The Worst Is Over For The Economy
Henry Blodget|May. 27, 2009,

But the recovery will be weak.

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• Hyperinflation Ahead - Hussman
• End of U.S. Economic Dominance - Satyajit Das

TARP: The Greatest Economic Swindle Ever Sold - Andy Kroll, The Nation
Big Banks' Best Friend In Washington - Steven Pearlstein, Washington Post
Stress Anxiety: What the Banks Still Won't Tell - Noam Scheiber, TNR
Exploding Debt Threatens America - John Taylor, Financial Times
America's Debt Is Still Triple A - Brian Wesbury & Robert Stein, Forbes

• Roubini The Revisionist by Keith McCullough
• Questions About the Dollar by Marc Chandler
• Positives on the Economic Front, PPIP and TALF. On Housing? Take a Pass. by James Byrne

• Preview from Europe: The Great Bond Massacre Spills Over onto Stocks by The Mole
• Time for Quantitative Easing 2? by Tyler Durden
• The Bond Market Strikes Back at the Fed by Vikram Saxena

• It's the Soil That's Bad, Not the Green Shoots by Marvin Clark
• Four Points on the 'Great Short Trade' by Michael Shulman
• U.S. Hyperinflation: Is Faber's Prediction Realistic? by Peter Cooper

• China: All's Not so Quiet on the Eastern Front by Kurt Brouwer
• Will China Dump the Dollar? by Kurt Brouwer

• Ten Year Treasury in the Woodshed. Time for a Major QE Overhaul? by Tyler Durden
• Ben Can't Win with the Market by Cam Hui
• Why Consumer Confidence Is Not a True Indicator by John Browne
• Notes on the Economy: Recession Momentum Has Yet to Be Halted by J Clinton Hill

• Ben Better Start Buying More Bonds by Tim Iacono
• As the Dollar Slides, Foreigners May Rethink U.S. Investments by Prieur du Plessis
• Goldman Thinks We're Likely Past the Worst by Prieur du Plessis
• Home Sales and Inventory Both Rise by Tim Iacono
• Are We Headed for Hyperinflation? by Tim Iacono

US Market

• Wall Street Breakfast: Must-Know News by Emily Church
• Remind Me Again, What's a Bubble? by Alex Trias
• Why to Short U.S. Treasury on the Next Uptick by Gold Digger
• Tax Revenue Slump: No Doubt in These Numbers by Michael Panzner
• The Long Bond in Pain by Mebane Faber
• Yield Shoots, Dollar Leaves by Ashraf Laidi
• Making Some Sense of the Current Market by Brett Steenbarger
• Friday Outlook: End of Month Tape Painting by David Fry
• U.S. Dollar: Short- and Long-Term Outlook by Kathy Lien
• Unemployment: The Number to Watch by Ron Rowland
• The Fed's Open Market Operations: Two Key Charts by Tyler Durden
• When Will The Economy Recover? These Three Key Areas Will Tell You by Smart Profits Report
• Spiraling Federal Debt: It's Likely to Get Worse by Contrarian Profits
• The Next Shoe to Drop: Muni Bonds by Tyler Durden
• New Home Sales: Flat Is Better than Flattened by Zacks.com
• U.S. Rating Outlook Stable Despite Debt - Moody's by Research Recap
• Too Much Supply, Too Little Support by Karl Denninger
• Not the Great Depression 2.0 by Donald Marron
• Thursday FX View: Japanese Bond Buying Weakens Yen by Andrew Wilkinson
• What Use Is Economic History? by Felix Salmon
• Mortgage Delinquencies Hit Record High, New Home Sales Disappoint by Tyler Durden
• The Fine Line Between Too Much Inflation and a W-Shaped Recession by Felix Salmon
• Bullish and Bearish Sentiment Both Up by Bespoke Investment Group
• Obama Says We're Out of Money by James Bibbings
• Can North Korean Nukes Rattle the Global Markets? by Gary Dorsch
• FDIC Fund Running Dry: Now What? by Zacks.com
• Is There Any Limit to Bank Arrogance? by Zacks.com
• FDIC Won’t Rule Out Banks as Buyers of Toxic Assets by Rolfe Winkler, CFA
• PPIP Starting to Die on the Vine by Tom Lindmark
• Securitization Accounting Rules Changing, But Interagency Action Necessary by Mark Sunshine
• We're Entering Extreme Hazard Zone - Bring Your Crash Helmet by Clive Corcoran

Is the commercial real estate bubble next? Fortune



Why US government bonds are not safe Money Morning



Protect yourself from the looming sell off Seeking Alpha



Why Beijing wants a strong dollar Wall Street Journal



Will “Helicopter” Ben get four more years at the Fed? Real Clear Markets



Roubini the revisionist Seeking Alpha



Barney Frank in 2005: What housing bubble? YouTube



GM reaches a deal with bondholders NYT

The Big Inflation Scare
Is a commercial real estate bust inevitable?
U.S. Home Sales Remain Sluggish as Supply Soars
N.J. home prices haven't hit bottom yet
Yield Curve Steepens to Record as Debt Sales Surge
The $4 trillion housing headache
Mortgage-Bond Yields Jump, Jeopardizing Fed’s Housing Effort
The next leg down is deflation
Homes: Almost 20% cheaper
Budget crises swamp state after state
Signs of more trouble ahead for housing market
Lowest Libor Hides ‘Exceptionally Wide’ Bank Spreads
Job Losses Push Safer Mortgages to Foreclosure
Wall Street nervously awaits data on home sales, consumer confidence
The Crisis Isn't California's Alone
Britain looks to the land of the rising sun with envy
European Slump May Stall Global Rebound
U.S. Jobless Rate Likely to Pass Europe’s
Fitch expresses concern about China's loan cascade
Fitch expects CA real estate to decline another 36%
Here Comes The Option ARM Mortgage Explosion
San Francisco Home Prices Fall 41% on Foreclosures
German April Producer Prices Record Biggest Drop in 22 Years
Stocks belted by British downgrade

http://www.frontlinethoughts.com/sendfrien...&sid=303949
Thoughts from the Frontline Weekly Newsletter This Way There Be Dragons by John Mauldin
May 29, 2009

In fantasy novels the intrepid heroes come across a sign saying "This Way Be Dragons." Of course, they venture on, facing calamity and death, but such is the nature of fantasy novels. We live in a very real world, and if we don't turn around there will be some very nasty dragons in our future. This week we look at three possible paths we can lead the world down. We then review a number of charts and data on the housing market.

If you just read the headlines on this week's data, you could be forgiven for assuming the worst is over -- not. And then finally we look at some rather stark comparative data on the health-care systems of the US, Canada, and Great Britain. Everyone knows the US pays way more in terms of GDP than the latter two countries. Are we getting our money's worth? There is a lot to cover, and I hope to finish this on a flight to Naples, so let's jump right in.


This Way Be Dragons
More and more we read about the growing concern over $1-trillion-dollar deficits. Stanford professor John Taylor (creator of the famous Taylor Rule) jumped into the debate with a rather alarming op-ed in the Financial Times this week, echoing much of what I wrote last week, but with some real insights into what trillion-dollar deficits mean. Quoting:

"I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis. To understand the size of the risk, take a look at the numbers that Standard and Poor's considers. The deficit in 2019 is expected by the CBO [congressional Budget Office] to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

"Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth -- probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession."

You can read the rest at (http://www.ft.com/cms/s/0/71520770-4a2c-11...?nclick_check=1)

While Obama gives lip service to cutting the deficit in half, his actual budget increases it over the next 10 years. As I have been writing for some time, this is a very dangerous path. And it is one that the bond market seems to be concerned about, as interest rates are rising, even on mortgages that the Federal Reserve is buying in massive quantities in its effort to hold down rates and stimulate the housing market.

