Ethanol Production Fueling ‘Food Inflation’

Courtesy of NEWSMAX:

While rising food prices have been a factor in recent riots in Egypt, Tunisia and elsewhere, the United States is continuing to increase its use of corn to make ethanol, pushing up grain and meat prices worldwide.

“The global economy is getting back on its feet, but so too is an old enemy: food inflation,” The Wall Street Journal states in an editorial, noting that the United Nations benchmark index for food reached a record high in December, “raising fears of shortages and higher prices.”

In 2001, only 7 percent of America’s corn crop, about 707 million bushels, was used to make ethanol fuel for vehicles. By 2010, nearly 40 percent of American corn went for ethanol — almost 5 billion bushels out of total U.S. production of 12.4 billion bushels.

American farmers account for about 39 percent of global corn production, and about 16 percent of the crop is exported, so America’s ethanol production can influence world prices.

March futures for corn recently hit a 30-month high of $6.67 a bushel, up from $4 a bushel a year ago.

Also, since 40 percent of U.S. corn production is used as animal feed, rising corn prices push up the cost of beef, poultry and other items as well.

“This trend is the deliberate result of policies designed to subsidize ethanol,” and it “coincides with a growing consensus that ethanol achieves none of its alleged policy goals,” The Journal observes.

Ethanol supporters claim it reduces American dependence on foreign oil, but a Cornell University scientist calculated that even if the entire American crop was used for ethanol, it would satisfy just 4 percent of our oil consumption.

And the Environmental Protection Agency has downplayed assertions that ethanol provides a cleaner source of energy than gasoline, saying it “has a minimal to negative impact on the environment,” according to The Journal.

The American Thinker on Monday observed: “Today there is a global food shortage and sky-rocketing prices. This has become the underlying factor in the riots in Tunisia, Algeria and Egypt, where up to 56 percent of a person’s income is dedicated to the acquisition of food. These riots are now leading to the upheaval of governments and the very real possibility of the ascendancy of the radical elements into control.”

A significant factor “in the overall global food situation is the American decision to, in essence, burn food in its cars, a policy championed by the environmentalists since the 1990s,” American Thinker also noted.

“There is no quicker way to foment riots and revolution than to deprive the populace of food, particularly when so much daily income goes into feeding oneself and one’s family. The pictures we have seen in North Africa may well be repeated elsewhere throughout the world.”

Noting that Congress recently voted to extend the $5 billion tax credit for blending ethanol into gasoline, The Journal concludes: “At a time when the world will need more corn and grains, it makes no sense to devote scarce farmland to make a fuel that exists only because of taxpayer subsidies and mandates.

“If food supplies tighten and prices keep rising, such a policy will soon become immoral.”

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.

THE COFFIN SHAPED RECOVERY

THE COFFIN SHAPED RECOVERY

While often wrong, Bernanke is right about the recession. It’s almost over. But a depression is about to replace it.

There has been much discussion about this recovery, whether it will be a “U”, “V” or a “W” shaped recovery. The answer is none of the above. It is going to be “C -shaped” recovery, but not as in the letter “C” but as in coffin.

 

 

The Coffin-Shaped Recovery

It would be a miracle if trillions of dollars of debt could be wiped out with one stock market crash and be succeeded by a new bull market driven by another large offering of credit by the Fed.

But such a central bank-engineered miracle today is impossible. Capitalism’s natural cycles derive from central banker’s unnatural infusion of credit into previously free markets. The subsequent distortion causes market demand to expand (which everybody loves) only to be followed by the inevitable contraction—which everybody hates.

Usually, central banks wait until previous levels of excess credit have been absorbed in an economic downturn before embarking on a fresh round of credit creation. This time, however, it is different.

This time, the cumulative buildup of debt over previous cycles where contractions were cut short to minimize economic pain and attendant political consequences is now so large that any contraction is sufficient to bring down the extraordinary backlog of debt built up over previous cycles.

The current contraction is more than sufficient to do so as it is more severe than any downturn since the 1930s; and despite the frantic attempts of central banks to contain the cumulative forces unleashed by previous cycles of credit and debt, the enormous but fragile paper-based economy built by central bankers’ paper money is now collapsing.

