Monday, February 11, 2008

Signs of the Economic Apocalypse, 2-11-08


Gold closed at 922.30 dollars an ounce Friday, up 1.0% from $913.50 for the week. The dollar closed at 0.6893 euros Friday, up 2.0% from 0.6756 at the close of the previous Friday. That put the euro at 1.4507 dollars compared to 1.4802 the Friday before. Gold in euros would be 635.76 euros an ounce, up 3.0% from 617.15 at the close of the previous Friday. Oil closed at 91.77 dollars a barrel Friday, up 3.2% from $88.96 for the week. Oil in euros would be 63.26 euros a barrel, up 5.3% from 60.10 at the close of the Friday before. The gold/oil ratio closed at 10.06, down 2.1% from 10.27 for the week. In U.S. stocks, the Dow Jones Industrial Average closed at 12,182.13 Friday, down 4.6% from 12,743.19 at the close of the previous week. The NASDAQ closed at 2,304.85 Friday, down 4.7% from 2,413.36 at the end of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.65% Friday, up six basis points from 3.59 for the week.

Stocks fell sharply last week, not just on recession concerns but on something more threatening: worries of corporate defaults. Worries, in other words, that corporate bonds will be worth much less than thought, which would add another layer to the existing credit problems stemming from the subprime mess.

U.S. Stocks Drop on Credit Concern; Banks, Weyerhaeuser Fall

Elizabeth Stanton

Feb. 8 (Bloomberg) -- U.S. stocks retreated, sending the market to its first weekly decline since mid-January, as concern that corporate defaults will increase outweighed gains in technology companies and commodities producers.

Bank of America Corp. and JPMorgan Chase & Co. led banks and brokerages to their steepest weekly drop in six years as indexes of corporate credit risk climbed to records.
Weyerhaeuser Co., the largest U.S. lumber producer, fell to a 16-month low in New York after posting a loss. Declines were limited as Inc., Microsoft Corp. and Apple Inc. rose and higher oil and metals prices boosted energy and mining companies.

The Standard & Poor's 500 Index lost 5.62 points, or 0.4 percent, to 1,331.29. The Dow Jones Industrial Average fell 64.87, or 0.5 percent, to 12,182.13. The Nasdaq Composite Index increased 11.82, or 0.5 percent, to 2,304.85. Almost two stocks dropped for every one that rose on the New York Stock Exchange.

“There's going to be more writedowns, more problems,” said Quincy Krosby, who helps manage $330 billion as chief investment strategist at the Hartford in Hartford, Connecticut, during an interview with Bloomberg Television. “It's hard to navigate a market like this.”

The S&P 500 snapped two straight weeks of gains after a report on Feb. 5 showed service industries contracted at the fastest pace since 2001. The index has lost 15 percent since its Oct. 9 record, while the Dow has fallen 14 percent from its all- time high the same day. The Nasdaq has slumped 19 percent since an almost-seven year peak on Oct. 31.

Credit Concern

JPMorgan lost $1.29, or 2.9 percent, to $43.82. Bank of America retreated $1.21, or 2.8 percent, to $42.16. An index of banks and brokerages in the S&P 500 fell 8.6 percent this week, its biggest weekly loss since September 2001.

The costs of insuring various forms of corporate debt against default using derivatives rose to records. Contracts on the benchmark Markit CDX North America Investment Grade Index jumped 5 basis points to 129.59, the highest since the index started in 2004, according to CMA Datavision in New York.

The Markit LCDX Series 9 index of leveraged buyout loan derivatives traded at 91.8, according to broker Phoenix Partners Group, matching the lowest since the latest series began trading in October. Banks sitting on $160 billion of unsold leveraged loans may have to write down more losses after a plunge in the value of the debt, according to Bank of America Corp. analysts.

