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.

Maybe the truckers want to strike?

There are rumors of a truckers' strike in the USA. Prominent blogger Mish writes a condescending post telling truckers to stop asking for hand outs because no one owes them a living. Well I think any working person who thinks they can improve their situation by the somewhat risky strategy of striking should go for it. Anyone who thinks they should take it on the chin for the good of Team America is crazy. But if the truckers think they can prevail in a strike they are also crazy. The economy is slowing, and transportation, especially hauling, will slow down dramatically. We have way too much trucking capacity. We need to, and will be, switching to rail and barge for everything that we can ship, except for the last few miles of delivery. BTW, cab drivers are facing similar problems:


This cab driver is so frustrated with King County (Seattle) that he is angrily calling for a strike. The strike never happened. But I think those guys have every right to do so.

A new conundrum: why would Bernanke destroy the dollar?

The breathtaking speed and force of the US dollar's ongoing disintegration amazes me, even though I saw it coming years ago. But there is one thing I got utterly wrong. I wrote a post in June, 2006, in which I postulated that the Fed, then led by newly appointed Ben Bernanke, would sacrifice the equity markets in an attempt to save the dollar. I thought they'd put up more of a fight, and that the dollar would crumble over the span of several years, not the nine months since the credit crisis started last summer. I concluded my analysis with this thought:

In the end the Fed will have to try defend the dollar to support the all important treasury bond market. This is what keeps the government solvent. And if things play out this way, I wonder how how much independance our Federal Reserve will really have anyway. I wonder if China's central bank Governor Zhou Xiaochuan, and Russian central bank chairman Sergei Ignatiev are now discrete and unofficial members of the Federal Reserve, and if they will be the ones who really set monetary policy.

Clearly, things have gone differently. In the first place, the Fed has no need to defend the treasury bond market right now. With all other kinds of fixed income paper looking like poison (i.e. toxic waste CDOs, etc), the only bond that has any attraction is the T-bill. That single bright spot in the Fed's universe will not last long. Next year, or this fall, when the T-bond market turns over, then the Fed will truly be out of options. Game over.

Most amazingly, the Fed has not made the slightest effort to save the dollar as it dropped like a stone. The dollar has fallen nearly 22% since December 2005, and is currently enduring an unprecedented and very possibly ruinous breakdown.

But instead of fighting to save the dollar, the Fed is fighting with all they've got to save wall street, and it's bond and stock markets.

The dollar's problem, denied against all reason by Bernanke, is inflation. We are clearly, indisputably, in double digit inflation right now. That is consumer price inflation. And cost inflation, felt by businesses, is rising very fast, with the price of oil. The United States of America is heading down the path of the Weimar Republic, if not Zimbabwe. Could we launch into hyper-inflation any faster? I don't think so. The Fed is desperately trying to prop up real estate prices, and monetizing the bond market. They are allowing the banks not to admit their insolvency. The Fed is spraying cash at the credit problem through high pressure hoses, but the money is going directly into commodities, not into the frozen bond markets.

Are the stock and bond markets really more important than the dollar? There has never been a worldwide currency collapse, so it is hard to predict the consequences. But there have been many stock market crashes and it seems that they are survivable. Ultimately, the dollar is far more important than the stock market. It is the uber-stock, the shares in the nation itself. A nation's currency represents citizens' belief in their country. It is significant that our bills have our founding fathers' portraits. And why would the Fed destroy the only thing that they have? Their only reason for existence is to regulate dollars. If the dollar is worthless and irrelevant, so is the Fed itself.

Jim Puplava has a theory that the Fed will succeed in re-inflating markets, at enormous cost, but that will only be a very short term solution. He calls it his oreo theory:

And the best way to describe what we see happening this year – and I was trying to think of an analogy, and here it is: An Oreo cookie. Dark on the outside and a creamy filling in the inside. And what I mean by that is the first quarter is we're going to see a lot of volatility, we're going to see a lot of roughness in the market, kind of what we're seeing right now with the major average is down anywhere from 3 to 5%. We may see a 10% to 15% correction in the markets. And then we're going to see monetary reflation kick in with a vengeance.

