Dearest One

For those of you sending emails this way, be advised that if it says "Dearest One" anywhere near the top it gets deleted in about 0.2 seconds. If it makes it past the 0.2 second mark and then says "to inform you" in the first paragraph, then it gets deleted in about 0.5 seconds. If it lingers past the half second mark and a very quick scan reveals any large dollar amounts, it will surely be deleted within one second of having laid eyes on it.

I see that Yahoo! Mail has collected about a thousand messages in the Spam folder which is never, ever checked anymore - sometimes legitimate messages get in there but the volume is now far too high to go through and pick out the real ones, so if you've sent me mail and I haven't responded, yours probably went in there.

Why can't the Yahoo! spam filters put these (apparently still successful) Nigerian scam emails in there with the thousands of others that get redirected to the SPAM folder?

I don't know what the monkey picture is all about, but it's from this website and I think it's related.

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The week's economic reports

Better than expected third quarter productivity gains and a good report on international trade reflected a more robust period prior to the impact of the summer's credit market troubles - sharply lower consumer sentiment was the more timely and significant economic report in the week just concluded.

Stocks and bonds ended with the S&P 500 Index down 3.7 percent to 1,454, now up just 2.5 percent for the year, and the yield of the 10-year U.S. Treasury note fell 7 basis points to 4.22 percent.


Productivity and Labor Costs: Productivity rose more than expected and labor costs fell, both of these developments coming as a surprise to analysts looking for lower productivity growth and higher unit labor costs. Worker productivity grew at an annualized rate of 4.9 percent in the third quarter following a downwardly revised 2.2 percent gain during the second quarter. This increase is consistent with real third quarter annualized GDP growth of 3.9 percent reported last week.

Unit labor costs fell at an annualized rate of 0.2 percent after increasing by an upwardly revised 2.2 percent in the second quarter. This follows relatively strong wage gains over the last year or so, the year-to-date increase falling from 5.1 percent as reported in the second quarter to 4.3 percent in the third quarter. This decline in wages may be part of a slight softening in the labor market where employers feel less inclined to boost wages amid fears that job cutbacks may be in store due to a weakening economy.

Consumer Credit: The amount of new consumer credit in September came in well below expectations, rising by only $3.7 billion, after an upwardly revised surge of $15.4 billion in August. It is hard to draw any conclusions about this report as it reflects activity during the height of the late-summer credit shock when both consumers and creditors were hesitant to borrow and lend, respectively.

International Trade: The U.S. trade deficit with the rest of the world unexpectedly narrowed in September after many thought that higher oil prices would result in an increase. The trade gap narrowed from a revised $56.8 billion in August to $56.5 billion in September as rising exports more than offset slightly higher imports.

The price of imported crude oil rose from $68.09 in August to $68.51 in September and, due to a slightly lower volume of oil imported, the overall oil trade deficit was about even with the month before at just over $24 billion. This oil price data implies that the worst of the recent crude oil price increases will show up in the October report on international trade.

Import/Export Prices: Both import and export prices rose more than expected in October, the higher cost of oil pushing import prices up 1.8 percent for the month and 9.6 percent higher on a year-over-year basis. Note that the report on international trade directly above lags most other economic reports by one month - this can result in a good deal of confusion as import prices for petroleum products rose 6.9 percent in October while they were almost flat in the September trade report.

Export prices rose 0.9 percent for a year-over-year increase of 5.6 percent, this increase driven largely by higher prices for agricultural products that rose 3.9 percent in October. Prices for agricultural exports have risen 29.6 percent on a year-over-year basis.

Consumer Sentiment: The housing and credit market turmoil and sharply rising energy prices are beginning to affect the mood of the American consumer as the Reuters/University of Michigan consumer sentiment index fell to lows not seen since Hurricane Katrina in 2005. In the preliminary report on consumer sentiment for October, the index plunged to 75.0 after a reading of 80.9 in September. The final index for November will be released in two weeks.

In the last 15 years, the current conditions index has been lower only one time - just prior to the invasion of Iraq in 2003. The consumer expectations index fell from 70.1 in October to 64.7 in November - also the lowest level since Hurricane Katrina. The outlook for "inflation expectations" worsened as the one-year expectations level jumped from 3.1 percent to 3.4 percent with the bulk of gasoline price increases yet to come.

It remains to be seen how much the souring consumer outlook will affect consumption in the months ahead. Surprisingly, consumer confidence from the Conference Board and consumer sentiment from the University of Michigan are only tenuously connected to retail sales and personal spending.

Summary: While higher productivity and stable labor costs were good news, they are also very old news reflecting activity in the third quarter prior to the effects of the credit market crisis spreading to the broader economy and relaxed monetary policy spurring higher commodity prices. The surprise narrowing of the trade deficit was also good news, but this report too reflects activity from months ago.

