The Economy Is A Lie, Too

By Paul Craig Roberts

September 21, 2009 — Americans cannot get any truth out of their government about anything, the economy included. Americans are being driven into the ground economically, with one million school children now homeless, while Federal Reserve chairman Ben Bernanke announces that the recession is over.

The spin that masquerades as news is becoming more delusional. Consumer spending is 70% of the US economy. It is the driving force, and it has been shut down. Except for the super rich, there has been no growth in consumer incomes in the 21st century. Statistician John Williams of shadowstats.com reports that real household income has never recovered its pre-2001 peak.

The US economy has been kept going by substituting growth in consumer debt for growth in consumer income. Federal Reserve chairman Alan Greenspan encouraged consumer debt with low interest rates. The low interest rates pushed up home prices, enabling Americans to refinance their homes and spend the equity. Credit cards were maxed out in expectations of rising real estate and equity values to pay the accumulated debt. The binge was halted when the real estate and equity bubbles burst.

As consumers no longer can expand their indebtedness and their incomes are not rising, there is no basis for a growing consumer economy. Indeed, statistics indicate that consumers are paying down debt in their efforts to survive financially. In an economy in which the consumer is the driving force, that is bad news.

The banks, now investment banks thanks to greed-driven deregulation that repealed the learned lessons of the past, were even more reckless than consumers and took speculative leverage to new heights. At the urging of Larry Summers and Goldman Sachs’ CEO Henry Paulson, the Securities and Exchange Commission and the Bush administration went along with removing restrictions on debt leverage.

When the bubble burst, the extraordinary leverage threatened the financial system with collapse. The US Treasury and the Federal Reserve stepped forward with no one knows how many trillions of dollars to “save the financial system,” which, of course, meant to save the greed-driven financial institutions that had caused the economic crisis that dispossessed ordinary Americans of half of their life savings.

The consumer has been chastened, but not the banks. Refreshed with the TARP $700 billion and the Federal Reserve’s expanded balance sheet, banks are again behaving like hedge funds. Leveraged speculation is producing another bubble with the current stock market rally, which is not a sign of economic recovery but is the final savaging of Americans’ wealth by a few investment banks and their Washington friends. Goldman Sachs, rolling in profits, announced six figure bonuses to employees.

The rest of America is suffering terribly.

The unemployment rate, as reported, is a fiction and has been since the Clinton administration. The unemployment rate does not include jobless Americans who have been unemployed for more than a year and have given up on finding work. The reported 10% unemployment rate is understated by the millions of Americans who are suffering long-term unemployment and are no longer counted as unemployed. As each month passes, unemployed Americans drop off the unemployment role due to nothing except the passing of time.

The inflation rate, especially “core inflation,” is another fiction. “Core inflation” does not include food and energy, two of Americans’ biggest budget items. The Consumer Price Index (CPI) assumes, ever since the Boskin Commission during the Clinton administration, that if prices of items go up consumers substitute cheaper items. This is certainly the case, but this way of measuring inflation means that the CPI is no longer comparable to past years, because the basket of goods in the index is variable.

The Boskin Commission’s CPI, by lowering the measured rate of inflation, raises the real GDP growth rate. The result of the statistical manipulation is an understated inflation rate, thus eroding the real value of Social Security income, and an overstated growth rate. Statistical manipulation cloaks a declining standard of living.

In bygone days of American prosperity, American incomes rose with productivity. It was the real growth in American incomes that propelled the US economy.

In today’s America, the only incomes that rise are in the financial sector that risks the country’s future on excessive leverage and in the corporate world that substitutes foreign for American labor. Under the compensation rules and emphasis on shareholder earnings that hold sway in the US today, corporate executives maximize earnings and their compensation by minimizing the employment of Americans.

Try to find some acknowledgement of this in the “mainstream media,” or among economists, who suck up to the offshoring corporations for grants.

The worst part of the decline is yet to come. Bank failures and home foreclosures are yet to peak. The commercial real estate bust is yet to hit. The dollar crisis is building.
When it hits, interest rates will rise dramatically as the US struggles to finance its massive budget and trade deficits while the rest of the world tries to escape a depreciating dollar.

Since the spring of this year, the value of the US dollar has collapsed against every currency except those pegged to it. The Swiss franc has risen 14% against the dollar. Every hard currency from the Canadian dollar to the Euro and UK pound has risen at least 13 % against the US dollar since April 2009. The Japanese yen is not far behind, and the Brazilian real has risen 25% against the almighty US dollar. Even the Russian ruble has risen 13% against the US dollar.

What sort of recovery is it when the safest investment is to bet against the US dollar?

The American household of my day, in which the husband worked and the wife provided household services and raised the children, scarcely exists today. Most, if not all, members of a household have to work in order to pay the bills. However, the jobs are disappearing, even the part-time ones.

If measured according to the methodology used when I was Assistant Secretary of the Treasury, the unemployment rate today in the US is above 20%. Moreover, there is no obvious way of reducing it. There are no factories, with work forces temporarily laid off by high interest rates, waiting for a lower interest rate policy to call their workforces back into production.

The work has been moved abroad. In the bygone days of American prosperity, CEOs were inculcated with the view that they had equal responsibilities to customers, employees, and shareholders. This view has been exterminated. Pushed by Wall Street and the threat of takeovers promising “enhanced shareholder value,” and incentivized by “performance pay,” CEOs use every means to substitute cheaper foreign employees for Americans .
Despite 20% unemployment and cum laude engineering graduates who cannot find jobs or even job interviews, Congress continues to support 65,000 annual H-1B work visas for foreigners.

