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http://www.financialsense.com/fsu/editorials/sutton/2007/1130.html

by Andy Sutton
My2CentsOnline.com
November 30, 2007

Turn on the evening news in most cities recently and you will see images of rows of homes, many for sale, many with foreclosure signs in the front yards. On weekends the tables come out and are strategically placed in the driveway heavily laden with the possessions of the soon-to-be-prior occupants of the home. These are selling off anything they can muster to scrape together rent for the next roof over their heads, the next car payment, or the next VISA bill. Most observers look at this and have at least a pang of pity or perhaps take a moment to be thankful for their good fortune.

Somehow though, when you put this wholesale liquidation into the terms of our country as a whole, the reaction turns from one of pity and contrite thankfulness to one of pure excitement and adrenalin. Earlier this week, we got news that Citigroup, the biggest bank in the US in terms of assets was receiving a much-needed $7.5 Billion infusion of cash from the Abu Dhabi Investment Authority (ADIA). That cash will not come for free though as ADIA will receive convertible stock yielding 11% annually. The deal will result in the ADIA owning not more than 4.9% of Citigroup. Between ADIA and Saudi Prince Walid bin Talal, they will now own nearly 10% of our biggest bank. 

Anyone see a problem here? Why is it that Citigroup can pay ADIA (who also happens to be a client) a return of 11% annually, while their common shareholders are only entitled to around half that? There are a number of possible conclusions that may be drawn from these facts. 

First, Citigroup was desperate; more so than anyone can imagine. 

Second, ADIA recognizes that a fall in the value of the dollar diminishes the purchasing power of their dollar holdings and is looking for ways to be compensated. Numerous reports stated that one of the main drivers behind the decision to make the investment is the recent fall in the dollar. Foreigners, sitting on trillions of dollars are scrambling to find suitable investment vehicles to cover the loss of purchasing power the dollar’s fall has caused. 

Third, foreign investors have been and continue to realize that their chances of getting paid back with actual products are slim and figure they’ll simply buy the cow instead of waiting for the milk. More than likely, it is a combination of all three.

Predictably, Wall Street reacted positively with the news of the deal touching off a two-day 500 point rise in the DOW Jones Industrial Average. I must be a royal party pooper, but I don’t see anything good coming of this. This certainly isn’t the first time foreigners have bought a stake in American companies. Recent deals include:

French telecommunications equipment maker Alcatel’s $13.4 billion takeover of Lucent.

The U.K’s National Grid buyout of New York’s KeySpan for $11.8 billion.

Saudi Basic Industries’ $11.6 billion purchase of GE Plastics.

At the beginning of November, Canada’s Toronto-Dominion Bank announced an $8.5 billion deal to acquire Commerce Bank.

In May, China spent $3 billion for a 10-percent equity stake in New York’s Blackstone Group. 

During September, Blackstone’s competitor, Carlyle Group, sold a 7.5 percent stake to the government of Abu Dhabi for $1.35 billion. 

Also in September, the government of Dubai agreed to purchase 20 percent of NASDAQ.

As a country, we are now akin to the family whose home has been foreclosed on. We are liquidating assets to make good on prior debts. While some will argue that this inflow of capital is a good thing and has been going on for many years, what I feel they fail to recognize is the pattern of acceleration in our debt accumulation and therefore the acceleration in the sell-off of American property, companies, resources, and other assets to cover the difference. This is another one of the drawbacks to the falling dollar that you will not hear about on the evening news. And yes, unlike popular opinion and the general consensus, it is a drawback.

In typical fashion, the mainstream press is presenting a rather one-sided view of the Abu Dhabi story and the underlying fundamentals. The contention is that we have them over a barrel because they can’t just exit the dollar. They would lose too much wealth in the process. While this might be somewhat true in the very short term, the real consequence is that eventually the title for the United States of America will be in the hands of foreigners. Who will have who over the barrel then? In a high stakes drag race much like the show ‘Pinks’, we are trying to beat a Lamborghini with a tricycle.

http://www.financialsense.com/fsu/editorials/schiff/2007/1130.html

by Peter Schiff
Euro Pacific Capital
November 30, 2007

In an article this week that examined the troubles brewing in Citigroup’s mortgage business, the Wall Street Journal focused on Natalie Brandon, a 51 year old married woman from Granada Hills, CA, who is currently unable to make the payments on her $625,000 adjustable rate home loan from Citigroup, despite the fact that the rate will not even reset higher until June of next year. Amazingly, the Journal reported that Mrs. Brandon bought the house in 1985 for just $105,000, but had chosen to refinance five times over the past seven years, borrowing more than $500,000 and spending every single penny. While this may be an extreme example of American profligacy, it is by no means unique. Unfortunately this type of behavior typifies everything that is wrong with the modern American economy.

