Global growth: American exceptionalism

American exceptionalism

Jul 1st 2011, 17:41 by R.A. | WASHINGTON; Courtesy, The Economist

AMERICA’S economic prospects seem to be improving, but it’s very nearly alone in that respect. The latest data from purchasing managers’ indexes around the world provide a snapshot of a global slowdown. While American manufacturing activity grew at a faster pace in June relative to May, most countries saw slowdowns and a few dipped back into contractionary territory. (See this useful interactive at Real Time Economics for an easy comparison.)

Slowing growth in China has grabbed attention, given recent headlines about debt loads and unrest there. China’s PMI dipped from 52 to 50.9, barely in expansionary territory, in June. That’s not entirely a bad thing, however. Chinese inflation has been running uncomfortably high, and the government has been working to slow the economy’s growth. The story is the same in India, where activity also slowed, and in Brazil, where production actually fell in June.

As the chart at right indicates, the Indian and Brazilian economies have been running especially hot. (You can see an interactive chart of the factors that make-up the index here.) Depending on the pace of the slowdown over the next few months, there are sure to be worries about hard landings. Emerging market governments have little choice but to combat destabilising inflation.

The good news for the rich world is that slowing emerging market growth will keep commodity prices. That, in turn, will dampen inflationary pressures and free central banks to respond more appropriately to domestic economic conditions. In Europe, those conditions are weak and getting weaker. Manufacturing activity for the euro zone decelerated sharply in June. The big core economies, Germany and France, weren’t spared. But matters are worse around the periphery.

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Emerging Markets in the New World Disorder

By Chris Mayer
Baltimore, Maryland

In horse racing, a match race is when two horses race against each other. One of the most famous such races happened at Pimlico, when Seabiscuit beat War Admiral in November 1938.

In markets, one of the most watched and ongoing match races is the one between Emerging (or developing) Markets and Developed Markets. The former include China, India, Brazil and others. The latter include the US, the EU and Japan. Which one do we bet on and when?

It’s a particularly good question now, as we pick through the smoldering ashes of the 2008 bust. Emerging markets have had a hot 10- year run, even if you include the crackup in 2008. In fact, even if you had invested in the MSCI Emerging Markets ETF (NYSE: EEM) on Jan. 1, 2008, you would be sitting on a profit today. By contrast, the S&P 500 Index has delivered a double-digit loss over the same timeframe.

The emerging markets have snapped back surprisingly quickly. As Jonathan Anderson, a UBS strategist put it, “Not even the worst economic crisis in the postwar era has been able to derail [them].” In financial markets, ideas, like thoroughbreds, run hot and cold. Past performance doesn’t necessarily decide the issue any more than it does in horse racing. But it turns out there is a pretty reliable way to handicap the race between Emerging and Developed Markets.

The “handicapper” in this case is the aforementioned Mr. Anderson, who wrote about his findings in the Far Eastern Economic Review. His title, “Emerging Markets Poised to Perform,” hints at his conclusion.

It all comes down to those old financial constructs called balance sheets. In essence, a balance sheet shows you what you own versus what you owe. These are snapshots in time, a measure of financial health, like an EKG of one’s heart rate. You can often spot trouble here before it becomes fatal.

In my investment services, I always seek out companies with strong balance sheets – the sorts of companies that own much, but owe little. Enterprises like theses have the ability to withstand adversity better than those with weak balance sheets. A strong balance sheet also means that a company can fund its growth independently and more securely, without having to rely on fickle lenders.

As investing star, Martin Whitman, wrote in his most recent shareholder letter: “Don’t invest in the common stocks of companies which need relatively continual access to capital markets, especially credit markets… Even the strongest, best-quality issuers can be brought down, or almost brought down, if they continually have to refinance.” Unfortunately, many investors learned this lesson the hard way during last year’s severe credit crisis.

As it turns out, balance sheet strength is also very important for entire nations. But that’s hardly a surprise. Countries that owe a lot of money tend not to grow as much or as reliably as those with healthy balance sheets. Anderson created a “stress index” to measure the financial health of entire nations. A country with high debt levels and deficits earns a high stress index score. He then plotted this index (inverted) against a rolling average of GDP growth, a rough measure of economic growth.

Guess what? There’s a close connection between the two.

So one way to explain the growth of emerging markets is to consider the strength of their balance sheets. When they have healthy balance sheets, they grow faster than when they have weak balance sheets.

You can see that the last time the emerging markets had a long stretch in the sun was in the 1960s and 1970s. Emerging markets grew 5% or better. As Anderson notes, not a single emerging market – not Africa, not even the Soviet Bloc – failed to post 5% annual growth during this time. And you’ll also note that the balance sheets were healthy.

As a result, emerging markets sailed through the first global oil shock in 1973-75 without much trouble. The developed world, by contrast, suffered the pain of a deep recession. Investors who stuck with their emerging market stocks throughout this period reaped big rewards.

According to Anderson, “Between 1965-1980 the dollar-adjusted return on nascent equity markets in Mexico, Hong Kong, Taiwan, Brazil, South Africa and other lower-income nations ran into the hundreds of percent – while indexes in the US and Europe were essentially flat over the same 15-year period.”

Of course, as I say, these things run hot and cold. The emerging markets “imploded” after the 1980-82 recession. A dozen different countries reported inflation rates north of 100%. As Anderson points out, 20 currencies lost 50% of their value each year. From 1980-99, emerging markets struggled mightily and barely grew. And as you see from the chart, their balance sheets went south as well.

Emerging Market returns during this period were poor overall. A dollar invested in emerging markets in 1990 was still worth only about a dollar 10 years later. In 2000, though, the game changed again. Emerging markets opened up. They cleaned up their debts. And the emerging markets went on a tear that continues today.

In general, emerging markets still have healthy balance sheets today. In fact, they are as strong as they’ve been in 50 years. At some point, that will swing the other way, as these things always do. At some point, there will be too much debt and too much leverage. But for now, that condition seems a ways off.

As Anderson concludes, “All the preconditions are in place for a protracted period of strong economic growth.” He guesses 5-6%, which would crush the Developed World’s growth rates. In fact, the superior (and diverging) growth rates of the Emerging economies are already very visible.

First up, take a look this graph, from The Economist, which shows the industrial production of emerging Asia compared to the United States.

Looks like Asia is recovering pretty well. The chart above clearly illustrates the “decoupling” that became such a hot topic of discussion last year. The idea was that the Emerging markets would not necessarily follow lockstep with the Western countries.

The Developed World suffers through what Richard Koo, the chief economist at Nomura Research in Tokyo, calls a “balance sheet recession.” The Western world suffers from too much debt. That fact shifts the focus from making profits to repaying debt, according to Koo. Debt repayment will continue until the West repairs its balance sheets, a process that takes years to correct, as Japan’s long recession shows.

