It’s true; gold has become noticeably less unpopular during the last few months. It is still not as popular an investment as, say, AIG or the shares of almost any other incompetent financial institution. But some investors have actually begun to admit that they’ve purchased some gold.

A couple of the most conspicuous gold-buyers – the Chinese government and hedge fund manager, John Paulson – represent quintessential examples of the “new” gold buyer. This new type of buyer does not also buy ammunition, bottled water and Lynyrd Skynyrd tank tops. Nor does this new gold buyer spend Saturday nights sipping Gallo Hearty Burgundy in his La-Z-Boy, while flipping through binders full of Walking Liberty gold coins.

These new gold buyers do not LOVE gold nearly as much as they FEAR paper. But they are buying aggressively nonetheless…and leaving their tracks everywhere.

Earlier this year, for example, Paulson & Co., the hedge-fund firm run by billionaire John Paulson, became the largest holder of the SPDR Gold Trust (NYSE: GLD), an ETF that buys gold bullion. The New York-based firm owned 8.7 percent of the fund, as of March 31. Paulson has also taken very large stakes in several gold mining companies – in particular Gold Fields Ltd. (NYSE:GFI), Kinross Gold Corp. (NYSE:KGC) and AngloGold Ashanti Ltd. (NYSE:AU)

Paulson has lots of company among mom and pop investors who are allocating some of their capital to gold. As the nearby chart illustrates quite clearly, the SPDR Gold Trust ETF has been accumulating ever-rising quantities of gold bullion – all in response to investor demand.

Although this chart is a bit dated, the trend it illustrates remains firmly entrenched. As of September 21, this ETF controlled 1,563 tonnes of gold, making it the world’s fifth individual holder of gold. The Swiss central bank, by comparison, holds only a little more than 1,000 tonnes of gold.

Meanwhile, the Chinese doubled their official gold holdings last year, and have been making a lot of headlines with some very public gripes about the dollar. A couple weeks ago, Cheng Siwei, former vice chairman of the Standing Committee of the Chinese Communist Party, complained, “If [the Fed] keeps printing money to buy bonds, it will lead to inflation, and after a year or two, the dollar will fall hard. Most of our [Chinese] foreign reserves are in U.S. bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen and other currencies…Gold is definitely an alternative.”

No wonder rumors were running rampant last week that the 403 tonnes of gold the IMF is selling will land in a Chinese vault.

Interestingly, while investment demand for gold inexorably rises, mined production of gold inexorably declines. Apparently, the folks who coax this precious metal from the earth can’t coax as much of it as they might like.

According to Grant’s Interest Rate Observer (citing statistics from the World Gold Council), worldwide gold production has dipped over the last seven years. Gold production since 2002 has declined from 2,590 metric tons to 2,486 metric tons through June 30.

These divergent trends – demand up and supply down – do not guarantee a rising gold price, but they do suggest that a rising gold price may become the path of least resistance.

Obviously, substantial above-ground supplies of gold – in bank vaults, around fingers, in belly buttons, etc. – will find its way into the gold market if/as/when prices rise. Nevertheless, a powerful inflationary trend would produce enough investment demand for gold to easily absorb all sources of supply…and ALSO push the gold price higher.

“There is a growing distrust of paper currencies amid a deluge of massive government deficits since late 2008,” Roseman concludes. “The dollar might be the biggest drunk at the bar, but the euro and other currencies are also drinking their way to devaluation against gold.”

Source: The New Gold Buyer

It’s true; gold has become noticeably less unpopular during the last few months. It is still not as popular an investment as, say, AIG or the shares of almost any other incompetent financial institution. But some investors have actually begun to admit that they’ve purchased some gold.

A couple of the most conspicuous gold-buyers – the Chinese government and hedge fund manager, John Paulson – represent quintessential examples of the “new” gold buyer. This new type of buyer does not also buy ammunition, bottled water and Lynyrd Skynyrd tank tops. Nor does this new gold buyer spend Saturday nights sipping Gallo Hearty Burgundy in his La-Z-Boy, while flipping through binders full of Walking Liberty gold coins.

These new gold buyers do not LOVE gold nearly as much as they FEAR paper. But they are buying aggressively nonetheless…and leaving their tracks everywhere.

Earlier this year, for example, Paulson & Co., the hedge-fund firm run by billionaire John Paulson, became the largest holder of the SPDR Gold Trust (NYSE: GLD), an ETF that buys gold bullion. The New York-based firm owned 8.7 percent of the fund, as of March 31. Paulson has also taken very large stakes in several gold mining companies – in particular Gold Fields Ltd. (NYSE:GFI), Kinross Gold Corp. (NYSE:KGC) and AngloGold Ashanti Ltd. (NYSE:AU)

Paulson has lots of company among mom and pop investors who are allocating some of their capital to gold. As the nearby chart illustrates quite clearly, the SPDR Gold Trust ETF has been accumulating ever-rising quantities of gold bullion – all in response to investor demand.

Although this chart is a bit dated, the trend it illustrates remains firmly entrenched. As of September 21, this ETF controlled 1,563 tonnes of gold, making it the world’s fifth individual holder of gold. The Swiss central bank, by comparison, holds only a little more than 1,000 tonnes of gold.

Meanwhile, the Chinese doubled their official gold holdings last year, and have been making a lot of headlines with some very public gripes about the dollar. A couple weeks ago, Cheng Siwei, former vice chairman of the Standing Committee of the Chinese Communist Party, complained, “If [the Fed] keeps printing money to buy bonds, it will lead to inflation, and after a year or two, the dollar will fall hard. Most of our [Chinese] foreign reserves are in U.S. bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen and other currencies…Gold is definitely an alternative.”

No wonder rumors were running rampant last week that the 403 tonnes of gold the IMF is selling will land in a Chinese vault.

Interestingly, while investment demand for gold inexorably rises, mined production of gold inexorably declines. Apparently, the folks who coax this precious metal from the earth can’t coax as much of it as they might like.

According to Grant’s Interest Rate Observer (citing statistics from the World Gold Council), worldwide gold production has dipped over the last seven years. Gold production since 2002 has declined from 2,590 metric tons to 2,486 metric tons through June 30.

These divergent trends – demand up and supply down – do not guarantee a rising gold price, but they do suggest that a rising gold price may become the path of least resistance.

Obviously, substantial above-ground supplies of gold – in bank vaults, around fingers, in belly buttons, etc. – will find its way into the gold market if/as/when prices rise. Nevertheless, a powerful inflationary trend would produce enough investment demand for gold to easily absorb all sources of supply…and ALSO push the gold price higher.

“There is a growing distrust of paper currencies amid a deluge of massive government deficits since late 2008,” Roseman concludes. “The dollar might be the biggest drunk at the bar, but the euro and other currencies are also drinking their way to devaluation against gold.”

