Commodity Digest

A False Sense of Insecurity?

2006-08-25T19:31:00.000-07:00

by John Mueller
Ohio, U.S.A.
for Whiskey & Gunpowder

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DETERMINING HOW TO respond to the terrorist challenge has become a major public policy issue in the United States over the last three years. It has been discussed endlessly, many lives have been changed, a couple of wars have been waged, and huge sums of money have been spent -- often after little contemplation -- to deal with the problem.

Throughout all this, there is a perspective on terrorism that has been very substantially ignored. It can be summarized, somewhat crudely, as follows:

--Assessed in broad but reasonable context, terrorism generally does not do much damage.

--The costs of terrorism very often are the result of hasty, ill-considered, and overwrought reactions.

A sensible policy approach to the problem might be to stress that any damage terrorists are able to accomplish likely can be absorbed, however grimly. While judicious protective and policing measures are sensible, extensive fear and anxiety over what may at base prove to be a rather limited problem are misplaced, unjustified, and counterproductive.

Terrorism’s Damage

For all the attention it evokes, terrorism actually causes rather little damage, and the likelihood that any individual will become a victim in most places is microscopic. Those adept at hyperbole like to proclaim that we live in “the age of terror.” However, while, obviously, deeply tragic for those directly involved, the number of people worldwide who die as a result of international terrorism is generally only a few hundred a year, tiny compared to the numbers who die in most civil wars or from automobile accidents. In fact, in almost all years, the total number of people worldwide who die at the hands of international terrorists anywhere in the world is not much more than the number who drown in bathtubs in the United States.

Until 2001, far fewer Americans were killed in any grouping of years by all forms of international terrorism than were killed by lightning, and almost none of those terrorist deaths occurred within the United States itself. Even with the Sept. 11 attacks included in the count, the number of Americans killed by international terrorism since the late 1960s (which is when the State Department began counting) is about the same as the number of Americans killed over the same period by lightning, accident-causing deer, or severe allergic reaction to peanuts.

Some of this is definitional. When terrorism becomes really extensive, we generally no longer call it terrorism, but war. But Americans seem to be concerned mainly about random terror, not sustained warfare. Moreover, even using an expansive definition of terrorism and including domestic terrorism in the mix, it is likely that far fewer people were killed by terrorists in the entire world over the last 100 years than died in any number of unnoticed civil wars during the century.

Obviously, this condition could change if international terrorists are able to assemble sufficient weaponry or devise new tactics to kill masses of people, and if they come to do so routinely. That, of course, is the central fear. As during the Cold War, commentators are adept at spinning out elaborate doomsday and worst-case scenarios. However, although not impossible, it would take massive efforts and even more stupendous luck for terrorists regularly to visit substantial destruction upon the United States.

Historical Record

It should be kept in mind that Sept. 11 continues to stand out as an extreme event. Until then, and since then, no more than 329 people have ever been killed in a single terrorist attack (in a 1985 Air India explosion). And extreme events often remain exactly that -- aberrations, rather than harbingers.

A bomb planted in a piece of checked luggage was responsible for the explosion that caused a Pan Am jet to crash into Lockerbie, Scotland, in 1988, killing 270 people. Since that time, hundreds of billions of pieces of luggage have been transported on American carriers and none have exploded to down an aircraft. (And millions of passengers who checked bags at hotels and retrieved them before heading to the airport have routinely lied to airline agents when answering the obligatory question about whether their luggage had at all times been in their possession.) This does not mean that one should cease worrying about luggage on airlines, but it does suggest that extreme events do not necessarily assure repetition any more than Timothy McVeigh’s Oklahoma City bombing of 1995 has.

Since its alarming release of poison gas in the Tokyo subway in 1995, the apocalyptic group Aum Shinrikyo appears to have abandoned the terrorism business, and its example has not been followed. Some sort of terrorist inoculated Tylenol capsules with cyanide in 1982, killing seven people. However, that frightening and much-publicized event (it generated 125,000 stories in the print media alone and cost the manufacturer more than $1 billion) failed to inspire much in the way of imitation.

I do not want to suggest that all extreme events prove to be the last in their line, of course. At its time, the “Great War” of 1914-18 was the worst war of its type, yet an even more destructive one followed. Moreover, while Aum Shinrikyo may be under control, al-Qaida and like-minded terrorist groups are unlikely to die out any time soon; Sept. 11 marked, after all, their second attempt to destroy the World Trade Center.

Much of the current alarm is generated from the knowledge that many of today’s terrorists simply want to kill, and kill more or less randomly, for revenge or as an act of what they take to be war. At one time, it was probably safe to conclude that terrorism was committed principally for specific political demands or as a form of political expression. In the oft-repeated observation of terrorism expert Brian Jenkins, “Terrorists want a lot of people watching, not a lot of people dead.” Moreover, the suicidal nature of many attacks, while not new, can be very unsettling because the would-be perpetrator cannot be deterred by the threat of subsequent punishment. And terrorism likely will never go away completely; it has always existed and presumably always will.

A central issue, however, is whether such spectacularly destructive terrorist acts will become commonplace. Although there have been many deadly terrorist incidents in the world since 2001, all (thus far, at least) have relied on conventional methods and have not remotely challenged Sept. 11 quantitatively. If, as some purported experts repeatedly claim, chemical and biological attacks are so easy and attractive to terrorists, it is impressive that none have so far been used in Israel (where four times as many people die from automobile accidents as from terrorism). Actually, it is somewhat strange that so much emphasis has been put on the dangers of high-tech weapons in the first place. Some of that anxiety may come from the post-Sept. 11 anthrax scare, even though that event killed only a few people. The bombings of Sept. 11, by contrast, were remarkably low-tech and could have happened long ago; both skyscrapers and airplanes have been around for a century now.

Responding to Terrorism

Frantz Fanon, the 20th-century revolutionary, contended that “the aim of terrorism is to terrify.” If that is so, terrorists can be defeated simply by not becoming terrified -- that is, anything that enhances fear effectively gives in to them.

The shock and tragedy of Sept. 11 does demand a focused and dedicated program to confront international terrorism and to attempt to prevent a repeat. But it seems sensible to suggest that part of this reaction should include an effort by politicians, officials, and the media to inform the public reasonably and realistically about the terrorist context, instead of playing into the hands of terrorists by frightening the public. What is needed, as one statistician suggests, is some sort of convincing, coherent, informed, and nuanced answer to a central question: “How worried should I be?” Instead, the message the nation has received so far is, as a Homeland Security official put (or caricatured) it, “Be scared; be very, very scared -- but go on with your lives.” Such messages have led many people to develop what Leif Wenar of the University of Sheffield has aptly labeled “a false sense of insecurity.”

Hyperbolic Overreaction

For example, there is at present a great and understandable concern about what would happen if terrorists were to shoot down an American airliner or two, perhaps with shoulder-fired missiles. Obviously, that would be a major tragedy. But the ensuing public reaction to it, many fear, could come close to destroying the industry.

Accordingly, it would seem to be reasonable for those in charge of our safety to inform the public about how many airliners would have to crash before flying becomes as dangerous as driving the same distance in an automobile. It turns out that someone has made that calculation: University of Michigan transportation researchers Michael Sivak and Michael Flannagan, in an article last year in American Scientist , wrote that they determined there would have to be one set of Sept. 11 crashes a month for the risks to balance out. More generally, they calculate that an American’s chance of being killed in one nonstop airline flight is about one in 13 million (even taking the Sept. 11 crashes into account). To reach that same level of risk when driving on America’s safest roads -- rural interstate highways -- one would have to travel a mere 11.2 miles.

Or there ought to be at least some discussion of the almost completely unaddressed but patently obvious observation that, in the words of risk analyst David Banks, “It seems impossible that the United States will ever again experience takeovers of commercial flights that are then turned into weapons -- no pilot will relinquish control, and passengers will fight.” The scheme worked in 2001 because the hijackers had the element of surprise working for them; previous airline hijackings had mostly been fairly harmless, as hijackers generally landed the planes someplace and released the passengers. The passengers and crew on the fourth plane on Sept. 11 had fragmentary knowledge about what had occurred earlier that day and they prevented the plane from reaching its target. Similar responses are likely for future attempted hijackings. Nonetheless, notes Banks, “enormous resources are being invested to prevent this remote contingency.” There is a distinction, he argues, “between realistic reactions to plausible threats and hyperbolic overreaction to improbable contingencies.”

Moreover, any problems caused by radiological, chemical, or perhaps biological weapons are likely to stem far more from the fear and panic they may cause than from the weapons themselves. While a “dirty bomb” might raise radiation 25% over background levels in an area, and therefore into a range the Environmental Protection Agency considers undesirable, there ought to be some discussion about whether that really constitutes “contamination” or much of a danger at all, given the somewhat arbitrary and exceedingly cautious levels declared to be acceptable by the EPA. The potential use of such bombs apparently formed the main concern during the orange alert at the end of 2003. Because the bombs simply raise radiation levels somewhat above normal background levels in a small area, a common recommendation from nuclear scientists and engineers is that those exposed should calmly walk away. But this bit of advice has not been advanced prominently by those in charge. Effectively, therefore, they encourage panic. As one nuclear engineer points out, “If you keep telling them you expect them to panic, they will oblige you. And that’s what we’re doing.”

Poor Results

For their part, biological and chemical weapons have not proven to be great killers. Although the basic science about them has been well known for a century at least, both kinds of weapons are notoriously difficult to create, control, and focus (and even more so for nuclear weapons).

To this point in history, biological weapons have killed almost no one. And the notion that large numbers of people would perish if a small number of chemical weapons were to be set off is highly questionable. Although they can be hugely lethal when released in gas chambers, their effectiveness as weapons has been unimpressive. In World War I, for example, chemical weapons caused less than 1% of the total combat deaths; on average, it took a ton of gas to produce one fatality. In the conclusion to the official British history of the war, chemical weapons are relegated to a footnote that asserts that gas “made war uncomfortable...to no purpose.” A 1993 analysis by the Office of Technology Assessment finds that a terrorist would have to deliver a full ton of sarin nerve gas perfectly and under absolutely ideal conditions over a heavily populated area to cause between 3,000-8,000 deaths -- something that would require the near-simultaneous detonation of dozens, even hundreds, of weapons. Under slightly less ideal circumstances -- if there were a moderate wind or if the sun were out, for example -- the death rate would be only one-tenth as great. The 1995 chemical attack launched in Tokyo by the well-funded Aum Shinrikyo (attempted only after several efforts to use biological weaponry had failed completely) managed to kill only 12 people.

Thus far at least, terrorism is a rather rare and -- in appropriate, comparative context -- not a very destructive phenomenon. However, the enormous sums of money being spent to deal with the threat have in part been diverted from other, possibly more worthy, endeavors. The annual budget for the Department of Homeland Security, for example, now tops $40 billion, while state and local governments spend additional billions. Some of that money doubtless would have been spent on similar ventures under earlier budgets, and much of it likely has wider benefits than simply securing the country against a rather limited threat. But much of it, as well, has very likely been pulled away from more beneficial uses.

Accordingly, three key issues, set out by risk analyst Howard Kunreuther, require careful discussion but do not seem ever to get it:

-- How much should we be willing to pay for a small reduction in probabilities that are already extremely low?

-- How much should we be willing to pay for actions that are primarily reassuring, but do little to change the actual risk?

-- How can measures such as strengthening the public health system, which provide much broader benefits than those against terrorism, get the attention they deserve?

As Banks puts it, “If terrorists force us to redirect resources away from sensible programs and future growth in order to pursue unachievable but politically popular levels of domestic security, then they have won an important victory that mortgages our future.” For instance, measures that delay airline passengers by half an hour could cost the economy $15 billion a year, calculates economist Roger Congleton.

Hysteria

Filmmaker Michael Moore happened to note on CBS’s popular 60 Minutes last year that “The chances of any of us dying in a terrorist incident is very, very, very small.” His interviewer, Bob Simon, promptly admonished, “But no one sees the world like that.” Both statements, remarkably, are true -- the first only a bit more so than the second.

It would seem to be reasonable for someone in authority to try to rectify this absurdity. In Kunreuther’s words, “More attention needs to be devoted to giving people perspective on the remote likelihood of the terrible consequences they imagine.” That would seem to be at least as important as boosting the sale of duct tape, issuing repeated and costly color-coded alerts based on vague and unspecific intelligence, and warning people to beware of Greeks bearing almanacs.

What we need is more pronouncements like the one in a recent book by Sen. John McCain (R-Ariz.): “Get on the damn elevator! Fly on the damn plane! Calculate the odds of being harmed by a terrorist! It’s still about as likely as being swept out to sea by a tidal wave. Suck it up, for crying out loud. You’re almost certainly going to be OK. And in the unlikely event you’re not, do you really want to spend your last days cowering behind plastic sheets and duct tape? That’s not a life worth living, is it?”

But admonitions like that are exceedingly rare, almost nonexistent. What we mostly get is fear-mongering, some of it bordering on hysteria. Some prominent commentators, like David Gergen, argue that the United States has become “vulnerable,” even “fragile.” Others, like Sen. Richard Lugar (R-Ind.), are given to proclaiming that terrorists armed with weapons of mass destruction present an “existential” threat to the United States or even, in columnist Charles Krauthammer’s view, to “civilization.” A best-selling book by an anonymous CIA official assures us that our “survival” is at stake.

The cosmic alarmism reached a kind of official pinnacle during [winter 2003-04’s] orange alert. At the time, Homeland Security Czar Tom Ridge declared that “America is a country that will not be bent by terror. America is a country that will not be broken by fear.” Meanwhile, however, Gen. Richard Myers, chairman of the Joint Chiefs of Staff, was telling a television audience that if terrorists were able to engineer a catastrophic event that killed 10,000 people, they would successfully “do away with our way of life.” The sudden deaths of that many Americans -- although representing less than four-thousandths of 1% of the population -- would indeed be horrifying and tragic, but the only way it could “do away with our way of life” would be if we did that to ourselves in reaction.

All societies are “vulnerable” to tiny bands of suicidal fanatics in the sense that it is impossible to prevent every terrorist act. But the United States is hardly “vulnerable” in the sense that it can be expunged by dramatic acts of terrorist destruction, even extreme ones. In fact, the country can readily, if grimly, overcome that kind of damage -- as it overcomes some 40,000 deaths each year from automobile accidents. As RAND’s Bruce Hoffman put it, “Unfortunately, terrorism is just another fact of modern life. It’s something we have to live with.”

Politicians and the Media

A problem with getting coherent thinking on the risk of terrorism is that reporters and politicians find extreme and alarmist possibilities so much more appealing than discussions of broader context, much less of statistical reality. That is, although hysteria and alarmism rarely make much sense, politicians and the media are often naturally drawn to them.

There is no reason to suspect that President Bush’s concern about terrorism is anything but genuine. However, his approval rating did receive the greatest boost for any president in history in September 2001, and it would be politically unnatural for him not to notice. His chief political adviser, Karl Rove, [in 2003 said] that the “war” against terrorism will be central to Bush’s re-election campaign. The Democrats, scurrying to keep up, have stumbled all over each other with plans to expend even more of the federal budget on the terrorist threat, such as it is, than President Bush.

This process is hardly new. The preoccupation of the media and of Jimmy Carter’s presidency with the hostages taken by Iran in 1979 to the exclusion of almost everything else may look foolish in retrospect, as Carter’s secretary of state, Cyrus Vance, conceded in his memoirs. But it doubtless appeared to be good politics at the time -- Carter’s dismal approval rating soared when the hostages were seized. Similarly, in the 1980s, the Reagan administration became fixated on a handful of American hostages held by terrorists in Lebanon. At the time, Reagan’s normally judicious secretary of state, George Shultz, was screaming that we needed desperately to blast somebody somewhere “on a moment’s notice” -- even without adequate evidence -- in order to avoid looking like the indecisive “Hamlet of nations.” He apparently preferred the King Lear approach. Normally, however, only lunatics and children rail at storms; sensible people invest in umbrellas and lightning rods.

Since Sept. 11, the American public has been treated to endless yammering about terrorism in the media. Politicians may believe that, given the public concern on the issue, they will lose votes if they appear insensitively to be downplaying the dangers of terrorism (though this fear does not seem to have infected Sen. McCain). However, the media like to tout that they are devoted to presenting fair and balanced coverage of important public issues. I may have missed it, but I have never heard anyone in the media stress that in every year except 2001, only a few hundred people in the entire world have died as a result of international terrorism.

As often noted, the media appear to have a congenital incapacity for dealing with issues of risk and comparative probabilities -- except, of course, in the sports and financial sections. But even in their amazingly rare efforts to try, the issue -- one that would seem to be absolutely central to any rounded discussion of terrorism and terrorism policy -- never goes very far. For example, in 2001 The Washington Post published an article by a University of Wisconsin economist that attempted quantitatively to point out how much safer it was to travel by air than by automobile, even under the heightened atmosphere of concern inspired by the Sept. 11 attacks. He reports that the article generated a couple of media inquiries, but nothing more. Gregg Easterbrook’s cover story in the Oct. 7, 2002, New Republic forcefully argued that biological and chemical weapons are hardly capable of creating “mass destruction,” a perspective relevant not only to terrorism, but also to the drive for war against Iraq that was going on at the time. The New York Times asked him to fashion the article into an Op-Ed piece, but that was the only interest the article generated in the media.

In addition, it should be pointed out that the response to Sept. 11 has created a vast and often well-funded terrorism industry. Its members would be nearly out of business if terrorism were to be back-burnered, and, accordingly, they have every competitive incentive (and they are nothing if not competitive) to conclude that it is their civic duty to keep the pot boiling.

Moreover, there is more reputational danger in underplaying risks than in exaggerating them. People routinely ridicule futurist H.G. Wells’ prediction that the conflict beginning in 1914 would be “the war that will end war,” but not his equally confident declaration at the end of World War II that “the end of everything we call life is close at hand.” Disproved doomsayers can always claim that caution induced by their warnings prevented the predicted calamity from occurring. (Call this the Y2K effect.) Disproved Pollyannas have no such convenient refuge.

The challenge, thus, is a difficult one. But it still seems sensible to suggest that officials and the press at least once in a while ought to assess probabilities and put them in some sort of context, rather than simply to stress extreme possibilities so much and so exclusively.

Know Your Audience

It is easy to blame politicians and the media for the distorted and context-free condition under which terrorism is so often discussed. In many respects, however, that circumstance arises not so much from their own proclivities, but rather from those of their customers. Hysteria and alarmism often sell.

The record with respect to fear about crime, for example, suggests that efforts to deal responsibly with the risks of terrorism will prove difficult. Fear of crime rose notably in the mid-1990s, even as statistics were showing crime to be in pronounced decline. When David Dinkins, running for re-election as mayor of New York, pointed to such numbers, he was accused by A. M. Rosenthal of The New York Times of hiding behind “trivializing statistics” that “are supposed to convince us that crime is going down.” New Yorkers did eventually come to feel safer from crime, but that was probably less because crime rates actually declined than because of atmospherics as graffiti, panhandlers, aggressive windshield washers, and the homeless were banished or hidden from view. So it may have made sense in the months after the Sept. 11 attacks to have armed reservists parading around in airports. It is not clear how they prevented terrorist attacks, and pulling them from productive jobs hardly helped the economy. But if they provided people with a sense of security, their presence may have been worth it.

In the end, it is not clear how one can deal with the public’s often irrational -- or at least erratic -- fears about remote dangers. Some people say they prefer comparatively dangerous forms of transportation like the private passenger automobile (the cause of over 3 million American deaths during the 20th century) to safe ones like commercial airliners because they feel they have more “control.” But they seem to feel no fear on buses and trains -- which actually are more dangerous than airliners -- even without having that sense of control and even though derailing a speeding train or crashing a speeding bus is likely to be much easier for a terrorist than downing an airliner. And people tend to be more alarmed by dramatic fatalities -- which the Sept. 11 crashes certainly provided -- than by ones that cumulate statistically. Thus, the 3,000 deaths of Sept. 11 inspire far more grief and fear than the 100,000 deaths from auto accidents that have taken place since then. In some respects, fear of terror may be something like playing the lottery, except in reverse: The chances of winning the lottery or of dying from terrorism may be microscopic, but for monumental events that are, or seem, random, one can irrelevantly conclude that one’s chances are just as good, or bad, as those of anyone else.

The communication of risk, then, is no easy task. Risk analyst Paul Slovic points out that people tend greatly to overestimate the chances of dramatic or sensational causes of death, that realistically informing people about risks sometimes only makes them more frightened, that strong beliefs in this area are very difficult to modify, that a new sort of calamity tends to be taken as harbinger of future mishaps, that a disaster tends to increase fears not only about that kind of danger, but of all kinds, and that people, even professionals, are susceptible to the way risks are expressed -- far less likely, for example, to choose radiation therapy if told the chances of death are 32% rather than that the chances of survival are 68%.

But risk assessment and communication should at least be part of the policy discussion over terrorism, something that may well prove to be a far smaller danger than is popularly portrayed. The constant, unnuanced stoking of fear by politicians and the media is costly, enervating, potentially counterproductive, and unjustified by the facts.

Conclusion

The policy perspective toward terrorism I suggest may not be more valid than other ones, and no one knows, of course, how the problem will play out in future years. However, the policy advanced here seems to me a sound and sensible one, and for there to be a really coherent policy discussion, it should be part of the mix.

Deep concern about extreme events is not necessarily unreasonable or harmful. Thus, efforts to confront terrorism and reduce its incidence and destructiveness are justified. But hysteria is hardly required. As always, there are uncertainties and risks out there, and plenty of dangers and threats. But none are existential. The sky, as it happens, is unlikely to fall anytime soon.

Regards,
John Mueller

John’s the Woody Hayes Chair of national security policy and professor of political science at Ohio State University. Today, he asks this pointed and salient question: “How does the risk of terrorism measure up against everyday dangers?” The following piece originally appeared in Regulation magazine in the fall of ’04. Considering the recent events in London, this essay merits a republishing.

John has worked the above central idea into a book called Overblown: How Politicians and the Terrorism Industry Inflate National Security Threats, and Why We Believe Them. Free Press will release the book in November of this year. You can purchase it

Why Are Americans So Angry?

2006-08-24T21:30:00.000-07:00

HON. RON PAUL OF TEXAS
Before the U.S. House of Representatives

( Watch Video )

I have been involved in politics for over 30 years and have never seen the American people so angry. It’s not unusual to sense a modest amount of outrage, but it seems the anger today is unusually intense and quite possibly worse than ever. It’s not easily explained, but I have some thoughts on this matter. Generally, anger and frustration among people are related to economic conditions; bread and butter issues. Yet today, according to government statistics, things are going well. We have low unemployment, low inflation, more homeowners than ever before, and abundant leisure with abundant luxuries. Even the poor have cell phones, televisions, and computers. Public school is free, and anyone can get free medical care at any emergency room in the country. Almost all taxes are paid by the top 50% of income earners. The lower 50% pay essentially no income taxes, yet general dissatisfaction and anger are commonplace. The old slogan “It’s the economy, stupid,” just doesn’t seem to explain things.

Some say it’s the war, yet we’ve lived with war throughout the 20th century. The bigger they were the more we pulled together. And the current war, by comparison, has fewer American casualties than the rest. So it can’t just be the war itself.

People complain about corruption, but what’s new about government corruption? In the 19th century we had railroad scandals; in the 20th century we endured the Teapot Dome scandal, Watergate, Koreagate, and many others without too much anger and resentment. Yet today it seems anger is pervasive and worse than we’ve experienced in the past.