So the same dynamics that make emerging markets look good, work in reverse for the Developed World. According to Anderson’s model, the stressed balance sheets of the Developed World predict slow growth.

As investors, then, we’ll have to continue to look to the emerging markets for growth. The market never ladles out its rewards evenly, though. To drill down further, the big winner is really Asia and its big markets of China, India and Indonesia.

Anderson estimates that these regions could grow 7% or more annually, well above the tepid rates of developed markets and better than most emerging markets. “This is a very hefty gap,” he writes, “and one that is very likely to continue to reward investors who take advantage of the opportunity.”

BRIC Nations: The Fundamentals

By Chuck Butler

10/14/09 St. Louis, Missouri

A few years ago, someone coined the term: BRICs. This was an acronym for the countries of Brazil, Russia, India, and China. Before the huge deleveraging of risk assets leading up the collapse of Lehman Brothers in the fall of 2008, the currencies of these 4 countries were very strong versus the dollar, and growing in global prominence.

But then came the huge deleveraging of risk assets beginning in July of 2008. There’s an old saying that when established currencies that are widely traded and very liquid, get grounded, the emerging market currencies (like the BRICs) get sent to the woodshed. And so, we had the BRIC currencies lose major ground to the dollar during this period of time.

However, in March of this year, the non-dollar currencies began to rebound versus the dollar once more. This rebound in the established currencies like, euro, francs, yen, and Aussie dollars, has led to an even stronger rebound in the emerging market currencies, including the BRICs.

So… I thought it best to take a step back, and look at the fundamentals of each of the BRIC countries, and see if the stage if set for yet another strong run on the dollar.

Before we start though, I wanted to tell you the two reasons I originally put these countries together to form EverBank’s BRIC MarketSafe CD.

In the spring of 2009, China was making noise about the need for a new reserve currency to replace the dollar. The other BRIC nations joined in and at the next G-7 meeting, all four nations stood up and wanted to be counted as countries that want a new reserve currency, for they had see enough deficit spending in the US to convince them the dollar had no other avenue to follow but down.

The “markets” sort of shrugged off the BRIC nations call for a new reserve currency to replace the dollar. But I looked at it differently. I saw nations that had HUGE Treasure chests of dollar reserves, and nations that currently have a very large portion of the globe’s population. I believed then as I do now, that these countries would need to be reckoned with, and eventually their cries for a new reserve currency to replace the dollar would be heard, loud and clear.

Since we announced the creation of the BRIC MarketSafe CD, where an owner of the CD receives the positive gains in the currencies over 3 years, but does not experience any currency risk, as the CD has 100% principal protection, the BRIC nations are receiving more notice!

At the last G-20 meeting, of which the BRIC nations are a part of, it was announced that the watchdog duties for the global economies were being taken over by G-20 (from G-8). And a week later, the G-7 Finance Ministers suggested that G-20 take over the currency watchdog duties!

Now G-20 has both global economies and currencies under their watch and care, and the BRIC nations are right there to offer their suggestions…

So… Now that we’ve gone through the background, let’s take a look at the current fundamentals of these four nations, to see if the prospect of further potential currency appreciation is warranted.

First up… Brazil!

Brazil was the first Latin American country and first in the Americas to see its economy grind out of its recession. Brazilian GDP for 2009 overall will probably be just a nick over flat, while the forecasts for 2010 GDP show that economic growth will expand by 3.8%, as firmer domestic demand leads the economy.

For instance, Brazil’s recent Industrial Production output grew 1.2% in August, which was the eighth consecutive month of growth.

Brazil currently enjoys a Trade Surplus of 1.5% of GDP, with forecasts for the Surplus to also grow to 3.1% of GDP by 2011.

Overall, Brazil’s Current Account Balance is a narrowing 1.1% of GDP Deficit… as the economy gets back on track; the Current Account Deficit is expected to grow to 1.5% of GDP.

These are “manageable” deficit figures, and ones that would be welcomed in many countries of the world.

Inflation as always been a problem in Brazil, but assuming no economic shocks, and a strong currency (the real), it is expected that inflation could fall to 4.1% by year-end 2009, and remain stable throughout 2010-2011.

Brazil is one of the world’s largest democracies and emerging markets, which leads one to believe that their influence on the international stage will only continue to grow. Recently, China has moved past the US as Brazil’s top trading partner. It is believed that Brazil and China will sign a currency swap agreement that would remove the dollar in trade settlements. I’ll talk more about this in the “China segment”.

The prospects for the real are good. However, one must always remember, that even with strong economic fundamentals, any mass sell off of risk assets, would be magnified for an emerging currency like the real.

Next, we have Russia…

When we announced the BRIC MarketSafe CD, I received a lot of responses to the announcement with wishes that we had not included Russia in the CD. Well, it wouldn’t be a BRIC without Russia!

I told people that in essence, the only way I would buy Russian rubles is in a MarketSafe CD, and that the only way to look at Russia was as an “oil play”…

Who among us believes that oil prices will continue to remain in the $70 a barrel range?

OK… now that we’ve played that game… Let’s get to the data!

Russia went against the flow in September, by cutting their base interest rate, when it was believed that a good number of countries around the world were preparing to begin rate hike cycles.

Russia’s economy is still mired in a deep recession, as witnessed by the 10.5% fall in GDP from a year earlier, and industrial activity contracted by 12.6% in August!

Russia’s economy had seen two consecutive months of growth before this step backwards in August, and thus the rate cut in September. There are only mixed signs that the recession in Russia has bottomed out. But that means the Russian ruble is much cheaper than a year ago, and will probably remain weak as long as 1. The price of oil remains in the $70 range, and 2. The Russian economy remains mired in a deep recession.

Growth for 2010 is forecast to be 3.5%, which would mean that Russia’s recession will have ended late in 2009. An end of the recession and economic growth are very dependent on the persisting problems of the bad assets on the books of Russian Banks.

So… the rebound in the ruble may take some time to come to fruition. The good thing about that is that the ruble will remain cheap for new buyers.

Next… India…

India has maintained strong economic growth through the global financial meltdown, and will post a very impressive growth of 5.5% this year. This does represent a sharp deceleration from the 10% growth rates during the go-go years before the global financial meltdown. So, while 5.5% growth is lower than previous growth rates, it remains one of the best rates of economic growth in Asia!

Economic growth in India is forecast to grow 6.3% in 2010 as private consumption, investment and trade growth all show renewed strength.

Inflation in India, at present is not a problem coming in at 1.3% in 2009. However, as domestic growth takes hold, inflation is expected to rise to 5.1% in 2010.

The Indian Central Bank will continue to fight inflation, probably raising rates as we go along in 2010. The higher interest rates will go a long way toward additional currency strength.

