Bill Bonner (The Daily Reckoning, UK):

Are we in a depression yet? The number of Americans living on food stamps has risen to 37 million. The ‘30s had soup lines. The ‘00s have food stamps.

And what else was big in the ‘30s? Escapist movies. Here’s a headline for you:

“Box office takings set to smash records,” says the Financial Times. What kind of movies? End of the world catastrophes… vampires… strange non-humans doing strange things.

For example, there are ads for Avatar all over Europe. The film seems to concern Spock-like creatures who use bows and arrows. Pure escapism, in other words.

Stocks went down a bit in America yesterday. The commentariat blamed it on higher producer prices, thought to be harbingers of consumer price inflation.

Of course, consumer price inflation is what everyone is counting on.

The debts of the past need to be reckoned with. Borrowers are doing the best they can. They pay when they’ve got the money. They default when they don’t. Since ’07, mortgage debt is down about 2% –to about $10 trillion. Most of that decline comes as a result of defaults and repossessions.

Let’s see, 2% over two years ain’t very much. At that rate, it will take half a century to bring mortgage debt down to the comfortable levels of the ‘80s.

What’s more, it will be hard to do at all. Incomes are stagnant… or actually falling. As people cut back on their spending in order to pay down debt, it reduces income to employers, as a consequence of which the economy is weaker… with fewer jobs and less income to the folks who are trying to pay off debt.

What a drag! People ran up huge debts believing that they would never actually have to pay them. They figured they would refinance, and pocket the built-up ‘equity’.

But, according to a report in this week’s press, though mortgage rates are at a multi-generational low, finding a banker willing to lend is as hard as finding a liquor store that makes home delivery on Sunday.

That’s largely because the equity most homeowners have is negative. Houses are down about 30% since ’07. Any buyer who bought or refinanced a house in the last four or five years is likely to be under water.

Even in normal circumstances paying off debt is a long, hard process. Mortgage debt is long-term. Paying it off is long-term too. Many people see years of painful scrimping and saving ahead of them.

What they would all appreciate is a little help from inflation. Inflation lightens the load. It increases nominal incomes while holding mortgage payments steady. It increases nominal ‘equity’ too.

House prices tracked inflation for a hundred years. It was only in the last ten years or so . . .

Click here for the rest of Mr. Bonner’s commentary on The Daily Reckoning, UK Edition.

GMAC is one of the 19 lenders waiting for results of the government’s “stress test,” designed to determine which firms need additional capital to weather a deep recession. Results are due Thursday, and some analysts believe GMAC will be one of the banks ordered to find more capital within six months.

Despite receiving a $6 billion government bailout in December, GMAC reported net losses increased to $675 million from $589 million a year earlier, as the Detroit-based company set aside 78% more for loan losses than a year earlier.
“The effects of a soft economy and weaker credit performance on legacy assets continued to put pressure on GMAC’s financial performance,” Chief Executive Officer Alvaro de Molina said in a statement.

GMAC’s auto finance business notched a profit of $225 million, while the mortgage division, which includes Residential Capital LLC (ResCap), lost $125 million. An earlier gain of $900 million was wiped off the books after the company eliminated mortgage debt and revalued some assets.

The first-quarter loss makes six losses out of the last seven quarters for GMAC. The company had reported five straight losses before breaking the string in the fourth quarter of 2008 on gains from a debt swap.

When GMAC became a bank holding company in December in order to tap federal bailout funds, Cerberus Capital Management LP was forced to relinquish most of its 51% controlling interest. GM, which owned 49% of the lender before the bailout, is also giving up its stake and putting it in a trust.

GMAC agreed to provide financing for Chrysler customers and dealers after the automaker filed for bankruptcy protection last week. GMAC is the main provider of financing to buyers of GM vehicles. Cerberus led a buyout of Chrysler in 2007.

In a press briefing on the day of the Chrysler bankruptcy filing, a White House official said GMAC would receive the “financial support necessary” to expand after agreeing to handle Chrysler’s new loans.

Nevertheless, GMAC “faces challenges if GM files for bankruptcy,” Gimme Credit LLC analyst Kathleen Shanley wrote in a May 1 report to investors, according to Bloomberg News. And while the Chrysler deal presents few risks for GMAC, she recommends selling the company’s bonds.

The company’s bonds rallied this year after the government said GMAC’s auto financing arm is critical to the survival of GM and Chrysler. GMAC said today (Tuesday) in a presentation on its Web site that a GM bankruptcy wouldn’t trigger its own filing.

But Pete Hastings, a fixed-income analyst at Morgan Keegan & Co. in Memphis, Tenn., told Bloomberg that a potential GM filing is a concern because it would have a “depressing effect on revenues.”

“The end markets are still troubled and the economy is still tough,” Hastings said.

GMAC said in April it would resume making car and truck loans to subprime borrowers to boost sales at GM, and that ResCap was hiring 1,000 people to handle a surge in refinancings and jumbo loans.