While the ISM services index did show an encouraging improvement, the report with the "freshest" data was the consumer sentiment index released on Friday, a report that probably provides the most accurate indication of where the economy is headed almost three months since the credit turmoil began in August. Fading consumer confidence, with another month or two of rising prices at the pump yet to come, may result in lower retail sales during a critical time of the year, but this is anything but guaranteed - the American consumer has been counted out many times before. Next week's report on retail sales will be greatly anticipated.

The Week Ahead: The week ahead will be highlighted by reports on retail sales on Wednesday and consumer prices on Thursday. Also scheduled for release are pending home sales on Monday, producer prices on Wednesday, two regional manufacturing reports on Thursday, and both international capital flows and industrial production on Friday.

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How did you do this week?

It doesn't always work out like this, but, when it does, it seems only fitting to share some of the good news with readers and subscribers before the update at the investment website on Sunday. While broad equity markets tumbled, the model portfolio at Iacono Research ended the week where it began, holding onto its considerable year-to-date gains.
Oh honey, why didn't we subscribe to Tim's investment service?

Sorry, I couldn't resist - this image was on the Yahoo! Finance page when I was collecting the data for the major U.S. stock indexes and somehow I thought they were looking at what happened to their portfolio over the last few days.

The current special offer for a two-year subscription at only $99 per year will be available for a limited time only.

To learn more about investing in natural resources using commonly traded ETFs, stocks, and mutual funds, see this description at Iacono Research. Or, sign up for a free trial.

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KEN BUYS HOUSES IN 3 DAYS

Ubiquitous - that's the word. That's what Ken's signs are. You can see 'em all over this part of Northern California - mostly tacked high up on telephone poles (how do they do that?) with a bright red-orange background and big bold type.

Ken's signs are much more subtle than the ones seen in Southern California earlier this year affixed to three-foot stakes and planted in the ground near stoplights like you'd see leading up to an election - AVOID FORECLOSURE.

Who knows how much things have changed since we fled the Southland more than six months ago - without a doubt, real estate prices are much lower and, who knows, maybe Ken buys houses all over California these days.

This story in USAToday is not directly related to Ken and his California home-buying business, but there might be people like the Reyes family in Illinois, pictured below, who could tell stories about Ken.

At the Legal Assistance Foundation of Metropolitan Chicago, the phone calls come nearly every day from yet another financially desperate homeowner who's become the victim of a "foreclosure rescue" scam.

"This has become the No. 1 problem in terms of calls we're getting and cases we're filing," says Daniel Lindsey, supervising attorney for the foundation's Home Ownership Preservation Project.

And it's clearly a nationwide problem that's likely to get worse.

Regulators and law enforcement in many states are targeting the two most common forms of foreclosure rescue scams: "equity skimming" and bogus or fruitless consulting services.

The first scam works like this: A company offers to take legal ownership of the home temporarily. The homeowners pay "rent" to the company, which promises to return legal ownership to them once they regain their financial footing.

But all too often, con artists borrow as much as they can against the equity in the house — and collect the rent from the original homeowners but never make any mortgage payments. In the end, the property still goes into foreclosure, and any equity the homeowner had built up is gone. Their financial ruin is complete.

The second-most-common foreclosure-rescue pitch goes like this: A company offers to renegotiate the homeowners' mortgage with the lender or help refinance the property. In exchange, they charge an up-front fee, typically $800 to $1,200.

Frequently, though, the company never contacts the lender, or knows the borrower can't qualify for another loan. What little extra cash the homeowner could have used to pay the mortgage or move to an apartment has been wiped out by worthless "services."

It is sad to think that many of the very same people who thought they were going to be rich beyond their wildest dreams just a few years ago are going to end up much poorer after the bursting of the housing bubble runs its course.

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Consumer sentiment plunges

Maybe Jim Cramer and John Sununu were right - the outlook of the American consumer appears to be dimming rather quickly as more light is shed on what went on during the housing boom. Of course, rising energy prices don't seem to be helping.

Consumer sentiment, as measured by Reuters and the University of Michigan, plunged in November to the lowest level since Hurricane Katrina in 2005 and it is barely over that mark. In the last 15 years, the current conditions index has been lower only one time - just prior to the invasion of Iraq in 2003.

Once the U.S. consumer loses confidence, they stop borrowing, they stop spending, and then someone plays a clip of Dandy Don Meredith, former Dallas Cowboys quarterback and 1970s Monday Night Football commentator, singing "Turn out the lights, the party's over" for the U.S. economy.

It turns out that the freakishly high 70 percent of GDP that comes from consumer spending might be a problem after all.

This MarketWatch report fills in some of the details.

The consumer expectations index for November reached 64.7 -- also the lowest level following Hurricane Katrina -- down from 70.1 in October.

Ian Shepherdson, chief U.S. economist with High Frequency Economics, wrote that the expectations index "is more worrying now because we can see no reason why it should improve" soon.

He added that confidence is much more likely to continue to slide than recover.

