Friday Lite

The story of the week, at least here at this blog, has to be what happened to the price of gold on Tuesday. Few words (actually no words) have been written on this subject in this space for fear of causing a further decline. Plummeting over $50 in a single day, it was breathtaking to watch - the declines are always much more powerful than the advances.
The good news for lovers of the yellow metal is that this is a marathon, not a sprint - short term volatility should matter little to those who appreciate the historic role that element number 79 has played in relation to organized man's inclination to overspend using money that can be created with virtually no effort or expense ... which leads directly to our second story.

Another $95 Billion Please

When the Defense Department and other agencies run low on money, more money is "authorized". Somehow, someway, the money is "authorized", it appears, it is spent, and life goes on. According to this report, the tidy sum of $94.5 billion was "authorized" yesterday, but lest anyone get the impression that off-budget spending is completely out of control, there were limits set by the White House.

"I am pleased that Congress has addressed these urgent national priorities within the spending limits I set," Bush said as the Senate passed the measure.

Congress is also advancing separate legislation adding an additional $50 billion in war funds to keep combat operations running from October through March or so.
...
Some Democrats criticized a provision in the bill that takes away funding for a special inspector to audit Iraq reconstruction contracts and shifts it to the State Department, which they said lacks expertise and resources to do the job.

If you think that the abuse of the U.S. Dollar is bad now, creating and borrowing greenbacks at rates never before seen (despite what the "official budget" numbers say), the years ahead are likely to be much worse. In the coming years, the lack of entitlement reforms will expose the finances of the world's only superpower for what they really are - a borrowing and spending spree the likes of which the world has never seen.

The story of rising gold prices in recent years is not really a story about gold at all - it's a story about the declining value of paper money issued by governments, particularly the one here in the U.S. As more and more people realize this, the short term volatility experienced in recent days will be viewed in retrospect for what it is - just a bump in the road toward much higher gold prices.

A Perfect Gold Storm

This story puts forth the idea of a perfect storm for gold, based on three factors - the dollar, new physical buying, and hedge funds going long again.

Robin Bhar, a UBS metals analyst, said gold was likely to settle near $575, though it may take a few weeks to build a floor.

The bank is waiting for three key signals: an end to the dollar rally; fresh physical buying; and signs that speculative funds are switching back to the "long" side.

"If all three happen, we have the perfect storm for gold," he said.

Vyacheslav Zabin, from BrokerCreditService in Moscow, said gold had reached a "permanently higher plateau" and would not fall much below $560.

He said the Russian central bank, flush with up to $6bn in fresh reserves each month, was becoming a major prop for the market. "They are accumulating but they do it quietly by purchasing lots straight from the producers," he said.

The story of Asian central banks buying gold is certainly an intriguing one - they quietly buy at low prices, as opposed to their European counterparts who loudly sell their bullion when prices are high, for reasons which are clear only to economists. The lone exception to the European rule is the U.K., where Gordon Browne emptied much of London's vaults back in 1999 when prices were under $300.

A Resurgent Russia

The relationship between Russia and the rest of the world is getting interesting. When you possess the natural resources that they do, certain respect is demanded. While this story from the Asia Times makes this point clear, the portrayal of Vladimir Putin in the accompanying photo certainly does not.

Two telephone calls from President George W Bush to President Vladimir Putin within the five days from May 30 to June 5, and a visit by Henry Kissinger, the ace US statesman of realpolitik, to the Russian leader's residence at Novo Ogaryovo in the Moscow suburbs last Wednesday, and the prospects of the Group of Eight (G8) summit in St Petersburg next month suddenly brightened.

All of Europe will be keenly watching the outcome of this latest Russian-US tango - most likely the Bush administration's last major act in addressing where exactly Putin's Russia belongs in the international system.

At the core of it lie the profound issues of energy security in the 21st century. Simply put, Russia has the capacity to supply the energy, but the West must reciprocate by granting Russia in political terms what has been denied to it in the past 15 years - integration with the Western world.

Oh, to be filling your central bank coffers with gold while exporting to the rest of the world - that worked out pretty well for the U.S. in the last century, it remains to be seen how well this will work for Russia, China, and the rest of Asia in the new century.

On the Way to China

It's too bad there's no picture with this story because we saw this report on the local news a few days ago and when the cameraman pointed his camera down the hole, you get a much better appreciation for what it really looks like 50 feet straight down.

A homeowner searching for gold admitted he got a bit "carried away" after neighbors complained about an 18-metre- deep hole in his front lawn.

Henry Mora, 63, began digging 10 days ago after his gold detector reported a positive hit near his front patio. He told authorities he only intended to go down about a metre.
...
A neighbor who saw the mound of dirt growing on Mora's lawn became concerned and called authorities Tuesday. Fire officials found two men Mora hired were inside the unreinforced hole, using a bucket and rope to remove dirt.

"We told him, 'You're done,'" Montclair fire Capt. Rich Baldwin said. "It's amazing no one got killed."

It's funny how American capitalists are taking advantage of rising gold prices by doing what capitalists do - finding something to sell into the market. Mostly it's been lots of TV and print ads to buy gold coins, but this report mentions a "gold detector", which is probably just a metal detector with the word "gold" liberally applied to the packaging and featured in the marketing.

