Vigilant Investor

Frequent Kudlow guest, Jerry Bowyer, published a piece today over at Town Hall that would appear to compound prevailing myths regarding the history of the gold monetary standard, as well as the present misinterpretation of the meaning of $800-plus gold. While tipping his hat to the Austrian / Misesian views on currency, like so many other pundits, Bowyer seems to not fully comprehend what Mises was saying. His piece also is filled with a few non sequiturs, and I’ll try to hit on a few of them.

I should, however, point out that I am a proponent of free market chosen currencies as opposed to fiat paper currencies. Those sentiments are bracketed by my ardent stance against dishonest currencies that are printed from thin air by people who’ve sacrifice nothing to attain this sudden purchasing power which is, in no uncertain terms, functionally stolen from those already storing their wealth in units of the currency! My general belief is that currencies left to the market’s choice will naturally become backed by something other than empty promises or debt, as is the current system. Be it gold, silver, or some other commodity that cannot be manipulated — I’m fine with it… so long as the public retains the right to choose or reject it!

Now, down to business. Continue Reading »

UPDATE: Oops! We crossed our labels in our DJIA and S&P500 vs. Oil Charts. Those are now corrected. If those barrels per unit seemed off before, they’re now corrected! 10-14-2007

In America its very common to think of the dollar in a vacuum. You actually hear pundits dismiss the dollar drop, saying “Who cares! In America we spend dollars.”

Well, while we believe the dollar dropping vs. other currencies has some serious implications for the debt addicted U.S. economy, the dollar has been dropping not just against other currencies. Here are a few sobering charts worth considering when change our measure away from dollar terms.

Grocery prices in the 12 months ending 6-30-2007

Continue Reading »

We’re live 3:30 NYT to discuss the recent weeks events with the giant credit bubble unwind. Has the Fed been nearly as liquid as many suspect, or have they been stingy? The market seems to think all is ok, but should it be so quick to jump back on the carry trade and drive equities yet higher?

Join our live worldwide streamed talkcast today. Call in. Chat. Just listen or download for later!

Signs are mounting that support for the U.S. dollar is beginning to wane as dull demand on new 2-year and 5-year Treasury notes are providing more evidence that foreign central banks are tiring of the dead-weight associated with dollar denominated currency reserves. This is crucial factor when you understand the relationship between these reserves and the U.S. economy.

These reserves are kept for two reasons.

One is to protect the native currency from currency raiders like George Soros from swooping in and crippling their economies.

The other is to maintain trade parity with the United States. In this case, a strong dollar relative to the native currency translates into exports to the U.S. — essential for many export-dependent emerging economies that lack internal demand for their own production. Foreign manufacturers have little use for dollars in their nations, hence when they earn dollars, they convert them into their native currencies — which translates literally into selling dollars into the market at market exchange price vs. their own currency. As with any commodity, this naturally increases the demand for their own currency and decrease the demand for dollars, resulting the dollar losing its purchasing power in their own nation — thus depressing their export dependent economies.

Hence, governments and their central banks intervene by keeping dollars and dollar denominated assets, like U.S. Treasuries, in reserves, while simultaneously they inflate their own currency supply to offset the increased demand. The net consequences it that parity between the dollar and their own currency remains, and trade is not affected. This artificial demand has had the effect of artificially depressing the borrowing / credit rates in the United States and globally. Contrary to what many debt apologists say — experts who believe that low rates and massive debt in the U.S. is a sign that foreigners are finding great deals in the U.S. and that debt is good (yes, they do say this) — these low rates merely reflect central planning intervention by the world’s governments and central banks, the U.S. included. (Now, for some reason many who agree that central planning in a sense of the Eastern Block economies is bad can, in the same breath, say that such meddling is good when its left in then hands of central banks and other economic policy meddlers…) These are not market rates. These are artificial, below market rates! Adjustments taking place as central banks back off are proof of this!!!

