Signs of the Economic Apocalypse, 6-26-06

From Signs of the Times, 6-26-06:

Gold closed at 586.00 dollars an ounce on Friday, up 0.2% from $584.70 the Friday before. The dollar closed at 0.7996 euros Friday, up 1.1% from 0.7910 for the week. The euro closed at 1.2507 dollars compared to 1.2640 at the end of the week before. Gold in euros would be 463.61 euros an ounce, up 0.2% from 462.47 at the previous Friday’s close. Oil closed at 70.84 dollars a barrel on Friday, up 1.2% from $69.97 for the week. Oil in euros would be 56.64 euros a barrel, up 2.3% from 55.34 at the end of the week before. The gold/oil ratio closed at 8.27, down 1.1% from 8.36 for the week. In the U.S. stock market, the Dow Jones Industrial Average closed at 10,989.09, down 0.2% from 11,014.55 for the week. The NASDAQ closed at 2,121.47 on Friday, down 0.4% from 2,129.95 at the close of the previous week. The yield on the ten-year U.S. Treasury note closed at 5.22%, up 9 basis points from 5.13 for the week (and up 25 basis points over the last two weeks).

Not a lot of change in the markets last week with the exception of long term interest rates in the United States (the ten-year Treasury up 25 basis points in two weeks). The widespread use of risky adjustable rate mortgages in the United States makes such interest rate increases potentially catastrophic:

Foreclosures may jump as ARMs reset

By J.W. Elphinstone, AP Business Writer

As more hybrid adjustable rate mortgages adjust upward and housing prices dip, many Americans can't refinance out of this squeeze. They are finding themselves trapped in too-high monthly payments, and some face foreclosures.

In 2003, Anita Britten refinanced her two-story brick cottage in Lithonia, Ga. using a hybrid adjustable rate mortgage, or ARM. Her lender reassured her that she could refinance out of the riskier loan into a traditional one when her interest rate started to reset.

Three years later, Britten can't get a new mortgage and her monthly payment has jumped by a third in six months. She can't afford her payments and may face foreclosure if her financial situation doesn't change.

For those who can't make their payments, foreclosure is the only way out.

Foreclosure figures just released by the Mortgage Bankers Association show that foreclosure activity fell in the first quarter of 2006 over the first quarter of 2005 for all loan categories except subprime loans. The MBA didn't specify how many of subprime loans were adjustable rate mortgages.

In the last several years, millions of Americans took equity out of their houses and refinanced when interest rates were at historical lows and housing prices were at record highs.

Many of them chose to refinance into hybrid ARMs that lenders were aggressively pushing. ARMs, which featured a low introductory interest rate that resets upward after a set period of time, were easier to qualify for than traditional fixed-rate loans.

…This year, more than $300 billion worth of hybrid ARMs will readjust for the first time. That number will jump to approximately $1 trillion in 2007, according to the MBA. Monthly payments will leap too, many beyond what homeowners can afford.

For example, Britten's monthly payment jumped from $1,079 to $1,340 at the beginning of this year. It rose again on June 1 by another $104 and is scheduled to increase again in December. Britten, who is also paying off student loans, went to a credit counseling service to help her avoid foreclosure.

"I've gotten rid of all my credit cards and I'm not supposed to refinance for another year," she said. "All I can do is tread water right now."

"ARMs are a ticking time bomb," said Brad Geisen, president and chief executive of property tracker Foreclosure.com. "Through 2006 and 2007, I'm pretty sure we'll see a high volume of foreclosures."

Last year, foreclosures hit a historical low nationwide at about 50,000. But that number has more than doubled since then, according to Foreclosure.com.

And delinquency rates appear to be rising, as well. While delinquency rates fell for most types of loans from the fourth quarter of 2005 because of a stronger economy, delinquencies for both prime and subprime ARM loans increased year-over-year in the first quarter, according to the MBA.

The hardest hit states so far are those that have experienced the roughest times economically. Michigan, Texas and Georgia lead the pack, specifically around Detroit, Dallas and Atlanta, whose major employers have run into strikes, bankruptcies and industry downturns.

But as the housing market slows, experts expect foreclosures to skyrocket in those areas that have experienced the highest appreciation rate — like California, Florida, Virginia and Washington, D.C.

"There is a direct correlation between foreclosure sales and market activity," said Dr. James Gaines, a research economist at The Real Estate Center at Texas A&M University. "If the rate of appreciation is not there, then there is an increase in foreclosure sales."

Gaines pointed out that although California's default notices are rising by the thousands, actual foreclosure sales remain in the hundreds. Because of California's still-active housing market, homeowners there can sell their properties before going into foreclosure.

On the flip side, in less active markets like Texas and Georgia, homeowners can't find a buyer in time and are forced into foreclosure.

But as the housing cools in these once hot markets at the same time that ARMs reset, many homeowners may be unable to dump their properties before going into foreclosure, Gaines predicts.

Additionally, Gaines pointed out that these same real estate markets also boasted a higher percentage of ARM originations, because most buyers could only get into their homes using an unconventional loan.

California, where the median home price reached $468,000 in April, leads the nation in the percentage of homes purchased with adjustable rate mortgages. Nationwide, ARMs account for 24 percent of all home loans.

"In our zeal to make mortgage lending more available to a greater number of people, it's normal to expect the foreclosure rate to go up," Gaines said.

Even investors in foreclosures are having a harder time finding good deals, as the housing market cools. Many homes that do end up in foreclosure auctions are saddled with more than one mortgage and have little or no equity — so the investors take a pass.

Falling home values are also affecting homeowners' ability to refinance into a traditional 30-year fixed rate loan to avoid foreclosure.

In 2002, Christopher Jones, 32, refinanced into a hybrid ARM with plans to refinance again when the rate started to readjust. At the time, his downtown Atlanta house appraised for $108,000.

Now, his monthly payments have shot up, but Jones can't sell his house for more than $84,000 and he can't get an appraisal for more than $85,000.

The appraisal firm told Jones that the value of houses in his neighborhood have fallen victim to a cooling market. With no other options left, Jones has decided to pack it in and foreclose on the house.

"I'm just going to take the loss," he said. "That's all I can do."

Some homebuyers, especially first-time buyers, may not have fully understood the risk of ARMs. In the rush to close on a house sale, especially in the frenzied market of the past few years, many first-time buyers often failed to get the full details of their loan from their mortgage broker.

"Sometimes buyers are very optimistic of how much mortgage they can handle, especially in a strong housing market with aggressive marketing of riskier mortgages," said Suzanne Boas, president of Consumer Credit Counseling Services of Greater Atlanta.

When Dora Angel of DeSoto, Texas bought her first home in 2003, she paid $141,000 for the brand new three-bedroom, two-bath home. At the time, her mortgage payment was $1,400 a month.

DeSoto originally thought that she had a fixed-rate loan. But about five months ago, she noticed that her monthly payment kicked up to $1,900. She only made the monthly payments by sacrificing payments on her credit cards, which pulled down her credit rating.

Now, DeSoto can't continue paying $1,900 each month, but, because of her credit ranking, she doesn't qualify for a fixed-rate mortgage.

"I was a first-time buyer. I was blind. I didn't know what questions to ask," she said. "And the mortgage brokers are there telling you what you want to hear just to get you in the mortgage."

Unfortunately, during a runaway market, many buyers, sellers and mortgage brokers were more excited about making deals than making smart deals, and the fallout has just begun.

"We are on the front of this ARM problem. It will roll out over the next several years," Boas said. "Owning a home is the American dream, but losing one is the ultimate nightmare."

Rising interest rates and foreclosures, in turn, lead to lower prices and sharp slowdown in the overall housing industry (including financial services workers, construction and renovation skilled tradespeople, real-estate agents, bankers and lawyers, hardware and home improvement retailers and those who manufacture all those goods sold by Ace and Home Depot and the lumber stores. All that now comprises a good chunk of the U.S. middle class.

Home sellers, builders feel pinch of slowdown
By Andrea Hopkins
Thu Jun 22, 12:34 PM ET

When Keith Gersin saw the perfect four-bedroom house in southern Ohio four years ago, he jumped to buy it before anyone else could snap it up. When he finally sold it last month, it went for $30,000 less than he had hoped -- and that after seven months on the market.

In retrospect, the 41-year-old physician admits he overestimated the U.S. housing market, which has begun cooling after five years of record-breaking sales and double-digit price appreciation.

"I was naive," said Gersin, who sold his Cincinnati-area home in May to move to North Carolina with his wife and son. He made about $60,000 on the sale, but had hoped for better.

"Everyone thinks their house is the most beautiful in the world, so it comes as a bit of a shock when it doesn't sell right away."

The housing slowdown -- sharp in some regions and more gradual in others -- is seen by many economists as an inevitable and even healthy moderation to an overheated market. Even so, for many homeowners, real-estate agents and builders, the market's new direction is not particularly welcome.

With mortgage rates rising, sales of existing homes were 5.7 percent slower in April than they were a year earlier, and the inventory of new homes is at a record high.

The rising supply of unsold homes makes it that much harder for homeowners to get the sale price they hoped for.

"In our neighborhood, on our street, there were three houses that went up for sale within months of each other," said Gersin.

Cincinnati real-estate agent Jeff Schnedl has seen a shift in the market.

"It is absolutely slower. Some areas are still chugging along but even those are chugging along more slowly than they used to," said Schnedl, who has been selling homes in the Ohio River city for five years.

A drive down any street in Cincinnati, whose suburbs straddle Ohio, Kentucky and Indiana, turns up plenty of "For Sale" signs -- with the occasional "Price Reduced" addendum slapped on top.

Schnedl said homes are staying on the market longer.

"There is a lot more inventory on the market this year than last year -- about 25 percent more. So buyers have more homes to choose from and that slows the sale cycle down. Plus with rising interest rates, people are thinking harder. That slows it down, too."

The average rate on a 30-year fixed mortgage rose to 6.63 percent last week, up a full percentage point from 5.63 percent last year, according to mortgage finance company Freddie Mac.

Such an increase boosts the cost of a $200,000 mortgage by about 11 percent, or $129 a month, to $1,281 -- an unwelcome jump for consumers who are already feeling the pinch of soaring energy prices.

The housing slowdown is also being felt by home builders. While housing starts rose 5 percent in May, permits for future groundbreaking -- an indication of builder confidence -- dropped to the lowest level since 2003, government figures showed this week…

But enough about the United States. What about the rest of the world? Well, nowadays, it’s all tied together:

A hard landing in 2006 – just not in the US?

Brad Setser
Jun 18, 2006

Nouriel and I postulated back in early 2005 that there was a meaningful risk that the next “emerging market” crisis might come from the US – and it might come sooner than most expected. The basic quite simple: Ferguson’s debtlodocus might find that it no longer could place its debt with the world’s central banks, the dollar would fall, market interest rates would rise, US debt servicing costs would go up, the economy would slow and the value of a host of financial assets would tumble.

