In an age where governments of
every political stripe distort data to promote their own self interests, it's
hardly surprising that they present inflation data in a manner that is best
suited to their particular needs. By the same token, it's entirely natural
for official inflation data to be wildly at odds with the reality that is
faced by consumers and businesses, and to be regarded with utter disbelief.
So it wasn't shocking to hear
Federal Reserve officials insist last week, that inflation in the United
States is under control, before telegraphing another tidal wave of liquidity
injections into the US economy in the months ahead. "Stable inflation expectations
give the Fed a lot of room for maneuver. If the evidence suggests that
substantial policy easing is appropriate, I don't think we're going to face a
risk of adverse inflation consequences," said St Louis Fed chief William
Poole on Jan 9th.
In an election year for the
highest office in the land, American politicians from both sides of the isle,
are quick to propose all kinds of fiscal stimulus and pork barrel projects to
jump start the sputtering US economy. But adding more monetary stimulus to
the mix has the potential to ignite hyper-inflation in the US economy, and a
speculative attack on the US dollar in the $3.2 trillion a day currency
market.
"It's difficult enough to
make good policy in a complex economy and complex financial system,"
said Fed chief Ben "B-52" Bernanke on January 11th. "Political
considerations will play no role, and I assure you as strongly as I can, that
we will be objective and analytical, and we'll do what's right for the
economy," he said.
It's now becoming increasing
clear, that the only prices the Fed is focusing on these days are home prices
and those for toxic sub-prime mortgage debt. The Fed is pegging the federal
funds rate in the direction of US home prices, mimicking the Bank of England
as an asset targeter. Last week, nearby futures contracts on the Standard
& Poor's/Case-Shiller, an index of home prices in the top-10 US cities,
fell below the 206-level, or roughly 7% lower from a year ago.
Robert Shiller, a Yale
University economist, and co-founder of the widely watched house-price index,
predicted on Dec 31st, a possibility that the US economy would stumble into a
Japanese-style recession, with house prices declining for years.
"American real estate values have already lost around $1 trillion. That
could easily increase threefold over the next few years. This is a much
bigger issue than sub-prime. We are talking trillions of dollars' worth of
losses."
He noted that Chicago futures
markets are pricing in further declines in US home prices, with farther dated
contracts on the S&P Shiller Index pointing to losses of up to 14
percent. In the third quarter of 2007, US homeowners withdrew $20 billion
less in equity from their homes than in the prior quarter, and since housing
prices have continued to tumble, the outlook for cash-outs has continued to
dim.
Lenders have also grown more
cautious in handing out cash through home equity lines of credit since those
loans were failing at their highest rate in ten years during the third
quarter. If the housing market continues to sink this year, consumers will
have less home equity to convert into cash, which could lead to a big
pullback in spending. With consumers struggling with high energy costs and a
softening jobs market, the drying up of home equity could usher in an
economic recession.
Slumping home prices and a
softer jobs market, could increase foreclosures on many sub-prime home
borrowers, and blow huge craters in the balance sheets of banks and brokers
worldwide. Credit Suisse projects 775,000 homes with $143 billion of mortgage
debt will go into foreclosure in the next two years. Goldman Sachs estimated
that losses in mortgage markets worldwide may reach $726 billion.
Some BBB rated sub-prime
mortgage bonds have already tumbled to 16-cents on the dollar from 50-cents
last July. AA rated paper isn't faring much better, fetching only 40-cents in
the $1.8 trillion sub-prime mortgage market. On January 15th, Citigroup C.n,
the nation's largest bank, took a fourth-quarter loss of nearly $10 billion,
stemming largely from $18 billion of write-downs of sub-prime mortgages.
The deepening gloom in the US
financial sector came as Bank of America BAC.n agreed to acquire battered
mortgage lender Countrywide Financial CFC.n for $4 billion, to avert one of
the biggest collapses due to the toxic sub-prime debt bomb. Merrill Lynch is
expected to suffer $15 billion in losses stemming from soured mortgage
investments, as the sub-prime debt bomb goes nuclear.
