Dollar: Faltering Foundation of US Economic Strength

I wrote this article back in Jan of 2008 in an attempt to shed light on the past history and likely future of the US Dollar as the World's reserve... Bottom line, dollar hegemony will eventually end and when this happens our standard of living will fall precipitously.

Since the end of World War II, the central foundation of US Economic Strength has rested on the US Dollar. Many of our strategic plans, geopolitical strategies, past and future wars--the entire global chess board if you will, has been played out by trying to maintain our undisputed economic power, based primarily through ownership of the World’s Reserve Currency.

SOME HISTORY ON THE DOLLAR

Throughout the history of the world, there have always been strong currencies, usually held by the economic powerhouses of the day. Theses currencies were primarily called Reserve Currencies. The Pound Sterling was the primary reserve currency for much of the world in the 18th and 19th centuries. But perpetual account and fiscal deficits, financed by cheap credit and unsustainable monetary and fiscal policies used to finance wars and colonial ambitions eventually led to the pound sinking (sound familiar?).

Post World-War II, the US dollar took over the sterling’s dominant position and became the world’s newest reserve currency. The Bretton Woods Accord, the first major economic transformation toward the end of World War II, established the International Monetary Fund (IMF) and a way to value the various currencies of the world relative to each other. All foreign currencies would trade in relationship to the US Dollar and only the US dollar (as the reserve currency) would be tied to a gold standard (meaning the value of dollars circulating must be backed by gold reserves).

The gold standard caused major problems in the 1960’s when France (under the London Gold Pool) called America’s bluff and demanded gold for payment of debt, rather than US dollars (they understood that we were printing more money, to finance the Vietnam conflict and fund new social programs, than we had available in gold reserves).

Due to the rapid loss of US gold reserves, President Nixon had no choice but to abolish the Bretton Woods accord in August of 1971 and he took the US dollar off the gold standard (it was $35 per ounce then; today it is ~ $900).

This Nixon shock of August 1971 caused a swift devaluation of the US dollar (gold doubled in price by 1972) and numerous efforts followed (by U.S. leadership) to develop a new system of international monetary management. They felt they must find another way, as currencies around the world were in turmoil and were now floating among one another…

The year 1974 provided the much needed answer. In June of 1974, Secretary of State Henry Kissinger established the US-Saudi Arabian Joint Commission on Economic Cooperation. One of the major components of this commission stated that OPEC would officially agree to sell its oil only for dollars—meaning any country purchasing oil from OPEC had to pay in U.S. dollars. This agreement enormously increased the demand for the floating dollar, as oil importing countries now had to earn or borrow dollars to pay for their oil.

OPEC oil countries were soon overflowing with petrodollars and most of them ended up recycled through accounts in London and New York banks.

Bottom Line: this 1974 act reestablished the dollar as the global monetary instrument and oil now replaced gold as basis for a strong dollar. Countries competed for dollars and they accumulated huge dollar reserves to sustain their own currencies.

Please allow me to shift gears a bit—we’ll get back to the dollar in a moment:
Post WWII, the US was the world’s manufacturing powerhouse, as our continent was unscathed by the ravages of war and the military industrial machine was running at maximum efficiency.

That however has changed over time, as thousands of corporations succumbed to the pressures of improving their bottom lines. Entire sectors were outsourced: U.S. Manufacturing, Steel, Technical services, Administrative call centers, Research & Technology and numerous others are now gone. Heck, you can’t even find a pair of Levis (the American Trademark) made in the good ole USA anymore.

Why did this happen? It’s all related to profits… A U.S. company can pay a worker overseas $1-2 bucks an hour to do the same job requiring $15-30 hour in the US... Either they outsource or they end up like the rest of our troubled U.S. home bound corporations (below).

Many of the home-bound US companies still trying to compete in the Global marketplace are reeling from high labor costs, pension plans, union benefits, health care costs and the like. Delphi, General Motors and Ford are prime examples of the growing trend of companies feeling the pressures. I expect to see more US corporate and worker problems in the future…

Outsourcing however did have its benefits. For many years we Americans were able to export inflation through the import of cheap manufactured goods and recycled dollars. Foreign manufacturing allowed Americans to purchase many things that otherwise they could have never afforded had they been made in the USA (e.g. $20 Jeans, $29 DVD players, $50 Microwave ovens, $60 cell phones, $100 TV’s; $200 computers, the list goes on and on). Our standard of living rose, but we eventually became a service-based economy dependant upon 1) selling each other foreign made goods and 2) foreigners recycling their excess dollars back to the US.

This foreign recycling of dollars provided Americans with low interest rates, plenty of available credit and it allowed us to live far beyond our means through cheap debt.

On the negative side, foreign governments built up huge dollar denominated holdings that they could use to secure long-term energy agreements, purchase Global assets/corporations, etc and these massive holdings realistically (it will never be admitted) tied our hands geo-politically, as foreign governments could now threaten to dump dollars into the world market as retribution for disliked policy.

