Buenos Aires, Argentina June 12, 2008

The prophecies regarding oil seem to be coming true. The barrel remains over $ 130 and is creating innumerable conflicts. Worse still, there are no short term fuel alternatives that can replace oil. OPEC states that speculators have been driving up prices at a time when supply and demand don’t seem to justify it.

It seems that biofuels are not the answer to the energy question but rather the source of a new problem. This is demonstrated by the current global debate regarding accusations that these alternatives to oil are actually creating a worldwide rise in food prices…. The situation is generating conflicts as much as, or perhaps greater than, the ones caused by the rising price of oil in itself.

In Europe, the oil price is generating massive unrest. Spain, is experiencing the worst situation in the Eurozone. In May, Spain’s year-on-year inflation variation reached 4.6%. This is also a problem for the competitiveness of its economy. In order to have an idea of the gravity of inflation rates, it should be noted that their current levels have not been registered since 1995…. And the price of oil is clearly one of the main causes of this phenomenon. It would seem that the rate of inflation is settling in at over 4% and with this being its fourth month at that level, it is expected to remain there.

However, the main problem for Spain is not the increase of oil prices itself, but rather the outbreak of situations created as a result of those rates. For example, the truck drivers’ union has been on strike because of the strong rise in the price of fuels and this action has already been at the expense of one life. This strike is by far the worst one that José Luís Rodríguez Zapatero has had to face since he assumed the presidency of Spain in March 2004.

The strike has generated shortages and widespread panic for Spaniards who have already begun stockpiling food. On the BBC’s Spanish site one can read about the impact of these shortages in Spain: “We went to the supermarket to buy groceries but there was nothing fresh. All the meat counters were completely empty. There was little fruit and no dairy products such as yogurt or milk… people are stocking up in case there is going to be a shortage”.

Zapatero proposed a series of thirty measures to alleviate the situation with the truckers’ union due to the constant rise in the price of fuels. These proposals were rejected due to the union’s demand for “minimal tariffs” on transport services so that the rise in the price of fuel could be offset by a decrease in transportation costs.

Spain’s current situation is much more complex than simply a conflict caused by the increased price of fuel. In the “Financial Times” Leslie Crawford noted that “It is hard to bid farewell to an era, particularly when it has been as dynamic and prosperous as the one drawing to a close in Spain”. And now, after the collapse of its 10-year construction boom, the Spanish real estate sector is significantly impacting the economy.

Using research conducted by the University of Barcelona, Leslie Crawford goes on to explain that the backlog of a million unsold homes will take about two years to clear. This situation indicates unfavorable prospects for this sector for the next few years.

In the face of economic deceleration and an increase in inflationary pressures, Spain’s government seems to lack a monetary policy that it can effectively wield to resolve its current situation…. and Spain will have to act quickly if it wants to avoid seeing this scenario worsen over time.

Next Wednesday, Zapatero promised to meet with union and business leaders to discuss the present economic crisis that is affecting Spain. Is a new agreement with Moncloa Palace possible? It seems that the economic situation is requiring the solidarity of all of Spain’s sectors in order to overcome the crisis. In the past Spain has experienced success combating situations such as this and is prepared to allow history to repeat itself… Will all the various sectors be willing to yield, to obtain an economic recovery in Spain?

We will meet again tomorrow,

Horacio Pozzo

Good day… And a Thundering Thursday to you! Well… The markets are still “hooked” and flailing about in the water over the Big Ben comments Tuesday, which were then followed up on Wednesday. What did he say this time? We’ll get to that in a minute.

But, first… Front and center this morning, we need to talk about the dollar strength that is prevalent in the currency markets right now. This all started a couple of weeks ago after the euro (EUR) hit 1.60. OK, too far too fast, right? And after an initial weakening to 1.54, the single unit recovered and all was right on the night again as it approached 1.58. Then the Big Ben Bomb…

The euro is the Big Dog of currencies, so you can use it as a proxy for the rest of the currencies. Sure, there are times that other currencies outperform the euro, but they didn’t do it alone. It takes the size and offset to the dollar capabilities of the euro to get the ball rolling. I talk to a lot of people that still don’t believe the euro is a viable currency. Well, it is. It’s here to stay… No matter what the pundits will tell you about Italy and Spain. As I’ve aid at least a dozen times, Italy and Spain should be thanking their lucky stars every night that they were asked to join the euro!