To hopefully prevent the collapse from reaching its catastrophic end, central bankers have now intervened far earlier and with far more credit hoping to prevent the day of reckoning, a reckoning soon to be evidenced by an historic deflationary depression that will wipe out all accumulated unpayble debts, albeit at the cost of a functioning world economy.

Such is Ben Bernanke’s considerable task. Despite his outwardly positive demeanor, Bernanke is well aware that his desperate gamble hasn’t worked.

In these times, the last thing you want to be is Ben Bernanke’s sphincter.

(note: Martha declined to produce my relevant cartoon)

KEYNESIAN COPS, FRIEDMAN’S FOLLIES, AND THE FLAWED THEORY BEHIND THE RECOVERY

The current chairman of the US central bank is Ben Bernanke, a self-described student of the Great Depression; but, learning is limited by what is taught and regarding the Great Depression, Bernanke’s teacher unfortunately was Milton Friedman.

The reason why central bankers (and Ben Bernanke in particular) are flooding the global economy with money, i.e. borrowed, printed, or monetized out of thin air with such abandon (who would have thought bankers could act with abandon except, of course, when believing risk is non-existent and they’re betting someone else’s money), is because of Milton Friedman’s theory, to wit that economic contractions can be reversed by sufficient monetary expansion.

Laid bare, Freidman’s theory is another iteration of the Keynesian belief in the power of government intervention, albeit an intervention cloaked in Friedman’s more palatable—at least to those on the right—conservative garb.

Friedman argued that if the Fed had aggressively expanded the money supply in the 1930s, it would have then counteracted deflationary forces and prevented the Great Depression, an argument unfortunately as flawed as another of Friedman’s pet theories, i.e. thatfloating exchange rates would naturally over time bring global trade deficits into balance.

Note: When exchange rates were allowed to float in 1974 as encouraged by Friedman who also encouraged Nixon to abandon the gold standard in 1971, the US had a positive balance of trade. Thirty five years later, the US trade deficit is well over $800 billion and is growing over $20 billion each month (Hey, Milton, how much more time will it take to balance the trade deficit?).

Professor Antal Fekete warned several years ago that Friedman would someday be proved wrong and that we would collectively suffer the consequences; and, that just as during the Great Depression when banks hoarded the government’s cheap money instead of lending it, they would do so again when Friedman’s theory of monetary expansion was tried during another contraction.

Professor Fekete’s warnings have now come true. Today, US bank lending growth has entered negative territory at the same time cash reserves at US banks increased by 1,460 %.

Frank Shostak in Does A Liquidity Trap Pose A Threat, 9/23/09, on mises.org writes:

The latest data for lending in the eurozone the United Kingdom, and the United States display a visible weakening. In the eurozone, the yearly rate of growth of bank lending to the private sector fell to 0.6% this July from 9.3% in July last year. In the United Kingdom, the yearly rate of growth of lending to the private sector fell to 2.2% in July 2009 from 10.1% in July 2008. In the United States, the rate of growth of lending plunged to minus 3.8% in August 2009 from a positive figure of 8.6% in August 2008…At the end of July this year, [however], US banks were sitting on $729 billion of cash against $1.9 billion in July last year.

http://mises.org/story/3697 [bracketed words, mine]

Friedman’s theory is flawed and as suspect as the paper money Friedman and Keynes both promoted. Central banks can print all the money they want but that will not necessarily increase the money supply as central bankers are discovering.

Severe monetary contractions that cause deflationary depressions are so powerful they, like monetary black holes, can destroy money faster than central banks can create it.

The on-going monetary contraction is now clearly evident. Ambrose Evans-Pritchard, columnist for The Telegraph UK, points out the glaring truth that Bernanke and most of his paper-weight brethren would like to avoid:

The US money supply has experienced the sharpest contraction in modern history, heightening the risk of a Wall Street crunch and a severe economic slowdown in coming months… the M3 ‘broad money” aggregates fell by almost $50bn (£26.8bn) in July, the biggest one-month fall since modern records began in 1959.

