The Broken Cycle Part 3: Spinning Gears

by Jim Willie, CB. Editor, Hat Trick Letter. January 30, 2004

The business cycle is the centerpiece topic among economic discussion, as is the radical stimulus to kick it into gear. Popular expectations are linked closely to events unfolding in a prescribed manner, according to the past cycles. Regrettably, stimulus has led to every imbalance becoming more dangerously out of kilter. This cycle is not producing the expected outcomes during the recovery. While nothing is similar with past cycles, expectations remain firmly held according "to the business cycle." However, the business cycle has been severely altered by globalization, by debt burdens, by foreign dependence, and by technology itself. This is not your father's business cycle anymore.

The debt-ridden economy is proving to be highly inefficient in generating new business, as it devours new credit and spins its credit gears in a demonstration of futility. The shrinking real economy is supplanted by metastasized speculative and financial encroachment. The US Economy does provide growth to the world economy, but at a price. Growth is powered by new debt, in large part as obligations held outside our shores. Our leaders regard huge trade gaps and even larger (when accounted for) federal deficits as not warranting any inherent alarm. Signals are altered in order to avoid alarm, even as leaders cling to heretical notions. Banking and govt leaders suffer from stripped mental gears. Something ugly this way comes.

STOCKS TO PROFIT IN CURRENT ENVIRONMENT:

Athlone Minerals Ltd C$1.58 (ATH.V in Canada, ALMLF for US equivalent) Legendary David Smith leads exploration and development of oil & gas in western Canada

*** Dr Richard Appel's top pick for year 2004 (see details)

Cardero Resource C$2.68 (CDU.V in Canada, CUEAF for US equivalent) Copper/gold (IOCG) in Mexico and Peru, silver in Argentina

Cassidy Gold C$1.02 (CDY.V in Canada, CSYGF for US equivalent)

Narrow high grade zones and broad consistent lower grade zones in Guinea, West Africa

International Barytex C$1.33 (IBX.V in Canada, IBYXF for US equivalent)

Zinc/ tin in China, led by CEO Chairman Roman Shklanka

Kenrich-Eskay Mining C$0.81 (KRE.V in Canada, KREKF for US equivalent)

British Columbia mining claims have the potential of hosting Eskay Creek types of transitional mineralization for gold, silver, copper, lead & zinc

New Bullet Group C$0.46 (NBG.V in Canada, NBULF for US equivalent)

John Andrews, formerly of Stillwater, has gold projects in Brazil, and a silver project in Mexico

Palladon Ventures C$0.68 (PLL.V in Canada, PLLVF for US equivalent)

Four gold projects in Argentina, and an agreement to mineral rights in a Utah copper district

Taseko Mines C$2.05 (TKO.V in Canada, TKOCF for US equivalent)

Canada's largest copper mine, plus substantial gold holdings

SPINNING THE CREDIT GEARS:

In the midst of historic imbalances, current reflation efforts are yielding distorted, if not grotesque, results. With debts continuing to default, both in business (at subsided levels) and among households (at record levels), new money creation is necessary to offset the unfortunate debt destruction and retirement. New money infusions counter the burned capital. With disproportionate emphasis on retail consumption, against a backdrop of extreme trade gap continuation, spending is supported by new debts. What masquerades as real capital, tends to flow directly into foreign coffers in Asia, where the products we buy are made. There it is converted from trade surpluses into high-powered money in the banking systems. Why is this so confounding? The Chinese trade surplus growth rate has for some time equaled the rate of increase in US household credit growth.

With US corporate competitiveness shackled by high tax burdens, huge debt burdens, lofty labor costs, heavy health care costs, and a grossly overvalued USDollar, new business investment tends to be installed in Asia and the Third World. Ingenious technology enables the outsourcing. Few opportunities are being risked inside the United States, or rather if they are risked, the scale is dwarfed by activity all across Asia. Most new capital spending is for information systems, prompted by lenient but temporary depreciation tax schedules. Time will tell if those schedules are made a permanent part of the landscape, as is most other intervention. Domestic expansion is confined to protected industries such as health care, direct personal services, real estate, and finance generally. The strong stimulus is not benefiting sites as much within our borders as in the past. Anything transportable that can be outsourced, is being outsourced. For the most part, the American worker is left out in the cold during this deranged recovery process. This is not your father's business cycle anymore.

One could accurately conclude that accommodative Federal Reserve monetary policy, in conjunction with loose fiscal actions, is building the next Asian powerhouse, namely China. This is far more than leakage of jobs. Complementing capital bloodletting in the financial market is the pure rupture taking place in the labor market. The mfg capacity utilization rate, stubbornly stuck at 75% for many quarters across US plants, confirms the misdirected reflation benefits and the ongoing labor rupture. The nourishment and erection of China is the great unintended consequence of our nation's response to the great stock bust in 2000 and the recession in 2001. While building new much more magnificent unstable bubble structures, the Fed has exposed our financial and economic system's vulnerability not only to job leakage, but to debt suffocation, to capital hemorrhage, and worse. Only Asia has benefited. Before long, however, China will be coerced into either slowing their credit and mfg capacity growth, or diverting capital export for domestic usage by their expanding middle class. I regard that to be the tipping point, certain to challenge our weak and highly fractured economic recovery in the current year. The next battle will be waged in the US Treasury Bond market.

