I've mentioned recently (including in this Money and Markets piece) that the fallout from Fannie Mae and Freddie Mac is spreading far and wide.  For instance, many banks and financial instiutions hold preferred shares issued by the two Government Sponsored Enterprises. There are a lot of questions about how those preferreds would be treated in any bailout. But what is not in question is that the value of the GSEs' preferred shares has fallen sharply. Today, another institution quantified the impact that's having. From JPMorgan's 8-K filing:

"JPMorgan Chase & Co. disclosed today that it held approximately $1.2 billion par value of Fannie Mae and Freddie Mac perpetual preferred stock. Such securities are held in the Firm's investment portfolio and are marked to market through the Firm's earnings. The Firm estimates that such preferred stocks have declined in value by approximately an aggregate $600 million in the third quarter to date, based on current market values. The precise amount of losses that may be incurred on these securities for the third quarter is difficult to determine, given the significant volatility being experienced in the market values of these securities."

Here is yet another interesting story on the spreading impact of wider spreads -- this time focused on the spread between yields on vehicle-loan Asset Backed Securities over Treasuries. From Bloomberg:

"Wider spreads on auto-loan securities may make it harder for the financing arms of Ford Motor Co., General Motors Corp. and Chrysler LLC to compete with banks for new business.

"Yields over benchmark rates on auto-loan debt from the automakers' lending units has soared to record highs, with the spread on AAA rated bonds maturing in three years climbing 35 basis points last week to 240 basis points more than the swap rate, according to Lehman Brothers Holdings Inc. The swap rate, a borrowing benchmark, is set at 3.7 percent. A basis point is 0.01 percentage point.

"Historically, tight spreads in the ABS market have allowed the auto manufacturers to offer attractive financing to both boost auto sales and compete with bank lending at a relatively low cost,"' Lehman analysts Brian Zola and Sandipan Deb in New York wrote in an Aug. 22 report. "That is no longer the case.

"The higher cost to sell debt in the asset-backed market makes it more expensive for lenders to fund new loans, squeezing auto companies already struggling with slower sales as consumers battered by record gasoline prices abandon the fuel-thirsty trucks that provided most of U.S. companies' profit. U.S. auto sales tumbled 13 percent in July, pushing the industry toward its worst year since 1993.

"Captive auto finance companies, needing to make up for the higher spreads the companies have to pay to raise money, may end up issuing loans to riskier borrowers who would pay higher interest rates, the Lehman analysts wrote."

News of Interest

ECONOMY

U.S. and Global Economies Slipping in Unison

Only a few months ago, some economists still offered hope that robust expansion could continue in much of the world even as the United States slowed. Foreign investment was expected to keep replenishing American banks still bleeding from their disastrous bets on real estate and to provide money for companies looking to expand. Overseas demand for American goods and services was supposed to continue compensating for waning demand in the States. Now, high energy prices, financial systems crippled by fear, and the decline of trading partners have combined to choke growth in many major economies. The International Monetary Fund expects global growth to slow significantly through the end of this year, dipping to 4.1 percent from 5 percent in 2007.

How to stop the next bubble

"The financial crisis has shown that markets are bubble-prone and that laissez-faire regulation doesn’t work. The authorities need to get a grip if we are to avoid a mega-bubble. But we may need an even deeper crisis for that to happen."

BANKS

Columbian Bank and Trust Company, of Topeka, Kansas, is the latest bank to fail. Can things get worse? Heck, yeah! Check out the following chart from Calculated Risk …

From Calculated Risk: even with the failure of almost 3,000 banks and thrifts during the S&L crisis, the overall economy stayed fairly healthy with only a mild-to-moderate recession starting in July 1990.

Libor Signals Credit Seizing Up as Banks Balk at Lending in Money Markets Most of the bond strategists and salesmen that Resolution Investment Management Ltd.'s Stuart Thomson talked to last August expected the credit crunch to be long over by now. Instead, money markets show there's no end in sight, and it may even worsen.

CURRENCIES

Organized Crime Groups Dump Weak US Dollar For Euro

The weakened US dollar has fallen out of favor with organized crime groups to pay for drug shipments or to settle scores, a Canadian government report said Friday.

