Politics is not about what works, it’s about what you can get away with. And what you can get away with is often exactly what doesn’t work at all.

Our beat is money, here at the Daily Reckoning. We specialize in fraud and folderol. We leave the homicide beat to someone else.

What the US is getting away with, from a financial point of view, in addition to counterfeiting, is very grand larceny on a Super-Madoff scale. It is borrowing trillions of dollars even though it has no way to honestly pay back the money.

Still, so eager are the lenders to part with their money that the yield on the 10-year T-note fell yesterday to 3.64%. The more the feds borrow, apparently, the more lenders are willing to lend.

We’re in the Third and Fatal stage of a great country – the political stage. In this stage, money and power migrate from the financial community to the political community. The politicians get away with taking trillions out of the productive economy and spending them on their pet projects and private corruptions.

Warren Buffett described the America of the Bubble years as “Squanderville.” Private citizens were living beyond their means, he pointed out. But he hadn’t seen nothin’. Now, the squandering is done by government. The politicians are spending trillions they don’t have on projects nobody was willing to pay for even when they had some money in their pockets.

What the government can get away with now – under cover of a financial crisis – is a big grab for money and power. It ‘works’ in the sense the feds are able to get away with it. But it will prove fatal to the dollar… and to the US economy.

We will return to that subject below…

Back in the markets, the Dow fell modestly yesterday, down 16 points. Oil clung to the $69 level. Gold was up $3 to $924. And the dollar saw its biggest drop in weeks as speculators waited for word from the Fed on its next move.

The Fed is expected to talk about an “exit strategy.” It is intervening in markets as no Fed ever has. Its balance sheet – a measure of how much intervention it has done – has shot up in a way that is not only unprecedented, but almost unbelievable. In an effort to provide liquidity, it has bought up the contents of every neglected refrigerator on Wall Street. The smelly, furry stuff – “toxic” derivatives… SIVs… MBAs… no one seems to know exactly what it is – enters the Fed’s books as an asset. Altogether, along with its not-so-pungent holdings of US Treasury bonds, the Fed’s balance sheet shows more than $2.7 trillion worth of assets.

What happens next?

We don’t know. But it is far too early to worry about it. The Fed is in no position to head for the exit. It will have to stay on this road for much, much longer.

Why? Because the “green shoots” are shrivelling up. There is no real economic revival. And there can’t be one until the underlying problems are corrected.

One of the big problems is too much capacity. We mentioned it yesterday. During the Bubble Epoque the squanderers would buy anything. So, you could make an almost unlimited amount of money by providing them with things to buy. This meant building factories… buying trucks… and renting retail space. Now, however, the squanderers have come to their senses. They want to save their money. So, no need for so much retail space in the malls, so many trucks on the highways or so many factories in China.

America’s middle class has rediscovered thrift.

There are a number of sit-down restaurant chains that cater to the middle class – Applebee’s… Chili’s… Ruby Tuesday and a few others. They expanded greatly during the ‘90s and ‘00s in order to meet the desires of the big spending masses. But now that the masses aren’t so free and easy with their money, New York Times reports that they are in desperate competition for remaining diners. This competition is manifesting itself as price deflation.

Applebee’s offers dinner for two for only $20. Chili’s advertises entrees (the main course in America) for just $7. Ruby Tuesday’s is going for a 2-for-1 deal. Buy one meal, get one free. All of them are making heavy use of discount coupons.

Oversupply is producing deflation. Prices are falling as suppliers fight for demand by offering more for less. And over at the Red Roof… the roof has already caved in as the chain has defaulted on its mortgage debt.

This is what you’d expect at the end of a long period of credit expansion. EZ credit brought forth too much demand and too much supply. Now, the demand is disappearing… and the suppliers struggle to hold on.

This is natural, normal and perhaps necessary to a market economy. And it will take years to sort out. Roofs have to fall in on thousands of enterprises, speculators and households. Then, the rebuilding can begin.

But the Bernanke Fed is not about to let nature take her course. The Fed is on the road to ruin… and it’s not about to “exit” yet. Deflation is still enemy number one. Don’t expect any tightening from the Fed anytime soon, dear reader… it is far too soon for that.

*** More news from Manraaj Singh on why “captains of industry” are furiously selling out of shares in the companies they run.

“Insiders are selling-out. Investors have increasingly reached the point where they been questioning the sustainability of the rally.

“The signs of a coming sell-off have been rising sharply recently. Share valuations in both emerging and developed markets have reached unsustainable levels. And another key indicator of a coming market correction has been the scale of insider selling within the big US companies. This is a measure of whether the top managers of publicly-listed companies have been buying or selling shares in the companies that they run. And the data has not been good.

“So far this month, company insiders in the US have sold 22 times more shares than they have bought. In other words, the majority of people who run listed companies in the US just don’t consider their own companies worth investing in right now. The data for June, up to now, shows that insiders of S&P 500 listed companies have sold $2.6 billion in shares, compared with just $120 million in purchases.

“This is a very important clue as to where markets are heading. Because the last time there were more U.S. corporations with executives reducing their share holdings than adding to them was during the week that ended 19th June 2007. Global stock markets went into meltdown shortly after that. I expect to see the same thing happen over the next couple of weeks.

“Right now, the chaps with ring-side seats of the US economy see plenty more pain head. And as the US economy goes, so goes the world economy… ”

Editor’s note: Manraaj Singh believes the sell-off is a good thing for long-term investors. The sharper the falls, the cheaper the price at which we can get into the investments that we want. Manraaj is Chief investment strategist of Profit Hunter, which looks to profit from special situations around the world. To learn more about his service and discover his latest investment recommendation, click here.

And more thoughts… .