The new indoctrination in economic language has been subliminal in nature, and effective in keeping our citizens unaware of the risk from debt generally. We applaud the arrival and availability of "liquidity" as though it is beneficial. Those who avail themselves of such liquidity typically engage in speculation, or commit themselves to future obligations. Benefits are fleeting at best, and hamper advanced purchasing power. The hampered will include governments (federal, state, local), corporations (public, private, utility), and households (mortgage, credit card, cars), which are all submerged in debts and commitments. That same liquidity which facilitates today's sale renders tomorrow's purchases more improbable. In fact, a credible argument can be made that the US Economy and financial system has stolen an entire future from the next generation, in essence selling the children's future in order to pay today's bills and enjoy today's thrills. Outsized household debt burdens obstruct spenders from feeling comfortable enough to further extend obligations. Given the hefty debt burden already, new transactions require a higher proportion of credit with each passing month. The debt acceleration process festers. We see growing inefficiency for new money to generate new business activity.

In the 1950 and 1960 decades, it took $1.4 new dollars of new money and credit extension to generate $1 in new GDP. In the years 2001 and 2002, suddenly over $5 was required to generate $1 in new GDP. A flood of money entered the economy to ward off the combined ill effects of the stock bust and the World Trade Center attack. Now fully $7 in added money & credit is necessary to produce a mere $1 in new business activity. The above chart addresses the ratio of GDP to debt only, a sad picture of paralleled inefficiency. This is a shocking story, which goes totally unreported. The game becomes far more dangerous when the USGovt distributes electronic credits to bankroll unmet demand for fresh Treasury debt issuance. Such monetization has already begun in recent Fed auctions, so as to minimize any adverse impact on prevailing interest rates. Desperation will become more clear if and when $10 of new money & credit is the requirement to turn out a meager $1 in new GDP business. At risk is the USDollar itself, which I believe is to be fully sacrificed. It will tragically collapse as the gears spin to the point of seizure, exacerbated by FOREX trading volume, when the next inevitable recession arrives.

REAL ECONOMY DISTORTION & STRUCTURAL DEFORMATION:

Nowhere is the distortion from financial speculation, inflicted upon the real economy, more visible than with the automobile manufacturer General Motors, whose real identity is in transition. The entire economy is subject to intense pressure: become involved with financial engineering, or wither. Hitch a ride on the Fed-inspired inflation locomotive, or be left behind. The more diverse conglomerate General Electric has responded, and now has a strong respected and profitable financial services subsidiary. Auto makers are crucial components to a nation's labor market and entire economy. So GM is worth a dissection in its exposure. One could argue that GM is a large pension fund, merged to a large mortgage & finance corporation, with a small profitless automobile operation attached. GM has transformed itself, in response to chronic lack of profitability in the automobile business. One cannot characterize the transition as speculative, but instead as a response to induced distortion from Fed policy which has led American business astray, in search of scarce profits lying downstream from the Green Machine Printing Press, whose inflationary course of action has caused a permanently shifting landscape in which all must adapt, or die.

General Motors is an insolvent business entity, kept alive principally for the jobs it provides, failing even at that role. GM cannot compete against foreign rivals, most notably the formidable Japanese. Toyota recently surpassed Ford Motors in worldwide sales. GM relies heavily on zero rate loans, little if any deposits, with lofty cashback bribes to move inventory. When they relax on inducements, sales decline. In response, promotional inducements have become as permanent as govt financial interventions. They have been strangled by labor contracts, recently expired. Expired contracts now permit widespread plant closures, a done deal new agreement. The GM debt burden is over five times the value of the company, while their pension obligation represents 65% of that same marketcap. The company is bankrupt, losing market share to the Japanese in every recent year of operation. Yet foolish bond buyers jumped to purchase its summertime debt issuance to cover pension obligations. Perhaps they sense an eventual govt nationalization guarantee.

Next on the eroding market share back track are American large trucks. The new Nissan Titan and larger Toyota Tundra trucks are sure to cut deeply into Detroit’s heretofore sacrosanct corner lot where 8-cylinder trucks are parked. Two upcoming challenges lie on the logistic front. As the Japanese make inroads into the truck group, production mix might evolve into a real miscue. Although truck assembly plants cannot easily be converted into rolling off sedans, Detroit might find itself with a surplus of unsold large trucks. Planning and forecasting are keys to success. Furthermore, the last few years have seen an extraordinary proportion of Sport Utility Vehicle unit sales, some 45% of all sales. A serious production mix problem approaches. As gasoline prices continue to rise, in some regions over $2 per gallon, I fully expect to see both new and used SUVs lined across dealer lots, unsold and not selling. These automotive hogs run on 10-15 miles per gallon, a travesty which worsens our foreign dependence. US auto makers have failed to inculcate in the minds of drivers the hazards of SUV ownership, which surely include cost of operation, and vulnerability to higher fuel costs.

The economy's fate rides in part on the success of not only GM, Ford, and Daimler-Chrysler, but also their many vertically integrated supporting industries. Subsystem assemblies, engine components, electronic parts, communications, tires, steel, glass, plastics, paint, these all depend upon the auto industry. However, leading car maker corporations are fast moving under the financial sector umbrella. A pattern of behavior is evident. Common practices (slashing costs, closing plants, moving operations overseas) point to sheer desperation in the quest to show profit, even if it means liquidation of key businesses domestically. Survival has rung as the constant issue in an uncompetitive international environment of global trade, which is not being remedied. In this climate, decisions are made with a short-term view that might jeopardize future viability. A worthwhile exercise comes from following one of these giants on its financial trail for an eye-opening view of absurd distortions and real distress. A transformation is revealed. The real economy decomposition is in progress. This is not progress, but rather panic.