"The good news," Taylor concludes, "is that it is not too late. There is time to wake up, to make a mid-course correction, to get back on track. Many blame the rating agencies for not telling us about systemic risks in the private sector that lead to this crisis. Let us not ignore them when they try to tell us about the risks in the government sector that will lead to the next one."

Taylor is right that the massive tax increases necessary to fund these deficits and programs should not happen. But it is not clear to me that they won't. A Democratic Congress is talking of adopting John McCain's plan to tax health-care benefits. While this would be a tax on the middle class (on everyone) that Obama said he would not do, he is clearly willing to sign a bill that has such a tax.

The administration is starting to float trial balloons about a new VAT, or value-added tax. Many of my non-US readers will be familiar with VAT taxes, especially in Europe. A combination of a VAT and taxing health-care benefits would raise enough to get us to a deficit of "only" a few hundred billion. Take away the Iraq war and you get even closer. You can make an economic case that a VAT tax would be preferable to an income tax.

However, the administration is not talking about a substitute but an additional tax. There is momentum in the heavily Democrat-controlled Congress for large new health-care programs. While there is resistance to large deficits on the part of a few moderate Democrats, there is a chance they could be brought on board with a tax or a series of new taxes that would offer the potential to pay for the new programs. (Even though everyone knows that the cost overruns on new health-care benefits will be much larger than estimated.)

As much as it grieves me to say it, a tax on health-care benefits or a VAT tax large enough to hold the proposed deficits to something under 3% of GDP would be preferable to running decade-long trillion-dollar deficits, which would destroy the US economy and the dollar and do severe damage to the world economy. (For the record, I am assuming the Bush tax cuts are history.)

But while a large tax increase would keep the economy from crisis and collapse, it is not without very serious consequences. It will put a serious crimp in economic growth. It will lock in European growth rates and European-like unemployment rates. And we will be using those tax increases to fund new spending and will still not have solved the future problems with Social Security and Medicare, which are going to require massive increases in spending in another 5-7 years. Which of course means that either a cut in benefits or another round of growth-crippling tax hikes is down the pike.

A third path would be to simply go ahead and raise taxes on the rich, say no to increased spending on programs until we can afford them, hold the line on any new spending, and see if we can reintroduce the gradual budget control that was the result of the stand-off (and to some extent cooperation) between Gingrich and Clinton.

I put about a 5% probability on the third scenario happening. Better than the chances of a snowball in hell, but not much. The first disaster scenario is about a 35% probability, which is quite scary. If we do choose such a path, then short the dollar, buy gold, and invest abroad. It will be a very tricky and difficult environment.

I assign a 60% probability to the middle path. Maybe it's my basically optimistic nature and I am simply being naive, but I am hopeful that cooler heads will prevail and we will not run continual massive deficits larger than the growth of GDP. While that means rather large tax increases, since the current leadership wants to create massive new health-care entitlements and will do so, I would rather have to simply overcome higher taxes in my business rather than deal with a collapse of the dollar, high unemployment, high interest rates, and an extremely sluggish economy.

Each scenario will create a different investment environment. Ironically, the middle scenario could be good for the dollar over the long term. But it will be hell on corporate profits from US sources. Given the above, it seems like a 95% chance that we should start looking at investing a significant percentage outside of the US and Europe. Think Canada, Australia, Asia (not Japan), Brazil, South Africa, etc.

Normally, politics does not have all that much of an impact on the stock market. As an example, both Democrats and Republicans can take credit for the '90s, but it was really the dynamic of the free market that worked in spite of government. Same for the Bush years. While the tax cuts did help, it was the free market and increasing leverage that were the dominating factors.

This time it will be different. The choices we make as to how to fund, or not fund, the increases in spending that are our clear and sad destiny, will have a major impact on not just the US but the world economy. As US consumers have been a major part of the growth of the developing world, and especially Asia (China), a slowing of consumption in the US will mean a very slow recovery for the rest of the world. It will happen, but the choices made by politicians this year will have many unintended consequences. Just as deciding we would take a major part of the corn crop and turn it into expensive ethanol raised the price of tortillas in Mexico, raising taxes in the US will mean lower global consumer spending and trade. It is a very tangled web we weave.


A Housing Update
If you read the headlines the last few days you would think that the housing market has turned. Mostly they read something like "Home Sales Rise 0.3%," and of course the reflexive bulls started talking about green shoots and a bottom in housing. And while someday we will actually have a bottom in housing, it will not be this month. It has been awhile since we have looked at the housing market, and it is time to review.

First. Of course home sales rose. It is April. Look at the graph below. It is the time of the year when home sales rise. And 0.3%? Really? The margin of error is close to plus or minus 10% or so, so 0.3% is a meaningless number. It will be revised. Who knows which way? I don't. (I am on the plane so I cannot access the exact margin of error, but 10% is not that far off.)



My main thesis since 2006 has been that the housing market was in a bubble that would burst. We built something like an extra 3 million homes over trend growth, and those homes are going to have to be absorbed in the normal way, through growth of population and the economy. We "need" about 1 million new homes a year to take care of population growth and demand. Further, we have cut off home availability to buyers who are in the subprime category, whereas during the boom you simply had to have a pulse, even a lying pulse, to get a home for which you did not have a chance of actually paying the mortgage.

The earliest we see a real bottom to housing is late 2010 or 2011. By real bottom I am talking about housing values in general being to rise (assuming we do not visit scenario one and have significant inflation.) There is nothing that can be done about that. We have to work through the excess capacity. (More later on that below.)

We had the Case-Shiller home price data come out this week. Home prices are still in free fall. They are down almost 19% year over year and 32% from their 2006 highs (see chart below). If we get back to the long-term price growth trend, we would see another average 10% drop; and as prices tend to overshoot on the upside and the downside, in some markets they could fall even further.



Yet there is hope that we will not see a fall below trend. Housing in many areas is starting to once again become affordable (see chart from Moody's below) to more and more Americans and even first-time home buyers. The cure for the housing crisis is actually lower prices, as that brings more and more potential home buyers into the market. While housing sales are still quite depressed, what are selling are homes in foreclosure, as buyers perceive that there are bargains. And they are right.



On the negative side, the supply of homes available for sale is again rising, as more and more foreclosures come onto the market. And as we will see, this foreclosure trend is going to slow down soon. (Thanks to Greg Weldon at www.weldononline.com for the chart.)



Notice in the above chart that the supply of homes for sale is over ten months. But that average can be misleading. If you are in Florida, I read recently that in many areas it is over 40 months. And that is for homes that can be financed with government-sponsored "conforming loans," typically up to $719,000. But what if your home cost more than that? National Association of Realtors chief economist Lawrence Yun said that the supply of existing homes for sale over $750,000 has reached a forty-month supply.

Diana Olick, the very on-top-of-it CNBC real estate reporter, had the following to say (emphasis mine).

"That's going to mean a new phase of the current housing recession. So far we've seen the 'correction' of a boom market that was driven by faulty, exotic loan products, investors looking to make a quick buck, and average Americans using their homes as ATMs. Now the losses are being driven by traditional economic factors and by sweeping price drops across the nation.

"Yesterday Fitch ratings estimated that up to 75 percent of the modifications now being done through the administration's Making Home Affordable program will re-default in six months to a year. I'm not talking about the old modifications, which were largely repayment plans that could actually raise monthly payments. I'm talking about the new mods, which lower monthly payments to 31 percent of a person's income. I couldn't understand Fitch's reasoning, so I called them.

"Diane Pendley, managing director at Fitch, said the problem is not on that "front-end" ratio, but on the back end, which is all of the borrowers other debt (credit cards, car loans, student loans, etc.). She said that in talking with servicers, she's hearing other debt is so high that most of today's troubled borrowers cannot afford any loan payment at all, even at a very modest debt-to-income ratio. 'Just getting the house payment done doesn't mean their lifestyle is sustainable,' she said.