‘Crunch Is Intensifying’

“It tells you the credit crunch is intensifying,” said Peter Boockvar, equity strategist at Miller Tabak & Co. in New York. “A lot of this paper is sitting on bank balance sheets. There’s further potential for more writedowns, and that constricts the supply of credit in other areas.”

The world’s largest banks and brokerage firms have written down the value of debt and related products on their books by $146 billion since the beginning of 2007, according to data compiled by Bloomberg. The charges stem from the collapse of the U.S. subprime mortgage market.

A U.S. recession is now an even bet as job losses and the housing contraction jeopardize the longest-ever expansion in consumer spending, according to a Bloomberg News survey. The world’s largest economy will expand at a 0.5 percent annual rate during the first quarter, capping the weakest six months since the last economic slump in 2001, according to the median estimate of 62 economists polled from Jan. 30 to Feb. 7.

Weyerhaeuser, a supplier to homebuilders, fell $2.37, or 3.7 percent, to $62.34 after reporting a fourth-quarter loss of $63 million amid the worst housing slump in a quarter century...

The economist Nouriel Roubini, who has been predicting the current crisis for a long time, posted a helpful summary of the dangers we face:

The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster

Nouriel Roubini

Feb 05, 2008

Why did the Fed ease the Fed Funds rate by a whopping 125bps in eight days this past January? It is true that most macro indicators are heading south and suggesting a deep and severe recession that has already started. But the flow of bad macro news in mid-January did not justify, by itself, such a radical inter-meeting emergency Fed action followed by another cut at the formal FOMC meeting.

To understand the Fed actions one has to realize that there is now a rising probability of a “catastrophic” financial and economic outcome, i.e. a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe. The Fed is seriously worried about this vicious circle and about the risks of a systemic financial meltdown.

That is the reason the Fed had thrown all caution to the wind – after a year in which it was behind the curve and underplaying the economic and financial risks – and has taken a very aggressive approach to risk management; this is a much more aggressive approach than the Greenspan one in spite of the initial views that the Bernanke Fed would be more cautious than Greenspan in reacting to economic and financial vulnerabilities.

To understand the risks that the financial system is facing today I present the “nightmare” or “catastrophic” scenario that the Fed and financial officials around the world are now worried about. Such a scenario – however extreme – has a rising and significant probability of occurring. Thus, it does not describe a very low probability event but rather an outcome that is quite possible.

Start first with the recession that is now enveloping the US economy. Let us assume – as likely - that this recession – that already started in December 2007 - will be worse than the mild ones – that lasted 8 months – that occurred in 1990-91 and 2001. The recession of 2008 will be more severe for several reasons: first, we have the biggest housing bust in US history with home prices likely to eventually fall 20 to 30%; second, because of a credit bubble that went beyond mortgages and because of reckless financial innovation and securitization the ongoing credit bust will lead to a severe credit crunch; third, US households – whose consumption is over 70% of GDP - have spent well beyond their means for years now piling up a massive amount of debt, both mortgage and otherwise; now that home prices are falling and a severe credit crunch is emerging the retrenchment of private consumption will be serious and protracted. So let us suppose that the recession of 2008 will last at least four quarters and, possibly, up to six quarters. What will be the consequences of it?

Here are the twelve steps or stages of a scenario of systemic financial meltdown associated with this severe economic recession…

First, this is the worst housing recession in US history and there is no sign it will bottom out any time soon. At this point it is clear that US home prices will fall between 20% and 30% from their bubbly peak; that would wipe out between $4 trillion and $6 trillion of household wealth. While the subprime meltdown is likely to cause about 2.2 million foreclosures, a 30% fall in home values would imply that over 10 million households would have negative equity in their homes and would have a big incentive to use “jingle mail” (i.e. default, put the home keys in an envelope and send it to their mortgage bank). Moreover, soon enough a few very large home builders will go bankrupt and join the dozens of other small ones that have already gone bankrupt thus leading to another free fall in home builders’ stock prices that have irrationally rallied in the last few weeks in spite of a worsening housing recession.

