April - 2009 Economic Brief

Closing in on $13 trillion

In addition to the original goal of TARP, the U.S. government has loaned, invested, or committed $400 billion to nationalize the world's two largest mortgage companies ... $42 billion for the Big Three auto manufacturers ... $29 billion for Bear Stearns, $185 billion for AIG, and $350 billion for Citigroup ... $300 billion for the Federal Housing Administration Rescue Bill ... $87 billion to pay back JPMorgan Chase for bad Lehman Brothers' trades ... $200 billion in loans to banks under the Federal Reserve's Term Auction Facility (TAF) ... $50 billion to support short-term corporate IOUs held by money market mutual funds ... $500 billion to rescue various credit markets ... $620 billion in currency swaps for industrial nations ... $120 billion in swaps for emerging markets ... trillions to cover the FDIC's new, expanded bank deposit insurance, plus trillions more for other sweeping guarantees.

And it STILL wasn't enough

If it had been enough, the Fed would not have felt compelled this week to announce its plan to buy $300 billion in long-term Treasury bonds, an additional $750 billion in agency mortgage backed securities, plus $100 billion more in Fannie Mae and Freddie Mac paper.

Total tally of government funds committed to date: Closing in on $13 trillionBut, you say, what about the recent advance

The recent advance in the S&P 500 was the largest in the equity market since 1938. From its recent March 6th bottom to March 27th peak, the Dow had jumped a resounding 21 percent in just 20 short days. And the rally may still not be over.

Before I go on, let my just say:

Going forward, we expect to be hearing numerous parallels between this market and the 1930s, not all of them positive.

For example:
1) In America's First Great Depression, the financial collapses beginning in 1929 led to GDP declines of 8.6 percent in 1930, 6.4 percent in 1931 and 13 percent in 1932. The U.S. GDP is currently collapsing at the annual rate of 6.2%.

2) Market corrections can be measured by two parameters: time and price. The current decline of 69 weeks has taken the Dow down 50%. The pace happens to precisely equal the pace of the Dow’s decline in 1929-1930.

3) Moody’s Investors Service now predicts that corporate bond defaults will more than triple this year — and exceed the levels seen during the great depression!

4) Bloomberg just reported that the AVERAGE S&P company suffered a massive 58% plunge in earnings in the last three months of last year. Average earnings have plunged 61% year-over-year, much more than during the 1930s. In fact, the last time earnings declined more than 61% was 141 long years ago! It took 25 years for the Dow to recoup its 1929 high; 19 years after the Japanese bubble popped, and Japan's stock market is still making new lows.

5) Like this crisis, the Great Depression was essentially a debt implosion. But in 1929, total debts represented no more than 170% of GDP. This time around, U.S. consumers are buried under a far larger mountain of mortgage debt, auto loan debt, credit card debt and other consumer debts. Result: Total debts are now close to 350% of GDP – TWO TIMES MORE!

6) In the first 18 months of the 1929-32 bear market, there were many small and medium-sized bank failures. However, none were as massive or as dangerous as the giant failures we’ve experienced in the first 18 months of this giant bear market. This time around, the failures (or bailouts) of giants like Bear Stearns, Lehman Brothers, Fannie and Freddie, Washington Mutual, and Wachovia dwarf anything seen in 1929. And even these large failures will be trumped several times over by the impending demise of Citigroup and AIG.

7) In 1929, the United States was a creditor nation, with substantial foreign reserves. Today, the U.S. is the world’s largest debtor nation, dependent on foreign lenders to keep it afloat. That means that there’s a definite limit to how much longer the U.S. government can continue to borrow to bail out failing institutions.

8) In 1929, there were fewer giant banks. They controlled a smaller share of the total market. And they were generally stronger than the thousands of community banks around the country. Today, by contrast, the nation's high-roller megabanks dominate the market. In 1929, derivatives were virtually nonexistent. Not today! U.S. banks alone control $200.4 trillion; and it's precisely in this dangerous sector that the megabanks dominate the most.

Just two weeks ago, the S&P 500 Index slipped once again to a new bear market low, the lowest level since 1996 to be exact ... 12-years worth of stock market gains LOST in just 18 months! But then stocks turned on a dime and rallied dramatically, with the S&P 500 up nearly 10% in less than two-weeks.

So, what made this most recent advance and what does it really mean?

The Geithner's Plan

The Geithner's program is for a Public Private Partnership to take toxic assets off the books of the banks.

With this plan, Geithner is stating that the assets in question are only temporarily undervalued due to liquidity issues. He argues that these "firesale prices" are unfair and that the true value of the pool of mortgage backed derivatives is significantly greater than the 15-30 percent of current pricing. So, the government is planning to step in and provide the temporary liquidity needed to help the market find a fair price for these assets.

Geithner's goes on to say that even though these assets were tragically mismarked as AAA, they actually represent a mixture within the standard junk category, and not all should be rated at the bottom. The market responded and is encouraged that companies with good reputations that specialize in evaluating bonds to purchase, such as PIMPCO, or is that PIMCO, will be involved in managing the portfolio of these assets and helping to price and sell them. S&P, Moodys and Fitch, the rating companies whose collusion caused the crisis in the first place, will not be involved.

It would not be an overstatement to assert that the economic future of the U.S. for the next generation or two depends on him being right. There are many details yet to be worked out, but the current market rally is a sign that a significant number of large players are betting that it will succeed. I hate to be pessimistic or seem unpatriotic, but I will be betting against The Plan. It is just a bit too heroic for my taste.

As the Wall Street adage reminds us, "Bear markets decline on a slope of hope." They tend to end in a period of hopelessness, not heroism. We are not there yet.
Specifically, the Fed said that it will ramp up its purchases of Fannie Mae and Freddie Mac Mortgage Backed Securities (MBS) from $500 billion to a whopping $1.25 TRILLION in the coming months. The Fed is also going to double its purchases of Fannie Mae, Freddie Mac, and Federal Home Loan Bank bonds to $200 billion from $100 billion.

And for the icing on the cake...

The Fed will buy as much as $300 billion in longer-term U.S. Treasury securities. It's going to focus on Treasuries with maturities between two and ten years, and make purchases two or three times a week.

I am sorry to say this, but this is Banana Republic-type stuff, Zimbabwe anyone? Printing money out of thin air at the central bank, only to turn around and buy debt securities issued by your Treasury, is the kind of practice you typically see in emerging market regimes.

We're essentially monetizing our country's debt and deliberately devaluing our country's currency. We're also screwing over our foreign creditors — a dangerous path to tread considering we're a net debtor nation that's trying to borrow tens of billions of dollars a month to fund our massive deficits.

The Treasury, Federal Reserve, FDIC, and Congress have now lent, spent, guaranteed, or committed roughly $13 trillion to bail out the financial industry and attack the credit crisis. One wonders whether the outright failure of AIG might have precipitated a necessary cleansing that would have been healthy in the long run for the global financial system.

Instead, we have zombie corporations and more importantly until the third quarter of last year, the banks' losses in derivatives were almost entirely confined to credit default swaps — bets on failing companies and sinking investments.
But credit default swaps are actually a much smaller sector, representing only 7.8 percent of the total derivatives market.

Credit quality is worsening... and I'm not talking about home mortgages or credit cards

In other words, forget about PRIVATE credit quality. SOVEREIGN credit quality is coming into question, that is a debt instrument guaranteed by a government. Just look at this chart...



Unfortunately, it's not a stock. This chart actually shows the cost of buying insurance against a U.S. government debt default in the Credit Default Swap (CDS) market.

And now, with new losses in interest rate derivatives, the disease has begun to infect a sector that encompasses a whopping 82 percent of the derivatives market.

And U.S. banks alone control $200.4 trillion.

In the 1930s, the banking crisis helped drive the economy into depression and the stock market into its worst decline of the century.

The same is happening today. Whether the nation's big banks are bailed out by the federal government or not, the fact remains that they're jacking up credit standards, squeezing off credit lines, and even shutting down major segments of their lending operations.

The problem is according to the OCC's Q4 2008 report, America's top five commercial banks control 96 percent of the industry's total derivatives, In other words, for every $100 dollar of derivatives, the big banks have $99.78 ... while the rest of the nation's 7,000-plus banking institutions control a meager 22 cents!

This is a massively dangerous concentration of risk.

The point is that large banks are exposed to the danger that, with exploding federal deficits and likely inflation to follow, interest rates will suddenly surge, delivering a whole new round of even bigger losses in the months ahead.
Worst of all, the five biggest banks are exposed to breathtaking default risk — the danger that their trading partners could fail to make good on their debts.
Specifically, at year-end 2008:
• Bank of America's total credit exposure to derivatives was 179 percent of its risk-based capital;

• Citibank's was 278 percent;

• JPMorgan Chase's, 382 percent; and

• HSBC America's, 550 percent.

What's excessive? The banking regulators won't tell us.

According to the OCC, Goldman Sachs' total credit exposure at year-end was 1,056 percent, or over ten times more than its capital.

Does this preclude sharp rallies? Absolutely not!

Don’t worry they have insurance, they have A.I.G.

A.I.G. didn’t specialize in pooling subprime mortgages into securities. Instead, it sold credit-default swaps.

These exotic instruments acted as a form of insurance for the securities. In effect, A.I.G. was saying if, by some remote chance (ha!) those mortgage-backed securities suffered losses, the company would be on the hook for the losses. And because A.I.G. had that AAA rating, when it sprinkled its holy water over those mortgage-backed securities, (now called “toxic assets”; remember Geithner's remark when speaking of the banks bailout earlier, that the “toxic assets” were tragically mismarked as AAA.) suddenly they had AAA ratings too. Already A.I.G. is into tax payers for 180 billion that they can’t be on the hook for; that’s equivalent to nearly HALF the U.S. government’s entire budget deficit for all of 2008! So much for insurance being of any real value and so much for a deregulated market...

Sadly, AIG's CDS portfolio is just one of many: Citibank's portfolio has $2.9 trillion, almost a trillion more than AIG's at its peak. JPMorgan Chase has $9.2 trillion, or almost five times more than AIG. And globally, the Bank of International Settlements reports a total of $57.3 trillion in credit default swaps, more than 28 times larger than AIG's CDS portfolio.

By the way, speaking of AAA ratings, last month saw two publicly-traded companies lose their AAA credit ratings, General Electric and Berkshire Hathaway . That might not sound like a lot ... until you realize that there were only seven to start with!

A recent quote by Paul Volker, ex-Fed Chairman, certainly causes one to stop and think, he said "The fate of the world economy is now totally dependant on the growth of the US economy, which is dependant on the stock market, whose growth is dependant on about 50 stocks, half of which have never reported any earnings."

So what does all this mean?

The U.S. government is heavily in debt to the tune of roughly $13 trillion. The U.S. government is going to have to print up trillions of dollars worth of new money in an attempt to break out of this economic crisis. This is a desperate attempt to maintain the status quo. Over the past several decades, we have burdened future generations with massive liabilities. With what we have added in the last year, we have ensured that those debts are mathematically impossible to pay. The only “solution” is to print more and inflate away those debts.

Buffett's answer...

"The precise nature is anyone's guess, though one likely consequence is an onslaught of inflation."

Buffett told CNBC that the economy “can't turn around on a dime” and that those efforts could trigger higher inflation once demand rebounds. We are certainly doing things that could lead to a lot of inflation. In economics there is no free lunch.”

How will we pay this back?

