Obamacare Is Much Worse Than Even Critics Imagined!

Six months ago, President Obama, Senate Majority Leader Harry Reid and House Speaker Nancy Pelosi rammed Obamacare down the throats of an unwilling American public. Half a year removed from the unprecedented legislative chicanery and backroom dealing that characterized the bill's passage, we know much more about the bill than we did then. A few of the revelations:
» Obamacare won't decrease health care costs for the government. According to Medicare's actuary, it will increase costs. The same is likely to happen for privately funded health care.
» As written, Obamacare covers elective abortions, contrary to Obama's promise that it wouldn't. This means that tax dollars will be used to pay for a procedure millions of Americans across the political spectrum view as immoral. Supposedly, the Department of Health and Human Services will bar abortion coverage with new regulations but these will likely be tied up for years in litigation, and in the end may not survive the court challenge.
» Obamacare won't allow employees or most small businesses to keep the coverage they have and like. By Obama's estimates, as many as 69 percent of employees, 80 percent of small businesses, and 64 percent of large businesses will be forced to change coverage, probably to more expensive plans.
» Obamacare will increase insurance premiums -- in some places, it already has. Insurers, suddenly forced to cover clients' children until age 26, have little choice but to raise premiums, and they attribute to Obamacare's mandates a 1 to 9 percent increase. Obama's only method of preventing massive rate increases so far has been to threaten insurers.
» Obamacare will force seasonal employers -- especially the ski and amusement park industries -- to pay huge fines, cut hours, or lay off employees.
» Obamacare forces states to guarantee not only payment but also treatment for indigent Medicaid patients. With many doctors now refusing to take Medicaid (because they lose money doing so), cash-strapped states could be sued and ordered to increase reimbursement rates beyond their means.
» Obamacare imposes a huge nonmedical tax compliance burden on small business. It will require them to mail IRS 1099 tax forms to every vendor from whom they make purchases of more than $600 in a year, with duplicate forms going to the Internal Revenue Service. Like so much else in the 2,500-page bill, our senators and representatives were apparently unaware of this when they passed the measure.
» Obamacare allows the IRS to confiscate part or all of your tax refund if you do not purchase a qualified insurance plan. The bill funds 16,000 new IRS agents to make sure Americans stay in line.
If you wonder why so many American voters are angry, and no longer give Obama the benefit of the doubt on a variety of issues, you need look no further than Obamacare, whose birthday gift to America might just be a GOP congressional majority.

Fed Wants to Pump MORE Inflation!

I've been saying this for weeks!

by Terry Woo at Minyanville:

et ready everybody. Things are about to get a lot more expensive. In yesterday’s FOMC statement, for the first time that I know of, the Fed stated that prices aren’t rising fast enough. The actual words were this, “Measures of underlying inflation are currently at levels somewhat below those the committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.”

They must be referring to the CPI but we all know that measure has been artificially engineered for decades. That’s why you can’t look to TIPS as an accurate gauge.

Maybe they haven’t checked the prices of commodities recently. Below are the performances since June 1 (a little more than three months ago).
 

• Corn +42%
• Copper +12.6%
• Crude +2%
• Cotton +27%
• Coffee +38%
• Gold +6%
• Silver +14%
• Dollar -8%

So if you think this isn’t going to feed into your daily purchases at the local grocery store, then I have some oceanfront property to sell you in Arizona.

It’s almost unbelievable. But what’s worse? The committee stands ready to provide additional accommodation if needed to support the economic recovery. Translation: We’re going to buy more bonds. It’s no wonder Treasuries rallied post FOMC. Traders are simply front running the Fed.

As usual the true lone hawk Thomas Hoeing dissented. See my recent comments on hawks and doves at the FOMC.

So what does this mean for your portfolio? The currency debasement trade is still on and very strong and inflation beneficiaries will continue to outperform. Gold mining plays will shine as well as stocks with dollar-denominated liabilities and revenues coming from other countries with more stable currencies. If gold’s not your thing, look to McDonald’s (MCD), YUM Brands (YUM), and Walmart (WMT) as some potential plays.

Lastly, if you're watching spot gold today and wondering why SPDR Gold Shares (GLD) isn't tracking gold as good as it should be, that's just the difference between the Comex close, which is at 1:30 PM EST and the close of the equity markets. Don't let the monkeys tell you that it's contango because GLD doesn't even use gold futures.

Michael Pento: We're Increasing Our Leverage!

There is wide agreement among economists and the financial media that our lackluster economic performance stems from continued "deleveraging" among consumers and businesses. Although it is certainly true that after decades of overly speculative borrowing, individuals and corporations are paying down debt, rebuilding their savings, and generally repairing their respective balance sheets. But these activities cannot be faulted for our economic malaise.
In fact, as a country, we haven't deleveraged at ALL. All the moves made by the private sector have been vastly outpaced by the federal government's efforts to add leverage to the economy. The net result is that we are much more indebted now than we were before the recession began; as a result, we are digging ourselves even faster into debt.
The good news is that households paid down debt for the 9th quarter in a row. In Q2, they deleveraged at a 2.3% annual rate, as their total debt outstanding dropped from $13.52 trillion to $13.45 trillion from Q1. That's still around 92% of GDP, which is way up from the 48% level in 1980, but the direction is positive. Ultimately, the message here could not be clearer: American households have decided - either voluntarily or involuntarily - that it is in their best interest to quit borrowing money and reduce their debt levels in order to reconcile their balance sheets. The bad news is that most economists view this as a pernicious tendency.
To counter the trend, economists have called for government to provide the spending that others have deferred - and the feds have been thrilled to comply. In fact, during Q2, Washington accumulated debt at a 24.4% annualized rate! So, even though households and state and local governments have begun to learn some valuable lessons, DC still managed to increase the overall level of non-financial debt in the US to a record $35.45 trillion. In an era of supposed deleveraging, the rate of debt accumulation has increased from 4.5% to 4.8% annualized over the past quarter.
By focusing solely on the behavior of the private sector, and ignoring the equally important fiscal habits of government, the financial media and mainstream economists have displayed a dangerous blind spot in their thinking. They fail to understand or acknowledge that borrowing done by a household or a government is virtually the same thing. The US government does not have any independent means to generate wealth to pay off debt. It doesn't own factories or mines, and it does not operate a profitable service-sector business. It does not have an independent store of savings in another dimension, from which it can produce goods outside the bounds of economic law.
In the real world, all government stimulus comes from borrowing, spending, or printing, or to put it another way: deferred taxation, capital redistribution, or inflation. That means all US debt is ultimately backed by the tax base of the country. Therefore, whether the consumer or the government that does the borrowing is really unimportant because, in the end, it is the consumer that will receive the bill.
Meanwhile, government interventions are particularly pernicious because they encourage short-sighted behavior in the private market as well. It was reported today that corporations are using the rock-bottom interest rate environment to execute leveraged buybacks of their shares. While this temporarily increases shareholder value, it ultimately leaves the corporations - and the broader economy - even further in debt.
As of Q2 2010, total non-financial debt is rising at a 4.8% annual rate but GDP is growing at only 1.6% annualized. US debt as a percentage of GDP continues to climb, which should put to bed any talk of a deleveraging or deflating economy. Consumers are clearly only part of the equation - and, for now, the smaller part. The US government, in fighting the claimed deleveraging, is sending the total debt level into the stratosphere. As we watch it soar upward, the dollar steadily drifts downward.

Trade Wars: China Vs. Japan

HONG KONG — Sharply raising the stakes in a dispute over Japan’s detention of a Chinese fishing trawler captain, the Chinese government has blocked exports to Japan of a crucial category of minerals used in products like hybrid cars, wind turbines and guided missiles.
Chinese customs officials are halting shipments to Japan of so-called rare earth elements, preventing them from being loaded aboard ships this week at Chinese ports, three industry officials said Thursday.
On Tuesday, Prime Minister Wen Jiabao personally called for Japan’s release of the captain, who was detained after his vessel collided with two Japanese Coast Guard ships about 40 minutes apart as he tried to fish in waters controlled by Japan but long claimed by China. Mr. Wen threatened unspecified further actions if Japan did not comply.
A spokesman for the Chinese commerce ministry declined Thursday morning to discuss the country’s trade policy on rare earths, saying only that Mr. Wen’s comments remained the government’s position. News agencies later reported that Chen Rongkai, another ministry spokesman, had denied that any embargo had been imposed.

