Is Government Debt the Next Crisis to Strike?

While American investors were busy enjoying their Thanksgiving dinners, global markets were shaken by word that Dubai asked for a payment holiday on the $59 billion it owes via its investment vehicle, Dubai World.

The move, which comes as oversized bets on Persian Gulf real estate sour, was considered a default by the major rating agencies.

Last week’s “standstill” request puts at risk up to $80 billion in debt linked to the emirate.

While this is small in the context of the $3 trillion in losses written down by global banks since the credit crisis began, it may very well result in the largest country debt default since Argentina in 2002.

So while Dubai is insignificant on its own, and will likely be bailed out by its larger and much wealthier neighbor and fellow United Arab Emirates member, Abu Dhabi, it ignited much larger concerns over the fiscal health of governments around the world. I discussed these concerns early last week in an in-depth discussion over rising insurance costs on government bonds.

This highlights concerns over the ability of governments to service their rapidly rising debt loads.

Those on the hot seat include Greece, Japan, and much of emerging Europe.

So, is this the beginning of a new crisis?

The team at Capital Economics in London doesn’t believe it is:

“Dubai’s current problems are a long overdue consequence of the bursting of the global property bubble rather than the start of a new financial crisis. Nonetheless, they are a timely reminder that the legacy of past excesses in heavily-indebted economies will linger for many years to come.”

In other words, imagine that the global financial system is like a patient recovering from a near fatal case of pneumonia. After being pumped with fluids and antibiotics via stimulus spending and ultra-low interest rates, the patient is on his feet again. But that doesn’t mean he isn’t vulnerable to a persistent cough and a low-grade fever.

Plus, Dubai was the country-sized equivalent of a full-tilt Miami condo flipper.

The United Arab Emirates pegs its currency to the U.S. dollar, which means that it imported interest rates that were too low for its fast growing economy — resulting in a credit bubble and asset boom.

Property prices have since fallen by 50% over the last 12 months.

What’s worse is that efforts to diversify its economy away from fossil fuels via free-trade zones made the country extremely vulnerable to a slowdown in global trade and a decline in financial markets.

It was an extreme case of the kind of overleveraged excesses that resulted in the 2007-2008 financial crisis in the first place. The country’s investment arm spent billions on artificial islands reclaimed from the Persian Gulf in the shape of palms. It took a stake in a new $8.5 billion MGM Mirage (NYSE: MGM) hotel in Las Vegas.

It invested in Canadian performance troop Cirque du Soleil.

It bought stakes in Aspen ski resorts.

It bought the Queen Elizabeth II ocean liner.

In other words, imagine that the global financial system is like a patient recovering from a near fatal case of pneumonia. After being pumped with fluids and antibiotics via stimulus spending and ultra-low interest rates, the patient is on his feet again. But that doesn’t mean he isn’t vulnerable to a persistent cough and a low-grade fever.

While the impressive rally over the past few months have brought a period of relative calm, it has merely masked the vulnerabilities that still remain.

Investors were lulled into a sense of false security and Dubai’s rulers rudely awakened them. But apart from the jarring psychological effect, the risk that Dubai’s debt restructuring will result in a global “contagion” that pulls down financial markets and undermines the nascent economic recovery remains low.

Market Action

As traders returned from their holiday, they wasted no time in responding to weakness in Asia and Europe as a wave of fear spread:

Dow Jones Industrial Average lost 1.5%,

Standard & Poor’s 500 Index,

Nasdaq Composite Index lost 1.7%,

Russell 2000 lost 2.5%.

Stocks and commodities weakened, risky credit sold off, and the dollar and U.S. Treasury debt rose as investors sought safe havens.

The CBOE Volatility Index or “Fear Index” was up 26.5% at one point — a jump of a magnitude that hasn’t been seen since the Lehman Bros. collapse. According to Tim Backshall at Credit Derivatives Research, credit markets had their worst day since March 5.

Intra-day losses were severe:

The Dow was down 2.2% at one point.

But an afternoon rally cut the losses. And over in Europe, where banks are expected to have a combined Dubai bond exposure of $40 billion according to Credit Suisse Group AG (NYSE ADR: CS) estimates, stocks climbed on Friday after deep losses on Thursday.

This could be a sign that as investors learn the true nature of the Dubai situation and realize it isn’t the beginning of a new credit crisis.

For the week, the Dow lost 0.1%, the S&P 500 lost 0.4%, the Nasdaq lost 0.4%, and the Russell 2000 lost 1.3%. It was the Dow’s first weekly decline since mid-October.

Technically, the S&P 500 has struggled to overcome resistance at the 50% retracement line measured from the Oct. 07 high to the Mar. 09 low.

A breakout would see a move to 1,200 for a gain of 10% where new resistance would be met.

While this would be nice, my research suggests the market has lost so much momentum that such a move isn’t likely without a pause to recharge the batteries.

A breakdown here would likely see a move to the 1,000 level, for a possible decline of as much as 8% in a retest of the September low.

Such a move would feel catastrophic but would be well within the bounds of a normal 10% correction in the context of a long-term bull market.

This would shake off speculative excess and set the stage for a decisive move over the 1,200 level on the SPX.

Yellow Fever

Given the ferocity of gold’s advance and the pressure being exerted on the dollar, the yellow metal’s rise could last longer than most expect.

But the movement is unsustainable just as the Nasdaq’s rise between 1998 and 2000 was unsustainable; just as home price appreciation in 2006 was unsustainable; or how the frenzy surrounding Dutch tulip bulbs in the 1600s was unsustainable.

The dramatic movements in gold and the dollar are being driven by a psychologically potent mix of fear and greed.

Normally, these two emotions are mutually exclusive with one occurring during boom times and the other accompanying periods of panic.

But now, both are encouraging people to sell the dollar and buy gold: Fear over the loss of the dollar’s purchasing power and greed as gold climbs makes it climb towards the heavens.

Remember that gold has no intrinsic value.

It has no cash flows.

It serves no practical purpose.

It costs money to store and protect. And its value has fluctuated greatly throughout human history:

Between 1980 and 1999, gold lost 71% of its value.

As for the dollar, let’s be clear:

It will not collapse.

And it is a long way from losing its status as the world’s main currency.

This fear is increasingly widespread, but it isn’t realistic.

It would result in dramatically higher interest rates and more expensive oil and other imported goods for American consumers.

In addition, the U.S. government would be forced to cut spending and hike taxes as financing the deficit became more difficult.

The result would be a hellish recession that makes our current affair seem like child’s play.

Exporters in Asia and the Persian Gulf understand this and aren’t keen on pushing the global economy off the cliff.

Indeed, Indian Prime Minister Manmohan Singh recently said that there is no substitute for the dollar as the global reserve currency.

And the economists at the ISI Group note that the real trade-weighted dollar index — which corrects for inflation and reflects the relative important of America’s trade partners — has fallen to a historical low that has held three times over the last thirty years.

So, it increasingly appears that central banks are using the IMF’s gold sale (being done to raise money to pay its bills) as a rare diversification opportunity.

But it’s not a reflection of wholesale abandonment of the dollar no matter how badly the gold fanatics want to believe it.

Another possible explanation is the huge inflation many are awaiting given the massive money supply expansion over the last year.

According to John Williams of Shadow Government Statistics, who reconstructs the discontinued broad M3 measure of money, the monetary base is up 129% since last August. My contacts in the hedge fund industry say that governments, central banks, and investors are pricing in inflation expectations five years out.

But this too is highly speculative:

Industrial activity remains well below capacity and wage pressures should continue as the unemployment rate remains buoyant.

The anecdotal evidence is also mixed.

A rise in inflation-adjusted Treasury debt isn’t being matched by decreases in non-adjusted Treasury bonds.

Technical analysis provides a few clues on timing.

While gold has reached overbought territory on its 14-week RSI, recent history suggests multiple incursions over the 70 threshold are needed to fully exhaust bullish sentiment.

So while a near-term pullback is likely, it probably won’t mark the end of the secular advance.

Also, this analysis suggests gold’s bull run has another six months or so to go before pulling back for good.

Week in review

Monday: A number of comments by Federal Reserve officials encouraged traders to sell the dollar short and push stocks higher. First, St. Louis Fed president James Bullard said that he would like to keep the Fed’s direct purchase authorization for mortgage-backed securities alive past the March deadline.

If implemented, Bullard’s wishes would help ensure that mortgage rates remain low and would give the housing market further times to heal.
Separately, Chicago Fed President Charles Evans said that interest rates may stay near 0% until “late 2010, perhaps later” as policymakers await improvement in the job market.

