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    Daily Digest – May 28

    by Davos

    Thursday, May 28, 2009, 2:57 PM

  • U.S. Inflation to Approach Zimbabwe Level, Faber Says (Update2)
  • Airman Ben Comes a Cropper (MachineHead)
  • Are the US and UK Too Spoiled to Accept Austerity?
  • Millionaires Go Missing
  • Case-Shiller: House Prices Tracking More Adverse Scenario (Chart 1 of 2)
  • Case-Shiller: House Prices Tracking More Adverse Scenario (Chart 2 of 2)
  • House Prices: Real Prices, Price-to-Rent, and Price-to-Income
  • Why Interest Rates will go UP
  • PetroChina to Pay $2.2 Billion for Singapore Refining (H/T Doug)
  • Re-defaults
  • Consumers ‘do believe in the green shoot story’ (Video on page)
  • Fall in Libor May Overstate Improvement in Interbank Lending Market
  • AIN’T NO REST FOR THE WICKED (Repost in case you missed it)
  • Towns Rethink Self-Reliance as Finances Worsen


U.S. Inflation to Approach Zimbabwe Level, Faber Says (Update2)

May 27 (Bloomberg) — The U.S. economy will enter “hyperinflation” approaching the levels in Zimbabwe because the Federal Reserve will be reluctant to raise interest rates, investor Marc Faber said.

Prices may increase at rates “close to” Zimbabwe’s gains, Faber said in an interview with Bloomberg Television in Hong Kong. Zimbabwe’s inflation rate reached 231 million percent in July, the last annual rate published by the statistics office.

“I am 100 percent sure that the U.S. will go into hyperinflation,” Faber said. “The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.”

Federal Reserve Bank of Philadelphia President Charles Plosser said on May 21 inflation may rise to 2.5 percent in 2011. That exceeds the central bank officials’ long-run preferred range of 1.7 percent to 2 percent and contrasts with the concerns of some officials and economists that the economic slump may provoke a broad decline in prices.

Airman Ben Comes a Cropper (MachineHead)

In March, ‘Airman Ben’ Bernanke — head space cadet at the Federal Reserve — announced a plan to buy up to $300 billion of medium-term Treasurys, ostensibly to drive interest rates down. I invite you to review the results, as shown in the chart below. On the day of the annoucement, yields screamed southward from 3.00% to almost 2.50%. Then, in a classic ‘news reversal,’ they proceeded to rise for five days straight.

Within six weeks, the entire 50-basis-point drop in yields had been retraced. After today’s bond market bloodbath, the 10-year T-note yield has actually soared 70 basis points ABOVE its level before the March announcement, to 3.70%.

The moral of this little cautionary tale? Hear me, Bennie: YOU CANNOT DRIVE DOWN YIELDS BY ‘BUYING’ BONDS WITH PRINTED SCRIP! That is like trying to drink yourself sober. It sounds quite plausible when you’re halfway through a bottle of vodka. But an objective observer (e.g., annoyed spouse) is unlikely to pronounce the experiment successful.

It gets worse. Not only did the Fed’s little ‘dog eating its own vomit’ caper fail, but also the issuer of the original debt — the Treasury — has lost its fat income from the Bubble years, and is now scraping by on the equivalent of an unemployment check. I quote from USA Today —

Federal tax revenue plunged 34% in April vs. a year ago, a study released Tuesday by the American Institute for Economic Research says. Six million people lost jobs in the 12 months ended in April. Income tax revenue dropped 44% from a year ago.


Are the US and UK Too Spoiled to Accept Austerity? 

We all know the question in the headline is strictly rhetorical. If the US cannot stand to make risk capital like bondholders take a whack (heavens, no, we cannot make hapless funds take losses, better to dump it on taxpayers who have no ready way to complain), it goes without saying that we are wildly unprepared for any sort of real hardship. Yet as the experience of other financial crisis countries suggests, taking the hit from bankruptcies and resturcturings and cleaning up banking systems faster is associated with steeper initial downturns and rapid rebounds.

And if we don’t take our medicine, I fear it will be imposed on us later by events regardless.

Gideon Rachman reminds us that a lot of countries have taken pretty serious reversals with very little whining and have come through them. The US has had three generations of improving or at least not worsening living conditions. Would we cope as well as Eastern Europe?

From the Financial Times:

Across the developed world, unemployment, public debt and taxes are rising. When the global economic crisis first hit, it was natural to assume that the poorer and more recent democracies would be most vulnerable to a political backlash. Without the accumulated wealth or the welfare systems to cushion the blow, their populations looked vulnerable. Most countries in central Europe or Latin America only made the transition to democracy in the 1980s, so authoritarian nasties might still be lurking in the shadows.

