“Absolutely,” replied Argentina’s president. “We would never give up the peso-dollar link. It is too important to our economy. Without it foreign investors would leave and the economy would collapse.”

Five years later, Argentina cut the peso loose from the dollar. Foreign investors fled and the economy collapsed.

What lesson can you draw from this narrow set of facts? If you say, ‘politicians can’t be trusted,’ you are merely stating an obvious, universal truth, like ‘public toilets stink.’ But do they stink more on the pampas than, say, in London or New York? That is the question before us.

We begin by posing other leading questions: can investors depend on the money custodians north of the Rio Grande more than they could depend on those south of the Rio Plata? Why do people do things they oughtn’t do – because they are stupid or because they are just bad?

Today, Argentina is a mess. But it is an adulterated mess. The restaurants in Buenos Aires are still full. The beef is tasty. The women are pretty. The weather is nice. But so distrustful of Argentina’s public finances are investors that you could earn as much as 70% yield on a peso bond – the implied yield at today’s heavily discounted prices. If everything goes according to plan, you will get your money. But the 70% yield is a measure of how often things don’t go according to the plan. Investors here are used it. It is as if they got on a flight to Sao Paulo and ended up in Cordova or Brisbane. Or they turned on the hot water and got molasses.

It is these adulterations that make an investor’s lot so treacherous. Argentina’s main source of revenue is agriculture. Farmers are blessed by nature and cursed by politics. Nature gives them the richest, flattest, best-watered dirt in the world. With these advantages under their feet, a fair sun overhead, and a hugely expanding population around the world, agriculture on the pampas should be as easy as rolling tourists in Buenos Aires or selling stolen autos in the ghetto. Instead, the farmers go broke. Why? Math…and popular democracy. For every lonely hick on the pampas, there are 10 voters in the big city eager for other peoples’ money. That’s why farmers pay 40% export tax on their products to the feds in Buenos Aires and as much as 30% more to their local governments. By the time the tax collectors are finished with them, they are out of business.

But even at this level of public larceny, the feds are still faced with a crisis. The country doesn’t have the problems of North America or England. It was spared the credit crunch by its own incompetence and the collective misjudgment of lenders all over the world. Instead of giving credit to people with little of it, they lent to people with too much. The problem here is not the credit crunch, it is a cash crunch. Local economists say the trouble will begin in late June when the government won’t be able to pay salaries. Then, the country may enter another crisis – similar to what it went through in the period of 1999 through 2002. In anticipation, the ruling husband and wife team, the Kirchners, have pushed the elections forward 4 months, hoping to be re-elected before the voters catch on.

When a big guy in a dark alley says, “I don’t want to hurt you…” it is time to run. But the Argentine parliament offered a similar assurance to citizens in 2001. A law was passed guaranteeing that bank deposits would be protected.

A few days later, the bankers revealed that they lacked the funds necessary to keep up with depositors’ withdrawals. Meanwhile, the government needed to refinance its debt…but investors, growing wary, demanded higher and higher rates. In the end, depositors and lenders were hurt after all. The government froze bank accounts and defaulted on its foreign debt. By the time the accounts thawed out, the peso had been cut loose from the dollar and both lenders and savers had lost about two-thirds of their money.

There are times, we conclude, when despite the best of intentions, people do naughty things. Carlos Menem and Fernando De la Rua are probably no dumber or badder than Barack Obama and Gordon Brown. Both might have preferred not to freeze accounts or to devalue the peso. Likewise, Barack Obama and Gordon Brown might rather keep their currencies strong…reduce their fiscal deficits, honor their nations’ commitments at home and abroad, and join the community of saints. Maybe they will succeed in these things. But what trapped Menem and De La Rua was the relentless logic of debt and popular democracy. Mr. Menem fixed the peso by gluing it to the dollar. But there were other things that needed glue too. The urban voters, for example. They still needed their fixes of bread and circuses. And those cost money. Mr. De la Rua’s deficits ran to 5% of GDP. The weight of them finally came down on the gauchos’ necks like a guillotine. But 5% seems like a problem from another era. In France, the fiscal deficit for 2009 is expected to be over 8%. In Britain, it is nearly 10%. And in America, the feds’ excess spending will equal 13% of GDP.

As far as we know, Mr. Obama speaks no Spanish. Whatever mischief is forced upon him, it will have to be declared in English.

Enjoy your weekend,

Bill Bonner

Source: Cry All You Want

However, Eurozone officials continued to put off a U.S. push for more coordinated government spending to stimulate economies.

Key players in the Eurozone, especially France and Germany, have rejected U.S. demands for spending increases to solve the recession, and said that recovery plans should focus on tighter regulation.

Last weekend’s meeting was intended to set the agenda for the group’s April 2 summit in London, which is being viewed as the acid test to determine whether the world’s leaders can find enough common ground for a solution to the global economic crisis.

U.S. Treasury Secretary Timothy Geithner, who has urged Europe to match Washington’s $787 billion package of spending and tax cuts, said there was “broad consensus globally on the need to act aggressively to restore growth to the global economy.”

But without further support from his European counterparts, Geithner won’t be able to piece together even a flimsy coalition to move forward with further spending programs, let alone establish a consensus.

European policymakers prefer instead to rely on the International Monetary Fund (IMF) to review individual government stimulus actions already taken and what more might be required, rather than racing ahead with accelerated spending.

Britain, led by Prime Minister Gordon Brown, attempted to bridge divisions between the United States and Europe on the stimulus issue, but was thwarted by Germany, whose officials maintain that fixing the financial system must remain priority one.

“It makes no sense to pump more and more money in our economy when we haven’t restored the confidence on the financial market,” German Finance Minister Peer Steinbrueck told the Associated Press.

Meanwhile, U.S. President Barack Obama dismissed reports that the United States and Europe had taken sides, saying it was a “phony debate.”