*** Governments are essentially parasites on productive activity. So the best governments are the smallest – meaning, the least parasitic. “The government with governs best governs least,” is how Jefferson put it.

But now we are in the third and fatal stage of a great country – the political stage. In this stage, the parasites take over. Government governs a lot. And governing a lot costs a lot of money. In England, the government budget is bumping up against half the total GDP of the nation. In America, health care is still largely a private matter, so the government spends a smaller percentage of GDP… but it is a percentage that is rising quickly.

Where will the money come from? Taxes. Gordon Brown has already put the income tax rate up to 50%. Michael Caine, an English actor who moved to California to escape the high taxes of the ‘70s, says he will tolerate 50%… but not a penny more.

“If it goes to 51% I will be back in America,” he says.

Ahem… he might have to try somewhere else. Everybody’s gunning for the rich – in America as well as England. Obama has pledged to raise taxes on the rich. The states, notably California, are desperate for more revenue too. Add federal, state and local levies… and private health care costs… and you could easily be over the 50% bracket in America too.

But when you rob the productive Peters to pay the parasite Pauls two things happen. The Peters get their backs up. And you’ve soon cleaned them out anyway.

So, governments need to find other sources of financial support. Typically, they borrow money.

The history of European monarchies is largely a history of debt. Kings and queens squeezed what they could out of the turnips. Then they turned to the moneylenders. These lenders had to be careful. They were happy to extend monarchs credit, because in this way they gained a measure of control over them. But there were many dangers.

Kings lost their heads… or went broke. Or, often, the monarchs could turn the tables on the moneylenders… and have their heads cut off. Reading the history of the loans to the French crown it is eye-opening. It is amazing anyone wanted to lend at all. The risks were great; the rewards were few. Rarely were the loans settled honorably.

What you come to see is that lending to the government – which always has the power to betray the loan and behead the lender – is merely another form of taxation. Government raises money. Sometimes it repays the loan with revenues from other taxes. Sometimes, it is the lender who pays the tax himself – either because the government defaults… or because inflation reduces the value of his money.

This week… indeed, this year… lenders are turning over massive amounts of money to the US government. There is so much demand for US paper that the yield on the 10-year note fell yesterday to 3.64% – despite the huge new supply of T-notes coming on the market. It is breathtaking to watch. But it is a story that will end badly. We predict that lenders will end up like the financiers who lent to Louis XIV and later regretted that they ever met the man.

“Every loan always diminishes the free revenue and necessitates, at the end of a certain time, either bankruptcy or the increase of taxes,” explained Turgot to a later Louis. “In times of peace it is permissible to borrow only in order to liquidate old debts, or in order to redeem other loans contracted on less advanta¬geous terms.”

Any borrowing in excess of that puts you on the road to ruin, Turgot went on to explain.

More on Turgot – a man sadly neglected by historians – in upcoming reckonings.

Source:  Grand Larceny on a Super-Madoff Scale

Given the response, I’d say that most had their eye on the ball with the jobs farce… And that’s all I’m going to say from here on out…

One person did ask me what the President had to do with currencies, in an attempt to obviously steer me back to what I DO know… Well, perception is a BIG thing in currencies folks, and if your leaders are perceived to be one way or the other, it can play big into currency direction. So, to say that what I had to say didn’t have anything to do with currencies is on the wrong path.

OK… Enough! The currencies did heal a bit yesterday, with the euro trading back to 1.39 and change during the day… After taking the euro down on Friday, and Sunday night, traders began to realize that the U.S. has to deal with more supply today… And… Once again, the fears that the U.S. won’t have anyone show up for a Treasury Auction, just brings back the reality that owning dollars probably isn’t a wise thing to do… $35 Billion in 3-year Treasury Notes will be auctioned today…

And… Treasury yields continue to rise… I keep coming back to the rising Treasury yields because, well… Because I want to! Seriously though, have you been keeping score at home on these rising yields? The 10-year Treasury hit a yield of 3.83% yesterday… Now that might not sound too high, but at year-end 2008, a mere 5 months ago, the 10-year’s yield was 2%… And if you just keep bringing more supply after more supply to the markets, they are going to demand that those yields get even higher!

And let me remind you that as the yield on a bond goes up, the price of the bond goes down! So… For example… At 2% the price was 110.08… And at 3.83% the price is 94.20… (according to my Bloomberg!) So… All those investors that bought Treasuries last summer in a flight to safety, need to check their statements! Any way… I’m going to add the 10-year Treasury’s yield to the Big Finish, so we can keep better track of it!

The political turmoil in the U.K. looks to be water under the bridge now, and the pound sterling came back strong! I’m shocked at how strong this currency bounced back after the U.K. elections were over. But then I was shocked that the currency was 1.65 last week too! But, as I always say, don’t step in front of a run-away bus!

The high yielders and Commodity Currencies all saw some healing too, except Mexico, which is watching the price of Oil back off from the higher levels of last week. I saw a story on the Aussie dollar (A$) that struck me as strange… Now, first of all, I have a few detractors that tell me that I only write about things that make a currency look good and bypass the bad stories… I don’t see it that way, but be it as it may… I saw a story that said the technical charts show that the A$ is going to fall back to 70-cents… Of course last week, another guys charts had it going back to 80-cents… Hmmm… I need to get these two chartists together and iron this out!

There’s a preliminary G-8 meeting this weekend to set the agenda for the Big G-8 meeting in a couple of weeks. I have to think that the currency moves in the past 3 months have got to be on the agenda… That, and… China’s latest rumblings about the dollar as a reserve currency. Speaking of China, the World Bank President, Robert Zoellick, was talking at a conference in Montreal last night, and said that China may seek to diversify its foreign currency holdings over time, moving them away from U.S. dollars… Here’s more… “over time I could see china moving to some further diversification of its reserves.”