Leave the Keys in the Ignition and a Half Ounce Gold Coin in the Glove Box

It seems that some SUV owners have about had it with high gas prices these days and are taking matters into their own hands. This story demonstrates what week after week of $80 fill-ups will lead some people to do (no, the arsonists didn't really ask for a gold coin - they'll still accept $300 in any assortment of U.S. currency).

A growing number of SUV owners unable to cope with rising gas prices are turning to arson to escape high car payments, according to published reports.

The trend was first spotted in California during the summer of 2005 as gas prices spiked. Arson investigators report that firefighters responding to a report of a vehicle fire arrived at the Los Angeles River Bed to find two SUVs burning at the same time.

According to police reports, the California arsonist would advise SUV owners to leave their keys in the ignition and $300 cash in the glovebox, Edmunds.com reported. An accomplice would then take the car to a remote location and set the SUV on fire. After the SUV fire, the owners would contact their insurance company and report the vehicle stolen.

The Californians they spoke of must not be homeowners - with real estate prices still at all-time highs, home equity extraction will continue for some time to come, allowing many SUV drivers to maintain the standard of living to which they've become accustomed without ever having to really make ends meet, unless of course, home equity withdrawal in California is universally viewed as income, which is entirely possible.

A Country Grinds to a Halt

This report from The Onion draws attention to just how big a non-event the World Cup is here in the U.S. when compared to how the games are perceived by the rest of the world.

With the Dow Jones average down over 600 points, factory productivity in a downward spiral, and workplace attendance down by nearly a third, experts say the U.S. World Cup team's heartbreaking 3-0 defeat at the hands of Czech Republic on Monday has brought life across the soccer-crazed nation to a virtual standstill.

"What happened in Gelsenkirchen has indeed dealt a grievous blow to the morale of the American people," said President Bush, who had promised his constituency a swift and speedy victory in the World Cup this year and whose popularity has taken a 9 percent hit since the U.S. team's loss. "I want the citizens of this great nation, the world's only remaining superpower, to know that I grieve alongside them and urge them to be strong in our hour of darkness, and urge them to return to their jobs and schools despite their heavy hearts."

The Economist sees it a bit differently. In this story($) soccer (or football, as the rest of the world calls it) is more like a universal religion where everyone but the U.S. is attending church.

FOR the next month the world will be engaged in the closest thing yet found to a universal religion—watching football (or soccer, as Americans call it). From the mansions of Pimlico to the favelas of Rio de Janeiro, everyone but a few eccentrics will stop what they are doing in order to watch teams of young men trying—usually without success—to get a ball into a net. The World Cup will be broadcast to 5 billion people in 189 countries.

Amid this global fervour the United States will stand out like a temperance preacher at a Bierfest.

Oh well, the U.S. Open is on TV this weekend and it looks like their off to a bruising start - only Colin Montgomerie is under par after the first round, but everyone knows how this year's Colin Montgomerie - U.S. Open saga is likely to end.

Read more...

How Not to Fight "Inflation"

The ongoing debate about the significance of owner's equivalent rent within the consumer price index is yet another example of how hapless the nation's dismal scientists are as they continue to formulate monetary policy based on fundamentally flawed measures of "inflation".

As you'll recall, most economists restrict the usage of the word "inflation" to mean "core inflation", which excludes things like energy and food, and since 1983 has utilized Owner's Equivalent Rent (OER) in lieu of actual costs of home ownership.

To determine OER, instead of measuring what homeowner's costs actually are - items such as principle, interest, taxes, insurance, upkeep, etc. - the Bureau of Labor Statistics asks homeowners, "If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?"

So, "core inflation" today is made up of about 38 percent housing rental costs - 30 percent OER and another 8 percent reflecting the prices paid by people who actually rent.

If you're a central banker in an Anglo Saxon country this is a great deal because you can have home prices skyrocket and these costs don't show up in the consumer price indices. High home prices boost the economy in many ways - many new mortgage lending and construction jobs are created and consumption increases dramatically through easy home equity withdrawal - but they don't hurt the banker's bottom line of price stability.

In a strange twist of fate however, as short-term interest rates continue to be pushed up, what has in recent years suppressed "core inflation" - declining demand for rental units while nearly everyone was out buying up real estate - is now working against central bankers for a number of reasons:

• Fewer people can afford to purchase homes at current sky-high prices and higher interest rates and will rent instead
  
• Some homeowners can no longer afford the adjustable rate loans they took out a few years ago after they started to adjust upward and will go back to renting
• Apartment building owners are coming in late to the game and converting staid apartment buildings into condos, reducing the supply of rental units
  

All this tilts the supply-demand equation in favor of the landlord, at least for the time being, and now rents are rising.

Housing rental costs that have behaved so well in recent years, checking in with benign price increases month after month, year after year, are now turning against their master. The single statistic on which central bankers are judged when they show up for their annual performance reviews is now out of control due to rent.

But is this fair to the central bankers? Maybe not.

Is basing monetary policy on this rent-bloated "core inflation" prudent? Well, that depends.

Taking a look at year-over-year core inflation with and without OER in the chart below, it is clear that without OER, core inflation has been essentially flat for some time now. In fact, core CPI less OER has been trending downward since it reached a peak in early 2005.

Click to enlarge

The same trend can be seen when six months of data is annualized as shown in the chart below. While OER is rising dramatically, without it, "core inflation" is essentially flat and within a range that appears normal. In fact, when including yesterday's data, the most recent measure shows a decline.