"President Obama is the most anti-business president of my lifetime." -- Cypress Semiconductor [CY]CEO T.J. Rodgers

Upward Move, Upwardly Revised New Claims

Futures dropped, but now the market is rallying, once again on poor economic performance. Since when is bad news cause for a rally? Is the Fed pumping the stock market again? Sure looks like it!

from Zero Hedge:

Initial claims not only missed consensus by 15K, jumping by 13K to 465K, but the previous number was of course revised higher from 450K to 453K. And a far bigger revision was in the continuin claims number, where the previous print was pushed higher from 4,485K to 4,537K. The current weekly number of 4,489K missed expectations of 4,473K nonetheless. Once again the BLS' endless "downward" revisions to prior economic data continue to misrepresent the economic at T-0 with impunity. But who cares about truth when patently wrong headlines is all that matters to the binary pirates. The only "good" news: EUC and Extended claims recipients jumped by over 200K in the past week, somewhat countering the prior week's plunge by over half a million as ever more claimants exhaust their full 99 weeks of various Tier benefits.

Stock Futures Lower on Weak Europe Data

from Fox Business:

U.S. markets were looking at a negative open to Thursday trading following a disappointing European economic output report dragged both European and U.S. equities lower.

As of 6:35 a.m. in New York, the Dow Jones Industrial Average futures lost 40 points, or 0.36%, to 10633, the S&P 500 index futures were down 5.8 points to 1124.00 and the Nasdaq 100 futures fell 5.5 points to 1974.00.

The European purchasing managers survey dropped to a reading of 53.8 in September, the firm Markit said Thursday, compared with the reading of 56.2 that was reported in August. While the report still shows some expansion in economic activity - a reading of 50 is neutral - traders expressed concerns that Europe could be next to suffer from the stalled recovery that's hindered the United States.

The major European indices were down between 0.7% and 1% across the continent.

Socialism Passed from Father to Son

Another Hyperinflationary Scenario

or nearly twenty years, we haven’t flinched from our prediction that the massive debt build-up of the last generation would precipitate out as a deflationary bust.  That is what we still expect, although we now believe there is likely to be a hyperinflationary phase at some point as the financial system implodes. But the bottom line is that no matter how things play out, America’s standard of living will fall more steeply than at any other time since the Great Depression. As for the deflation-vs.-hyperinflation “debate,” it is useful only to the extent it helps predict how mortgage debtors will fare as this economic cataclysm plays out. We seriously doubt they will be “saved” by the kind of hyperinflation that would put hundred-thousand-dollar bills in Joe Homeowner’s wallet. Imagine how mortgage lenders would react if Joe could peel off three or four of those bills and say, “Okay, pal, we’re square.”  This scenario will seem particularly unlikely to those who believe that these economic hard times have been engineered by Masters of the Universe intent on stealing our property.  Trust us on this:  If there’s a hyperinflation, it is the rentiers who will get screwed most ruinously, not the little guys.

Even so, that doesn’t rule out the prospect of a fleeting, hyperinflationary spike on the way down, since widespread notions concerning the dollar’s true value could change precipitously overnight. We mention this because notions are already beginning to change in ways that leave the dollar increasingly vulnerable to a global run. The exploding caldera of fear that will eventually bring this about bubbled to the surface yesterday when the Fed confirmed yet again that it is absolutely clueless about how to get the economy moving.  The central bankers’ muddled talk of still more “quantitative easing” (QE2) is about as reassuring as the promise of more sanctions against Iran.  Paul Krugman may be the last person in America who still believes that additional heaps of “stimulus” will do the trick. On Wall Street, however, the belief is clearly ascendant that QE2 will only wreck the dollar without providing any lift to the economy. That could explain why stocks fell yesterday while gold and silver soared. Not that the yahoos on Wall Street exhibited perfect knowledge. To the contrary, the broad averages shot up initially, driven by headless-chicken panic, and T-bonds finished the day with anomalously large gains despite the louche tittering about further easing.

Schiff’s Scenario

Peter Schiff has provided the most plausible scenario for a hyperinflation. He foresees a day when confidence in the dollar collapses, as it eventually must, forcing the Fed to become the sole buyer of Treasury debt.  When municipal and corporate bond traders realize on that same day that there is no official support for their markets, private debt will go into a death spiral, forcing the Fed to monetize all bonds. Under the circumstances, the Fed would not become merely domestic debt’s buyer of last resort, but the only buyer. Voila! Hyperinflation.

It should be noted that it is not some certain quantity of money injected into the banking system that will cause hyperinflation; rather, it will be the repudiation of all dollars already in circulation. Holders of physical dollars will panic to exchange them for anything tangible, causing the dollar’s value to fall to zero in mere days. Everything needed to trigger this collapse is already in the pipeline, and it is only the truly benighted, Nobelist Paul Krugman foremost among them, who cannot see the obvious. As for mortgage debt, you will still owe $250,000 on your home the Day After, except that your home will be much more deeply underwater than before – worth perhaps $20,000 instead of $180,000.  Mortgage lenders will have to work with you – work with scores of millions of homeowners who are in the same boat – to bring about a reconciliation.  No one can predict how already-unpayable mortgage debt will ultimately be paid, but it is almost certain to require a radical change in our laws in order to avoid the kind of social upheaval that could jeopardize the very rule of law.

Another Scenario Causing a Hyperinflationary Depression

You see millions of websites devoted to the topic. These would mostly be the self-proclaimed “Gold bugs” who warn us that an impending hyperinflationary event, which would significantly boost prices of all precious metals and necessities such as food, would lead to chaos as the country’s savings would vanish literally over the course of a couple of weeks.  Riots would occur. Commodities would gain in value as Fiat currencies see their end game.  Overall it portrays a very ugly picture indeed (let me pull out that Mayan Calendar).  My definition of hyperinflation revolves around a deep and sharp loss of confidence in a currency. This is different than inflation where it is simply a function of too many dollars in the economic system; however, the line between high levels of inflation and hyperinflation is quite gray primarily dominated (in my view) by “future inflation expectations”. Quick upward movements in this metric would signal to me that the public is less confident in the purchasing power of their currency, a prerequisite to hyperinflation. Another reason that I’ve thought of, though not heard much about, would be a supply-side shock in important material resources.   Regardless, I’ll come out and say upfront that there are so many headwinds, crosswinds, you name it, that predicting whether hyperinflation would occur would be akin to throwing darts. However, this will not stop me from researching the reasons why such an event may occur.
First my stance: Overall I believe that the probability of a hyperinflationary event occurring due to a loss of confidence in the US dollar remains very remote.
The other reason for hyperinflation is more unique and deserves more attention. The Fed, for all intents and purposes, is becoming a growing national security threat in my view. My main reason for such a diatribe is rooted in its quantitative easing strategy in an attempt to avoid deflation. This strategy seems shortsighted in my view from a longer-term perspective. Given the last round of quantitative easing and the low rates that it produced it is now obvious that consumers are not keen on increasing demand for loans. Despite the Fed’s best attempts to restart lending and keep the credit machine growing, the consumer has made its intentions known. They are in the process of de-leveraging and saving. Decades of profligate spending are coming home to roost; the bill now needs repaying.  Retirees must save as their largest asset (home) has taken a beating and doesn’t seem to be bouncing back anytime soon. The consumer is looking to fix its balance sheet, translating to an overall period of secular weakness in the economy.  The fundamental question that I have is whether the Fed, and perhaps more importantly, policymakers see continued debasement of the dollar via quantitative easing as a viable strategy to combat our problems. If they do, quantitative easing will continue and if it continues, I see an increasing probability of the following long-term scenario unfolding.

