Investment risks and opportunities

Is this the death of capitalism

2008-09-22T03:04:00.000-07:00

We all knew where this was going to end up. It was just a matter of how long it took.

You let a bubble get too big, and suddenly it's no longer the problem of the participants alone - it's everybody's problem. And so, when it comes to paying for the global property bubble, it won't just be those who over-extended themselves to buy over-priced houses who suffer. And it won't just be the bankers who sold them the loans.

It'll be you, me, and every other mug who ever paid a penny in taxes to governments who blatantly ramped the idea of property ownership as a right. Our own government might not do anything as obvious as creating a $700bn "bad bank" like the one being proposed in the US.

But rest assured, we'll be paying for the fall-out from this for years to come...

Who's really to blame for this crisis

It's been a hectic couple of weeks, and amid all the chaos, it's easy to lose sight of what this is all about. So let's go back to the basics.

This crisis has its roots in the actions of central banks. I think it's important to make this point very clear right now. George Bush might say there'll be plenty of time for "blame-storming" later. But funnily enough, once 'later' comes around, no one can quite remember who really was to blame, and the government ends up getting to point the finger at whoever it likes - usually the media.

Meanwhile, we're hearing about the 'death of capitalism', and even sensible people are warning that we need more regulation, over everything from City remuneration to short-selling. Now, I have no quarrel with bankers getting bonuses that actually reflect some sort of ability to manage money rather than their luck at being hired at the right stage of the economic cycle. And I'm not shedding a tear for any of the City wives who suddenly seem to have columns in all our broadsheets, bewailing the sheer hell of life without a bevy of domestic servants and carping about how charities will go short of money this year.

But regardless of how irritating all this poor-mouthing from former bankers becomes, we have to remember that their Caligula-esque pay and conditions were a symptom of the credit boom, not the cause.

Whatever is done now to bail out the system, we should remember that this credit bubble has its roots in government interference, in the form of central banking. And when we come to sort the system out, that's where we need to start, rather than with lots of tinkering around the edges.

The central bankers should have popped the property bubble

There was a rampant property bubble. The world's central bankers should have popped it before it grew too big. They didn't (although Mervyn King clearly thought that it would have been a good idea), mainly because Alan Greenspan put his hands over his eyes and said he couldn't see any bubble. He also added that, even if there was one, it would be better to clear up the mess after it had popped. It was obviously nonsense at the time, and by now hopefully everyone realises that.

Because instead of pricking it at a time when the fallout was manageable, we let it grow until harsh reality finally had to step in. Things grew so crazy that the long-term unemployed in the US were being given hundreds of thousands of dollars to buy homes on which they didn't make a single payment. This bubble stopped growing simply because it ran out of room. It just couldn't get any bigger.

Some of you might think it's too simplistic to blame central banks. But think about it for a minute. The first instinctive call of every columnist, estate agent, and business leader in the land, as they realised recession was coming, was to scream for a rate cut. That's a dramatic display of faith in the idea that whatever the problem, a quick wave of the Bank of England's magic wand would make it go away. Even now, some are still labouring under this misapprehension, even though the Fed has amply demonstrated that even slashing rates by more than half has done nothing to ease this crisis.

Because everyone thought that central banks would always be willing and able to save the economy - and the financial services industry - lenders thought they could get away with murder. All the risk ultimately lay with the government, after all. And if you take away the risk, people then do whatever they like without fear of consequences - particularly if regulators have adopted an otherwise hands-off approach.

Why we should let the market set interest rates

What's the solution? Ideally, I'd say just ditch central banks and let the market set interest rates. Central banks, regardless of how ostensibly independent they are, are instruments of the government. The government wants happy voters, and free money makes people happy. So there's always the temptation to keep the money flowing freely.

The market on the other hand, couldn't care less what voters think. One feature of the credit boom is that most people in the City and on Wall Street knew it couldn't last forever, and they had a hunch it would blow up in a very unpleasant way. But they couldn't stop playing along, because they had to compete with their peers. However, if markets set interest rates rather than governments, then arguably this mood of rising concern among the participants, would be reflected in the price of money long before things got out of hand. Anyone who had overplayed their hands would run into trouble long before they became "too big to fail".

The alternative is that we decide that banking is such a vital part of our infrastructure, that it cannot be left to the market. And if it really is the case that "banking is too important to be left to the bankers," as Roger Bootle argues in today's Telegraph, then there's no choice. We have to turn it into a utility. And just like with the water and power regulators, we need a big domineering regulator, who tells them how much profit they can make and how much they can charge us, and in return we get a government-backed banking system.

I know which option I prefer. But I suspect that by the end of this crisis, we'll be left with some half-hearted mish-mash which will simply sew the seeds for the next boom and bust.

Short-sellers aren't to blame for the banking sector's problems

2008-09-19T06:14:00.000-07:00

Short-sellers aren't to blame for the banking sector's problems

It's time to "clean up" the City, says Gordon Brown. He's going to rush forward better rules to protect whistleblowers, apparently and crack down on "irresponsible behaviour" in the financial markets. After all, he says, "we don't want these problems occurring in the future."

The FT reports how his noble words have roused the party's left-wing. Labour MP John Cruddas said: "In the wake of casino capitalism and with the onset of recession, the state is the only means society has of protecting itself from the destructive forces of global capitalism."

It would be hilarious if it didn't make you want to weep. Bankers may well have acted as if they've been sitting in the casino during the boom years. But it was a state-owned casino, with governments as the croupiers, and central bankers behind the bar giving out free booze.

This Government built its reputation for economic "stability" on soaring house prices and nothing else. It was happy enough to point to this growth in "wealth" (not "debt") as evidence of its competence all through the boom. And the reason that banks were able to lend as freely and as stupidly as they did, was because central bankers pushed interest rates so low. And who were central bankers working for? The Government, who set the inflation target too high, at a time when prices were being pushed lower - a healthy development - across the world by globalisation.

But of course, it can't be the Government's fault. So now we have a witch-hunt against the nearest available target - short-sellers. Yet, if you really want to protect whistleblowers, you should embrace short-sellers. Here's why.

Short-selling's a risky business. When it goes right, you can make a lot of profit. But when it goes wrong (as it clearly has today, given the rapid surge in the FTSE 100 and elsewhere), you can end up owing far more than your initial stake. So it's not something to be done lightly. Unlike many 'active' fund managers, who just buy what everyone else is buying, a short-seller has to pick their targets carefully.

So when a short-seller takes an interest in a company, you can bet it's got problems, or that it's about to run into problems. It's no coincidence that the most shorted stocks in the run-up to the UK recession have included retailers, newspapers, and of course, banks.

The point is that the shorts are just taking advantage of the underlying problem. The banks made wildly irresponsible loans all through the property boom, and now that the bubble has popped, they are in serious trouble. In a perfect world without politicians, there'd be no problem with short-sellers taking advantage of that - in fact, the banks are only getting their just desserts.

The real 'spivs' behind the financial crisis

If Alex Salmond and the like want to attack 'spivs', how about the spivs who were cheerily selling young couples interest-only mortgages at six times their joint income? "Don't worry about interest rates, love, you'll be able to remortgage to a better deal in a couple of years' time. And don't worry about the capital - you can always start paying that back once you can afford it. Besides, the house'll be worth a lot more by then."

Those unlucky homeowners are now staring negative equity and rising mortgage payments square in the face, and the truth is it doesn't matter a damn to them who owns their debt, because they can't pay it anyway. Banning short-selling won't help them.

But then, all that dodgy dealing was going on back in the good times. And when times are good, no one wants to hear the warnings, or to let anyone spoil the party. And unfortunately for short-sellers, when times turn bad, most people would rather throw the smart-alecs off a cliff, than admit that maybe they got it wrong.

What the failure of Fannie and Freddie means for capitalism

2008-09-12T00:51:00.000-07:00

I read a very pithy letter to The Telegraph the other day that made me chuckle. Referring to a story about Fannie and Freddie's nationalization, the correspondent asked: "Why didn't your headline 'World's biggest mortgage bail-out' read 'Capitalism fails'?"

Like many of the best headlines, it's witty and to the point. That almost makes it a pity that it's also completely wrong. It's also worrying that far too many other people also have this perception.

Because of course, the reality is that Fannie and Freddie were invented by the government in the first place. The reason they were able to dominate the market to the extent they did was because everyone knew they were government organisations, even when there was still some vague charade that they weren't.

In fact, all this miserable little episode in economic history tells us is this - the market will get you in the end, even if it takes 60-odd years to do so...

What the failure of Fannie and Freddie means for capitalism

As Simon Nixon points out in this week's edition of MoneyWeek (out on Friday), it was in part, the birth of Fannie and Freddie after the Great Depression in the 1930s (Freddie came later, but its roots were in that crisis) that has led directly to the current upheaval in the financial markets.

Fannie and Freddie had the implicit backing of the US government. That meant they could borrow money almost as cheaply as the government. That meant they could buy up more loans than anyone else. That's why they now dominate the US mortgage market. And that's why the government - which first created them - has now had to bring the prodigals back onto its balance sheet.

In other words, the biggest player in America's mortgage market has always been the public sector, complete with unaccountable, overpaid bosses, and dodgy book-keeping. It's only now that the majority of the population realises it.

So the 'failure' of Fannie and Freddie - or rather, the fact that the US government has finally had to admit it always owned these things - says nothing about capitalism. What it does show is that attempts by the government to buck the market are doomed to eventual failure.

It's the exact same story with attempts by central banks to set interest rates. There's a massive gap between what central banks generally say the cost of money should be, and what it actually is just now. And that's because the market has finally reasserted itself and said - this can't go on.

Why the credit crunch is 'the start of the solution', not the problem

As Leigh Skene of Lombard Street Research puts it (and I'm going to give the full quote here, because it's an unusually perceptive summary of what's going on): "The credit crunch is the start of the solution, not part of the problem. The problem is too much household debt, and it took the credit crunch to halt the hysterical borrowing / lending spiral. The crunch will be over when people understand that they should be looking to repay debt, not borrow."

That hits the nail right on the head. What needs to happen now is that people start rebuilding their savings, and companies rebuild their balance sheets. That's the way the market is pointing too. But what's the one big thing attempting to stand in the way of this vital process? That's right - the governments of the world.

Governments hate downturns. That's because voters tend to prefer good times to hard times, unsurprisingly. A government that presides over house price growth and full employment comes in for plaudits, regardless of how that growth was achieved.

The basic ideas behind how to run an economy for a long time now, have been rooted in Keynesian economics. The idea is that governments can take an active role in managing the economy through various tools, including setting the interest rate. You try to make sure the economy doesn't overheat during the good times, and in the hard times, you make money a bit more available, and maybe increase public spending too, to compensate for the downturn in the private sector and "stimulate" the economy.

There is very little the government can do to stop this downturn

Does it work? Who knows? Because while it sounds good in theory, what you actually get is a government that keeps pressing the "stimulate" button for as long as it can get away with it. The British economy has been flooded with cheap money and public spending even when times were good. It's over-inflated the economy, and left us with nothing to fall back on during the hard times.

With the coffers empty, there really is very little any government can now do to stand in the way of this downturn. But that won't stop them from trying. They won't make things any better. But as a long and grim history of price controls, currency market interventions, protectionist laws, and good old Fannie and Freddie demonstrate, they might just make things worse.

Turning to the wider markets...

The FTSE 100 closed at 5,366, down 49 points after a poor showing by banks - affected by their American counterparts' troubles - and miners. Among the risers were ITV, up 6.55% and BAE Systems, up 4.29%. For the latest stock market news and charts, click here.

In Europe, the Paris CAC closed at 4,283, down just 0.2%, and the German Xetra Dax finished down 0.4% at 6,210.

Over in the US, energy stocks were boosted by Opec's decision to restrict output, while financial shares were hit by worries about the future of Lehman. The Dow Jones closed up 38 points at 11,268; the wider S&P500 was up 0.6% to end at 1,232; and the Nasdaq Composite rose 0.9% to 2,228.

And in Asia, the Nikkei-225 was also hit by fears about Lehman, with Nomura holdings down 5.9%. The index closed at 12,102, down 2%.

Brent spot was trading at $96.17 a barrel this morning, with crude oil in New York at $101.76 a barrel. Gold spot was at around $740 an ounce; silver at $10.62 an ounce; and platinum $1,118.00 an ounce.

In the forex markets this morning, sterling was trading against the US dollar at 1.7498 and against the euro at 1.2569. The dollar was trading at 0.7191 against the euro and 107.06 against the Japanese yen.

This morning, owner of Argos and Homebase, Home Retail Group, revealed how badly it has been hit by the consumer slowdown. Second quarter same-store sales fell 5.8% at Argos, and 8.3% at Homebase in the three months to August 30th. Earlier this week, the British Retail Consortium said wider High Street sales were down 1% in August.

The US bail-out is a great opportunity to sell

2008-09-10T03:11:00.000-07:00

Yesterday's breakdown in the London Stock Exchange was a fitting metaphor for the state of the entire financial system. As one problem is apparently solved so another rears its ugly head.

The Federal Reserve flew in to 'save the planet' by nationalising Fannie and Freddie, but UK investors couldn't even get in to sell their rebounding banking shares, because the LSE computers imploded at the vital moment.

As trading finally restarted, London joined markets around the world in the relief rally. But anyone who genuinely believes that Hank Paulson's move to guarantee the US housing market is the end of our woes is kidding themselves...

The stock market party looks a little premature

"Today's meltdown from the LSE couldn't have come at a worse time," said Sejal Patel, a London-based trader at CMC Markets. It's all a bit of a disaster for the idea of the all-singing, dancing, 24-hour trading, etc, second-biggest market in the world that on one of those days it really needed to work properly... well, er, it didn't. "Pretty poor", said Simon Denham of Capital Spreads.

Exactly. But sadly, also typical of today's financial systems. Look at the US mess. The American property market seemed to be solid enough when everyone was making loads of money. But there was a huge fault line running right through the house.

Emboldened by Fed chief Alan Greenspan and his never-ending supply of cheap money, lenders and borrowers threw common sense out of the window, dishing out vast sums to people who had no hope of repaying. As a result, the works have been completely gummed up by a near-$550bn subprime write-off, said S&P last Friday - and the end total could prove even higher still.

So the US authorities jumped to the rescue of Freddie and Fannie with taxpayers' cash. While the first-up 'expert' view is that nationalisation is good because it'll re-establish some stability, the fact that this has happened pre-election (as my colleague John Stepek pointed out yesterday (see: The Fannie and Freddie bail-out: bad news for us all)) shows just how bad things are. And now that the risks have been dumped on the public, it will be much harder to hide the losses.

The move isn't likely to help US house prices, because it won't make life easier for millions of Americans struggling to repay mortgages. It won't reduce the massive stock of unsold American houses - 4.7m at the last count and the equivalent of over 11 months supply, roughly twice a 'stable' market level, according to the National Association of Realtors. It won't cut unemployment, which has now climbed to a five-year high of 6.1%, nor stem foreclosures, which at 2.75% of all home loans are at their highest since records began 29 years ago.

So the stock market party looks a little premature. And what's more, European traders shouldn't be cheering either - eurozone companies are facing a whole other set of problems.

Europe's companies have been spending more than they earn

One of the best barometers, eurozone consumer confidence, has nosedived within recent months. That suggests that the downturn in annual output, which shrank in the second quarter for the first time since the single currency started life 10 years ago, is the start of a lengthy trend.

And now lots of corporate concerns are building up, too. "European companies may be living on borrowed time", says Simon Kennedy at Bloomberg. "A decade of investing more than they've earned in profits has loaded corporations in the 15-nation euro area with debt, leaving them a thinner cushion than their US and Japanese counterparts as the world economy slumps".

In other words, eurozone companies have been living beyond their means. The shortfall between profits and investment for Europe's non-financial corporations rose to 4.5% of annual output last year, reckons Citigroup, compared with 3.6% for their counterparts in the US. Take out companies in Germany, where earnings still outstrip investment, and the gap swells to 6.6%.

It all means that Europe's non-financial companies are burdened with 5.3 trillion euros ($7.6 trillion) of debt, equal to about 57% of the euro-zone economy, up from 48% before the 2001 slowdown and compared with 46% in the US, according to the Federal Reserve and the European Central Bank.
Enough figures. You get the picture. As Europe's companies feel the debt pinch, so will we all. "The size of the debt imbalances makes it very difficult to envisage a strong euro-zone economy over the next year or so," says Dresdner Kleinwort's London chief economist, David Owen. "It increases the risk of recession." Deutsche Bank analysts agree, predicting that investment will shrink in 2009 for the first time in seven years, so that the eurozone's economy will grow just 0.1%.

And the cause? Too much cheap credit, of course, says Deutsche Bank. European companies are now "under attack from both sides''. Profit margins are being squeezed by slowing demand, high fuel costs and rising wages, while at the same time banks - once so keen to lend - are now trying to rebuild their own balance sheets by tightening loan standards and demanding higher interest rates.

It's no surprise that eurozone manufacturers' confidence dropped in August to its lowest level since May 2005, and that production expectations were the weakest in almost seven years.

This is a great opportunity to sell

It all adds up to a shedload more pain, with less investment and fewer jobs across Europe. As for share prices round the world, yes, they might rally for a day or two as some 'short' traders - i.e. those who had sold shares with the intention of buying back lower down - have had to close out their positions, prompting a temporary rally. That's a good opportunity to dump any retailers, property stocks or banking shares you're still holding on to.

But don't be fooled. That short-term fix across the Atlantic won't help Europe in the slightest. Nothing has changed, apart from US taxpayers being loaded up with a long-term potential mega-bill.

After recovering from a breakdown which halted trading for more than six hours, UK shares ended Monday sharply higher, with the FTSE 100 index climbing 3.9%, 205 points, to 5,446. Banks were among the top gainers after the Fannie and Freddie takeover, while oil stocks were also higher on fears that Hurricane Ike will shut down production in the Gulf of Mexico.

In Europe, shares were also higher, with the German Xetra Dax up 2.2% to 6,263 and the French CAC 40 gaining 3.4% to 4,340.

US markets also ended higher, with the Dow Jones Industrial Average rising 290 points to 11,510 and the wider S&P 500 gaining 25 points to 1,267. The tech-heavy Nasdaq Composite gained 13 points to 2,269.

But overnight the Japanese market gave back some of yesterday's gains as traders rapidly realised that the bail-out isn't going to cure the slowing global economy. The Nikkei 225 fell 1.5% to 12,439, and in Hong Kong the Hang Seng slipped 2.2% to 20,328.

This morning Brent spot was trading at $101 a barrel, spot gold was at $799, silver at $11.97 and platinum at $1,305.

In the forex markets this morning, sterling was trading against the dollar at 1.7571 and against the euro at 1.2441. The dollar was trading at 0.7084 against the euro and 107.75 against the Japanese yen.

And this morning, the Royal Institution of Chartered Surveyors reported that house prices continued to fall in August. The number of surveyors and estate agents reporting falls exceeded those reporting rises by 81 percentage points, compared to 83 in July. Average sales per agent were down to 12.7 in the past three months, the lowest since the survey began in 1978.

The reasons behind the Fannie and Freddie bail-out

2008-09-08T08:01:00.000-07:00

As the old saying goes, they do everything bigger in America.

Here in the UK, the government nationalised Northern Rock, a regional banking minnow whose failure wouldn't really have been very important on the scale of global finance, despite the hefty political fall-out.

Over in the US, they'll happily let their regional banks fail. Northern Rock wouldn't have stood a chance. But while the free market ethos might be applied in some instances, the US is more than happy to invoke the "too big to fail" clause when it wants to. Yesterday, the US government took over what are probably the most important financial institutions in the world at the moment, mortgage groups Fannie Mae and Freddie Mac.

The move will drag these two monsters kicking and screaming onto the government's balance sheet. According to The Telegraph, it represents a potential liability of £2,900bn. That's about £10,000 a piece for every man, woman and child in America.

Better start saving now, guys...

The reasons behind the Fannie and Freddie bail-out

Fannie Mae and Freddie Mac don't write mortgages themselves, but they own or guarantee almost half of America's $12 trillion mortgage debt. With the housing market in freefall, that's inevitably lead to a crisis of confidence in the companies' balance sheets. Their shares have been hammered - and after this latest move, shareholders seem likely to be wiped out altogether.

But it's not the shareholders who were the problem - it was bond holders. Fannie and Freddie are still responsible for almost 70% of new mortgage loans in the States. They raised cheap money by issuing bonds, and were thus able to fund cheap mortgages for US home buyers.

Now Fannie and Freddie have always inhabited a kind of "nudge, nudge, wink, wink" financial hinterland. The US government didn't exactly say it was responsible for the two mortgage providers. But everyone knew it was. So that meant that the two companies were able to borrow money at the same rate as the US government.

That's ended recently as fears for Fannie and Freddie's future grew. All those foreign governments buying up Fannie and Freddie debt suddenly started to worry - wait a minute, maybe these guys aren't bluffing. Maybe they really won't pay back any of the loans that we've got here. And that sent them rushing for the hills. That increased the cost of borrowing for Fannie and Freddie, which in turn made US mortgages more expensive.

How much is this going to cost?

So now the US government has been forced to turn around and explicitly back Fannie and Freddie. How much is this going to cost? Well, just like Northern Rock, the answer is that nobody really knows. The US Government is crossing its fingers and hoping that things go well enough so that it might even turn a profit at a later date as it gradually runs the two behemoths down. But as Hank Paulson admits, "the ultimate cost to the taxpayer will depend on the business results... going forward."

The general consensus is that this will make things better. Ruth Lea of Arbuthnot Banking Group tells The Telegraph: "this is good news for the global economy. The Fed has clearly taken a view that to allow these two to go under would have been horrendous."

But as Paul Kedrosky points out on his Infectious Greed blog, the fact that this has happened at all shows how bad things are. The Bush administration would far rather have put this off until after the election, making it the next president's problem. The fact that they couldn't "tells you how fast and out-of-control this apple cart is."

This is turning into a dirty great game of "pass the parcel" where nobody wants to be left holding the package. The bail-outs just keep getting bigger and bigger. And every time it happens, the idea of moral hazard is dismissed as being noble, but inapplicable in this case, because the consequences of collapse are just too great.

Let's track this back. We've gone from a situation where we bailed out a single hedge fund - Long Term Capital Management (LTCM) - in 1998. That fund, which had fewer than 200 employees, was deemed too big to fail at the time. Then the tech bubble burst, and Alan Greenspan slashed interest rates to bail out Wall Street. And now the housing bubble has burst, and slashing interest rates isn't enough. So the mortgage industry is being bailed out directly.

Meanwhile, every other industry is putting the begging bowl round for subsidies. The car makers want money from the government too. How long before the retailers start asking for a hand-out (though you could argue that they've already had theirs, in the form of the tax rebate earlier this year)?

Rising interest rates, a weaker dollar - stick with gold

America's stock of bad debt has now gone as far up the tree as it can. It's all with the government and the taxpayer now. I don't know what that means for the dollar today, but it can't be good in the long run. The government's aim has to be to inflate that debt away, and forget about the consequences.

As Roben Farzad points out in BusinessWeek this week, US savers must feel absolutely sick. Their reward for resisting "the siren call" of debt is "injurious savings yields, inflationary rot, and election-season neglect, all served up with a dollop of institutional insecurity." David Gitlitz of investment adviser TrendMacrolytics tells Farzad that with the Federal Reserve rate cuts, "rates haven't been this negative" since the 1970s.

The trouble is, the world has changed, but nobody seems to get it yet. Our past decade of care-free debt accumulation has been built on the US consumer spending money borrowed from Asia, on goods made in Asia. But now the US consumer is spent out, so that cycle can't carry on.

Asian governments might still be keen to prop up the dollar, but once they realise that their exporters aren't selling anything, regardless of how weak their currencies are, they'll stop. Why lend money to these people if they're not keeping their side of the bargain and spending it in your factories? And so, to keep borrowing money and rolling over its massive debts, the US will have to pay more interest, which means higher interest rates in the long run.

We'll see what happens. But in the meantime, this bail-out gives you another good reason to be holding onto gold. Think of it as insurance: if we face inflation, it'll preserve its value. If we end up facing deflation and financial instability, it'll lose out less than other assets. I'd stick with it.

Turning to the wider markets...

UK shares sold off sharply, with the FTSE 100 index eventually closing 2.3% down, 121 points, at 5,241. Over the week, the index dropped 7% to just 90 points above the 2 ½-year low hit in July, while the FTSE 350 mining index plunged 18% in its biggest monthly fall since 1987. Also over the week, the FTSE oil and gas index slid almost 10%. Amongst the worst hit stocks was car catalyst maker Johnson Matthey, which slipped 8.5%. Resource stocks suffered generally, with Kazakhyms and ENRC both tumbling 8% and Lonmin down 4%. In financials, Friends Provident slipped 4.4%. But Cadbury gained 2% on disposal talk.

In Europe, shares also dropped back sharply, with the German Xetra Dax easing 2.4% to 6,127 and the French CAC 40 sliding 2.5% to 4,197.

US markets were mixed, with the Dow Jones Industrial Average nudging up 33 points to 11,221 and the wider S&P 500 gaining 0.4% to 1,242, though the tech-heavy Nasdaq Composite eased 0.1% 2,256. News that unemployment had risen to 6.1%, a 5-year high, was offset by a rally in financials.

Overnight the Japanese market rallied 412 points, 3.4%, to 12,624, and in Hong Kong the Hang Seng gained 739 points, 3.7%, to 20,673.

This morning Brent spot was trading at $104, spot gold was at $815, silver at $12.57 and platinum at $1,374.

In the forex markets this morning, sterling was trading against the dollar at 1.7786 and against the euro at 1.2408. The dollar was trading at 0.6977 against the euro and 108.92 against the Japanese yen.

And in London this morning, Associated British Foods, food producer and owner of Primark, said profits will rise in the second half. The group has managed to pass through higher commodity prices to customers, while profit is also up at Primark as consumers trade down to discount shops.

How house prices could fall by 75% from here - in gold terms

2008-09-03T03:23:00.000-07:00

What I'm confident about is that we will get through it," said Alistair Darling yesterday about the current economic crisis.

Well, of course, we'll get through it. What I want to know is will we get through it with a currency?

It is a government's duty to provide its people with opportunity. So we must thank Alistair Darling for giving us with his wise words on Saturday what has to be the easiest money-making opportunity of the year: to sell the pound as soon as the markets opened on Monday. Not since Northern Rock a year earlier has such an obvious trade presented itself.

I said in MoneyWeek's New Year predictions for 2008 that I wouldn't rule out a sterling crisis later in the year. That moment is looking more and more likely. If it is the government's intention to devalue sterling as quickly as possible, it's hard to see how they could improve on the job they're doing.

Then again they may just be incompetent.

The story behind the pound's devaluation

Let's start with some charts of sterling. Two pictures that each tell a thousand ugly words. The pound against the euro:

And against the dollar:

The downturn accelerated in October-November 2007, shortly after Gordon Brown announced that he would not be holding a November election. The horrid realisation must have dawned on forex traders that we had three more years of the bloke and they began hitting the sell button. But it was an orderly decline. 'He can't last three years, surely?' they thought.

Then as August began, the grim reality hit home that not only was he coming back from his holiday, but that he had no intention of resigning, despite dire Scottish election results. We had what is known as a mad rush for the exit, punctuated by a brief moment of respite as somebody won another gold medal, then downwards into the abyss.

Just as you thought you could take a breather last Saturday - perhaps watch a bit of footy or take a stroll by the river - Darling has his Road-To-Damascus-Meets-Trisha moment and onwards and downwards went the pound.

Anything that you, me or my Aunt Joan own which is denominated in sterling has lost 15% of its value in a year in currency alone.

Devaluing sterling effectively devalues the Government's debt, so you might think for a second it's deliberate. But you know deep down it isn't. It's that old Labour favourite: incompetence.

The Government can't hope to save the housing market

Do they honestly think they can save the housing market? With this new £175k stamp duty threshold, I feel sorry for anyone who is struggling to sell a property currently valued at £250k. Before you can say party political broadcast, they're going to be getting a whole load of offers at £175k, plus some cash for curtains and white goods.

Interest-free loans to help low earners to get on the housing ladder! If they're low earners, why are you trying to get them into debt? That is highly irresponsible, is it not? How will they pay that debt back? They might go on to become high earners, yes, but then they might not - and with this lot in charge of the economy the latter is more likely - and what then? This is imprudent lending - the very cause of the problem.

The cure for the property crisis

It's so simple. Why not just let prices fall to a level which people can afford? The excesses of the previous 14 years are purged and trade will begin again. That is the cure for all this: lower prices. Why do they feel the need to interfere all the time?

Interest-free loans are highly inflationary. Labour is attempting to save the housing market at the expense of the currency. It is attempting to bail out debtors, when it is their very excesses that created this mess. Why not bail out those who saved instead? Why should the prudent have had their savings value eroded by 15% in one year because of their leaders' incompetence?

Here is an update of a chart I like to show from time to time. It shows how many ounces of gold it takes to purchase the average UK house since 1930. My thanks to Tom Fischer of Herriot-Watt University for putting together. It is a wonderful chart and well worth studying.

You can see the price rises during periods of credit expansion and declines during periods of contraction. Nothing Darling does can change the inevitability of further falls. He has two choices: to simply let prices fall to the point where houses have become affordable again; or, the option he appears to have taken, which is to devalue sterling, so the falls don't seem so bad. But the net result - the real value of houses - will be the same.

If the UK really is in the worst state it's been for 60 years, as Darling says, then look at the lows set during in the 1930s and the late 1970s. One hundred or less of gold ounces to buy the average UK home. That would mean another 75% fall from here, measured in gold. Impossible? Well...

Let's just say, for the sake of argument, that sterling falls by another 20% against the dollar (I think it will be more). That will take us to $1.40. (It's been there before). Let's also say housing falls by another 25%, which would more or less mirror the falls of previous downturns. We would have an average price of £123,490. And let's say gold reaches its inflation-adjusted all-time high of around $2,000. Then you see an average UK house price of just over 85 ounces of gold. It's not so impossible.

Gold may be all over the place in dollar terms, but such is the dire state of sterling, anyone who has been buying gold with their pounds will have been doing very well. The last twelve months have seen gold go from about £330 an ounce to £460. That's a nice 40% gain in a year.

Thank you very much, Mr Darling.

Things must be bad - politicians are telling the truth

2008-09-02T02:16:00.000-07:00

Things must be getting bad. Politicians are resorting to telling the truth.

Chancellor Alistair Darling caused something of a stir at the weekend by admitting that economic conditions are "arguably the worst they've been in 60 years." The financial crisis will be "more profound and long-lasting than people thought," he said in an interview with The Guardian.

Of course, Mr Darling does have to make the rather embarrassing admission that his earlier forecast for 2-2.5% economic growth this year, was so off-the-scale wrong as to be in the realms of surreal fantasy. So it's best if he tries to look as if he knows what he's talking about now.

And it's hardly breaking news. House prices have already fallen faster and harder than at any time since records began. Anyone who's still trying to compare this favourably to the 1990s recession is way behind the times.

But credit where credit's due. Mr Darling may finally be facing up to reality. Shame his colleagues aren't quite there yet…

Darling is finally facing up to the harsh reality

I'm no great fan of Alistair Darling, but I have to say he came across well in his "controversial" Guardian interview at the weekend. Granted, the paper was never going to give him a hard time. But to hear a member of the Cabinet dispense with the Orwellian New Labour-speak and just admit things were awful was refreshing.

That said, I'm not daft. I suspect Mr Darling's attempts to tell it "straight" and play up the image of the hard-working but slightly naïve politician, who doesn't quite understand the world of spin, is all part of some devious Gordon Brown election strategy. You know the kind of thing I mean. "Who do you want running the country? I, prudent Gordon Brown, with my straight-talking down-to-earth team, who tell it like it is? Or smarmy professional politicians like Miliband and Cameron?" Call me cynical, but you don't survive in the Cabinet as long as Mr Darling has without knowing how to play the game.

But still, compare Mr Darling's blunt appraisal of the British economy with the defensive gibberish spouted by Hazel Blears, the communities secretary. Ms Blears told The Times that "we know things are tough and understand that people are worried. But Britain's economy is fundamentally strong."

This is just patronising rubbish, and voters are rightly irritated by it. She may not realise it, but she's effectively saying: "you're all panicking over nothing. The economy's basically fine and you're just stupid people who are taken in by all these nasty newspaper headlines."

And what does "fundamentally strong" mean? Our houses are overpriced, and our economy is dependent on people spending money they don't have on non-productive goods imported from other countries. Our banks are short of money, our government is up to its eyeballs in debt, and unemployment is rising rapidly. Where's the strength in any of that?

And Home Office minister Jacqui Smith clearly doesn't agree with Ms Blears's cheery little assessment. According to the front page of today's Telegraph, Ms Smith's department reckons that a recession will also bring with it rising crime, increased budget pressures on the police and border controls as tax revenues fall, and worsening racial tensions.

It all adds up to a grim picture for UK plc.

2 tips to help you survive the recession

But let's take a step back a minute. Yes, recessions are painful, and all the more so when you've been using borrowed money to put one off for as long as we have. But a recession doesn't have to mean complete social collapse. Believe it or not, it's a natural part of the business cycle. And just as recessions clear out a lot of the bad, unproductive investments that should never have been made, it can also be a chance to perform a similar clean-up on the household balance sheet.

Because the reality is that for most people, recession won't be a life-changing experience. Many people will lose their jobs, but many more won't. Lots of people will lose their homes, but an awful lot more won't. For the majority of people, recession will be about saving more money, and paying down debt. They won't have to worry about keeping up with the Joneses anymore, because the Joneses will be too busy trying to stay ahead of the bailiffs.

The main thing to do is to make sure you have a savings cushion for if you end up being made redundant. So you need to save up three to six months' salary as an easily accessible emergency cash pile. You should always have one of these, but needless to say they tend to get frittered away in the good times. The basic aim is to be able to meet all your living costs for long enough to find another job, if necessary.

The other big issue many people may face is finding that when they come to renew their mortgage deal, it's got a lot more expensive. The best way to avoid this – particularly if you are coming to the end of a fixed deal soon - is to have as much equity in your house as possible. Many lenders are now looking for at least 25% before they'll give you their best deals. It may well be worth diverting investment money into paying down your mortgage if this is the case. For more on this topic, see Does a small mortgage beat a big pension?

Turning to the wider markets…

UK shares closed the week with the FTSE 100 index advancing another 35 points, 0.6%, to 5,637, its highest level for more than two months. For the month as a whole, the index rose 4.2%, its best August since 2000. London Stock Exchange fared well with a 4% climb. Energy stocks were boosted by firmer oil prices as BP and Shell both added 1% and BG gained 3%. Banks were led higher by HBOS, up 3.4% on disposal rumours. But Enterprise Inns was the biggest blue chip faller, losing 4% on bearish broker comment.

In Europe the German Xetra Dax was flat at 6,422 and the French CAC 40 advanced 0.5% to 4,483.

US stocks closed down, with the Dow Jones Industrial Average shedding 172 points, or 1.5%, to end at 11,544 and the wider S&P 500 slid 1.4% to 1,283. The tech-heavy Nasdaq Composite added 1.8% to 2,368.

Overnight the Japanese market lost 239 points, 1.8%, to 12,834 and in Hong Kong the Hang Seng eased 321 points, 1.7% to 20,911.