"Another problem is that with home prices continuing to fall, more and more borrowers, who are essentially just renting their mortgages now because they will never see any home equity, are walking away. Even if the mortgage payment is low, the property taxes and home maintenance costs are padding that payment, and without an upside to the investment, there's simply no reason to pay. Suffice it to say, the foreclosure crisis, on the high and low ends, is not getting any better."

And it gets worse.


More Prime Foreclosures In Our Future
The Mortgage Bankers Association noted that a record 12%, or 1 in 8 homeowners, in the US are now behind on their payments or in foreclosure. 10.6% of the mortgages in Florida are now somewhere in the process of actual foreclosure. (My seatmate here on the flight says the prices on the condos where he lives are now back to 1998 levels. It would be scary, he said, if you had to sell. There are new developments that only have 10% actual occupancy, as the bulk of the condos were bought for speculation. Now those 10% of buyers are having to shoulder all the fees for upkeep. Nobody will buy, because the upkeep costs can be more than the mortgage. It is a vicious cycle.)

In Nevada foreclosures are 7.8%, Arizona 5.6%, and California 5.2%. 25% of subprime loans are now in foreclosure, 14% of FHA (government, taxpayer-guaranteed) loans and a growing 6% of all prime loans are now in foreclosure. (Note: the seasonal adjustments may overstate the actual numbers, as we are in new territory in terms of actual foreclosures.) Quoting from the MBA press release:

"In looking at these numbers, it is important to focus on what has changed as well what continue to be the key drivers of foreclosures. What has changed is the shifting of the problem somewhat away from the subprime and option ARM/Alt-A loans to the prime fixed-rate loans. The foreclosure rate on prime fixed-rate loans has doubled in the last year, and, for the first time since the rapid growth of subprime lending, prime fixed-rate loans now represent the largest share of new foreclosures. In addition, almost half of the overall increase in foreclosure starts we saw in the first quarter was due to the increase in prime fixed-rate loans." (emphasis mine)

How could so many prime loans be in foreclosure? These were people with good credit and jobs. The answer is the very deep and lengthy recession, coupled with high and rising unemployment. The number of foreclosures will not abate until unemployment starts to fall. And even optimistic forecasts assume unemployment will keep rising into 2010. As I have written for a long time, I think it is quite likely that we will see unemployment rise to over 10%. When I first wrote that a few years ago, many called me just another doom and gloom guy. Now, many think I am Pollyanna. Such is the life of those who believe in Muddle Through.

For those who think the end of the recession will be like all past recessions, the problems in the housing market should make for serious concern. As we will see on Monday in my Outside the Box, the average homeowner with a mortgage has very little, if any, equity. There is little room for home equity withdrawals -- if banks were lending. And recent data shows a very serious and un-American-like drop in credit card borrowing. US consumers are retrenching, and global trade figures echo that.

We are in for a slow, Muddle Through recovery, with the real potential to slip back into recession when the tax increases hit. Stay tuned.


Are We Paying Too Much for Health Care?
I want to pass on this quick note from Dennis Gartman's eponymous letter. It should give all of those who favor a nationalized healthcare system pause, before they jump right in. Quoting Dennis:

"Canada is a wonderful place to have a nasty gash on one's forehead stitched, or to break one's nose in a game of pick-up baseball; but have cancer, or need eye surgery, or want an MRI, and the business of medicine in Canada and/or the UK breaks down badly in favour of medical care here in the US. For example... and we wish to thank The Investor's Business Daily for the data noted here this morning...

"... here in the US men and women survived cancer at an average of just a bit better than 65%. In England only 46% survive. In the US, 93% of those diagnosed with diabetes receive treatment within six months; in Canada only 43% do, and in the UK only 15% do! For those seniors needing a hip replacement and getting one within six months, 15% get it done in the UK; 43% get it done in Canada ... and in the US 90% do! For those waiting to see a medical specialist, 23% of those in the US get in within four weeks, while 57% in Canada have not yet done so, and in the UK 60% are still waiting after four weeks.

"When it comes to proper medical equipment, in the US there are 71 MRI or CT scanners available per million people. In Canada there are but 18, and in the UK there are only 14! Ah, but the best figure of all is this: 11.7% of those 'seniors' in the US with 'low incomes' say they are in excellent health, which in and of itself sounds rather low ... rather disconcerting ... and an indictment of the system itself, doesn't it? But in Canada only 5.8% do!

"Yessiree bob, ya' jus' gotta' luv that collectivized, socialized medical care! Let's all go break a collective arm and enjoy the benefits of socialized medicine in the Commonwealth! (Canada) ... but heaven help you if you've got something really, really wrong. If that's the case, you'll be running south to the border faster than you can reach a specialist anywhere in Canada; of that we are certain."

Do we pay too much for health care here in the US? Everyone says yes. And there is a lot of waste (and waist) in the system. But if you are the person who needs treatment, maybe the answer is "not really." If you can't get the medical help you need when you need it, maybe the fact that it is theoretically free doesn't mean anything.

As an aside, I have two friends who have had immediate family members diagnosed with Lou Gehrig's Disease. For all practical purposes, it is a death sentence. Yet one family was told (at a top-five cancer hospital) there could be a cure within a few years, or at least clinical trials. But just not now. Unfortunately, the prognosis is less than a year.

I can guarantee you, if that was me or my family, I would like to be able to make the decision whether to try a radical treatment. What's my downside if I die a little earlier? Shouldn't that be my choice?

And if I don't want some nameless bureaucrat dictating who gets to live or die in the name of his scientific system, why in God's name would I want a bureaucrat deciding to ration my access to health care? But that is what the majority in Congress are planning for our future. And bluntly, I find that far harder to swallow than my taxes going up.


Naples, London, and East Europe
I am literally in the taxi in Naples as I finish this letter (even for me, this is a first). I am supposed to go right into meetings when I arrive. Ground zero for the housing crisis. But it is still a pretty city. Hopefully I can get out and do a little power walking on the beach tomorrow. I am looking forward to being with good friend and fellow writer Gary Scott and business partner Steve Blumenthal, as well as my friends from Jyske Bank.

The schedule says I am home all of June. Then I am off to London in the middle of July for my partner Niels Jensen's 50^th birthday, and then a vacation to far Eastern Europe. Thanks to everyone who wrote with suggestions and offers to help.

School is just about over for youngest son Trey, and we have been spending a lot of time reviewing material for his finals (with some success!) But then you get a call from the vice principal. Seems there was a little trash talk and the other (bigger) kid hit first, and then ... "Really, Dad, it wasn't my fault. This is just so stupid." Well, you know how that goes. (Trey is fine.) After seven kids, I should get used to the regular surprises. Well, there is always next year to teach him how to avoid bullies. (Which of course Dad was soooo good at.)

It is time to hit the send button. We are pulling up to the resort. I have a good feeling about this summer. It will be busy (what else is new?), but I think it will be fun. Have a great first week of summer!