We continue to experience a deflationary environment over the short and medium term. At first, as it does now, it will seem that pursing a quantitative easing strategy is a more viable strategy as we have strong deflationary forces in the form of deleveraging. However, this is where I see it getting interesting. China is taking the steps necessary to boost its domestic consumption and rebalance its economy. Social safety nets are in the process of being enacted. As a Chinese official, it obviously makes sense to boost the domestic sector given that growth in export demand is not likely to continue as developed economies repair their balance sheets. We also know that presently China accounts for a large portion of demand in commodities. Its population remains mostly rural with poor incomes. What this means is that there is large pent-up demand and the prospects for accelerated and prolonged growth phase are very favorable. The day/month/year that the Chinese consumer begins to loosen its wallet and see credit as a viable tool, leading towards increased demand will bring about the moment of reckoning. For starters, commodities such as oil, copper, gold, silver, platinum and palladium would see a large acceleration in demand.  Agricultural commodities would also increase as Chinese citizens upgrade their diets. Investors would see renewed opportunities in the US manufacturing sector as exports would grow to quench the demand of the massive Chinese consumer. Job growth would stage a comeback as well as wages. Capacity utilization would increase rapidly after years of trimming down excess fat, which would have resulted in a very lean manufacturing base. We would have a major supply side-shock from higher commodity prices, coupled with low industrial capacity as the major contributors to a major increase in inflation. In the end, China’s economic restructuring would be the key that unlocks the hyper inflationary box. While an increase in jobs and higher wages are good things, the effects that they would bring (sharp moves higher in inflationary expectations) would negatively affect the retiring baby boomers and the unemployed. Furthermore, any hint of higher inflation would be met with sharply rising yields as a massive supply of bonds, which were issued  as the US built up massive deficits, would begin to be sold. Overall, we would be in an environment where persistently high yields, coupled with higher commodity and food prices would continuously sap the purchasing power of the US consumer and suppress investment in the domestic economy.  We would be in a depression, but with very high inflation as Chinese demand would ensure that important commodities retain a very high premium, while only decreasing marginally in value should there be a sell-off.  Whether our population begins to panic over the purchasing power of their dollars will determine whether we have a very bad stagflationary or hyper-depressionary event.  That would be the major wildcard.

The top risk to delaying this sequence of events would be a bout of protectionism/trade war with the US, which I do see happening. However, this would only set back this process, not prevent it. As long as our politicians and the federal reserve continue on their quest to debase our currency, the threat of a hyper-depression remains. I personally do not believe this will happen, as there would eventually be enough opposition to quantitative easing to cease it, due to fear that it may result in destroying the savings or our baby boomer population and the financially prudent (the people who are actually important towards having a healthy and sustainable economy).   However, we may very well be in a situation where Fed officials don’t realize what they’re doing until it’s too late.

One In Five Homes At Risk of Foreclosure

from Reuters:

The page proofs of my upcoming book, “Inflated: How Money and Debt Built the American Dream,” just went back to the editors. One of the benefits of writing a book about U.S. financial history is that it forces you to take a long view of both economics and the political narrative used to describe it. It is the issue of language and labels, in my view, that is making it so difficult for Americans to understand the current state of the economy.
The National Bureau of Economic Research just declared that the “recession” that began in 2007 ended in the middle of 2009, making it the longest downturn since WWII. The only problem is that none of the people who work at NBER today, which is one of my favorite research organizations, are old enough to remember what the U.S. economy was like before WWII; before the age of Keynesian socialism and the use of debt to stimulate growth and employment became standard policy in Washington.
Let’s start with the term “recession,” which itself reflects the assumption that economic growth is always positive and the trend line is always upward sloping. While many economists in the U.S. remain convinced that this is an accurate descriptor, what Americans and many other people of the world need to consider is whether the assumption that the economy will grow endlessly is reasonable.
In the period following the Crisis of 1907 and before the start of WWI, Americans faced a grim economic outlook. Jobs were scarce, product and commodity prices were flat, and the value of farm products and land had been falling for years. The American economy was entirely dependent upon Europe for financing and to buy U.S. products, mostly agricultural and other commodities. The dismal economic scene fed the rise of the Progressive movement in U.S. politics.
WWI provided a sharp relief from this picture of economic stagnation. Employment rebounded, American agricultural prices soared and the value of real estate around the U.S. also rose sharply. With renewed growth came inflation, however, so that by the time that WWI ended, prices for many consumer staples had doubled, but wages did not keep pace. Economic activity gradually slowed as the U.S. made its way through the Roaring Twenties, but many Americans never saw any benefit from this period of speculation and financial excess.
Following the Crash of 1929, the pretense observed by both political parties that all was well in the U.S. economy evaporated into almost twenty years of economic stagnation. While the massive mobilization  for WWII provided the appearance of a recovery, and the period of the Cold War extended this mirage on a sea of public debt and paper dollars, the basic issue of overcapacity remained.
From the 1970s, when the U.S. shifted from defense to housing as the chief driver of American economic growth, the illusion became ever more attractive and, seemingly at least, permanent. But the sad fact is that much of what Americans think was real growth supported by real income and real work was, in fact, the result of deficit spending and reckless monetary expansion by the Fed, first under Alan Greenspan and now Ben Bernake.
In an interview for my book former Fed Chairman Paul Volcker noted:

We live in an amazing world. Everybody has big budget deficits and big easy money, but somehow the world as a whole cannot fully employ itself. It is a serious question. We are no longer just talking about a single country having a big depression but the entire world. If the world as a whole cannot employ everyone who is ready and able to work, it raises some big questions.

Earlier this week in a research note for the IRA Advisory Service, we reported that some of the leading experts in the housing sector believe that the U.S. is less than 25% through the restructuring of defaulted loans on commercial and residential real estate, and that the backlog is growing.  Last week at the AmeriCatalyst conference held in Austin, TX, Laurie Goodman from Amherst Securities predicted that one in five U.S. households remains at risk of foreclosure. If this prediction turns out to be correct, the optimistic view of the U.S. economy and banking sector must be radically revised — and soon.
Just as the housing sector and the related debt was the driver of the U.S. economy over the past several decades, I believe that the deflation of the housing market could spell an equally drastic period of shrinkage in economic activity in the U.S. and around the world.  In order to meet this challenge, both the political and economic communities need to put aside preconceived notions of how the economy should look and begin to develop new language to describe what is really happening to consumers and businesses. Only then can we truly begin the process of working through what is the most serious economic contraction in the U.S. since WWI.

Greespan Warns That Gold Is the "Canary In the coal mine"

Another record high for gold today.

fron NY Sun:

Only days after the former Federal Reserve chairman Alan Greenspan warned that “fiat money has no place to go but gold,” the dollar has collapsed to a new low. The remarks of the former Fed Chairman were made a week ago at the Council on Foreign Relations, causing a flurry of excitement on the Internet. The dollar shed value, dropping to a record low yesterday, within minutes of the Federal Reserve declaring that it was, as characterized by Reuters, “ready to provide more support for the economy and expressing concerns about low inflation.”

It’s amazing to us that this doesn’t seem to be raising an alarm in either the halls of Congress, the administration, or the newsrooms. Kitco News, which is published by the gold dealer, reported the reaction this way: “Around 3:30 p.m. EDT (1930 GMT), spot gold was up $6.90 to $1,285.40 an ounce, compared to $1,272 about 10 minutes ahead of the Fed statement. December gold on the Comex division of the New York Mercantile Exchange was $6.90 higher at $1,287.70, compared to $1,273.30 ahead of time. In after-hours trading following the Fed statement, the December futures went on to a high of $1,290.40; that is a fresh record for a most-active Comex contract.”
Regular readers of these columns know that we prefer not to speak of the “price of gold” but rather of the “value of the dollar.” Kitco’s reporter quoted the managing director of Trend/Max Futures, Zachary Oxman, as saying the Fed “all but confirmed” quantitative easing and predicting that the value of the dollar would fall below a 1,300^th of an ounce of gold by the end of this week and to between a 1,400^th of an ounce and a 1,500^th of an ounce of gold by the end of the year. That would mean that the dollar would have dropped from a 271^st of an ounce on January 1, 2001.
Is Matt Drudge the only editor of a general interest publication who understands the front-page nature of this collapse? This is not about a sudden failure of the mines. Or a sudden manufacturing need. This is about a failure of the Congress to carry out its responsibilities under the Constitution. To suggest that the trend is reversible with an adjustment of interest rates does not address the issue we see. The issue is that there is neither a law or a policy being enforced or followed that references gold or silver as a matter of principle in the way that the Founders of the country understood — and, in the founding Congresses, wrote into law.
We have one recent Fed chairman, Mr. Greenspan, who seems to understand the importance of gold — it, he said at the Council on Foreign Relations, “is the canary in the coal mine. It signals problems with respect to currency markets.” Now we have another Fed chairman who, in Mr. Bernanke, is prepared to testify before Congress that he doesn’t “fully understand the movements in the gold price,” though he does acknowledge that “there’s a great deal of uncertainty and anxiety in financial markets right now and some people believe that holding gold will be a hedge against the fact that they view many other investments as being risky and hard to predict at this point.”