Why the emphasis on central banks? Simple: they have been the lender of last resort for the US, financing the US when private markets don’t want to. See April 2006. Consequently, a truly bad scenario for the US seemed to require a change in central banks’ policies. Real emerging markets aren’t so lucky. When private markets don’t want to finance them, they typically aren’t bailed by someone else’s central bank.

It sure doesn't look like sudden stops in financial flows and sharp markets moves have been banished from the international financial system. Certainly not this year. They just didn't strike the US, but other countries with large and rising current account deficits.

Iceland’s currency is way down (its stock market too) even though interest rates on Icelandic krona are up. The private market’s appetite for krona disappeared.

Inflation is up too, driven by the weak krona.

The Turkish lira is way down. Lira interest rates are way up – as is Turkish inflation.

Turkey's central bank sold dollars this week -- for the first time in quite some time. It was buying dollars in a big way in the first quarter. Times change.

Currency collapses do not necessarily translate into economic slumps. That was a key point that the Federal Reserve has made in response to fears about a US hard landing. A fall in the currency doesn’t always translate into higher interest rates, at least in post-industrial countries. And in part because lots of the damage from a fall in the currency comes when firms, banks and the government have borrowed in foreign currency, turning a currency crisis into a debt crisis.

The US, thankfully, has financed itself by selling dollar-denominated debt, pushing currency risks onto its creditors. But so did Iceland. And even Turkey increasingly financed itself in Turkish lira. Particularly in 2005, there were big inflows into Turkey’s local debt and equity markets. Turkey obviously still has a fair amount of dollar debt. It is an emerging market after all. But things were changing.

I still think the financial slump in both Iceland and Turkey could easily turn into a sharp economic slump. In both countries, both policy and market interest rates are up significantly – in part because a weaker currency (and still strong oil) translates into higher prices for imported goods. And I suspect higher interest will, over time, slow the pace of both economies’ expansion.

One big reason why Turkey was growing fast was that because its banks were lending tons of money to Turkey’s households, whether to buy a car or buy a house. But it only makes sense to lend long-term at 13% (say for a mortgage) if inflation and nominal interest rates are expected to fall over time. This year, both inflation and nominal rates rose. Ouch (if you are a bank).

I suspect that the result will be a significant slowdown in credit growth – and in the Turkish economy.

Charles Gottlieb of the European Capital Markets Institute notes that Iceland too was growing in part on the back of a strong expansion of credit (see his figure 1) – though in Iceland’s case, demand for Icelandic Krona was for a while so long strong that Icelandic issuance alone couldn’t meet it. Consequently, European banks started issuing so called Glacier bonds in krona (a note: I am sure the banks hedged their krona exposure, I just don’t know how).

And Gottlieb nicely shows what a sudden stop looks like. See his Figure 4. It shows a huge surge foreign purchases of Icelandic securities issued by Icelandic residents (I think that means it excludes Glacier bonds) up until January of this year. And then a huge – and I mean huge – fall. Inflows became outflows. Foreigners sold; Icelanders bought.

I am not convinced Iceland is the next Thailand – but there are lots of unpleasant outcomes that aren’t quite that severe.

Turkey and Iceland are not the only markets who went through a rather nasty sell-off. Emerging market equities just has their worst run since 1998. Of course, it comes after a huge run-up. And as no shortage of credible observers – like Ragu Rajan of the IMF -- have noted, the markets that are selling off the most are the markets that rose the most. That suggests that the causes of the sell-off are global, a change in the markets willingness to invest in emerging economies, not local – that is what the generally bearish BIS thinks and in this case they have support from some (former?) bulls, like MSDW’s Turkey analyst Serhan Cevik.

Despite this indiscriminate sell-off, there is still no agreement among investors as to what the sudden burst of global volatility actually reflects. …. Risk reduction always brings indiscriminate selling of all ‘risky’ assets at the early stages, regardless of underlying economic structures and policy frameworks.

The team at Danske bank hasn't been as consistently bullish at Cevik, but they seems to agree that it is hard to pin down any fundamental cause of the recent sell-off.

I certainly didn’t see this kind of global sell off of emerging economies coming, though I worried about a few specific markets. And not just ex post. But then again I am usually good for a cautionary quote …

And in some sense, the fact that the current global sell-off focused on emerging economies is a bit strange. I see the logic: what went up too fast has to come down.

But the defining characteristic of the recent boom in private capital flows to emerging economies is that, at least in aggregate, capital was flowing into emerging economies didn’t need the money. The US was attracting more financing that it needed to run very large deficits, and using some of the money to invest in emerging economies. And emerging economies were taking financial flows from say Europe and using them to lend to the US. It was a rather complex equilibrium.
Look at the statistical data in the latest issue of the World Bank’s (very useful) Global Development Finance. Developing economies collectively ran a current account surplus of $245 billion in 2005. Private inflows of $490 billion were used to pay back the IMF and to build up reserves -- these countries reserves were up by $395b or so in dollar terms, more than their current account surplus.

(One note for true balance of payments geeks: the GDF’s reserve increase isn’t adjusted for valuation changes. If you make that adjustment, total reserve growth would be bigger, and the errors and other flows term would fall)

Of course, what happens in aggregate can mask big differences in the specifics. China, Saudi Arabia and Russia all had big current account surpluses. Brazil a more modest surplus. India had a small and growing deficit. Turkey – and Hungary -- had big deficits.

Despite these differences the equity markets of Russia, Brazil and Turkey have all tumbled this year. Foreign funds that poured into these economies earlier this year poured out in May. When the data comes in, the change will look a bit like Gottlieb’s graph showing flows in and out of Iceland.

My hypothesis therefore is twofold:

The recent correction has been driven as much by developments inside the financial markets of the post-industrial economies as by a change in the emerging economies themselves. Hence the general sell-off.

And the impact of the correction will vary dramatically. Some countries didn’t need inflows. Russia. Others did. Turkey. But even in turkey, the inflows that were coming in far exceeded what Turkey needed. In the first quarter, annualized inflows were something like $60b relative to a current account deficit of $30b. If flows go to $30 or $25 Turkey is fine. If they go to zero, not so much.

Actually, my hypothesis is threefold.

In April, the G-7 communique triggered a fall in the market’s willingness to finance US deficits. We saw that in the TIC data. There also was a bit of a surge in capital inflows to Asia that prompted a bout of intervention. Central banks financed the US when markets didn't want to.

In May and early June, folks who borrowed dollars and yen to buy emerging market equities (and debt, to a lesser degree) sold their emerging market equities and repaid their loans. Call it deleveraging.

The net effect has been to help finance the US. Less money was flowing out of the US – US purchases of foreign equities averaged about $10b a month for the first four months of the year. And if Americans may have actually reduced their exposure to emerging economies in May and June. That too would help to finance the US deficit. Deficits can be financed by selling (external) assets as well as issuing (external) debt.

My question: What happens once this process is over?

Do higher US rates continue to draw the financing the US needs to run big current account deficits – a deficit that I still think will be over $900b?

In part because China and the oil exporters continue to use their central banks and oil investment funds to finance the US?

Or does the US join the list of high-carry (at least relative to Japan and Europe) countries that have experienced trouble in 2006?
And what happens if an incipient US slowdown start to generate expectations that US rates have peaked and won’t provide as much support for the dollar?

If I had to guess, I would say Bill Gross (quoted in Business Week) is right.
It's like Peter Pan who shouts, "'Do you believe?' And the crowd shouts back, in unison, 'We believe.'" You can believe in fairy tales and Peter Pan as long as the crowd shouts back, "we believe." That's what the dollar represents, a store of value that people believe in. They can keep on believing, but there comes a point that they don't.

Greenspan was here two months ago and talked with us for two hours. The most interesting point was his comment that there will come a time when foreign central banks and foreign investors reach saturation levels with their dollar holdings, and so he sort of drew his hand across his neck as if they've had it. Why can't they keep on swallowing dollars? Logic would suggest that these things start to fray at the fringes. Once the snowball starts it can really get going. ...

The dollar is really well supported by its yield. We've got 5% overnight rates and Japan has zero. You get over 2% relative to the euro, so obviously 5% or 5.25% is dollar-supportive, and the more that Bernanke sounds off that he's going even higher, the more that supports the dollar. The real question is what starts it on the way down? At the moment people believe that's O.K. and yes, housing is starting down, but the rest of the economy is looking good, 2% to 3% GDP growth isn't so bad. I would say that if that's the case we've got a pretty good little fairy tale going here. But if it doesn't, if 5% leads to a crack in the housing market and the unwind of various global markets and the U.S. stock market ... If the stock market keeps going down then that's a sign that 5.25% is too onerous a rate. So what the question becomes then is can the U.S. economy be supported at that level? That's when the question of whether there's the possibility of an avalanche begins. If we get rates then down to 4.5% and then all of a sudden the [other central bankers] are moving up, the money flows out. It's not because of the [lack of a] yield advantage; they've had it up to their necks in terms of dollars. The unwind of the dollar can come from saturation or geopolitical issues or simply that the U.S. economy isn't as strong as people think and they stop believing in Tinkerbelle.

A big fall in the dollar isn’t bad for the US. A big fall in financial inflows that led to a rise in US interest rates though is another story. A 200 bp move is not so big for emerging economies, but it is big for the US. And because the US financial system is much more leveraged, it would also have much bigger consequences.

Basically, to keep other central banks happy when the United States gobbling up debt, Bernanke has to raise interest rates much higher than would normally be warranted, just to avoid a currency collapse. And, he has to do it just when the economy is heading into a recession:

Key gauge points to slowing economy
Index of leading indicators fell more than expected in May as higher gas prices and interest rates start to bite.

June 22, 2006: 4:53 PM EDT

WASHINGTON (Reuters) - A key forecasting gauge for the U.S. economy fell by a larger-than-expected 0.6 percent in May, a report from a private research group showed on Thursday.

The sharp decline in the Index of Leading Economic Indicators from the Conference Board outpaced market expectations for a 0.5 percent fall in May after an unrevised 0.1 percent fall in April.

Ken Goldstein, a labor economist at the Conference Board, cited a slew of factors inhibiting the economy even as leading indicators in European and Asian countries were showing strength.

"The cumulative impact of higher gasoline prices, higher costs to run the air conditioner this spring, a slowing housing market, higher interest rates, a loss of confidence and even higher taxes in some localities, have all combined to slow the forward pace of economic activity, pushing growth to a sub-par level this summer -- possibly extending into the fall," Goldstein said in a statement.

"Given the slower pace, the economy has less ability to absorb another round of strong hurricanes this summer," he added.

Seven of the 10 indicators that make up the leading index fell in May, the Conference Board said.

The largest negative contributor to the index was initial claims for unemployment insurance. The index of consumer expectations made the second largest negative contribution.

