The Future of the Euro

The fire and brimstone clouding the European sky is not the volcanic ash from Iceland but rather the bleak outlook for a unified currency. To put it mildly the Euro is doomed, it is just a just a question of how the entire scenario unfolds.

Currencies only work for a nation when their own central government has control over the money. A country using a currency while ceding control of the exchange mechanism simply makes the nation a victim of all the other entities using the notes. Germany and other northern European nations recently learned this harsh lesson. The Euro worked while all the economies across the continent were rising, but quickly imploded when a recession occurred. The southern European nations with poor financial controls that that have historically defaulted multiple times are now in a position to collectively drag down the entire collection of economies due to the common currency. Prior the Euro these countries would default and their individual currencies would be devalued.

It is true that the more people that use a currency then the stronger the value. Witness the strength of the deutschemark after the inclusion of East Germany. However a country must have sole control over their currency and not yield power to a central authority in order to be successful. I found that the Germans were very supportive of the merger of East and West Germany despite concerns over the poverty in the East at the time. Today, Germans are outright furious that the country is bailing out Greece and other nations. Most of the people on the street recognize what is going to happen next which is why they are lining up at banks to demand Euro notes with X’s in the serial numbers that are associated with Germany and not other countries.

While the entire situation can play out in multiple scenarios; there are two obvious ones. The first is that the Euro will divide into two segments, the stronger northern European nations with one version of the Euro and the southern European nations with a version of the Euro which is next to worthless. This explains why German citizens are lined up demanding “their national Euro notes”. It is likely that outside notes will soon be devalued.

The second possible scenario involves individual countries withdrawing from the Euro exchange mechanism and reinstituting their own national currencies. A good number of barriers and political negotiations will have to be overcome to allow this type of withdrawal. On the other hand people rioting in the streets generally has the tendency to make central union decision making to move with more haste.

Another likely scenario involving individual nations withdrawing from the Euro focuses on the central union giving countries with debt problems the boot and demanding that they withdraw from the Euro. As the size and scope of the debt issues become more apparent there will be a greater howl across the continent for the offending nations to withdraw.

In the long term where will this leave the Euro? It would be best if it was used as a basket of currencies for international trade as it was originally intended – 23% franc, 34% deutschemark, etc. rather than being used as a universal note in retail trade across the entire EU block. The disbanding of the common Euro is the best solution and the obvious path for continent.

Humor: The Story of the Banks in Iceland

It started with bankers in the U.K. asking 'Where can we find some pansies to sell this CDO crap to?"

UK "We are going to make ourselves rich by selling wothless CDOs dressed up as jewels to your fishermen banks"
Iceland "Yeah we are getting rich.... Big Party."
UK "We will even sell short and bet against the crap we sold you"
Iceland "Hey, this stuff melted down and is worthless."
UK "By the way we expect you to tax all your citizens 3 million dollars each to make up for our 'losses'".
Iceland "FU - stuff it. We voted and ain't paying."
UK "We'll start seizing your international assets till you pay."
Iceland "FU. Enjoy some volcanic ash."
UK "Stop.... you're sinking our economy!"
Iceland "Maybe you should of thought about that before you demanded repayment on the worthless crap you sold us."
UK "Choke....cough.... choke...."

Today's Cartoon

Analysis: SEC vs. Goldman

The civil fraud charges filed by the Securities and Exchange Commission Friday accused Goldman Sachs of "defrauding investors by misstating and omitting key facts". These financial charges also mark a new era of government regulatory enforcement of Wall Street. No longer will the SEC simply come to consent decrees with financial firms where they do not admit guilt and in most cases pay a small fine viewed as a cost of doing illegal business.