These comments I’ve expressed many times in the past six months: Inflation hawks can complain all they want about U.S. money being too cheap, but the Fed is likely to keep short-term interest rates low until it has seen at least four to six months of employment growth in the United States. That won’t happen until late in the second half next year, at the earliest.

Tuesday: The government’s estimate of third-quarter economic growth was revised down to 2.8% from the original 3.5% mainly on less consumer spending, fewer exports, and a reduction in business inventories. Still, Q3 marks the first economic expansion since the slight rise in the middle of 2008.

On the housing front, the latest numbers from the Case-Shiller home price index covering 20 metropolitan areas squeaked out a 0.3% gain in September — suggesting some of the wind is being taken out of the nascent housing recovery. Back in August, the index gained 1.2%. Overall, the index is up 3.5% from the low set in May as prices have returned to levels that prevailed in the autumn of 2003.

Wednesday: A heavy economic calendar. The latest weekly jobless claims number was the day’s big economic report: The measure of job loss finally fell below the 500,000 threshold for the first since October 2008. While the loss of half a million jobs a week is still terrible, history suggests a sub-500k number increases the probability of a positive monthly payroll report and a reduction in the unemployment rate.

Historically, jobless claims in excess of 500k are associated with payroll losses of 245,000. Jobless claims between 450k and 500k are associated with losses of 40,000. And finally, claims between 400k and 450k are associated with a payroll expansion of 65,000. This means we will probably see a positive payroll report within the next two months or so — providing a huge confidence boost to consumers and investors alike.

In other news, consumer spending increased 0.7% in October, beating expectations and reversing the 0.6% decline in September thanks to a 0.2% expansion in incomes. Consumer sentiment was higher than expected but still below levels reached this summer. The one blemish: Durable goods orders fell 0.6% in October, coming in below the 0.5% expansion analysts predicted and the 1% expansion in September.

Thursday: U.S. markets closed for Thanksgiving holiday. Stocks in Asia and Europe fell on Dubai debt concerns.

Friday: Black Friday kicked off the holiday shopping season. Retailers reported strong crowds. Marshal Cohen at market research firm NPD Group said the day was driven by a mix of “pent-up demand and frugal fatigue.” Let’s hope it lasts.

The Week Ahead

Monday: The Chicago Business Barometer will provide an update on manufacturing activity in the Midwest.

Tuesday: Motor vehicle sales, the Institute for Supply Management Manufacturing index, and construction spending will all be reported. Vehicle sales will be closely watched as investors gauge true consumer demand now that the affects of the government’s cash-for-clunkers scheme have dissipated.

Wednesday: The ADP Employment report will provide a preview of the big employment situation report on Friday.

Thursday: Chain-store sales will tell us just how effective all those Black Friday promotions were in encouraging holiday shopping. Also, the weekly jobless claims report.

Friday: The employment situation report is expected to show a payroll decline of 100,000 and the unemployment rate unchanged at 10.2%.

Note: For the first time in 70 years, U.S. T-bills are paying 0% interest, while U.S stocks are continuing to rise. According to Bloomberg News, this last happened in 1938, when T-bill yields fell from 0.45% to 0.05%. Then came 1939, when stocks began a three-year slide that took the S&P down 34% after the U.S. Federal Reserve prematurely boosted borrowing costs to battle phantom inflation.

More Here: Dubai World Seeks to Delay Debt Payments as Default Risk Soars

Built on Debt and Sand

Dubai's Sovereign Debt Will bring it Crashing Down

Well, the days are dwindling down. September. November. Tomorrow it will be December.

This bubbly bounce must not have much time left.

And it is surrounded by 10,000 pins.

Last week, one of those pins looked as if it might pop it.

While Americans enjoyed their turkey dinners, Dubai announced that it would ‘postpone’ payments on its debt. The world was left to wonder: what’s going on? Is Dubai broke?

Dubai was the great success story of the Near East. With nothing but rich sheiks behind it, it had set itself the goal of becoming a major financial and tourism centre.

And for a while, it looked like the sheiks might just pull it off. Skyscrapers soared into the air. Manmade islands rose up out of the sea. You could ski indoors – and then go swimming in the warm waters of the Sea of Araby. They were even planning to put up the world’s tallest building...

But the whole place was built on debt and sand.

And as the debts mounted, the sands washed away.

On Friday, US markets reacted. The Dow lost 154 points. Gold lost $14. Oil slipped to $76.

Our crash flag is still flying. But that was not a crash. Just a bad day. And today’s news tells us that other Gulf states are rallying around Dubai, ready to extend a helping hand and lend a buck or two. Oil is rallying on the news.

Does that mean this bubbly trend is stronger than we thought?

Is this a bubble made of Kevlar? Will it resist other pins?

We wouldn’t count on it.

Remember, China is “ Dubai times 1,000”, as James Chanos put it.

When China pops, we’ll see US stocks down a lot more than 154 points.

In fact, we expect to see the Dow in 5,000-ish territory when this bounce is over.

And when that happens, emerging markets will probably be hit even harder.

Dubai was a “wake up call”, for investors in emerging markets, says the New York Times today.

But the pin that pricks recovery hopes won’t necessarily be imported. There are plenty of sharp objects in the homeland too. There is, for example, the growing realisation that the recovery is a fraud.

“Half a recovery,” says a New York Times columnist, may be all we get.

Today, the press will concentrate on analysing Black Friday sales results. Already, the Wall Street Journal has rendered its verdict: more shoppers, fewer sales.

If the initial reports are correct, the traffic wasn’t bad on Friday. But retail outlets were only able to snag sales by offering discounts. It’s a deflationary world, after all.

Shoppers want lower prices to make up for the fact that they have less money to spend. And they’ll get lower prices too. Because this is a de-leveraging cycle.

The world has too much debt, too many factories and too many workers... at least for the real, available purchasing power. Prices will go down naturally until excesses are absorbed... dismantled... or converted to other uses.

But wait... there are also unnatural forces at work. Governments are bailing out bungled companies. They’re supplying zombie industries with fresh blood from the taxpayers.

They’re standing in the way of de-leveraging progress.

They’re creating ‘money’ out of thin air.

It’s this last point that is most explosive. As long as government is just stalling the correction, it doesn’t cause too much distortion or volatility. But when it fiddles with the money... oh la la: that’s where it gets interesting.

Traditionally, people buy gold when they think the monetary authorities are up to something. Throughout the world, investors are getting edgy... they’re wondering how it is possible to add so much cash and credit to the economy without sending prices to the moon.

We’ll tell you how it’s possible: there’s a depression.

In a depression, the flow of cash and credit coagulates.

Even if you increase the cash in bank vaults, it doesn’t circulate into the real economy. Banks don’t lend. People don’t borrow. Consumers don’t consume.

It just sits there... waiting for the end of the depression... like a teenager waiting for Friday...

*** What goes around...

America flourished because its people believed in free enterprise and controlled public spending. Now, they seem to believe the exact opposite.

Now, they seem to believe that business must be carefully controlled... and the feds can spend however much they want.

But check this out.

Now, people in communist China have more faith in free enterprise than Americans do.

“I could understand why George Bush did such dumb things,”

“He had a chip on his shoulder and an inferiority complex. And he wasn’t a deep thinker. So he played the decisive, tough guy.

“But Obama is completely different.

And yet, he’s doing the same things.

He just extended Bush’s 9/11 wiretaps and other unconstitutional measures. And he says he’s going to finish the job in Afghanistan.

“What job is he talking about? I’ve got a friend who is a hospital administrator in the reserves. He’s got two small children. And now he’s being called up to go to Afghanistan. What a waste.

“I feel sorry for him. He signed up for the reserves and it paid for his education, so he can’t complain. But he signed up to defend the country. Now, he’s being sent off to take part in an unwinnable, hopeless war. It goes on forever.

“In Iraq, by the way... the same story. Obama just continues the policies that Bush gave him. And I thought we voted for change.”

Our contractor friend explained to us how it works:

“Look, they put out the call for bids on a project. Who’s going to ask if the project really makes sense? Not Congress. Nobody wants to get the reputation of the enemy of the military.

“The contractors have lobbyists all over the capital. And every congressman wants to get the project for his district. And, of course, the contractors have employees... and local newspapers... and so forth.

“The project goes forward. And then, it doesn’t work. I mean, either it just doesn’t work, like a lot of the computer systems the Pentagon buys... or it just doesn’t do anything worth doing.