General Motors announced on 10/10/2003 their quarterly earnings and financial statement for 2003Q3. Global automobile manufacturing operations generated a paltry $34 million in profits, totally eclipsed by the $630 million earned by GMAC, their lending subsidiary. End of model year clearance sales might have been the main theme. In the key North American market, earnings fell to $128 million from $533 million last year as production and marketing costs rose. Their finance arm saw a 30% increase in profits, year over year. Meanwhile, GM's European operations lost money due to exchange rates. The corporation must incur the costs of floating a staggering $168.5 billion in debt to their operations.

GM announced on 1/20/2004 their quarterly earnings and financial statement for 2004Q1. With the benefit of new model introductions, global car mfg operations generated a more robust $396 million in profits. The critical GMAC once again carried the corporate load, with an identical $630M in earnings. In the key North American market, earnings fell to $397M from $694M last year. Hence, the rest of their world operations were a wash. Their finance subsidiary enjoyed a hefty 47% increase in profits, year over year.

A recent reaction to the vagaries of the debt distress has resulted in a re-organization of GMAC itself. The GMAC Mortgage Corp unit restructured its rapidly growing default operations into two groups. GMAC Mortgage said it separated its Default Management operations into a group to handle collections with loss mitigation, and a unit focusing on foreclosure & bankruptcy. As of the end of 2003, GMAC Mortgage had originated $112 billion in residential mortgages, representing 773,135 transactions. The company's servicing portfolio of more than $196 billion represents nearly 2 million customers nationwide. This is no "small potatoes" business, vivid evidence that the corporation can properly be classified among financial sector entities. Implied future losses in the lending unit cannot be managed into "reperforming" portfolios only to be discharged to unaware foreign investors, as is the common practice by Fanny Mae. These losses will be real, not hidden as with GSE agencies, protected from scrutiny by collectivist audit rules.

GM's pension liabilities totaled $19.3 billion in the beginning of the year 2003. Deposits from the sale of its Hughes Electronics unit offset added severance obligations coming from new United Auto Worker union contracts. The largest bond issuance in history, a $13 billion bond sale this spring, was devoted to their woefully inadequate pension fund. Officials cited with audacity a repair of their balance sheet, when in effect they merely shifted ledger entries, and offloaded risk to investors. Within the US auto maker industry, commitments have been stated to reduce manufacturing operations inside the United States, even as foreign plants are expanding. See Mexico, Brazil, Philippines, and Thailand. Eleven US plants are subject to closure by 2005. Building cars has proven unprofitable inside the United States, for a host of reasons. Pressure on the industry might continue, leading them to transform more deeply into the financial realm, for the simple reason that potential profit lies nowhere else. What began as a lending arm toward the purchase of cars, has transformed beyond all reason. Without UAW union obligations and pressures, this corporation might have shut down long ago.

If interest rates rise in the year 2004, the vulnerability of the US Economy will be exposed. The transformation, distortion, and deformation of the real economy toward one skewed to financial speculation will end up interfering with the natural business cycle. We have a car maker company here, whose transmission and differential produces arm movements across a casino table to place financial bets, rather than to power the rotation of wheels for the transportation and movement of people.

The entire US Economy is subjected to similar evolutionary forces. Who are we kidding? The process seems more like de-evolution: from building tangible end products, toward arrangement of gambling bets. With the real economy redirecting production away from building, manufacturing, and assembling, a new and entirely aberrant direction has arisen toward issuing debt, financing purchases, and underwriting mortgages. All throughout the retail sector within the economy, the phenomenon is stark. Companies are selling cars, furniture, electronic equipment, and much more without the benefit of a down payment, via 100% extended credit. Worse still, much of what we sell is built by foreign workers. Tremendous deformation has become engrained within and throughout the entire US Economy. Its real economy has been gutted over three decades. The normal business cycle is nowhere visible, as far as pentup demand and reduced debt loads are concerned. The economic recovery will simply derail while the normal business cycle fails to kick in as usual. Rising rates, when they do come, will completely knock the legs out from under the speculative Frankenstein in our midst. As the housing boom stalls, job losses will sound from numerous mortgage agencies and lending outfits. Job losses have already been reported widely among mortgage brokers.

Another critical structural misalignment exists in the new dependence relationship between consumption, a large component of the economy, and capital extraction from newly inflated assets, principally housing property. Soon, cash might be drawn on margin away from stock accounts, as a new bubble has clearly arrived. Again the Fed shows up to provide false teaching, as it labels the increased values as "wealth creation" instead of what is really is, "inflated assets." The inflation engine is the historical mainstay of the Greenspasm Fed, easy credit at low rates. Never before in US history has the economy become so dependent on preserving such a grand asset bubble. Much of the consumer apparatus depends upon levitated real estate prices. In the late 1990 decade, stock accounts were improperly regarded as labeled as "managed savings" to the delight of consumers. Investors abandoned all savings habits, and still have. Now they focus on their homes as a tradable investment, toward which John Bollinger recently implicit criticism.

