Economic Fundamentals

The U.S. Economy literally screams recession at the top of its lungs, yet Wall Street cannot hear the voices from its ivory tower. It is my belief that the financial system has only adjusted to (started to deal with) the losses on mortgage bonds. But what about losses coming on industrial loans, municipal bonds, and consumer credit cards will be next.. I thus believe the banking crisis will broaden and intensify. When this next wave strikes—like the middle of the summer, you are going to have the debate as to whether the U.S. banking system is irreparably destroyed, and whether the recession can be terminated. Right now, I am not sure of that answer. The banking system is insolvent-at present. We have to see whether the Fed will bail out everyone.

You have got to stabilize the housing market. All the bad mortgages must be buried in a grave yard which I believe will become Fanny Mae and Freddie Mac. More below on this.


There are certain long term economic fundamentals that seem very clear to me. They dictate what is going to come. They are repeated time and again in the many books that I read on the subject of finance. I probably read five books a week on finance. (Von Mises)

These long term economic fundamentals are dictated nowadays by an insolvent banking system, an increasing number of insolvent homeowners, a largely abandoned manufacturing base, a crippled car industry, declining home prices, commercial property prices which are soon to decline (in my opinion), one third of all car loans with a negative equity, rapidly rising energy and food prices, a strong trend in job losses , and chronic wage erosion. I believe I have commented on all of these in previous Remarks.

It is because of all of the above, continuing unabated, that I have made the statement that we are going into the worst recession in 50 years. I call it the way I see it.

In addition to all of the above, the U.S. dollar has threatened the world financial stability and order. This process is gradual, but the changes coming will register like part of an earthquake, which is tectonic shifts after pressures build.

It thus has made sense to me to protect oneself against an historic and unprecedented level of U.S. bank failures (FRAUD), U.S. bank continuing losses, and U.S. dollar money growth. And the way one protects oneself is with gold and other precious metals. Again I mention to you that it does not matter what price gold is because you are measuring it in printed paper dollars-and other currencies, all continuing to lose value—but at different rates of speed.

I perceive a deep loss of confidence in both the US Fed and the U.S. banking system and its solvency, Mostly by foreigners, not the US public—yet. The comparative weakness of the US$ DX chart (a basket of currencies) speaks volumes about what I would call the coming gold run up, which I believe will start in the second half of this year. It does not matter how much the commercials will short the dollar when this occurs. They will be swept away. There is nothing in my last 20 Remarks that I have warned about that has not taken place or beginning to take place.

I perceive the dollar falling an additional 20% in the future several years. The ability of the US Fed to defend the US dollar has weakened considerably, as the Fed holds a rising proportion of damaged asset backed by –non U.S. Treasury securities. The Fed had $800 billion in US Treasuries in its portfolio, but has taken in $400 billion in CRAP and exchanged this for US Treasury bonds. They only have $400 billion left in U.S. Treasuries (as I read it)-and then what? Your protection again, is gold. There are many perceptions out there that are just plain ridiculous and I hope to touch upon some of them in this Remarks.

I believe there is a secret that no one wants to mention. And that is that private direct investment in the United States has come to a halt. Our external current account (trade deficit) and budget deficits are now being financed by foreign central banks almost exclusively. The U.S. is really living on the kindness of foreign central bankers. The reason for this is that they are defending the trillions of dollars in reserves that they have.
Nevertheless, the decline that I foresee in several years on the basket of currency index will be down to 50. It is 74 now.

The return on investment in the U.S. has fallen to the point where very few will send investment dollars here.

The U.S. is going to become the weakest economy by 2009. I think it is here already. It seems to me that the smart money in the currency options expects the US Dollar to decline imminently. By the way, both the European Union bank stock index and the British bank stock index have fallen dramatically, in unison with the disastrous US bank stock index.

The meddlers in the US Congress are incredibly naïve , and late to the scene of the crime. They usually cause ugly unintended consequences . They are considering restrictions against speculators who use commodities as hedges against major classes like stocks or the US dollar. Senator Lieberman seems to be leading this movement. He believes that the public is paying for speculator profits. He is way off. Better Congress should look in the mirror.

