TERMINO LA CRISIS FINANCIERA AMERICANA III

Última entrega from Outside the Box

Food Price Inflation, Monetary Policy & Financial Markets

By David Kotok

Suddenly food price inflation has become the premier hot topic. The media is now attuned to food issues including emerging market country riots.

In the US, the politicians are gearing up to castigate the speculators and blame everyone but themselves. They conveniently forget that they are the ones who passed the ethanol subsidy and they are the ones who appropriate taxpayer money to pay farmers not to grow crops. And so the political circus begins.

Notice how the three presidential candidates are silent on how the US ethanol subsidy has caused a food price explosion in grains. They avoid the issue of US policy starving many in the world. 1 billion very poor people sustain themselves on $1 or less a day. We have doubled the cost of their food.

Ethanol directly impacted corn which, in turn, also drove up maize. In addition, the substitution of wheat and rice are not easily occurring because of crop issues and concomitant price inflation in those items.

Well Cumberland is in the financial market and money management business. We eat food. We don't grow it and we don't process it. So let's try to inject some serious monetary policy issues into this media hysteria and political cacophony.

In the mature countries, food is a minor portion of the price index. And some of the food costs originate from eating out and some come from food processing. Processed food cost is heavily dependent on the inputs which are non-food items. Labor, machinery, transportation and distribution all come in to play. So in the mature countries we see that the food price inflation may be topical and attention getting but it is not a crisis.

Also, the major mature countries are mostly in food surplus. In the US we are very efficient in running our agriculture enterprise. We actually pay farmers not to till their soil. This is dumb. It occurs only because of our sorrowful Congress who has learned how to bribe the farm belt for votes at the expense of the rest of us.

In the US food has a 14% weight in the consumer price index. Compare that with Canada at 17%, the Euro zone at 16%, England at 11% and Japan at 25%. Only Japan lacks the fullness of food self sufficiency. Sure, food price inflation is important. But it is not the most important issue in these major economies.

The reverse is true for the emerging markets. In some of them the food price component is as much as half the price index. In a few it is above half. Since many of these economies are open to some degree, the importation of food price inflation is hitting them particularly hard. Some are responding with tariff adjustments. Others have actually embargoed food exports. Of course they ultimately make matters worse when they restrict world trade and in the end all suffer because of this protectionism.

What about monetary policy?

Here is where it gets difficult. We will admittedly simplify now and we acknowledge to our critics that we know there are second order effects and are ignoring them to make our point. In our view, monetary policy cannot easily and directly address food price inflation when the source of the inflation is in the raw food commodity. This is also true for energy costs when the source is in the oil or natural gas. The whole concept of "core" inflation vs. total inflation originates in this notion that monetary policy should be directed at the price level changes it can affect.

Let's get to the inflation problem in an emerging economy. Our example is imaginary for simplicity's sake. But it reflects characteristics that are very similar to many countries and regions in the emerging markets of the world.

We developed this simple and theoretical case study and then sent it to a number of economist friends. We suggested that following facts: the economy in question is a small and open emerging market. The food price component is 50% of the price index and is inflating at 15%. The non-food component is inflating at 5%. Thus the overall index is inflating at 10%. In this small and open economy, the main items in the food component are based on maize; therefore, the US ethanol policy which has raised the corn priced has also pressured an increase in the maize price.

Suppose you are the governor of the central bank. You have to set your policy interest rate. Do you base that decision on overall inflation rate of 10% or on the core inflation rate of 5%? Or are you going to confront the food inflation rate of 15%. Let's further assume that your economy is growing at a trend rate of 5% and all other aspects are in trend or neutral position. You have no negative output gap and no above trend pressures. Your only direct problem is what to do about inflation.

My economist friends who answered offered a suggested policy rate as low as 6% and as high as 13.5%. The answers were about equally divided and the respondents sample size is over 20. The distribution of answers was distinctly bi-modal. About half the answers were bunched in the lower range of 6%-8%; the other half were in the double digit area between 11% and 13.5%.