The distortions and deformations are so rampant and pervasive, that citizens now accept them as the norm. They often regard changes as confirmation of progress along evolutionary lines. Quite the contrary! The US Economy is no longer recognizable, when compared to its structure in the 1950 and 1960 decades. A complete transformation has taken place, which seems to me to be an economic form of a medical disease called acromegaly, otherwise known as "Frankenstein's Disease." Our economy has been distorted to the extreme toward financial engineering, based upon no work except for mental machinations. The entire system suffers monumentally from the round-the-clock irresponsible creation of money, via the USGovt, the Federal Reserve, the Dept of Treasury, banks, states, cities, corporations, and households. It has been suffering from overdoses of economic growth hormones for so long, that citizens not only consider it normal, but expect and demand their continuance. The system's output, its sour fruit, is testimony to its distortion and failure. John Maynard Keynes would be embarrassed, even if Milton Friedman and Paul Samuelson are not. Our nation's chief exports have tragically come to be debt, jobs, military hardware, and trade emissaries. Our mfg base is largely gone. Our credit devices are omnipresent and highly inventive. However, they can turn on their inventors. They depend overindulgently upon foreign capital whose guarantee is not certain. Human beings cannot walk straight, let alone enter a gallop, when out of balance. Neither can economies.

STRIPPED MENTAL GEARS:

In contrast to the spinning credit gears, where modest economic output comes from more voluminous credit extension, the mental side is vapid and equally lacking. Beliefs and expectations abound, based upon faulty economic thought process coalesced over the past decades. Economic policy is now based on assumptions and beliefs having little basis in historical fact, and every basis in accommodation to credit largesse. Little thought is given to the maintained engines of artificial wealth, which displaces real wealth. Many signals have been carefully re-engineered toward deception. The current conditions are being badly misread. Motives can be offered up for the perpetuation of debt. In my opinion, a strong case can be made that we are attempting to deceive both our creditors (who supply it), businesses (who must float it), and spenders (who depend on it). Our entire system is held hostage to debt in order to remain financially alive. Our newest speculative game (real estate) is now regarded as a real wealth generator by no less than our bank system spokesman, Dept of Inflation Secy Greenspasm. The situation seems without question unfixable.

Leaders and citizen voters alike continue to believe that consumption must continue uninterrupted. They believe that the economy actually can revive if only we step up consumer spending. How shallow. We tend to purchase things we do not need, built by people who do not live on American soil, with money we do not have, extended on credit by nations whose workers make the products we buy. This is insane. We believe that capital investment will follow and arrive if only consumer and business demand would increase. Again, no historical precedent. Investment tends to occur when conditions ripen for potential economic expansion. Right now, that expansion for labor and manufacturing resides in Asia, as our nation's business executives know all too well. They are outsourcing and investing heavily in China and the rest of Asia.

To the last press pundit, to the last analyst wag, to the last unschooled taxpayer, a belief stands unshakable that foreigners will always be there to provide the US Economy its much needed capital. By and large, the foreign source is Asia, which recycles their vast trade surplus to our markets, finding little alternative of sufficient size and magnificent proportion. Where else can they sock away almost $20 billion per month? They have come to the table with fists full of our own printed phony cash so often, that we have come to take its arrival for granted.

Our federal govt depends on Asians for 45% of new debt issuance. Our mortgage agencies Fanny Mae and Freddy Mac heavily depend on Asians to soak up regular debt issuance. Estimates on the opaque mortgage balance sheet and hedge fund books offer that Asians purchase up to 30-35% of GSE debt issuance. With the refinance movement stalled, dependence on external sources has become more magnified. Turnover once supplied some mortgage funding, but not so true any longer with the stalled REFI movement. Our alpha dog leaders have recently bitten the Asian trade partner hands that feed our credit markets, during trans-Pacific bickering over trade protection and job losses. In December we actually risked jet plane orders while holding up shipments of bras and bathrobes ! Any firm confidence in uninterrupted credit supply from Asia seems badly misplaced at best, and horribly naïve at worst.

So the thought process has gone awry, and the continued assumptions are unrealistic. Not to be outdone, reading of signals is replete with denial, and ignores past historical learning. A falling USDollar fails to confirm any claim of a US Economic recovery. The past decade saw a huge rise in our currency, based largely upon the positive forecasts for growth in the economy, reduced borrowing costs, belief in rising productivity, blind acceptance of the benefits of new technology, and increased corporate profitability. Surely, clandestine depletion in the last decade of the Fort Knox gold supply to subsidize USTBonds had much to do with the USDollar bull market. The US$ obverse, labeled the USTBond, was the vehicle for that spectacular dollar climb. Turn a USDollar on its back at the FOREX ball, and your dance partner is a USTBond. Gold was sold, as bonds were bought in a grand secretive transfer. Of course, US firms benefited, operating under a horrible debt burden made lighter. A stock market miracle was launched. Easy money was provided by the financially reckless Greenspasm. He was deemed a genius.