Could it be that war, vague yet persistent economic uncertainty, corruption, and the immigration problem all contribute to the anger we feel in America? Perhaps, but it’s almost as though people aren’t exactly sure why they are so uneasy. They only know that they’ve had it and aren’t going to put up with it anymore.

High gasoline prices make a lot of people angry, though there is little understanding of how deficits, inflation, and war in the Middle East all contribute to these higher prices.

Generally speaking, there are two controlling forces that determine the nature of government: the people’s concern for their economic self interests; and the philosophy of those who hold positions of power and influence in any particular government. Under Soviet Communism the workers believed their economic best interests were being served, while a few dedicated theoreticians placed themselves in positions of power. Likewise, the intellectual leaders of the American Revolution were few, but rallied the colonists to risk all to overthrow a tyrannical king.

Since there’s never a perfect understanding between these two forces, the people and the philosophical leaders, and because the motivations of the intellectual leaders vary greatly, any transition from one system of government to another is unpredictable. The communist takeover by Lenin was violent and costly; the demise of communism and the acceptance of a relatively open system in the former Soviet Union occurred in a miraculous manner. Both systems had intellectual underpinnings.

In the United States over the last century we have witnessed the coming and going of various intellectual influences by proponents of the free market, Keynesian welfarism, varieties of socialism, and supply-side economics. In foreign policy we’ve seen a transition from the founder’s vision of non-intervention in the affairs of others to internationalism, unilateral nation building, and policing the world. We now have in place a policy, driven by determined neo-conservatives, to promote American “goodness” and democracy throughout the world by military force-- with particular emphasis on remaking the Middle East.

We all know that ideas do have consequences. Bad ideas, even when supported naively by the people, will have bad results. Could it be the people sense, in a profound way, that the policies of recent decades are unworkable-- and thus they have instinctively lost confidence in their government leaders? This certainly happened in the final years of the Soviet system. Though not fully understood, this sense of frustration may well be the source of anger we hear expressed on a daily basis by so many.

No matter how noble the motivations of political leaders are, when they achieve positions of power the power itself inevitably becomes their driving force. Government officials too often yield to the temptations and corrupting influences of power.

But there are many others who are not bashful about using government power to do “good.” They truly believe they can make the economy fair through a redistributive tax and spending system; make the people moral by regulating personal behavior and choices; and remake the world in our image using armies. They argue that the use of force to achieve good is legitimate and proper for government-- always speaking of the noble goals while ignoring the inevitable failures and evils caused by coercion.

Not only do they justify government force, they believe they have a moral obligation to do so.

Once we concede government has this “legitimate” function and can be manipulated by a majority vote, the various special interests move in quickly. They gain control to direct government largesse for their own benefit. Too often it is corporate interests who learn how to manipulate every contract, regulation and tax policy. Likewise, promoters of the “progressive” agenda, always hostile to property rights, compete for government power through safety, health, and environmental initiatives. Both groups resort to using government power-- and abuse this power-- in an effort to serve their narrow interests. In the meantime, constitutional limits on power and its mandate to protect liberty are totally forgotten.

Since the use of power to achieve political ends is accepted, pervasive, and ever expanding, popular support for various programs is achieved by creating fear. Sometimes the fear is concocted out of thin air, but usually it’s created by wildly exaggerating a problem or incident that does not warrant the proposed government “solution.” Often government caused the problem in the first place. The irony, of course, is that government action rarely solves any problem, but rather worsens existing problems or creates altogether new ones.

Fear is generated to garner popular support for the proposed government action, even when some liberty has to be sacrificed. This leads to a society that is systemically driven toward fear-- fear that gives the monstrous government more and more authority and control over our lives and property.

Fear is constantly generated by politicians to rally the support of the people.

Environmentalists go back and forth, from warning about a coming ice age to arguing the grave dangers of global warming.

It is said that without an economic safety net-- for everyone, from cradle to grave-- people would starve and many would become homeless.

It is said that without government health care, the poor would not receive treatment. Medical care would be available only to the rich.

Without government insuring pensions, all private pensions would be threatened.

Without federal assistance, there would be no funds for public education, and the quality of our public schools would diminish-- ignoring recent history to the contrary.

It is argued that without government surveillance of every American, even without search warrants, security cannot be achieved. The sacrifice of some liberty is required for security of our citizens, they claim.

We are constantly told that the next terrorist attack could come at any moment. Rather than questioning why we might be attacked, this atmosphere of fear instead prompts giving up liberty and privacy. 9/11 has been conveniently used to generate the fear necessary to expand both our foreign intervention and domestic surveillance.

Fear of nuclear power is used to assure shortages and highly expensive energy.

In all instances where fear is generated and used to expand government control, it’s safe to say the problems behind the fears were not caused by the free market economy, or too much privacy, or excessive liberty.

It’s easy to generate fear, fear that too often becomes excessive, unrealistic, and difficult to curb. This is important: It leads to even more demands for government action than the perpetrators of the fear actually anticipated.

Once people look to government to alleviate their fears and make them safe, expectations exceed reality. FEMA originally had a small role, but its current mission is to centrally manage every natural disaster that befalls us. This mission was exposed as a fraud during last year’s hurricanes; incompetence and corruption are now FEMA’s legacy. This generates anger among those who have to pay the bills, and among those who didn’t receive the handouts promised to them quickly enough.

Generating exaggerated fear to justify and promote attacks on private property is commonplace. It serves to inflame resentment between the producers in society and the so-called victims, whose demands grow exponentially.

The economic impossibility of this system guarantees that the harder government tries to satisfy the unlimited demands, the worse the problems become. We won’t be able to pay the bills forever, and eventually our ability to borrow and print new money must end. This dependency on government will guarantee anger when the money runs out. Today we’re still able to borrow and inflate, but budgets are getting tighter and people sense serious problems lurking in the future. This fear is legitimate. No easy solution to our fiscal problems is readily apparent, and this ignites anger and apprehension.

Disenchantment is directed at the politicians and their false promises, made in order to secure reelection and exert power that so many of them enjoy.

It is, however, in foreign affairs that governments have most abused fear to generate support for an agenda that under normal circumstances would have been rejected. For decades our administrations have targeted one supposed “Hitler” after another to gain support for military action against a particular country. Today we have three choices termed the axis of evil: Iran, Iraq or North Korea.

We recently witnessed how unfounded fear was generated concerning Saddam Hussein’s weapons of mass destruction to justify our first ever pre-emptive war. It is now universally known the fear was based on falsehoods. And yet the war goes on; the death and destruction continue.

This is not a new phenomenon. General Douglas MacArthur understood the political use of fear when he made this famous statement:

“Always there has been some terrible evil at home or some monstrous foreign power that was going to gobble us up if we did not blindly rally behind it.”

We should be ever vigilant when we hear the fear mongers preparing us for the next military conflict our young men and women will be expected to fight. We’re being told of the great danger posed by Almadinejad in Iran and Kim Jung Il in North Korea. Even Russia and China bashing is in vogue again. And we’re still not able to trade with or travel to Cuba. A constant enemy is required to expand the state. More and more news stories blame Iran for the bad results in Iraq. Does this mean Iran is next on the hit list?

The world is much too dangerous, we’re told, and therefore we must be prepared to fight at a moment’s notice, regardless of the cost. If the public could not be manipulated by politicians’ efforts to instill needless fear, fewer wars would be fought and far fewer lives would be lost.

Fear and Anger over Iraq

Though the American people are fed up for a lot of legitimate reasons, almost all polls show the mess in Iraq leads the list of why the anger is so intense.

Short wars, with well-defined victories, are tolerated by the American people even when they are misled as to the reasons for the war. Wars entered into without a proper declaration tend to be politically motivated and not for national security reasons. These wars, by their very nature, are prolonged, costly, and usually require a new administration to finally end them. This certainly was true with the Korean and Vietnam wars. The lack of a quick military success, the loss of life and limb, and the huge economic costs of lengthy wars precipitate anger. This is overwhelmingly true when the war propaganda that stirred up illegitimate fears is exposed as a fraud. Most soon come to realize the promise of guns and butter is an illusion. They come to understand that inflation, a weak economy, and a prolonged war without real success are the reality.

The anger over the Iraq war is multifaceted. Some are angry believing they were lied to in order to gain their support at the beginning. Others are angry that the forty billion dollars we spend every year on intelligence gathering failed to provide good information. Proponents of the war too often are unable to admit the truth. They become frustrated with the progress of the war and then turn on those wanting to change course, angrily denouncing them as unpatriotic and un-American.

Those accused are quick to respond to the insulting charges made by those who want to fight on forever without regard to casualties. Proponents of the war do not hesitate to challenge the manhood of war critics, accusing them of wanting to cut and run. Some war supporters ducked military service themselves while others fought and died, only adding to the anger of those who have seen battle up close and now question our campaign in Iraq.

When people see a $600 million embassy being built in Baghdad, while funding for services here in the United States is hard to obtain, they become angry. They can’t understand why the money is being spent, especially when they are told by our government that we have no intention of remaining permanently in Iraq.

The bickering and anger will not subside soon, since victory in Iraq is not on the horizon and a change in policy is not likely either.

The neoconservative instigators of the war are angry at everyone: at the people who want to get out of Iraq; and especially at those prosecuting the war for not bombing more aggressively, sending in more troops, and expanding the war into Iran.

As our country becomes poorer due to the cost of the war, anger surely will escalate. Much of it will be justified.

It seems bizarre that it’s so unthinkable to change course if the current policy is failing. Our leaders are like a physician who makes a wrong diagnosis and prescribes the wrong medicine, but because of his ego can’t tell the patient he made a mistake. Instead he hopes the patient will get better on his own. But instead of improving, the patient gets worse from the medication wrongly prescribed. This would be abhorrent behavior in medicine, but tragically it is commonplace in politics.

If the truth is admitted, it would appear that the lives lost and the money spent have been in vain. Instead, more casualties must be sustained to prove a false premise. What a tragedy! If the truth is admitted, imagine the anger of all the families that already have suffered such a burden. That burden is softened when the families and the wounded are told their great sacrifice was worthy, and required to preserve our freedoms and our Constitution.

But no one is allowed to ask the obvious. How have the 2,500 plus deaths, and the 18,500 wounded, made us more free? What in the world does Iraq have to do with protecting our civil liberties here at home? What national security threat prompted America’s first pre-emptive war? How does our unilateral enforcement of UN resolutions enhance our freedoms?

These questions aren’t permitted. They are not politically correct. I agree that the truth hurts, and these questions are terribly hurtful to the families that have suffered so much. What a horrible thought it would be to find out the cause for which we fight is not quite so noble.

I don’t believe those who hide from the truth and refuse to face the reality of the war do so deliberately. The pain is too great. Deep down, psychologically, many are incapable of admitting such a costly and emotionally damaging error. They instead become even greater and more determined supporters of the failed policy.

I would concede that there are some-- especially the die-hard neoconservatives, who believe it is our moral duty to spread American goodness through force and remake the Middle East-- who neither suffer regrets nor are bothered by the casualties. They continue to argue for more war without remorse, as long as they themselves do not have to fight. Criticism is reserved for the wimps who want to “cut and run.”

Due to the psychological need to persist with the failed policy, the war proponents must remain in denial of many facts staring them in the face.

They refuse to accept that the real reason for our invasion and occupation of Iraq was not related to terrorism.

They deny that our military is weaker as a consequence of this war.

They won’t admit that our invasion has served the interests of Osama Bin Laden. They continue to blame our image problems around the world on a few bad apples.

They won’t admit that our invasion has served the interests of Iran’s radical regime.

The cost in lives lost and dollars spent is glossed over, and the deficit spirals up without concern.

They ridicule those who point out that our relationships with our allies have been significantly damaged.

We have provided a tremendous incentive for Russia and China, and others like Iran, to organize through the Shanghai Cooperation Organization. They entertain future challenges to our plans to dominate South East Asia, the Middle East, and all its oil.

Radicalizing the Middle East will in the long term jeopardize Israel’s security, and increase the odds of this war spreading.

War supporters cannot see that for every Iraqi killed, another family turns on us-- regardless of who did the killing. We are and will continue to be blamed for every wrong done in Iraq: all deaths, illness, water problems, food shortages, and electricity outages.

As long as our political leaders persist in these denials, the war won’t end. The problem is that this is the source of the anger, because the American people are not in denial and want a change in policy.

Policy changes in wartime are difficult, for it is almost impossible for the administration to change course since so much emotional energy has been invested in the effort. That’s why Eisenhower ended the Korean War, and not Truman. That’s why Nixon ended the Vietnam War, and not LBJ. Even in the case of Vietnam the end was too slow and costly, as more then 30,000 military deaths came after Nixon’s election in 1968. It makes a lot more sense to avoid unnecessary wars than to overcome the politics involved in stopping them once started. I personally am convinced that many of our wars could be prevented by paying stricter attention to the method whereby our troops are committed to battle. I also am convinced that when Congress does not declare war, victory is unlikely.

The most important thing Congress can do to prevent needless and foolish wars is for every member to take seriously his or her oath to obey the Constitution. Wars should be entered into only after great deliberation and caution. Wars that are declared by Congress should reflect the support of the people, and the goal should be a quick and successful resolution.

Our undeclared wars over the past 65 years have dragged on without precise victories. We fight to spread American values, to enforce UN resolutions, and to slay supposed Hitlers. We forget that we once spread American values by persuasion and setting an example-- not by bombs and preemptive invasions. Nowhere in the Constitution are we permitted to go to war on behalf of the United Nations at the sacrifice of our national sovereignty. We repeatedly use military force against former allies, thugs we helped empower—like Saddam Hussein and Osama bin Laden—even when they pose no danger to us.

The 2002 resolution allowing the president to decide when and if to invade Iraq is an embarrassment. The Constitution authorizes only Congress to declare war. Our refusal to declare war transferred power to the president illegally, without a constitutional amendment. Congress did this with a simple resolution, passed by majority vote. This means Congress reneged on its responsibility as a separate branch of government, and should be held accountable for the bad policy in Iraq that the majority of Americans are now upset about. Congress is every bit as much at fault as the president.

Constitutional questions aside, the American people should have demanded more answers from their government before they supported the invasion and occupation of a foreign country.

Some of the strongest supporters of the war declare that we are a Christian nation, yet use their religious beliefs to justify the war. They claim it is our Christian duty to remake the Middle East and attack the Muslim infidels. Evidently I have been reading from a different Bible. I remember something about “Blessed are the peacemakers.”

My beliefs aside, Christian teaching of nearly a thousand years reinforces the concept of “The Just War Theory.” This Christian theory emphasizes six criteria needed to justify Christian participation in war. Briefly the six points are as follows:

War should be fought only in self defense;
War should be undertaken only as a last resort;
A decision to enter war should be made only by a legitimate authority;
All military responses must be proportional to the threat;
There must be a reasonable chance of success; and
A public declaration notifying all parties concerned is required.
The war in Iraq fails to meet almost all of these requirements. This discrepancy has generated anger and division within the Christian community.

Some are angry because the war is being fought out of Christian duty, yet does not have uniform support from all Christians. Others are angry because they see Christianity as a religion as peace and forgiveness, not war and annihilation of enemies.

Constitutional and moral restraints on war should be strictly followed. It is understandable when kings, dictators, and tyrants take their people into war, since it serves their selfish interests-- and those sent to fight have no say in the matter. It is more difficult to understand why democracies and democratic legislative bodies, which have a say over the issue of war, so readily submit to the executive branch of government. The determined effort of the authors of our Constitution to firmly place the power to declare war in the legislative branch has been ignored in the decades following WWII.

Many members have confided in me that they are quite comfortable with this arrangement. They flatly do not expect, in this modern age, to formally declare war ever again. Yet no one predicts there will be fewer wars fought. It is instead assumed they will be ordered by the executive branch or the United Nations-- a rather sad commentary.

What about the practical arguments against war, since no one seems interested in exerting constitutional or moral restraints? Why do we continue to fight prolonged, political wars when the practical results are so bad? Our undeclared wars since 1945 have been very costly, to put it mildly. We have suffered over one hundred thousand military deaths, and even more serious casualties. Tens of thousands have suffered from serious war-related illnesses. Sadly, we as a nation express essentially no concern for the millions of civilian casualties in the countries where we fought.

The cost of war since 1945, and our military presence in over 100 countries, exceeds two trillion dollars in today’s dollars. The cost in higher taxes, debt, and persistent inflation is immeasurable. Likewise, the economic opportunities lost by diverting trillions of dollars into war is impossible to measure, but it is huge. Yet our presidents persist in picking fights with countries that pose no threat to us, refusing to participate in true diplomacy to resolve differences. Congress over the decades has never resisted the political pressures to send our troops abroad on missions that defy imagination.

When the people object to a new adventure, the propaganda machine goes into action to make sure critics are seen as unpatriotic Americans or even traitors.

The military-industrial complex we were warned about has been transformed into a military-media-industrial-government complex that is capable of silencing the dissenters and cheerleading for war. It’s only after years of failure that people are able to overcome the propaganda for war and pressure their representatives in Congress to stop the needless killing. Many times the economic costs of war stir people to demand an end. This time around the war might be brought to a halt by our actual inability to pay the bills due to a dollar crisis. A dollar crisis will make borrowing 2.5 billion dollars per day from foreign powers like China and Japan virtually impossible, at least at affordable interest rates.

That’s when we will be forced to reassess the spending spree, both at home and abroad.

The solution to this mess is not complicated; but the changes needed are nearly impossible for political reasons. Sound free market economics, sound money, and a sensible foreign policy would all result from strict adherence to the Constitution. If the people desired it, and Congress was filled with responsible members, a smooth although challenging transition could be achieved. Since this is unlikely, we can only hope that the rule of law and the goal of liberty can be reestablished without chaos.

We must move quickly toward a more traditional American foreign policy of peace, friendship, and trade with all nations; entangling alliances with none. We must reject the notion that we can or should make the world safe for democracy. We must forget about being the world’s policeman. We should disengage from the unworkable and unforgiving task of nation building. We must reject the notion that our military should be used to protect natural resources, private investments, or serve the interest of any foreign government or the United Nations. Our military should be designed for one purpose: defending our national security. It’s time to come home now, before financial conditions or military weakness dictates it.

The major obstacle to a sensible foreign policy is the fiction about what patriotism means. Today patriotism has come to mean blind support for the government and its policies. In earlier times patriotism meant having the willingness and courage to challenge government policies regardless of popular perceptions.

Today we constantly hear innuendos and direct insults aimed at those who dare to challenge current foreign policy, no matter how flawed that policy may be. I would suggest it takes more courage to admit the truth, to admit mistakes, than to attack others as unpatriotic for disagreeing with the war in Iraq.

Remember, the original American patriots challenged the abuses of King George, and wrote and carried out the Declaration of Independence.

Yes Mr. Speaker, there is a lot of anger in this country. Much of it is justified; some of it is totally unnecessary and misdirected. The only thing that can lessen this anger is an informed public, a better understanding of economic principles, a rejection of foreign intervention, and a strict adherence to the constitutional rule of law. This will be difficult to achieve, but it’s not impossible and well worth the effort.

Waving the Warning Flags

2006-08-24T19:07:00.000-07:00

by Puru Saxena

The eternal truth in the investment world is that every asset class goes
through boom and bust cycles, which typically last for several years.
However, it is ironic that toward the end of any bull-market, when the
risk is extreme, optimism toward the booming asset-class is usually at a
record-high. On the other hand, during the final phase of a bear-market,
when the downside risk is limited, the asset that is selling at a huge
discount is always neglected and hated by the public. The reason for this
irrational behavior is that most people find it hard to foresee and accept
change. The conditions that have been prevalent for a long time are
considered to be permanent, and investment decisions are made accordingly.

In the late 1990's, the entire world was in love with the "new era," which
was inspired by technology. Fund managers, economists, media commentators
and even the shoeshine boys were drooling over the prospects of retiring
young, thanks to their Microsoft and Intel shares. Of course, that turned
out to be the worst time to be invested in the hype as the technology
shares came crashing down to earth in March 2000. Back then, I recognized
that commodities were on the bargain table relative to financial assets.
Therefore, I started buying precious metals, but most people thought that
the "Millennium Bug" had infected me.

"Why are you buying gold? I lost a lot of money in gold 15 to 20 years ago
and I'll never touch it again," were comments I often heard. Once again,
the great majority failed to identify change, thereby ignoring the birth
of a new bull-market.

Once the great technology bubble burst and the United States slipped into
a recession, the central bankers decided to fight the slump by lowering
interest rates to a multi-decade low. In the United States, interest rates
were pulled down to a miniscule one percent. As the cost of borrowing came
down, Americans turned to real estate as the next sure thing. Real estate
prices surged, as demand rose due to cheap and abundant credit. As home
prices continued to rise, Americans started using their real estate as
collateral to borrow money.

Falling interest-rates and appreciating home values also created an
explosion in re-financing activity and the United States embarked on a
gigantic spending spree. It is worth noting that over the recent years,
Americans have extracted a ridiculous amount of equity from their homes.
In fact, since the beginning of this decade - 4.6 trillion U.S. dollars!
To make matters worse, the negative personal savings rate in the United
States highlights the fact that these loans taken out against homes
weren't saved for the proverbial rainy day; instead the money was spent on
consumption.

This recklessness has put the U.S. economy in a precarious situation.
Interest rates are now rising all over the world. After a multi-month
pause, I expect interest rates to continue their upward trend. So far, the
Federal Reserve has raised rates 17 times to 5.25% and the impact is
already being felt on American real estate. I'm afraid the property
industry in the United States is falling into a serious recession. In
June, new home sales fell to 1.49 million units, the lowest since November
2004. It's down 18.1% from the record-high of 1.81 million units during
January 2006. Furthermore, the supply of U.S. homes for sale has recently
jumped to a multi-decade high. In summary, rising-interest rates are
starting to bite into the real estate boom and trouble may be on the
horizon.

I've been warning about housing for several months now and still urge you
to get rid of your investment properties. In my opinion, we are in the
final stages of the housing boom and once again, the majority of people
can't foresee this change. The warning flags are everywhere! Recently, the
stocks of major U.S. homebuilding companies declined sharply and I
consider this an ominous development.

The S&P 500 Homebuilding Index is down 46.2% from its July 2005 record
high! Such a major sell off in this sector is the market's way of
forecasting deteriorating business conditions ahead in the real estate
industry. Moreover, if U.S. housing slips into a recession and prices
decline, consumption will also be badly hurt due an abrupt ending of the
refinancing boom. Remember, consumption accounts for roughly 70% of GDP
growth in the United States and any slowdown in this department may send
its entire economy into a recession.

Furthermore, it is my observation that apart from the United States, real
estate is generally overvalued in the majority of nations. Due to poor
wage growth and rising interest rates, housing simply isn't affordable
anymore. It may deflate over the coming months as demand continues to
evaporate. So, to reiterate, my sincere advice to you is to liquidate your
leveraged properties and invest in the world of natural resources where
the bull market is still in its infancy! A mega change is currently
underway and over the coming years, I envisage major capital flows from
financial assets to commodities.

In my view, every investor must allocate 20% to 25% of his or her total
net-worth to precious metals. This may sound extreme, but in a world where
central bankers continue to inflate the supply of money, gold and other
precious metals offer the best wealth protection.

Over the coming years, I expect the various central banks to print a
ridiculous amount of money. The United States faces a $46 trillion debt
monster and the only way it can remain solvent and pay off its debt is
through monetary inflation. Remember, the easiest way to repay debt is by
diluting the purchasing power of each unit of money. So, through monetary
inflation, the 46 trillion dollars the U.S. owes today may not "feel" like
$46 trillion in 10 years time! To complicate matters further, due to
globalization and international trade, no country wants a strong currency.