Source: The New Gold Buyer

But the trading day was not all about mere rumors. It was also about hearsay, hype and giddy optimism…

Meredith Whitney, “The Woman Who Called Wall Street’s Meltdown,” according to the Fortune Magazine cover of August 18, 2008, upgraded the shares of Goldman Sachs to a “Buy,” and predicted the stock would rise 30% from current levels. “Goldman has all the benefits of the capital markets in general,” said Whitney, “Without the ‘junk in the trunk’ as I like to call it.” Goldman shares jumped 5.3%.

Based on Whitney’s upgrade, and the subsequent market action, gullible investors could have deduced that the credit crisis has ended. The rest of us could have deduced that the credit crisis took a day off.

Lost in the celebration of Whitney’s upgrade was a smattering of bad news “below the fold.” For starters, Whitney did NOT upgrade any of the other seven banks she analyses. To the contrary, Whitney damned the other seven banks – and the economy in general – with her faint praise for Goldman.

“Our more bullish outlook on Goldman Sachs shares is deeply rooted in our sustained bearish stance on the U.S. economy and the state of U.S. financials at large,” said the influential analyst. “Specifically, we expect a tsunami of debt issuance from federal/sovereign, state, and local governments to fund woefully underfunded budget gaps. In addition, we expect corporate debt issuance to be at least 60% as strong as peak cycle levels, reflecting sizable debt maturity rolls. What’s more, given fewer players in the market, not only is GS benefiting from market share gains on these products but more widely in the derivatives products.

“To be clear, our reasons for liking GS stock today are drastically different from any we have had recommending the stock on and off over the past decade. In the past, GS shares were a great play on equity markets and expansive global gross domestic product. While that may still hold true down the line, our thesis today is that we expect GS to be the key competitor in some of the most unpredictable markets: government, corporate, and municipal debt.”

As if on cue, the U.S. Treasury disclosed yesterday that the U.S. federal deficit has already topped $1 trillion for 2009…and the year is barely half over! Sure, that might seem like bad news. But it’s actually GOOD news…for Goldman Sachs. More debts mean more Treasury bonds, which mean more trading profits for Treasury bond dealers like Goldman.

Whitney, who probably possesses more intellectual honesty than most equity analysts, probably possesses legitimate reasons to fancy the shares of Goldman. But a relatively promising outlook of one company is hardly a reason for investors to chase after all the other stocks in the market.

We would be surprised to discover any correlation whatsoever between the fortunes of Goldman Sachs and the fortunes of a bakery in Des Moines or a florist in Fargo. On the other hand, we have no trouble whatsoever imagining that Goldman might flourish while bakeries and florists are going out of business from coast to coast.

The only essential point here is that Goldman, circa 2009, is hardly General Motors, circa 1954. What happens in Goldman stays in Goldman. This company is not a bellwether for the economy at large.

“We’d suggest that whatever Goldman did to goose earnings is probably not going to be possible for the rest of corporate America,” observes Dan Denning, our insightful colleague at the Australian Daily Reckoning. Furthermore, Denning points out, most other American financial institutions are continuing to play “hide the bad asset.”

“A New York Times story from yesterday,” Denning remarks, “suggests that government capital injections and loan guarantees, along with new equity offerings, have allowed banks to evade the inevitable consequences of the popped credit bubble.

“‘The capital provided by the government through TARP, etc. has allowed the banks to continue holding deteriorated assets at values far in excess of their true market value,’ says Daniel Alpert of Westwood Capital in a note to clients, according to the Times. ‘It is unrealistic to believe that home or commercial real estate values are destined to recover any meaningful portion of bubble-era pricing.’

“This means all the new equity raised by banks after the stress-tests has merely papered over capital adequacy and solvency issues for now,” Denning continues. “The banks have simply refused to revalue loans on their books and continue to carry them at unrealistically high valuations. If they sold them, they’d got a lot less for them, forcing them to raise more capital (or wiping out their capital and revealing them to be insolvent)…

“The default and foreclosure data coming out of the U.S. housing market suggest the banks are kidding themselves, or misleading shareholders, or both!” says Denning. “It’s the sort of calculated mis-truth that can cause a short-term crisis to last years and years. The correction is postponed through phony accounting. It leads to an ‘Ushinwareta Junene,’ or ‘lost decade,’ as the Japanese say.”

While Goldman is busy kicking butt, everyone else is busy kicking the can down the road – hoping that if they keep kicking the can long and far enough, the crisis will end without further incident.

In a CNBC interview last week, Bryan Marsal, CEO of Lehman Brothers Holdings, remarked, “One of my partners said yesterday that we are going to call this phase the ‘extend and pretend’ phase in our economy. Which is you extend someone’s maturity – because they are going to default – and you pretend that business will come back…Then we’ll enter phase two, which he said is the request to extend or ‘amend.’ Then ‘send.’ In other words, send the keys.

“Those are the phases we are in right now.” Marsal concluded. “Everyone is trying to buy time, as opposed to dealing with the leverage, they are trying to buy time. Whether you are a banker or a company, they are all trying to buy time.”

Maybe all of this can-kicking will produce the desired outcome. But the more likely scenario is that the U.S. government will continue to throw newly printed dollars bills at the problem until eventually something that looks like a lot like a recovery will appear. Shortly thereafter, the recovery will yield to something that looks a lot like debilitating hyperinflation.

Source:  Gold…if Not Now, When?

The details of the repayments were as follows:

• Morgan Stanley (NYSE:MS) repaid $10 billion

• Goldman Sachs (NYSE:GS) – $10 billion

• BB&T (NYSE:BBT) – $3.1 billion

• US Bancorp (NYSE:USB) – $6.6 billion

• Bank of New York Mellon (NYSE:BK) – $3 billion

• Capital One (NYSE:COF) – $3.57 billion

• American Express (NYSE:AXP) – $3.39 billion.

Lost in the euphoric brouhaha over the TARP repayments was the dispiriting news that Standard & Poor’s had downgraded the credit ratings of 18 large American banks, including one of the seven that repaid its TARP loan!

Incredibly, the US Treasury deemed Capital One sufficiently healthy to repay its $3.57 billion loan while, at the very same moment, Standard & Poor’s downgraded the credit card firm to BBB – just two notches above “junk.” Standard & Poor’s also characterized the credit outlook for Capital One as “negative.”

We would not place much faith in the analyses of either the Treasury Department or Standard & Poor’s. But we are nevertheless fascinated by their conflicting conclusions. Maybe they’re both right. Maybe Capital One is in fine shape today, as the Treasury Department’s stress test implies. But maybe the credit card company will be in miserable shape tomorrow, as Standard & Poor’s downgrade implies.

As investors, we see these conflicting assessments of Capital One as a metaphor for the entire American financial sector. This sector is a hodgepodge of conflicting opinions, data points and risk/reward assessments. Both sides of every trade in the financial sector can point to some sort of fundamental justification. The buyers see a sector on the mend; the sellers see a sector in the mire.

Your California editor is not smart enough to know which assessment is correct; but he is fearful enough to recognize a potential tar pit when he sees one. So he’s got no problem watching others wade into the water while he remains back on the bank…at least for now.