In the midst of the highest unemployment since the Great Depression what kind of a fool do you need to be to think that there is a shortage of qualified US workers?

But Did Anyone Notice Inflation?

The mainstream media has been elated by early signs of economic activity picking up. In particular the Institute of Supply Management (ISM) issued their Purchasing Managers Index (PMI) on September 1:

http://www.reuters.com/article/pressRelease/idUS158400+01-Sep-2009+BW20090901

The index was reported at 52.9. This is the highest in two years and the first reading above 50 since the credit crisis began. A reading above 50 indicates expansion in manufacturing. The media was euphoric and investors have pushed the US stock indices to post recovery highs. What did not receive any attention was the prices paid component of the index. It increased to 65 from a reading of 55 in July. This is 18% increase in a single month! In May 2009 the index was at 43.5 which represents 49% increase in prices paid over 3 months. This is absolutely stunning. This is not a government massaged index; this is based on what purchasing managers are reporting they are paying. Only 8% of managers reported paying lower prices while 38% reported receiving higher prices.

This report was followed on September 3 by the Non-Manufacturing (Services) Index.

http://www.reuters.com/article/pressRelease/idUS173419+03-Sep-2009+BW20090903

It was reported at 48.4 and while this is still indicating contraction the index was 2 points higher than in July and 8 points higher than in March. Again the media were waxing lyrical about recovery. Again what was not mentioned was the prices paid component; it increased to 63.1 from 41.3 which is a simply shocking 52% jump in one month. It increased 34.5% from its May reading. Only 6% of managers reported paying lower prices while 23% reported paying higher prices.

On September 4 the Economic Cycle Research Institute’s (ECRI) U.S. Future

Inflation Gauge (USFIG) was released:

http://www.reuters.com/article/marketsNews/idUSNYS00538420090904

It was 89.6 in August compared to 84.6 in July. This is a 5.9% increase in one month. The August USFIG annualized growth rate, which smoothes out monthly fluctuations, rocketed to positive 6.5% from negative 8.8% in July! In other words the annualized indicator which smoothes out volatility went from a highly deflationary picture to one of rampant inflation in just a single month! The ECRI commented that the gauge was pushed higher by rising commodity prices. This dovetails with the picture we see from the reports of actual prices being paid as reported by the ISM.

The NY Federal Reserve Bank President, William Dudley, said on August 31^st “My view is we have tools to manage our balance sheet so we’re not going to have an inflation outcome, a bad inflation outcome”

http://www.americanbankingnews.com/2009/08/31/ny-federal-reserve-president-says-us-can-avoid-coming-inflation/

“I’m totally committed to taking away the punch bowl at the right time,” he said during the same interview. “It is possible that inflation could decline for a while because of the slack in economy and the banking system will take time to heal itself”, Dudley added.

Judging by the data I have presented it looks like Mr. Dudley only takes away the punch-bowl when his guests are rolling around on the floor incapable of drinking another drop!

Almost everyone has their eyes glued to the money supply data and the BLS CPI and PPI. Of course the government’s proclivity to exclude everything that is rising in price from the PPI and CPI in their special brand of hedonics means that the last place to observe the affects of monetary inflation will be in these indices. John Williams at shadowstats.com reports that his reconstructed M3 is only growing at a rate of 6% annualized. I however question the accuracy of the input data. I don’t think that all the actual monetary injections are being reported, which is probably one reason the FED does not want to be audited. Neil Barofsky, Inspector General of the TARP, recently testified before Congress that the total credit lines of the 50 or so stimulus programs totaled 23.7 Trillion dollars. A Treasury spokesman countered with a statement that only 2T$ had so far been spent. Where does that 2T$ appear in the M3 data? It doesn’t! If government officials have the capacity to access 23.7T$ of credit who will bet me that they will not spend it? Clearly money is being pumped into the system which is bypassing the reporting system.

Furthermore the weakness of the US dollar means that foreign holdings of dollars will return to the domestic market as they are dumped.

A very important factor in the growing inflationary scenario is the monster derivatives market. The derivatives market provided massive leverage to mask inflation created in the Greenspan era. Greenspan massively increased the money supply from 4 T$ in 1995 to 12T$ by 2006. This would normally have created rampant general price inflation. The prices of commodities, which are the raw materials we use for manufacturing and for much of our food chain, were suppressed by the derivatives market creating phantom paper supply of commodities resulting in the apparent supply appearing many times bigger than the physical supply and so suppressed prices. This was the main purpose of the derivatives market and why 5 US Banks held 96% of all OTC derivatives and why Greenspan vehemently defended it not being regulated. The derivatives market grew to a staggering 1,200 Trillion dollars. How can a market that has a notional value of 20 times the size of the global economy not be regulated? How can this market be excluded from a discussion of whether we face inflation or deflation? This monster has now contracted to less than half its peak size and is continuing to shrink. As the phantom paper promises of commodities are removed from the market the previous suppressing effect is also removed and prices will rise. The 15 years of price suppression has prevented any meaningful expansion in the global production capacity of commodities. We will now see many commodities become in short supply and the consequent ramp up in prices.

Many analysts are waiting at the “front door” of the economy for signs of inflation, while inflation is flooding in through the back door.

In my article “The Green Shoots of Hyperinflation”

http://www.marketforceanalysis.com/Published%20Articles_2009_assets/Green%20Shoots%20of%20Hyperinflation.pdf

I showed that the S&P500 has entered a new bull market trend. An updated version of the chart in that article is shown in Figure 1.