OK… So, dollar buying is on the agenda these days. Let’s just go with that, and then talk about how that might continue. Well… More jawboning by the Fed would help… So would Fed rate hikes… But come on, do you really believe the Fed is going to raise rates now, or in the near future with the economy teetering on the edge of a deep dark recession? Not a snowball’s chance in you know where! So, that leaves us with jawboning, because the economy isn’t going to be a reason for people to buy dollars… And the jawboning is where we circle back to Big Ben.

Yesterday, Big Ben was talking about inflation, and how it was too high… Oh my gosh! Isn’t this what I’ve been screaming at the walls about? Anyway, folks… That’s jawboning the dollar higher, because the markets read any talk about high inflation as a wink and nod that interest rates are going higher. Well, that may be the case in countries that have central banks that really care about fighting inflation… But that’s not the case here! This central bank has no intention on fighting inflation. They look at inflation and thank their lucky stars that it’s not deflation! Big Ben is just jawboning.

And in my opinion, and that of one of my fave economics professors, Big Ben is doing all this jawboning in an attempt to lower oil prices. He has nothing else to work with here to accomplish lower oil prices, so let’s jawbone the dollar!

It’s working, Ben… The dollar is stronger, and oil prices are weaker. But, there’s a fly in the ointment here, Big Ben. Oil prices may be weaker, but gas prices aren’t budging! That’s right; gas prices aren’t budging. Uh-Oh… You forgot about that part didn’t you, Big Ben?

So… I have to follow up on the rant I gave yesterday regarding Big Ben, at this point. So again, if you don’t want anything to do with my soapbox antics, just skip ahead to the section marked “***”.

OK… After my rant yesterday, I came to a couple of conclusions (with the help of readers!) First of all… Tell me, dear reader, wasn’t Big Ben the guy who talked about the Fed having a printing press to print as many dollars as needed to avoid deflation? And wasn’t he the one that talked about throwing those printed dollars out of a helicopter? (Thus his nickname: Helicopter Ben) Now, I know that my college economics classes are not nearly on par with those at Princeton, but come on, you mean to tell me he didn’t think that printing all those dollars was going to cause inflation? I learned that in Econ 101! At Meramec Community College!

And then there’s this, and I’ll leave it alone (I promise!)… With the markets believing that his comment means the Fed will intervene in the currency markets, I think this leaves him exposed. What if the markets decide to test Big Ben’s will, and he doesn’t have the arrows in his quiver to back up the threat of intervention? Uh-Oh! And I don’t believe he has a “war chest” to defend the dollar, like the Bank of Japan has to defend the yen… Or sell it, like they did in 2003.

***

Unfortunately… Right now, all the momentum – along with the investors jumping off the bandwagon of the weak dollar trend – has the dollar in favor. Look… If the dollar had the fundamentals to back this up, I would be telling you so… But it doesn’t!

And the economy isn’t going to shine for the dollar either! Look… The economy has survived the past few years on consumer spending… But where is the consumer going to get money to spend now? The dotcom busted… The House ATM busted… The housing market busted… And now credit cards are maxed-out.

The Big Boss, Frank Trotter, and I were talking yesterday, trying to come up with something that would keep the consumer spending. We’ve gone through all that above… We’ve put two people to work in households… We’ve maxed-out hours worked… The gains from the technology phenomenon have hit the ceiling… It’s been a tough row to hoe folks… But you would think that it’s all seashells and balloons! And that’s exactly what the government wants you to think. Everything is beautiful in its own way, like a starry summer night, or a snow covered winter’s day.

Two recent surveys tell a lot about the U.S. consumer. One says that 9 out of 10 Americans are making lifestyle changes to cope with rising energy costs… And 4 out of 10 Americans are considering moving closer to their place of work.