“Monthly data for July show that the broad money growth has almost collapsed,” said Gabriel Stein, the group’s leading monetary economist.

On a three-month basis, the M3 growth rate has fallen from almost 19pc earlier this year to just 2.1pc (annualised) for the period from May to July. This is below the rate of inflation, implying a shrinkage in real terms.

The growth in bank loans has turned negative to a halt since March…. shifts in M3 are a lead indicator of asset prices moves, typically six months or so ahead. If so, the latest collapse points to a grim autumn for Wall Street and for the American property market. As a rule of thumb, the data gives a one-year advance signal on economic growth, and a two-year signal on future inflation.

http://www.telegraph.co.uk/finance/economics/2795017/Sharp-US-money-supply-contraction-points-to-Wall-Street-crunch-ahead.html

This is not your mother’s contraction. Instead, this is the mother of all contractions, a contraction far greater than even that which sent the world into the Great Depression in the 1930s.

This time, the amounts owed are exponentially greater than what was owed in the 1930s; and, the greater the debts, the farther the fall. Debt does not just disappear without consequences, nor can it be outrun, sic outgrown, as economists are desperately hoping, especially today when economies are contracting, not expanding.

Economic contractions cannot be reversed by expanding the money supply any more than wishful thinking by itself will change the world. Despite the best efforts of central bankers like Ben Bernanke, Friedman’s flawed theory cannot save the world from what is now about to happen—the mother of all depressions that may be capitalism’s last.

Keynes and Friedman, both brilliant, were both believers in paper money. Paper money has many powers, not the least of which is the power to mislead and delude.

Milton Friedman thought a lot Of paper money and more Like Keynes and others who thought the same Milton showed gold the door And now our gold is spent and gone And so is Milton too And now we’re left bereft and broke Not knowing what to do But Ben Bernanke’s at the helm Of the sinking ship we’re on And soon like Milton and our gold We, too, will soon be gone So let’s make a toast while we’re still here To those who caused our ruin To those convinced that they were right But didn’t know what they were doing

WHO BENEFITS FROM THE FRAUD OF PAPER MONEY

The substitution of paper money for gold and silver has always been imposed by those who govern upon those governed; and, in the US it was done so illegally. The US Constitution explicitly defines the US dollar in silver, not paper money. The current regime of fiat money in the US is not only a monetary abomination, it is de jure unconstitutional.

The imposition of fiat money in the US was done without the consent of the governed. However, those who govern approved it. This is because the advantages of paper money accrue to those who rule; and it is in their interests, not society’s, that paper fiat money becomes the coin of the realm.

The disadvantages of paper money are borne by society-at-large, i.e. entrepreneurs, workers, businesses, retirees, savers, etc. who pay retail for the credit dispensed wholesale to those better connected, e.g. are you able to leverage your investments 50:1 as can JP Morgan Chase, Goldman Sachs, etc.; and, can you to carry your underwater investments at full book value and borrow against them as it does Wall Street? And were you bailed out last year as were the banks?

I have always been amazed at those who identify with a system that primarily serves the needs of others and only incidentally theirs. I can only conclude that such identification is symptomatic of low self-esteem, as self-interest alone would dictate otherwise.

We are now headed towards a rendering so extreme that such divisions will become clear and perhaps the many will finally cease identifying with a system that benefits the few closest to the fountainhead of credit while penalizing the many farther downstream which usually includes them.

Modern economics is a sophisticated Ponzi-scheme cross-pollinated with a shell game designed for the advantage of government, banks and those at the front of the line wherein money is created out of thin air to be loaned to others who will in the end be indebted beyond their means to repay and whose economic futures will be destroyed by the inevitable confluence of the bankers’ compounding interest and their constant inflation of the money supply.

 

If you doubt this is so, an article The Event by Eric Andrews, is a must read, especially the areas directly concerned with money and its creation. If you already believe this is so, Eric Andrew’s article is even more important. Clear, concise, and conclusive, it points out the inherent problems with our debt-based system of paper money, a system that contains its own seeds of destruction, seeds which are now flowering, www.financialsense.com/fsu/editorials/2009/0921.html.