Back to the dollar:

Once removed from the gold standard in 1971, the US dollar became a fiat currency (tied to nothing tangible and it was backed only by the word of the US government). The Fed Reserve Banking System could now print money at will -- and they did. Take a look at the chart below and the growth in M3 money supply since 1971. This chart ends in 2006, but (in case your wondering) today’s figure is ~ $12.5 Trillion.




As the world’s reserve currency, the US has been able to, year after year, import goods from the rest of the world (for consumption) and pay for it with dollars that were created from nothing. These dollars are then used by foreign central banks to purchase US assets (corporations, land, properties, etc) or debt instruments from the Fed, or they amass these excess dollars to keep inflation tame within their borders, as many have their own currencies pegged to the exchange rate of the US Dollar.

It is currently estimated that foreign governments (OPEC Nations, China, Japan, India, Great Britain, Korea, Russia, etc) have amassed ~ $4 Trillion of US dollar holdings. China alone is sitting on ~ $1 Trillion (Pretty scary stuff).

Over the last several years, foreign Central banks have started to become leery with the huge debt levels, massive trade deficits and unsustainable fiscal policy of the US and they are quietly working to diversify their dollar holdings.

Additionally, for decades now, many foreign countries have pegged their currencies to the US Dollar, but recent inflation increases, internal to their domestic economies, has become far too severe for them to handle (with the dollar peg, they have to print money as fast as we do, and it is stoking domestic inflation), therefore several countries have started a new trend of depegging. Recently, Vietnam, Qatar and Kuwait have all depegged while a host of others (Russia, and other OPEC Nations) are questioning whether or not they should do the same… When this currency de-peg happens on a larger scale (not if, but when) inflation within our borders will SCREAM. Why? Well, as they de-link from the dollar, their currencies become stronger causing our import costs to increase commensurately (e.g. Oil, consumer goods, etc)

Lastly, governments such as IRAN no longer want to accept dollars for oil. This was also the case with IRAQ back in Saddam Hussein’s day, but we all know what happened there. Anyway, the point is: There is wide-scale pressure afloat to price oil in currencies other than the depreciating US Dollar. If that happens on a larger scale, the artificial foundation for the World’s Reserve currency will be removed and all hell could break loose.

Bernanke: Rather than try to shore up foreign confidence in the dollar, Helicopter Ben Bernanke has made matters worse by officially sacrificing the dollar to save our faltering, sub-prime like, US banking/financial systems… By lowering rates at a time when the dollar is already at its weakest point in history, there is no other explanation to his actions.

Bottom line: Demand for the World’s Reserve Currency (dollar) has been kept artificially high for many years through oil pricing agreements and US inflation was held in check by importing cheaper goods. These were both net benefits for the US in times past, but are quickly moving towards being detriments.


Closing:

The US was once an economic powerhouse who earned the right to own/maintain the World’s Reserve currency, but we’ve squandered this luxury through massive debt loads, poor foreign policy decisions, excessive monetary printing, outsourcing our industrial base, making too many future promises and by living way beyond our means.

Foreign Governments are now growing tired of subsidizing our opulent lifestyles, and the recent fact that we put the world financial system in peril by offloading our toxic securitized garbage was (I believe) one of the final straws to break the dollar’s back. In another ~ 10 years, dollar hegemony will probably be a thing of the past. Our central foundation of US Economic Strength (dollar) is faltering and there is little we can do about it.

With that said, I think the Fed and our government officials are already aware of this and without any viable solutions to our current financial problems (baring raising interest rates and initiating a massive depression) they have made the best choice they can (cut rates and inflate).

I believe it has now become a matter of (unwritten) policy to try to hyper-inflate our financial system out of its current and future insolvency crisis. In their attempt to inflate, the world will experience significant dollar devaluations which will (over time) allow the United States to 1) eliminate much of its foreign debt and 2) pay for future (currently un-funded) obligations through devalued payouts.

As our standard of living drops more in-line with the rest of the world due to loss of purchasing power and a massive economic slowdown, it will (over time) become much cheaper to employ American workers again and this will slowly bring jobs back into our borders. Eventually, 20-30 years from now, our country will become competitive in the world again and we will do more than just sell each other cheaply made foreign goods--we will actually manufacture them again. BUT, we will (most likely) no longer own the World's Reserve Currency nor will we be the World's main economic power.

Ultimately, I believe massive currency devaluation and a much lower US standard of living is our country's only way out of this financial predicament...

The only wildcard I can think of is Oil. How in the world do we survive without cheap oil?
Guess we'll need to work out some new strategic plans and geopolitical strategies -- and I'll bet they lead to:

WAR!

Regards

Randy

Israelis 'rehearse Iran attack'

Israelis 'rehearse Iran attack'

Israel has carried out an exercise that appears to have been a rehearsal for an attack on Iran's nuclear facilities, US officials have told the New York Times.

More than 100 Israeli fighter jets took part in manoeuvres over the eastern Mediterranean and over Greece in the first week of June, US officials said.