The divided views centered on whether or not to target food, ignore food, or blend policy. No one wanted to set the interest rate above the 15% food price inflation. Nearly all acknowledged that this central bank would have difficulty in communicating whatever it decided. Most respondents worried about changes in inflation expectations because of the complexity of this issue. Most believed the citizens in the country would not understand the monetary policy dynamics that led to the decision.

Some worried that setting the policy interest rate in double digits would impose a very high financing cost on the non-food portion of the economy and cause it to go into recession. They argued that the real (inflation-adjusted) rate of interest for that non-food half of the economy would be 7% or so. That would set the threshold of finance too high.

Others argued that the monetary policy expectation effect would cause the rate of inflation to accelerate if the policy rate was not set in double digits. They were willing to take the recession in the non-food area in order to keep inflation expectations under control. No one mentioned substitution effects. Perhaps that was overlooked. Or it may be because rice and wheat are not easy cultural substitutes and those grains are each experiencing their own price pressures.

In sum, almost two dozen folks with some monetary economics expertise were equally divided on this technical question. It is a question that impacts billions of citizens in this world and many countries, their governments, their currencies and, possibly, their political stability.

We do not know the correct answer. Our view would support the lower interest rate and we would focus on the non-food portion of the economy but we can argue the other side with equal vigor. For us a lot would depend on how the food price inflation spreads into wages and if it could trigger a broader wage/price spiral.

In many respects this question is now being asked of the major and mature economy central banks as well. It appears that the European Central Bank (ECB) favors the higher mode while the US Federal Reserve is positioned in the lower one. For the emerging markets it appears that there is quite a mix of policy and that it is made more complicated by the management of each currency's foreign exchange rate. In sum, our simple case study is actually quite complex when applied in the real world.

David Kotok, the chief investment officer of Cumberland Asset Managers SEGUIR LEYENDO...

TERMINO LA CRISIS FINANCIERA AMERICANA II

Segunda entrega, from Outside the Box

Why This Crisis is Still Far From Finished

By Mohamed El-Erian

During the past few weeks we have seen a growing number of market participants predict an end to the dislocations that erupted last summer and claimed victims throughout the financial system and beyond. While their predictions are understandable, they are premature. The dynamics driving the disruptions are morphing and may again move ahead of both the market and policy responses.

The optimistic view is based on two distinct elements. First, that the de­leveraging process is reaching its natural end as valuations stabilize and institutions come clean about their losses and raise capital; second, that a series of previously unthinkable policy responses have been effective in restoring liquidity to the financial system.

Both views have merit. Financial institutions, particularly in the US, have recognized the scale of the problem and are taking remedial steps. Just witness the recent round of capital raising by Citigroup, Merrill Lynch, JPMorgan and Wachovia. At the same time central banks in Europe and the US have opened up their financing windows, expanding the size of the financing, the range of institutions that can access it and the list of eligible collateral.

Yet, consistent with what we have seen since last summer, the dislocations are entering a new phase. As such, bold reactions on the part of policymakers may, once again, prove to be too little and too late.

Persistent financial dislocations have now caused the real economy to become, in itself, a source of potential disruption. During the next few months there will be a reversal in the direction of causality: the unusual adverse contamination by the financial sector of the real economy is now morphing into the more common phenomenon of recessionary forces threatening to undermine the financial system.

Economic data in the US have taken a notable turn for the worse. Most im­portantly, the already weakening employment outlook is being further undermined by a widely diffused build-up in inventory and falling profitability. History suggests that the latter two factors lead to significant employment losses.

Pity the US consumers. Their ability to sustain spending is already challenged by the declining availability of credit, a negative wealth effect triggered by declining house values, and a lower standard of living as the result of higher energy and food prices and a depreciating dollar. Job losses will accentuate the pressures on consumers, leading to income declines and a further loss of confidence.

While the financial system has taken steps to enhance balance sheets, they speak essentially to addressing the consequences of excessive leveraging and imprudent financial alchemy. As such, the nasty turn in the real economy may fuel another wave of disruptions that, this time around, would also have an impact on mid-size and smaller banks.

