The Room : Credit Crisis, Bailout

The Room – 04/03/2009

David Galland — Fri, 03 Apr 2009 15:00:00 GMT

Dear Readers,

In the March 6, 2009 edition of this missive/blog/column/whatever you want to call it, I listed three "Desperate Measures" the U.S. government might turn to next in its futile attempt to rearrange the ruined economy into something more resembling a perfect world.

Suspend "mark to market" rules. At the time of my initial write-up (which you can read here), highly placed sources within the financial services industry that I spoke to were of the opinion that no significant changes would be made, for the simple reason that to do otherwise would risk destroying what little credibility was left for the financial sector.

As you now know, the government has strong-armed the FASB into modifying the rules, essentially allowing companies to "mark to model." Which simply means that the same financial wizards who helped create the models so pivotal to causing the mess in the first place are now free to dust those models off, give them a little tweak, and use them to fabricate more attractive values for the toxic waste than the market was willing to assign. Some might term these rule changes outrageous, fraud even... I call it business as usual.
Bad bank. The government has moved forward with this initiative as well, essentially rigging up a system that literally guarantees that a very small handful of firms -- likely just four or five -- will receive the sweetheart deal of the century, at the same time that the U.S. taxpayer gets the short end of the stick… right up the side of the head.
Fed buys long-term Treasuries. This, too, has now come to pass and is likely to accelerate. While there are many ways that one could describe this latest initiative, I find it best to keep these things simple... it's called inflation.

Maybe next week, I'll try to come up with some new candidates for desperate measures, but for now I would like to turn my attention to the much-anticipated and widely watched G20 meeting that has just wrapped up in London.

I imagine, because it is such a headliner event, many of you expect me to wax with some vitriol about it, but I fear I must let you down.

Sure, it bothers me that our president traveled to the event with an entourage of 500, including secret service agents, paper carriers, and other lucky sycophants -- all of whom were put up in grand style at taxpayer expense. (By way of comparison, my Portugal-based correspondent General Watson reminded me that when Maggie Thatcher was prime minister, for state visits, she used to travel commercial with a small group of aides. Often times, the other passengers were unaware she was even on the plane. )

This sort of excess is somewhat ironic and maybe even a little hypocritical, given Mr. Obama's derogatory comments about companies flying executives to corporate meetings in places such as Las Vegas, a topic I briefly touched upon last week.

I cannot begin to imagine what sort of costs are involved in transporting all those people -- along with three presidential helicopters and any number of stretch armored limousines -- to Europe, then keeping them in clover for a week... but I suspect it would be more than enough to keep the occupants of a moderately sized city in some third-world country in food for a decade or so.

G20 Meeting, Who Cares?

While I often don't succeed, I try to focus these weekly comments on matters that are actually of some importance -- on a broader scale, and to me personally. With that filter in place, the G20 meeting barely registers a blip.

Sure, there were a lot of fine-sounding speeches by politicians, but since when are those worth the paper they are written on? And yes, they managed to agree in principle to give over $1 trillion to the IMF – a topic I’ll have more to say about in a minute. In addition, they promised to collectively put the shoulder to the wheel in an effort to create a massive, new, global regulatory regime.

Run for cover? Hardly.

On the radio yesterday, I heard an African intellectual bemoaning the fact that the G20, by its numerically limited scope, excluded the representatives -- and therefore bypassed the inputs and opinions -- of over 180 other, lesser nations whose names did not make it onto the invite list.

Now, let me ask you, when it comes to implementing the high-sounding pronouncements that emanated from the G20 meeting, what are the odds that this collection of talk-a-crats will actually be able to come together to the extent required to create a functioning bureaucracy that delivers on its promises at any time in, say, the next 1,000 years?

Which makes the laments of the above-mentioned African intellectual all that more laughable. Can you imagine political junket-goers from 200 countries getting together and accomplishing anything other than drinking the hotel bar dry?

For the source of my skepticism, look no further than the United Nations.

(One thing I do find mildly amusing at gatherings such as the G20 is a circus of professional protesters who flail their thin arms at the rather better-equipped, truncheon-wielding security forces. The source of my humor is that the vast majority of these individuals are there to encourage the representatives of the world's governments -- the very same governments whose names should appropriately be entered into the blank following the question "Who is most responsible for the mess the world is in?" -- to further expand and extend their powers. Memo to protesters: the solution to bad government is not more government.)

The IMF

It seems somewhat ironic that the IMF, which was founded in 1944 as part of the Bretton Woods arrangement, should now be viewed as a possible source of the world's salvation.

In the way of history, its original purpose was to "promote international monetary cooperation," specifically by attempting to maintain fixed exchange rates for the world's many currencies. The idea was that the IMF would step in whenever a country suffered from a temporary deficit in its balance of payments. To help the country avoid having to debase its currency to meet its external obligations, the IMF will provide a short-term loan. These loans came with "strings" attached, in the form of various demands for monetary reform following the Keynesian principles favored by the functionaries of the organization.

According to a briefing paper prepared by the CATO organization for Congress (which they'll never read anyway)...

Read the complete paper here

In addition to spawning a coterie of kleptocrats around the world, the IMF has also failed miserably in its role of managing the global monetary system, witnessed by the persistent inflation the world has suffered since its founding.

(As for the fixed rate system it was supposed to be managing, that came to a sudden halt when the U.S. government closed the window on gold convertibility, a central tenet of the same Bretton Woods agreement that birthed the IMF.)
So what function does the IMF currently serve? Shedding light on that topic is Ken Ewert, writing in The Freemen...

Why then, the widespread support for the IMF? The reason is more straightforward than many of us would like to believe. When governments speak of the need for "increased economic coordination," what they mean is that governments around the world want to better synchronize their inflationary monetary policies. Inflation is politically expedient for every government in our age. It temporarily stimulates economic activity and in so doing buys considerable political favor. Only later when the unpleasant effects appear -- rising prices, economic dis-coordination, consumed capital, and unemployment -- does the inflation become a political liability. The illusive goal pursued by governments around the world is to reap the political benefits of inflation without paying its subsequent costs.
Even so, perhaps out of sheer frustration or even spite, the Chinese, Russians, and any number of other nations are now openly discussing the idea that the IMF should be given both the resources and the responsibilities to create a new international monetary regime that would serve to demote the U.S. dollar to just another currency, albeit a still very important one.

Ed. Note

The G20 moves the world a step closer to a global currency

Read it here.

Many observers assume the Chinese are bluffing when they raise the topic of pushing the U.S. dollar aside as the world's reserve currency... or that these comments were otherwise cooked up in a Beijing political meeting to give the Obama administration pause in its headlong rush to debase of the U.S. dollar.

Those assumptions could prove wrong -- the Chinese may be sincere in their calls for a new monetary regime. I say that after reading a paper written by Zhou Xiaochuan, governor of the People's Bank of China, titled "Reform International Monetary System. ”

I highly recommend that you at least give the article a quick scan, because it shows that Zhou has a clear understanding of the various monetary systems and a clear preference for currency that is "anchored to a stable benchmark and issued according to a clear set of rules." He goes on to take a direct shot at the world’s fiat monetary system, saying, correctly, "The acceptance of credit-based national currencies as a major international reserve currencies, as is the case in the current system, is a rare special case in history."

Read his essay by clicking the link here.

As per above, I am completely confident that despite China's wishes, the world's leading governments won't be able to get out of their own way long enough to produce a new monetary system -- let alone one that is based on something other than political hot air. That leaves the door open for a single country to decide to break the mould by backing its currency with gold or some other basket of tangibles. That, of course, we shall watch for with some anticipation.

Before leaving this subject, I thought I'd share the contents of a message that our own Bud Conrad sent across this morning on the topic of China and the beefed-up IMF Special Drawing Rights...

The IMF's Gold

Those among you who find gold to be an attractive asset, which I suspect is most, are well aware that this week the IMF announced that it was likely to sell off 400 or so tons of gold in order to continue supporting the borrowing habits of its regular clientele.

While these special sales have been threatened in the past, this time around it looks like it might actually happen. While the idea of the sale might spook the gold markets for a bit, the actual event is likely to have little if any lasting effect… other than continuing to hollow out the IMF.

That's because the odds are very high that the gold will never actually make it onto the market, but instead will trade hands in an off-market transaction between the IMF and the Chinese or some other nation looking for the earliest opportunity to trade its much abused paper dollars for something of tangible value.

At this writing, of China's $2 trillion in reserves, only about 1% is held in gold. There has been credible talk of them boosting that percentage to as much as 10%.

At $900 per ounce, the math looks something like this…

At 32,000 ounces per ton, 400 tons equals 12,800,000 ounces. Multiplied by $900, we arrive at a total value of the intended IMF sale of $11.5 billion.

Ready to be deployed against that amount is as much as another 9% of China's $2 trillion reserves -- which adds up to $180 billion. And that's just China. Of course, there are any number of other countries sitting on piles of U.S. dollars and viewing the outlook for those dollars in fairly negative terms.

