Friday, August 29, 2008

The Story of the Three Bears

This is not the story of Papa Bear, Mama Bear and Baby Bear. It is the story of three growling bears. Russia, Gustav and Bush.

Russia is the bear making the most noise. Russia does not like the fact that its former protectorates are joining "The West". NATO is no longer just Western Europe and the USA. It no longer has the purpose of "keeping Russia out, Germany down and the US in". But, perception is reality for Russia.

To understand the view from Russia, we should pretend for a moment that several of the 31 states of Mexico have joined the Commonwealth of Independent States, dominated by Russia, and that Russia has sent troops and missile defense systems into a couple of Mexican states.

In the early days, NATO was a weak federation. Even as a teenager, NATO lost the military services of the French; France withdrew in 1966. During the cold war, NATO gathered strength. Reagan established missile defense systems in Western Europe. When the Soviet Union Socialist System of Government collapsed in 1989, the "West had won." The Warsaw Pact states were freed to do as they wished, maybe? The treaty that permitted the unification of East and West Germany allowed Germany to remain in NATO, provided no troops or missile systems could be stationed in the East. Later, Estonia, Latvia, Lithuania, Slovenia, Slovakia, Bulgaria and Romania joined NATO. In April of 2008, Georgia announced its intention to withdraw from the Commonwealth of Independent States and both Georgia and Ukraine were promised future membership in NATO. Ukraine has been attending meetings of the Commonwealth of Independent States but it has never ratified the treaty.

Russia is notable for ruling with an Iron Hand. The country builds its relationships through intimidation. Such a leadership style works in only a few situations. In the long run, man wants the freedom to do what is best for himself. Unfortunately, most of us are not willing to accept the truth as explained by Ayn Rand. In essence, we help others when we help ourselves.

This week, Russia has hinted that it may cut down on energy supplies sold to Europe. As we all know, embargoes and cartels are very difficult to maintain. If there is "significant leakage" or alternatives, the one attempting to force the issue is hurt the most. Russia has even hinted that it will cut its imports of beef, pork and chicken from the USA. Naturally, if Russia cuts back on oil sales to Europe, it will need to cut back somewhere and meat is a luxury good for millions of Russians.

Those who are free tend to recognize that trade helps both parties to every transaction. Novices at a board game like high bid will tend to attempt to corner a market. The more they try to drive the price of a certain good up, the less business they will do. The player who buys and sells a lot of goods at small profits on each sell will make more profit than the guy that tries to corner a market. In real life, we see silly games played all the time. Unions drive wages to artificially high levels in America only to see production go overseas. Lawyer-politicians, with little or no business experience, raise taxes the most on the most productive of assets. Russia owns a lot of resources and controls even more. Together, Russia and Kazakhstan own huge amounts of uranium but it can't sell it without cooperating with the rest of the world.

Russia has growled in other ways. It just held meetings with Syria. Syria has been isolated as a sponsor of terror for many years. It is close to gaining its "get out of jail card". The pending treaties with Lebanon and Israel and pending commercial treaties which include the building of an oil pipelines and gas pipelines through Syria and the building of a major refinery are all nice carrots that can be collected through cooperation with the West. Russia and Syria can talk about weapons systems but neither really want to walk away from pending treaties.

Russia has growled that it may withdraw its help in regard to nuclear bombs in Iran. Iran is cheering in hopes of a major confrontation between the West and Russia, but, the third round of sanctions, already approved by Russia and China, have not been fully applied.

Russia has growled about NATO presence in the Black Sea but a NATO member, Turkey, controls access to the Black Sea and many tons of goods flow down the Danube and into the Black Sea. Germany and many others access world markets cheaply and easily via the Black Sea. The Black Sea offers the West a look at the soft under-belly for Russia but the purpose of keeping the Black Sea open is to allow the flow of goods. Ukraine, with just as much sea frontage as Russia, is on the list to join NATO. Russia can hardly stand the thought, what can it do? Nations such as Ukraine benefit more from commercial connections to Western Europe and the rest of the world than from commercial connections to Russia. Membership in NATO supplies security. NATO has 70% of the worlds military power. Russia does not want to risk war with NATO.

The loudest growl so far, other than the military support of two tiny little break away states from Georgia, has been the threat of a new Cold War. We know how the first Cold War ended. Again, it is in Russia's economic interest to sell oil to Europe and to buy chicken from the USA, etc. Russia cannot expect to collect transit fees forever by forcing neighboring states to send oil and natural gas through Russian pipelines.

It is in Russia's interest to keep nuclear bombs out of the hands of the Islamic Fascist of Iran which are currently spending large sums to support the movement of Hezbollah to South America, among many other places. Islamic Fascist now control the southern half of Somalia. Iran fought Iraq to a standstill from 1980 to 1988. It knows it cannot win a conventional war against the West. Iran has only three routes to success: 1) to build satellite states through terrorist techniques in places like Venezuela, Columbia, Lebanon, Afghanistan, Pakistan, Iraq and Somalia, 2) to acquire nuclear weapons, 3) to divide Russia and the West. Russia has battled Islamic Fascist in Chechnya, Afghanistan and all the way into its homeland.

CONCLUSION: Russia is not happy about having so many neighbors in NATO but there is nothing it can do. At a critical time of multiple pending peace agreements, Russia is trying to impart just a little Russian shape to the deals.


Gustave is making noise as it enters the war waters of the Gulf of Mexico, but not as much as the media hype would indicate. Storms make the news, but they are not in the same historical league as the spread of Islamic Fascism or the "battle between Russia and the West". If Islamic Fascism is not checked, it could truly result in WW III. Katrina was one of the "once in 50-year storms". Gustave could be another, but not likely.


On the first day of the democratic convention, Bush sent the USS Iwo Jima, an aircraft carrier, on the way to Iran. On September 8, the day congress returns to Washington, Bush will send another aircraft carrier, the USS Theodore Roosevelt, to join the USS Ronald Reagan and other ships off the coast of Iran. On September 9, OPEC will start its fall meeting. High oil prices will be in the news when congress is back in session.

Democratic congressional leaders want a short session. The Reid -- Pelosi strategy is to not pass any budget bills until after the "big win in November". Talk about a do nothing congress! The law requires a budget by October 1, but both republican and democratic congresses have failed in the past. In the past, they at least tried. They have normally passed several bills well before the October deadline. This time, none of the 12 bills have passed.

The bill that funds the interior department is the one where the prohibition to drill is normally attached. Bush has said that he will veto the interior bill if it has the drilling moratorium attached. After going through the motions of introducing "Christmas Tree" drilling proposals, containing subsides for wind mills and windfall taxes for oil, the leaders will be stuck. Such a bill will not pass. To get out of town and onto the campaign trail, a congress with only a 14% approval rating will then attempt to pass a continuing resolution. The drilling ban will be attached. Again, Bush will threaten to veto. Such a bill will not pass the Senate.

In the absences of compromise, by October 1, fur will fly. The words will not be the nicest you have heard. If the democrats buckle, a clean CR will be passed and the price of oil will fall about $20 per barrel in two or three days. If the democrats do not buckle, all but emergency services of government will start shutting down and republican candidates around the country will hold massive rallies. The public is overwhelmingly on the side of drill, drill, drill to lower prices.

The price of energy is the number one economic and foreign policy issue. John McCain has picked a running mate from the oil rich state of Alaska.

Governor Palin, a working mom with 5 kids, is a powerful force. She has fought and won against the big oil companies. Her accomplishments include the passage of a bill to build a $40 billion gas pipeline across Alaska. If we develop enough of our gas reserves, natural gas can be used to fuel clean burning cars in the summer and heat homes in the winter, avoiding the cumbersome storage process we currently use.

Palin has other accomplishments, including a successful fight against corruption. However, her greatest asset to McCain is not her list of achievements. One TV anchor and former supporter of Hillary responded passionately to Palen criticism today. A male anchor questioned her abilities and the female anchor said that any women that can raise 5 children while holding a tough job has demonstrated the ability to work under stress. This female reminded me of a Mama Bear protecting her cubs. What is not to like? A smart woman who believes in low taxes and free markets, who cannot be pushed around by the powerful.


Last night, on the 45th anniversary of the powerful Martin Luther King speech, "I Have a Dream", Obama latched onto Al Gore's fantasy. Obama, like Gore, believes we should end US dependence on foreign oil within 10-years by spending billions to support poor solutions. If he could do it, his method would still be wrong. America should not spend billions to subsidize windmills or any other wasteful method. The great irony is the great harm to the environment being done by those who oppose all but their energy solutions.

PREDICTION: McCain will win by more than 2%. A virtual landslide. The first woman VP is going to be a republican.

Thursday, August 28, 2008

The Perfect Political Speech

The Perfect Political Speech
Don Boudreaux

David Allan Coe's 1975 song "You Never Even Called Me By My Name" ends with Coe telling his live audience the following:
















It's a great song, with this incredibly clever, satirical ending.

Karol (who doesn't share my taste for much country'n'western music) has heard me sing these lyrics several times, just for fun. So this morning when she read parts of Hillary Clinton's speech to the Democratic National Convention, she exclaimed "This reminds me of that David Allan Coe song you're always singing!"

And Karol's correct. Sen. Clinton's speech is predictably full of typical political nonsense, posturing, and hubris pretending to be humility. In this sense, it's a really good political speech. But her inclusion of these lyrics are what make it the perfect political speech:

I will always remember the single mom who had adopted two kids with autism. She didn't have any health insurance, and she discovered she had cancer. But she greeted me with her bald head, painted with my name on it, and asked me to fight for health care for her and her children.

I will always remember the young man in a Marine Corps T-shirt who waited months for medical care. And he said to me, "Take care of my buddies. A lot of them are still over there. And then will you please take care of me?"

And I will always remember the young boy who told me his mom worked for the minimum wage, that her employer had cut her hours. He said he just didn't know what his family was going to do.

No tale, no matter how hackneyed, left untold -- no possible profiles of any 'victim' of the cruel forces of markets and inadequate regulation left unmentioned.

The perfect political speech.


I recently purchased shares in MBIA. I did not buy many because the stock is risky. Days like today make me wish I had more faith in my convictions.


Several ships, including the USS IWO JIMA and the USS SAN ANTONIO have left Norfolk. The USS Theodore Roosevelt is scheduled to depart on September 8. Six thousand marines and sailors will be involved in the "exercise".


US economic growth last quarter was 3.3%. That is a real number after deducting inflation.

Final sales were up 4.8%. The indication being that even the adjustment to 3.3% understates the strength in the economy.