But GMAC has also said substantial doubt remains about ResCap’s ability to continue operating, citing deteriorating credit and mortgage markets, liquidity and capital.

Source: Stress Tests and GM Bankruptcy Hang Over GMAC As it Reports $675 Million Loss

The biggest change in the American economy over the last few decades has been the transition from making things to making loans. We Americans abandoned the manufacturing industries that once powered our economy and devoted ourselves to merely financial activities. We became experts in “financial origami.” Precisely when and why this happened will be something for historians to debate. But sometime in the 1990s, the percentage of corporate profits from finance surpassed that from manufacturing.

The gap between the two has only grown wider ever since. Before the recent credit crisis hit, profits from financial firms made up nearly half of total corporate profits in the U.S. Only 10% came from the manufacturing sector! As recently as the mid-1960s, these percentages were the other way around.

Eventually America’s over-reliance of financial gimmickry, rather than traditional commerce, left our economy exposed to a serious shock. The shock has arrived. But every crisis brings opportunity. In the current crisis one, investors will go back to investing in simpler, more durable things (at least until forgetfulness kicks in). The focus will shift to things we need, rather than things we want. For instance, investing in a company that supplies grains to hungry people looks like a better bet than investing in one that sells mortgages to people who can’t afford them.

To a smaller degree, we had a similar crisis in the 1970s, Kevin Phillips tells us in his new book, Bad Money. Mortgage debt doubled from 1960-70. Then the stock market crashed, losing 36% of its value from 1969-70. Hedge funds blew up. The top 28 funds lost 70% of their assets, and about 100 brokerage and financial firms disappeared – by either acquisition or outright failure. Seems a lot like the headlines of the present day, does it not?

The 1970s also had two major oil price spikes. The first in 1973-74 and the second in 1979-80. We’ve already had one oil spike now, if a second one arrives in the next few years, it could push prices through $200 a barrel.

That’s because the global oil industry has not been re-investing very actively in developing new production. America’s neglect of “making things” is very evident in the oil business. Phillips says the U.S. has a “dated, ghost-of-glories past petroleum infrastructure.” He writes that the major oil companies “are wealthy, but aging behemoths, hard-pressed to maintain production levels, despite large exploration outlays, and no longer enjoying access to overseas oil fields they once commanded.”

Exxon Mobil, once the largest oil company in the world, now ranks 25th by booked oil reserves. The top 10 are all state-owned national oil companies (NOCs). The top 13 NOCs own four-fifths of the world’s known oil reserves. They don’t share them cheaply.

A look at where we get our oil is not encouraging. Most of these sources of supply are not particularly reliable. As Phillips opines (the table below comes from his book): “Of the eight principal 2007 suppliers of petroleum to the United States as of August, only one, Canada, could be called secure and reliable.” Mexico seems secure, but exports have been falling since 2004, as Mexican production has fallen. It could become an insignificant source of oil by 2012.

And we are not alone in competing for these oil reserves. China became a net oil exporter in 1993, and its appetite grows every year. It is now the world’s second largest consumer of oil, behind only the U.S. China actually imports more oil from Saudi Arabia than the U.S. This partnership is not surprising, given the dynamics of the New Silk Road.

The “New Silk Road” is a term I use for the boom in trade between countries from the Middle East to China. In matters of energy, you see a lot of deals inked on the New Silk Road. Saudi Arabia and China get together regularly like newfound pals. Sinopec, a Chinese oil company, recently got the OK to explore the Saudis’ Empty Quarter for oil and gas. Saudi Aramco, the big oil company, put $750 million toward a huge plant in China.

Just as interesting to me is what I like to call the “New Burma Road” – after the road of World War II fame that linked China and India via Burma. The New Burma Road identifies the booming trade between India and China. As Phillips writes, “China has already made a six-lane highway out of its portion of the road from Chinese Kunming to India’s state of Assam… The demographics of a Sino-Indian entente would make it especially momentous.”

Yeah, I’d say so, given the strengthened ties between more than 2 billion people.

As you know, there is an awful lot going on in the world today, and it’s all far more complex than I can get into here. But this is where we are, in brief: The U.S. economy faces a crisis in its biggest sector – finance. The neglect of making things is finally taking its toll, a fact most apparent in the oil and gas world, but also apparent in infrastructure across the spectrum. And the world is less U.S.-centric than it has been in a long time. We see this, too, in the oil and gas sector and in the flurry of deal making along the New Silk Road (and its “momentous” segment, the New Burma Road.)

The implication of this post-finance U.S. economy is a theme we’ll explore more in this letter. As an early conclusion, though, I believe the spread between finance and manufacturing has reached millennial extremes, like a rubber band at its limits. Now begins the snap back.

Now begins the time to invest in companies that make things. Many of these companies operate in the oil services industry, and many of them are EXTREMELY cheap right now. T-3 Energy Services (Nasdaq: TTES. $16.53) and Contango Oil & Gas (NYSE: MCF. $38.50) illustrate the point. Both are “old economy” companies that provide essential products. Both are selling for less than six times earnings. I’ll provide complete details in tomorrow’s Rude Awakening.