So, sure, the notion of a big IMF gold sale might spook the gold market a bit… but in the final analysis, it will amount to less than a hill of beans.

The Closing Door

Speaking selfishly, a human trait I won't apologize for, the headlong rush of global governments to debase their currencies might be viewed as something of a positive. That's because, being aware of it, we can take steps to arrange our investments in such a way that we should be able to profit from it.

Unfortunately, the currency debasement is only one of many actions we can anticipate that governments will take going forward. Because as they set about destroying their currencies, they’ll simultaneously be looking to raise revenue elsewhere -- specifically by squeezing the productive segments of society out of whatever money they can. But of course, until they actually put up The Wall, most people of means, in most countries, are still free to pick up their bags and move to climes where their capital is better treated.

Understanding that, one of the major initiatives that came out of the G20 soirée just ended was a rededication by the world's bureaucrats to tighten the vise on any country deemed to be overly capital-friendly. Doug Casey, who has long anticipated these developments, has warned that time is running short for U.S. citizens in particular to diversify globally.

Specifically, the gang of 20 announced they were going to use a list just published by the Organization for Economic Cooperation and Development to aggressively go after "tax havens." Regrettably, that list includes names such as Costa Rica and Uruguay, places that we know many of our subscribers have an interest in.

The implications of these moves on personal freedom are not to be sniffed at. While the G20 countries may lack the organizational skills to create a functional new monetary system or widespread regulatory regime, it is a fairly easy matter to apply financial pressures on “errant” countries. They have a lot of experience in that regard. And so, to quote the G20 communiqué on the subject, "We stand ready to deploy sanctions to protect our public finances and financial systems. The era of banking secrecy is over."

Few nations can stand up to the pressure of global sanctions, and so many if not most of those nations are likely to roll over. The only way to stave off this latest assault on the free flow of money would be if there were an eruption of a widespread public outcry, complete with rampaging mobs and a liberal throwing of rocks. But as you and I both know, that’s not going to happen.

Some of you may think that I am making much ado about nothing, but I believe it's important to view these sorts of developments not based upon the world as it now is… but rather as it could be.

That exercise is usually helped by taking a quick glimpse in the rearview mirror. And, looking back over history, you can find any number of examples where despots have taken control of governments and engaged in the wholesale confiscation of private property, either overtly or through determined inflation.

Up to this point in time, with some limitations, a person could always take some comfort in the idea that -- should push come to shove -- they will be able to escape to another jurisdiction with enough wealth to start over again.

In the brave new world we are headed for, that simply may not be possible.

As something of an experiment, I recently walked into a bank in Uruguay and asked for the papers required to open an account (one, I can assure you, that I would have fully disclosed), but was told in an apologetic tone by the bank manager that they would not accept accounts from Americans.

The door is closing, the noose tightening.

Letters from You

David again... as JK's email confirms, while there has been a huge pick-up in the interest in gold compared to even a couple of years ago, we are nowhere near the mania phase. In fact, if you step back and look at the situation dispassionately, you’ll note that gold has remained strong not because of but in spite of the current economic environment. An environment that includes, of late, a clear deflationary trend pretty much across the board in the commodity sector.

All of which is to say that once the environment for gold begins to change for the better and the consequences of today’s inflation begin to be widely felt, then and only then will gold really begin to move. In the interim, we can expect gold to fluctuate, which – for those of us who are comfortable getting positioned now, ahead of the crowd – simply means additional buying opportunities.

Miscellany

I'm sure the orphan will thank them later. It’s good to know that the poor orphans are safe from the horror of being adopted by zillionaire rock stars. Thanks in no small part to human rights groups, led by the Human Rights Consultative Committee, a coalition of 85 groups that apparently have nothing else to do with their time and their donors’ money, the Malawian government turned down Madonna’s request to adopt a second orphan from that country. Why should they oppose this adoption? Easy, it was out of heartfelt concern that the impoverished orphan might enjoy a better life than they. (Click here for more)
Kick them when they're down. This item also got my attention this week... “March 31 (Bloomberg) -- A Senate panel approved new restrictions on credit-card interest rates that are broader than those adopted by the Federal Reserve in December, brushing aside objections from Republicans and the banking industry.

“…The bill, known as the ‘credit card bill of rights,’ also would require the signature of a parent for a borrower under age 21, unless there’s proof of independent income or completion of a financial education course.”

So, let me get this straight. First the government bails out the banks, then promptly handcuffs them in their ability to price for the elevated risk of credit card loan losses, assuring that the money provided them will soon get flushed down a rat hole. Or, more likely, they’ll just stop offering credit. But wait -- isn’t that the very problem the government is trying to fix?

Now, I'm no fan of many of the practices of credit card companies, but I'm even less of a fan of the government establishing what is essentially price controls on the credit industry, with an added dose of nanny state thrown in via the requirement that adults – and anyone over the age of 18 is certainly an adult – must first take a course in finance prior to being allowed to get a credit card.

Do I think that adults will benefit from taking courses in finance? Of course. Do I think that they should be forced to it? Absolutely not. What's next, mandatory courses in parenting before being allowed to have a child?
Soup lines. Many commentators have observed that all that the current financial crisis is missing now is the sight of soup lines around the blocks of our cities. Actually, there's a reason these haven’t yet appeared. Namely that, thanks to the innovation of food stamps, the inconvenience of a soup line is no longer necessary. And at this point, according to a report just released by the Agriculture Department, fully 10% of Americans are now relying on food stamps for some portion of their daily bread. That is roughly 32,000,000 people – a very long line, indeed.

And on that unhappy note, I must sign off. As I do, a quick glance at the screens tells me that the S&P 500 is flat, taking a breather after the strong gains of last couple days. Given the onslaught of continued bad news, including the latest, poor unemployment numbers, the stock market should be in a freefall at this point.

And it probably would be if it hadn’t been buoyed up by the change in the "mark to market" rules that will soon usher in a new era of obfuscation and outright deceit. Those changes will also serve to extend the current downturn, for the simple reason that they postpone the value discovery process that ultimately must occur in order for some semblance of confidence to return to investment markets.

In the history books, I suspect that the best they'll be able to say about these rule changes will be "it seemed like a good idea at the time."

Meanwhile, I note that gold is below the $900 level for the first time in a while. I'd be very surprised to see a drop to below $850 anytime soon, and maybe never. If it were to happen, however, I’d be just one of many on the phone to the bullion dealer.

Until next week, thank you for reading and for subscribing to a Casey Research publication.

Sincerely,

David Galland
Managing Director
Casey Research

The Room - 10/10/2008

David Galland — Fri, 10 Oct 2008 19:27:07 GMT

October 10, 2008

Dear, Dear Reader,

In last week's edition of this meandering missive, I mused as follows...

"What, I wonder, will the government do when next week, or the week after maybe, the U.S. stock market takes another header for 500 points? Stay tuned. Meanwhile, gold is at $826, down considerably over the past week.

Like when a tsunami sucks the water away from the shore just before hitting, we're in a transition period. I'm not worried about where gold is going next. I wish I could say the same about the world."

According to the number crunchers, the U.S. stock market is on track to have its worst week since 1937. Which, as you can see from the DJIA chart here, is an acceleration of the broader trend that has held sway for some time now.

While we can't yet say what action the U.S. Government will take next, glancing over the horizon, we see a growing number of countries implementing a euphemistically named "market holiday." In Iceland, all banks and markets are now enjoying a day off. And Kevin Brekke, our Switzerland-based researcher, just wrote that there is a rising call to halt trading in Germany. It would not surprise me in the slightest if the same were to occur in the U.S.

As has previously been noted, we are wandering through deep woods, with little in the way of a map to guide us. And so we must rely on what few signs we can discern. And one of those signs is that, literally, all of the "solutions" to the problem now being pushed forward by governments around the globe have to do with trying to re-generate an expansion of credit through the liberal application of a thick layer of monetary grease. In other words, trying to solve the problem with more of the same.

It's like trying to sober up a prostrate drunk by pouring Vodka down his throat as a restorative.

To the extent that these exertions fail, government is forced to fall back on the coercive powers they have taken unto themselves over the decades... slap down the short traders, clamp shut the markets, or... or... we just can't say. But in our mind's eyes, we can hear the motto of our century, "Whatever it takes," bubbling from the blubbery lips of officialdom around the world.

Playing their part, the MMM (Mass Media for the Mindless) intone that the smart move for investors to make now is to play for the big bounce, a drumbeat that was heard especially loud as the week of October 5 opened for business.

This notion that sunny skies are surely just ahead was being championed, of course, by all of the king's men and most of the punditry. It is as if the words "The worst is now behind us" are etched on the inside of their lungs.

And so they urged the investing public to jump back onboard the Rebound Express... maybe even with the use of leverage, just to be sure to squeeze all of the juice possible out the rally that surely cometh.

