Saturday, December 6, 2008

The Big Three and Beyond

As if there was ever a doubt in any one's mind that it was coming, the government announced on Friday its new plan to bail out the auto companies. They have started the process with what they call a small amount of short term debt, but we all know that it is the first of a ton of money heading toward Detroit to be flushed down the toilet.

The companies can now continue to run their inefficient business models unprofitably as nationalized government entities paid for by the tax payers. Look for billions and billions more to be received by these companies in the months ahead.

With that behind us, what can we now look for in the year ahead? It is going to be a very exciting year with major headlines that continue to stream across the ticker.

One of biggest announcements of 2009 will be the failure and bail outs of both Bank of America and J.P. Morgan. These companies have loaded their books over the last year with toxic debt to ensure themselves of bail out money that is on its way. As their mortgage and corporate debt continues to decline, the amount of money needed to keep them from failing will be staggering.

With the investment banks and auto companies fully supported, who is the next beneficiary of the governments money? Our own states. California announced on Friday that it was now paying out with I.O.U.'s and will be approaching the nation's capital for support very soon. They will be the first of many, as states all across the country move closer toward failure. They will all get the money needed.

Up until now we have seen a very defensive strategy in dealing with our economic crisis, moving from one bail out to the next trying to put out the fires. I think to finish this year and start the next we will begin to see more offense from the Fed and Treasury.

Banks around the world are now flush with cash that has been dumped on them by central banks. The problem is that they are all too afraid to lend to each other, businesses, and consumers.

This poses a major problem for the Fed and other central banks because it is not increasing the money supply fast enough. When banks receive money from central banks, they only need to keep a small portion of that money in reserves. (Usually 10%) This means for every dollar a bank receives they can lend out $10. This has the effect of greatly increasing the money supply, which is not currently happening due to their fear and cash hoarding.

So the Fed will move to step two, which is a process called Quantitative Easing. (Something you will hear a lot about in 2009) What this means is that they will bypass the banks and just start injecting the money directly to businesses and consumers.

They have already started doing this with their use of Fannie Mae and Freddie Mac. By buying their toxic securities in exchange for cash they are essentially giving money to homeowners as that new money can now be lent out. This will be a major part of their new "interest rates to 4.5%" program.

The second part of that was the recent announcement of $200 Billion in credit card debt purchased by the Fed. This allows credit card companies to give new money to American consumers.

A third step, and very similar to the last two, will be the direct purchase of corporate debt. The goal here will be to stimulate business spending which has shut down as everyone has been hoarding cash across the board.

The final step will come from our new man in charge, President Barack Obama. He has said that he wants to hit the pavement running and is already working on a fiscal stimulus in the neighborhood of $500 to $700 Billion. I would guess that the total stimulus will approach $1 Trillion before next year ends. This will be similar to last year's stimulus in which the money will be sent directly to Americans in the mail. (Or dumped from the helicopters in the sky, whichever way they see as more efficient.)

All of these plans will have the effect of printing money and entering it directly into the economy. Along with the Fannie/Freddie and mortgage purchases from the Fed, I would look for a major new program to restructure mortgages. Currently 1 out of 10 homeowners are not paying their mortgage.

Where will the money come from? That's not important yet. You probably won't see that question on the front page of any newspapers in 2009 because people will be focused on bail outs and the government saving them. I don't think it will be front and center until we start 2010 and the real crisis presents itself; our currency crisis.

Either way, it will be fun to watch how long the herd will rush into treasuries before they stop, look around, and realize they have just run off a cliff.

Friday, December 5, 2008

What is wrong with the car you have now?

It's Friday, so it's a good time to take a breath and look around at what is happening:

1. Home Prices - The Case/Shiller Homes price index registered at 17.4% decline in September and that number continues to pick up speed. Home prices continue to plummet as we continue to deal with the subprime problems. Up next will be the Alt-A loan tsunami followed by the last stage of the housing meltdown which will be people walking away from homes that are not underwater. Why?

2. Job Loss - The unemployment numbers came out this morning and they were horrifying. Over 530,000 jobs lost last month, going by the governments rosy picture estimates. This was the worst month since 1974 and unemployment continues to grow.

3. Economy Indicators - The Empire State, Philly Fed, Richmond Fed, ISM manufacturing and service indicators are not indicating a recession or even a depression. They are indicating a full blown economic collapse. These numbers will pick up speed to the downside as we continue forward.