So once again we find ourselves in the paradoxical state of stagflation. High inflation, layoffs and high interest rates. The following piece by James Killus explains why stagflation is not as paradoxical as it seems:

Let me suggest a hypothetical.

Suppose there were two countries, in some sort of neo-colonial relationship. The rich country follows something like the German model, good social benefits, primarily tied to corporate employment, high capital stock, high education levels, and so forth. The poorer country has some social benefits, a social security system, a health care system that is overstressed and that doesn’t cover everybody, stagnating wages, and its capital stock is almost entirely colonial, i.e. the other country owns almost all of it.

Both share a common currency, and on a cash flow basis, the poorer country is sending a lot of cash to the richer country.

Monetary policy from the central bank clearly affects both countries, but both countries can have different fiscal policies. Moreover, cash flows between the two countries can dominate their local monetary policies. The cash flow from the poor country to the rich country has, in fact, produced a liquidity trap in the poor country. By the same token, the same cash flow has created a high degree of liquidity in the rich country, but, because the rich country imports much of its goods and services, it hasn’t seen much CPI inflation. Rather, it has had a series of asset price bubbles.

Now actually I’m talking about a single country here, the United States. The rich country consists of those who have substantial capital assets, and/or are well-situated in the corporate hierarchy. The poor country is low and middle income wage earners without major assets, whose primary asset, in fact, is their share of the social security system, and perhaps a low equity house in a “non-bubble” area like the mid-west.

The major cash flow is the Social Security surplus, which continues to divert enormous sums to the general fund, and the general fund pays out much of its cash to corporate contractors. Also whenever a member of the low income class buys something, a portion of that goes to the rich class, in the form of profits or the wages paid to the affluent class who manage the enterprise.

I think that, with only a few exceptions, “the poor country” has been in a liquidity trap for the past 25 years. CPI price inflation occurs when some of the liquidity that washes over the “rich country” manages to leak into “the poor country.” It is then immediately stamped down by raising interest rates, which pulls yet more money from low income workers (who tend to be debtors). Since high income liquidity primarily affects asset prices, and since asset price inflation is not considered inflation, monetary policy does not react.

Economic “growth” has been confined to the high income group, but since this tends to consist of nominal asset growth, it is not clear to what extent the growth is real. It may be largely an artifact of asset price inflation whose effects have been confined to a part of the economy that doesn’t show up in inflation estimates.

In short, the economy may actually be experiencing stagflation, but that is masked by asset price inflation. Any attempt to turn that nominal growth into actual consumption would trigger CPI inflation, which would immediately be met with interest rate hikes, which further hurt the real economy of low wage earners, but which does little to correct the underlying fiscal malady.

Signs of the Economic Apocalypse, 6-19-06

From Signs of the Times, 6-19-06 :

Gold closed at 584.70 dollars an ounce on Friday, down 4.8% from $612.50 at the close of the previous week. The dollar closed at 0.7910 euros on Friday, virtually unchanged from 0.7912 for the week. That put the euro at 1.2643 dollars compared to 1.2640 at the end of the week before. Gold in euros would be 462.47 euros an ounce, down 4.8% from 484.57 for the week. Oil closed at 69.97 dollars a barrel Friday, down 2.3% from $71.60 at the close of the previous Friday. Oil in euros would be 55.34 euros a barrel, down 2.4% from 56.65 for the week. The gold/oil ratio closed at 8.36, down 2.3% from 8.55 at the end of the previous week. In U.S. stocks, the Dow closed at 11,014.55, up 1.1% from 10,891.92. The NASDAQ closed at 2,129.95, down 0.2% from 2,135.06. The yield on the ten-year U.S. Treasury note closed at 5.13%, up 16 basis points from 4.97 for the week.

Gold prices continued to plummet last week and U.S. interest rates rose sharply. Everthing else remained pretty much unchanged. If interest rates are rising over fear of inflation and gold is a hedge against inflation, why are gold prices falling? The paradox of gold is that it is both money and commodity. If it is, in effect, a currency, then with inflation the value of gold should go down. Yet, since it is also a commodity, and has been throughout history seen as a safe haven, it’s value should go up in inflationary times. Most likely the price of gold will eventually go up against the paper currencies. What we are seeing is probably both a natural correction as well as an indication of increasing volatility.

Gold, Copper Lead Metals Decline on Concern Over Higher Rates

June 13 (Bloomberg) -- Gold had its biggest plunge in 15 years, falling below $600 an ounce, and copper tumbled to a seven- week low as investors bailed out of commodities and equities on concern about rising global interest rates.

Metals fell for a fourth straight session, the longest slide in three months, and billionaire investor George Soros says the commodity rout isn't over. Federal Reserve Bank of Cleveland President Sandra Pianalto said yesterday inflation exceeded her “comfort level,” boosting prospects for higher U.S. rates. Consumer prices in the U.K. reached a seven-month-high in May.

“The nervousness behind higher rates are anchoring down the markets,” said Michael Guido, director of hedge fund marketing and commodity strategy at Societe Generale in New York. “You have massive global equity losses. Many of these funds are selling secondary and tertiary holdings, which happen to be commodities, to raise cash.”

Gold for August delivery fell $44.50, or 7.3 percent, to $566.80 an ounce on the Comex division of the New York Mercantile Exchange, the biggest percentage drop since Jan. 17, 1991. Prices have tumbled 23 percent from a 26-year high of $732 on May 12. The metal still has gained 31 percent in the past 12 months.
Copper for delivery in three months fell $470, or 6.7 percent, to $6,570 a metric ton on the London Metal Exchange, the lowest close since April 20. The metal is down 25 percent from a record $8,800 on May 11. Prices still have doubled in the past year.

Silver futures for July delivery tumbled $1.44, or 13 percent, to $9.625 an ounce on the Comex. Prices have plunged 37 percent since reaching a 23-year high of $15.20 on May 11.

‘Reduction in Liquidity’

“Commodities probably are in for a period of correction,” Soros told financial news network CNBC yesterday. “We are in a situation where all asset classes are under pressure because of a reduction in liquidity.”

Industrial metals have tumbled from records this year, and gold and silver have slumped in the past month from the highest prices since the early 1980s amid growing speculation higher borrowing costs will stifle the five-year rally in commodities.

U.S. stocks fell for a third day, European equities dropped to a six-month low, and indexes in Japan and Australia had the biggest losses since September 2001. Emerging markets also tumbled.

“There's too much froth in this market,” said David Gornall, head of foreign exchange and bullion at Natexis Commodity Markets Ltd. in London. “People are removing higher risk from their portfolio.”

Gold climbed 18 percent last year and surged 39 percent from the end of 2005 to mid May, partly on demand from investors seeking returns unavailable from stocks, bonds and currencies. Tensions over Iran's nuclear program also boosted the precious metal's appeal as a haven.

‘Hot Money’

“There's hot money in the metals, and it can come and go, lending to volatility both ways,” said A.C. Moore, who manages the $500 million Dunvegan Growth fund in Santa Barbara, California. “People get nervous and sell commodities to raise some cash.”

Shares of mining companies also fell. The Philadelphia Stock Exchange Gold and Silver Index fell 3.92 or 3.1 percent to 120.79. Shares of Freeport-McMoRan Copper & Gold Inc., which operates the largest gold mine in Indonesia, tumbled $2.06 to $44.65.

The European Central Bank raised its benchmark interest rate on June 8 for the third time in six months. South Korea raised its key rate the same day, followed by India and South Africa. At least four Fed officials said last week they're concerned about inflation.

Interest-rate futures show traders are pricing in a 90 percent chance the Fed will raise its benchmark rate a quarter-percentage point to 5.25 percent at its meeting late this month, up from 84 percent odds yesterday and 72 percent on May 31.

U.K. Rates

U.K. consumer prices rose 2.2 percent from a year earlier after rising 2 percent in April, the Office for National Statistics said today, making it more likely the Bank of England will raise rates. Prices paid to U.S. producers in May also rose more than forecast, stoking inflation concerns.

“The fears of a slowing economy are going to cast doubt on the demand for metals,” said James Vail, who manages $700 million in natural-resource stocks at ING Investments LLC in New York. “It's a very unsettling time. We're overreacting on the downside as much as we were overreacting on the upside.”
The rising cost of gasoline propelled U.S. consumer prices higher last month, giving Federal Reserve policy makers reason to fret they're losing their grip on inflation, economists expect a report to show tomorrow.

‘Play Defense’

The consumer-price index rose 0.4 percent in May after a 0.9 percent gain the prior month, according to the median forecast of 72 economists surveyed by Bloomberg News.

Metal prices will tumble should the index increase more than forecast, some analysts said.

“The CPI is more Main Street,” Guido of Societe Generale said. “A higher number and the metals market continues to play defense.”

Demand still outstrips supply and the rally in metals may resume, Vail at ING said. Speculators increased copper purchases earlier this year amid forecasts global production will lag behind consumption.

“It's very difficult in today's world to find new supplies, and companies are having difficulty in meeting production targets,” Freeport-McMoRan Chief Executive Officer Richard Adkerson said today in an interview. Output will be lower in 2006, and “even at today's prices, we have the opportunity to have even a stronger year,” he said.

Time to Buy?

Some investors say the price decline offers a buying opportunity for some metals.
HSBC Holdings Plc estimated last month about $100 billion will be invested in commodity indexes by the end of 2006, compared with $10 billion at the end of 2003.

“This is not the end of the commodities rally,” said Michael Widmer, an analyst at Macquarie Bank Ltd. in London. “The fundamentals for most commodities, such as gold, are strong.”

Moore of Dunvegan, who sold some shares of the StreetTracks Gold Trust exchange-traded fund as the metal was rising to a 26- year high, said he's considering buying metals.

“We're more interested in gold and metals generally,” Moore said. “There's still a bull run in gold, and the money will be back.”

The drop in gold prices has emboldened those who have always ridiculed “gold bugs.” Al Martin does his share of ridiculing in the following piece, but ends up recommending that many people should buy and hold gold, primarily because he sees a collapse in the value of the dollar within three years:

What is [gold’s] ultimate value? Its ultimate value is as an inflation hedge, not as an alternative investment, not maintenance of purchasing power in a would-be deflationary environment. Its ultimate and final value is money. It is the currency of last resort. That is its final and ultimate value. And that is the value that the stuff has to the gold bugs.

…The financial apocalypse that people believe are waiting for will come about when the U.S. dollar falls apart. Why? Because the U.S. dollar is the ultimate currency. In the realm of paper currencies, the U.S. dollar is the ultimate currency. When the U.S. dollar falls apart, that’s when everything else falls apart.

…Thanks to Bushonomics I (Bush Sr.) and II (Bush Jr.) as well as the enormous multi-trillion-dollar accrual of debt that occurred from 1981 to 1992 and again from 2001 to present, the multi-trillion-dollar accrual of debt reduces the United States’ future financial flexibility by increasing future liabilities -- both real and contingent because of this debt and the strangulation that debt has.