On Monday and again on Tuesday, I received several emails from readers inquiring for my opinion on that very same theme, often accompanied by articles from this sage or that about the pending rally.

My response to one such inquiry is as follows...

It is this.

Everyone operates from within the framework of their experience. The author's experience is that when his phone begins ringing, it's a bottom. Or when the candlestick chart shows that X level is below Y, then a bounce is due.

He is likely right in one sense... that no market goes in one direction consistently, without pullbacks and bounces.

But what if this time things are, in actual fact, different?

Oh no! Not that old saying.

Well, consider that America has historic (as in, never happened before) levels of trade deficits, government deficits, record levels of personal indebtedness, the largest housing bubble ever – a housing bubble that qualifies as the largest financial bubble in history (by a wide margin), record number of dollars in the hands of foreigners, etc.

So, before we broke through all those negative records, one could have said, yeah, but for those things to happen, things would have to be different... and they were.

Both Doug Casey and Bud Conrad are on record saying that the entire global financial system – a system built on the house of cards of a fiat currency – may be about to fall. That the holders of trillions of dollars in misallocated capital and derivatives anchored to that capital may be about to learn just what the underlying value of a fiat currency actually is, and demand something else.

Look at the stock chart of the Great Depression and you won't see it moving in a straight line... there are bounces along the way... but if you had bought ahead of most of those bounces, it would have been a financial disaster.

All of which is a long way of saying, the author you quote may be right... but I would play the bounce only with money I could afford to lose.

Gold at these prices should be a good monetary medium to transfer wealth to calmer waters... that, and not as a speculative investment, is its best and highest purpose just now. And it is a hell of a lot safer than pretty much any mainstream security (by virtue of the fact that credit markets are frozen... which makes it kinda hard to buy raw materials, meet payrolls, build inventories, buy capital equipment, etc.)

Unless and until the credit markets are working again, caution is the word.

Prior to this week, perhaps, the concept that the world we live in might not be quite so predictable and well organized – you know, that stocks fall, then quickly recover, allowing you to close shop and head down to your preferred martini bar for a $15 libation -- had not made it through the well-coifed craniums of the young and the restless that now dominate the world of finance.

An email from our Jake Weber, the Chicago-based editor of our very useful (and free!) new e-letter, Casey's Charts, shed a passing glimpse on the cost associated with misunderstanding the nature of what's going on just now...

My friend, who's a day trader here in Chicago, said that he lost $100k for the company in 10 seconds, and had he waited 10 more seconds, it would have been $300k. It's a different game...

Now, multiply that experience by the tens of thousands, handling tens of millions, and you can begin to get a sense about the hard dose of reality that has been meted out to the optimistic this week.

It is said that a picture can tell a thousand words (or, these days, given inflation, is it a hundred thousand?), and so I would share the accompanying photo from the Financial Times. One can't say with certainty, but I suspect the look on the young gentleman's face is not enthusiasm but panic.

No $15 martini today, though a bottle of cheap gin in a darkened room might be called for.

Go Gold

As I don't need to tell you -- or at least those of you who have been with us for any length of time – the core fixative in our prescription for the immunization of portfolios large and small from the dark age now descending on global financial markets is a healthy dose of bright and shiny gold.

I hope you didn't drag your feet in laying in supplies, because it is now all but impossible to find physical gold... pretty much in any form (other than expensive rarities), anywhere.

Personally, I've never seen anything like it. Even in the gold bull market scramble of the late 1970s, you still could still walk into pretty much any gold shop and pick up an ounce or two (with a short wait in line, at worst).

Likewise, I couldn't have imagined we'd see such a disconnect between the paper price of gold – which, while comforting, seems restrained to us – in light of the physical shortages and all that those shortages imply.

Shedding some light on that topic, Sally Limantour, the editor of our soon-to-be-launched trading service, forwarded the following excerpt from recent writings by Bill Fleckenstein, one of the few money managers with the foresight to see what was about to unfold...

Lust for Gold Dust

If that's the case, it could cause a mad scramble at the COMEX, because there's not enough gold to meet the open interest. It looks like physical gold, as compared to paper gold, is rapidly becoming the flavor of the day -- meaning that a huge price move may lie just in front of us.

And, if that thesis is correct, when more folks start understanding it, there might not be enough gold around to satisfy demand at anywhere near current prices -- and their attention will turn to the place where they can find gold, namely the gold miners, whose job it is to "make" more. (With the price of energy dropping as world GDP slows, the profit potential for the gold miners is liable to be the best it has been in many years.) So, I think the stage may be set for a dramatic move in gold stocks.

This, of course, is a thesis we subscribe to in our BIG GOLD letter, which is dedicated to following the fortunes of the large market capitalization producers – as well as the various ways you can buy and hold the monetary metal (in the next edition, the BIG GOLD team looks for – and finds – physical gold available for purchase. Learn more.)

The bottom line is that if you are in gold and -- we continue to believe, gold stocks and other assets connected to gold – hold on tight because as interesting as things have been so far, the next three or four acts promise to bring down the curtain.

A Quick Conrad Commentary

Our Casey Research chief economist, the always-working Bud Conrad, shot me the following note and chart in an email yesterday. While his words are succinct, they do a good job of summarizing the situation as it now stands.

Taken together, the dollar is overvalued and stocks are still not reflecting the multi-year recession that, I expect, will bring much lower earnings than the current estimates that keep the CNBC rubes saying stocks are undervalued.

Until I hear something different from the government, other than pouring more gasoline on the fire, I don't expect this crisis to even begin to be solved. At this point, I don't think they have even determined what the problem is, namely too much debt and its deleveraging.

They are working on the wrong problem with the wrong solutions.

Meanwhile, the chart here provides a glimpse at where those solutions are taking the U.S. economy. Not a pretty picture. Gold remains the only safe harbor.

Snippets

The following items arrived this week from Mr. Watson, my longtime friend and correspondent in Portugal.

Running Out of Digits

To which I reply by sharing the message off a bumper sticker I saw earlier this week, "If you aren't angry, you aren't paying attention!"

Iceland on Ice. British local governments, it is now revealed, may have as much as 1 billion pounds parked in Iceland banks, banks with an AA rating. They all parked funds there on the recommendation of John Prescott, Tony Blair's deputy prime minister! The Iceland government wanted to seize control of the three bankrupt banks but discovered that there was no law on the books allowing them to do this. So they used the anti-terrorism laws to seize the banks' assets. Look out, America. Meanwhile, the Iceland president just had a heart attack and was rushed to hospital for heart surgery. I wonder if there is a cause-and-effect relationship at work?

David again, on the topic of Iceland, the following excerpt came out of an article that just came across the wires from an English news source...

Financial crisis: Gordon Brown to sue Iceland over near £1bn of frozen bank deposits

Gordon Brown has described the behaviour of the Icelandic government following the bank collapses as "totally unacceptable", adding that the Government was considering legal action.

The Prime Minister is furious that 300,000 bank customers are blocked from accessing deposits in online bank Icesave.

There are also concerns that councils and police authorities might not be able to retrieve nearly £900m of taxpayers' money which is stranded in Icelandic bank accounts.

Mr. Brown told a press conference: "We are taking legal action against the Icelandic authorities. We are showing by our action that we stand by people who save."

Alistair Darling, Chancellor of the Exchequer, added: "The Icelandic government, believe it or not, have told me yesterday they have no intention of honouring their obligations here."

In sandbox lingo, those comments would be equivalent to, "If you don't give me back my ball, I'm going to tell my mother!" Regardless, one government giving raspberries to another is not exactly the sort of big love international cooperation everyone is cooing about lately.

The Really BIG Bubble

As I wrote in the September 1 edition of The Casey Report, which focused on housing and how much longer the meltdown in that important sector might last, the global housing bubble at $30 trillion ranks as the biggest financial bubble in history.

It is, in fact, an amount roughly equivalent to the GNP of the entire world.

But my contention that it was the biggest bubble ever was an error. The Really BIG Bubble is in global derivatives, as shown here in this snapshot from the International Swaps and Derivatives Association. As you can see on the lower right-hand side of the really big bubble, the Credit Default Swaps alone come to over $54 trillion... and they are now coming unglued.

While we cannot know how the game will end, the simple fact that the pieces involved are this big is a lot more than a little concerning. I sincerely hope the best case will appear in a fresh suit and pressed tie and announce that all is well. For the time being, however, preparing for the worst case seems appropriate.

What to Watch Now

We expect this crisis to unfold in stages. So far, we have seen the real estate bubble beginning to deflate (and it has a long ways to go, increasingly involving commercial real estate, a play we are already profiting from in The Casey Report), a freeze-up in credit, the emergence of violent market volatility... and now a global stock market meltdown (dare we say "crash"?).

Next up will be widespread bank failures, corporate bankruptcies, soaring unemployment, increasingly draconian government interventions, all of which will end in a massive inflation. How's that for a string of happy thoughts?

Unfortunately, we'll have a lot of time to discuss those various developments in the weeks, months, and even years ahead.