Your real life just keeps on coming at you analyst,

John Mauldin
John@FrontLineThoughts.com

Copyright 2009 John Mauldin. All Rights Reserved

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US Market

• Sell in May? Not This Time by Ockham Research
• Six Trends to Profit From by Timothy Lutts
• The Week in Credit: Weekly Credit Market Summary by Tyler Durden
• Book Review: Financial Shock, by Mark Zandi by David Merkel
• MidAmerican’s David Sokol on Housing Market: No “Green Shoots†Yet by Ravi Nagarajan
• How Today’s 2.46% Dividend Yield Could Destroy Your Wealth by Contrarian Profits
• Dividend Stock Investing: Two Sectors with the Most Stable Yields by Smart Profits Report
• Candidates to Replace GM, Citigroup in the Dow by Donald Johnson
• Weekly Roundup: Strong Finish to a Choppy Week by Vikram Saxena
• What Price Stability Means to Market Sentiment by Sydney Williams
• ECRI: Economic Growth Outlook Brighter by Steven Hansen
• Treasuries Make a Comeback by Bespoke Investment Group
• The Cost of Capitalism, by Robert J. Barbera by John M. Mason
• Earnings Preview for Week of June 1-5 by Zacks.com
• SPX, VIX and Late-Day Rallies by Bill Luby
• Friday Closing Update by MidnightTrader.com
• Bond Expert: Friday Wrap by John Jansen
• Russell 3000 Stocks Up 200% or More Year to Date by Bespoke Investment Group
• Friday Options Recap by Frederic Ruffy
• Why Google Won't Replace GM in the Dow by Sajal
• Chicago PMI: More Yellow Weeds by Karl Denninger
• Unemployment vs. Local Public Policy by Bill Conerly
• Fears of Inflation Seem Overblown by Cam Hui
• Percentage of Stocks Above 50-Day Moving Averages by Bespoke Investment Group
• Friday Options Update: EEM, DRYS, SLV, GLD, DHI, BRCM, STSI, LFC by Andrew Wilkinson
• Commodities: Another Bubble Forming? by Calafia Beach Pundit
• U.S. Economy 'Less Bad' in Q1 by Tim Iacono
• Running the Risk Premiums by James Picerno
• 15 Thoughts on Advantage in the Markets by David Merkel
• When Short-Term Momentum Subsumes Long-Term Momentum by Alex Trias
• Three Solid Investment Themes by Dr. Stephen Leeb
• Consumer Confidence: Is the Bottom In? by Dr. Stephen Leeb
• Daily FX View: Global Recovery Weakens Dollar by Andrew Wilkinson
• Forex Pairs Break Key Levels by Kathy Lien
• Six Dividend Stocks That Are 'Slow Good' by Dividends4Life
• IPOs and Market Signals by Saj Karsan
• Commodities for Income Investors by Cliff Wachtel CPA
• Americans Find Jobs - But More Lose Them by Jeff Miller
• Markets Focus on U.S. Debt by Brett Steenbarger
• Bond Expert: Friday Outlook by John Jansen
• The Vicious Cycle of a Falling Dollar by Marc Courtenay
• Early Look: Game On by Keith McCullough
• End-of-Month Thoughts About Valuation by Macro Man
• Options Trader Friday Outlook: The Good, the Bad and the GDP by Philip Davis
• Preview from Europe: Confused and Confounded by The Mole

Improvement All Around, But Not for Long - Floyd Norris, New York Times
Will the Recent Cheerful Days Last or Disappear? - The Economist
How Economists Can Misunderstand the Crisis - Niall Ferguson, Fncl Times
Roubini Finds Economy Even He Can Be Bullish On - Bill Pesek, Bloomberg
Why the Bulls Just Won't Die - Michael Kahn, Barron's

Attention, Economic Optimists: Not So Fast - Donald Luskin, SmartMoney
The Next Crisis Has Already Begun - Bill Fleckenstein, MSN Money
Cutting Costs by Slashing Salaries, not Jobs - Jena McGregor, BusinessWeek
Obama Owns an Auto Company. What Now? - Jerry Hirsch, LA Times
Bureaucrats in Driver's Seat at Government Motors - Alex Taylor, Fortune
U.S. Hopes To Recoup GM Outlay In 5 Years - Peter Whoriskey, Wash Post
Obama Drives the Bond Market into the Ground - James Glassman, NYT
Obamanomics vs. The Newt Gringrich Plan - Peter Ferrara, Forbes
Imagining a President McCain's Stimulus Plan - Jim McTague, Barron's
The Rise and Fall of the Summer Home - Daniel Gross, Slate
An Inside Look at the Bailout with Neel Kashkari - Knowledge@Wharton

Zoellick: Stimulus ‘Sugar High’ Won’t Stem Unemployment - Bloomberg
GM Bankruptcy Seen as 'Best of Assets, Worst of Assets' - Bloomberg
Tentative Deal for GM’s Opel Is Latest Shift for Industry - New York Times
Congress's Afterthought, Wall Street's Trillion Dollars - Washington Post

Manipulation: How Markets Really Work
by Stephen Lendman / May 30th, 2009 (0)

Wall Street’s mantra is that markets move randomly and reflect the collective wisdom of investors. The truth is quite opposite. The government’s visible hand and insiders control markets and manipulate them up or down for profit — all of them, including stocks, bonds, commodities and currencies.

It’s financial fraud or what former high-level Wall Street insider and former Assistant HUD Secretary Catherine Austin Fitts calls “pump and dump,” defined as “artificially inflating the price of a stock or other security through promotion, in order to sell at the inflated price,” then profit more on the downside by short-selling. “This practice …

(Full article …)

US Market

• Return of the Bond Market Vigilantes? by Kurt Brouwer
• PIMCO's Bill Gross Sees a Bleak Future by Tom Lindmark
• Private Sector Employment Picture Is Shrinking by Tom Lindmark
• Federal Rescue: Unthinkable Trillions by Kurt Brouwer
• Paul Krugman, Please Call Ben on This 'Printing Money' Thing by Todd Sullivan
• The U.S. Housing Market's Very Sobering News by Todd Sullivan
• California Housing's Less Bad Bad News by Tim Plaehn
• Bernanke Has Lost Control by Karl Denninger
• New Home Sales Flat, Delinquencies Surge by Tim Iacono
• China Warns U.S. About Debt Monetization (WSJ) by The Daily Bail
• Mr. Geithner Goes to China by The Baseline Scenario
• Why Is Oil Creeping Back Up? by IPE at UNC
• Dollar's Weakness, Confirmed by Duru
• Dangers of a Dollar Collapse by Donald Ingram
• GM Bankruptcy: Cheaper Just to Start from Scratch? by BlindReason
• Rising Interest Rates Signal 'Hyperinflationary Depression' by Jeff Nielson
• The Economic Trifecta: Inflation, Devaluation, High Interest by Steven Hansen
• Obama (Should Say) to California: Drop Dead by Peter Schiff

Unemployment Probably Topped 9% in May: U.S. Economy Preview

• Bloomberg
• 05/31/2009 05:36 AM

Has economic twilight fallen on nation's Sun Belt?

• AP
• 05/30/2009 04:24 PM

California Scrambles Again to Avoid Cash Crunch

• CNBC
• 05/30/2009 05:29 AM

Geithner wields little leverage in China talks

• AP
• 05/30/2009 05:20 AM

Zoellick Warns Stimulus ‘Sugar High’ Won’t Stem Unemployment

• Bloomberg
• 05/30/2009 05:18 AM

Antiques dealers lament sales slowdown

• AP
• 05/30/2009 05:27 AM

Attention, Economic Optimists: Not So Fast - Donald Luskin, SmartMoney
The Next Crisis Has Already Begun - Bill Fleckenstein, MSN Money
Cutting Costs by Slashing Salaries, not Jobs - Jena McGregor, BusinessWeek
Obama Owns an Auto Company. What Now? - Jerry Hirsch, LA Times
Bureaucrats in Driver's Seat at Government Motors - Alex Taylor, Fortune
U.S. Hopes To Recoup GM Outlay In 5 Years - Peter Whoriskey, Wash Post

Stocks Trading 22 Times Earnings, Recession Getting Worse Stock markets continue a clearly unsustainable rally that runs on pure speculation and it cannot last. In a horrible, jobless, recession-plagued economy, the stock market...

Bad, and worse
to come
If the US money supply can double in one year, why can't it quadruple in one more year? And if the unemployment rate, measured the old-fashioned way, is about 20%, why should it stop there? And if you haven't already bought gold and silver, why should those that have care for your suffering now???