Debt has what’s called a re-strangulation effect over time. Even though the value of the currency may be debased by purposeful action of the government in an effort to monetize existing debt, you can’t monetize debt endlessly, which is what the United States is close to having to do.

David Walker, the Comptroller General of the United States, pointed out that, should the Bush Cheney Regime be re-ensconced in power for a second term and the fiscally corrosive practice of Bushonomic, i.e., negative debt finance consumption, be continued, then the United States would not be able to service its debt past 2009. That’s when the game ends. That’s when it all falls apart. When the United States government can no longer service its debt, the currency becomes worthless, or very nearly so.

…Unless the United States can engineer (the Bush Cheney Regime through economic policy and the Fed through market action) a dramatic fall, which would be at least another 40%, the ensuing decline in the dollar would help to monetize debt.

As we have explained debt monetization before, it is nothing more than the issuance of debt and the future servicing of the debt in ever-cheaper currency, which obviously causes interest rates to rise, which causes inflation and is something that this regime is desperate to create.

Despite having a Federal Reserve that has maintained money supply targets, in some cases, twice above what they would normally be maintained relative to GDP, they simply haven’t been successful in creating inflation in the United States because of the latent deflationary pressures that Bushonomics causes.How do you create deflation? Through the accrual of debt within all 3 legs of what could be called the national stool, i.e., government, business and industry, and the people.

We are now in a situation where government debt is at all levels of government–federal, state, local a record high. We also have a situation where consumer debt is also at an all-time high -- not only in the United States, but almost in every other country at the same time. Thus there are global deflationary pressures. How do you combat this deflation? You have to create some inflation.

This is simply the cheapening of money in order to repay existing debt in the future and make that less of a burden relative to total income, which is not only something that affects governments, but it affects business and industry, and the people as well.

The problem with Bushonomics, however, is that it adds in a new factor, namely, that the people aren’t able to successfully monetize debt the way government does. Under Bushonian Regimes, real wages, i.e., wages not including inflation, actually fall.

The reason they do so is because, under Bushonian Regimes, economic policies to dramatically increase the rate of productivity and to consequently decrease per-unit labor cost, are pushed.

Look at the tremendous increase in the rate of productivity that has occurred under the Bush Cheney regime.

…The answer is a conundrum. Gold is good. Gold is what you want to own. If you’re not a trader, or if you don’t have the smarts to trade it, …you still want to hold gold. Gold is the asset you want to hold.

But why do you want to hold it? Therein becomes the question that separates the gold bugs from the gold bulls. Why do you want to hold it? Do you want to hold it as an investor with the idea of selling it at some point in the future to take a profit?

That’s not the reason why the average citizen should be holding gold, because they’re not smart enough to time the markets in order to take a profit, simply put, to sell it high and buy it low, as they say. The reason why the average citizen should be holding gold is because of gold’s ultimate capacity as the money of last resort, knowing that it is now likely that the United States will not be able to service its debt after 2009.

Or that in order to continue to do so, it would have to create a hyper-inflationary scenario, which would only postpone the inevitable for a few years -- 4 years, or 6 or 8 years, maybe, at the most.

Ultimately, hyper-inflationary bubbles cannot be sustained. They burst and everything falls apart. Witness the 1981 “Bolivian Meltdown” wherein the Bolivian peso fell to a value that the physical weight of the banknotes was equal to the price of tomatoes.

For investors, the question of whether to buy precious metals is tied up with the likelihood of inflation or deflation. If there is deflation, cash is a good investment, if there is inflation gold and other commodities become more attractive. Analysts seem to be divided on the inflation versus deflation debate. But, as the following column in Forbes indicates, that very uncertainty should ultimately strengthen gold:

Glitter

James Grant
06.19.06, 12:00 AM ET

Gold is an August monetary asset but an undependable investment. Producing no income, it is inherently speculative. I am a value investor, but I am also a gold bull. I ought to try to explain myself.

Value investors buy stocks or bonds by the numbers. They compare price with value and buy if the discount is suitably deep. They turn a deaf ear to macroeconomic theorizing. Whether the gross domestic product is rising briskly or not at all is immaterial if a particular company is priced at less than its readily ascertainable net asset value.

Gold is something different. You buy it solely for macroeconomic considerations. I buy gold as a hedge against the stewards of paper money. I buy Krugerrands, the metal itself, suitable for burying in the turnip patch. I expect the price of the South African gold coins to keep going up, but I don't know how high.

There is much I don't know about gold. There is much that nobody can know--critically, for example, what the price ought to be. It's guesswork. If this is a cockamamie way to invest, I draw courage from the theory of central banking, which is more cockamamie still. These days it boils down to picking an interest rate and imposing that rate on the market. Some would call this "price-fixing." Can you name a single successful government price-fixing operation?

For a year, through June 2004, the Federal Reserve held the federal funds rate at 1%. Chairman Alan Greenspan and the chairman-to-be, Ben S. Bernanke, said they were fighting an anticipatory battle against deflation. They wanted to preserve the U.S. from a Japanese-style funk following the bursting of the stock-market bubble in 2000--01. So they dropped lending rates to the floor and pushed home prices to the moon.

Now house prices are falling, and mortgage rates are rising, which brings to mind Greenspan's advice to U.S. homeowners in February 2004.

He suggested they take out adjustable-rate mortgages. Many did--and are discovering that their disposable income, after mortgage payments, is adjusting to the down side. The real-estate-dependent U.S. economy is starting to wheeze.
And inflation is inconveniently starting to percolate. It's a quirk of the U.S. statistical apparatus that residential rents count for 29% of the measured rate of consumer price inflation. During the housing-price boom, rental rates sagged. But now that homeownership is losing some of its luster, rental rates are turning up. They are taking the Consumer Price Index up with them.

You are Chairman Bernanke. What do you do? A conscientious fellow, you try first to do no harm. You have made a lifelong study of deflation and the Great Depression. Of all the mistakes you could make at the helm of the Federal Open Market Committee, there is one you really want to avoid: You do not want to go down in history as the scholar of the Great Depression who inadvertently steered the highly leveraged U.S. economy into Great Depression Part II. You will be slow to tighten monetary policy when home prices are deflating, let the CPI be what it may.

Gold competes with the Bernanke dollar, just as it did with the Greenspan dollar and just as it has with government-issued money since the invention of the printing press. The historical record is undebatable: 1) Currencies ultimately lose their value. 2) Gold is a lousy long-term investment. 3) Yet when markets lose confidence in paper, there is nothing quite like a Krugerrand.

How confident are you? The U.S. annually consumes much more than it produces. It finances the deficit with dollars. More than $1.6 trillion has come to rest on the balance sheets of foreign central banks (as opposed, say, to the bank accounts of profit-seeking corporations). In recent months some of these central banks have signaled their intention to diversify into other currencies. Some of them have indicated they are buying gold.

The post-1971 dollar is uncollateralized. Its value is derived from the world's faith in America as much as from the strength of the U.S. economy or the level of U.S. interest rates. Reading the newspapers, I judge that faith to be wavering.

The gold price has doubled in the past three years. But it has only just kept up with the price of lead and has badly trailed the prices of copper and zinc.

Arguably, then, gold's rise to date is not as much a reflection on U.S. monetary management as it is an echo of the commodity boom.

You can be sure that gold will have its own bull market when the dollar resumes its bear market.

When will that day come, and how high is up? I don't know--and neither does Bernanke.

James Grant is the editor of Grant's Interest Rate Observer. Visit his homepage at www.forbes.com/grant.

Here is another analyst bullish on gold:

Bernanke Scares Pavlov's Sheep

Richard Benson

June 13, 2006

Ivan Petrovich Pavlov was a brilliant Russian Physiologist whose experiments on animals led to discoveries that would make the demented doctors in World War II, in both Germany and Japan, very jealous. Some of Pavlov’s early work was done on sheep. Unfortunately for the sheep, the experiments on them were so stressful they eventually died of heart attacks. Pavlov’s work on sheep, analogous to stock market investing, is critical for this article because speculators, hedge funds, and particularly retail stock investors, do tend to act a lot like sheep.

Pavlov’s work on the conditioned reflex reaction of sheep to stimuli should be of the utmost importance to the Federal Reserve and world central banks at this juncture in a world where signs of speculative excess – even to the bubble level – clearly remain in all major risk asset classes including housing, commodities, emerging markets, and even major stock markets.

In Pavlov’s research, he discovered that if he gave the sheep a mild electric shock, it would bother them very little and their life would go on pretty much as if nothing had happened as long as the shocks were random. Warning the sheep in advance of a shock by ringing a bell, however, affected their behavior and it changed radically. The sheep were just smart enough to realize that if they heard the bell, the shock was coming. After repeating this exercise a few times, the poor sheep lost control of bodily functions and after a few more warning bells, they started dying of heart attacks.

What Ben Bernanke and the Federal Reserve Governors should know, and are likely to find out the hard way, is that markets driven by speculation will react just like Pavlov’s sheep. Indeed, the major market participants and speculators, particularly greedy retail investors, are there to get “sheared at market tops”. Somebody has to buy when the smart money wants to sell and take their winnings out of the casino. Moreover, to keep the herd of retail investing sheep grazing on financial investments including commodities, there needs to be a steady stream of “feel good” press for stocks about how great productivity is and how the nomination of the new Treasury Secretary, Hank Paulson, will be good for the dollar. All the while, stock analysts and market touts are claiming “there has never been a better time to invest”.

With fears about a rising core inflation rate and slowing economic growth, Bernanke and the Federal Reserve Governors understand too much money was printed up over the last decade. They’re not alone. The central banks in Europe are not done raising interest rates either and Japan is just beginning to raise their rates from zero to drain excess liquidity. After 16 rates hikes, the Fed announced it is not done raising rates. This “ringing of the bell” has the sheep sensing that more shocks are coming. This could be downright ugly for the financial markets! We would recommend that the Fed have plenty of tranquilizers and lots of liquidity available to bail out the markets if they keep on scaring the sheep.

The market participants that started running like lemmings for the edge of the cliff are led by the market professionals! They have been heard shouting “get out before the sheep panic!” Over the last few months, easy money trades are down, and some Middle Eastern markets have crashed while other emerging markets are in a bear market. Commodities are also in a serious correction, including gold and silver.

All too often central banks tighten until the financial markets suffer a significant failure. The Federal Reserve and Treasury have regular practice “fire drills” on what to do during a market crash, and given their behavior and what Pavlov taught us about sheep, they will more than likely create an opportunity to fight a real financial market fire. However, when the Fed has to fight a market event – and cuts interest rates in an effort to save the lives of some of the sheep – you can kiss the dollar goodbye. So, while the dollar has gotten a technical lift over the past week or so, my cash is still going into “non-dollar cash”. The U.S. trade deficit is so massive, and our debt is so large, we believe the dollar will have to fall much lower.