Second, losses for the financial system from the subprime disaster are now estimated to be as high as $250 to $300 billion. But the financial losses will not be only in subprime mortgages and the related RMBS and CDOs. They are now spreading to near prime and prime mortgages as the same reckless lending practices in subprime (no down-payment, no verification of income, jobs and assets (i.e. NINJA or LIAR loans), interest rate only, negative amortization, teaser rates, etc.) were occurring across the entire spectrum of mortgages; about 60% of all mortgage origination since 2005 through 2007 had these reckless and toxic features. So this is a generalized mortgage crisis and meltdown, not just a subprime one. And losses among all sorts of mortgages will sharply increase as home prices fall sharply and the economy spins into a serious recession. Goldman Sachs now estimates total mortgage credit losses of about $400 billion; but the eventual figures could be much larger if home prices fall more than 20%. Also, the RMBS and CDO markets for securitization of mortgages – already dead for subprime and frozen for other mortgages - remain in a severe credit crunch, thus reducing further the ability of banks to originate mortgages. The mortgage credit crunch will become even more severe.

Also add to the woes and losses of the financial institutions the meltdown of hundreds of billions of off balance SIVs and conduits; this meltdown and the roll-off of the ABCP market has forced banks to bring back on balance sheet these toxic off balance sheet vehicles adding to the capital and liquidity crunch of the financial institutions and adding to their on balance sheet losses. And because of securitization the securitized toxic waste has been spread from banks to capital markets and their investors in the US and abroad, thus increasing – rather than reducing systemic risk – and making the credit crunch global.

Third, the recession will lead – as it is already doing – to a sharp increase in defaults on other forms of unsecured consumer debt: credit cards, auto loans, student loans. There are dozens of millions of subprime credit cards and subprime auto loans in the US. And again defaults in these consumer debt categories will not be limited to subprime borrowers. So add these losses to the financial losses of banks and of other financial institutions (as also these debts were securitized in ABS products), thus leading to a more severe credit crunch. As the Fed loan officers survey suggest the credit crunch is spreading throughout the mortgage market and from mortgages to consumer credit, and from large banks to smaller banks.

Fourth, while there is serious uncertainty about the losses that monolines will undertake on their insurance of RMBS, CDO and other toxic ABS products, it is now clear that such losses are much higher than the $10-15 billion rescue package that regulators are trying to patch up. Some monolines are actually borderline insolvent and none of them deserves at this point a AAA rating regardless of how much realistic recapitalization is provided. Any business that required an AAA rating to stay in business is a business that does not deserve such a rating in the first place. The monolines should be downgraded as no private rescue package – short of an unlikely public bailout – is realistic or feasible given the deep losses of the monolines on their insurance of toxic ABS products.

Next, the downgrade of the monolines will lead to another $150 of writedowns on ABS portfolios for financial institutions that have already massive losses. It will also lead to additional losses on their portfolio of muni bonds. The downgrade of the monolines will also lead to large losses – and potential runs – on the money market funds that invested in some of these toxic products. The money market funds that are backed by banks or that bought liquidity protection from banks against the risk of a fall in the NAV may avoid a run but such a rescue will exacerbate the capital and liquidity problems of their underwriters. The monolines’ downgrade will then also lead to another sharp drop in US equity markets that are already shaken by the risk of a severe recession and large losses in the financial system.

Fifth, the commercial real estate loan market will soon enter into a meltdown similar to the subprime one. Lending practices in commercial real estate were as reckless as those in residential real estate. The housing crisis will lead – with a short lag – to a bust in non-residential construction as no one will want to build offices, stores, shopping malls/centers in ghost towns. The CMBX index is already pricing a massive increase in credit spreads for non-residential mortgages/loans. And new origination of commercial real estate mortgages is already semi-frozen today; the commercial real estate mortgage market is already seizing up today.