We will certainly not default on our debt anytime soon. It’s likely that the government could simply inflate its way out of this mess, so essentially the biggest debt ever amassed could be paid back with almost worthless dollars printed to avoid deflation and keep us in a recession, the lesser of two evils.

The kicker is:

This means the excess supply of currency in circulation is going to lead to demand-pull inflation. Demand-pull inflation is described as too much money chasing too few goods.

Here is how and why...

The Fed cut interest rates to almost nothing in an attempt to head off the deflationary effects of falling house prices and weakening consumer demand. This “reflation” shows us that the Fed is no longer focused on fighting inflation; they are now completely focused on avoiding a depression.

We already know deflation is bad, so why is inflation bad too?

Well, inflation hurts people who have saved up a nest egg and those who live on a fixed-income. The same dollars buy less goods and services. So those who have saved are penalized as the dollar is destroyed. Also, wages never go up as fast as inflation, so working people can experience an increase in their cost of living, without the pay raise to go along with it. It’s important that you shield yourself from inflation to protect your wealth and buying power. Knowing this, today’s 30-year fixed rate mortgages at 4.89 % look really good... and what we are doing to our children and grandchildren is unconscionable.

Because of the inevitable surge in interest rates driven by massive government borrowing this will challenge most corporate bonds to a point where they could lose anywhere from half to 90 percent of their current market value. And let’s not forget Treasury bonds, OK?

Even Warren Buffet says, “When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s," he went on. "But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary."

Why do 30-year fixed rate mortgages at 4.89 % look really good...

Consider that the lowest annual average mortgage rate seen in the 20th and 21st centuries was 4.7 percent, set right after World War II. In other words, this is just about the cheapest that mortgage money has ever been.

What if foreign governments decide they don't want to loan us any more money by buying U.S. Treasury and other government-backed bonds?

And who buys most of our bonds? China and Japan

At the end of 2008, China owned $727.4 billion worth of U.S. Treasury bonds. And Japan was second, at $626 billion. But China has been — and continues to be — the most important lender to the U.S.

Inflation and a weaker dollar will erode the value of China's near $1 trillion loan to the U.S. not to mention China’s trade deficit of 266 billion and China knows it. In fact, the Chinese are already starting to move out of U.S. bonds as the mountain of debt shoots to the moon and the safety of U.S. obligations comes under attack. The Treasury will likely have to boost interest rates to get investors to buy its bonds which is why the bond market is primed for trouble and the reason for Buffet’s comments above.

What does it all mean?

It's Geithner and Bernanke's goal to stimulate the economy at all costs... they’re not going to raise rates until they are absolutely certain that they have gotten the economy going again. And it's Obama's goal to get interest rates down, too... to make mortgages more affordable. So, still lower rates could be coming in the short-tem; and a devalued dollar and inflation have already been set in motion for the long-term.

Right now, you know intuitively that a key factor which got us into trouble was too much debt. Yet the solution being offered is to encourage banks to lend more and people to borrow more. Go figure!

Remember the market tends to recover before the economy and the economy tends to recover before employment. When you see employment start improving, that is when you need to start worrying about inflation.

And that means the U.S. dollar is going to decline. Partly because Fed Chairman Bernanke knows we need a weaker dollar to help get us out of the mess we're in.
And partly because China — despite all the complaining that you're hearing from them about the sinking dollar — also wants a cheaper dollar.

You see, China needs a cheaper yuan just like the U.S. needs a cheaper dollar. With a cheaper currency, China can avoid deflation ... spark inflation ... and boost its exports. China and the U.S. get what they want: Cheaper currencies. Meanwhile, both countries' exports to the Euro region and other areas, like Canada and South America, get a huge boost.

It’s a strange world isn’t it.

Out of the blue:

Is this a government in denial? Yes, and desperate to maintain local as well as international aspirations with or without an economic foundation. We still have our 730 military bases in 160 foreign countries and we still spend more on military endeavors than the rest of the world combined. Could some of those resources be better used here at home? Remember,

a government of the people, by the people, for the people, shall not perish from the earth...

Today the federal budget accounts for nearly 30% of GDP - the most since WWII. Add in the highly regulated and highly subsidized health care industry and you've got the government in control of nearly half the economy. Now add in the banking system - which couldn't exist without the FDIC, which would already be insolvent without the backing of Congress. Now add in the insurance industry, which will surely collapse next. Now add in all the state governments' spending and employees.

Most Americans don't understand: The government is now running most of the economy, by a wide margin. And who keeps the government afloat? The Chinese. The United States is now dependent upon the Chinese to finance our consumption through ownership of U.S. Treasuries. And with an already fragile economy, the U.S. is put in a position of weakness relative to China. China realizes that if the U.S. Government continues to print money at the current pace, their holdings will decline in value due to a devaluation of the dollar. So if the Chinese won’t buy our bonds, we will just buy our own. That is a nice setup. We print the money, we need to borrow to finance our deficit, if no one is willing to lend us the money we will just lend it to ourselves. Sweet!

Think about that for a little while... Up until now, the so-called "Communist" Chinese, whose government makes up about 10% of China's GDP and who control the No. 1freest city in the world (Hong Kong), are now paying for the most government-controlled economy in the world - the so-called "land of the free."

P.S.
Notice, I haven't even mentioned the potential for mischief and instability coming out of the rest of the world -- enough black swans to blot out the sun.
And don't forget about a crisis that's killing 12 million people per year, including 10,000 children per day. Three billion people have been added to the planet just since 1970, but the per capita supply of fresh water is one-third lower today than it was then. In the United States — groundwater is being used up at a rate 25 percent faster than it is being replenished.

Note to readers:
One may wonder how it is that I accumulate such a mass of information, let alone have the time for this blog. First, it is purely self-interest as I too have to navigate these markets and since I am making the time to do the reading and discovery, why not share it with a larger audience, and so I do. Second, my sources are many and varied and what I do is take the best of the best, cut and paste, and string together a somewhat coherent thesis. In reference to my sources this month, they include in no particular order: Gregory Spear's Market Commentary, Automaticearth.com, The Motley Fool, DailyWealth Reader, The Daily Crux, Money and Markets, Louis Navellier, Investorsdailyedge.com, Moody’s, Bloomberg, The New York Times, The Associated Press, Financial Times, The Globe and Mail (Toronto), Financial Week, International Herald Tribune, Reuters, The Washington Post, InvestmentNews, CBS News, The Toronto Star, Forbes, Jim Kunstler, Rick Pendergraft, Business Week, The Wall Street Journal, Martin Weiss, Sharon Daniels, Dan Weil, BCA Research, Financial Post, Gulf News, Los Angeles Times, Larry Edelson, CNNMoney.com, Google.com, Mike Larson, CNBC, ETF Trends, and The Times (London).

2009 - March Economic Brief

March – 2009 Economic Brief

"Today, we have three interrelated problems: a collapse of the real economy, a collapse of the banking system and rapidly shrinking world trade," said Jeffrey Garten, a professor at the Yale University School of Management. "If you treat one without treating the others, you are doomed." However, Obama’s stimulus plan makes the U.S. real estate market the main pivot in the whole economic mess we're in right now.

Is your house in order?

Over 60% of dentists in one survey acknowledge that the present economy means they now plan to work longer than they'd expected.

Though not the precipitating factor in the current crisis, the weakening of household balance sheets (fewer assets, same liabilities, less net worth, more anxiety) has likely had a significant effect in depressing consumption, which has been the single largest factor in our recent decline in GDP. Since the Federal Reserve Survey of Consumer Finances was conducted in 2007, median net worth fell from $120,300 to between $90,000 and $95,000 - back around 1998 levels ($91,300).
When you or I get in a debt bind, we are forced to make difficult budgetary decisions. We cut back on our spending. Let me know when you hear this happening on a national level.

On the other hand, there is a true disconnect between “the people” and this past year’s Wall Street bonuses: $18.4 billion, the fifth-highest total ever. Did I mention that: the official unemployment rate has now exploded to 7.8%, that U.S. home prices continue to fall (still 20% overpriced), that the current crisis is global is hitting the whole world simultaneously and providing no outside support to offset U.S. domestic weakness. Did I mention that earnings are falling and stocks are still far from cheap based on those earning, that debt and leverage are gone, or that in the undeniable history of speculative bubbles that things always return to their norm?

The reason for this crisis, in a word — CONFIDENCE — or rather, a dramatic loss of confidence and faith in our financial system.

Like many people, I was disappointed by the Financial Stability Plan announced on Tuesday the 10th. The devil is in the details and we shall see just what is disclosed (made transparent) because fairly or unfairly, many people think that Tim Geithner is in Wall Street’s pocket because he has said that being tough on the banks and top bankers would further worsen credit markets and thus deepen/prolong the recession. On the other hand, if he had forced banks to write down their book values (bad assets) based on actual market conditions—and then deal with the consequences—he would have ended the financial crisis, but it would be ugly - it’s kind of a catch-22 thing, your damned if you do and your damned if you don’t, I guess.

Can the U.S. afford this $789 billion major fiscal stimulus package? What’s this government to do? Cutting spending is not really an option given the economic crisis and given the growth of entitlement commitments in the future, (the total U.S. debt – including Medicare, Medicaid and Social Security – is more than $99 TRILLION!), and that’s not to mention our increasing military needs. In fact, the only way the debt can be paid off is by inflating it away which will drive interest rates up and the dollar down, or so economic logic predicts.
Add to this, the information that the International Monetary Fund said last month that Japan’s economy would shrink 2.6 percent in 2009, versus contractions of 1.6 percent and 2 percent in the U.S. and Europe. Are you starting to get the picture that this downward spiral is now engulfing all the world’s economies? I hope so.
So what happened to the stimulus package, why did it drive the markets, yet again, down?

First, the Fed will be expanding its Term Asset-backed Securities Loan Facility, or TALF. In this program the Fed will lend money to investors who buy securities that fund various types of loans. The Treasury will seed the TALF program with as much as $100 billion. The Fed will provide additional leveraged funding, up to $1 trillion.

Second, the Treasury is going to set up a public-private program to buy “bad assets” from the banks, up to $500 billion.

Third, Regulators will "stress test" bank portfolios, and inject capital into them, if necessary, through the purchase of convertible preferred securities.

Fourth, there was some talk about foreclosure mitigation and prevention at Fannie Mae, Freddie Mac, and private banks. Recently, Mr. Obama rolled out a $275 billion anti-foreclosure plan, so it’s not all talk.

Let’s go over this again, first, he got Congress to pass a $787 billion stimulus package ...

Next, he got Treasury Secretary, Timothy Geithner, to unveil the administration's bank bailout plan which he now admits could cost up to $3 trillion .

Sound good so far, it’s nothing new. Are you still wondering why the markets reacted by going down?

Add it all up, and it comes to more than $4 trillion, an amount nearly ten times larger than the budget deficit for all of 2008. All in just 32 short days! Without a doubt, the $4 trillion makes Obama the single most profligate spender in history — bar none. And still the government didn’t spell out exactly how, when, and why it would save the day. So the “plan” is still to come up with yet another plan. What kind of plan is that?

Wall Street certainly didn’t like the ambiguity after so much of a “save the day” rhetoric. It was more of the same old failed logic. Remember the TAF, the TSLF, the PDCF, the TARP and all the rest of those acronyms? Those programs have kept many "failed" financial institutions alive. Is the TALF any different, no! Are we are still on life support, yes!

Look at it this way: If you were a very rich man living at the time of Christ ... and you could have started saving $1 billion per year every year thereafter, you'd still be only half way there! You'd need still another 2000 years to finance what Obama has committed to spending in just the one month since he began his presidency.

