And counter to our prediction of an imminent, counter-trend U.S. dollar rally, the dollar is most definitely not surging. Take a look at the chart below. We’ve been writing about the decline of the dollar for nigh on ten years. So we looked at a ten-year chart to tally up the damage. It is considerable.

Dollar Index Threatens New Lows

What’s at stake with the interpretation of this chart? If the dollar rallies on short covering from the dollar carry trade (a BIG if), then other “risk” assets like gold, stocks, and emerging markets would probably sell off.

The chart shows that the index’s 50-week moving average is set to cross below its 200-week moving average. That is mixed news. The first time it happened on this chart was back in early 2003. That was the early days of a long decline in the index. The second time, though the move failed to confirm the “flight to safety” rally of 2008 had staying power in 2009.

Once the fear that gripped markets in 2008 went away, the investment world sold the dollar and started borrowing en masse to buy other, higher-yielding currencies and assets (like the Aussie dollar and resource stocks). That’s where we are now.

But based on the chart, is the next move down in the dollar index a new low, which the crossing of the long-term MA by the short-term MA would suggest? Or is it a false move? Will the dollar quickly and violently rally for some reason (geopolitical perhaps) that currently remains unknown to the human beings of this world?

“It’s an interesting chart,” said our technical analyst Murray Dawes. “But it is not useful for timing your moves out of or into trades related to the dollar’s movement.”

“So you’re saying our chart doesn’t have any useful information from a trader’s perspective?”

“Not really.”

The one piece of important information communicated by our chart is that the dollar’s trend is down. But there IS a catch.

The catch is that when this many people are this uniformly bearish, everyone is probably wrong. Consider this a warning then, that a dollar rally is just the sort of thing that will lead to a correction in the gold price and the stock market. We won’t speculate on the sort of things that could lead to a dollar rally. But surely they’re out there and sooner or later they’ll come.

The other possibility is that the dollar is in its death throes and that this is the big one, in currency terms. That is such a momentous and disastrous event that people consider it both kooky and unlikely, not to mention undesirable to a predictable and comfortable world. But it IS possible.

And do you get the feeling that this kind of manic melt up rally is the sort of irrational frenzy that comes just before everything goes haywire? Haywire is not a precise financial term. So what do we mean?

We meant that the world enjoyed a 20-year economic relationship based on a fundamentally unbalanced global economy. Manufacturing capacity migrated to Asia where wages were lower. For awhile, this was mostly good news in Western countries. Goods got cheaper but jobs didn’t vanish.

Now the situation is not so pleasant. The world is awash in manufacturing over-capacity, especially in China. Wage deflation (in the Western world) looks like a long-term trend, leading to a lower standard of living. This wage deflation is occurring at exactly the same time that Western governments are encountering demographic crises of ageing populations.

We all knew the ageing of the Boomers would put pressure on public finances right around now. But no one reckoned on a global financial crisis further saddling the public balance sheet with debt. And no one reckoned that Western wages and incomes would be falling at just the time people needed them most. And no one reckoned that savers would lose the most from low interest rates on fixed income — even though those low rates are keeping the American housing sector on life support.

It’s a bit of global impasse. America’s needed structural adjustment has come. Households and businesses are reducing debt, trying to live within their means. But the net adjustment to the American balance sheet is not happening because public sector debt is growing so fast.

Meanwhile, the other obvious adjustment is that the Chinese currency ought to be allowed to strengthen. For political and social reasons though, China will not allow this. It means China is actually adding to its industrial over capacity. It is conjuring up the world’s largest ever bubble in fixed asset investment, including commercial real estate.

It is easy to see why China is reluctant to allow a stronger Yuan. Exports account for 39% of Chinese GDP. The Chinese economy, and probably the Communist Party itself, cannot survive on unleashed Chinese domestic demand. They need American markets. But American consumers — in addition to reducing debt — are now realising that the focus on finance over manufacturing from American policy makers has worked out for Washington and Wall Street, but not terribly well for the average American worker.

Where do we go from here? How about the blame game. U.S. Treasury Secretary Tim Geithner once blamed the Chinese for being currency manipulators. He back-tracked later. And yesterday, Liu Mingkang, the chairman of the China Banking Regulatory Commission, had a go at America.

“The continuous depreciation in the dollar, and the US government’s indication that, in order to resume growth and maintain public confidence, it basically won’t raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation.” He is blaming the U.S. for fuelling a destabilising global bubble.

Of course that bubble is felt most acutely because China pegs its currency to the dollar. China is right to blame the U.S. for manipulating its currency to try and improve its competitive position. And China is right to worry about the value of its dollar-denominated assets in a world of exploding U.S. debt supply.

But China has put itself in this position. And here we are at the end of 2009 with a world still fundamentally un-adjusted to a new, workable currency arrangement. The world remains burdened by trillions in assets purchased with debt. Those assets linger on bank balance sheets, on government life support but fundamentally lifeless at fictitious book value prices.

And meanwhile, the China-US currency arrangement has fuelled a global bubble. The question is how it will end. In the U.S., the housing market looms as the Achilles heel of the economy. It could strike households, banks, and the government again in the next 12 months are more mortgages reset at higher rates (with lower home values).

If the event that pops this bubble comes from America, look for the supply of credit to the emerging world to dry up again. If the bubble pricking comes from China, what then? Well, China does everything big. So a Chinese bust would be world-class.

Regards,
Dan Denning

November 18, 2009

Editor’s Note: This article originally appeared in the Daily Reckoning Australia as “Dollar Rally the Sort of Thing that Will Lead to Correction in Gold Price.” To view the original article, please click here.

Will a Dollar Rally Lead to a Gold Correction? was originally featured on Whiskey and Gunpowder

In deciding to make hardly any changes to its interest rate policy or even the language from its last statement, the Fed is encouraging traders to resume the dollar carry trade. For now, it looks safe to borrow in low-yielding currencies like the U.S. dollar and invest in higher-yielding assets like the Australian dollar, emerging market stocks, and some bonds.

Go, you bubble beauties!

It’s hard to believe the Fed is willfully stupid. The market, through the price of gold, has clearly communicated that it thinks U.S. monetary and fiscal policy is lousy. But rather than defend the U.S. dollar – indeed the integrity of U.S. monetary policy itself – the Fed is choosing to support asset prices through easy credit.

It’s also possible that the Fed thinks a weak dollar will reduce America’s trade deficit, boost its export competitiveness, and lead to higher employment. We think this is a pipe dream. And we’re not talking about a lead pipe. We’re talking William Blake-style opium.

But smoke and mirrors aside, does this mean there will be no end to the dollar carry trade? If the U.S. dollar index rallied, we expected to see a falling Aussie dollar, falling Aussie stocks, and (even though it’s strange) rising U.S. bond prices. All the leveraged risk trades would unwind a bit as dollar shorts covered.

But now what? Is this the all clear for stock indices to make new highs as traders borrow money and plow it into markets to engineer huge returns for the end-of-year statements to investors? The early returns are inconclusive. The Dow was all over the shop, unable to make heads or tails of what the Fed’s non-change means. Gold futures made a new nigh, though. And about that…

Gold is very popular lately. It’s not returning our calls anymore. And when we see it in public, all it does is glitter and bask in the glow of so many newfound admirers. That makes us very nervous, and perhaps a bit hurt. We stood by it all those years when no one loved it.

We like it all the same, although we’re just friends now and it’s based on gold’s ability to preserve the purchasing power of our wealth, not any inherent beauty it may or may not have. But as a practical matter, when you enter a position as the asset is making a new high, you usually get hammered.

