Great news: The Federal Reserve will retain its right to operate in secrecy.

“Thank God for Rule 16!”

Late yesterday, the Senate majority put the kibosh on a last-hour provision in the 2010 spending bill that would audit the Fed. Not because it’s a bad idea… but because of the arcane Rule 16, which prohibits policy legislation from being added to spending bills. (The kind of “rule” that’s only evoked when the majority gets uncomfortable.)

“The Federal Reserve will create and disburse trillions of dollars in response to our current financial crisis,” said Sen. Jim DeMint, who spearheaded the failed audit addition. “Americans across the nation, regardless of their opinion on the bailout, want to know where the money has gone.” Under his proposed plan, the Government Accountability Office would take a look into the Fed’s discount window lending, various funding “facilities,” bank bailouts and agreements with foreign players.

Shame on Mr. DeMint for such an outrageous request. Down-to-the-wire appropriations should be reserved for truly exigent causes… like protecting the makers of wooden arrows designed for use by children. Why bother wasting the time of the GAO with a simple audit of the most unaccountable monetary body in the world?

You can watch Mr. DeMint get what’s coming to him here. Ron Paul’s bill– that other shameful attempt to audit the Fed — now has 249 co-sponsors in the House. Wonder what brand of parliamentary fine print Barney Frank or Nancy Pelosi might summon to quash that one.

The number of U.S. consumer loans in default has hit a record high, reports the American Bankers Association. The ABA just polished off its first-quarter delinquency report (little late on that one, fellas) and revealed some disturbing results: Of all the consumer loans in America, 3.23% are more than 30 days in arrears. That’s the highest level since at least 1970, when the ABA started keeping track.

Of course, it’s no shocker that things got tough in the first quarter. But what of the most recent three-month stint, during the best of the sucker rally? “The No. 1 driver of delinquencies is job loss,” hints ABA’s chief economist, James Chessen. “When people lose their jobs, they can’t pay their bills. Delinquencies won’t improve until companies start hiring again and we see a significant economic turnaround.”

So practically no one expects the unemployment rate to stop its accent until at least 2010. And just as many are willing to admit there are boatloads of souring loans still on bank balance sheets. Hmmm….
While certainly better off than the U.S., Canada could face a consumer debt crisis of its own, reports the Bank of Canada. In its biannual Financial System Review, the BoC said yesterday that “There has been a further deterioration in the financial position of the Canadian household sector.” The average ratio of debt to income has hit a record level for Canadians… household debt there is averages roughly 140% of disposable income. Here in I.O.U.S.A., it’s closer to 170%. Suffice to say neither ratio is desirable.

We don’t want to say too much here, but when it comes to a few select Canadian financials, our short analyst Dan Amoss has his finger on the trigger. Stay tuned for more.
China has taken yet another “World’s No.1” title from the U.S., reports Chris Mayer.

“In 2000, China’s exports to the Arab world came to just $6 billion,” says Chris. “Last year, China’s exports to the Arab world climbed to $48 billion, which nearly passed America’s $50 billion in exports to same region. Earlier this year, China finally passed the U.S. to become the Arab world’s largest trading partner.

“This is a historic shift. What we’re seeing here is the New Silk Road in action…

“Today’s traders are following in the footsteps of their ancestors. The bookends of the new Silk Road are China and the Middle East, especially the Arab world. The Eastern bookend gets all the press, but what many people fail to appreciate about the rise of China is how it also sired the rise of the Arab world.

“What does this new Silk Road mean for investors? I believe the New Silk Road gives us a framework for looking at markets and sniffing out opportunities in energy, water, food and more.”
And just how Sino-centric has the Arab world become?“Dubai, for example,” continues Chris, “houses the DragonMart. It is the largest building to sell exclusively Chinese-made goods outside of China. It measures nearly 1.6 million square feet! And China seems to go out of its way to make Arabs feel at home in China — even using state money to build mosques. According to Ben Simpfendorfer, the Chinese will issue visas for visiting Egyptians in 24 hours. It takes 18 days for an Egyptian to get one for America.”

