Friday, June 30, 2006

Hyperinflation or Deflationary Depression - Part 1


By John Robino - Dollar

The other day Bloomberg ran an article on how all those doomsayers predicting a repeat of the 1970s are delusional. This paragraph pretty much sums it up:

“Surely the reporters and editors who put out this tripe know the difference between the U.S. economy of the 1970s and today's 21st-century juggernaut…Do folks think a case of 2.5 percent real growth and 3 percent inflation -- a likely scenario for the second quarter -- qualifies as stagflation? If they do, they need to revisit those wonder years of the 1970s, when the economy was over-regulated, oil shocks had the ability to paralyze the nation and central bankers still thought there was a trade-off between growth and inflation.”

With yesterday’s upward revision of 1st quarter GDP to a gorgeous 5.3%, this might be a good time to consider the whole “21st century juggernaut” idea. But where to begin…I guess first it should be pointed out that thanks to John Williams at Shadow Government Statistics, we now know that if the government hadn’t changed the way it calculates things like inflation and unemployment, today’s economy would be putting up 1970s style numbers already.

But even if you accept the accuracy of government numbers, the focus on headline numbers like GDP, employment and inflation misses the point by ignoring the other side of the ledger. It’s not just how many people are working and paying taxes, for instance, it’s how much we have to borrow to create each new job. Countries, like companies, have to understand their return-on-investment to know how they're doing.

So let’s see how today’s America stacks up against the wheezing invalid of the 1970s. On jobs, for instance, back in the 1970s it took about $370,000 of new debt to create each new position, while in the first half off this decade it took $2.5 million. Now, you could argue that the first five years of this decade were deceptive because they contain a recession in which the number of people working went down for a while. Fair enough, but 1) the 1970s included a nasty recession of its own, plus two oil shocks, and 2) when you look at just 2005, when employment was growing at a pretty good rate, the ratio is still ugly because debt spiked along with jobs. In other words, even when firing on all cylinders, today’s America has to borrow twice as much to create a new job as it did thirty years ago.

Jobs are just one part of a really big system, so maybe we're getting some other kind of bang for our borrowed buck. What about housing, maybe the healthiest industry of the past five years? Nope. In the 1970s our parents borrowed $400,000 (adjusted for inflation) for each new house that was built, while today we’re borrowing more than three times that much. Maybe that’s the real source of the housing bubble: Not home prices, but the amount of money we owe on our homes.

Or how about business investment, which would bring tech into the discussion, and which a lot of economists think will pick up the slack created by housing’s soft landing? Sorry, but that’s ugly too.

You can run the same kind of analysis on pretty much any seemingly-benign economic statistic, in the U.S. and most other non-OPEC countries, and get similar results. We’re all borrowing more and more each year to produce those comforting headline numbers. We’re all printing paper currency at whatever rate it takes to keep the headline writers happy. And we’re all, with the U.S. in the lead, approaching a time when our choices narrow to only two: Borrow and/or print fresh paper until our currencies enter a death spiral, or refuse to pay and go bankrupt en mass.

Which takes us—as pretty much every economic debate does these days—to the real question: If as a society we only have two ugly, seemingly mutually exclusive choices, how should investors play it? Hyperinflation means gold and land, deflationary depression means cash and long-term puts on banks and homebuilders. A lot of smart people are weighing in on one side or the other, and I’ll summarize their thoughts in a later column. But for now, we should all be watching for signs of which way the cards will fall. As Sprott Asset Management’s John Embry put it recently “This is THE question, really.”

Tuesday, April 04, 2006

Best Gold and Silver Quotes of March 2006

By John Rubino of Dollar Collapse

Ted Butler, Investment Rarities
"If someone had asked me to devise a method, or scheme, that could propel silver prices sharply higher, I don’t think I could have dreamed up anything more potentially bullish than the Barclays ETF.

At the heart of the silver story is the structural deficit and disappearing inventories. For more than 60 years, we have continuously consumed more silver than has been produced on a current basis, necessitating the draw down of inventories every year. As I have repeatedly stated, there is no more bullish or temporary a condition possible in any commodity than such a circumstance. In time, it guarantees a price rise sufficient to eliminate the deficit. The reason the silver deficit could exist for so many years was because so much silver had been accumulated through the ages that it took many decades to eat up those inventories. When inventories cease to be available, silver hits a brick wall. Prices must rise and the deficit end.

What the proposed ETF promises to achieve is the acceleration of the time that available silver inventory will run out and we will smack into a brick wall…The largest single pool of investment capital in the world exists in institutional and individual retirement accounts. The total amount of capital in this category runs into the trillions and trillion of dollars. In the US, much of this giant pool of assets that covers institutional pension plans is governed by the Employee Retirement Income Security Act of 1974 (ERISA), which sets standards in how these funds should be safeguarded. Very simply stated, fiduciary responsibilities by plan administrators must be conducted by "prudent man" principles, including what type of assets could be invested in with plan funds. Again, staying simple, this meant only investing in sound securities, mainly stocks and bonds. Commodities or commodities futures contracts were strictly forbidden.

