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    Blue Sunburst Peak Prosperity Logo

    The Game Is Afoot

    by Chris Martenson

    Wednesday, August 8, 2007, 4:00 AM

    Wednesday, August 8, 2007

    First, a warning about the dollar. As you know, I’ve been keeping a close eye on the US dollar and have been very concerned over the years that the dollar would someday steeply decline against foreign currencies. In fact, the dollar has been steadily eroding in value for since 2002, and it is now poised at a critical spot where there are really only two choices: a sustained rally or a serious drop.

    The dollar chart below shows the monthly ‘value’ of the dollar as measured against a basket of foreign currencies. The red line shows that the dollar is now perched at a level last seen in 2005 and (off the chart) in 1992.
    Foreign Currencies

    USD Monthly

    Foreign Currencies
    If the dollar breaks through this level of ~ 80 on this chart, then it’s anybody’s guess as to how much farther it would fall after that.

    In truth, the dollar should be a lot lower than even this dismal level right now, but foreign central banks, notably Japan and China, have been working very hard to keep the dollar propped up over the past few years. If this foreign propping should ever end, we’d immediately experience two things, a rapidly falling dollar (leading to rapidly rising import prices, notably for crude oil) and sharply higher interest rates (because the Chinese hold their dollars in US bonds, which, when sold, cause interest rates to rise).

    Higher oil and steeper interest rates? Crikey!

    That’s a certain recipe for unpleasantness in the US economy. So it is of critical importance that dollar support be maintained. However, China is now making threatening noises in this regard, warning the US that our insistence on a higher Chinese yuan is unwelcome:

    The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.

    Two officials at leading Communist Party bodies have given interviews in recent days warning – for the first time – that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress.

    There may be a lot of compelling reasons why China would not want to follow up on this threat, but it’s worth your time to consider what you’d do if it did. While there’s no "one size fits all" solution, a few basic steps to consider would be:

    • Get out of debt, especially variable rate debt such as credit cards and any adjustable rate loans.
    • Get some exposure to assets that tend to vary inversely with the dollar. Gold, silver, oil, natural gas, and foreign currencies are my favorites.
    • Build up some cash reserves (savings) to get you through a potentially severe recession that could be brought about by high(er) interest rates.
    • Be prepared for a serious decline in equity and bond values.

    On that last point (#4), there are some other reasons to be concerned right now. It turns out that the US credit markets, principally for mortgage debt, are undergoing some pretty dramatic convulsions, and while I can’t say for sure how bad it will all be, I can tell you that fear has finally returned to our capital markets after a particularly long absence.

    However, should the dollar start to break down in a serious way, I don’t know what else to counsel besides "Stay alert!" It is entirely unknowable to me how our highly leveraged house-of-cards economy would actually behave in a dollar crisis, but I think it’s prudent to question whether all of our financial institutions would remain solvent.

    As you know, I’ve always been deeply suspicious of the modern financial alchemy that has allowed Wall Street to skim record profits off of dodgy pools of repackaged mortgage loans while simultaneously claiming to have reduced the risk of those instruments. Huh? How does one start with a pool of bad credit risk loans (many of them fraudulent ‘liar loans’), strip out a whole bunch of money, and end up with a safer product? I don’t believe it’s any more complicated than that, and I’ve been saying so for several years.

    And, in truth, this is now pretty much obvious to everyone in the financial industry as well. Paul Muolo, executive editor and associate publisher of National Mortgage News, had this to say:

    "I’ll put it bluntly: if you operate a non-depository mortgage firm (lender or servicer) and don’t have a deep-pocketed parent or hedge fund as a sugar daddy you’re likely to be out of business by year-end, probably sooner.

    In the 20-plus years that I’ve been covering residential finance I haven’t seen a financial meltdown this swift since the S&L crisis of the mid-to-late 1980s. One subprime executive who closed his shop a few months ago told me, "This is a liquidity crunch the likes I have never seen."

    So industry insiders are publicly saying that this is the worst financial crisis to hit since the S&L crisis. Of course, that is the perfect analogy, because the S&L crisis was precipitated by the easing of lending standards that morphed into the usual mélange of bad investments and outright fraud. Same as our current crisis.

    Because of this similarity, what should you, the beleaguered taxpayer, be on the lookout for? A bailout, of course.

    Looks like we won’t have to wait very long for the government officials to begin to look for ways to "help people keep their houses," which is DC code-speak for "help my uber-rich banking buddies avoid paying for their mistakes."

    Here’s an email from the CEO of IndyMac, the second largest independent mortgage lender, that came out last week:

    Unfortunately, the private secondary markets (excluding the GSEs and Ginnie Mae) continue to remain very panicked and illiquid. By way of example, it is currently difficult, at present, to trade even the AAA bond on any private MBS transaction.

    In addition, to give you an idea as to how unprecedented this market has become…I received a call from U.S. Senator Dodd this morning who seeking an understanding of "what is really going on and how can I and Congress help?"

