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The Daily Reckoning Thursday, August 20, 2009 The dollar could go up...but we're keeping our distance... One of the most curious things about the financial world c. 2009... Thoughts from the Oracle of Omaha... Chris Mayer wonders if this is the end of cheap water...and more! Danger for the Dollar by Bill Bonner Ouzilly, France The dollar will probably go up. Still, we'd stay away... Here is Warren Buffett's view: "Last fall, our financial system stood on the brink of a collapse that threatened a depression. The crisis required our government to display wisdom, courage and decisiveness. Fortunately, the Federal Reserve and key economic officials in both the Bush and Obama administrations responded more than ably to the need. "They made mistakes, of course. How could it have been otherwise when supposedly indestructible pillars of our economic structure were tumbling all around them? A meltdown, though, was avoided, with a gusher of federal money playing an essential role in the rescue. "The United States economy is now out of the emergency room and appears to be on a slow path to recovery." This is probably the view shared by most economists and most investors. It is not our view. From where we sit there is no recovery underway...and there never will be one. You can recover from a hangover. You can recover from a nasty divorce. You can even recover from an earthquake. But once a depression begins, you can only endure it. Get on with it. Get it over. And then, you can begin rebuilding again. You will never recover the economy you had before the crisis. You must find a new economic model. A headline from yesterday: "Reluctant shoppers hold back recovery." That's one way to put it. Shoppers don't have any money. They need to cut back. Most likely, they will cut back until their savings rates reach 10% of disposable income. That will take $1 trillion out of consumer spending. The economy cannot possibly recover under those conditions; it can't return to its same old, consumer-led, credit-fuel self. Instead, it must go through a period of transition - in which output is depressed - until it finds a new personality, better suited to the new economic circumstances. But Buffett is not worried about the depression. He's worried about how the recovery is financed: "...enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself." Buffett does the math. This year, the US deficit will total $1.8 trillion. Since 1920, the largest peacetime deficit was 6% of GDP. This is 13% of GDP. The magnitude of it alone should be cause for alarm. But there's more. Where does this money come from? Even if you could direct 100% of the net US trade deficit (about $400 billion, the money that ends up in foreigners' hands as a result of American spending) and 100% of American's savings (estimated to be about $500 billion), you'd still be $900 billion short. Desperate borrowers should expect to pay high rates of interest. A borrower who doesn't need the money can shop for the best rates and hold out for a good deal. But when a person needs to borrow, he takes what the market gives him. Yet, one of the most curious things about the financial world circa 2009 is the yield on the 10-year Treasury note. It has fallen to under 3.5%. Despite record borrowing by the feds, lenders content themselves with the lowest yields in nearly half a century. Go figure. While you're figuring...here's the latest news: "Here's a small victory, worthy of breaking out some Andre Brut," writes Ian in today's issue of The 5 Min. Forecast. "The US government budget deficit is more likely to ring in at $1.58 trillion this year, not the $1.84 trillion the Obama administration reported in May. According to some purposefully leaked budget projections due out next week, roughly $250 billion that was set aside in the 2009 budget for bank bailouts will not be used by October, the end of the fiscal year. "Of course we'll end up with an annual budget deficit of 11.2% of GDP, the highest since 1945 and an all time high in dollar terms. But hey, (they must be thinking) now we'll have a little extra for that $1 trillion healthcare reform! "Back in our grammar school, team sports days, we'd say a game ending in a tie is 'like kissing your sister.' Heh, this kind of budget 'victory' feels the same, or worse (like your mother-in-law?)" Wanna make sure you get The 5 in its entirety delivered straight to your inbox every day? You can - The 5 is a free service, exclusive to subscribers of Agora Financial's paid services, such as Dan Amoss' Strategic Short Report. On Monday, August 24th, at noon, Dan Amoss will expose the biggest banking lie of the past 64 years...and you could stand to triple your money. See his latest report for all the details. And back to our train of thought: The market seems to be anticipating a depression. Why else would bond yields be so low? If the economy sours...and the stock market sinks...the safe yields