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Week of March 10, 2008

Sunday, March 16, 2008, 2:08 PM

Feb budget gap balloons to record $175.56 bln

03/12/2008

WASHINGTON (Reuters) - The U.S. government turned in a $175.56 billion
budget deficit for February, a record for any month, as federal
spending grew but a slowing economy caused receipts to fall 12.1
percent from a year earlier, the U.S. Treasury said on Wednesday.

The February deficit soundly beat the previous all-time
single-month deficit of $119.99 billion in February 2007 and also
exceeded Wall Street economists' consensus estimate of a $160.0 billion
deficit in a Reuters poll.

February receipts fell to $105.72 billion from $120.31 billion in
February 2007, the Treasury said as both corporate and individual
income tax payments slowed.

February outlays grew to $281.29 billion, a record for February, from $240.30 billion in February 2007, the Treasury said.

Whoops! This is a huge miss and has some pretty big implications.

Yesterday saw a massive boost in the stock markets presumably due to excitement over the Federal Reserve actions.

Today we find that the dollar has plunged to a new record low. One
of the reasons might be that foreign dollar holders did not find the
fed actions to be all that comforting.

But the much more likely explanation is that the Federal Government
is spending with wild abandon on a couple of wars plus the usual
assortment of election year earmarking to assure that the 98%
incumbency rate remains intact.

The key items to note in that above article are that OUTLAYS hit a brand new record even as RECEIPTS fell by more than 12%.

If you find yourself being confused by the economists' proclamations
that we are not yet in a recession, I would simply say that a 12%
decline in tax receipts is simply not consistent with anything other
than being in a recession.

There's one other dot to connect here. This record budget shortfall happened even before the
rebate/stimulus checks have been sent out. I think the dollar weakness
today (3/12/08) is telegraphing the expectation that the US government
is going to run larger and larger deficits from this point forward.

That certainly is my expectation, especially in an election year
when the political will to throw fiscal caution into the wind is the
strongest.

Where the wheels could really come off the cart is when our foreign
creditors lose faith and back away from US government Treasury
auctions. This has already happened to some extent - foreign
participation is way below past moments and appears to be declining -
but if we have the equivalent of an auction failure in this market we
could see two simultaneous events:

  1. A rapidly declining dollar
  2. Skyrocketing interest rates

Should either of these two events come to pass, here are some actions to consider:

  1. A falling dollar is very bullish for all commodities since
    they nearly all are priced in dollars. Thus, if the dollar is falling
    commodities will be rising. As always, consider gold and silver first
    especially if you have limited assets to protect or have not yet bought
    any and then, and only then, consider oil, grains, and other base
    metals.
  2. Skyrocketing interest rates will be exceptionally
    bad for the stockmarket. As soon as I see a significant uptick in
    interest rates due to an auction failure I will be shorting the stock
    market with leverage, both hands, and the kitchen sink.

Lastly, please keep in mind that nearly ALL of the recent data is
consistent with us already being in a recession, and probably the worst
one in at least 50 (or more) years.

On the plus side of NOT being in a recession, we have:

  • The pronouncements of unsourced groups of economists, courtesy of the mainstream media, that we are NOT yet in a recession
  • Ever-buoyant stock prices

On the down side of already BEING in a recession we have:

  • Record declines in retail sales
  • Extremely weak (read: negative) employment reports
  • Collapsing credit markets
  • Declining income tax receipts at the federal level
  • Massive state budget shortfalls indicative of declining tax receipts at the state level
  • Weak earning reports from nearly every industry segment
  • Record foreclosure levels
  • Rising bankruptcies

As always, believe your own experiences and intuitive take on things.

If, on one hand, you believe that we are NOT in recession, continue
to hold stocks. If, on the other hand, you believe that we are in
recession, trim your exposure to stocks as much as you possibly can.
If, on your third hand, you believe that the entire banking system is
possibly on the ropes (to which I now personally assign a greater than
50% probability), selling stocks is not sufficient.

Instead, please consider increasing the amount of wealth you hold that is entirely removed from the banking "system."

As always, this would include:

  • Buying gold & silver
  • Having 1 (TO 3) months of cash in your house, at the ready
  • Having 3 (OR MORE) months of food stored in your house
  • Considering
    any special needs you might have such as prescription meds or anything
    else that you find difficult to find in short supply for a few months.

As always, believe your own experiences and intuitive take on things.


Dollar Woes

03/13/2008

Extremely critical dollar-related information here


The dollar, after repeatedly testing 100 yen in Asian dealings and
early European action, broke through to touch 99.75 -- its lowest level
since November 1995.