The “New Silk Road” is one of the pillars of Chris’ current investment approach. For specific ways to invest in this sea change, click here.
Back in the U.S., lawmakers are looking to make it harder for traders to buy and sell the Middle East’s largest export. The Commodity Futures Trading Commission said late yesterday that it’s mulling limits on position sizes in commodity contracts – namely, for crude oil. No doubt the move is aimed directly at Wall Street, which played a significant role in driving oil to $145 this time last year… and back down to $33 in January.

“The CFTC is barking up the wrong tree,” opines Dan Denning, “if it wants to blame high energy prices entirely on speculators. One factor in oil’s rise is clearly investment demand from traders and institutions that foresee the decline of the U.S. dollar. Another factor subject to much debate is Peak Oil itself (that global oil production is peaking).

“For now, we’d say this is another sign of increasing government control of the markets. Some people think this is good and long overdue. Some people don’t. Either way, it looks like the world we’re headed to. And it looks to us like a sure sign that the U.S. government wants to have a lot more control of what you do with your money (capital controls). We reckon the oil trading will just move to London.”
Commodity traders continue their crude oil sell-off today. The front-month contract fell as low as $61 a barrel this morning. That’s almost a 14% fall just from this time last week.

And look for oil to be under even more pressure for the rest of the day. The Energy Department announced late this morning another uptick in oil and gas inventories.
“In the West, we are WAY too focused on our own oil demand,” says Byron King. Before we allow him to continue, a quick tip of the cap: Byron called the oil top almost to the day last month when he told you to take oil profits. Bravo.

“People look at U.S. inventory numbers, for example, and then think that the U.S. supply-demand situation ought to control oil prices. But that’s ancient history now.

“This year, we’ve encountered a new situation. Oil demand from the developing world is about equal to the demand from the developed world. That is, the developing world is using half the world’s daily oil output. And that developing-world demand is growing.

“China’s oil demand was up 12% in one year (May 2008-May 2009), during a time when the world’s economy fell off a cliff. It makes you wonder what the increase might have been if the world economy had not fallen off a cliff. And the volume of increase — 800,000 barrels per day — is TWICE the amount that passes daily through the Alaska Pipeline.

“These kinds of dramatic numbers out of China bolster the case that oil prices will continue to rise in the face of overall rising world demand.” Energy economist Michael Economides of the University of Houston expects to see $100 oil by the end of this year.

Will your portfolio benefit? Click here for Byron’s favorite oil plays.
Oil and energy stocks led the market down again yesterday. The major indexes fell about 2%.

Stocks today are drifting … we suspect any real moves will come after the closing bell when Alcoa kicks off the second-quarter earnings season. Of course, we’ll keep an eye on it for you.
The dollar, and subsequently gold, have been a pretty dull trade this week. Today we’re seeing just a bit more action, with the dollar index trending up to 80.6 and gold falling a few bucks, to $918 an ounce.
“The insane suggestion that we need more government stimulus,” writes a reader, “is similar to someone asking for more paper because the initial bonfire isn’t big enough to burn America to the ground fast enough. That’s the first insanity, but there’s more.

“Instead of cutting taxes on small businesses, where 90% of most profit-producing (hint: nongovernment) jobs are created, the feds plan on imposing a federal health care program that will cripple business’s ability to keep or add jobs. But that’s still not enough.

“There’s one more insanity to go: cap and tax. Here the perfect triple storm of economic disaster becomes complete. The feds will now add unnecessary energy taxes that will resonate throughout the economy, driving prices higher, profits lower and people out of work and ushering an era of perpetual penury for the vanishing middle and systemic lower classes. All this from the wiser and smarter-than-the-rest-of-us people in Washington, D.C., who started the dismantling of the greatest economic engine in history by deciding to get into the mortgage business and awarding homes to people who couldn’t afford them.

“I continue to reread the Declaration of Independence and see history repeating itself once again. Government tyranny is destroying our nation, and if we do not throw it off, it will crush us.”
“What if Barney Frank were Californian?” asks another reader, in reference to Moody’s recent downgrade of California’s credit rating.

“I haven’t seen it yet, but I imagine we will soon see politicians vilifying those Fitch rapscallions for self-serving, anti-American greed, arbitrarily lumping them into the same group with those evil capitalist ’speculators.’

“It wouldn’t be funny, but we’d still laugh and laugh.”

