Weaker-than-expected U.S. housing sales and durable goods orders on Friday drove U.S. stocks lower, and world and European stocks followed that trend on Monday.

Leaders of the Group of 20 rich and developing nations pledged on Friday to bring the global economy back into balance but their statement contained few surprises and investors are already looking ahead to U.S. employment data at the end of this week.

Global equities and other higher risk assets have risen sharply in the last six months on growing optimism about the economic outlook, but markets are starting to run out of impetus, analysts say.

“Investors are a little bit reluctant to add to their risk positions,” said Koen De Leus, economist at KBC Securities.

“The market is going to have a very good look at macroeconomic numbers this week. If some of these figures disappoint, then the market is going to go down further.”

Analysts are starting to question whether the global recovery is V-shaped, or if it could be W-shaped, with a second dip to come.

The MSCI world equity index <.MIWD00000PUS> was down 0.52 percent at 282.94, bringing losses since Sept 22 to 3 percent.

U.S. stock index futures , however, were indicating a slightly stronger open on Wall Street after the market scored a third consecutive day of losses on Friday.

The FTSEurofirst 300 index <.FTEU3> hit its lowest in nearly three weeks before trimming losses to 982.53, down 0.14 percent from the U.S. close.

GERMAN STOCKS UP

German stocks <.GDAXI>, however, rose 1.3 percent with particularly strong gains in utilities E.ON and RWE , on expectations of longer lifetimes for German nuclear power plants as a result of the German election.

German Chancellor Angela Merkel’s conservatives won a weekend parliamentary election with the pro-business Free Democrats (FDPP), enabling her to end her awkward four-year-old partnership with the Social Democrats (SPD).

“(This) government provides the greatest opportunities for equity market-friendly reforms compared to other party combinations,” said Tammo Greetfeld, equity strategist at Unicredit, in a client note.

The yen, typically regarded as a safe-haven currency, surged to an eight-month high against the dollar as Japanese officials waved off any plans to stem the currency’s rise.

The yen later gave up some gains as Finance Minister Hirohisa Fujii changed gear on his comments during the course of the day, saying yen gains were becoming one-sided just hours after saying the rise was “not abnormal”.

The dollar fell as far as 88.26 yen before trimming losses to 89.35, down 0.31 percent.

However, the dollar hit a 2-1/2 week high against an index of currencies <.DXY> and a 13-day high against the euro as the U.S. currency also attracted safe-haven flows.

Funds are starting to shift money home ahead of the quarter-end later this week, analysts say.

Crude oil dipped 20 cents to $65.82 a barrel .

Euro zone government bonds also benefited from safety trades, with 10-year yields briefly hitting a one-month low.

December Bund futures were up 5 ticks, trimming earlier gains.

Sept 28 (Reuters)

Nothing as groundbreaking as the G20, but more a clarification of its position and verbalization of some important changes to mark-to-market accounting (MMA).

Let’s see why this news is so significant and how it contributed to the stock market’s rally – as we predicted here a couple of months ago…

Mark-To-Market Accounting: What It Means

In case you’re unfamiliar with the “mark-to-market” term, here’s what it means:

Mark-to-market is an accounting concept that says you should mark the assets on your books according to what the market price is for them today.

It doesn’t sound like a very revolutionary idea until you dig into it a little deeper. Because in order to determine a fair price for something, there has to be a market for it. When a market does not exist due to lack of demand, supply, or fear, prices do not reflect the long-term reality, but rather a short-term occurrence that may or may not last.

For banks, this is a big deal because their massive mortgage-backed asset portfolios are mark-to-market, based on the last sale, rather than what the mortgages will ultimately pay. For example, if the last sale at 22 cents on the dollar, then that’s where they have to mark their assets. At such low levels, the banks must then post more collateral to meet margin requirements (they call it the leverage ratio), resulting in a weaker balance sheet and write-offs against income.

So what if there is no market? Does that mean your asset is worthless?

The Rule Change That Could Save Billions

Theoretically, the answer to the question above is “yes.” But practically speaking, it’s a no. The middle ground, which was announced today, is a “mark-to-model” system, whereby fair value is determined by the quality of the paper and the expected income by the time the paper matures.

And it could save the U.S. Government and taxpayers a few hundred billion dollars.

Because financial companies like banks can reduce the capital allocated to margin and improve their capital ratios, bank stocks like Wells Fargo (NYSE: WFC), Bank of America (NYSE: BAC), JP Morgan (NYSE: JPM) and Citigroup (NYSE: C) took off. All four made double-digit percentage moves at the open.

Exciting news, right? But hold on to your enthusiasm for a minute…

The Panic Party

It’s not that MMA didn’t offer some leeway to the financials that were affected by this rule. But interpreted in its strictest form, it became some type of Wahabi interpretation of the Koran: Way out there.