Over in the UK, high short rates have brought economic growth to a standstill, but these high short rates have also induced a massive rally in long term bonds. The rally has shifted to financial stocks. Companies such as Lloyd's of London have bounced.

In the old days, the economy of the USA was so big, relative to the rest of the world, that our policies moved the markets. Today, high short rates in the "rest of the world" are killing the demand for resources and setting up a dramatic fall in inflation rates.

It is very easy to get the cart before the horse on this one, changes in long term bond rates provides the most accurate forecast of e inflation. It is easy to flip this around, saying that inflation will cause higher bond rates. Central bankers can manipulate the tail of this dog but the dog will sniff out the trail of inflation.

Wow! A stronger economy with tamer inflation. The prospects for future real growth could hardly be better!


For more than 6 months, high short rates in countries such as England and Australia have caused long rates to fall. These countries are walking like men carrying 200 pound sacks on their shoulders. The USA carried the load for 19 months but is now letting others do the heavy lifting. Inflation is being fought far and near. In many a developing nation, (including Russia), short rates are above 10% and long rates are higher than short rates.

Under the situation, home builders, who use short term construction loans, find money to be scarce and expensive. When the price of any commodity goes up (money is a commodity), the quantity consumed goes down. Fewer homes are being built. This does not cause the price of homes to go up, in the short run, because there are more than plenty houses on the market. The supply of new homes is reduced but the total supply of available homes remains high. The whole process creates the opposite of inflation, which is too much money chasing too few goods. Suddenly, there is reduced demand for everything from bulldozers to roofing nails. There are suddenly too many goods chasing too little money. Under the situation inflation is falling, long rates are falling and houses are becoming more affordable.

Most countries have carried their inverted curve for more than a year. Short rates have been pushing down hard and the results are real. The interest rate on long term treasury securities has been falling for at least 6 months, in most countries, including the USA (the USA 10 year is down to 3.77, it reached a 60 year low at 3.33% a few months after the end of the 2001 recession). The demand for many goods has fallen. Gold and oil have held onto high prices because of geopolitical risks, but both have fallen sharply from their peaks.

The turn of long interest rates from up to down happened months ago but it is gradually causing a turn in houses from down to up. Last month, in the USA, according to the OFHEO index, 30 out of 50 states saw rising home prices. Only Florida, California and Nevada saw big drops, last month. Even the Case-Schiller Index, that includes big coastal cities such as San Fran and Miami saw increases in 10 of 20 markets.

Lower short rates in the USA are spurring business investment. The market was surprised yesterday by strong numbers. The final numbers for GDP last quarter will be revised up.

The rally in bond markets from Australia to England can only go so far. Lower long rates are encouraging all sorts of long term investment projects, all around the world. The financing for a refinery and a home are similar, the borrowers generally base their decisions on long term rates.

The pace of development in nuclear power is going to surprise the public. The big turn in construction of nuclear power is a virtually untold story. The news media is very selective about what it covers. The incredible example is the lack of coverage in regard to the Armada headed toward Iran. I checked with a few non readers last night and the average man is totally unaware that three aircraft carrier battle groups will soon be at Iran's door step.

I learned about the construction of the Chinese Nuclear Power Plant assembly line from the web site, Next Big Future, which had learned about it by constantly monitoring numerous industrial technical journals. The factory only took 11 months to build and it is up and running. Now, a letter of intent has been issued to build a similar plant in Louisiana. Westinghouse and Shaw Group are forming a joint venture. The shares of Shaw Group were showing strength several days before I found the notice. In the next 12 years, China will build more nuclear power production capacity than the total of the USA's current capacity!

Chevron has followed Exxon's lead. Both big oil companies are selling their retail gasoline stations. This does not mean that the "future car" will be here next week but it shows that long term investors feel the winds of change.

What is it that they know? It could be any sort of thing. The rapid developments occurring in carbon nanotubes is just one example of significant change underway. Carbon nanotubes have an incredible length to diameter ratio of a million to one! They enable the construction of the strongest and stiffest materials ever known. Many uses will develop in the coming years. Wires made of these materials carry 1,000 times the amount of electricity carried by copper. They carry 15 times the heat of copper. Cars will soon go the way of the new Boeing Dreamliner, a much stronger airplane that weighs 15% less.

The process of substitution is barely underway. The Dreamliner was made lighter by replacing aluminum panels and steel rivets with graphite sheets. Given time for development, everything from turbine blades to wheels to coffee cups will be converted. Imagine the weight difference in an armored personnel carrier!

The high electrical density of the materials are likely to dramatically improve the efficiency of batteries. Researchers have already improved batteries in the lab. Internal combustion engines lose about 2 thirds of their power to wasted heat. New materials will capture the heat and turn it into electricity. Better still, super electro magnets will allow light weight electric wheel motors to replace internal combustion engines.

The above is nothing but a mini history of natural resources. The Mongolian Empire was one of the largest ever built. It would never have happened had the Mongols not developed technology. They learned how to attach a sharpened stone to a stick, attach feathers to the other end and use a piece of animal gut and a bowed stick to propel this arrow a considerable distance. Like the oil sheik said, the stone age did not end because man ran out of rocks.

SHORT TERM: low interest rates are stimulating capital markets.

SHORT TERM: new oil and natural gas supplies are coming on line while demand is falling, the big drop in gasoline prices is yet to come

LONG TERM: construction of nuclear power plants, wind mills, efficient cars, and more will lower the relative use of oil.

LONG TERM: share prices on many stocks will benefit from lower costs of money and resources.

SHORT TERM: Congress must pass a bill to fund the operations of the government by September 30, Senator Jim Demint says he has the 41 votes needed to stop passage if it has a drilling moratorium attached.

SHORT TERM: A couple of months ago, against 70:30 odds, I bet on a McCain win. Since then the democratic message has been mixed at best. Last night, I could hardly believe my ears when democrats cheered sending 10's of thousands of US troops to Afghanistan. I am certain that scores of supports upchucked their lunch. After democrats got us into the Vietnam War, they became gun shy in the extreme. McCain now faces the possibility of winning going away, by 2, maybe 3 points.

It will be all the more interesting if he chooses a woman as VP. Fifty-two percent of voters are women and women start twice as many small businesses than men. Women want low taxes on businesses and low fuel costs. Soccer Mom's certainly want lower gasoline prices. Democrats are on the wrong side of the energy and the terrorism issues.

Republicans continue to catch much of the blame for the weak economy, but Jerry Boyer is correct. Bush won lower tax rates and the business economy is strong. Democrats won in areas such as forcing banks to lend for houses in the poorest communities to the least credit worthy customers. Democrats won in the area of restricting drilling for oil and natural gas. Democrats won in discouraging the construction of nuclear power plants. Democrats won in stopping free trade agreements to go through. The weakness in the US and world economies are related to the areas of congressional meddling in markets.

Democrats think they can win by being against the Iraq war while supporting a bigger war in Afghanistan? One of the many troubles with this strategy is that the terrorist training camps were built in Afghanistan during the Clinton presidency. Terrorist activities were growing before the Clinton term but he did almost nothing to counter the trend.


The political winds represent a major big money turn. Instead of spending huge sums to subsidize corn oil, wind mills and CO2 capturing schemes, huge sums are going to be allocated by the market to the most efficient production of energy. The more efficient the production, the less CO2 produced. Nuclear power uses tiny amounts of inputs and produces very little CO2.

Low interest rates, as the temporary result of high short rates is stimulating huge capital projects. The great "news" is that construction has already started. The bad "news" is that most of the construction is happening outside the USA.

The nuclear power plant assembly line in China will soon bring the cost of manufacturing goods down. Will the environmentalist dare attempting to stop the Louisiana plant? Not likely, the winds of sentiment have changed.

Wednesday, August 27, 2008


Last night, Hillary apparently delivered three speeches. To the talking heads at CNN, Hillary made a great speech in which she gave Obama a powerful boost. She made a generous speech that was not about her, but about a democratic win in November. To the talking heads at NBC, Hillary made a great speech. She rallied the troops for a win in November. To the talking heads at FOX, Hillary made a wonderful speech for her own benefit, she said all the words necessary to support democrats in the fall, but she did not personally endorse Obama. She never said that Obama is qualified to be president or that he would make a good president. Her speech came just hours after Bill Clinton implied that Obama will not be able to accomplish anything if elected.

Daily tracking poll shows that McCain got a bounce from the selection of Biden as VP. The daily Gallup poll has swung to 45 McCain, Obama 43. The daily Rasmussen poll has moved to a dead even heat. Obama will get a bounce from the convention but probably only 5 or 6 points worth.

Obama's selection of Biden was made in preparation for the coming stand off with Iran. Obama said yesterday that the US should increase the diplomatic pressure on Iran before Israel decides to attack Iran. Biden was the only one of 22 Senators on the Armed Services Committee to vote against sanctions against the Iranian Revolutionary Guard. It was the non partisan 9-11 Committee, pushed by democrats, that determined that the IRG was an active participant in various plots to kill US troops, including the bombing in Lebanon, way back in 1983, in which 243 US Marines were killed. The IRG has been actively training Hizbollah, Iraqi and other terrorist groups.

I must run. The summary of the above is that the Obama-Biden team is out of step with the importance of ending state support of terror. The US and allies have already demonstrated the ability to embargo Iranian oil. Ships are on the way to Iran. Iran is being given one last time to consider its options. Gold and oil are up. These commodities will turn down hard after the situation in Iran is resolved.

Tuesday, August 26, 2008


On occasion, the push back I receive is in regard to my skepticism. When I say that international events are timed for political purpose, some readers agree but most are skeptical. The timing of the announced departure of the battle ship strike force headed to the Middle East makes my point well.

The announcement was timed just before the start of the democratic convention and after the market closed on Friday. The first available response was Monday, the first day of the convention. Most people have not heard about the departure but big investors pride themselves in knowing what others do not know. It only takes a few "in the know" to move markets and this market was moved by the events. The price of oil was plunging before the announcement. The price of oil has held, even in the face of economic slowdown, since the announcement.

Bush Sr. did the right thing by isolating Saddam Hussein. When Hussein invaded Kuwait, Bush Sr. did the right thing in running him out. Bush did the right thing and the right political thing. His popularity soared. However, his timing was off. Between the end of the first Gulf War and the next election, Bill Clinton and the main street media hammered away at Bush by talking about the economy. The economy had already turned up but Clinton and the media focus looked backward to tell how terrible "things are". By the election the US economy was running flat out on all four cylinders. The US GDP was growing at the real (inflation adjusted) rate of 4%, but Bush lost.