This morning Brent spot was trading at $113, spot gold was at $835, silver at $13.76 and platinum at $1,459.

In the forex markets this morning, sterling was again weak, trading against the dollar at 1.8073 and against the euro at 1.2335. The dollar was trading at 0.6825 against the euro and 107.71 against the Japanese yen.

And in Europe this morning, Commerzbank has agreed to buy Dresdner bank from insurer Allianz for €9.8bn. It's Europe's biggest financial services takeover this year, reports Bloomberg, and means Commerzbank will overtake Deutsche Bank as Germany's number two banking group

UK market news 1st September 2008

2008-09-01T00:21:00.001-07:00

HBOS Plc's Bank West Retail unit in Australia has been approached by Commonwealth Bank of Australia and National Australia Bank (Times).

Associated British Foods Plc is in talks to purchase Azucarera Ebro in Spain (Mail).

WPP Group Plc could consider moving its head office out of the UK (Times).

Petrofac Ltd and Mubadala Petroleum Services Company LLC to establish a joint venture, Petrofac Emirates LLC in Abu Dhabi.

Travel & Leisure: Stagecoach Group (+5.88% to 319.75p) reached a new 3-month relative high against the FTSE 100.

British Airways Plc may consider a partnership with Alitalia (WSJ).

Industrial Goods & Services: G4S Plc (+2.98% to 233.5p), Charter Plc (+2.64% to 952p) and Bunzl (+2.07% to 715p) reached a new 3-month relative high against the FTSE 100.

BP bought back last Friday for cancellation 1,500,000 ordinary shares at prices between 520.75 pence and 530.50 pence per share.

National Grid bought back last Friday 1,184,117 ordinary shares at a price of 717.53 pence per share. The purchased shares will be held as Treasury shares.

Latest broker recommendations

Henderson price target was raised to 130p vs 110p at Citigroup.

Bodycote was cut to "underperform" from "neutral" at Merrill Lynch.

Imperial Energy price target was cut to 1250p vs 1500p at UBS.

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The stories, data, and stocks that may have the greatest impact during the coming trading week.

Today’s Corporate Events (FTSE 350 universe)

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Director Dealings

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techMARK (15min)

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European Markets

Germany / Austria

Commerzbank to buy Dresdner Bank from Allianz for appx. E9.8bln in a two steps transaction to be completed no later that the end of 2009. The transaction has potential synergies of E5bln. Allianz will have a stake of nearly 30% in the new entity. The insurance company agreed to buy Cominvest from Commerzbank, to commit up to E975m into a trust solution for specific ABS assets of Dresdner Bank. Oldenburgische Landesbank will remain with Allianz Group. The Co will cut 9,000 jobs out of about 67,000.

Technology: United Internet (-1.09% to E9.96) closed at a 3-month relative low against the Dax.

Retail: Arcandor (-1.64% to E5.41) reached a new 3-month relative low against the Dax.

Continental was cut to "underweight" from "neutral" at Merrill Lynch.

Volkswagen's commercial-vehicle unit to meet its 2H targets (WirtschaftsWoche).

Daimler: Tesla Motors may be the batteries supplier for the Co's electric Smart cars (FT Deutschland).

Deutsche Telekom price target was raised to E13.25 from E13 at Morgan Stanley.

France

Vivendi delivered 2Q adjusted net income of E757m compared to E728m consensus, EBIT of E1.24bln vs E1.23bln a year ago. Revenue reached appx. E6bln, an increase of 15.1% and of 17.4% at constant currency when compared to 2Q07. Furthermore, the Co expects to deliver 2008 profit growth similar to 2007, at constant perimeter.

GDF Suez announced 1H net profit up 14% to E3.38bln compared to E2.96bln a year earlier, beating the E3.16bln consensus. The group to pay an interim dividend of E0.8 a share.

Vinci reported 1H net income up to E731m (E678m consensus) compared to E614m a year ago, operating income of E1.46bln (E1.45bln expected), up 12% YoY on revenue up 15% to E15.7bln. Besides, the Co decided to pay an interim dividend of E0.52, up 11%.

Altarea posted 1H net income down to E67m compared to E147.5m a year earlier.

Thales and Cadbury Plc may sell their appx. 20% shares in Camelot Group Plc (Telegraph).

Industrial Goods & Services: Nexans (+1.27% to E86.25) closed at a 3-month relative high against the Cac 40.

Accor was cut to "sell" from "neutral" at UBS.

Michelin was raised to "buy" from "neutral" at Merrill Lynch.

PPR price target was raised to E86 from E84 at Lehman Brothers.

Spain / Portugal / Greece

Inmobiliaria Colonial posted 1H net loss of E2.4bln compared to a profit of E316m a year ago.

Cintra CIT 1H net loss seen at E42.7m compared to a loss of E29m a year ago.

Grupo Ferrovial could report 1H net income down to E192m compared to E756m a year ago on revenue of E6.8bln vs E7.1bln.

Banks: Banco Pastor (-0.45% to E6.62) closed at a 3-month relative low against the Ibex.

Construction & Materials: Sacyr Vallehermoso (-2.97% to E12.41) closed at a 3-month relative low against the Ibex.

Sacyr Vallehermoso and Faes Farma 1H results expected

Grupo Catalana Occidente price target was cut to E21.4 vs E27.6 at UBS.

Today’s economic events (CE time)

FR 09:50: Aug F PMI Manufacturing, exp.: 45.1
GE 09:55: Aug F PMI Manufacturing, exp.: 49.9
EC 10:00: Aug F PMI Manufacturing, exp.: 47.5
UK 10:30: Jul F M4 Money Supply (MoM)
UK 10:30: Jul F M4 Sterling Lending (BP)
UK 10:30: Jul Net Consumer Credit, exp.: 0.8B
UK 10:30: Jul Net Lending Sec. on Dwellings, exp.: 3.0B
UK 10:30: Jul Mortgage Approvals, exp.: 36K
UK 10:30: Aug PMI Manufacturing, exp.: 44

Indices

	Last	Daily Change	% YTD
FTSE 100	5,637	35.40	-12.70
FTSE 250	9,382	110.10	-11.97
FTSE techMARK 100	1,614	14.64	-1.68
Dow Jones	11,544	-171.63	-12.98
Nasdaq 100	1,873	-42.58	-10.19
S&P 500	1,283	-17.85	-12.64
DJ Euro STOXX 50	3,366	6.21	-23.50
Dax	6,422	1.76	-20.39
Cac 40	4,483	21.11	-20.15
SMI	7,239	48.34	-14.68
Nikkei 225	12,853	-219.87	-16.04
Hang Seng	20,879	-382.75	-24.93
ASX	5,099	-36.90	-19.58

Bonds

	Last %		Last %
10Y Gilt	4.48	US 10Y T-Note	3.81
10Y Bund	4.15	US 30Y T-Bond	4.42

EUR / USD (15min)

USD / JPY (15min)

Dax 30 (15min)

Cac 40 (15min)

Euro Stoxx 50 (15min)

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Spain's banking sector could be facing a death blow

2008-08-31T23:28:00.001-07:00

Sometimes it's the most innocuous-looking headlines that spell the most trouble.

With most papers leading on "here comes the recession"-type stories, it would be very easy to overlook the report on page five of yesterday's FT that the "ECB is to tackle abuse of liquidity aid". And no wonder. The story sounds either a) very technical or b) something about the financial equivalent of binge drinking.

But there's a bombshell being delivered here - the European Central Bank is about to stop bailing out eurozone commercial banks. And that could mean another big lender going 'bust'. Time to reach for your tin hat again…

The ECB is about to stop bailing out eurozone commercial banks

The European Central Bank has said nothing official as yet about its plans to take a closer look at its support for European banks. In true eurozone style, the ECB's thoughts are being carefully leaked in a dull bureaucrat-ese that's easily ignored and designed not to prompt a panic.

ECB policymakers have agreed a "certain amount" of refinement to the central bank's rules," said the governor of Luxembourg's central bank, Yves Mersch, at the weekend. The changes under consideration weren't "a broad-based revolution", he added. However, as markets evolved, "we have to adjust our framework regularly to market practices" which would "concern some instruments".

Hardly a "stop the press!" moment. But fortunately, Not Wellink, the Dutch central bank chief and a major figure on the ECB council, has been a bit more specific. He said that banks were becoming addicted to the Frankfurt 'liquidity window'. That's where the ECB has been providing cheap funding for eurozone banks by lending against the collateral of a whole range of so-called asset-backed securities (ABS).

Let me explain. A number of European banks weren't able to borrow enough cash to keep their balance sheets balanced because other investors weren't prepared to lend them the money. The only way they've managed to keep their heads above water recently has been to shovel the dodgy loans they have made onto the ECB – a sort of financial pass-the-parcel. Without it, those banks would have gone bust, a la Northern Rock.

But the bad news for these lenders is that it looks like the party's over. "If we see banks dependent on central banks, then we must push them to tap other sources of funding", Mr Wellink told Dutch financial daily Het Finacieele Dagblad. "There's a limit how long you can do this. There is a point where you take over the market".

Exactly. I can't think why it's taken the ECB so long to work out that it's storing up problems for the future. After all, it was prepared to hike interest rates two months ago when worried about too much inflation. Perhaps it was because the Bank of England and the US Federal Reserve had to put in place their own panic measures – sorry, emergency funding arrangements - while the ECB already had something suitable in place.

But this is where the second part of the problem arises. Though its policy buys time, the ECB ends up with a shed-load of assets whose value is highly debatable at best. That's bad enough in itself, but there could be much more fallout. The Maastricht Treaty – one of the EU foundation stones - formally prohibits long-term taxpayer support of this kind for the EMU banking system.

"The ECB is in an unenviable situation", says Paul McCulley of Pacific Investment Management. "The lender of last resort should be just that, not a permanent provider of funds."

Spanish banking sector could be facing collapse

So it's starting to look like the game could be up for a large chunk of the Spanish banking system. We've written before about the parlous state of the Spanish property market and, as a result, the hole into which the country's banks have dug themselves. The latest Bank of Spain data shows that the country's banks have increased their ECB borrowing to a record €49.6bn (£39bn). "A number have been issuing mortgage securities for the sole purpose of drawing funds from Frankfurt", says Ambrose Evans-Pritchard in The Telegraph. "These banks are heavily reliant on short-term and medium funding from the capital markets. This spigot of credit is now almost entirely closed".

But the ECB will have to end this bailing-out soon. Now it's possible - just – that the central bank can deal its way out of this mess, and somehow avoid the carnage that a Spanish bank bust would cause. But as the world's banking glitterati gather in Jackson Hole, they've got plenty of hard thinking to do. After all, if Spain's banking sector collapses, it would result in even tighter credit, less lending and less spending.

One – admittedly unorthodox solution – could be for the ECB to simply pretend that Spain doesn't exist. If that sounds silly, that's because it is. Yet, that hasn't prevented British buy-to-let lender Paragon from trying to disown an entire sector of amateur landlords who have fallen on hard times.

According to The Guardian, Paragon now says that investors in the kind of overpriced city-centre apartments which are now virtually unlettable and unsellable should not be classed as buy-to-let investors. "These properties were targeted by speculative purchasers who thought they could make a quick buck by flipping them. That is not the buy-to-let market. Buy-to-let investors do not own a property unless they can demonstrate that there is tenant demand".

It's an interesting solution to the housing bubble implosion – just stick your fingers in your ears and pretend it's not happening. But somehow we don't think it'll catch on.

Turning to the wider markets…

UK shares rallied strongly on Friday, as the FTSE 100 index climbed 135 points, 2.5%, to 5,506. Property stocks soared, with Liberty International - surrounded by bid rumours – jumping 8%, while British Land added 6% and Hammerson 5%. Banks also fared well with Royal Bank of Scotland and Barclays both gaining 5% while Lloyds TSB put on 7%. BT climbed 3.4% on vague bid talk. But Michael Page lost 4.4% having rejected Adecco's advances. The London market was closed yesterday for the August bank holiday.

Shares in Europe dropped yesterday, with the German Xetra Dax losing 0.7% to 6,297 and the French CAC 40 shedding 1% to 4,356.

US stocks fell sharply last night, with the Dow Jones Industrial Average dropping 242 points, or 2.1%, to end at 11,386 and the wider S&P 500 and the tech-heavy Nasdaq Composite both shedding 2% to 1,267 and 2,366 respectively.

Overnight the Japanese market shed 100 points, 0.8%, to 12,779, while in Hong Kong, the Hang Seng was almost flat, down 0.1% to 21,088.

This morning Brent spot was trading at $113, spot gold was at $821, silver at $13.52 and platinum at $1,443.

In the forex markets this morning, sterling was trading against the dollar at 1.8441 and against the euro at 1.2547. The dollar was trading at 0.6803 against the euro and 109.72 against the Japanese yen.

Also this morning, Bovis Homes said first-half profit plunged 83% after banks granted fewer mortgages. Sales dropped 43%.
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Northern Rock: yet more of your cash down the drain

2008-08-31T23:26:00.001-07:00

Turns out – would you believe – that the Newcastle-based lender, a pioneer of 125% mortgages and one of the most dominant lenders right at the peak of the market in early 2007, is getting clobbered by much higher-than-average default rates. Surprise, surprise!

Sarcasm aside, the Rock is just the tip of the iceberg, if you'll forgive the slightly mangled metaphor. The rest of the UK banking system, or certainly the bit that isn't effectively bust already, is getting set to slam down the loan window shutters as it runs shorter and shorter of money.

It all promises to be a very unhappy 2009 for borrowers…

Northern Rock is suffering much higher-than-average default rates

There've been probably more column inches within the last year devoted to the sorry Northern Rock nationalization saga than to any other company in the country, so I'm not going to add to them by talking about the right and wrongs of what the financial authorities did or didn't do.

We're stuck with it. But if anyone's looking for any further evidence that offering 125% mortgages is a completely brainless idea, particularly if the lenders responsible proceed to scatter their cash around like confetti, the latest news serves that up on a plate.

It turns out that from what The Telegraph calls "previously unseen documents" that Granite, the £40bn so-called 'off-balance sheet securitisation vehicle' which holds many of the mortgages issued by the Crock, is anything but rock-solid.

Payment arrears of 90 days or more on mortgages on Granite's books rocketed by two-thirds between this year's first and second quarters, according to the credit monitors at Standard & Poor's. That adds up to £508m-worth of dodgy home loans, even though rival banks saw relatively small increases in delinquencies. What's more, repossessions soared by 163% between the first and second quarters, again much worse than virtually every other lender.

The loan-to-value (LTV) ratio is another potential disaster. Average LTVs were 77% for Granite compared with 60% typically elsewhere, with almost 30% of Granite's loans at LTVs of 90%. That means a large chunk of borrowers will soon be dropping into negative equity territory as the housing market gets worse.

Today's Nationwide survey said that UK home values have already plunged 10.5% over the last year after a further 1.9% fall in August, while the Bank of England's governor Mervyn King this month forecast "a significant adjustment" downwards in house prices.

How much will this cost British taxpayers?

Here's the bad news for the public coffers: any financial pain of a major blowout in defaults would be shared between Granite bondholders and the Rock. Andrew South, S&P's senior structured finance director, tells The Times that "the deteriorating book increases the chances that taxpayers, ultimately, might have to shoulder some of the cost". And if that's not enough, you'll be less than glad to hear that on top of the £40bn Granite loan book, the Rock holds £37bn worth – on paper at least - of mortgages on its own balance sheet, which it says are of similar quality. Thanks, guys!

The cost to the taxpayer? "At the time of the nationalization, the Government was advised by Goldman Sachs that the loss could be between £450m and £1.28bn", says Patrick Hosking in The Times. And now? I dread to think. But I bet it'll be a long way north of even that higher figure, particularly as the economy gets worse. It doesn't take Einstein to work out why high-risk home loans have virtually disappeared off the radar screen. What's happening to over-indebted mortgage borrowers is, in a rather painful way, a microcosm of what's happening in the wider world.

Britain is heading for a major slump

The recent bank reporting season has already showed us that the balance sheets of UK lenders are looking fragile as both personal and corporate bad debts have started to stack up. In other words, demand for credit is dropping as bank customers' ability to make interest payments on their loans is getting worse by the day. And the other side of the coin is that the banks are toughening up their loan criteria.

"When lending standards go up, corporate defaults rise. And that's only just started", says James Fairweather, chief investment officer at fund manager Martin Currie. "This is the sharpest-ever rise in lending standards we have ever seen and it has continued to sky rocket."

But now, says Capital Economics, it's even looking unlikely that banks will be able to raise all the capital they need to keep expanding their balance sheets as fast as they have been. So they'll have to ration the supply of credit even more.

Lending growth won't just slow, it could actually fall outright: "if banks fail to raise any more capital than the £20bn raised so far, lending could contract by 7% - and reducing lending to UK households and firms could have dire implications".

It's all pretty desperate news for the UK economy, which "may already be in recession and is now expected to contract in 2009 as a whole", says Capital Economic's Vicki Redwood. She concludes: "A full-blown slump is a growing possibility".

There's not a lot more to add to that.

UK shares closed strongly, with the FTSE 100 index advancing 57 points, 1.16%, to 5,528, though the FTSE 250 was flat. Housebuilder Taylor Wimpey reversed much of the previous day's gain, shedding 7% after reporting a £1.54bn loss. Other stocks in the sector also suffered, with Persimmon and Barratt Developments both 2% down and Bovis losing 3%. In contrast, miners generally did well, with Antofagasta and Vedanta both up 4% and Kazakhyms adding 2%. BSkyB rose 1% on a bullish Goldman Sachs note but Johnston Press slid 7% after announcing an 18% pre-tax profit drop and a scrapped interim dividend.

Shares in Europe were mixed yesterday, with the German Xetra Dax easing 0.3% to 6,321 but the French CAC 40 nudging up 0.1% to 4,373.

US stocks were firmer, with the Dow Jones Industrial Average adding 90 points, or 0.8%, to end at 11,503 and the wider S&P 500 gaining a similar percentage to 1,282. The tech-heavy Nasdaq Composite added 0.9% to 2,382.

Overnight the Japanese market was again almost flat, adding 15 points, 0.1%, to 12,768, though in Hong Kong the Hang Seng slid 551 points, 2.6% to 20,914.

This morning Brent spot was trading at $115, spot gold was at $834, silver at $13.74 and platinum at $1,443.

In the forex markets this morning, sterling was again weak, trading against the dollar at 1.8370 and against the euro at 1.2447. The dollar was trading at 0.6776 against the euro and 109.03 against the Japanese yen.

And in London, French bank Credit Agricole reported that second quarter profit had slid by 94% to €76m, after writedowns related to troubled US bond insurers. However, its Tier 1 capital ratio remained steady, reports Bloomberg.

The second-most expensive four words in the English language

2008-08-31T23:24:00.001-07:00

The late great Sir John Templeton warned that the four most expensive words in the English language are “it’s different this time.”

He was absolutely right. You usually hear those words at the frenzy stage of an investment bubble, when there’s no conceivable sensible reason for prices to go any higher, and vested interests have to clutch at straws to promote their arguments. Just ask anyone who bought property stocks a year ago, or tech stocks in 2000.

But in the wake of a bubble popping, you often hear another phrase, which may well qualify as the second-most expensive four words in the English language. And we’re hearing it more and more from the property pundits, politicians and City hotshots who stand to lose most from the looming recession.

It’s that whiney little mantra, “something must be done!”

Property pundits are calling for government intervention

We have to do something to save the property market. Or so everyone who makes money from the property market is saying.

David Ritchie, chief executive of house builder Bovis, was among the latest to call for government intervention this week. “People need to be able to access finance to buy property and anything we can do to assist people getting on the housing ladder must be good.”

The Government agrees it seems, even if it can’t quite work out a plan yet. After all, nothing screams “get rid of this bunch of incompetents!” to a British voter louder than collapsing house prices. There’s the vague rumours about stamp duty, which no one has stamped on yet, so they must be getting ready to announce something. And The Times reports this morning that the Government is also considering helping councils to buy “repossessed and unsold properties.”

It seems that “something is being done.”

But let’s rewind a moment. Let’s just examine that statement from the Bovis boss, particularly the second half. “Anything we can do to assist people getting on the housing ladder must be good.”

Here’s an idea. Why don’t you give away your homes for free, Mr Ritchie? They’re not selling anyway. That would get people onto the housing ladder. And that must be good, right?

Oh, wait, I forgot – that would cost you money. In fact, it would bankrupt you. Why should you be expected to subsidise housing for the rest of the nation at your own expense?

Taxpayers shouldn't have to prop up the housing market

It’s a ridiculous notion, of course. And yet, when it’s taxpayers’ money that’s meant to fund other people’s property purchases, it’s apparently just fine.

Well, I’m a taxpayer, and I don't think it’s fine at all.

Let me explain why. The Government takes money from your pocket and mine in the form of tax. The justification for this is that it spends that money on public goods, things that can’t be provided more efficiently by the private sector. You can argue the point on what these things are, but we generally accept (in this country at least) that this includes the army, the police, universal health care, and some form of welfare safety net.

I don’t see anything on that list about propping up the housing market. A cut in stamp duty is simply taking money from people who don’t intend to buy a house, and giving it to those who do. That’s completely unfair. If the Government can afford to cut taxes at all, then it should be giving us all some of our money back.

How to make the recession less painful – cut taxes

And this takes us to the bigger point. If we want to get out of this recession in one piece, what really needs to be done?

Interest rate cuts won’t work. They haven’t worked in the US, they didn’t work in Japan. That’s because as a nation, we’re up to our eyeballs in debt. Banks can’t afford to lend money; we can’t afford to borrow it. All of us need to pay off our debts and build up our savings. So it doesn’t matter how cheap money gets, we’ve snapped out of spending mode and strapped on our tin hats.

So the quickest route out of recession is to help people pay down debt and build up their savings. Inflation is one way to reduce the value of debt, but it generally comes with a hefty price tag – currency collapse and economic meltdown. Higher interest rates might help build up savings, but they’d also make debt more expensive to service.

How can we help people save more without fuelling inflation or making our debt burden even worse? Simple. Cut taxes.

If you cut taxes, you almost automatically increase productivity, because you take money from a wasteful, inefficient organisation – the government – and reallocate it to someone who actually gives a damn about how effectively it’s spent – the individual. And rather than squander the money on property (as the Government is proposing), individuals would use it sensibly, saving it, or using it to pay down debt.

This isn’t a magic bullet. It won’t stop the recession – nothing can. The looming bust is nature’s way of telling us that we spent too much money on unproductive garbage during the good times.

Look at it this way. If we’d taken all the money we spent as a nation on property in the past ten years, and had pumped it into – let’s say – our energy infrastructure, then maybe we’d have lower gas bills, and a nice, productive industry providing highly paid, specialist jobs that would be tough to outsource. Instead, all we’ve got is big debts, an unwanted pile of jerry-built buy-to-let flats which are already turning into slums, thousands of unemployed estate agents, and a national energy crisis.

It’s depressing, yes. But what we can do now is put an end to the rot and the waste. The quicker those savings build up, the faster balance sheets are repaired and the quicker we can get out of this downturn.

Will this happen? I doubt it. The Government still believes the great lie, that you can spend yourself rich. It still believes that “something must be done.”

Better get ready for a long, drawn-out, painful recession.

Turning to the wider markets…

UK shares had another good day as takeover speculation helped the prices of several rumoured targets. The FTSE 100 index advanced 73 points, 1.3%, to 5,601. J Sainsbury flipped up 8% on hopes that former suitor the Qatar Investment Authority might be prepared to re-open bid negotiations, while insurer RSA climbed 5.5% on talk that several rivals could be considering acquiring it. Legal & General put on 4%. Banks also did well, with Barclays up 6%, and HBOS and Royal Bank of Scotland both 4% higher. Wolseley recovered 6% on better US economic numbers.

Shares in Europe were also stronger yesterday, with the German Xetra Dax gaining 1.6% to 6,421 and the French CAC 40 advancing 2% to 4,461.

US stocks were again firmer, with the Dow Jones Industrial Average adding 213 points, or 1.85%, to end at 11,715 and the wider S&P 500 gaining 1.5% to 1,301. The tech-heavy Nasdaq Composite added 1.2% to 2,412.

Overnight the Japanese market joined in, adding 305 points, 2.4%, to 13,073 and in Hong Kong the Hang Seng improved 321 points, 1.5% to 21,293.

This morning Brent spot was trading at $113, spot gold was at $837, silver at $13.85 and platinum at $1,473.

In the forex markets this morning, sterling was again weak, trading against the dollar at 1.8291 and against the euro at 1.2400. The dollar was trading at 0.6780 against the euro and 108.58 against the Japanese yen.

This morning also brought news that London luxury house prices have posted their first annual drop (-1.6%) since 2003, according to Knight Frank, after a 1.3% monthly fall, while UK consumer confidence remains around its record lows, said GfK.

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Why the credit crunch is good news for game birds

2008-08-15T10:39:00.000-07:00

The grouse shooting business is feeling the crunch

Grouse shooting is big business. The industry is worth £1.6bn to the UK economy. It generates the equivalent of 70,000 full-time jobs, while ensuring the management of two-thirds of the UK's rural land.

But like almost every other British business, it’s under pressure. Costs are rising. Both fuel and ammunition are getting more expensive. What’s more, the weakness of the US dollar – even allowing for the recent bounce - has pushed the cost of a day's grouse shooting in Scotland to around $13,300. That’s enough to make even high-rolling American hunters think twice about whether they can afford another trans-Atlantic trip.

However, the real concerns in the grouse shooting world run rather deeper. Much of the demand for shooting comes from the City and corporate business. So if the Square Mile’s hot shots aren’t gunning for a day on the moors, that could be bad news for shoot organisers.

This year’s season will probably be OK, says Christopher Graffius, director of communications for the British Association for Shooting and Conservation. Most bookings were paid for at the beginning of the year, “before the credit crunch really hit.”

Yet a study by specialists Fox Harris has found “some signs of softness in the market”, says Martin Waller in The Times. One unnamed banker told him that “in today's climate, taking large numbers of clients to shoots costing as much as £30,000, was probably a non-starter on PR grounds”. Another agent spoke of a dearth of corporate customers, and warned that some who’ve paid deposits may walk away. “We're aware of shoots normally full and difficult to get into that are now offering days. There will be some days coming back on the market discounted.”

“It’s not going to make any difference for the guys that come in their own private jets, but certainly at the lower end of the market there seems to be a bit of a slow-down”, says Russell Hird, who runs grouse-shooting expeditions on the Isle of Lewis.

Other birds may find they have fewer bullets to dodge this season. John Bingham in The Telegraph reports that “pheasant shooting - which gets under way in October – [is] thought to be particularly vulnerable to the downturn,” with “the number of birds expected to outstrip the number of shooters”. Even clay pigeon shooting has become more expensive due to the rising cost of metals.

Now, you may not care that much about the troubles of the City’s amateur hunters. But what this all demonstrates is that the view that the ‘crunch’ won’t affect the ‘top end’ is complete nonsense. When economies turn down sharply very few people escape unscathed.

And investors in premium brands are starting to realise that.

Why now's the time to sell luxury goods stocks

The FT revealed last month that inflation in the luxury goods market has halved in the last year, “indicating that the wealthy are watching the pennies as much as anyone else”.

Even down in Saint-Tropez, retailers are reporting a “dramatic drop in takings as the number of yachts dropping anchor is down 50%”, reports AFP.

The rich are having trouble paying their debts too. “The wide-ranging effects of the US housing downturn are highlighted by the worsening of credit quality in American Express’ affluent card member base,” wrote Oppenheimer analyst Meredith Whitney in a recent client note.

It all spells bad news for the luxury sector. In the year to July, the sector and luxury-brand dedicated funds fell between 15-20%, reports Funds Europe. Luxury goods makers are pinning their hopes on the newly wealthy in emerging markets. But decoupling has already been shown to be a myth, as China’s economy slows alongside America’s. Eastern millionaires will be no more inclined to keep spending than their counterparts in the West.

It’s yet another sector for investors to avoid – and if you do hold any luxury goods stocks, now would be a good time to sell them.

With the economic downturn picking up steam, prospects don’t look great for many sectors, in fact. But MoneyWeek contributor Stephen Bland reckons investors should take a longer-term view of things. To read his take on why you shouldn’t be worrying too much about the current volatility, see: Don't panic: the world isn't ending.

Turning to the wider markets…

UK shares recovered, with the FTSE 100 index closing 49 points higher, or 0.9%, at 5,497. Miners led the rally, with Antofagasta, Anglo American and Kazakhyms all up 5%. But banks generally continued to suffer, with Barclays down 1.5% on fears that more credit write-downs will be needed, though Royal Bank of Scotland managed to hold its price level after a Goldman Sachs recommendation. Housebuilders dropped after Bellway’s downbeat trading update, which hit Taylor Wimpey 11%, Barratt Developments 8% and Persimmon 4%.

Shares in Europe also picked up as the German Xetra Dax nudged up 0.3% to 6,442 and the French CAC 40 improved 0.4% to 4,421.

US stocks bounced off early-session lows, with the Dow Jones Industrial Average adding 83 points, or 0.7%, to 11,616. The wider S&P 500 gained 0.6% to 1,293 and the tech-heavy Nasdaq Composite advanced 1% to 2,454.

Overnight the Japanese market recouped 66 points, 0.5%, to 13,019, though in Hong Kong the Hang Seng eased 321 points, 1.5%, to 21,072.

This morning Brent spot was trading at $112, spot gold at $788, silver at $13.10 and platinum at $1440.

In the forex markets this morning, sterling was still weak against the US dollar - falling for its eleventh successive day, its longest losing streak for 37 years, according to Bloomberg - trading at 1.8555 and against the euro at 1.2599. The dollar was trading at 0.6789 against the euro and 110.41 against the Japanese yen.

And this morning, recruitment company Michael Page has rejected a 400p-a-share (£1.3bn) bid from rival Adecco, saying it “materially undervalued” the company.

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How the cheap money era led to the war in Georgia

2008-08-12T05:29:00.001-07:00

From John Stepek, across the river from the City

The end of the easy money era and the war in Georgia don’t, at first glance, seem to have an obvious connection. But they are linked. Bear with me, and I’ll explain why.

Cheap money gave us many things, including a global property bubble, and a £1.4 trillion debt mountain for UK consumers. Another noticeable trend was a taste for exotic new investment classes, from Iraqi government bonds to obscure derivatives.

All of these trends were the result of falling risk aversion. Investors believed that central bankers, lead by Alan Greenspan, now had complete control of the global economy. Globalisation would ensure economic growth went on forever. And if it didn’t, a soft landing could be engineered by judicious use of the emergency interest-rate cut button on Greenspan’s miraculous economic control panel.

As investors became bolder, and focused entirely on returns, rather than risks, one brave new investment class, invented entirely by a man working at Goldman Sachs, benefited more than most.

It was called the Brics…

The Brics were a great investment, when risk didn’t matter

The Brics – as you probably know by now - was a catchy acronym for Brazil, Russia, India and China. Jim O’Neill at Goldman Sachs coined the term in 2003, and predicted great things for these four countries.

And he was right. They’ve all benefited from booming commodity prices (in the case of Brazil and Russia), or booming US consumption (China), or the outsourcing boom (India). But another point has also worked in their favour.

Low interest rates pushed returns down too. As more and more money chased each new investment opportunity, yields fell on all major asset classes. That drove investors, particularly adventurous new players like hedge funds, into ever-more outlandish investment areas.

Risk took a back seat – political risk in particular. No one batted an eyelid at putting money into once-frontier markets. “China? Sure, it’s a totalitarian regime. And yes, communists have never quite got to grips with the idea of privately-owned property. But this is a globalised economy now. The government won’t want to upset investors. Especially not ahead of the Olympics.”

Why China and Russia have now become very risky for investors

But free and easy money has vanished now. Now some of the best returns you can get are in good old-fashioned hard cash. And when your best returns come from risk-free assets, suddenly things like political risk matter again.

That’s bad news for most emerging markets. And it’s a worry for the Brics too, all of which have seen their stock markets take a hit this year.

But it’s worse for China and Russia. Brazil and India have their problems, and plenty of them. India in particular has a fractious democracy, terrible infrastructure and chronic corruption. But at their core, they believe in democracy as a model for society, so the chances of dangerous social upheaval are comparatively low.

In China, the chances of a civil breakdown are higher. Economic problems tend to lead to unrest. The uprising in Tiananmen Square occurred at a time of high inflation, for example. We’ve more on China and the troubles it faces in the current issue of MoneyWeek.
But Russia’s probably the most risky for investors. The country is a basket-case in many ways. It has appalling social problems including high levels of alcoholism, HIV infection and suicide. And while surveys suggest that the Chinese population seems largely comfortable with the idea of capitalism, ordinary Russians seem to pine for the good old days.

Above all, Russia’s recovery from bankruptcy in the 1990s has been built on the soaring oil price. China makes things for US consumers; Brazil has a broad range of commodities for sale; and India has a bright, cheap white-collar workforce. All of those are under threat from the global slowdown, but none quite as much as the price of oil.

All those petro-roubles pouring into the coffers have given Russia back its swagger. But as the deflating credit bubble leads to global economic downturn, the oil price is already falling. That’s why if Russia wants to press home its advantage, it needs to do it now.

Hence the stepping up in state rhetoric and confiscation of assets, and its action in Georgia. What’s the US going to do after all? America doesn’t have any money – and all the funds it could borrow are being spent in Iraq. Who’s going to risk distracting the army’s attention from that over a minor satellite state?

It’s time to take profits on Russia

As for investors – well, Russia’s got what it needed from them. It doesn’t have to indulge them anymore. And that means that investors can no longer ignore political risk in the country. If I was you, I’d take any Russian profits you’ve made off the table. The time will come to get back in, but it’s not now.

“We didn’t need this,” one Russian fund manager reportedly said at the weekend. “It’s not going to break the Russian economy, but war is bad for investor sentiment.”

No kidding.

UK shares picked up a further 1% with the FTSE 100 index gaining 53 points to 5,542. House builders were in demand, with Barratt Developments jumping 24% after Polaris Capital increased its stake to 6.2%, Bellway climbing 7%, Bovis 10%, Persimmon 11% and Taylor Wimpey 14%. But miners dropped again, with ENRC losing 6% despite Kazakhyms (down 1%), raising its stake to 25%. Rio Tinto shed 2% and Ferrexpo 6%. In contrast, ITV gained 6% on bid hopes while Wolseley rallied another 13% on disposal hopes. For a full market report, see:
Shares in Europe were better again, as the German Xetra Dax advanced 0.7% to 6,610 and the French CAC 40 added 1% to 4,538.

US stocks continued to improve, with the Dow Jones Industrial Average gaining 48 points, or 0.4%, to 11,782, while the wider S&P 500 added 0.7% to 1,305, its first close above 1,300 since late June. The tech-heavy Nasdaq Composite gained 1.1% to 2,440.

Overnight, the Japanese market slid 127 points, 1%, to 13,304. But in Hong Kong, the Hang Seng tacked on 39 points, 0.2%, to 21,899.

This morning, commodity prices were weaker with Brent spot trading at $111, spot gold at $808, silver at $14.24 and platinum at $1,488.

