Unfortunately, revenues simply aren’t keeping up.

Your Treasury Secretary – accused tax-evader Timothy Geithner – tells you that the unfolding recession is starving the country’s government for tax revenue. Indeed, just as you unveiled your trillion-dollar national health plan, Tricky Timmy informed you that federal tax revenues were dropping the fastest since 1932 – at the height of the Great Depression.

What to do…cut spending? Well, Obama did challenge his cabinet in April to come up with a whopping US$100 million in budget cuts. That’s out of an estimated 2009 budget deficit exceeding US$1 trillion, perhaps more. To put that in perspective, Harvard economics Professor Greg Mankiw commented:

“…[I]magine that the head of a household with annual spending of $100,000 called everyone in the family together to deal with a $34,000 budget shortfall. How much would he or she announce that spending had to be cut? By $3 over the course of the year–approximately the cost of one latte at Starbucks. The other $33,997? We can put that on the family credit card and worry about it next year.”

But seriously, what could Obama do to make a significant reduction in the deficit? Obviously, it won’t be to cut spending. Instead, Obama needs to raise hundreds of billions in additional revenues. And he needs to do it very quickly…

Suppose Tricky Timmy suggests that higher income taxes on rich folks that make over US$250,000 annually may raise a hundred billion dollars or so annually…but at the expense of depressing consumer spending by about the only segment of the population that can afford to spend.

With wealth tax systems already in place in countries like France and Norway, it might seem a reasonable conclusion to an administration aiming to drastically expand entitlements (like healthcare) in an age of plummeting tax revenues.

Well, here’s an idea that Obama and Tricky Timmy might be considering, although I must emphasize that nothing official along these lines has yet been proposed: a tax, small at first, but potentially growing, on everything you own, anywhere in the world. A “wealth tax.”

And when I say “everything,” I mean everything:

• The equity in your home
• Your equity in any other real estate you own, anywhere in the world
• The value of any business you own
• The value of your retirement plan
• The cash value of your life insurance policies
• The value of your securities portfolio
• The value of any assets held for you in trust

Indeed, with a wealth tax, you’ll need to declare the value of those gold coins buried in your basement, the cash under the mattress, and of course, previously non-reportable offshore investments.

From Obama’s perspective, a wealth tax would have two powerful advantages:

1. It would generate considerable revenue on its own, although perhaps not as much as Obama and Terrible Timmy would like. For instance, the French “solidarity tax” on wealth – perhaps the world’s most severe wealth tax – raises only the equivalent of US$2.5 billion annually. The U.S. economy is five or six times larger than France’s so Obama might get his hands on an additional US$15 billion or so if he imposed a comparable tax. That’s still only a little more than 1% of the projected 2010 budget deficit, but it’s a lot more than Obama’s US$100 million challenge to his cabinet.
2. More importantly, a wealth tax would make it illegal to hide wealth in any form from the government. And Congress can increase the tab anytime it wants.

Of course, the natural reaction of many wealthy people to a wealth tax will be to move their wealth – and perhaps themselves as well – out of the United States.

That’s exactly what’s happened in France, from which thousands of wealthy tax exiles have fled. And this may be the real reason for the government’s greatly increased interest in any assets you hold offshore: to flush out assets for the future imposition of wealth tax.

The possibility of a wealth tax is just another reason why if you’re a U.S. citizen or long-term U.S. resident with substantial assets, you need to consider the admittedly radical step of expatriating from the United States. This means acquiring a second nationality and passport, and then subsequently giving up your U.S. citizenship and passport or U.S. green card status. You also need to live outside the United States.

Expatriation is the only way that a U.S. citizen or long- term resident can legally eliminate their obligation to pay U.S. income, estate, gift, and capital gains taxes. To learn more about expatriation, and the potentially huge payoff in tax savings, check out my “Billionaire’s Loophole” report here.

Sincerely,

Mark Nestmann

Source: How Would You Respond to an Obama Wealth Tax?

Good day… And a Tub Thumpin’ Thursday to you! Let’s hope it remains a Tub Thumpin’ Thursday later today, as I head downtown to watch my beloved Cardinals play a day game! For those of you who are baseball fans, you know what I mean when I carry on about how baseball should only be played during the day!

OK… Before I get to the currencies, economies and the dolts in the world, I wanted to briefly talk about the SEC, who made an announcement yesterday that they had done an investigation of the Madoff audits, and did not find any fraud… Just mistakes… Really? Mistakes? That’s what they call them? Even Bernie Madoff himself says that he was “astonished” that the SEC failed to shut him down after interviewing him in 2006!

Well… The currencies, led by the euro, have scratched and clawed their way back to levels they traded at before Tuesday’s sell off… The European Central Bank (ECB) is meeting this morning, and while the markets are not expecting rates to move here, they are holding out hope that ECB President, Trichet, will announce that the economic growth expectations have been raised. So… With these thoughts going through the markets, it’s no wonder the euro is back to 1.43 this morning.

However, not knowing what Trichet might say, opens Pandora’s Box of risks for the euro… For if Trichet does not talk glowingly about the economic growth expectations for the Eurozone, the euro will be hung out on a line. So… Let’s hope, Mr. Trichet had a good breakfast, and is feeling spry today!

But for now, it’s all skipping in the sun for the euro… The ECB rarely ever ends their meeting before I hit the “send” button on the Pfennig, so… I guess we’ll take it all up tomorrow!

The euro isn’t the only currency that has scratched and clawed back against the dollar… Yesterday, I told you how the Aussie dollar (A$) was rallying on the back of a stronger than expected 2nd QTR GDP report… Well, now that the euro has joined in, the A$ is really making tracks higher, trading right now, within spittin’ distance of 84-cents…

And… Not to gloat or anything… But, let me go back to yesterday’s Pfennig and quote something I said… This is from the Pfennig 9/2…

“Talk about getting “dumped” that’s what happened to the Brazilian real yesterday… Yes, most of the currencies sold off… But real was really sold off! That makes some sense in that real had out performed most currencies this year, and therefore, the selling, or profit taking would be on a larger scale… I think this selling was overdone though, and I would look for the real to make an attempt to come back today…”

Well… Guess what happened yesterday? That’s right! The real came back with a vengeance! Yesterday morning the real was trading 1.9140… This morning it’s trading 1.8850! OK… It’s not that I’m auditioning for some kind of “spot trading” position… Geez Louise, no! I like to sleep at night! I just wanted to show that sometimes even a blind squirrel can find an acorn! (with me being the blind squirrel, in case that was confusing!)

The real, and not Brazilian real, but real winner in terms of moves VS the dollar yesterday were the Precious Metals of Gold and Silver… Kicking sand in the face of the dollar, and laughing! Gold and Silver are both stronger again this morning too!