It is thus too early to declare the end of the turmoil that started last summer. Instead, during the next few months we may witness a new phase of dislocations, led this time by the real economy. The blame game will intensify; political pressure will continue to mount; momentum will build for greater and broader regulation of financial activities within the banking system and beyond.

The focus will also be on the reaction of policymakers. Here the outlook is mixed. The good news is that the crisis is now moving to an area where traditional policy tools are more effective. This is in sharp contrast to the situation of the past few months, where central banks were forced to use instruments that were too blunt for the purpose at hand.

But there is also bad news. The sharp slowdown in the US real economy will occur in the context of continued global inflationary pressures. As such, the Federal Reserve's dual objectives - maintaining price stability and solid economic growth - will become increasingly inconsistent and difficult to reconcile. Indeed, if the Fed is again forced to carry the bulk of the burden of the US policy response, it will find itself in the unpleasant and undesirable situation of potentially undermining its inflation-fighting credibility in order to prevent an already bad situation from becoming even worse.

It is still too early for investors and policymakers to unfasten their seatbelts. Instead, they should prepare for renewed volatility.

Mohamed El-Erian, the co-chief executive and co-chief investment officer of Pimco SEGUIR LEYENDO...

TERMINO LA CRISIS FINANCIERA AMERICANA I

Al parecer, y por el comportamiento que está teniendo el sector financiero americano, uno podría llegar a la conclusión que la crisis de dicho sector a llegado a su fin. Como no lo comparto, incluyo una tanda de tres notas relacionadas con el tema.


From The Daily Reckoning

FRIED IN THE FINANCIAL SUN
by The Mogambo Guru

There is a new report from the Comptroller of the Currency titled “OCC’s Quarterly Report on Bank Trading and Derivative Activities, Fourth Quarter 2007”, which shows that total bank holdings of derivatives is estimated to be “only” $164.2 trillion, whereas I seem to remember that the global glut of derivatives is upward of $700 trillion, which are both numbers so big that I cannot even begin to comprehend the enormity of them.

The report shows that the notional value of derivatives held by U.S. commercial banks has suddenly plunged by a whopping $8 trillion, which is (unbelievably) still only 5% of the total, and which merely takes the total down to the aforementioned-yet-still-staggering $164.2 trillion.

When I realized that $8 trillion is more than half of America’s GDP, that is when I realized that “Houston, we seem to have a problem, as we are on fire, and we are tumbling out of control into the sun where we will soon be fried to a cinder.”

And let’s not forget that even this baleful news is the best that the banks can come up with, as the whole report is based on banks volunteering to tell stories about themselves, which is unbelievably the same as with, according to an article in the Financial Times , Libor rates, which are the agreed-upon interest rates that London bankers agree to charge on short term loans to each other.

The upshot of asking lying, greedy bankers (the villains of history) to tell the truth and let everyone know what disreputable, untrustworthy scum they are has now proved to be an unreliable system of self-regulation, and thus the Libor rate may be understated because the rate is based on self-reports of people who are bankers, which means that they are lying scumbags who falsely report that their short-term borrowing costs are lower than they are, because they know it looks bad that they are getting charged a high interest rate, which proves that the people who are loaning the money to them know what kind of lying, scumbag bankers (as redundant as that is) they are.

But it is these self-reports, like the American O.C.C reports, that are the backbone of the Libor rate, which affects lots and lots and lots of other rates.

By how much is the Libor lending rate understated? Maybe as much as 0.3%, which doesn’t sound like that much, but when you are talking about trillions and trillions of pounds and euros of debt, it adds up to a lot of money! Now you see why they are so interested in lying!

And the last thing we need is higher interest rates, as Bloomberg.com reports that “U.S. corporate bankruptcies are accelerating as the economic slowdown compounds the end of easy credit”, which is being made manifest by noting that a Merrill Lynch index showed that “The amount of distressed corporate bonds jumped to $206 billion April 11 from $4.4 billion in March 2007.” Wow! What’s that, an increase of 5,000% or something?

