Week of May 12, 2008

Sunday, May 18, 2008, 7:13 AM

Growing deficits threaten pensions
(May 11 - MSNBC)

The funds that pay pension and health benefits to police officers,
teachers and millions of other public employees across the country are
facing a shortfall that could soon run into trillions of dollars.

But the accounting techniques used by state and local governments to
balance their pension books disguise the extent of the crisis facing
these retirees and the taxpayers who may ultimately be called on to pay
the freight, according to a growing number of leading financial

State governments alone have reported they are already confronting a
deficit of at least $750 billion to cover the cost of the retirement
benefits they have promised. But that figure likely underestimates the
actual shortfall because of the range of methods they use to make their
calculations, including practices that have been barred in the private
sector for decades.

This is a huge issue. As I've long been
harping, and will say again, we will soon face the prospect of either
honoring past agreements with retirees OR we will be paying for current
services. The pension obligations of this nation are just another form
of debt, which has made entirely too large of a claim on the future.
This article does a better job than most of calling out the fact that
the type of accounting used by states and municipalities is thoroughly
illegal for private businesses to employ. Why? Because it's fraudulent.

I often wonder how it is that those in charge believe that having
one set of laws for government and a different set for the citizens
helps to promote respect for the law.

Nice touch in the article here, though: "...the taxpayers who may
ultimately be called on to pay the freight..." Of course it's going to
be the taxpayers and retirees who will bear the burden. Who else? There
is no "may" about it. States and municipalities get 100% of their
revenues form taxpayers, and the retirees will be the ones getting
their promised benefits cut.

2008 growth outlook deteriorated: Blue Chip (May 10 - Reuters

Even with some signs of improvement in the U.S.
financial markets and a temporary boost from the economic stimulus
package, the growth outlook for the second half of this year has
deteriorated, according to a panel of economic forecasters.

The weakest annual consumer spending since 1991 will lead to a darker outlook, the Blue Chip Economic Indicators found.

The consensus of economists polled between May 5 and 6 in the survey
said the economy will grow at a 1.7 percent annual rate in the third
quarter, down from the 2.0 percent forecast a month ago.

For the fourth quarter, GDP is expected to grow by 1.5 percent, down from 1.9 percent seen earlier.

The outlook for 2009 has also darkened, with economists expecting
growth of just 2.0 percent, down from 2.2 percent forecast earlier.

Here's more confirmation that economic
conditions are deteriorating. No surprise there. I will note that I
take all of these proclamations with a grain of salt. First, because
they are continually behind the curve, both on the way down and then on
the way back up. Second, because they are basing their views in part on
government statistics that are patently false (especially unemployment
and inflation).

Chilean Drought, Power Shortages Drive Up World Metal Prices (May 11 -Washington Post)

Chile's worst drought in five decades and power
rationing from South Africa to China mean the price of aluminum, gold,
copper and platinum will keep climbing as the lights go out in the
world's biggest mines.

Those governments are being forced to choose whether to reduce power to
their 1.4 billion residents or curtail energy supplies to the largest
copper, aluminum, platinum and gold factories. The energy used by
China's aluminum smelters each week could provide enough power for more
than 2 million people for an entire year.

Runaway growth in emerging markets is squeezing world oil supplies and
has led to electricity shortages, cutting output of commodities needed
to meet ever-rising demand.

While some are saying that world oil supplies
are plentiful, I keep running cross these sorts of articles that seem
to tell a very different story...namely, one of continued energy
shortages that are creating very real supply/demand problems for a
resource-hungry world.

U.K. Producer Prices Rise at Fastest Pace Since 1986
(May 12 - Bloomberg)

U.K. producer prices climbed in April at the
fastest annual pace since at least 1986 as raw-material costs jumped,
adding to the case for the Bank of England to moderate the pace of
interest-rate cuts.

Prices charged by factories rose 7.5 percent from a year earlier, the
most since records began two decades ago, the Office for National
Statistics said in London today. Economists predicted 6.4 percent, the
median of 26 forecasts in a Bloomberg News survey shows. On the month,
prices increased 1.4 percent, also the fastest pace on record.

The UK adopted the the US methodology for
measuring inflation (the "CPI") about 3 years ago and they've been
consistently understating inflation ever since. Fortunately, they have
a rigorous press over there, which even went so far as to completely
re-run a recent inflation series past a private accounting firm.  It
determined that inflation in the UK was running between 200% and 300%
higher than the official proclamation, depending on what sort of
consumer you were. Even with this new and improved methodology at their
fingertips, the UK government had to admit to producer inflation
running at a 7.5% yr/yr rate, which is dangerously close to the 8% rate
that is widely considered to be a tipping point for consumer
expectations. Nonetheless, the UK central bank is firm in holding their
key interest rate at the current highly inflationary level, and is even
mulling further cuts. Contrast this behavior with the actions of
China's central bank below...