That’s what happens when you go along with the crowd. It’s an axiom that an asset has to make new highs…to make new highs. But it would be nice to buy gold on a correction. Perhaps, though, we are seeing a big shift in market psychology with respect to gold. India’s purchase of IMF gold is just one sign of that shift.

One interesting result from the events of 2009, Murray Dawes mentioned last week, is that gold is decoupling from the U.S. dollar. He sent over the chart below. It shows that two times in the last five years, gold (the black line) has strengthened eve as the U.S. dollar index (the blue line) rallied. And each time after this period of dollar strength, gold then took off to a new move up.

Why does that matter? Well, gold usually moves up when the U.S. dollar moves up, and down when the U.S. dollar moves up. For gold to show strength when the dollar is strong shows that gold itself may be breaking out of its correlation to the greenback. And what would that tell you?

The bigger picture: gold breaking its negative correlation with the USD would tell you that gold is being remonetized in the world financial system. It would tell you gold is appreciating against nearly all paper currencies. And it would tell you that even if we do see a U.S. dollar rally, you could still new highs in the gold price.

Above all, it shows you how valuable it is to own an asset that is not anyone else’s liability. We are entering a global sovereign debt crisis because the world’s large economies have been engaged in a multi-decade long competition to devalue their currencies. The cheaper your currency is relative to your trading partners, the cheaper your goods are and the higher your exports.

Overly the last fifty years, nearly every country in the world has engaged in some kind of currency manipulation to keep its currency cheap relative to the American dollar. That’s because the American economy was the world’s largest, and everyone wanted to sell into it.

America’s economy is still big, of course. But a lot is changing, yet the currency manipulation has not caught up with the new economy reality. And Western Welfare states are still borrowing money as if emerging market creditors will be happy to fund fundamentally flawed fiscal policies for ever. Not likely. But tomorrow is another day.

Regards,
Dan Denning
The Daily Reckoning Australia

November 10, 2009

Editor’s Note: This article originally appeared in The Daily Reckoning Australia as “Price of Gold Communicates U.S. Monetary and Fiscal Policy is Lousy.” To view the original article, please click here.

Gold Price Says U.S. Monetary and Fiscal Policy Stinks was originally featured on Whiskey and Gunpowder

Pound up…

Euro down…

Aussie pulling back…

Canadian giving way…

Yen losing ground…

October is coming to an end, and we haven’t really seen hide nor hair of any terrifying market moves or monstrous returns to the old days of dollar safety, when anything that even had a scent of risk was spurned as foolhardy investing.

But as of now, the dollar has been tanking and anything that is paying a higher interest rate has been soaring, thanks in part to the hawkish comments and actions by the Reserve Bank of Australia, but mostly due to the boneheaded actions of the United States.

Any way you put it, when a man shows up and says, “Hello! I’m from the government and I’m here to help” — RUN. As fast as you can. RUN.

We are following in the footsteps of Japan. Should this continue, we will have to replace our Stars and Strips with a new flag, ”The Land of the Setting Sun.”

No Happy Ending for the Dollar

We’re now at a 9.8% unemployment rate, and we lost a jaw-dropping 263,000 jobs in September. Now it’s true this isn’t the 700,000 we were losing not so long ago. But it still is not awe-inspiring evidence of a recovery.

The euro’s meteoric rise was on the G-7’s agenda this week. But before we start jumping up and down for joy as the powers that be begin pushing the euro back down (and the dollar up), I must confess that I smell a rat.

The folks at the European Central Bank have not been too worried about the strengthening euro up to this point. That could always change. But for now, they seem to be enjoying this appreciation. For them it acts as a nominal rate increase, which will keep inflation in check should it appear. But don’t get me wrong. Central bankers are men just like us (only often with a lot less common sense). They can get blinders on and only see things a certain way. After all, don’t all humans usually see things the way we want to see them? And this can handicap them when it comes to reading the data — the same way it can handicap us. Should they allow the euro to rise too much and too early, it will crush their budding recovery… much to their surprise and chagrin.

That being said, the dollar is in a bad way. Aside from the sheer size of its GDP, and the fact that historically it has managed to pull its fat out of the fire, I’m not sure what we can look at currently to construct any happy outcome for the dollar. That’s it, plain and simple.

The Dollar Will Be Let Down Gently

But nothing, not even the dollar, falls all at once. Hence all this jawboning about the euro (and yen, while were at it) being too expensive. None of these foreign economies can afford to let the dollar fall too much, too quickly. Thus, if they continue to badmouth the strength of their own currencies, it buoys the dollar and gives them opportunities to get out at a better price. But they can’t dump too much on the market all at once. If investors get wind of that, the big boys will have a harder time getting their target price.

So it seems to me that we should be looking for another return to dollar strength. That would play right into the hands of foreign economies that are looking to quietly unload the dollar. It is also the reason I don’t think we should look for the dollar to go into freefall — it is simply too costly for our trading partners. I believe they will do all they can to allow themselves an exit at a decent price.

No matter what may happen to the dollar’s reserve status in the decades to come, it will retain this status for a long, long time. Thus in this great tug of war between the currencies, there will always come periods when the dollar will be viewed as too cheap, and those who need it for continued trading purposes will not be able to resist the drive to buy it.

No Dollar Strength from This “Recovery”

For our last note, let me reassure you, dollar strengthening will not come as a result of the recovery we are supposedly in.

The stimulus has not performed as promised. A quick look at the figures from last November to the present will reveal it was no panacea:

Unemployment
November ’08: 6.6%
October ’09: 9.8%  (up 50%)

GDP
November ’08: $14.3 trillion
2nd quarter ’09: $14.1 trillion (down .25%)

Housing starts
November ’08: 655,000
October ’09: 590,000 (down 10%)

Food stamps participants
November ’08: 31.1 million
July ’09: 35.9 million (up 15%)

Home mortgages underwater
November ’08: 15 million
October ’09: 25 million (up 66%)

Deficit
November ’08: $450 billion
October ’09: $1.5 trillion (up 300%)

Looking for a Dollar Bounce

Let’s sum up. I am looking for a bounce in the dollar (and I have been since mid- September). I thought that perhaps the fall season might be enough to bring it on. That hasn’t happened. That’s not the same as saying it isn’t in the cards. We are now in the midst of the new equities earnings season. J.P. Morgan produced stellar figures that pumped risk appetite into the market strong and hard. Other corporations may not be able to do as well.

It seems to me that this rally is already on thin ice. At any rate, the dollar will bounce. It will likely end up being a bigger move than most anticipate and it will be fueled by fear and short covering. Then, when the big boys have had enough, the course will be reversed, fundamentals will resume their place, and the dollar will begin its drift toward the nether regions once again.

It is a treacherous pathway before us, but it should yield us some really nice profits if we position ourselves accordingly.

Due to the increased interest in currencies, the NASDAQ now offers an easy way for anyone to play up to ten currencies against each other. Click here to for the full fact sheet on the NASDAQ currency options. So you can do your positioning to take advantage of the coming strength in the dollar…and in the dollar’s ultimate decline.

Regards,
Bill Jenkins

October 22, 2009

Dollar Strength Then the Decline Resumes was originally featured on Whiskey and Gunpowder

Lately, the politicians and monetary bubbas have all been focused on big-picture stuff, like saving the world financial system. Dressed in their superhero suits, they’ve lost sight of issues like the fundamental soundness of the dollar. They’re just too busy admiring themselves in the mirror and patting their own backs about how smart they are.