There’s a great report going around by Frank Holmes, CEO and CIO of U.S. Global Investors. (NASDAQ:GROW) I had dinner with Frank Holmes in Las Vegas about 5 years ago, and run into him at conferences throughout the years… Any way… Frank Holmes put together a strong report on how September is the best month for Gold… “The gold price has risen in 16 of the 20 Septembers since 1989, by far the best success ratio of any month of the year.” My good friend, David Galland, has the full story in his daily letter from yesterday… I think you can sign up for it here… http://www.caseyresearch.com/casey-services/free-publications/caseys-daily-dispatch/

OK… Chinese stocks rose 5% overnight, and that has the risk takers coming out the woodwork! That’s quite a rebound for Chinese stocks. With all the talk going around about how it’s time to get out of stocks before the BIG sell off, one has to wonder if this isn’t akin to a star burning out… It’s burns brightest just before going dark…

The Swedish krona got hit with a blow to the mid-section yesterday when the central Bank (Riksbank) announced that they were going to keep rates at historical lows until the 3rd QTR of 2010! What? How can they say that? I mean I know, they open their mouths and begin to use their voice box… But what I’m talking about is what backs up what they are saying? How do they know that? What a bunch of dolts! I used to think the Riksbank was a good Central Bank, but this blows it for them! (Not that they will be worried that the Pfennig no longer believes them to be a good Central Bank!) So… These are the cards that have been dealt to the krona… Too bad…

So… The Fed is tossing around the idea of removing pieces of the stimulus… Treasury Sec. Geithner, a.k.a. the cheater, and not the song by Bob Kuban and the In Men from the 60’s! (if I recall correctly that was printed on the Pepsi label!) Any way, Geithner doesn’t agree and has stated that he believes it to be “too early” to exit stimulus strategies… Geithner is getting ready for the G-20 meeting of finance ministers and Central Bankers beginning tomorrow in London, and had this to say… “We’ve come a very long way but I think we have to be realistic, we’ve got a long way to go still.”

Well… That’s the most intelligent thing I’ve heard him say so far!

Hey did you see that bond king, Bill Gross of PIMCO, chimed in on this… “To the extent that we have had a trillion dollars worth of stimulus, from the standpoint of deficits, and more, the government basically has to continue to do that and to add to that in order to keep the economy chugging along,” he said. “To the extent that that’s limited, to the extent that they pull back on some of those stimulus programs — ‘Cash for Clunkers’ and those types of things — then the double dip moves into the realm of possibility.”

Yes… Double dipping… It’s my call for this economy… And I’ve said that for a lonnnnnnngggggg time now!

The OECD… The Organization for Economic Cooperation and Development, issued a report yesterday that says the global economy is emerging from its worst slump since WWII, and much faster than the OECD forecast just 3 months ago!

That’s nice…

You know… Whenever the currencies rally, the dollar and yen get sold, and vice versa… But… Sometimes, the yen rallies alongside its currency brothers, which is an indication of a real rout on the dollar. And that’s what we’ve got going on this morning… The Japanese yen has joined the “dark side” and is rallying alongside its currency brothers…

Well, yesterday’s data cupboard printed a stronger than expected Productivity number here in the U.S. So, doesn’t that make you feel better, that you probably had to work longer hours at the same wage, because 1 in 5 American workers are out of jobs, and you have to take up the slack? That’s the root of Productivity folks… Sure there are other things like technology, etc. but at the root… It’s all about you…

That’s why I don’t like this report… So now I’ve given it more Pfennig space than it deserves! UGH!

Today, we’ll see the Weekly Initial Jobless Claims as usual on a Tub Thumpin’ Thursday, and we’ll also see the color of the “services” piece of the ISM… Tomorrow is the Big Kahuna though, with the Jobs Jamboree for August…

Last week, I told you that the U.S. had to deal with another large amount of Treasuries to auction off… Last week it was $197 Billion… And no word of problems dealing with these… But, have you noticed that the 10-year yield, which just a few weeks ago was 3.80%, has fallen to 3.34%? Hmmm… I wonder how that happened? It means that the price of the 10-year has been rising, which would only happen if there was a truckload of buying… Hmmm… I had better go to the Big Finish here before I blow out a gasket!

Currencies today 9/3/09: A$ .8395, kiwi .6785, C$ .9090, euro 1.4310, sterling 1.6380, Swiss .9460, rand 7.7650, krone 6.0270, SEK 7.20, forint 192, zloty 2.8820, koruna 17.8720, RUB 31.67, yen 92.40, sing 1.44, HKD 7.7510, INR 48.91, China 6.8305, pesos 13.57, BRL 1.8850, dollar index 78.22, Oil $69.15, 10-year 3.34%, Silver $15.75, and Gold… $984.50

Chuck Butler

Source: Time to Remove Stimulus?

U.S. President Barack Obama yesterday (Tuesday) nominated Bernanke for a second four-year term as chairman of the U.S. Federal Reserve. The appointment was mildly controversial and must be approved by the Senate, but lawmakers and investors overwhelmingly approved of the decision to the central bank chief who has shepherded the U.S. economy though its worst financial crisis in more than 70 years.

Bernanke has been criticized for greatly expanding the powers of the U.S. central bank by bailing out large financial institutions like American International Group Inc. (NYSE: AIG) and The Bear Stearns Cos. – while letting Lehman Bros. Holdings Inc. (OTC: LEHMQ) collapse. At the same time, however, ambitious Fed programs designed to recapitalize banks and unfreeze credit markets have succeeded.

“Ben Bernanke, has led the Fed through the one of the worst financial crises that this nation and this world have ever faced,” said President Obama.  “As an expert on the causes of the Great Depression, I’m sure Ben never imagined that he would be part of a team responsible for preventing another. But because of his background, his temperament, his courage, and his creativity, that’s exactly what he has helped to achieve.”

Of course, that doesn’t mean Bernanke’s greatest challenges are already behind him. Over the next few years, the Fed chairman will have to unwind the programs he set in place to backstop the markets – such as the Commercial Paper Funding Facility – which holds $109.2 billion in short-term IOUs issued by corporations – and the Term Asset-Backed Securities Loan Facility (TALF) – which has lent $25 billion to investors to buy securities tied to auto and other consumer and business loans.

In all, Bernanke has injected more than $2 trillion into the U.S. financial system. He’s also lowered the Federal Reserve’s benchmark lending rate to a record low range of 0.00%- 0.25%.

As a result, the U.S. monetary base has about doubled during the past two years.

Earlier this month, Bernanke said that the central bank’s program to buy U.S. Treasury securities would be shut down by the end of October. He’s also pointed out that some of the Fed’s emergency lending facilities automatically wind down as the economy recovers, because they have onerous pricing and terms.

The central bank could undertake two key steps to accelerate that whole process. It could:

• Increase the amount of interest paid on balances held at the Federal Reserve by depository institutions (banks).
• Sell securities from the Federal Reserve’s portfolio with the agreement to buy them back at a later date.

However, Bernanke has provided very few clues about what his so-called “exit strategy” will involve, or how it will be implemented. That is, at what point will inflation become enough of a concern, and at what point does U.S. growth become sustainable enough, to warrant a change in Fed policy?

And that could easily prove to be Bernanke’s next big challenge.