But perhaps we are looking for trouble in the wrong places. It could be that it will be the richer democracies, such as Britain and the US, that find it most difficult to adapt to the politics of austerity.

Faced with hard times, some central European countries have had to take drastic measures. They do not have the British and American options of borrowing hugely to avoid making painful cuts. In Estonia, public-sector salaries have been sliced by 10 per cent. In Hungary, pensions have been cut by 8 per cent and the retirement age has been raised.


 Millionaires Go Missing

Here’s a two-minute drill in soak-the-rich economics:

Maryland couldn’t balance its budget last year, so the state tried to close the shortfall by fleecing the wealthy. Politicians in Annapolis created a millionaire tax bracket, raising the top marginal income-tax rate to 6.25%. And because cities such as Baltimore and Bethesda also impose income taxes, the state-local tax rate can go as high as 9.45%. Governor Martin O’Malley, a dedicated class warrior, declared that these richest 0.3% of filers were "willing and able to pay their fair share." The Baltimore Sun predicted the rich would "grin and bear it."

One year later, nobody’s grinning. One-third of the millionaires have disappeared from Maryland tax rolls. In 2008 roughly 3,000 million-dollar income tax returns were filed by the end of April. This year there were 2,000, which the state comptroller’s office concedes is a "substantial decline." On those missing returns, the government collects 6.25% of nothing. Instead of the state coffers gaining the extra $106 million the politicians predicted, millionaires paid $100 million less in taxes than they did last year — even at higher rates.

No doubt the majority of that loss in millionaire filings results from the recession. However, this is one reason that depending on the rich to finance government is so ill-advised: Progressive tax rates create mountains of cash during good times that vanish during recessions. For evidence, consult California, New York and New Jersey (see here).

The Maryland state revenue office says it’s "way too early" to tell how many millionaires moved out of the state when the tax rates rose. But no one disputes that some rich filers did leave. It’s easier than the redistributionists think. Christopher Summers, president of the Maryland Public Policy Institute, notes: "Marylanders with high incomes typically own second homes in tax friendlier states like Florida, Delaware, South Carolina and Virginia. So it’s easy for them to change their residency."

All of this means that the burden of paying for bloated government in Annapolis will fall on the middle class. Thanks to the futility of soaking the rich, these working families will now pay Mr. O’Malley’s "fair share."

Case-Shiller: House Prices Tracking More Adverse Scenario (Chart 1 of 2)

Case-Shiller: House Prices Tracking More Adverse Scenario (Chart 2 of 2)

House Prices: Real Prices, Price-to-Rent, and Price-to-Income


The second graph shows the price-to-income ratio:

This graph is based off the Case-Shiller national index, and the Census Bureau’s median income Historical Income Tables – Households (and an estimate of 2% increase in household median income for 2008 and flat for 2009).

Using national median income and house prices provides a gross overview of price-to-income (it would be better to do this analysis on a local area). However this does shows that the price-to-income is still too high, and that this ratio needs to fall another 10% or so. A further decline in this ratio could be a combination of falling house prices and/or rising nominal incomes.

In Q2 2008 this index was over 1.25. In Q4, the index was just over 1.1. Now the index is at 1.04. At this pace the index will hit 1.0 in mid-2009. However, during a recession, nominal household median incomes are usually stagnate – so it might take a little longer. And the index might overshoot too.

Why Interest Rates will go UP

How much longer can global central banks depress the true cost of money? If the business world has become a riskier place, then the cost of borrowing should be going up. If governments around the world need to borrow more to finance their spending programs, they should be paying higher rates on bonds, not lower rates.

Welcome to a world of inverted economics courtesy of quantitative easing and public debt issuance. The problem of course with suspending the laws of gravity for a period is that eventually the sky will come crashing down.

This means a period of very high inflation at best, and at worse an inability to raise funds for public expenditure on health, welfare and education, and real spending cuts or higher taxation. Why inflation?

This is the simplest phenomenon to understand. If governments print money then this inflates the money supply and more money in circulation leads to inflation.

Of course, this only happens when this money is spent. If consumers choose to save – as they are now – then the impact of the increase in the money supply is delayed until that new money finds its way into the economy.

That buys the government time – to get re-elected perhaps – but it does absolutely noting to tackle the underlying problem, in fact it makes it worse. The longer the delay in correcting imbalances and the worse the inflationary problem will be.

Once the new money is spent, then the inflation arrives, and bank account holders will demand a higher interest rate as compensation or take their money out and spend it, adding to inflation. In these circumstances central banks have no alternative but to raise interest rates.

Imagine what an impact that will have on financially stretched consumers, quite apart from the negative implications for public spending and its impact on economies. It is nothing short of a double-dip recession scenario.

