• The world’s biggest nuclear utility company, Electricité de France SA will offer as much as $6.5 billion for assets of Constellation Energy Group, Inc (CEG), source familiar with the matter told The Wall Street Journal. A previous offer by EDF was turned down, with Constellation opting for a $4.7 billion bid from Warren Buffett’s MidAmerican unit of Berkshire Hathaway Inc. (BRK.A,BRK.B).

• Research In Motion Ltd.’s (RIMM) third-quarter subscriptions and profit fell short of forecasts, as it simultaneously faces increased competition and recession in its largest market. Profit for the Blackberry maker rose no more than 83 cents a share in the quarter ended Nov. 29, well short of its goal of 97 cents, Bloomberg reported.

• Legg Mason fund manager Bill Miller said yesterday (Wednesday) that the “bottom has been made” in U.S. equities and that the Federal Reserve should purchase stocks and junk bonds to pull the United States out of the financial crisis Reuters reported. Miller said that all long-term investors believe that stocks today are cheap after acknowledging that his funds “performed far worse than I would’ve predicted we would” this year.

• Online retail spending rose 15% on “Cyber Monday,” the Monday immediately after Thanksgiving, from a year earlier, according to tracking firm comScore Inc. Consumers spent $846 million shopping online Monday, comScore said.

• Declining imports led to a surprise drop in U.S. crude oil stocks last week, the Energy Information Administration (EIA) said yesterday (Wednesday). Supplies of crude oil fell by 400,000 barrels to 320.4 million barrels in the week to November 28. Crude imports fell 1.46 million barrels per day (bpd), the IEA said.

• New Zealand’s central bank yesterday (Wednesday) cut its key interest rate by 1.5 percentage points to 5%, hoping to break the worst recession its faced in nearly two decades, Bloomberg reported. “Today’s decision takes monetary policy to an expansionary position,” Reserve Bank Governor Alan Bollard said in a statement in Wellington today. “Policy is working together with the depreciation of the New Zealand dollar and fiscal stimulus to create the conditions for some rebound in growth.”

Source: Global Investing Roundups Thursday, December 4th, 2008

This from Money Morning:

With America’s “Big Three” automakers all due to submit turnaround plans to Congress today (Tuesday) – a requirement if General Motor Corp. (NYSE:GM), Ford Motor Co. (NYSE:F), and Chrysler Corp., are to receive $25 billion in government loans – I couldn’t help but recall the moment eight years ago when I realized the U.S. auto industry was skidding toward a financial collapse.

I’ve been thinking about that market call of mine a lot of late, particularly after recently reading that JP Morgan Chase & Co. (NYSE:JPM) credit analysts had rated GM’s distressed debt as a “Buy,” noting that the company was likely going to survive.

It was October 2000, and I’d just joined a multi-billion-dollar asset management organization as its head of credit. While most of my experience before this was with very risky and fast-moving emerging markets, this new position was focused on the top tier of the investment market, since the group I was joining had a marked risk aversion and was managed with capital preservation as its main mantra.

“Piece of cake,” I thought to myself.  After decades of deciphering volatile emerging economies, I had “graduated” to analyzing strong companies in the top economies in the world. These credits were all rated “A” or better. And the proportion of our holdings that were not rated “AAA” was a rounding error.

WorldCom Inc., Enron Corp., and the U.S. “Big Three” carmakers were among the companies I had to analyze, as well as some 208 structured investment vehicles (SIVs).  The curious asymmetry was that while companies like Enron and WorldCom were rated “A,” and had tremendous – yet officially unrecognized – risks to the downside, their commercial paper was rated “A1” and “P1,” the highest possible rating offered by leading rating agencies.

The SIVs, Enron, and WorldCom did not resist even minimal analysis. I axed the two companies, as well as the SIVs that did not offer a full guarantee from the sponsor. So I ended up starting with the corporate bonds, by first addressing the largest exposures we had.

A Debt-Focused Tour of America’s “Big Three”

Since the three U.S. carmakers – all carrying “A” ratings on their bonds, and “A1” to “P1” on their commercial paper – accounted for about one-third of all investment-grade paper outstanding, I analyzed them first.  I had a large advantage over my peers in the investment grade industry:  Since emerging-market credits – both sovereign and corporate – were overwhelmingly in junk bond territory, I had seen over years how late the rating agencies were in adjusting their ratings to the credit reality of the issuers in general.