PAKISTAN -- THE NEXT CRISIS?

Pakistani Government On Brink Of Collapse

Pakistan's ruling coalition was at risk of collapsing Monday if its junior partner carries out a threat to quit unless judges ousted by ex-President Pervez Musharraf are restored immediately.

Taleban winning war (in Pakistan), says Zardari

The Pakistani Taleban have "the upper hand" and should be put on the list of banned organisations in Pakistan, Benazir Bhutto's widower has said.

CHINA

Olympics disappoint China business owners

Many owners of small restaurants, hotels and shops in Beijing are wearing long faces this summer, especially those who poured their life savings into buying businesses or sprucing up their shops ahead of the Games. About half a million foreign visitors were expected in Beijing this month. But many businesspeople think that because of stricter visa rules and other hassles, there are no more here now than there were last August, when 420,000 visitors from abroad came to the capital. In July, Air China, the nation's flagship carrier, saw its international passenger traffic fall by 19% from a year earlier.

China's Economic Gains Give Way to Hazy Future

In the next few years, China will cross the threshold to a majority-urban society. China's urbanization rate is about 40% to 45% now, well below levels of about 75% in most of Western Europe and Latin America, but statistics show that growth in China's urban population is already slowing.

China's 1.3 billion people each consumed the equivalent of 1.4 tons of oil in energy last year, a relatively low figure. If each Chinese was to consume the same amount of energy as each person in the U.S. does -- the equivalent of 7.82 tons of oil -- then China alone would consume nearly as much energy as the entire world does now.

So far, China's government is falling behind in its drive to cut the amount of energy required to produce each yuan of economic output. It managed a reduction of just 2.9% in the first half, less than last year's 3.7%

MINING & RESOURCES

Mining Industry Shifts on Bad News

Weaker commodity prices and higher costs are starting to take a toll on the global mining industry as the billions of dollars being spent on new projects could take years to recoup.

…

Demand for resources by China and other emerging markets still is expected to soar in the years ahead.

Some analysts view the recent mine closures as bullish for commodity prices in the long run, because the moves suggest companies are imposing more financial discipline than in past booms. As miners curb output, it could help prop up prices.

Still, the economics of mining have shifted drastically in recent years. The cost of energy to run mining trucks and other equipment has skyrocketed, while steel and other building materials also are more expensive.

Commodities Hint of Bottom as Mines Close, Crop Supplies at Five-Year Lows Corn and soybeans have rebounded as reduced crop yields push U.S. stockpiles to near five-year lows. Oil has reversed on U.S.-Russian tensions. Nickel has turned after Xstrata Plc closed a Dominican Republic plant.

Corn, Soybeans Jump as Midwest Crop Tour Forecasts Smaller U.S. Harvests Corn and soybeans gained after Professional Farmers of America said harvests in the U.S. will be smaller than forecast by the government as dry weather in August hurt Midwest crops already stunted by flooding in June.

Some interesting news worth mentioning: It looks like the AUTOMAKERS are now joining the list of companies shopping for bailout money in Washington -- perhaps $25 billion in subsidized, low-interest federal loans. From a Reuters story this afternoon:

"The Big 3 Detroit-based automakers are seeking about $25 billion in federal loans as they struggle to ride out a steep downturn in U.S. auto sales, The Wall Street Journal reported on Friday.

"Lobbyists for the U.S. automakers -- General Motors Corp, Ford Motor Co and Chrysler LLC -- briefed White House officials, as well as U.S. Rep. John Dingell and other Michigan Democrats, on a possible bailout and plan to unveil the proposal after Labor Day, according to the report.

"The plan is for the government to lend some $25 billion to the automakers in the first year at an interest rate of 4.5 percent, or about one-third what the companies are currently paying to borrow, the report said.

"Under the proposal, the government would have the option of deferring any payment at all for up to five years, the article said."

A separate Bloomberg story says GM, Ford, and Chrysler want even more - $50 billion -- with 25 up front and 25 in subsequent years.

This is the problem with bailouts. You do it for someone, you have to do it for everyone.