For now, however, the key measure to watch is the London Interbank Lending Rate, or LIBOR, as it is referred to in the trades.

As you may already be aware -- being a whole lot more astute than most people in such matters -- LIBOR is the rate at which banks are willing to lend money between themselves. In addition to being viewed as a measure of trust and normalcy in the global financial system – and on that measure, an upward-spiking LIBOR is the equivalent of a flashing red light these days – it is also used as a feature in financial contracts worldwide.

For example, if you have secured a loan to build your factory or a line of credit to finance the stream of materials you need to manufacture your goods, the underlying terms of your agreement almost invariably use LIBOR, plus some percentage, to express the interest rate you'll pay on the loan.

LIBOR is so widely used in this manner that it is estimated to be linked to over $370 trillion worth of financial contracts. Thus, when LIBOR spikes by 1.44% to 5.38%, as it did earlier this week (it has since settled in around 4.82%... for the moment), the financial consequences to already struggling businesses are huge.

To get the full picture, you have to understand that, pre-crisis, LIBOR was ticking along at about one-half of a percent. So, in raw numbers, multiply a 4.3% increase in LIBOR across $370 trillion worth of contracts and you come up with a financial punch in the gut of almost $16 trillion.

Businesses will fail. Industries will grind to a halt.

Watch LIBOR. Unless and until those rates come down, you can forget about that whole "Happy days are here again" thing. (And, when LIBOR does eventually come down, we'll still be in the deep, dark woods... just in another quadrant of the woods.)

Vive Le Difference!

The McCain/Palin team, correctly in my view, hurls bricks at Obama/Biden for looking to the government to fix all that ails.

Set the free market free, I cheered, pumping my arm enthusiastically in the air with a loud whoop or two thrown in for effect.

But then I came across the following, and my arm dropped across my forehead in an swoon of bitter despair.

"And it's my proposal, it's not Senator Obama's proposal, it's not President Bush's proposal," McCain said. His campaign estimates it would cost about $300 billion, some of which could be diverted from an existing $700 billion rescue package.

Democrat, Republican... two sides of a statist coin if you ask me.

But wait, just when my despair was about to turn to cynicism, I came across this other item from Bloomberg... they caught the culprit behind the financial crisis!

His name, in case you hadn't heard, is Kenneth Rickel. And better yet, he's from Beverly Hills! Rich and greedy, just as we suspected. Bring out the duct tape and truncheons, I say!

From Bloomberg's report on the miscreant behind the crime of the century...

Just what kind of short seller is our man Rickel? Not a naked short seller, like the kind Cox normally vilifies. And while the SEC may have called his civil violations "illegal," it didn't accuse him of fraud.

According to the SEC's complaint, Rickel covered short sales on 14 companies with shares he bought through their public stock offerings. If he'd covered his bets with stock he bought on the open market, he would've been OK under the rules. In a short sale, an investor sells borrowed shares, hoping to buy them back at a lower price and pocket the difference as profit. (Naked shorts sell shares without borrowing them first.)

And what was the totality of Rickel's ill-gotten gains? $207,291. For shame, Mr. Rickel, for shame! (You can read the whole story here:)

Kind of reminds me of Barney Frank's blaming the housing collapse on the free market (see last week's edition). On that topic, someone -- and I am sorry to say I don't recollect, but thanks to whomever you are -- sent along the following.

Which brings me to my song of the week, a classic and very appropriate to today's situation. It's Ship of Fools by World Party. You can listen to it here.

And, Now for Something Entirely Different...

I'm tired of writing about doom and gloom. So, let's take a quick breather by spending a few minutes on one of my favorite topics... the more optimistic topic of technology. This week, a couple of items came to my attention.

Cars for Teens. The first is that Ford announced they are coming out with a new car that allows parents control over maximum speed, music volume, and required seat belt usage. As the father of two pre-teens and remembering my own experience as a teenager behind the wheel (final tally four accidents, one serious), I am solidly in Ford's customer demographic for this innovation.

Kindle 2 Coming. Subscriber and regular correspondent Marv A. tipped me off to the fact that the much anticipated Kindle V.2 is on the way. In fact, here's a peek at it. As readers of any duration know, I am in love with this technology... and even more so with each passing day. If you don't have a Kindle yet, you just don't know what you're missing. In any event, here's a link to an article on the new version. I'll be a buyer (that will make three for a family of four... but I suspect it will be four for four in the not-too-distant future.)

Correspondence

I have received many wonderful and thoughtful emails over the last couple of weeks (along with a few not so wonderful, but hey, it is what it is). While I read all email addressed to me, the problem comes in responding, which takes longer. The problem is that the incoming mail – perfectly understandable given the temper tantrum being thrown by global markets – has reached the point where I am falling hopelessly behind.

Next week, I will try to be a better correspondent.

Sleep Walking into a Brave New World

"It's unreal," said Dean Price, 24, a graphic designer in London. "We've been sleep-walking into this. Everyone talks about Orwell and 1984, but no one ever does anything about it."

I'm running out of time, but I don't want to end this week without hoisting a warning flag about the rising tide of fascism, which typically occurs during economic crisis.

You don't need me to point out the signs that are there for everyone to see, if they weren't too sheepish or just too busy trying to survive to do so. Gitmo, wiretapping of civilians (and, according to breaking news, soldiers in Iraq and their loved ones), U.S. spy satellites being redirected to within U.S. borders for law enforcement purposes, even the deployment of a U.S. Army brigade within the U.S. with a specific mandate to be available to "help" in the event of a domestic emergency of an unspecified nature. A democratic congressman, during the floor debate on the big bailout, said that he and a number of his colleagues were told that if they didn't vote in favor of the bill, "the stock market would crash, and within two weeks martial law would be declared." (You can look all those references up for yourself. I would have done it for you, but I am already out of time.)

The quote at the top of this segment comes from an article I came across on Bloomberg this week on the very slippery slope that Britain is now on. It started with surveillance cameras here and there and has expanded to the point where even local councils have been given permission to deploy spy cameras and wire tapping.

It is worth reading, which you can do here.

As an aside, I am re-reading Orwell's 1984... on my Kindle, of course. It is a true classic and well worth a re-read, especially now.

My point is simple: if there was ever a time to be vigilant, this is it.

Miscellany

You Think Times Are Tough in the U.S.? Last week, I discussed the fact that, as bad as things are in the U.S. financial system, it is as bad, or worse, in Europe. How bad? Well, I can't say for sure if this photo out of England is real or not, but if things keep going the way they are, it could be... (thanks to Bill W. for sending that along!)
Stock Sale Notice. As is our policy, please be advised that a member of our team intends to sell his shares in Allied Nevada, a company we are currently have as a buy. The decision to sell is entirely due to the need to raise some of the money needed to pay a tax bill and has nothing to do with the company or its prospects. Also per our policy, he will not sell until you have had a head start of two business days.
Phyle Announcements. Glenn in Auckland, NZ, is looking to start a get-together group for subscribers, as is Hans in Tampa, FL. The inaugural gathering in Los Angeles is Oct. 18 at 7:00 pm at The Church and State located at 1850 Industrial Ave (east downtown LA). The next phyle meeting in Seattle is scheduled for Oct. 21 at 7:00 pm at the Starbucks in downtown Mercer Island, WA. For more on these events, drop a line to Kristen at phyle@caseyresearch.com.

That's it for this week. As I sign off, just after midday, I see the DJIA is off by 368 points, the S&P is off another 39 points to 865, and gold, after a morning surge, has backed off to around $880 per ounce, as traders close out positions ahead of the weekend. This weekend, the G-7 finance ministers, the IMF and Worldbank all meet in Washington, DC. Understandably, there is a lot of uncertainty in the markets about what's going to happen on Monday.

Speaking of which, Sally Limantour, in the current edition of The Casey Report, provided the technical break-up/break-down levels for a number of markets... i.e., the levels at which a breakthrough signals a bigger move up or down. I asked her to update the levels for stocks and gold. The current break-up level for the S&P 500 is 1005, the break-down is 825. For gold, the break-up is $942, the break-down is $866.

Now, obviously, those numbers move with time... but at least now you know what the traders are watching.

We live in interesting times. Stay in touch...

David Galland

Managing Director

Casey Research, LLC.

The Room - 09/26/2008

David Galland — Tue, 30 Sep 2008 21:34:16 GMT

September 26, 2008

Dear Readers,

What a world I have returned to from my cloistered retreat at the beautiful Vivenda Miranda, scenically situated on a cliff outside of the quaint port town of Lagos, Portugal.

Everything has changed.

Everything is changing.

The storm we have so long tried to help you prepare for is upon us. At this point, I can only hope you have your sails rigged for the storm now breaking, because time is running out.

The violent volatility I warned of when last I wrote has arrived, with towering waves now rising up and smashing into the economy - and as an unavoidable consequence, our personal portfolios -- from all sides.