Figure 1: S&P 500 Potential Energy Chart (1990-2009)

 

At Market Force Analysis we have developed a proprietary indicator which is called “Potential Energy” (PE) which uses the intraday data to determine whether buyers or sellers are more dominant. In figure 1 the S&P 500 is shown in black and the Potential Energy (PE) in blue. When the PE is rising the primary trend of the market is up and when it is falling the primary trend is down. It can be seen that this indicator is excellent at identifying a change in the primary trend. In the last 19 years only 4 turning points are identified as indicated by the arrows. The latest is a transition from bear to bull in March 2009. What is clear from PE is that the rise and fall cycles of the S&P500 in 2008 where the PE was falling are not the same as the rise we have seen since March 2009. The most recent rise is very similar to what was seen in 2003 when the market turned from Bear to Bull.

This is totally at odds with the fundamentals of the economy but this is another sign of inflation. As the dollar is debased money will flood into anything as a hedge against loss of purchasing power. The stock market will be such a hedge. It will rise in nominal terms but decline in real terms. This phenomenon was seen in Weimar Germany when its stock market made stellar nominal gains as the currency was debased and more recently in Zimbabwe the same phenomenon has been observed. The S&P500 will see pullbacks but it will not crash to new lows, below the March 2009 level of 676, as many expect.

I do not recommend buying general equities because investors will only gain in nominal terms while losing in real terms. The time tested hedge against inflation is precious metals and quality companies who explore for them and dig them out of the ground.

Real data is being reported, but ignored by the media and mainstream analysts, that reveal shocking increases in prices. There are still many who have their head stuck in the sands of deflation. Inflation and hyperinflation are baked in the cake by the promiscuous and unprecedented actions of the Federal Reserve and the unwinding of the massive derivatives commodity price suppression scheme.

Adrian Douglas
September 6, 2009

What risk of Deflation?

Neville Bennett

The price level in the UK was the same in 1815 and 1914. This did not mean that prices were stable throughout that 100 year period: they fluctuated in long waves, with periods of inflation followed by deflation. More recently, there was a decade of deflation at the time of the Great Depression, and in Japan prices fell by an average of 0.5% p.a. from 1999-2005.

Deflation may again affect the US and UK, and perhaps spread further through the world economy. Consumer prices slipped by 2.1% in the year to July in the US, and 0.7% in the EU. In the UK the CPI is expected to be 1.8%, despite the Bank of England and Government desperately trying to keep it at above 2% by cutting interest rates to their lowest level in 300 years and pouring ₤150 billion into financial markets, a sum more than 12% of GDP.

The UK’s CPI does not contain housing costs, the Retail Price Index is more inclusive and it indicates that the UK had a -1.6% fall in prices for the July year: its first fall since 1960. I believe deflation is already strong in the UK as goods have declines in price since about 1995, but services have lifted the CPI.

There is widespread fear that the massive pump-priming by Governments globally will be over-inflationary, but I question that because it will result in higher interest rates, higher government spending on debt service and lower spending on welfare, increased taxes and higher costs to business for credit. Japan has tried for 19 years to create inflation but has failed. Moreover, there is a huge ‘output gap” putting pressure on all producers.

I do not intend, however, to gaze into the crystal ball so much as to discuss deflation and explain some its properties.

What is it?

Deflation is simply a fall in prices, and is regarded negatively because it is associated with depressions and with very low interest rates. The UK has not had a full year of deflation since the 1930’s. Indeed, inflation has been the norm, averaging 7%, since 1945.

Conventionally, deflation has virtues: consumers enjoy falling prices creating increases in real wages (the Great Depression was good for people in work). Moreover, it causes low interest rates, yet it is good for savings as their real value increases annually.

Deflation is not so good, therefore, for people in debt. The value of real debt increases each year, which affects people on mortgages as their house or farm may also decrease in value each year. It also discourages spending because the prices will be cheaper next year. Wages fall creating a downward spiral. It damages banks because they end up with a lot of surrendered property. The BNZ was the biggest landowner in New Zealand in the early 1890’s.

Recent Research

A recent Bank of England study by Groth and Westaway [Groth} discusses deflation’s costs in detail. Price adjustments for firms are costly, both for reprinting price lists but more in setting optimal prices in an environment of changing prices. Zero inflation is preferable. Deflation has an effect on taxation. In most cases, tax systems are not inflation indexed, so taxes rise with inflation.

The argument that consumers will defer consumption in periods of deflation is challenged by Groth and Westaway. They argue that in most cases low interest rates weaken the case for postponement.

Wages

Groth also discusses the difficulty of business in reducing money wages when this is justified by economic conditions such as the distressed situation of a firm or when all prices are falling. Workers may have a “money illusion”: they might focus on nominal wages rather than real wages. It they have a money illusion; they will resist a wage cut because they think they can buy fewer goods.

Many workers may resist pay cuts, not because they have a money illusion, but because they want to be rewarded for increasing productivity. British workers have raised productivity by about 2% a year over the last 30 years, so even if prices fall, there would not generally be a necessity (in the short-term) to cut in nominal wages. But in some industries, especially those particularly hard-hit, there would be a stronger case for wage cuts. If these are resisted, it can increase unemployment.

What evidence is there for downward rigidity in wages? Certainly there are more raises than cuts. But I believe many employees are prepared to accept cuts when there is a strong case. Most economists believe there is strong resistance, but this is exaggerated by the actions of a few trade unions. Employers find ways of cutting labour costs, moreover, by slashing non-wage benefits and bonuses, avoid customary raises for merit or seniority, or employing new workers at lower wages than those paid to existing workers.

In the UK there are a growing number of wage freezes, while wage cuts are relatively few. But British Chambers of commerce data indicates that about 10% of companies plan nominal cuts in 2009. Workers may be more flexible than they have been in the previous inflationary periods because they perceive growing unemployment: a lower-paid job is better than the dole.