The foregone conclusion in “junk land” was that the rating agencies provided lagging indicators of credit risk.  In addition, having analyzed credits in Argentina with 1% inflation a day, as well as massive, surprising devaluations, I knew how distorted financial statements can become and was highly skeptical.

When I downloaded the balance sheet for General Motor back in the third quarter of 2000, I was stunned. Something just wasn’t right. These numbers I saw just couldn’t be correct.

“Surely I had made a mistake and downloaded the wrong one,” I thought to myself.  “I must have downloaded a subsidiary’s or maybe the parent company’s unconsolidated balance sheet.”

I checked and re-checked.  I had the right one.  The company’s equity-to-assets ratio was only about 2%  – and that was before counting its under-funded pension liabilities. With that deficit factored in, GM had negative equity.

In other words, the leading U.S. carmaker was technically bankrupt.

Now, I wouldn’t even lend money to a bank with such high leverage. And a bank diversifies the risks in its lending portfolio, is highly regulated, and secures a huge amount of its lending with hard assets.

But an industrial company sitting on hoards of car inventories and loans backed by used cars … that nobody particularly liked?  Not a chance.

With such low levels of equity, the ability of a company to withstand an economic shock is almost nonexistent.  So, I searched around for any possible redeeming qualities that I could be missing.  But after a very thorough review, I concluded that we had to drop all three of the U.S. carmakers – GM, Ford and Chrysler.

When I brought my decision to the firm’s chief investment officer, a portfolio manager with years of experience in the investment-grade debt market, and a person I’d known back during my days at Merrill Lynch & Co. Inc. (NYSE:MER), he was unnerved.  He trusted my judgment, but he, like the rest of the market, was confident that each of the Big Three was “too big to fail.”

Nevertheless, with our firm’s overarching commitment to capital preservation, we negotiated a fast wind-down of exposures: We would sell all the long-term exposure immediately, freeze any new exposure and we would not roll over the commercial paper – most of which was due to mature within a couple of weeks.  In this way, all of our Big Three exposure would be gone within weeks, and we were confident each of the three had the cash and near-term liquidity to pay us back.

A couple of weeks later, at a charity function, I happened to bump into the former head of one of the premier asset management organizations in the world.  In a short conversation, I mentioned my private concerns. The gentleman draped an arm across my shoulders and essentially told me that “the Big Three are not going to go bankrupt.”  That was it.  Another too-big-to-fail advocate.

The Too-Big-to-Fail Myth

Evidently, there were reasons beyond mere creditworthiness that led this very smart man – and others – to keep ignoring the fact that the automotive emperor had no clothes.  The pre-eminent one is the “too-big-to-fail argument,” and those who make that argument are trafficking in the moral hazard trade.  Yet, even today, GM on its website ardently contends that it is indispensable to the U.S. economy, hoping to persuade U.S. taxpayers to throw good money after bad.

(We’ll find out how Congress feels about that argument after GM, Ford and Chrysler submit their plans today. It certainly won’t help that today we’ll also likely find that November sales from the major automakers show only a limited bounce from 25-year lows.)

The other argument is that the auto industry is “strategic” to national interests.  That is to say: How can a country defend itself if it produces no vehicles?  And what about advanced transportation and classified technologies research?

But that argument does not hold up under scrutiny, either.

As eminent economist Martin Feldstein has reminded us, giving the Big Three $25 billion will last less than a year. The reason: They are burning through about $7 billion each a quarter.

Clearly, forcing the three carmakers to restructure will be in everybody’s interest.

Through bankruptcy – with some, minimal government intervention – we should force the inevitable restructuring to take place. As a result of that restructuring, worker compensation levels will be brought into line, employee and retiree health benefits will be reduced to lower-but-still-competitive levels, any dividends will be eliminated, and executive payouts and perks will be capped. How far must this go?

That’s easy – keep cutting until the companies are restored to health and, most important of all, to a state of long-term viability.

This does not mean that the Big Three will disappear. What will disappear is corporate waste. The companies will restructure/continuing profitable activities and liberating resources from unprofitable ones to expand future development.  This has been done successfully – and en masse – in many “strategic” industries, such as the steel business in the United States, and telephony, utilities, energy, aerospace, and many others that were restructured in the 1990s in Argentina, Brazil and South Korea.

There is no reason why each of the Big Three – each currently the laughingstock of the global auto industry – should not regain their leadership positions, as measured by profitability and technological prowess. In this way, GM, Ford or Chrysler – or even all three – can create good, secure jobs and contribute to the U.S. economy, rather than detracting from it.