Sixth, it is possible that some large regional or even national bank that is very exposed to mortgages, residential and commercial, will go bankrupt. Thus some big banks may join the 200 plus subprime lenders that have gone bankrupt. This, like in the case of Northern Rock, will lead to depositors’ panic and concerns about deposit insurance. The Fed will have to reaffirm the implicit doctrine that some banks are too big to be allowed to fail. But these bank bankruptcies will lead to severe fiscal losses of bank bailout and effective nationalization of the affected institutions. Already Countrywide – an institution that was more likely insolvent than illiquid – has been bailed out with public money via a $55 billion loan from the FHLB system, a semi-public system of funding of mortgage lenders. Banks’ bankruptcies will add to an already severe credit crunch.

Seventh, the banks losses on their portfolio of leveraged loans are already large and growing. The ability of financial institutions to syndicate and securitize their leveraged loans – a good chunk of which were issued to finance very risky and reckless LBOs – is now at serious risk. And hundreds of billions of dollars of leveraged loans are now stuck on the balance sheet of financial institutions at values well below par (currently about 90 cents on the dollar but soon much lower). Add to this that many reckless LBOs (as senseless LBOs with debt to earnings ratio of seven or eight had become the norm during the go-go days of the credit bubble) have now been postponed, restructured or cancelled. And add to this problem the fact that some actual large LBOs will end up into bankruptcy as some of these corporations taken private are effectively bankrupt in a recession and given the repricing of risk; convenant-lite and PIK toggles may only postpone – not avoid – such bankruptcies and make them uglier when they do eventually occur. The leveraged loans mess is already leading to a freezing up of the CLO market and to growing losses for financial institutions.

Eighth, once a severe recession is underway a massive wave of corporate defaults will take place. In a typical year US corporate default rates are about 3.8% (average for 1971-2007); in 2006 and 2007 this figure was a puny 0.6%. And in a typical US recession such default rates surge above 10%. Also during such distressed periods the RGD – or recovery given default – rates are much lower, thus adding to the total losses from a default. Default rates were very low in the last two years because of a slosh of liquidity, easy credit conditions and very low spreads (with junk bond yields being only 260bps above Treasuries until mid June 2007). But now the repricing of risk has been massive: junk bond spreads close to 700bps, iTraxx and CDX indices pricing massive corporate default rates and the junk bond yield issuance market is now semi-frozen. While on average the US and European corporations are in better shape – in terms of profitability and debt burden – than in 2001 there is a large fat tail of corporations with very low profitability and that have piled up a mass of junk bond debt that will soon come to refinancing at much higher spreads. Corporate default rates will surge during the 2008 recession and peak well above 10% based on recent studies. And once defaults are higher and credit spreads higher massive losses will occur among the credit default swaps (CDS) that provided protection against corporate defaults. Estimates of the losses on a notional value of $50 trillion CDS against a bond base of $5 trillion are varied (from $20 billion to $250 billion with a number closer to the latter figure more likely). Losses on CDS do not represent only a transfer of wealth from those who sold protection to those who bought it. If losses are large some of the counterparties who sold protection – possibly large institutions such as monolines, some hedge funds or a large broker dealer – may go bankrupt leading to even greater systemic risk as those who bought protection may face counterparties who cannot pay.

Ninth, the “shadow banking system” (as defined by the PIMCO folks) or more precisely the “shadow financial system” (as it is composed by non-bank financial institutions) will soon get into serious trouble. This shadow financial system is composed of financial institutions that – like banks – borrow short and in liquid forms and lend or invest long in more illiquid assets. This system includes: SIVs, conduits, money market funds, monolines, investment banks, hedge funds and other non-bank financial institutions. All these institutions are subject to market risk, credit risk (given their risky investments) and especially liquidity/rollover risk as their short term liquid liabilities can be rolled off easily while their assets are more long term and illiquid. Unlike banks these non-bank financial institutions don’t have direct or indirect access to the central bank’s lender of last resort support as they are not depository institutions. Thus, in the case of financial distress and/or illiquidity they may go bankrupt because of both insolvency and/or lack of liquidity and inability to roll over or refinance their short term liabilities. Deepening problems in the economy and in the financial markets and poor risk managements will lead some of these institutions to go belly up: a few large hedge funds, a few money market funds, the entire SIV system and, possibly, one or two large and systemically important broker dealers. Dealing with the distress of this shadow financial system will be very problematic as this system – stressed by credit and liquidity problems - cannot be directly rescued by the central banks in the way that banks can.