Debt Deflation

Deflation increases the debt burden and recessions are deeper for countries carrying the most debt. The key element is a transfer of wealth from debtors to creditors caused by an unexpected fall in inflation. Many mortgage holders expected benevolent inflation. About 40% of Britons entered fixed-rate contracts and are now suffering from a real rise in interest rates. This effect is magnified by falling employment and a fall in asset values. Defaults will rise and impact on financial institutions.

The authors say many writers have demonized deflation but it is important not to confuse the effects of the credit- crunch shock with the effects of deflation itself. Goth says British workers are flexible about wages. She believes that with a massive monetary policy response, the deflationary episode should be short-lived. My knowledge of the Japanese economy makes me skeptical of that conclusion.

Government Debt – Analysis of Developed & Emerging Countries

Government Debt

Neville Bennett

This “Greater Depression” is a profound turning point in history. Recently, I analyzed how it had tipped the balance in global GDP away from the West to the emerging world (NBR June19). That change arises partly from differential economic growth rates. Obviously more is involved, and my focus now is on public debt and demography.

In essence, ever since the Asian Crisis, emerging countries have cleaned up their balance sheets and now have significant savings. But the developed world is encumbered with an ageing population, and unsustainable commitments in health and pensions. These prevent the paying down of public debt, which has been overblown by the need to bailout banks and fund costly stimulus packages. Japan and the UK are illustrative cases, but there may be lessons for New Zealand in this issue, as credit ratings come under pressure.

Global Public Debt

Governments have possibly stabilized the financial sector but there must be doubt about the remedy: massive public debt. According to the IMF, by next year, the gross public debt of the 10 richest countries will have risen from 78% of GDP in 2007, to 106%. It is an increase of $9 trillion in three years. New Zealand has made a modest contribution to this. Its public debt in May 2007 was NZ$28.8 bn, rising by a quarter to NZ$36.6 bn in May 2009.

There is worse to come. Weak economic growth and revenue, plus increased expenditure point to large budget deficits. The IMF believes public debt will be 111% of this groups GDP in 2014, but in a worst case scenario it may reach 150%. (See chart.)

This is the highest peacetime borrowing on record. The world economy will struggle for a decade at least with the weight of this albatross around its neck. It is the result of the paradox that crash caused by too much debt has been remedied by government bailouts to keep economies completely falling off the cliff. Most economists agree with this pump-priming in principle, but they may thereafter disagree on some aspects (for example: too much to banks) and the timing the necessary return to sounder fiscal management.

To be sure, governments have been ably to service this debt quite cheaply. Their reserve banks have driven down rates in order to stimulate the economy, and markets rates have been low as investors have flocked to find safety in government-backed securities. Nevertheless, yields are rising in response to new issuances and the cost of debt servicing is increasing net debt appreciably.

Will governments try to pay off the debt at the cost of lower economic growth? Or will try to inflate the debt away? Inflation can reduce the real cost of debt, and is attractive to governments as it is more politically acceptable than tax increases. But the cost is much higher than many politicians think.

The cost of high inflation is horrendous. Investors will buy debt only if they can make a real return. This requires an interest rate well above the CPI. If inflation is running at 10% p.a., medium term interest rates have to be higher, say 12%-16%. In the process, unless a lot of debt is paid off, the remainder will grow in line with interest rates. It is like a dog chasing its tail. The debt reduces when the dog is exhausted and can chew its tail. Meanwhile, high interest rates have slayed the economy. Only hyper-inflation destroys debt but it also destroys the middle class.

Recent History

Public debt always rises after recessions because Keynes’s policy of pump-priming is universally accepted. Some countries default. But the richer countries rely on fast growth. More recently some very fiscally responsible states like Canada, Sweden, Ireland and New Zealand have restrained public debt.

Although New Zealand will triple its bond issuance from about NZ$5 bn p.a. in 2008-9, to NZ$ 15 bn. in 2013-15,

It will keep public debt at a reasonable proportion of GDP. It is forecasting gross public debt as a proportion of GDP at 41.1% this year, rising the 45% in 2012-13 and 49% in 2014-15.

This is clearly responsible, but it does rest on projections on increases in GDP which may be optimistic. I am apprehensive that interest rates may rise to attract foreign investors, and that will be a drag on economic growth. Moreover, if NZ yields are attractive, the NZ dollar is likely to soar above fair value, hurting exports and our important tourist and student markets.

Rebound?

A rebound is difficult. Exports may be sluggish, particularly as households are rebuilding their balance sheets, with a marked reluctance to buy big-ticket items. The richer countries may follow a version of Japan’s past, where it is very difficult to stimulate the domestic economy when asset prices are falling. The Japanese Government has pump-primed until it is gasping. The country is still in deflation, but its gross debt-ratio has tripled from 65% of GDP in 1990 to 170% now.

Other Fiscal costs

The problem of repaying the cost of the bailout is dwarfed by the cost of an ageing population. According to the IMF, the present cost of the bailouts is only one tenth of the financial cost of ageing. If this problem is not addressed, demographic pressures will send the debt of the big rich economies to around 200% of GDP by 2030.

The world has regarded emerging country debt as the most in risk of default. This is an anachronism. The emerging members of G20 had a debt-GDP ratio of 38% in 2007 and it is falling to perhaps 35% this year.

The rich countries need to be careful to avoid tightening policy too soon for fear of snuffing out economic growth. But they may need to take other action to free up fiscal elbow-room. Pensions are an obvious problem, and raising the retirement age seems imperative as many superannuation schemes are unfunded. S&P have made it clear that the UK either raises taxes or cuts pensions and health spending if it is to avoid a credit downgrade. This is problematic as funding civil service pensions alone can amount to 85% of GDP.