CREDIT BUBBLE BULLETIN
US core no longer the magnet
The era in which inflationary bias directed cash to the US credit system and securities markets, providing extraordinary latitude to the US Federal Reserve, has now reversed. Today, the bias directs cash flows away from the US core out to the periphery - that is, to China and other emerging markets.
Doug Noland looks at the previous week's events each Monday.

FROM THE BLOG
No help from there
The World Bank warned of a possible US$700 billion reversal out of emerging markets to finance the US Treasury's requirements. No such thing will happen. - David Goldman

<h3 class="h3-home"></h3> The Downturnaround Is Here - Hugo Lindgren, New York Magazine
Boom Times Are Back, Outside the U.S. - Fareed Zakaria, Newsweek
Say It Ain't So, Larry Summers - Irwin Stelzer, The Weekly Standard

The Next Crisis Has Already Begun
- Bill Fleckenstein, MSN Money
Attention, Economic Optimists: Not So Fast
- Donald Luskin, SmartMoney
Obama Drives the Bond Market into the Ground
- James Glassman, NYT
The Rise and Fall of the Summer Home
- Daniel Gross, Slate

• Trade War: Have We Dodged the Great Depression II? by Old Trader
• California and Florida Housing Outlook: More Hope for Recovery in 2010 by Ira Artman

• 'A Demon of Our Own Design' Advocates Simpler Financial Instruments, Less Leverage by Isam Laroui
• U.S. Dollar Now in a Downward Slope Compared to Euro by George Kesarios
• 'The Fourth Turning': Why This Crisis Was Inevitable by Brett Owens
• Why Is California in Economic Trouble? by Eric Falkenstein

Just another bailout where the taxpayer is burdened beyond the ability to cope.

FDIC Fund Running Dry
By: Dirk van Dijk, CFA
May 27, 2009

We highlight JP Morgan Chase & Co., Inc. (JPM - Snapshot Report), BankUnited Financial Corp. (BKUNA - Snapshot Report), Wells Fargo & Co. (WFC - Analyst Report) and Bank of America Corp. (BAC -Snapshot Report).

As the FDIC has had to step in to take over more and more insolvent banks, the fund has dwindled to dangerously low levels. At the same time, the number of problem banks continues to grow at a rapid pace.

At the end of the first quarter there were 305 “problem institutions” with a total of $220.0 billion in assets, up from 252 institutions and $159.4 billion in assets at the end of 2008. At the end of the quarter, the Deposit insurance fund was at just $13.0 billion, or 0.27% of insured deposits, a decline of 24.7% in the quarter alone.

The first graph (from http://www.calculatedriskblog.com/) shows the steep drop in the coverage ratio. Just a year ago, the fund was equal to 1.01% of covered deposits. The current level is its lowest since the first quarter of 1993, when we were digging out from the S&L fiasco.

However, don’t worry about losing the money in your checking account if your bank goes under. Congress has already approved a $500 billion line of credit to the FDIC. Without a doubt, that line of credit is going to have to be tapped. This does emphasize the insanity of having the FDIC provide the guarantees for the PPIP [Public-Private Investment Program]. The fund simply does not have the resources available to do it. The money for the inevitable large losses that the fund will take on the program will come from that line of credit.

More…

Chinese economists deem huge holding of US bonds “risky,” split on way out
2009-05-31 15:31:57

BEIJING, May 31 (Xinhua) — On the first day of U.S. treasury secretary Timothy Geithner’s visit to China, the Beijing-based Global Times published a survey of 23 famous Chinese economists on Sunday, saying that the majority of them deemed the vast holding of U.S. bonds “risky.”

Among the 23 experts polled, 17 said they believed that U.S. equities pose great risks to China’s economy.

eithner will begin his first visit to Beijing as US treasury secretary in an attempt to assure the U.S.’ biggest creditor that its large holding of purchased US bonds is safe.

The visit also highlights Geithner’s comments made earlier this year alleging that China has manipulated its currency.

Li Wei, an expert with the Institute of Ministry of Commerce, and Tian Yun, a scholar at the China Macro Economics Institute, expressed concerns over the risks, saying that the United States may export its deepening crisis to China “by printing U.S. dollar notes uncontrollably.”

More…

From The Business Insider, June 1, 2009:

In its own inimitable language, S&P warned last week that a debt-to-GDP ratio of 100% is "incompatible with" a Triple A rating. What it meant is that the United States is rushing headlong toward a ratings downgrade--and, in the opinion of some, disaster.

In a much-discussed piece in the FT this week, John Taylor echoed many others in clanging the alarm bells.

Under President Barack Obama’s budget plan, the federal debt...is rising – and will continue to rise – much faster than gross domestic product, a measure of America’s ability to service it. The federal debt was equivalent to 41 per cent of GDP at the end of 2008; the Congressional Budget Office projects it will increase to 82 per cent of GDP in 10 years. With no change in policy, it could hit 100 per cent of GDP in just another five years...

I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis.

To understand the size of the risk, take a look at the numbers that Standard and Poor’s considers....

Click "more" to view the full post.

See also from The Business Insider:
Brace For Hyperinflation
Brace For Hyperinflation 2
Brace For Hyperinflation 3

» More

The Economic Crisis in Australia- by Peter Murray - 2009-06-01
Grand Theft Auto: The Bankruptcy of General Motors- by Greg Palast - 2009-06-01
We Can't Break Up the Financial Giants . . . Or Can We? - 2009-06-01

Your Share of the US Debt By Bill Bonner

06/01/09 London, England Bonds down. Gold up $17.

Someone seems to think there is a whiff of inflation in the air.

Sniff…sniff….

We're not so sure. It seems too early to us.

But we're not even going to think about it. Today, we've got to make tracks. We're traveling.

In light of our voyage we're turning today's essay over to guest host Ian Mathias, of Agora Financial's 5 Min. Forecast. He'll take over from here…

Your family's share of the government debt is now over half a million dollars. A record $546,668, to be exact.

That cheery Monday stat comes courtesy of a USA Today study, which claims that each American family's share rose 12% in 2008. That's $55,000 in new government debt last year for every US household – thousands more than the median household annual income. Here's how it breaks down:



Last year's spike is the biggest since the Medicare prescription drug benefit was added in 2003. According to the rag, the government garnered $6.8 trillion in "new obligations" in 2008, bringing the total US tab to $63.8 trillion. Given our spending record so far in 2009, it's safe to say your family's burden is already much, much larger.

And you ain't seen nothin' yet… the Social Security program will grow by 1-2 million beneficiaries every year until 2032 as baby boomers retire. Medicare will add just as many each year starting in 2011, when that same demographic starts…Read more…

Tales from a Bankrupt Economy By Bill Bonner | London, England | 05/29/09 "Pssst…hey kid… You, in the red robe… "You're just graduating from college, right? "You wanna make some real money? "Then, rush to Detroit. Set up a law firm specializing in bankruptcy." (More of our advice to college graduates can be found here.) Two auto-parts suppliers have already filed under Chapter 11. GM is expected to do so momentarily. Too bad about…Read more…

Dollar Fails Crucial Test By Addison Wiggin | Baltimore, Maryland | 05/11/09 The U.S. dollar failed an important technical test recently. Roll the videotape: "This move has really lit a fire under the dollar bears," says Chuck Butler. "Many institutional investors use the dollar index as their means of trading the dollar. And to see it fall through its 200-day moving average was enough proof for them that…Read more…

The Dangers of an Exploding Money Supply By The Mogambo Guru

06/01/09 Tampa Bay, Florida With all the trillions of dollars of new money being deficit-spent by the federal government, not the least of which is the mind-boggling $1.84 trillion in new deficit-spending that the Obama administration and Congress have conspired to enact and spend This Freaking Year (TFY), it is at least amusing to know that we taxpayers are paying taxes for nothing! Hahaha! Paying taxes for nothing!