One immediate question is how do the SEC charges filed against Goldman Sachs change the playing field? Do these charges even mean anything in a broader regulatory context? In my opinion, the actions from the SEC on Friday defines a new playing field by Washington marked with the following game-changing alterations:

a) A broader effort to get the derivatives market properly regulated to minimize the possibility of future meltdowns.
b) The Goldman Sachs charges are expected to be the first of a lengthy string of government actions against multiple firms that contributed to the financial meltdown. The lack of accountability by firms which accepted bailouts is no longer acceptable to main street and their representatives in Washington.
c) A dismantling by regulation of firms that are "too big to fail"; including the scaling back of previous government legislation that allowed the merger of commercial and investment banks.
d) The teeth of the SEC are back in place. For the last twenty years the SEC has been a toothless enforcement entity; forcing state AGs to take a leading prosecution role in financial malfeasance. This is likely to be the start of a change where the federal government will have deep roots in the policing of problems involving large financial firms.

The roll out of these regulatory reforms are expected to take years; however as noted by an AFP news article "We suspect that after Friday, others on Wall Street may have a harder time sleeping."

Another good clip is Ratigan on MSNBC where he compares Goldman Sachs to an automobile manufacturing company that deliberately took critical component from the inside of cars (CDOs) and then sold the cars as being great investments while betting on the side that the cars they created would all blow up spectacularly. An apt analogy - watch it here.

A Tale of Two Depressions

Finally, an article complete with charts that compares the economic decline in 1929 to the situation today. After reading the information, it leaves little doubt the the current scenario in terms of industrial output decline and other factors is worse than the 1930s. It only leaves the question if the government policy reponse of massive stimulus and bailouts will actually improve the economic recovery this time around.

A Tale of Two Depressions
http://www.voxeu.org/index.php?q=node/3421

Today's must read article

One article showed up in my inbox today which is an excellent read. It has some solid information describing the differences between a Recession and a Depression mixed into the overview. Ray Dalio, founder of Bridgewater Associates and manager of what is now the world's biggest hedge fund, believes we are in the middle of a global depression.... or a 'D-process' as he calls it.

Inside the world's biggest hedge fund
http://biz.yahoo.com/hftn/090319/031809_okeefe_bridgewater_fortune.html?&.pf=retirement

"Most people, says Dalio, think that a depression is simply a really, really bad recession. But in reality, the two are distinct, naturally occurring events. A recession is a contraction in real GDP brought on by a central bank tightening monetary policy, usually to control inflation, and ends when the central bank eases. But a D-process occurs when an economy has an unsustainably high debt burden and monetary policy ceases to be effective, usually because interest rates are close to zero, and the central bank has no way to stimulate the economy. To compensate, the value of debt must be written down (risking deflation) or the central bank must print money (a trigger of inflation), or some combination of both."

Trillion Dollar Bailout

Come play the game: Trillion Dollar Bailout

"Punish greedy fat cats and save honest peoples! Hand out moneys to homeowners. Put the hurt on dudes in suits! Do it right and save the world!"

Drag the slap symbol to deny a bailout and drag the cash bag to provide assistance to the various characters that pop-up.

Here are some hints - don't give the money to banks & only give to homeowners who are not in foreclosure. Go to the Addicting Games site to play.

The Math that Destroyed Wall Street...... and Main Street

Wired magazine recently presented a good article about the underlying math which destroyed Wall Street.

Recipe for Disaster: The Formula That Killed Wall Street

Page 3 actually outlines the basic math of the Copula Function approach which underlies the CDO market.

The Socionomics of the Russia Georgia conflict

Socionomist and EWI Analyst who predicted Russia-Georgia conflict to appear on Bloomberg TV today at 5:30 p.m. ET.

In November 2007, the Socionomics Institute’s Alan Hall issued the 20-page research report, "Sizing Up A Superpower." It assessed the relationship between Russia's turbulent history and its then-current social mood.

More specifically, he spoke of "Georgia's desire to bring its pro-Russian separatist regions under control, but Russia has military plans to stop any move by Georgia to secure these regions."

Mr. Hall will discuss the developing situation in the region today, Tuesday, August 12 at 5:30 p.m. ET on Bloomberg television. Be sure to tune in! You can stream Bloomberg TV live online here.