“But who’s going to say anything? Nobody. Instead, they all rally around another project.”

Even a smart, well-meaning new president is helpless against the power of the military machine. Stop the war in Afghanistan? Are you kidding?

It would mean the loss of billions... hundreds of billions... in federal spending.

And there are surely a whole clique of ‘experts’ to tell him that strategically and geopolitically the war is critical to maintaining stability in the region.

*** But how are the feds able to get away with such rough handling of their own citizens... not to mention the foreigners?

Thank Napoleon Bonaparte’s great nephew, Charles Joseph Bonaparte, of Baltimore, Maryland.

Thoughts on the 2010 Stock Market

So, we got through earnings season OK.

Next Major Signpost:

The next major issue confronting investors will likely be the impact of the government’s fiscal and monetary credit expansion on the economy.

Will such a credit expansion lead to an increase or acceleration of inflation?

What will the impact of inflation have on equity valuations?

Inflation’s Impact on Stock Market Valuation:

Below is a chart of the “earnings yield” (P/E ratio inverted) of the S&P 500 versus the CPI –U (All Urban Consumers) index. The S&P 500 earnings yield is calculated by dividing the year-end EPS of the S&P 500 by its year-end index value. Example Below.

The graph above shows a positive relationship between the YOY change in the CPI and the S&P 500’s earnings yield at year-end.

This means that as inflation increases so does the earnings yields of the S&P 500. Since the P/E is the reciprocal of the earnings yield, an increase in inflation would lower the P/E and create a lower relative valuation for the S&P 500.

This would make sense:

As inflation increases investors would require a higher earnings yield to generate a “real return” (nominal return minus inflation).

In Search of a Real Return:

The average and median real earnings yield for the S&P 500 since 1942 has been 3.4%.

Based on a forecasted inflation rate for 2010 of 2.0%, the nominal earnings yield would be 5.4%. The P/E (reciprocal) would be 18.5.

Whether by the “luck of the draw” or the model’s merit, the current S&P’s trailing P/E is approximately 18.5. Based upon an estimated 33% YOY increase in S&P 500’s 2010 EPS and the current P/E, the S&P Index would be valued at 1400 year-end 2010.

The index would be up approximately 27 % from its current level based on these estimates.

Lurking Bears?

The “Bears” will be looking for the first sign of credit tightening.

When it does appear, we’re likely to have the Dow down 300 points on that day.

So get your “shorts” ready.

Then after the market stabilizes, be prepared to aggressively buy for an interim holding period as the S&P 500 will rally back.

When Predicting, Predict Often:

Central to this hopeful stock market outlook is the sanctity of the S&P 500 earnings projections. Analysts are notoriously late in calling earnings estimates and buy/sell recommendations. Analysts were collectively late at the peak and they’ll be underestimating earnings at the bottom. So, there’s a little positive wiggle room on projected earnings.

However, Don’t Get Too Excited: The events that move the stock market aren’t generally events you can predict—and this may be particularly true for 2010.

Domestic and geopolitical events that result in economic disruption, i.e., war, terrorism, bad policies, even atmospheric or geological events, such as hurricanes, famines and earthquakes, etc., are the stuff of major market disruptions.

No one predicted “9/11”, and judging by the post-analyses of the event, few even had a clue.

The probability of a random “out of the blue” event impacting the stock market is high--particularly, given the shifting sands and loose fabric of global leadership and the US’s vulnerability as its assets are spread thin.

As Voltaire, wrote to Fredrick the Great in 1767, " Doubt is not a pleasant condition, but certainty is an absurd one."

While being constructive regarding the 2010 stock market outlook, you still may need to sit next to the exit

Example: a stock has a price of $21 and year-end EPS is $3.

The earnings yield would be: 14.3% (3/21 = 14.3%). The P/E would be 7 times (21/3).

If you divide 1 by the P/E (7) you would arrive at an earning yield of 14.3 %.

Will Japan’s economy go belly up?

“As the Japanese certainly realize, both restoring banks and corporations to solvency and implementing significant structural change are necessary for Japan’s long-run economic health. But in the short run, comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy. As a natural result, politicians, economists, businesspeople, and the general public in Japan have sharply disagreed about competing proposals for reform. In the resulting political deadlock, strong policy actions are discouraged, and cooperation among policymakers is difficult to achieve. In short, Japan’s deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has.”
- U.S. Federal Reserve Chairman Ben Bernanke

EITHER THE BUSINESS of following the movement of money for a living attracts those of a saturnine cast, or the business of following money itself makes people that way. Even in the balmiest of economic climes, they scan the skies for storm clouds while issuing dire warnings about the sooty wisps that only float overhead or dissipate before any rain falls.

In today’s economic climate, however, those who put the dismal in the dismal science are reveling in a saturnalia of pessimism so extreme it’s time for the rest of us to pay attention to the racket they’re making instead of shutting the window. It isn’t just the United States that’s causing the analysts to pour themselves another stiff drink; even the layman senses that the Americans are building another house of cards on the lot filled with the debris from last year’s collapse. What has some money watchers reaching for the bottle this time is Japan and China.

Earlier this month, Ambrose Evans-Pritchard wrote this column in Britain’s Telegraph headlined, “It is Japan we should be worrying about, not America.”

The barman sets them up:

Japan is drifting helplessly towards a dramatic fiscal crisis. For 20 years the world’s second-largest economy has been able to borrow cheaply from a captive bond market, feeding its addiction to Keynesian deficit spending – and allowing it to push public debt beyond the point of no return.

And then pours:

Regime-change in Tokyo and the arrival of Yukio Hatoyama’s neophyte Democrats – raising $550bn (£333bn) to help fund their blitz on welfare and the “new social policy” – have concentrated the minds of investors at long last.

“Markets are worried that Japan is going to hit a brick wall: the sums are gargantuan,” said Albert Edwards, a Japan-veteran at Société Générale.

Here’s the chaser:

Simon Johnson, former chief economist of the International Monetary Fund (IMF), told the US Congress last week that the debt path was out of control and raised “a real risk that Japan could end up in a major default”.

“The debt situation is irrecoverable,” said Carl Weinberg from High Frequency Economics. “I don’t see any orderly way out of this. They will not be able to fund their deficit. There will be a fiscal shutdown, a pension haircut, and bank failures that will rock the world. It is criminally negligent that rating agencies are not blowing the whistle on this.”

“This is incredibly dangerous,” said Russell Jones from the RBC Capital Markets. “The rate of deflation is shocking. The debt dynamics are horrible and there is the risk of a downward spiral.”

The author points some fingers:

Japan’s terrible errors are by now well known.

It failed to jettison its mercantilist export model in time.

It resisted the feminist revolution, leading to a baby strike by young women.

It acquiesced in a mad investment bubble (like China now) in the 1980s, stealing growth from the future.

Some of that’s overstated. China and South Korea use the same mercantilist export model, and none of the three could have succeeded unless the U.S., among others, allowed it to succeed.

Birth rates are falling throughout Europe and East Asia, so if there’s any “baby strike”, the picket lines aren’t just in Japan.

(It also isn’t due to resistance to the feminist revolution, but we’ll be looking at that and the Chinese bubble in some upcoming posts.)

QE was too little, too late, and this is the lesson for the West. We must cut borrowing drastically over the next decade, and offset this with ultra-easy monetary policy.

By QE, he means quantitative easing, or the purchase of national and corporate debt instruments by the Bank of Japan.

Finance Minister Fujii Hirohisa is upset with the BOJ for halting their QE, by the way. The central bank’s justification was concern over rising public debt, but Mr. Fujii wants them to resume.

He says there’s a limit to what fiscal measures can accomplish. He did not mention structural reforms.

Added Deputy Finance Minister Noda Yoshihiko:

With the rate of price increases expected to be negative for a long period of time, we would like the Bank of Japan to indicate a clear stance on how it will deal with the situation.

Remember that it was fewer than two years ago the Democratic Party of Japan, then in the opposition, tried to create a political crisis by rejecting the Fukuda Administration’s BOJ appointments, claiming Finance Ministry OBs were unacceptable.

Their rationale, which has merit and is employed as a general rule of thumb in other countries, is that they wanted to keep fiscal and monetary policy separate.

But opposition parties everywhere have a problem with remembering the things they used to scream about once they’re in charge.