The six-month annualized figure was cited in last week's speech by Ben Bernanke. That is, the speech on June 5th to which most market participants had a violent reaction, after hearing words like "unwelcome" and "vigilant".

While monthly inflation data are volatile, core inflation measured over the past three to six months has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth. For example, at annual rates, core inflation as measured by the consumer price index excluding food and energy prices was 3.2 percent over the past three months and 2.8 percent over the past six months. For core inflation based on the price index for personal consumption expenditures, the corresponding three-month and six-month figures are 3.0 percent and 2.3 percent. These are unwelcome developments.

The 2.8 percent rate cited above is the end point of the blue line below - unchanged from last month.

Click to enlarge

So, seeing the heavy influence of OER, the largest, worst behaving component within "core inflation", a reasonable question to ponder is the likely impact of higher interest rates on owner's equivalent rent. After all, if pain is going to be inflicted on the populace in the form of higher rates, there should be a reasonable expectation of a reduction in "core inflation". Shouldn't there?

But, think about it.

In the near term at least, housing is only going to get less affordable with more interest rate hikes since house prices are "sticky down" (or at least that's what they say - we'll see just how sticky "sticky down" really is if rates continue rising).

And, if rates are at current levels or higher next March, when more than a trillion dollars of adjustable rate mortgages adjust upward, then there will likely be even more homeowners who revert to writing a check to a landlord, rather than to a mortgage company.

So what's the rationale for continuing to raise rates to fight this kind of "inflation"?

Wouldn't it make more sense to lower rates, so more renters can become homeowners and existing homeowners can refinance at lower interest rates, removing all the recent excess demand for rental housing, thus forcing OER back to a benign state?

Isn't raising rates now a perfect example of how not to fight "inflation"?

ooo

Previous articles on inflation:

10/17/2005 - Home Ownership Costs and Core Inflation
10/30/2005 - Housing Costs - Core CPI Recap
11/11/2005 - Open Enrollment and the CPI - Part One
11/14/2005 - Open Enrollment and the CPI - Part Two

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Housing and Debt

A Harvard study released yesterday, The States of the Nation's Housing 2006, paints a fairly rosy picture of the nation's housing market - it seems the only real problem that exists in real estate today is one of affordability.

Apparently, it's not a matter of prices having risen too high, the problem is that wages are not rising fast enough - some way must be found to make these expensive houses less of a burden on monthly budgets. The economy is strong, jobs are plentiful, demographics are favorable - there's just this affordability problem. And price declines are virtually ruled out.

With building levels still in check and the economy expanding, large house price declines appear unlikely for now. But if the economy falters, both job growth and housing prices will come under renewed pressure. This would spark higher default rates, especially among subprime borrowers, and turn housing from an engine of economic growth to a drag.

In this report from the Financial Times on the study, the head of the housing department at Harvard comments on the real estate outlook.

"Although housing prices are stretched, it is hard to see the catalyst for a crisis in the market," says Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard. "The overvaluation looks pretty well balanced by longer term supports for house prices, so we may just see a few years with little action. Houses will revert to being something to live in rather than money makers."

Well, how about lost jobs related to real estate as a catalyst for a crisis. Construction and mortgage lending jobs aren't being created at near the rate as in previous years now that home prices and interest rates have risen so much. The nearly one million construction jobs created in the last few years are not likely to stick around much longer if recent trends continue - the leveling off in recent months is plain to see.
It used to be the case that "as goes the local economy, so goes the housing market", but in much of the country today, the local housing market is the economy.

San Diego, not yet a loser ... barely

In San Diego, many people are becoming a bit concerned now that the single most widely accepted gauge of real estate prices, the year-over-year median price change, has come within a whisker of going negative. This story from Signs on San Diego provides the details.

San Diego County's home prices took their biggest tumble for any spring on record last month, DataQuick Information Systems reported Tuesday.

The median price of all homes sold in May was $490,000, down $15,000 from April, although it was still slightly higher than a year ago.
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Leslie Appleton-Young, chief economist for the California Association of Realtors, said she no longer uses the term “soft landing” to describe the state of the housing market, but has yet to find a way to characterize current conditions.

“I'm searching for a new moniker,” she said.

She and other industry leaders have rejected analogies like a “housing bubble” prone to popping.

The chart that goes along with the story paints a stark picture of the condo resale market. While new home sales prices are said to be unduly influenced by low-priced condo conversions, the median is the median, and the median price change for all homes sold now rounds to a goose egg.

The number of sales versus the same month last year are way down (despite the increase in condo conversion sales), and inventory is way up. Interest rates will be moving up a bit more in a few weeks and the peak summer selling months have yet to begin.

It appears that the buyer-seller standoff on prices is about to resolve itself in San Diego.

All that debt

Interest rates may have been rising in the last year or two, but that hasn't stopped people from borrowing money. The chart below is from the just-released Federal Reserve Z1 report where it is found that Americans continue to pile on the mortgage debt in spite of increased interest costs.
Note that the totals for 2006 are annualized based on the Q1 data.

Though the rate at which mortgage debt is being piled on has declined a bit in the most recent quarter it is still rising briskly - a rate of about a trillion dollars a year. A trillion here, a trillion there - pretty soon you're talking about real money.