    I also have talked to the Chairman of Fannie Mae this morning and have traded calls with the Chairman of Freddie Mac (Fannie Mae’s Chairman telling me that they are "prepared to step up and help the industry").

    The interesting part is to hear this kind of talk already before the crisis has even really begun. Over the next 12-145 months, more than $1.5 trillion of additional subprime mortgages will be resetting to higher rates, and that’s when I expect the crisis to really get underway. Still, I have to wonder how many more US tax dollars are going to be wasted trying to help people keep houses they can’t afford (which many lied to get into) and thereby bail out a mortgage and banking industry that would prefer not to have to give back any of the obscene profits they made off of this racket.

    I mean, what, with bridges crumbling, a waste-water infrastructure that scores a D-minus, two tragically expensive wars, and a looming pension crisis of biblical proportions, it’s not like we really can afford to bail out the rich, the greedy, and the stupid. I say, let them live with the consequences of their decisions. Call it tuition or something.

    Besides, a bailout will not help at all. The main problem is that house prices rose too far away from median incomes and no amount of mortgage assistance is going to remedy that problem. Median house prices need to fall anywhere from 10% to 60%, depending on the market.

    My prediction is that this will happen over the next 3-4 years, no matter what sort of government intervention schemes are hatched.

    In the meantime, I’m going to sit tight, stay alert, and ponder my options.

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    The United States Is Insolvent

    by Chris Martenson

    Thursday, March 15, 2007, 4:00 AM

    Thursday, March 15, 2007

    Prepare to be shocked.

    The US is insolvent. There is simply no way for our national bills to be paid under current levels of taxation and promised benefits. Our combined federal deficits now total more than 400% of GDP.

    That is the conclusion of a recent Treasury/OMB report entitled Financial Report of the United States Government that was quietly slipped out on a Friday (12/15/06), deep in the holiday season, with little fanfare.

    Sometimes I wonder why the Treasury Department doesn’t just pay somebody to come in at 4:30 am on Christmas morning to release the report. Additionally, I’ve yet to read a single account of this report in any of the major news media outlets, but that is another matter.

    But, hey, I understand. A report this bad requires all the muffling it can get.

    In his accompanying statement to the report, David Walker, Comptroller of the US, warmed up his audience by stating that the GAO had found so many significant material deficiencies in the government’s accounting systems that the GAO was "unable to express an opinion" on the financial statements. Ha ha! He really knows how to play an audience!

    In accounting parlance, that’s the same as telling your spouse, "Our checkbook is such an out-of-control mess, I can’t tell if we’re broke or rich!" The next time you have an unexplained rash of checking withdrawals from that fishing trip with your buddies, just tell her that you are "unable to express an opinion" and see how that flies. Let us know how it goes!

    Then Walker went on to deliver the really bad news:

    Despite improvement in both the fiscal year 2006 reported net operating cost and the cash-based budget deficit, the U.S. government’s total reported liabilities, net social insurance commitments, and other fiscal exposures continue to grow and now total approximately $50 trillion, representing approximately four times the Nation’s total output (GDP) in fiscal year 2006, up from about $20 trillion, or two times GDP in fiscal year 2000.

    As this long-term fiscal imbalance continues to grow, the retirement of the "baby boom" generation is closer to becoming a reality with the first wave of boomers eligible for early retirement under Social Security in 2008.

    Given these and other factors, it seems clear that the nation’s current fiscal path is unsustainable and that tough choices by the President and the Congress are necessary in order to address the nation’s large and growing long-term fiscal imbalance.

    Wow! I know David Walker has been vocal lately about his concern over our economic future, but it seems almost impossible to ignore the implications of his statements above. From $20 trillion in fiscal exposures in 2000 to over $50 trillion in only six years? What shall we do for an encore, shoot for $100 trillion?

    And how about the fact that boomers begin retiring in 2008…that always seemed to be waaaay out in the future. However, beginning January 1st we can start referring to 2008 as ‘next year’ instead of ‘some point in the future too distant to get concerned about now.’ Our economic problems need to be classified as growing, imminent, and unsustainable.

    And let me clarify something. The $53 trillion shortfall is expressed as a ‘net present value.’ That means that in order to make the shortfall disappear, we would have to have that amount of cash in the bank – today – earning interest (the GAO uses 5.7% & 5.8% as the assumed long-term rate of return). I’ll say it again – $53 trillion, in the bank, today. Heck, I don’t even know how much a trillion is, let alone fifty-three of ’em.

    And next year we’d have to put even more into this mythical interest-bearing account, simply because we didn’t collect any interest on money we didn’t put in the bank account this year. For the record, 5.7% on $53 trillion is a bit more than $3 trillion dollars, so you can see how the math is working against us here. This means the deficit will swell by at least another $3 trillion, plus whatever other shortfalls the government can rack up in the meantime. So call it another $4 trillion as an early guess for next year.

    Given how studiously our nation is avoiding this topic, both in the major media outlets and during our last election cycle, I sometimes feel as if I live in a small mountain town that has decided to ignore an avalanche, which has already let loose above, in favor of holding the annual kindergarten ski sale.