Oh, United Airlines is cutting up to 1,600 jobs and cutting flights… But don’t look for those 1,600 job losses to show up in the Bureau of Labor Statistics Jobs Jamboree. They’ll just create some ghost jobs and everything will be beautiful, in its own way.

OK… The Bank of England (BOE) and European Central Bank (ECB) are meeting as I pound away at the keys. I don’t expect a move from either of these two central banks, but what I am looking for is some strong Hawkish statements from ECB President, Trichet… Let’s see if he can jawbone the euro back up.

The Reserve Bank of New Zealand (RBNZ) met last night, and left rates unchanged. Unfortunately for kiwi (NZD), RBNZ Governor Bollard had some damaging words in the press conference afterward. Bollard mentioned that the RBNZ would entertain a rate cut this year. That news hit kiwi hard, and before anyone had a chance to bail, kiwi was off 1%, and not looking very good.

Speaking via satellite at the International Monetary Conference in Barcelona, Spain, Bernanke said the Fed is working with the Treasury to “carefully monitor developments in foreign exchange markets.” The Fed Chair said he was aware the effect of the dollar’s decline on inflation and price expectations, Bloomberg News reported.

Also, interest rates are currently “well positioned” to promote both growth and stable prices, he added.

“I can’t recall such a strong defense of the dollar from a Fed chairman,” Sophia Drossos, a currency strategist at Morgan Stanley (MS) who used to work at the New York Fed, where she helped manage the central bank’s foreign-exchange holdings, told Bloomberg. “The Fed is putting its marker down in letting the market know that a weaker dollar would be detrimental.”

Ordinarily, the state of the greenback would fall under the Treasury’s watchful eye, but Bernanke’s comments show the Fed chief is aware of the effect the aggressive rate-slashing campaign of the past several months has had on global currencies. The dollar has dropped 16% against the euro, driving up the cost of dollar-denominated commodities such as oil.

“The challenges that our economy has faced over the past year or so have generated some downward pressures on the foreign exchange value of the dollar, which have contributed to the unwelcome rise in import prices and consumer price inflation,” Bernanke said.

He went on to acknowledge the Fed’s commitment to “ensuring that the dollar remains a strong and stable currency.”

The comments from the Fed chairman gave an immediate boost to the dollar, as it climbed to $1.545 against the euro and commanded 105.3 against the yen in mid-afternoon trading.

Analysts, as well as Fed futures, are pointing to a Fed on pause at the June meeting of the Federal Open Market Committee (FOMC). It is expected the FOMC will vote to hold rates steady, especially in light of the minutes of the April meeting, which revealed the last vote to reduce the Fed Funds rate 25 basis points was a close call for many.

At least one Fed member has gone on record as being against further cuts. Dallas Fed President Richard W. Fisher is the only FOMC policymaker to “dissent” three times on prior votes to lower the central bank’s key interest rate. Fisher has gone so far as to suggest holding rates steady may not be enough to fight current price pressures.

“If inflationary developments and, more important, inflation expectations continue to worsen, I would expect a change of course in monetary policy to occur sooner rather than later, even in the face of an anemic” U.S. economy, Fisher said during a speech in San Francisco last week.

Source: Fed Chair Comments Boost Greenback

Good day… Well… Front and center this morning, I have to tell you that Eurozone inflation came in higher than expected (more in a minute), and that news has the euro (EUR) pounding the dollar into submission.

OK… Not my usual start, but I had to get that out, front and center this morning! So… A Wonderful Wednesday to you! It’s a Wonderful Wednesday for euro holders for sure! The single unit has reached an all-time high versus the dollar this morning. I’ve seen a bit of profit taking since I turned on the screens, but so far it has been muted at best.

So… Yesterday, we saw the currencies led by the Big Dog, euro, drift with a bias to sell them. I read an article in Forbes called “Demise of the euro”. Geez Louise, when will these guys give up? Sure the euro will weaken again some day… But not for reasons these guys keep dragging out of the trash bin and recycling! Spain and Italy aren’t going anywhere!