Bernanke Signals more Rate
cuts in Q'1
With the US economy sinking
deeper into the "Stagflation" trap, and credit worries clogging the
arteries of the Libor market, Mr Bernanke shouted loud and clear for the
whole world to hear on Jan 10th, that the Fed and the US Treasury (the
"Plunge Protection Team" - PPT) have decided to exercise the
"Greenspan Put" option, and will simply disregard elevated
inflationary pressures in the rest of the economy.
"In light of recent
changes in the outlook for and the risks to growth, additional policy easing
may be necessary," Bernanke said on January 11th. "We stand ready
to take substantive additional action as needed to support growth and to
provide adequate insurance against downside risks. Inflation expectations are
reasonably well anchored," and he pledged to monitor inflation
expectations closely.
For the PPT, the devil of
hyper-inflation is preferable to the specter of a bear market for the Dow
Jones Industrials and weaker home prices. Exercising the "Greenspan Put,"
means the Fed will slash the federal funds rate far below the US inflation
rate in the months ahead. But that's a frightening prospect for foreign
holders of $2.3 trillion of US Treasury debt, who must contend with negative
interest rates, which in turn, could severely weaken their US dollar
denominated investments.
The Fed is signaling
aggressive rate cuts at a dangerous time. Inflationary pressures in the US
economy are elevated at multi-decade highs. US producer prices were up +6.3%
last year, and US consumer prices up +4.1%, the highest in 17-years, compared
with +2.5% for 2006. Gasoline costs were up 37%, and food prices were up 9.3%
last year, embedding inflation fears into the American psyche.
Thanks to the Fed's cheap
dollar policy, US import prices rose +10.9% in 2007, the largest
calendar-year increase since 1987. The Dow Jones AIG Commodity Index soared
to an all-time high of 193.25, exerting upward pressure on raw material
costs. Only one lone voice of reason from Foggy Bottom is advising caution.
"I would be very careful, not to let inflation accelerate too
long," warned Kansas City Fed chief Thomas Hoenig on January 10th.
But Hoenig was rotated off the
Fed's interest rate setting committee, after he dissented against a rate cut
in October, in favor of keeping Fed policy on hold. Instead, the politically
correct thing to do in Washington these days is to cut rates and drop dollar
bills across America from helicopters and B-52 bombers.
The Fed's big Gamble
The Fed is betting that a
sharp slowdown in the global economy will weaken commodity prices, and that
Saudi Arabia will pump more oil, to keep inflationary pressures at bay. Until
now, the Fed's rate cutting campaign, its special $80 billion liquidity
injection scheme and promises of another big tidal wave of liquidity, have
severely weakened the value of the US dollar, which in turn, fueled parabolic
rallies in crude oil and precious metals to all-time highs.
Fed rate cuts also fueled
Agri-flation worldwide. In Chicago, March wheat jumped the to $9.40 /bushel,
after the USDA reported smaller than expected US plantings for hard red
winter wheat. Corn surged to an 11-year high of $5.15 /bushel, on a big
drawdown in US corn stocks. July soybeans soared to $13.76 a bushel, buoyed
by fears that corn's surge could cut into soybean plantings for 2008.
Rough rice futures in Chicago
hit an all-time high of more than $15 per hundredweight, 37% higher from a
year ago. Egypt is a major exporter of rice, but has suspended exports
indefinitely, due to hoarding and speculation in its local economy. In
Pakistan, armed guards escort trucks carrying high-prized wheat. India will
become a net importer of rice this year, for the first time.
Jordan intends to double the
stocks of wheat inside its country to 390,000 tons, equivalent to six months
of supply, plus a further 130,000 tons purchased and being shipped,
representing two months of supply. Doubling wheat stocks is an indication
that some major importers see no end to the bull market in Chicago and want
to protect themselves. Ocean shipping costs for dry goods have fallen 35% in
recent weeks, which may encourage more purchasing of grains.