Think back to when the Fed started its whole TAF and TSLF programs. Originally, they were largely designed to support the residential mortgage market. But then the financial industry whined and complained about how commercial mortgage backed securities markets had tightened up. So CMBS were added to the Fed's mix of eligible TSLF securities. Then, the student loan lenders joined in the chorus, asking the Fed to accept asset-backed securities packed with student loans. The Fed obliged.

Of course, the Fed had to follow up with the PDCF once it became clear that non-bank primary dealers might at some point need to tap into the Fed's largesse. And all of these facilities show no sign of being cut off any time soon, a point made clear today when Bernanke said the following:

"Briefly, these programs are intended to mitigate what have been, at times, very severe strains in short-term funding markets and, by providing an additional source of financing, to allow banks and other financial institutions to deleverage in a more orderly manner. We have recently extended our special programs for primary dealers beyond the end of the year, based on our assessment that financial conditions remain unusual and exigent. We will continue to review all of our liquidity facilities to determine if they are having their intended effects or require modification."

Of course, you don't need me to tell you the mother of all bailouts could also be in the works for Fannie Mae and Freddie Mac. This all begs the question: When is enough, enough?

It’s the weekend. You should go see the movie “I.O.U.S.A.” Some very smart people I know at Agora are deeply involved in the making of this movie. Here’s Roger Ebert’s review.

China’s Oil Thirst Hits New High

China's oil demand growth hit a two-year high in July but the pre-Olympic spurt will likely fall off in the autumn, undermined by high prices, global economic woes and the end of official pressure to stockpile for the games.

XX Sean’s note – funny, but I’d think that after the Olympics (or at least, after the Para-lympics), China’s oil demand will ramp up again. We’ll have to see.

China Warns on Winter Energy Supply

China warned on Thursday that its energy supply problems were likely to last into winter as it struggles to ensure stable sources of coal, oil and power, the People's Daily reported, citing a senior official.

Some markets are too illiquid to trade. Here is a cautionary tale about rhodium (with charts).

On the other hand, money is pouring into the SLV (silver ETF).

So much for a surplus of gold. You can’t buy American Gold Eagles now if you want to.

You know how things were going pretty well in Iraq lately because a bunch of Sunnis switched sides and became our friends (because we were paying them)? Well, now, the Shi’ite-led government of Iraq has decided to arrest and/or kill those Sunnis. It makes you wonder whose side the Iraqi government is on, anyway.

Want to know more about Obama’s economic plan? The New York Times breaks it down for you.

And here's some dance music to get your weekend off to a good start.

Happy weekend!

Please enjoy today’s complimentary issue of Currency Currents. If you’re interested in signing up and receiving this newsletter regularly, you can become a member at: http://www.blackswantrading.com/Currency_Currents.html

Key News
• The U.K. economy stagnated unexpectedly in the second quarter, ending the nation's longest stretch of economic growth in more than a century. (Bloomberg)

British pound futures 60-min: News of stagnation not taken well. Ouch!
 

• The Nikkei average sank 0.7 percent to its lowest close in almost five months. (Reuters)
• Investors pulled their money out of Russia in the wake of the Georgia conflict at the fastest rate since the 1998 rouble crisis, new figures showed on Thursday. (FT)

Key Reports Due (WSJ):
There are no economic indicators scheduled for today.

Quotable
“Hatred of the producers of wealth still flourishes and has become, in fact, the racism of the intelligentsia.” 
     George Gilder

FX Trading – That giant sucking sound and the daisy chain of dollar bullishness
I used to work for a man named Ross Perot back in the early 80’s, during my corporate finance life.  You may remember Mr. Perot; he was a colorful character to say the least.  But as odd as he was at times, I do admire the man as he built himself from nothing, worked hard, and cared deeply about his country.   He went on to national fame by creating his own political party and running for President.  He also gained fame for the phrase, “That giant sucking sound you hear is jobs leaving the US and heading to Mexico,” which is how he described the impact of the NAFTA Treaty.  Of course, he was right.  And the sound got even louder thanks to our jobs for corporate profits exchange with China.  In the financial markets today, we hear a different kind of sucking sound, but it’s growing louder by the day; it’s the sound of global capital draining from the global economy.