The public is paying for a terrible combination of a shallow national program for ethanol, Congressional waste and corruption, three decades of misguided economic counsel, a war economy, a pyramid of dangerous credit derivatives, reckless dependence upon a housing bubble, and the endorsement of a decision long ago to disband an important “tether” between the US dollar and gold. Thus no discipline exists and thus the system is literally unraveling. The blindness of our national leaders is incredible as they seek out villains to blame when they only need to look into that mirror Assets tied to commodity index strategies have risen from $13 billion in 2003 to $260 billion as of March. I suggest Congress should check out Wall Street where Goldman Sacks and Morgan Stanley top the list of energy derivatives dealers followed by Barclays and JP Morgan.

Amidst the loud cries by Wall Street and the US Congress that speculators are pushing up the price of oil, major banks are the biggest participants of these violations. The story is so lurid that to me it is a vivid reminder or the corrupted financial media that controls story lines.


The Price of Oil

The average price of gasoline just hit $4.00 and I do not believe it is going to go down any time soon. Long term, it will go higher simply because of the supply demand situation. From what I read, expect some gasoline stations to exit the business, as profit margins are down to two cents a gallon., an amount quickly eaten up by credit card fees on purchases. Truckers are dying off or on strike. They simply cannot afford over $5,00 for a gallon of diesel. The national transportation system in antiquated, which is consistent with under investment by any Third World nation.. No modern railroad system really exists, which I believe to be a national tragedy. My feeling is that rising gasoline prices will alter the valuations of entire suburban communities. Urban property will be priced at a premium, especially those with fine transportation systems.

In case you do not know it, my opinion is that we are not getting out of Iraq, no matter who gets in as president. The US, in my opinion, does have an energy policy, a sort of twisted on which is dominated by the big oil companies. The US military has invested a tremendous sum in the war of occupation in Iraq. That is the energy policy. Namely to bid on (right now) and develop the second largest source of oil in the middle east. To that end, the biggest military base in the middle east is being built right next to the major oil fields and port in Iraq. Our army, as I understand it, is going to remain right next to these oil fields and also protect major oil companies while they modernize Iraq’s oil fields..

Not a single wind farm has been funded by any recent Congress. Ethanol is a partial disaster ,so far. The profit margins have vanished for producers Ethanol from corn is three times less efficient per acre of farm land than sugar cane usage. And, as you know by now, using corn to produce ethanol has driven up the cost of all foods and meats. So there is an energy policy, but it is a highly destructive one, if not corrupted.


The Housing Market

The decline of this market is nowhere near at an end. In fact, the lingering oversupply across the board guarantees another 10-20% decline in price. How will bank bonds react? They are going to lose perhaps 50% of their value, even the Triple A ones Huge swaths of debt downgrades are in progress still and I believe that the news is kept quiet. It is hard for me to talk about recovery. The only thing that has recovered is the acceptance of falsehoods. This is but the first leg down in a powerful recession, the likes of which has not been seen in half a century. (my opinion)

The obvious recession and now job losses screams further additional US Fed rate cuts, if not now ,then later. A friend asked me in an E mail what affect the Fed holding the Fed Funds rate at 2% would have. And the answer is nothing. Much more monetary accommodation (easy money), wave after wave of further bank foreclosures, further bank losses, new waves of bank failures all of which will send gold up in the last half of the year. As said before, you want to stop inflation, or slow it down, then start raising interest rates. You want to let inflation keep rising, then do nothing or lower interest rates to nothing-which yet may happen-as this recession gets worse. There is no way the Fed, right now, can raise interest rates. The economy would literally go off a cliff.

The inventory of homes for sale is ever rising. A significant number of sales are linked to foreclosures and the bankers are increasingly desperate to dump properties that cost them money to carry, such as insurance, property taxes and maintenance. A shocking number of homes just sit and rot on the market. With 2.5 million homes vacant, the market has twice as much as the historical norm. To put it in another way, this represents a two year supply., but not all are for sale. This stubborn inventory supply dictates that the housing market is much further from the bottom than is widely accepted. I do not see any housing recovery before 2010.

Lenders are going to impose more strict standards for loans, like based on income to carry the loan (finally), and home purchase will be restricted to basic sanity.. In the final analysis ,affordability will be almost irrelevant, since a driving factor is a large bloated supply, added to by diminished demand, and hampered by tightening lending standards.


