Back on the job…

USA Today was in a blue mood on Friday. The stock market fell more than 300 points the day before, after its reporter realized that falling commodity prices were not necessarily such good news.

"Investors fear that crashing oil, coal and platinum prices signal something far more sinister: a sharp business slowdown abroad that could crimp the economy here and hamper US corporate profits."

Retail sales are weak. On Friday, we reported that unemployment is at a five-year high…and foreclosures have hit a new record.

Of course, when you sell houses to people who can't afford to pay for them, you have to expect to get some returns. And you have to expect that the folks who financed the mortgages will regret it. In the case at hand, the investors who bought shares in the mortgage twins - Mac and Mae - have already lost 80% of their money.

And yesterday, the U.S. government seized control of the mortgage giants. The New York Times reports:

"Hurricane Hank swept through the nation's capital yesterday with gale-force regulatory winds and a tidal surge of federal cash, upending two of Washington's biggest enterprises and permanently changing the landscape of housing finance in America.

"In wresting control of Fannie Mae and Freddie Mac, and in authorizing the Treasury to begin purchases of mortgage-backed securities, Secretary Henry M. Paulson Jr. has taken responsibility for assuring that low-interest loans will continue to flow into the country's hard-hit housing markets. Not since the early days of the Roosevelt administration, at the depth of the Great Depression, has the government taken such a direct role in the workings of the financial system.

"Although the details of yesterday's takeover are complex, the rationale is quite simple: to restore some semblance of normalcy to the housing market. Paulson and other policymakers think that until that happens, neither financial markets nor the wider economy will be able to regain their footing.

"Fannie and Freddie did not go gently into conservatorship. Although their access to badly needed equity capital had dried up and their borrowing costs had increased, they had hoped that they could muddle through by raising fees and demanding higher interest rates from borrowers. But that plan was cut short when Paulson, backed by Fed Chairman Ben Bernanke and their newly empowered regulator, James Lockhart, concluded that Fannie and Freddie could no longer reconcile their sometimes-conflicting obligations to shareholders and homeowners without posing additional risks to an already shaken financial system.

"Under the deal they could not refuse, Fannie and Freddie directors and top executives will lose their jobs. Shareholders will lose their dividends, voting rights and most of their ownership stake, while agreeing to pay dearly for the government's money and backing. Left unharmed will be holders of trillions of dollars in Fannie and Freddie debt - or securities backed by mortgages that Fannie and Freddie have insured against default - who will get all their money back, with interest."

We pause for a moment to review. For a long while, we described the financial world as though it were a war - a battle between the natural forces of deflation (following a bubble)…and the unnatural forces of inflation (as the feds continue to pump up the supply of money and credit).

Early this spring, inflation had the upper hand in this war. Prices were soaring for oil, metals, food, fertilizer - and just about everything else. Commodities were going up because the go-go economies of Brazil, Russia, China and India were going so fast. And not only were their raw materials prices moving up fast, so were there internal labor costs. So, instead of exporting lower priced goods - as they had been for the last 15 years - they began to raise prices too.

Then, the gods of financial war went over to the other side. The emerging economies slowed down. Demand for commodities slumped. The price of oil dropped from a high of $147 down to $106 on Friday. Gold fell down below $800. Yesterday, it rose $2.80 - to end the day at $806. And bonds too are signaling a weaker economy. The 10-year T-Note has risen in price to yield only 3.66%.

What is behind this shift in the fortunes of war? Why are the feds losing this battle?

Well, it's not clear that they are really losing. So far, they are beating an orderly retreat. The economy is pulling back. But the feds believe they can still win. Curiously, all the shooting and casualties have encouraged investors to seek safety. They believe they've found it in the U.S. dollar. Investors expect lower inflation rates; that's why they're willing to buy U.S. bonds and notes at yields well below the current inflation rate. As long as the dollar holds, and inflation rates are under control, they figure they can continue pulling back in good order…until the U.S. consumers get back on their feet.

We don't know what will happen. But that doesn't prevent us from taking a guess - that it ain't gonna work that way - and hang on to our gold. Take advantage of the dip in the precious metal's price…see here:

Zero-Downside Gold

*** Former Federal Reserve Chairman Paul Volcker says the U.S. financial system is "broken."

At a banking conference in Calgary, he went on to predict that "Growth in the economy in this decade will be the slowest of any decade since the Great Depression, right in the middle of all this financial innovation.''

"It is the most complicated financial crisis I have ever experienced, and I have experienced a few," said Volcker. That's quite a statement from a man who, as Fed chief from 1979 to 1987, had the duty of battling down the runaway inflation of the 1970s.

At the end of last year, Short Fuse and Addison had the opportunity to sit down with Dr. Volcker in his office above Rockefeller Center in New York City for an interview for I.O.U.S.A. He told the movie crew that he felt that the United States was careening down a path it had traveled before, when inflation got the best of the country.

"With respect to the fiscal crisis looming out there in the future," he said, "We'll see whether a democracy can deal with an obvious problem that's going to be present in not too many years. The earlier we take action to deal with it the better."

You can see Dr. Volcker's interview on the big screen…I.O.U.S.A. is still in theaters around the country. To find out if it is playing near you, just click on the link below and plug in your zip code:

http://www.fandango.com/i.o.u.s.a._113616/movieoverview

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. Colleague Alex Green has written a clever new book, which comes out today. He calls it his Gone Fishin' Portfolio…which explains how you can make investing a lot easier and more rewarding. Get your copy here.