WATCH OUT FOR A BIG JUMP IN CONSUMER PRICES

By JOHN CRUDELE
June 23, 2009

INFLATION IS NEAR.

Imagine that I’m walking around with one of those sandwich boards proclaiming that soon — very soon — Washington is going to start reporting that consumer prices are rising by uncomfortable amounts.

Sorry, folks.

But when you are doing a column about the Consumer Price Index — or CPI, as it is lovingly called by the Bureau of Labor Statistics (BLS), there’s very little a columnist (or even a magician) can do to make this very moist.

Warning: dry stuff ahead!

But you really should continue reading because what I’m about to tell you could have an immense impact on your lives if you invest in the stock market or in bonds, are going to borrow money or save it, care about the nation’s recession or maybe just want to know something that the bloodsuckers on Wall Street don’t.

For the past couple of springs the BLS, which is in charge of calculating the nation’s inflation rate, has been understating the amount of inflation we are experiencing.

Here’s what is happening.

Because we’ve had annual run-ups in the cost of energy these past few springs, the computers that calculate inflation at the BLS now tend to anticipate a jump in gasoline prices.

The computers look at the past five years for guidance on their seasonal adjustments. In other words, they saw this spring’s increase in gas prices coming.

And since it was expected, some of the rise in gasoline prices this year was subtracted out of the CPI by the seasonal adjustments.

Just look at the numbers that were reported by the BLS and repeated by the media.

Consumer prices rose just 0.1 percent on a seasonally adjusted basis in May compared with April. The index that measures energy prices rose 0.2 percent, but that was the first time in three months that there was an increase in energy costs.

Say it with me: How can that be?

You and I have both seen the price of gasoline go up and up at the pumps. Gas was a dollar a gallon cheaper last December and most of that increase has come in just the past few months as speculators anticipated (wrongly, it turned out) that people would do more driving and need more gasoline as the summer approached.

So why hasn’t the CPI reflected that rising cost?

Because the BLS’ CPI calculations — see, it really is dry — have gone kerflooey.

Wall Street doesn’t understand this. In fact, the million-dollar economists at financial companies were expecting energy prices in the CPI to rise more sharply this spring and were disappointed.

Here’s what they also don’t know: Because the CPI understated the rise in energy prices these past few months the BLS’ index will probably overstate gasoline prices in the coming months

It happened last year.

Even though the economy was already in a recession in 2008, the situation was still better than it is today.

Economic growth tends to go hand-in-hand with inflation — people are doing better, they feel richer and buy more stuff and push prices up because they are competing for the same limited number of goods.

Despite the fact that gasoline prices zoomed higher in the spring of 2008, the government reported that consumer prices only rose 0.4 percent that March; 0.2 percent that April and 0.5 percent that May.

Those are all very modest increases — and they were kept at acceptable levels because of the same seasonal adjustment flaw I’m now telling you about.

But here’s the real problem with seasonal adjustments like this: What the computers give, they have to take away.

By definition, if the effects of increased gasoline prices are understated in the spring they need to be overstated at some other time.

In the end, the effects of these seasonal adjustments have to be neutralized. They must offset each other by the end of the year.

In a column published on May 20, 2008, I mentioned my suspi cions that inflation would be going much higher in the months to come. And I quoted a senior econo mist at the BLS who confirmed my reason ing. The inflation num bers soon rose just like he and I had expected.

When consumer prices came out for June 2008 there was a monstrous jump of 0.9 percent from the month before. That was followed by a 0.7 percent climb for that July.

So are the BLS’ computers screwed up again? Have they been understating the rise in energy prices?

Last week I asked one of the people at the BLS who is instrumental in putting together the monthly consumer price report. He said that the computers “probably” have been weighing gasoline price increases too lightly.

And unless gasoline prices suddenly decline in the months ahead — and there was a drop yesterday in gas futures contracts — all those spring understatements will start catching up in the CPI.

And the amount of inflation being reported could rise uncomfortably. Here’s where you start to care about this column.

I’ve predicted that interest rates were going to climb because the nation’s economy would look better in spring than it really is. And rates have gone up — a lot.

But now the inflation numbers could have an added impact.

If the BLS computers are messed up, you should not only expect the cost of borrowing money to rise more aggressively but you can also count on Wall Street being flummoxed.

If I’m right, you can say that you knew all about this because you saw the sandwich board.

Derivatives Monster – Real Economic Data – Investment Strategy

OPPORTUNITIES & THREATS IN DERIVATIVES SHOCKER

 “With Key Mega-Financial Institutions around the World claiming in 2008 that they risked collapse if they were not bailed out, one must ask which ones benefited from the $13 Trillion plus Increase in Gross Market Value of their OTC Derivatives in the six months between June, 2008 and December, 2008 when the Equities Markets were crashing? A logical Conclusion: Key Central Bankers and Favored Financial Institutions of The Fed-led Cartel*, quite possibly including the shareholders of the private for-profit U.S. Federal Reserve”

Deepcaster, May 29, 2009

For investors, both Opportunities and Threats reveal themselves in the recently reported stunning drop ($90 Trillion+) in Total Notional Value of OTC Derivatives Contracts Outstanding worldwide and an equally stunning rise ($13 Trillion+) in Actual Gross Market Value of OTC Derivatives Contracts Outstanding, in just the last 6 months of 2008. (See Chart Below)

Source: Bank for International Settlements

The Total Notional Value of OTC Derivatives Outstanding dropped from some $683 Trillion as of June, 2008 to $592 Trillion as of December, 2008, according to the Bank for International Settlements (BIS – the Central Banker’s Bank – see www.bis.org, Path: Statistics > Derivatives > Table 19) (Ed Note: A Rough “Cocktail Party” Definition of “Notional Value” is “Unrealized Potential Maximum Value.”)