The 5: It would be humorous if the ratings agencies finally tasted some congressional wrath — not for their totally illogical/unethical ratings for financials over the last three years, but for their legitimate downgrades of U.S. municipalities. But you’re right… it wouldn’t be “funny ha-ha.” More like “laugh ’cause it’s easier than crying.”

Source: Audit the Fed, China’s New No. 1, Short Canada? and More!

The latest Federal Reserve survey of senior loan officers finds very few shoots of green in that garden. According to the survey, “A significant majority of banks reported that credit quality for all types of loans is likely to deteriorate over the year.” And this assumes the economy won’t get any worse than it already is now! Here are some specifics (hat tip, Real Time Economics)

Commercial and industrial loans: Of 52 banks responding, none said they expect improving quality, but seven said they expect delinquencies and charge offs to stabilize at current levels.

Commercial real-estate loans: Only 1 of 51 banks (the other doesn’t make such loans) sees improving quality, and three see quality stabilizing at current levels. Of the 47 who see a worsening picture, 13 expected a substantial deterioration in 2009.

Prime residential mortgages: Only 1 of 50 banks sees improving quality, and seven see quality stabilizing at current levels.

Subprime mortgages: No bank sees improving quality, and only two see quality stabilizing at current levels.

Home equity lines: No bank sees improving quality, though nine expect quality to stabilize around current levels.

Credit card loans: None of the 31 banks who make such loans expects improvement, and three expect stabilization.

Other consumer loans: Only one of 50 banks expects improvement, though 12 see loan quality stabilizing around current levels.

Investors who have studied the global trade figures lately are no doubt also aware that East Asian countries are in an entirely separate mess since their exports have dropped 30%-40% – or even more – in the past few months, because U.S. and European consumers have stopped buying their manufactured goods.

However, there is a third global disaster, equally intractable, in Eastern Europe – and it has nothing to do with the housing bubbles, falling exports, or the massive layoffs that are becoming problems everywhere. This third global disaster is being caused by a regional balance of payments problem and a localized currency crisis.

Internationally, that disaster is this week’s worry.

As the Eastern European countries closed in on membership in the European Union (EU) after 2001, preparatory to entering it in 2004 or 2007, they kept their currencies as stable as possible against the euro. At the same time, the economies of these countries were growing rapidly, so Western banks bought local operations and expanded their lending.

Local consumers heard from their governments that their currencies were now stable against the euro and noticed that local currency interest rates were much higher than euro, dollar or Swiss francs. Naturally, they borrowed from local banks in euro, dollars or Swiss francs.

This would all have turned out fine if the local currencies had indeed been stable against the euro (borrowers in dollars would have made out like bandits until last summer, and lost since, as the dollar reversed course and strengthened). However, in addition to foreign currency consumer loans, foreign investment of all kinds flooded into these countries; after all, they were EU members – or would soon become so – and yet they were growing much faster than Western Europe.

With all this money coming in, local wage rates and other costs rose. As a result, many Eastern European countries ran huge balance-of-payments deficits: For Latvia and Bulgaria, for example, the deficits were more than 20% of each country’s gross domestic product (GDP).

This all didn’t seem to matter too much at a time when world trade was robust and lending flowed freely (although those of us familiar with periodic Latin American catastrophes sucked through our teeth in a suitably concerned manner – we had seen it all before).

Since last September, however, world lending has stopped flowing freely – as has world trade. European, U.S. and Asian companies that had been madly keen to invest in Eastern Europe put their expansion plans on hold, as they discovered they had big problems of their own at home. Naturally, the Eastern European currencies started to decline.

This brought a horrible problem for the local banks, most of them owned by Western European banks. If they lent to local borrowers in euro, Swiss francs or dollars, their borrowers are suddenly in trouble.

For example, the Polish zloty has dropped by about a third against the euro in the last six months. Even without any decline in local real estate prices, an apartment in Warsaw is thus worth 33% less in euros, so the euro loan against it has suddenly become subprime. What’s more, the salary of the borrower has also dropped 33% in euro terms, so his ability to service the loan has declined correspondingly.

Conversely, if the foreign-owned banks lent primarily in local currencies, they internalized the problem if they borrowed in euros from their parent to do so; in that case, the bank is directly insolvent or close to it, rather than merely having a bunch of defaulting borrowers on its books.