India does not have a problematic current account deficit, like many emerging market countries. With rising exports at a 9.6% rate, the current account deficit will be the equivalent of 0.5% of GDP… Future growth in India will present itself as a problem as far as the Current Account Deficit is concerned. But it will remain manageable, and again, not the stuff that some countries experience.

The prospects for the rupee remain strong going forward.

And, last on the roster, but number one in the hearts of the fans….

China…

This is the proverbial 200 lb gorilla in the room! China has long been on my mind as the most undervalued currency on the planet, and as long as the Chinese government has their hands on the purse strings of the renminbi, it will remain that way.

However, there are signs that the Chinese government is looking to widen the use of the renminbi, which would eventually lead to more of a free float or at least a wider band of currency movement allowed.

The IMF recently wrote that the renminbi remains the most undervalued currency at probably a level of 40% undervalued versus the dollar. As long as the renminbi’s daily movement is controlled so strictly by the Chinese government the renminbi will not be allowed to cut into that 40% figure by very much. However, with the signs of a wider use of the currency, it is thought that the renminbi could be allowed to float more in the future.

What is this “wider use” I’m talking about? Well… you see, the renminbi is not a transactional currency, it is not liquid, and is traded on what’s called a “non-deliverable forward”. Which simply means it cannot be converted to physical form, or deliverable form.

It is my belief that China is taking baby steps to one day, have their currency take over the title of reserve currency of the world replacing the dollar. And to do this, the Chinese must begin to obtain a wider use of their currency.

They began this process by signing currency swap agreements with most of the Asian countries, and then moved on to Argentina. As I said earlier, it is believed that China will soon sign another of these currency swap agreements with Brazil.

The currency swap agreement between two countries eliminates the dollar from any transaction between the two countries, and only uses the currencies of the two respective countries. This is the “first step” toward gaining a wider use.

The “second step” came in September when China issued renminbi denominated bonds in Hong Kong. These were the first renminbi denominated bonds issued by China.

A wider use, in my mind, is equal to a stronger renminbi versus the dollar going forward.

Now for some data!

China’s GDP is expected to grow 8% in 2009, and 8.6% in 2010. China’s economic recovery this year has been fueled by government stimulus. But Hey! China has a treasure chest of reserves and surpluses… So, if any country was going to spend some money to boost their economy, China would be the one, for they have the money to do so!

And… with China being a Communist country, they were able to dictate where and to whom the money was being directed to, and how it was to be spent. This has gone a long way toward seeing the results of China’s stimulus.

Inflation remains a problem in China, and the sooner the Chinese realize that a strong currency can go a long way toward fighting inflation, the better!

So… For now, the renminbi remains pegged to a basket of currencies, and controlled by the Chinese Government, through the Chinese central bank. However, there are signs that this arrangement for the currency is changing, and a wider use of the renminbi is the objective… If that’s the case, then the prospects for a potentially stronger renminbi versus the dollar are very good.

And that’s how I see the BRIC currencies/ countries…

Regards,

Chuck Butler
for The Daily Reckoning

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The Sun Sets on the West

By Chris Mayer

What will the global economy look like in 2050?…and should we care about that now, forty years before the fact? Dr. Marc Faber, the 63- year-old Swiss editor of the well-regarded Gloom Boom & Doom Report, recently addressed both questions.

China ought to be the world’s largest economy by then, Faber predicts. The economies of the U.S. and India, should be neck and neck for the No. 2 spot – about 60% of the size of China’s. A distant fourth, at maybe a quarter of the size of the U.S. economy, will be Brazil, followed closely by Mexico, Russia, Indonesia and Japan.

That’s a very different world than the one we live in now, where the U.S. is No. 1 by a large margin and the European countries, such as Germany and the U.K., still figure prominently. What interests us most, though, is not so much the destination of 2050, but the path of growth to get there.

There are as many ways to show this growth trend as there are golf balls in the water at No. 15 at my local golf course. But Faber cites the trend in motor vehicle sales to illustrate the trend.

You can see that the “emerging 16? – the largest of the emerging markets, which includes China and India – caught up and passed the U.S., the European Union and Japan in 2008 as the world’s largest auto markets. What’s interesting here is that even in this recession that gap has widened.

There are all kinds of ideas that spin out of just that one observation. Cars don’t operate in a vacuum. They require an entire operating system to run, as software does. You need roads, for instance, and you need gasoline stations and gasoline. You need a lot of oil.

Just think about oil for a minute. The U.S. eats up about 25 barrels of oil per capita per year. Even countries such as South Korea and Japan consume around 15-20 barrels of oil per capita per year. China and India are tiny compared with that. China is at 1.5 barrels of oil per capita annually. And India barely registers.

So one can only imagine that as these economies grow and take up more of a share of the global economy, their oil consumption will rise exponentially. As far as investing goes, it boils down to investing in what these economies need, but don’t have.

In other words, we ought to ask the question, “For which commodities will demand not collapse?” Faber presents a chart that provides a partial answer. The chart presents China’s proven reserves of each commodity as a percentage of the world’s total reserves.

 

This chart does not include the agricultural commodities like soybeans and potash that China has in very short supply, but the chart does include many other important (and investible) commodities like copper, natural gas, uranium, bauxite (important in making aluminum), chromium (a steel additive) and manganese (important for making stainless steels). As investors, the left-hand side of the vertical line on the chart is where you want to be.

The commodities bull market, Faber ventured, is still on, though he cautioned that the road will be bumpy.

Even in commodity bull markets, 50% corrections are common.

“Hard asset booms are fueled as much by pessimism about economic prospects as by optimism about a continuously high appreciation of the commodity in question,” Faber explains. “In this sense, commodity booms are characterized by greed based on fear.”

On the question of the dollar, Faber was emphatic that we would see it lose value against the real world of things. Faber predicted that sooner or later we would have major inflation thanks to government stimulus and money printing. Therefore, Faber is long gold and silver.

He also thinks Japanese equities are depressed and points out that many Asian equities are near 20-year lows, except China’s. He also likes financial services in emerging economies and infrastructure stocks. On this latter idea, Faber said, “There are bottlenecks everywhere,” and noted a potential problem of delays or cancellations. He likes farmland, too.

As for what to avoid, Faber says turn your nose up at real estate and government bonds. There are also potential oversupply problems in tourism, with too many hotels, resorts and the like. Faber cautioned against these industries…and there are certainly too many government bonds as well.

We’ll see how it plays out, but I’m with Faber. The world is changing dramatically. And it’s the emerging markets that will provide the light at the end of the tunnel.

A Silkier Road

By Chris Mayer

Change is like a pin to the balloons of conventional wisdom. Just when people settle into their views, here comes the pin.

For instance, it’s become widely accepted when talking about emerging economies to focus on the so-called BRIC countries – Brazil, Russia, India and China. But there is a very important region that gets lost in that discussion.