Andrews also points out where we are and perhaps headed without guessing when we will arrive. We face a minefield of possible scenarios as deflation, inflation, hyperinflation, or a combination thereof may soon be in our future as the bankers’ paper money is now about to self-destruct.

THE BARRICKADE TO GOLD CRUMBLES

We are in the final stage of the paper-boys’ efforts to preserve their crumbling fiefdoms against gold’s advance. In truth, gold is not advancing at all. It is standing still. It is the constant decline in the value of paper money that makes it appear that gold is rising. Extant virtue needs no movement.

While I am in deep admiration of Professor Fekete’s insights on gold and money, I do not envy the price he paid for his learning. Professor Fekete’s understanding of monetary chaos derives from a childhood in Hungary beset by a hyperinflation more severe than even that of the Weimar Republic or Zimbabwe.

Professor Fekete then escaped communist oppression in Hungary to make his way to Canada where he received a front-seat look at the central bank and corporate collusion underpinning capitalism’s fraudulent paper-money scheme.

Upon retirement, Professor Fekete had invested his savings in Barrick Gold Corporation, a Canadian gold mining company. But instead of an expected return on his savings, the professor got an unexpected education in how Barrick assisted central banks in suppressing gold.

Barrick’s forward selling of unmined gold from 1988 to 2003 put thousands of ounces of paper gold on the market which forced down the price of physical gold. For years, the forwards sales of Barrick and Anglo-Gold Ashanti were responsible for the downward spiral of gold’s price, a goal desired by investment banks doing the bidding of central bankers.

Professor Fekete, as a shareholder, clearly understood that Barrick’s forward selling (or so-called hedging operations) came at the expense of shareholders. It did, however, directly benefit the central banks who wanted to cap the price of gold. Today, the “Barrick-cap”, a major “Barrickade” against gold’s rise is no more.

This month, on September 8, 2009, Barrick Gold Corporation announced it was taking a $5.9 billion charge against 3^rd quarter earnings in order to buy back all its forward contracts, a considerable sum to pay for succumbing to the wishes of those in power.

Once again, Professor Antal Fekete was right. Sponsored by the Gold Standard Institute, Professor Fekete will be in Canberra, Australia, November 2-5 speaking on “The World Financial Crisis and the Vanishing Gold Basis”, see http://www.professorfekete.com. I consider the Professor to be a light in these dark times. I and others will also be speaking.

It is absurd to discuss the price of gold without discussing central bank or government efforts to force the price of gold down, an effort that may soon be ending due to the imminent advent of the end-game.

In my Youtube video, http://www.youtube.com/watch?v=5o36Dj-ukPo, I discuss the possibility of whether or not the US will again confiscate gold. I wish the possibility were not so.

But, today, governments cannot see an alternative to that offered by central bankers, the merchants of debt who have enslaved nations with their fraudulent debt-based paper money. As yet, there are no alternatives to the bankers’ offerings. But after bankers and governments fall—and they will—alternatives will then become clear

Buy gold, buy silver, have faith.

Darryl Robert Schoon

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

Imperfect Futures

“A great deal of uncertainty exists in the global economy, making it extremely difficult to know how our customers will respond during the remainder of 2009.”

Where have we heard this line before? In this case, it was Caterpillar CEO James Owens, a former CFO and economist, explaining in April why the company cut annual profit estimates in half as it reported its first loss in 16 years. But Owens is hardly alone. Executives at companies from wine and spirits purveyor Brown-Forman Corp. to prison-builder Corrections Corp. of America have been invoking the “u” word with alarming regularity in earnings calls. There are few signs that that will change any time soon, even as the recession passes the 18-month mark.

Link to article

http://www.cfo.com/article.cfm/13983298

The Financial Crisis … The Problems Aren’t Over, Not By a Long Stretch

He Who Borrows the Most, Wins
by Niels Jensen

“Never in the history of the world has there been a situation so bad that the government can’t make it worse.” -Unknown

The stock market might bounce for a while, global currencies might stabilize for a while, but don’t be deceived, large problems remain…very large problems. And the price to fix these problems will run into the tens of trillions of dollars. That’s the kind of price tag that could ruin a national currency or two…even the world’s reserve currency.

