Economy Articles

Market Trends – August 09

General Market

A) Bad signs for the economy’s two most important measures

First, the Labor Department issued a worse-than-expected jobs report this morning (July 2^nd, 2009). The U.S. economy shed 467,000 jobs in June. As this chart shows, the Street was betting on the current trend to stay intact. Job losses have decreased every month since the January peak.

B-list data points from July 2^nd jobs report were equally lousy: The average hourly workweek fell to 33 hours, but hourly wages stayed the same. Those out of work for six months or more now exceed a record 4.4 million. And continuing claims for unemployment benefits remained at 6.7 million, just below an all-time high. By the government’s count, a record 14.7 million people are now unemployed. That makes for a 9.5% unemployment rate, a 26-year high.

Second, on the housing front, mortgage applications have fallen to a seven-month low. According to the Mortgage Bankers Association, requests for new home loans fell 19% last week while re-financing plunged 30%, both to levels unseen since November. While mortgage rates are well off March’s 4.6% record low (30-year fixed), they’re still at a reasonable 5.3%, a full 100bps below the average rate this time last year.

And since it worked so well the first time around: The Obama administration announced they will expand the “make home affordable” program to an even wider range of deadbeat borrowers. Previously, homeowners with mortgages worth more than 105% of their home’s value did not qualify for President Obama’s manipulated re-financing rates. That limit has been bumped up to 125%, which is incredible. Even more incredible thing is that one in five mortgage borrowers are “underwater,” meaning the value of their loan is worth more than the price of their home. That’s nearly 20 million homeowners.

Housing and jobs are the two cornerstones of American middle-class wealth and if they can’t hold the weight of a building economy, there is little chance of a broad recovery in the United States.

In addition, the American service industry contracted again in June, the ISM reports today. Their monthly gauge of the service sector scored 47 last month, 3 points below a Growth Reading of 50. At least that’s an improvement from May’s score of 44. In fact, June was the third straight monthly increase.

The FDIC closed down seven banks on July 2^nd, a single-day record for the credit crisis. That brings the total to 52 for the year. Considering the five bank failures the week before, it’s clear the pace of bank busts is accelerating.

B) State of emergency: How California could be the next bailout target

Let’s take a quick look at the world’s tenth largest economy, California. As the market expected, Fitch Ratings chopped California’s credit rating to BBB on July 7^th, based on the state’s continued inability to achieve timely agreement on budgetary and cash flow solutions to its severe fiscal crisis (BBB is just two levels above “junk bond” status). Still unable to resolve its $26 billion budget shortfall, The Golden State started issuing IOUs to its creditors since late June for just the second time since the Great Depression. Fitch’s downgrade will make closing that budget gap even more challenging.

Dan Amoss, a CFA, writes in his Strategic Short Report, “State governments will have a negative impact on GDP in coming quarters. In the next few payroll reports, we’ll start to see these budget crises lead to larger job losses in the government sector. These budget crises were seeded when state governments started spending on the naive assumption that the real estate bubble and windfalls from capital gains taxes would never end. They hired new employees in droves over the past decade on the assumption that tax ‘revenue’ was sustainable. According to Michael Mandel of BusinessWeek, the public sector of the U.S. economy created 2.4 million jobs over the past decade, twice as many as the private sector. California is preparing to pay its bills with IOUs. Eventually, some government jobs will have to go.”

U.S. taxpayers will likely extend a lifeline to California’s bankrupt state government before the end of summer. At a May 21 hearing in Congress, Rep. John Culberson of Texas asked Treasury Secretary Geithner if he would rule out bailing out California or any other states with our tax dollars. Geithner replied, “We will have to do exceptional things, as we have done already, to fix this mess. That’s not putting on the table or taking off the table any specific thing like that.” In other words, a bailout will likely arrive if California’s budget is in danger of a chaotic collapse, but it will have to come on tough terms. The Treasury will probably provide a bridge loan on the condition that California’s government will quickly pay back the money with fiscal austerity measures. Then the question is why the tough terms? Because after the recent moonshot in 10-Year Treasury yields, even Secretary Geithner is learning that the market will impose limits on the federal government’s deficit spending.