A friend forwarded the latest PIMCO piece penned by Paul McCulley and Saumil Parikh titled, The Narrowing Ecologies of Global Growth.  In the piece they presented a chart that I think tells the story:

 
                        Source: PIMCO

I have referred to this as the Big Four major economies heading south at the same time.  Others have termed it the global economic race to the bottom.  But needless to say, I think it has one important implication longer term, even if we can pull off a very difficult dollar correction near-term—this draining of global capital is US dollar bullish.

It is the center to the periphery back to the center money flow:

The developed world still provides the capital for the rest of the world.  Think of it as the center to the periphery i.e. credit created in the most efficient and deepest capital markets is used to fund investment (risky and otherwise) to markets outward on the periphery that don’t have their own domestic capital markets ready and available to do the job.  Therefore, when money starts to move out of the periphery (that which is still left possibly after systemic shock) and back to the center as it is now during this global delivering period, the dominant receiver of this flow back to the center is the US capital market.  Thus, receding global credit is dollar bullish.  The supply of the world’s money, the US dollar, is falling.  That is a big net positive for the buck.

Now of course the other implication is the impact of the Big Four’s declining demand as it impacts the demand for commodities.  Logically (a word that can always get us into trouble in a world that can be dominated by illogical players for long periods of time), one would think there is little chance of current prices for energy and industrial metals (and gold) to be sustained.  And if these commodities were hiding places for money fearing a dollar meltdown, that would be another net positive for the dollar.

And sticking to the commodities, oil in particular, we are gaining more confidence in our theory/guess that maybe the fall in crude means a rapid closing of the “Oil – Dollar Carry Trade.”  (We explained the “Oil – Dollar Carry Trade” in detail in a Currency Currents about a month or so ago, if you would like a copy of that please let us know.)  Closing of dollar borrowing by countries to buy high priced oil is yet another net positive for the dollar.

And of course, last but not least, interest rates. 

If global demand is tanking.  If global credit is receding.  If commodities prices fall.  Then we are confused how this great inflationary environment is going to overwhelm us. 

We believe there is far greater danger from global deflation in a world of continuous debt repudiation.   The central banks can pump all they want, but if the financial institutions are using the money to save themselves and consumers are shoring up their own balance sheets and business see fewer decent capital investment prospects, then this money is not stimulative. 

In this world, we expect central banks to aggressively cut interest rates—most all of the major economy banks that is.  They will be playing catch-up with the US Fed.  And of course, this means the seemingly very negative US dollar yield differential gap could close quite quickly.  And you guessed it; an improving dollar yield differential is a powerful net positive for the dollar.

And of course last but not least is the impact on credit from the world’s largest depository of collateral for loans—the stock market.  Falling stocks speed the process of credit draining from the economy, and it has broader psychological impact to boot.  Institutions and individuals lose a key source of wealth and major source of collateral value to support existing loans.  Financial institutions already in “save thy self mode” are calling loans more quickly; falling stocks will reinforce this trend.  

Looking at a chart of the Dow Jones World Stock Index Weekly we’d guess a major top is in place and we are clearly entering a major bear market.

In short, any cratering of stocks will speed this daisy chain of global macro interlinked events that in the minds of many will turn out to be perversely dollar positive. 

We are already hearing howls from those that say it isn’t fair.  It isn’t fair the US dollar could benefit by being the cause of much of the problems now in the global economy.  But the same crowd never thought of fair as the world’s money was funding risky asset investments and blowing bubbles of dubious wealth in its wake around the globe. 

 
The chart above is that of the famous US Current Account Deficit.  Though there is no, I repeat, no correlation between the dollar and the US Current Account Deficit, for reasons we have not the time to cover this morning, there has been an interesting correlation between stock market crashing and improvements in this series.

And of course, those dark grey vertical bars which represent official recessions also seem correlated to improvements in the US Current Account.  Why?  It’s because the dollar IS the world’s money.  And when the world’s money packs up and goes home, the world loses its major source of credit.  And when credit goes away in our global financial system, bad things happen.