Yet there is a sense of historic inevitability of this process. It all happened before in the late 1970s. Then the only investors who did well bought gold, silver and oil, and even cash out performed equities, bonds and real estate.

PetroChina to Pay $2.2 Billion for Singapore Refining (H/T Doug)

May 25 (Bloomberg) — PetroChina Co. agreed to pay as much as $2.2 billion to buy Singapore Petroleum Corp. to gain a foothold in Asia’s largest oil trading centre in an acquisition that may extend China’s influence over global resources pricing.

Singapore Petroleum has stakes in oil fields in Indonesia, Australia, Vietnam and Cambodia and also owns undersea pipelines carrying gas from Indonesia to Singapore and storage terminals. The company jointly owns Singapore Refining Co., one of the three biggest oil-processing plants in the city state, with Chevron Corp., the second-largest U.S. oil company. The refinery has capacity to process 285,000 barrels of oil a day.

“China is flush with cash and commodities aren’t inexhaustible, so it makes sense for them to go out and buy resources for future use,” Ong Eng Tong, a Singapore-based consultant with Hamburg-based oil trader Mabanaft Gmbh., said in a telephone interview.

Loans-for-Oil Agreements

China agreed to give Russia, Kazakhstan, Brazil and Venezuela $49 billion in loans this year in exchange for oil supplies. The government plans to tap its $1.95 trillion foreign-exchange reserves, the world’s largest, for acquisitions.

The government of the world’s second-largest oil user is encouraging local companies to buy commodities and energy assets made cheaper by crude’s 58 percent decline from a record in $147.27 a barrel in July.

“This is just the beginning for PetroChina to buy assets directly to boost its oil and gas reserves,” China Merchants Securities Ltd. analyst Qiu Xiaofeng said by telephone from Shanghai. “But the value of this acquisition isn’t very large, so it won’t have a big impact on PetroChina’s profit.”PetroChina’s main markets include Indonesia, Vietnam, Singapore, China and South Korea, according to the company’s statement. The company and smaller rival China Petroleum & Chemical Corp., or Sinopec, have announced plans to expand refining capacity to meet demand for fuels in the world’s third- largest economy.


An example that the more the US govt gets involved in cleaning up the economic mess, the longer it will last, aka Japan, Fitch is forecasting that between 65-75% of mortgage loans that are modified will redefault after 12 mo’s. An example of the damage that can be done to a family by artificially modifying a loan for one who should be renting and redefaults in 12 mo’s and thus prolongs the agony and delays the inevitable, is the money that a family spends each month on a mortgage during the initial 12 after modification that can be used for renting at a lower monthly price, with money leftover. It’s not the same as owning one’s own home but it improves the financial health of the family. The foreclosure process however painful also more quickly clears markets and brings out demand. The homeownership rate is now 67.5% versus the average of 65.3% dating back to ‘65 and we need to get back to that average and not keep artificially propping it up.

Consumers ‘do believe in the green shoot story’ (Video on page)

I should caution that an uptick in expectations of this magnitude has a dark side. [emphasis mine]

Fall in Libor May Overstate Improvement in Interbank Lending Market 

“Libor’s decline is not necessarily a sign of improving bank credit or the willingness of banks to lend to each other,” said Vogel, whose firm is one of the 10 biggest underwriters of Fannie Mae, Freddie Mac and other U.S. government agency debt. “It’s a sign of improving bank liquidity as customer deposit growth replaces borrowing in the short-term money markets.”


There ain’t no rest for the wicked, money don’t grow on trees, I got bills to pay, I got mouths to feed, there ain’t nothing in this world for free. I know I can’t slow down, I can’t hold back though you know I wish I could, oh no there ain’t no rest for the wicked, until we close our eyes for good.

Ain’t No Rest for the Wicked – Cage the Elephant

Money doesn’t grow on trees for most of America. We sit down at our kitchen tables and write out checks to the phone-company, electric company, credit card-company, mortgage-company, and auto finance company every month. We clip coupons and go to the grocery store every week to put food in the mouths of our children. This is what our parents did before us. We work 40 to 60 hours a week to pay these bills and feed those mouths. It’s not easy. We do it because that is what hard working American families do. We work hard, try to save some money for a rainy day and do the best we can. We had been taught that nothing in this world was free. We have been misled. If you were wicked, taking risks beyond the comprehension of average Americans and endangering the entire worldwide financial system, money does grow on trees and there is plenty for free. Money can be printed out of thin air by the wicked and doled out to the wicked. The definition of wicked is:

Evil in principle or practice; deviating from morality; contrary to the moral or divine law; addicted to vice or sin; sinful; immoral; profligate.