This first drop in Notional Amount of OTC Derivatives Outstanding in years, mainly reflects the massive deleveraging which occurred during the Fall, 2008 Market Crash.

Perhaps even more stunning was the drop in Notional Amounts of OTC Gold Contracts outstanding from $649 Billion in June, 2008 to $395 Billion as of December, 2008. Yet the change in Gross Market Values of the OTC Gold Contracts outstanding during that period was minimal – a drop from $68 Billion to $65 Billion. We comment on what that portends for Gold below.

In order to determine and evaluate the Opportunities and Threats created by the aforementioned drop in Notional Value of OTC Derivatives outstanding coupled with a dramatic increase of $13 Trillion in Gross Market Values we must first consider a few facts.

To put the Derivatives Monster in perspective, consider that the value of all publicly (exchange-traded) Equities now existing in markets world-wide is “only” about $31 Trillion.

That $31 Trillion is only just over 5% of the still remaining nearly $600 Trillion in Notional OTC Private (i.e. Dark) Derivatives Contracts outstanding. The implications are stunning:

1. If the unwinding of a “mere” $91 Trillion in Derivatives contracts (to bring the Total down to $592 Trillion from $683 Trillion) reflected the Magnitude of the pain that the Fall, 2008 Crash caused, then imagine the Pain which awaits if and when (and probably when) any substantial Portion of the $592 Trillion remaining get unwound.
2. But a substantial portion will likely have to be unwound given that various ongoing Crises have yet to be resolved, and, in many cases are worsening e.g.: Consider:
   1. The U.S. Treasury/Fed etc have already committed some $12.8 Trillion (by one reckoning) for Bailouts, Loans, Stimulus packages and Guarantees, much of it borrowed from, or guaranteed by, U.S. Taxpayers. Yet, clearly, the Toxic Derivatives problem has a long way to go before being solved.
   2. The Fed has moved over $577 billion of U.S. Treasuries onto its Balance Sheet in the short time since it publicly admitted it was monetizing the Debt. (One wonders how many hundreds of Billions in Treasuries were moved (and where!?) before that public admission.)
   3. The Chinese are switching from a U.S. Dollar basis to a Yuan basis domestically.
   4. The Chinese have authorized certain non-Chinese Banks to sell Yuan – based government Bonds.
   5. Foreign Creditors own over half the U.S. Dollar based government and Agency bonds leaving the fate of the U.S. Economy and Security in the hands of foreigners and primarily the Chinese government.
   6. The United Arab Emirates are spearheading plans to launch an Asset-backed (likely with Gold and Crude Oil) Currency, the Dinar.
   7. Germany has reportedly demanded return of all Gold held in custodial Accounts in the U.S.
   8. The Chinese have increased their Gold reserves from 400 Tonnes to over 1,000 Tonnes in the past five years.
   9. The default rate on U.S. Option ARMS recently rose to 35%. There are still some $300 Billion of these loans still outstanding.
   10. The interest Rates on about one Million Pick N Pay loans will reset in the next two years.
3. Clearly, given the foregoing, acquiring Gold and Silver as Safe Haven Assets is the Prudent Course. However, Gold and Silver are subject to price Manipulation by the Fed-led Cartel* of Central Bankers and Favored Financial Institutions as we explain below. But we also explain that there is a Strategy to Profit from these Interventions while acquiring an increasing core Position in these Precious Metals.
4. A substantial portion of the aforementioned $592 Trillion in OTC Derivatives is available to The Fed-led Cartel* to continue to overtly and covertly manipulate the Precious Metals, Strategic Commodities, and Equities Markets.*We encourage those who doubt the scope and power of Intervention by a Fed-led Cartel of Key Central Bankers and favored financial institutions to read Deepcaster’s December, 2008 Letter containing a summary overview of Overt and Covert Intervention entitled “A Strategy for Profiting from the Cartel’s Dark Interventions & Evolving Techniques” and Deepcaster’s July, 2008 Letter entitled “Market Intervention, Data Manipulation – - Increasing Risks, The Cartel ‘End Game’, and Latest Forecast” at http://www.deepcaster.com. Also consider the substantial evidence collected by the Gold AntiTrust Action Committee at http://www.gata.org for information on precious metals price manipulation. Virtually all of the evidence for Intervention has been gleaned from publicly available records. Deepcaster’s profitable recommendations displayed at http://www.deepcaster.com have been facilitated by attention to these “Interventionals.”
5. And Market Manipulation is an Enterprise with Great Profit Potential. Consider specifically, as of June 2008 the Gross Market Value of all Derivatives Outstanding was $20,353 billion (see chart below). By December 2008, that $20 trillion has risen to $33,889 billion, a rise of over $13 trillion in Actual Gross Market Value of OTC Derivatives. Clearly, some of the Derivatives that were liquidated in the drop from the notional value $683 to $592 trillion resulted in (or, at least, were accompanied by) a very considerable increase in market value (otherwise known as “profits” – whether realized or unrealized) for the Mega Financial Institutions holding them.These remarkable developments reflected in the BIS Gross Market Value of OTC Derivatives figures (below) for period June 2008 through December 2008 prompt certain questions.
   1. First question: which financial institutions in the world experienced an increase in $13 trillions of market value in their OTC Derivatives Positions in the last six months of 2008 while the Equities Market were crashing?
   2. Why do we not see anyone publicizing this information (Tongue-in-cheek-intended) much less the private for-profit U.S. Federal Reserve, which has declined to respond to inquires from Members of Congress about the specific amounts of, or parties to, their transactions and holdings.
   3. Can we not logically conclude that some Mega-financial entities profited immensely from the market takedowns of the Fall 2008 – specifically profiting in the amount of $13 Trillion in increase Gross Market Value of derivatives owned?Consider too that the aforementioned figures were generated by the Ultimate Official Source. They come from the Bank of Central Banks itself, The Bank Of International Settlements, Switzerland, housed in the Tower of Basel.