So, if your 401-k melts down to worthless territory, just remember all those financial commentators who told you the US must get its current account under control—it’s causing all the problems. 

Well ladies and gentlemen we think we just may be in the midst of what the economists wanted—global rebalancing.  US exports grew faster than did China over the last 12 months.  The US Current Account is improving.  The US consumer is buying less and saving more.  Commodities prices are about to breakdown in a big way.  And inflation will be squeezed out of the developed world economies no matter what the central banks decide to do. 

Maybe rebalancing is what is needed to cleanse a global financial system chock full of malinvestment.  But we think it will be a very painful process. But we also think it will usher in a major long-term bull market in the US dollar.

Have a great weekend.

Jack & JR

For the past several months, this is what you've heard from the financial industry about the scope of the credit crisis:

"It's just subprime mortgages."

Then ...

"No, it's just Alt-A and subprime."

Then ...

"Okay, you're right. Prime doesn't look so hot anymore either. But clearly, it's just residential mortgages.

Then ...

"Those auto loans? Alright. You caught me there too. But that's it. I swear."

But time and again, I have made the point that this credit crunch was never the result of just reckless subprime residential mortgage originations. It's the result of stupid LBO lending ... stupid commercial mortgage lending ... high-risk Alt-A and prime mortgage lending ... risky auto lending ... and so on. While the residential mortgage lenders were the worst offenders, banks and nonbank lenders went overboard extending other forms of credit. Now they're paying the price.

In fact, it's no surprise whatsoever that I'm now reading stories like this one from Bloomberg. It talks about how spreads on commercial mortgage backed securities, or CMBS, are blowing out due to deterioration in the underlying commercial real estate market. An excerpt (with a key quote highlighted by me):

"Yields on commercial real estate securities relative to benchmarks rose to near record highs on concern that Riverton Apartments, a high-rise complex in Manhattan's Harlem neighborhood, will default on a loan.

"AAA rated commercial mortgage-backed bonds widened about 37 basis points to 305.57 basis points more than 10-year swap rates during the week ended yesterday according to data from Bank of America Corp. A basis point is 0.01 percentage point.

"The gap, or spread, jumped after a trustee report showed payments wouldn't be made by Rockpoint Group LLC and Stellar Management in September on a $225 million loan on the 1,230-unit Riverton. The property was refinanced in December 2006 using optimistic assumptions for anticipated income, a practice that became common as prices reached their peak, said Alan Todd, head of commercial-mortgage backed securities research at JPMorgan Chase & Co.

"It is indicative of the type of loans that were allowed to get securitized during this time,'' Todd, who is based in New York, said yesterday in a telephone interview."

Food prices to post biggest rise since 1990: USDA

WASHINGTON (Reuters) - U.S. consumers should brace for the biggest increase in food prices in nearly 20 years in 2008 and even more pain next year due to surging meat and produce prices, the Agriculture Department said on Wednesday.

Food prices are forecast to rise by 5 percent to 6 percent this year, making it the largest annual increase since 1990. Just last month, USDA forecast food prices would climb between 4.5 and 5.5 percent in 2008.

"It's a little bit of a surprise how strong some of the numbers were in July," USDA economist Ephraim Leibtag, who prepared the forecast, said in an interview.

"We've been waiting for some moderation, but especially with some of the meat prices and how much has come through relatively recently (at the retail level) leads me to believe the overall number may be a little bit higher for the year," he added.

Leibtag said he expected food prices to moderate, but the timing depends on what happens to volatile energy and food ingredient costs.

Prices are expected to rise by 4 percent to 5 percent in 2009, lead by red meat and poultry. The forecast, if correct, would be the third straight year where food prices have surged at least 4 percent.

In its latest food prices report, USDA said the increase for 2008 was due partly to higher costs for meat, poultry and fish, which make up about 12 percent of total food spending. Overall, costs for these items are forecast to rise 3 percent compared to 2.5 percent estimated last month.

Prices for fruits and vegetables, which account for more than 8 percent of food spending, will also rise 5.5 percent versus 5 percent predicted in July.