Let me explain further…

Back in the fall, when there was no market for many of the mortgage assets held by banks, investors, analysts and short sellers questioned the value of these assets. The banks could have (and should have) just ignored it and marked the assets to what they believed they were worth, based on their grade and discounted cash flow.

But they took a different route – by far the worst of the two. They overreacted and bowed to the pressure of marking their assets, most of which are paying (and will continue to pay) until maturity at levels reflecting fire-sale prices.

I guess they figured that since everyone else was panicking, why not join the party?

But here’s why they shouldn’t have jumped off the with all the other lemmings…

The High Leverage-High Loss, Lose-Lose Situation

When banks mark assets to the market, they also have to mark their capital requirements to meet minimum standards for leverage. So if the asset is worth 100% of its face value, and the leverage at the time was 30-to-1, things would be fine.

But if that asset was marked down by 80%, all of a sudden that leverage would balloon, leaving the bank with one of two options…

Either increase capital to reduce the leverage, or go out of business by selling those assets at fire-sale prices.

Across the financial spectrum, both happened. Some banks went under (WAMU and IndyMac) because the weight of the increased leverage was too much to bear, while others had to raise capital or take it from the government.

However, some simply pocketed the money and decided not to lend it to stimulate borrowing. Instead, they used it to bolster capital requirements, which contributed to this “credit crunch.”

Irresponsible Merrill + Sluggish Accountants = Widespread Panic

What should have happened is this: Banks mark to a model that showed a higher value – something that the FASB allowed.

Basically, they would have had to mark their assets held to maturity on their books, using reasonable assumptions. They probably would have, except for one problem…

Last fall, Merrill Lynch sold a huge portfolio of its mortgage-backed securities at 22 cents on the dollar – a decision that caused widespread panic because that’s what established the market. While the banks did not mark to that price, investors made the assumption that the price was set and banks should adhere to it.

We all know what happened next. Stocks got punished, banks panicked, and the vicious circle of capital raising, dilution, government intervention, and market sell-offs began in earnest.

Had the FASB come out that day and said what it did today – that it supports taking the mark-to-model route, despite what the market was saying – we could have avoided a lot of bloodshed.

Course, that would require accountants making quick decisions – something they’re not exactly renowned for.

Maybe we’d still have seen some abuses of the rule. And perhaps it will be abused now, as I’m sure a lot of assets will be marked up. But overall, banks will now have the luxury of determining fair market value in the absence of an orderly market.

And more importantly, they can reduce the capital required to back these loans, taking pressure off their balance sheets.

So what should we do about it?

The Investment Strategy You Should Use On Bank Stocks Now

Just as it was a good time to sell put options on these shares over the past few weeks, it might be just as good now to sell call options.

And I see this as an opportunity to sell out-of-the-money (OTM) call options against your financial stocks.

Today’s mark-to-market news, along with volatility, means you’ll get more premium for your options. Take advantage of that.

I’m not saying that if you own Wells Fargo at $15.50 today that you should sell the $17.50 calls. Rather, you could sell $30 or $35 calls – because even those calls are paying a pretty fat premium.

And take the January 2010 $40 call options… which imply that the price will fully double in eight months – and will pay you $1.40 per contract today. That’s the equivalent of collecting a fat 10% dividend!

To which I have to say, “Ain’t volatility sweet?”

Source: How To Play Today’s Mark-To-Market Accounting News

Even President Obama allowed his less than impressive Secretary of the Treasury to make some noise against tax havens.

The orchestrated battle of words hurled at offshore financial centers got so heated that British PM Gordon Brown felt obliged to demand for “the end of tax havens.”

This belated anti-tax haven baloney comes from Her Majesty’s first minister whose government is in charge (and has been for a decade) of the United Kingdom’s many tax havens in its overseas territories (Bermuda, the Cayman Islands, British Virgin Islands, the Turks & Caicos) and its Crown Dependencies (the Channel Islands of Jersey and Guernsey and the Isle of Man), plus Gibraltar.

Does the Rt. Hon. Gordon believe that the City of London really can absorb all the dispossessed refugee bankers and trust officer that will flood in from these British world-class financial centers if he and the G-20 high tax goons shut them down? (Some unprincipled candidates, desperate for re-election, will do just about anything for votes!)

Spend vs. Regulate

The proponents claimed the G-20 meeting was not only going to solve the international economic crisis, (either by more Obama stimulus spending, or forced global regulation), but for desert, the G-20 would serve the collective severed heads of all tax havens displayed on a platter.