Bush Jr. learned several lessons. In the political game, what is real is not as important as what is perceived; doing right is not enough; timing is key; a strong economy makes democratic policies of tax and spend look attractive; a weak economy makes republican policies of low tax rates look attractive.

Obama has moved more than a country mile from the far left to slightly left of center in just a few months. His voting record is the most liberal in the Senate and his running mates record is the third most liberal, but he is running a centrist campaign. Suddenly, he is a hawk on Iran and his tax increases are only on those who make $250,000 per year. Watching his payroll tax evolve has been a sight to behold. During the battle with Hillary, he was for raising the payroll tax, period. Late in the campaign, he mentioned a "dough nut hole", meaning the tax would not kick-in at the $97,000 figure that had been mentioned in the past. Now it is only for those making $250,000.

The whole scam is like the ATM tax scam that was perpetrated long ago. The ATM was passed to tax the rich. Now it taxes the middle class. Because the move by Obama will change Social Security to a welfare program, it will ultimately eliminate the system. In its current form, the system has an excellent chance to survive. The hype about SSN running out of money in a few years has been pushed by democrat and republican alarmist in their attempts move the system in "their direction". Social security is not going to miss any payments!

One of the many things not appreciated is that the longer people live, the more taxes they pay on their 401-K and IRA accounts. Another is that many people are enjoying work into their 70's, 80's and 90's. This trend will continue.

Sunday, I discovered that a retired friend of mine works 36 hours per week as a Salem historical reenactor. He enjoys getting out of the house and being a friend to visitors from all over. Last night, George McGovern, who is 86, reported on national TV that he will stop working when he gets old. Only a few years ago, the social security program did not expect to receive payments from people like my friend at Salem or George McGovern.

Another thing not appreciated is that in the same way the government was able to "find" the money to pay for the war in Iraq, it will find the money to pay for social security. For multiple reasons, it is financially sound for the government to borrow a few percent of GDP from its citizens. To encourage savings, there must be borrowers. Without borrowers, there is no interest to be earned and little reason to save. The trick is that borrowing should be done for productive purposes. If necessary the government will borrow to fulfill its obligations to its senior citizens. Of course, if the system starts borrowing to make payments, the pressure to make adjustments on both the income side and the payment side will be increased.

The big hoax about 401-K and IRA accounts is that they convert capital gains earnings into ordinary taxable income. As lives are extended, the compounding effect converts compounded amounts of capital gains into compounded amounts of taxes for the government. IRA accounts and 401-K accounts have average growth over time that is much higher than the cost of borrowing by the government. The government compounds its "earnings" at the same rate of return as the owner of the 401-K.

The "golden pot at the end of the retirement rainbow" is partially owned by the government. Social Security will be around for a long time, unless it is converted to the Obama welfare system. Once it is nothing but a welfare scheme, a future president will be able to pass laws to eliminate it. The redistribution of money from the rich to the poor sounds so fair until it grows to onerous levels. As our forefathers demonstrated in Boston, onerous taxes will get your tea thrown over board.

Mark Perry, Professor of Economics and author of the Carpe Diem Blog, makes some neat comparisons. He shows the distribution of wealth next to the distribution of baseball hits, the distribution of basketball points or the distribution of Olympic Gold Medals. The numbers follow the Pareto distribution rather than the "normal" or bell curve distribution. The Pareto distribution is commonly known as the 80:20 rule. Sure enough, 20% of baseball players get about 80% of the hits. Twenty percent of Olympians win about 80% of all medals. Twenty percent of basketball players score about 80% of all points.

Under the Obama doctrine, some of Kobe Bryant's points should be redistributed. It is unfair for Kobe to score so many points. He was born as a gifted athlete. He does not deserve the accolades he receives, especially while other players must sit on the bench, get no playing time and no points. Under the Obama doctrine, Michael Phelps should be forced to give up 7 of his 8 Gold Medals to others who won none. Michael Phelps does not deserve extra metals, no matter if he did train hard for the past 12 years. Or, perhaps, in baseball, the best pitchers should be forced to throw slow balls to the worst hitters in order to be fair to both the weakest pitchers and the weakest batters.

Obama and other democrats fail to appreciate that it is wasteful spending that needs to be eliminated. The rich man, who risks his wealth to build factories, provides jobs to his fellow man and does the government (the people) a favor. Because this wealthy man knows how to build profitable businesses (think Warren Buffet here), he produces growing numbers of jobs, growing amounts of income for workers and himself and growing amounts of tax revenues for the people (government). Government revenues grow at the same compounded rate that he grows his investments.

Confiscating the wealthy mans money in order to subsidize the birth of thousands of more kids is bad policy. The world already has enough people. We certainly do not want to be forced into following the Chinese practice of making more than one child illegal. In a free society, the government should be neutral in regard to how many children a family will have. Those who want to have 5 are welcome but the standard policy should be that they must be able to support 5 to have 5. Welfare recipients have three times the children as non welfare mothers.

When governments confiscate money from the rich man to give it like manna from heaven to the poor, bad lessons are taught. Thrift is one of the unintended victims. Both the rich man and the poor man are taught that saving and investing are pointless.


The game of politics is a hard ball game. Democrats consider it fair to attack the strategy of our Commander in Chief and our Generals and to support the strategy of our enemies during a time of war. Republicans consider it fair for the departure of the battleship strike force against Iran to be the same day as the start of the democratic convention. Democrats are willing to buy votes with the promise of robbing the rich in order to give $1,000 "tax rebates" to the poor. (The words "tax rebates" are in quotes because the poor do not pay income tax. Obama's tax plan is a welfare plan disguised in the cloth of a "fairness to the middle class plan".) Republicans are willing to suggest that the total recoverable reserves of oil in the USA are greater than 2 trillion barrels. (These figures include shale oil that is not recoverable at current prices with current technology. Still, if the impediments to discovery were removed, the energy "crisis" would be solved by market forces. Billions of people will automatically work together to solve the energy "crisis" if allowed.)

The spirit of Machiavelli is alive in politicians throughout the world. Geopolitical risks and restrictive drilling policies are artificially holding the prices of energy and gold high, but geopolitical risks have not stopped the economic train from moving through its cycles. World wide demand for commodities has peaked, this cycle. The growth of the middle class in developing nations will continue to pressure commodity prices but supply has gotten the upper hand. Substitutions are having the expected effects. (Carbon graphite is replacing steel and the price of steel is coming down.)

Companies that use commodities as inputs will be among the big winners. Intel is my favorite example here. The price of materials used is coming down on products that are in greater demand as prices come down. The real reason the cost of the chip is coming down is because of improvements in technology. The total cost for all the materials used in a computer chip is a tiny portion of the total cost of the chip. Still, the decline in the cost of materials does increase the margins on each chip sold. Billions of chips are being sold.

Geopolitical risks will fall dramatically when a deal with Iran is completed. Iran is going to be a big winner, but the rest of the world will win too. Iran now has plans to build 6 more nuclear power plants and a Turkey natural gas pipeline deal is all but signed. This is a form of the T. Boone Pickens' plan. Iran will build nuclear power plants to provide local electricity, freeing up trillions of metric cubes of natural gas for export. The abundance of natural gas, through out the world, is going to allow auto manufacturers to move in the direction of eliminating the waste perpetrated by the internal combustion engine. Nature gas can be used in internal combustion engines but also it can be used in fuel cells, at least until abundant nuclear power is available to produce hydrogen.

The invisible hand of Adam Smith is more powerful than the spirit of Machiavelli. Billions of people are working together to rationalize markets without realizing the degree of cooperation involved. It takes the work of millions of people to bring all the components of a Dell computer together at just the right time. It is the conscious effort of the few who invoke the spirit of Machiavelli.

Bush is trying to do the right thing in regard to Iran. For seven years, he has tried to end state sponsorship of terror while trying to avoid a major war. Despite his efforts, Islamic extremists are engaged in battle in dozens of countries. For example, Shabab, a group connected to al-Qaeda, is now in control of Southern Somalia. It sounds alarmist, but, if we want to avoid WW III, we must confront these extremist. Adam Smith is in the fight automatically. There are times when it is appropriate to use Machiavelli tactics in order to prevent horrible consequences. George Bush has focused a lot of forces on the problem. France is more actively engaged than anyone would have ever imagined. Saudi Arabia has funded the Pakistani attempts to eliminate the threat from the Taliban. Russia and China have voted time and again to sanction Iran. Bush invaded Iraq only after having the 100% backing of the UN security council.

If an agreement is reached with Iran, the war against terror will not be over, but a major battle will have been won. History will record that Bush made huge progress toward winning this war. Events to be played out in September are critical.


Monday, August 25, 2008


Yesterday, I wrote about the tremendous weakness in everything from the GDP in England, the price of steel and the price of shipping. World wide, economies are slowing, inflation rates are falling, and commodity prices are falling. (The US Natural gas price is down 42% in just two months!) The coming economic reports are going to be scary but promising. Stock prices typically soar when the market shifts out of inflation investments and into growth investments. This happens after the down turn in commodity prices but before the economy reaches bottom.

Today the DOW dropped more than 200 points. The decline was not all about the slower economy. The Armada that I wrote about a couple of weeks ago is now afloat. A number of military and news sites have confirmed that ships are underway or preparing to be underway. Six thousand sailors and marines are headed to the Middle East.

Two aircraft carriers and other ships are already in the area. The ships underway or departing Tuesday or Friday include the USS Iwo Jima, the USS San Antonio, the USS Carter Hall, the USS Roosevelt, the USS Rampage and the USS Vella Gulf.

The Armada includes flight decks for French and US fighters, transportation for marines and equipment, amphibious landing craft, guided missile cruisers, guided missile destroyers and attack submarines (USS Hartford plus a UK ship). A number of French, UK and Canadian assets are involved.

The departures were announced Friday and Saturday. The price of oil hardly budged. A few months ago, an Armada underway to the Middle East would have caused oil prices to soar. By my rough count, Iran has until September 19th to satisfy the negotiators. In the absence of success at the negotiating table, the US and friends are prepared to virtually stop the importation of gasoline to Iran.


When it becomes more broadly known that the ships are underway, the first reaction by many will be that the US and Russia are about to face off. To an extent, that is true. Russia has consolidated command of its Mediterranean fleet under its Black Sea Fleet Commander. Russia has assets deployed at Georgia and at Syria. The US just used a destroyer to deliver food aid to Georgia.