You see… For years now, pundits have written about how Spain and Italy don’t like the “one policy for all” that the European Central Bank (ECB) uses, and that would lead them to leave the euro… HOGWASH! They may not like the policy, but being a part of the euro, is BIG TIME for them, and they know it!

OK… So, back to the euro rally… Inflation in the Eurozone bumped even higher than the previous 3.5%, hitting the 3.6% level in March. This represents the fastest pace of inflation in 16 years. I don’t think the ECB is going to go forward with a rate cut in May, or anytime soon for that matter! Recall, that a couple of weeks ago, I pulled the May rate cut forecast because of this nagging inflation, and now it’s gone higher!

I don’t think it means the ECB will entertain a rate hike… But, it certainly means they will not entertain a rate cut either! And THAT, my friends, is what is driving the euro higher this morning. ECB rates will remain steady Eddie, while the U.S. rates are going lower, and lower… How low can you go? Recall, that I told you a couple of weeks ago, that I fully expect 75 BPS total of rate cuts from the Fed at the next two meetings… That would bring rates here in the United States to 1.50%. The Eurozone would have 250 BPS in their favor. I don’t have to tell you that 250 BPS represents a HUGE differential, and that favors the euro!

I find this interesting in that, I was all prepared to talk about the drifting euro this morning, and instead, I did a 180-degree turn!

So… The Big Dog, euro, isn’t the only currency with the rally hat on this morning. But it has the brightest light shining on it for sure! So… There!

Yesterday, the TIC data came in below the $80-85 billion needed each month to finance the deficit, once again. The total was a net of $64 billion, and the previous month was revised down $2 billion.

I find it strange that I keep hearing people say that “Deficits Don’t Matter”. What a bunch of dolts! The TIC Net Flows tell us that they sure do matter if you can’t finance them!

I read a report by David Walker, the former Comptroller of the United States, where he was explaining the depth of the fiscal budget alone. He estimated that balancing the Federal Budget by 2040 would require actions as large as: 1. Cutting Total Federal Spending by 60%, or 2. Raising taxes to 2X today’s level.

He also states, “Closing the current long-term fiscal gap based on reasonable assumptions would require real average annual economic growth in the double digit range every year for the next 75 years.

Keep in mind that: During the 1990’s, the economy grew at an average 3.2% per year. So… “As a result, we cannot simply grow our way out of this problem.”

Well… Now that’s something to help wake you up, eh? But deficits don’t matter; so don’t worry about what the former Comptroller of the U.S. says… HA! You won’t catch me taking that bait! David Walker is a very smart man, and has been the Lone Ranger in the Government when it comes to pointing out the problems with these deficits.

OK… Remember a few weeks ago when I tried to explain why the Fed’s stepping in to bail out Bear Stearns wasn’t a good thing in the long run? And that the Fed taking mortgage securities as collateral at the lending window also wasn’t a good thing? Well… I don’t know if this scares you like it scares me, but the Fed’s holding of Treasuries, as collateral, as fallen from 92% to 65%. Remember… These are the same mortgage securities that no one else would take as collateral! But the Fed did! YAHOO! NOT!

I don’t know where this all leads us… But it sure looks as though it will lead us to the same place it led brokerages to last summer.

And inflation in the United States? Well… We’ll see the stupid CPI report this morning… But as I’ve explained on many occasions in the past, CPI doesn’t reflect “true inflation” because of all the changes that have been made to the index over the past 20 years. And, to make matters worse, the media, and the Fed only look at the “core” rate, that excludes food and energy.

OK, I understand when the monthly numbers are pushed around by volatile food and energy, but when these two push higher and higher every single month, shouldn’t someone take notice of them? Of course they should! And right now, food and energy are what’s eating away at our wallets… Escalating food and energy costs attract global concern, and should be a source of price support for gold. Let’s hope it plays out that way, and not just leave us with escalating food and energy costs!

So anyone arguing that we can’t have a recession or a house price crash because employment is high, is simply wrong.

As if to prove it, now JP Morgan has doubled its previous estimate for City job losses to 40,000. That would be 5% of all City staff, the biggest cull since the dot-com bubble burst.