The economy has not resolved any imbalances in the last three years. Consumers are burdened by debt and eroding jobs. Wages badly lag in this recovery environment. Productivity gains are based more on cut costs and shed workforce than anything new and revolutionary in the technology world. Corporate profits struggle. The USDollar is being sold worldwide as much from lack of confidence in our recovery, as from outright disdain for negative real interest rates underwritten by the myopic Federal Reserve monetary expansion policy. Perhaps FOREX traders are concerned about runaway dollar printing in the money supply. They do cite unresolved federal deficits and yawning trade gaps. Our nation's need to close the current account deficit is estimated at $1.5 billion per day, which seems to bring alarm, disquiet, or urgency to almost nobody. Our credit masters do not speak our language; they do not share our cultural values; they have no established history of capitalism built upon mutual trade cooperation and inter-dependence. In fact, a fresh view of capitalism in China might be the greatest threat to the US Economy in decades, as a geopolitical shift may be in progress. Something clearly is wrong in the mental dimension within the United States.

Over the course of modern history, no examples can be found where the money supply has grown so rapidly, the USDollar has tumbled so progressively, credit markets have grown so dependent upon foreign sources, yet interest rates have remained so low and obliging. The divergent signals cannot be mistaken. Before long, interest rates must rise to offset the many challenges, let alone risks borne by foreigners. Market watchers do not see it that way. Instead, they see international confidence in our bond market, subdued price inflation, a new and wondrous bond rally, a relentless stock rally, and a strong housing market. They fully expect accommodative interest rates for this entire year. The reality is that the Federal Reserve and other central banks work as principle agents behind USTBond support, which lifts strong hands under the USDollar. At no time in history have central banks been in such a foundational position for both the provision of liquidity and fuel for speculation. The Fed must itself act as bond vigilante, if it is to perform according to its charter.

The US financial markets, surely as aggressive as they are ingenious, have sponsored a significant outreach in financial leverage applied to the bond market, in order to keep long-term interest rates low. They employ monetization methods, where printed money purchases the long bond. They encourage a futures contract speculation carry trade, where borrowed 1% short rate money is used to purchase long bonds bearing a much higher yield. This is a coiled spring which cannot be held in check much longer. The entire scheme would capture the attention of Ponzi himself. Unfortunately, a short circuit is in progress, as Fed counterfeit money circles the globe to disrupt the ongoing scheme. Chinese demand must be monitored. It is purchasing commodities of all types, for commercial and financial purposes.

We live in the midst of a "dark quickening" of the bond market, building its differential fundamental electrical charge, as a super-cycle event appears on the horizon. Now the gold price has stabilized above the $400/oz level. Silver has breached the critical $6/oz level. Gold is the widely recognized meter of monetary distress and an imminent price inflation threat. As an amusement sideshow, the quixotic Prechter reneged on his white windmill flag, and has chosen to employ cartel tactics. Last year his line in the sand had been revised to the $400 gold price, where he promised to admit defeat. Mark Twain defined dogmatic as "wrong at the top of your voice." Prechter now has established his new bivouac at the $422 milepost, with very portable pitched tents. What will this charlatan be saying when gold is well along the powerful major EW3 wave, pushing the $500 price? Who knows? The man cannot read his own charts!

Commodity prices are registering new highs across a long list of indexed materials. The CRB index has shown a clear breakout since surpassing the 250 level. Yet the consensus view is that price inflation remains subdued, an observation that defies most evidence even in the conventional twisted perspective. Metals, energy, and food dispute such flimsy shallow claims. Check prices for gold, silver, copper, crude oil, soybeans, all at new multi-year highs. As well, corn, wheat, the soy complex, cotton, coffee, and lumber are at strong and rising price levels. Steel prices are up considerably in the last several months, with certain product grades poised (in the opinion of some experts) to rise 50% by summertime. The source appears to be a combination of spiraling Chinese demand, low world capacity, and cheap easy money. The best evidence for the inflation case lies in real estate, bonds, and technology stocks, whose basis is monetary inflation (accommodative Fed policy). A clever line was pasted on the financial rags at year's end, where an analyst described the 2003 stock rally as "a flight to garbage." Stocks with no profits, heavy debts on balance sheets, former speculative favorites, the majority of these issues were up 300-500% in the past year. NASD margin debt briefly topped levels seen in the spring of 2000. Signals are being missed, as mental gears have been stripped.

Plenty of editorial content addresses the longstanding connection between a falling US$ and rising gold price. I am actually impressed that the press & media has properly cited through anchor headlines and expert interview some proper basis for the dollar decline. They allude to low competitive interest rates, burgeoning trade gaps, escalating federal deficits, and rapidly increasing money supply. Gold is the antithesis of the world reserve currency. Gold typically begins a strong multi-year bull market when interest rates are low, especially when negative on a real basis (subtracting price inflation). We in the USA have had negative real rates since November 2002, almost fifteen full months. Since the US Economy is a great importer of commodities, energy, and finished foreign products, the horizon is littered by diverse threats to prices generally. With attention focused on the ridiculously narrow CPI, the gold warning of price inflation imminence is being overlooked and often ignored. The Greenspasm Fed has tragically trained market watchers and experts to use the CPI to gauge price inflation. They accept asset gains as bull markets, never to comprehend what price inflation encompasses or yields. However, price inflation will surface only in certain sectors. The consensus view holds that inflation is a commodity without location. Its location is critical to profit margins and product price power.

