Importing Inflation

If you’ve been following this blog for any length of time, you know that I’ve been warning that Washington would be seeking to devalue the dollar to try and inflate its way out of the great financial crisis, and especially the patently unpayable $133 trillion in IOUs it has.


In much less certain terms and with greater reservations, I believed that China would eventually cooperate with Geithner & Co to revalue their yuan higher.

A higher yuan is essentially the same thing as a LOWER dollar.

Now, it’s all coming to pass. Over the weekend Beijing agreed to depeg its currency from the dollar and start pushing the value of the yuan higher.

To do so, China’s central bank will effectively have to start buying its own currency — largely by selling some of its reserve currencies, chiefly the dollar.

Already, the dollar is plunging. Gold — which has hit one new record high after another — is leaping again, up more than $7 in early morning trading today ( 6/22 ).

Most brokers will tell you stocks will now rally because China’s revaluation of the yuan means the U.S. can now create more jobs and compete with China.

But that’s hogwash and merely a cover for the truth: This is a dollar devaluation, and an attempt to inflate all dollar-denominated assets. Even the stock markets.

Think it through: Washington is telling you this is about creating more jobs in America and that China has had an unfair advantage with an undervalued currency. But there is simply no way the yuan can be pushed up enough to account for wage differentials between the two countries and create millions of jobs in the U.S.

Just ask yourself: How could a $25-an-hour worker in the United States ever compete with a 75-cents-per-day worker in China? China’s currency would have to gain nearly 3,333% to level the playing field on jobs.

Even at $12.50 an hour, China’s currency would have to gain something like 1,500% to level the playing field.

Or, there would have to still be some very punitive trade sanctions against China, which would put the world on the path to a major depression and war somewhere.

And quite frankly, although there are some real dummies in Washington, I don’t think they’re stupid enough to knowingly put the world on that kind of course. 

So this is not about jobs. It’s about the dollar and inflation.

Keep in mind that when a currency strengthens in value, it effectively imports deflation into the country whose currency is rising. Put another way, its currency buys more.

Conversely, the currency that is losing value imports inflation, which is precisely what Obama, Geithner and Bernanke want for the U.S.

Bottom line: You are now witnessing Phase II of the Great Dollar Devaluation.

The Chinese will attempt to “control” the rise in the value of the yuan (and thereby, the devaluation of the dollar). And for a while, they may succeed at slowing down the yuan’s appreciation.

But history has repeatedly show that when a country depegs its currency from the dollar, market forces eventually take over, rapidly pushing the undervalued currency higher (in this case the yuan), and the dollar lower.

So while China is talking up a gradual appreciation of the yuan right now, don’t be surprised if they lose control, and the dollar starts to plummet.

Moreover, in the next phase, as the sovereign debt crisis leaps from Europe to the U.S. — you will see the worst of the dollar devaluation occur. Chairman Ben Bernanke and the Federal Reserve will use the sovereign debt crisis to create trillions of dollars out of thin air, further devaluing the U.S. dollar.

And in the final phase of the great dollar devaluation — you will see countries all over the world actively band together to replace the dollar as the world’s reserve currency.

Lest you forget: We already saw the opening acts of the move to replace the dollar last year, with China, Russia, India and even Japan calling for a new reserve currency.

And this weekend the G20 meet in Toronto, and Russian President Medvedev is already resurrecting the calls for a new world order and new world reserve currency to be put on the table at those G20 meetings.

Where will we be on Monday ?

The Shadow Market

Did the Federal Reserve collude with the big banks to hold millions of houses off the market until the Fed finished adding $1.25 trillion to the banks reserves? Did the Fed do this to make it appear that its bond purchasing plan (quantitative easing) was stabilizing prices when, in fact, it was the reduction in supply that stopped prices from plunging? It sure looks that way. This is from Bloomberg News:


"U.S. home foreclosures reached a record for the second consecutive month in May, with increases in every state, as lenders stepped up property seizures, according to RealtyTrac.Inc.


“Bank repossessions climbed 44 per cent from May 2009 to 93,777, the Irvine, California-based data company said today in a statement. Foreclosure filings, including default and auction notices, rose about 1 per cent to 322,920. One out of every 400 U.S. households received a filing." (Bloomberg)

Inventory steadily declined during the period the Fed was exchanging cash-for-trash (toxic assets and non performing loans for reserves) with the banks. Now inventories have begun to rise again as the banks try to get back to business as usual. The sudden uptick in repossessions and property seizures coincides perfectly with the ending of the Fed's giant "no bankster left behind" program. Clearly, there must have been a quid pro quo.