"The timing of this plunge in sentiment, coming just before the holidays, could not be worse," he wrote. "This is the time of year when retailers make their money, but the holiday season is shaping up to be a disaster."

On Thursday, U.S. retailers reported their worst October sales in 12 years, hurt by unseasonably warm weather, record high oil prices, and consumer worries about the housing and credit markets.

The really bad news is that the worst of the gasoline price increases have not yet appeared at gas stations - it is still relatively cheap at only $3 a gallon. More than anything else, the mood of the consumer tracks the price at the pump. If the price of oil remains elevated, many are predicting $4 a gallon just as the holiday shopping season gets into full swing.

That could be a problem.

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An update to the "Bernanke Cycle"

The pattern of Federal Reserve actions and responses by various markets, introduced here a few days ago, has been given a name today - the "Bernanke Cycle".

It is now in beta-testing and will likely be subject to further refinement in the days and weeks ahead - suggestions are encouraged. Back-testing begins next week. The latest update includes yesterday's "strong dollar" talk from the Treasury Department.

Here it is - updated today with new location indicators and a new step number 10 - "Federal Reserve talks tough on inflation" - an acknowledgment of the "equally balanced" assessment of the risks of slowing growth and inflation reiterated during yesterday's testimony before the Joint Economic Committee.

The Bernanke Cycle

1. Federal Reserve cuts interest rates
2. Equity markets surge
3. Dollar decline accelerates
4. The price of oil and gold soar
   
5. Treasury reiterates "strong dollar policy"
6. Housing market problems get worse
7. Credit market problems get worse
8. Dollar decline accelerates
9. The price of oil and gold soar
10. Federal Reserve talks tough on inflation <----- YESTERDAY
11. Treasury reiterates "strong dollar policy"<----- YESTERDAY
12. Equity markets plunge <------------ YOU ARE HERE
13. Go to step 1
    

Yes, if equity markets continue on their current trajectory, there is nowhere to go but back to step 1 and the next FOMC meeting on December 11th is a long way off.

Is an interim rate cut looming?

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So what if the appraisals were fraudulent!

Jim Cramer of CNBC joins Republican Senator John Sununu of New Hamphire in wondering about the timing of New York Attorney General Andrew Cuomo's probe into appraisal fraud by major mortgage lenders.

The historians are going to have a field day when writing about this era - unlike the aftermath of prior speculative bubbles, this one is on YouTube and in blogs.

Hopefully, the passage of time, along with some major (and probably painful) adjustments to what Ron Paul calls our "subprime economic system", will result in clearer heads prevailing someday - both on television and in Congress.

For those who missed it, here are Senator Sununu's comments from today's Joint Economic Committee group therapy session with Fed chief Ben Bernanke:

Yesterday, the Dow dropped 360 points and a number of analysts in the financial press blamed a lot of that drop on the New York Attorney General and his press release that alleged, in his words, "systemic fraud and a pattern of collusion in the mortgage industry" and he made those allegations with specific reference to transactions between Fannie Mae, Freddie Mac, and Washington Mutual for which he issued subpoenas. My question to you is, in this environment, where we see big problems with credit in the mortgage industry, is this kind of a press release really helpful in solving the problems in front of us?

Ben Bernanke didn't really offer up an answer - perhaps some help can be provided here.

No, Senator, we should handle this sort of thing quietly so that consumer confidence is not impaired because consumer spending is 70 percent of the U.S. economy and Christmas shopping season is just around the corner.

Clearly, the New York attorney general is not only trying to destroy the American economy and the American way of life - he's out to get Christmas too!

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Dumb things said at the JEC meeting today

Earlier today, Federal Reserve Chairman Ben Bernanke appeared before Congress' Joint Economic Committee to present the Fed's economic forecast. As usual, he was the second smartest guy in the room.

Following are some of the dumber things uttered by elected officials on the subject of the credit crisis, the mortgage lending mess, and the economy in general.

Note that some of these items do not so much demonstrate a lack of intelligence, but rather, only appear to be dumb because they come years, in some cases many years, after an intelligent observer would have drawn a similar conclusion. See CSPAN for the video.

Sen. Charles Schumer, D-New York: "Even our bedrock assumptions are being put into doubt. As housing prices decline, there are real fears that we won’t be able to depend on consumers, the engine of our economy over the past few years, to keep spending."

Sen. Sam Brownback, R-Kansas: "And I do hope that the Fed is considering a further cut in rates, to help the economy, to help the American consumer which is 70 percent of the economy going into the important Christmas buying season. It seems to me that now is the time and, I know you're weighing this but, I would certainly put my two-cents worth in for a rate cut at this time."

Rep. Jim Saxton, R-New Jersey: "On the positive side, it's good news that core inflation and the numbers that we look at to study core inflation lead us to think that inflation, at least core inflation, seems to be pretty much in check."