* * *

When we wrote about that testimony in the spring, we called Mr. Bernanke’s answer a classic. “One doesn’t go into gold because, as the be-puzzled Mr. Bernanke seems to suggest, one lacks confidence in, say, ‘other investments,’ soybeans, say, or iron ore,” we suggested. “One goes into gold because one lacks confidence in the fiat currencies.” That’s the point Mr. Greenspan spoke of at the Council. The Congressman who put Mr. Bernanke on the spot then was Paul Ryan of Wisconsin. We suggested at the time that when they next get the chairman back on the Hill they press him about the Founders and their understanding of money, their fear of paper money, their warnings to future generations, and the laws and definitions of the dollar that they put into the national currency. The Founders on the dollar are worth an entire hearing, and by our lights it can’t come too soon.

"He'll just keep printing money until the problem goes away!" Aaron Fennell

Aaron Fennell is the Chief Market Strategist in Canada for Lind-Waldock.Of course, he was speaking of Ben Bernanke.

No Inflation? Would Someone Please Show Bernanke This Chart?

If inflation in commodities is this high now, and the Fed has highlighted that its mandate is to create more inflation, what are the consequences of what the Fed is doing?

REAL U.S. National Debt Closer to $200 Trillion!

from news.com Australia:

THE actual figure of the US' national debt is much higher than the official sum of $US13.4 trillion ($14.3 trillion) given by the Congressional Budget Office, according to analysts cited on Sunday by the New York Post.
"The Government is lying about the amount of debt. It is engaging in Enron accounting," said Laurence Kotlikoff, an economist at Boston University and co-author of The Coming Generational Storm: What You Need to Know about America's Economic Future.
"The problem is we're seeing an explosion in spending," added Andrew Moylan, director of government affairs for the National Taxpayers Union.
In 1980, the debt - the accumulated red ink incurred by the Federal Government - was $US909 billion.

This represented some 33 per cent of gross domestic product, according to the Congressional Budget Office (CBO).
Thirty years later, based on this year's second-quarter numbers, the CBO said the debt was $US13.4 trillion, or 92 per cent of GDP.
The CBO estimates the debt will be at $US16.5 trillion in two years, or 100.6 per cent of GDP.
But these numbers are incomplete.

They do not count off-budget obligations such as required spending for Social Security and Medicare, whose programs represent a balloon payment for the Government as more Americans retire and collect benefits.
In the case of Social Security, beginning in 2016, the US Government will be paying out more than it is collecting in taxes.

Without basic measures - such as payment cuts or higher payroll taxes - the system could be on the road to bankruptcy, according to officials.
"Without changes," wrote Social Security Commissioner Michael Astrue, "by 2037 the Social Security Trust Fund will be exhausted. There will be enough money only to pay about $US0.76 for each dollar of benefits."
Mr Kotlikoff and Mr Moylan agree US national debt is much more than the official $US13.4 trillion number, but they disagree over how to add up the exact number.
Mr Kotlikoff says the debt is actually $US200 trillion.
Mr Moylan says the number is likely about $US60 trillion.

That is close to the figure quoted by David Walker, the US Comptroller General from 1998 to 2008.

He launched a campaign to convince Americans that the federal spending and debt is a greater threat than terrorism.
But whichever figure is accurate, all three agree that the problem has worsened in the last few years.

They say it is because Congress and the Administration, whether Republican or Democrat, consistently overspend.

Household Net Worth Continues to Plunge

from Reuters:

(Reuters) - U.S. household wealth fell by $1.5 trillion in the second quarter, according to Federal Reserve data on Friday that showed the strain a slow-paced recovery and high unemployment are putting on Americans.
Household net worth fell to $53.5 trillion, well below the $64.2 trillion it had reached at the end of 2007 when the recession officially began, according to the central bank's quarterly flow of funds report.
Declines in the value of financial assets -- especially in stocks and mutual funds -- accounted for much of the decline in second-quarter net worth. Stocks alone were down $1.9 trillion to $14.9 trillion, more than offsetting small gains in other areas like state and local government retirement funds.
Consumers pared debt at a seasonally adjusted annual rate of 2.3 percent, the ninth consecutive quarter in which they did so. Home mortgage debt fell at an annual rate of 2-1/4 percent after a 4-1/4 percent drop in the first three months this year.

Housing Starts Leap 10.5%!

from Marketwatch.com

WASHINGTON (MarketWatch) - New construction of U.S. houses surged in August, the Commerce Department estimated Tuesday. Starts rose 10.5% in August to a seasonally adjusted 598,000 annualized units, much stronger than the 535,000 pace expected by economists surveyed by MarketWatch. This is the highest level since April. Starts in July were revised down slightly to a 541,000 rate compared with prior estimate of 546,000. Starts of new single-family homes rose 4.3% to a 438,000 rate in August, while starts of large apartment units rose 32.2% to 160,000. Building permits, a leading indicator of housing construction, rose 1.8% to a seasonally adjusted annual rate of 569,000.

Morgan Stanley's Perspective on Sovereign Debt Defaults

By Arnuad Mares
September 20, 2010
This is the first issue of Sovereign Subjects, a new Morgan Stanley publication focusing on sovereign risk in advanced economies. In this first installment, we take a broad perspective on government balance sheets and raise several themes to which we will return in more depth in subsequent issues. We encourage clients to provide us with feedback on this new publication.
Debt/GDP ratios are too backward-looking and considerably underestimate the fiscal challenge faced by dvanced economies’ governments. On the basis of current policies, most governments are deep in negative equity.
This means governments will impose a loss on some of their stakeholders, in our view. The question is not whether they will renege on their promises, but rather upon which of their promises they will renege, and what form this default will take.
So far during the Great Recession, sovereign (and bank) senior unsecured bond holders have been the only constituency fully protected from partaking in this loss.
It is overly optimistic to assume that this can continue forever. The conflict that opposes bond holders to other government stakeholders is more intense than ever, and their interests are no longer sufficiently well aligned with those of influential political constituencies.
There exists an alternative to outright default. ‘Financial oppression’ (imposing on creditors real rates of return that are either negative or artificially low) has been used repeatedly in history in similar circumstances.
Investors should be prepared to face financial oppression, a credible threat against which current yields provide little protection.

---

Ask Not Whether Governments Will Default, but How

The sovereign debt crisis is not European: it is global. And it is not over. The European sovereign debt crisis of spring 2010 was a misnomer in more ways than one: there was not one crisis but two. And it will continue well beyond 2010, in our view. The first crisis was, and remains, an institutional crisis of the euro, caused by a flawed multilateral fiscal surveillance framework. Steps have been taken towards a correction of the flaws with a move from peer pressure to peer control of fiscal policy. This is reflected by the acceptance by the Greek, Spanish and Portuguese governments of fiscal measures largely dictated from Berlin and Brussels. The second crisis was, and remains, a sovereign debt crisis: a crisis caused by sovereign balance sheets being overstretched, to the point where insolvency ceases to be merely possible and becomes plausible. This crisis is not limited to the periphery of Europe. It is a global crisis and it is far from over. We take a high-level perspective on the state of government balance sheets and conclude that debt holders have to be prepared to enter an age of ‘financial oppression’.
Debt/GDP has been higher before, so why worry?  As government debt and deficits have swollen to levels for which there exist few recent references, all eyes have turned to a more distant past in the hope of finding some guidance as to what future awaits bondholders. At first glance, history appears to be reassuring, though that is deceptive, in our view. Several advanced countries have experienced debt/GDP levels well in excess of current ones. The US emerged from Word War II with a public debt/GDP ratio of approximately 110%, and the UK with a ratio of 250%. The UK national debt has averaged almost 100% of GDP since its creation in 1693 (see Exhibit 1). Yet the UK government never defaulted through that period. France’s public debt stood at about 280% of GDP at the end of World War II. It did not default either. As a matter of fact France defaulted only once – in 1797 – since the creation of its own national debt in 1789. This is remarkable, considering the number of political, military and economic crises the country went through. So why worry now?
 
