Schumer tells the Saudis.. something he'll apologize for

Senator Charles Schumer is trying to threaten OPEC, and Saudi Arabia in particular, to get them to sell America cheaper oil.

“The Saudis have to understand this is a two-way street. We provide them weapons, our troops provide them protection, and then they rake us over the coals when it comes to oil.”— Schumer

Wow. Schumer is threatening the Arabian oil producers. The whole thing about protecting them with our weapons and troops sounds just like a mafia shakedown, with the thing about our troops being already there. Amazing. Doesn't he know that most Saudis hate the fact that US military “protects” them? Does it occur to him that Saudi Arabia could trade American protection for Chinese and Russian protection?

Doesn't he know who recently bailed out America's investment banking system? Among the participants of Citicorp's private offering of convertible preferred securities are the Kuwait Investment Authority, and His Royal Highness Prince Al-Waleed bin Talal bin Abdul Aziz Al Saud (see Citi's own press release). Mr. Al-Waleed bin Talal is a member of the Saudi royal family, and one of the world's most successful investors.

The senator from New York, of all people, should know what's going on on wall street. He should know who now controls the huge money center banks. The large investment banks' recent preferred stock offerings were no ordinary stock offerings. These were last ditch efforts to re-capitalize America's banking infrastructure. If these offerings failed there would have been a global financial collapse. So, know that the rescue money from the Arabs did not come without conditions, far on top of the 7% coupon the preferred shares pay. The first condition would be “we control the oil now”.

An article that expands on Schumer's assumption that America can still prevail as a superpower, and gives a somewhat more logical and reasoned framework, was published last week by Chile based market analyst Clive Maund: Powerful Bullmarket In Us Stocks Looms As The Us Prepares For Global Hegemony.... Maund basically says that America now has control of Iraqi oil (because of it's permanent military installations), and, in addition, will soon secure Iran:

“The oil reserves contained within Iraq are gigantic, and thus its acquisition was a major economic and security leap forward for the United States. In addition its central position within the region and the earlier acquisition of Afghanistan make the eventual appropriation of oil-rich Iran an almost foregone conclusion... At present the US is only militarily the greatest power on earth, but in a few years it looks set to assume comprehensive hegemony of the planet, as the massive oil revenues from the spoils of the Mid-East campaigns flow in and correct the careening deficits. China will then comply with US demands or the oil tap will be swiveled in the off direction. Russia, currently blessed by an abundant supply of oil and other natural resources, should do well, but will be surrounded and eventually forced into compliance as its resources dwindle and it becomes increasingly isolated. Britain, as the 1st officer of the US in its wars of acquisition, will enjoy a privileged place at the table in an increasingly resource starved world. Israel will look on with quiet satisfaction at all of this.”

This is a fascinating thesis, and one that I disagree with. America had global hegemony. That ended last year when it became apparent that the USA is essentially insolvent. We simply don't have the time to get out of this: a domestic shitstorm of housing collapse, energy shortage and capital crises are slamming us concurrently. Far from expanding our influence in the Persian Gulf, I think we'll be forced to withdraw. Jim Willie has made a prediction on how the showdown would occur: a demonstration of Iranian firepower via a Russian Sunburn cruise missile.

“The Iran wild card cannot be dismissed. A casual observer might believe the United States Military eagerly desires an incident, even with loss of US soldier lives, provided a cause for war is achieved with Iran, for some greater good not easily understood. So far Tehran has not bitten the bait. In the wings is Russia, quietly in control of European energy supply and eyeing its odd bedfellows among the ruling mullahs. Hidden in the hills and along the shore of the Persian Gulf are oodles of Sunburn missiles, supplied by Russia, installed by Iran, aimed at US warships. The Sunburn is one generation ahead of the Tomahawk Cruise missile in the US arsenal, capable of evasive maneuvers. ”

A sunk aircraft carrier would be a convincing demonstration of power. Naturally such a blow would not go unanswered. Iran would suffer some terrible attack with probably far more loss of life. But the American generals know, as do the Iranian, Russian, and Chinese generals, that America can not prevail. With a depleted military, and without the capital to re-fit and re-build, America can no longer use its military to seize the remaining great oil prizes. Weapons and ideology can start wars, but only fuel and capital can win them.