Meanwhile, a single headline set the metals markets on fire. It was about how a group of Arab nations plus Russia, China, Japan and France are plotting to replace the dollar for trading oil. Sound plausible. Will that happen? Eventually, I’ll bet, but not overnight.

$1,000 Is the New $900

The point is the dollar replacement story is a monetary rumor, and we’ve heard it a zillion times before. This week, for some reason, the rumor gained traction. Why? Well, sometimes the rubber meets the right spot on the road. It’s just “time” for something to happen. And this week, it was time for $1,000 gold to become the new $900.

It’s not hard to understand why. For many years, American politicians have overspent the resources of the nation. It was one of the few bipartisan things that national leadership could agree on. Spend, spend, spend. No issue was too small for federal intervention and funding.

The U.S. dodged the monetary bullet because a) the U.S. economy was big and resilient and it appeared like the economy could deal with the hit, b) the rest of the world didn’t have an alternative to the dollar and c) most of the world wasn’t really on to the monetary con job of the U.S. writing checks that never got cashed.

The politicians spent money like it didn’t matter. Except… it did. We’ve been approaching some sort of monetary tipping point. Now it seems like we’re there. Information flows around the world in microseconds. So there’s no big con job anymore. People across the world are tired of getting jerked around by the U.S. dollar.

Thus, now we’re watching the dollar melt down before our eyes, like the Wicked Witch at the end of The Wizard of Oz.

Off to See the Wizard

Let me digress for a moment. Author Lyman Frank Baum wrote the original book, The Wonderful Wizard of Oz. The book, published in 1900, was whimsical. But among other things, it poked fun and caricatured the gold and silver debate in the U.S. in the 1890s. More broadly, Wizard was an allegory about life and political populism in the U.S. in the 1890s.

Author Baum had a keen eye for the gold-silver debate because he knew something about the subject. Baum was wealthy, and heir to serious family money that came from the 19th-century oil fields of Pennsylvania. So he took the idea of debased currency and ran with it.

Just look at just the title, The Wonderful Wizard of… Oz, where “Oz” stands for “ounces.” I’ve heard that in the real story, the “Emerald City” of Oz was a city of gold. (It became emerald when MGM Studios made the famous Depression-era movie in 1939.) The yellow brick road was a metaphor for gold. Dorothy’s slippers were silver in the book, and changed to ruby in the movie.

The Tin Woodman stood for the urban workers of America, who were left out in the cold and rain by the forces of banker capitalism. The Scarecrow stood for the farmers — and recall that he had no brain, because many East Coast snobs thought farmers were dumb hicks, ripe for the picking. The Cowardly Lion was a dead ringer for William Jennings Bryan, who made good speeches, but could not stand up to the entrenched big guys.

The Wizard was all smoke and mirrors, reflecting the political classes as a bunch of charlatans who promised much and delivered little.

Hey, Wizard is a children’s story. It’s not a cookbook for what ails us today. If there are any real answers in the Wizard book, it’s along the lines that things aren’t what they may at first appear. And the common people — workers and farmers — are smarter and nobler than the elites think.

The only thing that’ll begin to save us is if the elites realize that they’re not as smart as they think. Of course, then they have to admit it and pursue other policies that work — like not spending so much money at the federal level. That, and create conditions to rebuild the basic economy and maintain a stable dollar.

But these are politicians we speak of so I wouldn’t count on that anytime soon. Instead of hitching your cart to political salvation, you should be counting on gold, silver and oil to pull you and your portfolio through.

Until we meet again,
Byron King

October 16, 2009

Gold, Silver and the Wonderful Wizard of Oz was originally featured on Whiskey and Gunpowder

The Pause That Refreshes

We saw a short reversal in the recovery trade that has benefited the risk currencies, especially Australia, New Zealand and the Eurozone. As of last Tuesday morning when I began this column, the risk push is back on: The euro and Kiwi are pushing new yearly highs with the Aussie hot on their heels. Poor Canada got dumped on due to its poor retail sales but will likely fall back in line.

Let’s look first at the euro. This really looks like a gasping market. It resembles all those that make higher highs on a relentless basis. And when you talk about relentless, the mighty euro sure fits the bill. Until Monday, the euro had not seen two down days in a row for the entire month. That’s remarkable.

But the real question is, does that movement arise from its own strength, or is it something else? I have long been a proponent of an impending euro disaster — and I’ve positioned my paid Master FX Options Trader readers accordingly.

The one thing that would forestall my forecast of disaster would be an intermediate recovery. Please notice two words in that previous sentence — “forestall” and “intermediate.” The euro disaster is not over — it has only been delayed. Like all excesses, it must eventually come to light and be dealt with. A foundation can only be undermined for so long before the structure it supports has to topple.

That’s what has been going on in the United States. And without a doubt, the euro problems are much, much bigger. Moreover, the European Central Bank’s remedies thus far have not been nearly as effective as they have been in the United States. But the second item of note — “intermediate” — is the type of recovery that will allow the Eurozone to gloss over their immediate problems.

Thus it looks like “business as usual” for European banks and businesses. During the boom-boom years, the systemic problems of the Eurozone were easily glossed over. If we can return to that sense of “normalcy” — and believe me, that’s what every central bank is working toward — then the euro and the U.S. dollar will continue to part ways. Mainly because the U.S. problems are all exposed and out there for everyone to see. The Eurozone has managed to weather the storm, keeping its central bank rates higher than the U.S. rates, so it has all the appearances of not needing the drastic measures that America has taken. Ipso facto, it must not be in as bad shape as its North American counterpart.

But the way things seem is not always the way they are. Everybody has to pay the piper, and what you sow is what you reap. There are NO exceptions. So when we sow thievery and oppression, crushing economies to benefit the friends of central bankers, there will be hell to pay. And I’m not just using a figure of speech.

So then, the euro has posted a new high. It doesn’t have the internal strength on its own to continue higher. But as “good” recovery-style news comes out, they keep the Ponzi going.

So what will be the real drive going forward? Let’s take a look.

The Dollar Carries On

First of all, the U.S. dollar is in danger of becoming the currency of choice for the new “carry trade.” We’ve discussed this before, but it’s worth mentioning again — especially for new readers.

Plainly put, the carry trade is when a trader borrows money in a currency with a low interest rate, then uses the proceeds to buy a currency with a higher interest rate. So even though he has to pay interest on the currency he borrowed, he’s making even more in interest with the currency he bought.

Since the interest rate difference is so small, the carry trade is only worthwhile if it involves a tremendous amount of cash. That’s why it’s generally done by the really big, big players. Here’s an example of how it works.

Say an institutional investor borrows a bunch of dollars at a .25% interest rate. Then he uses those dollars to buy, say, Australian dollars, which are paying a 2.75% interest rate. So, he’s losing .25% on the dollars he borrowed, but making 2.75% on the Australian dollars he bought. And he earns that in perpetuity. He doesn’t have to do anything. It just keeps earning money day after day.

For years this has been done with the yen, as it always had the lowest rate of interest. It helped to keep the yen very cheap, which is exactly what the Bank of Japan wanted. It hoped the cheap currency would expand their perpetually receding economy.

Now this same scheme is being done to the dollar. So far, it’s only been in “bite-sized” chunks — but only because no one is very sure if the world economy is out of the woods. Still, unless more bad news comes, this is a profitable trade.