See http://pages.tvunetworks.com/ to download their player.

Gas at the Pump

A HingeFire survey early this summer asked readers about the projected price of gas at the pump on August 1st. The results showed the following:

Over $4.50 23%
Between $4.00 and $4.50 43%
Between $3.50 and $4.00 17%
Between $3.00 and $3.50 13%
Below $3.00 2%

The actual nationwide average price was $3.84 at the beginning of August. Congrats to the 17% who selected the $3.50 to $4.00 price range (I actually believed it would be above $4.00).

The good news for consumers at the pump is that it appears that the short term speculative bubble associated with oil has burst over the past couple of weeks. This will help both the market and your wallet when filling up the tank. As a note, 68% of readers in the most recent HingeFire survey believed that oil was in a speculative bubble. At this point, many analysts would say this perspective is correct.

Fear grips banking customers in Venezuela

The march towards nationalization continues unabated. Over the past year the oil, telecommunications, electric, and steel-making sectors have been impacted in President Chávez’s ceaseless drive towards a socialist paradise.

Now the crisis has spilled over to the financial sector as the government seized control of a large Spanish-owned bank, Banco de Venezuela. Nervous depositors lined up seeking reassurance, and many fear a run on the bank in the coming week. Not helping matters, the central Venezuelan bank has been vague in attempting to reassure depositors that the banking system was solid.

Nearly all the companies seized by the government have been run into the ground over a short period of time; productivity has dropped and the feeble earnings have not been reinvested back into the companies.

Venezuelan bonds fell Friday for a second day reflecting “fears over the possible collapse of several banks because of rules forcing them to sell $5 billion of complex securities called structured notes. Banks bought the notes last year at values tied to high black-market rates of the dollar, exposing some of them to huge losses after the local currency, the bolívar, strengthened this year.”

Attempts of individual banks to negotiate their way out of the crisis has not paid returns as the IMF and World Bank have effectively shut off the spigot after being threatened with expulsion by Mr. Chávez.

Even the high price of oil can not cover the cost of large scale programs in Venezuela beyond the next couple of years. Any significant drop in the price of oil will cause an immediate fiscal crisis. At 32%, Venezuela also is experiencing the highest inflation in Latin America. Food-based inflation is above 52%, a crushing level for most of the population. The fiscal crisis and high inflation levels can be directly linked to government policies. This has left the poorest portion of the population, which Chavez claimed would be helped by the government’s policies, in even greater despair.

Global Inflation: The New Crisis

A new monster has raised its ugly head to spook investors. Inflation is accelerating at a rapid pace providing policy makers with a new set of ulcers. Unfortunately basic antacid tablets will not cure the unsettled guts of national regulators.

The spike in inflation gives flashbacks to the dreaded 1970s with stagflation era. Many older investors do not enjoy reminiscing about interest rates above 14%, food rising in price each week, investors hoarding gold coins, and long gas lines. The dilemma is that all the statistics indicate that we are heading towards a scenario with run-away rising inflation worldwide.

Regulators have commented on rising inflation, raised interest rates in hopes of moderation, and are shocked to see the numbers running upward like an out-of-control train down the tracks. With rising commodity costs, pent up wage increase requirements, and tightening credit; there is not very much the regulators will be able to do to apply the brakes.

Certainly the news flow has not been encouraging, the ECB raised lending rates today amid record inflation, while U.S. Treasury Secretary Henry Paulson said inflation was becoming the top economic focus of many countries.

Inflation is a global phenomenon; impacting countries as diverse as Iran (with 26% inflation), the Philippines, Brazil, India, Russia, South Korea, Mexico, and Indonesia. No country is immune and no market is safe. Rapidly increasing inflation is the top concern in most nations, and the situation rapidly appears to be heading towards stagflation.

The immediate question becomes how should an investor prepare for this situation? The first emphasis is that a greater portion of your portfolio needs to be placed in commodities and precious metals, or in stocks focused on these industries. There is also a need to have your income oriented investments placed in vehicles which are inflation indexed in regards to interest rates. The other alternative is the keep cash in shorter term CDs as inflation and interest rates rise, allowing an investor to ride the rising curve.