Iran insists its programme is peaceful, but Israel sees Iran's development of the technology as a serious threat.

Tehran is defying a demand from the UN that it stop the enrichment of uranium.

The UN Security Council approved a third round of sanctions against Iran over the issue in March 2008.

'Signals'

Several US officials briefing the New York Times said the exercise was intended demonstrate the seriousness of Israel's concern over Iran's nuclear activities, and its willingness to act unilaterally.

"They wanted us to know, they wanted the Europeans to know, and they wanted the Iranians to know," a Pentagon official is quoted as saying by the newspaper.

"There's a lot of signalling going on at different levels."

The exercise involved Israeli helicopters that could be used to rescue downed pilots, the newspaper reported.

The helicopters and refuelling tankers flew more than 1,400km (870 miles), roughly the distance between Israel and Iran's main uranium enrichment plant at Natanz.

The New York Times reported that Israeli officials declined to discuss the details of the exercise.

A spokesman for the Israeli military said the air force "regularly trains for various missions in order to confront and meet the challenges posed by the threats facing Israel".

Warnings

Israeli Prime Minister Ehud Olmert warned on 4 June that drastic measures were needed to stop Iran obtaining nuclear weapons.

He said Iran must be shown there will be devastating consequences if it did develop such weapons.

Israeli deputy Prime Minister Shaul Mofaz - a former defence minister - said earlier this month that military strikes to stop Iran developing nuclear weapons looked "unavoidable".

In 1981, Israeli jets bombed the Iraqi nuclear reactor at Osirak, 30km (18 miles) outside Baghdad.

Israel said it believed the French-built plant was designed to make nuclear weapons that could be used against Israel.

Will Israel bomb Iran?

Reports that Israel has plans for an attack on Iran's nuclear facilities refuse to go away. The New York Times today carries a story on a major military exercise Israel carried out this month, described as a "dress rehearsal" for such a raid.

Such reports surface periodically. Back in 2005, the Sunday Times ran a big story with details of how Israeli forces practised destroying a mock-up of Iran's Natanz uranium enrichment plant in the Negev desert.

Virtually a year after the Sunday Times story, the New Yorker's ace investigative reporter, Seymour Hersh, wrote a cracking tale about how George Bush had increased clandestine activities inside Iran and intensified planning for a possible major air attack to stop Iran's nuclear programme.

As timing is everything, the question that poses itself with the latest incarnation of this "plan to attack Iran" story is why now?

This week, Gordon Brown announced new sanctions against Iran, including financial measures already agreed in principle by the EU and a vaguer reference to oil and gas sanctions yet to be decided on. Brown appeared to have bounced the EU into the new measures as Brussels had not agreed on their timing.

Be that as it may, the EU has now adopted a harder line towards Iran, as the US has been urging for some time. But is George Bush losing his ardour to hit Iran? A recent interview with the Times indicated that America's lame duck president had "mellowed" after eight years in office - talking up multilateral diplomacy instead of military action as a way out of the Iranian nuclear impasse.

Yet the recent resignation of Admiral William Fallon as head of US forces in the Middle East was seen as a victory for the hawks in the administration as he was perceived to be an opponent of military action. But if we take Bush's comments to the Times, a US military strike seems less likely than before.

There have been signs that Israel, which is widely believed to have nuclear weapons of its own, is none too pleased that the US has backed off its hawkish stance. Israel publicly disagreed with the America's recent national intelligence estimate which concluded that Iran had stopped its nuclear weapons programme in 2003, although it continued to enrich uranium.

The New York Times report indicates that Israel is keeping the military option open. Whether it will actually go ahead with a strike is another matter, given the difficulties of ensuring success, not to speak of the political repercussions should there be massive civilian casualties.

But it can be surmised that Israel wanted its dress rehearsal to be leaked to serve as a clear warning to Tehran of the risks it faces should it pursue uranium enrichment, which can lead to a nuclear bomb. Such a tough line is no bad thing politically for Ehud Olmert either as the Israeli prime minister is currently engulfed in a corruption scandal. Being tough with Iran also protects him against accusations that he is being weak in agreeing to an Egyptian-brokered truce with Hamas in Gaza.

In any event, Israel is not just relying on leaks to the New York Times to get its message across to the Iranians and everyone else about its resolve in stopping Iran developing an atomic weapon. Israel last September bombed what was alleged to be a covert nuclear reactor in Syria being built with North Korean help.

According to the New York Times, Iran is taking the risk of an Israeli attack seriously enough to be strengthening its air defences. Israeli sabre-rattling and bluster may have an unintended consequence. It could speed up Iran's bomb. North Korea showed that if you have bomb, people are more inclined to talk to you rather than attack you.

Prepare for the Collapse of the US Dollar

Lindsey Williams, author of the 'Energy Non Crisis' explains how the US Dollar Crisis is upon us via the World Bankers choice of using Oil as the US Dollar's backing.

Prepare for the collapse of the Dollar



Suggest you watch the prior set of Lindsey William videos for a better understanding of what he's talking about here.