The Daily Reckoning PRESENTS: In a world where "inflation is out of control and getting worse" there is only one place to turn… We'll give you a hint: it rhymes with mold. The Mogambo Guru expounds…

NO ACCOUNTING FOR CURRENCY
by The Mogambo Guru

All of this monetary crap, and the inevitable government responses, means that huge inflations and deflations in relative prices will re-shape this country and this world, and that means that I need more gold, silver and oil as vital protection against the financial upheavals it guarantees, a Mogambo Blast-Proof Bunker (MCPB) nearby in which to keep them, and more ammo, frozen pizza and pornography against the boredom of ignoring my wife and kids pleading, "Please come out of there and let us have the TV remote back!"

My only revenge is that I can buy gold while I am in here, and I am pleased that I was able to find somebody to agree with me, too, even though he will unfortunately not officially acknowledge my existence, agree to endorse my theories, or even answer the damned phone after the little bastard abruptly hung up after hearing them the first time, but I can still quote Jeff Clark from his work at Doug Casey's Big Gold newsletter, who says, so sarcastically that I can almost taste the bile, "If the bull market in gold were over, it would mean that inflation was under control, the dollar's long-term problems had been solved, the government had become restrained in printing new money, banks were healthy, house prices had stabilized, a surprising new source of energy had been discovered, unemployment was diminishing, and everyone was smiling."

Exactly! I rose to my feet to applaud, and I shouted out "Exactly! Bravo!", to not only prove that for once in my life I had a thought that preceded the action (instead of my usual tactic of "acting without thinking" and then blaming the catastrophic result on other people), but that it was perfectly phrased, too!

I fully endorse his theories, and I think that he should return the favor and endorse mine, which are mostly that we are freaking doomed just like all the other times in history when people were doomed by their stupid government creating excess money and credit to spend on one supreme idiocy or another, usually eventually resulting in the government desperately spending even MORE money for an expensive war, so as to produce an economic stimulus through Eisenhower's "military-industrial complex", get rid of a lot of the excess population at the same time, impose Martial Law, confiscate and nationalize things, and distract the stupid citizens from their usual panic about how they are starving to death.

Without even noting that this is exactly what I had Just Freaking Said (JFS), he writes, "Due to the bloating federal deficit and the big-dollar promises the politicians have made, but that the U.S. can't possibly pay, further rapid growth in the money supply lies ahead. And that means more inflation, which means the dollar's recovery will turn out to be temporary. And more debasement of the dollar equals higher gold."

In fact, he also figures that we are a lot worse off than anybody knows, and already the money supply has been expanded to the point where, "Today the U.S. inflation rate is 13.4%, almost as high as the worst of the 1970s", and that "Inflation is out of control and getting worse."

The words "inflation is out of control and getting worse" should be enough to give you a heart attack, unless you happen to have a copy of the new book by Mike Maloney, Guide to Investing in Gold and Silver, which contains the most calming-yet-riveting revelation right at the beginning, right in the Preface, which is real handy!

He writes,  "For the last 2,400 years a pattern was continually repeated in which governments debase their money supply", and "as the debasement progresses, the population senses the loss of their purchasing power. Then something miraculous happens. Through the free market system, the will of the public causes gold and silver to automatically revalue."

At this point, I have read almost half of the first page of the Preface, my lips are tired from all that reading, and I find that I disagree with Mr. Maloney right off the bat, as I can tell him, and you, from bitter, bitter experience that the public (as exemplified by my own family) does not merely "sense" their loss of buying power, but they feel it very keenly, and are whining and complaining about it every freaking day of their lives.

And I have to listen to their crap about how they need more money because prices have gone up so much, and they want me to give them more money, all the time more money, and if I don't give them actual cash, then they will just charge it on a credit card, like I am so stupid that I don't scan the monthly credit-card statement and can actually see how much money they are spending on stupid crap, like shoes!

And there is nothing wrong with any of them that getting up off of their fat butts and getting outside for some exercise once in awhile wouldn't cure.

So, I was going to get into a "thing" about how self-centered my family is because, I mean, it's not like they were buying gold and silver with the money, which I could understand, but suddenly it all seemed so irrelevant when Mr. Maloney writes, "In doing so, it accounts for all the currency that was created since the last revaluation."

The word "zounds!" flashed across the screens in the Greed Center of my finely-tuned Mogambo Money-Grubbing Mind (MMGM) when I tried to even contemplate the price of gold when it again miraculously revalues to "account for all the currency that was created since the last revaluation", mostly because it seemed like a lot, off-hand!

Now I am curious to know how much an ounce of gold would be if the $829 billion in actual U.S. cash-and-coin that exists was netted against the 261 million ounces of gold that the Fed is supposed to have. Hmmm!

So, I keep dividing $829 billion by 261 million ounces of gold, and most of the time I get the answer "$3,176.24 per ounce", which sounds really nice, and which sounds even nicer when you realize that this figure is too, too low, even without adding in the additional revaluation of gold to account for all of the money that has been created around the world, and how little gold they have against those mountains of currency!

Whee! This economics stuff is easy!

Until next time,

The Mogambo Guru
for The Daily Reckoning

Editor's Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter - an avocational exercise to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron's, The Daily Reckoning and other fine publications. Click here to visit the Mogambo archive page.

-- Posted Monday, 8 September 2008 | Digg This Article