Also, higher interest rates tend to attract more money going forward (as all the scared money comes back into the market) — so the higher-yielding currencies also appreciate against the lower-yielding ones. Therefore, the investor makes a double boon: the interest and the appreciation.

So the big institutions have an interest in depressing the dollar. Any gain in strength or interest rates threatens the easy money of the carry trade.

But, as noted, the institutional players aren’t the only ones who want to keep the dollar down.

Bad Politics = Bad Currency

As I mentioned, the Bank of Japan was all too happy to let the yen carry trade go on, since a weaker currency was seen as a way out of its economic mess. The U.S. government is essentially taking the same route. Without a doubt, it is complicit in driving the dollar lower.

Like in Japan, a cheaper currency helps service ever-increasing debt (I’m certain they have long since abandoned any prayer of paying it off). And the indebtedness is increasing at a faster rate than at any time in history. As long as the major economic power wants to see its currency cheaper, it will do whatever it takes to get that done.

By the time you read this missive, the Fed will be ending their two days of meetings to determine what to do about U.S. interest rates. If you haven’t already heard the answer, what do you think it will be? It is important to formulate an answer to that with all the evidence before you, because it will give you an added insight into how the central bank works. Here’s my answer. They will not be raising rates.

Now that, of course, is no new revelation. But what will they do looking ahead? When will they start earnestly looking at raising rates? The answer to that question lies in our own recovery.

While data appear to show that the economy might be coming out of recession, unemployment is still at multiyear highs and is not decreasing. Housing numbers are improving, but they will NOT be coming back to what they were. All the weight put on housing starts, new purchases, purchases of existing homes, new permits issued, etc., are all a smokescreen. And if not intentionally an “illusion,” it certainly will not make a difference to the economy. Here’s why…

Under the “old economy” (two years ago), a house was a store of value. We all implicitly knew that our savings were not “safe” in a bank, and if they were, they certainly were not growing to keep pace with inflation. So we invested in real estate. I don’t mean that everyone went out and bought rental properties or tried to flip houses. What I really mean is this:

If you ever refinanced your house and took “cash out,” you invested in real estate. If you ever used a home equity loan or a home equity line of credit — you invested in real estate. The unwritten assumption was that your house would continue to increase in value, even as you were using the equity. We became a nation of equity spenders. Treating our homes like ATM machines, we attempted to increase our wealth by means of a bubble market. Even if you didn’t think you understood the nature of a bubble market, implicitly, or even instinctively, you did.

Spending a house’s future earnings meant that we believed our money would be worth less in the future than it is now. We believed its value was decreasing. (Incidentally, we were right.) But we were on the “safe side of the bet.” Because we would spend valuable dollars now, but repay our bill with less valuable dollars later. This is why a 30-year mortgage in a centrally managed and inflationary economy is such a good deal. You lock in today’s price, but pay it off with increasingly inflated money. It is that very inflation that makes your house go up in “value.” Any reasonable consideration would conclude that a house is not as “valuable” after 30 years of living in it. It must depreciate, because it “wears out.” Anybody who has ever owned a home knows this to be true. Defer just a few years of maintenance, and it will soon overwhelm you. Before long, you begin to wonder if you own the house, or if the house owns you.

But in the end, when houses were all in debt up to their value, and many far more than their value, we stopped investing in real estate. Mainly because we couldn’t afford it any more. Either our payments were already too high, or our equity was too low. At any rate, when people stopped “investing,” the residential market began crashing. It will not return to what it was, and vainly hoping for more increases in housing numbers to do that will only bring to pass the old proverb, “He that sows to the wind will reap the whirlwind.” In other words, vain hope isn’t gonna save the farm.

Getting back to the moral of our story, the government, which will not control or reduce its spending, can only raise taxes, cut services or inflate the currency in order to get us out of this mess.

Of course, raising taxes or cutting services are the easiest ways for a politician to lose his or her job. So the third option is always exercised. If done properly (according to prevailing monetary theory), it will be painless, and the effects of inflation will be partially offset by the ever-popular cost of living increase. That way everyone shares in the illusion that they are “keeping up with” inflation. But that’s all it is… an illusion.

So we’re up to two entities with a vested interest in keeping the dollar down — the institutional investors who want the carry trade to continue, and the U.S. government, which needs a weak dollar to plaster over its massive debt.

And the dollar has yet another enemy…

Neither a Borrower Nor a Lender Be

It’s easy to overlook, but when you buy bonds, you’re buying debt. You are loaning the issuer your money and getting their interest rate as your profit. Corporate bonds represent the debt of individual companies. When you buy Treasury bills and the like, you’re buying the debt of the U.S. government.

No nation in the world sells more debt every single month than the United States. Because of our existing budget (that’s using the term very loosely), we are forced to borrow money every 30 days. To pay Social Security, welfare, medical payments, elected officials and bureaucrats, the military, foreign aid, student loans — anything and everything that gets money with a federal stamp on the check.

And we have to borrow it. Somebody has to give us their money with the expectation that they are going to get it back, plus interest (uninflated).

Now, imagine your neighbor asked you to loan him some money, promising to pay it back with interest. A week later, all that money has been spent… so your neighbor asks for another loan. And another. Then another. How much longer would you keep lending him money? Even if he continues to pay the interest he owes you, you still have to wonder how long before he needs to borrow money just to pay the interest he owes you for borrowing the money.

That’s why everyone I know is casting a wary eye on America’s “neighbors” — the countries holding much of the U.S. debt. With our massive spending plans and dim economic outlook, other nations must be worried about our ability to repay our debt. What will we do when the Chinese stop buying? What will happen when the European Central Bank stops buying? What will we do when Japan stops buying? Will the government stop spending even then?

One way or another, the you-know-what is going to hit the fan. Oddly enough, however, foreign investment is higher this year (43.1%) versus last year (only 27.1%). That’s a year-over-year increase of 60%!

So instead of being worried, the U.S. government feels invincible. Foreign countries will always be happy to buy our debt, it thinks, so there’s no reason to adjust our destructive spending plans. It’s like giving more liquor to an alcoholic to sooth his tremors — a short-term fix that doesn’t do anything to solve the problem. Make him feel good enough, and soon he won’t feel anything ever again.

If I were you, I’d position my short-term and long-term currency savings accordingly.

Regards,
Bill Jenkins

September 30, 2009

The Euro, the Dollar and the Future of the Forex was originally featured on Whiskey and Gunpowder

Today I have something new for you that I heard over the weekend. It may not be news to everyone, but its implications could be staggering.

As a father of seven whose children are all grown, I look to get frequent doses of youth from my grandchildren. They are a perpetual delight! This week’s insight comes to us courtesy of my grandson, Jack.

It started when my son-in-law, John (Jack’s Dad), celebrated a birthday recently. One of his gifts was a greatly needed new wallet.

In the spirit of kind giving, John passed his old wallet down to his son Jack.

“Here, Jack,” he said. “You can be like daddy and use this to put your allowance in and keep it safe.” He slipped his $1 allowance into the billfold. (I’ll let you guess Jack’s age based on the size of his allowance!)

Jack smiled warmly as he thanked his dad for his new present. He then proceeded to throw the dollar bill on the floor (where he left it in worthless shame) and began stuffing his new wallet with his sizeable Pokemon card collection. “This will be just right for holding all my cards!” he exclaimed.

There you have it. In the eyes of the next generation, the Almighty USD shall be replaced with the Japanese Pokemon currency. (And I’ll bet you thought it was going to be something Chinese!)