China Raises Bank Reserve Ratio as Inflation Surges
(May 12 - Bloomberg)

China ordered banks to set aside more deposits as reserves for the
fourth time this year after inflation accelerated, approaching the
fastest pace since 1996.

Banks must park a record 16.5 percent of deposits with the central
bank, up from 16 percent, the People's Bank of China said today on its
Web site. Consumer prices rose 8.5 percent in April from a year earlier
driven by food costs, the statistics bureau said today.

In response to inflation, which is a
monetary phenomenon primarily driven by excessive bank lending, China
decided to do something that I would stand up and applaud if it
happened here in the US. They actually raised bank reserve
requirements(!). When banks have to hold more in reserve, they can't
loan out as much. Less money loaned into existence means less floating
around to run up prices. It's very simple, really, although there is
much confusion on this topic in my home country. Also, I want you to
contrast the 16.5% reserve requirement of Chinese banks with our own
effective reserve ratio of 0.4%. Under the Chinese rate of reserve, a
single yuan on deposit can be multiplied into 6 yuan of lending. Under
the US rates, a single dollar on deposit can be multiplied into 250
dollars of lending. 6 vs. 250. Savers vs. debtors. There are many
interesting differences between China and the US.

Consumer-level inflation tame in April, U.S. says (May 14 - MarketWatch

U.S. consumer prices increased a moderate 0.2% in
April with decelerating energy prices offsetting rising food prices,
the Labor Department said Wednesday.

Excluding volatile food and energy prices, the core consumer price index increased 0.1%, the government said.

Uh, according the the US Government, inflation was surprisingly low,
again. Um. OK. Where does one begin with a tale this obviously flawed?
I guess with the next story down....

House Authorizes Use of Cheaper Metals in Coins (May 8)

The House passed legislation Thursday to change the
composition of pennies and nickels, addressing dramatic rises in metal
prices that have made the coins more expensive to produce than their
face value.

The last time the penny and the nickel were produced at face value was fiscal year 2005, according to the Mint.

Yes, inflation, especially core inflation, is so low that it's nearly
disappeared, which is why, naturally, the US Congress authorized that
we switch making pennies from Zinc (an extremely common base metal) to
Steel. If there were ever two stories that told completely different
tales, it is these two. Inflation is low, low, low, but we're going to make pennies and nickels out of steel. Um, OK. Tip:
About a year after the zinc-clad 'sandwich' coins were introduced in
1965 to replace the formerly 90% silver coinage, nearly all of the
silver coinage had been hoarded out of circulation. Time to stock up on

Home prices continue sharp descent (May 13 - CNNMoney)

Single-family home prices dropped 7.7% in the first
quarter in the largest year-over-year decline since the National
Association of Realtors began reporting prices in 1982.

The median sales price fell to $196,300, down 4.8% compared with the last three months of 2007.

Let me repeat that: the largest ever decline since the NAR began reporting prices in 1982.
That is the real story here, not whether Bernanke has stuffed enough
cash into the banking system to keep Wall Street's 2008 bonus structure
intact. Out on Main Street, the recession is beginning to bite, house
prices are declining at a record pace, and inflation is raging.

BIS warns over forex settlements risk (May 13 - FT)

More action is needed to reduce foreign exchange
settlement risk to avoid a meltdown in the global financial system, the
Bank for International Settlements said yesterday.

Foreign exchange settlement risk, the chance that one party to a trade
pays out the currency that it is sold but does not receive the currency
it bought, has long been a concern of global central bankers due to its
potential to introduce systemic risk into the global financial system.

FX transactions are one of the greatest source of settlement risk
exposure. In some cases, large banks have almost three times more
exposure to settlement risk than to credit risk.

There are a number of big risks lurking
within our largely untested global banking network. The BIS is
concerned about the prospect of counterparty failure in the foreign
exchange settlement system. And they should be - such an event could
bring the entire system to a standstill with unknowable effects. Since
counterparty failure is such a damaging prospect in any market, I am
glad to see that the BIS is working to minimize this possibility. But
it makes me wonder what our own SEC has been up to, by ignoring the
fact that hundreds of billions of dollars worth of stock that does not
exist has been sold into the system. The process is called "naked
shorting" and it refers to selling stock you don't have. Hedge funds
have been doing LOTS of this over the years. The problem would not be
quite so acute, except that in many instances they never bought back
this phantom stock. Do you have some? Does your pension or 401k? Odds
are, you do. If you want to know more about this insidious process, go
Deep Capture.