Bush Seeks Quick Fix to
Tame Oil prices
On his arrival in Riyadh on
January 15th, President Bush urged Saudi king Abdullah to put more crude oil
on the world market, warning that soaring prices could cause an economic
slowdown in the United States, and weaken the housing market. "High
energy prices can damage consuming economies. When consumers have less
purchasing power, it could cause the economy to slow down. I hope OPEC
nations put more supply on the market. It would be helpful," he said.
Saudi Arabia is the
only member of OPEC with spare capacity - roughly 2.8 million barrels per
day. Saudi Oil chief Ali al-Naimi said on Jan 15th, that Riyadh is ready to
boost oil output if the market needed more oil to tame high prices.
"Nobody would look with
pleasure on a recession in the United States. Concerns about US economic
growth are valid. But the price of oil is more than just the US economy.
Global economies are growing despite oil prices ranging between $90 and $100
a barrel," Naimi said.
For instance, China's oil
imports rose 12% last year to a record 3.26 mil bpd.
But al-Naimi also blamed
speculators in London and New York for inflating the price of crude oil by
$20 to $30 per barrel. "Twenty to thirty dollars is the outside
influence on the price of oil. If you look at who's in the market, you'll
find a lot financial institutions are speculating, using the market as a
hedge." Still, Naimi wouldn't say if Riyadh would agree to boost oil
output at OPEC's Feb 1 meeting.
King Abdullah must walk a
along a tightrope, balancing his military patron's request for more oil,
against Iran's opposition to further increases in output, which could hurt
Tehran's oil revenue. On Dec 5th, Iran's President Mahmoud Ahmadinejad scored
a big victory, when he convinced king Abdullah to join the hawks of OPEC -
Iran, Libya, and Venezuela, and hold the cartel's oil output steady at 27.25
million bpd.
"Our position is that
demand and supply are balanced and there is no need to increase oil to the
market," said Iranian Oil Minister Gholamhossein Nozari. Still, the key
question is which way will Saudi oil policy lean at the upcoming Feb 1st
meeting in Vienna, in favor of US Prez Bush or Iran's Ahmadinejad?
However, Riyadh is keen to
keep oil prices elevated within a higher target zone, to sustain the enormous
flow of petro-dollars to the Gulf, which has revived the speculative appetite
for the local stock market. The Saudi All Share Index hit the psychological
12,000 barrier last week, enriching the brokerage accounts of 7,000 Saudi
princes, who control 70% of the market.
Beijing warns US Treasury
against further Fed rate cuts
Beijing also finds itself in a
tough predicament, with $1.53 trillion of foreign exchange reserves over the
past five years, mostly stockpiled in depreciating US dollars. However,
Chinese leaders finally woke up to the folly of such a foolish investment
policy. "The world's currency structure has changed," declared Xu
Jian, vice director of the People's Bank of China (PBoC) on Nov 7th.
"The US dollar is losing
its status as the world reserve currency," he warned. "We will
favor stronger currencies over weaker ones, and will readjust
accordingly," added Cheng Siwei, vice chairman of China's National
People's Congress. On Dec 27th, Hu Xiaolian, director of China's Foreign
Exchange department, wrote, "If the US federal funds rate continues to
fall, this will certainly have a harmful effect on the US dollar exchange
rate and the international currency system," he said.
Traders closely watch any
change in China's strategy which could affect exchange rates. China's central
bank is tightening its monetary policy to combat inflation, which is raging
ahead at a 6.5% annualized rate. At the same time, the Bernanke Fed is
preparing to flood global money markets with another tidal wave of cheaper
US$'s. China raised benchmark interest rate six times in 2007, but the
benchmark one-year deposit rate of 4.14% is still far lower than the
inflation rate.
"We must be sure about
one thing, the central bank is moving towards the objective of positive real
interest rate instead of moving away from it, "said Yu Yongding, a key
advisor to the PBoC, on Janaury 3rd. The next day, the PBoC vowed to further
tighten monetary policy in 2008, aiming in particular to prevent inflation
from moving from certain sectors to the broader economy.