Curiously, bank stocks have gotten worse, ever since the government told us things are getting better. Most finance company stocks have been performing poorly, ever since the upbeat headlines about the “stress test” results first crossed the newswires. The BKX Index of bank stocks has tumbled nearly 19% since the close of trading on May 8, the first trading day after the Federal Reserve announced the “better than expected” results of its stress tests on America’s 19 largest financial institutions.

The TARP repayment announcements did not alter the downward trend of the BKX. Since June 9, when the Treasury Department disclosed which banks may repay their TARP loans, the BKX Index has dropped 5%.

Apparently, the finance company sector of the stock market has shifted into the “good news is no longer good news” phase. The BKX’s dazzling 135% rally between March 6 at May 8 may have adequately “priced in” all the good news that is likely to emerge for a while from the financial services industry.

Furthermore, the conspicuous recent weakness of the BKX Index is probably not good news for the overall stock market, since financial shares have been leading the market – both to the upside and the downside – during the last year and a half.

To cite just one example of this phenomenon, between February 1 and May 31 of 2008, the BKX slumped 21% while the S&P 500 actually advanced 1%. But during the ensuing month and a half, the S&P fell 13%. The BKX initiated a similar “bearish divergence” in early December last year, as it tumbled 35% between December 5 at February 6. The S&P 500 barely budged during this timeframe, but fell 20% over the next 30 days.

Obviously, the most recent decline of the BKX does not guarantee a subsequent decline in the S&P 500. But neither does it give us a warm, fuzzy feeling. So let’s call the weakness of the BKX a warning sign. Heed the warning, if you are so inclined.

Source: On the Mend or in the Mire?

“Are things getting worse or are things getting better?” we wondered aloud in yesterday’s edition of the Rude Awakening.

In today’s edition, we provide a few answers – well, not answers, really…just observations from you, the Rude readership. In the column below, we present a few real-world anecdotes from Rude Awakening readers. This narrow sampling of economic observations is hardly scientific, but it may be illuminating nonetheless.

Before we get into these real-world stories, let’s examine a couple of recent stories from Fantasyland – otherwise known as Wall Street. Seven of America’s largest banks repaid their TARP borrowings to the US Treasury yesterday, in the process providing one more occasion for hopeful investors to proclaim the end of the credit crisis. The details of the repayments were as follows:

• Morgan Stanley repaid $10 billion

• Goldman Sachs – $10 billion

• BB&T – $3.1 billion

• US Bancorp – $6.6 billion

• Bank of New York Mellon – $3 billion

• Capital One – $3.57 billion

• American Express – $3.39 billion.

Lost in the euphoric brouhaha over the TARP repayments was the dispiriting news that Standard & Poor’s had downgraded the credit ratings of 18 large American banks, including one of the seven that repaid its TARP loan!

Incredibly, the US Treasury deemed Capital One sufficiently healthy to repay its $3.57 billion loan while, at the very same moment, Standard & Poor’s downgraded the credit card firm to BBB – just two notches above “junk.” Standard & Poor’s also characterized the credit outlook for Capital One as “negative.”

We would not place much faith in the analyses of either the Treasury Department or Standard & Poor’s. But we are nevertheless fascinated by their conflicting conclusions. Maybe they’re both right. Maybe Capital One is in fine shape today, as the Treasury Department’s stress test implies. But maybe the credit card company will be in miserable shape tomorrow, as Standard & Poor’s downgrade implies.

As investors, we see these conflicting assessments of Capital One as a metaphor for the entire American financial sector. This sector is a hodgepodge of conflicting opinions, data points and risk/reward assessments. Both sides of every trade in the financial sector can point to some sort of fundamental justification. The buyers see a sector on the mend; the sellers see a sector in the mire.

Your California editor is not smart enough to know which assessment is correct; but he is fearful enough to recognize a potential tar pit when he sees one. So he’s got no problem watching others wade into the water while he remains back on the bank…at least for now.

Curiously, bank stocks have gotten worse, ever since the government told us things are getting better. Most finance company stocks have been performing poorly, ever since the upbeat headlines about the “stress test” results first crossed the newswires. The BKX Index of bank stocks has tumbled nearly 19% since the close of trading on May 8, the first trading day after the Federal Reserve announced the “better than expected” results of its stress tests on America’s 19 largest financial institutions.

The TARP repayment announcements did not alter the downward trend of the BKX. Since June 9, when the Treasury Department disclosed which banks may repay their TARP loans, the BKX Index has dropped 5%.

Apparently, the finance company sector of the stock market has shifted into the “good news is no longer good news” phase. The BKX’s dazzling 135% rally between March 6 at May 8 may have adequately “priced in” all the good news that is likely to emerge for a while from the financial services industry.

Furthermore, the conspicuous recent weakness of the BKX Index is probably not good news for the overall stock market, since financial shares have been leading the market – both to the upside and the downside – during the last year and a half.

To cite just one example of this phenomenon, between February 1 and May 31 of 2008, the BKX slumped 21% while the S&P 500 actually advanced 1%. But during the ensuing month and a half, the S&P fell 13%. The BKX initiated a similar “bearish divergence” in early December last year, as it tumbled 35% between December 5 at February 6. The S&P 500 barely budged during this timeframe, but fell 20% over the next 30 days.

Obviously, the most recent decline of the BKX does not guarantee a subsequent decline in the S&P 500. But neither does it give us a warm, fuzzy feeling. So let’s call the weakness of the BKX a warning sign. Heed the warning, if you are so inclined.

From Michigan, a reader reports:

Traveling thru some western and southern suburbs of Detroit for the first time since my cessation of employment at Chrysler showed some disturbing sights. Four of my old suppliers’ factories were either demolished completely, or in the final stages of demolition. This means the roughly 3-4,000 jobs won’t be returning at all.

The only “construction” I have seen in three years was a McDonalds restaurant, coincidently on the same trip. There you have it, four demolished factories that used to provide living wages, offset by a fast food place that provides minimum wage jobs earned by the sale of dollar meals.

PS. My relatives told me the McDonalds ran an ad for employment at that restaurant. Well over 2,000 desperate people showed hoping for a minimum wage job.

From Georgia, a reader reports:

Based on [what] I observe in my community – business either down or way down – and the information I hear from family, friends and acquaintances – major job losses – the green shoots bandied about in the press are not green shoots. They are really mushrooms growing on what is left of a rotting economy.

From Alabama, a reader reports:

Hi Y’all (haha), Houses are for sale and in foreclosure everywhere. My daughter, who is a student delivers newspapers in the summer, said that there are 54 homes vacant and for sale on her route.

The company I work for gave us a 5% pay cut 4 months ago, then 2 months ago they gave all full-time employees 2 weeks unpaid furlough, 2 days ago we were again advised that starting on the 29th of June we will be getting another 5% pay cut. A lot of hourly employees have been laid off and the salaried employees like myself are doing double duty. Half the people I know are unemployed and my teenage sons cannot find a summer job. My husband is a flooring installer and is contracted to the largest carpet store in the area. He has been there 12 years so he gets priority on work, which is 3 to 4 days a week and much smaller jobs than 2 years ago. His pay is about 1/3 of 2 years ago.