“I can’t be clearer in saying that there are no sides,” Obama told reporters.

The meeting was a coming out party of sorts for Angela Merkel, the German chancellor who is now leading European opposition to Obama’s call for a global pump-priming package.

“It’s Merkel who holds the key to the cashbox, and she doesn’t want to give it up,” Jean-Dominique Giuliani, chairman of the Robert Schuman Foundation, a research center in Paris, told Bloomberg News.

Merkel’s rejection of more stimulus measures ignited the first international clash of the Obama administration, and brought forth criticism that she might be responsible for delaying a recovery.

As if to establish her independent status, Merkel repeatedly rebuffed Obama’s call for a united front among nations to jump-start the economy.

“Germany really has contributed its share,” said Merkel, as she stood alongside Britain’s Brown in London, 42 miles away from the rest of the group.

European leaders will meet this week in Brussels at a EU summit to decide on what approach they should take to the financial crisis, ahead of the summit meeting on April 2. Merkel could decide the fate of a $6.4 billion (5 billion euro) infrastructure proposal during that meeting.

Casting a further shadow on the summit, Czech Prime Minister Mirek Topolanek said the European Union must beware of U.S. protectionism.

Topolanek, who holds the EU’s rotating presidency, told a German newspaper he believes Washington was solving the financial crisis by passing the buck to other countries.

“The different bailouts and protectionist appeals to buy American goods, the nationalizations that are being called ‘pre-privatizations’ of late — all this points to America fixing its problems at the expense of the rest of the world,” Topolanek told the Frankfurter Allgemeine Zeitung.

Trying to keep a positive face on the proceedings, Geithner said he was pleased with progress at the talks during the weekend, but noted that the world economic situation remains fluid and volatile.

“This is a very challenging period and this is still evolving,” he told reporters.

In one sign of unity, the finance ministers agreed on an “urgent need” for a big increase in the lending resources of the International Monetary Fund to assist struggling governments in the developing world.

However, they left specific amounts, and details about who would contribute how much, open for further discussion.

Source: G20 Meeting Fails to Resolve U.S.-Eurozone Spending Conflict

Last week, I promised to answer this popular question:

“Hey JL, what about all that gold in the vaults of the IMF and Fort Knox? Aren’t you worried they might try to dump it on the market?”

But before we get to that, a quick correction. In Friday’s piece, Europocalypse, I made reference to Colonel Kurtz as a “deranged flyboy lost deep in the Congo.”

The film-buff contingent among you corrected me with relish. Kurtz was in Cambodia, not the Congo, at the height of the Vietnam War when the movie took place.

My apologies… in Joseph Conrad’s novella, Heart of Darkness, Kurtz is a rogue ivory trader lost in the Congo. (Conrad himself drew on personal experiences as the captain of a Congo steamer in writing Heart of Darkness.)

Clearly the book and movie are two distinct entities. In referring to “a flyboy lost deep in the Congo,” I accidentally conflated the two.

Given the glee that some of your e-mails displayed, I’m tempted to hide future Easter eggs in my pop-culture references.

Anyhow, moving on…

A Golden Sword of Damocles?

It’s true – the United States and the IMF (International Monetary Fund) have a lot of gold in reserve. Some of you fear a good chunk of that gold could be dumped on the market, acting as a sharp break to the yellow metal’s rise.

Let’s start by asking the question, just how much gold do these guys have?

The World Gold Council regularly updates the stats on official holdings of central bank reserves. According to December 2008 data from the WGC, the U.S. holds 8,133.5 tonnes (metric tons) of gold. The IMF holds 3,217.3 tonnes.

When you do the math, that adds up to 11,350.8 metric tons (tonnes), or 12,512 short tons, of gold. Converted to ounces at $1,000 per ounce, that’s a touch over $400 billion bucks worth of bullion.

Does this count as a lot? Yes and no.

On one hand, it represents 8-10% (very roughly) of all the gold in the world. On the other hand, there are a heck of a lot more dollars in the world… and demand is the key driver to consider here.

Big Buyers in the Wings

Take Russia, for example. Russia has recently stated its intent to raise total gold holdings to 10% of total reserves.

Again according to the World Gold Council, Russia held 495.9 tonnes of gold as of December ‘08, accounting for just 2.2% of reserves.

We can do the math and see that, for Russia to hit its stated target of raising gold holdings to 10% of reserves (assuming total reserve values don’t change), they would need to purchase 1,758 tonnes of gold in the open market.

By stating a desire to up their gold holdings to 10% of reserves, Russia has all but said “Yeah, we wouldn’t mind owning another 1,750 tonnes of gold or so.” And that’s just Russia.

When you think about it, 10% is a pretty modest allocation. You think China wouldn’t like to have more of its dollar mountain converted to gold?

What central bank wouldn’t want to have 10% of its assets (or more) in bullion at a time like this, with paper currencies getting debased like crazy and creeping geopolitical tensions around the globe?

Below is a table showing a cross section of central banks with sizable gold holdings and low percentages of total reserves.

You can see from the table how many tonnes (metric tons) each of these banks would have to buy in order to get their total allocation up to 10%.

Remember, the U.S. and the IMF hold roughly 11,351 metric tons of gold.

If just these 10 central banks elected to raise their reserve allocations to 10%, they could hoover up all that U.S. and IMF gold by themselves (and still be hungry for more). And believe me, there are plenty more than these 10 with the same thoughts… not to mention institutional demand, don’t even get me started on that.

This doesn’t paint anything close to the total picture, of course. But it should help give you a better grasp of supply and demand. Right now, demand for gold is high and rising… and there just isn’t that much of it left to go round in the world.

“We Hate You Guys”

Part of the reason many of these banks haven’t upped their total gold holdings, by the way, is because it’s hard for them to buy gold without running the price up. You’re just not seeing that much supply on the open market relative to total demand.