Overnight the holders of my mortgage, WaMu, failed, the largest bank failure in history. This week, the golf course that I usually play on was taken over by the government... last week it belonged to AIG.

As you don't need me to tell you, that same government now wants to spend over a trillion dollars to bail out Wall Street and to shore up the money market mutual funds - which have so far flown under the radar screen despite portfolios stuffed to the brim with bad paper.

While no one was paying attention, U.S. automakers used their election year leverage to win approval for $25 billion in low-interest loans.

As you can see in the chart shown here, the monetary base of the U.S. has surged, a topic we'll have more on in The Casey Report, which will be released next week. Even before the bailout, the government has begun doing what it knows best... pumping up the money supply in a desperate attempt to save the economy from the crash it so desperately needs.

According to Reuters, last week the Fed lent nearly $188 billion per day, on average, to banks and money managers.

Last week, as this fiscal prolificacy was underway, gold surged as we expected it to. This week, it has consolidated, holding its gains but not pushing higher yet.

We don't care.

Owning gold right now is the right thing to do, on multiple levels. Others are now quickly coming to that same understanding. This week, I have had two calls from people I haven't heard from in years, asking me how to buy gold. And then there's this...

From a correspondent in Switzerland...

So, we call Bank Cantonale Bern. The Cantonale Banks are like BofA in the States - it's a huge retail banking company with branches in most towns. We learn, yes, they have limited bullion for gold but no silver.

The surprise came when we arrived at the bank this afternoon. The bank has a teller window, segregated off to the side of the others, with a sign above the window that read,

"Change & Gold" (foreign currency and gold coins)

We had to wait in line. I bought the last of the one-ounce bullion they had - Krugerands. And there were people behind us in line. The woman who helped us said that the demand for gold has been so strong that they made it available via front-line employees, rather than through a bank representative in a private, "behind the counter" transaction. And they haven't had silver for several weeks. She said supplies of silver had been sporadic at certain branches in Zurich.

So there you have it. A retail bank where you can conduct business in gold just as easy as Swiss francs. A developing trend? One can only hope.

Just a few minutes ago, my dear friend Mr. Watson, whose birthday it was I went to help celebrate in Portugal, tipped me to this... from the Toronto Star.

Coin dealers from the U.S. to Canada have reported a surge in buying of bullion coins and other gold products as troubles in the financial markets prompt people to seek a safe haven in precious metals.

"Demand has exceeded supply for American buffalo 24-karat gold one-ounce bullion coins, and our inventories have been depleted," the mint said in a note to its dealers. "We are, therefore, temporarily suspending sales of these coins."

The trading herd will follow the physical buyers. The recent $100 surge was just a precursor. The lag in understanding - and action - is understandable. The global economy is in a true paradigm shift. People don't want to believe what their eyes and ears are telling them. And so, at this point the trading herd is standing en masse, eyes wide open, nostrils flaring, muscles twitching spastically, waiting for the news that will tell them which way to bolt for safety.

While they are only to be used by the attentive, and with great caution, I am now using a variety of options and futures strategies to leverage what's coming. I will never risk so much as to put myself in any real financial trouble. But, with that filter, I am now positioning myself for higher gold prices and a falling stock market (I suspect one more dead-cat bounce after the bailout is passed... then watch out below).

Higher interest rates are a sure thing, but there will likely be a lag between now and then as well. Structure things right, and you can ride through any possible downturn, then earn extraordinary returns as things move in your favor. But the key thing to remember is that, like hot chili sauce, a little leverage goes a long way... and a lot of leverage can burn you, badly.

Knowing where your money is has also become very important. In the upcoming edition of The Casey Report, we'll also be presenting a detailed explanation of how to be sure your bank will be one of those still standing after the storm.

Ed. Note

The Casey Report

Try our 3-month no-risk trial now.

Whatever the final form of the bailout, and I am convinced there will be one - the money may not flow in exactly the way that Wall Street wants, but it will flow nonetheless -- in the medium to long term, the die is cast. The hegemony of the U.S. dollar in international trade is coming to an end (more on that momentarily). Given the lack of a tangible alternative, namely one that is not solely faith based, a new currency regime will arise. It's impossible to gauge from this distance what it will ultimately look like, or who will sponsor it (there is talk of the IMF fulfilling the role), but it's safe to assume it will have to include gold and other tangibles.

We live in dangerous, yet exciting, times. We'll continue doing our part to keep you in the know, and on the right side of things.

Moving along, I want to share a front-seat analysis on this week's congressional hearings on the bailout from Donald Grove, our new Washington correspondent.

The Bailout: Behind the Scenes

By Donald Grove

I went to hear Fed Chairman Ben Bernanke testify this morning before the Joint Economic Committee (Chairman Chuck Schumer, D-NY), primarily on the Bush administration's capital markets intervention proposal. I thought I would pass on my observations, which will probably be different than what you read in the mainstream press. Bernanke has had it rough lately. He was testifying yesterday with Treasury Secretary Hank Paulson and SEC Chairman Chris Cox before the Senate Banking Committee (Chairman Chris Dodd, D-Conn) and was scheduled to testify with Paulson later this afternoon before the House Financial Services Committee (Chairman Barney Frank, D-Mass).

Schumer recalled that Bernanke last appeared before the Joint Economic Committee in April, following the narrowly averted collapse of Bear Stearns. He said "Most of us thought we had just witnessed an event that we were likely never to see again in our lifetimes. And yet, here we are, only six months later, and we are discussing a crisis many orders of magnitude greater." Schumer stated, as did others, that "we must act and we must act soon." Those statements were not without reservations, however, and I would add that not acting may be the more prudent course. There seems to be a compulsion on the Hill to do something, even if it's wrong. I guess that's what legislators think their constituents expect - and maybe they do. New York Mayor Michael Bloomberg told NBC's "Meet the Press" that "nobody knows exactly what they should do, but anything is better than nothing." Not necessarily so - in fact, probably not so. "Expecting Congress to fix the current financial crisis is like expecting an arsonist to put out the fire he started," said Representative John Shadegg (R-Az).

Schumer told Bernanke that "Americans are furious" and that he and probably each of his colleagues have heard "amazement, astonishment, and intense anger" from constituents. No doubt, but why? According to Schumer, "over the last eight years, we were told that markets knew best, that financial alchemy had reduced risk to an afterthought, and that we were entering a new world of global growth and prosperity. Instead, what we have learned is that we now have to pay for the greed and recklessness of those who should have known better." Talk about the pot calling the kettle black. I personally recall hearing Schumer in a hearing on the Hill within the last eight years demanding that the less fortunate be given access to home mortgages so they, too, could realize the American dream. He was not alone. The former Fed chairman urged Americans to avail themselves of adjustable-rate mortgages. As was often noted during today's hearing, there is plenty of blame to go around. What worried me was the tendency to lay blame for this debacle on the free market.

As I noted above, I think doing nothing may be the best thing Congress can do right now. In fact, if Congress had done nothing in the past, we might have avoided a lot of these problems. It's never too late to stop meddling. Why not start right now? Rep. Kevin Brady (R-TX) suggested that we just let the free-market system correct itself. Of course the Fed chairman did not agree. He told Sen. John Sununu (R-NH) that we need to figure out what the price should be on complex securities so that private capital can come in and help buy them up so that banks can reestablish capital to make loans. Ron Paul, in prime form, said that most illiquid assets are illiquid because they are not worth anything. He added that price fixing prolonged the Great Depression, and that is what is being proposed now. He said that messing with prices risks socialism. Paul said the Fed is not smart enough to fix prices. Hear! Hear! Nor, I would add, is the Treasury Secretary or Congress. The free market, however, is uniquely able by its very nature to set prices just right, including, by the way, interest rates - the price of money.

Congressman Paul asked where this $700 billion will come from. Not from taxes or borrowing from China. He said it will come from us, presumably through the insidious tax of inflation. He explained that the downturn in housing is because housing is overpriced. Let housing prices come down, he said. He said, "We can't solve inflation with more inflation." Paul asked the Fed chairman where his authority comes from and noted that only 15% of Americans care about the Constitution or the rule of law - and less than that in Washington, D.C.

Bernanke conceded that price fixing was counterproductive but insisted that we have to somehow "discover" what prices are. Duhhh! That's what the free market is for! As to his authority, he cited the Federal Reserve Act ..... "now if you disagree with the Act...." Well, I do disagree, and I think Ron Paul also believes that the creation of the central bank in 1913 was where a lot of this trouble started. Nevertheless, I don't think the Fed has even been complying with the mandate and constraints of the Act.

Refreshingly, retiring Senator Jim Saxton, ranking member on the Committee (R-NJ), noted that it would be nice if we could go to a safe at Treasury and take out about 5% of GDP to bail out financial institutions, but we can't. We have to borrow it, he said (albeit probably surreptitiously from our unborn progeny). I am always heartened to see that someone on the Hill realizes that. Unfortunately, I suspect that a majority of Americans do vaguely suppose that there is something like a big safe with real money in it that the government taps to pay for things like this - kind of like believing that the Social Security Trust Fund is bundles of hundred-dollar bills stacked up in a cool, dry place.