Had this homeowner behaved responsibly, as was typical for Americans of prior generations, her current monthly mortgage payments would likely be less than $600 and the remaining balance on her loan would be about $40,000. In eight more years she would have owned her home free and clear, and would likely be on track for early retirement. Instead, after 22 years of making mortgage payments, she is now $625,000 in debt. The article stated that she had recently tried to refinance into a 6%, forty year, fixed-rate mortgage, but it fell through. Even if she had qualified, she would have been obligated to make monthly mortgage payments of close to $4,000 until she was in her nineties.

For years, Wall Street and the media have been singing the praises of the heroic American consumer. To that end Mrs. Brandon could be portrayed as Wonder Woman. She did her part to power our consumer driven economy by borrowing and spending to her heart’s content. Her last refinance even allowed her to buy a brand new Lexus. As long as she could find a greater fool willing to loan her more money, there was no limit to what she could buy. As it turned out, Citigroup was the greatest fool, left holding the bag on a $625,000 mortgage on a house now likely worth only half that amount.

Is it any wonder that we have enjoyed such a vibrant consumer based economy when a working class couple with perhaps $60,000 per year of household income can borrow over $500,000 (tax free) and buy whatever they want with the money? As the bills come due and those who have been doing all of the lending finally realize they will never be repaid, this crazy consumption binge will finally come to an end.

As the losses mount, the credit crunch will spread from mortgages to auto loans and to all forms of consumer lending. The days of Americans borrowing to consume are finally coming to a long over due end. Although it seems like science fiction to Americans raised on credit cards, within a few years most will only be able to buy those goods they can afford to pay for with cash.

In the long run of course, this will be a very positive development. Borrowing to consume is a waste of savings and undermines legitimate economic growth. Money loaned to consumers is unavailable to finance capital investment. By squandering savings on consumption, a society undermines its future standard of living.

When businesses borrow to make investments, those investments generate returns which enable the principal and interest to be repaid. When individuals borrow to consume, no investment is made and the loans can only be repaid out of reduced future consumption. As a result, business loans, especially when collateralized by real assets, are likely to be repaid, while consumer loans, collateralized by nothing but a promise to consume less in the future are much more likely to end in default. As lenders finally figure this out, consumer credit will dry up, and the American economy will enter a prolonged and severe recession. Unfortunately, an economy that lives by consumer credit will die by it as well. Hopefully a more viable economy will eventually rise in its place.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aHR5KklFq4X0&refer=home

By David Evans

Nov. 30 (Bloomberg) — School districts, counties and cities across Florida are scrambling to raise cash after being denied access to their deposits in a $15 billion state-run investment fund.

Florida’s State Board of Administration, manager of the Local Government Investment Pool, halted withdrawals yesterday at an emergency meeting after $12 billion was pulled out this month from participants. Governments from Orange County, home of Disney World, to Pompano Beach asked for their money back following disclosures that the fund held $1.5 billion of downgraded and defaulted debt.

“The unthinkable and the unimaginable have just happened here in Florida,” said Hal Wilson, chief financial officer of the Jefferson County school district, which kept its entire $2.7 million of cash in the fund. “What we just experienced here is a classic run-on-the bank meltdown.”

Thousands of school districts, towns and fire departments across the U.S. keep their cash in state- and county-run pools. These public accounts, modeled after private money-market funds, are supposed to invest in safe, liquid, short-term debt such as Treasuries and certificates of deposit from highly rated banks.

By freezing the Florida fund, officials left governments without ready access to cash they are accustomed to drawing upon for routine expenditures. The pool was the largest of its kind in the U.S. at $27 billion before the unprecedented withdrawals.