While equities continue to go up and up, most of us are left scratching our heads. Is this the real thing or will it go down in history as ‘just’ another bear market rally? Not so long ago, the entire financial system stared Armageddon in the face. Now, only a few months later, equity markets behave as if all the worries of yesterday have been washed away.

The dangerous conclusion to draw from the experience of the past few weeks is that all is now well and dandy and it is time to load up on stocks again. I cannot emphasize it strongly enough: The bull market of March-April 2009 is almost certainly a bear market rally. As one of my partners pointed out the other day, NYSE saw four 20%+ rallies between 1929 and 1932. Bear market rallies can be extremely powerful and hence deceiving.

But the problems are not over yet. Not by a long stretch. It will take longer than 18 months to unwind the excesses of the past 25 years. Analysts at Morgan Stanley reckon that the 15 largest banks, which between them have shrunk their balance sheets by about $3.6 trillion so far in this crisis, will shed another $2 trillion in 2009. The US financial sector debt load (as a % of GDP) is now 117%. In the early days of the great bull market in 1982, the same number was 22%. Households are not much better off than the banks, with total household debt now at 96% of GDP vs. 47% in 1982.

The IMF reckons that both European and US banks – but in particular the European ones – are well behind the curve in terms of recognizing their credit crunch related losses. According to the IMF, there is at least another $1.5 trillion to come.

As the recession bites into the lives of ordinary people, banks will face losses not only on sub-prime mortgages but on all loan products. In fact, sub-prime is indeed a small fraction of the total loan book for the US banking sector. Prime and Alt-A mortgages, together with commercial real estate loans total about seven times the size of the subprime market.

Delinquencies are now on the rise on all mortgage products; however, whereas sub-prime started to deteriorate as early as 2007, it is only recently that delinquencies related to Alt-A mortgages have taken off, and prime and jumbo loans are only now starting to suffer.

These defaulting mortgages pose a very serious threat to the U.S. economy, but they are only part of the economic crisis worldwide. By far my biggest concern at the moment is the enormity of the debt problem facing most OECD countries. In the March issue of the Absolute Return Letter, I referred to an important study conducted by Carmen Reinhart and Kenneth Rogoff back in December of last year.

Reinhart and Rogoff studied every banking crisis of the past generation and made some startling observations. One in particular caught my attention. According to the authors, governments inevitably underestimate the ultimate cost of a banking crisis, because the indirect costs (such as falling tax revenue in subsequent years) end up much higher than predicted.

The IMF estimates that the cost of the current crisis to the United States will eventually reach 34% of GDP or close to $5 trillion. However, the Obama administration, through its various implicit and explicit guarantees, is already using a number close to $9 trillion. And Reinhart and Rogoff’s historical average of 86% of GDP implies an ultimate cost of over $12 trillion!

The true cost is important, because it has to be financed through new bond issuance, and it is my thesis that the sheer size of this tsunami will eventually overwhelm the world’s bond markets. Even using the relatively conservative IMF estimates, the twelve largest industrialized countries of the world will have to issue about $10 trillion worth of new bonds to cover the cost of the current crisis.

However, if you (like me) believe that IMF underestimates the true cost of this crisis, Reinhart and Rogoff offer a more realistic approach. Using their least costly case study (Malaysia 1997) as our best case scenario, the true cost comes to $15 trillion. If one uses the average of 86% instead, the cost jumps to a whopping $33 trillion. I didn’t even bother to produce a worst case scenario – it all got too depressing!

I need to put the $33 trillion into perspective. Total global savings (loosely adjusted for the big losses in 2008) are probably somewhere in the region of $100 trillion. In other words, financing this crisis could absorb one-third of total global savings.

Hence it comes down to the price at which governments can attract sufficient demand from people like you and me. One of two things may happen. Either this crisis will ignite such a bout of deflation that investors will happily own government bonds yielding 2-3% or the deflation scare goes away ultimately, the global economy recovers and bond investors demand much higher yields for taking sovereign risk. I am not yet sure which scenario will prevail, but I do know that both are quite bad for equities longer term.