Iran -- New Military Rhetoric

US Rhetoric is increasing over: 1) Iran's military involvement in IRAQ and 2) their Nuclear ambition.

However, the bigger (unspoken) issues are the IRAN-PAKISTAN-INDA GAS PIPELINE and the US Dollar (USD):

America continues to lose clout/controlling power in the region 1) as these countries work to create their own interdependent energy region, and 2) as IRAN eliminates all US dollar holdings and then refuses to accept new dollars in all of its foreign energy transactions.

As stated previously, oil replaced gold in the mid 70's as the peg for the USD and until Iran's recent actions (note: Saddam/IRAQ previously did the same for a short while) all oil transactions around the globe had to be made in USD's. For three decades now, oil has provided the underlying foundation for the World's reserve currency, but the USD foundation is starting to crack...

Dollar: Faltering Foundation of US Economic Strength

Iran’s Oil Bourse Set to Open this Sunday

OPEC May Drop Dollar for Euro

The End of Dollar Hegemony

News of interest today

Irans yen for the euro

Iran, the worlds fourth largest oil producer, has reportedly shifted from the US dollar to euro and yen as currencies in which it will trade its crude produce.

This is seen as a major blow to the US dollar as a reserve currency.

Irans move may be determined partly because of its ongoing political stand-off with the US. However, that need not be the only consideration to have prompted Iran to shift to the euro and yen.

Many oil exporting nations, as indeed other emerging economies accumulating dollar reserves, have been worrying about the structural weaknesses in the US economy and the prospect of the dollars long-term decline.

A survey by the US treasury department measured foreign holdings of US securities as of June 30, 2007, to be $9,772 billion. This should easily cross $10 trillion this year, which is about 75% of the US GDP. Of this, $3,130 billion is held in US equities, $6,007 billion in US long-term debt securities, and $635 billion in US short-term debt securities.

Mind you, the outstanding foreign holdings in US securities are growing on an average at over 25% in recent years.

Emerging economies are beginning to feel uncomfortable about putting so much in US dollar-denominated assets year after year. Oil exporting countries themselves have about half a trillion dollars worth of US securities today. By designating future oil trading in euro and yen, Iran is clearly trying to diversify its assets by denominating them in currencies other than the dollar.

If other West Asian oil exporters were to do the same, the US or any other net oil importer, will be forced to buy euro and yen to purchase oil from the international market. The power of the US dollar as a reserve currency will certainly fall, to that extent. Indeed, nations holding US dollar assets will have to evolve new strategies to protect the value of their forex reserves as the axis of global economic power shifts rapidly. No one, including Americas arch rivals in the geo-strategic play, would want the dollar to suffer a precipitous decline as it would erode everyones asset value. But they must all prepare for a gradual decline, for sure.

(Note--for more info on Iran, Oil and the US Dollar see my other posts: IRANS Oil Bourse to Open, US Warns IRAN)


Consumer spending up mainly because of sharp price increases

Don't be fooled by a larger-than-expected increase in consumer spending. People aren't buying more — they're just paying more for what they buy.

That is raising doubts about whether the 130 million stimulus payments the government began sending out this week will be enough to lift consumers' sagging spirits.

The Commerce Department reported Thursday that consumer spending was up 0.4 percent, double the increase economists had forecast. However, once inflation was removed, spending edged up a much slower 0.1 percent.

The March reading was the fourth straight lackluster performance and did nothing to alleviate worries that consumer spending, which accounts for two-thirds of total economic activity, remains under severe strains, reflecting an economy beset by multiple problems.

Rising food costs, soaring energy prices and falling employment have pushed consumer confidence to its lowest levels in five years. Incomes in March rose a weak 0.3, but after removing inflation, after-tax incomes were flat.

The Bush administration is counting on its $168 billion stimulus program to give the economy enough of a lift to keep the country from slipping into a full-blown recession, but private economists are worried the boost could well be fleeting.

"Consumers are facing bad news on all fronts," said Nigel Gault, chief U.S. economist at Global Insight. "Any burst of spending based on the stimulus payments is likely to prove short-lived."

Sal Guatieri, senior economist at BMO Capital Markets, said economic growth could still turn negative this quarter even with the rebates. He cited a recent Associated Press-Ipsos poll that found only 19 percent of people plan to spend their rebates, with others surveyed preferring instead to use the $600 to $1,200 checks for the typical family to pay off bills or boost savings.


Home Depot Takes Wrecking Ball To Stores

The economy has been hurting since the subprime mortgages began their tumble toward foreclosure, taking anything housing related, especially home goods, along for the bumpy ride.

On Thursday, Home Depot announced that it was shutting down 15 of its underperforming flagship stores. The mercy killings are supposed to wrap up in the next few months with 1330 employees being axed or reassigned. Wall Street rallied after the tough love announcement.

In a bleeding real estate market and with new management at the helm, the Atlanta-based company has pulled back on expansion plans and is excising vestigial parts.