In fact, this region collectively has a bigger economy than Brazil, Russia or India. And in terms of growth, it is growing faster than any of these countries. In terms of population, it’s bigger than the U.S. and nearly as populous as the EU. It holds 60% of the world’s proven oil reserves and nearly half of its natural gas.

That last clue probably gives it away. I’m talking about the Middle East and North Africa, or MENA.

Among its largest economies are Saudi Arabia and the United Arab Emirates.

In one of my presentations at Vancouver, I focused on the growth in these economies because it touches on nearly everything we’ve talked about here recently – water and food scarcity issues, infrastructure needs, energy and the growth in non-U.S. trade. To start, let’s look at a couple of basic facts that push this along.

The first is explosive population growth. MENA is one of the fastest-growing regions in the world. Over the last 50 years, MENA’s population is up more than fourfold. And the population is still young, with the majority of the population under 25 years old. Over the next 30 years, MENA’s population will grow more than 60%, to nearly 700 million people.

The second is that trade is expanding in this part of the world, as I highlighted in last month’s letter. To show this in a different way, let’s look at Syria.

Yes, Syria. Long a pariah state with which the U.S. maintained frosty relations, all that is beginning to change. In July, the U.S. made a couple of announcements that I thought signaled an important shift. First, the U.S. would send an ambassador to Damascus after a four-year absence. Second, the U.S. would ease export bans to Syria.

But more important than this political thaw is the economic story. Syria has been a mercantile crossroads between East and West since its days as a link on the old Silk Road.

The ancient city of Aleppo, for instance, was a key stop along the old Silk Road. Even today, it still has the longest covered market in the Middle East – a souk seven miles long. There you can find goods that take you back in history – soap made from olive oil or silk scarves and keffiyehs of a variety of colors. Head down an alleyway and find gold jewelry and stands of fresh pistachios and sacks of spices and more. Then there are the backstreets of hawkers with lamb – always plenty of lamb – and you smell the scent of lime, garlic and mint.

But much has changed, as Ben Simpfendorfer relates in his book, The New Silk Road. Today, for the first time in 22 years, banks in Syria can set their own interest rates on loans and deposits. Today, you can change money on the street without the threat of a ball and chain winding up around your ankles. A stock market even opened for business in March.

The largest investor in the country is Haier, a Chinese company. It makes 50,000 washing machines and 50,000 microwave ovens in Syria every year. Another Chinese company, Sichuan Machinery Import & Export, recently completed a $180 million hydroelectric plant here. There are big real estate projects, including a new $300 million resort on the Syrian Mediterranean coast. There are some 40,000 new hotel beds coming online in the next three years – up from 48,000 currently. Tourism is already 13% of the economy.

Syria is basically following the “China model” of maintaining a closed political order but carving out free zones and allowing trade.

Of course, this isn’t some Big Rock Candy Mountain fantasy where the sun shines every day on the birds and the bees and the cigarette trees. There are all kinds of problems in Syria, and elsewhere, but I find the changes taking place so far absolutely remarkable.

In a sense, we’ve seen this movie before. Roger Owen wrote the classic study on the Middle East and its place in the economy. In his book, he covers the period 1800-1914. This was a time of growth and transformation. At least a few points are similar to today. Then, as now, the region experienced a huge population growth. The Middle East’s population alone grew 300%. Then, as now, trade grew even faster under a more liberalized economic regime.

Then, the Middle East benefited from growing demand for agricultural goods from European markets. (Somewhat ironic, in view of the situation today.) Today, the region benefits from expanded trade with China and the rest of Asia for the region’s oil.

The most interesting thing about this growth is that it is happening in a part of the world where it is most difficult to grow food. Water is scarce. MENA consumes far more water than it gets via rainfall. In some places, the disparity is dramatic. In Kuwait, for instance, annual water consumption is 22 times annual rainfall. No wonder the whole area is a net importer of food.

The Middle East is the world’s largest regional importer of food. Egypt, for instance, actually imports more wheat than China. The GCC countries – or Gulf Cooperation Council countries – will import 60% of their food by 2010. And it’s likely to get worse. Saudi Arabia aims to phase out wheat production by 2016 to conserve water.

For this reason, these MENA countries are looking to invest in farmland overseas. The Saudis have grabbed farmland in Indonesia. The UAE has locked down farmland in the Sudan and Pakistan. As Eckart Woertz of the Gulf Research Center in Dubai says: “In a global food crisis, you may find it difficult to secure food supplies at any price no matter how many oil revenues you have.”

Move over BRIC! There’s a new acronym in town, and its name is MENA!

Bad News for Homeowners – Good News Concerning Water, Food, and Energy

Joel Bowman, reporting from Manhattan, New York City…

The tide is rising…and American homeowners are strapped into their concrete boots.

According to a new report by Deutsche Bank half of U.S. mortgage- holders will be “underwater” or “upside down” on their loans by 2011 – that is, they will owe more on their loan than their property will be worth. And it’s not just those risky subprime borrowers who will feel the pressure of the rising debt waters (although the report suggests up to 69% of home “owners” in that category will be submerged).

As it turns out, prime conforming loans, those ordinarily considered to be the safest bets, will sink the quickest. The report suggests that 41% of these relatively “safe” home loans will be underwater by the first quarter of 2011, up from 16 percent at the end of the first quarter 2009. Furthermore, forty-six percent of prime jumbo loans (those greater than $417,000) will be larger than their properties’ value, up from 29% over the same period.

Partly, this equity to debt inversion will be due to continued fall in home prices. Covering 100 U.S. metropolitan areas, the bank predicts home prices will tumble another 14% through the first quarter of 2011, for a total drop of 41.7%. The problem is exacerbated when people simply give up on their loans, knowing full well that, without jobs or a rise in the value of their home anywhere on the horizon, they might just be better abandoning the whole situation and starting from scratch (with a demolished credit rating, of course).

It goes without saying that your editors have no idea what home prices will do tomorrow. Maybe the government will bulldoze excess inventory to stimulate prices on the supply side. (That sounds just dumb enough for them to undertake, come to think of it.) Or maybe they will fall another 14%, as Deutsche Bank forecasts. Either way, the days of the ARM ATM seem to be over. And, without a job to supplement that home equity “income,” consumers might find the going tough for some time.

This dour news, however, has nothing to do with the column below in which Rude favorite, Chris Mayer, offers some unusually uplifting news for commodity investors. Please enjoy…

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Oil and Water Do Mix
By Chris Mayer

The oil price is stubborn, like a two-year-old who refuses to eat his mashed peas. Despite all evidence that the market is well supplied, oil is over $70 a barrel again as I write. Taking the view out to the horizon, though, I think it will go higher and will drag the price of most commodities higher in its wake.

Part of the reason for the rise is weakness in the dollar. People often say that oil is denominated in dollars. But maybe it is the other way around; dollars are denominated in oil. A dollar is worth how much oil it can buy. Part of oil’s rise is simply marking down the value of the dollar. Weak dollar means higher oil prices.