USDA also forecast increases this year of 9.5 percent for cereals and bakery products, a 14 percent surge for eggs and a 13.5 percent hike for fats and oils. 

A  broad range of commodities posted record highs this year, including corn and soybeans. Prices have since backed off as concerns over smaller crops due to a wet spring in the U.S. Midwest have largely dissipated.

In its first estimate of the fall harvest, USDA last week forecast a corn crop of 12.29 billion bushels, the second largest on record.

Despite the near-record crops, farm-gate prices for this year's corn, wheat and soybean crops, while lower than earlier forecasts, will still set records.

Geopolitical events are driving oil prices. Russia blocked the entrance to Georgia’s main oil port, and Russia is showing that it can control Europe’s natural gas supply. The neocons in Washington seem to be hoping for a new cold war with Russia, and they just might get it. Unfortunately, fear of such a cold war add to the price of oil.

Supply and demand is also in play.

Drawdown of gasoline stockpiles in US was more than twice expectations -- 6.3 million barrels. Demand destruction may have been short-term. Since prices have pulled back, people may be driving again.

Chinese demand dipped during the Olympics as they shut down factories and took cars off the road. It will probably increase again after the Olympics.

On the supply side, Mexico, Nigeria, Norway, Britain and Russia are all seeing production go down year over year. Nigeria’s shortfall is due to civil war, everyone else may be hitting production peaks.

[End notes]

In other developments, I am so glad I sent out an issue yesterday to Red-Hot Commodity ETFs subscribers telling them to buy the DGP (double-gold ETF) and DIG (Double oil index ETF). Oil is up more than $4 this morning before the open and gold is up $20 an ounce as I write this.

Does this mean we're out of the woods on commodities? Not by a long shot! However, this is a playable bounce. What will determine how high the bounce will go? Probably action in the US dollar. Let's look at a weekly chart of the dollar ...

And now let's close up on that next support on a daily chart.

That test of support for the greenback will be very interesting.

In other news ...

The Neo-Cons are getting the war they always wanted -- a renewed cold war with Russia. This has sent oil prices soaring this morning which, again, is exactly what the powers that be in Washington (I'm looking at you, ExxonMobil) have wanted, despite their "drill-drill-drill" mantra.

This ugly turn of geopolitical events prompted former Soviet Union President Mikhail Gorbachev to write the following op-ed in the New York Times ...

In recent days, Secretary of State Condoleezza Rice and President Bush have been promising to isolate Russia. Some American politicians have threatened to expel it from the Group of 8 industrialized nations, to abolish the NATO-Russia Council and to keep Russia out of the World Trade Organization.

These are empty threats. For some time now, Russians have been wondering: If our opinion counts for nothing in those institutions, do we really need them? Just to sit at the nicely set dinner table and listen to lectures?

Read Gorbachev's whole piece.  He doesn't have a monopoly on the truth.  But we have to know where the Russians are coming from if we want to reach a compromise everyone can live with.

Honda Motor Co. and Komatsu Ltd. are turning to China, the world's fastest-growing major economy, as the U.S. slowdown intensifies and rising fuel and food costs weaken demand at home. Higher oil prices caused the import bill to climb to a record last month, triggering an 87 percent drop in the trade surplus.

Looks like my forecast is still right on the money -- producer prices the highest in 27 years. Once that feeds through to the consumer, the conservative, manipulated CPI will have no choice but to bust through to record highs as well. -- Larry

Producer Price Index Jumps 1.2%; Housing Starts Reverse June Rise

Washington (Wall Street Journal) -- U.S. producer prices unexpectedly soared at their highest annual rate in 27 years last month as rising wholesale prices for energy spread to a variety of products including automobiles, prescription drugs and capital equipment.

Relief is likely on the way as energy and commodity prices have retreated this month while the U.S. dollar has firmed.
Still, it will be difficult for Federal Reserve officials to look past this latest report, which comes on the heels of a 17-year-high rise in consumer prices.

Unless prices at both the wholesale and consumer level soften quickly in response to the drop in energy prices, Wall Street may have to rethink its view that the Fed will hold official interest rates at their current low levels into 2009.