Vice Chairman Carolyn Maloney (R-NY) asked if this proposal to intervene in the credit markets to the tune of $700 B would affect inflation and wondered if the Fed might have to raise rates. Bernanke said that this was not a stimulus. He said that if it helps the economy grow, the Fed may have to raise rates sooner, but the he did not expect it to have any effect on inflation. I'm speechless! Of course it's inflationary. I also have to wonder whenever I hear a comment like this, whether he actually believes that an expanding economy causes inflation - like some mysterious act of God - and that it is the Fed's role to counter that by raising rates.

He explained that this would not be an expenditure. He said it would be "acquisition of assets." If there is a loss, he said, it would be much less than $700 B. I think I agree with Ron Paul. We are basically trying to pretend that the real estate bubble never popped by saying that the debt instruments based on those inflated values still have value. Several legislators expressed their frustration over the fact that Hank Paulson added other toxic waste to the mix this weekend - car loans, student loans.

Congress is trying to add its own unique signature to this boondoggle. For example, there is talk of coming up with the money by placing a surcharge on those making over a certain amount per year (I think $1M). There is also a move to restrict the compensation of financial institution executives. Amy Klubuchar (D-MN), said, "There should be a limit on what you can make when taking our money." Bernanke said there has to be an incentive for risk taking. "For this to work," he said, "we need a wide range of participation. If we stigmatize institutions that participate, they won't participate." Jeff Bingaman (D-NM) suggested a $200 B tranche with Warren Buffett at the head of the board of some administering organization to "get these institutions functioning again." Bernanke noted that Buffett had invested $5 B in Goldman Sachs and that the Oracle of Omaha had said that we "go over the precipice if Congress does not act."

There was also a bright side to proposals from legislators. Kevin Brady suggested that Congress look at a holiday on the capital gains tax or temporarily lowering repatriation road blocks since taxes now make it too expensive to bring capital home from overseas. He noted that three years ago, $300 B came home when the tax barriers were lowered. Bernanke said these actions alone will not solve the problem. Again, I am not holding my breath - more likely that we will see exchange controls.

Representative Lloyd Doggett (D-TX) noted that although Bernanke says he will be "acquiring assets," he has asked Congress to raise the debt limit to do it and is acquiring the assets because they are toxic waste and we don't know what they're worth. "In Texas," he said, "we say ‘those chickens are coming home to roost.'" Then he thought better of it and said "vultures are coming home to roost." He said we have a bankrupt ideology. I'm not holding my breath waiting for taxpayers to get their $700 B back. Ron Paul later said that after Doggett's comments, he can't tell who the conservatives are.

As is often the case in exchanges with the Fed chairman, there was an emphasis on market psychology, not real sound money practices. The whole concern seems to be for creating the illusion of economic stability as if stability could not actually be achieved, so the illusion is the best we can do. For example, Schumer asked whether a $150 billion installment, with the rest to come later, wouldn't be enough to assure markets that Congress is serious. Bernanke agreed that it is about psychology and said $700 B is what the administration thought it would take to provide psychological reassurance. Representative Carolyn Maloney asked where he got that figure. He said it was not science. It's about 5% of the $14 trillion in outstanding residential and commercial mortgages, on which the loss rate is about 5 %. I couldn't help thinking that returning to the gold standard would certainly show the market that Congress was serious and would allow real financial planning instead of trying to guess at the unintended consequences of clumsy government intervention in the free market.

There was a lot of discussion of the technical aspects of getting banks lending again - putting taxpayers first, strong congressional oversight, enticing financial institutions, including foreign institutions, to participate in the auction of these troubled securities, fire sale vs. hold-to-maturity prices, the Fed paying a premium for them. Senator John Sununu asked if firms would be willing to sell at below book value. Bernanke said (apparently now agreeing with Ron Paul) that "over time there is no way to hide the real value of an asset." I think that was a "yes," but I found myself wondering whether the objective here isn't to pay above-market value for these securities with taxpayer's money. I think it is.

Bernanke said this is the most significant post-war economic crisis for the United States and the world. He noted the hardships for those on Main Street if banks can't lend - consumer credit dries up, car and small business loans are unavailable. Baron Hill (D-IN) asked Bernanke what he should tell his constituents who asked if their stock portfolios and 401(k)s were going to lose value. Bernanke said "yes," they would lose value if Congress does not act. He said the credit system is like plumbing that permeates the economy. He said choking credit takes the life blood out of the economy. That may be, but perhaps it should not be. It occurred to me that there are two components to interest: opportunity cost and risk of lost purchasing power. If you take away the latter, I think the credit system becomes quite simple and we don't have to go through all these contortions, and probably don't need the Federal Reserve. Inconveniently, the government would have to live within its means like the rest of us.

Bernanke said the pain on Main Street would be very significant if Congress does not authorize this plan. He urged Congress to solve this problem now and come back later and look at reforming regulation. As Representative John Shadegg said, however, you can't expect an arsonist to put out the fire he started. There is no way we are going to avoid pain at this point. It seems to me that each time Congress tries to avoid it, the inevitable pain gets worse. Let's bite the bullet and get it over with and for God's sake, no more regulation!

Jim DeMint (R-SC) said that unbridled capitalism is not at fault. He said this problem was caused by the government and its implied guarantee. He said we removed accountability for risk from the enterprise system and that this was a failure of government intervention, not a failure of the free market. Bernanke tried to clarify that he was not talking about heavier regulation, just reformed, smarter regulation - maybe even less regulation. I'm afraid I have evolved from a libertarian into an anarchist and find not the slightest comfort in those words. I was happy to hear DeMint point out that some of the institutions that Bernanke found too big to fail were government-created GSEs. He said that none of these programs support free-market activity. He noted that the Sarbanes-Oxley "monster" chased capital off shore but failed to tell us about Bear Stearns. He concluded that "no amount of government regulation will eliminate corruption if risk is removed." Bravo!

Rep. Phil English (R-PA) was troubled by the extraordinary power this proposal would give to the Treasury Secretary, an unelected official. He suggested that this was the path to "Crony Capitalism." I will add that the next Treasury Secretary will inherit this power and will not only be unelected, he or she has not even been named.

Rep. Maurice Hinchey (D-NY) observed that Bernanke and Paulson went to the White House with this problem last Thursday but had to have known about it before that. He wondered why Congress had been kept in the dark. Bernanke cited efforts taken to correct the problem, including the discount window, CDSs, and the market's natural healing process. Hinchey said he was skeptical in April when Bernanke and Paulson told the Committee that the economy was growing and that our financial institutions were healthy. He said there was motivation to keep this under cover and that we are seeing manipulations and distortions of the mortgage market. Bernanke cited the sharp interest rate cuts in January. Apparently he was still hopeful that they would work in April and did not want to alarm the Committee. He suggested that Congress "should look at substantial regulatory reform." He suggested a "1-2 punch. Stabilize and then fix it so it does not happen again." Again, I say that fixing it will take more than adjusting a few dials or fine tuning some regulations. The overhaul necessary to fix this I suspect no one on the Hill has the guts for except Ron Paul, maybe Tom Coburn.

In conclusion, I would say it sounds like this bailout may not be a done deal. Constituents are ringing phones off the hook, telling their legislators "don't do it." Many are suspicious that it came up so quickly and that they are being asked to act so quickly. Representative Mike Pence (R-IN) told CNN, "There are those in the public debate who have said that we must act now. The last time I heard that, I was on a used-car lot. The truth is, every time somebody tells you that you've got to do the deal right now, it usually means they're going to get the better part of the deal."

Always the optimist.

Regards, Don

More Views on the Bailout From the Washington Post...

During testimony before the House Budget Committee, Peter R. Orszag -- Congress's top bookkeeper -- said the bailout could expose the way companies are stowing toxic assets on their books, leading to greater problems.

"Ironically, the intervention could even trigger additional failures of large institutions, because some institutions may be carrying troubled assets on their books at inflated values," Orszag said in his testimony. "Establishing clearer prices might reveal those institutions to be insolvent."

In an interview later yesterday, Orszag explained using the following example: Suppose a company has Asset X, whose value is recorded on the books as $100. Because of the current economic decline, Asset X's real value has dropped to $50. If the company takes part in the government bailout and sells Asset X for $50, the company has to report a $50 loss on its books. On a scale of millions of dollars, such write-downs could ruin a company.

Such companies "look solvent today only because it's kind of hidden," Orszag said. "They actually are insolvent" already, he said.

From Ron Paul...

Dear Friends,

Whenever a Great Bipartisan Consensus is announced, and a compliant media assures everyone that the wondrous actions of our wise leaders are being taken for our own good, you can know with absolute certainty that disaster is about to strike.

The events of the past week are no exception.