(Incidentally, even when many in the DPJ signaled they were willing to accept some appointees with a Finance Ministry background, the idea was nixed by Big Boss Man Ozawa Ichiro. Mr. Ozawa has always been more interested in politics than in government, and in ruling rather than governing.)

The danger here is that central bank purchases of the debt securities of their own government create money, which is known as monetizing the debt.

In addition to putting into circulation specially made pieces of paper with elaborate colored engravings that everyone pretends has value, the process allows politicians to overspend revenues without raising taxes or risking default.

Since the Finance Ministry is agitating for tax increases, and there’s a real risk of default anyway, it would seem that Japan has painted itself into a corner. No wonder Mr. Fujii is concerned.

Credit rating downgrade

The following report came out about a week after the preceding article appeared:

Fitch Ratings warned Japan on Tuesday to keep to its borrowing target or risk a credit rating downgrade as the finance minister acknowledged the problem and tried to reassure rattled investors by saying spending had to be cut.

What’s the problem this time?

The government has said it plans to borrow 44 trillion yen ($490 billion) in the 2010/11 fiscal year starting next April, which would be on top of expected record issuance this fiscal year of more than 50 trillion yen.

But Fitch Ratings said it’s hard to see how the 2010/11 goal will be achieved and borrowing much more than 44 trillion yen would spark a ratings review.

Thus:

“It’s not the sole determinant that will drive our assessment but other things being equal, then I think that would prompt us to review Japan’s current double AA-minus rating.”

Just when you think things can’t get any worse, they get worse.

The Government announced that Japan was again officially in a deflationary period.

Here’s a passage from a website page explaining deflation, and how the lack of Japanese action in the past was deflationary:

Banks have delayed that decision (to collect on the loans), hoping asset prices would improve.

These delays were allowed by national banking regulators.

Some banks make even more loans to these companies that are used to service the debt they already have.

This continuing process is known as maintaining an “unrealized loss”, and until the assets are completely revalued and/or sold off (and the loss realized), it will continue to be a deflationary force in the economy.

Here’s the suggestion the Deflation page authors passed along for dealing with deflation in Japan:

Improving bankruptcy law, land transfer law, and tax law have been suggested (by the Economist magazine) as methods to speed this process and thus end the deflation.

Those are probably some of the steps Mr. Bernanke had in mind. But what did the government do?

They passed through the lower house—after only eight hours of debate—Financial Services Minister Kamei Shizuka’s plan to encourage a debt moratorium and have the taxpayers guarantee the loans.

In other words, instead of making the banks and businesses assume the risk—which is where it belongs—they’re making taxpayers liable for it.

Maintaining unrealized losses is deflationary.

Therefore, the Japanese government is implementing a measure that will make deflation worse during a deflationary period.

Here’s another straw for the camel’s back:

The government’s loan guarantee program has already used up half of its JPY 30 trillion (US$ 340 billion) budget, and the government says it doesn’t plan to allocate any more money. But how long will they keep singing that tune if too many default on those debts?

Some default is inevitable, which means the government will be throwing the taxpayers’ money away. But what the heck, it’s only fiat money anyway.

That’s the term for the money of the mind created after the debt has been monetized.

Still not worried?

As the old jest goes, if you can keep your head while those about you are losing theirs, perhaps you don’t understand the situation.

Now we learn the Financial Services Agency plans to revise its rules for financial institutions to exclude debts suspended by the moratorium from the bad debt classification.

In other words, the Government thinks that putting the peg in a different hole will hide the debt for the three-year moratorium period.

Then, like Cinderella’s pumpkin, the name changes back and the banks have to write off the bad debts.

If the banks struggle to survive while writing off this debt, there will be inevitable calls for more taxpayer money to bail them out.

Where will the government find the money to pay for all that?

Wasn’t “monetizing the debt” where we came in?

Yet another problem with Mr. Kamei’s economic demagoguery is the moral hazard.

Some of the businesses freed from the responsibility of repaying their debt will either be unable to restructure their finances, or, considering human nature, may not do it at all. That would mean they go bankrupt anyway in three years, while all that fiat money backing the government’s guarantees evaporates with their business.

Still more to come

The banks are also getting the shaft from another direction.

As this report notes

“The Basel Committee on Banking Supervision is expected to raise the level at which financial institutions are required to maintain their core Tier 1 capital as early as 2012. Core Tier 1 capital includes the sum of common shares and internal reserves.”

Understanding gold stock popularity

Gold’s amazing run since September has mainstream analysts, who are normally gold-haters, lauding its virtues.

All of a sudden gold is now an integral asset that all investors should own.

Why this quick shift of opinion?

Big developments on the fundamental front (that did not come as surprises to informed investors like our newsletter subscribers), coupled with a run of 22 new all-time nominal highs, can change one’s mindset rather quickly.

Gold investment has grown very popular. Not only are we seeing increasing demand on the physical front via coin and bullion hoarding, but retail stock investors are directing more and more capital into the famous SPDR Gold Shares ETF (GLD).

Large institutional investors have also participated in this trend. We’ve seen an elite hedge fund take a major stake in the world’s 6th largest gold depository (GLD). And even the world’s central banks have turned into net buyers of this yellow metal as seen in the latest World Gold Council report.

For a normally slow-moving commodity, a 24% run in just 3 months has garnered a lot of excitement. More and more investors are finally starting to understand the preciousness of gold. Whether for retail or institutional investment, it is an indispensible hedge to fading fiat currencies that are being inflated into oblivion.

Another exciting asset in the gold realm is the stocks of the mining companies that bring this metal to market.

And we’ve definitely seen the gold excitement spill over into gold stocks. Since the beginning of gold’s secular bull in 2001, gold stocks have been one of the best-performing sectors in all the markets.

But most of this run has been stealth to mainstream investors due to these stocks’ small market and lack of exposure. Those few contrarian investors who have been buying gold stocks since the beginning have seen extraordinary gains.

General gold-stock popularity and awareness has grown at a very slow pace. These stocks just haven’t received much face time in the financial media. And ultimately the onus has been on the investor to seek out the constituents of this sector.

But a growing number of investors have indeed found gold stocks, and they have grown very popular in their own right. And all we need to do is look to the venerable HUI gold-stock index to gain a measure of this popularity.

The HUI is comprised of a basket of 15 unhedged PM stocks that best represent the gold stock sector. Since the beginning of the gold bull the utility of this index has proven invaluable in helping us trade gold stocks and better understand their markets.

Not only has the action of the HUI allowed us to formulate reliable technical metrics that have guided us to profitable trading over the years, but HUI derived secondary measures have greatly helped us expand our analysis and understanding of these stocks.

One of these secondary measures is HUI volume. Now since the HUI itself is simply a tracking index, and hence doesn’t actually trade, it has no volume. But since its individual component stocks do have volumes, all we need to do is add them together to come up with a proxy for overall HUI volume. And this resulting HUI composite volume has given us some excellent insights into the gold stock world.

At Zeal we’ve spent many years accumulating and tracking this volume data in order to build this metric. And while anybody can pull historical volume data from the HUI’s current components and string it together for perhaps a general volume measure, it won’t tell the complete story considering the HUI’s radical composition changes over the years.

Our in-house database contains true volume data including that of former HUI component stocks that have since been acquired and/or replaced. This provides a more accurate picture of historical HUI volume.

With HUI composite volume in hand, conventional volume analysis can be applied to what is representative of the gold stock sector. Now the reason this tool is not a primary measure in reading HUI technicals is its dual nature. Essentially, volume spikes can signal both greed and fear. Both of these emotions excite trading activity.

Higher volume episodes in isolation don’t necessarily reveal clear buy or sell signals.

Price action and other technicals must be taken into account when determining what side of the sentiment spectrum a particular volume spike is associated with.

Low volume activity must also be considered in context.

Periods of lower volume in an environment where volume is rising on balance typically translate to complacency and a general lack of enthusiasm.

In many cases lower volume can signal interim lows, but not always. If you are interested in a little more technical depth on trading HUI volume, my business partner Adam Hamilton has penned an excellent series of essays on this topic.

In addition to general volume observations associated with recent HUI market action, my goal in this essay is to use HUI volume to highlight the growing popularity of the gold stock sector. And as seen by the recent popularity of these stocks’ underlying metal, there is no greater impetus for rising popularity than rising prices.

This first chart shows the performance of the HUI since 2001 along with its corresponding composite volume. The volume data, plotted in red, is simply calculated by adding up the raw daily volumes for each HUI component stock.