So, if every nation continues to print money in order to keep its own
currency weak against a fundamentally weak U.S. dollar, the entire basket
of "paper" currencies will decline against precious metals - the supply of
which can't be increased ad infinitum.

Precious metals are in a gigantic bull market, which is likely to continue
for as long as monetary inflation remains the norm. For sure, no bull
market continues to rise forever, and each boom is punctuated with
multi-month consolidations. After a stellar multi-month surge, the
precious metals bull market witnessed a vicious yet normal pullback in
May.

In my opinion, the worst is behind us now and this is an ideal time to add
to your positions in precious metals. After a few more weeks of
consolidation, I anticipate another strong advance over the coming six to
nine months. The rising geo-political tensions and a possible conflict
between the United States and Iran may cause precious metals to really
shine in the period ahead.

Back in 1980, on an inflation-adjusted basis, gold peaked at $2,100 per
ounce and silver peaked above $100 per ounce. Today, you can buy gold at
$630 per ounce and silver at $12.5 per ounce - absolute bargains, given
the money and credit growth we've seen over the past 26 years!

Regards,

Puru Saxena

Puru Saxena is the editor and publisher of Money Matters,
an economic and financial publication available at www.purusaxena.com

An investment adviser based in Hong Kong, he is a regular guest on CNN,BBC World, CNBC, Bloomberg TV & Radio, NDTV, RTHK Radio 3 and writes forseveral newspapers and financial journals.

HISTORY - THE GREAT TEACHER!

2006-07-22T12:30:00.000-07:00

by Puru Saxena

At present, there is a lot of noise about a "commodities bubble." The
majority of "experts" are convinced that commodity prices have risen too
much and they'll collapse. On the other hand, stocks and bonds are being
touted as bargains - or as the foolproof road to riches and financial
freedom! These days, the mainstream media is awash with analysts who are
claiming that commodities will suffer due to rising interest rates.
Frankly, I find their argument totally absurd.

History has shown that commodity prices are positively correlated to the
direction of interest rates. On the other hand, financial assets such as
stocks and bonds are negatively correlated to interest rates.

During the 1970's, interest rates soared and this period coincided with a
gigantic bull-market in commodities. Despite sky-high interest rates, all
the commodities went up several-fold! It is interesting to note that the
1970's saw a vicious bear market in stocks and bonds. Back then, the
United States underwent a huge recession and Britain had to be bailed out
by the IMF. Interest rates peaked in the early 1980's and this coincided
with the end of the commodities boom. In the following two decades, both
interest rates and commodities declined whilst stocks and bonds witnessed
a huge boom.

There is no doubt that the previous commodities boom took place amidst
rising interest rates and a severe recession. So, next time when the
"experts" claim that commodities are about to collapse because of rising
interest rates and a slowing economy, perhaps you can direct them to a
good history teacher!

I'll let you in on a secret, which is essential to your success as an
investor. You must understand that the central banks don't raise interest
rates to fight inflation. After all, the modern-day central banking system
is inflation! Central banks raise or lower interest rates in order to
manage the public's inflation fears or expectations. During such times
when the public wakes up to the inflation problem and starts losing faith
in the world's paper currencies (present scenario), central banks raise
interest rates to show that they're fighting inflation. Interest rates are
pulled up in an effort to restore confidence in the world's currencies as
a higher yield makes currencies more attractive. On the other hand, when
the public's inflation fears are under control and confidence in the
monetary system is high, central banks lower interest rates to create even
more inflation!

During cycles of monetary easing, the rate of inflation (money-supply and
credit growth) accelerates, thereby creating an economic boom. During
periods of monetary tightening (such as now), the rate of inflation
(money-supply and credit growth) slows down temporarily, causing financial
accidents in a highly leveraged global economy. Make no mistake though,
the response or cure offered by the central banks to every financial
accident is always more inflation and credit.

At present, every central bank has assumed the role of an
"inflation-fighter!" Interest rates are being increased in the majority of
countries under the pretence of controlling inflation. However, it is
worth noting that despite rising interest rates, our world is still awash
in liquidity. Recently, the non-gold foreign exchange reserves held by the
central banks rose to a record $4.4 trillion U.S., up nearly 10%
year-on-year! Emerging nations held a record $3.07 trillion U.S. and the
developed nations held a near-record $1.33 trillion U.S.

Opinion is divided as to whether interest rates will continue to rise. The
majority seems to think that the Federal Reserve won't raise interest
rates much further for the fear of seriously hurting the housing boom.
However, I feel that the U.S. interest rates will have to continue to rise
or else the U.S. dollar may stage a dramatic decline. Given a choice
between protecting either the housing boom or an outright collapse in the
U.S. dollar, I can assure you that the Federal Reserve will choose the
latter. The truth is that the Federal Reserve exports U.S. dollars to the
entire world and it'll do everything in its power to delay the destruction
of its merchandise. In summary, I concede that the Federal Reserve may
pause during the second half of this year to offer some respite before the
U.S. mid-term election in November. However, the major trend is now up and
interest rates may well be in double-digits within five years.

If my above assessment is correct, you can bet your bottom dollar that
stocks, bonds and property are going to come under serious pressure.
Already, the real-estate market in the United States is showing signs of a
slowdown as the establishment tries to engineer a soft landing. In my
opinion, we now amidst a global housing bubble, which will eventually
deflate due to rising borrowing costs. It is interesting to note that the
bond yields fell between 1981 and 2003. As the cost of borrowing declined,
housing as well as bond prices went through the roof! However, in June
2003, bond-yields bottomed out and have been rising ever since. Over the
past three years, the cost of borrowing has become more expensive and
we're beginning to see its impact on the slowing real-estate markets
worldwide. The U.S. 10-year Treasury yield has now broken out of its
20-year downtrend and this is an ominous development. This breakout points
to much higher interest rates in the future, so I'd have to advise you to
sell your leveraged properties and bonds without further delay. The great
bull market in bonds ended in June 2003 and this is not a good time to be
invested in fixed-income assets.

In the past, I've stated that in a highly inflationary environment,
stocks, commodities and real estate can all rise at the same time.
Basically, an over-supply of paper money causes its purchasing power to
diminish. I still maintain that over the coming decade, even if all assets
(with the exception of bonds) continue to rise, I expect commodities to
outperform all other asset classes on a relative basis.

Regards,

Puru Saxena

Note: Puru Saxena is the editor and publisher of Money Matters,
an economic and financial publication available at www.purusaxena.com

An investment adviser based in Hong Kong, Saxena is a regular guest on
CNN, BBC World, CNBC, Bloomberg TV & Radio, NDTV, RTHK Radio 3, and he
also writes for several newspapers and financial journals.

The above is an excerpt from Money Matters, a monthly economic
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BIG MONEY AND MOTHER NATURE

2006-06-29T14:55:00.000-07:00

by Byron King
for Whiskey & Gunpowder
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THE ANNOUNCEMENTS WERE REMARKABLE for many reasons, not the least of which was their coincidence in time. Last week, Anadarko Petroleum Corp., a large, independent oil company, announced a $21 billion deal to take over two other oil and gas firms, Kerr-McGee Corp. and Western Gas Resources Inc. And then this week began with Phelps Dodge Corp., a large mining concern, announcing a $40 billion deal to take over two Canadian mining companies, Inco Ltd. and Falconbridge Ltd. Welcome to the world in which big money meets Mother Nature.

The Anadarko Deal

Here is the background on the Anadarko deal. Anadarko is proposing to pay $16.4 billion for Kerr-McGee and $4.7 billion for Western Gas. Anadarko will finance the entire acquisition with debt. Upon completion of the deal, Anadarko will more than double its annual sales. In 2005, Anadarko, which has 3,300 employees, reported $7.1 billion in sales. Revenue for Kerr-McGee last year totaled $5.93 billion, and Western Gas Resources booked $3.96 billion in 2005 sales. Together, the three companies will ring the cash register for annual revenue of $17 billion.

“We are creating a combined company with industry-leading positions in the deep-water Gulf of Mexico and the Rockies, two of the fastest-growing oil- and natural gas-producing regions in North America,” said Jim Hackett, chairman, president, and CEO of Anadarko. Despite the recent weakening in natural gas prices, Anadarko managers are looking to the longer term. They are confident that natural gas prices will regain any lost ground and remain high, due to increasing demand and flattening output across North America. Also, in all likelihood, Anadarko wants to keep itself from falling prey to other potential buyers who may covet Anadarko’s own assets and personnel. (Shell Oil Co. has been mentioned as a possible suitor.) Hold that thought while we look at another takeover proposal.

The Phelps Dodge Deal

Here is the raw data on the Phelps Dodge deal. Phelps Dodge, one of the world’s largest copper producer, is proposing to acquire Inco, one of the largest nickel mining companies in the world. In turn, Inco will sweeten an existing offer to acquire Falconbridge, another nickel mining concern already in play, and thus complete a problematic merger.

By acquiring Inco and Falconbridge, Phelps Dodge will create a diversified mining superpower whose presence will reshape the industry in a world of booming commodity prices. If this deal closes successfully, it will create the fifth-largest mining firm in the world, behind BHP Billiton, Rio Tinto, Anglo American and Brazil-based CVRD, with a market capitalization of $40 billion.

The underlying assumption behind the Phelps Dodge deal has to be that worldwide demand for basic materials will remain strong, particularly from the factories of China. Otherwise, Phelps Dodge would be acquiring assets at a post-run-up premium price and risk getting caught at or near the top of a traditional commodity cycle.

The other side of this coin is that worldwide, the basic commodity mining business has suffered from over two decades of low investment in the infrastructure needed to bring ore to the surface and process it into a useable end product. Thus, real ore deposits with real mines and processing facilities sitting on top of them are a relatively scarce item. These big holes in the ground can and do command a premium.

According to a company press release, Phelps Dodge is proposing to pay $80 (Canadian) per share for every share of Inco. Of that amount, $17.50 will be paid in cash and the rest in Phelps Dodge stock. Inco will in turn increase its offer for Falconbridge by about C$5 a share, to about C$62 per share. Phelps Dodge has announced that it will commence a US$5 billion stock repurchase program as part of the transaction. Thus, in the end, the Inco offer will be even more valuable to Falconbridge shareholders as a result of the increased value of its stock due to the Phelps Dodge bid.

Phelps Dodge officials believe that the combined entity can save about $900 million annually as a result of the three-way combination. For example, both Inco and Falconbridge operate massive nickel mines near Sudbury, Ontario. But despite the proximity of their operations, the arrangement of their mines often verged on being silly. Ore from Inco’s operations, literally a stone’s throw from Falconbridge’s sites, was routinely moved long distances by rail to Inco operations, and vice versa.

Execution Risk

Corporate mergers and large-scale asset sales are relatively routine. But three-way deals, such as we are seeing here, are uncommon, and it is an almost astonishing coincidence that we see a simultaneous confluence of events in two natural resource sectors. It makes one wonder what is driving this phase of a business cycle in the natural resource industries. Hold that thought, too.

Buying two companies at once adds what investment bankers call “execution risk” to any transaction. Imagine the difficulty involved in merging just two corporate cultures, two sets of management, two groups of employees, and two different asset bases. Now consider the difficulty entailed when there are three distinct sets of players involved in a transaction. (And in the case of the Phelps Dodge acquisition, the joinder of the three firms spans two nations.) Aside from the financial angles, the Phelps Dodge deal for Inco and Falconbridge requires governmental approvals from authorities in the U.S., Canada, and Europe, along with Phelps Dodge and Inco shareholder approval. The transaction is expected to close in September.

Just in terms of employees, Phelps Dodge has about 13,500 on the payroll, and the proposed acquisitions will swell the ranks with 12,000 more from Inco and 14,500 from Falconbridge. Combining the three mining companies “will vault [Phelps Dodge] into super-major status within the global mining industry,” and make it easier to raise capital and develop giant projects, said Phelps Dodge chairman and CEO Steven Whisler on Monday, June 26. “Our key driver in this transaction,” said Mr. Whisler, “is the potential for significant synergies.” Ah yes, those wonderful “synergies.”

Synergies or not, the transactions present world-class financial challenges, because in both instances, management proposes vastly to increase company debt in an environment of rising interest rates. Phelps Dodge has lined up $22 billion in financing for the deal and the related share buyback program. Simply to enable Inco to acquire Falconbridge, Phelps Dodge has agreed to buy as much as $3 billion of convertible subordinated notes issued by Inco. This cash infusion would, in turn, provide Inco with the cash it requires to buy out the Falconbridge common shares and, as one spokesman put it, to “satisfy related dissent rights, as needed.”

$22 billion is, of course, a lot of money. But Phelps Dodge is focusing, according to Mr. Whisler, on the “extremely strong cash flow [estimated at $10 billion before interest, taxes, depreciation, and amortization], which will enable us to reduce debt quickly and fund growth projects.” Let’s hope that Mr. Whisler is not whistling Dixie.

Speaking of debt, Anadarko is proposing to fund its acquisition of Kerr-McGee and Western Gas by taking on debt greater than its market value. The acquisitions will cost Anadarko $23.3 billion, including assumed debt. To pay for it, Anadarko secured a $24 billion acquisition facility from UBS, Credit Suisse, and Citigroup that it proposes to pay down using proceeds from asset sales, free cash flow, and the sale of new stock over the next 18-24 months.

Because the offer for Kerr-McGee and Western Gas is all in cash, the Anadarko shareholders do not have a vote on the matter. Thus, there is no possibility of what is called a “fiduciary out” for the company (i.e., the company cannot back out by saying the shareholders voted this down.) The proposed takeover price for the two target firms is at something of a rich premium, as well. Pre-announcement, Kerr-McGee was selling for 15 times earnings. Western Gas was selling for 21 times earnings. Anadarko, by contrast, was selling at 9 times earnings, and its market capitalization dropped by $1.7 billion on the first day of trading after the takeover announcement.

Execution Benefit

For every risk, however, there are potential benefits. According to a summary provided by Anadarko, the company expects ultimately to recover 3.8 billion barrels of oil equivalent from Kerr-McGee and Western Gas at a price of less than $12 per barrel. It would certainly be difficult to find that amount of hydrocarbon the old-fashioned way, by going out in the field, acquiring acreage, and drilling wells. By way of comparison, crude futures are currently trading above $70 per barrel.

In a series of press releases, Anadarko stated:

“Opportunities to gain access to such large, high-margin resource opportunities at such economic full-cycle costs are rare…The core assets being acquired strongly complement Anadarko’s existing properties, providing the scale and focus needed to deliver more robust, predictable, and efficient growth…Kerr-McGee’s outstanding deep-water holdings (in the Gulf of Mexico) and skill sets will elevate Anadarko into the top echelon of deep-water operators.

“Similarly, Kerr-McGee’s long-lived natural gas resource plays in Colorado and Utah, along with Western Gas Resources’ [holdings] in Wyoming, will combine with Anadarko’s assets to make us one of the largest producers in several of the most prolific basins in the Rockies.”

“There Is Nothing Left to Drill”

About a year or so ago, no less a scholar of natural resources than T. Boone Pickens said of the United States oil and gas situation, “There is nothing left to drill.” Boone was, of course, being facetious. There is always “something” left to drill.

But Boone was making an important point, summing up in just a few words the notion that exploration for natural resources in the ground is always an issue that involves many variables. Among other things, exploration involves access to new areas, the quality of the prospect, the costs of drilling and production, and the return on investment. By these criteria, the U.S. environment for significant new natural resource discoveries, and future extraction, is distinctly unfavorable.

From a geological standpoint, there is not enough room between the dry holes of the American oil range to find any new deposits of oil or gas of significant size. Similarly, the most significant of the hard rock deposits of North America have been explored and fairly well defined. It is safe to say that there are few important mineral districts left to uncover in the U.S., and perhaps slightly less in Canada. Add to this the dramatically increased cost of exploration and production. Fuel costs have soared, as well as the costs for most of the basic equipment used in oil and mineral extraction. The cost of tubular goods and rock bits, for example, has skyrocketed in the past three years. And people are measuring waiting times for drilling rigs with a monthly calendar.

Sure, there is a lot of oil and gas left out there for the driller’s bit (if you can wait long enough for a delivery of drill bits), and there are significant numbers of mineralized anomalies in the Earth’s crust. But the deposits that the extraction companies will encounter will be smaller, further afield, and more expensive to develop and produce.

The Anadarko and Phelps Dodge plays certainly illustrate another point, one for which T. Boone Pickens is equally famous: that you can still “drill for reserves on Wall Street.” It was Boone who put my former employer Gulf Oil Co. into play back in 1983. The takeover that resulted, by so-called “white knight” Chevron, which swooped in to rescue Gulf from the hands of Boone, was among the first of the big takeovers within the traditional Western oil industry. So I have a certain bias when it comes to seeing oil and gas companies being taken over.

The Anadarko and Phelps Dodge deals will certainly make money for the investment bankers. This will be very good for the economies of Park Avenue, Long Island, and suburban Connecticut. And the takeover deals reward patient shareholders with a significant gain, especially the patient shareholders who took the risk of buying the variety of takeover stocks in the few days before the deal was announced (ahem!). A lot of people will sell their shares, and eventually, the tax collectors of the world will do well by this deal.

The parachute makers of the world (also known as “employment attorneys”) are probably working overtime sewing golden thread into the linings of the respective harnesses for many of the senior managers of the acquired companies. Everyone knows you cannot be too careful these days. So while the current environment in takeover land is all smiles, chuckles, camaraderie, and glowing optimism, I am sure that a good many senior employees are inspecting their ejection seats like a Blue Angels pilot just before a big air show.

To their credit, the Anadarko managers went out of their way to state that they are pleased with the potential to “acquire” the geological and other technical staff of Kerr-McGee and Western Gas. That is, Anadarko appears to want the human resource base of its takeover targets, as well as the oil and gas in the ground. Similarly, the Phelps Dodge managers have stated that layoffs of Canadian technical and production staff will be minimal.

This degree of solicitousness toward the employees is rather unusual. We used to say that the definition of an “optimist” was the geologist or engineer who brought lunch to work (as if he would be there to eat it by noon). It may truly be a reflection of management beginning to realize the severity of the shortage of human skills in the natural resource sector, after more than two decades of layoffs and declining enrollments in related earth science and engineering education programs.

The historical problem with mining and energy company takeovers is that ofttimes when one company buys another, a lot of the exploration and production people from the “other” outfit get laid off. This occurred as recently as last year when Chevron took over Unocal. And as a rule, with the merger of exploration and production departments, there tends to be less diversity of thought in the oil patch and among the rock-kickers. Fewer drilling prospects get generated in the oil and gas arena, and there is less creativity in following the mineral trend lines out in hard rock country. Considering the rising world demand for resources, and the shrunken talent pool, sooner or later it was going to become evident.

Companies that are the principal in big takeover plays almost always say something along the lines of, “Our larger size will allow us better to compete in the aggressive business climate of the modern petroleum industry.” This always a good line, and not unexpected considering the money that is in play. But it is not as if a smaller, well-managed company cannot partner up or obtain the financing it needs to pursue high-cost, risky ventures.

So the Anadarko and Phelps Dodge deals will play themselves out. We shall see what happens. Inquiring minds want to know how, when one company takes over two others, will the world be a better place? Will the combined company shoot more seismic or less? Will the combined firms drill more feet of core in the hard rocks, and drill more or fewer oil wells out in the oil patch, than the combination of the separate entities? Will the new larger entity discover and produce more stuff out of the ground than otherwise?

More on the Business Side

And now for just a few final words on the economic rationale behind the Anadarko and Phelps Dodge deals. Commentator Jim Cramer noted that “Neither deal should have ever been able to get done. But both deals reflect the playbook…that says all of these stocks must be sold because of the Fed.”

That is, the Fed has been steadily raising interest rates, causing the yield curve to turn inverted. There was, in consequence, a sell-off of natural resource stocks as people who had previously purchased shares on margin had to unload them at distressed prices. Deals that were otherwise uneconomical became possible. What this interesting coincidence of takeovers also says is that many companies involved in basic industrial activity -- mining, oil and gas, infrastructure, and basic manufacturing -- are relatively cheap. At Agora Financial, we have been saying this for a long time.

Until we meet again,
Byron W. King

Byron W. King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000-foot well, Byron also served for many years in both the active and reserve components of the United States Navy.
While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the recently-re-elected commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.

Flationed Out

2006-06-21T19:11:00.000-07:00

by Mike "Mish" Shedlock
Illinois, U.S.A.

for Whiskey & Gunpowder
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I HAVE BEEN pondering the word "stagflation." Nearly everyone but me seems to think we are in it or headed for it. What exactly does stagflation mean anyway?

Let's take a look at two definitions and a comment:

1. "Sluggish economic growth coupled with a high rate of inflation and unemployment" (American Heritage Dictionary)

2. "A condition of slow economic growth and relatively high unemployment -- a time of stagnation -- accompanied by a rise in prices, or inflation" (Investopedia.com)

3. "Investopedia commentary: "Stagflation occurs when the economy isn't growing, but prices are, which is not a good situation for a country to be in. This happened to a great extent during the 1970s, when world oil prices rose dramatically, fueling sharp inflation in developed countries...For these countries, stagnation increased the inflationary effects."

From above context, stagflation seems to be based on rising prices (instead of an expansion of credit), and furthermore, the term seems to imply that rising prices are bad only in context of the "stag."

An Austrian View of "Flation"

Inflation -- Expansion of money and credit

Deflation -- Contraction of money and credit

Disinflation -- Expansion of money and credit, but at a declining pace

Hyperinflation -- Rapid rise in inflation accompanied by a complete loss of confidence in currency

In Austrian terms, I find little use for such a term. Where exactly does it fit in?

Several days ago, I sent an article that called for "stagflation" to a good friend of mine who posts under the name "Trotsky" on Kitco. We had not discussed that term before, but knowing his Austrian leanings, his answer did not surprise me at all. It is as follows (note: He does not capitalize his sentences):

"what immediately comes to mind is that the term was coined with a Keynesian mind-set -- as if it were a new phenomenon that sort of 'just happens' without a sensible explanation at hand. at the time of the 1970s K summer, economists had been conditioned to associate economic downturns with deflation -- the inflationary recession of the early 1920s was long forgotten. when suddenly recession coincided with the effects of the concurrent inflationary monetary policy becoming highly visible, something happened that wasn't supposed to happen. so they thought it required a new term -- 'stagflation,' equaling recession cum inflation, the supposedly 'unnatural' state of affairs. Obviously, once you define inflation correctly (expansion of the fiat money supply), such a term makes no sense. especially considering that the Keynesian (as well as monetarist, i might add) recipe for 'combating economic downturns' consists of deficit spending cum monetization, i.e., printing lots of money, as a matter of course! perversely, application of this recipe leads only to bigger failures (proven by EVERY major application of it, including, IMO, the most recent one, which only created yet another surge in malinvestment, namely the housing bubble).

"the only reason why at times the inflation seemingly 'works' and at other times doesn't is that the initial conditions, as defined by the K seasons vary. IMO, there are two aspects that play a role -- the state of the pool of real funding (if it is shrinking, no amount of monetary pumping can even create the illusion of a new boom -- that's Japan from '89 onward) and the size of the private sector debt extant at the conclusion of the last boom.