This is why some central bankers despair that they have nowhere to go but into U.S. dollars and U.S. Treasury bonds. The amount of available gold on the market is so small, relative to the amounts that would be desirable for them to own, that trying to get the reserve percentages up is a very tough task.

That is why Luo Ping, director-general of the China Banking Regulatory Commission, had this to say a few weeks ago:

Except for US Treasuries, what can you hold? Gold? You don’t hold Japanese government bonds or UK bonds. US Treasuries are the safe haven. For everyone, including China, it is the only option… We hate you guys. Once you start issuing $1 trillion-$2 trillion… we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.

If gold suddenly became easier to buy in the open market, bankers like Luo Ping would quickly change their tune.

“Oh, you want to sell gold in size? That’s wonderful, because we want to BUY in size… something, anything that will hold its long-term store of value better than these stupid treasury bonds! Thank you, Thank you!”

Remembering Gordon “Goldfinger” Brown

The world’s bankers, too, will no doubt remember the lesson of Gordon “Goldfinger” Brown.

Gordon Brown, now prime minister of the U.K., was treasury minister back in May 1999. In that capacity, Mr. Brown decided to dump half of Britain’s gold reserves at 20-year lows, as the Sunday Times reports:

GATHERED around a table in one of the Bank of England’s grand meeting rooms, the select group of Britain’s top gold traders could not believe what they were being told.

Gordon Brown had decided to sell off more than half of the country’s centuries-old gold reserves and the chancellor was intending to announce his plan later that day.

It was May 1999 and the gold price had stagnated for much of the decade. The traders present — including senior executives from at least two big investment banks — warned that Brown, who was not at the meeting, could barely have chosen a worse moment.

…”The timing of the decision was ludicrous. We told them you are going to push the gold price down before you sell,” said Peter Fava, then head of precious metal dealing at HSBC who was present at the meeting. “We thought it was a disastrous decision; we couldn’t understand it. We brought up a lot of potential problems at the meeting.”

…The decision to sell 400 tons of gold is seen in City circles as a financial bungle on the scale of the Tories’ “Black Wednesday” that cost the taxpayer £3.3 billion, according to Treasury estimates.

Dominic Hall, a former gold dealer who now runs thebulliondesk.com, a website for the gold market, said: “Brown was keen to throw mud at the opposition over Black Wednesday but this was a financial disaster on a similar scale.”

Dumping 400 metric tons of gold over the side at prices well below $300 per ounce was an epically dumb decision – something that is all too clear today. At present-day prices, that is much more than the Tories’ debacle of 3.3 billion pounds sterling lost… it is more on the order of ten billion pounds sterling lost.

So it is doubtful that many bankers today will want to emulate the stupidity of Gordon “Goldfinger” Brown, especially with the public so aware of what’s happening in the world. To sell gold now and trade it for what – Dollars? Euros, are you kidding me? – would serve as open invitation to be publicly tarred and feathered.

Bluffing Into the Nuts

We’ll close with a quick poker analogy.

In No Limit Texas Hold ‘Em, to hold “the nuts” means you can’t be beaten – that your hole cards in combination with the board give you the best possible hand.

Needless to say, it is useless to bluff a player who is holding the nuts. Why would they fold? They know they have the best hand. If you raise such a player, they will happily call… or better yet shove their own stack in the middle, a reraise to put you all-in.

If the Fed or the IMF were to dump gold onto the market in this environment, I believe it would be the poker equivalent of bluffing into the nuts. I don’t think the powers that be are that dumb.

But even if they were, what would happen? If they tried to increase the gold supply discreetly, the central banks and institutional holders who are quietly accumulating bullion would simply pick up the pace a little.

If they tried to talk down gold in the open market, blathering about how they planned to sell a huge chunk, gold might take a sizable short-term hit… but then it would bounce back, and then what they do?

Source: Why the IMF and Fort Knox Won’t Put the Hurt on Gold

Britain is “uniquely at risk”, mainly because the Government has spent too much during the good times. The country faces house price falls of as much as 10%; while unemployment will rise to a ten-year high, with 200,000 people losing their jobs over the next 18 months.

Nice to see the world’s economic institutions are catching up to reality. But the OECD is still too optimistic…

The OECD has warned that the UK is in big trouble. It reckons the Bank of England needs to cut interest rates to 4.25%, but says it must hold off until next year because of inflation risks. The Bank will be announcing its decision on interest rates later today, and is widely expected to keep them on hold at 5%.

Why the government should be spending more right now but can’t

It also says that the Government probably shouldn’t be pulling in the reins in terms of public spending. The idea is that when times get hard, the Government spends a bit more to keep the economy ticking over until the private sector gets back on its feet.

But of course, this isn’t really possible, because the Government has bled the country dry during the good times. Gordon Brown has taken money that would once have gone into private sector pensions (which would have enabled more of our citizens to take care of themselves in the future, rather than relying on the state), borrowed a whole load more, and then sprayed it all over the public sector to almost no apparent effect at all (if you still have trouble believing this, read Squandered by David Craig – do remember to take your blood pressure pills first though).

As the OECD puts it, a little less bluntly: “The Government’s options have been limited by excessively loose fiscal policy in past years when economic growth was strong.”

It’s unusually tough talking from this type of body. Of course, the Treasury said the OECD was wrong. “The UK economy remains strong, and is well-placed to get through these global problems.” All I can say is, it’s little wonder that British consumer confidence is at a record-low ebb.