One of the things the media has gotten wrong is in statements about Russia not going along with the next set of sanctions against Iran. What they don't realize is that after negotiating progress was made with Iran, the toughest of the third set of sanctions was withdrawn. These sanctions have already been passed by a vote of 14 yes and 0 no by the UN Security Council. Russia and China have already voted for these sanctions.

Russia's problem with the USA and Europe is not in the handling of the Iranian situation. Russia and China protested when NATO was used like a mini-UN in regard to Kosovo. NATO's attempt to avoid another "ethnic cleansing" resulted in new borders. Russia and China have protested the actions, but, so far, the new borders stand.

The USA has about half of all the naval assets in the world. Russia's navy was allowed to rust after the collapse of the economy in 1989. Russia is rebuilding. The US has no interest in a confrontation with Russia. Today, Obama called for stepped up pressure on Iran. Obama's team is aware that the ships are already underway. Obama is on board as are the Russians. If a mission is going to be a success, a smart statesman makes sure he is "leading the band". Iran is ready to sign.

For those who do not know the whole story, it is hard to understand why Iran is being sanctioned for refining uranium while Pakistan and India have nuclear bombs. One day, we may be able to eliminate all nuclear weapons, but, until we can, we must try to avoid the proliferation of nuclear weapons.


Over the next four years, without adding a single power plant, the USA expects to increase its production of nuclear power by 4%. We will produce an extra 2 Gigawatts of electricity. Peace loving countries around the world are increasing their production by similar upgrades to existing plants.

MIT has discovered a way to boost production by another 50%! Toshiba-Westinghouse is currently working to commercialize the technology. Such technology is not going to be shared with rogue nations that secretly refine uranium.

Over the next 5 years, at least 47 Gigawatts of new nuclear energy will be built. China has a goal of producing 75 Gigawatts more within 12 years.

Some of the major companies involved are Areva, Mitsubishi Heavy Industries, GE, Hitachi, Toshiba and Shaw Group. Westinghouse is 70% owned by Toshiba.

The invisible hand is at work. Billions of people are making decisions daily that reduce the consumption of fuel. Germany is building huge wind farms, but nuclear power is going to be cheaper and more reliable. Three more plants are due to come on line this year. Seven more next year. Very large increases in natural gas and oil production is going to hold prices down until even more nuclear power can be brought online.


The political news out of Pakistan has been troubling. It remains to be seen if a smooth transfer of power will take place. However, the government just outlawed the Taliban! Bank accounts have been frozen and the government has shown no interest in being duped again by phony peace negotiations. Taliban leaders are ready to sue for peace because they are getting pounded by a well equipped government army. The Brits are sending another 4,500 troops to Afghanistan. It is great to see signs of progress.

The Armada is nothing but a tool to call an end to the games. It is time for Iran and Iraq to work out a few differences. It is time for Iran and Turkey to work out a few last minute differences. It is time for Syria to sign off on a deal with Israel. It is time for a long list of commercial projects to get started. It is time for Iran to agree to assist in the war on terror.

In Iraq today, a 13 year old girl turned herself in at the local police station. She had a suicide bomb strapped around her waist, but she did not want to go through with it. There is an awakening going on. Let us hope the powerful armada will help us reach agreement.


We have been in the second phase of the housing market where sales have started to climb in most markets, but prices are still getting hit hard in the softest markets. We are already transitioning into phase three, in which we will see both rising sales and rising prices.

Talking heads have generally taken the annual numbers to show that nationwide house prices fell 7% year over year last month. This would be the same as saying oil prices went up 79% year over year last month. The 79% is a true number because oil went from $67 to $120 but it leaves out the $147 peak and is thus misleading. The fact is that oil has fallen 20+ % since the peak. The median house bottomed at $197,000 in February. The July median of $212,000 was down 7% from a year ago but up more than 7% from the bottom. As is often the case, the number being reported, a 7% decline in price, is actually the opposite, a 7% increase in price.

Inventories of homes jumped when sales picked up. This was the result of pent up supply. Those who have been willing to sell at a certain price have jumped into the market now that they have hopes of getting that price. Just a minor turn has brought more houses to market. Because there are few new houses being completed, because there is now a tax credit for those who have not owned a home for three years, and because interest rates are falling, the overhang in supply is going to be worked off quicker than most expect.

Yesterday a local renter realized that the purchase price on a similar home would be lower than the rent. Learning about the $7,500 tax credit made the family excited. It remains to be seen if they will qualify for a loan but they are attempting to buy.

Meanwhile the 10-year treasury continues to zig-zag its way down. This morning it has been trading around 3.78%. Financial institutions not caught in the sub prime mess can offer 30 year loans at less that 5.5%. Homes purchased today should offer fat long term returns.

Real estate investors are picking up short sales and foreclosed homes at bargain basement prices. There are many signs of recovery. Some banks never offered short sales and some have stopped. Also, the recent short term bill sales by Fannie and Freddie went well.

The debt holders have bought the words of support from Paulson. The shareholders are at risk and the preferred stocks are yielding 16%. The retort is that the sale of short paper is a liquidity matter and the problem is a capital matter but the capital matter will be improved by using short paper to buy deeply discounted long paper. The irony is that it is the high spreads that will give Freddie and Fannie the ability to make the turn. Many a non government supported firm has operated for long periods with a negative net worth but a positive cash flow. I cannot recommend the shares but I will not be surprised if they survive and if they do they will bounce several hundred percent quickly.


The top 33 stocks in the NASDAQ 100 are winners this year; not bad in a tough year. Of the top three stocks in the index, two are biotechnology stocks. Celgene is number 1 and Amgen is number 3. Qualcom at number 2 and Symatec at number 4 are the two hottest "regular technology stocks".

The recent announcement of successful "manufacturing" of blood cells, through stem cell technology stirs the imagination of what is to come. The life span of humans is likely to increase dramatically as progress continues. Some time ago, I wrote about the noted scientist who believes the first man to live to be 150 will die only 10 years before man is able to live to 1,000 years. In other words, when a major breakthrough to the aging process is discovered, it will lead to a series of discoveries.

I looked up a few symbols of stem cell companies. Most are burning up their capital quickly. ACTC, STEM, CUR, BMTI, OSIR, PYMX, and MNTH are all worth reading about but all all probably risky. Some of the more established companies include Biogen, Genentech, Genzyme, and ISIS Pharmaceuticals.

Among the companies in the NASDAQ that are down this year; Cisco, Apple, Amazon, Intel, Bidu, Ebay, Google and Garmen. These firms are likely to do well over time, but, when the swamp is being drained, boats are likely to find the bottom.

Even though the central bank of the USA is trying to restart the economic engine, other central bankers are trying to drain the inflation swamp. Countries that have inverted yield curves include the UK, Germany, Mexico and Australia. Inverted curves make bank loans hard to find. In the USA, banks are avoiding making loans as they try to liquefy their balance sheets. The 10-year note has fallen all the way to 3.8% but the 30 year mortgage is still at 6.4%.

Pretty soon, the credit crisis will go away and the 30 year mortgage will fall to only 1.5% more than the 10-year note. This is kind of a chicken before the egg situation. Lower mortgage rates will make a lot of homes worth more than their mortgage balance and an improving ratio will make the banks healthier to lower their spreads.

In the countries with inverted curves it cost more to lend than can be earned. In the UK for example, a 2 year deposit earns 4.95%, which is about a half percent more than a 30 year deposit. The mentality of most investors is, why tie up money for 30 years if you can make a higher rate for 2 years. From the bankers point of view, why make a risky loan if you can earn 4.95% with no risk.

The mentality is upside down. For example, the buyer of a 30 year treasury last year locked in 4.94%. He earned the 4.94% plus the appreciation in the bond which was an additional 7% (caused by the fall in the yield to 4.6%). The total return without leverage was about 12%. Total return was extremely high for those who used heavy leverage. I made the mistake of selling bonds last year for two reasons. I failed to realize that tainted mortgage paper would freeze up so much of the worlds economy and (2) that the determination of Bush to force Iran to stop funding terror would cause a spike in oil prices far above the price needed to rectify normal supply and demand.


There is always good news to be found. Good news is often bad news in disguise. The worst of economic downturns is normally over by the time wage rate increases slow. For example, the peak in wage increases in 1990 was well in advance of the market upturn. Same in 2001. This time, the peak in wage increases was late in 2006. The slowdown in wages foreshadows lower prices for lots of stuff and therefore higher share prices for lots of stocks.

The evidence is all around you. How low will the cost of shipping commodities go? The Baltic Dry Index hit $235,000 in June of 2008 but it was all the way down to $125,000 last week. Back in 2005, it got all the way down to $20,000 when the market only thought an economic slowdown was at hand. How far will steel prices fall? China is now trying to catch up will competitors. It has lowered local and export steel prices by 15% in a month. Last Friday, when Ben Bernanke predicted falling inflation rates, he did not go out on a limb. Declines in every thing from gold to shipping costs are well underway.

The public still believes that inflation is out of control but the truth is that 76% of all goods and services are averaging low inflation rates. Things like houses, cars, furnishings, clothing and electronic goods are cheaper now than last year. Energy and food costs are the exceptions, but the average person in the USA only spends 9.7% of his budget on energy and 13.8% on food. Most US citizens are living much better today that 6 years ago. They don't believe it because their attention is focused on high food and fuel prices. Disposable income went up on average 720% since 2002! Over 10 years, real employment went up 10.5% while real personal income went up 32%! They guy making $500 a week 10 years ago and $1000 a week last year might be "hurting" because his income has fallen to $950.

The above is a very key fact in regard to buying at the bottom. The psyche of the human mind is such that we will spend twice the amount of time or twice the money to save a nickel as we are will to earn a nickel (after tax). In tough times, we become even more foolish. We might work four times as hard to save than to earn. The risk reward ratio goes up as the price of stocks goes down but we freeze up!


There is a whole new arms race developing. The US has installed new antimissile defense systems in the Czech Republic, Poland and Israel while Russia has been flopping around trying to stick fingers in its leaking bucket. Russia has made a lot of noise, but, so far, it has not plugged any big holes.

Russia has contracted to sell more surplus natural gas to Europe than it owns. In the past, it has relied on forcing satellite countries to send their natural gas through Russia. Russia has in effect "earned" a transit fee. Russia has not been happy to see pipeline deals springing up all across the Middle East. It was all the more upset about pipelines taking oil out of Central Asian markets.