Commodity ETFs change all that. Because they are structured as a common stock, they make it possible for investment by many types of accounts, where investment was not legal or possible before. This is what I would have never been able to imagine – someone actually came up with a way to connect or link the largest pool of investment capital in the world to the one market that could least handle (at least on an orderly pricing basis) an infusion of such funds, real silver. Just to put it into perspective, one-tenth of one percent of trillions is billions. I don’t see how billions of dollars could flow smoothly into the silver market. It’s like trying to stuff ten pounds of ice cream into a one-pound container – no matter how you do it; you’re going to make a mess. This is the other reason why I was sure the regulators would reject the silver ETF.

By the time this silver story plays out, the $50 Hunt Brothers episode will merely be a footnote in silver history."

Steve Saville, Speculative Investor
"It is very unlikely, however, that the US$ will ever COLLAPSE in value relative to any other fiat currency. The reason is that ALL of these currencies are in the process of being inflated into oblivion; it's just that over the next few years the dollar is likely to move towards that ultimate destination at a modestly faster pace than some of the other major currencies."

Jim Puplava, Financial Sense
"Inflation can manifest itself in either of two ways. It can show up in the real economy in the price of goods and services as it is doing now or it can surface in the asset markets in the form of higher prices for assets be it bonds, stocks, commodities or real estate. Just look at the '80s and '90s for financial inflation and this new decade for hard asset inflation in the price of real estate and commodities.

This brings me to the next reinflation effort which has now begun. Why else would M3, which has been growing at an annual rate of 8%, no longer be reported by the Fed? Monetary inflation is the reason. The U.S. is spending and borrowing too much money. Our current rate of spending is out of control and beyond balancing through tax increases, so monetary inflation through monetization is next. As the Fed goes on hold—perhaps after the Fed funds rate is taken to 5-5.25%—the dollar will begin its relentless decline."

Puru Saxena, Money Matters
"The absurd money-creation continues. Slowly yet surely, the "stealth" confiscation of savings is gaining momentum as money loses its value. Central banks claim that they are raising interest-rates to fight inflation. At the same time they are slipping in more rum into the punch bowl, thus creating just what they say they want to fight - inflation! Take a look at the latest year-on-year money supply growth-rates around the world:

Australia + 9.1%
Britain + 11.7%
Canada + 7.7%
Denmark + 14.7%
US + 8.1%
Euro area + 7.3%

When I glance at these mind-boggling figures, at least I don't see any monetary tightening taking place! Make no mistake, this excessive liquidity is inflation that banks are creating and this inflation is destroying the purchasing power of your hard-earned money. As asset-prices continue to benefit from this monetary insanity, the wealth inequality is getting wider resulting in social unrest in several parts of the world. The ultimate truth about inflation is that it always benefits the rich who are able to ride the inflationary wave by investing in assets, whereas the poor become even more impoverished as things continue to become more expensive."

Howard Ruff, Ruff Times
"Silver will not be just twice as profitable as gold in the next few years, but many times more profitable--maybe ten times more profitable. Silver is in huge short supply; the inventories are gone! Unlike gold, government can’t dump the silver in the market to artificially suppress the price because they have none. Silver is still the poor-man’s gold, and the time is not far away when it will be difficult to find any silver at any price short of $100 an ounce."

Stephen Roach, Morgan Stanley

"What happens to the world economy if the bond market conundrum is suddenly resolved and real long-term interest rates revert toward historical norms? My guess is that this is not good news for what has been a liquidity-driven, increasingly asset-dependent global economy."

Jim Willie, GoldenJackass
"A return to normalcy is poppycock, never to happen! We have gone so far afield, so far from anything recognizable or rectifiable, that normalcy is not even remotely possible in the gold and crude oil markets. The USFed will tighten until they cause a crisis, then deny their role, then clean it up, probably followed by easing of interest rates. The next LTCM fiasco lies around the corner, under the surface, ready to be revealed, sure to wreck havoc. Gold and crude oil will be given a grand assist when it happens, not if. It is guaranteed since the USFed can no longer even define what “neutrality” means in its policy. Besides, what it says usually obscures its actual policy motive. My firm belief is that the Enron model was hatched from the USGovt incubator, where it continues."

Doug Noland, Prudent Bear
"As easy as it seems that it should have been, I don’t feel I effectively countered the absolute nonsense that our Current Account Deficit is driven by unrelenting global 'capital' inflows. And I have not even come close to shedding light on the reality that unchecked – and inevitably unwieldy and unstable - global finance has been a commanding force within what the New Paradigm crowd trumpets as virtuous free-market 'globalization.'

Why then, you may question, do I suspect that Credit Bubble-like analysis will garner more attention going forward? Well, I believe the Fed and global central bankers may finally comprehend that they are facing a very serious problem – that Credit and speculative excesses begetting greater excess demand a true tightening of global financial conditions. Importantly, hope that a cooling housing market will obligingly chill the Bubbling U.S. economy is fading rapidly. As the 'Flow of Funds' confirmed, the Credit system is currently firing on all cylinders and the Bubble economy has a full head of steam. The U.S. Current Account and Global Imbalances are poised to only worsen, fueled by Bubble dynamics that now command Credit systems and asset markets around the globe. Expectations for a slowing U.S. are shifting to fears of a runaway Global (Credit)."