California can’t even afford a proper send-off for the King of Pop. Thousands upon thousands rushed into the Staples Center in Los Angeles on July 7^th for a memorial to Michael Jackson. Between keeping extra cops and medics on hand, to traffic control, to post-event cleanup, the city of Los Angeles spent around $2 million on the memorial. Money, of course, it doesn’t have: “I did reach out,” acting LA Mayor Jan Perry said. “I said, ‘Is there any way to direct me to people who can assist, in Michael’s memory, in deferring the cost of this event? I’m still waiting for a callback.”

Since the U.S. as a whole is just barely better off than the Golden State, we’re hearing more and more calls for another stimulus package.

Exhibit A: “We should be planning on a contingency basis for a second round of stimulus,” said Laura D’Andrea Tyson, one of President Obama’s economic advisers. Tyson claimed the $787 billion stimulus passed back in February was “a bit too small,” and that “the economy is worse than we forecast on which the stimulus program was based.”

Exhibit B: When pressed on CNBC of a second stimulus, leader of the president’s Council of Economic Advisers Christina Romer said quite confidently, “We’ll do whatever it takes.”

C) Commodities World is Changing

According to Frank Holmes of U.S. Global Investors, the trend of the commodities market has changed. Take a look at how historical patterns have shifted. The graph below shows the five-, 15- and 30-year patterns for copper prices. Holmes explains, “The 30-year pattern shows what used to be a rule of thumb when I first got into this business, “buy in November and sell in March.” This was because of seasonal stockpiling during winter months leading into major building and construction projects in the spring and summer months. In contrast, the 15-year pattern is dramatically different. This pattern shows copper prices rising from January-May and then trading pretty much sideways for the rest of the year, with modest peaks and valleys along the way. A similar pattern is drawn to represent the past five years.”

The main reason for this change in trend shift seems to be China. According to research from Dundee Wealth Economics, China’s copper consumption grew from about 1.8 million metric tons in 2000 to nearly 5 million metric tons in 2008. This pushed China’s share of global consumption from 13% in 2000 to 28.5% last year. In the first quarter of 2009, Dundee estimates, China accounted for 38% of the world’s copper usage. Copper isn’t the only metal where China is king. China also leads global consumption growth for aluminum, zinc, lead and nickel from 2000-2008.

We thought Asia faced some serious macro challenges at the beginning of this year, and we see no reason to change our mind yet. China, undoubtedly, has extraordinary potential, and we would not for a moment disregard the desire of Chinese leaders to achieve the status of the next global leader. The fact of the matter is that until China is prepared to accept currency appreciation, and thus prepared to reorient its growth strategy away from export-led development without simply putting up redundant capacity or building up speculative inventory stocks, its goal is likely to remain elusive. Asia’s production structure needs to recalibrate for a slower Western consumer growth profile, and that inevitably must involve steps that scrap excess capacity and allow new domestic demand sources to flourish.

D) Americans saving, cutting down debt VS China’s Credit Bubble

US consumer credit fell for the fourth straight month in May, the Federal Reserve reported on July 8^th. Credit inched down at an annual rate of 1.5% during the month, a $3.2 billion drop to a total consumer debt load of $2.52 trillion. Coupled with the previous three months, we’re now experiencing the biggest and longest consumer deleveraging since 1991. We even have a somewhat respectable savings rate, 6.9%, the highest since 1993.

While we welcome this deleveraging, it still doesn’t seem legit. With unemployment at a 26 year high and the sudden disappearance of easy-money credit, we wonder if this balance sheet restoration is a matter of choice or if the lowly American consumer is just playing the hand he’s been dealt. The U.S. household sector is currently saving more and deleveraging, while lenders both here and abroad remain wary of lending, except, apparently, in the case of bank loan officers for high rollers in China. To be clear, the household and business sector debt reduction is still in its early stages and has been dwarfed by the massive deleveraging of the financial sector itself as the so-called ‘shadow banking system’ has either collapsed or moved onto the Fed’s balance sheet.