At some point, Bernanke will have to raise the Fed’s benchmark rate from its current record low range. But it’s almost a classic Catch 22: Doing so too soon could stall the fragile U.S. economic recovery; waiting too long to boost rates could allow ruinous inflation to take hold, resulting in a major spike in the cost of food, energy and other essentials.

In this sense, “policymakers are damned if they do and damned if they don’t,” said Nouriel Roubini, a professor at the Stern Business School at New York University who is often credited with predicting the financial meltdown.

“If they take large fiscal deficits seriously and raise taxes, cut spending and mop up excess liquidity soon, they would undermine recovery and tip the economy back into stag-deflation (recession and deflation),” Prof. Roubini said. “But if they maintain large budget deficits, bond-market vigilantes will punish policymakers. Then, inflationary expectations will increase, long-term government bond yields would rise and borrowing rates will go up sharply, leading to stagflation.”

Part of the reason Obama is seeking to reappoint Bernanke is that another Fed chairman could disrupt the markets if he or she were to deviate from the path Bernanke has set.

“Wall Street can breath a little easier,” Christopher Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. (NYSE ADR: MTU), told Bloomberg News. “Having a new chairman come in at this late date would put the Fed-engineered solution to both the recovery and the exit strategy at risk.”

Government officials told reporters that White House Chief of Staff Rahm Emanuel, U.S. Treasury Secretary Timothy F. Geithner, and National Economic Council Chairman Lawrence H. Summers all recommended that Obama reappoint Bernanke.

And Summers, the former president of Harvard University, had been the leading candidate to replace Bernanke as chairman of the Fed.

Bernanke’s Political Challenges

Putting the economy back on the path to solid and sustainable growth won’t be Bernanke’s only task, either. In the years ahead, he will have a large role in the Obama administration’s push to overhaul financial market regulation.

“Looking forward, we must urgently address structural weakness in the financial system, in particular in the regulatory framework, to ensure that the enormous costs of the past two years will not be borne again,” Bernanke said earlier this week.

Obama’s plan puts Bernanke and the Federal Reserve in an awkward position. The plan broadly expands the central bank’s authority in dealing with systemic risks – such as the growth of reckless mortgage lending or the misuse of financial derivatives – by essentially giving the central bank the power to oversee from top to bottom almost any financial company in the country, including a firm’s foreign affiliates.

However, that would make Bernanke an even bigger target for members of Congress who believe the Fed already has too much power, and was far too cozy with banks and Wall Street firms as the mortgage crisis was building.

“Why does the Fed deserve more authority when institutionally it seemed to have failed to prevent the current crisis?” U.S. Sen. Christopher J. Dodd, D-CT, asked last month.

It’s possible that Bernanke will face similar questions at his upcoming confirmation hearing.

“I expect many serious questions will be raised about the role of the Federal Reserve moving forward and what authorities it should and should not have,” Sen. Dodd told The Wall Street Journal yesterday.

Despite these concerns about the expanding authority of the Fed, Sen. Dodd did support Bernanke’s reappointment.

“While I have had serious differences with the Federal Reserve over the past few years, I think reappointing chairman Bernanke is probably the right choice,” Dodd said. “Chairman Bernanke was slow to act during the early stages of the foreclosure crisis, but he ultimately demonstrated effective leadership and his reappointment sends the right signal to the markets.”

It was Bernanke’s slowness to act early on that may actually cost the Fed some of its powers. While Obama’s plan generally increases the role of the Fed, it also calls for the creation of a new, independent regulatory agency. That agency would write rules related to mortgages, credit cards and other consumer products, taking away powers previously held by the central bank.

Bernanke has acknowledged that the Fed underestimated the seriousness of the financial crisis at the outset – including the danger posed by subprime mortgage lending – but remains reluctant to relinquish the Fed’s role as a consumer advocate.

“We think the Fed can play a constructive role in protecting consumers,” Bernanke told members of the House Financial Services Committee last month.

Indeed, Bernanke’s response to the financial crisis – and what he does to keep the U.S. economy from relapsing – will play two vital roles: It will shape Bernanke’ s financial-crisis legacy; and it will help determine the future role of the Federal Reserve.

“This last couple of years has been clearly a move through uncharted territory, and as we’ve seen it’s taken a lot of unconventional moves to try to deal with the situation,” Robert Parry, former president of the San Francisco Fed, told Bloomberg. “There’s been a lot of innovation that’s gone on, and it seems to me that much of it has been successful.”

Source: With Reappointment in the Bag, Fed Chairman Ben Bernanke Turns to Face Troublesome New Challenges

It all started back in 1991, when J. Aron & Co., Goldman’s commodities-trading division, recommended that a large institutional client invest about $100 million in commodities.  The vehicle “du-jour” was Goldman’s own investment vehicle, the Goldman Sachs Commodity Index (now the S&P GSCI Commodity Index).

The GSCI is a 24-commodity dollar-weighted index, comprised of 70% energy (oil and natural gas), 8% industrial metals (aluminum, copper, lead, nickel and zinc), 3% precious metals (gold and silver), 14% agriculture (wheat, corn, soybeans, cotton, sugar, coffee and cocoa) and 4% livestock (cattle and hogs).

Goldman was to take the other side of the bet, meaning that should the index rise, Goldman would have to pay equivalent returns to the investor.  In order to hedge, J. Aron needed to institute similar positions in the futures markets for those commodities.

But the plan had one wrinkle in it.  At the time, the U.S. Commodity Futures Trading Commission (CFTC) – the agency that regulated the commodities sector – placed position limits on certain agricultural commodities, like wheat, corn and soybeans.  Other commodities weren’t subject to these same limits.  Yet it was necessary to hedge all the commodities concerned in order for this investment arrangement to work.

So with a large chunk of new business at stake, J. Aron asked the CFTC to grant it an exemption.  Goldman contended that it was not a speculator, but was instead a true “hedger.”

The upshot: In October 1991, J. Aron was granted the sought-after exemption.

Inspired by J. Aron’s success, other members of the commodities-trading oligopoly followed suit, and soon had similar exemptions in hand.

The Global Commodities Boom

In the 18 years that followed the exemption grants, the commodities sector was all in all a pretty orderly place. Between 1990 and 2002, in fact, commodities prices essentially traded sideways.

Unfortunately, that stability wasn’t to last. Like a greyhound that sets out after the hare after having been penned up for too long a stretch, commodity prices started to surge – and ended up doubling over the next six years, albeit in a relatively orderly fashion.

Finally, last year, a market that had been simmering for far too long finally came to a full-fledge boil – and last summer boiled over. Food prices soared, intensifying inflationary fears here in the United States while prompting the leader of the United Nation’s World Food Programme to warn that a “silent tsunami” of hunger was threatening to span the globe.

It seems, though, that the actual boiling point was reached last summer when oil went into a near-vertical climb, surging 63% in just five months, and hitting an all-time high of $147 a barrel last July. Given that oil is in many ways the most relevant commodity to the general public (think fuel for transportation and heating), the new record price touched off a media feeding and prompted projections that crude oil could be headed for $500 a barrel.