Reg Howe, GATA
"Alan Greenspan confessed to the gold price suppression scheme. The European Central Bank confessed to the gold price suppression scheme. Barrick Gold confessed to the gold price suppression scheme in U.S. District Court in New Orleans on February 28, 2003, The Reserve Bank of Australia confessed to the gold price suppression scheme in its annual report for 2003. And now the Bank for International Settlements, the central bank of the central banks, has confessed to the gold price suppression scheme by saying 'the provision of international credits and joint efforts to influence asset prices (especially gold and foreign exchange) in circumstances where this might be thought useful.'"

Richard Daughty, the Mogambo Guru
"The unusual action of silver and gold here lately is the result of lots and lots of guys, businesses and banks on the hook for billions and billions of dollars in short sales, year after year after year. The rise in the prices of gold and silver means financial death for them. So buy them with confidence, perhaps even with a little malice against those creeps, as they can't keep it up for much longer, and the prices of gold and silver will shoot to the moon when they finally give up."

James Turk, GoldMoney
"The federal government desperately needs strong economic activity in order to generate the highest possible tax revenue to decrease its reliance on debt. But rising interest rates dampen economic activity. Rising interest rates also have an unfavorable impact on expenditures: A 6% average interest rate on $8.2 trillion of debt results in a higher interest expense burden than a 4.6% rate.

Thus, higher interest rates restrain tax revenue while increasing the level of expenditures. Together these factors worsen the budget deficit, which then causes the federal government to borrow even more money. The resulting higher level of debt leads to a greater interest expense burden, further worsening the deficit. Consequently, the federal government is rapidly moving to the point where borrowing becomes necessary to meet its interest expense obligations. This condition is not sustainable. If the vicious circle is not addressed and corrected, it will turn into a death spiral in which the dollar is destroyed."

John Mauldin, Thoughts From the Front Line

"Why are home supplies rising? The simple answer is that demand is falling. The University of Michigan has an index which measures the intention of people to buy a home in the near future. It is at its lowest level in 15 years. The National Association of Homebuilders Index which tracks a number of things but includes potential buying traffic in new home developments is also dropping dramatically in the last few months.

Bear markets begin when growth in real consumer spending peaks and beings to slow. I think I made the case above that consumer spending is going to face a real uphill battle as cash-out financing slows down, higher energy costs don't go away, higher interest rates translate into higher mortgage and credit card payments on top of legislation requiring higher minimum payments on credit card balances."

Texas Congressman Ron Paul
"If there were a 'housing hurricane,' it would be just like a real hurricane. You spend whatever people demand you spend and worry about it later. FANNIE MAE and FREDDIE MAC have a line of credit from the Treasury, and they would use it if they had to. And I'm sure other mortgage companies would qualify. Congress would do whatever they feel they have to do…There is no historical example where paper money has lasted for a long period of time. It works for a while until the trust in that money is totally undermined, and then it ends up in an economic calamity, for the most part, in runaway inflation or other serious dislocations."

Paul McCulley, PIMCO

"The end of the housing boom will come soon, we think, and when it does, sales volume in the property market will reverse wickedly. Housing prices don't crash, but volume of transactions does, as sellers refuse to face reality on pricing and buyers wait them out."

Peter Schiff, Euro Pacific Capital
"This week, as statistics revealed that China has surpassed Japan as the world’s largest holder of foreign reserves, the U.S. Congress continues to threaten China with 27% tariffs on their exports to the U.S. The move, which is akin to a cornered gunman turning the pistol on himself and threatening to pull the trigger, reveals the extent to which American politicians fail to comprehend the true nature of the current Sino-U.S relationship.

In desperate need of capital, America is hardly in a position to insult those providing it, or dictate the terms by which they do so. However, the latest tough talk on China comes shortly after Congressional action which blocked key purchases of American assets by foreign interests. Such posturing sends a very dangerous message to our creditors. If as a nation we have decided to sell off our cows to pay for imported milk, we can not complain when our trading partners actually show up to collect the animals.

As a result of the unprecedented foreign-financed consumption binge in the U.S., it is likely that nearly every major U.S. asset will ultimately pass into foreign control, including most companies in the S&P 500 and trophy properties in major U.S. cities. As America lacks the industrial capacity necessary to redeem its IOU’s with actual consumer goods, access to capital goods and domestic assets is all that gives its currency value. Restrictions on the ability to acquire such assets will diminish foreign interest in accepting dollars in exchange for exports, and will dissuade foreign governments from holding huge reserves of dollars that they cannot hope to spend."

Paul Kasriel, Northern Trust Company
"Again, so what if mortgage defaults are on the rise? No biggie except that U.S. commercial banks have a record exposure to the mortgage market. About 62% of bank earning assets are mortgage-related. (I do not have access to the data to determine what part of this mortgage exposure pertains to commercial properties). What I'm driving at here is the potential for a bust in housing to cripple the banking system. History tells us that a crippled banking system renders central banks less potent in combating economic downturns and promoting robust recoveries. In other words, if a housing bust led to large credit losses to the banking system, Chairman Bernanke could cut the fed funds rate to 1% and be surprised that a low interest rate did not have the same magic for him as it had for his predecessor."