There is a third route, of course. Governments could print money for themselves, which they could then use to purchase their own bonds. We call that process inflation…and it is already underway.

An Updated Take on the Economic Situation

IMF Bombshell

Neville Bennett

There is a disconnect between the real world and Wall Street. Wall Street prices surge while real economy difficulties increase daily. Exports are falling, house prices are declining, and no-one can sell cars. However, There is a perception of “green shoots” indicate that that the real economy may recover quite soon because the financial sector has recovered, and a bull market is underway.

The financial sector, however, has been singled out by the IMF for a thorough review. It emphasizes the key challenge of breaking the downward spiral between the financial system and the economy. The IMF believes that “promising efforts” are under way to redesign the global financial system to provide a more resilient platform for sustained economic growth.

OVERVIEW

The financial sector needs mending. Banks and corporates need refunding, balance sheets have to be bolstered, and capital needs to flow across borders, especially to the merging countries. There is on-going destruction or corruption of assets, and the latest IMF estimate of write-downs has increased from US$ 2.2 trillion in January, to a possible US$4 trillion in April. The increase arises partly because of worsening picture of economic growth and the spread to other mature market-originated assets. About a third of newly-emerging write-downs will be incurred by non-banking institutions

There have been some improvement in interbank markets but funding remains a difficult issue, especially long-term funding. In some jurisdictions banks can issue government guaranteed, longer term debt. But the funding debt is big, with the result that many corporations are unable to obtain bank-supplied longer term debt or even working capital.

Present Risks

The crisis has deleveraged asset prices causing much distress. Some Pension funds and Life Insurers are now underfunded. Some managed their risks prudently, but others undertook risks which they did not really understand. The greatest problem is, however, the decline of cross-border funding. Emerging market economies desperately need refinancing, probably to the tune of $1.8 trillion in 2009. They had relied on private capital flows but these have been reversed.

Although there have been massive fiscal stimulus packages already, further policy action is necessary to restore confidence and thereby relieve uncertainty. Uncertainties are “undermining the prospects for an economic recovery”. The cost of these packages is causing concern, especially when the debt burden combines with longer-term pressures from an aging population. There is a “home-bias” as officials encourage banks to lend locally and consumers to keep their spending domestically orientated.

These are extremely challenging times as officials try to break a downward spiral which is dragging down the financial sector and the real economy.

Recommendations

The economic recovery will be protracted. The deleveraging process is not over and will continue to be slow and painful. Credit growth will contract in the US, UK, and EU, and only recover after a number of years. But political support for more fiscal and monetary aid by the state is waning. There is a risk that governments will be reluctant to allocate sufficient funds to solve the problem.

Restoring the banking system will take several years. Governments should co-ordinate policies to ensure that the banking system has access to liquidity; the impaired assets are identified and dealt with; and weak banks and other viable institutions should be recapitalized. Lessons from previous crises suggest that very forceful measures are required to resolve financial sector weakness.

The IMF has tried to assess existing losses and possible future write-downs in Western banking systems in 2009-2010. Its lowest estimate is $275 bn for US banks, $375 for Euro and $125 for British banks, and about $100 bn for other European banks. But the banks must first increase certainty identifying their capital needs and disclosing impaired assets. Bank supervisors must be very strict in evaluating bank claims and business plans. Viable with insufficient capital could get sufficient capital injections from the state to encourage private capital to join in raising capital ratios.

While banks use public money, their operations must be closely monitored, dividends and restricted, and compensation closely examined. There will be cases to replace top management. Non-viable banks could be merged with others or undergo orderly closure.

The difficulty in attracting private capital means deep government involvement is necessary, even to the extent of taking control. But ideally, the bank will be returned to the private sector as quickly as possible. It would be helpful to convert Government holdings of preferred shares to common stock.

Funding Needs

Bank funding remains highly stressed. Some governments have guaranteed deposits and some forms of bank debt, but wholesale funding is inadequate. Central banks will continue to need to provide ample liquidity for the foreseeable future.