A year ago, the US Treasury's
5-year T-note was yielding +2% more than China's 5-year note. But today, the
US T-note yields -1.2% less, putting enormous downward pressure on the US$
/Chinese yuan, and cementing big foreign currency losses in Beijing's
portfolio of US bonds. According to forward traders in Hong Kong, the dollar
is expected to fall another 9% to 6.6-yuan over the next 12-months.
Since March 2006, China has
been a net seller of US Treasury debt, reducing its exposure from $421
billion to $386.7 billion in November, and seeking to avoid further losses on
the dollar's exchange rate with the yuan. "The weakening dollar and
rising global commodity prices is also creating inflationary pressures for
China, but a quicker appreciation of the yuan would probably help offset some
of those price increases," said Yao Jingyuan, chief economist of the
state statistics agency.
On Jan 16th, the PBOC hiked
bank reserve requirements by 0.50% to a record 15%, a move that will drain
200 billion yuan ($28 billion) from the Shanghai money markets. The dollar
fell to 7.23 yuan, or -3.2% lower since late October, a faster decline than
the -1.2% slide in the US Dollar Index over same period, meaning the yuan is
rising at an even faster pace against a basket of six major global
currencies, including the Euro, British pound, and Canadian dollar.
Arab Oil kingdoms are
Saviors of US$,
Japan is the largest holder of
US Treasury debt, but has been a net seller of $46 billion, and South Korea
has sold $19 billion over the past 12-months. To pick-up the slack, the Bush
administration has relied heavily on the Arab Oil kingdoms, to recycle their
bulging petro-dollar surpluses back into US Treasury debt. Since 9/11,
America has assumed the financial costs of occupying Iraq, while the Arab oil
kingdoms have experienced a staggering infusion of new wealth.
Saudi Arabia has taken in
nearly $900 billion in oil revenues over the last six-years, and the emirate
of Abu Dhabi has a sovereign wealth fund approximating $1 trillion. There had
been a time, in the lean 1990's, when Saudi Arabia's debt had reached 120% of
Saudi GDP, but today it has fallen to 5 percent. And from a year ago, it is
estimated that the Arab oil kingdoms have recycled as much as $227 billion
into US Treasuries, mostly through their brokers in London.
In order to keep the archaic
dollar /riyal peg intact, the Saudi central bank has more doubled the growth
rate of its M3 money supply to 21.6%, to stay ahead the of Bernanke Fed's 16%
expansion of the US M3 money supply. The Saudi central bank has cut its key
repurchase rate, the benchmark for deposits, to 4% in tandem with the Fed.
But the rapid growth of the money supply pushed Saudi inflation to 6% in
October, it's highest since 1995. Food price inflation hit 7.5 percent.
Inflation in four of the six
Gulf Arab oil kingdoms has overtaken official lending rates, encouraging
speculation in real estate, which is the main cost of living across the
region. Saudis blame King Abdullah's insistence on pegging the riyal to the
US dollar for higher inflation at home. The central bank is handcuffed in the
fight against inflation by the riyal's peg to the dollar, which forces it to
track US monetary policy at a time when the Federal Reserve is cutting
interest rates.
Those who can afford to buy
gold have protected their wealth from the Saudi central's banks' money
spigots. But most of the Saudi population hasn't been so fortunate. "We
remind you of Prophet Mohammad's words that you are shepherds who are
responsible for your flock," said 19 well-known clerics, including
Nasser Al Omar, on Dec 16th. "The rulers should seek to try to remedy
this crisis in a way that would ease people's suffering. This crisis will
have a negative impact on all levels, causing theft, cheating, armed robbery
and resentment between rich and poor."
Bush offers $20 billion
arms deal for Saudi Oil
In a keynote speech in Abu
Dhabi on January 13th, US President George Bush reminded the leaders of the
oil kingdoms of what he called the threat to the world posed by Tehran.
"Iran seeks to intimidate its neighbors with missiles and bellicose
rhetoric, and its actions threaten the security of nations everywhere. So the
United States is strengthening our longstanding security commitments with our
friends in the Gulf to confront this danger before it is too late," he
warned.