To put it in the most basic terms, what has happened in this country in the last decade is that evil wicked people have attained positions of power in government, banking, and industry and have committed sins against humanity for their own glory and enrichment. Those who should have stood up to these evil doers are just as guilty as the engineer driving the train to Auschwitz. Albert Einstein understood this danger:

“The world is a dangerous place to live; not because of the people who are evil, but because of the people who don’t do anything about it.”

There have always been evil people. Adolf Hitler, Joseph Stalin, Bernie Madoff, Dennis Kozlowski, Charles Manson, Charles Keating Jr., Joe McCarthy, Jeff Skilling, Bernie Ebbers, Jim Jones, Michael Milken, and Ivan Boesky come to mind. Some committed horrendous atrocities, others stole billions, others destroyed reputations, and others lived lives of decadence and immorality. The reason they are all household names is because they were able to commit their crimes because other people didn’t do anything to stop them. All of these men could have been stopped if citizens, coworkers, auditors, Prime Ministers, government regulators, Boards of Directors, Congressmen, or family members had been brave enough and moral enough to make a stand against their evil deeds. The one and only poem that ever made an impression on me in high school was The Hangman by Maurice Ogden. Below are the last stanzas. Evil can only flourish in society if we allow it to flourish. A society united against wickedness, dishonesty, corruption and wantonness could stand the test of time. I’m afraid our Great American Republic has allowed evil to flourish, and the hangman’s scaffold has grown to enormous proportions.

"You tricked me Hangman." I shouted then,
"That your scaffold was built for other men,
and I’m no henchman of yours." I cried.
"You lied to me Hangman, foully lied."

Then a twinkle grew in his buckshot eye,
"Lied to you…tricked you?" He said "Not I…
for I answered straight and told you true.
The scaffold was raised for none but you."

"For who has served more faithfully?
With your coward’s hope." said He,
"And where are the others that might have stood
side by your side, in the common good?"

"Dead!" I answered, and amiably
"Murdered," the Hangman corrected me.
"First the alien … then the Jew.
I did no more than you let me do."

Beneath the beam that blocked the sky
none before stood so alone as I.
The Hangman then strapped me…with no voice there
to cry "Stay!" … for me in the empty square.

THE BOTTOM LINE: "…I did no more than you let me do."

Hell is Empty and all the Devils are Here

Bill Shakespeare sure had a way with words.

Towns Rethink Self-Reliance as Finances Worsen

As the recession batters city budgets around the U.S., some municipalities are considering the once-unthinkable option of dissolving themselves through "disincorporation."

Benefits of this move vary from state to state. In some cases, dissolution allows residents to escape local taxes. In others, it saves the cost of local salaries and pensions. And residents may get services more cheaply after consolidating with a county.

In Mesa, Wash., a town of 500 residents about 250 miles east of Portland, Ore., city leaders have initiated talks with county officials about the potential regional impact of disincorporating. Mesa has been hit by a combination of the recession and lawsuits that threaten its depleted coffers, leaving few choices other than disincorporation, said Robert Koch, commissioner of Franklin County, where Mesa is located.

Two California towns, Rio Vista and Vallejo, have said they may need to disincorporate to address financial difficulties; Vallejo filed for bankruptcy protection last year. Civic leaders in Mountain View, Colo., have alerted residents that they are left with few options but to disincorporate because the town can’t afford to salaries and services.

Incorporation brings residents a local government with the ability to raise money through taxes and bond issuances. It also gives them more control of zoning decisions and development, and usually provides for local services such as trash pickup and police as well.

Dissolving a town government, on the other hand, often shifts responsibility for providing services to the county or state. A city’s unexpired contracts usually remain binding, and residents are still obligated to pay off any debt.

But long-term commitments such as pension liabilities and day-to-day services such as sewage and water can be folded into services run by the county, public-policy experts say.

Disincorporations are rare, usually resulting from population declines that leave too few residents to support the government. The most recent in California occurred in 1972, when stalled growth and political instability led Cabazon to dissolve itself, according to the California Association of Local Agency Formation Commissions. In Washington state, the last one occurred in 1965, when Elberton gave up its autonomy after 70 years, according to the nonprofit Municipal Research and Services Center in Seattle.

Today, some small municipalities are exploring the step to escape some financial burdens that have been exacerbated by the recession.

Rio Vista says disincorporating would eliminate 38 jobs and shift its sewer services to the county. Vallejo says disincorporating would end public-safety-employee contracts, which city leaders blame for pushing the city into bankruptcy.

Most talk of disincorporation appears to be exploratory, and some public-finance experts say towns may not have that option if it is being used to unload financial obligations. "This is somewhat of a legal gray area, because disincorporation was not designed to allow cities to escape financial hardship," said John Knox, a public-finance consultant with the San Francisco office of law firm Orrick, Herrington & Sutcliffe.


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