In the forex markets this morning, sterling was trading against the US dollar at 1.9015 and against the euro at 1.2776. The dollar was trading at 0.6720 against the euro and 109.86 against the Japanese yen.

This morning the latest RICS report showed UK house prices falling again in July as the credit squeeze brought the property market to a “virtual standstill, with first time buyers rapidly becoming an endangered species”.

Knowledge: The New Power in Retail

2007-05-02T06:49:00.000-07:00

Knowledge: The New Power in Retail
by Glynn Davis

Everybody knows that knowledge is power so it seems strange that many
retailers seem to have little insight into their customers. But their
interest is growing as they increasingly recognise customer intelligence is
now a key factor in differentiating winners from the losers in the retail
sector. An example of how important it has become (in all parts of the
business world) is the recent Business Week 'Best Performers 2007' survey.
This concluded that the key distinguishing factor of many companies in the
top 50 was a deep understanding of their customers.

This gave them the competitive advantage to sell more goods and services
than their rivals. And nobody would argue that the likes of Google, Goldman
Sachs and Amazon, which finished high in the list, are exemplars in using
customer knowledge to drive sales.

Nowhere is the increased desire for customer insight more evident than in
the ultra-competitive food retailing sector. So much so in fact that even
the mighty Wal-Mart is in the midst of jumping onboard.

As the creator of the long-standing Every Day Low Prices
(EDLP) strategy (that was pretty much adopted by all retailers around the
globe in recent years) it believed that all it needed to attract customers
was low prices.
But it now realises this view was wrong and that its myopic focus has
limited its business development. For a company not keen on showing any
signs of weakness it was pretty open in admitting that it had to become more
customer-focused: "Broad stroke 'Always Low Prices' has not allowed us to
develop some of the businesses to their full potential, because that doesn't
resonate with the customers."

Nowhere has Wal-Mart seen greater proof of how customer intelligence can add
significant value to a retail business than with Tesco. For some years the
Wal-Mart owned Asda has been losing ground to Tesco in the UK as it
increasingly capitalises on its extensive customer knowledge to drive sales
harder and move into new categories.

It's fair to say that Tesco's insight into its customers is regarded as
second to none in the retail world. And what makes this possible is
marketing data specialist Dunnhumby (of which Tesco owns 83%). So successful
is it that the company has also sold its services to Kroger a US-based
supermarket and general store business that operates over 2,500 outlets that
trade under a variety of fascias including Fred Meyer, Kroger and Dillons
and also to leading French supermarket operator Groupe Casino.

It has helped Kroger to stage a recovery against Wal-Mart after a long
period of losing ground. Unsurprisingly, its smaller scale meant it was
unable to fight on an equal footing with Wal-Mart using an EDLP strategy. It
has been using Dunnhumby's expertise with customer data to segment
- or tailor - its stores to their specific local markets.

The Kroger chairman and chief executive David Dillon has described the data
company as his secret weapon in fighting Wal-Mart: "Dunnhumby has helped me
reset my understanding of what the customer is after, and it helps replace
intuition with actual data and actual facts. And it's those facts that are
driving our decision making."

Dunnhumby analyses the sales data from stores to enable it to construct
complex marketing strategies and promotional campaigns. This essential
information on actual buying behaviour has guided most of the key decisions
taken by the management team at Tesco in recent years (such as the launches
of both Tesco.com and its financial services arm, and its entry into
non-food categories such as clothing). It will increasingly have the same
effect on Kroger and will likely do the same for Casino in the future (the
link-up was only announced in October 2006).

What makes is possible to enjoy such customer insight from the data analysis
at these retailers are their loyalty schemes through which they are able to
collect personal details on their customers and to link this with the
purchases that they make in-store. Such loyalty schemes have not been
regarded as particularly good ideas to date and Tesco has received much
criticism about its loyalty programme since its launch in 1995. They were
just seen as a cost on a business since they would reduce margin as
customers collected points to redeem against goods or money off their
shopping bills. David Sainsbury infamously dismissed it as "no better than
electronic Green Shield stamps".

But he was to eat his words many times over because since the first customer
signed up to the scheme it has provided much of the fuel that has powered
Tesco to the top of the UK retailing tree. It is no coincidence that since
Tesco launched the scheme it has overtaken Sainsbury's to become, by a long
way, the UK's largest retailer.

Within only a few months its impact was obvious. Research showed that
customers spent 28% more at Tesco while cutting their spending at
Sainsbury's by 16%. This had a major effect on the market shares of the two
companies with Sainsbury's having a 19.4% share in January 1995 compared
with Tesco on 18.1% but by May of that year the former's share had slipped
to 18.8% while the latter had grabbed a 19.4% share. This trend has
continued to this day and Tesco now commands a 31.3% share against the 16.5%
of Sainsbury's.

From day one Tesco knew that the scheme would provide a whole lot more than
simply allowing people to collect loyalty points to reduce their shopping
bill. In fact this was never the point of the exercise because the
point-accrual mechanism was simply the carrot to customers that would get
them to dig out their loyalty cards whenever they visited a Tesco store,
thereby enabling Tesco to collect data on them.

But as other retailers launched their own loyalty programmes they soon
recognised that collecting data is one thing but making sense of it and
transforming it into customer intelligence is a completely different matter.

It was an inability to overcome this problem that prompted Sainsbury's (yes
it did ultimately launch a loyalty card despite David Sainsbury), Safeway,
Somerfield, Asda and Waitrose to abandon their schemes one-by-one.

Just consider that even when Clubcard had a mere five million cardholders,
during a three-month trial of the scheme, Tesco had to deal with 50 million
shopping trips that comprised 50 billion purchased items. What made the
analysis of this data mountain possible was the decision by Dunnhumby to
only analyse 10% of the data and then apply the findings back to the other
90%. It realised that even a 10% sample could give 90% accuracy whereas the
massively more complex and expensive task of analysing a much larger
percentage of data might only deliver 95% certainty so it came to the
conclusion that crunching any more than 10% of the numbers was simply not
worth the cost or effort.

So powerful were the findings from this trial period that the then Tesco
boss Ian MacLaurin said: "You know more about my customers in three months
than I know in 30 years." The belief at Tesco was that if Dunnhumby could
replicate the success from the trial across the whole business then there
was a chance that it could propel the company to become the UK's number one
food retailer - displacing Sainsbury's. Since this has come to pass
Dunnhumby has played a serious part in customer intelligence creeping up the
agenda of an increasing number of retailers. They have come to realise that
without sufficient knowledge of their customers'
behaviour and buying habits then they are doomed to failure.

A number of years ago I spoke with a former chief executive of Wal-Mart and
asked him whether the company - and its UK arm Asda - would be likely to
introduce a loyalty scheme to learn more about its customers and he gave a
categorical 'no'. Although he was right and neither company has launched
such a scheme this is not to say that they won't in the future. Especially
as Wal-Mart will soon find itself competing directly with Tesco on US soil
as the UK supermarket will shortly be opening a chain of 'Fresh & Easy'
shops on the West Coast.

Ominously for Wal-Mart, the Tesco boss Sir Terry Leahy recently stated that
the company intended to roll out its Clubcard scheme to each of the
countries in which it operates thereby throwing up the scenario where
Wal-Mart could be facing the might of Tesco's customer insight on its own
doorstep.

But even if Wal-Mart resists committing to a scheme there is little doubt
that it is increasingly looking to learn more about its customers having
recognised that price in no longer the be-all-and-end-all for consumers.

To this end last year it appointed a new head of marketing who had
previously spent 19 years at Target - which is recognised as very proficient
in targeting segments of customers through focused marketing made possible
by customer insight. Target has proved itself particularly adept at
extracting more money out of its customers by targeting them more
effectively through knowledge of their behaviour, thereby achieving higher
profits out of its existing stores. Target's business is regarded as the
'upmarket discounter' in the US.

Wal-Mart is now attempting to follow the same path. Its new marketing man
has set up a market research and consumer insights competency that is
intended to help the company adopt a marketing approach that focuses on
specific categories. This will help it to introduce new categories and
better tailor the mix of goods in each of its stores so they are better
suited to their location and customer bases.

There is evidence that retailers are using various methods to boost their
customer knowledge without necessarily running their own loyalty scheme. The
multi- retailer loyalty programme Nectar is one example of how retailers
have been able to increase their customer knowledge without running their
own scheme. In the UK Nectar has signed up some serious retail names
including Sainsbury's, Debenhams and Dollond & Aitchison but although it
provides the mechanism for cardholders to collect and redeem points it is
nowhere near as effective at providing customer insight as Dunnhumby is for
Tesco and Kroger.

To address the increasing demand for such insight Nectar is now working on
creating a data analytics division (a la Dunnhumby) that will enable it to
make much better sense of the mass of data that it collects each day on
behalf of its retail clients. Tesco has successfully used market
intelligence to steal a march on its competitors who are now belatedly
waking up to its potential.

Regards,

Glynn Davis
For the Daily Reckoning

We open the papers this morning and find the same two- headed schizophrenia
we have been watching for so many, many months.

One head proudly announces that not only is everything doing well - it is
doing better than ever in history. The Dow hit a new record yesterday. The
funds are flush with cash. Takeovers...Mergers and Acquisitions...new
IPOs...are all headline news. Rupert Murdoch is bidding for Dow Jones,
Microsoft is working on a major purchase.
Money...money...money! Deals...deals...deals..!

It is glorious to get rich...as Deng Tsaio Ping put it.
And many people, all over the world, think they are bound for glory.

Meanwhile, the other head hangs down in despair. "Actual underlying
conditions of the world economy continue to deteriorate," it mumbles.

Larry Fink, CEO of Black Rock, a trillion-dollar fund management company,
spoke out last week and said that all these mergers and acquisitions were
going to cause "tomorrow's problems." Why? Because they are all funded with
debt. And lending standards for big, commercial deals have gone the same
way as the lending standards for people buying trailers.

"Standards have deteriorated to a level that we never even dreamed we would
see," said Fink.

Almost on the very same day, the Bank of England said almost the same thing.
Loose credit standards have "increased the vulnerability of the [global
financial] system."

The Boston Globe helpfully provides
more detail:

"Private equity firms are raising gigantic new funds, which in turn are
buying companies on an unprecedented scale. The targets are bigger than
ever, and the deals are gushing at fire-hose volume. But that isn't just a
function of all the billions raised from limited partner investors. Borrowed
money is the real fuel driving an overheated market.

"I think of this as a debt bubble, not a private equity bubble," says Kevin
Landry, chief executive of the Boston private equity firm, TA Associates.

"Debt markets that finance private equity transactions have changed in three
important ways. They are charging lower interest rates, reducing the premium
normally charged for greater risk. They are lending more money for the
purchase of an operating company, exceeding normal caps based on the cash
generated by the acquired business. Finally, debt markets are reducing or
virtually eliminating covenants and other rules that now make it almost
impossible for private equity investors to default on loans used to buy
companies.

"Got that? Low rates, more leverage, practically no conditions. How do you
think that story is going to end?
"The reality is the markets are willing to provide extraordinary amounts of
debt, almost indiscriminately,"
says Scott Sperling, co-president of Thomas H. Lee Partners, the big Boston
private equity firm. "It's hard to put these companies into default. I can't
think of the last time we had a real covenant in one of our deals."
In the financial deal business, it is still like the middle of the property
boom, when householders practically couldn't default, because lenders
wouldn't let them. As soon as they got into trouble, the lenders would give
them more money.

Landry explained that in a deal his company made recently, he didn't even
have to make the scheduled payments. If he ran into trouble he could make a
"toggle payment," or "payment in kind," essentially borrowing more to make
the regularly scheduled loan payment.
"How do you default?" asks Landry. "You used to say,
'Can I pay down enough of this debt so if a recession
hits I can get through it?' Now it doesn't matter even if a recession hits
next week."

"Investors stretching for yield are making all kinds of markets do strange
things. Look at the sub-prime mortgage market to see how that practice can
end badly. Private equity's debt bubble could become another story with a
very ugly ending."

The bubble in sub-prime lending ended when the value of its collateral -
housing - stopped rising in price. The bubble in Private Equity financing
will pop too when its collateral - ultimately, the stock market - ceases to
go up.

Then, over-stretched lenders will go broke. A few high- profile hustlers,
prosecuted for financial hanky-panky, will go to jail. And, like soldiers
tripping over the bodies of their dead comrades, the survivors will have to
find some other route to glory.

More news:

*************************

Rob Mackrill pondering some very big numbers:

Accountability. Integrity. Reliability.

- These three words grace the web pages at the US Government Accountability
Office (GAO), formerly the General Accounting Office. They might strike some
of a cynical disposition as a tad ironic, not for the organisation itself,
but for the charges over which they must cast their analytic eye.

- The GAO changed its name almost three years ago. It wanted to clarify
things for the benefit of dim job hunters and journalists, that they weren't
just a bunch of nerdy bean counters poring over the government's books.

- These days they do so much more they say. But when all's said and done, it
remains by its own admission the lead auditor to the US government's
consolidated financial statements.

- If you feel your eyes glazing over at this point, you're not alone but
bear with me. The GAO is not the sex and violence of government. It's the
chronicler of the consequences of sex and violence...or as an old saying
would have it 'an auditor is someone who goes onto the battlefield after the
battle has been fought and shoots the survivors'. Whatever your definition
its recent report makes for some eye-popping reading.

- In February bean-counter in chief, Comptroller General David M. Walker,
amongst other representations, wrote a letter to Congress. We've got a
problem he tells them and we need to change our ways was the general
gist...oh, and by the way, I have prepared a little report that's easy to
read - even for those not good with numbers - and is near enough guaranteed
to ruin your day.

- The title of his report gives us a clue as to its nature:
Fiscal Stewardship: A Critical Challenge Facing Our Nation.

- Here we offer up a few choice excerpts from Mr Walker's assessment:

"We are failing to properly discharge one of our biggest stewardship
responsibilities to our children, grandchildren, and generations of unborn
Americans: fiscal responsibility.

"The federal government's financial condition and fiscal outlook are worse
than many may understand...in fiscal 2006...its costs exceeded its revenues
by $450bn...

"As at 30 September 2006, the US government reported that it owed more than
it owned by almost $9trn.

"In addition, the present value of the federal government's major reported
long-term 'fiscal exposures'
- liabilities (eg debt)... contingencies (eg insurance), and social
insurance and other commitments and promises (eg Social Security, Medicare)
- rose from $20trn to about $50trn in the last six years.

"GAO is responsible for auditing the financial statements included in the
Financial Report [prepared by the US Treasury], but we have been unable to
express an opinion on them for the 10th year in a row because the federal
government could not demonstrate the reliability of significant portions of
the financial statements...

- Not signed off for 10 years on the trot. Wow! Sounds bad, like the US is
just some giant Ponzi scheme waiting to tumble, but then the EU accounts top
that achievement.
They have not been signed off for 11 years. Reasons for which is now
engaging the attentions of a House of Lords Sub-Committee on Economic
Affairs.

- Maybe a nation's, or block of nations', accounts are just too complicated,
convoluted and twisted for even the boldest to dare putting a signature to?
We don't know, but certainly wouldn't relish the task.

- But wait there's more, how about those Social Security and Medicare
promises?

"...one would need approximately $39trn invested today to deliver on the
currently promised benefits for the next
75 years."

- Okay so Uncle Sam is rich. At $13trn it accounts for over a quarter of
global GDP, but even this vast wealth looks pretty puny against the job in
hand. Living beyond your means is ruinous whatever the scale. Time to wheel
out Dickens's timeless advice courtesy of Mr Micawber:

"Annual income twenty pounds, annual expenditure nineteen pounds, nineteen
shillings and sixpence, result happiness. Annual income twenty pounds,
annual expenditure twenty pounds and sixpence, result misery."

- So if the US is looking at misery what's the GAO got in mind? Well its
bitter medicine. To sort out the mess would require either spending cuts or
tax increases equal to 8% of the entire economy for the next 75 years.

- Try selling that to an electorate Messrs Guiliani, McCain, Clinton, Obama!
A critical challenge indeed...

For interested readers the full report can be found via this link:

http://www.gao.gov/fiscalstewardship.html

*** There may be considerable anxiety about the rise of China in many parts
of the world, not least the US, but a note from a reader tells us
Nostradamus - as ever - was on the case and provided a forecast long ago as
to who should be most worried.

'The Complete Prophecies of Nostradamus' by Henry C.
Roberts reportedly predicts that by the year 2025, by ritual, China, having
completed her industrial and economic expansions, will absorb almost the
whole of Northern Russia and Scandinavia.

So now you know...in advance.

*************************

And more views from Bill:

*** How time flies! It is already May...the 5th month of the 7th year of the
21st century. Who'd have thought?

We remember back in the 1950s...we wondered what it would be like in the
year 2,000. Flying cars...regular commutes to the moon...we imagined all
sorts of things that turned out to be farther in the future than we had
thought.

What really changed in the last half century?

Cars...airplanes...skyscrapers...golf...hamburgers...
TV...air-conditioning...antibiotics...nuclear bombs - all the big things
that shaped our lives had already been invented. What has been invented
since then?
Hmmm...the Internet?

We can't think of anything else.

Of course, the Internet is changing the world. It is part of the reason real
estate prices are going up faster in desirable resort locations than
elsewhere - so many more people can live in these places and still continue
working. It is also changing the way we get information and ideas...never
before have so many people had such ready access to so many bad ideas.

In today's headline news is a report from New York, where Rupert Murdoch has
just offered to buy Dow Jones. He's offered a 65% premium over yesterday's
share price. Major shareholders are said to be considering it.

Elsewhere is news that the New York Times has sold its flagship building in
Manhattan to a diamond merchant.

And everywhere traditional news media, in which the lies are printed on the
pulp of trees, is giving way to the new news media, in which the drivel
comes to you electronically.

Through no fault of our own, we have occasionally been the victim of news
stories, in which the 'news' differed dramatically from what we knew to be
true - often to such a degree that the reader would come away with the exact
opposite of the truth. But what would you expect? The fourth estate is no
less self-interested than the other three. And it is dominated by a class of
people who are particularly dull-witted and lazy. Generally, they have 'the
story-line' already in mind - because it has been written hundreds of times
already - before they ever take a single note or look at a single fact.

"But it's really gotten a lot worse in the last few years," explained a
journalist friend. "The newspapers used to spend a lot of money on
investigative journalism...to come up with facts that would keep readers
interested. But now, they don't want to spend any money on research or
investigating. They don't even want the facts, because they might interfere
with the story- line. They spend all their money hiring pundits..."

*** Our old friend Ron Paul is running for President.
Poor Ron. He is much too honest and thoughtful for a career in politics. We
are sure the press will trip over itself in its rush to ignore him. He will
get in the way of their story line.

*** Meanwhile, in London, global warming seems to having a delightful
effect. The trees are green. The wisteria is blooming a month early. The sun
is out all day long. It
is not spring at all; it more like midsummer.

The ocean is so warm, icebergs are melting faster than ever. Dry areas seem
to be getting drier.

Is Global Warming real? We don't know... all we know is that it seems
unusually warm and pleasant here in Europe.

"Winters have been milder than they used to be," said a couple from Nova
Scotia, with whom we lunched on Monday.
We were in Paris. The flowers were out. The smell of blooming things was in
the air. The sidewalks were crowded with tables. People were out...
walking...
sitting... sunning themselves in the parks.

*** And last night, we almost had a chance to sample urban poverty for
ourselves, when we had a brief brush with the life of the homeless.
Economists and investors should always remember to eat at regular intervals.

Otherwise, their blood sugar level is likely to drop to such dangerous
levels that they will do something stupid.
So it was, that upon entering our hotel, we got into an argument with the
desk clerk and at midnight proudly marched out of the hotel in 'high
dudgeon,' as they say...only to find ourselves with nowhere to stay.

We wandered the streets of South London for a while, wondering about the
life of the homeless. How did they support themselves? Where did they eat?
What did they do all day? They were beginning to bed down. A group of young
bums spread out filthy sleeping bags under a bridge An old man lay down on a
piece of cardboard in a doorway, covering himself with newspaper. A mental
defective sat in a dark corner, asleep, but still holding a cup and a
sign: Please Help.

We considered the choices. We could lie down with the young whelps under the
bridge. Or we could grab a piece of cardboard from a dumpster and join the
old dog in the doorway. Or, we could just sit in a corner until daybreak...
perhaps muttering to ourselves in order to look like we belonged there.

Instead, we checked into the Hilton...
The Daily Reckoning PRESENTS: Glynn Davis identifies the secret edge that
helped transform the British supermarket group Tesco, from high street dog
to retail superstar...

Tasty Morsels of Deficit Spending

2007-04-11T09:24:00.000-07:00

Behavioural finance and investment decisions

By Bill Bonner

"The bulk of the money in this world is managed in a cover-your-ass
fashion."

Thus speaks a modern day Zarathustra; a prophet of the school of
'behavioural finance,' Mr Whitney Tilson, fund manager, founder of T2
Partners, and Financial Times columnist.

As an investment theory, behavioural finance turns out to be a full-dress
version of the familiar truism about the fool-and-his-money. What worries
the behaviourists is the way investors make mistakes by following their
impulses...with nary a sign of rational profit- maximizing. If only the poor
suckers would stick with sober investment analysis, complain the
behaviourists, drumming their fingers in a nervous, academic sort of way.

Think about it. Here, an investor holds a stock too long. There, another
buys a fund simply because everyone else is buying it. A third bumbler
investigates so much he gets 'married' to his picks, having put so much time
and effort into them.

We might feel sorry for the poor fools for we realize that we make all those
'mistakes' ourselves...only, we wonder if they really are mistakes.

You see, the problem with the behavioural finance chaps is that they don't
go far enough. They pretend to analyze what people do, and then compare it
to what some fictional, non-existent investor 'ought' to do. So, today, we
ask the question, why should he?

If we investors do not really invest the way a theory says we should, where
is the fault? Where is the error?
In ourselves or in the theory? Why, after all, should investors behave in
any other way than the one they are accustomed to?

The behaviourist professors assume that man is essentially a rational,
profit-maximizing creature who simply makes 'mistakes.' But these 'mistakes'
are no mistakes. If an investor does not invest the way the professors think
he should, it is because he is not the animal they think he is. In other
words, we investors do not invest merely to make money.

If our only goal were to make money, we would go into pornography, illegal
drugs or even worse, hedge funds!
Yes, if men were only money-makers, we would go door-to- door in trailer
parks, offering zero-down, no-interest, negative amortization loans on new
houses. And we'd give a discount for buying two of them. Where we met
resistance, we'd throw in a subscription to one of those nifty Internet porn
sites for free with every purchase.
And maybe some crack cocaine too, just to ease the settlement.

But the 'lumpeninvestor' does not have only money-making as his goal. Making
money is merely a part of a whole complex of desires and prejudices that
drives him to his much-deserved fate. The lump wants not only to make money,
you see, but also to feel both wise and hip, both daring and cautious. He is
certainly willing to try contrarian investments, only so long as everyone
else is too!

And that is why in the hard world of investing, the lumps are losers. For,
in investing, what tends to go up are just those things that have gone down.
But, buying down-and-out investments is not what the average investor wants
to do. Why? Because it makes him feel marginalized, odd, in danger. It makes
him feel like an outsider when he wants to feel anything but, and would as
soon forego his profits to pay for that privilege. In fact, the lump tosses
and turns at night, unless he is firmly and squarely bedded down in the
middle of the vast herd of other slumbering fools.

The lumps may not maximize their investment returns...but they judge being
able to sleep well worth the cost.

Other investors don't care so much about making the right decision as they
do about avoiding the wrong one.
Such men fear losses less than laughter. They dread most of all being in a
position where anyone - especially their wives - might point a finger and
call them a jackass. To tell the truth, they would rather actually be a
jackass, financially speaking, than be accused of being one by an ignoramus.
And, what do you do to avoid your wife's criticism? Why, you do exactly what
Citibank or Lehman Bros does. Or what the Federal Reserve Bank tells you to
- even if it means taking out an adjustable rate housing payment.

Yet another lot of investors exhibit a loyalty we can only admire. They
stick with an investment sector - or even an individual company - through
thick or thin, rich or poor, success or failure...until death do them part.
And death often does. Others tend more to be bad boyfriends, dropping their
poor girls as soon as another bit of skirt wiggles in front of them.

But, of course, if you believe the behaviourist geeks, the cads are only
being rational, profit-maximizers. Not a whisper of spring fever in the
blood at all.

But if investment decisions really were such cold- blooded, binary choices -
one clearly right, the other clearly wrong - computer programs might make
them for us just as well. Only, computers don't get to read tomorrow's
headlines any sooner than we do and even a silicon chip can't tell which
investments intend to go up or down.

Which means that the whole idea of a rational profit- maximizer - a perfect
investor who doesn't make mistakes
- is so lacking in any connection to reality, we can safely classify it as a
bloodless intellectual fraud.

That is why our ingenuous and irrational investor is right, after all.
Knowing that the success or failure of his investments - money-wise - is
mostly beyond him, he goes for the non-monetary rewards - bragging rights,
sound sleep, social cache, derriere-covering, wife-
pleasing...skirt-chasing.

He may be a fool to finance professors. But, in the real world, he is a man.

Bill Bonner, August 23rd 2006

The Daily Reckoning Brings you: Tasty Morsels of Deficit Spending

by The Mogambo Guru

"And this pathetic performance occurs despite the fact that the government
has been buying huge, huge, HUGE amounts of war materiel from the 'defense
industry' and running up enormous, enormous, ENORMOUS deficits to pay for
it!"

Money must be getting tight, as Total Fed Credit is up only $1 billion from
last week, foreign central banks are cutting back on their gluttony (adding
only $4 billion to their holdings at the Fed), and now I am forced to make
the painful choice between paying for the kids' damned dental problems or
getting that expensive new driver that is GUARANTEED to give me another 15
yards off the tee, curing my accursed fade-away slice problems forever. And
this will (in the final analysis) make me a whole lot happier, and will last
a hell of a lot longer than anything that stupid dentist does, too.
("See you again in six months, suckers!")

But it is neither golf nor dentistry that disturbs my already restless
slumber; it is inflation that makes me wake up screaming in the night, with
a spasmatic trigger-finger, and my loud, irritating voice issuing both wails
of fear and sulfurous curses to add to the incessant Mogambo Inflation Alert
System (MIAS) buzzer - which indicates that monetary inflation is raging,
raging, raging around the globe, as all the central banks are busily,
busily, busily creating money and credit at monstrously high rates of
issuance, averaging (as I understand it) about 14% a year. That means that
inflation in prices will continue to get worse and worse
- as will my aforementioned sleeping and trigger-finger problems.

And surely things are going to get heated up pretty soon thanks to inflation
- especially when the middle class starts whining; Congress really comes
alive then. And speaking of that, we have Ty Andross of TraderView.com
newsletter reporting that "the broad middle class has not shared in the
wealth of this expansion except for the bubblicious appreciation of their
home values."

He adds, picturesquely, that they were "robbed at night while their money
was sitting in the bank and the Treasury's printing presses churned out
dollars and credit by the trillions", which made every dollar of that
appreciation in the house worth less! And then the homeowner had to pay
higher property taxes and insurance premiums on the now-expensive house!
Hahaha! I'll bet THAT is not in the stupid little econometric models the
stupid Federal Reserve uses! Hahahaha! What dorks!

And all that price inflation was spawned by the Federal Reserve, since it
created the money and credit to finance a stock market boom, and a bond
market boom, and a derivatives boom, and a financial-services industry boom,
and then a housing boom. All now busted, to one degree or another.

And while the inflation "problems" of the stock and bond markets is one
thing to be officially ignored, the inflation in the effective prices of
houses (taxes, mortgage and insurance) and the subprime mortgages that
spawned it, now has the idiotic Congress frantically looking into it (at
long last), now that the bust is here and it's too late to prevent the boom
that caused the ensuing bust that they are so bent out of shape about.

And why will the government try and bail out these homeowners and investors
who are looking at huge losses in a housing bust? Taxes, I figure! Same as
always!
Congress is surely aghast at the prospect of trillions of dollars of losses
being deducted on tax returns next year, and for years to come, too.

I mean, next year the federal budget balloons to a whopping $2.9 trillion,
up from $2.7 trillion this year, and so the LAST thing they need is less tax
revenue coming in!

But feigned ignorance and subsequently being aghast at the results also
comes naturally to the Federal Reserve, which has an annoying habit of
ignoring (and lying
about) inflation in prices, especially the kind of willful ignorance about
the results of creating inflation in money and credit, as perfectly
illustrated by the essay "Inflation and the Ironic Productivity Tax"
by Richard Benson of Benson's Economic & Market Trends newsletter.

He writes, "It dawned on me that the one thing the government never reports
on is that the dollar in my pocket will buy me more next year. Indeed, my
dollar should buy more because of the relentless increases in productivity,
and I should in reality be better off if I saved money, rather than spend
it."

I leap to my feet and shout, "Bravo! Well said! An increasing standard of
living is the whole promise of productivity!"

Ignoring me completely, he goes on to say, "But, in my lifetime, my world
has only known inflation, so buying goods today that I will need tomorrow,
and stashing them away, has proved to be a better investment than saving
cash in the bank. As a consumer, when I think about the escalating cost of
food today, I realize I really didn't benefit at all from all those
productivity gains!"

So where did the benefits of productivity increases go?
He explains, "With inflation, the government has basically stolen/taxed my
share of productivity away."

He dryly and sarcastically notes, "It's ironic that the best and brightest
at the BLS are employed to figure out how to use fancy statistics to rob
their grandparents of their social security increases". After which, he goes
on to calculate, "If money and credit growth were restrained, I estimate the
dollar could purchase about two percent more each year, and we would be
living in a saver's paradise." And a spender's paradise too, as prices would
go down each year!

He calculates that productivity, as measured by the Consumer Price Index,
deliberately understates inflation, and "Taking productivity out of the
Price Index means that when the CPI shows three percent, in reality it's
more like five percent." 5% inflation! Yow!

We glean a little macroeconomic forecasting lesson when he says, "So, when
looking forward, it is important to remember that whenever productivity
slows down, inflation will suddenly pick up", which I take to mean that if
productivity drops, you should immediately short bonds! Hahaha! This
investing stuff is so easy!

"Now that I clearly understand how this productivity tax works," Mr. Benson
goes on to say, "I am less inclined to buy inflation-indexed bonds and more
inclined to buy gold and silver. I believe precious metals are more likely
to track the real inflation numbers."

"And why is this?" you ask with that cute little innocent, quizzical look on
your adorable, trusting face. Instantly I am on my feet to deliver a
stirring and powerful condemnation of the Federal Reserve for creating all
that money and credit, gradually working the crowd into an absolute
blood-frenzy, see, ending with me being declared King Mogambo by cheering
throngs of adoring people ready to obey my every command, and given
unlimited powers of retribution and vengeance! I cruelly sneer as I laugh
the hollow laugh of the damned, "Hahaha! Let the games begin!"

However, I was not prepared for Mr. Benson apparently being so appalled at
the prospect of a King Mogambo, and he quickly preempted my plan for a
speech leading to world domination by pithily summing it up by saying, "The
U.S. is inflating like crazy, and it's only going to get worse."

Already angry at being thwarted in my attempt to deliver the Speech Of A
Lifetime (SOAL) that would have lead to my being crowned King, the news that
inflation is "only going to get worse" makes me angrier and angrier, until I
race home to fire off flaming emails and faxes to my Congresspersons ("Dear
Butthead, I hate you for allowing the Federal Reserve to create all that
money and
credit!") and the Federal Reserve ("Dear Buttheads, I hate you, too!").

But while stocks, bonds and houses may not be going up in price (and may be
going down in price!), the kinds of things you and I have to buy to satisfy
our insatiable wants and needs for tasty morsels and various kinds of fun,
ARE going up in price...every one of them! That is the horror of it all!

And speaking of raging price inflation, Doug Noland of the Credit Bubble
Bulletin says that last week "M2
(narrow) 'money' rose $9.1bn to a record $7.164 tn (week of 3/19). Copper
gained 2.5%. May crude surged $3.59 to $65.87. May Gasoline jumped 5.7% and
May Natural Gas 4.4%. For the week, the CRB index gained 1.9% (up 3.1%
y-t-d), and the Goldman Sachs Commodities Index (GSCI) surged 4.2% (up 7.9%
y-t-d)."

And now Bloomberg.com reports that we have entered a portal to what I think
may be characterized as the Worst Of All Worlds (WOAW): The economy is going
down and prices are going up. More specifically, "Manufacturing growth in
the U.S. slowed more than forecast last month"
as "The Institute for Supply Management said its factory index fell to 50.9,
from 52.3 in February."

And what's worse, "raw-materials costs jumped, reinforcing concerns that a
cooling economy isn't reducing inflation" as "A sub-index of prices rose the
most in seven months."

But worst of all, "measures of employment and new orders declined."

All of this is provided as more proof of the eerie accuracy of the economic
indicators, like the leading indicator has been right in forecasting future
economic activity, in that it has been going nowhere for quite a while and
thus has been predicting today's lower economic activity.

Specifically, we now find that in February, durable goods orders fell by
0.1% when you exclude aircraft orders - which was huge - but including
aircraft, durable goods orders, it would have risen by 2.5%!
Making an economy out of airplanes! Hahaha!

And this pathetic performance occurs despite the fact that the government
has been buying huge, huge, HUGE amounts of war materiel from the "defense
industry" and running up enormous, enormous, ENORMOUS deficits to pay for
it!

How much defense industry spending? Well, Mark Skousen of Forecasts and
Strategies newsletter says, "the U.S.
government's share of GDP spent on defense has gone from 3% to 3.7% since
September 11, 2001", adding, "while other nations collectively have declined
from 2% to 1%."

Well, as uncannily correct as the leading economic indicator has been in
forecasting this slowdown, the lagging economic indicator (which can be
characterized as measuring burdens and future inflation) has been on a
relative tear, and has been absolutely prescient in predicting the inflation
that we are seeing.

And the coincident indicator has always been right about current conditions
all along, too. It looks like three out of three!

On the site bbj.hu, which apparently got the news from somebody else, there
was the headline "Central Bank gold holdings fall to lowest since 1948" and,
"Gold holdings by central banks and other government organizations declined
for the eighth straight year in 2006, to the lowest in almost 60 years,
figures from the International Monetary Fund show. Bullion holdings were
867.6 million ounces last year, down 1.2% from 2005."

So where is all of this gold? Well, it turns out, "Of the 4.98 billion
ounces of gold in inventories at the end of 2005, 52% was in the form of
jewelry, 18% was in central bank vaults and 16% was investor owned."

As to why this may be important, we turn to the famous and handsome John
Embry of Sprott Asset Management, writing in the March 30 issue of
Investor's Digest under the title "The Time For Gold 'To Go Ballistic'
Approaches". He starts off by explaining, "In reality, it isn't the price of
gold that changes, but the value of the paper currency in which it is
denominated. I have made the case many times that paper money is being
seriously debased, and I think my position is strongly supported by the
recent spate of money-supply growth numbers that have emerged from around
the world."

He then ticks off the annualized growth of some broad money supplies, namely
Eurozone M3 up 9.0%, UK M4 up 13%, China M2 up 15.9%, South Korea up 10.6%,
Australia
M3 up 13%, United States M3 up 10%, Russia M2 up a staggering 48%.