Source: Down, But Not Out

But that’s just the way globalisation works. We have nothing against it, but neither would we mind if there were less of it. Which raises the big question: is the leveraged planet becoming even more leveraged…or less so?

Ah, dear reader…this is where inflation and deflation make common cause. They both deleverage the world…reducing the value of debt – either by defaults or by lowering the real value of the debt itself. That is the real story in the financial markets…and in the housing market: leverage is being marked down. A residential mortgage worth $200,000 two years ago may be worth only $150,000 now, for example. Bear Stearns – worth billions a few months ago – is now worth peanuts.

Inflation takes leverage down too. All those US dollars held abroad (and at home, for that matter)…all those dollar-denominated Treasury bonds…all those dollar denominated I.O.Us – they all lose value as inflation increases. Just take those two trillion odd dollars outside America. Every one of them is a claim against US assets – land, houses, tractors, food, stocks, buildings, you name it. And as inflation takes prices upwards, each of those dollars falls to the ground…it will buy less of what the US has to offer.

We have been talking about the battle raging between inflation and deflation. But this is one way to win, no matter which side comes out ahead. Want a sure bet? Bet on deleveraging. How do you do that? There are many ways. Sell the industry that provides leverage, for example – the financial sector. Sell Wall Street on rallies, in other words.

Yesterday was a good day to sell. After having gone up more in a single day than the entire value of the Dow in ’29, it was time to take profits. And that’s what investors did. The Dow sold off a little.

Gold, meanwhile, gave investors a buying opportunity. At $887, we’re not saying that that is the best price this correction will offer…but it wasn’t bad. And many buyers decided to take advantage of it. Gold rose back to $900.

Now let’s look at the US economy itself. Ah…so many foreclosures…so little time.

Food up 9%. Houses down 11%. What’s an upside down homeowner to do but walk away? According to yesterday’s USA Today, so many are walking away in Denver that it is producing an ‘Exodus’ of Biblical proportions. Some neighbours have one out of eight houses in foreclosure. City-wide, the total last year was one out of 32.

Where do these people go? They rent, naturally. Rental vacancy rates have fallen from 10% two years ago to 5% today

Meanwhile, from Manhattan come two bits of conflicting news: apartment sales are down to an 18-year low…but prices are at an all-time high. Buyers are holding back, in other words…but sellers hold out too – for more money.

Across the nation, repossession filings are up 93% from last year. And as we saw yesterday, food stamps are up big time. But there really aren’t any “stamps” any more. Now, the food comes via plastic, a type of credit card that can be used – theoretically – only for buying food. In practice, nice shopkeepers in bad neighbourhoods take the card and give back cash at steep discount. Say a $10 charge for 7 bucks worth of cash to buy life’s real necessities – liquor, cigarettes and gas.

It’s all going according to plan, as we see it. The empire is rolling over. Now, in its advanced, decadent phase, the imperial government must provide bread – in the form of plastic food stamps…and circuses – in the form of national party conventions, elections and foreign wars. The combination settles the public…and distracts them. They become docile, subservient, willing to stand in line to protect themselves from make-believe threats …and ready to put up with any nonsense, no matter how grotesque, absurd or faithless.

In the latest financial news comes word of new proposals to “regulate” Wall Street…and new initiatives to “save” homeowners. The free market is out. ‘Public responsibility’ is in.

Treasury Secretary Paulson:

“I think you will continue to see flexibility as we learn and go forward,” changing his tune from last month when he said proposals to use government funds were a “non- starter.”

Why are they a starter now? People come to believe what they must believe when they must believe it, is our observation. Both private citizens and the government too have taken on obligations that they can’t possibly fulfil. Since it cannot be paid, the debt must be made to disappear. The world – or at least most of the Anglo-Saxon part of it, must be de-leveraged. So, people must believe in a fantasy about how the government will “bail out” the homeowners… and how the Fed will “rescue” Wall Street.

How could they perform such miracles? When a man cannot pay for his house, can the feds make the mortgage disappear? When Wall Street has blundered –forgetting to sell its cheesy debt before it started to stink – what can the feds do about it? All they can do is to spray some deodoriser around the room.

Still, the voters have been conditioned by television, public education, and maybe something in the water; people will believe anything. And what they need to believe now is that the feds can somehow ease their hurt. This will make it possible to shift the debts that cannot be paid onto the government, where they will not be paid.

Among all the great debtors in the USA, circa 2008, only one has the power to pay its debts – no matter how large they are. Only one has printing presses that turn out pieces of paper with pictures of dead presidents on them. And only one can trade bad debt for political favour. That one is, of course, the US federal government…lender of first, last, and holiday resort.

Already, the Fed has taken onto its balance sheet some $30 billion in smelly collateral from Bear Stearns…and billions more from other financial institutions. That is just the beginning. Somehow, the whole shebang of mistakes, misjudgments, greed-stoked miscalculations will end on the shoulders of the US Treasury…on the backs of US citizens…and dollar holders all over the world.