The statistical spin doctors continue to ply their deceptive trade. The jobless rate is far higher than the reported 5.7% since workers who no longer qualify for benefits are not counted. Was it an oversight to include in the official jobs report that a "participation rate" of only 65% was registered? So the jobless rate is actually 8.8% in a realistic definition not meant to deceive. Jobs are lost. Few new ones are created. But the jobless rate falls. What a joke! The savings rate is actually negative, as self-paid rent for homeowners and free check service adjustments boost a number into the positive column. If these adjustments are removed from the income and savings formulas by our crack team of govt statisticians, the national savings rate continues at a negative $400 billion annually. Productivity, largely a meaningless gauge that fails to address and constantly assumes an inherent profit, is far less than reported if adjustments for equipment speed are removed. Again, more deception on a public unwilling or incapable to decipher any truth in numbers.

Sean Corrigan offers an insightful view of a remarkable shift underway among central bankers, where the European CB now appears to be in the catbird seat, led by Jean-Claude Trichet, in its influence of currency markets. In his "Currency Wars" article, he points out how the ECB and the Bank of Japan have recently shown uncharacteristic defiance toward the Greenspasm Fed. They openly challenge US-held views on deficits and inflation. Otmar Issing, the astute respected ECB chief economist, cautioned G-7 finance ministers not to foster "an artificial bubble of demand through expansive financial and monetary policy, [because] from such a momentary flame, little can be expected but more inflation." He went on to imply that the Fed has embarked on an unwise path, with ample failed precedent provided by Japan. In his words, "the wrong policy was pursued and the bubble only strengthened, the consequences of which, the Japanese economy suffers to this day."

Corrigan countered the Greenspasm claim that inflation, "the typical symptom of a weak currency, appears quiescent." His typical condescending arrogant vocabulary does little to shout down actual contradictory evidence to his contention. The author cited some statistics worthy of note to counter. Over the last two years, unfinished import prices are up 20%. Finished import prices are up 6.7% annualized since the start of spring, nearly a 9-year high. Unfinished goods are often called components, the parts within products. Since the autumn, Asian currencies have gained ground against the USDollar. Import prices are now quietly slamming against the back door. It is inconceivable that imported consumer products, a staple among shoppers acting out their retail addiction, will avoid the effects of rising prices.

Jeremy Grantham, legendary stock manager of Grantham, Mayo, Van Otterloo in Boston, made some crisp comments which relate to technology, the internet, and profits. His words seem to strike at the heart of most nonsensical wishful thinking directed at the remnants of the New Paradigm myth, wherein technology saves our economic bacon. "I am a huge fan of the Internet. But the thing that goes on in the Internet, above all, is price disclosure." Great as that may be for consumers, he says, it's not so good for business profits, and it gives them big obsolescence headaches. "Technology is often threatening to profit margins," he went on to declare. His listeners might add that jobs are the manifested export of our technological machinery.

Nowhere is the deception worse than with gross domestic product calculations. GDP growth is the statistic used to argue economic growth. Remove the hedonic lift from faster computer processors, faster storage access, and faster internet bandwidth to reveal both productivity and GDP growth at very tame levels. For example, 2003Q3 was hailed as the launch of robust growth. If the USGovt is to successfully offload billions of federal debt on a routine basis to foreigners, our leaders must promote a story of healthy growth, even if untrue. On its face, the practice appears to have criminal intent. Year-over-year, Q3 growth was about 3.5%, no more, no less, and far below anything seen in early quarters of verifiable recovery. Official "annualized" GDP growth is claimed to be 8.2% for Q3, replete with goofy lifts in the heels. Dissenters are shouted down, much like turncoats whose patriotism is challenged.

To counter claims, a closer look at treatment of information technology business activity in Q3 is highly revealing. Chain-weighted figures show $93.1 billion in IT spending, of which only $11.5 billion occurred in real terms. The remaining $81.6 billion, over 87% of the ledger item in the GDP calculation, incredibly was attributed to adjustment for speed improvements, a treatment called "hedonic adjustment." The practice is highly deceptive, totally fallacious, and not based in any reality known to mankind. Economies of scale and Moore's Law of R&D are the phenomena which motivate deceptive accounting by our govt officials. That extra eighty billion in dollars flows nowhere, is available for business expansion nowhere, can be devoted to worker payrolls or benefits nowhere, and appears nowhere on any financial balance sheet. It is pure fiction, but serves a very valuable service in keeping the myth alive that the US Economy is indeed in recovery mode. The recovery suffers from headwinds of debt and severe job leakage.

As long as assumptions are misplaced, economic principles are accepted backwards, signals are misread, and data is fraudulently modified, one can expect accidents to occur, in an endless repeated fashion. Our economic recovery is so twisted, that strange outcomes are not only likely, but virtually guaranteed. Sadly, economic growth, when based on consumption, will worsen the trade gap. The growing costs of imports will not encourage domestic production of output where we have no industrial capacity. How can it? It will cause a rise in imported product spending. Sure, US firms will export more, but that will do little to bridge the present giant trade chasm. Continued monetary ease will produce wild price inflation in all sectors outside the Chinese sphere of output influence, and especially within the commodity realm driven by the Chinese sphere of demand influence. Commodities have been the focal point of neglect in the last decade. Our national reflation project might only inflate production costs and household expenses. Nothing will turn out quite as expected in this cycle. We may be in the midst of a supercycle downdraft blowoff, rather than a business cycle reload. The main difference between 1930 and today is the daily presence of the Federal Reserve, its standby intervention, and round-the-clock money printing. Powerful cross-currents of unusually great power are building for the bond market, whose barricades are avidly defended by the world's central banks.