"note that the term 'boom' is actually a negative term, or should be. during the boom, which is itself a result of lax monetary policy, capital is malinvested and the economy's production structure damaged/distorted. the bust is the economy's attempt at RECTIFYING the mistakes of the boom by liquidating malinvested capital and redirecting those resources to their optimal use (usually, that entails the realization that assumptions about future demand were simply wrong, as they are based on the illusion created by the credit expansion).

"anyway, the rarer condition of deflation as we understand it in the context of the fiat system is simply a credit contraction so massive that it overwhelms the countervailing attempts of the central bank to inflate. one must not forget the credit was largely created from thin air -- in a deflation, it simply goes back there.

"in any event, ultimately, 'stagflation' does not describe anything really...even though we know what it is meant to describe. simply put, it's the type of bust where the usual inflationary policy is noticed by everybody because prices and wages start to rise everywhere (because the 'debtberg' is still able to expand further)."

An Austrian Debate

Actually, I think the origin is probably far simpler. Someone wanted to talk about "stagnation" and accidentally said "stagflation" or perhaps said "stagflation" purposely trying to be cute. In any case, the word stuck, but as Trotsky pointed out, the word makes no real sense from an Austrian point of view. Yet it is only from the Austrian point of view that I wish to debate anyone on inflation.

That last sentence is key, and it has caused a lot of frustration recently. In addition, I keep responding to the same questions over and over again from e-mail and replies to blogs, many from people that do not know (or refuse to accept) what inflation is. In other cases, people are just now finding my blog and just happen to be asking a question I have addressed elsewhere a dozen times. Here are some of the typical questions:

"Mish, doesn't the rise in the price of oil prove you are wrong?"

"Mish, you still haven't explained how we can have a falling U.S. dollar and deflation"

"Mish, the U.S. is not Japan"

"Mish, how is your favorable view of gold consistent with deflation?"

"Mish, isn't it about time for you to throw in the towel?"

"Mish, inflation is our past, present, and future"

And so on and so forth, with no one adding anything to the debate.

One of the problems I face is that people want to be a part of the debate, even though they refuse to accept the terms of the debate. Austrians in general would accept the "Flation" list above (or something reasonably close); others do not. Unless one can agree on definitions, however, there can be no meaningful debate. People keep telling me I am wrong when they do not agree to the terms of the debate.

Following are three people whom I believe do agree with those "Flation" terms as defined above:

1. Marc Faber

2. Steve Saville

3. Robert Blumen

Note that I said they agree with those definitions. All of them disagree with my position. Taking the other side of a debate with Faber is dangerous, but we agree on far more things than we disagree on. Faber also admits deflation is possible (even if unlikely). Most inflationists will not even grant that.

Anyway, I want to thank Robert Blumen for his piece "Must Bernanke Choose Deflation?" simply because he not only agrees with the terms of debate, but he also made a serious effort to understand what I am saying. Hardly anyone else has bothered to try. If you are new to this discussion, not only do I ask you to read Blumen's article, but to click on all the embedded links in his post and read those too. Unless you do that, you cannot understand what I am saying or why.

Blumen disagrees with my position, but there is nothing wrong with that. Should unanimous opinion ever form on something economically related, I confidently predict we would all be wrong, and probably sooner, rather than later.

Questions Answered

I will reply later to his rebuttal, but for now, I want to address some of those questions above.

Q: "Mish, doesn't the dramatic rise in the price of oil prove you are wrong?"

A: No, the price of oil could be rising for many reasons, and perhaps much of that price is related to Peak Oil, dwindling supplies, and geopolitical concerns, rather than directly to monetary expansion. One cannot know for sure what causes any price increase, and that is a key reason why attempting to define inflation by looking at prices is dead wrong. It simply cannot be done. At any rate, prices rise and fall for many reasons, so one simply cannot look at prices to decide if there is inflation. My views on deflation are forward looking, and in response to an expected credit collapse in housing. For now, I freely admit there is inflation, as credit and money supply are still expanding, but note that it is possible for oil prices to keep rising, perhaps dramatically, even during deflation on account of Peak Oil.

Q: "Mish, you still haven't explained how we can have a falling U.S. dollar and deflation"

A: I have not explained how, because a falling dollar is not part of the equation. Inflation is an expansion of money and credit. Rest assured, there was inflation when the U.S. dollar index hit an all-time high of 120. Rest assured the U.S. dollar can sink even in a contraction of money and credit. I am not saying the dollar will fall -- I am saying it could fall. More than likely, the dollar will hold its own. If it falls, I have many reasons why it is unlikely to crash (anytime soon). For starters, it has already collapsed in just a few short years. Everyone thought the euro was trash a few short years ago, and now everyone seems to be a euro bull. That said, I do think the dollar could crash much later on down the road, after debt is wiped clean. A dollar crash will probably occur after everyone gives up on it. In the meantime, I expect savings will rise, and in a worldwide economic debacle, there will be safety in U.S. Treasuries. Note too that many other fiat currencies look just as bad from where we are now. Ideas about hyperinflation with a housing bust and loss of jobs and a worldwide economic bust seem rather silly to me. You are free to disagree, of course. For a more complete discussion of the U.S. dollar, please consider "Is the U.S. Dollar Toast?"

Q: "Mish, the U.S. is not Japan, and besides, Japan really did not have deflation anyway"

A: I never said the U.S. was Japan. And yes, there are big differences. In fact, I have outlined many of those differences between the Japan and the U.S. Some factors, such as demographics, favor the U.S. for avoiding deflation versus Japan. Other factors, most notably consumer debt, are a bigger problem here. Even though we are not Japan, I expect the deflation experience here will be quite similar. Part of that was addressed in "Inflation: What the Heck Is It?" And as for "Japan being a nation of savers" and the U.S. being not: That fact will actually make the snapback to the mean all the more vicious for over-expanded retail stores of all kinds. The U.S. was once a nation of savers, and will likely be again.

Q: "Mish, how is your favorable view of gold consistent with deflation?"

A: This question is really simple. If one views gold as money, it will be hoarded in deflationary times. Housing and equities will both plunge relative to gold, even if gold just manages to stay flat against the U.S. dollar value. That is the key idea. I believe that gold will more than hold its own, but there are no guarantees.

Q: "Mish, isn't it about time for you to throw in the deflation towel?"

A: On the verge of victory? No chance. One of the conditions required for my deflation scenario to unfold was a housing bust: a loss of jobs and income, and rising bankruptcies. Housing is just starting to bust, and eventually that will affect jobs and income. The scenario is just now finally starting to play out.

Q: "Mish, inflation is our past, present, and future"

A: Spoken like a person that has not studied history. Yes, three-quarters of the time, those believing in inflation will be correct. K Cycles are long cycles, lasting up to 80 years in length. By the time a deflationary winter is upon us, most people have known nothing but inflation all their lives. That is why no one sees deflation as a possibility. Memories of 1930 are long, long gone. Note too that length makes timing it a problem. In a 60-80 year cycle, pinpointing the start is not that easy to do. If housing is the "bubble of last resort," as I believe it to be, we can be in a world of hurt over the next seven years or more.

Those questions and similar ones keep coming up again and again and again. I thought I would address them all in one place, and of course, everyone is free to disagree with my conclusions. That said, one cannot have a rational discussion unless one agrees to definitions, and I choose to accept Austrian monetary definitions. In that regard, stagflation is simply not the answer to the "Flation" debate. It has little to do with "Flation" at all, from my point of view.

Mish Addendum: I started writing the above last Thursday. No sooner do I finish writing the article, but right before posting it, a good friend of mine going by the name "Chispas" on Silicon Investor sent me a link to a Forbes article on the topic.

What are they doing reading my mind? Or can it be vice versa? Regardless, let's briefly consider "If It's Not Stagflation...":

"It's not stagflation, but no one can seem to agree on the new term for an economy in which growth is slowing while inflation is rising, such as it is today.

"Could it be 'fearflation,' a term that means it's all just fear, rather than actual inflation that's driving the current economy? Maybe it's 'bubblenomics,' as the U.S. seems to be stuck in a bubble of higher prices, growing unemployment, high housing prices, and a falling dollar. Then again, it could be 'transflation,' the cycle of high gas prices leading to higher inflation. Or how about 'moderflation,' a slowing down accompanied by inflation?...

"Of course, if Bernanke is to be believed, it's not inflation we need to fear, but expectations of inflation...

"So maybe we should describe the current economy as 'Fedflation.'"

Eleven terms were submitted to Forbes to describe the current economy. Click on the above link to see them. YES, I agree with Forbes that it's NOT stagflation (at least someone agrees with me), but NO, we do not need another term for it. With that thought in mind, I changed the title of this article from "Stagflation Anyone?" to the current title selected, because, quite frankly, I am "Flationed Out."

Regards,
Mike Shedlock ~ "Mish"

Michael Shedlock (Mish) worked in the financial services industry for 20 years at some of the top institutions in the country including Harris Bank, the Bank of Montreal, Bank One, First National Bank of Chicago, and First Data Corp. Mish is currently doing economic and investment research for a number of clients. In addition, Mish runs one of the more popular stock boards on the Motley Fool, Investment Analysis Clubs / Mishedlo and one of the more popular boards on Silicon Investor as well, Mish's Global Economic Trend Analysis. You can see more of Mish's writing on his blog also entitled Mish's Global Economic Trend Analysis. While he is not writing about stocks or the economy Mish spends a great deal of time on photography, one of his other passions. Mish has over 80 magazine and book cover credits, for magazines such as Country Magazine, Wisconsin Trails, the Chicago Tribune Sunday Supplement, Browntrout Calendars, and numerous other publications. Some of his Wisconsin and gardening images can be seen at www.michaelshedlock.com.

SAILING WITHOUT AN ANCHOR!

2006-06-21T19:00:00.000-07:00

by Puru Saxena
Editor, Money Matters
June 16, 2006

RECENT HISTORY – Up until the early 1970’s, our planet followed the Bretton Woods agreement of international monetary management. This system sought to secure the advantages of the gold standard without its disadvantages. The US dollar was linked to gold at the rate of $35 per ounce of gold and other nations pegged their currencies to the US dollar. At this fixed rate of US$35 per ounce, foreign governments and central banks were able to exchange dollars for gold. Bretton Woods established a system of payments based on the dollar, in which all currencies were defined in relation to the dollar, which was itself convertible into gold. The U.S. currency was now effectively the world currency, the standard to which every other currency was pegged. As the world's key currency, most international transactions were denominated in dollars.

During the 1960’s, the US accumulated massive deficits and when the French demanded gold in exchange for US dollars, the US refused to redeem its dollars in gold. On 15 August 1971, US President Nixon shut the “gold window”, thereby removing gold from the monetary system. The result was inevitable – currencies started floating against each other and without gold as the anchor, nations gave up on their monetary discipline. A fabulous new era of “endless prosperity” had arrived! Central banks became obsessed with monetary inflation, world-trade benefited and the world’s foreign exchange reserves exploded. Figure 1 captures this development in all its glory. In 1971, the non-gold reserves of all countries were worth US$100 billion and today these have grown to roughly $4.3 trillion – an alarming 43-fold increase in 35 years!

Figure 1: Explosion in global non-gold reserves!

Source: www.yardeni.com

As the amount of money within the financial system increased due to the absence of gold, prices within the economy started rising. Once currencies were no longer linked to gold, the global economy became a ship without an anchor, floating from one “boom and bust” cycle to another! Rampant monetary inflation fuelled by the growth of credit turned the capital markets into one giant casino as punters worldwide (often loaded with credit) searched for the next opportunity to make a fortune.

In the 1970’s, this excessive liquidity churned out by the central banks found a home in commodities as the price of raw materials went crazy. During the 1980’s, investors piled into Japanese assets as stocks and real-estate soared. And in the 1990’s, when we were ushering in the new millennium, our world fell in love with the technology, media and telecom sector. Each of these booms was accompanied by rapid credit growth, heavy speculation based on unrealistic expectations and unfortunately they all met their common fate – the eventual bust!

Since the “tech wreck” in 2000, this excessive capital floating around the system has found a refuge in real-estate. Today, the public’s money is predominantly in property and everyone is convinced that the current boom will last forever. “What me worry? Nah, real-estate always goes up!” seems to be the common argument. Allow me to share a secret – no asset-class goes up in a straight line and property investors may be in for a rude shock if interest-rates continue to rise, which in my view is inevitable.

History has shown that rising interest-rates have always been bad news for stocks, bonds and highly-leveraged properties. Will this time be different? I guess we’ll find out!

THE FUTURE – I must admit that I don’t have a crystal ball, but wait, neither does anybody else. In the business of investing, we’re always dealing with change and all we have in our arsenal are probabilities based on the ongoing developments around us. At present, I’m most certain about the following mega-trends, which are likely to intensify over the coming decade –

· Transfer of wealth from the West to the emerging world

· Transfer of capital from financial to tangible assets

I base my above forecasts on the fact that due to globalization and the opening up of China and India, 2.3 billion people have now entered the workforce and these people are hungry for success and a better quality of life. After having lived in dismal poverty for decades, the middle-class in these developing countries has now “tasted blood” and it is determined to catch-up with the West.

To be perfectly honest, China is much more developed and its infrastructure far superior than India’s. In fact, I would argue that China probably has the best roads in the world. I might as well add that the same can’t be said of its drivers!

Last week, I traveled to Suzhou (2-hour drive from Shanghai) for a meeting with an extremely successful Chinese businessman. Mr. Wong is the new breed of entrepreneurs and represents modern, capitalist China. He established his manufacturing business 10-years ago and today his annual turnover is US$240 million. Mr. Wong is in the process of building another factory; he has just bought a luxurious Mercedes and his children study in exclusive schools in England! Moreover, I was amazed to learn that one of Mr. Wong’s friends had just built a 5-star luxury hotel in Suzhou by paying US$30 million upfront in cash! Welcome to communist China

Let’s face it, the 21^st century will belong to China. Shanghai is a phenomenal city with countless skyscrapers, huge shopping malls, great restaurants and an energetic population. Even a small town like Suzhou is home to massive factories, modern buildings and its people have an incredible work ethic. You really have to visit China to see what’s going on in the world’s fastest growing economy! For sure, its vast majority is still poor and the wealth divide is getting bigger but I am very excited about China’s future. If my assessment is correct, the world’s oldest civilization has a bright future.

Puru Saxena Ltd.
Suite 1208, Citibank Tower
3 Garden Road, Central, Hong Kong
Phone: (852) 3589 6789 Fax: (852) 3585 5665 Email l Website

INFLATION: THE INVISIBLE TAX!

2006-05-20T13:43:00.000-07:00

by Puru Saxena
Editor, Money Matters
May 12, 2006

THE PICTURE – Officially, the Federal Reserve’s purpose is to fight inflation and manage the economy. Meanwhile, my claim to fame is turning stone into gold! Presented below is the real agenda of the Federal Reserve.

Every human being must understand that the Federal Reserve IS inflation. The Federal Reserve was established in 1913 to create inflation and its secondary role is to manage the public’s inflation FEARS. Over the past 25 years, the Federal Reserve has done a fantastic job at both – inflation (money supply growth) has gone out of control and the public’s inflation fears have been well contained.

Figure 1 shows the consumer price level over the past 200 years. It is interesting to note that consumer prices didn’t rise at all during the entire 19^th century. However, under the “guidance” and “supervision” of the Federal Reserve, consumer prices have risen dramatically. In fact, it is evident from the chart that prices in the economy have increased the most since the early 1970’s when gold was removed from the monetary system. “But why is that so?” you may wonder. The truth is that prices in an economy respond to changes in the supply of money. When we witness inflation (money supply growth), prices rise as the value of money declines due to an increase in its supply. On the other hand, during deflation (money supply contraction), prices fall as the value of money increases due to a decrease in its supply. The reason why prices did not rise at all during the 19^th century is because there was no inflation (money supply growth). In those days, money was backed by gold and the money supply was limited. Therefore, prices remained relatively stable, money held its purchasing power and savings didn’t get destroyed due to inflation.

Once the Federal Reserve came to power, things changed. Firstly, the gold standard was eliminated and then gold was completely removed from the monetary system in the early 1970’s. Once this was accomplished, the Federal Reserve along with other central banks decided to embark on an inflationary rampage. As the supply of money accelerated, consumer prices in the economy surged and savings got totally destroyed due to inflation (money supply growth). This phenomenon is represented in Figure 1, which shows that after remaining relatively stable for 170 years (1800-1970), prices have soared 600% over the past 35 years!

Figure 1: Massive surge in prices since 1971!

Source: Grandfather Economic Report

Inflation is an increase in the quantity of money and it is created deliberately by the central banks. As Nobel Prize winner, Dr. Milton Friedman said “Inflation is always and everywhere a monetary phenomenon. To control inflation, you need to control the money supply”. So, you see that inflation is NOT a mysterious by-product, which simply emerges in an economy. But why would central banks create inflation? To answer this question, you have to ask yourself who benefits from the monetisation of the economy? Who makes money from issuing more and more debt?

In order for the present monetary system to be accepted by the public, inflation must remain concealed. If the public discovered the truth, there would be tremendous uproar. Accordingly, central banks keep up the propaganda by claiming that inflation is tame and under control. I’m sorry to disappoint you, but what’s under control in not inflation but inflation FEARS. By artificially suppressing the Consumer Price Index through complicated adjustments, central banks continue to please the public. Still not convinced? Take a look at Figure 2, which compares growth of the broad money supply (red curve) with the shrinking value of a 1950 dollar as determined by the cost of living index (blue curve). The rising red curve shows that the money supply grew from $302 billion in 1959 to over $9.5 trillion in 2004 – an astonishing explosion of 3,000%! If this isn’t inflation, then I don’t know what is! During the same period, the US dollar’s purchasing power, as defined by the blue curve, collapsed by 85%! In other words, due to money supply growth, the dollar saved in 1950 is worth only 15 cents today!

Figure 2: Money supply growth = Destruction of your savings!

Source: Grandfather Economic Report

It’s only normal to expect that the standard of living in any civilisation should get better with industrialisation and advancements in technology. After all, in today’s “modern” world of abundance, food is plentiful and modes of transportation and communication are extremely efficient due to the progress made over the past 50 years. All these factors, should’ve translated into a much more relaxed and comfortable life for everyone. Unfortunately, if you look around today, you’ll realise that despite all these advancements, human life for the average person has never been tougher! 50 years ago, families could survive on one income and debt levels were very low. These days, the average household needs two incomes, people are working longer and everybody is up to their eyeballs in debt! So, what’s gone so horribly wrong? Basically, inflation (money supply growth) has turned people into slaves! No matter how much you save, it’s never enough because things always seem to get more expensive. I’ll let you in on a secret – as long as the current monetary system continues, life isn’t going to get any easier. However, we all have to live within the system, therefore it is vital to understand the situation and invest in appropriate assets which will benefit the most from the ongoing monetary inflation.

The above is an excerpt from Money Matters, a monthly economic publication, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly reports, subscribers also benefit from timely and concise "Email Updates", which are sent out when an important development in the capital markets warrants immediate attention. Subscribe Today!

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What the Price of Gold is Telling Us

2006-04-28T16:53:00.000-07:00

HON. RON PAUL OF TEXAS
Before the U.S. House of Representatives

April 25, 2006

The financial press, and even the network news shows, have begun reporting the price of gold regularly. For twenty years, between 1980 and 2000, the price of gold was rarely mentioned. There was little interest, and the price was either falling or remaining steady.

Since 2001 however, interest in gold has soared along with its price. With the price now over $600 an ounce, a lot more people are becoming interested in gold as an investment and an economic indicator. Much can be learned by understanding what the rising dollar price of gold means.

The rise in gold prices from $250 per ounce in 2001 to over $600 today has drawn investors and speculators into the precious metals market. Though many already have made handsome profits, buying gold per se should not be touted as a good investment. After all, gold earns no interest and its quality never changes. It’s static, and does not grow as sound investments should.

It’s more accurate to say that one might invest in a gold or silver mining company, where management, labor costs, and the nature of new discoveries all play a vital role in determining the quality of the investment and the profits made.

Buying gold and holding it is somewhat analogous to converting one’s savings into one hundred dollar bills and hiding them under the mattress-- yet not exactly the same. Both gold and dollars are considered money, and holding money does not qualify as an investment. There’s a big difference between the two however, since by holding paper money one loses purchasing power. The purchasing power of commodity money, i.e. gold, however, goes up if the government devalues the circulating fiat currency.

Holding gold is protection or insurance against government’s proclivity to debase its currency. The purchasing power of gold goes up not because it’s a so-called good investment; it goes up in value only because the paper currency goes down in value. In our current situation, that means the dollar.

One of the characteristics of commodity money-- one that originated naturally in the marketplace-- is that it must serve as a store of value. Gold and silver meet that test-- paper does not. Because of this profound difference, the incentive and wisdom of holding emergency funds in the form of gold becomes attractive when the official currency is being devalued. It’s more attractive than trying to save wealth in the form of a fiat currency, even when earning some nominal interest. The lack of earned interest on gold is not a problem once people realize the purchasing power of their currency is declining faster than the interest rates they might earn. The purchasing power of gold can rise even faster than increases in the cost of living.

The point is that most who buy gold do so to protect against a depreciating currency rather than as an investment in the classical sense. Americans understand this less than citizens of other countries; some nations have suffered from severe monetary inflation that literally led to the destruction of their national currency. Though our inflation-- i.e. the depreciation of the U.S. dollar-- has been insidious, average Americans are unaware of how this occurs. For instance, few Americans know nor seem concerned that the 1913 pre-Federal Reserve dollar is now worth only four cents. Officially, our central bankers and our politicians express no fear that the course on which we are set is fraught with great danger to our economy and our political system. The belief that money created out of thin air can work economic miracles, if only properly “managed,” is pervasive in D.C.

In many ways we shouldn’t be surprised about this trust in such an unsound system. For at least four generations our government-run universities have systematically preached a monetary doctrine justifying the so-called wisdom of paper money over the “foolishness” of sound money. Not only that, paper money has worked surprisingly well in the past 35 years-- the years the world has accepted pure paper money as currency. Alan Greenspan bragged that central bankers in these several decades have gained the knowledge necessary to make paper money respond as if it were gold. This removes the problem of obtaining gold to back currency, and hence frees politicians from the rigid discipline a gold standard imposes.

Many central bankers in the last 15 years became so confident they had achieved this milestone that they sold off large hoards of their gold reserves. At other times they tried to prove that paper works better than gold by artificially propping up the dollar by suppressing market gold prices. This recent deception failed just as it did in the 1960s, when our government tried to hold gold artificially low at $35 an ounce. But since they could not truly repeal the economic laws regarding money, just as many central bankers sold, others bought. It’s fascinating that the European central banks sold gold while Asian central banks bought it over the last several years.

Since gold has proven to be the real money of the ages, we see once again a shift in wealth from the West to the East, just as we saw a loss of our industrial base in the same direction. Though Treasury officials deny any U.S. sales or loans of our official gold holdings, no audits are permitted so no one can be certain.

The special nature of the dollar as the reserve currency of the world has allowed this game to last longer than it would have otherwise. But the fact that gold has gone from $252 per ounce to over $600 means there is concern about the future of the dollar. The higher the price for gold, the greater the concern for the dollar. Instead of dwelling on the dollar price of gold, we should be talking about the depreciation of the dollar. In 1934 a dollar was worth 1/20th of an ounce of gold; $20 bought an ounce of gold. Today a dollar is worth 1/600th of an ounce of gold, meaning it takes $600 to buy one ounce of gold.