And as you can see, back in 2001 gold stocks were not a very popular asset class. Even though the HUI gained 59% in a year where the flagship S&P 500 was down 13%, its average daily volume was only 6.8m shares.

Not only were most investors unaware of the existence of gold mining stocks, they were still caught up in tech-stock euphoria. Traders were clinging to their darling tech stocks even though they were in the middle of a steep correction off their apex from the year before. Only those few contrarians, like our newsletter subscribers, saw the beginnings of a secular stock bear and gold bull.

As time marched on, it was hard to ignore the spectacular gains that were coming out of the gold stock camp. And with more and more traders taking notice, HUI volume would greatly ramp up. In 2002 gold broke through $300, the HUI posted a staggering 123% gain, and HUI volume would more than triple to a daily average of 22.2m shares.

Indeed more and more shares were exchanging hands, but overall the HUI was still a relatively unknown index. Individual stocks on the big-board indices had average daily volumes that were many multiples higher than the volumes of all the gold stocks in the HUI combined.

Following the big HUI volume surge in 2002 there would only be modest volume growth over the next 3 years. The biggest volume days during this span occurred in early 2004, spikes that saw over 50m shares trade hands in a day. Interestingly all these volume spikes were heavily weighted on the sell side, occurring on big HUI down days.

Even though the HUI was up 91% from 2003 to 2005, average daily volume would only edge higher by about 7%. I suspect this was partially due to the cyclical stock bull taking some of the thunder away from gold stocks during this time. When the more popular big-board stocks are running higher, traders aren’t as likely to look for alternative investments. Big HUI corrections in early 2004 and early 2005 didn’t shine much light on gold stocks either.

It wasn’t until 2006 that gold stocks garnered a bit more mainstream popularity and volume really started to take off. The underlying metal of these mining stocks had a banner year that spawned huge volatility on the gold stock front. Gold decisively blasted through $500 for the first time in 25 years. It also shot through $600 and even $700 temporarily.

All the excitement surrounding the physical metal naturally spread to the stock arena.

From its 2005 low the HUI experienced a massive upleg, off a low-volume spell, to its interim high in May 2006. By the time this upleg was exhausted the HUI had gained 137%. And volume would follow suit.

More and more traders would take an interest in gold stocks, with the HUI’s average daily volume increasing by 93% year-over-year. And even though the HUI would consolidate again for awhile before it entered into its next upleg in August 2007, gold stock popularity would continue to grow. Average daily volume would increase by 37% in 2007 and then by another 51% in 2008.

And it is this 2008 volume to current that I want to take a closer look at. With the HUI reaching its apex in early 2008 followed by a once-in-a-lifetime stock panic taking hold of the markets later on in the year, how did volume react? This next chart zooms in on HUI volume activity over the last couple years.

As you can see in the first chart, the raw volume data can be quite erratic on a day-to-day basis. A high-volume day can be followed by a low-volume day, which can create a lot of visual noise when trying to drill down on a tighter period of time.

In order to smooth out this volatile volume data I like to use a 5-day moving average. With it averaging only the last week’s worth of data, the 5dma is restrained enough to still show volume extremes. Yet because it tames the wild day-to-day volume swings, the 5dma does give a much better visual.

In the first half of 2008 volume tracked closely with the HUI. Following this index’s March high it tracked on a downward consolidating trend. But when the rug was pulled from underneath the HUI in the second half of the year, traders reacted with ferocity.

The average daily volume in the second half of 2008 was 32% higher than the first half. And looking at the performance of the HUI, this volume was heavily weighted on the sell side.

From its high the HUI plunged 71% before finally bottoming in October. The stock panic had its way with the gold stocks, and at around 150 the HUI had retreated to July 2003 levels. In the midst of this downward spiral you’ll notice a huge spike in volume. Even with the smoothing feature of a 5dma it is glaringly apparent. Interestingly, the highest volume days corresponded with both big up and down days in the HUI.

The first big volume spike occurred on September 9th, when the HUI was down 9%. And only 6 trading days later was the next when the HUI fought the panic with a gain of 12%. The volumes on these respective days were 177m and 224m shares trading hands, the latter an all-time record.

A secondary period of high-volume days occurred in early October. On these days the volatile HUI had down days of 16%, 6%, 13%, and 9%, with an up day of 19% in between. Again, the volume spikes reflected both heavy selling and buying.

Following the volume spikes in September and October, HUI composite volume finally trended down to pre-panic levels. Selling pressure had been exhausted and many gold stock traders were out of the market for good after being burned so badly. This down-trending volume was heavily weighted on the buy side as evidenced by the HUI’s ongoing recovery.

After a summer 2009 consolidation that saw HUI volume drop to its year lows in August, the birth of a powerful gold upleg attracted renewed interest to gold stocks. And gold $1000 has proven to be a huge psychological boost to stock traders.

HUI volume has been way up since September 1st, averaging 116m shares per day as the HUI claws back toward 500. The volume activity these last few months is expected to push 2009’s daily average to exceed 2008’s.

Overall when we zoom back out and look at the secular trend, there is one very clear conclusion that can be made. As goes the HUI, so goes its volume. The HUI gained 1331% from its November 2000 low to its March 2008 high. And provocatively, from full year 2001 to 2009, HUI volume has risen by nearly the same amount. But this 1323% rise in average HUI daily composite volume only tells part of the story on the popularity front. If we want to gain a clearer picture of investor interest in gold stocks, we need to consider capital volume.

Capital volume is a way of quantifying volume in dollars. And with the availability of historical volume and price data, there are a number of different ways we can look at it.

In the chart above I present it at an individual-stock level in order to see the capital volume of the average HUI component stock over the course of this bull. The calculation is simple, multiplying the average annual share price of HUI component stocks by the average annual daily volume.

As is apparent, in the early years gold stocks didn’t swing around very much capital. In 2001 the average HUI gold stock traded at $6.72 per share with an average daily volume of 603k shares.

This is the equivalent of daily capital volume of only about $4.1m. In the subsequent years rising share prices naturally led to a higher HUI, and when volume is thrown into the mix we can gain a better understanding of the kind of money that was finding its way into the gold stock trade.

As mentioned earlier, 2006 was the breakout year for gold stocks. And capital volume was a big constituent of the coming-out party. With an average share price of nearly $23 and average daily component volume of about 3.0m shares, average capital volume skyrocketed to nearly $70m per day.

This 189% increase over 2005 capital volume showed sharply growing investor interest in these once-unknown gold mining companies.

And the popularity of these gold stocks has continued to grow into 2009. So far this year the average HUI component share price is right around $25 with average daily component volume at nearly 6.5m shares.

This average daily capital volume of $162m is a staggering 3908% higher than it was in 2001! Gold stocks have indeed grown in popularity, but there is a lot more room to run in this still-small sector.

To put the capital volume of the average HUI component stock in context, consider the average daily capital volume of these mainstream favorites so far in 2009. INTC - $1100m, USB - $528m, MCD - $553m, F - $421m, AAPL - $2900m, and CHK - $341m. To take this a step further, let’s compare the HUI’s full year 2008 cumulative capital volume to that of another market darling.

And at $589b, all the gold stocks in this entire index had a capital volume of only about 80% of that of Google ($743b) alone. If gold stocks are ever to truly become popular in the mainstream, a lot more capital will need to find its way into this sector.

Overall this HUI volume data shows that gold stocks have grown increasingly popular. While day-to-day volume activity typically doesn’t provide tactical trading signals, this information does give us a better collective understanding of the world of gold stocks.

We’ve seen big volume spikes amidst both greed and fear extremes, along with low-volume episodes that have often marked the beginning stages of another run higher. But ultimately in any bull market traders are drawn to performance. And HUI volume shows just that.

But even with the HUI and its raw and capital volumes on the rise, gold stocks are still not reflecting mainstream popularity. And for a variety of reasons they are not even reflecting the current price of gold. These mining companies are able to greatly leverage their profits to a rising gold price, and based on their inherent risks shareholders should see gains that well-outperform the underlying metal.

Gold stocks should have a lot more room to run at the current gold price and over the course of this ongoing secular bull. At Zeal our newsletter subscribers have been profitably trading gold stocks since this bull’s beginning, when we few contrarians were responsible for a large part of their small volume.

And our subscribers are still sitting pretty with gold stocks today. Between our monthly Zeal Intelligence and weekly Zeal Speculator newsletters, our current outstanding gold-stock trades have average unrealized gains of 86%. Subscribe today to get one of the most well-rounded commodities newsletters on the planet!