Those in power – both in the public and private sectors – of our key economic institutions seem to have one reaction to the credit bubble popping. That’s to stick their fingers in their ears and sing “la-la-la, I can’t hear you.” If it’s not Alistair Darling blethering about the UK being “well-placed”, then it’s any number of banking chief executives effectively saying: “Everything’s fine, our lending book is top notch, and even though the housing market is in meltdown, we will somehow be the one bank that can get through it unscathed. By the way, can any of you shareholders spare another few billion? No, don’t form a queue, people might get the wrong idea…”

A 10% fall in house prices? We should be so lucky

The unfortunate truth is that in fact, the OECD’s predictions that house prices could fall by as much as 10%, and that unemployment will rise by just 200,000, still seem quite tame.

Plenty of mainstream forecasters are now predicting falls of at least 10%. And during the 1990s recession, unemployment actually rose by closer to one million. And despite the increasingly desperate claims of the optimists, it is looking more and more as though this downturn could be much worse than the one in the 1990s.

One of the reasons behind yesterday’s 87-point drop in the FTSE 100 was a particularly worrying piece of economic data. The Chartered Institute for Purchasing and Supply released its services sector survey for May. The data showed that the sector shrunk for the first time in more than five years.

This is bad news. The service sector accounts for about three-quarters of Britain’s economic growth. But even worse was the news that employment saw its biggest contraction since records began in 1996, “with hotels and restaurant staff bearing the biggest brunt,” reports Edmund Conway in The Telegraph. And yet prices charged continue to rise. Companies are also more pessimistic than at any time since records began.

And all of this is already happening when we’re still at the start of the fall-out from the housing crisis – as the Halifax reported this morning (see below), prices are now down 3.8% year-on-year. The number of people in negative equity is creeping higher by the day.

It doesn’t matter what the Bank does today, or how many warnings the OECD gives out. The British economy is headed for recession. The only question is – how bad will it get?

Turning to the wider markets…

US stocks were mixed, with warnings that Moody’s may downgrade two major bond insurers (Ambac and MBIA) hanging over the market. The Dow Jones Industrial Average fell 12 points to 12,390. The wider S&P 500 was flat at 1,377, while the tech-heavy Nasdaq Composite gained 22 points to 2,503.

In Asia, the Nikkei 225 fell 0.7% to close at 14,328, as falling crude oil prices hit commodity trading groups. In Hong Kong, the Hang Seng climbed 0.2% to 24,161.

Brent spot was lower again this morning, trading at $121.02, with crude in New York trading at $122.25. Spot gold was at $875 an ounce. Silver was trading at $16.67 and Platinum was at $1,987.

Turning to forex, sterling was trading at 1.9515 against the dollar, and at 1.2636 against the euro. The dollar was last trading at 0.6478 against the euro and 105.87 against the Japanese yen.

And this morning, the Halifax reports that house prices fell by 3.8% in May compared to the same month last year. That’s the biggest annual drop since April 1993, when prices fell 2.4%.

Source: Why the Bank of England Can’t Save Britain from Recession

Today, we begin ab ova, as the Romans say – with the egg.

The price of eggs has gone up 30% in the last 12 months. Why the big increase? Because the things that go into making an egg have gone way up – feed for the chickens, heat, light, and transportation.

As the egg goes, so goes the chicken…and the whole chain of consumer products that make up our cost of living. Everything is going up.

If we were looking for something to blame, we could turn to the price of oil. It was only $80 a barrel as recently as last summer. This morning, it is trading at $127 a barrel – near an all-time record, even in inflation-adjusted terms.

Modern economies run on petroleum products. As oil has gone up…so has everything connected to it. But as the oil price rises, it sets in motion a whole contraption of actions and reactions. As the price of a gallon of gas rolls up a penny, it tips over a little cup in which there is a steel ball. The little ball rolls down a track, trips a number of levers and switches, and runs into another ball attached to a string, which then swings over to the left and knocks over a glass of water, which falls down onto a tray of fast-growing ivy seeds, which send out shoots and vines and strangle the entire apparatus.

Well…you get the point: one thing leads to another…

And one thing that high oil prices lead to is higher prices for everything else. And higher prices lead to less purchasing power on the part of the average consumer, which leads to fewer sales, which leads to less output, which leads to lower earnings and slower growth…etc. etc.

This has put the airline industry is in “desperate” condition, reports the New York Times . Fuel is the airlines’ biggest expense. As it has gone up, airlines’ profit margins have gone down.

The latest report from the manufacturing sector show declining factory orders for four months in a row. And USA Today reports that many people are seeing declines in their incomes – in ways that don’t show up in the employment numbers. While the unemployment figures show little contraction, sales commissions, tips, and even Wall Street bonuses are going down fast.

Foreclosures are still rising nationwide, says the Wall Street Journal . The famous Foreclosure Bus Tours have now moved beyond hard-hit cities in Nevada and California; now there’s one touring the New York area!

Forbes has a word for all this: Stagflation. Of course, it’s not a very original word, but Forbes is not a very original magazine. But it’s not a new situation either, says the magazine. Stagflation is the devil’s child you get from the unnatural union of consumer price inflation and a stagnant economy. It’s also what the United States endured in the 1970s…the last time oil prices were so high. The price of gasoline rose during the late ’70s…and hit a record high, adjusted to today’s dollars, over $3 at the beginning of the ’80s. For all the whining about it, today’s gasoline is not much higher. But by 1981, the price of fuel was headed down. Over the next four years it fell in half…and stayed low until George W. Bush invaded Iraq.

Are we enjoying a re-run of a ’70s show? Is it time to get out the strobe lights and the leisure suits? Should we repaint the house in ’70s style slime green and dirty-carpet beige? Can we forget about trading in the SUV or putting in a wood stove? Won’t this whole thing blow over – the way it did in the ’70s?

George Soros says the bubble in commodity prices will burst. We believe him. So, can we stop worrying about high oil prices and rising inflation?