And another scary Bloomberg item was that loans are becoming harder to get, regardless of the interest rates, and “Banks worldwide are demanding 60% more in collateral from investors such as hedge funds to cut the risk of derivative trades going bad, the International Swaps and Derivatives Association said.”

And another horror is that the stock market went up, which is Pretty Freaking Strange (PFS) since Barron’s reports that the earnings of the Dow Jones Industrials went down, dropping to $225.53 from $234.49. This has produced the unbelievable price-to-earnings ratio of 57! Earnings are going down, but the stocks are going up! To a P/E of 57! Un-freaking-believable!

And not only that, but DJ Transportation index saw its earning drop, too, to $218.60 from $230.91, taking this index’s P/E to 23!

And while the venerable S&P500 has not yet shown any more deterioration in its earnings, the fact that the market went up made the P/E of this index go to a lofty 21! All of this in the face of deteriorating conditions and economic collapse! This is beyond incredible!

How can you NOT run to gold in such crazy times? Ponder this question well, as a lot depends on your answering it correctly, much like when the minister asked you, “Do you take this woman to be your lawfully wedded wife?”, and you know how well that turned out. So, like I said, ponder it well!

Until next week,

The Mogambo Guru
for The Daily Reckoning

The Mogambo Sez: The nice thing about owning exclusively gold, silver and oil is that you make a lot of money when inflation is roaring like this, and you are sure to make a lot more in the future, too, which is even nicer!

There is a valuable lesson in there for you if you will look for it and then act on it. If not, then you are not as smart as you look! Hahaha!

Editor’s Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter - an avocational exercise to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s , The Daily Reckoning and other fine publications.

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ALGUNOS ANALISTAS AMERICANOS RAZONAN COMO LOS ARGENTINOS

Más allá del interesante punto de vista sobre hacia donde puede ir el precio del oro, me intereso esta entrevista en The Daily Reckoning a Doug Casey, ya que presenta un paralelismo de lo que hemos sufrido en la Argentina con la constante pérdida de valor de nuestra moneda. Es más, nos menciona como fuente de inspiración.

The Daily Reckoning PRESENTS: As part of Casey Research’s survey of expectations for gold in 2008, one of their BIG GOLD editors interviewed famous contrarian investor and Casey Research Chairman Doug Casey. Here’s his take on what’s to come...

GOLD IS GOING TO THE MOON
An interview with the editors of BIG GOLD, Casey Research

BIG GOLD: Gold has passed its 1980 nominal high. Why do you think it’s breaking out now?

Doug Casey: The fact that gold has moved above its 1980 high is meaningful only in an academic way; today’s dollar is worth only a fraction of a 1980 dollar. From here on, it’s best to avoid thinking about anything just in terms of dollars. What’s developing now is likely to be the biggest monetary crisis of the past 100 years, potentially the biggest since the U.S. Civil War. This isn’t a prediction, just an appraisal of the tumultuous possibilities that are opening up. Americans are going to have to learn to think more like Argentines: if an Argentine tried to keep track of value in the local peso, he’d be bankrupt in 5 years.

BG: There are those who agree with you about a possible crisis but believe we’ll see deflation instead of inflation, or at least deflation before inflation.

DC: What we’re facing is a monumental monetary crisis that can take one of two forms. It can be deflationary, where billions and billions of dollars are wiped out through bankruptcies and defaults, and the remaining dollars become worth more as a result. Or it can be inflationary, where the world’s central banks keep dollar assets from being wiped out by supporting the issuance of debt – which is what they’re currently doing, by propping up failing banks and homeowners who can’t pay their mortgages. Those are your two alternatives. You can have either one – it’s really a flip of the coin as to which you get.

It’s also possible you can have both at the same time. You could have deflation in some areas of the economy, such as real estate, which is happening now, and inflation in other areas of the economy, where prices are going up, as with food and oil.