Successful investing in a rising inflationary environment is difficult. Usually the stock market returns are dismal and many other investments are also victims of an inflationary spiral. Still it is best to keep your focus on the long term, and maintain a diversified portfolio of stocks that have wide economic moats. These companies invariably become stronger in downturns as competitors fall by the wayside.

Investors should pay close attention to news about inflation during the remainder of 2008 and start making appropriate adjustments to their portfolio to ride out the storm.

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Legal Nirvana

Nothing warms the hearts of corporate executives at public companies like the vision of class action lawyers being locked up in a cell. Especially when the visualization includes the lawyers responsible for 50% of the class action suits in the United States over a decade period.

Even more amusing is having one of the lawyers derided in the front page of a major newspaper for declaring that he is innocent, despite all the obvious evidence to the contrary. I expect that lawyer jokes will be at the top of the list in the executive happy-hour circuit during the month of June.

Serving Time, but Lacking Remorse

Q: What's wrong with lawyer jokes?
A: Lawyers don't think they're funny and other people don't think they're jokes.

Is Oil in a speculative bubble?

Oil continues to trend upward with some pull-backs. It is an open question if the increases merely reflect a speculative bubble, or is indicative of real supply and demand.

Take the new survey at the top left of the blog to voice your opinion.

One interesting regulatory change over the past couple of weeks is the tripling of margin requirements at the energy exchanges. The New York Mercantile Exchange (Nymex) and ICE Futures Europe in London have boosted the margin required by speculators to make trades. The exchanges are hoping that the margin calls will reduce volatility and keep the lid on speculative price increases in the energy markets. On the day the changes were implemented, oil dropped by more than $7. Since this time however, the price has recovered to near $130.

A number of officials such as U.S. Treasury Secretary Henry Paulson have stated that high oil prices are here to stay, and are reflective of the world supply and demand situation. Jim Rogers agrees, stating that the oil bull market has years to go.

Other sources state that oil is in a classic bubble. No different than houses, dotcoms or tulips. The article in The Times makes the case that the oil price increases are not attached to reality, and outlines the case with some compelling numbers.

This leaves the question. Is oil in a speculative bubble that will pop before the end of 2008? Or do the price increases have years to go?

One truth is that bubbles always tend to go on longer than any pessimist ever believes it can; and eventually crashes harder than any optimist ever believed was possible.


The last survey – Gas at the Pump

The last survey on the price of gas at the pump showed that 43% of the poll takers expected gasoline to be between $4 and $4.50 per gallon on August 1st. 67% of the responders expected gas to be above $4 per gallon.

Wall Street’s Graveyard

Bear Stearns was not the first firm to implode and float belly up on Wall Street. Portfolio.com takes us through the colorful history of other firms that have gone kaput since 1970.

Greed and lack of risk control is not a new story. However the danger in the modern era is that many of the firms are built on a mountain of derivatives and the collapse of one can lead to a cascading failure of others. Increased regulation of the derivatives market is needed to prevent this type of event.

Nuveen finds a way out

Investment firms such as Nuveen that offer leveraged Muni Closed End Funds have been suffering an inordinate amount of stress over the past few months. The auctions of preferred securities issued by the companys' municipal closed-end funds continues to fail; leaving most of the firms in a situation where they need to either forced to redeem their preferreds or make other financing arrangements.

Earlier HingeFire articles outlined the issues in the market (see Auction Rate Stress Continues: Muni Bond Funds Impacted and Revisiting: Muni Bond Fund shorts).

Nuveen has obtained a commitment of up to $1.75 Billion to refinance the struggling auction rate preferred securities. This enables the company issue variable-rate demand-preferred instruments to replace the current ARPS. This effectively alleviates the pain be endured by Nuveen and places the firm’s Closed End Fund (CEF) products back into a liquid situation. The company has also taken steps to remarket the new shares with another financial firm.