4. Consumer Sentiment - The consumer sentiment is so low right now there is nothing even to compare it to. People are walking around like zombies right now trying to understand what is happening to our economy. Many are worried, most are afraid.

So what does that mean?

I talk about things like depression and economic collapse, and I want to put that in context. What that means is the American standard of living is going to be reduced dramatically.

That means that when people want to buy something they are going to have to save for it. But let's stop right there for a second. If Americans were not allowed to buy anything new for the next two years, would it really be that terrible?

Do we all need new cars, and homes, and furniture, and clothes, and washing machines, and computers? Couldn't we just use the ones that we already have? People wouldn't be living in poverty, they just wouldn't be living in la la land.

When I say economic collapse, I don't mean we're going to have dirt roads, and bicycles, and shacks. We're just going to have a drastically lowered standard of living from what we have now.

There are benefits to this. People are going to get a lot closer to their family and friends. They'll have to stop for a second when the free gifts are taken away and think about the important things in life. We're going to have to come together as a country and try to rebuild it. We're going to have to start to work hard, save money, and produce goods.

I'm looking forward to the collapse of the stock market, bond market, our currency, and our bubble economy. I can't wait for the day when I can get excited about investing in the United States, and I can look people in the eye when I tell them it is a strong investment to own a home in our country.

People say that talking bad about your economy means you're not a patriot. I disagree. I think speaking up against people destroying the country is like yelling at your kids if they take drugs. It feels good to print $8 Trillion dollars and run $2 Trillion deficits, but for every cause there is an effect. The effect is on its way, and it is exactly what this country needs to sober itself up.

Thursday, December 4, 2008

Our Greatest Export

I would like to try to explain a concept that I refer to a lot on this site. It is the United States exporting inflation to the rest of the world.

A Chinese boat pulls up to a docking port in New York City to unload its cargo. When the cargo is dropped off the American then pays the Chinese worker with American dollars for the goods.

The Chinese worker then drives the boat back to China and deposits the American dollars into his account and the bank exchanges them for the Chinese Yuan (Chinese currency). The local Chinese bank now has a glut of dollars and a shortage of Yuan, so it exchanges the dollars with the People's Bank of China and buys more yuan.

You can think of the People's Bank of China as their Federal Reserve.

Now the People's Bank of China is sitting there with the dollars, and the dollars keep pouring in month after month. This is called a trade imbalance or deficit, which right now is enormous with American and China. (And the rest of the world)

China then must decide what to do with their dollar reserves. This decision is the most important factor guiding our global economy. One option would be to exchange the dollars on the foreign exchange market for yuan. This would increase the demand for yuan considerably and cause the value of the currency to rise.

When a currency rises in value the American worker at the New York City port now has to pay more dollars to purchase the goods and services. At the same time the Chinese worker on the boat can spend a few hours in New York while he is visiting and purchase American goods real cheap because the value of his yuan is so strong.

The Chinese (right now) do not like this strategy because they do not want to hurt their exports, which is what a strengthened currency will do. They have decided to take the excess dollars received and purchase American assets with the dollars, most notably US Treasuries. This has the effect of "neutralizing" their currency inflows and keeping their currency artificially suppressed.

It has another effect which is the rise in value in US assets such as the bond market because of the increase in demand. Sounds great right? There is one problem. When the Public Bank of China exchanges yuan with the local bank for the dollar, where do they get the yuan? Ah, they print the money or create it with a computer. You remember that trick right?

This money has poured into the local banks creating an explosion in the Chinese money supply. This explosion has caused inflation to rise tremendously. The cost of living is rising at a very rapid rate hurting their developing middle class. They do this (right now) to keep the yuan artificially low and keep the dollar artificially high.

This situation is unsustainable and will come to an end. The rest of the world will not suffer forever to pay for our excess. When the dollar begins to crack, they will send all those accumulated treasuries back to our shores, bursting our current bond bubble, and triggering the collapse of our currency.

Tuesday, December 2, 2008

Bernanke Speaks

Interesting speech yesterday from our great policy leader Mr. Helicopter Ben Bernanke. On a day when the markets were ravaged, he announced to the world his plans on bringing as much destruction as possible to our country in the future.

When asked about interest rates, he said that is was feasible to cut below the 1% Fed Funds rate. This means you can bet the house that interest rates are heading toward zero. That means free money for banks. Free.