    The Treasury Department soft-pedaled the whole unsustainable gigantic deficit thingy in last year’s report, but they have taken a quite different approach this year. From page 10 of the report:

    The net social insurance responsibilities scheduled benefits in excess of estimated revenues) indicate that those programs are on an unsustainable fiscal path and difficult choices will be necessary in order to address their large and growing long-term fiscal imbalance.

    Delay is costly and choices will be more difficult as the retirement of the ‘baby boom’ gets closer to becoming a reality with the first wave of boomers eligible for retirement under Social Security in 2008.

    I don’t know how that could be any clearer. The US Treasury Department has issued a public report warning that we are on an unsustainable path, and that we face difficult choices that will only become more costly the longer we delay.

    Perhaps the reason US bonds and the dollar have held up so well is that we are far from alone in our predicament. In a recent article detailing why the UK Pound Sterling may fall, we read this horrifying evidence:

    Officially, [UK] public sector net debt stands at £486.7bn. That’s equal to US$953.9bn and represents a little under 38% of annual GDP. Add the state’s "off balance sheet" debt, however – including its pension promises to state-paid employees – and the total shoots nearly three times higher. Research by the Centre for Policy Studies in London says it would put UK government deficits at a staggering 103% of GDP.

    If we perform the same calculations for the US, however, we find that the official debt stands at $8.507 trillion or 65% of (nominal) GDP, but when we add in our "off balance sheet" items, the national debt stands at $53 trillion or 403% of GDP.

    Now that’s horrifying. Staggering. Whatever you wish to call it. More than four hundred percent of GDP(!). And that’s just at the federal level. We could easily make this story a bit more ominous by including state, municipal, and corporate shortfalls. But let’s not do that.

    Here’s what the federal shortfall means in the simplest terms:

    There is no way to ‘grow out of this problem.’

    What really jumps out is that the US financial position has deteriorated by over $22 trillion in only 4 years and $4.5 trillion in the last 12 months (see table below, from page 10 of the report).

    The problem did not ‘get better’ as a result of the excellent economic growth over the past 3 years, but, rather, got worse, and is apparently accelerating to the downside. Any economic weakness will only exacerbate the problem. You should be aware that the budgetary assumptions of the US government are for greater than 5% nominal GDP growth through at least 2011. In other words, because no economic weakness is included in the deficit projections below, $53 trillion could be on the low side. Further, none of the long-term costs associated with the Iraq and Afghanistan wars are factored in any of the numbers presented (thought to be upwards of $2 trillion more).



    The future will be defined by lowered standards of living.

    As Lawrence Kotlikoff pointed out in his paper titled "Is the US Bankrupt?" posted to the St. Louis Federal Reserve website, the insolvency of the US will minimally require some combination of lowered entitlement payouts and higher taxes. Both of those represent less money in the taxpayer’s pockets, and the last time I checked, less money meant a lower standard of living.

    Every government facing this position has opted to "print its way out of trouble."

    That’s a historical fac,tand our country shows no indications, unfortunately, of possessing the unique brand of political courage required to take a different route. In the simplest terms, this means you and I will face a future of uncomfortably high inflation, possibly hyperinflation, if the US dollar loses its reserve currency status somewhere along the way.

    Of course, it is impossible to print our way out of this particular pickle, because printing money is inflationary and is therefore a ‘hidden tax’ on everyone. What is the difference between having half of your money directly taken (taxed) by the government and having half of its value disappear due to inflation?


    Except that raising taxes is political suicide, while the overprinting of money as the cause of inflation is, conveniently, never discussed by the US financial mainstream press (for some reason) and therefore goes undetected by a majority of people as a deliberate matter of policy. Ergo, we will get all manner of government monetary and fiscal excess, but carefully disguised as bailouts and deficit spending.

    Unfortunately, all that printing can ever realistically accomplish is the preservation of a few DC jobs and the decimation of the middle and lower classes.

    In summary, I am wondering how long we can pretend this problem does not exist? How long can we continue to buy stocks, flip houses, forget to save, pile up debt, import Chinese made goods, and export debt? Are these useful activities to perform while there’s an economic avalanche bearing down upon us?

    Unfortunately, I only know that hoping a significant and mounting problem will go away is not a winning strategy.

    I know that we, as a nation, owe it to ourselves to have the hard conversation about our financial future sooner rather than later. And I suspect that conversation will have to begin right here, between you and me, because I cannot detect even the faintest glimmer that our current crop of leaders can distinguish between urgent and expedient.

    What we need is a good, old-fashioned grassroots campaign.

    In the meantime, I simply do not know of any way to fully protect oneself against the economic ravages resulting from poorly managed monetary and fiscal institutions. For what it’s worth, I am heavily invested in gold and silver and will remain that way until the aforementioned institutions choose to confront "what is" rather than "what’s expedient." This could be a very long-term investment.

    Are you shocked?

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