The number of dollars created by the Federal Reserve, and through the fractional reserve banking system, is crucial in determining how the market assesses the relationship of the dollar and gold. Though there’s a strong correlation, it’s not instantaneous or perfectly predictable. There are many variables to consider, but in the long term the dollar price of gold represents past inflation of the money supply. Equally important, it represents the anticipation of how much new money will be created in the future. This introduces the factor of trust and confidence in our monetary authorities and our politicians. And these days the American people are casting a vote of “no confidence” in this regard, and for good reasons.

The incentive for central bankers to create new money out of thin air is twofold. One is to practice central economic planning through the manipulation of interest rates. The second is to monetize the escalating federal debt politicians create and thrive on.

Today no one in Washington believes for a minute that runaway deficits are going to be curtailed. In March alone, the federal government created an historic $85 billion deficit. The current supplemental bill going through Congress has grown from $92 billion to over $106 billion, and everyone knows it will not draw President Bush’s first veto. Most knowledgeable people therefore assume that inflation of the money supply is not only going to continue, but accelerate. This anticipation, plus the fact that many new dollars have been created over the past 15 years that have not yet been fully discounted, guarantees the further depreciation of the dollar in terms of gold.

There’s no single measurement that reveals what the Fed has done in the recent past or tells us exactly what it’s about to do in the future. Forget about the lip service given to transparency by new Fed Chairman Bernanke. Not only is this administration one of the most secretive across the board in our history, the current Fed firmly supports denying the most important measurement of current monetary policy to Congress, the financial community, and the American public. Because of a lack of interest and poor understanding of monetary policy, Congress has expressed essentially no concern about the significant change in reporting statistics on the money supply.

Beginning in March, though planned before Bernanke arrived at the Fed, the central bank discontinued compiling and reporting the monetary aggregate known as M3. M3 is the best description of how quickly the Fed is creating new money and credit. Common sense tells us that a government central bank creating new money out of thin air depreciates the value of each dollar in circulation. Yet this report is no longer available to us and Congress makes no demands to receive it.

Though M3 is the most helpful statistic to track Fed activity, it by no means tells us everything we need to know about trends in monetary policy. Total bank credit, still available to us, gives us indirect information reflecting the Fed’s inflationary policies. But ultimately the markets will figure out exactly what the Fed is up to, and then individuals, financial institutions, governments, and other central bankers will act accordingly. The fact that our money supply is rising significantly cannot be hidden from the markets.

The response in time will drive the dollar down, while driving interest rates and commodity prices up. Already we see this trend developing, which surely will accelerate in the not too distant future. Part of this reaction will be from those who seek a haven to protect their wealth-- not invest-- by treating gold and silver as universal and historic money. This means holding fewer dollars that are decreasing in value while holding gold as it increases in value.

A soaring gold price is a vote of “no confidence” in the central bank and the dollar. This certainly was the case in 1979 and 1980. Today, gold prices reflect a growing restlessness with the increasing money supply, our budgetary and trade deficits, our unfunded liabilities, and the inability of Congress and the administration to reign in runaway spending.

Denying us statistical information, manipulating interest rates, and artificially trying to keep gold prices in check won’t help in the long run. If the markets are fooled short term, it only means the adjustments will be much more dramatic later on. And in the meantime, other market imbalances develop.

The Fed tries to keep the consumer spending spree going, not through hard work and savings, but by creating artificial wealth in stock markets bubbles and housing bubbles. When these distortions run their course and are discovered, the corrections will be quite painful.

Likewise, a fiat monetary system encourages speculation and unsound borrowing. As problems develop, scapegoats are sought and frequently found in foreign nations. This prompts many to demand altering exchange rates and protectionist measures. The sentiment for this type of solution is growing each day.

Though everyone decries inflation, trade imbalances, economic downturns, and federal deficits, few attempt a closer study of our monetary system and how these events are interrelated. Even if it were recognized that a gold standard without monetary inflation would be advantageous, few in Washington would accept the political disadvantages of living with the discipline of gold-- since it serves as a check on government size and power. This is a sad commentary on the politics of today. The best analogy to our affinity for government spending, borrowing, and inflating is that of a drug addict who knows if he doesn’t quit he’ll die; yet he can’t quit because of the heavy price required to overcome the dependency. The right choice is very difficult, but remaining addicted to drugs guarantees the death of the patient, while our addiction to deficit spending, debt, and inflation guarantees the collapse of our economy.

Special interest groups, who vigorously compete for federal dollars, want to perpetuate the system rather than admit to a dangerous addiction. Those who champion welfare for the poor, entitlements for the middle class, or war contracts for the military industrial corporations, all agree on the so-called benefits bestowed by the Fed’s power to counterfeit fiat money. Bankers, who benefit from our fractional reserve system, likewise never criticize the Fed, especially since it’s the lender of last resort that bails out financial institutions when crises arise. And it’s true, special interests and bankers do benefit from the Fed, and may well get bailed out-- just as we saw with the Long-Term Capital Management fund crisis a few years ago. In the past, companies like Lockheed and Chrysler benefited as well. But what the Fed cannot do is guarantee the market will maintain trust in the worthiness of the dollar. Current policy guarantees that the integrity of the dollar will be undermined. Exactly when this will occur, and the extent of the resulting damage to financial system, cannot be known for sure-- but it is coming. There are plenty of indications already on the horizon.

Foreign policy plays a significant role in the economy and the value of the dollar. A foreign policy of militarism and empire building cannot be supported through direct taxation. The American people would never tolerate the taxes required to pay immediately for overseas wars, under the discipline of a gold standard. Borrowing and creating new money is much more politically palatable. It hides and delays the real costs of war, and the people are lulled into complacency-- especially since the wars we fight are couched in terms of patriotism, spreading the ideas of freedom, and stamping out terrorism. Unnecessary wars and fiat currencies go hand-in-hand, while a gold standard encourages a sensible foreign policy.

The cost of war is enormously detrimental; it significantly contributes to the economic instability of the nation by boosting spending, deficits, and inflation. Funds used for war are funds that could have remained in the productive economy to raise the standard of living of Americans now unemployed, underemployed, or barely living on the margin.

Yet even these costs may be preferable to paying for war with huge tax increases. This is because although fiat dollars are theoretically worthless, value is imbued by the trust placed in them by the world’s financial community. Subjective trust in a currency can override objective knowledge about government policies, but only for a limited time.

Economic strength and military power contribute to the trust in a currency; in today’s world trust in the U.S. dollar is not earned and therefore fragile. The history of the dollar, being as good as gold up until 1971, is helpful in maintaining an artificially higher value for the dollar than deserved.

Foreign policy contributes to the crisis when the spending to maintain our worldwide military commitments becomes prohibitive, and inflationary pressures accelerate. But the real crisis hits when the world realizes the king has no clothes, in that the dollar has no backing, and we face a military setback even greater than we already are experiencing in Iraq. Our token friends may quickly transform into vocal enemies once the attack on the dollar begins.

False trust placed in the dollar once was helpful to us, but panic and rejection of the dollar will develop into a real financial crisis. Then we will have no other option but to tighten our belts, go back to work, stop borrowing, start saving, and rebuild our industrial base, while adjusting to a lower standard of living for most Americans.

Counterfeiting the nation’s money is a serious offense. The founders were especially adamant about avoiding the chaos, inflation, and destruction associated with the Continental dollar. That’s why the Constitution is clear that only gold and silver should be legal tender in the United States. In 1792 the Coinage Act authorized the death penalty for any private citizen who counterfeited the currency. Too bad they weren’t explicit that counterfeiting by government officials is just as detrimental to the economy and the value of the dollar.

In wartime, many nations actually operated counterfeiting programs to undermine our dollar, but never to a disastrous level. The enemy knew how harmful excessive creation of new money could be to the dollar and our economy. But it seems we never learned the dangers of creating new money out of thin air. We don’t need an Arab nation or the Chinese to undermine our system with a counterfeiting operation. We do it ourselves, with all the disadvantages that would occur if others did it to us. Today we hear threats from some Arab, Muslim, and far Eastern countries about undermining the dollar system- not by dishonest counterfeiting, but by initiating an alternative monetary system based on gold. Wouldn’t that be ironic? Such an event theoretically could do great harm to us. This day may well come, not so much as a direct political attack on the dollar system but out of necessity to restore confidence in money once again.

Historically, paper money never has lasted for long periods of time, while gold has survived thousands of years of attacks by political interests and big government. In time, the world once again will restore trust in the monetary system by making some currency as good as gold.

Gold, or any acceptable market commodity money, is required to preserve liberty. Monopoly control by government of a system that creates fiat money out of thin air guarantees the loss of liberty. No matter how well-intended our militarism is portrayed, or how happily the promises of wonderful programs for the poor are promoted, inflating the money supply to pay these bills makes government bigger. Empires always fail, and expenses always exceed projections. Harmful unintended consequences are the rule, not the exception. Welfare for the poor is inefficient and wasteful. The beneficiaries are rarely the poor themselves, but instead the politicians, bureaucrats, or the wealthy. The same is true of all foreign aid-- it’s nothing more than a program that steals from the poor in a rich country and gives to the rich leaders of a poor country. Whether it’s war or welfare payments, it always means higher taxes, inflation, and debt. Whether it’s the extraction of wealth from the productive economy, the distortion of the market by interest rate manipulation, or spending for war and welfare, it can’t happen without infringing upon personal liberty.

At home the war on poverty, terrorism, drugs, or foreign rulers provides an opportunity for authoritarians to rise to power, individuals who think nothing of violating the people’s rights to privacy and freedom of speech. They believe their role is to protect the secrecy of government, rather than protect the privacy of citizens. Unfortunately, that is the atmosphere under which we live today, with essentially no respect for the Bill of Rights.

Though great economic harm comes from a government monopoly fiat monetary system, the loss of liberty associated with it is equally troubling. Just as empires are self-limiting in terms of money and manpower, so too is a monetary system based on illusion and fraud. When the end comes we will be given an opportunity to choose once again between honest money and liberty on one hand; chaos, poverty, and authoritarianism on the other.

The economic harm done by a fiat monetary system is pervasive, dangerous, and unfair. Though runaway inflation is injurious to almost everyone, it is more insidious for certain groups. Once inflation is recognized as a tax, it becomes clear the tax is regressive: penalizing the poor and middle class more than the rich and politically privileged. Price inflation, a consequence of inflating the money supply by the central bank, hits poor and marginal workers first and foremost. It especially penalizes savers, retirees, those on fixed incomes, and anyone who trusts government promises. Small businesses and individual enterprises suffer more than the financial elite, who borrow large sums before the money loses value. Those who are on the receiving end of government contracts--especially in the military industrial complex during wartime-- receive undeserved benefits.

It’s a mistake to blame high gasoline and oil prices on price gouging. If we impose new taxes or fix prices, while ignoring monetary inflation, corporate subsidies, and excessive regulations, shortages will result. The market is the only way to determine the best price for any commodity. The law of supply and demand cannot be repealed. The real problems arise when government planners give subsidies to energy companies and favor one form of energy over another.

Energy prices are rising for many reasons: Inflation; increased demand from China and India; decreased supply resulting from our invasion of Iraq; anticipated disruption of supply as we push regime change in Iran; regulatory restrictions on gasoline production; government interference in the free market development of alternative fuels; and subsidies to big oil such as free leases and grants for research and development.

Interestingly, the cost of oil and gas is actually much higher than we pay at the retail level. Much of the DOD budget is spent protecting “our” oil supplies, and if such spending is factored in gasoline probably costs us more than $5 a gallon. The sad irony is that this military effort to secure cheap oil supplies inevitably backfires, and actually curtails supplies and boosts prices at the pump. The waste and fraud in issuing contracts to large corporations for work in Iraq only add to price increases.

When problems arise under conditions that exist today, it’s a serious error to blame the little bit of the free market that still functions. Last summer the market worked efficiently after Katrina-- gas hit $3 a gallon, but soon supplies increased, usage went down, and the price returned to $2. In the 1980s, market forces took oil from $40 per barrel to $10 per barrel, and no one cried for the oil companies that went bankrupt. Today’s increases are for the reasons mentioned above. It’s natural for labor to seek its highest wage, and businesses to strive for the greatest profit. That’s the way the market works. When the free market is allowed to work, it’s the consumer who ultimately determines price and quality, with labor and business accommodating consumer choices. Once this process is distorted by government, prices rise excessively, labor costs and profits are negatively affected, and problems emerge. Instead of fixing the problem, politicians and demagogues respond by demanding windfall profits taxes and price controls, while never questioning how previous government interference caused the whole mess in the first place. Never let it be said that higher oil prices and profits cause inflation; inflation of the money supply causes higher prices!

Since keeping interest rates below market levels is synonymous with new money creation by the Fed, the resulting business cycle, higher cost of living, and job losses all can be laid at the doorstep of the Fed. This burden hits the poor the most, making Fed taxation by inflation the worst of all regressive taxes. Statistics about revenues generated by the income tax are grossly misleading; in reality much harm is done by our welfare/warfare system supposedly designed to help the poor and tax the rich. Only sound money can rectify the blatant injustice of this destructive system.

The Founders understood this great danger, and voted overwhelmingly to reject “emitting bills of credit,” the term they used for paper or fiat money. It’s too bad the knowledge and advice of our founders, and their mandate in the Constitution, are ignored today at our great peril. The current surge in gold prices-- which reflects our dollar’s devaluation-- is warning us to pay closer attention to our fiscal, monetary, entitlement, and foreign policy.

Meaning of the Gold Price-- Summation

A recent headline in the financial press announced that gold prices surged over concern that confrontation with Iran will further push oil prices higher. This may well reflect the current situation, but higher gold prices mainly reflect monetary expansion by the Federal Reserve. Dwelling on current events and their effect on gold prices reflects concern for symptoms rather than an understanding of the actual cause of these price increases. Without an enormous increase in the money supply over the past 35 years and a worldwide paper monetary system, this increase in the price of gold would not have occurred.

Certainly geo-political events in the Middle East under a gold standard would not alter its price, though they could affect the supply of oil and cause oil prices to rise. Only under conditions created by excessive paper money would one expect all or most prices to rise. This is a mere reflection of the devaluation of the dollar.

Particular things to remember:

If one endorses small government and maximum liberty, one must support commodity money.

One of the strongest restraints against unnecessary war is a gold standard.

Deficit financing by government is severely restricted by sound money.

The harmful effects of the business cycle are virtually eliminated with an honest gold standard.

Saving and thrift are encouraged by a gold standard; and discouraged by paper money.

Price inflation, with generally rising price levels, is characteristic of paper money. Reports that the consumer price index and the producer price index are rising are distractions: the real cause of inflation is the Fed’s creation of new money.

Interest rate manipulation by central bank helps the rich, the banks, the government, and the politicians.

Paper money permits the regressive inflation tax to be passed off on the poor and the middle class.

Speculative financial bubbles are characteristic of paper money-- not gold.

Paper money encourages economic and political chaos, which subsequently causes a search for scapegoats rather than blaming the central bank.

Dangerous protectionist measures frequently are implemented to compensate for the dislocations caused by fiat money.

Paper money, inflation, and the conditions they create contribute to the problems of illegal immigration.

The value of gold is remarkably stable.

The dollar price of gold reflects dollar depreciation.

Holding gold helps preserve and store wealth, but technically gold is not a true investment.

Since 2001 the dollar has been devalued by 60%.

In 1934 FDR devalued the dollar by 41%.

In 1971 Nixon devalued the dollar by 7.9%.

In 1973 Nixon devalued the dollar by 10%.

These were momentous monetary events, and every knowledgeable person worldwide paid close attention. Major changes were endured in 1979 and 1980 to save the dollar from disintegration. This involved a severe recession, interest rates over 21%, and general price inflation of 15%.

Today we face a 60% devaluation and counting, yet no one seems to care. It’s of greater significance than the three events mentioned above. And yet the one measurement that best reflects the degree of inflation, the Fed and our government deny us. Since March, M3 reporting has been discontinued. For starters, I’d like to see Congress demand that this report be resumed. I fully believe the American people and Congress are entitled to this information. Will we one day complain about false intelligence, as we have with the Iraq war? Will we complain about not having enough information to address monetary policy after it’s too late?

If ever there was a time to get a handle on what sound money is and what it means, that time is today.

Inflation, as exposed by high gold prices, transfers wealth from the middle class to the rich, as real wages decline while the salaries of CEOs, movie stars, and athletes skyrocket-- along with the profits of the military industrial complex, the oil industry, and other special interests.

A sharply rising gold price is a vote of “no confidence” in Congress’ ability to control the budget, the Fed’s ability to control the money supply, and the administration’s ability to bring stability to the Middle East.

Ultimately, the gold price is a measurement of trust in the currency and the politicians who run the country. It’s been that way for a long time, and is not about to change.

If we care about the financial system, the tax system, and the monumental debt we’re accumulating, we must start talking about the benefits and discipline that come only with a commodity standard of money-- money the government and central banks absolutely cannot create out of thin air.

Economic law dictates reform at some point. But should we wait until the dollar is 1/1,000 of an ounce of gold or 1/2,000 of an ounce of gold? The longer we wait, the more people suffer and the more difficult reforms become. Runaway inflation inevitably leads to political chaos, something numerous countries have suffered throughout the 20th century. The worst example of course was the German inflation of the 1920s that led to the rise of Hitler. Even the communist takeover of China was associated with runaway inflation brought on by Chinese Nationalists. The time for action is now, and it is up to the American people and the U.S. Congress to demand it.

Cash is Trash

2006-04-23T18:19:00.000-07:00

THE PICTURE - Your wealth is being stolen due to inflation, period. Whether you like it or not, central banks continue to churn out a ridiculous amount of paper currencies thereby robbing you of your savings. This is a crucial issue which you must understand if you want to survive and prosper over the coming years.

The global economy has severe imbalances with the US heavily in debt and facing record-high deficits. The total debt monster in the US has now grown to $46 trillion, the trade deficit now exceeds $800 billion and the American consumer is swimming in debt. Similar imbalances can be seen throughout the "developed" economies of the West. Therefore, bankers and governments who want to stay in power at all costs have decided to resort to accelerating the rate of monetary inflation. "But why would they do that?" you may wonder. The answer can be summed up in the following words -

Inflation makes debt less formidable and easier to handle.

Allow me to explain. I want you to imagine that your grandmother took out a loan of $50,000 in 1950. Back then, this was a lot of money and your grandmother would have found it quite hard to service and repay this debt. However, due to inflation over the past 56 years and its consequence (decline in the value of money), your grandmother's debt is now much easier to repay as $50,000 isn't worth that much today. So, you can see that with time and inflation, debt becomes more manageable.

Our world has faced inflation and nothing but inflation since the Great Depression of 1929 as the money supply has increased constantly. However, what concerns me is the fact that the rate of inflation (money supply growth) is likely to sky-rocket over the coming years. Below, I present the money supply growth rates around the world -

Australia +8.1%
Britain +12.2%
Canada +6.4%
Denmark +24%
US +8%
Euro area +8%

Looking at the above figures, you can see that over the past year, a significant amount of money has been introduced into the system. The thesis is that the surging money supply will cause the value of money to drop and make it easier to repay the mountains of debt. "But what about my savings?" you may ask. Frankly, the establishment does not care about your savings. In order to remain popular, the officials almost always cater to the needs of the majority. Today, the majority of the population is heavily in debt and with its back against the proverbial wall! Therefore, you can bet your bottom dollar that the rate of inflation will continue to surge and hyperinflation may not be far away.

Some argue that inflation is a good thing, a necessity in the modern economy as it facilitates trade. Personally, I don't buy into this concept because throughout the 19th century, we witnessed mild deflation, yet our world made huge progress over that period. Next time when somebody says that inflation is okay, ask them if they would like to own shares in a company, if this organisation issued and gave away new shares every year? Would they be interested in owning stock in this great company if roughly 10% new shares were being added to its share capital every year? The truth is that nobody in their right mind would invest in such a scam! Yet, people find it absolutely normal when the same thing happens to their money stock otherwise known as savings!

Money is supposed to be a store of value that acts as a medium of exchange. Well, the paper in circulation today does act as a medium of exchange because you can go to Starbucks and buy a cup of fancy coffee but it surely isn't a store of value! How can it be a store of value when it buys less and less with every passing year? In fact, the US dollar has proven to be such a great store of value that it has lost 92% of its purchasing power since the Federal Reserve was established in 1913! Figure 1 clearly demonstrates the consistent decline in the purchasing power of the US dollar. Unfortunately, this trend is going to worsen in the future, thanks largely to the loose monetary policy of the central banks. So, you can be rest assured that parking your wealth in the "safe haven" of cash is the quickest route to the poorhouse! It is sad but true - cash is trash! If you want to protect your family's wealth, you have to use the system to your advantage. Put simply, you must get rid of your cash and invest in appropriate assets.

Figure 1: Decline in the US dollar's purchasing power (1800-2005)

Source: Barron's

Now that we've established that cash is probably the worst asset to own, we need to figure out which assets are undervalued and worth owning. During highly inflationary times, cash declines in value against everything and this is what we are witnessing today. Real-estate is soaring, commodities are rising and the global stock-markets are also enjoying the liquidity-induced party. Now, I am sure that in a few years from now, all these asset-classes (with the exception of bonds) will be higher than where they are today at least when measured in dollars or euros. In other words, I expect paper currencies to continue losing their purchasing power. Furthermore, if my assessment is correct, commodities and equities of emerging markets will outperform property as well as bonds over the coming decade. The advance will be punctuated by severe corrections but the primary trend is now up.

Furthermore, it may well be that due to hyperinflation, the Dow Jones Industrial Average goes to 20,000 within the next 10 years (too much cash chasing too few stocks). However, I can promise you that if that happens, gold will be at $2,000 per ounce and crude oil will reach $200 per barrel or more. The point I am making is that on a relative basis, I expect tangible assets to outperform stocks and bonds by a long way.

Several analysts are now calling the end of the primary bull-market in commodities. Below, I present a list of some bull-markets we've seen over the past 35 years -

'70's - sugar went up 45 times
'70's - oil went up 30 times
'70's - gold went up 24 times
'70's - silver went up 24 times
'80's - NIKKEI went up 8 times
'80's -'90's - NASDAQ went up 50 times
'80's -'90's - Dow went up 14 times

As you can see from the above, these previous bull-markets in the past took the various items to unprecedented highs as prices surged several-fold. Coming back to the present situation, in the current ongoing bull-market in commodities, gold and silver have doubled in value, oil has increased six times, sugar has risen three-fold and stuff like corn, wheat and cotton haven't even moved. Moreover, the public remains oblivious and hasn't even started investing in this area. These factors combined with the industrialisation of China leave very little doubt in my mind that the current boom in commodities is still in its infancy. How high will she go? All I can safely say is that when the public gets worried about its savings and turns to tangibles, the '70's bull-market in commodities will look like a blip on the radar-screen.

Puru Saxena
www.purusaxena.com

Puru Saxena is the editor and publisher of Money Matters, an economic and financial publication NOW available at www.purusaxena.com.

An investment adviser based in Hong Kong, he is a regular guest on CNBC, BBC, Bloomberg, NDTV Profit and writes for several newspapers and financial journals.

Financial War Games

2006-04-21T08:39:00.000-07:00

by Mike Shedlock
for Whiskey & Gunpowder
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BEFORE GETTING TO "war games," let's recap some past wisdom from the man formerly behind the curtain:

1996 - Greenspan warns about irrational exuberance in the stock market
2000 - Greenspan embraces the "productivity miracle" and says there is no stock market bubble
2001 - Greenspan said bubbles can only be detected in hindsight
2004 - Greenspan says there is no housing bubble
2005 - Greenspan says there is no national housing bubble, even though he admits we have "froth."