Sen. John Sununu, R-New Hampshire: "Yesterday, the Dow dropped 360 points and a number of analysts in the financial press blamed a lot of that drop on the New York Attorney General and his press release that alleged, in his words, "systemic fraud and a pattern of collusion in the mortgage industry" and he made those allegations with specific reference to transactions between Fannie Mae, Freddie Mac, and Washington Mutual for which he issued subpoenas. My question to you is, in this environment, where we see big problems with credit in the mortgage industry, is this kind of a press release really helpful in solving the problems in front of us?"

Rep. Elijah Cummings, D-Maryland: "I want from you, every single thing that you can possibly do to help us help our constituents."

We interrupt this program to bring you about the only voice of reason in Washington...

Rep. Ron Paul, R-Texas: "The best way I could describe the problems that we face here in this country, as well as the problem the Federal Reserve faces, is that we are indeed between a rock and a hard place because we have a serious problem but we don't talk about how we got here. We talk about how we're going to "patch it up". The bubble has been burst - we saw what happened after the Nasdaq bubble burst and we don't ask how it was created and then we had a housing bubble and it's deflating and it's spreading.

Yet nobody says, "Where does it come from?" and what is the advice that you generally get? Inflate the currency. They don't say "inflate the currency", they don't say "debase the currency", they don't say "devalue the currency", they don't say "cheat the people who have saved", they say "lower the interest rates". But they never ask you and I never hear you say, "the only way I can lower interest rates is I have to create more money".
...
Unless we get down to the bottom of it and define what inflation is and not look at only prices... this was taught by the free market economists all through the 20th century, they said, "Beware, they will increase the money supply but they will make you concentrate on prices and they will give you CPIs and PPIs and they'll fudge those figures and they'll talk about wage and price controls to solve our problems".

We ignore the fundamental flaw and that is that not only have we had a subprime market in housing, the whole economic system is subprime in that we have artificially low interest rates. And it wasn't under your tenure in office - it's been going on for ten years or longer and now we're bearing the fruits of that policy. A one percent interest rate and that's not a distortion? Instead of looking at consumer prices, that nobody in this country really believes, we need to talk about the distortion, the malinvestment, the misdirection, the bad information that is gotten from artificially low interest rates."

We now return to our regular programming...

Rep. Maurice Hinchey, D-New York: "I think that you've done just about all that you can do. There will probably be some pressure to lower interest rates again, but the fact is, if those interest rates continue to go down, then the inflation issue is going to continue to be jacked up. We're right now facing an inflationary situation that is increasing. Estimates are that it could go up as high as two percent over the course of the next year - maybe higher than that."

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Subprime shockwaves

This report at Bloomberg is worth a look - kind of a stroll down memory lane for those of us who have been following the subject closely, just waiting for the bad stuff to happen.

The bad stuff is happening now.

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A much simpler way of describing monetary policy

As Ben Bernanke gets ready to trudge up to Capitol Hill today to explain to Congress how he intends to fix the mess that former Fed chief Alan Greenspan made, Federal Reserve Bank of St. Louis President William Poole tells you all you really need to know about contemporary monetary policy in the first twenty seconds of this 45 minute speech.

Click to play in new window

Mr. Poole opens by noting, "I have a much simpler way of describing monetary policy. If you print money in your basement, it's called counterfeiting. If we print money it's called monetary policy. (Sound of economists laughing) And that's literally true, we have the power to print money - that's what we do."

He then goes on to mention Charles Kindleberger's classic book "Manics, Panics, and Crashes" in relation to the bursting credit/housing bubble and, according to the Bloomberg report (sorry, couldn't make it through more than about five minutes of the video -good luck with that), went on to predict that "the housing industry's woes may not end soon and policy makers might need to consider 'additional rate cuts' should the problems spread."

It would have been better without all the laughing at the 20 second mark as once again the question comes to mind, "How can more easy money help to fix the problems caused by too much easy money?"

It is funny though how, like the former Fed chief, central bankers can view the current situation in a detached sort of way - as if they had nothing to do with the current mess.

Funny, that is, but not in a "ha-ha" sort of way.

Also at Bloomberg today, after a brief absence, Caroline Baum is back at her post with a few thoughts on Robert Rubin's Strong Stock Policy for Citigroup and a couple other topics:

For the past month, with my dominant hand in a cast, I've been relegated to the role of consumer of financial news and commentary. That's not easy for someone who's used to asking a lot of questions and expressing her views in real time.

Let's just say I have a lot of laundry that's accumulated over the last four weeks that needs to be hung out to dry. So herewith, in no particular order of importance, are some thoughts on a few subjects:

1. Daddy, What Do They Do on an Executive Committee?

Robert Rubin, everyone's favorite Treasury secretary and the Democratic Party's eminence grise, was chairman of Citigroup Inc.'s executive committee when SUV nation caught SIV fever. He had an office next to Citi CEO Chuck Prince, the cachet to reach anyone on the global stage and the stature to make a difference.