Four reasons why debt/GDP misses the point. The problem with these historical comparisons is not the reference: how governments dealt with their war debt burdens sheds useful light on what might be in store for coming years. Rather, the problem lies with the measurement tool: debt/GDP is the most widely used debt metric, but we believe that it is a very inadequate indicator of government solvency. There are four reasons for this:

• Gross versus net debt: First, debt/GDP is a measure of gross indebtedness. It therefore overstates the size of the government’s net financial liabilities, especially when – as has been the case through the crisis – debt is being raised for the purpose of on-lending or acquiring assets. Where measures of net debt exist, they provide an apparently less alarming picture of the government’s balance sheet. The difference can be sizeable (in excess of 17% of GDP in the UK currently, for instance). Good news, however, stops here.
• Missing liabilities: The second flaw of debt/GDP is that it only accounts for part of a government’s contractual liabilities. There exists a broad range of liabilities that are debt, yet are not captured in national accounts. To take one example, in March 2008 the UK Government Actuary Department valued the government’s unfunded civil service pension liabilities – that is, the contractual claims on government accumulated to date by civil servants – at £770 billion. That is 58% of GDP, not captured by the debt/GDP ratio. Debt/GDP does not capture contingent liabilities either.
• It is not GDP but government revenues that matter: Whatever the size of a government’s liabilities, what matters ultimately is how they compare to the resources available to service them. One benefit of sovereignty is that governments can unilaterally increase their income by raising taxes, but they will only ever be able to acquire in this way a fraction of GDP. Debt/GDP therefore provides a flattering image of government finances. A better approach is to scale debt against actual government revenues (see Exhibit 2). An even better approach would be to scale debt against the maximum level of revenues that governments can realistically obtain from using their tax-raising power to the full. This is, inter alia, a function of the people’s tolerance for taxation and government interference. Seen from this angle, the US federal debt no longer compares quite so favourably with that of European governments.

 

• Debt/GDP looks at the past. The main problem is in the future: The fourth and largest flaw of debt/GDP is that it is an entirely backward-looking indicator. It only accounts for the accumulation of past deficits. This captured reasonably well the magnitude of the fiscal challenge at the end of World War II because at that time the challenge did indeed result entirely from the past: large wartime deficits had pushed debt ratios higher, but governments were no longer running deficits, nor were there expectations of them doing so in subsequent years.
  By contrast, the accumulation of past deficits now represents only part of the problem for advanced economies’ governments. The other part consists of coping with the large structural deficits opened up by the crisis and compounded by the fiscal consequences of ageing. What raises questions about debt sustainability is not so much current debt levels as the additional debt that will accumulate in coming years if policies do not radically change. Debt ratios do not capture this part of the problem.

Looking beyond debt: valuing government equity. A comprehensive look at government balance sheets provides a much gloomier reading of their solvency. Exhibit 3 shows a stylised representation of the government balance sheet. In addition to financial assets and liabilities appear ‘fiscal’ assets and liabilities. On the asset side is the power to tax, which is the main asset and resource of any government. It can be conceived as a variable rate claim on GDP, where the rate depends on the level of taxation. Its value on the balance sheet is therefore the net present value of all future tax revenues. On the liability side appears a ‘social’ liability, which represents the promise of the government to its electorate to spend resources on defence, justice, education, health and any other existing government policy. Its value is the net present value of all future primary expenditure. The difference between the power to tax and the social liability is the net present value of all future structural primary deficits (by definition, the cyclical component of the deficit should sum up to zero over time).
 
The residual is represented on the balance sheet as the people’s equity, by analogy to a corporate balance sheet. This is effectively the net worth of the government in the broadest sense, and a measure of its solvency. It can be interpreted very simply as follows: if positive, the government can release value to taxpayers by lowering taxes without reneging on its promises to other stakeholders (bond holders and beneficiaries of public services). If negative, the government is insolvent. In other words, some or all of its stakeholders must suffer a loss: either taxpayers (through a higher tax burden), or beneficiaries of public services (through lower expenditure) or bond holders (through some form of default).
Adding the cost of ageing to that of the crisis. An estimate of government ‘equity’ value can be obtained by adding the net present value of all future primary deficits to existing financial debt. Future primary deficits result from two influences:

• Current structural deficits, opened up or aggravated during the crisis by the permanent loss of tax revenues that accompanies a permanent loss of output. This is the part of the deficit that will remain – once temporary stimulus measures are withdrawn and growth has returned to trend – under an assumption of unchanged policies;
• The additional structural deficit that – under the same assumption of unchanged policy – would gradually result from ageing, mostly through a rise in health and pension expenditure.

The fiscal challenge is unprecedented. Exhibit 4 provides illustrative estimates of government net worth under this approach. What matters here is not the exact numbers, which are very dependent on underlying assumptions (see box). What matters is the sign of net worth (negative everywhere), its broad order of magnitude (a large multiple of current or historical debt levels almost everywhere) and the ranking of governments.
 
This depressing perspective on global public finances is not exactly news. The same calculations based on pre-crisis data were not nearly as bad, but not significantly more encouraging either, with most governments already then in negative equity. The crisis has had three noticeable effects nonetheless:

Estimating Government Net Worth: Underlying Assumptions
Our illustrative estimates of government net worth are based on the following assumptions:
Initial debt level: For the purpose of simplicity, consistency and availability of data across countries, we use the projected debt level of gross debt/GDP at end-2010 – even though the correct aggregate to use here is clearly net financial debt. This has no material bearing on the conclusions of the exercise.
Structural deficit: The exact size of the structural deficit is a guesstimate at best – it requires an assessment of potential GDP, a notoriously imprecise concept. Calculations are based on official projections of cyclically adjusted primary deficits in 2011, and we assume that this deficit is unchanged in every subsequent year (as a percentage of GDP). This is consistent with the assumption of ‘unchanged policy’. In practice governments do intend to change policy – and thereby to reduce the size of the structural deficit. In doing so they inflict a loss on taxpayers (if raising taxes) and on other stakeholders (when cutting expenditure). As the purpose of the exercise is precisely to evidence the magnitude of the loss that these will suffer, assuming an unchanged structural deficit at current levels is the appropriate reference point. It is for this same reason that we use as a reference point 2011 and not 2010 data: the latter is still distorted in some countries by stimulus measures, which, being temporary by nature, never constituted a ‘promise to spend’. The removal of the stimulus measure does not therefore inflict on stakeholders a loss as we define it.
Cost of ageing: Estimates of the cost of ageing on public finances – even under unchanged policy – rely heavily on demographic and economic projections. For the purpose of our illustrative calculations, we used long-term projections of age-related expenditure published by the EU and – for the US – by the IMF. For the same reason as above, the reference point is pre-fiscal retrenchment, i.e., the calculation does not take account of the ongoing pension or healthcare reforms decided or being discussed this year in many countries.
Discount rate: The net present value of future fiscal deficits is naturally heavily dependent on the discount rate used. The calculations illustrated in Exhibit 4 assume a discount rate 100bp above the nominal GDP growth rate across all countries.

• It has aggravated the problem everywhere, mostly through a permanent shock to tax revenues and through a transfer of liabilities and risk from the private to the public sector, without a commensurate transfer of resources.
• In doing so, it has intensified the inherent conflict that exists between bond holders and other government stakeholders that all compete for resources that are finite and, crucially, insufficient to satisfy all their claims – to the point where holders of government debt have started contemplating default as a plausible outcome rather than a mere theoretical possibility...
• ... which, in turn, considerably shortened the time available to governments to resolve this conflict one way or the other, with a loss of market access a credible penalty for procrastination.

It is not whether to default, but how, and vis-à-vis whom. What this means is that – as indicated above – governments will impose a loss on some of their stakeholders and have in fact started to do so (across Europe at least). The question is not whether they will renege on their promises, but rather upon which of their promises they will renege, and what form this default will take. From the perspective of sovereign debt holders, this translates in two questions:

• Does their claim on governments rank senior enough relative to other claims to fully shelter them from losses?
• If it does not, what form will this loss take?