OK, maybe not Pokemon cards… but the story does represent what is happening to the dollar in a childlike way.  Jack may not know yet the “value of a dollar” (a phrase likely to perish as meaningless in years to come), but he does realize that there are things of value in his community… his community being the other little boys in his school class.

The fact of the matter is this: the USD is the world’s reserve currency by default. It is simply so by the function which it currently serves. It was not made the “World’s Reserve Currency” by some multinational edict out of the G-8, G-20, UN or IMF.

Nor do they have the ability to do so in the future. They may make such statements, and they may indeed produce a currency, but that does not guarantee its place as the premier money of the world.

Such statements are like a prisoner who is locked away for life saying, “I think I will choose to stay in jail.” He’s made a decision. He’s made his decision known. He acts on his decision. But it doesn’t change anything.

In the end, a currency only works if it is a real store of value.

Let’s say Jack takes his new wallet full of Pokemon treasure into school. But as a good capitalist, he also takes his allowance. Assuming the boys in his class also share the same mentality, how many of his friends’ cards can he buy for a buck? Zero.

In their “community,” cards are more valuable than cash. He is only going to get a coveted card from a friend, if he can offer him something that the friend perceives is of greater value. Perhaps a single card, or a whole slew of them together.

Such is the essence of the barter system, or any new currency system. If it is not a store of value, then you might as well try buying something with dirt!

At any rate, I hope I don’t live long enough to see the day that Pokemon becomes the new currency. If it does, Jack may have to take over the weekly wrap-up to explain the difference between a Pikachu and a Jigglypuff (who comes up with these names?).

Regards,
Bill Jenkins

July 28, 2009

Pokemon Currency Trumps Dollar was originally featured on Whiskey and Gunpowder

But some things are for sure and provide “reasonable markers” to see what a currency is doing. One of my “favorites,” although I hate to call it that, is the “civil unrest factor.”

Across the Eurozone riots and outbreaks of violence have been touched off by escalating economic problems and disagreements between members and neighbors. People involved in civil unrest are a multifold problem. First, they have too much time on their hands because they are not working. Jobless citizens, especially in a heavily socialist culture, are a continual drag on the system. Second, it costs money to keep repressing social upheaval — presenting another drag on the system. Additionally, the passions and fears of men being what they are, such activities tend to draw in more normally productive folks as the snowball gains speed and volume.

Here in the United States, we are not facing such difficulties (yet). This means a more reasonable system of work and distribution of goods and labor. All in all, this is good for a culture, the body politic and the economy. As a result, it also breeds greater confidence in the currency. And when all is said and done, investment money will go where there is a reasonable likelihood of return, even if the return may be lower.

Specifically, there are several exotic currencies that have offered high rates of return for speculative investors and traders, like the Brazilian real and the Indian rupee, just to name two. But it is difficult to place large sums of money there simply for the sake of the wild swings in value. A high interest rate is no good if the principle of the investment is destroyed by currency depreciation.

This is what has been good up to this point in the recession/depression for the U.S. dollar. And if this continues to unfold over the next year or two in similar fashion, this would still produce U.S. dollar strength compared to the euro simply by the “fear factor.”

Additionally, as I have tried to show, the situation in Europe is actually more severe than in the United States. I believe in the end that will make them copy, at least percentage wise, the same devaluing practices that have happened here. Should that occur, it would once again be advantage-USD.

If, in addition to those previous considerations, one or more of the countries leaves the Eurozone, I think the fear and disturbance that would produce again favors the U.S. dollar.

Longer term, I have to wonder if the euro has what it takes to survive this crisis. I have no doubt that the United States will emerge out the other side with all 50 states still members of the Union. I don’t know that such can be said for the European Union.

At the end of the Mel Gibson movie, The Patriot, there is a shot of Lord Cornwallis overlooking the field of battle as the colonists finish the rout of the British at Yorktown. He says, “How could it have come to this? Everything will change. Everything HAS changed.”

When I look at the dollar, I feel the same way. What we have done may be past the point of no return, the point of repair or recovery. The next generation may well find that the U.S. dollar has gone the way of all fiat currencies before her. What will replace it? I can’t say. But in the present environment, more shocks to the system will ultimately favor the dollar… at least for the time being, because it is supported by stability. And in unstable times — stability draws the highest premium.

Now let’s end with a look at my favorite currency, the Australian dollar.

Aussie Firm Despite Chinese Unrest

The Aussie dollar chart looks remarkably like the euro — going back to the beginning of June. All things considered, that’s rather remarkable given the relative strength of the Aussie economy compared to the Eurozone. Nevertheless, fundamentals will eventually rule the day, and though we may have to wait it out a bit, we look for the Aussie to rebound in the future.

One of the difficult parts of the equation at this point is the widely reported and detrimental riots in China’s western Urumqi (pronuonced U-rum-CHEE) province. Ethnic fighting between Muslims and Chinese citizens has threatened to overpower the police force.

As you know, Australia’s success going forward is inextricably tied to China. So worries about riots in one part of the country can certainly be detrimental in other parts as well. Even though the violence in other provinces may not be ethnically related, once a group of people feel they have been wronged and have the sheer numbers to overpower a military or police crackdown, all heck can break loose.

Remember, there is significant fear of unrest all over China as the depression sets in. The people were just getting their first dose of “la dolce vida,” only to have it stripped away. And gone are the days when they trusted their government to provide for them. Now it is beginning to look more like the enemy than a loving “big brother.”

For now, though, the Aussie dollar hasn’t been impacted by the fray. It has been well supported at the 78.25 level. A strong close below 78 on the daily chart would invalidate that forecast, and likely lead to more downside. We’ll just keep our eyes open.

Regards,
Bill Jenkins

July 20, 2009

Dollar Bad, Euro Worse was originally featured on Whiskey and Gunpowder

We have commented on their plans and purposes on numerous occasions. Now that the meeting has come and gone, let’s take a serious and sober look at what these countries are about, and why they are doing what they’re doing. Assuming that they are even doing anything at all…

First let’s look at the growth of these four dynamic economies. In the GDP growth department, last year India came in at 6.7%, Russia at 8.1%, Brazil at 5.08% and China a staggering 9%. Compare that to the United States’ -6.3%, and you start to get an idea about why they consider themselves superior to America and her economy.

No matter how much you may think those numbers are manipulated, the bottom line is that they are all ahead of the West by light years. They are in regions that were once shackled by the constraints of socialism and outright communism, and are just now breaking free into the light. (Meanwhile the United States is steadily advancing its war on capitalism by increasing debilitating taxation and regulation by the day!)

To put this even more into perspective, the United States has a GDP of about $14 trillion annually. Comparatively, Brazil is at $1.9 trillion, Russia at $2 trillion, India at $1.2 trillion, and China at $4.3 trillion. That means that the combined output of these four nations barely equals two-thirds of the United States.

The GDP per capita, where it is estimated what each person produces each year, also shows some marked disparity.

For the United States, GDP per capita is just under $47,000. Brazil is $8,200, Russia is $14,600, India is $1,000 and China is $3,200. Once again, in terms of output, the United States is far and away the leader, nearly doubling the output of the other four nations combined.

Additionally, the percentage of people in these countries that are below poverty level is shocking. The World Bank estimates that 42% of India’s population is below the poverty level; In China, 10%; Russia, 16%; Brazil, 22%. As that sinks in, also keep in mind that the World Bank defines poverty on an international scale as living on less than $1.08 per day

And not only are these people poor, there is no infrastructure in place to facilitate the increase of wealth among a large portion of their citizens.