A local lender writes

So what kind of new mortgage debt has been added in recent years? With interest rates higher, how can people continue to afford these high real estate prices? Local lender Mike explains:

A friend of mine works in the County Assessors office and he is in charge of filing all the PCORs (Public Change of Records, required for all property sales). I asked him of all the filings he did last year how many or what percentage of homes were bought in Ventura County with 100% financing.

He told me a pretty accurate figure was close to 80-85%. I could not believe it! Even as a lender I could not believe it! I then asked him what percentage of those homes were bought with adjustable rate mortgages or interest only loans. He immediately said "All of 'em."

The Harvard study, and many others like it, tend to place these non-traditional mortgage products in the context of the total mortgage market. They calm fears by stating things like, "While these types of mortgages accounted for forty percent of all new loans last year, they make up only ten percent of total outstanding mortgage debt."

That's all well and good, except that prices are set by recent sales, not from someone about to make their last mortgage payment, and according to local lender Mike, nearly every recent sale made in these parts has been of the "make my monthly payment as small as possible" variety.

For the thousands of home sales being made every month in at least one county in California, where the median price is over $600,000, prices are wholly dependent upon non-traditional mortgage products, which have yet to see any regulatory control from any federal agency (proposed guidance was circulated last fall, but lenders didn't like what they saw, though Ben Bernanke did recently promise to do something about this some day).

Don't count on prices remaining aloft if interest rates continue to rise and non-traditional mortgage products finally see some regulation. They may not even stay aloft if interest rates are lowered and the loan products get more even non-traditional.

UPDATE (June 14, 8:15 PST):

Here's a link to Keith's post at HousingPanic about the policy advisory board for the Harvard housing study, and here's a link to the Harvard website with the same info.

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"I have some bad news for everyone in the room"

That's what John Winkleman of the Nebraska Retirement System said to a group of fifty year olds at a small retirement information and planning session in another excellent PBS Frontline documentary titled, Can You Afford to Retire?

Mr. Winklemnan went on discuss how Americans aren't saving enough money in their 401k plans and that a lot of people are going to be in for a nasty surprise in the next ten or fifteen years if they think they're going to be able to stop working, "How many of you have seen somebody of retirement age working at McDonald's or Burger King? Now, do you think their retirement goals are to supersize fries?"

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The marketing department is on our backs again. They demanded that the "blue pills" on this blog and on the Iacono Research website be replaced with something a little more "contemporary" - done. Then they demanded that a special welcome message be created over at the website with a free trial offer for readers of the blog - done (click on the new graphic or here).

They demanded a few more things, but were promptly told to bugger off.

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Many baby boomers are under the mistaken impression that they're going to be enjoying a life of leisure in their golden years - if not funded by their meager savings, then somehow financed by the wealth that has accumulated in their home.

Think again.

ANNOUNCER: For the Baby Boom generation, there's trouble ahead.

BROOKS HAMILTON, Corporate Benefits Consultant: Workers are going to retire into despair and run out of money.

ANNOUNCER: The reality of retirement is starting to sink in.

BESS CRABB: I thought when he retired, it was going to be a lot different.

PAT O'NEILL, Retired Mechanic, United: It's scary as hell.

ROBIN GILINGER, Flight Attendant, United: The hardest thing is not knowing that I'll be able to retire.

HEDRICK SMITH, Correspondent: Good morning. How are you?

ANNOUNCER: Tonight on FRONTLINE, correspondent Hedrick Smith explores the changing world of retirement, discovering how corporations are dumping old-fashioned pensions­

Prof. ELIZABETH WARREN, Harvard Law School: Bankruptcy is a way to take legal promises and burn them.

ANNOUNCER: ­examining how the new 401(k) plans are working­

Prof. ALICIA MUNNELL, Boston College: The idea that we should all be financial experts is a crazy idea.

ANNOUNCER: ­and asking, Can You Afford to Retire?

Prof. TERESA GHILARDUCCI, Notre Dame University: We're now shifting from lifetime pensions to lifetime work.

Cue the cool Frontline music and the neat graphics. The entire program is available for viewing online - just one of many outstanding works by this group of documentary makers.
Can you afford to retire? That's a question that baby boomers are asking themselves in increasing numbers today.

The days of generous pensions are nearing an end and even if you do retire with a nice package from a large corporation, you never know how long you'll keep getting what's been promised to you. After years of underfunding their pension plans, bankruptcy now appears to be an increasingly convenient way for corporations to regain their competitiveness in a changing market place.

Lightening up during a Chapter 11 reorganization, now mostly accepted as just part of doing business, results in the jettisoning of high cost defined benefit plans that are then turned over to the Pension Benefit Guarantee Corporation (PBGC), whose check writers have a nasty habit of halving the amount that shows up on the monthly checks.

HEDRICK SMITH: [voice-over] By exploiting those [pension funding] loopholes, corporate America has created a time bomb. More than 18,000 companies have underfunded their pensions. In five years, several large companies have dumped their pension debts onto the PBGC. Its deficit is now $23 billion and threatens to balloon far larger.

BRADLEY BELT: The level of under funding in the system as a whole, which we estimate at $450 billion today, is substantially more than it was just four or five years ago. It was less than $100 billion.

HEDRICK SMITH: [on camera] Let me get this straight. You're saying that the current corporate pension system in the private sector today is underfunded by $450 billion?

BRADLEY BELT: That's if everybody were to try to terminate their pension plan today.