The bailout package that is about to be rammed down Congress' throat is not just economically foolish. It is downright sinister. It makes a mockery of our Constitution, which our leaders should never again bother pretending is still in effect. It promises the American people a never-ending nightmare of ever-greater debt liabilities they will have to shoulder. Two weeks ago, financial analyst Jim Rogers said the bailout of Fannie Mae and Freddie Mac made America more communist than China! "This is welfare for the rich," he said. "This is socialism for the rich. It's bailing out the financiers, the banks, the Wall Streeters."

That describes the current bailout package to a T. And we're being told it's unavoidable.

The claim that the market caused all this is so staggeringly foolish that only politicians and the media could pretend to believe it. But that has become the conventional wisdom, with the desired result that those responsible for the credit bubble and its predictable consequences - predictable, that is, to those who understand sound, Austrian economics - are being let off the hook. The Federal Reserve System is actually positioning itself as the savior, rather than the culprit, in this mess!

The Treasury Secretary is authorized to purchase up to $700 billion in mortgage-related assets at any one time. That means $700 billion is only the very beginning of what will hit us.
Financial institutions are "designated as financial agents of the Government." This is the New Deal to end all New Deals.
Then there's this: "Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency." Translation: the Secretary can buy up whatever junk debt he wants to, burden the American people with it, and be subject to no one in the process.

There goes your country.

Even some so-called free-market economists are calling all this "sadly necessary." Sad, yes. Necessary? Don't make me laugh.

Our one-party system is complicit in yet another crime against the American people. The two major party candidates for president themselves initially indicated their strong support for bailouts of this kind - another example of the big choice we're supposedly presented with this November: yes or yes. Now, with a backlash brewing, they're not quite sure what their views are. A sad display, really.

Although the present bailout package is almost certainly not the end of the political atrocities we'll witness in connection with the crisis, time is short. Congress may vote as soon as tomorrow. With a Rasmussen poll finding support for the bailout at an anemic seven percent, some members of Congress are afraid to vote for it. Call them! Let them hear from you! Tell them you will never vote for anyone who supports this atrocity.

The issue boils down to this: do we care about freedom? Do we care about responsibility and accountability? Do we care that our government and media have been bought and paid for? Do we care that average Americans are about to be looted in order to subsidize the fattest of cats on Wall Street and in government? Do we care?

When the chips are down, will we stand up and fight, even if it means standing up against every stripe of fashionable opinion in politics and the media?

Times like these have a way of telling us what kind of a people we are, and what kind of country we shall be.

In liberty,

Ron Paul

Quotes from the Quislings

Not to be indelicate, but the working title I had chosen for this next section was "FCUK YOU!"... that, by virtue of my feeling that strong words are in order for the quislings who purport to be free marketers and who have been lined up to support the government's bailout.

Here's my Rogues List...

Laurence Fink

BlackRock Inc

"If this plan works, taxpayers are not going to be out money," Fink, a pioneer of mortgage-backed securities, said in an interview with Bloomberg TV.

... Based on current prices, buyers of distressed debt, including the government, will earn "strong returns over the next five to seven years," said Fink, who declined to say whether his New York-based company will bid on contracts to manage the proposed Treasury fund.

And there's the well-regarded Mr. Buffett...

"I am betting on the Congress doing the right thing for the American public and passing this bill," Buffett said on cable channel CNBC today. "I certainly have a vote of confidence in Goldman and vote of confidence in Congress."

Of course, Buffett didn't mention how much money his company stood to lose if the government failed to rush into the breach. Or how much extra money he'd make by trading his good name to Goldman for a sweetheart deal that will form a footnote in all future books on financial topics... but only if the bailout goes through. Among other kisses, Buffett's coup includes perpetual preferred shares that pay a 10% coupon. Simply, that means if the U.S.G. bails out Goldman, Buffett will collect $500 million a year on his $5 billion investment, and his payments will come before those sent to any other shareholders. He also gets under-the-market warrants on another $5 billion worth of shares.

Goldman never would have agreed to this deal unless their feet were roasting in the coals of calamity. One can hardly blame Buffett for making his move (it's not like he couldn't withstand the loss of $5 billion, should the worst come to pass), but now that he is so handsomely positioned, his cheerleading should be viewed as the disingenuous self-dealing that it is.

And then there's this, from the Washington Post, quoting mega-bond manager Bill Gross...

"The Treasury proposal will not be a bailout of Wall Street but a rescue of Main Street, as lending capacity and confidence is restored to our banks and the delicate balance between production and finance is given a chance to work its magic. Democratic Party earmarks mandating forbearance on home mortgage foreclosures will be critical as well. If this program is successful, however, it is obvious that the free market and Wild West capitalism of recent decades will be forever changed. Future economic textbooks are likely to teach that while capitalism is the most dynamic and productive system ever conceived, it is most efficient over the long term when there is another delicate balance -- between private incentive and government oversight."

On that last bit, I feel it's worth mentioning that Freddie and Fannie may have "enjoyed" more government oversight than any other two institutions on the planet.

If there is one certainty, and there are several related to this fiasco, it will be that the free market will be made the patsy, and the result will be a public outcry for more, not less government.

In the end, now that the government has broached the topic, the $700 billion is going to get spent... whether it starts by going into the pockets of the Wall Street, or is cycled back into the public pocket through the vehicle of FDIC guarantees, or making the money market funds whole, or giving millions of householders a free ride on their mortgages... or simply writing checks to consumers... it, and a lot more is going to get spent.

For my money, and it is my money (and yours), the best argument for the bailout was offered by none other than President Bush, who succinctly opined in a meeting yesterday of congressional leaders, "If money isn't loosened, this sucker could go down."

Unfortunately this sucker, aka the economy, is going down no matter what they do at this point.

At this point, all we can do is to wait and watch. Focus on liquidity for your personal portfolio and prepare for the worst. It's coming.

About Those Foreigners...

In all of the frenzy, the U.S. Government seems to be largely ignoring the foreign holders of our many trillions of dollars. This is also, as we have repeatedly said would be the case, because foreigners don't vote, and if they do decide to dump their dollars - as we expect they will (and actually are) - they will only hurt themselves. Or, so runs the logic of desperate policymakers, relying on MMAD (Monetary Mutual Assured Destruction) to rationalize their massive unleashing of dollars.

If you've voted for any of the clowns running our country for the last 40 or so years, you might want to take a moment to apologize to your children and, if you have them, your grandchildren as well. (Ron Paul supporters, you can take a pass on this.)

That's because, as I mentioned above, the U.S. Government has managed to squander the unbelievable advantage of being the suppliers of the world's de-facto reserve currency... an advantage made almost miraculous given that it was backed by nothing.

All the bureaucrats had to do was show even modest restraint and occasionally take a few moments to remind themselves of the principles of self-reliance and open opportunity that made this country what it is. Instead, the political class, cheered on by the voting public, fell in love with virtually every perfect-world social program, every new make work, corporate suck-up and pork barrel program waved in front of their snout-bedecked faces these many years. In the process, they have traded away something that no nation will again enjoy... a global blank check.

Bud Conrad is assembling the eye-opening hard data showing the trend reversal in foreign investment in U.S. dollar assets for the next edition of The Casey Report.

In the meantime, the anecdotal evidence is beginning to mount, an example being this item from MarketWatch this week..

HONG KONG (MarketWatch) -- Chinese regulators have asked domestic banks to stop lending to U.S. financial institutions in the interbank money markets to prevent possible losses during the financial crisis, the South China Morning Post reported Thursday. The China Banking Regulatory Commission's ban on interbank lending of all currencies applied to U.S. banks, but not to lenders from other countries, the report added, citing a source.

I don't need to tell you that the Chinese government operates on group-think. For an official arm of the government to take this step is a howitzer shot across the bow of the U.S. ship of state.

Meanwhile, the current administration has managed to almost entirely alienate the Russians with our persistent meddling overseas ("Avoid foreign entanglements," said George Washington and Thomas Jefferson. "Take over the world," answered a succession of modern politicos). Not shy about giving as good as they get, the Putinistas are moving game pieces closer to home ground.

The memorandum was signed on Monday in Caracas, as a Russian Navy squadron, including the heavy cruiser Peter the Great and three escorts, set sail from St. Petersburg to join Venezuelan vessels in the first show of Russian naval power in the American hemisphere for many years.

They have been preceded by the Russian Air Force, which dispatched a pair of long-range bombers to Venezuela for the past week. A Russian naval spokesman told Mineweb the squadron will operate in the Caribbean, and will enter the sea from the Atlantic Ocean.

And the official mouthpieces of the Russian government, this one from the Russian News and Information Agency, are firing torpedoes at the U.S. dollar. This excerpt from an article entitled "Time for a gold rouble" published yesterday...

Second, the Russian leaders might also consider making their own currency, the ruble, convertible into gold. The idea of gold convertible currencies is extremely unpopular among most economists; they dismiss gold as a "barbarous relic" (to use the famous phrase of John Maynard Keynes) and suggest either the present regime of paper currencies or, at best, a link to a basket of commodities.