The Asian threat to bonds and prices are discussed in my autumn article on the subject, which attempted to comprehensively lay out many complex factors at work. Asian currencies are now gaining ground against the USDollar. This heralds the advent of the dangerous phase#2 of the Great USDollar Decline. Import prices are on the rise. See "Dragon at the Back Door"

PONZI ECONOMICS:

Martin Hutchinson defines the specific Ponzi Scheme criteria, and builds an argument for our economy and financial markets satisfying those requirements. The resolution of this trap will be higher interest rates, economic damage, and financial crises, probably later than sooner. The key ingredients to the pyramid scheme are:

magic mushroom to deceive the public participants (see the New Economy myth, and technology miracle façade)
external sources of capital infusions (see extreme capital dependence upon Asian supply)
cheerleaders to promote the fraud (see Greenspasm and Fed Governors such as Bernanky, Meyers, Lindsay)
deception within actual fundamental statistics (see GDP, productivity, CPI, jobless, and questionable confidence measures)

A few friends of mine found the "The Bear's Lair: Greenspan's Ponzi Scheme" article to be a mix of highly illuminating, disturbing, and tragically comical. Many in our society have heard the term "Ponzi Scheme" but few could actually define it. Charles Ponzi conducted an enormous scam in 1920 with money to be invested in international postal coupons following World War I. The author identified them as the key "magic mushroom" which were easily exchanged between Spain and the United States. The principal dynamic behind the scheme was that the coupons served as a poorly understood hallucinogenic agent enabling fantastic returns, while disbelief was suspended during newly perceived extraordinary times. Seeding the foundation of the scheme, early investors were paid in cash. Ponzi used new money infusions to redeem older investors until the pyramid collapsed and the fraud was exposed.

In parallel fashion today, investors poorly understand the role and effect of technology. A widely held belief system exists, wherein a New Economy miracle has transformed communication, lifestyle, and investment opportunity.

Parallels between Ponzi's Scheme and the entire US Economy and Financial Markets are alarming. Greenspasm harbors naïve delusions on the role of technology which overlook certain pernicious ill effects. For instance, productivity was less in the fabled 1990 decade than in the previous decade, and corporate profitability remains in decline since the mid-1980's. America's unsound economy, replete with imbalances and debt dependence, relies upon foreign capital sources in a manner which Ponzi required to keep the scheme afloat. Asia sends their precious savings for Americans to support a socialist govt system, to wage war abroad, to squander on consumption, and to speculate with investments and homes. Sudden shock & awe delivered to the stock market in 2000 has now given way to a renewed round of enthusiasm. However, the same imbalances, dependence, and foreign reliance exist. Actually, they are much worse than three years ago. The author regards foreign central banks as the new bagholders, motivated by domestic considerations, in the hope to maintain their export economies. European investors are notably absent in the recent 2003 stock rally in the US markets. In Euro denomination terms, the S&P stock index performance has been flat. Trade friction could be the pinprick to set in motion the reversal process, unless the Fed orchestrates an unwinding of bond speculation with increases in interest rates.

A public relations campaign is essential, in our case led by the Fed Chairman himself, who has taken stock & bond sales promotions. He and henchman Bernanke deliver speeches with tripled frequency. In 1999 Greenspasm spoke in glowing terms about technology, which he believed to spawn a productivity miracle, permitting increased risk premiums in stock shares from vastly improved speed in information flow. What a naïve view, when in fact shared technological advantages reduce both price and profit margins to the benefit mainly of consumers. See George Gilder and his personal Telecosm investment tragedy for evidence. Never mind that the Bureau of Economic Analysis and Bureau of Labor Statistics revised productivity statistics, to rewrite and downgrade that miracle. The period 1995-2001 held productivity to grow on revised basis at a slightly lower rate than the preceding decade! Historically, central bankers used to dampen political enthusiasm toward fiscal irresponsibility, to raise interest rates when speculation emerged as too prevalent, and to attempt to rectify foreign capital dependence upon financed trade gaps. No more, as central bankers have assumed the heretical role of apologists for speculation and chief agents for abortive intervention. Now they rationalize huge federal budget deficits and huge trade gaps, relying on speeches which claim they are not a problem. Any banking apprentice could conclude they obviously are a massive problem. Bankers are now co-conspirators, if not hapless cheerleaders.

The Cato Institute sees two potential outcomes to the US Ponzi scheme experiment, which has obviously gone amok. Dissenters need only turn attention to federal deficits, trade gaps, debt loads, consumption, obesity, and SUV sales. Natural forces demand resolution, the objective of which is to correct the devastating trade imbalance, now running at a $450 billion annual pace. We can export an overpriced currency (euro to hit $1.60 by 2005), sure to trigger a recession in the EU, which would ameliorate to some degree the current account deficit plaguing the United States. Since most US imports come from Asia, a EuroZone recession would accomplish nothing in the closure of the US trade gap. Hence, the second potential outcome is much more likely. Both the US and EU are free to duke it out as non-producing siblings of world commerce. The European Central Bank will eventually hold its ground in defense of their currency, and resist a rising euro with fiat paper defense to fortify sea jetties. By unleashing monetary excess, coerced to duplicate the errors of the Federal Reserve, the EU would undergo long-term damage from engrained inflationary structural damage. The ECB is under tremendous pressure to copy US inflationary largesse. Such is anathema to Europeans, but is likely. Their leaders will attempt to avert short-term damage, only to ensure long-term dislocations. In time, the US will be forced to suffer Asian currency damage alone. And it is certain to be significant. US imported products would rise substantially in price from currency exchange rate effects. The consumption bubble will wind down.