Well… He sees it… But do the Chinese see it as a need? One would think that they do, given their worries that a weaker dollar could hurt Chinese investments in U.S. assets, and the fact that they brought to the table an alternative currency as the reserve currency of the world… I’ve reported all of this numerous times in the past couple of months, so nothing new… Just a need to review it once again…

As I write this morning, I’m watching the euro, which was 1.3920 when I came in, lose some ground to 1.3875… Not much of a move, but a direction that is not likely to last, in my opinion… Not with the supply thing hanging over the dollar’s head.

Don’t know if you follow stuff like this or not… But the elections for the European Parliament took place last week. In Germany, France, Spain and the U.K. the representatives that believed that throwing taxpayer money at failing corporations, got hammered… Hmmm… I wonder how that would play out here? But I’m not going to go down that road…

I mention that piece above, because I think it had something to do with German Chancellor, Angela Merkel’s comments last week… Most of us thought she was taking a shot at the Fed and Bank of England… And she probably was… But her main goal, I believe now, after see the results of the elections, was to bring all this to light right before the voters went to the polls… I’m telling you… She’s one smart cookie!

Gold and Silver are having a tough row to hoe in finding a bid… The Bid winds have not filled the main sails of Gold and Silver for 3 days now… And with this following story that I’m going to provide, the bid winds will be even tougher to find… As it will signal to the markets that the tourniquet has been wrapped around the patient (financial institutions) and some are recovering…

It was reported last night that 10 Banks will be allowed to repay their TARP (troubled assets relief program) funds… Could total $50 Billion! With the Fed being so demanding in their grading of these banks before allowing them to repay the TARP, I would think that these banks will be well suited to move forward from here…

With Gold hovering around $950 and Silver around $15, it certainly provides an opportunity to buy at cheaper levels than last week’s lofty figures, eh? I would use these dips to my advantage… But then that’s just me… It doesn’t mean that it’s the right thing to do!

My friend, Bill Bonner, had a great piece in his Daily Reckoning (www.dailyreckoning.com) yesterday, regarding house prices… Check this out!

Robert Shiller was talking about Home prices in the NY Times, and this just kind of hit me like a V-8 slap… “Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997.”

We’re also looking at $2.4 trillion worth of Alt-A mortgages that will need to be refinanced or reset. The peak in those resets won’t happen until January 2013.

Hmmm… That’s not anything that anyone selling a house wants to hear! But anyone that wants to buy, well… That’s not as devastating to hear!

Well, the data cupboard is empty today, with the U.S. Treasury auction the only thing to deal with today. Tomorrow we get the Trade Balance report for April… Yesterday, I made a mistake talking about the Trade Deficit saying it was “millions”… When I know all too well that it is in the Billions! Just put that down to being writing too early in the morning! But for those of you keeping score at home, the Trade Deficit is forecast to be $29 Billion in April!

But more importantly, tomorrow we’ll see the Budget Deficit, which is expected to be $180 Billion for the month of May… If it tallies there at $180 Billion, the Budget Deficit in the first 5 months of this year will have exceeded $650 Billion… And that’s before the $787 Stimulus gets added… And other items that will come along… And don’t forget that we posted a deficit in April! I still believe the Budget Deficit will be at least $3 Trillion this year!

That would push our National Debt to around $14 Trillion… You can keep score at home if you want by clicking on this link… http://www.brillig.com/debt_clock/

Time to head to the Big Finish…

Currencies today 6/9/09: A$ .7925, kiwi .6210, C$ .9025, euro 1.3890, sterling 1.6150, Swiss .9160, rand 8.1450, krone 6.4340, SEK 7.8150, forint 202.65, zloty 3.2350, koruna 19.3020, yen 98.30, sing 1.46, HKD 7.7515, INR 47.55, China 6.8354, pesos 13.40, BRL 1.9630, dollar index 80.83, Oil $68.85, 10-year 3.83%, Silver $15.07, and Gold… $952.45

Source: Rising Treasury Yields

The old mantra was that if the United States sneezed, the rest of the world would catch a cold, as the US was seen as the main driver of world growth. That was then. Economists and analysts began to argue that China and the developing markets were starting to provide a consumer base for the world. And Europe’s new and growing markets would be able to stave off problems from abroad and stay on their own growth path. The world, we were assured last year, would not suffer from problems in the US economy.

Today, we look at evidence that this might not quite be the case. And if it is not, those who look for diversification in global markets may be disappointed. Also, I quickly look back at my January forecasts and feel it may be time for a mid-course correction. It seems I may have been a little too optimistic. It should make for an interesting letter.

But first, a quick commercial. I spent two days at the Caves Valley Golf Club outside of Baltimore with good friend and business partner Steve Blumenthal, the president of CGM. He has developed a platform of money managers who can take direct accounts, and I recommend that readers interested in outside money management take a look at them. Normally, to take a look at the managers, we have you sign up to get a “pass” to take a peek behind the curtain. We decided we would change that policy, at least for this week. If you would like to look at a manager I think quite highly of, you can click on this link to see a few details about him. http://www.cmgfunds.net/sys/docs/118/ARS%20Scotia_new.pdf (Remember, past performance is not indicative of future results.) If you would like to talk with Steve or his team about this manager or the others that are on the platform, simply click on the following link, fill out the form, and they will call you. http://www.cmgfunds.net/public/mauldin_questionnaire.asp

And as always, if you have a net worth of $1.5 million or more and are interested in hedge funds, commodity funds, and other alternative investments, you can go to www.accreditedinvestor.ws and one of partners from around the world will show you what is available on their platforms. (In this regard, I am president and a registered representative of Millennium Wave Securities, LLC, member FINRA.) And now to the letter.