Not so fast, says Paul Krugman. This ain’t the ’70s because we don’t have the same kind of inflation, he points out. At the end of the ’70s, everyone was sure prices would continue to go up. In May of ’81, the United Mineworkers Union was able to negotiate a 33% pay raise spread over three years. The miners thought they needed the increase to make up for increases in the cost of living. And the mine owners thought they could afford it – because the price of coal had been going up for many years. They were both wrong.

But that was “wage-push” inflation, Krugman maintains, very different from what we have today.

Yes, he is right. This is a different kind of inflation…a different kind of stagflation…and, we predict, a story with a different kind of ending.

Stay tuned…

*** How will the story turn out?

Well, we repeat ourselves, what ultimately turned the situation around at the end of the ’70s was a change in regime at the Fed…the worst recession since the ’30s…and a whipsaw on Wall Street that whacked both the bond market and then the stock market, wiping out more than half the value of each of them.

At the end of the ’70s, the jig was up. When everyone had come to expect more inflation from the Fed, the central bank no longer saw any benefit in it. Its new money and credit was being anticipated and absorbed – in wage and price increases – even faster than they made it available. Inflation no longer worked, in other words. It no longer deceived businessmen into thinking they should expand production. It no longer deceived investors into believing their assets were going up in value. And even the lumpen householders had caught onto the game; as soon as they got a wage increase, they spent it quickly…and then demanded another one.

The feds didn’t have much choice. They could either inflate much more heavily than expected and wait for the disaster to catch up to them…or they could admit that the flimflam no longer worked, raise rates, and squeeze the “inflationary expectations” out of the system. Paul Volcker took the latter course. That, combined with the natural feedback look of the oil cycle – in which higher prices drew forth new supplies, as they always do – sent the price of oil back down. In today’s dollars, a gallon of gasoline sold for about $1.50 from 1986 until 2003.

Volcker’s anti-inflation Fed also knocked the price of gold down from over $800 in 1980 to around $275 in 1998.

(It was at this point that the then-chancellor, now-Prime Minister of England, Gordon Brown, decided to sell tons of Britain’s gold. It is why the low point in the gold market, set in the late ’90s, is still known as the “Brown bottom.”)

Here it is:

We need to pump 50,000 barrels more each day.

It’s a masterstroke. A policy that manages to be really bad in two different, fundamental ways.

Point one — we don’t have much oil left. This will deplete our reserves faster.

Point two — the world as a whole produces 85 million barrels a day. This extra production will have no impact on the oil price. It’s like throwing a dart at a tank.

Of course, there could be another motive for this. Brown famously sold a lot of our gold in 1999. Since then, the price of gold has soared. It was a really, really bad trade. If Brown was your fund manager, you’d sack him.

Maybe Gordon’s trying to make up for it now. Britain is a price taker in the global oil market. We have no influence on how much a barrel of crude costs. Now oil is hitting record highs. Some, like our own Bill Bonner and our Time Trader, Robin Tracey, suspect we could be in bubble territory.

Perhaps Brown is advocating increased production to capitalise on the high price (though even then, I don’t think it’s at all his call to make). I don’t really believe this… but I’m trying to think of a rationale for this mad policy.

If that is the case… OK. We’ll talk about it.

Just don’t dress it up as the energy solution it clearly, clearly isn’t.

Below, commodities hound Garry White proposes a far more workable solution. He also follows up on yesterday’s Blackout Britain story — why was it that the lights went out in Cleveland?

House prices lose their footing

Woops!

You remember my rock climbing analogy from two days ago? The one that likened the housing market to a climber on a rock face, trying to descend to a sustainable level and groping around for a foot hold?

Well, the climber’s slipped. He’s not at the bottom (at least, we don’t believe so). But he has slipped a bit, and grazed his face on the rock.

According to the latest Nationwide house price index, the average house price has fallen 4.4% since May last year. That’s the biggest fall since December 1992 (when prices fell by 6.3%).

But here’s a line from the FT that puzzles me:

“The price drop makes the position of the Bank of England’s monetary policy committee even more complex as it struggles to set an interest rate policy which is consistent both with surging inflation and a deep slowdown in economic activity”.

Why? Why should it make the Bank’s job more difficult?

I’m going to have to quote from the Bank of England Act again, aren’t I? Here we go…

In relation to monetary policy, the objectives of the Bank of England shall be — (a) to maintain price stability, and (b) subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.

The key phrase is ‘subject to that’. If prices are stable, worry about growth and employment. If they’re not, don’t.

There isn’t an interest rate policy consistent with both surging inflation and a deep slowdown in economic activity. There’s no reason to think there would be. That’s why each policy tool should be used to achieve one, and only one, policy goal.

In the case of interest rates, the goal is price stability. Keeping inflation down.

Falling house prices may make ugly headlines, but that shouldn’t be the Bank’s concern. And besides, house prices got too high anyway.The housing market is trying to find an equilibrium. Let’s go back to my climber on the rock face. He knows there’s solid ground below. He’s making his way down… from time to time he slips, but then the safety rope kicks in.

This “Belay Effect” takes the form, for example, of people desperate to buy, but priced out of the market. As soon as prices slip a little, they’re in!

But our climber’s still searching for a surer footing. So he’ll keep edging downwards. And here’s where the Bank of England might make a nuisance of itself. The equilibrium is below the climber. Cutting rates has the effect of temporarily hoisting him higher up the wall.

But he still has to come down.

Solving Britain’s power crisis — the Garry White two-step

Step one — start building nuclear reactors. But remember — these take over a decade to build. You can’t just throw them up. Best get started, then, however unpopular it may be with environmentalists.

Step two — find a workable solution for the interim period. For Garry, the solution is a four-letter word. Coal!

“Coal’s making a comeback,” says Garry. And that, dear reader, leads me onto step three:

Invest in coal. This is exactly what Garry told his Smart Commodities readers to do last October. But Garry was too far ahead of the curve — his coal stock slumped straight after.