      Indeed we encourage readers to consider the figures themselves, by visiting http://www.bis.org > statistics > derivatives > Table 19, “Amounts outstanding of over-the-counter (OTC) derivatives by risk category and instrument.” Of course, not all “official” statistics are accurate as we demonstrate below. Indeed, some are intentionally misleading.

      But an increase of $13 trillion in gross market value of Derivatives held by major Financial Institutions, is testimony to the Resources and Power of The Fed-led Cartel*. See Deepcaster’s article “Coping with the Superpower-Cartel Threat!” (1/30/09) at http://www.deepcaster.com.

6. Moreover, Key Statistics continue to be gimmicked by Official Sources much to the detriment of American Citizens and Investors Worldwide.

Indeed, the True State of the Economy is much worse than the Official Figures suggest.

As the Real Numbers mentioned below demonstrate, our ongoing economic and financial crisis is not merely a “normal” business cycle Recession, but a System-Threatening Crisis. Indeed, we have entered into a Depression. (see below)

It is thus another Naïve and False Assumption that the Official Figures accurately reflect the state of the Economy and Markets – - for example, that the current Recession is merely a normal “business cycle” phenomenon.

Making matters worse, Investors and citizens-at-large are misled by Official Statistics which have been gimmicked, as shadowstats.com demonstrates. All of the following Genuine Numbers are calculated by shadowstats.com, which calculates them according to traditional methods used in the 1980s, and early 1990s, before The Political Adjustments currently being utilized began.

Consider the following Real Numbers from shadowstats:

U.S. Consumer Price Inflation (CPI) actually averaged about 11% annualized for much of 2008, rather than the 5% to 6% figures, which have been reported as Official Statistics. Thus, the consumer must cope with diminished purchasing power and the threat or reality of job loss.

Though Official Figures show CPI dropping to 0% in early 2009, the Real early 2009 numbers reveal that CPI was still about 7% annualized.

U.S. Unemployment has (according to Official Numbers) been ranging 4% to 6% from 1995 to 2007, spiking “only” to about just under 7% in late 2008 and 8% in early 2009. In fact, Real U.S. Unemployment in 2009 now about 20% and is still increasing. (shadowstats.com) Thus the consumer (70% of U.S. GDP, we reiterate) is increasingly unemployed, under-employed, and indebted.

As well, the Delusion of Economic Growth claimed by Official Statistics is just that – - a Delusion. Real GDP growth has been negative since 2004. Indeed, in early 2009 GDP “growth” is a negative 5%. (shadowstats.com) Thus the consumer is faced with a deteriorating economy, as well as diminishing job prospects and purchasing power.

As well, the 2008 U.S, Federal Deficit, rather than being about $1 trillion as reported officially, is over $5 trillion if one includes Social Security and Medicare. And, if downstream-unfunded U.S. obligations are included, the U.S. National Debt is about $66 trillion and rising!

Knowing these Real Numbers facilitated Deepcaster’s recommending “Opportunities in the Impending Perfect Storm” – - the title of his early September, 2008 (pre-Crash) Article warning of the impending Crash (available in the Articles Cache at www.deepcaster.com) and his making five short (and subsequently quite profitable) recommendations to subscribers at about that time.

A Strategy for Profit and Protection

Normally, (that is to say, in a Genuine Free Market situation) the go-to “Safe Haven” Assets in times of Financial Crisis would be the Precious Monetary Metals Gold and Silver, as well as other assets such as Strategic Commodities.

We say “normally” because nearly every time yet another Financial Market Crisis has come prominently into the public eye in recent years The Cartel* of Central Bankers has successfully taken down the price of what would normally be The Safe Haven Assets – - the Precious Monetary Metals. A prime example occurred during the much-publicized demise of Bear Stearns in March, 2008, which was accompanied by a vicious Takedown of Gold and Silver. In a non-manipulated Market, given the fact that Bear Stearns reflected great and increasing weaknesses in the Financial System, Gold and Silver should have skyrocketed. But instead they were dramatically taken down.

Yet, the late 2008 – early 2009 Crises appear to be different. Gold launched from the mid $700s/oz. to around $900/oz. during September, 2008, fell back to the low $700s and then launched again toward $900 in December, 2008 and has actually exceeded $900 several times in 2009.

So the question now, near the beginning of June, 2009, is it different this time around? Have Gold and Silver finally thrust off the shackles of Cartel Intervention? Or will The Cartel be able once again to cap and take down the prices of these Precious Monetary Metals and Strategic Commodities? Deepcaster has very recently addressed this question in a Forecast he issued for the likely fate of Gold, Silver, Crude Oil & the U.S. Dollar in the Alerts Cache at www.deepcaster.com.

One thing is certain: The Cartel will certainly attempt again to take down Gold, Silver and Crude Oil at the earliest opportunity because the Strategic Commodities and Precious Monetary Metals are Competitors as Stores and Measures of Value with the Central Bankers’ Treasury Securities and Fiat Currencies.