Not only that, but he followed up with additional measures to support the economy. His eyes lit up when talking about additional liquidity injections coming down the road. He even had the audacity to say he has plans to purchase treasuries directly. I have been talking about the Fed purchasing treasuries as the final step in our destruction as foreigners stop buying, and he is already talking about doing it now.

In previous discussions I said that the Fed has declared war against our currency, and that doing so would greatly diminish the purchasing power of American's savings. I was terribly mistaken, and I apologize. What we can look forward to now is a nuclear holocaust.

As we enter the final month of 2008 we are winding down one of the greatest periods of deleveraging in history. Hedge funds, investment banks, and major portfolios of all types have spent the last 90 days selling every asset in their portfolio and replacing it with cash and short term treasury bonds. They have sold assets whether they were good, bad, rational, or irrational.

So as 2009 begins we will enter a period of liquidity trapping. This means that all these portfolio's will look at their holdings and realize they are awash with cash and short term treasuries that are yielding close to nothing. They will then look for a place to put this money to work. Where will it go? That is the ten trillion dollar question. Here is where I think:

1. Commodities

As the smoke continues to clear around the world from the credit crisis bomb that was dropped on the global marketplace, the rest of the world will realize that they still have productive economies and that they will continue to grow and produce goods. They will need industrial metals, oil, food, etc., and the artificial prices that are seen today due to the deleveraging process will disappear and begin to move much higher. The second part of this story will come with the falling dollar that I was discussing above. When the dollar falls, commodities become more expensive. The biggest beneficiaries will be oil producing companies, and miners, specifically precious metal miners. I would expect their returns to dwarf all other assets in 2009.

2. Foreign Stocks

Not all foreign stocks. I would be looking at stocks that have no relation to exports to the United States, and I would also stay away from foreign banks in the short term. Both those groups will continue to experience pain as the United States collapses. However, there are an abundance of foreign companies that will feel little to no effect of the US collapse and will benefit as the rest of the global economy continues to push forward. In the past three months, just like commodities, many of these stocks have been irrational sold due to the forced liquidations. They will lead the rebound not only because of their attractive pricing, but because of their strong dividends. Investors will look closely at a 13% dividend from a safe Asian water producing company, over a .02% yield on a bubble treasury bond.

The dollar's recent artificial rise is like a roller coaster rising on the final crest. To me, this means the opportunity of a lifetime for long term investors to exit poor positions and enter others.

Monday, December 1, 2008

The Eye Of The Storm

It seems as if we're entering a calmer period in the market place and will most likely be in that period for the foreseeable future. The Fed and treasury have effectively taken the financial system collapse off the table with their recent actions of nationalizing every bank and now looking to continue purchase trillions of dollars in toxic debt.

The underlying debt that they are purchasing will continue to lose value as home prices fall, credit card, student loan, and auto delinquencies rise, and corporate debt defaults. With the "no one fails" system in place, it will take trillions more to cover the continuous losses that will pour in over the next year. The money needed for the continued bail outs will come from printed money from the Fed and borrowed money from foreigners.

This will continue until the United States as a nation collapses under its own debt and declares bankruptcy. How long will this take? Probably at least another 12-18 months. During that period we will continue under the same macroeconomic paradigm that we have for the previous 20 years. That is the rest of the world living below their means, saving, and producing goods that they send to us. We then purchase those good with borrowed money from them and now printed money from the Federal Reserve.

Most economists feel this will continue on for many years into the future because our debt to GDP ratio is still very low compared to most other countries. What they fail to realize is that 72% of our GDP is consumption which is going to vanish without the ability to borrow. This is happening as we speak with home equity lines being pulled across the board, and news this morning of credit card companies pulling back $2 Trillion in credit lines.

When Americans are no longer able to borrow and spend the system will begin to break down. Our GDP will then collapse and be seen for what it really is which is just smoke and mirrors. Foreign countries will then see our debt levels at their true horrific values, and proceed to slowly cut off our credit lines. This will leave only the Fed as the money source of last resort. At this point the Fed will be buying treasuries, mortgage securities, credit card debt, student loans, and auto loans. Trillions and trillions and trillions will continue to enter the system.

Somewhere during the year 2010 the house of cards will begin to topple and we'll begin to experience a hyperinflationary depression. In the near term, however, I expect to see the recent trillions of dollars entering the system to continue to have a calming effect on the markets.

Under the surface, however, the losses will be real and continue to grow. They will just be temporarily covered with printed and borrowed money, but as the great Warren Buffet has said, "once the tide goes out you'll be able to see who was swimming naked."