While a general stock market crash may pressure all stocks (including precious metal stocks) to go lower, precious metals and precious metal stocks are being offered now at significant discounts (much of the excess that causes sharp drops in price has been washed out).

In the years ahead, the high prices we have all seen in gold and silver will be surpassed many times over. In addition, leaving your money in short-term cash with no price risk while receiving 5 percent, looks a lot better than losing money in stocks or real estate! Suddenly, risk is a four letter word and cash is not trash.

On the deflationary side, housing inventories are rising, indicating sharp drops in prices soon:

Cheerleader Panic, the HPI, and the Battle of New Orleans

Michael Shedlock

Saturday, June 10, 2006

Speaking for the National Association of Realtors on June 6th, David Lereah, the NAR’s top cheerleader had this to say:

Home sales are settling into a slower pace. “In recent years we were occasionally challenged to find appropriate superlatives to describe surprisingly high home sales,” he said. “Now the housing market has cooled, but 2006 is still expected to be the third strongest on record. In this case, experiencing a slowing from a hot market is a good thing because we need a solid housing sector to provide an underlying base to the economy, and slower appreciation will help to preserve long-term affordability. But this is a time for the Fed to pause on rate hikes because we have some interest-sensitive housing markets that have become vulnerable.”

Let's summarize:

This year will be the "third strongest on record".

Slowing from a hot market is a "good thing"

"Slower Appreciation will preserve affordability"

"The Fed should Pause"

It's now Mish Question Time (but this is an easy one).

Which one of the above does not logically fit in?

Ding Ding Ding the answer of course is number 4.

Lereah is now in panic mode,talking out of both sides of his mouth at the same time. I am not the only one that noticed this either.

In "Burning Down the House" Independent economist Bob Brusca had this to say:

The 10-year note is still yielding just 5%, and 30-year mortgage rates are still historically reasonable. In that light, Mr. Lereah's demand "smacks of desperation," and might cause enough alarm to make potential first-time home-buyers more likely to stay on the sidelines. "I would see this as a mistake [on Mr. Lereah's part] and not an indicator of bad things to happen," Mr. Brusca said, adding: "Except for home builders."

... What is David Lereah really worried about?

…Lereah knows things are rapidly deteriorating or he would not be so contradictory. But the three things that probably worrying him most are inventory, inventory, and inventory. The next four things he is worried about are falling sales, falling prices, rising foreclosures, and rising bankruptcies. Let's take a quick look at some recent inventory charts.

Orange County

Fairfax County Virginia

There is little atypical about any of the above charts.

Florida looks the same way and I am sure countless other places do too.

Beneath the facade I sense David Lereah is in a near panic.

How long he can remain an optimistic cheerleader rooting for a team down 20 points in the fourth quarter with under 2 minutes left remains to be seen. I am already ready for the next ploy: "Homes won't stay at these prices forever". He will of course be correct. Prices will head lower, much lower. We have only just begun to unwind the craziness of the last few years.

The Producer Price Index numbers for May were released last week, raising inflation concerns:

Producer prices up more than expected

By Mark Felsenthal

U.S. producer prices excluding energy and food rose faster than expected last month and high gasoline prices boosted otherwise tepid retail sales, the government said on Tuesday in reports that signal inflationary pressures.

U.S. producer prices rose just 0.2 percent last month as food costs fell, but prices outside of food and energy rose a steeper-than-expected 0.3 percent. Retail sales in May rose just 0.1 percent, matching Wall Street expectations, with declines in auto, furniture and building material sales.

Analysts said the rise in core producer prices shows the risk that rising prices may be working their way from producers to consumers.

"Pipeline inflation pressures continue to build, and that impression was not dispelled by today's release," said William O'Donnell, head of U.S. interest rate strategy and research at UBS in Stamford, Connecticut.

The dollar climbed to its highest levels in over a month against the euro and the yen as the higher-than-expected core producer price reading heightened expectations the Federal Reserve would raise interest rates in June.

U.S. Treasury debt prices pared gains, while stocks were little changed in volatile trading.

The producer price report "supports the idea that (the Federal Reserve) will raise rates another 25 basis points on June 29, and the dollar has reacted positively to that," said Alex Beuzelin, foreign exchange market analyst at Ruesch International in Washington.

The consumer price report for May will be released on Wednesday, providing a much broader outlook on inflationary pressures. Analysts expect the 0.4 percent rise in the CPI, while the core rate is expected to rise on 0.2 percent.

George Ure points out that crude goods rose in May by a 2% monthly rate which means a 26.8% annual rate.

PPI: Crude Goods: 26.8% Inflation

Welcome to the Weimar? It depends on how much of the coming increases in crude goods are passed on to consumers, but here's the picture: Crude goods are up - a lot! 2% from last month to this (May) report and that pencils out to an annual rate (26.8%) that could spell disaster for the markets, especially in light of inflation results from elsewhere which we'll get to in a minute.

To keep things in perspective, here's how the flow of inflation data looks like when you step back far enough from the numbers:

So what we're talking about today is inflation down the supply chain a ways from where it hits the retail outlets where the numbers morph into CPI (consumer prices) which will come out tomorrow.

Now, here's where things are by the Labor Department's latest:

"The Producer Price Index for Finished Goods rose 0.2 percent in May, seasonally adjusted, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. This increase followed a 0.9-percent jump in April and a 0.5-percent advance in March. At the earlier stages of processing, prices received by manufacturers of intermediate goods climbed 1.1 percent in May after rising 0.9 percent in the preceding month, while the crude goods index moved up 2.0 percent following a 1.2-percent gain in April. "

Now this is absolutely key: At the Crude Goods level (Raw Materials) prices are going up like crazy. Why? Haven't you been paying attention to our "inflation is a worry" discussions?

The change in crude goods of 2% for the month - which is the same as saying 26.8% inflation is working its way into the front end of the pipeline.

The report makes it sound like the slight improvement in finished goods is just a twitch of energy price impacts:

"Most of the deceleration in the finished goods index can be traced to prices for energy goods, which slowed to a 0.4-percent increase in May after advancing 4.0 percent in April. Prices for finished consumer foods turned down 0.5 percent following a 0.1-percent gain in the prior month. Alternatively, the index for finished goods other than foods and energy increased 0.3 percent in May compared with a 0.1-percent rise in April."

"Before seasonal adjustment, the Producer Price Index for Finished Goods advanced 0.4 percent in May to 161.2 (1982 = 100). From May 2005 to May 2006, prices for finished goods increased 4.5 percent. Over the same period, the index for finished energy goods climbed 20.6 percent, prices for finished goods other than foods and energy rose 1.5 percent, and the index for finished consumer foods fell 1.5 percent. For the 12 months ended May 2006, prices for intermediate goods increased 8.9 percent and the crude goods index moved up 8.6 percent."

OK, there you have it: The BLS folks admitting that there is 8-9% inflation down the pipeline.

Looking ahead, it’s hard to see whether the ultimate fear should be inflation or deflation. Doug Casey says both can happen at the same time:

The Greater Depression—an Update

Doug Casey

June 5, 2006

…[A] depression is probably inevitable this time.

The only serious question in my mind is whether it will be essentially deflationary in nature, as it was the case in the U.S. in the 1930s, or inflationary like in Germany in the 1920s. My guess is the latter because the government is so much more powerful today. Or it could actually be both at once, in different sectors of the economy.

How?

Inflation could drive interest rates to 20%. This would collapse the bond and real estate markets, wiping out trillions of dollars of purchasing power—which is deflationary. Meanwhile, that same inflation doubles the cost of food and fuel. In other words, the opposite of what we’ve mostly had for the last generation, when we had “good” inflation in stocks, bonds and property, but stable or dropping prices in “cost of living” items. This time the pattern could reverse, which would be a nightmare for most people.

And as people become more focused on speculation in a generally futile attempt to stay ahead of financial chaos, they inevitably divert effort from economic production. Which will decrease the general standard of living even more.

The situation isn’t made easier by the possibility that we’re facing Peak Oil—the start of a secular decline in world oil production. Or the fact that Americans, both individually and collectively, are deeply in debt and living on the kindness of strangers. The problem with debt is that it artificially increases our standard of living. But when we pay it off, especially with interest, it reduces our standard of living in a very real way.

Wrap this economic environment around the so-called War on Terror, which is rapidly morphing into the War on Islam, which could easily turn into World War III, and you’re looking at the perfect storm. The odds of a major conflagration are very high, and it’s not being adequately discounted. If Bush starts a war against Iran, or if another incident like that of 9/11 occurs, or even if the trend of the last five years accelerates, the U.S. is going to be locked down like one of its numerous new federal penitentiaries. And that will be accompanied, and compounded, by mass hysteria among Boobus americanus.

At that point, your investment portfolio will be among your lesser concerns. People forget that, in every country and time, there’s a standard distribution of sociopaths and misdirected losers. In normal times, they seem like normal people. But when the time is right, they show their colors, and they love to get jobs with the government, where they can lord it over their betters.

Is the Greater Depression really inevitable? How bad will it be? Is there another side to the argument? Can it be avoided?

I suppose it’s not absolutely inevitable. Perhaps friendly aliens will land on the roof of the White House and present the government with a magic technology that can undo all the damage it’s done. But we live in a world of cause and effect where actions have consequences. That being the case, I expect truly serious financial and economic trouble…

Signs of the Economic Apocalypse, 6-12-06

From Signs of the Times, 6-12-06:

Gold closed at 612.50 dollars an ounce on Friday, down 5.0% from $643.00 at the previous Friday’s close. The dollar closed at 0.7912 euros on Friday, up 2.2% from 0.7741 for the week. The euro closed at 1.2640 dollars compared to $1.2918 at the end of the week before. Gold in euros would be 484.57 euros an ounce, down 2.8% from 497.99 for the week. Oil closed at 71.60 dollars a barrel, down 1.6% from $72.75 at the close of the previous week. Oil in euros would be 56.65 euros a barrel, up 0.6% from 56.32 euros at the end of the week before. The gold/oil ratio closed at 8.55, down 3.4% from 8.84 for the week. In the U.S. stock market, the Dow Jones Industrial Average closed at 10,891.92 on Friday, down 3.3% from 11,247.87 at the close of the previous Friday. The NASDAQ closed at 2,135.06, down 4.0% from 2,219.41 at the end of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.97%, down two basis points from 4.99 for the week.

The big news last week was the continued drop in stock prices.

U.S. Stocks Stumble, Ending the Worst Week Since April 2005

June 9 (Bloomberg) -- Inflation concerns sent U.S. stocks lower, ending the market's worst week since April 2005, after May import prices rose twice as much as economists forecast.

The government report fueled speculation that the Federal Reserve and central banks worldwide will stunt economic growth by raising interest rates to curtail inflation. Global equity markets had their biggest weekly losses in almost four years.