Please note, I am not talking about wealth redistribution by government mandate. That will ALWAYS make the poor even poorer. As a matter of fact, it will make the rich poorer, also.

But as a rising tide does lift all boats, severe divergences in wealth from various parts of the population is indicative of markets that are not functioning “normally.” We see this in the United States as well, as government regulation interferes with properly functioning markets and facilitates the destruction of the middle class, leaving only the rich and the poor — not to mention a widening chasm between the two.

How do these relatively “poorer” countries get to call the shots? Why are they influencing policy discussions around the globe? Why do markets tremble when they speak? What is going on here?

You may remember the axiom of Baron Acton, “Power tends to corrupts, and absolute power corrupts absolutely.” Let us be careful here. Absolute power does not corrupt absolutely. God, of course, is exempt, however, in the world of men, it is indeed seemingly axiomatic that the more powerful a man becomes, the greater the temptation to corruption.

No place is this more true than in politics (except maybe religion!). And frankly, it doesn’t matter whence a man hails, what color his skin may be or even what language he speaks, the intoxicating effects of power are universal.

The four BRIC nations have been drinking deeply from this well. They want more power. They want more influence. They want more wealth. In short, they want more. They want what the United States has flaunted. They want the American dream. But they want it wrapped in a turban, served with fine vodka and no more white rice.

They’ve also learned the meaning of another English proverb: “Strike while the iron is hot…”

There is no doubt that that the international media often depicts the United States as an absurd mix between the playground bully and the dunce in the corner. When was the last time you heard an international story praising the U.S. position on anything? From economics to foreign policy, bureaucratic regulation to welfare statism, the United States has become the international piñata.

The fact is, many nations — especially BRIC nations — would like to increase their own amount of “loot” by beating it out of the United States.

The question is, can they do it? Can they decrease the usability of the U.S. dollar while increasing their own. The United States seems fairly determined to bring the first portion to pass by its own volition. The BRICs may not need much help in that arena. But does that automatically guarantee them a seat at the table? Does a U.S. decline mean, ipso facto, that any one, or all four, of these countries gets moved to the head of the class?

I’m not sure that question has been thought through. Frankly, I believe they just see an opportunity and figure they will jump on it. But only lightly. Because there are repercussions, and some of them are not so favorable.

As they’ve sent up a hue and cry for a supranational currency, I have to wonder if they have really learned any lessons at all. Their complaints have centered around a single manipulated currency at whose mercy they find themselves. They seem to intuitively know that a fiat currency system is flawed. It is flawed because men are easily corrupted.

After all, what good is the guilt of corruption, and who would want to bear that burden, unless they could effectively salve their conscience by the increase of wealth? In short, power is rarely of any use to men unless it results in more money. That’s what the United States is being accused of (and rightly so). We have taken our position of unquestioned strength and used it to create the illusion of wealth at home, at the expense of our neighbors. And now the neighbors don’t like it.

But what is their solution? More of the same. Another fiat currency. Actually, a currency made up of a basket of currencies. This should really strike us as hilariously funny, if it weren’t so sad. And by sad, I mean stupid.

It’s like draining bad oil out of a motor and replacing it with equally bad oil. Or like removing a tire that has a nail in it, only to replace it with one that is dry rotted. Or like trading a job you hate for one that will eventually kill you. Or like… well, I hope you get the picture. Essentially, the solution they have put forward is no different from the problem they’re attempting to repair.

And that’s not the only problem…

Here’s what I mean. Both India and Russia still receive foreign aid from the United States. They’re rather like a rebellious teenager who takes potshots at their parents while holding out their hands for cash and car keys.

Beyond that, consider that the BRIC nations hold over 30% of the U.S. Treasury market. That’s a lot of eggs in one basket. So when they start grumbling about policy, they can really strike a fire. On the other hand, upsetting the basket breaks a lot of their own eggs.

The problem is that they must measure their blows carefully. If memory serves correctly, it was China who fired the first shots across the bow of the U.S. economic state. But then, like a playground dog pile, Russia jumped on top as well. Then, lo and behold, the statements are retracted (or at least ameliorated!).

This has gone back and forth, and I imagine it will for some time, since they can ill-afford to knock the United States completely off its horse. To that end, the BRICs have discussed intermarket trading with each other while bypassing the U.S. dollar and talking about a new currency reserve.

Now this is some pretty braggadocio poppycock from upstart powers that “wannabe.” It was just a decade ago that Russia scored big on the international monetary scene by defaulting on a $40 billion dollar debt. (That was back in the day when a billion dollars actually meant something!)

If that were you or I, we’d still have that default on our credit report! And no one would let us forget it, no matter how well we had rearranged our household finances.

So then… have these four countries turned the corner financially? Have any of them got the economic muscle to merge the other three into a formidable monetary force against the United States? Let’s take a look.

Last year during the first leg of the global economic collapse, commodities took a real whack. So did the economies associated with their production and distribution. That means oil — and that means Russia and Brazil.

Even though the Russian stock market climbed more than 6,000% in the previous 10 years, it fell 80% in the eight months of crisis. 80%! While it was the worst of the BRIC alliance, Brazil fared little better. Its equities were down 60%!

And how about the other two BRICs in the wall? Indian stocks were down almost 65%, and Chinese companies… a whopping 73%!

We also now know that while Russia’s equities were tanking, so was their currency, the ruble. After losing nearly 60% of its value, the bleeding was only stopped when Russian authorities jumped in and sold nearly $200 BILLION worth of dollars to support their currency in crisis. That was nearly one-third of their currency reserves — up in smoke to defend an already overvalued currency.

Now, after all that, they start talking about the concept of buying one another’s bonds, and lessening their investment exposure in the United States.

Now let me ask you a simple question: If you had to buy the bonds of either the United States or Russia, which would make you feel safer? One that defaulted on their debt not so long ago and was just hemorrhaging the value of their currency in the last six months? I’m not saying that America is rock solid as an investment, but if you have to pick the lesser of two evils, who you gonna choose?

At this point the U.S. dollar index is hovering around 80 against the weighted basket of currencies by which its value is measured. Last June it was around 72.50 at its lows. That puts it up about 10% on the year.

Conversely, the rupee, real, and ruble, even after some recovery, are still down 35%, 25% and 35% respectively.

Also, consider that from top to bottom of the crisis moves, the ruble was down nearly 60%, the real nearly 70% and the rupee down 30%.

China, of course, has continued to peg its currency, the yuan / renminbi, to the dollar, so such fluctuations, “don’t exist.” Because when a nation, like China, pegs its currency to another nation’s currency, such as the United States, the foreign authorities continually buy and sell their own currency to keep it in a trading range against the other. That way it never suffers from severe fluctuation shock.

But when all is said and done, this betrays the fragility of each of their economies, and how connected they are to dollar based difficulties. So as they chop away at the tree, they had better be careful lest it fall on them.

It is hard to say what the future may bring in terms of changes, but even now, although the BRIC’s are referred to as an alliance or “federation,” the only two countries that have a trade relation of any substance with one another are Russia and China. India and Brazil see very little trading action with them, and are not even in their top seven in terms of import/export volume.

Just some things to keep in mind as we take a closer look at the news…

BRICs Buying Less Debt

Last week we talked about the Treasury Income Capital (TIC) figures, which shows foreign net purchases of long-term U.S. securities. Essentially, it’s a measure of how foreigners are funding U.S. debt.

The headline April TIC number fell to $11.2 billion from the $55.4 billion recorded in March.

