Smart Money

A reader of Agora Financial’s 5-Minute Forecast wrote, “You spend a lot of time talking about the loss of purchasing power of the dollar – and rightly so. Therefore, I fail to see the problem with anyone spending dollars as quickly as possible and incurring debt. That dollar spent today will be worth less, if not worthless, tomorrow, and the dollar repaid will be of lower value than the dollar borrowed. Can’t have the argument both ways.”

I was hoping that someone would ask me to field that question, as I was really chomping at the bit at the sight of a potential target for a test-drive of Random Mogambo Attack Mode (RMAM), where I take strange, unnatural delight in punishing stupidity by being rude, sarcastic, insulting, arrogant, argumentative and truly hateful, as is implied by the words “Attack Mode”.

And my reply would have been a real bargain, too, as it was a “two-fer”; not only would I have rebutted the argument, but I would have also been entertaining in a horrifying, embarrassing way, for no extra charge! Free!

For those who wish to hear my entire reply, I have handily expurgated the screaming obscenities, malicious lies, various libels, incoherent words and phrases, personal attacks and random death threats, and now the entire 50-page essay is boiled down to just the paragraph, “If you can guarantee that you will have an income that will rise faster than inflation, interest and taxes for the rest of your future life as your debt rises for the rest of your future life, then you are right; borrow as much as you want and party down, dude! You will, indeed, be paying back with cheaper dollars, handing yourself a bargain in the process, which is no problem for you because you are so smart and important that your employer will no doubt be happy – happy! – to pay you more and more wages and benefits at a rate that is actually higher than inflation in prices and taxes, for all the rest of your life! Lucky you!

“But if you are like the rest of us miserable creeps out here who are living hand-to-mouth and are one lousy ‘written reprimand in our employee file’ away from being fired and probably sued for sexual harassment or that whole embezzling thing, then no; borrowing for the sake of getting more of a bargain on some consumer item is really, really, really stupid.”

And I say this because a study by the University of Central Florida found that, as reported by the St. Petersburg Times, “56 percent of low-income respondents said they could not pay their bills if they missed one month’s pay”, which is not very remarkable since these are low-income people. But the startling part is that “38 percent of middle-income respondents” also said that they could not pay their bills if they missed one month’s income, and that “24 percent of upper-income respondents made that same claim”!

And what percent of each class felt like they were so far in debt that “they will never be able to get out”? Oops! Low income: 25 percent. Middle income: 14 percent. Upper income: 10 percent!

And they are not going to get any help from their houses going up in value, as Martin Weiss of moneyandmarkets.com reports that, “The S&P/Schiller Home Price Index plunged 9.1% in December. Worse, the median price of new homes sold has tanked 15.1% from January of last year, the biggest drop in any month since at least 1964, when they first began tracking this measure.”

And so it is obvious that the reason nobody has any money is because they have no more money or credit after paying higher prices for everything else, as you can surmise from Ambrose Evans-Pritchard at Telegraph.uk.co, who reports that “40pc of the world economy has an inflation problem”, which he proves by reporting inflation of consumer prices in China (7%), Vietnam (15%), Russia (12%), Bulgaria (12%) Romania (8%) Estonia (11%), The Emirates (12%), Qatar (14%), and India (5%).

And where did all of this inflation in prices come from that is making people hungry and angry? Mr. Evans-Pritchard is right on the money when he says, “I totally agree with those who blame the debt crisis on the irresponsible policies of the Fed and fellow central banks from 2003 to 2006, and indeed for [the] better part of fifteen years. They stoked this bubble by artificially holding rates too low (by government fiat). The money leaked into asset prices, just as it [did] in the US in [the] 1920s, and in Japan in the 1980s. (Two other low inflation eras).

“In effect”, he says, “central banks rigged the price of credit. In doing so they caused massive ‘inter-temporal misallocations’, to use the posh term of the BIS. Or put another way, they stole prosperity from the future.”

You can imagine the powerful cinematic effect when he added, with just the perfect touch of ominous undertones, and augmented by my adding a soundtrack of people screaming while being torn apart by ravenous wolves, “The future has now arrived.” Ugh.