Bonds remain the most senior government liability. There are good reasons why government bonds should rank senior to most other liabilities. To mention one: governments need to be able to raise finance to fund public investment as well as to perform their macroeconomic stabilisation role. They cannot issue equity, and cannot credibly issue secured debt. Unrestricted access to unsecured, confidence-based funding is core to their ‘business model’, as it is for banks. This was, historically at least, the main argument for honouring sovereign debt. There are others, not least the consequences of a government default for output and for financial stability when banks own substantial exposure to the sovereign.
Bond holders have been fully sheltered from loss through the Great Recession – so far. This seems consistent with historical experience, both from yesteryear (see Exhibit 1) and yesterday. So far indeed, holders of sovereign debt have been exempt from sharing in the loss of income and wealth that has affected everybody else: shareholders have absorbed direct losses. Homeowners have faced (uneven) losses of property value. Taxpayers have experienced a reduction in their lifetime income through current and prospective increases in taxation. Government employees and other stakeholders are suffering even larger losses through current or prospective reduction in government expenditure. Only holders of senior unsecured debt issued by the largest governments and – in most cases – banks have been sheltered so far.
Can this realistically continue forever? This is ultimately a question of political economy. It is worth noting that, in the case of Greece, public acceptance of austerity measures – cuts in civil service compensation in particular – has become conditional on the perception that the cost of fiscal retrenchment would be distributed fairly across constituencies (hence the very public crackdown on wealthy tax evaders). Whether and when bond holders are asked to share in the common pain – not just in Greece – depends on:

• The intensity of the conflict that opposes them to other stakeholders. As discussed earlier, this is likely stronger than it has ever been; and
• The extent to which the interests of bond holders are aligned with those of the most politically influential constituencies.

Financial oppression as an alternative to outright default. Outright default is not the only way to impose losses on creditors. Financial oppression – the fact of imposing on creditors real rates of return that are negative or artificially low – can take other forms: repaying debt in devalued money (e.g., through unanticipated inflation), taxation or regulatory incentives on institutions to purchase government debt at uneconomic prices, for instance (see also “Default or Inflate or…”, The Global Monetary Analyst, February 24, 2010). Repaying debt in devalued money is particularly effective when the initial stock of debt is high – as it is now. Distorting prices in the government’s favour is particularly effective when the financing requirement is high – also a situation we face now and for years to come.
History is not so reassuring after all. Financial oppression has taken place in the past as an alternative to default in countries that are generally considered to have a spotless sovereign credit record. Examples include: the revocation of gold clauses in bond contracts by the Roosevelt administration in 1934; the experience by then Chancellor of the Exchequer Hugh Dalton of issuing perpetual debt at an artificially low yield of 2.5% in the UK in 1946-47; and post-war inflationary episodes, notably in France (post both world wars), in the UK and in the US (post World War II). Each took place at a time when conflicting demands on finite government resources were high, and rentiers wielded reduced political power.
 
The interests of bond holders are no longer perfectly aligned with those of the most powerful constituency. Exhibit 5 shows the rapid increase in the age of the median voter in large western European countries. In principle, having governments and policies shaped by older voters ought to be favourable to bond holders, because bonds are more likely to be held by the old than the young and policies that would harm bond holders would often also harm the old (inflation for instance redistributes wealth from the old to the young). The first problem with this argument is that the constituency of the elderly is also the biggest competitor to bond holders because of the considerable size of the direct claim it has on the government balance sheet in the form of pensions, social security and health insurance, etc. The more reluctant they are to relinquish these claims, the higher the risk for bond holders. The second problem is the dilution of bond ownership, which results in lesser alignment of the interest of bond holders with older voters: even in the UK, where the domestic and pension industry has traditionally dominated the gilt market, its ownership of gilts has decreased in recent years from around 60% to 40% of the market excluding Bank of England purchases), to the benefit of foreign investors.
No insurance against financial oppression at current yield levels. Against this background, it seems dangerously optimistic to expect that sovereign debt holders can be continuously and fully sheltered from partaking in the loss of wealth and income that has affected every other group. Outright sovereign default in large advanced economies remains an extremely unlikely outcome, in our view. But current yields and break-even inflation rates provide very little protection against the credible threat of financial oppression in any form it might take. Note that a double-dip recession would not invalidate this conclusion: it would cause yet further damage to the governments’ power to tax, pushing them further in negative equity and therefore increasing the risks that debt holders suffer a larger loss eventually.

Warren Buffett Got a Bailout? $95 BILLION Worth!

Worse still, $7 billion went into his personal pocket!

Fed pours $5.2 Billion Into Stocks Today

from Zero Hedge:

Today's POMO is over, and the result is a whopper: Brian Sack has just injected a record for QE Lite $5.2 billion in stock, in order to complete all the elements of today's orchestrated Obama Town Hall meeting, during which the president is now fully expected to announce that he not only managed to end the recession singlehandedly (what an opportune time for the NBER to announce its results), but that stocks are now ripping every single time he appears on TV (same goes for gold, oil, and pretty much everything else: and furthermore, Treasurys are unchanged, refuting all of Mr. Pisani's BS about capital reallocation in process). $5 billion today, add another $6 billion on Wednesday and Friday, lever up 30 times and you have some $300 billion in free buying given to the Primary Dealers so they can ramp the S&P to 1,150 by the end of the month. Job well done Mr. President. Too bad nobody but Wall Street and a few HFT prop desks care about the stock market any more.

NBER Announces Recession is OVER! (last year!)

Tell that to the American People!

From the NBER: "The Business Cycle Dating Committee of the National Bureau of Economic Research met yesterday by conference call. At its meeting, the committee determined that a trough in business activity occurred in the U.S. economy in June 2009. The trough marks the end of the recession that began in December 2007 and the beginning of an expansion. The recession lasted 18 months, which makes it the longest of any recession since World War II. Previously the longest postwar recessions were those of 1973-75 and 1981-82, both of which lasted 16 months."

POMO Stock Buying -- Right on Time!

Malaysia Begins Dumping Dollars

from Zero Hedge:

Overnight gold hit a fresh all time record as increasingly more people make their own decision to go back to the gold standard, away from endless currency dilution, and away from the dollar as reserve currency. Curiously, the latest salvo in the case of the latter came from Malaysia which, courtesy of the FT, we learn has "bought renminbi-denominated bonds for its reserves, marking a significant advance for Beijing’s attempts to internationalise the use of its currency, pitched by Chinese policymakers as a long-term rival to the US dollar." While relatively under the radar, this development will have huge implications for global capital flows: as Credit Agricole's Dariusz Kowalczyk, says, "the central bank’s move is also expected to herald further diversification into Chinese government securities by other Asian countries. This brings the renminbi’s credibility to a whole new level. It will have a domino effect, starting among China’s trading partners in Asia. Then it will gradually spread globally." Of course, it also shows that what China does to Japan by buying up its bonds, the world can do to China. However, in exchanging the renminbi for the dollar as global reserve currency of choice, Beijing will be more than happy to allow this, even as the US, its infinite budget deficit, and its outright lack of a budget, grows increasingly isolated.
More from the FT:

The Malaysian central bank refused to comment on the move, saying that it never discusses the composition of its reserves, which amounted to M$311bn (US$100bn) at the end of August, which was then equivalent to US$95bn.

However, people with knowledge of the transaction said it had taken place recently and was thought to have been accompanied or followed by purchases by other Asian central banks, although none of these has yet been identified.

In August, China opened its domestic interbank bond market to foreign central banks that have access to renminbi through a series of bilateral currency swaps totalling Rmb800bn ($120bn).

The agreements, signed since 2008, are with Argentina, Belarus, Hong Kong, Iceland, Indonesia, Malaysia, Singapore and South Korea, although there are no details about how many of these swap lines have actually been activated. Commercial banks such as HSBC and Citigroup that have accumulated renminbi through cross-border trade settlement were also told last month they would be able to invest in China’s interbank bond market, although none has yet been given formal approval.

The decision to allow some central banks to invest in the domestic bond market is part of a push by Beijing to increase the international use of the Chinese currency. An expanded role for the renminbi would be a threat to the position of the US dollar, although many economists believe it will be years before it becomes a major reserve currency, given China’s tight financial market controls.

To be sure, our idiot politicians are sure to welcome this move as it will lead to further appreciation of the CNY, and more dollar destruction, which presumably will make the export of US-based financial innovation cheaper. Which of course, when faced with $10 trillion in budget deficits over the next decade, which will need about $15 trillion in incremental debt issuance, is completely irrelevant. Instead of focusing all its attention on the one thing that matters, i.e., making US Treasury debt purchases as attractive as possible for as long as possible, the US is now happy to throw future bond buyers under the bus, just so a few incumbents can get reelected on a myopic campaign promise. In the meantime, follow the price of gold: it speaks volumes about what the world thinks of the current reserve currency system.

Gold Reaches Still Another New High

That's four new highs in five days!