Now, there are many definitions of nothing, most of them referring directly to me, as in "you are nothing as a husband, father, employee, neighbor, citizen or even a pale resemblance to a normal human being," but in this particular case I am referring to all of the federal personal income taxes paid last year, net of refunds.

And how much personal federal income taxes were collected last year? Only about $700 billion dollars! And total corporate net federal income taxes paid was a paltry $171 billion! Hahaha!

"Yet," I say with scorn and contempt, "here is the government spending almost four times as much as that, combined, while we working bozos still have to pay taxes (and, for some, more taxes)! I want to know why? Why?"

I get this data from the Treasury's "Monthly Treasury Statement of Receipts and Outlays of the United States Government For Fiscal Year 2009 Through April 30, 2009, and Other Periods," sent to me by Junior Mogambo Ranger (JMR) J. Scott N.

Also from it we learn that, to this point in the fiscal 2009 year, which started in October 2008 and ends in October 2009, the federal government is already showing a deficit…Read more…

From Richard Russell's Dow Theory Comment

June 1, 2009 -- It's a basic tenet of Dow Theory that the primary trend of the market and of business cannot be manipulated. I've long thought about this basic thesis, and I've wondered how it would fit into what the Bernanke Fed and the Geithner Treasury are doing. Clearly, these two are attempting to halt the primary bear trend while reversing it to the bull side. I don't believe they will be successful in manipulating the primary trend.

In a desperate attempt to turn the tide, these two have created trillions of dollars in new debt. Further, they have cast doubt on the viability of the dollar -- how will the new trillions of debt ever be paid off except by reneging on our debt (unthinkable) or by inflation and a devaluation of the dollar (more likely)? But how do we devalue the dollar? To devalue the dollar it will be necessary for the dollar to decline relative to the major currencies. If the dollar is being devalued, we'll see it in a decline in the Dollar Index or we'll see it in a rising dollar price of gold.

The US Dollar Index (USDX) is an index or measure of the value of the United States dollar relative to a basket of foreign currencies. It is a weighted geometric mean of the dollar's value compared to the euro (EUR), Japanese yen (JPY), Pound sterling (GBP), Canadian dollar (CAD), Swedish krona (SEK) and Swiss franc (CHF).

When I first started writing these reports, most of our debt was owned by the US and its investors. In those days it was said, "Debt is not a problem, we simply owe it to ourselves." But that's not true any more. Today most of the US debt is owned by foreign creditors, the leading creditor of which is China.

Now when the debt becomes too ridiculously large or when the dollar (in which our debt is denominated) declines, our foreign creditors become frightened. China, which owns over $750 billion of US Treasuries, has been issuing warnings to the effect that it is worried about the dollar and that it would prefer a "different" currency, one that is not a product of one specific nation (see article below).

The big question in my mind now is -- will the Fed and the Treasury be successful in doing what the Dow Theory states can not be done -- that is, halting or reversing the primary trend of the market and business?

Personally, I believe we would have been wise to step back and allow the bear market to fully express itself without government interference. That would have been painful, but the result of creating and spending trillions of dollars in an attempt to defeat the bear may ultimately be more harmful than a full-fledged bear market -- and more dangerous.

GM News by CalculatedRisk on 6/01/2009 09:30:00 PM

Just some excerpts ...

From the WSJ: Filings Reveal Depth of Problems

General Motors Corp.'s $82.2 billion in assets and $172 billion in liabilities spell out the extent of its problems and sheer breadth of the 101-year-old giant's bankruptcy.

In a torrent of filings at the U.S. Bankruptcy Court in Manhattan, GM's mind-numbing scale is evident: It has 463 subsidiaries and has built 450 million cars and trucks over the years. It employs 235,000 people worldwide. This includes 91,000 in the United States, which it pays $476 million each month, and 493,000 retirees with various benefits. It spends $50 billion a year buying parts and services from 11,500 vendors in North America.

More details from Bloomberg: GM Files Bankruptcy to Spin Off More Competitive Firm

From the WSJ: GM to Announce Tentative Hummer Sale

General Motors Corp., fresh off filing for bankruptcy protection Monday, will start its second day of court proceedings by announcing the tentative sale of the Hummer brand ...

Auto sales for May will be announced tomorrow. The bankruptcy of Chrysler - and now GM - will probably depress auto sales further for a few months, although probably not by much.

News of Economic Recovery Warrants Skepticism

Market prognosticators who claim that an economic recovery is at hand have probably have it all wrong. This shouldn't be surprising. According to Independent Institute Research Fellow Dominick Armentano, most of the economists and stock-market analysts who say the economy is recovering were caught off guard when the housing market collapsed, taking many financial institutions and other sectors of the economy.

Armentano cites two reasons to be skeptical about recent reports of recovery. First, the federal government's massive infusion of liquidity into the financial system is creating a new round of unsustainable investment, just as the unsustainable housing boom itself was created by the Federal Reserve's earlier expansion of credit. Second, recent massive increases in federal spending will eventually drive up interest rates. In other words, both monetary and fiscal policies are laying the foundation for more economic trouble ahead.

"A sustainable economic recovery requires that the credit-dependent industries (housing, autos, construction) and their suppliers shrink back to levels of production that are consistent with current incomes and current levels of savings," writes Armentano. "All of this is painful but necessary. And any government attempt to make (consumer) credit more available through bailouts, subsidies and regulations is counterproductive to any real recovery."

"Economic Recovery? Not So Fast," by Domick Armentano (5/26/09)

"The Contradictions of Secretary Geithner," by D. W. MacKenzie (5/20/09)

"Anatomy of a Train Wreck: Causes of the Mortgage Meltdown," by Stan J. Liebowitz (10/3/08)

Americas: Money Sent Home by Mexican Workers in U.S. Falls
Sharply
By ELISABETH MALKIN
The central bank says job losses in construction and other
industries have put migrants' payments in a tailspin.

Full Story:
http://www.nytimes.com/2009/06/02/world/am...amp;tntemail1=y

China

• 6 Challenges for Qualcomm's Zeebo in China by David Wolf
• China to U.S.: Show Us the Math by Kurt Brouwer
• Multiple Warning Shots from China by Plan B Economics
• Liquidity Is Working... At Least in China by Dr. Stephen Leeb
• Telling China to Stop Buying Dollars Now Would Be a Foolish Idea by Jeffrey Frankel
• WSP Holdings: A Favorable Risk / Reward Opportunity by North Fork Investors
• Is Obama Selling Military Secrets to China for Debt Forgiveness? by Tyler Durden
• China's Statements About U.S. Debt Are Overblown by BlindReason
• China's Arithmetic When It Comes to the Dollar by Research Edge
• Geithner to Get a Spanking in China by Ron Rowland
• China, Don't Believe Turbo Tax Tim by Karl Denninger
• Geithner's Obeisance to Chinese Officials Reveals U.S. Weakness by The Baseline Scenario

The Big Collapse Could Be Very Near - by Robert Wenzel - 2009-06-02

Greetings from RGE Monitor!

Today we look at some of the geostrategic risks to the global economy. Recent events, including a North Korean missile test and signs of a deteriorating situation in Pakistan, did little to shatter the ongoing asset market reflation. The zero interest rate policy adopted by most central banks and signs that the chance of a near depression has lessened, buoyed world markets generally and emerging markets in particular. Even a near doubling of oil prices since mid-March seems to be pegged more to inflationary fears and a renewed search for yield than political risk. However, in the near term, the geostrategic risks are mounting and the new U.S. administration is being faced with critical challenges. It has become increasingly clear the U.S. must contend with the national interests of other players wielding vetos –or at least the ability to create significant problems for Washington--in areas and issues where American power and diplomacy once held sway. The financial crisis might actually accelerate this challenge to U.S. global leadership as it calls into question the financial and economic growth model and limits the fiscal resources to meet all of Washington’s policy goals.