Additionally, we’ve learned that the current account deficit for Q1 was a negative $101 billion. The TIC data for January through March showed foreigners funding only $40 billion of that deficit. That means effectively we were a negative $61 billion in the hole as a country for Q1. We are still paying our bills — so where did the money pay them come from?

In line with our theme for the week, China’s purchases of U.S. Treasuries decreased to $10.3 billion from $14.8 Billion. Russia and Brazil showed small outflows in April, which was similar to the past few months. But the biggest change came from Japan, which showed an outflow of -$1.2 billion, way down from the previous $23.2 Billion inflow.

While one series of number releases does not make a trend, one can’t help but wonder where this will lead. As we covered last week, there are only two destinations that I know. If foreign entities are unwilling to fund our deficits with the higher Treasury yields (up from 2.1% to 3.75%), one of two things will happen:

1. Yields have to go up more, raising rates across the spectrum from mortgages to loans to credit cards, thus inducing a second wave of “Credit Crunch”

2. Or foreigners will NOT fund our U.S. deficits. That means the Fed will purchase more U.S. Treasuries, and it means they will print more cash to do so.

Neither of these choices bodes well for the United States or the U.S. Dollar. Only time will tell us if April data was a fluke month or if it was a sign portending things yet to be.

But not all is dreary in the world. Our friend Chuck Butler over at EverBank had this to say:

“It seems that Australia’s government has decided to put government backing on state-issued bonds like the QTC’s (Queensland Treasury).

“This is HUGE for these bond issues, especially since Australian states were seeing downgrades in ratings! The country of Australia has a higher rating, so these bonds will also inherit that rating, since the government is backing them!

“However, this will tighten up the yield on these bonds, probably by about 10-15 basis points.

“Why is this important? If the QTC bonds now have a higher rating, more institutions will be able to buy them. That means more investments flowing into Australia, and more cash flows into Aussie dollars!”

The thing here is that in the long run, this is good for the Aussie dollar!

Thanks, Chuck! Notice he said, “in the long run.” Since that news broke last week, the Aussie dollar has been on a fall. But as soon as it firms up a bit, we’ll be jumping back on board!

And here’s a little good news from Stateside (especially for the Fed). Consumer inflation dropped 1.3% over the last 12 months, the biggest decline since 1950. What? No inflation in the United States? Hey, Ben! Keep those presses rollin’! We can continue to “stimulate.” Good Lord, deliver us!

Also, some other good news — continuing claims for unemployment finally dropped last week, ending their heartbreaking streak. Hard to say what this week will hold, so we’ll wait and see.

We will also be looking at the Treasury auction this week. The U.S. government will be issuing a record $104 billion of 2-year, 5-year and 7-year Treasury notes between Tuesday and Thursday. Traders are watching these auctions because of their sheer enormity and also because it will shed some light on whether bond buyers are willing to fund the growing U.S. budget deficit. If demand comes up short, the dollar could get whacked. But, as always, it is not that simple.

You can’t just sell the dollar if the auction appears weak. Because weak demand may drive up yield rates, which will be good for the dollar, as long as there are buyers. And as I’ve covered above, there are likely to be more dollar buyers than there are those who buy everything else.

Thus as we come to the end of our musings and examinations today, we are looking at consolidations taking place.

The euro has been locked in a down drifting channel but remains in a larger uptrend. And now it is hanging around a crossroad. Yogi Berra said once said, “When you come to a fork in the road, take it.” We are currently waiting to see which road the euro will take. Yesterday’s move up was unusually strong and uncharacteristic. We will watch to see if it was just short covering or a real rally beginning.

The pound can’t quite seem to make up its mind either. It has out-appreciated its European counterpart and moved higher. But we may see some weakness to come, as it is having difficulty pressing up at this level. If it breaks through, however, we could be in for another extended run.

The Aussie has drifted further down, but has not violated its 30-day lows. Just about time to take a new position here. But we need to wait for a bit more confirmation.

Today the Fed will announce interest rates. No one expects that they will be changed. But we do expect to hear something on the Fed’s view of the economy. In his last appearance before Congress, he stated in no uncertain terms that the deficits could not continue. Now deficits are not really his department. That is the domain of Congress. But if he hints at the fact that the existing Treasury buy-up is going to be stopped at $300 billion, this could be massive for the dollar. There are only two paths ahead of us.

Bernanke knows as well as any, that inflating the currency further will lead to dollar destruction. It is my feeling that as the dollar has seen a sell-off, that this month they are going to stand on the other end of the see-saw and talk up some dollar strength.

Regards,
Bill Jenkins

June 25, 2009

BRIC Nations Getting Bolder was originally featured on Whiskey and Gunpowder

I’m like a former child star, tidying up the cell he shares with his prison boyfriend and wondering where it all went wrong…

How many of you are wondering on this latest April 15 — as I am — how this present slavery became so thorough?

I just grudgingly did my taxes. Turns out I owe my lecherous Uncle Sammy more money in fees and surprising amounts of progressive taxes than I can truly hope to pay in one natural lifetime. How could this have happened?

It’s a sad and sordid tale of misspent youth, ruinous debt and the women and booze that caused them. You see, I wasn’t always the stalwart Austrian economic schoolboy and ascetic doomsayer you’ve come to know and love. Like my fellow benighted consumer statists, I prayed in the same temple of credit worship and government trust.

I thought Citibank would lovingly provide my electronic toys and shiny vehicles at negligible interest forever and ever. I thought the government was giving me the best of every world with social security and the stock-boosted defined benefit plan.

Live and learn.

The 401(k) is a trap. The banks and the government — as usual — have given the populace enough rope to hang themselves with credit and intimations of retirement security…and the ability to borrow from the retirement accost or even withdraw from it…at very high cost…

Try to take out that money you’ve been saving. I dare ya. See, the deal is that you cannot use it before the age of 59 ½ except under a narrow band of circumstances. If you contract with the devil, don’t be surprised when you wind up in hell.

If you need that money before you’re halfway through your 59th year — say to pay off those enormous debts that the banks were so happy to let you run up — then expect to pay a 10% vig off the top and then have whatever you save count as income on the year. In a progressive tax system, that means you get to watch roughly half of it disappear.

The 401(k) only works under circumstances that don’t exist in the real world. The fiat currency in which you save won’t be worth diddly by the time you are allowed to get it. Try to take it out before that and the government will kill you with fees and progressive tax.

And I certainly hope you don’t still believe the one about growth and interest outpacing inflation.

Looking back, the come-on does bear a strong resemblance to those internet scam letters I get in my inbox. The maliciousness of the scammer and the greed of the victim have to work together closely and well for the crime to take place.

“We’ll let you save pre-tax (taxes we impose in the first place) dollars, and guard your account (forbid you from taking it out without making it extremely costly).”

When I jumped ship from my last job to become your editor, I made the mistake of demanding all the money I’d trusted to Fidelity under the rules of the defined pension plan. I wanted nothing further to do with them or the banks…but they sure don’t make escape easy or cheap.

For the love of God and the sake of liberty, don’t do it. Steer clear of these complications.

Having the government guard your retirement money is more than a little like putting a wolf on watch duty at the door of your hen house.

Much like Morgan Freeman’s character in The Shawshank Redemption told the parole board: I wish I could meet the young man I used to be, talk some sense into him. I’d tell him that the bankers and the government were not his friends, that those mortgages, credit cards and tax-deferred government accounts were not in his best interest.

Alas, it is too late.

