Vigilant Investor

This is truly worrisome.  The Commodity Futures Trading Commission is set to release new rules on Monday:

“The (CFTC) has been wrestling for more than a year over farm industry demands that it examine the role that new financial investors are having in the futures markets, especially those who are investing through commodity index funds.

As commodity prices have risen over the last several years, these funds have become an increasingly large player in the commodity futures markets, rising from a stake of roughly $13 billion in 2003 to an estimated $250 billion this year.

Unlike traditional commodity investors or balanced hedge funds, these index funds do not both buy and sell commodity futures — they only buy, reflecting investors’ desire for a stake in a rising market.

That lopsided trading pattern has generated complaints — most recently at a hearing last week before the Senate Committee on Homeland Security and Governmental Affairs — that index investors are artificially driving up commodity prices at the expense of consumers.

One Senate witness even proposed that federally regulated pension funds, a major source of index fund investments, should be forbidden from investing in commodities because of their impact on consumer prices.”

That’s from the New York Times today. While it is tough to say what these rules will do, we certainly hope those wanting to limit the flow of dollars to where they want to go to get there way.   Granted, it is unfortunate that so many dollars flooded the world economy over the last few decades, and now they wish to find a home outside of financial assets that have been exposed as economically not viable absent ever increasing credit and money supply vs. genuine economic growth.  So, naturally, the laws of scarcity and supply and demand are at work, as are the laws of venting bubbles.  Supply of dollars super-high, and investors have lost their appetite for bubble assets, so they want something more tangible and less likely to be printed where they can more reliably store their wealth.  Were they not to, down the road they’d simply lose their purchasing power.

You see, investors have been wakened from their slumber at long last, and now they realize that inflation was running rampant.  See our prior two posts for the details.

That aside, should the fools in Congress pressure the commodities exchange to prevent the free flow of capital into commodities, well ladies and gentlemen, there goes a big vestige of what’s left of the U.S. free market. Those, dear readers, are called capital controls.

If that happens, expect the largest investors — those with the clout to do so — to hope on other exchanges to buy those assets.  Expect foreign oil producers to start dealing in other currencies.  Expect Congress to have to react to the massive problems that will create — the ones such controls half of them are pushing for, hence the commodities Exchanges urgency for Monday’s proposal.    And, expect those new proposals to only further worsen the condition.

This, folks, is why you don’t get onto the inflationary money and credit policy for ginning up the economy artificially. Eventually it breaks and catches up with you. But like a smoker of thirty years who is diagnosed with cancer asking his doctor, “what do I do?”, we all know the answer to the question was well known thirty years prior: Don’t smoke. You’ll get lung cancer.

And, so now, the die is caste. The options are all unattractive and painful, but some are clearly in the direction of clearing the economy if this mess, while others will only worsen and compound the crisis.  One simply bites the bullet and gets it over with, the other — the solution currently demanded by Wall Street, the Lunatics on the Potomac, and their economically illiterate constituencies — the same one being pushed by policy makers at the FEd –  will simply drag out the process, much like a heroine addict who believes feeding his habit is better than the abyss of the withdrawal.

Hold on to your hats and your commodities.  The eye of the storm is passing, and the back side of this will turn very ugly.  The question of Depression and the end of the U.S. dollar, quite frankly, rests in the hands of the politicians and the Fed — both of whom seem hell bent on avoiding the day of reckoning at any cost.  But that day will not be denied, and each day its pushed off with more of the very policies that created the malignancy, the worse the inevitable becomes.

It didn’t take long for Congress to make an emphatic point that it does not understand the value of a free market, or for that matter, that it fails to comprehend the importance of a freely operating pricing mechanism. Said another way, Congress is proving its members to be the economic jackasses they’ve generally always tended to be.  In this case, some are attempting to disrupt the free flow of dollars into commodities — the same dollars whose supply were expanded at a decent clip over the last few decades.

The attempt at preventing the market place from determining the real price of commodities as dollars flood  from other, bloated priced items — real estate and related securities, financial equities, and less attractive, low interest rate debt — and into real, hard, tangible assets that are forced to be backed by labor and sacrifice as opposed the Wall Street alchemy, Ponzi finance, and the money printing press.  Robert Mugabe’s inflation in Zimbabwe clearly is far more dramatic abuse of a currency, but his policies to hide inflation are fundamentally no different.  He attempts to prevent price discovery as well, and the consequences he has will be what the U.S. can expect — earlier stages, of course, but dramatic nonetheless:  capital shifting to where it can find a true price vs. being hampered by centralized cover-up.