No Money

Just 30 miles (48 kilometers) east of the state capitol in Tallahassee, there was no money to pay the 220 teachers and other employees in Wilson’s Jefferson County school district today. Wilson said he trusted the State Board of Administration’s assurances that the money was safe even as other pool participants withdrew billions of dollars.

“We are in the process of working out provisions of a short-term loan with our bank to cover the overdrafts that will occur in our payroll account today,” Wilson said.

State Board Administration officials plan today to select an independent investment adviser, who will work over the weekend to help analyze the pool’s predicament, said Tara Klimek, a spokeswoman for Alex Sink, Florida’s chief financial officer. Sink is one of three trustees of the board along with Governor Charlie Crist and Attorney General Bill McCollum.

Avoiding Conflicts

One complication of the search for an adviser is finding an investment bank without conflicts of interest, Klimek said. With input from that adviser, and a newly created advisory panel of pool participants, the board may announce a plan to permit emergency withdrawals at a meeting scheduled for Dec. 4 in Tallahassee, she said.

Standard & Poor’s yesterday said it contacted state officials about whether the fund holds any money for debt service payments by local governments and whether that cash will be made available. The credit-rating company said it hadn’t yet received information and was monitoring the situation.

The Florida fund has invested $2 billion in structured investment vehicles, or SIVs, and other debt tainted by the collapse of the subprime mortgage market, state records show. Connecticut, Maine, Montana and King County, Washington, are among other governments holding similar investments, in smaller quantities.

The Local Government Investment Pool had $3.5 billion of withdrawals yesterday alone, said Coleman Stipanovich, executive director of the State Board of Administration, at yesterday’s special meeting in Tallahassee. The board manages the fund along with other short-term investments and the state’s $137 billion pension fund.

Improvements Planned

The board is considering ways to shore up the fund, including obtaining credit protection for $1.5 billion of downgraded and defaulted holdings hurt by the subprime market collapse. In voting for the suspensions, officials sought to stem the flood of money leaving the pool and avoid losses on forced sales of assets.

The investment pool’s debt holdings that were downgraded below its minimum standards have a face value amounting to about 10 percent of the pool. Officials disclosed the investments in a report delivered to Crist Nov. 14 following a month of inquiries by Bloomberg News.

“This situation points up the need for monies held in trust by local and state governments to be subject to searching due diligence and constant risk assessment,” said Harvey Pitt, former chairman of the U.S. Securities and Exchange Commission.

The fund’s $900 million of asset-backed commercial paper that was downgraded to default amounts to 6 percent of its assets. Another $650 million, or 4 percent, is invested in certificates of deposit at Countrywide Bank FSB, a unit of Countrywide Financial Corp. The bank’s rating was cut to Baa1, three levels above junk status, by Moody’s Investors Service on Aug. 16.

KKR Trusts

The pool owns $168 million of debt from KKR Atlantic Funding Trust cut to D, or default, from B by Fitch Ratings on Oct. 8. It also has $356 million issued by KKR Pacific Funding Trust, cut to D from B by Fitch Ratings on Oct. 2. Fitch said the cut to default on the debt reflected non-payment under the original terms. The debt was restructured to extend the maturities to February and March, and interest payments are continuing.

Florida’s pool has $180 million of paper from Ottimo Funding, cut to D from C by S&P on Nov. 9. S&P said an auction of Ottimo’s collateral “did not generate cash proceeds” to repay the asset-backed commercial paper.

The pool also holds $175 million of short-term debt issued by Axon Financial Funding, a SIV. It was cut to D from C by S&P this week. S&P said Axon failed to pay liabilities maturing Nov. 26, causing an “automatic liquidation event.”

To contact the reporter on this story: David Evans in Los Angeles at davidevans@bloomberg.net .

Last Updated: November 30, 2007 11:37 EST

By Dan Lonkevich and Jim Kennett

Nov. 29 (Bloomberg) — OAO Gazprom, the world’s largest natural-gas exporter, may start selling its crude and gas production in rubles rather than dollars and euros after the U.S. currency weakened.

“We are seriously thinking about selling our resources in rubles,” Alexander Medvedev, Gazprom’s deputy chief executive officer, told reporters today in New York. He didn’t give a specific timeline for the decision.