To be fair to GM and the others, they all have attempted to restructure. They’ve secured agreements with the United Auto Workers union that were designed to control costs. And they’ve tried to launch newer, better vehicles.  But those agreements are too little/too late, and the sands have run out of the hourglass.

Union leaders from GM, Ford and Chrysler have now scheduled an emergency session for tomorrow (Wednesday) in Detroit as the companies plan to seek concessions from the United Auto Workers to help land those win $25 billion in government loans, Bloomberg News reported yesterday (Monday). Participants will be asked to reopen a 2007 labor agreement to consider concessions. GM, which has said it may run out of cash to meet its obligations, wants to stop paying union workers when plants are closed and there isn’t any other work for them to do. Now Ford and Chrysler are expected to ask the UAW for similar concessions as part of their bid for the government aid package, Bloomberg said.

All three of the American carmakers were technically bankrupt since at least the time of my first analysis near the end of 2000, and the union agreements still did not bring compensation down to levels comparable to that of their competitors. Now the U.S. automakers are on life support.  There is no time left for gradualism.  They missed that window long ago and the costs imposed on all U.S. taxpayers figure to be huge.

The current predicament in which GM, Ford and Chrysler now find themselves is not only their own fault, as we’ve now already been subsidizing the unions for far too long.

Are Unions to Blame?

One of the biggest reasons Detroit’s Big Three have run out of capital is the extraordinary compensation that has been paid out to unionized workers in the United States.

Even in the last reported quarter, when the economies of Europe and Asia had slowed dramatically, GM was almost breakeven in those two regions and actually had 10% profit growth in Latin America, Africa and the Middle East, where GM also has unionized work forces. But the company is losing money in the United States.

That’s because the GM pays about $75 per hour – $156,000 a year – to its assembly line employees.

And because of that, the Big Three are lagging far behind in technology investment. That has not only damaged the auto-related technology industry, but has decreased productivity and innovation, delaying the shift to more fuel-efficient technologies.  And because they have jointly held the market leadership, they set prices high, allowing foreign competitors to undercut them.

These phenomena have increased the costs of transportation for all Americans for decades.  Americans have overwhelmingly voted with their dollars by buying foreign brands, which has contributed to our growing trade deficit.

Ultimately, inefficiencies in the auto industry have imposed huge costs on the rest of the economy, putting the Big Three at a competitive disadvantage that has hurt profits, cost the economy jobs, and opened the door to foreign companies to export U.S. dollars back to Germany and Japan (and now South Korea and China).

GM lost $21.3 billion in the third quarter and burned through about $7 billion in cash.  It has only about $16 billion in cash left, and already its liabilities are $60 billion larger than its assets, which means that GM has negative equity.

And the current quarter will be worse.

The bottom line is that GM is essentially bankrupt – and has been for years.

At this point, GM should – like so many companies before – have to restructure its costs to a point that allows it to be competitive before receiving a single taxpayer dollar.  Otherwise, we are just throwing good money after bad and it won’t be long before GM comes crawling back for more.

I just hope that the politicians and government officials in Washington are wise and determined enough to control the situation, and force the bitter medicine down the company’s throat.

To Buy, or Not to Buy

In this environment of high uncertainty, I would not go near any GM securities.

However, highly sophisticated players may consider making a very small bet, in one of several ways. With GM’s bonds and credit default swaps trading at near-bankruptcy levels (15 cents on the dollar), it may be attractive (albeit highly speculative) to buy GM’s bonds, in the hope of converting these debt securities into the debt-and-equity of a newly restructured General Motors. Over the course of a couple of years, this could turn out to be extremely profitable, but only if GM’s work-force wage-and-benefits costs are brought into line with the company’s global rivals – and if the U.S. economy recovers. Among the many financial scenarios under review, GM’s board of directors is reportedly considering an option that would grant current bondholders equity in a restructured company in return for maneuvering room, according to media reports.

Reuters reported that GM’s bonds fell nearly 12% early yesterday (Monday) as investors waited for the automaker to submit a new turnaround plan that might actually have a chance of winning lawmaker support. GM’s 7.125% notes due in 2013 fell to 23 cents on the dollar, down from 26 cents on Friday, according to MarketAxess. As we noted earlier, GM is due to submit that plan by today.

When JP Morgan’s credit analysts made their market call last month, GM’s benchmark 8.375% bond due 2033 has dropped to 25.75 cents on the dollar, which was down from 36.5 cents at the end of October, MarketAxess said. The bonds had traded at more than 80 cents on the dollar at the beginning of the year and currently yield 32.5%.