Ships bring water to parched Barcelona (May 13 - BBC)

In a year that so far ranks as Spain's driest since records began 60
years ago, the reservoir is currently holding as little as 18% of its
capacity - at a time of year when winter rains would usually have
provided an essential boost by now.

Rainfall figures show a consistent series of shortfalls in recent years
- just as Barcelona's population has expanded to more than five million
and the region's booming agribusinesses demand ever more irrigation.

For residents here, the arrival of water by ship is a profound shock -
normally it's the drier areas further South that are notoriously

Already they are living with restrictions on the use of hosepipes and the filling of swimming pools.

Now the Barcelona authorities are having to take the unprecedented step
for any major European city of topping up supplies by the highly
visible means of giant tankers arriving in relays, each bringing 28
million litres, up to a dozen ships coming over the next month.

What does endless growth get you? Well, in a
semi-arid region coupled to a normal style drought and a booming city,
it gets you a severe water shortage. Question: if for some reason
Barcelona did not have the option of bringing water in by tanker ship,
then what would it do?

Pols fail to comprehend breadth of infrastructure crisis
May 12 - (Scholars & Rogues)

The United States has much more than failing bridges to find, fund and
fix. The proposals of the remaining presidential candidates do little
to inspire faith that they understand the breadth of the problem or
have the political skill, will and courage to address it forthrightly.

In December, a commission established by Congress in 2005 under the
Safe, Accountable, Flexible, Efficient Transportation Equity Act—A
Legacy for Users (SAFETEA-LU) provided the sobering statistics. The
United States needs to spend $225 billion annually — more than twice
what it does now — for the next 50 years. That’s more than $11 trillion
worth of fix-ups on surface transportation systems alone.

As I noted in A National Failure to Save (Chapter 13),
we have a severe failure to invest as well. The above article is the
best summary of the situation I've yet read. I'm going to check into
the figures a bit further, but at face value I am shocked to find that
they are more than five times higher than previous figures I've seen. Note
that the $11 trillion number assumes spending right across the
'twenty-teens,' as do so many other pressing national needs. We're
going to have to face the music at some point and admit that it may not
be possible for our nation to 'have it all'. Perhaps we can't afford to
spend more than the rest of the world on military expenditures than the
rest of the world combined AND have reliable sewer systems or bridges
that remain standing the whole way across.

most amazing thing to watch is the massive disconnect between what I am
reading and seeing (we're in a recession and the mood is dark) and the
stock market. Normally, one would expect a consumer-led recession to
result in a 30%-40% decline in the stock market, but instead, the
market is within a few percent of its all time highs. What gives? The
articles below provide confirmation of the fact that we are firmly in a
recession, no matter what the official statistics are claiming.

Inflation pressures ease in April despite biggest food price jump in 18 years (May 14 - AP)

Consumer prices slowed in April despite the biggest jump in food costs
in nearly two decades. But with oil near record levels, Americans
should brace for more pain at the pump in coming months.

The Labor Department reported Wednesday that consumer prices edged up
0.2 percent last month, slightly lower than expected and better than
the 0.3 percent rise in March.

The lower inflation reflected a flat reading for energy, which helped offset a 0.9 percent jump in food. That was the biggest one-month surge since a 1.5 percent increase in January 1990.


For April, energy prices were unchanged and gasoline prices even fell by 2 percent,
a decline that would strike motorists as strange, given that they have
been watching the price of gasoline rise relentlessly in recent weeks.

Did you catch that? In April, according the
the government, gasoline declined by -2%. Hee hee. All I can do is
guess that this is a desperate cry for help by some beleaguered
statistical worker at the BLS. They probably thought "Nobody will
believe this. Somebody will have to come and rescue me from my
cubicle." Either that, or this was just a direct slap in the face to
all sentient people everywhere. Let me put it this way - the former
Soviet crop reports were more believable.

Remember all last week where I was aghast that even such economic
luminaries as Paul Krugman were discussing oil price rises without
mentioning inflation or growth in the money supply? Well, once again,
if we travel over the pond, we can find perfectly logical and rational
discussions about inflation right in their main newspapers! Right
there, out in the open. Like this one written by a Professor of
European Political Economy, London School of Economics and Political

Inflation here, there and everywhere
(May 14 - FT)

Who or what causes inflation?