Yesterday Bloomberg began reporting that the Chairman of the Senate oversight committee, Joseph Lieberman, is considering legislation limiting what he defines as speculation in the commodities markets. While it is geared at preventing mostly larger players — hedge funds, and other institutional investors — from hedging in the commodities market, the effects of this proposal, should it be enacted, will cause shudders all the way down to the average person.

Mind you, we’ve been pointing out since the early part of this decade that Greenspan’s attempts at warding off the market crash and ensuing recession of 2001 would create severe dislocations in the economy as prices bubbled into new bubbles and economic activity would be distorted as the all elements of the economy restructured itself around what it perceived to be legitimate economic growth. Yet we were clear that this activity would serve only as a head-fake to the economy given it was rooted not in genuine growth, but rather through credit and monetary inflation — a process that rips wealth from the organic / functioning sections of the economy, reallocating it to the hot money, synthetic areas of the economy that can’t stand on their own absent the artificially created life support. With the collapse of the housing and credit markets, we’ve been proven about as correct as one can be — especially when compared to the supposedly reliable experts on Wall Street, at the Fed, and in Washington D.C. who were overwhelmingly blindsided by the collapse.

Says Lieberman:

“We may need to limit the opportunity people have to maximize their profits because a lot of the rest of us are paying through the nose, including some who can’t afford it.”

Meanwhile, Senator Claire McCaskill, Democrat of Missouri, is warning that the people are ready to reach for the Pitchforks. Well, let’s make sure they know who the real culprits are.  In short summary, here’s a few key reason why commodities are going up:

• Too much money has been printed over the last few decades. The consequences of this were beneficial as they often are when the government and its sanctioned central banks (ala our Federal Reserve) inflate in the early stages in that some “nice” assets were inflated in price, such as stocks and bonds, and houses. Only, investors failed to make the connection that these bubbles, with bonds still in high gear, were inflationary.
• The other benefit was a double edged sword: free trade.  While many lost there older, higher paying jobs in the United States, most Americans were only mildly inconvenienced as newly minted dollars were quickly vented off shore with the trade deficit.  All that wealth was invested by foreigners into vastly expanding low cost production capacity, and hence, the U.S. consumer benefitted as prices plummeted.  Were these dollars stuck in the United States, its high cost labor and cumbersome regulatory nonsense would have combined with the natural consequence of an increasing money supply facing a supply of goods and services growing at a dramatically slower pace.  Inflation would have strangled the economy pretty quickly.
• All this foreign production and accumulation of wealth requires commodities to feed it. That demand is competing with the U.S. as supply has not increased so drmatically. Flush with U.S. dollars, trade partners are ever more willing to part with dollars to satiate their demand for commodities.
• All those dollars are printed, and they exist in the economies of many countries across the globe. Most still remain invested in the Bond bubble, focusing heavily in the perceived safety of U.S. Treasuries. However, other U.S. bond assets, especially the once sturdy mortgage sector has imploded.   This, as commodities were gaining pretty much since 2002.  Since then, Sovereign State and Central Bank investors have been contemplating the problems of the dollar, and have begun braodening their positioning of new dollars in areas other than just bonds and equities.  Hello, commodities as an asset class.
• More private and institutional Investors have been looking to diversify as well, with the most savvy having understood the nature of the inflation that took  place over the last twenty years and its contribution to a vast credit bubble that will require yet more inflation to support Wall Street investment banks. They’ve also noticed the U.S. government has a long term insolvency problem given politicians have promised the sun, moon, and stars at such a level that it will literally bankrupt the nation, and with that they expect politicians to to the politically surreptitious method of paying off things like Social Security, Medicare and Medicaid.  They’ll do it with freshly printed dollars vs. doubling taxes and cutting benefits by a third.  These savvy investors have diversified into commodities as a basic inflation hedge given they believe the die were long ago cast.
• Other savvy investors expect foreign sovereigns to lose their appetite for U.S. debt at near 50 year low yields given they expect the emerging recession will be severe.  This will result in more commodity hedging / dumping of the dollar, they expect.   F
• or decades we exported our inflation, and foreign nations gladly imported it for trade purposes. Now we will pay for it as foreigners slowly export it back to us.
• Finally, Peak Oil theory has been right on, and this problem of decreasing light sweed crude supply means oil producers will be forced to retrieve harder to get and less easily refined resources vs. what so easily flowed for the past sixty years.  The quality of Saudi oil has been steadily decreasing suggesting that the Saudis are not so flush as in the past, further explaining their recent shift to preserve their resource for future generations of their own people (a trend emergin among all OPEC nations) vs. supplying the United States, which refuses to develop its own resources while it’s politicians, delusional as always, wag their fingers at the OPEC for not producing enough.
• U.S. energy policy has been swamped by Green and NIMBY (not in my back yard) legislation that simply has caught up with the U.S. via higher priced energy.  Oil is a crucial factor in the production of everything, including fertilizer, transportation, and every single facet of production. As it goes up in price, invariably so will all else.  Nuclear energy has been virtually outlawed while many nations globally use it very safely.  Meanwhile, alternative energy has been a goal, but its still not viable technology.  NIMBY and environmental legislation hammers some of it, such as wind farms, which have been prohibited for killing some birds and making unsightly beach views.
• Just in Time Delivery was dependent on low energy costs. Supply will be constrained as the economy rewires itself to slower delivery and larger inventories in order to lower costs.