The solution everybody is looking at is a bailout, and it will again have to be a big one. World Bank President Robert B. Zoellick is putting together a $25 billion trade facility, but he wants the EU to help with more money. Austria has tried to put together a $200 billion loan for Eastern Europe – not unreasonably, as Austrian banks have about $300 billion in loans outstanding to that area – equal to about 70% of Austria’s GDP.

Total Eastern European debt is reckoned to be around $1.7 trillion, with about $400 billion of it maturing this year.

With the EU, Austria and Eastern Europe all looking for money, the eyes of the region automatically turn to Germany. Germany has an almost balanced budget, and the German finance minister called British stimulation policies “crass Keynesianism” as recently as December. If it weren’t for Eastern Europe, Germany would be in pretty good shape. However, with 10 Eastern European countries among the 27 EU members, Germany’s finance minister better be concerned about getting his pocket picked.

My own guess is, the less the EU and the unfortunate Germans are forced to subsidize their neighbors, the quicker the problem will sort itself out, albeit at the cost of a lot of defaults on Polish home mortgages. In a world where all major countries are providing “stimulus” and bailouts for everything, the ultimate winner will be the country that bails out the least.

Bottom line? You might look at Brazil …

Source: Eastern Europe’s Banks are Next in Line for a Bailout

In a recent interview with Bloomberg Television, Mobius said there are “terrific bargains all over the place” and his biggest holdings are in Asia, adding that he is “aggressively” purchasing Chinese stocks.

Emerging market stocks have nosedived this year at a much faster pace than indices from larger, more affluent economies. So far this year, The MSCI Emerging Markets Index, a benchmark for equities in 24 developing nations, has fallen 53% – driven mainly by falling commodity prices and a freeze in credit globally.

Russia’s stocks were slugged the hardest; its equities have dived 72% this year. India’s stocks have fallen 65% this year. Brazil and China stocks are down 56% and 52%, respectively, this year, MarketWatch reported.

“We’re beginning to see this bottoming situation,” said Mobius, who oversees about $26 billion in emerging-market stocks as executive chairman of Templeton Asset Management Ltd. “I sincerely believe that next year we’re going to be beginning the next bull phase. The amount of money going into the system has to find a home.”

He’s got a point. The BRIC economies – Brazil, Russia, India and China – each unveiled stimulus plans aimed to spur domestic consumption and boost GNPs.

• Brazil’s government called for $3.6 billion in tax cuts on personal income, consumer loans and automobiles.

• In November, Russia Prime Minister and former President Vladimir Putin unveiled a $20 billion stimulus, which included a cut in profit tax.

• India’s government said in early December it would spend $4 billion more from December to March 2009 than previously planned.

• China’s $586 billion economic stimulus plan is one for the record books. The infrastructure overhaul will pump boatloads of money into low-income housing, water and energy projects, airports, disaster relief and new railroads over the next two years.

And those stimulus plans are on top of several interest rate cuts from each BRIC economy.

“What you are going to see is a reversion to emerging markets first because those markets are the cheapest” and the economies are growing faster, Mobius told Bloomberg. “There’s no reason why, going forward, they shouldn’t be the first ones to get the attention of investors.”

Source: Emerging Markets – Especially BRIC Economies – “Bottoming”

According to a November report by the Federal Reserve, nearly 60% of banks severely tightened their lending standards on credit card loans and 65% on other consumer loans in the last three months. As unemployment and delinquency rates go up and lenders are trying to minimize their risk, the average American all of a sudden finds himself cash strapped… this at a time when home equity has dried up, 401(k)s and IRAs are losing value by the day, and many common stocks are barely worth the paper they’re printed on.

“We’ve been hearing about the liquidity crisis affecting banks for quite a while,” Joe Ridout, spokesman for the advocacy group Consumer Action, told the Washington Post. “Now we’re seeing it transform into a crisis affecting people’s personal finances as well. The next wave of the financial crisis may well be a credit-card-related crisis.”

Credit card companies are indeed clamping down hard on customers. Many Americans may have noticed that while their mailbox used to burst with junk mail of the “You’re Pre-Approved!” sort, these days the influx has slowed down to a dribble. That’s no coincidence – credit card direct mail offers in the third quarter of 2008 have seen a 28% drop year-over year as Visa, AmEx & Co. are struggling to cope with a tidal wave of defaults.