We haven’t even talked about failed commercial loan originations which dropped 80% year-over-year in the fourth quarter. EIGHTY PERCENT! Just think of the impact that's going to have on the commercial real estate business which is destined to collapse next.

I could go on, but the real point is that you can buy into Washington’s hype or you can prepare your portfolio for a long, low, lean time ahead.

That's why, despite $4 trillion in new spending schemes and guarantees, the Dow has plunged to new lows, that’s why every stock index in Asia and Europe have also cratered in unison.

That’s why gold — the world's crisis hedge of last resort — has once again shot for the moon. Did I mention that the Feds, Ben Bernanke, has admitted in the latest release of the FOMC minutes that there will be no recovery in 2009. The rationale for owning gold, as it once again approaches the $1,000 an ounce level, is the prospect of mounting monetary disorder. The long-term story for gold is as a remonetization play as investors lose faith in inflating currencies alongside monetary and fiscal policy measured up against the desire of Central Banks to keep asset prices relatively stable, if not volatile, but certainly not wanting the dreaded Deflation economic apocalypse.

Here, gold is a prime candidate to become a “mania asset” once its demand becomes chiefly financially driven.

How high can gold ultimately go?

Normally, Central Bankers see high gold prices as a lack of trust in the financial system (not to mention their ability as Central Bankers). We saw this in 1932 and 1980 when the Dow Jones Industrial Average/gold ratio was 2:1. Only nine years ago in 2000, this ratio was over 40:1. Arriving at 2:1 again does not necessarily mean the Dow must decline significantly from here; more likely gold prices will surge and the Dow will stay range-bound but volatile. For this reason, this is the first time I can see Central Bankers actually favoring a high gold price as it would suggest that their attempts to stave off deflation were starting to work. Central Bankers in favor of higher gold prices; my how things have really changed.

These are the three essential truths to be drawn from the market...

1. Analysts have consistently underestimated the seriousness of our current economic problems. Weren’t we supposed to have a turnaround by the end of last year? And then it was supposed to happen the second half of this year... and now it is not going to happen this year at all.

2. All the fundamental numbers are still worsening. Jobs, factory orders, housing, bank writedowns, economic growth, unemployment and so on.

3. Most of those who are predicting an imminent turnaround are doing so on the basis of the government’s bailout plans. But government actions so far have failed dismally. “Government as the answer” just doesn’t do it for me, how about you?

Let’s take a step back and look at the big picture.

Somewhere near $30 trillion has been lost in global stock markets. Global real estate has suffered a similar fate. This doesn't include bond, commodity or other market losses. These losses are only in markets that are fairly transparent. Who knows what has happened in the hidden and unregulated derivatives market, where somewhere near $600 trillion sloshes around, nothing good for sure. These toxic problems are at the root of what ails us, yet the public is left in the dark. You can't make any of these markets, businesses or individuals whole by throwing around a few trillion freshly digitized dollars. The scale is simply too big. With this in mind, perhaps it is useful to understand something about economic philosophy. Let me explain.

An epic battle being waged between "David vs. Goliath"

School of Goliath — The intellectual leader is Milton Friedman (Money Supply Theory). Milton Friedman believed that the government should flood the economy with massive amounts of money to enhance and increase consumer demand.

Basic Premise: In order to keep the current recession from turning into a depression as we witnessed in 1929, the government must stimulate the economy with massive amounts of money so that we can enhance and increase consumer demand.

This is where Mr. Bernanke, Mr. Giethner and President Obama's advisors reside.

School of David — The intellectual leader is Irving Fischer (Debt-Deflation Theory). Irving Fischer's Debt-Deflation Theory holds that the government must let the invisible cleansing hand of the market wash away the debt before economic growth can resume.

Basic Premise: In order to keep the current recession from turning into a depression as we witnessed in 1929, the government must step-back and let the invisible cleansing hand of the market let those business who fail, fail - and clear the debt before any real economic growth can again take hold in the economy.

The point where we are at now in this battle is the part where debt levels have reached such huge proportions in the economy, that due to the size of the money involved, pumping more money into the system is ineffective because the velocity of money declines as the size increases.

Let me explain the term "monetary velocity" and how important it is:

Monetary velocity means how fast money is circulated in the economy — the speed in which it is spent. And it is a key measure in the definition of economic growth and output.

But, in this epic battle, eventually, when debt levels become so huge, as they are now, people get scared. They save, hoard and use their money to pay down debt. They don't take on more debt or run out and spend more just because the money supply has been increased magically (digitized dollars) by the government.
In fact, the more money pumped into the system only adds to the total debt in the economy, and therefore prolongs the downturn.

We will be locked in a sustained period of risk aversion (rising unemployment, deflation, and sovereign debt defaults) as this crisis plays out. And at a time of major risk aversion, the world will flock to its reserve currency — the U.S. dollar, until inflationary pressures (more digitized dollars) move the herd to gold. Why? Because the endgame to this crisis will eventually bring much higher interest rates to keep the herd feeding on US dollars, a downgrade of the US government's credit status, hyperinflation, and the destruction of the dollar.

If demand for money rises faster than supply, then prices for other goods will fall because people want cash rather than assets. This is what's happening right now. The feds are increasing money supply by the trillion. But there's huge demand for that money, too, people want to be in cash, not assets because of the downside risk in the recession/deflation environment based on the total debt and the inability to efficiently service it due to its size. That’s why the US treasury is able to sell short-term bonds at 0% interest, because people want the cash more than any risk associated with some return.

Money demand is all about people's confidence and sentiment. It could change rapidly at any moment (herd mania). When confidence returns and when people start spending money as fast as they get it, watch out: because we're headed for a huge inflation and you should turn your paper money into gold and silver because all of a sudden money will be worth less making prices for goods and other assets worth more.

In fact, if you go back to my March and April 2008 posts you will understand that the US Empire has been insolvent, and run on debt for many years. We've long had the privilege of issuing the primary currency in international trade because of demand for the US dollar. No other nation has been able to print money out of thin air and purchase goods and services with it from abroad (Thank you China, it’s our money, but it’s your problem).

Here’s the rub

The US needs over $2 billion per day coming in from foreign sources to balance our trade and budget shortfalls. We have been and remain at the mercy of foreigners. A total of $1.5 billion was all that came in for the entire month of October. November actually saw a negative $21.7 billion. That means $21.7 flowing out of the US and nothing flowing in on a net basis. Who exactly is going to pay for the trillions in spending the US has on the agenda this year?

Yes, the Fed will have to do this deed. They create money (digitized dollars) in which to fund our debts. (Don't try this at home, it’s illegal to print money.) In whose behalf is the US Treasury piling up all these debts? Taxpayers; of course, you and me and your grandchildren’s children for many generations out. It's little more than a house of cards at this point. The amounts of debt are too astronomical (In god we trust!) to be repaid, ever.

The US is insolvent by any reasonable method of accounting. The debts cannot be paid. When they can no longer be serviced, it's over!
I'm not trying to depress you, though that has likely happened. This is all really ugly. Maybe it's the darkest night before dawn, but it's hard to imagine how all this can pass us by and leave the world unchanged.

Some good news:

If this stimulus package doesn't work, there will probably be Stimulus Plan II.
Interestingly, one neat effect of this coming US dollar inflation is that it will reduce our trade imbalance with China at the same time.

The price of gold has jumped from $737 to over $995 an ounce, a gain of more than 35%! This situation makes gold the de facto reserve currency. Gold alone cannot be devalued or manipulated. It is the safe haven standard of value today, just as it has been for the last 5,000 years.

It would be hard to pick a more interesting time to be alive.

Thankfully, despite all the bad news, we still have efficient free transactions — not only in goods, but also in services; not only in assets, but also in debts; not only for private-sector securities, but also for government securities.

And Canada is now the largest single supplier of oil and refined products to the United States. Northern Alberta is sitting on the biggest petroleum deposit in the world. It has 300 billion barrels of proven reserves ... and another TRILLION barrels that are just waiting for recovery technology to improve. That's eight times the oil in all of Saudi Arabia!

Some Bad News:

Economist, Paul Krugman, a recipient of the Nobel Prize in Economics, said in a speech at the University of Pennsylvania on February 19th that the U.S. economic-stimulus program doesn't deliver enough stimulus to pull the U.S. out of its downturn.

On the dame day at a Columbia University dinner reported by Reuters...

George Soros said the financial system has effectively disintegrated, with the turbulence more severe than during the Great Depression and with the decline comparable to the fall of the Soviet Union, while ...

Paul Volcker said he could not remember any time, even in the Great Depression, when things went down so fast and quite so uniformly around the world.

Another point of view out of the blue:

Did you know the exhalations of breath and other gaseous emissions by the nearly seven billion people on Earth, their pets and livestock are responsible for 23% of all greenhouse gas emissions? Like it or not, we are the problem!

February - 2009 Economic Brief

"If you have fiscal stimulus without fixing the banking system, it will be like a sugar high," said Robert Zoellick, president of the World Bank, and Dominique Strauss-Kahn, managing director of the International Monetary Fund.

The contagion has now hit Main Street!

Unemployment has gone through the roof in almost every industry. This also means that the value of almost every bank asset is greatly overstated whether it be 50 cents on the dollar or 20 cents on the dollar, who knows?

Can the U.S. government bailout Citigroup and Bank of America? Can it do this even as thousands of large and small retail companies, air transport firms, auto companies and others file for Chapter 11, even as Europe and Asia keep sinking? And that’s not all, did you know how this crisis is spreading overseas to other banks? The Royal Bank of Scotland (RBS) announced recently that its losses for 2008 would be a staggering 28 billion pounds (41.3 billion U.S. dollars)!

If you have been following my blog then you already know about Bank of America’s $2.4 billion loss, Citigroup’s $8.3 billion loss, but did you know JPMorgan Chase's derivatives could double the size of the banking crisis overnight. On the day that JPMorgan Chase needs to join the ailing Bank of America and Citigroup in Uncle Sam's intensive care unit, the derivatives mess doubles immediately. In fact, the International Monetary Fund raised its estimate of bank losses on U.S.-originated loans from $1.4 trillion just this past October to $2.2 trillion just three months later-- and that does not cover the cost of capital needed to allow banks to resume normal lending. No wonder these bailouts keep failing! All this is in addition to the Obama administration discussions on the need for a second round of bank bailouts that could cost U.S. taxpayers an additional $1 trillion to $2 trillion. Hold on to your hat.

Does this sound like a B-grade movie? Well, they're actually trying to do it.

Congress has approved the second $350 billion from the original 700 billion TARP bailout even though according to the Congressional Budget Office (CBO), taxpayers have already lost at least $64 billion on the first 350 billion on that “investment’ into the banks. And while the Treasury has abandoned its plan to buy up “bad bank” assets, the Federal Reserve has gone ahead with another $500 billion program that does precisely that through a massive entity that acts like a giant insurance company, picking up most or all of the bank losses. Go figure? And yet, despite all these efforts, the economy is still collapsing. Why? Because this debt scenario is on top of all the other debt scenarios.

You must expect that each new incarnation of the debt crisis will be a bigger threat to your wealth and your income.

Take a look at the more than 2.6 million families who lost a paycheck in 2008. This may not be you, but this is sure as heck represents your patients. That means the total number of unemployed workers are now over 11 million — fully 74% as many as were unemployed in The Great Depression. Obama himself has warned that the unemployment rate will explode to at least 10% in 2009, more than 15 million workers will be without a job — more, even than during the depths of The Great Depression. Wage freezes and outright salary reductions
are already spreading like some kind of new economic plague!