“Investors are still trying to sort out inflation and interest rates and how much further they're going to go up,” said Franklin Morton, who helps oversee $19 billion at Ariel Capital Management in Chicago. “Until we get some clarity, markets are going to be flat to down.”

Texas Instruments Inc., the world's biggest maker of mobile-phone chips, led the retreat. Citigroup Inc., citing slowing demand for handsets, cut its 2007 earnings estimate a day after the company raised forecasts for this quarter.

The Dow average dropped 46.90, or 0.4 percent, to 10,891.92, bringing its decline over the last five days to 3.2 percent. It fell 3.6 percent in the week ended April 15, 2005. The Standard & Poor's 500 Index lost 5.63, or 0.5 percent, to 1252.30, the lowest this year. The Nasdaq Composite Index declined 10.26, or 0.5 percent, to 2135.06, a level not seen since November.

The S&P 500 slipped 2.8 percent this week, also the biggest loss since April 2005, as speculation higher rates will push the economy and profits into a recession increased. The index, which briefly gave up its 2006 advance this week, has now dropped 5.5 percent from a five-year high set on May 5. The Nasdaq lost 3.8 percent this week.

Global Drop

Morgan Stanley Capital International's Europe, Australasia, Far East Index, or EAFE, declined 5.9 percent this week. The drop in the index, a benchmark for U.S.-based international investors, was the biggest since July 2002. The MSCI Emerging Markets Index tumbled 8 percent the last five days, as investors fled riskier assets.

Import prices rose 1.6 percent in May, on higher commodity prices, the Labor Department said. Economists expected a 0.7 percent increase. Last month's rise, coupled with April's 2.1 percent jump, was the biggest two-month gain in prices for imports since 1990. A shortfall in trade widened to $63.4 billion from $62 billion in March, the Commerce Department said.

The Fed has raised the benchmark U.S. rate to 5 percent from 1 percent in two years and comments from central bankers including Chairman Ben S. Bernanke this week suggest policy makers may lift them again this month. Bernanke said on June 5 that inflation is accelerating and “unwelcome.”

Central banks for Europe and India were among those that raised lending rates this week…

Gold has dropped sharply from its peak, but it is actually up 5% for the quarter so far. I am not sure why gold has dropped so far recently. A correction was to be expected but this is a sharp correction. Maybe it dropped due to a perceived lessening in the likelihood of a U.S./Israeli/Neocon attack on Iran. Or because the prospect of higher interest rates increases the value of currencies, thereby reducing the value of precious metals and commodities. Putting both things together—the rise in interest rates and the supposed lessening of the likelihood of war in Iran—we can see some reasons for the U.S. dollar’s sharp rise against the euro last week.

Dollar Posts Biggest Weekly Gain Since November Versus Euro

June 9 (Bloomberg) -- The dollar gained this week by the most since November against the euro as Federal Reserve speakers suggested they will raise interest rates this month to keep inflation in check.

Traders pushed the dollar to the highest in a month against the euro after a government report showed U.S. import prices climbed in May. The U.S. currency has rallied five straight days against the euro as mounting expectations for higher U.S. rates led traders to exit bets on a dollar decline. Fed Chairman Ben S. Bernanke led a chorus of central bank officials this week signaling concern over inflation.

“What's given the dollar a lift this week is the Federal Reserve's hawkish campaign,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman & Co. in New York. The remarks fueled “a large-scale unwinding” of holdings in emerging-markets and a flight to the dollar, he said.

The U.S. currency has advanced 2.1 percent this week to $1.2642 per euro at 4:13 p.m. in New York, and reached $1.2598, its strongest since May 4. The U.S. currency fell to 114.01 yen, from 114.24 late yesterday, when it reached 114.72 yen, the strongest since April 27.

For the week, the dollar has gained 2.1 percent versus the yen, the most since March.

The 1.6 percent increase in U.S. import prices followed a 2.1 percent surge the month before, the Labor Department said today in Washington. The jump compared with a 0.7 percent increase that was the median forecast in a Bloomberg survey.

Fed Odds

The dollar has rebounded about 2.5 percent from a 13-month low of $1.2979 per euro, reached June 5, and 4.6 percent from an eight-month low of 109 yen, touched last month.

Traders are pricing in about an 84 percent chance the Fed will boost its key rate a quarter-point to 5.25 percent in its June 28-29 meeting, up from 48 percent at the end of last week, interest-rate futures show.

The Fed has lifted its benchmark rate from 1 percent in June 2004. The European Central Bank raised its key rate by a quarter- point yesterday to 2.75 percent, the third increase since December. The Bank of Japan has kept its benchmark rate near zero since 2001. Fed Governor Donald Kohn yesterday described recent inflation data as “troubling.”

Euro losses accelerated yesterday after ECB President Jean- Claude Trichet refrained from using the word “vigilant” in describing the bank's stance toward inflation, suggesting a slower pace of rate increases than some analysts had predicted.

Trade Gap

The U.S. currency also got support today as the U.S. trade gap, the amount by which imports exceed exports, widened to $63.4 billion in April from $61.9 billion in March, the government said. The shortfall was less than the median forecast of $65 billion in a Bloomberg survey.

The report may damp concern the dollar needs to weaken to narrow the U.S. trade shortfall. The dollar has dropped about 2 percent versus the euro and yen since the Group of Seven nations on April 21 called on China and other Asian nations to let their currencies strengthen to help shrink global trade deficits.

A narrower deficit “could add to the momentum of dollar bears having to take a back seat,” said Samarjit Shankar, director of global strategy for the foreign exchange group in Boston at Mellon Financial Corp, before the report.

The dollar weakened to a record $1.3666 per euro in December 2004, partly on concern the U.S. would fail to attract enough international investment to compensate for the shortfall in the current account, the broadest measure of trade. The trade deficit reached a record $68.5 billion in January.

Investment Flow

The deficit in the current account, a measure of trade, services, tourism and investments, widened to a record $224.9 billion in the fourth quarter.

The U.S. needs to attract about $2.5 billion a day to fund the gap and keep the value of the dollar steady. Net holdings of Treasury notes, corporate bonds, stocks and other financial assets increased by $69.8 billion in March, less than February's $90.5 billion, the Treasury Department said last month.

This week's 2 percent gain in the U.S. Dollar Index is the biggest since March 2005. The index gauges the dollar's value against a basket of six currencies, including the euro and yen.

Lehman Brothers Holdings Inc. advised investors to stop betting on a drop in the U.S. dollar in the next few weeks on speculation the Fed will lift rates this month.

Now were Bernanke’s signal that he wants to fight inflation by raising interest rates and Bush’s diplomatic overtures to Iran both done precisely for this reason? To prop up the dollar and stop the rise in commodities? Most likely the two events are not related, but it is fun to speculate.

More generally, though, there is no doubt the long-term health of the imperial economy is tied to success in war and success in war has eluded the neocon leadership. I’m not counting the psyops fake killing of the already-dead-for-years fake terrorist leader al-Zarqawi as any kind of success. The playing of this card probably indicates how desperate they are. Of course we will know they are really in trouble (or the election is really near) when they announce they have killed the already-dead Bin Laden.

For a better view of the real success of the Global War on Terrorism, or whatever it is they are calling it, and some of the economic costs, here is Paul Craig Roberts:

You'd Better Shut Up
War Criminal Nation
By Paul Craig Roberts

June 9, 2006

Faced with mounting civilian carnage, both from war crimes committed by demoralized and broken US troops and from the raging civil war unleashed by Bush's ill-fated illegal invasion of Iraq, the House Defense Appropriations Subcommittee has decided to waste another $50 billion to continue the lost war for five more months. Our elected "representatives" are so in thrall to the powerful military-industrial complex that no amount of American shame, pariah status and military defeat can shut off the flow of taxpayers' funds to the merchants of death.

Bush's wars in Iraq and Afghanistan are costing hard-pressed US taxpayers $300,000,000 per day! These wars are lost. Yet, imbecilic members of Congress are in the process of funding the war for another year. Multiply $300 million by 365 days and you get $109,500,000,000. These are not the full costs. The huge figure does not include the destroyed equipment, destroyed lives, and long-term care of the maimed and disabled.

Gentle reader, are you getting enough vicarious pleasure from the slaughter of Iraqi women and children to justify this price tag? Is murdering "ragheads" that important to you? If so, you are one sick person, just like every member of the Bush administration.

US forces in Iraq and Afghanistan have killed far more civilians than they have resistance fighters. Bush administration spokespersons are crowing that they have killed Musab al-Zarqawi in an air strike. But al-Zarqawi was an al Qaeda leader, not a member of the Iraqi resistance. Al-Zarqawi's death will have no affect on the outcome in Iraq.

Far more important is the news that civil war in Baghdad alone claimed 1,400 deaths last month. Perhaps even more important is the news that the Taliban's resurgence has forced the Bush administration to launch more than 750 air strikes in Afghanistan in May. That is 25 air strikes per day! It is a foregone conclusion that most of the casualties are women and children.

America is drowning in the shame of war crimes. One monstrous slaughter of civilians after another, each denied and covered up until brought to light by photos and eye witnesses. The once proud US Marines, unable to defeat the resistance that is picking them off one by one, is now a frustrated, demoralized force that is getting even by murdering 3-month old babies and old women…

It may be that the dollar is being propped up solely by short term investments for the interest rate return. Surely knowing the facts laid out by Roberts in the above article, and those of us in the United States should make no mistake in thinking that the rest of the world, especially investors and central banks, is as fooled as we are about the reality of the situation in Iraq and Afghanistan, would make the longer term prospects for the dollar much weaker. And any backing down by Bush from confrontation with Iran is too late to stop the losses the U.S. is enduring in Iraq and Afghanistan. So why, even given the short term trends, is the dollar worth any thing at all? The Cryptogon blogger, “Kevin,” raised this question in a discussion with a reader:

Robert wrote:

Subject: Comments on Gold/Stocks?I enjoy the financial commentary on your blog, and while it may not be the central focus, I am curious to hear your thoughts on the current trends in gold and stocks. I am a novice at best when it comes to economics and market analysis, but it would stand to reason that gold would be trending upwards as stocks decline and investors look for safer investments. At the moment both gold and stocks are trending down. Perhaps there really is no logic left in economic decisions?

I wrote back:

Hi Robert,

How the system is up at all right now is a COMPLETE mystery to me. Specifically, I don't understand how the U.S. dollar is still viable, with the national debt closing in on $8.4 trillion... It's probably sheer voodoo and black ops at this point.

Don't get me wrong, I'm glad that it's up, because it would be difficult for my wife and I to establish our permaculture farm with the global economy in a state of collapse. After all, the same economic system that produces tanks, rockets and bombs also produces chicken wire.

We need chicken wire.