This entire hypocritical anti-tax haven campaign, as I have oft noted, is but an extension of the phony blacklists that have streamed for years from the tax-exempt minions at the Paris headquarters of the Organization for Economic Cooperation and Development (OECD), a taxpayer financed, pro-tax mouthpiece for the G-20 major nations who pay their salaries.

The OECD invented the blacklist and has used it skillfully as a public relations ploy to smear tax havens.

But in a classic case of removing the wind from the sails, the OECD blacklist ploy deflated when Switzerland, Austria, Luxembourg, Belgium, Hong Kong, Singapore, Liechtenstein, Andorra and Monaco, among others, all announced their agreement to broader but limited tax information exchange.

Even German foreign minister Steinbrueck, one of the most caustic anti-tax haven critics, has said he does not think G-20 leaders would come up with a blacklist of tax havens now. “As far as I see, there will be no such list at the London meeting,” he said.

Despicable Communiqué

When I asked one the leading American tax experts, Dan Mitchell (left) of the Cato Institute, what he thought the G-20 outcome might be he said,: “To be honest, I’m not sure what to expect from the G-20 meeting, other than a despicable communiqué attacking tax competition. My guess is that the real enemy is still the OECD, and the G-20 is just engaging in public relations warfare.”

As The Telegraph’s James Kirkup writes,: “The transatlantic disagreement over stimulus vs. regulation isn’t a full-blown row yet, but it’s not far off, and the still-skeletal Obama administration has enough worries at home without looking for more abroad. Better for the president to play safe and sign something anodyne in London.”

List Grows Long

The Swiss daily Tages Anzeiger reported that in a letter dated March 5 to British Chancellor Alistair Darling, OECD chief Angel Gurria provided an anti-tax haven blacklist including Switzerland and Singapore, as well as territories such as the Cayman Islands, Andorra and Montserrat.

The OECD branded 46 countries and territories for “insufficient progress” in meeting standards on tax cooperation and banking secrecy. (To the OECD that means an end to all financial privacy and automatic exchange of tax information among nations, as well as uniform higher taxes in all jurisdictions).

The OECD list also included Costa Rica, Chile, Grenada, Guatemala, Hong Kong, Liberia, Panama, the Philippines, San Marino and Uruguay, as well as Gibraltar, Guernsey and Jersey and a host of Pacific and Caribbean islands.

How Many Legions?

But as the brutal Soviet dictator, Josef Stalin was reportedly to have said about the influence of his enemy, His Holiness, the Pope,: “How many legions does the Pope have?”

The Pope was said to have responded through Stalin’s Foreign Minister, Molotov,: “Tell your master he will meet my legions in Eternity.”

Well, the OECD is loud and demanding, but it has neither any enforcement legions norand certainly not any heavenly allies.

The Tax Haven Test

So remember that on April 2nd, if tax havens and offshore finance are anything more than a minor part of the “global new deal” struck in London, then the G-20 global economic meeting will have failed.

And no matter what the G-20 does, tax havens will still be with us, fortunately.

Source: How to Gauge the Coming Failure of the London G-20 Meeting

This from Money Morning:

The gathering of 20 largest industrial countries in Washington this past weekend – billed as a crucial G20 summit – turned out to be a rather dull scrum.

There were promises of a coordinated approach to bank regulation, additional economic stimulus packages, and increased allocations for the International Monetary Fund (IMF) –one of the five “aftershock-investing” opportunities Money Morning has counseled readers to watch for. But none of the G20 meeting proposals seemed even remotely likely to make a difference in the here and now.

Even so, when you consider the kind of mischief the world’s 20 largest governments are capable of getting into, it’s best to just breathe a sigh of relief.

The G20 communiqué starts by getting the cause of the crisis wrong. It blames banks that “sought higher yields without an adequate appreciation of the risks” as the primary cause of the crisis, while government was to blame only for inadequate supervision. That begs the question: What made banks – which for decades had been model citizens, leading perfectly blameless lives – suddenly go off the reservation in this way?

The answer, of course, is sloppy monetary policy.

These slapdash policies, pursued by the U.S. Federal Reserve since 1995 and by other central banks since 2002, have translated into very low interest rates, and asset bubbles that over-inflated the value of stocks, real estate and commodities throughout world markets.  Naturally, since borrowing was cheap and asset prices always went up, bankers, acting like the well-trained economic men they are, leveraged too much and stuffed their balance sheets with all sorts of snoozy assets.

But central banks’ misdeeds are not failures of the private sector; indeed, central banks are government institutions.

Likewise, the misdeeds in the housing market – while perpetrated by private-sector wheeler-dealers among the mortgage brokers and asset securitizers – were initially prompted by Fannie Mae (FNM) and Freddie Mac (FRE), two government-based enterprises (even though these companies tried to masquerade as private-sector ventures, so they could pay their top brass like Pharaohs, instead of the civil servants that they actually were). They were spurred on by the Community Reinvestment Act, which positively forced banks to lend large sums of money to impoverished unfortunates who couldn’t pay it back – creating the subprime-mortgage market.