A titanic battle can be seen over the horizon by students of US Treasury Bonds. Foreign supply is to be threatened from a declining USDollar, even as prices rise for materials, energy, and food, not to mention the relentless rise in health care. So credit supply will face possible interruption, while evidence of price increases hits the economy. Pockets of price inflation threaten all imports, even as profit margin erosion is to slow the US Economy. So higher consumer prices on preferred items will interrupt retail spending, while corporate earnings inhibit their ability to expand and hire. Falling long-term rates always accompany a slowing economy. One cannot lose sight of the role of the USDollar as the predominant instrument of change. Ultimately, higher rates will prevail, in defense of a crippled US currency, since foreign creditors must not be discouraged.

The Fed has been situated between a rock and a hard place for several months. Raise rates to defend the USDollar, and kill the US Economy. Wait until the US Economy is strong enough to withstand higher rates, and risk substantial imported inflation from abroad. Such is the essence of the Greenspasm Gambit, whose resolution is far from over. The result will be a painful US recession to rectify imbalances. The reflation policy is backfiring, and our Fed Chairman is beginning to see the horrendous damage from unintended consequences. He has long run out of weapons in his limited arsenal, as policy has become far more toothless than perceived. The FOREX traders might be far more aware, but then again, they are far smarter.

It is my view that the change in FOMC the January 28^th statement of words issued might have been the result of bickering, rhetoric, and outright conflict between the Federal Reserve and the European Central Bank. Greenspasm has given every indication that the Fed will blink first. He has served warning to bond speculators who have enjoyed a downhill ride, a free lunch, in their highly prosperous yield carry trade. It is amazing to watch the effect of the Fed Open Mouth Committee changes, where mere words roil the financial markets. While US rates have not moved, futures contracts in distant months certainly have. The Fed will raise interest rates eventually, when their patience runs out, or when the USDollar Decline becomes disorderly. Disorder is a major concern in Europe. Traders must now find a way to unwind their staggeringly large positions without inflicting damage to themselves or the bond market, let alone the economy. Financial leverage contraptions have a way of removing the limbs of their users when they go into reverse. We are witnessing the end game to the Greenspasm Gambit. Given the debt levels and imbalances, a positive outcome comes with heavy odds against.

The Gambit has an unwilling participant, Europe. The ECB now must ward off temptations to relent to American monetary blackmail, or else face an abrupt brick wall in export trade, combined with an incoming flood of cheap Chinese imports. The EuroZone economic future structure and well-being lie in the balance. A clear signal has been sent across the Atlantic from the European Central Bank as we approach the February G-7 meeting in Florida. ECB council member Nout Wellink said an interest rate cut would do little to halt euro gains versus the US$. Wellink said "There is no need to take special measures" when finance ministers meet. He went on to say, "The forces at work are much stronger and can’tbe neutralized by a minor change in rates." He implicitly refers to large structural problems with interest rates and currency exchange rates. Small interest rate maneuvers may do precious little to change the US$ bear trend. US federal and trade deficits are squarely on the table for discussion. Economics, politics, and war will enter the closed-door debate.

Little did Greenspasm realize in 1996, when he changed policy to allow monetary aggregates to surpass GDP growth levels, that such colossal disruption and dislocation would befall the US Economy and our financial markets. At least he has become a knighted folk hero. Globalization, technology, debts, foreign dependence, financial leverage, and systemic monetary inflation have combined to make a witch's brew, only to wreak havoc. Financial engineering has aimed a canon squarely at our nation, yet only the gold bugs seem aware. Our financial devices of leveraged futures contracts, options, interest rate swaps, spreads, carry trades, strangles, straddles, collars, hedges, exotics, these are being turned against their makers. Let us not forget the Plunge Protection Team intervention and their many tools. This will be the most challenging and exciting period for the US Treasury Bond market in its entire history. We are entering the next stage of a grand liquidity trap, but with foreign bagholders in control of our burgeoning Treasury debt. This new chapter of stagflation (compared to 1970 decade) will prove to be more deadly. Huge offsetting forces are now aligning. I plan to keep a mishedlo device close by for consultation. Like most weather systems, where large low-pressure zones encounter large high-pressure zones, big storms await us.

As UPI Business and Economics Editor Hutchinson concludes,

"that is what comes of getting your economic policy from Charles Ponzi."

The Broken Cycle Series

Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a Ph.D. in Statistics. His career has stretched over 25 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials.

Jim Willie CB is the editor of the "Hat Trick Letter" Use the below link to subscribe to the paid research reports, which include coverage of several small cap companies positioned to rise like a cantilever during the ongoing panicky attempt to sustain an unsustainable system burdened by numerous imbalances aggravated by global village forces. An historically unprecedented mess has been created by heretical central bankers and charlatan economic advisors, whose interference has irreversibly altered and damaged the world financial system. Analysis features Gold, Crude Oil, U.S. Dollar, Treasury bonds, and inter-market dynamics with the U.S. Economy and U.S. Federal Reserve monetary policy. A tad of relevant geopolitics is covered as well. Articles in this series are promotional, an unabashed gesture to induce readers to subscribe.

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