Both these solutions are highly artificial and based on the same level of state control which has now just so spectacularly failed. Indeed, which is more "barbarous" -- the reintroduction of gold as an instrument of payment, or the practice of amassing huge quantities of the precious metal to keep it locked underground in the vaults of central banks? The contempt of the Keynesians notwithstanding, it is an indisputable fact that gold does remain the ultimate store of value, which is precisely why states own so much of it.

At this point, even our "friends" are starting to make excuses and reach for their coats. This from a Reuters report on the strong words falling out of the mouth of the German finance minister...

In some of the toughest language since the crisis worsened this month, German Finance Minister Peer Steinbrueck told parliament the financial turmoil would leave "deep marks" but was primarily an American problem.

"The world will never be as it was before the crisis," Steinbrueck, a deputy leader of the center-left Social Democrats, told the Bundestag lower house.

"The United States will lose its superpower status in the world financial system. The world financial system will become more multi-polar."

It is impossible to fully appreciate, let alone understand, the implications of the loss of the dollar's global reserve status... but it's a topic we'll be digging into. It won't happen overnight, but it will happen.

A Musical Interlude

For something a little lighter, I want to share some of the musical recommendations that were sent by readers in response to my recent solicitation.

Before getting to your recommendations, however, I'll tell you that today I have been listening, repetitively, to the soundtrack from "Once," an excellent film we watched earlier this week. Our own Louis James had first recommended it, followed by another friend, and so I thought I should check it out. It is a simple, beautifully executed, romantic little film... overlaid with powerful music.

The track I'm currently listening to is one of my favorites, "When Your Mind's Made Up." You can listen to it and see a scene from the film, compliments of YouTube, by clicking here. It starts slow, then builds to the point where it pretty much blows me away -- just the kind of music I love.

Okay, so that's my entry this week... now here are yours.

Explosions in the Sky

The Birth and Death of the Day

It's Natural to Be Afraid

All of a Sudden I Miss Everyone

My All Time 5 Favorites... Foo Fighters - Pretender - awesome video where they fight the riot police, btw...

KRS1 - Sound of Da Police ...

NWA - F*** Da Police

Pink Floyd - Another Brick in the Wall Pt. 2

Public Enemy - Fight the Power.

As you may have noticed, I like my music with a message... Music to overthrow your government by! Jeff B.

JS Bach's Toccata and Fugue

It is surpassed only by Hector Berlioz's Requiem, scored for full symphony orchestra, a double choir, and a brass band in each of the hall's four corners. Despite its title, it's a rouser! If you have a good sound system, open

http://www.youtube.com/results?search_query=berlioz+requiem&search_type=&aq=2&oq=berlio

Start with Requiem et Kyrie, and keep going. C V.

First off, the Isley Bros, in general, are hard to beat. For passion and purity of voice you gotta hear (the late, due to cancer) Eva Cassidy, not exactly rockin' music but well worth the listen. I was delighted to actually find recordings of her live performances on YouTube, though her best album was Songbird.

Other mentionables from assorted categories that are worth a listen and whom you may or may not be familiar with (we're about the same age) are Dan Hicks and His Hot Licks (hippie country rock), Zap Mamma (world), (the late due to dying) Shirley Horn (torch jazz), and early John Mayall (blues).

www.generalfuzz.net

Thanks for all the great insights so far. . . James

So here is my must have for you and maybe you are already enlightened... Yo La Tengo. Writing beautiful rock and roll for 20 years. Check Youtube "Today is the day" and listen to the live performance on John McEnroe's show. Then graduate to "Blue Line Swinger" It is a 9 minute song and the first time you hear it, by minute 4 and 20 seconds your foot will be tapping, the second time I think it will be tapping the whole time. John W.

Gypsy Soul

Obsession Confession

Slash

While speaking of songs that get me movin' (and STOP me from working), I might mention one called Orinoco Flow (Sail Away) by Enya. Sounds as if it would be rather staid if you know anything of her, but there again is something about that song... it got airplay at a time when I was training for powerlifting at some ungodly early time in the morning before work. Whenever that song would come on, I would have to wait to start my set, but I was awake and movin' by the end of it.

How about Classical Gas for a movin' song?

Country music provides the bulk of the really good guitar playing (and I honestly am not that impressed by most rock guitar playing). Roy Clark has been my favorite since I was a kid (although I don't really care to have him sing). And if they were to map my DNA, I believe they would discover a Boogie gene.

And on that note, give a listen to an Aussie flatpicking champion named Tommy Emmanuel.

Now back to work (me, not you). Matt B.

A tune that is a favourite of mine and in keeping with the problems at present (Chris Rea's Highway to Hell) (listen carefully to the lyrics) for your entertainment. Chris M.

David again, I have many more... and will try to cycle in your recommendations in future editions. But for now, time is running short and I need to move on. Thanks to all of you who have contributed... my musical horizons have been expanded.

McPalin Is Toast

This week I finally found the time to spend a little time, figuratively speaking, with Sarah Palin (encouraged by an article Doug Casey is preparing for The Casey Report on McCain's surprise running mate).

I have to say, I was pretty shocked. As I think many Americans will be, as they watch the candidate in action in the weeks just ahead.

The following quote is from Palin's interview with Katie Couric, in response to a question on the bailout.

"That's why I say, I, like every American I'm speaking with, we're ill about this position that we have been put in [fumbling for words to continue] where it is the taxpayers looking to bail out. But ultimately, what the bailout does is help those who are concerned about the healthcare reform that is needed to help shore up our economy. Um, helping, oh -- it's got to be all about job creation too. Shoring up our economy, and putting it back on the right track. So healthcare reform and reducing taxes and reining in spending has got to accompany tax reductions, and tax relief for Americans, and trade, we've got to see trade as opportunity, not as a competitive, um, scary thing, but one in five jobs being created in the trade sector today. We've got to look at that as more opportunity. All of those things under the umbrella of job creation. This bailout is a part of that."

Huh? What?

Listen, I know there are McPalin supporters out there and, I will say it again, strictly from a personal perspective - i.e., I really don't want to pay any more taxes - if I were forced to pull a lever, it would be for McCain (because a victory by him would mean gridlock, that glorious state where the government's power to "do good" is curtailed). So, don't get angry or send me emails accusing me of being some sort of commie-sympathizer or member of the left-wing media conspiracy.

I'm sure Sarah Palin is a perfectly wonderful person, but she is way out of her league here. And, shortly, the boomerang effect of her media appearances is going to smack McPalin upside the head.

If you don't believe me, watch the following excerpt from the Couric interviews, this one on Palin's purported experience in foreign affairs. (You may have already seen this, because it's starting to make the rounds on the net... which is exactly the problem.)

At this point, I can't see any conceivable way McPalin wins. Which means, get ready for a serious asset stripping come next year.

Miscellaney

Phyling On

phyle

In any event, Herb in Jacksonville, FL is looking to start a phyle.

And the next meeting of the Sacramento phyle is scheduled for September 30th with Ron Parratt of AuEx (one of my favorite explorers) as a guest participant.

And the Toronto group, one of the most active, will be held on October 3... with our own Doug Casey sitting in.

For more details on any of these get-togethers, or any of the other phyles now up and running (this is all happening organically, by the way... all we're doing is facilitating the introductions of the new members to the organizers), contact Kristen at phyle@caseyresearch.com.

Well, that's all that time allows for today. It has been a long and immensely interesting week. We are living through a crisis of a magnitude seen only once a century. While one might take satisfaction by being able to say "I told you so" to sundry friends and associates - you know, the ones who have habitually rolled their eyes and parroted the "all is well" mantra of the financial talk show hosts whenever you have tried to warn them about what's coming... the reality is that these are dangerous times. Even for the prepared.

So, be careful. Especially when discussing topics related to wealth and precious metals ownership. Those who "have" could easily become targets for those who "have not" as this crisis unfolds. Mum's the word.

As I sign off, stocks are largely flat and precious metals are up nicely, to $888. If I were to guess what's going to happen next, it will be that an agreement on the bailout will be announced, the stock market will have another dead-cat bounce... after which it is going to start on a sharp slide.

As always, I greatly appreciate you using some of your valuable time to read this column, blog, musings - whatever it is. Your comments and suggestions are always welcomed, and often directly responded to, by writing david@CaseyResearch.com.

A final note. If you have friends who you think might benefit from our service, we would take it as a great favor if you'd tell them about our services and suggest they take us up on our 3-month no-risk trial subscription for The Casey Report. The next three months should be particularly important, so now's the time to act. You'll be doing them a favor, if for no other reason that our analysis is unbiased because it is beholding to no one except you, our subscribers.

As for the money managers and other talking heads now cheering for the bailout versus warning the people who listen to them to run for cover... well...

I'll leave it at that...

Until next week,

David Galland
Managing Director
Casey Research, LLC.