Emerging markets are hemorrhaging capital and this will continue over the “next few years”. Their central banks will also need to provide ample liquidity, and also perhaps foreign currency through swaps or outright sales. IMF’s enhanced resources can buffer the financial crisis. The larger problem in emerging markets is a lack of capital to roll over corporate debt. Government support seems warranted to keep trade flowing and limiting damage to the real economy. The situation warrants devising contingency plans to prepare for large-scale restructurings in case circumstances deteriorate further.

Pressure to support domestic lending may lead to financial protectionism. In several countries authorities have stated that banks receiving support should expand their domestic lending. This could crowd-out foreign lending as banks face on-going pressure to delever balance sheets, sell foreign operations and remove risky overseas assets. These policies can damage the global economy.

Fiscal issues

Credit growth is necessary to sustain economic activity. In countries with fiscal room for maneuver, fiscal stimulus will be welcomed by markets. But markets are showing concern in countries where debt is an issue, and bond yields have increased and currencies weakened.

There is a universal need for stimulus now, but this clashes often with issues of sustainability. Governments risk a loss of confidence in their solvency if there are no plans for debt reduction

Conclusion

Policymakers have to address urgently the present crisis as well as devising a more robust financial system. Improved financial regulation and supervision are key components in preventing future crises by mitigating future systemic risk. The financial system will remain under pressure for years and require massive new funds.

Time for Obama to Figure It Out

I heard a quote today that struck a chord.  When Albert Einstein witnessed the horrors of WWI, he commented that the technological developments of the time – “were like an axe in the hands of a madman”.

In a way the same could be said of the information revolution that empowered our finance houses to create the greatest greed-driven boondoggle in the history of mankind.

There’s nothing wrong with the technology.  It’s just a dumb tool that, when used properly, has wonderful effects; ie the internet.  Once again, as always, it comes down to what humans do with it.

The roots of our current predicament come down to the actions of the Fed, which arrogantly believed that they could create endless credit and fiat money without consequence.  Somehow they came to believe that if they did it on a large enough scale, there would be no price to pay.  But, of course, there are always consequences; and we’re just starting to pay the bill now.

Long before the real estate mess imploded, we were already a debtor nation, with ridiculously-low savings rates and a junkie’s buying habit.  Those factors in and of themselves were due to have negative consequences.  But then the finance houses decided to take matters to a whole new level.  The problem went global, and the effects are reverberating back & forth with ugly new surprises almost daily.

We now find ourselves in the absurd position of having to create even more massive debt and fiat money to make whole the very finance houses that created this mess; a bill we’ll be paying for years.

The fact that we’re not already starting to recover is a function of one of two factors:

• Either the Fed & Treasury just don’t get it yet, and are throwing thimbles of water on a wildfire

             or

• The mess is so big that they don’t have enough water to throw.

I think it’s the second alternative, and I fear for our country.

Obama doesn’t get it yet.  He’s playing a Lincolnesque/Rooseveltesque game of holding “fireside chats” while shaping a classic Roosevelt style stimulus package.  The amount of money in his plan for financial stabilization is like spitting on that proverbial wildfire.  He doesn’t understand that until we get the liquidity freeze broken, all the other efforts will be for naught.

Wall Street knows this.  Not that I really care what they think because they were complicit in creating the mess.  But they understand what needs to be done, and are frustrated at the lack of progress.

Congress never has had a clue, and never will.  It’s like a lifetime nursery school for privileged lawyers.

I hate big government because it’s invasive and lives to perpetuate its own power.  I’m not eager to help the culprits who created this mess either.  But if ever there was a time to get the printing presses going overtime, it’s now.  There will be a huge price to pay later, but failure to act will cause chaos now.   Just take a look around you.  The place is starting to come apart at the seams.  Even our government representatives warn of the troubles to come.  I wish they would do more to head it off.

For those who argue that the dollar will be destroyed, we already destroyed it.  Our only consolation is that the other nations have destroyed theirs too, so we’re all in the same leaky boat.