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Wednesday, 13 May 2009 High debts, high costs and low management... US is spending $2 for every dollar it brings in... One empire declines so another can rise... Rob Parenteau on disturbing statistical inconsistencies...and more! --------------------- Special Offer --------------------------- Only 63 people know how 6 tiny companies will change the world... Become the 64th and get your chance to join the ultra-wealthy. This "story of our era" only happens once in a lifetime... and the upcoming, shocking announcement could be your best shot ever at a different life. YOUR chance ends at midnight on Friday, May 15th, read on... --------------------------------------------------------------- GM and US Both Skid Off Course by Bill Bonner London, England As GM goes...so goes America... Uh oh... Stocks rose yesterday; the Dow went up 50 points. The bear market rally is still on. Oil touched the $60 mark...a sure sign, say analysts, that the global economy is picking up. And the dollar fell further...to $1.36 per euro. Gold held steady, at $912 an ounce. While most stocks advanced yesterday, General Motors backed up. The experts say the company is going broke. "Chapter 11 looms," says a Bloomberg report. Investors sold the stock down to $1.15 - a price GM hasn't seen in more than 70 years. At that price you can buy the whole company for $700 million. Peanuts. Some fund managers earn that much in a single year. Meanwhile, the USA follows the same downward slide as GM. Both are dogged by high debts, high costs and low management. The Financial Times reports: "America's Triple A rating at risk." Moody's has issued a warning. Either the US cleans up its ledgers or it will be downgraded like a bad company. The US was first awarded a Triple-A credit rating in 1917. Not even a century later, it looks like it will lose it. David Walker, star of Addison's movie - I.O.U.S.A. - writes in the Financial Times that the US is headed for bankruptcy just like GM. It owes $11 trillion officially, with another $45 trillion in "off balance sheet" obligations. And, as we reported yesterday, this year it will lose another $1.8 trillion. That's according to the Obama administration's official count. Our own guess is that the loss will come to $2 trillion or more...and that trillion dollar losses will continue for years in to the future. You can read his full transcript in the companion book to the award- winning documentary film. Learn how to get the I.O.U.S.A. DVD, companion book - and your own personal bailout strategy by clicking here. Even by the official estimates, the US government is spending $2 for every dollar it brings in. Even GM doesn't operate that recklessly. GM loses money on every car it makes...but the loss is nowhere near 50% of sales. What's going on? How come the world's biggest, most successful company...and its biggest, most successful country...are both skidding out of control? The casual reader will be quick with an answer. They "made mistakes," he will say. He will point to GM and say: "They should have come out with something like the Prius or Honda's new Insight...which is already setting sales records in Japan. They're just producing the wrong cars...and, oh yes, they pay their employees too much." As to the US, he will have roughly the same insight: "They made a number of mistakes. They never should have kept interest rates so low for so long. And they should never have allowed the bankers to run wild the way they did. Now, the banking system is broke...and the government thought it was forced to step in with trillions of dollars. Of course, it made a mistake in how it supported the banks. It shouldn't have given the bankers so much money so those b**tards could pay themselves such bonuses." But here at The Daily Reckoning, we notice that mistakes always seem to come along when you need them. Take California, for example. Governor Schwarzenegger says its deficit may rise to $21 billion. Analysts say the state will run out of money by July. Maybe it and GM will go broke together. What mistake did California make? It increased expenses - counting on Bubble Epoque growth rates to continue. But instead of continuing to rise, property prices - which held the bubble aloft - collapsed. Now comes word that housing prices are still going down. In fact, they went down faster than ever during the first quarter of this year - 14% year on year. The biggest drops were not in California...but in Cape Coral/Ft. Myers, Florida, and Saginaw, Michigan. The Cape Coral area saw a staggering 59% collapse in house prices. Saginaw was not far behind; there, house prices fell 54%. But wait, there's good news too. Each month the losses diminished. Though prices are still going down, it appears that they are going down less fast each month. David Rosenberg...chief economist at Merrill Lynch...is leaving the firm, and here are his parting words: "Just as the clock is winding down on my tenure at Merrill Lynch, the equity market is winding up with an impressive near-40% rally in just nine weeks... "The nine-week S&P 500 surge from 666 at the March lows to 920 as of yesterday has all but retraced the prior nine-week decline from the 2009 peak of 945 on January 6 to the lows on March 9. We believe it is appropriate to put the last nine weeks in the perspective of the previous nine weeks. To the casual observer, it really looks like nothing at all has happened this year, with the market relatively unchanged. But something very big has happened because the risk in the market, in our view, is much higher than it was the last time we were close to current market prices back in early January, for the simple reason that we believe professional investors have covered their shorts, lifted their hedges and lowered their cash positions in favor of being long the market. "While it may be the case that the pace of economic decline is no longer as negative as it was at the peak of the post-Lehman credit contraction, the reality is that employment, output, organic personal income and retail sales are still in a fundamental downtrend. "This is a bear market rally that may have run its course... "So yes, there may well be some improvement in the GDP data, but it is based largely on transitory factors. We strongly believe it is premature to totally rule out the end of the vicious cycle of real