While U.S. credit tightens, new loans in China more than tripled in the first half of 2009. The People’s Bank of China reported overnight that lending reached $1.07 trillion by the end of the first half. That’s more than three times bigger than the same period in 2008, lending doubled from May to June alone. Looks like, the credit bubble has found a new home. Chinese auto sales are soaring too, up 36% from this time last year. The Chinese snapped up 1.14 million cars, trucks and busses in June and 6.1 million in the first half, says the China Association of Auto Manufacturers. Both of those numbers easily top U.S. auto sales.

E) The Great Shifts of 2009

Wal-Mart is no longer No. 1. That title now goes to Royal Dutch Shell. The American consumer is out, and a global oil conglomerate is in. There’s a clear sea change in American business. AIG, Lehman and Bear Stearns fell off the list from 2008-2009. Nike, Google and Amazon moved up. The world is increasingly less Amero-centric. An American company is not No. 1 for the first time in over a decade. In the whole list for 2009, 140 companies are American, the lowest number on record. The world is increasingly more Sino-centric. Look at China National Petroleum and Sinopec. Both Chinese companies are by far the biggest movers up from 2008-2009. Sinopec, an oil and gas company also marks China’s first foray into Fortunes’ top 10. China now has 37 companies in the list of 500, its largest presence ever.

Oil is still where it’s at. In spite of all the price drama over the last year, seven of the top 10 firms are oil companies. In the face of the worst global economic environment of our lifetimes, the world’s biggest companies are still making lots of money. The 2008 top 25 pulled in $4.88 trillion in revenue. This year, they made $5.38 trillion.

The world’s producer of everything, GE, was one of very few companies to retain the same position from 2008-2009. And despite the infamous GE Capital, the finance arm that apparently threatened to torpedo the whole company, GE ended up increasing revenues by nearly $7 billion.

F) Summery of Second Quarter of 2009

Jeremy Grantham, a financial analyst, begins, “We recommend taking some risk units off the table. A year ago, equities globally … and everything else, for that matter, were very overpriced, particularly if they were risky. A quarter ago, in mid-March, prices everywhere were cheap. Now they have all or almost all converged for a few unusual moments at fair value. It’s difficult to be inspired at fair value. Given our view that we are in for seven lean years in which the market will be looking for an excuse to be cheap, we recommend taking some risk units off the table, including becoming underweight in equities, between 1,000 and 1,100 on the S&P, if it gets there this year. Around 880, you should continue to move slowly to fair value, twiddle your thumbs and wait to see what happens.”

The stock market finished the best July since 1989. The S&P 500 finished the month up around 8%, its best month since April and best July in 20 years. After yesterday’s 1% rally, the index is up to 987. Baring catastrophe today, the S&P will register its fifth consecutive monthly gain.

With data like this, it seems the credit crisis is over.

Speaking of credit crisis, banking lending rates reached a historic low on July 29^th. At a low 0.48%, three-month Libor is at its lowest rate since at least 1986, when the British Bankers’ Association started keeping track. Compared to its post-Lehman Brothers peak of 4.8%, banks can now lend to each other at practically no cost. Credit, it would seem, is extremely liquid.

The Libor/OIS spread is the complicated ratio of interbank lending rates to overnight index swaps. It peaked at 3.6% basis points in October. Alan Greenspan said credit would be in a “normal” state when the spread hit 0.25%. On July 29^th morning, it shrank to 0.29%. Interbank credit is flowing, but that’s no longer the problem. It was once about what banks didn’t have; credit. Nevertheless, currently it is all about what they have got; bad assets. Too bad there’s no three-month swap rate for those.