The G20’s refusal to admit that government bears a large part of the responsibility for the crisis is important. Public beliefs about the cause of disasters can affect policy for decades. This happened during the 1930s. For decades the public was convinced that the Wall Street Crash of 1929 caused the Great Depression. Indeed, it was two other factors – the Fed’s inability to expand the money supply during the banking crisis of 1931-33 (identified as a big problem by Milton Friedman and Anna Schwarz in 1963), and the highly protectionist 1930 Smoot-Hawley Tariff Act (not really blamed until the late 1970s) – were much more centrally responsible.

Only when another almost identical crash happened in 1987 – and no “Depression” followed – was this long-held misnomer finally put to rest.

But this long-held misdiagnosis caused U.S. policymakers to devote much effort to preventing another Wall Street Crash, in order to avoid another Depression. In doing so, they made matters much worse in some respects, notably by splitting commercial and investment banking by the 1933 Glass-Steagall Act. That legislation almost shut down the U.S. capital markets in the late 1930s, because the tiny new investment banks, split off from their commercial bank parents, could not afford to underwrite large, risky stock-and-bond offerings.

With its mistaken assessment of the market’s current backdrop, the G20 will focus mainly on bank regulation, tightening down so that banks will be forced to keep more capital on hand to sustain their balance sheets – therefore unable to make as many risky investments or high-risk loans.

We’re already seeing the fallout from this assessment. First, banks are de-leveraging as fast as they can, forcing down asset prices and helping fuel the whipsaw volatility that’s become the market norm of late (hedge funds and other institutional players are de-leveraging, too, which is contributing to the chaos). Second, credit has tightened throughout the world economy, and we’re now watching as one market after another is succumbing to recessionary forces.

Controlling the salaries of bank executives will also have a modest economic effect, probably in increasing the number of hedge fund and other speculators that infest the financial system – not a good recipe for stability in the long run.

What won’t happen is a proper reform of the government policies that went wrong. There will be no tightening of monetary policy – until rapidly rising inflation forces it to happen, probably about a year from now, once the economy has touched bottom. There will be no reform of the housing market – we are unfortunately unlikely to return to the sepia-toned days when local savings-and-loan companies run by “It’s a Wonderful Life’s” George Bailey (Jimmy Stewart) made home loans directly to customers they deal with on a first-name basis. This failure to reform will make housing finance a source of future instability, and increase the bureaucratic cost and hassle of getting a mortgage.

Despite these many missteps, however, there’s reason to be very thankful.

For all its mistakes, the G20 avoided the biggest blunder of all, the misstep that touched off the Great Depression – a move toward protectionism that could devastate world trade. Indeed, the group specifically pledged to avoid trade-inhibiting moves for the next 12 months and to work towards a Doha global trade agreement. I’ll believe the reality of the latter when I see it, but if the world’s statesmen are negotiating Doha, even unsuccessfully, they’re not passing Smoot-Hawley.

Simply having the world’s leaders meeting frequently keeps them from moving in this specific wrong direction – passing protectionist legislation is unpopular with leaders who know they will have lunch with their country’s trading partners soon, meaning they’ll do all they can to avoid that embarrassment!

With world trade unaffected, even this very unpleasant downturn is likely to be fairly short and nothing at all like the Great Depression. Twelve months from now, the world economy will be starting to emerge from a recession, stock prices will be rising and the major problem facing us will be rapidly accelerating inflation.

But at least we’ll have inflation-hawk Paul Volcker around, advising President-elect Barack Obama on the moves to make to tackle that problem. That’s one problem that won’t be misdiagnosed.

Source: Despite the G20’s Latest Missteps, Reason for Economic Optimism Remains

- Of course a depression is what they used to call a recession. Then came the Great Depression. After that, economists and politicians stopped using the word for fear of jinxing the economy. Now, a depression means a severe and protracted recession.

- Bush may be right about the chances of the US slumping into a depression. Part of the problem is that it’s not only the US that’s suffering a bout of economic woes. Japan’s economy, the world’s second largest, has just officially entered its first recession since 2001. Third-quarter growth fell 0.1% after a second-quarter drop of 0.9%. The euro area is also in recession. A 0.2% drop in growth there in the third-quarter followed a similar second-quarter fall.

- Lucky the leaders of the G20 nations are on the case. The pols from the  world’s 20 largest economies have promised to work together to achieve “needed reforms” in the world’s financial systems. US stock futures reacted poorly to the G20 pledge. Economists at UBS probably summed it up best, calling the G20 statement “a bland recitation of past policy initiatives, coupled with comments that were blindingly obvious.”