But Garry’s stuck with it. And he’s told his readers to stick with it, too. He sees the current energy crisis for what it is — a gap to be plugged… and a great investment opportunity.

Garry’s been rewarded for his patience — his coal stock’s now showing a 19% profit since recommendation, despite the earlier dip. Now, past performance is not a reliable indicator of future results. Perhaps Garry was lucky?

“Not a bit of it!” says the man himself. “Investors are slowly waking up to coal’s profit potential. The world needs energy — and coal, however dirty it may be, is a proven source. This stock has a way to go yet. Get it in your portfolio!”

Find out today what Garry believes is the number one coal investment on the market right now!

Until tomorrow

Ben Traynor

Source: Gordon Brown’s Barmy Answer To The Oil Crisis

Or how about this one:

“When the government actually did something about getting our nuclear strategy on track, it got it so utterly wrong that Greenpeace took it to court on a technicality!”

Angry Garry’s been warning about Britain’s dreadful energy strategy for a long time now. As he explains today, he’s worried our energy needs will ultimately be dictated by Moscow.

And something happened last night that has Garry even more worried.

Find out why Garry believes we’re now on the road to an energy nightmare!
Will the lorries force Brown into U-turn?

Why does the Government tax fuel? Is it to raise revenue? Or is it an environmental measure? Either way, it seems the latest little hike in fuel duty — the 2p increase — won’t be going ahead. And quite right too.

British hauliers are feeling the squeeze. Yesterday, many of them converged on London, parked on the A40, and delivered a petition to Downing Street. They want the Government to scrap the 2p increase.

Gordon Brown first proposed this latest 2p hike — due to come into effect this autumn — over a year ago, while still Chancellor. Since then, the price of crude oil has gone through the roof.

This, in turn, has sent prices at the pump soaring. According to petrolprices.com, the average cost of a litre of unleaded petrol is 115p. For diesel it’s 128p.

If the Government’s plan was to price cars off the road to help the environment, it can stop worrying. By going up so much, the oil price has already done more than this extra tax would have done had oil prices stayed the same.

Even in the car-crazy US, the high oil price has finally fed through to a reduction in car usage, as Bill Bonner notes below in today’s Daily Reckoning.

If the purpose of the 2p hike was to raise revenue (as I suspect it was), then things are a bit trickier. Only a bit, mind.

Yes, the Treasury will have budgeted for the extra revenue. But then again, higher fuel prices will have affected consumer behaviour. If Britons drive less, that in itself will impact the Treasury’s fuel duty income.

Not only that, but the higher oil price has boosted the state’s North Sea revenues. And besides, it wouldn’t be the first time this year the Treasury has had to do the sums again.

I’ve had a pop at the Government here before (If I’m honest with myself, that last sentence felt like a bit of a ‘mini-pop’). I’m sure I will again.

But if the Government changes its mind on this one, let’s not just blithely label it a U-turn, in the manner of some newspapers this morning.

Pressing ahead with the 2p increase would be the wrong policy, at the wrong time and hitting the wrong people. As one protester pointed out yesterday, we still need lorries to take goods from place to place.

If domestic hauliers go bust, foreign firms will do the job instead — and the Treasury will receive even less revenue. Not to mention the fact that allowing the industry to wither would be another step on the road to the so-called “backrub economy” — a society in which everyone derives their employment from the service sector.

Much has changed since the 2p hike was first proposed. At the time, crude oil was around $60 a barrel. Now it’s more than double that. In all likelihood, then, the Government will change its policy. And they’ll be right.

It’s just common sense, really.

Brasil! Brasil!

Ever since my days playing capoeira, I’ve liked to spell ‘Brasil’ with an ‘s’. It makes me feel cultural.

“It’s Brazil with a ‘z’,” says my down-to-earth colleague Manraaj Singh. “Now stop it.”

Brazil, you’ll be aware, is one of the hottest economies in the world right now. Manraaj tells me growth this year is expected to be close to 5%. Strong in oil, sugar, and with a buoyant service sector, Brazil is the place to be for many investors.

Leading the Fleet Street charge is our man Manraaj, who today shows us why the stock market there is rapidly outgrowing São Paulo…
Fleet Street Research presents: 3 firms hoping to escape the UK consumer gloom

I don’t know what it’s like where you are, but outside my office window the weather’s pretty grim. I don’t think it’s raining… but it may do soon.

A bit like the economy then (I know! Seamless!)

Tenuous links aside, the UK economy is in wobbly health. The canniest UK firms have protected themselves, and now make a significant amount of their money well away from these shores.

I’ve asked our research department to take a look at some such companies. There’s still work to be done (our boys are thorough, and wouldn’t dream of issuing a recommendation without doing the necessary prodding and poking).

But my colleague Theo has agreed to give you a sneak preview of some of the companies he’s been looking at.

Remember, these are NOT recommendations (happy Theo?). This is just to give you an idea of the kind of opportunities we’re looking at right now.

Until tomorrow

Ben Traynor

Source: How Blair’s Blunders Sold Us to the Russians

He looked nervously over his shoulder, hoping no-one had spotted him, had recognised him. He approached the counter.

“I’d like to cash this bet,” he told the cashier, passing her the slip. She almost fainted when she saw it. This shadowy punter had bet billions of pounds that Labour would lose the Crewe and Nantwich by-election. Even at short odds the winnings were enormous.

“You could pay off half the national debt with that!” she said, as she handed the man his winnings in a very, very big brown paper bag. And then it hit her. She realised who the man before her was.

It was Gordon Brown. Of course, it all made sense! He knew Labour didn’t have a hope of winning that by-election. The economy’s too screwed up for that.

So Brown had bet against his own party, using Treasury funds. That’s the only way he could make the public sums work.