About the first half of the documentary is used to look at the United Airlines reorganization from the viewpoint of what it cost employees in retirement benefits, how company executives were affected, and how the bankruptcy lawyers fared.

This is a sad tale for current and former employees, but a great success story for management. The hourly worker with thirty years in - all he ever wanted was what the company promised him. The executives and bankruptcy lawyers - they get stock options and a whole new growth industry.

HEDRICK SMITH: Jamie Sprayregen, the lead bankruptcy lawyer for United Airlines, is the most visible edge of an entire new industry that has developed in law firms and Wall Street banks to move companies through bankruptcy.

JAMES H.M. SPRAYREGEN: These days, every large law firm in the country has some sort of bankruptcy practice. We have around a hundred lawyers who do nothing but this. The practice has really moved to be a mainstream part of most big law firms these days.

HEDRICK SMITH: The business has mushroomed as bankruptcy lost its stigma and gained acceptance as a corporate strategy.

At least somebody is benefiting. If you can fund both your child's college education and your retirement, try to get little Johhny interested in bankruptcy law - it looks to be a good career path.

For most individuals these days, 401ks are the primary vehicle for retirement saving.

Since the advent of the 401k plan in the 1980s there has been a gradual shift of responsibility from the employer to the employee, something that has worked out well for some, but not very well for most. The whole idea of employee managed individual retirement accounts in lieu of company pensions seems doomed to failure for a number of very simple reasons having to do with your typical employee:

1. They don't manage money well
2. They know little about investing
3. Timing is everything

In general, the idea of managing money for employees, as in a defined benefit plan makes much more sense when considering the same points:

1. Professionals manage the money
2. They know a lot about investing
3. Timing doesn't matter
   

The idea that everyone should become a financial expert is indeed crazy - just getting people to manage their money a little better and not take on so much debt would be a huge step in the right direction. Asking them to also become good stock pickers is asking a bit too much.

Many companies go to great lengths to encourage and educate their workers - National Semiconductor in Dallas, Texas was singled out as an example of how a good 401k plan could be run. Attractive matching contributions and mandatory attendance at retirement workshops all help, but in the end it is up to the individual. The individual is in control of everything.

How's it going so far?

HEDRICK SMITH: [voice-over] Of course, the test of any 401(k) plan is how well retirees are actually doing, so I went to call on some National retirees living nearby. One was a former customer tech rep, Gil Thibeau.

GIL THIBEAU, Natl. Semiconductor Retiree: Before I jumped into it, I did my own personal research on the computer and talked with other people who were in different plans and what was working best for them.

HEDRICK SMITH: Thibeau is the kind of employee 401(k)s are made for. An engineer with a master's in business administration, he was making more than $90,000 a year. Over 14 years, Thibeau built up a nest egg of $450,000.

GIL THIBEAU: My retirement was a half a million because I got a started late. I would have­ if I had started earlier, I would have set my target at a million, but I waited too long, like I think most people do.

HEDRICK SMITH: But not far away, I found another National retiree living a very different kind of retirement. Winson Crabb retired three years ago as a $50,000-a-year equipment technician. During 16 years at National, Crabb says, he faithfully funded his 401(k) plan.

WINSON CRABB, Natl. Semiconductor Retiree: My assumption was that when I got to be 65, well, there would be a large amount of money in there for me to take cash out to put in our bank to utilize for whatever. Well, that didn't work out.

HEDRICK SMITH: But Crabb's wife, Bess, remembers the market dropping sharply in the two years before Crabb retired. So what's your recollection about the maximum amount there was in your husband's 401(k)?

BESS CRABB: A hundred and twenty thousand. That was our goal, and that's what was there.

HEDRICK SMITH: And then the market fell.

BESS CRABB: That's right.

HEDRICK SMITH: So you lost about half of it.

BESS CRABB: Oh, we lost more than that because it went down to $45,000, and we built it back up to $64,000. And then when­ the day that he drew out the 401(k), it was $52,000.

HEDRICK SMITH: Fifty-two thousand.

BESS CRABB: Yes.

HEDRICK SMITH: Things got worse. Crabb had some debts to pay, and he got socked with a tax bill when he cashed out his 401(k) in a lump sum.

WINSON CRABB: I just went with the information that I had and thought I was doing the right thing, which I wasn't.

HEDRICK SMITH: So what'd you wind up with out of the $52,000?

WINSON CRABB: I think it was $26,000.

HEDRICK SMITH: So how do you manage financially? What do you do?

WINSON CRABB: Well, you do what you have to do, for one thing, you know? I had a couple jobs in between there, and my wife works.

BESS CRABB: Well, I thought when he retired, it was going to be a lot different, you know, money-wise.

WINSON CRABB: It was a jolt when we got to counting funds at the end of all that. You know, one day we had to set down and say, "Whew! This is not like what we thought," you know?

So, the engineering type seems to have done OK but the hourly worker is having trouble. Things would have been much simpler for the hourly worker if he could just put in his time and then collect a retirement check every month without having to think too much about it.

The current system is set up to favor someone like Gil, an engineer with a master's degree, over someone like Winson, who probably favors a cold beer over a spreadsheet. The following question asked of company executives, demonstrates how the current system is stacked against your typical middle-income employee.