James Grant, Grant’s Interest Rate Observer
"There are more values in your hotel mini-bar than in the U.S. bond market,"

Eric Andrews, Financial Sense University

"In 2008, the first Boomers will begin retirement and sell their stocks, bonds, and other paper promises into the market to pay for rent, health care, and gasoline. Who will buy them? The younger generation makes far less per hour, and even if their wages were equal, there are not enough of them to offset a 30-year supply of selling pressure. Worse, as their selling drives the market down, no one could buy even if they wanted to, because who would buy a stock when the tide of the market will sink for 30 years? Our Generational Transfer problem can be mostly righted by canceling Medicare and increasing the Social Security retirement age to well over 70. Not so the stock and paper markets."

I. M. Vronsky, Gold-Eagle
"Gold & Silver Equities' fantastic performance in the last 5 years will slowly mesmerize and galvanize investor attention to the point Gold Fever contagion will spread through the world -- as frantic investors seek to place their hard earned savings in vehicles demonstrating intrinsic value and high liquidity…like gold and silver equities."

Friday, March 31, 2006

The Fear Index Goes Out On Top

By John Robino of Dollar Collapse .com

M3 died a controversial death this week. As for whether the Fed’s decision to stop reporting its broadest measure of money was simply a recognition that money has become too complex to quantify, or an attempt to hide the accelerating debasement of the dollar, time will tell. But one thing is certain: The best gauge of gold’s near-term direction has now become impossible to calculate. Called the “Fear Index,” it was created by GoldMoney’s James Turk in the 1980s, and since then it’s been nearly flawless (read on for its final prediction). Here’s how James and I explained it in our book, The Coming Collapse of the Dollar:

“The dollar is a balance sheet currency, which is to say an accounting fiction. Its value is derived from the assets held by the Federal Reserve and commercial banks, some of which, like gold, are real and tangible, and some, like bank loans, foreign currencies, and derivatives, are not. The Fear Index measures the relative importance of gold within the U.S. monetary system, and is calculated by multiplying the U.S. gold reserve (i.e., the weight of gold reportedly under the Treasury’s control) by gold’s exchange rate to get its total market value, and dividing this result by M3, the broadest measure of money supply.

A reading of, say, 2%, indicates that for every $100 circulating as M3, there is gold worth $2 sitting in the U.S Treasury’s vaults. Gold would thus account for 2% of the dollar’s value, with the other 98% dependent upon the financial assets of the Fed and the nation’s banks. The calculation for December 31, 2003 is as follows:

When the Fear Index is falling (that is, when the number of dollars in circulation is rising faster than the market value of the gold in U.S. reserves, or when the number of dollars is falling more slowly than the value of the gold reserves) the implication is that people are willing to hold these extra dollars because they’re optimistic about the prospects of the dollar and/or the U.S. economy. When the Fear Index is rising (which occurs when money is flowing into gold, pushing up its exchange rate and raising the market value of U.S. gold reserves), it’s usually because people are worried about the dollar or the health of the U.S. banking system, and are looking for alternative stores of value.

And when the Fear Index exceeds its 21-month moving average and the moving average rises above its level of the previous month, the result is a ‘Buy’ signal, indicating that gold is headed higher. As you can see from the chart below, there have been only five such signals in the past thirty-five years, all of which were followed by gold rallies.”

Investors who bought gold at the last Fear Index buy signal are up about 80% today. So now the question becomes, where’s the top (which is the same thing as asking where the dollar will bottom out). Without the Fear Index, this question has become a lot harder to answer. But it’s also a long way off. As James wrote in his most recent Freemarket Gold and Money Report newsletter:

“As we can see from the page-1 chart [posted below], the Fear Index has again been climbing over the past few years. There are a couple of noteworthy points to make as a result. There are two solid red downtrend lines on the page-1 chart. Look at what happened after the first downtrend line was broken. The Fear Index soared. Now look at what is happening.

The Fear Index is again soaring, and I expect it to continue climbing higher, repeating the experience of the 1970s. I’ve drawn two uptrend channels to show that I expect the Fear Index to climb within an uptrend channel just like it did through the 1970s. The second point to which I want to draw your attention on the page-1 chart is the dotted, red downtrend line.

I expect the Fear Index in time to reach and eventually break through that downtrend line. In other words, the Fear Index over the next several years is heading back to – and probably above – 10%. In fact, it is my expectation that within several years, the Fear Index will climb toward the peak reached during the Great Depression. It will do this as the problems with dollar fiat currency become more apparent, causing a flight from the dollar into the safety and security of gold. The flight out of the dollar is already underway. It’s only a matter of time before the rush for the exits turns into a torrent.

Assuming M3 grows at 8% a year over the next three years, and the Fear Index rises to 10%, implying that we’re worried as in the 1970s, the Fear Index yields a target gold price of $4,961 per ounce."