People will blame the higher oil price on speculators, but something interesting is happening in the markets for minor metals like molybdenum. Prices are rising, too. The silvery metal, used to strengthen steel, is now $15 a pound — nearly double the $8 and change it fetched in April. This is significant, because there is no futures exchange for “moly.” It trades on a physical spot market. Speculators play a very small role here. The buyers of the metal use the metal.

So there is a demand story shaping up here, too, mostly focusing on a fragile recovery of some sort and mostly centered on China and the emerging markets. The market is looking ahead.

For instance, over the weekend, South Korea reported numbers that show signs of a recovery in that country. Industrial output fell less than expected, and trade volume surged to $60 billion. That was its best showing since last October. Also, South Korean companies have been reporting better-than-expected results.

The biggest buyer of South Korean goods is China. Still, it’s a confusing time because of all the stimulus money that governments around the world have been spending. So it’s hard to say what’s real and what’s just an illusion created by a temporary spending binge.

Another piece of the puzzle from last week: Spot iron prices in China (meaning iron ore for immediate delivery) topped $100 per ton. That’s the highest level since October 2008. The other breakthrough in iron ore last week came when BHP Billiton, the world’s largest miner, announced that a third of its customers were moving to prices linked to the spot market.

This is big news for the industry. The old way was to have annual contracts with a negotiated price. This was bad for iron ore companies because the contracted price lagged the increase in iron ore prices. And when iron ore prices fell, steelmakers just reneged on their contracts. As the iron companies found out, having contracts was a great way for iron ore producers to cap their upside and leave them with all the downside. Not so good.

The industry now looks like it is moving toward more spot pricing, which is a good thing for the producers. Iron ore prices have rallied too, along with crude oil and moly.

Every rally, like every bottle of beer, has a finite life span. There will be lots of bumps along the way, but the prices of many commodities — such as oil, iron ore and moly — will tack higher, in my view.

The price of water is also rising — at least in China. I’ve long watched for this, as it affects companies like Hyflux (HYFXF:pink sheets) – a stock I recommended to the subscribers of my investment service, Mayer’s Special Situations. Water rates in China are well below average. One cubic meter of water in China costs about one tenth of what it does in Germany, for example.

Yet as we’ve covered here, China has a serious water crisis. Mother Nature did not smile on China when it came to water. The amount of water available per capita is only a third of the global average. Low prices only make that worse. Raise the price and people will get smarter about how they use water.

So finally, many cities are raising the price of water. The WSJ points out several places where water prices could rise 25-48%. Shanghai, for instance, raised water rates 25% in June and plans another 22% increase next year.

This is all good for Hyflux, which is in great position to capture those increases. The fact that those water prices are now rising partly explains why the stock is up 80% from its lows.

The stock was too cheap before, anyway. As I pointed out in an e- mail alert on March 16, Hyflux had gotten about as cheap as it has ever been on an earnings basis when it hit $1 per share. I continue to believe that Hyflux has a great future and enormous growth potential ahead of it.

One other note on the news this week: Japan is shifting its focus to investing in agricultural commodities. Japan is the largest importer of food in the world, with an annual bill of more than $40 billion. Now Japan’s big trading houses are looking to invest in assets that produce soybeans, wheat, corn and more. They are eyeing grain elevators and export terminals and grain processors. Some of them are investing in their own farmland.

Mitsui, for example, has nearly 250,000 acres of farmland in Brazil. Itochu, Japan’s fourth largest trading company, aims to double the amount of grain it handles. (All of this from the Financial Times piece this weekend titled, “Japan Thinks Global to Fix Food Shortage” by Javier Blas).

Years of underinvestment in food production around the world is now catching up with us. So I continue to believe that some of the best performing stocks over the next few years will come from the ranks of commodity companies that keep the world supplied with water, food and energy.

I like to say that now is a good time to invest in those things that keep civilization a going concern. The budding economic recovery may prove to be a mirage, but dwindling water and food and energy resources certainly will not.

What have become of the promising “green shoots” of recovery?

Eric Fry, reporting from Laguna Beach, California….

What have become of the promising “green shoots” of recovery?

Back on March 15, Federal Reserve Chairman, Ben Bernanke, remarked that the “green shoots” of recovery had become evident. Instantly, the phrase captured the hearts and imagination of the investing public. No matter how dismal the actual economic news, green shoots seemed to be spouting up everywhere.

Every economic data point, no matter how horrible, provided yet another opportunity to exclaim, “Aha!…Another green shoot!”

Sure, unemployment continued to soar, home prices continued to slide, and industrial production continued to contract, but things could have been much worse. And since the bad news has not been as awful as it could have been, the economy must be recovering, right?

Ummmm….not exactly. To gain a little insight on this curious case of “green shoots,” let’s consult a 2,000-year-old perspective.

“Listen!” Jesus declared in the Gospel of Mark, “A farmer went out to sow his seed. As he was scattering the seed, some fell along the path, and the birds came and ate it up. Some fell on rocky places, where it did not have much soil. It sprang up quickly, because the soil was shallow. But when the sun came up, the plants were scorched, and they withered because they had no root. Other seed fell among thorns, which grew up and choked the plants, so that they did not bear grain. Still other seed fell on good soil. It came up, grew and produced a crop, multiplying thirty, sixty, or even a hundred times.”

Although Jesus intended this parable to describe an individual’s receptivity to his message of hope and salvation, the metaphor of sowing seeds could also pertain to the character of economic recoveries. For example, what sorts of seeds are sprouting from the soil of the American economy?

The answer to this question may hold the key to stock market trends over the coming months.

Christ’s parable presents four possibilities:

1) Seeds that the birds consume;

2) Seeds that sprout in shallow soil, then quickly wither

3) Seeds that sprout among thorns, and cannot grow

4) Seeds that take root in fertile soil and flourish

So, to repeat the question, what sort of green shoots have been sprouting from the soil of the U.S. economy?

If you believe that #4 is the correct answer, you will want to be buying stocks tomorrow morning…and for several mornings thereafter. However, if you, like your California editor, believe that America’s green shoots more closely resemble the seeds that sprout among thorns and/or in shallow soil, you will want to hide out in the safest assets you can find.

Your editor would like to trust in the green shoots that so many folks claim to see. But he doesn’t. He can’t. “Less bad” is not good, and it never will be. “Less bad” might throw off a greenish hue for a short while, but it will never grow into an oak tree…or even a daffodil.

Green shoots need roots…and that’s what’s missing. The underlying American economy is still sick; it cannot provide very much nourishment to resurgent economic activity. Almost all essential “root systems” of economic activity remained impaired, diseased or compromised in some way.

Meanwhile, above ground, the economy continues to contract in every imaginable (and unimaginable) way.