Fortunately it need not come to warfare. The Chinese could use discreet diplomatic and financial threats to steer us away from the path of global hegemony, even though that is America's natural default stance. We'll just have to spend the money on something boring, like building public transportation. We should mention it to Schumer one of these days. And next time New York needs a little cash he might be saying “sorry!” to His Royal Highness Prince Al-Waleed bin Talal bin Abdul Aziz Al Saud.

Lessons of the Russian Ponzi scheme

This is how Wikipedia describes the Russian financial crisis of 1998:

“Prior to the culmination of the economic crisis, the GKO bonds (Russian treasury bonds) issuance policy was similar to a pyramid, or Ponzi scheme”.

A Ponzi scheme! How America gloated in 1998 at the victorious end of the cold war. We were flush with pride over the beautiful new internet, and the stock market was soaring. But America, having gone a little overboard on internet frenzy, and hoping to pull off something bigger and better, soon built the most spectacular Ponzi scheme the world had ever seen: the housing and mortgage bond Ponzi. A Ponzi to end all Ponzis.

The thing that finally drove Russia into insolvency was a peculiar problem: oil was selling too cheap. It was essential to government revenues. Now people want Russia to increase oil production for the convenience of American drivers. If Russia (or the Arabian nations) increased production, the price of oil will go down. Why would they do that? Earth to America: nobody owes you any favors. It is America that owes.

A few weeks ago I wrote that when the treasury bill market finally softens, it will be “game over” for the Fed. A strong treasury market is the only thing that is maintaining the illusion of American solvency right now. I was thinking the treasury might start to turn over in November or December (08). But almost as soon as I wrote it, the treasury chart started to look a little softer:


Well a little softness in the very strong treasury is not going to crash the dollar — yet. But what would happen if it decisively broke down out of its up-trending channel? Suppose it went into a secular bear trend, chasing the dollar to the bottom? There would be a stampede out of treasuries, that's what. We'd blame the Chinese, naturally. “Economic Warfare”, we'd shout (although American hedge funds would be selling too). The Persian Gulf states would finally give up on us. They would try to separate their economies from ours. The only question is what sellers of treasuries would buy? Euros? Rubles? Gold? All three, probably.

Don't forget that the yield on a bond moves inversely to the price. A falling price makes the yield on a bond rise. And how would an insolvent USA pay the increasing interest on its debt? Simple: not for very long. The point will come, maybe within a year, when America defaults on its debt. Just as Russia did in 1998, as a result of its own top heavy financial system, America will default. That will be the final, ignominious end of a spectacularly successful era of American history, and it's sudden collapse. Maybe it will also be a beginning? I hope so.

And now for copper's turn

I don't know if other people find commodity prices as fascinating as I do, but that's why I blog after all. This chart of copper is very interesting:
Copper seems to be trying to break out to the upside. Now, when the US economy is just entering recession? There are three explanations that come to mind:

• The United States' economy is no longer the world's economy. The four largest growing economies are the BRIC nations: Brazil, Russia, India and China. They accounted for 40% of global growth in 2007, and they don't need America for much these days. BRIC nation exports to the US have become relatively small portions of their economies. Brazil only 3%, Russia only 1%, India only 4%, and China only 8%. 95% of Chinese economic growth came from internal domestic demand, as wealth has grown from actual work in factories (source: Hat Trick Letter).
• Copper smells hyper inflation coming. Copper is not be a precious metal, but it is priced in dollars. If you need copper to do your job or produce something, you might want to stock up. The problem that all global commodity markets are priced in dollars. Does anyone really know what the dollar is worth today (and what it will be worth next month)? And if it is hard to value the dollar, how would you ever be able to correctly price copper?
• Copper production might have peaked. This is part of the “Peak Everything” theory. I don't know if this is true, actually. Copper was predicted by some to peak in 08, but the latest numbers don't bear that out, so we'll see. I still think all commodity production is ultimately linked to the availability of energy.

Greenspan begs and pleads

Is there a decent way to get Alan Greenspan to shut up? The guy is out there, trying to defend his reputation, sounding increasingly desperate, pleading. A recent Financial Times editorial by Greenspan is simply embarassing: The Fed is blameless on the property bubble.

Greenspan asserts repeatedly that stronger banking regulation and oversight would not have prevented a property bubble, that it is not his fault, and that he is surprised at how bad things have become so fast, and that no Fed policy would have prevented it. Here are some pullquotes:

“Bank loan officers, in my experience, know far more about the risks and workings of their counterparties than do bank regulators.”