So there you have it, and that’s just the tip of the iceberg. Congress can reshuffle the deck chairs and search to blame, blame, blame everyone but themselves and the private banking cartell they collude with called the Federal Reserve.  But inflation is catching up to us, and it the stupid legislation in the United States that made the U.S. too complicated for doing business, and its currency so common, well… that’s to blame.

That said, expect the politicians to distract from the real problems as they always do. They will, instead, look for politically popular scapegoats to help their re-election.

No doubt, there are quite a few problems behind why oil has jumped above $128 a barrel.  Never mind hooey arguments about greedy oil companies that resonate with the economic illiterates among the loudmouth media and the complaining voters.

While we don’t have much good to say about any politician on the matter of energy, we really can’t disagree with President Bush’s observations about pressuring the Saudi’s for more output:

“Our problem in America gets solved when we aggressively go for domestic exploration. Our problem in America gets solved if we expand our refining capacity, promote nuclear energy and continue our strategy for the advancing of alternative energies as well as conservation,” he said.

“One interesting thing about American politics these days is those who are screaming the loudest for increased production from Saudi Arabia are the very same people who are fighting the fiercest against domestic exploration, against the development of nuclear power and against expanding refining capacity.”

This, said Bush, after noting that Saudi output really is not the ultimate solution to the U.S. price problem.  Mind you, many in the U.S. Congress are wagging their fingers at the Saudis — like candidate Hillary Clinton — for not increasing their production significantly enough to alleviate U.S. price pressures, as if the world should rotate around the U.S. dilemma.  The same folks giving grief to the Saudis are the same ones who refuse to allow the U.S. to develop its own energy resources as Bush notes above.

Not that the Republicans have been any great movement as of late to get anything done themselves, with R candidate John McCaine having been a pivotal vote in the Senate preventing the development of Alaskan reserves.  Indeed, the U.S. has not built a new refinery in three decades, and refuses to allow development of both oil and clean burning coal, not to mention nuclear reactors.  Even environmentalists are preventing air windmills, much to the happiness of those with fancy homes on the coasts who loath having their million dollar views ruined by windmill farms harvesting the constant ocean breezes.

Hypocrisy aside, we’re not hearing one of the core causes for skyrocketing energy costs: plain old fashioned inflation. And by “inflation”, we don’t mean the modern misuse of the word to describe the consequences of inflation — rising prices –, but rather the actual cause of the rising prices: climbing money supply.   The world is now awash with dollars thanks to a steady thirty years of the Fed and the U.S. banking system creating dollar after dollar with its fractional reserve, fiat privilege.

Looking at the money supply graph, you can see that the various measures of U.S. dollars have been on a steady rise since the 1980s, and especially ramped up in the 1990s.   Most were lulled to sleep about the ugly effects of inflation due to two factors, both of which served as siren songs for the unsuspecting public and the herd of sheep hitting their record bonuses on Wall Street:

1. Inflating nice asset prices like stocks, bonds, and houses
2. Exported inflation dollars bought cheap goods made abroad, a honeymoon that lasted until the last few years, when foreign nations were flush to the gills with dollars and ready to part with them to buy things that were not so easily printed and common — and very essential, like energy!

This is too ripe. From the Financial Times:

ECB voices ‘high concern’ over liquidity scheme
By Paul J Davies and Norma Cohen in London and Anousha Sakoui in Vienna
Thursday May 15 2008 17:45

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.

Yves Mersch, a governing council member, said the ECB was now “looking very hard at whether there is not a specific deterioration of collateral” which the central bank is accepting in return for funds.

He was speaking amid signs of some banks creating low-rated assets specifically so they can be traded for treasuries at the European Central Bank.