I think that the rest of the world will continue to prop up the U.S. for as long as possible, simply because the rest of the world has gotten used to exchanging its goods and services for funny money. How and why that state of affairs came to be is a long and complicated story that doesn't even matter anymore; not at this late stage of the game. But once it's clear that the scam is unraveling, the U.S. will just print money at will. Paying off the massive debt will then simply be a matter of zapping X trillion nearly worthless U.S. dollars into the central banks of America's creditors.

The global economic system could, should and probably would collapse at that point.

When will it happen?

Who knows? Certainly not me. Maybe it will never happen and the U.S. national debt will be allowed to go to $50 trillion or $100 trillion and it will be new Hummers and iPods for all!

Or... Maybe the collapse is happening now, in slow motion. Look at the growing list of states that are divesting away from the dollar. Russia is the latest and most influential state to do this. Why is that happening? Because the U.S. has a bright future ahead?

The U.S. dollar works because people pretend that it's real, and nuclear weapons, thirteen carrier strike groups, and millions of soldiers make it so. As more and more major actors wake up to the fact that the dollar represents a total joke, and that the joke isn't funny anymore... Watch out.

Over the last few decades, the most powerful states in the world have lashed themselves to the mast of a sinking ship. It's that simple. And I'm not being cavalier about it! I don't feel financially secure because my money is out of the U.S. I firmly believe that, when the U.S. goes down, it will take the rest of the global economy down with it…

I think Kevin may be onto something with this: “Or... Maybe the collapse is happening now, in slow motion.” Susan C. Walker, writing about the effects of a drop in housing prices, quoted a historian of the Great Depression:

The real problem is that markets can move much slower than we expect, which makes it all the more difficult to decide what to do. For reference, historian John Brooks wrote about how it felt to live during the Great Depression . In one word, it was "surreal." Keep in mind his description of the 1929-1933 experience:

[It] came with a kind of surrealistic slowness … so gradually that, on the one hand, it was possible to live through a good part of it without realizing that it was happening, and, on the other hand, it was possible to believe one had experienced and survived it when in fact it had no more than just begun.

Or, as Bob Dylan put it: “There’s a slow, slow train comin’ up around the bend.”

Signs of the Economic Apocalypse, 6-5-06

From Signs of the Times, 6-5-06:

Gold closed at 643.00 dollars an ounce on Friday, down 1.6% from $653.30 at the previous Friday’s close. The dollar closed at 0.7741 euros on Friday, down 1.5% from 0.7860 at the end of the previous week. That put the euro at 1.2918 dollars, compared to 1.2722 at the end of the week before. Gold in euros, then, would be 497.99 euros an ounce, down 3.1% from 513.52 for the week. Oil closed at 72.75 dollars an ounce on Friday, up 1.9% from $71.38 for the week. Oil in euros would be 56.32 euros a barrel, up 0.4% from 56.11 at the end of the week before. The gold/oil ratio closed at 8.84 on Friday, down 3.5% from 9.15 at the previous week’s close. In the U.S. stock market, the Dow closed at 11,247.87 on Friday, down 0.3% from 11,278.61 for the week. The NASDAQ closed at 2,219.41, up 0.4% from 2,210.37 at the end of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.99%, down six basis points from 5.05 for the week.

Last week we looked at the trial of Enron executives Jeffrey Skilling and Kenneth Lay and how Enron really is an emblem of U.S. corporate capitalism. Joe Kay of the World Socialist Web Site expanded on this topic Monday:

The Enron verdicts: corruption and American capitalism

By Joe Kay

29 May 2006

The guilty verdicts handed down by a Houston jury last week against former Enron chiefs Kenneth Lay and Jeffrey Skilling provide an opportunity to evaluate the significance of the company’s rise and fall within the context of American capitalism.

Accounts by jurors given after the verdicts were announced indicate they all agreed that the evidence against the two executives was overwhelming. It consisted mainly of testimony from over a dozen former executives, who implicated Lay and Skilling for their roles in defrauding investors and employees through various forms of accounting manipulation. The jurors quickly rejected the absurd position of the defense that Enron was basically a healthy company that collapsed into bankruptcy in December 2001 largely as the result of Wall Street machinations and negative press coverage.

Several jurors indicated they reacted negatively to the testimony of the defendants, and particularly Lay, who could not hide his arrogance while on the stand. Others said Lay’s move to sell millions of dollars of company stock in the months before the bankruptcy, even as he encouraged employees to keep buying, was appalling.

One juror noted, “That was very much the character of the person that he was. He cashed out before the employees did.” Some jurors spoke about social conditions in the US, voicing the hope that the verdicts would send a message to other executives across the country.

There is certainly an element of social protest here, directed both at Enron and the broader conditions of inequality and corporate greed, whatever limitations there might be in the jurors’ understanding of the underlying forces at work. The conviction of Lay and Skilling stems ultimately from the fact that they headed a company that engaged in market manipulations and fraud which, in their scale and flagrancy, exceeded anything that had gone before in a long history of corrupt business practices. And Enron has since been shown to have been only one of many companies that engaged in similar practices.

It is by no means assured that the two executives will spend significant time in prison, though commentators have generally agreed that the legal bases for their appeals are very limited. But, as one juror suggested, money has a way of solving such problems.

There are additional factors at work—in particular, the close political connections that Lay and Skilling have with the political establishment in general and the Bush administration in particular. Lay, after all, was for a long time one of Bush’s most important political supporters. He is certainly in possession of important information that could be damaging to powerful people. (For example, what exactly was discussed during Cheney’s secret Energy Task Force meetings, in which Enron took part?).

One would suppose that Lay still has a few aces up his sleeve, as well as friends in high places. A presidential pardon—no doubt as a reward for philanthropic good works—is not out of the question.

The verdict has predictably been followed by self-congratulatory comments from sections of the media and the government prosecutors: the convictions demonstrate that the system works, that nobody is above the law, that all misdeeds will eventually be punished, etc., etc. The Wall Street Journal published an editorial along these lines Friday, voicing the arguments that finance capital has made after every one of the major trials involving corporate corruption. It concluded with the claim that “assertions of widespread corporate fraud back in 2001 and 2002 were way overblown.”

Following the verdict, Sean Berkowitz, the head of the government’s Enron Task Force, said that it “sent an unmistakable message to boardrooms across the country—you can’t lie to shareholders. You can’t put yourself in front of your employees’ interests.” This under conditions where it remains common practice for executives to award themselves multi-million dollar salaries even as they carry out mass layoffs!

Other commentators have been more penetrating, noting that not only was the “Enron phenomenon” widespread, but that the same problems persist today. Kurt Eichenwald, in an article for the New York Times on Friday, wrote that Enron “will forever stand as the ultimate reflection of an era of near madness in finance, a time in the late 1990s when self-certitude and spin became a substitute for financial analysis and coherent business models.”

The ultimate lesson of Enron, Eichenwald suggested, is the picture it presents of “a corporate culture poisoned by hubris, leading ultimately to a recklessness that placed the business’s survival at risk.”

The Times’ business commentator, Gretchen Morgenson, entitled her Sunday article “Are Enrons Bustin’ Out All Over?” and cited recent cases of corporate fraud, particularly that of housing lender Fannie Mae.

Lawyers for Lay and Skilling were close to the truth when they argued that the prosecution’s logic implied the criminalization of standard business practices (and therefore their defendants should not be convicted for doing what every one else was doing). Skilling’s lawyer Dan Petrocelli stated in his closing arguments that if the jury accepted the government’s case, “we might as well put every CEO in jail.”

Certain conclusions may legitimately be drawn from this statement that Mr. Petrocelli never intended.

However, even the more probing comments in the media miss the central lesson: that Enron and the corporate environment which created it were the products of basic tendencies of American capitalist development. They were the outcome of a political and social policy that has been pursued by both big business parties—a policy that has encouraged greed, corruption and criminality as part of a ruthless drive to attack the living standards and social gains of American workers.

Beginning particularly in the 1980s, the American ruling elite responded to the economic crisis of the previous decade by shifting the way businesses operate. Greater competition from Europe and Asia had begun to cut into the American ruling class’ status as hegemon of the world capitalist system. From the standpoint of the social position of Wall Street and corporate America, it became necessary to eliminate concessions granted to workers in an earlier period.

Deregulation, the attack on higher-quality jobs, the elimination of social programs—these were all part of a policy aimed at redistributing wealth from the bottom to the top, cutting into the share allocated to the actual producers of this wealth. Big Wall Street investors began placing ever-greater demands on corporate management to return quick profits, often by means of wage cuts and downsizing. The measure of corporate success increasingly became short-term earnings, closely linked to the fluctuations in a company’s stock.

As the World Socialist Web Site noted shortly after Enron’s collapse, the operations of the stock market have become central to the functioning of the world capitalist economy. “Every day trillions of dollars course through global equity, currency and financial markets in the search for profit. Since the start of the 1980s as much as 75 percent of the total return on investments has resulted from capital gains arising from an appreciation of market values, rather than from profits and interest. In this drive for shareholder value, each corporation is compelled, on pain of extinction, to devise measures which attract investment funds by lifting the price of securities above that which would be justified by an objective valuation of the underlying assets.” (See “Enron: The real face of the ‘new economy’”)

The interests of executives were tied in with the interests of Wall Street through a variety of mechanisms—in particular, the increased use of such forms of compensation as stock options. Executives who managed to keep their stock prices high were, and continue to be, richly rewarded.

While originally developed as part of the drive to increase productivity and cut costs in response to the economic problems of American capitalism, financial speculation has inevitably taken on a life of its own. To keep stock prices high, companies have resorted to all sorts of operations—including fraud and accounting manipulations.

Such considerations as the long-term health of the company have increasingly taken a back seat to the need to satisfy Wall Street’s demands for ever-rising short-term earnings. It has been widely acknowledged by executives themselves that they often make decisions contrary to the longer-term interests of their own corporations.

The process was a means of generating vast, previously unheard of fortunes, particularly during the late 1990s. That half-decade saw an explosion of social inequality. Some people made lots of money, and companies like Enron were essential to this process of wealth redistribution.

A new social type was created in the process, one that calls to mind Marx’s description of the French finance aristocracy before the revolution of 1848, in which “the mania to get rich was repeated in every sphere... to get rich not by production, but by pocketing the already available wealth of others.”

In words that could apply just as well to the likes of Skilling and Lay, Marx wrote: “Clashing every moment with the bourgeois laws themselves, an unbridled assertion of unhealthy and dissolute appetites manifested itself, particularly at the top of bourgeois society—lusts wherein wealth derived from gambling naturally seeks its satisfaction, where pleasure becomes debauched, where money, filth and blood commingle.”

Enron combined within itself the basic features of a new type of American business operation. It was a company whose operations did not, for the most part, involve the production of anything of value. Enron exploited the deregulation of the energy markets to insert itself as a middleman, siphoning off revenues at the expense of consumers and speculating on energy prices. Skilling considered one of his and Enron’s greatest accomplishments the virtually single-handed creation of the wholesale energy market, which during the late ‘90s became a new means of speculation and price-gouging.