Still, Saudi Arabia
and other Gulf Arab states are looking beyond the last 12-months of the Bush
presidency, and are determined to maintain good relations with Iran, which
might only be a few years away from acquiring nuclear weapons.
"We'll listen to
everything the president says. He can raise any issue he likes. We're a
neighbor to Iran in the Gulf, which is a small area, so we're keen for
harmony and peace among countries in the area," said Foreign Minister
Saud al-Faisal.
Saudi Arabia invited Iran's
Ahmadinejad to the Haj in Mecca in December and Qatar invited Ahmadinejad to
a summit of the Gulf Cooperation Council (GCC) last month.
The underlying message is
simple, in return for American military protection against Iran, the Bush
clan expects the Arab oil kingdoms to stick with their archaic dollar pegs,
and recycle much of their oil surplus into US Treasuries. To keep the Saudi
petro-dollars flowing into US Treasury debt, Bush offered Riyadh a $20
billion package of advanced weaponry, to shore up their defenses against
Iran.
Bush spoke with the Saudi king
in his opulent palace. Its marble floors and walls contain sheets of gold,
colored with precious stones and embedded jewels. The king also invited Bush
to his lavish horse farm where 150 Arabian stallions are stabled, as a
payback to his visit to the Bush ranch in Crawford, Texas.
European Central Bank Rules
out Rate cuts
The Bernanke Fed is playing
Russian roulette with the US dollar, reckoning that other central banks will
eventually join its money printing orgy, to prevent their currencies from
rising sharply higher against the greenback. But while the Fed is trying to
brainwash the media into believing that inflation is under control, ECB chief
Jean "Tricky" Trichet has flatly ruled out any Euro rate cuts in
the months ahead, arguing that inflation is a major threat faced by the Euro
zone.
On Jan 10th, Trichet was asked
whether it was correct to say the ECB had a bias to tighten rates, "We
are certainly not neutral," warning the ECB is not prepared to tolerate
a wage-price spiral triggered by higher food and oil prices. Speaking on
French television on January 14th, Trichet rebuffed suggestions by French
government officials, that the ECB should pay more attention to stimulating
growth, like the Federal Reserve, rather than focusing on keeping inflation
under control.
"There is not one
European to say that now is the moment to be particularly lax in the matter
of fighting inflation," Trichet declared. ECB member Michael Bonello
backed his new boss, "The bank remains prepared to act to insure that
the upside risks to price stability, which are clearly mounting at the
moment, do not materialize," he said. Austrian central bank chief Klaus
Liebscher added, "We have clear upward risks from inflation, $95 per
barrel of oil and dramatic food price increases. On top of this, we could see
second round effects," he said.
Compared to the reckless
amateurs at the Federal Reserve, ECB officials are sounding more responsible
and like stalwart guardians of the Euro's purchasing power. But one must also
keep in mind, that the ECB is inflating its M3 money supply at a record 12.3%
annual rate. In doing so, the ECB has been a major accomplice to the historic
rally in food and energy prices over the past few years.
The ECB is now warning Euro
zone workers to avoid asking for higher wages, which they seek to compensate
for the inflation that was created by the central bank itself. "Wages
must not seek to catch up with prices to compensate for a weakening in
purchasing power following this price rise," warned Italy's central bank
chief Bini Smaghi on Jan 14th. "Otherwise inflation might not go down
and at that point there won't be any other solution than a monetary
tightening," he said.
On January 15th, Bundesbank
chief Axel Weber said there were signs that wage pressure and inflation
expectations were starting to drift up. "The currently noticeable higher
rates of inflation in Germany and the Euro area overall should not be the
yardstick for upcoming wage negotiations. We are observing current
developments very carefully and, if needed, action will follow our
words."
Around 2 million German public
sector workers are seeking an 8% increase in wage talks which began last
week, while German train drivers have already secured an 11% raise. German
union bosses are calling the ECB's bluff, figuring the central bank does not
have the green light from government finance officials for a rate hike, given
the severity of the credit crunch in the Euro Libor markets.