These measures are excellent news for the holders of the Nuveen muni CEFs – most whom are common investors looking for tax-free income with minimal risk.

Nuveen gets infusion for auction rate securities

Your Tax Dollars at work: Housing Bailout

Want to know where $1.7 Billion of your tax dollars are going? Thanks to Congress your money is going directly to bail out speculators and irresponsible lenders.

The Senate leaders moved closer today to passing a bill that would provide $300 billion in direct mortgages to homeowners; requiring a reduction in principal and cost basis so these homeowners will not be under-water. The majority of these homeowners would never have received loans under traditional lending criteria. Many will still go into foreclosure eventually even under a government financing program, leaving taxpayers holding the bag.

This Senate bill will be merged with an earlier bill passed in the House, Congressional analysts have estimated the House version of the bill would cost taxpayers $1.7 billion. It is an open question of how much the Senate measure would tack on to this.

Despite the twisting of words from politicians that Fannie Mae and Freddie Mac are actually “funding” the mortgage measure, the reality is that every last dime of this measure is backed by your tax dollars. So much for moral hazard, the only lesson learned in the housing fiasco will be that it pays to speculate in the housing market for both gamblers and financial institutions. Washington will always be happy to bail you out of your mistakes.

Dodd, Shelby Agree on $300 Billion Mortgage-Insurance Measure

Venezuela: The slide continues

Hugo Chavez is still running amok in Venezuela. Despite voters rejecting a referendum giving the president sweeping power over the economy a mere few months ago, Chavez has taken steps over the past weeks to seize more businesses.

Chavez is driving the take-over of Sidor, a large, Argentine-controlled steel maker; cement companies owned by Mexican, Swiss and French investors; more than 30 sugar plantations; a large dairy products company; and a sprawling cattle estate on the southern plains…and these firms are just a component of overall list.

As expected these moves have spooked foreign investors and infuriated neighboring countries (whose public companies own many of the assets). The compensation offered by the Venezuelan for these companies is under 20 cents on the dollar. Foreign investment in Venezuela has hit record lows, with only $500 million investing in 2007 as Chavez nationalized electric, telephone, and oil companies.

All this socialist exploitation has tanked the Venezuelan economy, which is now beset with foot shortages, building supply problems, and a lack of many other staples. At a time where many other South American economies are booming, the Venezuelan bolivar currency is in free-fall with the black-market rate climbing over 20% in the past couple of months to 3.4 per dollar. The government moves to prop up the currency have failed miserably. One can only expect that the name-sake of the currency, Simon Bolivar would have been shocked at government policies that are so destructive to the people, if he was alive today.

Only high oil prices are propping up the centralized economy of the nation. Of course this is only a short-term situation because oil production is drastically declining at the oil wells seized by the government. The entire government house of cards will fold as oil prices or production fall, further illuminating the reality of why centralized economies do not work. It is one thing to have social programs in countries that aid the poor, homeless, aged, and disadvantaged; it is another thing entirely to seize companies that your entire productive economy is built upon.

Looking ahead one can only expect further unrest and economic turmoil in Venezuela. This situation is unfortunate since the country is rich in natural resources and formerly endowed with a rising economy prior Mr. Chavez’s administration.

Chávez Seizes Greater Economic Power

Recession Proof Cities: Raleigh makes the list

With over 40,000 people moving to the RTP area each year, the Raleigh area has made another list - America's Recession-Proof Cities. Charlotte (NC) also made the top 10 list, as well as many cities in Texas.

Surprising many, San Jose (CA) is also on the recession proof city list due to the strength of the Silicon Valley economy. However Forbes offered the following note of caution regarding San Jose.

And in the San Jose area, the median home sale price is over $830,000. That's 11% higher than it was in the fourth quarter of 2006, helping to land the area at No. 4 on our list. Problem is, that growth has since cooled, and it remains to be seen whether pricey homes coupled with a 5.3% unemployment rate will cause trouble for homeowners this year.