It's Different This Time

Here are some select comments from just-released FOMC minutes from the May 16, 2000 meeting shortly after the Nasdaq blowoff top:

Chairman Greenspan:

"My own judgment, and what I plan to recommend to the committee, is that we have an opportunity now to move the funds rate up 50 basis points, remain asymmetric, and effectively adjust our longer-term posture to a better position than the one we are in at the moment. The reason I am not concerned about moving the rate up quickly at this stage is that I think the evidence indicates that productivity, indeed perhaps underlying GDP, is still accelerating. I recognize that the staff's estimate of productivity growth for the first [quarter] is 1 1/2%. I don't believe that estimate for a fraction of a second. Indeed, using the available data on income and profits, which essentially reflect the unit cost structure of nonfinancial corporations, the productivity growth number that falls out of that system according to staff estimates is a 6% annual rate.

"I think we are in a quite different environment than we have seen in the past. In such an environment real long-term interest rates have to rise, and indeed they have risen very significantly in the last several weeks. Real long-term BBB rates are up over 50 basis points after gradually edging higher for quite some period of time. This indicates that the markets are adjusting rapidly to the evidence that overall demand forces are becoming very strong, driven in large part by the supply factors themselves.

"I think what we have is still the beginning, or perhaps we are well into it at this stage, of a significant long-term change in the behavior of the economy. I believe the risks in moving 50 basis points today are not very large because I think the underlying momentum in the economy remains very strong. What is going to happen in the future is probably going to be dependent on a number of developments that we can't really forecast."

Mr. Hoenig:

"Mr. Chairman, everything you said convinced me that a 1/4-point hike seems right. Inflation is not taking off and in fact a lot of the evidence suggests some easing off in the expansion. Moreover, I don't think we should be validating the market necessarily. I think we should be looking at what is in front of us, and 1/4 point with asymmetric language seems most appropriate. A year ago when we were at 4 3/4% on the funds rate, there was a better case for moving more aggressively in the sense that we had put in a lot of stimulus. And yet we were very cautious in moving up."

Is it possible for anyone to have been more wrong? In one meeting he was wrong about productivity, the strength of the economy, where the risks were…and most importantly, right after the start of the Nascrash, came out with one of his most absurd statements ever when he commented, "I think we are in a quite different environment than we have seen in the past." Hook, line, and sinker, Mr. Greenspan bought into "it's different this time" logic, right as the bubble was bursting in front of his own eyes.

Greenspan on Financial Stability

What should have everyone worried right now is this Greenspan flashback from May 5, 2005, when he spoke about risk transfer and financial stability:

"Perhaps the clearest evidence of the perceived benefits that derivatives have provided is their continued spectacular growth. The use of a growing array of derivatives and the related application of more-sophisticated approaches to measuring and managing risk are key factors underpinning the greater resilience of our largest financial institutions, which was so evident during the credit cycle of 2001-02 and which seems to have persisted. Derivatives have permitted the unbundling of financial risks. Because risks can be unbundled, individual financial instruments now can be analyzed in terms of their common underlying risk factors, and risks can be managed on a portfolio basis. Partly because of the proposed Basel II capital requirements, the sophisticated risk-management approaches that derivatives have facilitated are being employed more widely and systematically in the banking and financial services industries.

"As is generally acknowledged, the development of credit derivatives has contributed to the stability of the banking system by allowing banks, especially the largest, systemically important banks, to measure and manage their credit risks more effectively. In particular, the largest banks have found single-name credit default swaps a highly attractive mechanism for reducing exposure concentrations in their loan books while allowing them to meet the needs of their largest corporate customers."

The greatest evidence of the benefits of derivatives is spectacular growth? That sounds like bubble logic to me. There is $17 trillion in derivatives floating around with $1 trillion bet on GM alone, even though GM has a market cap of $20 billion or so. Is that a sign of a spectacular success, or is that a sign of unbelievable speculative leverage? Obviously, Greenspan learned nothing from the stock market crash of 2000. He is now claiming that derivatives have permitted the unbundling of financial risks. Have they? I have a couple of questions for you, Mr. Greenspan, that might bring you back to reality. Is there not a counter party to those trillions of dollars worth of derivatives? Has that risk been magically offloaded to Pluto or Mars? If not, who has that risk?

Clearly, Greenspan was babbling nonsense in May 2005, just as he was babbling nonsense in May 2000 and at nearly every other point in his career as well.

Liquidity Concerns

On April 11, the IMF warns over credit derivative liquidity.

"Investors in structured credit products risk not being able to sell or obtain an acceptable price following a market downturn because buyers may shun the fast-growing market, the IMF said on Tuesday.

"The risk of liquidity disturbances is 'material ... (and) certain products and market segments are particularly vulnerable,' the International Monetary Fund said in its annual Global Financial Stability Report.

"The secondary market, away from the biggest banks, was more likely to be at risk, it said…

"Still, IMF concern over credit derivative liquidity was set in the report against a largely positive overview.

"'Credit derivative and structured credit markets help to improve financial stability by facilitating the dispersion of credit risks,' the Fund concludes, as 'banks, especially systemically important institutions...shift credit risk to a broader set of investors'…

"In addition, the Fund said, the rapid growth of the $17.3 trillion market raised concerns over the potential for operational failures.

"The Fund welcomed moves by regulators to tackle operational issues, but said the industry should be 'encouraged to pursue these efforts expeditiously in order to avoid potential disputes in the event of a default'…

"In some cases more credit default swaps have been written on specific companies than there are bonds of that company outstanding. After a default there is a need for a system to settle the contracts without conventional delivery of a bond."

Leave it to the IMF to ruin a decent report with "Greenspanesque" talk such as "credit derivative and structured credit markets help to improve financial stability by facilitating the dispersion of credit risks." There is little evidence of dispersion, but there is mammoth evidence of speculation when hedge funds and others have massively leveraged bets on whether companies go bankrupt or not, even when they have no vested interest. Even the mortgage market is insane, with everyone attempting to pass the trash to Fannie Mae while trying to keep the "good loans" on their books. Even if everyone did miraculously manage to disperse the risk, will it be a good thing if trillions of dollars in bets vanish on some sort of blowup?

It seems to me there is some sort of uncertainty as to what might really happen in a derivatives meltdown. Back on Feb. 28, the Bond Market Association announced a "new bank" to provide crucial liquidity in emergencies:

"The Bond Market Association announced that it has accepted an invitation by a private-sector working group established by the U.S. Federal Reserve Board to develop and lead the creation of a so-called 'NewBank', a standby bank that would only be activated if one of two existing clearing banks in the U.S. government securities markets was suddenly forced to leave the business. Both government officials and market participants have long been concerned about the possibility, even if remote, of one of the banks suddenly exiting the markets and have agreed the NewBank concept is an appropriate precautionary measure…

"Since the mid-1990s all of the major participants in the U.S. government securities markets have depended critically on one of two clearing banks, Bank of New York and J.P. Morgan Chase, to settle their trades and to facilitate financing of their securities inventory positions. Interruption of a clearing bank's services has the potential to severely disrupt those markets, as was evident in the wake of the tragic events of Sept. 11.

"'Securities dealers need a contingency plan in the event one of the clearing banks is forced to exit the markets,' commented Micah S. Green, president and CEO of the Bond Market Association. 'Establishing NewBank is a prudent market-based initiative aimed at mitigating any potential problems caused by the sudden involuntary exit of one of the banks.'"

Preparation for a Crisis

Over in the United Kingdom, The Times Online is reporting that E.U. regulators are told to be prepared for a crisis:

"Financial regulators in all E.U. countries are to be asked today to prepare for the collapse of a big hedge fund or a similar sudden financial shock. E.U. finance ministers and central bankers, meeting in Vienna, were told that the collapse of a hedge fund could now destabilize European financial systems as well as the financial markets.

"They have equally raised anxieties about the rapid growth of private equity. They fear that this could unravel if one of the key sources of funds or markets for selling on companies dries up. Officials also argue that many regulators do not understand the risks involved in the £10,000 billion market in credit derivatives, which are traded privately between banks rather than on public exchanges.

"A private report drawn up by finance ministry officials of E.U. states says: 'Hedge funds can contribute to market efficiency and sharing of risks but can also be a source of systems risks.' The report urges the central banks and regulators to monitor banks' exposure to hedge funds, both as lenders and as counterparties to massive speculative positions in financial and commodity derivatives. Banks are also heavy lenders to private equity buyouts, which provide them with more profitable but riskier business."

War Games

Also in the United Kingdom, I am pleased to report that Europe simulates a financial meltdown:

"Europe's financial regulators have held a 'war game' exercise, simulating a continent-wide financial crisis, amid fears they are ill- prepared to stop a problem in one country spreading across borders.

"The exercise involved simulating the collapse of a big bank with operations in several large countries to see whether the European Central Bank, national central banks, and finance ministries could work together to contain the crisis.

"It is understood the exercise took place at the headquarters of the ECB in Frankfurt at the end of last week. One person involved said: 'It is like checking whether a nuclear power plant can survive a plane crashing into it'…

"Europe's vulnerability to a cross-border financial crisis was revealed in a confidential report prepared by officials for the Ecofin council. Regulators are particularly worried about the risks to financial stability posed by the growth in hedge funds and credit derivatives.

"It said that 'progress has been insufficient in most of the member states' in putting in place national structures for crisis management, and urged national regulators to stage their own crisis simulation exercises.

"The E.U. has rejected the creation of a single European financial regulator to manage cross-border risks, and has instead placed its faith in national authorities working together."

What We Are Saying vs. What We Are Doing

Here is a recap of what Greenspan said:

· Perhaps the clearest evidence of the perceived benefits that derivatives have provided is their continued spectacular growth
· The use of a growing array of derivatives and the related application of more-sophisticated approaches to measuring and managing risk are key factors underpinning the greater resilience of our largest financial institutions
· The development of credit derivatives has contributed to the stability of the banking system by allowing banks, especially the largest, systemically important banks, to measure and manage their credit risks more effectively.

Here is what we are doing:

· Creating a 'NewBank' to provide liquidity in emergencies
· Simulating financial meltdowns caused by an explosion in hedge funds and credit derivatives.

I have three questions:

1. If the explosion in credit derivatives is making us safer, why do we need to create a new bank to deal with liquidity issues?
2. If the explosion in credit derivatives is making us safer, why are we simulating financial meltdowns based on those very same derivatives blowing up?
3. How long will it take before Greenspan is proven spectacularly wrong once again?

Regards,
Mike Shedlock ~ "Mish"

Michael Shedlock (Mish) worked in the financial services industry for 20 years at some of the top institutions in the country including Harris Bank, the Bank of Montreal, Bank One, First National Bank of Chicago, and First Data Corp. Mish is currently doing economic and investment research for a number of clients. In addition, Mish runs one of the more popular stock boards on the Motley Fool, Investment Analysis Clubs / Mishedlo and one of the more popular boards on Silicon Investor as well, Mish's Global Economic Trend Analysis. You can see more of Mish's writing on his blog also entitled Mish's Global Economic Trend Analysis. While he is not writing about stocks or the economy Mish spends a great deal of time on photography, one of his other passions. Mish has over 80 magazine and book cover credits, for magazines such as Country Magazine, Wisconsin Trails, the Chicago Tribune Sunday Supplement, Browntrout Calendars, and numerous other publications. Some of his Wisconsin and gardening images can be seen at www.michaelshedlock.com.

The Oil Crisis and Indian Demand

2006-04-20T16:44:00.000-07:00

by Julian D.W. Phillips
April 18, 2006

Gold has now firmly broken through the $600 level and set to rise much higher.

The Oil Crisis

Perhaps this title is an understatement, because we are facing far more than simply an oil crisis. The difference between the price of Brent Crude and West Texas is disappearing as supplies are rapidly being overtaken by demand.

The capacity cushion in the entire oil industry was at 1.7 million barrels, 1.5 million of which sits with OPEC. We believe this has dropped to perhaps below 1 million barrels per day by now and dropping fast. The questions we have to ask now are:

The interruption in supplies from the Nigerian Delta region are continuing, that’s up to 600,000 barrels down on global supplies. What will happen if supplies from Nigeria, Iran or places like Venezuela are interrupted?

Chad is threatening to hold back 160,000 barrels a day.

What if suppliers turn to exclusive contracts with individual nations like China to the detriment of other buyers?

To what extent will individual nations go to, to secure their own supplies of oil?

ust how far will the U.S. go to, to ensure continued supplies from the Middle East?

Clearly we are on the brink of a global oil shortage.

Iran

A strike against Iran is close to a certainty now. Few doubt this it seems. But we have to ask why? Yes, the nuclear enrichment programme is a focal point, but far more is at stake here. And we are not talking about political factors or nuclear threats. We are talking of the consequences of these actions. We are not here to moralise, to justify or support or oppose any of these actions. We are here to help our Subscribers assess the consequences and their effect on the gold market primarily, through the events that take place in this globe of ours.

One of the immediate consequences is rising levels of tension, as war raises its ugly head. Should there be a strike against Iran’s nuclear facilities, Iran is unable to react, effectively, militarily. Their ‘revenge’ will probably only be seen in its control of its own oil supplies. It has always had the option of diverting all its production to the East, to attempt to keep the oil price rising. But such ploys will lead to three figure oil prices and elevated levels of global tension.

On top of this the possibility of sectarian violence lies ready to persuade the Middle East in its entirety, to expand sectarian violence, causing supply ruptures thereby eliminating any remaining surpluses.
Indian Demand.

The Indian economy itself continues to enjoy growing wealth. A holding back of investment into gold has been because of the price. The enrichment of all Indians will over the longer term, be to the benefit of the gold market. The acquisition of wealth will lead to greater consumer goods being purchased, but gold is the destination of savings and investments away from the visible economy too, so gold will remain a major feature of Indian’s lives.

As the wedding season kicked off on the 14th April, we expect the break through the Rs. 27,000 to spur buying, as the realisation that the high prices are here to stay. Yes, there is dishoarding and it is growing. Indian demand has reached 1,000 tonnes a year in the past of which 850 tonnes was imported previously. Imports this year are close to zero and even now wedding purchases of gold are down 30 to 50% so far, but that leas 50 – 70% of normal gold buying continuing. This could well lead to Indian imports even below 400 tonnes this year if this continues, but this is clearly not slowing the price rise of gold.

Those staying out of the market have and will miss out on these rises unless they change their stance. It appears that small retailers and their clients will adjust their view, so we do expect them to return to the market once they realise that prices are not going to come down.

How can we be so certain? A family Elder in India is cautious in the face of the price rises in the market. Imagine him going home and telling his wife and daughter that because the gold price has risen 20 or 30% he is going to break the age-old tradition of buying gold for the daughter on her wedding day to provide financial security for the couple. He would risk a lynching for sure. No, we expect that after six months of waiting, he will go to the market and buy gold, albeit in smaller volumes. There are signs that this is now happening.

One dealer said the current prices were sustainable. "People now have a little more confidence in high prices," said one dealer in Mumbai. Consumers are used to high prices it seems?

© 2006 Julian D. W. Phillips

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Lighten Up and Enjoy the Commodities Ride

2006-04-12T22:20:00.000-07:00

by Dudley Baker

Our rather pessimistic articles of late on the housing bubble, the ominous warnings from a long list of financial experts and their suggestions on how to best weather the impending financial hurricane have been refuted by none other than the well read author of our "Crazy Man" articles (see "A Crazy Man's Rant or Right On? You be the Judge" and "Crazy Man's Rant - He's Crazy Like a Fox!") who sees things completely differently. Who is right - the eternal optimist with a different take on the economic environment or the big bad bears? Below are his comments.

"I have been beset, of late, by a number of anomalies in what I read and know about the economy and how they translate into an imminent housing collapse and how those linkages to other major segments of the economy would cause general economic bedlam.

Be that as it may, I am convinced that we are in the early stages of a multi-year secular commodities bull market.

I am equally convinced of "peak oil" and the merits of energy investments whether they be for reasons of supply, geopolitical or for environmental reasons.

I am also convinced of the large and continuing incremental demand for base metals and other commodities by the growing economies of Asia centered around China and India.

And, finally, I am totally convinced that this demand for base metals and other commodities will continue to escalate even if recession becomes the order of the day in the United States and other developed western economies because of the explosion of savings and demand by the growing middle class of Asia.

I am puzzled, however, as to why you are so convinced that housing demand and prices are on the brink of tanking.

As I see it the recent increase in short term interest rates are not that unsettling (John Mauldin, in his recent article entitled 'When Will the Fed Stop?' supports my contention making the point that from an historical basis the Fed funds rate is not that high given the fact that from 1946 through 2000 the median fed fund rate was over 6% and yet the U.S. economy grew rapidly during that period) and the almost permanently static longer term interest rates continue to make housing a tremendously affordable proposition. In addition, institutional lenders continue to bend over backwards to accommodate buyers.

Your "Our Worst Nightmare" articles on the housing market (see "Our Worst Nightmare - The Puncture of the Current US Housing Bubble" and "Our Worst Nightmare - The Bubble Has Burst") are sensationalist and misleading. Housing is a hard commodity. It is real, concrete, can be seen and used. Compared to paper representing bonds and equity shares, it is tangible just as all other commodities are. So if we are really in a commodity secular bull cycle, why should we despair over the suggested imminent collapse of the housing market? Where is the nightmare? Moreover, if the FED continues to be accommodative in terms of money supply, interest rates and credit generally, why should the buoyant housing market fall apart prompting all the other elements of the economy dependent upon it to do the same? Again I ask: where is the nightmare?

As I see it, official employment figures indicate a strong economy and the CPI index is not in the least inflationary. Also, surveys of consumer and producer confidence stand almost at multi-year highs. Knowing that Robert Prechter preaches that public attitudes and social mood lead to behavior and activity - not the other way around as we almost all believe - this public optimism bodes well for a continuation of the current economic reality. With an always accommodating FED policy of M3 annual growth in the money supply of almost ten percent, all should be sweetness and light for continuing consumer led demand and economic growth. As I see it, all your 'ominous warnings and dire predictions' are also way off base and are alarmist at best.

You go on and on in your "Ominous Warnings and Dire Predictions" articles (see "Ominous Warnings and Dire Predictions of the World's Financial Experts Part 1 and 2 of a 6 part series) about all kinds of things but:

a) fail to address why so many people are so optimistic given the obvious inflationary consequences of growth in the money supply, bubble-like housing prices and a loss of affordability because of rising house prices.

b) fail to express concern that official numbers relating to the Consumer Price Index, unemployment, GDP and other measures of economic reality are largely bogus and

c) fail, most importantly, to mention the unfunded liabilities of Social Security IOU's, Medicaid, Medicare and its new drug plan, Freddie and Fannie Mae and the Pension Guaranty Corporation which purportedly backstops underfunded private and public sector defined benefit pension plans.

Now I may be talking out of both sides of my mouth here but I also feel strongly that this lengthening list of economic fundamentals are, indeed, alarming and can not continue indefinitely without a blow up. Politicians and central bankers along with their cheerleaders in the brokerage, banking and mutual fund industries, assisted by a largely ignorant and culpable popular news media, will, however, do their best to leave the toiling masses largely ignorant of economic realities for as long as possible.

Inevitably though, when the 'dam breaks' or the 'deck of cards' collapses, it will be quick and calamitous in its magnitude and impact. That is why I am well positioned in precious metals (gold and silver bullion, mining company shares and some well placed long term precious metals warrants to reap the major benefits of leverage these assets continue to give my portfolio) but somewhat less so in base metals and energy. That is my comfort zone which allows me to sleep soundly because it is the best way to protect my hard earned equity and prosper from the fallout of the coming financial collapse. The only thing I do not know is the extent of this future financial dislocation or its timing. What the heck, life wouldn't be very interesting if we could predict the future with absolute certainty, now would it?

For what it is worth, and I have been laughing all the way to the bank of late, I believe we are in a genuine commodities bull market and, as such, see no need to spend much time paying attention to the daily ebbs and flows of the market for these investments. I have done my research and analysis and taken a position. I periodically review the performance of my investments, fine tune them on occasion and then get on with my life confident that the markets will develop as we know they are destined to with our assets safe and growing. If there is a fiscal hurricane approaching as you suggest I am confident my portfolio is secure. (See "Warning! Fiscal Hurricane Approaching! Is Your Portfolio Secure?").

Call this the standard 'buy and hold' approach if you will, but it isn't. Traditional buy and hold investing makes a fetish out of percentage asset allocation between market sectors, stocks and bonds, picking individual stock winners and pruning losers all in the name of 'balance and diversification. "Lighten up and enjoy the commodities ride."

The bottom line conclusion appears to be for investors to strategically position themselves in a wide variety of assets including precious metals, mining shares and long-term warrants.

Dudley Baker
PreciousMetalsWarrants

Dudley Baker is the owner/editor of Precious Metals Warrants, a market data service which provides you with the details on all mining & energy companies with warrants trading on the U. S. and Canadian Exchanges. As new warrants are listed for trading we alert you via an e-mail blast. You are provided with links to the companies' websites, links to quotes and charts, tips for placing orders and much, much more. We do not make any specific recommendations in our service. We do the work for you and provide you with the knowledge, trading tips and the confidence in placing your orders.

Visit us soon, http://www.preciousmetalswarrants.com

Disclaimer/Disclosure Statement: PreciousMetalsWarrants.com is not an investment advisor and any reference to specific securities does not constitute a recommendation thereof. The opinions expressed herein are the express personal opinions of Dudley Baker. Neither the information, nor the opinions expressed should be construed as a solicitation to buy any securities mentioned in this Service. Examples given are only intended to make investors aware of the potential rewards of investing in Warrants. Investors are recommended to obtain the advice of a qualified investment advisor before entering into any transactions involving stocks or Warrants.

Copyright © 2005-2006 Dudley Baker

Gold Knows What No One Knows!

2006-04-10T09:06:00.000-07:00

by Gary Dorsch

April Fools day usually arrives on April 1st, but the day for the European Central Bank chief Jean "Tricky" Trichet, to play dirty tricks came on April 6th, and left over zealous Euro bulls licking their wounds. Expectations of an ECB rate hike to 2.75% on May 4th, seems like a slam dunk, with the Euro M3 money supply exploding at an annualized rate of 8% in February, way above the ECB's 4.5% reference level for stable inflation, and European bank loans to the private sector expanding at a 10.3% clip, the fastest rate in over six years.

Such a potent cocktail is fueling takeover mania across Europe, where mergers and buyouts doubled to $454 billion in the first quarter from the same period a year earlier, after a whopping $1.03 trillion of deals in 2005. "Tricky" Trichet and his cohorts at the ECB are holding down borrowing costs in the Euro zone by expanding the Euro money supply to meet strong loan demand, in a brazen effort to lift European stock and real estate markets higher.

With demand for cheap long-term credit rising strongly in Germany, questions must be asked about whether the low level of global interest rates are appropriate, said the future ECB chief economist Juergen Stark on March 28th. "We are dealing with a global wave of liquidity today. One must ask oneself whether key interest rates are sending the correct signal here. This development is unsustainable," he said.

Other ECB policymakers were barking loudly last week whipping the Euro bulls into a buying frenzy. "There are risks to price stability and among those are second-round effects," said Spain's central banker Jose Manuel Gonzalez-Paramo. "The ECB is concerned principally about price stability, and if monetary aggregates showed dynamic growth and if asset prices rise, that would be a concern," he said.

Luxembourg central bank governor Yves Mersch was more explicit, and indicated that the ECB's work was not done. "Where we still have to walk the talk is to deliver on price stability to bring about inflation that is close to but below 2 percent. That is also part of walking the talk, to be faithful to what we say," he said.