Now, the real problem is emerging in that Continue Reading »

Listen to our live Streamcast today from 3:30 - 4:30 p.m. We’ll be covering:

• The unpopular effects of Money Supply creation: Bubbles. The inflation tax. Dislocation.
• Globalization: Hoe much can the bubble take?
• Can the U.S. Survive a Trade War?
• The GOP wants to ban Ron Paul
• Bill Gross: Accepting Defeat? Hiring Greenspan?!?
• And more!

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It looks like New Century is fighting for it’s dear life. Says one analyst, according to Bloomberg, “The only possibility for survival now is for someone, potentially an investment bank, to step in.”

One can only imagine where the liquidity is going to come from as this problem worsens.

To Think that 20 months ago the overwhelming majority of Wall Street analysts and economists were telling us that there was no housing bubble. Just four months ago there was no chance of a Sub-Prime mortgage implosion. A few weeks ago they were saying the sub prime problems would be confined.

Does anyone else notice a trend? It reminds me of the stock slide in 2000, where the perpetually bullish Goldilocks crowd championed all news as good news for the economy and the market.

This is just the tip of the iceberg. Housing is just beginning its slide because the buildup to, and fundamentals supporting this bubble are structurally different than any before it.

Stay Vigilant!

Note:  It has come to our attention that there is actually a Health and Beauty company called Lendron. In no way are we referencing this company.  We should be clear that “Lendron” as we use the term is a reference to “Enron”, combined with the word “Lend”, and it is a term not of our creating.  Rather, it is being used “on the Street” to describe New Century Financial.

The Wall Street Journal site has a nice interactive map that shows last week’s historic volatility, country by country.

It would appear risk aversion is suddenly going out the window. A deeper question now is, amid the losses and the unwinding carry trade, will generating the necessary liquidity cause a deeper venting in equities?

Ok. We know we yap day in and day out about the problems created by central bank policy addicted to inflating the money supply. All the dislocations (bad, unsustainable business decisions) that are encouraged; all the wealth redistributed to hot money hands, from savers and producers and into the hands of dot-com twenty-something CEOs eagerly buying 30-second Super Bowl commercial spots, or more recently, into the hands of condo flipping moguls with advance degrees issued by real estate seminars.

Another consequences is that, the more you use inflation and credit to bail out economic slowdowns, progressively the effectiveness wears thin. That’s because of the compounding dislocations create a Frankenstein economy that is a garish impersonator of a real, natural free market.

Anyway… enough background, and on to the point — We were surprised to have missed this bit of evidence to our argument published by Business Week this past fall:

What’s Really Propping Up The Economy

“Since 2001, the health-care industry has added 1.7 million jobs. The rest of the private sector? None.”

Clearly the quasi socialized health care system in the U.S. running at 48% of all jobs represents a host of issues that we’ll save for another day. Let it suffice to say that the redirected bloat cannot continue indefinately for a host of reasons.

Let us, for now, focus on the two other dominant job growth areas: Construction and Real Estate at 27% and government 25%.

The former is large concern given it represents classic inflation-driven bubble activity. Absent the liquidity deluge courtesy of emergency low interest rates and the trade deficit dollar recycling back to the U.S., the housing bubble never would have grown so distended. Instead, its various symptoms — bubbling prices, easy lending, the home equity withdrawal bonanza, and the flipper get rich mentality, etc. — were encouraged year after year, with the billions of liquidity luring many a moth to the flame. Now that the bubble is releasing and the old tricks for enhancing it further apparently exhausted, what’s left in its wake?

I suppose we could look at the latter: government growth. But anyone with any sense knows that government redirects revenue toward poor use, as well.

Meanwhile, if you look at the final figure on the chart related to losses of jobs, that should raise an eyebrow, too.

Let the Pollyanna’s say all they will about Goldilocks economy. Vigilant folks are a bit more skeptical. Far too much information is documented here at Vigilant Investor that should at least raise concern.