In the case of selling credit default swaps, an investor would get paid some 80% to 85% of the value they are “insuring” up front. If GM gets bailed out, which is an increasingly likely scenario, that investor would keep the full premium and walk away.  And in the case of default, that investor would have to pay the buyer 100%, therefore losing some 15% to 20% after the default, but getting the bonds he is insuring in exchange for that loss.  We would then take the bonds into the restructuring as noted above.

I would not buy the actual GM shares, even though I have friends in high places in finance that still believe in the too-big-to-fail theory. My concern with GM’s stock is that there would be a very strong chance the company’s equity gets totally wiped out in a bankruptcy, or at least heavily diluted as a result of any government infusion the company receives.

GM’s shares closed yesterday at $4.59 each, down 65 cents each, or 12.4%. They have traded as high as $29.95 in the past 12 months. The company right now has a market value of only $2.8 billion.

Source: Buy, Sell or Hold Insight: GM Remains a High Risk Profit Play – Even as it Files its Turnaround Plan Today

Anyway, the money we were planning to use for the purchase I kept in a Vanguard Tax-Free Money Market Fund.

“I know a better alternative,” one broker told me. “I have a money market plus fund that will yield more, even after taxes.”

I told him thanks but I wasn’t interested.

“What’s wrong with a higher yielding money market?” he asked.

“Nothing,” I said. “It’s the ‘plus’ that bothers me.”

As a young man starting out on Wall Street, I confess I learned many lessons the hard way. One is that every financial product with a plus has a corresponding minus. The bigger the plus, the bigger the potential minus.

You want to own junk bonds instead of high-grade corporates? Expect hair-raising volatility – and occasional defaults – from time to time.

You want to own stocks instead of bonds? Good idea. But, remember, the trade-off is likely to be occasional sleepless nights.

You want the even higher potential returns available in companies headquartered in Brazil, India or China? Fine. But expect to go off Niagara Falls from time to time. That’s just the nature of emerging market investing.

Of course, most people don’t expect too many thrills and chills in a “money market plus.” This year, however, Halloween arrived early.

Friday’s Wall Street Journal reports that Charles Schwab is offering settlements to investors in its Schwab YieldPlus Fund, advertised as “a vehicle for conservative investors looking for a slightly higher yield while preserving their capital.”

So far this year the fund is down 26%.

Some investors are wondering what the heck happened. Here’s a brief tutorial.

Money market funds generally invest in high-quality, short-term securities with minimal credit risk. They pay dividends that fluctuate, reflecting what is happening with short-term interest rates. According to the Investment Company Institute, approximately $3.4 trillion was invested in money markets at the end of last week. (Stock funds, by comparison, hold roughly $6.5 trillion.)

A “money market plus” or “ultra-short-term bond fund” is a different animal. These are known as “enhanced cash” products.

Enhanced cash funds are typically not registered with the SEC and seek higher yields than money market funds. Unfortunately, Milton Friedman was right. There is no free lunch.

To earn these higher yields, enhanced cash funds exceed the SEC rule restrictions on money market funds governing the credit quality, diversification, and maturity of investments.

In Schwab’s case, YieldPlus bet heavily on mortgage-related securities. When those securities tanked, so did YieldPlus.

Schwab has offered a settlement to investors, who had more than $13 billion invested in the fund at its peak last year. But the offer amounts to pennies on the dollar.

Schwab isn’t the only company to experience this problem, incidentally. Other major Wall Street firms have paid millions to settle similar class-action suits.

The lesson here? Higher yields always come with higher risks. Always.

Long-term bonds can get creamed while short-term bonds hold steady. Junk bonds can default while Treasuries rally. And the “plus” in your money market plus fund?

Read the prospectus. Some day it just might turn into a minus.

Good investing,

Alex

“I’ve already called this credit crunch, ‘the worst financial crisis since the Great Depression’…and unfortunately, we’re not through it yet” says Eric Roseman.

It’s true the worst of this credit storm has probably passed. But banks, companies and individual investors are still facing funding pressures. That tells me the absolute bottom of this crisis has yet to arrive.

The highest estimates I’ve heard say it will take US$1.7 trillion to clean-up this credit crisis. The more conservative projections allude to a US$500 billion cleaning bill (remember when half a trillion dollars seemed like a lot of money?).

Either way, it’s not time to buy aggressively into stocks.