Chris Mayer provides the details in a fascinating column below…

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Depression Then and Now
By Chris Mayer

This is an eye-opener. Whenever I talk about the Great Depression and compare it with what is going on today, I get a lot of skepticism. I hear a lot of people say, definitively, “This isn’t as bad as the Great Depression.”

What you have to remember, though, is the Great Depression unfolded like a train wreck in slow motion. It took awhile before it became the Great Depression. It wasn’t like someone flipped a switch and poof! — bread lines, Hoovervilles and hobos.

Another point to remember is that the Great Depression was a global economic event. It wasn’t just confined to the U.S. You have a take a wide-angle view of the global economy to get a better sense of the breadth of the slump. And so it is today.

Take a look at the next few charts, from economists Barry Eichengreen and Kevin O’Rourke. The first plots world industrial output from June 1929 against industrial output from April 2008:

We’re tracking that path pretty closely.

Then there are world stock markets:

We’re actually worse off right now.

Finally, take a look at the volume of world trade:

Again, here we’re actually ahead of the pace set in the Great Depression.

There are several other charts, but I think you get the point. Eichengreen and O’Rourke conclude:

“To summarize: The world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the U.S. leads one to overlook how alarming the current situation is even in comparison with 1929-30.”

Even so, there are many differences between now and then. One big difference that doesn’t get much play is the fact that today we have large emerging economies such as China, India, Russia and Brazil.

Investment strategist Murray Stahl, in a recent letter, pointed out “the most important difference between that era and this era…is the robust economic development of China, India, Russia and Brazil. During the Great Depression, those nations were in the opposite condition.”

China was in the midst of a civil war and then had to fend off a Japanese invasion. India wasn’t even on the economic map as anything of any consequence. Russia was backward and militantly communist. And Brazil had all kinds of political problems, including trying to put down a communist movement.

Today, those four countries are in much better shape. They are much larger and are still growing.

There are many more differences, and I don’t expect what we’re going through to play out like the Great Depression, except maybe in some of the broadest outlines. This is, or will be, known as the greatest crisis the world has faced since the Great Depression.

How it is similar is also in some of the valuations in individual stocks and securities. As Stahl writes, we share with the Great Depression the “bizarre valuations on highly liquid securities in the world capital markets [such] that I have never before seen in my 30-plus years of investment practice.” In that, there is opportunity.

As I’ve written before, I think there is room for investing even in a weak economy. There are lessons we can learn from the Great Depression. Some stocks will do better than others. I expect the needed commodities that fuel those big emerging economies will be good places to be.

And these hard assets also provide some protection in a world where paper currencies are not likely to hold their value as cash-strapped governments around the world crank up the printing presses.

Bankers B.S. – Brazilian Oil Opportunities

Eric Fry, reporting from the scene of the crime, New York City…

Your California editor returned to New York City yesterday, his old stomping grounds. The place didn’t look much different than the last time he passed through, about three months ago. The sidewalks weren’t very crowded and the restaurants weren’t very full. Maybe the “green shoots” of recovery aren’t as green as advertised.

So let’s turn to the news…

A quick perusal of yesterday’s headlines revealed little news of great importance. Hmmm…let’s see…a Southern governor publicly confessed his sins and sought forgiveness. Wall Street firms publicly denied their sins and launched a massive P.R. campaign.

“Wall Street’s largest trade group has started a campaign to counter the ‘populist’ backlash against bankers,” Bloomberg News reports. “In memos of confidential meetings with top financial executives, the Securities Industry and Financial Markets Association said it began this month the ‘execution phase’ of the operation, which pledges to ‘embrace change’ and accountability.”

To conduct this campaign of “change” and “accountability” Wall Street will toss tens of thousands of dollars at pollsters, P.R. firms and other public-image managers.

A cynical observer might be tempted to deduce, “Oh, that’s nice, first these firms blow up the American banking industry, solely for the sake of enriching themselves, then they funnel a portion of their bailout monies toward P.R. firms, for the sake of repairing their reputations.”

But let’s not yield to cynicism. Instead, let’s step inside Wall Street’s Gucci loafers for a moment.

If you were one of the individuals who’s unbridled greed had helped bring the economy to its knees, wouldn’t you want the public to focus on something else? And if you were one of the folks who’s raw self-interest helped investors lose trillions of dollars and helped workers lose millions of jobs, wouldn’t you want to launch a campaign “against populist overreaction?”

Living a charmed life – financed by taxpayers – isn’t as easy as it seems…especially not when so many folks are struggling. Do you think it’s easy to continue receiving multi-million-dollar paychecks while the economy struggles to digest the poison you fed it?

But this situation brings us to the heart of the problem. Where is the gratitude? Where is the compassion for the tens of thousands of low-level Wall Street employees who have lost their jobs, just so that the executives who remain can resume paying themselves salaries and bonuses they do not deserve?

Wall Street’s new P.R. effort might work, but your editors here at the Rude Awakening would suggest an alternative approach. We would offer a two-part image-recovery plan, free of charge:

1) Fire the P.R. firms.

2) Stop acting like complete jerks.

“The best P.R. comes from doing good,” one professional investor observes, “not from having to manage your image.”

In fairness to SIFMA, the trade organization represents 600 securities firms, brokerages and asset-management companies. The overwhelming majority of these operations conduct themselves with honesty and integrity. The employees they represent usually show up for work sober, work hard for their clients, and rarely kick the dog when they return home from a tough day.

Unfortunately, SIFMA also includes pariahs like Goldman Sachs, Citigroup Inc. and JP Morgan Chase. None of their bailout activities would be such a problem if they did not consume so much of our precious national capital, reputation and most importantly, investment opportunity cost.

When we hand $170 billion to AIG (who, in turn hands billions to Goldman Sachs, UBS and others), we do not invest $170 billion in dynamic capitalistic enterprises that could multiply our return down the road.

When we toss billions of dollars into the Wall Street black hole, the investment expectation is merely to “get our money back” or to “not lose a cent.” What private investor would risk capital with such a grim expectation?

While we here in America pile up massive debts to bail out failing industries, the next generation of leading world economies is busy deploying its wealth in promising endeavors around the globe.

China recently invested $10 billion to help develop offshore oil reserves in Brazil. This seems like a MUCH better investment than buying $10 billion worth of Citigroup preferred stock.

Byron King explains in the column below…

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Deep, Wet and Brazilian
By Byron King

Offshore areas of the world — especially in deep water — are the key to the world’s energy future. Far out and deep down. That’s where the last great hydrocarbon discoveries remain to be made.

That’s why, in my investment letter, Outstanding Investments, I’ve constructed a kind of end-to-end offshore energy mutual fund – from prospect to pipeline. Each company has a broad skill set. None is just a one-trick pony. Some of the companies overlap in skill sets, and even compete with each other.