on Treasury bonds will seem like a good alternative. But Buffett believes the Treasury yields are not as safe as they appear. That other $900 billion has to come from somewhere. And the feds can't allow interest rates to rise significantly; that would undermine all their stimulus efforts. High real interest rates depress economic activity. So, what can the feds do? "Washington's printing presses will need to work overtime," says Buffett prophetically. Of the two ways of financing the deficit, one is a flimflam; the other is robbery. In the great credit expansion consumers borrowed so they could buy things such as automobiles. Now, the feds borrow and bribe the voters with money to buy automobiles. No matter who does it, borrowing for consumption is merely taking from the future. Then, when the future comes...the account has to be settled. Result: no net gain. What was consumed in one year is not consumed in the next. Of course, the feds don't spend money the same way consumers did. Consumers wasted their money on frou-frou and watchamacallits of their own choosing. The government wastes money on different things - like turtle crossings and billion-dollar bailouts. Not that we're complaining about government spending. We're just pointing out that it's not the same as private spending. What makes goods good is that people choose them and buy them with their own money. They get what they've got coming. But the feds are spending other peoples' money. If they get any goods at all it is practically an accident. But what we're talking about this morning is the dollar. According to Buffett, the dollar is in danger. He's worried about the larceny, not the flim-flam. Printing up additional dollars robs savers. Each new dollar created to buy US debt makes each one already in existence - say, in a vault in the Bank of China - worth less than it was before. If that isn't true, the whole body of economic thinking from Adam Smith to Irving Fisher is nothing but a fantasy. And the only way to protect the value of the dollars held by savers, theoretically, is to withdraw the stimulus money before inflation sends prices soaring. Buffett is an optimistic fellow. He believes that responsible authorities will turn off their dollar-printing machines in order to protect the greenback. Here at The Daily Reckoning, we're not so sure. First, the depression is likely to be worse than people think. This will mask the effects of dollar printing. Plus, it will make the need for more dollars - more federal spending, more US debt - seem more urgent than ever. Instead of pulling the plug, they'll turn up the speed. Second, the feds are not really interested in the health of the real economy anyway. This is an insight, which while it may seem obvious, it only came to us recently. When the feds put in place absurd policies to delay and restrain the inevitable correction, they are making things worse, generally, for everyone. But the politicians are responding to their constituents' demands. One campaign donor wants to keep his business alive. Another wants to keep his job. Still another promises the feds high paying jobs on Wall Street, after their term in Washington is over. Millions of others - more than enough to turn an election - want free pills and mortgage subsidies and so forth. When the feds try to bailout the economy, they are only doing their jobs! They're not going to stop doing their jobs - especially in a depression - just to protect foreign dollar-holders. Until tomorrow, Bill Bonner The Daily Reckoning [Ed. Note: Though the feds are trying to bailout the economy, they aren't trying to bailout those who are funding these stimulus programs: you, and your fellow American taxpayers. Don't wait for the government to save you...set up your own 'personal bailout'. All the resources you need to get started can be found here. The Daily Reckoning PRESENTS: If cheap energy helped fuel the boom in China and India, then a vanishing supply of fresh water will apply the brakes. Chris Mayer explores two recent events that really brought this home. Read on... The End of Cheap Water? by Chris Mayer Gaithersburg, Maryland The price of water is starting to rise in a big way, at least in China. I've expected this for a few years. To set the table, water rates in China have been so far below the global average it's ridiculous. Especially when you consider the severe water problems in China. The graphic below is from The Wall Street Journal ("China Cities Raise Water Price in Bid to Conserve" by Andrew Batson): The Chinese are water-poor. They are sucking their aquifers dry. It is particularly bad in the north of China. The groundwater under the North China Plains is draining away quickly. By some estimates, China will exhaust this water supply in the next ten years. You probably know that the city of Venice is sinking a fraction of an inch per year. But that's nothing compared to what is going on in Beijing. Parts of Beijing are sinking 8 inches