But investment-grade bonds are starting to look increasingly attractive – particularly as credit spreads start to stabilize among highly-rated corporate debt instruments and Treasury bonds. But it’s still too early for bargain-hunting in equities and riskier debt markets.

The Smart Money Isn’t Following the
Sucker Stock Rallies

This morning’s edition of the Wall Street Journal points to lingering concerns in debt markets. According to the Journal, credit spreads for higher risk bonds, short-term inter-bank lending rates and investment-grade corporate financing remain under severe pressure.

Stocks might have mustered a big rally yesterday, but the smart money in credit markets is showing a very different picture on the state of the American economy.

How will investors know it’s time to load-up on distressed common stocks again? Is there a set of indicators that allow you to measure credit stress?

As the bottom of this bear market eventually arrives, look to credit markets for signals that it’s time to resume your buying. Bonds and credit spreads will provide a far more accurate gauge to global investors than stocks, which tend to harbor false recoveries or “sucker” rallies.

Yield-Curve Inversion Warning in 2006-2007

Back in 2006, the Treasury yield curve turned negative, and accurately forecast an economic recession. Back then, I was writing about it - warning about this dangerous anomaly.

Today, it’s still my opinion that bonds represent the “smart money” in the financial markets. Historically, bonds have accurately predicted economic recessions more often than not.

An inverted or negative yield-curve occurs when short-term interest rates yield more than long-term rates. That’s an anomaly in fixed-income markets that has historically preceded a slowdown or an economic recession about 12 months later.

At the time, most analysts refuted this price action, but it still proved incredibly accurate. By July 2007, the credit markets had begun to unwind and stocks tanked, finally hitting bear market territory for the first time since 2002.

While Treasury bond inversion accurately forecasted trouble ahead, that wasn’t the case for the Dow or the S&P 500 Index.

In stark contrast, the S&P 500 Index in mid-2006 was still in bull market mode, defying the repeated warnings from the Treasury market as yield inversion grew louder. And most high-risk credit markets, namely high-yield or junk bonds, also continued to race higher even as the Treasury market began predicting trouble.

The Credit Crisis Check-List

I thought I’d give you a little insight to how I gauge the markets. These are the indicators I’ve been watching like a hawk for years. And today, I’m using this checklist to predict when the current credit crisis will bottom. More importantly, I’ve got my eye on these indicators so I know exactly when I can re-enter the stock market. You can do the same.

I’ll elaborate on each of these indicators so you can better identify what to follow and eventually, call your broker and start loading-up on equities again!

• LIBOR and SWAP rates
• Credit spreads
• Mortgage-backed securities
• Junk bond defaults
• Credit hedge fund failures

LIBOR and EURO LIBOR are important short-term overnight lending rates. LIBOR or the London Interbank Offered Rate has historically traded slightly above the official Federal Funds rate. Euro LIBOR has also historically traded just above the European Central Bank’s official base rate since the currency was introduced in 1999.

The SWAP Rate -
A Sign That Banks Aren’t Confident to Lend

The difference between LIBOR and overnight interest rates set by central banks is called the SWAP rate. This spread number must relax or narrow before credit markets get a “green” light to unclog and start lending as usual again.

But since last summer when sub-prime began to boil, overnight lending rates have skyrocketed. Despite the Federal Reserve’s best efforts to lubricate the wheels of the funding markets since last summer, inter-bank lending rates remain high. And institutions are reluctant to commit overnight funds to one another.

This lack of confidence among banks in the United States, Canada and Europe, is spreading to Asia. As banks grow wary of lending to one another and question inter-bank collateral, the cost of funds increases exponentially. And that slows economic growth.

LIBOR Rates Say Banks Are Holding onto Their Cash -
A Sign the Credit Crisis Is Still With Us

From its high last fall, U.S. dollar LIBOR SWAP rates managed to decline before Christmas. That was after the Fed and other central banks injected gobs of credit to stabilize the financial system.

But since March, LIBOR SWAPS and its European counterpart, Euro LIBOR SWAPS, have jumped. This is an important signal that the credit crisis is not over. Until LIBOR SWAP rates decline and return to normal spreads above central bank monetary targets, the crisis continues.

CREDIT SPREADS are another indicator worth watching. The spread between risk-free Treasury debt and other bonds like corporate debt and junk bonds is called a “credit spread.”