We're probably going to see fiscal stimulus. So by the second and third quarter I call that the filling. You're going to see the positive sides of monetary reflation and that's going to be higher asset prices. And then, however, by the time we get to the fourth quarter of the year, you're going to see inflation come back with a vengeance and you're going to see higher bond yields, higher inflation rates so that, John, when we get into the year 2009, central banks will be back into the rate-raising mode. And by 2010 – and hold onto your seat, get your Maalox, by 2010, if things unfold the way we think, the US will experience a depression.

Puplava knows a lot more about financial markets than I do. Maybe he is right, and the global economy won't collapse this year. Right, it will collapse in 2010. That's a relief. And maybe it explains what Bernanke is doing with his hyper-inflation game. He is doing what everyone does when they get into a financial tight spot: he is desperately trying to buy some time, and hoping for a miracle. It is not working so far. But when you are desperate, hope is always free. As is printing dollars.

Eco-terrorists?

The media is reporting with a very straight face the latest act of eco-terrorism. The Earth Liberation Front supposedly fire bombed a development of McMansions in Seattle suburb Woodinville. Pardon my skepticism. In the first place, the ELF is probably heavily seeded with undercover agents (which means that if they did fire-bomb Street Of Dreams we'll be seeing indictments within hours).

I hope at least that the police and FBI are not quite so credulous as the media. This developer is probably benefitting from this fire-bombing in a big way. Developers need eco terrorists right now just as much as banks need rogue traders. Maybe we'll see more of both this year?

BTW, what is the difference between arson and terrorism? It is terrorism if an activist sets a fire and arson if a developer sets a fire?

Who ever heard of monolines?

The financial news has been reporting on the hard times of the monolines, or bond-insurance companies lately. Ambac and MBIA are the two biggest ones. But it is not like bond insurance has become the latest sexy business sector.

Bond insurance is like your home's foundation. If you have to think about it, it probably isn't good news.
It is not good news. The core of the monolines' business has been insuring municipal bonds. Originally this was all they did and thus the odd name (which I had never heard of, like everyone else, until recently). Like many sensible businesses that worked perfectly well, they got bored of the municipal bond insurance trade. Maybe it didn't generate 20% return on capital or some other obscene profit target? In any case they wanted a little more action, and they got it — by expanding into mortgage-security insurance. They were probably crowing about innovation..

Now they are in trouble. The problem with any insurance company is that they would be fine if a few of their policies filed claims. But suppose a whole lot of mortgage-backed securities (which are a form of bond) defaulted at the same time? There is no way they can pay all those hundreds of billions of defaulting mortgages. Of course we all know that the sub-prime mortgages are toast, and that the alt-A and prime mortgages will soon follow. But the real problem is how insolvent monolines will affect municipal bonds.

Cities and towns assume that they will be able to get cash when they need it to build schools and transportation and other infrastructure. And typically they would issue a bond, which has to be insured for it to trade in public markets. On the one hand, paying premiums to a likely insolvent insurance company seems rather stupid. On the the other hand buying a bond insured by an insolvent company seems also stupid. So, right now, simply on the suspicion that the bond-insurers are insolvent, they are probably experiencing a devastating cash flow shortfall. Business on both ends of their model will fall off very sharply if they can't inspire confidence.

The upshot is that it will be much harder for municipalities to raise cash this year, or at least until credibility can be brought back into the insurance business. This is the sort of thing that makes a recession painful and last a long time. It is a much bigger problem for most Americans than the stock market. We might see construction projects halted suddenly, bus drivers not getting paid.

Give the Ford 150 a rest, please..

The North American International Auto Show is this week in Detroit. It seems that the most exciting cars that Detroit has to offer us are new versions of their flagship pickup trucks, The Dodge Ram and Ford F-150 with a herd of longhorn cattle as a selling stunt. This is stupid. The American fetish of the pickup truck is getting old. We don't need to drive all these trucks, or their cousins, the SUVs, which are cars built on truck chassis. Sure, ranchers need pickups. But Detroit is not selling that many trucks to ranchers, they are selling the image of ranching to suburban wannabes and weekend warriors.

I was actually thinking just last week that the Detroit carmakers could help us out a bit in the next few years. I hear a lot about how American innovation will save our butts in the coming recession and energy crisis. I am wondering when the innovation starts? I think a new line of fuel efficient cars would be innovative.