- We wish the G20 good luck in their endeavors. Unfortunately, however, we don’t hold much hope that their efforts will avert further pain. The G20, just like the Bush administration, is focused on reinflation measures, without addressing the underlying cancer eating away at the global economy: 40 years of monetary policy indulgence. As Doug Noland writes at PrudentBear.com,

There is little prospect that the direction of global policymaking will engender the return of stability anytime soon.  As [Judy] Shelton adeptly notes [in an op-ed piece in the WSJ], “In the absence of a rational monetary system, investment responds to the perverse incentives of paper profits.” …

The global abandonment of any semblance of monetary or fiscal discipline is a hallmark of this extraordinary period of bursting Bubbles.  Stable “money” may be the key – but it’s also nowhere to be seen.

- Meanwhile, bankruptcies continue to rise back in good ol’ US of A. The NYT reports that the number of personal bankruptcy filings “jumped nearly 8% in October from September, after marching steadily upward for the last two years … Filings totaled 108,595, surpassing 100,000 for the first time since a law that made it more difficult — and often twice as expensive — to file for bankruptcy took effect in 2005.” This means an average of 4,936 Americans filed for bankruptcy each business day last month.”

- And it’s not just America’s citizens who are facing bankruptcy; whole states are facing going under. The NYT also has a report on the massive deficits eating away at some of the country’s biggest state governments.

Two short months ago lawmakers in California struggled to close a $15 billion hole in the state budget. It was among the biggest deficits in state history. Now the state faces an additional $11 billion shortfall and may be unable to pay its bills this spring.

The astonishing decline in revenues is without modern precedent here, but California is hardly alone. A majority of states — many with budgets already full of deep cuts and dependent on raiding rainy-day funds or tax increases — are scrambling to find ways to get through the rest of the year without hacking apart vital services or raising taxes …

In Michigan, to reduce overtime costs, fewer streets will be salted this winter. In Ohio, where the unemployment rate is above 7 percent, the state may need a federal loan for the first time in 26 years to cover unemployment costs. In Nevada, which is almost totally dependent on sales taxes and gambling revenues, a health administrator said the state may be unable to pay claims in a few months.

- Such problems are just the tip of the iceberg, according to perma-bear NYU economics professor NourielRoubini . There are at least 20 reasons why Bush may actually be talking sense when he says the US faces a depression greater than the Great Depression. Here’s a quick rundown, courtesy of NakedCapitalism.com:

· The US consumer is shopped-out having spent for the last few years well above its means.

· The US consumer is saving-less as the already low household savings rate at the beginning of this decade went to zero/negative by 2006 and has now to raise to more sustainable levels.

· The US consumer is debt burdened with the debt to disposable income having increased from 70% in the early 1990s to 100% in 2000 and to 140% in 2008.

· Not only debt ratios are high and rising but debt servicing ratios are also high and rising having gone from 11% in 2000 to almost 15% now as the interest rate on mortgages and consumer debt is resetting at higher levels.

· The value of housing wealth is now sharply falling by over $6 trillion as home price depreciation will soon be 30% and reach a cumulative fall of over 40% by 2010. Recent estimates of this wealth effect suggest that the effect may be closer to 12-14% rather than the historical 5-7%….

· Mortgage equity withdrawal (MEW) is collapsing from $700 billion annualized in 2005 to less than $20 billion in Q2 of this year. Thus, with falling housing wealth and collapsing MEH US households cannot use their homes anymore as ATM machines borrowing against them.

· The value of the equity wealth of US households has fallen by almost 50%, another ugly wealth effect on consumption.

· The credit crunch is becoming more severe as the recent Q2 flow of funds data and the Fed Loan Officers’ Survey suggests: it is spreading from sub-prime to near prime to prime mortgages and home equity loans; and from mortgages to credit cards, auto loans and student loans. Both the price and the quantity of credit are sharply tightening.

· Consumer confidence is down to levels not seen since the 1973-75 and 1980-82 recessions.

· Real wage growth and real income growth has been stagnant in the last few years as income and wealth inequality has been rising. And now with GDP and real incomes falling real consumption will fall sharply.

· The Fed is reaching the zero-bound on interest rates as the economy gets close to deflation given the slack in goods, labor and commodity markets. Deflation means that consumers will postpone consumption as future prices are lower than current prices, as real rates are positive and rising and as debt deflation increases the real value of the households nominal debts

· Employment has been falling for 10 months in a row and the rate of job losses is now accelerating… In this cycle job losses have been so far “only” slightly over 1 million while labor market conditions are severely worsening based on all forward looking indicators…Massive job losses and concerns about job losses will further dampen current and expected income and further contract consumption.