There are empty commercial buildings everywhere.

As for credit, I had several cards most did not have a balance, I was advised on 2 of them that they were being closed due to inactivity, on 2 that had balances I was advised that due to the economic situation that my interest rates were being raised. And one that had a very large credit limit but a small balance, changed by available credit to match the balance due, due to economic conditions.

From Texas, a reader reports:

Hello, I am a commercial property owner in a small town in East Texas. This property has been in my family for 50 years. I have been remodeling and building new retail space for the last 5 years. There is still additional bare land to develop, and currently, I am at 100% occupancy. “Mom and Pops” are my main tenants with 2-3 major corporations. I have held off from further development since last August to see what the new administration would do. I guess, I am one of the exceptions. Debt is low and the only reason I have any debt is due to a buy-out of a sibling and major renovation. I am cautiously optimistic. If other commercial market retailers get in trouble and reduce rental rates, it could adversely affect my position. The future of commercial real estate, according to your reports, looks dismal. I hope our area will be spared from the fallout, but anything is possible.

From Oregon, a reader reports:

Here in Portland Oregon, home of the second highest unemployment rate in the nation, jobs are scarce. Graduates are finding it hard to find jobs, even in “recession proof” areas like Healthcare. A year and half ago, an employer might receive 100 applicants for an open position, now he receives a thousand. Residential real estate is slow to sell, and most sellers are still in denial, not wanting to reduce their price. Not many for sale signs either, most are bravely waiting for the new recovery, sure to be just around the corner. Folks are still visiting the malls (less than usual, but still many) and carrying fewer bags. Scamps at the mall shut down just last weekend. The manager told me that they could not get the needed funding to continue operations. And one of the trendy cheap clothing stores also went out of business last month. Most others are still open, but offering big discounts. Lots of inventory in many of the higher end stores. Appears folks are going for the cheaper stuff. Starbucks is still busy, fancy drinks still in vogue.

From Nevada, a reader reports:

I’ll give you some “boots on the ground!”

Until yesterday, when I met with a bankruptcy attorney, I thought I could financially survive this debacle. But it doesn’t look like I can.

I live in Vegas, own a high rise condo at the Strip that is worth $125K less than the loans on it, am a 50% partner in an LLC that developed 4 fabulous warehouse buildings. Sold one a year ago but still have 3 warehouses for sale that have been sitting empty since built in January, ‘08, possess First Deeds of Trust with face value of about $500,000 that haven’t made any payments in over a year (just now starting to foreclose to get property that can’t be sold today) and are worth about 10-25 cents on the dollar (but have no idea when I will see it), have a $1M investment in a mezzanine loan on a high rise condo that is probably worth 30-40 cents on the investment dollar (but have no idea when I will see it), and of course I still have to pay my alimony, pay for my kids college and private high school education, not to mention my health insurance premiums (WHICH RECENTLY INCREASED 22% FROM LAST YEAR), auto insurance and every other daily expenditure to live. My retirement accounts are down 50% and my income from all sources has basically dried up (a few sales commissions and consulting jobs bring in some cash)…Bottom line is unless something happens quickly on the upside, I am in a bit of financial trouble.

The point is, there are probably tens of thousands, if not millions of people in the same overall trouble that I am in…and my story doesn’t make the headlines!!! Perhaps it will as my BK filings will ultimately be magnified by those thousands who soon will flood the system with such filings.

I know for a fact that there are no green shoots…everything is browning out! After talking to my bankers who are about to foreclose on my warehouses, from my attorneys who tell me I am not alone and some of the most successful and well known developers in town are in worse shape, and from my “friends” at Bank of America, who after 4 months of trying to get a loan modification so I can continue to live in my hi-rise condo told me “NO” twice, once from their internal “Loss Mitigation” division who said I don’t have enough income relative to my expenses to modify, and then from their “Obama Modification Plan” division because the bank had not sold my 2nd TD to FNMA, thus I don’t qualify, clearly the world I am living in is not improving.

I only wish the “spin machine” of Wall Street would turn into a “truth machine,” but I guess truth, integrity, transparency, etc. are not in our best interests!!!

Source: For Better or Worse

But this quintessentially laissez-faire perspective gains very little traction in modern-day America. In fact, it gains no traction whatsoever, except in a few fringey financial publications. Instead, America’s political elite conspires with the Wall Street bourgeoisie to lead the nation from the highest degree of affluence to the lowest barbarism.

The process begins innocently enough in the name of “crisis management,” as the political elite provides multi-trillion-dollar guarantees and bailouts to the Wall Street bourgeoisie. The proletariat embraces these bizarre, counterintuitive remedies because they genuinely believe these “remedies” contain curative powers. In other words, the proletariat believes that bureaucrats and politicians, following the self-serving recommendations of inept finance company executives, can deploy taxpayer dollars to the benefit of the masses.

Include us out.

The bureaucrats and politicians lack the requisite skills; the Wall Street bourgeoisie lack the requisite morality. Like a meeting between coyotes and butchers, nothing good could ever come from close interaction between Washington and Wall Street. If the butchers suggested converting all felines into meal, the coyotes would simply yelp and howl their approval.

Your editors here at the Rude Awakening would prefer that the coyotes and butchers not conspire with one another. No one benefits….other than the coyotes and the butchers.

But what’s the use of complaining. We try never to complain, merely to understand. We try to identify and anticipate the key influences that are operating upon the financial markets. Identifying the key influences is usually not that difficult. But determining the effect of these influences is often very difficult.

During the last several months, for example, investors have been greeting the daily barrage of bad economic news as GOOD news for the stock market. We are not exactly certain why this would be so, but we are familiar with the daily banter of various financial news media. Therefore, we have encountered, ad nausea, phrases like, “better than expected,” “green shoots of recovery,” and “credit markets improving.”

We have encountered these phrases, and we have thoroughly and completely rejected them. We do not believe these phrases contain a single atom of validity, nor a single molecule of data that will produce a profitable investment result. That said, we should point out to the newest readers of the Rude Awakening that your editors have been wrong before…and may be again.

But we won’t let that stop us. The stock market’s splendid rally during the last three months was a classic bear market rally. The S&P 500, the Dow Jones Industrials and the NASDAQ Composite all rallied more than 40%. But great big rallies like these are not rare during great big bear markets.

As we pointed out last week, Japan’s Nikkei 225 Index rallied more than 30% on ten different occasions during the last two decades. And yet, the Nikkei remains more than 50% below the all-time high it established in 1989.

Could a version of this sorry scenario unfold here United States? Sure. Why not?

The nearby charts place the recent rally on Wall Street in a “Japanese context.” The chart above compares the first 20 months of our current American bear market to the first 20 months of the Nikkei’s bear market. The chart below places this 20-month period in a 20-year context. If the American stock market were to have the misfortune of mimicking the Nikkei, the road ahead would be long and painful.

Your California editor is not predicting such a scenario. But neither does he believe that “Happy days are here again.” The road ahead – both for the economy and for the stock market – is likely to be long and painful. How long and how painful is anyone’s guess. Our guess would be: Not as bad as Japan’s experience, but much worse than most Americans currently expect.