Back to economy, the U.S. economy shrank at 1% annualized rate in the second quarter, the Commerce Department estimated on July 29^th. Since that’s better than the 1.5% contraction the Street had predicted, we see headlines of “The Pain Is Easing,” and “Recession Easing” left and right. Those data are true, the latest GDP number is better than that of previous quarters, but here are some of the stats that we should pay our attention to as well:

The U.S. economy has now contracted four quarters in a row, the worst streak since the Great Depression.

GDP has contracted 3.9% in the last year, the worst fall since at least 1947, when the Commerce Department started keeping track.

First quarter GDP was revised down heavily, from a 5.5% to 6.4%; the biggest quarterly GDP drop in almost 30 years.

The Commerce Department revised 2008 down as well, from a 0.4% annual contraction to a 1% decline.

Consumer spending, 70% of U.S. GDP, contracted 1.2%. The retrenchment was largely replaced by government spending, up 10.9%.

Employment compensation rose by just 1.8% over the last 12 months, the slowest rate on books that go back to 1982.

But as you’d expect, the market has clung to the expectations-beating, lower-than-usual “headline GDP,” thus, stocks are currently holding onto July 28^th gains and hovering around break-even.

Stocks and Commodities Market

The American stock market reacted harshly to this July 2^nd’s jobs report, given the Street missed the number by nearly 100,000 jobs. The Dow and S&P 500 opened down over 2%.

There was a scare at the start of the year: banks were in trouble, the housing market was crashing and unemployment was rising. The S&P fell at a rate unseen in a long, long time. But The U.S. consumer, China and oil companies promised to lead us out of this mess. And of course, the current administration’s new multibillion stimulus plan will kick in any second.

After bottoming in early March, stocks soared well off their lows. With the S&P 500 at break-even for the year, stocks now face an inflection point. We need not remind you of what happened in the second half of 2008. But it’s not worth worrying about, it’ll be different this time!

Stocks took quite a tumble on Thursday (July 2^nd). The worse-than-expected jobs report gave traders more than enough reason to be short into the three-day weekend. The S&P 500 fell nearly 3%. Since reaching its 2009 high in early June, the S&P is down 5%. Major indexes were in trouble again on July 6^th. The Dow and S&P opened down 0.75%, mostly thanks to sour moods left over from Thursday. And just as in 2008, the smart money says there is more pain ahead: “You may have green shoots, whatever you want to call them,” said market sage and author of The Black Swan, Nassim Taleb. “You may have temporary relief, but you are still in a world that’s breaking. We’re in the middle of a crash. So if I’m going to forecast something, it is that it’s going to get worse, not better.” “The monkey on our back is debt.”

Just like in 2008, the logical move is to sell dollars and buy useful assets, like gold. But just like last year, the current trade du jour is buy greenbacks, sell everything else. After July 2^nd’s stock sell-off, the dollar index broke out of its recent range. It had been hovering just around

80 and by July 6^th goes for 80.7.

The stock market registered another dull day of trading on July 9th. The Dow finished flat, while the S&P 500 inched up 0.3%. With second-quarter earnings season now in full swing, we fear for the major indexes. It is one thing to have “less awful” numbers in the first quarter, but it is doubtful that many companies will be able to produce the “green shoots” results the market now craves.

Back in I.O.U.S.A., $73 billion in American debt was auctioned off on the second week of July with relative ease. On July 10^th, $11 billion auction of 30-year bonds capped off a busy week for the U.S. treasury. Wednesday’s (July 8^th) $19 billion auction of 10-year notes was the biggest since March. Incredibly, that 10-year auction drew the largest bid-to-cover ratio since 1995. The 10-year currently yields 3.4%, just off a seven week low. Nevertheless the success in selling debts, the U.S. is still on track to issue an incredible $2 trillion in notes and bonds this year.