Bank of Japan is Silent on
dollar's Slide to 106-yen
Japan's ministry of finance is
the most notorious manipulator of inflation data, and for good reason.
Japan's outstanding public debt is 776 trillion yen ($7.25 trillion), or
roughly 147% of gross domestic product, the highest among leading
industrialized countries. In order to keep its interest rates and debt
service costs low, Tokyo's uses fuzzy math to calculate it inflation rate, to
provide the Bank of Japan with the political cover to peg its overnight loan
rate at an abnormally low 0.50 percent.
Japan imports almost all of
its oil, or 4.2 mil bpd, and is the world's third-largest oil consumer after
the US and China. Japan runs an industrial economy and is only 40% self
sufficient in agricultural commodities, so 60% of its domestic demands for
food and agricultural products are imported. Yet Tokyo claims that Japan's
consumer price index is only +0.4% higher from a year ago, by far the lowest
on the planet, despite a near doubling of food and energy prices from a year
ago.
Japan has an enormous stash of
cash, and can easily afford to pay for sharply higher prices for food and
energy imports. Japan's current-account surplus, the widest measure of a
country's financial performance on an international basis, expanded 46% to
2.2 trillion yen ($20.1 billion) in October from a year earlier. Japan's
foreign exchange reserves rose 9% to a record $973 billion last year, and are
the world's second largest behind China's $1.53 trillion.
Currency traders are attracted
to the yen because of Japan's large external surpluses, but are also
discouraged from buying the currency, because of abnormally low interest
rates for Japanese bonds. On the flip side, global traders have borrowed $1.2
trillion in Japanese yen at 1% or less, to purchase stocks and commodities on
worldwide exchanges, popularly known as the "yen carry" trade.
Recently, the US$ has been
tumbling against the yen, because the US Treasury's 2-year note yield has
plunged from +394 basis points above the Japanese 2-year yield to as low as
+250 bp over the past two months. And in a chain reaction, Japan's Nikkei-225
plunged to a 26-month low, as key exporters sank on fears of a possible
recession in the US market and the surging yen. A weaker dollar will hurt
exporter profits earned in the US, when converted back into yen.
Thus, unilateral Fed rate cuts
have become a big headache for Tokyo's financial warlords. Yet Japanese
finance officials were surprisingly silent this week, as the dollar fell
below 109-yen, previously regarded as the MoF's red line in the sand, where
intervention was expected to defend the dollar. The lack of intervention
raises the possibility that Tokyo may have acquiesced to a stronger yen, in
order to help dampen the high cost of imported food and energy.
Traders might probe the
dollar's downside, until subtle threats of intervention are sounded out by
the MoF. There is also simmering speculation that the BoJ might lower its
overnight loan rate to zero percent, after BoJ chief Toshihiko retires in
March. The yield of two-year Japanese government bonds fell to 0.60%, just 10
basis points above the overnight call rate target.
A rate cut to zero percent
could raise speculation of the BOJ returning to "quantitative
easing", a policy of force-feeding banks with excess cash to kick-start
the economy. Annual growth in Japanese bank lending has slowed to +0.1% from
a year ago, indicative of an anemic economy. Odds are rising that the world's
second largest economy is slipping into recession, led by weaker exports to
the US.
Breakdown of Fiat (paper)
Currency System
In a world of fiat
(paper) currency, the full faith and trust in a nation's currency often lies
in the policy actions and honesty of its central bankers. Under the Bernanke
Fed, global confidence in the US dollar has been badly shaken, and the Fed
rookies hand picked by Mr Bush, are just learning about gold's special role
in the international monetary markets.
Trading in the foreign
exchange market is akin to a reverse beauty contest, judging the least ugly
(least inflated) currency as the winner. So far, only two central banks in
Canada and England have shown a interest in joining the Fed's money printing
orgy.
Gold cannot be printed and
mining output is 9% lower than a year ago. The Bernanke Fed is playing
Russian roulette with the greenback, and a serious breakdown of the fiat
(paper) currency system might only be a Fed rate cut or two away.
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