What's so impressive about Bernanke's trillion dollar sleight-of-hand operation is its simplicity. We're just talking "supply and demand" here, not rocket science. The banks agreed to cut supply (by temporarily stockpiling homes) while the Fed loaded them up with a cold trillion-plus in reserves.
The Gov is doing its part in this “shadowing” by shunting off an unpublished number of properties (of all descriptions) from failed banks that are now in its possession to its own black holes, such as the FDIC and other such agencies for an indeterminable amount of time. The public (including most real estate professionals) are left to assume that Bernanke's program stabilized prices. It's a very ingenious deception.

These properties in government possession are actually just sitting, under the management of law firms specializing in such matters, receiving bare bones maintenace from contractors, all at the taxpayers expense. You probably drive by more than one such property a day and are unaware of its vacancy.

I drive by two a day that I am aware of.

Those properties shadowed by the banks are usually less fortunite.
Regardless, the taxpayer is getting the bill one way or another.

Those who follow the Fed may remember that "quantitative easing" was promoted as a way to increase lending to consumers and to keep interest rates on mortgages low. But that was all public relations hype. Consumer lending contracted in the last year while interest rates on the 30-year mortgage have fallen since Bernanke's QE program ended at the end of March.

So what does it all mean? It means the public was snookered yet again. It also means that housing prices will fall further as the banks & Gov eventually dump more inventory on the market. How far prices drop will depend on how quickly this “shadow” inventory clears which, in turn, depends on agreements they've made with the Fed and the other banks. Housing inventory is being released in drips and drabs according to an unknown plan of some banker/Treasury bureaucrat – or worse – with no plan at all.

Some would call this price-fixing. Here's an excerpt from an article in the Wall Street Journal that says that there's a 9-year backlog of distressed homes:

"How much should we worry about a new leg down in the housing market? If the number of foreclosed homes piling up at banks is any indication, there’s ample reason for concern. As of March, banks had an inventory of about 1.1 million foreclosed homes, up 20 per cent from a year earlier....

“Another 4.8 million mortgage holders were at least 60 days behind on their payments or in the foreclosure process, meaning their homes were well on their way to the inventory pile. That “shadow inventory” was up 30 per cent from a year earlier. Based on the rate at which banks have been selling those foreclosed homes over the past few months, that entire inventory, real and shadow, would take 103 months to unload. That’s nearly nine years. Of course, banks could pick up the pace of sales, but the added supply of distressed homes would weigh heavily on prices — and thus boost their losses." ("Number of the Week: 103 Months to Clear Housing Inventory" Mark Whitehouse, Wall Street Journal)

No matter how you look at it, housing will be in a funk for the next 5 to 10 years. There's just too much product and too few buyers. The uncertain hand of Team Obama will only put more pressure on sales and prices.

Now that the government's homebuyer credits, subsidies and incentives have ended, demand for housing is drying up fast. The Mortgage Bankers Association (MBA) reports that new mortgage purchase applications have tumbled nearly 40 per cent to their lowest level since April of 1997. Sales are in freefall. Prices have already slipped 30 percent from their peak in 2006. Another 10 percent could be the straw that breaks the camel’s back.

Housing market guru Whitney Tilson explains this excerpt from his recent article titled "The Housing Non Recovery".

"Today about 17.2 % of homeowners are underwater. But if home prices drop 10 % from here, 27 % of homeowners would go underwater. In other words, as little as a 10 % drop in home prices would cause a 56% increase in the number of people underwater…which would almost certainly lead to another surge in defaults." ("The Housing Non Recovery", The Daily Reckoning)

This excerpt deserves a second reading. The next 10 % dip in prices will be more painful than the first 30 percent. The market is on a razor’s edge and any further downward move could prove deadly. It has been reported recently that more than 7 million homeowners have already stopped paying their mortgages which means that the inventory-pipeline will be bulging for years to come.

The administration needs to get on top of this problem before the next downward spiral begins, but I expect nothing further to come from that direction. The elected are far too concerned with other problems: both the real and the ideological. Foremost of which is jobs: Theirs jobs that is.  What Bernake & the unelected will do is obvious: print more money and shadow more property as more banks fail.   

The next disaster becomes unavoidable and its only another 10 % away.

Omar P Bounds III

What I was told on Tuesday.

If you haven’t headed my warnings, it is too late to do anything today.
Regardless what the DOW does on Monday morning – sell and keep selling.

On Tuesday, June 1st I received my regular e- newsletter from one of my favorite contrarian brokers. It said this:

“This is no time for mincing words or pulling punches. This is a special red alert, the great global debt disaster is about to trigger a U.S. stock market implosion. “

Here we are Friday and look where we are at.

I was a little busy trying to cobble together a living and didn’t take much notice of the newsletter until yesterday ( Thursday June 3rd ) There are 3 fundamental indicators that when taken together shocked even I, the consummate contrainian investor.