On July 2^nd, the oil patch, light sweet crude finally fell out of its recent range. The front-month contract was down two bucks and changed to $66 a barrel. As we advice at last months report, it would have been good if you have taken some oil profits off the table. With crude down to $64 a barrel by July 7^th, a $9 fall since this time last week, dreams of $100 barrel profits and new drilling projects are being dashed left and right. Gold is still consolidating. An ounce goes for $930 as of July 2^nd, 2009.

From a technical standpoint, gold looks set for some short-term pain. Just like stocks, the gold chart is taking a page from 2008. When it hit the fan last year, gold failed to deliver the righteous moonshot many had forecast. It certainly was a better place to be than stocks, but gold still suffered. After sticking to a tight range the last few weeks from July 6^th, gold fell along with stocks. The spot price shed $10, to $925 an ounce.

NVI see everything coming up roses for gold and we are not the only one: For the first time in a couple of decades, some of America’s most successful, big-name investors are buying gold. David Einhorn, the hedge fund manager who predicted the downfall of Lehman Bros., recently bought gold for the first time. John Paulson, the guy who made billions of dollars by correctly anticipating the housing bust and credit crisis, plunked down $1.3 billion for an 11% stake in AngloGold. He’s also got a big position in Kinross Gold. Peter Munk, the 81-year-old chairman and founder of Barrick Gold, also offers up his own anecdote about gold’s broadening appeal: “I have had more phone calls in the past six months than ever before, from people who have $120,000 inherited from grandmother, and from hedge fund managers with millions. I am not saying George Soros, but people of that caliber have told me they are buying gold. You no longer have to be a gold bug to think gold will rise in price. In fact, this buying by some of the world’s greatest investors may be the leading indicator for a quick 116% climb, to $2,000 per ounce or higher. Give gold the cold stare of a professional handicapper and the odds look very good, indeed.”

Commodities registered another small gain on the very last day of July as stocks rise and the dollar falls. Gold added about $6, to $941 an ounce. Oil is up almost a buck, to $67 a barrel.

The dollar has resumed its losing ways. Thanks to two days of rising stocks, the dollar index is down almost a full point from Wednesday’s high at 78.6.

US Housing Market

In general, U.S. home prices will likely continue falling all through 2010, says a report from mortgage insurer PMI Group. According to PMI Group, home prices in 30 of the 50 biggest metropolitan areas of the U.S. have at least a 75% chance of falling through 2010 and into 2011. While we won’t dive too deep into the forecast, the fundamentals make sense: “home prices could get another shot by a demand shock of high unemployment and a supply shock of distressed foreclosure sales,” said LaVaughn Henry, senior economist at PMI.

More bad news in the housing industry: The number of U.S. consumer loans in default has hit a record high, reports the American Bankers Association. The ABA just polished off its first-quarter delinquency report and revealed some disturbing results: Of all the consumer loans in America, 3.23% are more than 30 days in arrears. That’s the highest level since at least 1970, when the ABA started keeping track. Of course, it’s no shocker that things got tough in the first quarter. But how can we explain the most recent three-month stint? “The No. 1 driver of delinquencies is job loss,” explains ABA’s chief economist, James Chessen. “When people lose their jobs, they can’t pay their bills. Delinquencies won’t improve until companies start hiring again and we see a significant economic turnaround.” So practically no one expects the unemployment rate to stop its accent until at least 2010. And just as many are willing to admit there are boatloads of souring loans still on bank balance sheets.

However, here’s a headline we can’t resist: “Home Prices Rose in May,” trumpets The New York Times on July 28^th. We understand they’ve got papers to sell and a hell of a mortgage. But in reality, the U.S. housing market is only decaying at a slower pace. Today’s S&P/Case-Shiller home price index reading is par for the course for the last quarter. Home prices and sales are still falling, just no longer accelerating into the abyss.

May registered a 16.8% annual decline in S&P’s 10-City Composite, with its 20-City just a bit worse. Even though that’s still a far cry from home price appreciation, May marks the fourth month in a row in annual return improvement.