The invasion of Georgia was all about trying to take control of the Baku-Tbilisi-Ceyhan pipeline. Under diplomatic pressure, Russia backed off. It has not gained control of the pipeline, but it has encouraged Ukraine, Poland and others to be closer allies with the USA. Other pipelines continue to be constructed or planned. Kazakhstan currently sends most of its natural gas through Russia's system. However, Kazakhstan is in the process of converting an oid Soviet Union oil line into a gas pipeline to China. It is also cooperating with Turkmenistan to send even more gas to China and India. The World Bank has already approved funding for a gas pipeline that will go from Turkmenistan though Afghanistan and Pakistan and on to India and ultimately China. Countries are naturally investing in more than one way to send natural gas. Natural gas is relatively abundant but it is difficult to ship.

Russia is like a kid trying to hold the ocean back from his sand castle. Maybe a big kid with a bulldozer but the ocean still wins in the long run. Russia, like the USA, uses its military might to influence economic treaties.

Russia and India are jointly manufacturing the BrahMos Missile System. This system will deliver a 660 pound warhead 250 miles. The delivery is both fast and accurate, faster than the speed of a rifle bullet. The updated model is expected to travel at double the speed, making it hard to defend against. The 660 pounds can be a nuclear warhead. India has committed to 800 of these units at a price of 2.5 million dollars each. You can see why the US is installing antimissile systems in friendly countries. The Russian's hint at their readiness to sell these and other systems to Syria, Iran and North Korea. Countries such as India can get away with playing both sides of the fence by maintaining their membership in the NAM (Non Alliance Movement).

It has been reported that Condi Rice will recommend that the President withdraw the Russian 123 agreement from congress and that talks to admit Russian into the WTO be killed. Russia would be better off to peacefully sell nuclear fuel services rather than to belligerently sell natural gas. It is obviously hard for the old bear to learn new tricks, but Condi and Bush will put the bears feet to the fire. Russia stands to make and save trillions of dollars by being included in the Global Nuclear Energy Partnership.

The first set of stocks that come to mind are Boeing, Lockheed and Raytheon. Other defense stocks include NOC, SPAB, GR and GD. I don't plan to buy these but I can see why they might work.

I am still very hopeful for deals to be struck. There are so many multi-billion dollar deals pending that it seems likely that some kind of grand compromise will be worked out. The skeptic in me thinks that the breaks will start to come in the week after the democratic convention. Complicated stuff, but economically extremely powerful stuff. The technological advances in nuclear power are sufficient to bring the price of gasoline down to below $1 per gallon within the next 15 to 20 years. Very powerful economic stuff indeed.


Economist magazine reports that Australia's Eamon Sullivan swam 100 meters in the Olympic trials at the world record time of 47.05 seconds. This was 19 seconds faster than the world record that was set in 1905! One is left to wonder how it is possible for man to continue to get physically stronger. The world has changed. Sullivan lost in the finals! The Jamaican runner who won the 100m and the 200m was a streak of lightening relative to runners 50 years ago.

On the other hand, various tribes in the high mountains of Afghanistan and Pakistan have been fighting a civil war for more than 30 years. Indeed, two tribes, the Turis and Bangnash, have been at war with one another for over 300 years! The world has not changed so much after all.

Before 9-11-2001, it mattered little to the US if there was war in Afghanistan or Pakistan. Today, we understand that the buildup of Jihadist in these mountains is no longer just a local matter. In the area of Bajaur, Pakistan, more than 1,000 war deaths occurred within the past 30 days. Many of the combatants had rather be plotting ways to kill Americans. Despite the shake up in the government of Pakistan, government troops are going after the "bad guys". Only the hard core are sticking around to fight and winter is coming. This means that the heat from campfires will allow our infrared sensors to identify exact locations. How would you like to be camping through the winter in the Himalayan mountains while hearing the buzzing of Reapers above? Reapers armed with smart bombs and Helfire Missiles.

The amazing thing is that the military is running low on bandwidth. Sophisticated high resolution cameras in numerous UAVs are taxing US satellite power. One new satellite can proved many gigabytes of bandwidth but the cost is $4 billion per bird. My friends tell me the $4 billion should be spent feeding the hungry people of the world. They fail to appreciate that if all 6.5 billion people in the world were well fed starting tomorrow, there would be 8.3 billion people in the world in 5 years and not enough food to go around. Poverty is a problem that needs to be solved but avoiding the next World War has to be a top priority because we know how to prevent world wars, we still do not know how to prevent poverty.

Pretty soon, incredible new hand held computers will open a whole new world. Apple is selling iPhones in 27 countries. The bandwidth needs are going to be huge. I still hold a few shares of LVLT which is 21st on the list of NASDAQ performers this year. The big satellite companies like RTN are not a part of the QQQQ.


Obama is a smart man. He recognizes his biggest weakness in the Presidential race is in regard to Foreign Affairs. He has wisely chosen a vice-presidential running mate who is experienced. The problem is that Biden has shown naivety and poor judgment in regard to the Iranian situation. Iran was declared a state sponsor of terrorism in 1984. No other country has done more to support Islamic fanatics. Hundreds of thousands of innocent people have been killed as a result of Iranian support. The world knows this to be true. The 15 members of the UN Security Council voted unanimously to sanction Iran because it has supported terror. When the US Senate voted to declare the Iranian Revolutionary Guard Corps and the QUDS Force sponsors of terror, Biden voted no. This vote occurred in October of 2007. Biden either voted no for political reasons, trying to win leftest democratic votes, or he simply does not understand how serious the terrorist threat is.

It took a number of years of heavy doses of financial backing for a rag tag group of Islamic fanatics to be able to pull off the 9-11 style bombings that occurred in scores of nations around the world. The US took action and has so far avoided further incidence. The action needed is not complete. The Iraqi minister of defense says that it will be 2018 before Iraq's Air Force is ready to defend the country. By 2020, Iraq will have 376 sophisticated aircraft and fully trained personnel. The US is not going to sell its most sophisticated equipment to an unstable government. It makes no sense for us to risk the gains made by pulling out now. In the negotiated deal, the US will pull troops out of major cities by next summer and combat troops out by 2011, provided progress continues. There will be additional negotiations after January to determine how many aircraft and support personnel will remain after 2011.


In the short run, the energy "crisis" in the USA is being solved largely by the discovery of natural gas. The US is currently drilling an average of about 2,700 natural gas wells per month. The price of natural gas has fallen to less than half the price per BTU of oil. Every company, utility and consumer that can is burning natural gas in lieu of oil. All the while, the powerful law of substitution is working its magic.

Today's substitution example is Carbon Fiber. Carbon fiber usage is growing in all kinds of situations but one of the fastest is in aircraft construction. Airplanes are 15% lighter as a result of aluminum being replaced with supper strong, super light weight, carbon fiber materials. Toyota and other car companies are cranking up to do the same thing. If a cars weight is reduced by 600 pounds, the total pound miles saved during the life of the car are huge. Three companies that are involved in the carbon fiber business are ZOLT, GTI and EMN.


A core holding in this environment should be the QQQQ. This is the way to own 100 solid NASDAQ growth companies.

Negative yield curves are putting great pressure on the cost of materials, at the same time the users of materials are finding ways to produce more goods with less materials. Intel is my favorite example of a company that keeps on making faster and smaller computers. The next version will be much faster than the current models and use much less electricity. Low power use is critical in mobile applications. It does not get much better than this. One can buy the premier computer chip maker at a low price even though its cost of materials are falling like stones and the demand for its products is ready to explode.

The cost of hand held computers are working their way down the acceleration curve. For example, it is absolutely amazing that Apple iPods can now be sold in India. The average citizen of India would have to give several months wages to own an iPod. As the price falls and as the average income rises for billions of consumers, the demand for hand held computers is going to soar. Baidu, Google, Amazon, Apple, Intel, Level III and satellite makers should all see huge increases in businesses over the next several years.

Friday, August 22, 2008


This morning we are seeing a strong rally in Europe. A number of bank stocks are up 4% or more. Oil producers are down.


If you drop a super ball from 10 feet, it might bounce 9 feet high. The second bounce might only be 7.5 feet. Depending on the resiliency of the ball, it will lie on the floor after a certain number of bounces.

Yesterday, I talked about the big swing, but until certain markets get a boost from an outside source, they will go down in a bouncing ball fashion.

In January of 07 the Chinese Bank Reserve Ratio was at 9%. It has since been raised about a dozen times. In August of 08, the ratio hit 18%, more than double the US bank reserve requirement. The Chinese have been applying more and more pressure to its main economic brake. In local currency, the Dow Jones Commodity Price Index went from 1240 in January of 07 to 1650 in July of 08. The price of commodities was in great demand. The last increase in the bank reserve ratio was the "straw that broke the camels back". The commodity index has fallen in two months from 1650 to 1280. The action makes one appreciate why the Core Consumer Price Index is used. The negative annualized inflation of this index for the past two months has been a minus 134%. Yet, the index has hardly changed from where it was 20 months ago. The good news is that the pressure has been taken off the core inflation rate. In the USA, it appears that the FOMC has a 2% core inflation target. The decline in commodities is going to make the 2% easily achievable.

China has not been fighting alone. The ECB, Russia, Brazil, South Korea and India were among the countries that tightened money just before or just after commodity prices broke. Saudi Arabia lent help from the other side. OPEC oil production was running at 29 million barrels per day in May but it was increased to 30.2 million barrels per day by August.

Pundits have suggested that the sharp slowdown will be over as soon as Chinese workers return to work after the Olympics. This slowdown is more than a factory holiday. Euroland's factory index peaked around 58 in 2006, it fell to 47.4 by July of 08. Japan's output growth was better than 8% in 05, 6% in 06, 4.5% in 07 and is down to zero now. India's industrial production was growing at 16% in 2006 but it hit 4% a few months ago.

What would happen to the price of a product if production went up 1.6% but consumption fell by 3.7%? During the first 7 months of 2008, oil production went up 1.6% in the USA and oil consumption fell 3.7%. Day after day, the USA is having success in the oil patch. The hottest "new" location is the Bakken Formation in Montana and North Dakota. Day after day, consumers drive fewer miles and drive a higher percentage of miles in fuel efficient vehicles. The drop in gasoline prices from $4 to $3.45 is not going to cause consumers to buy monster trucks again.

It is part of the "normal" economic cycle for prices of stocks to go up about the same time that commodities and interest rates come down. It took a long time for commodities to peak but most headed down months ago. US short rates are the exception to the rule. The economic brakes have been applied from Russia to India to Australia to Euroland. High short rates in these countries will cause long term mortgage rates to fall. The first increase in US short rates will be the indication that the US economy has been healed. Investors must always remember that the economy will not be healed until long after stocks have been rising.