Moody’s Investors Service reported that charge-off rates rose 48% in August compared to the same month last year, the 20th consecutive year-over-year increase. This number is expected to go even higher in 2009, potentially exceeding the charge-off rates during past recessions.

Thus, credit card members are increasingly coming under scrutiny – and not just those in the subprime category. Customers with a credit score of 700, who were deemed “most creditworthy” just a year ago are not anymore. According to cardratings.com, 730 is the new 700.

The palette of “risk factors” has also broadened. Aside from late bill and mortgage payments, now location, profession, and even shopping behavior are considered. If you live in a high-foreclosure area, work in the real estate, auto, or construction business, and buy your household necessities at Wal-Mart, you’re likely on the target list.

One of the measures credit card issuers have devised to reduce risk is slashing credit limits in half. 60% of banks lowered the credit ceiling for existing nonprime and 20% for prime customers. And, as a testament that the intended “trickle-down effect” of the Fed’s massive rate cuts didn’t work at all, many companies have kept their interest rates at the same level or even raised them by two or three percentage points. Late fees, too, have been increased.

This tightening of credit translates directly to people’s shopping habits. While Black Friday weekend brought an overall growth of 0.9% in sales from last year, retail sales data show that that wasn’t enough to save the month of November. The MasterCard SpendingPulse reading noted that electronics and appliance sales dropped by 25% in November, luxury goods by 24%, and sales at clothing and department stores by 20%. Foot traffic decreased by 19% from 2007, meaning shoppers visited fewer stores.

C. Britt Beemer, CEO and founder of America’s Research Group, who has correctly predicted percentage changes in Christmas retail sales for 16 of the last 17 years, published his first negative forecast (of -1%) in 23 years, calling the 2008 Christmas shopping season a “perfect storm” for retailers.

Even as the average American is battening down the hatches and reining in consumption, the Federal Reserve seems to be going the opposite way, judging from the $700 billion bailout package that has – literally within weeks – ballooned into an estimated $8.5 trillion colossus. But despite throwing fistfuls of money at the problem, says Bud Conrad, Casey Research chief economist and editor of The Casey Report, “all the king’s horses and all the king’s men haven’t been able to put Humpty back together again.”

We don’t know whether the Humpty Dumpty economy can be saved… what we do know, though, is that every crisis holds danger and opportunity. By making the trend your friend instead of swimming against the stream, you can preserve your assets and profit handsomely, especially in highly volatile environments like the one we are seeing now. To learn more about how to generate double- and triple-digit returns in a crisis, click here.

Source: The Credit Crunch, Close Up and Personal

The buck declined despite some upbeat news from the Institute for Supply Management. The ISM said nonmanufacturing sectors of the U.S. economy expanded during April after three months of contraction. Its services index rose to 52.0% from 49.6% in March. That handily beat economists’ projections for a decline to 49.4%.

Analysts believe traders were locking in their gains from last week’s rally, which was based on signals from the Federal Reserve that it is near the end of its interest-rate cuts. The dollar index, which charts the greenback against a basket of currencies, rose 2.5% last week.

Currency strategists at Brown Brothers Harriman are of the opinion that the “pieces of the puzzle we believe will contribute to a U.S. dollar uptrend this year are beginning to fall into place, but more pieces are needed for a more significant U.S. dollar rally.”

But the good feelings were diluted considerably by a report from the Federal Reserve on the credit crunch, which continues.

More than half of the banks surveyed by the Fed said they had tightened commercial and industrial loans, commercial real estate loans, residential mortgages, and home-equity lines of credit. Almost no banks eased credit terms for any type of loan, the Fed said in its quarterly senior loan officer survey.

“The significant tightening of standards for consumer loans is probably the ugliest news of this report,” wrote Harm Bandholz, of UniCredit Markets. “Investment will continue to shrink, while private consumption growth will come to a halt or even turn negative” in the second quarter.

Wachovia Corp. (WB:NYSE), one of the largest banks in America, reported a large “unexpected loss” recently. And the main problem? Bad California home loans.

I hope they were joking when they used the word “unexpected.” Unless you’ve been living under a rock, you know that the housing earthquake is still sending out pockets of seismic activity.

As Soon As Possible

Like a post-modern movie plot, America’s economic big picture is deeper and darker than most realize. It’s only going to get worse.