But when the moment of truth arrived for the ECB to walk the talk on April 6th, "Tricky" Trichet pulled the rug from under the Euro, and in the process, created a lot of ill will towards the 12-nation common currency. "The present high probability which is given for an increase of rates in our next meeting does not correspond to the present sentiment of the Governing Council," sending the Euro tumbling against the US and Canadian dollars and the British pound.

But the gold market remained defiant, hovering just below 500 Euros per ounce, even after global bond yields moved swiftly higher. Euro traders are learning the hard way, what gold traders have known to be true for quite some time. Central bankers can not be trusted to preserve the purchasing power of paper money. Gold knows what no one knows!

Explosive Euro M3 money supply combined with double digit Euro loan growth calls for immediate rate hikes on the order of a half-percent. However, at his April Fools Day press conference, Trichet said the ECB would not be bullied by futures traders on the Frankfurt Eurex who were pricing in a 100% probability of a quarter-point ECB rate in May. Instead, Trichet will stick to a snail's pace of lifting rates in baby steps every three months.

Trichet indicated that a handful of economic reports, such as a large 0.5% jump in Euro zone producer prices in March to an annualized 5.4% rate, were certainly no reason for the bank's Governing Council to rush into action. Instead, the ECB wants to remain comfortably behind the inflation curve to stimulate corporate profits, and prevent an unraveling the EuroStoxx-600 rally that it worked so hard to engineer.

Trichet's endless brainwashing about his self-proclaimed vigilance against inflation falls on deaf ears in the gold market these days. "We are still, and will continue to be credible, as we were at the first day," he told leading bankers at the Institute of International Finance on March 30th. "Our anchoring of inflationary expectations remain impeccable because markets know we are very, very serious when we are speaking of preserving and maintaining price stability," he said, even as gold moved in on 500 Euros /oz, and is up 48% against the Euro from a year ago.

But Trichet's audience is the investment banking community which is reaping huge profits from merger mania in Europe, which in turn, needs the daily injection of cheap money to keep business executives in the mood to buy other companies. European exporters prefer a weaker Euro, so the ECB is aiming for a sweet spot of $1.20, which can keep foreign sales buoyant to the Far East and the US, yet help to hold down the cost of dollar denominated raw material and crude oil imports.

European gold traders were a bit slow to recognize Trichet's strategy, but finally saw through the smokescreens in September 2005, when the Euro M3 money supply expanded at an 8.5% clip, without a protest from the vigilant Trichet. Jawboning and stepped up gold sales in the fourth quarter of 2005 failed to keep the yellow metal under sedation, cornering "Tricky" Trichet, and forcing the ECB into two baby step rate hikes to 2.50 percent.

Now, the ECB faces a dilemma, because the gold market in Europe has become more sophisticated, and is pegging the gold price to the performance of leading Euro equity markets. So unless the ECB steps up to the plate to tighten its monetary policy, neither gold nor EuroStoxx blue chips are likely to give up much ground. And according to Trichet, the ECB wants to stick to its three month timetable of raising rates, and refuses to be bullied into a faster track, like the Federal Reserve.

Across the English Channel, the bankers on Thread-Needle Street make the ECB look like monetary hawks. The Bank of England became the first disciple of former Fed chief Alan Greenspan's "Asset Targeting" policy in 2001, when it slashed its base rate to 3.50%, in a desperate effort to cushion the decline of the Footsie-100. Either by design or fanciful luck, the BOE succeeded in doubling UK home prices, helping the British economy to avoid a recession that gripped the Euro zone and the US.

The Bank of England has opened wide the money spigots, fueling asset inflation in the UK equities markets and in gold. Housing prices have begun to percolate again, rising for six consecutive months to stand 5.3% higher from a year ago. With its manufacturing base moving overseas and dwindling oil supplies from the North Sea, the UK economy hinges on asset inflation, much like the US economy.

Official data on March 20 th showed UK government spending and borrowing at the highest levels since Labor took power in 1997, with a 37 billion pound shortfall for public sector net borrowing projected for the fiscal year ending April. UK Exchequer chief Gordon Brown requires a 2.0-2.5% growth rate for this year and 2.75-3.25% for 2007 to meet his budget targets.

The Bank of England is accommodating the UK Treasury's loan demands by expanding its M4 money supply 12.2% from a year ago, and keeping borrowing costs low to prevent a downturn in UK home prices. British traders turned to gold after the BOE lowered its base rate to 4.50% in August 2005, when it became obvious that the BOE's jawboning about fighting inflation was just empty words.

On February 24th, 2005, the Bank of England's Rachel Lomax predicted inflation would rise above its 2% target and while there "almost always is a case for waiting to raise interest rates, we need to be pre-emptive against inflation. Any weakness in consumer spending is likely to be temporary. There is very little slack in the UK economy," suggesting that growth would feed through to faster inflation.

But a BOE rate hike never materialized. Instead, the UK central bank lowered its base rate six months later in August 2005, to prevent a downturn in British home prices and consumer spending. That triggered a gold rally from 220 pounds to 340 pounds per ounce, and natural resource and oil stocks led the Footsie-100 above the psychological 600-mark. Super easy money in the UK has also nurtured $350 billion of takeover deals over the past 15-months, much to the delight of UK bankers.

The Bank of England has never really understood the psychology of the gold market. The BOE dumped two-thirds of its gold, or 415 tons, between 1999 and 2001 at an average price below $300 per ounce. But what is more surprising, the gnomes of Zurich, stationed at the Swiss National Bank made the same blunder, by selling half of the Swiss gold reserves, or 1300 tons, between May 2000 and May 2005.

Overall, the SNB gold sales amounted to 21.1 billion Swiss francs, at an average selling price of $351.40 per ounce. Soon after the SNB's final gold sale in May 2005, the price of gold climbed by nearly 50% over the next eleven months to 760 francs per ounce, to reflect a 50% loss of gold behind the Swiss currency. The collapse of the Swiss franc in relation to gold, puts into question the psychological status of the Swiss franc as a safe haven currency.

The SNB lifted its target band for the three-month Swiss franc Libor rate to 0.75% to 1.75% from 0.50% to 1.50% on March 16th, its second rate hike in three months, aiming for the mid-point 1.25%, within the new target band. The SNB is following the lead of ECB, with both banks sticking to three month intervals between rate hikes, to keep the Euro /Swiss franc exchange rate in a stable range.

The SNB will tighten rates gradually, said SNB member Philipp Hildebrand on March 23rd. "The fact is that from today's point of view we are in a situation to conduct a cautious approximation of rates towards neutrality, thanks to a favorable inflationary development and still well-anchored inflationary expectations," said Hildebrand, attempting to brainwash the financial media while ignoring the 50% devaluation of the Swiss franc versus gold.

"If the economic development continues as expected, the SNB will continue its adjustment of the monetary policy course gradually so that price stability is insured in the medium term. Even after raising the target band of the three-month franc Libor by 25 basis points the National Bank supports the upswing," Hildebrand noted.

However, the Swiss franc will remain a low interest rate currency that hedge funds can utilize for funding operations in gold, silver, crude oil, copper, and zinc, the premier leaders of the "Commodity Super Cycle".

In the Far East, the Bank of Japan announced on March 9th that is would begin to dismantle to ultra easy money policy, by draining 26 trillion yen ($220 billion) from the Tokyo money markets in the months ahead. But nobody knows for sure what time frame the BOJ has planned to lift its overnight loan rate above zero percent. Instead, BOJ chief Fukui has gone out of his way to assure Japan's financial warlords of the ruling LDP party, that BOJ policy would remain accommodative.

On March 22nd, Fukui said, "It'll take several months to finish absorbing current account deposits. We don't plan to cut the amount of outright JGB buying immediately after those several months." The BOJ buys 1.2 trillion yen ($10 billion) in long-term JGB's outright from the market per month. So while the BOJ is draining yen by refusing to rollover maturing short-term debt, it is also pumping 1.2 trillion yen into the banking system each month through JGB purchases.

Japanese Finance Minister Sadakazu Tanigaki warned that the recent rises in long-term interest rates could damage the economy, adding the Japanese economy is still in mild inflation. Asian Development Bank President Haruhiko Kuroda urged the BOJ to be "cautious" about further interest rate increases. "Although the economy has recovered very strongly, the price situation has not changed much, so I think the BOJ would be very careful and cautious in executing its monetary policy."

Tanigaki said Asian and European financial chiefs meeting in Vienna on April 9th, were concerned that credit tightening in advanced countries could hurt the world economy. "Many of them share the outlook that global growth will continue amid low inflation," he said. But the financial officials "consider high crude oil prices, rising interest rates in advanced economies, global current-account imbalances and bird flu to be risk factors," he said.

So the Bank of Japan remains under heavy political pressure to go slow with its tightening campaign, and to keep yen plentiful and cheap, insulating the Japanese economy and Nikkei-225 stock index from record high oil prices. Japanese gold traders understand the scheme that LDP financial warlords are pursuing, and are pegging the price of gold to the Nikkei-225, both rivals for investment funds seeking a safe haven from BOJ monetary inflation.

After hiking the fed funds rate to 4.75% on March 28th, the Federal Reserve acknowledged that the "Commodity Super Cycle" might be signaling higher inflation. "Possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures," the FOMC said. Engaging in a battle with the "Commodity Super Cycle" would represent a 180 degree turn in Bernanke's thinking on commodity prices and inflation.

On February 5th, 2004, Bernanke said "rising commodity prices are a variable of growth rather than inflation." As for soaring energy prices, "while a sudden shock may cause oil prices to rise, there is an equally good chance that oil prices might go down over the next couple of years. Barring some kind of major shock, I personally don't find the energy issue crucial to the recovery. I don't expect inflation at the core level to rise significantly this year or even in 2005," Bernanke said.

Then on May 24, 2005, Bernanke again played down worries about higher energy and commodity prices. "Much of the recent price gains in energy and commodities reflect the rapid growth of the Chinese economy. Chinese authorities are now trying to slow that growth, and should help check the growth of commodity prices."

On October 25th, 2005, the newly appointed Fed chief Bernanke said that there was little reason to fear that the sharp rise in energy prices would feed through into wider inflation. "The evidence seems to be that it is primarily in energy and some raw materials and has not fed into broader inflation measures or expectations. My anticipation is that's the way it's going to stay."

But the Federal Reserve is almost out of ammunition in its 21-month old battle against gold, silver, copper, zinc, and crude oil, the premier leaders of the "Commodity Super Cycle." Sales of new US homes had the biggest monthly decline in almost nine years in February and the number of properties on the market rose, evidence the housing bubble is deflating after a five-year boom.

New US home sales fell 10.5% to an annual rate of 1.08 million, the lowest since May 2003, from a revised 1.207 million in January. The number of homes for sale rose to a record 548,000 from January's 525,000. At the current sales pace, there were enough new homes on the market to satisfy demand for the next 6.3 months, the largest amount in more than a decade. The median selling price of a new home last month was $230,400, from $243,900 in October.

A gauge of US mortgage applications fell to the lowest level of the year as home purchases and refinancing declined. But the Federal Reserve is not about to pull any nasty tricks like Jean Trichet, and should follow through on its widely telegraphed quarter-point rate hike to 5.0% on May 10th. But beyond 5.0%, the Fed would risk killing the goose that lays the golden eggs for the US economy, the housing bubble, and that might be a red line that Bernanke & Company cannot cross.

If correct, which central bank would assume the mantle of fighting gold, silver, crude oil and commodities rallies with a tighter monetary policy? European and Japanese central banks are playing a double game, tightening monetary policy at a snail's pace, but leaving plenty of Euros and yen floating in the banking system at negative real interest rates, in an effort to keep their equity markets afloat.

Memories of the Enron and Worldcom scandals are fading into the distant past, but there was a time when Congress demanded greater transparency of accounting records. But with a slight of hand, the Federal Reserve, under the leadership of Ben Bernanke announced on November 10th, 2005, that it would no longer disclose to Americans what it is doing with the US M3 money supply. Since then, gold has soared $110 per ounce, bumping against the psychological $600 level.

So while the Dow Jones Industrials rally to 5-year high might look impressive in US dollar terms, the DJI is in a raging bear market in hard money terms. Last week, the DJI fell below 19 ounces of gold, or 30% lower than two years ago. Over the past 6-months, the DJI has plunged by 50% in silver ounces per share. Without the honest transparency of M3 reporting, all major US assets should be measured in terms of gold ounces, a de-facto gold standard.

But while gold is matching the performances of European and Japanese equity benchmarks, and blowing away the Dow Industrials, the yellow metal is still in a four year bear market against the crude oil market. Gold has rebounded from as low as 6.5 barrel of crude oil per ounce, but meeting resistance at 9.25 barrels this year. Gold might outperform crude oil, if Arab oil kingdoms in the Persian Gulf decide to allocate more Petro-dollars to gold, in a flight to safety from the Ayatollah of Iran.

Countries close to Iran, including Kuwait and the United Arab Emirates, are focused on Iran's nuclear weapons program, which "still poses a big worry," said Sheik Abdullah bin Zayed Al Nayyan, the foreign minister of the United Arab Emirates on March 22 nd. Iran's first nuclear reactor is expected to go online this year, in Bushehr in southern Iran, just 150 miles across the Persian Gulf from Kuwait.

Iran is seismically unstable, and an earthquake could cause an accident that would be more disastrous for Gulf countries than for Iran. "A catastrophe that kills 200,000 people could mean wiping out half of Bahrain," Al Nayyan noted. In addition, any pollution of the Gulf would shut down the six water desalination plants on the Arab shore. A possible military confrontation between Iran and the US could trigger Shiite-Sunni sectarian tensions across the region.

Yahya Rahim Safavi, commander-in-chief of the Iranian National Guards, was speaking to state television on April 5th, during a week of naval war games in which Tehran announced the successful testing of new weapons, including missiles and torpedoes. "The Americans should accept Iran as a great regional power and they should know that sanctions and military threats are going to be against their interests and against the interests of some European countries," he said.

"We regard the presence of America in Iraq, Afghanistan and the Persian Gulf as a threat, and we recommend they do not move towards threatening Iran," Safavi said. Iran has a commanding position on the north coast of the Strait of Hormuz, and could still disrupt shipping of two-fifths of the world's globally traded oil, or 17 million barrels per day, that passes through the narrow Strait of Hormuz.

The Washington Post said April 9th, no US military attack appears likely in the short term, but Pentagon officials are preparing for a possible military option and using the threat to convince Iranians of the seriousness of their intentions. Pentagon and CIA planners have been exploring possible targets, such as Iran's underground uranium enrichment facility at Natanz and its uranium conversion plant at Isfahan, both located in central Iran, the report said.

Iran is not about to be cowed by planted stories in the media. It sounds like the boy crying Wolf. "We regard that planning for air strikes as psychological warfare stemming from America's anger and helplessness," replied foreign ministry spokesman Hamid Reza Asefi. "Sending our file to the UN Security Council will not make us retreat. During the past 27 years, we underwent economic sanctions and in spite of that we made economic, technical and scientific progress," he added.

The Ayatollah Khameni has bought the Chinese and Russian vetoes of any credible UN sanctions against Iran, with multi-billion dollar arms deals, construction deals for nuclear sites, and is dangling a $100 billion deal for development rights of the Yardavan oil fields before Beijing. Without the credible threat of economic sanctions against Iran, the world would either witness a nasty military confrontation in the Persian Gulf or a nuclear armed Iran in the months or years ahead.

The Ayatollahs drive for nuclear invincibility appears to be unstoppable, short of military action. Diplomacy could drag on for a few more months, to convince a skeptical public that all measures to avoid war were exhausted. But Beijing and Moscow are expected to continue blocking the UN from tough sanctions against Iran, effectively closing the door for a diplomatic solution.

Venezuela 's Hugo Chavez is a staunch supporter of the Ayatollah, and is the world's fifth largest oil exporter. "The US imperialists invaded Iraq looking for oil and now they are threatening Iran for oil, not because the Iranians are developing some kind of nuclear bomb," Chavez said on March 21st. Chavez could become a wildcard in the oil market in the event of a US strike against Iran's nukes.

Pension funds poured money into crude oil, base and precious metals in March, putting the "Commodity Super Cycle" back on track after a period of consolidation in February. Copper, which has gained 98% over the last two years, has zoomed nearly 32% higher so far this year. Zinc has doubled from a year ago. Crude oil has gained only 10% since the start of the year, but is up 93% from two years ago.

Copper supplies at the London Metals Exchange stand at 111,800 tons, or less than three days of global consumption. Zinc stockpiles have plunged 53% in the past year to 267,650 tons, equal to less than 10 days of global consumption. US crude oil supplies are at a 7-year high, but only represent 20 days of imports. US oil companies appear to be stockpiling oil for an uncertain future.

There are about 10,000 hedge funds managing up to $1.5 trillion in assets around the world, and institutional investment in commodity index funds has topped $80 billion. Former Fed chief "Easy" Al Greenspan, was quoted in January, saying gold's rally did not reflect heightened inflation expectations, but rather geo-political tensions around the world. With the yellow metal bumping up against the psychological $600 per ounce level, its highest in 25-years, perhaps Gold knows what no one knows!

This article may be re-printed with links to www.sirchartsalot.com.

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Gary Dorsch
http://www.sirchartsalot.com/

Mr Dorsch worked on the trading floor of the Chicago Mercantile Exchange for nine years as the chief Financial Futures Analyst for three clearing firms, Oppenheimer Rouse Futures Inc, GH Miller and Company, and a commodity fund at the LNS Financial Group.

As a transactional broker for Charles Schwab's Global Investment Services department, Mr Dorsch handled thousands of customer trades in 45 stock exchanges around the world, including Australia, Canada, Japan, Hong Kong, the Euro zone, London, Toronto, South Africa, Mexico, and New Zealand, and Canadian oil trusts, ADR's and Exchange Traded Funds.

He wrote a weekly newsletter from 2000 thru September 2005 called, "Foreign Currency Trends" for Charles Schwab's Global Investment department, featuring inter-market technical analysis, to understand the dynamic inter-relationships between the foreign exchange, global bond and stock markets, and key industrial commodities.

Disclaimer: SirChartsAlot.com's analysis and insights are based upon data gathered by it from various sources believed to be reliable, complete and accurate. However, no guarantee is made by SirChartsAlot.com as to the reliability, completeness and accuracy of the data so analyzed. SirChartsAlot.com is in the business of gathering information, analyzing it and disseminating the analysis for informational and educational purposes only. SirChartsAlot.com attempts to analyze trends, not make recommendations. All statements and expressions are the opinion of SirChartsAlot.com and are not meant to be investment advice or solicitation or recommendation to establish market positions. Our opinions are subject to change without notice. SirChartsAlot.com strongly advises readers to conduct thorough research relevant to decisions and verify facts from various independent sources.

THE WEALTH ILLUSION!

2006-03-29T22:11:00.000-08:00

by Puru Saxena
Editor, Money Matters
March 29, 2006

CURRENT SITUATION – The absurd money-creation continues. Slowly yet surely, the “stealth” confiscation of savings is gaining momentum as money loses its value. Central banks claim that they are raising interest-rates to fight inflation. At the same time they are slipping in more rum into the punch bowl, thus creating just what they say they want to fight – inflation! Take a look at the latest year-on-year money supply growth-rates around the world:

Australia + 9.1%
Britain + 11.7%
Canada + 7.7%
Denmark + 14.7%
US + 8.1%
Euro area + 7.3%

When I glance at these mind-boggling figures, at least I don’t see any monetary tightening taking place! Make no mistake, this excessive liquidity is inflation that banks are creating and this inflation is destroying the purchasing power of your hard-earned money. As asset-prices continue to benefit from this monetary insanity, the wealth inequality is getting wider resulting in social unrest in several parts of the world. The ultimate truth about inflation is that it always benefits the rich who are able to ride the inflationary wave by investing in assets, whereas the poor become even more impoverished as things continue to become more expensive.

So far, the ongoing inflation has been masked by the bogus core inflation figures released by the authorities. According to the official statistics, inflation is tame and under control. But if you take a look around, you will realise that the cost of living is rising much faster than the officials would have you believe. The cost of energy has gone up six times; the cost of housing is at a record-high in most countries; education is ridiculously expensive and insurance premiums are soaring. And we should believe that inflation is not a problem? If inflation is really not an issue, why has the Federal Reserve decided to stop publishing the money supply (M3) growth rate as of the next month? For sure, the prices of consumer goods (televisions, computers, clothing etc.) have come down in recent years due to vast improvements in technology and the economies of mass production, but the overall cost of living is rising rapidly due to inflation as there is too much money being created.

At a human level, inflation is a tragedy and totally immoral. However, we all have to work within the system and protect our assets as best as we can. It has become obvious to me that the central banks will continue to inflate the supply of money (inflation). The Federal Reserve came into power in 1913 and with the exception of the Great Depression that occurred in the early-1930’s, we have experienced inflation and nothing but inflation every single year! Put simply, the US money supply has increased every year over the past 70 years! Figure 1 clearly demonstrates that inflation has prevailed for a very long time. Moreover, most of this inflation has taken place after 1971 when gold was removed from the monetary system.

Figure 1: The constant inflation program!

Source: www.economagic.com

The point I am making is that under the present monetary system inflation is a constant. What changes though, are the rates of inflation (money supply growth) in various countries and the sectors of the economy that benefit from inflation. For instance, during the 1970’s, commodities were the main beneficiaries of inflation and financial assets lost out. However, in the following two decades, it was financial assets which were the biggest beneficiaries of inflation. Since 2001, this excess liquidity has (once again) started flowing into commodities as can be seen from the recent massive gains in tangibles relative to gains made in financial assets such as stocks and bonds.

There is another crucial point I’d like to make. During highly inflationary times (such as now), the purchasing power of money declines against all asset-classes. In other words, if enough money is printed, despite a horrendous economy, stocks, bonds, property, commodities as well as collectibles may all rise at the same time. Such a rise in asset prices due to high inflation gives the ILLUSION of prosperity. Nothing can be further from the truth however. Hyperinflation almost always leads to a collapse in the inflating country’s currency relative to other major world currencies. Now, if all the countries decide to print money (inflate) at the same time, which seems to be happening now, instead of declining against each other, the various currencies may decline against assets. So as investors, we need to try and figure out which assets are likely to appreciate the most due to inflation.

Puru Saxena Ltd.
Suite 1208, Citibank Tower
3 Garden Road, Central, Hong Kong
Phone: (852) 3589 6789 Fax: (852) 3585 5665 Email l Website

Warning! Fiscal Hurricane Approaching! Is Your Portfolio Secure? Part 2

2006-03-29T00:04:00.000-08:00

by Dudley Baker

In a previous article entitled "The Ominous Warnings and Dire Predictions of World's Financial Experts - Parts 1 and 2", we learned what was probably in store for us short-term and in the next few years. These experts used words like 'Economic Armageddon', 'Financial Apocalypse', 'Financial Disaster', 'Financial Train Wreck', 'Deep Funk', 'Great Disruption', 'Category 6 Fiscal Storm', 'Economic Earthquake', 'Serious Collapse', 'God-Awful Fiscal Storm', 'Debt-Driven Meltdown', 'Major Upheaval', 'Demographic Tsunami', 'Rude Awakening', 'Economic Pain', ' Systemic Banking Crisis', 'An Accident Waiting to Happen', etc. to describe what we are in for. It begs the question "How should we position our assets given the dire predictions of these imminent economists and analysts who are all much of the same mind as to what may well be in store for the U.S and, indeed, the global economy very soon?" Again, we have compiled a detailed and comprehensive summary of what many of these very same individuals, and others, have to say. It is so extensive and informative we have taken the liberty to divide it into 4 parts.