Yet there is a Strategy which accommodates Cartel Interventional attempts and at the same time provides excellent Profit Opportunities, whether the Cartel Interventional attempts are successful or not.

A major premise of The Strategy is that one can certainly remain a Hard Assets Partisan (as Deepcaster is) while at the same time insulating oneself somewhat from future Takedowns. The following points provide an outline of The Strategy (particularly as applied to the Gold and Silver Markets) and are designed to help avoid Portfolio unpleasantness, or even possible financial ruin, in the future, as well as to profit along the way:

1. Recognize that The Cartel is still Potent, as difficult as that may be psychologically for Deepcaster and other Hard Asset Partisans to acknowledge. The Cartel is still the Biggest Player in many markets and, if the timing and market context are propitious, the Biggest Player makes Market Price. In addition, The Cartel has the advantage of de facto controlling the structure and regulation of various marketplaces and that is a tremendous advantage; just as the Hunt Brothers years ago discovered much to their dismay and misfortune, when they tried to corner the Silver Market.
2. Accumulate Hard Assets near the Interim Bottoms of Cartel- engineered Takedowns.
3. In order to know when one is likely near the bottom of a Cartel-generated takedown, it is essential to take account of the Interventionals as well as the Technicals and Fundamentals. Paying attention to the Interventionals facilitated Deepcaster recommending five short equities positions as of early September (just before the Fall Crash) all of which we subsequentially recommended be liquidated profitably.
4. For example, regarding Gold & Silver, near such Interim Bottoms, accumulate a combination of the Physical Commodity (Deepcaster prefers “low premium to melt” bullion coins) and well-managed Juniors with large reserves. (Deepcaster provides a list of such Junior Candidates in our December 20, 2007 Alert “A Strategy for Profiting from Cartel Intervention” available in the Alerts Cache at www.deepcaster.com.) The “Physical” and “Juniors” are for holding for the long-term as a Core Position.
5. Then, to the extent one wishes to speculate on the next “long” move, one should buy the major producers or long-term call options on them. These latter positions are for ultimate liquidation at the next Interim Top and are not for holding for the long-term.
6. However, there will be a time when The Cartel price capping is ineffective and Gold & Silver make record moves upward. The benefit of this Strategy is that one will likely be long in one’s speculative positions when this happens.
7. Near the next Interim Top, liquidate the long options and majors. Again, in order to know when we are close to the next Interim Top, it is essential to monitor the Interventionals, as well as Fundamentals and Technicals.
8. Near that Top, sell short or buy puts on Majors. We re-emphasize the Majors as preferred vehicles for trading positions because such positions are more liquid and tend to be quite responsive to Cartel moves.
9. Near the next Interim Bottom, cover your shorts and liquidate your puts and go long again to begin the process all over again. We emphasize that it is essential to consider the Interventionals as well as the Fundamentals and Technicals in order to determine the approximate Interim Tops and Bottoms.
10. Finally, Hard Assets Partisans have the opportunity to become involved in Political Action to diminish the power of The Cartel. It is truly outrageous that the average unsuspecting citizen, and prospective retiree, can and does put his hard won assets in Tangible Assets and/or Retirement Accounts only to have those assets effectively de-valued by Cartel Takedowns and other Cartel actions. This is extremely injurious to many average citizens in many countries who are saving for the rainy day or retirement and have their retirement and/or reserves effectively taken from them. In order to help prevent this and similar outrages, we recommend taking three steps:
    1. Become involved in the movement to Audit and then abolish the private-for-profit U.S. Federal Reserve as Deepcaster, former Presidential candidate Rep. Ron Paul, and legendary investor Jim Rogers, all have advocated. The ‘Audit The Fed’ Bill is H.R. 1207 (and has over 180 co-sponsors); and The Abolish The Fed Bill is H.R. 2755.
    2. Join the Gold AntiTrust Action Committee, which works to eliminate the manipulation of the Gold and Silver markets (www.gata.org). GATA is a non-profit organization, which makes a great contribution by gathering evidence regarding the suppression of prices of Gold, Silver and other commodities.
    3. Work to defeat The Cartel ‘End Game.’ Deepcaster has laid out the evidence regarding the Ominous Cartel “End Game.” Clearly The Cartel is sacrificing the U.S. Dollar to prop up Favored International Financial Institutions and to maintain its power. But this sacrifice cannot continue forever. See Deepcaster’s July 2008 Letter in the ‘Latest Letter’ Archives at http://www.deepcaster.com.

If this aforementioned Strategy is employed effectively, it can result both in an increasing Core Position in Gold and Silver, and in considerable profit along the way.

Additional insights and details regarding this Strategy, which are essential to profiting from The Cartel’s Policies, are laid out in Deepcaster’s article of 3/06/09 entitled “Investor Advantage: Revisiting The Cartel’s ‘End Game’.”

Protection and profit required Proactivity and attention to the Interventionals, Fundamentals and Technicals, not “Buy and Hold.” “Buy and Hold” rarely succeeds anymore as current market conditions attest.

Indeed, the Key Point of the Strategy for Protection and Profit is careful attention not only to the Fundamentals and Technicals but also to the Interventionals. These Overt and Covert Cartel-generated Interventions have the power to move markets as those who study the matter can attest.

Thus, the Key to Profit and Protection is a Strategy: Successful Investors must become Long-Term Position Traders, with their trading choices informed by the Interventionals, as well as the Fundamentals and Technicals. Moreover engaging in the Actions suggested above can help prevent The Cartel’s obtaining Superpower status, and aid in achieving wealth protection and profits as well.

Deepcaster

May 29, 2009

DEEPCASTER LLC