Ben Oostdam story # 499

The World Financial System's Achilles' Heel

by Bill Bonner, Ouzilly, France

The dollar fell to $1.42 per euro yesterday.
 Many believe it is the Achilles' heel of the entire
  world financial system -
  and Warren Buffett is among them.

The story goes, Achilles was dipped in the river
 Styx and made invulnerable.
 But his mother held him by his heel, leaving that
  part untouched by the magic waters.
  Naturally, that is where a poison arrow got him.

The moral of this story is that you have to go
 all the way. If you want your baby to be
  invulnerable, put him all the way under
   the water...even the heels.
  Or, maybe there's another point:
   that there's always some place 
   where you're vulnerable.

For the purpose of today's tale, we'll take the
 second possibility.
 Try as you may, you can never escape all risks. 

All over the world, consumer prices are falling.
 The world has too much capacity...
 too many factories...and too many workers.
  Too many, that is, for current demand.
   The 'world's mouth' - the USA -
    has gone on a diet.
    And if the United States reduces its intake,
     that means the rest of the world -
     especially China - must reduce its output.
      Otherwise, the whole thing will become

Yesterday's news tells us that despite press
 reports of a recovery, the key indicators of
  real economic growth are still falling. 
 Almost one out of ten mortgages are now
  delinquent.  And the rate of foreclosures
   is increasing faster than any time
    in the last 30 years.
   Housing prices, meanwhile, fell 16% 
   in the 2nd quarter, from a year earlier,
    according to the National Association
     of Realtors. 

Unemployment claims went up last week.
 The sharp eyes of The Financial Times
  see the link:
  "Mounting joblessness fuels US housing
   crisis," says its headline.

In the real economy, people are cutting back...
with the inevitable results we discuss
 every day here in The Daily Reckoning.
 One major consequence of reduced demand
  is too much supply.
  The factories built in China to supply
   products to America
   during the bubble years now find 
   they have no market. 

Currently, overcapacity and oversupply are
 causing prices to fall.
 Falling prices mean rising currency values.
  Each unit of 'money' buys more stuff.
   But there are many competing currencies,
    and they don't all rise and fall together.
    Even in a world of deflation, some
     currencies will deflate more than others.

The dollar is, of course,
 the world's main money.
 In a sense, the whole world economy is
  under its heel.
  But it is a heel that has never been
   dipped in the river Styx.
   It is now a heel that waits for an arrow.

PIMCO is the biggest manager of bond funds
 in the world.
 It says the greenback is going to lose
  its status and lose its value.

"Investors should consider whether it
 makes sense to take advantage of
 any periods of US dollar strength to
  diversify their currency exposure,"
  says its Emerging Markets Watch report.
   "The massive amounts of US dollar
    liquidity produced in response
     to the crisis"
    doom the currency. 

Both China and Russia are calling for
 a new global currency to replace the dollar. 

"While we have not yet reached the point
 where a new global reserve
 currency will arise, we are clearly seeing
  a loss of status for the US dollar
  as a store of value even in the absence
   of a single viable alternative," 
  continues the PIMCO report. 

Meanwhile, our old friend Jim Rogers
 says he is moving all his assets
 out of dollars and buying Chinese yuan.
  And Warren Buffett warned this week 
 - writing in The New York Times -
  that "greenback emissions" 
  threaten the whole world econo-system.

But what does it mean? What are the threats 
to you? What are the opportunities?
 If you pay your bills and keep score
  in dollars,  what does it matter if
   the dollar loses value against the yuan?
   If prices are generally falling,
    the dollar is actually getting stronger,
    isn't it? So what if some other
     currencies are getting even stronger still? 

Colleague Bill Jenkins, at Master FX 
Options Trader puts in his two cents:

"We lived through a financial earthquake in 2008.
 The effects of it are still being felt.
  Aftershocks may still be ahead.
   But predicting when they'll strike
    is just as hard as
    predicting natural earthquakes. 
    We had a number of prognosticators
     for years telling us
     about what would happen last year;
      it's just that they didn't know when.
      And that is the hard part of
       the life of a prophet.

"And while it is equally difficult to
 tell when the next economic tremors
 will hit, we can look at the numbers
  and make some predictions
  as to their cataclysmic effect." 

Bill goes on to say that he thinks
 the US is headed for another shockwave...
which will include another round of
 dollar buying - even while the 'experts'
  are touting 'green shoots' and
   a return to normalization.

[While Bill Jenkins doesn't see rosier
 days in the cards,
 he does see more opportunity to play
  the global turmoil,
  using some choice foreign currencies. 

More...after the news:

"After a remarkable 51% rise,
 the S&P 500 has spent most of August
 wondering what to do next," 
 writes Ian Mathias in today's issue 
 of The 5 Min. Forecast. 
 "There have been some sell-offs and rebounds, 
  but essentially, stocks have taken
  the month off. See for yourself:


"Since forecastin' is our business,
 let's tackle the mother of all
 barstool queries:
  Where's the market heading?