Two Competing Expectations For the Future

They are:
1. That uncontrollable money-printing and excess spending on bailouts and stimulus will breed a new, super-inflationary environment, or

2. The change in capital flow as evidenced by shifting consumer confidence is ushering in a period of deleveraging and deflation that will force a global economic rebalance. Psst, don’t tell any one, but we are already in a depression.

Consumption is obviously on the decline. The declines in credit market have made a huge impact on consumer demand. Investment is likely heading in the same direction. A labor expert said there is "a vicious circle of depression, where job losses lead to falling consumption, which lowers industrial confidence."

The result of uncertainty in expectations has created hoarding of cash; not just by individuals, but also by banks and institutions that are not willing to lend. That means the U.S. government plans to make up for the shortfall in consumer demand and institutional credit by increasing its spending. How can it do this? It can do this because the U.S. government has one weapon no other country has – the world's reserve currency.

Inflation is not a short-term concern, if you're looking at the U.S. on a relative basis, relative to competing economies and currencies, thus the story for the ongoing bull market for the U.S. dollar begins to make sense. For example, the British pound just hit a new 23-year low against the dollar which is a good sign for the U.S. dollar. Add to this mix that China is also facing pressure from President Obama to allow the Yuan to rise in value which would be the equivalent to economic suicide. Timothy Geithner, Obama's pick for Treasury Secretary, said that "China is manipulating its currency." How about a currency war, anybody?

Nevertheless, the last thing China can afford is to allow its currency to rise and make its exports more expensive. So I foresee that the currency-valuation issue will probably turn into some sort of political battle down the road, threatening to make things worse for both the U.S. and China. It is getting ugly out there.

But, and this is the major “but” in this scenario, it seems improbable that this level of deficit spending can continue without sparking a run on the dollar via foreign governments selling U.S. Treasury bonds. In the last 6 weeks the Treasury market was hit harder than it's been hit since 1987 and further, there is not sufficient global savings to buy more than 30 percent of the proposed extreme spending programs. Only the Treasury market can spend freshly minted money like this because it is vastly larger than the stock market and also, by the way, this kind of money is way too big for effective internal Federal Reserve control. Why?
Simply, our creditors, other foreign governments and investors will not allow us to print money forever.

Two cases in point, 1) South Korea's economy contracted a painful 5.6% last quarter — twice as bad as had been expected. The problem, China is South Korea's biggest export market. And exports to China are nose diving. South Korea is also one of the largest holders of U.S. Treasury bonds and on January 19, the head of investments for South Korea's government pension service, Kim Heeseok, told Bloomberg, "It's time to sell U.S. Treasuries" because the ongoing stimulus is going to cause inflation. 2) In December, investors who were buying the longest Treasury bond in existence — the 4.5% "long bond" expiring May 15, 2038 ended up with only 2.52% and since then the bond value has lost $1,890. In other words, they lost the equivalent of more than five years of interest in just six weeks. So don't count on Uncle Sam to save your bank, your business, or the economy.

Still not convinced? Add to this equation the fact that China's exports have plummeted so they don't have the money to lend us anymore. With the U.S. economy in the dumps, these government bonds aren't as attractive as they used to be. China has already said they want to diversify away from them. Recently, China's Premier Wen Jiabao laid the responsibility for this global crisis squarely on Washington's doorstep: The financial crisis, he said, is "attributable to inappropriate macroeconomic policies and their unsustainable model of development characterized by prolonged low savings and high consumption; excessive expansion of financial institutions in blind pursuit of profit." The reality is the world’s biggest investors in US Treasury bonds — China and Japan — need the funds to help offset their own economic slide.

Did I mention that oil prices have dropped sharply, so OPEC doesn't have as much to lend us either. The same can be said for other major investors in Russia, Western Europe and Latin America.

What to do?

Keep up to 90% of your money in cash (short-term) or gold bullion (long-term). Why gold? It’s an inflationary hedge, its supply is limited. All the gold that's ever been mined in the history of the world can fit into two Olympic-size swimming pools. At the end of last year, the total paper money and IOUs of the entire globe totaled more than $600 trillion. That’s 10 times the GDP of the WORLD. Gold, at its 2008 year-end price of $869.75 an ounce, equals just $831 billion — less than 1% of the total outstanding paper in the world.

Simply Put:

The U.S. banking system is toast. It's bankrupt in every sense of the word and in every number you can imagine. The U.S. Government is also broke. Think of the implications of creating more debt to pay off existing debt ... printing more paper money to circulate in the economy ... and then spending trillions of previously non-existent dollars to try and stimulate the economy.

Then printing trillions more to save the banking system ... to pay off eventual Social Security obligations as they come due ... to pay Medicare liabilities ... to fund failing pensions ... and more. I’ll put it to you this way, if you or I spend hundreds of thousands more than we earn each year ... and then borrow nearly every penny we need to pay our bills, it's called "insanity." When Washington does it, nobody bats an eyelash.

So what's left?

Cash and Gold —

Gold performs admirably in deflations as well as inflations!

We could be facing multiple years of adversity before our economy rids itself of excess leverage, before bad debts are liquidated, and before a sustainable recovery can begin.

We are witnessing nothing less than a sea change in the way Americans think about their spending, savings, investments and debt.

Want some good news?

If you look at the last 12 months or the last six months, health care has been the best-performing sector. So far, so good.

Want another perspective?

Chris Buckley's satirical novel "Boomsday” is more than satirical, it is prophetic.

It says:

In the long term, Obama's adding a $1 - 2 trillion stimulus package on top of what Nobel economist Joseph Stiglitz calls a "$10 trillion hangover" of debt left over by former President Bush from the economic meltdown, two wars... and then adding to that the fact that Pakistan and India are ready to go at each other, plus the wild card that is Israel, plus melting ice caps on both poles, plus reforming out-of-control economics of retirement entitlements, like Social Security, (which eat up 40% of the federal budget), all this, will be like rearranging deck chairs on the Titanic because the real problem is population growth.

If you are over 50 years of age you have lived 1/10 of the time since Columbus discovered America. If you agree the average life time is 80 years, then any 8 of those years represents the same 1/10 of your life time. In the year 400 AD the world’s population was 200 million. It took 1,000 years for the world’s population to double to 400 million in the 1400’s when Columbus first thought he had discovered Asia. Now it takes two years for the population to grow by 200 million, not 1,000 and that is the real problem that no one is talking about; bigger even than our current economic crisis!

Yes, population is the core problem that, unless confronted and dealt with, will render all solutions to all other problems irrelevant. Population is the one variable in an economic equation that impacts, aggravates, irritates and accelerates all the other problems. The point is more and more people are filling up our little planet.

A United Nation's study estimates the world population will continue exploding, from 6.6 billion to 9.3 billion by 2050! By 2050 America's then 400 million will be vastly out numbered by 8.9 billion others across the planet, all competing with America. In short, within four decades, half your life time, human demands will easily double. That makes population growth the key variable in every economic equation ... impacting every other major issue facing world economies ... from peak oil to global warming ... from foreign policy to nuclear threats ... from religion to science ... everything.

The focus for government, and for everyone, should be on how to minimize the risk that people will not freeze to death in their mortaged homes or are not poisoned by their own drinking water. Trying to save the banking system doesn't address that. Trying to save the banking system with the money that belongs to the people makes it more likely they will freeze to death. That in a few words is the choice before us.

How Much More Economic Pain Is Yet to Come?

The answer: A whole lot more!

The S&P 500's November low was 752, which amounted to a peak-to-trough loss of 52%; that makes this current downturn the third worst in modern stock market history, but not as bad as either of the Great Depression bears of the 1930’s, at 86% and 54%. However, the current downturn has already been deeper and faster than any other bear market in recent history. Why just last quarter, the U.S. economy shrank the most since 1982 as consumer spending recorded the worst slide in the postwar era. The means the US economy is shrinking at a 3.8% pace. Unadjusted for inflation, GDP shrank at a 4.1 percent pace, the most since the first three months of 1958.
The IMF dropped its forecast for global economic growth to a measly 0.5% for 2009 — the weakest pace since World War II. What's more, that's a drastic reduction from the 2.2% growth the IMF had predicted as recently as November.

The S&P 500 lost 8.57% last month, which was the worst January on record. In January, we saw gold climb nearly 5% and silver jump 11%. January was the worst January ever for the DOW and the S&P 500.

Lawrence Summers, director of the National Economic Council, said the country faces "a real risk" of slipping into deflation. ADP Employer Services said in a report that the U.S. private sector eliminated 522,000 jobs in January. Fitch Ratings said U.S. credit-card payments that are at least 60 days late reached a record 3.75% in January. We know from comments made by participants at the World Economic Forum in Davos that bankers the world over anticipate a huge wave of commercial real estate defaults that will begin later this year and stretch into 2010. Federal regulators have closed six banks this year already so we are well on pace to pass twenty-five U.S. banks that failed last year.

Still not concerned?

Did you know that the costs of the government bailouts of the housing crisis, the credit crisis, and the Wall Street bailout exceeds the costs of all US Wars, The Louisiana Purchase, the New Deal, the Marchall Plan and the NASA Space program combined!

Did you know that America’s massive accumulation of debts now totals $294 trillion.

That’s 420 times larger than the $700 billion TARP bailout program and nearly 300 times bigger than the largest estimates of the Obama rescue package. This icludes $52 trillion in interest-bearing debts tallied by the Federal Reserve; $60 trillion in government Medicare, Social Security and pension obligations estimated by the Government Accountability Office; and $182 trillion in derivatives, as reported by the Comptroller of the Currency.

All this in addition to:
•The Fed reports that say U.S. households lost $7.9 trillion in real estate, stocks and other assets.

•Plunging income in households

•Government rescues are slow, we are still waiting for the 2nd half of TARP

•Sinking confidence

•The cost of financing the rescues - already the price of long-term bonds are collapsing and yields increasing so much so that the average A-grade corporate bond costs 16.95%. I ask you, how can they or anyone afford this higher borrowing cost long-term?

•National Association of Realtors said the nationwide median price of an existing home fell 15.3% in December, the largest drop ever. And there is still an over supply of between 1.5 million and 1.75 million new and existing homes on the market. Yes, sales are going up, but prices are going down. Wholesale dumping is still ahead, forcing sellers to slash prices, driving millions more into foreclosure and swamping any foreclosure prevention efforts.

•Alright, I’ll stop, I know its too much to take in all at once, but stay tuned... and don’t get euphoric over the “bad bank” solution, the name says it all, or would you prefer to call it BARF, bad asset repository fund.

January - 2009 Economic Brief

Good news!

To those of you who have been following my economic surveys since March 2008 you will be happy to learn that I have a New Year’s resolution - to be brief, and not include so much documentation and/or references. These commentaries represent a mélange of newsletters, CFA resources, media and my own spin. For specific reference, ask me directly. So what follows is in summary format...

More good news because of bad news

The U.S. trade deficit has narrowed substantially; our trade deficit fell to $40.4 billion from $56.7 billion. Such an improvement in the U.S. trade deficit means that dollars aren't leaving to flood other overseas investments. In fact, they're coming back to our shores ... a sure argument for why the U.S. dollar is in a position to appreciate ... despite the global recession. That's why I remain bullish on the U.S. dollar, short-term. Ultimately inflation will re-inflate almost all tangible assets, and the chief beneficiary... gold anyone? (See March and April’s 2008 postings for more on this.)