And if you are wondering how the dollar is faring right now, after this kind
of debasement, Yahoo.Reuters.com reports, "The dollar fell around 3 percent
against a basket of major currencies in the final quarter of 2006." This is
a huge move! Huge!

I know what you are thinking: "That Mogambo Idiot (TMI) has gotten off the
subject again, which was supposed to be about the world's gold. And so why
in the hell is he is yammering about money supplies? Who needs this crap?
Screw this! What's on TV? We got any beer left?"

If you were not so rude, impatient or thirsty, you would have soon learned
that Mr. Embry feels, "we are very, very close to that key moment when there
could be insufficient central-bank gold to meet mounting demand.
As I have said before, that is when the gold is price is going to go
ballistic."

This assessment agrees perfectly with that of Richard Russell, of the Dow
Theory Letter, who says that he thinks "the dollar will die a slow, probably
a very slow death. It will be death by inflation. In other words, the dollar
will, over the years, lose an increasing amount of its purchasing power."

And as for gold, he says, "Another irony is this - essentially, holding gold
is a rich man's escape. The reason is that gold doesn't pay interest, and it
doesn't pay dividends. The rich man can hold a large amount of gold, and it
doesn't affect his life style. The poor man, the middle class man, can't
afford to hold a significant portion of his assets in gold. No, the average
American remains at the mercy of his government and the Fed. He's doomed to
see his savings (assuming he has any savings) taxed away or inflated away",
as will his increasingly meager earnings, I might add.

To tell you the truth, I disagree with the idea that only the rich can buy
gold. When I see the enormous amounts of money the middleclass and the poor
spend on pure trash every year, I say, "And you want me to believe that out
of all that money, they can't manage to buy a stinking half-ounce of gold a
year? Or some silver? Hahaha! Don't hand me that crap!"

I think that the important point is that gold is a "rich man's escape",
which, by definition, means that rich people will be buying gold to effect
their escape! And given the staggeringly huge amounts of money now in the
world (mostly owned by the rich!), versus the pitifully small amount of gold
in the world, this could be Really Big Time Stuff (RBTS) indeed, because 1.)
History has shown that rich people always take their money and rush to the
safety of gold at the inflationary ends of booms (like this one), 2.) Gold
is essentially (like all
markets) an auction market, and 3.) Rich people bidding against other rich
people for a finite supply of gold, with unimaginable amounts of money, is
the stuff of which auction history, and newspaper headlines, is made!

And the good news, the better news, the best possible news, is that gold is
still selling at only about $660 a lousy ounce! What a screaming bargain
when viewed against what is surely coming, just like it has always come!
Unbelievable! But, "Whee!"

To a suspicious little creep like me, I naturally connect Mr. Embry's point
that there may not be enough central-bank gold to satisfy demand, to Bill
Murphy of Le Metropole Café citing a Dow Jones report that "The
International Monetary Fund has proposed to increase transparency in the
gold market by publishing statistics that reveal the amount of gold loaned
and swapped into the market by central banks."

What? This surprises the hell out of me! Then I remember (and make some
rude, disparaging noises) that the IMF has mismanaged itself, which comes
mostly from the fact that no country needs to borrow any money from the IMF
these days, as the entire world has long since gone completely freaking
insane with creating all this excess money and credit in which the world is
currently sloshing greedily around.

Now, with the slowdown in the "bail-out-and-meddle-in-
your-sovereign-affairs" business, the IMF desperately needs more money with
which to overpay themselves and maintain their expensive little lifestyles,
empires and power, to which end they recently actually proposed to sell the
gold (their capital) that the United States loaned them to fund the damned
IMF in the first place!
What thieving arrogance!

Rebuffed, I guess, this proposed new disclosure rule by the IMF to reveal
the actual gold holdings of central banks is, I figure, just the usual slimy
blackmail.
"Give us more money, or we will tell what you did!"
(Which is sort of how I ended up getting married, but that's another ugly
story, which I don't want to get into because I will cry like a baby and get
all embarrassed. And then angry. Very angry. And nobody wants that!)

Exactly what the central banks did (but not how much) is hinted at by the
news that "Although they provide regular reports of their gold purchases and
sales, central banks don't currently reveal how much gold is loaned and
swapped."

But there are just too many tremors, and tremors in central bankers
everywhere, not to think about predicting earthquakes in the gold market,
and getting long gold.

And speaking of central bankers, from Bloomberg we read, "Federal Reserve
Chairman Ben S. Bernanke said monetary policy is still aimed at combating
inflation even though risks to economic growth are multiplying. 'Our policy
is still oriented towards control of inflation, which we consider to be at
this time to be the greater risk,' he told the Joint Economic Committee of
Congress in Washington."

Bernanke is reported to have said, with no hint of embarrassment,
"uncertainties have risen, and therefore a little more flexibility might be
desirable." The Mogambo is also reported to have said "Hahaha!" in snarling
disdain, and if you didn't read or hear about it, it obviously means that
this highly-illuminating Mogambo Editorial Comment (MEC) was censored by
government goons, which that proves they're all out to get me. And it also
proves that snooping government agents and spies are prowling around in my
bushes, probably right now, and thus I am fully justified in ruthlessly
hosing down the shrubbery with withering machinegun fire until I feel safe
again (or until I run out of bullets, whichever comes first).

Okay, well, maybe it doesn't actually mean all that, but it DOES mean that
the Fed wants to ignore inflation, although preventing inflation and
attendant boom/bust cycles is the reason that power over America's money was
given to the Fed in the first damned place! They obviously haven't done
their damned jobs - I mean, look at the record! They've failed miserably!
And now, they still don't want to do their damned job; they want "more
flexibility" to give us more of the same! This is insane! And yet Congress
does nothing! Nothing! I am incensed!

But wait! I may be too hasty! With a sudden, powerful insight, I realize
that I could use this unusual stalling technique to my own advantage: Since
my Annual Employee Evaluation is coming up soon, I evilly twirl my mustache
as I scheme to myself, "This 'more flexibility'
thing could come in very, very handy indeed!"

Goals not met? I cry out "I need more flexibility!"
Losses mounting? I wail, "I need more flexibility!"
Employees and customers in open revolt at my arrogance and incompetence?
With a tone of voice that speaks volumes about what I am going to do to my
boss's car if this Evaluation thing doesn't work out for me the way I want,
I say, through clenched teeth, "I need more flexibility!"

Another way of looking at it was provided by Bloomberg:
"Bernanke said the central bank last week dropped its stated tilt toward
higher borrowing costs because policy makers wanted more room to maneuver."
Thanks! Now I realize I need more room to maneuver, too! I need room to
maneuver! For God's sake, give me room to maneuver!

The message is clear; my boss now hates and fears me more than ever, and the
Fed is clearly signaling that lots of inflation is in our future, as it is
the price we must pay to bail out the blinding, incandescent incompetence of
the Federal Reserve under Alan Greenspan, who created the housing bubble,
which was created to bail out the busted stock market bubble, and the bond
market bubble, and the size-of-government bubble that he also created.
Grrrr!

And how bad is inflation in consumer prices? Bloomberg itself provides an
answer with "The Fed's preferred inflation benchmark, the personal
consumption expenditures price index, minus food and energy, has been at or
above the two percent comfort zone of at least six Fed officials for 34
months. The price measure rose 2.3 percent for the twelve months ending
January."

Three years! Three long, long years of inflation above zero, which is de
facto evidence of their incompetence, and even more so when you realize
that, in reality, even that unacceptable recent 2.3% measure of inflation
actually understates inflation by about four to seven huge percentage points
or so! Gaaaaah! We're freaking doomed!

Even worse, "An index of 18 industrial materials tracked by the JOC-ECRI
Index is up 2.5 percent year-to-date, and 12 percent over the past year. Oil
prices are climbing."

John Stepek, of MoneyMorning at Money Week.com, must have overheard us
talking about oil prices climbing, and says that in Britain, "The rising oil
price was one of the major factors driving official inflation figures higher
across the globe in the past few years. It's also served as a convenient
excuse for politicians to point to - 'rising inflation isn't our fault, we
can't do anything about the oil price' - as Tony Blair effectively said last
year."

He says that he was reading an interesting report from Donald Coxe of BMO
Financial Group, who says, "he's also not expecting the Fed to cut interest
rates. And the reason is that the world is very short on food, at a time
when demand has never been stronger."

As to what this means, he correctly notes that I am an American, I am
stupid, and thus, carefully tailors his answer with, "This means that U.S.
consumers are about to find that their burgers, their buns, their daily pint
of milk, and everything else they eat are going to tick up in price over the
coming year."

By this time I am actually gagging on Mogambo Vomit Of Fear (MVOF), and
since I was so preoccupied with making the crucial decision of whose lap I
was gonna barf in, I almost missed him saying, "The latest U.S. producer
price index data from February showed that food prices rose 6.8% on the
previous year. It's little wonder - data from the U.S. Department of
Agriculture suggests that the amount of coarse grains left over this year to
carry over to the next 'could be the lowest - in relation to consumption -
in decades.'" Gaaaaah! MVOF!

And this is at a time when there have been, "16 straight years of favourable
growing conditions in the Midwest - the world's leading producing region.
This is an historic winning streak."

So, to recap, we ended up with nothing in savings, at the end of remarkably
long booms in stock markets, bond markets, houses, size of governments, and
now even in commodities, too? Hahaha! I laugh in derision because, I mean,
isn't this supposedly an overwhelmingly Christian nation, and thus shouldn't
we, as a people, overwhelmingly know about the Biblical admonition to save
during the fat years in preparation for the cyclically-inevitable lean
years? Hahaha! We're religious idiots, too!

As further evidence of that, I point to the Economist magazine article about
Lynn Westmoreland, "a Republican from Georgia", who appeared on the Comedy
Channel's hit show, the Colbert Report, and who "co-sponsored a bill to have
the Ten Commandments displayed in the Capitol."
Mr. Colbert reportedly asked him to name the Ten Commandments. He could
name, in all, seven.

It is not just The Mogambo and a few of you other gold- bug, whack-job,
paranoid lunatics out there ("Hi, Lucy!"
"Go to hell, Mogambo!"), who are buying gold, as MoneyandMarkets.com
breathlessly reports, "Dubai's Gold Souk, an open-air market that contains
some 500 gold shops, is the largest retail gold market in the world.
An estimated 500 metric tonnes of gold, or nearly 18 million ounces, are
bought and sold each year. In the gold souks of Dubai, both the ultra-rich
and regular citizens are buying gold. I watched wealthy businessmen,
construction workers, and imams all snatching up the yellow metal."

And speaking of prices and gold, Junior Mogambo Ranger
(JMR) Richard D writes "I got this from Sinclair newsletter. 1941 prices.

Gallon of Milk $0.34

Loaf of Bread $0.08

New Auto $925.00

Gallon of Gas $0.15

New Home $6,954.00

Average Income $1,231.00 pa

Dow Jones 110

Gold $34.60"

I note with a certain satisfaction that, since 1941, gold has pretty much
held its own against the rest of the items on the list, which are all up
about 20 times (except milk - which is government-subsidized, so who knows -
and the Dow Jones, which is up by over 100 times
- which is now also government-subsidized by the Plunge Protection Team, so,
again, who knows.

So, is the stock market overpriced in relative comparison to everything
else, or is everything else under-priced in relation to stock prices? A lot
will depend on your answer, but it is bad news either way.
Ugh.

**** Mogambo sez: If GATA is right, and the gold market is being manipulated
with the collusion of the central banks (and I have absolutely no doubt that
it is, and would be stunned, absolutely stunned, to learn that it wasn't), I
again think of John Embry and his phrase, "the gold price is going to go
ballistic" when central banks can't meet demand.

My Mogambo Profit-Sensing Gland (MPSG) recognizes the screamingly obvious
profit that will come when this kind of manipulation ends (as it must), and
it squirts a jolt of "greed hormone" into my bloodstream. In response, I
look at my pitiful stash of gold and silver, and I compare that to how
freaking much wealth I want to have when the inevitable explosion in gold
finally happens, and I wonder "Do I have enough?" which is Polite And
Genteel Mogambo-Speak (PAGMS) for "Has my embarrassing, gluttonous greed and
unspeakable depths of avarice been satisfied with this pathetic little pile
of gold and silver?" Upon reflection, I find the answer is, of course, "no".

Then I wonder, "Should I get a job, to earn some money with which to buy
more gold and silver?" Again, upon reflection, the answer is, of course,
"no".

Then I wonder, "Should I make the wife and kids drop out of school, get
second jobs so that they can buy their own food and clothes (saving me a
bundle!), and maybe pay a little room and board around here (the little
worthless, parasite freeloaders!), and then use the money to buy more gold
and silver?" At last, I arrive at a solution I can live with. Even optimal,
in its own way!

So while I don't know how it works out for you, and you'll do what you do,
but whatever you do, you'll find that you are usually better off if you do
what you know you should do, as this gold and silver thing is "do it or it's
doo-doo!"

The End Of The World As We Know It

2007-03-29T22:41:00.001-07:00

"IT'S THE END OF THE WORLD AS WE KNOW IT"
by Doug Casey

.."And I feel fine."

That's not just the title of an R.E.M. song. It's how today's gold and
silver investors feel every time they get a reminder from a newspaper or
news program.

They see what you see, and anyone paying even a little attention can't help
but notice the stunning array of problems that are menacing the global
economy and threatening traditional investments. In fact, I can't say I've
experienced the like of it before. And that's saying something, considering
I've made crisis (and how to profit from it) the focus of my life's work.

This time around, the unfolding crisis carries several especially dangerous
features - and a locked-in profit
opportunity available to anyone even moderately fleet
of foot.

First, the intractability of the situation. That's the word Paul Volcker,
former Chairman of the Fed, used to describe things, and it's a perfectly
good word meaning, simply, that the underlying problems can't be fixed.
In the Middle East, for example, even if we pull all our troops out today,
the situation won't settle down for years... or maybe even decades. And each
day of turmoil will cost the U.S. more tens of millions in direct and
indirect costs - and keep the global economy in a state of chronic worry
over energy supplies. Then there's the collapsing housing bubble. For years
a galloping real estate market was the primary driver of our economy. Now
real estate is hobbling on three legs and has become the primary driver of
personal and corporate bankruptcies.

Even more serious is the 6 trillion or so U.S. dollars in increasingly
twitchy foreign hands. Hardly a day goes by without some government or
another announcing plans to diversify out of the dollar. And no wonder,
given the record levels of personal and government debt in the U.S.
And even more debt is baked in the cake. We have a freshly-elected slate of
Democrat law makers looking to "do something"... from universal health care,
to global warming, to confronting the "unfair" trade practices of China and
Japan (the very people who own much of the above mentioned $6 trillion).
Those projects are just for starters, of course. Congress's "must-do" list
goes on and on, and for politicians, "do something" never means "do
something cheaply."

So far, so bad.

But it gets worse. Much worse. Over 20% of the U.S.
population - the baby boomers - are now beginning to retire, and most of
them have nowhere near enough savings to enjoy their senior years. So
they'll be absolutely dependent on the Social Security and Medicare promises
they've been hearing all their lives. Politically, those promises are
impossible to renege on. Financially, they're impossible to pay. And along
with the government's other unfunded entitlement programs, they add up to
$50 trillion of off-the-books debt.
Mr.Volker spoke well. Intractable is the word.

There's more, but that's enough. We're in a box canyon with a floor of
quicksand, and the only exit is blocked by a landslide. Investors who take a
business-as-usual attitude are not going to have a nice day.

In case that litany of problems isn't enough to get the sweat beading on
your forehead, ponder derivatives. While these hybrids have been around for
decades, the rocket- shot rise of hedge funds and the advances in financial
modeling techniques have spawned something of a competition among the
so-called best and brightest to find ever-more-complex ways of skimming
pennies from very large piles of money.

The collective result is that our financial system has been wired up to $370
trillion dollars of privately negotiated investment contracts. They're
usually written to shift risk from one bank, pension fund, insurance company
or brokerage firm to another. And many are linked together in long chains,
with each contract providing collateral for the next.

It's all very clever, but layering the enormous size- $370 trillion dollars,
far more than the net worth of all the financial institutions in the world -
on top of all that complexity is downright scary. In simpler times, a home
loan going bad would affect only the particular lender. Enough defaults
would put the lender out of business. And that would be the end of it. But
today a wave of defaults can send a shock through the portfolios of
financial institutions around the globe, including hedge funds, banks and
pension funds far removed from the troubled borrowers.

Imagine an electrical circuit with thousands of connections. No one designed
it. No one tested it. No one has a diagram for it. It just grew. Now,
because of its size and power and pervasiveness, everything depends upon it.
So what happens when one of those thousands of connections burns out? No one
really knows, but I say it's a circuit you should disconnect from before the
world learns the answer.

If you are relying on traditional investments to pad your nest for the
future, the problems stalking the world economy should be a matter of
serious concern.
Especially given that as bad as we think things are about to get, there
remains the potential for things to spin entirely and un-recoverably out of
control. That's because so many wildcards are now in play. A war in Iran?
New York hit by a freelance nuke? A worldwide panic exodus out of the
dollar? Traditional investments would be the first casualty.

The $2 trillion or so loss in stock market valuations during the recent
correction is a precursor of what's to
come... in a best case. The worse case is... much,
much worse.

Working apart from the investment multitudes, a very small minority of
investors over the past few years have been building portfolios of precious
metals and Canadian precious metals stocks. It's a minority I'm happy to be
a part of, as it allows me peace of mind and the
considerable advantage of viewing these crises
somewhat dispassionately.

That doesn't mean I'll enjoy standing on the sidelines and watching the
impact of a monetary crisis on the lives of the unprepared. Of course not.
Yet I would be a fool, having recognised a crisis shaping up, not to take
the fairly obvious steps to profit.

Which brings me to the opportunity that the crisis is carrying on its back.

For any number of reasons, but first and foremost its use as money in all
the world's cultures, throughout all recorded history, gold has begun to
find renewed favour with in-the-know investors as the currency of last
resort.

Make no mistake, despite gold's rise from its $255 low in April of 2001 to
over $650 as I write, so far, only the thinnest of trickles, a minor
fraction of global capital, has made it into gold. When the flight to safety
really heats up, the real fun will begin, and the price of gold won't just
add dollars, it will add digits.

If that sounds like hyperbole, remember that, unlike the U.S. dollar, which
can be created at the speed of light, the available supply of gold is finite
and is painfully slow to change.

You can't print gold the way you print paper money. And you can't just build
a gold mine the same way you might build a Starbucks almost anywhere and on
short notice.
Instead, you first have to find a promising ore body - which is, without
exaggeration, like finding a needle in a haystack... a haystack buried
"somewhere" in the earth's crust.

Then you need to go through the immensely complex and expensive exercise of
confirming that the ore body is economically viable. Then, years after you
started exploring, you can start the even more time consuming and expensive
process of actually building your mine. That entails finding a labour force,
bringing in power, roads, mills, etc., etc... with every step hindered by
environmentalists waving court injunctions.

The long and short is that there are hardly any gold mines of size scheduled
to come on stream... and we are not talking about just over the next year or
two, but ever. Most people in the know see annual gold production falling
from here on.

For proof, there was news recently out of South Africa,
the most world's prolific gold producer. Despite the
loud incentive of higher gold prices, South African
gold production in 2006 dropped to the lowest level
since 1922.

And, above ground, there just isn't much gold to go around either. The U.S.
government, for example, possesses the world's largest gold reserves...and
those reserves amount to only about $170 billion at today's prices...not
even a rounding error on the trillions of dollars in debt the government has
guaranteed.

Put simply, the amount of gold available to investors and central banks is
like the number of beachfront home sites at Malibu - it's not going to
change much. As a result, when the rush for the lifeboats begins in earnest,
the upward pressure on gold will be unimaginable. As will be the profits for
anyone who acts now, ahead of the crowd.
If you haven't yet started accumulating precious metals, you still have
time. Start by picking up some bullion coins from a reputable dealer (silver
should do as well as gold).

Then build a portfolio of the better small companies exploring for new
deposits - the ones with the best management teams, working on the best
projects, in the best geology. These stocks are the true profit gems - in
part because of an accident of recent history.

During the long bear market that ended in 2001, the large mining companies
all but eliminated their exploration departments. Now they urgently need new
deposits to restock their declining ore reserves. But rather then scouring
the world themselves, the majors let the more agile and entrepreneurial
junior explorers - often Canadian firms, due to the resource orientation of
that country's economy - invest the capital and sweat needed to find a new
deposit. Then, when a junior company's project seems ripe, the majors
compete to buy the deposit or to acquire the junior explorer itself - and
they pay up in a most serious way.

Pick your companies right, and you can pay pennies today for shares in a
junior exploration company that history has shown again and again will sell,
with a little success, for $10, $20 or more when the market gets rocking and
investors at large rush into all things gold.
While there's no such thing as a sure thing, there are times - like now -
when the deck is heavily, massively, stacked in your favour.

You are, therefore, left with a relatively simple choice.
Do nothing and hope that all the world's troubles just drift away-and risk
personal financial disaster if they don't. Or take action, if even with a
modest share of your portfolio, and position yourself for extreme profits.

Regards,

Doug Casey

Prime slips...and slides into sub-prime.

Problems in sub-prime mortgage loans could be spreading into sub-prime
auto-loans...and sub-prime commercial loans...

As to the sub-prime auto and truck loans alone, there are some $34 billion
outstanding. As to the rest of the loans that were made to shaky borrowers,
without proper credit standards, the total may reach into the hundreds of
billions...

And what about politics? Isn't the US government operating at sub-prime
levels? And aren't the candidates for next year's presidential election also
less than prime?

Oh where...oh where...dear reader...shall we begin?

No big breaks in the financial markets yesterday. But the millwheels keep
grinding...turning the pretensions of the smart...the conceits of the
powerful...the assets of the rich – all to dust.

When standards go out the window, they just don't go out of windows in
trailer parks and ghettos. They go out of windows in gated communities in
Florida...and in Washington...and they would go out of windows of
skyscrapers in Manhattan and London, if you could only open the windows.

Even in education and art...standards slip...

We were looking at Henry's report card last night. Ai yi yi...

"Needs to work harder..." said his science teacher.

"Performing below his capacity..." said his math teacher.

"Work okay...but could be much better..." said his Latin teacher.

The half-empty part of that glass was obvious. But there was a half full
part too.

Henry does his homework until midnight every night...and works on it at
least 8 hours each weekend. And still, his teachers aren't satisfied.

We checked his grades and class ranking (in France, every student knows
exactly where he stands) and found that Henry is above the average in what
must be one of the toughest schools in France. Ah ha! A school with
STANDARDS...

From what we've heard, in most of the schools in France – and America -
students get passing grades, even without really knowing anything.

Meanwhile, yesterday, Elizabeth came back from an exhibit of Greek
statues...attributed to Praxiteles or his imitators.

"It was unbelievable," she remarked. "The sculptures had such dignity. It
is incredible that they were done more than 2,000 years ago..."

A thought crossed our mind. How many of today's artists could create a
beautiful statue out of a block of marble?

But blocks of marble are not our beat, here at the Daily Reckoning, so let
us get back to money.

What is endangering America's money is the same thing that is undermining
its position in the world – slipping standards.

And slipping standards is what had brought about the fifth of our Big E's.

We began to review our Five Big E trends yesterday:
Energy, Experimental Money (the faith-backed dollar), and the Exodus of
power and wealth from West to East. Today, we look at our fifth – the
Empire.

When we say that America is an Empire, it is neither a matter of desire or
reproach. It is simply an observation.

Some readers think it is unpatriotic or un-American to notice. But while a
good husband doesn't notice when his wife gets fat, perhaps, a citizen with
his wits about him might do well to keep a close eye on his government. And
if he looks carefully at America circa 2007 he will see it resembles an
empire more than a modest republic. Its troops...its culture...its
commerce... impose themselves over almost the entire planet.

Empires must be empires and follow the imperial path...from humbug, to
farce, to disaster. They must believe what isn't true (that they have some
intrinsic, inalienable advantage)...and they must relax their standards...as
they stretch...and then overstretch...until they have stretched too far.

Nine trillion in federal debt...a 'fiscal gap' 50 trillion dollars wide...
an $800 billion trade deficit...an everlasting War on Terror...

And in today's news comes word that the US is "no longer technology king."

The BBC reports:

"The US has lost its position as the world's primary engine of technology
innovation, according to a report by the World Economic Forum.
"The US is now ranked seventh in the body's league table measuring the
impact of technology on the development of nations.
"A deterioration of the political and regulatory environment in the US
prompted the fall, the report said.

NETWORKED READINESS
INDEX RANKINGS 2006
(2005)
1: Denmark (3)
2: Sweden (8)
3: Singapore (2)
4: Finland (5)
5: Switzerland (9)
6: Netherlands (12)
7: US (1)
8: Iceland (4)
9: UK (10)
10: Norway (13)
Source: WEF

And more bad news. Alan Blinder writes in the Wall Street Journal that
globalised competition could cost the US as many as 40 million jobs over the
next two decades. Fifty years ago, America was the world's most competitive
economy. Now, Asians have an edge when it comes to low cost production. And
Europeans have an edge when it comes to innovation and high quality
production. The Empire is peaking out...

What will it do when it can't pay its bills? We're going to find out...

More news...

*** "What did the economic boom ever do for us?"

The world is booming...the economy's growing...and yet.
And yet somehow we feel poorer. Somehow we are poorer too, according to a
report in today's FT. Disposable household income fell by 1.7% in the last
quarter of 2006 and managed a miserable 1.3% for the year as a whole.
With inflation nearer 3% than 2%, this for happy campers does not make.

And that doesn't help Britain's Chancellor Gordon Brown either regardless of
the quality of his recent dental work. In the run up to the push (or is it a
shoo-in?) for No 10 a disgruntled swathe of Middle England totters a step
nearer the financial edge as higher taxes, rising interest rates and rising
inflation put a squeeze on take home pay.

And what happens when standards of living are under siege? Pull in our belts
and save a little harder in case things get worse? Sounds a sensible idea
but that's not the way it works in practice explains Jonathan Loynes of
Capital Economics.

People do what they want rather than what they need.
Given the choice between foregoing the annual cash ISA allowance and the
holiday in Florida, it's the ISA that gets the bullet. To keep up the
spending, something's got to give and what's giving is the rate of saving.
At 3.7%, the UK household savings rate is at its lowest level since 2004.

So as the queen bee of globalisation coins it in the average drone is
getting squeezed...and these are the good times.

And as money gets tighter the risks considered to get more of it become
wilder and hopes more delusional. A gambler's mentality can develop...

Looking at a chart published in The Times this has already happened in the
virtual world of the internet. It publishes a chart plotting the growth in
UK online gambling revenues since 2000. Were this a stock chart and had I
bet the house on it, I would not be straining away at my keyboard today. UK
revenues have ballooned from around £300m in 2000 to £2,750m in 2005. And
that was 2005! Then there's other temptations for a 'flutter'...spread
betting, the National Lottery, gaming machines, super casinos... Oh there
are many ways for the financially squeezed to throw the dice one last time.

And while Middle England struggles to keep up appearances we hear a
confession from a senior civil servant:

'I'm an alcoholic and do very little for my £737,000 a year'.

Bob Kiley, formerly London mayor Ken Livingstone's transport czar charged
amongst other things with making the London Underground less of a hell hole,
has gone public with his personal problems. We can admire the candour but
despair at the waste. More taxes, more wasted spending - twas ever thus.

Finally, good news. Bao Xishun, at 7ft 9 inches the world's tallest man has,
after a global search for a partner, found a wife says The Times. He's
managed to stumble on a bride living in his home town of Chifeng, 5ft 6 inch
Xia Shujuan. Given the lousy demographic odds of finding a wife in China,
achievement indeed.

--------------------------

And more views:

*** Et tu, Dear Reader?

The Daily Reckoning is too long. That's what readers tell us. We're sorry.
But we don't have time to write something short.

*** And we promised to explain our Theory of Modern Politics...

The question before is how come all governments – including the supposedly
freedom-loving U.S. of A – have edged towards collectivism?

We begin with a conversation we had with our bus driver.
The last two days were spent at the Chateau de Courtomer, where we were
attending a conference with Addison and Eric and many others on the Daily
Reckoning team. The days were bright and sunny. The conversation quick and
agreeable. The wine soft and smooth.

Coming back, we sat up next to the bus driver, where we could get a good
view of the rolling Normandy hills.

"I worry about what will happen to our kids and grandchildren...about what
kind of world they're going to live in," he said.

He was a very-French looking man of about 50, with a full head of dark hair
with gray streaks in it, and an ironic smile. He wore a tie and might have
passed for a waiter in a good restaurant.

"I started my career as a chauffeur 30 years ago," he went on. "Back then,
you had no trouble getting a job.
And they didn't ask you a million questions or tell you what to do. You just
had to drive the bus.

"But now, everything is regulated. Everything. I can't drive more than 4
hours without stopping for a 45 minute break. That's why I couldn't move the
bus out of the parking lot when we got to the chateau. I had to stay there
and do nothing for 45 minutes. The 45-minute break is supposed to be a
safety measure. But, the effect of it was that I was driving at night...and
I was tired.

"Back when I started, I could decide for myself But now everything is
decided for us."

He is onto something. Just look at the current issue of Fortune Magazine for
proof. It is supposedly the voice of conservative, capitalistic freedom
lovers – people who treasure the liberty of the individual to decide for
himself when to drive his bus...or how organize his work...or how to spend
his money.

"Fix the health care system: Raise taxes," says the headline. "Sometimes
raising taxes makes sense, even to conservatives."

The writer, Matt Miller, goes on to explain that there is an "opening of the
capitalist mind," going on, allowing the old robber barons to appreciate the
benefits of taxation.

We almost fell out of our chair when we realised what he was proposing; we
were laughing so hard.

The story is this: employers are finding it hard to keep up with the cost of
health care benefits. For example, another article explains that a
65-year-old couple, not covered by a private health care plan, should plan
on spending $215,000 on health care through the end of their lives – an
amount up 7% from the year before.

But far as we have observed, there is no direct relationship between
spending money and enjoying good health. Many of the most expensive health
problems are simply a result of bad habits. We suspect that 90% of
heath-care expenditures is unnecessary or inefficient, or both. But if
people want to spend their money on health care, well...it's their money.

Already, company-sponsored health care is collectivised.
But it is collectivised privately...and honestly. For the most part,
employers and employees can decide for themselves what they want to do about
their health and how much they want to spend on it. But employees want
health care benefits...and many employers have health care plans with
crushing legacy costs. So what do they want to do? Own up to the fact that
they their costs are out of control? Raise the standards...and cut the
costs?
Figure out how to fix their own health care system problems? No, they want
to shove the costs of their health care obligations onto the general
taxpayer!
They want a program of forced collectivisation – where their employees spend
someone else's money on their health...and where the government will be
ultimately responsible for the health care of everyone in the country.

Most likely, the pseudo-conservatives at FORTUNE will get their wish.
George W. Bush went a long way towards forced collectivisation of health
care costs with his big drug bill. The next president is likely to go even
further.

And so...the whole world goes in Marx's direction...in Bismarck's
direction...away from Liberte and towards Egalite...away from the Theory of
the Individual and towards the Theory of the Collective.

Private equity is the hottest thing on Wall Street

2007-03-28T10:56:00.001-07:00

Private equity is the hottest thing on Wall Street.

Here's why. Profits in 2006 reached $2.27 billion, more than double that of
the previous year.

"That means," says the FT, "each of its 770 workers produced an average of
$2.95 million in net income. By comparison, employees at Goldman Sachs Group
Inc. - the largest U.S. investment bank - each averaged about $360,000 for
the company in 2006."

And now, more news of a fabulous offer by the same Blackstone Group. We say
'fabulous' because it is the stuff of fable…a morality tale telling itself.

Blackstone, this fabulously sucessful firm of private equity investors, now
will offer 10% of its shares to the public for $4 billion. We asked 'Why?'
earlier in the week.

We will endeavour to answer today.

The facts: The Blackstone Group is the largest private
equity firm in the world. According to the report in the
Financial Times, Blackstone's assets have grown from $14 billion to $78
billion in less than 6 years. That is, it has multiplied its assets under
management more than 5 times in 6 years.

Even more remarkable has been the incredible profitability of the firm. Its
annual rate of return is better than Warren Buffett's. Since 1987 it has
averaged 23% a year, while Buffett's rate of return has been 22% -- though
over a much longer time. Blackstone's real estate holdings have done even
better – up 29% per year since 1991.

But now cometh these uber money shufflers with an offer to shuffle some
money to the public.

Or from it?

How does it make so much money? We turned for an explanation to our
colleague, Eric Fry, who is sitting next to us:

"Private equity can mean a number of things. But what a company like
Blackstone does, typically, is to buy a company from the public, reorganize
it and sell it back to the public. Or, sometimes it will buy a private
company and sell it to the public. The paper almost always ends up with the
public."

Today, we stop to marvel at the chutzpah of it.

Associated Press describes the deal:

"Consider this: Blackstone is a great firm. Going public will bring even
greater riches to those at the top. That said, great riches have already
been captured by those up and down the management hierarchy. This is not the
case of a go-go high-technology firm that generates little free cash flow
and requires an IPO or a sale to crystallise value for its shareholders.
Blackstone has been and will continue to be a cash machine that can
distribute substantial sums to its minions every year. Therefore, either an
IPO or a leveraging of the balance sheet is simply a means of extracting
even more cash from the business. Given the friendly nature of today's
equity markets, going public offers the best risk/reward decision for
Blackstone's existing shareholders. This is an opportunistic step driven by
the state of today's equity markets and other considerations such as the
state of the private equity market."

Yes, but what does that mean?

The Financial Times comments:

"These self-motivated, intelligent individuals are trying to tell us
something important. The question is: do we have the ability to look beyond
their words and actions and intuit motivation? Greed, uncertainty and fear.
What are the implications? That the equity markets are in trouble?
That the credit markets are on the verge of a sharp sell- off? That we are
at the dangerous stage of a private equity bubble?"

There is no magic to the Blackstone Group or other private equity firms.
The genius of private equity prime capital is no different from the genius
of subprime credit. When liquidity rises…both ride high.

But money and credit are no different from bananas or lovers; the more you
have, the more will go bad on you.
This is what economists call the Law of Marginal Utility.
Each additional increment, of whatever it is, is less
valuable than the one that came before.

We find in the Fed statistics that the total credit market debt has been
increasing five times as fast as GDP for the entire 21st century, or at
least, what we have seen of it so far. Subprime lenders had so much money
to lend that they gave it away to people who couldn't possibly pay it back.
There are only so many good borrowers. And there are only so many good
private equity deals. And a credit bubble lasts only so long.

AP again:

"What will happen when the debt markets grow less friendly and additional
equity is required to get deals done?
Returns will fall. What will happen to those who have invested in private
equity funds? They will not be happy.
And those who have invested in common shares of the private equity
management company? Unhappier still.

More news:
--------------------------------

Adrian Ash, just trying to make the repayments in Tunbridge Wells:

- Hands up for a housing crash! What's not to love about falling property
prices?

- Bill Gross at Pimco, for instance. He forecasts "an ongoing bond bull
market of still undefined proportions"
to follow the subprime collapse in the US.

- Manager of the world's biggest bond fund, Gross thinks lower house prices
will force the Fed to cut Dollar interest rates. His model puts US interest
rates back at 4%, down from the current 5.25%, if the Fed's going to keep
home prices stable.