To put it in perspective, this is the first time we have seen broad increases in home prices in 34 months. This could be an indication that home price declines are finally stabilizing. While many indicators are showing signs of life in the U.S. housing market, on a year-over-year basis, home prices are still down about 17% on average across all metro areas.

The World

A) World Unemployment

The unemployment scene in Europe is turning ugly as well as in the US. The unemployment rate in the 16-nation eurozone hit 9.5% in May, the EU statistics office announced early this morning. That’s a 10-year high. If you’re looking for work over there, steer clear of Spain. Spaniards rank at the top of the EU’s jobless list, with an unemployment rate of 18.7%. Job seekers are better served in the Netherlands, where only 3.2% are unemployed.  The European Central Bank chose to keep lending rates at 1% on July 2^nd, 2009, a record low.

B) China’s call for an alternative global reserve currency

China wants to add a new global reserve currency debate to next G-8 meeting. Unnamed Chinese officials asked the organizers of the G-8 gathering to include such a discussion on July 1^st. Last year, we heard little hints here and there of China’s dollar unease. Now they are practically shouting it from the rooftop. This could get interesting soon.

In a similar vein, the IMF announced today it will issue more bonds denominated in Special Drawing Rights, a fancy phrase for a basket of global currencies. After much demand from BRIC nations, the IMF said it will print bonds worth $150 billion, each denominated in a basket consisting of the dollar, euro, pound and yen. China, Brazil and Russia have already promised to buy $70 billion worth of the bonds, a convenient way to diversify out of the dollar and gain some say in the governance of the IMF’s war chest.

China’s call for an alternative global reserve currency put the dollar index down almost a full point. But traders refuse to leave their recent range, after falling as low as 79.5 on July 1^st, 2009, the dollar index was already back up to 80.1 on very next day.

“The dollar system or the system based on the dollar and euro have shown that they are flawed,” Russian President Medvedev told the international press on July 6^th, yet another call from a BRIC nation to ditch the dollar. “In the long term, we must also think about a single unit of payment such as the International Monetary Fund’s Special Drawing Rights. We cannot be hostages to the economic situation of a single country, as is happening today with the United States.”

“Of the major world currencies, I have to say that Australia’s dollar is my favorite,” says foreign exchange trader Bill Jenkins. “It has an edge because of its commodity-related economies and currencies. Now, Canada has the same edge. In fact, you may hear the Canadian and Australian dollars called the CommDolls (commodity dollars) for short. But Canada is inextricably tied to its neighbor to the south (the US), and that’s more than just a little problematic. Australia, on the other hand, is not tied to the United States. Instead, it’s better placed to trade with another resource-hungry nation, China. As China attempts to lift itself up by its own bootstraps, Australia comes into the picture. It has been widely understood that Australia is a little China. Not in culture, custom or language, but in economics. A significant part of Australia’s commodities flow into China, and the more the Chinese move ahead, the better it is for Australia. Also, let’s consider that Australia’s central bank is still holding its interest rates at 3%. In a fairly stable country, with a fairly stable currency, that is one heck of an attractive rate. Why, it is downright appealing! Indeed, Australia may now become the benefiting member of the next carry trade. After all, if can you borrow money at 0.25% and invest it at 3%, you stand to make a decent haul. And as risk appetite re-enters the market, you can bet your bottom dollar that Australia will likely be a real beneficiary.”

C) Could Canadians be Next?

While certainly better off than the U.S., Canada could face a consumer debt crisis of its own, reports the Bank of Canada. In its biannual Financial System Review, the BoC said on July 7^th that “There has been a further deterioration in the financial position of the Canadian household sector.” The average ratio of debt to income has hit a record level for Canadians. Household debt there is averages roughly 140% of disposable income. Here in I.O.U.S.A., it’s closer to 170%. Suffice to say neither ratio is desirable.