Until next week,

The Mogambo Guru

Today, March 17, 2008, I turned on the TV to CNBC and see that oil has hit an all time high.

Gold has hit an all time high.

The Yen is at an all time high against the dollar.

The Euro is at an all time high against the dollar.

Everybody’s money is getting more valuable, except ours.

This is all due to the devaluation of the dollar.  The FED just keeps printing more and more Funny Money.  And as they do, the Funny Money in your pocket becomes worth less and less.

Last week the FED announced it was making another $200 Billion available to bail out the banks.  This is in addition to the hundreds of billions of dollars they have already added to the system to bail out the banks.

What have they done for you?

Have you noticed that all the bailout efforts are directed towards the banks.  They haven’t offered to forgive one dime of your debt.

So, what are you going to do?   How high do prices have to get before you say enough is enough?  Gas at $6/gal?  Milk at $10/gal?  Hamburger at $10/lb?  $10 loaf of bread?

When are you going to stop paying the banks money you don’t owe them?  When you can no longer afford to feed your family and still pay the theives?  When you’re starving and on the streets?

Just some questions to ponder…

Are you one of thousands of Americans who thinks the dollar drop doesn’t really affect you?

Somehow I doubt it, if you’re one of our readers. But I have to tell you, there are plenty of Americans out there who feel completely detached from what’s quickly becoming an outright dollar crisis.

In fact, I love it when Americans say the “falling dollar isn’t affecting me because I never travel outside America.”

My response is…do you buy oil, gas, gold, silver wheat, soybeans, etc…or any products derived from them?

If so, then you’re affected by the drop in the U.S. dollar whether you ever go to Europe and “exchange for euros” or not.

Ben Bernanke has even fallen victim to this. Many economists don’t understand it, so certainly Main Street investors don’t either.

However, whether you realize it or not, a falling dollar is bad for most everyone, especially Americans…even the ones that don’t travel internationally or make purchases internationally directly. Get ready for $4 gasoline this summer.

SEAN HYMAN, Currency Director

THE SOVEREIGN SOCIETY OFFSHORE A-LETTER

Gold just hit US$1,000 an ounce…oil is at US$111/ barrel now. Gasoline futures just rose to an all-time high (even though the “summer driving season” hasn’t hit yet). I don’t even want to think about how much we’ll be paying for gas this summer.

And it wasn’t just oil and gas…

* The euro hit an all-time high (once again) against the buck at 1.5624.
* The yen is at parity with the dollar (USD/JPY = 100). It may not be long before the Swiss franc reaches parity with the dollar. Meanwhile, the Canadian dollar is still “better than parity” with the greenback.
* The U.S. dollar index hit fresh lows at 71.80.
* The Singapore dollar just hit fresh highs against the buck.

Not to mention that food costs are still soaring…foreclosures on homes are still rising…in fact, bank repossessions just doubled last month over the previous month.

So what am I trying to say…it’s ugly out there. It’s going to get even uglier in the near term. Unemployment will rise, more firings will happen.

Economies can’t turn around on a dime no matter what “rabbit” the Fed pulls out of its hat. So you’d better tighten your seat belt and get ready for the ride. If you live in the U.S., plan to save back some cash and trim the fat financially. You’ll be glad you did.

As the U.S. dollar continues to sink in the near term, most anything priced in dollars will become much more expensive: gas, oil, electricity, gold, silver, food, etc.

So watch your spending…because you’re going to see many around you in tough times.

The good news: Many currency trades out there are soaring, particularly the “anti-carry trades,” I’ve been talking about for quite some time. In fact, betting against the traditional carry trades (EUR/JPY, GBP/JPY, EUR/CHF, etc.) has been a really good strategy these past few weeks.

Also, my favorite high-yielders like the Australian and New Zealand dollars have soared. So you’re a part of a knowledgeable crowd that’s positioned in these currencies, you’ve been able to counteract the falling buck and higher energy costs.

SEAN HYMAN, Currency Director

The stock market took another wallop on Friday.

But the bad news came in the jobs report. “Jobs Data Suggest Already in Recession,” says a headline in the Wall Street Journal .

Another headline from Bloomberg rounds out the picture: “Gasoline at record $3.20 a gallon.”