This one is easy. In a fiat money world, central banks cause inflation,
or, more precisely, only central banks are responsible for inflation.
Other shocks, real and nominal, can influence the general price level
if the central bank does not respond swiftly and determinedly, but
these non-central bank-induced changes in the general price level can
always be offset by the central bank, given enough time, freedom to act
and courage.

But, in the medium and long term (at horizons of two years and over, say) central banks choose the average rate of inflation. Not
globalisation; not indirect taxes; not bad harvests; not OPEC and the
price of oil; not the Chinese and their exchange rate management. There
is no oil inflation, food inflation or cost-push inflation. There is
just inflation.
Inflation may be accompanied by changes in key
relative prices - in the real prices of oil, of food, of oil and of
labour for instance - if other relative demand and supply shocks
accompany the inflationary impulses created by the central bank. Large
increases in the real price of food will be bad news to food importers
(including most urban households) and good news to rural food producers
and exporters. But don’t confuse it with inflation.

*Sigh* If only we could have such clear
writing in our home country newspapers. At any rate, there it is.
Central banks are the source of monetary creation and therefore central
banks cause inflation. For some reason, this notion is simply not
permitted in print over there in the US. Period. Inflation is a
deliberate matter of policy. Inflation is cause by too much money
chasing too few goods and services. Inflation is, everywhere and
always, a monetary phenomenon. It's vital that we understand this,
because without understanding the source of our troubles, there is no
point in talking about solutions.

U.S. Builders Broke Ground on Fewest Houses Since '91 (May 16 - Bloomberg)

Construction of U.S. single-family houses in April
dropped to the lowest level in 17 years, even as building of
condominiums and townhouses rebounded.

Builders broke ground on 692,000 single-family homes at an annual rate,
the fewest since January 1991, the Commerce Department said today in
Washington. Total housing starts jumped 8.2 percent to 1.032 million as
construction of multifamily units rose 36 percent following a 35
percent drop in March.

Yes, it's true that home builders are
breaking ground on fewer housing units than at any time since 1991, but
it's also true that they are building at a rate that will deliver
1,000,000 new units at a time when there are nearly 3,000,000 empty
housing units awaiting buyers. Which means that an increase in building
activity is actually a bad sign, not a good sign. It means that
builders who, uh, build for
a living, are simply building because they have land, crews, and
financing. They do it because it's what they do, not because there's an
increase in demand.

Consumer sentiment falls in May to lowest since 1980 (May 16 – MarketWatch)

Consumer sentiment dropped in May to its lowest level since 1980,
according to a Friday report, as higher fuel and food prices, coupled
with declining home values, weighed on financial expectations.

The U.S. consumer sentiment index in May fell to 59.5 from 62.6 in
April, according to a Friday report from University of
Michigan/Reuters. Economists surveyed by MarketWatch were looking for a
result of 61.0.

The expectations index fell to 51.7 -- the lowest level since 1990 -- from 53.3 in April.

And the current conditions index declined to 71.7 -- the lowest level since 1980 -- from 77.0 in April.

Ouch. The 59.5 reading on the Consumer Confidence Index is the worst
reading since 1980. It bears telling that in 1980 things were pretty
bad. Unemployment was high, the dollar was tanking, inflation was
raging, riots were occurring, and interest rates were in the high
teens. Things were in pretty poor shape. And consumers today 'feel'
just about as lousy. This represents a massive disconnect from the
happy-happy stories being pumped out endlessly by Hank Paulson, Wall
Street, and an ever-compliant US financial press. It's almost as if
happy talk is all we have left, and some are convinced that happy talk
will work. Oh well, we'll see.

Foreclosure flood: 1,000 auctions per day in California

California's foreclosure crisis passed another
ominous milestone in April, when more than 1,000 foreclosed homes were
auctioned off every weekday at courthouses across the state, the
auction tracking firm ForeclosureRadar reported today.

1,000 foreclosures every single business day. In
just one state. 1,000 families losing their home every single day.
Think about that. I live in a very small town with 400 households, so
this is like losing two and a half towns like mine every single day.
This is the sort of data that tells me that a happy print on the stock
market, coupled with happy words from Hank Paulson, are not going to do
the trick. The problem stems from an overextended and tapped-out
consumer, who, in many cases, has been living wildly beyond their
means. A few bonus points on the stock market isn't going to 'solve'
that problem any more than a funhouse mirror is going to 'solve' a
potato chip addiction.

U.S. Economy: Manufacturing Weak as Expansion Falters (May 15 - Bloomberg)

The slump in U.S. manufacturing deepened while the economy skirted recession, reports today showed.