John Hussman: Leading, Lagging, and Coincident Indicators

from HussmanFunds:

"Series that represent early stages of production and investment processes (new orders for durable goods, housing starts, or permits) lead series that represent late stages (finished output, investment expenditures). Under uncertainty, less binding decisions are taken first. For example, hours of work are lengthened (shortened) before the work force is altered by new hirings (layoffs)."

Victor Zarnowitz and Geoffrey Moore, "Sequential Signals of Recession and Recovery"
Journal of Business, 1982

Last week, we got a fresh set of economic indications from the Philadelphia Fed Survey. While the market evidently took relief from the modest uptick in the composite index to -0.7, a quick look at the component indices suggests a worsening of economic conditions in the latest report. Specifically, the Philly Fed new orders component fell to -8.1 from -7.1, which is the third month in negative territory. While there was a slight uptick in the index for number of employees (to 1.8 from -2.7), the better leading measure is the average employee workweek, where the index weakened to -21.6 from -17.1.

As I've emphasized in recent weeks, the U.S. economy is still in a normal "lag window" between deterioration in leading measures of economic activity and (probable) deterioration in coincident measures. Though the lags are sometimes variable, as we saw in 1974 and 2008, normal lags would suggest an abrupt softening in the September ISM report (due in the beginning of October), with new claims for unemployment softening beginning somewhere around mid-October. It's possible that the historically tight relationships that we've reviewed iin recent weeks will not hold in this particular instance, but we have no reasonable basis to expect that. Indeed, if we look at the drivers of economic growth outside of the now fading impact of government stimulus spending, we continue to observe little intrinsic activity.

The strongest forces driving economic expansion during a post-recession recovery phase is expansion in credit-sensitive expenditures such as housing, durable goods (such as autos) and gross investment, and in particular, inventory rebuilding. While capital expenditure for upgraded information technology is the clearest bright spot in recent GDP reports, it also represents a very small share of the economy. Other credit-sensitive classes of expenditure continue to face strong headwinds.

It is also important to understand that while consumption represents roughly 70% of economic activity, it is by far the least volatile component of GDP, particularly when durable goods are excluded. The main sources of fluctuation in GDP growth are credit-sensitive expenditures and inventories. Given the recent buildup of inventories and the expenditures on autos and home buying that were brought forward by programs such as cash-for-clunkers and the first-time homebuyers' credit, we are likely on the downside of those bursts of spending. For that reason, it appears likely that the positive growth of GDP in recent quarters will have relatively poor follow-through. A careful examination of sub-components of GDP growth leaves little reason to expect actual economic activity to deviate from what is already suggested by weak leading indicators.

If we observe both an improvement in those leading indicators and an improvement in market internals, our evaluation of investment conditions would be more constructive. For now, however, we remain defensive about risks that still appear significant.

On the housing front, last week's comments from Rick Sharga, the V.P. of RealtyTrac, are worth noting - "We're on track for a record year for homes in foreclosure and repossessions. There is no improvement in the underlying economic conditions. Whether things fall precipitously depends on government and lenders controlling the inflow of new foreclosure actions. If the market is left to fend for itself, you may see more serious price depreciation."

Lender Processing Services concurred, with its senior V.P. noting "Loans that have been delinquent for a historically long period of time are just now beginning to move through the pipeline. As of July 2010, the average length of time a loan in foreclosure had been delinquent was nearly 470 days. Now, after the intensive efforts of the last year or two, remaining home retention options appear to be exhausted and servicers are beginning to process more of these seriously delinquent loans."

My view remains that the underlying condition of the U.S. housing market is one of deep insolvency. The Treasury, Fed and the FASB have effectively made a policy out of opaque disclosure, so that at least the deterioration in the housing market is slow to appear on the balance sheets of major banks and financials. At present, the FASB allows "substantial discretion" in the valuation of mortgage-backed securities, which I suspect are being carried at a higher level than the value that the underlying cash flows (mortgage repayments) can actually support. Given that there is little pressure to disclose losses, and that mechanisms are in place (at least until the end of 2012) for the Treasury to bail out the entire flow of bad mortgages that funnel through Fannie Mae and Freddie Mac, it's not clear whether the growing mountain of delinquent and unforeclosed mortgages will provoke an abrupt crisis. My own expectation is that fresh economic pressure would provoke contagious pressure on the housing market to an extent that would be difficult to obscure.

That said, if the U.S. economy averts a period of fresh economic weakness, we could instead observe a more drawn out period of stagnation and price pressure. Ultimately the bad assets have to be placed on the market, which suggests further price pressure in the next few years. Weak labor conditions would also contribute further mortgage deterioration. Long-term, deficit-led inflation might be able to avert mortgage losses as home values gradually rise above the principal balances, eroding the real value of the debt, but this appears very unlikely in the immediate few years.

On the subject of inflation, I should emphasize that while I expect inflation pressures to be contained for several years, the impact of massive deficit spending should not be disregarded simply because Japan, with an enormously high savings rate, was able to pull off huge fiscal imbalances without an inflationary event. We may be following many of the same policies that led to stagnation in Japan, but one feature of Japan that we do not share is our savings rate. It is one thing to expand fiscal deficits in an economy with a very elevated private savings rate. In that event, the economy, though weak, has the ability to absorb the new issuance. It is another to expand fiscal deficits in an economy that does not save enough. Certainly, the past couple of years have seen a surge in the U.S. saving rate, which has absorbed new issuance of government liabilities without pressuring their value. But it is wrong to think that the ability to absorb these fiscal deficits is some sort of happy structural feature of the U.S. economy. It is not. It relies on a soaring savings rate, and without it, our heavy deficits will ultimately lead to inflationary events.

Hyperinflation is a much different story, and as I've said before, I am not in that camp. This doesn't exclude the possibility that enough policy mistakes will change that, but for now, my inflation outlook is flat for several years and then accelerating in the second half of this decade.

As Peter Bernholz notes in Monetary Regimes and Inflation (an economic study of inflation, including more than two dozen cases of hyperinflation), "The figures demonstrate clearly that deficits amounting to 40 per cent or more of expenditures cannot be maintained. They lead to high [inflation] and hyperinflations, reforms stabilizing the value of money, or in total currency substitution leading to the same results. The examples of both Germany and Bolivia suggest that at least deficits of about 30 per cent or more of gross domestic product are not maintainable since they imply hyperinflations... [In nearly all] cases of hyperinflation deficits amounting to more than 20 per cent of public expenditures are present."

At present, U.S. federal expenditures are about $5 trillion, versus about $4 trillion of revenues, and GDP of about $14.6 trillion. So the federal deficit is running at about 20% of expenditures, but less than 7% of GDP. This is not a profile that is consistent with hyperinflation, but it is also not a benign policy. Continued deficits will have substantial economic consequences once the savings rate fails to increase in an adequate amount to absorb the new issuance, and particularly if foreign central banks do not pick up the slack. We're not there for now, but it's important not to assume that the current period of stable and even deflationary price pressures is some sort of structural feature of the economy that will allow us to run deficits indefinitely.

Finally, given probable economic pressures and continued strong demand for default-free instruments, the likelihood of sustained upward pressure on bond yields remains limited here. At some point, probably years from now, we'll face a likely sustained increase in bond yields. We're often asked how that sort of environment would affect the Strategic Total Return Fund, given that we don't short bonds, and we don't buy "inverse floaters" or the like. A simple answer is that just as poor valuations and weak market returns have kept us from taking much exposure to stock market risk during the past decade, while the S&P 500 has gone nowhere, rising interest rates will limit the ability to profit from interest rate exposure. Water can't be squeezed from stones. Frankly, however, the returns of the Strategic Total Return Fund since its inception have not been dependent on a great deal of interest rate exposure in the first place. Even our present portfolio duration of 4 years is well below the average duration of the bond market.

So to a large degree, I expect we'll simply continue what we normally do, which is to vary our exposure in proportion to the expected return/risk profile of the various markets and security groups that we invest in. Markets rarely move in a straight line, and there is typically enough cyclical fluctuation within secular trends to present many opportunities to vary market exposure and portfolio duration. We have the ability to invest in a range of assets such as inflation protected securities, precious metals shares, and foreign currencies, as well as utility shares and other assets. An extended period of rising interest rates is likely to produce a bias toward shorter portfolio durations rather than longer ones. However, I don't expect that economic cycles would be eliminated, and to that extent, I don't expect that we'll be at a loss for opportunities to vary our investment exposures over the course of those cycles.