Wednesday, March 22, 2006

The Real U.S. National Debt

By John Robino of Dollar Collapse

Funny how some rituals persist long after their original point is forgotten. Take the federal debt limit, that relic of a time when lawmakers were actually embarrassed about piling debt onto our kids. Nothing embarrasses these guys any more, of course, and the annual process of raising the limit has devolved from tragedy to farce, with Treasury threatening to bounce Social Security checks (secure in the knowledge that it will never have to) and legislators pontificating on fiscal responsibility (certain that their pork won’t be touched), followed by a quiet vote to raise the bar by another half-trillion.

That was last week. Now comes the usual round of media hand-wringing, to which the don’t-worry-be-happy crowd will respond as it always does, with the observation that America’s “national debt” is no higher—and in some cases a lot lower—than that of other countries. Get ready to see variations of the following chart in the Wall Street Journal and on CNBC:

Viewed this way, Washington’s obligations actually do look pretty manageable. If we’re doing as well as Germany and better than Japan, how bad can it really be? Well, it can be very bad indeed, because the “national debt” in the above chart refers only to direct obligations of the federal government, and government doesn’t have to borrow to finance itself with debt. Consider: If the Fed lowers interest rates and liberalizes lending rules enough to convince me to build my dream house, I go out and borrow, say, $500,000, which generates taxable income for my mortgage banker and her support staff. Then I hire a contractor and crew, who spend six months earning good money and paying taxes. Then I furnish the house and landscape the yard, generating taxable income for furniture makers and gardeners. Government, by encouraging me to borrow, has pocketed tens of thousands of dollars that it doesn’t have to borrow for itself.

Now, at this point an astute reader might say, “Ah, but there’s a difference between a mortgage held by a bank and a bond issued by the Treasury. If you default on your mortgage, only the bank and its shareholders have a problem. This is private, not ‘national’ debt.”

Not so long ago, this would have been true. But no more. To understand why, let’s contrast yesterday’s banking practices with today’s New Age securitization machine. Back in, say, 1986 a bank that wrote a mortgage generally held onto it, collecting the monthly payments and netting them against the borrowing necessary to fund the loan, earning a profit on the difference. If a borrower defaulted, the problem was indeed strictly private-sector, impacting the bank and its owners but not the general public.

But that quaint arrangement is history, thanks to the emergence of Fannie Mae and Freddie Mac. These “government-sponsored enterprises,” or GSEs, were created decades ago by Washington to buy mortgages from banks, thus giving banks a little extra cash to lend to would-be homeowners. And for a long time, they stuck pretty much to their original charter, buying modest numbers of mortgages and helping banks fund modestly greater numbers of home purchases. But in the 1990s they had an epiphany: What they could do on a small scale, they could also do on a vast scale, making easy fortunes for their execs and shareholders in the process. They started buying literally trillions of dollars of mortgages from banks. Then they packaged them into bonds, slapped a guarantee on them (giving the bonds AAA ratings) and sold them to global investors for a nice profit. Then they started borrowing at really low rates (possible since everyone thinks they’re part of the government) to buy back portfolios of these same bonds, earning the spread between the bond yields and the GSEs’ borrowing costs.

Fannie and Freddie between them now own and/or insure about $4 trillion of mortgage debt, which means trouble at either would cause a financial earthquake. Picture a scenario in which a derivatives accounting problem costs a GSE its AAA rating, which causes all the bonds it has insured to fall, which lowers the value of its bond portfolio, which cuts its credit rating even further, and so on, in a death spiral that takes the whole global financial system along for the ride. No government that wants to stay in power will allow this to happen, which means that Fannie and Freddie are officially too big to fail, and taxpayers are on the hook for their liabilities.

We’ve seen this movie before, by the way. Back in the 1980s, easy money and lax regulations (the Feds actually encouraged S&Ls to buy junk bonds) allowed the junk bond market to inflate into a full-scale bubble. When it burst, those supposedly private sector bonds bankrupted thousands of S&Ls, which the government bailed out to the tune of several hundred billion dollars.

This time around the amount of money directly at stake is maybe twenty times as large. But that’s just the beginning. Because the value of the bonds Fannie and Freddie own and insure depends on the behavior of mortgages in general, you can make the case that taxpayers are now on the hook for the whole $10 trillion mortgage market. Viewed this way, the “national debt” doesn’t look nearly so benign.

Wednesday, March 01, 2006

Why Buy Gold and Silver

Best Quotes of February 2006
By John Rubino posted at Dollar Collapse .com

Texas Congressman Ron Paul
“Since printing paper money is nothing short of counterfeiting, the issuer of the international currency must always be the country with the military might to guarantee control over the system. This magnificent scheme seems the perfect system for obtaining perpetual wealth for the country that issues the de facto world currency. The one problem, however, is that such a system destroys the character of the counterfeiting nation’s people--just as was the case when gold was the currency and it was obtained by conquering other nations. And this destroys the incentive to save and produce, while encouraging debt and runaway welfare.

The artificial demand for our dollar, along with our military might, places us in the unique position to ‘rule’ the world without productive work or savings, and without limits on consumer spending or deficits. The problem is, it can’t last.

Price inflation is raising its ugly head, and the NASDAQ bubble-- generated by easy money-- has burst. The housing bubble likewise created is deflating. Gold prices have doubled, and federal spending is out of sight with zero political will to rein it in. The trade deficit last year was over $728 billion. A $2 trillion war is raging, and plans are being laid to expand the war into Iran and possibly Syria. The only restraining force will be the world’s rejection of the dollar. It’s bound to come and create conditions worse than 1979-1980, which required 21% interest rates to correct.”