BLOOD FROM STEM CELLS -- Scientist have used stem cell technology to grow red blood cells. Human trials are expected to start within two years. This could be a long awaited break through. My family routinely gives blood at the Red Cross. It is a minor inconvenience to millions of people. Add up the time and all the cost and one can see the potential for huge savings. Lives will be saved!

Another group has discovered that menstrual stem cells have very powerful healing properties. Stem cell technology is unlocking some doors that have never been opened before. It is realistic to believe that paralyzed people will walk again. It is realistic to believe that failed organs will one day be regrown.

ETHANOL FROM PLANT STEMS -- My rants about US ethanol production are against the subsides being paid to farmers and the use of food crops for fuel. Japanese Sake makers have just discovered how to use powerful yeasts to make ethanol out of plant stems. While knowing how to do something and doing it commercially are two stories, it is great to see this progress. Despite the rants by environmental extremist, the history of man is of using resources more efficiently. One day, we will efficiently "recycle" our resources. We simply should not recycle just to say we did it. If it cost more to recycle, then it is better not to do so.

Brazil has made the headlines about ethanol production even though the USA produces much more than Brazil. The difference is that Brazil uses sugar cane to produce a profitable profit and the USA uses government subsidies to give the ethanol makers a profit. The more corn ethanol we make, the more damage we do to the environment and the more harm we do to the American taxpayer.


McCain and Obama are now in a dead heat. If the votes were made today, Obama would get 264 electoral votes, McCain would get 261 and Virginia's 13 electoral votes would be counted and recounted. The above tallies give New Hampshire's 4 votes to Obama even though he leads by the statistically insignificant 1%. Only a few votes would make the numbers 260 Obama and 265 McCain. Democrats continue to hold substantial leads in house and senate races. It is unlikely that the democrats will win a filibuster proof majority in the senate. Should the current trend continue, it is possible that a switch by Lieberman could give republicans a majority.


The settlement made by investment bankers in regard to auction rate securities is another step toward the healing that is taking place in the credit markets. The buybacks of auction paper might produce some more paper write downs, but these dollars are now free at last. The jamming up in the credit markets is on the way to an end. When the FOMC is in the position to raise short term interest rates, the credit markets will rally. For now, the fear of what is next is weighing on the markets more than is reality.

Housing sales leveled off 4 months ago. One at a time, bad loans are getting paid off. Even foreclosed loans are a part of the healing process. The best housing bargains are being picked off daily. The best real estate agents are showing apartment renters that they are eligible for $7,500 interest free loans from Uncle Sam. You can expect to see improving real estate numbers in the months ahead. The declining price ball has hit the floor in most markets. It will soon be bouncing again, with each bounce being higher than the last.

Thursday, August 21, 2008


Pakistan just suffered a sophisticated al-Qaeda attack against one of its two Nuclear Bomb locations. The story was sugar coated in the NY Times and TV pundits blamed the $5 per barrel jump in oil prices on the possibility that hurricane Fay will turn around and head back to the Gulf of Mexico. (Others blamed it on the fall of the dollar but the dollar fell because of the bombing in Pakistan and the tough talk from Russia.) The final demand for oil continues to fall even though the risk premium has risen since the invasion of Georgia.

The war in Pakistan is a "big deal". Pakistan is the 6th most populous nation on earth, 167 million people. It has the 7th largest Army and it supplies more peace keeping troops to the UN than any other nation. It is 77% Sunni and 20% Shiite. Since 2003, Pakistan has been a strong ally of the USA in the war on terror. Since it joined the US, its economy has grown at an average of better than 7% per year. Saudi Arabia, also primarily a Sunni nation, has helped to fund the governments war.

Georgia has gotten a ton of press but Georgia does not possess nuclear bombs and it is no where near the importance of Pakistan. The GDP of Pakistan is not as large as Poland's, 410 billion versus 620 billion (Georgia 20 billion), but Pakistan has nuclear weapons and it is basically in a civil war against the enemies of the USA.

Believe it or not, northern Pakistan is a vacation spot for thousands of international tourist. The country covers the length of the Indus river and its many contributories. The river starts in the high Himalayan Mountains and flows to the beaches of the Arabian Sea. There are areas in Pakistan where you don't want to go, deserts that reach 122 degrees in the summer (they freeze in the winter), but Pakistan is a beautiful country and likely to be an economic powerhouse in years to come.

Pakistan has been at war with India off and on since 1947. Conditions between the countries have improved in recent years, but the Pakistani secret service has its own agenda and has been accused of supporting terror. It may have been involved in the assassination of Benito and a recent bombing in India.

Since the resignation of General Musharraf, the US has continued to strike Pakistani terrorist leaders from the air. Our eyes in the sky help us know much about who is for us and who is agin us. The government of Pakistan has been using conventional aircraft to bomb the 100's of terrorist camps. The battle with Pakistani government troops has put the Taliban between the NATO forces in Afghanistan and the Pakistani forces.

The US market is now resilient. The talk all day was about the implosion of the credit markets but the market closed higher on the day. Admittedly, it was Energy and Basic Materials that lead the way. Still, it is nice for the market to show such resilience in the face of bad news on top of bad news.


Condi Rice made a surprise visit to Iraq but the deal to keep troops in Iraq is a slippery fish. The worst of the war in Iraq is over, assuming Iran does not stir up more trouble, but the war in Pakistan has a long way to go. It would be foolish to land a slippery fish and then let it get away.

The NY Times said the bombings in Pakistan were next to weapons factories and ammunition depots, but it did not mention the site as one of two locations where the Pakistanis have nuclear weapons. If necessary, the US will correctly invade Pakistan to prevent al-Qaeda from capturing nuclear weapons.

While TV shows put up pictures of Hurricane Fay, the risk of the US going to war in another country has increased, and the country is not Russia. Russia, which has been fighting terrorist for years, is very opposed to allowing terrorist to have nuclear weapons. It may even be that the armada that is being assembled in the Arabian Sea, near the Straight of Hormuz is all about protecting nuclear bombs in Pakistan. It makes sense to embargo Iran to stop the process of building nuclear bombs, but even more sense to protect existing bombs from terrorist organizations.

While I only know a tiny bit of what is going on in Pakistan, US government employees in several agencies know in great detail. General Musharraf resigned under pressure. There is a battle between left and right within the Pakistani government. The Islamic Republic form of government has been plagued by the occasional coup or government reorganization. It is important that all nations that possess nuclear bombs have stable governments. Those who say the US should pull out of Iraq in order to focus our energy on finding Osama bin Laden are not looking at the big picture. The potential for terrorist obtainment of nuclear bombs is in Iran and Pakistan.


There is evidence that Pakistani citizens are joining the fight. The Pakistani army is a voluntary force and "awakening councils" similar to those in Iraq have begun to appear. The war in Iraq was won when thousands switched sides. Time is needed to prove that the switch is permanent, but former enemies are now killing our enemies.

None of the above changes any of the pending deadlines. The congress must vote on its budget by October 1. Iran has until around September 19 to make a key decision. The odds of the US invading to protect Pakistani Nuclear Bombs is quite low, but necessary if needed. The $5 bump in oil will be temporary. US refineries are running at only 85.7% of capacity. The demand is low enough to bring prices way down.



There has been a big swing in the presidential race. McCain has quickly seen Indiana go from leaning democratic to a significant republican lead. He also has picked up small leads in Colorado and Nevada. The most recent Zogby national poll gives McCain a 5 point lead. The average poll gives Obama a slight lead which is likely to tighten or disappear as other polls are updated.

Over the next few weeks, the election pendulum is likely to swing from one side to the other. Obama is likely to pick up points during the democratic convention and McCain is likely to take them back during the Republican convention.

McCain is in the lead because of two issues. 1) He is the obvious choice for Commander in Chief. 2) He is for reducing energy costs by increasing the energy supply. Obama has appeared "in over his head" in international affairs and he is for spending huge sums on poor ways "to save the environment". He is among those who do not understand that the lowest cost way to produce clean energy is the most environmentally friendly way. Drilling for oil does effect the environment but making all the concrete and steel that goes into the thousands of wind wills needed as substitutes would do even more damage.

Obama and McCain have pretty much battled to a political draw as far as taxes go. McCain is for lower taxes and Obama is for higher taxes but Obama does a good job of selling tax fairness. Obama is willing to take money from "the rich" in order to pay for extra babies because he wins votes with such a program. The fact that births per thousand are three times as high among those who receive welfare payments is nothing but a fact. The political backlash for bringing up the fact is too great but facts are stubborn things (John Adams). The result of Obamanomics would be more children and substantially lower wealth per person. As Hillary has so well noted, it takes a village to raise a child. All Americans will eventually suffer economic duress under the Obama plan. The common retort is that Bill Clinton presided over rapid growth, but the fact is that Bill Clinton presided over reduced spending on welfare, increased trade and lower capital gains tax rates; the opposite of the Obama plan.


Numerous cartoons and editorials equate the invasion of Georgia with the invasion of Iraq. How silly! The US went before the UN and presented reams of evidence against Iraq. Much of the evidence, including the use of chemical weapons on Iranians, Kurds and Iraqi citizens, was proven to be true. Some of the evidence has never been proven but the US went before the international court and received the approval of the main body and the unanimous approval of the Security Council. The US acted in accordance with international law. Russia's invasion of Georgia was a multiple violation of international laws.

McCain warned of the danger about 18 months before it happened and again about a month before it happened. When it did happen, he quickly gave a strong well reasoned response. Obama waffled, which has has hurt him in the polls. The primary purpose of the federal government is to protect our sovereignty.

The invasion has temporarily taken the pressure off Iran. America and Europe have turned their focus on what to do about Russia. Since the invasion, a US missile defense system has been deployed in Poland and a defense treaty has been signed. Poland joined NATO in 1999. It became a member of the EU in 2004. Russia is not pleased to have a NATO country bordering Russia. Georgia has applied for membership in NATO. Russia cannot stand the thought of having another NATO country with Russian borders. According to international law, Russia has no say in the matter.

China makes the bulk of the news about economic development but the former Eastern Bloc countries and the former Soviet States have enjoyed substantial economic growth since the fall of the Soviet Union. Strong neighbors are not what Russia wants.