With the dollar lower, tight cash, and gas prices practically certain to hit $5 this year, a lot of Americans will be planning to trade down in cars. Suddenly, Priuses and diesel VWs will be lot more expensive. Ford, Chrysler and GM could sell a lot of cars if they had some that got 40 mpg. A lot of Americans could get work making such cars. We might even sell them overseas, with our cheap currency. So come on, Detroit, you can do better than the "next generation pickup".

globalization, the end game

In the 1990s, the era of permanent global “free trade”, so called, or globalization, was ushered in. Local production workers everywhere, that is in America and abroad, hated it, and protested. Economists loved it because it was more “efficient”. Global trade's most charismatic promoter was probably Bill Clinton. I don't know where, but I think I read some theorist saying that globalization was a permanent beneficial change to the world's economic system. Maybe it was the same train of logic that led philosopher Francis Fukuyama to declare permanent prosperity and peace for the globe in the form of the “end of history”. History, it turns out, is now proceeding to change things at an accelerating rate. And the era of globalization will end a lot sooner than those ideolouges thought. Three powerful trends will seem to conspire to break up the world trade routes (despite the fact that a lot of wealth is created for a few powerful rich magnates and they will try to preserve this system at all costs):

• Nationalization of Resources
• Protectionism
• Capital Controls

In the first place, we are witnessing an era of resource nationalization. Globalization was predicated on the assumption of efficient worldwide commodity markets, and such markets only function with a relative abundance of commodities. One of the curious and most exploitive of the tenants of the GATT talks (so viscously protested in Seattle in 1999) was the idea that all signatory nations had to agree to produce, and sell in open markets, any natural resources they possessed. Efficient production usually occured alongside the environmental degradation of the less wealthy nation. But that is now changing. Nations such as Bolivia, Russia, etc, are finding that they do have to power to regulate and nationalize oil, gas, and mining production.

There have been no shortages of commodities to slow down global economies for a long time, and some economists seem to think shortages are so obsolete they it couldn't possibly occur in the 21st Century. But the trend is for commodities of all kinds to rise in price and value. Scarcity of resources is the coming dynamic and free markets do not love scarcity. This will not just slow down the global trade in the resources themselves, but also affect trade in such manufactured goods which require non-local resources. China, for example, will be limited in its manufacturing by how much energy and copper it can import, now that it is no longer self sufficient. In time even American precious metal mining and energy production will need to be nationalized, if only to keep them out of the control of our creditors.

The second anti-global-trade factor is a slowly building force in the USA. It is simply the demand by citizens to support their domestic production. Protectionism. Now that the the American economy is obviously stumbling and there will be layoffs, and people losing their homes due to mortgage defaults, the government will need to do everything it can to try and keep as many people employed as possible. Even if it is not economically efficient. Social unrest will be a bigger threat than loss of cheap imports. This is the same force that was protesting against globalization in Seattle, but now they will have a much more sympathetic ear from congress. We will very likely see import quotas, tariffs and other abrogations of our trade treaty obligations.

The third trend will hit the global economy with terrible shock waves in the next two years: capital controls. Why economists assume that currency will remain freely exchangeable is baffling to me. The world now runs on fiat currency managed by central banks. This system was created to finance the gigantic economic expansions of the past half century. It is now teetering on the brink of collapse. The huge structure of artifice convinced people that paper money was as good as gold, and it was very effective in the times of plenty that the world has seen. Now that almost all central banks (Switzerland is the sole exception) are inflating their money supply at double digit rates, and the US dollar is in a death spiral, the system is doomed. The plunging dollar has created a global state of emergency: pretty much everything traded internationally is priced in dollars. If no one knows what, if anything, a dollar is worth, how do they know what anything else is worth?

Nations holding US treasury bills will be forced to sell their dollars and no county, including America, will be happy to take them in. Like destitute refugees, no nation will want to give the dollar a home. I have heard people say that because the dollar is the world's reserve currency, and no other currency will serve, it has to stay. I don't buy it. Within a very few years all fiat currency (unbacked by gold or other assets) will not be welcome in international trade. The euro can not save fiat currency either: the European Central Bank is racing America's Fed to inflate concurrently with the dollar. BTW, If you think you will always be able to own stock in that Australian mining corporation.. well I'm saying maybe not, unless you are in Australia. Soon, capital will have to stay closer to home.