“Aside from far greater efforts to ferret out fraud (a long-time concern of mine), would a material tightening of regulation improve financial performance?”

What did Greenspan ever do to ‘ferret out fraud’? His whole carrer he was enthralled with innovation and productivity. He never saw any financial fraud of any kind.

“The core of the subprime problem lies with the misjudgments of the investment community.”

Not my fault, not my fault!

“I have been surprised by the fierceness of investors in retrenching from risk since August.”

Alan, you're not needed any longer. Just shut up and try not to do any more damage. You are a Knight of the British Empire, you are rich. Go away and save your dignity. You have, all your life, stood for what your believed and you prevailed. Few can say as much. Now history will provide your reputation, not squirming editorials.

what do brokerages really do with your money?

We will never know the whole story of the Bear Stearns fire-sale to Morgan Stanley. There is not a lot of transparency in these things. But I have a different perspective. I think Bear Stearns was no bailout. It was a cover up.

Some indication of what might have happened if Bear had been allowed to fail was given last week when Australian brokerage Opes Prime went bankrupt. Opes Prime's laundry is seeing the light of day.

What was Opes Prime doing that resulted in their bankrupcy? It seems that some of their best customers, either hedge funds or “high net worth individuals”, were getting in trouble with their leveraged positions. They were getting shredded. Normally this would result in a simple margin call, the fund would liquidate its losing position and settle up. Things would be fine. But there might be a problem if the client's loss was very large. The worst thing that could happen is that the client would declare bankruptcy and not pay.

This is a problem because of the way modern brokerages work. All investments in brokerages these days are held in street name. None are registered to the account holder. The brokerage is the real owner of the investment. This is true for shares, contracts, derivatives, bonds, everything. This is what allows quick discount trading. The broker takes advantage of the situation to keep the securities on their books as assets. All the account holder has is a claim on those assets. On the other hand, every asset is also a liability. Just in the way a bank can be “too big to fail” for the Fed, a customer can be too big to fail for a brokerage. A large and heavily leveraged investor can take down a brokerage. If the client goes bankrupt, its liabilities become the brokerage's liabilities.

So what happened to Opes' customers? They lost everything. Not just the ones with losing positions, but any customer with a margin loan of any size, even if they were well in the black. This is because Opes pledged clients' shares as collateral for capital loans from another bank. They needed cash to keep their biggest clients solvent.

Was Opes the only brokerage in this age of widespread greed and fraud to play fast and loose with its customer's money? And, even more importantly, how would we ever know? Wall street is one of those magical self-regulating industries that needs only token oversight. Do you think the SEC cares about you or your account? I think you should assume your brokerage has pledged your shares and mutual funds as collateral for it's own needs. There is a prevalent attitude on wall street that anything goes as long as it makes money and doesn't show up in the news. But bad news is now coming out daily.

You are hanging on the end of a chain that has a series of weak links. It doesn't matter if you have a large account, small account, IRA account, mutual fund, margin or cash, or whatever. It is all registered in street name, and you are last to get paid if things go badly. If any one of various counter-parties to your brokerages' own positions defaults, your brokerage can be wiped out very fast. Or if one or more big clients turns turtle, either funds or individuals, your chain breaks. Your account can go from anything to zero overnight, not because your stocks went down but because you no longer own your shares. All you can do is take them to court. (who do your think will have the more effective legal team?) Sure you might have a strong case and a good claim. But just because someone else commited a crime, and you didn't, doesn't mean you will get your money back. In the end, if your brokerage goes down, you will be lucky to see pennies for dollars.

the price of gasoline

This is a weekly chart of wholesale gasoline. Gas is currently at $2.75 a gallon (lower than the retail price by about a dollar).

Gasoline is painting itself into a corner. A quickly approaching point will cause the price to break out of this triangle. A wedge like this predicts a dramatic change. It is unlikely to hold the current price. And when it breaks out it will either go up or down. Given the scale of the chart (rather long term) it could move quite far.

This looks like a bearish rising wedge, meaning the price should break downwards, and send retail gas down well below $3.00, maybe to $2.50. That would no doubt give much needed relief to recession-strapped Americans, truckers, taxi drivers, and the whole American economy in general. But this wedge can also break upwards. Gasoline could spike to $5.00. This would be the devastating blow that crushes all hope of any quick recovery from the current recession. Even mainstream economists would start uttering the anathematic word hyper-inflation.