BROOKS HAMILTON: I used to ask the CEO, CFO of my major clients, often in an environment, a conference room­ some young employee would bring in coffee and all, and as they would be leaving, I would ask the CEO, "Fred, let me ask you, would you allow that employee to direct the investment of your account in the 401(k) plan?" And they always thought I was some kind of idiot. It's kind of like, "Don't they teach you anything down in Texas, Brooks? Of course not. I wouldn't let them touch my account with a 10-foot pole." And I'd say, "Well, but you force them to manage their own, and they are running their money into the ground."

HEDRICK SMITH: The roots of the problem, some say, lie in how the 401(k) system was born in Washington. Originally, it was not set up to have millions of us managing our own retirement.

Prof. ALICIA MUNNELL: 401(k) plans were originally introduced as supplemental plans. No one ever said, "Oh, let's end these traditional pensions and replace them with 401(k) plans."

What is sold as giving control to the individual, part of the grand "ownership society" of recent years, is really a burden to many employees. The "free money" in the form of matching contributions from the employer is just a small part of what the employer used to contribute for for each employeed under traditional pensions.

Since 1974 the total contribution to employee retirement savings has gone from 89 percent by the employer and 11 percent by the employee, to about 50-50 in 2004.

Naturally, the big winners are corporations opting for 401k plans versus traditional pensions since their overall costs have decreased dramatically. In a world of global competition, this cost savings is not that objectionable, what is objectionable is making individual employees manage their own savings - few do it well.

This documentary, as good as it is, doesn't touch on one of the worst aspects of 401k plans as they currently exist. While large pension funds such as CalPers are committing funds to investments such as commodities after the 20 year bull market in equities seems to have run its course, employees with 401k plans are generally restricted to stocks, bonds, and cash.

Sure, they get occasional non-advice during company seminars from the 401k plan manager's representative prodding curious workers to stay heavy on equities early in their career, diversifying over all nine Morningstar style boxes. But, this will be of little help to account balances if the coming decade for stocks turns out like the last bear market in stocks - so far this decade, that's where it looks like we're headed.

The lifecycle funds are an improvement, but if the last five years and the last five weeks are any indication, many employees who do everything in their 401k "by the book" in the coming years may be quite disappointed with the results.

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Influencing Inflation Expectations

Wow! The folks at the Federal Reserve will be making lots of speeches this week. All this jaw-boning in an attempt to influence "inflation expectations" is starting to look a lot like the White House's occasional media saturation for what appears to be an ultimately failed attempt to influence "Iraq expectations".

On several occasions in recent years, the entire White House staff, much of the Cabinet, and some of the kitchen help have fanned out across the country to talk about how "unwelcome" certain developments were - how we must be "vigilant" in Iraq because our future prosperity rides on keeping that part of the world "well-contained".

Well, the White House didn't really use those words - but they could have. Those are the words of the Fed when talking about rising prices - something that people see all around them now, many realizing for the first time in recent months that something has gone awry in their idyllic world of high asset prices and low consumer prices.

As evidenced by this week's schedule of speeches shown below, courtesy of Econoday, it looks like the Federal Reserve is putting the "tough talk on inflation" public relations campaign into high gear.

Monday - Jun 12, 2006

7:30 PM ET: Federal Reserve Chairman Ben Bernanke to speak about risk management to Stonier Graduate School of Banking students, at Georgetown University, in Washington. Audience Q&A expected .

9:15 AM ET: Cleveland Federal Reserve Bank President Sandra Pianalto to speak about the U.S. economy & monetary policy, at a conference, in Orlando, Florida. Audience Q&A expected.

10:30 AM ET: Dallas Federal Reserve Bank President Richard Fisher to speak about global relations at the University of Texas, in Austin, Texas. Audience Q&A expected.

12:15 PM ET: Federal Reserve Governor Mark Olson to speak about regulatory compliance, at a bankers conference, in Lake Buena Vista, Florida. Audience Q&A expected.

3:00 PM ET: Federal Reserve Governor Susan Schmidt Bies to speak about enterprise risk management at the Financial Women's Association conference, in Washington. Audience Q&A expected.

Tuesday - Jun 13, 2006

11:00 AM ET: Federal Reserve Chairman Ben Bernanke to speak about consumer issues at a leaders conference, in Washington. Audience Q&A expected .

Wednesday - Jun 14, 2006

11:30 AM ET: Federal Reserve Governor Susan Schmidt Bies to speak about real estate at the Mortgage Bankers Association conference in Half Moon Bay, California. Audience Q&A expected.

1:00 PM ET: Dallas Federal Reserve Bank President Richard Fisher to speak about the U.S. economy, at a luncheon in Corpus Christi, Texas.

Thursday - Jun 15, 2006

2:00 PM ET: Federal Reserve Chairman Ben Bernanke to speak about energy to the Economic Club of Chicago. Audience Q&A expected .

1:00 PM ET: Federal Reserve Governor Randall Kroszner to address International Bankers meeting on the subject of international capital markets, in New York. Audience Q&A expected.

Friday - Jun 16, 2006

5:00 AM ET: St. Louis Federal Reserve Bank President William Poole to speak at a conference, in Seoul, South Korea.

11:00 AM ET: Federal Reserve Governor Donald Kohn participates in a panel discussion on policy recommendations at the Boston Federal Reserve Bank's conference on global imbaances in Chatham, Mass. Audience Q&A expected .

1:15 PM ET: Federal Reserve Governor Randall Kroszner to speak about international capital markets to the Institute of International Bankers, in New York. Audience Q&A expected.