When the economy is strong and deal-flow is rampant, credit spreads will narrow. That happened as we headed into 2007 last year. Junk bonds, which are below investment-grade credits, saw their yields hit historic lows versus Treasury bonds last spring. That was just ahead of the July sub-prime blow-up. At the time, high-yield bonds paid under two hundred basis points (2%) above T-bonds – unbelievably low.

Today, that spread is just below 10%. And it’s likely it will rise further as default rates climb in a recessionary economy. Until credit spreads for riskier bonds begin to tighten or narrow significantly, the economy remains on the rocks.

Those Mortgage-Backed Securities
We’re All So Fond Of

MORTGAGE-BACKED SECURITIES encompass a wide spectrum of instruments ranging from synthetic illiquid CDOs or collateralized debt obligations to bonds issued by government agencies like Fannie Mae (FNMA) and Freddie Mac (FHLMC).

You’ll be able to tell when stability returns to the mortgage-backed area by watching the mortgage-backed derivatives and the more conservative mortgage bonds guaranteed by FNMA. When both of these numbers bottom, that’s a sign this credit crunch is easing.

The good news is that PIMCO’s Bill Gross, the world’s savviest bond investor, has loaded-up on 30-year mortgage bonds guaranteed by Fannie Mae. These bonds yield almost 2% more than Treasury bonds. That’s a bullish sign that investors are returning to the safest segment of the tattered mortgage market.

However, the mortgage-backed market still has a long way to recover. In all likelihood, the CDO market and other synthetics tied to mortgages will probably never trade at par-value again. But at some point, deep value investors will start buying some of the more liquid CDOs, and that will point to a bottom in this market.

Sometimes It Pays to Watch the Junk

JUNK BOND DEFAULTS typically hit a high in excess of 5% of outstanding instruments during a recession.

At the moment, the junk bond default rate is under 2%. That suggests many more financially leveraged and indebted companies will head into bankruptcy or credit default. I would have to see a much higher default rate among American high-yield or junk bond companies before turning bullish on the stock market.

CREDIT HEDGE FUNDS represent the largest segment of total hedge fund assets, now an estimated US$2 trillion. Combined with leverage, credit hedge funds are the dangerous pariahs of the investment world in 2008 as more of their investors scramble to redeem assets.

Many credit hedge funds have already collapsed or have been liquidated since 2007. As assets are liquidated to meet growing redemptions, hedge funds must unwind leverage and ultimately, abandon many positions in the credit markets that are illiquid. This will snowball into a major disaster for leveraged hedge funds in asset-backed, distressed and event-driven hedge fund strategies.

The end of the credit crisis will likely coincide with a major blow-up at one of the largest credit hedge funds in the world. To date, the failures have mostly represented second-tier or smaller industry players.

Hang In There, This Will Pass

The above credit market check list is by no means absolute. But if you’re looking for a bottom in stocks, these numbers can help you gauge when it’s time to buy again. And of course, I’ll continue to watch all these indicators for signs of a bottom. And I’ll let you know the moment I see it coming here in the A-Letter.

This credit crisis will eventually pass. The worst is probably behind us for most segments of the debt markets but danger still lurks for equity investors. Tread carefully and heed the signs of credit, not stocks, for a true bear market bottom.

ERIC ROSEMAN, Investment Director

EDITOR’S NOTE: As Eric watches for signs this credit crunch is easing, a related crisis is emerging worldwide. It’s a dangerous cocktail of worldwide food and fuel inflation. This disastrous combination has already sent commodity prices sky-high and sparked protests, hoarding, strikes and deadly riots the globe over. Today is your last day to find out FREE of charge exactly why these record-high food prices will continue to rise – and how to use that information to make up to 910% on these soaring commodities. You have until MIDNIGHT tonight. Click here.

“America’s triple-A credit rating may be in danger”, says Standard and Poor’s.

If the country has to bail out Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) through a prolonged recession, it could cost the nation’s treasury as much as 10% of GDP.

We’re beginning to see the whole world financial situation as a U.S. problem. There is a lot going on…but the big story seems to be about America (and Britain, to the extent it shared the Anglo-Saxon economic model)…its money, its wealth and its place in the world.

The plot is simple enough. After an extremely successful run, the United States is struggling to maintain its edge. Its people are deeply in debt. Its currency is being sold off. Its labor…its capital markets…and its technological lead are all being challenged by faster, more youthful competitors.

Like any Greek tragedy, the hero is a victim of his own hubris. He thought he could steal the gods’ fire and get away with it.