This is not to say Saudi Arabia, China and other exporting nations will no longer export oil or goods. They can't do much else after all. Trade will be negotiated between nations under secret terms in guilded state department halls and embassies instead of open electronic trading bourses. Agreements will be made with armies and navies in the background, always the subtle threat of war (historically, most wars have been fought for control of resources and trade routes). Terms of trade will consist of exchanges of hard assets, military services, manufactured goods, or precious metal bullion. Barter between nations is the future of trade, and will be made to secure strategic advantage, not the best price. No nation will want to trade with its strategic rival, except under threat of war or other coercion.

a $700 trillion volcano

This is a fascinating essay by Mike Whitney, published at Rense.com. Whitney explains several key items, the most important of which is how "the markets have been transformed by 'structured finance'."

What's so destructive about structured finance is that it allows the banks to create credit "out of thin air", stripping the Fed of its role as controller of the money supply. David Roache explains how this works in an excerpt from his book "New Monetarism" which appeared in the Wall Street Journal:

The reason for the exponential growth in credit, but not in broad money, was simply that banks didn't keep their loans on their books any more-and only loans on bank balance sheets get counted as money. Now, as soon as banks made a loan, they "securitized" it and moved it off their balance sheet.

There were two ways of doing this. One was to sell the securitized loan as a bond. The other was "synthetic" securitization: for example, using derivatives to get rid of the default risk (with credit default swaps) and lock in the interest rate due on the loan (with interest-rate swaps). Both forms of securitization meant that the lending bank was free to make new loans without using up any of its lending capacity once its existing loans had been "securitized."

So, to redefine liquidity under what I call New Monetarism, one must add, to the traditional definition of broad money, all the credit being created and moved off banks' balance sheets and onto the balance sheets of nonbank financial intermediaries. This new form of liquidity changed the very nature of the credit beast. What now determined credit growth was risk appetite: the readiness of companies and individuals to run their businesses with higher levels of debt. (Wall Street Journal)

The banks have been creating trillions of dollars of credit (by originating mortgage-backed securities, collateralized debt obligations and asset-backed commercial paper) without maintaining the proportional capital reserves to back them up. That explains why the banks were so eager to provide mortgages to millions of loan applicants who had no documentation, no income, no collateral and a bad credit history. They believed there was no risk, because they were making enormous profits without tying up any of their capital. It was, quite literally, money for nothing.

Right, money for nothing. Structured finance explains the $681 trillion value of outstanding financial derivatives out there, according to the Bank of International Settlements. Whitney's key point here is that all of this money creation is out of the Fed's control. Adjusting interest rates won't fix the problem. The Fed certainly doesn't want to try to take control of monstrous toxic pile of money either, because then it would surely blow up, not just immediately, but also in their own hands.

If some unscrupulous financiers can come up with a way to generate money out of thin air, they are probably going to choose to generate a whole lot of it, not just a little money. Especially if it is hidden from all oversight and regulation. And in theory this money is risk free. It is insured (via credit default swaps). No doubt. Those insurers will surely pay off, now that the shit is officially hitting the fan. It's not like we have a $700 trillion volcano about to explode or anything..

About time for indictments

I just want to make one simple point, and it is not that complicated. I don't think anything the Federal Reserve Bank can do, this year or in the next six months anyway, can help free up the frozen credit markets. It simply has nothing to do with interest rates.

There is one thing the U.S. Justice Department could do though: a few indictments of fraud would help a lot. I know that white collar criminal cases are never quick to file or prosecute. It took years to bust the Enron executives. I certainly hope we get some soon. Angelo Mozilo of Countrywide Financial would be one good place to start. Definitely the Citibank perpetrators of the sale of the CDOs sold to the three Norwegian townships. That got a lot of press - they should be indicted. There are no doubt hundreds of people who participated in all this fraud. They should do the time. That would restore confidence in credit markets.

And now Israel too?

I couldn't believe this! The always sharp Jim Willie has this amazing piece of news in his Hat Trick Letter:

Another sign of the times. The Israeli Govt has requested that all foreign aid payments and loans be delivered in euro currency. US Secy State Rice has confirmed the formal request by Israeli foreign minister Tzipi Livni. The minister cited the rapidly declining USDollar exchange rate and its disfavor. Egypt was denied a similar request recently. Rice said, “In the spirit of Yom Kippur, the United States will not hold Israel to any agreements obligating them to accept dollars as payment for their foreign aid. We will translate our obligations in euros or whatever currency that best fits Israel’s needs. We need to place our Israeli obligations at the top of our national priority list. Israel should not suffer any inconvenience due to currency fluctuations.” So the American people should not expect to receive euro payments for federal pensions or Social Security payments. They can eat cake! As for the request out of Tel Aviv, you gotta admit, that took chutzpah.