But Wall Street meanders along. VIX at near record lows. Yield spreads still alarmingly narrow. Hoh hum.

We thought readers would find this series of charts of interest.

Of course, we’re told we live in an environment with inflation under control:

We’ve been posting updates on the sub-prime mortgage implosion that has begun. Here’s a reason why we worry about it only being the tip of the iceberg:

What’s happened to housing so far, by region:

That’s a question I often get about our ongoing commentary on the busting of the housing bubble.

Let’s see what one of the nation’s largest home related retailers has to say about the situation:

Stalled housing market clouds Lowe’s outlook

The real problem, you see, isn’t the housing market directly — it is the credit bubble that created a bubble in all things housing, and then by inference, most things in the economy servicing those folks. And this is no small issue: It is said that half of all jobs created since the recession of 2001 were housing related. Consider these graphs:

[click charts for full sized]

There’s no doubt that the Fed will work feverishly to engineer a soft landing for the economy as a consequence. But given the many structural headwinds we speak of here on a daily basis — and we truly encourage you to flip through our past for material that will help you understand the severity of the situation — Ben Bernanke and crew have their hands full. At the moment we can only hope that many folks lured into Adjustable Rate Mortgages over the past few years are taking advantage of the opportunity locking in lower fixed rates given the bond market’s current cooperation.

A big concern of ours, however, is that many ARM users were unable to accept 30-year fixed mortgages and needed the ARM to make it in the door. With $1.2 and $1.5 trillion of these resetting in 2006 and 2007, it is impossible to not expect that a large percentage of those homeowners will find higher fixed mortgage payments, leaving those individuals with dramatically less disposable income. Those who manage to refi into a new ARM in our current window… well… interest rate roulette comes to mind.

With that in mind, the fact that officially reported (and fudged) inflation is on the rise, and that wages are stagnating by comparison, only adds insult to injury. The thought of the fed attempting to pump more liquidity into an already saturated environment only begs the questions of “how?”, and “at what cost to prices?” The only problem is, what alternative do they have in their bag of tricks?

Can you say recession? You should contemplate the possibility of a bad one with inflation, too.

We often point out that, because economic changes tend to happen at a glacial pace, most folks have a tendency to allow dislocations - like bubbles - to go unnoticed, or even embraced. In fact, there is a tendency to believe that if a dislocation goes on long enough that the new environment has somehow neutralized it.

Well, regular readers are aware of the slow deterioration that has taken place in the U.S. balance sheet over the last 30 years. We came across this chart today and thought it was worth posting. It shows in bold numbers how far we’ve come (or degraded) in the last 12 years.

Give it a look (click on the graph for a full screen image), and feel free to post a comment. We’d love to hear your thoughts.

As for ours, we can’t help but notice the collapse in consumer credit growth - which has been the key driver of economic activity in the past five years. We also note the personal savings rate going negative as well as the massive plunge in household cash-liabilities. Note also how the financial sector has doubled its representation in the S&P - thanks largely to the massive injection in money supply flooding through the investment and banking communities.

We could go on, but we’d love to hear your thoughts.

In the meantime, we are still amazed that few pundits seem to think this is a serious problem, or that it is anything that ivestors ought to concern themselves with. It harkens us back to Stephan Roach’s Layford Cay comments of late last year about intra industry complacency.

“There’s a 75 percent chance of a financial crisis in the next 5 years.”
- Paul Volcker, 2004

With former Fed governor Paul Volcker’s comments in mind, we just came across this chart from Bridgewater Associates showing mortgage borrowing as a percentage of GDP vs. residential construction as a percentage of GDP. (This ties into last Friday’s post regarding the U.S. debt addiction.)

The chart (click chart for full sized image) tells us yet another way that the U.S. economy and consumer is in uncharted waters when it comes to structural imbalances. The bang for each buck is clearly down when it comes to highly inflating housing prices. Stats also show that over 1/3 of mortgage borrowing is home equity withdrawal related, and has been drifting into non-housing spending. At $670 and $650 billion the past two years, home equity ATMs have made a massive impact on GDP - something that cannot go on indefinitely.