"'Consider the sentiment toward overall market,'
 Dan Amoss suggests.
 'Aside from the investor sentiment polls,
  you can tell how bullish  investors are by
   the multiples they are willing to pay for stocks.
   And right now, after the sharpest 5-month 
   rally since the 1930s,
    the market is trading at valuations that
     require a strong economic recovery
    , and a return to credit bubble conditions.
     The rally was powered entirely by P/E 
     multiple expansion, not earnings growth.
      That sort of rally would be justifiable
       if corporate revenues and earnings
        were about to soar, but they're not.
        Most earnings surprises were due
         to cost cutting, rather than top-line
          growth, which is like burning
          your furniture to stay warm.

"'The market is not even that cheap when
 you consider how artificially
 inflated earnings were at the 2007 peak.
  Financial earnings made up
  18% of the S&P 500's earnings in 2007 -
   much more if you add the 'earnings' 
   from the finance divisions of
    industrial conglomerates like GE and GM.
     Any claims that the S&P 500 is cheap
      because 2007 somehow represents 
     'normalized earnings power' are bogus.
      The corporate profit margins and
       earnings won't return to
       that level for many years."

On Monday, August 24th, at noon,
 Dan Amoss will expose the biggest banking
  lie of the past 64 years...
  and you could stand to triple your money.
  See his latest report for all the details...
  and find out how you can get a month-long
   trial subscription to  Strategic Short
    Report research service for just $1.
And now, back to the dollar:

The trouble with the Achilles' heel
 is that it is connected
 to the Achilles' tendon...
 which is connected to the leg muscles...
 which is what keeps the whole
  thing moving forward.
  Cut the tendons and the feet go
   flippety, floppety and you get nowhere.

Yesterday came word that the US deficit
 for 2009 might come in lower than expected.
  Instead of borrowing $1.8 trillion as anticipated,
  the feds might only borrow $1.58 trillion.
   Well, that still leaves them about
    $680 billion short -  even if every dollar
     of trade deficit and every dollar of domestic
     savings is applied to it.
      But definitely a step in the right direction!
      This gap must be closed by quantitative
       easing, or, in other words,  by printing
        press money. So, holders of old dollars
         are bound to wonder how much their savings
          will be weakened  by the addition 
          of so many new ones. 

They're likely to wonder, too, how much those
 US Treasury notes will be worth
 after this monetary inflation catches up to them.
  At some point,
  they are likely to think twice about buying
   more of them...
  and possibly even want to sell the ones
   they have already.
   Either way, it could create a nasty
    financial whirlpool that sucks
    down the entire world economy.
     As private investors reject US dollar credits,
     the Fed would be forced to print
      up more money to buy them itself.
      As the Fed buys more, private investors
       become more fearful that 
      this monetary inflation will lead
       to consumer price inflation;
       they may panic and dump all 
       dollar-denominated assets. 

But if investors drop the dollar,
 what do they take up in its place? Oil...maybe.
 Oil is selling for $72 a barrel,
  even while the world is in a major downturn.
  What makes it so expensive, if not the fear
   that the currency in which it is
   quoted is more slippery than the
    black goo itself? 

And gold? Yesterday, gold lost $3. 
But is still trading in the mid- $900s -
 not far from its all-time high. 
 And this at a time when consumer price inflation
  is going down! In the US non-oil export prices
   are falling at a 5% rate.
   If people are buying gold as a hedge
    against inflation, 
   they must know something we don't.
    Consumer prices are falling...
   actual CPI rates are negative 
   in many countries already. 
   Take out the effect of speculation
    on oil and commodities,
    and deflation is probably a fact of life
     almost everywhere. 
    Gold buyers are not hedging against
     an increase in the price of bread,
     in other words; they're hedging against
      a poison arrow directed 
     at the dollar itself.

[Though gold may not make you rich
 tomorrow, as a long-term investment,
 there's nothing better.
  Strike while the iron is hot...
 or, while gold is relatively cheap.
  It's sure to get much higher than it is now...
  perhaps as high as $2000 an ounce. 
  Learn how you can avoid the rush
   and pad your portfolio
   with the yellow metal now. ]

No Recovery, Not Now...Not Ever
by Bill Bonner
Ouzilly, France

That we live in an age of miracles
 has become common knowledge.
 A man may sit on a beach near Sydney,
  with nothing but the bucket
  bottom of the universe over his head,
   and still carry on a casual
   conversation with an Eskimo
    near the North Pole.
    Using an Internet-based phone service,
     he may do so at negligible cost.
     If this were not miracle enough,
      he may now grow himself a new nose,
      if he needs one, on his own arm.

In this age of miracles, people seem ready
 to believe that anything is possible.
 Recklessly crossing the street at the
  end of the Late Bubble Epoque,
  the world economy got hit by 
  a cross-town bus.
   Now, the feds propose to reverse and 
   run over the poor fellow again.
    It will be as if they had reversed
     the film; the economy will
     be as good as new, they say. 

But we are suspicious.
 And we begin today's rumination
  by examining the bus driver's motives.