Even more astonishing is that we agreed to it. "Israel should not suffer any inconvenience", says Condi. Wow, how far and fast the mighty do fall. See America's Secretary of State grovel. Who is next in line to take pot shots at America? Nicaragua?

Saudis Say Fuck Off Dollar

Wow: Saudi Arabia just told us to fuck off. Its not like we weren't asking for it. Link goes to Britain's Telegraph:

Fears of Dollar Collapse as Saudis Take Fright
Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.

When Bernanke drastically cut interest rates, on September 18th, ostensibly to support the American homeowner, but also to support the US mortgage industry (and what do you know it worked out pretty well for the stock market also), it sucked for the rest of the world, which has to deal with our inflation. I thought there would be a backlash, but for it to come from the Saudis first, that must sting. Bernanke is probably saying "I thought you were my friends!"

It pissed me off that we sold the fraudulent mortgage bonds overseas. I mean that we sold these stupid homes for way too much money and then packaged them into crazy bonds, that was bad enough. But then we went and sold them to foreigners - that was rude. I think Wall Street's "collateralized debt obligations" and other such trash have done for American financial credibility what Iraq did for American military credibility. That is to say wrecked it.

I don't know how much US mortgage debt the Saudis bought. But they have, I think, 800 billion in US T-bills. I read somewhere most of it is short term, too. And if we insist on flooding our markets with "liquidity", i.e. printing cash to save our own markets, and driving down the dollar (which is making 14 year lows this week), all those bond holders are going to get annoyed. They may just decide to sell off their dollars. And the Chinese, and the the Koreans and the Brits for that matter (I know Britain could use the cash right now). They may start to think it would be better if they sold first, because no one wants to be the last to sell. It could become a rout. Is it the apocalypse? No: its just the worst recession since the depression. Maybe it will be like the depression, if we don't get it together.

The problem is not just all the foreign owned treasuries, the even bigger problem is the petro-dollar itself. This is why getting the finger from Saudi Arabia, of all places, is so significant. It is a very strong signal that they will sever the riyal from the dollar for good. And if they do that, why would they want to insist on only accepting US dollars for their oil? The petro dollar has been under fierce attack for a year now, fom Russia, which sells oil for euros and rubles now, from Venezuela, from Iran, which sells for yen, and Kuwait, which pegs the dinar to a basket of currencies. The dollar is crumbling, day by day. Saudi Arabia has been one of the pillars that has supported it since the seventies. The business deals that Kissenger put together with OPEC were one of his most long reaching and successful ideas: that oil could only be traded in US dollars, anywhere. And for the most part, except the Soviet Union, this deal has held together, for the immense profit of a few super-rich families and for the American empire.

Until yesterday, that is, when Saudi Arabia said fuck you.

just say it: recession

I've been following the ongoing crisis in the credit markets obsessively. This is a fascinating addition to the global picture: China's mortgage quality worse than US.

Yi Xianrong, a banking and finance expert at the Chinese Academy of Social Sciences, said Chinese banks had been lax as they built up 3 trillion yuan (S$583 billion) of mortgage lending.
Defaults in the US subprime mortgage market now total about S$200 billion, on some S$1 trillion of loans, according to Credit Suisse.
'The quality of housing loans are much worse than the subprime loans in the United States,' Mr Yi was quoted as saying by the South China Morning Post.

Interesting. I have read elsewhere that England, Austalia and Spain have all had massive real estate appreciation bubbles. So at least we know that Americans are not the only greedy ones. But if we are expecting foreigners to bail us out (see this insightful Asia Times story), that is to say keep on financing our debt, we may have an even bigger problem. Maybe China (and Austalia, et al) will be dealing with their own liquidity problems? At present the Chinese must be relieved that their massive pile of US Treasury bonds are rising in value. But they will have to sell off their treasury book eventually, as the profitability of global trade begins to falter with the coming recession.