We will put 2 and 2 together. Falling employment means families have less to spend. Rising prices mean they will need to spend more to stay in the same place. And here, Dear Reader, do you see what has happened? The immoveable force of deflation has run smack into the irresistible force of inflation right in Americans’ own backyards. And we will tell you how the smash up will resolve itself: standards of living will fall.

And here comes the New York Times with even more bad news. “Seeing an end to the good times,” begins its report. Then, it allows as how the good times weren’t really so good after all. The median household earned $49,244 in ’99. Now, it earns $48,201. It is a strange boom that doesn’t boost family incomes. But heck, we’ve been saying that it was a freak and an imposter all along.

Inevitably, the feds have to react to the weakening U.S. economy. They can’t allow people to realize that their living standards are going down – not in an election year! In theory, they can boost economic activity by lowering the cost of credit. In practice, things often turn out much differently.

We take a step back this morning to admire the intricate natural mechanisms of a market economy. Finely tuned, carefully balanced, exquisite gears, divine workmanship…the finest watchmakers of Geneva can’t even come close. But nature’s handiwork has more than wheels and levers – it has a quality that man cannot reproduce…nor even understand.

George Soros calls it ‘reflexivity.’ Mathematicians try to describe it with chaos theory and feedback loops. But what it means is that while prices look random, and professors of economics earned Nobel Prizes for proving that they were random, they really are not. Nor are they fixed…nor do they respond to simple, mechanical manipulation. You may push on Lever A…but you might get either Result B or Result Q…or something entirely unexpected.

As we say here at The Daily Reckoning , and you may quote us: prices are neither fixed, nor random, but subject to influence.

The Fed is desperately pulling on levers. Each day brings more evidence of a system-wide credit breakdown. The Fed intends to stop the meltdown in the only way it can – by pulling on the lever of inflation; that is, by introducing more ‘liquidity’ into the marketplace.

This might work, if the problem really were merely a lack of available cash and credit. But consider the problem in housing. A man’s house goes down in price . He has a mortgage to pay. He notices that the mortgage is greater than the value of the house. In the past, he may have been too embarrassed or too proud to do it, but now he is likely to resort to what is being called ‘jingle mail.’ That is, he’s likely to put the keys in the mailbox…and walk away.

What can the feds do about this? The problem is not liquidity. You could offer to lend the man more money on his house, but that doesn’t really help his situation. And to whom would you lend more money, with the value of the collateral falling? As the value of the collateral falls, so do the value of the derivative assets and the institutions that hold them. All up and down the credit capital structure, losses whack into one another like balls on a billiard table. Hedge funds…banks…lenders…borrowers – as one takes a loss, the next one in line takes a hit…which causes the third to lose money too.

It is not a liquidity problem, in other words, but a solvency problem. Too much debt has led to too much lending to too many people who can’t pay it back. And this lending was secured by too many assets that aren’t worth what investors hoped they’d be worth. The losses are there. They are real. They won’t go away – even if you offer more credit.

“Turmoil in the credit derivatives markets is having an increasingly brutal impact on the wider financial system,” reports the Financial Times this morning, “as a vicious cycle of forced selling drives risk premiums on company debt to new highs.”

Now, here’s one of those curve balls that nature’s markets like to throw. The Fed decreases rates – but actual borrowing costs go up! Mortgage rates are higher today than they were when the Fed began cutting last September. As asset prices slip…and the financial industry takes losses…lenders are afraid that they might not get repaid; they want higher yields to justify the risks. And since the real cost of borrowing is going up, real business activity is going down. The economy is sinking…along with the value of the collateral.

Meanwhile, the feds do the only thing they can – lower rates and come up with schemes to put more money in circulation. This produces the financial world we have come to know and love, with inflation on the one side (coming from the feds) and deflation on the other (coming from a natural market correction). Our hypothesis continues to be that the feds cannot reflate the real economy. The problem is debt – too much of it. Offering to lend more won’t help. On the other hand, the feds’ inflation will drive up commodity, gold, oil and consumer prices.

How long this trend will last, we don’t know. But it is a dangerous time to buy stocks…or hold treasuries. Stick with gold and cash.

The Daily Reckoning