All of the various components of American capitalism were involved in the operation: Wall Street investors and analysts, who bought and boosted Enron stock; investment banks, which provided loans and helped Enron cover up its losses; the media, which perpetuated the myth that companies like Enron and executives like Lay and Skilling were representatives of a new, vibrant and productive stage of capitalism.

Enron personified the new social layer in which “money, filth and blood commingle.” One need only recall the tapes recording the gloating of Enron energy traders over the California energy crisis of 2001, a crisis caused to a considerable degree by Enron’s own market manipulations. (They joked about gouging money from “those poor grandmothers in California.”)

Or the shooting death in January 2002 of former Enron vice chairman J. Clifford Baxter, who had opposed to some extent the high-handed methods at Enron and was, at the time of his extraordinarily timely suicide, due to testify in various investigations into the collapse of the company. (See “The strange and convenient death of J. Clifford Baxter—Enron executive found shot to death”)

The consequences for ordinary Americans (and not just Americans, since Enron and companies like it operate and have interests all over the world) have been devastating, and have been particularly felt since the stock market collapse of 2001: the decline in living standards, increasing indebtedness, a relentless assault on decent-paying jobs and benefits. The increased exploitation of working people has been a critical part of the drive to maintain and expand the wealth of a tiny oligarchy. When the companies mired in corruption collapsed, jobs and retirement savings were eliminated overnight.

None of these conditions has been eliminated. The drive to reduce wages, cut health care and pension programs and eliminate regulations on business has, in fact, intensified.

Recent revelations of the widespread practice of backdating stock options (to ensure the largest possible gains for executives) demonstrate that corruption persists. The stock market and financial manipulations play as important and damaging a role today as they did five years ago. In the event of another stock market collapse, which is inevitable given the precarious world economic situation, a host of new Enrons will be exposed.

Largely ignored in the mass of media reportage on the Enron verdicts is the intimate political connection between Lay and George W. Bush. Lay was one of Bush’s key backers from Bush’s early political career in Texas until Enron went bankrupt, after Bush had become president. Former Enron executives took up posts in the Bush administration, and Lay exercised veto power over an important position dealing with energy regulation. At the Enron CEO’s request, one candidate was ditched in favor of another hand-picked by Lay.

Enron also played a critical role in the formulation of the Bush administration’s energy policy and plans for war in Iraq, through participation in Vice President Cheney’s secret Energy Task Force. And while Enron was price-gouging and restricting energy supplies in California, costing residents of the state billions of dollars, the Bush administration refused to intervene and impose price caps, despite repeated requests from the state government.

In view of the scale of the scandal and the obvious political connections, the political fallout has been remarkably negligible. But then again, the nominal opposition party is thoroughly complicit in promoting the network of social relations that produced Enron. The company’s rise, and the vast growth of speculation and inequality, took place mainly during the administration of Bill Clinton. It would be difficult, if not impossible, to point to one instance in which the Democratic president raised criticisms of the company while it was making money for Wall Street and the American ruling class as a whole.

The conviction of Lay and Skilling will, in the end, do nothing to address the more fundamental issues confronting working people. Even if the two do go to jail for a significant period of time, the outcome provides cold comfort to the thousands of workers who have lost their jobs and savings. The wealthy who profited from Enron can write off their subsequent losses and move on to the next speculative money-making scheme. The situation is altogether different for ordinary working people.

The government felt compelled to bring the case because of the public outcry that followed the revelations of massive corruption. There was, and still is, great concern within ruling circles that such crimes could become a focus for broader social grievances, and that outrage could take on more overtly political forms.
Lay and Skilling are guilty of crimes, but they are not limited to the particular instances of fraud committed at Enron. They are an expression and outgrowth of broader social crimes. The guilt of Kenneth Lay and Jeffrey Skilling is the guilt of American capitalism.

In a connected, but little-noticed act, Bush granted ghoulish intelligence chief John Negroponte the power to grant corporations the right to conceal financial information from public scutiny if there is some connection with “national security.”

The Circle of Greed: The Cloak of Invisibility
by Mark Faulk

"Assignment of Function Relating to Granting of Authority for Issuance of Certain Directives: Memorandum for the Director of National Intelligence."

While just today, Enron executives Ken Lay and Jeffery Skilling have been convicted of conspiracy, fraud, insider trading and making false statements in deceiving their shareholders and employees, and while advocates for stock market reform continue to call for more transparency in our financial system, the federal government continued to opt instead for invisibility, granting intelligence czar John Negroponte the authority to “exempt companies from certain critical legal obligations. These obligations include keeping accurate ‘books, records, and accounts’ and maintaining ‘a system of internal accounting controls sufficient’ to ensure the propriety of financial transactions and the preparation of financial statements in compliance with ‘generally accepted accounting principles.’"

President Bush, and in fact, every president since Carter, has had the authority to allow publicly-traded companies to be exempt from the Securities Exchange Act of 1934, purportedly to hide information about top-secret defense contracts. How many times has the exemption been used? Who knows? The administration isn’t telling, and since the companies who are exempt don’t have to “keep accurate books, records, and accounts,” there is no way to know whether any…or whether all…defense contractors, or even companies who are loosely-related to defense spending, are playing by the rules. It is effectively a corporate cloak of invisibility.

And with these ambiguous words: "Assignment of Function Relating to Granting of Authority for Issuance of Certain Directives: Memorandum for the Director of National Intelligence," President Bush passed on the absolute authority to exempt whatever companies he deemed worthy of being above the law to Negroponte.

Want to know whether Halliburton’s financial records are accurate, or even if they’re required to keep records at all? Sorry, the administration won’t tell you that. Wonder if Boeing or Lockheed, or any of a thousand other publicly-traded companies, is telling you the truth about their financial condition? Nope, that’s top secret (refer to section 13[b][3][A] of the Securities Exchange Act of 1934, thank you very much).

There might be one company who’s exempt from telling the truth to their shareholders about their financial well being…or there might be thousands. And every one is a potential Enron waiting to happen. In a BusinessWeek Online article yesterday, former SEC enforcement chief William McLucas, suggested that “the ability to conceal financial information in the name of national security could lead some companies ‘to play fast and loose with their numbers.’ McLucas, a partner at the law firm Wilmer Cutler Pickering Hale & Dorr in Washington, added: ‘It could be that you have a bunch of books and records out there that no one knows about.’”

This bears repeating: for every company that the federal government has exempted from following the same laws that every other publicly-traded company has to adhere to, there is another potential Enron waiting to happen. Except this time, we might never know about it, we might never see justice served to those who are robbing their shareholders. Because this time, those companies, whoever they might be, don’t have to follow the rules. Don’t want another Enron to happen? Simple, just allow companies to quit following the rules altogether. Problem solved.

In other news, Bush replaced his Secretary of the Treasury, John Snow with Henry Paulsen. Some saw the appointment of the well-respected Paulsen as a sign of desperation by the Bush administration. They were so desperate to avoid finanical calamity that they were forced to nominate someone competent, “scraping the top of the barrel” as Paul Krugman put it. Interestingly, the desperation was widely reported, as in this Reuters article:

Not even Paulson can save the dollar

Tue May 30, 2006
By Kevin Plumberg

NEW YORK (Reuters) - The nomination of Henry Paulson as U.S. Treasury secretary is seen as a boon for financial markets, but the Wall Street free-marketeer is unlikely to stand in the way of the falling dollar.

The depth of the U.S. current account deficit is such that financial markets increasingly believe this fundamental root of widening global imbalances will adjust only if the dollar weakens.

Having the market-savvy chief executive of Goldman Sachs at the helm of the world's largest economy instead of John Snow, often seen as more of a cheerleader for the White House's economic policies than a policy-maker himself, could lend confidence to Wall Street's perception of the Bush administration. But it won't be enough to prop up the dollar.

"Financial markets do typically like it when a Wall Streeter takes a key role in the administration," said David Mozina, head of foreign exchange strategy with Lehman Brothers in New York.

"It could be modest positive for the dollar, but still, with what has been thrown at the dollar, it's not going to be allowed to have a respite for too long," he said.

The dollar has tumbled 2.6 percent since late April after central bankers and finance ministers from the Group of Seven rich nations agreed more must be done to alleviate imbalances, including further strengthening of the Chinese yuan.

The G7 meeting, coinciding with what many observers believe to be the near end of the Federal Reserve's campaign of rising interest rates, was pivotal because it sparked the resumption of the dollar's multiyear decline after a halt in 2005.

Despite the impression that Paulson may be a steward for a stronger dollar, he is on record saying the dollar has to decline to restore balance to the U.S. current account deficit. Last year, the deficit grew to more than 6 percent of gross domestic product.

In a U.S. public television interview two years ago, Paulson said, "I'm concerned about the current account deficit, but I would say by order of magnitude, I'm more concerned about the budget deficit than the current account deficit because I really believe that the decline in the dollar -- the orderly decline in the dollar -- will lead to a natural adjustment."

Paulson, who told the Wall Street Journal in April that he has visited China 70 times since 1990, is expected to keep up pressure on the world's fastest-growing economy to allow the yuan to strengthen more, which traders equate with a weaker dollar.

"Paulson will drive home the fact that the dollar needs to be weaker against the Asian currencies specifically," said a senior dealer with an asset management firm…

Paulson’s appointment comes at a touchy time, one where world markets seem to be pausing before big changes. The pause seems to have resulted from efforts to pump money into markets to postpone the downturn, including a startling, record-high 1.5 trillion yen pumped into money markets by the Bank of Japan and the sell-off (by central banks?) of gold.

Signs of a slowdown include a low U.S. job-creation number of 75,000 for May, low consumer sentiment numbers, and more indications of the end of the housing boom:

Pulte Homes Slashes 2006 Forecast as Orders Fall 29%

June 2 (Bloomberg) -- Pulte Homes Inc., the largest U.S. homebuilder, cut its 2006 earnings forecast after orders in April and May fell 29 percent from a year earlier.

The company expects to earn $4.70 to $5 a share for the year, down from its previous forecast of $6 to $6.25 a share. Earnings in the second quarter will be 85 cents to 95 cents a share, the Bloomfield Hills, Michigan-based company said today in a statement.

Demand for U.S. housing is flagging at the height of what is usually the busiest time of year for real estate sales. Home-loan applications fell last week to the lowest level in four years, the Mortgage Bankers Association said yesterday. The average rate for a 30-year fixed mortgage was 6.6 percent last week, a four-year high, according to mortgage buyer Freddie Mac.

“Current demand varies by market, but overall it continues to transition after an extended period of stronger sales,” Richard J. Dugas Jr., president and chief executive officer of Pulte, said in the statement. Orders are falling because of an increase in homes on the market, more cancellations and rising interest rates, he said