- And if the Fed doesn't cut? Average home prices may fall by one fifth,
says Gross.

- "Investigate the Fed's own study," he advises, "written in September of
2005 [and] covering housing cycles in aggregate and individually for 18
countries over the past
35 years. This study's important conclusion...is that if home prices in the
US have peaked, and are expected to stay below that peak on a real price
basis for the next three years, then the Fed will cut rates and cut them
significantly over the next few years in order to revigorate an anemic US
economy."

- Here in the UK, cheaper housing would save the Bank of England from having
to raise Sterling interest rates, too. Which explains why the Old Ladies
keep wishing away their own property bubble, too. Mervyn King told a
Treasury Committee on Tuesday "there are now some signs that the housing
market is beginning to slow."

- Ha! You should be so lucky, Dr. 'Blin' King! Perhaps the chief pooh-bah is
reading different data from everyone else. Because average national asking
prices have risen 12% from this time last year, according to Rightmove. That
estate agency website covers half of all properties for sale. In March
alone, it shows, average asking prices rose £3,381 ($6,626).

- You call that beginning to slow?

- And while Mervyn King shuts his eyes, sticks his fingers in his ears and
cries "I can't see you! I can't hear you!", would-be buyers are starting to
demand home- ownership as part of their human rights. No, really.

- "Everyone has the right to own property alone as well as in association
with others," says Article 17 of the UN human rights declaration. It's
quoted by a regular blogger at PricedOut.org, the website where first-time
home buyers yet to enjoy their first time gather to bewail their lack of
mortgage debt.

- "No one shall be arbitrarily deprived of his property,"
the UN goes on. "Everyone has the right to a standard of living adequate for
the health and well-being of himself and of his family, including food,
clothing [and] housing..."

- The UN doesn't mention mortgage indemnity insurance or stripped pine
flooring from Ikea. But never mind. That lower house prices will soon prove
obligatory, we have no doubt. The first-time buyers will get what they want,
just in time to dive into negative equity.

- "Legislation must be bought into place to control the market," says Carron
Miller, a young mother and teacher.
She's now threatening a BBC chatroom that she'll emigrate if she can't buy a
house soon. "People need to be put before profit."

- Over in Tokyo, meantime, it's the Bank of Japan praying for slower
real-estate inflation. Incredibly, after 17 years of depression, land prices
in Tokyo finally turned higher in 2006 according to official data last week.

Trouble is, rather than just picking up, land prices in some parts of Tokyo
leapt 46% higher. How the gods must be howling with laughter!

- "We aren't yet in a situation in which land-price gains warrant concern of
excessiveness," said Toshihiko Fukui, governor of the BoJ to the Japanese
parliament Tuesday.
"But we'd like to keep a close watch on them."

- Commercial land prices in Japan's three biggest cities rose 8.9% in 2006.
With interest rates still next to zero, why not? The fastest property gains
came in the Omotesando Hills of central Tokyo, a retail and residential
development that opened in Feb. last year.
Amid the developers' scramble, the city's tallest building is now due to
open on Friday. A 42-storey skyscraper will open in front of Tokyo Station
next month.

- Still, there's a long way to go before Tokyo, Osaka and Yokohama catch up
with Glasgow, Baltimore, Derry, San Diego, Pula, Beijing, Buenos Aires,
Reykjavik, Jo'berg, Auckland and the rest of the planet. Japanese land
values for commercial and residential property now trade for half the price
of their 1989 peak.

- But what a peak! And what a mess Japan's had to endure trying to unwind it
ever since. Gearing up to speculate on the wasting asset called real estate
cost Japan more than a decade of recession, depression, banking defaults and
deflation.

- "The buy to let market," says the young British teacher who can't get a
mortgage, "is responsible for a lot of misery." We don't doubt she's right.
But it's not created half as much misery yet as it will when house prices
really do start slowing down.

- Beware what you wish for, Dr. King...
--------------------------------

And more views?

*** Well, at least we know the fire alarm works.
We were sleeping soundly last night. Then, all of a sudden, at about 3AM, we
became a victim of modern technology. A fire alarm interrupted our dreams.
Was the place on fire?
It didn't seem likely. But we couldn't sleep with the screeching alarm
going off…so we dressed and went downstairs.

It is one thing to turn on an alarm. It is another to turn it off.

Pierre was already at the control panel when we got downstairs. He was
pushing buttons. But the noise continued for another 10 minutes – until
everyone was wide awake.

What could we do, but open another bottle of wine?

*** We know we left you on the edge of your chair, last week, with our
theory of modern politics.

Why has collectivism triumphed everywhere, we asked.
But for today, we have to cease with our views. We're attending a conference
and we need to pay attention; maybe we'll learn something. More tomorrow,
dear reader…

FOLLOW THE SILICON TRAIL TO GLIMPSE THE FUTURE OF MEDICINE

Michael Orme

Set your sights on medical diagnostics as the next big thing. The bloated
$3-$4 trillion global healthcare industry shows itself overripe for radical
disruption and the alchemists of Silicon Valley have set their sights firmly
on it.

When they home in on an industry, the game changes and wealth creation
amounting to hundreds of billions or even trillions of dollar can result.
And sometimes be destroyed, it should be added, when a bubble bursts, like
the Internet 1.0 bubble in 2000, only to bubble up again as Web 2.0.

Here, though, we're in at the creation. So let me give you a sense of what's
being spawned. Today, doctors are overwhelmed by administration and
forceably moved far beyond their main function of old of the laying on of
hands and offering a comforting bedside manner. In prospect, is a medical
world where they will be superseded by medical knowledge and expertise
captured in silicon, software and algorithms and delivered cheaper every
year.

It's been called 'rebooting your doctor.'

In prospect are diagnostic tools that will detect early signs of plaque in
arteries or tiny clusters of cancer cells to enable preventive therapies—all
without the need for hospitals, prima donna specialists or blockbuster drug
treatments. We don't have to speculate about weird nanobots cruising through
our gizzards and blitzing incipient cancer cells en route to get the picture
and see that radical change is afoot.

If you want to glimpse where medicine's going, best to talk to those silicon
alchemists rather than medicos, biotech scientists or government policy
makers. Better still, perhaps, to a truly switched on venture capitalist
with a technology background. I sat next to Don Valentine, the doyen of
Silicon Valley venture capitalists a few years ago at a dinner in Menlo
Park, California.

Formerly, a top executive at National Semiconductor, he is worth over a
billion dollars and put seed corn into CISCO and Google when each was little
more than a couple of bright sparks from Stanford with a business plan. I
asked Valentine his secret. "Follow the silicon'' was his brusque reply as
he turned to his other neighbour.

The one thing I learned in 20 years tracking the technology business, first
as a journalist and then as a consultant, is that once silicon focuses on
something you only have to wait for the big markets to be created from
almost nothing - witness PCs, mobile phones, digital cameras and iPODs.

The master mantra is 'better, faster, cheaper, smaller.' Silicon gets
cheaper by 30% every two years and halves in price roughly every two years.
If you find something that works today, more or less, but is too expensive,
then wait a bit and the fireworks start. Look at PCs, routers, mobile
phones, iPODs, search engines, GPS systems for cars, digital cameras. Under
the lash of this relentless mantra, silicon integrated circuits get better,
faster, cheaper, and smaller with every shortening product cycle.

The same cycle of innovation is about to hit medicine, which contrary to
everything in information technology, gets more expensive, more muscle bound
and less satisfying to its customers every year. This is why medicine meets
the criteria laid out by Professor Clay Christensen of the Harvard Business
School, author of best seller, The Innovator's Dilemma, and the chief
theorist of disruptive forces in business, for being 'ripe for disruption'
from the bottom-up.

This is why Andy Grove, the legendary ex-chief honcho at microprocessor
giant Intel, talks of the need for medicine to move "from the mainframe to
the PC era''.
He is talking metaphorically. He means that technology must now be deployed
to undermine the current medical establishments and their ways of doing
things, not least to evaporate the crippling fiscal burden of healthcare on
governments across the world.

In his recent book, End of Medicine, a sprightly but profound study of the
scene, Wall Street veteran and ex-hedge fund manager Andy Kessler points to
what he calls "the cholesterol cancer conspiracy'' as the main culprit. He
argues that hospitals, specialists, and insurance and drug companies have
combined to put the medical focus on costly 'cut and drug' treatments for
chronic conditions, mostly around 'the Big Three', heart disease, stroke and
cancer. But this 'conspiracy' and this focus on costly late stage treatments
is on the point of being subverted by new breeds of diagnostic tools - real
time 3D scanners, biomarker chips to scan for cancer cells, neural networks
to read mammograms, portable ultrasound kits and expert system GPs etc - all
built around silicon.

Rather as the mainframe and minicomputer cultures were subverted by silicon
dominated and defined PCs, and by employees smuggling them into their places
of work twenty years ago, so these diagnostic tools will surround, squeeze
and suffocate medicine's old ways of operating. And they will keep on
improving in lockstep, just like mobile phones or digital cameras do now,
with the remorseless power of siliconomics.
Let's quickly look at what's happening with CT Scanners (Computerised
tomography scanners: a diagnostic medical imaging technology) to round all
this out and make it tangible.

You're a baby boomer and you may have a heart attack, but then again you may
not.
How about having a look in your arteries to see if there's a blockage?
The test is doable with the current generation of 64 slice CT scanners but
is still too expensive and perhaps still not a good enough test.
Coming next is the new generation of 256 slice scanner making its way to
market. They can scan your heart in 4/10ths of a second or less and create a
colour 3D image of it of sufficient quality that you and a medical
professional, not necessarily a heart specialist, can look at to identify
any clogged arteries. Following that, in two to three years time, will come
new and improved volume produced scanners costing less than $200. They will
become a mainstream product and heart attacks will be a lot less common.

Same for strokes.

With cancer, the development of 'molecular imaging' will be able to detect
tumours 3-5 years earlier when they are easier to treat. Antibody chips
costing 10 cents or less will scan your blood or urine for unique proteins
of circulating cancer cells. The current medical establishments hold on late
stage treatment will be increasingly undermined by technology driving
medical practice to the front end, to early detection and preventive
therapy.

As Grove, looking back on over 40 years in the tech business, remarks:
"technology always wins''. Nobody is forecasting root and branch change
overnight in medicine.
But as Kessler puts it: "even if the things budge slightly from chronic to
early detection, waves of change like a Cat 5 hurricane will rip through
medicine.'' And they will.

Regards

Michael Orme

for The Daily Reckoning

Michael Orme is a financial journalist and former stockbroker.

Editor's Note: A Cambridge philosophy graduate, Michael Orme has worked in
the UK Treasury and in stockbroking, the latter under the legendary fund
manager Nils Taube. He was Mr Bearbull on the Investors Chronicle in the
1970s, then a tech journalist covering Silicon Valley for various journals
in the 1980s, including Management Today, Computing and the Mail on Sunday.
He is currently an Associate at Westhall Capital, a investment house
specialising in Asia.

FW: Why British prosperity is no illusion

2007-03-28T03:48:00.001-07:00

WHY BRITISH PROSPERITY IS NO ILLUSION
by Brian Durrant

Many people in Britain are perplexed by UK's apparent prosperity. How can we
enjoy such a rising standard of living while at the same time we do not seem
to produce anything? City and town centres, even in the formerly depressed
industrial regions of the north, are buzzing with busy shopping complexes
and restaurants. Out-of-town supermarkets and D-I-Y superstores are
springing up everywhere as are new private housing estates. People dress
well, eat out more often and drive bigger cars.

When whole swathes of manufacturing industry closed down in the early 1980's
and the coalmines were shut down in the second half of the decade, a bleak
future of economic decline beckoned with mass unemployment, boarded up shops
and crumbling amenities. Somehow Britain has, in most parts, escaped this
outcome of economic hardship. But people still harbour nagging doubts that
their apparent prosperity is built on sand. This Easter there will be a
credit-fuelled spending spree on D-I-Y goods made in China, Swedish
furniture and Australian wine, while our wealth is somehow based on
homeowners bidding up the value of each other's property. It is
understandable that people who measure their own wealth in terms of material
possessions tend to see prosperity based on services like entertainment as
some kind of statistical trickery.

Scepticism about our economic prosperity is deep rooted particularly among
those endured the trials and tribulations of the 1970's. This miserable
decade included a three-day week, power cuts, a near 70% fall in share
prices in the 1973-75 bear market, inflation at 26%, an IMF loan and the
winter of discontent. Sir Nicholas Henderson, the British Ambassador to
Paris, sent a telegram to the new British Prime Minister Margaret Thatcher
in June 1979 saying "our economic decline in relation to our European
partners has been so marked that today we are not in the first rank even as
a European one". He supported the message with a table which showed how
Britain's GDP per head had fallen to 46% below the German level and 41%
below that of France. Britain's economic success particularly in relation to
Europe over the last 15 years bucks a century old trend, which is still
embedded in the psyche of those who suffered in the 1970's. It is indeed
difficult to believe that in 2005 British per capita income was over 8%
higher than France and 6% above a united Germany, despite the fact that
Britain no longer makes anything that one can lay one's hands on.

While it is true that almost everything we buy today has a "made in China"
label, this does not mean that the all money we spend on these goods ends up
in China and drains jobs and resources from our economy. Here is an example
that may seem trivial but it makes a point.

Later this month the shelves of toy shops will be flooded with Spider-man
merchandise ahead of the launch of Sony Pictures third block buster movie
"Spider-man 3" in May. A simple action figure toy will have "made in China"
embossed on it. Say for example it retails at £10.00, roughly half the
retail price will go to the UK retailer and distributor, with another 20% or
so paid to Hasbro, a US toy company which will spend much of this on
advertising, promotion and distribution in the UK. A further 10% or so will
go Sony Pictures Limited, which owns the Spider-man film rights and
additional royalties will be paid to Marvel Enterprises Inc. Furthermore
£1.49 will go to the UK Treasury in VAT, and there's the cost of shipping
and insurance too, leaving a small remnant of the purchase price going to
the toy manufacturer in China, who has to buy materials and plastic moulding
machines, probably imported from Korea or Japan. In the end less than 5% of
the £10 you paid for the Spider-man toy will end up as wages for Chinese
workers or profits for Chinese manufacturers. Meanwhile the retail and
wholesale margins, advertising and promotion will probably contribute around
£7 to Britain's GDP.

In the 1960's and 1970's the economic success stories were West Germany and
Japan. These countries enjoyed strong growth led by manufactured exports.
The nature of the world economy has been turned upside down since then.
Manufactured goods, whose production can be readily transferred to the
lowest labour cost economies like China, are falling relentlessly in price.
This process of outsourcing has created a new type of business, called a
"platform company" which sell everywhere but do not own factories. Examples
include Dell, Nokia, L'Oreal, Ikea, GSK and Apple. These companies
subcontract almost all their manufacturing to other businesses, mostly in
developing companies. A generation ago production and manufacture was the
key to business success. Today design and marketing add the most value,
because manufacturing is in the hands of subcontractors in developing
countries that compete intensely to drive down costs.

Moreover if there are changes in demand for goods, it is the manufacturing
part of the business that bears the brunt of the adjustment, so the
volatility of the business cycle is outsourced to developing countries while
mature economies enjoy greater economic stability. This new found stability
has in turn made higher levels of borrowing safer and more attractive for
businesses and consumers in advanced economies. And it is the countries
which are financially the most deregulated like the UK that have benefited
most from the processes of globalisation and outsourcing. The new world
order has played into the hands of Britain, which throughout the last
century always struggled to compete in manufacturing goods, but has always
enjoyed a comparative advantage in finance and other knowledge based
services. The prices of manufactured goods have collapsed in the last 15
years, while the prices of knowledge based services like finance, law and
entertainment have risen in price. In economics jargon Britain has enjoyed
an improvement in the "terms of trade".

To illustrate this point, an international lawyer earning £250,000 a year
today probably works no harder than his counterpart in 1990 when he probably
earned less than half this amount. Although the lawyer's productivity has
not doubled, his contribution to the British economy from his foreign
income, his taxes and his consumer spending has.

However for Britain to be in a position to benefit from this new world
order, it had to lick itself into shape domestically. Two events are crucial
to the story: the election of Mrs Thatcher in 1979 and the ERM debacle of
September 1992. The trade union reforms, deregulation and privatisation of
the Thatcher era created a truly competitive market economy in Britain for
the first time since before the First World War. Cast your mind back to the
world of the 1970's when you had to "queue" for a mortgage, have
restrictions on how much money you took out of the country and the
nationalised telecoms industry lacked funds for investment because the
government was too busy backing losers like British Leyland.

But Thatcherism alone was not enough, the government was still making a mess
of the economy by using interest rates to target the exchange rate. This
resulted in the Lawson boom and bust of 1988-90 and the unnecessarily long
recession that followed. It took the climactic events of 16th September
1992, which I like to call "White Wednesday"
to bring economic policy makers to their senses. Thereafter interest rates
were set according to the domestic needs of the British economy and our
decision to stay out of the euro has ensured that this framework that has
delivered economic stability has remained in place.

The market reforms of the Thatcher era, the sane monetary policy framework
after White Wednesday and fall in the prices of manufactured goods relative
to knowledge based services have helped transform Britain's economic
performance and reverse a 100 years of relative decline.
How long Britain's economic renaissance lasts depends on the wisdom of
policy makers and the evolution of the world economy. But for now, Britain's
prosperity is no illusion.

Regards,

Brian Durrant

What's it all about, Alpha?

Alpha (above market returns) is what hedge funds are supposed to bring
investors. Alpha is why they get away with charging outrageous fees (usually
2% of capital and 20% of performance).

Alpha is why, developing a case of 'mission creep,' the funds then began
speculating rather than hedging.

But after that came news of another extraordinary
development: hedge funds started going public. The lay public, it seems is
willing to pay for alpha and pay more for alpha than alpha is making for the
funds. What gives?

Take a look at the amazing sale of shares in the Blackstone Group.
Blackstone is one of the multi-billion dollar groups of 'Private Equity'
money that prove to us that Wall Street is no place for an honest man.

Think about it a minute and it almost makes you stop breathing. The idea of
the hedge fund was, primarily, that it could protect investors by hedging
risk. It did so by being able to go both long and short. Mutual funds, by
contrast, are always long. You buy a fund that invests in China, for
example, because you want a little sliver of the China pie. If Chinese
shares go up, you want to go up with them. And you know you're not
competent to select shares in China yourself. So, you don't mind paying a
mutual fund manager for helping you. It wouldn't make any sense for the
manager to hold cash…you could do that yourself without paying a commission
or fee.

Along comes the hedge fund with a different mandate -- to make money even
if shares go down. The idea was to protect the investor on the downside.
All very well to own shares in China and the US, but what if the shares went
down? The hedge fund manager hedged an investor's bets, by shorting
(selling shares he didn't own) or by using put options (giving him the right
to buy shares at a lower price) or other strategies designed to make money
when most investors lose it.

Then came the curious news that a few hedge funds were selling shares to the
public. That too took our breath away. The only justification for the high
fees was the 'alpha' performance. But if a hedge fund manager could get
'alpha,' why would he want to sell shares to perfect strangers? Hedge fund
managers can do math. They wouldn't sell shares of their own fund unless
someone else thought they were worth more than they did. You could infer
from that that either the public was paying more for alpha than alpha was
worth. Or, that there really wasn't any alpha at all.

And now, before us is Private Equity, the hottest thing on Wall Street,
because it delivers alpha. In theory, you can't really beat the public
market – because it has so much more information than any individual
investor or group of investors. But along came the Private Equity money…and
phyzzzt went the theory. In fact and in practice…the smart, well-informed,
well-funded private investors were letting us know that they were the ones
making money, not the rubes in the public marketplace.

But Private Equity is going one step further now…a step too far, in our
opinion. The Blackstone Group is going public to raise billions of dollars.
"Look," it says to the rubes, yahoos, and lumpencapitalists, "We can get you
alpha; buy our shares."

But the Blackstone Group is not a religious or charitable order. They are
not going to give away alpha. Nor are they innumerate; they can do the
math. The only circumstance in which they would possibly sell their shares
to the public was if they felt their alpha was over- estimated by the
share-buying public...or, they didn't have any alpha.

What is happening to Private Equity is what has happened to hedge
funds...and happens to everything else in the markets...and indeed, to the
rest of life. Alpha – the extraordinary, the special, the above-market -- is
in short supply. And the more people chase after it, the harder it is to
get.

As more capital sought out more above-market returns, the returns fell.
That's why hedge funds are already yesterday's news.

Now Private Equity too is running into the Law of Diminishing Returns. Or,
the Law of the Declining Marginal Utility of capital chasing alpha.

Private Equity is probably selling to the public for the same reason hedge
funds did: they've lost alpha.

Meanwhile a look at the headlines tells us immediately what 'gives' in the
market these days:

"Subprime Bust Forces Families From Homes," says the AP.

"American dream becomes nightmare as millions face foreclosure," trumpets
the AFP.

Is the problem containable, as Treasury Secretary Paulson says?

We don't know...but we wonder if he does either.

And more news:

-------------------------

Adrian Ash, reporting from BullionVault in Hammersmith:

- So the US housing market picked up in February, or so said the National
Association of Realtors in Washington on Friday. Sales of previously owned
homes in the US, said the real estate shills, rose 3.9%.

- Phew! That was close. And there we were thinking the biggest housing
bubble in US history might take more than a few months to unwind.

- Forty-four lenders in the subprime market have now gone kaput since late
2006, reports ML-implode.com. "It is clear that some subprime lenders have
engaged in abusive practices," barked Emory Rushton, senior deputy
comptroller, at a senate hearing in Washington last week.

- In the wider economy, "the US housing recession has contributed to pushing
overall GDP growth down to a 2% annual rate over the past three quarters
ending 1Q07," says Stephen Roach, chief economist at Morgan Stanley – "well
below the 3.7% average gains over the previous three years."

- But c'mon! What's to fear as the world's biggest economy, driven by
consumer debt, moves from those super-low "teaser" rates onto full-fat Fed
funds rates nearer 5.25% and above?

- "The headlines in the financial press proclaim (for the umpteenth time)
that the worst of the housing slump is behind us," notes our friend John
Mauldin in his latest missive. "Home prices are down a mere 1.3% from a year
ago, although the number of homes for sale rose slightly to a supply of 6.7
months, meaning homes are staying on the market longer, as sellers are still
reluctant to sell at lower prices."

- "But the problems for new and existing home sales are in the future," says
John. "Last year there were 400,000 foreclosures. Moody's estimates that
that number will double in 2007. That means that there will be an additional
800,000 homes added to the supply of existing homes this year, which is at a
seasonally adjusted 6.69 million homes."

- Outside the real estate offices, "jobs are supposedly plentiful," adds
Mike Shedlock for Whiskey & Gunpowder.
"Yet 2.1 million Americans with a home loan missed at least one payment at
the end of 2006. That seems pretty hard to me. And it's going to get a lot
harder paying that mortgage when ARM interest rates reset and unemployment
starts to rise. Both are going to happen."

- And still there's nothing to fear. "Most of the housing adjustment is
completed," reckons one Californian economist interviewed by Bloomberg. Put
another way, "House prices to recover next year," as the Times of London
announced in November 1989...just before the UK real estate market lost
one-third of its value over the next 7 years.

- Regular readers won't need reminding, but that's never stopped us before.
"Recovery [was] forecast for house prices in market awash with loan funds,"
reported the Times in Jan. 1990. Not even broad money supply growing by 18%
year-on-year could stop the rot, however.

- By July 1990, "the bottom of the current house price cycle may have
passed," the paper went on. Come the autumn of that year, however, The Times
had to repeat itself again.

- "House prices bottom out...the long slide in house prices could be nearing
its end," it said. National prices continued to slide regardless.

- By Sept. '91, real house prices - adjusted for inflation
- stood 25% down from the peak. "House-price surge is on the way," said The
Times, "but wait for it."

- No fooling! The following month, Oct. 1991, The Times finally admitted
that "Fall in house prices dashes market hopes."

- Why so glum? Well, mortgages more than 6 months in arrears accounted for
3.5% of all loans outstanding at the start of 1992. Cue The Times to report
that "record repossessions are keeping down house prices" - even though the
mortgage lenders themselves had long since stopped repossessing when they
could possibly help it.

- Ahead of the United Kingdom's last house-price crash, nine out of every 10
late-paying mortgages more than 12 months in arrears were taken into
repossession. By the bottom of the slump, however, the mortgage lenders
slashed that kill rate beneath one-in-5. America's mortgage lenders may well
try the same remedy in 2007.

- US foreclosures rose 42% in 2006 according to RealtyTrac.com, up from
855,000 in 2005 to 1.2 million nationally. But throwing young families out
on the street rarely makes for good PR. And during a genuine real-estate
slump, it only adds to the downward pressure on home prices.

- For now, reports Bloomberg, many US lenders are urging their late-paying
borrowers to sell their homes themselves...and redeem whatever they can of
their outstanding debts. Better that, the lenders are thinking, than collect
ever-more default properties on their books.

- But leaving late-payers where they are could soon become the subprime
strategy of choice. What that decision will do to America Inc's credit
rating – and the implied value of its paper promise, the Dollar – we'll just
have to wait and see...

And more thoughts…

*** Remember Harry Dent?

He's the one who forecast the Dow at 40,000, based upon his reading of
demographic trends. All those aging baby boomers had to save for their
retirement, he said. And the logical place for them to put their money was
in the stock-market.

Well, as the years have passed…it now becomes clearer that the boomers
aren't all that interested in saving money – not when credit is easily
available and when their houses are rising in price. So, this past November,
Dent felt it was time for a little backtracking. Now he says the new bubble
will reach its maximum in late 2009, with the Dow near 20,000 and the Nasdaq
at 5,000.

Could he be right? Anything is possible. We suspect that the boomers will
start saving again. They've been on a spending binge for the last 10 years.
They're probably about ready to go on a saving binge. Not only will they
need the money, we've noticed signs that saving money is becoming avant
garde. There may be a backlash against conspicuous consumption coming.
We'll have to explain more tomorrow – when we take up our new theory of
modern politics. But there are times when spending is hip, stylish and
trendy. There are other times when spending is regarded as vulgar, crass
and foolish. The times could be changin' now.

*** If boomers begin saving…what will they do with their money? Will they
put it in stocks? Or real estate?

We noticed, recently, how much of a drag owning real estate is. You're not
bothered by it when prices are rising sharply. But when they begin to
flatten out…and when sales sag…you begin to resent having to fix the roof or
the dishwasher.

This came home to us when we looked at what it costs us to hold onto our
farm in Maryland. There are a couple of houses on the farm, which are
rented out. It should be making money for us. Instead, we get this message
from our property manager:

"Last year there was around an $8,500 loss. The main house was rented for
$2,500 a month for six months. We had to replace an HVAC in the dairy
apartment, a water heater in the tenant house, a heating stove in the barn,
carpet in the dairy apartment.
Last year we spent the following for maintenance and repairs (parts & labor)
on each of the buildings:

Barn-$1,665
Dairy $3,667
Main House $17,250
Tenant house $890
Grounds $9,659 ($2,547 for labor, the rest for mulch, gravel, etc.)
Management $2,770.00"

We doubt boomers will want to deal with these problems.
And we wouldn't be surprised to see attitudes to real estate revert back to
what they were 30 years ago – when people regarded property as an expensive
burden, not as an investment.

*** Want to buy property where property is still going up.
Buy in Japan. For the first time in 16 years, Japanese real estate prices
are going up nationwide.

The biggest gains came in Tokyo commercial property – where prices were up
by 9.4% in 2006.

ores why and how Britain has become so prosperous...

FW: An Unprecedented Speculative Spree

2007-03-22T11:32:00.001-07:00

AN UNPRECEDENTED SPECULATIVE SPREE
by Dr. Kurt Richebächer

A study recently published by the Bank for International Settlements
(Monetary and Prudential Policies at a
Crossroad?) says:

"Financial liberalisation is undoubtedly critical for the better allocation
of resources and long-term growth.
The serious costs of financial repression around the world have been well
documented. But financial liberalisation has also greatly facilitated the
access to credit... more than just metaphorically. We have shifted from a
cash flow-constrained to an asset- backed economy."

Though we basically agree with the analysis and the conclusions of the
study, we radically disagree with the one sentence that "Financial
liberalisation is undoubtedly critical for the better allocation of
resources and long-term growth." The indispensable first condition for
proper resource allocation at a national as well as global scale is
avoidance of excessive money and credit creation. In many countries, and in
particular in the United States, they are excessive as never before.

If Mr. Bernanke complains about irregularities of M2, this is nothing in
comparison with the fact that credit and debt growth in the United States
has exploded for more than two decades. When Mr. Greenspan took over at the
helm of the Fed in 1987, outstanding debt in the United States totaled $10.5
billion. In less than 20 years, this sum has quadrupled to $41.9 billion. In
reality, this significantly understates the rise in debts because, for
example, highly leveraged hedge funds with trillions of outstanding debts
are not captured. In 1987, indebtedness was equivalent to 223% of GDP, which
was already pretty high. Lately, it is up to 317% of GDP.

In actual fact, there used to be a very stable relationship between money or
credit growth and GDP or income growth until the early 1980s. Growth of
aggregate outstanding indebtedness of all non-financial borrowers – private
households, businesses and government - had narrowly hovered around $1.40
for each $1 of the economy's gross national product. Debt growth of the
financial sector was minimal.

The breakdown of this relationship started in the early 1980s. Financial
liberalisation and innovation certainly played a role. But the most
important change definitely occurred in the link between money and credit
growth to asset markets. Money and credit began to pour into asset markets,
boosting their prices, while the traditional inflation rates of goods and
services declined.
The worst case of this kind at the time was, of course, Japan.

Do not be fooled by the sharp decline in consumer borrowing into the belief
that money and credit has been tightened in the United States. Instead,
borrowing for leveraged securities purchases (in particular, carry trade and
merger and acquisition financings) has been outright rocketing, with
security brokers and dealers playing a key role. Over the three quarters of
2006, their net acquisitions of financial assets have been running at an
annual rate of more than $600 billion, more than double their expansion in
the past.

Federal funds and repurchase agreements expanded in the third quarter at an
annual rate of $606.3 billion, or an annual 26%. The main borrowers were
brokers and dealers.
During the first three quarters of the year, their assets increased $427
billion, or 27% annualised, to
$2.57 billion. A large part of the money came from the highly liquid
corporations. There is no reason to wonder about low and falling long-term
interest rates.

All this confirms that financial conditions remain extraordinarily loose.
Even that is a gross understatement. Credit for financial speculation is
available at liberty. Expectations for weaker economic activity only foster
greater financial sector leverage.
Why such unusually aggressive speculative expansion in the face of a slowing
economy?

The apparent explanation is that the financial sector intends to make the
greatest possible profit from the coming decline of interest rates,
promising further rises in asset prices against falling interest rates.
While the real economy slows, the leveraged speculation by the financial
fraternity goes into overdrive.
Principally, there is nothing new about such speculation. New, however, is
its exorbitant scale.

Before leading his jumbo-sized delegation to Beijing, Henry Paulson, U.S.
Treasury secretary, cautioned against expecting any big breakthroughs from
the visit.
And so it has turned out. The meeting produced plenty of statements about
the desirability of improving relations, but nothing concrete to do so.

Of course, the Chinese are in a very strong position with the central bank
holding more than $1 trillion of bonds in its portfolio, mostly denominated
in dollars.
According to reports, the American visit was initiated by Mr. Paulson in an
effort to contain rising Sinophobia in the U.S. Congress, which increasingly
blames China for America's economic problems, from its huge current account
deficit to stagnating real incomes. In other words, those troublemakers, not
the trade deficit, are the problem.

One cannot say that U.S. policymakers and economists have been preoccupied
with worries about possible harmful effects of the exploding trade deficit.
They appear obsessed with the conventional wisdom that free trade is good
and must always be good under any and all circumstances, as postulated in
the early 19th century by David Ricardo.

Ricardo exemplified this by comparing trade in wine and cloth between
Portugal and England. Portugal was cheaper in both products, but its
comparative advantage was greater in wine. As a result, according to
Ricardo, Portugal boosted its production and exports of wine. In contrast,
England gave up its wine production and could produce more sophisticated
goods. In both countries, living standards rose.

For sure, it appears highly plausible that American policymakers feel they
are following Ricardo's logic.
Only they are disregarding some caveats of Ricardo's.
For equal benefit, first of all, balanced foreign trade is required.
"Exports pay for imports" was a dogma of classical economic theory. Ricardo,
furthermore, disapproved of foreign investment, with the argument that it
slows down the home economy.

With an annual current account deficit of more than $800 billion, the U.S.
economy is definitely a big loser in foreign trade. To offset this loss of
domestic spending and income, alternative additional demand creation is
needed. Essentially, all job losses are in high-wage manufacturing, and most
gains are in low-wage services.
In essence, the U.S. economy is restructuring downward, while the Chinese
economy is restructuring upward.

Considering that Chinese wages are just a fraction of U.S. or European
wages, it appears absurd that the Chinese authorities deem it necessary to
additionally subsidise their booming exports by a grossly undervalued
currency, held down by pegging the yuan to the dollar.

In the U.S. financial sphere, the year 2006 has set new records everywhere:
records in stock prices, records in mergers and acquisitions, records in
private equity deals, record-low spreads, record-low volatility.
Manifestly, there is not the slightest check on borrowing for financial
speculation. There is epic inflation in Wall Street profits.

One wonders what can stop this unprecedented speculative binge. Pondering
this question, we note in the first place that the gains in asset prices -
look at equities, commodities and bonds - have been rather moderate. To make
super-sized profits, immense leverage is needed. We think the speculation is
unmatched for its scope, intensity and peril. Plainly, it assumes absence of
any serious risk in the financial system and the economy.
The surest thing to predict is that the next interest move by the Fed will
be downward.

In our view, the obvious major risk for speculation is in the economy - that
is, in the impending bust of the gigantic housing bubble. Home ownership is
broadly spread among the population, in contrast to owning stocks. So the
breaking of the housing bubble will hurt the American people far more than
did the collapse in stock prices in 2000-02.

For sure, the U.S. economy is incomparably more vulnerable than in 2001.

Another big risk is in the dollar.

Regards,

Dr. Kurt Richebächer
for The Daily Reckoning

Market Notes

Adrian Ash, shouting at the traffic in 'Ammersmith:

- So fat tongue in fat cheek, the great Gordondo pulled off his greatest
feat of magic in 10 years of trickery at Westminster.

- "Abracadabra...ala-ka-zam" he shouted for 54 minutes.
And poof! Nothing had changed except the detail – and the press coverage. He
got the headlines alright. Even the London press knows to watch his sleight
of hand these days.

- Now that's magic!

- The detail's so dull, in fact, that only London's army of financial hacks
could spin it out to 20 pages packed with "analysis". Gordon Brown's
swag-bag was £1 billion lighter in 2005/6 than he had projected. Now he
reckons he'll nab £1 billion more in 2006/7 than he forecast 12 months ago.

- A billion here...a billion there...who cares?

- The Cabinet Office alone will spend £2.4 billion this year. On what, you
might wonder – new mugs and biros?
Only inflation looks certain after yesterday's palaver.
Keeping the New Labour executive in tea and biscuits will cost 9% more in
2007/8 than it did during the last fiscal year.

