THE INTERNATIONAL FORECASTER

JUNE 2006 (#2) Vol. 10 No. 6-2

P. O. Box 510518, Punta Gorda, FL 33951-0518

An international financial, economic, political and social commentary.

Published and Edited by: Bob Chapman

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US MARKETS

We find it of great interest that the Federal Reserve tells us whether or not they will continue to increase short—term interest rates based upon upcoming data. They have to know as we do that the data, at least from the Bureau of Labor Statistics, has been altered. The question is do they use the altered data? Does the Fed have its own unaltered data? We don’t know because the Fed won’t tell us. It is a secret, just like M3 is now a secret. The Fed has partial transparency, so it’s very difficult to discern on what they are basing their decisions. It’s certainly not completely on data as they say it is. Based upon past performance the Fed is still a year behind what has already happened in the economic and financial worlds.

            That brings us to today’s monetary world. If the Fed carries through and raises interest rates ¼% in June and ¼% in August, the dollar index probably at this time won’t brake down through the long-term support level of 80. On the other hand, if the Fed pauses, the professionals in the bond market will sell Treasuries and drive yields up anyway and the dollar could break 80. This is not an enviable position. The best avenue for the Fed is to make the two increases. That would put the US ten-year Treasury note at 6 7/8% to 7 1/8%. That would slow the economy, would slip into recession. The Fed would continue to increase money and credit trying its best to hide what it is doing. That means an inflationary recession, known as stagflation (stagnation and inflation simultaneously.) Historically the Fed has always tightened too long and too much and they’ll probably do so again. In addition, this time not only have they created monetary aggregates, but they have also continued to do so. This time they have to deal with a dollar that has to be depressed by 30% to 50% - probably 50%. In addition, both government and consumer debt, both of which are at record highs, has to be serviced at an ever more expensive rate. As housing prices flatten out and then decline, so will consumer spending that makes up 71% of GDP. There are a number of reasons for real estate to decline, besides being well overpriced. Staggering inventory, higher interest rates and affordability. April’s affordability index was the lowest since July 1990. Last week’s 30-year fixed rate mortgage averaged 6.66%, the highest in some time. In 1990, the median house price was 2.7 times the median family income. Today it is 5.9 times. A year ago real estate began challenging the law of diminishing returns. Today the growth in prices is almost gone and by September it will be gone and the slide will be underway. Interest rates are not going to spike higher, but they will gradually go higher. At no time in the immediate future can rates fall. If they were too the dollar would be decimated. As an aside, the dollar will be under constant pressure as Russia, Iran and Venezuela sell oil-denominated in euros and rubles. The very foundations of the dollar as the world’s reserve currency will be under constant threat. As the dollar depreciates goods and services being imported into the US will be more expensive. That means a reduction in consumer spending and higher inflation. As house prices slide equitys reduced. That means fewer equity loans and cash outs, which have been adding billions in spending by consumers - sixty percent of which kept consumers from financial difficulty. We have had wage and salary increases but they have been limited. Income rises 3% and inflation rises 10%. That means even less purchasing power or less discretionary money available for spending.

            Over the past four months the economy has started to slow down and that doesn’t help matters. The momentum has been lost. Just look at the new orders index. It fell from 61.9% in February to 53.7% in May. Prices have risen ten months in a row. In just four months that index has risen from 62.5 to 77. The choice is higher prices and inflation or less corporate profits. We believe most of the higher costs and inflation will be passed on to the consumer. During the third and fourth quarter there will be a peaking out which we predicted early in the year. A poor real estate high season will be a shocker to many, as will persistent inflation...

            During the 18 Greenspan years overall indebtedness has virtually quadrupled from $10.569 trillion to $38,889.3 trillion, while savings out of current income plunged into negative territory.   

            GDP numbers are easily manipulated. There is more reality in the income numbers, and even with grossly understated inflation rates, they are the worst since 2000 because tax cuts are missing. Real disposable income was up just 1.4% in 2005 and is slowing in 2006. And worse, this is true even with a bogus 900,000 jobs added in 2005 by the net birth/death model.

            The Iranian talks look like a giant giveaway to Iran. Nuclear technology, upgrading their Boeing airplane fleet, plus spares, the purchase of agricultural technology and an end to trade sanctions.

            You say to yourself, how did this all come about so quickly? It’s been two months since we told you the top elitists were disgusted with the Bush-neocon incompetence and did not want an invasion of Iran at this time with the messes they have in Iraq and Afghanistan and the deplorable foreign policy practiced by these fascist nitwits.

            Furthermore, the go between is big internationalist-Illuminist Javier Solana, currently the EU’s foreign policy director who is putting the deal together. This is the worst disaster in American foreign policy we can remember. The US and Europe will back Iran’s membership in the WTO as well. Talk about selling the farm. We cannot see Iran rejecting the deal. If they do, then they are set on nuclear bomb development, or they are totally insane. Before going to Tehran, Solana went to Israel. The deal was laid out and Israel was told to accept it and shut up...

            The yen carry trade is winding down. That is when you borrow yen at ½%, buy US dollars with the proceeds, and then invest it usually using leverage. If Japanese rates are rising, which they will, and the yen rises in value, which it will you will be hard pressed to make a profit and you may lose money.

            Trillions of dollars have been purchased in this manner over the past eight years. This has put a prop under the dollar because it creates dollar demand and devalues the yen. As the trade is reversed the opposite happens. The dollar weakens and the yen strengthens. This change in tactics is going to profoundly affect the purchase of US Treasury and Agency debt and to an extent affect stocks, bonds and to a lesser degree commodities. As the carry trade ends Treasury and Agency debt will be sold, which in turn will cause interest rates to rise in the US. As this debt falls in value all those holding it will be sellers as well. Not only will interest rates rise, but also who among foreigners will supply $3 billion a day so the US doesn’t go bankrupt? This pressure will also cause the dollar to fall in value. Countries exporting to the US have been keeping the value of their currencies low by printing yen or Yuan, buying dollars and then Treasuries. That scenario will end and the currencies of exporters will rise in value, the dollar will fall, foreign goods sold in America will cost more and America will have more unwanted inflation. It’s all pretty simple, nothing esoteric. If government, Wall Street and corporate America explained such things everyone would understand and then this triumperate would have to stop screwing the public. To think that such a Japanese policy existed is pure insanity. Now it’s hangover time.

            The end of the yen carry trade is going to be very painful for Americans. Most of the money from the carry trade went into Treasuries and Agencies, that were leveraged, then invested in this order: third world stocks and bond markets, other stock and bond markets and to a small extent in commodities. As you have seen over the past two months foreign stocks and bonds are off 28% and 10% respectively. That is one reason why. The pressure will really start to build on US markets, particularly debt markets. An illegitimate source of funding will have ended. The problem left for foreigners is what do they do with the physical dollars they are holding? They don’t want to be in US debt or stocks so the only alternative is commodities, gold and silver. That is because they are a store of value. That is why they have been buying them and this is why they are rising in value. It’s a flight to quality, a flight to reality. That means the correction you have just seen in these metals is just another chance to buy, served up on a platter by elitists who want to destroy our dollar and our economy. They have been shorting all these metals as they have fallen. They haven’t bought any of their shorts back. This is like a rubber band. Sooner or later they have to cover. The correction in commodities was triggered by the Bank of England bailing out copper positions held by members of the LME, London Metals Exchange. When they did that they also hit the gold and silver markets. The copper problem hasn’t gone away. There is little supply. The worldwide financial crisis is now widening. This bull market is about 40% over in commodities and 25% over in gold and silver...