Poland is more than double the size of Georgia, which is smaller than the state of South Carolina. Poland's population is 8 times as large. Georgia is a mountainous country with no large cities. Poland's GDP a couple of years back was 620 Billion Dollars while Georgia's was 20 Billion Dollars; Poland's economy is 31 times the size of Georgia. The size does not diminish the illegality of the evasion by Russia. The real point is that the West has already strengthened its relations with former Soviet and Eastern Bloc States as a result of the unlawful invasion. When a Bear comes growling out of the woods, the homesteaders seek safety and comfort among their friends.

Russia overran Poland in the late 1700's and again around 1921. Germans overran Poland several times. Yet, Poland has maintained its identity, which includes its religious history. Poland is more than 90% Christian, mostly Roman Catholic.

The Big Swing has swung. The presence of US troops in Poland helps the country go about the business of democracy with reduced fear from being bullied by Russia. Russia has never tried to manhandle a NATO country, it certainly does not want to try to manhandle a NATO country with US troops. It will take time to sort out but Russia has lost more than it has gained by invading Georgia. (Unless, some compromise negotiations are necessary to get Russia into the WTO and to get the 123 Nuclear Agreement with the USA passed).

Russia has responded to the deployment of defense missiles in Poland by holding meetings with Syria. The indication is that Russia might sell advanced military equipment to Syria. Russian hardware is a poor match for the benefits of transit fees for oil and gas out of the Middle East. The bottom line is that it is economic strength that gives a nation power. The EU is the largest economy in the world, the USA is second and Japan is third. The economic trade pouring in and out of Poland is powerful stuff relative to a few missiles in Syria.

Russia agreed to sell Iran an advanced missile defense system long ago, but it has procrastinated. Russia, like the rest of the world, does not wish to permit Iran to posses nuclear weapons. It wants to complete the sale of defense missiles after Iran has agreed to surrender its nuclear bomb ambitions. Iran will be much better off if it agrees to sell oil and gas and quits trying to become a super power. Ironically, it stands a better chance of becoming a super power by developing its energy resources than by adding nuclear bombs that can never be used to advantage.

So, the big swing away from Iran is temporary. After a "cooling off", Iran is going to once again become the focus of the international community. It is in every nations interest to reach a peaceful settlement with Iran. Besides, the confrontation between the USA and Russia over Georgia does not change the mutual benefits contained in the 123 Nuclear Agreement. Passing the agreement though the congress may be much more difficult but, one should not cut off ones nose to spite ones face. Some way or another, I believe the 123 Agreement will be completed. Perhaps as part of a "global settlement" that includes the withdrawal of troops from Georgia.

The progress in regard to the Indian 123 Agreement has been remarkable. This has been and continues to be a very complicated negotiation. The original agreement was negotiated back in 2005. To make last minute adjustments work, an International Council of 45 nations must pass the deal without objection. Japan was recently won over. A presentation was made yesterday. A meeting of international atomic energy exporters is underway today. The prospects have come from nearly impossible to better than even odds. Should the international community pass the deal, the US Congress will have the option to pass it or to let it go forward without the participation of US vendors. GE, Westinghouse and many other US companies will push for passage.


Back in 2000, US short interest rates were at 6.5% and inflation was low. The US Dollar soared. At the time, UK short rates were at 6% and Eurodollar rates were at 4.25%. The Internet bubble popped, the economy was hammered and short rates fell. The worst of the economic slowdown was about over when the events of 9-11-2001 hit the economy hard. By mid 2003, US short rates were down to 1%, UK rates were down to 3.75% and Eurodollar rates were down to 2%. By taking a ride on the BIG SWING, pushing rates from the highest to the lowest levels, the US economy made it through some tough times. The UK and Eurodollar Land tagged along, experiencing more moderate swings.

Similarly, to prevent a fast moving train from jumping the tracks, by the middle of 2006, the FOMC slammed on the brakes. The FOMC rate had climbed from 1% to 5.25% and the US held firm on the brakes for 19 months (the US yield curve was inverted 19 months). During the time that US rates went from 1% to 5.25%, UK rates went from 3.75% to 4.5% and Eurodollar rates only went from 2% to 3%. It took until June 2007 for UK rates to go above US rates. By March of 2008, the US economy had slowed so much that rates were once again pushed down. The US 5.25% of 2007 was 2.25% by March of 2008. It is the opinion of many that the FOMC held rates low too long or high too long or both. The past does not matter except as a guide to the future.

The most recent decline in US rates has not been sufficient to provide another world wide swing because the UK and the ECB are still standing on the brakes. The 19 months of high rates in the US were insufficient to bring down world wide inflation. The UK and the ECB have continued to fight inflation; their rates have averaged about double the US rate for the past 6 months or so. The swing in Japan has not been as wild but Japan also still has its foot on the brakes. Real rates are deceptively high in Japan because inflation is lower than in other nations. As a result, the economies of Europe and Japan are slowing quickly. Both Europe and Japan are close to recession.

The combined GDP of Eurodollar Land makes it the largest economy in the world. The USA is second and Japan is third. In the USA, the FOMC has let off the brakes but tight credit at commercial banks is doing the braking for the FOMC. With the three top economies in the world braking, the demand for imported goods from the rest of the world is falling. China, India, Saudi Arabia and the rest of the world are being hit by the slowdown. The verification of this story can be found in the capacity utilization rate at US oil refineries last week, 85.7%! After Katrina, working US refineries ran flat out to achieve 90% utilization as repairs were being made. Today, the run rate is at 85.7% because demand is weak.


The current situation is very similar to that of 1990. As a result of the Gulf War, oil prices had soared, but the world was in the middle of a slowdown. Headline inflation peaked at 6.38% before oil prices rolled over. Within 4 months of the peak in oil prices, the average big stock had jumped 32%. The 32% is a deceptive number because massive numbers of oil shares fell. The big stock markets averages are weighted averages. There were many stocks that appreciated more than 100% in just 4 months in order to bring the total average gain to 32%. Just like the turn in 1990, in recent weeks, US small cap stocks have been outperforming big cap stocks, again, partly because the big caps include Exxon, etc.

In 1990, when oil prices fell, the real estate market turned up. Savings and loans and bank stocks soared. Some of them doubled and doubled and doubled again in three years or less. This time there has been a bounce in bank stocks that is still being tested while Fannie and Freddie continue to head toward zero.

However, there is much more going on than the pending bail out of Fannie and Freddie. For example, first time home buyers (anyone who has not owned a home in three years) are eligible for a $7,500 interest free loan from Uncle Sam. Accountants are now showing people how the credits can be used for down payments. A second example is the actions of the FDIC in regard to IndyMac customers. Hundreds of thousands of home owners are being offered better terms. Most of these homeowners want to keep their homes, they simply need to stretch out the payments a little.

Housing sales bottomed four months ago. Even some very weak markets, such as Orange County California are now experiencing higher sales. The world wide slowdown will bring lower interest rates and lower commodity rates. While it is true that the fall in oil prices will put pressure on the price of other goods because consumers will have more money to spend on other goods, the other items are not in short supply as has been oil. Inflation is too much money chasing too few goods which means that more goods are automatically available when spending losses its focus on energy.

Many pundits talk about the turn in home building taking another year or more. They could be right, but even new home construction bounced back quickly after prior recessions. Still, inventory of existing homes is the current sword hanging over the market place. As a result, bargains can be found. Yesterday, I learned that a condo at Myrtle Beach sold for less than 50% of the price that it sold for in 2005. Three hundred ninety thousand dollars worth of loss to the seller and a savings of $390,000 to the buyer.


After the "temporary embargo of Iranian oil" pushed oil prices to $147 per barrel, a sense of calm set-in. The "temporary embargo" proved two things; 1) the rest of the world can make it without Iranian oil, 2) the UN + 1 plans to use sanctions rather than military confrontation if at all possible.

There are unconfirmed reports that Russia is sending ships to "protect Syria" and Syria reports that it is considering accepting defense missiles from Russia. The increased tensions have pushed the price of oil back up.

These tensions only add to the economic problems. In the short run, the tensions have re-invigorated oil market bulls. In the long run, the tensions increase the logic of voting for drilling in America, voting for McCain over Obama, moving forward with nuclear power with haste, and continuing to pressure Iran to make a deal. The wisdom of having bases and troops in Iraq is highlighted by the understanding that Russia would run rough shod over the whole area if the EU and the US were to stand down. If you want to pay $10 a gallon for gasoline, let Russia get its choke hold on Middle Eastern oil.

The history of Georgia is interesting. While Poland has been repeatedly hammered by Russians and Germans, Georgia has been the stomping ground for Persians, Turks and Arabs. That is until Russia entered the territory some 90 years ago. Turks, Arabs and Persians have never been what you would call fond of Russians. Islamic tribes have fought Russians for decades.

Turkey does wholesale trade with Russia and encourages Russians to vacation at Turkey's resorts, but Turkey's oil pipelines carry oil out of the Middle East and into Europe. Russia covets pipelines, but (perhaps due to private communications between the US and Russia and Europe and Russia) stopped short of taking the pipeline that runs through Georgia. Iran is a close ally of Syria and Iran (Persia) would like to once again become the Persian Empire. It wants to own Georgia and beyond. Interesting also is that Georgia is 85% Christian and 10% Islamic. Clearly, Christian, democratic Poles and Christian, democratic Georgians want the Russians to go home. It is a thorn in Iran's side that Georgia accepts the military council of the Israelis.

The table has been set for some interesting political conventions and, alas, it is still 18 days before the congress comes back into session. Both parties are ready to drill. Democrats will not allow an up or down vote. Major issues are not going to be resolved during the first days of the return of congress. One of the firm deadlines is the fiscal year beginning on October 1.

Central bankers around the world are currently unified around the goal of "starving Iran out". The vote on drilling is being timed to occur around the deadline that has been given to Iran. Incumbent politicians will vote for a drilling bill at an opportune time, just as central bankers will release their strangle hold on the worlds economy at just the right time. The tough part for investors is the "hurry-up and wait". Even the Fannie Mae, Freddie Mac crisis will be solved at an appropriate time.

Hank Paulson has gotten what the investment banking community wanted. He has already announced that he will return to the private sector in January (Presumably back to Goldman Sachs). He is currently in control of the fate of Fannie and Freddie. The government can bail out or close these institutions at any moment. The bail out could be an infusion of capital that allows them to survive as crippled reminders of the folly of two headed Government-Private Corporations or the bail out could be the buyout by the government.


Tuesday, August 19, 2008


We all know the old saw that you can't have your cake and eat it too. Still, some folk see depression if the economy continues to slow and hyper-inflation if it speeds up. In effect, they see stagflation, a beast that hides out with Sasquatch. Sasquatch and Stagflation are often spotted just briefly at the tale end of recessions. The US exception being the late 1970's when the misery index (the sum of the inflation rate and the unemployment rate) went through the roof.