Certainly the Federal Reserve may be able to engineer yet another reflation cycle through the credit system in an attempt to provide a soft-landing for housing (and the entire economy), but already we see that foreclosures are on the rise:

• South Florida owners are losing their homes; foreclosures rates rise nationally
• Foreclosure filings in Delaware up 50 percent
• Massachusetts foreclosure rate increases at dizzying pace: 105% and up!
• As mortgage rates rise, so do Mid-Atlantic foreclosure figures
• Foreclosures are back
• Foreclosure rate jumps in Oklahoma
• Foreclosures Up 28 Percent From Last Year

However, it is very possible that enough liquidity (read: newly minted money supply) can be injected into the economy to keep the 10-year and 30-year Treasury rates down, which would enable the $1.5 Trillion of Adjustable Rate Mortgages due to reset in the next 18 months to find a more comfortable 30-year home than they might today. But the noose is tightening on lending practices as it appears the zero-down piggyback mortgage is getting more scrutiny as ratings agency S&P is planning on tagging lenders who use them with an rating reflecting the increased default risk these types of loans actually represent. This will only tighten lending standards precisely when pressured borrowers need the flexibility, reminding us all of the old adage that the bankers are quick to lend you an umbrella when it’s sunny, and even faster to take it away as storm clouds approach.

All said, it seems all the more likely that the Fed will have to take the liquidity route. In the short run we may see some consequences of the tough talk on tightening. Again referring to Friday’s post on the subject, the U.S. requires ever increasing amounts of credit / money supply expansion to create the same amount of economic growth. In other words, keeping the same pace of expanding money supply is not enough - like an experienced drug addict looking for the fix, supply must increase constantly to gain new highs or a withdrawal slowdown can be expected. Even though the current pace of expansion is at a good clip, it may not be high enough. But soon enough, Bernanke, et. al, will ride to the rescue and open the spiggots. But with each dose, the risks increase that the market says “enough!”.

As we always say, this cannot go on and on indefinitely. We’ll be the first to admit that it is impossible to predict how The Great Economic Rebalancing will unfold, especially timing wise, but we can be sure of the consequences of too much liquidity in the long run. Moreover, we can hold up fiat currencies to the test of time and history, and note that not one has ever survived the meddling of governments or central banks, and that always the result is suffering among the majority of the population who are unprepared for the consequences of the ultimate day of reckoning.

Vigilant investors know this and are keeping one eye always on this subject when it comes to their entrepreneurial decisions, related to both business and personal finances.

• Asia Is Getting Ready to Dump the Dollar Peg
• On watch for the next LTCM crisis
• Dollar’s failed rally shows strength of downturn
• High gas prices take a toll on businesses
• US competitiveness ‘threatened’
• Stock market will turn on inflation clues
• Bankruptcy filings soaring again
• U.S. April Payrolls Rose 138,000; Unemployment Rate at 4.7%
• U.S. April Import Prices Rise 2.1%; Unchanged Excluding Oil
• Bankruptcy filings soaring again
• U.S. Stocks Slide On Rate Worry; Nasdaq At Two month Low
• Energy prices seen stoking April inflation reading
• Latin America wrestles with Big Oil
• SEC chairman acknowledges corporate governance weaknesses
• 50-year mortgage hits the market

Paul Kasriel at Northern Trust points to yet another indicator — the index of Leading Economic Indicators — that is supporting our assertion that a recession is imminent, if not already in full swing given the official fudging of CPI and GDP.

Unless you are in the business, you ordinarily don’t get to see the yield curve on bond rates up close.  As the long end of the curve begins to move after stagnating, we think the chart below tells the story of just how unusually tight rates have been as of late.

But as the saying goes, “what can’t last forever, won’t.”