Warning! Fiscal Hurricane Approaching! Is Your Portfolio Secure? Part 2
by Dudley Baker and Lorimer Wilson

Charles Carlson, CEO of Horizon Investment Services and author of a number of books including 'Eight Steps to Seven Figures,' 'Buying Stocks Without a Broker' and 'No-Load Stocks' offers hands-on advice on how to survive - and thrive - in a wildly fluctuating market in his latest book 'The Smart Investor's Survival Guide.' As he says "The storm's eye is an excellent metaphor for what investors must do during stormy market periods. Find the eye. Get to the calm. Play in the space where you won't get hurt.

What kind of investments?

1. Liquid investments: During uncertain market times investors usually migrate toward the most liquid investments because liquidity provides flexibility; the flexibility to respond quickly to changes in opinions about certain investments; the flexibility to raise cash quickly if need be. Such liquid investments include large cap stocks, larger corporate bond issuers and also cash which always works well in volatile markets.

2. Dividends and Interest: During volatile markets, when certainty of returns is an especially prized commodity, investors will migrate to those investments offering at least some modicum of income via dividends and interest. Stocks with high dividend yields, and particularly considerable dividend growth, generally hold up better during down markets than stocks with low yields.

3. Consistent earnings: Certain industry sectors are more conducive than others for weathering volatile markets. At the top of the list is the health care sector, followed by the consumer staples sector. These groups, especially health care, have steady product demand regardless of economic conditions. That consistent demand usually leads to consistent earnings.

4. Low-Volatility investments: In the eye of the storm, less volatile issues will generally weather the fury better than volatile investments. Stocks and stock mutual funds have the most volatility. Cash, bonds and treasury securities have the least expected volatility. Within fixed-income investments short-term bonds are less volatile than long-term bonds and U.S. corporate bonds are less volatile than foreign bonds.

5. Diversified portfolio: Diversification makes perfect sense especially during turbulent market conditions. When you diversify, you buy a bit of insurance for your portfolio against catastrophes. By definition, diversification reduces risk. You don't know with complete certainty what groups will be leading and lagging the market at any point of time. Since you don't know where the next leaders will come from, a prudent approach is to own a bunch of investments a) within a variety of asset classes (i.e. investments with different risk/reward profiles), b) of a variety of different asset classes (i.e. investments that don't correlate with one another), and c) that are appropriately weighted one to the other and rebalanced in relationship to each other every 12-18 months should one or more get out of whack by 5 to 10 percentage points. In that way, you're sure to avoid owning all the groups getting killed and increase your chances of owning groups and investments that are doing well.

6. Proper Allocation:

a) You need to determine the percentage weighting of assets in the total portfolio. The two biggest determinants of asset allocation are risk tolerance and investment time horizon. The more risk-adverse you are as an investor, the greater the portion of bonds/cash versus stocks you should have in your portfolio. Also, the shorter the time horizon the larger the percentage of the portfolio should be devoted to bonds/cash. A good rule of thumb for setting an allocation is to subtract your age from 100 or 110 (depending on how aggressive you are) and invest that number in stocks and split the remainder between bonds and cash. However, if you have an extremely limited investment time horizon, an extremely low tolerance for risk, or a limited need for growth given your financial position, obligations, etc., then consider allocating 15-25% to stocks, 40-50% to bonds (40-45% in a short-term bond fund, 40-45% in a total market bond fund and 10-20% in a high-yield bond fund) and 25-35% to cash.

b) You need to spread the stock component of your portfolio across various industry groups and among 25 to 35 individual stocks or a broad based mutual fund. I think an investor with a 20-or 30-year time horizon would be OK with a single stock making up 20 percent of a portfolio. Conversely, an investor in his or her sixties should keep individual stock weightings to 2 percent to 15 percent of the portfolio.

7. Timing: Smart investors take advantage of volatile markets in two important ways:

a) smart investors step up to the plate to buy, even if everyone is shouting 'sell.' Even if you get nervous and move some of your cash or bonds, make sure that you are putting at least something into stocks or stock mutual funds during the rough patches and

b) smart investors use volatile markets to upgrade portfolios. Smart investors don't miss the future by looking at the past. They take their lumps, learn their lessons, and do what they can to position their portfolios for the market's inevitable upturn. That means smart investors use volatile markets to trim their deadwood and buy those stocks that they always wanted to own if they got cheap enough."

Ibbotson Associates, a Chicago research firm, suggests that "adding precious metals to a portfolio of U.S. equities, bonds, and Treasury bills would modestly improve long-term returns without adding risk to a portfolio. An asset allocation of 7.1% to metals would increase the expected return on a conservative portfolio by 0.2%. A 12.5% allocation in a moderate portfolio would add 0.4% to the expected return. Indeed, the performance of an equally-weighted gold/silver/platinum portfolio is actually closer to fixed-income assets than to equities over the period from 1972 to 2004."

James Shepherd, President of JAS MTS Inc. and editor of the Shepherd Investment Strategist, has stated that "my investment philosophy is based on one simple premise: we must be invested in areas that provide the best returns, with safety, of our core capital. Then, when other opportunities arise that give us the ability to use speculative leverage to propel our overall portfolio higher, we should avail ourselves of the opportunity with a small percentage of our capital in order to take advantage of this potential. Unfortunately for many investors, they never seem to be flexible enough to be in the right things at the right time. I recommend putting 33% of ones portfolio in 30 year U.S. Treasury bonds due to the deflationary pressures that are very much in evidence, although currently just under the surface, which will drive long-term interest rates even lower and 67% in short-term government securities or, for the more aggressive investors, placing 33% in URSA and the balance in short-term government securities.." In addition, when it is evident that a stock market crash is imminent, he intends to "utilize more aggressive means of playing the anticipated decline in long-term rates by using instruments or funds comprised of zero-coupon bondsfunds that move inversely to the major indices and perhaps even leveraged versions of these derivatives that move inversely in multiples to the underlying index. We will also be utilizing some leverage instruments such as put options. These can increase dramatically in the event of a collapsing stock market. Regarding gold I am of the opinion that if we get rampant inflation at some time in the future, we could confidently expect gold to rise very sharply to well above the $2,000/ounce level. That said, however, the most likely outcome is a deflationary environment. In that scenario gold would not do well, nor would many other 'hard' assets." which move higher in price relatively much faster than regular Treasuries, to take substantial positions in

Richard Benson, President of Specialty Finance Group, LLC, is of the opinion that "the financial markets are leveraged for a crash. The capital markets have become one massive casino. Very few people believe they are gambling with their own money because borrowing with other people's money to place the bets has become so easy. Money is being made in the leveraged carry trade or in speculating on margin. Even the patriotic homeowner with a variable rate mortgage is borrowing short-term to buy stocks, and to pay bills. What happens when investors want to reduce their risk and need to sell but can't find a buyer? They would be trapped because the markets are just not that liquid, especially when everyone wants to sell! That's why it is important to be in cash before the crash! Short-term Treasuries, bank CD's (but only up to $100,000 per institution), TIPS (Treasury Inflation-Protected Security), I-bonds, and gold coins are all wonderful places to sit out any potential storm. For the average investor who is risk adverse and for any investor who considers losing a dollar worse than making a dollar our advice is to get into cash and be prepared to wait. Good hunters know how to wait and good things happen to those who are patient, like buying what they like at half price!"

It is recommend investors strategically position themselves in a wide variety of assets including precious metals, mining shares and long-term warrants. Nothing like taking what the experts say to heart and investing accordingly.

Join us at the:

Dudley Baker
PreciousMetalsWarrants

Dudley Baker is the owner/editor of Precious Metals Warrants, a market data service which provides you with the details on all mining & energy companies with warrants trading on the U. S. and Canadian Exchanges. As new warrants are listed for trading we alert you via an e-mail blast. You are provided with links to the companies' websites, links to quotes and charts, tips for placing orders and much, much more. We do not make any specific recommendations in our service. We do the work for you and provide you with the knowledge, trading tips and the confidence in placing your orders.

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ts.com

Disclaimer/Disclosure Statement: PreciousMetalsWarrants.com is not an investment advisor and any reference to specific securities does not constitute a recommendation thereof. The opinions expressed herein are the express personal opinions of Dudley Baker. Neither the information, nor the opinions expressed should be construed as a solicitation to buy any securities mentioned in this Service. Examples given are only intended to make investors aware of the potential rewards of investing in Warrants. Investors are recommended to obtain the advice of a qualified investment advisor before entering into any transactions involving stocks or Warrants.

Excerpts From - "Gold Forecaster - Global Watch"

2006-03-26T17:34:00.000-08:00

by Julian D. W. Phillips

HIGHLIGHTS in "Gold Forecaster - Global Watch"
Silver - COT, Gold : Silver Ratio EDR.V, SSRI, PAAS, SIL, SLW / Platinum.
SHARES: HUI, XAU, NEM, FCX, DROOY, NG, VGZ, GSS, GFI, Portfolio - Buy Orders
Index:
1-2. Market Forecasts / Short-term forecasts across the Board!
2-3. Comex Update
3-12. Central Bank gold Sales in 2006 / Central Bank purchases/Germany NO gold sales/ Silver E.T.F./Peru/ China loves gold, so does the next generation/ The Oil crisis / The U.S. economy and the $ / Gold: Oil Ratio / Dow Jones / Technical Analysis of the Gold Price: Long / Gold price drivers 2006 / Short term in the U.S. $ / Treasury Notes / CRB Index
12 - 27. International Gold Markets / Silver / Gold vs. Silver / Gold:Silver Ratio / Platinum / Silver & Gold Shares

Trial Sub. 3 months for $99- go to www.goldforecaster.com.

Do you want to receive your own copy of Excerpts from "Gold Forecaster - Global Watch"? - Send your e-mail address to: gold-authenticmoney@iafrica.com.

The Silver E.T.F. - A new Dawn for Silver

It is clear that the permission to list on AMEX is confirmation that the Silver E.T.F. will list, despite final clearance not having been given yet. "The S-1, which is the registration statement submitted by BGI, has not become effective yet with the SEC, so we are still in the quiet period of the registration and a launch date cannot be determined," says Christine Hudacko, spokeswoman for Barclays Global Investors, which is behind the creation of the silver ETF.

Barclays Global Investors is applying to list 13 million shares backed by 129 million ounces of silver in an arrangement similar to that for the streetTRACKS Gold Trust shares. Under this structure, silver will be held in the Bank's vaults and each share will represent 10 ounces of Silver.

Present Demand / Supply for Silver

As we have said consistently, the demand for Silver is going to overtake supply and it may well be in the process of doing so now. With demand for silver for photography having dropped, but being more than replaced by new applications in industry and prints of digital photographs, global demand has moved to a point where it is greater than new global production. This deficit has been accommodated by sales of "Official" silver from the government of China. Sales of Indian "Official" silver should be completed by the end of the year. At that point Indian demand should spill over into the global silver market. We suspect that the sales of Chinese "Official" silver are near to completion as we see imports of silver into China rising quickly. However, we cannot be sure that this has happened. When it is completed, Chinese demand will come to the global market for the needs that are in excess of its present internal supplies. So irrespective of any other factors, the Silver market and its price will have to deal with a potentially very large demand on top of present global demand.

Now add to that the prospects of a Silver based E.T.F. and you have an explosive situation! At its start the Exchange Traded Fund will require 129 million ounces of Silver. Whichever way one looks at it they purchase over a relatively short period of time of 129 million ounces is a massive off-take from the market, equating to roughly 16% of the world's annual silver production and 21% of the known above-ground inventories of silver. This by itself will send the Silver price well up on present levels. However more pertinently a vast array of new Investors into Silver will come forward possessing investment power the Silver market has never experienced, even with the Hunt Brothers and Warren Buffet's Berkshire Hathaway, 130 million ounce holding already present.

Because Speculators/Investors will delight in taking new long-term positions in Silver through an E.T.F. we would expect the holdings of the E.T.F. to grow very quickly, on the back of the success of the gold E.T.F.

It was one thing a single Investor trying to corner the market, but when many large Investors move in like a pack, the chance of huge silver price 'spikes' grows. The difference also lying in the fact that individual control of such a situation has to give way to the group, so giving a decent market at much higher prices. This translates to the addition of a genuine investment side to Silver.

The complaint that this will prejudice industrial users has to be true to some extent, but at the same time the S.E.C. could not withhold permission on that ground, for that would have been manipulation of the worst kind. After all the S.E.C. could not withhold permission because Silver buyers didn't want to pay more. Industrial users will simply have to adjust to higher prices or alternatives, if a free market is to be continued. Silver Producers are delighted, with the prospect of earning more, against the annoyance of Silver users having to pay more. We also wait with curiosity to see just how much scrap or hoarded silver finds its way back to the market as prices rise and how quickly new production comes on stream?

This is a major step for Silver, which has to transform the whole market. We do expect the silver price, should it be placed under such pressures as these, to be considerably higher than we see at the moment. Relatively speaking silver could outperform gold, price-wise and volatility-wise.

Having said all this we have to emphasize that Silver companies and their share are likely to outperform the Silver price simply because of their gearing! [See below our recommendations]

To Subscribe to "Gold Forecaster - Global Watch", please go to: www.goldforecaster.com

Julian D. W. Phillips
Gold-Authentic Money

"Global Watch: The Gold Forecaster" covers the global gold market. It specializes in Central Bank Sales and details, the Indian Bullion market [supported by a leading Indian Bullion professional], the South African markets [+ Gold shares shares] plus the currencies of gold producers [ Euro, U.S. $, Yen, C$, A$, and the South African Rand]. Its aim is to synthesise all the influential gold price factors across the globe, so as to truly understand the global reasons behind the gold price. FIND OUT MORE

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This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold-Authentic Money / Julian D. W. Phillips, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold-Authentic Money / Julian D. W. Phillips make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold-Authentic Money / Julian D. W. Phillips only and are subject to change without notice.

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Ominous Warnings and Dire Predictions of World's Financial Experts - Part 2

2006-03-22T22:04:00.000-08:00

by Dudley Baker

As I have mentioned in previous articles, I have the most informed, intelligent and savvy subscribers one could ask for. One of them, Lorimer Wilson, previously wrote me with his insights on "Our Worst Nightmare - the Puncture of the Current US Housing Bubble." It was very well received when published by me recently and he has just sent me more information which I think you will find timely and of particular interest.

Together we have compiled a remarkable summary of the ominous warnings, dire predictions and perceived devastating consequences that the vast majority of economists, financial analysts, economic research firms and financial commentators are saying about our current economic situation and what is most likely to unfold in the months and years ahead. It is a must read to more clearly understand and appreciate the financial state of the union, the impact it will likely have on various investments, and how better to allocate ones assets.

Nobody has a crystal ball, but to just ignore the following warning signs and hope that everything will turn out okay would simply be foolish.

Below is Part 2 of our 6-part article.

Ominous Warnings and Dire Predictions of World's Financial Experts - Part 2
by Dudley Baker and Lorimer Wilson

Widening Global Imbalances

Rodrigo de Rato, Managing Director of the International Monetary Fund at a recent speech at the University of California at Berkeley, stated that "while global current account imbalances have been widening, the fact that they have been financed easily thus far seems to be inducing a sense of complacency among policy makers. I think they should be more concerned. This is not to say that the risk of a disorderly adjustment is imminent, but the problem is growing, and if a disorderly adjustment does take place, it will be very costly and disruptive to the world economy.

The most visible aspect of the global imbalances problem is a very large deficit in the current account of the balance of payments of the United States - amounting to about 6.25% of GDP. The main problem is that in the United States savings are too low. These global imbalances could unwind quickly, and in a very disruptive way, with either an abrupt fall in the rate of consumption growth (i.e. increased savings) in the United States which is holding up the world economy or by investors abroad becoming unwilling to hold increasing amounts of U.S. financial asset, and demand higher interest rates and a depreciation of the U.S. dollar, which in turn forces U.S. domestic demand to contract."

Economic Pain

Timothy Adams, Undersecretary of Treasury for International Affairs, stated recently that "the world economy is dangerously imbalanced and the U.S. current account deficit is now at levels that many experts fear could trigger a run on the dollar, soaring interest rates, and global economic pain."

Severe Consequences

Robert E. Rubin, director of Citigroup Inc. and former Secretary of the Treasury; Peter Orszag, Senior Fellow at Brookings Institution; and Allen Sinai, Chief Global Economist at Decision Economics Inc., made a presentation to a joint session of the American Economic Foundation and the North American Economics and Finance Association recently.

They stated that "the scale of the nation's projected budgetary imbalances is now so large that the risk of severe consequences must be taken very seriously. Continued substantial deficits could cause a fundamental shift in market expectations and a related loss of confidence both at home and abroad. This, in turn, could cause investors and creditors to reallocate funds away from dollar-based investments, causing a depreciation of the exchange rate, and to demand sharply higher interest rates on U.S. government debt. The increase of interest rates, depreciation of the exchange rate, and the decline in confidence could reduce stock prices and household wealth, raise the cost of financing to business, and reduce private-sector domestic spending."

Wild Ride

Paul Kasriel, Director of Economic Research at Northern Trust and co-author of the book 'Seven Indicators That Move markets', has stated that "If foreign creditors should question our ability and willingness to repay them without resorting to the currency printing press, there could be a run on the dollar, which would lead to sharply higher U.S. interest rates, which would do great harm to household finances and the housing market, which would put a crimp in consumer spending, which would increase unemployment, which would result in a spike in mortgage defaults, which would likely cripple the banking system given that a record 61% of total bank credit is mortgage related, which would, in turn, render future Fed interest rate cuts - expected on or about September 20th, 2006 - less potent in reviving the economy.

We have the most highly leveraged economy in the postwar period and the Fed is still raising rates and in the past 30 years or so, whenever the Fed has raised interest rates, we have usually had financial accidents. Our federal government is spending like a drunken sailor so my advice is to put on your safety harness as it is going to be a wild ride. My bet is that we are going to end up on the rocks."

Category 6 Fiscal Storm

Isabel V. Sawhill, Vice President and Director and Alice M. Rivlin, Senior Fellow of Economic Studies at the Brookings Institution have said that "the federal budget deficits pose grave risks - a category 6 fiscal storm - to the U.S. economy. The current course is simply not sustainable. Promises to the elderly, especially about medical care, cannot be kept unless taxes are raised to levels that are unprecedented or other activities of the government are slashed. Postponing such action would be reckless and short-sighted. Massive amounts of capital have flowed in from around the world, financing much of America's federal deficit, as well as its international (or current account) deficit. While this inflow of foreign capital has kept investment in the American economy strong it means that Americans are accumulating obligations to service these debts and repay foreigners out of their future income. As a result, the future income available to Americans will be lower than it would have been without the government deficits. Foreign borrowing also makes the United States vulnerable to the changing whims of foreign investors. There is a risk that Asian central banks, or other large purchasers of dollar securities, will lose confidence in the ability of the United States to manage its fiscal affairs prudently and shift their purchases to euros or other currencies. Such a shift could precipitate a sharp fall in the value of the dollar, which could cause a spike in interest rates, a plunge in the stock and bond markets, and possibly a severe recession. The risk of such a meltdown is unknown, but it seems foolish to run the risk in order to perpetuate large fiscal deficits, which will ultimately reduce Americans' standard of living."

Drastic Fall

Sebastian Edwards, the Henry Ford ll Professor of International Business Economics at UCLA's Anderson School of Management and a research associate of the National Bureau of Economic Research and has been a consultant to the Inter-American Development Bank, the World Bank, the OECD and a number of national and international corporations, has stated that "The future of the U.S. current account - and thus of the dollar - depend on whether foreign investors will continue to add U.S. assets to their investment dollars. Any major reduction in the USA's ability to obtain sufficient foreign financing would causethe dollar to fall by 21% to 28% during the first three years of any adjustment period, cause a deep GDP growth reduction, and push the USA into recession."

Substantial Macroeconomic Consequences

Ian Morris, Chief US Economist at HSBC, has said that "about half the US housing market may be overvalued by as much as 35-40%. When these housing bubbles begin to deflate, it is likely to have a substantial macroeconomic consequence."

Serious Collapse

Ian Shepherdson, Chief US Economist for High Frequency Economics, has warned that "house price increases are going to slow much further dragging down expectations for future price gains and therefore raising real mortgage rates. This, in turn, will be the trigger for a serious collapse in home sales. The housing market is a bubble, and it will burst."

Economic Earthquake

Robert R. Prechter, President of Elliott Wave International and author of 'At the Crest of the Tidal Wave' and 'Conquer the Crash,' calls for "a slow motion economic earthquake that will register 11 on the financial Richter scale.
The Great Asset Mania of recent years is in its final euphoric months and the next event will be a sharp decline of historic proportion in stock prices - the Dow should fall to below the starting point of its mania which was 777 in August 1982 and probably below 400 by no later than 2008 - resulting in a deep economic depression lasting until about 2011. If an across-the-board deflation occurs, which has a substantial probability, then real estate, commodities and all bonds issued by other than those rated AAA will fall in value as well.
That we are in the midst, and apparently near the end, of the greatest debt build-up in world history suggests that the resulting deflation and depression will be the biggest deflation in history by a huge margin. A corollary of deflation will be a soaring value for the U.S. dollar, contrary to virtually all current expectations. Credit expansion is a major reason why stocks have kept rising and the dollar has kept falling but when the bubble begins to deflate, the investment markets will go down and the dollar will start up. The period after the market crash will be the most vulnerable in terms of the potential for hyperinflation. The ultimate result will be the destruction of any value remaining in bonds and the wipe-out of all dollar-denominated paper assets."

Giant Speculative Bubble

Ravi Batra, Professor of Economics at Southern Methodist University, in his book 'The Crash of the Millennium' foresees not a deflationary depression but an inflationary one. He sees "the giant speculative bubble that we are currently in bursting, the stock market crashing and then the U.S. dollar collapsing almost immediately followed by a rise in interest rates and plunging bond prices culminating in a depression made doubly damaging by rising inflation through the early part of this decade. In spite of the inflationary nature of the coming depression, property values will tumble in most parts of the United States. In the long run, home prices will probably continue to climb but in the short run, however, they could sink and sink hard."

Systemic Banking Crisis

Richard Duncan, a former consultant for the International Monetary Fund, current Financial Sector Specialist (Asia) at the World Bank and author of the book, 'The Dollar Crisis', writes that "the United States' net indebtedness to the rest of the world, already at record highs, will continue to increase every year into the future until a sharp fall in the value of the dollar against the currencies of all its major trading partners puts an end to the gapping US current account deficit or until the United States is so heavily indebted to the rest of the world that it become incapable of servicing the interest on its multi-trillion dollar debt. In the meantime, as long as the US current account deficit continues to flood the world with US dollar liquidity, new asset price bubbles are likely to inflate and implode; more systemic banking crises can be expected to occur; and intensifying deflationary pressure can be anticipated as low interest rates and easy credit result in excess industrial capacity and falling prices (i.e. deflation)."

The above comments are from some of the best minds in the business and what they have said about our current financial situation and what is in store for us in the years ahead. We advise investors to listen, to learn and to recognize the need to be strategically positioned in a wide variety of assets including precious metals, mining shares and long-term warrants. Nothing like taking what the experts say to heart and investing accordingly.

Dudley Baker
PreciousMetalsWarrants

Visit us soon, http://www.preciousmetalswarrants.com