Americans thought they could do things that have always been off-limits to mortals. They believed they could operate a financial system based entirely on paper money, for example. They believed they could spend money they hadn’t earned – and live off credit forever. They believed the myths of the Efficient Market Hypothesis and Benign Capitalism…the Black Scholes Option Pricing Model and the Great Moderation…that Deficits Don’t Matter and the War on Terror does.

And now…the whole society is being marked down – by inflation, deflation and a trillion-dollar, unwinnable war.

On the surface, it is merely another chapter in the world’s financial history. George Soros elaborates:

“The current financial crisis was precipitated by a bubble in the US housing market. In some ways it resembles other crises that have occurred since the end of the second world war at intervals ranging from four to 10 years. However, there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.”

Those last 60 years were the 60 glorious years in which the United States was on top of the world. It’s the period roughly corresponding to Baby Boomers’ lives. Born after WWII…growing up in the ’60s…taking command in the ’80s…and now looking forward to retirement. Was there any better time to be alive? Was there any better place to be alive in than the United States of America? Its money was the world’s best. Its economy was the most dynamic and productive. And its people were the world’s richest. Full employment. Full stomachs. Free love and open bars…what more could you ask for?

Yesterday, the dollar hit another record low against oil. It now takes $111 to buy a barrel of oil…and, in Atlanta, $3.36 to buy a gallon of gasoline.

“That’s nothing,” said our driver in Manchester yesterday. “Here, the price of gas is nearly $10 a gallon. Of course, you don’t see any big American gas guzzlers either.”

Our driver showed us the instrument panel of his 2-year-old Skoda. It revealed an average fuel consumption of 56 mpg.

The car was comfortable and reasonably large. It didn’t seem to lack power.

“Here in England, we couldn’t afford to drive your cars,” he concluded.

Our guess is that Americans can’t afford to drive American cars either. The latest numbers show consumer spending rising – but only because consumers are forced to spend more on fuel. And experts believe that the summer of ‘08 will be the first in which Americans actually drive less – forced off the road by high fuel prices.

Most people think of inflation as affecting prices they pay for bread and magazines. But inflation has a bigger agenda; it adjusts the wealth of whole societies.

The problem for Americans – and many others in the developed world – is that their wages are too high. They are used to earning a lot more money than their counterparts in, say, China or Vietnam. But why? Only because they have more capital and more skills, so they can produce more. But that situation is changing fast. Capital is piling up in China, Russia, Brazil and India – and elsewhere. As a result – wages in those places are soaring. Nestle just agreed to a 16% wage increase for its St. Petersburg, Russia, staff. In China, urban wages rose 18.7% in 2006. Ten percent annual increases in India are said to be the average.

In the United States, the last real, hourly wage increases came in the 1970s. Since then, adjusted for inflation, wages have been flat. But we Baby Boomers scarcely noticed. Because we were entering our peak earning years, our assets (stocks, then houses) were rising in value, and the expanding credit cycle left us with more money to spend.

But now, as Soros points out, that credit cycle has turned against us. The super boom is over. Our houses are going down. And the value of our labor and our stocks – which have held fairly steady – are being marked down by inflation. We are not becoming a Third World country…but we are becoming a poorer one…with a labor force that is less and less overpriced each year. Seems like a good time to retire. But forget the Winnebago – with gasoline at $3.36 a gallon, who can afford to cruise around on the wide-open spaces?

“Inflating is immoral in a sense because it steals,” Ron Paul said to us in an interview for I.O.U.S.A. “It steals value if you double the money supply and your prices go up twice as much…it’s an invisible hidden tax. But the real immorality here is that some people pay higher prices then others. So if you’re in the middle class, or especially low middle income, your prices might be going up fifteen percent a year. Somebody on Wall Street working leverage buyouts doesn’t have to worry about the rising cost of living. This to me is a immoral act, that is prohibited by the Constitution, and the outcome is always tragic.”

Could it be downhill from here on out – to the end of our lives?

Maybe…

[For your updates on I.O.U.S.A. see here.]

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Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

One of them is detecting tremors from the change in the holdings of U.S. government debt by foreign central banks, as indicated by their accounts at the Fed. These guys bought up, last week alone, a mighty, mighty $22 billion’s worth!

If you are one of the people who write me and ask things like, “Do you realize you are an idiot?” (Answer: yes) and, “Why are interest rates so low that only a freaking idiot would be buying bonds that yielded less than the rate of inflation?”, then this, perhaps, is part of the answer you are looking for; foreign central banks are (for one) buying, buying, buying government bonds and increasing their ownership of your future tax dollars, and providing a lot of buying power to the bond markets, which makes bond prices go up and the yields go down, down, down.