· Tax rebates of over $100 billion failed to stimulate real consumption earlier in 2008. Only 25% of the tax rebate was spent as US consumers are worried about jobs and need to use funds to pay their credit card and mortgage….another general tax rebate would be as ineffective as the first one in boosting consumption.

· The 1990-91 and 2001 recessions were not global; this time around the IMF is forecasting a global recession for 2009.

· The recent rise in inflation – that is only now slowing down – reduced real incomes even further for lower income households who spend more than the average households on gas, transportation, energy and food. The recent sharp fall in gasoline and energy prices will increase real incomes by a modest amount (about $150 billion) but the losses of real disposable income and thus falling consumption from other sources (wealth, income, debt servicing ratios) are much larger and more significant.

· The trade weighted fall in the value of the U.S. dollar since 2002 has worsened the terms of trade of the US and reduced further real disposable income and the purchasing power of US consumers over foreign goods.

· With consumption being over 71% of GDP a sharp and persistent contraction of consumption all the way through at least Q4 of 2009 implies a more severe recession than otherwise. Consumption did not fall even a single quarter in the 2001 recession and one has to go back to 1990-91 to see a single quarter of negative consumption growth…

· Monetary easing will not stimulate durable consumption and demand for residential housing as demand for such capital goods becomes interest rate insensitive when there is a glut of capital goods; monetary policy becomes like pushing on a string. In the previous recession the Fed cut the Fed Funds rate from 6.5% to 1% and long rates fell by 200bps. In spite of that capex spending of the corporate sector fell by 4% of GDP between 2000 and 2004 as there was a glut of tech capital goods and it took years to work out such a glut. Today there is a glut of housing, consumer durables and autos/motor vehicles; so it will take years to work out this glut…

· While policy rates are sharply falling the nominal and real rates faced by households are rising rather than falling…. together with less availability of credit are severely dampening the ability of households to borrow and spend.

· To bring back the household savings rate to the level of a decade ago (about 6% of GDP) consumption will have to fall – relative to current GDP levels – by almost a trillion dollar. If all of this adjustment were to occur in 12 months GDP would contract directly by 7% and indirectly (including the further collapse of residential and corporate capex spending in a severe recession) by 10%, an exemplification of the Keynesian “paradox of thrift”. If such an adjustment were to occur over 24 months rather than 12 months you would still have negative GDP growth of 5% for two years in a row with a cumulative fall in GDP from its peak of 10% (note that in the worst US recession since WWII such cumulative fall in GDP was only 3.7% in 1957-58). One can thus only hope that this adjustment of consumption and savings rates occurs only slowly over time – four years rather than two. Even in that scenario the cumulative fall of GDP could be of the order of 4-5%, i.e. the worst US recession since WWII. Note that the cumulative fall in GDP in the 2001 recession was only 0.4% and in the 1990-9 recession was only 1.3%. So, the current recession may end up being three times as long and at least three times as deep (in terms of output contraction) than the last two and worse than any other post WWII recession.

But shortly after the London p.m. fix was in, a serious seller showed up and took both gold and silver down to their respective lows of the day. Then, at precisely 1:00 p.m., G-Dubya opened his mouth…and one of the biggest turnarounds in gold, silver…and the stock markets…took place. The prices of both metals continued higher into after-hours trading on the Globex. Once again, these rallies in gold and silver looked like short covering to me. But, regardless of the cause of the price rises, the precious metals stocks did equally as well. Volume was only so-so in both metals.

Gold open interest on Wednesday’s $20+ decline in the price showed a drop of only 1,709 contracts to 292,122. Silver’s 50 cent drop only coughed up 160 contracts to 94,334. This is not a lot of change for such big drops in price…so you can see that even big price declines no longer get much selling activity, as there aren’t a lot of contracts to liquidate at these low prices. However, there could have been some new shorts put on. The volume on Wednesday was very light…air, really. What happened in Wednesday’s action won’t show up until the the COT on the 21st…next Friday.

Lots of gold news today. In a mineweb.com story I noted that South Africa’s September gold production fell 17.7% year over year. As I’ve said before, production could fall 100% and JPMorgan would not allow it to show up in the price…and any rally based on that news would be capped immediately. The usual NY gold commentator had three points of note yesterday: 1) Investment demand…plus gold sales to India…are still extremely high. 2) Last week the European Central Bank reported that there were NO gold sales at all, and inventories actually rose a hair. 3) After twelve consecutive days, GLD has finally shown some activity…down 8,000 ounces! And lastly, I note in commentary over at Bill Murphy’s lemetropolecafe.com that at the current price for gold, 90+% of all December gold options would expire out of the money. So much for a squeeze in the December delivery month. I guess the boyz at JPMorgan/HSBC can read too.