If you think Canada escaped the downward trend in U.S. banking, think again. While the country may not have plunged headfirst into subprime mortgages, it did dip heavily into risky derivatives. The leverage it took on generated impressive returns on equity in good times, but that same leverage is set to wipe out equity today. Canada has just entered what will ultimately be an enormous credit loss cycle, and by the time it’s over, the Canadian banks could easily lose their pristine reputations. Until the middle of 2008, Canada’s economy was booming. Its mining, energy and manufacturing sectors are world-class, and every other sector was pulled along for the ride.

But the wheels fell off last fall. According to Statistics Canada, the unemployment rate rose to 8.4% in May, the highest in 11 years. Ontario, with its heavy manufacturing base and ties to the ‘Detroit Three’ auto companies, is especially hard hit; Ontario lost 234,000 jobs, or 14% of its entire manufacturing work force, since last October. Ontario will lose even more jobs this summer as GM and Chrysler dramatically cut auto production. Alberta has slowed dramatically too. Just a year ago in Alberta, every skilled construction worker was working overtime on oil sands projects. Now many projects are postponed and workers are getting laid off. The unemployment rate in Alberta nearly doubled from May 2008 to May 2009, to 6.6%, and is heading higher.

For Canada, this credit cycle will probably be worse than the one in the late 1980s. According to RBC Capital Markets, annualized loan loss provisions for the entire Canadian banking system peaked at 2.88% of all loans in 1988. As of April 2009, this figure was just 0.77%. Over the next year or two, loan loss provisions should easily triple or quadruple, which would cut deeply into profits and capital.

D) Iran, the Rising Market and Asia II

China has taken yet another World’s No.1 title from the U.S. In 2000, China’s exports to the Arab world came to just $6 billion, but last year, China’s exports to the Arab world climbed to $48 billion, which nearly passed America’s $50 billion in exports to same region. Earlier this year, China finally passed the U.S. to become the Arab world’s largest trading partner. This is a historic shift. What we’re seeing here is the New Silk Road in action. Today’s traders are following in the footsteps of their ancestors. The bookends of the new Silk Road are China and the Middle East, especially the Arab world. The Eastern bookend gets all the press, but what many people fail to appreciate about the rise of China is how it also sired the rise of the Arab world.

I believe the New Silk Road gives us a framework for looking at markets and sniffing out opportunities in energy, water, food and more. Arab world has become Sino-centric: Dubai, for example, houses the DragonMart. It is the largest building to sell exclusively Chinese-made goods outside of China. It measures nearly 1.6 million square feet! And China seems to go out of its way to make Arabs feel at home in China, even using state money to build mosques. A side note: the Chinese will issue visas for visiting Egyptians in 24 hours. It takes 18 days for an Egyptian to get one for America.

E) Not All is Well With China

But lest you think all is well and good in the Far East, China announced on July 10^th its exports fell another 21% in June. The year-over-year decline was an improvement from May’s record 26% fall, but still, the pillar of the Chinese economy is as wobbly as ever.

What’s more, a Chinese bond auction failed for the third time this week yesterday. The Chinese Ministry of Finance was only able to dish out $3.7 billion of the $5.1 billion in bonds they aimed to sell. Just like the U.S., Chinese investors are losing their appetite for government debt thanks to massive government spending — in China’s case, a $585 billion stimulus package.

This week marks the first unsuccessful Chinese bond auctions in nearly six years.

Due to recent failures in their ventures, slowly but surely Chinese are starting to concern about their assets: “We sincerely hope the U.S. fiscal deficit will be reduced, year after year,” China’s Assistant Finance Minister Zhu Guangyao said overnight after talks with Treasury Secretary Geithner on July 28^th. He continues, “The Chinese government is a responsible government, and first and foremost our responsibility is the Chinese people, so of course we are concerned about the security of the Chinese assets.” The Chinese now own over $801 billion in U.S. debt, nearly double their holdings at the start of 2007 and by far the world’s largest stash of American paper.