A Mid-Year Correction

I wrote in my January 4 letter the following predictions:

“So let’s get to the predictions. I think that we are in a recession for most of the first half of this year, and that we begin a slow recovery in the second half. It will be a Muddle Through Economy for at least another year after that. That would suggest that most companies will come under serious earnings pressure. If history is any indicator, that means we should see a bear market in the first half of this year. How deep will depend on how fast the Fed cuts, but I don’t think we are looking at anything close to the bear market of 2000-2001. Still, I wouldn’t want to stand in front of a bear market train.

“Consumer spending is going to slow, and it will be slower to rebound, for reasons outlined above. That will also make the recovery in the stock market a little slower. But I expect to become bullish on the market sometime this summer, if not before. I’m looking forward to it.”

To be blunt, that optimism now seems misplaced. I think we are likely to stay in recession for perhaps the rest of the year and well into 2009 before we start a very slow recovery. It is not time to get bullish on stocks, as I have been writing for the past few months. Earnings are going to continue to come under pressure, and earnings are what drive the stock market over the long term. We could see total S&P 500 as-reported earnings drop below $50. You do the math. Even with a 20 multiple, that does not yield a pretty picture.

I think we are going to test the recent lows and then watch the market go lower as the market gets disappointed in the earnings from the third quarter, and re-test those lows again. We are in for an extended period of Muddle Through, while we wait for the housing market to find a bottom and the credit crisis to abate. Banks and other institutions have written off about $500 billion. There is at least another $500 billion to go. The amount of capital that is going to need to be raised is astronomical, and it is going to be very dilutive to current shareholders.

I did predict that the euro would top out against the dollar this summer, and that looks to be the case, although the dollar went lower against the euro than I thought it would when I forecast $1.50 about 4-5 years ago.

Whatever Happened to Decoupling?

I was reminded of an article by Desmond Lachman of the American Enterprise Institute (by Leo Kolivakis of www.pensionpulse.blogspsot.com). Lachman wrote these very prescient words last January in a paper called “The Myth of Decoupling.” Quoting:

“Sadly, the ‘decoupling’ thesis has little support in theory or in practice. Its proponents overlook the fact that during the past five years the U.S. economy grew faster than all the other G-7 economies. During that time, America’s economy remained the principal generator of global aggregate demand, accounting for around one-fifth of global imports and 25 percent of global production. This evidence suggests that, as in the past, if the U.S. economy sneezes the rest of the world will catch a cold.

“… A number of the shocks presently affecting the U.S. economy are global in nature, and are already slowing European and Japanese growth. The credit crunch flowing from America’s subprime woes is causing a global increase in market interest rate spreads and a global tightening of bank lending standards. This is hardly surprising: almost half of all U.S. asset-backed subprime mortgage securities were distributed abroad.

“… The ‘decoupling’ optimists are ever hopeful that China’s rapid growth, together with the rest of Asia’s emerging market economies, will offset any U.S. economic downturn. But they tend to forget that Asia is filled with export-dependent economies: in some countries, exports to the United States alone [emphasis mine] account for more than 10 percent of annual GDP. The “decouplers” also forget how relatively small these Asian economies still are, at least in relation to the G-7 industrialized economies. Even the vaunted Chinese economy is barely 15 percent the size of the U.S. economy.”

We are now seeing the major economies of the world go into simultaneous recessions and in many of them elevated inflation as well, giving way to stagflation. Let’s first take Europe. Today we learned that “GDP growth is easing in a number of European economies as highlighted by national accounts figures out during the week. The flash second quarter GDP data for the euro zone noted a 0.2% q/q contraction, following a 0.7% expansion in the first three months of the year. This was primarily the result of a 0.5% downturn in the region’s largest economy, Germany, and a 0.3% contraction in second biggest, France.” (www.economy.com) The chart below shows the latest data results.

Point is, though, the government has ploughed another £3 billion into Britain’s most damaged bank. That’s a lot of money when you consider that, at its peak, the Rock was worth only £5 billion. It’s especially huge given that we will likely never see it again.The funding takes the form of a debt for equity swap. Basically, the government has agreed to waive £3 billion of debt in return for shares in the bank. There’s a strong likelihood that these shares will ultimately prove to be worthless.

So the question is, why is the government doing this? Why, at a time when the public finances are in such a state, is it putting £3 billion into a broken business that’s heavily exposed to a falling property market?

I worked in one of the Northern Rock’s mortgage centres in 2004 and 2005. A lot of our business involved the now infamous Together product — the one designed to help first-time buyers by lending them up to 125% of a property’s value.

As part of the job we naturally got to see applicants’ private financial details. Bank statements. Wage slips. Employers’ references. Loan repayments. How much it cost the applicant to drive to work. I suspect some of the applicants I saw will struggle in a recession.

I was not surprised, therefore, to read yesterday that up to 5% of Northern Rock’s mortgage book is thought to be in negative equity. The figure is expected to rise to 20% over the next year.

So why is our strapped-for-cash government putting more money into Northern Rock?

I’ll tell you why — fear. In terms of the banking industry Northern Rock was never in the ‘too big to fail’ club. But in terms of the north east economy, a precipitous collapse could have sent shockwaves. That, at least, is the fear in Westminster.

The government is resorting to old school, 1960s-style Keynesian economics. Propping up a lame duck with public money to avoid the spectre of job losses.

We shouldn’t be surprised. As I wrote here last Thursday, the government has got into the habit of giving the jobs figures a leg up.

Maybe the government is right to try and support the local economy in this way. I’m not convinced by this argument. But the politicians seem to be, so why can’t they just say so?

Instead, we have this silly pantomime of pretending that an overexposed and failed mortgage lender will return to profitability in a couple of years time.

Even though the economic downturn will sour its loan book. Even though falling house prices reduce the value of collateral. Even though its savings arm is prevented from competing aggressively for funds (European competition law bans this as the bank receives state aid).