Spain is already beginning to seize banks. Portugal, Italty, and especially Ireland are now on what the Euro bankers are calling a “blacklist”.  My source on this is an analyst with a major European bank with offices here in Phila..  As these Euro socialist economies head the way of Greece, we as investors – nay Americans must be ask the question, what is the difference between these Blacklisted Sovereign Debts and Greece. Greece goes broke – so what?

Greece went south over a measly $236 Billion in external bad paper owed almost entirely to European banks. BUT Spain – one of the worlds larger economies is on the hook for $1.1 TRILLION, owned either directly or indirectly to American Banks.

“ Like several Lehmans all failing at the same time” said newsletter:

When Lehman Brothers went under 20 months ago, instantly, global markets froze up, shutting down short-term lending, sent the economy into a nosedive, and helped drive the Dow down nearly 5,000 points.

But by any measure, a default by a country like Spain would be far bigger than that of any single corporation, with the potential to wreck even greater havoc in financial markets.

Indicator #1 The single most important interest rate in the entire world is now on the rise!

The London Interbank Offered Rate — LIBOR. This is the rate that’s behind virtually every short-term loan in the United States.

When LIBOR goes up, it promptly drives up the rates in the multi-trillion-dollar market for adjustable-rate mortgages, the $7.2 trillion market for corporate loans — and more all right here in the U.S. And right now, that’s precisely what LIBOR is doing — GOING UP!

That alone can be a shock to the global economy. But what is especially shocking is the fact that there’s virtually nothing the Federal Reserve or even the European Central Bank (ECB) can do about it. This has earth-shattering implications. It not only means the global debt crisis is heating up. It also means that the Fed and central banks around the world are losing their power to STOP the global debt crisis from getting a lot worse!
Indicator #2 The cost of insuring against big corporate defaults has nearly DOUBLED in just the past few weeks!

The two-year swap spread — essentially reflecting what banks charge for managing the risk on two-year loans over and above equivalent Treasury yields.

Last year, when Washington borrowed & printed trillions of dollars to rescue nearly every major U.S. bank in trouble, this crisis indicator fell sharply, signaling — at least temporarily — that the worst of the crisis had passed. But now, it’s surging again, up SEVEN-FOLD from its lows. The clear message: A new, potentially BIGGER debt crisis is in the offing.

That means investors believe the risk that corporate bonds will default has also nearly doubled - and I am NOT talking about just junk companies that everyone knew were risky to begin with. I’m talking about INVESTMENT-grade companies, the ones meriting some of the highest ratings handed out by S&P, Moody’s, or Fitch.

The big question: If even supposedly “safe” corporate BONDS are growing riskier almost by the day ... Imagine the massive risk investors are taking with STOCKS issued by those same corporations!

These are exactly the same indicators that told us that a Great Debt Crisis would soon crush the U.S. stock market beginning back in late 2007.

Indicator #3 American Banks Are Exposed.

This is NOT rocket science. The big dilemma is that despite the recent recovery, many of the nation’s banks are STILL vulnerable. Weiss Ratings, the only ratings group that has consistently warned investors of nearly every major banking failure in recent years rates the following in their recent report:

* Bank of America merits a Weiss Financial Strength Rating of D (weak). It still has huge amounts of bad loans on its books, with close to one third of its capital tied up bad loans alone. It’s taking massive risks with derivatives. It’s definitely not yet out of the woods.

* Citibank gets a D- for similar reasons.

* SunTrust Bank also gets a D-. Its bad loans make up an even bigger share of its capital than BofA’s.

* Overall, there are 2,259 banks and thrifts in the U.S. meriting a weak rating from Weiss, with only 962 getting a strong rating. The bigger problem: The strong banks control only 3.7% of the banking industry’s assets. The weak banks control 43.8%.

And this is BEFORE they feel the inevitable impacts of the European debt crisis on global markets or our economy!

In conclusion : It was mostly the recovery in our nation’s largest banks — bought and paid for by Washington — that created the illusion that a real, sustainable economic recovery was beginning.

That illusion triggered a recovery in the Dow.

But now, with thousands of U.S. banks barely able to fog a mirror ... and with European borrowers in danger of defaulting, these banks are now facing a new peril that they did not anticipate and we ( US taxpayers) could be on the hook for.

Adding to these 3 certainties, you cannot ignore that the prime indicator of the American markets, the mood of the American people is in the toilet. They are out of work, out of money and out of patience with big government, big oil, & big banks.

They are sellerish.

Prediction : We will see Dow 8000 ( maybe 7500 ) before we see DOW 11,000 again.

What to buy: More gold, ETF’s that are designed for short selling profits. Canadian natural gas trust that are still paying dividends.

Or go to France this summer; visit the Louvre, Normandy and Epernay while your dollar still has some buying power.

Omar P Bounds III
The Bounds Auction Company