Fed Chairman Ben Bernanke will speak three times this week, each with a Question and Answer session expected to follow, and Dallas Federal Reserve Bank President Richard "ninth inning" Fisher will speak twice.

[In fairness to Richard Fisher, when he predicted the end of interest rate hikes in June just over a year ago, he never did specify the year, so his prediction may ultimately prove to be accurate if this month's rate hike is followed by a pause.]

Do they really think that they can make people believe that prices will not rise too much in the future because they keep talking about how vigilant they're going to be? Apparently so. You see, inflation expectations are something that, like expectations for the outcome in Iraq, need to be managed - otherwise they may become self-fulfilling.

People can not be left to formulate their own expectations - they must be helped along.

Like watching reports from Iraq on the evening news week after week, the weekly dose of pain at the pump has been like Chinese water torture to the pocket books of Americans for much of the last year.

Like the violence in Iraq, it seems there is little anyone in Washington can do about high energy costs, save for trying to influence public opinion about how things might be in the future.

In both cases, better policy would have lessened the need to influence expectations.

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Supply-Sider Investment Advice

There's been a little yellow sticky note at the top of my computer monitor since the end of January of this year. It says, "1/21 - Cavuto - Herman Cain - BZH - $75", in reference to a recommendation made by Herman Cain on the Fox business news show Cavuto on Business to buy Beazer Homes at $75 about five months ago.

It's been sitting there for a while now, and it wasn't really clear what should be done with it aside from maybe adding it to the collection of prognostications that are kept in a text file on my computer desktop. But that text file contains predictions from people whose opinions are respected here, so Herman's little stock tip really didn't fit neatly into that category.

So, when John Rutledge started talking about commodities the other day on Larry Kudlow's show (a program that is viewed here about once every few weeks, and then only to listen to Barry Ritholtz and Herb Greenberg unsuccessfully try to beat some sense into Larry's skull on Thursday afternoons) the idea was hatched to combine these two bits of supply-sider clairvoyance into a short little Sunday post to demonstrate the dangers that lie in wait for anyone taking investment advice from these types.

First, what followed Herman's prediction:
OK - it's not clear what could possibly be added in words, the chart says it all. Whoever those poor saps are that bought Beazer Homes back in January on Herman's advice - they deserve what they got.

So, what did John Rutledge have to say?

The exact words are now lost, because the Thursday afternoon Kudlow show has not moved up from "Keep until space needed" to "Keep until I delete" status on my faithful Tivo, but it was something like the following.

After Herb Greenberg gave a thumbs up to buying gold at Thursday prices (adding that he'd buy more if it went lower), and new favorite Jeffrey Saut of Raymond James gave it a big booyah, and then Barry hesitated, mumbling something about looking for a slightly lower low said he'd be a buyer at between $580 and $600, Larry quickly cut off that discussion which was not going in his favor and turned the mike over to John Rutledge so someone, anyone, could say something that didn't trigger Larry's cognitive dissonance synapses which just make him talk louder than he usually does.

Like a true supply-side, Reagan Republican, trickle-down savant, John Rutledge explained that the commodities bubble has burst and the clear confirmation comes from the widespread purchase of commodity ETFs by grandmothers.

Larry liked that answer.

ooo

This week's cartoon from The Economist.

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Friday Lite

Another bruising week in nearly every market - maybe it's time to go on vacation and check back in around Labor Day. Had market participants sold in May and gone away, a summer vacation could have been much more luxurious than one paid for with proceeds from recent sales.

Oh well - on to the Liteness that is Friday.

Commodities and Credibilities

One thing that hasn't been bruised in the last few weeks is the credibility of central bankers. It's too bad you can't trade futures contracts for central bank inflation fighting credibility. Maybe now that the Chicago Mercantile Exchange offers futures and options trading for residential real estate they'll offer a similar product for central bankers where traders can place bets on how successful Federal Reserve officials are in influencing inflation expectations.

If you'd had call options on the Fed talking inflation down, you would have done quite well over the last month - maybe it's time to sell the calls and buy some puts.

The commodities markets have taken a beating as a result of all the inflation fighting talk. Gold and silver are dropping like rocks and copper is back down around $3.40 from highs near $4. But, what does the recent market correction really mean? Was that the popping of a commodity bubble?

To put things into perspective, consider the chart below - a precipitous decline, following a strong run-up from under $500 which commenced shortly after Ben Bernanke was nominated as new Fed chief last fall.
A rise of 70 percent in a year is a bit much, but the vast majority of this gain occurred within a six month period leading up to the May high - maybe gold and other commodities are already off on an early, extended summer vacation.

Double Counting of Gold

Speaking of the price of gold, the IMF has recently reported that central banks, one in particular, have been counting gold that has left their vaults as though it were still there.

International Monetary Fund (IMF) seems to have had apparently directed member central banks to double-count their gold when it had been leased or swapped or otherwise had left a central bank’s vault or possession. Such a provision allowance for the central banks may have led to the gold price suppression which lasted between 1989-2001, after which price started moving upwards.

Gold hit a 26-year high of $732 an ounce on May 12. Gold has dropped 11% since then. Gold has not yet been able to cross the high of $ 830 mark it hit in 1988.

Central bank of US in particular has been seen as the primary mover in suppressing the gold price by lending the gold for trading without accounting for it. However, there have been no concrete proofs in this regard.