Further, the monetary base was increasing at 3-4% per year through September 2008, nice and steady.

But then it kicked into overdrive and accelerated to a mind-blowing 990.9% annual rate for the three months ending. And, if averaged out, that's an annual increase of 86%. All this will tend to push the market to rally some and volatile it will be.
The name of the game for 2009 is going to be avoiding losses. A Treasury-only money fund gives you immediate availability to your money. You can have your funds wired to your local bank overnight. And you can even write checks against it, much as you'd write checks against any bank checking account. That’s the end of the good news.

What happened?

The entire safeguards system, consisting of disclosure, regulation and supervision failed. The point at issue is the Glass-Steagall Act – passed in 1933, in response to the Wall Street crash. It prevented commercial banks – which take deposits from ordinary households and firms – from engaging in high-risk speculative activities undertaken by investment banks. Or at least it did until 1999 when, it was repealed by President Clinton. One of the main proponents of scrapping Glass-Steagall was Clinton's Treasury Secretary Larry Summers. Despite his key role in enacting this historic blunder, Summers is to be Obama's chief economic advisor. Go figure? James Wolfensohn, the former president of the World Bank said, it is "not the system; the system did not drive it... (it happened) because individuals took advantage in the absence of appropriate regulation." This month, the Congressional Oversight Panel is reporting that the U.S. Treasury is doing nothing, including failing to properly track the hundreds of billions of dollars it doled out in bailouts (referring to TARP - Troubled Asset Relief Program). The more things change, the more things remain the same.

Treasury Secretary Paulson said, "In the years leading up to the crisis, super-abundant savings from fast-growing emerging nations such as China and oil exporters... laid the seeds of a global credit bubble that extended far beyond the U.S. sub-prime mortgage market and has now burst with devastating consequences worldwide... investors looking for yield, missed pricing risk.” So, massive levels of new, exotic derivatives (mortgage-backed securities) funded by emerging countries’ savings is one of the core reasons for the lack of U.S. consumer savings and the global crisis. This has been confirmed, says the Organization for Economic Co-operation and Development, who have said that the crisis in the US started to really surge beginning in 2004 with investment in residential mortgage-backed securities. The European banks invested this new money in Eastern Europe, Spain and the UK invested like the U.S. into a housing bubble, and Japan’s banks continued to invest more and more into their own equities.

What’s happening now?

A new phase of the bank crisis is beginning ... soaring unemployment, plunging stocks, canceled dividends, and sinking investment income is ahead.

Robert Shiller, professor of economics at Yale University, said the U.S. economic downturn "is no ordinary recession", the problems are much worse.

The U.S. economy is in trouble. And it could get much worse for the U.S. as unemployment seems set to shoot higher. But, it's all relative to the rest of the world. And relative to the potential for a lot more pain elsewhere. Still, consider that the U.S. financial assets could surprise investors, meaning: expect a lot of volatility.

Retail:

Expect thousands of store closures, reeling from the worst falloff of US holiday sales since the 1970s. Industry experts said the economic downturn is not following patterns seen before, and consumers may be in the process of changing their spending habits permanently.

Stock market:

Last year's 32% decline in the stock price of Warren Buffett's Berkshire Hathaway was the worst fall in more than 30 years but still better than the 39.8% drop of the S&P 500 or the Dow Jones Industrials, which has lost 33.9% since January 1, 2007 or the Nasdaq which lost 35.49%.

Call it what you want: depression or recession, but factor in a 24 month contraction, given the circumstances. I remind readers that Ronald Regan defined recession as when your neighbor loses his job and a depression when you lose yours. Note that the P/E ratio of the S&P 500 based on trailing reported earnings for 2008 is 19, which is not cheap because Bear markets tend to end with trailing P/E ratios in single digits, so we still have lots of room to move.

On the other hand, and in consideration of the expected market volatility going forward, we could get a rally lasting a few more weeks to a few months (see chart http://www.spearreport.com/update/1.2.09_Dow.gif.). The last three times the Dow was this oversold, which occurred in the 1970s, the market rallied for 6-8 months.

Commodities:

Commodities in 2008 posted their worst performance in history.

Manufacturing:

The Institute for Supply Management's (ISM) factory index tumbled from 36.2 in November to just 32.4 in December, the lowest level since June of 1980. The all-time low for this data series, which began in 1948, was 29.4 in May 1980.

Industrial Production:

Ford and General Motors, for example, are down more than 90% from their peaks. Industrial production dropped by a bigger-than-expected 2 percent in December.

Financials:

Bank of America has fallen 68%. Bank of America posted its first loss in 17 years — a whopping $1.7 billion and cut the dividend it pays to stockholders. Bank of America has been given a $138 billion rescue package that matches that given to Citigroup. Citigroup’s total losses for the year are a staggering $18.7 billion, including a $8.29 billion loss for the fourth quarter.

State governments:

The number of states facing urgent fiscal difficulties has suddenly surged to at least 45. The Center on Budget and Policy Priorities (CBPP) projects that their combined deficits will surge to $350 billion.

City Governments in Even Worse Shape:

Cities are typically unencumbered by the legal requirement to balance their budgets. In New York City the New York Independent Budget Office is now pegging it’s deficit at $11.3 billion. In California, the biggest borrower in the municipal market has torn a $42 billion hole in the state’s budget. This scene, repeated across the nation, could create a whopping $100 billion in new municipal deficits on top of the $350 billion in deficits at the state level.

Grand total: $450 billion in red ink flowing from state and local governments ...

Real Estate:

More than 861,000 homeowners lost their houses to foreclosure in 2008, and filings surpassed 3.1 million.

Pension Funds:

The consulting firm Mercer recently estimated that the pension funds of big U.S. companies are underfunded to the tune of $409 billion! This could also lead to reduced business investment as companies are forced to divert money from equipment and facilities budgets to their pension funds.

Federal Home Loan Banks:

After the federal government, they’re the biggest borrowers in the country. Moody’s recently warned that eight out of the 12 FHLBs could ultimately face capital problems thanks to losses on their $76 billion of mortgage securities not backed by Fannie Mae and Freddie Mac. While many investors have never heard of the FHLBs, they collectively have roughly $1.25 trillion.

US Federal Government deficit:

Add to this an estimated additional $1.186 trillion deficit at the federal level for 2009 plus the latest woes of the nation's megabanks and all in the midst of a collapsing economy! And, by the way, how much is that? That’s more than the inflation-adjusted cost of the Vietnam ($698 billion) and Korean Wars ($454 billion). It makes last year's $455 billion deficit look like chump change. The projected 2009 figure is equal to about 8.3% of U.S. GDP. Further, the Budget and Economic Outlook for Fiscal Years 2009 to 2019 (available at: http://www.cbo.gov/ftpdocs/99xx/doc9957/01-07-Outlook.pdf - see page 23), projects red ink as far as the eye can see: An additional $3.135 trillion from 2010 through 2019. WOW!

Add to this:

The more than $70 TRILLION in debts Washington already has incurred during the “good” economy that is comprised of the more than $10.6 trillion in national debt... plus the $58 trillion in unfunded Social Security obligations and Medicare.
And this is all before Obama’s estimated $1.2 trillion in fiscal stimulus programs coming... to once again bail us out. Isn’t Washington doing the same thing that the private sector did, spending money it doesn't have? Go figure?

Confidence:

Sure Obama will bail us out, create jobs, bail out millions of defaulting homeowners, provide universal public health, embark on the most extensive public works campaign, create deep tax–cuts, and let’s assume he does get some money to Main Street, what will they do with excess funds? They'll use it to bump-up their balance sheets, they’ll start saving — (a process that has already begun with the bank bailouts and is, by the way, bullish for the dollar).

Six Trends Ahead:

1) All eyes will likely remain focused on the real estate, mortgage and stock markets while quietly behind the scenes another bubble will be bursting: The bond market. Debt issues from the Treasury to borrow the money planned for the fiscal stimulus will remove trillions more in wealth from investors who have fled to the so-called safety of government bonds. U.S. Treasury long-term bonds are now the riskiest of all assets on the planet. Expect to see a 30% to 40% plunge in these bond prices in 2009 because at some point investors are going to balk at all of this debt issuance... and when they do they'll demand higher yields to buy US debt, driving bond prices down and interest rates up making long-term treasuries the next bubble to burst.

Mortgage giant Freddie Mac said on January 15th that rates on 30-year fixed-rate mortgages fell below 5% this week — the lowest level since it began surveying lenders in 1971.

2) The Fed will continue to bail out institutions like Fannie Mae, Freddie Mac, AIG, Citigroup, Bank of America, GM, Chrystler and others that are sure to fail in 2009 and will be eventually forced to stop the bailouts (at around 2 trillion, current estimates at $1.186 trillion) because the insurance industry’s capital and surplus cushions are eroding fast. There will be an unstoppable chain of bankruptcies. The Fed will also be forced to keep short-term interest rates near zero to try and pump up the economy, setting the stage for a massive re-inflation of virtually all assets (through a weaker dollar).

3) A rise in social unrest all over the world. This includes terrorism, and inevitable attacks on U.S. targets overseas and possibly at home. Don’t expect the Middle East story to go away.

4) Expect the economy to continue to slide, unemployment to soar (10%), corporate earnings to collapse —yet the stock market will surge, then fall in one powerful paradoxical rally after another. Be mindful that these rallies are short term. Use these surges to get out of all this crazy making until consumer confidence returns.

5) The real estate collapse will continue, not just in home markets, but spreading to commercial markets too. Increase unemployment will lead to increased delinquencies, credit will go down. Home equity loans are a thing of the past, REITs will dry up.

6) Real incomes are going to go down – deflation is the way forward and the cure to inflation.

What to expect outside the US?

Developing countries will have to make major changes to their export-only model. This means developing a viable domestic market. That means transferring economic and political power. Simply put: Developing countries lack domestic demand because the ruling powers refused to invest in their own people. Instead they focused solely on exporting and investing their surpluses abroad, as Paulson said. And that means a lot of social unrest could be in the cards in 2009. While developing economies are suffering, they are also dragging down emerging economies. Emerging stock markets declined more in 2008 than developing and will continue to be harder hit.

Consider:
• Emerging markets of all stripes have been cut-off from their funding sources.

• India, also heavily dependent on foreign demand for its goods, is suffering its worst export slump in recent memory. India is off 55%. Overseas shipments plunged 12.1% in October and another 9.9% in November.

• Russia's pure, energy-dependent economy is imploding and unrest is rising. The Russian government has devalued the ruble 11 times since November, and thrown a quarter of its foreign currency reserves at the raging debt crisis. Standard & Poor's has cut Russia's long-term debt rating for the first time in nine years. Russia's RTSI index has plummeted 75%.

• Ukraine is already teetering! They are hugely exposed to emerging markets in Eastern Europe and elsewhere.

•Portugal became the fourth country (after Spain, Greece and Ireland) in the eurozone in as many days to face a rating warning from Standard & Poor, citing high debt burden as a reason for their credit rating being at risk.

• Unrest in Greece

• Scandal in Italy on privatization of pensions and municipal bonds

• The Organization for Economic Co-operation and Development's index is pointing to a "deep slowdown" in the global economy, with Russia, China and Germany posting the sharpest declines. In Germany, November export figures tumbled more severely ... by 10.6% from the month prior.