The bottom line is even though gold stocks still reside in a relatively small sector, measured by raw and capital volume they’ve seen immense popularity gains. HUI volume has skyrocketed since 2001 as more and more traders are following the gains and recognizing the now and future potential of these mining companies.

Gold stock volume has steadily grown and will continue to grow. There are different catalysts that spark high-volume episodes, but whether greed- or fear-driven so far every occurrence has not hindered the uptrend. Even the panic saw some anomalous volume activity that may never be replicated, but the HUI has recovered and is nearing its highs once again.


Scott Wright

The Economic Crisis and What Must be Done

The United States does not control its own destiny.

Rather it is controlled by an international financial elite, of which the American branch works out of big New York banks like J.P. Morgan Chase, Wall Street investment firms such as Goldman Sachs, and the Federal Reserve System.

They in turn control the White House, Congress, the military, the mass media, the intelligence agencies, both political parties, the universities, etc. No one can rise to the top in any of these institutions without the elite’s stamp of approval.

This elite has been around since the nation began, becoming increasingly dominant as the 19thcentury progressed.

A key date was passage of the National Banking Act of 1863, when the system was put into place whereby federal government debt was used to collateralize bank lending. Since then we’ve paid the freight through our taxes for bank control of the economy.

The final nails in the coffin came with the passage of the Federal Reserve Act of 1913.

In 1929 the bankers plunged the nation into the Great Depression by constricting the money supply. With Franklin D. Roosevelt as president, the nation struggled through the decade of the 1930s but did not pull out of the Depression until the industrial explosion during World War II.

After the war came the Golden Age of the U.S. economy, when the working man, protected by strong labor unions, became a true partner in the prosperity of the industrial age. That era lasted a full generation. The bankers were largely spectators as Americans led the world in exports, standard of living, science and space exploration, and every measure of health, longevity, and culture.

Roosevelt had kept the bankers subservient to the interests of the economy at large. The Federal Reserve was part of the New Deal team, and interest rates were held at historic lows despite a large federal deficit.

One main impact was the huge increase in home ownership.

After World War II, the G.I. Bill allowed home ownership to grow further and millions of veterans to attend college. The influx of educated graduates led to productivity growth and the emergence of new high-tech industries.

But the bankers were laying their plans. In the early 1950s they got the government to agree to allow the Federal Reserve to escape its subservience to the U.S. Treasury Department and set interest rates on its own. Rates rose throughout the 1950s and 1960s.

By the time of the interest rate hikes of 1968, the economy was slowing down.

Both federal budget and trade deficits were beginning to replace the post-war surpluses. High interest rates were the likely cause.

In 1971, President Richard Nixon removed the dollar’s gold peg, allowing the huge inflation resulting from oil price increases that the international bankers engineered through control of U.S. foreign policy when Henry Kissinger was national security adviser and secretary of state.

Nixon’s opening to China resulted in early agreements, also overseen by banking interests, to begin to transfer U.S. industry to overseas producers like China which had cheap labor costs.

By the mid-1970s, the U.S. had been taken over by a behind the scenes coup-d’etat that included events in 1963 when President John F. Kennedy was assassinated by a conspiracy that could only have been instigated by the highest levels of world financial control.

In the election of 1976, David Rockefeller succeeded in placing fellow Trilateral Commission member Jimmy Carter in the White House, but Carter upset the banking community, thoroughly Zionist in orientation, by working toward peace in the Middle East and elsewhere.

I was working in the Carter White House in 1979-80. Unbeknownst to the president, Federal Reserve Chairman Paul Volcker, another Rockefeller protégé, suddenly raised interest rates to fight the inflation the bankers had caused by the OPEC oil price deals, and plunged the nation into recession.

Carter was made to look weak and uninformed and was defeated in the election of 1980 by Republican candidate Ronald Reagan. It was through the “Reagan Revolution” that the regulatory controls over the banking industry were lifted, mainly in allowing the banks to use their fractional reserve privileges in making mortgage loans.

Volcker’s recession shattered American manufacturing and hastened the flight of jobs abroad. Under the “Reagan Doctrine,” the U.S. military embarked on an unprecedented mission of world conquest by attacking one small nation at a time, starting with Nicaragua.

Global capitalism was also on the march, with the U.S. armed forces its own private police force. With the invasion of Iraq under George H.W. Bush in 1991, mainland Asia was revealed as the principle target.

The economy was floated by productivity gains through computer automation and a huge sell-off of assets through the merger-acquisition bubble of the late 1980s which ended in a recession.

This resulted in the defeat of Bush by Bill Clinton in the election of 1992.

Clinton was able to create another bubble through a strong dollar policy that attracted foreign capital.

The dot-com bubble that resulted lasted all the way through to the crash of December 2000.

Meanwhile, the U.S. Air Force led the way in the destruction of the sovereign state of Yugoslavia, whereby the international bankers took over the resource wealth of the entire Balkan region, and the U.S. military gained forward bases for further incursions into Asia.

Do we need to say that none of this was ever voted on by the American electorate?

But they bought into it nevertheless, both with their silence and through participation in a generally favorable job market in the emerging service occupations, particularly finance.

By the time George W. Bush was inaugurated president in January 2001, the U.S. was facing a disaster.

$4 trillion in wealth had vanished when the dot.com bubble collapsed. NAFTA caused even more American manufacturing jobs to disappear abroad.

The Neocons who were moving into key jobs in the Pentagon knew they would soon have new wars to fight in the Middle East, with invasion plans for Afghanistan and Iraq ready to be pulled off the shelf.

But the U.S. had no economic engine available to generate the tax revenues Bush would need for the planned wars. At this moment Chairman Alan Greenspan of the Federal Reserve stepped in. Over a two year period from 2001-2003 the Fed lowered interest rates by over 500 basis points.

Meanwhile, the federal government removed all regulatory controls on mortgage lending, and the housing bubble was on.

$4 trillion in new home loans were pumped into the economy, much of it through subprime loans borrowers could not afford.

The Fed began to put on the brakes in 2003, but the mighty work of re-floating a moribund economy had been accomplished.

By late 2006 another recession loomed, but it would take two more years before the crisis of October 2008 brought the entire system down.

The impact on the job market was immediate and profound.

By the time Barack Obama was elected president in November 2008, the U.S. was mired in seemingly endless wars in Afghanistan and Iraq, and the worst recession since the Great Depression was picking up speed.

In order to prevent total disaster, the Bush administration ended its eight years of catastrophic misrule with a flourish, by allocating over $700 billion in financial system bailouts to cover the bad loans the banks had been making since Greenspan gave the housing bubble the green light.

It is now November 2009. Since Barack Obama was inaugurated in January, unemployment has soared from 7.9 percent to 10.2 percent.

A few hundred billion dollars were allocated for “stimulus” purposes, but most of that went to pay unemployment benefits and to keep state and local governments from laying off more employees.

A fraction has been distributed for highway improvements, but largely through the bank bailouts the federal deficit has been running at an annual rate of $1.5 trillion, by far the largest in history, with the national debt now topping $12 trillion. Ironically, those Americans who still have productive jobs continue to grow in efficiency, with productivity up over five percent in the last year.

So much federal money has been spent that the Obama administration has been struggling to make its health care proposals budget-neutral through a raft of new taxes, fees, and penalties, and by announcing in recent days that the government’ first priority must now shift to deficit reduction.

The word “austerity” has been mentioned for the first time since the Carter administration. Yet Congress voted $655 billion in military expenditures to continue fighting in the Middle East. A U.S. military attack on Iran, possibly in conjunction with Israel, would surprise no one.

So where do we now stand?

At present, the Federal Reserve is trying to prevent a total economic collapse.

Interest rates are near-zero, to the chagrin of foreign investors in U.S. Treasury securities, and close to half of new Treasury debt instruments have been bought by the Federal Reserve itself as a way of providing free money for federal government expenditures.

But the U.S. economy shows no signs of coming back, with no economic driver emerging that could bring it back.

For all the talk about alternative energy, there has been no significant growth of any home-grown industry that could possibly make up so much lost ground in either the short or the long-term.

The industries in the U.S. that are holding up are the military, including arms exports, universities that are attracting large numbers of students from abroad, especially China, and health care, especially for the aging baby boomer population.

But the war industry produces nothing with a long-term economic benefit, and health care exists mainly to treat sick people, not produce anything new.

None of this provides a foundation that can bring about a restoration of prosperity to 300 million people when the jobs of making articles of consumption are increasingly scarce.