- But hey – you gotta keep the troops' strength up! War never came cheap.
And now they're waging war on terror...poverty...light bulbs...and what's
left of British manufacturing.

- So what if Gordon Brown knocked 2p off the basic rate of income tax? He
more than doubled the tax rate on your first £2,000 of taxable income.

- He cut 2% off corporation tax, but excluded anyone investing in plant. R&D
firms got a £100m tax cut, but the punitive charges on North Sea oil & gas
firms remain. Better to trade "carbon credits" than squeeze the last few
drops out of Britain's domestic resources.
Offshore hedge funds trading these 21st century indulgences will now enjoy
zero tax.

- He also gave fresh tax breaks to "sukuk" investors looking for financial
products to comply with Koranic law. But he raised the tax-rate paid by very
small businesses. A smart way to encourage risk-taking outside the financial
markets, eh?

- He gifted free money to property speculators too, sharing the tax
advantages of REITs with unit trusts invested in real estate. Their number
has swollen from four to 15 over the last two years.

- You might wonder where the value-added lies here, but so what? That kind
of growth at M&G and New Star deserves recognition – as do second-home
owners buying property overseas. Cutting income tax charges on holiday homes
will reward around 2-3% of British adults, the FT says today. Failing to cut
the 70% charge on pension assets passed onto your family, on the other hand,
hurts everyone wanting to save for the future.

- "Mr Deputy Speaker," said Prudence, "I want to send a signal about the
importance we attach to encouraging saving." Raising interest rates would
make a start. For basic-rate payers, cash in the bank now pays minus 0.4%
after tax and inflation.

- He also recalled his "ambition for this Parliament...of two million new
owner occupiers." Yet again, higher interest rates would actually help here.

Even Mervyn King knows that cheap money has failed!
Meddling with shared-ownership schemes only pushes inflation in house prices
still higher.

- But simple economics was never going to be Gordon Brown's game.

- Oh, and in a move of brilliance he cut the new issuance of index-linked
gilts, too. The pensions industry, as regular readers well know, is forced
by government to hunt down these rare beasts...matching liabilities to
assets as judged by the price of inflation-proof bonds.

- Just last week, Ed Balls – our dear Chancellor-in- waiting – told pension
fund managers in Edinburgh that New Labour would skew new gilt issues
towards index- linked and long-dated bonds. Did he really not see a draft of
yesterday's Budget? In 2007/8, the government will issue £4 billion less in
these bonds than in 2006/7.

- "This is not particularly helpful to pension funds,"
says Nick Horsfall, a senior consultant at Woodrow Wyatt. "We are already
struggling to get pension funds long-dated, high-quality assets."

- Not that it matters, of course. No budget from Culpability Brown, Ed
'Chocolate' Balls, George Osborne or any other buffoon will ever halt the
megatrend towards big government stealing your money just to give you a
little of it back...and all at the policy wonks'
discretion and a time of the bureaucrats' choosing.

- Better look after yourself and get what wealth you can to safety. The
ballot box will only pay dividends if you sneak into Westminster and grab a
few non-exec directorships alongside your state-paid expenses.

Mexican Jumping Oil

2007-03-21T01:49:00.000-07:00

MEXICAN JUMPING OIL
by The Mogambo Guru

Sean Brodrick at Money and Markets writes that it appears Peak Oil has
affected Mexico, as, "In December 2005, Mexico sent the U.S. 1.7 million
barrels of oil per day (bpd). This past December, Mexico only exported 1.2
million bpd to the U.S."

He asks, "Why is Mexico sending less oil?" For some reason, I thought that
he was really asking a question, so I leap up and say, "Because they are
selling it to China and India and everywhere else, but they don't need the
money, anyway, because my appetite for tacos is off the charts here lately,
and they are making plenty of money that way! And speaking of tacos, that
sounds good!
Let's break for lunch! Your turn to buy! Let's go! Hup!
Hup! Move it! Let's go, go, go!"

This was, as I interpret the pained and angry look on his face, the wrong
answer, probably because it is only 9:30 in the morning. He pointedly
ignores me and explains, instead, "Because it's producing less oil. Total
oil output fell to just below 3 million bpd in December 2006.
That's down from nearly 3.4 million barrels at the start of the year, and
Mexico's lowest rate of oil output in seven years."

This is bad news for Mexico because "Mexico relies on oil exports for about
40% of its revenue." Notice the complete lack of exclamation points in those
four previous sentences. When it is reported in the Mexican newspapers, you
can bet your burrito supremo that headlines will have PLENTY of exclamation
points all over the damned place. For example (showing off my impressive
command of Spanish), "Ustamos Mucho Grande Freaking Doomed, Just Exacta
Mundo Para El Mogambo Habla!!!" which got three exclamation marks, since
they understand the true significance of, "Mexico relies on oil exports for
about 40% of its revenue"!!!

It seems that half of the revenue of the whole economy of Mexico is
unhealthily dependent on just one source of revenue! Hahaha! If the Mexican
government had taken the time to look, they would have seen that my family
is dependent on me as their sole source of revenue, and as I am as similarly
corrupt, stupid and worthless as the Mexican government, they should have
noticed from the chaos and hostility that it clearly hasn't worked out here,
either! I mean, the parallel is obvious! What in the hell is the matter with
those people?
Even worse, "55% of Pemex's sales revenue went to the Mexican government
last year".

And it is not just the Mexicans that seemed to be gripped by the looming
terrors of Peak Oil Syndrome, as "Kuwait's giant Burgan field has also
peaked. Iran's energy use is rising so fast that its oil exports are being
crimped badly. And despite the fact that the Saudis are supposed to be
sitting on a thousand years of oil, their oil production declined 8% last
year". Of course, "The Saudis will say they made their cuts to 'stabilise'
the market."

Hahaha! "stabilise" the market! I did not realise the generous beneficence
of the Saudis! They will sell less oil and make less money, while their
competitors wax rich by continuing to pump furiously, so that the cost to
the ultimate consumer, mainly Chinese and Western infidels, doesn't rise!
What can I say, except "Thanks, dudes!"?
But the underlying message is that (and pay particular attention here)
demand for oil is going up, but supply is going down. And I am sure that
something flickered in your Fledgling Mogambo Mind (FMM) about the effect on
the price of oil (an absolute energy necessity) resulting from such a
falling supply/growing demand imbalance, which is actually getting worse
rapidly, and which will continue to get worse for a long time.

And if you are a Junior Mogambo Ranger (JMR), then you are probably
salivating, literally, at the prospect of reaping a lot of those enormous
oil riches for yourself so that you can easily afford to stretch your Second
Amendment rights to include getting some tactical nuclear weapons. That'll
show that pesky Skyview Neighbourhood Association who's REALLY the freaking
boss around here, and it will be very educational to see if the threat of
imminent nuclear obliteration will make my decrepit hovel seem a little less
of an "eyesore" and "public nuisance"
to them! I'm betting it will! Hey! I love this investing stuff!

Doug Noland's Credit Bubble Bulletin at PrudentBear.com starts out this week
with some interesting graphs. All of them are bad news, of course, but the
one that really grabbed my attention was the one labeled "Balance Sheet of
Household Sector". Going back to March of 1989, the average household had
$19,000 in net worth, which was, back then, about the average household
yearly income.
Now, as our bloodshot eyes nervously scan across the graph, we see that the
average household net worth is about $55,000, which is, again, about the
average household yearly income! Hahaha! You are right back where you
started, in terms of buying power, and yet you think that the stock market
and the housing market and the bond market are going to provide you with a
decades-long comfortable retirement? Hahahaha!

I'm laughing so hard that I am actually spitting up blood! Hahaha! I can't
stop! Hahahaha! With a burst of Mighty Mogambo Self-Control (MMSC), I gain
dominance over my giddy emotions, and with rasping, gasping breath I say,
"If you believe that everyone will make money and retire in comfort by
investing long-term in the stock and/or bond markets, then that is the
biggest load of hooey that a gullible, dim-witted population has ever
swallowed without even gagging."

The ugly truth is that the majority of investors will not only suffer a loss
in strict dollars ("the majority is always wrong"), but even those who
manage to get marginally ahead, in nominal terms, will have the purchasing
power of the money stolen by the ravages of the inflation caused by the
Federal Reserve constantly creating so much money and credit, which is,
ironically, where the money came from that enabled them to buy the stocks
and bonds!

The bottom line? The best that you can expect to do is to invest one
dollar's worth of buying power to get, in the future, an equivalent amount
of buying power. The majority, alas, will lose both nominal money AND the
buying power of what's left!

Until next week,
The Mogambo Guru
for the Daily ReckoningBill Bonner in London:

Yesterday, the markets seemed to return to 'normal' - or, at least to what
is taken for normal by today's investors. That is to say, things that were
already over- priced became more overpriced. And investors who were already
over-stretched, reached a little further.

Time heals all wounds...and wounds all heels. Got a problem? One way or
another, time will solve it.
Something not right? Someone getting away with something?
Don't worry...time will take care of it.

And if we can't sort out what is going on in the financial markets, time
will have to do it.

The Dow rose 115 points. "Investors regain an appetite for risk," says the
Financial Times.

Regaining an appetite is a good thing when you are sick.
We are not so sure it is a good thing when you are about to explode from
over-eating.

And if time can heal things...it can rot them too.

"Oh time...won't you spare me over another year? I'll give you my gold
coins. I'll give you my stocks. How 'bout my beach house?

"I'm not asking much. Just make my face look like it did in '68...just let
me buy a gallon of gas for 25 cents, like I did in '72...just let us stay up
all night and howl at the moon like we did in '82...just make my dot.com
stocks worth what they were in '99...

"That's not asking too much is it?"

Yes, you can ignore time, but it won't ignore you.

Time sorts out everything and everybody. Nothing and nobody is missed.

You can't hide from it.... You can't escape it. You can't outrun it. You
can't make a deal with it.

If only we could arrange time...chivvy it into place where we want it, we
would have ourselves a bit of fun.

We would set the highway traffic back to the levels of '50s. And our
automobiles back to the '50s too...but then, let's put 21st century
technology under the hood.
We don't want to have to fool with carburetors like we did back then. And
consumer prices...let's put them back into the early '60s too...before the
first big wave of inflation hit. We recall buying a hamburger at The Little
Tavern in Annapolis for 25cents. Another quarter got us a coke. And what did
it cost to go to the movies? We can't remember, but we think it was about 60
cents a ticket.
Everything was cheap. Of course, it didn't seem cheap back then. So, since
we're rearranging the sequence of things, let's set incomes at 2007 levels.

And let's go back to the Eisenhower era to find a political system we can
live with. There were real conservatives back then - people who were
reluctant to spend the public's money...and reluctant to meddle in the
public's affairs. Now, we have only phoney conservatives - people who
preach 'conservatism' while pushing the most
activist agendas since FDR.

'Turn the desert tribes of Mesopotamia into Dixie democrats?' the old timers
would have joked. 'Why not turn them into Baptists too? Ha ha..."

Meanwhile, the front page of the USA Today tells us that this latest attempt
to remake the world in our own image is running into problems. A few months
ago, Iraqis held up their purple fingers and proudly supported democracy.
But now that they've had some experience with it, a new poll shows that the
majority of them are against it. Only 43% think democracy would be good for
Iraq. The rest have other ideas. By contrast, a majority of Iraqis think it
is 'acceptable' to kill U.S. soldiers. These are the same people - at least,
according to the fiction of it - that U.S. soldiers are trying to protect.
Take them out of the picture, said America's president last night, and the
Iraqis might start killing each other.

Oh, if only we could rewind the tape. If only we could go back to the
Eisenhower era when US presidents still had wit and charm! Yes, those were
the good old days - at least they seem pretty good looking from a half a
century later. America was still a free country, as near as we can recall.
No phoney wars against terror...no Sarbanes...no Oxley...no Hillary...no
George... And who was chairman of the Federal Reserve in 1956? Who knew?
Who cared? The dollar was still linked to gold. You could trust it. America
was the world's biggest factory...the world's biggest creditor...the world's
biggest exporter...the world's fastest growing economy. All people cared
about was that 'Ike & Dick... 'were 'Sure to Click' - no kidding, we have an
old campaign button.

Of course, public life was as full of humbug as it is now...but the humbug
seemed more innocent, less intrusive...and ultimately, more humane.

But enough of this reminiscing...no point to it. Time cuts no deals for no
one.
Not even for the New York Stock Exchange.

Let's see. According to the press reports, three things helped investors
chow down again.

First, Chinese stocks took off. After a brief and feeble panic attack a
couple of weeks ago, the Shanghai stock exchange is as fat and happy as
ever. The index is nearly in record territory again.

Second, a whole new selection of merger and acquisition targets was added to
the menu. How could investors resist? All that delicious, syrupy, rich sauce
floating around! There is even talk of a major acquisition in the gold
mining sector. Barrick is said to have its eye on Newmont whose shares are
expected to bring in the mid-50s.

And third, investors are coming to terms with the whole sub-prime issue. Tim
Harris, a strategist at JP Morgan, put the matter in perspective:

"It is estimated that the US mortgage market is worth some $10,000 billion,
approximately 10 per cent of which is cumulatively classified as sub-prime;
12-15% of which may be in or approaching distress/default."

No biggie, in other words. But wait! Ten trillion dollars is still a lot of
money. And 10% of it is still $1 trillion...and 15% of $1 trillion is still
$150 billion.
Who's got $150 billion to lose?

And the problem - again, according to the press - is the risks now
overflowing into other segments of the mortgage market - notably into Alt-A
and Jumbo loans. The same stretch for profit that led lenders to make loans
to people who couldn't pay them back...led investors to buy the loans
packaged as debt-back securities...along with high priced stocks in a
communist country...and a great deal more. They will keep stretching until
something snaps, we figure. Maybe it already has.

Time will tell.

More news:

--------------------------

*** Adrian Ash, emptying his wallet into the bin in
Hammersmith:

- Money, money, money...the more we get - £13.9 billion more last month than
in January according to the Bank of England today - the less anyone wants
it.

- Stuff your cash in the trash, gentle reader; the bin men will be round in
a fortnight and cart it off to the landfill. It's not even worth trying to
recycle. Paper money's so smelly, ugly, bulky, out-dated...ugh!

- Hence the rise and rise of stock markets, vintage wines, junk bonds, real
estate prices, fine art, race horses, physical gold bullion, beachfront in
Central America, English soccer teams and African mining resources. So much
money's now flooding the world that anything and everything looks a safer
bet for growing your wealth - or merely preserving it - after tax.

- The price of terraced housing in West Belfast, for instance, has risen 45%
year-on-year. It doesn't matter where the money has come from; it's wound up
on the Falls Road. Prices there have trebled since 2002.

- No matter that two-thirds of Ulster's economy is run by tax-funded
government programs rather than private enterprise. No matter that Tony
Blair think peace in the province has to mean giving Stormont to a pair of
class idiots who won't shake hands with each other. Paisley and McGuinness
will conspire for as long as murder alone fails to put new patio doors on
the pebble-dashed bungalows out in Donegal and Spain.

- The real estate agents certainly don't care either way, and nor do the
lenders. Prices are up, Up, UP...and all because the value of money has
shrunk to nothing.

- Cross the 'Peace Line' (if you can) onto the Shankhill Road, and prices
for Loyalist home-owners have more than doubled over the last 12 months
alone. There's a legacy for Tony Blair to be proud of! Priced at up to
£150,000 according to The Independent, houses on the Shankhill now draw
bidders routinely offering 10-20% over the asking price.

- Sail across the Irish Sea to the mainland, and the cheapest housing in the
UK now sits in Nelson and Burnley, according to the BBC, heart of
Lancashire's industrial waste land. These bargain-priced terraces are all
empty, vandalized, boarded up, and due for demolition or arson - depending
on whether the government's "compulsory purchase" scheme gets there first.

- But empty shells that are utterly worthless, these abandoned terraces are
STILL worth 22,000 times the Pound in your pocket!

- Just what might it take to restore confidence in currency today? During
autumn 1992, the Bank of England hiked UK base rates to defend the Pound
Sterling.
Somebody had to. Speculators across the world, most famously George Soros,
were betting that Europe's exchange rate mechanism - the precursor of
today's Eurozone currency system - was about to collapse.

- The Pound, thought the traders, couldn't defy the UK's housing collapse
and broad-based recession forever. But the Bank of England tried to defy
gravity regardless. On
16 Sept. 1992, the Old Lady took base rates from 10% to 12%. She then
promised to take rates to 15%, too!

- Speculators continued to sell Sterling, however...and by the end of that
terrible day, George Soros had made £1 billion betting the Pound would be
forced to devalue. He was right, and the Bank of England was wrong, in
short.
Higher interest rates failed to revive confidence in the value of Sterling.

- The same problem hit Mexico in late 1994. Following the Peso's devaluation
in December, the Mexican government struggled to find foreign investors to
stump up at its monthly bond auctions - despite interest rates exceeding
40%.

- And this same hatred of cash at any price whacked the US Dollar even as
deflation hit and the value of money seemed to be rising during the Great
Depression of the early 1930s. As Sam Hewitt of Sun Valley Gold noted in a
paper of 10 years ago, the risk of a Dollar devaluation led Americans to
hoard gold rather than cash. It was appreciating much faster.

- It took the Presidential executive order of 5th April
1933 to force US citizens - at gunpoint - back into the Dollar. President
Roosevelt made gold ownership illegal, punishable by $10,000 fines and/or
imprisonment.

- Today, we hazard, it will take more than a few 0.25% hikes in interest
rates to restore the world's faith in money. But at least in 2007, investors
have the option of hoarding physical gold overseas at low cost...beyond the
reach of their own government's caprice and diktat.

And more thoughts, views, ideas from Bill...

*** The dollar! Is anyone paying attention? The greenback is slipping. But
in all the commotion hardly anyone seems to notice. We checked this morning
and found the euro priced at nearly $1.33.

What could go wrong? Well, the dollar could continue slipping.

Now, let us imagine that you have the world's biggest stash of money, which
today is more than $1 trillion. No one ever had such a big pile. But let us
imagine that the money isn't really yours. You have been put in to manage it
on behalf of the People's Republic of China. And if you lose it, the people
aren't going to be very happy.

Now, about 70% of that money - $700 billion or so - are in dollars.

You have already gone on record saying you intended to diversify out of
dollars. You expect to do it in an orderly way. But with the dollar going
down, you realise that when you finally do diversify you're going to get
less for your dollars than you could get now. In fact, if the dollar falls 5
cents against the euro, you have effectively lost 5% of your dollar holdings
- or $35 billion. Hmmmm...what will the people say?

What if the dollar goes down 10%? Hmmm....now you're talking serious money.

Of course, this is not the first time we have posed this
question: why don't the people with serious money at stake move to protect
themselves? And how come the dollar has, so far, resisted our predictions.
With a current account deficit at 6% of GDP...it seems obvious that the
dollar must fall. So must it fall when the carry traders unwind their
trades? Many borrowed yen to buy dollars.
When they get out of their positions they will have to sell dollars and buy
yen. The dollar should fall. But it doesn't. Or it hasn't. Yet.

**** Mogambo sez: Oil is getting so cheap that I am drooling at the glaring
bargain. And gold and silver?
Don't get me started, as I could go on for hours and hours about why you
should buy as much as you can, as soon as you can, turning the exercise into
a long, angry harangue which will end with you desperately trying to get
away from me. Of course, I'll be grabbing you by the sleeve and hitting you
up to loan me a lousy twenty bucks so that I can save up to buy some gold,
too. But you say "no", you selfish little bastard, and we get into a big
fight, and it's all real, real ugly.

Anyway, like I said, don't get me started. Just buy the stuff and save us
both a lot of hassle.

Editor's Note: Richard Daughty is general partner and COO for Smith
Consultant Group, serving the financial and medical communities, and the
editor of The Mogambo Guru economic newsletter - an avocational exercise to
heap disrespect on those who desperately deserve it.
The Mogambo Guru is quoted frequently in Barron's, The Daily Reckoning and
other fine publications.

A Different Kind of Cold War

2007-03-19T12:53:00.001-07:00

A Different Kind of Cold War
by Justice Litle

"In much the same condition as the Aral Sea, the former Soviet Union is a
disaster that is about to spiral into a catastrophe."

— Jim Rogers, Adventure Capitalist

Inside, the lead article closes with a bland flourish of hope: "Russia is
one of the few countries that could produce more oil — if only Mr. Putin
changed his thuggish ways."

This cloying sentiment brings to mind a crusty old nugget of bartender
wisdom: "If ifs were a fifth, we'd all be drunk."

Is there any chance Mr. Putin will soon reform and make nice? Not really. It
is far more likely that the
opposite is true. Russia may well be gearing up for
an ugly — and possibly brutal — confrontation with
the West.

The American Heritage Dictionary defines empathy as "identification with and
understanding of another's situation, feelings and motives." In terms of
understanding markets — and cagey petrocrats — empathy can be a powerful
investigative tool. Western journalists have little perspective to add to
the debate because, for the most part, they are not seeing the world through
Mr. Putin's eyes. What's worse, they are not even trying to.

We have no inside access to the Kremlin. (If it did, your humble editor
would probably be eating caviar in Sardinia right now, rather than pushing
hard to meet a
deadline.) But we can still make productive use of empathy by imagining the
world as others see it. As a literary device, the rest of the piece will be
written as if Putin's thoughts are known, in an attempt to
answer the question, "What might Russia's president
be thinking?"

To begin, when Mr. Putin hears righteous pleas from the likes of The
Economist to "give up his thuggish ways,"
he is no more moved than you or I would be upon urging from animal rights
activists to give up beef. The Western protests, and the airy-fairy
motivations behind them, are simply not taken seriously by a man with
serious business to do.

What's worse, Putin sees the West as densely populated by hypocrites. He
perceives our love affair with democratic ideals to be merely a thin
veneer... a fiction we are gullible enough to believe (except at the higher
levels) and wealthy enough to maintain. (And in fact, a case can be made for
this view.) On top of all this, Mr. Putin has no time for glib Westerners in
the first place. He is a man with a desperate mission — and that mission is
saving Mother Russia from oblivion.

Flush with oil and gas revenues as it may be, Russia is a country on the
brink. For all his faults, Putin is a man who dearly loves his country. He
does not want collapse to happen, and seeks to prevent it at all costs.
Thanks to Russia's unique set of problems, this
means taking some "unconventional" measures, to say
the least.

Thanks to all the petrodollars flowing in, Russia can scratch finances off
the emergency list. (The ruble has strengthened so much, in fact, that it
has replaced the greenback as currency of choice in a number of regional
transactions.) But three additional problems continue to weigh on Mr. Putin
like riders of doom. These
problems are criminal, demographic and geographic
in nature.

First, the criminal problem. As we have noted previously, the real power in
Russia is largely invisible. The Kremlin must frequently succumb to the
hidden hand of the siloviki, or "strong men," and also somewhat to the
oligarchs, fleet-footed players who siphoned off illicit billions in the
Yeltsin years.
Some Russians cast the siloviki as patriots — brutal men with hearts in the
right place — and the oligarchs as self-serving scum out for only
themselves. But the
divide is not quite that simple. (In Russia, few
things are.)

The upshot is that Russia's criminal element wields great power over great
distances — far too much for one leader to control. In his interaction with
this powerful netherworld, Mr. Putin is a bit like a mafia don trying to
keep his capos and consiglieres in check.
It's a tired cliché, but the Kremlin must keep its friends close and its
enemies closer. To stay on top, Putin must make productive alliances with
the strong, while punishing insubordination from the weak. He must keep tabs
on who is rising and who is falling in the ranks — lest he insult the wrong
player or back the wrong horse. And he must switch private allegiances
with the subtlety and finesse of a chess player all
the while.

We in the West see none of this — and we are far too naïve, from Mr. Putin's
point of view, to see that he has no choice but to play the game. If Putin
were to have a gallant Hollywood moment, so to speak, and declare it time
for a new broom to sweep clean, he would likely be dead within days. Perhaps
hours.
Putin's real objective in managing the criminal element (we speculate) is
putting Mother Russia first — with a long-lived retirement the second goal.
Putin must strike a balance between allowing free reign of that which cannot
be controlled, while reining in rogue interests deemed a legitimate danger
to the state. A great and abiding fear is that Putin's successor will get
the balancing act wrong. If the balance is lost, Mother Russia itself could
be lost... sacked by looters as the barbarians sacked Rome.

If Putin's criminal problem is akin to Tyrannosaurus rex, his demographic
problem is on par with Godzilla.
(A T-rex is at least theoretically manageable.) In 1994, The New York Times
published an article titled, "Climb in Russia's Death Rate Sets off
Population Implosion." In 2006, the Los Angeles Times published a similar
piece titled, "A Dying Population."
What is remarkable is that the two articles are 12 years apart, yet the news
is almost exactly the same:
widespread alcohol poisoning, rampant drunkenness, blatant self-abuse,
wretched medical conditions; everywhere there is despair. Only the fallen
faces in the anecdotes have changed.

If the birthrate in Russia does not pick up smartly, the country will
eventually disappear — or be overrun by outsiders. The demographic issue is
so huge and intractable — money is no help in the face of such a wretchedly
broken system — that it is not clear what Mr. Putin can do. He may not be
able to do much at all, other than tinker at the margins... and channel his
frustration into other dealings.

Putin's demographic problem feeds directly into his geographic problem.
Russia is an awesomely huge and sprawling country, spanning 11 time zones.
Its lands are chockablock with coveted natural resources. In addition to oil
and gas, there is timber, metal, fertile soil and other treasures galore.
Huge swathes of these resources are yet untapped, waiting for active hands
to exploit them.

Logistically speaking, China would get far more mileage from invading
resource-rich Russia than trying to take over, say, the tiny but
well-defended and well- connected Taiwan. Putin knows this. He also knows
that, as the Russian population recedes, it only makes sense to let others
in. If there are too few Russians, then other warm bodies should get a
chance at the job.
China is all too happy to provide those warm bodies.

North of the Russia-Mongolia border, for example, industrious migrants are
anxious to till Russian lands that would otherwise lie barren. The private
owners of these lands are happy to see the Chinese come, as locals have
proven unable or unwilling to do the work.
Unfortunately, The Wall Street Journal reports, Russian locals see the
newcomers as a "landing force." This is a widespread sentiment that runs to
the top of the ladder. For patriotic Russians, the horns of the dilemma are
these: Stubbornly cling to poverty... or embrace a Trojan horse. This
schizophrenic calculus colors all dealings between the Bear and the Dragon.

These are the Mission Impossible-type challenges that keep Mr. Putin up at
night. As you can imagine, snarky criticisms from Western journalists barely
register.
While he may look and act like a ruthless bully, Putin is, in reality,
something of a cornered fighter with few options at his disposal. This makes
him all the more dangerous. A determined opponent will wield his last weapon
with all the strength he has.

That last and most formidable weapon, of course,
is energy.

From the Kremlin's perspective — remember, this is conjecture — China is
strong, while Europe and America are weak. This is a psychological and
strategic judgment, not an economic or military one. Because Europe and
America are weak, they can safely be ignored... and insulted... and
manipulated. All this nastiness is a byproduct of Putin's driving goal:
consolidating as much power as possible — energy power, that is — in the
hands of the state.

From a Western perspective, this is a horrible, awful, not-nice goal. From
the Kremlin's perspective, it is necessary for ensuring Russia's long-term
survival.
When confrontation hits, from the south or west or wherever it comes, Putin
must have all the levers of power at hand. No one else can be trusted with
them. No one else — except maybe his handpicked successor — will
have what it takes to shepherd Russia through these
dangerous waters. Better to be as strong as possible when the gloves come
off.

How and where, then, might the next shoe drop? As weak as Europe is, it is
slowly awakening to the menace that is Gazprom. It is probably just a matter
of time before the E.U. draws a line in the sand, demanding that Gazprom
succumb to fair market practices in its delivery of European gas. Meanwhile,
Gazprom (i.e., the
Kremlin) is in a race to consolidate as much pipeline leverage as possible
before that fateful day.

In a nutshell, there will come a day when Europe says in squeaky unison:
"Mr. Putin! This infernal 'thuggishness' has to stop!" To which Putin might
coolly reply: "Da, what was that? You want all deliveries to stop, citizens
to revolt, markets to implode? I did not think so. Perhaps now you will take
Russia's interests more seriously..."

Regards

Justice Litle

for The Daily Reckoning

Bill Bonner in London:

"Housing nightmare tarnishes the American dream," says a report from
Reuters.

Meanwhile, the Financial Times quotes Martin Eakes – chief economist at
Self-Help, who estimates that
2.2 million Americans could lose their homes to foreclosure.

That's the general narrative. But now for the plot twist.

What we will soon hear more about is the way the pain of all this falls
disproportionately on Blacks and Hispanics. These two groups already tend to
be poorer than white people, which means they tend to suffer more from the
slings and arrows that drop down to the bottom of the wealth pyramid. They
die younger. They take fewer vacations. And they pay more for credit. The
reason is obvious. A member Federal Reserve bank pays the prime rate for
overnight funds, so there is little risk that the money won't be paid back.
But a janitor with an old truck and a new girlfriend is a credit risk and
lenders protect themselves by charging high rates of interest.

Mr. Eakes even tells us that this will become "the largest loss of
African-American wealth in American history."

Indeed, figures out last week showed Blacks nearly four times as likely to
get stuck with a "high cost" home loans. More than half the loans made to
black people in
2005 were sub-prime. And 80% of them were "exploding"
ARMS – adjustable rate mortgages with much higher monthly payments after the
initial teaser rate period expired.

Just ask a good lender in a bad neighbourhood. He will charge as much as 50%
or 100% on a one-month I.O.U. And if you don't pay on time, he might double
the interest...or smash your face.

Sub-prime mortgage lenders typically enticed customers with low initial
rates. But after adjustment, the rates often shot up to 10% or more. These
were the '2 and 28'
mortgages, where the monthly payment was put up sharply after the first 2
years. This not only put the borrower in a squeeze, it practically
guaranteed the lender more fees when the customer came back to refinance.

Still, there is a funny side to this story. For many decades, meddlers have
been urging the credit industry to provide more loans and encourage home
ownership among poor people. Now they have got what they wanted.
In the last few years, after lenders figured out how to make a buck at it by
laying the risk onto other investors, they complied. The poor got home
ownership in spades. Bad credit? No problem. Low income? Who asked? No
savings? Don't worry about it.

But now that the industry has done as it was bid, do you think it will get
any thanks? Not likely. Instead, the busybodies are likely to come around
with a subpoena in their hands...if not a rope.

We have no doubt that a lot of people are going to whine and moan about it.
Nor do we doubt that the fools in Congress will rush in with promises of
mortgage abatement and other subsidies.

Corrections involve pain and Americans hate pain. They count on their
elected representatives to protect them from it. But not all pain is a bad
thing. Suffering the pain of a small correction now, for example, can help
prevent the pain of a larger one, down the line.

But who really will suffer from the sub-prime crisis remains to be seen.
People with neither money nor savings to begin with may complain when the
houses they couldn't afford - and never should have afforded - are taken
away from them. But they are wiser, and probably not really too much poorer.
The real pain will be felt elsewhere...where the lesson will be that much
more expensive.

More news:

-------------------------

Rob Mackrill:

- In the UK this week the Budget looms large. The Chancellor, Gordon Brown
is expected 'to hit gas guzzlers hard' according to a BBC report. A move
that would enjoy strong public support (69%) according to accountants Grant
Thornton, where those of us that can't afford a Sports Utility Vehicles
(SUVs) are quite happy to see those that can, pay for it...and all in a good
cause too. Guilt-free schadenfreude.

Stamp duty is another possible target given a runaway property market immune
to interest rate rises. Home purchases under £125,000 are currently free of
stamp duty but rise to 4% over £500,000.

In another slice of the tax pie, Ernst & Young don't expect too much action
on corporation tax in spite of increasing concerns that the UK is becoming a
fiscally uncompetitive place to do business. A mood that Shadow Chancellor,
George Osborne, has caught today. He's declared a Tory government would cut
corporation tax by 3% funded via a phasing out of other corporate tax
breaks says the FT.

- Looking for a new start? A report from US internet security company,
Symantec, says you can get a new identity online from as little as $14 (£7).
It comes with a bank account, credit card, government identity number and
date of birth. Dean Turner, senior researcher for Symantec on the project,
speaking to the FT said there were hundreds if not thousands of websites
where trades could be made.

- The Children's Investment Fund may conjure warm fuzzy feelings in the
uninitiated but don't be deceived. It is an 'activist' hedge fund that owns
1% of Dutch bank ABN Amro. It is agitating for change at the bank to unlock
the group's 'undervalued assets'. City AM reports this morning it is
supporting an 'informal' bid approach from Barclays about an £80bn tie-up.
'Is no one immune to the lure of the transformational deal"?'
asks a sceptical FT Lex column, though it's got the market excited. ABN
Amro's shares traded up almost 10% this morning.

- The Chinese have announced they're going to build aeroplanes. In a
government announcement, they stated their intention to build big passenger
jets to rival Boeing and Airbus. It could take decades to reach their goal
but as one of their own once memorably said, a journey of 1,000 miles begins
with a single step.

- When will the current bout of market turbulence end?
Look to the stars for you answer says Henry Weingarten of the New York-based
Astrologer's Fund. In addition to economic and statistical analysis, this
fund uses astrological charts to help make its investment bets.

"We have a real estate recession that astrologically is similar to 1989.
Some people are saying it's over. It's not over. It hasn't even started
yet," he tells Reuters. Regular Daily Reckoning readers will know there are
clues aplenty in the real estate market that keep appearing without the need
for a horoscope.

Weingarten also discloses a couple of areas he is bullish on that meet his
current criteria – Brazil and Germany.

---------------------

And more views from Bill:

*** The best bet for long-term profits, argues Mark McLornan, is grain.

"When incomes rise, so does meat consumption – growth in beef and chicken
consumption in China is running at 20% a year. It takes nine kilograms of
grain to produce one of beef. Already, 67% of global grains are used as
animal feed, so this surge in demand will have a huge impact on the grains
market. Demand for biofuels is making matters worse. Corn used in fuel
production in America is set to rise from 6.4% of US corn production in 2001
to 30% by 2007/2008."

McLornan says that stocks of corn and wheat, the main global grains, are at
record low levels. And as demand rises, it is getting harder and harder to
expand supplies. Fertilizers have added to output greatly in the last 50
years, but additional inputs of fertilizers now produce diminishing returns.
Nor is it easy to put new land into production. While land is available,
water is scarce. And as a populations and human development increases,
agriculture has to compete for water with other uses.

"I believe the fundamentals make grains a once-in-a- decade opportunity,"
says McLornan.

*** "Mass demonstration to bring back the franc," says a poster along the
road in Paris.

Not everyone is happy with the European money. Many French people think it
is just a devious means of raising prices. The cost of living has clearly
gone up in France. How much, if any, of it is attributable to the
introduction of the euro, we don't know.

But dissatisfaction with Europe runs deeper than just the new currency. A
poll taken across the continent showed that most people thought life had
gotten worse, not better, since the European Union was established.
And a large minority of respondents said they thought that the major thing
the EU had provided was more bureaucracy.

This Sunday marks the EU's 50th anniversary. The papers are bound to be full
of retrospectives, introspectives, and other babble. The EU is one of a long
list of things about which your editor has no opinion. Is it a good thing or
a bad one? How would he know?