Thirty-year home mortgages average slightly more than 1.5% above the 10-year treasury bond rate, in normal times. These are not normal times; or, are they? Numbers have a nasty habit of returning to normal but aberrations can last for decades.

During the 36 years, from 1966 until 2002, the baby boomer generation born after WWII went from teenagers to retirees or near retirees. Prior to 1966, home mortgage rates were seldom above 6%. From 1966 until 2002, mortgage rates stayed very high, the moving average stayed above 6.5%.

By 2002, a combination of factors caused inflation rates to fall. Inflation is the result of too much money trying to buy too few goods. By 2002, China was producing goods like crazy just as the baby boom generation was finally saving for retirement. Many boomers added chunks of money to 401-K retirement plans. Year after year, the price of manufactured goods fell.

As usual, the pundits got the story upside down. The pundits said that Americans were not saving. In truth, Americans net worth soared. Part of the savings was hidden by the accounting system for 401-K deposits and withdrawals. A $10,000 deposit might grow to a $30,000 value and then be withdrawn. The result according to government account was $20,000 of "negative savings". Millions more were saved through the process of buying and maintaining homes. Millions of people paid down principle on mortgages, bought building supplies at Lows and Home Depot to add to their home, and put sweat equity into their homes, when they sold the homes for capital gains, they got no credit for ever saving any money.

Inflation also fell because trade doors had been opened. The best way to increase the supply of goods is to be open to around the world competition. Inflation also fell as a result of productivity. The amount of goods available is increased as a result of productivity. US trade is growing at double digit rates. The extra good news is that exports are booming.

In 2003, the 10-year treasury bond hit 3.3% and the 30 year mortgage went down to 4.8%. The lower the mortgage rate, the more valuable the home. Home prices soared. American families, who had never "saved a dime", found they had substantial wealth. Americans do poorly with stock investments because, outside of 401-K accounts, they refuse to buy when times are tough. They buy when times are good, paying high prices, and they chicken out when times are tough. They do much better with homes because they hold on during the tough times.


The doomers believe the US economy is in deep recession. They believe nominal GDP is going to approach zero over the next two to four quarters. Since the rate on the 10-year treasury bond averages about the same rate as the nominal GDP, if nominal GDP falls to 2%, the ten year bond will approach 2% and fixed rate mortgages will approach 3.5%.

Doomers tend to forget that the invisible hand of Adam Smith is always at work. The higher the price of oil, the greater the incentive to produce oil; the lower the growth of the economy the cheaper the cost to purchase houses, the largest asset owned by most Americans. Jobs are still plentiful. Salaries tend to hold up or go up; a stable pay rate can make one all the more qualified to buy a home as the interests costs fall.

The doomers will retort that it is real GDP that will be negative while the nominal GDP is kept up by a very high inflation rate. On the way up, inflation hawks said it was foolish not to count food and energy in the inflation rate. They said the core rate misrepresented inflation because we must eat and we must consume energy.

The assumption that rapidly rising food and energy prices means very high inflation is a poor assumption. Again, inflation is too much money chasing goods. If a family has $1,000 to spend on goods and services and if food and energy costs double from $100 to $200, the family still spends $1,000 per month. They simply shift their spending around. Sure, families may borrow to meet unexpected jumps but the debt must be repaid. The average expenditure remains at $1,000 per month until incomes rise. Inflation is a weighted average of cost. A family that spends an extra $100 on food and energy while reducing its newspaper, telephone and vacation budget by $100 has maintained the family GDP at $1,000. Because families are afraid of how bad the economy will get, for the first time in a long time even the official measures of savings are positive.

The inflation hawks who focused on headline inflation on the way up, should focus on headline inflation on the way down. The price of gasoline has fallen from above $4 to the $3.58 range and based on current wholesale prices, gasoline will be at $3.39 in a week or two. Headline inflation is now being pulled downward by falling energy prices. If inflation is falling and if GDP is slowing, the 10-year bond rate should be falling. It is. In the past few weeks, the 10-year bond has gradually moved lower by about half a point. It is currently at 3.81%, implying 30-year mortgages of as low as 5.3%. One of the lowest rates seen in many years.

OOPS, let's not forget about the credit crunch. Banks were hammered when the value of trillions of mortgage backed securities fell by an average of about 5%. Five percent does not sound like a terrible disaster but the worst performers were concentrated. As a result, banks are in a short term scramble to increase their capital ratios. Thirty year rates are running at 6.4%. As the treasury rate falls, the value of the holdings of the banks will soar. Soon after, they will be eager to lend.

DSL, a savings and loan company has fallen 94% in value even though it has solid core deposits. It would be a gamble to invest in DSL but there is risk in all investments. Should this savings and loan survive, it will likely double and double again in price.


If one only looks at the rates offered by the FOMC it looks like money is lose, however, money is printed when it is lent, deposited and lent again. By raising credit standards, banks have slowed the velocity of money, by saving more of their incomes, consumers have slowed the velocity of money. To keep GDP from falling down the tube (GDP = M x V), the FOMC has had to increase the supply of available money. In good times, a $1 increase in M by the FOMC results in a much higher GDP as that $1 becomes $5 due to the magic of the multiplier effect (again, it is deposited, lent, deposited, lent).

Money supply charts show that the FOMC has not had to flood the markets with money to the degree of past tough times. For example, immediately after 9-11-2001, the FOMC opened the discount window wide. Suddenly 0% car loans were available and auto sales soared. A potential depression was averted.

Besides, the FOMC is not the only central banker. The FOMC stayed tight for 19 consecutive months, throughout most of 2006 and 2007. The US economy slowed. Today, central bankers in the EU, Australia and many other countries are keeping their foot on the brake. The worlds economic train is definitely linked. It is linked in multiple ways which makes those who look for one constant link loose faith but the links are always there. If the money chasing goods in the EU is sopped up, it affects the demand for goods in the USA.


When gasoline went above $4 per gallon, the congress looked for scapegoats. An attempt was made to sacrifice speculators on the temple alter. The fact of the matter is that speculators generally level markets and reduce prices. The more speculators you have, the more likely you are to have fair prices.

Nice bargains can be found at public auctions. For example, I once purchased a Lone Ranger - Merita Bead advertisement for less than half its value because there were few bidders. The same sign on EBAY at the same price would have attracted hundreds of bidders. Hard commodities markets have gotten most of the attention, but the financial futures are where the action is.

One form of financial future is the interest rate swap. An investor who believes inflation is going to soar should bet on rising interest rates. He should sell long term bonds, even though he has none to sell. He might accomplish a sale by entering an interest rate swap.

With the 10-year trading at 3.8% and short rates trading at 3. He might swap the interest on one million dollars worth of bonds for interest on 1 million dollars worth of short rate funds. In other words, he would agree to pay 3.8% or $38,000 in interest per year in exchange for a variable payment to start at $30,000. The settlement is in net payment. Thus, stable rates would leave him with a loss of $8,000 per year. If the yield curve steepened, as a result of a fall in short rates, he would lose more than $8,000 per year. If short rates were to soar to 6.8%, he would collect a net of $30,000 per year. A business might enter such a swap to offset the risk inherent in a business project.

The above example was simplified by excluding the risk premium. A few days ago, the 10-year swap rate was at 4.7%. The difference in the 3.8 yield and the swap rate is the risk premium. In this case, the risk premium being "charged" by the market is .9%.

Swaps can be made between currencies. "You pay me the London short rate and I will pay you the US short rate."

Tight money in Europe, Japan and Australia is causing these economies to slow. The slow down in one nation influences the GDP of its trading partners.

Commodities and interest rates tend to trade together. The slowdown in world economies is reducing the price of oil and the price of money. The difference in the price of short term money and long term money is a difference of leverage. Mortgages represent highly leveraged money.

If you believe the economy is weak, then you should consider buying levered financial assets, such as banks or savings and loans that hold mortgages. You could also purchase long bonds or you could do the reverse of the example swap from above. You would pay $30,000 to receive $47,000 but face the risk that the $30,000 would increase.

Big banks such as WB and BAC hold substantial amounts of long dated paper. Surely, some of it is hedged, but obviously a lot was not as shown by the steep decline in the price of these stocks.

The levered financial assets will pop before real estate prices pop. The real estate market will not show much strength when the offers to purchase rise enough to start taking out the lower rung on houses available. In other words, a lot of sellers are refusing to lower their price more but are waiting for the market to recover. About one third of the metropolitan districts saw rising sales last month.


If you are planning to buy a home, now is the time. Bargains are being picked off daily. Because the trade doors have not been closed, because productivity is still soaring and because demand from boomers has slowed, the risk of greatly higher interest rates is low. One can buy right now on favorable terms. NC Credit Unions are offering variable rate loans tied to the one year treasury index. The index fell to 1.5% a few months ago but is currently at 2.3%. Add a Credit Union spread of 2.5% and you have a 4.8% loan!

A bargain price at a bargain rate! With prospects good that the slowing economies of Europe, Japan and others will cause less demand for goods, lower inflation and lower long rates. Those who take out a variable 4.8% rate today, may soon be able to refi at 5% for 30 years.


The congress will reconvene on September 8. The deadline for passing a CR is September 30. Will the congress pass an energy bill before the deadline?

Russia has thrown a monkey wrench into the negotiations to admit Russia to the WTO, to pass the US-Russian 123 Agreement and to negotiate a settlement with Iran. Or has it? Passing the 123 agreement right now seems to be a stretch but both countries have much to gain.

Yesterday, Iran had more discussions with the IAEA and then made a big to do about contracting with 6 companies to find suitable sites for nuclear power plants. It is known that the UN + 1 has offered to assist in the construction of at least 1 additional Iranian nuclear power plant. Could it be that another step has been taken toward a final deal?

Turkey has not been the best of friends with Iran but the two countries have recently discussed pipelines and trade. Turkey, like so many countries in the region, has to walk a narrow path between Russia and the West. Under pressure from the USA, Turkey decided to wait at least a month before making a deal with Iran. Iranian deals with dozens of nations are pending. I believe the "hard deadline" with Iran is September 19.

A month from now, the congress will be locked in tough debate and the Iranian - Russian - Iraqi situations will be arriving at a head. Between now and then, oil prices should trend lower, home sales in many markets should show small improvement and long interest rates should trend downward.

The see-saw is low interest rates push up home prices. How weak is the economy? How low will oil and interest rates go?