Who are these people trying to kid? The very essence of all the emergency action at CBs, including the Federal Reserve, has been to provide a way for banks (and now others) getting sucked under by toxic assets backed by plummeting collateral to find cash to bail themselves out. The Fed has entirely rewritten the rules, including going outside of the banking community by rescuing Investment Brokerage Firms. At one time the Fed required AAA Treasuries as collateral, but now it will swap those AAA Treasuries from its reserves and accept in its place those tens of billions in mortgage backed toxic waste that has no marketplace. And CBs claim to be caught off guard? What a joke!

“The Federal Reserve as other central banks is obviously taking onto its balance sheet a lot of mortgages these days.” “Well, the creators of the Federal Reserve system would be rolling over in their graves if they knew the Federal Reserve is buying mortgages.”
– Former Federal Reserve Chariman Paul Volcker

Whether or not the creators of the Fed would be rolling over in their graves is debatable in our opinion. Like Andrew Jackson — we believe central bankers have always been dangerous, incompetent meddlers. We feel the Fed should never have been created — and and that it continues to prove itself as bungling as any other central planning committee. But we digress…. That said, the former chairman’s grave concern over the central bank taking on billions of not so hot private debt is quite valid.

Volcker went on to warn that recent intervention by the Fed in securities markets might compromise it’s independence. He went on to say that the Fed’s inability to contain inflation will create a 1970’s like scenario. Again, he’s right there. We’ll also add, it’s too late Paul — the nationalization of the US private debt has begun. When politicians, who’s outlook is only as far as the next election — get involved, the trend will only accelerate. So to will corresponding inflation and Dollar degradation.

Beyond the blatant example of the Fed’s $30 Billion bailout of Bear Stearns — we now see Senator Christopher Dodd proposing the creation of an FHA program to insure refinanced mortgages following partial forgiveness of the loans by lenders. OK, let’s think about this. In an environment where U.S. foreclosures have risen 65% over the past year — and private banks/lenders are preferring to seize homes rather than renegotiate with already defaulting borrowers — the Federal Government is going to step in with money it does not have (but will be all to happy to print) — to back already bad debt.

Also, earlier this month, the Fed agreed to accept securities backed by student loans pledged as collateral for Treasuries the central bank would in turn lend to Wall Street Investment Banks. Let’s analyze that deal. Investors had become far less willing to finance student loan debt at pre-existing prices — due to liquidity issues, the economy, and the fact that consumers (including students) are hurting — and are therefore higher credit risks. The cost to finance such loans would have to naturally go up. Wall Street investment banks (you know, the ones who paid themselves billions in record bonuses over the past year) were less willing to hold onto securities they owned backed by this type of debt. However, if they tried to sell it — they would sell it for a loss. No worry, the Fed would lend/swap them Treasuries for the riskier (and worth far less) student loan backed securities.

Effectively, you have the government, or quasi government institutions backing substandard debt with money it will have to print. That spells one thing — accelerating inflation — and the always accompanying confiscation of private savings. And we’re not talking the low single digit inflation figure the government “calculates” (and bases Social Security payment increases on). We’re talking about the inflation you see in the supermarket ($4 for a handful of blueberries anybody?) — and at the gas pump.

When we hear the Treasury Secretary, or the Chairman of the Fed talk tough on inflation and defending the Dollar — we just smile. When we hear political candidates blaming oil companies and “speculators” for rising prices — we smile again.

We think the next 3-5 years will be quite interesting.

Its always a small sidebar in these type of crisis: the banks too small for the big guys to care.  Rather than being bailed out, they simply are absorbed at pennies on the dollar by the big boys whose hands are firmly in the till of the Fed.

Only three banks have failed year to date, but the third — ANB Financial, which controlled $2.1 billion in assets with $1.8 in deposits — much of it demand deposits like your checking account — is no small fry.  Expect more as the recession really takes hold and payments hit the skids on the extreme overhang caused by massive easy-credit-caused dislocations.  Seems the Feds expect more, as well:

“FDIC is planning to beef up its staff, including temporarily hiring up to 25 retired FDIC employees who worked in the agency’s more than 200-person division that handles failed banks. They will handle an anticipated increase in bank failures.”

Obviously the failure of Bear Stearns would have triggered cascading defaults given so many players were writing credit default swaps on securities that did not even exist, thus adding multiples to Bear’s actual debt market value — at least in terms of liabilities to those who were insuring the risk.   You can imagine 12 months ago those writing these derivatives never would have dreamed Bear Stearns could go under, and you can be sure there premiums were well under priced vs. the risk, yet still considered easy money.  Think there’s any coincidence that JP Morgan had been writing upwards of 45% of all credit default swaps in the market place and the fact that the Fed enabled them to keep Bear’s head above water? Imagine the liabilities that would have sucked JP Morgan down with the ship.