And it worked! Labour lost heavily. Voters elected Conservative Edward Timpson though for alliteration’s sake I’d like us to all start calling him Ted). A constituency that had been a safe Labour stronghold had seen a 17% swing to the Tories.

Gordon was delighted!

At least, that’s how I’m making sense of Labour’s terrible, terrible strategy in the Crewe and Nantwich by-election. Labour was always going to be up against it. SO, in desperation, they resorted to name-calling.

They handed out flyers mocking Ted’s supposed upper-class credentials. The flyers had a picture of a top hat on them…

This sort of tactic is childish, small-minded and is completely irrelevant to anything voters actually care about. As William Rees-Mogg writes in tomorrow’s Fleet Street Letter:

“When prices are up in the supermarkets and at the petrol pump, it is no good Labour attacking the Conservative candidate, who is a family lawyer by profession, because he spent some years getting a good education at Uppingham. Anti-toff propaganda is irrelevant to the problems of the credit crunch. It belongs, if anywhere, to the politics of the 1940s, not to the present day.”

For his part, the Tedster was full of talk about ‘change’. Voters had “rejected the old politics”, he said.

“Gordon just doesn’t get it and the Government needs to change,” continued ‘new politics’ Ted.

This is all the Tories need to do now. Keep saying the word ‘Change’, Barack Obama-style, and they’ll be home and dry.

And then we’ll see change… at least for those MPs who get to move to a different office and have a more important job.

I guess what I’m saying is this: let’s not get carried away.

Ted may carry the lustre of being Britain’s newest MP, but he’s still just a politician. They’re all politicians. Don’t expect too much of them.

Is oil in a bubble?

“Looking at the long term, we suspect that oil will be expensive for a long time,” writes Bill Bonner in today’s Daily Reckoning. “But in their enthusiasm, markets tend to overdo it. Our guess is that they’re overdoing it in the oil market now…or close to it.”

Oil has fallen back a little in the last couple of days. My angry colleague, Frank Hemsley, told me this morning that there is less open interest — the total number of futures contracts that are yet to be closed — on the oil market, a point also made by our commodities hero Garry White:

“A lot of people were shorting oil, hoping the price would fall. But it went up. So, to cut losses, they closed their positions by buying oil futures, sending the price up to $135. It’s the classic short squeeze!”

Garry concurs that the recent spike in oil had a speculative tailwind. But he’s not worried by the slight pull back. Because oil would need to fall a long, long way to impact on the oil companies he’s invested in.

Also wading into the oil debate is Time Trader, Robin Tracey. As he wrote to his subscribers yesterday:

“Higher oil prices are here to stay. This does not mean that in the short term there cannot be profit taking, and a pull back of $15 or so. But unless there is a significant reduction in demand, do not expect any relief in the longer term.

“What this means for us is that equity markets will struggle to make any headway. It also means that inflation will become the bête noir again and we will start hearing about interest rate rises.”

But for Robin, it’s actually a good thing equity markets are held back. He doesn’t want a boom in stocks — he wants a stable market that helps him, and his subscribers, make money.

Robin’s confident that that’s exactly what we’ll get. As the man himself wrote yesterday:

“Bottom line: the outlook for Time Trader is great!”

Some more nice profit for Manraaj’s copper play

“Since we wrote our last update on the company, the shares have risen by a further 16%. We are already up by 122% on this investment and the news just keeps on getting better.”

So writes Manraaj Singh in today’s free edition of Profit Hunter. Manraaj is writing about his copper play, which, as those numbers demonstrate, has proved to be a nice little earner — on paper, at least, as the position is still open — for his subscribers.

“We were in this copper play before anyone was talking about,” he says. “Now it’s getting a lot of press attention — hence we’re seeing these rather lovely moves.”

Now, here’s the thing. Just because Profit Hunter has made big gains on that stock (and others) is not a guarantee it will happen again. Past performance is not a reliable indicator of future results.

But Manraaj is confident that this isn’t the end of the road for his copper investment.

“We could be looking at a 2,514% gain,” he told me this morning.

“You must be joking!” I said. But the Manraaj stare told me that he was most definitely not.

And then he showed me the facts. Granted, it looks like a bit of a speculative play. But if you’re an adventurous type, the potential rewards are very much worth it.

Find out why Manraaj reckons his copper play could make you up to 25 times your money!

Until tomorrow

Ben TraynorSource: Conservatives Crush Labour In Crewe And Nantwich

This is amusing in many ways. There is a nice irony in seeing the government, whose tax and easy-money policies drove the buy-to-let bubble, backed into becoming a buy-to-let investor itself just as everyone else rushes for the exit.

There is also the absurdity of Brown suggesting that his £200m can help the housing market or that it would be a good thing if it did: there surely aren’t many left who think that endlessly rising house prices are a good thing. Then there is Brown’s other idea – that he will push shared ownership, perhaps of these unwanted houses, as a way of helping first-time buyers on to the ladder, just at the very moment that most first-time buyers have realised that the last thing they want is to get on that ladder. Instead, they want to sit back and wait for the market to sort things out for them.

But the best bit of all is the way this seemingly sudden surplus of new houses – houses no one wants to buy – throws light on the nonsense that has been used to rationalise the housing bubble over the past decade. The argument, spouted by everyone, from the founders of now bankrupt buy-to-let “investment” club Inside Track, to the strategists of supposedly respectable international banks went like this: the UK is a small island; there aren’t enough houses on it for our growing population; this shortage of supply means house prices will go up for ever.

So much for that – even our housing minister thinks prices are going to fall 5-10 per cent at best. As it turns out, there are plenty of houses. Some 163,900 houses were completed in 2006 and another 174,900 in 2007 – assume three people per household and that puts a new roof over the heads of not far off one sixtieth of the population. The thing in short supply was never houses. No, it was common sense.