Instead of getting swept out with the boss last weekend, Rubin was elevated to interim chairman -- in part, we're told, because there was no one else to clean up the mess (in a country of 300 million people?); and in part because of his sterling credentials as a crisis manager.
...
3. I'm Still Here

Remember the fellow who said you couldn't know a bubble until after it burst? With some distance from his perch at the Fed, Greenspan seems to have acquired 20-20 vision. He now dispenses bubble diagnoses freely (on the U.K. housing market and Chinese stock market), handicaps U.S. recession (the odds are less than 50 percent currently), and finally found a bailout he doesn't like (the Treasury-supported plan to combine the best assets from bank-related Structured Investment Vehicles into a Super SIV).

Rubin, Greenspan's former colleague on "The Committee to Save the World,'' as Time magazine put it in its Feb. 15, 1999, cover story, is back in the clean-up business. The job of cleaning up the mess that Greenspan made has been left to Bernanke.

Welcome back Caroline.

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Ron Paul: Money and mouth, same place

Fresh off a record day of fund raising that fetched $4.3 million in campaign contributions, check out Republican Presidential candidate Ron Paul's portfolio of mining stocks and mutual funds courtesy of OpenSecrets.org(.pdf).

This is in addition to a few hundred thousand dollars in real estate and some other odds and ends from a filing in March of this year.

Note that the Rydex Dynamic Venture Fund (RYVNX) is a 2x short fund for the Nasdaq 100 (a big loser since March) and the Prudent Bear Fund (BEARX) is a short fund as well. Given the amounts involved, these short bets were probably just for fun.

Full Disclosure: No position in RYVNX or BEARX at time of writing.

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And so the cycle repeats

On days like today you get the feeling that we'll be seeing the same cycle repeat about every six weeks or so for the better part of the next year.

1. Federal Reserve cuts interest rates
2. Equity markets surge ahead
3. Dollar decline accelerates
4. The price of oil and gold soar
   
5. Treasury reiterates "strong dollar policy"
6. Housing market problems get worse
7. Credit market problems get worse
8. Dollar decline accelerates
9. The price of oil and gold soar
   
10. Treasury reiterates "strong dollar policy"
11. Equity markets plunge <------- YOU ARE HERE
12. Go to step 1
    

Does anyone aside from the Fed really believe that interest rates will not be cut when they meet on December 11th? Look at what the three most recent central bank actions have done for stocks.

Aside from countries with a dollar-peg and the tiny fraction of Americans who travel abroad, there has been very little pain as a result of a weaker dollar and a weaker dollar has done wonders for equity markets.

Oil and gold? They are more of an interesting side show at this point.

However, the bad news is that, like any drug that is overused, the beneficial effects tend to diminish with each dose. Perhaps stronger doses will be required.

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Eighteen months and another $99 special

From time to time it is necessary to remind readers about the Iacono Research investment website that accompanies this blog - today is one of those days. For those of you who don't already know, I've been writing an investment newsletter for a year and a half now and things have gone pretty well as you can see below.
Since the model portfolio was formalized early last year, prior to the launch of the investment website in May, it has gained a total of 64 percent - 25 percent during 2006 and 31 percent for 2007, as of yesterday's close.

And one of the best parts about the investment approach, aside from the emphasis on natural resources, is the unique asset allocation - less than half of the model portfolio is in equities. This can be particularly important on days like today with the Dow Jones Industrial Average down more than 250 points as this is written.

In recognition of the eighteen month anniversary of the website launch and as an acknowledgment that I plan to do this for many years to come, the following special offer is being made available for a limited time only:

Two Year Subscription - Only $99 per Year

The regular pricing is $129 per year, $229 for two years, or $12 per month and this special offer expires two weeks from today on November 21st. Those starting a free trial between now and November 21st, as well as those currently on free trials, will have this special rate extended to them until their free trials expire.

Since there is a 60-day money back guarantee with every one or two year subscription, you can get up to a 90-day risk-free look at this service to decide whether or not it is for you - I personally think that anyone who does not have exposure to hard assets today is doing themselves a big disservice.

There is a good deal of help for those new to investing in natural resources including a "starter" model portfolio containing only nine positions - all ETFs or mutual funds - that is up almost 27 percent so far in 2007.

Please feel free to have a look around the public areas of the website or send me mail with any questions or comments.

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Cheng Siwei Feng Shui

It looks as though the U.S.-China disagreement over how fast the Chinese currency should appreciate is turning into one giant game of "Chicken". Does the Treasury Department really think that a stronger Chinese currency is going to solve our problems?

While other countries are dropping, or talking about dropping, their currency pegs due to a rapidly weakening dollar and, hence, rapidly rising domestic prices, the Chinese have been reluctant to allow the yuan to appreciate at more than a snail's pace.