The 100-yen level is "massively significant" to the
foreign-exchange market, said James Hughes, currency analyst at CMC
Markets in London.

The dollar also set new all-time lows against the euro and the
Swiss franc and dropped to its weakest level against the British pound
since December.

The dollar traded at 100.30 yen in recent action, a loss of 1.2% on
the day, while changing hands at $1.5585 against the euro after sagging
to its weakest-ever level against the single currency above $1.56.
Also, the dollar was within a whisker of par with the Swiss franc,
trading at $1.0085 after notching an an all-time low of $1.0043 earlier
in the session.

With markets in a "highly nervous" state, there was no single trigger for Thursday's dollar plunge, Hughes said.

OK folks, this is it. We are in very
dangerous territory here for the dollar which could become a
self-reinforcing loop to the downside.

The dollar is now in territory that it has never been in before,
not even during the worst of the US economic crises of the late 1970's.

As a consequence, gold, silver and oil are all breaking into new territory. In my estimation, this has only just begun.

So it's safe to say that this is not you granddaddy's currency crisis.
Take a look at this chart:

The green line is drawn at the all time low
touched in 1993. If you look to the right you'll see that we've broken
through that. In fact, this chart is a few weeks out of date and so the
break is actually more convincing than what you see.
Here are the factors working against the dollar:

  • A trade deficit that remains persistently high
  • A fiscal deficit in the Federal Government that is in record territory
  • Extremely low US interest rates
  • The costs of fighting two wars


So, what actions should you consider?

Here's the scenario that lurks in the background that Wall Street fears.

  1. The dollar breaks some important
    psychological barrier and a key foreign buyer of the dollar breaks
    ranks and stops buying dollars.
  2. Because
    of this 'buyers strike' the dollar decline picks up speed causing
    interest rates to suddenly rise. This is because foreigners don't
    actually hold 'dollars' when they accumulate dollars, they actually
    hold US debt instruments, primarily US treasury bonds (and bills and
    notes). Buying bonds causes the interest rate, or yield, of the bond to
    fall while selling bonds causes the interest rate, or yield, to rise.
    In fact, the US government has to sell so many bonds just to fund
    current operations that a failure to buy bonds will also cause the
    interest rates (yields)to rise.
  3. As
    interest rates spike, the US stock market gets hammered. As stocks go
    down, foreign investors are now losing money on both their stocks AND
    due to the impact of the dollar decline.
  4. This
    'double whammy' causes even more foreign withdrawal of their funds from
    the US markets leading to an even steeper decline in the value of the
    dollar.
  5. And so on until some sort of a bottom is found.
  6. The
    wild card in all this is what might happen if there was a sudden and
    violent unwinding of the 'carry trade' - a trading strategy which
    borrowed cheap money from Japan and Switzerland and invested it in US
    treasury bonds to capture the difference between the interest rates.
    This is free money until there's a currency adjustment that wipes out
    your interest rate gains. Then it is a gigantic blackhole of losses.

Besides stock market risk, what are the other possible outcomes from a dollar decline?

  • Rapidly rising interest rates. Be sure
    you are not in the position of having to rely on carrying variable rate
    interest in order to live. Credit cards and auto loans would be the
    biggest sources of this type of debt. Here are some actions for you to
    consider.
  • Trim
    your exposure to stocks. If you want to 'be prudent' in the eyes of the
    conventional world of investing, then be sure that your total stock
    exposure is at the very bottom of the 'suggested range' for someone in
    your age/risk group. Personally? I only hold 5% of my total net worth
    in a pair of stock funds and those are both positioned to gain value
    only if the stock market declines (they are both short funds held with
    Rydex - INVERSE OTC STRATEGY and INVERSE S&P 500 STRATEGY). As
    always, these are not specific recommendations for you, only my
    specific holdings which I offer in the interest of full disclosure. I
    have no remunerative financial relationship with Rydex or any other
    financial outfit.
  • I you have a credit card balance(s), pay it(them) down.
  • If you have a variable rate auto loan, see if you can convert it to fixed rate.
  • Buy
    foreign currencies. I have been invested in Canadian and Swiss
    currencies for 3+ years. I still think the SWI franc is a great deal
    even here at these levels. I use Everbank.com as my means of holding
    these currencies. Holding these will protect you from a declining
    dollar and are very liquid.
  • Of course,
    you already have your physical gold and silver purchased and in hand.
    If you do not, you really should. At least 10% of your total liquid net
    worth.
  • STAY AWARE! This is the time to
    have your eye firmly on the ball. Should the dollar go into a rapid
    swan-dive, I will be moving into a second layer of actions that are not
    purely financial in nature and will keep you informed of these via the
    alerts.