Stephen Roach, Morgan Stanley
“Suffering from the greatest domestic saving shortfall in modern history, the US is increasingly dependent on surplus foreign saving to fill the void. The net national saving rate -- the combined saving of individuals, businesses, and the government sector after adjusting for depreciation -- fell into negative territory to the tune of -1.3% of national income in late 2005. That means America doesn’t save enough even to cover the replacement of its worn-out capital stock. This is a first for the US in the modern post-World War II era -- and I believe a first for any hegemonic power over a much longer sweep of world history.”

Richard Daughty, the Mogambo Guru
"But, for some perverse reason that future historians will make whole careers arguing about, the moronic people of America think all of these price inflations are good! Hahaha! A nation of morons! I sort of remember a quote by Benjamin Franklin, who was asked, when they finished work on the Constitution, 'And what kind of government do we have?' and he replied 'A democracy, if you can keep it.'

What he surely meant by that enigmatic phrase was if you let people decide tax policy, the numerous have-not people will always vote to give themselves somebody else's money. A democratic, majority-rule government always elects to provide a 'free lunch' for everybody! Whee! Thus, democracy will ultimately destroy the economy. That is why the Founding Fathers wrote into the Constitution that money shall only be of silver and gold, which is the only thing that would possibly prevent it.”

Ben Bernanke, Federal Reserve Board Chairman
"In the past, when the inverted yield curve presaged a slowdown in the economy, it was usually in a situation where both long-term and short-term interest rates were actually quite high in real terms, suggesting a good bit of drag on the economy. With the real interest rate not creating a drag on economic activity, I don’t anticipate that the term structure signals an oncoming slowing of the economy.”

Peter Schiff, Euro Pacific Capital
"The only way for housing prices to stay high is for the Fed to keep inflating. Conveniently, the captain currently at the helm of the monetary ship of state just happens to be Ben Bernanke, who as a Fed governor spoke about the Fed’s ability to fend of deflation by using the handy invention of the printing press. Though his words may have may have spoken in reference to consumer prices, his actions will certainly be concentrated on asset prices, especially housing. Like a lounge club magician, the Feb distracts the audience with short-term rate hikes, while behind its back it monetizes long-term government bonds. It creates the illusion of its being an inflation fighter, while in reality it is an inflation creator. No wonder it wants to further cover its tracks by no longer reporting M3!”

James Turk, GoldMoney
"We moving closer to that moment in time when silver breaks down from its current pennant formation, which is the first step needed for the precious metals to resume their uptrend in this ongoing bull market. If this first step happens, then I expect everything to fall into place. A breakout from the rising trend channel will not be far behind, and by then, the precious metals will be near or at new high prices - with silver leading the way.”

Bill Fleckenstein, Fleckenstein Capital
“But let me just ask you this: If you feared for the value of this piece of paper called the dollar and you put it into a hard asset, does that de facto constitute a bubble? Of course not. That constitutes a bull market. To be a bubble, in my opinion, behavior in and around the asset class under discussion has to spin so out of control as to distort the underlying economy. I don't believe the commodity markets are anywhere near that point. Maybe they'll reach it somewhere down the road, though I kind of doubt that. In the meantime, I anticipate a bullish chain of events for the metals: When the ‘right’ data emerge to support the fact that the economy is weaker than it appears, I believe the Fed will make clear that it's closer to pausing than people think. (Bernanke himself told Congress last Wednesday that whatever the Fed does will be ‘dependent on the data.’) If that turns out to be the case, I think there will an explosion in the precious metals and currencies, an outcome that I intend to capture.”

Ted Butler, Investment Rarities
"This proposed silver ETF, as well as any ETF on any commodity, is as dumb as a bag of rocks. Sure, it will make the price explode, and precisely for that aspect virtually all silver investors, including me, look upon it favorably. Suddenly take away a big chunk of any commodity’s supply and there will be a big impact on price. That’s elementary. But there is more to the story than that.

My main objection with commodity ETFs is that, in addition to artificially altering supply and demand, they turn legitimate commodity law and regulation on its head. The main thrust of commodity law is to prevent concentrated speculative buying and selling from artificially influencing prices. This primary premise and intent of commodity law is obliterated by the concentrated buying (and selling someday) that a commodity ETF insures. It’s as if someone sat down and devised an idea that would upend all the safeguards and regulations against manipulation that have taken many decades to develop.

Over twenty-five years ago, the weight of commodity law came to bear on the Hunt Brothers in the most famous manipulation of them all, the great silver manipulation. The basis of the manipulation was the related and concentrated buying and resultant price pressure brought on the price of silver. The proposed Barclays silver ETF promises to legitimize the very acts which the US Government succeeded in prosecuting. Talk about irony."

Doug Noland, PrudentBear
“A solid case can be made that 14 rate increases have failed to tighten monetary conditions. Despite the inverted yield curve, Credit conditions are generally as loose as ever and, as one would expect, imbalances balloon only larger. Of course, the bond bulls will contend that we are merely waiting patiently for the traditional monetary policy lag to run its course. I suggest there’s much more to it than that.