estate deflation - residential and now commercial - that we have been experiencing since 2007. Balance sheet compression in the household sector will continue to pressure the personal savings rate higher at the expense of discretionary consumer spending. This is a secular development, meaning that we expect it will last several more years." Now over to Ian in Charm City, for a look at the news... "American home prices just suffered their worst quarter in recorded history," writes Ian Mathias in today's issue of The 5 Min. Forecast. "That's the word from the National Association of Realtors today...the median home price fell 14% from the first quarter of 2008 to the first three months of 2009, to just $169,000. Of the 152 metropolitan areas surveyed by the NAR, just 18 registered annual price gains. Nearly half of all sales during the first quarter were foreclosed properties or short sales. A whopping 3.7 million previously owned homes are still on the market. "Is this rock bottom for U.S. housing? Ehh...probably not. "After staying flat for most of the '90s, the Case/Shiller home price index more than tripled during a 10-year boom. If this 'credit crisis' is what people say it is - a generational calamity, Bill Bonner's 'Depression with a capital "D"' - then a mere 26% retrenchment from the peak seems kind of...lame. Even the Dow managed a bigger fall than that. "If you're a real estate opportunist (or just looking for a damn cheap house), you might want to check out Saginaw, Mich. The median existing home price there during the first quarter was a stunning $30,300, the lowest in the U.S. We won't pretend to know what's going on over there, but geez...they're practically giving 'em away. "And if you're also a newshound, like us, Saginaw might bring back the memory of this little love shack: "Back in October 2008, a Chicago woman famously bought this Saginaw home on eBay for $1.75. Ouch." Notably $1.75 is about all you need to consider purchasing shares of the numerous companies carefully tracked by Agora Financial's Penny Stock Fortunes. And, when you sign up for the publication you'll automatically receive a free subscription to The 5 Min Forecast, which will be sent to your inbox every Monday through Friday. Read the details in this special report. Now back to Bill in London with more thoughts... When a company goes broke, analysts always say: 'it made mistakes.' But people always make mistakes. One invests too little. Another invests too much. One innovates too little. One innovates too much. Over time, all companies go broke. Countries make mistakes too. Reliably. One empire declines so another can rise. In modern history, one western country has replaced another, as the world's dominant power, about every century. Spain until the Armada sank, France until the battle of Waterloo, England until 1914, and then America until...? The mistakes made by America are the same mistakes that empires always make. "Imperial overstretch," it is called. Spain reached for England...and drowned in the North Sea. France stretched to Moscow...and froze in the snow. England's elastic stretched all over the world - to colonial outposts in Singapore, Australia, and Rhodesia. But by the time she was challenged by the Huns in WWI, her economy had already been surpassed not only by Germany but by America too. Now, it is the US that wears the purple. It has its fingers in every pie, its ships in every port, and its red ink running over everywhere. Even at the very peak of its authority - in the '90s - it was already relying on the savings of poor people in Asia in order to continue its big spending ways. And now, confronted with the challenge of a worldwide financial meltdown...the obvious consequence of too much spending and too much borrowing for too many years...what does it do? Does it cut back? Does it bring the troops home and the deficit down? NO! It spends and borrows even more! In other words, it makes a grand, fatal mistake. Now, an amount equal to its total receipts must be borrowed just to keep the federal government going. Even taking 100% of domestic savings only brings in less than half of the amount needed to finance its deficit. So, the rest - an amount equivalent to the entire US military budget - must be borrowed from kind strangers, business competitors and potential rivals for power. Sooner or later, the foreigners will not be so easy with their money. Instead of buying US Treasury debt, they will sell it. Instead of supporting America's imperial ambitious, they will undermine them. Until next tomorrow, Bill Bonner The Daily Reckoning P.S. We know...Dear Reader...there are many challenges to be faced in the times ahead. One way we've thought to help you out is by providing five or so fresh posts in addition to the articles you find here in this e-letter. And, we're using Twitter to let you know - throughout the day - when new thoughts are posted online...so please, follow us here. --------------------- Special Offer --------------------------- You could have turned $5,000 into $1 million... Make one buy each week...because since 2006 not a one has lost value! Before you could've turned $5,000 into $1 million in just over five years... Now, we're closing on $2 million! --------------------------------------------------------------- The Daily Reckoning PRESENTS: Dr. Richebächer was remarkably adept at digging out the inconsistencies - and sometimes the absurdities - in government-reported economic results. Below, Rob Parenteau has one to add to The Good Doctor's list, and it is very relevant to gauging the depth of the current recession. Read on... More Disturbing Inconsistencies by Rob Parenteau San Francisco, California If we compare consumer spending on services with hours worked in the service sector employment report, we find a huge surge in implied service sector productivity. We suspect the service sector consumer spending series is overstated, which means real GDP growth, while already horrible, is also overstated. As we've mentioned before, government surveys of service sector activity are not as timely or as complete as those available for the manufacturing sector, so a lot of trend extrapolation goes on in the Washington, D.C., data mills, at least on the initial estimates of service sector activity. Since productivity growth is used to estimate unit labor cost growth, costs also must be understated