Recession. Lets just all say it. We should get used to it. The economy is not going to be "growing" for a while. All those American workers who are losing their jobs in the mortgage industry - are they going to find work anywhere near as well paid as the jobs they had? I don't think so. And see CNN's Job cuts at financial services firms surge. BTW, mortgage brokers also have homes with adjustable rate mortgages (like everyone else on the planet). And the construction workers, the decorators, the realtors.. they too are at risk of losing not just their jobs, but their homes. The Mexican and Latino immigants and illegals who did the unskilled labor? They will no doubt have to go home, and their families will lose their remittances. And the Wal-Marts that fed and clothed them in the USA will not get their dollars either. And there will be layoffs in retail. It is a shrinking pie now. We will all be losing our dessert, and for many, dinner too. It sucks.

I should say something positive and optimistic. Well here is one way forward: the biggest problem is that all the debt, at least coming from the USA, was mis-rated, some of it faudulently. We will need some truth and reconciliation, as well as litigation and prosecution. John Maudlin, a Wise Old Man of finance, is calling for Warren Buffet to step up to the plate:

..the rating agencies need to restore their credibility. Warren Buffett's Berkshire Hathaway owns about 19% of Moody's [a prominent bond rating agency]. I would suggest that Mr. Buffett step in take over the company (much as he did with Salomon years ago) and put his not inconsiderable credibility on the line for all future ratings and the inevitable re-ratings that are going to be done.

Suppose Buffet takes Maudlin's advice. Then all the actuaries and appraisers will have to go over all those bonds and find out what they are really worth (at least it will keep some people employed). Such a process would be slow and very painful because people will simply be told that the value of their home or condo just went down 30%. And that the chance of selling a home or condo, even with a 30% discount, this year, is very small. But it is better to know what things are worth, and then deal.

Blame the Chinese for Inflation?

Highly amusing headline: The Latest Chinese Export May Be Inflation. Actually this is a smart article, by Bloomberg's Simon Kennedy and John Fraher, in spite of the flippant headline. It paints a picture of inflation as the product of years of out-of-balance globalization. Now the global economy is slowly and inevitably re-balancing:

Central bankers have harnessed the effects of low-cost production from China and other countries like India to hold down interest rates and stimulate domestic growth. The Organization for Economic Cooperation and Development in Paris estimates that globalization knocked as much as 0.2 percentage point off inflation in rich nations from 2000 to 2005, even as the world economy sped up and buoyed raw-material costs.

Now, when "inflation is above target, the cost of reducing it has been increased," said Robert Lind, chief economist at ABN AMRO Holding in London. Interest rates in Britain and the 13-country euro zone are already the highest in six years, with officials hinting that more changes may be on the way.

China is actually struggling to keep it's own economy under control, and is raising interest rates:

China reported the quickest pace of growth in a dozen years, pushing inflation to 4.4 percent in June. On Saturday, China raised its benchmark interest rate to an eight-year high of 6.84 percent.

Kennedy and Fraher give examples of central banks struggling with inflation not only from China, but also from Britain, New Zealand, and Canada.
Britain:

The Bank of England's policy makers highlighted import prices as a "growing" inflation risk and one of the reasons for this month's increase in the benchmark rate to 5.75 percent.

It is not just the cost of imported goods that troubles Mervyn King, governor of the Bank of England. On May 16 he said that British house prices were "heavily influenced by what is happening overseas, independent of U.K. monetary policy," as wealthy foreigners purchase property.

New Zealand:

Bollard, of the New Zealand central bank, is expected to raise the official cash rate to a record 8.25 percent this week, in part because overseas orders for butter and milk are pushing up dairy prices.

Canada:

The Bank of Canada this month increased its main rate for the first time in more than a year to 4.5 percent partly because of surging investment in the western province of Alberta to develop the world's largest pool of oil reserves outside the Middle East.

Hyperinflation in Zimbabwe. USA next..

This business of the Fed simply printing up cash to buy the stock market is nuts. We are going the way of Zimbabwe. And nobody seems to notice, or care. As long as the stock market goes up, everything else can go to hell.

By the way, the Zimbabwe Stock Exchange is soaring much faster than the mighty Dow:

Here is a chart that shows the hyper inflation of the Zimbabwe Stock Exchange (click for a higher res image). It seems to show the ZSE's Industrial Index going from almost zero to 55 million in one year! A helpful Harare stock analyst, Shumba Seti of the African Banking Corporation, emailed me this chart and the weekly closing prices for this index for the past year. The ZSE was not actually at zero in July 19, 2006, it was at seventy thousand (70,084). One year later this index closed at thirty three million (33,582,892). This gives a year on year percentage rise of 47,818%!!! This is down considerably from its peak at July 3rd at 53,354,792 (a 76,000% rise in less than one year). The reason for the recent downturn is that Zimbabwe's authoritarian president Mugabe imposed price controls in the last week in June, a few days before the ZSE hit its peak. Price contols has had the effect of making almost all commerce other than barter impossible in the country: Zimbabwe Price Controls Wreak Havoc on Economy.