The paper, “Treatment of Gold Swaps and Gold Deposits (Loans),” written by Hidetoshi Takeda of the IMF’s Statistics Department and published in April acknowledges at length the potential for double-counting central bank gold under current IMF rules and suggests rules to prevent it.

Maybe that's why Fort Knox hasn't been audited in twenty five years.

The Best Week Ever

No, not the markets - no more talk about financial markets today. This week has been the best week ever in the ongoing quest to secure the number one spot on all the major search engines for the phrase, "Friday Lite".

Previously the best showing was #1, #1, and #7 on Google, MSN, and Yahoo! respectively, which was followed by a big fall at MSN and a slight rise at Yahoo!.

This week, as has been the case for months now, the top spot is secured at Google, but this blog is also back in the good graces of Yahoo!, garnering the top two spots there. As the normal check sequence is Google, Yahoo!, and MSN, there was brief hope that a trifecta would be achieved, however, the search at MSN shows a third place finish.

It's the usual nemeses again - Strategic Public Relations and The View from Her. Perseverance will win in the end - it's just a matter of time.

A Damn Fine Dam

The Three Gorges Dam took on its first real strain earlier in the week after a temporary dam that had protected it during its construction was demolished. There were additional cofferdams set for demolition later this week, all leading up to the full operation of world's largest hydroelectric dam, five times the size of Hoover Dam.

The Three Gorges Dam has been engineered to prevent and control floods and "even in the rare occurrence of a 1,000 year flood, mass damages or injuries can still be prevented," according to Zhang.

Deadly floods are a frequent occurrence along the Yangtze, China's longest river and the world's third longest after the Nile and the Amazon.

The floods have claimed more than a million lives in the past century, with the latest flood, in 1998, responsible for about 1,000 deaths and approximately 100 billion yuan (US$12.5 billion) of damage.
...
Designed for power generation as well as flood control, when operating at full capacity the dam's generators are expected to produce 18.2 million kilowatts of energy up to one ninth of China's output.

Damn, that's a lot of energy.

A Damn Fine Movie

The Da Vinci Code was pulled from movie theatres across China after only three weeks in general release. Ticket sales were brisk, and it was well on its way to becoming one of the highest grossing foreign films of all time.

The withdrawal is to make way for domestic movies, Weng Li, spokesman for China Film Corporation one of the two co-distributors of the Hollywood blockbuster on the Chinese mainland told China Daily yesterday.

The decision was made in response to calls for promotion of domestic movies by the Chinese Movie Distributors' Association, the Chinese Movie Producers' Association and the Chinese Urban Movie Theatres Association last month, he said.

"We are not against foreign films," the spokesman noted. "My company will continue to arrange their screenings in China according to market demand."

A gatekeeper at the Cineplex in Beijing's upscale Oriental Plaza said: "It is surprising news. The movie has drawn the largest number of viewers in the year."
...
Before the movie was released in China, the Chinese Catholic church issued a notice to followers nationwide asking them to "firmly boycott" it, accusing the movie of going against, and distorting, the tenets and history of the Catholic church.

Maybe it was Tom Hanks' hair that was objectionable, it certainly couldn't have been anything to do with Audrey Tautou.

Mentos and Soda

Poking fun at their goofy TV spots isn't the only enjoyment that can be derived from Mentos candy. According to this report, the small oblate spheroids, with a slightly hard exterior and a soft, chewy interior, have a violent reaction to carbonated drink.

What happens when you put a handful of Mentos candy into a bottle of diet soda? As many fans of Web video have found out, the results are pretty explosive.

But it's no secret -- folks are taking video cameras and posting images of their homemade soda explosions on the Internet -- and there is actually a scientific explanation. Michele Norris speaks with science correspondent David Kestenbaum about the science behind Diet Coke and Mentos.

Torrey's science experience can be viewed on Google Video here, while the much more elaborately produced eepybird film, which concludes with an oral demonstration, can be found here.

Gold is Really a Noxious Gas

From The Onion it is learned that gold is really a noxious gas - at least that's what one rogue scientist claims.

Only months after abandoning a tenured position at Lehigh University, maverick chemist Theodore Hapner managed to disprove two of the three laws of thermodynamics and show that gold is a noxious gas, turning the world of science—defined for centuries by exhaustive research, painstaking observation, and hard-won theories—completely on its head.

The brash chemist, who conducts independent research from his houseboat, has infuriated peers by refusing to "play by the rules of Socrates, Bacon, and Galileo," calling test results as he sees them, despite overwhelming evidence to the contrary.

"If you're looking for some button-down traditionalist who relies on so-called induction, conventional logic, and verification to arrive at what the scientific community calls 'proof,' then I'm afraid you've got the wrong guy," said the intrepid 44-year-old rebel, who last month unveiled a revolutionary new model of atomic structure that contradicted 300 years of precedent. "But if you want your results fast and with some flair, then come with me and I'll prove that the boiling point of water is actually 547 degrees Fahrenheit."
...
Hapner is undoubtedly taking a great risk with his latest study, but the maverick scientist is confident his work will pay off.

"Bombarding a plutonium nucleus with accelerated electrons, long believed to produce a nuclear fission reaction, has, in fact, no consequence at all," Hapner said. "I'm going to prove that if it's the last thing I ever do."

Independent research performed on houseboats has been proven to be the most reliable form of research.

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