It is worth noting that broad money supply has rapidly approached $10.3 Trillion. It is also worth pondering that M3 has inflated almost 40% since Fed funds were last at 4.50% (May 2001). At a 5% rate, M3 savers will receive more than $500 billion of interest-income, a huge increase from only a couple years back when rates were 1% and M3 was significantly smaller. There is scant attention paid to this source of augmented income, with analysts instead focusing on the restraining effect of adjustable-rate mortgage resets. But with the ongoing proliferation and easy-availability of mortgage products with low initial payments (teaser-rate ARMs, negative amortization and option-ARMs, and balloon structures), I would be surprised if the household sector in aggregate experiences a significant increase in monthly mortgage payments this year.”

Steven Saville, Speculative Investor
"We would be extremely surprised if the uninterrupted inflation of the past 70 years were followed by a period of genuine deflation (a prolonged decline in the total supply of money and credit). One of the reasons this would surprise us is that there IS so much debt in the system. The high debt levels actually make deflation LESS likely, not more likely, because the current monetary system -- the world's greatest-ever Ponzi scheme -- could not survive a bout of genuine deflation. That is, deflation will never be a viable policy option regardless of how bad things get. Instead, the central banks of the world will likely risk destroying their currencies and obliterating the values of their bonds before they will permit deflation to occur."

Tom Au,
"Another commentator opined that the U.S. government is probably underestimating inflation because it is focusing on the wrong type of inflation. I would agree with that, having identified no less than five different types of inflation: commodity inflation, wage inflation, monetary inflation, fiscal inflation, and foreign exchange inflation. Before discussing 'inflation,' it helps to identify which form of inflation is being talked about."

Tuesday, February 28, 2006

Housing History: Is it 1986 or 1929?

Housing History: Is it 1986 or 1929?
Friday, February 24, 2006,
By John Rubino posted at Dollar Collapse .com
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Housing stocks got a nice pop this week, as both Barron’s and the Wall Street Journal called luxury homebuilder Toll Brothers a buy. Interesting timing, this. Why would such usually-sensible papers talk up a cyclical industry at the peak of its cycle? Well, it seems that the big home builders have diversified into lots of different regions, and used their financial muscle to buy up all the good home sites. This makes them immune from a mild slump, which is what their fans expect. As the Wall Street Journal put it:

“That's why the bulls need this housing slowdown. They are expecting that the companies will be able to have some earnings growth, grab more market share, and throw off enough cash to buy back stock to shore up their share prices.”

So the idea that the homebuilders—and by extension, I guess, the mortgage lenders and big consumer banks—are a buy hinges on the severity of the housing slowdown. If it’s modest, as the past few have been, then the homebuilders, trading at, like, 6 times earnings, will push their weaker local competitors off the field and emerge even stronger and more valuable. And based on the behavior of housing starts since the 1980s, that doesn’t seem too farfetched. Starts have fluctuated, sure, but they haven’t fallen by very much for very long. A few years of modest decline is the worst recent history says to expect. The leading homebuilders would breeze through another 1990 or 2001 without a scratch.

Unfortunately for the homebuilders and their investors, the history on which they base their optimism has another component: Leverage. While housing has been doing its onward-and-upward thing, Americans have been borrowing like crazy, mostly to buy, you guessed it, houses. And once inside, they’ve been sucking out the remaining equity via cash-out refis and home equity loans. It’s the perfect self-reinforcing cycle: Home prices go up because we can borrow, and we can borrow because our homes are going up.

In 1985, total U.S. debt came to a not-inconsiderable $55,000 per person, or $220,000 per family of four. Two decades and 25 million new houses later, those totals have risen to $140,000 and $560,000, respectively. Our debt burden is now three times the size of the economy.

For the brief-slowdown-followed-by-another-building-spree thesis to work out, you have to assume that Americans will spend the rest of the decade borrowing two trillion more dollars each year. And for that to be possible you have to assume that America’s trading partners will buy another $700 billion of new Treasury bonds each year without demanding a higher interest rate. Who knows, maybe they will, and the housing bubble will inflate for another decade. As an economist said to me on a radio show a while back, “People have been complaining about American debt for thirty years and it hasn’t slowed us down. This economy can handle whatever amount of debt we care to take on.”

But what if this time a different bit of history is about to repeat? Since we’re borrowing like it’s 1929, maybe the housing market will start behaving that way too. Here’s what happened after that debt binge:

Monday, February 20, 2006

Gold Price Short Squeeze

Shorting this Market, Volume I
By John Robino of

These days, millions of people around the world have pretty much the same problem. They see America borrowing like crazy and making a mess of one foreign adventure after another, and they suspect that U.S. markets, as a result, are headed for disaster. But they don’t know what to do about it. Five decades of growth and prosperity have trained them to look at only the long side of the market. The short side—that is, betting on things going down—is foreign territory.

So this column will be the first in a series on how to make money when the Dow and the dollar both head south. The plan is come back every few months to see how we’re doing. My guess is that we’ll be doing great.