A few of my favorite names include Norway’s offshore powerhouse StatoilHydro (STO: NYSE), as well as subsea equipment provider FMC Technologies (FTI: NYSE). Then there’s platform and pipeline builder McDermott Intl. (MDR: NYSE), as well as offshore services provider Superior Energy Services (SPN: NYSE).

Going forward, I’m be looking to recommend other deepwater plays…at the right price, of course. I’m looking for companies that can grab hold of key parts of the growing offshore business, and produce great profits in the coming years. I think you’re going to be astonished at what unfolds.

I recently attended the annual convention of the American Association of Petroleum Geologists (AAPG). (Some guys go to classic car shows; I go to geologist conventions). I’ve been a member of AAPG for 30 years, and it’s always fascinating to spend some time there. The meeting rooms and poster sessions feature reports from the front lines of the search for petroleum, natural gas and other energy resources.

One theme emerged loud and clear from this year’s conference: Deepwater. Most of the major oil discoveries that remain to be found in the world will be offshore, in deep water.

The always-ebullient Brazilian geochemist, Marcio Mello — CEO of Brazil’s HRT Petroleum Co. — wowed the crowd with a discussion of the oil potential of the South Atlantic. “Six of the last ten giant oil discoveries in the world were offshore Brazil,” he pointed out. And then Marcio moved the discussion to the other side of the South Atlantic and gave an eye-popping description of the oil potential of the offshore regions of Namibia.

“The Namibian offshore is analogous to that of Brazil,” Marcio stated, with slides and hard data to back it up. Then he showed his proprietary research into natural offshore oil seeps off Namibia, and the geochemistry that demonstrates immense hydrocarbon potential. “But Namibia,” said Marcio, “is way underexplored. So you can put down a little money for the concessions and get very rich.”

The point for investors is how much of future world energy development will involve subsea systems.

For additional perspective, let’s examine the current structure of the American energy supply. Right now, most of the U.S. energy mix comes from burning coal, natural gas and oil. In fact, according to the U.S. Department of Energy, the U.S. gets 87% of its total energy mix from burning fossil fuels. Another 7% of U.S. energy supply comes from nuclear power. The total is 94%.

That leaves about 6% of the U.S. energy mix to come from so-called “renewable” and alternative sources. And 3% of that 6% is renewable hydropower from unique sources like the Hoover, Grand Coulee and other dams. And we’re not building any more big dams.

Thus, only about 3% of U.S. total energy comes from things that grow, blow or shine. Of that 3%, about half (1.5%) is from “biofuels,” and that’s if you count a company like Weyerhaeuser (WY: NYSE) burning sawdust to run the sawmills.

Finally, there’s a very minor part of the total U.S. energy mix — about 1.5% — that comes from windmills, solar and geothermal. For as much visibility as these things get in the media and pop culture, their energy output is tiny — slightly above statistical noise in the overall national mix.

So just follow the numbers. The “alternative” energy sources are a miniscule component of the current energy mix. That’s after a few good years of significant investment, with lots of political support and plenty of tax breaks.

It will take many years (many decades!) for these energy sources to expand and meet the energy needs of the U.S. And that’s despite whatever the politicians and policymakers wish for in their dreams.

That’s why the U.S. must continue exploring for oil and gas. I cringe when I look at the falling rig counts in the U.S. and around the world. Every well that’s NOT drilled is one less source of hydrocarbon in the years to come, as depletion causes output from current wells to decline…which brings us back to the South Atlantic, one of the world’s greatest petroleum provinces.

Some experts think that the hydrocarbon resources in the pre-salt formations off the Brazilian coast may rival those of Saudi Arabia in magnitude. We’ll see about that. But it’s beyond dispute that Brazil and its energy resources are a complete game-changer for that nation, and the rest of the energy-consuming world. It goes back to basic geology and the history of plate tectonics.

When South America started to pull away from Africa about 140 million years ago, an isolated seaway formed — a proto-Atlantic Ocean — that filled again and again with sequences of limestone, thin shales and, finally, massive salt beds. The processes of petroleum geology worked as advertised in the region. And these processes left utterly eye-popping volumes of petroleum locked in high-quality reservoirs covering vast areas.

The big downside (and it’s big and down, to be sure!) is that all that oil is under a mile or two of South Atlantic seawater, covered by three or four miles of rock and salt beds — it depends where you’re located on the continental shelf and slope.

But that’s why it takes companies with phenomenal technical and managerial skills, plus deep pockets, to play in this great game. The bottom line is that with the right companies working at it, there’s enough oil down there to produce a very big payday, not just for Brazil, but for many of the companies that contribute to the effort

Fall of the West

Fall of the West

Neville Bennett

Is the West in long time decline relative to the rest of the world? I believe it is, and will indicate some sources bearing that out. It is not a new question for me as in my youth I enjoyed reading Toynbee, Spengler and others.

Many of my generation received a broad liberal education at a state grammar school. Science was very strong at my school, where many friends later became engineers, but we were all taught to love literature, art, music (you had to play an instrument), history and 5 years of at least two languages. At school we debated the rise and fall of Rome, plus the British and other Empires.

West below 50% world GDP

“The Greater Depression (NBR 12 June ) has accelerated the decline of Western GDP of 60% to 64% of global GDP over 1995-2004. A British think-tank, CEBR, had earlier forecast 2015 as the date when the West’s GDP would go below 50% of world GDP, but the credit crunch and changes in foreign exchange has brought the date forward from 2015 to 2009. Defined as US, Canada and Europe, the West’s share of global GDP is predicted to decline further to 45% by 2012.

The report identifies an inventory-led recovery conforming to my bullish attitude to oil and metals (NBR May 29). They predict some bounce in 2009, but in 2010 recovery will be held back by fiscal retrenchment and the impact of structural deleveraging. They conclude, the West “has to get to grips with the fact that we are no longer dominant and cannot expect to have things our own way”. China’s recovery is having a marked effect on oil and commodities.

Oil as an indicator

Crude oil prices have increased by 120% since February, at a time when the IMF confirms a recession in the world economy. Normally, falling crude prices would be expected. Actually, the price is about $72 p.b. and the futures market is predicting $88. So the prices defy “demand destruction”, or the idea that price rises lower demand. BP’s statistical review has shown that for the first time in history, emerging market demand has outstripped the West’s. This is significant in our oil-based civilization.

Until now traders have tended to look at US conditions for oil market leads. Henceforth, Western demand can slump while overall consumption is rising. Perhaps this is one reason why oil prices are strong now. 2008 oil consumption fell in the US by 6.4%; in the BRICs consumption grew y-o-y by 3.3% in China, 4.8% in India, 5.3% in Brazil, and 3.1% in Russia.

The BRICs

The BRICs now muster 20% of global GDP, about the same as the USA. These are rapidly changing societies with a large propensity to consume oil and commodities. Presumably their oil demand will burgeon, as industrialization proceeds at pace. One tends to think of them as financially undeveloped, but they have at least one huge advantage: they save.