As commodity prices were shooting skyward, however, U.S. stock prices saw their already-steep descent turn into a nearly vertical plunge – thank to a worsening of the deepest financial crisis since the Great Depression.

As a result of that crisis, the world’s largest banks, insurance firms and brokerages have been forced to take nearly $1.5 trillion in writedowns, Bloomberg News reported. Because of that and some other related problems, U.S. Treasury Secretary Timothy F. Geithner is pressing Congress to somehow restrain the $600 trillion worldwide derivatives market.

And that has set the stage for a showdown that pits the regulators against the speculators.

What Gensler Wants …

As the spotlight has increasingly been focused on Goldman in the last couple of years for its trading prowess, it’s been suggested on many occasions that the investment bank must be benefiting from some sort of a “special” relationship with the federal government.

The suggestion is understandable on several levels.

Only a month ago, for instance, when Goldman reported its financial results for the second quarter, the investment bank’s trading results helped it record all-time-record profits of $3.44 billion – a good 50% above what experts had been forecasting for what had been expected to be a “blowout” quarter for Goldman.

The stunning profit results once again reminded observers that Goldman Sachs alumnae seem to have a “knack” for landing in positions of high influence.
Former U.S. Treasury Secretary Henry M. “Hank” Paulson Jr., who held that position under former U.S. President George W. Bush – where he was widely viewed as the mastermind behind many of the bank bailout programs conceived last fall – was once the chairman and CEO of Goldman Sachs.

While he was serving as Treasury secretary, Paulson’s office calendar says he called Goldman Sachs Chairman Lloyd C. Blankfein roughly 24 times the week that the federal government opted to bailout out busted insurance giant American International Group Inc. (NYSE: AIG). Remember, had AIG been allowed to collapse, Goldman would have been left holding the biggest of all bags, because of the oversized bets they’d made on AIG’s financial insurance.  Paulson, it seems, would have none of that.

The “Six Degrees of Goldman Sachs” doesn’t end there, either, as the many connections show. Geithner, the current Treasury secretary, was mentored by Goldman alumnus John Thain [the last chairman and CEO of Merrill Lynch before it merged with Bank of America Corp. (NYSE: BAC)].  Plus, Geithner just chose Mark Patterson, formerly a lobbyist for Goldman, as his top aide.

And don’t forget about Gary Gensler, the newly installed head of the CFTC whose resume includes a 20-year stint at Goldman Sachs. But interestingly – perhaps even ironically – Gensler’s new job pits him directly against Goldman, as the CFTC looks to rein in what some consider to excessive speculation.

During hearings held in July and August, attended by representatives from both Goldman Sachs and JPMorgan Chase & Co. (NYSE: JPM), Gensler commented that the CFTC “must seriously consider setting strict position limits in the energy market.” He also indicated that his staff had been instructed to determine “every authority available to the agency” to guard the interests of the public as well as the markets.

What Goldman Should Get

In its defense, Goldman has argued that setting position limits on trading commodities is likely to prove harmful, as restricting access could affect liquidity.  (Highly liquid markets, or “deep” markets with large volume, are considered to be more fairly priced).

Steven Strongin, a managing director at Goldman, recently told a Senate hearing committee that “attempts to regulate volatility have rarely – if ever – succeeded.  Yet they often have unintended and significant consequences.”

Although commodities trading accounts for a considerable part of Goldman’s revenue – some estimates place it at about 8% to 9% – making it a target for would-be reformers, Strongin’s cautionary words should serve as a warning to back off for one simple reason.

He’s right.

Because of the exemption granted to the trading houses, institutional investors have been better able to provide commodity diversification to their portfolios, thereby minimizing some asset and inflation risks.
United States Oil Fund LP (NYSE: USO) and the United States Natural Gas Fund LP (NYSE: UNG) – two ETFs that are among the largest such products in the world.

Though very popular, such exchange-traded funds (ETFs) as the United States Oil Fund LP (NYSE: USO) and the United States Natural Gas Fund LP (NYSE: UNG) could also be affected.  They currently boast large volumes in the 12 million and 40 million units traded/day, respectively. That means that a limitation on futures positions – let alone an outright prohibition – would work against the best interests of individual investors.

Even producers and refiners of petroleum products could end up being squeezed, as well. These oil-sector players sometimes hedge risks by calling on the large commodities traders who can provide them with custom trades on demand.  The dealer then turns around and wisely hedges its own risk.  Now, doubt is being cast on the ability to perform these transactions.
So we know that Goldman, along with JPMorgan Chase) and others – as the largest owners of derivatives – have a lot to defend.
But there’s actually an even-bigger-picture view that argues against regulation – of any kind.

Who Needs Rules?

Government oversight, intervention, and insurance schemes usually lead to problems – often really big problems.

A simple example should be enough to make my point.

Just think back to what happened last year to mortgage giants Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE).  It doesn’t take an accounting degree to figure out that, by having their loans government guaranteed, management had no incentive to follow cautious lending practices.

After all, why should they?  When a base salary is certain, a bonus is tied to sales or growth, and there are no consequences for bad results, why not take on more risk and just shoot for the moon?  If you hit it out of the park, your bonus swells.  If you strike out – even so badly that you even make “Mighty Casey” look like Henry Aaron – and you lose really badly and your company loses big, even to the point of bankruptcy or outright collapse, you still get your base salary.

Where’s the incentive to manage your risks?

In the case of a bank, there’s no incentive to be careful with depositor assets when the Federal Deposit Insurance Corp. (FDIC) is your bottomless backstop.

Clearly, the government does not always know better.

And that brings us back to Goldman Sachs.

Goldman Sachs: Unplugged, Unfettered, Unregulated

In the debate about regulating the commodities markets, I come down on the side of Goldman, reasoning that a free market – left unfettered – knows best, since the forces of supply and demand will ultimately price things fairly.

Inside an economic system as highly developed as that of the United States, everything operates at a level of complexity that no single person – let alone a government bureaucracy – can operate, or even fine tune. And as soon as anyone begins to tinker with it, there are always going to be unintended consequences.  Which leads us back to the question of regulation.

According to Prof. Kent Moors, a noted global oil consultant, only a small portion of a commodity’s price, at any given point in time, can be attributed to speculators.  He believes that speculators they are necessary to provide liquidity and that, in the end, the benefits speculators provide cancel out any of the negatives often ascribed to their marketplace activities.

If regulations with real “teeth” – in this case, position limits on energy futures – are actually put in place, U.S. financial leaders will end up playing the economic equivalent of Whac-A-Mole – an unwinnable game, and a dangerous one, at that.

While the final result is difficult – if not impossible – to picture, here’s my best guess: The financially lucrative, economically prestigious and strategically important commodities-trading business won’t fold up and disappear – it will just move to another country, where it’s better treated, and even nurtured.
Perhaps it will end up in Asia, as has been the case with so many other important businesses during the past couple of decades.  And that, once again, will end up costing America jobs – these jobs high-paying and prestigious – at the worst possible juncture.