for the service sector as well, which further implies service sector profits are overstated. This should all come out in the wash in future revisions, but for the meantime, it is very likely that the GDP, consumer spending and profit realities are worse than currently reported. Transfer payments have reached a higher share of personal income than interest and dividend income. Together, that means over 30% of the U.S. personal income flows are now being earned for no increase in work devoted to production of goods and services (although we do recognize loans earning interest may, "Money doesn't chase anything. People spending money who did not produce anything to get the money - now, that's a recipe for inflation." in fact, finance increased production, rather than financial market speculation). The more people get paid without directly producing goods and services, the higher the inflationary bias likely to arise in an economy. Purchasing power without production is another, perhaps more accurate, way of depicting the old saw about "too much money chasing too few goods." Money doesn't chase anything. People spending money who did not produce anything to get the money - now, that's a recipe for inflation (or less disinflation/less deflation, than otherwise would be the case from favorable cost and supply conditions, to put the point more generally). In this regard, the major rise in transfer payments from 1966-76 may have played a role in the original onset of the stagflationary '70s, while the surge in interest income from 1978-82 may have contributed to the second wave of stagflation. Higher money incomes without increased production tends to lead to higher prices, unless, of course, saving rates among money income recipients rise sufficiently. Treasury Inflation-Protected Securities have been one way to hedge for an eventual inflation result, although they are no longer as cheap - but then again, neither are most inflation hedges, which have, for the most, part been bid up year to date. We have been investigating which sectors have been accumulating Treasuries lately, as we believe placing new Treasury bond issuance may become more challenging not just because of the huge supply forthcoming, but because the quantitative easing measures adopted by the Fed and other central banks are designed in part to force investors out of the risk spectrum and away from cash and default-free Treasury holdings. Results from the Fed show broker-dealers, foreign investors and money market mutual funds have been the largest buyers of Treasuries of late. We are especially concerned the large buildup of long Treasury positions at primary dealers is unlikely to be sustained and there may be a rout in the Treasury market reminiscent of 1994, when Goldman Sachs had to borrow from the Japanese in order to stay afloat after getting caught the wrong way round in yield curve carry trades. With 10-year Treasuries hitting 3.36% and passing through their 200-day moving average this week, our concern is looking less and less theoretical. We asked seasoned bond veteran Lou Crandall at Wrightson Associates about the unusual buildup in dealer position in Treasuries, and this was his assessment, which we have corroborated elsewhere: "The large structural short positions that dealers developed in the middle part of this decade were a function of their market-making and hedging strategies. As a general matter, dealers would hold inventories of less-liquid spread products such as mortgages, ABSs and corporates on the long side, and then hedge them by shorting Treasuries of comparable duration. "Once the liquidity crisis hit in the summer of 2007, a couple of things happened. First, the basis risk on those trades exploded, because spreads became highly volatile. Treasuries were no longer as efficient a hedge for private instruments as they had been. After Bear Stearns, you also started to see a rapid contraction in dealer balance sheets - even if Treasuries had still been an effective hedge for private-sector instruments, dealers were trying to lighten their inventories of those private obligations. "In 2009, a couple of additional factors have come into play. Dealers wanted to front-run the Fed's purchases of Treasuries, which probably led to a modest amount of speculative long positions in Treasuries. More importantly, the Treasury market in May has adopted new delivery protocols that impose a 300-basis point penalty on anyone who fails to delivery a Treasury on time. The prospect of that fee created a lot of uncertainty in the market in April, and led some dealers to conclude that it would be safer to conduct their market-making activity from the long side, rather than the short side, of the market in the near term. (Just about everyone came to that conclusion about the bill sector, but some applied the same logic to coupons.) "The increase in outright long dealer positions in Treasuries is close to having run its course. We could continue to see increases for a few more weeks as dealers complete the transition. However, we are seeing a restructuring of dealers' market-making business model, rather than an increase in outright long-term holdings in Treasuries driven by an investment view on the part of the dealers." Essentially, dealers covered their spread trades by purchasing Treasuries and selling agency mortgage-backed securities and corporate bond positions. Some of them reconfigured themselves as banks, where procedures for the risk weighting of capital favors holding Treasuries. These, along with some procedural changes, are essentially one-off transitions. We, therefore, do not believe broker-dealers are likely to be big buyers in future Treasury auctions. Unless U.S. macro data start to get more alarming soon - and auto production cuts could dampen the Institute for Supply Managements' numbers, while the minor consumer bounce in Q1 was really mostly over in January and could cool further in Q2 - Treasury yields are likely to surge higher. So far, the backup in Treasury yields has not taken 30-year fixed mortgage rates higher, but this is the type of challenging set-up in the Treasury market that could squash attempts to stabilize the U.S. housing market. If you were planning on refinancing your mortgage this year, you may wish to consider acting sooner rather than later. Best regards, Rob Parenteau for The Daily Reckoning