Tenth, stock markets in the US and abroad will start pricing a severe US recession – rather than a mild recession – and a sharp global economic slowdown. The fall in stock markets – after the late January 2008 rally fizzles out – will resume as investors will soon realize that the economic downturn is more severe, that the monolines will not be rescued, that financial losses will mount, and that earnings will sharply drop in a recession not just among financial firms but also non financial ones. A few long equity hedge funds will go belly up in 2008 after the massive losses of many hedge funds in August, November and, again, January 2008. Large margin calls will be triggered for long equity investors and another round of massive equity shorting will take place. Long covering and margin calls will lead to a cascading fall in equity markets in the US and a transmission to global equity markets. US and global equity markets will enter into a persistent bear market as in a typical US recession the S&P500 falls by about 28%.

Eleventh, the worsening credit crunch that is affecting most credit markets and credit derivative markets will lead to a dry-up of liquidity in a variety of financial markets, including otherwise very liquid derivatives markets. Another round of credit crunch in interbank markets will ensue triggered by counterparty risk, lack of trust, liquidity premia and credit risk. A variety of interbank rates – TED spreads, BOR-OIS spreads, BOT – Tbill spreads, interbank-policy rate spreads, swap spreads, VIX and other gauges of investors’ risk aversion – will massively widen again. Even the easing of the liquidity crunch after massive central banks’ actions in December and January will reverse as credit concerns keep interbank spread wide in spite of further injections of liquidity by central banks.

Twelfth, a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices will ensue leading to a cascading and mounting cycle of losses and further credit contraction. In illiquid market actual market prices are now even lower than the lower fundamental value that they now have given the credit problems in the economy. Market prices include a large illiquidity discount on top of the discount due to the credit and fundamental problems of the underlying assets that are backing the distressed financial assets. Capital losses will lead to margin calls and further reduction of risk taking by a variety of financial institutions that are now forced to mark to market their positions. Such a forced fire sale of assets in illiquid markets will lead to further losses that will further contract credit and trigger further margin calls and disintermediation of credit. The triggering event for the next round of this cascade is the downgrade of the monolines and the ensuing sharp drop in equity markets; both will trigger margin calls and further credit disintermediation.

Based on estimates by Goldman Sachs $200 billion of losses in the financial system lead to a contraction of credit of $2 trillion given that institutions hold about $10 of assets per dollar of capital. The recapitalization of banks sovereign wealth funds – about $80 billion so far – will be unable to stop this credit disintermediation – (the move from off balance sheet to on balance sheet and moves of assets and liabilities from the shadow banking system to the formal banking system) and the ensuing contraction in credit as the mounting losses will dominate by a large margin any bank recapitalization from SWFs. A contagious and cascading spiral of credit disintermediation, credit contraction, sharp fall in asset prices and sharp widening in credit spreads will then be transmitted to most parts of the financial system. This massive credit crunch will make the economic contraction more severe and lead to further financial losses. Total losses in the financial system will add up to more than $1 trillion and the economic recession will become deeper, more protracted and severe.