On top of everything else, since government inevitably looks to its own requirements first, the total tax burden continues to increase to the point where the average employee now pays close to 50 percent of his or her income on taxes of all types, including federal and state income taxes, real estate taxes, payroll taxes, excise taxes, government fees, etc. Plus the cost of utilities continues to rise steadily and threatens to skyrocket if cap-and-trade legislation is passed.

The Obama administration has no plans to deal with any of this.

They have projected a budget for 15 years hence that shows the budget deficit decreasing and tax revenues going way up, but it is all lies.

They have no roadmap for getting us there and no plans for following the roadmap if it portrayed a realistic goal.

And yet the U.S. military is still trying to conquer Asia. It is madness.

And it is madness because the big decisions are not made by the U.S., by Congress, or by the Obama administration.

The U.S. has, for half-a-century, been marching to the tune played by the international financial elite, and this fact did not change with the election of 2008.

The financiers have put the people of this nation $57 trillion in debt, according to the latest reports, counting debt at the federal, state, business, and household levels. Interest alone on this debt is over $3 trillion of a GDP of $14 trillion.

Failure of our political leadership to deal with this tragedy over the past three decades is nothing less than treason.

But then again, at some point the decision was made that the U.S. and its population would be discarded by history, the economic status of the nation reduced to a shadow of what it once was, but that its military machine would be used for the financial elite’s takeover of the world until it is replaced by that of some other nation.

All indications are that the next country up to bat as military enforcer for the financiers is China.

Great evils have been done in the world in the last century, and there is nothing anyone can do about it.

Except…. and that’s what each person caught up in these travesties must decide. What are you going to do about it?

In mulling over this question, it would be wise to recognize that the dominance of the financial elite has largely been exercised through their control of the international monetary system based on bank lending and government debt. Therefore it’s through the monetary system that change can and must be made.

The progressives are wrong to think the government should go deeper in debt to create more jobs. This will just create an even deeper hole of debt future generations will have to crawl out of.

Rather the key is monetary reform, whether at the local or national levels.

People have lost control of their ability to earn a living. But change could be accomplished through sovereign control by people and nations of the monetary means of exchange.

This control has been stolen.

It is time to take it back.

One way would be for the federal government to make a relief payment to each adult of $1,000 a month until the crisis lifted.

This money could be earmarked for goods and services produced within the U.S. and used to capitalize a new series of community development banks.

The plan could be funded through direct payment from a Treasury relief account without new taxes or government borrowing.

The payments would be balanced on the credit side by GDP growth or be used by individuals to pay off debt.

It would be direct government spending as was done with Greenbacks before and after the Civil War without significant inflation.

Another method increasingly being used within the U.S. today is local and regional credit clearing exchanges and the use of local currencies or “scrip.”

Use of such currencies could be enhanced by legislation at the state and federal levels allowing these currencies to be used for payment of taxes and government fees as well as payment of mortgages and other forms of bank debt.

The credit clearing exchanges could be organized as private non-profit regional currency co-operatives similar to credit unions.

These would be immediate emergency measures.

In the longer run, sovereign control of money and credit must be returned to the public commons and treated as public utilities. This does not mean exclusive government control to replace bank control.

As stated previously, it would be done in partnership between government and private trade exchanges.

Nor does it mean government takeover of business, industry, or the banking system, though all should be regulated for the common good and fairly taxed.

This program would lead to a new monetary paradigm where money and credit would be available by, as, when, and where needed, to facilitate trade between and among legitimate producers of goods and services.

In this way trade and commerce will come to serve human freedom, not diminish it as is done with today’s dysfunctional partnership between big government trillions of dollars in debt and big finance with the entire world in hock.

Such a change would be a true populist revolution.

Could Dubai Default?

On November 25, 2009, on the eve of the Eid holiday, Dubai World, the state-owned holding company asked creditors for a'standstill' or payment delay on outstanding debt until May 2010 for debt of Nakheel, the property developer subsidiary and Dubai world itself.

The move, coming, just ahead of the December 14 maturity date could if implemented be viewed as a technical default by many investors.

As a whole, state-owned Dubai World, has US$59 billion in liabilities, a significant amount of the total estimated US$80-100 billion in Dubai liabilities.

So far in 2009, all the maturing government-linked debt of Dubai has been paid off in full, with government funds making up any shortfall in private funds. Yet, given the vulnerabilities of the property sector and challenges of the economic model, Nakheel could be a different story given the government's desire to support only viable companies.

Yet, the costs in raising future funds may thus be even more costly. The lack of transparency about corporate and national finances and which debt might be honored, is adding to uncertainty and credit risk.

•Local markets are closed until November 2009 due to the Eid holiday. In addition to sending Dubai CDS spreads up 200 basis points, to levels higher than those of Iceland, the uncertainty has infected the CDS spreads of Abu Dhabi and other GCC countries (to a much lesser extent) and has been cited as an explanation in the 2%+ corrections in European asset markets, some of which were already worried about European debt defaults. Dubai-exposed banks were most affected as were EMEA FX assets.

•RGE's Rachel Ziemba argues that "Extending the maturity of Nakheel debt is feeding the market’s uncertainty on which debt Dubai will honor in full.” (via Bloomberg, 11/25/09)

•Dubai's total external debt, held mostly by government-linked corporations, is estimated at US$80-100 billion or 148-200% of 2007 GDP. Despite new capital, the vulnerabilities of Dubai World, the state holdings company, have reemerged in November 2009, with the company announcing a corporate restructuring and request by Nakheel, a property developer to delay payment on its debt.

•So far in 2009, all the maturing debt associated with Dubai-linked companies has been paid off in full, with government funds offsetting any shortfall in private funds, however, given the vulnerabilities of the property sector and challenges of its economic model, Nakheel could be a different story. The government suggested in the fall that it might ration scarce resources to companies that have viable business models, which might seem to exclude Nakheel. The ratings agencies which previously worried that the State-linked company debt might not be paid in full, responded to the debt standstill request by sharply downgrading many state-linked companies to junk status.

•Although the US$3.5 billion Nakheel sukuk is backed by collateral, the value of the underlying assets has been eroded. Moreover, the bankruptcy and default regulations are still relatively untested meaning that the leverage of creditors making this in many ways a test case.

•Rating agencies have been sharply downgrading Dubai government-owned corporations in the last year as the degree of government support has become less than clear. On November 2009, Moody’s cut the ratings on Dubai Ports World, Dubai Electricity and Water to Baa2 (junk status) from A3 and downgraded 4 other government linked companies as it reduced the assumption of government support to these companies, bringing ratings closer to the ratings indicated by the fundamental credit position of the companies rather than an expectation of government support.

The agency noted that the debt restructuring plan "highlights the government's intention to strictly adhere to its stated policy of supporting only those companies with viable long-term business prospects, which implies that support for distressed or weaker companies may be less forthcoming...confirmation of such policy could result in further reductions in support assumptions that would align ratings entirely with the companies' fundamental credit profile."

Uncertain Government Support

•When Dubai floated a (sub)sovereign Sukuk in October 2009, the prospectus argued that the emirate had no legal obligation to settle state company debt, adding to creditor concern that there would be different classes of Dubai government-linked debt.

•The quest for the standstill agreement comes just a week after the leaders of Dubai World and several other state holding companies were replaced. There continues to be uncertainty about the way in which the restructuring might take place and if the standstill will be granted voluntarily or forced. Despite recent capital raising, Dubai has as much as US$9 billion in payments due by March 2010 and an estimated US$50 billion in the next three years.

• Una Galani of Breaking Views argues that Dubai "is biting the bullet... finally realising that it can't pay off all its debts without a serious financial restructuring." Although Creditors will resent making concessions, its necessary for the long-term. (11/25/09)

Dubai World Restructuring?

•The property companies have been the most vulnerable and while others benefitted from the bounce-back in tourism as well as global inventory restocking. the free zones, and Dubai Ports World have engaged in some significant cost-cutting also which has helped stem losses. However, the property development model has been challenged as prices have suffered sharp 40% declines in price before stabilizing at low levels in mid 2009.

•In late November 2009, Sheikh Mohammad replaced some of the head managers of Dubai World and Dubai Holding, the most credit-constrained parts of the Dubai Inc.

• On October 15, Dubai World, the government-owned corporation which has been seeking to restructure its debt, announced a significant restructuring including job cuts of as much as 12,000 workers. It has consolidated several of its operations especially its overleveraged property vehicles. It has tried to avoid distressed sales of its assets to raise capital but may offer equity in several Dubai World subsidiaries to some of its creditors.