• Europe's economy contracted at the fastest rate since the 1930s

• Everywhere from Australia to New Zealand and from Argentina to Mexico and even the once-rich Middle East, the worldwide debt crisis, the bust in commodities and the sharp slowdown in global trade are transforming massive booms into instant recessions. Already, Ecuador has defaulted on its bonds because of falling revenues as oil prices continue to tumble. Venezuela is quietly wooing large oil giants to come back and Brazil's Bovespa index is down about 45%.

• Japan has been slammed by its worst recession since World War II... The Japanese Manufacturing Purchasing Managers' Index has been below 50 for 10 straight months. For December, the index dropped to its lowest level in history to 30.8, down sharply from 36.7 in November.

• South Korea'sNational Statistical Office reported that industrial production dropped by 14.1% year-over-year in November, after falling 2.3% in October. That, too, is the biggest decline ever recorded.

• The Economic Development Board of Singapore said manufacturing output fell 7.5% in November from the previous year and warned that it expects the recession to last...

• Factories across China are closing, unemployment is soaring, and social tensions are rising. China's SSE Composite index has fallen 66%; imports, down 17.9% in November alone; foreign investments to China, off 36.5% from last year. The key thing to keep in mind about China is that manufacturing represents about 40% of the Chinese economy. So this manufacturing slowdown hurts them proportionately more than it does our consumer-based economy. Exports fell for a second consecutive month in December (the first time in the last decade) by 2.8%.

2009 Economic Forecast:

The market damage to the U.S. consumer is the biggest factor that's going to spread economic pain across the globe. Remember when inflation pervaded every money decision we ever made or thought about making, every retirement plan or business model? Remember when inflation was factored into our leases, our employment contracts, our budgets, our investment programs, even our staff wages?
Now, all of that is changing and it's doing so dramatically! Suddenly, the polar opposite of inflation is taking hold in America: Deflation!

Shell-shocked consumers are killing retailers: Nordstrom announced that third quarter earnings plunged, then slashed its forecast for the year by 25%. Third-quarter same-store sales dropped throughout the industry: Down 12% at Kohl's and Saks Fifth Avenue, and down 15% at Neiman Marcus. J.C. Penny reported that its profits fell for the fifth consecutive quarter and net income has fallen 53% from this time last year.

Greek shipping prepares to sail into economic storm The Greek shipping industry, the world's biggest merchant fleet, is bracing itself for combined effects of the economic crisis and a huge oversupply of ships. Shipping rates on dry cargo have plummeted more than 90% in a matter of months. International Herald Tribune/Reuters (19 Nov.)

Berkshire shares see largest drop in more than 2 decades Berkshire Hathaway, the company headed by iconic Warren Buffett, saw its stock price plunge 12%, its biggest drop in at least 23 years. It was the eighth consecutive daily decline after Berkshire reported a 77% decline in third-quarter profit. An investment adviser said there is nothing wrong fundamentally with Berkshire, but some investors see the company as a proxy for the economy as a whole. Bloomberg (19 Nov.)

Here's what we can expect for the majority of 2009:
· Stocks will hit lower lows
· Emerging nations will weaken dramatically, and
· Risk-aversion will win the battle over risk-taking

Libor drops, but private lending remains paralyzed The Federal Reserve and other central banks managed to drive down interest rates on short-term lending, but that is not bringing private money back into commercial-paper and money-market lending. Instead, private financial institutions are struggling to bolster their balance sheets and reduce leverage, effectively turning central banks into "lenders of sole resort." Financial Times (12 Nov.)

U.S. foreclosures up 25% in October over last year U.S. foreclosure filings increased 25% in October compared with the same month last year, indicating a slowing of foreclosure activity. But RealtyTrac CEO James Saccacio said the number understates the severity of the problem. The net effect "may be merely delaying inevitable foreclosures," he said. Bloomberg (13 Nov.)

Foreclosures still exploding: RealtyTrac reported that foreclosures soared 25% in October. By the end of 2008, more than one million bank-owned properties will be crushing real estate values nationwide.

U.S. unemployment reaches 25-year high The number of workers claiming unemployment benefits hit a record high this month. Last week, new claims saw a spike of 32,000, the highest since the Sept. 11, 2001, terrorist attacks. Individuals receiving aid hit 3.9 million during the week that ended Nov. 1, the most since 1983. Reuters (13 Nov.)

Unemployment skyrocketing: The Labor Department reported that jobless claims soared to 516,000 last week, 52% higher than this time last year ... about the same as they were the week after 9/11 ... and more than at any other time in 19 long years.

Default risk rises for synthetic CDOs Analysts said $103 billion of synthetic collateralized debt obligations are vulnerable to catastrophic losses, based on defaults involving underlying derivatives. Defaults by Lehman Brothers and other institutions already touched off $24 billion in synthetic CDO losses. JPMorgan Chase said there is about $757 billion of synthetic CDOs outstanding that are tied solely to corporate-debt derivatives. Financial Times (13 Nov.)

Developed economies fear deflation to come Rich countries are worried that deflation, likely to take hold in earnest next year, could accelerate into a 1930s-type spiral. They fear that convergence of high leverage and falling prices could launch "debt-deflation," in which accelerated debt repayment dries up demand, leading to price cuts. That in turn drives up the real cost of debt, spurring further repayment. The Economist (13 Nov.)

The G20 is comprised of the world's major developed and emerging economies: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, United Kingdom, and the U.S.

In a statement issued after the meeting, the G20 said,
"Against this background of deteriorating economic conditions worldwide, we agreed that a broader policy response is needed, based on closer macroeconomic cooperation, to restore growth, avoid negative spillovers and support emerging market economies and developing countries."

Financial crisis forces Paulson to change his tune When Henry Paulson arrived in Washington, he was one of the most successful bankers on Wall Street and highly skeptical of government intervention in markets. Now, as Treasury secretary, Paulson has changed his stance and is dealing with the global financial crisis through a series of substantial federal intrusions, urging politicians and bankers to participate. "My thinking has evolved a lot to the point where I've seen regulation up close and personal," Paulson said. "I've realized how flawed it is and how imperfect but how necessary it is." The Washington Post (18 Nov.)

The good news and the harsh reality is that the economy is cyclical. Busts follow booms. They have for hundreds of years and they always will. But even though busts are healthy over the longer term, they're painful in the short-term. This is where we are today, painful as it is, and the fork in the road ahead is between:
a) deflation and depression or
b) hyperinflation and destruction of our currency

We are in deflation now, but the government-fueled inflation wave is sure to follow, tsunami anyone, but right now:

Pure fear chases investors to U.S. dollarDespite a runaway deficit and an economy slipping into recession, investors still turn to the U.S. dollar as a safe haven, possibly aware of the fact that at the end of most U.S. recessions, the dollar is worth more than it was at the beginning. The dollar has been rising against other currencies for some time, and economists think the trend may continue. Spiegel Online (27 Nov.)

Therefore, the mighty U.S. dollar's bull run is far from almost over.

Cash becomes king as financial crisis spreads What started as a subprime-mortgage meltdown has evolved into a global financial crisis that is forcing companies of all shapes and sizes to cut their work forces. Businesses are seeking a resolution to their problems, and the most attractive fix appears to be cash. Those with cash may not only survive the economic downturn but could also thrive, if they are able to use that cash wisely. The Economist (20 Nov.)

The deflation road is extremely arduous, but ultimately leads to recovery. The hyperinflation road can provide a temporary palliative, but it ultimately leads to the destruction of our society and culture.

Rising U.S. dollar triggers emerging-market inflation A soaring value of the U.S. dollar on currency markets is ratcheting up inflationary pressures and depressing foreign investment in emerging markets. The chief currency strategist at the Bank of New York Mellon proposed creating "an unbiased party" to develop benchmarks for evaluating currencies and forming regulations for managing them. If nothing is done about the volatility of currency values, he said, emerging markets may end up getting hit harder than major markets. FinancialWeek (15 Nov.)

China replaces Japan as biggest U.S. debt holder After years of accelerating purchases of U.S. debt, China has taken over Japan's spot as the biggest foreign holder of Treasury bills, notes and bonds. China's investment in U.S. debt rose from $541.4 billion in August to $585 billion in September, while Japan's holdings declined from $586 billion to $573.2 billion. Meanwhile, U.S. investors sold a record $38 billion in foreign bonds. Financial Times (18 Nov.)

If you owe the bank $10,000, you’re in trouble. But if you owe the bank $1 TRILLION, the BANK is in trouble!

Hedge funds see trouble for 5th consecutive month The Eurekahedge Fund Index marked a 4.5% drop last month, with investors pulling $62.7 billion from the $1.65 trillion hedge-fund industry. Citigroup expects the figure to fall to about $1 trillion by the middle of 2009. Bloomberg (19 Nov.)

The next major bank to fail could be Citigroup, the nation's largest. In addition to its other debts, its 185.1 million in credit card accounts globally are especially worrisome as default rates skyrocket.

“The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance." Cicero , 55 BC

Fed announces facility to boost consumer lending The Federal Reserve announced the establishment of a facility aimed at helping consumers and small businesses with credit needs. Under the Term Asset-Backed Securities Loan Facility, the Federal Reserve Bank of New York will lend as much as $200 billion to holders of specific AAA-rated, asset-backed securities that are collateralized by small-business, credit-card, student and auto loans. The Fed also announced a program through which it will purchase direct obligations of Fannie Mae, Freddie Mac and Federal Home Loan Banks, as well as mortgage-backed securities guaranteed by Fannie, Freddie and Ginnie Mae. Bloomberg (25 Nov.) , Reuters (25 Nov.)

Analysis: Fed action may be easing of unwanted credit: The Federal Reserve's $800 billion program to loosen up the flow of credit to consumers could end up having little or no impact on the economy because consumers are increasingly afraid to borrow money that they might not be able to pay back, and banks do not want to make loans that will not be repaid. Economist Michael Darda described the Fed's effort to revive consumer spending through the purchase of consumer debt from banks as "spitting in the wind." Bloomberg (26 Nov.)

U.S. economic data raise probability of deeper recession In the third quarter, the U.S. economy shrank at its quickest pace in seven years as consumer spending hit a 28-year low, according to recent data. U.S. home prices continued to fall, and corporate profits fell for a second consecutive quarter. "We are in the early stages of one of the worst recessions in the postwar period, even factoring in a massive stimulus program," said Nariman Behravesh, chief economist at IHS Global Insight. Reuters (25 Nov.)

1)Already the Fed has pledged $7.2 trillion of your money. Bloomberg News and The New York Times reports that the U.S. government is prepared to lend more than $7.4 trillion.
·$200 billion to nationalize the world's two largest mortgage companies, Fannie Mae and Freddie Mac;
·$25 billion for the Big Three auto manufacturers;
·$29 billion for Bear Stearns;
·$150 billion for AIG;
·$350 billion for Citigroup;
·$300 billion for the Federal Housing Administration rescue bill to refinance bad mortgages;
·$87 billion to pay back JPMorgan Chase for bad Lehman Brothers trades;
·$200 billion in loans to banks under the Fed's Reserve Term Auction Facility (TAF);
·$50 billion to support short-term corporate IOUs held by money market mutual funds;
·$500 billion to rescue various credit markets;
·$620 billion for industrial nations, including the Bank of Canada, Bank of England, Bank of Japan, National Bank of Denmark, European Central Bank, Bank of Norway, Reserve Bank of Australia, Bank of Sweden, and Swiss National Bank;
·$120 billion in aid for emerging markets, including the central banks of Brazil, Mexico, South Korea and Singapore;
·Trillions to guarantee the FDIC's new, expanded bank deposit insurance coverage from $100,000 to $250,000; plus ...
·More trillions for other sweeping guarantees.