The chart above may contain a helpful glimpse into the future we fear. Despite the fact that most investors believe the worst of the recession is behind us, the nation’s employment situation is far worse than anything we have endured during the last five recessions.

So you tell me, are things getting worse or are things getting better?

The only thing we know for certain is that government intervention increases by the day, Wall Street’s malevolent influence increases by the day, the pressure to raise taxes increases by the day, the nation’s monstrous indebtedness increases by the day, threats to the dollar’s vulnerabilituy increases by the day, and therefore the long-term viability of America’s legendary capitalistic dynamism DE- creases by the day.

Source: The US Recession Versus Japan’s Slump

But this quintessentially laissez-faire perspective gains very little traction in modern-day America. In fact, it gains no traction whatsoever, except in a few fringey financial publications. Instead, America’s political elite conspires with the Wall Street bourgeoisie to lead the nation from the highest degree of affluence to the lowest barbarism.

The process begins innocently enough in the name of “crisis management,” as the political elite provides multi-trillion-dollar guarantees and bailouts to the Wall Street bourgeoisie. The proletariat embraces these bizarre, counterintuitive remedies because they genuinely believe these “remedies” contain curative powers. In other words, the proletariat believes that bureaucrats and politicians, following the self-serving recommendations of inept finance company executives, can deploy taxpayer dollars to the benefit of the masses.

Include us out.

The bureaucrats and politicians lack the requisite skills; the Wall Street bourgeoisie lack the requisite morality. Like a meeting between coyotes and butchers, nothing good could ever come from close interaction between Washington and Wall Street. If the butchers suggested converting all felines into meal, the coyotes would simply yelp and howl their approval

Your editors here at the Rude Awakening would prefer that the coyotes and butchers not conspire with one another. No one benefits….other than the coyotes and the butchers.

But what’s the use of complaining. We try never to complain, merely to understand. We try to identify and anticipate the key influences that are operating upon the financial markets. Identifying the key influences is usually not that difficult. But determining the effect of these influences is often very difficult.

During the last several months, for example, investors have been greeting the daily barrage of bad economic news as GOOD news for the stock market. We are not exactly certain why this would be so, but we are familiar with the daily banter of various financial news media. Therefore, we have encountered, ad nausea, phrases like, “better than expected,” “green shoots of recovery,” and “credit markets improving.”

We have encountered these phrases, and we have thoroughly and completely rejected them. We do not believe these phrases contain a single atom of validity, nor a single molecule of data that will produce a profitable investment result. That said, we should point out to the newest readers of the Rude Awakening that your editors have been wrong before…and may be again.

But we won’t let that stop us. The stock market’s splendid rally during the last three months was a classic bear market rally. The S&P 500, the Dow Jones Industrials and the NASDAQ Composite all rallied more than 40%. But great big rallies like these are not rare during great big bear markets.

As we pointed out last week, Japan’s Nikkei 225 Index rallied more than 40% on ten different occasions during the last two decades. And yet, the Nikkei remains more than 50% below the all-time high it established in 1989.

Could a version of this sorry scenario unfold here United States? Sure. Why not?

The nearby charts place the recent rally on Wall Street in a “Japanese context.” The chart above compares the first 20 months of our current American bear market to the first 20 months of the Nikkei’s bear market. The chart below places this 20-month period in a 20-year context. If the American stock market were to have the misfortune of mimicking the Nikkei, the road ahead would be long and painful.

Your California editor is not predicting such a scenario. But neither does he believe that “Happy days are here again.” The road ahead – both for the economy and for the stock market – is likely to be long and painful. How long and how painful is anyone’s guess. Our guess would be: Not as bad as Japan’s experience, but much worse than most Americans currently expect.

The chart above may contain a helpful glimpse into the future we fear. Despite the fact that most investors believe the worst of the recession is behind us, the nation’s employment situation is far worse than anything we have endured during the last five recessions.

So you tell me, are things getting worse or are things getting better?

The only thing we know for certain is that government intervention increases by the day, Wall Street’s malevolent influence increases by the day, the pressure to raise taxes increases by the day, the nation’s monstrous indebtedness increases by the day, threats to the dollar’s vulnerabilituy increases by the day, and therefore the long-term viability of America’s legendary capitalistic dynamism DE-creases by the day.

This from Marc Farber:

When I consider that prosperity is created by “peace, easy taxes and a tolerable administration of justice,” I begin to fear that the U.S. and other Western governments are doing their very best to impoverish their countries.

A friend of mine, Michael Berry, whose missives I always read, could not have phrased this idea better than in “Importance of the Individual”, a recent report in which he quotes Milton Friedman in a 1979 interview by Phil Donohue.

Berry writes: “On February 11, 1979, Milton Friedman took two and a half minutes to explain the critical importance of the individual and choice in the free enterprise system to a doubting Phil Donohue…The individual’s freedom and ability to choose and take risks to create value are, of course, all-important life elements and a cornerstone of our country…

And yet, Berry continues, “Under the guise of saving the economy, there is a not so stealthy encroachment on the rights of the individual…This is not, ‘Change We Can Believe In.’ It is ‘change we must be wary of.’ Where is Milton Friedman when we really need him? Think carefully about the following interview which was conducted 30 years ago:

‘Phil Donohue: When you see around the globe the mal distribution of wealth, the desperate plight of millions of people in underdeveloped countries. When you see so few haves and so many have-nots. When you see the greed and the concentration of power. Did you ever have a moment of doubt about capitalism? And whether greed is a good idea to run on?

‘Milton Friedman: Well first of all tell me, is there some society you know that doesn’t run on greed? You think Russia doesn’t run on greed? You think China doesn’t run on greed? What is greed? Of course none of us are greedy. It’s only the other fella that’s greedy. The world runs on individuals pursuing their separate interests. The greatest achievements of civilization have not come from government bureaus. Einstein didn’t construct his theory under order from a bureaucrat. Henry Ford didn’t revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the kind of grinding poverty that you are talking about, the only cases in recorded history are where they have had capitalism and largely free trade. If you want to know where the masses are worst off, it’s exactly in the kind of societies that depart from that.

‘So that the record of history is absolutely crystal clear, there is no alternative way, so far discovered, of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.

‘Phil Donohue: Seems to reward not virtue as much as the ability to manipulate the system.

‘Milton Friedman: And what does reward virtue? You think the Communist commissar rewards virtue? You think a Hitler rewards virtue? Do you think… American presidents reward virtue? Do they choose their appointees on the basis of the virtue of the people appointed or on the basis of political clout? Is it really true that political self-interest is nobler somehow than economic self-interest? You know, I think you are taking a lot of things for granted. And just tell me where in the world you find these angels that are going to organize society for us? Well, I don’t even trust you to do that.’”

Certainly, you won’t find any angels at central banks around the world or in the Economics faculties of universities. I needed quite a stiff drink after reading a recent Wall Street Journal article by Harvard Professor Gregory Mankiw, who advocates creating negative real interest rates through inflation and seems to have great sympathy for the outright expropriation of savers’ capital.