According to commodities guru Jim Rogers – who is frequently quoted here in Money Morning – “the three commodity exchanges in China are booming.  Dalian trades more soybean contracts than Chicago does already, and that’s with a blocked currency [and] a closed market.  Can you imagine what’s going to happen if and when they open that market up to foreigners?  It’s going to explode.”

So as you think about “big bad trading firms” such as Goldman Sachs, and commodities speculators, remember the necessary role they play.  And realize that restrictive regulations will end up being bad for consumers, investors, and the same free markets we should be defending.

Source: How Over-Regulating Goldman Sachs Will Lead to Higher Oil and Commodity Prices

After the Commerce Department reported last week that retail sales fell 0.1% in July from June, and 8.3% year-over-year, retailers will stay in the limelight this week as several high-profile companies report second-quarter earnings. Target Corp. (NYSE: TGT), Limited Brands Inc. (NYSE: LTD), and Gap Stores (NYSE: GPS) are among the big-name retailers set to report.

Meanwhile, the Hewlett-Packard Co’s (NYSE: HPQ) report will provide a further glimpse into the world of technology, and The Home Depot Co.’s (NYSE: HD) results will confirm or counter claims that the recent housing rebound is for real.  On that note, the upcoming economic releases include July housing starts and existing home sales, while the wholesale inflation gauge may show that price pressures are not yet creeping into the producers’ side of the equation either.

Market Matters

While many more bearish analysts continue to proclaim “gloom and doom” and a drop back to the March-lows in equities, at least one noted naysayer may have shifted to the other team.  Hedge fund manager John Paulson purchased over $165 million shares of Bank of America Corp. (NYSE: BAC) to become the banking giant’s fourth largest shareholder.  Paulson was among the select few who predicted the subprime debacle, so his allocation into financials may be interpreted as a nice vote of confidence from an unexpected source.

Meanwhile, the U.S. Federal Reserve made a few bold moves to promote its case for recovery as well.  Following the policy meeting, Federal Reserve Chairman Ben S. Bernanke announced his intent to cease the program of buying up to $300 billion of Treasuries in October, as a major economic lifeline may have served its purpose well.  Additionally, banks have scaled back borrowing from the Fed’s emergency short-term lending facility, a sign that the frozen credit markets have thawed considerably.

Finally, the Car Allowance Rebate System (CARS), popularly known as “Cash for Clunkers,” was expanded, allowing car buyers to receive vouchers for future purchases as automakers report dwindling inventories.

Retailers took center stage in the earnings game as Wal-Mart Stores Inc. (NYSE: WMT) and Kohl’s Corp. (KSS) beat expectations, but still offered cautious projections for the months ahead (including the upcoming holiday season).  Macy’s Inc. (NYSE: M) posted a declining profit, but gave an optimistic outlook, as it benefits from cost-cutting measures.  Liz Claiborne Inc. (NYSE: LIZ), on the other hand, reported a wider loss and new streamlining plans and J.C. Penney Co. (NYSE: JCP) issued some pessimistic comments about the state of the consumer.

Seemingly recession-proof McDonalds Corp. (NYSE: MCD) announced strong July same-store sales as its coffee drinks competed effectively with the “big boys.”  On the transactional front, China continued its expansion into the global commodities markets as China National Petroleum Corp. and CNOOC Ltd. (NYSE ADR: CEO) have eyes on the Argentinean unit of Repsol YPF SA’s (NYSE: REP) to the tune of $17 billion. Microsoft Corp. (NYSE: MSFT) and Nokia Corp. (NYSE ADR: NOK) are teaming up to take on PDA leader Research in Motion Ltd. (Nasdaq: RIMM) in an alliance that brings the popular software together with a solid cellular player.

Fixed income investors got a boost from a successful 30-year bond auction, as $75 billion in new Treasury securities were well-received during the week.  The Treasury also announced a plan to issue more TIPS (inflation-adjusted bonds), a move aimed at alleviating concerns in China (the largest foreign holder of U.S. debt) that the government would allow a surge in inflation as it tries to finance the stimulus plans.

Higher inflation would increase the yields on TIPS and result in greater costs for the government.  Bond prices fell mid-week after the Fed announced its intent to end its Treasury purchase program, though the auction news was a welcome relief and a late-week flight-to-quality also ensued.

Investors focused on the lackluster consumer activity – illustrated by both earnings and economic releases – and worried that economic growth will be stunted as long as shoppers remain in hibernation.

Despite favorable reviews by the Fed, major equity indexes gave up slight ground during the week with the Standard & Poor’s 500 Index and Nasdaq Composite Index still flirting with 1,000 and 2,000 respectively.

Economically Speaking

No rest for the weary (especially when auditioning to keep a job).  Fed Chief Bernanke guided the latest Fed policy meeting that saw strong signs (and language) pointing to the recession nearing an end.  The Fed claimed the economy is “leveling out” and felt the Treasury purchase program could go away with no material detriment to the nation’s financial system.

The accompanying statement also indicated that the funds rate would remain just above zero for “an extended period” as many anticipate the recovery will be slow to take hold.  Noted economists apparently have Bernanke’s back as a recent survey revealed that most prefer he remain on as Fed Chair for another four-year term and President Barack Obama should reappoint him based on his strong performance in righting the ship during the worst economic downturn since the Great Depression

Treasury Secretary Timothy F. Geithner shared some tough talk as he objected to certain concerns that major financial companies have not learned their lessons and the recent profits are indications of pre-crisis-like risk-taking.

The economic data of the week offered mixed signals as retail sales surprisingly declined in July despite the popularity of the “clunker” program, though continuous claims for unemployment benefits fell to the lowest level since April.

The anticipated rebirth of the consumer may be on hold for now as the Reuters/U. of Michigan sentiment index fell again and individuals continue to worry about the state of the job market.

While the trade deficit increased in June, exports climbed for the second consecutive month and manufacturers experienced increased demand for products like semiconductors and telecommunication devises.  Likewise, industrial production rose in July as the “new and improved” domestic automakers attempt to get back on track.

On another favorable note, inflation remains a non-issue as the consumer price index (CPI) was unchanged from June and prices have fallen by 2.1% over the past year.  On the global stage, the French and German economies posted surprising growth in the second quarter and, though the broader Eurozone countries continue to contract, the recovery is already taking hold in that region of the world.

Weekly Economic Calendar

Source: Will This Week’s Earnings Reports Reflect a Recovery or a Relapse for the U.S. Economy?

By “shows signs of improvement”, I suppose he means things like another extension in unemployment benefits, which he admits “is something that the administration and Congress are going to look very carefully at as we get closer to the end of this year.”

Naturally, I take points off his grade and I note that “look very carefully at” is a prepositional phrase, and he should have more correctly said that extending unemployment benefits “is something at which the administration and Congress are going to look very carefully” but either way it means that it is a “done deal” since there is going to be almost $3 trillion in deficit-spending money ($1.84 trillion in budgeted deficit and the usual $2 trillion in Supplemental Appropriations that will appear in the next year), all seemingly just sitting there! Hahaha!

