First the Bailout - Now the Hedge

With a bailout deal now all but done, get ready for the next collapse in the financial house of cards that is the US economy. On Tuesday, investors in hedge funds can take advantage of the first in a series of "cracks". Cracks provide investors with the opportunity to pull their capital out of hedge funds. There are four such cracks. The first is this Tuesday, followed by opportunities in December, March and June.

I predict a run of selling that will see the collapse of many highly marginalized hedge funds. This will be followed by an increase in the stock market as wealth seeks a safe haven in offshore stocks (Asian and European Markets will have a good week this week.) There will also be sharp increases in commodities like oil and gold.

By the end of next week we will be seeing increases in the price of gas at the pumps. Because oil and food increases are no longer are factored in the Consumer Price Index, the CPI will remain unchanged, but in real terms families will begin feeling the pinch.

The injection of $700b into the system waters down the currency, so investors will transfer their dollars to gold. I expect gold prices to hit new highs by the end of next week. The Fed will have no choice but to increase lending rates as the value of the dollar falls inverse to the rise of gold. Companies will revise their profit projections and behind the scenes, the first in a long series of layoffs will be announce.

That's what I think will happen in the coming week.

This Video should be seen.

Peter Schiff wrote about this stuff a while ago. His predictions have been right on the money. Nothing I write comes from any knowledge I might pretend to have. Call it a "gut feeling" or a revelation.

Who Do You Trust II ?

I'm more convinced that the market needs to sort out this mess on its own. The War on Terror enabled civil rights to be thrown out the window. Today, Americans can be eavesdropped on, arrested, and held without due cause. There exists a state of martial law in the US.

Now the executive branch of the government is holding Congress hostage over the Bailout Bill. This bill would eliminate any congressional oversight and not be subject to challenge in the courts. The President appoints the Treasury Secretary - whom serves at his pleasure.

I can't believe it, but it looks like Senators have resisted the pressure to just hold their nose and vote for the Bailout. If this Bill is not signed the Stock Market is going to experience the Great Mother of all Runs as investors move their assets offshore. The market will survive. It may be 10 or so years before it flushes the rot out of the system and recovers, but it will happen.

The real threat is - and has always been the 'shadow value' of the American Dollar. America needs to go back on the Gold Standard and throw Bretton Woods out the window. If I had money to invest I would buy gold and silver - and not certificates but stuff I could hold in my hands. Gold will go to $2,000 by Christmas - the dollar will be worth .50c; that's my prediction. I would also spread my liability around by buying commodities like oil (Canadian Oil Sands), copper, and food ( not dairy, because that has been artificially inflated in value by the Chicago Mercantile Exchange and will fall to its real value very soon ) . Buying Asian currency would also be a safer bet than buying T Bills at 0% interest.

I have a long-shot prediction that things will decline so rapidly that the 2008 elections will be suspended, even if it takes a war with Pakistan or Iran to cement the issue. I think George W. Bush will serve a third term. I know it sounds nuts, but there it is.

Who do you trust?

Wait for it.

Economies are governed by numbers; unlike doomsday theories about phantom planets entering our solar system or other 2012 predictions. A power shot of adrenaline to a damaged heart may keep it beating a season longer, but takes nothing away from the realization that an operation, transplant, or death is the only likely outcome.

A US election is just 6 weeks away. Congress is being asked to trust Treasury Secretary Henry Paulson to take $700b of taxpayer money to bail out financial institutions as 'the fix' needed to right the economy. Every twitch of the stock market is a call to act quickly. Paulson is asking for an unfettered hand. One aspect of the Bailout Bill before Congress states:
“Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”

Where is this money coming from? The Federal Reserve will create a bond issue to cover it - in other words, they will print the money. As early as 1974, the national US foreign debt had a $3b surplus. Today, with a national debt of $10 trillion dollars, soon to increase to $11 trillion when the bailout bill is factored in, means that each individual taxpayer is holding about $25,000 worth of public debt. US dollars have yet to find their real value. By 2009 the value of the US dollar will be half what it is today.

The Credit Default Swap will give way to a collapse of Hedge Funds. It has to. Hedge Funds bear good returns for investors because of the freedom they have to act quickly, short-selling to take advantage of a fluctuating stock market. But short trading has been stopped for 900 stocks, and how will they pay for stocks held when 30, 60, & 90 day margin calls come due. With similar debt-to-net capital profiles as Investment Banks, Hedge Funds can only collapse a month or so from now.