A near global economic recession will ensue as the financial and credit losses and the credit crunch spread around the world. Panic, fire sales, cascading fall in asset prices will exacerbate the financial and real economic distress as a number of large and systemically important financial institutions go bankrupt.
A 1987 style stock market crash could occur leading to further panic and severe financial and economic distress. Monetary and fiscal easing will not be able to prevent a systemic financial meltdown as credit and insolvency problems trump illiquidity problems. The lack of trust in counterparties – driven by the opacity and lack of transparency in financial markets, and uncertainty about the size of the losses and who is holding the toxic waste securities – will add to the impotence of monetary policy and lead to massive hoarding of liquidity that will exacerbates the liquidity and credit crunch.

In this meltdown scenario US and global financial markets will experience their most severe crisis in the last quarter of a century.

Can the Fed and other financial officials avoid this nightmare scenario that keeps them awake at night? The answer to this question – to be detailed in a follow-up article – is twofold: first, it is not easy to manage and control such a contagious financial crisis that is more severe and dangerous than any faced by the US in a quarter of a century; second, the extent and severity of this financial crisis will depend on whether the policy response – monetary, fiscal, regulatory, financial and otherwise – is coherent, timely and credible. I will argue – in my next article - that one should be pessimistic about the ability of policy and financial authorities to manage and contain a crisis of this magnitude; thus, one should be prepared for the worst, i.e. a systemic financial crisis.

It’s a sure sign of a crisis when we learn about institutions that few even knew existed. A case in point is the bond insurers that we have been hearing about quite a bit in recent weeks.

Bonds Unbound

James Surowiecki

February 11, 2008

If the ongoing turmoil in the world’s financial markets has made anything clear, it’s that the list of things that can go wrong in those markets is a very long one. Month after month, it seems, another potentially disastrous problem rises to the surface. The latest looming crisis is the possible implosion of a group of companies called monoline insurers. If you haven’t heard of monoline insurers, don’t worry: until recently, few people, even on Wall Street, were all that interested in them. Yet their problems have become a serious threat to global markets. Rumors that monoline insurers, like M.B.I.A. and Ambac, were in serious trouble helped spark the vast market sell-off that prompted the Federal Reserve’s interest-rate cut two weeks ago, and, only a few days later, rumors of a government-orchestrated bailout of these companies set off a six-hundred-point rally in the Dow.

Monoline insurers do a straightforward job: they insure securities—guaranteeing, for instance, that if a bond defaults they’ll cover the interest and the principal. Historically, this was a fairly sleepy business; these companies got their start by insuring municipal bonds, which rarely default, and initially they confined themselves to bonds with relatively predictable risks, which were easy to put a price on. Unfortunately, a sleepy, straightforward business wasn’t good enough for the insurers. Like everyone else in recent years, they wanted to cash in on the housing and lending boom. In order to expand, they started insuring the complex securities that Wall Street created by packaging mortgages, including subprime ones, for investors. This was a lucrative business—M.B.I.A.’s revenues rose nearly a hundred and forty per cent between 2001 and 2006—but it rested on a false assumption: that the insurers knew how risky these securities really were. They didn’t. Instead, they gravely underestimated how likely the loans were to go bad, which meant that they didn’t charge enough for the insurance they were offering, and didn’t put away enough to cover the claims. They’re now on the hook for tens of billions of dollars in potential losses, and some estimates suggest that they’ll need more than a hundred billion to restore themselves to health.

Obviously, this is bad news for the insurers—at one point, M.B.I.A.’s and Ambac’s stock prices were down more than ninety per cent from their all-time highs—but it’s also very dangerous for credit markets as a whole. This is because of a peculiar feature of bond insurance: insurers’ credit ratings get automatically applied to any bond they insure. M.B.I.A. and Ambac have enjoyed the highest rating possible, AAA. As a result, any bond they insured, no matter how junky, became an AAA security, which meant access to more investors and a generally lower interest rate. The problem is that this process works in reverse, too. If the insurers lose their AAA ratings—credit agencies have made clear that both companies are at risk of this, and one agency has already downgraded Ambac to AA—then the bonds they’ve insured will lose their ratings as well, which will leave investors holding billions upon billions in assets worth a lot less than they thought. That’s why so many people on Wall Street are pushing for a bailout for the insurers. It may be an abandonment of free-market principles, but no one has ever accused the Street of putting principle above profit.