These tough calls weren't in the game plan a year and a half ago. In September 2007, it had been reported that Blake said he had no plans to make any broad-based job cuts or reduce the number of its core retail stores in the face of a persistent housing slump that wasn't expected to improve anytime soon.


Sun Micro turns in loss of $34 million

Sun Microsystems Inc. on Thursday said it swung to a fiscal third-quarter loss and that it will cut up to 2,500 jobs as the computer server and software company said "significant challenges" in the U.S. market contributed to its sales slipping from a year ago.

On a conference call to discuss the results Sun Chief Executive Jonathan Schwartz said the company was hampered by weakness in the U.S. economy that "presented Sun with significant challenges" and overwhelmed progress that Sun made in developing nations.


Auto Sales Remain Weak; Chrysler Posts 23% Drop

The U.S. auto industry's struggles continued in April as General Motors Corp. (GM) and Ford Motor Co. (F) and Chrysler LLC posted double-digit drops in U.S. light-vehicle sales despite having two extra selling days than a year earlier.

GM, hobbled by a strike at a major axle supplier, posted a 16% sales drop while Ford sales slid 12%. Chrysler reported a 23% decline. Japan's Toyota Motor Corp. (TM), thanks to Easter falling in March this year, managed to snap a four- month streak of weaker sales and post a 3.4% rise.

The gas-price spike combined with persistent economic turbulence had set the stage for April to be yet another tough month in what is expected to be the industry's toughest year in at least a decade.


Fed Discount-Window Lending to Banks Rises 8% to $11.6 Billion

May 1 (Bloomberg) -- The Federal Reserve's cash loans to commercial banks rose 8 percent in the past week, reflecting borrowers' continuing need for funds.

Loans to commercial banks through the traditional lending facility increased $857 million in the week ended yesterday to a daily average of $11.6 billion.

As of April 30, $17.8 billion of overnight loans through the primary-dealer program were outstanding with Wall Street firms, while commercial banks had $12 billion of discount-window loans, the Fed reported.

The Fed also reported that the M2 money supply rose by $27.9 billion in the week ended April 21. That left M2 growing at an annual rate of 6.7 percent for the past 52 weeks, above the target of 5 percent the Fed once set for maximum growth. The Fed no longer has a formal target.

The Fed reports two measures of the money supply each week. M1 includes all currency held by consumers and companies for spending, money held in checking accounts and travelers checks. M2, the more widely followed, adds savings and private holdings in money market mutual funds.
During the latest reporting week, M1 rose by $19.4 billion. Over the past 52 weeks, M1 declined 0.1 percent. The Fed no longer publishes figures for M3.


Airlines slow down flights to save on fuel

Drivers have long known that slowing down on the highway means getting more miles to the gallon. Now airlines are trying it, too — adding a few minutes to flights to save millions on fuel.

Southwest Airlines started flying slower about two months ago, and projects it will save $42 million in fuel this year by extending each flight by one to three minutes.

On one Northwest Airlines flight from Paris to Minneapolis earlier this week alone, flying slower saved 162 gallons of fuel, saving the airline $535. It added eight minutes to the flight, extending it to eight hours, 58 minutes.

Across the board, airlines are feeling the pain of higher energy prices. For jet fuel delivered at New York Harbor, the spot price — airlines pay it when they need more fuel than they've already locked down in a contract — has jumped 73 percent in the past year, to $3.54 a gallon, according to government data.

Airlines are trying other measures as well to deal with higher fuel costs, including raising fares, adding fuel surcharges to tickets and charging extra for a second checked bag rather than a third.

It's a tough time for the airline industry. Several smaller airlines have filed for bankruptcy protection in recent weeks, many citing high fuel costs. Fuel costs have also resulted in sharp first-quarter losses by some airlines.


Have a good evening

Randy

OPEC May Drop Dollar for Euro

As I've stated previously, for over 3 decades now, U.S. Oil pricing agreements with OPEC have provided THE foundation for the US dollar's elite status in the world and oil replaced gold (after being dropped by Nixon in 1971) as the backing for the World’s Reserve Currency.

We Americans, however, were never satisfied with just having a good thing, as we wanted our cake and needed to eat it too, so we racked up enormous/un-payable debts to pay for lots of guns and butter, sold toxic securitized AAA rated garbage to our best friends, family and business partners, squandered international goodwill through inept/arrogant foreign policy, and as of late, we’ve thrown all caution and common sense into the wind and are now vigorously trying to hyperinflate our way out of this current deflationary banking/financial crisis.

Well it was great while it lasted, but the gig is nearly up.

OPEC Rattles the Dollar

The possibility that OPEC would make an active decision to price oil barrels in a currency other than the dollar has been bandied about, but never spoken of by anyone with any real power. That changed today, after OPEC Secretary-General Abdullah al-Badri was quoted in the Middle East Economic Digest, saying “maybe we can price the oil in the euro.”