The IMF (International Monetary Fund) thinks the credit crisis could cost up to $1 trillion. Banks have already written down nearly $250 billion in assets to date.

The IMF bluntly cautions banks to keep taking write-downs “as soon as reasonable estimates of their size can be established.”

In other words: Nip it in the bud ASAP.

The Consumer’s Movie Role

The bank write-downs include lots of consumer debt gone bad. You can blame the banks for giving out frivolous loans, or you can blame individuals for biting off more than they can chew. But regardless of who’s to blame, the American Bankers Association reports that the bad consumer debt problem is the worst it’s been since 1992.

Overdue bank-card accounts have increased 20 basis points to 4.38% in the recent quarter. Late payments for car loans (which count for two-thirds of fixed balance consumer loans) are on the top of the list. And exposed firms, like American Express Company (AXP:NYSE) and Capital One Financial Corp. (COF:NYSE), have doubled their cash reserves for bad debt.

Paying credit card bills is taking a back seat to necessities like gas and food and heat. While wages have increased 3.6%, prices have jumped more than 4% over the past year.

Unemployment isn’t helping, either. In March, 80,000 jobs were cut, continuing a trend of consecutive job losses.

According to Merrill Lynch, U.S. families now spend more on debt service than they spend on food (even as food is getting more expensive).

Unemployment, credit crunch, housing crisis, inflation, high gas prices… These all lead to one dirty little word: recession. The evidence is hard to dispute.

Resisting Temptation

Consumers are now faced with the challenge of saving as much as possible and spending more frugally. As a result, they are visiting thrift and discount stores more often, and generally looking for ways to cut back.

Starbucks, for example, is aware that people won’t keep paying $4 for a specialty cup of joe. Instead they are switching to lower cost competitors like McDonald’s and Dunkin Donuts. So Starbucks is focusing on making its regular brew better, and has even talked about bringing out a $1 cup of coffee to compete.

Meanwhile, discount store Family Dollar (FDO:NYSE) is “adjusting to its shoppers’ greater reliance on basics during an economic downturn” by focusing on foodstuffs and getting rid of some of its fashion merchandise.

The bottom line is, monetary constraint is here to stay, at least for a while… including resisting the temptation to make frivolous purchases.

Building a Recession-Proof Portfolio

At Diligent Investor, we’re well aware of the perils of the current market. Many investors’ hopes have been dashed. And some even think it might be worth just pulling out all their money and waiting.

In our opinion, the downturn is far from over. All these factors are affecting the market. The credit crunch and the dollar crisis have yet to reach their apex.

At Diligent, our top strategy is to build a recession-proof portfolio — one full of companies that have solutions to the country’s economic woes. For instance, last month we looked at a low-priced discount retailer that made it through the last recession with triple-digit gains, even as the rest of the market tanked.

Holding a position in a rainy-day retailer is one way we’re combating the credit and cash flow crunch. Now I’d like to tell you about another…

From Consumers to Banks

Individual credit defaults add up to countless billions. If consumers can’t pay back the loans, the banks lose money. So who is going to help the banks?

When banks announce write-downs, they are admitting they don’t plan on receiving any payment for the loans gone bad. Banks are shrugging their shoulders, claiming the losses on taxes and getting them out of sight.

So where do all those writed-owns go? What happens to all that bad debt?

A big chunk of it goes straight into the hands of a company I’ve profiled in the latest Diligent Investor issue.

This company is a sort of life preserver for the banks. The company buys debt portfolios at a serious discount — often pennies on the dollar — to take them off the banks’ hands. Then they use an elite force of call centers to try to collect full or partial payments on the debts over the course of seven years. The company often earns up to three times what it paid for the defaulted debt. (Not a bad rate of return.)

Saving the Banks’ Hides

With this recommendation, we’re giving credit where credit is truly due: to a company that will safely and quietly absorb the banks’ big problems, and profit nicely while doing so.

This debt company is an integral building block for a recession-proof portfolio… and will end up a very good long-term investment. It will carve more and more profits from more and more bad debt over time.

I just released this new recommendation to Diligent Investor subscribers. So if you choose to join us now, you’ll be on the road to having your own recession-proof portfolio with this rock-solid debt solutions company.