But it has clearly made a change. It has got people on the move. London is
full of Frenchmen. Provence is full of Englishmen. The Swedes and Danes fill
the beaches of Spain...while Spanish fruits and vegetables appear on plates
all over Europe as commonly as California avocados make it to New York. In
some ways it is easier to move around Europe than the US. The airports are
more relaxed and, often, more efficient. The distances are shorter. And in
the last few years, a whole group of discount airlines has taken to the
skies. They offer flights from Manchester to Marseilles for as little as
29 euros. And if you prefer to stay on terra firma, the trains are much
better than in the US.

All this movement has brought prosperity – especially to the periphery of
Europe. Ireland and Spain are the big winners. The heartland countries –
France and Germany – have a tougher time of it. They've had to deal with new
competitors and a more fluid
labour market.

*** Our office moved too, but we miss our old neighbourhood. Our office in
Paris used to be over near the "Marais" – the old Jewish quarter, which had
been a swamp. Now, we are in a fancier part of down, near the American
embassy, between the Place de la Concorde and the Madeleine. Across the
street is a shop that is all white. The floor is white, the walls are
white...the two women who work in the shop are dressed all in white...and
the clothes the shop sells are all white too. We don't know what the point
of it is, but at least it is clean.

There are a couple of bars catering to a professional class. Last week, we
went over for a cup of tea. While we were sitting there, we suddenly noticed
that all the other customers were weirdoes. There was a young man whose head
and back...down to his feet...seemed to run in a straight line as if he were
carved out of a solid block of wood. Strange. And there was another man,
short and round, with eye-glasses as thick as coke bottles, who muttered to
himself constantly while standing at the bar drinking a café. He was clearly
mad. Another pair were shopkeepers whom we have seen quite often - a couple
in their late 70s, who look fairly good from a distance. But get closer and
you realise that they must have mortgaged their business to buy surgery and
cosmetics. The pair are so done up they look as they if had just climbed out
of their coffins and need to have stakes driven through their hearts.

Besides that one place, however, this neighbourhood is too 'normal' for us.
It is full of office workers.
Merchants. Tourists. In short, it is boring.

It must have been a coincidence that such odd-looking people had gathered in
the bar at the same time. But it reminded us of our old digs across the
Paradis bar.
What a pleasure it was to go to work there. The two geriatric prostitutes
were always amusing to see – one with her shiny black raincoat and tiny
white dog...the other with her huge cavalier boots and very short skirt.
Neither one of them could have been mistaken for young or attractive – even
on a very dark night.
But what they lacked in boudoir appeal they made up in bonhomie.

And there was the Japanese drunk who sang at the top of his lungs and then
collapsed on the steps of St.
Merry's church, next to the Paradis. One morning they found him there...as
dead and cold as the stone steps themselves.

And who can forget the man who lived in the cardboard box, with his long,
flowing beard and his enigmatic responses...
For all we know he is still there muttering in his box.

We'll have to go by and sell hello to all of them again sometime.

A Different Kind of Cold War

2007-03-15T08:01:00.001-07:00

A Different Kind of Cold War
by Justice Litle

"In much the same condition as the Aral Sea, the former
Soviet Union is a disaster that is about to spiral into a
catastrophe."
— Jim Rogers, Adventure Capitalist

The Dec. 16 edition of The Economist has a mocking sendup
of Vladimir Putin on the cover. The Russian president's
head is pasted on the body of a Prohibition-era gangster,
complete with white fedora hat and zoot suit. In shades
of Al Capone, Putin aims a gas pump nozzle as if it were
a Tommy gun. The text reads, "Don't Mess With Russia."
Inside, the lead article closes with a bland flourish of
hope: "Russia is one of the few countries that could
produce more oil — if only Mr. Putin changed his
thuggish ways."

This cloying sentiment brings to mind a crusty old
nugget of bartender wisdom: "If ifs were a fifth, we'd
all be drunk."

Is there any chance Mr. Putin will soon reform and make
nice? Not really. It is far more likely that the opposite
is true. Russia may well be gearing up for an ugly — and
possibly brutal — confrontation with the West

Blustery March winds blew through global markets
again yesterday.

At one point, the Dow was sold off to under 12,000,
before recovering. The London stock exchange took a
beating too.

Investors are "jittery" says the Financial Times, over
the subprime crisis in the US. European and Asian
stockmarkets suffered their second biggest losses of the
year yesterday.

One thing is clear – volatility has returned. That long,
lazy, self-assured and complacent period that annoyed us
for so long seems to be over. And good riddance.

We are literary economists and market voyeurs, here at
the Daily Reckoning. We like action...something to look
at...someone to laugh at. We like tragedies...
comedies...something that causes our ribs to heave...
someone who gets what he has coming...a story with some
excitement and drama. At last, we seem to be getting one.

For months...no years...we have been watching. Waiting.
Hoping. 'Something has to give..' we kept saying. 'This
can't go on forever...' we wrote so many times we began
to wonder if it was true. 'When the end comes...' we
warned ominously.

Well, the end may still be far away. But at least a few
more people can see it coming. They've seen prices go up
and down sharply. It doesn't take too much imagination to
see them going down decisively.

Which means that the price of insurance is going up.

"Banks face rise in cost of default protection," says the
FT. Credit Default Swaps are going up. So is the
protection available to the average investor.
Yesterday, the VIX reached its highest level since
June of last year.

What is gratifying about this sort of action is that it
has genuine heroes and cads...people whom the gods reward
for their virtue or destroy for their vices. New Century
Financial, for example. Teetering on the edge of
bankruptcy, we regretted that we couldn't give it a push.
But yesterday, along came Barclay's bank to do what we
couldn't. The British bank demanded $900 million, and it
wants it right now.

But don't worry about Barclay's. "All of our exposure to
US subprime lending is fully collateralised..." it told
the press. "We do not envisage any material losses due to
exposure to the sector."

We are not privy to the details. But we can also
perfectly well imagine that Barclays is misinformed. All
the subprime debt was fully collateralised. That was not
the problem. The problem was that the collateral was
fraudulent. Encouraged by rising property prices, aided
and abetted by appraisers, mortgage brokers, and real
estate agents, enabled by 'low document' lending
procedures – neither the subprime collateral, the
subprime securitised debt, nor the subprime borrowers
were worth what they said they were worth. Now, with
property prices falling in many parts of the country, it
may be impossible to unload the foreclosed houses for
anything near to what lenders had expected – especially
if subprime troubles spread into the rest of the
mortgage market.

"The reliance on judgment and reason will be pushed
aside," said 80-year-old Henry Kaufman in New York on
Tuesday night. What we found interesting was his use of
the future tense, referring to the growing tendency to
replace wisdom and experience in the financial markets
with sharp calculations. If there is a half a point of
yield to be gained by exchanging yen for ringgit...buying
emerging market bonds...leveraging with zlotys and
hedging with euros...even though the old timers might
judge it too risky or too complicated, the mathematicians
will find it irresistible.

We fuddy-duddy literary economists are not the ones who
have made money in this liquidity bubble. We're not
complaining. Our gold rose from a low of $252 in 1999 to
around $645 last time we looked. But the real money was
made by those who reached for yield, leveraged it up and
sold it on. Yesterday, we learned that Goldman Sachs
actually outperformed analysts' expectations. Yes, the
master of the masters of the universe masterfully
masterminded a masterstroke...theirs is a masterpiece of
...well, never mind.

The report referred to earnings 'in the first quarter.'
The quarter ended on February 23...only four days later
world markets sold off on panic following a 9% drop in
the Shanghai composite index. And what's this? On
February 27 Goldman was down 12% from its all-time high
of 222.75 made on Feb. 22.

Talk about nice timing.

There's something screwy about the whole spectacle. The
numbers – for all their pretended precision – never seem
to add up. How can you have a 'quarter' that ends in
February? How could the whizzes on Wall Street make such
errors about the value of their subprime debt?

Still, who says the top is in? Who says America is in
decline? Who says the liquidity bubble is over? Who says
there isn't more money to be made?

We literary economists don't to presume to know and don't
pretend to care. But at the show is definitely getting
more interesting.

More news:

----------------

Rob Mackrill:

*** An opposition to the global warming consensus
appears to be making itself known. The Times reports an
angry email exchange between Martin Durkin, executive
producer of a recent UK Channel 4 programme entitled
'The Great Global Warming Swindle' and two respected
British scientists.

"The BBC is now a force for bigotry and intolerance..."
said Mr Durkin. "Since 1940 we have had four decades of
cooling, three of warming, and the last decade when
temperature has been doing nothing. Why have we not heard
this in the hours and hours of shit programming on global
warming shoved down our throats by the BBC?"

- John Authors in the FT reports on a speech Henry
Kaufman made in Wall Street on Tuesday. The ex-chief
economist of Salomon Brothers earned the nickname Dr Doom
for his gloomy views. Now in his 80s he's not turning any
more cheerful says Authors. Kaufman reckons 'the problem
[today] lies in the changing definition of liquidity.

'After the war, liquidity was an "asset-based concept" –
companies cash on hand and so on. Now "firms and
households alike often blur the distinction between
liquidity and credit availability. Money matters but
security counts". Securitisation and improved technology,
he said, stimulated risk appetites.'

- On the subject of securitisation, UK Chancellor Gordon
Brown has a novel idea to raise more cash reports the FT.
Package up the £16bn in student debt and sell it in the
market, then recycle the estimated £4.5bn a year back
into... education.

- You've heard of OPEC, how about OPEGASUR says the Wall
Street Journal? A South American inspired gas cartel was
established yesterday that embraces Brazil, Bolivia and
Venezuela. A development that has got some in its energy
dependent northern neighbour worried. Michael Economides,
editor of Energy Tribune warns:

"With domestic gas production in decline, the United
States and many of its allies will grow more dependent on
imports to generate electricity and heat homes," he
wrote. "Gas suppliers will band together in response to
the growing global demand, just as oil producers did
decades ago. Few people talk about the looming U.S.
dependency on imported natural gas, but it could
be painful."

And the potential pain of gas dependency is something
Europeans have become all too aware of as well. Russia,
the big daddy of natural gas, has already cut off the
taps a couple of times to get its way with uppity Ukraine
and Belarus. And President Putin is moving to strengthen
his hand in the gas market. Last month he visited the
Middle East and sat down for talks with the emir of
Qatar, another leading gas producer, about...you guessed
it... setting up a gas cartel. (See today's essay from
Justice Litle for more on Putin's Russia)

- European stockmarkets tanked yesterday after nervous
investors took fright that the US subprime mortgage
meltdown could spread to other financial markets.
Investment guru Jim Rogers shares their fears. Falling US
real estate prices will trigger defaults. "It is going to
be a huge mess. When markets turn from bubble to reality,
a lot of people get burned." He tells The Times. European
markets are all positive this morning, however, with
the FTSE 100 up over 100 points at 6,120 having shed
160 yesterday.

- Lost in the fury of falling stock prices, a modest item
of semi-positive news. The US current account deficit
actually shrunk in the final quarter of 2006 to $195.8bn
against estimates of $204bn. But the overall for the year
it was still an ugly number. At $856.7bn it was up 8% on
2005 and amounted to 6.5% of GDP. A record says the New
York Times.

-----------------------------

And more thoughts from Bill...

*** The world's second largest economy looks like a much
better bet for investors than its first largest one.
While the rest of the world enjoyed one sunny day after
another, poor Japan has remained in darkness. Its stocks
had crashed. Its property had crashed. Its consumer
prices had crashed. For, what....14 long years?...
nothing seemed to come from Japan but good cars and bad
news. But in 2005, thus rising sun began to peek over the
horizon. Stocks soared 40%. Consumers and businessmen
seemed to recover some of their old bonsai spirit. Last
year, again, stocks rose...though much less than in 2005.
And now the economy is expanding nicely.

But what attracts our attention today is Japan's property
market, where prices are still going down! Japan, and
Japan alone, is still bucking the worldwide trend towards
higher prices for immoveable objects. Its property is
down 32% since 1997. Last year, the stuff fell another
2.7%. By contrast, US housing rose 102% during the last
10 years. This was modest compared to Ireland, with a
253% increase...and South Africa, where prices
jumped 351%.

For a contrarian, what's not to like in Japan? The
currency has been going down for years. Speculators are
short the yen...hundreds of billions of dollars worth.
Stocks are still less than half what they were 17 years
ago. And the Japanese economy...after a long period of
on-again, off-again deflation... finally seems to be
growing at decent rates.

It is America, Britain, China and the other high-fliers
that a contrarian should be wary of. A few years ago, we
wrote a book, with Addison Wiggin, predicting that the US
would follow Japan into a long, dark slump. We were
surely early. We're still not convinced we were wrong.

*** "Zimbabwe sinks into hell of hyperinflation," says
the lead editorial in today's Financial Times. You know
the story already, dear reader. Inflation is running at
more than 1,700% in the country...and seems to be out
of control.

Also out of control are Zimbabwe's police, who rounded up
protestors the other day – including the man seen as most
likely to replace the current president – and beat them
up. The challenger, Morgan Tsvangirai, was then hauled
before the courts and charged with inciting people to
commit acts of violence. But it was obvious to everyone –
including the judge, who promptly ordered the defendant
to the hospital – that Tsvangirai, with his swollen and
beaten head, was not so much the inciter of violence as
the victim of it.

But then comes the most remarkable part of the editorial.
Here, on the very Ides of March, the FT is prodding
Cassius and Brutus to stick the knife into a lawfully
elected president of a sovereign, democratic state! "Get
involved now," it urges neighbouring South Africa, "while
the Zimbabwe state can still be saved."

Our friend Michel is still puzzling over the issue. He
took out a dictionary to get a definition for democracy
and found this: "a government where the people exercise
sovereignty." If we recall correctly, Robert Mugabe was
elected by the people of Zimbabwe to run the state.
According to the press reports at the time, the election
was as honest as most below the Sahara...and probably not
much more dishonest than some above the Rio Grande. Maybe
a few voters were roughed up. Maybe more were discouraged
from taking to the polling stations. But there is no
such thing as an election that functions perfectly.

Whatever can be said for the election, Robert Mugabe has
been running the state...into the ground. There is no
doubt about that. And to the extent that the people of
Zimbabwe elected him...or even tolerated him...they get
what they deserve.

What's more, there's no definition of democracy that we
know of that permits a foreign people to "get involved"
in the misgovernment of another democratic state...or
even in an undemocratic state. And in every example we've
heard of – whether of the Napoleonic army in Spain or the
Bushian army in Iraq – the results have been disastrous.
Nevertheless, that is the central inspiration of
America's 'Wilsonian' foreign policy...and the fervent
wish of every addled neo-conservative in Washington.

Alternative Energy Alternatives

2007-03-14T08:38:00.000-07:00

Alternative Energy Alternatives
by Kevin Kerr

Opportunities abound for investors in the energy market right now, just
looking at what's being set in motion globally. The end of the age of oil
will not be a disaster if we are prepared for it as investors and consumers.
Acceptance is the first step.

Aside from water, the world is most thirsty for oil.
Since the last major oil crisis in the 1980s, there's been tremendous
population growth, with no less than one-third of that population beginning
to industrialise their economies. Look at China, home to 1.3 billion people,
and India, with more than another billion.
Both these economies are growing fast, and they must have oil.

Then add the United States's oil addiction to the mix, with our ever larger
gas guzzlers and our seemingly insatiable desire for bigger and better,
whether it's cars, boats, houses, amusement parks, shopping malls, or
whatever.

Combine this demand with dwindling global supply, the ongoing threat of
terrorist attacks, the fact that there has not been a major oil find in more
than 36 years, natural disasters such as last year's hurricanes along the
Gulf Coast, and continued geopolitical tensions, and don't be surprised if
oil reaches $150 a barrel, or more. How can you capitalise on this?

It's always important to have vision, to see beyond the short-term outlook
and predict what can and may happen in the future. It's essential to know
which seasonal and geopolitical factors will drive demand. Do your homework!
Learn to decipher and understand industry reports such as the Energy
Information Agency weekly inventory report.

Oil is the lifeblood that moves things, that keeps the whole world
functioning and growing. In the last 100 years we have become very spoiled -
we've been used to easily obtained, easily moved, and easily processed
petroleum, crude oil, and natural gas. We have simply come to expect that
they will be there forever, or at least for our lifetime. Oil, among other
things, spurred the development of the internal combustion engine, which
does the work of a thousand people. Oil essentially constitutes a major
workforce throughout the world.

This virtually invisible workforce has allowed the world's population to
grow to over 6 billion. Not only that, it has allowed us to plough millions
of acres of land, to produce fertilizers, to transport people and goods,
even to wage global wars and to set up global communication systems. Our
dependence on oil, and energy as we know it, is similar to an addict's
powerful affliction. The world's craving for oil is just as debilitating.

At this moment the United States doesn't have an energy source that would be
as easy to produce and transport as oil. Nuclear power can produce
electricity, but the remaining rich uranium ore will last for decades, not
for centuries. Renewable energy can probably never cover the current levels
of global energy consumption or even U.S. consumption.

So what is a practical solution right now?

Recovery from oil addiction is possible, and the long- term, easy-to-reach
answer may be in a fuel source that is right under our feet - coal. Coal is
cheap and reliable and much cleaner-burning than it use to be. As the world
goes through painful withdrawal from oil dependence, coal may help. It seems
that the market feels this way to as coal prices have been soaring over the
past year.

Clean coal technology (CCT) is employed when coal arriving at a power plant
contains other by-products that need to be taken out before it can be used.
A facility like this uses a number of processes to remove unwanted minerals,
which makes the coal burn cleaner and more efficiently.

Coal has often been stereotyped as a dirty and less desirable product of the
energy industry, but not anymore. As the world searches for energy
solutions, coal is at the forefront, and new, clean-burning coal technology
means it's highly likely that coal will be around for some time to come.

It turns our turbines and runs our assembly lines . . .
it powers the Internet, our databases, and company networks. When we read in
bed, turn on the air- conditioning, look at the night time skyline, it's
there.

And we take for granted that it will always be there, every time. But when
more and more people, in more and more countries, start making that
assumption, you have a situation. Right now, one in every three people
doesn't even have electricity. And already, our electrical grids are
overtaxed and electricity demand is higher than it's ever been.

What happens when the rest of China and India hop on to the power grid?

In China alone, electricity demand is 150 percent higher right now than it
was when China first started
to boom, back in 1980. Worldwide electricity demand
is expected to explode by another 85 percent before
the year 2020, faster than demand for any other kind of energy.

What happens when the world population hits 7 billion?
How about 8 billion? Or 9 billion, as the United Nations is predicting?
Hospitals without life-support machines. Grocery stores without
refrigerators.
Shopping malls, office towers, and neon gone dark.
Printers and fax machines that don't hum. Trains that don't run, phones that
don't ring, computers that don't blip or announce new e-mail. . . because
there is no e- mail; there is no Internet. The global grid is down.
And where it's still up and running, it's pockmarked with dead zones that
have made the whole network slow to a crawl. Even the electronic stock
tickers on Wall Street have flickered out.

Without billions of dollars invested in new electricity resources right now,
imagine brownouts, blackouts, shutdowns, and worse on a scale 10 times
greater than anything we're seeing today.

This all sounds scary and not quite real. It doesn't have to be real if the
biggest and most ambitious economies in the world kick in right now with
several hundred billion dollars to jump-start a whole new era of electricity
investing.

The good news is that the total $16 trillion headed for all the energy
markets - including the $10 trillion that will go into electricity - is
still just a fraction of the total global gross domestic product
(GDP) - only about 1 percent. So making the investment is not only very
possible, it's nearly certain.

The electricity markets are still in their infancy in the commodities world.
As with so many other up-and- coming opportunities, you just have to be
ready to seize those chances when they come. Speaking of opportunities,
alternative energy is another area investors are focusing on, and one of the
biggest is solar power.

The idea of using the sun to solve the earth's energy needs is hardly new;
it's been used since the dawn of time. What is new is the technology and
research money that are breathing life into the industry. The rallying cry
for quick and easy solutions to our nation's oil addiction spurred immediate
interest in alternative energy, from nuclear to ethanol. Solar power faces
some challenges, to be sure, but there are some solid players who certainly
bloom in this sector. Just add
sunshine and a little ingenuity, and watch the
profits grow.

Since the 1970s, the solar power industry has come a long way. We've reached
a point where solar power is no longer a gimmicky, peculiar energy source;
it's now more of a necessity.

The solar energy industry has made enormous progress in the past 20 years,
finding new solutions to the ongoing problems of high costs and massive
regulatory barriers
- but there are still roadblocks. Solar technology has become more
affordable, due mainly to higher demand and the goal of eliminating
dependence on foreign oil.

Manufacturing processes have been streamlined and continue to become more
cost-efficient with the help of government subsidies, consumer rebates, and
tax credits. As oil prices continue to increase exponentially, it seems
inevitable that a convergence of the cost of conventional and alternative
energy costs will occur. Many companies in the solar sector seem to be
focused on the development of improved solar efficiency through broad based
applications that can be put to practical, immediate use.

Now, one thing that is very important to investors in any sector is the fact
that every trade has flaws. In the case of solar power, there are several.

Although there is so much good news for solar power, there are challenges,
too. For example, there's the lack of silicon, which is needed for making
solar panels. A silicon shortage has limited the supply of the panels and
frustrated potential buyers. Orders take several months to complete, and
prices, after years of floundering, have increased by as much as 15 percent.

The real winners are those companies that benefit from the lack of silicon,
primarily producers of less efficient, yet available, thin-film solar
panels. Of course, other beneficiaries include companies that have emerging
technologies, such as plastic solar cells.

Worldwide, the solar market has exploded, growing by 40 percent annually in
just the last five years. Germany and Japan alone use 39 percent and 30
percent, respectively, of the global solar panel stockpile. The United
States is a distant third, at only 9 percent of the global solar panel
supply, according to various energy information sites. California is likely
to drive that stat much higher as demand grows exponentially in that state
and others, too.

Regards,

Kevin Kerr
for The Daily Reckoning

Bill Bonner in London:

Uh oh...here come the clowns.

"The impact of losing 2.2 million homes, I suspect, will be in a lot of
areas of our cities and towns that are already pretty hard hit, so we
clearly want to look at it."

What the chairman of the Senate banking committee wants to look at is the
same thing that Wall Street was eyeing yesterday...the thing was so
disagreeable it sent the Dow down 242 points...and, according to the English
papers, upset stock markets all over the world.

And... "it's going to get uglier," said Angelo Mozilo on TV yesterday.

The whole U.S. mortgage industry - with over $10 trillion outstanding - is
already not prepossessing sight. It faces a 'liquidity crisis,' the CEO of
Countrywide Credit, the nations' number one mortgage lender, told viewers.
There are more than $1 trillion in 'subprime' mortgages outstanding. Many of
these are turning out as anyone with half a brain might have expected -
badly. And yet, the mathematical geniuses who package and trade these
things seem to have been caught unawares.

Take a look at the ABX index, where
subprime-collateralised debt is traded. The ABX, says the New York Times,
"tracks how much it costs to insure a group of BBB-minus bonds based upon
subprime mortgages. The Index is a derivative which falls in value when the
cost of insurance rises, so it can be seen as a proxy for the value of the
underlying bonds".
With defaults in the mortgage business mounting, insurance costs have
increased dramatically, sending the index into a spiral down. It has
declined approximately 30% since January 1, 2007, and 7.4% literally
overnight during the recent subprime crisis.

Yesterday was not exactly ugly...but nor was the picture as placid and
pretty as it has been for the last few years. Mortgage payments are getting
later...nearly 5% of them are delinquent. Among subprimes, the delinquency
rate has jumped to 13.33%...with subprime ARMs (adjustable rate mortgages)
at 14.44%.

Of the entire mortgage market, about a third is insured by the U.S. federal
government - that is, about $360 billion worth. But according to Martin
Hutchinson's calculations, if the US housing market goes down just 15% - a
rather modest decline for such an immodest boom - the mortgage industry and
its backers, lenders and investors would suffer a capital loss of about $1
trillion, with about a quarter of that amount in loans guaranteed by the
federal government's bagholder - Freddie Mac.

Freddie Mac, unfortunately, has only about $79 billion to draw on...which
would leave it a little short.
Seeing the handwriting on the wall and reading it without moving their lips,
its executives announced that they would tighten standards. Henceforth, it
would be harder to lay defective mortgage credits onto the feds. Thus
Mozilo's comments. A 'liquidity crisis,'
after all, doesn't arise in the desert. Where there is no credit, no one
expects credit. Where there is a flood of it, on the other hand, people come
to rely on it. And where there is excess credit, people come to rely on it
excessively.

How quickly a market can go from excess to shortage! We now see what can
happen to the entire 'flood of liquidity' that buoys up everything from the
prices of Bombay apartments to the art auctions at Christie's. It can
disappear in a trice. Then what happens to all those assets? Simple, they
sink back to more reasonable prices...and then (because markets tend to
over-react in both directions) to prices that are unreasonably low. So, you
see, dear reader, there is much to look forward to.

But let us return to the US Senate, just to laugh at the clowns. The gap
between what the feds' insurer has on hand...and the loss it is likely to be
asked to cover...is approximately $150 billion. Small change, to be sure.
But where will it get the money? And it is not as if the entire rest of the
financial picture will remain as soggy as it is now - even as the mortgage
industry dries out. We saw yesterday that the Dow is likely to follow the
mortgage industry. And the economy, too, it likely to feel the dry breezes
blowing off the mortgage financing badlands. Just as the consumer's water
line is connected to the community reservoir, so is his individual consumer
spending firmly attached to community house price trends. Come the parching
winds and it is likely to curl up and blow away.

Still, the Daily Telegraph reports that "American politicians are
considering an emergency bail-out of
2.2 million borrowers struggling with their mortgage payments."

Are these the same politicians that are already adding half a trillion to
the US national debt in the next two years? But anything is possible. If the
government - against all odds - can bring peace and prosperity to Iraq,
surely it can stop a liquidity crisis...can't it?

More news:

------------------

Adrian Ash, reposing in Kent:

- Happy birthday to the Reflation Rally! The global mega-trend in cheap
money turned four years old last Sunday. And my, hasn't she grown...

- What, you missed the celebrations? Quick, grab a party hat and a slice of
cake. And here, tie this balloon to your wrist. Mind it doesn't burst!

- The love-child of scared central bankers and bear- weary investors, the
Reflation Rally was born back when the Challenger tanks first rolled into
Basra. Spring
2003 was when cheap money got cheaper - so cheap, in fact, that the dash for
cash following the Tech Stock collapse finally turned tail.

- Only a fool would hold money paying less than inflation - and only an
idiot would sit out the bull market in everything else. The Reflation Rally
quadrupled crude oil prices, and took the Dow to fresh all-time highs. It
put a floor - at last - under Tokyo land prices. The yield-premium on junk
bonds shrank almost to nothing. Copper rose five times over.

- The FTSE recovered 6,000...the Dax climbed back to
2001 prices...UK house values doubled again...and gold shot more than 150%
higher.

- But no one likes a know-it-all, and the Reflation Rally became annoyingly
precocious. This wünderkind could pump stocks in Mandarin as easily as write
"buy"
notes in German. Her sales patter in Dutch matched her Korean
mortgage-market analysis.

- Shadey-looking Russian balance sheets, Icelandic bonds, credit-default
swaps on Ukrainian chicken-farm debt...you name it, the Reflation Rally
could talk it up with a smile. She welcomed investors the world over to the
cheap money bonanza each day - greeting them with a cheerful G'day,
ohiogazaimasu, dobré ráno, bonjour and good morning, America - without
missing a beat.

- The sun never set on the Reflation Rally, and her bull-market energy
brought joy to billions. Even those poor schmucks holding gold! "2003
provided an exception to the rule that gold prices tend to vary inversely
with those of financial assets," noted John Hathaway of Tocqueville Asset
Management as the Reflation Rally celebrated her first birthday. The trouble
was, 2004 proved an exception too - as did 2005 and 2006.

- The action in 2007 so far only serves to beg the question more urgently
still. Just what happened four years ago to kill gold's "safe haven" appeal?
It joined the same trend as stocks, real estate, emerging markets and
high-yield bonds - upwards...ever upwards.

- Now everything is plunging again, gold's started falling in sympathy! What
gives?

- Investec Australia today blamed gold's decline - down towards $640 per
ounce - on "worries that we might have another risk aversion sell-off". But
gold shines when risk aversion increases, or so everyone says. It's the
classic "safe haven" - or at least, it was until 2003.

- Has something gone wrong with the data? In a word, yes. Gold's magical
powers really did desert it four years ago this week. And the kryptonite
that zapped its powers - forcing it to rise with everything else - was the
plunging cost of money.

- In 2003 the European Central Bank (ECB) cut Eurozone base rates from 3.75%
to 3.0% - and left them there for the next 30 months. Across the Channel in
London, the Bank of England slashed its lending rate to 3.5%, a forty-year
low. Three-month rates on the Swiss Franc - recently cut free from all
gold-backed security - were pushed below 0.75%.

- In Washington, the gabby Greenspan Fed cut Dollar interest rates all the
way down to a half-century "emergency" low of 1%. And to complete the
bonanza of giveaway money, the Bank of Japan in Tokyo stuck with cheap money
so cheap, it was free.

- By the middle of 2003, the world's five leading currencies paid such
little interest, only a fool would hold cash. So the alternatives - every
alternative - shot higher, all at the same time. For the first time since
anyone bothered to crunch the data, that meant gold rose together with
stocks, bonds and real estate.

- Does that mean gold won't protect you against falling stock, bond and
property prices today? Short-term, we guess, gold may continue to struggle.
Too many hedge funds went "long" of gold in the futures market for it to
escape a whipping. They need cash to repay their investors. Taking profits
in gold is pushing it down.

- But today's dash-for-cash comes after four years of cheap money. And here
in spring 2007, confidence in government-approved cash continues to leak
away. Tapped by negative real interest rates on the world's five leading
currencies, faith in paper has been slowly ebbing since 2003.

- The bear market in money created the Reflation Rally in assets.
Government-led and central bank-sanctioned, it has halved the value of
Dollars against gold.
Sterling and Swiss Francs have both dropped more than 40% versus the metal.
The Euro's fallen by 30%, and the Japanese Yen has sunk to one-third of its
value since the Bank of Japan slashed its interest rates to 0.10% in Sept.
2001.

- Call it a flood of liquidity...a flood now washing the ink out of Mervyn
King's "promise to pay" on the notes in your wallet.

- This slump in the value of money will roll on for as long as interest
rates fail to outpace inflation. And with the US subprime collapse now
calling the entire financial world into crisis, don't expect a sharp rise in
real interest rates anytime soon.
------------------------

And more thoughts from Bill...

*** "The real worry lies much deeper than share prices," writes Anthony
Hilton in the Evening Standard in London.

The real worry, Hilton believes, is that we don't know what to worry about.

"This is the first truly modern financial crisis, the first born of the age
in which we live. For the past five years, cheap money from America and Asia
has been lent and re-lent with less and less concern about whether it will
ever be paid back, because new financial products - credit derivatives -
allowed those lending the money to insulate themselves from the possible
loss by selling the risk of default to other people."

"Three out of four mortgages that are made are made by a person who is not
employed by a bank or savings and loan," added Fed governor Susan Bies in
February. Ms.
Bies meant to look on the bright side. All this extra activity by extra
participants, she thought, made the whole lending world less risky. The
risk, such as it is, was thought to be spread around.

But to whom? How? And how much? And how might it be brought under control?

We don't know the answer to any of those questions save the last one. To the
first three, the appropriate responses are 'we don't know' three times. But
to the last one the answer is: it will be brought under control by the
natural contraction of the credit expansion. That same "liquidity crisis'
that now threatens subprime will someday threaten the whole mortgage
industry...and then the whole economy. Always has. Always will. What goes
up, comes down.

Still, the 'we don't know' answers probably hide bigger problems and more
expensive resolutions than we are used to. In the old days, if credit seemed
to be expanding a little too quickly, it was brought into line quickly too.
The Fed merely instructed member banks to tighten credit. Banks, then, were
the source of credit. When they tightened, the easy credit disappeared. Now,
credit comes from many sources - some of them relatively unknown to the
average investor as well as to the average banking regulator. The potential
uncontrolled run-up of credit is much greater (which is what we have been
seeing for the last few years). But so is the potential uncontrolled rundown
too (a preview of which we just saw). That there is more to come is the
opinion of Mr. Hilton, shared by your editor.

*** We love democracy. It is more entertaining than any other system of
government...and you can laugh at it without going to jail (at least, you
could before the passage of the Patriot Act).

Our friend Michel tells us about a hot
election campaign:

"...One promises change without disruption...another promises disruption
without change...: Umaru Yar'Adua (Democratic Peoples' Party), Chief Emeka
Odumegwu Ojukwu (Progressive Grand Alliance), Orji Uzor Kalu (Peoples'
Progressive Party), Chris Okotie (New Democratic Party), and don't forget
General Muhammadu Buharih (Peoples' Party) et Alhaji Atiku Abubakar
(Congrèssional Action). This last candidate is affectionately nicknamed the
""glutton for money" and is particularly critical of the government's
record,
namely: the disappearance of the railroads, the 28 million children who are
missed by the school system (out of a total of 34 million supposedly in
school), malaria, leprosy and tuberculosis rising to double digit rates,
spectacular increase in kidnapping, and importing 100% of the oil needed in
the country, despite the fact that the nation is the world's third largest
oil producer!"

Which is this example of democracy in action?

Nigeria...

The Precious Metal Set to Shine

2007-03-13T23:25:00.001-07:00

You would have to have been living on a desert island
for quite a long time now not to be aware that
something has been going on in the world of
commodities. Oil increased in price sevenfold between
1999 and 2006. Copper did almost the same in 4 1/2
years from its low at the end of 2001. The precious
metals have also soared in this new decade. Now it's
the turn of the grains, where wheat and particularly
corn have exploded higher on the US futures exchanges.

This has all given rise to much loose talk in
investment circles of a commodities super cycle which
will stretch several years into the future. But what do
people mean by a super cycle? Over the years some
economists have observed that there are phases of
economic activity, where waves of expansion and growth
are followed by slowdown and recession, and that these
phases can be quantified in terms of duration.

Kondratieff was probably the most famous exponent of
this approach in the 1920s, while in the US Dewey and
Dakin took up the theme in their book "Cycles – The
Science of Predictions" published in 1947. In both
cases, a long wave (or super cycle) is posited as
lasting between fifty and sixty years in which we move
from trough to peak to trough again. Within the long
wave there are deemed to be smaller waves, in which
activity ebbs and flows in briefer time periods. All of
these studies focused as much on the historical
analysis of commodity prices as on interest rates,
trade, inflation and the rest of the available
economic data.

The equivalent in the technical analysis of markets is
to be found in the wave theory of R.N. Elliott, in
which he breaks down the trends in bull and bear moves
into cycles that last from minutes through to decades.

Of course, the value of all these cycle studies lies in
their supposed predictive power. And here is where the
problems begin. Even as convinced a believer in the
commodity bull cycle as Jim Rogers points out that the
shortest boom lasted 15 years, while the longest lasted
23 years. His conclusion is that we have much further
to go, but don't expect a great deal more precision
than that. Oh, and don't forget that we'll endure some
huge corrections along the way.