The switch would happen “sooner, rather than later,” Gazprom Chief Financial Officer Andrei Kruglov told the same gathering of reporters. The dollar has dropped 11 percent against the euro this year, reducing the value of exports by oil-rich nations and contributing to a 49 percent jump in crude- oil prices.

The dollar’s value isn’t likely to be affected if the switch is limited to Gazprom because the volume of trading in Russian oil isn’t enough to drag down international demand for the U.S. currency, said Michael Lynch, president of Strategic Energy & Economic Research in Winchester, Massachusetts.

Lynch said it’s also unlikely that oil markets would be affected by such a switch. “It’s a lot more smoke than fire,” he said. “There’s just this weird perception that if the dollar’s weak, somehow you’ll get more money if oil’s priced in rubles, but you just convert one to the other.”

Middle East Talks

Saudi Arabia, the world’s largest oil supplier, fought off an attempt this month by Iran and Venezuela to get the Organization of Petroleum Exporting Countries to discuss pricing oil in different currencies rather than in dollars. Six Gulf Arab states will discuss a proposal next month to revalue their currencies against the U.S. currency, the secretary general of the Gulf Cooperation Council said last week.

The strength of the ruble has encouraged Russian officials to quit selling oil and gas in dollars and euros, said Michael Malpede, a senior currency analyst in Chicago at Man Global Research, part of MF Global Ltd., the world’s largest broker of exchange-traded futures and options contracts. The ruble has climbed 7.9 percent against the dollar this year.

“The Russians have been considering selling energy in rubles for a while,” Malpede said. He called the move “a modest negative for the dollar, but nothing that will trigger any real selling of the currency.”

Russian President Vladimir Putin is pushing to lift the country’s international standing and secure its national resources by pressuring foreign oil companies to rewrite production contracts. His efforts to bolster his country’s self image also extend to history books, where he supports a new manual for high school teachers that softens the reputation of Josef Stalin, who killed millions of his countrymen.

`Political Deal’

“This is a political deal,” Bill O’Grady, director of fundamental futures research at A.G. Edwards & Sons in St. Louis, said of the possible shift to rubles. “It’s almost as if Putin has decided that what makes him strong is basically showing he can stand up to the U.S.”

Gazprom pumped 662,000 barrels of crude a day during the first six months of this year. About 80 percent of that production was refined into diesel, gasoline and other fuels domestically.

Crude oil for January delivery rose 39 cents to $91.01 a barrel on the New York Mercantile Exchange. Gas for January delivery fell 3.4 cents to $7.452 per million British thermal units. Gas futures have climbed 18 percent this year.

Gazprom would be “comfortable” with crude oil trading above $70 a barrel, Medvedev said. The company expects natural gas to trade between $300 and $350 per thousand cubic meters ($8.45 to $9.86 per thousand cubic feet).

To contact the reporters on this story: Dan Lonkevich in New York at dlonkevich@bloomberg.net ; Jim Kennett in Houston at jkennett@bloomberg.net .

Last Updated: November 29, 2007 17:16 EST

By Robert Scheer

http://www.ft.com/cms/s/0/16505568-9d5b-11dc-af03-0000779fd2ac.html?nclick_check=1

By Stacy-Marie Ishmael in New York

Published: November 28 2007 03:38 | Last updated: November 28 2007 03:38

The housing crisis that has held both Wall Street and Main Street in thrall this year will worsen in coming months, homebuilding executives said on Tuesday.

At a conference in Las Vegas, chief executives of major US homebuilding companies said rising foreclosures and tighter lending standards would aggravate an already bad situation.

“[Next year] is going to be worse than 2007 for us and for the industry in general,” said Donald Tomnitz, chief executive of DR Horton.

Homebuilders have been struggling to cope with falling house prices, overstocked inventories and a sharp drop in demand caused by stricter mortgage loan requirements.

Rising foreclosures have led to a glut of homes hitting the market, adding to builders’ already overstocked inventories, the consequence of speculative building during the house price boom.

“Speculative” investors – people who bought homes with the intention of selling them on at a profit – comprised perhaps a fifth of the market, Mr Tomnitz said.