Labour wants to avoid job losses in one of its heartlands. It wants to avoid negative headlines.

That’s the main reason it will continue to support Northern Rock. But it’s not the reason we’ll be given.

Will oil carry on falling?

Oil was at $119 this morning. That’s quite a drop from its high last month of $147.

Oil bears are starting to write the invitations to their picnic. But they should refrain from being hasty. There are two wild cards that could send the price back up whence it fell.

One is Iran. Israeli prime minister Ehud Olmert has stepped down. Mooted as a replacement is Tzipi Livni, a former Mossad agent whose mother robbed a train as part of a Zionist campaign against the British. If Israel takes a more hawkish line on Iran, might this spook the oil market, and send the price higher?The other wildcard is the hurricane season. If an ill-placed storm knocks out producing capacity, that too could cause the price to jump.

If we do see such an event, it could cause a mini chain reaction, as colleague Frank Hemsley explains:

“A lot of blame was levelled at speculators for the dramatic rise in oil prices. Everyone, it seemed, was jumping on the most exciting bandwagon in town.

“Now speculators are driving the price back down. The FT reports today that over the last week, for every buyer of insurance against a rise in prices in 2009 there were almost 10 buyers of protection against a fall.

“In other words, ten times as many traders are betting on a fall by buying put options. The Wall Street banks, who are the originators of these options, have to sell oil futures to hedge their position… which pushes the oil price down.

“All we need is a shock to reverse this trend, and send the oil price up. That would send the short sellers scrabbling to cover their positions, sending the oil price higher still.”

A bullish sign for platinum?

FTSE giant Xstrata (XTA) has bid £5 billion for Lonmin, a producer of platinum group metals (PMGs). Lonmin has rejected the hostile approach. It reckons it undervalues the company’s assets.

Xstrata’s bid could be interpreted as a bullish sign for platinum. Indeed, technical analysts are suggesting PMGs are oversold.

So should you be adding platinum to your portfolio right now? Here’s our commodities expert Garry White with his view…

Until tomorrow,

Ben Traynor, Editor

Source: Why Is The Government Supporting Northern Rock?

In case these people hadn’t noticed, governments are already up to their necks in the markets, particularly the ones in the worst trouble. Fannie Mae (FNM) and Freddie Mac (FRE)– the twin financial neutron bombs underpinning the US mortgage sector – are Government Sponsored Entities (GSE) after all. They were created by the US Government to interfere with the property market because at some point the authorities decided that universal home ownership – like full employment – was a desirable goal in itself, regardless of whether people could actually afford a home or not.

Now the very existence of the GSEs threatens to bring down the financial system (you can read more about Fannie and Freddie here: How Fannie and Freddie are pulling the US towards crisis).

These knee-jerk calls for added regulation just show that despite all the talk of Thatcherite revolutions and how we’re all capitalists now, plenty of people still don’t understand how or why markets work.

One very obvious example of this is the constant indulgence of the idea of a windfall tax on energy companies…

How the market system is supposed to work

My colleague David Stevenson wrote about the specific stupidities of a windfall tax on energy on Friday (you can read it here: Why an energy windfall tax is a bad idea). But on a broader note, calls for a windfall tax just show how badly understood markets are. Let’s just clarify roughly how they are supposed to work.

If a good or service becomes expensive, that shows that there’s not enough of it to go around – there’s more demand than supply. The companies involved in the sector then make “excess” profits, or to put it more clearly, they rake it in because they were smart or lucky enough to be in the right place at the right time.

But this happy situation won’t last forever. Just as in the recent housing bubble, everyone else sees them making money hand over fist and decides “I’ll have a piece of that.” Or the company itself realises if it can make and sell more goods, it’ll make even bigger profits. One way or another, supply rises to meet demand, therefore driving down the price.

Read the Full Article

Source: Why We Need Less Government Interference, Not More

As my colleague Glenn (himself a former council worker) points out: “The lowest-paid member of staff tends to be the guy who locks and unlocks the office. So if he strikes, you’ve kind of got no choice!”

I’ve been predicting industrial unrest for months now. As I see it, a union’s natural inclination is to demand higher pay if its members are feeling poorer. Right now, the official inflation rate is 3.8%. But if you look at the retail price index (RPI) — the measure commonly used in pay negotiations — it’s 4.6%.

So, people feel poorer, and Unison, the public sector union, has called a two-day strike.

Brendan Barber, secretary general of the TUC, supports the action.

“All they want,” he says, “is a decent living wage. “Claims that decent wages will lead to spiraling inflation are wrong.”

But the sad fact is that these claims are not wrong — and I’ll explain why.

One of the reasons inflation rates — including the higher RPI measure — appear suspiciously low is because they track a whole range of products that we buy.

Crucially, those purchases that are rising most quickly are the very ones we can’t do without — food and fuel. No wonder Unison members are feeling the pinch.

But here we come to the sad truth of the matter. Food and oil prices are set on the global market. Britain is, to use the economic term, a price taker. We can’t influence what we pay for these essentials. That we’re having to pay more for them is a symptom of the fact that we, as a nation are getting poorer.

We managed to mask this fact for a while by resorting to credit. But now the credit’s run out.

To put it in crude terms, we can no longer have as much ‘stuff’ as we used to have. Other people — Chinese, Russians, Indians — want it. And many of them have more money than we do.

Pushing up nominal wages here won’t make the country wealthier. It’ll just mean prices will have to adjust more — upwards — to reflect our straitened circumstances. Wage rises will cause a wage-price spiral.

Either that, or the recession will kick in hard, throw more people out of work, and dampen aggregate spending power that way. This is the sad truth — we’re poorer as a nation, and we have to accept it. What was once a ‘decent wage’ is now an unfordable luxury.