Shifting Strategy

The Obama administration entered office pledging to abandon Bush administration policies which had sought to quarantine so-called “rogue actors” in order to influence their behavior. Instead, the Obama team has launched a self-described “smart power” campaign aimed at engaging states like Iran, North Korea, Syria, Cuba and Venezuela, while improving relations with countries like Russia and taking a more multilateral approach to key global issues like climate change and the global financial crisis. It is far too soon to assess the success of such policies, but four months of extending his hand to U.S. rivals has paid no tangible dividend to date, yet has underscored the challenges inherent in relying on abstract theories in the real world.

The U.S. government’s deteriorating fiscal position will have medium- and long-term effects on its geostrategic posture, with defense spending the most visible example. While few changes can be made in the short-term given the lead time of military appropriations, in the long-term the administration has called for cuts in major weapons procurement and a reorientation in strategy toward non-state threats and counterinsurgency. Under the Bush administration, the military budget grew at 8% annually on average; Obama’s proposal would decrease the growth rate to 4% next year and seeks further reductions in the future (even after absorbing the ongoing costs of the war in Afghanistan and Iraq, which to date had been funded with off-budget supplementary appropriations). Beyond cost control, the budget shows a strategic shift from conventional warfare and big-ticket weapons purchases to irregular warfare and upgrading existing technologies. The budget focuses relatively more on outfitting the military for the wars it is currently fighting in Afghanistan and Iraq, and less on planning for the day when a “peer competitor” emerges. Still, irregular warfare accounts for only 10% of the proposed FY 2010 budget.

Asian Arms Race?

This shift away from “hard” power resources toward a more flexible “smart” power-focused military is likely to benefit the U.S.-led campaigns in Iraq and Afghanistan, smooth cooperation with Russia, and reduce the impact of Venezuela’s rhetoric in Latin America. However, it may serve to accelerate the arms buildup in Asia, where a relative decline in U.S. power and its role as the region’s guarantor of stability will continue.

In fact, Asian defense spending is increasing even with the current fiscal pressures. China announced a 14.9% increase in military spending this year, with a focus on expanding its navy. In a white paper released earlier this year, the People’s Liberation Army announced a shift in strategic focus to a more global role for the Chinese military, and for the first time has dispatched a naval force abroad to join a UN flotilla off the pirate-infested coast of Somalia. Australia’s defense department , ever wary of changes in China’s military strategy, announced a shift of its own, proposing new warship programs to prepare for the day when the U.S. will not be the sole dominant military power in Asia. India and South Korea are also expanding their navies, and Japan, to date second to the powerful U.S. Seventh Fleet in the region, may follow. Meanwhile, North Korea’s nuclear test and missile launches will only add to the pressures on Japan and South Korea to expand their militaries, in particular their missile defense efforts. With the region’s naval expansion, the Pacific and Indian oceans will grow more crowded in future years, which could spark a conflict—accidental or not. Military-to-military cooperation failed to prevent several incidents between the Chinese and U.S. navies earlier this year.

U.S. ties with China have focused primarily on economic not political issues. China is now the largest of the U.S. creditors and its willingness to absorb U.S. treasuries could be key to the success of the U.S. fiscal stimulus and banking sector rescues. Despite Chinese officials' public worries about the long-term value extensive U.S. dollar holdings, in 2009, China has continued to buy U.S. treasury bonds and bills. Given that hot money outflows may have ebbed, China may now be buying significant U.S. assets again, particularly as the renminbi is sinking along with the dollar. Yet China is clearly diversifying its assets on the margins, investing in strategic resources and allowing the renminbi to be used outside of China, steps that could limit its demand for U.S. assets in the long-term. No wonder Treasury Secretary Geithner faced questions about the U.S. fiscal deficit reduction plan in Beijing this week. Such issues will no doubt re-emerge at the summer meeting of the Strategic and Economic dialogue (SAED) to be led by Secretary Geithner, Secretary of State Clinton and their Chinese counterparts respectively. In a whole range of issues ranging from the management of economic imbalances, nuclear proliferation and climate change, China wields significant leverage. However Chinese officials vary in their views about the country’s global role.

The North Korean Gauntlet

North Korea’s missile test and erratic behavior since the rumored stroke of its leader pushed it onto the frontburner. Since 2003, the U.S has engaged North Korea through a series of negotiations and sanction under the guise of the Six Party Talks in corporation with South Korea, Japan, Russia, and China. However, attempts to convince North Korea to denuclearize in exchange for food and fuel have failed to date, leaving the U.S. in a strange predicament as the President vowed to engage in sustained, direct, and aggressive diplomacy with the state.

North Korea’s economy remains weak and vulnerable to shifts in external aid and trade flows from South Korea and especially China, which accounted for 75% of North Korea’s external trade in 2008. China may not use this leverage as North Korea remains a strategic buffer between the American troops based in South Korea and China, and Beijing and South Korea both fear a flood of North Korean refugees following an economic collapse. However, China could once again support targeted sanctions on the North Korean regime. Additionally the relationship between the Koreas is deteriorating.

Given President Obama’s recent global call to rid the world of nuclear weapons, his policy on North Korea will serve as true test on how the U.S will deal with recalcitrant states.

Iran and Its Discontents

Iran has been somewhat wary of starting direct communication, at least until after the imminent presidential elections. With economic woes, including still high inflation, rising unemployment and lower government resources, President Ahmadinejad may emphasize foreign policy concerns to trump domestic opposition. In fact the most recent missile test was announced in the midst of campaign season. In addition to its nuclear development plans, Iran’s influence and funding of militant groups in the Middle East, means that its role as a regional veto player should not be ignored. Despite the drop in oil revenue (and Iran did not save as much as GCC countries), Iran continues to issue inflammatory threats aimed at Israel, and it maintains influence over Hamas, Hezbollah and some groups in Iraq that gives it significant leverage, , particularly as the U.S. withdraws from Iraq.

The risks of a military conflict involving Iran are not negligible, as Israeli officials frequently make clear in private conversation. Any conflict could lead to an oil price spike given that it could reduce not only Iranian supplies but also supplies from the GCC that transit through the Strait of Hormuz, one of the most significant chokepoints in the global energy market. However, the risks of an Iranian oil weapon (withholding oil supply from global markets to meet policy aims) may be overstated given Iran’s need for the foreign exchange from its oil exports to Asia. Iran has reportedly had one of the lowest compliance rates among OPEC members despite its hawkish talk. Moreover blocking the straits for more than a short period of time could be very difficult. With global oil inventories at a high and Saudi Arabian surplus capacity at twice their 2008 averages, a sustained supply shock may be unlikely, however, the short-term response could be quite significant.

Iraq and ‘Af-Pak’

The U.S. is in the process of drawing down its military presence in Iraq, even as the security outlook remains uncertain. Planned elections have already been deferred to the fall and the lower oil price has led to budget cuts including long-delayed reconstruction, all factors adding to the strains on Iraq’s political and security institutions. Pulling off the withdrawal by the end of 2010 would fulfill a major Obama campaign promise but Iran could benefit from any ensuing vacuum. Meanwhile, the oil investment regime remains fragmented, with the legal status of deals in Iraqi Kurdistan still pending approval by the federal government.

Even as the U.S. draws down in Iraq, it may be settling in for a long stay in Afghanistan and security threats in Pakistan are on the rise. Despite U.S. economic assistance, Pakistan continues to be marred by more violence including attacks on economic hubs. This growing instability in Pakistan calls into question the security of its nuclear arsenal, already a source of nuclear proliferation and a major concern of American security officials. Pakistan is one of the four sovereign states that has not signed the Nuclear Nonproliferation Treaty (NPT) and is completing construction of several new reactors and seeking to purchase inputs from China to expand its arsenal.