These buyers have now disappeared and more than eight months’ worth of unsold homes sit on the market, according to data from the Census Bureau.

Meanwhile, consumers’ inability to access credit has limited prospects for new home sales, particularly in markets like California, where “jumbo” mortgages – of at least $415,000 – are needed, Mr Tomnitz said. “Financing is just not available, and when financing dries up, sales dry up.”

And those buyers who might qualify for loans were either delaying their purchases or demanding lower prices and concessions amid fears their homes would depreciate in value and leave them with negative equity.

Consequently, Mr Tomnitz said he did not expect to match this fiscal year’s sales of 40,000 homes in 2008.

Ian McCarthy, Beazer chief executive, contributed to the gloom, saying he expected 2008 to be another tough year for his company and the industry at large.

Chad Dreier, chief executive of Ryland Group, said his company had slashed its inventory by around $373m so far this year to cope with the housing slump.

http://archive.gulfnews.com/articles/07/11/25/10170189.html11/25/2007 07:40 PM | WAM

Abu Dhabi: It is time for Gulf states to break free from the declining dollar to stop rising inflation, The Economist has said.

The London-based magazine warned in a report published last Thursday that the dollar’s relentless decline against major currencies was “prompting jibes from America’s critics, jangling investors’ nerves and giving policymakers headaches.”

It urged the Gulf states to “loosen their ties to the dollar” when their leaders meet on December 3 in Qatar.

“Nowhere are the dilemmas more acute than in the Gulf, where virtually all the oil-rich states peg their currencies to the greenback. The combination of soaring oil prices and the tumbling dollar is distorting their economies and fuelling inflation,” the magazine said.

“The argument for linking to the greenback was to provide an anchor for the region’s economies, many of which are small, open and financially immature. In effect, the Gulf states import America’s monetary policy. The trouble is that a fixed currency makes it hard for oil exporters to adjust to swings in the price of oil. And monetary policy in the world’s largest oil-importer is not always right for those who sell the stuff.”

It added that soaring oil prices have brought the Gulf huge riches. Their real exchange rates, as a result, ought to rise. The simplest way to do that is for the currency to strengthen, but the peg prevents nominal appreciation.

Worse, the dollar itself has been falling. The result is rising domestic inflation.

The report suggested including the oil price as part of a basket that includes the leading currencies. “This would ensure their currencies absorbed some of the impact of oil-price swings.”

It also voiced fear that ending the dollar peg may cause panic among investors. “The worry is that the end of the Gulf states’ dollar peg would send jittery investors into a panic. That risk is real. But with oil prices rising and the dollar falling, the dangers of inaction are greater.”

President Putin accused Nato yesterday of threatening Russia’s security and ordered the military to place the country’s strategic nuclear arsenal on a higher state of alert.

“In violation of previous agreements, certain member countries of the Nato alliance are increasing their resources next to our borders,” Mr Putin told generals in a meeting broadcast on state television. “Russia cannot remain indifferent to this obvious muscle-flexing.”

Mr Putin, whose rhetoric has become more strident as relations with the West have deteriorated, went on: “One of the most important tasks remains raising the combat readiness of the strategic nuclear forces. They should be ready to deliver a quick and adequate reply to any aggressor.”

He issued his stark message as Russia confirmed that it would pull out of a landmark arms limitation treaty on December 12. The Conventional Forces in Europe (CFE) treaty was fundamental to ending the Cold War.

Mr Putin hit out at Nato less than two weeks before Russians vote in parliamentary elections. While there is a clear element of sabre-rattling for domestic purposes, the Kremlin has also been alarmed by what it regards as a Nato plot to contain Russia.

Mr Putin is determined to increase pressure on Nato in an attempt to divide European members over a United States plan to place a missile defence shield in Poland and the Czech Republic. He has already threatened to station nuclear missiles in the Russian exclave of Kaliningrad, which is surrounded by EU states, if Nato ignores Moscow’s objections.

Poland’s new Government has stated that it is willing to review the US proposal to place interceptor missiles on its territory. Washington says that the shield is aimed at rogue states such as Iran, but Russia is adamant that its own security is at risk.