Inflation can only increase. The Federal Reserve has held off increasing interest rates to buy dollars since 2000. With Treasury Bills bearing .017 % interest, rates have nowhere to go but up. When - not if, the Fed begins to raise interest rates to protect the US dollar, the consumer economy will grind to a halt. Mortgage rates, credit card rates, student loans, etc. will all increase. Lowered demand for goods will result in a huge increase in unemployment, at the same time as prices begin to increase for necessities like food and energy.

And what about energy? OPEC is refusing to increase production (perhaps because they don't have the reserves they purport to have). Hurricanes have damaged 800 oil rigs in the Gulf of Mexico to say nothing of the damage to oil refining facilities on the US mainland. No new oil fields in the world have been found. America has yet to give the go-ahead for Alaskan exploration and even if new fields are discovered, they will be decades away from production. Wealth, seeking a safe haven, is flowing into commodities. Yesterday, oil futures experienced the biggest 1 day gain ever, going to $125 a barrel. Some people are predicting oil will reach $250 a barrel in 2009. The US auto industry will be the next demanding a bailout. The cost of credit and oil at the pump will combine to cripple it.

Doomsayer? Or Realist? I am not an economist, but the Housing/Investment crisis is only the first salvo. Yet to come will be a cascading series of crisis' that shifts from the investment community, to the stock market, to the banking industry, to the energy sector, to the auto industry. Unemployment, housing defaults, credit defaults and inflation will paint tomorrow's American landscape.

In my next post, I'll talk about the geo-political ramifications.

Building a House of Cards

Governments and institutions are telling everyone not to panic and stay the course. This to give the top 3% of society time to liquidate before the coming collapse. By the time the little guy at the back of the line gets wise, there will be nothing left.

Economists themselves cannot agree on what is happening. The instruments of the coming catastrophe were established during the climate of fear surrounding 9/11. The stock market could have collapsed then. The dot.com bust and Enron had exposed the weak underbelly, and delicate nature of the market economy. The Securities and Exchange Commission (SEC) needed to do something different to inject capital and confidence back into the marketplace.

So, the SEC relaxed the rules governing some investment banks. Five solid banks: Goldman Sachs, Merril Lynch, Lehman Bros., Bear Stearns and Morgan Stanley, restricted to operating on a 12:1 debt-to-capital ratio for lending, were sanctioned by The SEC to increase their debt to capital ratio to 30 and in some cases 40:1 . In a single stroke, these five institutions; were infused with tens of trillions of dollars. Overnight, it was as if the US mint had printed trillions of dollars and injected it into the economy. These banks don't lend to people, they lend to companies like Freddie Mac and Fannie Mae (Fannie-Mac). Fannie-Mac lend money for mortgages.

Lenders need security for loans. Those insurers are governed by Regulatory bodies to make sure there are sufficient assets for repayment in the event lenders forfeit. To get around these regulatory bodies a new term called "credit default swaps" entered the financial vocabulary. There is no regulatory body for credit default swaps. AIG became the holding company for the credit default swaps that would secure this new investment capital.

The set pieces were all in place.

Home mortgages could be had for a 0% downpayment. First-time home buyers flocked to take advantage with mortgage rates stabilized at 5 & 6%. It became a sellers market and the real estate boom started. New home construction took off, accounting for 15% of new jobs. Houses selling for $100,000 in 2001 were now being evaluated for $200,000 and then $300,000. Ordinary people by the thousands were channelled into seminars where they were told to leverage their mortgages into buying more houses and become millionaires overnight. The magic was many did become millionaires.

Flush with money, banks and lending institutions rode the wave into a new consumer-driven economy. Credit was extended to anyone. In America, a $50,000 income was guarantee enough for a million dollar loan. Illegal immigrants could borrow money. Consumer spending for home furnishings, cars, boats, second homes, education, stocks, and travel was paid for with credit cards and second mortgages. Sub-prime financiers for large-scale construction projects, guaranteeing incredibly high returns, attracted pension funds and the life's savings of retirees and baby boomers hoping to retire early.

Even the war in Iraq, costing $2 billion dollars per week, and a US national debt at $10 Trillion dollars and growing at $600 dollars a second couldn't slow it down. Inflation was steady, GDP was growing, and dollar remained strong. The first inkling people had that something was wrong was when oil crossed the $100 a barrel threshold. It was a gust of wind that teetered the house of cards.