The 5-Minute Forecast took a look at the specifics, and found that “Congress is under pressure to extend benefits again. Emergency legislation has already bumped unemployment programs to 79 weeks in half the states, about triple the norm and the longest since its 1930 inception (the rest of the states have programs ranging from 46-72 weeks).”

Yikes! We’re already at records of unemployment never even seen before! Nevertheless, they continue “Word on the street is that Congress will tack on another 13 weeks for states with unemployment rates over 9%… at a cost of $70 billion”, which seems like such chump change when next year’s federal budget deficit is, by itself, $2 trillion!

Blomberg says that Larry Summers, director of the White House National Economic Council, glossing over the fact that he has not been right about the economy or raised a peep about the rampant “creating excess money and credit” crap that Alan Greenspan and his loathsome Federal Reserve were doing for the last 15 years, says that he is now sure, sure, sure that the economy will resume growth in the second half of the year, although the job picture “will be serious for some time to come.”

Naturally, one wonders how economic growth can resume when more and more people are unemployed, with no viable options, and staggering under the biggest debt loads in the history of America, but even when you send him an email asking “What kind of stupid thing is that to say, you ignorant, loudmouth neo-Keynesian halfwit lowlife?” he never explains!

Just in time, The 5-Minute Forecast sort of obliquely answers my question when they reported that “both Larry Summers and Tim Geithner refused to rule out a middle-class tax hike.” Hahaha!

Oh! Growth in government taxation! Hahahaha!

Ignoring my rude laughter, Bloomberg continues with the insight that has Mr. Summers saying, “the Obama administration will work with Congress to ‘do what’s necessary to make sure appropriate unemployment benefits are available.’”

And working with Congress ought to be a snap, as Congressman Charles Rangel, chairman of the House Ways and Means Committee, said he “supports extending unemployment insurance benefits for another 13 weeks” because there is “no question” that the unemployed “deserve it”, because the are the “the true victims of this fiscal disaster.” Hahahaha!

The truth is that everyone is a victim of the abject stupidity of government morons like Congressman Rangel, who happily voted to deficit-spend monstrous amounts of money year after year after year, plus pledging a hundred trillion dollars in future benefits, and encouraged the Federal Reserve to create massive amounts of excess money and credit so that people could go into crushing debt by borrowing Too Much Money (TMM) to buy, among other things, the gobs of new government debt, all of which cemented into place a bloated, dysfunctional, corrupt, government-centric economy! Hahaha! We’re freaking doomed!

And now – unbelievably! – Congressman Rangel thinks that increasing federal government deficit-spending, via expansions of the money supply by the Federal Reserve to promise another 13 weeks of unemployment benefits to the victims, is going to fix things? Hahahahahahackahackahaha!

The extended “Hahahahahahackahackahaha!” is to cleverly denote that I am laughing and laughing until my sides are starting to hurt, and I am coughing and hacking up what appears to be pieces of lung at such preposterously and overwhelmingly funny Theater of the Absurd stupidity! Hahahaha!

In such a giddy state, I obviously cannot continue to the inevitable climax where I demand that you buy gold, silver and oil immediately as protection against the best intentions of government or suffer my contempt and scorn, which admittedly seems so far away from my current fit of laughing and coughing! Hahahahahackahackahaha!

Anyway, I could never say, “Buy gold, silver and oil because your own government is destroying your money and you!” better than when Mr. Rangel says it for me with “Victims deserve more of what they got!”

Whee! This investing stuff is easy!

Source: The True Victims of Government Stupidity

Treasury Secretary Timothy Geithner is once again traveling abroad to assure foreign nations that their investments in the United States are safe But this time it’s not China he’s trying to assure; it’s another large supporter of the dollar: Saudi Arabia.

While inflation has held steady in the face of increasing budget deficits, the purpose of Geithner’s multinational tour will be to repeat assurances that such deficits will not trigger a strong bout of inflation and in turn sink the value of the dollar and foreign holdings. Last month, Geithner was in China – the largest holder of U.S. treasuries – to make the same assurances.

Geithner reiterated the Obama administration’s commitment to protecting the value of the dollar and maintaining investor confidence in the U.S. financial system in an interview broadcast on CNN’s“Freed Zakaria GPS.”

“A strong dollar is in the interest of the United States. Of course, I deeply believe that,” Geithner said. “Our commitment … to the world and of course, the American people, is to make sure we’ll put in place the policies that can sustain confidence in this economy and this financial system.”

While rising unemployment – well beyond what the Obama administration expected – is prompting talk of a second stimulus package, Geither said it’s too soon for that. Only 11% of the $308 billion stimulus funds allocated to discretionary programs will be spent in the current fiscal year, and only half by the end of fiscal 2010,Money Morning reported last week.

“I don’t think that’s [deciding on a second stimulus is] a judgment we need to make now,” Geithner said Sunday on the CNN program. “We can’t really make it prudently or responsibly.”

Assurances from the man in charge of the world’s largest economy are important to those whom have invested in it, but several economists believe the Obama administration needs to do more to address worries about U.S. deficits.

“We have a fiscal policy that will ultimately undermine the value of their holdings and that has got foreign investors nervous,” said Mark Zandi, chief economist at Moody’s Economy.com told The Associated Press. “They are seeking assurances that the U.S. is committed to dealing with its long-term deficit problems.”

Geithner will also discuss with officials from Saudi Arabia and the United Arab Emirates the lack of stability of oil prices, which rallied about 115% to $73 a barrel after falling below $34 a barrel in February. The Commodity Futures Trading Commission (CFTC) last week said it will hold a series of hearings this month and in August to determine whether or not it should place new limits on energy futures contracts.

There’s a good chance that the United States and other economies will start growing again, Geithner said in a Reuters interview.

“In my view there are significant risks and challenges ahead,” he said. “We have a very powerful set of policies in place, coming on stream. I think there is a very good chance we will see the U.S. economy and the world economy get back to recovery, get growing again, over the next few quarters.”

Source: Geithner Takes Dollar Assurances to Mideast ]]> http://www.contrarianprofits.com/articles/geithner-takes-dollar-assurances-to-mideast/19081/feed 0 http://www.contrarianprofits.com/articles/dollar-declines-3/18471 http://www.contrarianprofits.com/articles/dollar-declines-3/18471#comments Mon, 29 Jun 2009 19:30:01 +0000 Doug Casey http://www.contrarianprofits.com/?p=18471 In the currency market, the dollar lost some more ground to the euro. Late Friday, the euro was trading at $1.4068 vs. $1.3991 on Thursday.

China took center stage as Marketwatch.com reported that “the People’s Bank of China’s annual financial stability report repeated an earlier call by central bank chief Zhou Xiaochuan for the development of a new super-sovereign currency that would largely take the place of the dollar…

“The Chinese central bank’s comments come after Chinese government officials had played down concerns over the dollar’s reserve-currency role following a visit to China by U.S. Treasury Secretary Timothy Geithner earlier this month.