This report from Reuters tells of the latest developments as the vice-chairman of China's parliament, Cheng Siwei, apparently favors a feng shui approach to ther foreign exchange reserves rather than a stronger currency in response to the dollar's slide.

China delivered a one-two punch to the dollar as a top lawmaker suggested a bigger role for the euro in its $1.43 trillion hoard of foreign reserves and a central banker said the dollar is losing its global currency status.

The euro hit a record high above $1.47 following remarks on Wednesday by Cheng Siwei, vice-chairman of the standing committee of the National People's Congress, China's parliament, pointing to diversification of the country's reserves.

"In terms of the structure of our foreign exchange reserves, we should take advantage of the appreciation of strong currencies to offset the depreciation of weak currencies," Cheng told a financial forum.

"For example, in the current foreign reserves structure, I mean the bonds we bought, the euro is appreciating against the yuan while the U.S. dollar is depreciating against the yuan. So we should make a balance between the two," Cheng said.

Cheng's position gives him influence in Beijing, where he holds a rank equivalent to vice premier. However, he does not have real authority over financial matters and has been known to speak on a range of subjects, from the stock market to foreign acquisitions, on which he does not control policy.

Cheng Siwei has been speaking out about the dollar for some time now. In this story from early in 2006 he called for China to "trim its holdings of U.S. debt and to stop buying dollar bonds" - a reasonable stance given the decline in the dollar since that time.

Also in this report, Xu Jian, the vice head of the People's Bank of China's Communist Party school (they have very long titles, don't they?), commented on surging oil and gold prices while dumping on the dollar as well.

"The U.S dollar's global currency status is shaky and the creditworthiness of dollar assets is falling," Xu, who said he was speaking in a personal capacity, told the same forum.

He said he expected the dollar to weaken further in 2008 under the impact of the gaping U.S. trade deficit. That could push the price of gold to $1,000 an ounce from a 28-year peak of $840 scaled on Wednesday, Xu said.

As noted at the end of this report, all the Chinese have to do to see what impact a rapidly strengthening currency might have is to look at the Japanese experience following the Plaza Accord in 1985.

If you think there are bubbles in China today, a rapidly rising currency and reduced capital controls would make the situation much, much worse and then they might get decades of "deflation", just like the Japanese.

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Gold, take the night off - you're starting to scare me

You've had a good couple of months, you've started off the week well by blasting through the $800 mark, but, to be honest, this latest move in Hong Kong is starting to scare me.
Haven't you done enough already in 2007?

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Protect our stock options

This report from Reuters (based on this story($) in the Wall Street Journal) about beleaguered mortgage lender Countrywide Financial's efforts to protect employee stock options brings to mind two questions.

1. Are they all done with their image rebuilding campaign?
2. Do they plan to issue bracelets to management?

Countrywide extends employee stock options
Countrywide Financial Corp is giving several thousand employees more time to exercise stock options, making it less likely the options will prove worthless, the Wall Street Journal reported Tuesday in its online edition.

The Journal also reported that as of Monday afternoon, senior executives of the company had not reported any purchases of Countrywide stock at the current depressed level.

Countrywide recently suffered through a mortgage and capital markets crisis that peaked in August. The company's stock has fallen 73.3 percent from its 52-week high of $45.19 reached February 2, through Monday's close.

According to the Journal, Countrywide disclosed in filings with the U.S. Securities and Exchange Commission last week that eight senior executives were getting one or two-year extensions to buy shares in the company at prices ranging from $32 to $39.

A company spokesman told the Journal that the extensions are aimed at retaining "valued employees" and apply to nearly all stock options granted in 2004 and 2005 to several thousand workers.

Countrywide was not immediately available for comment.

If it's not too late for item number two above, the phrase OPTIONSTRONG would be appropriate and, clearly, green would be the right color.

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Supermodel Gisele and the declining dollar

You'll probably be seeing many more excerpts here from stories appearing in the online edition of the U.K.'s Daily Telegraph since they saw fit to include this humble little blog in their list of External and relevant links for their Subprime crisis special feature.

The story of Supermodel Gisele and her shrewd business acumen has been seen in a number of places over the last day or two, the most dreary report appearing in Bloomberg titled Supermodel Bundchen Joins Hedge Funds Dumping Dollars". But, none captured the story as well as the Telegraph in their account of the latest high-profile investor to lose confidence in the buck.

She's probably thinking about all her current dollar denominated investments as she makes her way down the runway in the photo below.

Brazilian Supermodel Gisele Bündchen is refusing to accept payment in US dollars while the currency remains so weak.

Proving that she has business sense to match her beauty, the former girlfriend of actor Leonardo DiCaprio, has said that she is willing to be paid in nearly any currency apart from the dollar to maximise her earnings.

According to Bloomberg, Patricia Bündchen, the model's twin sister and manager said: "Contracts starting now are more attractive in euros because we don't know what will happen to the dollar."