The weakened dollar has eroded the purchasing power of the oil-rich nations at a time when consumers in those countries are also dealing with growing inflation risks, in part because several prominent nations, such as the UAE and Qatar, maintain currency pegs to the U.S. dollar. Inflation has been rising in those countries, but these countries have been lowering interest rates in order to keep pace with U.S. policy, even though they have very different fundamentals.

Eventually, those pegs are likely to be abandoned. “The days of the peg are numbered as these nations can’t continue to cut rates to 3% with inflation 4 times that rate,” says Ashraf Laidi, head of currency strategy at CMC Markets. “They will need to revalue the peg and change it to a basket of currencies.”

When this 1974 OPEC dollar pricing agreement is finally abandoned, the US Dollar's foundation as World Reserve will be yanked out from beneath it.

We in the U.S. better start preparing for a much lower standard of living because it's coming.

Randy

Global Food Crisis--Credit Crunch Could Pale in Comparison

Grains, food inflation give markets a jolt

Soaring world grain prices will keep driving food price inflation in 2008 as China and India carve out a bigger place at the table and a new dinner guest -- biofuels -- threatens to become the biggest glutton of all.

In 2007, Chicago Board of Trade prices -- world benchmarks for wheat, corn, rice and soybeans -- soared despite big U.S. harvests. Wheat prices rose 90 percent, soybeans 80 percent, corn 20 percent. U.S. prices are key because America is still the world's breadbasket, the single biggest grain exporter.

"The fact we're having higher commodity prices here will have an impact around the world on food prices," Lapp said.

Bill Lapp, former economist for food giant Conagra Foods Inc said the U.S. producer prices for food for the first 11 months of 2007 rose at an annualized rate of 7.5 percent, the highest since 1980, with the exception of the year 2003.

"We've only started to see the impact of higher costs translate into higher consumer prices," Lapp said.

One indicator that markets are watching more closely than even U.S. prices is world grain stocks. U.S. wheat stocks in 2008 will hit a 60-year low and world barley stocks a 42-year low. Global oilseed stocks are projected down 22 percent in one year.


Rice Prices Are Steaming, With Many Implications

The global commodities boom that has lifted prices of everything from gasoline to gold is now elevating rice -- a staple food for half of the world -- to its highest level in nearly 20 years.

A particular humanitarian concern is that the world's poorest consumers, many dependent on rice, often have little or no voice. "When they suffer food shortages, they starve in silence," says Joachim von Braun, director general at the International Food Policy Research Institute.


Lowest Food Supplies in 50 or 100 Years

The United States Department of Agriculture (USDA) released its first projections of world grain supply and demand for the coming crop year: 2007/08. USDA predicts supplies will plunge to a 53-day equivalent-their lowest level in the 47-year period for which data exists.

"The USDA projects global grain supplies will drop to their lowest levels on record. Further, it is likely that, outside of wartime, global grain supplies have not been this low in a century, perhaps longer," said NFU Director of Research Darrin Qualman .

Most important, 2007/08 will mark the seventh year out of the past eight in which global grain production has fallen short of demand. This consistent shortfall has cut supplies in half-down from a 115-day supply in 1999/00 to the current level of 53 days. "The world is consistently failing to produce as much grain as it uses," said Qualman. He continued: "The current low supply levels are not the result of a transient weather event or an isolated production problem: low supplies are the result of a persistent drawdown trend."

In addition to falling grain supplies, global fisheries are faltering. Reports in respected journals Science and Nature state that 1/3 of ocean fisheries are in collapse, 2/3 will be in collapse by 2025, and our ocean fisheries may be virtually gone by 2048. "Aquatic food systems are collapsing, and terrestrial food systems are under tremendous stress," said Qualman.


Severe food shortages, price spikes threaten world population

Worldwide food prices have risen sharply and supplies have dropped this year, according to the latest food outlook of the United Nations Food and Agriculture Organization. The agency warned December 17 that the changes represent an “unforeseen and unprecedented” shift in the global food system, threatening billions with hunger and decreased access to food.

The USDA has cautioned that wheat exporters in the US have already sold more than 90 percent of what the department had expected to be exported during the fiscal year ending June 2008. This has dire consequences for the world’s poor, whose diets consist largely of cereal grains imported from the United States and other major producers.

The food crisis is intensifying social discontent and raising the likelihood of social upheavals. The FAO notes that political unrest “directly linked to food markets” has developed in Morocco, Uzbekistan, Yemen, Guinea, Mauritania and Senegal. In the past year, cereal prices have triggered riots in several other countries, including Mexico, where tortilla prices were pushed up 60 percent. In Italy, the rising cost of pasta prompted nationwide protests. Unrest in China has also been linked to cooking oil shortages.

All national governments are keenly aware of the possibility of civil unrest in the event of severe food shortages or famine, and many have taken minimal steps to ease the crisis in the short term, such as reducing import tariffs and erecting export restrictions. On December 20, China did away with food export rebates in an effort to stave off domestic shortfalls. Russia, Kazakhstan, and Argentina have also implemented export controls.

But such policies cannot adequately cope with the crisis in the food system because they do not address the causes, only the immediate symptoms. Behind the inflation are the complex inter-linkages of global markets and the fundamental incompatibility of the capitalist system with the needs of billions of poor and working people.