Industrial production declined 0.7 percent in April, the Federal
Reserve said in Washington today, more than twice the drop forecast by
economists. Separate figures from the New York and Philadelphia
branches of the central bank indicated the slide may continue this

Manufacturing has been in recession for over 15
years, at least if you consider employment your guide. That aside, this
report was a bit surprising, in that the depth of the most recent
decline was twice what was expected, and it points to an accelerating
rate of deterioration in the productive portion of our economy - what's
left of it, at any rate.

Opposition Builds to $300 Billion Government Mortgage Bail Out (May 14 - Forbes)

The more Americans learn about the $300 billion taxpayer bailout of
reckless lenders and borrowers, the more the opposition and outrage

The Frank plan that passed the House of Representatives last week lets
banks cherry-pick the worst loans with the least-qualified borrowers,
and shift those loans 100 percent to the taxpayers.

It's not fair to force responsible Americans to foot the bill for the least worthy borrowers and their lenders.

Yay! I, for one, am quite happy that this ill-conceived government
bailout is headed for the rocks. The only way we are going to 'fix'
this housing crisis is to let the bad loans go bust and let house
prices fall back to affordable levels. The sooner we can do this, the
sooner we can pick up the pieces and move on. However, this is an
election year, and the desire to "do something" is overwhelming amongst
the DC politicos who fear that their 98% rate of re-election could be
in jeopardy. Unfortunately, their instincts are unerringly wrong, and
their bailout plan would have merely let guilty parties off the hook
and stretched the misery out.

Dollar rally, leaks put fresh focus on G7 meetings (May 15 – MarketWatch)

Currency traders now suspect U.S. and European finance officials of
some atypical arm-twisting to support the U.S. dollar at last month's
G7 meeting, a gathering that initially made little splash in currency

Gains of 2% to 5% in the U.S. dollar from a key low point last month,
combined with recent press statements from anonymous senior finance
officials, have fostered suspicions that the group of industrialized
nations backed up their public statements with some backdoor

More rumors and rumblings that the central
banks are mucking about in supposedly "free and fair" markets because
price levels were not quite where they wanted them. The reason I care
so deeply about these interventions is that over the long haul they end
up making things worse, not better. For markets to work at all, prices
must convey meaningful information. Intervention inevitably leads to
false price signals and mal-investment.

We simply cannot afford any more slip-ups at this point and need to be
dedicating our dwindling resources to the exact right spots. Secondly,
one little "emergency only" intervention leads to a couple more "touch
ups," until intervention is a daily event. It's a very slippery slope,
and before you know it, the market place is filled with bad price
signals, leading individuals and even entire countries astray. Need an
example? Read the next article.

Fed's Direct Loans to Banks Climb to Record Level (May 15 - Bloomberg)

The Federal Reserve's direct loans of cash to
commercial banks climbed to the highest level on record in the past
week as money-losing lenders increasingly turn to the central bank for

Funds provided through the so-called discount window for banks rose by
$2.8 billion to a daily average of $14.4 billion in the week to May 14,
the central bank said today in Washington. Separately, the Fed's loans
to Wall Street bond dealers rose by $75 million to $16.6 billion.

Policy makers have increased the attractiveness of direct loans as they
seek to alleviate the impact of the credit crunch. Fed Chairman Ben S.
Bernanke said two days ago that while markets have improved, they
remain "far from normal," adding that the central bank is prepared to
increase its twice monthly auctions of funds to banks.

"The Fed is providing an extraordinary amount of liquidity through
various mechanisms," said Stephen Stanley, chief economist at RBS
Greenwich Capital in Greenwich, Connecticut. While "credit markets are
showing signs of improvement" there is "a long way to go," he said.

Here we have the Federal Reserve, in their
infinite wisdom, allowing banks to trade in all manner of trash debt,
ranging from auto-loans to defaulted pools of subprime mortgages, for
cash. Instead of asking the banks to raise cash by selling their toxic
debt, the Fed has stepped in and created a false market and therefore
false prices for these dodgy loans. The consequence of this is that
many are now claiming that the debt crisis is behind us, when nothing
could be further from the truth (see Foreclosure flood, above). And because of this false confidence, many investors,
believing the false price signals, are again placing their money into risky investments.

ECB concern over liquidity scheme (May 15 – FT)

The European Central Bank on Thursday voiced its “high concern” at
growing evidence that banks are exploiting its efforts to unblock the
frozen funding markets by using its liquidity scheme to offload more
risky assets than it envisaged.

Meanwhile, on the other side of the pond, the
central bank over there is beginning to get nervous about how rapidly
and willingly the banks have been dumping their trash debts onto the
central bank. My only surprise is that they are surprised. I mean, what
else did they expect? That's what banks do.

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