The newswire said that when she signed a new contract in August with American company Procter & Gamble to advertise Pantene hair products, the deal included the stipulation that she be paid in euros. P&G declined to comment on the terms of the deal.
...
According to US magazine Forbes Ms Bündchen is the highest-earning model in the world. She follows in the footsteps of wealthy investors Warren Buffett and Bill Gross who are turning their backs on the dollar in favour of stronger currencies.

Buffet, Gross, Jim Rogers, and now Gisele.

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UPDATE: Nov 6, 2007, 12:10 PM PST

In addition to the editorial page as noted in the comments below, this story also appeared in the back of section C (Money and Investing) in today's Wall Street Journal with a little teaser at the top of the front page of this section.

Mark to Supermodel
Gisele Bündchen has a Wall Street-size income of $30 million a year. Make that €21 million. The Brazilian supermodel is reported to have demanded that her contracts be valued in euros, not the unstable greenback. The 27-year old clearly isn't just another pretty face.

The dollar has long been the reference currency of the world. It is the measure for global gross domestic product and Israeli real-estate prices, not to mention the value of the Chinese yuan. So, it used to be natural for a multinational contract -- as Ms. Bündchen negotiated to represent Procter & Gamble's Pantene hair products -- to be priced in the U.S. currency.

Setting pay in dollars now looks like rank speculation, with the dollar earner taking inferior odds. The U.S. has a big trade deficit, low interest rates and a government that doesn't seem particularly fussed about its international monetary standing. Furthermore, the euro is now a plausible and solid alternative.

A one-of-a-kind such as Ms. Bündchen is in an especially good position to negotiate. But some of the superstars of Wall Street and the City of London financial district probably could follow her lovely example -- in this domain at least. Almost all of the big banks, even the European ones, keep their books and set their bonuses in dollars. Jet-setting bankers could rebel. In these days of mortgage troubles, the phrase mark-to-model usually causes shivers on Wall Street. But mark-to-supermodel could be a different story for international financiers.

True or not, it is an irresistible story.

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A look back at January 1980

With gold apparently wanting to take out the 28-year high of $850 per ounce sooner rather than later, a look back at the price of the metal in 1980 is warranted. Aside from the highs that were reached, that period is notable for how little time was spent at those highs.
Originally a business major before switching back to engineering, the memory of discussions during a macro economics class in late 1979 will always stick with me. While there is no recollection of what was said, I do remember the instructor's disbelief as the gold price moved from $200 to $400 and then on toward $600 and $800.

What are economics professors saying today?

That time is remembered for soaring oil prices as well - the hostage crisis in Iran began in November of 1979 and would reach a climax more than a year later. During 1979, black gold had risen from just $15 to $40 - a figure that remains as the inflation-adjusted high-water mark for crude oil that many think will be surpassed in the weeks or months ahead.

The annual rate of inflation reported by the Bureau of Labor Statistics rose from 10 percent in early 1979 to a peak of 14.6 percent in March of 1980 and during that same period, the Fed Funds rate rose from about 10 percent to 20 percent.

Though the oil price began to decline very gradually (still at $35 by the end of 1981) and consumer prices eased (falling below 10 percent again in mid-1981), short-term rates didn't peak until the summer of 1981 when they rose to over 22 percent.

As for the price of gold, on only two occasions did it close at over $800 - at $835 on January 18th and at $850 the following Monday. In fact, it closed at over $700 on only eight occasions ever - six in January and two in February.

This was very much a spike in the the gold price rather than the sustained increase in price that has been seen in recent years. By way of comparison, the closing price for gold has exceeded $700 on 45 days since first breaching that level in May of 2006.

Of course, the most notable difference between 1980 and 2007 is that interest rates were being hiked then - from 10 percent to over 20 percent - and today they are below five percent and being cut.

Oh, and the calculation of "inflation" by the Bureau of Labor Statistics has changed in many very fundamental ways.

I wonder how that's all going to work out.

To learn more about investing in natural resources using commonly traded ETFs, stocks, and mutual funds, see this description at Iacono Research. Or, sign up for a free trial.

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Why the Fed cut (and will continue to cut) interest rates

The charts below originally appeared in How owners' equivalent rent duped the Fed back in August. Over the weekend, a reader asked for an update and the results are below.

The first chart shows the S&P Case-Shiller Home Price Index (by far, the best indicator of home prices in the U.S.), versus the proxy for home prices used in the Consumer Price Index - the nefarious owners equivalent rent.

[Note: For those new to this subject, be advised that the government's inflation statistics do not track home prices directly. Instead, they use an estimate of what homes would rent for - yes, it sounds and is a very dumb thing to do. Also see "Homeownership Costs and Core Inflation" from a couple years ago where all the gory details are explained.]

So, what would the consumer price index look like if real home prices were used instead of owners' equivalent rent?

The last couple months of plunging home prices would take the annual rate of inflation to zero as shown below (actually, it's still positive at 0.01%).