The Socialization of the Banking System

The rescue of Bear Sterns was evidence of how far the financial and political authorities will act to insure the financial system. As said so many times here, they will print the money and they will do whatever it takes. The central banks may try to hide the fact that they are taking in crappy paper and lending against it, but that is the bottom line.. The securitized markets for CDO’s. ClO’s, MBS’s etc are now severely impaired and the G-7 central banks have substituted themselves in one form or another as funders of last resort. The various banks have rushed to market hundreds of billions of dollars in long-term obligations to bolster their balance sheets. In doing this, the banks are impairing the future earnings of their shareholders in exchange for locked in funds for about 10 years. They are paying top dollar for non-callable debt provisions, as the public will no longer fund them..

There is no corner of the lending industry which is not toughening up borrowing requirements. This is thus the credit picture rolling into the real economy. Congress wants Bernanke to start buying securitized student loans. You can count on more reflationary policies in the near future. Do you see the helicopters overhead.? The money will be printed out of this air—there is no other way. The dollar will fall .sooner or later. (said above)

Fannie Mae just announced another multi billion dollar loss and announced another $6 billion dollar round of capital raising. You can expect Fannie and Freddie Mac to have to raise another $100 billion before the bloodletting is all over as their solvency rests on accounting fiction. I have also read that there are HUGE losses on pension funds which bought SIV’s, and securitized debt known as CLO’s, MBS, and so on, In addition, funding problems are starting to surface in many state and municipal governments as boom time budgets are busting.

Goldman Sachs just came out with a strong sell recommendation for Citi Group, and it hit a new low. There is nothing new here, that I have not said 10 Remarks ago. Citi has 1.25 trillion in level 2 assets ( bonds of all types) . They also have level three assets which amount to 125% of total shareholder equity. Many of these assets are going to go belly up and will wipe out Citi . They must keep on raising more and more capital. But this problem is with all the banks. Apparently, Goldman wants to make money on Citi and GM by selling short and seeing them go down.

I have a high degree of disdain for JP Morgan (the Fed) and Goldman (the US Treasury—Paulson) because they sit in a place of high privilege, (I feel). But I do want to quote Jamie Dimon , head of JP Morgan, in a speech I read that he made in Germany.
“We are not done with this crisis for a very long time”




Summation

As I write this the market has dropped 358 points and gold went up about $30. Most of this I believe happened because the world realizes that the Fed cannot raise rates to defend the dollar. The economy is just too fragile. Thus the dollar is going down, gold up, and the housing debacle and bank debacle will continue. I caution the reader that many investment assumptions that have worked in the past for generations will no longer work out. Mother nature rewards the strongest and smartest with abundance and punishes the weakest and dumbest with their unfolding demise to make way for the new powers.

The financial system of this country and indeed the public have believed what the media has been telling them—namely that there is a bank system recovery ,that mortgage losses are beginning to stabilize, and that the economy is now slowly recovery from the housing decline. Also that the housing decline has abated. None of these are true. It is sheer nonsense. There is going to be a financial failure somewhere again, and that will dispel any notion of a rate hike. I am looking for a kind of PANIC in the banking and financial world. The reason for this is because the DEBT and Derivatives with no market at all, are in the trillions. The major banks and others own this debt valued at many times their net worth. Bringing them on any balance sheet will destroy the bank or brokerage house.. So they do this slowly, and that is why you see the need to raise continuous new money. On top of all this, expect shocks to the auto industry.

I believe that a secular bear market began in 2000 and is destined to last at least four to six more years. I also believe that we may soon have an intermediate low which should last on the upside for several months. I cannot ignore that every election ending in 8 has been an up year. This may be the exception year, but I would not take that chance. Any upward movement in this stock market would be just a bear market rally. After election, it is “going to be brutal” (I would like to be wrong but I see us WRINGING out the excesses which will be long and painful) I might use the words, God Help US.

It is different for gold.. I believe we have been in a secular bull market which is intact and the odds favor a good upside in all probability with a major move starting in August lasting through the end of the year. We have to break $934 before I can get excited. I think we can see $1200 by year end, and then much higher next year. To quote Will Rogers, “ I am more interested in the return of my money than the return on my money”

My last post was comments was from a friend who shares his thoughts with his friends and those who listen usually fair pretty well... at least I have. Personally, I think most ordinary people in the US have no clue as he so eloquently writes his comments every week.

My last post was comments was from a friend who shares his thoughts with his friends and those who listen usually fair pretty well... at least I have. Personally, I think most ordinary people in the US have no clue as he so eloquently writes his comments every week. - Stuart Lesley