This brings me neatly to oil, another area where any price level can seemingly be justified by the shortage of supply argument. A few years ago, only a few brave analysts were predicting oil above $50. Now to be taken seriously in analyst land you’ve got to be forecasting $200. And the argument used to back all this up? Yes, it’s limited supply meets limitless demand. Years of cheap oil meant that until very recently the oil majors made no effort whatsoever to explore for new oil reserves, nor to find ways of upping production from existing reserves: every presentation ever given on oil contains a slide on the fact that a major new oilfield has not been discovered for 40 years. This stupendous underinvestment has now, as Tim Price of PFP Group puts it, “crashed horribly into a historic surge in global demand”.

I’m not for a second suggesting that this fundamental case isn’t true. It is – just as it is true that the UK has a limited amount of land and a large population. But that doesn’t mean that it justifies an oil price of $200 or $150 or for that matter of $120 in the same way as the fact that the UK land shortage can’t justify a price of six times the average salary for the average house.

Right now, in a rational world, the oil price should be at least stalled and probably falling. Let’s not forget that in the UK we are almost certainly on the edge of recession (even Mervyn King admits to the possibility now) as is the US and as are the likes of Ireland and Spain. That suggests that much of our direct demand for oil is going to fall away, as is our indirect demand: note that a percentage of the oil used in China is used to make and transport the stuff the West buys – stuff it might not buy so much of next year.

At the same time, supply is rising – albeit slowly. There are more oilrigs in action than ever; there are a good number of big projects in the pipeline; and according to Citigroup, world oil production was up 2.5 per cent in the first quarter of 2008.

So why is the oil price still rising? The picture is complicated by the fact that that so many countries pay out vast subsidies to keep the price of oil products down. In Saudi Arabia a litre of petrol costs a couple of pence, in Venezuela it comes in at around 8p and prices are heavily subsidised in India and China too. This means that as global prices rise, consumption doesn’t fall as it would in a free market. It is also complicated by the arrival of the global investing community: US pension funds poured $40bn into commodities in the first quarter of this year, more than they put in in all of 2007 and money is still piling into the story. The result is that oil could, just as houses did in the UK in the first half of 2007, “melt up” – move higher and higher on a wave of overblown “supply shortage” conviction. You might make a lot of money if you bet on this – modern markets love melt-ups – but the problem with doing so is that when markets melt up they then melt down very fast indeed. I’m not nearly brave enough to be in the oil market right now.

Source: No Oil or Housing Shortage, Just a Lack of Common Sense

Down in Putney, along the bank of the Thames, there’s an oldish Jag parked on a side street with a personalised number plate. Given the one time reliability reputation of Jags, it was perhaps chosen with some justification.

It reads: PE51MST.

The word fits the view prevailing on the UK economic outlook – whether you’re a central bankers, a politician or most likely amongst the majority economists call ‘consumers’. Bad news is chasing us down the street…

The Bank of England says it could be recession down the road. Inflation is going up for some time to come – north of 3%, unemployment is starting to edge up too, credit is harder to come by and costs more – in spite of the best efforts of the Bank of England, house prices are going down and house building has slumped, commercial property prices have too – by 16% since last summer says the Bank of England. Our leading banks have lost billions – Barclays announces another £1bn write down this morning – and once proudly touted government golden rules on borrowing become instead lead weights around Gordon Brown’s increasingly vulnerable neck.

Okay so we’ve had our fill of the bad news. Is there anything we can be OPT1M1ST about? Well, looking at the stock market Mr Market’s mood appears to be cautiously more positive. The FTSE 100 hit a low for the year to date on March 17 closing a little over 5,400. It’s up 15% since at a little over 6,200. MoneyWeek is bullish on Japan and the Nikkei is showing signs of recovery. It hit a four month high close today.

UK stock market sentiment as measured by Sharescope has risen since its March low though remains marginally bearish. As we’ve said, stock markets are the great expectation machines and always straining their eyes on the horizon to see what’s coming…then discounting it before it arrives.

The worst of the credit crisis is over they say but as we can see from Barclays latest £1bn write down and collapsing bank shares, it is by no means over. The FTSE 100 is marginally higher today yet RBS, a constituent of it, has slumped 14%. The bank has given up half its market value over the past year, a grim stat that causes some degree of personal financial pain to your editor. Given the bank is reported to be sounding out shareholders about the level of support for top management; it has hardly a vote of confidence.

Commodities have edged down from their highs perhaps only temporarily but no boom lasts forever. Central bankers will hope this one ends sooner rather than later and the market price mechanism will assert itself once again as the universal regulator of demand. Oil is a little down from its high at $124 and food prices are showing signs of stabilising reports the FT.

As for the Eurozone, “old Europe” – France and Germany – is leading the charge. European growth in the first quarter came in at 0.7% against consensus of 0.5% and that in spite of the drag of sluggish Med economies such as Spain and Italy.

Growth has hit its fastest pace in 12 years in Germany and surprised on the upside in France. Eurozone rates remain at 4% as inflation has bubbled up to a 3.6% high in March, easing to 3.3% in April. If he can keep that virtuous cycle going in the face of ‘cost shocks from abroad’ the European Central Bank’s Jean-Claude Trichet will be in clover.

*** News from the frontline on the ongoing creative destruction of traditional print media… Johnston Press plc, a regional newspaper publishing business with a heavy debt load, is raising £200m plus in emergency funds as ad revenue wilts under the pressure of the internet.

“Traditionally,” reports the Independent “three-quarters of its revenue comes from ad sales.” Those sales have been falling relentlessly. Last year classified ads fell over 3%, car ads more than 8% and larger display ads 4%. Ad revenue fell another 4% in January and February this year. We’ve said it before, we’ll say it again. Sooner or later someone is going to start closing newspapers.

Regards,

Rob Mackrill
The Daily Reckoning

Source: Old Europe, New Growth