Professor Mankiw declared his faith in the curative powers of inflation in February 1, 2000 article in the dead Wall Street Journal. “When you look at the mistakes of the 1920s and 1930s,” he said, “they were clearly amateurish. It is hard to imagine that happening again – we understand the business cycle much better.”

The current Federal Reserve Chairman, and of a very large number of US economists, share Mankiw’s perspective – a perspective that he reiterated in a very recent Wall Street Journal piece, entitled, “It May be Time for the Fed to Go Negative” (Wall Street Journal, April 19, 2009).

“With unemployment rising and the financial system in shambles,” Mankiw observes, “it’s hard not to feel negative about the economy right now. The answer to our problems, however, could well be more negativity. [He means negative interest rates]…Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand.

Inflation is the answer says Mankiw – a Goldilocks style of inflation that is neither too hot nor too cold.

“Ben S. Bernanke, Fed chairman, is the perfect person to make this commitment to higher inflation,” Mankiw concludes. “Mr. Bernanke has long been an advocate of inflation targeting. In the past, advocates of inflation targeting have stressed the need to keep inflation from getting out of hand. But in the current environment, the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative.”

Unfortunately, inflation is a wolf in sheep’s clothing. It seems relatively tame and friendly. But it is quite the opposite. Inflation leads an economy down the path of impoverishment. If a government is determined to create inflation, there is really nothing standing in the way of its doing so.

Nevertheless, an investor can – and should –take precautions. When governments speak openly about creating inflation as a cure for macro-economic ills, the seeds of economic malaise are already germinating.

Gold anyone?

Source:  The Death of American Capitalism

In fact, most experienced investors have reached a similar conclusion. These sophisticated investors know that Goldman is a far better investment than gold, not merely because CNBC worships the former and despises the latter, but also because Warren Buffett took a $5 billion position in Goldman Sachs, not in gold.

That said, a few of us experienced investors are slow learners. We do not comprehend as rapidly and facilely as most folks do that Goldman is better than gold. We are slow to understand that a highly leveraged trading operation – subsisting on short-term financing, friendly accounting conventions and intermittent governmental coddling – is a better vehicle for preserving wealth than a bar of gold.

Sure, we understand that speculations sometimes succeed, and that leveraged speculations sometimes succeed in spectacular fashion. But we have a hard time making the leap from “leveraged speculation” to “prudent long-term investment.” And, therefore, we have a hard time making the leap from “pinstriped crap shoot” to “better than gold.”

Admittedly, over the last eight months, Goldman has performed seven times better than the gold. But if we extend the time frame of our analysis, back to May 1999, when Goldman Sachs first became a public company, we discover that gold has produced twice the return of Goldman Sachs’ stock. Which prompts the question: Which of these pasts will be prologue? The last eight months? Or the last 10 years?

To answer this question, we must examine the relative virtues of each investment, as well as their relative deficiencies.

First, let’s consider a few of gold’s deficiencies:

Gold never installs an ally in the office of Treasury Secretary. Gold does not receive multi-billion-dollar bailouts from the US treasury. Gold has no CEO to dispatch to Washington D.C. to attend closed-door meetings with the Treasury Secretary. Gold has no “prop trading” desk that can sell short the very same toxic mortgage- backed securities that it just sold to its own clients. Gold has no access to credit, and therefore, has no mechanism for leveraging its balance sheet 40-to-1 in the pursuit of outsized investment returns.

Come to think of it, gold doesn’t have much going for it at all. Of course, that’s also gold’s principal virtue. It is what it is – simply a rare, naturally occurring element without a CEO or a standing army or even an official fan club. Instead, gold’s short list of virtues would include only its alluring gleam in the sunlight and its multi-millennial history of preserving wealth.

Goldman Sachs, for its part, has also withstood the test of time…sort of. Goldman has been an operating enterprise since 1869, when a German Jewish immigrant by the name of Marcus Goldman first hung out a shingle. Thirteen years later, his son-in-law, Samuel Sachs joined the firm. From this humble beginning a modern-day financial marvel has emerged.

But a closer look into the annals of Goldman Sachs’ history would reveal that this illustrious investment firm has flirted with corporate death on more than one occasion.

“I just recently finished perusing Charles Ellis’ new history The Partnership: The Making of Goldman Sachs,” Chris Mayer, editor of Capital & Crisis, observed a while back. “I was particularly interested in the early history of Goldman Sachs. I thought I would come away thinking how Goldman Sachs used to be a simpler business. I thought Goldman’s history would show how it took prudent risks with adequate equity backing those risks. My conclusion would then be that the current crop of leaders at Goldman were just reckless and had imperiled a franchise that had been around since the 1880s.

“In fact, that’s not what I learned at all,” Mayer continued. “From Goldman’s earliest days as a commercial paper specialist it operated with minimal capital. All through its history, it has been an enterprise that took big risks and often took huge losses. That Goldman even exists at all today is something of a financial miracle.

“In reading this history,” said Mayer, “I was struck by how the company found itself in the soup again and again and again. In the 1920s, one of the biggest speculative busts was in investment trusts in which a small amount of capital supported a spider’s web of investments in other companies. Guess who had the biggest blow-up of them all?

“Goldman was big in this through a subsidiary called Goldman Sachs Trading Corporation, which basically lost everything for its investors. Ellis writes: ‘While all the investment trusts suffered, Goldman Sachs Trading Corporation – because it was so large and so highly leveraged…became one of the largest, swiftest, and most complete investment disasters of the twentieth century.’

“The loss to Goldman Sachs itself was enormous,” Mayer explained. “It basically wiped out thirty years of profits and eliminated the ‘fruits of all the labors of a generation.’ Fast forward to 1970 and the biggest bankruptcy in the country at that time. You find Goldman was waist-deep in it. Penn Central at the time of its bankruptcy in 1970 was the eighth largest corporation in the country. Again, Ellis writes: ‘The loss it [Penn Central] threatened to impose on Goldman Sachs was not only larger than any prior loss, it was larger than Goldman Sachs.’

“And so it is again today that the company finds itself in the middle of another big crisis,” Mayer concluded. “All of these anecdotes scream at me to avoid complex and leveraged companies, where the potential for large, potentially catastrophic, losses is never far away.

But who says history has to repeat itself? According to Goldman’s top brass, the successful investment firm has emerged from the credit crisis (it’s over, isn’t it?) in tip-top shape, and certainly does not need any of that nasty, compensation-crimping TARP money.

Hopefully, things are just as good as Goldman proclaims. But that doesn’t mean its stock is anything more than a call option on leveraged speculation. In other words, the worst might be over…or it might not be. Not even Warren Buffett knows for sure.

The nearby chart suggests that the worst is NOT over.

The estimates of total losses in the banking industry continue to climb. One year ago, $1 trillion of total losses seemed like an outlandish number. Today, most estimates range from $2 trillion to $4 trillion (of which only $1 trillion has been recognized to date). In other words, the banking industry is still in deep doo-doo. The industry’s ENTIRE tangible common equity is only $1 trillion, which means the banking industry does not have the balance sheet to absorb losses of this magnitude.