So you can understand why Alistair Darling has reiterated his call for wage restraint. But it’ll fall on deaf ears. Pay in the private sector isn’t the government’s business — and private sector employers will do what’s best for themselves.

Of course, public sector pay is the government’s business. Or so you’d think. But here’s an odd thing. While the chancellor is urging restraint, a spokesman for Gordon Brown says that local authority pay — the subject of the current strike — is not set by the government.

That may be so. But it’s a curious point to make right now; effectively, the government has washed its hands of a problem it expects every other employer to tackle head on.

We’ve not heard the last of all this. There’ll be other strikes — and other attempts by politicians to look tough while being anything but.

Indeed, the thing that will save us is the recession. It’s sad but true that those fearful for their jobs are less likely to strike.

It may be cold comfort, but when the downturn bites hard, at least your bin will be collected.

Name the successful investment

The markets took yet another smashing yesterday. Very depressing stuff.

So, to lighten the mood, here’s an interesting poser I was sent by my colleague Frank Hemsley.

To the surprise of nobody at all, the Bank decided to leave rates on hold today. That won’t really help anyone, but it won’t leave anyone feeling victimized either (apart from those who think a rate cut is a birthright whenever things look tough. They should just buy Alan Greenspan’s book and be done with it).

The average first-time buyer now has to save an entire year’s salary just to stump up the deposit on a house. This, I believe, is a temporary phenomenon. Lenders are spooked, but to stay in business, they’re going to have to start lending sooner or later.

Nevertheless, it’s a sign of the times. And the times are not good.

Most worrying today is the news from the jobs front. For half of last year we had a crisis in the financial markets. It fed through to the big banks early this year. ‘Credit crunch’ became such a popular phrase, it entered the Oxford English Dictionary.

Then home builders, whose share prices took a hammering last year, took another hammering towards the end of spring. They’re still being hammered.

But, until recently, employment has held up. That’s because unemployment lags the economic cycle. People don’t get canned at the first sign of trouble. But the greater the strain becomes, the more employers have to let people go.

Unsurprisingly, the home builders are leading the way. Today we read that Bovis (BVS) and Redrow (RDW) sent another 1,000 construction workers to the dole queue. This is on top of the 900 jobs lost at Taylor Wimpey and the 1,100 lost at Persimmon during the last week.

Expect manufacturing to be next — the sector is already seeing its output contract. And then the service sector. The public sector will also have to contract, as tax revenues take a hit in the downturn.

All of which will drag confidence, profits and the economy as a whole down further. And we’ll see more lay-offs.

Indeed, today we discover that 11,000 manufacturing jobs are under threat. The Americans — who have plenty of their own problems right now — have turned protectionist. The Pentagon has torn up a contract with Airbus worth £18 billion. It puts jobs in the US, France and Germany under threat — as well as 11,000 here in Britain. Global economic woes are combining with domestic ones to create misery.

Those 11,000 face an uncertain wait as the bidding process — to build a fleet of tankers for the US Air Force — reopens. But they’re not alone. Sector by sector, insecurity creeps through the economy like a plague.

For all the current complaints about inflation, policymakers could soon look back wistfully to the time when they had cause to raise interest rates. Because people have already started cutting back… and we won’t be loosening our belts for a long time yet.

All of which means the recession is pretty much here. All we’re waiting on is some economists ringing a bell and saying “Yes, we’ve had two consecutive quarters of negative growth.” And by then it will hardly be news…

It deeply saddens me to write this. I know from experience that being unemployed is horrible. No one likes the morning commute, but once you have no reason to do it, you feel like a second class citizen. A big part of the world has been shut off from you.

All we can do is brace ourselves for the worst. It’s going to be a tricky couple of years, to say the least.

Can a share protect you from rising prices?

“Weren’t equities meant to protect us from inflation?” asks colleague Andrew Vaughan.

It’s one of the bedrock cases for buying a share. If you hold cash, you’re guaranteed to lose out as inflation erodes your wealth. But buy a share and, if it goes up enough, your wealth maintains its purchasing power. Ideally it gains more. That’s the story, anyway. But recently theory and reality have diverged horribly. Will this continue?

For most stocks, almost certainly. But Andrew reckons there are some that, very soon, could be well worth getting into.

Here he looks at one company which, when the time is right, could offer the kind of inflation-beating credentials investors love.

Why you should ignore commodities bears

Tomorrow is World Population Day. A day devoted to raising awareness about how many of us there are in the world (to be honest, I’m reminded of that fact every morning on the District Line).

For the raw numbers, check out this population clock to see just how quickly this planet is filling up.

If you read Garry White’s contributions, you’ll already be aware of the investment angle on this. More people need more stuff. And that means those who control the “stuff” stand to make a fortune in the years ahead.

Next week, Garry publishes his latest investment report, giving you specific ways you could profit over the next decade.

For a sneak preview, check out why Garry reckons those who are calling a top for commodities will miss out on some massive opportunities

Until tomorrow

Ben Traynor

Source: Unemployment To Keep Rising As Economy Weakens

We’ve been saying you should avoid investing in house builders for quite a while now. It looks like the City has come around to our point of view with a vengeance.

Taylor Wimpey hasn’t been able to convince investors to give it the £500m it needs to shore up its balance sheet. The country’s biggest house builder by volume may face “collapse when covenants are tested in February,” said Dresdner Kleinwort analyst Alastair Stewart.

It was just one grim story among many from yesterday that all pointed to one thing. That Britain is facing one hell of a slump…

Taylor Wimpey shocked the market yesterday by warning that it hadn’t yet been able to raise money from investors. Its shares ended down nearly 42% as it said it could breach its covenants by February if cash isn’t forthcoming. The company is shutting down a third of its regional offices, cutting 900 jobs. It won’t be paying a first-half dividend.