Normally when companies make bad decisions and fail to deliver value, it’s just their workers and investors who suffer. But monoline insurers’ desire to grab as much new business as they could, risks be damned, quickly radiated across global markets and will have huge consequences for millions of people who have never heard of M.B.I.A. or Ambac. The situation illustrates a fundamental paradox of today’s financial system: it’s bigger than ever, but terrible decisions by just a few companies—not even very big companies, at that—can make the entire edifice totter…

The food crisis has also been accelerating recently. Food prices have been rising rapidly and reserve stocks have been falling. A perfect storm of climate disruption, energy cost increases, and demand for biofuels adds yet another threat to the economic and physical well being of people.

Wheat continues to surge above $10 a bushel

Sue Kirchhoff,

USA Today

U.S. wheat prices continued to soar Wednesday as export demand remained robust despite record high prices, with values in the United States rising by the maximum allowed in a trading day and helping to rally corn and soybeans.

Overall, wheat prices have doubled since last June at the Chicago Mercantile Exchange, which owns the Chicago Board of Trade. Prices have been pushed higher by surging world demand and bad weather in some major producing nations.

"For the near-term price, it's still heading higher," says Joe Victor, vice president of marketing at Allendale, a commodity research firm. He says prices will stay elevated until the markets get a better handle on potential production in coming months. "If we have good weather, plenty of plantings, then there's likely a price correction," Victor says. "If it's bad weather … (prices will) continue their upward trends."

There were fresh signs that record high prices for wheat had yet to dent demand from importing nations.

Egypt, one of the world's largest importers of wheat, bought 150,000 tons of the grain, including 25,000 tons from the United States, the world's top exporter of wheat.

"That is such an important factor in the wheat market," says grains analyst Bill Nelson of A.G. Edwards, referring to the purchase by Egypt.

"Egypt is being seen as a proxy for world grain buyers who are, in general, willing to buy grain even at record prices. This is evidence that day after day of record prices are not limiting demand," he says.

The May futures contract for Chicago soft red winter wheat, used in cakes and crackers, jumped by the daily limit of 30 cents to an all-time high of $10.50 a bushel. The nearby March contract rose its 30-cent daily limit to a high of $10.33. Wheat prices briefly jumped to more than $10 a bushel in December.

Minneapolis Grain Exchange March spring wheat also rose by the daily limit to $14.93 a bushel, the highest price for any U.S. wheat futures contract. High-protein spring wheat, prized by millers and bakers for its quality, is forecast to have the smallest surplus in at least 30 years, and harvest doesn't start till August. The Minneapolis Exchange will raise the daily trading limit to 40 cents, beginning Feb 12.

Trading on Tuesday was influenced by a Canadian government report showing the wheat supply in that nation plummeting 30% from December 2006 to December 2007. The sharp drop was mainly caused by a more than 20% dip in wheat production last year.

The U.S. Department of Agriculture expects the U.S. wheat surplus this year to be the smallest in 60 years.
Despite higher prices, U.S. plantings of winter wheat rose only about 4% from last year. Farmers had been expected to increase plantings by far more.

Prices for corn, soybeans and other grains have also surged in recent months. That helped push U.S. food inflation up to 4.9% in 2007 from 2.1% in 2006. The impact has been far greater in less-affluent nations, where people spend more of their income on food.

Merrill Lynch analysts in a recent report said the rate of what they call "agflation" could slow if economic growth cools. But costs will remain elevated. "Longer term, however, we remain convinced that agflation will be an important issue for consumers and policymakers alike," the Merrill Lynch report said.

The following chart from Doug Nolan’s Credit Bubble Bulletin shows wheat prices over the past five years:

I Guess soon we won’t have to worry about the obesity crisis anymore.

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