“ ‘There may be signs here of tensions mounting between the PBOC’s economic concerns over China’s holdings of dollars and the…

Summer begins in 3 days. We can hardly wait. We predict it will be a killer.

Several interesting things are likely to happen this summer.

1) Unemployment rates will go up.

2) Rising joblessness will increase rates of defaults, foreclosures, and bankruptcies. Not just at the consumer level – but throughout the system… including banks, states, businesses, as well as households.

3) The stock market will take a dive as earnings fall and investors realize that there will be no quick recovery.

Oh… and one more thing: US bonds could collapse. But watch out; here’s where it gets tricky. Another swoon in the stock market could send investors running for the smelling salts in the bond market. A collapse of bond prices, on the other hand, could send them helter-skelter into stocks.

Yesterday, the Dow rose 7 points. Oil held at $71. The dollar lost a little ground – to $1.39 per euro. And gold added 3 bucks.

It is impossible to predict what will happen – or when – in the markets. So let us turn our attention to the real economy. Here, we see the picture more clearly: We’re in a depression. We write depression with a small ‘d.’ We’re saving the big one for later.

Few economists or analysts will tell you we’re in a depression. They’re looking at “green shoots” and rising trendlines. They’d do better to read a little history. Such as the history of the Great Depression.

Martin Wolf in the Financial Times (reporting the results of a study by two American professors):

“First, global industrial output tracks the decline in industrial output during the Great Depression horrifyingly closely. Within Europe, the decline in the industrial output of France and Italy has been worse than at this point in the 1930s, while that of the UK and Germany is much the same. The declines in the US and Canada are also close to those in the 1930s. But Japan’s industrial collapse has been far worse than in the 1930s, despite a very recent recovery.

“Second, the collapse in the volume of world trade has been far worse than during the first year of the Great Depression. Indeed, the decline in world trade in the first year is equal to that in the first two years of the Great Depression. This is not because of protection, but because of collapsing demand for manufactures.

“Third, despite the recent bounce, the decline in world stock markets is far bigger than in the corresponding period of the Great Depression.

“The two authors sum up starkly: “Globally we are tracking or doing even worse than the Great Depression … This is a Depression-sized event.”

Yesterday, we proposed two sine qua non for a new boom. Either the feds revive the old economy – by getting people to borrow and spend more money. Or, the mistakes of the past must be corrected… whereupon new investment and growth can take place. While the free market is busy working on the latter, central banks and national governments all over the world are trying to stop it. They’ve got the voters and campaign contributors to answer to, none of whom wants to get what he deserves. Instead, they’re hoping to revive the Bubble Epoque. Citizens are already up to their necks in debt; but the feds raise the water level!

This flood of fed liquidity seems to be raising boats and animal spirits among speculators. But it is doing nothing to revive the real economy.

“Consumer Costs Fall Most in Six Decades,” reports Bloomberg. Europe is already in deflation. America is not far behind. We had a hard time following the Bloomberg report. It said consumer prices were 1.3% below those of 12 months ago. We don’t believe that’s true. What we think Bloomberg meant to say was that prices are increasing at the slowest pace in 6 decades… but, for the moment, inflation is still (barely) positive.

With prices falling, the last thing the feds are worrying about is inflation. Except that there isn’t any. And they’re going to worry a lot more over the summer, when the hot sun beats down on a lifeless economy and it becomes obvious that their revival efforts have failed.

Meanwhile, Theo Casey’s predicting it the other way. He’s predicting an “H-Bomb” ahead… “H” for hyper-inflation.

And more thoughts for the summer ahead:

*** Global commerce has fallen in line with the Great Depression. That means producers don’t need to produce so much… and don’t need so many people to produce it. Jobs are lost. And then the people who lose their jobs don’t go out to restaurants and malls so much… so more jobs are lost.

These job losses take time to show up. And then they take time to “ripen.” People tend to have a little something set aside for a rainy day – or at least, unemployment compensation. But after a few weeks of stormy weather, the reserves are exhausted. Then… they have to cut back much more.

USA Today asked people: “If you lost your job, how long could you afford to pay for your own health insurance?” More than 65% of respondents said they could only manage for 6 months or less.

In America “there hasn’t been a shock like this since the de-mobilization of millions of soldiers following WWII: something like 3 million unemployed people are going to fall out of the safety net in the third quarter. With their families, that’s about 10 million people who will sink suddenly into deep poverty,” says GEAB a private research service headquartered in Paris. The group anticipates a “Very Great Depression” coming to the US.

More than three million jobs have been lost in the US during the last 5 months. As these out-of-work cases ripen, there will be some rotten fruit falling to ground.

There are also the millions who are working fewer hours and earning less money. In fact, the number of hours worked per week has fallen to a record low.

Where do people without jobs, without incomes, without savings – and without benefits – shop? What money do they spend? How does a consumer economy launch a boom when consumers have less money to spend?

These questions have obvious answers and obvious implications: there ain’t going to be any consumer spending boom in the USA… not this summer… and probably not for many summers to come. Martin Wolf explains why:

“Robust private sector demand will return only once the balance sheets of over-indebted households, overborrowed businesses and undercapitalised financial sectors are repaired or when countries with high savings rates consume or invest more. None of this is likely to be quick. Indeed, it is far more likely to take years, given the extraordinary debt accumulations of the past decade. Over the past two quarters, for example, US households repaid just 3.1 per cent of their debt. Deleveraging is a lengthy process.” .

If we assume that debt levels need to go back to where they were before the Bubble Epoque… well, let’s say to 200% of GDP just to make the maths easy… that means 170% of GDP worth of debt needs to be paid off. That’s $20 trillion, in round numbers – or about 40% of the total. At 6% per year, even if households kept paying off debt at the current rate it would still take nearly 7 years to get household debt down to pre-bubble levels.

Then, of course, there is the government debt – now expanding faster than ever. The US has the biggest deficit – even as a percentage of GDP – of any serious country in the world. The US deficit is 12% or 13% of GDP. Compare that to Russia at 2.6%…. Spain at 6%… France at 5%… Brazil at 1.3%…. Even Argentina has a much smaller deficit than the US – only 3.6% of GDP.

(More on the pampas tomorrow….)

But don’t worry about it. The ‘Committee to Save the World, Part II’ is on the case. Geithner, Bernanke and Summers are staying in the office throughout the hot months. They kept us out of trouble so far, didn’t they?

So enjoy the beach!

*** The US has entered the Third Stage of a great nation. The Political Stage.

In the late 20th century, power and money moved from the banks of the Monongahela to the banks of the Hudson. Now they’re moving again – to the banks of the Potomac. Washington calls the shots.

“Obama Blueprints Deepen Federal Role in Markets,” says a headline in yesterday’s Washington Post.

Of course, this change didn’t happen overnight. George W. Bush was a trailblazer – turning ‘conservatives!’ into big spending activists. And the business community – particularly the banks – saw it coming and got ready.