A ‘Dialogue’ with the Muslim World

President Obama travels in the Middle East this week, making a highly anticipated speech in Cairo on June 4, the next step in the administration’s outreach to Arab and Muslim countries. Deepening his role in the Middle East process, President Obama supports the creation of a Palestinian state alongside Israel as the best way to establish peace in the region, a plan that is likely to meet a number of challenges. A newly formed Israeli right-wing coalition government led by Benjamin Netanyahu has avoided committing to a two-state solution and has shown little readiness to halt the settlement expansion on the West Bank, one of the key requests made by Washington. Moreover, the Israeli leadership insists there can be no progress on the Israeli-Palestinian issue until the threat posed by Iran’s nuclear program has been resolved. Palestinian internal rifts, meanwhile, continue to bedevil efforts to create a coherent negotiating strategy. The Palestinians remain deeply divided between the moderate Fatah, which t controls the West Bank, and the Western-shunned militant Hamas which controls the Gaza Strip and rejects the Israel’s right to exist.

Brokering the successful peace deal requires reaching consensus among the parties on the two-state solution and more importantly, on the actual borders. A regional approach might include reaching out to Syria, which has been pursuing talks with Israel on the Golan Heights through Turkish mediation. But upcoming elections in Lebanon and the likely victory of Hezbollah, a Shiite political movement aided by Syria and Iran, will provide another test for the Obama administration’s ‘smart power’ policy in the region.

Gulf Oil Powers

Another planned stop on the president’s itinerary, in Saudi Arabia, will place energy security and stability of oil supplies on the agenda. Saudi Arabia, as OPEC’s largest oil producer and the only country with significant spare capacity, is one of the few swing players in the energy markets. Moreover, Saudi Arabia is a member of the G20 and might play a role in supporting the IMF by purchasing its bonds. Furthermore, as oil prices climb, Saudi Arabia could again add to its purchases of U.S. securities. The dollar maintains a disproportionate share of Saudi Arabia’s foreign asset accumulation, as it does in the reserves, if not the sovereign wealth funds, of other gulf states. However, it would take a significant oil price spike, well above $80 a barrel for the Kingdom to begin saving at a significant pace especially since its spending has risen at a sharp pace in recent years

The Gulf states have long been under the U.S. military umbrella, housing bases and providing a key market for U.S. military contractors. The U.S.-UAE nuclear cooperation deal is a major step. The deal, recently approved by the President and now waiting out a 90 period when congress could object, could provide a blueprint for other such deals and provide opportunities for U.S. companies but detractors worry it could set off a regional arms race.

Greening America’s Image

Climate change is a major priority and the new members of Obama’s energy team have focused on increasing energy efficiency and the share of alternative fuels in the energy mix. It has introduced a number of policies in recent months, laying the groundwork for the upcoming climate change summit in Copenhagen. President Obama unveiled a new auto efficiency program which hopes to reduce oil consumption by 1.8 billion barrels by 2016. Most importantly it aims to create a national standard rather than a patchwork of state-level standards Meanwhile The American Clean Energy and Security bill (introduced in the House by Democratic Reps. Waxman and Markey) aims to increase the use of renewable energy by utilities. While some opine that it combines standards and incentives for rapidly deploying clean energy and energy efficiency technologies with firm economy-wide limits on the carbon pollution that is driving global warming, others worry about the economic costs especially given the U.S. recession.

Many of these changes are back-loaded, with the significant changes coming many years in the future. Moreover, the hopes for a comprehensive global climate change regime to replace Kyoto this year may be a bit optimistic, particularly given that many emerging market economies, including China, are wary of making cuts. China has been introducing policies trying to reduce its energy consumption (and energy imports), however, it argues that the consumers of its goods should bear part of the cost for the emissions that went into producing them. Getting other emerging economies like Russia and India on board may also be difficult.

Wooing Old Foes

After years of frosty relations during the Bush era, the new U.S. administration has showed willingness to repair ties with Russia that hit a new post- Cold War low following the August war with Georgia. While cutting nuclear weapons seems as the most promising topic for reaching an agreement ahead of the Obama-Medvedev summit in July, Moscow’s insistence on its “privileged sphere of influence” in the former Soviet space will continue to hamper efforts to repair ties between the two countries. Even though NATO leaders deferred the alliance’s eastward expansion at the April summit, Moscow was infuriated by the recent NATO maneuvers in Georgia. Obama has been lukewarm on the U.S. missile defense bases in Eastern Europe, a project proposed by the Bush administration and deeply opposed by Moscow. Yet, the plan is still not off the table and competing influences in the former Soviet countries may keep souring Russia-West relations, not the least because most of these countries are critical for the EU’s energy security. The January gas war between Russia and Ukraine, Russia’s success in having Kyrgyzstan eject a vital American airbase in Central Asia, and the recent spate of political unrest in Moldova and Georgia provided a sharp reminder of Moscow’s clout in the region.

The Obama administration made steps to improve its relations with Cuba. The island’s communist government agreed to restart talks with the U.S. on immigration, following the Washington’s decision in April to relax sanctions and lift restrictions on travel and remittances. The move signals the reversal of the Bush administration’s hard line policies that failed to undermine the Castro rule. However, it remains to be seen how far such talks will advance, particularly as both China and Russia have been increasing their investments in the country. However, the rapprochement also hailed by the Latin American leaders who met with Obama at the April summit in Trinidad and Tobago and could be a sign of improving ties with Latin America, a region in which China has been increasingly involved in trade, investment and loan granting.

• Auto Bankruptcies: Consequences of Political Interests by Ravi Nagarajan
• U.S. Dollar: Which Interest Rate Is Key? by Marc Chandler
• A Rally of Historic Proportions by Dr. Stephen Leeb
• Is the Treasury Driving the Dollar's Fall? by Joseph Trevisani
• How the SEC Coddled Corporate Wrongdoing by Gary Weiss

• Baltic Dry Index Advances 24 Straight Days in a Row by Mark J. Perry
• High Housing Affordability, Low Mortgage Rates Boost Pending Real Estate Sales by Mark J. Perry
• The Sad Truth About Housing Data by Jeff Miller
• Eats Green Shoots and Leaves by Chris Cook
• Bernanke 'Puzzled' by Collapse of Bond Bubble by Jeff Nielson

• Geithner Smart Not to Confront Chinese Yet About U.S. Borrowing Needs by BlindReason
• As Goes GM, So Goes the Country by John Browne

Is the U.S. Dollar at Risk of Being Replaced? by Clive Corcoran

Still dreaming
big in Macau
The US$2.1 billion City of Dreams hotel-casino complex opened in Macau this week, its owners, two sons of billionaires, taking a second bet they can get richer yet from gambling even as Macau's visitor arrivals and gaming revenue decline. This could be a financial nightmare. - Muhammad Cohen

Dollar's fate written in history
Investors have plenty of recent examples, from Russia to Argentina, Thailand to Brazil, if they want to chart how the United States will likely emerge from this crisis. The result is far from comforting if you harbor US dollars. - John Lee

China needs no sales pitch
Chinese leaders know very well the state of the Chinese, the US and the world economies; they don't need a sales pitch on buying US debt. So what's the purpose of US Treasury Secretary Timothy Geithner's trip to Beijing?- Axel Merk

IMF gains illusory strength
As the financial crisis reached global and historic proportions last year, many commentators identified the International Monetary Fund as the debacle's great winner. Yet in reality there is little to suggest a sense of renewed faith in the institution by its main shareholders, let alone by the borrowers.

CREDIT BUBBLE BULLETIN
US core no longer the magnet
The era in which inflationary bias directed cash to the US credit system and securities markets, providing extraordinary latitude to the US Federal Reserve, has now reversed. Today, the bias directs cash flows away from the US core out to the periphery - that is, to China and other emerging markets. (Jun 1,'09)