But it’s also set to write down its land bank by £550m (that’s 11%), and it’s carrying £1.7bn in net debt. As the company delicately put it, if it can’t sort out the terms of its banking facilities: “in certain negative market scenarios we might breach one or more banking covenants at the first testing date in 2009.”

It’s hard to believe that the market will be positive enough to save Taylor Wimpey by then. Reservation levels are down 45% in the 26 weeks to June 26, compared to the same time last year; completions down by a third. No one is buying houses anymore. The group is also exposed to the US and Spain. It’s hard to imagine a worse group of countries to be building in at the moment.

That doesn’t mean the company won’t be able to find a solution given time. The banks won’t be keen to shut down house builders, given their own hefty exposure to the sector. But these problems are by no means exclusive to Taylor Wimpey, although it is one of the most vulnerable.

Construction industry data from the Chartered Institute of Purchasing and Supply showed that activity in the sector is at its lowest level since the series began in 1997. Meanwhile, costs are soaring, and unemployment is creeping up.

As Anthony Hilton said in the Evening Standard, even if house builders do manage to raise new money, all this will buy them is time. “But it may not be enough. They still have a huge litany of problems to work through.” The mortgage market will take a long time to defrost, and the levels of lunacy seen in recent years won’t return any time in the foreseeable future. And builders haven’t helped themselves – during the boom they’ve been building almost nothing but flats in inner-city areas, much of which “only sold because it was fueling the buy-to-let market. They are going to take a long time to shift.”

House builders aren’t the only ones in trouble of course. We were also treated to a trading update, which was actually a profit warning, from none other than Marks & Spencer. Overall sales in the UK were down 5.3%. Clothing and general merchandise fell 6.2%, while there was a 4.5% fall in like-for-like food sales.

Why the slump has hit M&S hardest

Sir Stuart Rose claimed he’d never seen “such a sharp and continuous slowdown” in his entire retail career. And he’s right to say that M&S won’t be the only one suffering. However, it should come as no surprise that it’s the first high-profile retailer to issue a major warning. After all, as Damian Reece in The Telegraph pointed out, M&S is “the ultimate good-time grocer.”

If your average middle-class shopper is looking to make some easy cuts in the household budget, then swapping the weekly trip to M&S for a jaunt to Tesco (TSCDY), or even Aldi , is a relatively painless way to make some big savings. A bag of potatoes is a bag of potatoes, whether you carry it home in an M&S carrier bag (now 5p a pop) or an Asda one.

While all this trading down may well be uncomfortable for consumers, it shouldn’t be that much of a shock. The British economy has been built on debt, mainly fueled by the housing market. The housing market has collapsed – it’s not too much of a jump to assume that the British economy will follow.

Yet we’re only now seeing the first mainstream forecasts of recession. And that’s from the traditionally bearish Capital Economics, who have now said that there is “a strong chance” the economy will enter “a technical recession” – that’s two quarters of falling GDP. But to be fair to economists, they tend to get hung up on these little technical definitions, which probably explains their reluctance to use the ‘R’ word.

As the research group’s Jonathan Lloynes goes on to say: “Whether or not the economy actually enters recession, the consequences of the downturn will be severe. Aside from the drop in house prices, unemployment could rise by almost a million by the end of 2010.”

It seems that Gordon Brown didn’t really eliminate boom and bust after all. Who would have thought it? Even the Iron Chancellor couldn’t change the laws of economic physics. What goes up, must come down. It’s just a shame that, having stacked up a debt mountain of more than £1.4 trillion, we’ve got so far to fall.

As Jon Moulton of private equity group Alchemy puts it: “It’s not the end of the world – it’s part of the cycle – but it will be pretty tough this time… there’s three years more to come – two if you’re lucky, four if you’re not.” Our own City commentator Simon Nixon gives MoneyWeek readers the rundown on the good, the bad and the ugliest scenarios in this week’s issue, out on Friday. If you’re not already a subscriber, then sign up to get your first three issues free.

Source: How Bad will the Recession Get?

Yes, today brings a veritable avalanche of economic gloom. But there is hope. If you’re an investor, there is definitely hope! I’ll tell you why in just a moment…

First, though, let’s brace ourselves for the Monday misery (has that kettle boiled yet?).

We kick off with the annual report of the Bank of International Settlements (BIS). The BIS may not be the most famous of financial institutions. But the Switzerland-based ‘central bankers’ bank’ is certainly among the most respected.

In its 2007 report, published last June, the BIS predicted the financial world was headed for a fall. It stated that “mortgage credit has become more available and on easier terms to borrowers almost everywhere. Only in recent months has the downside become more apparent”.

Well we know what happened next! The credit crunch — sparked off by dodgy mortgage-backed securities.

If anything, this year’s report is even more unnerving. Take a look at this extract:

“Historians would recall the long recession beginning in 1873, the global downturn that began in the late 1920s, and the Japanese and Asian crises of the early and late 1990s respectively.

“In each episode, a long period of strong credit growth coincided with an increasingly euphoric upturn in both the real economy and financial markets, followed by an unexpected crisis and extended downturn.

“In virtually every instance, some form of new economic discovery or new financial development provided a further ‘new era’ justification for rapid credit expansion, and predictably became a focus for blame in the downturn.”

The report goes on to predict a deep, long-lasting slowdown. I hope the BIS is wrong this time, but, sadly, I fear the worst. Because closer to home there is yet more ‘bad data’ to contend with.
Estate agents report prices falling in 83% of England and Wales, compared with 53% a month ago. Hometrack data show the number of properties changing hands last month hit a 30 year low.