In 2001 the banking industry spent $5 million on lobbying in Washington. The total went up every year. By 2008, they were spending $20 million. Campaign contributions from bankers increased too… from only $4 million from the bankers’ political action committees in 2000 to $8 million last year.

Judging from the bailouts given to Wall Street last year, this investment paid off handsomely.

Source: Killer Summer Ahead

In fact, most experienced investors have reached a similar conclusion. These sophisticated investors know that Goldman is a far better investment than gold, not merely because CNBC worships the former and despises the latter, but also because Warren Buffett took a $5 billion position in Goldman Sachs, not in gold.

That said, a few of us experienced investors are slow learners. We do not comprehend as rapidly and facilely as most folks do that Goldman is better than gold. We are slow to understand that a highly leveraged trading operation – subsisting on short-term financing, friendly accounting conventions and intermittent governmental coddling – is a better vehicle for preserving wealth than a bar of gold.

Sure, we understand that speculations sometimes succeed, and that leveraged speculations sometimes succeed in spectacular fashion. But we have a hard time making the leap from “leveraged speculation” to “prudent long-term investment.” And, therefore, we have a hard time making the leap from “pinstriped crap shoot” to “better than gold.”

Admittedly, over the last eight months, Goldman has performed seven times better than the gold. But if we extend the time frame of our analysis, back to May 1999, when Goldman Sachs first became a public company, we discover that gold has produced twice the return of Goldman Sachs’ stock. Which prompts the question: Which of these pasts will be prologue? The last eight months? Or the last 10 years?

To answer this question, we must examine the relative virtues of each investment, as well as their relative deficiencies.

First, let’s consider a few of gold’s deficiencies:

Gold never installs an ally in the office of Treasury Secretary. Gold does not receive multi-billion-dollar bailouts from the US treasury. Gold has no CEO to dispatch to Washington D.C. to attend closed-door meetings with the Treasury Secretary. Gold has no “prop trading” desk that can sell short the very same toxic mortgage- backed securities that it just sold to its own clients. Gold has no access to credit, and therefore, has no mechanism for leveraging its balance sheet 40-to-1 in the pursuit of outsized investment returns.

Come to think of it, gold doesn’t have much going for it at all. Of course, that’s also gold’s principal virtue. It is what it is – simply a rare, naturally occurring element without a CEO or a standing army or even an official fan club. Instead, gold’s short list of virtues would include only its alluring gleam in the sunlight and its multi-millennial history of preserving wealth.

Goldman Sachs, for its part, has also withstood the test of time…sort of. Goldman has been an operating enterprise since 1869, when a German Jewish immigrant by the name of Marcus Goldman first hung out a shingle. Thirteen years later, his son-in-law, Samuel Sachs joined the firm. From this humble beginning a modern-day financial marvel has emerged.

But a closer look into the annals of Goldman Sachs’ history would reveal that this illustrious investment firm has flirted with corporate death on more than one occasion.

“I just recently finished perusing Charles Ellis’ new history The Partnership: The Making of Goldman Sachs,” Chris Mayer, editor of Capital & Crisis, observed a while back. “I was particularly interested in the early history of Goldman Sachs. I thought I would come away thinking how Goldman Sachs used to be a simpler business. I thought Goldman’s history would show how it took prudent risks with adequate equity backing those risks. My conclusion would then be that the current crop of leaders at Goldman were just reckless and had imperiled a franchise that had been around since the 1880s.

“In fact, that’s not what I learned at all,” Mayer continued. “From Goldman’s earliest days as a commercial paper specialist it operated with minimal capital. All through its history, it has been an enterprise that took big risks and often took huge losses. That Goldman even exists at all today is something of a financial miracle.

“In reading this history,” said Mayer, “I was struck by how the company found itself in the soup again and again and again. In the 1920s, one of the biggest speculative busts was in investment trusts in which a small amount of capital supported a spider’s web of investments in other companies. Guess who had the biggest blow-up of them all?

“Goldman was big in this through a subsidiary called Goldman Sachs Trading Corporation, which basically lost everything for its investors. Ellis writes: ‘While all the investment trusts suffered, Goldman Sachs Trading Corporation – because it was so large and so highly leveraged…became one of the largest, swiftest, and most complete investment disasters of the twentieth century.’

“The loss to Goldman Sachs itself was enormous,” Mayer explained. “It basically wiped out thirty years of profits and eliminated the ‘fruits of all the labors of a generation.’ Fast forward to 1970 and the biggest bankruptcy in the country at that time. You find Goldman was waist-deep in it. Penn Central at the time of its bankruptcy in 1970 was the eighth largest corporation in the country. Again, Ellis writes: ‘The loss it [Penn Central] threatened to impose on Goldman Sachs was not only larger than any prior loss, it was larger than Goldman Sachs.’

“And so it is again today that the company finds itself in the middle of another big crisis,” Mayer concluded. “All of these anecdotes scream at me to avoid complex and leveraged companies, where the potential for large, potentially catastrophic, losses is never far away.

But who says history has to repeat itself? According to Goldman’s top brass, the successful investment firm has emerged from the credit crisis (it’s over, isn’t it?) in tip-top shape, and certainly does not need any of that nasty, compensation-crimping TARP money.

Hopefully, things are just as good as Goldman proclaims. But that doesn’t mean its stock is anything more than a call option on leveraged speculation. In other words, the worst might be over…or it might not be. Not even Warren Buffett knows for sure.

The nearby chart suggests that the worst is NOT over.

The estimates of total losses in the banking industry continue to climb. One year ago, $1 trillion of total losses seemed like an outlandish number. Today, most estimates range from $2 trillion to $4 trillion (of which only $1 trillion has been recognized to date). In other words, the banking industry is still in deep doo-doo. The industry’s ENTIRE tangible common equity is only $1 trillion, which means the banking industry does not have the balance sheet to absorb losses of this magnitude.

Presumably, finance companies like Citigroup (NYSE:C), Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC) are holding most of the industry’s toxic assets, but Goldman Sachs certainly owns SOME of them. Goldmans’ “Level 3” assets, for example, total nearly $100 billion (“Level 3” is an accounting term for the kind of assets that are hard to value. In the real world, Level 3 assets are the kind of assets that hardly ever hold their value. This is the toxic stuff.)

$100 billion is a dangerously large quantity of illiquid, partially impaired, assets – equal to 150% of the company’s total shareholder equity. And remember, Level 3 assets are only one part of Goldman’s toxic-asset pie. The investment firm also holds billions of dollars of other toxic assets that are EASY to value. So it’s not hard to imagine that one little, unanticipated wiggle here, or one unexpected wiggle there could cause a big part of the Goldman balance sheet to go “Poof!”

Goldman’s situation is not unique. In fact, Goldman probably remains one of the best investment banks still standing. But that’s exactly the reason for raising a few questions about the company’s bullet- proof public image. The company’s share price seems to assume business-as-normal.

But forward-looking investors would probably do well to assume that business-as-abnormal will resume sometime soon.

Gold or Goldman? Your call.

Source: Gold Versus Goldman