Collectively their currency reserves are half of the global total. A recent Telegraph article said G7’s reserves’ (excluding Japan) has only 6% of world reserves. This makes it a little odd that the US dominates the IMF, World Bank etc. How can that last?

The BRIC’s are holding their first formal summit this week in Yekaterinburg, Russia. Curious that it gets little reported because the BRICs could stop lending the West money and deepen the recession. Their agenda includes ways to reshape the financial system and perhaps produce a new reserve currency. The Brazilian President wants the BRICs “change the political and trade geography of the world”.

The Chinese premier arrived as I went to press. I imagine that China will be much less confrontational than Brazil and Russia. China holds the most US Treasuries and does not want to undermine the dollar. It merely wants to supplant the USA as the world’s biggest economy, as it may do in 20 years.

World Economic Forum

Readers may recall an earlier article in which I outlined the briefing for the upcoming Davos meeting. The article specifically questioned the western model of development, and adopted the spirit of Asian capitalism with stronger central direction, saving and heavy capital investment. The report went beyond extending current trends and explicitly discussed “critical uncertainties”, and “potential discontinuities”. It also stressed rapidly shifting geo-economic power. (NBR Jan 23). Changing demography is a factor: “western” populations are shrinking, but emerging country populations are not.

Philosophers: Oswald Spengler

Spengler insisted in the 1920’s, when he was extremely influential, that we were living in the winter time of the Faustian civilization. His description of the Faustian civilization is where the populace constantly strives for the unattainable—making the western man a proud but tragic figure, for while he strives and creates he secretly knows the actual goal will never be reached. His “unattainable” is materialism.

Spengler asserted that democracy is simply the political weapon of money, and the media is the means through which money operates a democratic political system. Politics becomes an unprincipled struggle for executive power. Instead of conversations between men, the press and the “electrical news-service keep the waking-consciousness of whole people and continents under a deafening drum-fire of theses, catchwords, standpoints, scenes, feelings, day by day and year by year.”

Philosopher: Arnold Toynbee

Toynbee wrote magnificent Annual reports during the 1930’s are which I often set as required reading for graduate students. I had the joy once of meeting him. He dropped into Hong Kong University and asked if he could help. I took him to a tutorial, where unforgettably he raged against the state but lauded the polis (city).

Toynbee predicted the decline of the west. All civilizations are surrounded by peripheral countries of greater resources. Once the periphery absorbs the civilizations superior technology, especially military technology, it conquers.

Conclusion

Two centuries of western dominance has passed. The emerging world has caught up in terms of development. The West still has cutting-edge technology and military power, but it is being challenged on every front.

Sell Bonds, Buy Energy

Sell Bonds, Buy Energy
By Dan Denning, editor of the Australian Daily Reckoning

When a large holder of U.S. dollars declares that the dollar is in “great shape,” should we believe him? My answer is, “Probably not.”

Russia’s Finance Minister Alexei Kudrin told journalists this week that the U.S. dollar is in “good shape.” He added that, “It’s too early to speak of an alternative [to the U.S. dollar].” These remarks came after Chinese and Russian officials have quite publicly suggested that the world’s financial system would benefit from using a currency that wasn’t being run by a bunch of inflationistas in America.

But the dilemma for the large dollar-holders of the world – Japan, Russia, and China to name a few – is how candidly they should verbalize in public about what everyone knows in private. By blowing the whistle on the Fed’s inflationary monetary policy, dollar- holders penalize themselves. The lesson? There’s a price to pay for rightly pointing out that a huge supply of Treasury bonds threatens the credit rating of the U.S. That price is paid by owners of dollar-denominated assets.

The dollar-supportive remarks by Kudrin, then, should be seen for what they are: a white lie, designed to halt the dollar’s slide…at least temporarily. In the meantime, however, you can bet that these same dollar-holders are working behind the scenes to find alternatives to the greenback and, of course, to diversify their currency reserves into other currencies or tangible assets. It’s just that you don’t want to precipitate a crisis until you’re good and ready to profit from it with a well-planned trade. Goldman Sachs would never make that kind of mistake!

There may be a few escape avenues from the dollar. It comes down to figuring out what-if anything-will go up when the U.S. dollar resumes going down. In fact, the question on everyone’s minds is what U.S. creditors will do with their money if they aren’t lending it to Barack Obama to spend.

“Over time,” says Nouriel Roubini, professor of economics at the Stern School of Business at NYU, “the willingness of the U.S. creditors to finance U.S. spending and buy dollar reserves is going to be reduced. People are getting nervous rightly about us devaluing or inflating our way out of the debt problem and causing real losses on the holdings of those assets.”

If you’re losing money on an asset, naturally you’re going to either sell of it, or at the very least, accumulate less of it. But then what? Where does your money go after that? We’d suggest the investment needs of the emerging market nations are the natural replacement for throwing away money in the U.S. Treasury market. Granted, there’s risk in emerging markets. But it’s now clear there’s risk in the sovereign bond market too. Take your pick.

Speaking of those emerging markets, four of them spoke with one voice in Russia this week. The leaders of Brazil, Russia, India, and China gathered to figure out how to solve their dollar dilemma. Criticize it too much, you lose value on your current dollar- denominated holdings. Do nothing, you lose value on your dollar- denominated holdings as Obama and his Congress spend America into poverty and servitude…and then inflate like mad men.

“There is a strong need for a stable, predictable and more diversified international monetary system,” the final statement from the BRIC nations read. Russia’s Dmitry Medvedev added his own “two roubles,” saying that existing reserve currencies, “have not managed to perform their functions.”

And what is the function of a reserve currency? Well, it’s probably the same as the tripartite function of any money: as a store of value, a unit of account, and a medium of exchange. Countries hold baskets of currencies (yen, Euros, Swiss Francs, U.S. dollars) in order to conduct international trade and commerce.

Of course all this is relatively new. That is, when money used to be a commodity (gold and/or silver) then a country’s monetary reserves were the same as its precious metal reserves. Debtor nations that consumed more than they produced and borrowed to do so paid the price in a net outflow of commodity money. But things don’t work that way in a world where everyone uses fiat money. So what we’re seeing now is a worldwide monetary system that is, well, systemically flawed.

Make of it what you will. What we make of it is that the very foundation of the world’s commerce and the currency in which it’s conducted is shifting. The stock markets of the world have no idea what to make of all this because it is not clear yet who the winners and losers will be.

All that we know is that paper currencies and government debts are proliferating very rapidly. We also know that natural resources are not. In fact, they are depleting very steadily. So we conclude that the prices of most natural resources will go up…a lot. That’s why lots of bears on the U.S. dollar suggest buying gold. We are sympathetic to this idea, but we’d suggest a slightly different strategy: Sell bonds. Buy energy.