To return to America, it sounds like good news that the Dow Industrials has closed over 14,000 for the first time. Suppose it happened to close above 18,000 by year end? What's not to like? And maybe 25,000 or 30,000 the next year? Wow! But at what point would the celebrations in the NYC ballrooms turn to panic? At what point do we start to suspect there is nothing there, that these "dollars" are becoming increasingly worthless and irrelevent even as they multiply geometrically?

Some people might point out that a soaring stock market could be an inflation hedge. Perhaps. Unfortunately it is also the most un-equal distributer of wealth. This is how it works: the Fed has its Plunge Protection Team (see wiki page). They buy futures in the Dow, the S&P, and other indexes. Brokers and their automated trading programs see a fat spread between the future contract and the underlying stocks, so they buy the stock and sell the future. They get as sure a profit as is possible in this uncertain world. The stocks go up. The Fed sells the contract at a loss. This way the Fed injects money into the economy. Much of it goes directly into broker's pockets. The corporations love the flow of capital.

Does any of it trickle down to those not participating in the market? In a real, and growing economy a little bit would in fact trickle down (not that this method of economic stimulous is in any way justified). Corporations would invest in new plants, new stores, they would hire more workers. That is not happening in the USA. Corporations are buying back their own stock, buying other corporations. The market is simply feeding on itself. This is not growth. It is a dead end. The end result, in an extreme example, is for all to see: Zimbabwe. National economic collapse. There, but for a little common sense, we'll be.

USD Painting Itself Into a Corner

The dollar is finding itself in a 'falling wedge' pattern. This is normally a bullish configuration, meaning it indicates that the dollar will likely break out to the upside. If it was a stock it might be a buy. Yet it can also break downwards. Read any article about the dollar, the fundamentals look horrendous. Like this one: Global Exodus From The US Dollar In Motion.

Since the Bernanke Fed discontinued the decades-old reporting of the broad M3 money supply in March of 2006, the growth rate of M3 has accelerated from an 8% rate to a sizzling 13.7% clip, its fastest in more than three decades. The Bernanke Fed is preventing borrowing rates from rising at a time of explosive loan demand for US corporate mergers and takeovers, by rapidly increasing the US money supply.

Just why should we care so much about the dollar? Because it is holding the world's economy together, and by the thinnest of threads at this point. Here is a piece in the British Telegraph: Credit Crunch Will 'Shred Investment Portfolios To Ribbons'

Markets have been wobbly since the surge in yields on 10-year US Treasuries, the world's benchmark price of money. Yields have jumped 55 basis points since early May on inflation scares, the steepest rise since 1994. It infects everything; hence that ugly "double top" on Wall Street and Morgan Stanley's "triple sell signal" on equities.

Wobbles are turning to fear. Just $3bn of the $20bn junk bonds planned for issue last week were actually sold. Lenders are refusing "covenant-lite" deals for leveraged buy-outs, especially those with "toggles" that allow debtors to pay bills with fresh bonds. Carlyle, Arcelor, MISC, and US Food Services are all shelving plans to raise money. This is how a credit crunch starts.

"This is the big one: all investment portfolios will be shredded to ribbons," said Albert Edwards, from Dresdner Kleinwort.

The BIS had warned days earlier that markets were febrile: "more risk-taking, more leverage, more funding, higher prices, more collateral, and in turn, more risk-taking. The danger with such endogenous market processes is that they can, indeed must, eventually go into reverse if the fundamentals have been over-priced. Such cycles have been seen many times in the past," it said.

The last few months look like the final blow-off peak of an enormous credit balloon. Global M&A deals reached $2,278bn in the first half, up 50pc on a year. Corporate debt jumped $1,450bn, up 32pc. Private equity buy-outs reached $568.7bn, up 23pc. Collateralised debt obligations (CDOs) rose $251bn in the first quarter, double last year's record rate.