I entered into this bondage willingly, but ignorantly. I didn’t have a clue how dangerous bankers and government gangsters were. I accepted the promises of ease and plenty and I’ve been justly rewarded for my gullibility. I suspect I’m not alone.

I don’t believe, however, that most of my fellow slaves have woken up yet. More and more, however, are starting to stir.

Surely millions of them will be sending off a hefty check to their masters even as they stew about how the government is bailing out rich, evil banksters.

As you read this I will indeed be joining a few folks that have some notion that government by its nature uses money that it doesn’t earn. They demand at least a little accountability, a little representation to go with the taxation. Roving Whiskey reporter Samantha Buker and I will be attending the Tax Day Tea Party in both Annapolis and Baltimore. (We’ll let you know how it goes.)

These Tea Parties will be held nationwide today. Folks want to know what the hell is going on with the money continually hijacked from their paychecks. But how many of them wonder at the criminality of the income tax itself, no matter what it goes to support? How many realize that greedy conmen in nice suits are eating out their substance, legally but immorally? Does anyone question the notion that government must be funded?

An income tax and a fiat currency: what a fine pairing. The one is a gun in the face and the other is a shell game. Both break the Eighth Commandment and both will lead to complete ruin.

Far be it from me to incite you Shooters more than I normally do. Whether or not you fund the fraudulent thug that is government is between you, your god and those with the power to investigate and arrest you. This tax day, I just want you to think very carefully about the whole shebang.

At the very least, stay the hell away from any enticements the government may offer. You have to earn an income in their paper and odds are there’s no way to keep them from tracking everything you collect…but instead of a 401k, you may want to look at gold and silver.

For those of you already entangled in the web of the defined benefits plan, tread very carefully. As we say here in the Whiskey Room: sometimes there is no forgiveness, only punishment.

And today your editor accounts for the sins of his youth.

Oh well, Baltimore is a fantastic place to make less money and ride out an economic disaster all while owing obscene amounts of money to the imperial government. The city never really picked itself up from the postwar urban freefall. Won’t be so good in the event of the collapse of industrial society, but if you’re gonna be down and out, this is the place to do it.

Regards,
Gary Gibson

April 15, 2009

A Tax Day Lament and a Warning was originally featured on Whiskey and Gunpowder

At the time, I got excited. I thought real action was coming. Unfortunately, my initial prejudice against fellow Americans held up. They are lazy, gullible, and apathetic. If I touched a nerve there, prove me wrong. I’m about to show you a significant flaw that has already made a small group of people serious money. If you want in, it’s time to man up.

Further Perversion of MBS Ridiculousness

So far, the U.S. government has piled up more than $2 trillion worth of debt to finance bailouts for banks, insurance companies and even the struggling auto industry. And unless you are the CEO of one of these companies or worth enough to make sweetheart deals like Warren Buffett, you haven’t received a dime of this money. That’s all right, because the government’s overreaction to this recession left an opening for gutsy investors.

As you know, mortgages have been the central problem in today’s economic meltdown. From there, greedy financial product creation boards went crazy. You’d have to be living under a rock not to hear the terms “collateralized debt obligations” and “credit default swaps.” These are the real doozies in today’s market slide.

However, the most important term in today’s financially-minded world is “mortgage-backed securities.” You see, it’s not the mortgages that caused the system to fail. It was the mortgage-backed securities, or MBS. These securities are not a new development in the financial world. In fact, they’ve been around longer than most of the “too-big-to-fail” banks Washington is bailing out.

During the last Depression, in 1938, President F.D. Roosevelt helped create the National Mortgage Association. Later, the word “federal” was added to the beginning. This organization, now called Fannie Mae, was created to bundle mortgages together and resell them as – you guessed it – mortgage-backed securities.

Wall Street’s further perversion of this already perverted “asset class” is a story for another day. But these “securities” are important today because the actions of the last 9 months of government intervention combined with plenty of MBS ridiculousness created an enormous opportunity for income investors.

You see, 2008 was a tough year for Fannie and her brother, Freddie Mac. Both companies’ shares lost about 98% of their value. The highly incompetent and worryingly scared Bush Administration took them over. In a very important piece of legislation, these two government-sponsored enterprises (GSE) were placed under the authority of the brand-new Federal Housing Finance Agency (FHFA).

In September, the FHFA took extraordinary action by placing Fannie and Freddie into a federal conservatorship. This conservatorship, backed by the U.S. Treasury, was designed to guarantee all GSE-backed securities. This September announcement means that the U.S. Treasury is obligated to pay anyone holding a Fannie- or Freddie-backed MBS. That’s a 100% guarantee by the U.S. Treasury. In a moment, I’ll tell you why this is important…

The Pseudo-Bank Loophole

The financial industry is full of penniless banks, uninsured insurance companies, and toxic assets. But it also includes about five pseudo banks that are in the perfect spot to take advantage of the collapsing market and the U.S. government’s desperate attempts to save it.

These companies are called mortgage real estate investment trusts, or REITs. If someone would’ve come up to me and asked me what I thought about a mortgage REIT a few weeks ago, I’d have laughed at them. But after I did some research, I found a bailout loophole that this small sector uses to make a few people very rich.

These mortgage REITs buy mortgage-backed securities from Fannie, Freddie, and occasionally Ginnie Mae (Government National Mortgage Association) at about a 5% yield. Until Bush’s ridiculous Fannie/Freddie bailout, the only government-backed securities came from Ginnie. Now, after the September conservatorship announcement, Fannie- and Freddie-backed securities are backstopped by the U.S. Treasury. That means whoever holds securities originally bundled by Fannie, Freddie, or Ginnie will get paid.

I can’t stress this enough… Until the U.S. government declares bankruptcy or the Chinese army overtakes Fort Knox, these securities are as safe as Treasury Notes. But here’s where it gets interesting…

Multiplying the Spread for Government-Guaranteed Income

The five (or so) pseudo banks that receive this “government-guaranteed” income from mortgage securities are still financial companies. And what do financial companies do? They leverage the hell out of any debt they can grab.

Here’s how it works:

Mortgage REIT A buys a bunch of government-backed MBS from Fannie. In turn, he receives a AAA+ credit rating because his portfolio is 100% backed by the U.S. government. He takes his credit rating to Lending Banks X, Y and Z. These banks give REIT A a bunch of 90-day, $100 million loans at 2% interest to buy more mortgage securities from Fannie. And we repeat, again and again.

When all is said and done, REIT A is leveraged 6-to-1. Its income comes from the 3% spread between its borrowing rate and the yield on the MBS. Multiply that by its leverage ratio, and REIT A grosses 18%.

Because of an obscure law that publicly traded realty companies cut decades ago, REITs aren’t taxed (so long as they pay shareholders all of their earnings through dividends). Therefore, with everything else equal, REIT A’s shareholders receive an 18% dividend yield.

With interest rates artificially held down by the Fed, and government-supported mortgage yields artificially held high to promote more MBS buying, we get a spread (and thus, income) that’s extremely large. And with these companies required to pay shareholders all of their earnings, we get an extraordinarily large dividend yield.

Finally, because of the mortgage mess, shares of these companies are undervalued. While most financial companies deserve their shares driven into the ground, these mortgage REITs don’t.

Investors with big cojones have already taken advantage of this. The spreads are even larger and safer now. If this is new to you, I suggest you check it out before investors jack shares back up – deflating the dividends’ effect.

Sincerely,
Jim Nelson

April 6, 2009

Fannie Mae and Freddy Mac for Safe Income was originally featured on Whiskey and Gunpowder