Also on gold was this item posted at arabiannews.net. I don’t have the URL to validate the information, but it looks legit to me. “There has been an unprecedented surge in Saudi gold purchases in the past two weeks with over $3.5 billion being spent on the yellow metal, reported Gulf News citing local industry sources…Gold market expert Sami Al Mohna told the leading regional newspaper that this buying had substantially increased the gold reserves of the country: ‘Many Saudi investors see this as the right time for making investments in gold as the price is the most reasonable one at present’…He said gold was seen as a traditional safe haven at a time of global financial turmoil. Gulf regional stock markets have fallen very sharply since early October, leading to an exodus of cash which needs to find a safe haven.”

In other news, GE’s credit rating was confirmed AAA yesterday…even though they have their hand in one of TARP’s pockets! Go figure! The U.S. monthly deficit for October was…are you ready?…$237 BILLION. No wonder yesterday’s 30-year bond auction was a bust!

Today’s first story is a ‘must read’…and I mean it! I’ve been talking about this issue for over a year now, as more and more stories keep surfacing (like the one I posted in my rant yesterday) about a return to some new monetary system backed by gold…a return to the first Bretton Woods agreement. This article by Larry Edelson over at moneyandmarkets.com sums up my opinion exactly. It’s entitled “The G-20’s Secret Debt Solution”. None of the gold price numbers he mentions shock me in the slightest…as I’ve seen similar figures over the years. I thank Paul Bowman for sending this article to me…and the link is here.

The second story is from The Standard in Hong Kong which was filed yesterday evening in North America…but first thing Friday morning in Hong Kong. Here’s the first paragraph…”The mainland is seriously considering a plan to diversify more of its massive foreign exchange reserves into gold, a person familiar with the situation told The Standard.” Needless to say I think the story, entitled “Gold Rush”, is worth reading. The link is
here.

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Government’s view of the economy cold be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it. – Ronald Reagan (1986)

Will there be a surprise new monetary order coming out of the G-20 this weekend? That’s what should happen, but I don’t know for sure, as I’m not a prophet. I had dinner with James Turk et al last night, and he thinks it’s all smoke and mirrors. Our group was evenly split on it. I know that printing more money is not the answer…and sooner rather than later…everything is either going to blow up or melt down. Will the voice or reason rule…or will insanity win the day? We’ll find out soon enough.

Source: And Then There’s This… Friday, November 14, 2008

Investors will be utterly confused today about what to fear most. First, you had the nightmare open in New York on Friday. The futures markets were limit down and closed briefly. By the time order was restored to electronic markets, the Dow opened down 6%.

The Dow rallied-if you can call it that-to close down “just” 3.6% on the day. A that point, you could safely say the market was ‘pricing in’ the fear of a global recession, and just what that would mean for corporate earnings. Not even an oil price of US$65-meaning lower prices at the pump-could cheer investors.

And then, this weekend, European and Asian leaders met and, “pledged to undertake effective and comprehensive reform of the international monetary and financial systems,” according to Bloomberg. China’s Premier summed up the argument for the 40 heads of state present by saying, “we need even more financial regulation to ensure financial safety.”

And thus a great debate unfolds in the weeks ahead of the November 15th G20 summit in Washington. Was the crisis a result of unregulated “cowboy capitalism”? Or did it have its roots in phony, government-regulated interest rates, which skewed corporate and personal incentives in favour of debt-based speculation? More that in a moment.

Did you see news reports that the RBA intervened in the currency markets? The Bank is trying to prevent the Aussie dollar from going “splat!” Truly, there are few currencies in the world that have fallen so much, so quickly. But why?

Chatting with Swarm Trader Gabriel Andre this morning, he said the seven-year up-trend in the Aussie-Yen currency pair has been completely reversed in the last three months. Kris Sayce will be running Gabriel’s comments in today’s Money Morning. What does it mean?

The currency pair is as good a symbol as any for what fuelled the global rise in speculation. You could borrow virtually for free in yen and invest in high-yielding currencies and assets. Those assets included Aussie stocks and the Aussie currency itself. The collapse of the yen and dollar carry trades is what’s behind the plummeting Aussie dollar.

Meanwhile, the government still hasn’t fixed the problem that’s mushrooming in the cash and mortgage fund market. Over $11 billion is still frozen in those accounts as the firms that run them try to work out a deal with the government. But what deal could there really be?

Investments in mortgage funds are not deposits in banks. By guaranteeing bank deposits, the government drew attention to the fact that investments always have risks, and that some risks cannot be insured against. You either take them and accept the risk (in exchange for the return), or you keep your cash in a safer, but lower-yielding security (or in cash, subject to inflation).