Hedge funds on the brink as US Federal Reserve cash fails to ease crisis

03/14/2008
The
potential closure of six funds came as a leading private equity
executive, who declined to be named, said that such funds were
“snapping like twigs”, with one failing every day.


Several hedge funds with assets of more than $4 billion (£2 billion)
were on the brink of collapse last night or had halted withdrawals,
despite moves by the US Federal Reserve this week to ease America’s
deteriorating credit crisis with a $200 billion collateral lending
facility.

The potential closure of six funds came as a leading private equity
executive, who declined to be named, said that such funds were
“snapping like twigs”, with one failing every day.

Yesterday Patti Cook, Freddie Mac’s chief business officer, predicted
that the Federal Reserve’s $200 billion bond lending facility this week
would fail to solve the long-term problem of Wall Street’s deepening
credit crisis.

The funds’ predicament – seven funds have been frozen this month – was
seen as evidence that the initiative by America’s central bank to allow
lenders to swap their risky mortgage-backed bonds for safer Treasury
debt, will be of help only in the short term. Those fears hit the
dollar and New York equity markets, with the greenback falling to a new
low against the euro and sterling, as the European currency hit $1.55
for the first time.

What I'd like you to observe here is the
difference in language between the UK and the US press. Writing about
this exact same story the AP headline for US distribution read "Fed
Easing Liquidity in Funding Markets".

Hmmmm, let's review that again.

US investors get to read, "Fed Easing Liquidity in Funding Markets".

While European investors get to read, "Hedge funds on the brink as US Federal Reserve cash fails to ease crisis".

The first headline puts me to sleep while the second seems rather dramatic. Which to believe?

The failure of dodgy hedge funds may sound like
a well-deserved comeuppance for well-heeled people who failed to
perform proper due diligence, but this actually presents a substantial
risk for the entire banking/financial industry.

The reason is that the hedge funds never went
out and raised a billion dollar and then invested a billion dollars.
Usually they raised $1 billion and invested $25 billion.

An analogy would be you going to Las Vegas with a dollar in your pocket
but you borrowed 24 more from a banker conveniently located at the
front door of a casino. As long as you only lose $1, all you've done is
wiped out your stake. But if you lose $2, or $5, or $25 in all, then
there's a different sort of trouble at hand.

The big problem arises when it turns out that
the $24 you borrowed was all the bank had and so the bank has to call
in its other loans leading to a big cascade of other defaults down the
line. Whereas you may have blown your entire dollar plus 24 more, your
actions could cause another 100 or 200 dollars to explode somewhere
else down the line.

Here's the lowdown. Somewhere between 10 and
20 hedge funds have now failed with more announcing everyday. Oddly,
most of these are from Europe which makes me suspicious since the US
should have more all things considered. I am actively wondering if bad
news about US hedge fund accidents is being withheld, but that is pure
conjecture and speculation.

Of course, this isn't baseless speculation, as I always have a reason for my suspicions. In this case, it was this seemingly trite article in BusinessWeek in 2006 that caught my eye:

President George W. Bush has bestowed on his intelligence czar, John
Negroponte, broad authority, in the name of national security, to
excuse publicly traded companies from their usual accounting and
securities-disclosure obligations. Notice of the development came in a
brief entry in the Federal Register, dated May 5, 2006, that was opaque
to the untrained eye.

A trip to the statute books showed that the amended version of the 1934 act states that "with
respect to matters concerning the national security of the United
States," the President or the head of an Executive Branch agency may
exempt companies from certain critical legal obligations. These
obligations include keeping accurate "books, records, and accounts" and
maintaining "a system of internal accounting controls sufficient" to
ensure the propriety of financial transactions and the preparation of
financial statements in compliance with "generally accepted accounting
principles."

At the time I was puzzled, but now that there's a relative flood of bad
info coming from Europe and Canada about hedge funds and banking losses
I wonder if it hasn't been deemed somewhere to "be in the interest of
national security" to keep bad financial news out of the public eye. I
wish I could say that's a stretch in my thinking but, sadly, these days
it wouldn't surprise me at all.

At any rate, this flood of bankruptcies deserves our very keenest
attention because it could quickly morph into a systemic banking
crisis.

Stay tuned.

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