,
shattering assumptions that Europe would prove able to shrug off the
effects of the credit crunch.

The picture is darkening so fast
in Spain that Prime Minister Jose Luis Zapatero cancelled holidays and
called his cabinet back to Madrid yesterday for the first emergency
session of its kind since the Franco dictatorship. The crisis meeting
agreed to a €20bn (£16bn) blitz on public works, tax cuts, and a
mortgage rescue to halt the downward spiral.

One of the
‘reasons’ given for the dollar rally is that the US economy is still
expanding, while the European economy is declining. As you know from
watching Fuzzy Numbers, the US GDP is overstated by a very large
amount, and, if calculated the same way as that in Europe, it would
actually be far lower.

The other defect in the GDP calculation
that I didn’t go into is that the effects of borrowing are not canceled
out of the GDP calculation. Here’s an example: If you and your neighbor
both earn $100,000, but your neighbor borrows an additional $100,000
and spends that, should we count your neighbor's “GDP” as being twice
as large as yours? Of course not. Similarly, the fact that the US is
borrowing over a trillion dollars a year from the rest of the world
really ought to be backed out of the GDP number, but it is not. I guess
that’s okay in some people’s minds, because it will be backed out in
the future when the loans have to be repaid, but it badly distorts the
health of the economy in the short term.

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