Let’s begin with options, which are contracts to buy or sell 100 shares of stock for a given period of time at a given strike price. A call option gives its holder the right to buy (or call away) 100 shares, while a put confers the right to sell (or put the shares into someone else’s account). Said another way, calls become more valuable when the underlying stock goes up, and puts become more valuable when it goes down. If not exercised by their expiration date, options cease to exist, costing the owner their entire investment. This short lifespan was a drawback of old-style options, which ran for only nine months. But that problem was solved by the creation of Long-Term Equity Anticipation Securities, or LEAPS, which last up to two-and-a-half years.

LEAPS let you place multi-year bets for relatively little money. But they’re tricky. They come in a wide variety of expiration dates, strike prices, and underlying securities, which makes it possible to construct strategies both brilliant and incredibly stupid. Doing LEAPS right requires expert help.

So I stopped by the office of Bill Lambert, a Moscow, Idaho money manager and options guru who spends his days constructing arcane strategies with amusing names, most of which make his clients a lot of money (call him at 866-525-9194 for a free consultation). We spent an hour in front of Bill’s four 19 inch screens, him pulling up charts, running simulations and rattling off figures for volatility and delta and gamma (“the Greeks,” he calls them), and me scribbling furiously and asking the occasional really dumb question. The result: four slick ways to turn bad times into major windfalls.

Gold Price Suppression Short Squeeze Spread

In sound-money circles, it’s accepted as fact that the world’s central banks have been colluding with a handful of commercial banks (known as bullion banks) to depress the price of gold. For the full story, see Sprott Asset Management’s “Not Free, Not Fair,” at But for now, suffice it to say that the central banks secretly lend their gold to bullion banks, which sell it on the open market (thus depressing gold's price) and invest the proceeds. The bullion banks are obligated to return the gold to the central banks someday, which means they're short gold and stand to make a lot of money if gold goes down. But of course it hasn’t gone down. It's up big, which means:

1) The bullion banks have tens of billions of dollars of unrealized losses on their gold shorts which, when reported, will crush their stock prices.

2) At some point the bullion banks will have to buy all this gold back, which will send its price through the roof. A classic short squeeze!

So let’s buy LEAPS calls for GoldCorp, a high quality, low risk gold mining company, and LEAPS puts for Goldman Sachs, reputed to be one of the leading bullion banks. We’ll buy round lots of ten contracts (giving us exposure to 1,000 shares of stock) at their closing prices on Friday, February 17. Total cost: $13,900.

Bill’s take: “Goldman can peel off $50 easy. If it does, this put will go up 600%-700%.”


Price 2/17/06

10 Contracts

Buy GoldCorp $30 Jan 08 call




Buy Goldman $130 Jan 08 put




Total Cost


Gold Price Suppression Short Squeeze Calendar Spread

For a less costly variation on the above spread, let’s also sell a shorter-dated Goldman Sachs put, and use the proceeds to defray the cost of the longer-dated put. Ten of the Jan 07 130s bring in $4,800, lowering the up-front cost of the strategy to $9,100. This is what’s known as a calendar spread. With it, you don’t make as much if Goldman tanks in 2006. But 2007 is when everything is due to fall apart anyway. And in the meantime, you still win big if GoldCorp goes up.


Price 2/17/06

10 Contracts

Buy GoldCorp $30 Jan 08 call




Buy Goldman $130 Jan 08 put




Sell Goldman $130 Jan 07 put




Total Cost


Oil Kills Retail Spread

Now let’s say you expect oil to soar in the next couple of years. $4 gas might finally convince American consumers to stop their obsessive shopping, which in turn would cause upscale retailers like Abercrombie & Fitch to implode. So we’ll go long Exxon $65 calls of 08, and short Abercrombie & Fitch via its Jan 08 $70 puts.

Bill’s take: “Exxon is a right near its ‘05 high. It’s been going sideways for a year, building a base. It’s a slam dunk to go higher. Abercrombie & Fitch was $15 in ‘02, and now it’s $65. It’s put in a beautiful double top, and could fall to $30 easy.”


Price 2/17/06

10 Contracts

Buy Exxon Mobil $65 Jan 08 call




Buy Aber. & Fitch $70 Jan 08 put




Total Cost


The NASDAQ Tanks in 07 Calendar Spread

One of the risks of using options on individual stocks is that any given company can do things —good and bad—that have nothing to do with the market. GoldCorp could a have mine accident or Exxon another Valdez. Or Goldman Sachs could merge with CitiGroup or some other monstrous entity, making its puts worthless.

You can eliminate this risk with options on broad indexes like the S&P 500 or the NASDAQ. Because the NASDAQ is heavy on tech and light on energy and mining companies, its options, known as QQQQs, are especially juicy shorts. The QQQQ is currently $41, so let’s buy the Jan 08 $40 puts and sell the Jan 07 $40 puts, for a net cost of only $1,075 on ten contracts.

Bill “I’m looking for the Qs to be down in the 20s…hell, you’ll be $15 in the money if the market tanks in 07.”


Price 2/17/06

10 Contracts

Buy QQQQ $40 Jan 08 put




Sell QQQQ $40 Jan 07 put




Total cost