As the housing market in the United States collapsed, compounding problems in the credit market and threatening recession, speculation shifted to the commodities markets, exacerbating inflation in basic goods and materials. The international food market is particularly prone to volatility because current prices are greatly influenced by speculation over future commodity prices. This speculation can then trigger more volatility, encouraging more speculation.

The rising oil price not only affects the costs of transportation and importation. It also has a direct impact on the costs of farm operation in the working of agricultural and industrial processing machinery. Moreover, fertilizer, which takes its key component, nitrogen, from natural gas, is also spiking in price because of the impact of rising oil prices on the demand and costs of other fuels. By the same token, as oil prices rise, the demand for biofuel sources such as corn, sugarcane, and soybeans also rises, resulting in more and more feedstock crops being devoted to fuel and additives production.


BMO strategist Donald Coxe warns credit crunch and soaring oil prices will pale in comparison to looming catastrophe.

A new crisis is emerging, a global food catastrophe that will reach further and be more crippling than anything the world has ever seen. The credit crunch and the reverberations of soaring oil prices around the world will pale in comparison to what is about to transpire, Donald Coxe, global portfolio strategist at BMO Financial Group said at the Empire Club's 14th annual investment outlook in Toronto on Thursday.

"It's not a matter of if, but when," he warned investors. "It's going to hit this year hard."

Mr. Coxe said the sharp rise in raw food prices in the past year will intensify in the next few years amid increased demand for meat and dairy products from the growing middle classes of countries such as China and India as well as heavy demand from the biofuels industry.

"The greatest challenge to the world is not US$100 oil; it's getting enough food so that the new middle class can eat the way our middle class does, and that means we've got to expand food output dramatically," he said.

Wheat prices alone have risen 92% in the past year, and yesterday closed at US$9.45 a bushel on the Chicago Board of Trade.

At the centre of the imminent food catastrophe is corn - the main staple of the ethanol industry. The price of corn has risen about 44% over the past 15 months, closing at US$4.66 a bushel on the CBOT yesterday - its best finish since June 1996.

This not only impacts the price of food products made using grains, but also the price of meat, with feed prices for livestock also increasing.

"You're going to have real problems in countries that are food short, because we're already getting embargoes on food exports from countries, who were trying desperately to sell their stuff before, but now they're embargoing exports," he said, citing Russia and India as examples.


So, what is the take-away from this post?

Expect 2008 to bring much higher food prices around the globe. The main issue for US consumers (baring any calamity) will, most likely, just be significantly increased costs to feed the family, but we will probably see much more civil unrest and famine around the world.

On the other hand, if we do experience some type of calamity in 2008 or if food stockpiles continue to decline in the out years, we could potentially see one hell of a problem.


As an aside, I spent many months in Somalia back in 1992/93 as Operation Restore Hope (A United Nations Humanitarian Effort--before Blackhawk Down) tried to put food supplies in the hands of the starving (vs the controlling Warlords) and let me tell you, it was the most appalling thing I have ever witnessed... Thousands upon thousands of skeletal shells of human beings, trying to survive any way they could--the smell of death hanging in the stale air as untold numbers of bodies slowly decayed beneath shallow improvised graves baking in the desert sun…

Lets hope/pray we never experience something like this on our continent.

Regards
Randy

EMPIRE OF DEBT I

Though I don’t post very often (full-time job and family), every day I try to read various opinions regarding geopolitics, financial markets, the housing debacle, banking issues and the swiftly approaching credit/financial crisis (of which the masses, fed by daily mainstream propaganda, are completely oblivious).

Anyway, one of the many folks who I regularly follow is Charles Hugh Smith-—a superb writer with a knack for simplifying various complex economic issues... Well, today I ran across one of his articles that I absolutely had to share, as it simplified the very complex financial instruments called derivatives (identified by Warren Buffet as financial weapons of mass destruction).

Derivative instruments are used by markets to hedge bets, and their use/popularity has exploded over the last 10 years. Today, the world is awash with these weapons of mass destruction and hundreds of TRILLIONS (yes, that was not a typo) of these bets are so over-utilized and intertwined throughout the various financial markets, hedging one’s bets against losses, that no one really understands the true impact of any one loss against another and the daisy chain effect caused by simultaneous losses of many with the same bet.

Problem is: we’re now starting to find out... As the housing bubble bursts, the financial world is swiftly realizing that their insurance bets on losses (derivatives) were also used by everyone else and the losses are so staggering, there is absolutely no way anyone can get paid.

Aah… I’m starting to get emotional and I’m pounding on the keyboard so I’ll just let you read the article for yourself... Enjoy!

(Caution: If you thought I was pessimistic, you ain’t seen nothing yet).

Empire of Debt I: The Great Unraveling Begins

Some readers have been concerned that my recent posts have been overly bleak or strident. Perhaps; but I sense the Great Unraveling of the Empire of Debt is finally upon us, and breathtaking losses could be revealed any day now.