How much is that?

·That's half the yearly output of the entire U.S. economy.
·It's equal to $25,507 for every single man, woman, and child in the United States.
·In the more than 200 years the U.S. has been a nation, it has racked up almost $10.7trillion in public debt. Now, in just a few months, policymakers have added contingent and direct obligations equal to almost three-fourths of that amount.

How the heck we were going to pay for this stuff?

The truth is the U.S. government is going to have to flood the market with a wave of Treasuries the likes of which the world has never seen. And just like any other market, the bond market reacts to supply and demand.

Already the government has spent $4.3 trillion bailing out Wall Street. According to CNBC, as of last week, the Federal government had already spent but not necessarily distrubuted $4.3 trillion in bailouts, from $900 billion for the Term Auction Facility ... to $112 billion bailing out AIG ... to $540 billion backing up Money Market funds ... to $700 billion for the Treasury Asset Relief Program (TARP), and more.

$4.3 trillion — that's more than America spent on World War II, adjusted for inflation.

The overall, long-term impact of what the bailout will ultimately cost should be very negative for the U.S. dollar, but because of the fear factor, that’s not happening ... and when inflation returns along side consumer confidence that should be very bullish for gold.

Yet, meanwhile the economic news continues to sour:

U.S. has been in recession almost a year, economists say The National Bureau of Economic Research confirmed that the U.S. economy officially slid into a recession nearly 12 months ago. "We will rewrite the record book on length for this recession," said Allen Sinai, president of Decision Economics in Lexington, Mass. "It's still arguable whether it will set a new record on depth. I hope not, but we don't know." Both Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson pledged to revive the economy using all of the tools in their arsenal. ClipSyndicate/Bloomberg (02 Dec.) , International Herald Tribune (02 Dec.) , Financial Times (01 Dec.)

Cost of protecting debt against default hits record high Concerns about a recession and the world economy sent the cost of protecting bonds from default to an all-time high this week. Weakening manufacturing figures throughout Europe, the U.K., China and the U.S., as well as slumping equity markets, have hit credit default swaps. The iTraxx Crossover index reached a record high of 934 basis points. Financial Times (01 Dec.)

Capital injections won't help lending, panel chief says Elizabeth Warren, chairwoman of an oversight panel created by Congress to evaluate the Troubled Asset Relief Program, said pouring capital into banks is not going to get credit markets moving again. She said banks do not want to loan because potential borrowers are becoming less creditworthy day by day, and injecting cash into banks "isn't going to fix that problem." The New York Times (01 Dec.)

Yields of U.S. long-term debt plunge to record lows Plummeting capital markets touched off a rush to safety by investors and drove U.S. government long-term debt yields to record lows. Yields on 30-year and 10-year bonds fell to the lowest levels since the Treasury started selling them. BusinessWeek/The Associated Press (01 Dec.)

Let's apply this market dynamic to lessons learned from a Golden perspecitve...

This five-year chart shows the comparative performance of gold, the CRB index, which tracks a broad basket of commodities, the S&P 500, the Dow Jones Industrial Average and the U.S. dollar. Over a five-year period, gold has doubled. At the same time, the rest of these investments are down.

On October 10, in inflation-adjusted, honest money terms, the Dow hit about 2,550.
When you start looking at asset values in both nominal and real terms as reflected by the price of gold — only then will you truly understand what's happening today.

You are witnessing the greatest redistribution of wealth in the history of civilization — from savers to debtors ... from creditors to borrowers.
Gold will eventually triumph, ultimately and eventually from systemic currency devaluations related to inflation. And your best chance of financially surviving this economic crisis is to understand how it's going to impact your investments and why it's going to happen, (and I hope I am doing my part).

Hello, the economy just lost a half-million more jobs and retail sales have just suffered their worst plunge in 35 years. However, one all-important investment that has not only survived, but actually thrived is the United States dollar. Currently, because of deflation, prices are falling on virtually everything —commodities, farm land, homes, automobiles, consumer goods, even labor. And because of fear, investors are going to shy away from risk (credit), seeking the safety of cash. Result: The dollar's purchasing power and value will continue to go up.

Recognize that the U.S. government alone has embarked on the most expensive financial rescue operations of all time. The U.S. government alone has spent, lent, committed or guaranteed $7.8 trillion, fourteen times its biggest-ever federal deficit. European governments too have jumped in with another $2 trillion; China, $586 billion. Can you see where this is going?

They're bailing out bankrupt banks, broken brokerage firms, insolvent insurers and any company they deem essential to the economy. Aready the grand total of $7.8 trillion and counting is eleven times more than the hotly debated and widely opposed $700 billion bailout package passed just 4 months ago. And that excludes a new bailout for Detroit, and a new $500 billion stimulus package expected early next year from Obama’s administration, plus hundreds of billions for at least 19 states running out of money for unemployment benefits.

At this time because of fear, the U.S. dollar, in short-term Treasury securities, is now your single best safe haven for your money, even at zero interest because a bird in the hand is worth two in the bush (no pun intended).

Flight to safety pushes yield of T-bills below zero The implied yield on three-month U.S. Treasury bills swung briefly to negative 0.01% on Tuesday, with buyers essentially paying the Treasury for holding its debt. This marked the first time since 1940 that the yield on three-month bills went negative. A Morgan Stanley economist said the demand for cash was "extreme" and described the resulting negative interest rate as "absurd." International Herald Tribune (10 Dec.)

Fed expected to cut interest rate to almost zero The Federal Reserve is anticipated to take the benchmark federal-funds rate down to 0.5% at its meeting Tuesday, marking the lowest figure for the bellwether rate since the central bank began keeping records in 1954. Having exhausted almost all opportunities for interest-rate cuts, the Fed is expected to search for other tools to cope with the steepening economic downturn. Reuters (14 Dec.)

Due to today’s deflation, the dollar's purchasing power is improving rapidly with each day. Due to a global flight to quality, the dollar's exchange rate is rising sharply against nearly every currency in the world. And due to the massive deflation and capital flight still ahead, the bull market in the dollar is just beginning!
The government-inspired rally on Wall Street is your signal for this phenomenon. All your assets are going to deflate and it's now time to sell if you have a short term investment horizon (5 years or less).

A Year Later and Deeper in Debt: Just over one-year since the credit crunch began, American taxpayers are now on the hook for an estimated $8 TRILLION in total spending and "commitments" by the government in its desperate attempt to prevent a total meltdown of the financial system — yet stocks continue to tumble, banks refuse to lend, and the economy keeps sinking!

By and large, the stock market selloff that we have witnessed so far has been mainly due to investor concerns over housing and the Wall Street financial crisis — but not the result of any recognition that Main Street America could be in store for a deep and painful recession too. If anything, recent data tells us that our current economic slump is only accelerating.

Chief financial officers gloomy about next year: Among the world's chief financial officers, those in the U.S. hold the darkest views of the economy for 2009, with pessimists outnumbering optimists 9-to-1, according to a survey by CFO Europe magazine. European officers were found to be only slightly more optimistic. Financial Times (09 Dec.)

Professor: House prices could drop below prebubble level Martin Feldstein, an economics professor at Harvard University, said housing prices still have to drop 10% to 15% to reach the prebubble level, but he warned that they could get a lot worse before things get better. It is the fear that prices could "overshoot" and continue falling that makes banks and other financial institutions afraid to lend to one another, he said. Bloomberg (09 Dec.)

You may ask again, why?

Because the U.S., the European Union and Japan — which together consumed 48% of the world's oil in 2007 — are in the first simultaneous recession since World War II.

One out of ten households is already delinquent or foreclosed on their mortgage.

Four out of ten families owe more than their homes are worth. Foreclosure rates are now at their highest levels in recorded history.

Commercial vacancy rates are skyrocketing.

And here's the clincher: The impact of surging unemployment is just BEGINNING to kick in.

Just one of these signals would be enough to raise alarm bells. All three coming together spell one, five-letter word for real estate stocks: CRASH!

U.S. government on pace to post record $1 trillion deficit The U.S. deficit could reach a record $1 trillion this budget year. The projection comes after the federal government hit an all-time-high deficit in November. The figure for the fiscal year that started Oct. 1 could also be a record high in terms of percentage of the economy in the post-World War II era. BusinessWeek/The Associated Press (10 Dec.)

China's trade volume marks stunning drop An analyst described China's plummeting trade figures -- down 2.2% down in November from a year ago -- and imports -- a 17.9% decrease -- as "a shock." Consequences for the rest of the world could be quite grave because China has been for some time the engine driving the economy. The Economist (10 Dec.)

U.S. House modifies pension rules to cope with downturn The U.S. House of Representatives placed a moratorium on the deadline for retirees withdrawing funds from 401(k) plans and eased requirements for companies fully funding pensions. Both measures were intended to prevent undue hardship for retirees and employers caused by falling asset values. The Washington Post (11 Dec.)

Well, the Treasury Department recently sold $30 billion worth of four-week bills. And like any debt instrument, T-bills usually pay interest. So you're guaranteed some kind of return if you hold them to maturity.But these bills? They were sold at a 0% yield.

The government racked up $455 billion in red ink in the fiscal year that ended September 30, 2008. And recently, we learned that the 2009 deficit is ALREADY at $401.6 billion — just two months into the new fiscal year!

At this rate that's another potential $6,539 of debt for each and every person in this country — in just one year on top of the already $25,507 for every person from the 7.4 trillion in recent bailouts.

And government really has no idea on how much it will take to restore confidence. Remember in September when Secretary Paulson literally drops to his knees begging Congress for a $700 billion rescue package ... and just six weeks later his entire plan is washed away by events, even if it had been quickly distributed, which it hasn’t. In this month alone, Chairman Bernanke, dropped interest rates to virtually zero, Wall Street rejoiced with a grand rally ... and, just 48 hours later, the entire rally is gone. President Bush bequeathed $17.4 billion to Detroit, and the Dow surged ... and just seven hours later the entire rally is gone AGAIN, every point wiped out. Meanwhile, auto sales, retail sales and technology sales are collapsing globally. Factories are being shut down. Entire nations are sinking into a black hole.

Listen to what, Karthik Ramanathan, the acting assistant secretary for financial markets at the Treasury, said this month:

"Recent market estimates have suggested $1.5 trillion in net marketable borrowing in fiscal year 2009, with some raising the possibility of net marketable borrowing in excess of $2 trillion. While this uncertainty remains, it is our responsibility as debt managers to act as transparently as possible meet these borrowing needs in the least disruptive manner."

They have no idea, and then there is the question of oversight, is that an oxymoron?

Madoff case raises questions about effectiveness of SEC
The Securities and Exchange Commission and the U.S. Department of Justice launched lawsuits against Bernard Madoff, investment manager of Bernard L. Madoff Investment Securities, for allegedly running a $50 billion "Ponzi scheme." Madoff's arrest is raising questions about the SEC's oversight abilities. Observers said the SEC needs to review businesses that it oversees more frequently. MarketWatch (15 Dec.)

It’s hitting home and yes the Federal Reserve knows it, they reported that, in the third quarter alone, American households have suffered ...
$647 billion in real estate losses
$922 billion in stock market losses
$523 billion mutual funds losses
$128 billion private business losses, plus
$653 billion losses in life insurance and pension fund reserves!

That's a $2.8 TRILLION in wealth loss overall — four times more than the Treasury's entire $700-billion bailout program in just one quarter.

Finding these numbers too large to believe?