As The Times puts it – ‘that’s 12 empty Gherkins’…

So far roughly 2,500 City jobs have been cut, reports The Times, so if JP Morgan’s 40,000 estimate is correct, there’s a lot more pain to come. And not just in the City. Discount retailer, Ethel Austin, went to the wall yesterday, which could see a large number of the group’s 2,800 staff laid off depending on the outcome of a rescue deal.

600,000 people are facing bankruptcy

Certainly, there’s no sign of the credit crunch easing yet. If Gordon Brown hoped he could say anything to make a difference when he met banking heads at Downing Street yesterday, he’d have been sorely disappointed this morning. Halifax is raising the rate on its two-year tracker – it’ll now track at 1.99% above the base rate, from 1.49%.

Meanwhile, a report by TDX Group suggested that around 600,000 people might end up facing bankruptcy or taking out an IVA (bankruptcy-lite, as it’s sometimes called), because they won’t be able to roll over their debts. TDX says that’s about double the number that took such action last year. The group based its findings on the fact that around 400,000 people remortgaged or took out new debts to pay off old loans last year – with tighter credit conditions, the same escape route won’t be open this year.

Britain’s not the only place feeling the squeeze. The first big domino to topple, the US, still sees no bottom in sight for its collapsing housing market. The number of homes entering foreclosure proceedings in March more than doubled year-on-year, to nearly 235,000. About 40% of foreclosures result in actual repossession.

Spain is feeling the squeeze

And even in Europe, car manufacturers saw their worst month in four years, with sales in western Europe falling 10.4% in March, with Spain particularly bad, down 28.2%. This was partly down to changes in tax rules on scrapping older cars, but the country is also in serious trouble due to the end of its construction boom.

Earlier this week, data showed that Spanish service sector confidence was at its lowest on record, while activity in the sector is contracting, according to the latest purchasing managers’ index. Sales of ‘big-ticket’ items such as washing machines fell 32% last month.

It goes to show just how much consumer activity comes to rely on house prices in countries that have experienced property bubbles. However, while things look bad for Spain, the country does have a few advantages. For one thing, its government has been pretty careful in recent years – the country still runs a budget surplus, and so has been able to promise large spending on public works to help economic activity. It’s also dishing out a €400 tax rebate in July.

Then there’s the fact that Spain’s banks have largely avoided the problems associated with off-balance sheet vehicles and creative finance which have plagued many other countries. As William Underhill points out in Newsweek, this isn’t necessarily because they are any better run. It’s because in Spain, tighter regulations meant that banks couldn’t keep this sort of stuff off their balance sheets, and have thus stuck to older-fashioned ways of making money.

As Willem Buiter of the London School of Economics puts it: “there’s some advantage to being slow when the speedy crowd all go off the cliff together.”

The outlook for the UK is far worse

Of course, the Spanish banks will have a hard enough time with consumer spending dropping off and all those home loans turning bad. But anyone who thinks that Spain is in trouble should be far more worried about the UK. Our banks are much more exposed to the global credit crisis; our government has spent itself into a corner; and our housing market is about to go the same way as Spain’s.

With the euro at record levels against the pound, don’t be surprised if the Spanish start looking for holiday homes over here long before we’ve got enough money to start picking up bargains on the Costa del Sol again.

By the way, just before I go, I wanted to let you know about a special offer for Money Morning readers. Amid all this upheaval, it’s hard to know what to invest in, but you should certainly pick up plenty of ideas at the Master Investor 2008 investment show. Speakers include Pizza Express entrepreneur Luke Johnson, Nigel Wray, Mark Slater, fund manager Jim Mellon, as well as share tipster Tom Winnifrith and short-seller Evil Knievil AKA Simon Cawkwell, while executives from more than 100 growth companies will also be attending.

The organisers are offering Money Morning readers a 70% discount (£14.99 against a price of £49.99) on the event, which takes place on Saturday 26th April from 9am to 5:30pm at London’s Business Design Centre in Islington. Simply call 020 7562 3372 and quote “Money Morning” or book via www.masterinvestor.co.uk, using the discount code SS8.

Turning to the wider markets…