For example, from Bloomberg.com we learn that the bond market is bad all over the place, and “Every industry group except energy and utilities posted negative returns this year. Bonds of finance companies lost 20 percent; media bonds, 10.2 percent; and real estate securities, 9.9 percent. High-yield, high-risk bonds are off to their worst start ever. Junk bonds have fallen an average 3.9 percent this year, losing about $35 billion, according to data from Merrill Lynch & Co. indexes.”

And one of the sensitive Mogambo Economic Tremor Detectors (METD) shows that the apparent slowdown in Total Fed Credit for the past few months has now been revealed as a mirage, and Federal Reserve Credit has now ballooned another $6.1 billion last week, handily taking the total to a new, all-time record of $876.6 billion.

Even more staggeringly, the Treasury Gross Public Debt expanded by over $150 billion in March! Hell, it was up $60 billion last week alone!

And not content to just destroy the currency, they are up even weirder stuff, and to show you the kind of weird things that you will see a lot of from now on, Jon Nadler at Kitco.com writes, “And now, for something completely different: The birth of the ‘BPT.’ The Bubble Protection Team. If anyone had (valid) doubts that the ‘Plunge Protection Team’ either existed at all, or was noticeable in certain markets, welcome to the new reality of a revamped Fed.”

He says that according to the New York Times, “The plan of Treasury Secretary Paulson to overhaul the financial system includes a crucial proposal: it would officially transform the Federal Reserve into a ‘market stability regulator’ rather than merely a banker’s bank. The Fed is no longer just a regulatory agency presiding over a narrow group of businesses called banks. Rather, its mission increasingly is to maintain macro confidence – confidence that the entire financial system is functioning well as part of the whole economy.”

Wow! The Fed deliberately created so much money and credit, for so long, totally distorting the economy of the United States and the world into a grotesque, twisted, cancerous monstrosity so that the entire financial system is choking to death on the poison of un-payable debt loads, and now this same Federal Reserve is going to get MORE powers to create MORE weird distortions and more inflation in the money supply and more inflation in consumer prices like food? Yow! We are freaking doomed!

The weird stuff at the Fed, the weird stuff at the Treasury, and the weird Bear Stearns fiasco becomes a little more suspicious, if that was even possible, after reading, “Wall Street’s Latest Illusion” in Barron’s. Andrew Bary explains, “some Wall Street titans have been able to book gains from the declining value of their own debt.”

If you are like me, you immediately stopped stuffing a yummy burrito into your mouth and intelligently asked, “Huh? Buh a baffa a uhki n aoo uh o eh? A ee nuh grah?” Junior Mogambo Rangers (JMRs) around the world, of course, immediately knew that I was saying “Huh? Book a profit on a decline in your own debt? What is this crap?”

Obviously repelled by the way I am spewing little bits of burrito and saliva all over everything while I speak, Mr. Bary explains, “When a company’s credit weakens and the yield on its debt rises relative to risk-free Treasuries, the debt becomes worth less to the holder. The financial company, which is the debt issuer, then takes a gain, because theoretically it could buy back its debt below face value.” Hahahaha!

So Bear Stearns, bankrupt as it is, would had to have booked a taxable profit on the collapse of their debt, on which taxes may be due? Hahaha! No wonder everybody wanted them to be bailed out!

And with free slop available to anybody who asks for it, from the AP we learn that the hogs are wallowing in the Fed slop, as they are borrowing like crazy from “the Federal Reserve’s unprecedented emergency lending program.”

The Federal Reserve admits that “that those firms averaged $38.1 billion in daily borrowing over the past week from the new lending program. That compared with $32.9 billion in the previous week and $13.4 billion in the first week the lending facility opened.”

Junior Mogambo Ranger (JMR) Paul H. noted that the Fed is going crazy in the Mortgage Backed Securities arena, too, and “Over $51 billion with over $24 billion in MBS alone for the past 2 days”, which he figures “Over a work week (5 days)” would come to “about $128 billion per week. That would make it somewhere in the neighborhood of $6,400 billion per year, if I am nice and give them a 2 week vacation! Yikes, that’s $6 trillion per year !!!”

JMR’s around the world note the use of three exclamation points, which seems just about right for such excesses!! Hell, I just used two of them to comment on his comment, which ought to show you how bad things are!

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Editor’s Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter – an avocational exercise to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning and other fine publications. Click here to visit the Mogambo archive page.