I’m of the opinion that government is so big and so powerful now, and the average person – idiotically – relies on it so heavily, that much higher inflation is inevitable. They’re certainly going to do their very best to keep a deflationary collapse from happening, because they all remember what it was like in the U.S. in the 1930s. Yet not too many people think about Germany’s inflationary collapse in the 1920s. It was much more unpleasant.

Inflation is the enemy of the person who works, saves and invests. But it’s the friend of the speculator.

BG: Why do you think gold stocks have lagged while gold has taken off?

DC: Gold stocks are a play on gold. But they’re also stocks. The best environment for them is when both gold and the general market are moving up, and lately the stock market has been problematical. People are going to panic into gold, because it’s cash – money in the most basic form. Gold stocks are not money; they’re speculative vehicles. And despite the strength in gold, the costs and risks of finding and building mines have gone up just as fast in the last couple of years. There’s no necessity for them to move in lockstep with gold itself. That said, I think gold stocks are really going to howl as gold goes into the Mania stage.

BG: The water in the pot is definitely getting hotter. Where do you think gold is going this year?

DC: Gold has been in a bull market since 2001. It’s gone up, on average, about 25% per year compounded, and there’s absolutely no reason the bull market should stop now. On the contrary, there’s every reason to believe that the gold bull market, having gone through its Stealth stage and still being in its Wall of Worry stage, is going to hit the Mania stage. To sell now would be to leave the big money on the table.

My best advice is, be right and sit tight. And that means staying long until you see a golden bull tearing apart the New York Stock Exchange on the front cover of Newsweek magazine, at which point it will be time to sell.

BG: What price do you think gold will hit in 2008?

DC: Strictly gazing through a crystal ball, I think it’s going over $1,200, no problem.

BG: What about the long-term price for gold?

DC: Just to reach its previous high in purchasing power, gold will have to go over $2,500 – probably more like $3,000 after you discount the phoniness in the government’s CPI numbers. But because this crisis is much more serious than the one in the late 1970s and early ‘80s and much more far-ranging, $3,000 is actually a fairly conservative number. I’ll say it again: gold is not just going through the roof, it’s going to the moon.

BG: What advice would you give to readers of Big Gold about how to invest in gold and gold stocks in the coming environment?

DC: The first thing is, you’ve got to have a lot of physical gold in the form of gold coins. Second, make sure a large chunk of those coins is outside the political jurisdiction where you live. If you live in the U.S., they’ve got to be outside the U.S. If you live in Canada, they’ve got to be outside Canada, and so forth. Third, gold stocks are definitely going to howl, so you definitely should have a good position in them.

As important as gold and gold stocks are, though, I suspect we’re going to see foreign exchange controls of some type or description in the years to come. That means if you don’t have assets outside your native country, you’re going to be caught like a lobster in a trap. I think it’s very important to diversify internationally. Buying foreign real estate is one prudent way to do so because, even though there’s been a worldwide property mania, there are still some places where property is very cheap, leaving plenty of upside. In addition, if you pick a locale where you’d like to live, you’ll have a comfortable place to wait things out – which is a serious plus, because I think things in the U.S. are going to get really ugly in the years to come. And most important, the government can’t make you repatriate foreign real estate.

BG: What if I don’t have the ability to buy real estate outside the country I live? I know you can have a foreign bank account and a safe deposit box, but I have to report those, so how does that help me?

DC: You have to report a bank account, but you don’t have to report a safe deposit box.

BG: What if I have over $10,000 of coins in that box?

DC: It doesn’t matter. It’s just like having a million dollars of foreign real estate – not reportable. Of course they can change these arbitrary laws – probably to make them more restrictive and invasive – at any time.

BG: Thanks, Doug, for the practical advice. Anything else you’d like to say to Big Gold readers?

DC: Hold on to your hat; you’re in for the ride of your life.

BIG GOLD is a monthly advisory from Casey Research, one of the nation’s oldest and most respected organizations providing unbiased research on natural resource investments.

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