And consumer confidence, according to GfK NOP, is at its lowest level since 1990 — right before the last UK recession. Back then the index was at minus 35. Today it’s at minus 34…

Of course, none of this comes as a huge surprise. Last week I asked Fleet Street Daily readers the following question:

Within the next two years, do you believe the British economy will have a recession?

We had hundreds of replies. And, you won’t be astonished to know, the result was an overwhelming and emphatic Yes!

In fact, many of you went further, saying the contraction had already begun.

“I have a small retail business,” wrote one respondent, “and believe me – we’re already in a recession, no doubt about it.”

Another reader had this to say:

“No enquiries for units on the industrial estate in the last 6 months, except from those recently unemployed who are thinking of importing pogo sticks or some such.”

Indeed, there was only one bit of positive business news — and it hardly bodes well for the economy:

“We rescue struggling businesses across the UK, we are growing fast and recruiting!”

There were many other replies from business owners, accountants and others on the ‘economic front line’. And they made for fascinating reading. I’m a firm believer that those on the ground have a much better idea of what’s going on than politicians and economists.

The latter have to wait a full six months to ‘confirm’ a recession. Those of us living in the real world don’t have the luxury of waiting half a year. If we’re going to protect our wealth, we need to act now.

The question is, of course, what action should you take? Here’s where being an investor could offer you a way out. Because there are good investments on the stock market. And the falls the stock market has seen this year offer you the chance to pick up some great bargains.

I asked the team at Fleet Street Research to identify the best investments available to private investors right now. Within the next two weeks, our sister publication the Fleet Street Letter will publish the team’s report.

I’m told I can’t give away too much at present. But I can tell you this — the team has more than risen to the challenge!

Rest assured, I’ll keep you posted on developments as and when they unfold…

Why I had a nice lie-in on Saturday morning…

Saturday’s email was earlier than usual. I usually send it out around 11am. But two days ago it went out at 9.

The reason was simple. I didn’t write it. Let me explain…

All last week our special situations guy Manraaj was on my case. He had a recommendation coming up, and he was keen for it to get top billing.

To be honest, I found his pestering a little annoying at first. But that’s because I thought it was just another, run-of-the-mill share recommendation.

“Why’s he so excited?” I thought. “What’s the big deal about this particular share?”

Well, on Friday his report came out. And as I read it, I began to see why Manraaj had been so worked-up…

The report is a tale of cannibals… the CIA… military coups… Che Guevara… a UN secretary general dying in a plane crash… never mind the money it can make you, this is worth reading for the story alone!

Add in the potential profit — 127% in the first year — and this report is a must. Of course, that figure is a forecast, and forecasts are not a reliable indicator of future results.

But one thing’s for sure — I’ve never seen Manraaj as excited by one company as he is by this one. It’s why I allowed him to write to you on Saturday — which he did, sending it out a full two hours ahead of schedule!

Of course, because it went out early, I realise you may have missed it. In which case you’ll be wondering what on earth I’m talking about!

Actually, even if you did read it, there weren’t too many details. Manraaj was in a race against time to get this out — so he had to keep it brief.

That’s why I’ve asked him to write about it today, and fill in a few of the blanks.

Find out why Manraaj believes his new free report could be the most profitable document you read all year.

Until tomorrow

Ben Traynor

Source: We’re Not The Only Ones Who Fear a Recession…

What was Mr Brown expecting? He’s run the country into the ground and people are showing their disapproval at the polling stations.

After screwing up the banking sector and making many, many people’s financial situation worse… the country has stood up together with Paddy Chayefsky like exuberance and stated: “I’m as mad as hell… and I’m not going to take it anymore”.

The country’s mad, we’re mad, the finance sector’s crippled – what can be done?

Well consider this…

The finance sector makes up one third of our economic output, contributes £20 billion to the trade balance… and accounted for nearly HALF of UK GDP growth in 2007.

There are now more finance sector workers in Britain than there are construction workers, farmers and factory workers combined.

And they are in trouble!

Let me ask you something dear reader…

What do you think’s going to happen to the domestic economy… and to YOUR savings and investments… if Britain’s ‘Miracle Money Machine’ has its output slashed by one tenth… one third… or even half?

Well – as the pound continues to perform disastrously against the Euro and the dollar… investment banks brace themselves for further fallout… it’s time to batten down the hatches, because you’re about to find out.

Below you’ll find the link to a brand new Crisis Report published by The Fleet Street Letter. They’ve also identified three stocks poised to benefit from the finance sector-led recession they believe has to kick off in 2008.

Click here to read the Crisis Report

Not only is the most dramatic asset bubble of modern times clearly over… not only are the recent falls in real estate and equities just a taste of what’s to come… but a sector that accounts for nearly one third of Britain’s entire economy is about to get hammered!

If City activity dries up, so does growth, says Damian Reece in The Daily Telegraph. “The entire southeast, from house prices to employment, is a geared play on global financial markets.”

According to its analysts this could be one of the biggest challenges to face the British economy in The Fleet Street Letter’s entire 70-year history.

And it’s hurtling towards your savings and investments like a freight train even as you read this.

And if you’re not ready yet, you’ll want to be soon.

The Fleet Street Letter has been helping its readers prepare their portfolios for the coming crisis since October 2005.

With the situation deteriorating daily, they’ve decided to issue some advice to you today.

Specifically, the team have identified three “gloom loving” stocks they believe will thrive during the finance sector-led recession.

This could be the most important investment advice you read this year.

Click here for the full briefing

Regards,

Rob Mackrill
The Daily Reckoning

P.S. If like 75% of the country you’re fed up with the way Labour are running the country into the ground… you may as well take the chance to make a little bit of money on the back of their ineptitude (it’s something that makes me feel a little better anyway). So give our report a read – you will not be disappointed…

Go here for the full report