You cannot properly anticipate the coming wealth destruction unless you understand that the entire model rests on financial instruments (derivatives) which mask and distort risk. Thanks to readers Cheryl A. and U. Doran, I read the best description of how derivatives are written and sold--and how they blow up: Fiasco: The Inside Story of a Wall Street Trader .

Here is an analogy. Let's say you are offered a chance to play roulette, a very risky game of chance, but with an option for insurance which guarantees you will suffer no more than a tiny loss.

Let's say you place a $10 bet, in the hopes of winning $100. Your "insurance"--what we call a hedge, as in "hedging your bets"--costs only $1. Thus you can gamble $10, with a chance of winning as much as $100, and your loss is limited to a mere $1--the cost of your hedge. If you lose the $10, the other side of the hedge trade--whoever took your $1--will give you $10. Life is good, n'est pas?

Note what this hedge does: it makes you believe a high-risk game can be played at almost no risk. But alas, the game is inherently risky, and the reduction of risk is ultimately illusory: you can't change roulette into a low-risk gamble.

Since this is such a low-risk bet, you are soon gambling, say $100 billion. And why not? The hedges are so cheap! Abd everything goes swimmingly until the day you lose the $100 billion. Ah, bad luck, Mate; but no worries, you turn to the other side of your hedge and politely request your $100 billion.

Oops--that guy just lost his bets, too, and can't pay you. Now the risk of the underlying game is fully revealed; the entire hedge which made it all so "safe" is revealed as a house of cards which depends on all the other players being able to pay off their bets. Once they can't, well, as the saying goes, all bets are off.

To hide your immense losses, you continue to claim your bet is still worth $100 billion. Since you aren't required to "mark to market," i.e. reveal the market value of your bet, you stash the $100 billion loss in "Level 3" of your assets--a dark place where you can temporarily hide your worthless bets.

In other words, you bought an insurance policy to protect your risky bet on mortgage-backed securities and derivatives and now you find the insurer is belly-up and can't pay you.

If their bad bets were marked to market, Citicorp and Merrill Lynch would be declared insolvent. Why? Because they are insolvent--right now. The meaning of insolvency is straightforward: their losses exceed their capital. Recall that these firms list assets of $100 billion (or whatever) but their actual net capital is on the order of 2.5% - 5% --a mere sliver of their stated assets. In other words: a 5% loss of their stated assets wipes them out.

And once those leviathans fall, what other dominoes will they strike down?

The financial catastrophe which will unfold within the next few weeks is fundamentally a gross mispricing of risk. Inherently risky bets were encouraged because they were "hedged." That's what Hedge funds do: place bets on both sides so they collect gains whether the markets go up or down. But the risks of the gamble didn't really change; the introduction of low risk to a high-risk bet was an illusion.

The whole risk-management model depends on somebody being able to pay off the hedge. If they can't-- the game is over. the game is now over, and the players shuffling losses can only last a few more days or weeks.

The game is over for other fundamental reasons, too. The U.S. "prosperity" of the past five years has depended on one thing and one thing alone: cheap, easy borrowing, by consumers, home buyers, businesses, gamblers/bankers and government--cheap easy credit for everyone.

This was funded by capital inflows of billions each and every day. Foreigners poured trillions into U.S. markets, buying up risky mortgage-backed securities, supposedly "safe" U.S. Treasuries, and U.S. stocks, bonds and derivatives.

Now as the Fed and the Treasury destroy the dollar's value, foreign owners of dollar-denominated assets are seeing their wealth decimated. That "safe" Treasury you bought in 2002? It's down 30% as the dollar has been depreciated. You're underwater so deep you'll never make that money back.

And how about all those Yankee CDOs, MBS, interest-swaps and other exotic derivatives which Yankee ingenuity invented and sold to you as low-risk, high yield investments? They're mostly worthless now. You lost most of your money in a "safe investment." How anxious are you now to buy more Yankee "investments" denominated in the sinking dollar?

There goes the capital inflows which have funded our profligacy. They're gone, and not coming back. Mr. Bernanke and Mr. Paulson are busy destroying the dollar with interest-rate cuts, fueling runaway inflation as they flail mightily to save their banking buddies--but they can't succeed. Making more debt available to bankrupt entities, be they investment bankers or homeowners, solves nothing. It's called "putting good money after bad," and it simply guarantees ever-larger losses.

Allow me to sum it up: the money's lost, folks. You can't borrow more and pretend you made the money back. All those trillions in bad debt and derivatives are already lost. The Ministry of Propaganda is in a tizzy, trying to mask the meltdown and offer up a facade of normalcy. But the money's already lost.

Will it be contained to the U.S.? Why should it? The bad debt is everywhere. And the spending spree all that borrowing unleashed washed over the entire globe. Now that Americans can't borrow any more, the spending dries up--and so does the global "prosperity" built on an Empire of Debt.

Please link to original site for the rest of his article: Empire of Debt I: The Great Unraveling Begins


Regards