In its naked form, government is not evil;
 it is merely a self- interested parasite,
  like a bank lobbyist.
  Its main value comes from its ability
   to elbow out other parasites.
   Of course, the typical citizen
    is no saint either.
    Instead, he is merely a parasite 
    in the larval stage.
     If he is lucky enough or cunning enough,
      he could grow into a parasite himself. 
      The citizen, generally, doesn't mind
       being lied to and robbed -
       just so long it is by someone 
       he elected.
        Or at least by someone
         whom tradition or 
        local connivance put in place. 
        He does not usually resent his 
        homegrown government,
         even though it routinely 
         costs him a substantial part
          of his output.
          On the contrary, he grows so 
          fond of it he even dons his helmet
           from time to time to protect it.
            Naturally, the feds return the favor.

The basic business model of government 
is to keep order,
 protect campaign contributors and
  lure supporters with the 
 promise of other peoples' money. 
 The game plan of the typical citizen is
  even simpler: to be on the receiving end,
   not the paying end.
   Over time, more and more of them 
   get into position.
    And the whole society becomes
     more costly, and more corrupt. 

In the United States, entire industries
 now operate as wards of the state.
 They may have too little capital. 
 Or, their operations may be too costly.
  Or, their products may be simply
   out-of-date and unattractive.
   Still, government keeps them going - 
   even at the cost of at the expense
    of competitors.
    And the money doesn't only go to business.
     Cities stay solvent only by the grace
      of federal government grants.
      Whole sections of the population 
      depend on government -
       including 34 million who draw
        their rations directly
        from the federal food stamp program.
         The spectacle is breathtaking and 
         alarming at the same time -
          like a Pakistani bus on a mountain road,
           freighted with passengers 
          clinging to the roof.
           The old rust bucket could tip
            over at any time,
           but what politician would
            tell a voter to get off?

That preface on the state out of the way,
 we turn to the state of the economy.
 The key to understanding the great
  credit bubble of 1945-2007 is
  to capture the codependent relationship
   between China and the 
  United States of America. 
  It seemed to serve both parties well.
   Each enabled each other's excess.
    China added mightily to the world's supply - 
    far more than was actually needed.
     America, meanwhile, did heroic work
      on the demand side.
      While the growth in the United States
       was led by consumer spending,
       the growth in China was led by
        capital investment;
        factories expanded, towns were built,
         and output was revved up.
         But there was a flaw. 
         Americans ran out of money.
          After the '70s, they could only
           increase their buying by going into debt.
           This they did with insouciance
           bordering on insanity.
            Total debt rose 370% of GDP
             and then blew up in 2007,
             with major lenders forced into
              bankruptcy and mergers,
              while GDP sank at its fastest
               pace since the end of WWII. 
"Borrowing to consume is merely tricking
 stuff from the future 
to enjoy in the present... 
It would be better to invite
 the future in...
let her collect her debts...
and then get on with things.
 Yet government officials on
  both sides of the Pacific
  continue their numbskull efforts 
  to revive the bubble economy." 

Now, the old formula no longer works -
 neither for Americans nor for the Chinese.
 Despite the urging of their government, 
 Americans cannot be expected to take on
  more debt in order to consume
   more stuff from China.
   As savings rates grow toward 10%,
    demand from the United States will collapse
    by an estimated $1 trillion per year.
     With the China trade now accounting
      for 83% of America's non-oil trade deficit,
      you'd think the Chinese would panic. 
      They already have as much as two
       times the    output capacity needed
        to meet real demand. 
      They should trim their manufacturing
       sector, not expand it. 

We draw out that relationship
 only to show how hopeless
 it would be to draw it out further.
  Borrowing to consume is merely 
 tricking stuff from the future to
  enjoy in the present.
  By 2007, some $30 trillion worth of spending
   that would have occurred
   'in the future' had already
    occurred in the past.
    Factories that would have produced 
    consumer items for 2009 discovered 
    that they had already produced more
     than enough of them in 2005 and 2006. 

It would be better to invite the future in
...let her collect her debts...
and then get on with things. 
Yet government officials on both sides 
of the Pacific continue their numbskull
 efforts to revive the bubble economy.
  On the US side, the feds are trying 
  to stimulate demand for more stuff.
   On the far side, Chinese stimulation
    is going into producing more stuff.
    As if the world didn't have too
     much stuff already.

But the role of government is neither 
prosperity nor plausibility...
but protection of the pests and parasites.
 They will keep paying them off and carrying 
 them along... until the bus runs off the road. 

But it's not prosperity that government really cares about.
 The big bus keeps trundling along -
  picking up pests and parasites along the way.
  It will keep going until it runs off the road.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

Editor's Note: Bill Bonner is the founder
 and editor of The Daily Reckoning.
 He is also the author, with Addison Wiggin,
  of the national best sellers 
 Financial Reckoning Day: 
 Surviving the Soft Depression
  of the 21st Century 
 and Empire of Debt: 
 The Rise of an Epic Financial Crisis.
  He is also the author of,
   along with Lila Rajiva, 
  Mobs, Messiahs and Markets: 
  Surviving the Public Spectacle 
  in Finance and Politics.

Bill's latest book, an update of 
Financial Reckoning Day,
 co-authored with Addison Wiggin:
Financial Reckoning Day Fallout:
 Surviving Todays Global Depression
BLO copied it 20090821b - stories