a year! According to Andrew Lees (The Right Game), it is the world's largest cone of depression (an underground hole created by a depleted water table) at over 15,000 square miles. The second largest cone of depression is around Shanghai. So finally, many cities are raising the price of water. The WSJ points out several places where water prices could rise 25-48%. Shanghai, for instance, raised water rates 25% in June and plans another 22% increase next year. The second event that caught my eye was the collaboration between China and India to monitor the health of Himalayan glaciers. This area is very important to both countries. They fought a war over it in 1962. So, the fact that they are getting together on the Himalayan glaciers is meaningful. Here is why it is so important: Seven of the world's largest rivers, including the Ganges and the Yangtze, are fed by the glaciers of the Himalayas. They supply water to about 40 per cent of the world's population. Well, those glaciers are shrinking. The Indian Space Research Organization, using satellite images, has studied the changes in 466 glaciers. It found they had lost more than 20% of their size between 1962 and 2001. This melting increases the water flow at first, but eventually slows dramatically as the glaciers either melt completely or reform. These observations have given rise to a kind of "Peak Himalaya" where people wonder if we have not seen the maximum water flow from the mountains. "Fresh water, like oil, is getting a lot harder to find for 40% of the world's population. It will get worse before it gets better. The days when we think of water as a cheap resource are coming to a close." We know the current run rate on demand is already well above what is sustainable given annual rainfall and river flows. That's why you have those depressions. That explains the depleted aquifers and the rivers that don't reach the sea. Now throw into that ugly brew a decline in water supply from the Himalayas. The situation is worse than it seems, if that is possible, because much of the existing fresh water in both countries is so polluted it is unfit for human consumption. As if all of that weren't bad enough, the demand for water is still rising rapidly in China and India. The water use per capita in China and India are still well below global averages. As these countries industrialize, they'll consume exponentially more water. It takes water to make just about everything. For example, to make a 1 tonne passenger car takes more than 100,000 gallons of water. Just to make a cotton shirt takes over 1,000 gallons of water. And most of our water goes into making our food. So, population growth by itself guarantees increased water demand. (Globally, water consumption increases at more than twice the rate of population growth.) These two countries already have big populations and both will get bigger. When you look at demographic trends, China and India alone will add close 600 million people over the next 30 years. That's two present-day United States. Fresh water, like oil, is getting a lot harder to find for 40% of the world's population. It will get worse before it gets better. The days when we think of water as a cheap resource are coming to a close. That's especially true for China and India. Bottom line: We need to create more fresh water. You do that by finding new sources either through new supplies (drilling deeper, desalination, etc.) or by using existing supplies more efficiently (irrigation and other efficiency gains). All of that takes time and energy. Desalination is energy intensive. Drilling deeper for water or going to more distant source requires energy to pump and move the water. Replacing older, less efficient plants and equipment takes time and energy again. (Detect a theme here?) Countries, companies and people will find ways to make this transition. The companies that can solve these problems will do well. Regards, Chris Mayer for The Daily Reckoning Editor's Note: One company Chris likes a lot that is helping in the water crisis is already in the Mayer's Special Situations portfolio - and is up 80% from its lows. To learn how you can get in on this play (and see the rest of the MSS portfolio) see here. Chris Mayer studied finance at the University of Maryland, graduating magna cum laude. He went on to earn his MBA while embarking on a decade-long career in corporate banking. Chris is the editor of Capital and Crisis and Mayer's Special Situations, a monthly report that unearths unique and unconventional opportunities in smaller-cap stocks. --------------------- Special Offer --------------------------- Put Your Pocket Change to Use You can pad your portfolio with everyone's favorite yellow metal...for just a penny per ounce. No joke. See how here.   The Daily Reckoning - Special Reports: Gold: The Truth About Gold Fiat Currency: Using the Past to See into the Future Introducing the Single Best Way to Make Sure You'll Never Run Out of Money...