It would be nice if you could get a guarantee in life that you’d never lose money no matter what kind of decision you made. But no such guarantee exists. It just happens that we live in an age where no one expects to lose at anything, ever. This goes for kid’s soccer games as well as financial markets. But if there aren’t real winners and losers, you don’t have a real market.

Congratulations to our friends at www.businessspectator.com.au. The financial news and analysis site is turning one year old this week. It’s a precocious one-year old, though. And there is a lot of collected wisdom there.

For instance, Robert Gottliebsen recently made this chilling observation about the hedge fund meltdown, “The mortgage fund freeze has escalated the number of superannuation investors who are demanding to exit the managed fund equity system. At the moment it is containable but if the move to quit shares balloons we will see big forced selling of Australian stocks.”

Hopefully the mortgage freeze will end soon. Perpetual says this morning that it would like to end its freeze on redemptions as soon as possible. Exactly when that is is anybody’s guess.

As if the credit crunch and a global recession weren’t bad enough, investor now have to deal with calls by the Europeans and Asians for Bretton Woods two. Everyone wants a new global financial system. But it’s not like buying a new shower head or toilet seat, is it? You can’t just run down to the shops and get one, along with some beef jerky.

It’s obvious the current system is breaking down. Globalisation-made possible by cheap money and cheap energy-is contracting. You know for certain that governments, being blame artists, will blame markets. But it’s not the market’s fault. As with every bubble, from Tulips to the South Seas to the Mississippi Scheme, it’s people who pervert markets.

Sure, CEOs and corporations turned normal businesses into vehicles for private speculation. But that is a failure of management, not the market. More oversight by corporate boards and shareholders might have made for better discipline in risk taking. But discipline is exactly what people lose in a bubble.

The credit bubble was remarkable because it leveraged the interconnectedness of global markets, allowing investors to borrow in weak currencies and invest in high-risk, high-yield assets. It wasn’t a regional or even national bubble. It was the whole planet.

But in its other essential features, it is indistinguishable from previous bubbles, manias, panics, and crashes. One of those features in fact, is how governments and bad regulations actually enlarge, prolong, and generally abet the bubble. And in this one, because everyone had a stake in its expansion, everyone has tried to keep it going. The best example of this is the determined allegiance to the dollar-pegged world financial system.

The price of money is fixed by central banks via interest rates. For years, everyone followed the Fed’s lead in the U.S. and set the price of money below rate of consumer price inflation. Australian mined. China produced. Europe traded. OPEC pumped. The U.S. spent.

Global bubbles in all asset classes ensued. That is a failure of the highest order by the regulators of global interest rates. Now politicians see massive wealth destruction and blame free markets for screwing things up when it was the non-market price of money that touched off the crisis to begin with.

In any event, we’re going to get some sort of hogwash in the next month from the confab in DC. There will be more supervision of banks. It will probably lead to less bank lending and tighter credit. Hedge funds will be regulated. Many investors will anticipate this by taking their money out ahead of time. Redemptions will force more asset sales. Stocks will fall.

The International Monetary Fund will probably enjoy some enhanced status. The IMF is already bailing out a bankrupt Iceland. It will loan US$16.5 billion to Ukraine. Before it’s all over, we reckon Japan and China might even consent to loaning some of their huge dollar reserves to the IMF in exchange…for something.

We’re not sure what it would be yet. The IMF may become a super-bank with access to funding from central banks, a kind of supra-sovereign wealth fund in the service of a world government and regulation. That sounds…not encouraging.

Also, keep in mind that the entire strain of the crisis in the U.S. was generated by a politically desirable outcome in residential housing. The original mis-allocation of investment dollars came about because politicians insisted that banks make loans to people who couldn’t repay them. Market discipline was actively subverted by political opportunism.

The U.S. set up Fannie Mae (FNM) and Freddie Mac (FRE) with preferential borrowing terms so those two could buy up mortgages originated by the banks. The banks could sell the mortgages quickly, which put them in the position to fund even more mortgages and expand “home ownership” in America.

We all know how that’s working out. Median U.S. house prices continue to fall. The loans made to finance those homes are going bad. The securities made up of bundles of those mortgages are rotting, taking bank capital with them. And insurance sold against default in them is putting the sellers of that insurance into great difficulty.

Europe, for its part, has a brewing problem in emerging market debt. Austrian banks are exposed to sovereign emerging market debt to the tune of 85% of GDP. Swiss banks have emerging market debt equivalent to 50% of GDP. It’s 25% in Sweden, 25% in the U.K., and 23% in Spain. If more emerging markets go the way of Iceland and default on debt or go bankrupt, Europe’s banking system faces major trouble. Just what we needed. More trouble.

Dan Denning
for The Daily Reckoning Australia

Source: Europe Faces Day of Reckoning in Emerging Market Debt