•This corporate restructuring could allow it to focus on core assets and consolidate some of the most vulnerable sections of the company. Moreover, making the cuts may be a precondition from creditors, both private and public. Reports suggested that Istithmar, one of dubai's sovereign funds might be liquidated or at least investments stopped. On Sep 17, Dubai World transfered some staff and property to Istithmar World from property developer Nakheel.

•RGE's Rachel Ziemba: Istithmar, the leveraged alternative investment arm of Dubai World has been under pressure for some time. Rather than a liquidation, what might transpire might be a reorganization within the holding company. (09/14/09)

• The 2009 Debt Renewals

•RGE's Rachel Ziemba notes that the Nakheel debt expiry this fall will be a significant test case as it’s the largest debt coming due until next year (via Bloomberg 10/14/09).

•The Dubai government has been raising funds to provide financing for state-linked companies who might not be able to raise capital themselves. Already several large refinancings have taken place (Borse Dubai, DEWA and Dubai Civil Aviation) with the government providing some funds to each. However, if the government may be rationing its capital despite a possible default.

•In September, Caroline Grady of Deutsche Bank suggested that Dubai needs the other US$10 billion bond issuance to help repay the debts coming due by the end of 2009 including US$3.52 billion sukuk (Islamic bond) of Nakheel and the US$1 billion global sukuk. Most of the debt holders are local which could increase their likelihood of rolling over the debt.

•Rating agencies have been worried that Nakheel's debt would be restructured since at least April.
•US$14 billion in interest and principal payments came or comes due in 2009 (most has already been restructured). Dubai is slated to run a fiscal deficit in 2009 as revenues decline. The US$10 billion in instruments bought by the central bank of the UAE are five-year bonds that carry an annual interest rate of 4%, below the rate of Abu Dhabi government and government-linked corporations bonds issued in 2009. (EFG-Hermes)

•To ease its cash flow, Nakheel arranged to pay half the interest on the debt, 3.1725% , during the life of the bond and the rest at maturity. It backed up the sukuk with significant collateral: land and other assets worth more than twice the value of the sukuk (though the value has subsequently slumped but it now faces worse cash flow issues (National)

•The government insists that it has adequate funds to pay off any debts belonging to Dubai's quasi-sovereign companies (“Dubai Inc”) and its banks, especially as it will issue the next US$10 billion in bonds later this year.

•April: DEWA, the Dubai utility which is a majority stakeholder in TAQA, and Dubai Civil Aviation both raised funds to refinance debt. DCA's loan includes a 1.7 billion UAE dirham tranche, US$100 million and 52 million euros. The facility will pay a profit rate of 300 basis points above benchmark interest rates. Dubai government will contribute US$365 million to bridge the shortfall. Dewa got US$2.2 billion loan at an interest rate of 300bps above the interbank offered rates and may also scale back capex plans

•February: US $1.2 billion of the US$2.5 billion loan for Borse Dubai was raised from international banks with another US$1.3 billion from state-owned Dubai banks after ICD, a state-owned investor deposited cash with them. Borse Dubai also received a US$1 billion equity injection from shareholders including the government.

•Central bank of the UAE had $25 billion in fx reserves in June (most recent data) including include some of the Dubai currency bonds. Abu Dhabi has the ability to channel funds to federal government institutions but it might be only willing to grant funds to viable operations.

•UAE's total external borrowing remains much lower than Abu Dhabi governments assets but even the assets of Abu Dhabi's sovereign funds may be smaller and less liquid than some public reports suggest.

Dubai Sends Markets into Chaos

“Dubai sends markets into turmoil,” begins the Financial Times. Dubai is a financial center, built on sand.

Probably a good thing US markets were closed. In Europe, the Dubai affair caused the biggest drop in 7 months. European banks have lent $40 billion to Dubai.

Emerging markets lost 2.1% yesterday. Worldwide, the loss was 1.5%.

Even gold lost a little ground.

Jim Chanos, a famous short seller, thinks Dubai is merely the camel’s nose in the tent, so to speak. “ China is Dubai times 1,000...if not a million.”

“People are panicking: this whole process counters everything that the rulers have been saying and the way it has been communicated before the holidays is confusing,” said one hedge fund manager.

The ‘rulers’ are the fellows who run “Dubai World,” and incidentally Dubai itself. Whether they are fools, knaves or sly geniuses was what everyone wanted to know yesterday. Dubai officials announced that they had raised $5 billion on Tuesday.

Two hours later they said they weren’t paying interest on it or on any of the rest of the $80 billion in borrowings. What’s going on? Are they really broke? Or are they playing for some kind of advantage?

“ Dubai gambles with its financial reputation,” says one headline at the FT.

Then, on the facing page, the editors think they know how the gamble will turn out:

“A breath-taking blunder in Dubai... Dubai is looking more like Argentina than Singapore – but a lot less predictable,” says the FT editorial.

No one is sure what is going on. Most people take from this story what we knew all along:

Lending to shady characters in sunny places is not an easy way to make money. Especially when the shady characters own the country.

Trouble is, shady characters run near all the world’s countries. If an investor cannot trust the ruling family of Dubai, how can he trust the commies who run China? Or the hacks who run the United States of America?

To err is human. For a central banker, it is practically a professional requirement. Count on a major ‘error’ to trigger a sell-off in the world’s bond market.

But Dubai’s mistake did not infect all other sovereign debt. German bond yields went down, not up. Investors sought safety from Dubai debt in Deutschland debt.

And gold sold off. Which makes us wonder: when investors get another big fright – say, when the stock market crashes – will they run to US dollar bonds...just as they did a year ago?

Yesterday, the dollar fell to its lowest level against the yen in 14 years. And Japan is back in deflation.

But what is the real meaning of what is going on in Dubai? It’s the story of the collapse of the financial industry. Dubai has no oil...no natural resources...and no real industry. The rulers tried to turn it into a financial center. Entirely financed by debt. And now finance itself is falling apart.

“The camel put his nose in the tent,” says colleague Simone Wapler. “He saw that there was nothing there.”

What will he think when he gets a closer look at Britain’s finances? Britain, too, relies heavily on the financial industry. And Britain, too, is heavily dependent on debt. Its public finances are among the worst in the world. Japan’s public debt, to add another example, is already 200% of GDP. It’s expected to reach 300% in a few years.

And yet, Japan – like the US and Britain – just keeps borrowing.

How long can this go on?

When will Britain, the US, and Japan announce their own moratoria on debt service payments?

“A couple years ago, there would be only a handful of bidders on a job. Now, there are hundreds of them. The guys who used to be putting up shopping malls and housing developments are now trying to get work from the government.

“There’s a lot of work.

They’ve got projects starting up all over the place. Most of them are a ridiculous waste of money. Those Homeland Security projects, for example, are a big joke. They are always buying computer systems.

Half the time they don’t work. The other half of the time, they’re just useless. You can see that just by looking at the news tonight. A couple of people just walked through the security systems at the White House and sat down to a state dinner. If they had wanted to they could have easily killed the president. Any determined and resourceful terrorist could do it. Fortunately, there aren’t many of them.

“Homeland security is a joke. But they’re spending more than the whole defense budget of France.”

US personal income rose in October. But it was boosted by government benefits, says David Rosenberg. Take away the free money from the feds and income actually went down.

Income has been going down for a long time in the US. English colleague Brian Durrant wonders why there is no revolution:

“Consider a country. For the top 20% of the population real incomes have increased by 60% since 1970. But for the other four-fifths real income has fallen by more than 10%. Am I talking about Guatemala or Bolivia? These sort of inequalities have in the past provoked resentment sometimes articulated through revolutionary movements and social unrest.

But I am not talking about a tiny Latin American state; these figures apply to the US. How can this be? Middle class America is surely better off compared to 1970; if you look at higher car ownership, better housing, more white goods and gadgets. The answer is debt. No wonder the politicians are frightened of it contracting!”

We have been saying that the last 10 years was a ‘lost decade’ in terms of income, employment and stock market growth. For most people, their whole adult lives have been spent slipping backward. Since the Carter Administration, the typical American has lost income.

A whole generation made no financial progress.

But they didn’t revolt. Instead, they borrowed.

It gave them more gadgets, gizmos and floor space. It also gave them the impression that things were getting better. Now we’ve reached the end of that period of debt expansion.

Now debt is contracting. So are lifestyles.