The Chancellor, Gordon Brown, has of course famously
had his own problems in this area: he laid great stress
on balancing the books over the course of the economic
cycle only to be forced to change the starting point of
the current cycle from 1999 to 1997 in order to meet
this "golden rule".

In reality, all economic cycles and wave patterns are
best identified with the benefit of hindsight and
forcing current circumstances into some pre-ordained
mould will usually prove to be a pretty unrewarding
activity, and a dangerous forecasting mechanism.

What we can say is that there clearly are long-term
cycles and that they are driven by fundamental changes
in the world around us. Global wars, the industrial
revolution, major innovations in transport and
communications are just some of the factors that can
instigate long-lasting shifts in economic growth, that
in turn stimulate demand for commodities. Increased
demand drives prices higher while producers struggle to
increase the capacity to meet that demand. Ultimately,
prices peak when excess capacity has been developed –
the cycle is then completed when demand abates and
general surpluses force prices lower.

The big event of the moment is clearly China. I could
run through endless statistics indicating the dramatic
nature of the new industrial revolution that is taking
place there – its double digit annual growth rates, its
spectacular leap up the league tables to become the
world's fourth largest economy and so on. In focusing
on China, we shouldn't forget about India – it is the
second fastest growing major economy in the world, with
GDP growth up just under 10% - or Korea (up 5%) or
countless other booming countries. It's just that the
sheer size and scale of everything Chinese makes it
stand out and suits it to the role of representing the
emerging market economic boom as a whole.

The staggering numbers on Chinese economic growth are
matched by equally impressive figures in relation to
its consumption of commodities. The International
Monetary Fund reports that its share of the overall
growth in global consumption of industrial commodities
between 2002 and 2005 was massive – 51% for copper, 48%
for aluminium, 110% for lead, 87% for nickel, 54% for
steel, 86% for tin, 113% for zinc, and 30% for crude
oil. On the subject of oil, the Energy Information
Administration (the US government's provider of
official energy statistics) envisages a 47% increase in
global demand from 2003 to 2030, and that non-OECD Asia
(including China and India) will account for 43% of
that increase.

Frankly, all future projections are no more than
sophisticated guesswork, but what we can assume is that
unless the world economy really hits the buffers and we
are plunged into a global depression, the relentless
demand for industrial materials of all kinds from the
likes of China is set to continue.

We are still at the stage where supply is struggling to
match this huge increase in demand. If we take the
example of copper, only 12% of supply is generated by
recycling scrap, which means that 88% has to be mined
from the ground. Commissioning new mining production
inevitably takes years not months and in the lag we see
copper stockpiles around the world run down. Total
exchange inventories have fallen to under a quarter of
what they were four years ago, although this is above
the alarmingly low levels they reached in 2005. In
fact, the inventories held on the London Metal Exchange
and New York's Comex market are as good a guide to
ongoing tightness as you are likely to get, and
until they rise significantly the current phase
will not be over.

Although we are in a generally fundamentally benign
environment for the base metals markets right now and
will remain so for the next 3-4 years in all
probability, this doesn't of course mean that the
prices of these commodities will inexorably rise from
here. The dramatic rallies witnessed on futures markets
over the past few years have already discounted much of
the story. The news is well and truly in the price in
the case of copper: the steep parabolic rise,
culminating in the final doubling in price in the six
months to May 2006, has all the appearance of a
speculative bubble. We have already fallen from over
$4.00 per lb to a recent low of $2.40 on the Comex
exchange. That said, what had previously been a multi-
year price ceiling at around $1.60 per lb is still a
long way off and will probably prove a floor for the
foreseeable future.

As for the other base metals, aluminium peaked around
the same time as copper last year, and zinc has also
stalled for the time being; only lead, nickel and tin
are continuing the immediate surge higher.

Because it began its recent long-term rally at the same
time as copper and also peaked (for the moment) in May
of last year, it is tempting to put gold in the same
category as the base metal. Certainly the supply/demand
picture is similarly tight: mining produces around
2,500 tonnes per annum, while demand is running at
around 3,500 tonnes per annum. Scrap and central bank
sales make up the shortfall. However, there is one
crucial difference between the two metals, as the CEO
of the World Gold Council reminded us in the Financial
Times in early February: only 11% of gold demand comes
from the industrial and dental sector. This means that
89% of gold demand represents discretionary spending.

The jewellery business accounts for the lion's share of
this, general investment demand the rest. Not
surprisingly, the appetite for gold jewellery is
strongest in those traditional regions – India, the
Middle East and East Asia – which are currently
booming. It shows no sign of abating and underpins the
market. What will put the icing on the cake and push
gold prices on through last year's highs is the general
investment demand side of things. Low real interest
rates, persistent US dollar feebleness and the need for
asset diversification will continue to create an
attractive environment for speculation in the yellow
metal, while new mechanisms such as ETFs will make it
ever easier for the less sophisticated investor to
access the market.

Although gold has enjoyed a very good rally, nearly
trebling in price off its 1999 lows, it has not matched
the sevenfold move in copper, and the thing about these
major cycles is that they always overshoot in value
terms and end with a climactic bang, not a whimper.

In sum, unless the global economy hits the skids
dramatically, it is likely to take another 3-4 years
for supply to catch up with demand for industrial
commodities. This should put a floor under the price of
base metals and maintain a secular bullish environment,
even if some - like copper - may have discounted much
of this positive outlook already. Right now, the best
opportunities are in the precious metals, where gold
could easily top $1000 an ounce, and would need to
reach around $1700 an ounce to match the recent
performance of copper.

Regards

David Guthrie
For The Daily Reckoning ---------------------
Bill Bonner in Paris:

What gives?

After the mini-crash two weeks ago, we expected some hot action in the
financial markets.

Instead, investors – who had been shaken out of their torpor by plunging
stock prices worldwide – hit the snooze button again, rolled over, and went
back into dreamland.

Why not? The news at the end of the week was soothing enough. Employment was
up. Payrolls were up. A report from the Feds said that the trade deficit was
supposed to have narrowed January.

The Dow lifted slightly. Gold held over $650. The dollar stayed about where
it was and where it has been for a long, long time – at $1.31 per euro.

And so another week ticked by...the National Debt crowded up against the $9
trillion mark...and approximately another $2 billion of U.S. assets slipped
into foreign hands.

As to the former number, we were tempted to put a capital T on the trillion
but decided against it. It needs no additional emphasis. The biggest pile of
money ever put together in the history of the planet is now owned by people
who call themselves communists. It is just a little more than $1 trillion –
most of it in the form of claims against U.S. assets (dollars). But the U.S.
federal government owes 9 times that amount, about half to the public...of
which more than half the owners are foreigners.

The interest on the part in public hands alone comes to $240 billion per
year – or 11% of tax receipts. It is expected to double in the next 10
years...in 33 years it would take 100% of the entire federal budget.
Obviously, that can't happen. The U.S. government would be out of business.

Instead, something's gotta give.

But even though something's gotta give it doesn't mean that something's
gotta give right now...and it doesn't mean that the majority of investors
will not act like nothing's ever gotta give...right up to moment when all
Hell breaks loose.

Take the U.S. mortgage market...please. Something had to give there too, but
that didn't prevent a lot of very smart people from lending money right up
to the moment when they heard the subprime bumpers crunching up against the
foreclosure concrete.

And even then...the experts rushed to tell us that the damage would be
minor. We have our seat belts, our air bags, they said – go back to sleep.

Less than two weeks ago, Scott Coren, an analyst with Bear Stearns, wrote
clients that New Century Financial was not a bad buy at $15, since the
lowest it could go was about $10 in "a rescue-sale scenario."

But what's this? The stock traded last week down to $3.21. When something
finally did give at New Century, where were the rescuers?

The entire U.S. mortgage market is worth $6.5 trillion
- more than the US. Treasury market. Something seems to be giving in spades,
but where are the rescuers?

"Already, more than two dozen mortgage lenders have failed or closed their
doors," reports Gretchen Morgenson in the International Herald Tribune, "and
shares of big companies in the mortgage industry have declined
significantly. Delinquencies on loans made to less creditworthy borrowers –
known as subprime mortgages - recently reached 12.6%. Some banks have
reported rising problems among borrowers who were
deemed more creditworthy as well."

About a third of all mortgages written last year were 'subprime' – a share
that has tripled in the last 3 years.

When you make so many loans to so many people who can't pay you back,
something's gotta give sooner or later.
Now is as good a time as any.

More news...

------------------------

Adrian Ash, on another cloudless day in Hammersmith:

- Government meddling and crack cocaine have so much in common. It's a
wonder New Labour doesn't claim credit for the booming market in celebrity
rehab!

- Both are just one step away from what's already accepted and practiced –
running the country for government, snorting cocaine amongst middle-class
party goers. A little of either sounds like fun at first too.

- But the real cost of both meddling and crack always turns out to be far
greater than anyone dares to guess at the start. And once you've begun –
meddling or toking alike – it's just so hard to stop. Take the UK housing
market, for instance.

- By 2006, average house prices in Britain had more than trebled inside 10
years. The buzz felt so good, no one worried about who'd pay for the next
hit. All the cash unleashed by mortgage-equity withdrawal helped avoid
recession in 2001. The bubble also made for great slogans at election time.
What a rush!

- Even New Labour, however, could spy the problem with runaway inflation in
the nation's right to own the upkeep costs of bricks-and-mortar. First-time
buyers couldn't afford to buy. Like sunken eyes and an outbreak of acne, it
gave the game away.

- Worse still, nurses and firemen kept popping up on the telly, complaining
that they'd been disenfranchised by New Labour's home-owning democracy. They
had to live in Swansea and commute if they wanted to work in London!

- Something, as ever, had to be done. So New Labour rolled up its sleeves
and stuck its fist into the market, right up to the elbow. Grabbing the bull
by the horns, they pulled out a radical answer – use taxpayers' money to
prop up the lower-end of the market!

- "HomeBuy helps people who wish to buy a property but cannot afford to,"
explains the eponymous website. It also helps "those who wish to rent but
cannot afford to pay market rents". Letting the market set going rates is
such an old-fashioned idea, after all. Why leave first-time buyers to wait
for a pullback in prices?
Invite lower-income families to buy only half the flat they fancied. Get
taxpayers to stump up for the rest. Simple!

- Half the mortgage meant half the mortgage repayments, creating twice the
purchasing power. It also meant twice the upwards pressure on prices, too.
But market dynamics are beyond New Labour, remember. If Gordon Brown ever
thinks about market forces, it must be to proudly smile at the fact he's
abolished them – along with the boom-bust cycle in the economy.

- Open Market HomeBuy...New Build HomeBuy...New Build discounted
rent...Social HomeBuy...First Time Buyers Initiative – all such lovely,
friendly names. Trouble is, the scheme's advantage to new buyers has already
been parsed to nothing. The extra buying power that HomeBuy pumped into the
property market evaporated in the steamy heat of Britain's lust for bricks
and mortar.

- Now public-sector workers in shared ownership schemes say their rents are
rising at twice the rate of their salaries, according to Radio 4. Nurses in
one London development have seen their rent – tied to the old Retail Price
Index (RPI) – rise by 5.5% year on year.
Their salaries, on the other hand, are pegged to the Consumer Price Index
(CPI). So wages are only rising by 1.9%.

- "I'm paid by the government and this is also a government funded scheme,"
said one South London nurse to MoneyBox on Saturday. "My rent continues to
rise but my salary doesn't reflect that."

- Welcome back to the free market, in other words. For the scheme to keep
bringing fresh meat into the market, the government will have to increase
the proportion of purchase-price that it's willing to cover. The equity
owned by wannabee buyers, therefore, will have to shrink. It's already
happened to Social HomeBuy, for instance. The government will now buy 90% of
a council house from...ummm...well, from itself...leaving the tenant to buy
just one tenth of the roof over their head. You might wonder why they'd
bother.

- Meantime, the cost of buying your own home just keeps on soaring, up 10.9%
year-on-year in January, according to the government's own data today, up
from 9.9% in December. The average British pile now costs £205,286.

- Something should be done, right? "I think housing is probably as important
an issue now as it was in 1945,"
says Labour chair Hazel Blears. "Ordinary families are quite aspirational.
They want to own their own home and it is becoming more difficult."

- Her answer, of course, is more meddling...just like a crack addict whose
answer to suffering withdrawal is to buy yet more rocks.

- "Being more imaginative about shared equity, shared ownership, and staying
on the side of those people who want to do well, is where the Labour Party
has got to completely anchor itself," says Blears, lashing herself to the
mast instead.

- Dabbling with socialism, kids, puts you on a slippery slope. Just say no.

And more views:

*** Subprime may be suffering, but speculators still think they can make
good money buying and selling houses.

Our colleague Lila Rajiva sent us this item from the net. Apparently, a
group of investors has made a tour of Jackson, Mississippi, buying up
distress properties:

"On February 16 & 17th we made history with the first ever TWO-DAY
Mississippi Magic Bus Tour. During those two days more than 28 houses were
sold to investors from all corners of the United States. The prices were so
low that most participants bought 2 or 3 houses.
Unfortunately, snow storms and bad weather kept about 10 of our buyers from
making the trip in February.

"Our estimates are that the buyers of these houses picked up in excess of
$829,000 in EQUITY in just TWO DAYS!

"This could be you!

"Here's one example. There was stiff competition for a great corner house
that bidding started at $9,900. It sold for $25,000 and has a retail value
of $59,000. The amazing thing about this property is that it only needed
about $3,500 in repairs and it's ready to go!
That's just one of the many, many great deals we had on the Mississippi
Magic Bus Tour.

"These are the GREAT kind of deals you can get in Jackson Mississippi when
you attend a Mississippi Magic Bus Tour!

"Some of these houses make great rentals. Some of them are ideal for a
buy/fix/sell strategy. Either way, they are ALL Super Cheap Houses!

"If you're sick and tired of trying to find a good deal in your own
backyard, maybe it's time to look someplace else. We've found all the BEST
deals in Jackson so you don't have to spend a fortune on marketing or making
trips back and forth.

"We've got the deals. We've got the contractors lined up and ready to fix
your purchases. We've got property managers ready with tenants. So it's an
easy decision.

"Join us on April 6th and 7th for another fun and profitable TWO-DAY
Mississippi Magic Bus Tour. We'll have at least 26 - 28 houses available for
you! You can be sure we'll throw in a surprise or two....

"There's no other opportunity available like this anywhere!

"The prices are so low, you'll probably want to buy 2 or 3 houses, maybe
more. These Super Cheap Houses deals are the BEST DEALS we're ever had on
ANY Magic Bus.

"To get on the Magic Bus, go to:

http://www.SuperCheapHouses.com/magicbus

"DO IT NOW!

"There's only room for 30 buyers on the Mississippi Magic Bus and it WILL
sell out quickly

"You can get on the TWO-DAY Mississippi Magic Bus Tours for one low
registration fee of $500. The fee will be applied towards the first house
you buy. If you don't buy anything, $400 of your money will be refunded.

"If you're not coming to buy, don't bother coming! We want serious buyers
who can make a quick decision.

"We will have appraisals on each property. We have contractors standing by
ready to do any work that needs to be done. We have property managers ready
to fill them up with good tenants. And... we've got financing available if
you need it for each property!

"Making money with real estate just does not get any easier than this!

"Sign up for the Mississippi Magic Bus NOW at

http://www.SuperCheapHouses.com/magicbus

"To Your Extreme Success,

"Jackie Lange

"p.s. A new rule for this Mississippi Magic Bus Tour.
We will no longer be able to allow flipping of contracts during the Bus
Tour. You will need to close on your purchases before you can sell to anyone
else. We're sorry for the inconvenience but we had some problems with this
on a previous Bus Tour and had to put a stop to it."

Editor's Note: Yes, dear reader, we are all on a magic bus ride now.

*** We enjoyed some early spring weather in France over
the weekend. Henry had to stay in Paris to study for
exams, but the rest of us got in the car and drove out
to the country.

Plum trees are already ready to burst into flower.
Forsythia bushes are yellow, though not fully in bloom.
Other fruit trees and flowering bushes are budded out.

"What's that awful smell," Elizabeth wanted to know. It
smelled like something dead in the kitchen. Sniffing
around, we realised that it came from the home-cured
ham hanging from the ceiling. It turned out the ham was
not as cured as we thought.

The rot was around the bone, where the meat had turned
gray, green and putrid.

"I left the bone in," our gardener explained. "Because
it gives it more flavour. But it's true that most
people take the bone out, because it often makes the
meat go bad."

We aired out the house...and it was so warm and sunny
we were able to eat lunch outside.

"Springtime in Europe is nicer than it is in America,"
Elizabeth remarked. "It is a longer season. It happens
more slowly, more grandly...and you have more of an
opportunity to appreciate it. In Maryland, it would get
hot so soon after the daffodils bloomed. The spring
plants didn't last long in the heat.

"But autumn is prettier in the U.S. The fall is crisper
in the U.S...especially up in New England. The leaves
turn more vivid colours.

"Maybe – after the boys are out of school – we should
spend spring in Europe and fall in America?"

Editor's note: David Guthrie is an investment analyst
with specialist interest in commodities, currencies and
interest rates. It first appeared in The Zurich Club

Alpha, Betas, Scamps and Scalawags: Planet Money, 2007

2007-03-09T06:17:00.000-08:00

Alpha, Betas, Scamps and Scalawags: Planet Money, 2007

Probably the greatest disappointment to a modern man over the age of 50
comes when he looks in the mirror.

We say that not as a man who has just had his vacation in a bathing suit,
but as one who has spent the last couple of days reading the financial
press. The two are alike in that every time you look the picture seems to
get worse.

A brief summary of the sub-prime industry's business
model: There is a market, lenders noticed, of people who cannot afford
houses and do not qualify for the credit necessary to buy them. On the
surface of it, lending money to these people does not seem like a business
you would want to take up. But 'sub-prime'
borrowers could be decent fish, the sharks reasoned, as long as they could
make the mortgage payments. The quants did the math. The strategists looked
ahead. Even if the occasional client couldn't pay up, they had the rising
housing market to lift the value of their collateral. And so, a go-go new
financial industry got going...and pretty soon, its hustlers and
entrepreneurs - like the whiz kids of the dot.coms who preceded them
- were driving Ferraris and drinking Chateau Petrus.

The Orange County (California) Register:

"For Kal Elsayed, a former executive at New Century Financial, a large
lender based in Irvine, California, driving a red convertible Ferrari to
work at a company that provided home loans to people with low incomes and
weak credit might have appeared ostentatious, he now acknowledges. But, he
says, that was nothing compared with the private jets that executives at
other companies had.

"You just lost touch with reality after a while because that's just how
people were living," said Mr. Elsayed, 42, who spent nine years at New
Century before leaving to start his own mortgage firm in 2005. "We made so
much money you couldn't believe it. And you didn't have to do anything. You
just had to show up."

It was this last line that caught our attention and triggered our
disappointment. It reminded us how each generation of geniuses are later
unmasked as frauds and fools. It reminded us too of what weak-minded
simpletons we humans are; we are always falling for our own line of guff.

Modern Homo Sapiens Economicus believes in capitalism.
He believes in it as he once believed in the Holy Trinity or the Virgin
birth - as dogma. And so, he takes up its tenets and excesses without
question or arriere pensees. And, he makes as big a mess of it as his
ancestors did of the Crusades.

This is as true of the lumpen as it is of the masters of the universe.

Recall Henry Paulson's soothing words:

"Credit issues are there, but they are contained," the U.S. Treasury
Secretary said to reporters in Tokyo during a four-day tour of Asia. The
U.S. financial sector is healthy and most institutions won't feel "a big
impact".

But a big impact is just what institutions feel - after they have flapped
their wings and taken to the air.
Typically, they come down with a thud.

The geniuses packaged, bought and sold sub-prime debt right until they heard
the crashing noises. They believed the credits were good as long as
homeowners could make their payments. And they saw no reason why homeowners
wouldn't be able to make their payments as long as they had jobs. That was
their line of guff; and they believed it. In a world of full employment
there was no reason for the mortgages to go bad - in theory. But theories
arise as needed when there is a sale to be made.

The theory was that low interest rates were giving a whole new group of
borrowers' access to credit. The reality was that what made credit available
to un- creditworthy borrowers was the kind of corruption that wishful
thinking hides but mirrors...and history...reveal.

"What drove the housing-led cycle was not as much the cost of credit," notes
Merrill Lynch's David Rosenberg, "but rather the widespread availability of
credit - irrespective of your FICO score [a measure of your ability to
repay]...only a third of the parabolic run- up in the home price-to-rent
ratio was due to low interest rates. The other two-thirds reflected other
non-price influences, such as lax credit guidelines by the banks and
mortgage brokers."

Now, despite 4.6% unemployment and a 4.7% yield on the 10-year Treasury
note...the sub-prime lending business is crashing and burning. From Orange
County comes news that the aforementioned New Century Financial is trading
below $5 a share...a precipitous fall from its high of $66 in December of
2004. At today's price, in theory, the Golden State lender must be the
bargain of a century, with a dividend yield of 167%. But, again, the reality
is different: the news report also tells us that the company may be forced
into bankruptcy.

While the sub-prime lenders are being pulled from the wreckage, the
super-prime borrowers are still flying high. In theory, hedge funds charge
extraordinary fees for extraordinary performance - 2% of capital and 20% of
performance. For what? To return to the Greek alphabet, for helping
investors get 'alpha' - a rate of return above and beyond 'bet', which is
what the general market produces.

Warren Buffett, probably the greatest investor who ever lived, says the
whole idea is "grotesque". In last week's letter to shareholders, he
explains that you can invest in his "hedge fund", otherwise known as
Berkshire Hathaway, and pay no management fees at all.

The compounded average annual gain of Berkshire Hathaway from 1965 to 2006
is 21.4%. What does the average hedge fund get? In 2006, hedge funds
produced a 14% return, almost doubling the 7.6% of 2005 and better than the
10% they did in 2004. Over the longer run, hedge funds show an annual return
of about 7%.

Mark Gilbert, summing up for Bloomberg News, concludes that hedge funds
"levy outsized fees on the pretence of generating tons of clever alpha, when
they are really just seizing the beta available to anyone".

In other words, in practice, the hedge fund managers, like the dot.com
entrepreneurs and the sub-prime lenders, are not really geniuses at all.
They make their money just by showing up...just like everyone else. And they
get the same rate of return. Or worse.

Many funds and hedge funds jumped into Japan after that market went up 40%
in 2005. The following year, 2006, was disappointing. The Nikkei Dow rose
barely 4%. How did the hedge funds do? As Merryn Somerset Webb reported
last week, "far from proving their ability to make absolute returns in any
market conditions, [hedge funds] did particularly badly; they all fell
between 5% and 20% over the year."

Sub-prime lenders did not hedge the risk inherent in lending to weak
borrowers. Instead, they sought it out and leveraged it up. Hedge funds seem
to have done the same thing - reaching out a little too far in order to grab
a few extra points of yield. Now, we wonder who owns the $23 billion of New
Century Financial debt...and who owns the rest of the debt in the sub- prime
area? We wonder too, who owned the $2.5 trillion worth of equity value that
disappeared last week?
Surely, there's some more 'big impact' lurking out there...still waiting to
hit someone.

We look in the mirror and hope it isn't us.

Regards

Bill Bonner
The Daily Reckoning
Bill Bonner in Paris:

"It seems I have a yen to lose..."

Carly Simon

Viva Recklessness! Long Live the Prom Queens!

Today, the significant news is that the European Central Bank has raised its
key lending rate to 3.75%, warning of growing inflation.

That puts exactly 325 basis points between the yen and the euro. A
speculator can still borrow in yen, convert to euro, and lend the money out
- pocketing 3.25% of gross margin yield. Using leverage unwisely he can
leverage that return up to the point where he is almost sure to go broke.

The yen carry trade lives on!

But we are not high rolling international speculators here at the Daily
Reckoning. We are low-rolling, stay- at-home plodders more interested in the
return on the local Laundromat than on yen carries.

Still, there are butterflies flapping their shiny little wings all over the
world of finance. One of them is bound to send shirt tails flying somewhere.

And thus begin some rambling reflections fit for a quiet Friday morning.

If investors think they can make money by investing in euros they should
look at the New Zealand dollar. The Kiwis raised their rates too - citing
the same zeal to declare preemptive war on inflation. The gap between a
short yen position and a long NZ$ position is precisely 700 basis points.
That looks like easy money to us...as long as nothing goes wrong.

And nothing ever goes wrong...until something goes wrong. We had our eye on
the yen, because we saw it as something that probably would go wrong. At
some point - perhaps last week - investors were bound to get a little
nervous. When they got nervous, we reasoned, they would make haste to exit
their risky speculations.
Since they are overwhelmingly short the yen, they would necessarily have to
buy it back in order to unwind their positions. This would force the yen to
rise.

And the yen has been going up. If it continues upward it will both signal
the demise of the carry trade...and bring it about.

The math is elementary. Let's say you have $1 million you want to put into
this play. You leverage it up to borrow $10 million in yen. Then you invest
the $10 million in NZ dollar bonds. If all goes well, in raw numbers, you
make $700,000 in net yield - or 70% or your original investment.

But what if it is the yen that goes up 7%? Ai yi yi...that's $700,000 more
that you have to pay back.
Now you've lost 70% of your original investment.

Yes, dear reader, it is a wicked, treacherous world, although no one else
seems to notice. While we still fly our 'Crash Alert' flag...and while the
world lost
$2.5 trillion in equity value last week (before recovering some of it)...and
while the yen rises ominously...we see few signs that investors have gotten
the message. Most think that today's gush of liquidity will gush on forever
and that today's investment sweethearts - stocks, bonds, art, property -
will remain prom queens forever. Eternally young.
Forever beautiful. Oh, dear reader...if only it worked that way!

And here we let you in on a little secret.
Pssst...don't tell anyone...but stocks are going to sag and fall. Especially
those cute little Asian beauties.
Bonds too. And art? Today's belles will be yesterday's news...rejected,
ignored, neglected - like the prom queen's mom!

Even housing will fade and fall out of fashion. It's already happening.
Quietly, prices are being cut...while mortgages go bad. It may not yet be
the end, nor even the beginning of the end, but it is surely the end of the
beginning for America's housing boom.

Our old friend Marc Faber says he's lived through four MAJOR financial booms
in his lifetime. There was the boom in commodities and precious metals in
the '70s...then the boom in Japanese assets in the '80s...then the mania in
emerging markets in the '90-
'98 period...and finally, the bubble in tech and telecoms in the '90- 2000
era. During each one of these booms people thought the good times would last
forever, 'because there was so much new money coming in'. Today, that is
just what people say about China, art, London property - and stocks and
bonds, generally. But each bubble popped...and its brightest stars - its
alpha companies...its go-go market leaders...its prom queens...and its
celebrity kings - all quickly vacated the headlines. When they reappeared in
the news, it was in the fine print... that is, in the notices for workout,
refinance and chapter 11.

More news:

------------------------

>From Dan Denning in Melbourne, Australia:

*** "Invest for the long-term." "Diversify." "We are in a period of Great
Moderation in volatility, so don't panic."

- The short version of today's post is that you should probably ignore all
the soothing platitudes about investing for the long-term. No one has ever
proven that an entire generation can retire by treating the stock market
like a savings account. With no evidence that it's ever been true, we have
no reason to believe this time will be any different. It's a big gamble to
take with a life time's worth of capital at stake. But it should be fun to
watch!

- Our suggestion is to panic now and avoid the rush later. Soothing axioms
barely disguise the truth that markets today are more volatile, not less,
and that what you saw last week is a taste of what you'll have to get used
to from now on. Depending on the goodwill of "the market" to see you through
to retirement is like depending on the goodwill of a cannibal to not to eat
you once he's got you in a boiling pot. A cannibal can't help what he is.
And the market can't help doing what it does best, separating a fool from
his money.
There are millions of fools out there, although some are bigger than others.

- "An investor's two best friends," writes American financial guru Ben
Stein, "are time and diversification. Get the broadest possible market
indexes. Spread yourself out over large and small caps.
Have a large dollop of the developed foreign and a goodly chunk of the
developing market. Yes, it'll be a rocky ride in China and Brazil, but over
long periods you'll do great.

- Exactly what portion of your portfolio is a dollop?
How do you tell a goodly chunk from a badly chunk? And over the long-term,
aren't we all dead?
- We don't mean to be petty or quibble. But man, if anyone walks into the
Old Hat Factory and starts mentioning the word diversification as a
bear-market survival strategy, he had better duck. There will be coke
bottles and curse words flying, unless he can explain himself, and quickly.

- Here's our beef with the word: the idea of diversification is based on the
existence of negative correlations between sectors or asset classes. When X
zigs, Y tends to zag. And diversification makes sense if some things go up
while others go down. And it used to be that some things went up while
others went down.
Bonds went down in inflation, commodities up. Cash is more valuable when the
money supply shrinks. Shares and property don't always move in tandem.
Emerging markets move up faster in bull markets than blue chips, but fall
faster in bear markets.

- Pre-Greenspan, there were certain inter-marker relationships that made
sense and that you could prove with real performance data. There were, for
example higher yields on foreign markets and emerging market bonds than on
U.S. savings bonds. Perhaps it sounds naïve today, but those higher returns
- those risk premia - were the reward you got for taking a bigger risk with
your capital. If you wanted a safe savings account, you weren't going to
make much money in it, maybe a few percent above inflation. But if you were
willing to buy Brazilian stocks or Icelandic bonds, well that was another
matter entirely. You might be crazy. But you might also be right. And you
deserve an extra few hundred basis points for being crazy, brave, and
correct.

- But for the last four years, risk premia have nearly vanished. These days,
everyone is crazy, no one is brave, and many people are wrong. We say no one
is brave because bravery requires some knowledge or appreciation of the
nature of the risk you're taking.
Yet no one seems to think investing in shares is all that dangerous.

- "Corporate balance sheets are in good shape. There's been a sustained
decline in macro-economic volatility over the past decade, thanks to
structural changes that have improved the ability of economies to absorb
shocks and better monetary policy. It is, as then-Federal Reserve Governor
Ben Bernanke said in 2004, the era of "the Great Moderation". Such an
extended period of calm probably explains investors' bold, risk-happy
behaviour," writes Corinne Lim in today's Australian Financial Review.

- Such an extended period of calm usually precedes all hell breaking loose.
Stability breeds instability, as economist Hyman Minsky famously pointed
out. There has been a ton of breeding going on in the last few years.
We saw the first birth-pangs of instability last week.
But not the last.

- All of this happens for a simple reason, there is too much money chasing
too few assets. This doesn't mean the risk has vanished from certain types
of assets. It just means you no longer get compensated for taking it, which
seems like a bad bet to us. And with money charging around the globe buying
up things willy nilly, the art and science of valuation itself appears to be
temporarily worthless.

- Can diversification save you? What does that word even mean in a world
flooded with liquidity and cheap money? How is it possible to truly
diversify in a market where there's so much money chasing so few stocks that
everything is going up regardless of traditional methods of valuation?

- If diversification is based on the observation that some asset classes are
inversely correlated (that x goes up when y goes down and y goes up when x
does down), what happens in a liquidity-driven market (say one where super
contributions are increasing while the supply of assets is not)? When all
asset classes start moving up because of excess liquidity, there is no
longer any negative correlation. X and Y move up along with A, B, C, D, E,
and F. And they all move down at the same time too, right?

- How, then, is it possible to structure a portfolio in the modern world
where you are compensated for the decline in one asset or sector with the
rise in another? With everything rising in lock-step over the last few
years, isn't the risk now that everything will fall in lock-step too?

- No! We read that real diversification is possible, but at a price, in an
article called "Special strategies come at a high price," by Jonathan
Barrett in today's Australian Financial Review. To achieve it, you must
expect to pay a 2 per cent fee, an adviser trailing commission of 0.3 per
cent, and an annual management fee of 1.85 per cent. And for that pretty
penny you will buy a fund which, "has the potential to generate positive
returns in market conditions that are adverse to traditional asset classes,
thereby providing diversification benefits within higher risk traditional
growth portfolios" says firm Researcher Lonsec.

- Also featured in the article were steps on how to eat chocolate without
getting fat, cheat on your taxes without getting caught, and make more money
by doing less work and drinking only single-malt scotch for breakfast and
lunch, and red wine for dinner.

- Does anyone really believe this anymore, that you can generate positive
returns in market conditions that are "adverse to traditional asset
classes," without taking more risk? How exactly would that get done? What
non- traditional asset classes out-perform when stocks, real estate, gold,
oil, and bonds are all getting hammered?
Figurines? Pin ball machines? Does e-Bay count as an asset class?

And more views from Bill:

*** "You're wrong about that," said a new friend earlier this week. Paul
Tustain runs something called BullionVault.com. It allows investors to buy
gold at the lowest-possible markup and store it at the lowest- possible
price.

We replied that we knew a cheaper way to store gold - simply bury it.

"Not a good idea", he replied. "You are either storing it so that you'll be
able to make a profit on it when it goes up in price...or you're storing it
for when society breaks down and you really need cash. In either case,
you're better off storing it with a reputable, reliable storage company -
like Brinks - where the chain of title is clear. If you want to sell it, you
can sell it at a better price and without ever touching it.

"And if you think you'll be better off with coins in your hand, I have news.
I met a guy who'd gotten his family of Iraq. He was trapped in a remote area
and needed to buy supplies and transport from the locals to get across the
border. He had gold coins so he thought he would be all right. But they
didn't want gold coins.
They didn't trust them. They wanted dollars. He had to sell the coins at
huge discount...and he said he felt lucky to get out at all.

"Today, not many people will recognise a gold coin. In extremis, you might
be able to use a coin to buy a loaf of bread, but you'll get much less for
your coin than it is really worth."

*** Last week, one of the biggest jackasses in the U.S.
Congress took his leave of the free parking, free travel, and luxury dining
facilities provided at the capitol and checked in to the more Spartan
comforts of the federal pen in Morgantown, West Virginia.

The crime that landed Bob Ney in the hoosegow was conspiracy and making
false statements in the Jack Abramoff Indian lobbying scandal. But what gets
him notice in these pages is his meddling with the menu at the Capitol Hill
eateries. Readers will recall the occasions. It was when George W. Bush made
known his intention to invade Iraq and French president Jacques Chirac
shrugged, 'Not a good idea,' adding that it would probably turn into a
bloody mess.

If they had had any sense, the jacks and the knaves running the U.S. at the
time would have thanked the French - who have far more experience fighting
Arab insurgents than we have - and side-stepped the calamity. (Footnote: It
was not the first piece of good advice from the French. When the Kennedy and
Johnson administrations were gearing up for war in Vietnam, Charles de
Gaulle advised against it. There too, France had just had a recent and
sobering experience.
'You'll never win in that rotten country,' said the French president.)

Nonetheless, the Bush administration thumbed its nose at Chirac and rolled
out its campaign of shock and awe - with the results we see in the daily
papers today.

But the aforementioned Mr. Ney took the French demeure particularly hard. It
seemed to stick in his craw. So, he ordered the lawmakers' restaurants,
cafeterias and snack bars to halt all reference to 'french fries' or 'french
toast.' That would show 'em!

He announced: "This action today is a small, but symbolic, effort to show
the strong displeasure many on Capitol Hill have with our so-called ally,
France."

The poor buffoon. What's a friend for...except to try to stop you from doing
something stupid?