Again, some banks are small enough to fail.  Tough luck. Others?  Let the shell game continue.

You have to love Alan Greenspan.  Today he’s quoted as having declared the worst over for the credit crisis during a speech in New York.  Yet, at the same time he still thinks housing has a long way to go down, and will not be hitting bottom by year end.  Well, which one is it going to be, Sir Alan?   Given the implications of the latter, it certainly can’t be both!  Perhaps that’s why Mr. Greenspan is requesting the press not cover his speech comments?

Longtime readers of VI know where we stand on the issue, but as of late your writers have been busy in our full time consulting business — the economy unfolding much as we predicted to many people we’ve talked to over the years has brought much interest as you can imagine.  That aside, though, updates like this one will continue as our schedules allow.

Currently we’re taking the approach that we’re now amid a sort of eye of the hurricane situation, with one glaring exception.   The eye of the storm is welcome to those enduring the prior chaos, but even though it might appear that the worst is past, there are still plenty of signs that all is not normal.   Usually the eye represents the half-way point for a hurricane, but in our economic case, our estimation is that we are fortunate to be about 1/3 of the way through.  Just consider the signs:

• Oil Record Smashed: $126 Barrel
• Citigroup Plans to `Wind Down’ About $400 Billion of Bank Assets
• Citigroup Leads Wall Street Drive to Punish Taxpayers in Auction-Rate Debt
• UBS’s Exit Strikes at Heart of Municipal-Bond Market
• UBS Set to Cut 5,500 Jobs After First-Quarter Loss
• Swiss Re First-Quarter Profit Falls on Writedown
• Legg Mason hit by first loss in 25 years
• Bad Investments and a $7.8 Billion Loss at A.I.G.
• Commodities Aren’t in a Bubble, Demand Key Factor, Economists Say
• Mortgage crisis seeps to prime loans
• D.R. Horton swings to $1.3 billion loss
• Property Mogul Poised to Take a Second Fall
• Americans unload prized belongings to make ends meet
• Credit crunch to claim 40,000 financial jobs
• Bankruptcies and defaults gather pace
• GE to stop financing boat, motor home purchases
• Doubts Raised on Big Backers of Mortgages
• Home lender ResCap facing cash crunch
• Economic Troubles Affect the Vegas Strip
• Tight Credit Worries for a Hotel and Mall Operator
• Tropicana casino group files for bankruptcy
• Las Vegas used to be a recession-proof oasis. Not anymore
• Key facts about U.S. April auto sales
• Auto dealers face tough road for second-quarter sales

Does this sound like a real “all clear” signal to you?  We’ve been hearing the calls of “the bottom” since the implosion hit last summer with Bear Stearns at the epicenter.  These calls keep coming from the people who failed to see any of this mess arriving, and are the same ones who’ve continually misdiagnosed problems since then.

Don’t count on these same rascals to correctly call anything, especially Honest Al Greenspan who is doing whatever he can to salvage his eroding reputation as the man who tamed inflation and the business cycle.  In reality, he merely compounded the distortions on both ends.

Recessions are like earthquakes — better to have the pressure relieved in many smaller releases.  In the real world, you rarely feel earthquakes since most are so mild.   Consider that the natural business cycle, where you have normal ups and downs. Only problem is the meddling policy maker find those not politically tenable while the banker finds their restraint terribly inconvenient, so in cahoots they inflate and create boom / bust cycles. Everyone loves the highs these injections give the economic addict, but nobody likes the abyss of withdrawal. And the abyss is deep.

Instead, Fed policy under Greenspan and now Bernanke is all about holding off any release of tension as long as possible.  In an attempt to sustain the unsustainable (overly inflated asset prices backing the entire Wall Street system) they’ll go back to the old inflationary tricks and rewrite the rules for the Fed without any Congressional authority.   The tension only compounds, and eventually the release will be much uglier thanks to their meddling.

We expect serious consumer pull back as more jobs are hacked in the face of tight credit. We also expect stagflation — the Fed, its Wall Street backers, and the Dependent politicians in D.C. will do what they can to punt this problem into some future administration’s lap. Problem is, they appear to have finally run out of rope.

Hence, as the eye of the storm passes, get ready for the worst 2/3′rds of it.

Stay Vigilant!