Presumably, finance companies like Citigroup (NYSE:C), Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC) are holding most of the industry’s toxic assets, but Goldman Sachs certainly owns SOME of them. Goldmans’ “Level 3” assets, for example, total nearly $100 billion (“Level 3” is an accounting term for the kind of assets that are hard to value. In the real world, Level 3 assets are the kind of assets that hardly ever hold their value. This is the toxic stuff.)

$100 billion is a dangerously large quantity of illiquid, partially impaired, assets – equal to 150% of the company’s total shareholder equity. And remember, Level 3 assets are only one part of Goldman’s toxic-asset pie. The investment firm also holds billions of dollars of other toxic assets that are EASY to value. So it’s not hard to imagine that one little, unanticipated wiggle here, or one unexpected wiggle there could cause a big part of the Goldman balance sheet to go “Poof!”

Goldman’s situation is not unique. In fact, Goldman probably remains one of the best investment banks still standing. But that’s exactly the reason for raising a few questions about the company’s bullet- proof public image. The company’s share price seems to assume business-as-normal.

But forward-looking investors would probably do well to assume that business-as-abnormal will resume sometime soon.

Gold or Goldman? Your call.

Source: Gold Versus Goldman

REITs may appear cheap, but they are very dangerous to hold right now. A basic tenet of corporate finance is that a company or a sector is only creating value for shareholders if its return on invested capital (ROIC) exceeds its weighted average cost of capital (WACC). If its WACC exceeds its ROIC, it is destroying value. This describes the situation facing the REIT sector for the next few years.

Most REITs cannot float unsecured debt at anything less than 10% or 12%, so their cost of capital is high and rising. At the same time, due to the glut of supply in commercial real estate supply, and waning demand from stressed tenants, the returns on incremental investment in new capacity are very low — possibly negative.

Summing it all up: REITs will be destroying shareholder value until supply and demand for commercial real estate reaches equilibrium. The free market is screaming as loudly as it can that millions of square feet of capacity need to be absorbed or eliminated over the next several years in order for the surviving REITs to have a chance at generating respectable returns on capital.

This process has barely even begun, after the biggest lending binge in the history of commercial real estate. It will last a long time. The lending binge ensured that a large swathe of REITs will not make it to see the next commercial real estate up-cycle, which is still several years away at minimum. The title to many properties will go back to creditors in bankruptcy, and auctions will bring down asset values across the sector until they are cheap enough to earn respectable returns in a weak rental environment.

Another example of stress surfaced earlier this week. The auction to settle credit default swaps related to the General Growth Properties bankruptcy indicates serious pain to come for mall REIT owners: GGP’s senior loans effectively liquidated for 44 cents on the dollar! This means that lenders are demanding extreme discounts and high yields to hold debts secured by mall collateral. This isn’t good news for peers like Kimco (NYSE: KIM) and Simon Property Group (NYSE: SPG).

Another argument I’ve seen lately is that REITs will be a good inflation hedge if you buy them at these prices. This is an overly simplistic view of Fed-created inflation and its ultimate symptoms.

Fed Chairman Bernanke can debase the dollar all he wants, but most of the new dollars will act to push up the prices of goods and services in sectors with relatively tight capacity. Mostly, this translates into lower living standards for the average American — an echo of the 1970s, only without the real estate appreciation.

The Fed’s inflation will find its way into tangible assets like gold and silver, oil and gas, uranium ore, farmland, potash mines, and any other commodity China needs to import. Conversely, the fed’s inflation will NOT find its way into the pricing of American shopping malls, which arre in a condition of extreme oversupply.

Over time, the capacity to supply light, sweet oil to the global economy will be far tighter than the capacity to supply American retailers with real estate in malls. Demand for oil will be far more resilient than the U.S.-centric consensus expects, while demand for discretionary items — like “Color Fiend Neon Green Hair Spray” at Hot Topic (this product actually exists) — will fluctuate up and down, but generally head lower. Rising prices for several necessary goods and services will crowd out discretionary spending in many family budgets.

Inflation does not re-inflate old bubbles — especially in the case of residential and commercial real estate. It will only slow the previously violent deleveraging process.

On a related note, it was a breath of fresh air to hear Howard Davidowitz of Davidowitz & Associates interviewed on Bloomberg Radio recently. (You can find a link to download an mp3 of the 17-minute interview here). Davidowitz has decades of in-the-trenches experience in retail consulting and analysis. Rarely do you find an industry analyst express an informed opinion so forcefully in the mainstream financial media. I highly recommend listening to the interview for an overview of how the retail and commercial real estate business will evolve in the coming quarters.

A preview: It ain’t good.

This from Eric Fry:

“Success is never final. But failure can be,” Bill Parcels, the former NFL coach, once observed. Investors in real estate investment rusts (REITs) might want to pay particular attention to this truism.

REITs, as the name suggests, invest in real estate of various types. But what the name does not suggest is that REITs usually utilize leverage in their pursuit of investment returns. Leverage, as many investors learned during the last 12 months, is fun on the way up, but potentially fatal on the way down (unless you happen to be one of America’s 19 largest financial institutions).

At the moment, the REIT industry finds itself squarely in the middle of the “way down” phase – both because asset values are plummeting and because interest rates are climbing. Just yesterday, the yield on 10-year Treasury notes kissed 4%, which means that the 10-year yield has nearly doubled since the start of this year!

When long-term interest rates rise this dramatically and rapidly, many different industries suffer. But few industries suffer as much as the commercial real estate industry. Even in the best of times, rising interest rates increases the cost of capital, while also undermining the value of commercial real estate assets. In the worst of times – or even in less-good times – rising rates can produce catastrophic consequences.

Today’s commercial real estate market was distressed, even before rates starting rising. The problem, in a nutshell, was excess capacity. During the last several years, America constructed shopping malls and office buildings to satisfy the excess, phony demand that easy credit produced. But now that home equity loans and other readily available forms of credit have disappeared, so has the phony demand.

The unfortunate result: a glut of shopping malls, office buildings and hotel/motel properties.

“Vacancies are definitely rising across the commercial real estate market,” observed hedge fund manager, Jason Stock, at last month’s Value Investing Congress in Pasadena, California. “You’ve got office vacancies well over 15%. We think those are going to approach 25% before this is over.”

Stock and his partner, Will Waller, oversee the M3 Fund, a hedge fund that invests solely in the banking sector. Stock and Waller claim they are finding a number of attractive stocks to buy. Nevertheless, they remain very anxious about the health of the overall banking sector. In particular, they fear that commercial loan defaults will skyrocket from current levels, causing a large number of banks to fail during the next two years.

“So far this year there’s been just over 30 bank failures,” Stock reported in early May. “We expect they’ll be roughly 150 bank failures by the end of the year. And we would actually expect that number should be significantly higher.