The Kremlin is also angry at the prospect of Nato expanding to take in former Soviet satellites such as Georgia, Ukraine and Azerbaijan, bringing the military alliance along most of Russia’s western border.

The 1990 CFE treaty imposed limits on the deployment of tanks and other forces in Europe. Nato refused to ratify an updated treaty in 1999 until Russia pulled troops out of the former Soviet republics of Georgia and Moldova.

Moscow has rejected any link between the two issues. Mr Putin said that Russia had honoured the CFE treaty while Nato members had continued to build up their military capabilities.

Mr Putin said that Russia would return to the CFE treaty only after Nato countries had ratified it. He urged the generals to seek “new ways to mitigate threats in the early stages”.

Mr Putin also praised the military potential of the Shanghai Cooperation Organisation (SCO), which links Russia, China and four former Soviet states in Central Asia. The group held its first joint military exercises in August at Chebarkul in the Urals.

http://www.timesonline.co.uk/tol/news/world/europe/article2910112.ece

http://www.financialsense.com/fsu/editorials/sutton/2007/1116.html

by Andy Sutton
My2CentsOnline.com
November 16, 2007

These are just some of the headlines that have emerged during the past year concerning the ails of the US Dollar. There have been hundreds, perhaps thousands of explanations for why this is a good or bad thing. Thousands more questions asked, but never answered. At the end of the day though, it is really about our old friend: The law of Supply and Demand.

The Demand Side

There are three major areas of demand for US dollars. The first is the domestic US economy, which needs enough dollars to run smoothly. This includes the broader categories such as mortgages, credit cards, various consumer loans, corporate credit and circulating specie (printed dollar) currency. We have seen waning demand for dollars in the area of mortgages, and an overall flattening in terms of consumer spending. If the consumer spending numbers were adjusted honestly, we would likely be seeing real declines in consumer spending. This all translates into a decreased demand for dollars. One point worth mentioning in this case is that it explains on several levels the Fed’s decision to drive their target interest rates lower. They are attempting to induce borrowing through lowered costs of money. This is a classic response to diminished demand. The Fed was clearly at a crossroads. They could have saved the dollar or the debt-reliant economy. They chose to save the economy. Given the hyper-dependent condition of our society, it was the only choice really.

There is a tug of war going on with regard to decreased demand for dollars and the perceived counterparty risk when loaning dollars. Those lending want to be compensated for the risk they take when making loans. However, their desired rate of return doesn’t match the rates at which borrowers are willing to take on more debt. The result? Turmoil, volatility, and eventually, panic in even the shortest-term money markets.

The second is the foreign demand for dollar denominated assets to soak up their accumulated dollars. The below diagram is a graphic representation of the flow of dollars around the globe:

As can easily be seen by the chart, the demand for dollars exists only so long as there is profit to be had from re-enabling US consumers to buy products they could otherwise not afford. For decades now we have not been able to pay for our consumption with production. This is the reason for our persistent trade deficits. Our overconsumption fuels the dollar cycle. When enough of our wealth has been transferred to foreigners, they will no longer need us to purchase their products since they will be able to afford to purchase the products themselves. Headlines screaming of the fact that Chinese automobile, retail and household electronics are increasing at a rapid pace fuels speculation that the fuel for the Dollar Cycle pump is beginning to run out.

The third source of demand is for petrodollars. Since the dollar is still used as the medium of exchange for many (although a slowly shrinking) number of oil transactions, countries that are net importers of oil need to keep a stock of dollars around for financing their oil habit. Smaller examples of oil-producing nations demanding something other than dollars for purchase of their oil have been emerging recently. These actions while individually small, in aggregate, serve to erode demand for the dollar. When the combined effect of petrodollars, flattening US consumption, and the drying up of the Dollar Cycle are considered, it is easy to understand the concept of diminishing dollar demand.