Will the trillions MORE that Washington throws at this crisis bring inflation back? The short answer is yes, (long-term), however, meanwhile this deflation will continue to be so massive that no amount of Fed funny money stands a chance of preventing it.

Despite the government's Herculean efforts, the bottom line is that DEFLATION is happening right here, right now, right before our very eyes...

Expert: Economy lucky if it reaches bottom in 2009 Damage suffered by the world's economy this year was so enormous and widespread that the most that central banks and governments can hope for is to stop things from getting worse and start building the foundation for a comeback in 2010, experts said. "We will be very lucky if we reach the bottom in 2009," Harvard University professor Martin Feldstein said. Bloomberg (15 Dec.)

Do you see what is going on? The destruction of wealth is so large and swift; the government rescues, are relatively so small and slow.
More evidence of deflation:

1.U.S. consumer prices falling at an annual rate of 12%, CPI report revealed consumer prices plunged by a bone-chilling 1.7% in November alone. If it continued at that pace for a year, it would be a 20% deflation — fully twice the plunge in consumer prices we were seen during The Great Depression nearly 80 years ago! Suddenly prices are plummeting — not just for real estate, but also for automobiles, appliances, clothing and gasoline, while retailers and others are stepping up their discounting to move goods and sell services.. The CPI has fallen by the most since the government first introduced this index in 1946.

2.U.S. producer prices, the best future predictor of consumer prices, are falling at an annual rate of 26.4%

3.Commodity prices slammed by as much as 70% from their peak! The price of oil has plunged 73% ... copper has fallen 66% ... lead and nickel are down 73% ... platinum is down 66% ... and wheat is off 64%.

4.Core consumer prices, which exclude volatile food and energy prices, were unchanged in November. In the past three months, they have risen at an annual rate of just 0.4%.

5.A devastating plunge in GDP that has taken place just now in the fourth quarter, estimated at an annual rate of minus 8% or worse.

Yet despite this widespread acknowledgement, government and nearly every authority still tries to persuade you to keep your money in the stock market.

Financial experts on NBC Nightly News tell millions of viewers that, as long as they've got plenty of years to live and recoup losses, they should continue investing most of their 401k or IRA in stocks. In Time Magazine, the New York Times, the Wall Street Journal and virtually every newspaper in the country, similar advice is liberally dispensed.

We are obviously living in risky times. So why would you want to double the whammy by putting your money in obviously risky investments? Yes, I know, your broker, your financial planner — even some of your best friends — are telling you to stay in the market and over time, they are right; but are they right - right now?

If they fooled you once, shame on them. If they fool you again, shame on you!
If ever there was a time when stock market investing is too risky, this is it. Wait for consumer confidence to show some life.

Yields of long-term Treasuries hover near record lows Longer-dated U.S. Treasuries came close to hitting record-low yields Tuesday, after data from the Consumer Price Index showed that the rate of inflation is plummeting. Yields on 10-year Treasury debt briefly slid to 2.47%, setting a 50-year record. FinancialWeek/Reuters (16 Dec.)

Sixteen months into the official recession and the Fed's efforts have so far failed, despite cutting interest rates more than five percentage points. In yet another example of the deepening recession, the Commerce Department said new home building dropped 19% in November, another record monthly low.

"The Fed gets an 'A' or 'A-minus' for effort and not very good marks for results," said Alan Blinder, a Princeton economist and former Fed vice chairman. Clearly, we got into this mess because everyone — from banks to companies to consumers — have too MUCH debt and are now scared to death, cancelling purchases, hoarding dollars like there’s no tomorrow.

Here’s the key: The cheap money the Fed is providing can buy some things. But it cannot buy CONFIDENCE!

Commentary: U.S., Japan use same solutions for different issues
The U.S. has an account deficit and high debt, while Japan has an account surplus and low debt. Yet the biggest and second-biggest economies in the world are converging toward zero-interest rates and quantitative easing as foundations for their recoveries. Economists warned that there is no assurance that either the U.S. or Japan will succeed. FinanceAsia.com (19 Dec.)

Isn't the Fed submitting prudent savers to total abuse by slashing the returns they can earn on their savings accounts and Treasuries?

What about the hundreds of billions of dollars of additional debt our country is taking on? The first trillion-dollar deficit in U.S. history?

What if the economy and asset prices are going to get where they're headed ... no matter what the government does? Do you think Japan’s policy has worked? I think not. The steps that Japan took included about $1.35 trillion at today's dollar-yen exchange rate. And yet, it was all for nothing. The economy still suffered a "Lost Decade" of deflation and lackluster growth.

What if we spend all this money and end up with nothing to show for it — except for a multi-trillion dollar bill that we'll be paying for the rest of our lives? Or as the CFA Journal explained:

"Keynesian 'pump-priming' in a recession has often been tried, and as an economic stimulus it is overrated. The money that the government spends has to come from somewhere, which means from the private economy in higher taxes or borrowing.”Just this month, we saw oil prices crack below $35 per barrel — down more than 75% since August and proof positive that this deflationary spiral is growing more intense.

And also this month, we saw the U.S. dollar take off like a rocket to the moon — blasting higher against the euro, the pound, and virtually every other currency on the planet.

The dollar will climb sharply through most, if not all, of 2009. Why?

1.Deflationary forces impacting the global economy appear too strong to be counteracted by Fed policy in any reasonable amount of time. In other words, the stimulus isn't going to bring back a recognizable boom. The recovery process will take some serious time.

2.The global economy is shifting quickly, and the rest of the world is lagging the U.S. downturn. When stabilization of financial markets and the U.S. economy does finally occur, there's a good chance the U.S. will be looked upon more favorably than many other comparable players in the global economy.

3.Even the government's slow-to-change, lagging index of inflation — the CPI — has caved in to deflation, And there are plenty of other reasons why:

·Unemployment is rising...

·The credit crunch has made it almost impossible to qualify for loans...

·IRAs and 401(k)s have been chopped in half... if not more...

·And real estate continues to get clobbered on all fronts. New home sales dropped 2.9% in November. That was the worst sales rate since January 1991, and down more than 35% from a year earlier. Existing home sales plunged 8.6% for the month, with single family sales hitting the lowest level in more than 11 years. While dramatic cutbacks in housing starts have led to a decline in the raw number of new homes on the market, sales have dropped so much that we're seeing little net progress overall. Case in point: There were 11.5 months worth of new homes on the market based on the November sales pace. That was only slightly below October's 11.8 months, which itself was the worst reading ever (Census data goes back to 1963).
On the existing side, we have more than 4.2 million homes on the market — far above the 2 million to 2.5 million considered normal. That's good for 11.2 months of over supply.

As far as pricing is concerned, you won't find any comfort in the latest figures either. New home prices were down 11.5% from a year earlier, the second-biggest decline ever. Existing home prices dropped 13.2%, the most on record. The median price of a used home is now hovering around $181,300, meaning we have wiped out every penny of gains generated since February 2004.

Until fundamental equilibrium is restored in the housing market — until we work through the vast inventory of houses — home prices aren't going to stop falling.

In fact, expect further declines throughout 2009.

The next shoe to drop:

·With credit tighter, commercial real estate sales and prices are now following home prices lower. The final numbers haven't been added up yet. But it appears that commercial sales plunged by about 70% between 2007 and 2008.

·Meanwhile, the Moody's/REAL Commercial Property Price Index dropped 2.4% in October, the tenth month out of the last 14 where it declined. Prices are now down more than 11% from their late 2007 peak. National Association of Realtors just forecast that office vacancy rates will rise to 16.4% by late 2009, from 12.5% in 2007, while retail rents will drop by 7.3%.

Another problem: according to research firm Foresight Analytics LCC, “$530 billion of commercial mortgages will be coming due for refinancing in the next three years — with about $160 billion maturing in the next year. Credit, meanwhile, is practically nonexistent and cash flows from commercial property are siphoning off."

But the lesson from the residential industry is that all these bailouts merely ease the symptoms of this crisis somewhat, without curing the underlying problem.
Expect commercial real estate fundamentals to weaken in 2009, loan defaults and foreclosures to climb, and prices to fall - no matter what Bernanke & Co. do in Washington.

AIG may have trouble repaying taxpayers for bailout American International Group is getting about a third less from the auction of Hartford Steam Boiler than it paid for the insurer eight years ago, raising doubts about whether AIG can come up with the money to pay back its rescue loan from the U.S. government. If the sale accurately represents how the market is valuing AIG assets, "it's bad news for the American taxpayer," said an analyst at Fox-Pitt Kelton Cochran Caronia Waller. Bloomberg (23 Dec.)

Number of U.S. homes sold posts biggest drop in 20 years U.S. prices on resale of houses plummeted 13% in November, the biggest decline since records were first kept in 1968. The National Association of Realtors said it is probably the biggest drop since the 1930s. Marking the largest decline since 1989, the number of sales for single-family houses fell 7.6% from October. Bloomberg (23 Dec.)

For 2008, loan volumes plunge 44% while bonds lose 27% Loan and bond volumes dropped in 2008 to lows last seen at the height of the dot-com bust in 2000. Dealogic figures show that syndicated loan volumes dropped 44%, while bond volumes slid 29%. During the past year, U.S. banks went through significant changes, including bankruptcy, rescues and mergers. The year also included establishment of government-guaranteed bank debt, an asset class that has had significant impact on markets. Financial Times (22 Dec.)

Analyst expects record for underfunded U.S. pensions Standard & Poor's analyst Howard Silverblatt projected an all-time record for underfunding of U.S. pensions for 2008, totaling about $257 billion. He said stock-market losses devastated portfolios, and any pension-fund manager "who came remotely close to breaking even" is quietly celebrating survival in one of the worst markets in modern times. FinancialWeek/Reuters (23 Dec.)

Please, I'm not pointing this out to sound like Mr. Grinch. It's just that retail sales represent two-thirds of U.S. gross domestic product (GDP). So investors should be very worried that this retail and commercial real estate weakness is going to push our economy into an even deeper recession

The Good News?

I hate to leave you on such a gloomy note, what with New Year's festivities right around the corner. So let me wrap up with this: Falling asset prices will eventually restore TRUE, intrinsic value to real estate. Education and food will be more affordable.

This decline will get home prices back to levels that make sense when compared against incomes and rents. It will make it so home buyers can purchase affordable homes at reasonable debt-to-income ratios, using traditional 30-year mortgages instead of all the junk loans. The U.S. economy and financial system has begun a noticeable period of cleansing: Stocks, real estate, and many commodities are getting pounded into the ground. Therefore, you can chock up at least a small victory to the market process.

The Federal Reserve, the Treasury, and our politicians don't seem to share these sentiments. Rather they favor reckless bailouts, out-of-control stimulus packages, and unabated aid. Nevertheless, there's a tight correlation between currencies and stocks: As risk ebbs and flows, the buying of U.S. dollars ebbs and flows ... in an opposite direction. And the flight to safety combined with a deflationary environment should lead to a short-term bull market for the U.S. dollar.

Beyond 2009, the U.S. economy may show signs of a recovery. Whereas competing, developed nations will continue to wallow after a much longer monetary and fiscal response time from their governments. This growth differential could very easily be another short-term shift in favor of the U.S. dollar and spell bad news for the euro. However, having said that, beware of the relationship between peak oil (2004) and the credit bubble that has ensued. Don’t be caught picking up starfish (Treasury Bills) on the ebb without a full awareness of the tsunami effect, for the massive inflation wave is building off shore and wouldn’t that be good news for the credit imbalance or trade deficit with China? Have a HAPPY Golden NEW YEAR!