Market Climate

As of last week, the Market Climate for stocks remained characterized by unfavorable valuations, mixed market action, increasing bullish sentiment (approaching levels of overbullishness), and clear overbought conditions. As we've observed for months now, the stock market is still trading between widely followed support and resistance levels, with the S&P 500 bouncing off of the higher end of that channel last week. My primary concern is still the "recognition window" that I believe we have entered. The next several weeks will be important. As noted above, however, if leading measures of economic activity improve and internals improve, we'll be willing to accept a moderately more constructive position, but even here, our latitude to do so is somewhat restricted by valuations that are historically rich. As always, our intent is to align our position in proportion to the return/risk profile we expect. There's a moderate positive range that we'd be willing to operate within if we observe improvement in various economic measures, but for now, the evidence continues to warrant a strong defense. Both the Strategic Growth Fund and the Strategic International Equity Fund are tightly hedged.

In bonds, the Market Climate remained characterized by moderately unfavorable yield levels and favorable yield pressures. The Strategic Total Return Fund continues to carry a duration of about 4-years, and we are maintaining a range of 15-20% of assets allocated between precious metals shares, foreign currency exposure and modest holdings of utility shares.

...And the Dollar Drops!

Grains Bust Loose

Beans are now up 20 cents in evening trading!?

from Arlan earlier this evening:

Follow-thru buying continues in the grains; Money chasing chart signals now; corn up 8, beans up 17, wht up 7

"...there are only two kinds of paper money - those which are already worthless and those which are going to be worthless"

"Before it can be exchanged, wealth must be created. Wealth cannot be created out of thin air. By definition, an economic good is “scarce”. If it were not, there would be no such thing as economics or exchange. Neither would be necessary because no effort or choice in the face of alternatives would be required in order to provide the GOODS which further our lives. Before we can talk about money and the VITAL role it performs, we must stress this point. Money is NOT wealth, it is the means by which wealth is exchanged amongst those who produce it. Paper money is not suited to this function...

The paper money “price” of Gold will last as long as the attempt to make paper money “work” lasts. In the end, Gold will no longer have a “price” because it has reverted to its role as MONEY. Whenever and wherever that happens, that nation can return to the production of wealth - rather than “money”.

 -- Bill Buckler

Pension Bubble to Pop?

Many of America's largest pension funds are sticking to expectations of fat returns on their investments even after a decade of paltry gains, which could leave U.S. retirement plans facing an even deeper funding hole and taxpayers on the hook for huge additional contributions.
The median expected investment return for more than 100 U.S. public pension plans surveyed by the National Association of State Retirement Administrators remains 8%, the same level as in 2001, the association says.
The country's 15 biggest public pension systems have an average expected return of 7.8%, and only a handful recently have changed or are reconsidering those return assumptions, according to a survey of those funds by The Wall Street Journal.
Corporate pension plans in many cases have been cutting expectations more quickly than public plans, but often they were starting from more-optimistic assumptions. Pension plans at companies in the Standard & Poor's 500 stock index have trimmed expected returns by one-half of a percentage point over the past five years, but their average return assumption is also 8%, according to the Analyst's Accounting Observer, a research firm.
The rosy expectations persist despite the fact that the Dow Jones Industrial Average is back near the 10000 level it first breached in 1999. The 10-year Treasury note is yielding less than 3%, and inflation is running at only about 1%, making it tougher for plans to hit their return targets.
Return assumptions can affect the size of so-called funding gaps—the amounts by which future liabilities to retirees exceed current pension assets. That's because government plans use the return rates to calculate how much money they need to meet their future obligations to retirees. When there are funding gaps, plans have to get more contributions from either employers or employees.
The concern is that the reluctance to plan for smaller gains will understate the scale of the potential time bomb facing America's government and corporate pension plans.
"It's unrealistic," John Bogle, founder of mutual fund giant Vanguard, says of the return assumptions in place at most pension plans.
Pension funds at companies in the S&P 500 faced a $260 billion shortfall at the end of 2009, according to Standard & Poor's. Estimates of the fund deficits faced by state and local governments range from $500 billion to $1 trillion.
Some plans are beginning to trim their return forecasts.
Earlier this month, New York State Comptroller Thomas DiNapoli said he would reduce the expected rate of investment return for his state's pension system, the third-largest in the nation, to 7.5%, from 8%.

The country's two biggest plans—the California Public Employees Retirement System, or Calpers, and the California State Teachers' Retirement System, or CalSTRS—both are undergoing reviews of projected investment returns that could lead to reductions later this year.
Many plans have held onto an 8% return expectation though thick and thin. Such return assumptions partly reflect the heady years of the 1990s bull market. Public pension plans posted a median, annualized return of 9.3% over the past 25 years, but just 3.9% over the past 10, according to consulting firm Callan Associates.
The Oregon Public Employees Retirement System has had an 8% assumption since 1989. Its actual return averaged 10.7% annually from 1970 through 2009. The Teachers Retirement System of Texas has had a similar expectation since 1986, with an annual return of 9% return since then.
A spokeswoman for the Texas system said it doesn't change assumptions "in response to short-term situations," and currently "sees no reason to change our investment-return assumption." A spokesman for the Oregon system said there are no special plans to review its return expectation.
The challenge for many plans, given investment horizons that can stretch out 50 years, is gauging which time period to look at when charting a future course.
George Diehr, vice president of the Calpers board, said in May that the question is whether the credit crisis has "dramatically altered long-held assumptions about investing in the world's financial markets. Are investors in for a sustained period of meager or below-market growth? Or will the traditional business and economic cycles, the ones investors have grown accustomed to over the past couple of decades, return?"
The outcome of Calpers's ongoing review "hangs on how we answer that question," a spokesman says.
Depressed stock prices aren't the only thing putting pressure on potential returns. Plummeting bond yields mean that plans' fixed-income portfolios will likely earn less in the future. A lower inflation outlook means that funds will have to generate greater real returns to meet their return targets.
Funds use a so-called discount rate to estimate the size of future obligations to retirees, and thus the contributions needed to fund them. Corporate plans use a discount rate based on corporate bond yields. But government plans use their expected return rate on all investments as their discount rate.
The higher the discount rate, the smaller a fund's pension obligation. That gives public plans another big reason to hesitate before cutting their expected return rates.
The Colorado Public Employees Retirement Association showed in its 2009 financial report the impact of reducing the rate. Using a 8% expected return rate, the plan faced a $23.4 billion deficit, based on market values, at the end of 2009. If the rate was cut to 6.5%, the shortfall would jump to $34 billion.
Meredith Williams, the Colorado plan's chief executive, says cutting the rate "creates pain." Nevertheless, Colorado at year-end of 2009 cut its return assumption to 8%, from 8.5%. Mr. Williams says the rate may be lowered again later this year.
Others have been more hesitant. In 2009, Matt Smith, state actuary for Washington state, recommended that its retirement system cut its return expectation to 7.5%, from 8%. That advice was rejected by the state's pension-funding council.
Mr. Smith says he thinks Washington and other states eventually will lower expected returns, but that it will be a slow process because reduced assumptions "will increase the cost of pension benefits, and right now the budgetary environment is a big obstacle to that."

Pension plans say they take a decades-long view of potential returns. "We can't knee-jerk our way through this. Funding a retirement system is a long-term proposition," says David Stella, secretary of Wisconsin's department of employee trust funds. Last year Wisconsin's plan reviewed its expected return rate of 7.8% and remains comfortable with it, he says.
Companies have found out the hard way that their options are limited. From 2005 to 2009, S&P 500 companies with pension plans expected to generate about $475 billion in returns. The actual returns were only about $239 billion, a 50% undershoot, according to Jack Ciesielski of the Analyst's Accounting Observer.
In recent years, some funds have tried to boost returns by shifting funds out of stock and into alternative investments such as hedge funds or private equity.
Some find this approach too risky. This summer, the Virginia Retirement System cut its expected investment rate to 7%, from 7.5%, giving it the lowest assumption among the nation's 15 largest pension systems. The shift began in 2005, when the plan's board cut the rate to 7.5%, from 8%.
"There was a general thinking that equity markets were unlikely to repeat the period of the 1990s," explains director Robert Schultze.
The alternative was to take more risk, he says, but the board didn't want to "stretch or be swinging for the fences" to meet higher investment expectations.
Other plans, he predicts, will follow suit. "I just think people are going to be coming off that 8% view," he says.