Stock continued:

“Every Friday night (we jokingly call it ‘death watch,’ because that’s when you get the notices of the banks that have failed [from the FDIC]), when we look at the banks that are coming across as failures, we’ll say to ourselves, ‘Geez, that bank is a lot better off than 20, 30, 40 banks that we can think of. The regulators right now are completely overwhelmed. You have to have people to close down banks. And it’s not a very quick and easy process. It takes a fair bit of manpower. So if the regulators had the staffing to do it, there are definitely 50 to 100 banks that you could say, ‘This Friday we are going to go in and close all these banks down.’ So it’ll just be a matter of time before that pace picks up.”

In last month’s letter to their investors, Stock and Waller reiterated their skeptical outlook:

“The Government’s release of the ‘stress test’ results on May 7th was a key driver of the rally in large bank stocks. The results indicated that nine of the 19 firms have adequate capital under the test’s most adverse scenario…In our opinion, this ‘stress test’ was in no way stressful and could more accurately be compared to a beach vacation in Hawaii where the weather forecast had a 10% chance of afternoon showers.

“The ‘worst case’ scenarios that the Government utilized in this test included unemployment reaching 8.9% in 2009 and 10.3% in 2010 (as of May 31, 2009 the unemployment rate was 9.4%), and GDP growth of .50% in 2010. We believe unemployment could easily exceed 10.3% and that it is absurd to use a positive number as a worst case scenario for GDP in 2010. This ‘stress test’ created a false sense of stability in the banking sector and created a historic opportunity for banks to raise capital at significantly inflated valuations…While extremely beneficial to the banks, we believe the investors who participated in these offerings will be choking on these investments over the upcoming months.”

Contradicting the sanguine conclusions of the stress tests, Stock and Waller point out, “The Federal Reserve chimed in with an alarming report on first quarter loan delinquency rates at commercial banks. Total loan and lease delinquencies increased by 96 basis points, a 20.7% increase in only one quarter (from 4.6% to 5.6%)…We maintain our bearish outlook…we believe this bear market rally is unsustainable and that fundamental trends for banks are negative…”

Your California editor concurs, which is why he does not hesitate to say that most bank stocks are better sold than bought at their new and improved “recovery prices.” Similarly, most REITs are better sold than bought.

Source: Real Estate Investment (Dis)Trusts

Editors Note: Dan Amoss appears courtesy of today’s Rude Awakening.

If you happen to be the world’s largest debtor, and you happen to need another $2 trillion of credit from the rest of the world, you should not be surprised that your creditors demand a higher interest rate on the funds they provide. And yet, some members of the Federal Reserve are perplexed by this result.

“The Federal Reserve is not really sure what is driving the sharp rise in long-dated bond yields,” Reuters News reports. “Do rising U.S. Treasury yields and a steepening yield curve suggest an economic recovery is more certain, meaning less need for safe haven government bonds and a healthy demand for credit?…Or does the steepening yield curve mean investors are worried about the deterioration in the U.S. fiscal outlook, or the potential for a collapse in the U.S. dollar as the Fed floods the world with newly minted currency as part of its quantitative easing program?”

Um, yeah, let’s go with that second explanation.

Here in the “Twilight Zone” phase of the American response to the credit crisis, we find many otherwise-intelligent individuals – some of whom hold advanced degrees from Ivy League schools – advocating raw, unbridled debasement of the dollar. We also find legions of professional investors applauding the dollar’s debasement as a shrewd solution to the nation’s economic crisis. The advocates of dollar debasement are so numerous, powerful and vocal that they have conquered public opinion. (A massive stock market rally has not hurt the cause). Unfortunately, public opinion cannot conquer fundamental economic realities.

Only in mythology can a snake sustain itself by swallowing its own tail. Only in the logic of central banking can a nation sustain itself by purchasing its own bonds with a currency that the nation prints for itself. This process is utterly asinine, utterly ridiculous and utterly doomed to failure. The world simply does not work this way, no matter how many Harvard MBAs and Wall Street strategists argue the contrary.

“Current policies by the American government and the Fed are potentially wildly inflationary,” asserts Jean-Marie Eveillard, the legendary investor who recently retired as head of the First Eagle Overseas Fund. Nations do not generate or sustain wealth by printing currency. Neither do they generate or sustain wealth by amassing debts. Nations generate and sustain wealth by producing goods and services the rest of the world desires. Period.

Quantitative easing is Santa Claus for adults. Do you still believe in Santa? The Chinese certainly don’t. Every day the Chinese announce some new initiative to reduce or eliminate exposure to dollars – both now and forever more.

When the Federal Reserve announced its plan to purchase $300 billion in longer-term Treasury securities and $1.25 trillion of mortgage- backed securities (MBS) over a six-month timeframe, the Chinese must have said to themselves, “Surely the Fed is kidding!” But no, the Fed was not kidding. As promised, the Fed has already sopped up $700 billion worth of debt securities, paid for with newly minted dollar bills.

Is this really what high finance is all about? Maybe REALLY high finance…like the kind that would follow a Grateful Dead tour around the country for six months. But for those of us who believe in drug- free investing, the Fed’s quantitative easing policy is nothing but a fraud – a multi-trillion-dollar shell game. Simply stated, AAA credits do not repay their debts with currencies they print for themselves; they repay their debts from the proceeds of profitable capitalistic enterprises.

“An obvious culprit for the move in bond yields is the country’s record fiscal deficit,” Reuters remarks, “which will generate a massive amount of new government issuance. The U.S. Treasury must sell a record net $2 trillion in new debt in 2009 to fund a $1.8 trillion projected fiscal deficit, resulting from falling tax revenues, an economic stimulus package and sundry bank bailouts.”

Reuters, unfortunately, is an interantional news agency. So we’d guess that this story has leaked into the Chinese press. We’d also guess that the Chinese – along with every other major American creditor – will continue devising ways to move away from a dollar- centric economic model.

On the other hand, maybe your California editor is over-reacting. Maybe he just doesn’t “get it.” Echoing this sentiment, our colleague at the Australian Daily Reckoning, Dan Denning, observes, “Maybe we’re just being grumpy old bears about the whole thing. Maybe it’s time to admit that the bailouts, the asset purchases, the cash splashes, the quantitative easing, and the credit facilities all worked. They got us through the worst of it and good times are here again. Or at least less bad times (negative but improving good times).

“The only problem with that idea is that it’s not true,” Dan continues. “A huge amount of bad debt remains on bank balance sheets…And even if the market interventions were temporary (a big IF), the debt added by national governments to pay for the pain alleviation is not temporary. All that debt is a big fat drag on growth. And so it’s no surprise that when U.S. Treasury Secretary Tim Geithner goes to China and tells the Chinese that America will not inflate its way out of debt, laughter greets his remarks.

“Almost everyone outside America sees it the same way,” Dan winds up. “The debt amassed by households, corporations, and governments is real. It must be paid off, defaulted on, or inflated away. That’s why this balance-sheet recession – the liquidation of bad debts and the scaling back of debt itself – is far from over…”

Source: US Outlook Deteriorates, Bond Yeilds Soar