And, yes, a big reason why we are in the mess we are in today is that inflation, with real home prices included, was much, much higher than inflation with OER back in 2003, 2004, and 2005 when interest rates and lending standards were at multi-generational lows.

The chart below should be of keen interest to the dismal scientists at the Federal Reserve since core inflation (excluding food and energy) with real home prices has now entered negative territory with the addition of fresher data.

Of course you won't hear this from anyone at the Fed, but the shape of these curves is a very big part of the reason why short-term interest rates were cut last week and why they are likely to be cut again many times over the next year or so.

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Two guesses for next year's contest

If Matt Simmons of Simmons & Company and Philip Manduca of Titanium Capital were to enter next year's "Guess the year-end price of oil and gold" they'd probably have two of the more extreme guesses - $300 oil and $2,000 gold. First, Matt Simmons on CNBC:

That often heard "oil priced by the cup" story has never seemed on the mark to me - surely if you bought water, soybean oil, or other liquids in 1,000 barrel lots on a commodity exchange, you'd come up with a lower price.

No?

Other than that, Mr. Simmons appears to be the only one making sense again regarding the potential impact of Peak Oil as the CNBC on-air personalities all seem to think that markets are already adjusting to higher oil prices and that we'll make a smooth transition.

We will see.

On Bloomberg video this morning, Phillip Mantuca seems to think we'll be moving right past the $1,000 level for gold and toward $2,000 within the next 24 months (skip to the one minute mark).


His comment regarding the long term, that "hard assets are going to come more and more into value in people's portfolios over stocks and paper assets" seems all too obvious.

To learn more about investing in natural resources using commonly traded ETFs, stocks, and mutual funds, see this description at Iacono Research. Or, sign up for a free trial.

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External and relevant

The online version of the Telegraph UK has a special Subprime crisis edition and look which blog showed up in the section EXTERNAL LINKS - Relevant Blogs and Websites.

It looks as though Ambrose Evans Pritchard, a favorite at this blog, has a whole category to himself. He rarely disappoints.

And yes, the link at the very bottom on the right does go to the Federal Reserve website - it takes you to their Statement on Subprime Mortgage Lending from July 24, 2007 that emphasized "the need for prudent underwriting standards and clear and balanced consumer information so that institutions and consumers can assess the risks arising from certain ARM products with discounted or low introductory rates."

Nice timing boys - we could have used that back in 2003.

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Hey, I'm still talking

The latest Alan Greenspan sighting came and went last week with little fanfare - it didn't come to my attention until a few days after the fact and now the Bloomberg link appears to be broken. Aren't people getting tired of reporting every little thing he says ?

If the credit market mess continues on its current path with Ben Bernanke trudging up to Capitol Hill again this week to try to explain how he's going to try to fix things, look for more stories like this one from the Financial Times rather than mindless parroting of what the former Fed chief has to say.

Central banks should prick asset bubbles
By Paul De Grauwe

The credit crisis that hit the world economy in August teaches us many lessons about the workings of integrated financial markets. It also teaches us something about the responsibilities of central banks.

Until the crisis, the consensus view was that central banks should target inflation and that is pretty much all they should do. In this view, central banks should not target (or try to influence) asset prices either, as was stressed by the former Federal Reserve chairman Alan Greenspan, because central banks cannot recognise bubbles ex ante. Or, if they can, the macro­economic consequences of bubbles and crashes are limited as long as central banks keep inflation on track. Inflation targeting, we were told, is the new best practice for central bankers that makes it unnecessary for them to try to influence asset prices.

The credit crisis has unveiled the fallacy of this hands-off view.
...
So, what should central banks do besides target inflation? First, central banks should recognise that asset bubbles are a source of concern and that they should act on the emergence of such a bubble. The argument that a bubble can never be recognised ex ante is a very weak one. One had to be blind not to see the bubble in the US housing market, or the internet bubble. This is the case for most asset bubbles in history.

It has been argued that even if central banks can detect bubbles, they are pretty much powerless to stop them. This argument is unconvincing. It is not inherently more difficult to stop asset bubbles than it is to stop in­flation. Central banks have been highly successful at stopping inflation.

Second, central banks should be involved in the supervision and regulation of all institutions that create credit and liquidity. The UK approach of dissociating monetary policy from banking supervision has not worked. Central banks are the only insurers against liquidity risks. Therefore they are the ones who should control those who ­create credit and liquidity. Failure to do so will continue to induce agents to create excessive amounts of liquidity, endangering the financial system.

The fashionable inflation-targeting view is a minimalist view of the responsibilities of a central bank. The central bank cannot avoid taking more responsibilities beyond inflation targeting. These include the prevention of bubbles and the supervision of all institutions that are in the business of creating credit and liquidity.

The writer is one very sharp professor of economics at the University of Leuven.

ooo

This week's cartoon from The Economist:

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