The Supply Side

There are several mechanisms by which the supply of dollars may be manipulated. First, the Fed can create electronic digits and infuse them directly into the banking system. Secondly, they can purchase assets of compromised value at par (near what they used to be worth). Third, they can purchase bonds directly from the Treasury, thereby monetizing our debt. In effect, what the Treasury is doing is robbing Peter (future generations of Americans) to pay Paul (current and prior deficits). The Treasury takes the dollars they get from the Fed in exchange for the debt they sold to the Fed and spends them into the economy causing inflation. There is a common misunderstanding among many individuals. They think that the Fed is part of the government. It is not. The Fed is a private banking cartel whose ownership is divided up among the world’s largest banks. Every dollar they create is a debt that is owed them with interest. In addition to the Fed, the banking system itself can create money out of thin air with fractional reserve banking by using ridiculously low reserve requirements. Combined, our money supply growth is accelerating at an alarming rate. One look at the reconstructed M3 chart from www.nowandfutures.com tells the story:

In summary, the demand for dollars is beginning to wane while the supply is clearly growing at an ever-increasing rate. The results are predictable: The price (value) of the dollar will go down against other types of currency and real money. One caveat to this analysis is that it is not safe to assume that the Euro et al are ‘hard’ currencies just because they are appreciating versus the dollar. Nothing could be further from the truth. While it is true that many of these other currencies have implicit backing by natural resources or strong productive economies, none of them have the one true hallmark of a stable money system: an indestructible link to tangible value.

http://www.financialsense.com/fsu/editorials/schiff/2007/1116.html

by Peter Schiff
Euro Pacific Capital
November 16, 2007

When home prices skyrocketed in the early part of this decade, everyone seemed to forget that the subprime borrowers were high risk by definition. Now that losses are snowballing, lenders are belatedly rethinking the “wisdom” of making such loans in the first place. Similar conclusions will soon be reached by foreign nations that have supplied American consumers with goods that they can not afford. In reality, America is a nation of subprime consumers. 

For most of recorded history, nations have paid for their imports with exports. When a nation runs a trade deficit, and instead pays for imports with its own currency, it in effect issues an IOU to the seller to buy an exported good at a future date. After all, the currency of the nation running the deficit is only legal tender in the country of issue, and is therefore useless to other nations unless it can be exchanged for goods in the issuing country or exchanged for other currencies. However, no matter how many times the currency is passed around, at some point the final holder must spend the money on something in the issuing country.

By providing goods in exchange for IOUs, foreign nations are in essence engaged in vendor financing. This concept came to mass attention during the dot.com boom, when many telecommunications equipment companies sold their goods to give cash to poor start-ups in exchange for credit or stock positions (in effect, IOUs). When the dot coms went bust, the equipment providers were forced to restate earnings as losses. 

As the world surveys the landscape of the American economy, it will notice an industrial base too hollow to produce sufficient quantities of exportable consumer goods necessary to make good on our outstanding IOU’s (U.S. dollars). As those dollars continue to lose value, the losses will suddenly become increasingly apparent. Just as lenders eventually figured out that loaning money to borrowers who could not pay them back was a bad idea, nations will discover that selling products to Americans who can not afford to pay for them is just as foolish.

Think about this. Currently, foreign tour operators are organizing shopping tours, where foreign citizens fly to America for the specific purpose of buying goods cheaper here than they can buy the same goods in their own countries. Of course, most of the goods they are buying, such as clothing, electronics, jewelry, etc., were not made in America in the first place. How absurd is it for Italians to come to New York to buy Italian made shoes cheaper than they can find them in Milan? Does it make sense for foreign producers to offer products to Americans for less than their own citizens? Of course not. In short order the free market will correct this by raising prices here in America and lowering them in the rest of the world. 

Many naively believe that this scenario is unlikely as foreigners will indefinitely prop up the U.S. economy in order to preserve their “best” export market. However, the same argument could have been made regarding mortgage lenders and subprime borrowers. After all, based on the outsize fees generated by subprime lending products, risky borrowers were clearly the mortgage industry’s best customers. Given their profitability, why didn’t lenders simply extend subprime borrowers even more credit to preserve the market? The obvious answer is that at some point lenders discovered that the market was not worth preserving. They realized that the short-term profits came at the expense of far greater future losses.

The same revelations are about to be made around the world as other nations realize that selling consumer goods to Americans is a losing proposition, as the profits they believe they are earning today will simply evaporate tomorrow. When that happens, just as subprime borrowers are losing access to mortgage credit, America’s subprime consumers will find far fewer bargain basement imported products at their local Wal-Mart.