“We are committed,” responded Tim Geithner, “to taking measures to maintaining greater personal saving and to reducing the federal deficit to a sustainable level by 2013.” However, We have no idea what he might mean by that. The CBO still projects a $1.8 trillion budget deficit this year, $1.4 trillion next year, $984 billion in 2011 and $633 billion by the end of 2012. That makes the Bush administration look like penny pinchers, and is certainly not even in the realm of “sustainable.” The U.S. government issued another $42 billion in 2-year notes today, the first of this week’s record $115 billion debt issuance.

The Issues We Need to Think About:

A) Assets in Roller-coaster Ride

“If asset prices accurately reflect all the available information,” writes financial analyst Rob Parenteau, “about future cash flows and the appropriate discount rates on those cash flows, as is required under the efficient market view, then we have to ask ourselves, what has the roller-coaster ride of the past decade and a half been all about? Compare the difference between the ratio of household net worth to disposable income before and after 1995 in the chart below.

“If you lived through this roller-coaster ride as an investor — especially as an investor approaching retirement — the experience is seared into your mind, and it has probably left a few scars on your heart as well. So we have to ask ourselves, what has changed so dramatically in the ability of capital equipment to generate profits or houses to generate rental income to homeowners over the past decade and a half? Alternatively, what has changed so dramatically in the long-run yield on Treasury bonds, considered the default risk-free rate, and therefore a key component of the discount rate on future cash flows?

“The answer, my friend, is indeed blowing in the wind, because the answer is basically as empty as air. What changed was the approach toward a decidedly asymmetric directive (no intentional popping allowed, just mopping up the mess afterward), and the remarkable skewing of the incentive structure facing investment professionals — incentives that basically encouraged the pursuit of asset bubbles regardless of the state of the fundamental factors like reasonable estimates of future cash flows and reasonable discount rates on those cash flows. As evident in the opening chart, there was no Great Moderation in asset markets — only a greater corruption of asset-pricing mechanisms. In retrospect, it is truly remarkable that the financial system held together as long as it did through the last years of Dr. Richenbächer’s illustrious career.”

B) Despite the recession, a raging bull market: Diplomatic Excursions

We’ve found a raging bull market despite the current recession: Congressional travel expenses. Lawmaker spending on overseas diplomatic excursions has nearly tripled since 2001. According to a study from The Wall Street Journal, hundreds of lawmakers (and their spouses and entourages) traveled overseas last year at a record taxpayer cost of $13 million. And that doesn’t include off-budget costs like spending in war zones or borrowing government planes to jet set abroad.

Some of last year’s most diplomatically vital trips include: Five representatives checked out the Galapagos Islands to “learn about global warming.” Six senators attended the Paris Air Show. Eight lawmakers enjoyed a delightful eight-day Italian excursion. And perhaps taking the cake, the House Homeland Security Committee’s jaunt to Brazil, Argentina, Peru and Panama, pertaining to the defense of U.S. borders, we must assume.

While the official numbers are not out yet, the WSJ claims expenses this year appear just as outrageous. There are over 20 government employees whose sole job function is to plan congressional outings.

C) Capital Controls of the US Government

Lawmakers are looking to make it harder for traders to buy and sell the Middle East’s largest export. The Commodity Futures Trading Commission said late July 6^th that it’s mulling limits on position sizes in commodity contracts, namely, for crude oil. No doubt the move is aimed directly at Wall Street, which played a significant role in driving oil to $145 this time last year and back down to $33 in January.

“The CFTC is barking up the wrong tree,” opines Dan Denning, a financial analyst, “if it wants to blame high energy prices entirely on speculators. One factor in oil’s rise is clearly investment demand from traders and institutions that foresee the decline of the U.S. dollar. Another factor subject to much debate is Peak Oil itself (that global oil production is peaking). For now, we’d say this is another sign of increasing government control of the markets. Some people think this is good and long overdue. Some people don’t. Either way, it looks like the world we’re headed to. And it looks to us like a sure sign that the U.S. government wants to have a lot more control of what you do with your money (capital controls). We reckon the oil trading will just move to London.”